<PAGE>
 
 
                                                                    SMITH BARNEY
                                                                         Managed
                                                                     Governments
                                                                       Fund Inc.
                                                           
                                                          NOVEMBER 27, 1998  
 
                                                   Prospectus begins on page one
 
 
P R O S P E C T U S


[LOGO] Smith Barney Mutual Funds
       Investing for your future.
       Every day.
<PAGE>
 
PROSPECTUS                                                
                                                         NOVEMBER 27, 1998  
 
Smith Barney Managed Governments Fund Inc.
388 Greenwich Street
New York, New York 10013
800-451-2010
 
  Smith Barney Managed Governments Fund Inc. (the "Fund") is a diversified fund
designed to provide investors with high current income consistent with liquid-
ity and safety of capital. The Fund seeks to achieve this objective by invest-
ing in debt obligations of varying maturities issued or guaranteed by the
United States government or its agencies or instrumentalities (with emphasis on
mortgage-backed government securities) and by writing covered put and call
options against certain of such securities. The Fund also may enter into cer-
tain other options and futures transactions for hedging purposes.
 
  This Prospectus sets forth concisely certain information about the Fund,
including sales charges, distribution and service fees and expenses, that pro-
spective investors will find helpful in making an investment decision. Invest-
ors are encouraged to read this Prospectus carefully and retain it for future
reference.
 
  Additional information about the Fund is contained in a Statement of Addi-
tional Information dated November 25, 1998, (the "SAI") as amended or supple-
mented from time to time, that is available upon request and without charge by
calling or writing the Fund at the telephone number or address set forth above
or by contacting a Salomon Smith Barney Financial Consultant. The SAI has been
filed with the Securities and Exchange Commission (the "SEC") and is incorpo-
rated by reference into this Prospectus in its entirety.
 
CFBDS, INC.
Distributor
 
MUTUAL MANAGEMENT CORP.
Investment Adviser and Administrator
 
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
 
                                                                               1
<PAGE>
 
TABLE OF CONTENTS
 
 
<TABLE> 
<S>                                           <C>
PROSPECTUS SUMMARY                              3
-------------------------------------------------
FINANCIAL HIGHLIGHTS                           10
-------------------------------------------------
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES   15
-------------------------------------------------
VALUATION OF SHARES                            24
-------------------------------------------------
DIVIDENDS, DISTRIBUTIONS AND TAXES             24
-------------------------------------------------
PURCHASE OF SHARES                             26
-------------------------------------------------
EXCHANGE PRIVILEGE                             34
-------------------------------------------------
REDEMPTION OF SHARES                           37
-------------------------------------------------
MINIMUM ACCOUNT SIZE                           40
-------------------------------------------------
PERFORMANCE                                    40
-------------------------------------------------
MANAGEMENT OF THE FUND                         41
-------------------------------------------------
DISTRIBUTOR                                    42
-------------------------------------------------
ADDITIONAL INFORMATION                         43
</TABLE> 
 
--------------------------------------------------------------------------------
 
  No person has been authorized to give any information or to make any
representations in connection with this offering other than those contained in
this Prospectus and, if given or made, such other information or
representations must not be relied upon as having been authorized by the Fund
or the distributor. This Prospectus does not constitute an offer by the Fund or
the distributor to sell or a solicitation of an offer to buy any of the
securities offered hereby in any jurisdiction to any person to whom it is
unlawful to make such offer or solicitation in such jurisdiction.
 
--------------------------------------------------------------------------------
 
2
<PAGE>
 
PROSPECTUS SUMMARY
 
 
  The following summary is qualified in its entirety by detailed information
appearing elsewhere in this Prospectus and in the SAI. Cross references in
this summary are to headings in the Prospectus. See "Table of Contents."
 
INVESTMENT OBJECTIVE The Fund is an open-end, diversified management invest-
ment company designed to provide investors with high current income consistent
with liquidity and safety of capital. The Fund seeks to achieve its objective
by investing in debt obligations of varying maturities issued or guaranteed by
the United States government or its agencies or instrumentalities ("U.S. gov-
ernment securities") and by writing covered put and call options. The Fund's
portfolio of U.S. government securities will consist principally of mortgage-
backed securities issued or guaranteed by the Government National Mortgage
Association ("GNMA"), the Federal National Mortgage Association ("FNMA") and
the Federal Home Loan Mortgage Corporation ("FHLMC"). The Fund may seek to
hedge against changes in the value of its portfolio securities by purchasing
options on securities and by purchasing and selling interest rate futures con-
tracts and related options. See "Investment Objective and Management Poli-
cies."
 
ALTERNATIVE PURCHASE ARRANGEMENTS The Fund offers several classes of shares
("Classes") to investors designed to provide them with the flexibility of
selecting an investment best suited to their needs. The general public is
offered three Classes of shares: Class A shares, Class B shares and Class L
shares, which differ principally in terms of sales charges and rates of
expenses to which they are subject. A fourth Class of shares, Class Y shares,
is offered only to investors meeting an initial investment minimum of
$15,000,000. See "Purchase of Shares" and "Redemption of Shares."  
 
  Class A Shares. Class A shares are sold at net asset value plus an initial
sales charge of up to 4.50% and are subject to an annual service fee of 0.25%
of the average daily net assets of the Class. The initial sales charge may be
reduced or waived for certain purchases. Purchases of Class A shares of
$500,000 or more, will be made at net asset value with no initial sales
charge, but will be subject to a contingent deferred sales charge ("CDSC") of
1.00% on redemptions made within 12 months of purchase. See "Prospectus Summa-
ry--Reduced or No Initial Sales Charge."
 
  Class B Shares. Class B shares are offered at net asset value subject to a
maximum CDSC of 4.50% of redemption proceeds, declining by 0.50% the first
year after purchase and 1.00% each year thereafter to zero. This CDSC may be
waived for certain redemptions. Class B shares are subject to an annual serv-
ice fee of 0.25% and an annual distribution fee of 0.50% of the average daily
net assets of the Class. The Class B shares' distribution fee may cause that
Class to have higher expenses and pay lower dividends than Class A shares.
 
                                                                              3
<PAGE>
 
PROSPECTUS SUMMARY (CONTINUED)
 
 
  Class B Shares Conversion Feature. Class B shares will convert automatically
to Class A shares, based on relative net asset value, eight years after the
date of the original purchase. Upon conversion, these shares will no longer be
subject to an annual distribution fee. In addition, a certain portion of Class
B shares that have been acquired through the reinvestment of dividends and
distributions ("Class B Dividend Shares") will be converted at that time. See
"Purchase of Shares--Deferred Sales Charge Alternatives."
 
  Class L Shares. Class L shares are sold at net asset value plus an initial
sales charge of 1.00% of the purchase price. They are subject to an annual
service fee of 0.25% and an annual distribution fee of 0.45% of the average
daily net assets of the Class, and investors pay a CDSC of 1.00% if they
redeem Class L shares within 12 months of purchase. The CDSC may be waived for
certain redemptions. The Class L shares' distribution fee may cause that Class
to have higher expenses and pay lower dividends than Class A shares. Purchases
of the Fund's shares, which when combined with current holdings of Class L
shares of the Fund equal or exceed $500,000 in the aggregate, should be made
in Class A shares at net asset value with no sales charge, and will be subject
to a CDSC of 1.00% on redemptions made within 12 months of purchase.
 
  Class Y Shares. Class Y shares are available only to investors meeting an
initial investment minimum of $15,000,000. Class Y shares are sold at net
asset value with no initial sales charge or CDSC. They are not subject to any
service or distribution fees.
 
  In deciding which Class of Fund shares to purchase, investors should con-
sider the following factors, as well as any other relevant facts and circum-
stances:
 
  Intended Holding Period. The decision as to which Class of shares is more
beneficial to an investor depends on the amount and intended duration of his
or her investment. Shareholders who are planning to establish a program of
regular investment may wish to consider Class A shares; as the investment
accumulates shareholders may qualify for reduced sales charges and the shares
are subject to lower ongoing expenses over the term of the investment. As an
alternative, Class B shares are sold without any initial sales charge so the
entire purchase price is immediately invested in the Fund. Any investment
return on these additional invested amounts may partially or wholly offset the
higher annual expenses of this Class. Because the Fund's future return cannot
be predicted, however, there can be no assurance that this would be the case.
Class L shares which have a lower upfront sales charge but are subject to
higher distribution fees than Class A shares, are suitable for investors who
are not investing or intending to invest an amount which would receive a sub-
stantial sales charge discount and who have a short-term or undetermined time
frame.  
 
4
<PAGE>
 
PROSPECTUS SUMMARY (CONTINUED)
 
 
  Finally, investors should consider the effect of the CDSC period and any con-
version rights of the Classes in the context of their own investment time
frame. For example, while Class L shares have a shorter CDSC period than Class
B shares, they do not have a conversion feature, and therefore, are subject to
an ongoing distribution fee. Thus, Class B shares may be more attractive than
Class L shares to investors with longer term investment outlooks.
 
  Reduced or No Initial Sales Charge. The initial sales charge on Class A
shares may be waived for certain eligible purchasers, and the entire purchase
price will be immediately invested in the Fund. In addition, Class A share pur-
chases of $500,000 or more, will be made at net asset value with no initial
sales charge, but will be subject to a CDSC of 1.00% on redemptions made within
12 months of purchase. The $500,000 investment may be met by adding the pur-
chase to the net asset value of all Class A shares offered with a sales charge
held in funds sponsored by Salomon Smith Barney Inc. ("Salomon Smith Barney")
listed under "Exchange Privilege." Class A share purchases may also be eligible
for a reduced initial sales charge. See "Purchase of Shares." Because the ongo-
ing expenses of Class A shares may be lower than those for Class B and Class L
shares, purchasers eligible to purchase Class A shares at net asset value or at
a reduced sales charge should consider doing so.
 
  Salomon Smith Barney Financial Consultants may receive different compensation
for selling different Classes of shares. Investors should understand that the
purpose of the CDSC on the Class B and Class L shares is the same as that of
the initial sales charge on the Class A shares.
 
  See "Purchase of Shares" and "Management of the Fund" for a complete descrip-
tion of the sales charges and service and distribution fees for each Class of
shares and "Valuation of Shares," "Dividends, Distributions and Taxes" and "Ex-
change Privilege" for other differences between the Classes of shares.
 
SMITH BARNEY 401(K) AND EXECCHOICE(TM) PROGRAMS Investors may be eligible to
participate in the Smith Barney 401(k) Program, which is generally designed to
assist plan sponsors in the creation and operation of retirement plans under
Section 401(a) of the Internal Revenue Code of 1986, as amended (the "Code"),
as well as other types of participant directed, tax-qualified employee benefit
plans. Investors may also be eligible to participate in the Smith Barney
ExecChoice(TM) Program. Class A and Class L shares are available without a
sales charge as investment alternatives under both of these Programs. See "Pur-
chase of Shares--Smith Barney 401(k) and ExecChoice(TM) Programs."
 
DISTRIBUTOR The Fund has entered into an agreement with CFBDS, Inc. ("CFBDS")
to distribute the Fund's shares.  
 
                                                                               5
<PAGE>
 
PROSPECTUS SUMMARY (CONTINUED)
 
PURCHASE OF SHARES Investors may purchase shares from a Salomon Smith Barney
Financial Consultant, an investment dealer in the selling group or a broker
that clears securities through Salomon Smith Barney. (An investment dealer in
the selling group and a broker that clears securities through Salomon Smith
Barney are collectively referred to as "Dealer Representatives.") In addition,
certain investors, including qualified retirement plans and investors purchas-
ing through certain Dealer Representatives, may purchase shares directly from
the Fund through the Fund's transfer agent, First Data Investor Services Group,
Inc. (the "Transfer Agent"). See "Purchase of Shares."  
 
INVESTMENT MINIMUMS Investors in Class A, Class B and Class L shares may open
an account by making an initial investment of at least $1,000 for each account,
or $250 for an individual retirement account ("IRA") or a Self-Employed
Retirement Plan. Investors in Class Y shares may open an account for an initial
investment of $15,000,000. Subsequent investments of at least $50 may be made
for all Classes. For participants in retirement plans qualified under Section
403(b)(7) or Section 401(a) of the Code, the minimum initial investment
requirement for Class A, Class B, and Class L shares and the subsequent invest-
ment requirement for all Classes is $25. For minimum investment requirements
for all Classes through the Systematic Investment Plan, see below. See "Pur-
chase of Shares."
 
SYSTEMATIC INVESTMENT PLAN The Fund offers shareholders a Systematic Investment
Plan under which they may authorize the automatic placement of a purchase order
each month or quarter for Fund shares. The minimum initial investment require-
ment for Class A, Class B and Class L shares and the subsequent investment
requirement for all Classes for shareholders purchasing shares through the Sys-
tematic Investment Plan on a monthly basis is $25 and on a quarterly basis is
$50. See "Purchase of Shares."
 
REDEMPTION OF SHARES Shares may be redeemed on each day the New York Stock
Exchange, Inc. ("NYSE") is open for business. See "Purchase of Shares" and "Re-
demption of Shares."
 
MANAGEMENT OF THE FUND Mutual Management Corp. ("MMC" or the "Advisor") (for-
merly known as Smith Barney Mutual Funds Management Inc.) serves as the Fund's
investment adviser and administrator. MMC is a wholly owned subsidiary of Salo-
mon Smith Barney Holdings Inc. ("Holdings"). Holdings is a wholly owned subsid-
iary of Citigroup Inc. ("Citigroup"). Citigroup businesses produce a broad
range of financial services -- asset management, banking and consumer finance,
credit and charge cards, insurance, investments, investment banking and trading
-- and use diverse channels to make them available to consumer and corpo  -
 
6
<PAGE>
 
PROSPECTUS SUMMARY (CONTINUED)
 
rate customers around the world. Among these businesses are Citibank, Commer-
cial Credit, Primerica Financial Services, Salomon Smith Barney, SSBC Asset
Management, Travelers Life & Annuity, and Travelers Property Casualty. See
"Management of the Fund."  
 
EXCHANGE PRIVILEGE Shares of a Class may be exchanged for shares of the same
Class of certain other funds of the Smith Barney Mutual Funds at the respec-
tive net asset values next determined. See "Exchange Privilege."
 
VALUATION OF SHARES Net asset value of the Fund for the prior day generally is
quoted daily in the financial section of most newspapers and is also available
from Salomon Smith Barney Financial Consultants. See "Valuation of Shares."
    
DIVIDENDS AND DISTRIBUTIONS Dividends from net investment income are 
paid monthly. Distributions of net realized capital
gains, if any, are paid at least annually. See "Dividends, Distributions and
Taxes."
     
REINVESTMENT OF DIVIDENDS Dividends and distributions paid on shares of a
Class will be reinvested automatically, unless otherwise specified by an
investor, in additional shares of the same Class at current net asset value.
Shares acquired by dividend and distribution reinvestments will not be subject
to any sales charge or CDSC. Class B shares acquired through dividend and dis-
tribution reinvestments will become eligible for conversion to Class A shares
on a pro rata basis. See "Dividends, Distributions and Taxes."  
 
RISK FACTORS AND SPECIAL CONSIDERATIONS There can be no assurance that the
Fund's investment objective will be achieved. Historically, the yields pro-
vided by mortgage-backed U.S. government securities have exceeded the yields
on other types of U.S. government securities of comparable maturity. Thus, the
Fund's yield may at times be higher than that of mutual funds investing solely
in other types of U.S. government securities. However, mortgage-backed U.S.
government securities may be less effective than other such securities as a
means of "locking in" attractive long-term interest rates due to the need to
reinvest prepayments of principal generally and the possibility of significant
unscheduled prepayments resulting from declines in mortgage interest rates. In
addition, the market values of the U.S. government securities held in the
Fund's portfolio--and, accordingly, the Fund's net asset value--generally will
vary inversely with changes in market interest rates, both declining when
interest rates rise and rising when interest rates decline. Mortgage-backed
U.S. government securities, however, may have less potential for capital
appreciation than other investments of comparable maturities due to the like-
lihood of increased prepayments of mortgages as interest rates decline, while
having comparable risk of decline in value during periods of rising rates. See
"Investment Objective and Management Policies."
 
                                                                              7
<PAGE>
 
PROSPECTUS SUMMARY (CONTINUED)
 
 
THE FUND'S EXPENSES The following expense table lists the costs and expenses
that an investor will incur either directly or indirectly as a shareholder of
the Fund, based on the maximum sales charge or maximum CDSC that may be
incurred at the time of purchase or redemption and the Fund's operating
expenses for its most recent fiscal year:
 
<TABLE> 
<CAPTION>
  MANAGED GOVERNMENTS FUND                   CLASS A  CLASS B CLASS L* CLASS Y
------------------------------------------------------------------------------
  <S>                                        <C>      <C>     <C>      <C>
  SHAREHOLDER TRANSACTION EXPENSES
    Maximum sales charge imposed on
      purchases
      (as a percentage of offering price)     4.50%    None     1.00%   None
    Maximum CDSC (as a percentage of
      original cost or redemption proceeds,
      whichever is lower)                     None**   4.50%    1.00%   None
------------------------------------------------------------------------------
  ANNUAL FUND OPERATING EXPENSES
    (as a percentage of average net assets)
    Management Fees                           0.65%    0.65%    0.65%   0.65%
    12b-1 Fees***                             0.25     0.75     0.70    None
    Other Expenses                            0.13     0.16     0.14    0.04
------------------------------------------------------------------------------
  TOTAL FUND OPERATING EXPENSES               1.03%    1.56%    1.49%   0.69%
------------------------------------------------------------------------------
</TABLE> 
 
  * Class L shares were called Class C shares until June 12, 1998. For
    shareholders who owned Class C shares of the Fund as of June 12, 1998,
    Class L shares may be purchased without paying the 1% initial sales charge
    until June 22, 2001.  
 ** Purchases of Class A shares of $500,000 or more will be made at net asset
    value with no sales charge, but will be subject to a CDSC of 1.00% on
    redemptions made within 12 months of purchase.
*** Upon conversion of Class B shares to Class A shares, such shares will no
    longer be subject to a distribution fee. Class L shares do not have a
    conversion feature and, therefore, are subject to an ongoing distribution
    fee. As a result, long-term shareholders of Class L shares may pay more
    than the economic equivalent of the maximum front-end sales charge
    permitted by the National Association of Securities Dealers, Inc.
 
  Class A shares of the Fund purchased through the Smith Barney AssetOne Pro-
gram will be subject to an annual asset-based fee, payable quarterly, in lieu
of the initial sales charge. The fee will vary to a maximum of 1.50%, depending
on the amount of assets held through the Program. For more information, please
call your Salomon Smith Barney Financial Consultant. The sales charge and CDSC
set forth in the above table are the maximum charges imposed on purchases or
redemptions of Fund shares and investors may actually pay lower or no charges
depending on the amount purchased and, in the case of Class L and certain Class
A shares, the length of time the shares are held and whether the shares are
held through the Smith Barney 401(k) and ExecChoice(TM) Programs. See "Purchase
of Shares" and "Redemption of Shares." Salomon Smith Barney receives an annual
12b-1 service fee of 0.25% of the value of average daily net assets of Class A
shares. Salomon Smith Barney also receives, with respect to Class B shares, an
annual 12b-1 fee of 0.75% of the value of the average daily net assets of that
Class, consisting of a 0.50% distribution fee and a 0.25% service fee. For
Class L shares, Salomon Smith Barney receives an annual 12b-1 fee of 0.70% of
the value of average daily net assets of this Class, consisting of a 0.45% dis-
tribution fee and a 0.25% service fee. "Other expenses" in the above table
include fees for shareholder services, custodial fees, legal and accounting
fees, printing costs and registration fees.  
 
8
<PAGE>
 
PROSPECTUS SUMMARY (CONTINUED)
 
 
  EXAMPLE The following example is intended to assist an investor in under-
standing the various costs that an investor in the Fund will bear directly or
indirectly. The example assumes payment by the Fund of operating expenses at
the levels set forth in the table above. See "Purchase of Shares," "Redemption
of Shares" and "Management of the Fund."
 
<TABLE>
<CAPTION>
  MANAGED GOVERNMENTS FUND                    1 YEAR 3 YEARS 5 YEARS 10 YEARS*
------------------------------------------------------------------------------
  <S>                                         <C>    <C>     <C>     <C>
  An investor would pay the following
  expenses on a $1,000 investment, assuming
  (1) 5.00% annual return and (2) redemption
  at the end of each time period:
    Class A..................................  $55     $76     $99     $165
    Class B..................................   61      79      95      171
    Class L..................................   35      57      91      186
    Class Y..................................    7      22      38       86
  An investor would pay the following
  expenses on the same investment, assuming
  the same annual return and no redemption:
    Class A..................................  $55     $76     $99     $165
    Class B..................................   16      49      85      171
    Class L..................................   25      57      91      186
    Class Y..................................    7      22      38       86
------------------------------------------------------------------------------
</TABLE>
 * Ten-year figures assume conversion of Class B shares to Class A shares at
   the end of the eighth year following the date of purchase.
 
  The example also provides a means for the investor to compare expense levels
of funds with different fee structures over varying investment periods. To
facilitate such comparison, all funds are required to utilize a 5.00% annual
return assumption. However, the Fund's actual return will vary and may be
greater or less than 5.00%. THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTA-
TION OF PAST OR FUTURE EXPENSES AND ACTUAL EXPENSES MAY BE GREATER OR LESS THAN
THOSE SHOWN.
 
                                                                               9
<PAGE>
 
FINANCIAL HIGHLIGHTS
 
The following information for the four year period ended July 31, 1998 has
been audited by KPMG Peat Marwick LLP, independent accountants, whose report
thereon appears in the Fund's Annual Report dated July 31, 1998. The following
information for the fiscal years ended July 31, 1989 through July 31, 1994 has
been audited by other auditors. This information should be read in conjunction
with the financial statements and related notes that also appear in the Fund's
Annual Report, which is incorporated by reference into the Statement of Addi-
tional Information.  
 
FOR A SHARE OF EACH CLASS OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR:
MANAGED GOVERNMENTS FUND
 
<TABLE> 
<CAPTION>
CLASS A SHARES                 1998   1997(1)  1996(1)   1995    1994   1993(1)
-------------------------------------------------------------------------------
<S>                           <C>     <C>      <C>      <C>     <C>     <C>
NET ASSET VALUE, BEGINNING
OF YEAR                       $12.84   12.27   $12.63   $12.50  $13.29  $12.88
-------------------------------------------------------------------------------
INCOME FROM OPERATIONS:
 Net investment income          0.75    0.80     0.81     0.81    0.75    0.69
 Net realized and unrealized
   gain (loss)                 (0.06)   0.59    (0.34)    0.10   (0.74)   0.61
-------------------------------------------------------------------------------
Total Income From Operations    0.69    1.39     0.47     0.91    0.01    1.30
-------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income         (0.80)  (0.82)   (0.82)   (0.74)  (0.61)  (0.66)
 Net realized gains              --      --       --       --      --    (0.23)
 Capital                         --      --     (0.01)   (0.04)  (0.19)    --
-------------------------------------------------------------------------------
Total Distributions            (0.80)  (0.82)   (0.83)   (0.78)  (0.80)  (0.89)
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR  $12.73  $12.84   $12.27   $12.63  $12.50  $13.29
-------------------------------------------------------------------------------
TOTAL RETURN                    5.51%  11.80%    3.76%    7.67%   0.08%  10.43%
-------------------------------------------------------------------------------
NET ASSETS, END OF YEAR
(MILLIONS)                      $374    $415     $455     $529    $371    $463
-------------------------------------------------------------------------------
RATIOS TO AVERAGE NET
ASSETS:
 Expenses                       1.03%   1.01%    1.04%    1.07%   1.03%   0.99%
 Net investment income          5.78    6.43     6.46     6.57    5.60    5.35
-------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE          363%    121%     275%     292%    236%    436%
-------------------------------------------------------------------------------
</TABLE> 
(1) Per share amounts have been calculated using the monthly average shares
    method, rather than the undistributed net investment income method,
    because it more accurately reflects the per share data for the period.
 
10
<PAGE>
 
FINANCIAL HIGHLIGHTS (CONTINUED)
 
 
 
FOR A SHARE OF EACH CLASS OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR:
MANAGED GOVERNMENTS FUND
 
<TABLE> 
<CAPTION>
CLASS A SHARES                            1992    1991    1990    1989
------------------------------------------------------------------------
<S>                                      <C>     <C>     <C>     <C>
NET ASSET VALUE, BEGINNING OF YEAR       $12.09  $12.13  $12.19  $12.04
------------------------------------------------------------------------
INCOME FROM OPERATIONS:
 Net investment income                     0.91    0.98    1.07    0.96
 Net realized and unrealized gain (loss)   0.87    0.07   (0.03)   0.26
------------------------------------------------------------------------
Total Income From Operations               1.78    1.05    1.04    1.22
------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income                    (0.91)  (0.98)  (1.07)  (0.96)
 Capital                                  (0.08)  (0.11)  (0.03)  (0.11)
------------------------------------------------------------------------
Total Distributions                       (0.99)  (1.09)  (1.10)  (1.07)
------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR             $12.88  $12.09  $12.13  $12.19
------------------------------------------------------------------------
TOTAL RETURN                              15.25%   9.02%   9.01%  10.62%
------------------------------------------------------------------------
NET ASSETS, END OF YEAR (MILLIONS)         $489    $474    $512    $622
------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
 Expenses                                  0.82%   0.82%   0.81%   0.81%
 Net investment income                     7.23    8.12    8.87    8.12
------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE                     426%    365%    163%     51%
------------------------------------------------------------------------
</TABLE> 
 
 
                                                                              11
<PAGE>
 
FINANCIAL HIGHLIGHTS (CONTINUED)
 
 
FOR A SHARE OF EACH CLASS OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR:
 
MANAGED GOVERNMENTS FUND
 
<TABLE> 
<CAPTION>
CLASS B SHARES            1998(1)  1997(1)  1996(1)   1995    1994    1993(2)
-------------------------------------------------------------------------------
<S>                       <C>      <C>      <C>      <C>     <C>      <C>
NET ASSET VALUE,
BEGINNING OF YEAR         $12.84   $12.27   $12.63   $12.50  $13.29   $12.64
-------------------------------------------------------------------------------
INCOME (LOSS) FROM
OPERATIONS:
 Net investment income      0.67     0.74     0.75     0.75    0.69     0.47
 Net realized and
   unrealized gain (loss)  (0.05)    0.59    (0.34)    0.09   (0.75)    0.75
-------------------------------------------------------------------------------
Total Income (Loss) From
Operations                  0.62     1.33     0.41     0.84   (0.06)    1.22
-------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income     (0.73)   (0.76)   (0.76)   (0.67)  (0.56)   (0.41)
 Net realized gains          --       --       --       --      --     (0.16)
 Capital                     --       --     (0.01)   (0.04)  (0.17)     --
-------------------------------------------------------------------------------
Total Distributions        (0.73)   (0.76)   (0.77)   (0.71)  (0.73)   (0.57)
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF
YEAR                      $12.73   $12.84   $12.27   $12.63  $12.50   $13.29
-------------------------------------------------------------------------------
TOTAL RETURN                4.99%   11.23%    3.24%    7.04%  (0.46)%   9.92%++
-------------------------------------------------------------------------------
NET ASSETS, END OF YEAR
(MILLIONS)                   $74      $97     $111     $133    $389     $474
-------------------------------------------------------------------------------
RATIOS TO AVERAGE NET
ASSETS:
 Expenses                   1.56%    1.53%    1.56%    1.57%   1.55%    1.62%+
 Net investment income      5.27%    5.91     5.94     6.07    5.08     4.72+
-------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE      363%     121%     275%     292%    236%     436%
-------------------------------------------------------------------------------
</TABLE> 
(1) Per share amounts have been calculated using the monthly average shares
    method, rather than the undistributed net investment income method,
    because it more accurately reflects the per share data for the period.
(2) For the period from November 6, 1992 (inception date) to July 31, 1993.
++ Total return is not annualized, as it may not be representative of the
   total return for the year.
+  Annualized.
 
12
<PAGE>
 
FINANCIAL HIGHLIGHTS (CONTINUED)
 
 
FOR A SHARE OF EACH CLASS OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR:
 
MANAGED GOVERNMENTS FUND
 
<TABLE>
<CAPTION>
CLASS L SHARES(1)         1998(2)  1997(2)  1996(2)   1995    1994    1993(3)
-------------------------------------------------------------------------------
<S>                       <C>      <C>      <C>      <C>     <C>      <C>
NET ASSET VALUE,
BEGINNING OF YEAR         $12.84   $12.27   $12.63   $12.50  $13.29   $13.18
-------------------------------------------------------------------------------
INCOME (LOSS) FROM
OPERATIONS:
 Net investment income      0.67     0.74     0.75     0.76    0.69     0.07
 Net realized and
 unrealized gain (loss)    (0.04)    0.59    (0.34)    0.08   (0.75)    0.09
-------------------------------------------------------------------------------
Total Income (Loss) From
Operations                  0.63     1.33     0.41     0.84   (0.06)    0.16
-------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income     (0.74)   (0.76)   (0.76)   (0.67)  (0.56)   (0.03)
 Net realized gains          --       --       --       --      --     (0.02)
 Capital                     --       --     (0.01)   (0.04)  (0.17)     --
-------------------------------------------------------------------------------
Total Distributions        (0.74)   (0.76)   (0.77)   (0.71)  (0.73)   (0.05)
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF
YEAR                      $12.73   $12.84   $12.27   $12.63  $12.50   $13.29
-------------------------------------------------------------------------------
TOTAL RETURN                5.07%   11.26%    3.25%    7.04%  (0.46)%   1.25%++
-------------------------------------------------------------------------------
NET ASSETS, END OF YEAR
(000S)                    $2,811   $1,866   $1,238     $299     $72      $12
-------------------------------------------------------------------------------
RATIOS TO AVERAGE NET
ASSETS:
 Expenses                   1.49%    1.46%    1.49%    1.52%   1.58%    1.55%+
 Net investment income      5.28     6.01     5.99     6.12    5.05     4.80+
-------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE      363%     121%     275%     292%    236%     436%
-------------------------------------------------------------------------------
</TABLE>
(1) Class L shares were called Class C shares until June 12, 1998.
(2) Per share amounts have been calculated using the monthly average shares
    method, rather than the undistributed net investment income method, because
    it more accurately reflects the per share data for the period.
(3) For the period from June 29, 1993 (inception date) to July 31, 1993.
 ++Total return is not annualized, as it may not be representative of the total
   return for the year.
 + Annualized.
 
                                                                              13
<PAGE>
 
FINANCIAL HIGHLIGHTS (CONTINUED)
 
 
FOR A SHARE OF EACH CLASS OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR:
 
MANAGED GOVERNMENTS FUND
 
<TABLE> 
<CAPTION>
CLASS Y SHARES                              1998   1997(/1/)  1996(/1/)(/2/)
----------------------------------------------------------------------------
<S>                                        <C>     <C>        <C>
NET ASSET VALUE, BEGINNING OF YEAR         $12.84   $12.27        $12.86
----------------------------------------------------------------------------
INCOME (LOSS) FROM OPERATIONS:
 Net investment income                       0.80     0.84          0.35
 Net realized and unrealized gain (loss)    (0.06)    0.59         (0.49)
----------------------------------------------------------------------------
Total Income (Loss) From Operations          0.74     1.43         (0.14)
----------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income                      (0.84)   (0.86)        (0.44)
 Capital                                      --       --          (0.01)
----------------------------------------------------------------------------
Total Distributions                         (0.84)   (0.86)        (0.45)
----------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR               $12.74   $12.84        $12.27
----------------------------------------------------------------------------
TOTAL RETURN                                 5.94%   12.16%        (1.10)%++
----------------------------------------------------------------------------
NET ASSETS, END OF YEAR (MILLIONS)         $   91   $   85        $   27
----------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
 Expenses                                    0.69%    0.69%*        0.78%+
 Net investment income                       6.10     6.82          6.62+
----------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE                       363%     121%          275%
----------------------------------------------------------------------------
</TABLE> 
(1) Per share amounts have been calculated using the monthly average shares
    method, rather than the undistributed net investment income method, because
    it more accurately reflects the per share data for the period.
(2) For the period from February 7, 1996 (inception date) to July 31, 1996.
 ++Total return is not annualized, as it may not be representative of the total
   return for the year.
 + Annualized.
 * Amount has been restated from the July 31, 1997 Annual Report.
 
14
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES
 
  The investment objective of the Fund is to provide investors with high cur-
rent income consistent with liquidity and safety of capital. This objective may
not be changed without the approval of the holders of a majority of the Fund's
shares. There can be no assurance that the Fund will achieve its investment
objective.
 
  The Fund invests substantially all of its assets in U.S. government securi-
ties and, under normal circumstances, the Fund is required to invest at least
65% of its assets in such securities. The Fund's portfolio of U.S. government
securities consists primarily of mortgage-backed securities issued or guaran-
teed by GNMA, FNMA and FHLMC. Assets not invested in such mortgage-backed secu-
rities are invested primarily in direct obligations of the United States Trea-
sury, such as Treasury Bills, Treasury Notes and Treasury Bonds ("U.S. Treasury
Securities"), and other U.S. government securities. Obligations issued by U.S.
government agencies and instrumentalities include: obligations that are sup-
ported by the full faith and credit of the United States, such as GNMA certifi-
cates and obligations of the General Services Administration and Federal Mari-
time Administration; securities that are supported by the right of the issuer
to borrow from the United States Treasury, such as securities of Federal Home
Loan Banks and others; and securities that are supported only by the credit of
the instrumentality, such as FNMA and FHLMC certificates. Because the United
States government is not obligated by law to provide support to an instrumen-
tality that it sponsors, the Fund invests in obligations issued by such an
instrumentality only when the Advisor determines that the credit risk with
respect to the instrumentality does not make its securities unsuitable for
investment by the Fund.  
 
  The GNMA certificates in which the Fund will invest will be of the "modified
pass-through" type, which means that the scheduled monthly interest and princi-
pal payments related to mortgages in the pool backing the certificates will be
"passed-through" to investors. Timely payment of principal and interest on GNMA
certificates is guaranteed by GNMA and backed by the full faith and credit of
the United States, but market value and yield are not guaranteed.
 
  Mortgage participation certificates issued by FHLMC and FNMA generally repre-
sent ownership interests in a pool of fixed-rate conventional mortgages. Timely
payment of principal and interest on these certificates is guaranteed solely by
the issuer of the certificates. FHLMC is a U.S. government-created entity con-
trolled by the Federal Home Loan Banks. FNMA is a government-chartered corpora-
tion owned entirely by private stockholders, which is subject to general regu-
lation by the Secretary of Housing and Urban Development.
 
  Mortgage-backed U.S. government securities differ from conventional bonds in
that principal is paid back to the certificate holder over the life of the loan
rather than at maturity. As a result, the Fund will receive monthly scheduled
payments of
 
                                                                              15
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
principal and interest. In addition, the Fund may receive unscheduled principal
payments representing prepayments on the underlying mortgages, which will cause
the maturity of and realized yield on specific GNMA, FNMA and FHLMC certifi-
cates to vary based on the prepayment experience of the underlying pool of
mortgages. The Fund will reinvest all payments and unscheduled prepayments of
principal in additional GNMA, FNMA and FHLMC certificates or other U.S. govern-
ment securities (which may have lower interest rates than the balance of the
obligations held by the Fund), and will distribute the interest to shareholders
in the form of monthly dividends.  
 
  To the extent that they are purchased at par or at a discount, GNMA certifi-
cates offer a high degree of safety of principal investment because of the GNMA
guarantee, and other mortgage-backed U.S. government securities also are
believed to offer significant safety of principal investment. If the Fund buys
mortgage-backed U.S. government securities at a premium, however, mortgage
foreclosures and prepayments of principal by mortgagors (which may be made at
any time without penalty) may result in some loss of the Fund's principal
investment to the extent of the premium paid.
 
  The composition and weighted average maturity of the Fund's portfolio will
vary from time to time, based upon the determination of the Fund's management
of how best to further the Fund's investment objective. The Fund may invest in
U.S. government securities of all maturities: short-term, intermediate-term and
long-term. The Fund may invest without limit in securities of any issuer of
U.S. government securities, and may invest up to an aggregate of 15% of its
total assets in securities with contractual or other restrictions on resale and
other instruments that are not readily marketable (such as repurchase agree-
ments with maturities in excess of seven days). The Fund may invest up to 5% of
its net assets in U.S. government securities for which the principal repayment
at maturity, while paid in U.S. dollars, is determined by reference to the
exchange rate between the U.S. dollar and the currency of one or more foreign
countries ("Exchange Rate-Related Securities"). The interest payable on these
securities is denominated in U.S. dollars and is not subject to foreign cur-
rency risk. The Fund also is authorized to borrow in an amount of up to 10% of
its total assets under unusual or emergency circumstances, including when nec-
essary to meet redemptions, and to pledge its assets to the same extent in con-
nection with such borrowings. When the Advisor believes that market conditions
warrant, the Fund may, for temporary defensive purposes and without limitation,
invest in short-term instruments including certificates of deposit of domestic
banks and repurchase agreements involving U.S. government securities. Repur-
chase agreements also may be used as one of the Fund's normal investment
techniques.  
 
16
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 
 ADDITIONAL INVESTMENTS
  In attempting to achieve its investment objective, the Fund may employ, among
others, the following portfolio strategies:
 
  Writing Options. The Fund may from time to time write covered put and call
options on U.S. government securities in its portfolio. The Fund will realize a
fee (referred to as a "premium") when it writes an option. The Fund will only
write covered put and call options, which means that for so long as the Fund
remains obligated as the writer of the option it will, in the case of a call
option, continue to own the underlying security and, in the case of a put
option, maintain an amount of cash or high-grade liquid debt securities in a
segregated account equal to the exercise price of the option. A put option
embodies the right of its purchaser to compel the writer of the option to pur-
chase from the optionholder an underlying security at a specified price at any
time during the option period. In contrast, a call option embodies the right of
its purchaser to compel the writer of the option to sell the option holder an
underlying security at a specified price at any time during the option period.
Thus, the purchaser of a put option has the right to compel the Fund to pur-
chase from it the underlying security at the agreed-upon price for a specified
time period, while the purchaser of a call option has the right to purchase
from the Fund the underlying security owned by the Fund at the agreed-upon
price for a specified time period.
 
  Upon the exercise of a put option, the Fund may suffer a loss equal to the
difference between the price at which the Fund is required to purchase the
underlying security and its market value at the time of the option exercise,
less the premium received for writing the option. Upon the exercise of a call
option, the Fund may suffer a loss equal to the excess of the security's market
value at the time of the option exercise over the Fund's acquisition cost of
the security, less the premium received for writing the option. The Fund ordi-
narily will write only covered put and call options for which a secondary mar-
ket exists on a national securities exchange or in the over-the-counter market.
 
  In order to realize a profit, to prevent an underlying security from being
called or to unfreeze an underlying security (thereby permitting its sale or
the writing of a new option on the security prior to the option's expiration),
the Fund may engage in a closing purchase transaction. The Fund will incur a
loss if the cost of the closing purchase transaction, plus transaction costs,
exceeds the premium received upon writing the original option. To effect a
closing purchase transaction, the Fund would purchase, prior to the exercise of
an option that it has written, an option of the same series as that on which it
desires to terminate its obligation. There can be no assurance that the Fund
will be able to effect a closing purchase transaction at a time when it wishes
to do so. The obligation of the Fund to purchase or deliver
 
                                                                              17
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
securities, respectively, upon the exercise of a covered put or call option
which it has written terminates upon the effectuation of a closing purchase
transaction.
 
  Purchasing Options. By purchasing put options on U.S. government securities,
the Fund seeks to limit the risk of loss from a decline in the market value of
the underlying securities in its investment portfolio. For the purchase of a
put option to be profitable, the market price of the underlying security must
decline sufficiently below the exercise price to cover the premium and transac-
tion costs, unless the put option is sold at a profit before expiration in a
closing sale transaction.
 
  By buying call options on U.S. government securities the Fund could acquire
the underlying securities at prices that avoid any additional costs resulting
from substantial increases in the market value of securities at any time during
the option period. At times, the net cost of acquiring securities in this man-
ner may be less than the cost of acquiring the securities directly.
 
  The Fund may (a) enter into closing transactions with respect to put and call
options that it purchases, (b) exercise the options or (c) permit the options
to expire. Profit or loss from a closing transaction will depend on whether the
amount that the Fund receives on the transaction is more or less than the pre-
mium paid for the option plus any related transaction costs.
 
  Repurchase Agreements. The Fund may engage in repurchase agreement transac-
tions on U.S. government securities with certain member banks of the Federal
Reserve System and with certain dealers on the Federal Reserve Bank of New
York's list of reporting dealers. Under the terms of a typical repurchase
agreement, the Fund would acquire an underlying debt obligation for a rela-
tively short period (usually not more than one week) subject to an obligation
of the seller to repurchase, and the Fund to resell, the obligation at an
agreed-upon price and time, thereby determining the yield during the Fund's
holding period. Under each repurchase agreement the selling institution will be
required to maintain the value of the securities subject to the repurchase
agreement at not less than their repurchase price. MMC, acting under the super-
vision of the Fund's Board of Directors, reviews on an ongoing basis the value
of the collateral and the creditworthiness of those banks and dealers with
which the Fund may enter into repurchase agreements to evaluate potential
risks.
 
  Zero Coupon Securities. The Fund may invest in zero coupon bonds. A zero cou-
pon bond pays no interest in cash to its holder during its life, although
interest is accrued during that period. Its value to an investor consists of
the difference between its face value at the time of maturity and the price for
which it was acquired, which is generally at significantly less than its face
value (sometimes referred to as a "deep discount" price). Because such securi-
ties usually trade at a
 
18
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
deep discount, they will be subject to greater fluctuations of market value in
response to changing interest rates than debt obligations of comparable matu-
rities which make periodic distributions of interest. On the other hand,
because there are no periodic interest payments to be reinvested prior to
maturity, zero coupon securities eliminate reinvestment risk and lock in a
rate of return to maturity.
 
  Reverse Repurchase Agreements. The Fund may enter into reverse repurchase
agreements. A reverse repurchase agreement involves the sale of a money market
instrument by the Fund and its agreement to repurchase the instrument at a
specified time and price. The Fund will maintain a segregated account consist-
ing of U.S. government securities or cash or cash equivalents to cover its
obligations under reverse repurchase agreements with broker-dealers and other
financial institutions. The Fund will invest the proceeds in other money mar-
ket instruments or repurchase agreements maturing not later than the expira-
tion of the reverse repurchase agreement. Under the Investment Company Act of
1940, as amended, (the "1940 Act") reverse repurchase agreements may be con-
sidered borrowings by the seller.  
 
  Reverse repurchase agreements create opportunities for increased returns to
the shareholders of the Fund but, at the same time, create special risk con-
siderations. Although the principal or stated value of such borrowings will be
fixed, the Fund's assets may change in value during the time the borrowing is
outstanding. To the extent the income or other gain derived from securities
purchased with borrowed funds exceed the interest or dividends the Fund will
have to pay in respect thereof, the Fund's net income or other gain will be
greater than if this type of leverage had not been used. Conversely, if the
income or other gain from the incremental assets is not sufficient to cover
this cost, the net income or other gain of the Fund will be less than if the
reverse repurchase agreement had not been used.
 
 The Fund currently intends to invest not more than 33% of its net assets in
reverse repurchase agreements.
 
  When-Issued Securities and Delayed-Delivery Transactions. In order to secure
yields or prices deemed advantageous at the time, the Fund may purchase or
sell securities on a when-issued or delayed-delivery basis. The Fund will
enter into a when-issued transaction for the purpose of acquiring portfolio
securities and not for the purpose of leverage. In such transactions delivery
of the securities occurs beyond the normal settlement periods, but no payment
or delivery is made by the Fund prior to the actual delivery or payment by the
other party to the transaction. Due to fluctuations in the value of securities
purchased or sold on a when-issued or delayed-delivery basis, the yields
obtained on those securities may be higher or lower than the yields available
in the market on the dates when the investments are actually delivered to the
buyers. The Fund will establish with its custodian a segregated account con-
sisting of cash or equity and debt securities of any grade provided
 
                                                                             19
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
such securities have been determined by MMC to be liquid and unencumbered pur-
suant to guidelines established by the Directors in an amount equal to the
amount of its when-issued and delayed-delivery commitments. Placing securities
rather than cash in the segregated account may have a leveraging effect on the
Fund's net assets.
    
  Lending of Portfolio Securities. Consistent with applicable regulatory
requirements, the Fund may lend its portfolio securities that it holds to bro-
kers, dealers and other financial organizations. The Fund's
loans of securities will be collateralized at all times in a segregated
account with the Fund's custodian in an amount at least equal to 100% of the
current market value of the loaned securities. The segregated account may con-
sist of cash, cash equivalents, U.S. government securities or debt securities
of any grade provided such assets are liquid, unencumbered and marked to mar-
ket daily. By lending its portfolio securities, the Fund will seek to generate
income by continuing to receive interest on the loaned securities, by invest-
ing the cash collateral in short-term instruments or by obtaining yield in the
form of interest paid by the borrower when debt securities are used as collat-
eral.  
     
  Forward Roll Transactions. In order to enhance current income, the Fund may
invest up to 30% of its assets in forward roll transactions with respect to
mortgage-backed securities issued by GNMA, FNMA and FHLMC. In a forward roll
transaction, the Fund sells a mortgage security to a financial institution,
such as a bank or broker-dealer, and simultaneously agrees to repurchase a
similar security from the institution at a later date at an agreed upon price.
The mortgage securities that are repurchased will bear the same interest rate
as those sold, but generally will be collateralized by different pools of
mortgages with different prepayment histories than those sold. During the
period between the sale and repurchase, the Fund will not be entitled to
receive interest and principal payments on the securities sold. Proceeds of
the sale will be invested in short-term instruments, particularly repurchase
agreements, and the income from these investments, together with any addi-
tional fee income received on the sale will generate income for the Fund
exceeding the yield on the securities sold. Forward roll transactions involve
the risk that the market value of the securities sold by the Fund may decline
below the repurchase price of those securities. At the time that the Fund
enters into a forward roll transaction, it will place in a segregated custo-
dial account cash and liquid debt securities having a value equal to the
repurchase price (including accrued interest) and will subsequently monitor
the account to insure that such equivalent value is maintained. Forward roll
transactions are considered to be borrowings by the Fund.
 
  Interest Rate Futures Contracts and Options on Futures. The Fund will enter
into interest rate futures contracts solely for the purpose of hedging against
changes in the value of its portfolio securities due to anticipated changes in
interest rates
 
20
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
and market conditions and not for purposes of speculation. An interest rate
futures contract provides for the future sale by one party and the purchase by
the other party of a certain amount of a specified financial instrument (debt
security) at a specified price, date, time and place. The Fund may enter into
futures contracts and options on futures contracts (a) without limit for bona
fide hedging purposes and (b) for other purposes, provided the aggregate ini-
tial margin deposits and premiums do not exceed 5% of the fair market value of
the Fund's assets after taking into account unrealized profits and unrealized
losses on futures contracts into which it has entered. With respect to each
long position in a futures contract or option thereon, the underlying commodity
value of such contract always will be covered by cash and cash equivalents
equal to the market value of the underlying commodity set aside in a segregated
account with the Fund's custodian.
 
  The Fund may purchase put options on interest rate futures contracts to hedge
its portfolio securities against the risk of rising interest rates, and may
purchase call options on interest rate futures contracts when it believes that
interest rates will decline, in anticipation of purchases of portfolio securi-
ties at a higher price, but may not enter into these transactions for purposes
of speculation. The Fund will write put or call options on interest rate
futures contracts as part of closing purchase transactions to terminate its
option positions, although there is no guarantee that such closing transactions
can be effected. The Fund may write put and call options on interest rate
futures contracts other than as a part of closing sale transactions, in order
to increase its ability to hedge against the effect of changes in interest
rates. The Fund will write put and call options only on interest rate futures
contracts which are traded on a domestic exchange or board of trade. A call
option gives the purchaser of such option the right to buy (assume a long posi-
tion) and obliges the Fund as its writer to sell, a specified underlying
futures contract at a stated exercise price at any time prior to the expiration
date of the option. A purchaser of a put option has the right to sell (assume a
short position), and obliges the Fund as the writer to buy, such contract at
the exercise price during the option period.
 
 CERTAIN RISK CONSIDERATIONS
 
  Historically, the yields provided by mortgage-backed U.S. government securi-
ties have exceeded the yields on other types of U.S. government securities of
comparable maturity. Thus, the Fund's yield may at times be higher than that of
mutual funds investing solely in other types of U.S. government-securities.
However, mortgage-backed U.S. government securities may be less effective than
other U.S. government securities as a means of "locking in" attractive long-
term interest rates due to the need to reinvest prepayments of principal gener-
ally and the possibility of significant unscheduled prepayments resulting from
declines in mortgage interest rates. In addition, the market values of the U.S.
government securities held in the
 
                                                                              21
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
Fund's portfolio--and, accordingly, the Fund's net asset value--generally will
vary inversely with changes in market interest rates, both declining when
interest rates rise and rising when interest rates decline. Mortgage-backed
U.S. government securities, however, may have less potential for capital
appreciation than other investments of comparable maturities due to the like-
lihood of increased prepayments of mortgages as interest rates decline, while
having comparable risk of decline in value during periods of rising rates.
 
  The purchase of securities on a when-issued or delayed-delivery basis
involves the risk that, as a result of an increase in yields available in the
marketplace, the value of the securities purchased will decline prior to the
settlement date. The sale of securities for delayed delivery involves the risk
that the prices available in the market on the delivery date may be greater
than those obtained in the sale transaction.
 
  Repurchase agreements could involve certain risks in the event of default or
insolvency of the other party, including possible delays or restrictions upon
the Fund's ability to dispose of the underlying securities, the risk of a pos-
sible decline in the value of the underlying securities during the period in
which the Fund seeks to assert its rights to them, the risk of incurring
expenses associated with asserting those rights and the risk of losing all or
part of the income from the agreement.
 
  The risks associated with lending portfolio securities, as with other exten-
sions of credit, consist of possible loss of rights in the collateral should
the borrower fail financially. Forward roll transactions involve the risk that
the market value of the securities sold by the Fund may decline below the
repurchase price of the securities. Forward roll transactions are considered
borrowings by the Fund. Although investing the proceeds of these borrowings in
repurchase agreements or money market instruments may provide the Fund with
the opportunity for higher income, this leveraging practice will increase the
Fund's exposure to capital risk and higher current expenses. Any income earned
from the securities purchased with the proceeds of these borrowings that
exceeds the cost of the borrowings would cause the Fund's net asset value per
share to increase faster than would otherwise be the case; any decline in the
value of the securities purchased would cause the Fund's net asset value per
share to decrease faster than would otherwise be the case.
 
  There are several risks in connection with the use of futures contracts and
options on futures contracts as a hedging device. A decision of whether, when
and how to hedge involves the exercise of skill and judgment, and even a well-
conceived hedge may be unsuccessful to some degree because of market behavior
or unexpected trends in interest rates. There can be no assurance that there
will be a correlation between price movements in the securities underlying the
interest rate futures or options thereon, on the one hand, and price movements
in the Fund's portfolio securities which are the subject of the hedge, on the
other hand. In addition, the Fund's transactions in futures contracts or put
or call options on them will
 
22
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
be based upon predictions as to anticipated interest rate trends, which could
prove to be inaccurate. The potential loss related to the purchase of an option
on an interest rate futures contract is limited to the premium paid for the
option. Positions in futures contracts and options on futures contracts may be
closed out only on the exchange or board of trade on which they were entered
into, and there can be no assurance that an active market will exist or be
maintained or that closing transactions can be effected. Losses incurred in
hedging transactions and the costs of these transactions will affect the Fund's
performance.
 
  Year 2000--The investment management services provided to the Fund by the
Advisor and the services provided to shareholders by Salomon Smith Barney
depend on the smooth functioning of their computer systems. Many computer soft-
ware systems in use today cannot recognize the year 2000, but revert to 1900 or
some other date, due to the manner in which dates were encoded and calculated.
That failure could have a negative impact on the Fund's operations, including
the handling of securities trades, pricing and account services. The Adviser
andSalomon Smith Barney have advised the Fund that they have been reviewing all
of their computer systems and actively working on necessary changes to their
systems to prepare for the year 2000 and expect that their systems will be com-
pliant before that date. In addition, the Adviser has been advised by the
Fund's custodian, transfer agent and accounting service agent that they are
also in the process of modifying their systems with the same goal. There can,
however, be no assurance that the Adviser, Salomon Smith Barney or any other
service provider will be successful, or that interaction with other non-comply-
ing computer systems will not impair Fund services at that time.
 
  In addition, the ability of issuers to make timely payments of interest and
principal or to continue their operations or services may be impaired by the
inadequate preparation of their computer systems for the year 2000. This may
adversely affect the market values of securities of specific issuers or of
securities generally if the inadequacy of preparation is perceived as wide-
spread or as affecting trading markets.
 
 PORTFOLIO TURNOVER
 
  Under certain market conditions the Fund may experience high portfolio
turnover as a result of investment strategies. For example, the exercise of a
substantial number of options written by the Fund and the purchase or sale of
securities in anticipation of a rise or decline in interest rates could result
in high portfolio turnover. Short-term gains realized from portfolio transac-
tions are taxable to shareholders as ordinary income. The Fund will not con-
sider portfolio turnover rate a limiting factor in making investment decisions
consistent with its objective and policies.
 
                                                                              23
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
    
  Further information about the Fund's investment policies, including a list
of those restrictions on its investment activities that cannot be changed
without shareholder approval, appears in the SAI.
     
VALUATION OF SHARES
 
 
  The Fund's net asset value per share is determined as of the close of regu-
lar trading on the NYSE on each day that the NYSE is open, by dividing the
value of the Fund's net assets attributable to each Class by the total number
of shares of the Class outstanding.
   
  When, in the judgment of the pricing service, quoted bid prices for invest-
ments are readily available and are representative of the bid side of the mar-
ket, these investments are valued at the mean between the quoted bid and asked
prices. Investments for which, in the judgment of the pricing service, there
is no readily obtainable market quotation (which may constitute a majority of
the portfolio securities) are carried at fair value of securities of similar
type, yield and maturity. Pricing services generally determine value by refer-
ence to transactions in municipal obligations, quotations from municipal bond
dealers, market transactions in comparable securities and various relation-
ships between securities. Short-term investments that mature in 60 days or
less are valued at amortized cost whenever the Board of Directors determines
that amortized cost is fair value. Amortized cost valuation involves valuing
an instrument at its cost initially and, thereafter, assuming a constant amor-
tization to maturity of any discount or premium, regardless of the impact of
the fluctuating interest rates on the market value of the instrument. Securi-
ties and other assets that are not priced by a pricing service and for which
quotations are not available will be valued in good faith at fair value by or
under the direction of the fund's Board of Directors. Further information
regarding the Fund's valuation policies is contained in the SAI.  
 
DIVIDENDS, DISTRIBUTIONS AND TAXES
   
 DIVIDENDS AND DISTRIBUTIONS  
 
  The Fund's policy is to declare and pay monthly dividends from its net
investment income. Dividends from net realized capital gains, if any, will be
distributed annually. The Fund may also pay additional dividends shortly
before December 31 from certain amounts of undistributed ordinary income and
capital gains realized, in order to avoid a Federal excise tax liability. If a
shareholder does not otherwise instruct, dividends and capital gain distribu-
tions will be automatically reinvested in additional same Class shares at the
appropriate net asset value, with no additional sales charge or CDSC.  
 
 
24
<PAGE>
 
DIVIDENDS, DISTRIBUTIONS AND TAXES (CONTINUED)
 
  The per share amounts of dividends form net investment income on Classes B
and L may be lower than that of Classes A and Y, mainly as a result of the dis-
tribution fees applicable to Class B and L shares. Similarly, the per share
amounts of dividends from net investment income on Class A shares may be lower
than that of Class Y, as a result of the service fee attributable to Class A
shares. Capital gain distributions, if any, will be the same amount across all
Classes of Fund shares (A, B, L and Y).  
 
 TAXES
 
  The following is a summary of the material federal tax considerations
affecting the Fund and Fund shareholders. Please refer to the SAI for further
discussion. In addition to the considerations described below and in the SAI,
there may be other federal, state, local, and/or foreign tax applications to
consider. Because taxes are a complex matter, prospective shareholders are
urged to consult their tax advisors for more detailed information with respect
to the tax consequences of any investment.  
 
  The Fund intends to qualify, as it has in prior years, under Subchapter M of
the Internal Revenue Code (the "Code") for tax treatment as a regulated invest-
ment company. In each taxable year that the Fund qualifies, so long as such
qualification is in the best interests of its shareholders, the Fund will pay
no federal income tax on its net investment company taxable income and long-
term capital gain that is distributed to shareholders.  
 
  Dividends paid from net investment income and net realized short-term
securities gain, are subject to federal income tax as ordinary income.
Distributions, if any, from net realized long-term securities gains, derived
from the sale of securities held by the Fund for more than one year, are
taxable as long-term capital gains, regardless of the length of time a
shareholder has owned Fund shares.  
 
  Shareholders are required to pay tax on all taxable distributions, even if
those distributions are automatically reinvested in additional Fund shares. A
portion of the dividends paid by the Fund may qualify for the corporate
dividends received deduction. Dividends consisting of interest from U.S.
government securities may be exempt from state and local income taxes. The Fund
will inform shareholders of the source and tax status of all distributions
promptly after the close of each calendar year.  
 
  A shareholder's gain or loss on the disposition of Fund shares (whether by
redemption, sale or exchange), generally will be a long-term or short-term gain
or loss depending on the length of time the shares had been owned at disposi-
tion. Losses realized by a shareholder on the disposition of Fund shares owned
for six  
 
                                                                              25
<PAGE>
 
DIVIDENDS, DISTRIBUTIONS AND TAXES (CONTINUED)
 
months or less will be treated as a long-term capital loss to the extent a
capital gain dividend had been distributed on such shares.  
 
  The Fund is required to withhold ("backup withholding") 31% of all taxable
dividends, capital gain distributions, and the proceeds of any redemption,
regardless of whether gain or loss is realized upon the redemption, for share-
holders who do not provide the Fund with a correct taxpayer identification
number (social security or employer identification number). Withholding from
taxable dividends and capital gain distributions also is required for share-
holders who otherwise are subject to backup withholding. Any tax withheld as a
result of backup withholding does not constitute an additional tax, and may be
claimed as a credit on the shareholders' federal income tax return.  
 
PURCHASE OF SHARES
  
 SALES CHARGE ALTERNATIVES
 
  The following Classes of shares are available for purchase through this
Prospectus. See "Prospectus Summary--Alternative Purchase Arrangements" for a
discussion of factors to consider in selecting which Class of shares to
purchase.
 
  Class A Shares. Class A shares are sold to investors at the public offering
price, which is the net asset value plus an initial sales charges as follows:
 
 
<TABLE>
<CAPTION>
                                   SALES CHARGE    DEALERS'
                      SALES CHARGE  AS A % OF   REALLOWANCE AS
      AMOUNT OF        AS A % OF      AMOUNT         % OF
      INVESTMENT      TRANSACTION    INVESTED   OFFERING PRICE
--------------------------------------------------------------
  <S>                 <C>          <C>          <C>
  Less than $25,000       4.50%        4.71%         4.00%
  $ 25,000 - 49,999       4.00         4.17          3.60
    50,000 - 99,999       3.50         3.63          3.15
   100,000 - 249,999      2.50         2.56          2.25
   250,000 - 499,999      1.50         1.52          1.35
   500,000 and over        *            *             *
--------------------------------------------------------------
</TABLE>
* Purchases of Class A shares of $500,000 or more will be made at net asset
  value without any initial sales charge, but will be subject to a CDSC of
  1.00% on redemptions made within 12 months of purchase. The CDSC on Class A
  shares is payable to Salomon Smith Barney, which compensates Salomon Smith
  Barney Financial Consultants and other dealers whose clients make purchases
  of $500,000 or more. The CDSC is waived in the same circumstances in which
  the CDSC applicable to Class B and Class L shares is waived. See "Deferred
  Sales Charge Provisions" and "Waivers of CDSC."
 
  Members of the selling group may receive up to 90% of the sales charge and
may be deemed to be underwriters of the Fund as defined in the Securities Act
of 1933, as amended (the "1933 Act"). The reduced sales charges shown above
apply to the aggregate of purchases of Class A shares of the Fund made at one
time by
 
26
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
 
"any person," which includes an individual and his or her immediate family, or
a trustee or other fiduciary of a single trust estate or single fiduciary
account.
 
  Class B Shares. Class B shares are sold without an initial sales charge but
are subject to a CDSC payable upon certain redemptions. See "Deferred Sales
Charge Provisions" below.
 
  Class L Shares. Class L shares are sold with an initial sales charge of 1.00%
(which is equal to 1.01% of the amount invested) and are subject to a CDSC pay-
able upon certain redemptions. See "Deferred Sales Charge Provisions" below.
Until June 22, 2001 purchases of Class L shares by investors who were holders
of Class C shares of the Fund on June 12, 1998 will not be subject to the 1.00%
initial sales charge.  
 
  Class Y Shares. Class Y shares are sold without an initial sales charge or
CDSC and are available only to investors investing a minimum of $15,000,000
(except purchases of Class Y shares by Smith Barney Concert Allocation Series
Inc., for which there is no minimum purchase amount).  
 
 GENERAL
 
  Investors may purchase shares from a Salomon Smith Barney Financial
Consultant or a Dealer Representative. In addition, certain investors,
including qualified retirement plans purchasing through certain Dealer
Representatives, may purchase shares directly from the Fund. When purchasing
shares of the Fund, investors must specify whether the purchase is for Class A,
Class B, Class L or Class Y shares. Salomon Smith Barney and Dealer
Representative may charge their customers an annual account maintenance fee in
connection with a brokerage account through which an investor purchases or
holds shares. Accounts held directly at the Transfer Agent are not subject to a
maintenance fee.  
 
  Investors in Class A, Class B and Class L shares may open an account in the
Fund by making an initial investment of at least $1,000 for each account, or
$250 for an IRA or a Self-Employed Retirement Plan. Investors in Class Y shares
may open an account by making an initial investment of $15,000,000. Subsequent
investments of at least $50 may be made for all Classes. For participants in
retirement plans qualified under Section 403(b)(7) or Section 401(c) of the
Code, the minimum initial investment requirement for Class A, Class B and Class
L shares and the subsequent investment requirement for all Classes in the Fund
is $25. For shareholders purchasing shares of the Fund through the Systematic
Investment Plan on a monthly basis, the minimum initial investment requirement
for Class A, Class B and Class L shares and subsequent investment requirement
for all Classes is $25. For shareholders purchasing shares of the Fund through
the Systematic Investment Plan on a quarterly basis, the minimum initial
investment required for Class A, Class B and Class L shares and the subsequent
investment requirement for all Classes is $50. There are no minimum investment
requirements  
 
                                                                              27
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
 
for Class A shares for employees of Citigroup and its subsidiaries, including
Salomon Smith Barney, and Directors/Trustees of any of the Smith Barney Mutual
Funds and their spouses and children. The Fund reserves the right to waive or
change minimums, to decline any order to purchase its shares and to suspend the
offering of shares from time to time. Shares purchased will be held in the
shareholder's account by the Transfer Agent. Share certificates are issued only
upon a shareholder's written request to the Transfer Agent.  
 
  Purchase orders received by the Fund or a Salomon Smith Barney Financial
Consultant prior to the close of regular trading on the NYSE, on any day the
Fund calculates its net asset value, are priced according to the net asset
value determined on that day (the "trade date"). Orders received by a Dealer
Representative prior to the close of regular trading on the NYSE on any day the
Fund calculates its net asset value, are priced according to the net asset
value determined on that day, provided the order is received by the Fund or the
Fund's agent prior to its  
 
close of business. For shares purchased through Salomon Smith Barney or a
Dealer Representative purchasing through Salomon Smith Barney, payment for Fund
shares is due on the third business day after the trade date. In all other
cases, payment must be made with the purchase order.  
 
 SYSTEMATIC INVESTMENT PLAN
 
  Shareholders may make additions to their accounts at any time by purchasing
shares through a service known as the Systematic Investment Plan. Under the
Systematic Investment Plan, Salomon Smith Barney or the Transfer Agent is
authorized through preauthorized transfers of at least $25 on a monthly basis
or at least $50 on a quarterly basis to charge the shareholder's account held
with a bank or other financial institution on a monthly or quarterly basis as
indicated by the shareholder to provide for systematic additions to the
shareholder's Fund account. A shareholder who has insufficient funds to
complete the transfer will be charged a fee of up to $25 by Salomon Smith
Barney or the Transfer Agent. The Systematic Investment Plan also authorizes
Salomon Smith Barney to apply cash held in the shareholder's Salomon Smith
Barney brokerage account or redeem the shareholder's shares of a Salomon Smith
Barney money market fund to make additions to the account. Additional
information is available from the Fund or a Salomon Smith Barney Financial
Consultant.
 
 SALES CHARGE WAIVERS AND REDUCTIONS
 
 INITIAL SALES CHARGE WAIVERS
 
  Purchases of Class A shares may be made at net asset value without a sales
charge in the following circumstances: (a) sales to (i) Board Members and
 
28
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
 
employees of Citigroup and its subsidiaries and any Citigroup affiliated funds
including the Smith Barney Mutual Funds (including retired Board Members and
employees); the immediate families of such persons (including the surviving
spouse of a deceased Board Member or employee); and to a pension, profit-
sharing or other benefit plan for such persons and (ii) employees of members of
the National Association of Securities Dealers, Inc., provided such sales are
made upon the assurance of the purchaser that the purchase is made for
investment purposes and that the securities will not be resold except through
redemption or repurchase, (b) offers of Class A shares to any other investment
company to effect the combination of such company with the Fund by merger,
acquisition of assets or otherwise; (c) purchases of Class A shares by any
client of a newly employed Salomon Smith Barney Financial Consultant (for a
period up to 90 days from the commencement of the Financial Consultant's
employment with Salomon Smith Barney), on the condition the purchase of Class A
shares is made with the proceeds of the redemption of shares of a mutual fund
which (i) was sponsored by the Financial Consultant's prior employer, (ii) was
sold to the client by the Financial Consultant and (iii) was subject to a sales
charge; (d) purchases by shareholders who have redeemed Class A shares in the
Fund (or Class A shares of another Smith Barney Mutual Fund that is offered
with a sales charge) and who wish to reinvest their redemption proceeds in the
Fund, provided the reinvestment is made within 60 calendar days of the
redemption; (e) purchases by accounts managed by registered investment advisory
subsidiaries of Citigroup; (f) direct rollovers by plan participants of
distributions from a 401(k) plans enrolled in the Smith Barney 401(k) Program
(Note: subsequent investment will be subject to the applicable sales charge);
(g) purchases by separate accounts used to fund certain unregistered variable
annuity contracts; and (h) purchases by investors participating in a Salomon
Smith Barney fee-based arrangements. In order to obtain such discounts, the
purchaser must provide sufficient information at the time of purchase to permit
verification that the purchase would qualify for the elimination of the sales
charge.  
 
 RIGHT OF ACCUMULATION
 
  Class A shares of the Fund may be purchased by "any person" (as defined
above) at a reduced sales charge or at net asset value determined by
aggregating the
 
dollar amount of the new purchase and the total net asset value of all Class A
shares of the Fund and of other Smith Barney Mutual Funds that are offered with
a sales charge as currently listed under "Exchange Privilege" then held by such
person and applying the sales charge applicable to such aggregate. In order to
obtain such discount, the purchaser must provide sufficient information at the
time of purchase to permit verification that the purchase qualifies for the
reduced sales charge. The right of accumulation is subject to modification or
discontinuance at any time with respect to all shares purchased thereafter.
 
  
                                                                              29
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
 
 
 LETTER OF INTENT
 
  Class A Shares. A Letter of Intent for an amount of $50,000 or more provides
an opportunity for an investor to obtain a reduced sales charge by aggregating
investments over a 13 month period, provided that the investor refers to such
Letter when placing orders. For purposes of a Letter of Intent, the "Amount of
Investment" as referred to in the preceding sales charge table includes (i) all
Class A shares of the Fund and other Smith Barney Mutual Funds offered with a
sales charge acquired during the term of the Letter plus (ii) the value of all
Class A shares previously purchased and still owned. Each investment made
during the period receives the reduced sales charge applicable to the total
amount of the investment goal. If the goal is not achieved within the period,
the investor must pay the difference between the sales charges applicable to
the purchases made and the charges previously paid, or an appropriate number of
escrowed shares will be redeemed. The term of the Letter will commence upon the
date the Letter is signed, or at the option of the investor, up to 90 days
before such date. Please contact a Salomon Smith Barney Financial Consultant or
the Transfer Agent to obtain a Letter of Intent application.
 
  Class Y Shares. A Letter of Intent may also be used as a way for investors to
meet the minimum investment requirement for Class Y shares (except purchases of
Class Y shares by Smith Barney Concert Allocation Series Inc., for which there
is no minimum purchase amount). Such investors must make an initial minimum
purchase of $5,000,000 in Class Y shares of the Fund and agree to purchase a
total of $15,000,000 of Class Y shares of the Fund within 13 months from the
date of the Letter. If a total investment of $15,000,000 is not made within the
13 month period, all Class Y shares purchased to date will be transferred to
Class A shares, where they will be subject to all fees (including a service fee
of 0.25%) and expenses applicable to the Fund's Class A shares, which may
include a CDSC of 1.00%. Please contact a Salomon Smith Barney Financial
Consultant or the Transfer Agent for further information.  
 
 DEFERRED SALES CHARGE PROVISIONS
 
  "CDSC Shares" are: (a) Class B shares; (b) Class L shares; and (c) Class A
shares that were purchased without an initial sales charge but are subject to a
CDSC. A CDSC may be imposed on certain redemptions of these shares.
 
  Any applicable CDSC will be assessed on an amount equal to the lesser of the
original cost of the shares being redeemed or their net asset value at the time
of redemption. CDSC Shares that are redeemed will not be subject to a CDSC to
the extent that the value of such shares represents: (a) capital appreciation
of Fund assets; (b) reinvestment of dividends or capital gain distributions;
(c) with respect to Class B shares, shares redeemed more than five years after
their purchase; or (d) with respect to Class L shares and Class A shares that
are CDSC Shares, shares redeemed more than 12 months after their purchase.
 
30
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
 
  Class L shares and Class A shares that are CDSC Shares are subject to a 1.00%
CDSC if redeemed within 12 months of purchase. In circumstances in which the
CDSC is imposed on Class B shares, the amount of the charge will depend on the
number of years since the shareholder made the purchase payment from which the
amount is being redeemed. Solely for purposes of determining the number of
years since a purchase payment, all purchase payments made during a month will
be aggregated and deemed to have been made on the last day of the preceding
Salomon Smith Barney statement month. The following table sets forth the rates
of the charge for redemptions of Class B shares by shareholders, except in the
case of Class B shares held under the Smith Barney 401(k) Program, as described
below. See "Purchase of Shares--Smith Barney 401(k) and ExecChoice(TM)
Programs."  
 
<TABLE>
<CAPTION>
      YEAR SINCE PURCHASE
      PAYMENT WAS MADE      CDSC
---------------------------------
      <S>                   <C>
      First                 4.50%
      Second                4.00
      Third                 3.00
      Fourth                2.00
      Fifth                 1.00
      Sixth and thereafter  0.00
---------------------------------
</TABLE>
 
  Class B shares will convert automatically to Class A shares eight years after
the date on which they were purchased and thereafter will no longer be subject
to any distribution fees. There will also be converted at that time such
proportion of Class B Dividend Shares owned by the shareholder as the total
number of his or her Class B shares converting at the time bears to the total
number of outstanding Class B shares (other than Class B Dividend Shares) owned
by the shareholder. See "Prospectus Summary--Alternative Purchase
Arrangements--Class B Shares Conversion Feature."  
 
  The length of time that CDSC Shares acquired through an exchange have been
held will be calculated from the date that the shares exchanged were initially
acquired in one of the other Smith Barney Mutual Funds, and Fund shares being
redeemed will be considered to represent, as applicable, capital appreciation
or dividend and capital gain distribution reinvestments in such other funds.
For Federal income tax purposes, the amount of the CDSC will reduce the gain or
increase the loss, as the case may be, on the amount realized on redemption.
The amount of any CDSC will be paid to Salomon Smith Barney.
 
  To provide an example, assume an investor purchased 100 Class B shares at $10
per share for a cost of $1,000. Subsequently, the investor acquired 5
additional shares through dividend reinvestment. During the fifteenth month
after the
 
                                                                              31
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
 
purchase, the investor decided to redeem $500 of his or her investment.
Assuming at the time of the redemption the net asset value had appreciated to
$12 per share, the value of the investor's shares would be $1,260 (105 shares
at $12 per share). The CDSC would not be applied to the amount which represents
appreciation ($200) and the value of the reinvested dividend shares ($60).
Therefore, $240 of the $500 redemption proceeds ($500 minus $260) would be
charged at a rate of 4.00% (the applicable rate for Class B shares) for a total
deferred sales charge of $9.60.
 
 WAIVERS OF CDSC
 
  The CDSC will be waived on: (a) exchanges (see "Exchange Privilege"); (b)
automatic cash withdrawals in amounts equal to or less than 1.00% per month of
the value of the shareholder's shares at the time the withdrawal plan commences
(see "Automatic Cash Withdrawal Plan") (provided, however, that automatic cash
withdrawals in amounts equal to or less than 2.00% per month of the value of
the shareholder's shares will be permitted for withdrawal plans that were
established prior to November 7, 1994); (c) redemptions of shares within 12
months following the death or disability of the shareholder; (d) redemptions of
shares made in connection with qualified distributions from retirement plans or
IRAs upon the attainment of age 59 ; (e) involuntary redemptions; and (f)
redemptions of shares to effect a combination of the Fund with any investment
company by merger, acquisition of assets or otherwise. In addition, a
shareholder who has redeemed shares from other Smith Barney Mutual Funds may,
under certain circumstances, reinvest all or part of the redemption proceeds
within 60 days and receive pro rata credit for any CDSC imposed on the prior
redemption.
 
  CDSC waivers will be granted subject to confirmation (by Salomon Smith Barney
in the case of shareholders who are also Salomon Smith Barney clients or by the
Transfer Agent in the case of all other shareholders) of the shareholder's
status or holdings, as the case may be.
 
 SMITH BARNEY 401(K) AND EXECCHOICE(TM) PROGRAMS
 
  Investors may be eligible to participate in the Smith Barney 401(k) Program
or the Smith Barney ExecChoice(TM) Program. To the extent applicable, the same
terms and conditions, which are outlined below, are offered to all plans
participating ("Participating Plans") in these programs.
 
  The Fund offers to Participating Plans Class A and Class L shares as invest-
ment alternatives under the Smith Barney 401(k) and ExecChoice(TM) Programs.
Class A and Class L shares acquired through the Participating Plans are subject
to the same service and/or distribution fees as the Class A and Class L shares
acquired by other
 
32
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
 
investors; however, they are not subject to any initial sales charge or CDSC.
Once a Participating Plan has made an initial investment in the Fund, all of
its subsequent investments in the Fund must be in the same Class of shares,
except as otherwise described below.
 
  Class A Shares. Class A shares of the Fund are offered without any sales
charge or CDSC to any Participating Plan that purchases $1,000,000 or more of
Class A shares of one or more funds of the Smith Barney Mutual Funds.
 
  Class L Shares. Class L shares of the Fund are offered without any sales
charge or CDSC to any Participating Plan that purchases less than $1,000,000 of
Class L shares of one or more funds of the Smith Barney Mutual Funds.
 
  401(k) and ExecChoice(TM) Plans Opened On or After June 21, 1996. At the end
of the fifth year after the date a Participating Plan enrolled in the Smith
Barney 401(k) Program or the Smith Barney ExecChoice(TM) Program, if its total
Class L holdings in all non-money market Smith Barney Mutual Funds equal to at
least $1,000,000, it will be offered the opportunity to exchange all of its
Class L shares for Class A shares of the Fund. (For Participating Plans that
were originally established through a Salomon Smith Barney retail brokerage
account, the five year period will be calculated from the date the retail bro-
kerage account was opened.) Such Participating Plans will be notified of the
pending exchange in writing within 30 days after the fifth anniversary of the
enrollment date and, unless the exchange offer has been rejected in writing,
the exchange will occur on or about the 90th day after the fifth anniversary
date. If the Participating Plan does not qualify for the five year exchange to
Class A shares, a review of the Plan's holdings will be performed each quarter
until either the Plan qualifies or the end of the eighth year.  
 
  401(k) Plans Opened Prior to June 21, 1996. In any year after the date a Par-
ticipating Plan enrolled in the Smith Barney 401(k) Program, if its total Class
L holdings in all non-money market Smith Barney Mutual Funds equal at least
$500,000 as of the calendar year-end, the Participating Plan will be offered
the opportunity to exchange all of its Class L shares for Class A shares of the
Fund. Such Plans will be notified in writing within 30 days after the last
business day of the calendar year and, unless the exchange offer has been
rejected in writing, the exchange will occur on or about the last business day
of the following March.
 
  Any Participating Plan in the Smith Barney 401(k) Program whether opened
before or after June 21, 1996, that has not previously qualified for an
exchange into Class A shares will be offered the opportunity to exchange all of
its Class L shares for Class A shares of the Fund regardless of asset size, at
the end of the eighth year after the date the Participating Plan enrolled in
the Smith Barney 401(k) Program. Such Plans will be notified of the pending
exchange in writing approximately 60
 
                                                                              33
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
 
days before the eighth anniversary of the enrollment date and, unless the
exchange has been rejected in writing, the exchange will occur on or about the
eighth anniversary date. Once an exchange has occurred, a Participating Plan
will not be eligible to acquire additional Class L shares of the Fund but
instead may acquire Class A shares of the Fund. Any Class L shares not con-
verted will continue to be subject to the distribution fee.
 
  Participating Plans wishing to acquire shares of the Fund through the Smith
Barney 401(k) Program or the Smith Barney ExecChoice(TM) Program must purchase
such shares directly from the Transfer Agent. For further information regarding
these Programs, investors should contact a Salomon Smith Barney Financial
Consultant.  
 
EXCHANGE PRIVILEGE
 
 
Except as otherwise noted below, shares of each Class may be exchanged for
shares of the same Class in the following funds of the Smith Barney Mutual
Funds, to the extent shares are offered for sale in the shareholder's state of
residence. Exchanges of Class A, Class B and Class L shares are subject to min-
imum investment requirements and all shares are subject to the other require-
ments of the fund into which exchanges are made.
 
 FUND NAME
 
  Growth Funds
    Concert Peachtree Growth Fund
    Concert Social Awareness Fund
    Smith Barney Aggressive Growth Fund Inc.
    Smith Barney Appreciation Fund Inc.
    Smith Barney Balanced Fund
    Smith Barney Contrarian Fund
    Smith Barney Convertible Fund
    Smith Barney Fundamental Value Fund Inc.
    Smith Barney Funds, Inc.--Large Cap Value Fund
    Smith Barney Large Cap Blend Fund
    Smith Barney Large Capitalization Growth Fund
    Smith Barney Mid Cap Blend Fund
    Smith Barney Natural Resources Fund Inc.
    Smith Barney Premium Total Return Fund
    Smith Barney Small Cap Blend Fund, Inc.
    Smith Barney Special Equities Fund
 
34
<PAGE>
 
EXCHANGE PRIVILEGE (CONTINUED)
 
 
  Taxable Fixed-Income Fund
     
    *Smith Barney Adjustable Rate Government Income Fund  
    Smith Barney Diversified Strategic Income Fund
     
    +Smith Barney Funds, Inc.--Short-Term High Grade Bond Fund  
    Smith Barney Funds, Inc.--U.S. Government Securities Fund
    Smith Barney Government Securities Fund
    Smith Barney High Income Fund
    Smith Barney Investment Grade Bond Fund
    Smith Barney Total Return Bond Fund
 
  Tax-Exempt Funds
    Smith Barney Arizona Municipals Fund Inc.
    Smith Barney California Municipals Fund Inc.
     
    **Smith Barney Intermediate Maturity California Municipals Fund  
     
    **Smith Barney Intermediate Maturity New York Municipals Fund  
    Smith Barney Managed Municipals Fund Inc.
    Smith Barney Massachusetts Municipals Funds
    Smith Barney Municipal High Income Fund
    Smith Barney Muni Funds--Florida Portfolio
    Smith Barney Muni Funds--Georgia Portfolio
     
    **Smith Barney Muni Funds--Limited Term Portfolio  
    Smith Barney Muni Funds--National Portfolio
    Smith Barney Muni Funds--New York Portfolio
    Smith Barney Muni Funds--Pennsylvania Portfolio
    Smith Barney New Jersey Municipals Fund Inc.
    Smith Barney Oregon Municipals Fund
    Smith Barney Tax-Exempt Income Fund
 
  Global-International Funds
    Smith Barney Hansberger Global Small Cap Value Fund
    Smith Barney Hansberger Global Value Fund
    Smith Barney World Funds, Inc.--Emerging Markets Portfolio
    Smith Barney World Funds, Inc.--European Portfolio
    Smith Barney World Funds, Inc.--Global Government Bond Portfolio
    Smith Barney World Funds, Inc.--International Balanced Portfolio
    Smith Barney World Funds, Inc.--International Equity Portfolio
    Smith Barney World Funds, Inc.--Pacific Portfolio
 
  Smith Barney Concert Allocation Series Inc.
    Smith Barney Concert Allocation Series Inc.--Balanced Portfolio
    Smith Barney Concert Allocation Series Inc.--Conservative Portfolio
    Smith Barney Concert Allocation Series Inc.--Global Portfolio
    Smith Barney Concert Allocation Series Inc.--Growth Portfolio
    Smith Barney Concert Allocation Series Inc.--High Growth Portfolio
    Smith Barney Concert Allocation Series Inc.--Income Portfolio
 
                                                                              35
<PAGE>
 
EXCHANGE PRIVILEGE (CONTINUED)
 
 
  Money Market Funds
     
    ++Smith Barney Exchange Reserve Fund  
     
    +++Smith Barney Money Funds, Inc.--Cash Portfolio  
     
    +++Smith Barney Money Funds, Inc.--Government Portfolio  
  ***Smith Barney Money Funds, Inc.--Retirement Portfolio
     
    +Smith Barney Municipal Money Market Fund, Inc.  
     
    +Smith Barney Muni Funds--California Money Market Portfolio  
     
    +Smith Barney Muni Funds--New York Money Market Portfolio  
-------------------------------------------------------------------------------
   
  * Available for exchange with Class A and Class B shares of the Fund. In
    addition, shareholders who own Class L shares of the Fund through the
    Smith Barney 401(k) Program may exchange those shares for Class L shares
    of this fund.  
 
 ** Available for exchange with Class A, Class L and Class Y shares of the
    Fund.  
*** Available for exchange with Class A shares of the Fund.
 
  + Available for exchange with Class A and Class Y shares of the Fund.  
 
 ++ Available for exchange with Class A and Class Y shares of the Fund. In
    addition, Participating Plans opened prior to June 21, 1996 and investing
    in Class L shares may exchange Fund shares for Class L shares of this
    fund.  
 
  Class B Exchanges. In the event a Class B shareholder wishes to exchange all
or a portion of his or her shares in any of the funds imposing a higher CDSC
than that imposed by the Fund, the exchanged Class B shares will be subject to
the higher applicable CDSC. Upon an exchange, the new Class B shares will be
deemed to have been purchased on the same date as the Class B shares of the
Fund that have been exchanged.
 
  Class L Exchanges. Upon an exchange, the new Class L shares will be deemed
to have been purchased on the same date as the Class L shares of the Fund that
have been exchanged.
 
  Class A and Class Y Exchanges. Class A and Class Y shareholders of the Fund
who wish to exchange all or a portion of their shares for shares of the
respective Class in any of the funds identified above may do so without impo-
sition of any charge.
 
  Additional Information Regarding the Exchange Privilege. Although the
exchange privilege is an important benefit, excessive exchange transactions
can be detrimental to the Fund's performance and its shareholders. The Advisor
may determine that a pattern of frequent exchanges is excessive and contrary
to the best interests of the Fund's other shareholders. In this event, the
Fund may, at its discretion, decide to limit additional purchases and/or
exchanges by a shareholder. Upon such a determination, the Fund will provide
notice in writing or by telephone to the shareholder at least 15 days prior to
suspending the exchange privilege and during the 15 day period the shareholder
will be required to (a) redeem his or her shares in  
 
36
<PAGE>
 
EXCHANGE PRIVILEGE (CONTINUED)
 
the Fund or (b) remain invested in the Fund or exchange into any of the funds
of the Smith Barney Mutual Funds ordinarily available, which position the
shareholder would be expected to maintain for a significant period of time.
All relevant factors will be considered in determining what constitutes an
abusive pattern of exchanges.
 
  Certain shareholders may be able to exchange shares by telephone. See "Re-
demption of Shares--Telephone Redemption and Exchange Program." Exchanges will
be processed at the net asset value next determined. Redemption procedures
discussed below are also applicable for exchanging shares, and exchanges will
be made upon receipt of all supporting documents in proper form. If the
account registration of the shares of the fund being acquired is identical to
the registration of the shares of the fund exchanged, no signature guarantee
is required. A capital gain or loss for tax purposes will be realized upon the
exchange, depending upon the cost or other basis of shares redeemed. Before
exchanging shares, investors should read the current prospectus describing the
shares to be acquired. The Fund reserves the right to modify or discontinue
exchange privileges upon 60 days' prior notice to shareholders.
 
REDEMPTION OF SHARES
 
 
  The Fund is required to redeem shares tendered to it, as described below, at
a redemption price equal to their net asset value per share next determined
after receipt of a written request in proper form at no charge other than any
applicable CDSC. Redemption requests received after the close of regular trad-
ing on the NYSE are priced at the net asset value next determined.
 
  If a shareholder holds shares in more than one Class, any request for
redemption must specify the Class being redeemed. In the event of a failure to
specify which Class, or if the investor owns fewer shares of the Class than
specified, the redemption request will be delayed until the Transfer Agent
receives further instructions from Salomon Smith Barney, or if the sharehold-
er's account is not with Salomon Smith Barney, from the shareholder directly.
The redemption proceeds will be remitted on or before the third business day
following receipt of proper tender, except on any days on which the NYSE is
closed or as permitted under the 1940 Act, in extraordinary circumstances.
Generally, if the redemption proceeds are remitted to a Salomon Smith Barney
brokerage account, these funds will not be invested for the shareholder's ben-
efit without specific instruction and Salomon Smith Barney will benefit from
the use of temporarily uninvested funds. Redemption proceeds for shares pur-
chased by check, other than a certified or official bank check, will be remit-
ted upon clearance of the check, which may take up to ten days or more.  
 
  Shares held by Salomon Smith Barney as custodian must be redeemed by submit-
ting a written request to a Salomon Smith Barney Financial Consultant. Shares
 
                                                                             37
<PAGE>
 
REDEMPTION OF SHARES (CONTINUED)
 
other than those held by Salomon Smith Barney as custodian may be redeemed
through an investor's Financial Consultant, Dealer Representative or by sub-
mitting a written request for redemption to:  
 
  Smith Barney Managed Governments Funds Inc.
  Class A, B, L or Y (please specify)
  c/o First Data Investor Services Group, Inc.
  P.O. Box 5128
  Westborough, Massachusetts 01581-5128
 
  A written redemption request must (a) state the Class and number or dollar
amount of shares to be redeemed, (b) identify the shareholder's account number
and (c) be signed by each registered owner exactly as the shares are regis-
tered. If the shares to be redeemed were issued in certificate form, the cer-
tificates must be endorsed for transfer (or be accompanied by an endorsed
stock power) and must be submitted to First Data together with the redemption
request. Any signature appearing on a share certificate, stock power or writ-
ten redemption request in excess of $10,000 must be guaranteed by an eligible
guarantor institution such as a domestic bank, savings and loan institution,
domestic credit union, member bank of the Federal Reserve System or member
firm of a national securities exchange. Written redemption requests of $10,000
or less do not require a signature guarantee unless more than one such redemp-
tion request is made in any 10-day period or the redemption proceeds are to be
sent to an address other than the address of record. Unless otherwise direct-
ed, redemption proceeds will be mailed to an investor's address of record.
First Data may require additional supporting documents for redemptions made by
corporations, executors, administrators, trustees or guardians. A redemption
request will not be deemed properly received until First Data receives all
required documents in proper form.
 
 TELEPHONE REDEMPTION AND EXCHANGE PROGRAM
 
  Shareholders who do not have a Salomon Smith Barney brokerage account may be
eligible to redeem and exchange Fund shares by telephone. To determine if a
shareholder is entitled to participate in this program, he or she should con-
tact First Data at 1-800-451-2010. Once eligibility is confirmed, the share-
holder must complete and return a Telephone/Wire Authorization Form, including
a signature guarantee, which will be provided by First Data upon request.
(Alternatively, an investor may authorize telephone redemptions on the new
account application with a signature guarantee when making his/her initial
investment in the Fund.)  
 
  Redemptions. Redemption requests of up to $10,000 of any class or classes of
the Fund's shares may be made by eligible shareholders by calling First Data
at 1-800-451-2010. Such requests may be made between 9:00 a.m. and 4:00 p.m.
(Eastern time) on any day the NYSE is open. Redemption requests received after
 
38
<PAGE>
 
REDEMPTION OF SHARES (CONTINUED)
 
the close of regular trading on the NYSE are priced at the net asset value
next determined. Redemptions of shares (i) by retirement plans or (ii) for
which certificates have been issued are not permitted under this program.
 
  A shareholder will have the option of having the redemption proceeds mailed
to his/her address of record or wired to a bank account predesignated by the
shareholder. Generally, redemption proceeds will be mailed or wired, as the
case may be, on the next business day following the redemption request. In
order to use the wire procedures, the bank receiving the proceeds must be a
member of the Federal Reserve System or have a correspondent relationship with
a member bank. The Fund reserves the right to charge shareholders a nominal
fee for each wire redemption. Such charges, if any, will be assessed against
the shareholder's account from which shares were redeemed. In order to change
the bank account designated to receive redemption proceeds, a shareholder must
complete a new Telephone/Wire Authorization Form and, for the protection of
the shareholder's assets, will be required to provide a signature guarantee
and certain other documentation.
 
  Exchanges. Eligible shareholders may make exchanges by telephone if the
account registration of the shares of the fund being acquired is identical to
the registration of the shares of the fund exchanged. Such exchange requests
may be made by calling First Data at 1-800-451-2010 between 9:00 a.m. and 4:00
p.m. (Eastern time) on any day the NYSE is open. Exchange requests received
after the close of regular trading on the NYSE are priced at the net asset
value next determined.
 
  Additional Information Regarding Telephone Redemption and Exchange
Program. Neither the Fund nor its agents will be liable for following instruc-
tions communicated by telephone that are reasonably believed to be genuine.
The Fund and its agents will employ procedures designed to verify the identity
of the caller and legitimacy of instructions (for example, a shareholder's
name and account number will be required and phone calls may be recorded). The
Fund reserves the right to suspend, modify or discontinue the telephone
redemption and exchange program or to impose a charge for this service at any
time following at least seven (7) days' prior notice to shareholders.
 
 AUTOMATIC CASH WITHDRAWAL PLAN
 
  The Fund offers shareholders an automatic cash withdrawal plan, under which
shareholders who own shares with a value of at least $10,000 may elect to
receive cash payments of at least $50 monthly or quarterly. Retirement plan
accounts are eligible for automatic cash withdrawal plans only where the
shareholder is eligible to receive qualified distributions and has an account
value of at least $5,000. The withdrawal plan will be carried over on
exchanges between funds or Classes of the
 
                                                                             39
<PAGE>
 
REDEMPTION OF SHARES (CONTINUED)
 
Fund. Any applicable CDSC will not be waived on amounts withdrawn by a share-
holder that exceed 1.00% per month of the value of the shareholder's shares
subject to the CDSC at the time the withdrawal plan commences. (With respect to
withdrawal plans in effect prior to November 7, 1994, any applicable CDSC will
be waived on amounts withdrawn that do not exceed 2.00% per month of the share-
holder's shares subject to the CDSC.) For further information regarding the
automatic cash withdrawal plan, shareholders should contact a Salomon Smith
Barney Financial Consultant, Introducing Broker or dealer in the selling group.
 
MINIMUM ACCOUNT SIZE
 
 
  The Fund reserves the right to involuntarily liquidate any shareholder's
account in the Fund if the aggregate net asset value of the shares held in the
Fund account is less than $500. (If a shareholder has more than one account in
this Fund, each account must satisfy the minimum account size.) The Fund, how-
ever, will not redeem shares based solely on market reductions in net asset
value. Before the Fund exercises such right, shareholders will receive written
notice and will be permitted 60 days to bring accounts up to the minimum to
avoid involuntary liquidation.
 
PERFORMANCE
 
 
 YIELD
 
  From time to time, the Fund may advertise the 30-day "yield" of each Class of
shares. The Fund's yield refers to the income generated by an investment in
those shares over the 30-day period identified in the advertisement and is com-
puted by dividing the net investment income per share earned by the Class dur-
ing the period by the maximum public offering price per share on the last day
of the period. This income is "annualized" by assuming the amount of income is
generated each month over a one-year period and is compounded semi-annually.
The annualized income is then shown as a percentage of the net asset value.
 
 TOTAL RETURN
 
  From time to time the Fund may include its total return, average annual total
return and current dividend return in advertisements and/or other types of
sales literature. These figures are computed separately for Class A, Class B,
Class L and Class Y shares of the Fund. These figures are based on historical
earnings and are not intended to indicate future performance. Total return is
computed for a specified period of time assuming deduction of the maximum sales
charge, if any, from the initial amount invested and reinvestment of all income
dividends and capital gain distributions on the reinvestment dates at prices
calculated as stated in this
 
40
<PAGE>
 
PERFORMANCE (CONTINUED)
 
Prospectus, then dividing the value of the investment at the end of the period
so calculated by the initial amount invested and subtracting 100%. The standard
average annual total return, as prescribed by the SEC, is derived from this
total return, which provides the ending redeemable value. Such standard total
return information may also be accompanied with nonstandard total return infor-
mation for differing periods computed in the same manner but without
annualizing the total return or taking sales charges into account. The Fund
calculates current dividend return for each Class by annualizing the most
recent monthly distribution and dividing by the net asset value of the maximum
public offering price (including sales charge) on the last day of the period
for which current dividend return is presented. The Fund's current dividend
return may vary from time to time depending on market conditions, the composi-
tion of its investment portfolio and operating expenses. These factors and pos-
sible differences in the methods used in calculating current dividend return
should be considered when comparing a Class' current return to yields published
for other investment companies and other investment vehicles. The Fund may also
include comparative performance information in advertising or marketing its
shares. Such performance information may include data from Lipper Analytical
Services and other financial publications.
 
MANAGEMENT OF THE FUND
 
 
 BOARD OF DIRECTORS
 
  Overall responsibility for management and supervision of the Fund rests with
the Fund's Board of Directors. The Directors approve all significant agreements
between the Fund and the companies that furnish services to the Fund, including
agreements with the Fund's distributor, investment adviser, administrator, cus-
todian and transfer agent. The day-to-day operations of the Fund are delegated
to the Fund's investment adviser and administrator. The SAI contains general
background information regarding each Director and executive officer of the
Fund.  
 
 INVESTMENT ADVISER AND ADMINISTRATOR--MMC
 
  The Fund's investment adviser, MMC, is a registered investment adviser whose
principal executive offices are located at 388 Greenwich Street, New York, New
York 10013. MMC was incorporated in March, 1968 under the laws of Delaware and
renders investment advice to a wide variety of individual, institutional and
investment company clients that had aggregate assets under management as of
September 30, 1998 in excess of $108 billion.  
 
  Subject to the supervision and direction of the Fund's Board of Directors,
the Advisor manages the Fund's portfolio in accordance with the Fund's stated
investment objective and policies, makes investment decisions for the Fund,
places orders to purchase and sell securities and employs professional portfo-
lio managers and
 
                                                                              41
<PAGE>
 
MANAGEMENT OF THE FUND (CONTINUED)
 
 
securities analysts who provide research services to the Fund. Under the
investment advisory agreement, the Fund pays the Advisor a monthly fee at the
annual rate of 0.45% of the value of the Fund's average daily net assets up to
$1 billion and 0.415% of the value of its average daily net assets in excess of
$1 billion. This fee is calculated daily and paid monthly. For the fiscal year
ended July 31, 1998, the Fund paid investment advisory fees to the Advisor in
an amount equal to 0.45% of the value of its average daily net assets.
 
  MMC also serves as the Fund's administrator and oversees all aspects of the
Fund's administration. For administration services rendered to the Fund, the
Fund pays MMC a fee at the annual rate of 0.20% of the value of the Fund's
average daily net assets up to $1 billion and 0.185% of the value of the aver-
age daily net assets in excess of $1 billion. This fee is calculated daily and
paid monthly.
 
 PORTFOLIO MANAGEMENT

  James Conroy, an investment officer of MMC and a Managing Director of Salomon
Smith Barney, has been and is respon-
sible for managing the day-to-day operations of the Fund, including the making
of investment decisions, since February 1990.  
 
  Management discussion and analysis, and additional performance information
regarding the Fund during the fiscal year ended July 31, 1998, is included in
the Annual Report dated July 31, 1998. A copy of the Annual Report may be
obtained upon request and without charge from a Salomon Smith Barney Financial
Consultant or by writing or calling the Fund at the address or phone number
listed on page one of this Prospectus.
 
  On October 8, 1998, the merger of Travelers Group, Inc. and Citicorp, Inc.
was consummated thereby creating a new entity called Citigroup. Citigroup is
a bank holding company subject to regulation under the Bank Holding Company Act
of 1956 (the "BHCA"), the requirements of the Glass-Steagall Act and certain
other laws and regulations. MMC does not believe that its compliance with
the applicable law will have a material adverse effect on its ability to
continue to provide the Fund with the same level of investment advisory
services that it currently
receives.  
 
DISTRIBUTOR
    
  CFBDS is located at 21 Milk Street, Boston, MA 02109-5408. It distributes
shares of the Fund as principal underwriter and as such conducts a continuous
offering pursuant to a "best efforts" arrangement requiring CFBDS to take
and pay for only such securities as may be sold to the public.  
     
42
<PAGE>
 
DISTRIBUTOR (CONTINUED)
 
  The Fund has adopted a plan of distribution under Rule 12b-1 under the 1940
Act (the "Plan"), pursuant to which Salomon Smith Barney is paid an annual
service fee with respect to Class A, Class B and Class L shares of the Fund at
the annual rate of 0.25% of the average daily net assets of the respective
Class. Salomon Smith Barney is also paid an annual distribution fee with
respect to Class B and Class L shares at the annual rate of 0.50% and 0.45%,
respectively, of the average daily net assets attributable to those Classes.
Class B shares which automatically convert to Class A shares eight years after
the date of original purchase will no longer be subject to distribution fees.
The fees are used by Salomon Smith Barney to pay its Financial Consultants for
servicing shareholder accounts and, in the case of Class B and Class L shares,
to cover expenses primarily intended to result in the sale of those shares.
These expenses include: advertising; the cost of printing and mailing prospec-
tuses to potential investors; payments to and expenses of Salomon Smith Barney
Financial Consultants and other persons who provide support services in con-
nection with the distribution of shares; interest and/or carrying charges; and
indirect and overhead costs of Salomon Smith Barney associated with the sale
of Fund shares, including lease, utility, communications and sales promotion
expenses.  
 
  The payments to Salomon Smith Barney Financial Consultants for selling
shares of a Class include a commission or fee paid by the investor or Salomon
Smith Barney at the time of sale and, with respect to Class A, Class B and
Class L shares, a continuing fee for servicing shareholder accounts for as
long as a shareholder remains a holder of that Class. Salomon Smith Barney
Financial Consultants may receive different levels of compensation for selling
different Classes of shares.
 
  Payments under the Plan with respect to Class A and Class B shares are not
tied exclusively to the distribution and shareholder service expenses actually
incurred by Salomon Smith Barney and the payments may exceed distribution
expenses actually incurred. The Fund's Board of Directors evaluates the appro-
priateness of the Plan and its payment terms on a continuing basis and in
doing so will consider all relevant factors, including expenses borne by Salo-
mon Smith Barney, amounts received under the Plan and proceeds of the CDSC.
 
ADDITIONAL INFORMATION
 
 
  The Fund was incorporated under the laws of the State of Maryland on
June 15, 1984 and is registered with the SEC as a diversified, open-end man-
agement investment company. Each Class of shares of the Fund has a par value
of $.001 per share. Each Class of shares has the same rights, privileges and
preferences, except with respect to: (a) the designation of each Class; (b)
the effect of the respective sales charges for each Class; (c) the distribu-
tion and/or service fees borne by each
 
                                                                             43
<PAGE>
 
ADDITIONAL INFORMATION (CONTINUED)
 
Class; (d) the expenses allocable exclusively to each Class; (e) voting rights
on matters exclusively affecting a single Class; (f) the exchange privileges of
each Class; and (g) the conversion feature of the Class B shares. The Fund's
Board of Directors does not anticipate that there will be any conflicts among
the interests of the holders of the different Classes. The Directors, on an
ongoing basis, will consider whether any such conflict exists and, if so, take
appropriate action.
 
  The Fund does not hold annual shareholder meetings. There normally will be no
meeting of shareholders for the purpose of electing Directors unless and until
such time as less than a majority of the Directors holding office have been
elected by shareholders. The Directors will call a meeting for any purpose upon
written request of shareholders holding at least 10% of the Fund's outstanding
shares, and the Fund will assist shareholders in calling such a meeting as
required by the 1940 Act. When matters are submitted for shareholder vote,
shareholders of each Class will have one vote for each full share owned and a
proportionate, fractional vote for any fractional share held of that Class.
Generally, shares of the Fund will be voted on a Fund-wide basis on all matters
except matters affecting only the interests of one or more of the Classes.
 
  PNC, located at 17th and Chestnut Streets, Philadelphia, Pennsylvania, serves
as custodian of the Fund's investments.
 
  First Data, located at Exchange Place, Boston, Massachusetts 02109, serves as
the Fund's transfer agent.
 
  The Fund sends its shareholders a semi-annual report and an audited annual
report, which include listings of investment securities held by the Fund at the
end of the period covered. In an effort to reduce the Fund's printing and mail-
ing costs, the Fund plans to consolidate the mailing of the Fund's semi-annual
and annual reports by household. This consolidation means that a household hav-
ing multiple accounts with identical address of record will receive a single
copy of each report. In addition, the Fund also plans to consolidate the mail-
ing of its Prospectus so that a shareholder having multiple accounts (that is,
individual, IRA and for Self-Employed Retirement Plan accounts) will receive a
single Prospectus annually. Shareholders who do not want this consolidation to
apply to their accounts should contact their Salomon Smith Barney Financial
Consultant, or the Fund's Transfer Agent.  
 
44
<PAGE>
 
                                                 SALOMON SMITH BARNEY
                                                 -------------------------------
                                                    A member of citigroup [LOGO]

             Salomon Smith Barney is a service mark of Salomon Smith Barney Inc.

 
                                                                                

                                                                    SMITH BARNEY
                                                                         MANAGED
                                                                     GOVERNMENTS
                                                                       FUND INC.

                                                            388 Greenwich Street
                                                        New York, New York 10013
 
                                                                   FD0212  11/98