1998
- --------------------------------------------------------------------------------
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
January 26, 1999
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, 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 2, L.P.
(a limited partnership)
STATEMENTS OF FINANCIAL CONDITION
December 31,
--------------------------
1998 1997
- --------------------------------------------------------------------------------------------------
ASSETS
Equity in commodity trading accounts:
Cash $ 4,870,709 $ 6,552,063
U.S. Treasury bills, at amortized cost 19,282,809 24,241,834
Net unrealized gain on open commodity positions 587,862 1,584,684
----------- -----------
Total assets $24,741,380 $32,378,581
----------- -----------
----------- -----------
LIABILITIES AND PARTNERS' CAPITAL
Liabilities
Redemptions payable $ 566,962 $ 740,550
Accrued expenses 56,959 55,038
Management fees payable 44,165 97,818
Incentive fees payable 19,484 226,348
Due to affiliates 11,263 7,663
Options, at market 10,929 3,600
----------- -----------
Total liabilities 709,762 1,131,017
----------- -----------
Commitments
Partners' capital
Limited partners (98,989 and 119,135 units outstanding) 23,791,274 30,934,928
General partner (1,000 and 1,204 units outstanding) 240,344 312,636
----------- -----------
Total partners' capital 24,031,618 31,247,564
----------- -----------
Total liabilities and partners' capital $24,741,380 $32,378,581
----------- -----------
----------- -----------
Net asset value per limited and general partnership unit ('Units') $ 240.34 $ 259.66
----------- -----------
----------- -----------
- --------------------------------------------------------------------------------------------------
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,
-----------------------------------------------------
1998 1997 1996
- ---------------------------------------------------------------------------------------------------------
REVENUES
Net realized gain on commodity transactions $ 669,325 $ 5,486,720 $ 8,858,731
Change in net unrealized gain on open commodity
positions (1,001,790) 919,014 (212,725)
Interest from U.S. Treasury bills 986,548 1,219,506 1,114,103
--------------- --------------- ---------------
654,083 7,625,240 9,760,109
--------------- --------------- ---------------
EXPENSES
Commissions 2,208,844 2,602,752 2,566,587
Management fees 831,579 1,124,398 1,101,928
Incentive fees 27,241 433,379 704,792
General and administrative 150,768 156,283 139,510
--------------- --------------- ---------------
3,218,432 4,316,812 4,512,817
--------------- --------------- ---------------
Net income (loss) $(2,564,349) $ 3,308,428 $ 5,247,292
--------------- --------------- ---------------
--------------- --------------- ---------------
ALLOCATION OF NET INCOME (LOSS)
Limited partners $(2,538,726) $ 3,275,346 $ 5,203,383
--------------- --------------- ---------------
--------------- --------------- ---------------
General partner $ (25,623) $ 33,082 $ 43,909
--------------- --------------- ---------------
--------------- --------------- ---------------
NET INCOME (LOSS) PER WEIGHTED AVERAGE
LIMITED AND GENERAL PARTNERSHIP UNIT
Net income (loss) per weighted average
limited and general partnership unit $ (22.84) $ 25.75 $ 35.04
--------------- --------------- ---------------
--------------- --------------- ---------------
Weighted average number of limited and
general partnership units outstanding 112,273 128,507 149,733
--------------- --------------- ---------------
--------------- --------------- ---------------
- ---------------------------------------------------------------------------------------------------------
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
LIMITED GENERAL
UNITS PARTNERS PARTNER TOTAL
- -----------------------------------------------------------------------------------------------------
Partners' capital--December 31, 1995 161,818 $29,692,794 $ 1,976,675 $31,669,469
Net income -- 5,203,383 43,909 5,247,292
Redemptions (28,790) (4,199,389) (1,710,345) (5,909,734)
-------- ----------- ----------- -----------
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
-------- ----------- ----------- -----------
-------- ----------- ----------- -----------
- -----------------------------------------------------------------------------------------------------
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 since September 1, 1998 are 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 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.
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 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.'
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.
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. 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).
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 Trading Manager 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).
6
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, 1998 were:
1998 1997 1996
---------- ---------- ----------
Commissions $2,208,844 $2,602,752 $2,566,587
General and administrative 69,689 86,018 87,997
---------- ---------- ----------
$2,278,533 $2,688,770 $2,654,584
---------- ---------- ----------
---------- ---------- ----------
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, 1998:
1998 1997 1996
----------- ---------- ----------
Net income (loss) per financial statements $(2,564,349) $3,308,428 $5,247,292
Change in unrealized gain/loss on nonregulated
commodity positions 153,409 263,932 (216,909)
----------- ---------- ----------
Tax basis net income (loss) $(2,410,940) $3,572,360 $5,030,383
----------- ---------- ----------
----------- ---------- ----------
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 (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.
7
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 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, 1998, such segregated assets totalled $18,024,934. 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 $7,005,960 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, forward and option
contracts mature within six months.
At December 31, 1998 and 1997, gross contract amounts of open futures,
forward and options contracts are:
1998 1997
----------- ------------
Currency Forward Contracts:
Commitments to purchase $22,873,426 $ 318,066
Commitments to sell 34,657,512 24,765,572
Currency Futures and Options Contracts:
Commitments to purchase 5,856,239 1,232,952
Commitments to sell 6,186,805 4,626,480
Financial Futures and Options Contracts:
Commitments to purchase 64,800,054 183,537,088
Commitments to sell 63,817,191 126,817,265
Other Futures and Options Contracts:
Commitments to purchase 67,482 2,876,350
Commitments to sell 5,956,997 14,809,027
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 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 involved, while the market risk associated with its
commitments to sell is unlimited since the Partnership's potential
8
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 $ 182,195 $ (10,003) $ 178,094 $ (4,700)
Currencies 163,687 (80,275) 41,016 (6,677)
Other 105,886 (31,160) 1,020,252 (1,810)
Foreign exchanges
Financial 640,142 (45,819) 493,686 (229,030)
Other 61,678 (98,026) 170,110 (4,500)
Forward Contracts:
Currencies 445,954 (746,397) 374,665 (446,422)
Options Contracts:
Domestic exchanges
Financial -- (2,046) -- (3,600)
Currencies -- (7,150) -- --
Other -- (1,733) -- --
---------- ----------- ---------- -----------
$1,599,542 $(1,022,609) $2,277,823 $(696,739)
---------- ----------- ---------- -----------
---------- ----------- ---------- -----------
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 $ 183,434 $ (36,878) $ 253,723 $ (32,496)
Currencies 139,493 (34,466) 222,701 (35,346)
Other 179,925 (50,069) 338,062 (21,850)
Foreign exchanges
Financial 612,348 (108,534) 917,265 (112,232)
Other 57,838 (80,330) 39,112 (18,236)
Forward Contracts:
Currencies 227,693 (620,391) 669,467 (591,182)
Options Contracts:
Domestic exchanges
Financial -- (18,606) -- (20,186)
Currencies -- (4,040) 1,969 (32,900)
Other -- (4,499) 14,323 (2,642)
Foreign exchanges
Financial -- (69) 3,441 (4,528)
---------- ----------- ---------- -----------
$1,400,731 $(957,882) $2,460,063 $(871,598)
---------- ----------- ---------- -----------
---------- ----------- ---------- -----------
The following table presents the trading revenues from futures, forward and
options contracts during the three years ended December 31, 1998:
1998 1997 1996
----------- ---------- -----------
Futures Contracts:
Domestic exchanges
Financial $ 849,120 $ 574,788 $ 222,713
Currencies 116,940 102,452 831,840
Other (1,336,822) 1,699,643 1,245,429
Foreign exchanges
Financial 1,983,641 2,972,822 4,029,715
Other (151,461) 217,780 (16,314)
Forward Contracts:
Currencies (1,890,440) 660,518 2,205,953
Options Contracts:
Domestic exchanges
Financial 111,046 40,668 27,225
Currencies 5,851 110,600 100,225
Other (22,135) 98,356 10,749
Foreign exchanges
Financial 1,795 (71,893) (11,529)
----------- ---------- -----------
$ (332,465) $6,405,734 $ 8,646,006
----------- ---------- -----------
----------- ---------- -----------
10
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 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, 1998, 100% of the Partnership's total net assets (the 'Net
Asset Value') was allocated to commodities trading. A significant portion of the
Net Asset Value was held in U.S. Treasury bills (which represented approximately
78% 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 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, forwards and options contracts.
Redemptions by limited partners and General Partner for the year ended
December 31, 1998 were $4,604,928 and $46,669, respectively. Redemptions by
limited partners and the General Partner recorded from the commencement of
operations, October 6, 1989, through December 31, 1998 totalled $122,922,116 and
$1,787,699, 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.
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 Registrant, 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.
11
Results of Operations
The net asset value per Unit as of December 31, 1998 was $240.34, a decrease
of 7.44% from the December 31, 1997 net asset value per Unit of $259.66, which
was an increase of 11.40% from the December 31, 1996 net asset value per Unit of
$233.09. 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 had an unprofitable 1998 with losses sustained in the
currency, metal, index, energy, grain, and soft sectors. Mitigating losses were
profits in the financial and meat sectors.
Lack of any discernable trends drove losses in the currency sector. In
January, investor optimism over efforts to revive ailing Asian economies boosted
the Japanese yen against the U.S. dollar. However, shifting investor sentiment
regarding Asian economies in February caused losses, particularly in Japanese
yen positions. In June, investors fled to the safety of the British pound as the
result of Russian and Japanese turmoil causing losses for the Partnership. The
second half of 1998 brought little opportunity for profit as significant market
trends failed to develop.
Negative performance in the metal sector resulted from changing market
direction, with gold positions experiencing the biggest losses. As the year
opened, the Partnership incurred losses as gold prices reversed in January. Then
in March, short gold positions lost value as a strong housing report renewed
fears of inflation in the U.S., thus generating interest in gold as a hedge
against inflation. The market reversed again in April as investors sold gold on
a strengthening bond market. Gold prices continued to fall through July,
rebounding in August and September as global stock markets fell and investors
moved to the 'safety' of gold. The year ended with another reversal in gold when
tensions in the Middle East caused prices to fall.
The Partnership profited from positions in the financial sector, which
provided various opportunities throughout the year. In January, reduced
inflation worries benefited European bond markets and consequently the
Partnership. 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, generating profits for U.S. and European bond
positions. In the fourth quarter, short Japanese government bond positions
gained amid indications of a substantial reduction in local demand and potential
increased supply as the government proposed financing the economic stimulus
package with debt.
Interest income is earned on the Partnership's investment 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 approximately
$233,000 for the year ended December 31, 1998 compared to 1997 due to fewer
funds being invested in U.S. Treasury bills as a result of redemptions and weak
trading performance during 1998, and a decline in interest rates during 1998.
Interest income from U.S. Treasury bills increased by approximately $105,000 for
the year ended December 31, 1997 compared to 1996 primarily due to an increase
in funds available for investment in U.S. Treasury bills following a strong 1996
fourth quarter and a profitable 1997 year.
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 $394,000 for
the year ended December 31, 1998 as compared to 1997 principally due to the
effect of weak trading performance during 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. Commissions increased by approximately $36,000 for the year
ended December 31, 1997 as compared to 1996 principally reflecting the effect of
strong trading performance during the last quarter of 1996 and throughout 1997
on monthly Net Asset Values offset, in part, by redemptions.
All trading decisions are currently being made by Welton, Eclipse, Trendlogic
and Gaiacorp. Effective September 1, 1998, the General Partner reallocated
assets previously managed by John W. Henry & Company, Inc. as further discussed
in Liquidity and Capital Resources above. Management fees are calculated on 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 $293,000 for the year ended December
31, 1998 as compared to 1997, but increased by approximately $22,000 for the
year ended December 31, 1997 as compared to 1996 due to fluctuations in monthly
Net Asset Values as described in the discussion on commissions above. The 1998
versus 1997
12
decrease was also caused by a reduction in the management fee rate on
Reallocated Assets as further discussed in Liquidity and Capital Resources
above.
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, Welton and Trendlogic each generated sufficient
trading profits during 1998 to earn incentive fees of approximately $22,000 and
$5,000, respectively. During 1997, John W. Henry & Company, Inc. ('JWH'),
Welton, and Eclipse earned incentive fees of approximately $273,000, $50,000 and
$110,000, respectively. During 1996, JWH and Analytic/TSA Capital Management
earned incentive fees of approximately $657,000 and $48,000, respectively. See
Liquidity and Capital Resources above for information concerning changes to
incentive fee rates during 1998.
General and administrative expenses decreased by approximately $6,000 for the
year ended December 31, 1998 as compared to 1997, but increased by approximately
$17,000 for the year ended December 31, 1997 as compared to 1996. 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, as
'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, clearing houses, 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 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
13
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
- --------------------------------------------------------------------------------
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
- --------------------------------------------------------------------------------
15
OTHER INFORMATION
The actual round-turn equivalent of brokerage commissions paid per contract
for the year ended December 31, 1998 was $73.
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
16
Peck Slip Station BULK RATE
P.O. Box 2016 U.S. POSTAGE
New York, NY 10272 PAID
Automatic Mail
PBCR2/171781