UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number 811-02631
Chestnut Street Exchange Fund
---------------------------------------------------------
(Exact name of registrant as specified in charter)
400 Bellevue Parkway
Wilmington, DE 19809
------------------------------------------------
(Address of principal executive offices) (Zip code)
Edward J. Roach
400 Bellevue Parkway
Wilmington, DE 19809
----------------------------------------------
(Name and address of agent for service)
Registrant's telephone number, including area code: 302-792-2555
Date of fiscal year end: December 31, 2004
Date of reporting period: June 30, 2004
Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 450 Fifth Street, NW,
Washington, DC 20549-0609. The OMB has reviewed this collection of information
under the clearance requirements of 44 U.S.C. Section 3507.
ITEM 1. REPORTS TO STOCKHOLDERS.
The Report to Shareholders is attached herewith.
CHESTNUT STREET EXCHANGE FUND
(A CALIFORNIA LIMITED PARTNERSHIP)
ROBERT R. FORTUNE
Chairman
July 26, 2004
Fellow Partner:
Our Fund earned $2.48 per share of net investment income in the six months
ended June 30, 2004. Earnings in the same period of 2003 were $2.13 per share.
Dividend increases continue as the leading factor in the increased investment
income.
After providing for the $1.05 per share distribution to partners of record
on June 29, 2004, the net asset value per partnership share at June 30, 2004 was
$328.48. The net asset value at March 31, 2004, our last report date, was
$316.37.
During the second quarter of 2004, our Fund received additional proceeds of
$56,388 from settlement of a suit against Cendant Corporation. In mid-2003 the
sum of $624,855 was received from that settlement. A distribution of 24,392
shares of Hospira, Inc. was made by Abbott Laboratories, Inc. in May 2004.
Commentary on market conditions and a comparison of our Fund's performance
to the Standard & Poor's 500 Index and the Dow Jones Industrial Average will be
found in the accompanying Investment Adviser's Report.
Your comments or questions concerning Chestnut Street Exchange Fund are
welcomed.
Yours sincerely,
/s/ Robert R. Fortune
Robert R. Fortune
INVESTMENT ADVISER'S REPORT
SECOND QUARTER 2004
MARKET REVIEW
Equity markets were generally strong in June as investor fears about higher
inflation and increasing interest rates subsided somewhat. While there were
still plenty of negatives to mute market returns throughout the month, including
increased terrorist activity, strong campaign rhetoric, a slowdown in China's
economic growth and generally high energy prices, investors keyed on the
month-end Fed meeting and worried about the prospects for a surprise 0.50%
increase in the Fed Funds. But at mid-month, this fear was relieved when the CPI
was released showing a 1.7% year over year core rate of inflation, which
investors took as a sign that the Fed would be able to stick to its well
publicized plan to raise rates in a measured fashion. For the month, the S&P 500
Index rose 1.94%, the Dow Jones Industrial Average rose 2.58% and the NASDAQ
Index rose 3.07%. Smaller companies outperformed once again, with the Russell
2000 Index of small company stocks rising 4.21% in June.
For the quarter, U.S. equity markets were more mixed. Generally strong
earnings results released during the quarter battled with fears over rising
inflation and interest rates, which resulted in price volatility for most equity
indexes. The S&P 500 Index finished up 1.71% for the quarter after being down
more than 3% at the trough in mid-May. Small stocks ended the quarter up 0.47%
after being down more than 9% mid-quarter. The Dow and NASDAQ finished the
quarter up 1.26%, and 2.69% respectively. In our view, the market behavior
during the second quarter may well typify that of the next several quarters as
we expect the markets to be range-bound with investors attempting to balance a
generally healthy economy and corporate earnings with steadily rising interest
rates. In addition, valuation support is a concern as equity markets have surged
globally with the NASDAQ up nearly 60%, the Russell 2000 up approximately 70%
and the S&P 500 Index up approximately 42% off their lows of last March.
Declining investor confidence and a moderation in GDP growth expectations
resulting from tepid labor market statistics caused a sell-off in more
economically sensitive groups and caused a move into more defensive stocks in
the first quarter. This trend largely reversed itself in the second quarter.
Industrial stocks were the best performers, rising 8% during the quarter,
followed closely by the energy group, which gained 7%. While the industrial
sector was buoyed by a diverse group of stocks that rallied strongly for
different reasons, the energy sector was generally strong due to higher oil
prices. Information technology, health care and materials, rose 2.8%, 2.3% and
2.0%, respectively, during the quarter while financials and utilities
underperformed on fears over rising interest rates. In the financial group,
rising rates and a flattening yield curve are expected to hurt profitability for
the banks. Mortgage lenders are also expected to see a quick end to the
refinancing boom and as well as deteriorating balance sheets as portfolios
decline in value along with rising rates. The prospects of rising rates also
buffeted the utility sector, as these yield-oriented stocks will face greater
competition from fixed income investments, going forward.
Style returns were bifurcated during the quarter as growth stocks
outperformed in the large cap markets but value outperformed in the mid and
small cap markets. The Russell 1000 Growth Index (large caps) posted a 1.94%
return in the quarter compared to a gain of 0.88% for the Russell 1000 Value
Index. The Russell Midcap Growth Index rose 1.06% in the quarter while the
Russell Midcap Value Index gained 1.73%. In the small cap universe, the Russell
2000 Growth Index returned 0.10% for the quarter while the Russell 2000 Value
Index gained 0.85%. Small cap stocks outperformed larger
2
caps consistently from the beginning of the rally in 2003 until interest rate
fears took over at the beginning of 2004. Since that time, returns have been
similar but the small caps have shown much more volatility. As a result of the
small cap rally, valuation levels of the two asset classes are near parity.
Smaller stocks are generally perceived to have higher betas with respect to
broader equity market movements and, as the risk appetite of investors around
the globe expanded in response to the global economic recovery, these stocks
benefited from strong flows. At this point, however, we believe that the trend
of small cap outperformance is near an end and that larger companies will begin
to lead the markets in the near future.
For the first quarter, profits for the S&P advanced 26% over the first
quarter of 2003, according to Thomson Financial. Based on the strength of the
first quarter and the expected robust health of the economy in the second,
earnings expectations for the second quarter have risen from an increase of 18%
to 22% year over year. It is almost certain that earnings growth rates for the
second half of the year will slow significantly as companies encounter tougher
year over year comparisons. That being said, we still expect positive growth and
believe many companies may hit record profit levels. Currently, Thomson
Financial's First Call is estimating growth of 14% year over year in each of the
next two quarters. We believe the market will price in this slowdown and as a
result do not expect a significant sell-off.
ECONOMY
Economic figures released during the second quarter continued to indicate
that the U.S. economy is growing at a healthy annual rate of approximately 4%.
Core inflation has been increasing, but at this point remains under control.
Overall inflation data is more troublesome due to the increase in energy prices.
The latest Consumer Price Index indicated an increase of 3.1% year over year
while the core CPI, which does not include food or energy prices, increased only
1.7%. The Producer Price Index rose 5.0% -- clearly a concern for inflation
hawks -- but the core PPI rose only 1.7%, again indicating that, excluding the
volatile food and energy components, inflationary pressure is modest. On June
30th, the Fed made its long awaited announcement of a .25% increase in the Fed
Funds rate to 1.25%. Fed comments included in the announcement indicated that,
although there is not an immediate need to move more aggressively to curb
inflationary pressure, the Fed stands ready to do so should the need arise.
Strong employment reports throughout the quarter led to fear in the bond
market that the Fed would move more aggressively in the near term. But the Fed's
announcement of only a quarter point increase, combined with tame core inflation
data, weak durable goods order growth of -1.6% (versus expectations of +1.5%)
and much lower than expected job growth at the end of the quarter resulted in a
rally in the bond market with the 10 year Treasury yield falling from 4.87% at
its peak to 4.56% at quarter end. We believe the Fed has been accommodative for
more than enough time and that they need to raise rates to a more neutral level
in the 3.0% to 4.0% range. Therefore, our central thesis is that interest rates
will continue to rise and the yield curve will flatten. In the short run, there
may be a pause in this trend but we expect rates to begin to move up again
fairly soon.
OUTLOOK
Earnings growth for the S&P 500 has been very strong and earnings revisions
have been moving up. However, we believe there will be a profit growth slowdown
in the back half of the year, as year over year comparisons become more
challenging. Additionally, we believe equity valuations in the
3
U.S. are fairly full. In our view, the combination of these factors is likely to
keep U.S. equities range-bound, offering scant returns for 2004 as valuations
compress in response to rising interest rates.
We continue to believe that large caps should outperform as valuations
between large and small cap stocks have converged and the preference for
speculative high-beta stocks appears to have waned. Additionally, across market
cap ranges we believe that leadership is more likely to be defined by individual
stock specific issues than by broad trends.
PORTFOLIO REVIEW
During the second quarter, Chestnut Street Exchange Fund returned 4.16%,
outperforming the S&P 500 Index, which gained 1.71%. The strong performance in
the quarter helped the portfolio gain back some ground lost to the S&P 500
earlier in the year. As of quarter end, the Fund lagged the S&P 500 on a year to
date basis with a return of 0.99% compared to a return of 3.44% for the Index.
In recent reports, we have addressed the negative impact the small cap and mid
cap rally has had on the relative performance of the Fund as it is invested
almost entirely in very large cap companies. We have been of the opinion that
the trend of large cap underperformance would be coming to an end as the
valuation advantage of smaller cap stocks has recently diminished. This came to
fruition in the second quarter as large cap stocks outperformed small caps with
the S&P's 1.71% return beating the 0.47% return of the Russell 2000 Index.
Industry weightings largely offset one another for the quarter as positive
contributions from the relative positions in department stores, medical products
and asset managers were offset by the negative impact of an overweight in
semiconductors. The Fund does not have any positions in department stores or
asset managers, which were poor performers during the quarter, and the
overweight in medical products added to relative returns due to the strong
industry showing for the quarter. On the other hand, semiconductors
significantly underperformed the market for the quarter, losing approximately 2%
in a rising market.
Stock selection was the primary source of the outperformance for the
quarter with Johnson & Johnson, Merck and 3M contributing the most to
performance. J&J rose nearly 10% for the quarter on the strength of a positive
earnings announcement in which the company stated that earnings rose 20% over
the same period last year. The company also gave an upbeat forecast based on
additional earnings upside through the remainder of the year as a result of
their highly successful cost reduction program. Despite the current relative
strength at J&J, the future looks to be more difficult. We continue to view the
company favorably over the long term based on new drug development, a
diversified product line and strong management, but the market will have to come
to grips with a slowing growth rate going out past 2005 due to increased generic
competition. Given the current high valuation, we would not be surprised to see
the stock confined to a tight trading range in the short term. Although we are
not very optimistic on Merck, the stock traded back toward the high end of its
recent range during the quarter and ended up approximately 7%, largely in
sympathy with other stocks in the group. Merck continues to face revenue and
earnings pressure from patent expirations on important products. Sales and
earnings are expected to grow only 4% to 5% over the next several years as the
company struggles to develop and launch new products. 3M Company returned nearly
10% for the quarter with no meaningful news flow. Additionally, two smaller
holdings in the portfolio, Safeway and Albertson's, each gained approximately
20% for the quarter and together added considerably to performance. Both stocks
rallied following the settlement of the labor dispute in Southern California
that had significantly impacted operations in the West. These stocks remain very
attractively valued and we anticipate strong performance as they continue to
recover.
4
On the negative side, Cabot Microelectronics fell 27% during the quarter
and had the most negative impact on returns. Cabot is highly dependent on the
semiconductor industry where it is seeing increasing pricing pressure for many
of its products. The stock now trades at a relatively low P/E multiple within
its group and we expect the stock to recover from current levels. J.P. Morgan
fell 7.8% during the quarter, which also hurt performance. Fears over rising
interest rates and the likelihood of a flattening yield curve hurt many of the
banks and financial services stocks. Rising rates may damage balance sheets due
to their impact on bond portfolios and a flattening yield curve will crimp
profitability as the spread between the rate at which banks lend and fund loans
will tighten.
Transaction activity within the Fund during the quarter was modest.
Generally, we took advantage of price strength in a limited number of holdings
to meet redemption requests. A small number of shares of J&J were delivered in
addition to more significant reductions in holdings in Merck and Motorola.
Motorola's stock was reduced following a surge in price from approximately $8.00
in early 2003 to over $20.00 during the recent quarter. Valuation levels for the
stock reached 68 times trailing earnings, making the stock a good candidate for
reduction.
PERFORMANCE SUMMARY
<Table>
<Caption>
CHESTNUT STREET S&P 500 DJIA
AS OF JUNE 30, 2004 EXCHANGE FUND INDEX INDEX
- ------------------- --------------- -------- --------
2nd Quarter, 2004.............................. 4.16% 1.71% 1.26%
1 Year......................................... 15.41% 19.10% 18.59%
3 Years*....................................... 0.72% -0.69% 1.92%
5 Years*....................................... -1.17% -2.17% 0.92%
10 Years*...................................... 10.70% 11.87% 13.43%
Inception (12/29/76)
Annualized*.................................. 12.84% 12.61% 12.86%
Cumulative................................... 2,701.29% 2,517.23% 2,683.71%
</Table>
The performance data represent past performance and should not be
considered indicative of future performance which will fluctuate with changes in
market conditions. These performance fluctuations will cause an investor's
shares, when redeemed, to be worth more or less than their original cost.
In addition, the data does not reflect the deduction of taxes that a
shareholder would pay on distributions or redemption of Fund shares.
BLACKROCK INSTITUTIONAL MANAGEMENT CORPORATION
5
CHESTNUT STREET EXCHANGE FUND
(A CALIFORNIA LIMITED PARTNERSHIP)
STATEMENT OF NET ASSETS
JUNE 30, 2004
(UNAUDITED)
<Table>
<Caption>
SHARES VALUE
- ---------- ------------
COMMON STOCKS--98.4 %
BASICS--3.7 %
106,123 Air Products & Chemicals,
Inc. ....................... $ 5,566,151
90,747 Cabot Corporation ............ 3,693,403
52,855 *Cabot Microelectronics
Corp. ...................... 1,617,892
------------
10,877,446
------------
CAPITAL EQUIPMENT--6.8 %
95,519 Emerson Electric
Company .................... 6,070,232
384,000 General Electric Co. ......... 12,441,600
41,300 Pitney Bowes, Inc. ........... 1,827,525
------------
20,339,357
------------
CONSUMER CYCLICALS--6.8 %
105,300 *Comcast Corp. Class A ....... 2,951,559
136,206 Disney (Walt) Company ........ 3,471,891
152,000 3M Co. ....................... 13,681,520
------------
20,104,970
------------
ENERGY--4.4 %
44,280 BP plc ADR ................... 2,372,080
155,296 Exxon Mobil Corp. ............ 6,896,695
60,432 Schlumberger, Ltd. ........... 3,838,036
------------
13,106,811
------------
FINANCIAL--22.6 %
117,433 American Express Co. ......... 6,033,708
30,000 American International Group,
Inc. ....................... 2,138,400
208,286 Bank of America Corp. ........ 17,625,161
70,000 Fannie Mae ................... 4,995,200
116,352 Marsh & McLennan Companies,
Inc. ....................... 5,280,054
50,647 Moody's Corporation .......... 3,274,835
148,000 J.P. Morgan Chase & Co. ...... 5,737,960
97,200 Wachovia Corporation ......... 4,325,400
314,532 Wells Fargo & Co. ............ 18,000,666
------------
67,411,384
------------
</Table>
<Table>
<Caption>
SHARES VALUE
- ---------- ------------
HEALTHCARE--25.8 %
243,928 Abbott Laboratories, Inc. .... $ 9,942,505
68,547 Baxter International, Inc. ... 2,365,557
24,392 Hospira, Inc. ................ 673,219
79,516 IMS Health, Inc. ............. 1,863,855
750,069 Johnson & Johnson, Inc. ...... 41,778,843
48,448 *Medco Health
Solutions, Inc. ............ 1,816,800
387,154 Merck & Company, Inc. ........ 18,389,815
------------
76,830,594
------------
RETAIL--0.9 %
57,133 Albertson's, Inc. ............ 1,516,310
47,000 *Safeway, Inc. ............... 1,190,980
------------
2,707,290
------------
STAPLES--4.3 %
234,213 Coca Cola (The)
Company..................... 11,823,072
48,000 Sara Lee Corp. ............... 1,103,520
------------
12,926,592
------------
TECHNOLOGY--19.0 %
61,097 Hewlett-Packard Company ...... 1,289,147
41,884 International Business
Machines Corporation ....... 3,692,075
1,529,352 Intel Corp. .................. 42,210,115
110,800 Microsoft Corp. .............. 3,164,448
292,895 Motorola, Incorporated ....... 5,345,334
78,000 *Oracle Corp. ................ 930,540
------------
56,631,659
------------
TRANSPORTATION--2.2 %
119,796 Burlington Northern Santa Fe
Corp. ...................... 4,201,246
40,000 Union Pacific Corp. .......... 2,378,000
------------
6,579,246
------------
UTILITIES--0.0 %
151,713 Verizon
Communications, Inc. ....... 5,490,494
------------
Total Common Stocks
(Cost: $37,860,513)......... 293,005,843
------------
<Caption>
PAR
- ----------
SHORT-TERM OBLIGATIONS--1.8 %
$5,300,000 Federal Home Loan Mortgage
Corp. 07/01/04, 1.20%
(Cost: $5,300,000).......... 5,300,000
------------
</Table>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
6
STATEMENT OF NET ASSETS (CONCLUDED)
<Table>
<Caption>
VALUE
------------
TOTAL INVESTMENT IN SECURITIES
(Cost: $43,160,513)............ 100.2% $298,305,843
Assets in excess of other
liabilities.................... 0.1% 436,622
Distributions payable............ (0.3)% (951,627)
Payable to:
Investment Advisors (Note C)... (0.0)% (81,480)
Managing general partners (Note
C)........................... (0.0)% (3,974)
Custodian (Note C)............. (0.0)% (4,626)
Transfer Agent (Note C)........ (0.0)% (2,878)
----- ------------
NET ASSETS (Applicable to 906,296
partnership shares
outstanding)................... 100.0% $297,697,880
===== ============
NET ASSET VALUE PER SHARE........ $ 328.48
============
NET ASSETS APPLICABLE TO SHARES
OWNED BY:
Limited partners
(901,484 shares)............... $296,117,246
Managing general partners
(4,812 shares)................. 1,580,634
------------
Total net assets
(906,296 shares)............... $297,697,880
============
</Table>
* Non-Income Producing
ADR--American Depositary Receipt
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
7
CHESTNUT STREET EXCHANGE FUND
(A CALIFORNIA LIMITED PARTNERSHIP)
STATEMENT OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2004
(UNAUDITED)
<Table>
INVESTMENT INCOME
Dividends (Net of foreign taxes withheld of $1,993)..................... $ 2,844,328
Interest................................................................ 24,910
-----------
Total investment income.............................................. 2,869,238
-----------
EXPENSES
Investment advisory fee................................................. 490,768
Managing general partners' compensation and officer's salary............ 42,285
Legal................................................................... 37,588
Audit................................................................... 8,977
Custodian............................................................... 12,712
Printing................................................................ 9,303
Transfer agent.......................................................... 8,011
Insurance............................................................... 1,765
Miscellaneous........................................................... 2,728
-----------
Total expenses....................................................... 614,137
-----------
NET INVESTMENT INCOME.............................................. 2,255,101
-----------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Realized gain on sale of investment securities (for federal tax purposes
net gain of $56,388)................................................. 56,388
Realized gain from security transactions: distributed upon redemption of
partnership shares................................................... 2,909,315
Unrealized appreciation of investments:
Beginning of period.................................... $257,484,371
End of period.......................................... 255,145,330
------------
Net change in unrealized appreciation.............................. (2,339,041)
-----------
Net realized and unrealized gain on investments.................... 626,662
-----------
Net increase in net assets resulting from operations................. $ 2,881,763
===========
</Table>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
8
CHESTNUT STREET EXCHANGE FUND
STATEMENTS OF CHANGES IN NET ASSETS
<Table>
<Caption>
SIX MONTHS ENDED YEAR ENDED
JUNE 30, 2004 DECEMBER 31,
(UNAUDITED) 2003
---------------- ------------
INCREASE (DECREASE) IN NET ASSETS
Operations:
Net investment income.................................. $ 2,255,101 $ 4,341,303
Net realized gain/(loss) from security transactions
(for federal income tax purposes net gain/(loss) is
$56,388 and $3,705,400).............................. 56,388 (3,705,400)
Excess of market value over book value of securities
distributed upon redemption of partnership shares.... 2,909,315 25,691,943
Increase/(decrease) in unrealized appreciation of
investments.......................................... (2,339,041) 38,197,777
------------ ------------
Increase in net assets resulting from operations....... 2,881,763 64,525,623
------------ ------------
DISTRIBUTIONS TO PARTNERS FROM:
Net investment income..................................... (1,908,318) (4,330,721)
------------ ------------
CAPITAL SHARE TRANSACTIONS:
Net asset value of 746 and 1,390 shares issued in lieu of
cash distributions..................................... 241,068 391,979
Cost of 9,507 and 100,338 shares repurchased.............. (3,100,113) (28,990,104)
------------ ------------
Decrease in net assets from capital share transactions of
8,761 and 98,948....................................... (2,859,045) (28,598,125)
------------ ------------
Total increase/(decrease) in net assets................... (1,885,600) 31,596,777
NET ASSETS:
Beginning of period....................................... 299,583,480 267,986,703
------------ ------------
End of period*............................................ $297,697,880 $299,583,480
============ ============
</Table>
- ---------------
* Includes undistributed net investment income of $358,383 and $11,600
respectively.
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
9
CHESTNUT STREET EXCHANGE FUND
FINANCIAL HIGHLIGHTS
(FOR A SHARE OF THE FUND OUTSTANDING THROUGHOUT EACH PERIOD)
<Table>
<Caption>
SIX MONTHS
ENDED YEARS ENDED DECEMBER 31,
JUNE 30, 2004 ----------------------------------------------------
(UNAUDITED) 2003 2002 2001 2000 1999
------------- -------- -------- -------- -------- --------
Net Asset Value, Beginning of
Period..................... $ 327.39 $ 264.29 $ 340.39 $ 362.68 $ 369.83 $ 347.51
-------- -------- -------- -------- -------- --------
Income From Investment
Operations:
Net investment income...... 2.48 4.61 3.99 3.79 3.76 3.64
Net gain (loss) on
securities (both
realized and
unrealized)............. 0.71 63.09 (76.09) (22.30) (7.15) 22.39
-------- -------- -------- -------- -------- --------
Total from investment
operations............ 3.19 67.70 (72.10) (18.51) (3.39) 26.03
-------- -------- -------- -------- -------- --------
Less Distributions:
From net investment
income.................. (2.10) (4.60) (4.00) (3.78) (3.76) (3.65)
From realized gains........ -- -- -- -- -- (0.06)
-------- -------- -------- -------- -------- --------
Total distributions..... (2.10) (4.60) (4.00) (3.78) (3.76) (3.71)
-------- -------- -------- -------- -------- --------
Net Asset Value, End of
Period..................... $ 328.48 $ 327.39 $ 264.29 $ 340.39 $ 362.68 $ 369.83
======== ======== ======== ======== ======== ========
Total Return................. 0.99% 25.78% (21.25)% (5.05)% (0.92)% 7.52%
Ratios/Supplemental Data:
Net Assets, End of Period
(000's)................. $297,698 $299,583 $267,987 $360,055 $398,580 $422,604
Ratios to average net
assets:
Operating expenses...... 0.42% 0.43% 0.41% 0.39% 0.38% 0.38%
Net investment income... 1.53% 1.57% 1.31% 1.12% 0.96% 1.00%
Portfolio Turnover Rate.... 0.00% 1.18% 0.98% 0.00% 1.77% 2.48%
</Table>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
10
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
(A) ORGANIZATION
Chestnut Street Exchange Fund (the "Fund"), a California Limited
Partnership, is registered under the Investment Company Act of 1940, as
amended, as a diversified open-end management company. The Fund's investment
objective is to seek long-term growth of capital and, secondarily, current
income. Effective January 1, 1998, the Fund changed its status for tax
purposes from a partnership to a regulated investment company. The change
resulted from the enactment of the "Publicly Traded Partnership" rules to
the Internal Revenue Code in 1987, which first applied to the Fund after
1997.
(B) SIGNIFICANT ACCOUNTING PRINCIPLES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates. The following is a
summary of significant accounting policies followed by the Fund in the
preparation of its financial statements.
SECURITY VALUATIONS
Securities listed or traded on an exchange are valued generally at the last
sales price as of the close of the customary trading session on the exchange
where the security is principally traded, or lacking any sales on a
particular day, valued at the closing bid price on that day. Each security
reported on the NASDAQ National Market System is valued at the NASDAQ
Official Close Price. Securities for which market quotations are not readily
available or are believed to be unreliable are valued at fair value as
determined in good faith using methods approved by the Managing General
Partners. Short-term obligations having 60 days or less to maturity are
valued at amortized cost which approximates market value.
SECURITIES TRANSACTIONS AND INVESTMENT INCOME
Securities transactions are accounted for on a trade date basis. Realized
gains and losses on sales and redemptions in kind are computed on the basis
of specific identification for both financial reporting and income tax
purposes. For securities exchanged into the Fund at the Fund's inception in
1976, the cost for financial reporting purposes is the value of those
securities as used in the Exchange. The cost, for income tax purposes, of
securities exchanged into the Fund is the tax basis of the individual
investor. Interest income is recorded on the accrual basis. Dividend income
is recorded on the ex-dividend date.
DISTRIBUTIONS
Distributions from net investment income are paid quarterly and recorded on
the ex-dividend date. Distributions of capital gains, if any, are paid
annually and recorded on the ex-dividend date.
11
FEDERAL INCOME TAXES
The Fund intends to comply with the requirements of the Internal Revenue
Code necessary to qualify as a regulated investment company and, as such,
will not be subject to federal income taxes on otherwise taxable income
which is distributed to shareholders. The Fund may elect not to distribute
long-term capital gains to shareholders, but retain these gains and pay the
income tax at the applicable corporate income tax rate. If the Fund elects
to pay the tax on long-term capital gains, on the last day of the year the
tax is paid, the partners are entitled to a proportionate credit for the tax
payment and the tax basis of their shares is increased by the amount of
undistributed gains less the tax paid by the Fund. At December 31, 2003, the
Fund had a capital loss carryforward of $5,993,660, of which $2,288,260
expires December 31, 2010 and $3,705,400 expires December 31, 2011.
Therefore, no provision for federal income taxes is recorded in the
financial statements.
(C) INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES
PNC Bank and BlackRock Institutional Management Corporation ("BIMC"), a
majority-owned subsidiary of PNC Bank, are co-investment advisers to the
Fund pursuant to an Advisory Agreement dated January 1, 1998. In June 1998,
PNC Bank and BIMC restructured their operations and BlackRock Financial
Management, Inc. ("BFM"), a majority-owned subsidiary of PNC Bank, assumed
the rights and obligations of PNC Bank under the Advisory Agreement. The
Fund pays BIMC an investment advisory fee for advisory, accounting and
administrative services of BIMC and BFM.
The Advisory Agreement provides for a fee at the annual rate of 4/10ths of
1% of the first $100,000,000 of the Fund's average daily net assets plus
3/10ths of 1% of net assets exceeding $100,000,000.
PFPC Inc., an affiliate of PNC Bank, serves as the Fund's transfer and
dividend disbursing agent. As compensation for these services, PFPC Inc. is
entitled to a fee equal to $12,500 per year plus related out-of-pocket
expense.
PFPC Trust Company, a subsidiary of PFPC Inc, serves as the Fund's
custodian. As compensation for its services as custodian, PFPC Trust Company
is entitled to a fee computed at an annual rate of .0065% of the Fund's
average gross assets plus additional fees based on the number and type of
transactions.
The managing general partners each receive a fixed fee as compensation for
their services. In addition, the President and Principal Financial Officer
receives additional payments for overseeing the Fund's activities and
reimbursements of related expenses. Total payments to or for the managing
general partners amounted to $42,285.
(D) INVESTMENT TRANSACTIONS
Purchases and sales of investment securities (excluding short-term
obligations) were $2,788,670 and $0, respectively, for the six months ended
June 30, 2004.
12
(E) NET ASSETS
At June 30, 2004, net assets consisted of:
<Table>
Undistributed net investment income......................... $ 358,383
Accumulated net realized losses on securities............... (5,937,272)
Net unrealized appreciation of investments (book basis)..... 255,145,330
Other capital -- paid-in or reinvested...................... 48,131,439
------------
$297,697,880
============
</Table>
(F) TAX MATTERS
At June 30, 2004, the components of distributable earnings on a tax basis
were as follows:
<Table>
Undistributed ordinary income
(before tax allocation described above)................... $ 358,383
Undistributed net realized gains on securities.............. 56,388
Capital loss carryover...................................... (5,993,660)
Net unrealized appreciation of investments.................. 260,325,167
------------
$254,746,278
============
</Table>
The cost of investments for federal income tax purposes at June 30, 2004 was
$37,980,676. The unrealized appreciation (an excess of value over cost) was
$260,325,167. The difference between book basis and tax basis of investments
is attributable to the use of the individual partners' tax basis for those
securities contributed to the Fund at its inception, as required by law.
On June 30, 2004 undistributed net realized gains (losses) on securities was
decreased by $2,909,315 and additional paid in capital was increased by
$2,909,315 due to permanent differing book and tax treatment of realized
gains and losses. Net assets of the Fund were unaffected by this change.
(G) PROXY VOTING
A description of the Fund's Proxy Voting Policies and Procedures is
available upon request and without charge by calling (800) 852-4750 or by
visiting the Securities and Exchange Commission's website at
http://www.sec.gov.
(H) AVAILABILITY OF PROXY VOTING RECORD
Information on the voting of proxies relating to portfolio securities in the
twelve month period ended June 30, 2004 will be available, without charge,
upon request, by calling (800)852-4750 or by visiting the Securities and
Exchange Commission's website at http://www.sec.gov after August 31, 2004.
13
---------------------------------------------------
---------------------------------------------------
MANAGING GENERAL PARTNERS
Richard C. Caldwell
Robert R. Fortune
Edward J. Roach
Langhorne B. Smith
David R. Wilmerding, Jr.
INVESTMENT ADVISERS
BlackRock Financial Management, Inc.
and
BlackRock Institutional
Management Corporation
100 Bellevue Parkway
Wilmington, Delaware 19809
TRANSFER AGENT
PFPC Inc.
P.O. Box 8950
Wilmington, Delaware 19899
(800) 852-4750
[CHESTNUT STREET LOGO]
Semi-Annual Report
June 30, 2004
Chestnut Street Exchange Fund
400 Bellevue Parkway
Wilmington, Delaware 19809
(302) 792-2555
Edward J. Roach, President & Treasurer
---------------------------------------------------
---------------------------------------------------
ITEM 2. CODE OF ETHICS.
Not applicable.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
Not applicable.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Not applicable.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
Not applicable.
ITEM 6. SCHEDULE OF INVESTMENTS
Not applicable.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
Not applicable.
ITEM 8. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
Not applicable.
ITEM 9. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There have been no material changes to the procedures by which the shareholders
may recommend nominees to the registrant's board of directors, where those
changes were implemented after the registrant last provided disclosure in
response to the requirements of Item 7(d)(2)(ii)(G) of Schedule 14A (17 CFR
240.14a-101), or this Item.
ITEM 10. CONTROLS AND PROCEDURES.
(a) The registrant's principal executive and principal financial
officers, or persons performing similar functions, have concluded
that the registrant's disclosure controls and procedures (as defined
in Rule 30a-3(c) under the Investment Company Act of 1940, as
amended (the "1940 Act") (17 CFR 270.30a-3(c))) are effective, as of
a date within 90 days of the filing date of the report that includes
the disclosure required by this paragraph, based on their evaluation
of these controls and procedures required by Rule 30a-3(b) under the
1940 Act (17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b)
under the Securities Exchange Act of 1934, as amended (17 CFR
240.13a-15(b) or 240.15d-15(b)).
(b) There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the 1940 Act
(17 CFR 270.30a-3(d)) that occurred during the registrant's last
fiscal half-year (the registrant's second fiscal half-year in the
case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting.
ITEM 11. EXHIBITS.
(a)(1) Not applicable.
(a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and
Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto.
(a)(3) Not applicable.
(b) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and
Section 906 of the Sarbanes-Oxley Act of 2002 are attached hereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
(registrant) Chestnut Street Exchange Fund
--------------------------------------------------------------------
By (Signature and Title)* /s/ Edward J. Roach
-------------------------------------------------------
Edward J. Roach, President & Treasurer
(principal executive officer)
Date August 26, 2004
----------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By (Signature and Title)* /s/ Edward J. Roach
-------------------------------------------------------
Edward J. Roach, President & Treasurer
(principal executive and principal financial officer)
Date August 26, 2004
----------------------------------------------------------------------------
* Print the name and title of each signing officer under his or her signature.