1999
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Prudential-Bache Annual
Capital Return Futures Report
Fund 2, L.P.
LETTER TO LIMITED PARTNERS FOR
PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 2, L.P.
1
PricewaterhouseCoopers LLP (LOGO)
PricewaterhouseCoopers LLP
1177 Avenue of the Americas
New York, NY 10036
Telephone (212) 596 8000
Facsimile (212) 596 8910
Report of Independent Accountants
To the General Partner and
Limited Partners of
Prudential-Bache Capital Return Futures Fund 2, L.P.
In our opinion, the accompanying statements of financial condition and the
related statements of operations and changes in partners' capital present
fairly, in all material respects, the financial position of Prudential-Bache
Capital Return Futures Fund 2, L.P. at December 31, 1999 and 1998, and the
results of its operations for each of the three years in the period ended
December 31, 1999 in conformity with accounting principles generally accepted in
the United States. These financial statements are the responsibility of the
General Partner; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by the General Partner, and evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
January 28, 2000
2
PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 2, L.P.
(a limited partnership)
STATEMENTS OF FINANCIAL CONDITION
December 31,
--------------------------
1999 1998
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ASSETS
Cash $ 4,573,677 $ 4,870,709
U.S. Treasury bills, at amortized cost 14,715,473 19,282,809
Net unrealized gain on open futures and options contracts 582,280 896,734
Net premium on options 83,238 (19,358)
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Total assets $19,954,668 $25,030,894
----------- -----------
----------- -----------
LIABILITIES AND PARTNERS' CAPITAL
Liabilities
Redemptions payable $ 935,402 $ 566,962
Accrued expenses payable 60,689 56,959
Net unrealized loss on open forward contracts 59,834 300,443
Due to affiliates 40,762 11,263
Management fees payable 34,924 44,165
Incentive fees payable -- 19,484
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Total liabilities 1,131,611 999,276
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Commitments
Partners' capital
Limited partners (81,738 and 98,989 units outstanding) 18,634,742 23,791,274
General partner (826 and 1,000 units outstanding) 188,315 240,344
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Total partners' capital 18,823,057 24,031,618
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Total liabilities and partners' capital $19,954,668 $25,030,894
----------- -----------
----------- -----------
Net asset value per limited and general partnership unit ('Units') $ 227.98 $ 240.34
----------- -----------
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The accompanying notes are an integral part of these statements.
3
PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 2, L.P.
(a limited partnership)
STATEMENTS OF OPERATIONS
Year ended December 31,
-----------------------------------------------------
1999 1998 1997
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REVENUES
Net realized gain on commodity transactions $ 800,974 $ 669,325 $ 5,486,720
Change in net unrealized gain/loss on open
commodity positions (73,845) (1,001,790) 919,014
Interest from U.S. Treasury bills 763,868 986,548 1,219,506
--------------- --------------- ---------------
1,490,997 654,083 7,625,240
--------------- --------------- ---------------
EXPENSES
Commissions 1,766,009 2,208,844 2,602,752
Management fees 467,596 831,579 1,124,398
Incentive fees 180,115 27,241 433,379
General and administrative 154,909 150,768 156,283
--------------- --------------- ---------------
2,568,629 3,218,432 4,316,812
--------------- --------------- ---------------
Net income (loss) $(1,077,632) $(2,564,349) $ 3,308,428
--------------- --------------- ---------------
--------------- --------------- ---------------
ALLOCATION OF NET INCOME (LOSS)
Limited partners $(1,066,852) $(2,538,726) $ 3,275,346
--------------- --------------- ---------------
--------------- --------------- ---------------
General partner $ (10,780) $ (25,623) $ 33,082
--------------- --------------- ---------------
--------------- --------------- ---------------
NET INCOME (LOSS) PER WEIGHTED AVERAGE
LIMITED AND GENERAL PARTNERSHIP UNIT
Net income (loss) per weighted average
limited and general partnership unit $ (11.57) $ (22.84) $ 25.75
--------------- --------------- ---------------
--------------- --------------- ---------------
Weighted average number of limited and
general partnership units outstanding 93,100 112,273 128,507
--------------- --------------- ---------------
--------------- --------------- ---------------
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STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
LIMITED GENERAL
UNITS PARTNERS PARTNER TOTAL
- -----------------------------------------------------------------------------------------------------
Partners' capital--December 31, 1996 133,028 $30,696,788 $ 310,239 $31,007,027
Net income -- 3,275,346 33,082 3,308,428
Redemptions (12,689) (3,037,206) (30,685) (3,067,891)
-------- ----------- ----------- -----------
Partners' capital--December 31, 1997 120,339 30,934,928 312,636 31,247,564
Net loss -- (2,538,726) (25,623) (2,564,349)
Redemptions (20,350) (4,604,928) (46,669) (4,651,597)
-------- ----------- ----------- -----------
Partners' capital--December 31, 1998 99,989 23,791,274 240,344 24,031,618
Net loss -- (1,066,852) (10,780) (1,077,632)
Redemptions (17,425) (4,089,680) (41,249) (4,130,929)
-------- ----------- ----------- -----------
Partners' capital--December 31, 1999 82,564 $18,634,742 $ 188,315 $18,823,057
-------- ----------- ----------- -----------
-------- ----------- ----------- -----------
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The accompanying notes are an integral part of these statements.
4
PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 2, L.P.
(a limited partnership)
NOTES TO FINANCIAL STATEMENTS
A. General
Prudential-Bache Capital Return Futures Fund 2, L.P. (the 'Partnership') is a
Delaware limited partnership formed on June 8, 1989 which will terminate on
December 31, 2009 unless terminated sooner under the provisions of its Amended
and Restated Agreement of Limited Partnership (the 'Partnership Agreement'). On
October 6, 1989, the Partnership completed its offering having raised
$101,010,000 from the sale of 1,000,000 units of limited partnership interest
and 10,100 units of general partnership interest (collectively, 'Units') and
commenced operations. The Partnership was formed to engage in the speculative
trading of commodity futures, forward and options contracts. Physical
commodities may also be traded from time to time. The general partner of the
Partnership is Prudential Securities Futures Management Inc. (the 'General
Partner'), a wholly owned subsidiary of Prudential Securities Group Inc.
('PSGI'). Prudential Securities Incorporated ('PSI'), a wholly owned subsidiary
of PSGI, was the principal underwriter of the Units and is the commodity broker.
The General Partner is required to maintain at least a 1% interest in the
Partnership as long as it is acting as the Partnership's general partner.
The General Partner generally maintains not less than 75% of the
Partnership's net asset value ('NAV') in interest-bearing U.S. Government
obligations (primarily U.S. Treasury bills), a significant portion of which is
utilized for margin purposes for the Partnership's commodity trading activities.
The remaining 25% of NAV is held in cash in the Partnership's commodity trading
accounts.
All trading decisions for the Partnership are currently being made by Welton
Investment Corporation ('Welton'), Eclipse Capital Management, Inc. ('Eclipse'),
Gaiacorp Ireland Limited ('Gaiacorp') and Trendlogic Associates, Inc.
('Trendlogic'), independent commodity trading managers (collectively, the
'Trading Managers'). Effective September 1, 1998, all assets previously managed
by John W. Henry & Company, Inc. (the 'Reallocated Assets') were reallocated to
Welton, Eclipse and to two trading managers new to the Partnership--Gaiacorp and
Trendlogic--so that each Trading Manager began managing approximately 27% of the
Partnership's assets, except for Trendlogic, which began managing approximately
19%. The Trading Managers receive monthly management fees on their portion of
the Reallocated Assets equal to a 2% annual rate as compared to the 4% annual
rate paid to John W. Henry & Company, Inc. The Trading Managers earn a quarterly
incentive fee equal to 20% of New High Net Trading Profits (as defined in the
Advisory Agreement among the Partnership, the General Partner and each
respective Trading Manager) on the Reallocated Assets, except for Trendlogic
whose quarterly incentive fee rate is 17.5%. John W. Henry & Company, Inc.
received quarterly incentive fees at a 15% rate. Eclipse replaced Analytic/TSA
Capital Management ('TSA') as a trading manager effective July 1, 1997. Eclipse
receives management fees at the same rate as did TSA (a monthly fee on traded
assets equal to a 2% annual rate). In addition, Eclipse earns a quarterly
incentive fee equal to 20% of New High Net Trading Profits (as defined in the
Advisory Agreement among the Partnership, the General Partner and Eclipse) as
compared to 15% paid to TSA. The General Partner retains the authority to
override trading instructions that violate the Partnership's trading policies.
B. Summary of Significant Accounting Policies
Basis of accounting
The financial statements of the Partnership are prepared in accordance with
generally accepted accounting principles.
The preparation of financial statements in conformity with generally accepted
accounting principles requires the General Partner to make estimates and
assumptions that affect the reported amounts of liabilities at the date of the
financial statements and the reported amounts of expenses during the reporting
period. Actual results could differ from those estimates.
Commodity futures and forward transactions are reflected in the accompanying
statements of financial condition on trade date. The difference between the
original contract amount and market value of futures and forward contracts is
reflected as net unrealized gain or loss. Options transactions are reflected in
the statements of financial condition at market value which is inclusive of the
net unrealized gain or loss. The
5
market value of each contract is based upon the closing quotation on the
exchange, clearing firm or bank on, or through, which the contract is traded.
To the extent practicable, the Partnership invests a significant portion of
its NAV in U.S. Treasury bills which are often used to fulfill margin
requirements. U.S. Treasury bills are carried at amortized cost, which
approximates market value. Interest on these obligations accrues for the benefit
of the Partnership.
The weighted average number of limited and general partnership units
outstanding was computed for purposes of disclosing net income (loss) per
weighted average limited and general partnership unit. The weighted average
limited and general partnership units are equal to the number of Units
outstanding at year end, adjusted proportionately for Units redeemed based on
their respective time outstanding during such year.
The Partnership has elected not to provide a Statement of Cash Flows as
permitted by Statement of Financial Accounting Standards No. 102, 'Statement of
Cash Flows--Exemption of Certain Enterprises and Classification of Cash Flows
from Certain Securities Acquired for Resale.'
Certain balances from prior years have been reclassified to conform with the
current financial statement presentation.
Income taxes
The Partnership is not required to provide for, or pay, any Federal or state
income taxes. Income tax attributes that arise from the Partnership's operations
are passed directly to the individual partners. The Partnership may be subject
to other state and local taxes in jurisdictions in which it operates.
Profit and loss allocations, distributions and redemptions
Net realized profits or losses for tax purposes are allocated first to
partners who redeem Units to the extent the amounts received on redemption are
greater than or are less than the amounts paid for the redeemed Units by the
partners. Net income or loss for financial reporting purposes is allocated
quarterly to all partners on a pro rata basis based on each partner's number of
Units outstanding during the quarter.
Distributions (other than on redemptions of Units) are made at the sole
discretion of the General Partner on a pro rata basis in accordance with the
respective capital accounts of the partners. No distributions have been made
since inception.
The Partnership Agreement provides that a partner may redeem its Units as of
the last business day of any full calendar quarter at the then current net asset
value per Unit.
Accounting for Derivative Instruments
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ('SFAS') No. 133, Accounting for Derivative
Instruments and Hedging Activities, which the Partnership adopted effective
October 1, 1999. SFAS No. 133 establishes accounting and reporting standards for
derivative instruments and for hedging activities and requires that an entity
recognize all derivatives as assets or liabilities measured at fair value. SFAS
No. 133 supersedes SFAS No. 119, Disclosure about Derivative Financial
Instruments and Fair Value of Financial Instruments and SFAS No. 105, Disclosure
of Information about Financial Instruments with Off-Balance Sheet Risk and
Financial Instruments with Concentrations of Credit Risk which required the
disclosure of average aggregate fair values and contract/notional values,
respectively, of derivative financial instruments for an entity like the
Partnership which carries its assets at fair value. The adoption of SFAS No. 133
has not had a material effect on the carrying value of assets and liabilities
within the financial statements.
C. Costs, Fees and Expenses
Commissions
The General Partner, on behalf of the Partnership, entered into an agreement
with PSI to act as commodity broker for the Partnership. Effective August 1,
1998, the Partnership pays PSI commissions at a flat rate of .6666% per month
(8% annualized) of the Partnership's NAV as of the first day of each month.
Prior to August 1998, the Partnership paid commissions at a flat rate of .7083%
per month (8.5% annualized).
6
Management and incentive fees
The Partnership pays Eclipse, Gaiacorp, and Trendlogic monthly management
fees equal to 1/6 of 1% (2% annualized) of the portion of the Partnership's NAV
allocated to each of these Trading Managers as of the end of each month. The
Partnership pays Welton monthly management fees ranging from 1/6 of 1% (2%
annualized) to 1/3 of 1% (4% annualized) of its allocated portion of the
Partnership's NAV as of the end of each month.
In addition, the Partnership pays Eclipse and Gaiacorp a quarterly incentive
fee equal to 20%, Trendlogic 17.5% and Welton 15% to 20% of the New High Net
Trading Profits (as defined in each Advisory Agreement among the Partnership,
the General Partner and each Trading Manager).
See Note A for further information concerning changes in Trading Managers
during the two years ended December 31, 1998 which has resulted in changes to
management fees and incentive fees during 1998 and a change to incentive fees
during 1997.
General and administrative expenses
In addition to the costs, fees and expenses previously discussed, the
Partnership reimburses the General Partner and its affiliates for actual
Partnership operating expenses payable by, or allocable to, the Partnership. The
amount of reimbursement from the Partnership is limited by the provisions of the
Partnership Agreement. The Partnership also pays amounts directly to unrelated
parties for certain operating expenses.
D. Related Parties
The General Partner and its affiliates perform services for the Partnership
which include, but are not limited to: brokerage services; accounting and
financial management; registrar, transfer and assignment functions; investor
communications, printing and other administrative services.
The costs incurred for the three years ended December 31, 1999 were:
1999 1998 1997
---------- ---------- ----------
Commissions $1,766,009 $2,208,844 $2,602,752
General and administrative 68,070 69,689 86,018
---------- ---------- ----------
$1,834,079 $2,278,533 $2,688,770
---------- ---------- ----------
---------- ---------- ----------
The Partnership's assets are maintained either in trading or cash accounts
with PSI, or for margin purposes, with the various exchanges on which the
Partnership is permitted to trade.
The Partnership, acting through its Trading Managers, executes
over-the-counter, spot, forward and/or option foreign exchange transactions with
PSI. PSI then engages in back-to-back trading with an affiliate,
Prudential-Bache Global Markets Inc. ('PBGM'). PBGM attempts to earn a profit on
such transactions. PBGM keeps its prices on foreign currency competitive with
other interbank currency trading desks. All over-the-counter currency
transactions are conducted between PSI and the Partnership pursuant to a line of
credit. PSI may require that collateral be posted against the marked-to-market
position of the Partnership.
E. Income Taxes
The following is a reconciliation of net income (loss) for financial
reporting purposes to net income (loss) for tax reporting purposes for the three
years ended December 31, 1999:
1999 1998 1997
----------- ----------- ----------
Net income (loss) per financial statements $(1,077,632) $(2,564,349) $3,308,428
Change in unrealized gain/loss on nonregulated
commodity positions (336,198) 153,409 263,932
----------- ----------- ----------
Tax basis net income (loss) $(1,413,830) $(2,410,940) $3,572,360
----------- ----------- ----------
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The differences between the tax and book bases of partners' capital are
primarily attributable to the cumulative effect of the book to tax income
adjustments.
7
F. Credit and Market Risk
Since the Partnership's business is to trade futures, forward and options
contracts, its capital is at risk due to changes in the value of these contracts
(market risk) or the inability of counterparties to perform under the terms of
the contracts (credit risk).
Futures, forward and options contracts involve varying degrees of off-balance
sheet risk; and changes in the level or volatility of interest rates, foreign
currency exchange rates or the market values of the contracts (or commodities
underlying the contracts) frequently result in changes in the Partnership's
unrealized gain (loss) on open commodity positions reflected in the statements
of financial condition. The Partnership's exposure to market risk is influenced
by a number of factors including the relationships among the contracts held by
the Partnership as well as the liquidity of the markets in which the contracts
are traded.
Futures and options contracts are traded on organized exchanges and are thus
distinguished from forward contracts which are entered into privately by the
parties. The credit risks associated with futures and options contracts are
typically perceived to be less than those associated with forward contracts,
because exchanges typically provide clearinghouse arrangements in which the
collective credit (subject to certain limitations) of the members of the
exchanges is pledged to support the financial integrity of the exchange. On the
other hand, the Partnership must rely solely on the credit of its broker (PSI)
with respect to forward transactions. The Partnership presents unrealized gains
and losses on open forward positions as a net amount in the statements of
financial condition because it has a master netting agreement with PSI.
The General Partner attempts to minimize both credit and market risks by
requiring the Partnership and its Trading Managers to abide by various trading
limitations and policies. The General Partner monitors compliance with these
trading limitations and policies which include, but are not limited to:
executing and clearing all trades with creditworthy counterparties (currently,
PSI is the sole counterparty or broker), limiting the amount of margin or
premium required for any one commodity or all commodities combined, and
generally limiting transactions to contracts which are traded in sufficient
volume to permit the taking and liquidating of positions. Additionally, pursuant
to each Advisory Agreement among the Partnership, the General Partner and each
Trading Manager, the General Partner shall automatically terminate a Trading
Manager if the NAV allocated to the Trading Manager declines by 33 1/3% since
the commencement of its trading activities or from the value at the beginning of
any year (except for Welton for which automatic termination relates only to a
decline from the commencement of trading activities). Futhermore, the Amended
and Restated Agreement of Limited Partnership provides that the Partnership will
liquidate its positions, and eventually dissolve, if the Partnership experiences
a decline in the NAV to less than 50% of the value at commencement of trading
activities. In each case, the decline in NAV is after giving effect for
distributions and redemptions. The General Partner may impose additional
restrictions (through modifications of such trading limitations and policies)
upon the trading activities of the Trading Managers as it, in good faith, deems
to be in the best interest of the Partnership.
PSI, when acting as the Partnership's futures commission merchant in
accepting orders for the purchase or sale of domestic futures and options
contracts, is required by Commodity Futures Trading Commission ('CFTC')
regulations to separately account for and segregate as belonging to the
Partnership all assets of the Partnership relating to domestic futures and
options trading and is not to commingle such assets with other assets of PSI. At
December 31, 1999, such segregated assets totalled $15,639,452. Part 30.7 of the
CFTC regulations also requires PSI to secure assets of the Partnership related
to foreign futures and options trading which totalled $4,315,216 at December 31,
1999. There are no segregation requirements for assets related to forward
trading.
As of December 31, 1999, the Partnership's open futures, forward and options
contracts mature within six months.
Gross contract amounts represent the Partnership's potential involvement in a
particular class of financial instrument (if it were to take or make delivery on
an underlying futures, forward or options contract). Gross contract amounts
significantly exceed future cash requirements as the Partnership intends to
close out open positions prior to settlement and thus is generally subject only
to the risk of loss arising from the change in the value of the contracts. As
such, the Partnership considers the 'fair value' of its futures, forward and
options contracts to be the net unrealized gain or loss on the contracts (plus
premiums on options). Thus, the amount at risk associated with counterparty
nonperformance of all contracts is the net unrealized gain
8
included in the statements of financial condition. The market risk associated
with the Partnership's commitments to purchase commodities is limited to the
gross contract amounts involved, while the market risk associated with its
commitments to sell is unlimited since the Partnership's potential involvement
is to make delivery of an underlying commodity at the contract price; therefore,
it must repurchase the contract at prevailing market prices.
At December 31, 1998, gross contract amounts of open futures, forward and
options contracts were:
1998
-----------
Currency Forwards:
Commitments to purchase $22,873,426
Commitments to sell 34,657,512
Currency Futures and Options:
Commitments to purchase 5,856,239
Commitments to sell 6,186,805
Interest Rate Futures and Options:
Commitments to purchase 60,131,094
Commitments to sell 62,618,266
Stock Index Futures:
Commitments to purchase 4,668,960
Commitments to sell 1,198,925
Commodity Futures and Options:
Commitments to purchase 67,482
Commitments to sell 5,956,997
At December 31, 1999 and 1998, the fair value of open futures, forward and
options contracts was:
1999 1998
------------------------- -------------------------
Assets Liabilities Assets Liabilities
---------- ----------- ---------- -----------
Futures Contracts:
Domestic exchanges
Interest rates $ 78,005 $ -- $ 9,795 $ (8,953)
Stock indices 75,245 (5,420) 172,400 (1,050)
Currencies 76,089 (30,830) 163,687 (80,275)
Commodities 52,327 (24,170) 105,886 (31,160)
Foreign exchanges
Interest rates 116,588 (1,038) 574,781 (39,674)
Stock indices 81,199 (1,899) 65,361 (6,145)
Commodities 168,686 (26,889) 61,678 (98,026)
Forward Contracts:
Currencies 14,912 (74,746) 445,954 (746,397)
Options Contracts:
Domestic exchanges
Interest rates -- -- -- (2,046)
Stock indices 95,700 -- -- --
Currencies -- -- -- (7,150)
Commodities 13,050 (1,125) -- (1,733)
---------- ----------- ---------- -----------
$ 771,801 $ 166,117 $1,599,542 $(1,022,609)
---------- ----------- ---------- -----------
---------- ----------- ---------- -----------
9
The following tables present the average fair value of futures, forward and
options contracts during the year ended December 31, 1998 and the trading
revenues from futures, forward and options contracts during each of the two
years in the period ended December 31, 1998:
Average Fair Value Trading Revenues
-------------------------- -------------------------
Assets Liabilities 1998 1997
---------- ------------ ----------- ----------
Futures Contracts:
Domestic exchanges
Interest rates $ 156,764 $ (36,630) $ 597,370 $ 397,275
Stock indices 26,670 (248) 251,750 177,513
Currencies 139,493 (34,466) 116,940 102,452
Commodities 179,925 (50,069) (1,336,822) 1,699,643
Foreign exchanges
Interest rates 552,515 (80,788) 2,605,329 1,902,280
Stock indices 59,833 (27,746) (621,688) 1,070,542
Commodities 57,838 (80,330) (151,461) 217,780
Forward Contracts:
Currencies 227,693 (620,391) (1,890,440) 660,518
Options Contracts:
Domestic exchanges
Interest rates -- (1,846) 102,312 30,772
Stock indices -- (16,760) 8,734 9,896
Currencies -- (4,040) 5,851 110,600
Commodities -- (4,499) (22,135) 98,356
Foreign exchanges
Interest rates -- -- -- (73,581)
Stock indices -- (69) 1,795 1,688
---------- ------------ ----------- ----------
$1,400,731 $ (957,882) $ (332,465) $6,405,734
---------- ------------ ----------- ----------
---------- ------------ ----------- ----------
10
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I hereby affirm that, to the best of my knowledge and belief, the information
contained herein relating to Prudential-Bache Capital Return Futures Fund 2,
L.P. is accurate and complete.
PRUDENTIAL SECURITIES FUTURES
MANAGEMENT INC.
(General Partner)
by: Barbara J. Brooks
Chief Financial Officer
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11
PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 2, L.P.
(a limited partnership)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
The Partnership commenced trading operations on October 6, 1989 with gross
proceeds of $101,010,000. After accounting for organizational and offering
costs, the Partnership's net proceeds were $99,010,000.
At December 31, 1999, 100% of the Partnership's total net assets was
allocated to commodities trading. A significant portion of the net asset value
was held in U.S. Treasury bills (which represented approximately 74% of the net
asset value prior to redemptions payable) and cash, which are used as margin for
the Partnership's trading in commodities. Inasmuch as the sole business of the
Partnership is to trade in commodities, the Partnership continues to own such
liquid assets to be used as margin.
The percentage that U.S. Treasury bills bears to the net assets varies each
day, and from month to month, as the market values of commodity interests
change. The balance of the net assets is held in cash. All interest earned on
the Partnership's interest-bearing funds is paid to the Partnership.
The commodities contracts are subject to periods of illiquidity because of
market conditions, regulatory considerations and other reasons. For example,
commodity exchanges limit fluctuations in certain commodity futures contract
prices during a single day by regulations referred to as 'daily limits.' During
a single day, no trades may be executed at prices beyond the daily limit. Once
the price of a futures contract for a particular commodity has increased or
decreased by an amount equal to the daily limit, positions in the commodity can
neither be taken nor liquidated unless traders are willing to effect trades at
or within the limit. Commodity futures prices have occasionally moved the daily
limit for several consecutive days with little or no trading. Such market
conditions could prevent the Partnership from promptly liquidating its commodity
futures positions.
Since the Partnership's business is to trade futures, forward and options
contracts, its capital is at risk due to changes in the value of these contracts
(market risk) or the inability of counterparties to perform under the terms of
the contracts (credit risk). The Partnership's exposure to market risk is
influenced by a number of factors including the volatility of interest rates and
foreign currency exchange rates, the liquidity of the markets in which the
contracts are traded and the relationships among the contracts held. The
inherent uncertainty of the Partnership's speculative trading as well as the
development of drastic market occurrences could result in monthly losses
considerably beyond the Partnership's experience to date and could ultimately
lead to a loss of all or substantially all of investors' capital. The General
Partner attempts to minimize these risks by requiring the Partnership and its
Trading Managers to abide by various trading limitations and policies, which
include limiting margin amounts, trading only in liquid markets and utilizing
stop loss provisions. See Note F to the financial statements for a further
discussion on the credit and market risks associated with the Partnership's
futures, forward and options contracts.
Redemptions by limited partners and the General Partner for the year ended
December 31, 1999 were $4,089,680 and $41,249, respectively. Redemptions by
limited partners and the General Partner recorded from the commencement of
operations, October 6, 1989, through December 31, 1999 totalled $127,011,796 and
$1,828,948, respectively. Future redemptions will impact the amount of funds
available for investment in commodity contracts in subsequent periods.
The Partnership does not have, nor does it expect to have, any capital
assets.
Results of Operations
The net asset value per Unit as of December 31, 1999 was $227.98, a decrease
of 5.14% from the December 31, 1998 net asset value per Unit of $240.34, which
was a decrease of 7.44% from the December 31, 1997 net asset value per Unit of
$259.66. The MAR (Managed Account Reports) Fund/Pool Index, which tracked the
performance of 317 and 281 futures funds in 1999 and 1998, returned gains of
1.48% and 6.81%, respectively. Past performance is not necessarily indicative of
future results.
12
The Partnership's negative return for 1999 was attributed to losses in the
metal, soft, and financial sectors. Mitigating these losses were gains recorded
in the currency, energy, index, grain, and meat sectors.
The metal sector contributed substantial losses, particularly from silver,
copper, and zinc. The Partnership incurred the majority of these losses in the
second quarter as these markets experienced extreme volatility. Zinc prices, for
example, consolidated within a 250 point range. As a result of this broad
congestion pattern, zinc exhibited choppy trade action with no trend.
Additionally, copper rallied sharply in the second quarter following
announcements that two major corporations would significantly cut copper output.
Short copper positions incurred losses.
During the second quarter, losses from long cotton positions were experienced
in the soft sector as cotton prices fell. Coffee prices plummeted as seasonably
warm weather in Brazil reduced the likelihood that a winter freeze would damage
this vulnerable crop, thus promising ample supplies. In the fourth quarter, the
Partnership incurred losses as coffee markets experienced volatility with no
trends materializing.
Trading in the currency sector profited the Partnership in three of the four
quarters of 1999. First and second quarter profits were the result of a strong
U.S. dollar against European currencies. In the second quarter, the Swiss franc
fell, profiting the Partnership, as it lost its safe haven attraction as the war
ended in Kosovo and lost value versus the U.S. dollar when the Federal Reserve
increased U.S. interest rates by 0.25%. Weakness in the euro continued due to
deteriorating confidence in that currency and Italy's possible retraction from
the European Economic Union. Consequently, the European Central Bank was rumored
to be considering an interest rate increase. Short euro and Swiss franc
positions added gains. Long Japanese yen positions added profits in the third
quarter. The yen continued to appreciate in value in light of threatened
intervention by the Bank of Japan. Spurred by higher growth expectations and a
strong stock market, the yen reached levels in August not seen since its last
big rally in 1996.
Long positions in the energy sector provided profits in the first, second,
and third quarters. OPEC production cuts drove the rally in crude oil and
derivative products throughout most of the year. Also boosting the rise in crude
oil were high energy demand due to an unusually hot June and threat of a
Venezuelan oil workers strike in the third quarter.
An overall rising global stock market led to profits in the index sector
during the second and fourth quarters. The Nikkei Dow recorded a low of 13050 in
the first week of January, but proceeded to accelerate up to 18455 within the
last two weeks of June. Capital flows out of the U.S. market and into the Asian
region helped to drive this move under the perception that the Asian economies
had formed a base from which to improve. Consequently, long Nikkei Dow and SFE
(Australia) index positions recorded gains. During the fourth quarter, long S&P
500 and NASDAQ index positions profited the Partnership as these markets reached
historical highs. Additionally, Hong Kong's Hang Seng index rose following a
breakthrough in negotiations regarding China's entry into the World Trade
Organization. This market also rallied when an anticipated Hong Kong interest
rate increase failed to materialize. As a result, long Hang Seng stock index
positions generated gains.
Interest income is earned on the Partnership's investment in U.S. Treasury
bills and varies monthly according to interest rates as well as the effect of
trading performance and redemptions on the level of interest-bearing funds.
Interest income from U.S. Treasury bills decreased by approximately $223,000
during 1999 compared to 1998 and decreased $233,000 during 1998 as compared to
1997 due to fewer funds being invested in U.S. Treasury bills as a result of
redemptions and weak trading performance in 1999 and 1998, and lower overall
interest rates in 1999 versus 1998 and 1998 versus 1997.
Commissions paid to PSI are calculated on the Partnership's net asset value
on the first day of each month and, therefore, vary monthly according to trading
performance and redemptions. Commissions decreased by approximately $443,000
during 1999 as compared to 1998 and decreased by $394,000 during 1998 as
compared to 1997 principally due to the effect of weak trading performance in
1999 and 1998 and redemptions on the monthly net asset values as well as a
reduction in the commission rate from 8.5% to 8% during August 1998.
All trading decisions are currently being made by Welton, Eclipse, Trendlogic
and Gaiacorp. Management fees are calculated on the portion of the Partnership's
net asset value allocated to each Trading Manager as of the end of each month
and, therefore, are affected by trading performance and redemptions. Management
fees decreased by approximately $364,000 during 1999 as compared to 1998, and
decreased by $293,000 during 1998 as compared to 1997 due to fluctuations in
monthly net asset values as described in
13
the discussion on commissions above. These declines were also caused by a
reduction in the management fee rate from a 4% annual rate to a 2% annual rate
on the portion of net assets that were reallocated from John W. Henry & Company,
Inc. to the current Trading Managers effective September 1, 1998.
Incentive fees are based on the New High Net Trading Profits generated by
each Trading Manager, as defined in each Advisory Agreement among the
Partnership, the General Partner and each Trading Manager. Despite overall
Partnership trading losses during 1999 and 1998, Eclipse generated sufficient
trading profits during 1999 to earn incentive fees of approximately $180,000 and
during 1998, Welton and Trendlogic earned incentive fees of approximately
$22,000 and $5,000, respectively. During 1997, John W. Henry & Company, Inc.,
Welton, and Eclipse earned incentive fees of approximately $273,000, $50,000 and
$110,000, respectively.
General and administrative expenses remained relatively constant throughout
the three years ended December 31, 1999. These expenses include reimbursements
of costs incurred by the General Partner on behalf of the Partnership, in
addition to accounting, audit, tax and legal fees as well as printing and
postage costs related to reports sent to limited partners.
Accounting for Derivative Instruments
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ('SFAS') No. 133, Accounting for Derivative
Instruments and Hedging Activities, which the Partnership adopted effective
October 1, 1999. SFAS No. 133 establishes accounting and reporting standards for
derivative instruments and for hedging activities and requires that an entity
recognize all derivatives as assets or liabilities measured at fair value. SFAS
No. 133 supersedes SFAS No. 119, Disclosure about Derivative Financial
Instruments and Fair Value of Financial Instruments and SFAS No. 105, Disclosure
of Information about Financial Instruments with Off-Balance Sheet Risk and
Financial Instruments with Concentrations of Credit Risk which required the
disclosure of average aggregate fair values and contract/notional values,
respectively, of derivative financial instruments for an entity like the
Partnership which carries its assets at fair value. The adoption of SFAS No. 133
has not had a material effect on the carrying value of assets and liabilities
within the financial statements.
Year 2000 Risk
The arrival of year 2000 was much anticipated and raised serious concerns
about whether or not computer systems around the world would continue to
function properly and the degree of 'Year 2000 Problems' that would have to be
resolved.
The Partnership engages third parties to perform primarily all of the
services it needs and also relies on other third parties such as governments,
exchanges, clearinghouses, vendors and banks. The Partnership has not
experienced any material adverse impact on operations related to Year 2000
Problems. While the Partnership believes that it has mitigated its Year 2000
risk, the Partnership cannot guarantee that an as yet unknown Year 2000 failure
will not have a material adverse effect on the Partnership's operations.
Inflation
Inflation has had no material impact on operations or on the financial
condition of the Partnership from inception through December 31, 1999.
14
OTHER INFORMATION
The actual round-turn equivalent of brokerage commissions paid per contract
for the year ended December 31, 1999 was $71.
The Partnership's Annual Report on Form 10-K as filed with the Securities and
Exchange Commission is available to limited partners without charge upon written
request to:
Prudential-Bache Capital Return
Futures Fund 2, L.P.
P.O. Box 2016
Peck Slip Station
New York, New York 10272-2016
15
Peck Slip Station BULK RATE
P.O. Box 2016 U.S. POSTAGE
New York, NY 10272 PAID
Automatic Mail
PBCR2/171781