1998
- --------------------------------------------------------------------------------
Prudential-Bache Annual
Capital Return Futures Report
Fund 3, L.P.
LETTER TO LIMITED PARTNERS FOR
PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 3, L.P.
1
PricewaterhouseCoopers (LOGO)
PricewaterhouseCoopers LLP
1177 Avenue of the Americas
New York, NY 10036
Telephone (212) 596 8000
Facsimile (212) 596 8910
REPORT OF INDEPENDENT ACCOUNTANTS
January 26, 1999
To the General Partner and
Limited Partners of
Prudential-Bache Capital Return Futures Fund 3, 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 3, L.P. at December 31, 1998 and 1997, and the
results of its operations for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
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
generally accepted auditing standards 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
2
PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 3, L.P.
(a limited partnership)
STATEMENTS OF FINANCIAL CONDITION
December 31,
----------------------------
1998 1997
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ASSETS
Equity in commodity trading accounts:
Cash $ 2,838,700 $ 3,247,888
U.S. Treasury bills, at amortized cost 10,175,171 14,063,335
Net unrealized gain on open commodity positions 494,136 795,209
Options, at market -- 124,575
------------ ------------
Total assets $13,508,007 $18,231,007
------------ ------------
------------ ------------
LIABILITIES AND PARTNERS' CAPITAL
Liabilities
Redemptions payable $ 712,663 $ 587,036
Accrued expenses 66,586 64,500
Management fees payable 22,378 37,646
Due to affiliates 14,709 20,512
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Total liabilities 816,336 709,694
------------ ------------
Commitments
Partners' capital
Limited partners (83,196 and 103,033 units outstanding) 12,564,659 17,346,056
General partner (841 and 1,041 units outstanding) 127,012 175,257
------------ ------------
Total partners' capital 12,691,671 17,521,313
------------ ------------
Total liabilities and partners' capital $13,508,007 $18,231,007
------------ ------------
------------ ------------
Net asset value per limited and general partnership unit ('Units') $ 151.02 $ 168.35
------------ ------------
------------ ------------
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The accompanying notes are an integral part of these statements.
3
PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 3, L.P.
(a limited partnership)
STATEMENTS OF OPERATIONS
Year ended December 31,
-------------------------------------------
1998 1997 1996
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REVENUES
Net realized gain (loss) on commodity transactions $ (122,467) $ (294,359) $ 6,497,225
Change in net unrealized gain on open commodity
positions (344,998) 497,262 (1,002,361)
Interest from U.S. Treasury bills 581,840 750,962 753,904
------------ ----------- -----------
114,375 953,865 6,248,768
------------ ----------- -----------
EXPENSES
Commissions 1,109,510 1,458,094 1,518,807
Other transaction fees 157,723 235,087 191,327
Management fees 336,673 538,158 600,463
Incentive fees 8,831 226,785 597,331
General and administrative 161,030 163,720 160,359
------------ ----------- -----------
1,773,767 2,621,844 3,068,287
------------ ----------- -----------
Net income (loss) $(1,659,392) $(1,667,979) $ 3,180,481
------------ ----------- -----------
------------ ----------- -----------
ALLOCATION OF NET INCOME (LOSS)
Limited partners $(1,642,756) $(1,651,267) $ 3,157,728
------------ ----------- -----------
------------ ----------- -----------
General partner $ (16,636) $ (16,712) $ 22,753
------------ ----------- -----------
------------ ----------- -----------
NET INCOME (LOSS) PER WEIGHTED AVERAGE LIMITED AND
GENERAL PARTNERSHIP UNIT
Net income (loss) per weighted average limited and
general partnership unit $ (17.13 ) $ (14.85) $ 24.90
------------ ----------- -----------
------------ ----------- -----------
Weighted average number of limited and general
partnership units outstanding 96,844 112,297 127,714
------------ ----------- -----------
------------ ----------- -----------
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STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
LIMITED GENERAL
UNITS PARTNERS PARTNER TOTAL
- ----------------------------------------------------------------------------------------------------
Partners' capital--December 31, 1995 134,867 $20,572,015 $551,634 $21,123,649
Net income -- 3,157,728 22,753 3,180,481
Redemptions (18,656) (2,684,449) (361,644) (3,046,093)
------- ----------- -------- -----------
Partners' capital--December 31, 1996 116,211 21,045,294 212,743 21,258,037
Net loss -- (1,651,267) (16,712) (1,667,979)
Redemptions (12,137) (2,047,971) (20,774) (2,068,745)
------- ----------- -------- -----------
Partners' capital--December 31, 1997 104,074 17,346,056 175,257 17,521,313
Net loss -- (1,642,756) (16,636) (1,659,392)
Redemptions (20,037) (3,138,641) (31,609) (3,170,250)
------- ----------- -------- -----------
Partners' capital--December 31, 1998 84,037 $12,564,659 $127,012 $12,691,671
------- ----------- -------- -----------
------- ----------- -------- -----------
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The accompanying notes are an integral part of these statements.
4
PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 3, L.P.
(a limited partnership)
NOTES TO FINANCIAL STATEMENTS
A. General
Prudential-Bache Capital Return Futures Fund 3, L.P. (the 'Partnership') is a
Delaware limited partnership formed on November 27, 1989 to engage in the
speculative trading of commodity futures, forward and options contracts. The
Partnership will terminate on December 31, 2009 unless terminated sooner under
the provisions of its Amended and Restated Agreement of Limited Partnership (the
'Partnership Agreement'). These provisions, as set forth in Article XVII of the
Partnership Agreement include, but are not limited to, the dissolution of the
Partnership if the Partnership's net asset value declines to less than $10
million as of the end of any business day. On May 30, 1990, the Partnership
completed its offering having raised $65,520,000 from the sale of 648,625 units
of limited partnership interest and 6,575 units of general partnership interest
and commenced operations.
The general partner of the Partnership is Seaport Futures Management, Inc.
(the 'General Partner') which is an affiliate of Prudential Securities
Incorporated ('PSI'), the Partnership's commodity broker. Both the General
Partner and PSI are wholly owned subsidiaries of Prudential Securities Group
Inc. ('PSGI'). 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.
During the three years ended December 31, 1998, 100% of the Partnership's
assets were allocated for commodity trading purposes. The General Partner
generally maintains not less than 75% of the Partnership's net assets 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 the net assets
is held in cash in the Partnership's commodity trading accounts.
All trading decisions for the Partnership are being made by Sjo, Inc. ('Sjo')
and Tamiso & Company ('Tamiso') (the 'Trading Managers'). During July 1998,
Willowbridge Associates Inc. ('Willowbridge') ceased to serve as a Trading
Manager to the Partnership. All assets previously managed by Willowbridge were
allocated to Tamiso, who began trading Partnership assets on August 28, 1998.
The monthly management fee paid to Tamiso equals 1/6 of 1% (a 2% annual rate) of
assets allocated to Tamiso as compared to 1/4 of 1% (a 3% annual rate) paid to
Willowbridge. The quarterly incentive fee paid to Tamiso equals 17% of the New
High Net Trading Profits (as defined in the Advisory Agreement among the
Partnership, the General Partner and Tamiso) as compared to 20% of the New High
Net Trading Profits paid to Willowbridge. The General Partner retains the
authority to override trading instructions that violate the Partnership's
trading policies.
Effective September 1, 1997, Sjo implemented their Global Diversified Program
which replaced their Foreign Financials Program. Additionally, the fee structure
of the assets under Sjo's management was changed to a monthly management fee at
an annual rate of 2% of assets allocated to Sjo and a quarterly incentive fee of
17% of New High Net Trading Profits (as defined in the Advisory Agreement among
the Partnership, the General Partner and Sjo). Prior to the change, Sjo was paid
a monthly management fee at an annual rate ranging from 2%-3% and a quarterly
incentive fee ranging from 15%-17%.
Certain balances from the prior year have been reclassified to conform with
the current financial statement presentation.
B. Summary of Significant Accounting Policies
Basis of accounting
The books and records of the Partnership are maintained on the accrual basis
of accounting 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.
5
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 is reflected as net unrealized gain or
loss. Option transactions are reflected in the statements of financial condition
at market value which is inclusive of the net unrealized gain or loss. The
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 assets 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 the 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 Standard No. 102, 'Statement of
Cash Flows--Exemption of Certain Enterprises and Classification of Cash Flows
from Certain Securities Acquired for Resale.'
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 realized profits or losses remaining after these allocations are
allocated to each partner in proportion to such partner's capital account at
year-end. 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 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.
New Accounting Guidance
In June 1998, the Financial Accounting Standards Board issued Statement No.
133, Accounting for Derivative Instruments and Hedging Activities ('SFAS 133'),
which the Partnership is required to adopt effective January 1, 2000. SFAS 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. The Partnership does not believe
the effect of adoption will be material.
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. The Partnership pays
PSI monthly fees equal to 5/8 of 1% (a 7.5% annual rate) of the Partnership's
net asset value as of the first day of each month.
Management and incentive fees
The Partnership pays each Trading Manager monthly management fees equal to
1/6 of 1% (a 2% annual rate) of the portion of the Partnership's assets
allocated to that Trading Manager as of the end of each month.
6
In addition, the Partnership also pays the Trading Managers quarterly
incentive fees of 17% of the 'New High Net Trading Profits' generated by each
Trading Manager (as defined in the Advisory Agreements among the Partnership,
the General Partner and each Trading Manager).
See Note A for information concerning changes to management and incentive
fees paid by the Partnership during 1997 and 1998.
General and administrative fees
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 services and other administrative services.
The costs incurred for these services for the years ended December 31, 1998,
1997 and 1996 were:
1998 1997 1996
----------------------------------------
Commissions $1,109,510 $1,458,094 $1,518,807
General and administrative 81,400 93,899 104,370
---------- ---------- ----------
$1,190,910 $1,551,993 $1,623,177
---------- ---------- ----------
---------- ---------- ----------
The Partnership's assets are maintained either in trading or cash accounts
with PSI, the Partnership's commodity broker, 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 years
ended December 31, 1998, 1997 and 1996, respectively:
1998 1997 1996
-----------------------------------------
Net income (loss) per financial
statements $(1,659,392) $(1,667,979) $3,180,481
Change in unrealized gain/loss on
nonregulated commodity positions (71,251) 227,676 (304,542)
----------- ----------- ----------
Tax basis net income (loss) $(1,730,643) $(1,440,303) $2,875,939
----------- ----------- ----------
----------- ----------- ----------
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.
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
7
(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's 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. 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 interests 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, 1998, such segregated assets totalled $7,157,275. 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 $6,614,657 at December 31,
1998. There are no segregation requirements for assets related to forward
trading.
As of December 31, 1998, the Partnership's open futures and forward contracts
mature within one year.
At December 31, 1998 and 1997, gross contract amounts of open futures,
forward and options contracts are:
1998 1997
------------ ------------
Financial Futures and Options Contracts:
Commitments to purchase $42,939,543 $232,456,787
Commitments to sell 70,231,314 3,415,906
Currency Futures and Options Contracts:
Commitments to purchase 4,047,975 3,813,407
Commitments to sell 6,715,726 20,598,159
Other Futures Contracts:
Commitments to purchase 1,180,941 3,477,900
Commitments to sell 5,823,477 7,212,160
Currency Forward Contracts:
Commitments to purchase 8,606,922 2,621,143
Commitments to sell 8,306,752 477,804
Other Forward Contracts:
Commitments to purchase -- 333,510
The 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). The gross
contract amounts significantly exceed the future cash requirements as the
Partnership intends to
8
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 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, 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 and 1997, the fair value of open futures, forward and
options contracts was:
1998 1997
------------------------ --------------------------
Assets Liabilities Assets Liabilities
-------- ------------ ---------- ------------
Futures Contracts:
Domestic exchanges
Financial $ 17,975 $ 3,591 $ 204,288 $ 83,550
Currencies 239,260 37,299 171,503 10,585
Other 155,300 36,717 279,386 41,549
Foreign exchanges
Financial 462,890 72,197 396,408 9,479
Other 84,761 52,321 63,081 103,725
Forward Contracts:
Currencies -- 263,925 -- 68,270
Other -- -- -- 2,299
Options Contracts:
Domestic exchanges
Financial -- -- 23,375 --
Currencies -- -- 101,200 --
-------- ------------ ---------- ------------
$960,186 $466,050 $1,239,241 $319,457
-------- ------------ ---------- ------------
-------- ------------ ---------- ------------
9
The following table presents the average fair value of futures, forward and
options contracts during the years ended December 31, 1998 and 1997,
respectively.
1998 1997
-------------------------- --------------------------
Assets Liabilities Assets Liabilities
---------- ------------ ---------- ------------
Futures Contracts:
Domestic exchanges
Financial $ 136,456 $ 33,194 $ 123,796 $ 14,567
Currencies 223,374 52,833 199,120 28,543
Other 191,220 94,869 177,680 56,170
Foreign exchanges
Financial 431,993 37,790 346,591 110,195
Other 83,438 91,112 327,551 108,966
Forward Contracts:
Currencies 200,298 239,510 3,491 30,363
Other 31,171 43,014 3,394 6,792
Options Contracts:
Domestic exchanges
Financial 16,404 -- 8,823 --
Currencies 10,604 -- 16,610 --
Other -- -- 5,868 --
Foreign exchanges
Financial 1,760 -- -- --
Other 3,852 -- 20,761 --
---------- ------------ ---------- ------------
$1,330,570 $592,322 $1,233,685 $355,596
---------- ------------ ---------- ------------
---------- ------------ ---------- ------------
The following table presents trading revenues from futures, forward and
options contracts for the three years ended December 31, 1998:
1998 1997 1996
----------- ----------- ----------
Futures Contracts:
Domestic exchanges
Financial $ (70,318) $(1,634,928) $ 801,008
Currencies (1,126,789) 1,893,243 758,643
Other (536,249) 369,626 684,445
Foreign exchanges
Financial 2,807,927 (729,244) 3,797,346
Other (177,954) 800,586 92,879
Forward Contracts:
Currencies (310,976) (113,089) --
Other (505,252) (49,419) 10,020
Options Contracts:
Domestic exchanges
Financial (287,081) (9,303) (134,985)
Currencies (214,125) (155,643) (148,763)
Other (1,670) (80,538) (289,027)
Foreign exchanges
Financial (25,054) -- (76,702)
Other (19,924) (88,388) --
----------- ----------- ----------
$ (467,465) $ 202,903 $5,494,864
----------- ----------- ----------
----------- ----------- ----------
10
PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 3, L.P.
(a limited partnership)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
The Partnership commenced operations on May 30, 1990 with gross proceeds of
$65,520,000. After accounting for organizational and offering costs, the
Partnership's net proceeds were $64,222,750.
At December 31, 1998, 100% of the Partnership's total net assets were
allocated to commodities trading. At December 31, 1998, a significant portion of
the net asset value was held in U.S. Treasury bills (which represented
approximately 76% 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 total net assets varies
each day, and from month to month, as the market values of commodity interests
change. The balance of the total 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 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 relationship 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's Trading Managers to abide by
various trading limitations and policies. See Note F to the financial statements
for a further discussion on the credit and market risks associated with the
Partnership's futures and options contracts.
The Partnership does not have, nor does it expect to have, any capital
assets.
Redemptions by limited partners recorded for the years ended December 31,
1998, 1997 and 1996 were $3,138,641, $2,047,971 and $2,684,449, respectively.
Additionally, redemptions by the General Partner recorded for the years ended
December 31, 1998, 1997 and 1996 were $31,609, $20,774, and $361,644,
respectively. Redemptions by limited partners and the general partner recorded
from commencement of operations, May 30, 1990, through December 31, 1998
totalled $65,168,252 and $764,572, respectively. Future redemptions will impact
the amount of funds available for investment in commodity contracts in
subsequent periods.
Results of Operations
The net asset value per Unit as of December 31, 1998 was $151.02, a decrease
of 10.29% from the December 31, 1997 net asset value per Unit of $168.35, which
was a decrease of 7.97% from the December 31, 1996 net asset value per Unit of
$182.93. The MAR (Managed Account Reports) Fund/Pool Index, which tracked the
performance of 281 and 315 futures funds in 1998 and 1997, returned 6.57% and
9.34%, respectively. Past performance is not necessarily indicative of future
results.
The Partnership's negative performance for 1998 resulted from losses in the
currency, metal, soft, and grain sectors offset, in part, by gains in the
financial, energy, and index sectors.
11
Changing sentiment drove losses in the currency sector. In January, currency
sector positions lost value as fears regarding the Far East waned and investors
were no longer concerned with moving their investments to higher quality
currencies. Further hopes that the Japanese government might take stronger
fiscal action to improve the economy spurred a February market reversal in the
yen leading to losses in short positions. Early in April, the U.S. dollar rose
sharply against the Japanese yen partially due to a report concerning a weak
Japanese economy. Subsequently, the currency markets experienced a sharp
reversal, with the U.S. dollar falling versus the Japanese yen and other major
currencies. Finally in November, good news concerning relief for Brazil from the
International Monetary Fund boosted the U.S. dollar, only for it to reverse in
December as the result of a falling U.S. stock market, impeachment proceedings
against President Clinton, and concerns about economic uncertainty in Latin
America.
Negative performance in the metal sector also resulted from changing market
direction with silver experiencing the biggest losses, particularly during the
first half of the year. In February, long silver positions profited as prices
soared in response to significant buying by a large investor. February profits
were offset in May as investors who had purchased silver in hopes of a price
increase began to liquidate their holdings.
The Partnership benefited from positions in the financial sector which
provided profit opportunities throughout the year. In May, long positions in the
Japanese government bond ('JGB') led to profits when JGB prices rallied to new
highs on news that Southeast Asian economic turmoil was not over. Rising
concerns in the third quarter regarding the soundness of Japanese banks and the
devaluation of the Russian ruble drove investors out of stocks and back into
bonds, particularly profiting U.S. and European bond positions. However, in the
fourth quarter, the Partnership gave back some profits previously earned in
Australian, Canadian, European and U.S. bond positions as the U.S. Federal
Reserve Bank continued to ease credit conditions by lowering rates.
During July 1998, Willowbridge Associates Inc. ('Willowbridge') ceased to
serve as a trading manager to the Partnership. All assets previously managed by
Willowbridge were allocated to Tamiso & Company ('Tamiso'), who began trading
Partnership assets on August 28, 1998. As a result, the Partnership did not
incur management fees, commissions or other transaction fees during the period
these assets were not allocated for commodities trading. The monthly management
fee paid to Tamiso equals 1/6 of 1% (a 2% annual rate) of assets allocated to
Tamiso as compared to 1/4 of 1% (a 3% annual rate) paid to Willowbridge. The
quarterly incentive fee paid to Tamiso equals 17% of the New High Net Trading
Profits (as defined in the Advisory Agreement among the Partnership, the General
Partner and Tamiso) as compared to 20% of the New High Net Trading Profits paid
to Willowbridge.
Effective September 1, 1997, Sjo, Inc. ('Sjo') implemented their Global
Diversified Program which replaced their Foreign Financials Program.
Additionally, the fee structure of the assets under Sjo's management was changed
to a monthly management fee at an annual rate of 2% of assets allocated to Sjo
and a quarterly incentive fee of 17% of New High Net Trading Profits (as defined
in the Advisory Agreement among the Partnership, the General Partner and Sjo).
Prior to the change, Sjo was paid a monthly management fee at an annual rate
ranging from 2%-3% and a quarterly incentive fee ranging from 15%-17%.
Interest income is earned on the Partnership's investments in U.S. Treasury
bills and varies monthly according to interest rates, trading performance and
redemptions. Interest income from U.S. Treasury bills decreased by $169,000 for
the year ended December 31, 1998 as compared to 1997. This decrease was
primarily due to the effect of declining interest rates during the current year
as well as the effect of fewer funds available for investment in U.S. Treasury
bills resulting from poor trading performance and the liquidation of such
investments for the payment of redemptions. Interest income declined
approximately $3,000 for the year ended December 31, 1997 as compared to 1996
due to poor trading performance in 1997 and redemptions, which was partially
offset by slightly higher interest rates in 1997.
Commissions are calculated on the net asset value on the first day of each
month and, therefore, vary based on monthly trading performance and redemptions.
Commissions decreased by $349,000 and $61,000 for the years ended December 31,
1998 and 1997, respectively, as compared to prior years. The effect on the
monthly net asset values of poor trading performance during 1998 and the
second quarter of 1997, as well as redemptions, caused a majority of the
decreases. The replacement of Willowbridge as a Trading Manager as discussed
above also resulted in decreases to commissions during 1998.
Other transaction fees consist of National Futures Association, exchange,
floor brokerage and clearing fees which are based on the number of trades the
Trading Managers execute. Other transaction fees
12
decreased by $77,000 for the year ended December 31, 1998 as compared to 1997
due primarily to lower trading volume and the replacement of Willowbridge as a
Trading Manager as discussed above. Other transaction fees increased by $44,000
for the year ended December 31, 1997 as compared to 1996 due primarily to
increased trading volume, which is partially attributable to the implementation
of a new trading strategy by Sjo as discussed above.
All trading decisions are currently being made by Sjo and Tamiso. Management
fees are calculated on the 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 $201,000 and $62,000 for the years
ended December 31, 1998 and 1997, respectively, as compared to prior years for
the same reasons commissions decreased as discussed above.
Incentive fees are based on New High Net Trading Profits generated by each
trading manager, as defined in the Advisory Agreements among the Partnership,
the General Partner and each Trading Manager. Although the Partnership ended
1998 and 1997 with losses, the Partnership paid incentive fees of $9,000 and
$227,000, respectively, during these years. These fees were primarily
attributable to positive trading performance during the third quarter of 1998
and the first quarter of 1997. The payment of these fees is not contingent upon
future trading performance and, therefore, is unaffected by the Partnership's
poor trading performance during the remainder of each year. Incentive fees of
$597,000 were paid during the year ended December 31, 1996.
General and administrative expenses remained relatively stable during the
three years ended December 31, 1998. 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.
New Accounting Guidance
In June 1998, the Financial Accounting Standards Board issued Statement No.
133, Accounting for Derivative Instruments and Hedging Activities ('SFAS 133'),
which the Partnership is required to adopt effective January 1, 2000. SFAS 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. The Partnership does not believe
the effect of adoption will be material.
Year 2000 Risk
Investment funds, like financial and business organizations and individuals
around the world, depend on the smooth functioning of computer systems. The year
2000, however, holds the potential for a significant disruption in the operation
of these systems. Many computer systems in use today cannot distinguish the year
2000 from the year 1900 because of the way in which dates are encoded. This is
commonly known as the 'Year 2000 Problem.' The Partnership could be adversely
affected if computer systems used by it or any third party with whom it has a
material relationship do not properly perform date comparisons and calculations
concerning dates on or after January 1, 2000, which in turn could have a
negative impact on the handling or determination of trades and prices and the
services provided to the Partnership.
The Partnership has engaged third parties to perform primarily all of the
services it needs. Accordingly, the Partnership's Year 2000 Problems, if any,
are not its own but those that center around the ability of the General Partner,
Prudential Securities Incorporated, its Trading Managers and any other third
party with whom the Partnership has a material relationship (individually, a
'Service Provider,' and collectively, the 'Service Providers') to address and
correct problems that may cause their systems not to function as intended as a
result of the Year 2000 Problem.
The Partnership has received assurances from its General Partner and
Prudential Securities Incorporated that they anticipate being able to continue
their operations without any material adverse impact from the Year 2000 Problem.
Although other Service Providers, such as the Partnership's Trading Managers,
have not made similar representations to the Partnership, the Partnership has no
reason to believe that these Service Providers will not take steps necessary to
avoid any material adverse impact on the Partnership, though there can be no
assurance that this will be the case. The costs or consequences of incomplete or
untimely resolution of the Year 2000 Problem by the Service Providers, or by
governments, exchanges, clearinghouses, regulators, banks and other third
parties, are unknown to the Partnership at this time, but could have a material
adverse impact on the operations of the Partnership. The General Partner will
promptly
13
notify the Partnership's limited partners in the event it determines that the
Year 2000 Problem will have a material adverse impact on the Partnership's
operations.
The Partnership has considered various alternatives as a contingency plan. If
the Year 2000 Problems are systemic, for example, the federal government, the
banking system, exchanges or utilities are affected materially, there may be no
adequate contingency plan for the Partnership to follow other than to suspend
operations. If the Year 2000 Problems are related to one or more of the other
Service Providers selected by the Partnership, the Partnership believes that
each such Service Provider is prepared to address any Year 2000 Problems which
arise that could have a material adverse impact 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, 1998.
14
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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 3, L.P. is accurate and complete.
SEAPORT FUTURES
MANAGEMENT, INC.
(General Partner)
By: Barbara J. Brooks
Chief Financial Officer
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15
OTHER INFORMATION
The actual round-turn equivalent of brokerage commissions paid per contract
for the year ended December 31, 1998 was $19.
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 3, L.P.
P.O. Box 2016
Peck Slip Station
New York, New York 10272-2016
16
Peck Slip Station BULK RATE
P.O. Box 2016 U.S. POSTAGE
New York, NY 10272 PAID
Automatic Mail
PBCR3/171879