As filed with the Securities and Exchange Commission
on November 27, 1996
								Registration No. 2-96408 
										811-4254

U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM N-1A

REGISTRATION STATEMENT UNDER 
THE SECURITIES ACT OF 1933    

[ ] Pre-Effective Amendment No.	[X] Post-Effective Amendment No.    43    

REGISTRATION STATEMENT UNDER THE INVESTMENT
COMPANY ACT OF 1940, as amended

Amendment No.  44  [X]     

SMITH BARNEY INCOME FUNDS
(Exact name of Registrant as Specified in Charter)

388 Greenwich Street, New York, New York 10013
(Address of principal executive offices) (Zip Code)

(212) 723-9218
(Registrant's telephone number, including Area Code)

Christina T. Sydor
Secretary

Smith Barney Income Funds
388 Greenwich Street
New York, New York 10013, 22nd Floor
(Name and address of agent for service)

copies to:

Burton M. Leibert, Esq.
Willkie Farr & Gallagher
One Citicorp Center
153 East 53rd Street
New York, NY  10022

Approximate Date of Proposed Public Offering:
As soon as possible after this Post-Effective Amendment becomes effective.

It is proposed that this filing become effective:
   
          Immediately upon filing pursuant to Rule 485(b) 
     X      on November 28, 1996 pursuant to Rule 485(b) 
           60 days after filing pursuant to Rule 485(a) 
_____  on -------------- pursuant to Rule 485(a)

    

The Registrant has previously filed a declaration of indefinite registration 
of its shares pursuant to Rule 24f-2 under the Investment Company Act of 1940.  
Registrant's Rule 24f-2 Notice for the fiscal year ended  July 31, 1996 was 
filed on September 27, 1996 as Accession Number 000076424-96-000002









SMITH BARNEY INCOME FUNDS

CONTENTS OF
REGISTRATION STATEMENT

This Registration Statement contains the following pages and documents:

Front Cover

Contents Page

Cross-Reference Sheet

Part A - Prospectus

Part B - Statement of Additional Information

Part C - Other Information

Signature Page

Exhibits


	SMITH BARNEY INCOME FUNDS

	FORM  N-1A CROSS REFERENCE SHEET
	Pursuant to Rule 495(a) Under the Securities Act of 1933, as amended


Part A 
Item No. and Caption					Prospectus Caption


1.	Cover Page					Cover Page

2.	Synopsis					Prospectus Summary 

3.	Condensed Financial Information		Financial Highlights;

4.	General Description of Registrant		Cover Page; Prospectus 
Summary;
							Investment Objective and Policies;
							Distributor; Additional Information

5.	Management of the Fund			Prospectus Summary; Management of 
							the Trust and the Fund; Distributor;
							Additional Information

6.	Capital Stock and Other Securities		Investment Objective and 
Policies;
							Dividends, Distributions and Taxes;
							Additional Information

7.	Purchase of Securities Being Offered		Valuation of Shares; 
Purchase of
							Shares; Exchange Privilege; 
Redemption
							of Shares;     Purchase, Exchange 
and 
							Redemption of Shares    ; Minimum
							Account Size; 
							Distributor

8.	Redemption or Repurchase of Shares		Purchase of Shares; Redemption 
of 
							Shares; Exchange Privilege;
							    Purchase, Exchange and
							Redemption of Shares    

9.	Pending Legal Proceedings			Not Applicable


Part B 							Statement of Additional
Item No. and Caption					Information Caption


10.	Cover Page					Cover page

11.	Table of Contents				Contents

12.	General Information and History			Distributor; Additional 
Information

13.	Investment Objectives and Policies		Investment Objectives and 
Management
							Policies

14.	Management of the Fund			Management of the Trust and the 
Funds;
							Distributor

15.	Control Persons and Principal			Management of the Trust and 
the Funds
	Holders of Securities

16.	Investment Advisory and			Management of the Trust and the 
Funds;
	Other Services					Distributor

17.	Brokerage Allocation				Investment Objectives and 
Management
							Policies; Distributor

18.	Capital Stock and Other Securities		Investment Objectives and 
Management
							Policies; Purchase of Shares;
							Redemption of Shares; Taxes

19.	Purchase, Redemption and Pricing		Purchase of Shares; Redemption 
of
	of Securities Being Offered			Shares; Valuation of Shares; 
Distributor;
							Exchange Privilege

20.	Tax Status					Taxes

21.	Underwriters					Distributor

22.	Calculation of Performance Data		Performance Data

23.	Financial Statements				Financial Statements




SMITH BARNEY INCOME FUNDS
PART A

 
 
                                                                    SMITH BARNEY
                                                                         Premium
                                                                           Total
                                                                          Return
                                                                            Fund
                                                             
                                                          NOVEMBER 28, 1996     
 
                                                   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 28, 1996     
   
Smith Barney     
   
Premium Total Return Fund     
388 Greenwich Street
New York, New York 10013
(212) 723-9218
 
  Smith Barney Premium Total Return Fund (the "Fund"), a diversified fund,
seeks to provide shareholders with total return, consisting of long-term capi-
tal appreciation and income, by investing primarily in a diversified portfolio
of dividend-paying common stocks. The Fund also purchases put and call options
and writes covered put and call options on securities it holds and on stock
indexes primarily as a hedge to reduce investment risk. The Fund is one of a
number of funds, each having distinct investment objectives and policies, mak-
ing up Smith Barney Income Funds (the "Trust"). The Trust is an open-end man-
agement investment company commonly referred to as a mutual fund.
 
  This Prospectus sets forth concisely certain information about the Fund and
the Trust, including sales charges, distribution and service fees and expenses,
that prospective investors will find helpful in making an investment decision.
Investors are encouraged to read this Prospectus carefully and retain it for
future reference. Shares of other investment funds offered by the Trust are
described in separate prospectuses that may be obtained by calling the Fund at
the telephone number set forth above, or by contacting a Smith Barney Financial
Consultant.
   
  Additional information about the Fund and the Trust is contained in a State-
ment of Additional Information dated November 28, 1996, as amended or supple-
mented from time to time, that is available upon request and without charge by
calling or writing the Trust at the telephone number or address set forth above
or by contacting a Smith Barney Financial Consultant. The Statement of Addi-
tional Information has been filed with the Securities and Exchange Commission
(the "SEC") and is incorporated by reference into this Prospectus in its
entirety.     
 
SMITH BARNEY INC.
Distributor
 
SMITH BARNEY STRATEGY ADVISERS INC.
Investment Adviser
 
SMITH BARNEY MUTUAL FUNDS MANAGEMENT INC.
Administrator
 
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES 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 POLICIES      15
-----------------------------------------
VALUATION OF SHARES                    23
-----------------------------------------
DIVIDENDS, DISTRIBUTIONS AND TAXES     23
-----------------------------------------
PURCHASE OF SHARES                     24
-----------------------------------------
EXCHANGE PRIVILEGE                     34
-----------------------------------------
REDEMPTION OF SHARES                   37
-----------------------------------------
MINIMUM ACCOUNT SIZE                   40
-----------------------------------------
PERFORMANCE                            40
-----------------------------------------
MANAGEMENT OF THE TRUST AND 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 Trust
or the distributor. This Prospectus does not constitute an offer by the Trust
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 Statement of Additional
Information. Cross references in this summary are to headings in the Prospec-
tus. See "Table of Contents."
 
INVESTMENT OBJECTIVE The Fund is an open-end, diversified management invest-
ment company that seeks total return by investing primarily in a diversified
portfolio of dividend-paying common stocks. The Fund may engage in various
portfolio strategies involving options to seek to increase its return and to
hedge its portfolio against movements in the equity markets and interest
rates. See "Investment Objective and Management Policies."
   
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 C
shares, which differ principally in terms of sales charges and rate 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
$5,000,000. 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 5.00% 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, which
when combined with current holdings of Class A shares offered with a sales
charge equal or exceed $500,000 in the aggregate, 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 Summary--Reduced or No Initial Sales Charge."
 
  Class B Shares. Class B shares are offered at net asset value subject to a
maximum CDSC of 5.00% of redemption proceeds, declining by 1.00% each year
after the date of purchase to zero. This CDSC may be waived for certain
redemptions. Class B shares are subject to an annual service 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.
 
  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
 
                                                                              3
<PAGE>
 
       
PROSPECTUS SUMMARY (CONTINUED)                       
 
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 C Shares. Class C shares are sold at net asset value with no initial
sales charge. 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 C shares within 12 months
of purchase. The CDSC may be waived for certain redemptions. The Class C
shares' distribution fee may cause that Class to have higher expenses and pay
lower dividends than Class A shares. Purchases of Fund shares, which when com-
bined with current holdings of Class C 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 $5,000,000. Class Y shares are sold at net asset
value with no initial sales charge or CDSC. They are not subject to any serv-
ice 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 length 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
investment alternative, Class B and Class C shares are sold without any ini-
tial 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 these Classes. Because the
Fund's future return cannot be predicted, however, there can be no assurance
that this would be the case.
 
  Finally, investors should consider the effect of the CDSC period and any
conversion rights of the Classes in the context of their own investment time
frame. For example, while Class C 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 C shares to investors with longer term investment outlooks.
 
4
<PAGE>
 
       
PROSPECTUS SUMMARY (CONTINUED)                       
       
  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, which when combined with current holdings of Class A shares offered
with a sales charge equal or exceed $500,000 in the aggregate, 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 aggregate
investment may be met by adding the purchase to the net asset value of all
Class A shares offered with a sales charge held in funds sponsored by Smith
Barney Inc. ("Smith Barney") listed under "Exchange Privilege." Class A share
purchases may also be eligible for a reduced initial sales charge. See "Pur-
chase of Shares." Because the ongoing expenses of Class A shares may be lower
than those for Class B and Class C shares, purchasers eligible to purchase
Class A shares at net asset value or at a reduced sales charge should consider
doing so.
   
  Smith Barney Financial Consultants may receive different compensation for
selling different Classes of shares. Investors should understand that the pur-
pose of the CDSC on the Class B and Class C shares is the same as that of the
initial sales charge on the Class A shares.     
   
  See "Purchase of Shares" and "Management of the Trust and the Fund" for a
complete description of the sales charges and service and distribution fees for
each Class of shares and "Valuation of Shares," "Dividends, Distributions and
Taxes" and "Exchange Privilege" for other differences among 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. Other investors may be eligible to participate in the Smith Barney
ExecChoice(TM) Program. Class A and Class C 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."     
   
PURCHASE OF SHARES Shares may be purchased through a brokerage account main-
tained with Smith Barney, a broker that clears securities transactions through
Smith Barney on a fully disclosed basis (an "Introducing Broker") or an invest-
ment dealer in the selling group. Direct purchases by certain retirement plans
may be made through the Fund's transfer agent, First Data Investor Services
Group, Inc. ("First Data"). See "Purchase of Shares."     
 
INVESTMENT MINIMUMS Investors in Class A, Class B and Class C shares may open
an account by making an initial investment of at least $1,000 for each
 
                                                                               5
<PAGE>
 
       
PROSPECTUS SUMMARY (CONTINUED)                       
   
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 $5,000,000. 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 C shares and the subse-
quent investment requirement for all Classes is $25. For minimum investment
requirements for all Classes through the Systematic Investment Plan, see
below. See "Purchase of Shares."     
   
SYSTEMATIC INVESTMENT PLAN The Fund offers shareholders a Systematic Invest-
ment Plan under which they may authorize the automatic placement of a purchase
order each month or quarter for Fund shares. The minimum initial and subse-
quent investment for shareholders purchasing shares through the Systematic
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
"Redemption of Shares."
   
MANAGEMENT OF THE FUND Smith Barney Strategy Advisers Inc. ("Strategy Advis-
ers") serves as the Fund's investment adviser. Strategy Advisers is a wholly
owned subsidiary of Smith Barney Mutual Funds Management Inc. ("SBMFM"). SBMFM
provides investment advisory and management services to investment companies
affiliated with Smith Barney. SBMFM is a wholly owned subsidiary of Smith Bar-
ney Holdings Inc. ("Holdings"). Holdings is a wholly owned subsidiary of Trav-
elers Group Inc. ("Travelers"), a diversified financial services holding com-
pany engaged, through its subsidiaries, principally in four business segments:
Investment Services, Consumer Finance Services, Life Insurance Services and
Property & Casualty Insurance Services.     
 
  SBMFM also serves as the Fund's administrator. Boston Partners Asset
Management, L.P. ("Boston Partners") serves as the Fund's sub-adviser. See
"Management of the Trust and 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 value next determined. See "Exchange Privilege."     
 
VALUATION OF SHARES The net asset value of the Fund for the prior day gener-
ally is quoted daily in the financial section of most newspapers and is also
available from any Smith Barney Financial Consultant. See "Valuation of
Shares."
 
6
<PAGE>
 
       
PROSPECTUS SUMMARY (CONTINUED)                       
 
 
DIVIDENDS AND DISTRIBUTIONS Dividends are paid monthly generally from net
investment income and annually from net realized capital gains. See "Divi-
dends, 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. The Fund may employ investment
techniques which involve certain risks, including entering into repurchase
agreements, reverse repurchase agreements and forward roll transactions,
engaging in when-issued and delayed-delivery transactions, lending portfolio
securities, covered option writing on securities it holds and on stock indi-
ces. See "Investment Objective and Management Policies."     
 
                                                                              7
<PAGE>
 
       
PROSPECTUS SUMMARY (CONTINUED)                     
   
THE FUND'S EXPENSES The following expense table lists the costs and expenses 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>
  SMITH BARNEY
  PREMIUM TOTAL RETURN FUND                      CLASS A CLASS B CLASS C CLASS Y
--------------------------------------------------------------------------------
  <S>                                            <C>     <C>     <C>     <C>
  SHAREHOLDER TRANSACTION EXPENSES
    Maximum sales charge imposed on purchases
      (as a percentage of offering price)         5.00%   None    None    None
    Maximum CDSC (as a percentage of original
      cost or redemption proceeds, whichever is
      lower)                                      None*   5.00%   1.00%   None
--------------------------------------------------------------------------------
  ANNUAL FUND OPERATING EXPENSE
      (AS A PERCENTAGE OF AVERAGE NET ASSETS)
    Management fees                               0.75%   0.75%   0.75%   0.75%
    12b-1 fees**                                  0.25%   0.75%   0.70%   None
    Other expenses                                0.12%   0.12%   0.14%   0.12%
--------------------------------------------------------------------------------
  TOTAL FUND OPERATING EXPENSES                   1.12%   1.62%   1.59%   0.87%
--------------------------------------------------------------------------------
</TABLE>    
   
  * Purchase of Class A shares, which when combined with current holdings of
    Class A shares offered with a sales charge equal or exceed $500,000 in the
    aggregate, 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 C shares do not have a
    conversion feature and, therefore, are subject to an ongoing distribution
    fee. As a result, long-term shareholders of Class C shares may pay more
    than the economic equivalent of the maximum front-end sales charge
    permitted by the National Association of Securities Dealers, Inc.
       
       
  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 B, Class C shares 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) Program. See "Purchase of Shares" and "Redemption of
Shares." Smith Barney receives an annual 12b-1 service fee of 0.25% of the
value of average daily net assets of Class A shares. Smith Barney also
receives, with respect to Class B shares, an annual 12b-1 fee of 0.75% of the
value of average daily net assets of that Class, consisting of a 0.50% distri-
bution fee and a 0.25% service fee. With respect to Class C shares, Smith Bar-
ney receives an annual 12b-1 fee of 0.70% of the value of the average daily net
assets, consisting of a 0.45% distribution 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 understanding 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>
  SMITH BARNEY
  PREMIUM TOTAL RETURN 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...................................   $61     $84    $109     $180
    Class B...................................    66      81      98      178
    Class C...................................    26      50      87      189
    Class Y...................................     9      28      48      107
  An investor would pay the following expenses
  on the same investment, assuming the same
  annual return and no redemption:
    Class A...................................   $61     $84    $109     $180
    Class B...................................    16      51      88      178
    Class C...................................    16      50      87      189
    Class Y...................................     9      28      48      107
--------------------------------------------------------------------------------
</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 two-year period ended July 31, 1996 has
been audited by KPMG Peat Marwick LLP, independent accountants, whose report
thereon appears in the Fund's Annual Report dated July 31, 1996. The following
information for the fiscal years ended July 31, 1987 through July 31, 1994 has
been audited by other independent auditors. The information set out below 
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 Additional Information.     
 
FOR A CLASS A SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH PERIOD:
 
<TABLE>   
<CAPTION>
                                          YEAR      YEAR     YEAR      PERIOD
SMITH BARNEY                             ENDED     ENDED     ENDED     ENDED
PREMIUM TOTAL RETURN FUND               7/31/96   7/31/95   7/31/94  7/31/93(1)
--------------------------------------------------------------------------------
<S>                                     <C>       <C>       <C>      <C>
NET ASSET VALUE, BEGINNING OF PERIOD      $16.33    $15.69   $15.65    $15.15
--------------------------------------------------------------------------------
INCOME FROM OPERATIONS:
 Net investment income                      0.37      0.44     0.33      0.19
 Net realized and unrealized gain on
 investments                                1.98      1.48     0.99      1.33
--------------------------------------------------------------------------------
Total Income From Operations                2.35      1.92     1.32      1.52
--------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income                     (0.37)    (0.43)   (0.31)    (0.17)
 Overdistribution of net investment
 income                                      --         --    (0.24)    (0.03)
 Net realized gains                        (0.91)    (0.14)   (0.52)    (0.44)
 Overdistribution of net realized gains      --         --       --     (0.05)
 Capital                                     --      (0.71)   (0.21)    (0.33)
--------------------------------------------------------------------------------
Total Distributions                        (1.28)    (1.28)   (1.28)    (1.02)
--------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD            $17.40    $16.33   $15.69    $15.65
--------------------------------------------------------------------------------
TOTAL RETURN++                             14.76%    12.92%    8.65%    10.31%++
--------------------------------------------------------------------------------
NET ASSETS, END OF PERIOD (000S)        $534,329  $471,578  $67,699   $39,677
--------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
 Expenses                                   1.12%     1.16%    1.19%     1.20%+
 Net investment income                      2.16      2.81     2.05      1.64+
--------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE                       58%       63%      34%       55%
--------------------------------------------------------------------------------
AVERAGE COMMISSIONS PER SHARE
   PAID ON EQUITY TRANSACTIONS(2)          $0.06       --       --        --
--------------------------------------------------------------------------------
</TABLE>    
(1) For the period from November 6, 1992 (inception date) to July 31, 1993.
   
(2) As of September 1995, the SEC instituted new guidelines requiring the dis-
    closure of average commissions per share.     
++Total return is not annualized as it may not be representative of the total
  return for the year.
+ Annualized.
++ Total return represents the aggregate total return for the period indicated
   and does not reflect any applicable sales charge.
 
10
<PAGE>
 
       
FINANCIAL HIGHLIGHTS (CONTINUED)
 
 
FOR A CLASS B SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH PERIOD:
 
<TABLE>   
<CAPTION>
                             YEAR     YEAR     YEAR     YEAR     YEAR     YEAR
SMITH BARNEY                 ENDED    ENDED    ENDED    ENDED    ENDED    ENDED
PREMIUM TOTAL RETURN FUND   7/31/96  7/31/95  7/31/94  7/31/93  7/31/92  7/31/91
--------------------------------------------------------------------------------
<S>                         <C>      <C>      <C>      <C>      <C>      <C>
NET ASSET VALUE, BEGINNING
OF PERIOD                   $16.33   $15.69   $15.65   $15.21   $14.26   $13.30
--------------------------------------------------------------------------------
INCOME FROM OPERATIONS:
 Net investment income        0.28     0.36     0.25     0.23     0.22     0.24
 Net realized and
 unrealized gain on invest-
 ments                        1.99     1.48     1.00     1.47     1.93     1.92
--------------------------------------------------------------------------------
Total Income From Opera-
tions                         2.27     1.84     1.25     1.70     2.15     2.16
--------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income       (0.29)   (0.34)   (0.27)   (0.16)   (0.22)   (0.24)
 Overdistribution of net
 investment income              --       --    (0.22)   (0.03)      --       --
 Net realized gains          (0.91)   (0.14)   (0.52)   (0.57)      --       --
 Overdistribution of net
 realized gains                 --       --       --    (0.06)      --       --
 Capital                        --    (0.72)   (0.20)   (0.44)   (0.98)   (0.96)
--------------------------------------------------------------------------------
Total Distributions          (1.20)   (1.20)   (1.21)   (1.26)   (1.20)   (1.20)
--------------------------------------------------------------------------------
NET ASSET VALUE, END OF
PERIOD                      $17.40   $16.33   $15.69   $15.65   $15.21   $14.26
--------------------------------------------------------------------------------
TOTAL RETURN++               14.21%   12.36%    8.12%   11.68%   15.68%   17.53%
--------------------------------------------------------------------------------
NET ASSETS, END OF PERIOD
(000S)                      $2,021   $1,655   $1,697   $1,231   $  585   $  470
--------------------------------------------------------------------------------
RATIOS TO AVERAGE NET
ASSETS:
 Expenses                     1.62%    1.66%    1.66%    1.69%    1.69%    1.75%
 Net investment income        1.66     2.31     1.58     1.16     1.53     1.84
--------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE         58%      63%      34%      55%      57%      43%
--------------------------------------------------------------------------------
AVERAGE COMMISSIONS PER
   SHARE
   PAID ON EQUITY TRANSAC-
   TIONS(1)                  $0.06       --       --       --       --       --
--------------------------------------------------------------------------------
</TABLE>    
++ Total return represents the aggregate total return for the period indicated
   and does not reflect any applicable sales charges.
 (1) As of September 1995, the SEC instituted new guidelines requiring
the disclosure of average commissions per share.
                                                                              11
<PAGE>
 
       
FINANCIAL HIGHLIGHTS (CONTINUED)
 
 
FOR A CLASS B SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH PERIOD:
 
<TABLE>   
<CAPTION>
                                           YEAR      YEAR      YEAR      YEAR
SMITH BARNEY                              ENDED     ENDED     ENDED     ENDED
PREMIUM TOTAL RETURN FUND                7/31/90   7/31/89   7/31/88   7/31/87
--------------------------------------------------------------------------------
<S>                                      <C>       <C>       <C>       <C>
NET ASSET VALUE, BEGINNING OF PERIOD       $13.98    $12.90    $14.47    $14.52
--------------------------------------------------------------------------------
INCOME FROM INVESTMENT OPERATIONS:
 Net investment income                       0.22      0.56      0.51      0.28
 Net realized and unrealized gain/(loss)
 on investments                              0.38      2.00     (0.62)     1.37
--------------------------------------------------------------------------------
Total From Investment Operations             0.60      2.56     (0.11)     1.65
--------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income                      (0.22)    (0.89)    (0.18)    (0.28)
 Overdistribution of net investment
 income                                        --        --        --        --
 Net realized capital gains                    --     (0.26)    (1.28)    (1.42)
 Overdistribution of net realized capi-
 tal gains                                     --        --        --        --
 Capital                                    (1.06)    (0.33)       --        --
--------------------------------------------------------------------------------
Total Distributions                         (1.28)    (1.48)    (1.46)    (1.70)
--------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD             $13.30    $13.98    $12.90    $14.47
--------------------------------------------------------------------------------
TOTAL RETURN++                               4.62%    21.49%     0.21%    12.07%
--------------------------------------------------------------------------------
NET ASSETS, END OF PERIOD (000S)         $507,762  $599,849  $585,634  $960,898
--------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
 Expenses                                    1.78%     1.75%     1.70%     1.74%
 Net investment income                       1.66%     4.17%     3.58%     1.97%
--------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE                        47%       41%       56%      294%
--------------------------------------------------------------------------------
AVERAGE COMMISSIONS PER SHARE
   PAID ON EQUITY TRANSACTIONS(1)           --        --        --        --
--------------------------------------------------------------------------------
</TABLE>    
   
(1) As of September 1995, the SEC instituted new guidelines requiring the dis-
    closure of average commissions per share.     
       
++ Total return represents the aggregate total return for the period indicated
   and does not reflect any applicable sales charge.
 
12
<PAGE>
 
       
FINANCIAL HIGHLIGHTS (CONTINUED)
   
FOR A CLASS C SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH PERIOD:
    
<TABLE>   
<CAPTION>
                                         YEAR     YEAR       YEAR      PERIOD
SMITH BARNEY                             ENDED    ENDED     ENDED      ENDED
PREMIUM TOTAL RETURN FUND               7/31/96  7/31/95  7/31/94(1) 7/31/93(2)
--------------------------------------------------------------------------------
<S>                                     <C>      <C>      <C>        <C>
NET ASSET VALUE, BEGINNING OF PERIOD     $16.33   $15.69    $15.65     $15.45
--------------------------------------------------------------------------------
INCOME FROM OPERATIONS:
 Net investment income                     0.29     0.36      0.23       0.05
 Net realized and unrealized gain on
 investments                               1.99     1.48      1.02       0.35
--------------------------------------------------------------------------------
Total Income From Operations               2.28     1.84      1.25       0.40
--------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income                    (0.29)   (0.35)    (0.27)     (0.03)
 Overdistribution of net investment
 income                                      --       --     (0.22)     (0.01)
 Net realized gains                       (0.91)   (0.14)    (0.52)     (0.08)
 Overdistribution of net realized gains      --       --        --      (0.01)
 Capital                                     --    (0.71)    (0.20)     (0.07)
--------------------------------------------------------------------------------
Total Distributions                       (1.20)   (1.20)    (1.21)     (0.20)
--------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD           $17.41   $16.33    $15.69     $15.65
--------------------------------------------------------------------------------
TOTAL RETURN++                            14.30%   12.36%     8.12%      2.60%++
--------------------------------------------------------------------------------
NET ASSETS, END OF PERIOD (000S)        $31,044  $12,937    $1,878     $  357
--------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
 Expenses                                  1.59%    1.62%     1.60%      1.31%+
 Net investment income                     1.68     2.35      1.65       1.54+
--------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE                      58%      63%       34%        55%
--------------------------------------------------------------------------------
AVERAGE COMMISSIONS PER SHARE
  PAID ON EQUITY TRANSACTIONS(3)          $0.06       --        --         --
--------------------------------------------------------------------------------
</TABLE>    
(1) On November 7, 1994 the former Class D shares were renamed Class C shares.
(2) For the period from June 1, 1993 (inception date) to July 31, 1993.
   
(3) As of September 1995, the SEC instituted new guidelines requiring the dis-
    closure of average commissions per share.     
++Total return is not annualized as it may not be representative of the total
  return for the year.
+ Annualized
++ Total return represents the aggregate total return for the period indicated
   and does not reflect any applicable sales charge.
 
                                                                             13
<PAGE>
 
       
FINANCIAL HIGHLIGHTS (CONTINUED)
   
FOR A CLASS Y SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH PERIOD:
    
<TABLE>   
<CAPTION>
                                    PERIOD ENDED
                                     7/31/96(1)
------------------------------------------------
<S>                                 <C>
NET ASSET VALUE, BEGINNING OF YEAR     $17.57
------------------------------------------------
INCOME FROM OPERATIONS:
 Net investment income                   0.19
 Net realized and unrealized gain        0.33
------------------------------------------------
Total Income From Operations             0.52
------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income                  (0.21)
 Net realized gains                     (0.46)
------------------------------------------------
Total Distributions                     (0.67)
------------------------------------------------
NET ASSET VALUE, END OF YEAR           $17.42
------------------------------------------------
TOTAL RETURN++                           2.93%
------------------------------------------------
NET ASSETS, END OF YEAR (000S)        $13,192
------------------------------------------------
RATIOS TO AVERAGE NET ASSETS+:
 Expenses                                0.87%
 Net investment income                   2.24
------------------------------------------------
PORTFOLIO TURNOVER RATE                    58%
------------------------------------------------
AVERAGE COMMISSIONS PER SHARE
 PAID ON EQUITY TRANSACTIONS(2)         $0.06
</TABLE>    
-------------------------------------------------------------------------------
   
(1) For the period from February 7, 1996 (inception date) to July 31, 1996.
           

    
   
(2) As of September 1995, the SEC instituted new guidelines requiring
the disclosure of average commissions per share.
++Total return is not annualized, as it may not be representative of the total
  return for the year.     
   
+ Annualized.     
 
14
<PAGE>
 
          
INVESTMENT OBJECTIVE AND POLICIES     
   
  The Fund's investment objective is total return. The Fund's investment objec-
tive may be changed only with the approval of a majority of the Fund's out-
standing shares. There can be no assurance that the Fund will achieve its
investment objective. The Fund will seek to achieve its objective by investing
primarily in a diversified portfolio of dividend-paying common stocks. The Fund
may engage in various portfolio strategies involving options to seek to
increase its return and to hedge its portfolio against movements in the equity
markets and interest rates. Because the Fund seeks total return by emphasizing
investments in dividend-paying common stocks, it will not have as much invest-
ment flexibility as total return funds which may pursue their objective by
investing in both income and equity stocks without such an emphasis. The Fund
also may invest up to 10% of its assets in: (a) medium- or low-rated securities
or unrated securities of comparable quality. Medium- and low-rated securities
are securities rated less than investment grade by Moody's Investors Service,
Inc. ("Moody's") or Standard & Poor's Ratings Group ("S&P"). See "Risk Factors
and Special Considerations--Medium-, Low- and Unrated Securities" below; (b)
interest-paying debt securities, such as obligations issued or guaranteed as to
principal and interest by the United States government ("U.S. government secu-
rities"); and (c) other securities, including convertible bonds, convertible
preferred stock and warrants. In addition, the Fund will limit its investments
in warrants to 5% of its net assets. The Fund also may lend its portfolio secu-
rities and enter into "short sales against the box." Special considerations
associated with the Fund's investment strategies are described below.     
 
 CERTAIN INVESTMENT STRATEGIES
  In attempting to achieve its investment objective, the Fund may employ, among
others, one or more of the strategies set forth below. More detailed informa-
tion concerning these strategies and their related risks is contained in the
Statement of Additional Information.
 
  In the future, the Fund may desire to employ additional investment strate-
gies, including hedging strategies such as entering into futures contracts and
related options. The Fund will do so only upon 60 days' notice to shareholders
and in conformity with its investment restrictions.
 
  Short Sales Against the Box. The Fund may make short sales of common stock
if, at all times when a short position is open, the Fund owns the stock or owns
preferred stocks or debt securities convertible or exchangeable, without pay-
ment of further consideration, into the shares of common stock sold short.
Short sales of this kind are referred to as "short sales against the box." The
broker-dealer that executes a short sale generally invests cash proceeds of the
sale until they are paid to the Fund. Arrangements may be made with the broker-
dealer to obtain a portion of the interest earned by the broker on the invest-
ment of short sale proceeds. The
 
                                                                              15
<PAGE>
 
          
INVESTMENT OBJECTIVE AND POLICIES (CONTINUED)     
 
Fund will segregate the common stock or convertible or exchangeable preferred
stock or debt securities in a special account with PNC Bank, National Associa-
tion ("PNC Bank"), the Fund's custodian. Not more than 10% of the Fund's net
assets (taken at current value) may be held as collateral for such sales at any
one time. The extent to which the Fund may make short sales of common stocks
may be limited by the requirements contained in the Code for qualification as a
regulated investment company. See "Dividends, Distributions and Taxes."
 
  Covered Option Writing. The Fund may write put and call options on securi-
ties. The Fund realizes fees (referred to as "premiums") for granting the
rights evidenced by the options. A put option embodies the right of its pur-
chaser to compel the writer of the option to purchase from the option holder 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 to the option holder an underlying security at a
specified price at any time during the option period. Thus, the purchaser of a
put option written by the Fund has the right to compel the Fund to purchase
from it the underlying security at the agreed-upon price for a specified time
period, while the purchaser of a call option written by the Fund 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 written by the Fund, 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 written by the Fund, 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 will write only covered options. Accordingly, whenever the Fund
writes a call option, it will continue to own or have the present right to
acquire the underlying security for as long as it remains obligated as the
writer of the option. To support its obligation to purchase the underlying
security if a put option is exercised, the Fund will either (a) deposit with
PNC Bank in a segregated account cash or equity and debt securities of any
grade provided such securities have been determined by Strategy Advisers on
Boston Partners to be liquid and unencumbered pursuant to guidelines estab-
lished by the Trustees, having a value at least equal to the exercise price of
the underlying securities or (b) continue to own an equivalent number of puts
of the same "series" (that is, puts on the same underlying security having the
same exercise prices and expiration dates as those written by the Fund), or an
equivalent number of puts of the same "class" (that is, puts on the same under-
lying security) with exercise prices greater than those that it has written
(or, if the exercise prices of the puts that it holds are less than the exer-
cise prices of those     
 
16
<PAGE>
 
          
INVESTMENT OBJECTIVE AND POLICIES (CONTINUED)     
 
that it has written, it will deposit the difference with PNC Bank in a segre-
gated account).
 
  The Fund may engage in a closing purchase transaction to realize a profit, to
prevent an underlying security from being called or put or, in the case of a
call option, to unfreeze an underlying security (thereby permitting its sale or
the writing of a new option on the security prior to the outstanding option's
expiration). To effect a closing purchase transaction, the Fund would purchase,
prior to the holder's exercise of an option the Fund has written, an option of
the same series as that on which the Fund desires to terminate its obligation.
The obligation of the Fund under an option it has written would be terminated
by a closing purchase transaction, but the Fund would not be deemed to own an
option as the result of the transaction. There can be no assurance the Fund
will be able to effect closing purchase transactions at a time when it wishes
to do so. To facilitate closing purchase transactions, however, the Fund ordi-
narily will write options only if a secondary market for the options exists on
a domestic securities exchange or in the over-the-counter market.
 
  Purchasing Put and Call Options on Securities. The Fund may utilize up to 10%
of its assets to purchase put options on portfolio securities and may do so at
or about the same time that it purchases the underlying security or at a later
time. By buying a put, the Fund limits the risk of loss from a decline in the
market value of the security until the put expires. Any appreciation in the
value of, or in the yield otherwise available from the underlying security,
however, will be partially offset by the amount of the premium paid for the put
option and any related transaction costs. The Fund may utilize up to 10% of its
assets to purchase call options on portfolio securities. Call options may be
purchased by the Fund in order to acquire the underlying securities for the
Fund at a price that avoids any additional cost that would result from a sub-
stantial increase in the market value of a security. The Fund also may purchase
call options to increase its return to investors at a time when the call is
expected to increase in value due to anticipated appreciation of the underlying
security.
 
  Prior to their expirations, put and call options may be sold in closing sale
transactions (sales by the Fund, prior to the exercise of options it has pur-
chased, of options of the same series), and profit or loss from the sale will
depend on whether the amount received is more or less than the premium paid for
the option plus the related transaction costs.
 
  Stock Index Options. The Fund may purchase and write exchange-listed put and
call options on stock indexes primarily to hedge against the effects of market-
wide price movements. A stock index measures the movement of a certain group of
stocks by assigning relative values to the common stocks included in the index.
 
                                                                              17
<PAGE>
 
          
INVESTMENT OBJECTIVE AND POLICIES (CONTINUED)     
 
(Examples of well-known stock indexes are the Standard & Poor's Daily Price
Index of 500 Common Stocks and the NYSE Composite Index.) Options on stock
indexes are similar to options on securities. However, because options on
stock indexes do not involve the delivery of an underlying security, the
option represents the holder's right to obtain from the writer in cash a fixed
multiple of the amount by which the exercise price exceeds (in the case of a
put) or is less than (in the case of a call) the closing value of the under-
lying index on the exercise date.
 
  The advisability of using stock index options to hedge against the effects
of market-wide movements will depend on the extent of diversification of the
Fund's stock investments and the sensitivity of its stock investments to fac-
tors influencing the underlying index. The effectiveness of purchasing or
writing stock index options as a hedging technique will depend upon the extent
to which price movements in the portion of the Fund being hedged correlate
with price movements in the stock index selected.
 
  When the Fund writes an option on a stock index, it will deposit cash or
cash equivalents or a combination of both in an amount equal to the market
value of the option in a segregated account with PNC Bank, and will maintain
the account while the option is open.
 
 ADDITIONAL INVESTMENTS
  Money Market Instruments. When Strategy Advisers and Boston Partners believe
that market conditions warrant, the Fund may adopt a temporary defensive pos-
ture and invest in short-term instruments without limitation. Short-term
instruments in which the Fund may invest include U.S. government securities;
certain bank obligations (including certificates of deposit, time deposits and
bankers' acceptances of domestic or foreign banks, domestic savings and loan
associations and similar institutions); commercial paper rated no lower than
A-2 by S&P or Prime-2 by Moody's or the equivalent from another major rating
service or, if unrated, of an issuer having an outstanding, unsecured debt
issue then rated within the three highest rating categories; and repurchase
agreements as described below.
 
  United States Government Securities. U.S. government securities are obliga-
tions of, or guaranteed by, the United States government, its agencies or
instrumentalities. The U.S. government securities in which the Fund may invest
include: direct obligations of the United States Treasury (such as Treasury
Bills, Treasury Notes and Treasury Bonds) and obligations issued by U.S. gov-
ernment agencies and instrumentalities, including securities that are sup-
ported by the full faith and credit of the United States (such as Government
National Mortgage Association ("GNMA") certificates); securities that are sup-
ported by the right of the issuer to borrow from the United States Treasury
(such as securities of Federal Home Loan Banks); and securities that are sup-
ported by the credit of the instrumentality (such as Federal
 
18
<PAGE>
 
          
INVESTMENT OBJECTIVE AND POLICIES (CONTINUED)     
 
National Mortgage Association ("FNMA") and Federal Home Loan Mortgage Corpora-
tion ("FHLMC") bonds). Treasury Bills have maturities of less than 1 year,
Treasury Notes have maturities of 1 to 10 years and Treasury Bonds generally
have maturities of greater than 10 years at the date of issuance. Certain U.S.
government securities, such as those issued or guaranteed by GNMA, FNMA and
FHLMC, are mortgage-related securities. U.S. government securities generally
do not involve the credit risks associated with other types of interest-bear-
ing securities, although, as a result, the yields available from U.S. govern-
ment securities are generally lower than the yields available from interest-
bearing corporate securities.
   
  Repurchase Agreements. The Fund may engage in repurchase agreement transac-
tions with banks which are the issuers of instruments acceptable for purchase
by the Fund 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 relatively 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 peri-
od. This arrangement results in a fixed rate of return that is not subject to
market fluctuations during the Fund's holding period. The value of the under-
lying securities will be at least equal at all times to the total amount of
the repurchase obligation, including interest. Repurchase agreements could
involve certain risks in the event of default or insolvency of the other par-
ty, including possible delays or restrictions upon the Fund's ability to dis-
pose of the underlying securities, the risk of a possible 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. Strategy Advisers, SBMFM or Boston Partners, acting under the
supervision of the Trust's Board of Trustees, 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.     
       
       
  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 any portfolio 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 transac-
tions, 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 such 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 a segregated
 
                                                                             19
<PAGE>
 
          
INVESTMENT OBJECTIVE AND POLICIES (CONTINUED)     
   
account in an amount equal to the amount of its when-issued and delayed-deliv-
ery commitments. Placing securities rather than cash in the segregated account
may have a leveraging effect on the Fund's net assets. The Fund will not accrue
income with respect to a when-issued security prior to its stated delivery
date.     
       
  Lending of Portfolio Securities. The Fund has the ability to lend portfolio
securities to brokers, dealers and other financial organizations. These loans,
if and when made, may not exceed 20% of the Fund's assets taken at value. Loans
of portfolio securities will be collateralized by cash, letters of credit or
U.S. government securities that are maintained at all times in an amount at
least equal to the current market value of the loaned securities.
 
 CERTAIN INVESTMENT GUIDELINES
   
  The Fund may invest up to 10% of its total assets in securities with contrac-
tual or other restrictions on resale and other instruments that are not readily
marketable, including (a) repurchase agreements with maturities greater than
seven days, (b) time deposits maturing from two business days through seven
calendar days and (c) to the extent that a liquid secondary market does not
exist for the instruments, futures contracts and options thereon. In addition,
the Fund may invest up to 5% of its assets in the securities of issuers which
have been in continuous operation for less than three years. The Fund also may
borrow from banks for temporary or emergency purposes, but not for investment
purposes, in an amount up to 10% of its total assets, and may pledge its assets
to the same extent in connection with such borrowings. Whenever these
borrowings exceed 5% of the value of the Fund's total assets, the Fund will not
make any additional investments. Except for the limitations on borrowing, the
investment guidelines set forth in this paragraph may be changed at any time
without shareholder consent by vote of the Trust's Board of Trustees. A com-
plete list of investment restrictions that identifies additional restrictions
that cannot be changed without the approval of a majority of the Fund's out-
standing shares is contained in the Statement of Additional Information.     
 
 RISK FACTORS AND SPECIAL CONSIDERATIONS
   
  Options. The Fund may enter into options transactions primarily as hedges to
reduce investment risk, generally by making an investment expected to move in
the opposite direction of a portfolio position. A hedge is designed to offset a
loss on a portfolio position with a gain on the hedge position; at the same
time, however, a properly correlated hedge will result in a gain on the portfo-
lio position being offset by a loss on the hedge position. The Fund bears the
risk that the prices of the securities being hedged will not move in the same
amount as the hedge. The Fund will engage in hedging transactions only when
deemed advisable by Strategy Advisers and Boston Partners. Successful use by
the Fund of options will depend on Strategy Advisers' and Boston Partners'
ability to correctly predict movements in     
 
20
<PAGE>
 
          
INVESTMENT OBJECTIVE AND POLICIES (CONTINUED)     
 
the direction of the stock or index underlying the option used as a hedge.
Losses incurred in hedging transactions and the costs of these transactions
will affect the Fund's performance.
 
  The ability of the Fund to engage in closing transactions with respect to
options depends on the existence of a liquid secondary market. While the Fund
generally will purchase or write stock options and options on stock index
options only if there appears to be a liquid secondary market for the options
purchased or sold, for some options no such secondary market may exist or the
market may cease to exist.
 
  Medium-, Low- and Unrated Securities. The Fund may invest up to 10% of its
assets in medium- or low-rated securities and unrated securities of comparable
quality. Generally, these securities offer a higher return potential than
higher-rated securities but involve greater volatility of price and risk of
loss of income and principal. The issuers of such securities may be in default
or bankruptcy at the time of purchase or may have a high probability of future
default or bankruptcy. Medium- and low-rated and comparable unrated securities
will likely have large uncertainties or major risk exposures to adverse condi-
tions and are predominantly speculative with respect to the issuer's capacity
to pay interest and repay principal in accordance with the terms of the obliga-
tion. Accordingly, it is possible that these types of factors could, in certain
instances, reduce the value of securities held by the Fund, with a commensurate
effect on the value of the Fund's shares.
 
  The markets in which medium- and low-rated or comparable unrated securities
are traded generally are more limited than those in which higher-rated securi-
ties are traded. The existence of limited markets for these securities may
restrict the availability of securities for the Fund to purchase and also may
have the effect of limiting the ability of the Fund to (a) obtain accurate mar-
ket quotations for purposes of valuing securities and calculating net asset
value and (b) sell securities at their fair value either to meet redemption
requests or to respond to changes in the economy or the financial markets. The
market for certain medium- and low-rated and comparable unrated securities has
not fully weathered a major economic recession. Any such economic downturn
could adversely affect the value of such securities and the ability of the
issuers of these securities to repay principal and pay interest thereon.
 
  While the market values of medium- and low-rated and comparable unrated secu-
rities tend to react less to fluctuations in interest rate levels than do those
of higher-rated securities, the market values of certain of these securities
also tend to be more sensitive to individual corporate developments and changes
in economic conditions than higher-rated securities. In addition, medium- and
low-rated and comparable unrated securities generally present a higher degree
of credit risk. Issuers of medium- and low-rated and comparable unrated securi-
ties are often highly leveraged and may not have more traditional methods of
financing available to them so that their ability
 
                                                                              21
<PAGE>
 
          
INVESTMENT OBJECTIVE AND POLICIES (CONTINUED)     
 
to service their debt obligations during an economic downturn or during sus-
tained periods of rising interest rates may be impaired. The risk of loss due
to default by such issuers is significantly greater because medium- and low-
rated and comparable unrated securities generally are unsecured and frequently
are subordinated to the prior payment of senior indebtedness. The Fund may
incur additional expenses to the extent that it is required to seek recovery
upon a default in the payment of principal or interest on its portfolio hold-
ings.
 
  Fixed-income securities, including medium- and low-rated and comparable
unrated securities, frequently have call or buy-back features that permit their
issuers to call or repurchase the securities from their holders, such as the
Fund. If an issuer exercises these rights during periods of declining interest
rates, the Fund may have to replace the security with a lower yielding securi-
ty, resulting in a decreased return to the Fund.
 
  Securities which are rated Ba by Moody's or BB by S&P have speculative char-
acteristics with respect to capacity to pay interest and repay principal. Secu-
rities which are rated B generally lack characteristics of a desirable invest-
ment and assurance of interest and principal payments over any long period of
time may be small. Securities which are rated Caa or CCC or below are of poor
standing. Those issues may be in default or present elements of danger with
respect to principal or interest. Securities rated C by Moody's and D by S&P
are in the lowest rating class and indicate that payments are in default or
that a bankruptcy petition has been filed with respect to the issuer or that
the issuer is regarded as having extremely poor prospects. See the Appendix in
the Trust's Statement of Additional Information on bond ratings by Moody's and
S&P.
   
  In light of these risks, Strategy Advisers and Boston Partners, in evaluating
the creditworthiness of an issue, whether rated or unrated, will take various
factors into consideration, which may include, as applicable, the issuer's
financial resources, its sensitivity to economic conditions and trends, the
operating history of and the community support for the facility financed by the
issue, the ability of the issuer's management and regulatory matters.     
 
  Securities of Unseasoned Issuers. Securities in which the Fund may invest may
have limited marketability and, therefore, may be subject to wide fluctuations
in market value. In addition, certain securities may lack a significant operat-
ing history and be dependent on products or services without an established
market share.
 
 PORTFOLIO TRANSACTIONS
   
  All orders for transactions in securities and options on behalf of the Fund
are placed by Strategy Advisers and Boston Partners with broker-dealers that
Strategy Advisers and Boston Partners select, including Smith Barney and other
affiliated     
 
22
<PAGE>
 
          
INVESTMENT OBJECTIVE AND POLICIES (CONTINUED)     
   
brokers. The Fund may utilize Smith Barney or a Smith Barney-affiliated broker
in connection with a purchase or sale of securities when Strategy Advisers and
Boston Partners believe that the broker's charge for the transactions does not
exceed usual and customary levels. The same standard applies to the use of
Smith Barney as a commodities broker in connection with entering into options
and futures contracts.     
   
VALUATION OF SHARES     
 
 
  The Fund's net asset value per share is determined as of the close of regular
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.
 
  Generally, the Fund's investments are valued at market value or, in the
absence of a market value with respect to any securities, at fair value as
determined by or under the direction of the Trust's Board of Trustees. Short-
term investments that mature in 60 days or less are valued at amortized cost
whenever the Trustees determine that amortized cost reflects fair value of
those instruments. Further information regarding the Fund's valuation policies
is contained in the Statement of Additional Information.
 
DIVIDENDS, DISTRIBUTIONS AND TAXES
 
 
 DIVIDENDS AND DISTRIBUTIONS
  The Fund will be treated separately from the Trust's other funds in determin-
ing the amounts of dividends from net investment income and distributions of
capital gains payable to shareholders.
 
  If a shareholder does not otherwise instruct, dividends and capital gains
distributions will be reinvested automatically in additional shares of the same
Class at net asset value, subject to no sales charge or CDSC. Dividends from
net investment income, if any, of the Fund will be declared monthly and paid on
the last Friday of the month. The Fund's final distribution for each calendar
year will include any remaining net investment income and net realized long-
and short-term capital gains realized during the year and deemed undistributed
during the year for Federal income tax purposes. In order to avoid the applica-
tion of a 4% nondeductible excise tax on certain undistributed amounts of ordi-
nary income and capital gains, the Fund may make an additional distribution
shortly before December 31 in each year of any undistributed ordinary income or
capital gains and expects to pay any other dividends and distributions neces-
sary to avoid the application of this tax.
 
  The per share dividends on Class B and Class C shares of the Fund may be
lower than the per share dividends on Class A and Class Y shares principally as
a
 
                                                                              23
<PAGE>
 
          
DIVIDENDS, DISTRIBUTIONS AND TAXES (CONTINUED)     
 
result of the distribution fee applicable with respect to Class B and Class C
shares. The per share dividends on Class A shares of the Fund may be lower than
the per share dividends on Class Y shares principally as a result of the serv-
ice fee applicable to Class A shares. Distributions of capital gains, if any,
will be in the same amount for Class A, Class B, Class C and Class Y shares.
 
 TAXES
  The Fund has qualified and intends to continue to qualify each year as a reg-
ulated investment company under the Code. Dividends paid from net investment
income and distributions of net realized short-term capital gains are taxable
to shareholders as ordinary income, regardless of how long shareholders have
held their Fund shares and whether such dividends and distributions are
received in cash or reinvested in additional Fund shares. Distributions of net
realized long-term capital gains will be taxable to shareholders as long-term
capital gains, regardless of how long shareholders have held Fund shares and
whether such distributions are received in cash or are reinvested in additional
Fund shares. Furthermore, as a general rule, a shareholder's gain or loss on a
sale or redemption of Fund shares will be a long-term capital gain or loss if
the shareholder has held the shares for more than one year and will be a short-
term capital gain or loss if the shareholder has held the shares for one year
or less. Some of the Fund's dividends declared from net investment income may
qualify for the Federal dividends-received deduction for corporations.
 
  Statements as to the tax status of each shareholder's dividends and distribu-
tions are mailed annually. Each shareholder also will receive, if appropriate,
various written notices after the close of the Fund's prior taxable year as to
the Federal income tax status of his or her dividends and distributions which
were received from the Fund during the Fund's prior taxable year. Shareholders
should consult their tax advisors about the status of the Fund's dividends and
distributions for state and local tax liabilities.
 
PURCHASE OF SHARES
 
 
 GENERAL
   
  The Fund offers four Classes of shares. Class A shares are sold to investors
with an initial sales charge and Class B and Class C shares are sold without an
initial sales charge but are subject to a CDSC payable upon certain redemp-
tions. Class Y shares are sold without an initial sales charge or CDSC, and are
available only to investors investing a minimum of $5,000,000 (except for pur-
chases of Class Y shares by the Smith Barney Concert Series Inc., for which
there is no minimum purchase amount). See "Prospectus Summary-- Alternative
Purchase Arrange     
 
24
<PAGE>
 
          
PURCHASE OF SHARES (CONTINUED)     
 
ments" for a discussion of factors to consider in selecting which Class of
shares to purchase.
   
  Purchases of Fund shares must be made through a brokerage account maintained
with Smith Barney, an Introducing Broker or an investment dealer in the selling
group, except for investors purchasing shares of the Fund through a qualified
retirement plan who may do so directly through First Data. When purchasing
shares of the Fund, investors must specify whether the purchase is for Class A,
Class B, Class C or Class Y shares. No maintenance fee will be charged by the
Fund in connection with a brokerage account through which an investor purchases
or holds shares.     
   
  Investors in Class A, Class B and Class C shares may open an account by mak-
ing an initial investment of at least $1,000 for each account, or $250 for an
IRA or a Self-Employed Retirement Plan in the Fund. Investors in Class Y shares
may open an account by making an initial investment of $5,000,000. 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
C 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 C shares and the minimum 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 requirement for Class A, Class B and Class C shares and the
subsequent investment requirement for all Classes is $50. There are no minimum
investment requirements for Class A shares for employees of Travelers and its
subsidiaries, including Smith Barney, Trustees of the Trust 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 Fund's transfer agent, First Data. Share certificates are issued only
upon a shareholder's written request to First Data.     
   
  Purchase orders received by the Fund or Smith Barney prior to the close of
regular trading on the NYSE, on any day the Fund calculates its net asset val-
ue, are priced according to the net asset value determined on that day. Orders
received by dealers or Introducing Brokers prior to the close of regular trad-
ing 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 Smith Barney prior to Smith Barney's close of business
(the "trade date"). For shares purchased through Smith Barney or Introducing
Brokers purchasing through 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.     
 
                                                                              25
<PAGE>
 
          
PURCHASE OF SHARES (CONTINUED)     
 
 
 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, Smith Barney or First Data is authorized through
preauthorized transfers of $25 and $50 or more to charge the regular bank
account or other financial institution indicated by the shareholder on a
monthly or quarterly basis, respectively, to provide 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 Smith Barney or
First Data. The Systematic Investment Plan also authorizes Smith Barney to
apply cash held in the shareholder's Smith Barney brokerage account or redeem
the shareholder's shares of a Smith Barney money market fund to make additions
to the account. Additional information is available from the Fund or a Smith
Barney Financial Consultant.     
 
 INITIAL SALES CHARGE ALTERNATIVE--CLASS A SHARES
  The sales charges applicable to purchases of Class A shares of the Fund are
as follows:
 
<TABLE>
<CAPTION>
                                  SALES CHARGE
                         ------------------------------
                                                             DEALERS'
                              % OF           % OF       REALLOWANCE AS % OF
  AMOUNT OF INVESTMENT   OFFERING PRICE AMOUNT INVESTED   OFFERING PRICE
---------------------------------------------------------------------------
  <S>                    <C>            <C>             <C>
  Less than  $ 25,000         5.00%          5.26%             4.50%
  $ 25,000 - $ 49,999         4.00%          4.17%             3.60%
  $ 50,000 - $ 99,999         3.50%          3.63%             3.15%
  $100,000 - $249,999         3.00%          3.09%             2.70%
  $250,000 - $499,999         2.00%          2.04%             1.80%
  $500,000 and over            *               *                 *
---------------------------------------------------------------------------
</TABLE>
* Purchases of Class A shares, which when combined with current holdings of
  Class A shares offered with a sales charge, equal or exceed $500,000 in the
  aggregate, 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 Smith Barney, which
  compensates 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 C shares is
  waived. See "Deferred Sales Charge Alternatives" 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 reduced sales charges shown above apply to the aggregate of purchases of
Class A shares of the Fund made at one time by "any person," which includes an
individual, his or her spouse and children, or a trustee or other fiduciary of
a single trust estate or single fiduciary account. The reduced sales charge
minimums may also be met by aggregating the purchase with the net asset value
of all Class A shares offered with a sales charge held in funds sponsored by
Smith Barney listed under "Exchange Privilege."
 
26
<PAGE>
 
       
PURCHASE OF SHARES (CONTINUED)
 
 
 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) Trustees or Directors
of any of the Smith Barney Mutual Funds and employees of Travelers and its sub-
sidiaries (including retired Board members and employees), the immediate fami-
lies 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 in connection with 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 Smith Barney
Financial Consultant (for a period up to 90 days from the commencement of the
Financial Consultant's employment with Smith Barney), on the condition the pur-
chase 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) shareholders who have redeemed Class A shares in
the Fund (or Class A shares of another of the Smith Barney Mutual Funds that
are offered with a sales charge equal to or greater than the maximum sales
charge of the Fund) and who wish to reinvest their redemption proceeds in the
Fund, provided the reinvestment is made within 60 calendar days of the redemp-
tion; (e) accounts managed by registered investment advisory subsidiaries of
Travelers; and; (f) purchase by Section 403(b) or Section 401(a) or (k)
accounts associated with Copeland Retirement Programs. 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 elimi-
nation of the sales charge.     
   
  Purchases of Class A shares also may be made at net asset value without a
sales charge in the following circumstances: (1) direct rollovers by plan par-
ticipants of distributions from a 401(k) plan enrolled in the Smith Barney
401(k) Program (Note: Subsequent investments will be subject to the applicable
sales charge); (2) purchases by separate accounts used to fund certain unregis-
tered variable annuity contracts; and (3) purchases by investors participating
in a Smith Barney fee based arrangement.     
 
 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 aggregat-
ing the dollar amount of the new purchase and the total net asset value of all
Class A
 
                                                                              27
<PAGE>
 
       
PURCHASE OF SHARES (CONTINUED)
 
shares of the Fund and of funds sponsored by Smith Barney which are offered
with a sales charge 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 discon-
tinuance at any time with respect to all shares purchased thereafter.
 
 GROUP PURCHASES
  Upon completion of certain automated systems, a reduced sales charge or pur-
chase at net asset value will also be available to employees (and partners) of
the same employer purchasing as a group, provided each participant makes the
minimum initial investment required. The sales charge applicable to purchases
by each member of such a group will be determined by the table set forth above
under "Initial Sales Charge Alternative--Class A Shares," and will be based
upon the aggregate sales of Class A shares of certain Smith Barney Mutual Funds
offered with a sales charge to, and share holdings of, all members of the
group. To be eligible for such reduced sales charges or to purchase at net
asset value, all purchases must be pursuant to an employer- or partnership-
sanctioned plan meeting certain requirements. One such requirement is that the
plan must be open to specified partners or employees of the employer and its
subsidiaries, if any. Such plan may, but is not required to, provide for pay-
roll deductions, IRAs or investments pursuant to retirement plans under Sec-
tions 401 or 408 of the Code. Smith Barney may also offer a reduced sales
charge or net asset value purchase for aggregating related fiduciary accounts
under such conditions that Smith Barney will realize economies of sales efforts
and sales related expenses. An individual who is a member of a qualified group
may also purchase Class A shares at the reduced sales charge applicable to the
group as a whole. The sales charge is based upon the aggregate dollar value of
Class A shares offered with a sales charge that have been previously purchased
and are still owned by the group, plus the amount of the current purchase. A
"qualified group" is one which (a) has been in existence for more than six
months, (b) has a purpose other than acquiring Fund shares at a discount and
(c) satisfies uniform criteria which enable Smith Barney to realize economies
of scale in its costs of distributing shares. A qualified group must have more
than 10 members, must be available to arrange for group meetings between repre-
sentatives of the Fund and the members, and must agree to include sales and
other materials related to the Fund in its publications and mailings to members
at no cost to Smith Barney. In order to obtain such reduced sales charge or to
purchase at net asset value, the purchaser must provide sufficient information
at the time of purchase to permit verification that the purchase qualifies for
the reduced sales charge. Approval of group purchase reduced sales charge plans
is subject to the discretion of Smith Barney.
 
 
28
<PAGE>
 
       
PURCHASE OF SHARES (CONTINUED)
 
 LETTER OF INTENT
   
  Class A Shares. A Letter of Intent for amounts 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 pur-
chases of all Class A shares of the Fund and other funds of the Smith Barney
Mutual Funds offered with a sales charge over the 13 month period based on the
total amount of intended purchases plus the value of all Class A shares previ-
ously purchased and still owned. An alternative is to compute the 13 month
period starting up to 90 days before the date of execution of a Letter of
Intent. 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. Please con-
tact a Smith Barney Financial Consultant or First Data 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. Such investors must
make an initial minimum purchase of $1,000,000 in Class Y shares of the Fund
and agree to purchase a total of $5,000,000 of Class Y shares of the same Fund
within six months from the date of the Letter. If a total investment of
$5,000,000 is not made within the six month period, all Class Y shares pur-
chased to date will be transferred to Class A shares, where they will be sub-
ject 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
Smith Barney Financial Consultant or First Data for further information.     
 
 DEFERRED SALES CHARGE ALTERNATIVES
   
  "CDSC Shares" are sold at net asset value next determined without an initial
sales charge so that the full amount of an investor's purchase payment may be
immediately invested in the Fund. A CDSC, however, may be imposed on certain
redemptions of these shares. "CDSC Shares" are: (a) Class B shares; (b) Class C
shares; and (c) Class A shares which, when combined with Class A shares offered
with a sales charge currently held by an investor equal or exceed $500,000 in
the aggregate.     
 
  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
 
                                                                              29
<PAGE>
 
       
PURCHASE OF SHARES (CONTINUED)
 
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 C shares and Class A shares that are
CDSC Shares, shares redeemed more than 12 months after their purchase.
   
  Class C 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
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
purchases by Participating Plans, 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                 5.00%
      Second                4.00%
      Third                 3.00%
      Fourth                2.00%
      Fifth                 1.00%
      Sixth                 0.00%
      Seventh               0.00%
      Eighth                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 also will be converted at that time such pro-
portion 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. Shareholders who held Class B shares of Smith Barney Shearson
Short-Term World Income Fund (the "Short-Term World Income Fund") on July 15,
1994 and who subsequently exchange those shares for Class B shares of the Fund
will be offered the opportunity to exchange all such Class B shares for Class A
shares of the Fund four years after the date on which those shares were deemed
to have been purchased. Holders of such Class B shares will be notified of the
pending exchange in writing approximately 30 days before the fourth anniversary
of the purchase date and, unless the exchange has been rejected in writing, the
exchange will occur on or about the fourth anniversary date. See "Prospectus
Summary--Alternative Purchase Arrangements Class B Shares Conversion Feature."
 
30
<PAGE>
 
       
PURCHASE OF SHARES (CONTINUED)
 
 
  In determining the applicability of any CDSC, it will be assumed that a
redemption is made first of shares representing capital appreciation, next of
shares representing the reinvestment of dividends and capital gains distribu-
tions and finally, of other shares held by the shareholder for the longest
period of time. 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 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 addi-
tional shares through dividend reinvestment. During the fifteenth month after
the 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) au-
tomatic 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) redemption of
shares made in connection with qualified distributions from retirement plans or
IRAs upon the attainment of age 59 1/2; (e) involuntary redemptions; and (f)
redemptions of shares in connection with 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 funds of the 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 Smith Barney in the
case of shareholders who are also Smith Barney clients or by First Data in the
case of all other shareholders) of the shareholder's status or holdings, as the
case may be.     
 
                                                                              31
<PAGE>
 
       
PURCHASE OF SHARES (CONTINUED)
    
 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 par-
ticipating ("Participating Plans") in these programs.     
   
  The Fund offers to Participating Plans Class A and Class C shares as invest-
ment alternatives under the Smith Barney 401(k) and ExecChoice(TM) Programs.
Class A and Class C shares acquired through the Participating Plans are subject
to the same service and/or distribution fees as the Class A and Class C shares
acquired by other 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 C Shares. Class C 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 C 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. If at the
end of the fifth year after the date the Participating Plan enrolled in the
Smith Barney 401(k) Program or the Smith Barney ExecChoice(TM) Program, a Par-
ticipating Plan's total Class C holdings in all non-money market Smith Barney
Mutual Funds equal at least $1,000,000, the Participating Plan will be offered
the opportunity to exchange all of its Class C shares for Class A shares of the
Fund. (For Participating Plans that were originally established through a Smith
Barney retail brokerage account, the five year period will be calculated from
the date the retail brokerage 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 Participating
Plan's holdings will be performed each quarter until either the Participating
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 a Participating
Plan's total Class C 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     
 
32
<PAGE>
 
       
PURCHASE OF SHARES (CONTINUED)
   
the opportunity to exchange all of its Class C 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 that has not previ-
ously qualified for an exchange into Class A shares will be offered the oppor-
tunity to exchange all of its Class C shares for Class A shares of the Fund,
regardless of asset size, at the end of the eighth year after the date the Par-
ticipating Plan enrolled in the Smith Barney 401(k) Program. Such Plans will be
notified of the pending exchange in writing approximately 60 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 C shares of the Fund but instead may acquire Class
A shares of the Fund. Any Class C shares not converted will continue to be sub-
ject 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 First Data. For further information regarding these
Programs, investors should contact a Smith Barney Financial Consultant.     
   
  Existing 401(k) Plans Investing in Class B Shares. Class B shares of the
Smith Barney Mutual Funds are not available for purchase by Participating Plans
opened on or after June 21, 1996, but may continue to be purchased by any Par-
ticipating Plan in the Smith Barney 401(k) Program opened prior to such date
and originally investing in such Class. Class B shares acquired are subject to
a CDSC of 3.00% of redemption proceeds, if the Participating Plan terminates
within eight years of the date the Participating Plan first enrolled in the
Smith Barney 401(k) Program.     
   
  At the end of the eighth year after the date the Participating Plan enrolled
in the Smith Barney 401(k) Program, the Participating Plan will be offered the
opportunity to exchange all of its Class B shares for Class A shares of the
Fund. Such Participating Plan will be notified of the pending exchange in writ-
ing approximately 60 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 the exchange has occurred, a Par-
ticipating Plan will not be eligible to acquire additional Class B shares of
the Fund but instead may acquire Class A shares of the Fund. If the Participat-
ing Plan elects not to exchange all of its Class B shares at that time, each
Class B share held by the Participating Plan will have the same conversion fea-
ture as Class B shares held by other investors. See "Purchase of Shares--
Deferred Sales Charge Alternatives."     
 
                                                                              33
<PAGE>
 
       
PURCHASE OF SHARES (CONTINUED)
   
  No CDSC is imposed on redemptions of Class B shares to the extent that the
net asset value of the shares redeemed does not exceed the current net asset
value of the shares purchased through reinvestment of dividends or capital gain
distributions, plus the current net asset value of Class B shares purchased
more than eight years prior to the redemption, plus increases in the net asset
value of the shareholder's Class B shares above the purchase payments made dur-
ing the preceding eight years. Whether or not the CDSC applies to the redemp-
tion by a Participating Plan depends on the number of years since the Partici-
pating Plan first became enrolled in the Smith Barney 401(k) Program, unlike
the applicability of the CDSC to redemptions by other shareholders, which
depends on the number of years since those shareholders made the purchase pay-
ment from which the amount is being redeemed.     
   
  The CDSC will be waived on redemptions of Class B shares in connection with
lump-sum or other distributions made by a Participating Plan as a result of:
(a) the retirement of an employee in the Participating Plan; (b) the termina-
tion of employment of an employee in the Participating Plan; (c) the death or
disability of an employee in the Participating Plan; (d) the attainment of age
59 1/2 by an employee in the Participating Plan; (e) hardship of an employee in
the Participating Plan to the extent permitted under Section 401(k) of the
Code; or (f) redemptions of shares in connection with a loan made by the Par-
ticipating Plan to an employee.     
       
EXCHANGE PRIVILEGE
   
  Except as otherwise noted below, shares of each Class may be exchanged at the
net asset value next determined 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 C shares are subject to minimum investment requirements and all shares
are subject to the other requirements of the fund into which exchanges are
made.     
 
 FUND NAME
  Growth Funds
   Smith Barney Aggressive Growth Fund Inc.
   Smith Barney Appreciation Fund Inc.
   Smith Barney Fundamental Value Fund Inc.
   Smith Barney Growth Opportunity Fund
   Smith Barney Managed Growth Fund
      
   Smith Barney Natural Resources Fund Inc.     
   Smith Barney Special Equities Fund
          
  Growth and Income Funds
   Smith Barney Convertible Fund
      
   Smith Barney Funds, Inc.--Equity Income Portfolio     
 
34
<PAGE>
 
       
EXCHANGE PRIVILEGE (CONTINUED)
       
   Smith Barney Growth and Income Fund
   Smith Barney Strategic Investors Fund
   Smith Barney Utilities Fund
 
  Taxable Fixed-Income Funds
    *Smith Barney Adjustable Rate Government Income Fund
   Smith Barney Diversified Strategic Income Fund
   **Smith Barney Funds, Inc.--Income Return Account Portfolio
   +Smith Barney Funds, Inc.--Short-Term U.S. Treasury Securities Portfo-
   lio
   Smith Barney Funds, Inc.--U.S. Government Securities Portfolio
   Smith Barney Government Securities Fund
   Smith Barney High Income Fund
   Smith Barney Investment Grade Bond Fund
   Smith Barney Managed Governments Fund Inc.
 
  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 Fund
          
          
   Smith Barney Muni Funds--Florida Portfolio
   Smith Barney Muni Funds--Georgia Portfolio
   **Smith Barney Muni Funds--Limited Term Portfolio
   Smith Barney Muni Funds--New York Portfolio
          
   Smith Barney Muni Funds--Pennsylvania Portfolio
   Smith Barney New Jersey Municipals Fund Inc.
          
   Smith Barney Tax-Exempt Income Fund
 
  International Funds
       
   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 Series Inc.     
      
   Smith Barney Concert Series Inc.--Balanced Portfolio     
      
   Smith Barney Concert Series Inc.--Conservative Portfolio     
      
   Smith Barney Concert Series Inc.--Growth Portfolio     
      
   Smith Barney Concert Series Inc.--High Growth Portfolio     
      
   Smith Barney Concert 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, Class B and Class Y shares of the
    Fund. In addition, shareholders who own Class C shares of the Fund through
    the Smith Barney 401(k) Program may exchange those shares for Class C
    shares of this fund.
 ** Available for exchange with Class A, Class C 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 B and Class C shares of the Fund.
+++ Available for exchange with Class A and Class Y shares of the Fund. In
    addition, shareholders who own Class C shares of the Fund through the Smith
    Barney 401(k) Program may exchange those shares for Class C shares of this
    fund.
       
  Class B Exchanges. In the event a Class B shareholder (unless such share-
holder was a Class B shareholder of the Short-Term World Income Fund on July
15, 1994) 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 C Exchanges. Upon an exchange, the new Class C shares will be deemed to
have been purchased on the same date as the Class C 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 respec-
tive Class in any of the funds identified above may do so without imposition 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. Strategy Advis-
ers may determine that a pattern of frequent exchanges is excessive and con-
trary 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     
 
36
<PAGE>
 
       
EXCHANGE PRIVILEGE (CONTINUED)
 
the 15-day period the shareholder will be required to (a) redeem his or her
shares in 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 abu-
sive 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 dis-
cussed 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 reg-
istration 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 the shares of the Fund 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 trading 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 redemp-
tion must specify the Class being redeemed. In the event of a failure to spec-
ify which Class, or if the investor owns fewer shares of the Class than speci-
fied, the redemption request will be delayed until First Data receives further
instructions from Smith Barney, or if the shareholder's account is not with
Smith Barney, from the shareholder directly. The redemption proceeds will be
remitted on or before the third day following receipt of proper tender, except
on any days on which the NYSE is closed or as permitted under the Investment
Company Act of 1940, as amended (the "1940 Act") in extraordinary circumstanc-
es. Generally, if the redemption proceeds are remitted to a Smith Barney bro-
kerage account, these funds will not be invested for the shareholder's benefit
without specific instruction and Smith Barney will benefit from the use of tem-
porarily uninvested funds. Redemption proceeds for shares purchased by check,
other than a certified or official bank check, will be remitted upon clearance
of the check, which may take up to ten days or more.     
 
 
                                                                              37
<PAGE>
 
       
REDEMPTION OF SHARES (CONTINUED)
 
  Shares held by Smith Barney as custodian must be redeemed by submitting a
written request to a Smith Barney Financial Consultant. Shares other than those
held by Smith Barney as custodian may be redeemed through an investor's Finan-
cial Consultant, Introducing Broker or dealer in the selling group or by sub-
mitting a written request for redemption to:
 
  Smith Barney Premium Total Return Fund
  Class A, B, C or Y (please specify)
  c/o First Data Investor Services Group, Inc.
  P.O. Box 9134
  Boston, Massachusetts 02205-9134
   
  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 written
redemption request in excess of $2,000, must be guaranteed by an eligible guar-
antor institution such as a domestic bank, savings and loan institution, domes-
tic credit union, member bank of the Federal Reserve System or member firm of a
national securities exchange. Written redemption requests of $2,000 or less do
not require a signature guarantee unless more than one such redemption request
is made in any 10-day period. Redemption proceeds will be mailed to an invest-
or'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.     
 
 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 share-
holder 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 Fund. Any applicable CDSC will not be waived on
amounts withdrawn by a shareholder 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. For further information regarding the automatic cash withdrawal
plan, shareholders should contact a Smith Barney Financial Consultant.
 
38
<PAGE>
 
   
REDEMPTION OF SHARES (CONTINUED)     
 
 
 TELEPHONE REDEMPTION AND EXCHANGE PROGRAM
   
  Shareholders who do not have a Smith Barney brokerage account may be eligible
to redeem and exchange Fund shares by telephone. To determine if a share holder
is entitled to participate in this program, he or she should contact First Data
at 1-800-451-2010. Once eligibility is confirmed, the shareholder must complete
and return a Telephone/Wire Authorization Form, along with a signature guaran-
tee that will be provided by First Data upon request. (Alternatively, an
investor may authorize telephone redemptions on the new account application
with the applicant's 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 5:00 p.m. (New
York City time) on any day the NYSE is open. Redemption requests received after
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 com-
plete 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 5:00
p.m. (New York City time) on any day on which the NYSE is open. Exchange
requests received after the close of regular trading on the NYSE are processed
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
 
                                                                              39
<PAGE>
 
   
REDEMPTION OF SHARES (CONTINUED)     
 
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.
 
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
 
 
 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 C 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 Prospectus, then dividing the value of the invest-
ment 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 redeem-
able value. Such standard total return information may also be accompanied with
nonstandard total return information 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 or the maximum public offering price (including sales charge) on the last
day of the period for which current dividend return is presented. The current
dividend return for each Class may vary from time to time depending on market
conditions, the composition of its investment portfolio and operating expenses.
These factors and possible differences in the methods used in calculating cur-
rent dividend return should be considered when comparing a Class' current
return to
 
40
<PAGE>
 
   
PERFORMANCE (CONTINUED)     
 
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, Inc. and other financial publications.
 
MANAGEMENT OF THE TRUST AND THE FUND
 
 
 BOARD OF TRUSTEES
  Overall responsibility for management and supervision of the Fund rests with
the Trust's Board of Trustees. The Trustees approve all significant agreements
between the Trust and the companies that furnish services to the Trust and the
Fund, including agreements with the Fund's distributor, investment adviser,
sub-investment adviser, administrator, custodian and transfer agent. The day-
to-day operations of the Fund are delegated to the Fund's investment adviser,
sub-investment adviser and administrator. The Statement of Additional Informa-
tion contains background information regarding each Trustee and executive offi-
cer of the Trust.
 
 INVESTMENT ADVISER--STRATEGY ADVISERS
   
  Strategy Advisers, located at 388 Greenwich Street, New York, New York 10013,
serves as the Fund's investment adviser. Strategy Advisers has been in the
investment counseling business since 1968 and is a wholly owned subsidiary of
SBMFM. SBMFM is a registered investment adviser whose principal executive
offices are located at 388 Greenwich Street, New York, New York 10013. Strategy
Advisers renders investment advice to investment companies that had aggregate
assets under management as of September 30, 1996 in excess of $3 billion. For
advisory services rendered to the Fund, under an Advisory Agreement dated
August 31, 1996, the Fund pays Strategy Advisers a fee at the annual rate of
0.55% of the value of the Fund's average daily net assets. From its fee, Strat-
egy Advisers pays Boston Partners a fee of 0.10% of the value of the Fund's
average daily net assets, for its services as sub-investment adviser.     
 
 ADMINISTRATOR--SBMFM
   
  SBMFM serves as the Fund's administrator and generally assists in all aspects
of the Fund's administration and operation. SBMFM provides investment manage-
ment and administration services to investment companies that had aggregate
assets under management as of September 30, 1996 in excess of $77 billion.     
 
  As the Fund's administrator, SBMFM oversees all aspects of the Fund's admin-
istration and operations. Pursuant to an administration agreement with the
Fund, SBMFM is paid a fee at the annual rate of 0.20% of the Fund's average
daily net assets.
 
 
                                                                              41
<PAGE>
 
          
MANAGEMENT OF THE TRUST AND THE FUND (CONTINUED)     
 
 SUB-INVESTMENT ADVISER--BOSTON PARTNERS
   
  Boston Partners, located at One Financial Center, Boston, Massachusetts
02111, serves as the Fund's sub-investment adviser. Boston Partners provides
investment management and investment advisory services to investment companies
that had aggregate total assets under management as of September 30, 1996, in
excess of $6.8 billion.     
 
  Subject to the supervision and direction of the Trust's Board of Trustees,
Strategy Advisers and Boston Partners manage the Fund's portfolio in accordance
with the Fund's investment objective and policies, make investment decisions
for the Fund, place orders to purchase and sell securities and employ profes-
sional portfolio managers and securities analysts who provide research services
to the Fund.
 
 PORTFOLIO MANAGEMENT
  Harry Rosenbluth, Equity Portfolio Manager of Boston Partners, has served as
Portfolio Manager of the Fund since August 16, 1995 and manages the day-to-day
operations of the Fund, including the oversight of all investment decisions.
Mr. Rosenbluth previously served as Investment Administrator of the Fund from
1992 until April, 1995, while he was a Senior Vice President of The Boston Com-
pany Asset Management, Inc. Mr. Rosenbluth has managed investment portfolios
since 1986.
   
  Management's discussion and analysis and additional performance information
regarding the Fund during the fiscal year ended July 31, 1996 is included in
the Annual Report dated July 31, 1996. A copy of the Annual Report may be
obtained upon request without charge from a Smith Barney Financial Consultant
or by writing or calling the Fund at the address or phone number listed on page
one of this Prospectus.     
   
DISTRIBUTOR     
 
 
  Smith Barney is located at 388 Greenwich Street, New York, New York 10013.
Smith Barney distributes shares of the Fund as principal underwriter and as
such conducts a continuous offering pursuant to a "best efforts" arrangement
requiring Smith Barney to take and pay for only such securities as may be sold
to the public. Pursuant to a plan of distribution adopted by the Fund under
Rule 12b-1 under the 1940 Act (the "Plan"), Smith Barney is paid a service fee
with respect to Class A, Class B and Class C shares of the Fund at the annual
rate of 0.25% of the average daily net assets of the respective Class. Smith
Barney is also paid a distribution fee with respect to Class B and Class C
shares at the annual rate of 0.50% and 0.45% of the average daily net assets
attributable to each of those Classes, respectively. Class B shares that auto-
matically convert to Class A shares eight years after the
 
42
<PAGE>
 
          
DISTRIBUTOR (CONTINUED)     
 
date of original purchase will no longer be subject to a distribution fee. The
fees are used by Smith Barney to pay its Financial Consultants for servicing
shareholder accounts and, in the case of Class B and Class C shares, to cover
expenses primarily intended to result in the sale of those shares. These
expenses include: advertising expenses; the cost of printing and mailing pro-
spectuses to potential investors; payments to and expenses of Smith Barney
Financial Consultants and other persons who provide support services in connec-
tion with the distribution of shares; interest and/or carrying charges; and
indirect and overhead costs of Smith Barney associated with the sale of Fund
shares, including lease, utility, communications and sales promotion expenses.
 
  The payments to Smith Barney Financial Consultants for selling shares of a
Class include, a commission or fee paid by the investor or Smith Barney at the
time of sale and, with respect to Class A, Class B and Class C shares, a con-
tinuing fee for servicing shareholder accounts for as long as a shareholder
remains a holder of that Class. Smith Barney Financial Consultants may receive
different levels of compensation for selling different Classes of shares.
 
  Payments under the Plan with respect to Class B and Class C shares are not
tied exclusively to the distribution and shareholder service expenses actually
incurred by Smith Barney and the payments may exceed distribution expenses
actually incurred. The Trust's Board of Trustees will evaluate the appropriate-
ness of the Plan and its payment terms on a continuing basis and in so doing
will consider all relevant factors, including expenses borne by Smith Barney,
amounts received under the Plan and proceeds of the CDSC.
 
ADDITIONAL INFORMATION
   
  The Trust was organized on March 12, 1985, under the laws of the Commonwealth
of Massachusetts and is an entity commonly known as a "Massachusetts business
trust." The Trust offers shares of beneficial interest currently classified
into four Classes--A, B, C and Y. Each Class of shares represents identical
interests in the Fund's investment portfolio. As a result, the Classes have the
same rights, privileges and preferences, except with respect to: (a) the desig-
nation of each Class; (b) the effect of the respective sales charges, if any,
for each Class; (c) the distribution and/or service fees, if any, borne by each
Class pursuant to the plan; (d) the expenses allocable exclusively to each
Class; (e) voting rights on matters exclusively affecting a single Class; (f)
the exchange privilege of each Class; and (g) the conversion feature of the
Class B shares. The Trust's Board of Trustees does not anticipate that there
will be any conflicts among the interests of the holders of the different Clas-
ses of shares of the Fund. The Trustees, on an ongoing basis, will consider
whether any such conflict exists and, if so, take appropriate action.     
 
                                                                              43
<PAGE>
 
       
ADDITIONAL INFORMATION (CONTINUED)
   
  When matters are submitted for shareholder vote, shareholders of each Class
of each fund will have one vote for each full share owned and a proportionate,
fractional vote for any fractional share held of that Class. Shares of the
Trust will be voted generally on a Trust-wide basis on all matters, except mat-
ters affecting the interests of one Fund or one Class of shares.     
 
  Normally, there will be no meetings of shareholders for the purpose of elect-
ing Trustees unless and until such time as less than a majority of the Trustees
holding office have been elected by shareholders. Shareholders of record of no
less than two-thirds of the outstanding shares of the Trust may remove a
Trustee through a declaration in writing or by vote cast in person or by proxy
at a meeting called for that purpose. The Trustees will call a meeting for any
purpose upon written request of shareholders holding at least 10% of the Fund's
outstanding shares and the Trust will assist shareholders in calling such a
meeting as required by the 1940 Act.
 
  PNC Bank, located at 17th and Chestnut Streets, Philadelphia, PA 19103,
serves as custodian of the Trust'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, each of which includes a listing of the investment securities held by
the Fund at the end of the reporting period. In an effort to reduce the print-
ing and mailing costs, the Trust plans to consolidate the mailing of the Fund's
semi-annual and annual reports by household. This consolidation means that a
household having multiple accounts with the identical address of record will
receive a single copy of each report. In addition, the Trust also plans to con-
solidate the mailing of the Fund's Prospectus so that a shareholder having mul-
tiple accounts (that is, individual, IRA and/or 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 Smith
Barney Financial Consultants or First Data.     
       
44
<PAGE>
 
 
                                              SMITH BARNEY
                                              --------------------------------- 

                                              A Member of Travelers Group [LOGO]
 
 
 
 
                                          SMITH BARNEY PREMIUM TOTAL RETURN FUND
 
                                   388 Greenwich Street New York, New York 10013
                                                                 
                                                              FD 0213 11/96     

<PAGE>
 
 
                                                                    SMITH BARNEY
                                                                       Utilities
                                                                            Fund
                                                             
                                                          NOVEMBER 28, 1996     
 
                                                   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 28, 1996     
   
Smith Barney     
   
Utilities Fund     
388 Greenwich Street
New York, New York 10013
(212) 723-9218
 
  The Smith Barney Utilities Fund (the "Fund") is a diversified fund that seeks
current income by investing in equity and debt securities of utility companies
selected by the Fund's investment adviser. Long-term capital appreciation is a
secondary objective of the Fund. The Fund is one of a number of funds, each
having distinct investment objectives and policies, making up the Smith Barney
Income Funds (the "Trust"). The Trust is an open-end management investment com-
pany commonly referred to as a mutual fund.
 
  This Prospectus sets forth concisely certain information about the Fund and
the Trust, including sales charges, distribution and service fees and expenses,
that prospective investors will find helpful in making an investment decision.
Investors are encouraged to read this Prospectus carefully and retain it for
future reference. Shares of other funds offered by the Trust are described in
separate prospectuses that may be obtained by calling the Trust at the tele-
phone number set forth above or by contacting a Smith Barney Financial Consul-
tant.
   
  Additional information about the Fund and the Trust is contained in a State-
ment of Additional Information dated November 28, 1996, as amended or supple-
mented from time to time, that is available upon request and without charge by
calling or writing the Trust at the telephone number or address set forth above
or by contacting a Smith Barney Financial Consultant. The Statement of Addi-
tional Information has been filed with the Securities and Exchange Commission
(the "SEC") and is incorporated by reference into this Prospectus in its
entirety.     
 
SMITH BARNEY INC.
Distributor
 
SMITH BARNEY MUTUAL FUNDS MANAGEMENT INC.
Investment Adviser and Administrator
 
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES 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   14
-------------------------------------------------
VALUATION OF SHARES                            26
-------------------------------------------------
DIVIDENDS, DISTRIBUTIONS AND TAXES             27
-------------------------------------------------
PURCHASE OF SHARES                             29
-------------------------------------------------
EXCHANGE PRIVILEGE                             39
-------------------------------------------------
REDEMPTION OF SHARES                           42
-------------------------------------------------
MINIMUM ACCOUNT SIZE                           44
-------------------------------------------------
PERFORMANCE                                    45
-------------------------------------------------
MANAGEMENT OF THE TRUST AND THE FUND           46
-------------------------------------------------
DISTRIBUTOR                                    47
-------------------------------------------------
ADDITIONAL INFORMATION                         48
-------------------------------------------------
</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 Trust
or the distributor. This Prospectus does not constitute an offer by the Trust
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 Statement of Additional
Information. Cross references in this summary are to headings in this Prospec-
tus. See "Table of Contents."     
 
INVESTMENT OBJECTIVE The Fund is an open-end, diversified management invest-
ment company that seeks current income by investing in the equity and debt
securities of companies in the utility industries. Long-term capital apprecia-
tion is a secondary objective. The utility industries are comprised of compa-
nies principally engaged (that is, at least 50% of a company's assets, gross
income or net profits results from utility operations or the company is regu-
lated as a utility by a government agency or authority) in the manufacture,
production, generation, transmission and sale of electric and gas energy and
companies principally engaged in the communications field, including entities
such as telephone, telegraph, satellite, microwave and other companies regu-
lated by governmental agencies as utilities that provide communication facili-
ties for the public benefit, but not including those in public broadcasting.
Under normal circumstances, the Fund will invest at least 65% of its assets in
equity and debt securities of companies in the utility industries and will
concentrate in excess of 25% of its assets in the securities of these compa-
nies. See "Investment Objective and Management Policies."
 
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 C
shares, which differ principally in terms of sales charges and rate 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
$5,000,000. In addition, a fifth Class, Class Z shares, which is offered pur-
suant to a separate prospectus, is offered exclusively to (a) tax-exempt
employee benefit and retirement plans of Smith Barney Inc. ("Smith Barney")
and its affiliates and (b) unit investment trusts ("UITs") sponsored by Smith
Barney and its affiliates. 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 5.00% imposed at the time of purchase 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. Pur-
chases of Class A shares, which when combined with current holdings of Class A
shares offered with a sales charge equal or exceed $500,000 in the aggregate,
will be made at net asset value with no initial sales charge, but will be sub-
ject to a contingent deferred sales charge ("CDSC") of 1.00% on redemptions
made within 12 months of purchase. See "Prospectus Summary--Reduced or No Ini-
tial Sales Charge."
 
                                                                              3
<PAGE>
 
       
PROSPECTUS SUMMARY (CONTINUED)
 
 
  Class B Shares. Class B shares are offered at net asset value subject to a
maximum CDSC of 5.00% of redemption proceeds, declining by 1.00% each year
after the date of purchase to zero. This CDSC may be waived for certain redemp-
tions. Class B shares are subject to an annual service 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.
 
  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 dis-
tributions ("Class B Dividend Shares") will be converted at that time. See
"Purchase of Shares--Deferred Sales Charge Alternative."
 
  Class C Shares. Class C shares are sold at net asset value with no initial
sales charge. 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 C
shares, and investors pay a CDSC of 1.00% if they redeem Class C shares within
12 months of purchase. This CDSC may be waived for certain redemptions. The
Class C shares' distribution fee may cause that Class to have higher expenses
and pay lower dividends than Class A shares. Purchases of Fund shares, which
when combined with current holdings of Class C 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 redemp-
tions made within 12 months of purchase.
 
  Class Y Shares. Class Y shares are available only to investors meeting an
initial investment minimum of $5,000,000. 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 consider
the following factors, as well as any other relevant facts and circumstances:
 
  Intended Holding Period. The decision as to which Class of shares is more
beneficial to an investor depends on the amount and intended length 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 investment
alternative, Class B and Class C shares are sold without any initial sales
charge so the entire purchase
 
4
<PAGE>
 
       
PROSPECTUS SUMMARY (CONTINUED)
 
price is immediately invested in the Fund. Any investment return on these addi-
tional invested amounts may partially or wholly offset the higher annual
expenses of these Classes. Because the Fund's future return cannot be predict-
ed, however, there can be no assurance that this would be the case.
 
  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 C 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 C 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 which, when combined with current holdings of Class A shares offered
with a sales charge equal or exceed $500,000 in the aggregate, 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 aggregate
investment may be met by adding the purchase to the net asset value of all
Class A shares offered with a sales charge held in funds sponsored by 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 ongoing expenses of Class A shares will be lower than those for Class B and
Class C shares, purchasers eligible to purchase Class A shares at net asset
value or at a reduced sales charge should consider doing so.     
   
  Smith Barney Financial Consultants may receive different compensation for
selling different Classes of shares. Investors should understand that the pur-
pose of the CDSC on the Class B and Class C shares is the same as that of the
initial sales charge on the Class A shares.     
   
  See "Purchase of Shares" and "Management of the Trust and the Fund" for a
complete description of the sales charges and service and distribution fees for
each Class of shares and "Valuation of Shares," "Dividends, Distributions and
Taxes" and "Exchange Privilege" for other differences among 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. Other investors may be eligible to participate in the Smith Barney
ExecChoice(TM) Program. Class A and Class C shares are available without a
sales     
 
                                                                               5
<PAGE>
 
       
PROSPECTUS SUMMARY (CONTINUED)
   
charge as investment alternatives under both of these Programs. See "Purchase
of Shares--Smith Barney 401(k) and ExecChoice(TM) Programs."     
   
PURCHASE OF SHARES Shares may be purchased through the Fund's distributor,
Smith Barney, a broker that clears securities transactions through Smith Bar-
ney on a fully disclosed basis (an "Introducing Broker") or an investment
dealer in the selling group. In addition, certain investors, including quali-
fied retirement plans and certain other institutional investors, may purchase
shares directly from the Fund through the Fund's transfer agent, First Data
Investor Services Group, Inc. ("First Data"). See "Purchase of Shares."     
   
INVESTMENT MINIMUMS Investors in Class A, Class B and Class C 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 $5,000,000. 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 C shares and the subse-
quent investment requirement for all Classes is $25. For minimum investment
requirements for all Classes through the Systematic Investment Plan see below.
There is no minimum investment required in Class A for unitholders who invest
distributions from a unit investment trust ("UIT") sponsored by Smith Barney.
See "Purchase of Shares."     
   
SYSTEMATIC INVESTMENT PLAN The Fund offers shareholders a Systematic Invest-
ment Plan under which they may authorize the automatic placement of a purchase
order each month or quarter for Fund shares. The minimum initial and subse-
quent investment for shareholders purchasing shares through the Systematic
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
"Redemption of Shares."
 
MANAGEMENT OF THE TRUST AND THE FUND Smith Barney Mutual Funds Management Inc.
("SBMFM"), serves as the Fund's investment adviser and administrator. SBMFM
provides investment advisory and management services to investment companies
affiliated with Smith Barney. SBMFM is a wholly owned subsidiary of Smith Bar-
ney Holdings Inc. ("Holdings"). Holdings is a wholly owned subsidiary of Trav-
elers Group Inc. ("Travelers"), a diversified financial services holding com-
pany engaged, through its subsidiaries, principally in four business segments:
Investment Services, Consumer Finance Services, Life Insurance Services and
Property & Casualty Insurance Services. See "Management of the Trust and the
Fund."
 
6
<PAGE>
 
       
PROSPECTUS SUMMARY (CONTINUED)
   
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 respective
net asset value next determined.  See "Exchange Privilege."     
 
VALUATION OF SHARES Net asset value of the Fund generally is quoted daily in
the financial section of most newspapers and is also available from Smith Bar-
ney Financial Consultants. See "Valuation of Shares."
 
DIVIDENDS AND DISTRIBUTIONS Dividends from net investment income are declared
and paid monthly. Distributions of net realized capital gains are paid annual-
ly, although distributions of short-term capital gains may be paid more fre-
quently than 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 distribution rein-
vestments 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. Because the Fund concentrates its
investments in one sector, its portfolio may be subject to greater risk and
market fluctuations than a portfolio of securities representing a broader range
of investment alternatives. The Fund will be affected by general changes in
interest rates which will result in increases or decreases in the market value
of the debt securities held by the Fund; the market value of the debt securi-
ties held by the Fund can be expected to vary inversely to changes in prevail-
ing interest rates. The Fund may invest up to 10% of its assets in lower-rated
fixed-income securities, which securities (a) will likely have some quality and
protective characteristics that, in the judgment of a rating organization, are
outweighed by large uncertainties or major risk exposures to adverse conditions
and (b) are predominantly speculative with respect to the issuer's capacity to
pay interest and repay principal in accordance with the terms of the securi-
ties. Certain of the investments held by the Fund and certain of the investment
strategies and techniques that the Fund may employ might expose it to certain
risks. The investments presenting the Fund with risks are low-rated securities,
as described above, foreign securities and non-publicly traded and illiquid
securities. The investment strategies and techniques presenting the Fund with
risks are entering in repurchase agreements, lending portfolio securities,
engaging in short sales against the box and entering into transactions involv-
ing options and futures contracts. See "Investment Objective and Management
Policies."     
 
                                                                               7
<PAGE>
 
       
PROSPECTUS SUMMARY (CONTINUED)
   
THE FUND'S EXPENSES The following expense table lists the costs and expenses
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>
  SMITH BARNEY
  UTILITIES FUND                               CLASS A CLASS B CLASS C CLASS Y
------------------------------------------------------------------------------
  <S>                                          <C>     <C>     <C>     <C>
  SHAREHOLDER TRANSACTION EXPENSES
    Maximum sales charge imposed on purchases
      (as a percentage of offering price)       5.00%   None    None    None
    Maximum CDSC (as a percentage of original
      cost or redemption proceeds, whichever
      is lower)                                 None*   5.00%   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                              0.14    0.15    0.15    0.13
------------------------------------------------------------------------------
  TOTAL FUND OPERATING EXPENSES                 1.04%   1.55%   1.50%   0.78%
------------------------------------------------------------------------------
</TABLE>    
   
  * Purchases of Class A shares, which when combined with current holdings of
    Class A shares offered with a sales charge equal or exceed $500,000 in the
    aggregate, 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
    purchases.     
 ** Upon conversion of Class B shares to Class A shares, such shares will no
    longer be subject to a distribution fee. Class C shares do not have a
    conversion feature and, therefore, are subject to an ongoing distribution
    fee. As a result, long-term shareholders of Class C shares may pay more
    than the economic equivalent of the maximum front-end sales charge
    permitted by the National Association of Securities Dealers, Inc.
       
  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 B, Class C 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) Program. See "Purchase of Shares" and "Redemption of Shares." Smith
Barney receives an annual 12b-1 service fee of 0.25% of the value of average
daily net assets of Class A shares. Smith Barney also receives an annual 12b-1
fee of 0.75% of the value of average daily net assets of Class B shares, con-
sisting of a 0.50% distribution fee and a 0.25% service fee. In Class C
shares, 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% distribution 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 understanding 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 Trust and the Fund."
 
<TABLE>   
<CAPTION>
  SMITH BARNEY
  UTILITIES 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..................................  $60     $81    $105     $171
    Class B..................................   66      79      94      171
    Class C..................................   25      47      82      179
    Class Y..................................    8      25      43       97
  An investor would pay the following
  expenses on the same investment, assuming
  the same annual return and no redemption:
    Class A..................................   60      81     105      171
    Class B..................................   16      49      84      171
    Class C..................................   15      47      82      179
    Class Y..................................    8      25      43       97
------------------------------------------------------------------------------
</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 two year period ended July 31, 1996 has
been audited by KPMG Peat Marwick LLP, independent auditors, whose report
thereon appears in the Fund's Annual Report dated July 31, 1996. The following
information for the fiscal years ended July 31, 1989 through July 31, 1994 has
been audited by other independent auditors. The information set out below 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 Additional Information.     
 
FOR A CLASS A SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH PERIOD:
 
<TABLE>   
<CAPTION>
                                         YEAR      YEAR     YEAR       PERIOD
SMITH BARNEY                            ENDED     ENDED     ENDED      ENDED
UTILITIES FUND                         7/31/96   7/31/95   7/31/94   7/31/93(1)
--------------------------------------------------------------------------------
<S>                                    <C>       <C>       <C>       <C>
NET ASSET VALUE, BEGINNING OF PERIOD   $  14.03  $  13.28  $ 15.97    $ 14.36
--------------------------------------------------------------------------------
INCOME (LOSS) FROM OPERATIONS:
 Net investment income                     0.83      0.85     0.56       0.66
 Net realized and unrealized gain
 (loss) on investments                     0.47      0.82    (1.92)      1.72
--------------------------------------------------------------------------------
Total Income (Loss) From Operations        1.30      1.67    (1.36)      2.38
--------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income                    (0.82)    (0.82)   (0.80)     (0.63)
 Overdistribution of net investment
 income                                      --        --    (0.03)     (0.01)
 Net realized gains                          --        --    (0.50)     (0.13)
 Overdistribution of net realized
 gains                                       --     (0.08)      --         --
 Capital                                     --     (0.02)      --         --
--------------------------------------------------------------------------------
Total Distributions                       (0.82)    (0.92)   (1.33)     (0.77)
--------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD         $  14.51  $  14.03  $ 13.28    $ 15.97
--------------------------------------------------------------------------------
TOTAL RETURN++                             9.21%    13.24%   (8.99)%    17.01%++
--------------------------------------------------------------------------------
NET ASSETS, END OF PERIOD (000S)       $266,163  $168,963  $41,458    $53,856
--------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
 Expenses                                  1.04%     1.07%    1.07%      1.07%+
 Net investment income                     5.55      6.36     5.54       5.67+
--------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE                      58%       36%      28%        37%
--------------------------------------------------------------------------------
AVERAGE COMMISSIONS PER SHARE PAID ON
EQUITY TRANSACTIONS (2)..............  $   0.06        --       --         --
--------------------------------------------------------------------------------
</TABLE>    
(1) For the period from November 6, 1992 (inception date) to July 31, 1993.
   
(2) As of September 1995, the SEC instituted new guidelines requiring the
    disclosure of average commissions per share.     
 ++Total return is not annualized as it may not be representative of the total
   return for the year.
 + Annualized.
++ Total return represents the aggregate total return for the period indicated
   and does not reflect any applicable sales charge.
 
10
<PAGE>
 
       
FINANCIAL HIGHLIGHTS (CONTINUED)
 
 
FOR A CLASS B SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH PERIOD:
 
<TABLE>   
<CAPTION>
                           YEAR     YEAR     YEAR      YEAR       YEAR       YEAR    YEAR     YEAR       YEAR
SMITH BARNEY               ENDED    ENDED    ENDED     ENDED     ENDED       ENDED     ENDED    ENDED     ENDED
UTILITIES FUND            7/31/96  7/31/95  7/31/94   7/31/93  7/31/92(1)  2/28/92 2/28/91  2/28/90  2/28/89(3)
-------------------------------------------------------------------------------------------------------------------
<S>                       <C>      <C>      <C>       <C>      <C>         <C>        <C>      <C>      <C>
NET ASSET VALUE,
BEGINNING OF PERIOD       $14.02   $13.28   $15.97    $14.83     $13.95      $13.21   $12.93   $12.09     $12.00
-------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM
OPERATIONS:
 Net investment income      0.77     0.78     0.75      0.79       0.35        0.82     0.88     0.87       0.64
 Net realized and
  unrealized gain (loss)
  on investments            0.47     0.82    (2.19)     1.30       0.89        0.94     0.40     1.08       0.17
-------------------------------------------------------------------------------------------------------------------
Total Income (Loss) From
Operations                  1.24     1.60    (1.44)     2.09       1.24        1.76     1.28     1.95       0.81
-------------------------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income     (0.75)   (0.76)   (0.72)    (0.79)     (0.35)      (0.84)   (0.90)   (0.90)     (0.57)
 Overdistribution of net
 Investment income            --       --    (0.03)    (0.01)        --          --       --       --         --
 Net realized gains           --       --    (0.50)    (0.15)        --       (0.15)   (0.10)   (0.21)     (0.15)
 Overdistribution of net
 realized gains               --    (0.08)      --        --         --          --       --       --         --
 Capital                      --    (0.02)      --        --      (0.01)      (0.03)      --       --         --
-------------------------------------------------------------------------------------------------------------------
Total Distributions        (0.75)   (0.86)   (1.25)    (0.95)     (0.36)      (1.02)   (1.00)   (1.11)     (0.72)
-------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF
PERIOD                    $14.51   $14.02   $13.28    $15.97     $14.83      $13.95   $13.21   $12.93     $12.09
-------------------------------------------------------------------------------------------------------------------
TOTAL RETURN++              8.78%   12.62%   (9.52)%   14.69%      8.98%++    13.63%   10.46%   16.34%      6.80%++
-------------------------------------------------------------------------------------------------------------------
NET ASSETS, END OF
PERIOD (MILLIONS)         $1,310   $1,573   $1,823    $2,766     $1,721      $1,275    $ 707    $ 604      $ 416
-------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET
ASSETS:
 Expenses                   1.55%    1.56%    1.54%     1.56%      1.57%+      1.58%    1.65%    1.70%      1.77%+
 Net investment income      5.13     5.82     5.07      5.17       5.78+       6.04     6.89     6.83       6.99+
-------------------------------------------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE       58%      36%      28%       37%        10%         33%      31%      50%        46%
-------------------------------------------------------------------------------------------------------------------
AVERAGE COMMISSIONS PER
SHARE PAID ON EQUITY
TRANSACTIONS (2)........  $ 0.06       --       --        --         --          --       --       --         --
-------------------------------------------------------------------------------------------------------------------
</TABLE>    
(1) For the period from March 1, 1992 to July 31, 1992.
(2) For the period from March 28, 1988 (commencement of operations) to
    February 28, 1989.
   
(3) As of September 1995, the SEC instituted new guidelines requiring the
    disclosure of average commissions per share.     
 ++Total return is not annualized as it may not be representative of the total
   return for the year.
 + Annualized.
++ Total return represents the aggregate total return for the period indicated
   and does not reflect any applicable sales charge.
 
                                                                             11
<PAGE>
 
       
FINANCIAL HIGHLIGHTS (CONTINUED)
 
 
FOR A CLASS C SHARE(1) OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH
PERIOD:
 
<TABLE>   
<CAPTION>
                                         YEAR     YEAR     YEAR       PERIOD
SMITH BARNEY                             ENDED    ENDED    ENDED      ENDED
UTILITIES FUND                          7/31/96  7/31/95  7/31/94   7/31/93(2)
-------------------------------------------------------------------------------
<S>                                     <C>      <C>      <C>       <C>
NET ASSET VALUE, BEGINNING OF PERIOD    $ 14.02  $13.28   $15.97      $15.17
-------------------------------------------------------------------------------
INCOME (LOSS) FROM OPERATIONS:
 Net investment income                     0.77    0.78     0.73        0.35
 Net realized and unrealized gain
 (loss) on investments                       0.47      0.82    (2.17)       0.86
-------------------------------------------------------------------------------
Total Income (Loss) From Operations     1.24    1.60    (1.44)       1.21
-------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income                     (0.75)   (0.76)   (0.72)      (0.38)
 Overdistribution of net investment
 income                                      --      --    (0.03)      (0.01)
 Net realized gains                          --      --    (0.50)      (0.02)
 Overdistribution of net realized gains      --   (0.08)      --          --
 Capital                                     --   (0.02)      --          --
-------------------------------------------------------------------------------
Total Distributions                       (0.75)  (0.86)   (1.25)      (0.41)
-------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD          $ 14.51  $14.02   $13.28      $15.97
-------------------------------------------------------------------------------
TOTAL RETURN ++                            8.80%  12.62%   (9.52)%      8.08%++
-------------------------------------------------------------------------------
NET ASSETS, END OF PERIOD (000)         $11,441  $3,925   $1,894      $  252
-------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
 Expenses                                  1.50%   1.51%    1.48%       1.49%+
 Net investment income                     5.19    5.77     5.13        5.25+
-------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE                      58%     36%      28%         37%
AVERAGE COMMISSIONS PER SHARE PAID ON
EQUITY TRANSACTIONS(3)                  $0.06      --       --          --
-------------------------------------------------------------------------------
</TABLE>    
(1) On November 7, 1994, the former Class D shares were renamed Class C
    shares.
(2) For the period from February 4, 1993 (inception date) to July 31, 1993.
   
(3) As of September 1995, the SEC instituted new guidelines requiring the
    disclosure of average commissions per share.     
 ++Total return is not annualized as it may not be representative of the total
   return for the year.
 + Annualized.
++ Total return represents the aggregate total return for the period indicated
   and does not reflect any applicable sales change.
 
 
12
<PAGE>
 
          
FINANCIAL HIGHLIGHTS (CONTINUED)     
   
FOR A CLASS Y SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH PERIOD:
    
<TABLE>   
<CAPTION>
                                                             PERIOD
                                                             ENDED
                                                           7/31/96(1)
---------------------------------------------------------------------
<S>                                                        <C>
NET ASSET VALUE, BEGINNING OF YEAR                           $14.88
---------------------------------------------------------------------
INCOME FROM OPERATIONS:
 Net investment income                                         0.64
 Net realized and unrealized gain                             (0.29)
---------------------------------------------------------------------
Total Income From Operations                                   0.35
---------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income                                        (0.71)
---------------------------------------------------------------------
Total Distributions                                           (0.71)
---------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD                               $14.52
---------------------------------------------------------------------
TOTAL RETURN++                                                 2.28%
---------------------------------------------------------------------
NET ASSETS, END OF YEAR (000S)                               $7,617
---------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS+:
 Expenses                                                      0.78%
 Net investment income                                         5.54
---------------------------------------------------------------------
PORTFOLIO TURNOVER RATE                                          58%
---------------------------------------------------------------------
AVERAGE COMMISSIONS PER SHARE PAID ON EQUITY TRANSACTIONS     $0.06
---------------------------------------------------------------------
</TABLE>    
   
(1) For the period October 9, 1995 through July 31, 1996.     
   
 ++Total return is not annualized, as it may not be representative of the total
   return for the year.     
   
+ Annualized.     
 
                                                                              13
<PAGE>
 
       
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES
 
 INVESTMENT OBJECTIVE
 
  The primary investment objective of the Fund is to provide current income.
Long-term capital appreciation is a secondary objective. The Fund's investment
objectives may be changed only with the approval of a majority of the Fund's
outstanding shares. There can be no assurance that the Fund will achieve its
investment objectives.
 
 INVESTMENT POLICIES
   
  The Fund seeks to achieve its objectives by investing in equity and debt
securities of companies in the utility industries. For purposes of this Pro-
spectus, the utility industries are deemed to be comprised of companies princi-
pally engaged (that is, at least 50% of a company's assets, gross income or net
profits results from utility operations or the company is regulated as a util-
ity by a government agency or authority) in the manufacture, production, gener-
ation, transmission and sale of electric and gas energy and companies princi-
pally engaged in the communications field, including entities such as tele-
phone, telegraph, satellite, microwave and other companies regulated by govern-
mental agencies as utilities that provide communication facilities for the pub-
lic benefit, but not including those in public broadcasting. The Fund will
invest primarily in utility equity and debt securities that have a high
expected rate of return, as determined by the Fund's investment adviser, SBMFM.
Under normal market conditions, the Fund will invest at least 65% of its assets
in such securities. The Fund may invest up to 35% of its assets in equity and
debt securities of non-utility companies believed to afford a reasonable oppor-
tunity for achieving the Fund's investment objectives. When SBMFM believes that
market conditions warrant, the Fund may adopt a temporary defensive posture and
may invest, without limit, in: debt securities (whether or not they are utility
securities) such as rated or unrated bonds, debentures and commercial paper,
United States government securities and money market instruments. The Fund may
invest up to 10% of its assets in securities rated BB or B by Standard & Poor's
Ratings Group ("S&P") or Ba or B by Moody's Investors Service, Inc. ("Moody's")
whenever SBMFM believes that the incremental yield on such securities is advan-
tageous to the Fund in comparison to the additional risk involved. Securities
rated BBB/Baa are considered medium grade obligations, neither highly protected
nor poorly secured. Interest payments and principal security of BBB/Baa rated
securities appear adequate for the present but certain protective elements may
be lacking or may be unreliable over any great length of time. BBB/Baa rated
securities lack outstanding investment characteristics and may in fact have
speculative characteristics. The yields on lower-rated fixed-income securities
generally are higher than the yields available on higher-rated securities. See
"Risk Factors and Special Considerations" below. In addition, the Fund may
enter into repurchase agreements.     
 
 
14
<PAGE>
 
       
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 INVESTMENT SECURITIES, STRATEGIES AND TECHNIQUES
 
  The Fund has the ability to engage in a number of specialized investment
strategies and techniques designed to enable the Fund to achieve its invest-
ment objectives. Included among these strategies are lending its portfolio
securities, selling securities "short against the box," writing covered call
and secured put options, as well as purchasing options on securities, purchas-
ing and selling interest rate futures contracts, options on futures contracts,
stock index put and call options and stock index futures contracts, each of
which is discussed below.
 
  United States Government Securities. United States government securities are
obligations of, or guaranteed by, the United States government, its agencies
or instrumentalities ("U.S. government securities"). These include bills, cer-
tificates of indebtedness, notes and bonds issued by the United States Trea-
sury or by agencies or instrumentalities of the United States government. Some
U.S. government securities, such as Treasury bills and bonds, are supported by
the full faith and credit of the United States; others, such as those of Fed-
eral Home Loan Banks, are supported by the right of the issuer to borrow from
the United States Treasury; others, such as those of the Federal National
Mortgage Association, are supported by the discretionary authority of the
United States government to purchase the agency's obligations; still others,
such as those of the Student Loan Marketing Association, are supported only by
the credit of the instrumentality. U.S. government securities generally do not
involve the credit risks associated with other types of interest-bearing secu-
rities, although, as a result, the yields available from U.S. government secu-
rities are generally lower than the yields available from interest-bearing
corporate securities.
   
   Zero Coupon Securities. The Fund may also invest in zero coupon bonds. A
zero coupon bond pays no interest in cash to its holder during its life,
although interest is accrued during that period. Its value to an investor con-
sists of the difference between its face value at the time of maturity and the
price for which it was acquired, which is generally an amount significantly
less than its face value (sometimes referred to as a "deep discount" price).
Because such securities usually trade at a deep discount, they will be subject
to greater fluctuations of market value in response to changing interest rates
than debt obligations of comparable maturities which make periodic distribu-
tions 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.     
 
  Repurchase Agreements. The Fund may engage in repurchase agreements 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
 
                                                                             15
<PAGE>
 
       
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
obligation for a relatively short period (usually not more than one week) sub-
ject 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 dur-
ing the Fund's holding period. This arrangement results in a fixed rate of
return that is not subject to market fluctuations during the Fund's holding
period. The value of the underlying securities will be at least equal at all
times to the total amount of the repurchase obligation, including interest.
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 right 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. SBMFM, acting under the supervision of
the Trust's Board of Trustees, reviews on an ongoing basis the value of the
collateral and creditworthiness of those banks and dealers with which the Fund
enters into repurchase agreements to evaluate potential risks.
 
  Lending Portfolio Securities. The Fund is authorized to lend its portfolio
securities to brokers, dealers and other financial organizations. The Fund's
loans of securities will be collateralized by cash, letters of credit or U.S.
government securities that are maintained at all times in an amount at least
equal to the current market value of the loaned securities. By lending its
securities, the Fund seeks to generate income by continuing to receive interest
on the loaned securities, by investing the cash collateral in short-term
instruments or by obtaining yield in the form of interest paid by the borrower
when U.S. government securities are used as collateral.
 
  Short Sales Against the Box. The Fund may sell its securities short
up to 5% of the Fund's net assets.  In addition, the Fund may make 
short sales  if at all times when a position is open,
the Fund owns the stock or owns preferred stock or debt securities convertible
or exchangeable without payment of further consideration for, securities of the
same issue as the securities sold short. Short sales of this kind are referred
to as "against the box." Short sales against the box are used to defer recogni-
tion of capital gains or losses.
   
  Options Activities. The Fund may write (that is, sell) call options ("calls")
if the calls are covered throughout the life of the option. A call is covered
if the Fund (a) owns the optioned securities, (b) maintains in a segregated
account with the Trust's custodian, PNC Bank, National Association ("PNC
Bank"), cash or equity and debt securities of any grade provided such securi-
ties have been determined by SBMFM to be liquid and unencumbered pursuant to
guidelines established by the Trustees ("eligible segregated assets") with a
value sufficient to meet the Fund's obligations under the call, or (c) owns an
offsetting call option. The aggregate value of the obligations underlying calls
on securities which are written by the     
 
16
<PAGE>
 
       
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
   
Fund and covered with cash or other eligible segregated assets securities,
together with the aggregate value of the obligations underlying put options
written by the Fund, will not exceed 50% of the Fund's net assets. When the
Fund writes a call, it receives a premium and gives the purchaser the right to
buy the underlying security at any time during the call period (usually not
more than nine months in the case of common stock or fifteen months in the case
of U.S. government securities) at a fixed exercise price regardless of market
price changes during the call period. If the call is exercised, the Fund for-
goes any gain from an increase in the market price of the underlying security
over the exercise price. The Fund may purchase calls on securities. The Fund
also may purchase and sell stock index calls which differ from calls on indi-
vidual securities in that they are settled in cash based on the values of the
securities in the underlying index, rather than by delivery of the underlying
securities. In writing a call on a stock index, the Fund receives a premium and
agrees that during the call period purchasers of a call, upon exercise of the
call, will receive an amount of cash if the closing level of the stock index
upon which the call is based is greater than the exercise price of the call.
When the Fund buys a call on a stock index, it pays a premium and during the
call period the Fund, upon exercise of the call, receives an amount of cash if
the closing level of the stock index upon which the call is based is greater
than the exercise price of the call.     
 
  The Fund may write and purchase put options ("puts"). When the Fund writes a
put, it receives a premium and gives the purchaser of the put the right to sell
the underlying security to the Fund at the exercise price at any time during
the option period. When the Fund purchases a put, it pays a premium in return
for the right to sell the underlying security at the exercise price at any time
during the option period. For the purchase of a put to be profitable, the mar-
ket price of the underlying security must decline sufficiently below the exer-
cise price to cover the premium and transaction costs, unless the put is sold
in a closing sale transaction; otherwise, the purchase of the put effectively
increases the cost of the security and thus reduces its yield. The Fund also
may purchase and sell stock index puts, which differ from puts on individual
securities in that they are settled in cash based on the values of the securi-
ties in the underlying index, rather than by delivery of the underlying securi-
ties. Purchase of a stock index put is designed to protect against a decline in
the value of the Fund's portfolio generally, rather than an individual security
in the portfolio. Stock index puts are sold primarily to realize income from
the premiums received on the sale of such options. If any put is not exercised
or sold, it will become worthless on its expiration date. The Fund will not
purchase puts or calls on securities if more than 5% of its assets would be
invested in premiums on puts and calls, not including that portion of the pre-
mium which reflects the value of the securities owned by the Fund and under-
lying a put at the time of purchase.
 
                                                                              17
<PAGE>
 
       
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
   
  The Fund may write puts on securities only if they are "secured." A put is
"secured" if the Fund maintains cash or other eligible segregated assets with a
value equal to the exercise price in a segregated account or holds a put on the
same underlying security at an equal or greater exercise price. The aggregate
value of the obligations underlying puts written by the Fund, together with the
aggregate value of the obligations underlying calls on securities which are
written by the Fund and covered with cash, cash equivalents or U.S. government
securities, will not exceed 50% of the Fund's net assets. The Fund also may
write "straddles," which are combinations of secured puts and covered calls on
the same underlying security.     
 
  The Fund will realize a gain (or loss) on a closing purchase transaction with
respect to a call or put previously written by the Fund if the premium, plus
commission costs, paid to purchase the call or put is less (or greater) than
the premium, less commission costs, received on the sale of the call or put. A
gain also will be realized if a call or put which the Fund has written lapses
unexercised, because the Fund would retain the premium. See "Dividends, Distri-
butions and Taxes" below. The Fund will purchase and sell only options which
are listed on a national securities exchange and will write options only
through a national options clearing organization.
 
  There can be no assurance that a liquid secondary market will exist at a
given time for any particular option. In this regard, trading in options on
U.S. government securities is relatively new, so that it is impossible to pre-
dict to what extent liquid markets will develop or continue. See the Statement
of Additional Information for a further discussion of risks involved in options
trading, and particular risks applicable to options trading on U.S. government
securities, including risks involved in options trading on Government National
Mortgage Association ("GNMA") certificates and the characteristics and risks of
stock index options transactions.
   
  Futures Contracts--General. The Fund may not purchase futures contracts or
related options if, immediately thereafter, more than 30% of the Fund's total
assets would be so invested. In purchasing and selling futures contracts and
related options, the Fund will comply with rules and interpretations of the
Commodity Futures Trading Commission ("CFTC"), under which the Fund is excluded
from regulation as a "commodity pool." CFTC regulations require, among other
things, that (a) futures and related options be used solely for bona fide hedg-
ing purposes (or that the underlying commodity value of the Fund's long posi-
tions not exceed the sum of certain identified liquid investments) and (b) the
Fund not enter into futures and related options for which the aggregate initial
margin and premiums exceed 5% of the fair market value of the Fund's assets. In
order to prevent leverage in connection with the purchase of futures contracts
by the Fund, an amount of cash or other eligible segregated assets equal to the
market value of futures     
 
18
<PAGE>
 
       
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
contracts purchased will be maintained in a segregated account with PNC Bank.
The Fund will engage only in futures contracts and related options which are
listed on a national commodities exchange.
 
  Interest Rate Futures Contracts. The Fund may purchase and sell interest rate
futures contracts as a hedge against changes in interest rates. An interest
rate futures contract is an agreement between two parties to buy and sell a
security for a set price on a future date. Interest rate futures contracts are
traded on designated "contracts markets" which, through their clearing corpora-
tions, guarantee performance of the contracts. Currently, there are interest
rate futures contracts based on securities such as long-term Treasury bonds,
Treasury notes, GNMA certificates and three-month Treasury bills.
 
  Generally, if market interest rates increase, the value of outstanding debt
securities declines (and vice versa). Entering into an interest rate futures
contract for the sale of securities has an effect similar to the actual sale of
securities, although sale of the interest rate futures contract might be accom-
plished more easily and quickly. For example, if the Fund holds long-term U.S.
government securities and SBMFM anticipates a rise in long-term interest rates,
the Fund could, in lieu of disposing of its portfolio securities, enter into
interest rate futures contracts for the sale of similar long-term securities.
If interest rates increased and the value of the Fund's securities declined,
the value of the Fund's interest rate futures contracts would increase, thereby
protecting the Fund by preventing the net asset value from declining as much as
it otherwise would have declined. Similarly, entering into interest rate
futures contracts for the purchase of securities has an effect similar to the
actual purchase of the underlying securities, but permits the continued holding
of securities other than the underlying securities. For example, if SBMFM
expects long-term interest rates to decline, the Fund might enter into interest
rate futures contracts for the purchase of long-term securities, so that it
could gain rapid market exposure that may offset anticipated increases in the
cost of securities that it intends to purchase, while continuing to hold high-
er-yielding short-term securities or waiting for the long-term market to stabi-
lize.
 
  The Fund may purchase and sell listed put and call options on interest rate
futures contracts. An option on an interest rate futures contract gives the
purchaser the right, in return for the premium paid, to assume a position in an
interest rate futures contract (a long position if the option is a call and a
short position if the option is a put), at a specified exercise price at any
time during the option period. When an option on a futures contract is exer-
cised, delivery of the interest rate futures position is accompanied by cash
representing the difference between the current market price of the interest
rate futures contract and the exercise price of the option. The Fund may pur-
chase put options on interest rate futures contracts in lieu of, and for the
same purpose as, sale of a futures contract. It also may purchase
 
                                                                              19
<PAGE>
 
       
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
such put options in order to hedge a long position in the underlying interest
rate futures contract in the same manner as it purchases "protective puts" on
securities. The purchase of call options on interest rate futures contracts is
intended to serve the same purpose as the actual purchase of the futures con-
tract, and the Fund will set aside cash and cash equivalents sufficient to pur-
chase the amount of portfolio securities represented by the underlying futures
contracts. See "Options Activities" and "Dividends, Distributions and Taxes."
 
  Stock Index Futures Contracts. The Fund may purchase and sell stock index
futures contracts. These transactions, if any, by the Fund will be made solely
for the purpose of hedging against the effects of changes in the value of its
portfolio securities due to anticipated changes in market conditions and will
be made when the transactions are economically appropriate to the reduction of
risks inherent in the management of the Fund. A stock index futures contract is
an agreement under which two parties agree to take or make delivery of the
amount of cash based on the difference between the value of a stock index at
the beginning and at the end of the contract period. When the Fund enters into
a stock index futures contract, it must make an initial deposit, known as "ini-
tial margin," as a partial guarantee of its performance under the contract. As
the value of the stock index fluctuates, either party to the contract is
required to make additional margin deposits, known as "variation margin," to
cover any additional obligation that it may have under the contract. The Fund
may not at any time commit more than 5% of its total assets to initial margin
deposits on futures contracts.
 
  Successful use of stock index futures contracts by the Fund is subject to
certain special risk considerations. A liquid stock index futures market may
not be available when the Fund seeks to offset adverse market movements. In
addition, there may be an imperfect correlation between movements in the secu-
rities included in the index and movements in the securities in the Fund. Suc-
cessful use of stock index futures contracts is further dependent on SBMFM's
ability to predict correctly movements in the direction of the stock markets
and no assurance can be given that its judgment in this respect will be cor-
rect. Risks in the purchase and sale of stock index futures are further
referred to in the Statement of Additional Information.
 
  Foreign Securities and American Depositary Receipts. The Fund may purchase
foreign securities or American Depositary Receipts ("ADRs"). ADRs are U.S.
dollar-denominated receipts issued generally by domestic banks and representing
the deposit with the bank of a security of a foreign issuer. ADRs are publicly
traded on exchanges or over-the-counter in the United States.
 
  Investing in the securities of foreign companies involves special risks and
considerations not typically associated with investing in U.S. companies. These
risks
 
20
<PAGE>
 
       
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
include differences in accounting, auditing and financial reporting standards,
generally higher commission rates on foreign portfolio transactions, the possi-
bility of expropriation or confiscatory taxation, adverse changes in investment
or exchange control regulations, political instability which could affect U.S.
investments in foreign countries and potential restrictions on the flow of
international capital. Additionally, dividends payable on foreign securities
may be subject to foreign taxes withheld prior to distribution. Foreign securi-
ties often trade with less frequency and volume than domestic securities and
therefore may exhibit greater price volatility. Changes in foreign exchange
rates will affect the value of those securities which are denominated or quoted
in currencies other than the U.S. dollar. Many of the foreign securities held
by the Fund will not be registered with, nor will the issuers thereof be sub-
ject to the reporting requirements of, the SEC. Accordingly, there may be less
publicly available information about the securities and the foreign company or
government issuing them than is available about a domestic company or govern-
ment entity. Moreover, individual foreign economies may differ favorably or
unfavorably from the U.S. economy in such respects as growth of gross national
product, rate of inflation, capital reinvestment, resource self-sufficiency and
balance of payment positions.
 
  Non-Publicly Traded and Illiquid Securities. The sale of securities that are
not publicly traded is typically restricted under the Federal securities laws.
As a result, the Fund may be forced to sell these securities at less than fair
market value or may not be able to sell them when SBMFM believes it desirable
to do so. The Fund's investments in illiquid securities are subject to the risk
that should the Fund desire to sell any of these securities when a ready buyer
is not available at a price that the Fund deems representative of their value,
the value of the Fund's net assets could be adversely affected.
 
 INVESTMENT RESTRICTIONS
 
  The Trust has adopted certain fundamental investment restrictions with
respect to the Fund that may not be changed without approval of a majority of
the Fund's outstanding shares. The fundamental investment restrictions adopted
by the Trust prohibit the Fund from:
 
   1. Purchasing the securities of any issuer (other than U.S. government
 securities) if as a result more than 5% of the value of the Fund's total
 assets would be invested in the securities of the issuer, except that up to
 25% of the value of the Fund's total assets may be invested without regard
 to this 5% limitation.
 
   2. Purchasing more than 10% of the voting securities of any one issuer,
 provided that this limitation shall not apply to investments in U.S. govern-
 ment securities.
 
                                                                              21
<PAGE>
 
       
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 
   3. Purchasing securities on margin, except that the Fund may obtain any
 short-term credits necessary for the clearance of purchases and sales of
 securities. For purposes of this restriction, the deposit or payment of ini-
 tial or variation margin in connection with futures contracts or related
 options will not be deemed to be a purchase of securities on margin by the
 Fund.
 
   4. Making short sales of securities or maintaining a short position,
 except to the extent of 5% of the Fund's net assets and except that the Fund
 may engage in such activities without limit if, at all times when a short
 position is open, the Fund owns an equal amount of the securities or securi-
 ties convertible into or exchangeable, without payment of any further con-
 sideration, for securities of the same issuer as, and at least equal in
 amount to, the securities sold short.
 
   5. Borrowing money, including reverse repurchase agreements, except that
 the Fund may borrow from banks for temporary or emergency (not leveraging)
 purposes including the meeting of redemption requests that might otherwise
 require the untimely disposition of securities, in an amount not exceeding
 20% of the value of the Fund's total assets (including the amount borrowed)
 valued at market less liabilities (not including the amount borrowed) at the
 time the borrowing is made. Whenever borrowings exceed 5% of the value of
 the Fund's total assets, the Fund will not make any additional investments.
 
   6. Pledging, hypothecating, mortgaging or otherwise encumbering more than
 10% of the value of the Fund's total assets as security for any indebted-
 ness. For purposes of this restriction (a) the deposit of assets in escrow
 in connection with the writing of covered put or call options and the pur-
 chase of securities on a when-issued or delayed-delivery basis and (b) col-
 lateral arrangements with respect to (i) the purchase and sale of stock
 options, options on foreign currencies and options on stock indexes and (ii)
 initial or variation margin for futures contracts will not be deemed to be
 pledges of the Fund's assets.
 
   7. Investing in commodities, except that the Fund may purchase or write
 futures contracts and options on futures contracts as described in this Pro-
 spectus.
 
   8. Making loans to others, except through the purchase of qualified debt
 obligations, loans of portfolio securities and the entry into repurchase
 agreements.
 
   9. Concentrating in any industry, except that the Fund will concentrate in
 excess of 25% of its assets in the securities of companies within the util-
 ity industries.
   
  In addition, the Fund will not purchase restricted securities, illiquid secu-
rities (such as repurchase agreements with maturities in excess of seven days)
or other securities that are not readily marketable if more than 10% of the
total assets of the Fund would be invested in such securities.     
 
22
<PAGE>
 
       
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 
  Certain other investment restrictions, including fundamental restrictions as
well as restrictions that may be changed without a shareholder vote, adopted by
the Trust are described in the Statement of Additional Information.
 
 PORTFOLIO TRANSACTIONS
 
  Securities and commodities transactions on behalf of the Fund will be exe-
cuted by a number of brokers and dealers, including Smith Barney and certain of
its affiliated brokers. The Fund may use Smith Barney or a Smith Barney-
affiliated broker in connection with a purchase or sale of securities when
SBMFM believes that the charge for the transaction does not exceed usual and
customary levels. The Fund also may use Smith Barney as a commodities broker in
connection with entering into futures contracts and commodity options. Smith
Barney has agreed to charge the Fund commodity commissions at rates comparable
to those charged by Smith Barney to its most favored clients for comparable
trades in comparable accounts. In selecting a broker for a transaction, includ-
ing Smith Barney or its affiliates, the primary consideration is prompt and
effective execution of orders at the most favorable price. Subject to that pri-
mary consideration, dealers may be selected for research, statistical or other
services to enable SBMFM to supplement its own research and analysis with the
views and information of other securities firms.
 
 RISK FACTORS AND SPECIAL CONSIDERATIONS
 
  Investment in the Fund involves special considerations, such as those
described below:
   
  General. Investment in the Fund may involve above-average risk of loss
because of, among other things, the Fund's use of strategies and techniques
that may be considered to be speculative. The strategy followed by the Fund and
certain of the strategies and techniques used by the Fund depend on forecasts
made by SBMFM that may or may not prove to be correct.     
 
  Low-Rated Securities. Low-rated and comparable unrated securities (a) will
likely have some quality and protective characteristics that, in the judgment
of the rating organization, are outweighed by large uncertainties or major risk
exposures to adverse conditions and (b) are predominantly speculative with
respect to the issuer's capacity to pay interest and repay principal in accor-
dance with the terms of the securities.
 
                                                                              23
<PAGE>
 
       
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 
  While the market values of low-rated and comparable unrated securities tend
to react less to fluctuations in interest rate levels than the market values
of higher-rated securities, the market values of certain low-rated and compa-
rable unrated securities also tend to be more sensitive to individual corpo-
rate development and changes in economic conditions than higher-rated securi-
ties. In addition, low-rated securities and comparable unrated securities gen-
erally present a higher degree of credit risk. Issuers of low-rated and compa-
rable unrated securities are often highly leveraged and may not have more tra-
ditional methods of financing available to them so that their ability to serv-
ice their debt obligations during an economic downturn or during sustained
periods of rising interest rates may be impaired. The risk of loss due to
default by such issuers is significantly greater because low-rated and compa-
rable unrated securities generally are unsecured and frequently are subordi-
nated to the prior payment of senior indebtedness. The Fund may incur addi-
tional expenses to the extent it is required to seek recovery upon a default
in the payment of principal or interest on its portfolio holdings. The exist-
ence of limited markets for low-rated and comparable unrated securities may
diminish the Fund's ability to (a) obtain accurate market quotations for pur-
poses of valuing such securities and calculating its net asset value and (b)
sell the securities at fair value either to meet redemption requests or to
respond to changes in the economy or in the financial markets.
 
  Fixed-income securities, including low-rated securities and comparable
unrated securities, frequently have call or buy-back features that permit
their issuers to call or repurchase the securities from their holders, such as
the Fund. If an issuer exercises these rights during periods of declining
interest rates, the Fund may have to replace the security with a lower yield-
ing security, thus resulting in a decreased return to the Fund.
 
  The market for certain low-rated and comparable unrated securities is rela-
tively new and has not fully weathered a major economic recession. Any such
economic downturn could adversely affect the ability of the issuers of such
securities to repay principal and pay interest thereon.
 
  Investment in Utility Securities. Because the Fund concentrates its invest-
ments in one sector, its portfolio may be subject to greater risk and market
fluctuations than a portfolio of securities representing a broader range of
investment alternatives. The Fund is particularly subject to risks that are
inherent to the utility industries that make up this sector, including diffi-
culty in obtaining an adequate return on invested capital, difficulty in
financing large construction programs during an inflationary period, restric-
tions on operations and increased cost and delays attributable to environmen-
tal considerations and regulation, difficulty in raising capital in adequate
amounts on reasonable terms in periods of high inflation and unsettled capital
markets, increased costs and reduced availability of certain types of fuel,
occasional
 
24
<PAGE>
 
       
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
reduced availability and high costs of natural gas for resales, the effects of
energy conservation, the effects of a national energy policy and lengthy delays
and greatly increased costs and other problems associated with the design, con-
struction, licensing, regulation and operation of nuclear facilities for elec-
tric generation, including, among other considerations, the problems associated
with the use of radioactive materials and the disposal of radioactive wastes.
There are substantial differences between the regulatory practices and policies
of various jurisdictions, and any given regulatory agency may make major shifts
in policy from time to time. There is no assurance that regulatory authorities
will grant rate increases in the future or that such increases will be adequate
to permit the payment of dividends on common stocks. Additionally, existing and
possible future regulatory legislation may make it even more difficult for
these utilities to obtain adequate relief. Certain of the issuers of securities
held by the Fund may own or operate nuclear generating facilities. Governmental
authorities may from time to time review existing policies, and impose addi-
tional requirements governing the licensing, construction and operation of
nuclear power plants.
 
  Each of the risks referred to above could adversely affect the ability and
inclination of public utilities to declare or pay dividends and the ability of
holders of common stock to realize any value from the assets of the issuer upon
liquidation or bankruptcy. All of the utilities which are issuers of the secu-
rities held by the Fund have been experiencing one or more of these problems in
varying degrees. Moreover, price disparities within selected utility groups and
discrepancies in relation to averages and indices have occurred frequently for
reasons not directly related to the general movements or price trends of util-
ity common stocks. Causes of these discrepancies include changes in the overall
demand for and supply of various securities (including the potentially depress-
ing effect of new stock offerings), and changes in investment objectives, mar-
ket expectations or cash requirements of other purchasers and sellers of secu-
rities.
 
  Interest Rate Risk. The Fund will be affected by general changes in interest
rates which will result in increases or decreases in the market value of the
debt securities held by the Fund. The market value of the debt securities held
by the Fund can be expected to vary inversely to changes in prevailing interest
rates.
 
  Options on Securities. Because option premiums paid by the Fund are small in
relation to the market value of the investments underlying the options, buying
put options can result in large amounts of leverage. The leverage offered by
trading in options could cause the Fund's net asset value to be subject to more
frequent and wider fluctuation than would be the case if the Fund did not
invest in options.
 
  No assurance can be given that the Fund will be able to effect closing trans-
actions at a time when it wishes to do so. If the Fund cannot enter into a
closing
 
                                                                              25
<PAGE>
 
       
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
transaction, the Fund will continue to be subject to the risk that a put option
it has purchased will decline in value or become worthless as a result of any
increase in the value of the underlying security. The Fund also could face
higher transaction costs, including brokerage commissions.
 
  Lending of Portfolio Securities. The risk associated with lending portfolio
securities, as with other extensions of credit, consists of possible loss of
rights in the collateral should the borrower fail financially.
 
  Short Sales. Possible losses from short sales differ from losses that could
be incurred from a purchase of a security, because losses from short sales may
be unlimited, whereas losses from purchases can equal only the total amount
invested.
 
  Futures Transactions. The use of futures contracts as a hedging device
involves several risks. No assurance can be given that a correlation will exist
between price movements in the stock index and price movements in the securi-
ties that are the subject of the hedge; the risk of imperfect correlation
increases as the composition of the securities held by the Fund diverges from
the securities included in the applicable stock index. Positions in futures
contracts may be closed out only on the exchange on which they were entered
into (or through a linked exchange) and no secondary market exists for those
contracts. In addition, although the Fund intends to enter into futures con-
tracts only if an active market exists for the contracts, no assurance can be
given that an active market will exist for the contracts at any particular
time. Certain exchanges do not permit trading in particular contracts at prices
that represent a fluctuation in price during a single day's trading beyond a
certain set limit. If prices fluctuate during a single day's trading beyond
those limits, the Fund could be prevented from promptly liquidating unfavorable
positions and thus be subjected to losses. Losses incurred in hedging transac-
tions and the costs of these transactions will affect the Fund's performance.
Successful use of stock index futures by the Fund for hedging purposes is sub-
ject to the ability of SBMFM to correctly predict movements in the direction of
the stock market.
 
VALUATION OF SHARES
 
 
  The Fund's net asset value per share is determined as of the close of regular
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.
 
  Generally, the Fund's investments are valued at market value or, in the
absence of a market value with respect to any securities, at fair value as
determined by or under the direction of the Trust's Board of Trustees. Portfo-
lio securities which are
 
26
<PAGE>
 
       
VALUATION OF SHARES (CONTINUED)
 
traded primarily on foreign exchanges are generally valued at the preceding
closing values of such securities on their respective exchanges, except that
when an occurrence subsequent to the time a value was so established is likely
to have changed such value, then the fair market value of those securities will
be determined by consideration of other factors by or under the direction of
the Board of Trustees or its delegates. A security that is traded primarily on
an exchange is valued at the last sale price on that exchange or, if there were
no sales during the day, at the current quoted bid price. Over-the-counter
securities are valued on the basis of the bid price at the close of business on
each day. Investments in U.S. government securities (other than short-term
securities) are valued at the average of the quoted bid and asked prices in the
over-the-counter market. Short-term investments that mature in 60 days or less
are valued at amortized cost whenever the Trustees determine that amortized
cost reflects fair value of those investments. An option generally is valued at
the last sale price or, in the absence of the last sale price, the last offer
price. The value of a futures contract equals the unrealized gain or loss on
the contract, which is determined by marking the contract to the current set-
tlement price for a like contract acquired on the day on which the stock index
futures contract is being valued. A settlement price may not be used if the
market makes a limited move with respect to a particular commodity or if the
underlying securities market experiences significant price fluctuations after
the determination of the settlement price. In such event, the futures contract
will be valued at a fair market price to be determined by or under the direc-
tion of the Board of Trustees. Further information regarding the Trust's valua-
tion policies with respect to the Fund is contained in the Statement of Addi-
tional Information.
 
DIVIDENDS, DISTRIBUTIONS AND TAXES
 
 
 DIVIDENDS AND DISTRIBUTIONS
 
  The Fund will be treated separately from the Trust's other funds in determin-
ing the amounts of dividends from investment income and distributions of capi-
tal gains payable to shareholders.
 
  If a shareholder does not otherwise instruct, dividends and capital gain dis-
tributions will be reinvested automatically in additional shares of the same
Class at net asset value, subject to no sales charge or CDSC. Dividends from
net investment income, if any, of the Fund will be declared monthly and will be
paid on the last Friday of the month. Distributions of any net long-term capi-
tal gains earned by the Fund will be made annually after the close of the fis-
cal year in which they are earned. Distributions of short-term capital gains
may be paid more frequently with dividends from net investment income. In order
to avoid the application of a 4% nondeductible excise tax measured with respect
to certain undistributed amounts of
 
                                                                              27
<PAGE>
 
       
DIVIDENDS, DISTRIBUTIONS AND TAXES (CONTINUED)
 
ordinary income and capital gains, the Fund may make such additional distribu-
tions as may be necessary to avoid the application of this tax.
 
  If, for any full fiscal year, the Fund's total distributions exceed net
investment income and net realized capital gains, the excess distributions gen-
erally will be treated as a tax-free return of capital (up to the amount of the
shareholder's tax basis in his or her shares). The amount treated as a tax-free
return of capital will reduce a shareholder's adjusted basis in his or her
shares. Pursuant to the requirements of the Investment Company Act of 1940, as
amended (the "1940 Act") and other applicable laws, a notice will accompany any
distribution paid from sources other than net investment income. In the event
the Fund distributes amounts in excess of its net investment income and net
realized capital gains, such distributions may have the effect of decreasing
the Fund's total assets, which may increase the Fund's expense ratio.
 
  The per share dividends on Class B and Class C shares may be lower than the
per share dividends on Class A and Y shares principally as a result of the dis-
tribution fee applicable with respect to Class B and Class C shares. The per
share dividends on Class A shares of the Fund may be lower than the per share
dividends on Class Y shares principally as a result of the service fee applica-
ble to Class A shares. Distributions of capital gains, if any, will be in the
same amount for Class A, Class B, Class C and Class Y shares.
 
 TAXES
 
  The Fund will be treated as a separate taxpayer with the result that, for
Federal income tax purposes, the amount of investment income and capital gains
earned by the Fund will be determined without regard to the earnings of the
other funds of the Trust. The Fund has qualified and intends to continue to
qualify each year as a "regulated investment company" under the Code. To meet
those requirements, the Fund may need to restrict the degree to which it
engages in short-term trading, short sales of securities and transactions in
options. If the Fund qualifies as a regulated investment company and meets cer-
tain distribution requirements, the Fund will not be subject to Federal income
tax on its net investment income and net capital gains that it distributes to
its shareholders.
 
  Dividends paid by the Fund from investment income and distributions of short-
term capital gain will be taxable to shareholders as ordinary income for Fed-
eral income tax purposes, whether received in cash or reinvested in additional
shares. Distributions of long-term capital gain will be taxable to shareholders
as long-term capital gain, whether paid in cash or reinvested in additional
shares, and regardless of the length of time the investor has held his or her
shares of the Fund. Generally, dividends of investment income (to the extent
derived from most types of dividends
 
28
<PAGE>
 
          
DIVIDENDS, DISTRIBUTIONS AND TAXES (CONTINUED)     
 
from domestic corporations) from the Fund will qualify for the Federal divi-
dends-received deduction for corporate shareholders. Each shareholder of the
Fund will receive a statement annually from the Trust, which will set forth
separately the aggregate dollar amount of dividends and capital gains distrib-
uted to the shareholder by the Fund with respect to the prior calendar year and
the amount of the distributions that qualifies for the dividends-received
deduction.
 
  Shareholders should consult their tax advisors about the status of the Fund's
dividends and distributions for Federal, state and local tax liabilities.
 
PURCHASE OF SHARES
 
 
 GENERAL
   
  The Fund offers five Classes of shares. Class A shares are sold to investors
with an initial sales charge and Class B and Class C shares are sold without an
initial sales charge but are subject to a CDSC payable upon certain redemp-
tions. Class Y shares are sold without an initial sales charge or a CDSC and
are available only to investors investing a minimum of $5,000,000 (except for
purchases of Class Y shares by the Smith Barney Concert Series Inc., for which
there is no minimum purchase amount.) Class Z shares are offered without a
sales charge, CDSC, or service or distribution fee, exclusively to: (a) tax-
exempt employee benefit and retirement plans of Smith Barney and its affiliates
and (b) certain UITs sponsored by Smith Barney and its affiliates. Investors
meeting either of these criteria who are interested in acquiring Class Z shares
should contact a Smith Barney Financial Consultant for a Class Z Prospectus.
See "Prospectus Summary--Alternative Purchase Arrangements" for a discussion of
factors to consider in selecting which Class of shares to purchase.     
   
  Purchases of Fund shares must be made through a brokerage account maintained
with Smith Barney, an Introducing Broker or an investment dealer in the selling
group, except for investors purchasing shares of the Fund through a qualified
retirement plan who may do so directly through First Data. When purchasing
shares of the Fund, investors must specify whether the purchase is for Class A,
Class B, Class C or Class Y shares. No maintenance fee will be charged by the
Fund in connection with a brokerage account through which an investor purchases
or holds shares.     
 
  Investors in Class A, Class B and Class C shares may open an account by mak-
ing an initial investment of at least $1,000 for each account, or $250 for an
IRA or a Self-Employed Retirement Plan in the Fund. Investors in Class Y shares
may open an account by making an initial investment of $5,000,000. Subsequent
investments of at least $50 may be made for all Classes. For participants in
retirement
 
                                                                              29
<PAGE>
 
       
PURCHASE OF SHARES (CONTINUED)
   
plans qualified under Section 403(b)(7) or Section 401(a) of the Code, the min-
imum initial investment requirement for Class A, Class B and Class C 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 C shares and the minimum subsequent investment minimum 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
requirement for Class A, Class B and Class C shares and the subsequent invest-
ment requirement for all Classes is $50. There are no minimum investment
requirements for Class A shares for employees of Travelers and its subsidiar-
ies, including Smith Barney, Trustees of the Trust and their spouses and chil-
dren and unitholders who invest distributions from a UIT sponsored by Smith
Barney. 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 Fund's
transfer agent, First Data. Share certificates are issued only upon a share-
holder's written request to First Data.     
   
  Purchase orders received by the Fund or Smith Barney prior to the close of
regular trading on the NYSE, on any day the Fund calculates its net asset val-
ue, are priced according to the net asset value determined on that day. Orders
received by dealers or Introducing Brokers prior to the close of regular trad-
ing 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 Smith Barney prior to Smith Barney's close of business
(the "trade date"). For shares purchased through Smith Barney or Introducing
Brokers Purchasing through 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, Smith Barney or First Data is authorized through
preauthorized transfers of $25 or $50 or more to charge the regular bank
account or other financial institution indicated by the shareholder on a
monthly or quarterly basis, respectively, to provide 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 Smith Barney or
First Data. The Systematic Investment Plan also authorizes Smith Barney to
apply cash held in the shareholder's Smith Barney brokerage account or redeem
the shareholder's shares of a Smith Barney money market fund to make additions
to the account. Additional information is available from the Fund or a Smith
Barney Financial Consultant.     
 
30
<PAGE>
 
       
PURCHASE OF SHARES (CONTINUED)
 
 
 INITIAL SALES CHARGE ALTERNATIVE--CLASS A SHARES
 
  The sales charges applicable to purchases of Class A shares of the Fund are
as follows:
 
<TABLE>
<CAPTION>
                                  SALES CHARGE
                         ------------------------------
                                                              DEALERS
                              % OF           % OF       REALLOWANCE AS % OF
  AMOUNT OF INVESTMENT   OFFERING PRICE AMOUNT INVESTED   OFFERING PRICE
---------------------------------------------------------------------------
  <S>                    <C>            <C>             <C>
  Less than $25,000           5.00%          5.26%             4.50%
  $ 25,000 - $ 49,999         4.00%          4.21%             3.60%
  $ 50,000 - $ 99,999         3.50%          3.63%             3.15%
  $100,000 - $249,999         3.00%          3.09%             2.70%
  $250,000 - $499,999         2.00%          2.04%             1.80%
  $500,000 and more            *               *                 *
---------------------------------------------------------------------------
</TABLE>
* Purchases of Class A shares which, when combined with current holdings of
  Class A shares offered with a sales charge, equal or exceed $500,000 in the
  aggregate, 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 Smith Barney, which
  compensates 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 C shares is
  waived. See "Deferred Sales Charge Alternatives" 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 reduced sales charges shown above apply to the aggregate of purchases of
Class A shares of the Fund made at one time by "any person," which includes an
individual, his or her spouse and children, or a trustee or other fiduciary of
a single trust estate or single fiduciary account. The reduced sales charge
minimums may also be met by aggregating the purchase with the net asset value
of all Class A shares held in funds sponsored by Smith Barney that are offered
with a sales charge listed under "Exchange Privilege."
 
 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) Trustees or Directors
of any of the Smith Barney Mutual Funds, and employees of Travelers and its
subsidiaries and (including retired Board members and employees), the immedi-
ate 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 Associa-
tion of Securities Dealers, Inc., provided such sales are made upon the assur-
ance of the purchaser that the purchase is made for investment purposes and
that the securities will not be resold except through redemption or repur-
chase; (b) offers of Class A shares to any other     
 
                                                                             31
<PAGE>
 
       
PURCHASE OF SHARES (CONTINUED)
   
investment company in connection with 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 Smith Barney Financial Consultant (for
a period up to 90 days from the commencement of the Financial Consultant's
employment with 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) shareholders who have redeemed Class A shares in the Fund (or Class
A shares of another fund of the Smith Barney Mutual Funds that are offered with
a sales charge equal to or greater than the maximum sales charge of the Fund)
and who wish to reinvest their redemption proceeds in the Fund, provided the
reinvestment is made within 60 calendar days of the redemption; (e) accounts
managed by registered investment advisory subsidiaries of Travelers; (f)
investments from a UIT sponsored by Smith Barney, and (g) purchases by Section
403(b) or Section 401(a) or (k) accounts associated with Copeland Retirement
Programs. In order to obtain such discounts, the purchaser must provide suffi-
cient information at the time of purchase to permit verification that the pur-
chase would qualify for the elimination of the sales charge.     
   
  Purchases of Class A shares also may be made at net asset value without a
sales charge in the following circumstances: (1) direct rollovers by plan par-
ticipants of distributions from a 401(k) plan enrolled in the Smith Barney
401(k) Program (Note: Subsequent investments will be subject to the applicable
sales charge); (2) purchases by separate accounts used to fund certain unregis-
tered variable annuity contracts; and (3) purchases by investors participating
in a Smith Barney fee based arrangement.     
 
 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 aggregat-
ing the dollar amount of the new purchase and the total asset value of all
Class A shares of the Fund and of funds sponsored by Smith Barney, which are
offered with a sales charge 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.
 
 GROUP PURCHASES
 
  Upon completion of certain automated systems, a reduced sales charge or pur-
chase at net asset value will also be available to employees (and partners) of
the
 
32
<PAGE>
 
       
PURCHASE OF SHARES (CONTINUED)
 
same employer purchasing as a group, provided each participant makes the mini-
mum initial investment required. The sales charge applicable to purchases by
each member of such a group will be determined by the table set forth above
under "Initial Sales Charge Alternative--Class A Shares" and will be based upon
the aggregate sales of Class A shares of Smith Barney Mutual Funds offered with
a sales charge to, and share holdings of, all members of the group. To be eli-
gible for such reduced sales charges or to purchase at net asset value, all
purchases must be pursuant to an employer- or partnership-sanctioned plan meet-
ing certain requirements. One such requirement is that the plan must be open to
specified partners or employees of the employer and its subsidiaries, if any.
Such plan may, but is not required to, provide for payroll deductions, IRAs or
investments pursuant to retirement plans under Sections 401 or 408 of the Code.
Smith Barney may also offer a reduced sales charge or net asset value purchase
for aggregating related fiduciary accounts under such conditions that Smith
Barney will realize economies of sales efforts and sales related expenses. An
individual who is a member of a qualified group may also purchase Class A
shares at the reduced sales charge applicable to the group as a whole. The
sales charge is based upon the aggregate dollar value of Class A shares offered
with a sales charge that have been previously purchased and are still owned by
the group, plus the amount of the current purchase. A "qualified group" is one
which (a) has been in existence for more than six months, (b) has a purpose
other than acquiring Fund shares at a discount and (c) satisfies uniform crite-
ria which enable Smith Barney to realize economies of scale in its costs of
distributing shares. A qualified group must have more than 10 members, must be
available to arrange for group meetings between representatives of the Fund and
the members, and must agree to include sales and other materials related to the
Fund in its publications and mailings to members at no cost to Smith Barney.
In order to obtain such reduced sales charge or to purchase at net asset value,
the purchaser must provide sufficient information at the time of purchase to
permit verification that the purchase qualifies for the reduced sales charge.
Approval of group purchase reduced sales charge plans is subject to the discre-
tion of Smith Barney.
 
 LETTER OF INTENT
 
  Class A Shares. A Letter of Intent for amounts 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 pur-
chases of all Class A shares of the Fund and other funds of the Smith Barney
Mutual Funds offered with a sales charge over the 13-month period based on the
total amount of intended purchases plus the value of all Class A shares previ-
ously purchased and still owned. An alternative is to compute the 13-month
period starting up to 90 days before the date of execution of a Letter of
Intent. Each investment made during the
 
                                                                              33
<PAGE>
 
       
PURCHASE OF SHARES (CONTINUED)
   
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. Please contact a Smith Barney Financial Consultant or
First Data 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. Such investors
must make an initial minimum purchase of $1,000,000 in Class Y shares of the
Fund and agree to purchase a total of $5,000,000 of Class Y shares of the same
Fund within six months from the date of the Letter. If a total investment of
$5,000,000 is not made within the six-month period, all Class Y shares pur-
chased to date will be transferred to Class A shares, where they will be sub-
ject 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%. The Fund expects
that such transfer will not be subject to Federal income taxes. Please contact
a Smith Barney Financial Consultant or First Data for further information.
    
 DEFERRED SALES CHARGE ALTERNATIVES
 
  "CDSC Shares" are sold at net asset value next determined without an initial
sales charge so that the full amount of an investor's purchase payment may be
immediately invested in the Fund. A CDSC, however, may be imposed on certain
redemptions of these shares. "CDSC Shares" are: (a) Class B shares; (b) Class
C shares; and (c) Class A shares which, when combined with Class A shares
offered with a sales charge currently held by an investor, equal or exceed
$500,000 in the aggregate.
 
  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 C shares and
Class A shares that are CDSC Shares, shares redeemed more than 12 months after
their purchase.
 
  Class C 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
 
34
<PAGE>
 
       
PURCHASE OF SHARES (CONTINUED)
 
aggregated and deemed to have been made on the last day of the proceeding
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 purchases by Participating Plans, as described below. See "Purchase of
Shares--Smith Barney 401(k) Program.
 
<TABLE>
<CAPTION>
      YEAR SINCE PURCHASE
      PAYMENT WAS MADE      CDSC
---------------------------------
      <S>                   <C>
      First                 5.00%
      Second                4.00%
      Third                 3.00%
      Fourth                2.00%
      Fifth                 1.00%
      Sixth                 0.00%
      Seventh               0.00%
      Eighth                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 also will 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. Shareholders who held Class B shares of
Smith Barney Shearson Short-Term World Income Fund (the "Short-Term World
Income Fund") that were held on July 15, 1994 and who subsequently exchange
those shares for Class B shares of the Fund will be offered the opportunity to
exchange all such Class B shares for Class A shares of the Fund four years
after the date on which those shares were deemed to have been purchased. Hold-
ers of such Class B shares will be notified of the pending exchange in writing
approximately 30 days before the fourth anniversary of the purchase date and,
unless the exchange has been rejected in writing, the exchange will occur on
or about the fourth anniversary date. 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 applicable 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 real-
ized on redemption. The amount of any CDSC will be paid to Smith Barney.
 
                                                                             35
<PAGE>
 
       
PURCHASE OF SHARES (CONTINUED)
 
 
  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 addi-
tional shares through dividend reinvestment. During the fifteenth month after
the 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 shareholders's shares at the time the withdrawal plan com-
mences (see "Automatic Cash Withdrawal Plan") (provided, however, that auto-
matic 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) redemption
of shares made in connection with qualified distributions from retirement plans
or IRAs upon the attainment of age 59 1/2; (e) involuntary redemptions; and (f)
redemptions of shares in connection with 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 funds of the 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 Smith Barney in the
case of shareholders who are also Smith Barney clients or by First Data 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) PROGRAM.     
          
  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 partic-
ipating ("Participating Plans") in these Programs.     
   
  The Fund offers to Participating Plans Class A and Class C shares as invest-
ment alternatives under the Smith Barney 401(k) and ExecChoice (TM) Programs.
Class A and Class C shares acquired through the Participating Plans are subject
to the same service and/or distribution fees as the Class A and Class C shares
acquired by other     
 
36
<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 C Shares. Class C 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 C 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. If at the
end of the fifth year after the date the Participating Plan enrolled in the
Smith Barney 401(k) Program or the Smith Barney ExecChoice (TM) Program, a Par-
ticipating Plan's total Class C holdings in all non-money market Smith Barney
Mutual Funds equal at least $1,000,000, the Participating Plan will be offered
the opportunity to exchange all of its Class C shares for Class A shares of the
Fund. (For Participating Plans that were originally established through a Smith
Barney retail brokerage account, the five year period will be calculated from
the date the retail brokerage 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 Participating
Plan's holdings will be performed each quarter until either the Participating
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 a Participating
Plan's total Class C 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 C 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 that has not previ-
ously qualified for an exchange into Class A shares will be offered the oppor-
tunity to exchange all of its Class C shares for Class A shares of a Fund,
regardless of asset size, at the end of the eighth year after the date the Par-
ticipating Plan enrolled in the Smith Barney 401(k) Program. Such Plans will be
notified of the pending     
 
                                                                              37
<PAGE>
 
       
PURCHASE OF SHARES (CONTINUED)
   
exchange in writing approximately 60 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 C shares of the Fund but instead may acquire Class A shares of the Fund.
Any Class C shares not converted will continue to be subject to the distribu-
tion fee.     
   
  Participating Plan 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 First Data. For further information regarding
these Programs, investors should contact a Smith Barney Financial Consultant.
       
  Existing 401(k) Plans Investing Class B Shares. Class B shares of the Fund
are not available for purchase by Participating Plans opened on or after June
21, 1996, but may continue to be purchased by any Participating Plan opened
prior to such date and originally investing in such Class. Class B shares
acquired are subject to a CDSC of 3.00% of redemption proceeds, if the Partici-
pating Plan terminates within eight years of the date the Participating Plan
first enrolled in the Smith Barney 401(k) Program.     
   
  At the end of the eighth year after the date the Participating Plan enrolled
in the Smith Barney 401(k) Program, the Participating Plan will be offered the
opportunity to exchange all of its Class B shares for Class A shares of the
Fund. Such Plans will be notified of the pending exchange in writing approxi-
mately 60 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 the exchange has occurred, a Participating
Plan will not be eligible to acquire additional Class B shares of the Fund but
instead may acquire Class A shares of the Fund. If the Participating Plan
elects not to exchange all of its Class B shares at that time, each Class B
share held by the Participating Plan will have the same conversion feature as
Class B shares held by other investors. See "Purchase of Shares--Deferred Sales
Charge Alternatives".     
   
  No CDSC is imposed on redemptions of Class B shares to the extent that the
net asset value of the shares redeemed does not exceed the current net asset
value of the shares purchased through reinvestment of dividends or capital gain
distributions, plus the current net asset value of Class B shares purchased
more than eight years prior to the redemption, plus increases in the net asset
value of the shareholder's Class B shares above the purchase payments made dur-
ing the preceding eight years. Whether or not the CDSC applies to the redemp-
tion by a Participating Plan depends on the number of years since the Partici-
pating Plan first became enrolled in the Smith Barney 401(k) Program, unlike
the applicability of the CDSC to redemptions by other shareholders, which
depends on the number of years since those shareholders made the purchase pay-
ment from which the amount is being redeemed.     
 
38
<PAGE>
 
          
PURCHASE OF SHARES (CONTINUED)     
   
  The CDSC will be waived on redemptions of Class B shares in connection with
lump-sum or other distributions made by a Participating Plan as a result of:
(a) the retirement of an employee in the Participating Plan; (b) the termina-
tion of employment of an employee in the Participating Plan; (c) the death or
disability of an employee in the Participating Plan; (d) the attainment of age
59 1/2 by an employee in the Participating Plan; (e) hardship of an employee in
the Participating Plan to the extent permitted under Section 401(k) of the
Code; or (f) redemptions of shares in connection with a loan made by the Par-
ticipating Plan to an employee.     
       
EXCHANGE PRIVILEGE
   
  Except as otherwise noted below, shares of each Class may be exchanged at the
net asset value next determined 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 C shares are subject to minimum investment requirements and all shares
are subject to the other requirements of the fund into which exchanges are
made.     
 
 FUND NAME
 
  Growth Funds
  Smith Barney Aggressive Growth Fund Inc.
  Smith Barney Appreciation Fund Inc.
  Smith Barney Fundamental Value Fund Inc.
  Smith Barney Growth Opportunity Fund
  Smith Barney Managed Growth Fund
     
  Smith Barney Natural Resources Fund, Inc.     
  Smith Barney Special Equities Fund
         
  Growth and Income Funds
  Smith Barney Convertible Fund
     
  Smith Barney Funds, Inc.--Equity Income Portfolio     
  Smith Barney Growth and Income Fund
  Smith Barney Premium Total Return Fund
  Smith Barney Strategic Investors Fund
 
  Taxable Fixed-Income Funds
  *Smith Barney Adjustable Rate Government Income Fund
  Smith Barney Diversified Strategic Income Fund
  **Smith Barney Funds, Inc.--Income Return Account Portfolio
         
  +Smith Barney Funds, Inc.--Short-Term U.S. Treasury Securities Portfolio
  Smith Barney Funds, Inc.--U.S. Government Securities Portfolio
  Smith Barney Government Securities Fund
 
                                                                              39
<PAGE>
 
       
EXCHANGE PRIVILEGE (CONTINUED)
 
  Smith Barney High Income Fund
  Smith Barney Investment Grade Bond Fund
  Smith Barney Managed Governments Fund Inc.
 
  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 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
 
 International Funds
        
  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 Series Inc.     
       
            
  Smith Barney Concert Series Inc.--Balanced Portfolio     
     
  Smith Barney Concert Series Inc.--Conservative Portfolio     
     
  Smith Barney Concert Series Inc.--Growth Portfolio     
     
  Smith Barney Concert Series Inc.--High Growth Portfolio     
     
  Smith Barney Concert Series Inc.--Income Portfolio     
 
 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
 
40
<PAGE>
 
       
EXCHANGE PRIVILEGE (CONTINUED)
 
-------------------------------------------------------------------------------
  * Available for exchange with Class A, Class B and Class Y shares of the
    Fund. In addition, shareholders who own Class C shares of the Fund through
    the Smith Barney 401(k) Program may exchange those shares for Class C
    shares of this fund.
 ** Available for exchange with Class A, Class C 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 B and Class C shares of the Fund.
+++ Available for exchange with Class A and Class Y shares of the Fund. In
    addition, shareholders who own Class C shares of the Fund through the
    Smith Barney 401(k) Program may exchange those shares for Class C shares
    of this fund.
       
  Class B Exchanges. In the event a Class B shareholder (unless such share-
holder was a Class B shareholder of the Short-Term World Income Fund on July
15, 1994) 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 C Exchanges. Upon an exchange, the new Class C shares will be deemed
to have been purchased on the same date as the Class C 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. SBMFM 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 sus-
pending the exchange privilege and during the 15-day period the shareholder
will be required to (a) redeem his or her shares in 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 after the redemption pro-
ceeds are available. Redemption procedures discussed below are also applicable
for     
 
                                                                             41
<PAGE>
 
          
EXCHANGE PRIVILEGE (CONTINUED)     
 
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 the shares of the Fund 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 trading 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 First Data receives
further instructions from Smith Barney, or if the shareholder's account is not
with Smith Barney, from the shareholder directly. The redemption proceeds will
be remitted on or before the third 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 Smith Barney brokerage account, these funds will not be invested
for the shareholder's benefit without specific instruction and Smith Barney
will benefit from the use of temporarily uninvested funds. Redemption proceeds
for shares purchased by check, other than a certified or official bank check,
will be remitted upon clearance of the check, which may take up to ten days or
more.     
 
  Shares held by Smith Barney as custodian must be redeemed by submitting a
written request to a Smith Barney Financial Consultant. Shares other than
those held by Smith Barney as custodian may be redeemed through an investor's
Financial Consultant, Introducing Broker or dealer in the selling group or by
submitting a written request for redemption to:
 
  Smith Barney Utilities Fund
  Class A, B, C or Y (please specify)
  c/o First Data Investor Services Group, Inc.
  P.O. Box 9134
  Boston, Massachusetts 02205-9134
 
42
<PAGE>
 
       
REDEMPTION OF SHARES (CONTINUED)
   
  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 written
redemption request in excess of $2000 must be guaranteed by an eligible guaran-
tor 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 $2000 or less do
not require a signature guarantee unless more than one such redemption request
is made in any 10-day period. Redemption proceeds will be mailed to an invest-
or'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 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 contact First Data
at 1-800-451-2010. Once eligibility is confirmed, the shareholder must complete
and return a Telephone/Wire Authorization Form, along with a signature guaran-
tee that will be provided by First Data upon request. (Alternatively, an
investor may authorize telephone redemptions on the new account application
with the applicant's 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 5:00 p.m. (New
York City time) on any day the NYSE is open. Redemption requests received after
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     
 
                                                                              43
<PAGE>
 
       
REDEMPTION OF SHARES (CONTINUED)
   
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 5:00
p.m. (New York City time) on any day on which the NYSE is open. Exchange
requests received after the close of regular trading on the NYSE are processed
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 instructions com-
municated 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 share-
holder 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 Fund. Any applicable CDSC will not be waived on
amounts withdrawn by a shareholder 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. For further information regarding the automatic cash withdrawal
plan, shareholders should contact a Smith Barney Financial Consultant.
 
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
 
44
<PAGE>
 
          
MINIMUM ACCOUNT SIZE (CONTINUED)     
   
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, however, 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 involun-
tary liquidation.     
   
PERFORMANCE     
 
 
 YIELD
 
  From time to time, the Fund advertises 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 offering price per share on the last day of the
period. This income is "annualized" by assuming that 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 C 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 gains distributions on the reinvestment dates at prices
calculated as stated in this Prospectus, then dividing the value of the invest-
ment 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 redeem-
able value. Such standard total return information may also be accompanied with
nonstandard total return information 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 or the maximum public offering price (including sales charge) on the last
day of the period for which current dividend return is presented. The current
dividend return for each Class may vary from time to time depending on market
conditions, the composition of its investment portfolio and operating expenses.
These factors and possible differences in the methods used in calculating cur-
rent
 
                                                                              45
<PAGE>
 
          
PERFORMANCE (CONTINUED)     
 
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, Inc. and other financial publications.
   
MANAGEMENT OF THE TRUST AND THE FUND     
 
 
 BOARD OF TRUSTEES
 
  Overall responsibility for management and supervision of the Fund rests with
the Trust's Board of Trustees. The Trustees approve all significant agreements
between the Trust and the companies that furnish services to the Trust and the
Fund, including agreements with the Fund's distributor, investment adviser,
administrator, custodian and transfer agent. The day-to-day operations of the
Fund are delegated to the Fund's investment adviser and administrator. The
Statement of Additional Information contains background information regarding
each Trustee and executive officer of the Trust.
 
 INVESTMENT ADVISER--SBMFM
   
  SBMFM, located at 388 Greenwich Street, New York, New York 10013, serves as
the Fund's investment adviser. SBMFM is a wholly owned subsidiary of Hold-
ings). SBMFM (through predecessor entities) has been in the investment coun-
seling business since 1934 and is a registered investment adviser. SBMFM ren-
ders investment advice to investment companies that had aggregate assets under
management as of September 30, 1996 in excess of $77 billion.     
 
  Subject to the supervision and direction of the Fund's Board of Trustees,
SBMFM manages the Fund's portfolio in accordance with the Fund's investment
objective and policies, makes investment decisions for the Fund, places orders
to purchase and sell securities and employs professional portfolio managers
and securities analysts who provide research services to the Fund. For invest-
ment advisory services rendered to the Fund, the Fund pays SBMFM a fee at the
annual rate of 0.45% of the value of the Fund's average daily net assets.
 
 PORTFOLIO MANAGEMENT
 
  Jack S. Levande, a Managing Director of Smith Barney, has served as Vice
President and Investment Officer of the Fund since it commenced operations and
manages the day-to-day operations of the Fund, including making all investment
decisions.
   
  Management's discussion and analysis, and additional performance information
regarding the Fund during the fiscal year ended July 31, 1996 is included in
the     
 
46
<PAGE>
 
          
MANAGEMENT OF THE TRUST AND THE FUND (CONTINUED)     
   
Annual Report dated July 31, 1996. A copy of the Annual Report may be obtained
upon request without charge from a Smith Barney Financial Consultant or by
writing or calling the Fund at the address or phone number listed on page one
of this Prospectus.     
 
 ADMINISTRATOR--SBMFM
 
  SBMFM 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 SBMFM a fee at the annual rate of 0.20% of the value of the Fund's
average daily net assets.
   
DISTRIBUTOR     
 
 
  Smith Barney is located at 388 Greenwich Street, New York, New York 10013.
Smith Barney distributes shares of the Fund as principal underwriter and as
such conducts a continuous offering pursuant to a "best efforts" arrangement
requiring Smith Barney to take and pay for only such securities as may be sold
to the public. Pursuant to a plan of distribution adopted by the Fund under
Rule 12b-1 under the 1940 Act (the "Plan"), Smith Barney is paid an annual
service fee with respect to Class A, Class B and Class C shares of the Fund at
the annual rate of 0.25% of the average daily net assets of the respective
Class. Smith Barney is also paid an annual distribution fee with respect to
Class B and Class C shares at the annual rate of 0.50% and 0.45%, respectively,
of the average daily net assets attributable to these Classes. Class B shares
that 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 Smith Barney to pay its Financial Consultants for servicing shareholder
accounts and, in the case of Class B and Class C shares, to cover expenses pri-
marily intended to result in the sale of those shares. These expenses include:
advertising expenses; the cost of printing and mailing prospectuses to poten-
tial investors; payments to and expenses of Smith Barney Financial Consultants
and other persons who provide support services in connection with the distribu-
tion of shares; interest and/or carrying charge; and indirect and overhead
costs of Smith Barney associated with the sale of Fund shares, including lease,
utility, communications and sales promotion expenses.
       
  The payments to Smith Barney Financial Consultants for selling shares of a
Class include a commission or fee paid by the investor or Smith Barney at the
time of sale and, with respect to Class A, Class B and Class C shares, a con-
tinuing fee for servicing shareholder accounts for as long as a shareholder
remains a holder of that Class. Smith Barney Financial Consultants may receive
different levels of compensation for selling different Classes of shares.
 
                                                                              47
<PAGE>
 
          
DISTRIBUTOR (CONTINUED)     
 
 
  Payments under the Plan with respect to Class B and Class C shares are not
tied exclusively to the distribution and shareholder service expenses actually
incurred by Smith Barney and the payments may exceed distribution expenses
actually incurred. The Trust's Board of Trustee's will evaluate the appropri-
ateness of the Plan and its payment terms on a continuing basis and in so doing
will consider all relevant factors, including expenses borne by Smith Barney,
amounts received under the Plan and proceeds of the CDSC.
   
ADDITIONAL INFORMATION     
   
  The Trust was organized on March 12, 1985 under the laws of the Commonwealth
of Massachusetts and is an entity commonly known as a "Massachusetts business
trust." The Trust offers shares of beneficial interest of separate series hav-
ing a $.001 per share par value. Shares of beneficial interest of the Fund are
currently classified into five Classes: A, B, C, Y and Z.     
 
  Each Class of Fund shares represents identical interests in the Fund's
investment portfolio. As such, they have the same rights, privileges and pref-
erences, except with respect to: (a) the designation of each Class; (b) the
effect of the respective sales charges for each Class; (c) the distribution
and/or service fees, if any, borne by each Class; (d) the expenses allocable
exclusively to each Class; (e) voting rights on matters exclusively affecting a
single Class; (f) the exchange privilege of each Class; and (g) the conversion
feature of the Class B shares. The Trust's Board of Trustees does not antici-
pate that there will be any conflicts among the interests of the holders of the
different Classes. The Trustees, on an ongoing basis, will consider whether any
such conflict exists and, if so, take appropriate action.
   
  When matters are submitted for shareholder vote, shareholders of each Class
of each fund will have one vote for each full share owned and a proportionate,
fractional vote for any fractional share held of that Class. Shares of the
Trust will be voted generally on a Trust-wide basis on all matters, except mat-
ters affecting the interests of one Fund or one Class of shares.     
 
  The Trust does not hold annual shareholder meetings. There normally will be
no meetings of shareholders for the purpose of electing Trustees unless and
until such time as less than a majority of the Trustees holding office have
been elected by shareholders. The Trustees will call a meeting for any purpose
for voting on the 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.
 
  PNC Bank, located at 17th and Chestnut Streets, Philadelphia, PA 19103,
serves as custodian of the Trust's investments.
 
48
<PAGE>
 
       
ADDITIONAL INFORMATION (CONTINUED)
   
  First Data, located at Exchange Place, Boston, Massachusetts 02109, serves as
the Trust's transfer agent.     
 
  The Fund sends its shareholders a semi-annual report and an audited annual
report, each of which includes a list of the investment securities held by the
Fund at the end of the reporting period. In an effort to reduce the Fund's
printing and mailing costs, the Trust plans to consolidate the mailing of the
Fund's semi-annual and annual reports by household. This consolidation means
that a household having multiple accounts with the identical address of record
will receive a single copy of each report. In addition, the Trust also plans to
consolidate the mailing of the Fund's Prospectus so that a shareholder having
multiple accounts (e.g., individual, IRA and/or 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 Smith
Barney Financial Consultants or the Fund's transfer agent.
       
                                                                              49
<PAGE>
 
 
                                              SMITH BARNEY
                                              ----------------------------------

                                              A Member of TravelersGroup  [LOGO]
 
 
 
 
 
                                                     SMITH BARNEY UTILITIES FUND
 
                                                            388 Greenwich Street
                                                        New York, New York 10013
                                                                 
                                                              FD 0229 11/96     

<PAGE>
 
 
 
                                                                    SMITH BARNEY
                                                                       Utilities
                                                                            Fund
                                                             Class Z Shares Only
                                                             
                                                          NOVEMBER 28, 1996     
 
                                                   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 28, 1996     
   
Smith Barney     
   
Utilities Fund--Class Z Shares     
388 Greenwich Street
New York, New York 10013
(212) 723-9218
 
  Smith Barney Utilities Fund (the "Fund") is a diversified fund that seeks
current income by investing in equity and debt securities of utility companies
selected by the Fund's investment adviser. Long-term capital appreciation is a
secondary objective of the Fund.
 
  The Fund is one of a number of funds, each having distinct investment objec-
tives and policies, making up the Smith Barney Income Funds (the "Trust"). The
Trust is an open-end, management investment company commonly referred to as a
mutual fund.
 
  This Prospectus sets forth concisely certain information about the Fund and
the Trust, including expenses, that prospective investors will find helpful in
making an investment decision. Investors are encouraged to read this Prospectus
carefully and retain it for future reference.
 
  The Class Z shares described in this Prospectus (previously designated as
Class C shares) are currently offered exclusively for sale to tax-exempt
employee benefit and retirement plans of Smith Barney Inc. ("Smith Barney") or
any of its affiliates ("Qualified Plans") and to certain unit investment trusts
sponsored by Smith Barney or any of its affiliates ("Smith Barney UITs").
   
  Additional information about the Fund and the Trust is contained in a State-
ment of Additional Information dated November 28, 1996 as amended or supple-
mented from time to time, that is available upon request and without charge by
calling or writing the Trust at the telephone number or address set forth above
or by contacting a Smith Barney Financial Consultant. The Statement of Addi-
tional Information has been filed with the Securities and Exchange Commission
(the "SEC") and is incorporated by reference into this Prospectus in its
entirety.     
 
SMITH BARNEY INC.
Distributor
 
SMITH BARNEY MUTUAL FUNDS MANAGEMENT INC.
Investment Adviser and Administrator
 
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES 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>
THE FUND'S EXPENSES                             3
-------------------------------------------------
FINANCIAL HIGHLIGHTS                            4
-------------------------------------------------
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES    5
-------------------------------------------------
VALUATION OF SHARES                            17
-------------------------------------------------
DIVIDENDS, DISTRIBUTIONS AND TAXES             18
-------------------------------------------------
PURCHASE, EXCHANGE AND REDEMPTION OF SHARES    20
-------------------------------------------------
PERFORMANCE                                    20
-------------------------------------------------
MANAGEMENT OF THE TRUST AND THE FUND           21
-------------------------------------------------
ADDITIONAL INFORMATION                         23
-------------------------------------------------
</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 Trust
or the distributor. This Prospectus does not constitute an offer to buy any of
the securities offered hereby in any jurisdiction to any person to whom it is
unlawful to make such an offer or solicitation in such jurisdiction.
 
--------------------------------------------------------------------------------
 
2
<PAGE>
 
THE FUND'S EXPENSES
 
 
The following expense table lists the costs and expenses an investor will incur
either directly or indirectly as a shareholder of Class Z shares of the Fund,
based on the Fund's operating expenses for its most recent fiscal year:
 
<TABLE>   
<CAPTION>
  SMITH BARNEY                         AS A % OF
  UTILITIES FUND--CLASS Z SHARES   AVERAGE NET ASSETS
-----------------------------------------------------
  <S>                              <C>
  ANNUAL FUND OPERATING EXPENSES
    Management fees                       0.65%
    Other expenses                        0.13%
-----------------------------------------------------
  TOTAL FUND OPERATING EXPENSES           0.78%
-----------------------------------------------------
</TABLE>    
 
  The nature of the services for which the Fund pays management fees is
described under "Management of the Trust and the Fund." "Other expenses" in the
above table include fees for shareholder services, custodial fees, legal and
accounting fees, printing costs and registration fees.
 
 EXAMPLE
 
  The following example is intended to assist an investor in understanding 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 and Redemption of Shares" and "Manage-
ment of the Trust and the Fund."
 
<TABLE>   
<CAPTION>
  SMITH BARNEY
  UTILITIES FUND--CLASS Z SHARES               1 YEAR 3 YEARS 5 YEARS 10 YEARS
------------------------------------------------------------------------------
  <S>                                          <C>    <C>     <C>     <C>
  You would pay the following expenses on a
  $1,000 investment in Class Z shares of the
  Fund, assuming (1) 5% annual return and (2)
  redemption at the end of each time period:    $ 8     $25     $43     $97
------------------------------------------------------------------------------
</TABLE>    
 
  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.
 
                                                                               3
<PAGE>
 
FINANCIAL HIGHLIGHTS
   
 The following information for the two-year period ended July 31, 1996 has been
audited by KPMG Peat Marwick LLP., independent auditors and appears in the
Fund's Annual Report dated July 31, 1996. The following information for the
fiscal years ended July 31, 1993 and July 31, 1994 has been audited by
independent auditors. The information set out below should be read in con-
junction with the financial statements and related notes that also appear in
the Fund's 1996 Annual Report, which is incorporated by reference into the
Statement of Additional Information.     
   
FOR A CLASS Z SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH PERIOD:
    
<TABLE>   
<CAPTION>
                                      YEAR     YEAR       YEAR       PERIOD
SMITH BARNEY                          ENDED    ENDED     ENDED       ENDED
UTILITIES FUND--CLASS Z SHARES       7/31/96  7/31/95  7/31/94(1)  7/31/93(2)
------------------------------------------------------------------------------
<S>                                  <C>      <C>      <C>         <C>
NET ASSET VALUE, BEGINNING OF
  PERIOD                             $ 14.02  $ 13.28   $ 15.97     $ 14.36
------------------------------------------------------------------------------
INCOME (LOSS) FROM OPERATIONS:
 Net investment income                  0.88     0.89      0.89        0.69
 Net realized and unrealized gain
   (loss) on investments                0.47     0.82     (2.21)       1.72
------------------------------------------------------------------------------
Total Income (Loss) From Operations     1.35     1.71     (1.32)       2.41
------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income                 (0.85)   (0.87)    (0.84)      (0.65)
 Overdistribution of net investment
   income                                 --       --     (0.03)      (0.01)
 Net realized gains                       --       --     (0.50)      (0.14)
 Overdistribution of net realized
   gains                                  --    (0.08)       --          --
 Capital                                  --    (0.02)       --          --
------------------------------------------------------------------------------
Total Distributions                    (0.85)   (0.97)    (1.37)      (0.80)
------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD       $ 14.52  $ 14.02   $ 13.28     $ 15.97
------------------------------------------------------------------------------
TOTAL RETURN++                          9.62%   13.55%    (8.78)%     17.21%++
------------------------------------------------------------------------------
NET ASSETS, END OF PERIOD (000S)     $14,515  $14,631   $11,372     $22,251
------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
 Expenses                               0.78%    0.81%     0.69%       0.68%+
 Net investment income                  5.90     6.58      5.92        6.06+
------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE                   58%      36%       28%         37%
------------------------------------------------------------------------------
AVERAGE COMMISSION PER SHARE PAID
  ON EQUITY TRANSACTIONS (3)           $0.06       --        --          --
------------------------------------------------------------------------------
</TABLE>    
(1) On November 7, 1994, the former Class C shares were renamed Class Z shares.
(2) For the period from November 6, 1992 (inception date) to July 31, 1993.
   
(3) As of September 1995, the SEC instituted new guidelines requiring the
    disclosure of average commissions per share.     
  ++Total return is not annualized as it may not be representative of the total
    return for the year.
  + Annualized.
 ++ Total return represents aggregate total return for the period indicated and
    does not reflect any applicable sales charge.
 
4
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES
    
 INVESTMENT OBJECTIVE     
 
  The primary investment objective of the Fund is to provide current income.
Long-term capital appreciation is a secondary objective. The Fund's investment
objectives may be changed only with the approval of the holders of a majority
of the Fund's outstanding shares. There can be no assurance that the Fund's
investment objectives will be achieved.
 
 INVESTMENT POLICIES
   
  The Fund seeks to achieve its objectives by investing in equity and debt
securities of companies in the utility industries. For purposes of this Pro-
spectus, the utility industries are deemed to be comprised of companies princi-
pally engaged (that is, at least 50% of a company's assets, gross income or net
profits results from utility operations or the company is regulated as a util-
ity by a government agency or authority) in the manufacture, production, gener-
ation, transmission and sale of electric and gas energy and companies princi-
pally engaged in the communications field, including entities such as tele-
phone, telegraph, satellite, microwave and other companies regulated by govern-
mental agencies as utilities that provide communication facilities for the pub-
lic benefit, but not including those in public broadcasting. The Fund will
invest primarily in utility equity and debt securities that have a high
expected rate of return, as determined by the Fund's investment adviser, Smith
Barney Mutual Funds Management Inc. ("SBMFM"). Under normal market conditions,
the Fund will invest at least 65% of its assets in such securities. The Fund
may invest up to 35% of its assets in equity and debt securities of non-utility
companies believed to afford a reasonable opportunity for achieving the Fund's
investment objectives. When SBMFM believes that market conditions warrant, the
Fund may adopt a temporary defensive posture and may invest without limit in:
debt securities (whether or not they are utility securities) such as rated or
unrated bonds, debentures and commercial paper, United States government secu-
rities and money market instruments. The Fund may invest up to 10% of its
assets in securities rated BB or B by Standard & Poor's Ratings Group ("S&P")
or Ba or B by Moody's Investors Service, Inc. ("Moody's") whenever SBMFM
believes that the incremental yield on such securities is advantageous to the
Fund in comparison to the additional risk involved. Securities rated BBB/Baa
are considered medium grade obligations, neither highly protected nor poorly
secured. Interest payments and principal security of BBB/Baa rated securities
appear adequate for the present but certain protective elements may be lacking
or may be unreliable over any great length of time. Such securities lack out-
standing investment characteristics and may in fact have speculative character-
istics. The yields on lower-rated fixed-income securities generally are higher
than the yields available on higher-rated securities. See "Risk Factors and
Special Considerations" below. In addition, the Fund may enter into repurchase
agreements.     
 
 
                                                                               5
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 INVESTMENT SECURITIES, STRATEGIES AND TECHNIQUES
 
  The Fund has the ability to engage in a number of specialized investment
strategies and techniques designed to enable the Fund to achieve its invest-
ment objectives. Included among these strategies are lending its portfolio
securities, selling securities "short against the box," writing covered call
and secured put options as well as purchasing options on securities, purchas-
ing and selling interest rate futures contracts, options on futures contracts,
stock index put and call options and stock index futures contracts, each of
which is discussed below.
 
  United States Government Securities. United States government securities are
obligations of, or guaranteed by, the United States government, its agencies
or instrumentalities ("U.S. government securities"). These include bills, cer-
tificates of indebtedness, notes and bonds issued by the United States Trea-
sury or by agencies or instrumentalities of the United States government. Some
U.S. government securities, such as Treasury bills and bonds, are supported by
the full faith and credit of the United States; others, such as those of Fed-
eral Home Loan Banks, are supported by the right of the issuer to borrow from
the United States Treasury; others, such as those of the Federal National
Mortgage Association, are supported by the discretionary authority of the
United States government to purchase the agency's obligations; still others,
such as those of the Student Loan Marketing Association, are supported only by
the credit of the instrumentality. U.S. government securities generally do not
involve the credit risks associated with other types of interest-bearing secu-
rities, although, as a result, the yields available from U.S. government secu-
rities are generally lower than the yields available from interest-bearing
corporate securities.
   
  Zero Coupon Securities. The Fund may also invest in zero coupon bonds. A
zero coupon bond pays no interest in cash to its holder during its life,
although interest is accrued during that period. Its value to an investor con-
sists of the difference between its face value at the time of maturity and the
price for which it was acquired, which is generally an amount significantly
less than its face value (sometimes referred to as a "deep discount" price).
Because such securities usually trade at a deep discount, they will be subject
to greater fluctuations of market value in response to changing interest rates
than debt obligations of comparable maturities which make periodic distribu-
tions 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.     
 
  Repurchase Agreements. The Fund may engage in repurchase agreements 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 relatively short period (usually not more than one week)
subject to an
 
6
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
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. This arrangement results in a fixed rate of return that
is not subject to market fluctuations during the Fund's holding period. The
value of the underlying securities will be at least equal at all times to the
total amount of the repurchase obligation, including interest. 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 possible decline
in the value of the underlying securities during the period in which the Fund
seeks to assert its right 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. SBMFM, acting under the supervision of the Trust's Board of
Trustees, reviews on an ongoing basis the value of the collateral and credit-
worthiness of those banks and dealers with which the Fund enters into repur-
chase agreements to evaluate potential risks.
 
  Lending Portfolio Securities. The Fund is authorized to lend its portfolio
securities to brokers, dealers and other financial organizations. The Fund's
loans of securities will be collateralized by cash, letters of credit or U.S.
government securities that are maintained at all times in an amount at least
equal to the current market value of the loaned securities. By lending its
securities, the Fund seeks to generate income by continuing to receive interest
on the loaned securities, by investing the cash collateral in short-term
instruments or by obtaining yield in the form of interest paid by the borrower
when U.S. government securities are used as collateral.
 
  Short Sales Against the Box. The Fund may sell its securities short up to 5%
of the Fund's net assets.  In addition,
the Fund may make short sales  if at all times when a position is open,
the Fund owns the stock or owns preferred stock or debt securities convertible
or exchangeable without payment of further consideration for, securities of the
same issue as the securities sold short. Short sales of this kind are referred
to as "against the box." Short sales against the box are used to defer recogni-
tion of capital gains or losses.
   
  Options Activities. The Fund may write (that is, sell) call options ("calls")
if the calls are covered throughout the life of the option. A call is covered
if the Fund (a) owns the optioned securities, (b) maintains in a segregated
account with the Trust's custodian, PNC Bank, National Association ("PNC Bank")
cash or equity and debt securities of any grade provided such securities have
been determined by SBMFM to be liquid and unecumbered pursuant to guidelines
established by the Trustees ("eligible segregated assets") with a value suffi-
cient to meet the Fund's obligations under the call, or (c) owns an offsetting
call option. The aggregate value of the obligations underlying calls on securi-
ties which are written by the Fund and covered with cash, or other eligible
segregated assets, together with the aggregate     
 
                                                                               7
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
value of the obligations underlying put options written by the Fund, will not
exceed 50% of the Fund's net assets. When the Fund writes a call, it receives a
premium and gives the purchaser the right to buy the underlying security at any
time during the call period (usually not more than nine months in the case of
common stock or fifteen months in the case of U.S. government securities) at a
fixed exercise price regardless of market price changes during the call period.
If the call is exercised, the Fund forgoes any gain from an increase in the
market price of the underlying security over the exercise price. The Fund may
purchase calls on securities. The Fund also may purchase and sell stock index
calls which differ from calls on individual securities in that they are settled
in cash based on the values of the securities in the underlying index, rather
than by delivery of the underlying securities. In writing a call on a stock
index, the Fund receives a premium and agrees that during the call period pur-
chasers of a call, upon exercise of the call, will receive an amount of cash if
the closing level of the stock index upon which the call is based is greater
than the exercise price of the call. When the Fund buys a call on a stock
index, it pays a premium and during the call period the Fund, upon exercise of
the call, receives an amount of cash if the closing level of the stock index
upon which the call is based is greater than the exercise price of the call.
 
  The Fund may write and purchase put options ("puts"). When the Fund writes a
put, it receives a premium and gives the purchaser of the put the right to sell
the underlying security to the Fund at the exercise price at any time during
the option period. When the Fund purchases a put, it pays a premium in return
for the right to sell the underlying security at the exercise price at any time
during the option period. For the purchase of a put to be profitable, the mar-
ket price of the underlying security must decline sufficiently below the exer-
cise price to cover the premium and transaction costs, unless the put is sold
in a closing sale transaction; otherwise, the purchase of the put effectively
increases the cost of the security and thus reduces its yield. The Fund also
may purchase and sell stock index puts, which differ from puts on individual
securities in that they are settled in cash based on the values of the securi-
ties in the underlying index, rather than by delivery of the underlying securi-
ties. Purchase of a stock index put is designed to protect against a decline in
the value of the Fund's portfolio generally, rather than an individual security
in the portfolio. Stock index puts are sold primarily to realize income from
the premiums received on the sale of such options. If any put is not exercised
or sold, it will become worthless on its expiration date. The Fund will not
purchase puts or calls on securities if more than 5% of its assets would be
invested in premiums on puts and calls, not including that portion of the pre-
mium which reflects the value of the securities owned by the Fund and under-
lying a put at the time of purchase.
   
  The Fund may write puts on securities only if they are "secured." A put is
"secured" if the Fund maintains cash or other eligible segregated assets with a
    
8
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
value equal to the exercise price in a segregated account or holds a put on
the same underlying security at an equal or greater exercise price. The aggre-
gate value of the obligations underlying puts written by the Fund, together
with the aggregate value of the obligations underlying calls on securities
which are written by the Fund and covered with cash, cash equivalents or U.S.
government securities, will not exceed 50% of the Fund's net assets. The Fund
also may write "straddles," which are combinations of secured puts and covered
calls on the same underlying security.
 
  The Fund will realize a gain (or loss) on a closing purchase transaction
with respect to a call or put previously written by the Fund if the premium,
plus commission costs, paid to purchase the call or put is less (or greater)
than the premium, less commission costs, received on the sale of the call or
put. A gain also will be realized if a call or put which the Fund has written
lapses unexercised, because the Fund would retain the premium. See "Dividends,
Distributions and Taxes" below. The Fund will purchase and sell only options
which are listed on a national securities exchange and will write options only
through a national options clearing organization.
 
  There can be no assurance that a liquid secondary market will exist at a
given time for any particular option. In this regard, trading in options on
U.S. government securities is relatively new, so that it is impossible to pre-
dict to what extent liquid markets will develop or continue. See the Statement
of Additional Information for a further discussion of risks involved in
options trading, and particular risks applicable to options trading on U.S.
government securities, including risks involved in options trading on Govern-
ment National Mortgage Association ("GNMA") certificates and the characteris-
tics and risks of stock index options transactions.
   
  Futures Contracts--General. The Fund may not purchase futures contracts or
related options if, immediately thereafter, more than 30% of the Fund's total
assets would be so invested. In purchasing and selling futures contracts and
related options, the Fund will comply with rules and interpretations of the
Commodity Futures Trading Commission ("CFTC"), under which the Fund is
excluded from regulation as a "commodity pool." CFTC regulations require,
among other things, that (a) futures and related options be used solely for
bona fide hedging purposes (or that the underlying commodity value of the
Fund's long positions not exceed the sum of certain identified liquid invest-
ments) and (b) the Fund not enter into futures and related options for which
the aggregate initial margin and premiums exceed 5% of the fair market value
of the Fund's assets. In order to prevent leverage in connection with the pur-
chase of futures contracts by the Fund, an amount of cash or other eligible
segregated assets equal to the market value of futures contracts purchased
will be maintained in a segregated account with PNC Bank. The Fund will engage
only in futures contracts and related options which are listed on a national
commodities exchange.     
 
                                                                              9
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 
  Interest Rate Futures Contracts. The Fund may purchase and sell interest rate
futures contracts as a hedge against changes in interest rates. An interest
rate futures contract is an agreement between two parties to buy and sell a
security for a set price on a future date. Interest rate futures contracts are
traded on designated "contracts markets" which, through their clearing corpora-
tions, guarantee performance of the contracts. Currently, there are interest
rate futures contracts based on securities such as long-term Treasury bonds,
Treasury notes, GNMA certificates and three-month Treasury bills.
 
  Generally, if market interest rates increase, the value of outstanding debt
securities declines (and vice versa). Entering into an interest rate futures
contract for the sale of securities has an effect similar to the actual sale of
securities, although sale of the interest rate futures contract might be accom-
plished more easily and quickly. For example, if the Fund holds long-term U.S.
government securities and SBMFM anticipates a rise in long-term interest rates,
the Fund could, in lieu of disposing of its portfolio securities, enter into
interest rate futures contracts for the sale of similar long-term securities.
If interest rates increased and the value of the Fund's securities declined,
the value of the Fund's interest rate futures contracts would increase, thereby
protecting the Fund by preventing the net asset value from declining as much as
it otherwise would have declined. Similarly, entering into interest rate
futures contracts for the purchase of securities has an effect similar to the
actual purchase of the underlying securities, but permits the continued holding
of securities other than the underlying securities. For example, if SBMFM
expects long-term interest rates to decline, the Fund might enter into interest
rate futures contracts for the purchase of long-term securities, so that it
could gain rapid market exposure that may offset anticipated increases in the
cost of securities that it intends to purchase, while continuing to hold high-
er-yielding short-term securities or waiting for the long-term market to stabi-
lize.
 
  The Fund may purchase and sell listed put and call options on interest rate
futures contracts. An option on an interest rate futures contract gives the
purchaser the right, in return for the premium paid, to assume a position in an
interest rate futures contract (a long position if the option is a call and a
short position if the option is a put), at a specified exercise price at any
time during the option period. When an option on a futures contract is exer-
cised, delivery of the interest rate futures position is accompanied by cash
representing the difference between the current market price of the interest
rate futures contract and the exercise price of the option. The Fund may pur-
chase put options on interest rate futures contracts in lieu of, and for the
same purpose as, sale of a futures contract. It also may purchase such put
options in order to hedge a long position in the underlying interest rate
futures contract in the same manner as it purchases "protective puts" on secu-
rities. The purchase of call options on interest rate futures contracts is
intended to serve
 
10
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
the same purpose as the actual purchase of the futures contract, and the Fund
will set aside cash and cash equivalents sufficient to purchase the amount of
portfolio securities represented by the underlying futures contracts. See "Op-
tions Activities" and "Dividends, Distributions and Taxes."
 
  Stock Index Futures Contracts. The Fund may purchase and sell stock index
futures contracts. These transactions, if any, by the Fund will be made solely
for the purpose of hedging against the effects of changes in the value of its
portfolio securities due to anticipated changes in market conditions and will
be made when the transactions are economically appropriate to the reduction of
risks inherent in the management of the Fund. A stock index futures contract is
an agreement under which two parties agree to take or make delivery of the
amount of cash based on the difference between the value of a stock index at
the beginning and at the end of the contract period. When the Fund enters into
a stock index futures contract, it must make an initial deposit, known as "ini-
tial margin," as a partial guarantee of its performance under the contract. As
the value of the stock index fluctuates, either party to the contract is
required to make additional margin deposits, known as "variation margin," to
cover any additional obligation that it may have under the contract. The Fund
may not at any time commit more than 5% of its total assets to initial margin
deposits on futures contracts.
 
  Successful use of stock index futures contracts by the Fund is subject to
certain special risk considerations. A liquid stock index futures market may
not be available when the Fund seeks to offset adverse market movements. In
addition, there may be an imperfect correlation between movements in the secu-
rities included in the index and movements in the securities in the Fund. Suc-
cessful use of stock index futures contracts is further dependent on SBMFM's
ability to predict correctly movements in the direction of the stock markets
and no assurance can be given that its judgment in this respect will be cor-
rect. Risks in the purchase and sale of stock index futures are further
referred to in the Statement of Additional Information.
 
  Foreign Securities and American Depositary Receipts. The Fund may purchase
foreign securities or American Depositary Receipts ("ADRs"). ADRs are U.S. dol-
lar-denominated receipts issued generally by domestic banks and representing
the deposit with the bank of a security of a foreign issuer. ADRs are publicly
traded on exchanges or over-the-counter in the United States.
 
  Investing in the securities of foreign companies involves special risks and
considerations not typically associated with investing in U.S. companies. These
risks include differences in accounting, auditing and financial reporting stan-
dards, generally higher commission rates on foreign portfolio transactions, the
possibility of
 
                                                                              11
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
expropriation or confiscatory taxation, adverse changes in investment or
exchange control regulations, political instability which could affect U.S.
investments in foreign countries and potential restrictions on the flow of
international capital. Additionally, dividends payable on foreign securities
may be subject to foreign taxes withheld prior to distribution. Foreign securi-
ties often trade with less frequency and volume than domestic securities and
therefore may exhibit greater price volatility. Changes in foreign exchange
rates will affect the value of those securities which are denominated or quoted
in currencies other than the U.S. dollar. Many of the foreign securities held
by the Fund will not be registered with, nor will the issuers thereof be sub-
ject to the reporting requirements of, the SEC. Accordingly, there may be less
publicly available information about the securities and the foreign company or
government issuing them than is available about a domestic company or govern-
ment entity. Moreover, individual foreign economies may differ favorably or
unfavorably from the U.S. economy in such respects as growth of gross national
product, rate of inflation, capital reinvestment, resource self-sufficiency and
balance of payment positions.
 
  Non-Publicly Traded and Illiquid Securities. The sale of securities that are
not publicly traded is typically restricted under the Federal securities laws.
As a result, the Fund may be forced to sell these securities at less than fair
market value or may not be able to sell them when SBMFM believes it desirable
to do so. The Fund's investments in illiquid securities are subject to the risk
that should the Fund desire to sell any of these securities when a ready buyer
is not available at a price that the Fund deems representative of their value,
the value of the Fund's net assets could be adversely affected.
 
 INVESTMENT RESTRICTIONS
 
  The Trust has adopted certain fundamental investment restrictions with
respect to the Fund that may not be changed without approval of a majority of
the Fund's outstanding shares. The fundamental investment restrictions adopted
by the Trust prohibit the Fund from:
 
  1. Purchasing the securities of any issuer (other than U.S. government
 securities) if as a result more than 5% of the value of the Fund's total
 assets would be invested in the securities of the issuer, except that up to
 25% of the value of the Fund's total assets may be invested without regard
 to this 5% limitation.
 
  2. Purchasing more than 10% of the voting securities of any one issuer,
 provided that this limitation shall not apply to investments in U.S. govern-
 ment securities.
 
  3. Purchasing securities on margin, except that the Fund may obtain any
 short-term credits necessary for the clearance of purchases and sales of
 securi-
 
12
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 ties. For purposes of this restriction, the deposit or payment of initial or
 variation margin in connection with futures contracts or related options
 will not be deemed to be a purchase of securities on margin by the Fund.
 
  4. Making short sales of securities or maintaining a short position, except
 to the extent of 5% of the Fund's net assets and except that the Fund may
 engage in such activities without limit if, at all times when a short posi-
 tion is open, the Fund owns an equal amount of the securities or securities
 convertible into or exchangeable, without payment of any further considera-
 tion, for securities of the same issuer as, and at least equal in amount to,
 the securities sold short.
 
  5.  Borrowing money, including reverse repurchase agreements, except that
 the Fund may borrow from banks for temporary or emergency (not leveraging)
 purposes including the meeting of redemption requests that might otherwise
 require the untimely disposition of securities, in an amount not exceeding
 20% of the value of the Fund's total assets (including the amount borrowed)
 valued at market less liabilities (not including the amount borrowed) at the
 time the borrowing is made. Whenever borrowings exceed 5% of the value of
 the Fund's total assets, the Fund will not make any additional investments.
 
  6. Pledging, hypothecating, mortgaging or otherwise encumbering more than
 10% of the value of the Fund's total assets as security for any indebted-
 ness. For purposes of this restriction (a) the deposit of assets in escrow
 in connection with the writing of covered put or call options and the pur-
 chase of securities on a when-issued or delayed-delivery basis and (b) col-
 lateral arrangements with respect to (i) the purchase and sale of stock
 options, options on foreign currencies and options on stock indexes and (ii)
 initial or variation margin for futures contracts will not be deemed to be
 pledges of the Fund's assets.
 
  7. Investing in commodities, except that the Fund may purchase or write
 futures contracts and options on futures contracts as described in this Pro-
 spectus.
 
  8. Making loans to others, except through the purchase of qualified debt
 obligations, loans of portfolio securities and the entry into repurchase
 agreements.
 
  9. Concentrating in any industry, except that the Fund will concentrate in
 excess of 25% of its assets in the securities of companies within the util-
 ity industries.
   
  In addition, the Fund will not purchase restricted securities, illiquid
securities (such as repurchase agreements with maturities in excess of seven
days) or other securities that are not readily marketable if more than 10% of
the total assets of the Fund would be invested in such securities.     
 
                                                                             13
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 
  Certain other investment restrictions, including fundamental restrictions as
well as restrictions that may be changed without a shareholder vote, adopted
by the Trust are described in the Statement of Additional Information.
 
 PORTFOLIO TRANSACTIONS
 
  Securities and commodities transactions on behalf of the Fund will be exe-
cuted by a number of brokers and dealers, including Smith Barney. The Fund may
use Smith Barney in connection with a purchase or sale of securities when
SBMFM believes that the charge for the transaction does not exceed usual and
customary levels. The Fund also may use Smith Barney as a commodities broker
in connection with entering into futures contracts and commodity options.
Smith Barney has agreed to charge the Fund commodity commissions at rates com-
parable to those charged by Smith Barney to its most favored clients for com-
parable trades in comparable accounts.
 
  In selecting a broker for a transaction, including Smith Barney or its
affiliates, the primary consideration is prompt and effective execution of
orders at the most favorable price. Subject to that primary consideration,
dealers may be selected for research, statistical or other services to enable
SBMFM to supplement its own research and analysis with the views and informa-
tion of other securities firms.
 
 RISK FACTORS AND SPECIAL CONSIDERATIONS
 
  Investment in the Fund involves special considerations, such as those
described below:
 
  General. Investment in the Fund may involve above-average risk of loss
because of, among other things, the Fund's use of strategies and techniques
that may be considered to be speculative. The strategy followed by the Fund
and certain of the strategies and techniques used by the Fund depend on fore-
casts made by SBMFM that may or may not prove to be correct.
 
  Low-Rated Securities. Low-rated and comparable unrated securities (a) will
likely have some quality and protective characteristics that, in the judgment
of the rating organization, are outweighed by large uncertainties or major
risk exposures to adverse conditions and (b) are predominantly speculative
with respect to the issuer's capacity to pay interest and repay principal in
accordance with the terms of the securities.
 
  While the market values of low-rated and comparable unrated securities tend
to react less to fluctuations in interest rate levels than the market values
of higher-rated securities, the market values of certain low-rated and compa-
rable unrated securities also tend to be more sensitive to individual corpo-
rate development and changes in economic conditions than higher-rated securi-
ties. In addition, low-rated
 
14
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
securities and comparable unrated securities generally present a higher degree
of credit risk. Issuers of low-rated and comparable unrated securities are
often highly leveraged and may not have more traditional methods of financing
available to them so that their ability to service their debt obligations dur-
ing an economic downturn or during sustained periods of rising interest rates
may be impaired. The risk of loss due to default by such issuers is signifi-
cantly greater because low-rated and comparable unrated securities generally
are unsecured and frequently are subordinated to the prior payment of senior
indebtedness. The Fund may incur additional expenses to the extent it is
required to seek recovery upon a default in the payment of principal or inter-
est on its portfolio holdings. The existence of limited markets for low-rated
and comparable unrated securities may diminish the Fund's ability to (a) obtain
accurate market quotations for purposes of valuing such securities and calcu-
lating its net asset value and (b) sell the securities at fair value either to
meet redemption requests or to respond to changes in the economy or in the
financial markets.
 
  Fixed-income securities, including low-rated securities and comparable
unrated securities, frequently have call or buy-back features that permit their
issuers to call or repurchase the securities from their holders, such as the
Fund. If an issuer exercises these rights during periods of declining interest
rates, the Fund may have to replace the security with a lower yielding securi-
ty, thus resulting in a decreased return to the Fund.
 
  The market for certain low-rated and comparable unrated securities is rela-
tively new and has not fully weathered a major economic recession. Any such
economic downturn could adversely affect the ability of the issuers of such
securities to repay principal and pay interest thereon.
 
  Investment in Utility Securities. Because the Fund concentrates its invest-
ments in one sector, its portfolio may be subject to greater risk and market
fluctuations than a portfolio of securities representing a broader range of
investment alternatives. The Fund is particularly subject to risks that are
inherent to the utility industries that make up this sector, including diffi-
culty in obtaining an adequate return on invested capital, difficulty in
financing large construction programs during an inflationary period, restric-
tions on operations and increased cost and delays attributable to environmental
considerations and regulation, difficulty in raising capital in adequate
amounts on reasonable terms in periods of high inflation and unsettled capital
markets, increased costs and reduced availability of certain types of fuel,
occasional reduced availability and high costs of natural gas for resales, the
effects of energy conservation, the effects of a national energy policy and
lengthy delays and greatly increased costs and other problems associated with
the design, construction, licensing, regulation and operation of nuclear facil-
ities for electric generation, including, among other considerations, the prob-
lems associated with the use of radioactive
 
                                                                              15
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
materials and the disposal of radioactive wastes. There are substantial differ-
ences between the regulatory practices and policies of various jurisdictions,
and any given regulatory agency may make major shifts in policy from time to
time. There is no assurance that regulatory authorities will grant rate
increases in the future or that such increases will be adequate to permit the
payment of dividends on common stocks. Additionally, existing and possible
future regulatory legislation may make it even more difficult for these utili-
ties to obtain adequate relief. Certain of the issuers of securities held by
the Fund may own or operate nuclear generating facilities. Governmental author-
ities may from time to time review existing policies, and impose additional
requirements governing the licensing, construction and operation of nuclear
power plants.
 
  Each of the risks referred to above could adversely affect the ability and
inclination of public utilities to declare or pay dividends and the ability of
holders of common stock to realize any value from the assets of the issuer upon
liquidation or bankruptcy. All of the utilities which are issuers of the secu-
rities held by the Fund have been experiencing one or more of these problems in
varying degrees. Moreover, price disparities within selected utility groups and
discrepancies in relation to averages and indices have occurred frequently for
reasons not directly related to the general movements or price trends of util-
ity common stocks. Causes of these discrepancies include changes in the overall
demand for and supply of various securities (including the potentially depress-
ing effect of new stock offerings), and changes in investment objectives, mar-
ket expectations or cash requirements of other purchasers and sellers of secu-
rities.
 
  Interest Rate Risk. The Fund will be affected by general changes in interest
rates which will result in increases or decreases in the market value of the
debt securities held by the Fund. The market value of the debt securities held
by the Fund can be expected to vary inversely to changes in prevailing interest
rates.
 
  Options on Securities. Because option premiums paid by the Fund are small in
relation to the market value of the investments underlying the options, buying
put options can result in large amounts of leverage. The leverage offered by
trading in options could cause the Fund's net asset value to be subject to more
frequent and wider fluctuation than would be the case if the Fund did not
invest in options.
 
  No assurance can be given that the Fund will be able to effect closing trans-
actions at a time when it wishes to do so. If the Fund cannot enter into a
closing transaction, the Fund will continue to be subject to the risk that a
put option it has purchased will decline in value or become worthless as a
result of any increase in the value of the underlying security. The Fund also
could face higher transaction costs, including brokerage commissions.
 
 
16
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
  Lending of Portfolio Securities. The risk associated with lending portfolio
securities, as with other extensions of credit, consists of possible loss of
rights in the collateral should the borrower fail financially.
 
  Short Sales. Possible losses from short sales differ from losses that could
be incurred from a purchase of a security, because losses from short sales may
be unlimited, whereas losses from purchases can equal only the total amount
invested.
 
  Futures Transactions. The use of futures contracts as a hedging device
involves several risks. No assurance can be given that a correlation will exist
between price movements in the stock index and price movements in the securi-
ties that are the subject of the hedge; the risk of imperfect correlation
increases as the composition of the securities held by the Fund diverges from
the securities included in the applicable stock index. Positions in futures
contracts may be closed out only on the exchange on which they were entered
into (or through a linked exchange) and no secondary market exists for those
contracts. In addition, although the Fund intends to enter into futures con-
tracts only if an active market exists for the contracts, no assurance can be
given that an active market will exist for the contracts at any particular
time. Certain exchanges do not permit trading in particular contracts at prices
that represent a fluctuation in price during a single day's trading beyond a
certain set limit. If prices fluctuate during a single day's trading beyond
those limits, the Fund could be prevented from promptly liquidating unfavorable
positions and thus be subjected to losses. Losses incurred in hedging transac-
tions and the costs of these transactions will affect the Fund's performance.
Successful use of stock index futures by the Fund for hedging purposes is sub-
ject to the ability of SBMFM to correctly predict movements in the direction of
the stock market.
 
VALUATION OF SHARES
 
 
  The net asset value per share of Class Z shares is determined as of the close
of regular trading on the New York Stock Exchange, Inc. (the "NYSE"), on each
day that the NYSE is open, by dividing the value of the Fund's net assets
attributable to Class Z by the total number of shares of the Class outstanding.
The per share net asset value of the Class Z shares may be higher than those of
other Classes because of the lower expenses attributable to Class Z shares.
 
  Generally, the Fund's investments are valued at market value or, in the
absence of a market value with respect to any securities, at fair value as
determined by or under the direction of the Trust's Board of Trustees. Portfo-
lio securities which are traded primarily on foreign exchanges are generally
valued at the preceding closing values of such securities on their respective
exchanges, except that when an occurrence subsequent to the time a value was so
established is likely to have changed such value, then the fair market value of
those securities will be determined by
 
                                                                              17
<PAGE>
 
VALUATION OF SHARES (CONTINUED)
 
consideration of other factors by or under the direction of the Board of Trust-
ees or its delegates. A security that is traded primarily on an exchange is
valued at the last sale price on that exchange or, if there were no sales dur-
ing the day, at the current quoted bid price. Over-the-counter securities are
valued on the basis of the bid price at the close of business on each day.
Investments in U.S. government securities (other than short-term securities)
are valued at the average of the quoted bid and asked prices in the over-the-
counter market. Short-term investments that mature in 60 days or less are val-
ued at amortized cost whenever the Trustees determine that amortized cost
reflects fair value of those investments. An option generally is valued at the
last sale price or, in the absence of the last sale price, the last offer
price. The value of a futures contract equals the unrealized gain or loss on
the contract, which is determined by marking the contract to the current set-
tlement price for a like contract acquired on the day on which the stock index
futures contract is being valued. A settlement price may not be used if the
market makes a limited move with respect to a particular commodity or if the
underlying securities market experiences significant price fluctuations after
the determination of the settlement price. In such event, the futures contract
will be valued at a fair market price to be determined by or under the direc-
tion of the Board of Trustees. Further information regarding the Trust's valua-
tion policies with respect to the Fund is contained in the Statement of Addi-
tional Information.
 
DIVIDENDS, DISTRIBUTIONS AND TAXES
 
 
 DIVIDENDS AND DISTRIBUTIONS
 
  The Fund will be treated separately from the Trust's other funds in determin-
ing the amounts of dividends from investment income and distributions of capi-
tal gains payable to shareholders. Dividends and capital gain distributions
will be reinvested automatically for each shareholder's account at net asset
value in additional Class Z shares of the Fund, unless the shareholder is eli-
gible for qualified distributions and instructs the Fund to pay all dividends
and capital gain distributions in cash. Dividends from net investment income,
if any, of the Fund will be declared monthly and will be paid on the last Fri-
day of the month. Distributions of any net long-term capital gains earned by
the Fund will be made annually after the close of the fiscal year in which they
are earned. Distributions of short-term capital gains may be paid more fre-
quently with dividends from net investment income. In addition, in order to
avoid the application of a 4% nondeductible excise tax measured with respect to
certain undistributed amounts of ordinary income and capital gains, the Fund
may make an additional distribution shortly before December 31 in each year of
any undistributed ordinary income on capital gains and expects to pay any other
dividends and distributions necessary to avoid the application of this tax.
 
 
18
<PAGE>
 
DIVIDENDS, DISTRIBUTIONS AND TAXES (CONTINUED)
 
  If, for any full fiscal year, the Fund's total distributions exceed net
investment income and net realized capital gains, the excess distributions gen-
erally will be treated as a tax-free return of capital (up to the amount of the
shareholder's tax basis in his or her shares). The amount treated as a tax-free
return of capital will reduce a shareholder's adjusted basis in his or her
shares. Pursuant to the requirements of the Investment Company Act of 1940, as
amended (the "1940 Act") and other applicable laws, a notice will accompany any
distribution paid from sources other than net investment income. In the event
the Fund distributes amounts in excess of its net investment income and net
realized capital gains, such distributions may have the effect of decreasing
the Fund's total assets, which may increase the Fund's expense ratio.
 
 TAXES
 
  The Fund will be treated as a separate taxpayer with the result that, for
Federal income tax purposes, the amount of investment income and capital gains
earned by the Fund will be determined without regard to the earnings of the
other funds of the Trust. The Fund has qualified and intends to continue to
qualify each year as a regulated investment company under Subchapter M of the
Internal Revenue Code of 1986, as amended. To meet those requirements, the Fund
may need to restrict the degree to which it engages in short-term trading,
short sales of securities and transactions in options. If the Fund qualifies as
a regulated investment company and meets certain distribution requirements, the
Fund will not be subject to Federal income tax on its net investment income and
net capital gains that it distributes to its shareholders.
 
  Dividends paid by the Fund from investment income and distributions of short-
term capital gain will be taxable to shareholders as ordinary income for Fed-
eral income tax purposes, whether received in cash or reinvested in additional
shares. Distributions of long-term capital gain will be taxable to shareholders
as long-term capital gain, whether paid in cash or reinvested in additional
shares, and regardless of the length of time the investor has held his or her
shares of the Fund. Generally, dividends of investment income (to the extent
derived from most types of dividends from domestic corporations) from the Fund
will qualify for the Federal dividends-received deduction for corporate share-
holders. Each shareholder of the Fund will receive a statement annually from
the Trust, which will set forth separately the aggregate dollar amount of divi-
dends and capital gains distributed to the shareholder by the Fund with respect
to the prior calendar year and the amount of the distributions that qualifies
for the dividends-received deduction.
 
  Shareholders should consult their plan document or tax advisors about the
consequences associated with participating in a Qualified Plan or Smith Barney
UIT.
 
                                                                              19
<PAGE>
 
   
PURCHASE, EXCHANGE AND REDEMPTION OF SHARES     
 
 
  Purchases of the Fund's Class Z shares must be made in accordance with the
terms of a Qualified Plan or Smith Barney UIT. Purchases are effected at net
asset value next determined after a purchase order is received by Smith Barney
(the "trade date"). Payment is due to Smith Barney on the third business day
(the "settlement date") after the trade date. Investors who make payment prior
to the settlement date may designate a temporary investment (such as a money
market fund of the Smith Barney Mutual Funds) for such payment until settlement
date. The Fund reserves the right to reject any purchase order and to suspend
the offering of shares for a period of time. There are no minimum investment
requirements for Class Z shares; however, the Fund reserves the right to vary
this policy at any time.
 
  Purchase orders received by the Fund or Smith Barney prior to the close of
regular trading on the NYSE, currently 4:00 p.m., New York time, on any day
that the Fund calculates its net asset value, are priced according to the net
asset value determined on that day. See "Valuation of Shares." Certificates for
Fund shares are issued upon request to the Trust's transfer agent.
   
  Qualified Plans may redeem their shares on any day on which the Fund calcu-
lates its net asset value. See "Valuation of Shares." Redemption requests
received in proper form prior to the close of regular trading on the NYSE are
priced at the net asset value per share determined on that day. Redemption
requests received after the close of regular trading on the NYSE are priced at
the net asset value as next determined. Shareholders acquiring Class Z shares
through a Qualified Plan or a Smith Barney UIT should consult the terms of
their respective plans for redemption provisions.     
   
  Holders of Class Z shares should consult their Qualified Plans for informa-
tion about available exchange options.     
       
       
PERFORMANCE
 
 
 YIELD
 
  From time to time, the Fund advertises the 30-day "yield" of its Class Z
shares. The yield refers to the income generated by an investment in the Fund
over the 30-day period identified in the advertisement and is computed by
dividing the net investment income per share earned by the Fund with respect to
a Class during 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.
 
20
<PAGE>
 
PERFORMANCE (CONTINUED)
 
 
 TOTAL RETURN
 
  From time to time the Fund may include its total return, average annual total
return and current dividend return for Class Z shares in advertisements and/or
other types of sales literature. 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 divi-
dends and capital gains distributions on the reinvestment dates at prices cal-
culated as stated in this Prospectus, then dividing the value of the investment
at the end of the period so calculated by the initial amount invested and sub-
tracting 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 non-
standard total return information 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 by annualizing the most
recent monthly distribution and dividing by the net asset value or 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 the Fund's current return to yields pub-
lished for other investment companies and other investment vehicles. The Fund
may also include comparative performance information in advertising or market-
ing the Fund's shares. Such performance information may include data from
Lipper Analytical Services, Inc. and other financial publications.
       
MANAGEMENT OF THE TRUST AND THE FUND
 
 
 BOARD OF TRUSTEES
 
  Overall responsibility for management and supervision of the Fund rests with
the Trust's Board of Trustees. The Trustees approve all significant agreements
between the Trust and companies that furnish services to the Trust and the
Fund, including agreements with the Fund's distributor, investment adviser,
administrator, custodian and transfer agent. The day-to-day operations of the
Fund are delegated to the Fund's investment adviser and administrator. The
Statement of Additional Information contains background information regarding
each Trustees and executive officer of the Trust.
 
21
<PAGE>
 
MANAGEMENT OF THE TRUST AND THE FUND (CONTINUED)
 
 
 INVESTMENT ADVISER--SBMFM
   
  SBMFM is a registered investment adviser whose principal executive offices
are located at 388 Greenwich Street, New York, New York 10013, and serves as
the Fund's investment adviser. SBMFM is a wholly owned subsidiary of Smith
Barney Holdings Inc. ("Holdings"). Holdings is a wholly owned subsidiary of
Travelers Group Inc. ("Travelers"), a diversified financial services holding
company engaged, through its subsidiaries, principally in four business seg-
ments: Investment Services, Consumer Finance Services, Life Insurance Services
and Property & Casualty Insurance Service. SBMFM (through its predecessor
entities) has been in the investment counseling business since 1934 and is a
registered investment adviser. SBMFM renders investment advice to investment
companies that had aggregate assets under management as of September 30, 1996
in excess of $77 billion.     
 
  Subject to the supervision and direction of the Fund's Board of Trustees,
SBMFM manages the Fund's portfolio in accordance with the Fund's investment
objectives and policies, makes investment decisions for the Fund, places
orders to purchase and sell securities and employs professional portfolio man-
agers and securities analysts who provide research services to the Fund. For
investment advisory services rendered the Fund pays SBMFM a fee at the annual
rate of 0.45% of the value of the Fund's daily net assets.
 
 PORTFOLIO MANAGEMENT
 
  Jack S. Levande, a Managing Director of Smith Barney, has served as Vice
President and Investment Officer of the Fund since it commenced operations and
manages the day to day operations of the Fund, including making all investment
decisions.
   
  Management's discussion and analysis and additional performance information
regarding the Fund during the fiscal year ended July 31, 1996 is included in
the Annual Report dated July 31, 1996. A copy of the Annual Report may be
obtained upon request and without charge from a Smith Barney Financial Consul-
tant or by writing or calling the Fund at the address or phone number listed
on page one of this Prospectus.     
 
 ADMINISTRATOR--SBMFM
 
  SBMFM also serves as the Fund's administrator and oversees all aspects of
the Fund's administration. For administration services rendered, the Fund pays
SBMFM a fee at the annual rate of .20% of the value of the Fund's average
daily net assets.
 
                                                                             22
<PAGE>
 
MANAGEMENT OF THE TRUST AND THE FUND (CONTINUED)
 
 
 DISTRIBUTOR--SMITH BARNEY
 
  Smith Barney is located at 388 Greenwich Street, New York, New York 10013,
and serves as the Fund's distributor. Smith Barney is a wholly owned subsidiary
of Holdings.
   
ADDITIONAL INFORMATION     
 
 
  The Trust was organized on March 12, 1985 in the Commonwealth of Massachu-
setts and is a business entity commonly known as a "Massachusetts business
trust."
 
  The Trust offers shares of beneficial interest of separate series having a
$.001 per share par value. Shares of beneficial interest of the Fund are cur-
rently classified into five Classes: A, B, C, Y and Z. Each Class of shares
represents identical pro rata interests in the Fund's investment portfolio. As
a result, the Classes have the same rights, privileges and preferences, except
with respect to: (a) the designation of each Class; (b) the effect of the
respective sales charges, if any, for each Class; (c) the distribution and/or
service fees, if any, borne by each Class pursuant to a plan adopted under Rule
12b-1 under the 1940 Act; (d) the expenses allocable exclusively to each Class;
(e) voting rights on matters exclusively affecting a single Class; (f) the
exchange privilege of each Class; and (g) the conversion feature of a Class.
The Trust's Board of Trustees does not anticipate that there will be any con-
flicts among the interests of the holders of the different Classes of shares of
the Fund. The Trustees, on an ongoing basis, will consider whether any such
conflict exists and, if so, take appropriate action.
   
  The Trust does not hold annual shareholder meetings. There normally will be
no meeting of shareholders for the purpose of electing Trustees unless and
until such time as less than a majority of the Trustees holding office have
been elected by shareholders. The Trustees will call a meeting for any purpose
upon the written request of shareholders holding at least 10% of the Fund's
outstanding shares and the Trust 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 of the Fund will have one vote for each full
share owned and a proportionate, fractional vote for any fractional share held
of that Class. Shares of the Trust will be voted generally on a Trust-wide
basis except on all matters, except matters affecting only the interests of one
Fund or one or more of the Classes of shares.     
       
  The Fund sends its shareholders a semi-annual report and an audited annual
report, which include a listing of the investment securities held by the Fund
at the end of the reporting period. In an effort to reduce the Fund's printing
and mailing costs, the Trust plans to consolidate the mailing of the Fund's
semi-annual and
 
23
<PAGE>
 
ADDITIONAL INFORMATION (CONTINUED)
   
annual reports by household. This consolidation means that a household having
multiple accounts with the identical address of record will receive a single
copy of each report. In addition, the Trust also plans to consolidate the mail-
ing of the Fund's Prospectus so that a shareholder having multiple accounts
(that is, individual, IRA and/or Self-Employed Retirement Plan accounts) will
receive a single Prospectus annually. Shareholders who do not want this consol-
idation to apply to their accounts should contact a Smith Barney Financial Con-
sultant or First Data Investor Services Group, Inc.     
 
  PNC Bank, located at 17th and Chestnut Streets, Philadelphia, PA 19103,
serves as custodian of the Fund's investments.
   
  First Data Investor Services Group, Inc., located at Exchange Place, Boston,
Massachusetts 02109, serves as the Trust's transfer agent.     
 
                                                                              24
<PAGE>
 
 
                                              SMITH BARNEY
                                              ----------------------------------

                                              A Member of TravelersGroup  [LOGO]
 
 
 
 
 
 
 
 
 
 
                                                     SMITH BARNEY UTILITIES FUND
 
 
                                                            388 Greenwich Street
                                                        New York, New York 10013
                                                                 
                                                              FD 0791 11/96     

                                   PROSPECTUS

                                                                    SMITH BARNEY
                                                                            High
                                                                          Income
                                                                            Fund

   
                                                              November 28, 1996
    

                                                   Prospectus begins on page one


[LOGO] Smith Barney Mutual Funds
       Investing for your future
       Every day.


<PAGE>

Smith Barney High Income Fund

   
--------------------------------------------------------------------------------
Prospectus                                                     November 28, 1996
--------------------------------------------------------------------------------
    

     388 Greenwich Street
     New York, New York 10013
     (212) 723-9218

     Smith Barney High Income Fund (the "Fund") seeks to provide shareholders
with high current income by investing in a diversified portfolio of
high-yielding corporate bonds, debentures and notes.

     The Fund is one of a number of funds, each having distinct investment
objectives and policies, making up the Smith Barney Income Funds (the "Trust").
The Trust is an open-end management investment company commonly referred to as a
mutual fund.

     The Fund invests primarily in lower-rated bonds, commonly known as "junk
bonds". Bonds of this type are subject to a greater risk of loss of principal
and interest. Purchasers should carefully assess the risks associated with an
investment in the Fund. See "Risk Factors and Special Considerations."

     This Prospectus sets forth concisely certain information about the Fund and
the Trust, including sales charges, distribution and service fees and expenses,
that prospective investors will find helpful in making an investment decision.
Investors are encouraged to read this Prospectus carefully and retain it for
future reference. Shares of other investment funds offered by the Trust are
described in separate prospectuses that may be obtained by calling the Trust at
the telephone number set forth above or by contacting a Smith Barney Financial
Consultant.

   
     Additional information about the Fund and the Trust is contained in a
Statement of Additional Information dated November 28, 1996, as amended or
supplemented from time to time, that is available upon request and without
charge by calling or writing the Trust at the telephone number or address set
forth above or by contacting a Smith Barney Financial Consultant. The Statement
of Additional Information has been filed with the Securities and Exchange
Commission (the "SEC") and is incorporated by reference into this Prospectus in
its entirety.
    

Smith Barney Inc.
Distributor

Smith Barney Mutual Funds Management Inc.
Investment Adviser and Administrator

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.


                                                                               1


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Table of Contents
--------------------------------------------------------------------------------

Prospectus Summary                                                             3
--------------------------------------------------------------------------------
Financial Highlights                                                          10
--------------------------------------------------------------------------------
Investment Objective and Policies                                             14
--------------------------------------------------------------------------------
Valuation of Shares                                                           26
--------------------------------------------------------------------------------
Dividends, Distributions and Taxes                                            26
--------------------------------------------------------------------------------
Purchase of Shares                                                            28
--------------------------------------------------------------------------------
Exchange Privilege                                                            39
--------------------------------------------------------------------------------
Redemption of Shares                                                          42
--------------------------------------------------------------------------------
Minimum Account Size                                                          45
--------------------------------------------------------------------------------
Performance                                                                   45
--------------------------------------------------------------------------------
Management of the Trust and Fund                                              46
--------------------------------------------------------------------------------
Distributor                                                                   47
--------------------------------------------------------------------------------
Additional Information                                                        48
--------------------------------------------------------------------------------

================================================================================

     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 and
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>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Prospectus Summary
--------------------------------------------------------------------------------

   
The following summary is qualified in its entirety by detailed information
appearing elsewhere in this Prospectus and in the Statement of Additional
Information. Cross references in this summary are to headings in this
Prospectus. See "Table of Contents."

Investment Objective The Fund is an open-end, diversified management investment
company that seeks high current income by investing primarily in a diversified
portfolio of high-yielding corporate bonds, debentures and notes denominated in
U.S. dollars and foreign currencies. Although growth of capital is not an
investment objective of the Fund, Smith Barney Mutual Funds Management Inc.
("SBMFM") may consider potential for growth as one factor, among others, in
selecting investments for the Fund. Up to 40% of the Fund's assets may be
invested in fixed-income obligations of foreign issuers, and up to 20% of its
assets may be invested in common stock or other equity or equity-related
securities, including convertible securities, preferred stock, warrants and
rights. Securities purchased by the Fund generally will be rated in the lower
rating categories of recognized rating agencies, as low as Caa by Moody's
Investors Service, Inc. ("Moody's") or D by Standard & Poor's Ratings Group
("S&P"), or in unrated securities of comparable quality. See "Investment
Objective and Management Policies."
    

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 C
shares, which differ principally in terms of sales charges and rate 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 $5,000,000. In
addition, a fifth Class, Class Z shares, which is offered pursuant to a separate
prospectus, is offered exclusively to (a) tax-exempt employee benefit and
retirement plans of Smith Barney Inc. ("Smith Barney") and its affiliates and
(b) unit investment trusts ("UITs") sponsored by Smith Barney and its
affiliates. 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, which when
combined with current holdings of Class A shares offered with a sales charge
equal or exceed $500,000 in the aggregate, will be made at net asset value with
no initial sales


                                                                               3


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

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 Summary
-- 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 service 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.

   
     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 C Shares. Class C shares are sold at net asset value with no initial
sales charge. 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 C shares within 12 months of
purchase. The CDSC may be waived for certain redemptions. The Class C shares'
distribution fee may cause that Class to have higher expenses and pay lower
dividends than Class A shares. Purchases of Fund shares, which when combined
with current holdings of Class C 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 $5,000,000. 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 fee.

     In deciding which Class of Fund shares to purchase, investors should
consider the following factors, as well as any other relevant facts and
circumstances:

     Intended Holding Period. The decision as to which Class of shares is more
beneficial to an investor depends on the amount and intended length of his or
her


4


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

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 investment
alternative, Class B and Class C 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 these Classes. Because the Fund's future
return cannot be predicted, however, there can be no assurance that this would
be the case.

     Finally, investors should consider the effect of the CDSC period and any
conversion rights of the Classes in the context of their own investment time
frame. For example, while Class C 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
C 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
purchases which, when combined with current holdings of Class A shares offered
with a sales charge equal or exceed $500,000 in the aggregate, may 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 aggregate
investment may be met by adding the purchase to the net asset value of all Class
A shares offered with a sales charge held in funds sponsored by 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
ongoing expenses of Class A shares may be lower than those for Class B and Class
C shares, purchasers eligible to purchase Class A shares at net asset value or
at a reduced sales charge should consider doing so.

     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 C shares is the same as that of the
initial sales charge on the Class A shares.
    

     See "Purchase of Shares" and "Management of the Trust and the Fund" for a
complete description of the sales charges and service and distribution fees for
each Class of shares and "Valuation of Shares," "Dividends, Distributions and
Taxes" and "Exchange Privilege" for other differences among the Classes of
shares.


                                                                               5


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

   
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. Other investors may be eligible to participate in the Smith Barney
ExecChoice(TM) program. Class A and Class C shares are available without a sales
charge as investment alternatives for both of these programs. See "Purchase of
Shares - Smith Barney 401(k) and ExecChoice(TM) Programs."

PURCHASE OF SHARES Shares may be purchased through a brokerage account
maintained with Smith Barney, a broker that clears securities transactions
through Smith Barney on a fully disclosed basis (an "Introducing Broker") or an
investment dealer in the selling group. In addition, certain investors,
including qualified retirement plans and certain other institutional investors,
may purchase shares directly from the Fund through the Fund's transfer agent,
First Data Investor Services Group, Inc. ("First Data"). See "Purchase of
Shares."

INVESTMENT MINIMUMS Investors in Class A, Class B and Class C 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 $5,000,000. 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 C shares and the subsequent investment requirement
for all Classes is $25. For minimum investment requirements for all Classes
through the Systematic Investment Plan, see below. There is no minimum
investment requirement for Class A for unitholders who invest distributions from
a UIT sponsored by Smith Barney. See "Purchase 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 and subsequent
investment for shareholders purchasing shares through the Systematic 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
"Redemption of Shares."


6


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

MANAGEMENT OF THE FUND SBMFM serves as the Fund's investment adviser and
administrator. SBMFM provides investment advisory and management services to
investment companies affiliated with Smith Barney. SBMFM is a wholly owned
subsidiary of Smith Barney Holdings Inc. ("Holdings"). Holdings is a wholly
owned subsidiary of Travelers Group Inc. ("Travelers"), a diversified financial
services holding company engaged, through its subsidiaries, principally in four
business segments: Investment Services, Consumer Finance Services, Life
Insurance Services and Property & Casualty Insurance Services. 

   
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 respective
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 Smith Barney Financial Consultants. See "Valuation of Shares."

DIVIDENDS AND DISTRIBUTIONS Dividends from net investment income are paid
monthly and distributions of net realized capital gains are paid 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 distribution
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. The market value of fixed-income
securities, which constitute a major part of the investments of the Fund, may
vary inversely in response to changes in prevailing interest rates. The foreign
securities in which the Fund may invest may be subject to certain risks in
addition to those inherent in domestic investments. The medium- or lower-rated
securities in which the Fund may invest, some of which have speculative
characteristics, may be subject to greater market fluctuations and greater risk
of loss of income or principal than higher-rated securities. The Fund may employ
investment techniques which involve certain other risks, including entering into
repurchase agreements, engaging in when-issued and delayed-delivery
transactions, lending portfolio securities and entering into options on futures
contracts and currencies. See "Investment Objective and Management Policies." 


                                                                               7


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
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:

                                          Class A    Class B   Class C   Class Y
================================================================================
Shareholder Transaction Expenses
  Maximum sales charge imposed on 
  purchases (as a percentage of 
  offering price)                          4.50%      None       None      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                          0.70%      0.70%      0.70%     0.70%
  12b-1 fees**                             0.25       0.75       0.70      None
   
  Other expenses                           0.15       0.14       0.11      0.06
================================================================================
TOTAL FUND OPERATING EXPENSES              1.10%      1.59%      1.51%     0.76%
================================================================================
    
                                                                      
* Purchases of Class A shares, which when combined with current holdings of
  Class A shares offered with a sales charge, equal or exceed $500,000 in the
  aggregate, 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.
**Upon conversion of Class B shares to Class A shares, such shares will no
  longer be subject to a distribution fee. Class C shares do not have a
  conversion feature and, therefore, are subject to an ongoing distribution fee.
  As a result, long-term shareholders of Class C shares may pay more than the
  economic equivalent of the maximum front-end sales charge permitted by the
  National Association of Securities Dealers, Inc. (the "NASD").

     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 B, Class C 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)
Program. See "Purchase of Shares" and "Redemption of Shares." Smith Barney
receives an annual 12b-1 service fee of 0.25% of the value of average daily net
assets of Class A shares. Smith Barney also receives, with respect to Class B
shares, an annual 12b-1 fee of 0.75% of the value of average daily net assets of
that Class, consisting of a 0.50% distribution fee and a 0.25% service fee. For
Class C shares, 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% distribution
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>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

Example The following example is intended to assist an investor in understanding
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 Trust and the Fund."

                                          1 year   3 years   5 years   10 years*
================================================================================
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                               56        78        103       173
     Class  B                               61        80         97       176
     Class  C                               26        48         82       180
     Class  Y                                8        24         42        94
    

An investor would pay the following expenses on the same investment, assuming
the same annual return and no redemption:

   
     Class  A                               56        78        103       173
     Class  B                               16        50         87       176
     Class  C                               15        48         82       180
     Class  Y                                8        24         42        94
                                   
================================================================================

* 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
representation of past or future expenses and actual expenses may be greater or
less than those shown.


                                                                               9
<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Financial Highlights
--------------------------------------------------------------------------------

   
The following information for the two-year period ended July 31, 1996 has been
audited by KPMG Peat Marwick, LLP, independent accountants, whose report thereon
appears in the Fund's Annual Report dated July 31, 1996. The following
information for the fiscal years ended July 31, 1987 through July 31, 1994 has
been audited by other independent auditors. The information set out below 
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 Additional Information. 
    

For a Class A share of beneficial interest outstanding throughout each period:

<TABLE>
<CAPTION>
   
                                                   Year         Year         Year       Period
                                                   Ended        Ended        Ended       Ended
                                                  7/31/96      7/31/95      7/31/94    7/31/93(1)
===================================================================================================
<S>                                             <C>          <C>          <C>          <C>      
Net Asset Value, Beginning of Period            $   11.10    $   11.16    $   12.01    $   11.03
---------------------------------------------------------------------------------------------------
Income From Operations:
  Net investment income                              1.08         1.08         1.08         0.75
  Net realized and unrealized gain (loss)
    on investments                                  (0.12)       (0.02)       (0.81)        1.09
---------------------------------------------------------------------------------------------------
Total Income From Operations                         0.96         1.06         0.27         1.84
---------------------------------------------------------------------------------------------------
Less Distributions From:
  Net investment income                             (1.08)       (1.05)       (1.06)       (0.82)
  Overdistribution of net investment income          --           --          (0.06)       (0.04)
  Capital                                            --          (0.07)        --           --
---------------------------------------------------------------------------------------------------
Total Distributions                                 (1.08)       (1.12)       (1.12)       (0.86)
---------------------------------------------------------------------------------------------------
Net Asset Value, End of Period                  $   10.98    $   11.10    $   11.16    $   12.01
---------------------------------------------------------------------------------------------------
Total Return++                                       8.95%       10.28%        2.11%       17.29%#
---------------------------------------------------------------------------------------------------
Net Assets, End of Period (000s)                $ 341,040    $ 316,716    $ 233,678    $ 242,371
---------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
  Expenses                                           1.10%        1.11%        1.11%        1.16%+
  Net investment income                              9.65        10.03         9.27         9.52+
---------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                                72%          60%          98%          95%
===================================================================================================
    
</TABLE>
(1) 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.
++ Total return represents aggregate total return for the period indicated and
  does not reflect any applicable sales charge. 


10


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Financial Highlights
--------------------------------------------------------------------------------

For a Class B share of beneficial interest outstanding throughout each period:

<TABLE>
<CAPTION>
   
                                        Year           Year           Year           Year           Year           Year
                                        Ended          Ended          Ended          Ended          Ended          Ended
                                       7/31/96        7/31/95        7/31/94        7/31/93        7/31/92        7/31/91
=========================================================================================================================
<S>                                <C>            <C>            <C>            <C>            <C>            <C>        
Net Asset Value,
  Beginning of Period              $     11.11    $     11.16    $     12.01    $     11.15    $     10.05    $     10.59
-------------------------------------------------------------------------------------------------------------------------
Income From Operations:
  Net investment income                   1.02           1.03           1.02           1.08           1.11           1.27
  Net realized and unrealized
   gain (loss) on investments            (0.12)         (0.02)         (0.81)          0.88           1.16          (0.52)
-------------------------------------------------------------------------------------------------------------------------
Total Income From Operations 0.90         1.01           0.21           1.96           2.27           0.75
-------------------------------------------------------------------------------------------------------------------------
Less Distributions From:
  Net investment income                  (1.02)         (0.99)         (1.00)         (1.05)         (1.11)         (1.27)
  Overdistribution of net
    investment income                     --             --            (0.06)         (0.05)          --             --
  Capital                                 --            (0.07)          --             --            (0.06)         (0.02)
-------------------------------------------------------------------------------------------------------------------------
Total Distributions                      (1.02)         (1.06)         (1.06)         (1.10)         (1.17)         (1.29)
-------------------------------------------------------------------------------------------------------------------------
Net Asset Value,
  End of Period                    $     10.99    $     11.11    $     11.16    $     12.01    $     11.15    $     10.05
-------------------------------------------------------------------------------------------------------------------------
Total Return++                            8.41%          9.77%          1.60%         18.55%         23.86%          8.82%
-------------------------------------------------------------------------------------------------------------------------
Net Assets,
  End of Period (000s)             $   560,031    $   478,499    $   509,608    $   448,639    $   304,035    $   238,588
-------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
  Expenses                                1.59%          1.61%          1.60%          1.66%          1.65%#         1.75%
  Net investment income                   9.16           9.52           8.77           9.02          10.52          13.30
-------------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                     72%            60%            98%            95%           137%           112%
=========================================================================================================================
    
</TABLE>
++ Total return represents aggregate total return for the period indicated and
  does not reflect any applicable sales charge. 
# The annualized operating expense ratio excludes interest expense. The
  annualized operating expense ratio including interest expense was 1.66% for
  the year ended July 31, 1992.


                                                                              11


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Financial Highlights (continued)
--------------------------------------------------------------------------------

For a Class B share of beneficial interest outstanding throughout each period:

<TABLE>
<CAPTION>
                                         Year         Year         Year       Period
                                         Ended        Ended        Ended       Ended
                                        7/31/90      7/31/89      7/31/88    7/31/87(1)
=========================================================================================
<S>                                   <C>          <C>          <C>          <C>      
Net Asset Value, Beginning of Period  $   13.36    $   14.01    $   14.26    $   14.00
-----------------------------------------------------------------------------------------
Income From Operations
  Net investment income                    1.53         1.61         1.53         1.03
  Net realized and unrealized
    gain (loss) on investments            (2.68)       (0.73)       (0.20)        0.29
-----------------------------------------------------------------------------------------
Total Income(Loss)
 From Operations                            (1.15)        0.88         1.33         1.32
-----------------------------------------------------------------------------------------
Less Distributions From:
  Net investment income                   (1.61)       (1.53)       (1.54)       (1.03)
  Overdistribution of net
    investment income                      --           --          (0.04)       (0.03)
  Capital                                 (0.01)        --           --           --
-----------------------------------------------------------------------------------------
Total Distributions                       (1.62)       (1.53)       (1.58)       (1.06)
-----------------------------------------------------------------------------------------
Net Asset Value, End of Period        $   10.59    $   13.36    $   14.01    $   14.26
-----------------------------------------------------------------------------------------
Total Return++                            (8.66)%       6.60%       10.06%        9.55%#
-----------------------------------------------------------------------------------------
Net Assets, End of Period (000s)      $ 323,139    $ 609,862    $ 434,272    $ 221,683
-----------------------------------------------------------------------------------------
Ratios to Average Net Assets:
  Expenses                                 1.68%        1.63%        1.64%        1.74%+*
  Net investment income                   12.93        11.93        11.12         9.49+
-----------------------------------------------------------------------------------------
Portfolio Turnover Rate                      43%          74%           5%          19%
=========================================================================================
</TABLE>
(1) For the period from September 2, 1986 (commencement of operations) to July
  31, 1987.
# Total return is not annualized as it may not be representative of the total
  return for the year.
+ Annualized.
++ Total return represents aggregate total return for the period indicated and
  does not reflect any applicable sales charge. * Annualized expense ratio
  before waiver of fees by investment adviser and sub-investment adviser and
  administrator was 1.77%.


12


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Financial Highlights (continued)
--------------------------------------------------------------------------------

   
For a Class C share of beneficial interest and Class Y share of beneficial
interest outstanding throughout each period:
    

                                   Class C Shares            Class Y Shares
                              ========================  ========================
   
                              Year Ended  Period Ended  Year Ended  Period Ended
                               7/31/96   7/31/95(1)(2)    7/31/96    7/31/95(3)
================================================================================
Net Asset Value, Beginning 
  of Period                     $  11.11    $ 10.90     $  11.10    $  10.88
--------------------------------------------------------------------------------
Income From Operations:
  Net investment income           1.03       0.95         0.92        0.09
  Net realized and unrealized 
    gain (loss) on investments    (0.11)      0.23        (0.11)       0.23
--------------------------------------------------------------------------------
Total Income From Operations        0.92       1.18         0.81        0.32
--------------------------------------------------------------------------------
Less Distributions From:
  Net investment income            (1.03)     (0.90)       (0.92)      (0.03)
  Overdistribution of
    net investment income           --         --           --          --
  Capital                           --        (0.07)        --         (0.07)
--------------------------------------------------------------------------------
Total Distributions                (1.03)     (0.97)       (0.92)      (0.10)
--------------------------------------------------------------------------------
Net Asset Value, End of Period  $  11.00    $ 11.11     $  10.99    $  11.10
--------------------------------------------------------------------------------
Total Return++                      8.56%     11.50%++      9.32%       2.91%#
--------------------------------------------------------------------------------
Net Assets, End of 
  Period (000s)                 $ 21,049    $ 6,011     $ 35,097    $ 10,306
--------------------------------------------------------------------------------
Ratios to Average Net Assets:
  Expenses                          1.51%      1.56%+       0.76%       0.86%+
  Net investment income             9.23       9.58+        9.98       10.28+
--------------------------------------------------------------------------------
Portfolio Turnover Rate               72%        60%          72%         60%
================================================================================
    

(1) On November 7, 1994 the former Class D shares were renamed Class C shares.
(2) For the period from August 24, 1994 (inception date) to July 31, 1995.
(3) For the period from April 28, 1995 (inception date) to July 31, 1995.
#   Total return is not annualized as it may not be representative of the total
    return for the year.
+   Annualized.
++  Total return represents aggregate total return for the period indicated and
    does not reflect any applicable sales charge.


                                                                              13
<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies
--------------------------------------------------------------------------------

   
     The Fund's investment objective is high current income. The Fund's
investment objective may be changed only with the approval of the holders of a
majority of the Fund's outstanding shares. There can be no assurance that the
Fund will achieve its objective. Although growth of capital is not an investment
objective of the Fund, SBMFM may consider potential for growth as one factor,
among others, in selecting investments for the Fund. The Fund will seek high
current income by investing, under normal circumstances, at least 65% of its
assets in high-yielding corporate bonds, debentures and notes denominated in
U.S. dollars or foreign currencies. Up to 40% of the Fund's assets may be
invested in fixed-income obligations of foreign issuers, and up to 20% of its
assets may be invested in common stock or other equity or equity-related
securities, including convertible securities, preferred stock, warrants and
rights. Securities purchased by the Fund generally will be rated in the lower
rating categories of recognized rating agencies, as low as Caa by Moody's or D
by S&P, or in unrated securities that SBMFM deems of comparable quality.
However, the Fund will not purchase securities rated lower than B by both
Moody's and S&P unless, immediately after such purchase, no more than 10% of its
total assets are invested in such securities. The Fund may hold securities with
higher ratings when the yield differential between low-rated and higher-rated
securities narrows and the risk of loss may be reduced substantially with only a
relatively small reduction in yield. The Fund may also invest in zero coupon
bonds and payment-in-kind bonds. The Fund also may invest in higher-rated
securities when SBMFM believes that a more defensive investment strategy is
appropriate in light of market or economic conditions. The Fund also may lend
its portfolio securities, purchase or sell securities on a when-issued or
delayed-delivery basis and write covered call options on securities. In order to
mitigate the effects of uncertainty in future exchange rates, the Fund may
engage in currency exchange transactions and purchase options on foreign
currencies. The Fund also may hedge against the effects of changes in the value
of its investments by purchasing put and call options on interest rate futures
contracts. Special considerations associated with the Fund's investments are
described below.
    

     CERTAIN INVESTMENT STRATEGIES

     In attempting to achieve its investment objective, the Fund may employ,
among others, one or more of the strategies set forth below. More detailed
information concerning these strategies and their related risks is contained in
the Statement of Additional Information.

     Covered Option Writing. The Fund may write call options on securities. The
Fund realizes fees (referred to as "premiums") for granting the rights evidenced
by


14


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

the options. A call option embodies the right of its purchaser to compel the
writer of the option to sell to the option holder an underlying security at a
specified price at any time during the option period. Thus, the purchaser of a
call option written by the Fund 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 call option written by the Fund, 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 will write only covered options. Accordingly, whenever the Fund
writes a call option, it will continue to own or have the present right to
acquire the underlying security for as long as it remains obligated as the
writer of the option.

     The Fund may engage in a closing purchase transaction to realize a profit
or to unfreeze an underlying security (thereby permitting its sale or the
writing of a new option on the security prior to the outstanding option's
expiration). To effect a closing purchase transaction, the Fund would purchase,
prior to the holder's exercise of an option the Fund has written, an option of
the same series as that on which the Fund desires to terminate its obligation.
The obligation of the Fund under an option it has written would be terminated by
a closing purchase transaction, but the Fund would not be deemed to own an
option as the result of the transaction. There can be no assurance the Fund will
be able to effect closing purchase transactions at a time when it wishes to do
so. To facilitate closing purchase transactions, however, the Fund ordinarily
will write options only if a secondary market for the options exists on a
domestic securities exchange or in the over-the-counter market.

   
     Convertible Securities and Synthetic Convertible Securities. Convertible
securities are fixed-income securities that may be converted at either a stated
price or stated rate into underlying shares of common stock. Convertible
securities have general characteristics similar to both fixed-income and equity
securities. Although to a lesser extent than with fixed-income securities
generally, the market value of convertible securities tends to decline as
interest rates increase and, conversely, tends to increase as interest rates
decline. In addition, because of the conversion feature, the market value of
convertible securities tends to vary with fluctuations in the market value of
the underlying common stocks and, therefore, also will react to variations in
the general market for equity securities. A unique feature of convertible
securities is that as the market price of the underlying common stock declines,
convertible securities tend to trade increasingly on a yield basis, and so
    


                                                                              15


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

may not experience market value declines to the same extent as the underlying
common stock. When the market price of the underlying common stock increases,
the prices of the convertible securities tend to rise as a reflection of the
value of the underlying common stock. While no securities investments are
without risk, investments in convertible securities generally entail less risk
than investments in common stock of the same issuer.

     As fixed-income securities, convertible securities are investments which
provide for a stable stream of income with generally higher yields than common
stocks. Of course, like all fixed-income securities, there can be no assurance
of current income because the issuers of the convertible securities may default
on their obligations. Convertible securities, however, generally offer lower
interest or dividend yields than non-convertible securities of similar quality
because of the potential for capital appreciation. A convertible security, in
addition to providing fixed income, offers the potential for capital
appreciation through the conversion feature, which enables the holder to benefit
from increases in the market price of the underlying common stock. However,
there can be no assurance of capital appreciation because securities prices
fluctuate.

     Convertible securities generally are subordinated to other similar but
non-convertible securities of the same issuer, although convertible bonds, as
corporate debt obligations, enjoy seniority in right of payment to all equity
securities, and convertible preferred stock is senior to common stock of the
same issuer. Because of the subordination feature, however, convertible
securities typically have lower ratings than similar non-convertible securities.

     Unlike a convertible security which is a single security, a synthetic
convertible security is comprised of two distinct securities that together
resemble convertible securities in certain respects. Synthetic convertible
securities are created by combining non-convertible bonds or preferred stocks
with warrants or stock call options. The options that will form elements of
synthetic convertible securities will be listed on a securities exchange or on
the National Association of Securities Dealers Automated Quotation Systems. The
two components of a synthetic convertible security, which will be issued with
respect to the same entity, generally are not offered as a unit, and may be
purchased and sold by the Fund at different times. Synthetic convertible
securities differ from convertible securities in certain respects, including
that each component of a synthetic convertible security has a separate market
value and responds differently to market fluctuations. Investing in synthetic
convertible securities involves the risk normally involved in holding the
securities comprising the synthetic convertible security.


16


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

     ADDITIONAL INVESTMENTS

     Money Market Instruments. When SBMFM believes that market conditions
warrant, the Fund may adopt a temporary defensive posture and may invest in
short-term instruments without limitation. Short-term instruments in which the
Fund may invest include: U.S. government securities; certain bank obligations
(including certificates of deposit, time deposits and bankers' acceptances of
domestic or foreign banks, domestic savings and loan associations and similar
institutions); commercial paper rated no lower than A-2 by S&P or Prime-2 by
Moody's or the equivalent from another major rating service or, if unrated, of
an issuer having an outstanding, unsecured debt issue then rated within the
three highest rating categories; and repurchase agreements as described below.

     United States Government Securities. U.S. government securities are
obligations of, or guaranteed by, the United States government, its agencies or
instrumentalities. The U.S. government securities in which the Fund may invest
include: direct obligations of the United States Treasury (such as Treasury
Bills, Treasury Notes and Treasury Bonds) and obligations issued by U.S.
government agencies and instrumentalities, including securities that are
supported by the full faith and credit of the United States (such as Government
National Mortgage Association ("GNMA") certificates); 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 securities that are
supported by the credit of the instrumentality (such as Federal National
Mortgage Association ("FNMA") and Federal Home Loan Mortgage Corporation
("FHLMC") bonds). Treasury Bills have maturities of less than 1 year, Treasury
Notes have maturities of 1 to 10 years and Treasury Bonds generally have
maturities of greater than 10 years at the date of issuance. Certain U.S.
government securities, such as those issued or guaranteed by GNMA, FNMA and
FHLMC, are mortgage-related securities. U.S. government securities generally do
not involve the credit risks associated with other types of interest-bearing
securities, although, as a result, the yields available from U.S. government
securities are generally lower than the yields available from interest-bearing
corporate securities.

   
     Zero Coupon Securities. The Fund may also invest in zero coupon bonds. A
zero coupon 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 an amount significantly
less than its face value (sometimes referred to as a "deep discount" price).
Because such securities usually trade at a deep discount, they will be subject
to greater fluctuations of market value
    


                                                                              17


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

   
in response to changing interest rates than debt obligations of comparable
maturities 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.
    

     Repurchase Agreements. The Fund may engage in repurchase agreement
transactions with banks which are the issuers of instruments acceptable for
purchase by the Fund 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 relatively
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.
This arrangement results in a fixed rate of return that is not subject to market
fluctuations during the Fund's holding period. The value of the underlying
securities will be at least equal at all times to the total amount of the
repurchase obligation, including interest. Repurchase agreements could involve
certain risks in the event of default or insolvency of the other party,
including possible delays in or restrictions upon the Fund's ability to dispose
of the underlying securities, the risk of a possible 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.
SBMFM, acting under the supervision of the Trust's Board of Trustees, 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.

     Futures Contracts and Options on Futures Contracts. When deemed advisable
by SBMFM, the Fund may enter into futures contracts or related options that are
traded on a domestic exchange or board of trade. Such investments, if any, by
the Fund will be made solely for the purpose of hedging against the effects of
changes in the value of the portfolio securities due to anticipated changes in
interest rates, currency values and market conditions and when the transactions
are economically appropriate to the reduction of risks inherent in the
management of the Fund. The Fund may not enter into futures and options
contracts for which aggregate initial margin deposits and premium paid for
unexpired options to establish such positions that are not bona fide hedging
positions (as defined by the Commodity Futures Trading Commission), 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


18


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

   
a futures contract or option thereon, the underlying commodity value of such
contract always will be covered by cash or debt securities of any grade provided
such securities have been determined by SBMFM to be liquid and unencumbered
pursuant to guidelines established by the Trustees ("eligible segregated
assets") set aside plus accrued profits held in a segregated account.
    

     The use of futures contracts and options on futures contracts as a hedging
device involves several risks. There can be no assurance that there will be a
correlation between price movements in the underlying securities on the one
hand, and price movements in the securities which are the subject of the hedge,
on the other hand. 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 for a particular contract or option at any particular time. Losses
incurred in hedging transactions and the costs of these transactions will affect
the Fund's performance.

     Foreign Securities. There are certain risks involved in investing in
securities of companies and governments of foreign nations which are in addition
to the usual risks inherent in domestic investments. These risks include those
resulting from revaluation of currencies, future adverse political and economic
developments and the possible imposition of currency exchange blockages or other
foreign governmental laws or restrictions, reduced availability of public
information concerning issuers and the lack of uniform accounting, auditing and
financial reporting standards or of other regulatory practices and requirements
comparable to those applicable to domestic companies. The yield of the Fund may
be adversely affected by fluctuations in value of one or more foreign currencies
relative to the U.S. dollar. Moreover, securities of many foreign companies and
their markets may be less liquid and their prices more volatile than those of
securities of comparable domestic companies. In addition, with respect to
certain foreign countries, there is the possibility of expropriation,
nationalization, confiscatory taxation and limitations on the use or removal of
funds or other assets of the Fund, including the withholding of dividends.
Foreign securities may be subject to foreign government taxes that could reduce
the yield on such securities. Because the Fund will invest in securities
denominated or quoted in currencies other than the U.S. dollar, changes in
foreign currency exchange rates may adversely affect the value of portfolio
securities and the appreciation or depreciation of investments. Investments in
foreign securities also may result in higher expenses due to the cost of
converting foreign currency to U.S. dollars, the payment of fixed brokerage
commissions on foreign exchanges, which generally are higher than commissions on
domestic exchanges, and the expense of maintaining securities with foreign
custodians, and


                                                                              19


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

the imposition of transfer taxes or transaction charges associated with foreign
exchanges.

   
     The Fund may also purchase foreign securities in the form of American
Depositary Receipts ("ADRs") and European Depositary Receipts ("EDRs") or other
securities representing underlying shares of foreign companies. ADRs are
publicly traded on exchanges or over-the-counter in the United States and are
issued through "sponsored" or "unsponsored" arrangements. In a sponsored ADR
arrangement, the foreign issuer assumes the obligation to pay some or all of the
depositary's transaction fees, whereas under an unsponsored arrangement, the
foreign issuer assumes no obligation and the depositary's transaction fees are
paid by the ADR holders. In addition, less information is available in the
United States about an unsponsored ADR than about a sponsored ADR, and the
financial information about a company may not be as reliable for an unsponsored
ADR as it is for a sponsored ADR. The Fund may invest in ADRs through both
sponsored and unsponsored arrangements.

     Corporate securities in which the Fund may invest include corporate
fixed-income securities of both domestic and foreign issuers, such as bonds,
debentures, notes, equipment lease certificates, equipment trust certificates,
and preferred stock. The Fund's investments in each of equipment leases or
equipment trust certificates will not exceed 5% of its assets.
    

     Certain of the corporate fixed-income securities in which the Fund may
invest may involve equity characteristics. The Fund may, for example, invest in
warrants for the acquisition of stock of the same or of a different issuer or in
corporate fixed-income securities that have conversion or exchange rights
permitting the holder to convert or exchange the securities at a stated price
within a specified period of time into a specified number of shares of common
stock. In addition, the Fund may invest in participations that are based on
revenues, sales or profits of an issuer or in common stock offered as a unit
with corporate fixed-income securities.

     Currency Exchange Transactions and Options on Foreign Currencies. In order
to protect against uncertainty in the level of future exchange rates, the Fund
may engage in currency exchange transactions and purchase exchange-traded put
and call options on foreign currencies. The Fund will conduct its currency
exchange transactions either on a spot (i.e., cash) basis at the rate prevailing
in the currency exchange market or through entering into forward contracts to
purchase or sell currencies. The Fund's dealings in forward currency exchange
and options on foreign currencies are limited to hedging involving either
specific transactions or portfolio positions.

     A forward currency contract involves an obligation to purchase or sell a


20


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Smith Barney High Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

specific currency for an agreed-upon price at an agreed-upon date which may be
any fixed number of days from the date of the contract agreed upon by the
parties. These contracts are entered into in the interbank market conducted
directly between currency traders (usually large commercial banks) and their
customers. Although these contracts are intended to minimize the risk of loss
due to a decline in the value of the hedged currency, at the same time they tend
to limit any potential gain that might result should the value of the currency
increase.

     The Fund may purchase put options on a foreign currency in which securities
held by the Fund are denominated to protect against a decline in the value of
the currency in relation to the currency in which the exercise price is
denominated. The Fund may purchase a call option on a foreign currency to hedge
against an adverse exchange rate of the currency in which a security that it
anticipates purchasing is denominated in relation to the currency in which the
exercise price is denominated. An option on a foreign currency gives the
purchaser, in return for a premium, the right to sell, in the case of a put, and
buy, in the case of a call, the underlying currency at a specified price during
the term of the option. Although the purchase of an option on a foreign currency
may constitute an effective hedge by the Fund against fluctuations in the
exchange rates, in the event of rate movements adverse to the Fund's position,
the Fund may forfeit the entire amount of the premium plus related transaction
costs. Options on foreign currencies purchased by the Fund may be traded on
domestic and foreign exchanges or traded over-the-counter.

     Although the foreign currency market may not necessarily be more volatile
than the market in other commodities, the foreign currency market offers less
protection against defaults in the forward trading of currencies than is
available when trading in currencies occurs on an exchange. Because a forward
currency contract is not guaranteed by an exchange or clearinghouse, a default
on the contract would deprive the Fund of unrealized profits or force the Fund
to cover its commitments for purchase or resale, if any, at the current market
price.

   
     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 any portfolio 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 period, 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 such securities may be higher or lower than the yields
available in the market on the dates when the
    


                                                                              21


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Smith Barney High Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

   
investments are actually delivered to the buyers. The Fund will establish a
segregated account consisting of cash or other eligible segregated assets 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. The Fund will not accrue income with
respect to a when-issued security prior to its stated delivery date.
    

     Lending of Portfolio Securities. The Fund has the ability to lend portfolio
securities to brokers, dealers and other financial organizations. These loans,
if and when made, may not exceed 20% of the Fund's assets taken at value. Loans
of portfolio securities will be collateralized by cash, letters of credit or
U.S. government securities that are maintained at all times in an amount at
least equal to the current market value of the loaned securities.

     Non-Publicly Traded and Illiquid Securities. The sale of securities that
are not publicly traded is typically restricted under the Federal securities
laws. As a result, the Fund may be forced to sell these securities at less than
fair market value or may not be able to sell them when SBMFM believes it
desirable to do so. The Fund's investments in illiquid securities are subject to
the risk that should the Fund desire to sell any of these securities when a
ready buyer is not available at a price that the Fund deems representative of
its value, the value of the Fund's net assets could be adversely affected.

     Securities of Developing Countries. A developing country generally is
considered to be a country that is in the initial stages of its
industrialization cycle. Investing in the equity and fixed-income markets of
developing countries involves exposure to economic structures that are generally
less diverse and mature, and to political systems that can be expected to have
less stability, than those of developed countries. Historical experience
indicates that the markets of developing countries have been more volatile than
the markets of the more mature economies of developed countries; however, such
markets often have provided higher rates of return to investors.

     CERTAIN INVESTMENT GUIDELINES

     Up to 15% of the assets of the Fund may be invested in securities with
contractual or other restrictions on resale and other instruments that are not
readily marketable, including (a) repurchase agreements with maturities greater
than seven days, (b) time deposits maturing from two business days through seven
calendar days, and (c) to the extent that a liquid secondary market does not
exist for the instruments, futures contracts and options thereon.
Notwithstanding the foregoing, the Fund shall not invest more than 10% of its
net assets in securities (excluding


22


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

those subject to Rule 144A under the Securities Act of 1933, as amended) that
are restricted. In addition, the Fund may invest up to 5% of its assets in the
securities of issuers which have been in continuous operation for less than
three years. The Fund also may borrow from banks for temporary or emergency
purposes, but not for investment purposes, in an amount up to 10% of its total
assets, and may pledge its assets to the same extent in connection with such
borrowings. Whenever these borrowings exceed 5% of the value of the Fund's total
assets, the Fund will not make any additional investments. Except for the
limitations on borrowing, the investment guidelines set forth in this paragraph
may be changed at any time without shareholder consent by vote of the Trust's
Board of Trustees. A complete list of investment restrictions that identifies
additional restrictions that cannot be changed without the approval of the
majority of the Fund's outstanding shares is contained in the Statement of
Additional Information.

     RISK FACTORS AND SPECIAL CONSIDERATIONS

     Options. The Fund may enter into options transactions primarily as hedges
to reduce investment risk, generally by making an investment expected to move in
the opposite direction of a portfolio position. A hedge is designed to offset a
loss on a portfolio position with a gain on the hedge position; at the same
time, however, a properly correlated hedge will result in a gain on the
portfolio position being offset by a loss on the hedge position. The Fund bears
the risk that the prices of the securities being hedged will not move in the
same amount as the hedge. The Fund will engage in hedging transactions only when
deemed advisable by SBMFM. Successful use by the Fund of options will depend on
SBMFM's ability to correctly predict movements in the direction of the stock
underlying the option used as a hedge. Losses incurred in hedging transactions
and the costs of these transactions will affect the Fund's performance.

     The ability of the Fund to engage in closing transactions with respect to
options depends on the existence of a liquid secondary market. While the Fund
generally will purchase options only if there appears to be a liquid secondary
market for the options purchased or sold, for some options no such secondary
market may exist or the market may cease to exist.

     Medium-, Low- and Unrated Securities. The Fund may invest up to 10% of its
assets in medium- or low-rated securities and unrated securities of comparable
quality. Generally, these securities offer a higher return potential than
higher-rated securities but involve greater volatility of price and risk of loss
of income and principal. Generally, these securities offer a higher current
yield than the yield offered by higher-rated securities, but involve greater
volatility of price and risk of


                                                                              23


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

loss of income and principal, including the probability of default or bankruptcy
of the issuers of such securities. Medium-and low-rated and comparable unrated
securities will likely have large uncertainties or major risk exposures to
adverse conditions and are predominantly speculative with respect to the
issuer's capacity to pay interest and repay principal in accordance with the
terms of the obligation. Accordingly, it is possible that these types of factors
could, in certain instances, reduce the value of securities held by the Fund,
with a commensurate effect on the value of the Fund's shares.

     The markets in which medium- and low-rated or comparable unrated securities
are traded generally are more limited than those in which higher-rated
securities are traded. The existence of limited markets for these securities may
restrict the availability of securities for the Fund to purchase and also may
have the effect of limiting the ability of the Fund to (a) obtain accurate
market quotations for purposes of valuing securities and calculating net asset
value and (b) sell securities at their fair value either to meet redemption
requests or to respond to changes in the economy or the financial markets. The
market for medium- and low-rated and comparable unrated securities has not fully
weathered a major economic recession. Any such economic downturn could adversely
affect the value of such securities and the ability of the issuers of these
securities to repay principal and pay interest thereon.

     While the market values of medium- and low-rated and comparable unrated
securities tend to react less to fluctuations in interest rate levels than do
those of higher-rated securities, the market values of certain of these
securities also tend to be more sensitive to individual corporate developments
and changes in economic conditions than higher-rated securities. In addition,
medium- and low-rated and comparable unrated securities generally present a
higher degree of credit risk. Issuers of medium- and low-rated and comparable
unrated securities are often highly leveraged and may not have more traditional
methods of financing available to them so that their ability to service their
debt obligations during an economic downturn or during sustained periods of
rising interest rates may be impaired. The risk of loss due to default by such
issuers is significantly greater because medium-and low-rated and comparable
unrated securities generally are unsecured and frequently are subordinated to
the prior payment of senior indebtedness. The Fund may incur additional expenses
to the extent that it is required to seek recovery upon a default in the payment
of principal or interest on its portfolio holdings.

     Fixed-income securities, including medium- and low-rated and comparable
unrated securities, frequently have call or buy-back features that permit their
issuers to call or repurchase the securities from their holders, such as the
Fund. If an issuer exercises these rights during periods of declining interest
rates, the Fund may have to replace the security with a lower yielding security,
resulting in a decreased return


24


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

to the Fund.

     Securities which are rated Ba by Moody's or BB by S&P have speculative
characteristics with respect to capacity to pay interest and repay principal.
Securities which are rated B generally lack characteristics of a desirable
investment and assurance of interest and principal payments over any long period
of time may be small. Securities which are rated Caa or CCC or below are of poor
standing. Those issues may be in default or present elements of danger with
respect to principal or interest. Securities rated C by Moody's and D by S&P are
in the lowest rating class and indicate that payments are in default or that a
bankruptcy petition has been filed with respect to the issuer or that the issuer
is regarded as having extremely poor prospects. See the Appendix in the Trust's
Statement of Additional Information on bond ratings by Moody's and S&P.

     In light of these risks, SBMFM, in evaluating the creditworthiness of an
issue, whether rated or unrated, will take various factors into consideration,
which may include, as applicable, the issuer's financial resources, its
sensitivity to economic conditions and trends, the operating history of and the
community support for the facility financed by the issue, the ability of the
issuer's management and regulatory matters.

   
     The Fund's holdings in fixed-income securities (as rated by Moody's) for
the fiscal year ended July 31, 1996 were composed as follows: 0.51% rated Baa; 
27.52% rated Ba; 52.98% rated B; 1.26% rated Caa; and 4.79% in non-rated 
securities.The percentages were calculated on a dollar weighted average 
basis by determining monthly the percentage of the Fund's net assets 
invested in each rating category and do not necessarily indicate what the 
composition of the Fund's holdings will be in subsequent years.
    

     Securities of Unseasoned Issuers. Securities in which the Fund may invest
may have limited marketability and, therefore, may be subject to wide
fluctuations in market value. In addition, certain securities may lack a
significant operating history and be dependent on products or services without
an established market share.

     PORTFOLIO TRANSACTIONS

     All orders for transactions in securities and options on behalf of the Fund
are placed by SBMFM with brokers and dealers (including Smith Barney) that SBMFM
selects. The Fund may utilize Smith Barney or a Smith Barney-affiliated broker
in connection with a purchase or sale of securities when SBMFM believes that the
broker's charge for the transactions does not exceed usual and customary levels.
The same standard applies to the use of Smith Barney as a commodities broker in
connection with entering into options and futures contracts.


                                                                              25


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Valuation of Shares
--------------------------------------------------------------------------------

     The Fund's net asset value per share is determined as of the close of
regular 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. Net asset value is calculated separately for
Class A, B, C and Y shares.

   
     Generally, the Fund's investments are valued at market value or, in the
absence of a market value with respect to any securities, at fair value as
determined by or under the direction of the Trust's Board of Trustees. Portfolio
securities which are traded primarily on foreign exchanges are generally valued
at the preceding closing values of such securities on their respective
exchanges, except that when an occurrence subsequent to the time a value was so
established is likely to have changed such value, then the fair market value of
those securities will be determined by consideration of other factors by or
under the direction of the Trust's Board of Trustees or delegates. A security
that is traded primarily on an exchange is valued at the last sale price on that
exchange or, if there were no sales during the day, at the current quoted bid
price. Over-the-counter securities are valued on the basis of the bid price at
the close of business on each day. Investments in U.S. government securities
(other than short-term securities) are valued at the average of the quoted bid
and asked prices in the over-the-counter market. Short-term investments that
mature in 60 days or less are valued at amortized cost whenever the Trustees
determine that amortized cost reflects fair value of those investments. An
option generally is valued at the last sale price or, in the absence of the last
sale price, the last offer price. Further information regarding the Fund's
valuation policies is contained in the Statement of Additional Information.
    

--------------------------------------------------------------------------------
Dividends, Distributions and Taxes
--------------------------------------------------------------------------------

     DIVIDENDS AND DISTRIBUTIONS

     The Fund will be treated separately from the Trust's other funds in
determining the amounts of dividends from investment income and distributions of
capital gains payable to shareholders.

     If a shareholder does not otherwise instruct, dividends and distributions
will be reinvested automatically in additional shares of the same Class at net
asset value, subject to no sales charge or CDSC. Dividends from net investment
income, if any, of the Fund will be declared monthly and paid on the last day of
the Smith Barney statement month. The Fund's final distribution for each
calendar year will include any remaining net investment income and net realized
long- and short-term capital


26


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Dividends, Distributions and Taxes (continued)
--------------------------------------------------------------------------------

gains realized during the year and deemed undistributed during the year for
Federal income tax purposes. In order to avoid the application of a 4%
nondeductible excise tax measured with respect to certain undistributed amounts
of ordinary income and capital gains, the Fund may make any additional
distributions as may be necessary to avoid the application of this tax.

     If, for any full fiscal year, the Fund's total distributions exceed net
investment income and net realized capital gains, the excess distributions
generally will be treated as a tax-free return of capital (up to the amount of
the shareholder's tax basis in his or her shares). The amount treated as a
tax-free return of capital will reduce a shareholder's adjusted basis in his or
her shares. Pursuant to the requirements of the Investment Company Act of 1940,
as amended (the "1940 Act") and other applicable laws, a notice will accompany
any distribution paid from sources other than net investment income. In the
event the Fund distributes amounts in excess of its net investment income and
net realized capital gains, such distributions may have the effect of decreasing
the Fund's total assets, which may increase the Fund's expense ratio.

     The per share dividends on Class B and Class C shares of the Fund may be
lower than the per share dividends on Class A and Y shares principally as a
result of the distribution fee applicable with respect to Class B and Class C
shares. The per share dividends on Class A shares of the Fund may be lower than
the per share dividends on Class Y shares principally as a result of the service
fee applicable to Class A shares. Distributions of capital gains, if any, will
be in the same amount for Class A, Class B, Class C and Class Y shares.

     TAXES

     The Fund will be treated as a separate taxpayer with the result that, for
Federal income tax purposes, the amount of investment income and capital gains
earned by the Fund will be determined without regard to the earnings of the
other funds of the Trust. The Fund has qualified and intends to continue to
qualify each year as a "regulated investment company" under the Code. To meet
those requirements, the Fund may need to restrict the degree to which it engages
in short-term trading and transactions in options. If the Fund qualifies as a
regulated investment company and meets certain distribution requirements, the
Fund will not be subject to Federal income tax on its net investment income and
net capital gains that it distributes to its shareholders.

     Dividends paid by the Fund from investment income and distributions of
short-term capital gain will be taxable to shareholders as ordinary income for
Federal income tax purposes, whether received in cash or reinvested in
additional shares.


                                                                              27


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Dividends, Distributions and Taxes (continued)
--------------------------------------------------------------------------------

Furthermore, as a general rule, distributions of long-term capital gain will be
taxable to shareholders as long-term capital gain, whether paid in cash or
reinvested in additional shares, and regardless of the length of time that the
investor has held his or her shares of the Fund.

     Distributions of capital gains or dividends received from foreign
corporations will not qualify for the Federal dividends-received deduction for
corporate shareholders (the "Corporate Deduction"). The Fund anticipates that
most of its dividends will not qualify for the Corporate Deduction. Each
shareholder will receive a statement annually from the Trust, which will set
forth separately the aggregate dollar amount of dividends and capital gains
distributed to the shareholder by the Fund with respect to the prior calendar
year.

     Dividends and interest received by the Fund may give rise to withholding
and other taxes imposed by foreign countries. Tax conventions between certain
countries and the United States may reduce or eliminate such taxes.

     Shareholders are urged to consult their tax advisors regarding the
application of Federal, state and local tax laws to their specific situation
before investing in the Fund.

--------------------------------------------------------------------------------
Purchase of Shares
--------------------------------------------------------------------------------

     GENERAL

   
     The Fund offers five Classes of shares. Class A shares are sold to
investors with an initial sales charge and Class B and Class C shares are sold
without an initial sales charge but are subject to a CDSC payable upon certain
redemptions. Class Y shares are sold without an initial sales charge or a CDSC
and are available only to investors investing a minimum of $5,000,000 (except
for purchases of Class Y shares by the Smith Barney Concert Series Inc., for
which there is no minimum purchase amount). Class Z shares are offered without a
sales charge, CDSC, or service or distribution fee, exclusively to: (a)
tax-exempt employee benefit and retirement plans of Smith Barney and its
affiliates and (b) certain UITs sponsored by Smith Barney and its affiliates.
Investors meeting either of these criteria who are interested in acquiring Class
Z shares should contact a Smith Barney Financial Consultant for a Class Z
Prospectus. See "Prospectus Summary - Alternative Purchase Arrangements" for a
discussion of factors to consider in selecting which Class of shares to
purchase.
    

     Purchases of Fund shares must be made through a brokerage account
maintained with Smith Barney, with an Introducing Broker or with an investment


28


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

   
dealer in the selling group, except for investors purchasing shares of the Fund
through a qualified retirement plan who may do so directly through First Data.
When purchasing shares of the Fund, investors must specify whether the purchase
is for Class A, Class B, Class C or Class Y shares. No maintenance fee will be
charged by the Fund in connection with a brokerage account through which an
investor purchases or holds shares.

     Investors in Class A, Class B and Class C shares may open an account by
making an initial investment of at least $1,000 for each account, or $250 for an
IRA or a Self-Employed Retirement Plan in the Fund. Investors in Class Y shares
may open an account by making an initial investment of $5,000,000. 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
C 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 C shares and the minimum 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 requirement for Class A, Class B and Class C shares and the
subsequent investment requirement for all Classes is $50. There are no minimum
investment requirements for Class A shares for employees of Travelers and its
subsidiaries, including Smith Barney, unitholders who invest distributions from
a UIT sponsored by Smith Barney and Trustees of the Trust 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
Trust's transfer agent, First Data. Share certificates are issued only upon a
shareholder's written request to First Data.

     Purchase orders received by the Fund or Smith Barney 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. Orders
received by dealers or Introducing Brokers 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 Smith Barney prior to Smith Barney's close of business
(the "trade date"). For shares purchased through Smith Barney or Introducing
Brokers purchasing through 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.
    


                                                                              29


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

     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, Smith Barney or First Data is authorized through
preauthorized transfers of $25 or $50 or more to charge the regular bank account
or other financial institution indicated by the shareholder on a monthly or
quarterly basis, respectively, to provide 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 Smith Barney or First Data.
The Systematic Investment Plan also authorizes Smith Barney to apply cash held
in the shareholder's Smith Barney brokerage account or redeem the shareholder's
shares of a Smith Barney money market fund to make additions to the account.
Additional information is available from the Fund or a Smith Barney Financial
Consultant.
    

     INITIAL SALES CHARGE ALTERNATIVE -- CLASS A SHARES

     The sales charges applicable to purchases of Class A shares of the Fund are
as follows:

                                   Sales
                                 Charge as         Sales             Dealers
                                   % of          Charge as         Reallowance
                                 Offering          % of              as % of
Amount of Investment               Price      Amount Invested    Offering Price
================================================================================
     Less than $25,000              4.50%            4.71%             4.05%

     $25,000 - $49,999              4.00%            4.17%             3.60%

     $50,000 - $99,99               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                *                *                 *
================================================================================
* Purchases of Class A shares, which when combined with current holdings of
  Class A shares offered with a sales charge equal or exceed $500,000 in the
  aggregate, 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 Smith Barney, which
  compensates 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 C shares is
  waived. See "Deferred Sales Charge Alternatives" 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.


30


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

     The reduced sales charges shown above apply to the aggregate of purchases
of Class A shares of the Fund made at one time by "any person," which includes
an individual, his or her spouse and children, or a trustee or other fiduciary
of a single trust estate or single fiduciary account. The reduced sales charge
minimums may also be met by aggregating the purchase with the net asset value of
all Class A shares held in funds sponsored by Smith Barney that are offered with
a sales charge listed under "Exchange Privilege."

     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 of any of
the Smith Barney Mutual Funds and employees of Travelers and its subsidiaries
(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 in connection with 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 Smith Barney Financial
Consultant (for a period up to 90 days from the commencement of the Financial
Consultant's employment with 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) shareholders who have redeemed Class A shares in the Fund (or
Class A shares of another fund of the Smith Barney Mutual Funds that are offered
with a sales charge equal to or greater than the maximum sales charge of the
Fund) and who wish to reinvest their redemption proceeds in the Fund, provided
the reinvestment is made within 60 calendar days of the redemption; (e) accounts
managed by registered investment advisory subsidiaries of Travelers; (f)
investments of distributions from a UIT sponsored by Smith Barney; and (g)
purchases by Section 403(b) or Section 401(a) or (k) accounts associated with
Copeland Retirement Programs. 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.
    


                                                                              31


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

   
     Purchases of Class A shares also may be made at net asset value without a
sales charge in the following circumstances: (i) direct rollovers by plan
participants of distributions from a 401(k) plan enrolled in the Smith Barney
401(k) Program (Note: Subsequent investments will be subject to the applicable
sales charge); (ii) purchases by separate accounts used to fund certain
unregistered variable annuity contracts; and (iii) purchases by investors
participating in a Smith Barney fee based arrangement.
    

     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 funds sponsored by Smith Barney which are offered
with a sales charge 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.

     GROUP PURCHASES

     Upon completion of certain automated systems, a reduced sales charge or
purchase at net asset value will also be available to employees (and partners)
of the same employer purchasing as a group, provided each participant makes the
minimum initial investment required. The sales charge applicable to purchases by
each member of such a group will be determined by the table set forth above
under "Initial Sales Charge Alternative - Class A Shares," and will be based
upon the aggregate sales of Class A shares of Smith Barney Mutual Funds offered
with a sales charge to, and share holdings of, all members of the group. To be
eligible for such reduced sales charges or to purchase at net asset value, all
purchases must be pursuant to an employer- or partnership-sanctioned plan
meeting certain requirements. One such requirement is that the plan must be open
to specified partners or employees of the employer and its subsidiaries, if any.
Such plan may, but is not required to, provide for payroll deductions, IRAs or
investments pursuant to retirement plans under Sections 401 or 408 of the Code.
Smith Barney may also offer a reduced sales charge or net asset value purchase
for aggregating related fiduciary accounts under such conditions that Smith
Barney will realize economies of sales efforts and sales related expenses. An
individual who is a member of a


32


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Smith Barney High Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

qualified group may also purchase Class A shares at the reduced sales charge
applicable to the group as a whole. The sales charge is based upon the aggregate
dollar value of Class A shares offered with a sales charge that have been
previously purchased and are still owned by the group, plus the amount of the
current purchase. A "qualified group" is one which (a) has been in existence for
more than six months, (b) has a purpose other than acquiring Fund shares at a
discount and (c) satisfies uniform criteria which enable Smith Barney to realize
economies of scale in its costs of distributing shares. A qualified group must
have more than 10 members, must be available to arrange for group meetings
between representatives of the Fund and the members, and must agree to include
sales and other materials related to the Fund in its publications and mailings
to members at no cost to Smith Barney. In order to obtain such reduced sales
charge or to purchase at net asset value, the purchaser must provide sufficient
information at the time of purchase to permit verification that the purchase
qualifies for the reduced sales charge. Approval of group purchase reduced sales
charge plans is subject to the discretion of Smith Barney.

     LETTER OF INTENT

   
     Class A Shares. A Letter of Intent for amounts 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
purchases of all Class A shares of the Fund and other funds of the Smith Barney
Mutual Funds offered with a sales charge over a 13 month period based on the
total amount of intended purchases plus the value of all Class A shares
previously purchased and still owned. An alternative is to compute the 13 month
period starting up to 90 days before the date of execution of a Letter of
Intent. 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. Please contact a
Smith Barney Financial Consultant or First Data 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. Such investors must
make an initial minimum purchase of $1,000,000 in Class Y shares of the Fund and
agree to purchase a total of $5,000,000 of Class Y shares of the same Fund
within


                                                                              33


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

   
six months from the date of the Letter. If a total investment of $5,000,000 is
not made within the six-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%. The Fund expects that such transfer
will not be subject to Federal income taxes. Please contact a Smith Barney
Financial Consultant or First Data for further information.
    

     DEFERRED SALES CHARGE ALTERNATIVES

     "CDSC Shares" are sold at net asset value next determined without an
initial sales charge so that the full amount of an investor's purchase payment
may be immediately invested in the Fund. A CDSC, however, may be imposed on
certain redemptions of these shares. "CDSC Shares" are: (a) Class B shares; (b)
Class C shares; and (c) Class A shares which when combined with Class A shares
offered with a sales charge currently held by an investor equal or exceed
$500,000 in the aggregate.

     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 C shares and Class A shares that are CDSC
Shares, shares redeemed more than 12 months after their purchase.

     Class C 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
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
purchases by Participating Plans, as described below. See "Purchase of Shares -
Smith Barney 401(k) Program."


34


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

Year Since Purchase
Payment Was Made                                                      CDSC
================================================================================
   First                                                              4.50%
   Second                                                             4.00%
   Third                                                              3.00%
   Fourth                                                             2.00%
   Fifth                                                              1.00%
   Sixth                                                              0.00%
   Seventh                                                            0.00%
   Eighth                                                             0.00%
================================================================================

     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 also will 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. Shareholders who held Class B shares of Smith Barney
Shearson Short-Term World Income Fund (the "Short-Term World Income Fund") on
July 15, 1994 and who subsequently exchange those shares for Class B shares of
the Fund will be offered the opportunity to exchange all such Class B shares for
Class A shares of the Fund four years after the date on which those shares were
deemed to have been purchased. Holders of such Class B shares will be notified
of the pending exchange in writing approximately 30 days before the fourth
anniversary of the purchase date and, unless the exchange has been rejected in
writing, the exchange will occur on or about the fourth anniversary date. 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 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


                                                                              35


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

after the 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) redemption of
shares made in connection with qualified distributions from retirement plans or
IRAs upon the attainment of age 591 1/42; (e) involuntary redemptions; and (f)
redemptions of shares in connection with 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 funds of the 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 Smith Barney in
the case of shareholders who are also Smith Barney clients or by First Data 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 C shares as
investment alternatives under the Smith Barney 401(k) and ExecChoice(TM)
Programs. Class A and Class C shares acquired through the Participating Plans
are subject to the same service and/or distribution fees as the Class A and
Class C
    


36


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

   
shares acquired by other investors; however, they are not subject to any initial
sales charge or CDSC. Once a Participating Plan has made an initial investment
in a 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 C Shares. Class C 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 C 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. If at the
end of the fifth year after the date the Participating Plan enrolled in the
Smith Barney 401(k) Program or the Smith Barney ExecChoice(TM) Program, a
Participating Plan's total Class C holdings in all non-money market 
Smith Barney Mutual Funds equal
at least $1,000,000, the Participating Plan
 will be offered the opportunity to exchange all of its
Class C shares for Class A shares of the Fund. (For Participating Plans that
were originally established through a Smith Barney retail brokerage account, the
five year period will be calculated from the date the retail brokerage 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 Participating Plan's holdings will be performed each
quarter until either the Participating 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
Participating Plan enrolled in the Smith Barney 401(k) Program, if  
a Participating Plan's total
Class C 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 C 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 that has not
previously qualified for an exchange into Class A shares will be offered the
opportunity to exchange all of its Class C 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 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
    


                                                                              37


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

   
     Class C shares of the Fund but instead may acquire Class A shares of the
Fund. Any Class C shares not converted 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 First Data. For further information regarding these
Programs, investors should contact a Smith Barney Financial Consultant.

     Existing 401(k) Plans Investing in Class B Shares. Class B shares of the
Funds are not available for purchase by Participating Plans opened on or after
June 21, 1996, but may continue to be purchased by any Participating Plan opened
prior to such date and originally investing in such Class. Class B shares
acquired are subject to a CDSC of 3.00% of redemption proceeds, if the
Participating Plan terminates within eight years of the date the Participating
Plan first enrolled in the Smith Barney 401(k) Program.

     At the end of the eighth year after the date the Participating Plan
enrolled in the Smith Barney 401(k) Program, the Participating Plan
 will be offered the opportunity
to exchange all of its Class B shares for Class A shares of the Fund. Such Plans
will be notified of the pending exchange in writing approximately 60 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 the exchange has occurred, a Participating Plan will not be eligible
to acquire additional Class B shares of the Fund but instead may acquire Class A
shares of the Fund. If the Participating Plan elects not to exchange all of its
Class B shares at that time, each Class B share held by the Participating Plan
will have the same conversion feature as Class B shares held by other investors.
See "Purchase of Shares Deferred Sales Charge Alternatives".

     No CDSC is imposed on redemptions of Class B shares to the extent that the
net asset value of the shares redeemed does not exceed the current net asset
value of the shares purchased through reinvestment of dividends or capital gain
distributions, plus the current net asset value of Class B shares purchased more
than eight years prior to the redemption, plus increases in the net asset value
of the shareholder's Class B shares above the purchase payments made during the
preceding eight years. Whether or not the CDSC applies to the redemption by a
Participating Plan depends on the number of years since the Participating Plan
first became enrolled in the Smith Barney 401(k) Program, unlike the
applicability of the CDSC to redemptions by other shareholders, which depends on
the number of years since those shareholders made the purchase payment from
which the amount is being redeemed.

     The CDSC will be waived on redemptions of Class B shares in connection with
    


38


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

   
lump-sum or other distributions made by a Participating Plan as a result of: (a)
the retirement of an employee in the Participating Plan; (b) the termination of
employment of an employee in the Participating Plan; (c) the death or disability
of an employee in the Participating Plan; (d) the attainment of age 591 1/42 by
an employee in the Participating Plan; (e) hardship of an employee in the
Participating Plan to the extent permitted under Section 401(k) of the Code; or
(f) redemptions of shares in connection with a loan made by the Participating
Plan to an employee.
    

--------------------------------------------------------------------------------
Exchange Privilege
--------------------------------------------------------------------------------

   
     Except as otherwise noted below, shares of each Class may be exchanged at
the net asset value next determined 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 C shares are subject to minimum investment requirements and
all shares are subject to the other requirements of the fund into which
exchanges are made.
    

FUND NAME
--------------------------------------------------------------------------------
Growth Funds

      Smith Barney Aggressive Growth Fund Inc.
      Smith Barney Appreciation Fund Inc.
      Smith Barney Fundamental Value Fund Inc.
      Smith Barney Growth Opportunity Fund
      Smith Barney Managed Growth Fund
   
      Smith Barney Natural Resources Fund, Inc.
    
      Smith Barney Special Equities Fund

Growth and Income Funds
       

      Smith Barney Convertible Fund

   
      Smith Barney Funds, Inc. -- Equity Income Portfolio
    
      Smith Barney Growth and Income Fund
      Smith Barney Premium Total Return Fund
      Smith Barney Strategic Investors Fund
      Smith Barney Utilities Fund

Taxable Fixed --Income Funds

    * Smith Barney Adjustable Rate Government Income Fund
      Smith Barney Diversified Strategic Income Fund
   ** Smith Barney Funds, Inc. -- Income Return Account Portfolio


                                                                              39


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Exchange Privilege (continued)
--------------------------------------------------------------------------------

  +++ Smith Barney Funds, Inc. -- Short-Term U.S. Treasury Securities Portfolio
       
      Smith Barney Funds, Inc. -- U.S. Government Securities Portfolio
      Smith Barney Government Securities Fund
      Smith Barney Investment Grade Bond Fund
      Smith Barney Managed Governments Fund Inc.

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 Fund
      Smith Barney Muni Funds -- Florida Portfolio
       
      Smith Barney Muni Funds -- Georgia Portfolio
   ** Smith Barney Muni Funds -- Limited Term 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

International Funds
      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 Series Inc.
      Smith Barney Concert Series Inc. -- Balanced Portfolio
      Smith Barney Concert Series Inc. -- Conservative Portfolio
      Smith Barney Concert Series Inc. -- Growth Portfolio
      Smith Barney Concert Series Inc. -- High Growth Portfolio
      Smith Barney Concert Series Inc. -- Income Portfolio
    

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


40


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Exchange Privilege (continued)
--------------------------------------------------------------------------------

  +++ 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, Class B and Class Y shares of the Fund.
    In addition, shareholders who own Class C shares of the Fund through the
    Smith Barney 401(k) Program may exchange those shares for Class C shares of
    this fund.
**  Available for exchange with Class A, Class C and Class Y shares of the Fund.
*** Available for exchange with Class A shares of the Fund.
+   Available for exchange with Class B and Class C shares of the Fund.
++  Available for exchange with Class A and Class Y shares of the Fund. In
    addition, shareholders who own Class C shares of the Fund through the Smith
    Barney 401(k) Program may exchange those shares for Class C shares of this
    fund.
+++ Available for exchange with Class A and Class Y shares of the Fund.

   
     Class B Exchanges. In the event a Class B shareholder (unless such
shareholder was a Class B shareholder of the Short-Term World Income Fund on
July 15, 1994) 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 C Exchanges. Upon an exchange, the new Class C shares will be deemed
to have been purchased on the same date as the Class C 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
imposition 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. SBMFM 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 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
    


                                                                              41


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Exchange Privilege (continued)
--------------------------------------------------------------------------------

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
"Redemption 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 the shares of the Fund 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 trading 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 First Data receives
further instructions from Smith Barney, or if the shareholder's account is not
with Smith Barney, from the shareholder directly. The redemption proceeds will
be remitted on or before the third 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 Smith Barney brokerage account, these funds will not be invested
for the shareholder's benefit without specific instruction and Smith Barney will
benefit from the use of temporarily uninvested funds. Redemption proceeds for
shares purchased by check, other than a certified or official bank check, will
be remitted upon clearance of the check, which may take up to ten days or more.
    

     Shares held by Smith Barney as custodian must be redeemed by submitting a
written request to a Smith Barney Financial Consultant. Shares other than those


42


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Redemption of Shares (continued)
--------------------------------------------------------------------------------

held by Smith Barney as custodian may be redeemed through an investor's
Financial Consultant, Introducing Broker or dealer in the selling group or by
submitting a written request for redemption to:

     Smith Barney High Income Fund 
     Class A, B, C or Y (please specify) 
     c/o First Data Investor Services Group, Inc.
     P.O. Box 9134
     Boston, Massachusetts 02205-9134

   
     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 registered.
If the shares to be redeemed were issued in certificate form, the certificates
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 written redemption
request in excess of $2,000, 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 $2,000 or less do
not require a signature guarantee unless more than one such redemption request
is made in any 10-day period. 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.
    

     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 Fund. Any applicable CDSC will not be waived on
amounts withdrawn by a shareholder 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. For further information regarding the automatic cash withdrawal plan,
shareholders should contact a Smith Barney Financial Consultant.


                                                                              43


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Redemption of Shares (continued)
--------------------------------------------------------------------------------

   TELEPHONE REDEMPTION AND EXCHANGE PROGRAM

   
   Shareholders who do not have a 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 contact First Data
at 1-800-451-2010. Once eligibility is confirmed, the shareholder must complete
and return a Telephone/Wire Authorization Form, along with a signature
guarantee, that will be provided by First Data upon request. (Alternatively, an
investor may authorize telephone redemptions on the new account application with
the applicant's 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 5:00 p.m. (New
York City time) on any day the NYSE is open. Redemption requests received after
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 5:00 p.m.
(New York City time) on any day on which the NYSE is open. Exchange requests
received after the close of regular trading on the NYSE are processed 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 instructions


44


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Redemption of Shares (continued)
--------------------------------------------------------------------------------

   
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.
    

--------------------------------------------------------------------------------
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,
however, 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 advertises 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
computed by dividing the net investment income per share earned by the Class
during 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 C 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


                                                                              45


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Redemption of Shares (continued)
--------------------------------------------------------------------------------

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 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 information 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 or the maximum public
offering price (including sales charge) on the last day of the period for which
current dividend return is presented. The current dividend return for each Class
may vary from time to time depending on market conditions, the composition of
its investment portfolio and operating expenses. These factors and possible
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, Inc.
and other financial publications.

--------------------------------------------------------------------------------
Management of the Trust and the Fund
--------------------------------------------------------------------------------

     BOARD OF TRUSTEES

     Overall responsibility for management and supervision of the Fund rests
with the Trust's Board of Trustees. The Trustees approve all significant
agreements between the Trust and the companies that furnish services to the
Trust and the Fund, including agreements with the Fund's distributor, investment
adviser and administrator, custodian and transfer agent. The day-to-day
operations of the Fund are delegated to the Fund's investment adviser and
administrator. The Statement of Additional Information contains background
information regarding each Trustee and executive officer of the Trust.

     INVESTMENT ADVISER -- SBMFM

     SBMFM, located at 388 Greenwich Street, New York, New York 10013, serves as
the Fund's investment adviser. SBMFM is a wholly owned subsidiary of


46


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Management of the Trust and the Fund (continued)
--------------------------------------------------------------------------------

   
Holdings. SBMFM (through its predecessor entities) has been in the investment
counseling business since 1934 and is a registered investment adviser. SBMFM
renders investment advice to investment companies that had aggregate assets
under management as of September 30, 1996 in excess of $77 billion.

     Subject to the supervision and direction of the Trust's Board of Trustees,
SBMFM manages the Fund's portfolio in accordance with the Fund's investment
objective and policies, makes investment decisions for the Fund, places orders
to purchase and sell securities and employs professional portfolio managers and
securities analysts who provide research services to the Fund. Under an
investment advisory agreement, the Fund pays SBMFM a monthly fee at the annual
rate of 0.50% of the value of the Fund's average daily net assets. For the
fiscal year ended July 31, 1996, the Fund paid investment advisory fees to SBMFM
in an amount equal to 0.50% of the value of its average daily net assets.
    

     PORTFOLIO MANAGEMENT

     John C. Bianchi, a Managing Director of Smith Barney, has served as
Investment Officer of the Fund since 1988 and is responsible for managing its
day-to-day operations, including the making of investment decisions.

   
     Management's discussion and analysis and additional performance information
regarding the Fund during the fiscal year ended July 31, 1996 is included in the
Annual Report dated July 31, 1996. A copy of the Annual Report may be obtained
upon request without charge from a Smith Barney Financial Consultant or by
writing or calling the Fund at the address or phone number listed on page one of
this Prospectus.
    

     ADMINISTRATOR -- SBMFM

     SBMFM also serves as the Fund's administrator and oversees all aspects of
the Fund's administration. Pursuant to an administration agreement with the
Fund, SBMFM is paid a fee at the annual rate of 0.20% of the Fund's average
daily net assets.

--------------------------------------------------------------------------------
Distributor
--------------------------------------------------------------------------------

     Smith Barney is located at 388 Greenwich Street, New York, New York, 10013.
Smith Barney distributes shares of the Fund as principal underwriter and as such
conducts a continuous offering pursuant to a "best efforts" arrangement
requiring Smith Barney to take and pay for only such securities as may be sold
to


                                                                              47


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Distributor (continued)
--------------------------------------------------------------------------------

the public. Pursuant to a plan of distribution adopted by the Fund under Rule
12b-1 under the 1940 Act (the "Plan"), Smith Barney is paid an annual service
fee with respect to Class A, Class B and Class C shares of the Fund at the
annual rate of 0.25% of the average daily net assets of the respective Class.
Smith Barney is also paid an annual distribution fee with respect to Class B and
Class C 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
Smith Barney to pay its Financial Consultants for servicing shareholder accounts
and, in the case of Class B and Class C shares, to cover expenses primarily
intended to result in the sale of those shares. These expenses include:
advertising expenses; the cost of printing and mailing prospectuses to potential
investors; payments to and expenses of Smith Barney Financial Consultants and
other persons who provide support services in connection with the distribution
of shares; interest and/or carrying charges; and indirect and overhead costs of
Smith Barney associated with the sale of Fund shares, including lease, utility,
communications and sales promotion expenses.

     The payments to Smith Barney Financial Consultants for selling shares of a
Class include a commission or fee paid by the investor or Smith Barney at the
time of sale and, with respect to Class A, Class B and Class C shares, a
continuing fee for servicing shareholder accounts for as long as a shareholder
remains a holder of that Class. Smith Barney Financial Consultants may receive
different levels of compensation for selling different Classes of shares.

     Payments under the Plan with respect to Class B and Class C shares are not
tied exclusively to the distribution and shareholder service expenses actually
incurred by Smith Barney and the payments may exceed distribution expenses
actually incurred. The Trust's Board of Trustee's will evaluate the
appropriateness of the Plan and its payment terms on a continuing basis and in
so doing will consider all relevant factors, including expenses borne by Smith
Barney, amounts received under the Plan and proceeds of the CDSC.

--------------------------------------------------------------------------------
Additional Information
--------------------------------------------------------------------------------

     The Trust was organized on March 12, 1985, under the laws of the
Commonwealth of Massachusetts and is an entity commonly known as a
"Massachusetts business trust." The Trust offers shares of beneficial interest
of separate series having a $.001 per share par value. When matters are
submitted for


48


<PAGE>

Smith Barney High Income Fund

--------------------------------------------------------------------------------
Additional Information (continued)
--------------------------------------------------------------------------------

   
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. Shares of the Trust will be voted generally on a Trust-wide basis
on all matters, except matters affecting the interests of one Fund or one Class
of shares.
    

     Each Class of Fund shares represents identical interests in the Fund's
investment portfolio. As such, they have 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 distribution
and/or service fees, if any, borne by each Class; (d) the expenses allocable
exclusively to each Class; (e) voting rights on matters exclusively affecting a
single Class; (f) the exchange privilege of each Class; and (g) the conversion
feature of the Class B shares. The Trust's Board of Trustees does not anticipate
that there will be any conflicts among the interests of the holders of the
different Classes. The Trustees, on an ongoing basis, will consider whether any
such conflict exists and, if so, take appropriate action.

     The Trust does not hold annual shareholder meetings. There normally will be
no meetings of shareholders for the purpose of electing Trustees unless and
until such time as less than a majority of the Trustees holding office have been
elected by shareholders. The Trustees will call a meeting for any purpose upon
written request of shareholders holding at least 10% of the Trust's outstanding
shares and the Trust will assist shareholders in calling such a meeting as
required by the 1940 Act.

     PNC Bank, National Association, located at 17th and Chestnut Streets,
Philadelphia, PA 19103, serves as custodian of the Trust's investments.

   
     First Data, located at Exchange Place, Boston, Massachusetts 02109, serves
as the Trust's transfer agent.
    

     The Fund sends its shareholders a semi-annual report and an audited annual
report, each of which includes a list of the investment securities held by the
Fund at the end of the reporting period. In an effort to reduce the Fund's
printing and mailing costs, the Trust plans to consolidate the mailing of the
Fund's semi-annual and annual reports by household. This consolidation means
that a household having multiple accounts with the identical address of record
will receive a single copy of each report. Shareholders who do not want this
consolidation to apply to their accounts should contact their Smith Barney
Financial Consultants or the Fund's transfer agent.


                                                                              49
<PAGE>

                                                                    SMITH BARNEY
                                                                    ------------
                                               A Member of TravelersGroup [LOGO]


                                                                    Smith Barney
                                                                            High
                                                                          Income
                                                                            Fund

                                                            388 Greenwich Street
                                                        New York, New York 10013


   
                                                                    FD0220 11/96
    


                                   PROSPECTUS

                                                                    SMITH BARNEY
                                                                            High
                                                                          Income
                                                                            Fund

                                                             Class Z Shares Only

   
                                                               November 28, 1996
    

                                                   Prospectus begins on page one


[LOGO] Smith Barney Mutual Funds
       Investing for your future.
       Every day.


<PAGE>

Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Prospectus                                                    November 28, 1996
--------------------------------------------------------------------------------

     388 Greenwich Street
     New York, New York 10013
     (212) 723-9218

     Smith Barney High Income Fund (the "Fund") is a diversified fund that seeks
to provide shareholders with high current income by investing in high-yielding
corporate bonds, debentures and notes. The Fund also purchases put and call
options and writes covered put and call options on securities it holds and on
stock indexes primarily as a hedge to reduce investment risk.

     The Fund is one of a number of funds, each having distinct investment
objectives and policies, making up the Smith Barney Income Funds (the "Trust").
The Trust is an open-end management investment company commonly referred to as a
mutual fund.

     The Funds invests primarily in lower-rated bonds, commonly known as "junk
bonds". Bonds of this type are subject to a greater risk of loss of principal
and interest. Purchasers should carefully assess the risks associated with an
investment in the Fund. See "Risk Factors and Special Considerations."

     This Prospectus sets forth concisely certain information about the Fund and
the Trust, including expenses, that prospective investors will find helpful in
making an investment decision. Investors are encouraged to read this Prospectus
carefully and retain it for future reference.

     The Class Z shares described in this Prospectus (previously designated as
Class C shares) are currently offered exclusively for sale to tax-exempt
employee benefit and retirement plans of Smith Barney Inc. ("Smith Barney") or
any of its affiliates ("Qualified Plans") and to certain unit investment trusts
sponsored by Smith Barney or any of its affiliates ("Smith Barney UITs").

   
     Additional information about the Fund and the Trust is contained in a
Statement of Additional Information dated November 28, 1996, as amended or
supplemented from time to time, that is available upon request and without
charge by calling or writing the Trust at the telephone number or address set
forth above or by contacting a Smith Barney Financial Consultant. The Statement
of Additional Information has been filed with the Securities and Exchange
Commission (the "SEC") and is incorporated by reference into this Prospectus in
its entirety.
    

Smith Barney Inc.
Distributor

Smith Barney Mutual Funds Management Inc.
Investment Adviser and Administrator

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.


                                                                               1

<PAGE>

Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Table of Contents
--------------------------------------------------------------------------------

The Fund's Expenses                                                            3
--------------------------------------------------------------------------------
Financial Highlights                                                           4
--------------------------------------------------------------------------------
Investment Objective and Policies                                              5
--------------------------------------------------------------------------------
Valuation of Shares                                                           17
--------------------------------------------------------------------------------
Dividends, Distributions and Taxes                                            17
--------------------------------------------------------------------------------
   
Purchase, Exchange and Redemption of Shares                                   19
    
--------------------------------------------------------------------------------
Performance                                                                   20
--------------------------------------------------------------------------------
Management of the Trust and the Fund                                          21
--------------------------------------------------------------------------------
Additional Information                                                        23
--------------------------------------------------------------------------------

================================================================================

     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 and
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>

Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
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 Class Z shares of
the Fund, based upon the Fund's operating expenses for its most recent fiscal
year:

Annual Fund Operating Expenses
(as a percentage of average net assets)

    Management fees                                                  0.70%
   
    Other expenses                                                   0.07%
================================================================================
TOTAL FUND OPERATING EXPENSES                                        0.77%
================================================================================
    

     The nature of the services for which the Fund pays management fees is
described under "Management of the Trust and the Fund." "Other expenses" in the
above table include fees for shareholder services, custodial fees, legal and
accounting fees, printing costs and registration fees.

EXAMPLE The following example is intended to assist an investor in understanding
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 and Redemption of Shares" and
"Management of the Trust and the Fund."

                                             1 year  3 years  5 years  10 years
================================================================================
   
     An investor would pay the following
expenses on a $1,000 investment in Class
Z shares of the Fund, assuming (1) 5.00%
annual return and (2) redemption at the
end of each time period:                        $8      $25      $43      $95
    
================================================================================

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
representation of past or future expenses and actual expenses may be greater or
less than those shown.


                                                                               3


<PAGE>

Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Financial Highlights
--------------------------------------------------------------------------------

   
The following information for the two-year period ended July 31, 1996 has been
audited by KPMGPeat Marwick LLP, independent accountants and appears in the
Fund's Annual Report dated July, 31 1996. The following information for the
fiscal years ended July 31, 1993 and July 31, 1994 has been audited by
other independent auditors. The information set forth below should be read in
conjunction with the financial statements and related notes that also appear in
the Fund's 1996 Annual Report, which is incorporated by reference into the
Statement of Additional Information.
    

For a Class Z share(1) of beneficial interest outstanding throughout each
period:

<TABLE>
<CAPTION>
   
                                                   Year        Year        Year         Period
                                                   Ended       Ended       Ended        Ended
                                                  7/31/96     7/31/95     7/31/94      7/31/93(2)
====================================================================================================
<S>                                            <C>          <C>          <C>           <C>       
Net Asset Value, Beginning of Period           $    11.09   $    11.16   $    12.01    $    11.03
----------------------------------------------------------------------------------------------------
Income From Operations:
    Net investment income                            1.11         1.11         1.10          0.79
    Net realized and unrealized
      gain (loss) on investments                    (0.10)       (0.03)       (0.80)         1.07
----------------------------------------------------------------------------------------------------
Total Income from Operations                         1.01         1.08         0.30          1.86
----------------------------------------------------------------------------------------------------
Less Distributions From:
    Net investment income                           (1.11)       (1.08)       (1.09)        (0.84)
    Overdistribution of net investment income         --           --         (0.06         (0.04)
    Capital                                           --         (0.07)         --            --
----------------------------------------------------------------------------------------------------
Total Distributions                                 (1.11)       (1.15)       (1.15)        (0.88)
----------------------------------------------------------------------------------------------------
Net Asset Value, End of Period                 $    10.99   $    11.09   $    11.16    $    12.01
----------------------------------------------------------------------------------------------------
Total Return++                                       9.42%       10.55%        2.37%        17.47%#
----------------------------------------------------------------------------------------------------
Net Assets, End of Period (000's)              $    7,158   $    9,917   $   11,370    $   26,112
----------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
    Expenses                                         0.77%        0.86%        0.77%         0.81%+
    Net investment income                            9.98        10.28         9.61%         9.88%+
----------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                                72%          60%          98%           95%
====================================================================================================
    
</TABLE>

(1) On November 7, 1994, the former Class C shares were renamed Class Z shares.
(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.
++  Total return represents aggregate total return for the period indicated and
    does not reflect any applicable sales charge.


4

<PAGE>

Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Investment Objective and Policies
--------------------------------------------------------------------------------

   
     The Fund's investment objective is high current income. The Fund's
investment objective may be changed only with the approval of the holders of a
majority of the Fund's outstanding shares. There can be no assurance that the
Fund will achieve its investment objective. Although growth of capital is not an
investment objective of the Fund, Smith Barney Mutual Funds Management Inc.
("SBMFM") may consider potential for growth as one factor, among others, in
selecting investments for the Fund. The Fund will seek high current income by
investing, under normal circumstances, at least 65% of its assets in
high-yielding corporate bonds, debentures and notes denominated in U.S. dollars
or foreign currencies. Up to 40% of the Fund's assets may be invested in
fixed-income obligations of foreign issuers, and up to 20% of its assets may be
invested in common stock or other equity or equity-related securities, including
convertible securities, preferred stock, warrants and rights. Securities
purchased by the Fund generally will be rated in the lower rating categories of
recognized rating agencies, as low as Caa by Moody's Investors Service, Inc.
("Moody's") or D by Standard & Poor's Corporation ("S&P"), or unrated securities
that SBMFM deems of comparable quality. The Fund may invest up to 10% of its
assets in low-rated securities or unrated securities of comparable quality.
Low-rated securities are securities rated less than investment grade by Moody's
or S&P. See "Special Considerations - Medium-, Low- and Unrated Securities"
below. The Fund may hold securities with higher ratings when the yield
differential between low-rated and higher-rated securities narrows and the risk
of loss may be reduced substantially with only a relatively small reduction in
yield. The Fund may also invest in zero coupon bonds and payment-in-kind bonds.
The Fund also may invest in higher-rated securities when SBMFM believes that a
more defensive investment strategy is appropriate in light of market or economic
conditions. The Fund also may lend its portfolio securities, purchase or sell
securities on a when-issued or delayed-delivery basis and write covered call
options on securities. In order to mitigate the effects of uncertainty in future
exchange rates, the Fund may engage in currency exchange transactions and
purchase options on foreign currencies. The Fund also may hedge against the
effects of changes in the value of its investments by purchasing put and call
options on interest rate futures contracts. Special considerations associated
with the Fund's investments are described below.
    

     Certain Investment Strategies

     In attempting to achieve its investment objective, the Fund may employ,
among others, one or more of the strategies set forth below. More detailed
information concerning these strategies and their related risks is contained in
the Statement of Additional Information.


                                                                               5
<PAGE>

Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Investment Objective and Policies (continued)
--------------------------------------------------------------------------------

     Covered Option Writing. The Fund may write call options on securities. The
Fund realizes fees (referred to as "premiums") for granting the rights evidenced
by the options. A call option embodies the right of its purchaser to compel the
writer of the option to sell to the option holder an underlying security at a
specified price at any time during the option period. Thus, the purchaser of a
call option written by the Fund 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 call option written by the Fund, 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 will write only covered options. Accordingly, whenever the Fund
writes a call option, it will continue to own or have the present right to
acquire the underlying security for as long as it remains obligated as the
writer of the option.

     The Fund may engage in a closing purchase transaction to realize a profit
or to unfreeze an underlying security (thereby permitting its sale or the
writing of a new option on the security prior to the outstanding option's
expiration). To effect a closing purchase transaction, the Fund would purchase,
prior to the holder's exercise of an option the Fund has written, an option of
the same series as that on which the Fund desires to terminate its obligation.
The obligation of the Fund under an option it has written would be terminated by
a closing purchase transaction, but the Fund would not be deemed to own an
option as the result of the transaction. There can be no assurance the Fund will
be able to effect closing purchase transactions at a time when it wishes to do
so. To facilitate closing purchase transactions, however, the Fund ordinarily
will write options only if a secondary market for the options exists on a
domestic securities exchange or in the over-the-counter market.

     Convertible Securities and Synthetic Convertible Securities. Convertible
securities are fixed-income securities that may be converted at either a stated
price or stated rate into underlying shares of common stock. Convertible
securities have general characteristics similar to both fixed- income and equity
securities. Although to a lesser extent than with fixed-income securities
generally, the market value of convertible securities tends to decline as
interest rates increase and, conversely, tends to increase as interest rates
decline. In addition, because of the conversion feature, the market value of
convertible securities tends to vary with fluctuations in the market value of
the underlying common stocks and, therefore, also will react to variations in
the general market for equity securities. A unique feature of


6

<PAGE>

Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Investment Objective and Policies (continued)
--------------------------------------------------------------------------------

convertible securities is that as the market price of the underlying common
stock declines, convertible securities tend to trade increasingly on a yield
basis, and so may not experience market value declines to the same extent as the
underlying common stock. When the market price of the underlying common stock
increases, the prices of the convertible securities tend to rise as a reflection
of the value of the underlying common stock. While no securities investments are
without risk, investments in convertible securities generally entail less risk
than investments in common stock of the same issuer.

     As fixed-income securities, convertible securities generally provide a
steady dividend which is higher than dividends paid by common stocks but at
lower interest rates or dividend yields than non-convertible fixed-income
securities. Like all fixed-income securities, there can be no assurance of
current income because issuers may default on their obligations. Similarly,
although the conversion feature of a convertible security enables the holder to
benefit from increases in the market price of the underlying common stock (to a
lesser extent than a direct holder of the common stock) there can be no
assurance of capital appreciation because of market fluctuations.

     Convertible securities generally are subordinated to other similar but
non-convertible securities of the same issuer, although convertible bonds, as
corporate debt obligations, enjoy seniority in right of payment to all equity
securities, and convertible preferred stock is senior to common stock of the
same issuer. Because of the subordination feature, however, convertible
securities typically have lower ratings than similar non-convertible securities.

     Unlike a convertible security which is a single security, a synthetic
convertible security is comprised of two distinct securities that together
resemble convertible securities in certain respects. Synthetic convertible
securities are created by combining non-convertible bonds or preferred stocks
with warrants or stock call options. The options that will form elements of
synthetic convertible securities will be listed on a securities exchange or on
the National Association of Securities Dealers Automated Quotation System. The
two components of a synthetic convertible security, which will be issued with
respect to the same entity, generally are not offered as a unit, and may be
purchased and sold by the Fund at different times. Synthetic convertible
securities differ from convertible securities in certain respects, including
that each component of a synthetic convertible security has a separate market
value and responds differently to market fluctuations. Investing in synthetic
convertible securities involves the risk normally involved in holding the
securities comprising the synthetic convertible security.


                                                                               7


<PAGE>

Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Investment Objective and Policies (continued)
--------------------------------------------------------------------------------

     Additional Investments

     Money Market Instruments. When SBMFM believes that market conditions
warrant, the Fund may adopt a temporary defensive posture and may invest in
short-term instruments without limitation. Short-term instruments in which the
Fund may invest include: United States government securities; certain bank
obligations (including certificates of deposit, time deposits and bankers'
acceptances of domestic or foreign banks, domestic savings and loan associations
and similar institutions); commercial paper rated no lower than A2 by S&P
or Prime 2 by Moody's or the equivalent from another major rating service
or, if unrated, of an issuer having an outstanding unsecured debt issue then
rated within the three highest rating categories; and repurchase agreements as
described below.

     United States Government Securities. United States government securities
are obligations of, or guaranteed by, the United States government, its agencies
or instrumentalities ("U.S. government securities"). The U.S. government
securities in which the Fund may invest include: direct obligations of the
United States Treasury (such as Treasury Bills, Treasury Notes and Treasury
Bonds) and obligations issued by U.S. government agencies and instrumentalities,
including securities that are supported by the full faith and credit of the
United States (such as Government National Mortgage Association ("GNMA")
certificates); 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 securities that are supported by the credit of the instrumentality
(such as Federal National Mortgage Association ("FNMA") and Federal Home Loan
Mortgage Corporation ("FHLMC") bonds). Treasury Bills have maturities of less
than 1 year, Treasury Notes have maturities of 1 to 10 years and Treasury Bonds
generally have maturities of greater than 10 years at the date of issuance.
Certain U.S. government securities, such as those issued or guaranteed by GNMA,
FNMA and FHLMC, are mortgage-related securities. U.S. government securities
generally do not involve the credit risks associated with other types of
interest-bearing securities, although, as a result, the yields available from
U.S. government securities are generally lower than the yields available from
interest-bearing corporate securities.

   
     Zero Coupon Securities. The Fund may also invest in zero coupon bonds. A
zero coupon 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 an amount significantly
less than its face value (sometimes referred to as a "deep discount" price).
Because such securities usually trade at a deep discount, they will be subject
to greater fluctuations of market value
    


8


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Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Investment Objective and Policies (continued)
--------------------------------------------------------------------------------

   
in response to changing interest rates than debt obligations of comparable
maturities 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.
    

     Repurchase Agreements. The Fund may engage in repurchase agreement
transactions with banks which are the issuers of instruments acceptable for
purchase by the Fund 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 relatively
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.
This arrangement results in a fixed rate of return that is not subject to market
fluctuations during the Fund's holding period. The value of the underlying
securities will be at least equal at all times to the total amount of the
repurchase obligation, including interest. Repurchase agreements could involve
certain risks in the event of default or insolvency of the other party,
including possible delays in or restrictions upon the Fund's ability to dispose
of the underlying securities, the risk of a possible 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.
SBMFM, acting under the supervision of the Trust's Board of Trustees, 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.

     Futures Contracts and Options on Futures Contracts. When deemed advisable
by SBMFM, the Fund may enter into futures contracts or related options that are
traded on a domestic exchange or board of trade. Such investments, if any, by
the Fund will be made solely for the purpose of hedging against the effects of
changes in the value of the portfolio securities due to anticipated changes in
interest rates, currency values and market conditions and when the transactions
are economically appropriate to the reduction of risks inherent in the
management of the Fund. The Fund may not enter into futures and options
contracts for which aggregate initial margin deposits and premium paid for
unexpired options to establish such positions that are not bona fide hedging
positions (as defined by the Commodity Futures Trading Commission), 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


                                                                               9

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Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Investment Objective and Policies (continued)
--------------------------------------------------------------------------------

   
will be covered by cash or debt securities of any grade provided such securities
have been determined by SBMFM to be liquid and unencumbered pursuant to
guidelines established by the Trustees ("eligible segregated assets") set aside
plus accrued profits held in a segregated account.
    

     The use of futures contracts and options on futures contracts as a hedging
device involves several risks. There can be no assurance that there will be a
correlation between price movements in the underlying securities on the one
hand, and price movements in the securities which are the subject of the hedge,
on the other hand. 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 for a particular contract or option at any particular time. Losses
incurred in hedging transactions and the costs of these transactions will affect
the Fund's performance.

     Foreign Securities. There are certain risks involved in investing in
securities of companies and governments of foreign nations which are in addition
to the usual risks inherent in domestic investments. These risks include those
resulting from revaluation of currencies, future adverse political and economic
developments and the possible imposition of currency exchange blockages or other
foreign governmental laws or restrictions, reduced availability of public
information concerning issuers and the lack of uniform accounting, auditing and
financial reporting standards or of other regulatory practices and requirements
comparable to those applicable to domestic companies. The yield of the Fund may
be adversely affected by fluctuations in value of one or more foreign currencies
relative to the U.S. dollar. Moreover, securities of many foreign companies and
their markets may be less liquid and their prices more volatile than those of
securities of comparable domestic companies. In addition, with respect to
certain foreign countries, there is the possibility of expropriation,
nationalization, confiscatory taxation and limitations on the use or removal of
funds or other assets of the Fund, including the withholding of dividends.
Foreign securities may be subject to foreign government taxes that could reduce
the yield on such securities. Because the Fund will invest in securities
denominated or quoted in currencies other than the U.S. dollar, changes in
foreign currency exchange rates may adversely affect the value of portfolio
securities and the appreciation or depreciation of investments. Investments in
foreign securities also may result in higher expenses due to the cost of
converting foreign currency to U.S. dollars, the payment of fixed brokerage
commissions on foreign exchanges, which generally are higher than commissions on
domestic exchanges, and the expense of maintaining securities with foreign
custodians, and the imposition of transfer taxes or transaction charges
associated with foreign exchanges.


10


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Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Investment Objective and Policies (continued)
--------------------------------------------------------------------------------

   
     The Fund may also purchase American
Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs") 
and Global Depositary Receipts or other
securities representing underlying shares of foreign companies. ADRs are
publicly traded on exchanges or over-the-counter in the United States and are
issued through "sponsored" or "unsponsored" arrangements. In a sponsored ADR
arrangement, the foreign issuer assumes the obligation to pay some or all of the
depositary's transaction fees, whereas under an unsponsored arrangement, the
foreign issuer assumes no obligation and the depositary's transaction fees are
paid by the ADR holders. In addition, less information is available in the
United States about an unsponsored ADR than about a sponsored ADR, and the
financial information about a company may or may not be as reliable for an
unsponsored ADR as it is for a sponsored ADR. The Fund may invest in ADRs
through both sponsored and unsponsored arrrangements.

     Corporate securities in which the Fund may invest include corporate
fixed-income securities of both domestic and foreign issuers, such as bonds,
debentures, notes, equipment lease certificates, equipment trust certificates,
and preferred stock. The Fund's investments in each of equipment leases or
equipment trust certificates will not exceed 5% of its assets.
    

     Certain of the corporate fixed-income securities in which the Fund may
invest may involve equity characteristics. The Fund may, for example, invest in
warrants for the acquisition of stock of the same or of a different issuer or in
corporate fixed-income securities that have conversion or exchange rights
permitting the holder to convert or exchange the securities at a stated price
within a specified period of time into a specified number of shares of common
stock. In addition, the Fund may invest in participations that are based on
revenues, sales or profits of an issuer or in common stock offered as a unit
with corporate fixed-income securities.

     Currency Exchange Transactions and Options on Foreign Currencies. In order
to protect against uncertainty in the level of future exchange rates, the Fund
may engage in currency exchange transactions and purchase exchange-traded put
and call options on foreign currencies. The Fund will conduct its currency
exchange transactions either on a spot (i.e., cash) basis at the rate prevailing
in the currency exchange market or through entering into forward contracts to
purchase or sell currencies. The Fund's dealings in forward currency exchange
and options on foreign currencies are limited to hedging involving either
specific transactions or portfolio positions.

     A forward currency contract involves an obligation to purchase or sell a
specific currency for an agreed-upon price at an agreed-upon date which may be


                                                                              11


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Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Investment Objective and Policies (continued)
--------------------------------------------------------------------------------

any fixed number of days from the date of the contract agreed upon by the
parties. These contracts are entered into in the interbank market conducted
directly between currency traders (usually large commercial banks) and their
customers. Although these contracts are intended to minimize the risk of loss
due to a decline in the value of the hedged currency, at the same time they tend
to limit any potential gain that might result should the value of the currency
increase.

     The Fund may purchase put options on a foreign currency in which securities
held by the Fund are denominated to protect against a decline in the value of
the currency in relation to the currency in which the exercise price is
denominated. The Fund may purchase a call option on a foreign currency to hedge
against an adverse exchange rate of the currency in which a security that it
anticipates purchasing is denominated in relation to the currency in which the
exercise price is denominated. An option on a foreign currency gives the
purchaser, in return for a premium, the right to sell, in the case of a put, and
buy, in the case of a call, the underlying currency at a specified price during
the term of the option. Although the purchase of an option on a foreign currency
may constitute an effective hedge by the Fund against fluctuations in the
exchange rates, in the event of rate movements adverse to the Fund's position,
the Fund may forfeit the entire amount of the premium plus related transaction
costs. Options on foreign currencies purchased by the Fund may be traded on
domestic and foreign exchanges or traded over-the-counter.

     Although the foreign currency market may not necessarily be more volatile
than the market in other commodities, the foreign currency market offers less
protection against defaults in the forward trading of currencies than is
available when trading in currencies occurs on an exchange. Because a forward
currency contract is not guaranteed by an exchange or clearinghouse, a default
on the contract would deprive the Fund of unrealized profits or force the Fund
to cover its commitments for purchase or resale, if any, at the current market
price.

     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 any portfolio 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 such 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 a segregated account consisting of


12


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Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Investment Objective and Policies (continued)
--------------------------------------------------------------------------------

   
cash or other eligible segregated assets 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. The Fund will not accrue income with respect to a when-issued security
prior to its stated delivery date.
    

     Lending of Portfolio Securities. The Fund has the ability to lend portfolio
securities to brokers, dealers and other financial organizations. These loans,
if and when made, may not exceed 20% of the Fund's assets taken at value. Loans
of portfolio securities will be collateralized by cash, letters of credit or
U.S. government securities that are maintained at all times in an amount at
least equal to the current market value of the loaned securities.

     Non-Publicly Traded and Illiquid Securities. The sale of securities that
are not publicly traded is typically restricted under the Federal securities
laws. As a result, the Fund may be forced to sell these securities at less than
fair market value or may not be able to sell them when SBMFM believes it
desirable to do so. The Fund's investments in illiquid securities are subject to
the risk that should the Fund desire to sell any of these securities when a
ready buyer is not available at a price that the Fund deems representative of
its value, the value of the Fund's net assets could be adversely affected.

     Securities of Developing Countries. A developing country generally is
considered to be a country that is in the initial stages of its
industrialization cycle. Investing in the equity and fixed-income markets of
developing countries involves exposure to economic structures that are generally
less diverse and mature, and to political systems that can be expected to have
less stability, than those of developed countries. Historical experience
indicates that the markets of developing countries have been more volatile than
the markets of the more mature economies of developed countries; however, such
markets often have provided higher rates of return to investors.

     Certain Investment Guidelines

     Up to 15% of the assets of the Fund may be invested in securities with
contractual or other restrictions on resale and other instruments that are not
readily marketable, including (a) repurchase agreements with maturities greater
than seven days, (b) time deposits maturing from two business days through seven
calendar days, and (c) to the extent that a liquid secondary market does not
exist for the instruments, futures contracts and options thereon.
Notwithstanding the foregoing, the Fund shall not invest more than 10% of its
net assets in securities (excluding those subject to Rule 144A under the
Securities Act of 1933, as amended) that are


                                                                              13


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Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Investment Objective and Policies (continued)
--------------------------------------------------------------------------------

restricted. In addition, the Fund may invest up to 5% of its assets in the
securities of issuers which have been in continuous operation for less than
three years. The Fund also may borrow from banks for temporary or emergency
purposes, but not for investment purposes, in an amount up to 10% of its total
assets, and may pledge its assets to the same extent in connection with such
borrowings. Whenever these borrowings exceed 5% of the value of the Fund's total
assets, the Fund will not make any additional investments. Except for the
limitations on borrowing, the investment guidelines set forth in this paragraph
may be changed at any time without shareholder consent by vote of the Trust's
Board of Trustees. A complete list of investment restrictions that identifies
additional restrictions that cannot be changed without the approval of the
majority of the Fund's outstanding shares is contained in the Statement of
Additional Information.

     Risk Factors and Special Considerations

     Options. The Fund may enter into options transactions primarily as hedges
to reduce investment risk, generally by making an investment expected to move in
the opposite direction of a portfolio position. A hedge is designed to offset a
loss on a portfolio position with a gain on the hedge position; at the same
time, however, a properly correlated hedge will result in a gain on the
portfolio position being offset by a loss on the hedge position. The Fund bears
the risk that the prices of the securities being hedged will not move in the
same amount as the hedge. The Fund will engage in hedging transactions only when
deemed advisable by SBMFM. Successful use by the Fund of options will depend on
SBMFM's ability to correctly predict movements in the direction of the stock
underlying the option used as a hedge. Losses incurred in hedging transactions
and the costs of these transactions will affect the Fund's performance.

     The ability of the Fund to engage in closing transactions with respect to
options depends on the existence of a liquid secondary market. While the Fund
generally will purchase options only if there appears to be a liquid secondary
market for the options purchased or sold, for some options no such secondary
market may exist or the market may cease to exist.

     Medium-, Low- and Unrated Securities. The Fund may invest up to 10% of its
assets in medium- or low-rated securities and unrated securities of comparable
quality. Generally, these securities offer a higher return potential than
higher-rated securities but involve greater volatility of price and risk of loss
of income and principal Generally, these securities offer a higher current yield
than the yield offered by higher-rated securities, but involve greater
volatility of price and risk of loss of income and principal, including the
probability of future default or bankruptcy of the issuers of such securities.
Medium- and low-rated and


14


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Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Investment Objective and Policies (continued)
--------------------------------------------------------------------------------

comparable unrated securities will likely have large uncertainties or major risk
exposures to adverse conditions and are predominantly speculative with respect
to the issuer's capacity to pay interest and repay principal in accordance with
the terms of the obligation. Accordingly, it is possible that these types of
factors could, in certain instances, reduce the value of securities held by the
Fund, with a commensurate effect on the value of the Fund's shares.

     The markets in which medium- and low-rated or comparable unrated securities
are traded generally are more limited than those in which higher-rated
securities are traded. The existence of limited markets for these securities may
restrict the availability of securities for the Fund to purchase and also may
have the effect of limiting the ability of the Fund to (a) obtain accurate
market quotations for purposes of valuing securities and calculating net asset
value and (b) sell securities at their fair value either to meet redemption
requests or to respond to changes in the economy or the financial markets. The
market for certain medium- and low-rated and comparable unrated securities has
not fully weathered a major economic recession. Any such economic downturn could
adversely affect the value of such securities and the ability of the issuers of
these securities to repay principal and pay interest thereon.

     While the market values of medium- and low-rated and comparable unrated
securities tend to react less to fluctuations in interest rate levels than do
those of higher-rated securities, the market values of certain of these
securities also tend to be more sensitive to individual corporate developments
and changes in economic conditions than higher-rated securities. In addition,
medium- and low-rated and comparable unrated securities generally present a
higher degree of credit risk. Issuers of medium- and low-rated and comparable
unrated securities are often highly leveraged and may not have more traditional
methods of financing available to them so that their ability to service their
debt obligations during an economic downturn or during sustained periods of
rising interest rates may be impaired. The risk of loss due to default by such
issuers is significantly greater because medium-and low-rated and comparable
unrated securities generally are unsecured and frequently are subordinated to
the prior payment of senior indebtedness. The Fund may incur additional expenses
to the extent it is required to seek recovery upon a default in the payment of
principal or interest on its portfolio holdings.

     Fixed-income securities, including medium- and low-rated and comparable
unrated securities, frequently have call or buy-back features that permit their
issuers to call or repurchase the securities from their holders, such as the
Fund. If an issuer exercises these rights during periods of declining interest
rates, the Fund may have to replace the security with a lower yielding security,
resulting in a decreased return to the Fund.


                                                                              15


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Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Dividends, Distributions and Taxes (continued)
--------------------------------------------------------------------------------

     Securities which are rated Ba by Moody's or BB by S&P have speculative
characteristics with respect to capacity to pay interest and repay principal.
Securities which are rated B generally lack characteristics of the desirable
investment and assurance of interest and principal payments over any long period
of time may be small. Securities which are rated Caa or CCC or below are of poor
standing. Those issues may be in default or present elements of danger with
respect to principal or interest. Securities rated C by Moody's and D by S&P are
in the lowest rating class and indicate that payments are in default or that a
bankruptcy petition has been filed with respect to the issuer or that the issuer
is regarded as having extremely poor prospects. See the Appendix in the Trust's
Statement of Additional Information on bond ratings by Moody's and S&P.

     In light of these risks, SBMFM, in evaluating the creditworthiness of an
issue, whether rated or unrated, will take various factors into consideration,
which may include, as applicable, the issuer's financial resources, its
sensitivity to economic conditions and trends, the operating history of and the
community support for the facility financed by the issue, the ability of the
issuer's management and regulatory matters.

   
     The Fund's holdings in fixed-income securities (as rated by Moody's) for
the fiscal year ended July 31, 1996 were composed as follows: 0.51% rated Baa;
27.52% rated Ba; 52.98% rated B; 1.26% rated Caa; 
and 4.79% in non-rated securities. The
percentages were calculated on a dollar weighted average basis by determining
monthly the percentage of the Fund's net assets invested in each rating category
and do not necessarily indicate what the composition of the Fund's holdings will
be in subsequent years.
    

     Securities of Unseasoned Issuers. Securities in which the Fund may invest
may have limited marketability and, therefore, may be subject to wide
fluctuations in market value. In addition, certain securities may lack a
significant operating history and be dependent on products or services without
an established market share.

     Portfolio Transactions

     All orders for transactions in securities and options on behalf of the Fund
are placed by SBMFM with broker-dealers that SBMFM selects, including Smith
Barney. The Fund may utilize Smith Barney or a Smith Barney-affiliated broker in
connection with a purchase or sale of securities when SBMFM believes that the
broker's charge for the transactions does not exceed usual and customary levels.
The same standard applies to the use of Smith Barney as a commodities broker in
connection with entering into options and futures contracts.


16


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Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Valuation of Shares
--------------------------------------------------------------------------------

     The net asset value per share of Class Z shares is determined as of the
close of regular trading on the New York Stock Exchange, Inc. (the "NYSE"), on
each day that the NYSE is open by dividing the value of the Fund's net assets
attributable to Class Z by the number of shares of the Class outstanding. The
per share net asset value of the Class Z shares may be higher than those of
other Classes because of the lower expenses attributable to Class Z shares.

     Generally, the Fund's investments are valued at market value or, in the
absence of a market value with respect to any securities, at fair value as
determined by or under the direction of the Trust's Board of Trustees. Portfolio
securities which are traded primarily on foreign exchanges are generally valued
at the preceding closing values of such securities on their respective
exchanges, except that when an occurrence subsequent to the time a value was so
established is likely to have changed such value, then the fair market value of
those securities will be determined by consideration of other factors by or
under the direction of the Trust's Board of Trustees or delegates. A security
that is traded primarily on an exchange is valued at the last sale price on that
exchange or, if there were no sales during the day, at the current quoted bid
price. Over-the-counter securities are valued on the basis of the bid price at
the close of business on each day. Investments in U.S. government securities
(other than short-term securities) are valued at the average of the quoted bid
and asked prices in the over-the-counter market. Short-term investments that
mature in 60 days or less are valued at amortized cost whenever the Trust's
Board of Trustees determines that amortized cost reflects fair value of those
investments. An option generally is valued at the last sale price or, in the
absence of the last sale price, the last offer price. Further information
regarding the Fund's valuation policies is contained in the Statement of
Additional Information.

--------------------------------------------------------------------------------
Dividends, Distributions and Taxes
--------------------------------------------------------------------------------

     Dividends and Distributions

     The Fund will be treated separately from the Trust's other funds in
determining the amounts of dividends from investment income and distributions of
capital gains payable to shareholders.

     If a shareholder does not otherwise instruct, dividends and distributions
will be reinvested automatically in additional shares of the same Class at net
asset value, subject to no sales charge or CDSC. Dividends from net investment
income, if any, of the Fund will be declared monthly and paid on the last Friday
of the month. The


                                                                              17


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Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Dividends, Distributions and Taxes (continued)
--------------------------------------------------------------------------------

Fund's final distribution for each calendar year will include any remaining net
investment income and net realized long- and short-term capital gains realized
during the year and deemed undistributed during the year for Federal income tax
purposes. In order to avoid the application of a 4% nondeductible excise tax
measured with respect to certain undistributed amounts of ordinary income and
capital gains, the Fund may make any additional distributions shortly before
December 31 in each year as may be necessary to avoid the application of this
tax.

     If, for any full fiscal year, the Fund's total distributions exceed net
investment income and net realized capital gains, the excess distributions
generally will be treated as a tax-free return of capital (up to the amount of
the shareholder's tax basis in his or her shares). The amount treated as a
tax-free return of capital will reduce a shareholder's adjusted basis in his or
her shares. Pursuant to the requirements of the Investment Company Act of 1940,
as amended (the "1940 Act") and other applicable laws, a notice will accompany
any distribution paid from sources other than net investment income. In the
event the Fund distributes amounts in excess of its net investment income and
net realized capital gains, such distributions may have the effect of decreasing
the Fund's total assets, which may increase the Fund's expense ratio.

     Taxes

     The Fund will be treated as a separate taxpayer with the result that, for
Federal income tax purposes, the amount of investment income and capital gains
earned by the Fund will be determined without regard to the earnings of the
other funds of the Trust. The Fund has qualified and intends to continue to
qualify each year as a "regulated investment company" under Subchapter M of the
Internal Revenue Code of 1986, as amended. To meet those requirements, the Fund
may need to restrict the degree to which it engages in short-term trading and
transactions in options. If the Fund qualifies as a regulated investment company
and meets certain distribution requirements, the Fund will not be subject to
Federal income tax on its net investment income and net capital gains that it
distributes to its shareholders.

     Dividends paid by the Fund from investment income and distributions of
short-term capital gain will be taxable to shareholders as ordinary income for
Federal income tax purposes, whether received in cash or reinvested in
additional shares. Furthermore, as a general rule, distributions of long-term
capital gain will be taxable to shareholders as long-term capital gain, whether
paid in cash or reinvested in additional shares, and regardless of the length of
time that the investor has held his or her shares of the Fund.


18


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Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Dividends, Distributions and Taxes (continued)
--------------------------------------------------------------------------------

     Distributions of capital gains or dividends received from foreign
corporations will not qualify for the Federal dividends-received deduction for
corporate shareholders (the "Corporate Deduction"). The Fund anticipates that
most of its dividends will not qualify for the Corporate Deduction. Each
shareholder will receive a statement annually from the Trust, which will set
forth separately the aggregate dollar amount of dividends and capital gains
distributed to the shareholder by the Fund with respect to the prior calendar
year.

     Dividends and interest received by the Fund may give rise to withholding
and other taxes imposed by foreign countries. Tax conventions between certain
countries and the United States may reduce or eliminate such taxes.

     Shareholders are urged to consult their tax advisors regarding the
application of Federal, state and local tax laws to their specific situation
before investing in the Fund.

--------------------------------------------------------------------------------
Purchase, Exchange and Redemption of Shares
--------------------------------------------------------------------------------

     Purchases of the Fund's Class Z shares must be made in accordance with the
terms of a Qualified Plan or Smith Barney UIT. Purchases are effected at the net
asset value next determined after a purchase order is received by Smith Barney
(the "trade date"). Payment is due to Smith Barney on the third business day
(the "settlement date") after the trade date. Investors who make payment prior
to the settlement date may designate a temporary investment (such as a money
market fund of the Smith Barney Mutual Funds) for such payment until settlement
date. The Fund reserves the right to reject any purchase order and to suspend
the offering of shares for a period of time. There are no minimum investment
requirements for Class Z shares; however, the Fund reserves the right to vary
this policy at any time.

     Purchase orders received by the Fund or Smith Barney prior to the close of
regular trading on the NYSE, currently 4:00 p.m., New York time, on any day that
the Fund's net asset value is calculated, are priced according to the net asset
value determined on that day. See "Valuation of Shares." Certificates for Fund
shares are issued upon request to the Trust's transfer agent.

   
     Qualified Plans may redeem their shares on any day the Fund calculates its
net asset value. See "Valuation of Shares." Redemption requests received in
proper form prior to the close of regular trading on the NYSE are priced at the
net asset value per share determined on that day. Redemption requests received
after the close of regular trading on the NYSE are priced at the net asset value
as next
    


                                                                              19


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Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Purchase, Exchange and Redemption of Shares (continued)
--------------------------------------------------------------------------------

determined. Shareholders acquiring Class Z shares through a Qualified Plan or a
Smith Barney UIT should consult the terms of their respective plans for
redemption provisions.

   
     Holders of Class Z shares should consult their Qualified Plans for
information about available exchange options.
    

--------------------------------------------------------------------------------
Performance
--------------------------------------------------------------------------------

     Yield

     From time to time, the Fund advertises the 30-day "yield" of its Class Z
shares. The yield refers to the income generated by an investment in Class Z
shares over the 30-day period identified in the advertisement and is computed by
dividing the net investment income per share earned by the Class Z shares during
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 for Class Z shares in advertisements.
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 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 information 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
by annualizing the most recent monthly distribution and dividing by the net
asset value on the last day of the period for which current dividend return is
presented. The current dividend return for Class Z shares may vary from time to
time depending on market conditions, the


20


<PAGE>

Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Performance (continued)
--------------------------------------------------------------------------------

composition of its investment portfolio and operating expenses. These factors
and possible differences in the methods used in calculating current dividend
return should be considered when comparing the Class Z share's 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 the Class Z shares. Such performance information may include data from
Lipper Analytical Services, Inc.
and other financial publications.



--------------------------------------------------------------------------------
Management of the Trust and the Fund
--------------------------------------------------------------------------------

     Board of Trustees

     Overall responsibility for management and supervision of the Fund rests
with the Trust's Board of Trustees. The Trustees approve all significant
agreements between the Trust and the persons and companies that furnish services
to the Trust and the Fund, including agreements with its distributor, investment
adviser and administrator, custodian and transfer agent. The day-to-day
operations of the Fund are delegated to the Fund's investment adviser and
administrator. The Statement of Additional Information contains background
information regarding the Trustees and executive officers of the Trust.

   
     Investment Adviser
    

     SBMFM, located at 388 Greenwich Street, New York, New York 10013, and
serves as the Fund's investment adviser. SBMFM is a wholly owned subsidiary of
Smith Barney Holdings Inc. ("Holdings"). Holdings is a wholly owned subsidiary


                                                                              21


<PAGE>

Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Management of the Trust and the Fund (continued)
--------------------------------------------------------------------------------

   
of Travelers Group Inc. ("Travelers"), a diversified financial services holding
company engaged, through its subsidiaries, principally in four business
segments: Investment Services, Consumer Finance Services, Life Insurance
Services and Property & Casualty Insurance Services. SBMFM (through its
predecessor entities) has been in the investment counseling business since 1934
and is a registered investment adviser. SBMFM renders investment advice to
investment companies that had aggregate assets under management as of September
30, 1996 in excess of $77 billion.
    

     Subject to the supervision and direction of the Trust's Board of Trustees,
SBMFM manages the Fund's portfolio in accordance with the Fund's investment
objective and policies, makes investment decisions for the Fund, places orders
to purchase and sell securities and employs professional portfolio managers and
securities analysts who provide research services to the Fund. For investment
advisory services rendered to the Fund, the Fund pays SBMFM a fee at the annual
rate of 0.50% of the value of the Fund's average daily net assets.

     Portfolio Management

     John C. Bianchi, a Managing Director of Smith Barney, has served as Vice
President and Investment Officer of the Fund since 1988 and is responsible for
managing its day-to-day operations, including the making of investment
decisions.

   
     Management's discussion and analysis, and additional performance
information regarding the Fund during the fiscal year ended July 31, 1996, is
included in the Annual Report dated July 31, 1996. A copy of the Annual Report
may be obtained upon request without charge from a Smith Barney Financial
Consultant or by writing or calling the Fund at the address or phone number
listed on page one of this Prospectus.
    

     Administrator -- SBMFM

     SBMFM also serves as the Fund's administrator and oversees all aspects of
the Fund's administration. Pursuant to an administration agreement with the
Fund, SBMFM is paid a fee at the annual rate of 0.20% of the value of the Fund's
average daily net assets.

     Distributor -- Smith Barney

     Smith Barney is located at 388 Greenwich Street, New York, New York 10013,
and serves as the Fund's distributor. Smith Barney is a wholly owned subsidiary
of Travelers.

 


22


<PAGE>

Smith Barney High Income Fund -- Class Z Shares

--------------------------------------------------------------------------------
Aditional Information
--------------------------------------------------------------------------------
The Trust was organized on March 12, 1985, in the Commonwealth of 
Massachusetts and is an entity commonly known as a "Massachusetts business
trust." The Trust offers shares of beneficial interest of separate series having
a $.001 per share par value. Shares of beneficial interest of the Fund are
currently classified into five Classes: A, B, C, Y and Z. When matters are
submitted for shareholder vote, shareholders of each Class of the Fund will have
one vote for each full share owned and a proportionate, fractional vote for any
fractional share held of that Class. Shares of the Trust will be
voted generally on a Trust-wide basis except on all matters,
except matters  affecting the interests of one Fund or
one Class of shares.

     Each Class of Fund shares represents an identical pro rata interest in the
Fund's investment portfolio. As such, they have the same rights, privileges and
preferences, except with respect to: (a) the designation of each Class; (b) the
effect of the respective sales charges, if any, for each Class; (c) the
distribution and/or service fees, if any, borne by each 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 a Class of shares. The Trust's Board of Trustees does not
anticipate that there will be any conflicts among the interests of the holders
of the different Classes of shares of the Fund. The Trustees, on an ongoing
basis, will consider whether any such conflict exists and, if so, take
appropriate action.

     The Trust does not hold annual shareholder meetings. There normally will be
no meeting of shareholders for the purpose of electing Trustees unless and until
such time as less than a majority of the Trustees holding office have been
elected by shareholders. The Trustees will call a meeting for any purpose upon
the written request of shareholders holding at least 10% of the Fund's
outstanding shares and the Trust will assist shareholders in calling such a
meeting as required by the 1940 Act.

     PNCBank, National Association, located at 17th and Chestnut Streets,
Philadelphia, PA 19103, serves as custodian of the Trust's investments.

   
     First Data Investor Services Group, Inc., located at Exchange Place,
Boston, Massachusetts 02109, serves as the Trust's transfer agent.
    

     The Fund sends its shareholders a semi-annual report and an audited annual
report, each of which includes a listing of the investment securities held by
the Fund at the end of the reporting period. Shareholders may seek information
regarding the Fund from their Smith Barney Financial Consultant.


                                                                              23
<PAGE>

                                                                    SMITH BARNEY
                                                                    ------------

                                               A Member of TravelersGroup [LOGO]


                                                                    Smith Barney
                                                                            High
                                                                          Income
                                                                            Fund

                                                            388 Greenwich Street
                                                        New York, New York 10013


   
                                                                    FD0792 11/96
    


                                   PROSPECTUS



                                                                    SMITH BARNEY
                                                                      Tax-Exempt
                                                                          Income
                                                                            Fund

   
                                                               November 28, 1996
    

                                                   Prospectus begins on page one


[Logo]    Smith Barney Mutual Funds
          Investing for your future.
          Every day.

<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Prospectus                                                November 28, 1996
--------------------------------------------------------------------------------

     388 Greenwich Street
     New York, New York 10013
     (212) 723-9218

      Smith Barney Tax-Exempt Income Fund (the "Fund") is a diversified fund
that seeks to maximize current income exempt from Federal income taxes by
investing primarily in municipal bonds and notes. The Fund is one of a number of
funds, each having distinct investment objectives and policies, making up Smith
Barney Income Funds (the "Trust"). The Trust is an open-end management
investment company commonly referred to as a mutual fund.

      This Prospectus sets forth concisely certain information about the Fund
and the Trust, including sales charges, distribution and service fees and
expenses, that prospective investors will find helpful in making an investment
decision. Investors are encouraged to read this Prospectus carefully and retain
it for future reference. Shares of other funds offered by the Trust are
described in separate prospectuses that may be obtained by calling the Trust at
the telephone number set forth above or by contacting a Smith Barney Financial
Consultant.

   
      Additional information about the Fund and the Trust is contained in a
Statement of Additional Information dated November 28, 1996, as amended or
supplemented from time to time, that is available upon request and without
charge by calling or writing the Trust at the telephone number or address set
forth above or by contacting a Smith Barney Financial Consultant. The Statement
of Additional Information has been filed with the Securities and Exchange
Commission (the "SEC") and is incorporated by reference into this Prospectus in
its entirety.
    

Smith Barney Inc.
Distributor

Smith Barney Mutual Funds Management Inc.
Investment Adviser and Administrator

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A


                                                                               1
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Table of Contents
--------------------------------------------------------------------------------

Prospectus Summary                                                            3
--------------------------------------------------------------------------------
Financial Highlights                                  10
--------------------------------------------------------------------------------
Investment Objective and Policies	14

Dividends, Distributions and Taxes                                           25
--------------------------------------------------------------------------------
Purchase of Shares                                                           28
--------------------------------------------------------------------------------
Exchange Privilege                                                           36
--------------------------------------------------------------------------------
Redemption of Shares                                                         39
--------------------------------------------------------------------------------
Minimum Account Size                                                         42
--------------------------------------------------------------------------------
Performance                                                                  42
--------------------------------------------------------------------------------
Management of the Trust and the Fund                                         43
--------------------------------------------------------------------------------
Distributor                                                                  45
--------------------------------------------------------------------------------
Additional Information                                                       46
--------------------------------------------------------------------------------
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 Trust 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 an offer or solicitation in any such jurisdiction.



2

<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Prospectus Summary
--------------------------------------------------------------------------------

The following summary is qualified in its entirety by detailed information
appearing elsewhere in this Prospectus and in the Statement of Additional
Information. 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 investment
company that seeks maximum current income exempt from Federal income taxes by
investing primarily in intermediate- and long-term municipal bonds and notes
rated A, Baa or Ba by Moody's Investors Service, Inc. ("Moody's") or A, BBB or B
by Standard & Poor's Ratings Group ("S&P"). Intermediate-term bonds have
remaining maturities at the time of purchase of between five and fifteen years.
Long-term bonds have remaining maturities at the time of purchase of between
fifteen and thirty years. It is anticipated that the average remaining maturity
of bonds purchased by the Fund will be between fifteen and twenty-five years.
See "Investment Objective and Management Policies."
    

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 C
shares, which differ principally in terms of sales charges and rate 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 $5,000,000. 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 4.00% and are subject to an annual service fee of 0.15% 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, which when
combined with current holdings of Class A shares offered with a sales charge
equal or exceed $500,000 in the aggregate, 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 Summary -- 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 the date of purchase and by 1.00% each year thereafter to zero. This CDSC
may be waived for certain redemptions. Class B shares are subject to an annual
service fee of 0.15% 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


                                                                               3
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

Class to have higher expenses and pay lower dividends than Class A shares.

      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 C Shares. Class C shares are sold at net asset value with no initial
sales charge. They are subject to an annual service fee of 0.15% and an annual
distribution fee of 0.55% of the average daily net assets of the Class, and
investors pay a CDSC of 1.00% if they redeem Class C shares within 12 months of
purchase. The CDSC may be waived for certain redemptions. The Class C shares'
distribution fee may cause that Class to have higher expenses and pay lower
dividends than Class A shares. Purchases of Fund shares, which when combined
with current holdings of Class C 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 $5,000,000. 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
consider the following factors, as well as any other relevant facts and
circumstances:

      Intended Holding Period. The decision as to which Class of shares is more
beneficial to an investor depends on the amount and intended length 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 charge and the shares are subject to
lower ongoing expenses over the term of the investment. As an alternative, Class
B and Class C 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 these Classes. Because the Fund's future return cannot be
predicted, however, there can be no assurance that this would be the case.

      Finally, investors should consider the effect of the CDSC period and any


4

<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

conversion rights of the Classes in the context of their own ininvested in the 
Fund. In addition, Class A share
purchases which, when combined with current holdings of Class A shares offered
with a sales charge equal or exceed $500,000 in the aggregate, 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 aggregate
investment may be met by adding the purchase to the net asset value of all Class
A shares offered with a sales charge held in funds sponsored by Smith Barney
Inc. ("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 ongoing expenses of Class A shares may be lower than those
for Class B and Class C shares, purchasers eligible to purchase Class A shares
at net asset value or at a reduced sales charge should consider doing so.

      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 C shares is the same as that of the
initial sales charge on the Class A shares.

      See "Purchase of Shares" and "Management of the Trust and the Fund" for a
complete description of the sales charges and service and distribution fees for
each Class of shares and "Valuation of Shares," "Dividends, Distributions and
Taxes" and "Exchange Privilege" for other differences among the Classes of
shares.
   
PURCHASE OF SHARES Shares may be purchased through a brokerage account
maintained with Smith Barney, a broker that clears securities transactions
through Smith Barney on a fully disclosed basis (an "Introducing Broker") or an
investment dealer in the selling group. In addition, certain investors,
including certain institutional investors, may purchase shares directly from the
Fund through the Fund's transfer agent, First Data Investor Services Group, Inc.
("First Data"). See "Purchase of Shares."
    

INVESTMENT MINIMUMS Investors in Class A, Class B and Class C 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


                                                                               5
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

   
Retirement Plan. Investors in Class Y shares may open an account for an initial
investment of $5,000,000. Subsequent investments of at least $50 may be made for
all Classes. For minimum investment requirements for all Classes through the
Systematic Investment Plan, see below. There is no minimum investment
requirement in Class A for unitholders who invest distributions from a unit
investment trust ("UIT") sponsored by Smith Barney. See "Purchase 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 and subsequent
investment for shareholders purchasing shares through the Systematic 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
"Redemption of Shares."

MANAGEMENT OF THE TRUST AND THE FUND Smith Barney Mutual Funds Management Inc.
("SBMFM") serves as the Fund's investment adviser and administrator. SBMFM
provides investment advisory and management services to investment companies
affiliated with Smith Barney. SBMFM is a wholly owned subsidiary of Smith Barney
Holdings Inc. ("Holdings"), which is in turn a wholly owned subsidiary of
Travelers Group Inc. ("Travelers"), a diversified financial services holding
company engaged, through its subsidiaries, principally in four business
segments: Investment Services, Consumer Finance Services, Life Insurance
Services and Property & Casualty Insurance Services. See "Management of the
Trust and 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 respective
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 Smith Barney Financial Consultants. See "Valuation of Shares."

DIVIDENDS AND DISTRIBUTIONS Dividends are paid monthly from net investment
income and distributions of net realized capital gains, if any, are declared and
paid 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


6
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

dividend and distribution reinvestments will not be subject to any sales charge
or CDSC. Class B shares acquired through dividend and distribution 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
will achieve its investment objective. General changes in interest rates will
result in increases or decreases in the market value of the obligations held by
the Fund. The Fund may invest up to 35% of its assets in obligations rated Ba or
below by Moody's or BB or below by S&P or in nonrated securities deemed by SBMFM
to be of comparable quality, commonly known as "junk bonds." In addition, the
Fund may invest in obligations rated as low as Caa by Moody's or CCC by S&P.
Securities that are rated B generally lack characteristics of the desirable
investment and assurance of interest and principal payments over any long period
of time may be small. Securities that are rated Caa or CCC are of poor standing.
These issues may be in default or present elements of danger may exist with
respect to principal or interest. Although medium- or low-rated securities of
the type in which the Fund may invest offer a higher current yield than the
yield offered by higher rated securities, they involve greater volatility of
price and risk of loss of income and principal, including the probability of
price and risk of loss of income and principal, including the probability of
default by or bankruptcy of the issuers of such securities. Medium- and
low-rated and comparable unrated securities (a) will likely have some quality
and protective characteristics that, in the judgment of the rating
organizations, are outweighed by large uncertainties of major risk exposures to
adverse conditions and (b) are predominantly speculative with respect to the
issuer's capacity to pay interest and repay principal in accordance with the
terms of the obligation. The Fund has the right to invest up to 20% of its net
assets in state and local obligations that are "private activity bonds," the
income for which may be taxable as a specific preference item for purposes of
the Federal alternative minimum tax. Certain of the investments held by the Fund
and certain of the investment strategies that the Fund may employ might expose
it to certain risks. See "Investment Objective and Management Policies --
Certain Portfolio Strategies."


                                                                               7
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

      The Fund's Expenses The following expense table lists the costs and
expenses 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,
unless otherwise noted, the Fund's operating expenses
for its most recent fiscal year:
<TABLE>
<CAPTION>
<S>            <C>       <C>     <C>   <C>
Shareholder Transaction Expenses
Maximum sales charge imposed on purchases
(as a percentage of offering price)
             4.00%     None      None     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                                   0.60%     0.60%     0.60%    0.60%
  12b-1 fees**                                      0.15%     0.65%     0.70%    None
   
  Other expenses***                                 0.09%     0.08%     0.09%    0.09%
--------------------------------------------------------------------------------------
TOTAL FUND OPERATING EXPENSES                       0.84%     1.33%     1.39%    0.69%
    
======================================================================================
</TABLE>

   
*   Purchases of Class A shares, which when combined with current holdings of
    Class A shares offered with a sales charge, equal or exceed $500,000 in
    the aggregate, 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 C shares do not have a
    conversion feature and, therefore, are subject to an ongoing distribution
    fee. As a result, long-term shareholders of Class C shares may pay more
    than the economic equivalent of the maximum front-end sales charge
    permitted by the National Association of Securities Dealers, Inc.
   
*** For Class Y shares, "Other expenses" have been estimated based on expenses
    incurred by Class A shares because as of July 31, 1996, no Class Y shares
    were outstanding.
    

      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 B, Class C 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)
Program. See "Purchase of Shares" and "Redemption of Shares." Smith Barney
receives an annual 12b-1 service fee of 0.15% of the value of average daily net
assets of Class A shares. Smith Barney also receives, with respect to Class B
shares, an annual 12b-1 fee of 0.65% of the value of average daily net assets of
that Class, consisting of a 0.50% distribution fee and a 0.15% service fee. For
Class C shares,


8
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

Smith Barney receives an annual 12b-1 fee of 0.70% of the value of average daily
net assets, consisting of a 0.55% distribution fee and a 0.15% service fee.
"Other expenses" in the above table include fees for shareholder services,
custodial fees, legal and accounting fees, printing costs and registration fees.

Example The following example is intended to assist an investor in understanding
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 Trust and the Fund."

                                               1 Year  3 Years 5 Years 10 Years*
================================================================================
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                                     $48     $66     $85     $140
   
      Class B                                      59      72      83      147
    
      Class C                                      24      44      76      167
      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                                     $48     $66     $85     $140
   
      Class B                                      14      42      73      147
    
      Class C                                      14      44      76      167
      Class Y                                       7      22      38       86
================================================================================

* 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
representation of past or future expenses and actual expenses may be greater or
less than those shown.


                                                                               9

<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Financial Highlights
--------------------------------------------------------------------------------

   
The following information for the two year period ended July 31, 1996 has been
audited by KPMG Peat Marwick LLP, independent auditors, whose report thereon
appears in the Fund's Annual Report dated July 31, 1996. The following
information for the fiscal years ended July 31, 1987 through July 31, 1994 has
been audited by other independent auditors. The information set out below 
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 Additional Information. No information is presented for Class Y
shares, because no Class Y shares were outstanding for the periods shown.
    

For a Class A share of beneficial interest outstanding throughout each period:
<TABLE>
<CAPTION>
   
                                               Year         Year        Year        Period
                                               Ended        Ended       Ended        Ended
                                              7/31/96      7/31/95     7/31/94     7/31/93(1)
=============================================================================================
<S>                                           <C>          <C>          <C>         <C>    
Net Asset Value, Beginning of Period          $  17.25     $  17.26     $ 18.24     $ 17.45
---------------------------------------------------------------------------------------------
Income From Operations:
  Net investment income                           1.00         1.04        1.06        0.78
  Net realized and unrealized gain (loss)
  on investments (2)                              0.06         0.01       (0.85)       1.00
---------------------------------------------------------------------------------------------
Total Income From Operations                      1.06         1.05        0.21        1.78
---------------------------------------------------------------------------------------------
Less Distributions From:
  Net investment income                          (1.00)       (1.00)      (1.02)      (0.80)
  Overdistribution of net investment income       --           --         (0.04)      (0.03)
  Net realized gains                              --           --         (0.13)      (0.16)
  Overdistribution of net realized gains          --          (0.02)       --          --
  Capital                                         --          (0.04)       --          --
---------------------------------------------------------------------------------------------
Total Distributions                              (1.00)       (1.06)      (1.19)      (0.99)
-------------------------------------------------
Net Asset Value, End of period          $17.31      $17.25       $17.26       $18.24

Total Return                                          6.28%      6.42%        1.14%        10.24%

Net Assets, End of Period                     $231,589   $237,656    $17,792   $13,508
---------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
  Expenses                                        0.84%        0.84%       0.84%       0.86%+
  Net investment income                           5.74         6.04        5.83        6.03+
---------------------------------------------------------------------------------------------
Portfolio Turnover Rate                             44%          38%         39%         34%
=============================================================================================
    
</TABLE>

(1) For the period from November 6, 1992 (inception date) to July 31, 1993.
(2) Includes the net per share effect of shareholder sales and redemption
    activity during the period, most of which occurred at net asset values
    less than the beginning of the period.
++  Total return is not annualized as it may not be representative of the
    total return for the year.
+   Annualized.
++  Total return represents aggregate total return for the period indicated
    and does not reflect any applicable sales charge.


10
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Financial Highlights (continued)
--------------------------------------------------------------------------------

For a Class B share of beneficial interest outstanding throughout each period:
<TABLE>
<CAPTION>
   
                                         Year        Year          Year        Year       Year        Year
                                         Ended       Ended         Ended       Ended      Ended       Ended
                                        7/31/96     7/31/95       7/31/94     7/31/93    7/31/92     7/31/91
=============================================================================================================
<S>                                     <C>         <C>           <C>         <C>        <C>         <C>    
Net Asset Value, Beginning
 of Period                              $ 17.26     $ 17.26       $ 18.24     $  18.00   $ 16.97     $ 16.98
-------------------------------------------------------------------------------------------------------------
Income From Operations:
  Net investment income                    0.92        0.95          0.96         0.98      1.04        1.10
  Net realized and unrealized
    gain (loss) on
    investments                         0.06        0.02(1)         (0.85)        0.45      1.17        0.10
-------------------------------------------------------------------------------------------------------------
Total Income From Operations  0.98        0.97          0.11         1.43      2.21    1.20
 ----------------------------------------------------------------------------------------------------------
Less Distributions From:
  Net investment income                   (0.92)      (0.91)        (0.92)       (0.98)    (1.04)      (1.10)
  Overdistribution of net
    investment income                      --          --           (0.04)       (0.04)     --          --
  Net realized gains                       --         (0.02)        (0.13)       (0.17)    (0.14)      (0.11)
  Capital                                  --         (0.04)         --           --        --          --
-------------------------------------------------------------------------------------------------------------
Total Distributions                       (0.92)      (0.97)        (1.09)       (1.19)    (1.18)      (1.21)
-------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Period          $ 17.32     $ 17.26       $ 17.26     $  18.24   $ 18.00     $ 16.97
-------------------------------------------------------------------------------------------------------------
Total Return++                             5.74%       5.91%         0.60%        8.28%    13.50%       7.40%
-------------------------------------------------------------------------------------------------------------
Net Assets, End of Period
 (millions)                             $   653     $   737       $ 1,069     $  1,108   $   871     $   639
-------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
  Expenses                                 1.33%       1.35%         1.33%        1.38%   1.45%#        1.45%
  Net investment income                    5.23        5.61          5.34         5.52      5.96        6.48
-------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                      44%         38%           39%          34%       61%         44%
=============================================================================================================
    
</TABLE>

(1) Includes the net per share effect of shareholder sales and redemption
    activity during the period, most of which occurred at net asset values
    less than the beginning of the period.
#   The annualized operating expense ratio excludes interest expense. The
    annualized operating expense ratio including interest expense was 1.48%
    for the year ended July 31, 1992.
++  Total return represents aggregate total return for the period indicated
    and does not reflect any applicable sales charge.


                                                                              11

<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Financial Highlights (continued)
--------------------------------------------------------------------------------

For a Class B share of beneficial interest outstanding throughout each period:
<TABLE>
<CAPTION>
   
                                  Year        Year        Year        Year         
                                  Ended       Ended       Ended       Ended       
                                 7/31/90     7/31/89     7/31/88     7/31/87     
===========================================================================================
<S>                              <C>         <C>         <C>         <C>             
Net Asset Value, Beginning
  of Period                      $ 17.31     $ 16.44     $ 16.48     $ 16.30    
-------------------------------------------------------------------------------------------
Income From Operations:
  Net investment income             1.12        1.13        1.13        1.10    
  Net realized and unrealized
    gain (loss)
 on investments                          (0.30)       0.88        0.02        0.18      
-------------------------------------------------------------------------------------------
Total Income From Operations        0.82        2.01        1.15        1.28
-------------------------------------------------------------------------------------------
Less Distributions From:
  Net investment income            (1.12)      (1.13)      (1.13)      (1.10)  
  Overdistribution of net
    investment income               --          --          --          --          
  Net realized gains               (0.03)      (0.01)      (0.06)       --         
-------------------------------------------------------------------------------------------
Total Distributions                (1.15)      (1.14)      (1.19)      (1.10)     
-------------------------------------------------------------------------------------------
Net Asset Value, End of Period   $ 16.98     $ 17.31     $ 16.44     $ 16.48   
-------------------------------------------------------------------------------------------
Total Return++                      4.95%      12.68%       7.32%       7.90%      
-------------------------------------------------------------------------------------------
Net Assets, End of Period
  (millions)                     $   574     $   558     $   451     $   453    
-------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
  Expenses                          1.47%       1.44%       1.43%       1.57%    
  Net investment income             6.57        6.70        6.99        6.43      
-------------------------------------------------------------------------------------------
Portfolio Turnover Rate               29%         21%         12%         16% 

==================================================================
For a Class C share of beneficial interest outstanding throughout each period:

</TABLE>
<TABLE>
<CAPTION>

    
   
                                                                         Year ended    Period Ended
                                                                         7/31/96         7/31/95(1)
<S>                                                                        <C>         <C>             
Net Asset Value, Beginning of Period                 $ 17.25         $ 15.83
--------------------------------------------------------------------------------
Income From Operations:
  Net investment income                                 0.89            0.60
  Net realized and unrealized
    gain (loss) on investments(2)                       0.08            1.50
--------------------------------------------------------------------------------
Total Income From Operations                            0.97            2.10
--------------------------------------------------------------------------------
Less Distributions:
  Net investment income                                (0.91)          (0.62)
  Net realized gains                                    --             (0.02)
  Capital                                               --             (0.04)
--------------------------------------------------------------------------------
Total Distributions                                    (0.91)          (0.68)
--------------------------------------------------------------------------------
Net Asset Value, End of Period                       $ 17.31         $ 17.25
--------------------------------------------------------------------------------
Total Return++                                          5.69           13.45%++
--------------------------------------------------------------------------------
Net Assets, End of Period (000s)                     $   546         $   211
--------------------------------------------------------------------------------
Ratios to Average Net Assets:
  Expenses                                              1.39%           1.39%+*
  Net investment income                                 5.18            5.56+
--------------------------------------------------------------------------------
Portfolio Turnover Rate                                   44%             38%
================================================================================
    

(1) For the period from November 17, 1994 (inception date) to July 31, 1995.
(2) Includes the net per share effect of shareholder sales and redemption
    activity during the period, most of which occurred at net asset values
    less than the beginning of the period.
++  Total return is not annualized as it may not be representative of the
    total return for the year.
+   Annualized.
++  Total return represents aggregate total return for the period indicated
    and does not reflect any sales charge.
*   Amount has been restated from the July 31,1995 Annual Report.


                                                                              13


<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies
--------------------------------------------------------------------------------

      The Fund's investment objective is the maximization of current income
exempt from Federal income taxes. Under normal market conditions, the Fund will
invest at least 80% of its net assets in (a) "Municipal Bonds," which generally
are intermediate- and long-term debt obligations issued by or on behalf of
states, territories and possessions of the United States and the District of
Columbia and their political subdivisions, agencies and instrumentalities, or
multistate agencies or authorities and (b) Municipal Leases, which generally are
participations in intermediate- and short-term debt obligations issued by
municipalities consisting of leases or installment purchase contracts for
property or equipment. Under normal market conditions, the Fund's assets will be
invested primarily in Municipal Bonds and municipal leases (collectively,
"Municipal Securities") rated A, Baa or Ba by Moody's, or A, BBB or BB by S&P,
or in unrated Municipal Securities that are deemed to be of comparable quality
by SBMFM. Up to 35% of the Fund's assets may be invested in Municipal Securities
rated Ba or below by Moody's or BB or below by S&P or, if unrated, judged by
SBMFM, to be of comparable quality. The Fund's investment objective may be
changed only with the approval of the holders of a majority of the Fund's
outstanding shares. There can be no assurance that the Fund will achieve its
investment objective.

      The Fund may invest without limit in "municipal leases," which generally
are participations in intermediate- and short-term debt obligations issued by
municipalities consisting of leases or installment purchase contracts for
property or equipment. Municipal leases may take the form of a lease or an
installment purchase contract issued by state and local government authorities
to obtain funds to acquire a wide variety of equipment and facilities such as
fire and sanitation vehicles, computer equipment and other capital assets.
Although lease obligations do not constitute general obligations of the
municipality for which the municipality's taxing power is pledged, a lease
obligation is ordinarily backed by the municipality's covenant to budget for,
appropriate and make the payments due under the lease obligation. However,
certain lease obligations contain "non-appropriation" clauses which provide that
the municipality has no obligation to make lease or installment purchase
payments in future years unless money is appropriated for such purpose on a
yearly basis. In addition to the "non-appropriation" risk, these securities
represent a relatively new type of financing that has not yet developed the
depth of marketability associated with more conventional bonds. Although
"non-appropriation" lease obligations are often secured by the underlying
property, disposition of the property in the event of foreclosure might prove
difficult. There is no limitation on the percentage of the Fund's assets that
may be invested in municipal lease obligations. In evaluating


14
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

municipal lease obligations, SBMFM will consider such factors as it deems
appropriate, which may include: (a) whether the lease can be canceled; (b) the
ability of the lease obligee to direct the sale of the underlying assets; (c)
the general creditworthiness of the lease obligor; (d) the likelihood that the
municipality will discontinue appropriating funding for the leased property in
the event such property is no longer considered essential by the municipality;
(e) the legal recourse of the lease obligee in the event of such a failure to
appropriate funding; (f) whether the security is backed by a credit enhancement
such as insurance; and (g) any limitations which are imposed on the lease
obligor's ability to utilize substitute property or services rather than those
covered by the lease obligation.

      Under normal circumstances, the Fund may invest up to 20% of its net
assets in "private activity bonds." Interest income on certain types of private
activity bonds issued after August 7, 1986 to finance nongovernmental activities
is a specific tax preference item for purposes of Federal individual and
corporate alternative minimum taxes. Individual and corporate shareholders may
be subject to a Federal alternative minimum tax to the extent that the Fund's
dividends are derived from interest on these bonds. These private activity bonds
are included in the term "Municipal Securities" for purposes of determining
compliance with the 80% test described above. Dividends derived from interest
income on all Municipal Securities are a component of the "adjusted current
earnings" item for purposes of the Federal corporate alternative minimum tax.

   
      The Fund may invest in short-term obligations ("Temporary Investments"),
some of which may not be tax-exempt. Included among the Temporary Investments
are tax-exempt notes rated within the four highest grades by a nationally
recognized statistical rating organization ("NRSRO"), including Moody's or S&P;
tax-exempt commercial paper rated no lower than A-2 by S&P or Prime-2 by
Moody's; and taxable money market instruments. At no time will more than 20% of
the Fund's assets be invested in Temporary Investments unless SBMFM temporarily
has adopted a defensive investment posture.  In addition, the Fund may enter 
into municipal bond index futures and options on interest rate futures
contracts for hedging purposes.  The fund may also acquire variable rate
demand notes, purchase securities on a when-issued basis and enter into
stand-by commitments with respect to portfolio securities.

ADDITIONAL INVESTMENTS
Money MArket Instruments. Under normal conditions, the Fund may invest up
to 20% of its assets in Temporary Investments, including taxable money
market instruments.
In addition, when SBMFM believes that market conditions warrant,


                                                                              15
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------


    
   
the Fund may invest in Temporary Investments without limitation for defensive
purposes. Short-term instruments in which the Fund may invest include
obligations issued or guaranteed as to principal and interest by the United
States government ("U.S. government securities"), certain bank obligations
including certificates of deposit, time deposits and bankers' acceptances of
domestic or foreign banks, domestic savings and loan associations and similar
institutions); commercial paper rated no lower than Prime-2 by Moody's or A-2 by
S&P or the equivalent from another NRSRO or, if unrated, of an issuer having an
outstanding, unsecured debt issue then rated within the three highest rating
categories; and repurchase agreements with respect to the securities in which
the Fund may invest. The Fund will invest in obligations of a foreign bank or
foreign branch of a domestic bank only if SBMFM determines that the obligations
present minimum credit risks. These obligations may be traded in the United
States or outside the United States, but will be denominated in U.S. dollars.
    

      U.S. Government Securities. The U.S. government securities in which the
Fund may invest include direct obligations of the United States Treasury (such
as Treasury Bills, Treasury Notes and Treasury Bonds), and obligations issued by
U.S. government agencies and instrumentalities, including securities that are
supported by the full faith and credit of the United States; securities that are
supported by the right of the issuer to borrow from the United States Treasury;
and securities that are supported by the credit of the instrumentality. Treasury
Bills have maturities of less than one year, Treasury Notes have maturities of
one to 10 years and Treasury Bonds generally have maturities of greater than 10
years at the date of issuance. U.S. government securities generally do not
involve the credit risks associated with other types of interest-bearing
securities, although, as a result, the yields available from U.S. government
securities are generally lower than the yields available from interest-bearing
corporate securities.

   
      Zero Coupon Securities. The Fund may also invest in zero coupon bonds. A
zero coupon 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 an amount significantly
less than its face value (sometimes referred to as a "deep discount" price).
Because such securities usually trade at a deep discount, they will be subject
to greater fluctuations of market value in response to changing interest rates
than debt obligations of comparable maturities 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.
    


16
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

      Certain Investment Strategies

      In attempting to achieve its investment objective, the Fund may employ,
among others, one or more of the strategies set forth below. More detailed
information concerning these strategies and their related risks is contained in
the Statement of Additional Information.

      Repurchase Agreements. The Fund may engage in repurchase agreement
transactions 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 relatively 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. This arrangement results
in a fixed rate of return that is not subject to market fluctuations during the
Fund's holding period. The value of the underlying securities will be at least
equal at all times to the total amount of the repurchase obligation, including
interest. 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 possible 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. SBMFM, acting under the
supervision of the Trust's Board of Trustees, 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.
Investments by the Fund in repurchase agreements, if any, may be limited by the
restrictions on the Fund's investment in taxable investments.

      When-Issued Securities. New issues of Municipal Securities are frequently
offered on a when-issued basis, which means that delivery and payment for such
securities normally take place within 45 days after the date of commitment to
purchase. The payment obligation and the interest rate that will be received on
when-issued securities are fixed at the time the buyer enters into the
commitment. Municipal Securities, like other investments made by the Fund, may
decline or appreciate in value before their actual delivery to the Fund. Due to
the fluctuations in the value of securities purchased and sold on a when-issued
basis, the yields obtained on these securities may be higher or lower than the
yields available in the market on the date when the investments actually are
delivered to the buyers. The Fund will not accrue income with respect to a
when-issued security prior to its


                                                                              17
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

stated delivery date. The Fund will establish a segregated account with the
Trust's custodian, PNCBank, National Association ("PNCBank") consisting of cash,
U.S. government securities or other high grade debt obligations in an amount
equal to the amount of the purchase price of the when-issued securities. Placing
securities rather than cash in the segregated account may have a leveraging
effect on the Fund's net assets. The Fund generally will make commitments to
purchase Municipal Securities on a when-issued basis only with the intention of
actually acquiring the securities, but the Fund may sell these securities before
the delivery date if it is deemed advisable.

      Futures Contracts and Options on Futures Contracts. A municipal bond index
futures contract of the type in which the Fund may trade is based on an index of
long-term, tax-exempt municipal bonds. The contract is an agreement under which
two parties agree to take or make delivery of an amount of cash equal to the
difference between the value of the index at the close of the last trading day
of the contract and the price at which the index contract was originally
written. An option on an interest rate futures contract, as contrasted with the
direct investment in a futures contract, gives the purchaser the right, in
return for the premium paid, to assume a position in an interest rate futures
contract at a specified exercise price at any time prior to the expiration date
of the option. A call option gives the purchaser of the option the right to
enter into a futures contract to buy and obliges the writer to enter into a
futures contract to sell the underlying debt securities. A put option gives the
purchaser the right to sell and obliges the writer to buy the underlying
contract. 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 to hedge against a
decline in interest rates. The Fund may write put and call options on interest
rate futures contracts in entering into closing sale transactions and to
increase ability to hedge against changes in interest rates. The Fund will write
put and call options only on interest rate futures contracts that are traded on
a domestic exchange or board of trade.

   
      Variable Rate Demand Notes. Municipal Securities purchased by the Fund may
include variable rate demand notes issued by industrial development authorities
and other governmental entities. Although variable rate demand notes are
frequently not rated by credit rating agencies, unrated notes purchased by the
Fund will be determined by SBMFM to be of comparable quality at the time of
purchase to instruments rated "high quality" (that is, within the two highest
ratings) by any NRSRO. In addition, while no active secondary market may exist
with respect to a particular variable rate demand note purchased by the Fund,
the Fund may, upon the notice specified in the note, demand payment of the
principal of and
    


18
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

accrued interest on the note at any time and may resell the note at any time to
a third party. The absence of such an active secondary market, however, could
make it difficult for the Fund to dispose of the variable rate demand note
involved in the event that the issuer of the note defaulted on its payment
obligations, and the Fund could, for this or other reasons, suffer a loss to the
extent of the default.

      Stand-by Commitments. The Fund may acquire "stand-by commitments" with
respect to Municipal Securities held in its portfolio. Under a stand-by
commitment, a dealer agrees to purchase, at the Fund's option, specified
Municipal Securities at a specified price. The Fund may pay for stand-by
commitments either separately in cash or by paying a higher price for the
securities acquired with the commitment, thus increasing the cost of the
securities and reducing the yield otherwise available for them. The Fund intends
to enter into stand-by commitments only with brokers, dealers and banks that, in
the view of SBMFM, present minimal credit risks. In evaluating the
creditworthiness of the issuer of a stand-by commitment, SBMFM will periodically
review relevant financial information concerning the issuer's assets,
liabilities and contingent claims. The Fund will acquire stand-by commitments
solely to facilitate portfolio liquidity and does not intend to exercise its
rights thereunder for trading purposes.

      Certain Investment Guidelines

   
      The Fund may invest up to 10% of its total assets in securities with
contractual or other restrictions on resale and other instruments that are not
readily marketable, including (a) repurchase agreements with maturities greater
than seven days, (b) time deposits maturing from two business days through seven
calendar days and (c) futures contracts and options on them and certain variable
rate demand notes, to the extent that a liquid secondary market does not exist
for these instruments. In addition, the Fund may invest up to 5% of its assets
in the securities of issuers that have been in continuous operation for less
than three years. The Fund also may borrow from banks for temporary or emergency
purposes, but not for investment purposes, in an amount up to 10% of its total
assets, and may pledge its assets to the same extent in connection with such
borrowings. Whenever these borrowings exceed 5% of the value of the Fund's total
assets, the Fund will not make any additional investments. Except for the
limitations on borrowing, the investment guidelines set forth in this paragraph
may be changed at any time without shareholder consent by vote of a majority of
the Trust's Board of Trustees. A complete list of investment restrictions that
identifies additional restrictions that cannot be changed without the approval
of a majority of the Fund's outstanding shares is contained in the Statement of
Additional Information.
    


                                                                              19
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

      Risk Factors and Special Considerations

      Investment in the Fund involves risk factors and special considerations,
such as those described below:

      Municipal Securities. Even though Municipal Securities are
interest-bearing investments that promise a stable stream of income, their
prices are inversely affected by changes in interest rates and, therefore, are
subject to the risk of market price fluctuations. The values of Municipal
Securities with longer remaining maturities typically fluctuate more than those
of similarly rated Municipal Securities with shorter remaining maturities. The
values of fixed-income securities also may be affected by changes in the credit
rating or financial condition of the issuing entities.

      Opinions relating to the validity of Municipal Securities and to the
exemption of interest on them from Federal income taxes are rendered by bond
counsel to the respective issuers at the time of issuance. Neither the Fund nor
SBMFM will review the proceedings relating to the issuance of Municipal
Securities or the basis for opinions of counsel. The Fund may invest without
limit in debt obligations that are repayable out of revenues generated from
economically related projects or facilities or debt obligations whose issuers
are located in the same state. Sizable investments in these obligations could
involve an increased risk to the Fund should any of such related projects or
facilities experience financial difficulties.

      Municipal Leases. Municipal leases, like other municipal debt obligations,
are subject to the risk of non-payment. The ability of issuers of municipal
leases to make timely lease payments may be adversely impacted in general
economic downturns and as relative governmental cost burdens are allocated and
reallocated among Federal, state and local governmental units. Such non-payment
would result in a reduction of income to the Fund, and could result in a
reduction in the value of the municipal lease experiencing non-payment and a
potential decrease in the net asset value of the Fund. Issuers of municipal
leases might seek protection under the bankruptcy laws. In the event of
bankruptcy of such an issuer, the Fund could experience delays and limitations
with respect to the collection of principal and interest on such municipal
leases and the Fund may not, in all circumstances, be able to collect all
principal and interest to which it is entitled. To enforce its right in the
event of a default in lease payments, the Fund may take possession of and manage
the assets securing the issuer's obligations on such securities, which may
increase the Fund's operating expenses and adversely affect the net asset value
of the Fund. Any income derived from the Fund's ownership or operation of such
assets may not be tax-exempt.

      Potential Legislation. In past years, the United States government has
enacted


20
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

various laws that have restricted or diminished the income tax exemption on
various types of Municipal Securities and may enact other similar laws in the
future. If any such laws are enacted that would reduce the availability of
Municipal Securities for investment by the Fund so as to affect the Fund's
shareholders adversely, the Trustees will reevaluate the Fund's investment
objective and policies and might submit possible changes in the Fund's structure
to Fund shareholders for their consideration. If legislation were enacted that
would treat a type of Municipal Securities as taxable for Federal income tax
purposes, the Fund would treat the security as a permissible taxable Temporary
Investment within the applicable limits set forth in this Prospectus.

      Medium-, Low- and Unrated Securities. The Fund may invest in medium-or
low-rated securities commonly known as "junk bonds," and unrated securities of
comparable quality. Generally, these securities offer a higher current yield
than the yield offered by higher-rated securities, but involve greater
volatility of price and risk of loss of income and principal, including the
probability of default by or bankruptcy of the issuers of such securities.
Medium- and low-rated and comparable unrated securities (a) will likely have
some quality and protective characteristics that, in the judgment of the rating
organization, are outweighed by large uncertainties or major risk exposures to
adverse conditions and (b) are predominantly speculative with respect to the
issuer's capacity to pay interest and repay principal in accordance with the
terms of the obligation. These types of factors could, in certain instances,
reduce the value of securities held by the Fund with a commensurate effect on
the value of the Fund's shares. Therefore, an investment in the Fund should not
be considered as a complete investment program and may not be appropriate for
all investors.

      While the market values of medium- and low-rated and comparable unrated
securities tend to react less to fluctuations in interest rate levels than do
those of higher-rated securities, the market values of certain of these
securities also tend to be more sensitive to individual corporate developments
and changes in economic conditions than higher-rated securities. In addition,
medium- and low-rated and comparable unrated securities generally present a
higher degree of credit risk. Issuers of medium- and low-rated and comparable
unrated securities are often highly leveraged and may not have more traditional
methods of financing available to them so that their ability to service their
debt obligations during an economic downturn or during sustained periods of
rising interest rates may be impaired. The risk of loss due to default by such
issuers is significantly greater because medium- and low-rated and comparable
unrated securities generally are unsecured and frequently are subordinated to
the prior payment of senior indebtedness. The Fund may incur additional expenses
to the extent that it is required to seek recovery upon a default in


                                                                              21
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

the payment of principal or interest on its portfolio holdings. In addition, the
markets in which medium- and low-rated securities are traded are generally more
limited than those in which higher-rated securities are traded. The existence of
limited markets for these securities may restrict the availability of securities
for the Fund to purchase and also may have the effect of limiting the ability of
the Fund (a) to obtain accurate market quotations for purposes of valuing
securities and calculating net asset value and (b) to sell securities at their
fair value either to meet redemption requests or to respond to changes in the
economy or the financial markets. The market for medium- and low-rated and
comparable unrated securities is relatively new and has not fully weathered a
major economic recession. Any such recession, however, could likely disrupt
severely the market for such securities, adversely affect the value of such
securities and also could adversely affect the ability of the issuers of such
securities to repay principal and pay interest thereon.

      Fixed-income securities, including medium- and low-rated and comparable
unrated securities, frequently have call or buy-back features that permit their
issuers to call or repurchase the securities from their holders, such as the
Fund. If an issuer exercises these rights during periods of declining interest
rates, the Fund may have to replace the security with a lower yielding security,
resulting in a decreased return to the Fund.

   
      Securities that are rated Ba by Moody's or BB by S&P have speculative
characteristics with respect to capacity to pay interest and repay principal.
Securities that are rated B generally lack characteristics of the desirable
investment, and assurance of interest and principal payments over any long
period of time may be small. Securities that are rated Caa by Moody's or CCC by
S&P are of poor standing. These issues may be in default or present elements of
danger may exist with respect to principal or interest.
    

      In light of these risks described above, SBMFM, in evaluating the
creditworthiness of an issue, whether rated or unrated, will take various
factors into consideration. Those factors may include, as applicable, the
issuer's financial resources, its sensitivity to economic conditions and trends,
the operating history of and the community support for the facility financed by
the issue, the ability of the issuer's management and regulatory matters.

   
      The Fund's holdings in fixed-income securities (as rated by Moody's) for
the fiscal year ended July 31, 1996 were composed as follows: 39.70% rated Aaa; 8.51%
rated Aa; 15.31% rated A; 21.47% rated Baa; 4.40% rated Ba; 1.34% rated B;
0.10% rated Ca or lower; and 9.20% in
non-rated securities. The percentages were calculated on dollar weighted average
basis by determining the percentage of the Fund's net assets invested in
    


22
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

each rating category  during the most recent fiscal year
and do not necessarily indicate what the composition of the
Fund's holdings will be in subsequent years.

      Securities of Unseasoned Issuers. Securities in which the Fund may invest
may have limited marketability and, therefore, may be subject to wide
fluctuations in market value. In addition, certain securities may lack a
significant operating history and be dependent on products or services without
an established market share.

      Non-Publicly Traded and Illiquid Securities. The Fund's sale of securities
that are not publicly traded is typically restricted under the Federal
securities laws. As a result, the Fund may be forced to sell these securities at
less than fair market value or may not be able to sell them when SBMFM believes
it desirable to do so. The Fund's investments in illiquid securities are subject
to the risk that should the Fund desire to sell any of these securities when a
ready buyer is not available at a price that the Fund deems representative of
their value, the value of the Fund's net assets could be adversely affected.

   
      Futures and Options on Futures. When deemed advisable by SBMFM, the Fund
may enter into futures contracts or related options that are traded on a
domestic exchange or board of trade. Such investments, if any, by the Fund will
be made solely for the purpose of hedging against the effects of changes in the
value of its portfolio securities due to anticipated changes in interest rates
and market conditions and when the transactions are economically appropriate to
the reduction of risks inherent in the management of the Fund. The Fund may not
enter into futures and options contracts for which aggregate initial margin
deposits and premium paid for unexpired options to establish such positions that
are not bona fide hedging positions (as defined by the Commodity Futures Trading
Commission), 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 set aside plus
accrued profits held in a segregated account.
    

      The use of futures contracts and options on those contracts as a hedging
device involves several risks. No assurance can be given that a correlation will
exist between price movements in the underlying securities or index, on the one
hand, and price movements in the securities that are the subject of the hedge,
on the other hand. Positions in futures contracts and options on those contracts
may be closed out only on the exchange or board of trade on which they were
entered into, and no assurance can be given that an active market will exist for
a particular contract or option at any particular time. Losses incurred in
hedging transactions and the costs



                                                                              23
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

of these transactions will affect the Fund's performance. Furthermore, because
any interest earned from transactions in municipal bond index futures contracts
and options on interest rate futures contracts will be taxable, it is
anticipated that the Fund will invest in these instruments only in unusual
circumstances, such as when SBMFM anticipates an extreme change in interest
rates or market conditions.

      Portfolio Transactions

      The Fund's portfolio securities ordinarily are purchased from and sold to
parties acting as either principal or agent. Newly issued securities ordinarily
are purchased directly from the issuer or from an underwriter; other purchases
and sales usually are placed with those dealers from which it appears that the
best price or execution will be maintained.

      Usually no brokerage commissions, as such, are paid by the Fund for
purchases and sales undertaken through principal transactions, although the
price paid usually includes an undisclosed compensation to the dealer acting as
agent. The prices paid to underwriters of newly issued securities usually
include a concession paid by the issuer to the underwriter, and purchases of
after-market securities from dealers ordinarily are executed at a price between
the bid and asked price.

      Transactions on behalf of the Fund are allocated to various dealers,
including Smith Barney and other affiliated brokers, by SBMFM in its best
judgment. The primary consideration is prompt and effective execution of orders
at the most favorable price. Subject to that primary consideration, dealers may
be selected for research, statistical or other services to enable SBMFM to
supplement its own research and analysis with the views and information of other
securities firms.

--------------------------------------------------------------------------------
Municipal Securities
--------------------------------------------------------------------------------

      The term "Municipal Securities" generally is understood to include debt
obligations issued to obtain funds for various public purposes, the interest on
which qualifies, in the opinion of bond counsel to the issuer, as excluded from
gross income for Federal income tax purposes. In addition, Municipal Securities
may include "private activity bonds" if the proceeds from such bonds are used
for the construction, equipment, repair or improvement of privately operated
industrial or commercial facilities, and the interest paid on such bonds may be
excluded from gross income for Federal income tax purposes. Current Federal tax
laws place substantial limitations on the aggregate amount of such bonds that
any given state may issue.


24
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Municipal Securities (continued)
--------------------------------------------------------------------------------

      Classifications

      The two principal classifications of Municipal Securities are "general
obligation" and "revenue" bonds. General obligation bonds are secured by the
issuer's pledge of its full faith, credit and taxing power for the payment of
principal and interest. Revenue bonds are payable from the revenues derived from
a particular facility or class of facilities or, in some cases, from the
proceeds of a special excise or other specific revenue source, but not from the
general taxing power. Sizeable investments in such obligations could involve an
increased risk to the Fund should any of such related facilities experience
financial difficulties. Private activity bonds are in most cases revenue bonds
and generally do not carry the pledge of the credit of the issuing municipality.
There are, of course, variations in the security of Municipal Securities, both
within a particular classification and between classifications.

--------------------------------------------------------------------------------
Valuation of Shares
--------------------------------------------------------------------------------

      The Fund's net asset value per share is determined as of the close of
regular 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 that Class outstanding.

      Generally, the Fund's investments are valued at market value or, in the
absence of a market value with respect to any securities, at fair value as
determined by or under the direction of the Trust's Board of Trustees.
Short-term investments that mature in 60 days or less are valued at amortized
cost whenever the Trust's Board of Trustees determine that amortized cost
reflects fair value of those investments. Amortized cost valuation involves
valuing an instrument at its cost initially and, thereafter, assuming a constant
amortization to maturity of any discount or premium, regardless of the impact of
fluctuating interest rates on the market value of the instrument. Further
information regarding the Fund's valuation policies is contained in the
Statement of Additional Information.

--------------------------------------------------------------------------------
Dividends, Distributions and Taxes
--------------------------------------------------------------------------------

      Dividends and Distributions

      The Fund will be treated separately from the Trust's other funds in
determining the amounts of dividends from investment income and distributions of
capital gains payable to shareholders.



                                                                              25
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Dividends, Distributions and Taxes (continued)
--------------------------------------------------------------------------------

      The Fund declares dividends from its net investment income (that is,
income other than its net realized long- and short-term capital gains) monthly
and pays dividends on the last Friday of the month. Distributions of net
realized long- and short-term capital gains, if any, are declared and paid
annually after the end of the fiscal year in which they have been earned.

      If a shareholder does not otherwise instruct, dividends and capital gains
distributions will be reinvested automatically in additional shares of the same
Class at net asset value, subject to no sales charge or CDSC. In addition, in
order to avoid the application of a 4% nondeductible excise tax on certain
undistributed amounts of ordinary income and capital gains, the Fund may make an
additional distribution shortly before December 31 of each year of any
undistributed ordinary income or capital gains and expects to make any other
distributions as are necessary to avoid the application of this tax.

      If, for any full fiscal year, the Fund's total distributions exceed net
investment income and net realized capital gains, the excess distributions
generally will be treated as a tax-free return of capital (up to the amount of
the shareholder's tax basis in his or her shares). The amount treated as a
tax-free return of capital will reduce a shareholder's adjusted basis in his or
her shares. Pursuant to the requirements of the Investment Company Act of 1940,
as amended ("1940 Act") and other applicable laws, a notice will accompany any
distribution paid from sources other than net investment income. In the event
the Fund distributes amounts in excess of its net investment income and net
realized capital gains, such distributions may have the effect of decreasing the
Fund's total assets, which may increase the Fund's expense ratio.

      The per share dividends on Class B shares and Class C shares may be lower
than the per share dividends on Class A and Y shares principally as a result of
the distribution fee applicable with respect to Class B and Class C shares. The
per share dividends on Class A shares of the Fund may be lower than the per
share dividends on Class Y principally as a result of the service fee applicable
to Class A shares. Distributions of capital gains, if any, will be in the same
amount for Classes A, B, C and Y.

      Taxes

      The Fund will be treated as a separate taxpayer with the result that, for
Federal income tax purposes, the amount of investment income and capital gains
earned by the Fund will be determined without regard to the earnings of the
other funds of the Trust. The Fund has qualified and intends to continue to
qualify each year as a "regulated investment company" under the Internal Revenue
Code of 1986,


26
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Dividends, Distributions and Taxes (continued)
--------------------------------------------------------------------------------

as amended. Dividends paid from the Fund's net investment income (other than
dividends derived from interest earned on qualifying tax-exempt obligations as
described below) and distributions of the Fund's net realized short-term capital
gains are taxable to shareholders as ordinary income, regardless of how long
shareholders in the Fund have held their shares and whether the dividends or
distributions are received in cash or reinvested in additional shares of the
Fund. Distributions of the Fund's net realized long-term capital gains will be
taxable to shareholders as long-term capital gains, regardless of how long
shareholders have held their shares of the Fund and whether the distributions
are received in cash or are reinvested in additional Fund shares. In addition,
as a general rule, a shareholder's gain or loss on a sale or redemption of
shares of the Fund will be a long-term capital gain or loss if the shareholder
has held the shares for more than one year and will be a short-term capital gain
or loss if the shareholder has held the shares for one year or less. The per
share dividends and distributions on Class A shares will be higher than the per
share dividends and distributions on Class B shares as a result of lower
distribution and transfer agency fees applicable to Class A shares.

      Dividends paid by the Fund that are derived from interest earned on
qualifying tax-exempt obligations are expected to be "exempt-interest" dividends
that shareholders may exclude from their gross incomes for Federal income tax
purposes if the Fund satisfies certain asset percentage requirements. Any
exempt-interest dividends of a Fund derived from interest on Municipal
Securities, the interest on which is a specific tax preference item for Federal
income tax purposes, will be a specific tax preference item for purposes of the
Federal individual and corporate alternative minimum taxes. In addition, all
exempt-interest dividends will be a component of the "current earnings"
adjustment item for purposes of the Federal corporate alternative minimum income
tax and corporate shareholders may incur a larger Federal environmental tax
liability through the receipt of dividends and distributions from the Fund.

      Statements as to the tax status of the dividends and distributions
received by shareholders of the Fund are mailed annually. These statements set
forth the dollar amount of income excluded from Federal income taxes and the
dollar amount, if any, subject to Federal income taxes. These statements will
also designate the amount of exempt-interest dividends that are a specific
preference item for purposes of the Federal individual and corporate alternative
minimum taxes and will indicate the shareholder's share of the investment
expenses of the Fund. The Fund notifies its shareholders annually as to the
interest excluded from Federal income taxes earned by the Fund with respect to
those states and possessions in which the Fund has or had investments.


                                                                              27
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Dividends, Distributions and Taxes (continued)
--------------------------------------------------------------------------------

      Shareholders should consult their tax advisors with specific reference to
their own tax situations. Shareholders of the Fund should in particular consult
their tax advisors about the status of the Fund's dividends and distributions
for state and local tax purposes in order to assess the consequences of
investing in the Fund under state and local laws generally and to determine
whether dividends paid by the Fund are exempt from any otherwise applicable
state or local income taxes.

      Tax-Exempt vs. Taxable Income

      The table below shows individual taxpayers how to translate the tax
savings from investments such as the Fund into an equivalent return from a
taxable investment. The yields used below are for illustration only and are not
intended to represent current or future yields for the Fund, which may be higher
or lower than those shown.

</TABLE>
<TABLE>
<CAPTION>
                                     Federal
                                    Marginal                  Tax-Exempt Yield
           Taxable Income           Tax Rate*   2.00%   3.00%   4.00%   5.00%    6.00%   7.00%
==============================================================================================
      Single            Joint                         Equivalent Taxable Yield
<C>               <C>                <C>        <C>     <C>     <C>     <C>      <C>      <C>  
$        22,750   $        38,000    15.00%     2.67%   4.01%   5.35%   6.68%    8.02%    9.36%
  22,751-55,100     38,001-91,850    28.00      3.16    4.73    6.31    7.89     9.47    11.05
 55,101-115,000    91,851-140,000    31.00      3.29    4.94    6.59    8.23     9.88    11.5
115,001-250,000   140,001-250,000    36.00      3.55    5.33    7.10    8.88    10.651    2.43
        250,000      over 250,000    39.60      3.76    5.54    7.53    9.41    11.29    13.17
==============================================================================================
</TABLE>
   
* The Federal tax rates shown are those currently in effect for 1996. The
  calculations assume that no income will be subject to the Federal
  alternative minimum tax.
    

--------------------------------------------------------------------------------
Purchase of Shares
--------------------------------------------------------------------------------

      General

      The Fund offers four Classes of shares. Class A shares are sold to
investors with an initial sales charge and Class B and Class C shares are sold
without an initial sales charge but are subject to a CDSC payable upon certain
redemptions. Class Y shares are sold without an initial sales charge or a CDSC,
and are available only to investors investing a minimum of $5,000,000. See
"Prospectus Summary -- Alternative Purchase Arrangements" for a discussion of
factors to consider in selecting which Class of shares to purchase.

      Purchases of Fund shares must be made through a brokerage account
maintained with Smith Barney, an Introducing Broker or an investment dealer in
the selling group. When purchasing shares of the Fund, investors must specify


28
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

whether the purchase is for Class A, Class B, Class C or Class Y shares. No
maintenance fee will be charged by the Fund in connection with a brokerage
account through which an investor purchases or holds shares.

   
      Investors in Class A, Class B and Class C shares may open an account by
making an initial investment of at least $1,000 for each account in the Fund.
Investors in Class Y shares may open an account by making an initial investment
of $5,000,000. Subsequent investments of at least $50 may be made for all
Classes. 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 C shares and the minimum 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 requirement for Class A, Class B and Class C shares and the
subsequent investment requirement for all Classes is $50. There are no minimum
investment requirements for Class A shares for employees of Travelers and its
subsidiaries, including Smith Barney, unit holders who invest distributions from
a UIT sponsored by Smith Barney and Trustees of the Trust 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
Fund's transfer agent, First Data. Share certificates are issued only upon a
shareholder's written request to First Data.

      Purchase orders received by the Fund or Smith Barney 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. Orders
received by dealers or Introducing Brokers 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 Smith Barney prior to Smith Barney's close of business
(the "trade date"). For shares purchased through Smith Barney or Introducing
Brokers purchasing through 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, Smith Barney or First Data is authorized
through preauthorized transfers of $25 or $50 or more to charge the regular bank
account or other financial institution indicated by the shareholder on a monthly
or quarterly
    


                                                                              29
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

   
basis, respectively, to provide 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 Smith Barney or First Data. The Systematic
Investment Plan also authorizes Smith Barney to apply cash held in the
shareholder's Smith Barney brokerage account or redeem the shareholder's shares
of a Smith Barney money market fund to make additions to the account. Additional
information is available from the Fund or a Smith Barney Financial Consultant.
    

      Initial Sales Charge Alternative -- Class A Shares

      The sales charges applicable to purchases of Class A shares of the Fund
are as follows:

                                                                     Dealers
                              Sales Charge      Sales Charge       Reallowance
                                 as % of           as % of           as % of
  Amount of Investment       Offering Price    Amount Invested   Offering Price
================================================================================

Less than $25,000                 4.00%             4.17%             3.60%
$25,000-$49,999                   3.50%             3.63%             3.15%
$50,000-$99,999                   3.00%             3.09%             2.70%
$100,000-$249,999                 2.50%             2.56%             2.25%
$250,000-$499,999                 1.50%             1.52%             1.35%
$500,000 and over                   *                 *                 *
================================================================================

* Purchases of Class A shares, which when combined with current holdings of
  Class A shares offered with a sales charge equal or exceed $500,000 in the
  aggregate, 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 Smith
  Barney, which compensates 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 C shares is waived. See "Deferred Sales Charge Alternatives" 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 reduced sales charges shown above apply to the aggregate of purchases
of Class A shares of the Fund made at one time by "any person," which includes
an individual, his or her spouse and children, or a trustee or other fiduciary
of a single trust estate or single fiduciary account. The reduced sales charge
minimums may also be met by aggregating the purchase with the net asset value of
all Class A shares held in funds sponsored by Smith Barney that are offered with
a sales charge listed under "Exchange Privilege."


30
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

      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 of any of
the Smith Barney Mutual Funds and employees of Travelers and its subsidiaries
(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 seucrities will not be
resold except through redemption or repurchase; (b) offers of Class A shares to
any other investment company in connection with 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 Smith Barney Financial
Consultant (for a period up to 90 days from the commencement of the Financial
Consultant's employment with 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) shareholders who have redeemed Class A shares in the Fund (or
Class A shares of another fund of the Smith Barney Mutual Funds that are offered
with a sales charge equal to or greater than the maximum sales charge of the
Fund) and who wish to reinvest their redemption proceeds in the Fund, provided
the reinvestment is made within 60 calendar days of the redemption; (e) accounts
managed by registered investment advisory subsidiaries of Travelers; and (f)
investments of distributions from a UIT sponsored by Smith Barney. 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.

      Purchases of Class A shares also may be made at net asset value without a
sales charge by investors participating in a Smith Barney fee based arrangement.
    

      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 asset value of all Class A
shares of the Fund and of funds sponsored by Smith Barney which are offered with
a sales charge 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


                                                                              31
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

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.

      Group Purchases

      Upon completion of certain automated systems, a reduced sales charge or
purchase at net asset value will also be available to employees (and partners)
of the same employer purchasing as a group, provided each participant makes the
minimum initial investment required. The sales charge applicable to purchases by
each member of such a group will be determined by the table set forth above
under "Initial Sales Charge Alternatives -- Class A Shares," and will be based
upon the aggregate sales of Class A shares of Smith Barney Mutual Funds offered
with a sales charge to, and share holdings of, all members of the group. To be
eligible for such reduced sales charges or to purchase at net asset value, all
purchases must be pursuant to an employer or partnership-sanctioned plan meeting
certain requirements. One such requirement is that the plan must be open to
specified partners or employees of the employer and its subsidiaries, if any.
Such plan may, but is not required to, provide for payroll deductions. Smith
Barney may also offer a reduced sales charge or net asset value purchase for
aggregating related fiduciary accounts under such conditions that Smith Barney
will realize economies of sales efforts and sales related expenses. An
individual who is a member of a qualified group may also purchase Class A shares
at the reduced sales charge applicable to the group as a whole. The sales charge
is based upon the aggregate dollar value of Class A shares offered with a sales
charge that have been previously purchased and are still owned by the group,
plus the amount of the current purchase. A "qualified group" is one which (a)
has been in existence for more than six months, (b) has a purpose other than
acquiring Fund shares at a discount and (c) satisfies uniform criteria which
enable Smith Barney to realize economies of scale in its costs of distributing
shares. A qualified group must have more than 10 members, must be available to
arrange for group meetings between representatives of the Fund and the members,
and must agree to include sales and other materials related to the Fund in its
publications and mailings to members at no cost to Smith Barney. In order to
obtain such reduced sales charge or to purchase at net asset value, the
purchaser must provide sufficient information at the time of purchase to permit
verification that the purchase qualifies for the reduced sales charge. Approval
of group purchase reduced sales charge plans is subject to the discretion of
Smith Barney.


32
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

      Letter of Intent

   
      Class A Shares. A Letter of Intent for amounts 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
Invested" as referred to in the preceding sales charge table includes purchases
of all Class A shares of the Fund and other funds of the Smith Barney Mutual
Funds offered with a sales charge over a 13 month period based on the total
amount of intended purchases plus the value of all Class A shares previously
purchased and still owned. An alternative is to compute the 13 month period
starting up to 90 days before the date of execution of a Letter of Intent. 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. Please contact a Smith
Barney Financial Consultant or First Data 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. Such investors
must make an initial minimum purchase of $1,000,000 in Class Yshares of the Fund
and agree to purchase a total of $5,000,000 of Class Yshares of the same Fund
within six months from the date of the Letter. If a total investment of
$5,000,000 is not made within the six-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 0.15%)and expenses applicable to the Fund's
Class A shares, which may include a CDSC of 1.00%. The Fund expects that such
transfer will not be subject to Federal income taxes. Please contact a Smith
Barney Financial Consultant or First Datafor further information.
    

      Deferred Sales Charge Alternatives

      "CDSC Shares" are sold at net asset value next determined without an
initial sales charge so that the full amount of an investor's purchase payment
may be immediately invested in the Fund. A CDSC, however, may be imposed on
certain redemptions of these shares. "CDSC Shares" are: (a) Class B shares; (b)
Class C shares; and (c) Class A shares which when combined with Class A shares
offered with a sales charge currently held by an investor equal or exceed
$500,000 in the aggregate.

      Any applicable CDSC will be assessed on an amount equal to the lesser of


                                                                              33
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

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 C shares and Class A shares, that are
CDSC Shares, shares redeemed more than 12 months after their purchase.

      Class C 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 Smith
Barney statement month. The following table sets forth the rates of the charge
for redemptions of Class B shares by shareholders.

        Year Since Purchase
        Payment was Made                                             CDSC
================================================================================
        First                                                        4.50%
        Second                                                       4.00%
        Third                                                        3.00%
        Fourth                                                       2.00%
        Fifth                                                        1.00%
        Sixth                                                        0.00%
        Seventh                                                      0.00%
        Eighth                                                       0.00%
================================================================================

      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. Shareholders who held Class B shares of Smith Barney
Shearson Short-Term World Income Fund (the "Short-Term World Income Fund") on
July 15, 1994 and who subsequently exchange those shares for Class B shares of
the Fund will be offered the opportunity to exchange all such Class B shares for
Class A shares of the Fund four years after the date on which those shares were
deemed to have been purchased. Holders of such Class B shares will be notified
of the pending exchange in writing approximately 30 days before the fourth
anniversary of the purchase date and,


34
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

unless the exchange has been rejected in writing, the exchange will occur on or
about the fourth anniversary date. 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 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 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 shareholders'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) involuntary
redemptions; and (e) redemptions of shares in connection with 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 funds
of the 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.


                                                                              35
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

   
      CDSC waivers will be granted subject to confirmation (by Smith Barney in
the case of shareholders who are also Smith Barney clients or by First Data in
the case of all other shareholders) of the shareholder's status or holdings, as
the case may be.
    

--------------------------------------------------------------------------------
Exchange Privilege
--------------------------------------------------------------------------------

   
      Except as otherwise noted below, shares of each Class may be exchanged at
the net asset value next determined 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 C shares are subject to minimum investment requirements and
all shares are subject to the other requirements of the Fund into which
exchanges are made.
    

Fund Name

Growth Funds

      Smith Barney Aggressive Growth Fund Inc.
      Smith Barney Appreciation Fund Inc.
      Smith Barney Fundamental Value Fund Inc.
      Smith Barney Growth Opportunity Fund
      Smith Barney Managed Growth Fund
   
      Smith Barney Natural Resources Fund Inc.
    
      Smith Barney Special Equities Fund

       

Growth and Income Funds
      Smith Barney Convertible Fund
   
      Smith Barney Funds, Inc. -- Equity Income Portfolio
    
      Smith Barney Growth and Income Fund
      Smith Barney Premium Total Return Fund
      Smith Barney Strategic Investors Fund
      Smith Barney Utilities Fund

Taxable Fixed-Income Funds
    * Smith Barney Adjustable Rate Government Income Fund
      Smith Barney Diversified Strategic Income Fund
   ** Smith Barney Funds, Inc. -- Income Return Account Portfolio
   ++ Smith Barney Funds, Inc. -- Short-Term U.S. Treasury Securities Portfolio
       
      Smith Barney Funds, Inc. -- U.S. Government Securities Portfolio


36
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Exchange Privilege (continued)
--------------------------------------------------------------------------------

      Smith Barney Government Securities Fund 
      Smith Barney High Income Fund
      Smith Barney Investment Grade Bond Fund 
      Smith Barney Managed Governments Fund Inc.

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 Fund
      Smith Barney Muni Funds -- Florida Portfolio
       
      Smith Barney Muni Funds -- Georgia Portfolio
   ** Smith Barney Muni Funds -- Limited Term 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

International Funds
      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 Series Inc.
      Smith Barney Concert Series Inc. -- Balanced Portfolio
      Smith Barney Concert Series Inc. -- Conservative Portfolio
      Smith Barney Concert Series Inc. -- Growth Portfolio
      Smith Barney Concert Series Inc. -- High Growth Portfolio
      Smith Barney Concert Series Inc. -- Income Portfolio
    

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


                                                                              37
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Exchange Privilege (continued)
--------------------------------------------------------------------------------

   ++ 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, Class B and Class Y shares of the
      Fund.
   ** Available for exchange with Class A, Class C and Class Y shares of the
      Fund.
  *** Available for exchange with Class A shares of the Fund.
    + Available for exchange with Class B and Class C shares of the Fund.
   ++ Available for exchange with Class A and Class Y shares of the Fund.

   
      Class B Exchanges. In the event a Class B shareholder (unless such
shareholder was a Class B shareholder of the Short-Term World Income Fund on
July 15, 1994) 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 C Exchanges. Upon an exchange, the new Class C shares will be deemed
to have been purchased on the same date as the Class C 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
imposition 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. SBMFM 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 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
"Redemption of Shares --Telephone Redemption and Exchange Program."


38
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Exchange Privilege (continued)
--------------------------------------------------------------------------------

   
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 the shares of the Fund 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 trading 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 First Data receives
further instructions from Smith Barney, or if the shareholder's account is not
with Smith Barney, from the shareholder directly. The redemption proceeds will
be remitted on or before the third 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 Smith Barney brokerage account, these funds will not be invested
for the shareholder's benefit without specific instruction and Smith Barney will
benefit from the use of temporarily uninvested funds. Redemption proceeds for
shares purchased by check, other than a certified or official bank check, will
be remitted upon clearance of the check, which may take up to ten days or more.
    

      Shares held by Smith Barney as custodian must be redeemed by submitting a
written request to a Smith Barney Financial Consultant. Shares other than those
held by Smith Barney as custodian may be redeemed through an investor's
Financial Consultant, Introducing Broker or a dealer in a selling group or by
submitting a written request for redemption to:


                                                                              39
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Redemption of Shares (continued)
--------------------------------------------------------------------------------

      Smith Barney Tax-Exempt Income Fund
      Class A, B, C or Y (please specify)
      c/o First Data Investor Services Group, Inc.
      P.O. Box 9134 Boston, Massachusetts 02205-9134

   
      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 registered.
If the shares to be redeemed were issued in certificate form, the certificates
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 written redemption
request in excess of $2,000, 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 $2,000 or less do
not require a signature guarantee unless more than one such redemption request
is made in any 10-day period. 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.
    

      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. The withdrawal plan
will be carried over on exchanges between funds or Classes of the Fund. Any
applicable CDSC will not be waived on amounts withdrawn by a shareholder 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. For further information
regarding the automatic cash withdrawal plan, shareholders should contact a
Smith Barney Financial Consultant.

      TELEPHONE REDEMPTION AND EXCHANGE PROGRAM

   
      Shareholders who do not have a 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 contact
First
    


40
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Redemption of Shares (continued)
--------------------------------------------------------------------------------

   
Data at 1-800-451-2010. Once eligibility is confirmed, the shareholder must
complete and return a Telephone/Wire Authorization Form, along with a signature
guarantee that will be provided by First Data upon request. (Alternatively, an
investor may authorize telephone redemptions on the new account application with
the applicant's 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 5:00 p.m.
(New York City time) on any day the NYSE is open. Redemption requests received
after 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 5:00 p.m.
(New York City time) on any day on which the NYSE is open. Exchange requests
received after the close of regular trading on the NYSE are processed 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
instructions 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


                                                                              41
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Redemption of Shares (continued)
--------------------------------------------------------------------------------

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.

--------------------------------------------------------------------------------
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,
however, 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" and
"equivalent taxable yield" of each Class of shares. The yield refers to the
income generated by an investment in those shares over the 30-day period
identified in the advertisement and is computed by dividing the net investment
income per share earned by the Class during the period by the maximum offering
price per share on the last day of the period. This income is "annualized" by
assuming that 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.

      The equivalent taxable yield demonstrates the yield on a taxable
investment necessary to produce an after-tax yield equal to the Fund's
tax-exempt yield for each Class. It is calculated by increasing the yield shown
to the extent necessary to reflect the payment of taxes at specified tax rates.
Thus, the equivalent taxable yield always will exceed the Fund's yield. For more
information on equivalent taxable yields, refer to the table under "Dividends,
Distributions and Taxes."


42
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Performance (continued)
--------------------------------------------------------------------------------

      Total Return

      From time to time the Fund may include the Fund's 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 C 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 gains distributions on the reinvestment
dates at prices calculated as stated in this 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 information 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 or the maximum public offering price (including sales charge) on
the last day of the period for which current dividend return is presented. The
current dividend return for each Class may vary from time to time depending on
market conditions, the composition of its investment portfolio and operating
expenses. These factors and possible 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, Inc. or similar independent
services that monitor the performance of mutual funds or other industry
publications.

--------------------------------------------------------------------------------
Management of the Trust and the Fund
--------------------------------------------------------------------------------

      Board of Trustees

      Overall responsibility for management and supervision of the Fund rests
with the Trust's Board of Trustees. The Trustees approve all significant
agreements between the Trust and companies that furnish services to the Trust
and the Fund, including agreements with the Fund's distributor, investment
adviser, administrator,


                                                                              43
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Management of the Trust and the Fund (continued)
--------------------------------------------------------------------------------

custodian and transfer agent. The day-to-day operations of the Fund are
delegated to the Fund's investment adviser and administrator. The Statement of
Additional Information contains background information regarding each Trustee
and executive officer of the Fund.

      Investment Adviser --SBMFM

   
      SBMFM, located at 388 Greenwich Street, New York, New York 10013, serves
as the Fund's investment adviser. SBMFM is a wholly owned subsidiary of
Holdings. SBMFM (through predecessor entities) has been in the investment
counseling business since 1934 and is a registered investment adviser. SBMFM
renders investment advice to investment companies that had aggregate assets
under management as of September 30, 1996 in excess of $77 billion.
    

      Subject to the supervision and direction of the Fund's Board of Trustees,
SBMFM 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 portfolio
managers and securities analysts who provide research services to the Fund. For
investment advisory services rendered, the Fund pays SBMFM a monthly fee at the
annual rate of 0.40% of the value of its average daily net assets.

      Portfolio Management

      Lawrence T. McDermott, a Managing Director of Smith Barney, has served as
Vice President and Investment Officer of the Fund since it commenced operations
and manages the day to day operations of the Fund, including making all
investment decisions.

   
      Management's discussion and analysis, and additional performance
information regarding the Fund during the fiscal year ended July 31, 1996 is
included in the Annual Report dated July 31, 1996. A copy of the Annual Report
may be obtained upon request and without charge from a Smith Barney Financial
Consultant or by writing or calling the Fund at the address or phone number
listed on page one of this Prospectus.
    

      Administrator --SBMFM

      SBMFM also serves as the Fund's administrator and oversees all aspects of
the Fund's administration. For administration services rendered, the Fund pays
SBMFM a fee at the annual rate of 0.20% of the value of its average daily net
assets.


44
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Distributor
--------------------------------------------------------------------------------

      Smith Barney is located at 388 Greenwich Street, New York, New York 10013.
Smith Barney distributes shares of the Fund as principal underwriter and as such
conducts a continuous offering pursuant to a "best efforts" arrangement
requiring Smith Barney to take and pay for only such securities as may be sold
to the public. Pursuant to a plan of distribution adopted by the Fund under Rule
12b-1 under the 1940 Act (the "Plan"), Smith Barney is paid a service fee with
respect to Class A, Class B and Class C shares of the Fund at the annual rate of
0.15% of the average daily net assets of the respective Class. Smith Barney is
also paid a distribution fee with respect to Class B and Class C shares at the
annual rate of 0.50% and 0.55%, 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 a distribution fee. The fees are used by Smith Barney to pay its
Financial Consultants for servicing shareholder accounts and, in the case of
Class B and Class C shares, to cover expenses primarily intended to result in
the sale of those shares. These expenses include: advertising expenses; the cost
of printing and mailing prospectuses to potential investors; payments to and
expenses of Smith Barney Financial Consultants and other persons who provide
support services in connection with the distribution of shares; interest and/or
carrying charges; and indirect and overhead costs of Smith Barney associated
with the sale of Fund shares, including lease, utility, communications and sales
promotion expenses.

      The payments to Smith Barney Financial Consultants for selling shares of a
Class include a commission or fee paid by the investor or Smith Barney at the
time of sale and, with respect to Class A, Class B and Class C shares, a
continuing fee for servicing shareholder accounts for as long as a shareholder
remains a holder of that Class. Smith Barney Financial Consultants may receive
different levels of compensation for selling different Classes of shares.

      Payments under the Plan with respect to Class B and Class Cshares are not
tied exclusively to the distribution and shareholder service expenses actually
incurred by Smith Barney and the payments may exceed distribution expenses
actually incurred. The Fund's Board of Trustees will evaluate the
appropriateness of the Plan and its payment terms on a continuing basis and in
so doing will consider all relevant factors, including expenses borne by Smith
Barney, amounts received under the Plan and proceeds of the CDSC.


                                                                              45
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Additional Information
--------------------------------------------------------------------------------

      The Trust was organized on March 12, 1985 under the laws of the
Commonwealth of Massachusetts and is a business entity commonly known as a
"Massachusetts Business Trust." Each Class of the Fund represents identical
interests in the Fund's investment portfolio. As a result, the Classes have the
same rights, privileges and preferences, except with respect to: (a) the
designation of each Class; (b) the impact of the respective sales charges, if
any, for each Class; (c) the distribution and/or service fees, if any, borne by
each Class pursuant to the Plan; (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 Trust's Board of Trustees does not anticipate that there will be any
conflicts among the interests of the holders of the different Classes of shares
of the Fund. The Trustees, on an ongoing basis, will consider whether any such
conflict exists and, if so, take appropriate action.

   
      When matters are submitted for shareholder vote, shareholders of each
Class of each Fund will have one vote for each full share owned and a
proportionate, fractional vote for any fractional share held of that Class.
Shares of the Trust will be voted generally on a Trust-wide basis on all
matters, except matters affecting the interests of one Fund or one Class of
shares.
    

      The Trust does not hold annual shareholder meetings. There normally will
be no meetings of shareholders for the purpose of electing Trustees unless and
until such time as less than a majority of the Trustees holding office have been
elected by shareholders. The Trustees will call a meeting for any purpose upon
the written request of holders of 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.

      PNCBank, located at 17th and Chestnut Streets, Philadelphia, PA 19103
serves as custodian of the Trust's investments.

   
      First Data, located at Exchange Place, Boston, Massachusetts 02109, 
serves as the Trust's transfer agent.
    

      The Fund sends its shareholders a semi-annual report and an audited annual
report, which includes a listing of the investment securities held by the Fund
at the end of the reporting period. In an effort to reduce the Fund's printing
and mailing costs, the Trust plans to consolidate the mailing of the Fund's
semi-annual and annual reports by household. This consolidation means that a
household having multiple accounts with the identical address of record will
receive a single copy of each report. Shareholders who do not want this
consolidation to apply to their


                                                                              46
<PAGE>

Smith Barney Tax-Exempt Income Fund

--------------------------------------------------------------------------------
Additional Information (continued)
--------------------------------------------------------------------------------

account should contact their Smith Barney Financial Consultant or the Trust's
transfer agent.
                              ____________________


                                                                              47

<PAGE>

                                                                    SMITH BARNEY
                                                                    ------------

                                                A Member of TravelersGroup[Logo}


                                                                      Tax-Exempt
                                                                          Income
                                                                            Fund


                                                            388 Greenwich Street
                                                        New York, New York 10013



   
                                                                    FD0214 11/96
    



                                   PROSPECTUS

                                                                    SMITH BARNEY
                                                                     Convertible
                                                                            Fund


   
                                                               November 28, 1996
    
                                                   Prospectus begins on page one


[LOGO] Smith Barney Mutual Funds
       Investing for your future.
       Every day.


<PAGE>

Smith Barney Convertible Fund
   
--------------------------------------------------------------------------------
Prospectus                                                     November 28, 1996
--------------------------------------------------------------------------------
    

     388 Greenwich Street
     New York, New York 10013
     (212) 723-9218

     The Smith Barney Convertible Fund (the "Fund") is a diversified fund that
seeks current income and capital appreciation by investing in convertible
securities and in combinations of nonconvertible fixed-income securities and
warrants or call options that together resemble convertible securities. The Fund
is one of a number of funds, each having distinct investment objectives and
policies, making up Smith Barney Income Funds (the "Trust"). The Trust is an
open-end management investment company commonly referred to as a mutual fund.

     This Prospectus sets forth concisely certain information about the Fund and
the Trust, including sales charges, distribution and service fees and expenses,
that prospective investors will find helpful in making an investment decision.
Investors are encouraged to read this Prospectus carefully and retain it for
future reference. Shares of other investment funds offered by the Trust are
described in separate prospectuses that may be obtained by calling the Trust at
the telephone number set forth above or by contacting a Smith Barney Financial
Consultant.

   
     Additional information about the Fund and the Trust is contained in a
Statement of Additional Information dated November 28, 1996, as amended or
supplemented from time to time, that is available upon request and without
charge by calling or writing the Trust at the telephone number or address set
forth above or by contacting a Smith Barney Financial Consultant. The Statement
of Additional Information has been filed with the Securities and Exchange
Commission (the "SEC") and is incorporated by reference into this Prospectus in
its entirety.
    

SMITH BARNEY INC.
Distributor

SMITH BARNEY MUTUAL FUNDS MANAGEMENT INC.
Investment Adviser and Administrator

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.


                                                                               1
<PAGE>

Smith Barney Convertible Fund

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Table of Contents
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Prospectus Summary                                                             3
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Financial Highlights                                                          11
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Investment Objective and Management Policies                                  16
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Valuation of Shares                                                           26
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Dividends, Distributions and Taxes                                            26
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Purchase of Shares                                                            28
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Exchange Privilege                                                            38
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Redemption of Shares                                                          42
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Minimum Account Size                                                          45
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Performance                                                                   45
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Management of the Trust and the Fund                                          46
--------------------------------------------------------------------------------
Distributor                                                                   47
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Additional Information                                                        48
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================================================================================
     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 and
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>

Smith Barney Convertible Fund
   

--------------------------------------------------------------------------------
Prospectus Summary
--------------------------------------------------------------------------------
    

The following summary is qualified in its entirety by detailed information
appearing elsewhere in this Prospectus and in the Statement of Additional
Information. 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 investment
company that seeks current income and capital appreciation by investing in
convertible securities and in combinations of nonconvertible fixed-income
securities and warrants or call options that together resemble convertible
securities ("synthetic convertible securities"). Under normal circumstances, the
Fund will invest at least 65% of its assets in convertible securities, and may
invest up to 35% of its assets in synthetic convertible securities and in equity
and debt securities that are not convertible into common stock. See "Investment
Objective and Management Policies."

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 C
shares, which differ principally in terms of sales charges and rate 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 $5,000,000. 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 5.00% 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, which when
combined with current holdings of Class A shares offered with a sales charge
equal or exceed $500,000 in the aggregate, 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 Summary -- Reduced or No Initial Sales Charge."

     Class B Shares. Class B shares are offered at net asset value subject to a
maximum CDSC of 5.00% of redemption proceeds, declining by 1.00% each year after
the date of purchase to zero. This CDSC may be waived for certain


                                                                               3

<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

redemptions. Class B shares are subject to an annual service 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.

     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 C Shares. Class C shares are sold at net asset value with no initial
sales charge. 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 C shares within 12 months of
purchase. The CDSC may be waived for certain redemptions. The Class C shares'
distribution fee may cause that Class to have higher expenses and pay lower
dividends than Class A shares. Purchases of Fund shares, which when combined
with current holdings of Class C 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 $5,000,000. 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
consider the following factors, as well as any other relevant facts and
circumstances:

     Intended Holding Period. The decision as to which Class of shares is more
beneficial to an investor depends on the amount and intended length 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 charge and the shares are subject to
lower ongoing expenses over the term of the investment. As an alternative, Class
B


4

<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

and Class C 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 these Classes. Because the Fund's future return cannot be
predicted, however, there can be no assurance that this would be the case.

     Finally, investors should consider the effect of the CDSC period and any
conversion rights of the Classes in the context of their own investment time
frame. For example, while Class C 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
C 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
purchases which, when combined with current holdings of Class A shares offered
with a sales charge equal or exceed $500,000 in the aggregate, 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 aggregate
investment may be met by adding the purchase to the net asset value of all Class
A shares offered with a sales charge held in funds sponsored by Smith Barney
Inc. ("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 ongoing expenses of Class A shares may be lower than those
for Class B and Class C shares, purchasers eligible to purchase Class A shares
at net asset value or at a reduced sales charge should consider doing so.

     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 C shares is the same as that of the
initial sales charge on the Class A shares.

     See "Purchase of Shares" and "Management of the Trust and the Fund" for a
complete description of the sales charges and service and distribution fees for
each Class of shares and "Valuation of Shares," "Dividends, Distributions and
Taxes" and "Exchange Privilege" for other differences among the Classes of
shares.
    


                                                                               5

<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

   
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. Other investors may be eligible to participate in the Smith Barney
ExecChoice(TM) Program. Class A, Class B, Class C and Class Y shares are
available without a sales charge as investment alternatives under both of these
Programs. See "Purchase of Shares -- Smith Barney 401(k) and ExecChoice(TM)
Programs."

PURCHASE OF SHARES Shares may be purchased through the Fund's distributor, Smith
Barney, a broker that clears securities transactions through Smith Barney on a
fully disclosed basis (an "Introducing Broker") or an investment dealer in the
selling group. In addition, certain investors, including qualified retirement
plans and certain other institutional investors may purchase shares directly
from the Fund through the Fund's transfer agent, First Data Investor Services
Group, Inc. ("First Data"). See "Purchase of Shares."

INVESTMENT MINIMUMS Investors in Class A, Class B and Class C 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 $5,000,000. 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 C shares and the subsequent investment requirement
for all Classes is $25. For minimum investment requirements for all Classes
through the Systematic Investment Plan see below. There is no minimum investment
requirement in Class A for unitholders who invest distributions from a unit
investment trust ("UIT") sponsored by Smith Barney. See "Purchase 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 and subsequent
investment requirement for shareholders purchasing shares through the
    


6

<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

   
Systematic 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
"Redemption of Shares."

MANAGEMENT OF THE TRUST AND THE FUND Smith Barney Mutual Funds Management Inc.
("SBMFM") serves as the Fund's investment adviser and administrator. SBMFM
provides investment advisory and management services to investment companies
affiliated with Smith Barney. SBMFM is a wholly owned subsidiary of Smith Barney
Holdings Inc. ("Holdings"), which is in turn a wholly owned subsidiary of
Travelers Group Inc. ("Travelers"), a diversified financial services holding
company engaged, through its subsidiaries, principally in four business
segments: Investment Services, Consumer Finance Services, Life Insurance
Services and Property & Casualty Insurance Services.

   
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 respective
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 Smith Barney Financial Consultants. See "Valuation of Shares."

DIVIDENDS AND DISTRIBUTIONS Dividends are paid monthly from net investment
income and distributions of net realized capital gains, if any, are declared and
paid 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 distribution
reinvestments will become eligible for conversion to Class A shares on a pro
rata basis. See "Dividends, Distributions and Taxes."


                                                                               7

<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

RISK FACTORS AND SPECIAL CONSIDERATIONS There can be no assurance that the
Fund's investment objective will be achieved. The market value of fixed-income
securities, which constitute a major part of the investments of the Fund, may
vary inversely in response to changes in prevailing interest rates. The foreign
securities in which the Fund may invest may be subject to certain risks in
addition to those inherent in domestic investments. The medium- or lower-rated
securities in which the Fund may invest, some of which have speculative
characteristics, may be subject to greater market fluctuations and greater risk
of loss of income or principal than higher-rated securities. The Fund may employ
investment techniques which involve certain other risks, including entering into
repurchase agreements, engaging in when-issued and delayed-delivery
transactions, lending portfolio securities, entering into options on securities
and short sales "against the box." See "Investment Objective and Management
Policies."


8

<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

THE FUND'S EXPENSES The following expense table lists the costs and expenses 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:

                                              Class A  Class B  Class C  Class Y
================================================================================
Shareholder Transaction Expenses
  Maximum sales charge imposed on purchases
   (as a percentage of offering price)        5.00%    None     None     None
  Maximum CDSC                                                           
   (as a percentage of original cost or                                  
   redemption proceeds whichever is lower)    None*    5.00%    1.00%    None
================================================================================
Annual Fund Operating Expenses                                           
  (as a percentage of average net assets)                                
  Management fees                             0.70%    0.70%    0.70%    0.70%
  12b-1 fees**                                0.25%    0.75%    0.70%    None
   
  Other expenses                              0.45%    0.45%    0.46%    0.30%
================================================================================
TOTAL FUND OPERATING EXPENSES                 1.40%    1.90%    1.86%    1.00%
    
================================================================================
   
*  Purchases of Class A shares, which when combined with current holdings of
   Class A shares offered with a sales charge, equal or exceed $500,000 in
   theaggregate, 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 C shares do not have a
   conversion feature and, therefore, are subject to an ongoing distribution
   fee. As a result, long-term shareholders of Class C shares may pay more than
   the economic equivalent of the maximum front-end sales charge permitted by
   the National Association of Securities Dealers, Inc.

       
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 B, Class C 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) Program.
See "Purchase of Shares" and "Redemption of Shares." Smith Barney receives an
annual 12b-1 service fee of 0.25% of the value of average daily net assets of
Class A shares. Smith Barney also receives, with respect to Class B shares, an
annual 12b-1 fee of 0.75% of the value of average daily net assets of that
Class, consisting of a 0.50% distribution fee and a 0.25% service fee. For Class
C shares, Smith Barney receives an annual 12b-1 fee of 0.70% of the value of
average daily net assets, consisting of a 0.45% distribution 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.


                                                                               9

<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Prospectus Summary (continued)
--------------------------------------------------------------------------------

EXAMPLE The following example is intended to assist an investor in understanding
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 Trust and the Fund."

                                         1 Year    3 Years   5 Years   10 Years*
================================================================================
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                               $64       $92      $123       $210
      Class B                                69        90       113        209
      Class C                                29        58       101        218
      Class Y                                10        32        55        122
    
An investor would pay the following                                     
expenses on the same investment,                                        
assuming the same annual return and no                                  
redemption:                                                             
   
      Class A                               $64       $92      $123       $210
      Class B                                19        60       103        209
      Class C                                19        58       101        218
      Class Y                                10        32        55        122
    
================================================================================

* 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
representation of past or future expenses and actual expenses may be greater or
less than those shown. 


10

<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Financial Highlights
--------------------------------------------------------------------------------

   
The following information for the two year period ended July 31, 1996, has been
audited by KPMG Peat Marwick LLP, independent auditors, whose report thereon
appears in the Fund's Annual Report dated July 31, 1996. The following
information for the fiscal years ended July 31, 1987 through July 31, 1994 has
been audited by other independent auditors. The information set out below 
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 Additional Information. 
    

For a Class A share of beneficial interest outstanding throughout each period:

<TABLE>
<CAPTION>
   
                                              Year         Year        Year       Period
                                              Ended        Ended       Ended       Ended
                                            7/31/96(1)    7/31/95     7/31/94    7/31/93(2)
==========================================================================================
<S>                                         <C>          <C>          <C>         <C>     
Net Asset Value, Beginning of Year          $   15.27    $   14.56    $  14.99    $  13.82
------------------------------------------------------------------------------------------
Income From Operations:
  Net investment income                          0.74         0.74        0.72        0.49
  Net realized and unrealized gain (loss)
  on investments                                 0.38         0.70       (0.42)       1.22
------------------------------------------------------------------------------------------
Total Income From Operations                     1.12         1.44        0.30        1.71
------------------------------------------------------------------------------------------
Less Distributions From:
  Net investment income                         (0.73)       (0.73)      (0.70)      (0.50)
  Overdistribution of net investment income       --           --        (0.03)      (0.01)
  Overdistribution of net realized gains          --           --          --        (0.03)
------------------------------------------------------------------------------------------
Total Distributions                             (0.73)       (0.73)      (0.73)      (0.54)
------------------------------------------------------------------------------------------
Net Asset Value, End of Year                $   15.66    $   15.27    $  14.56    $  14.99
------------------------------------------------------------------------------------------
Total Return++                                   7.41%       10.35%       1.99%      12.63%#
------------------------------------------------------------------------------------------
Net Assets, End of Year (000s)              $  34,888    $  35,238    $  2,294    $  1,655
------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
  Expenses                                       1.40%        1.40%       1.40%       1.37%+
  Net investment income                          4.65         5.13        4.80        4.86+
------------------------------------------------------------------------------------------
Portfolio Turnover Rate                            59%          48%         54%         95%
------------------------------------------------------------------------------------------
Average Commissions  per Share
Paid on Equity Transactions(3)              $    0.06          --          --          --
    
==========================================================================================
</TABLE>
   
(1)  Per share amounts have been calculated using the monthly average shares
     method, which more appropriately presents per share data for this year
     since use of the undistributed income method did not accord with result of
     operations.
(2)  For the period from November 6, 1992 (inception date) to July 31, 1993.
(3)  As of September 1995, the SEC has instituted new guidelines requiring the
     disclosure of average commissions per share. 
    
#    Total return is not annualized as it may not be representative of the total
     return for the year.
+    Annualized.
++   Total return represents aggregate total return for the period indicated and
     does not reflect any applicable sales charge.


                                                                              11
<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Financial Highlights (continued)
--------------------------------------------------------------------------------

For a Class B share of beneficial interest outstanding throughout each period:

<TABLE>
<CAPTION>
   
                                                Year         Year          Year           Year          Year        
                                                Ended        Ended         Ended          Ended         Ended       
                                              7/31/96(1)    7/31/95       7/31/94        7/31/93       7/31/92      
==============================================================================================================
<S>                                           <C>           <C>           <C>           <C>           <C>           
Net Asset Value, Beginning of 
  Period                                      $  15.27      $  14.56      $  14.99      $  13.84      $  12.51      
--------------------------------------------------------------------------------
Income From Operations:
  Net investment income                           0.66          0.67          0.65          0.61          0.64      
  Net realized and unrealized
  gain (loss) on investments                      0.39          0.70         (0.42)         1.20          1.35      
--------------------------------------------------------------------------------------------------------------
Total Income From Operations                      1.05          1.37          0.23          1.81          1.99      
--------------------------------------------------------------------------------------------------------------
Less Distributions From:
  Net investment income                          (0.66)        (0.66)        (0.64)        (0.60)        (0.64)     
  Overdistribution of net investment
    income                                         --            --          (0.02)        (0.02)          --         
  Net realized gains                               --            --            --          (0.04)          --         
  Capital                                          --            --            --            --          (0.02)     
--------------------------------------------------------------------------------------------------------------
Total Distributions                              (0.66)        (0.66)        (0.66)        (0.66)        (0.66)     
--------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Period                $  15.66      $  15.27      $  14.56      $  14.99      $  13.84      
--------------------------------------------------------------------------------------------------------------
Total Return++                                    6.91%         9.80%         1.50%        13.40%        16.25%     
--------------------------------------------------------------------------------------------------------------
Net Assets, End of Period (000s)              $ 42,420      $ 45,524      $ 85,190      $ 74,857      $ 57,120      
Ratios to Average Net Assets:
  Expenses                                        1.90%         1.90%         1.88%         2.00%         1.88%     
  Net investment income                           4.18          4.63          4.32          4.20          4.76      
--------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                             59%           48%           54%           95%           77%     
--------------------------------------------------------------------------------------------------------------
Average Commissions Per Share
  Paid on Equity Transactions(2)              $   0.06           --            --            --            --       
==============================================================================================================
    
</TABLE>

   
(1)  Per share amounts have been calculated using the monthly average shares
     method, which more appropriately presents per share data for this year
     since use of the undistributed income method did not accord with result of
     operations.
(2)  As of September 1995, the SEC has instituted new guidelines requiring the
     disclosure of average commissions per share.
    


12

<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Financial Highlights (continued)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                Year         Year           Year          Year            Year           
                                                Ended        Ended          Ended         Ended           Ended          
                                               7/31/91      7/31/90        7/31/89       7/31/88        7/31/87(1)       
=====================================================================================================================
<S>                                           <C>          <C>            <C>           <C>             <C>              
Net Asset Value, Beginning of                                                                                            
  Period                                      $  12.21     $   13.80      $   13.04     $    13.93      $   13.00        
---------------------------------------------------------------------------------------------------------------------
Income From Operations:                                                                                                  
  Net investment income                           0.68          0.79           0.85           0.87           0.63        
  Net realized and unrealized                                                                                            
    gain (loss) on investments                    0.33         (1.40)          0.78          (0.64)          0.95        
---------------------------------------------------------------------------------------------------------------------
Total Income From Operations                      1.01         (0.61)          1.63           0.23           1.58        
---------------------------------------------------------------------------------------------------------------------
Less Distributions From:                                                                                                 
  Net investment income                          (0.68)        (0.83)         (0.86)         (0.85)         (0.62)       
  Overdistribution of net investment                                                                                     
    income                                         --            --             --             --             --           
  Net realized gains                               --          (0.11)         (0.01)         (0.27)         (0.03)       
  Capital                                        (0.03)        (0.4)            --             --             --         
---------------------------------------------------------------------------------------------------------------------
Total Distributions                              (0.71)        (0.98)         (0.87)         (1.12)         (0.65)       
---------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Period                $  12.51     $   12.21      $   13.80     $    13.04      $   13.93        
---------------------------------------------------------------------------------------------------------------------
Total Return++                                    8.86%        (4.53)         13.09%          2.22%         12.34%#     
---------------------------------------------------------------------------------------------------------------------
Net Assets, End of Period (000s)              $ 65,523     $  97,157      $ 153,157     $  172,587      $ 235,685        
Ratios to Average Net Assets:                                                                                            
  Expenses                                        1.92%         1.85%          1.74%          1.75%          1.78%+**    
  Net investment income                           5.81          6.10%          6.41%          6.74%          5.85%+      
---------------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate                             26%           24             32%            45%            21%
   
Average Commissions Per Share                                                                                            
  Paid on Equity Transactions(2)                   --            --             --             --             --            
    
=====================================================================================================================
</TABLE>

(1)  For the period from September 9, 1986 (commencement of operations) to July
     31, 1987 
#    Total return is not annualized as it may not be representative of the total
     return for the year.
+    Annualized.
++   Total return represents aggregate total return for the period indicated and
     does not reflect any applicable sales charge. 
**   Annualized expense ratio before waiverof fees by investment adviser and
     sub-investment adviser and administrator was 1.82%.


                                                                              13

<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Financial Highlights (continued)
--------------------------------------------------------------------------------
   
For a Class C share of beneficial interest outstanding throughout each period:
    

   
                                                 Year         Period
                                                 Ended         Ended
                                              7/31/96(1)   7/31/95(2)(3)
================================================================================
Net Asset Value, Beginning of Period             $15.27        $14.09
--------------------------------------------------------------------------------
Income From Operations:
  Net investment income                            0.67          0.50
  Net realized and unrealized
    gain on investments                            0.37          1.17
--------------------------------------------------------------------------------
Total Income From Operations                       1.04          1.67
--------------------------------------------------------------------------------
Less Distributions From:
  Net investment income                           (0.67)        (0.49)
--------------------------------------------------------------------------------
Total Distributions                               (0.67)        (0.49)
--------------------------------------------------------------------------------
Net Asset Value, End of Period                   $15.64        $15.27
--------------------------------------------------------------------------------
Total Return++                                     6.82%        12.17%#
--------------------------------------------------------------------------------
Net Assets, End of Period (000s)                 $  641        $   83
--------------------------------------------------------------------------------
Ratios to Average Net Assets:
  Expenses                                         1.86%         1.87%+
  Net investment income                            4.17          4.77+
--------------------------------------------------------------------------------
Portfolio Turnover Rate                              59%           48%
--------------------------------------------------------------------------------
Average Commissions per Share
  Paid on Equity Transactions (4)                 $0.06            --
================================================================================
(1)  Per share amounts have been calculated using the monthly average shares
     method, which more appropriately presents per share data for this year
     since use of the undistributed income method did not accord with result of
     operations.
(2)  On November 7, 1994, the former Class D shares were renamed Class C shares.
(3)  For the period from November 7, 1994 (inception date) to July 31, 1995.
(4)  As of September 1995, the SEC has instituted new guidelines requiring the
     disclosure of average commissions per share.
    
#    Total return is not annualized as it may not be representative of the total
     return for the year.
+    Annualized.
++   Total return represents aggregate total return for the period indicated and
     does not reflect any applicable sales charge.


14
<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Financial Highlights (continued)
--------------------------------------------------------------------------------
   
For a Class Y share of beneficial interest outstanding throughout each year

                                                            Year
                                                            Ended
                                                         7/31/96(1)(2)
================================================================================
Net Asset Value, Beginning of Year                          $16.15
--------------------------------------------------------------------------------
Income (Loss) From Operations:
  Net investment income                                       0.38
  Net realized and unrealized loss                           (0.46)
--------------------------------------------------------------------------------
Total Loss From Operations                                 (0.08)
--------------------------------------------------------------------------------
Less Distributions From:
  Net investment income                                      (0.39)
--------------------------------------------------------------------------------
Total Distributions                                          (0.39)
--------------------------------------------------------------------------------
Net Asset Value, End of Year                                $15.68
--------------------------------------------------------------------------------
Total Return++                                               (0.56)%
--------------------------------------------------------------------------------
Net Assets, End of Year (000s)                              $9,189
--------------------------------------------------------------------------------
Ratios to Average Net Assets:+
  Expenses                                                    1.00%
  Net investment income                                       4.98
--------------------------------------------------------------------------------
Portfolio Turnover Rate                                         59%
--------------------------------------------------------------------------------
Average Commissions per Share
Paid on Equity Transactions(3)                               $0.06
================================================================================
(1) Per share amounts have been calculated using the monthly average shares
    method, which more appropriately presents per share data for this year since
    use of the undistributed income method did not accord with results of
    operations.
(2) For the period from February 7, 1996 (inception date) to July 31, 1996.
(3) As of September 1995, the SEC has instituted new guidelines requiring the
    disclosure of average commissions per share.
++  Total return is not annualized as it may not be representative of the total
    return for the year.
+   Annualized.
    


                                                                              15
<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies
--------------------------------------------------------------------------------

     The Fund's investment objective is current income and capital appreciation.
The Fund's investment objective may not be changed without the approval of a
majority of the Fund's outstanding shares. There can be no assurance that the
Fund's investment objective will be achieved.

   
     The Fund seeks to achieve its objective by investing in convertible
securities and "synthetic convertible securities." Under normal circumstances,
the Fund will invest at least 65% of its assets in convertible securities. The
Fund is not required to sell securities to conform to this 65% limitation and
may retain on a temporary basis securities received upon conversion of
convertible securities or upon exercise of warrants or call options that are
components of synthetic convertible securities to permit their orderly
disposition, to establish long-term holding periods for tax purposes or for
other reasons. The Fund will not invest in fixed-income securities that are
rated lower than B by Moody's Investors Services, Inc. ("Moody's") or Standard &
Poor's Ratings Group ("S&P") or, if unrated, deemed by SBMFM to be comparable to
securities rated lower than B. The Fund may invest up to 35% of its assets in
synthetic convertible securities and in equity and debt securities that are not
convertible into common stock and, for temporary defensive purposes when deemed
appropriate by the Fund's investment adviser in light of current market
conditions, may invest in these securities without limitation. In seeking to
achieve its investment objective, the Fund may write covered call options on a
small portion of its assets, lend portfolio securities and enter into short
sales "against the box." The Fund may utilize up to 10% of its assets to
purchase put options on securities for hedging purposes and may invest up to 10%
of its assets in foreign securities. Special considerations associated with the
Fund are described under "Risk Factors and Special Considerations."
    

     CERTAIN INVESTMENT STRATEGIES

     In attempting to achieve its investment objective, the Fund may employ,
among others, one or more of the strategies set forth below. More detailed
information concerning these strategies and their related risks is contained in
the Statement of Additional Information.

     In the future, the Fund may desire to employ additional investment
strategies, including such hedging strategies as entering into futures contracts
and related options. The Fund will do so only upon 60 days' notice to
shareholders and in conformity with its investment restrictions.

     Lending of Portfolio Securities. The Fund has the ability to lend portfolio
securities to brokers, dealers and other financial organizations. These loans,
if and


16
<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

when made, may not exceed 20% of the Fund's assets taken at value. Loans of
portfolio securities will be collateralized by cash, letters of credit or U.S.
government securities that are maintained at all times in an amount at least
equal to the current market value of the loaned securities. Any gain or loss in
the market price of the securities loaned that might occur during the term of
the loan would be for the account of the Fund.

     Short Sales Against the Box. The Fund may make short sales of common stock
if, at all times when a short position is open, the Fund owns the stock or owns
preferred stocks or debt securities convertible or exchangeable, without payment
of further consideration, into the shares of common stock sold short. Short
sales of this kind are referred to as short sales "against the box." The
broker-dealer that executes a short sale generally invests cash proceeds of the
sale until they are paid to the Fund. Arrangements may be made with the
broker-dealer to obtain a portion of the interest earned by the broker on the
investment of short sale proceeds. The Fund will segregate the common stock or
convertible or exchangeable preferred stock or debt securities in a special
account with PNC Bank, National Association ("PNCBank"), the Trust's custodian.
The Fund may utilize up to 50% of its assets as collateral for short sales
against the box. The extent to which the Fund may make short sales of common
stocks may be limited by the requirements contained in the Code for
qualification as a regulated investment company. See "Dividends, Distributions
and Taxes."

     Covered Option Writing. The Fund may write call options on securities. The
Fund realizes fees (referred to as "premiums") for granting the rights evidenced
by the options. A call option embodies the right of its purchaser to compel the
writer of the option to sell to the option holder an underlying security at a
specified price at any time during the option period. Thus, the purchaser of a
call option written by the Fund 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 call option written by the Fund, 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 will write only covered
options. Accordingly, whenever the Fund writes a call option, it will continue
to own or have the present right to acquire the underlying security for as long
as it remains obligated as the writer of the option.

     The Fund may engage in a closing purchase transaction to realize a profit,
to prevent an underlying security from being called or put or to unfreeze an
underlying


                                                                              17


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

security (thereby permitting its sale or the writing of a new option on the
security prior to the outstanding option's expiration). To effect a closing
purchase transaction, the Fund would purchase, prior to the holder's exercise of
an option that the Fund has written, an option of the same series as that on
which the Fund desires to terminate its obligation. The obligation of the Fund
under an option that it has written would be terminated by a closing purchase
transaction, but the Fund would not be deemed to own an option as the result of
the transaction. There can be no assurance that the Fund will be able to effect
closing purchase transactions at a time when it wishes to do so. To facilitate
closing purchase transactions, however, the Fund will write options only if a
secondary market for the options exists on a domestic securities exchange or in
the over-the-counter market.

   
     Purchasing Put and Call Options on Securities. The Fund may purchase put
and call options that are traded on a domestic securities exchange. The Fund may
utilize up to 10% of its assets to purchase put options on portfolio securities
and may do so at or about the same time that it purchases the underlying
security or at a later time. By buying a put, the Fund limits the risk of loss
from a decline in the market value of the security until the put expires. Any
appreciation in the value of the yield otherwise available from the underlying
security, however, will be partially offset by the amount of the premium paid
for the put option and any related transaction costs. Call options may be
purchased by the Fund in order to acquire the underlying securities for the Fund
at a price that avoids any additional cost that would result from a substantial
increase in the market value of a security. The Fund also may purchase call
options to increase its return to investors at a time when the call is expected
to increase in value due to anticipated appreciation of the underlying security.
    

     Prior to their expirations, put and call options may be sold in closing
sale transactions (sales by the Fund, prior to the exercise of options that it
has purchased, or options of the same series), and profit or loss from the sale
will depend on whether the amount received is more or less than the premium paid
for the option plus the related transaction costs.


	Futures and Options on Futures.  Beginning February 10, 1997, when 
deemed advisable by Smith Barney Mutual Funds Management Inc., the Fund's 
investment adviser, the Fund may enter into interest rate futures contracts, 
stock index futures contracts and related options that are traded on a 
domestic exchange or board of trade.  These transactions will be made solely 
for the purpose of hedging against the effects of changes in the value of 
portfolio securities due to anticipated changes in interest rates and market 
conditions, as the case may be.  All futures and options contracts will be 
entered into only when the transactions are economically appropriate for the 
reduction of risks inherent in the management of the Fund.

	An interest rate futures contract provides for the futures sale by the 
one party and the purchase by the other party of a specified amount of a 
particular financial instrument (debt security) at a specified price, date, 
time and place.  A stock index futures contract is an agreement pursuant to 
which two parties agree to take or make delivery of an amount of cash equal to 
the difference between the value of the index at the close of the last trading 
day of the contract and the price at which the index contract was originally 
entered into.  Stock index futures contracts are based on indexes that reflect 
the market value of common stock of the companies included in the indexes.  An 
option on an interest rate or stock index contract gives the purchaser the 
right, in return for the premium paid, to assume a position in a futures 
contract (a long position if the option is a call and a short position if the 
option is a put) at a specified exercise price at any time prior to the 
expiration date of the option.

	In entering into transactions involving futures contracts and options on 
futures contracts, the Fund will comply with applicable requirements of the 
Commodities Futures Trading Commission (the "CFTC") which require that its 
transactions in futures and options be engaged in for "bona fide hedging" 
purposes or other permitted purposes, provided that aggregate initial margin 
deposits and premiums required to establish positions, other than those 
considered by the CFTC to be "bona fide hedging," will not exceed 5% of the 
Fund's net asset value, after taking into account unrealized profits and 
unrealized losses on any such contracts.

	The use of futures contracts and options on futures contracts as a 
hedging device involves several risks.  There can be no assurance that there 
will be a correlation between price movements in the underlying securities or 
index on the one hand, and price movements in the securities that are the 
subject of the hedge, on the other hand.  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 for a particular contract or option at any 
particular time.


     ADDITIONAL INVESTMENTS

     Money Market Instruments. When SBMFM believes that market conditions
warrant, the Fund may adopt a temporary defensive posture and may invest in
short-term instruments without limitation. Short-term instruments in which the
Fund may invest include: U.S. government securities; certain bank obligations
(including certificates of deposit, time deposits and bankers' acceptances of
domestic or foreign banks, domestic savings and loan associations and similar


18


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

institutions); commercial paper rated no lower than A-2 by S&P or Prime-2 by
Moody's or the equivalent from another major rating service or, if unrated, of
an issuer having an outstanding, unsecured debt issue then rated within the
three highest rating categories; and repurchase agreements as described below.

     U.S. Government Securities. The U.S. government securities in which the
Fund may invest include: direct obligations of the United States Treasury (such
as Treasury Bills, Treasury Notes and Treasury Bonds), and obligations issued by
U.S. government agencies and instrumentalities, including securities that are
supported by the full faith and credit of the United States (such as Government
National Mortgage Association ("GNMA") certificates); 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 securities that are
supported by the credit of the instrumentality. Treasury Bills have maturities
of less than 1 year, Treasury Notes have maturities of 1 to 10 years and
Treasury Bonds generally have maturities of greater than 10 years at the date of
issuance. Certain U.S. government securities, such as those issued or guaranteed
by GNMA, Federal National Mortgage Association ("FNMA") and Federal Home Loan
Mortgage Corporation ("FHLMC"), are mortgage-related securities. U.S. government
securities generally do not involve the credit risks associated with other types
of interest-bearing securities, although, as a result, the yields available from
U.S. government securities are generally lower than the yields available from
interest-bearing corporate securities.

     Repurchase Agreements. The Fund may engage in repurchase agreement
transactions 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 relatively 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. This arrangement results
in a fixed rate of return that is not subject to market fluctuations during the
Fund's holding period. The value of the underlying securities will be at least
equal at all times to the total amount of the repurchase obligation, including
interest. 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 possible 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


                                                                              19


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

   
part of the income from the agreement. SBMFM, acting under the supervision of
the Board of Trustees, 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.
    

     CERTAIN INVESTMENT GUIDELINES

     Up to 15% of the assets of the Fund may be invested in securities with
contractual or other restrictions on resale and other instruments that are not
readily marketable, including (a) repurchase agreements with maturities greater
than seven days and (b) time deposits maturing from two business days through
seven calendar days. Not withstanding the foregoing, the Fund shall not invest
more than 10% of its net assets on securities excluding those subject to Rule
144A under the Securities Act of 1933, as amended, that are restricted. In
addition, the Fund may invest up to 5% of its assets in the securities of
issuers which have been in continuous operation for less than three years. The
Fund also may borrow from banks for temporary or emergency purposes, but not for
investment purposes, in an amount up to 10% of its total assets, and may pledge
its assets to the same extent in connection with such borrowings. Whenever these
borrowings exceed 5% of the value of the Fund's total assets, the Fund will not
make any additional investments. Except for the limitations on borrowing, the
investment guidelines set forth in this paragraph may be changed at any time
without shareholder consent by vote of the Trust's Board of Trustees. A complete
list of investment restrictions that identifies additional restrictions that
cannot be changed without the approval of the majority of the Fund's outstanding
shares is contained in the Statement of Additional Information.

     RISK FACTORS AND SPECIAL CONSIDERATIONS

     Convertible Securities and Synthetic Convertible Securities. Convertible
securities are fixed-income securities that may be converted at either a stated
price or stated rate into underlying shares of common stock. Convertible
securities have general characteristics similar to both fixed-income and equity
securities. Although to a lesser extent than with fixed-income securities
generally, the market value of convertible securities tends to decline as
interest rates increase and, conversely, tends to increase as interest rates
decline. In addition, because of the conversion feature, the market value of
convertible securities tends to vary with fluctuations in the market value of
the underlying common stocks and, therefore, also will react to variations in
the general market for equity securities. A unique feature of convertible
securities is that as the market price of the underlying common stock


20


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

declines, convertible securities tend to trade increasingly on a yield basis,
and so may not experience market value declines to the same extent as the
underlying common stock. When the market price of the underlying common stock
increases, the prices of the convertible securities tend to rise as a reflection
of the value of the underlying common stock. While no securities investments are
without risk, investments in convertible securities generally entail less risk
than investments in common stock of the same issuer.

     As fixed-income securities, convertible securities are investments which
provide for a stable stream of income with generally higher yields than common
stocks. Of course, like all fixed-income securities, there can be no assurance
of current income because the issuers of the convertible securities may default
on their obligations. Convertible securities, however, generally offer lower
interest or dividend yields than non-convertible securities of similar quality
because of the potential for capital appreciation. A convertible security, in
addition to providing fixed income, offers the potential for capital
appreciation through the conversion feature, which enables the holder to benefit
from increases in the market price of the underlying common stock. However,
there can be no assurance of capital appreciation because securities prices
fluctuate.

     Convertible securities generally are subordinated to other similar but
non-convertible securities of the same issuer, although convertible bonds, as
corporate debt obligations, enjoy seniority in right of payment to all equity
securities, and convertible preferred stock is senior to common stock of the
same issuer. Because of the subordination feature, however, convertible
securities typically have lower ratings than similar non-convertible securities.

     Unlike a convertible security which is a single security, a synthetic
convertible security is comprised of two distinct securities that together
resemble convertible securities in certain respects. Synthetic convertible
securities are created by combining non-convertible bonds or preferred stocks
with warrants or stock call options. The options that will form elements of
synthetic convertible securities will be listed on a securities exchange or on
the National Association of Securities Dealers Automated Quotations System. The
two components of a synthetic convertible security, which will be issued with
respect to the same entity, generally are not offered as a unit, and may be
purchased and sold by the Fund at different times. Synthetic convertible
securities differ from convertible securities in certain respects, including
that each component of a synthetic convertible security has a separate market
value and responds differently to market fluctuations. Investing in synthetic
convertible securities involves the risks normally involved in holding the
securities comprising the synthetic convertible security.


                                                                              21


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

     Medium-, Low- and Unrated Securities. The Fund may invest in medium- or
low-rated securities and unrated securities of comparable quality. Generally,
these securities offer a higher current yield than the yield offered by
higher-rated securities but involve greater volatility of price and risk of loss
of income and principal, including the probability of default by or bankruptcy
of the issuers of such securities. Medium- and low-rated and comparable unrated
securities (a) will likely have some quality and protective characteristics
that, in the judgment of the rating organization, are outweighed by large
uncertainties or major risk exposures to adverse conditions and (b) are
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligation. Accordingly,
it is possible that these types of factors could, in certain instances, reduce
the value of securities held by the Fund, with a commensurate effect on the
value of the Fund's shares. Therefore, an investment in the Fund should not be
considered as a complete investment program and may not be appropriate for all
investors.

     While the market values of medium- and low-rated and comparable unrated
securities tend to react less to fluctuations in interest rate levels than do
those of higher-rated securities, the market values of certain of these
securities also tend to be more sensitive to individual corporate developments
and changes in economic conditions than higher-rated securities. In addition,
medium- and low-rated and comparable unrated securities generally present a
higher degree of credit risk. Issuers of medium- and low-rated and comparable
unrated securities are often highly leveraged and may not have more traditional
methods of financing available to them so that their ability to service their
debt obligations during an economic downturn or during sustained periods of
rising interest rates may be impaired. The risk of loss due to default by such
issuers is significantly greater because medium-and low-rated and comparable
unrated securities generally are unsecured and frequently are subordinated to
the prior payment of senior indebtedness. The Fund may incur additional expenses
to the extent that it is required to seek recovery upon a default in the payment
of principal or interest on its portfolio holdings. In addition, the markets in
which medium- and low-rated or comparable unrated securities are traded
generally are more limited than those in which higher-rated securities are
traded. The existence of limited markets for these securities may restrict the
availability of securities for the Fund to purchase and also may have the effect
of limiting the ability of the Fund to (a) obtain accurate market quotations for
purposes of valuing securities and calculating net asset value and (b) sell
securities at their fair value either to meet redemption requests or to respond
to changes in the economy or the financial markets. The


22


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

market for medium- and low-rated and comparable unrated securities is relatively
new and has not weathered a major economic recession. The effect that such a
recession might have on such securities is not known. Any such recession,
however, could likely disrupt severely the market for such securities and
adversely affect the value of such securities. Any such economic downturn also
could adversely affect the ability of the issuers of such securities to repay
principal and pay interest thereon.

     Fixed-income securities, including medium- and low-rated and comparable
unrated securities, frequently have call or buy-back features that permit their
issuers to call or repurchase the securities from their holders, such as the
Fund. If an issuer exercises these rights during periods of declining interest
rates, the Fund may have to replace the security with a lower yielding security,
resulting in a decreased return to the Fund.

     Securities which are rated Ba by Moody's or BB by S&P have speculative
characteristics with respect to capacity to pay interest and repay principal.
Securities which are rated B generally lack characteristics of the desirable
investment and assurance of interest and principal payments over any long period
of time may be small.

     In light of these risks, SBMFM, in evaluating the creditworthiness of an
issue, whether rated or unrated, will take various factors into consideration,
which may include, as applicable, the issuer's financial resources, its
sensitivity to economic conditions and trends, the operating history of and the
community support for the facility financed by the issue, the ability of the
issuer's management and regulatory matters.

   
     The Fund's fixed-income security holdings (as rated by Moody's) for the
fiscal year ended July 31, 1996 were composed as follows:  6.28% rated Aa; 
17.88 % rated A;  25.90 % rated Baa; 22.35 % rated Ba; 20.58 % rated B; 
and  7.02% in non-rated securities. The percentages were calculated on a 
dollar weighted average basis by determining  the percentage of the Fund's 
net assets invested in each 
rating category during the most recent fiscal year and does not necessarily 
indicate what the composition of the 
Fund's holdings will be in subsequent years.
    

     Options. Option writing for the Fund may be limited by position and
exercise limits established by the national securities exchanges and the
National Association of Securities Dealers, Inc. (the "NASD") and by
requirements in the Code for qualification as a regulated investment company
(see "Dividends, Distributions and Taxes"). The Fund may write covered call
options to generate current income. In addition, the Fund may enter into options
transactions as hedges to reduce


                                                                              23


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

   
investment risk, generally by making an investment expected to move in the
opposite direction of a portfolio position. A hedge is designed to offset a loss
on a portfolio position with a gain on the hedge position; at the same time,
however, a properly correlated hedge will result in a gain on the portfolio
position being offset by a loss on the hedge position. The Fund bears the risk
that the prices of the securities being hedged will not move in the same amount
as the hedge. The Fund will engage in hedging transactions only when deemed
advisable by SBMFM adviser. Successful use by the Fund of options will depend on
SBMFM's ability to correctly predict movements in the direction of the
securities underlying the option used as a hedge. Losses incurred in hedging
transactions and the costs of these transactions will affect the Fund's
performance.
    

     The ability of the Fund to engage in closing transactions with respect to
options depends on the existence of a liquid secondary market. While the Fund
generally will purchase or write options only if there appears to be a liquid
secondary market for the options purchased or sold, for some options no such
secondary market may exist or the market may cease to exist.

     Securities of Unseasoned Issuers. Securities in which the Fund may invest
may have limited marketability and, therefore, may be subject to wide
fluctuations in market value. In addition, certain securities may lack a
significant operating history and be dependent on products or services without
an established market share.

     Foreign Securities. There are certain risks involved in investing in
securities of companies and governments of foreign nations which are in addition
to the usual risks inherent in domestic investments. These risks include those
resulting from revaluation of currencies, future adverse political and economic
developments and the possible imposition of currency exchange blockages or other
foreign governmental laws or restrictions, reduced availability of public
information concerning issuers and the lack of uniform accounting, auditing and
financial reporting standards or of other regulatory practices and requirements
comparable to those applicable to domestic companies. The yield of the Fund may
be adversely affected by fluctuations in value of one or more foreign currencies
relative to the U.S. dollar. Moreover, securities of many foreign companies and
their markets may be less liquid and their prices more volatile than those of
securities of comparable domestic companies. In addition, with respect to
certain foreign countries, there is the possibility of expropriation,
nationalization, confiscatory taxation and limitations on the use or removal of
funds or other assets of the Fund, including the withholding of dividends.
Foreign securities may be subject to foreign government taxes that could reduce
the yield


24


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

on such securities. Because the Fund may invest in securities denominated or
quoted in currencies other than the U.S. dollar, changes in foreign currency
exchange rates may adversely affect the value of portfolio securities and the
appreciation or depreciation of investments. Investment in foreign securities
also may result in higher expenses due to the cost of converting foreign
currency to U.S. dollars, the payment of fixed brokerage commissions on foreign
exchanges, which generally are higher than commissions on domestic exchanges,
and the expense of maintaining securities with foreign custodians, and the
imposition of transfer taxes or transaction charges associated with foreign
exchanges.

      The Fund may also purchase American Depositary Receipts ("ADRs),
European Depositary Receipts and Global Depositary Receipts or other
securities representing underlying shares of foreign companies.  ADRs
are publicly traded on exchanges or over-the-counter in the United 
States and are issued through 'sponsored" or "unsponsored" arrangements.
In a sponsored ADR arrangement, the foreign issuer assumes the 
obligation to pay some or all of the depositary's transaction fees, whereas
under an unsponsored arrangement, the foreign issuer assumes no obligation 
and the depositary's transaction fees are paid by the ADR holders.  In addition,
less information is available in the United States about an unsponsored ADR 
than about a sponsored ADR, and the financial information
about a company may or may not be as reliable for an unsponsored
ADR as it is for a sponsored ADR.  The Fund may invest in ADRs
through both sponsored and unsponsored arrangements.

     Corporate securities in which the Fund may invest include corporate
fixed-income securities of both domestic and foreign issuers, such as bonds,
debentures, notes, equipment lease certificates, equipment trust certificates,
and preferred stock.

     Certain of the corporate fixed-income securities in which the Fund may
invest may involve equity characteristics. The Fund may, for example, invest in
warrants for the acquisition of stock of the same or of a different issuer or in
corporate fixed-income securities that have conversion or exchange rights
permitting their holder to convert or exchange the securities at a stated price
within a specified period of time into a specified number of shares of common
stock. In addition, the Fund may invest in participations that are based on
revenues, sales or profits of an issuer or in common stock offered as a unit
with corporate fixed-income securities.

     Non-Publicly Traded and Illiquid Securities. The sale of securities that
are not publicly traded is typically restricted under the Federal securities
laws. As a result, the Fund may be forced to sell these securities at less than
fair market value or may not be able to sell them when its investment adviser
believes it desirable to do so. The Fund's investments in illiquid securities
are subject to the risk that should the Fund desire to sell any of these
securities when a ready buyer is not available at a price that the Fund deems
representative of their value, the value of the Fund's net assets could be
adversely affected.

     PORTFOLIO TRANSACTIONS AND TURNOVER

     All orders for transactions in securities and options on behalf of the Fund
are placed by SBMFM with broker-dealers that SBMFM selects, including Smith
Barney and other affiliated brokers. The Fund may utilize Smith Barney or a
Smith Barney affiliated broker in connection with a purchase or sale of
securities when SBMFM believes that the broker's charge for the transactions
does not exceed usual and customary levels. In selecting a broker, including
Smith Barney, for a


                                                                              25


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Investment Objective and Management Policies (continued)
--------------------------------------------------------------------------------

transaction, the primary consideration is prompt and effective execution of
orders at the most favorable prices. Subject to that primary consideration,
dealers may be selected for research, statistical or other services to enable
SBMFM to supplement its own research and analysis with the views and information
of other securities firms.

--------------------------------------------------------------------------------
Valuation of Shares
--------------------------------------------------------------------------------

     The Fund's net asset value per share is determined as of the close of
regular 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. Net asset value is calculated separately for
Class A, B, C and Y.

     Generally, the Fund's investments are valued at market value, or in the
absence of a market value with respect to any securities, at fair value as
determined by or under the direction of the Fund's Board of Trustees. Short-term
investments that mature in 60 days or less are valued at amortized cost whenever
the Trustees determine that amortized cost reflects fair value of those
instruments. Amortized cost valuation involves valuing an instrument at its
cost, initially and, thereafter, assuming a constant amortization to maturity of
any discount or premium, regardless of the impact of fluctuating interest rates
or the market value of the instrument. Further information regarding the Fund's
valuation policies is contained in the Statement of Additional Information.

--------------------------------------------------------------------------------
Dividends, Distributions and Taxes
--------------------------------------------------------------------------------

     DIVIDENDS AND DISTRIBUTIONS

     The Fund will be treated separately from the Trust's other funds in
determining the amounts of dividends from investment income and distributions of
capital gain payable to shareholders. The Fund's policy is to distribute its
investment income (that is, income other than its net realized capital gains)
and net realized capital gains, if any, once a year, normally at the end of the
year in which earned or at the beginning of the next year.

     If a shareholder does not otherwise instruct, dividends and capital gain
distributions will be reinvested automatically in additional shares of the same
Class at net asset value, subject to no sales charge or CDSC. In order to avoid
the application of a 4% nondeductible excise tax on certain undistributed
amounts of


26


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Dividends, Distributions and Taxes (continued)
--------------------------------------------------------------------------------

ordinary income and capital gains, the Fund may make an additional distribution
shortly before December 31 in each year of any undistributed ordinary income or
capital gains and expects to pay any other dividends and distributions necessary
to avoid the application of this tax.

     The per share dividends on Class B and Class C shares of the Fund may be
lower than the per share dividends on Class A and Class Y shares principally as
a result of the distribution fee applicable with respect to Class B and Class C
shares. The per share dividends on Class A shares of the Fund may be lower than
the per share dividends on Class Y shares principally as a result of the service
fee applicable to Class A shares. Distributions of capital gains, if any, will
be in the same amount for Class A, Class B, Class C and Class Y shares.

     TAXES

     The Fund will be treated as a separate taxpayer with the result that, for
Federal income tax purposes, the amount of investment income and capital gains
earned by the Fund will be determined without regard to the earnings of the
other funds of the Trust. The Fund has qualified and intends to continue to
qualify each year as a regulated investment company under the Code. Dividends
paid from net investment income and distributions of net realized short-term
capital gains are taxable to shareholders as ordinary income, regardless of how
long shareholders have held their Fund shares and whether such dividends and
distributions are received in cash or reinvested in additional Fund shares.
Distributions of net realized long-term capital gains will be taxable to
shareholders as long-term capital gains, regardless of how long shareholders
have held Fund shares and whether such distributions are received in cash or are
reinvested in additional Fund shares. Furthermore, as a general rule, a
shareholder's gain or loss on a sale or redemption of Fund shares will be a
long-term capital gain or loss if the shareholder has held the shares for more
than one year and will be a short-term capital gain or loss if the shareholder
has held the shares for one year or less. Some of the Fund's dividends declared
from net investment income may qualify for the Federal dividends-received
deduction for corporations.

     Statements as to the tax status of each shareholder's dividends and
distributions are mailed annually. Each shareholder also will receive, if
appropriate, various written notices after the close of the Fund's prior taxable
year as to the Federal income tax status of his or her dividends and
distributions which were received from the Fund during the Fund's prior taxable
year. Shareholders should consult their tax advisors about the status of the
Fund's dividends and distributions for state and local tax liabilities.


                                                                              27


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Purchase of Shares
--------------------------------------------------------------------------------

     GENERAL

   
     The Fund offers four classes of shares. Class A shares are sold to
investors with an initial sales charge and Class B and Class C shares are sold
without an initial sales charge but are subject to a CDSC payable upon certain
redemptions. Class Y shares are sold without an initial sales charge or a CDSC
and are available only to investors investing a minimum of $5,000,000 (except
for purchases of Class Y shares by Smith Barney Concert Series Inc., for which
there is no minimum purchase amount.) See "Prospectus Summary -- Alternative
Purchase Arrangements" for a discussion of factors to consider in selecting
which Class of shares to purchase.

     Purchases of Fund shares must be made through a brokerage account
maintained with Smith Barney, an Introducing Broker or an investment dealer in
the selling group, except for investors purchasing shares of the Fund through a
qualified retirement plan who may do so directly through First Data. When
purchasing shares of the Fund, investors must specify whether the purchase is
for Class A, Class B, Class C or Class Y shares. No maintenance fee will be
charged by the Fund in connection with a brokerage account through which an
investor purchases or holds shares.

     Investors in Class A, Class B and Class C shares may open an account by
making an initial investment of at least $1,000 for each account, or $250 for an
IRA or a Self-Employed Retirement Plan in the Fund. Investors in Class Y shares
may open an account by making an initial investment of $5,000,000. 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
C 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 C shares and the minimum subsequent investment
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 requirement for Class A, Class B and Class C shares and the
subsequent investment requirement for all Classes is $50. There are no minimum
investment requirements for Class A shares for employees of Travelers and its
subsidiaries, including Smith Barney, Trustees of the Fund and their spouses and
children and unitholders who invest distributions from a UIT sponsored by Smith
Barney. 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
    


28


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

   
in the shareholder's account by First Data. Share certificates are issued only
upon a shareholder's written request to First Data.

     Purchase orders received by the Fund or Smith Barney 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. Orders
received by dealers or Introducing Brokers 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 Smith Barney prior to Smith Barney's close of business
(the "trade date"). For shares purchased through Smith Barney or Introducing
Brokers purchasing through 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

     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, Smith Barney or First Data is authorized
through preauthorized transfers of $25 or $50 or more to charge the regular bank
account or other financial institution indicated by the shareholder on a monthly
or quarterly basis, respectively, to provide 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 Smith Barney or First Data.
The Systematic Investment Plan also authorizes Smith Barney to apply cash held
in the shareholder's Smith Barney brokerage account or redeem the shareholder's
shares of a Smith Barney money market fund to make additions to the account.
Additional information is available from the Fund or a Smith Barney Financial
Consultant.
    


                                                                              29


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

     INITIAL SALES CHARGE ALTERNATIVE -- CLASS A SHARES

     The sales charges applicable to purchases of Class A shares of the Fund are
as follows:

   
                                                                    Dealers
                             Sales Charge      Sales Charge       Reallowance
                                as % of           as % of           as % of
  Amount of Investment      Offering Price    Amount Invested   Offering Price
    
================================================================================
  Less than $25,000             5.00%              5.26%              4.50%
  $25,000-$49,999               4.00%              4.17%              3.60%
  $50,000-$99,999               3.50%              3.63%              3.15%
  $100,000-$249,999             3.00%              3.09%              2.70%
  $250,000-$499,999             2.00%              2.04%              1.80%
   $500,000 and over              *                  *                  *
================================================================================

*  Purchases of Class A shares, which when combined with current holdings of
   Class A shares offered with a sales charge, equal or exceed $500,000 in the
   aggregate, 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 Smith Barney, which
   compensates 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 C shares is
   waived. See "Deferred Sales Charge Alternatives" 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 reduced sales charges shown above apply to the aggregate of purchases
of Class A shares of the Fund made at one time by "any person," which includes
an individual, his or her spouse and children, or a trustee or other fiduciary
of a single trust estate or single fiduciary account. The reduced sales charge
minimums may also be met by aggregating the purchase with the net asset value of
all Class A shares held in funds sponsored by Smith Barney that are offered with
a sales charge listed under "Exchange Privilege."

     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 of Class A shares to (i)
Trustees or Directors of any of the Smith Barney Mutual Funds and employees of
Travelers and its subsidiaries and to the immediate families of such persons
(including the surviving spouse of a deceased Trustee or employee, and retired
Trustees or employees), pension, profit-sharing or other benefit plan for such
persons and
    


30


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

   
(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
re-sold except through redemption or repurchase; (b) offers of Class A shares to
any other investment company in connection with 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 Smith Barney Financial
Consultant (for a period up to 90 days from the commencement of the Financial
Consultant's employment with 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) shareholders who have redeemed Class A shares in the Fund (or
Class A shares of another Fund of the Smith Barney Mutual Funds that are offered
with a sales charge equal to or greater than the maximum sales charge of the
Fund) and who wish to reinvest their redemption proceeds in the Fund, provided
the reinvestment is made within 60 calendar days of the redemption; (e) accounts
managed by registered investment advisory subsidiaries of Travelers; (f)
investments of distributions from a UIT sponsored by Smith Barney; and (g)
purchases by Section 403(b) or Section 401(a) or 401(k) accounts associated with
Copeland Retirement Programs. 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.

     Purchases of Class A shares also may be made at net asset value without a
sales charge in the following circumstances: (i) direct rollovers by plan
participants of distributions from a 401(k) plan enrolled in the Smith Barney
401(k) Program (Note: Subsequent investments will be subject to the applicable
sales charge); (ii) purchases by separate accounts used to fund certain
unregistered variable annuity contracts; and (iii) purchases by investors
participating in a Smith Barney fee based arrangement.
    

     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 funds sponsored by Smith Barney which are offered
with a sales charge 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


                                                                              31


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

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.

     GROUP PURCHASES

     Upon completion of certain automated systems, a reduced sales charge or
purchase at net asset value will also be available to employees (and partners)
of the same employer purchasing as a group, provided each participant makes the
minimum initial investment required. The sales charge applicable to purchases by
each member of such a group will be determined by the table set forth above
under "Initial Sales Charge Alternative Class A Shares," and will be based upon
the aggregate sales of Class A shares of Smith Barney Mutual Funds offered with
a sales charge to, and share holdings of, all members of the group. To be
eligible for such reduced sales charges or to purchase at net asset value, all
purchases must be pursuant to an employer- or partnership-sanctioned plan
meeting certain requirements. One such requirement is that the plan must be open
to specified partners or employees of the employer and its subsidiaries, if any.
Such plan may, but is not required to, provide for payroll deductions, IRAs or
investments pursuant to retirement plans under Sections 401 or 408 of the Code.
Smith Barney may also offer a reduced sales charge or net asset value purchase
for aggregating related fiduciary accounts under such conditions that Smith
Barney will realize economies of sales efforts and sales related expenses. An
individual who is a member of a qualified group may also purchase Class A shares
at the reduced sales charge applicable to the group as a whole. The sales charge
is based upon the aggregate dollar value of Class A shares offered with a sales
charge that have been previously purchased and are still owned by the group,
plus the amount of the current purchase. A "qualified group" is one which (a)
has been in existence for more than six months, (b) has a purpose other than
acquiring Fund shares at a discount and (c) satisfies uniform criteria which
enable Smith Barney to realize economies of scale in its costs of distributing
shares. A qualified group must have more than 10 members, must be available to
arrange for group meetings between representatives of the Fund and the members,
and must agree to include sales and other materials related to the Fund in its
publications and mailings to members at no cost to Smith Barney. In order to
obtain such reduced sales charge or to purchase at net asset value, the
purchaser must provide sufficient information at the time of purchase to permit
verification that the purchase qualifies for the reduced sales charge. Approval
of group purchase reduced sales charge plans is subject to the discretion of
Smith Barney.


32


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

     LETTER OF INTENT

   
     Class A Shares. A Letter of Intent for amounts 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
Invested" as referred to in the preceding sales charge table includes purchases
of all Class A shares of the Fund and other funds of the Smith Barney Mutual
Funds offered with a sales charge over the 13 month period based on the total
amount of intended purchases plus the value of all Class A shares previously
purchased and still owned. An alternative is to compute the 13 month period
starting up to 90 days before the date of execution of a Letter of Intent. 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 sale charges
applicable to the purchases made and the charges previously paid, or an
appropriate number of escrowed shares will be redeemed. Please contact a Smith
Barney Financial Consultant or First Data 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. Such investors
must make an initial minimum purchase of $1,000,000 in Class Y shares of the
Fund and agree to purchase a total of $5,000,000 of Class Y shares of the same
Fund within six months from the date of the Letter. If a total investment of
$5,000,000 is not made within the six-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%. The Fund expects that such
transfer will not be subject to Federal income taxes. Please contact a Smith
Barney Financial Consultant or First Data for further information.
    

     DEFERRED SALES CHARGE ALTERNATIVES

     "CDSC Shares" are sold at net asset value next determined without an
initial sales charge so that the full amount of an investor's purchase payment
may be immediately invested in the Fund. A CDSC, however, may be imposed on
certain redemptions of these shares. "CDSC Shares" are: (a) Class B shares; (b)
Class C shares; and (c) Class A shares which when combined with Class A shares
offered with a sales charge currently held by an investor equal or exceed
$500,000 in the aggregate.


                                                                              33


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

     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 C shares and Class A shares that are CDSC
Shares, shares redeemed more than 12 months after their purchase.

   
     Class C 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
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
purchases by Participating Plans, as described below. See "Purchase of Shares --
Smith Barney 401(k) and ExecChoice(TM) Programs."
    

        Year Since Purchase
        Payment was Made                                       CDSC
================================================================================
        First                                                  5.00%
        Second                                                 4.00%
        Third                                                  3.00%
        Fourth                                                 2.00%
        Fifth                                                  1.00%
        Sixth                                                  0.00%
        Seventh                                                0.00%
        Eighth                                                 0.00%
================================================================================

     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 also will 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. Shareholders who held Class B shares of Smith Barney
Shearson Short-Term World Income Fund (the "Short-Term World Income Fund") on
July 15, 1994 and who subsequently exchange those shares for Class B shares of
the Fund will be


34


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

offered the opportunity to exchange all such Class B shares for Class A shares
of the Fund four years after the date on which those shares were deemed to have
been purchased. Holders of such Class B shares will be notified of the pending
exchange in writing approximately 30 days before the fourth anniversary of the
purchase date and, unless the exchange has been rejected in writing, the
exchange will occur on or about the fourth anniversary date. 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 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 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) redemption of
shares made in connection with qualified distributions from retirement plans or
IRAs upon the attainment of age 591 1/42; (e) involuntary redemptions; and (f)
redemptions of shares in connection with a combination of the Fund with any
investment company by


                                                                              35


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

merger, acquisition of assets or otherwise. In addition, a shareholder who has
redeemed shares from other funds of the 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 Smith Barney in
the case of shareholders who are also Smith Barney clients or by First Data 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 C shares as
investment alternatives under the Smith Barney 401(k) and ExecChoice(TM)
Programs. Class A and Class C shares acquired through the Participating Plans
are subject to the same service and/or distribution fees as the Class A and
Class C shares acquired by other 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 C Shares. Class C 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 C 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. If at the
end of the fifth year after the date the Participating Plan enrolled in the
Smith Barney 401(k) Program or the Smith Barney ExecChoice(TM) Program, a
Participating Plan's total Class C holdings in all non-money market Smith Barney
Mutual Funds equal at least $1,000,000, the Participating Plan will be offered
the opportunity to exchange all of its Class C shares for Class A shares of the
Fund. (For Participating Plans that were originally established through a Smith
Barney retail brokerage account, the five year period will be calculated from
the date the retail brokerage account was opened.) Such Participating Plans will
be notified of the pending exchange in writing within 30 days after the fifth
anniversary of the
    


36


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

   
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 Participating Plan's holdings will be performed each
quarter until either the Participating 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
Participating Plan enrolled in the Smith Barney 401(k) Program, if a
Participating Plan's total Class C 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
C shares for Class A shares of a 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 that has not
previously qualified for an exchange into Class A shares will be offered the
opportunity to exchange all of its Class C shares for Class A shares of a 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 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 C shares of the Fund but instead may acquire Class A
shares of the Fund. Any Class C shares not converted will continue to be subject
to the distribution fee.

     Participating Plans wishing to acquire shares of a Fund through the Smith
Barney 401(k) Program or the Smith Barney ExecChoice(TM) Program must purchase
such shares directly from FDISG. For further information regarding these
Programs, investors should contact a Smith Barney Financial Consultant.

     Existing 401(k) Plans Investing in Class B Shares. Class B shares of the
Fund are not available for purchase by Participating Plans opened on or after
June 21, 1996, but may continue to be purchased by any Participating Plan opened
prior to such date and originally investing in such Class. Class B shares
acquired are subject to a CDSC of 3.00% of redemption proceeds, if the
Participating Plan terminates within eight years of the date the Participating
Plan first enrolled in the Smith Barney 401(k) Program.

     At the end of the eighth year after the date the Participating Plan
enrolled in the Smith Barney 401(k) Program, the Participating Plan will be
offered the opportunity to exchange all of its Class B shares for Class A shares
of the Fund.
    


                                                                              37


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Purchase of Shares (continued)
--------------------------------------------------------------------------------

   
Such Plans will be notified of the pending exchange in writing approximately 60
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 the exchange has occurred, a Participating Plan
will not be eligible to acquire additional Class B shares of the Fund but
instead may acquire Class A shares of the Fund. If the Participating Plan elects
not to exchange all of its Class B shares at that time, each Class B share held
by the Participating Plan will have the same conversion feature as Class B
shares held by other investors. See "Purchase of Shares -- Deferred Sales Charge
Alternatives."

     No CDSC is imposed on redemptions of Class B shares to the extent that the
net asset value of the shares redeemed does not exceed the current net asset
value of the shares purchased through reinvestment of dividends or capital gain
distributions, plus the current net asset value of Class B shares purchased more
than eight years prior to the redemption, plus increases in the net asset value
of the shareholder's Class B shares above the purchase payments made during the
preceding eight years. Whether or not the CDSC applies to the redemption by a
Participating Plan depends on the number of years since the Participating Plan
first became enrolled in the Smith Barney 401(k) Program, unlike the
applicability of the CDSC to redemptions by other shareholders, which depends on
the number of years since those shareholders made the purchase payment from
which the amount is being redeemed.

     The CDSC will be waived on redemptions of Class B shares in connection with
lump-sum or other distributions made by a Participating Plan as a result of: (a)
the retirement of an employee in the Participating Plan; (b) the termination of
employment of an employee in the Participating Plan; (c) the death or disability
of an employee in the Participating Plan; (d) the attainment of age 591 1/42 by
an employee in the Participating Plan; (e) hardship of an employee in the
Participating Plan to the extent permitted under Section 401(k) of the Code; or
(f) redemption of shares in connection with a loan made by the Participating
Plan to an employee.

--------------------------------------------------------------------------------
Exchange Privilege
--------------------------------------------------------------------------------

     Except as otherwise noted below, shares of each Class may be exchanged at
the net asset value next determined for shares of the same Class in the
following 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
C shares are subject to minimum investment requirements and all shares are
subject to the other requirements of the Fund into which exchanges are made.
    


38


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Exchange Privilege (continued)
--------------------------------------------------------------------------------

FUND NAME


Growth Funds
      Smith Barney Aggressive Growth Fund Inc.
      Smith Barney Appreciation Fund Inc.
      Smith Barney Fundamental Value Fund Inc.
      Smith Barney Growth  Opportunity Fund
      Smith Barney Managed Growth  Fund
   
      Smith Barney Natural Resources Fund, Inc.
    

      Smith Barney Special Equities Fund

       

Growth and Income Funds

   
      Smith Barney Funds, Inc. -- Equity Income Portfolio
    
      Smith Barney Growth and Income Fund
      Smith Barney Premium Total Return Fund
      Smith Barney Strategic Investors Fund
      Smith Barney Utilities Fund

Taxable Fixed-Income Funds
    * Smith Barney Adjustable Rate Government Income Fund
      Smith Barney Diversified Strategic Income Fund
   ** Smith Barney Funds, Inc. -- Income Return Account Portfolio
  +++ Smith Barney Funds, Inc. -- Short-Term U.S. Treasury Securities Portfolio
       
      Smith Barney Funds, Inc. -- U.S. Government Securities Portfolio
      Smith Barney Government Securities Fund
      Smith Barney High Income Fund
      Smith Barney Investment Grade Bond Fund
      Smith Barney Managed Governments Fund Inc.

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 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


                                                                              39


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Exchange Privilege (continued)
--------------------------------------------------------------------------------

      Smith Barney Muni Funds -- Pennsylvania Portfolio
       
      Smith Barney New Jersey Municipals Fund Inc.
      Smith Barney Oregon Municipals Fund
      Smith Barney Tax-Exempt Income Fund

International Funds

      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 Series Inc.
      Smith Barney Concert Series Inc. -- Balanced Portfolio
      Smith Barney Concert Series Inc. -- Conservative Portfolio
      Smith Barney Concert Series Inc. -- Growth Portfolio
      Smith Barney Concert Series Inc. -- High Growth Portfolio
      Smith Barney Concert Series Inc. -- Income Portfolio
    

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, Class B and Class Y shares of the
      Fund. In addition, shareholders who own Class C shares of the Fund through
      the Smith Barney 401(k) Program may exchange those shares for Class C
      shares of this Fund.
   ** Available for exchange with Class A, Class C and Class Y shares of the 
      Fund.
  *** Available for exchange with Class A of the Fund
    + Available for exchange with Class B and Class C shares of the Fund.
   ++ Available for exchange with Class A and Class Y shares of the Fund. In
      addition, shareholders who own Class C shares of the Fund through the
      Smith Barney 401(k) Program may exchange those shares for Class C shares
      of this Fund.
  +++ Available for exchange with Class A and Class Y shares of the Fund.


40


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Exchange Privilege (continued)
--------------------------------------------------------------------------------

       
     Class B Exchanges. In the event a Class B shareholder (unless such
shareholder was a Class B shareholder of the Short-Term World Income Fund on
July 15, 1994) 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 C Exchanges. Upon an exchange, the new Class C shares will be deemed
to have been purchased on the same date as the Class C 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
imposition 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. SBMFM 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 the Fund or (b) remain invested in the Fund
or exchange into any of the funds of the Smith Barney Mutual Funds listed above,
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
"Redemption 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
    


                                                                              41


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Exchange Privilege (continued)
--------------------------------------------------------------------------------

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 the shares of the Fund 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 trading 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 First Data receives
further instructions from Smith Barney, or if the shareholder's account is not
with 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
Investment Company Act of 1940, as amended ("1940 Act"), in extraordinary
circumstances. Generally, if the redemption proceeds are remitted to a Smith
Barney brokerage account, these funds will not be invested for the shareholder's
benefit without specific instruction and Smith Barney will benefit from the use
of temporarily uninvested funds. Redemption proceeds for shares purchased by
check, other than a certified or official bank check, will be remitted upon
clearance of the check, which may take up to ten days or more.
    

     Shares held by Smith Barney as custodian must be redeemed by submitting a
written request to a Smith Barney Financial Consultant. Shares other than those
held by Smith Barney as custodian may be redeemed through an investor's
Financial Consultant, Introducing Broker or dealer in the selling group or by
submitting a written request for redemption to:

         Smith Barney Convertible Fund 
         Class A, B, C or Y (please specify) 
         c/o First Data Investor Services Group, Inc.
         P.O. Box 9134
         Boston, Massachusetts 02205-9134


42


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Redemption of Shares (continued)
--------------------------------------------------------------------------------

   
     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 registered.
If the shares to be redeemed were issued in certificate form, the certificates
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 on a written
redemption request in excess of $2,000, share certificate or stock power, 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 $2,000 or less do not require a signature guarantee
unless more than one such redemption 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 directed, 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 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 contact
FDISG at 1-800-451-2010. Once eligibility is confirmed, the shareholder must
complete and return a Telephone/Wire Authorization Form, along with a signature
guarantee that will be provided by First Data upon request. (Alternatively, an
investor may authorize telephone redemptions on the new account application with
the applicant's 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 5:00 p.m.
(New York City time) on any day the NYSE is open. Redemption requests received
after 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


                                                                              43


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Redemption of Shares (continued)
--------------------------------------------------------------------------------

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 5:00 p.m.
(New York City time) any day on which the NYSE is open. Exchange requests
received after the close of regular trading on the NYSE are processed 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 instructions
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 Fund. Any applicable CDSC will not be waived on
amounts withdrawn by a shareholder 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. For further information regarding the automatic cash withdrawal plan,
shareholders should contact a Smith Barney Financial Consultant.
    


44


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
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,
however, 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 advertises 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
computed by dividing the net investment income per share earned by the Class
during the period by the maximum public offering price per share on the last day
of the period. This income is "annualized" by assuming that 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 C 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 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 information 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 or the maximum public offering price (including


                                                                              45


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Performance (continued)
--------------------------------------------------------------------------------

sales charge) on the last day of the period for which current dividend return is
presented. The current dividend return for each Class may vary from time to time
depending on market conditions, the composition of its investment portfolio and
operating expenses. These factors and possible 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, Inc. and other financial
publications.

--------------------------------------------------------------------------------
Management of the Trust and the Fund
--------------------------------------------------------------------------------

     BOARD OF TRUSTEES

     Overall responsibility for management and supervision of the Fund rests
with the Trust's Board of Trustees. The Trustees approve all significant
agreements between the Trust and the companies that furnish services to the
Trust and the Fund, including agreements with the Fund's distributor, investment
adviser, administrator, custodian and transfer agent. The day-to-day operations
of the Fund are delegated to the Fund's investment adviser and administrator.
The Statement of Additional Information contains background information
regarding each Trustee and executive officer of the Trust.

     INVESTMENT ADVISER -- SBMFM

   
     SBMFM, located at 388 Greenwich Street, New York, New York 10013, serves as
the Fund's investment adviser. SBMFM is a wholly owned subsidiary of Smith
Barney Holdings Inc. ("Holdings"). SBMFM (through its predecessor entities) has
been in the investment counseling business since 1934 and is a registered
investment adviser. SBMFM renders investment advice to investment companies that
had aggregate assets under management as of September 30, 1996 in excess of $77
billion.
    

     Subject to the supervision and direction of the Fund's Board of Trustees,
SBMFM 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 portfolio
managers and securities analysts who provide research services to the Fund. For
advisory


46


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Management of the Trust and the Fund (continued)
--------------------------------------------------------------------------------

services rendered to the Fund, the Fund pays SBMFM a fee at the annual rate of
0.50% of the value of the Fund's average daily net assets.

     PORTFOLIO MANAGEMENT

     Robert Swab, Vice President of Smith Barney has managed the day-to-day
operations of the Fund since 1995, including making all investment decisions.

   
     Mr. Swab's management discussions and analysis, and additional performance
information regarding the Fund during the fiscal year ended July 31, 1996 are
included in the Annual Report dated July 31, 1996. A copy of the Annual Report
may be obtained upon request and without charge from a Smith Barney Financial
Consultant or by writing or calling the Fund at the address or phone number
listed on page one of this Prospectus.
    

     ADMINISTRATOR -- SBMFM

     SBMFM 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 SBMFM a fee at the annual rate of .20% of the value of the Fund's
average daily net assets.

--------------------------------------------------------------------------------
Distributor
--------------------------------------------------------------------------------

     Smith Barney is located at 388 Greenwich Street, New York, New York, 10013.
Smith Barney distributes shares of the Fund as principal underwriter and as such
conducts a continuous offering pursuant to a "best efforts" arrangement
requiring Smith Barney to take and pay for only such securities as may be sold
to the public. Pursuant to a plan of distribution adopted by the Fund under Rule
12b-1 under the 1940 Act (the "Plan"), Smith Barney is paid an annual service
fee with respect to Class A, Class B and Class C shares of the Fund at the
annual rate of 0.25% of the average daily net assets of the respective Class.
Smith Barney is also paid an annual distribution fee with respect to Class B and
Class C 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
Smith Barney to pay its Financial Consultants for servicing shareholder accounts
and, in the case of Class B and Class C shares, to cover expenses primarily
intended to result in the sale of those


                                                                              47


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Distributor (continued)
--------------------------------------------------------------------------------

shares. These expenses include: advertising expenses; the cost of printing and
mailing prospectuses to potential investors; payments to and expenses of Smith
Barney Financial Consultants and other persons who provide support services in
connection with the distribution of shares; interest and/or carrying charges;
and indirect and overhead costs of Smith Barney associated with the sale of Fund
shares, including lease, utility, communications and sales promotion expenses.

     The payments to Smith Barney Financial Consultants for selling shares of a
Class include a commission or fee paid by the investor or Smith Barney at the
time of sale and, with respect to Class A, Class B and Class C shares, a
continuing fee for servicing shareholder accounts for as long as a shareholder
remains a holder of that Class. Smith Barney Financial Consultants may receive
different levels of compensation for selling different Classes of shares.

     Payments under the Plan with respect to Class B and Class C shares are not
tied exclusively to the distribution and shareholder service expenses actually
incurred by Smith Barney and the payments may exceed distribution expenses
actually incurred. The Trust's Board of Trustees will evaluate the
appropriateness of the Plan and its payment terms on a continuing basis and in
so doing will consider all relevant factors, including expenses borne by Smith
Barney, amounts received under the Plan and proceeds of the CDSC.

--------------------------------------------------------------------------------
Additional Information
--------------------------------------------------------------------------------

     The Trust was organized on March 12, 1985, under the laws of the
Commonwealth of Massachusetts and is an entity commonly known as a
"Massachusetts business trust." The Trust offers shares of beneficial interest
of separate series having a $.001 per share par value. When matters are
submitted for shareholder vote, shareholders of each Class of each Fund 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 Trust vote by
individual fund on all matters except (a) matters affecting only the interest of
one or more of the funds, in which case only shares of the affected Fund or
funds would be entitled to vote, or (b) when the 1940 Act requires that shares
of the funds be voted in the aggregate. Similarly, shares of the Fund will be
voted generally on a Fund-wide basis except matters affecting the interests of
one Class of shares.

     Each Class represents identical interests in the Fund's investment
portfolio. As a result, the Classes have the same rights, privileges and
preferences, except with respect to: (a) the designation of each Class; (b) the
effect of the respective sales


48


<PAGE>

Smith Barney Convertible Fund

--------------------------------------------------------------------------------
Additional Information (continued)
--------------------------------------------------------------------------------

charges for each Class; (c) the distribution and/or service fees borne by each
Class; (d) the expenses allocable exclusively to each Class; (e) voting rights
on matters exclusively affecting a single Class; (f) the exchange privilege of
each Class; and (g) the conversion feature of the Class B shares. The Board of
Trustees does not anticipate that there will be any conflicts among the
interests of the holders of the different Classes of shares of the Fund. The
Trustees, on an ongoing basis, will consider whether any such conflict exists
and, if so, take appropriate action.

     The Trust does not hold annual shareholder meetings. There normally will be
no meetings of shareholders for the purpose of electing Trustees unless and
until such time as less than a majority of the Trustees holding office have been
elected by shareholders. The Trustees will call a meeting for any purpose for
voting on the written request of shareholders holding at least 10% of the
Trust'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
of each fund will have one vote for each full share owned and a proportionate,
fractional vote for any fractional share held of that Class. Shares of the Trust
will be voted generally on a Trust-wide basis on all matters, except matters
affecting the interests of one Fund or one Class of shares.

     PNC Bank National Association, located at 17th and Chestnut Streets,
Philadelphia, PA 19103, serves as custodian of the Trust's investments.

     First Data, located at Exchange Place, Boston, Massachusetts 02109, serves
as the Trust's transfer agent. 

     The Fund sends its shareholders a semi-annual report and an audited annual
report, which include listings of the investment securities held by the Fund at
the end of the period covered. In an effort to reduce the Fund's printing and
mailing costs, the Trust plans to consolidate the mailing of the Fund's
semi-annual and annual reports by household. This consolidation means that a
household having multiple accounts with the identical address of record will
receive a single copy of each report. In addition, the Trust also plans to
consolidate the mailing of the Fund's Prospectus so that a shareholder having
multiple accounts (e.g., individual, IRA and/or 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 Smith
Barney Financial Consultants or First Data.
    


                                                                              49


<PAGE>

                                                                    SMITH BARNEY
                                                                    ------------
                                               A Member of TravelersGroup [LOGO]



                                                                    Smith Barney
                                                                     Convertible
                                                                            Fund

                                                            388 Greenwich Street
                                                        New York, New York 10013

   
                                                                    FD1210 11/96
    

<PAGE>
 
 
                                                                    SMITH BARNEY
                                                                        Exchange
                                                                         Reserve
                                                                            Fund
                                                             
                                                          NOVEMBER 28, 1996     
 
                                                   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 28, 1996     
   
Smith Barney     
   
Exchange Reserve Fund     
388 Greenwich Street
New York, New York 10013
(212) 723-9218
 
  Smith Barney Exchange Reserve Fund (the "Fund"), a diversified fund, seeks to
maximize current income to the extent consistent with the preservation of capi-
tal and the maintenance of liquidity by investing in a diversified portfolio of
high quality money market instruments.
 
  SHARES OF THE FUND ARE NOT INSURED OR GUARANTEED BY THE U.S. GOVERNMENT.
THERE IS NO ASSURANCE THAT THE FUND WILL BE ABLE TO MAINTAIN A STABLE NET ASSET
VALUE OF $1.00 PER SHARE.
   
  The Fund is one of a number of funds, each having distinct investment objec-
tives and policies making up the Smith Barney Income Funds (the "Trust"). The
Trust is an open-end management investment company commonly referred to as a
mutual fund. Shares of other funds offered by the Trust are described in sepa-
rate prospectuses that may be obtained by calling the Trust at the telephone
number set forth above or by contacting a Smith Barney Financial Consultant.
    
  This Prospectus sets forth concisely certain information about the Fund and
the Trust, including distribution fees and expenses, which prospective invest-
ors will find helpful in making an investment decision. Investors are encour-
aged 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 28, 1996, as amended or supplemented from
time to time, that is available upon request and without charge by calling or
writing the Trust at the telephone number or address set forth above, or by
contacting your Smith Barney Financial Consultant. The Statement of Additional
Information has been filed with the Securities and Exchange Commission (the
"SEC") and is incorporated by reference into this Prospectus in its entirety.
    
SMITH BARNEY INC.
Distributor
 
SMITH BARNEY MUTUAL FUNDS MANAGEMENT INC.
Investment Adviser and Administrator
 
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES 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                            8
-------------------------------------------------
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES   10
-------------------------------------------------
VALUATION OF SHARES                            14
-------------------------------------------------
DIVIDENDS, DISTRIBUTIONS AND TAXES             14
-------------------------------------------------
PURCHASE OF SHARES                             16
-------------------------------------------------
EXCHANGE PRIVILEGE                             21
-------------------------------------------------
REDEMPTION OF SHARES                           23
-------------------------------------------------
MINIMUM ACCOUNT SIZE                           26
-------------------------------------------------
YIELD INFORMATION                              26
-------------------------------------------------
MANAGEMENT OF THE FUND AND THE TRUST           26
-------------------------------------------------
DISTRIBUTOR                                    27
-------------------------------------------------
ADDITIONAL INFORMATION                         28
-------------------------------------------------
</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 Statement of Additional
Information. Cross references in this summary are to headings in the Prospec-
tus. See "Table of Contents."
 
INVESTMENT OBJECTIVE The Fund is an open-end diversified management investment
company that seeks to maximize current income to the extent consistent with
the preservation of capital and the maintenance of liquidity by investing in
high quality short-term money market instruments. See "Investment Objective
and Management Policies."
   
PURCHASE OF SHARES Shares of the Fund may be acquired by the general public
only through the exchange of Class B or Class C shares of other Smith Barney
Mutual Funds. Class B or Class C shares of the Fund acquired through exchange
are subject to the contingent deferred sales charge ("CDSC"), if any, of the
shares with which the exchange is made. All Class B and Class C shares are
subject to an annual distribution fee of .50% of the value of average daily
net assets of the Fund. Eight years after the date of their original purchase,
Class B shares will be automatically redeemed at net asset value and the
redemption proceeds will be reinvested, at net asset value, in Class A shares
of Smith Barney Money Funds Inc.--Cash Portfolio ("Cash Portfolio"). Upon this
conversion, the shares will no longer be subject to the annual distribution
fee.     
   
  Shares may be purchased through the Fund's distributor, Smith Barney Inc.
("Smith Barney"), a broker that clears securities through Smith Barney on a
fully disclosed basis (an "Introducing Broker") or an investment dealer in the
selling group. Direct purchases by certain retirement plans may be made
through the Fund's transfer agent, First Data Investor Services Group, Inc.
("First Data"). See "Purchase 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. Other investors may be eligible to participate in the Smith Barney
ExecChoice(TM) Program. See "Purchase of Shares--Smith Barney 401(k) and
ExecChoice(TM) Programs."     
 
INVESTMENT MINIMUMS Investors may open an account by making an initial invest-
ment of at least $1,000 for each account, or $250 for an individual retirement
account ("IRA") or a Self-Employed Retirement Plan. Subsequent investments of
at least $50 may be made for both Classes. For participants in retirement
plans qualified under Section 403(b)(7) or Section 401(a) of the Code, the
minimum initial and subsequent investment requirement is $25. See "Purchase of
Shares."
 
 
                                                                              3
<PAGE>
 
PROSPECTUS SUMMARY (CONTINUED)
 
 
REDEMPTION OF SHARES Shares may be redeemed on each day that the New York
Stock Exchange, Inc. ("NYSE") is open for business. See "Redemption of
Shares."
 
MANAGEMENT OF THE FUND Smith Barney Mutual Funds Management Inc. (the "Manag-
er") serves as the Fund's investment adviser and administrator. The Manager is
a wholly owned subsidiary of Smith Barney Holdings Inc. ("Holdings"). Holdings
is a wholly owned subsidiary of Travelers Group Inc. ("Travelers"), a diversi-
fied financial services holding company engaged, through its subsidiaries
principally in four business segments: Investment Services, Consumer Finance
Services, Life Insurance Services and Property & Casualty Insurance Services.
See "Management of the Trust and the Fund."
 
EXCHANGE PRIVILEGE Shares of a Class may be exchanged for shares of the same
Class of other funds of the Smith Barney Mutual Funds at the respective net
asset values next determined, plus any applicable sales charge differential.
See "Exchange Privilege."
 
DIVIDENDS AND DISTRIBUTIONS Dividends are declared daily and paid monthly from
net investment income. See "Dividends, Distributions and Taxes."
 
REINVESTMENT OF DIVIDENDS Dividends and distributions paid on shares of the
Fund will be reinvested automatically in additional shares at current net
asset value unless otherwise specified by an investor. Shares acquired by div-
idend and distribution reinvestment will not be subject to any CDSC. Class B
shares acquired through dividend and distribution reinvestments will become
eligible for conversion to Class A shares of Cash Portfolio. See "Dividends,
Distributions and Taxes."
   
SPECIAL CONSIDERATIONS AND RISK FACTORS There is no assurance that the Fund
will achieve its investment objective. In light of the fees and CDSC imposed
on Class B and Class C shares, an investment in the Fund should be viewed as
part of a long-term investment in the Smith Barney Mutual Funds. Investors
seeking only to invest in a money market fund and who do not expect to re-
exchange Fund shares for Class B shares of other Smith Barney Mutual Funds
should consider more suitable investments, including other money market funds
offered to the public by Smith Barney. See "Investment Objective and Manage-
ment Policies" and "Purchase of Shares."     
 
4
<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 CDSC that may be incurred at the time of
redemption and the Fund's operating expenses for its most recent year:     
 
<TABLE>   
<CAPTION>
  SMITH BARNEY
  EXCHANGE RESERVE FUND                                CLASS B  CLASS C
-----------------------------------------------------------------------
  <S>                                                  <C>      <C>
  SHAREHOLDER TRANSACTION EXPENSES
    Maximum CDSC (as a percentage of original cost or
      redemption
      proceeds, whichever is lower)                     4.50%*   None*
-----------------------------------------------------------------------
  ANNUAL FUND OPERATING EXPENSES
    (as a percentage of average net assets)
    Management fees                                      .50%     .50%
    12b-1 fee**                                          .50      .50
    Other expenses                                      0.17     0.17
-----------------------------------------------------------------------
  TOTAL FUND OPERATING EXPENSES                         1.17%    1.17%
-----------------------------------------------------------------------
</TABLE>    
   
 * Class B or Class C shares of the Fund acquired through exchanges with
   shares of other Smith Barney Mutual Funds are subject to the CDSC, if any,
   of the shares with which the exchange is made, which may be more or less
   than 4.50%, in the case of Class B shares or may be 1.00%, in the case of
   Class C shares depending on the date such shares were purchased. Class B
   shares acquired by plans participating in the Smith Barney 401(k) Program
    are subject to a CDSC of 3.00%. See "Purchase of Shares--Smith Barney
    401(k) and ExecChoice( Programs."     
** Upon conversion, Class B shares will no longer be subject to a distribution
   fee. Class C shares do not have a conversion feature and, therefore, are
   subject to an ongoing distribution fee. As a result, long-term shareholders
   of Class C shares may pay more than the economic equivalent of the maximum
   front-end sales charge permitted by the National Association of Securities
   Dealers, Inc.
   
  The CDSC set forth in the above table is the maximum CDSC imposed by the
Fund on Class B shares purchased by certain qualified and non-qualified
 retirement plans. See "Purchase of Shares - Deferred Sales Charge." Investors
may pay actual charges of less than 4.50% depending on the CDSC of the 
shares exchanged for shares of the Fund or for Plans participating in the
Smith Barney 401(k) Program. See "Purchase of Shares - Smith Barney 
401(k) and ExecChoice( Programs." Smith Barney receives an annual
12b-1 distribution fee of .50% of the Fund's average daily net assets.
"Other expenses"in the above table include fees for shareholder 
services, custodial fees,
legal and accounting fees, printing costs and registration fees.     
 
                                                                              5
<PAGE>
 
PROSPECTUS SUMMARY (CONTINUED)
 
 
 EXAMPLE
 
  The following example is intended to assist an investor in understanding 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 above table. See "Purchase of Shares," and "Management of the
Fund and the Trust."
 
<TABLE>   
<CAPTION>
  SMITH BARNEY
  EXCHANGE RESERVE FUND                       1 YEAR 3 YEARS 5 YEARS 10 YEARS*
------------------------------------------------------------------------------
  <S>                                         <C>    <C>     <C>     <C>
  Assumes complete redemption at maximum
  applicable CDSC at end of each time period
    Class B..................................  $57     $67    $74     $127
    Class C..................................   12      37      64      142
  Assumes no redemption
    Class B..................................  $12     $37    $ 64     $127
    Class C..................................   12      37      64      142
------------------------------------------------------------------------------
</TABLE>    
* Ten year figures assume exchange of Class B shares for Class A shares of
  Smith Barney Money Funds, Inc.--Cash Portfolio at the end of the eighth year
  following the date of original purchase of such Class B shares. Accordingly,
  the expenses reflected above utilize the expenses of a Class A share of Cash
  Portfolio.
 
  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 REPRESEN-
TATION OF PAST OR FUTURE EXPENSES AND ACTUAL EXPENSES MAY BE GREATER OR LESS
THAN THOSE SHOWN.
 
6
<PAGE>
 
 
 
 
                      [This page intentionally left blank]
 
                                                                               7
<PAGE>
 
FINANCIAL HIGHLIGHTS
   
  The following information for the two-year period ended July 31, 1996 has
been audited by KPMG Peat Marwick LLP, independent auditors, whose report
thereon appears in the Fund's Annual Report dated July 31, 1996. The following
information for the fiscal years ended July 31, 1987 through July 31, 1994 has
been audited by other independent 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 Additional Information.     
   
FOR A CLASS B SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH YEAR:
    
<TABLE>   
<CAPTION>
                                        YEAR      YEAR      YEAR      YEAR
SMITH BARNEY                           ENDED     ENDED     ENDED     ENDED
EXCHANGE RESERVE FUND                 7/31/96   7/31/95   7/31/94   7/31/93
-----------------------------------------------------------------------------
<S>                                   <C>       <C>       <C>       <C>
NET ASSET VALUE, BEGINNING OF YEAR    $   1.00  $   1.00  $   1.00  $   1.00
-----------------------------------------------------------------------------
 Net investment income                   0.044     0.044     0.022     0.021
 Dividends from net investment income   (0.044)   (0.044)   (0.022)   (0.021)
-----------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR          $   1.00  $   1.00  $   1.00  $   1.00
-----------------------------------------------------------------------------
TOTAL RETURN++                            4.53%     4.49%     2.18%     2.15%
-----------------------------------------------------------------------------
NET ASSETS, END OF YEAR (000'S)       $150,421  $160,432  $252,246  $166,262
-----------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
 Expenses                                 1.17%     1.24%     1.26%     1.25%
 Net investment income                    4.45      4.35      2.24      2.16
-----------------------------------------------------------------------------
</TABLE>    
 
 
8
<PAGE>
 
FINANCIAL HIGHLIGHTS (CONTINUED)
 
<TABLE>
<CAPTION>
   YEAR          YEAR            YEAR            YEAR            YEAR           YEAR
  ENDED         ENDED           ENDED           ENDED           ENDED           ENDED
 7/31/92       7/31/91         7/31/90         7/31/89         7/31/88         7/31/87
---------------------------------------------------------------------------------------
 <S>           <C>             <C>             <C>             <C>             <C>
 $   1.00      $   1.00        $   1.00        $   1.00        $   1.00        $  1.00
---------------------------------------------------------------------------------------
    0.040         0.062          0.0740          0.0802          0.0566         0.0460
   (0.040)       (0.062)        (0.0740)        (0.0802)        (0.0566)       (0.0460)
---------------------------------------------------------------------------------------
 $   1.00      $   1.00        $   1.00        $   1.00        $   1.00        $  1.00
---------------------------------------------------------------------------------------
     4.06%         6.36%           7.62%           8.32%           5.85%          4.69%
---------------------------------------------------------------------------------------
 $225,476      $426,862        $686,756        $829,743        $215,731        $83,366
---------------------------------------------------------------------------------------
     1.22%         1.17%           1.15%           1.22%           1.46%          1.61%
     4.13          6.27            7.42                 8.36                5.69             4.96
---------------------------------------------------------------------------------------
</TABLE>
 
FOR A CLASS C SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH PERIOD:
 
<TABLE>   
<CAPTION>
                                       YEAR       PERIOD
SMITH BARNEY                           ENDED      ENDED
EXCHANGE RESERVE FUND                 7/31/96   7/31/95(1)
-----------------------------------------------------------
<S>                                   <C>       <C>
NET ASSET VALUE, BEGINNING OF YEAR    $ 1.00      $ 1.00
-----------------------------------------------------------
 Net investment income                 0.044       0.035
 Dividends from net investment income (0.044)     (0.035)
-----------------------------------------------------------
NET ASSET VALUE, END OF YEAR          $ 1.00      $ 1.00
-----------------------------------------------------------
TOTAL RETURN++                          4.51%       3.52%++
-----------------------------------------------------------
NET ASSETS, END OF YEAR (000'S)       $9,445      $2,850
-----------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
 Expenses                               1.17%+      1.21%+
 Net investment income                  4.39        4.76+
-----------------------------------------------------------
</TABLE>    
   
(1) For the period from November 7, 1994 (inception date) to July 31, 1995.
        
 ++Total return is not annualized as it may not be representative of the total
   return for the year.
 + Annualized.
++  Total return represents aggregate total return for the period indicated
    and does not reflect any applicable sales charge.
 
                                                                              9
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES
 
 
  The Fund seeks to maximize current income to the extent consistent with the
preservation of capital and the maintenance of liquidity. This investment
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's investment
objective will be achieved.
 
  The Fund attempts to achieve its investment objective by investing in short-
term money market instruments, including: securities issued or guaranteed by
the United States government, its agencies and instrumentalities ("U.S. govern-
ment securities"); repurchase agreements with respect to the foregoing; bank
time deposits, certificates of deposit and bankers' acceptances; and high grade
commercial paper. The following is a brief description of the kinds of instru-
ments in which the Fund may invest:
 
  U.S. Government Securities in which the Fund may invest include: direct obli-
gations of the United States Treasury such as Treasury Bills, Treasury Notes
and Treasury Bonds; obligations which are supported by the full faith and
credit of the United States such as Government National Mortgage Association
pass-through certificates; obligations which are supported by the right of the
issuer to borrow from the United States Treasury, such as securities of Federal
Home Loan Banks; and obligations which are supported by the credit of the
instrumentality, such as Federal National Mortgage Association and Federal Home
Loan Mortgage Association bonds. Because the United States government is not
obligated by law to provide support for an instrumentality that it sponsors,
the Fund will invest in obligations issued by such an instrumentality only when
the Fund's investment adviser determines that the credit risk with respect to
the instrumentality does not make its securities unsuitable for investment by
the Fund.
   
  Certificates of Deposit, Time Deposits and Bankers' Acceptances in which the
Fund may invest generally are limited to those instruments issued by domestic
and foreign banks, including branches of such banks, savings and loan associa-
tions and other banking institutions having total assets in excess of $1 bil-
lion. Certificates of deposit ("CDs") are short-term negotiable obligations of
commercial banks; time deposits ("TDs") are non-negotiable deposits maintained
in banking institutions for specified periods of time at stated interest rates;
and bankers' acceptances are time drafts drawn on commercial banks by borrowers
usually in connection with international transactions. The Fund may invest in
U.S. dollar-denominated bank obligations, such as CDs, bankers' acceptances and
TDs, including instruments issued or supported by the credit of domestic or
foreign banks or savings institutions having total assets at the time of pur-
chase in excess of $1 billion. The Fund generally will invest at least 25% of
its assets in these securities. The Fund will invest in an obligation of a for-
eign bank or foreign branch of a domestic bank only if the Fund's investment
adviser deems the obligation to present minimal credit     
 
10
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
   
risks. Nevertheless, this kind of obligation entails risks that are different
from those of investments in domestic obligations of domestic banks due to
differences in political, regulatory and economic systems and conditions. The
Fund will not purchase TDs maturing in more than six months and will limit to
no more than 10% of its assets its investment in TDs maturing from two busi-
ness days through six months.     
   
  Commercial Paper in which the Fund may invest is limited to debt obligations
of domestic and foreign issuers that at the time of purchase are Eligible
Securities (as defined below under "Fund Quality and Diversification") that
are (a) rated by at least one nationally recognized statistical rating organi-
zation ("NRSRO") in the highest rating category for short-term debt securities
or (b) comparable unrated securities. The Fund also may invest in variable
rate master demand notes, which are unsecured demand notes typically purchased
directly from large corporate issuers providing for variable amounts of prin-
cipal indebtedness and periodic adjustments in the interest rate according to
the terms of the instrument. Demand notes normally are not traded in a second-
ary market. However, the Fund may demand payment of principal and accrued
interest in full at any time without penalty. In addition, while demand notes
generally are not rated, their issuers must satisfy the same criteria as those
set forth above for issuers of commercial paper. The Manager will consider the
earning power, cash flow and other liquidity ratios of issuers of demand notes
and continually will monitor their financial ability to meet payment on
demand.     
 
 CERTAIN INVESTMENT POLICIES
 
  Price and Portfolio Maturity. The Fund invests only in securities which are
purchased with and payable in U.S. dollars and which have (or, pursuant to
regulations adopted by the SEC, will be deemed to have) remaining maturities
of thirteen months or less at the date of purchase by the Fund. For this pur-
pose, variable rate master demand notes (as described above under "Commercial
Paper"), which are payable on demand or, under certain conditions, at speci-
fied periodic intervals not exceeding thirteen months, in either case on not
more than 30 days' notice, will be deemed to have remaining maturities of
thirteen months or less. The Fund maintains a dollar-weighted average portfo-
lio maturity of 90 days or less. The Fund follows these policies to maintain a
constant net asset value of $1.00 per share, although there is no assurance
that it can do so on a continuing basis.
 
  Fund Quality and Diversification. The Fund will limit its investments to
securities that the Trust's Board of Trustees determines present minimal
credit risks and which are "Eligible Securities" at the time of acquisition by
the Fund. The term Eligible Securities includes securities rated by the "Req-
uisite NRSROs" in one of the two highest short-term rating categories, securi-
ties of issuers that have received such ratings with respect to other short-
term debt securities and comparable unrated securities. "Requisite NRSROs"
means (a) any two NRSROs that have issued a
 
                                                                             11
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
   
rating with respect to a security or class of debt obligations of an issuer,
or (b) one NRSRO, if only one NRSRO has issued such a rating at the time that
the Fund acquires the security. If the Fund acquires securities that are
unrated or that have been rated by a single NRSRO, the acquisition must be
approved or ratified by the Trust's Board of Trustees. The NRSROs currently
designated as such by the SEC are Standard & Poor's Ratings Group, Moody's
Investors Service, Inc., Thomson BankWatch, Fitch Investors Services, LP, Duff
& Phelps Inc. and IBCA Limited and its affiliate, IBCA, Inc. A discussion of
the ratings categories of the NRSROs is contained in the Appendix to the
Statement of Additional Information.     
 
  The Fund generally may not invest more than 5% of its total assets in the
securities of any one issuer, except for U.S. government securities. In addi-
tion, the Fund may not invest more than 5% of its total assets in Eligible
Securities that have not received the highest rating from the Requisite NRSROs
and comparable unrated securities ("Second Tier Securities") and may not
invest more than 1% of its total assets in the Second Tier Securities of any
one issuer. The Fund may invest more than 5% (but no more than 25%) of the
then-current value of the Fund's total assets in the securities of a single
issuer for a period of up to three business days, provided that (a) the secu-
rities are rated by the Requisite NRSROs in the highest short-term rating cat-
egory, are securities of issuers that have received such rating with respect
to other short-term debt securities or are comparable unrated securities, and
(b) the Fund does not make more than one such investment at any one time.
 
  Repurchase Agreements. The Fund may engage in repurchase agreement transac-
tions. Under the terms of a typical repurchase agreement, the Fund would
acquire a U.S. government security for a relatively 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. This arrangement
results in a fixed rate of return that is not subject to market fluctuations
during the Fund's holding period. The Fund will enter into repurchase agree-
ments with banks which are the issuers of instruments acceptable for purchase
by the Fund and certain dealers on the Federal Reserve Bank of New York's list
of reporting dealers. Under each repurchase agreement the selling institution
will be required to maintain the value of the securities subject to the repur-
chase agreement at not less than their repurchase price. 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 possible 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 Fund's investment adviser or administrator, acting under
the supervision of the Trust's Board of Trustees, reviews on an ongoing basis
the value of the collateral and the
 
12
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
creditworthiness of those banks and dealers with which the Fund enters into
repurchase agreements to evaluate potential risks.
   
  Mortgage and Asset-Backed Securities. The Fund may purchase fixed or adjust-
able rate mortgage-backed securities issued by the Government National Mortgage
Association, Federal National Mortgage Association or the Federal Home Loan
Mortgage Corporation. In addition, the Fund may purchase other asset-backed
securities, including securities backed by automobile loans, equipment leases
or credit card receivables. These securities directly or indirectly represent a
participation in, or are secured by and payable from, fixed or adjustable rate
mortgage or other loans which may be secured by real estate or other assets.
Unlike traditional debt instruments, payments on these securities include both
interest and a partial payment of principal. Prepayments of the principal of
underlying loans may shorten the effective maturities of these securities and
may result in the Fund having to reinvest proceeds at a lower interest rate.
    
 CERTAIN INVESTMENT GUIDELINES
   
  The Fund will concentrate its investments in the banking industry except dur-
ing temporary defensive periods. Up to 25% of the assets of the Fund may be
invested at any time in the obligations of issuers conducting their principal
business activities in any industry other than banking. The Fund may not
acquire more than 10% of the voting or any other class of securities of any one
issuer, except that U.S. government securities may be purchased without regard
to these limits. In addition, the Fund may invest up to an aggregate of 10% of
its total assets in illiquid securities with contractual or other restrictions
on resale (excluding (i) securities subject to Rule 144A of the Securities Act
of 1933 (the "1933 Act") as amended, provided at least two dealers make a mar-
ket in such securities and (ii) certain privately issued commercial paper eli-
gible for resale to institutional investors without registration pursuant to
Section 4(2) of the 1933 Act) and other instruments which are not readily mar-
ketable, including: (a) repurchase agreements providing for settlement in more
than seven days after notice by the Fund and (b) TDs maturing from two business
days through six months. The Fund also is authorized to borrow in an amount of
up to 10% of its total assets for temporary or emergency purposes, but not for
leverage, and to pledge its assets to the same extent in connection with such
borrowings. Whenever borrowings exceed 5% of the value of the Fund's total
assets, the Fund will not make any additional investments. A more detailed
description of these policies, together with an enumeration of additional
investment restrictions which the Fund has adopted and which cannot be changed
without the approval of the holders of a majority of the Fund's outstanding
shares, is contained in the Statement of Additional Information.     
 
                                                                              13
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 
 SPECIAL CONSIDERATIONS AND RISK FACTORS
 
  The Fund will be affected by general changes in interest rates which will
result in increases or decreases in the value of the obligations held by the
Fund. The market value of the obligations held by the Fund can be expected to
vary inversely to changes in the prevailing interest rates. Investors also
should recognize that, in periods of declining interest rates, the Fund's yield
will tend to be somewhat higher than prevailing market rates and, in periods of
rising interest rates, the Fund's yield will tend to be somewhat lower. Also,
when interest rates are falling, the inflow of net new money to the Fund from
the continuous sale of its shares will likely be invested in instruments pro-
ducing lower yields than the balance of its portfolio, thereby reducing the
Fund's current yield. In periods of rising interest rates, the opposite can be
expected to occur. In addition, securities in which the Fund will invest may
not yield as high a level of current income as might be achieved by investing
in securities with less liquidity and safety and longer maturities.
 
  Investments in foreign banks or foreign issuers present certain risks,
including those resulting from fluctuations in currency exchange rates, revalu-
ation of currencies, future political and economic developments and the possi-
ble imposition of currency exchange blockages or other foreign governmental
laws or restrictions and reduced availability of public information. Foreign
issuers generally are not subject to uniform accounting, auditing and financial
reporting standards or to other regulatory practices and requirements applica-
ble to domestic issuers. In addition, there may be less publicly available
information about a foreign bank than about a domestic bank.
 
VALUATION OF SHARES
 
 
  The Fund's net asset value per share is determined as of the close of regular
trading on the NYSE, and is computed by dividing the value of the Fund's net
assets attributable to each Class by the total number of shares of the Class
outstanding. The Fund employs the amortized cost method of valuing portfolio
securities and intends to use its best efforts to continue to maintain a con-
stant net asset value of $1.00 per share.
 
DIVIDENDS, DISTRIBUTIONS AND TAXES
 
 
 DIVIDENDS AND DISTRIBUTIONS
 
  The Fund will be treated separately from the Trust's other funds in determin-
ing the amount of dividends from net investment income and distributions of
capital gains payable to shareholders.
 
  The Fund declares dividends daily consisting of substantially all of its net
investment income, and pays dividends monthly. Any net realized gains will be
distrib-
 
14
<PAGE>
 
DIVIDENDS, DISTRIBUTIONS AND TAXES (CONTINUED)
 
uted at least annually. If a shareholder does not otherwise instruct, divi-
dends and capital gains will be reinvested automatically in additional shares
of the same Class at net asset value subject to no CDSC. Dividends and distri-
butions are treated the same for tax purposes whether taken in cash or rein-
vested in additional shares.
 
 TAXES
 
  The Fund will be treated as a separate taxpayer with the result that, for
federal tax purposes, the amount of investment income and capital gains earned
will be determined on a fund-by-fund basis, rather than on a Trust-wide basis.
The Fund intends to continue to qualify as a regulated investment company
under Subchapter M of the Code. In any taxable year in which the Fund so qual-
ifies and distributes at least 90% of its investment company taxable income
(which includes, among other items, dividends, interest and the excess of any
net short-term capital gains over net long-term capital losses), the Fund (but
not its shareholders) generally will be relieved of federal income tax on the
investment company taxable income and net realized capital gains (the excess
of net long-term capital gains over net short-term capital losses), if any,
distributed to shareholders. In order to qualify as a regulated investment
company, the Fund will be required to meet various Code requirements.
 
  Amounts not distributed on a timely basis in accordance with a calendar year
distribution requirement are subject to a nondeductible 4% excise tax. In
order to avoid application of the excise tax, the Fund intends to make its
distributions in accordance with this requirement.
 
  Distributions of any investment company taxable income are taxable to share-
holders as ordinary income. Distributions of any net capital gains designated
by the Fund as capital gain dividends are taxable to shareholders as long-term
capital gain regardless of the length of time a shareholder may have held
shares of the Fund.
 
  Dividends (including capital gain dividends) declared by the Fund in Octo-
ber, November or December of any calendar year to shareholders of record on a
date in such a month will be deemed to have been received by shareholders on
December 31 of that calendar year, provided that the dividend is actually paid
by the Fund during January of the following calendar year.
 
  Upon the disposition of shares of the Fund (whether by redemption, sale or
exchange), a shareholder generally will realize a taxable gain or loss. Such
gain or loss generally will be a capital gain or loss if the shares are capi-
tal assets in the shareholder's hands, and generally will be long-term or
short-term depending upon the shareholder's holding period for the shares. Any
loss realized by a shareholder on disposition of Fund shares held by the
shareholder for six months or less will be treated as long-term capital loss
to the extent of any distributions of capital gain dividends received by the
shareholder with respect to such shares.
 
                                                                             15
<PAGE>
 
DIVIDENDS, DISTRIBUTIONS AND TAXES (CONTINUED)
 
 
  Shareholders will be notified annually about the amounts of dividends and
distributions, including the amounts (if any) for that year which have been
designated as capital gain dividends. Dividends and distributions and gains
realized upon a disposition of Fund shares may also be subject to state, local
or foreign taxes depending on each shareholder's particular situation. Divi-
dends consisting of interest from obligations of the United States government
and certain of its agencies and instrumentalities may be exempt from all state
and local income taxes. Shareholders should consult their tax advisors for
specific information on the tax consequences of particular types of distribu-
tions.
 
PURCHASE OF SHARES
   
  Fund shares may be acquired only through exchanges with Class B and Class C
shares of other Smith Barney Mutual Funds, except that Class C shares may be
acquired directly by participants in the Smith Barney 401(k) Program or the
Smith Barney ExecChoice(TM) Program ("Participating Plans") and Class B shares
may be acquired directly by certain qualified and non-qualified retirement
programs (collectively with Participating Plans, "Benefit Plans"). Investors
purchasing shares of the Fund through a Benefit Plan may do so directly
through First Data. Class B shares or Class C shares
acquired through exchange are subject to the CDSC, if any, of the shares with
which the exchange is made. Class B shares acquired directly by a Benefit Plan
other than a Participating Plan will be subject to the CDSC as set forth
below.     
 
  In light of the distribution fee imposed on Class B shares and Class C
shares, an investment in the Fund should be viewed as part of a long-term
investment in the Smith Barney Mutual Funds. Investors seeking only to invest
in a money market fund and who do not expect to exchange Fund shares for
shares of other funds of the Smith Barney Mutual Funds should consider more
suitable investments, including other money market funds offered by Smith Bar-
ney.
 
  The Fund employs a distribution method which differs from that of certain
other mutual funds that invest in money market instruments. Before investing
in the Fund, among other things, investors should consider that certain other
funds with an investment objective and policies similar to those of the Fund
do not pay distribution expenses or impose any sales charge.
 
  Purchase orders received by the Fund or Smith Barney prior to the close of
regular trading on the NYSE, on any day the Fund calculates its net asset val-
ue, are priced according to the net asset value determined on that day. Orders
received by dealers or Introducing Brokers prior to the close of regular trad-
ing 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 Smith
 
16
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
 
Barney prior to Smith Barney's close of business (the "trade date"). Payment
for Fund shares is due on the third business day after the trade date.
 
 DEFERRED SALES CHARGE
 
  Class B shares sold directly to Benefit Plans other than a Participating Plan
will be assessed a CDSC on an amount equal to the lesser of the cost of the
shares being redeemed or their net asset value at the time of redemption. Such
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; and (c) shares
redeemed more than five years after their purchase. The amount of the CDSC will
depend on the number of years since the shareholder made the purchase payment
from which the amount is being redeemed. Solely for the purpose 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 Smith Barney statement month. The following table sets forth the
rates of the charge for redemptions of Class B shares by Benefit Plans other
than Participating Plans.
 
<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 of Cash Portfolio
eight years after the date on which they were purchased and will thereafter 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. Shareholders who held Class B shares of Smith
Barney Shearson Short-Term World Income Fund (the "Short-Term World Income
Fund") on July 15, 1994 and who subsequently exchange those shares for Class B
shares of the Fund will be offered the opportunity to exchange all such Class B
shares for Class A shares of the Cash Portfolio four years after the date on
which those shares were deemed to have been purchased. Holders of such Class B
shares will be notified of the pending exchange in writing approximately 30
days before the fourth anniversary of the purchase date and, unless the
exchange has been rejected in writing, the exchange will occur on or about the
fourth anniversary date.
 
                                                                              17
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
 
 
  The length of time that Class B or Class C shares subject to a CDSC have been
held will be calculated from the date that the shares were initially acquired
in the Fund or one of the other Smith Barney Mutual Funds, and Fund shares
being redeemed will be considered to represent, as applicable, capital appreci-
ation 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 Smith Barney.
 
 WAIVERS OF CDSC
   
  The CDSC will be waived on: (a) exchanges (see "Exchange Privilege"); (b) au-
tomatic 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) involuntary
redemptions; and (e) redemptions of shares in connection with a combination of
the Fund with any investment company by merger, acquisition of assets or other-
wise. In addition, a shareholder who has redeemed shares from other Smith Bar-
ney 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 Smith Barney in case
of shareholders who are also Smith Barney clients or by First Data in the case
of all 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 Participat-
ing Plans in these programs. Participating Plans may acquire shares of the Fund
only through an exchange from shares of another fund in the Smith Barney Mutual
Funds or through direct investment only if they hold Class C shares of another
of the Smith Barney Mutual Funds.     
   
  The Fund offers to Participating Plans Class C shares as an investment choice
under the Smith Barney 401(k) and ExecChoice(TM) Programs. Class C shares
acquired through the Participating Plans are subject to the same service and/or
distribution fees as the Class C shares acquired by other investors; however,
they are not subject to any initial sales charge or CDSC.     
 
18
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
   
  401(k) and ExecChoice(TM) Plans Opened On or After June 21, 1996. If, at the
end of the fifth year after the date the Participating Plan enrolled in the
Smith Barney 401(k) Program or the Smith Barney ExecChoice(TM) Program, a Par-
ticipating Plan's total Class C holdings in all non-money market Smith Barney
Mutual Funds equal at least $1,000,000, the Participating Plan will be offered
the opportunity to exchange all of its Class C shares for Class A shares of the
Cash Portfolio. (For Participating Plans that were originally established
through a Smith Barney retail brokerage account, the five year period will be
calculated from the date the retail brokerage account was opened.) Such Partic-
ipating 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 anniversary date. If the Participating Plan does
not qualify for the five year exchange to Class A shares, a review of the Par-
ticipating Plan's holdings will be performed each quarter until either the Par-
ticipating 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 a Participating
Plan's total Class C 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 C shares for Class
A shares of the Cash Portfolio. 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 that has not previ-
ously qualified for an exchange into Class A shares will be offered the oppor-
tunity to exchange all of its Class C shares for Class A shares of the Cash
Portfolio, 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 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 C shares of the Fund but instead may
acquire Class A shares of the Cash Portfolio. Any Class C shares not converted
will continue to be subject to the distribution fee.     
   
  Participating Plans wishing to acquire shares of a 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 Smith Barney Financial Consultant.
       
  Existing 401(k) Plans Investing in Class B Shares. Class B shares of the
Smith Barney Mutual Funds are not available for purchase by Participating Plans
opened     
 
                                                                              19
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
   
on or after June 21, 1996, but may continue to be purchased by any Participat-
ing Plan in the Smith Barney 401(k) Program opened prior to such date and orig-
inally investing in such Class. Class B shares acquired are subject to a CDSC
of 3.00% of redemption proceeds, if the Participating Plan terminates within
eight years of the date the Participating Plan first enrolled in the Smith Bar-
ney 401(k) Program.     
   
  At the end of the eighth year after the date the Participating Plan enrolled
in the Smith Barney 401(k) Program, the Participating Plan will be offered the
opportunity to exchange all of its Class B shares for Class A shares of Cash
Portfolio. Such Participating Plan will be notified of the pending exchange in
writing approximately 60 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 the exchange has occurred,
a Participating Plan will not be eligible to acquire additional Class B shares
of the Fund but instead may acquire Class A shares of the Cash Portfolio. If
the Participating Plan elects not to exchange all of its Class B shares at that
time, each Class B share held by the Participating Plan will have the same con-
version feature as Class B shares held by other investors. See "Purchase of
Shares--Deferred Sales Charge".     
   
  No CDSC is imposed on redemptions of Class B shares to the extent that the
net asset value of the shares redeemed does not exceed the current net asset
value of the shares purchased through reinvestment of dividends or capital gain
distributions, plus the current net asset value of Class B shares purchased
more than eight years prior to the redemption, plus increases in the net asset
value of the shareholder's Class B shares above the purchase payments made dur-
ing the preceding eight years. Whether or not the CDSC applies to the redemp-
tion by a Participating Plan depends on the number of years since the Partici-
pating Plan first became enrolled in the Smith Barney 401(k) Program, unlike
the applicability of the CDSC to redemptions by other shareholders, which
depends on the number of years since those shareholders made the purchase pay-
ment from which the amount is being redeemed.     
   
  The CDSC will be waived on redemptions of Class B shares in connection with
lump-sum or other distributions made by a Participating Plan as a result of:
(a) the retirement of an employee in the Participating Plan; (b) the termina-
tion of employment of an employee in the Participating Plan; (c) the death or
disability of an employee in the Participating Plan; (d) the attainment of age
59 1/2 by an employee in the Participating Plan; (e) hardship of an employee in
the Participating Plan to the extent permitted under Section 401(k) of the
Code; or (f) redemption of shares in connection with a loan made by the Partic-
ipating Plan to an employee.     
       
       
20
<PAGE>
 
   
EXCHANGE PRIVILEGE     
   
  Except as otherwise noted below, shares of each Class may be exchanged for
shares of the same Class in the following Smith Barney Mutual Funds, to the
extent shares are offered for sale in the shareholder's state of residence.
Exchanges are subject to minimum investment requirements and other requirements
of the fund into which exchanges are made and a sales charge differential may
apply.     
 
 FUND NAME
 
  Growth Funds
   Smith Barney Aggressive Growth Fund Inc.
   Smith Barney Appreciation Fund Inc.
   Smith Barney Fundamental Value Fund Inc.
   Smith Barney Growth Opportunity Fund
   Smith Barney Managed Growth Fund
      
   Smith Barney Natural Resources Fund Inc.     
   Smith Barney Special Equities Fund
          
  Growth and Income Funds
   Smith Barney Convertible Fund
      
   Smith Barney Funds, Inc.--Equity Income Portfolio     
   Smith Barney Growth and Income Fund
   Smith Barney Premium Total Return Fund
   Smith Barney Strategic Investors Fund
   Smith Barney Utilities Fund
 
  Taxable Fixed-Income Funds
    *Smith Barney Adjustable Rate Government Income Fund
   Smith Barney Diversified Strategic Income Fund
   **Smith Barney Funds, Inc.--Income Return Account Portfolio
          
   Smith Barney Funds, Inc.--U.S. Government Securities Portfolio
   Smith Barney Government Securities Fund
   Smith Barney High Income Fund
   Smith Barney Investment Grade Bond Fund
   Smith Barney Managed Governments Fund Inc.
 
  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 Fund
          
          
   Smith Barney Muni Funds--Florida Portfolio
   Smith Barney Muni Funds--Georgia Portfolio
 
                                                                              21
<PAGE>
 
EXCHANGE PRIVILEGE (CONTINUED)
 
   **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
 
  International Funds
       
   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
-------------------------------------------------------------------------------
 * Available for exchange with Class B and Class C shares of the Fund. In
   addition, shareholders who own Class C shares of the Fund in a Smith Barney
   401(k) Program may exchange those shares for Class C shares of this fund.
** Available for exchange with Class C shares of the Fund.
 
  Class B Exchanges. In the event a Class B shareholder unless such share-
holder was a Class B shareholder of the Short-Term World Fund on July 15, 1994
wishes to exchange all or a portion of his or her shares in any of the funds
imposing a CDSC higher 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 C Exchanges. Upon an exchange, the new Class C shares will be deemed
to have been purchased on the same date as the Class C shares of the Fund that
have been exchanged.
 
  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 after the redemption pro-
ceeds are available. Redemption procedures discussed below are also applicable
for exchanging shares, and exchanges will be made upon receipt of all support-
ing 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.
 
22
<PAGE>
 
REDEMPTION OF SHARES
 
 
  The Fund is required to redeem the shares of the Fund 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 trading 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 redemp-
tion must specify the Class being redeemed. In the event of a failure to spec-
ify which Class, or if the investor owns fewer shares of the Class than speci-
fied, the redemption request will be delayed until FDISG receives further
instructions from Smith Barney, or if the shareholder's account is not with
Smith Barney, from the shareholder directly. The redemption proceeds will be
remitted on or before the third business day following receipt of proper ten-
der, except on a day 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 Smith Barney brokerage account, these funds will not be invested
for the shareholder's benefit without specific instruction and Smith Barney
will benefit from the use of temporarily uninvested funds. Redemption proceeds
for shares purchased by check, other than a certified or official bank check,
will be remitted upon clearance of the check, which may take up to ten days or
more.     
 
  Shares held by Smith Barney as custodian must be redeemed by submitting a
written request to a Smith Barney Financial Consultant. Shares other than those
held by Smith Barney as custodian may be redeemed through an investor's Finan-
cial Consultant, Introducing Broker or dealer in the selling group or by sub-
mitting a written request for redemption to:
 
  Smith Barney Exchange Reserve Fund
  Class B or Class C (please specify)
  c/o First Data Investor Services Group, Inc.
  P.O. Box 9134
  Boston, Massachusetts 02205-9134
   
  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 a written 
redemption
request in excess of $2,000, share certificate or stock power, must be guaran-
teed 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 $2,000 or less do not require a signature guarantee unless more
than one such redemption request is made in any     
 
                                                                              23
<PAGE>
 
REDEMPTION OF SHARES (CONTINUED)
 
10-day period or the redemption proceeds are to be sent to an address other
than the address of record. Unless otherwise directed, 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, administra-tors, 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 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 contact First 
Data at
1-800-451-2010. Once eligibility is confirmed, the shareholder must complete
and return a Telephone/Wire Authorization Form, along with a signature guaran-
tee that will be provided by First Data upon request. (Alternatively, an 
investor
may authorize telephone redemptions on the new account application with the
applicant's 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 5:00 p.m. (New York City time) on any day the NYSE is open. Redemption 
requests received after
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 com-
plete 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 5:00 p.m.(New York City time) on any day on which the NYSE is open. 
Exchange requests
 
24
<PAGE>
 
REDEMPTION OF SHARES (CONTINUED)
 
received after the close of regular trading on the NYSE are processed 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 instructions com-
municated 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 fol-
lowing 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 periodic cash payments of at least $50 monthly or quarterly. Retire-
ment 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. Any applicable CDSC will not be waived on amounts
withdrawn by a shareholder that exceed 1.00% per month of the value of the
shareholder's shares subject to the CDSC at the time the withdrawal plan com-
mences. For further information regarding the automatic cash withdrawal plan,
shareholders should contact a Smith Barney Financial Consultant.     
   
  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
the 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
involuntary liquidation redemption.     
 
YIELD INFORMATION
 
 
  From time to time the Fund may advertise its yield and effective yield of
Class B and Class C shares. These yield figures are based on historical earn-
ings and are not intended to indicate future performance. The yield of a Class
refers to the net investment income generated by an investment in the Class
over a specific seven-day period (which will be stated in the advertisement).
This net investment income
 
                                                                             25
<PAGE>
 
YIELD INFORMATION (CONTINUED)
 
is then annualized. The effective yield is calculated similarly but, when
annualized, the income earned by an investment in the Class is assumed to be
reinvested. The effective yield will be slightly higher than the yield because
of the compounding effect of the assumed reinvestment.
 
MANAGEMENT OF THE FUND AND THE TRUST
 
 
 BOARD OF TRUSTEES
 
  Overall responsibility for management and supervision of the Trust and the
Fund rests with the Trust's Board of Trustees. The Trustees approve all signif-
icant agreements between the Trust and the companies that furnish services to
the Fund, including agreements with its investment adviser, administrator, cus-
todian and transfer agent. The day-to-day operations of the Fund are delegated
to its investment adviser and administrator. The Statement of Additional Infor-
mation contains general background information regarding each Trustee and exec-
utive officer of the Fund.
 
 INVESTMENT ADVISER
   
  The Manager is located at 388 Greenwich Street, New York, New York 10013, and
serves as the Fund's investment adviser pursuant to an advisory agreement dated
August 31, 1995. The Manager (through its predecessors) has been in the invest-
ment counseling business since 1934 and is a registered investment adviser. The
Manager renders investment advice to investment companies that had aggregate
assets under management as of October 31, 1996 in excess of $79 billion.     
 
  Subject to the supervision and direction of the Trust's Board of Trustees,
the Manager manages the Fund in accordance with the Fund's stated investment
objective and policies, makes investment decisions for the Fund, places orders
to purchase and sell securities on behalf of the Fund and employs professional
portfolio managers and securities analysts who provide research services to the
Fund. For investment services rendered, the Fund pays the Manager a fee at the
annual rate of 0.30% of the Fund's average daily net assets.
 
 ADMINISTRATOR
 
  The Manager also serves as the Fund's administrator and oversees all aspects
of the Fund's administration and operation. For administration services ren-
dered, the Fund pays the Manager a fee at the annual rate of .20% of the Fund's
average daily net assets.
 
26
<PAGE>
 
MANAGEMENT OF THE FUND AND THE TRUST (CONTINUED)
    
 PORTFOLIO MANAGEMENT     
   
  Phyllis M. Zahorodny, Managing Director of Smith Barney and Investment Offi-
cer of the Fund, is responsible for managing the day-to-day operations of the
Fund including making all investment decisions.     
   
  Ms. Zahorodny's management discussion and analysis, and additional perfor-
mance information regarding the Fund during the fiscal year ended July 31, 1996
are included in the Annual Report dated July 31, 1996. A copy of the Annual
Report may be obtained upon request and without charge from a Smith Barney
Financial Consultant or by writing or calling the Fund at the address or phone
number listed on page one of this Prospectus.     
 
DISTRIBUTOR
   
  Smith Barney is located at 388 Greenwich Street, New York, New York 10013.
Smith Barney distributes shares of the Fund as a principal underwriter and as
such conducts a continuous offering pursuant to a "best efforts" arrangement
requiring Smith Barney to take and pay for only such securities as may be sold
to the public. Pursuant to a plan of distribution adopted by the Fund under
Rule 12b-1 under the Act (the "Plan"), Smith Barney is paid a distribution fee
with respect to Class B and Class C shares of the Fund at the annual rate of
0.50% of the average daily net assets of each respective Class' shares. Class B
shares that automatically convert to Class A shares of Cash Portfolio eight
years after the date of original purchase will no longer be subject to distri-
bution fees. The fees are used by Smith Barney to pay its Financial Consultants
to cover expenses primarily intended to result in the sale of shares. These
expenses include: advertising expenses; the cost of printing and mailing pro-
spectuses to potential investors; payments to and expenses of Smith Barney
Financial Consultants and other persons who provide support services in connec-
tion with the distribution of shares; interest and/or carrying charges; and
indirect and overhead costs of Smith Barney associated with the sale of Fund
shares, including lease, utility, communications and sales promotion expenses.
    
  Payments under the Plan with respect to Class B and Class C shares are not
tied exclusively to the distribution expenses actually incurred by Smith Bar-
ney, and such payments may exceed distribution expenses actually incurred by
Smith Barney. The Board of Trustees evaluates the appropriateness of the Plan
and its payment terms on a continuing basis and in doing so considers all rele-
vant factors, including expenses borne by Smith Barney and amounts received
under the Plan and the proceeds of CDSC.
 
                                                                              27
<PAGE>
 
ADDITIONAL INFORMATION
   
  The Trust was organized on March 12, 1985 under the laws of the Commonwealth
of Massachusetts and is an entity commonly known as a "Massachusetts business
trust." The Trust offers shares of beneficial interest of separate series hav-
ing a $.001 per share par value. When matters are submitted for shareholder
vote, shareholders of each fund of the Trust will have one vote for each full
share owned and a proportionate, fractional vote for any fractional share held.
Shares of the Trust will be voted generally on a Trust-wide basis on all mat-
ters except matters affecting the interests of one Fund or one Class of shares.
    
  The Trust does not hold annual meetings of shareholders for the purpose of
electing Trustees unless and until such time as less than a majority of the
Trustees holding office have been elected by shareholders. The Trustees will
call a meeting for any purpose upon the written request of holders of 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.
   
  PNC Bank, National Association, located at 17th and Chestnut Streets, Phila-
delphia, PA 19103, serves as custodian of the Fund's investments.     
   
  First Data is located at Exchange Place, Boston, Massachusetts 02109, and
serves as the Trust's transfer agent.     
   
  The Fund sends to each shareholder a semi-annual report and an audited annual
report, each of which includes a list of the investment securities held by the
Trust. In an effort to reduce the Fund's printing and mailing costs, the Fund
plans to consolidate the mailing of its semi-annual and annual reports by
household. This consolidation means that a household having multiple accounts
with the identical address of record will receive a single copy of each report.
In addition, the Fund also plans to consolidate the mailing of its Prospectus
so that a shareholder having multiple accounts will receive a single Prospectus
annually. Any shareholder who does not want this consolidation to apply to his
or her account should contact his or her Financial Consultant or the Trust's
transfer agent.     
 
28
<PAGE>
 
 
                                              SMITH BARNEY

                                              ----------------------------------
                                              A Member of TravelersGroup  [LOGO]
 
 
 
                                              SMITH BARNEY EXCHANGE RESERVE FUND
 
                                                            388 Greenwich Street
                                                        New York, New York 10013
                                                                 
                                                              FD 1208 11/96     
<PAGE>
 
   
PROSPECTUS                                               NOVEMBER 28, 1996     
   
Smith Barney     
   
Exchange Reserve Fund     
3100 Breckinridge Blvd., Bldg. 200
Duluth, Georgia 30199-0062
(800) 544-5445
 
  Smith Barney Exchange Reserve Fund (the "Fund"), a diversified fund, seeks
to maximize current income to the extent consistent with the preservation of
capital and the maintenance of liquidity by investing in a diversified portfo-
lio of high quality money market instruments.
 
  SHARES OF THE FUND ARE NOT INSURED OR GUARANTEED BY THE U.S. GOVERNMENT.
THERE IS NO ASSURANCE THAT THE FUND WILL BE ABLE TO MAINTAIN A STABLE NET
ASSET VALUE OF $1.00 PER SHARE.
 
  The Fund is one of a number of funds, each having distinct investment objec-
tives and policies making up the Smith Barney Income Funds (the "Trust"). The
Trust is an open-end management investment company commonly referred to as a
mutual fund.
 
  This Prospectus sets forth concisely certain information about the Fund and
the Trust, including distribution fees and expenses, which prospective invest-
ors will find helpful in making an investment decision. Investors are encour-
aged 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 28, 1996, as amended or supplemented from
time to time, that is available upon request and without charge by calling or
writing the Trust at the telephone number or address set forth above, or by
contacting an Investments Representative of PFS Investments Inc. ("PFS Invest-
ments"). The Statement of Additional Information has been filed with the Secu-
rities and Exchange Commission (the "SEC") and is incorporated by reference
into this Prospectus in its entirety.     
 
PFS DISTRIBUTORS, INC.
Distributor
 
SMITH BARNEY MUTUAL FUNDS MANAGEMENT INC.
Investment Adviser and Administrator
 
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES 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                            6
-------------------------------------------------
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES    8
-------------------------------------------------
VALUATION OF SHARES                            12
-------------------------------------------------
DIVIDENDS, DISTRIBUTIONS AND TAXES             12
-------------------------------------------------
PURCHASE OF SHARES                             14
-------------------------------------------------
EXCHANGE PRIVILEGE                             15
-------------------------------------------------
REDEMPTION OF SHARES                           16
-------------------------------------------------
MINIMUM ACCOUNT SIZE                           17
-------------------------------------------------
YIELD INFORMATION                              18
-------------------------------------------------
MANAGEMENT OF THE FUND AND THE TRUST           18
-------------------------------------------------
DISTRIBUTOR                                    19
-------------------------------------------------
ADDITIONAL INFORMATION                         20
-------------------------------------------------
</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 Statement of Additional
Information. Cross references in this summary are to headings in the Prospec-
tus. See "Table of Contents."
 
INVESTMENT OBJECTIVE The Fund is an open-end diversified management investment
company that seeks to maximize current income to the extent consistent with
the preservation of capital and the maintenance of liquidity by investing in
high quality short-term money market instruments. See "Investment Objective
and Management Policies."
   
PURCHASE OF SHARES Shares of the Fund may be acquired by the general public
only through the exchange of Class B shares of other Smith Barney Mutual
Funds. Class B shares of the Fund acquired through exchange are subject to the
contingent deferred sales charge ("CDSC"), if any, of the shares with which
the exchange is made. All Class B shares are subject to an annual distribution
fee of .50% of the value of average daily net assets of the Fund. Eight years
after the date of their original purchase, Class B shares will be automati-
cally redeemed at net asset value and the redemption proceeds will be rein-
vested, at net asset value, in Class A shares of Smith Barney Money Funds
Inc.--Cash Portfolio ("Cash Portfolio"). Upon this conversion, the shares will
no longer be subject to the annual distribution fee. In addition to Class B
shares, the Fund offers Class C shares to investors exchanging Class C shares
of another Smith Barney Fund purchased through Smith Barney Inc. ("Smith Bar-
ney"), a distributor of the Fund.     
   
  Shares may be exchanged through the Fund's distributor, PFS Distributors,
Inc. ("PFS") See "Purchase of Shares."     
 
INVESTMENT MINIMUMS Investors may open an account by making an initial invest-
ment of at least $1,000 for each account, or $250 for an individual retirement
account ("IRA") or a Self-Employed Retirement Plan. Subsequent investments of
at least $50 may be made for Class B shares. For participants in retirement
plans qualified under Section 403(b)(7) or Section 401(a) of the Code, the
minimum initial and subsequent investment requirement is $25. See "Purchase of
Shares."
 
REDEMPTION OF SHARES Shares may be redeemed on each day that the New York
Stock Exchange, Inc. ("NYSE") is open for business. See "Redemption of
Shares."
   
MANAGEMENT OF THE FUND Smith Barney Mutual Funds Management Inc. (the "Manag-
er") serves as the Fund's investment adviser and administrator. The Manager is
a wholly owned subsidiary of Smith Barney Holdings Inc. ("Holdings"). Holdings
is a wholly owned subsidiary of Travelers Group Inc. ("Travelers"), a diversi-
fied financial services holding company engaged, through its subsidiaries,
    
                                                                              3
<PAGE>
 
PROSPECTUS SUMMARY (CONTINUED)
 
principally in four business segments: Investment Services, Consumer Finance
Services, Life Insurance Services and Property & Casualty Insurance Services.
See "Management of the Trust and the Fund."
 
EXCHANGE PRIVILEGE Shares may be exchanged for Class B shares of certain other
funds of the Smith Barney Mutual Funds at the net asset value next determined,
plus any applicable sales charge differential. See "Exchange Privilege."
 
DIVIDENDS AND DISTRIBUTIONS Dividends are declared daily and paid monthly from
net investment income. See "Dividends, Distributions and Taxes."
 
REINVESTMENT OF DIVIDENDS Dividends and distributions paid on shares of the
Fund will be reinvested automatically in additional shares at current net
asset value unless otherwise specified by an investor. Shares acquired by div-
idend and distribution reinvestment will not be subject to any CDSC. Class B
shares acquired through dividend and distribution reinvestments will become
eligible for conversion to Class A shares of Cash Portfolio. See "Dividends,
Distributions and Taxes."
   
RISK FACTORS AND SPECIAL CONSIDERATIONS There is no assurance that the Fund
will achieve its investment objective. In light of the fees and CDSC imposed
on Class B shares, an investment in the Fund should be viewed as part of a
long-term investment in the Smith Barney Mutual Funds. Investors seeking only
to invest in a money market fund and who do not expect to re-exchange Fund
shares for Class B shares of other Smith Barney Mutual Funds should consider
more suitable investments, including other money market funds offered to the
public by PFS. See "Investment Objective and Management Policies" and "Pur-
chase of Shares."     
 
4
<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 CDSC that may be incurred at the time of
redemption and, unless otherwise noted, the Fund's operating expenses for its
most recent year:
 
 SMITH BARNEY EXCHANGE RESERVE FUND
<TABLE>   
----------------------------------------------------------------------------------
  <S>                                                                        <C>
  SHAREHOLDER TRANSACTION EXPENSES
    Maximum CDSC
     (as a percentage of original cost or redemption proceeds, whichever is
       lower)                                                                None*
----------------------------------------------------------------------------------
  ANNUAL FUND OPERATING EXPENSES
    (as a percentage of average net assets)
    Management fees                                                          0.50%
    12b-1 fee**                                                              0.50
    Other expenses***                                                        0.17
----------------------------------------------------------------------------------
  TOTAL FUND OPERATING EXPENSES                                              1.17%
----------------------------------------------------------------------------------
</TABLE>    
  * Class B shares of the Fund acquired through exchanges with shares of other
    Funds of the Smith Barney Mutual Funds are subject to the CDSC, if any, of
    the shares with which the exchange is made.
 ** Upon conversion, Class B shares will no longer be subject to a
    distribution fee. Smith Barney receives an annual 12b-1 distribution fee
    of .50% of the Fund's average daily net assets.
   
*** "Other expenses" in the above table include fees for shareholder services,
    custodial fees, legal and accounting fees, printing costs and registration
    fees.     
 
 EXAMPLE
 
  The following example is intended to assist an investor in understanding 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 above table. See "Purchase of Shares," and "Management of the
Fund and the Trust."
 
<TABLE>   
<CAPTION>
  SMITH BARNEY
  EXCHANGE RESERVE FUND                       1 YEAR 3 YEARS 5 YEARS 10 YEARS*
------------------------------------------------------------------------------
  <S>                                         <C>    <C>     <C>     <C>
  Assumes complete redemption at maximum
  applicable CDSC at end of each time period   $12     $37     $64     $128
  Assumes no redemption                        $12     $37     $64     $128
</TABLE>    
-------------------------------------------------------------------------------
* Ten year figures assume exchange of Class B shares for Class A shares of
  Smith Barney Money Funds, Inc.--Cash Portfolio at the end of the eighth year
  following the date of original purchase of such Class B shares. Accordingly,
  the expenses reflected above utilize the expenses of a Class A share of Cash
  Portfolio.
 
  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 REPRESEN-
TATION OF PAST OR FUTURE EXPENSES AND ACTUAL EXPENSES MAY BE GREATER OR LESS
THAN THOSE SHOWN.
 
                                                                              5
<PAGE>
 
FINANCIAL HIGHLIGHTS
   
  The following information for the two-year period ended July 31, 1996 has
been audited by KPMG Peat Marwick LLP, independent auditors, whose report
thereon appears in the Fund's Annual Report dated July 31, 1996. The following
information for the fiscal years ended July 31, 1987 through July 31, 1994 has
been audited by other independent 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 Additional Information.     
   
FOR A CLASS B SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH YEAR:
    
<TABLE>   
<CAPTION>
                                        YEAR      YEAR      YEAR      YEAR
SMITH BARNEY                           ENDED     ENDED     ENDED     ENDED
EXCHANGE RESERVE FUND                 7/31/96   7/31/95   7/31/94   7/31/93
-----------------------------------------------------------------------------
<S>                                   <C>       <C>       <C>       <C>
NET ASSET VALUE, BEGINNING OF YEAR    $   1.00  $   1.00  $   1.00  $   1.00
-----------------------------------------------------------------------------
 Net investment income                   0.044     0.044     0.022     0.021
 Dividends from net investment income   (0.044)   (0.044)   (0.022)   (0.021)
-----------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR          $   1.00  $   1.00  $   1.00  $   1.00
-----------------------------------------------------------------------------
TOTAL RETURN+                             4.53%     4.49%     2.18%     2.15%
-----------------------------------------------------------------------------
NET ASSETS, END OF YEAR (000'S)       $150,421  $160,432  $252,246  $166,262
-----------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
 Expenses                                 1.17%     1.24%     1.26%     1.25%
 Net investment income                    4.45      4.35      2.24      2.16
-----------------------------------------------------------------------------
</TABLE>    
 
 
6
<PAGE>
 
FINANCIAL HIGHLIGHTS (CONTINUED)
 
    
<TABLE>
<CAPTION>
   YEAR          YEAR            YEAR            YEAR            YEAR           YEAR
  ENDED         ENDED           ENDED           ENDED           ENDED           ENDED
 7/31/92       7/31/91         7/31/90         7/31/89         7/31/88         7/31/87
---------------------------------------------------------------------------------------
 <S>           <C>             <C>             <C>             <C>             <C>
 $   1.00      $   1.00        $   1.00        $   1.00        $   1.00        $  1.00
---------------------------------------------------------------------------------------
    0.040         0.062          0.0740          0.0802          0.0566         0.0460
   (0.040)       (0.062)        (0.0740)        (0.0802)        (0.0566)       (0.0460)
---------------------------------------------------------------------------------------
 $   1.00      $   1.00        $   1.00        $   1.00        $   1.00        $  1.00
---------------------------------------------------------------------------------------
     4.06%         6.36%           7.62%           8.32%           5.85%          4.69%
---------------------------------------------------------------------------------------
 $225,475      $426,862        $686,756        $829,743        $215,731        $83,366
---------------------------------------------------------------------------------------
     1.22%         1.17%           1.15%           1.22%           1.46%          1.61%
     4.13          6.27            7.42%           8.36%           5.89%          4.96%
---------------------------------------------------------------------------------------
</TABLE>
    
 
 
                                                                              7
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES
 
 
  The Fund seeks to maximize current income to the extent consistent with the
preservation of capital and the maintenance of liquidity. This investment
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's investment
objective will be achieved.
 
  The Fund attempts to achieve its investment objective by investing in short-
term money market instruments, including: securities issued or guaranteed by
the United States government, its agencies and instrumentalities ("U.S. govern-
ment securities"); repurchase agreements with respect to the foregoing; bank
time deposits, certificates of deposit and bankers' acceptances; and high grade
commercial paper. The following is a brief description of the kinds of instru-
ments in which the Fund may invest:
 
  U.S. Government Securities in which the Fund may invest include: direct obli-
gations of the United States Treasury such as Treasury Bills, Treasury Notes
and Treasury Bonds; obligations which are supported by the full faith and
credit of the United States such as Government National Mortgage Association
pass-through certificates; obligations which are supported by the right of the
issuer to borrow from the United States Treasury, such as securities of Federal
Home Loan Banks; and obligations which are supported by the credit of the
instrumentality, such as Federal National Mortgage Association and Federal Home
Loan Mortgage Association bonds. Because the United States government is not
obligated by law to provide support for an instrumentality that it sponsors,
the Fund will invest in obligations issued by such an instrumentality only when
the Fund's investment adviser determines that the credit risk with respect to
the instrumentality does not make its securities unsuitable for investment by
the Fund.
   
  Certificates of Deposit, Time Deposits and Bankers' Acceptances in which the
Fund may invest generally are limited to those instruments issued by domestic
and foreign banks, including branches of such banks, savings and loan associa-
tions and other banking institutions having total assets in excess of $1 bil-
lion. Certificates of deposit ("CDs") are short-term negotiable obligations of
commercial banks; time deposits ("TDs") are non-negotiable deposits maintained
in banking institutions for specified periods of time at stated interest rates;
and bankers' acceptances are time drafts drawn on commercial banks by borrowers
usually in connection with international transactions. The Fund may invest in
U.S. dollar-denominated bank obligations, such as CDs, bankers' acceptances and
TDs, including instruments issued or supported by the credit of domestic or
foreign banks or savings institutions having total assets at the time of pur-
chase in excess of $1 billion. The Fund generally will invest at least 25% of
its assets in these securities. The Fund will invest in an obligation of a for-
eign bank or foreign branch of a domestic bank only if the Fund's investment
adviser deems the obligation to present minimal credit     
 
8
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
   
risks. Nevertheless, this kind of obligation entails risks that are different
from those of investments in domestic obligations of domestic banks due to
differences in political, regulatory and economic systems and conditions. The
Fund will not purchase TDs maturing in more than six months and will limit to
no more than 10% of its assets its investment in TDs maturing from two busi-
ness days through six months.     
   
  Commercial Paper in which the Fund may invest is limited to debt obligations
of domestic and foreign issuers that at the time of purchase are Eligible
Securities (as defined below under "Fund Quality and Diversification") that
are (a) rated by at least one nationally recognized statistical rating organi-
zation ("NRSRO") in the highest rating category for short-term debt securities
or (b) comparable unrated securities. The Fund also may invest in variable
rate master demand notes, which are unsecured demand notes typically purchased
directly from large corporate issuers providing for variable amounts of prin-
cipal indebtedness and periodic adjustments in the interest rate according to
the terms of the instrument. Demand notes normally are not traded in a second-
ary market. However, the Fund may demand payment of principal and accrued
interest in full at any time without penalty. In addition, while demand notes
generally are not rated, their issuers must satisfy the same criteria as those
set forth above for issuers of commercial paper. The Manager will consider the
earning power, cash flow and other liquidity ratios of issuers of demand notes
and continually will monitor their financial ability to meet payment on
demand.     
 
 CERTAIN INVESTMENT POLICIES
 
  Price and Portfolio Maturity. The Fund invests only in securities which are
purchased with and payable in U.S. dollars and which have (or, pursuant to
regulations adopted by the SEC, will be deemed to have) remaining maturities
of thirteen months or less at the date of purchase by the Fund. For this pur-
pose, variable rate master demand notes (as described above under "Commercial
Paper"), which are payable on demand or, under certain conditions, at speci-
fied periodic intervals not exceeding thirteen months, in either case on not
more than 30 days' notice, will be deemed to have remaining maturities of
thirteen months or less. The Fund maintains a dollar-weighted average portfo-
lio maturity of 90 days or less. The Fund follows these policies to maintain a
constant net asset value of $1.00 per share, although there is no assurance
that it can do so on a continuing basis.
 
  Fund Quality and Diversification. The Fund will limit its investments to
securities that the Trust's Board of Trustees determines present minimal
credit risks and which are "Eligible Securities" at the time of acquisition by
the Fund. The term Eligible Securities includes securities rated by the "Req-
uisite NRSROs" in one of the two highest short-term rating categories, securi-
ties of issuers that have received such ratings with respect to other short-
term debt securities and comparable unrated
 
                                                                              9
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
   
securities. "Requisite NRSROs" means (a) any two NRSROs that have issued a
rating with respect to a security or class of debt obligations of an issuer,
or (b) one NRSRO, if only one NRSRO has issued such a rating at the time that
the Fund acquires the security. If the Fund acquires securities that are
unrated or that have been rated by a single NRSRO, the acquisition must be
approved or ratified by the Trust's Board of Trustees. The NRSROs currently
designated as such by the SEC are Standard & Poor's Ratings Group, Moody's
Investors Service, Inc., Thomson BankWatch, Fitch Investors Services LP, Duff
& Phelps Inc. and IBCA Limited and its affiliate, IBCA, Inc. A discussion of
the ratings categories of the NRSROs is contained in the Appendix to the
Statement of Additional Information.     
 
  The Fund generally may not invest more than 5% of its total assets in the
securities of any one issuer, except for U.S. government securities. In addi-
tion, the Fund may not invest more than 5% of its total assets in Eligible
Securities that have not received the highest rating from the Requisite NRSROs
and comparable unrated securities ("Second Tier Securities") and may not
invest more than 1% of its total assets in the Second Tier Securities of any
one issuer. The Fund may invest more than 5% (but no more than 25%) of the
then-current value of the Fund's total assets in the securities of a single
issuer for a period of up to three business days, provided that (a) the secu-
rities are rated by the Requisite NRSROs in the highest short-term rating cat-
egory, are securities of issuers that have received such rating with respect
to other short-term debt securities or are comparable unrated securities, and
(b) the Fund does not make more than one such investment at any one time.
 
  Repurchase Agreements. The Fund may engage in repurchase agreement transac-
tions. Under the terms of a typical repurchase agreement, the Fund would
acquire a U.S. government security for a relatively 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. This arrangement
results in a fixed rate of return that is not subject to market fluctuations
during the Fund's holding period. The Fund will enter into repurchase agree-
ments with banks which are the issuers of instruments acceptable for purchase
by the Fund and certain dealers on the Federal Reserve Bank of New York's list
of reporting dealers. Under each repurchase agreement the selling institution
will be required to maintain the value of the securities subject to the repur-
chase agreement at not less than their repurchase price. 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 possible 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 Fund's
 
10
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
investment adviser or administrator, acting under the supervision of the
Trust's Board of Trustees, reviews on an ongoing basis the value of the col-
lateral and the creditworthiness of those banks and dealers with which the
Fund enters into repurchase agreements to evaluate potential risks.
   
  Mortgage and Asset-Backed Securities--The Fund may purchase fixed or adjust-
able rate mortgage-backed securities issued by the Government National Mort-
gage Association, Federal National Mortgage Association or the Federal Home
Loan Mortgage Corporation. In addition, the Fund may purchase other asset-
backed securities, including securities backed by automobile loans, equipment
leases or credit card receivables. These securities directly or indirectly
represent a participation in, or are secured by and payable from fixed or
adjustable rate mortgage or other loans which may be secured by real estate or
other assets. Unlike traditional debt instruments, payments on these securi-
ties include both interest and a partial payment of principal. Prepayments of
the principal of underlying loans may shorten the effective maturities of
these securities and may result in the Fund having to reinvest proceeds at a
lower interest rate.     
 
 CERTAIN INVESTMENT GUIDELINES
   
  The Fund will concentrate its investments in the banking industry except
during temporary defensive periods. Up to 25% of the assets of the Fund may be
invested at any time in the obligations of issuers conducting their principal
business activities in any industry other than banking. The Fund may not
acquire more than 10% of the voting or any other class of securities of any
one issuer, except that U.S. government securities may be purchased without
regard to these limits. In addition, the Fund may invest up to an aggregate of
10% of its total assets in illiquid securities with contractual or other
restrictions on resale (excluding (i) securities subject to Rule 144A of the
Securities Act of 1933, as amended (the "1933 Act"), provided at least two
dealers make a market in such securities and (ii) certain privately issued
commercial paper eligible for resale to institutional investors without regis-
tration pursuant to Section 4(2) of the 1933 Act) and other instruments which
are not readily marketable, including: (a) repurchase agreements providing for
settlement in more than seven days after notice by the Fund and (b) TDs matur-
ing from two business days through six months. The Fund also is authorized to
borrow in an amount of up to 10% of its total assets for temporary or emer-
gency purposes, but not for leverage, and to pledge its assets to the same
extent in connection with such borrowings. Whenever borrowings exceed 5% of
the value of the Fund's total assets, the Fund will not make any additional
investments. A more detailed description of these policies, together with an
enumeration of additional investment restrictions which the Fund has adopted
and which cannot be changed without the approval of the holders of a majority
of the Fund's outstanding shares, is contained in the Statement of Additional
Information.     
 
                                                                             11
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 
 SPECIAL CONSIDERATIONS AND RISK FACTORS
 
  The Fund will be affected by general changes in interest rates which will
result in increases or decreases in the value of the obligations held by the
Fund. The market value of the obligations held by the Fund can be expected to
vary inversely to changes in the prevailing interest rates. Investors also
should recognize that, in periods of declining interest rates, the Fund's
yield will tend to be somewhat higher than prevailing market rates and, in
periods of rising interest rates, the Fund's yield will tend to be somewhat
lower. Also, when interest rates are falling, the inflow of net new money to
the Fund from the continuous sale of its shares will likely be invested in
instruments producing lower yields than the balance of its portfolio, thereby
reducing the Fund's current yield. In periods of rising interest rates, the
opposite can be expected to occur. In addition, securities in which the Fund
will invest may not yield as high a level of current income as might be
achieved by investing in securities with less liquidity and safety and longer
maturities.
 
  Investments in foreign banks or foreign issuers present certain risks,
including those resulting from fluctuations in currency exchange rates, reval-
uation of currencies, future political and economic developments and the pos-
sible imposition of currency exchange blockages or other foreign governmental
laws or restrictions and reduced availability of public information. Foreign
issuers generally are not subject to uniform accounting, auditing and finan-
cial reporting standards or to other regulatory practices and requirements
applicable to domestic issuers. In addition, there may be less publicly avail-
able information about a foreign bank than about a domestic bank.
 
VALUATION OF SHARES
 
 
  The Fund's net asset value per share is determined as of the close of regu-
lar trading on the NYSE, and is computed by dividing the value of the Fund's
net assets attributable to each Class B share by the total number of Class B
shares outstanding. The Fund employs the amortized cost method of valuing
portfolio securities and intends to use its best efforts to continue to main-
tain a constant net asset value of $1.00 per share.
 
DIVIDENDS, DISTRIBUTIONS AND TAXES
 
 
 DIVIDENDS AND DISTRIBUTIONS
 
  The Fund will be treated separately from the Trust's other funds in deter-
mining the amount of dividends from net investment income and distributions of
capital gains payable to shareholders.
 
12
<PAGE>
 
DIVIDENDS, DISTRIBUTIONS AND TAXES (CONTINUED)
 
 
  The Fund declares dividends daily consisting of substantially all of its net
investment income, and pays dividends monthly. Any net realized gains will be
distributed at least annually. If a shareholder does not otherwise instruct,
dividends and capital gains will be reinvested automatically in additional
shares of Class B at net asset value subject to no CDSC. Dividends and distri-
butions are treated the same for tax purposes whether taken in cash or rein-
vested in additional shares.
 
 TAXES
 
  The Fund will be treated as a separate taxpayer with the result that, for
federal tax purposes, the amount of investment income and capital gains earned
will be determined on a fund-by-fund basis, rather than on a Trust-wide basis.
The Fund intends to continue to qualify as a regulated investment company
under Subchapter M of the Code. In any taxable year in which the Fund so qual-
ifies and distributes at least 90% of its investment company taxable income
(which includes, among other items, dividends, interest and the excess of any
net short-term capital gains over net long-term capital losses), the Fund (but
not its shareholders) generally will be relieved of federal income tax on the
investment company taxable income and net realized capital gains (the excess
of net long-term capital gains over net short-term capital losses), if any,
distributed to shareholders. In order to qualify as a regulated investment
company, the Fund will be required to meet various Code requirements.
 
  Amounts not distributed on a timely basis in accordance with a calendar year
distribution requirement are subject to a nondeductible 4% excise tax. In
order to avoid application of the excise tax, the Fund intends to make its
distributions in accordance with this requirement.
 
  Distributions of any investment company taxable income are taxable to share-
holders as ordinary income. Distributions of any net capital gains designated
by the Fund as capital gain dividends are taxable to shareholders as long-term
capital gain regardless of the length of time a shareholder may have held
shares of the Fund.
 
  Dividends (including capital gain dividends) declared by the Fund in Octo-
ber, November or December of any calendar year to shareholders of record on a
date in such a month will be deemed to have been received by shareholders on
December 31 of that calendar year, provided that the dividend is actually paid
by the Fund during January of the following calendar year.
 
  Upon the disposition of shares of the Fund (whether by redemption, sale or
exchange), a shareholder generally will realize a taxable gain or loss. Such
gain or loss generally will be a capital gain or loss if the shares are capi-
tal assets in the shareholder's hands, and generally will be long-term or
short-term depending upon the shareholder's holding period for the shares. Any
loss realized by a shareholder on disposition of Fund shares held by the
shareholder for six months or less will be
 
                                                                             13
<PAGE>
 
DIVIDENDS, DISTRIBUTIONS AND TAXES (CONTINUED)
 
treated as long-term capital loss to the extent of any distributions of capi-
tal gain dividends received by the shareholder with respect to such shares.
 
  Shareholders will be notified annually about the amounts of dividends and
distributions, including the amounts (if any) for that year which have been
designated as capital gain dividends. Dividends and distributions and gains
realized upon a disposition of Fund shares may also be subject to state, local
or foreign taxes depending on each shareholder's particular situation. Divi-
dends consisting of interest from obligations of the United States government
and certain of its agencies and instrumentalities may be exempt from all state
and local income taxes. Shareholders should consult their tax advisors for
specific information on the tax consequences of particular types of distribu-
tions.
 
PURCHASE OF SHARES
   
  Fund shares may be acquired only through exchanges with Class B shares of
other Smith Barney Mutual Funds. Class B shares acquired through exchange are
subject to the CDSC, if any, of the shares with which the exchange is made.
       
  In light of the distribution fee imposed on Class B shares, an investment in
the Fund should be viewed as part of a long-term investment in the Smith
Barney Mutual Funds. Investors seeking only to invest in a money market fund
and who do not expect to exchange Fund shares for shares of other Smith Barney
Mutual Funds should consider more suitable investments, including other money
market funds offered by PFS.     
 
  The Fund employs a distribution method which differs from that of certain
other mutual funds that invest in money market instruments. Before investing
in the Fund, among other things, investors should consider that certain other
funds with an investment objective and policies similar to those of the Fund
do not pay distribution expenses or impose any sales charge.
 
  Class B shares will convert automatically to Class A shares of Cash Portfo-
lio eight years after the date on which they were purchased and will thereaf-
ter no longer be subject to any distribution fees. There will also be con-
verted 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.
 
 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 com-
mences
 
14
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
   
(see "Automatic Cash Withdrawal Plan"); (c) redemptions of shares within 12
months following the death or disability of the shareholder; (d) involuntary
redemptions; and (e) redemptions of shares in connection with a combination of
the Fund with any investment company by merger, acquisition of assets or other-
wise. In addition, a shareholder who has redeemed shares from other Smith Bar-
ney 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 PFS of the sharehold-
er's status or holdings, as the case may be.
 
EXCHANGE PRIVILEGE
   
  Except as otherwise noted below, Class B shares may be exchanged for Class B
shares in the following Smith Barney Mutual Funds, to the extent shares are
offered for sale in the shareholder's state of residence. Exchanges are subject
to minimum investment requirements and other requirements of the fund into
which exchanges are made and a sales charge differential may apply.     
 
 FUND NAME
 
  .Smith Barney Appreciation Fund Inc.
     
  .Smith Barney Concert Series Inc.--Balanced Portfolio     
     
  .Smith Barney Concert Series Inc.--Conservative Portfolio     
     
  .Smith Barney Concert Series Inc.--Growth Portfolio     
     
  .Smith Barney Concert Series Inc.--High Growth Portfolio     
     
  .Smith Barney Concert Series Inc.--Income Portfolio     
  .Smith Barney Growth Opportunity Fund
  .Smith Barney Investment Grade Bond Fund
 
  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 CDSC higher 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 pur-
chased on the same date as the Class B shares of the Fund that have been
exchanged.
 
  Exchanges will be processed at the net asset value next determined after the
redemption proceeds are available. 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 pro-
 
                                                                              15
<PAGE>
 
REDEMPTION OF SHARES
 
spectus describing the shares to be acquired. The Fund reserves the right to
modify or discontinue exchange privileges upon 60 days' prior notice to share-
holders.
 
  Shareholders may redeem for cash some or all of their shares of the Fund at
any time by sending a written request in proper form directly to PFS Share-
holder Services, the Fund's Sub-Transfer Agent (the "Sub-Transfer Agent"), at
3100 Breckinridge Blvd., Bldg. 200, Duluth, Georgia 30199-0062. If you should
have any questions concerning how to redeem your account after reviewing the
information below, please contact the Sub-Transfer Agent at (800) 544-5445,
Spanish-speaking representatives (800) 544-7278 or TDD Line for the Hearing
Impaired (800) 824-1721.
 
  As described under "Purchase of Shares," redemptions of Class B shares are
subject to a contingent deferred sales charge.
   
  The request for redemption must be signed by all persons in whose names the
shares are registered. Signatures must conform exactly to the account registra-
tion. If the proceeds of the redemption exceed $50,000, or if the proceeds are
not to be paid to the record owner(s) at the record address, if the sharehold-
er(s) has had an address change in the past 45 days, or if the shareholder(s)
is a corporation, sole proprietor, partnership, trust or fiduciary, signa-
ture(s) must be guaranteed by one of the following: a bank or trust company; a
broker-dealer; a credit union; a national securities exchange, registered secu-
rities association or clearing agency; a savings and loan association; or a
federal savings bank.     
 
  Generally, a properly completed Redemption Form with any required signature
guarantee is all that is required for a redemption. In some cases, however,
other documents may be necessary. For example, in the case of shareholders
holding certificates, the certificates for the shares being redeemed must
accompany the redemption request. Additional documentary evidence of authority
is also required by the Sub-Transfer Agent in the event redemption is requested
by a corporation, partnership, trust, fiduciary, executor or administrator.
Additionally, if a shareholder requests a redemption from a Retirement Plan
account (IRA, SEP or 403(b)(7)), such request must state whether or not federal
income tax is to be withheld from the proceeds of the redemption check.
   
  A shareholder may utilize the Sub-Transfer Agent's FAX to redeem his or her
account as long as a signature guarantee or other documentary evidence is not
required. Redemption requests should be properly signed by all owners of the
account and faxed to the Sub-Transfer Agent at (800) 554-2374. Facsimile
redemptions may not be available if the shareholder cannot reach the Sub-Trans-
fer Agent by FAX, whether because all telephone lines are busy or for any other
reason; in such case, a shareholder would have to use the Fund's regular
redemption procedure described above. Facsimile redemptions received by the
Sub-Transfer Agent     
 
16
<PAGE>
 
REDEMPTION OF SHARES (CONTINUED)
 
prior to 4:00 p.m. Eastern time on a regular business day will be processed at
the net asset value per share determined that day.
   
  In all cases, the redemption price is the net asset value per share of the
Fund next determined after the request for redemption is received in proper
form by the Sub-Transfer Agent. Payment for shares redeemed will be made by
check mailed within three business days after acceptance by the Sub-Transfer
Agent of the request and any other necessary documents in proper order. Such
payment may be postponed or the right of redemption suspended as provided by
the rules of the SEC. If the shares to be redeemed have been recently purchased
by check or draft, the Sub-Transfer Agent may hold the payment of the proceeds
until the purchase check or draft has cleared, usually a period of up to 15
days. Any taxable gain or loss will be recognized by the shareholder upon
redemption of shares.     
 
  After following the above-stated redemption guidelines, a shareholder(s) may
elect to have the redemption proceeds wire-transferred directly to the share-
holder's bank account of record (defined as a currently established pre-autho-
rized draft on the shareholder's account with no changes within the previous 45
days), as long as the bank account is registered in the same name(s) as the
account with the Fund. If the proceeds are not to be wired to the bank account
of record, or mailed to the registered owner(s), a signature guarantee will be
required from all shareholder(s). A $25 service fee will be charged by the Sub-
Transfer Agent to help defray the administrative expense of executing a wire
redemption. Redemption proceeds will normally be wired to the designated bank
account on the next business day following the redemption, and should ordinar-
ily be credited to your bank account by your bank within 48 to 72 hours.
 
 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 periodic 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. Any applicable CDSC will not be waived on amounts withdrawn by a
shareholder 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. For fur-
ther information regarding the automatic cash withdrawal plan, shareholders
should contact the Sub-Transfer Agent.
 
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
the Fund, each     
 
                                                                              17
<PAGE>
 
MINIMUM ACCOUNT SIZE (CONTINUED)
   
account must satisfy the minimum account size.) The Fund, however, 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.     
 
YIELD INFORMATION
 
 
  From time to time the Fund may advertise its yield and effective yield of
Class B shares. These yield figures are based on historical earnings and are
not intended to indicate future performance. The yield of a Class B share
refers to the net investment income generated by an investment in that Class
over a specific seven-day period (which will be stated in the advertisement).
This net investment income is then annualized. The effective yield is calcu-
lated similarly but, when annualized, the income earned by an investment in
the Class is assumed to be reinvested. The effective yield will be slightly
higher than the yield because of the compounding effect of the assumed rein-
vestment.
 
MANAGEMENT OF THE FUND AND THE TRUST
 
 
 BOARD OF TRUSTEES
   
  Overall responsibility for management and supervision of the Trust and the
Fund rests with the Trust's Board of Trustees. The Trustees approve all sig-
nificant agreements between the Trust and the companies that furnish services
to the Fund, including agreements with its investment adviser, administrator,
custodian, transfer and sub-transfer agents. The day-to-day operations of the
Fund are delegated to its investment adviser and administrator. The Statement
of Additional Information contains general background information regarding
each Trustee and executive officer of the Fund.     
 
 INVESTMENT ADVISER
   
  The Manager is located at 388 Greenwich Street, New York, New York 10013,
and serves as the Fund's investment adviser. The Manager (through its prede-
cessors) has been in the investment counseling business since 1934 and is a
registered investment adviser. The Manager renders investment advice to
investment companies that had aggregate assets under management as of October
31, 1996 in excess of $79 billion.     
 
  Subject to the supervision and direction of the Trust's Board of Trustees,
the Manager manages the Fund in accordance with the Fund's stated investment
objective and policies, makes investment decisions for the Fund, places orders
to purchase and sell securities on behalf of the Fund and employs professional
portfolio managers and securities analysts who provide research services to
the Fund. For investment services rendered, the Fund pays the Manager a fee at
the annual rate of 0.30% of the Fund's average daily net assets.
 
18
<PAGE>
 
MANAGEMENT OF THE FUND AND THE TRUST (CONTINUED)
 
 
 ADMINISTRATOR
 
  The Manager also serves as the Fund's administrator and oversees all aspects
of the Fund's administration and operation. For administration services ren-
dered, the Fund pays the Manager a fee at the annual rate of .20% of the Fund's
average daily net assets.
    
 PORTFOLIO MANAGEMENT     
   
  Phyllis M. Zahorodny, Managing Director of Smith Barney and Investment Offi-
cer of the Fund is responsible for managing the day-to-day operations of the
Fund including making all investment decisions.     
   
  Ms. Zahorodny's management discussion and analysis and additional performance
information regarding the Fund during the fiscal year ended July 31, 1996 are
included in the Annual Report dated July 31, 1996. A copy of the Annual Report
may be obtained upon request and without charge from an Investments Representa-
tive of PFS or by writing or calling the Fund at the address or phone number
listed on page one of this Prospectus.     
 
DISTRIBUTOR
   
  PFS is located at 3100 Breckinridge Boulevard, Duluth, Georgia 30199-0001 and
distributes shares of the Fund as a principal underwriter and as such conducts
a continuous offering pursuant to a "best efforts" arrangement requiring PFS to
take and pay for only such securities as may be sold to the public. Pursuant to
a plan of distribution adopted by the Fund under Rule 12b-1 under the 1940 Act
(the "Plan"), PFS is paid an annual distribution fee with respect to Class B
shares at the annual rate of 0.50% of the average daily net assets attributable
to that Class. Class B shares that automatically convert to Class A shares of
Cash Portfolio eight years after the date of original purchase will no longer
be subject to distribution fees. The fees are paid to PFS which, in turn pays
PFS Investments to pay its Investments Representatives to cover expenses pri-
marily intended to result in the sale of those shares. These expenses include:
advertising expenses; the cost of printing and mailing prospectuses to poten-
tial investors; payments to and expenses of PFS Investments Representatives and
other persons who provide support services in connection with the distribution
of shares; interest and/or carrying charges; and indirect and overhead costs of
PFS Investments associated with the sale of Fund shares, including lease, util-
ity, communications and sales promotion expenses.     
   
  PFS Investments may be deemed to be an underwriter for purposes of the 1933
Act. From time to time, PFS or its affiliates may also pay for certain non-cash
sales incentives provided to PFS Investments Representatives. Such incentives
do not have any effect on the net amount invested. In addition to the
reallowances from     
 
                                                                              19
<PAGE>
 
DISTRIBUTOR (CONTINUED)
 
the applicable public offering price described above, PFS may, from time to
time, pay or allow additional reallowances or promotional incentives, in the
form of cash or other compensation to PFS Investments Representatives that sell
shares of the Fund.
   
  Payments under the Plan are not tied exclusively to the distribution expenses
actually incurred and the payments may exceed distribution expenses actually
incurred. The Board of Trustees will evaluate the appropriateness of the Plan
and its payment terms on a continuing basis and in so doing will consider all
relevant factors, including expenses borne by PFS, amounts received under the
Plan and proceeds of the CDSC.     
 
ADDITIONAL INFORMATION
   
  The Trust was organized on March 12, 1985 under the laws of the Commonwealth
of Massachusetts and is an entity commonly known as a "Massachusetts business
trust." The Trust offers shares of beneficial interest of separate series hav-
ing a $.001 per share par value. When matters are submitted for shareholder
vote, shareholders of each fund of the Trust will have one vote for each full
share owned and a proportionate, fractional vote for any fractional share held.
Shares of the Trust will be voted generally on a Trust-wide basis on all mat-
ters except matters affecting the interests of one Fund or one Class of shares.
    
  The Trust does not hold annual meetings of shareholders for the purpose of
electing Trustees unless and until such time as less than a majority of the
Trustees holding office have been elected by shareholders. The Trustees will
call a meeting for any purpose upon the written request of holders of 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.
 
  PNC Bank, National Association, is located at 17th and Chestnut Streets,
Philadelphia, PA 19103, and serves as custodian of the Trust's investments.
 
  First Data Investor Services Group, Inc. is located at Exchange Place, Bos-
ton, Massachusetts 02109, and serves as the Trust's transfer agent.
   
  PFS Shareholder Services is located at 3100 Breckinridge Blvd., Bldg. 200,
Duluth, Georgia 30199-0002, and serves as the Fund's Sub-Transfer Agent.     
   
  The Fund sends to each shareholder a semi-annual report and an audited annual
report, each of which includes a list of the investment securities held by the
Trust. In an effort to reduce the Fund's printing and mailing costs, the Fund
plans to     
 
20
<PAGE>
 
ADDITIONAL INFORMATION (CONTINUED)
 
consolidate the mailing of its semi-annual and annual reports by household.
This consolidation means that a household having multiple accounts with the
identical address of record will receive a single copy of each report. In addi-
tion, the Fund also plans to consolidate the mailing of its Prospectus so that
a shareholder having multiple accounts will receive a single Prospectus annual-
ly. Any shareholder who does not want this consolidation to apply to his or her
account should contact the Sub-Transfer Agent.
 
                                                                              21
<PAGE>
 
 
 
 
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<PAGE>
 
 
 
 
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<PAGE>
 
 
                                                                    SMITH BARNEY
                                              A Member of TravelersGroup  [LOGO]
 
 
 
 
                                              SMITH BARNEY EXCHANGE RESERVE FUND
 
                                                            388 Greenwich Street
                                                        New York, New York 10013
 
                                                                         FUND 26
                                                                
                                                             FD 01234 11/96     

<PAGE>
 
 
                                                                    SMITH BARNEY
                                                                     Diversified
                                                                       Strategic
                                                                          Income
                                                                            Fund
                                                             
                                                          NOVEMBER 28, 1996     
 
                                                   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 28, 1996
                                                                 
Smith Barney     
   
Diversified Strategic Income Fund     
388 Greenwich Street
New York, New York 10013
(212) 723-9218
 
  Smith Barney Diversified Strategic Income Fund (the "Fund"), a diversified
fund, seeks high current income primarily through investment in fixed-income
securities. The Fund attempts to achieve this objective by allocating and real-
locating its assets primarily among various types of fixed-income securities
selected by its investment adviser on the basis of an analysis of economic and
market conditions and the relative risks and opportunities of those types of
fixed-income securities. The Fund is one of a number of funds, each having dis-
tinct investment objectives and policies, making up the Smith Barney Income
Funds (the "Trust"). The Trust is an open-end, management investment company
commonly referred to as a mutual fund.
 
  This Prospectus sets forth concisely certain information about the Fund and
the Trust, including sales charges, distribution and service fees and expenses,
that prospective investors will find helpful in making an investment decision.
Investors are encouraged to read this Prospectus carefully and retain it for
future reference. Shares of other funds offered by the Trust are described in
separate prospectuses that may be obtained by calling the Trust at the tele-
phone number set forth above or by contacting a Smith Barney Financial Consul-
tant.
   
  Additional information about the Fund and the Trust is contained in a State-
ment of Additional Information dated November 28, 1996, as amended or supple-
mented from time to time, that is available upon request and without charge by
calling or writing the Trust at the telephone number or address set forth above
or by contacting a Smith Barney Financial Consultant. The Statement of Addi-
tional Information has been filed with the Securities and Exchange Commission
(the "SEC") and is incorporated by reference into this Prospectus in its
entirety.     
 
SMITH BARNEY INC.
Distributor
 
SMITH BARNEY MUTUAL FUNDS MANAGEMENT INC.
Investment Adviser and Administrator
 
SMITH BARNEY GLOBAL CAPITAL MANAGEMENT INC.
Sub-Investment Adviser
 
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES 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                           11
-------------------------------------------------
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES   15
-------------------------------------------------
VALUATION OF SHARES                            29
-------------------------------------------------
DIVIDENDS, DISTRIBUTIONS AND TAXES             30
-------------------------------------------------
PURCHASE OF SHARES                             32
-------------------------------------------------
EXCHANGE PRIVILEGE                             42
-------------------------------------------------
REDEMPTION OF SHARES                           45
-------------------------------------------------
MINIMUM ACCOUNT SIZE                           48
-------------------------------------------------
PERFORMANCE                                    48
-------------------------------------------------
MANAGEMENT OF THE TRUST AND THE FUND           49
-------------------------------------------------
DISTRIBUTOR                                    50
-------------------------------------------------
ADDITIONAL INFORMATION                         51
-------------------------------------------------
</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 Trust
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 Statement of Additional
Information. Cross references in this summary are to headings in the Prospec-
tus. See "Table of Contents."
 
INVESTMENT OBJECTIVE The Fund is an open-end, diversified management invest-
ment company that seeks high current income primarily through investment in
fixed-income securities. The Fund attempts to achieve this objective by allo-
cating and reallocating its assets primarily among various types of fixed-
income securities selected by its investment adviser on the basis of an analy-
sis of economic and market conditions and the relative risks and opportunities
of those types of fixed-income securities. See "Investment Objective and Man-
agement Policies."
 
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 C
shares, which differ principally in terms of sales charges and rate 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
$5,000,000. In addition, a fifth Class, Class Z shares, which is offered pur-
suant to a separate prospectus, is offered exclusively to (a) tax-exempt
employee benefit and retirement plans of Smith Barney Inc. ("Smith Barney")
and its affiliates and (b) unit investment trusts ("UITs") sponsored by Smith
Barney and its affiliates. 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, which
when combined with current holdings of Class A shares offered with a sales
charge equal or exceed $500,000 in the aggregate, 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 Summary--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 C Shares. Class C shares are sold at net asset value with no initial
sales charge. 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 C shares within 12 months
of purchase. This CDSC may be waived for certain redemptions. The Class C
shares' distribution fee may cause that Class to have higher expenses and pay
lower dividends than Class A shares. Purchases of Fund shares, which when com-
bined with current holdings of Class C 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 $5,000,000. Class Y shares are sold at net asset
value with no initial sales charge or CDSC. They are not subject to any serv-
ice 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 length of his or
her investment. Shareholders who are planning to establish a program of regu-
lar investment may wish to consider Class A shares; as the investment accumu-
lates 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 and Class C 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 these Classes. Because the Fund's future
return cannot be predicted, however, there can be no assurance that this would
be the case.
 
  Finally, investors should consider the effect of the CDSC period and any
conversion rights of the Classes in the context of their own investment time
frame. For example, while Class C shares have a shorter CDSC period than Class
B shares, they do not have a conversion feature, and therefore, are subject to
an ongoing
 
4
<PAGE>
 
PROSPECTUS SUMMARY (CONTINUED)
 
distribution fee. Thus, Class B shares may be more attractive than Class C
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
purchases which, when combined with current holdings of Class A shares offered
with a sales charge equal or exceed $500,000 in the aggregate, 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 aggregate
investment may be met by adding the purchase to the net asset value of all
Class A shares offered with a sales charge held in funds sponsored by 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 ongoing expenses of Class A shares may be lower than those for Class B and
Class C shares, purchasers eligible to purchase Class A shares at net asset
value or at a reduced sales charge should consider doing so.     
   
  Smith Barney Financial Consultants may receive different compensation for
selling different Classes of shares. Investors should understand that the pur-
pose of the CDSC on the Class B and Class C shares is the same as that of the
initial sales charge on the Class A shares.     
 
  See "Purchase of Shares" and "Management of the Trust and the Fund" for a
complete description of the sales charges and service and distribution fees
for each Class of shares and "Valuation of Shares," "Dividends, Distributions
and Taxes" and "Exchange 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. Other investors may be eligible to participate in the Smith Barney
ExecChoice(TM) Program. Class A and Class C shares are available without a
sales charge as investment alternatives. See "Purchase of Shares--Smith Barney
401(k) and ExecChoice(TM) Programs."     
   
PURCHASE OF SHARES Shares may be purchased through the Fund's distributor,
Smith Barney, a broker that clears securities transactions through Smith Bar-
ney on a fully disclosed basis (an "Introducing Broker") or an investment
dealer in the selling group. In addition, certain investors, including quali-
fied retirement plans and certain other institutional investors, may purchase
shares directly from the Fund     
 
                                                                              5
<PAGE>
 
PROSPECTUS SUMMARY (CONTINUED)
   
through the Fund's transfer agent, First Data Investor Services Group, Inc.
("First Data"). See "Purchase of Shares."     
   
INVESTMENT MINIMUMS Investors in Class A, Class B and Class C 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 $5,000,000. 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 C shares and the subse-
quent investment requirement for all Classes is $25. For minimum investment
requirements for all classes of shares through the Systematic Investment Plan,
see below. There is no minimum investment required in Class A shares for
unitholders who invest distributions from a UIT sponsored by Smith Barney. See
"Purchase of Shares." See "Purchases of Shares."     
   
SYSTEMATIC INVESTMENT PLAN The Fund offers shareholders a Systematic Invest-
ment Plan under which they may authorize the automatic placement of a purchase
order each month or quarter for Fund shares. The minimum initial and subse-
quent investment for shareholders purchasing shares through the Systematic
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
"Redemption of Shares."
 
MANAGEMENT OF THE FUND Smith Barney Mutual Funds Management Inc. ("SBMFM"),
serves as the Fund's investment adviser and administrator. SBMFM provides
investment advisory and management services to investment companies affiliated
with Smith Barney. SBMFM is a wholly owned subsidiary of Smith Barney Holdings
Inc. ("Holdings"). Holdings is a wholly owned subsidiary of Travelers Group
Inc. ("Travelers"), a diversified financial services holding company engaged,
through its subsidiaries, principally in four business segments: Investment
Services, Consumer Finance Services, Life Insurance Services and Property &
Casualty Insurance Services.
 
  Smith Barney Global Capital Management Inc. ("Global Capital Management")
serves as a sub-investment adviser to the Fund. Global Capital Management is a
wholly owned subsidiary of Holdings. See "Management of the Trust and the
Fund."
 
 
6
<PAGE>
 
PROSPECTUS SUMMARY (CONTINUED)
   
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 Smith Barney Financial Consultants. See "Valuation of Shares."
 
DIVIDENDS AND DISTRIBUTIONS Dividends from net investment income are declared
and paid on the last Friday of the month. Distributions of net realized long-
and short-term capital gains, if any, are declared and paid annually after the
end of the fiscal year in which they are earned. 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. General changes in interest
rates will result in increases or decreases in the market value of the obliga-
tions held by the Fund. The Fund may invest up to 35% of its assets in corpo-
rate fixed-income securities of domestic issuers rated Ba or lower by Moody's
Investors Service, Inc. ("Moody's") or BB or lower by Standard & Poor's
Ratings Group ("S&P") or in nonrated securities deemed by SBMFM to be of com-
parable quality. The Fund may invest in fixed-income securities rated as low
as Caa by Moody's or CCC by S&P. Securities that are rated Ba by Moody's or BB
by S&P have speculative characteristics with respect to capacity to pay inter-
est and repay principal. Securities that are rated B generally lack character-
istics of a desirable investment and assurance of interest and principal pay-
ments over any long period of time may be small. Securities that are rated Caa
or CCC are of poor standing. These issues may be in default or present ele-
ments of danger may exist with respect to principal or interest. Although
medium- or low-rated securities offer a higher current yield than the yield
offered by higher rated securities, they involve greater volatility of price
and risk of loss of income and principal, including the probability of default
by or bankruptcy of the issuers of such securities. Medium- and low-rated and
comparable unrated securities (a) will likely have some quality and protective
characteristics that, in the judgment of the rating organization, are out-
weighed by large uncertainties of major risk exposures to adverse conditions
and (b) are     
 
                                                                              7
<PAGE>
 
PROSPECTUS SUMMARY (CONTINUED)
 
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligation. The Fund's
investing in the securities of foreign issuers involves special risks and con-
siderations not typically associated with investing in domestic issuers. These
risks include differences in accounting, auditing and financial reporting stan-
dards, generally higher commission rates on foreign portfolio transactions, the
possibility of expropriation or confiscatory taxation, adverse changes in
investment or exchange control regulations, political instability that could
affect domestic investments in foreign countries and potential restrictions on
the flow of international capital. Foreign securities often trade with less
frequency and volume than domestic securities and therefore may exhibit greater
price volatility and changes in foreign exchange rates will affect the value of
those securities held by the Fund that are denominated or quoted in currencies
other than the U.S. dollar. Certain of the investments held by the Fund and
certain of the investment strategies that the Fund may employ might expose it
to certain risks. The investments presenting the Fund with risks are mortgage-
related securities, medium- or low-rated securities, as described above, for-
eign securities, as described above, and securities of unseasoned issuers. The
investment strategies presenting the Fund with risks are entering in repurchase
agreements and reverse repurchase agreements, entering into forward roll trans-
actions, purchasing or selling securities on a when-issued or delayed-delivery
basis, lending portfolio securities, entering into transactions involving
options and futures contracts and entering into currency transactions. See "In-
vestment Objective and Management Policies."
 
8
<PAGE>
 
PROSPECTUS SUMMARY (CONTINUED)
   
THE FUND'S EXPENSES  The following expense table lists the costs and expenses
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>
  SMITH BARNEY
  DIVERSIFIED STRATEGIC INCOME FUND            CLASS A CLASS B CLASS C 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    None    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                              0.14    0.12    0.12    0.04
------------------------------------------------------------------------------
  TOTAL FUND OPERATING EXPENSES                 1.04%   1.52%   1.47%   0.69%
------------------------------------------------------------------------------
</TABLE>    
   * Purchases of Class A shares, which when combined with current holdings of
     Class A shares offered with a sales charge, equal or exceed $500,000 in
     the aggregate, 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.
  ** Prior to August 9, 1995, Global Capital Management voluntarily waived 50%
     of its sub-investment advisory fee. On August 9, 1995, the Board of
     Trustees of the Fund approved the elimination of this fee waiver.
 *** Upon conversion of Class B shares to Class A shares, such shares will no
     longer be subject to a distribution fee. Class C shares do not have a
     conversion feature and, therefore, are subject to an ongoing distribution
     fee. As a result, long-term shareholders of Class C shares may pay more
     than the economic equivalent of the maximum front-end sales charge
     permitted by the National Association of Securities Dealers, Inc.
       
  The sales charge and CDSC set forth in the above table are the maximum
charges imposed upon 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 B, Class C 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) Program. See "Purchase of Shares" and "Redemption of Shares." Smith
Barney receives an annual 12b-1 service fee of 0.25% of the value of average
daily net assets of Class A shares. 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 C shares, Smith Barney receives an annual 12b-1
fee of .70% of the value of average daily net
 
                                                                              9
<PAGE>
 
PROSPECTUS SUMMARY (CONTINUED)
 
assets of this Class, consisting of a 0.45% distribution fee and a 0.25% serv-
ice fee. "Other expenses" in the above table include fees for shareholder serv-
ices, custodial fees, legal and accounting fees, printing costs and registra-
tion fees.
 
 EXAMPLE
  The following example is intended to assist an investor in understanding 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 Trust and the Fund."
 
<TABLE>   
<CAPTION>
  SMITH BARNEY
  DIVERSIFIED STRATEGIC INCOME 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     $77    $100     $166
    Class B..................................   60      78      93      168
    Class C..................................   25      46      80      176
    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      77     100      166
    Class B..................................   15      48      83      168
    Class C..................................   15      46      80      176
    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.
 
10
<PAGE>
 
FINANCIAL HIGHLIGHTS
   
  The following information for the two-year period ended July 31, 1996 has
been audited by KPMG Peat Marwick LLP, independent auditors, whose report
thereon appears in the Fund's Annual Report dated July 31, 1996. The following
information for the fiscal years ended July 31, 1990 through July 31, 1994 has
been audited by other independent auditors. The information set out below 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 Additional Information.     
   
FOR A CLASS A SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH YEAR:
    
<TABLE>   
<CAPTION>
                                        YEAR      YEAR     YEAR      PERIOD
SMITH BARNEY                           ENDED     ENDED     ENDED     ENDED
DIVERSIFIED STRATEGIC INCOME FUND     7/31/96   7/31/95   7/31/94  7/31/93(1)
------------------------------------------------------------------------------
<S>                                   <C>       <C>       <C>      <C>
NET ASSET VALUE, BEGINNING OF YEAR      $ 7.85    $ 7.76   $ 8.41    $ 8.24
------------------------------------------------------------------------------
INCOME FROM OPERATIONS:
 Net investment income(2)                 0.61      0.94     0.63      0.47
 Net realized and unrealized
 gain/(loss) on investments               0.03     (0.18)   (0.52)     0.27
------------------------------------------------------------------------------
Total Income From Operations              0.64      0.76     0.11      0.74
------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income                   (0.62)    (0.48)   (0.56)    (0.45)
 Overdistributions of net investment
 income                                     --        --    (0.06)       --
 Net realized gains                         --        --    (0.10)    (0.12)
 Capital                                 (0.05)    (0.19)   (0.04)       --
------------------------------------------------------------------------------
Total Distributions                      (0.67)    (0.67)   (0.76)    (0.57)
------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR            $ 7.82    $ 7.85   $ 7.76    $ 8.41
------------------------------------------------------------------------------
TOTAL RETURN++                            8.39%    10.35%    1.16%     9.30%++
------------------------------------------------------------------------------
NET ASSETS, END OF YEAR (IN 000'S)    $202,700  $177,336  $76,019   $48,334
------------------------------------------------------------------------------
RATIO TO AVERAGE NET ASSETS:
 Expenses(2)                              1.04%     1.09%    1.10%     1.10%+
 Net investment income                    7.85      8.15     7.67%     8.26+
------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE                     90%       83%      93%      116%
------------------------------------------------------------------------------
AVERAGE COMMISSION PER SHARE PAID ON
 EQUITY TRANSACTIONS(3)                  $0.00*       --       --        --
------------------------------------------------------------------------------
</TABLE>    
 (1) For the period from November 6, 1992 (inception date) to July 31, 1993.
    
 (2) The Manager has waived part of its fees for the years ended July 31,1995
     and 1994. If such fees had not been waived, the per share effect on
     expenses and the ratios of expenses to average net assets would be as
     follows:     
<TABLE>    
<CAPTION>
                                RATIOS WITHOUT
             PER SHARE DECREASE   FEE WAIVERS
  ---------------------------------------------
               1995     1994     1995    1994
             ------------------ ------- -------
   <S>       <C>      <C>       <C>     <C>
   Class A      $0.01    $0.00*   1.14%   1.12%
</TABLE>    
    
 (3) As of September 1995, the SEC instituted new guidelines requiring the
     disclosure of average commissions per share.     
    
  * Amount represents less than $0.01 per share.     
  ++Total return is not annualized as it may not be representative of the
    total return for the year.
  + Annualized.
 ++ Total return represents the aggregate total return for the period
    indicated and does not reflect any applicable sales charge.
 
                                                                              11
<PAGE>
 
FINANCIAL HIGHLIGHTS (CONTINUED)
 
FOR A CLASS B SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH PERIOD:
 
<TABLE>   
<CAPTION>
SMITH BARNEY                  YEAR        YEAR        YEAR        YEAR        YEAR       YEAR      PERIOD
DIVERSIFIED STRATEGIC        ENDED       ENDED       ENDED       ENDED       ENDED      ENDED      ENDED
INCOME FUND                 7/31/96     7/31/95     7/31/94     7/31/93     7/31/92    7/31/91   7/31/90(1)
-------------------------------------------------------------------------------------------------------------
<S>                        <C>         <C>         <C>         <C>         <C>         <C>       <C>
NET ASSET VALUE,
BEGINNING OF YEAR              $ 7.86      $ 7.76      $ 8.41      $ 8.55      $ 7.98    $ 8.06     $ 8.00
-------------------------------------------------------------------------------------------------------------
INCOME FROM OPERATIONS:
 Net investment income (2)       0.58        0.70        0.59        0.65        0.68      0.71       0.41
 Net realized and
 unrealized gain/(loss)
 on investments                  0.01        0.02       (0.51)      (0.07)       0.64      0.07       0.05
-------------------------------------------------------------------------------------------------------------
Total Income From
Operations                       0.59        0.72        0.08        0.58        1.32      0.78       0.46
-------------------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income          (0.57)      (0.44)      (0.54)      (0.58)      (0.68)    (0.71)     (0.40)
 Overdistributions of
 net investment income             --          --       (0.06)         --          --        --         --
 Net realized gains                --          --       (0.10)      (0.14)         --     (0.06)        --
 Capital                        (0.05)      (0.18)      (0.03)         --       (0.07)    (0.09)        --
-------------------------------------------------------------------------------------------------------------
Total Distributions             (0.62)      (0.62)      (0.73)      (0.72)      (0.75)    (0.86)     (0.40)
-------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF
YEAR                           $ 7.83      $ 7.86      $ 7.76      $ 8.41      $ 8.55    $ 7.98     $ 8.06
-------------------------------------------------------------------------------------------------------------
TOTAL RETURN++                   7.80%      10.00%       0.66%       7.28%      17.12%    10.42%      6.00%++
-------------------------------------------------------------------------------------------------------------
NET ASSETS, END OF YEAR
(000'S)                    $2,380,000  $2,366,680  $2,468,922  $2,105,089  $1,464,744  $502,571   $179,496
-------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET
ASSETS:
 Expenses (2)                    1.52%       1.56%       1.57%       1.59%       1.62%     1.63%      1.74%+
 Net investment income           7.36        6.82        7.20        7.77        7.99      9.21       9.59+
-------------------------------------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE            90%         83%         93%        116%        125%      131%        56%
-------------------------------------------------------------------------------------------------------------
AVERAGE COMMISSIONS PER
SHARE PAID ON EQUITY
TRANSACTIONS(3)                 $0.00*         --          --          --          --        --         --
-------------------------------------------------------------------------------------------------------------
</TABLE>    
 (1) For the period from December 28, 1989. (commencement of operations) to
     July 31, 1990.
    
 (2) The Manager has waived part of its fees for the years ended July 31,1995
     and 1994. If such fees had not been waived, the per share effect on
     expenses and the ratios of expenses to average net assets would be as
     follows:     
<TABLE>     
<CAPTION>
                                RATIOS WITHOUT
            PER SHARE DECREASE    FEE WAIVERS
  ---------------------------------------------
              1995      1994     1995    1994
            --------- --------- ------- -------
   <S>      <C>       <C>       <C>     <C>
   Class B     $0.00*    $0.00*   1.61%   1.59%
</TABLE>    
    
 (3) As of September 1995, the SEC instituted new guidelines requiring the
     disclosure of average commissions per share.     
    
  * Amount represents less than $0.01 per share.     
  ++Total return is not annualized as it may not be representative of the
 total return for the year.
  + Annualized.
 ++ Total return represents the aggregate total return for the period
    indicated and does not reflect any applicable sales charge.
 
12
<PAGE>
 
FINANCIAL HIGHLIGHTS (CONTINUED)
   
FOR A CLASS C SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH PERIOD:
    
<TABLE>   
<CAPTION>
                                      YEAR       YEAR     YEAR      PERIOD
SMITH BARNEY                          ENDED     ENDED     ENDED     ENDED
DIVERSIFIED STRATEGIC INCOME FUND    7/31/96  7/31/95(1) 7/31/94  7/31/93(2)
-----------------------------------------------------------------------------
<S>                                  <C>      <C>        <C>      <C>
NET ASSET VALUE, BEGINNING OF YEAR    $ 7.84    $ 7.76   $ 8.41     $ 8.36
-----------------------------------------------------------------------------
INCOME FROM OPERATIONS:
 Net investment income (3)              0.52      1.16     0.55       0.22
 Net realized and unrealized gain
 (loss) on investments                  0.07     (0.46)   (0.47)      0.06
-----------------------------------------------------------------------------
Total Income From Operations            0.59      0.70     0.08       0.28
-----------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income                 (0.57)    (0.44)   (0.54)     (0.20)
 Overdistributions of net investment
 income                                   --        --    (0.06)        --
 Net realized gains                       --        --    (0.10)     (0.03)
 Capital                               (0.05)    (0.18)   (0.03)        --
-----------------------------------------------------------------------------
Total Distributions                    (0.62)    (0.62)   (0.73)     (0.23)
-----------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR          $ 7.81    $ 7.84   $ 7.76     $ 8.41
-----------------------------------------------------------------------------
TOTAL RETURN++                          7.82%     9.73%    0.66%      3.41%++
-----------------------------------------------------------------------------
NET ASSETS, END OF YEAR (000S)       $42,222   $12,730   $1,065     $   11
-----------------------------------------------------------------------------
RATIO TO AVERAGE NET ASSETS
 Expenses (3)                           1.47%     1.46%    1.57%      1.50%+
 Net investment income                  7.61     10.23     7.20       7.87+
-----------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE                   90%       83%      93%       116%
-----------------------------------------------------------------------------
AVERAGE COMMISSIONS PER SHARE
 PAID ON EQUITY TRANSACTIONS(4)        $0.00*       --       --         --
-----------------------------------------------------------------------------
</TABLE>    
 (1) On November 7, 1994, the former Class D shares were renamed Class C
     shares.
 (2) For the period from March 19, 1993 (inception date) to July 31, 1993.
    
 (3) The Manager has waived part of its fees for the years ended July 31,1995
     and 1994. If such fees had not been waived, the per share effect on
     expenses and the ratios of expenses to average net assets would be as
     follows:     
<TABLE>     
<CAPTION>
                                RATIOS WITHOUT
            PER SHARE DECREASE    FEE WAIVERS
  ---------------------------------------------
              1995      1994     1995    1994
            --------- --------- ------- -------
   <S>      <C>       <C>       <C>     <C>
   Class C     $0.00*    $0.00*   1.51%   1.58%
</TABLE>    
    
 (4) As of September 1995, the SEC instituted new guidelines requiring the
     disclosure of average commissions per share.     
  * Net investment income per share decrease is less than $0.01.
  ++Total return is not annualized as it may not be representative of the
    total return for the year.
  + Annualized.
 ++ Total return represents the aggregate total return for the period
    indicated and does not reflect any applicable sales charge.
 
                                                                              13
<PAGE>
 
FINANCIAL HIGHLIGHTS (CONTINUED)
   
FOR A CLASS Y SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH PERIOD:
    
<TABLE>   
<CAPTION>
SMITH BARNEY
DIVERSIFIED STRATEGIC INCOME FUND                             1996(1)
----------------------------------------------------------------------
<S>                                                           <C>
NET ASSET VALUE, BEGINNING OF YEAR                             $ 7.89
----------------------------------------------------------------------
INCOME FROM OPERATIONS:
 Net investment income                                           0.50
 Net realized and unrealized gain                                0.01
----------------------------------------------------------------------
Total Income From Operations                                     0.51
----------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income                                          (0.53)
 Capital                                                        (0.05)
----------------------------------------------------------------------
Total Distributions                                             (0.58)
----------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR                                   $ 7.82
----------------------------------------------------------------------
TOTAL RETURN++                                                   6.65%
----------------------------------------------------------------------
NET ASSETS, END OF YEAR (000S)                                $26,940
----------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS+:
 Expenses                                                        0.69%
 Net investment income                                           8.54
----------------------------------------------------------------------
PORTFOLIO TURNOVER RATE                                            90%
----------------------------------------------------------------------
AVERAGE COMMISSIONS PER SHARE PAID ON EQUITY TRANSACTIONS(2)    $0.00*
----------------------------------------------------------------------
</TABLE>    
    
 (1) For the period from October 10, 1995 (inception date) to July 31, 1996.
            
 (2) As of September 1995, the SEC instituted new guidelines requiring the
     disclosure of average commissions per share.     
    
  * Amount represents less than $0.01 per share.     
    
  ++Total return is not annualized, as it may not be representative of the
    total return for the year.     
    
  + Annualized.     
 
14
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES
 
 
  The Fund's investment objective is high current income primarily through
investment in fixed-income securities. In attempting to achieve its objective,
the Fund allocates and reallocates its assets primarily among various types of
fixed-income securities selected by SBMFM. The types of fixed-income securi-
ties among which the Fund's assets will be primarily allocated are: obliga-
tions issued or guaranteed as to principal and interest by the United States
government ("U.S. government securities"); mortgage-related securities issued
by various governmental and non-governmental entities; domestic and foreign
corporate securities; and foreign government securities. The Fund's investment
objective may be changed only with the approval of the holders of a majority
of the Fund's outstanding shares. There can be no assurance that the Fund will
achieve its investment objective.
 
  The allocation and reallocation of the Fund's assets will be undertaken by
SBMFM on the basis of its analysis of economic and market conditions and the
relative risks and opportunities of particular types of fixed-income securi-
ties. In general, the particular types of fixed-income securities selected for
investment by the Fund at any given time will be those that, in the view of
SBMFM, offer the highest income available at the time. The Fund typically
would not invest in fixed-income securities offering the highest income poten-
tial if SBMFM determined that the income potential is not sufficient to jus-
tify the higher risks associated with the securities.
   
  At any given time, the Fund may be entirely or only partially invested in a
particular type of fixed-income security. Under normal conditions, at least
65% of the Fund's assets will be invested in fixed-income securities, which
for this purpose will include non-convertible preferred stocks. The Fund gen-
erally will invest in intermediate- and long-term fixed-income securities with
the result that, under normal market conditions, the weighted average maturity
of the Fund's securities is expected to be between five and 12 years. Up to
20% of the Fund's assets may be invested in common stock or other equity-
related securities, including convertible securities, preferred stock, war-
rants and rights.     
 
  Mortgage-related securities in which the Fund may invest include mortgage
obligations collateralized by mortgage loans or mortgage pass-through certifi-
cates. Under current market conditions, the Fund's holdings of mortgage-
related securities may be expected to consist primarily of securities issued
or guaranteed by Government National Mortgage Association ("GNMA"), Federal
National Mortgage Association ("FNMA") and Federal Home Loan Mortgage Corpora-
tion ("FHLMC"). The composition of the Fund's investments in mortgage-related
securities, however, will vary from time to time based upon the determination
of SBMFM on how best to achieve the Fund's investment objective taking into
account factors such as the liquidity and yield of various mortgage-related
securities. Mortgage-related securities held by the Fund generally will be
rated no lower than Aa by Moody's or AA
 
                                                                             15
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
by S&P or, if not rated, will be of equivalent investment quality as deter-
mined by SBMFM. SBMFM also may consider the ratings, if any, assigned to mort-
gage-related securities by recognized rating agencies other than Moody's and
S&P.
 
  The Fund typically will purchase a corporate debt security if SBMFM believes
that the yield and, to a lesser extent, the potential for capital apprecia-
tion, of the security are sufficiently attractive in light of the risks of
ownership of the security. In determining whether the Fund should invest in
particular debt securities, SBMFM will consider factors such as: the price,
coupon and yield to maturity; the credit quality of the issuer; the issuer's
available cash flow and the related coverage ratios; the property, if any,
securing the obligation; and the terms of the debt securities, including the
subordination, default, sinking fund and early redemption provisions. SBMFM
also will review the ratings, if any, assigned to the securities by Moody's,
S&P or other recognized rating agencies. SBMFM's judgment as to credit quality
of a debt security may differ, however, from that suggested by the ratings
published by a rating service.
 
  The Fund may invest up to 35% of its assets in corporate fixed-income secu-
rities of domestic issuers rated Ba or lower by Moody's or BB or lower by S&P
or in nonrated securities deemed by SBMFM to be of comparable quality. The
Fund may invest in fixed-income securities rated as low as Caa by Moody's or
CCC by S&P.
 
  Corporate fixed-income securities of foreign issuers in which the Fund may
invest will include securities of companies, wherever organized, that have
their principal business activities and interests outside the United States.
Foreign government securities in which the Fund may invest consist of fixed-
income securities issued by foreign governments. In general, the Fund may
invest in debt securities issued by foreign governments or any of their polit-
ical subdivisions that are considered stable by Global Capital Management. Up
to 5% of the Fund's assets, however, may be invested in foreign securities
issued by countries with developing economies.
 
  The Fund may invest in fixed-income securities issued by supranational orga-
nizations, which are entities designated or supported by a government or gov-
ernmental entity to promote economic development, and include, among others,
the Asian Development Bank, the European Coal and Steel Community, the Euro-
pean Economic Community and the World Bank. These organizations have no taxing
authority and are dependent upon their members for payments of interest and
principal. Moreover, the lending activities of supranational entities are lim-
ited to a percentage of their total capital (including "callable capital" con-
tributed by members at an entity's call), reserves and net income.
   
  The Fund may also invest in zero coupon securities and payment-in-kind
bonds.     
 
 
16
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
       
 ADDITIONAL INVESTMENTS
 
  Money Market Instruments. Up to 20% of the Fund's assets may be invested in
cash and money market instruments at any time. In addition, when SBMFM believes
that market conditions warrant, the Fund may invest in short-term instruments
without limitation for temporary defensive purposes. Short-term instruments in
which the Fund may invest include: U.S. government securities; certain bank
obligations (including certificates of deposit, time deposits and bankers'
acceptances of domestic or foreign banks, domestic savings and loan associa-
tions and similar institutions); commercial paper rated no lower than Prime-2
by Moody's or A-2 by S&P or the equivalent from another major rating service
or, if unrated, of an issuer having an outstanding, unsecured debt issue then
rated within the three highest rating categories; and repurchase agreements
with respect to the securities in which the Fund may invest. The Fund will
invest in obligations of a foreign bank or foreign branch of a domestic bank
only if SBMFM determines that the obligations present minimum credit risks.
These obligations may be traded in the United States or outside the United
States, but will be denominated in U.S. dollars.
 
  U.S. Government Securities. The U.S. government securities in which the Fund
may invest include, direct obligations of the United States Treasury (such as
Treasury Bills, Treasury Notes and Treasury Bonds), and obligations issued by
U.S. government agencies and instrumentalities, including: securities that are
supported by the full faith and credit of the United States (such as GNMA cer-
tificates); 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 securities that are supported by the credit of the instrumentality
(such as FNMA and FHLMC bonds). Treasury Bills have maturities of less than one
year, Treasury Notes have maturities of one to 10 years and Treasury Bonds gen-
erally have maturities of greater than 10 years at the date of issuance. Cer-
tain U.S. government securities, such as those issued or guaranteed by GNMA,
FNMA and FHLMC, are mortgage-related securities. U.S. government securities
generally do not involve the credit risks associated with other types of inter-
est-bearing securities, although, as a result, the yields available from U.S.
government securities are generally lower than the yields available from inter-
est-bearing corporate securities.
   
  Zero Coupon Securities. A zero coupon 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 an
amount significantly less than its face value (sometimes referred to as a "deep
discount" price). Because such securities usually trade at a deep discount,
they will be subject to greater fluctuations of market value in response to
changing interest rates than debt obligations of comparable maturities which
make periodic distributions of interest. On the     
 
                                                                              17
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
   
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.     
 
 CERTAIN INVESTMENT STRATEGIES
 
  In attempting to achieve its investment objective, the Fund may employ, among
others, one or more of the strategies set forth below. More detailed informa-
tion concerning these strategies and their related risks is contained in the
Statement of Additional Information.
 
  Repurchase Agreements. The Fund may engage in repurchase agreement transac-
tions 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 relatively 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. This arrangement results in a fixed
rate of return that is not subject to market fluctuations during the Fund's
holding period. The value of the underlying securities will be at least equal
at all times to the total amount of the repurchase obligation, including inter-
est. 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
possible 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. SBMFM or Global Capital Management, act-
ing under the supervision of the Trust's Board of Trustees, reviews on an ongo-
ing basis the value of the collateral and the creditworthiness of those banks
and dealers with which the Fund may enter into repurchase agreements to evalu-
ate potential risks.
 
  Reverse Repurchase Agreements. The Fund may enter into reverse repurchase
agreement transactions with member banks of the Federal Reserve Bank of New
York's list of reporting dealers. A reverse repurchase agreement, which is con-
sidered a borrowing by the Fund, involves a sale by the Fund of securities that
it holds concurrently with an agreement by the Fund to repurchase the same
securities at an agreed-upon price and date. The Fund typically will invest the
proceeds of a reverse repurchase agreement in money market instruments or
repurchase agreements maturing not later than the expiration of the reverse
repurchase agreement. This use of the proceeds is known as leverage. The Fund
will enter into a reverse repurchase agreement for leverage purposes only when
the interest income to be earned from the investment of the proceeds is greater
than the interest expense of
 
18
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
the transaction. The Fund also may use the proceeds of reverse repurchase
agreements to provide liquidity to meet redemption requests when the sale of
the Fund's securities is considered to be disadvantageous.
   
  Forward Roll Transactions. In order to enhance current income, the Fund may
enter into forward roll transactions with respect to mortgage-related securi-
ties 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 gener-
ally will be collateralized by different pools of mortgages with different pre-
payment 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 additional 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 securi-
ties sold by the Fund may decline below the repurchase price of those securi-
ties. At the time the Fund enters into forward roll transactions, it will place
in a segregated account with the Fund's custodian cash or equity and debt
securities of any grade provided such securities have been determined by SBMFM
or Global Capital Management to be liquid and unencumbered pursuant to guide-
lines established by the Trustees ("eligible segregated assets") having a value
equal to the repurchase price (including accrued interest) and will subse-
quently monitor the account to insure that such equivalent value is maintained.
       
  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 securi-
ties 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 consisting of cash or
other eligible segregated assets 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.
    
                                                                              19
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
   
  Lending of Portfolio Securities. The Fund has the ability to lend portfolio
securities to brokers, dealers and other financial organizations. These loans,
if and when made, may not exceed 20% of the Fund's assets taken at value.
Loans of portfolio securities by the Fund will be collateralized by cash, let-
ters of credit or U.S. government securities that are maintained at all times
in an amount at least equal to the current market value of the loaned securi-
ties. Any gain or loss in the market price of the securities loaned that might
occur during the term of the loan would be for the account of the Fund. The
Fund will segregate the common stock or convertible or exchangeable preferred
stock or debt securities in a special account with its custodian.     
 
  Covered Option Writing. The Fund may purchase and sell put, call and other
types of option securities that are traded on domestic or foreign exchanges or
the over-the-counter market including, but not limited to, "spread" options,
"knock-out" options, "knock-in" options and "average rate" or "look-back"
options. The Fund may realize fees (referred to as "premiums") for granting
the rights evidenced by the options. A put option embodies the right of its
purchaser to compel the writer of the option to purchase from the option
holder 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 to the option holder an underlying
security at a specified price at any time during the option period. Thus, the
purchaser of a put option written by the Fund has the right to compel the Fund
to purchase from it the underlying security at the agreed-upon price for a
specified time period, while the purchaser of a call option written by the
Fund 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 call option written by the Fund, 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 option's exercise price, less the premium received
for writing the option.
   
  The Fund will write only covered options. Thus, whenever the Fund writes a
call option, it will continue to own or have the present right to acquire the
underlying security for as long as it remains obligated as the writer of the
option. To support its obligation to purchase the underlying security if a put
option is exercised, the Fund will either (a) deposit with its custodian in a
segregated account cash or other eligible assets having a value at least equal
to the exercise price of the underlying securities or (b) continue to own an
equivalent number of puts of the same "series" (that is, puts on the same
underlying security having the same exercise prices and expiration dates as
those written by the Fund), or an equivalent number of puts of the same
"class" (that is, puts on the same underlying security) with exercise prices
greater than those that it has written (or, if the exercise prices of the puts
that it holds are less than the exercise prices of those that it has written,
it will deposit the difference with its custodian in a segregated account).
    
20
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 
  Purchasing Put and Call Options on Securities. The Fund may utilize up to 15%
of its assets to purchase options and may do so at or about the same time that
it purchases the underlying security or at a later time. In purchasing option
securities, the Fund will trade only with counterparties of high standing in
terms of credit quality and commitment to the market. Risks associated with
options transactions and foreign futures contracts are described below under
"Special Considerations."
   
  Futures Contracts and Options on Futures Contracts. The Fund may enter into
futures contracts or related options that are traded on domestic and foreign
exchanges or boards of trade as well as the over-the-counter market with
respect to options on such futures contracts. A futures contract provides for
the future sale by one party and the purchase by the other party of a certain
amount of specified debt security at a specified price, date, time and place.
The Fund may enter into futures contracts to sell debt securities when SBMFM
believes that the value of the Fund's debt securities will decrease. The Fund
may enter into futures contracts to purchase debt securities when SBMFM antici-
pates purchasing the underlying debt securities on behalf of the Fund and
believes that prices will rise before the purchases will be made. When the Fund
enters into a futures contract to purchase an underlying security, an amount of
cash or other eligible segregated assets, equal to the market value of the con-
tract, will be deposited in a segregated account with the Fund's custodian to
collateralize the position, thereby insuring that the use of the contract is
unleveraged. The Fund will not enter into futures contracts for speculation and
will enter into futures contracts that are traded on a domestic or foreign
exchange or board of trade as well as the over-the-counter market.     
 
  An option on a futures contact, as contrasted with the direct investment in a
futures contract, gives the purchaser the right, in return for the premium
paid, to assume a position in a futures contract at a specified exercise price
at any time prior to the expiration date of the option. A call option gives the
purchaser of the option the right to enter into a futures contract to buy and
obliges the writer to enter into a futures contract to sell the underlying debt
securities. A put option gives the purchaser the right to sell and obliges the
writer to buy the underlying contract.
 
  The Fund may purchase put options on futures contracts to hedge its portfolio
of debt securities against the risk of rising interest rates, and may purchase
call options on futures contracts to hedge against a decline in interest rates.
The Fund may write put and call options on futures contracts in entering into
closing sale transactions and to increase its ability to hedge against changes
in interest rates. The Fund will write put and call options on futures con-
tracts that are traded on a domestic or foreign exchange or board of trade as
well as the over-the-counter market.
 
 
                                                                              21
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
  Currency Exchange Transactions and Options on Foreign Currencies. The Fund
will conduct its currency exchange transactions either on a spot (that is,
cash) basis at the rate prevailing in the currency exchange market or through
entering into forward contracts to purchase or sell currencies. The Fund's
dealings in forward currency exchange and options on foreign currencies are
limited to hedging involving either specific transactions or portfolio posi-
tions.
 
  A forward currency contract involves an obligation to purchase or sell a spe-
cific currency for an agreed-upon price at an agreed-upon date which may be any
fixed number of days from the date of the contract agreed upon by the parties.
These contracts are entered into in the interbank market conducted directly
between currency traders (usually large commercial banks) and their customers.
Although these contracts are intended to minimize the risk of loss due to a
decline in the value of the hedged currency, at the same time they tend to
limit any potential gain that might result should the value of the currency
increase.
 
  The Fund may purchase and sell put, call and other types of options on for-
eign currencies that are traded on domestic or foreign exchanges or in the
over-the-counter market, including but not limited to, "spread" options,
"knock-out" options, "knock-in" options and "average rate" or "look-back"
options.
 
  The Fund may purchase put options on a foreign currency in which securities
held by the Fund are denominated to protect against a decline in the value of
the currency in relation to the currency in which the exercise price is denomi-
nated. The Fund may purchase a call option on a foreign currency to hedge
against an adverse exchange rate of the currency in which a security that it
anticipates purchasing is denominated in relation to the currency in which the
exercise price is denominated. An option on a foreign currency gives the pur-
chaser, in return for a premium, the right to sell, in the case of a put, and
buy, in the case of a call, the underlying currency at a specified price during
the term of the option. Although the purchase of an option on a foreign cur-
rency may constitute an effective hedge by the Fund against fluctuations in the
exchange rates, in the event of rate movements adverse to the Fund's position,
the Fund may forfeit the entire amount of the premium plus related transaction
costs. Options on foreign currencies purchased by the Fund may be traded on
domestic and foreign exchanges or over-the-counter.
 
 CERTAIN INVESTMENT GUIDELINES
 
  Up to 15% of the assets of the Fund may be invested in securities with con-
tractual or other restrictions on resale and other instruments that are not
readily marketable, including (a) repurchase agreements with maturities greater
than seven days, (b) time deposits maturing from two business days through
seven calendar days and (c) to the extent that a liquid secondary market does
not exist for the instruments,
 
22
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
    
futures contracts and options on those contracts. Notwithstanding the forego-
ing, the Fund shall not invest more than 10% of its net assets in securities
(excluding those subject to Rule 144A under the Securities Act of 1933, as
amended) that are restricted. In addition, the Fund may invest up to 5% of its
assets in the securities of issuers that have been in continuous operation for
less than three years. The Fund also may borrow from banks for temporary or
emergency purposes, but not for investment purposes, in an amount up to 10% of
its total assets, and may pledge its assets to the same extent in connection
with such borrowings. Whenever these borrowings exceed 5% of the value of the
Fund's total assets, the Fund will not make any additional investments.
Immediately after any borrowing (including reverse repurchase agreements and
forward roll transactions) by the Fund, the Fund will maintain an asset coverage
of at least 300% with respect to all of its borrowings. Except for the
limitations on bor-rowing, the investment guidelines set forth in this paragraph
may be changed at any time without shareholder consent by vote of the Trust's
Board of Trustees. A complete list of investment restrictions that identifies
additional restric-tions that cannot be changed without the approval of a
majority of the Fund's outstanding shares is contained in the Statement of
Additional Information.     

 RISK FACTORS AND SPECIAL CONSIDERATIONS
 
  Medium-, Low- and Unrated Securities. The Fund may invest in medium- or low-
rated securities and unrated securities of comparable quality. Generally, these
securities offer a higher current yield than the yield offered by higher-rated
securities but involve greater volatility of price and risk of loss of income
and principal, including the probability of default by or bankruptcy of the
issuers of such securities. Medium- and low-rated and comparable unrated secu-
rities (a) will likely have some quality and protective characteristics that,
in the judgment of the rating organization, are outweighed by large uncertain-
ties or major risk exposures to adverse conditions and (b) are predominantly
speculative with respect to the issuer's capacity to pay interest and repay
principal in accordance with the terms of the obligation. Thus, it is possible
that these types of factors could, in certain instances, reduce the value of
securities held by the Fund with a commensurate effect on the value of the
Fund's shares. Therefore, an investment in the Fund should not be considered as
a complete investment program and may not be appropriate for all investors.
 
  While the market values of medium- and low-rated and comparable unrated secu-
rities tend to react less to fluctuations in interest rate levels than do those
of higher-rated securities, the market values of certain of these securities
also tend to be more sensitive to individual corporate developments and changes
in economic conditions than higher-rated securities. In addition, medium- and
low-rated and comparable
 
                                                                              23
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
unrated securities generally present a higher degree of credit risk. Issuers
of medium- and low-rated and comparable unrated securities are often highly
leveraged and may not have more traditional methods of financing available to
them so that their ability to service their debt obligations during an eco-
nomic downturn or during sustained periods of rising interest rates may be
impaired. The risk of loss due to default by such issuers is significantly
greater because medium- and low-rated and comparable unrated securities gener-
ally are unsecured and frequently are subordinated to the prior payment of
senior indebtedness. The Fund may incur additional expenses to the extent that
it is required to seek recovery upon a default in the payment of principal or
interest on its portfolio holdings. In addition, the markets in which medium-
and low-rated or comparable unrated securities are traded generally are more
limited than those in which higher-rated securities are traded. The existence
of limited markets for these securities may restrict the availability of secu-
rities for the Fund to purchase and also may have the effect of limiting the
ability of the Fund to (a) obtain accurate market quotations for purposes of
valuing securities and calculating net asset value and (b) sell securities at
their fair value either to meet redemption requests or to respond to changes
in the economy or the financial markets. The market for medium- and low-rated
and comparable unrated securities is relatively new and has not fully weath-
ered a major economic recession. Any such recession, however, could likely
disrupt severely the market for such securities and adversely affect the value
of such securities. Any such economic downturn also could adversely affect the
ability of the issuers of such securities to repay principal and pay interest
thereon.
 
  Fixed-income securities, including medium- and low-rated and comparable
unrated securities, frequently have call or buy-back features that permit
their issuers to call or repurchase the securities from their holders, such as
the Fund. If an issuer exercises these rights during periods of declining
interest rates, the Fund may have to replace the security with a lower yield-
ing security, resulting in a decreased return to the Fund.
 
  Securities that are rated Ba by Moody's or BB by S&P have speculative char-
acteristics with respect to capacity to pay interest and repay principal.
Securities that are rated B generally lack characteristics of a desirable
investment and assurance of interest and principal payments over any long
period of time may be small. Securities that are rated Caa or CCC are of poor
standing. These issues may be in default or present elements of danger may
exist with respect to principal or interest.
 
  In light of the risks described above, SBMFM, in evaluating the creditwor-
thiness of an issue, whether rated or unrated, will take various factors into
consideration, which may include, as applicable, the issuer's financial
resources, its sensitivity to economic conditions and trends, the operating
history of and the community support for the facility financed by the issue,
the ability of the issuer's management and regulatory matters.
 
 
24
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
   
  The Fund's fixed-income security holdings (as rated by S&P or Moody's,
respectively) for the fiscal year ended July 31, 1996 were composed as fol-
lows: 0.19% rated BBB or Baa; 8.92% rated BB or Ba; 17.44% rated B or B; 5.73%
rated CCC or Caa; 1.35% in unrated securities; 0.04% in common stocks and
1.64% in preferred stocks. The percentages were calculated on a dollar
weighted average basis by determining monthly the percentage of the Fund's net
assets invested in each rating category and does not necessarily indicate what
the composition of the Fund's holdings will be in subsequent years.     
 
  Securities of Unseasoned Issuers. Securities in which the Fund may invest
may have limited marketability and, therefore, may be subject to wide fluctua-
tions in market value. In addition, certain securities may lack a significant
operating history and be dependent on products or services without an estab-
lished market share.
 
  Foreign Securities. There are certain risks involved in investing in securi-
ties of companies and governments of foreign nations that are in addition to
the usual risks inherent in domestic investments. These risks include those
resulting from revaluation of currencies, future adverse political and eco-
nomic developments and the possible imposition of limitations on the repatria-
tion of currencies or other foreign governmental laws or restrictions, reduced
availability of public information concerning issuers and the lack of uniform
accounting, auditing and financial reporting standards or of other regulatory
practices and requirements comparable to those applicable to domestic compa-
nies. The yield of the Fund may be adversely affected by fluctuations in value
of one or more foreign currencies relative to the U.S. dollar. Moreover, secu-
rities of many foreign companies and their markets may be less liquid and
their prices more volatile than those of securities of comparable domestic
companies. In addition, with respect to certain foreign countries, the possi-
bility exists of expropriation, nationalization, confiscatory taxation and
limitations on the use or removal of funds or other assets of the Fund,
including the withholding of dividends. Foreign securities may be subject to
foreign government taxes that could reduce the yield on such securities.
Because the Fund will invest in securities denominated or quoted in currencies
other than the U.S. dollar, changes in foreign currency exchange rates may
adversely affect the value of portfolio securities and the appreciation or
depreciation of investments. Investment in foreign securities also may result
in higher expenses due to the cost of converting foreign currency to U.S. dol-
lars, the payment of fixed brokerage commissions on foreign exchanges, which
generally are higher than commissions on domestic exchanges, the expense of
maintaining securities with foreign custodians, and the imposition of transfer
taxes or transaction charges associated with foreign exchanges.
   
  The Fund may also purchase American Depositary Receipts ("ADRs"), European
Depositary Receipts ("EDRs") and Global Depositary Receipts ("GDRs") or other
securities representing underlying shares of foreign companies. ADRs are pub-
licly traded on exchanges or over-the-counter in the United States and are
issued     
 
                                                                             25
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
   
through "sponsored" or "unsponsored" arrangements. In a sponsored ADR arrange-
ment, the foreign issuer assumes the obligation to pay some or all of the
depositary's transaction fees, whereas under an unsponsored arrangement, the
foreign issuer assumes no obligation and the depositary's transaction fees are
paid by the ADR holders. In addition, less information is available in the
United States about an unsponsored ADR than about a sponsored ADR, and the
financial information about a company may not be as reliable for an
unsponsored ADR as it is for a sponsored ADR. The Fund may invest in ADRs
through both sponsored and unsponsored arrangements.     
 
  Corporate securities in which the Fund may invest include corporate fixed-
income securities of both domestic and foreign issuers, such as bonds, deben-
tures, notes, equipment lease certificates, equipment trust certificates, and
preferred stock. The Fund's investments in each of equipment lease or equip-
ment trust certificates will not exceed 5% of its assets.
 
  Certain of the corporate fixed-income securities in which the Fund may
invest may involve equity characteristics. The Fund may, for example, invest
in warrants for the acquisition of stock of the same or of a different issuer
or in corporate fixed-income securities that have conversion or exchange
rights permitting their holder to convert or exchange the securities at a
stated price within a specified period of time into a specified number of
shares of common stock. In addition, the Fund may invest in participations
that are based on revenues, sales or profits of an issuer or in common stock
offered as a unit with corporate fixed-income securities.
 
  Mortgage-Related Securities. Mortgage-related securities provide a monthly
payment consisting of interest and principal payments. Additional payments may
be made out of unscheduled repayments of principal resulting from the sale of
the underlying residential property, refinancing or foreclosure, net of fees
or costs that may be incurred. Prepayments of principal on mortgage-related
securities may tend to increase due to refinancing of mortgages as interest
rates decline. Mortgage pools created by private organizations generally offer
a higher rate of interest than government and government-related pools because
no direct or indirect guarantees of payments are applicable with respect to
the former pools. Timely payment of interest and principal in these pools,
however, may be supported by various forms of private insurance or guarantees,
including individual loan, title, pool and hazard insurance. There can be no
assurance that the private insurers can meet their obligations under the poli-
cies. Prompt payment of principal and interest on GNMA mortgage pass-through
certificates is backed by the full faith and credit of the United States. FNMA
guaranteed mortgage pass-through certificates and FHLMC participation certifi-
cates are solely the obligations of those entities but are supported by the
discretionary authority of the United States government to purchase the agen-
cies' obligations. Collateralized mortgage obligations are a type of bond
secured by an underlying pool of mortgages or mortgage pass-through certifi-
cates that are struc-
 
26
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
tured to direct payments on underlying collateral to different series or clas-
ses of the obligations.
 
  To the extent that the Fund purchases mortgage-related securities at a premi-
um, 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 Fund's yield may be
affected by reinvestment of prepayments at higher or lower rates than the orig-
inal investment. In addition, like other debt securities, the values of mort-
gage-related securities, including government and government-related mortgage
pools, generally will fluctuate in response to market interest rates.
   
  Securities of Developing Countries. A developing country generally is consid-
ered to be a country that is in the initial stages of its industrialization
cycle. Investing in the equity and fixed-income markets of developing countries
involves exposure to economic structures that are generally less diverse and
mature, and to political systems that can be expected to have less stability,
than those of developed countries. Historical experience indicates that the
markets of developing countries have been more volatile than the markets of the
more mature economies of developed countries; however, such markets often have
provided higher rates of return to investors.     
 
  Non-Publicly Traded and Illiquid Securities. The Fund's sale of securities
that are not publicly traded is typically restricted under the Federal securi-
ties laws. As a result, the Fund may be forced to sell these securities at less
than fair market value or may not be able to sell them when SBMFM believes it
desirable to do so. The Fund's investments in illiquid securities are subject
to the risk that should the Fund desire to sell any of these securities when a
ready buyer is not available at a price that the Fund deems representative of
their value, the value of the Fund's net assets could be adversely affected.
 
  Options. Because option premiums paid or received by the Fund are small in
relation to the market value of the investments underlying the options, buying
and selling options can result in large amounts of leverage. The leverage
offered by trading in options may cause the Fund's net asset value to be sub-
ject to more frequent and wider fluctuation than would be the case if the Fund
did not invest in options.
 
  Upon the exercise of a put option written by the Fund, 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 written by the Fund, 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 exercise price of the option less the premium received for writing the
option.
 
                                                                              27
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 
  The Fund may engage in a closing purchase transaction to realize a profit, to
prevent an underlying security from being called or put or, in the case of a
call option, to unfreeze an underlying security (thereby permitting its sale or
the writing of a new option on the security prior to the outstanding option's
expiration). To effect a closing purchase transaction, the Fund would purchase,
prior to the holder's exercise of an option that the Fund has written, an
option of the same series as that on which the Fund desired to terminate its
obligation. The obligation of the Fund under an option that it has written
would be terminated by a closing purchase transaction, but the Fund would not
be deemed to own an option as a result of the transaction. No assurance can be
given that the Fund will be able to effect closing transactions at a time when
it wishes to do so. If the Fund cannot enter into a closing transaction, the
Fund may be required to hold a security that it might otherwise have sold, in
which case it would continue to be at market risk on the security and could
face higher transaction costs, including brokerage commissions.
   
  The ability of the Fund to engage in closing transactions with respect to
options depends on the existence of a liquid secondary market. While the Fund
generally will purchase or write options or financial futures only if there
appears to be a liquid secondary market for the options or futures sold or pur-
chased, for some options or futures, no such secondary market may exist or the
market may cease to exist.     
   
  Futures and Options on Futures. Investments in futures and options on futures
made by the Fund will be made solely for the purpose of hedging against the
effects of changes in the value of its portfolio securities due to anticipated
changes in interest rates and when the transactions are economically appropri-
ate to the reduction of risks inherent in the management of the Fund. In enter-
ing into transactions involving futures contracts and options on futures con-
tracts, the Fund will comply with applicable requirements of the Commodities
Futures Trading Commission (the "CFTC") which require that its transactions in
futures and options be engaged in for "bona fide hedging" purposes or other
permitted purposes, provided that aggregate initial margin deposits and premi-
ums required to establish positions, other than those considered by the CFTC to
be "bona fide hedging," will not exceed 5% of the Fund's net asset value, after
taking into account unrealized profits and unrealized losses on any such con-
tracts.     
 
  The use of futures contracts and options on futures contracts as a hedging
device involves several risks. No assurance can be given that a correlation
will exist between price movements in the underlying securities on the one
hand, and price movements in the securities which are the subject of the hedge,
on the other hand. Positions in futures contracts and options on futures con-
tracts may be closed out only on the exchange or board of trade on which they
were entered into, and no assurance can be given that an active market will
exist for a particular contract or option at any particular time. Losses
incurred in hedging transactions and the costs of these transactions will
affect the Fund's performance.
 
28
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 
  Foreign Commodity Exchanges. Unlike trading on domestic commodity exchanges,
trading on foreign commodity exchanges is not regulated by the Commodity
Futures Trading Commission and may be subject to greater risks than trading on
domestic exchanges. For example, some foreign exchanges may be principal mar-
kets so that no common clearing facility exists and a trader may look only to
the broker for performance of the contract. In addition, unless the Fund hedges
against fluctuations in the exchange rate between the U.S. dollar and the cur-
rencies in which trading is done on foreign exchanges, any profits that the
Fund might realize in trading could be eliminated by adverse changes in the
exchange rate, or the Fund could incur losses as a result of those changes.
 
  Foreign Currency. Although the foreign currency market may not necessarily be
more volatile than the market in other commodities, the foreign currency market
offers less protection against defaults in the forward trading of currencies
than is available when trading in currencies occurs on an exchange. Because a
forward currency contract is not guaranteed by an exchange or clearing house, a
default on the contract would deprive the Fund of unrealized profits or force
the Fund to cover its commitments for purchase or resale, if any, at the cur-
rent market price.
 
 PORTFOLIO TRANSACTIONS
 
  Securities and commodities transactions on behalf of the Fund will be exe-
cuted by a number of brokers and dealers, including Smith Barney and certain of
its affiliated brokers. The Fund may use Smith Barney or a Smith Barney affili-
ated broker in connection with a purchase or sale of securities when SBMFM
believes that the charge for the transaction does not exceed usual and custom-
ary levels. The Fund also may use Smith Barney as a commodities broker in con-
nection with entering into futures contracts and commodity options. Smith Bar-
ney has agreed to charge the Fund commodity commissions at rates comparable to
those charged by Smith Barney to its most favored clients for comparable trades
in comparable accounts.
 
  In selecting a broker for a transaction, including Smith Barney or its affil-
iates, the primary consideration is prompt and effective execution of orders at
the most favorable price. Subject to that primary consideration, dealers may be
selected for research, statistical or other services to enable SBMFM to supple-
ment its own research and analysis with the views and information of other
securities firms.
 
VALUATION OF SHARES
 
 
  The Fund's net asset value per share is determined as of the close of regular
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.
 
                                                                              29
<PAGE>
 
VALUATION OF SHARES (CONTINUED)
 
 
  Generally, the Fund's investments are valued at market value or, in the
absence of a market value with respect to any securities, at fair value as
determined by or under the direction of the Trust's Board of Trustees. Portfo-
lio securities which are traded primarily on foreign exchanges are generally
valued at the preceding closing values of such securities on their respective
exchanges, except that when an occurrence subsequent to the time a value was so
established is likely to have changed such value, then the fair market value of
those securities will be determined by consideration of other factors by or
under the direction of the Board of Trustees or its delegates. A security that
is traded primarily on a domestic or foreign stock exchange is valued at the
last sale price on that exchange or, if there were no sales during the day, at
the current quoted bid price. Over-the-counter securities are valued on the
basis of the bid price at the close of business on each day. Investments in
U.S. government securities (other than short-term securities) are valued at the
average of the quoted bid and asked prices in the over-the-counter market.
Short-term investments that mature in 60 days or less are valued at amortized
cost whenever the Trustees determine that amortized cost reflects fair value of
those investments. An option generally is valued at the last sale price or, in
the absence of the last sale price, the last offer price. The value of a
futures contract equals the unrealized gain or loss on the contract, which is
determined by marking the contract to the current settlement price for a like
contract acquired on the day on which the futures contract is being valued. A
settlement price may not be used if the market makes a limit move with respect
to a particular commodity or if the underlying securities market experiences
significant price fluctuations after the determination of the settlement price.
In such event, the futures contract will be valued at a fair market price to be
determined by or under the direction of the Board of Trustees. Further informa-
tion regarding the Trust's valuation policies with respect to the Fund is con-
tained in the Statement of Additional Information.
 
DIVIDENDS, DISTRIBUTIONS AND TAXES
 
 
 DIVIDENDS AND DISTRIBUTIONS
 
  The Fund will be treated separately from the Trust's other funds in determin-
ing the amount of dividends from net investment income and distributions of
capital gains payable to shareholders.
   
  If a shareholder does not otherwise instruct, dividends and capital gains
distributions will be reinvested automatically in additional shares of the same
Class at net asset value, subject to no sales charge or CDSC. Dividends and
distributions are treated the same for tax purposes whether taken in cash or
reinvested in additional shares. The Fund declares and pays dividends monthly,
consisting of estimated daily net investment income. Any net realized gains,
after utilization of capital loss carryforwards, will be distributed at least
annually, and net realized short-term capital     
 
30
<PAGE>
 
DIVIDENDS, DISTRIBUTIONS AND TAXES (CONTINUED)
 
gains (including short-term capital gains from options transactions, if any)
may be paid more frequently, with the distribution of dividends from net
investment income.
 
  The per share dividends on Class B and Class C shares of the Fund may be
lower than the per share dividends on Class A and Class Y shares principally as
a result of the distribution fee applicable with respect to Class B and Class C
shares. The per share dividends on Class A shares of the Fund may be lower than
the per share dividends on Class Y shares principally as a result of the serv-
ice fee applicable to Class A shares. Distributions of capital gains, if any,
will be in the same amount for Class A, Class B, Class C and Class Y shares.
 
  In addition, as determined by the Board of Trustees, distributions of the
Fund may include a return of capital. Shareholders will be notified of the
amount of any distribution that represents a return of capital. In order to
comply with a calendar year distribution requirement under the Code, it may be
necessary for the Fund to make distributions at times other than those set
forth above.
 
 TAXES
 
  The Fund will be treated as a separate taxpayer with the result that, for
Federal income tax purposes, the amount of investment income and capital gains
earned by the Fund will be determined on a fund by fund basis, rather than on a
Trust wide basis. The Fund intends to qualify each year as a regulated invest-
ment company under Subchapter M of the Code. To meet those requirements, the
Fund may need to restrict the degree to which it engages in short-term trading
and transactions in options. If the Fund qualifies as a regulated investment
company and meets certain distribution requirements, the Fund will not be sub-
ject to Federal income tax on its net investment income and net capital gains
that it distributes to its shareholders.
 
  Dividends paid by the Fund from investment income and distributions of short-
term capital gain will be taxable to shareholders as ordinary income for Fed-
eral income tax purposes, whether received in cash or reinvested in additional
shares. Distributions of long-term capital gain will be taxable to shareholders
as long-term capital gain, whether paid in cash or reinvested in additional
shares, and regardless of the length of time the investor has held his or her
shares of the Fund. Dividends and distributions paid by the Fund will not qual-
ify for the Federal dividends-received deduction for corporate shareholders.
 
  Income received by the Fund from sources within foreign countries may be sub-
ject to withholding and other foreign taxes. The payment of these taxes will
reduce the amount of dividends and distributions paid to the Fund's sharehold-
ers. Each shareholder of the Fund will receive a statement annually from the
Trust, which will set forth separately the aggregate dollar amount of dividends
and capital gains distributed to the shareholder by the Fund with respect to
the prior calendar year.
 
  Shareholders should consult their tax advisors about the status of the Fund's
dividends and distributions for Federal, state and local tax liabilities.
 
                                                                              31
<PAGE>
 
PURCHASE OF SHARES
 
 
 GENERAL
   
  The Fund offers five Classes of shares. Class A shares are sold to investors
with an initial sales charge and Class B and Class C shares are sold without an
initial sales charge but are subject to a CDSC payable upon certain redemp-
tions. Class Y shares are sold without an initial sales charge or a CDSC and
are available only to investors investing a minimum of $5,000,000 except for
purchases of Class Y shares by Smith Barney Concert Series Inc., for which
there is no minimum purchase amount. Class Z shares are offered without a sales
charge, CDSC, or service or distribution fee, exclusively to: (a) tax-exempt
employee benefit and retirement plans of Smith Barney and its affiliates and
(b) certain UITs sponsored by Smith Barney and its affiliates. Investors meet-
ing either of these criteria who are interested in acquiring Class Z shares
should contact a Smith Barney Financial Consultant for a Class Z Prospectus.
See "Prospectus Summary--Alternative Purchase Arrangements" for a discussion of
factors to consider in selecting which Class of shares to purchase.     
   
  Purchases of Fund shares must be made through a brokerage account maintained
with Smith Barney, an Introducing Broker or an investment dealer in the selling
group, except for investors purchasing shares of the Fund through a qualified
retirement plan who may do so directly through First Data. When purchasing
shares of the Fund, investors must specify whether the purchase is for Class A,
Class B, Class C or Class Y shares. No maintenance fee will be charged by the
Fund in connection with a brokerage account through which an investor purchases
or holds shares.     
   
  Investors in Class A, Class B and Class C shares may open an account by mak-
ing an initial investment of at least $1,000 for each account, or $250 for an
IRA or a Self-Employed Retirement Plan in the Fund. Investors in Class Y shares
may open an account by making an initial investment of $5,000,000. 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
C 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 C shares, and the minimum 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 requirement for Class A, Class B and Class C shares and the
subsequent investment requirement for all Classes is $50. There are no minimum
investment requirements for Class A shares for employees of Travelers and its
subsidiaries, including Smith Barney, or Trustees of the Trust and their
spouses and children and unitholders who invest distributions from a UIT spon-
sored by Smith Barney. The Fund reserves the right to waive or change minimums,
to decline any order to purchase     
 
32
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
   
its shares and to suspend the offering of shares from time to time. Shares pur-
chased will be held in the shareholder's account by First Data. Share certifi-
cates are issued only upon a shareholder's written request to First Data.     
   
  Purchase orders received by the Fund or Smith Barney prior to the close of
regular trading on the NYSE, on any day the Fund calculates its net asset val-
ue, are priced according to the net asset value determined on that day. Orders
received by dealers or Introducing Brokers prior to the close of regular trad-
ing 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 Smith Barney prior to Smith Barney's close of business
(the "trade date"). For shares purchased through Smith Barney or Introducing
Brokers purchasing through 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, Smith Barney or First Data is authorized through
preauthorized transfers of $25 or $50 or more to charge the regular bank
account or other financial institution indicated by the shareholder on a
monthly or quarterly basis, respectively, to provide 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 Smith Barney or
First Data. The Systematic Investment Plan also authorizes Smith Barney to
apply cash held in the shareholder's Smith Barney brokerage account or redeem
the shareholder's shares of a Smith Barney money market fund to make additions
to the account. Additional information is available from the Fund or a Smith
Barney Financial Consultant.     
 
                                                                              33
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
 
 
 INITIAL SALES CHARGE ALTERNATIVE--CLASS A SHARES
 
  The sales charges applicable to purchases of Class A shares of the Fund are
as follows:
<TABLE>   
<CAPTION>
                                SALES CHARGE
                       ------------------------------
                                                           DEALERS'
  AMOUNT OF                 % OF           % OF       REALLOWANCE AS % OF
  INVESTMENT           OFFERING PRICE AMOUNT 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, which when combined with current holdings of
  Class A shares offered with a sales charge, equal or exceed $500,000 in the
  aggregate, 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 Smith Barney, which
  compensates 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 C shares is
  waived. See "Deferred Sales Charge Alternatives" 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 reduced sales charges shown above apply to the aggregate of purchases of
Class A shares of the Fund made at one time by "any person," which includes an
individual, his or her spouse and children, or a trustee or other fiduciary of
a single trust estate or single fiduciary account. The reduced sales charge
minimums may also be met by aggregating the purchase with the net asset value
of all Class A shares held in funds sponsored by Smith Barney that are offered
with a sales charge listed under "Exchange Privilege."
 
 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 Trustees or Directors of
any of the Smith Barney Mutual Funds and employees of Travelers and its subsid-
iaries and employees of members of the National Association of Securities Deal-
ers, Inc. or the spouses and children of such persons (including the surviving
spouse of a deceased Trustee or employee, and retired Trustees or employees),
or sales to any trust, pension, profit-sharing or other benefit plan for such
persons 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 re-sold except through     
 
34
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
   
redemption or repurchase; (b) offers of Class A shares to any other investment
company in connection with 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 Smith Barney Financial Consultant (for a period
up to 90 days from the commencement of the Financial Consultant's employment
with 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) shareholders who have redeemed Class A shares in the Fund (or Class A
shares of another fund of the Smith Barney Mutual Funds that are offered with a
sales charge equal to or greater than the maximum sales charge of the Fund) and
who wish to reinvest their redemption proceeds in the Fund, provided the rein-
vestment is made within 60 calendar days of the redemption; (e) accounts man-
aged by registered investment advisory subsidiaries of Travelers; (f) invest-
ments from a UIT sponsored by Smith Barney; and (g) purchases by Section 403(b)
or Section 401(a) or (k) accounts associated with Copeland Retirement Programs.
In order to obtain such discounts, the purchaser must provide sufficient infor-
mation at the time of purchase to permit verification that the purchase would
qualify for the elimination of the sales charge.     
   
  Purchases of Class A shares also may be made at net asset value without a
sales charge in the following circumstances: (1) direct rollovers by plan par-
ticipants of distributions from a 401(k) plan enrolled in the Smith Barney
401(k) Program (Note: Subsequent investments will be subject to the applicable
sales charge); (2) purchases by separate accounts used to fund certain unregis-
tered variable annuity contracts; and (3) purchases by investors participating
in a Smith Barney fee based arrangement.     
 
 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 aggregat-
ing the dollar amount of the new purchase and the total net asset value of all
Class A shares of the Fund and of funds sponsored by Smith Barney, which are
offered with a sales charge 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.
 
                                                                              35
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
 
 
 GROUP PURCHASES
 
  Upon completion of certain automated systems, a reduced sales charge or pur-
chase at net asset value will also be available to employees (and partners) of
the same employer purchasing as a group, provided each participant makes the
minimum initial investment required. The sales charge applicable to purchases
by each member of such a group will be determined by the table set forth above
under "Initial Sales Charge Alternative--Class A Shares," and will be based
upon the aggregate sales of Class A shares of Smith Barney Mutual Funds offered
with a sales charge to, and share holdings of, all members of the group. To be
eligible for such reduced sales charges or to purchase at net asset value, all
purchases must be pursuant to an employer- or partnership-sanctioned plan meet-
ing certain requirements. One such requirement is that the plan must be open to
specified partners or employees of the employer and its subsidiaries, if any.
Such plan may, but is not required to, provide for payroll deductions, IRAs or
investments pursuant to retirement plans under Sections 401 or 408 of the Code.
Smith Barney may also offer a reduced sales charge or net asset value purchase
for aggregating related fiduciary accounts under such conditions that Smith
Barney will realize economies of sales efforts and sales related expenses. An
individual who is a member of a qualified group may also purchase Class A
shares at the reduced sales charge applicable to the group as a whole. The
sales charge is based upon the aggregate dollar value of Class A shares offered
with a sales charge that have been previously purchased and are still owned by
the group, plus the amount of the current purchase. A "qualified group" is one
which (a) has been in existence for more than six months, (b) has a purpose
other than acquiring Fund shares at a discount and (c) satisfies uniform crite-
ria which enable Smith Barney to realize economies of scale in its costs of
distributing shares. A qualified group must have more than 10 members, must be
available to arrange for group meetings between representatives of the Fund and
the members, and must agree to include sales and other materials related to the
Fund in its publications and mailings to members at no cost to Smith Barney. In
order to obtain such reduced sales charge or to purchase at net asset value,
the purchaser must provide sufficient information at the time of purchase to
permit verification that the purchase qualifies for the reduced sales charge.
Approval of group purchase reduced sales charge plans is subject to the discre-
tion of Smith Barney.
 
 LETTER OF INTENT
 
  Class A Shares. A Letter of Intent for amounts 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 pur-
chases of all Class A
 
36
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
   
shares of the Fund and other funds of the Smith Barney Mutual Funds offered
with a sales charge over the 13 month period based on the total amount of
intended purchases plus the value of all Class A shares previously purchased
and still owned. An alternative is to compute the 13 month period starting up
to 90 days before the date of execution of a Letter of Intent. 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 appli-
cable to the purchases made and the charges previously paid, or an appropriate
number of escrowed shares will be redeemed. Please contact a Smith Barney
Financial Consultant or First Data 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. Such investors
must make an initial minimum purchase of $1,000,000 in Class Y shares of the
Fund and agree to purchase a total of $5,000,000 of Class Y shares of the same
Fund within six months from the date of the Letter. If a total investment of
$5,000,000 is not made within the six-month period, all Class Y shares pur-
chased to date will be transferred to Class A shares, where they will be sub-
ject 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%. The Fund expects
that such transfer will not be subject to Federal income taxes. Please contact
a Smith Barney Financial Consultant or First Data for further information.
    
 DEFERRED SALES CHARGE ALTERNATIVES
 
  "CDSC Shares" are sold at net asset value next determined without an initial
sales charge so that the full amount of an investor's purchase payment may be
immediately invested in the Fund. A CDSC, however, may be imposed on certain
redemptions of these shares. "CDSC Shares" are: (a) Class B shares; (b) Class
C shares; and (c) Class A shares which when combined with Class A shares
offered with a sales charge currently held by an investor equal or exceed
$500,000 in the aggregate.
 
  Any applicable CDSC will be assessed on an amount equal to the lesser of the
original cost of 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 C shares and Class A shares that
are CDSC Shares, shares redeemed more than 12 months after their purchase.
 
  Class C 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
 
                                                                             37
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
   
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
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
purchases by Participating Plans, 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 also will be converted at that time such por-
tion 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. Shareholders who held Class B shares of Smith Barney Shearson
Short-Term World Income Fund (the "Short-Term World Income Fund") on July 15,
1994 and who subsequently exchanged those shares for Class B shares of the Fund
will be offered the opportunity to exchange all such Class B shares for Class A
shares of the Fund four years after the date on which those shares were deemed
to have been purchased. Holders of such Class B shares will be notified of the
pending exchange in writing approximately 30 days before the fourth anniversary
of the purchase date and, unless the exchange has been rejected in writing, the
exchange will occur on or about the fourth anniversary date. 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 applicable 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
 
38
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
 
increase the loss, as the case may be, on the amount realized on redemption.
The amount of any CDSC will be paid to 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 purchase, the investor decided to redeem $500 of his or her invest-
ment. Assuming at the time of the redemption the net asset value had appreci-
ated 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.
 
 WAIVER 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) re-
demptions of shares made in connection with qualified distributions from
retirement plans or IRAs upon the attainment of age 59 1/2; (e) involuntary
redemptions; and (f) redemptions of shares in connection with a combination of
the Fund with any investment company by merger, acquisition of assets or oth-
erwise. In addition, a shareholder who has redeemed shares from other funds of
the 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 Smith Barney in the
case of shareholders who are also Smith Barney clients or by First Data 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 par-
ticipating ("Participating Plans") in the Programs.     
 
                                                                             39
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
   
  The Fund offers to Participating Plans Class A and Class C shares as invest-
ment alternatives under the Smith Barney 401(k) and ExecChoice(TM) Programs.
Class A and Class C shares acquired through the Participating Plans are subject
to the same service and/or distribution fees as the Class A and Class C shares
acquired by other investors; however, they are not subject to any initial sales
charge or CDSC. Once a Participating Plan has made an initial investment in a
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 C Shares. Class C 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 C 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. If, at the
end of the fifth year after the date the Participating Plan enrolled in the
Smith Barney 401(k) Program or the Smith Barney ExecChoice(TM) Program, a Par-
ticipating Plan's total Class C holdings in all non-money market Smith Barney
Mutual Funds equal at least $1,000,000, the Participating Plan will be offered
the opportunity to exchange all of its Class C shares for Class A shares of the
Fund. (For Participating Plans that were originally established through a Smith
Barney retail brokerage account, the five year period will be calculated from
the date the retail brokerage 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 Participating
Plan's holdings will be performed each quarter until either the Participating
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
C 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 C 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 that has not previ-
ously qualified for an exchange into Class A shares will be offered the oppor-
tunity to     
 
40
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
   
exchange all of its Class C 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 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 C shares of the Fund but instead may acquire Class A
shares of the Fund. Any Class C shares not converted will continue to be sub-
ject 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 First Data. For further information regarding these
Programs, investors should contact a Smith Barney Financial Consultant.     
   
  Existing 401(k) Plans Investing in Class B Shares. Class B shares of the Fund
are not available for purchase by Participating Plans opened on or after June
21, 1996, but may continue to be purchased by any Participating Plan opened
prior to such date and originally investing in such Class. Class B shares
acquired are subject to a CDSC of 3.00% of redemption proceeds, if the Partici-
pating Plan terminates within eight years of the date the Participating Plan
first enrolled in the Smith Barney 401(k) Program.     
   
  At the end of the eighth year after the date the Participating Plan enrolled
in the Smith Barney 401(k) Program, the Participating Plan will be offered the
opportunity to exchange all of its Class B shares for Class A shares of the
Fund. Such Plans will be notified of the pending exchange in writing approxi-
mately 60 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 the exchange has occurred, a Participating
Plan will not be eligible to acquire additional Class B shares of the Fund but
instead may acquire Class A shares of the Fund. If the Participating Plan elects
not to exchange all of its Class B shares at that time, each Class B share held
by the Participating Plan will have the same conversion feature as Class B
shares held by other investors. See "Purchase of Shares--Deferred Sales Charge
Alternatives."     
   
  No CDSC is imposed on redemptions of Class B shares to the extent that the
net asset value of the shares redeemed does not exceed the current net asset
value of the shares purchased through reinvestment of dividends or capital gain
distributions, plus the current net asset value of Class B shares purchased
more than eight years prior to the redemption, plus increases in the net asset
value of the shareholder's Class B shares above the purchase payments made dur-
ing the preceding eight     
 
                                                                              41
<PAGE>
 
PURCHASE OF SHARES (CONTINUED)
   
years. Whether or not the CDSC applies to the redemption by a Participating
Plan depends on the number of years since the Participating Plan first became
enrolled in the Smith Barney 401(k) Program, unlike the applicability of the
CDSC to redemptions by other shareholders, which depends on the number of years
since those shareholders made the purchase payment from which the amount is
being redeemed.     
   
  The CDSC will be waived on redemptions of Class B shares in connection with
lump-sum or other distributions made by a Participating Plan as a result of:
(a) the retirement of an employee in the Participating Plan; (b) the termina-
tion of employment of an employee in the Participating Plan; (c) the death or
disability of an employee in the Participating Plan; (d) the attainment of age
59 1/2 by an employee in the Participating Plan; (e) hardship of an employee in
the Participating Plan to the extent permitted under Section 401(k) of the
Code; or (f) redemptions of shares in connection with a loan made by the Par-
ticipating Plan to an employee.     
       
EXCHANGE PRIVILEGE
   
  Except as otherwise noted below, shares of each Class may be exchanged at the
net asset value next determined 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 C shares are subject to minimum investment requirements and all shares
are subject to the other requirements of the fund into which exchanges are
made.     
 
 FUND NAME
 
  Growth Funds
    Smith Barney Aggressive Growth Fund Inc.
    Smith Barney Appreciation Fund Inc.
    Smith Barney Fundamental Value Fund Inc.
    Smith Barney Growth Opportunity Fund
    Smith Barney Managed Growth Fund
       
    Smith Barney Natural Resources Fund Inc.     
    Smith Barney Special Equities Fund
    Smith Barney Telecommunications Growth Fund
 
  Growth and Income Funds
    Smith Barney Convertible Fund
       
    Smith Barney Funds, Inc.--Equity Income Portfolio     
    Smith Barney Growth and Income Fund
    Smith Barney Premium Total Return Fund
    Smith Barney Strategic Investors Fund
    Smith Barney Utilities Fund
 
42
<PAGE>
 
EXCHANGE PRIVILEGE (CNTINUED)
 
 
  Taxable Fixed--Income Funds
    *Smith Barney Adjustable Rate Government Income Fund
   **Smith Barney Funds, Inc.--Income Return Account Portfolio
    Smith Barney Funds, Inc.--Monthly Payment Government Portfolio
   +Smith Barney Funds, Inc.--Short-Term U.S. Treasury Securities
      Portfolio
    Smith Barney Funds, Inc.--U.S. Government Securities Portfolio
    Smith Barney Government Securities Fund
    Smith Barney High Income Fund
    Smith Barney Investment Grade Bond Fund
    Smith Barney Managed Governments Fund Inc.
 
  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 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
 
  International Funds
       
    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 Series Inc.     
       
    Smith Barney Concert Series Inc.--Balanced Portfolio     
       
    Smith Barney Concert Series Inc.--Conservative Portfolio     
       
    Smith Barney Concert Series Inc.--Growth Portfolio     
       
    Smith Barney Concert Series Inc.--High Growth Portfolio     
       
    Smith Barney Concert Series Inc.--Income Portfolio     
 
                                                                              43
<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, Class B and Class Y shares of the
    Fund. In addition, shareholders who own Class C shares of the Fund through
    the Smith Barney 401(k) Program may exchange those shares for Class C
    shares of this fund.
 ** Available for exchange with Class A, Class C 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 B and Class C shares of the Fund.
+++ Available for exchange with Class A and Class Y shares of the Fund. In
    addition, shareholders who own Class C shares of the Fund through the
    Smith Barney 401(k) Program may exchange those shares for Class C shares
    of this fund.
       
       
  Class C Exchanges. Upon an exchange, the new Class C shares will be deemed
to have been purchased on the same date as the Class C 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. SBMFM 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 sus-
pending the exchange privilege and during the 15 day period the shareholder
will be required to (a) redeem his or her shares in 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 dis
    
44
<PAGE>
 
EXCHANGE PRIVILEGE (CONTINUED)
 
cussed 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 reg-
istration 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 the shares of the Fund 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 trading 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 redemp-
tion must specify the Class being redeemed. In the event of a failure to spec-
ify which Class, or if the investor owns fewer shares of the Class than speci-
fied, the redemption request will be delayed until First Data receives further
instructions from Smith Barney, or if the shareholder's account is not with
Smith Barney, from the shareholder directly. The redemption proceeds will be
remitted on or before the third business day following receipt of proper ten-
der, 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 Smith Barney brokerage account, these funds will not be
invested for the shareholder's benefit without specific instruction and Smith
Barney will benefit from the use of temporarily uninvested funds. Redemption
proceeds for shares purchased by check, other than a certified or official bank
check, will be remitted upon clearance of the check, which may take up to ten
days or more.     
 
  Shares held by Smith Barney as custodian must be redeemed by submitting a
written request to a Smith Barney Financial Consultant. Shares other than those
held by Smith Barney as custodian may be redeemed through an investor's Finan-
cial Consultant, Introducing Broker or dealer in the selling group or by sub-
mitting a written request for redemption to:
     
  Smith Barney Diversified Strategic Income Fund     
  Class A, B, C or Y (please specify)
  c/o First Data Investor Services Group, Inc.
  P.O. Box 9134
  Boston, Massachusetts 02205-9134
 
 
                                                                              45
<PAGE>
 
   
REDEMPTION OF SHARES (CONTINUED)     
   
  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 a
written redemption request in excess of $2,000 must be guaranteed by an eligi-
ble guarantor institution such as a domestic bank, savings and loan institu-
tion, domestic credit union, member bank of the Federal Reserve System or mem-
ber firm of a national securities exchange. Written redemption requests of
$2,000 or less do not require a signature guarantee unless more than one such
redemption 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
directed, redemption proceeds will be mailed to an investor's address of rec-
ord. 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 Smith Barney brokerage account may be eligi-
ble to redeem and exchange Fund shares by telephone. To determine if a share-
holder is entitled to participate in this program, he or she should contact
First Data at 1-800-451-2010. Once eligibility is confirmed, the shareholder
must complete and return a Telephone/Wire Authorization Form, along with a
signature guarantee that will be provided by First Data upon request. (Alter-
natively, an investor may authorize telephone redemption on the new account
application with the applicant's signature guarantee when making his/her ini-
tial 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 5:00 p.m.
(New York City time) on any day the NYSE is open. Redemption requests received
after 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
 
46
<PAGE>
 
REDEMPTION OF SHARES (CONTINUED)
   
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 5:00
p.m. (New York City time) on any day on which the NYSE is open. Exchange
requests received after the close of regular trading on the NYSE are processed
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 Fund. Any applicable CDSC will not
be waived on amounts withdrawn by a shareholder 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. For further information regarding the automatic
cash withdrawal plan, shareholders should contract a Smith Barney Financial
Consultant.     
 
 
                                                                             47
<PAGE>
 
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 advertises 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 C 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 Prospectus, then dividing the value of the invest-
ment 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 redeem-
able value. Such standard total return information may also be accompanied with
nonstandard total return information 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 or the maximum public offering price (including sales charge) on the last
day of the period for which current dividend return is presented. The current
dividend return for each Class may vary from time to time depending on market
conditions, the composition of its investment portfolio and operating expenses.
 
48
<PAGE>
 
   
PERFORMANCE (CONTINUED)     
       
These factors and possible differences in the methods used in calculating cur-
rent 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, Inc. and other financial publications.
 
MANAGEMENT OF THE TRUST AND THE FUND
 
 
 BOARD OF TRUSTEES
   
  Overall responsibility for management and supervision of the Fund rests with
the Trust's Board of Trustees. The Trustees approve all significant agreements
between the Trust and the companies that furnish services to the Trust and the
Fund, including agreements with the Fund's distributor, investment adviser,
sub-investment adviser, administrator, custodian and transfer agent. The day-
to-day operations of the Fund are delegated to the Fund's investment adviser
and Administrator and sub-investment adviser. The Statement of Additional
Information contains background information regarding each Trustee and execu-
tive officer of the Fund.     
 
 INVESTMENT ADVISER--SBMFM
   
  SBMFM, located at 388 Greenwich Street, New York, New York 10013, serves as
the Fund's investment adviser. SBMFM (through its predecessors) has been in
the investment counseling business since 1934 and is a registered investment
adviser. SBMFM renders investment advice to investment companies that had
aggregate assets under management as of October 31, 1996 in excess of $79 bil-
lion.     
 
  Subject to the supervision and direction of the Trust's Board of Trustees,
SBMFM manages the Fund's portfolio in accordance with the Fund's investment
objective and policies, makes investment decisions for the Fund, places orders
to purchase and sell securities and employs professional portfolio managers
and securities analysts who provide research service to the Fund. For advisory
services rendered to the Fund, the Fund pays SBMFM a fee at the annual rate of
0.45% of the value of the Fund's average daily net assets. From its fee, SBMFM
pays Global Capital Management a fee of 0.10% of the value of the Fund's aver-
age daily net assets for its services as sub-investment adviser.
 
 SUB-INVESTMENT ADVISER--GLOBAL CAPITAL MANAGEMENT
 
  Global Capital Management, located at 10 Piccadilly, London W1V 9LA, United
Kingdom, serves as the Fund's sub-investment adviser pursuant to a sub-
investment advisory agreement dated August 31, 1995. Global Capital Management
has
 
                                                                             49
<PAGE>
 
MANAGEMENT OF THE TRUST AND THE FUND (CONTINUED)
   
been in the investment counseling business since 1988 and renders advice to
client companies with aggregate assets under management, as of October 31,
1996 in excess of $2.98 billion.     
   
  In its capacity as a sub-investment adviser, Global Capital Management is
responsible for, and selects, the Fund's investments in foreign securities and
selects the brokers and dealers that execute the Fund's investments in foreign
securities.     
 
 PORTFOLIO MANAGEMENT
 
  John C. Bianchi and James E. Conroy, both Managing Directors of Smith Bar-
ney, have served as Vice Presidents and Investment Officers of the Fund since
it commenced operations. Along with Victor S. Filatov, an Investment Officer
of the Fund since March 21, 1994 and President of Global Capital Management,
they manage the day-to-day operations of the Fund, including making all domes-
tic investment decisions.
   
  Simon Hildreth, Managing Director of Smith Barney and a member of the
Investment Policy Committee of Global Capital Management, is responsible for
managing the day-to-day operations of the Fund's investments in foreign secu-
rities. Prior to 1994, Mr. Hildreth was Director of Mercury Asset Management,
a fund manager located in the United Kingdom.     
   
  Management's discussion and analysis, and additional performance information
regarding the Fund during the fiscal year ended July 31, 1996 are included in
the Annual Report dated July 31, 1996. A copy of the Annual Report may be
obtained upon request and without charge from a Smith Barney Financial Consul-
tant or by writing or calling the Fund at the address or phone number listed
on page one of this Prospectus.     
 
 ADMINISTRATOR--SBMFM
 
  SBMFM also serves as the Fund's administrator and oversees all aspects of
the Fund's administration and operation. For administration services rendered
to the Fund, the Fund pays SBMFM a fee at the annual rate of .20% of the value
of the Fund's average daily net assets.
 
DISTRIBUTOR
 
 
  Smith Barney is located at 388 Greenwich Street, New York, New York 10013.
Smith Barney distributes shares of the Fund as principal underwriter and as
such conducts a continuous offering pursuant to a "best efforts" arrangement
requiring Smith Barney to take and pay for only such securities as may be sold
to the public. Pursuant to a plan of distribution adopted by the Fund under
Rule 12b-1 under the
 
50
<PAGE>
 
DISTRIBUTOR (CONTINUED)
   
1940 Act (the "Plan"), Smith Barney is paid a service fee with respect to Class
A, Class B and Class C shares of the Fund at the annual rate of 0.25% of the
average daily net assets of the respective Class. Smith Barney is also paid a
distribution fee with respect to Class B and Class C 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 Smith Barney to pay its Financial Con-
sultants for servicing shareholder accounts and, in the case of Class B and
Class C shares, to cover expenses primarily intended to result in the sale of
those shares. These expenses include: advertising expenses; the cost of print-
ing and mailing prospectuses to potential investors; payments to and expenses
of Smith Barney Financial Consultants and other persons who provide support
services in connection with the distribution of shares; interest and/or carry-
ing charges; and indirect and overhead costs of Smith Barney associated with
the sale of Fund shares, including lease, utility, communications and sales
promotion expenses.     
 
  The payments to Smith Barney Financial Consultants for selling shares of a
Class include a commission or fee paid by the investor or Smith Barney at the
time of sale and, with respect to Class A, Class B and Class C shares, a con-
tinuing fee for servicing shareholder accounts for as long as a shareholder
remains a holder of that Class. Smith Barney Financial Consultants may receive
different levels of compensation for selling different Classes of shares.
 
  Payments under the Plan with respect to Class B and Class C shares are not
tied exclusively to the distribution and shareholder service expenses actually
incurred by Smith Barney and the payments may exceed distribution expenses
actually incurred. The Trust's Board of Trustees will evaluate the appropriate-
ness of the Plan and its payment terms on a continuing basis and in so doing
will consider all relevant factors, including expenses borne by Smith Barney,
amounts received under the Plan and proceeds of the CDSC.
 
ADDITIONAL INFORMATION
 
 
  The Trust was organized on March 12, 1985 under the laws of the Commonwealth
of Massachusetts and is a business entity commonly known as a "Massachusetts
business trust." The Trust may issue an unlimited number of shares of benefi-
cial interest, of separate series with a par value of $.001 per share. The Fund
offers shares of beneficial interest currently classified into five Classes--A,
B, C, Y and Z.
 
  Each Class of shares represents identical interests in the Fund's investment
portfolio. As a result, the Classes have the same rights, privileges and pref-
erences, except with respect to: (a) the designation of each Class; (b) the
effect of the respec-
 
                                                                              51
<PAGE>
 
   
ADDITIONAL INFORMATION (CONTINUED)     
   
tive sales charges for each Class; (c) the distribution and/or service fees, if
any, borne by each Class pursuant to the Plan; (d) the expenses allocable
exclusively to each Class; (e) voting rights on matters exclusively affecting a
single Class; (f) the exchange privilege of each Class; and (g) the conversion
feature of the Class B shares. The Trust's Board of Trustees does not antici-
pate that there will be any conflicts among the interests of the holders of the
different Classes. The Trustees, on an ongoing basis, will consider whether any
such conflict exists and, if so, take appropriate action.     
   
  When matters are submitted for shareholder vote, shareholders of each Class
of each Fund will have one vote for each full share owned and a proportionate,
fractional vote for any fractional share held of that Class. Shares of the
Trust will be voted generally on a Trust-wide basis on all matters except mat-
ters affecting the interests of one Fund or one Class of shares.     
 
  Normally there will be no meetings of shareholders for the purpose of elect-
ing Trustees unless and until such time as less than a majority of the Trustees
holding office have been elected by shareholders. Shareholders of record of no
less than two-thirds of the outstanding shares of the Trust may remove a
Trustee through a declaration in writing or by vote cast in person or by proxy
at a meeting called for that purpose. The Trustees 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.
   
  Morgan Guaranty Trust Company of New York, located at 60 Wall Street, New
York, NY 10260, serves as custodian of the Fund's investments. Effective Decem-
ber 6, 1996, The Chase Manhattan Bank, located at Chase Metrotech Center,
Brooklyn, NY 11245, will serve as custodian of the Fund's investments.     
   
  First Data, located at Exchange Place, Boston, Massachusetts 02109, serves as
the Trust's transfer agent.     
   
  The Fund sends its shareholders a semi-annual report and an audited annual
report, which include listings of the investment securities held by the Fund at
the end of the reporting period. In an effort to reduce the Fund's printing and
mailing costs, the Trust plans to consolidate the mailing of the Fund's semi-
annual and annual reports by household. This consolidation means that a house-
hold having multiple accounts with the identical address of record will receive
a single copy of each report. In addition, the Trust also plans to consolidate
the mailing of the Fund's Prospectus so that a shareholder having multiple
accounts (that is, individual, IRA and/or 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 a Smith Bar-
ney Financial Consultant or First Data.     
 
52
<PAGE>
 
 
                                              SMITH BARNEY

                                              ----------------------------------
                                              A Member of TravelersGroup  [LOGO]
 
 
 
 
                                  SMITH BARNEY DIVERSIFIED STRATEGIC INCOME FUND
 
                                                            388 Greenwich Street
                                                        New York, New York 10013
                                                                 
                                                              FD 1209 11/96     
<PAGE>
 
 
 
                                                                    SMITH BARNEY
 
                                               Diversified Strategic Income Fund
                                                             Class Z Shares Only
                                                             
                                                          NOVEMBER 28, 1996     
                                                   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 28, 1996     
   
Smith Barney     
   
Diversified Strategic Income Fund--Class Z Shares     
388 Greenwich Street
New York, New York 10013
(212) 723-9218
   
  Smith Barney Diversified Strategic Income Fund (the "Fund"), a diversified
fund, seeks high current income primarily through investment in fixed-income
securities. The Fund attempts to achieve this objective by allocating and real-
locating its assets primarily among various types of fixed-income securities
selected by its investment adviser on the basis of an analysis of economic and
market conditions and the relative risks and opportunities of those types of
fixed-income securities.     
 
  The Fund is one of a number of funds, each having distinct investment objec-
tives and policies, making up Smith Barney Income Funds (the "Trust"). The
Trust is an open-end, management investment company commonly referred to as a
mutual fund.
 
  This Prospectus sets forth concisely certain information about the Fund and
the Trust, including expenses, that prospective investors will find helpful in
making an investment decision. Investors are encouraged to read this Prospectus
carefully and retain it for future reference.
 
  The Class Z shares described in this Prospectus (previously designated as
Class C shares) are currently offered exclusively for sale to tax-exempt
employee benefit and retirement plans of Smith Barney Inc. ("Smith Barney") or
any of its affiliates ("Qualified Plans") and to certain unit investment trusts
sponsored by Smith Barney or any of its affiliates ("Smith Barney UITs").
   
  Additional information about the Fund and the Trust is contained in a State-
ment of Additional Information dated November 28, 1996, as amended or supple-
mented from time to time, that is available upon request and without charge by
calling or writing the Trust at the telephone number or address set forth above
or by contacting a Smith Barney Financial Consultant. The Statement of Addi-
tional Information has been filed with the Securities and Exchange Commission
(the "SEC") and is incorporated by reference into this Prospectus in its
entirety.     
 
SMITH BARNEY INC.
Distributor
 
SMITH BARNEY MUTUAL FUNDS MANAGEMENT INC.
Investment Adviser and Administrator
 
SMITH BARNEY GLOBAL CAPITAL MANAGEMENT INC.
Sub-Investment Adviser
 
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES 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>
THE FUND'S EXPENSES                             3
-------------------------------------------------
FINANCIAL HIGHLIGHTS                            4
-------------------------------------------------
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES    5
-------------------------------------------------
VALUATION OF SHARES                            19
-------------------------------------------------
DIVIDENDS, DISTRIBUTIONS AND TAXES             20
-------------------------------------------------
PURCHASE, EXCHANGE AND REDEMPTION OF SHARES    21
-------------------------------------------------
PERFORMANCE                                    22
-------------------------------------------------
MANAGEMENT OF THE TRUST AND THE FUND           23
-------------------------------------------------
ADDITIONAL INFORMATION                         25
-------------------------------------------------
</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 Trust
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>
 
THE FUND'S EXPENSES
 
The following expense table lists the costs and expenses an investor will incur
either directly or indirectly as a shareholder of Class Z shares of the Fund,
based on the Fund's operating expenses for its most recent fiscal year:
 
<TABLE>   
<CAPTION>
  SMITH BARNEY
  DIVERSIFIED STRATEGIC INCOME        AS A % OF
  FUND--CLASS Z SHARES            AVERAGE NET ASSETS
----------------------------------------------------
  <S>                             <C>
  ANNUAL FUND OPERATING EXPENSES
    Management fees*                     0.65%
    Other expenses                       0.05
----------------------------------------------------
  TOTAL FUND OPERATING EXPENSES          0.70%
----------------------------------------------------
</TABLE>    
 
  The nature of the services for which the Fund pays management fees is
described under "Management of the Trust and the Fund." "Other expenses" in the
above table include fees for shareholder services, custodial fees, legal and
accounting fees, printing costs and registration fees.
 
 EXAMPLE
   
  The following example is intended to assist an investor in understanding 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, Exchange and Redemption of Shares" and
"Management of the Trust and the Fund."     
 
<TABLE>   
<CAPTION>
  SMITH BARNEY
  DIVERSIFIED STRATEGIC INCOME
  FUND--CLASS Z SHARES                          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 in Class Z shares of
  the Fund, assuming (1) 5% annual return and
  (2) redemption at the end of each time
  period:                                        $ 7     $22     $39     $87
-------------------------------------------------------------------------------
</TABLE>    
 
  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
REPRESENTATION OF PAST OR FUTURE EXPENSES AND ACTUAL EXPENSES MAY BE GREATER OR
LESS THAN THOSE SHOWN.
 
                                                                               3
<PAGE>
 
FINANCIAL HIGHLIGHTS
   
  The following information for the two year period ended July 31, 1996 has
been audited by KPMG Peat Marwick LLP, independent auditors, whose report
thereon appears in the Fund's Annual Report dated July 31, 1996. The following
information for the fiscal years ended July 31, 1993 through July 31, 1994 has
been audited by other independent autitors. The information set forth below 
should
be read in conjunction with the financial statements and related notes that
also appear in the Fund's 1996 Annual Report, which is incorporated by refer-
ence into the Statement of Additional Information.     
   
FOR A CLASS Z SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH YEAR:
    
<TABLE>   
<CAPTION>
SMITH BARNEY                          YEAR       YEAR     YEAR      PERIOD
DIVERSIFIED STRATEGIC INCOME          ENDED     ENDED     ENDED     ENDED
FUND--CLASS Z SHARES                 7/31/96  7/31/95(1) 7/31/94  7/31/93(2)
-----------------------------------------------------------------------------
<S>                                  <C>      <C>        <C>      <C>
NET ASSET VALUE, BEGINNING OF YEAR    $ 7.85    $ 7.76    $ 8.41    $ 8.24
-----------------------------------------------------------------------------
INCOME FROM OPERATIONS:
 Net investment income(3)               0.64      0.84      0.68      0.51
 Net realized and unrealized gain
 (loss)                                 0.02     (0.06)    (0.54)     0.25
-----------------------------------------------------------------------------
Total Income From Operations            0.66      0.78      0.14      0.76
-----------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
 Net investment income                 (0.63)    (0.49)    (0.59)    (0.47)
 Overdistributions of net investment
 income                                  --        --      (0.06)      --
 Net realized gains                      --        --      (0.10)    (0.12)
 Capital                               (0.06)    (0.20)    (0.04)      --
-----------------------------------------------------------------------------
Total Distributions                    (0.69)    (0.69)    (0.79)    (0.59)
-----------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR          $ 7.82    $ 7.85    $ 7.76    $ 8.41
-----------------------------------------------------------------------------
TOTAL RETURN                            8.72%    10.94%     1.43%     9.47%++
-----------------------------------------------------------------------------
NET ASSETS, END OF YEAR (000S)       $16,270   $14,361   $11,552   $11,803
-----------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
 Expenses(3)                            0.70%     0.75%     0.75%     0.80%+
 Net investment income                  8.19      8.30      8.02      8.56+
-----------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE                   90%       83%       93%      116%
-----------------------------------------------------------------------------
AVERAGE COMMISSIONS PER SHARE PAID
 ON EQUITY TRANSACTIONS(4)             $0.00*      --        --        --
-----------------------------------------------------------------------------
</TABLE>    
    
 (1) On November 7, 1994, the former Class C shares were renamed Class Z
     shares.     
    
 (2) For the period from November 6, 1992 (inception date) to July 31, 1993.
            
 (3) The Manager has waived part of its fees for the years ended July 31, 1995
     and 1994. If such fees had not been waived, the per share effect on net
     investment income and the expense ratios would have been as follows:     
<TABLE>     
<CAPTION>
               PER SHARE DECREASES        EXPENSE RATIOS
            IN NET INVESTMENT INCOME    WITHOUT FEE WAIVERS
  -----------------------------------------------------------
                1995          1994        1995       1994
            ------------  ------------  ---------  ---------
   <S>      <C>           <C>           <C>        <C>
   Class Z         $0.00*        $0.00*      0.80%      0.77%
</TABLE>    
    
 (4) As of September 1995, the SEC instituted new guidelines requiring the
     disclosure of average commissions per share.     
    
   * Amount represents less than $0.01 per share.     
    
   ++Total return is not annualized, as it may not be representative of the
     total return for the year.     
    
   + Annualized.     
 
4
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES
 
  The investment objective of the Fund is high current income primarily
through investment in fixed-income securities. In attempting to achieve its
objective, the Fund allocates and reallocates its assets primarily among vari-
ous types of fixed-income securities selected by Smith Barney Mutual Funds
Management Inc. ("SBMFM"). The types of fixed-income securities among which
the Fund's assets will be primarily allocated are: obligations issued or guar-
anteed as to principal and interest by the United States government ("U.S.
government securities"); mortgage-related securities issued by various govern-
mental and non-governmental entities; domestic and foreign corporate securi-
ties; and foreign government securities. The Fund's investment objective may
be changed only with the approval of the holders of a majority of the Fund's
outstanding shares. There can be no assurance that the Fund will achieve its
investment objective.
 
  The allocation and reallocation of the Fund's assets will be undertaken by
SBMFM on the basis of its analysis of economic and market conditions and the
relative risks and opportunities of particular types of fixed-income securi-
ties. In general, the particular types of fixed-income securities selected for
investment by the Fund at any given time will be those that, in the view of
SBMFM, offer the highest income available at the time. The Fund typically
would not invest in fixed-income securities offering the highest income poten-
tial if SBMFM determined that the income potential is not sufficient to jus-
tify the higher risks associated with the securities.
   
  At any given time, the Fund may be entirely or only partially invested in a
particular type of fixed-income security. Under normal conditions, at least
65% of the Fund's assets will be invested in fixed-income securities, which
for this purpose will include non-convertible preferred stocks. The Fund gen-
erally will invest in intermediate- and long-term fixed-income securities with
the result that, under normal market conditions, the weighted average maturity
of the Fund's securities is expected to be between five and 12 years. Up to
20% of the Fund's assets may be invested in common stock or other equity-
related securities, including convertible securities, preferred stock, war-
rants and rights.     
 
  Mortgage-related securities in which the Fund may invest include mortgage
obligations collateralized by mortgage loans or mortgage pass-through certifi-
cates. Under current market conditions, the Fund's holdings of mortgage-
related securities may be expected to consist primarily of securities issued
or guaranteed by Government National Mortgage Association ("GNMA"), Federal
National Mortgage Association ("FNMA") and Federal Home Loan Mortgage Corpora-
tion ("FHLMC"). The composition of the Fund's investments in mortgage-related
securities, however, will vary from time to time based upon the determination
of SBMFM on how best to achieve the Fund's investment objective taking into
account factors such as the liquidity and yield of various mortgage-related
securities. Mortgage-related securi-
 
                                                                              5
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
   
ties held by the Fund generally will be rated no lower than Aa by Moody's
Investors Service, Inc. ("Moody's") or AA by Standard & Poor's Ratings Group
("S&P") or, if not rated, will be of equivalent investment quality as deter-
mined by SBMFM. SBMFM also may consider the ratings, if any, assigned to mort-
gage-related securities by recognized rating agencies other than Moody's and
S&P.     
 
  The Fund typically will purchase a corporate debt security if SBMFM believes
that the yield and, to a lesser extent, the potential for capital apprecia-
tion, of the security are sufficiently attractive in light of the risks of
ownership of the security. In determining whether the Fund should invest in
particular debt securities, SBMFM will consider factors such as: the price,
coupon and yield to maturity; the credit quality of the issuer; the issuer's
available cash flow and the related coverage ratios; the property, if any,
securing the obligation; and the terms of the debt securities, including the
subordination, default, sinking fund and early redemption provisions. SBMFM
also will review the ratings, if any, assigned to the securities by Moody's,
S&P or other recognized rating agencies. SBMFM's judgment as to credit quality
of a debt security may differ, however, from that suggested by the ratings
published by a rating service.
 
  The Fund may invest up to 35% of its assets in corporate fixed-income secu-
rities of domestic issuers rated Ba or lower by Moody's or BB or lower by S&P
or in nonrated securities deemed by SBMFM to be of comparable quality. The
Fund may invest in fixed-income securities rated as low as Caa by Moody's or
CCC by S&P.
   
  Corporate fixed-income securities of foreign issuers in which the Fund may
invest will include securities of companies, wherever organized, that have
their principal business activities and interests outside the United States.
Foreign government securities in which the Fund may invest consist of fixed-
income securities issued by foreign governments. In general, the Fund may
invest in debt securities issued by foreign governments or any of their polit-
ical subdivisions that are considered stable by Smith Barney Global Capital
Management Inc. ("Global Capital Management"). Up to 5% of the Fund's assets,
however, may be invested in foreign securities issued by countries with devel-
oping economies.     
 
  The Fund may invest in fixed-income securities issued by supranational orga-
nizations, which are entities designated or supported by a government or gov-
ernmental entity to promote economic development, and include, among others,
the Asian Development Bank, the European Coal and Steel Community, the Euro-
pean Economic Community and the World Bank. These organizations have no taxing
authority and are dependent upon their members for payments of interest and
principal. Moreover, the lending activities of supranational entities are lim-
ited to a percentage of their total capital (including "callable capital" con-
tributed by members at an entity's call), reserves and net income.
 
6
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
   
  The Fund may also invest in zero coupon securities and payment-in-kind
bonds.     
       
 ADDITIONAL INVESTMENTS
  Money Market Instruments. Up to 20% of the Fund's assets may be invested in
cash and money market instruments at any time. In addition, when SBMFM
believes that market conditions warrant, the Fund may invest in short-term
instruments without limitation for temporary defensive purposes. Short-term
instruments in which the Fund may invest include: U.S. government securities;
certain bank obligations (including certificates of deposit, time deposits and
bankers' acceptances of domestic or foreign banks, domestic savings and loan
associations and similar institutions); commercial paper rated no lower than
Prime-2 by Moody's or A-2 by S&P or the equivalent from another major rating
service or, if unrated, of an issuer having an outstanding, unsecured debt
issue then rated within the three highest rating categories; and repurchase
agreements with respect to the securities in which the Fund may invest. The
Fund will invest in obligations of a foreign bank or foreign branch of a
domestic bank only if SBMFM determines that the obligations present minimum
credit risks. These obligations may be traded in the United States or outside
the United States, but will be denominated in U.S. dollars.
 
  U.S. Government Securities. The U.S. government securities in which the Fund
may invest include, direct obligations of the United States Treasury (such as
Treasury Bills, Treasury Notes and Treasury Bonds), and obligations issued by
U.S. government agencies and instrumentalities, including: securities that are
supported by the full faith and credit of the United States (such as GNMA cer-
tificates); 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 securities that are supported by the credit of the instrumentality
(such as FNMA and FHLMC bonds). Treasury Bills have maturities of less than
one year, Treasury Notes have maturities of one to 10 years and Treasury Bonds
generally have maturities of greater than 10 years at the date of issuance.
Certain U.S. government securities, such as those issued or guaranteed by
GNMA, FNMA and FHLMC, are mortgage-related securities. U.S. government securi-
ties generally do not involve the credit risks associated with other types of
interest-bearing securities, although, as a result, the yields available from
U.S. government securities are generally lower than the yields available from
interest-bearing corporate securities.
   
  Zero Coupon Securities. A zero coupon 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
an amount significantly less than its face value (sometimes referred to as a
"deep discount" price). Because such securities usually trade at a deep dis-
count, they will be subject to greater fluctuations of market value in
response to changing interest rates than debt obliga     
 
                                                                              7
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
   
tions of comparable maturities which make periodic distributions of interest.
On the other hand, because there are no periodic interest payments to be rein-
vested prior to maturity, zero coupon securities eliminate reinvestment risk
and lock in a rate of return to maturity.     
 
 CERTAIN INVESTMENT STRATEGIES
  In attempting to achieve its investment objective, the Fund may employ, among
others, one or more of the strategies set forth below. More detailed informa-
tion concerning these strategies and their related risks is contained in the
Statement of Additional Information.
 
  Repurchase Agreements. The Fund may engage in repurchase agreement transac-
tions 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 relatively 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. This arrangement results in a fixed
rate of return that is not subject to market fluctuations during the Fund's
holding period. The value of the underlying securities will be at least equal
at all times to the total amount of the repurchase obligation, including inter-
est. 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
possible 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. SBMFM or Global Capital Management, act-
ing under the supervision of the Trust's Board of Trustees, reviews on an ongo-
ing basis the value of the collateral and the creditworthiness of those banks
and dealers with which the Fund may enter into repurchase agreements to evalu-
ate potential risks.
 
  Reverse Repurchase Agreements. The Fund may enter into reverse repurchase
agreement transactions with member banks of the Federal Reserve Bank of New
York's list of reporting dealers. A reverse repurchase agreement, which is con-
sidered a borrowing by the Fund, involves a sale by the Fund of securities that
it holds concurrently with an agreement by the Fund to repurchase the same
securities at an agreed-upon price and date. The Fund typically will invest the
proceeds of a reverse repurchase agreement in money market instruments or
repurchase agreements maturing not later than the expiration of the reverse
repurchase agreement. This use of the proceeds is known as leverage. The Fund
will enter into a reverse repurchase agreement for leverage purposes only when
the interest income to be earned from the investment of the proceeds is greater
than the interest expense of the transaction. The Fund also may use the pro-
ceeds of reverse repurchase agree-
 
8
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
ments to provide liquidity to meet redemption requests when the sale of the
Fund's securities is considered to be disadvantageous.
   
  Forward Roll Transactions. In order to enhance current income, the Fund may
enter into forward roll transactions with respect to mortgage-related securi-
ties 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 gener-
ally will be collateralized by different pools of mortgages with different pre-
payment 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 additional 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 securi-
ties sold by the Fund may decline below the repurchase price of those securi-
ties. At the time the Fund enters into forward roll transactions, it will place
in a segregated account with the Fund's custodian, cash or equity and debt
securities of any grade provided such securities have been determined by SBMFM
or Global Capital Management to be liquid and unencumbered pursuant to guide-
lines established by the Trustees ("eligible segregated assets") having a value
equal to the repurchase price (including accrued interest) and will subse-
quently monitor the account to insure that such equivalent value is maintained.
       
  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 securi-
ties 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 consisting of cash or
other eligible segregated assets 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. The Fund has the ability to lend portfolio
securities to brokers, dealers and other financial organizations. These loans,
if and when
 
                                                                               9
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
   
made, may not exceed 20% of the Fund's assets taken at value. Loans of portfo-
lio securities by the Fund will be collateralized by cash, letters of credit
or U.S. government securities that are maintained at all times in an amount at
least equal to the current market value of the loaned securities. Any gain or
loss in the market price of the securities loaned that might occur during the
term of the loan would be for the account of the Fund. The Fund will segregate
the common stock or convertible or exchangeable preferred stock or debt secu-
rities in a special account with its custodian.     
 
  Covered Option Writing. The Fund may purchase and sell put, call and other
types of option securities that are traded on domestic or foreign exchanges or
the over-the-counter market including, but not limited to, "spread" options,
"knock-out" options, "knock-in" options and "average rate" or "look-back"
options. The Fund may realize fees (referred to as "premiums") for granting
the rights evidenced by the options. A put option embodies the right of its
purchaser to compel the writer of the option to purchase from the option
holder 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 to the option holder an underlying
security at a specified price at any time during the option period. Thus, the
purchaser of a put option written by the Fund has the right to compel the Fund
to purchase from it the underlying security at the agreed-upon price for a
specified time period, while the purchaser of a call option written by the
Fund 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 call option written by the Fund, 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 option's exercise price, less the premium received
for writing the option.
   
  The Fund will write only covered options. Thus, whenever the Fund writes a
call option, it will continue to own or have the present right to acquire the
underlying security for as long as it remains obligated as the writer of the
option. To support its obligation to purchase the underlying security if a put
option is exercised, the Fund will either (a) deposit with its custodian in a
segregated account cash or other eligible segregated assets having a value at
least equal to the exercise price of the underlying securities or (b) continue
to own an equivalent number of puts of the same "series" (that is, puts on the
same underlying security having the same exercise prices and expiration dates
as those written by the Fund), or an equivalent number of puts of the same
"class" (that is, puts on the same underlying security) with exercise prices
greater than those that it has written (or, if the exercise prices of the puts
that it holds are less than the exercise prices of those that it has written,
it will deposit the difference with its custodian in a segregated account).
    
10
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 
  Purchasing Put and Call Options on Securities. The Fund may utilize up to 15%
of its assets to purchase options and may do so at or about the same time that
it purchases the underlying security or at a later time. In purchasing option
securities, the Fund will trade only with counterparties of high standing in
terms of credit quality and commitment to the market. Risks associated with
options transactions and foreign futures contracts are described below under
"Special Considerations."
   
  Futures Contracts and Options on Futures Contracts. The Fund may enter into
futures contracts or related options that are traded on domestic and foreign
exchanges or boards of trade as well as the over-the-counter market with
respect to options on such futures contracts. A futures contract provides for
the future sale by one party and the purchase by the other party of a certain
amount of specified debt security at a specified price, date, time and place.
The Fund may enter into futures contracts to sell debt securities when SBMFM
believes that the value of the Fund's debt securities will decrease. The Fund
may enter into futures contracts to purchase debt securities when SBMFM antici-
pates purchasing the underlying debt securities on behalf of the Fund and
believes that prices will rise before the purchases will be made. When the Fund
enters into a futures contract to purchase an underlying security, an amount of
cash or other eligible segregated asset equal to the market value of the con-
tract, will be deposited in a segregated account with the Fund's custodian to
collateralize the position, thereby insuring that the use of the contract is
unleveraged. The Fund will not enter into futures contracts for speculation and
will enter into futures contracts that are traded on a domestic or foreign
exchange or board of trade as well as the over-the-counter market.     
 
  An option on a futures contact, as contrasted with the direct investment in a
futures contract, gives the purchaser the right, in return for the premium
paid, to assume a position in a futures contract at a specified exercise price
at any time prior to the expiration date of the option. A call option gives the
purchaser of the option the right to enter into a futures contract to buy and
obliges the writer to enter into a futures contract to sell the underlying debt
securities. A put option gives the purchaser the right to sell and obliges the
writer to buy the underlying contract.
   
  The Fund may purchase put options on futures contracts to hedge its portfolio
of debt securities against the risk of rising interest rates, and may purchase
call options on futures contracts to hedge against a decline in interest rates.
The Fund may write put and call options on futures contracts in entering into
closing sale transactions and to increase its ability to hedge against changes
in interest rates. The Fund will write put and call options on futures con-
tracts that are traded on a domestic or foreign exchange or board of trade as
well as the over-the-counter market.     
 
                                                                              11
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 
  Currency Exchange Transactions and Options on Foreign Currencies. The Fund
will conduct its currency exchange transactions either on a spot (that is,
cash) basis at the rate prevailing in the currency exchange market or through
entering into forward contracts to purchase or sell currencies. The Fund's
dealings in forward currency exchange and options on foreign currencies are
limited to hedging involving either specific transactions or portfolio posi-
tions.
 
  A forward currency contract involves an obligation to purchase or sell a spe-
cific currency for an agreed-upon price at an agreed-upon date which may be any
fixed number of days from the date of the contract agreed upon by the parties.
These contracts are entered into in the interbank market conducted directly
between currency traders (usually large commercial banks) and their customers.
Although these contracts are intended to minimize the risk of loss due to a
decline in the value of the hedged currency, at the same time they tend to
limit any potential gain that might result should the value of the currency
increase.
 
  The Fund may purchase and sell put, call and other types of options on for-
eign currencies that are traded on domestic or foreign exchanges or in the
over-the-counter market, including but not limited to, "spread" options,
"knock-out" options, "knock-in" options and "average rate" or "look-back"
options.
 
  The Fund may purchase put options on a foreign currency in which securities
held by the Fund are denominated to protect against a decline in the value of
the currency in relation to the currency in which the exercise price is denomi-
nated. The Fund may purchase a call option on a foreign currency to hedge
against an adverse exchange rate of the currency in which a security that it
anticipates purchasing is denominated in relation to the currency in which the
exercise price is denominated. An option on a foreign currency gives the pur-
chaser, in return for a premium, the right to sell, in the case of a put, and
buy, in the case of a call, the underlying currency at a specified price during
the term of the option. Although the purchase of an option on a foreign cur-
rency may constitute an effective hedge by the Fund against fluctuations in the
exchange rates, in the event of rate movements adverse to the Fund's position,
the Fund may forfeit the entire amount of the premium plus related transaction
costs. Options on foreign currencies purchased by the Fund may be traded on
domestic and foreign exchanges or traded over-the-counter.
 
 CERTAIN INVESTMENT GUIDELINES
  Up to 15% of the assets of the Fund may be invested in securities with con-
tractual or other restrictions on resale and other instruments that are not
readily marketable, including (a) repurchase agreements with maturities greater
than seven days, (b) time deposits maturing from two business days through
seven calendar days and (c) to the extent that a liquid secondary market does
not exist for the instruments, futures contracts and options on those con-
tracts. Notwithstanding the foregoing, the
 
12
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
Fund shall not invest more than 10% of its net assets in securities (excluding
those subject to Rule 144A under the Securities Act of 1933, as amended) that
are
   
restricted. In addition, the Fund may invest up to 5% of its assets in the
securities of issuers that have been in continuous operation for less than
three years. The Fund also may borrow from banks for temporary or emergency
purposes, but not for investment purposes, in an amount up to 10% of its total
assets, and may pledge its assets to the same extent in connection with such
borrowings. Whenever these borrowings exceed 5% of the value of the Fund's
total assets, the Fund will not make any additional investments. Immediately
after any borrowing (including reverse repurchase agreements and forward roll
transactions) by the Fund, the Fund will maintain an asset coverage of at
least 300% with respect to all of its borrowings. Except for the limitations
on borrowing, the investment guidelines set forth in this paragraph may be
changed at any time without shareholder consent by vote of the Trust's Board
of Trustees. A complete list of investment restrictions that identifies addi-
tional restrictions that cannot be changed without the approval of the major-
ity of the Fund's outstanding shares is contained in the Statement of Addi-
tional Information.     
 
 RISK FACTORS AND SPECIAL CONSIDERATIONS
  Medium-, Low- and Unrated Securities. The Fund may invest in medium- or low-
rated securities and unrated securities of comparable quality. Generally,
these securities offer a higher current yield than the yield offered by high-
er-rated securities but involve greater volatility of price and risk of loss
of income and principal, including the probability of default by or bankruptcy
of the issuers of such securities. Medium- and low-rated and comparable
unrated securities (a) will likely have some quality and protective character-
istics that, in the judgment of the rating organization, are outweighed by
large uncertainties or major risk exposures to adverse conditions and (b) are
predominantly speculative with respect to the issuer's capacity to pay inter-
est and repay principal in accordance with the terms of the obligation. Thus,
it is possible that these types of factors could, in certain instances, reduce
the value of securities held by the Fund with a commensurate effect on the
value of the Fund's shares. Therefore, an investment in the Fund should not be
considered as a complete investment program and may not be appropriate for all
investors.
 
  While the market values of medium- and low-rated and comparable unrated
securities tend to react less to fluctuations in interest rate levels than do
those of higher-rated securities, the market values of certain of these secu-
rities also tend to be more sensitive to individual corporate developments and
changes in economic conditions than higher-rated securities. In addition,
medium- and low-rated and comparable unrated securities generally present a
higher degree of credit risk. Issuers of medium- and low-rated and comparable
unrated securities are often highly leveraged
 
                                                                             13
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
and may not have more traditional methods of financing available to them so
that their ability to service their debt obligations during an economic down-
turn or during sustained periods of rising interest rates may be impaired. The
risk of loss due to default by such issuers is significantly greater because
medium- and low-rated and comparable unrated securities generally are
unsecured and frequently are subordinated to the prior payment of senior
indebtedness. The Fund may incur additional expenses to the extent that it is
required to seek recovery upon a default in the payment of principal or inter-
est on its portfolio holdings. In addition, the markets in which medium- and
low-rated or comparable unrated securities are traded generally are more lim-
ited than those in which higher-rated securities are traded. The existence of
limited markets for these securities may restrict the availability of securi-
ties for the Fund to purchase and also may have the effect of limiting the
ability of the Fund to (a) obtain accurate market quotations for purposes of
valuing securities and calculating net asset value and (b) sell securities at
their fair value either to meet redemption requests or to respond to changes
in the economy or the financial markets. The market for medium- and low-rated
and comparable unrated securities is relatively new and has not fully weath-
ered a major economic recession. Any such recession, however, could likely
disrupt severely the market for such securities and adversely affect the value
of such securities. Any such economic downturn also could adversely affect the
ability of the issuers of such securities to repay principal and pay interest
thereon.
 
  Fixed-income securities, including medium- and low-rated and comparable
unrated securities, frequently have call or buy-back features that permit
their issuers to call or repurchase the securities from their holders, such as
the Fund. If an issuer exercises these rights during periods of declining
interest rates, the Fund may have to replace the security with a lower yield-
ing security, resulting in a decreased return to the Fund.
 
  Securities that are rated Ba by Moody's or BB by S&P have speculative char-
acteristics with respect to capacity to pay interest and repay principal.
Securities that are rated B generally lack characteristics of a desirable
investment and assurance of interest and principal payments over any long
period of time may be small. Securities that are rated Caa or CCC are of poor
standing. These issues may be in default or present elements of danger may
exist with respect to principal or interest.
 
  In light of the risks described above, SBMFM, in evaluating the creditwor-
thiness of an issue, whether rated or unrated, will take various factors into
consideration, which may include, as applicable, the issuer's financial
resources, its sensitivity to economic conditions and trends, the operating
history of and the community support for the facility financed by the issue,
the ability of the issuer's management and regulatory matters.
 
14
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
 
  Securities of Unseasoned Issuers. Securities in which the Fund may invest
may have limited marketability and, therefore, may be subject to wide fluctua-
tions in market value. In addition, certain securities may lack a significant
operating history and be dependent on products or services without an estab-
lished market share.
   
  The Fund's fixed-income security holdings (as rated by S&P) for the fiscal
year ended July 31, 1996 were composed as follows: 0.19 rated BBB or Baa;
8.92% rated BB or Ba; 17.44% rated B or B; 5.73 5% rated CCC or Caa
1.35% rated in non-rated securities; 0.04% in common stocks and 1.64% in
 preferred stocks. The percentages were calculated on a dollar
weighted average basis by determining monthly the percentage of the Fund's net
assets invested in each rating category and does not necessarily indicate what
the composition of the Fund's holdings will be in subsequent years.     
 
  Foreign Securities. There are certain risks involved in investing in securi-
ties of companies and governments of foreign nations that are in addition to
the usual risks inherent in domestic investments. These risks include those
resulting from revaluation of currencies, future adverse political and eco-
nomic developments and the possible imposition of limitations on the repatria-
tion of currencies or other foreign governmental laws or restrictions, reduced
availability of public information concerning issuers and the lack of uniform
accounting, auditing and financial reporting standards or of other regulatory
practices and requirements comparable to those applicable to domestic compa-
nies. The yield of the Fund may be adversely affected by fluctuations in value
of one or more foreign currencies relative to the U.S. dollar. Moreover, secu-
rities of many foreign companies and their markets may be less liquid and
their prices more volatile than those of securities of comparable domestic
companies. In addition, with respect to certain foreign countries, the possi-
bility exists of expropriation, nationalization, confiscatory taxation and
limitations on the use or removal of funds or other assets of the Fund,
including the withholding of dividends. Foreign securities may be subject to
foreign government taxes that could reduce the yield on such securities.
Because the Fund will invest in securities denominated or quoted in currencies
other than the U.S. dollar, changes in foreign currency exchange rates may
adversely affect the value of portfolio securities and the appreciation or
depreciation of investments. Investment in foreign securities also may result
in higher expenses due to the cost of converting foreign currency to U.S. dol-
lars, the payment of fixed brokerage commissions on foreign exchanges, which
generally are higher than commissions on domestic exchanges, the expense of
maintaining securities with foreign custodians, and the imposition of transfer
taxes or transaction charges associated with foreign exchanges.
   
  The Fund may also purchase American Depositary Receipts ("ADRs"), European
Depositary Receipts ("EDRs") and Global Depositary Receipts ("GDRs") or other
securities representing underlying shares of foreign companies. ADRs are pub
    
                                                                             15
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
   
licly traded on exchanges or over-the-counter in the United States and are
issued through "sponsored" or "unsponsored" arrangements. In a sponsored ADR
arrange-ment, the foreign issuer assumes the obligation to pay some or all of
the depositary's transaction fees, whereas under an unsponsored arrangement, the
foreign issuer assumes no obligation and the depositary's transaction fees are
paid by the ADR holders. In addition, less information is available in the
United States about an unsponsored ADR than about a sponsored ADR, and the
financial information about a company may not be as reliable for an unsponsored
ADR as it is for a sponsored ADR. The Fund may invest in ADRs through both
sponsored and unsponsored arrangements.     
 
  Corporate securities in which the Fund may invest include corporate fixed-
income securities of both domestic and foreign issuers, such as bonds, deben-
tures, notes, equipment lease certificates, equipment trust certificates, and
preferred stock. The Fund's investments in each of equipment lease or equip-
ment trust certificates will not exceed 5% of its assets.
 
  Certain of the corporate fixed-income securities in which the Fund may
invest may involve equity characteristics. The Fund may, for example, invest
in warrants for the acquisition of stock of the same or of a different issuer
or in corporate fixed-income securities that have conversion or exchange
rights permitting their holder to convert or exchange the securities at a
stated price within a specified period of time into a specified number of
shares of common stock. In addition, the Fund may invest in participations
that are based on revenues, sales or profits of an issuer or in common stock
offered as a unit with corporate fixed-income securities.
 
  Mortgage-Related Securities. Mortgage-related securities provide a monthly
payment consisting of interest and principal payments. Additional payments may
be made out of unscheduled repayments of principal resulting from the sale of
the underlying residential property, refinancing or foreclosure, net of fees
or costs that may be incurred. Prepayments of principal on mortgage-related
securities may tend to increase due to refinancing of mortgages as interest
rates decline. Mortgage pools created by private organizations generally offer
a higher rate of interest than governmental and government-related pools
because no direct or indirect guarantees of payments are applicable with
respect to the former pools. Timely payment of interest and principal in these
pools, however, may be supported by various forms of private insurance or
guarantees, including individual loan, title, pool and hazard insurance. There
can be no assurance that the private insurers can meet their obligations under
the policies. Prompt payment of principal and interest on GNMA mortgage pass-
through certificates is backed by the full faith and credit of the United
States. FNMA guaranteed mortgage pass-through certificates and FHLMC partici-
pation certificates are solely the obligations of those entities but are sup-
ported by the discretionary authority of the United States government to pur-
chase
 
16
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
the agencies' obligations. Collateralized mortgage obligations are a type of
bond secured by an underlying pool of mortgages or mortgage pass-through cer-
tificates that are structured to direct payments on underlying collateral to
different series or classes of the obligations.
 
  To the extent that the Fund purchases mortgage-related securities at a pre-
mium, 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 Fund's yield may
be affected by reinvestment of prepayments at higher or lower rates than the
original investment. In addition, like other debt securities, the values of
mortgage-related securities, including government and government-related mort-
gage pools, generally will fluctuate in response to market interest rates.
   
  Securities of Developing Countries. A developing country generally is con-
sidered to be a country that is in the initial stages of its industrialization
cycle. Investing in the equity and fixed-income markets of developing coun-
tries involves exposure to economic structures that are generally less diverse
and mature, and to political systems that can be expected to have less stabil-
ity, than those of developed countries. Historical experience indicates that
the markets of developing countries have been more volatile than the markets
of the more mature economies of developed countries; however, such markets
often have provided higher rates of return to investors.     
 
  Non-Publicly Traded and Illiquid Securities. The Fund's sale of securities
that are not publicly traded is typically restricted under the Federal securi-
ties laws. As a result, the Fund may be forced to sell these securities at
less than fair market value or may not be able to sell them when SBMFM
believes it desirable to do so. The Fund's investments in illiquid securities
are subject to the risk that should the Fund desire to sell any of these secu-
rities when a ready buyer is not available at a price that the Fund deems rep-
resentative of their value, the value of the Fund's net assets could be
adversely affected.
 
  Options. Because option premiums paid or received by the Fund are small in
relation to the market value of the investments underlying the options, buying
and selling options can result in large amounts of leverage. The leverage
offered by trading in options may cause the Fund's net asset value to be sub-
ject to more frequent and wider fluctuation than would be the case if the Fund
did not invest in options.
 
  Upon the exercise of a put option written by the Fund, 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
 
                                                                             17
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
call option written by the Fund, 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
exercise price of the option less the premium received for writing the option.
 
  The Fund may engage in a closing purchase transaction to realize a profit, to
prevent an underlying security from being called or put or, in the case of a
call option, to unfreeze and underlying security (thereby permitting its sale
or the writing of a new option on the security prior to the outstanding
option's expiration). To effect a closing purchase transaction, the Fund would
purchase, prior to the holder's exercise of an option that the Fund has writ-
ten, an option of the same series as that on which the Fund desired to termi-
nate its obligation. The obligation of the Fund under an option that it has
written would be terminated by a closing purchase transaction, but the Fund
would not be deemed to own an option as a result of the transaction. No assur-
ance can be given that the Fund will be able to effect closing transactions at
a time when it wishes to do so. If the Fund cannot enter into a closing trans-
action, the Fund may be required to hold a security that it might otherwise
have sold, in which case it would continue to be at market risk on the security
and could face higher transaction costs, including brokerage commissions.
 
  The ability of the Fund to engage in closing transactions with respect to
options depends on the existence of a liquid secondary market. While the Fund
generally will purchase or write options or financial futures only if there
appears to be a liquid secondary market for the options or futures sold or pur-
chased, for some options or futures no such secondary market may exist or the
market may cease to exist.
   
  Futures and Options on Futures. Investments in futures and options on futures
made by the Fund will be made solely for the purpose of hedging against the
effects of changes in the value of its portfolio securities due to anticipated
changes in interest rates and when the transactions are economically appropri-
ate to the reduction of risks inherent in the management of the Fund. In enter-
ing into transactions involving futures contracts and options on futures con-
tracts, the Fund will comply with applicable requirements of the Commodities
Futures Trading Commission (the "CFTC") which require that its transactions on
futures and options be engaged in for "bona fide hedging" purposes or other
permitted purposes, provided that aggregate initial margin deposits and premi-
ums required to establish positions, other than those considered by the CFTC to
be "bona fide hedging," will not exceed 5% of the Fund's net asset value, after
taking into account unrealized profits and unrealized losses on any such con-
tracts.     
 
  The use of futures contracts and options on futures contracts as a hedging
device involves several risks. No assurance can be given that a correlation
will exist between price movements in the underlying securities on the one
hand, and price
 
18
<PAGE>
 
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
 
movements in the securities which are the subject of the hedge, on the other
hand. 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 no assurance can be given that an active market will exist for a par-
ticular contract or option at any particular time. Losses incurred in hedging
transactions and the costs of these transactions will affect the Fund's perfor-
mance.
 
  Foreign Commodity Exchanges. Unlike trading on domestic commodity exchanges,
trading on foreign commodity exchanges is not regulated by the Commodity
Futures Trading Commission and may be subject to greater risks than trading on
domestic exchanges. For example, some foreign exchanges may be principal mar-
kets so that no common clearing facility exists and a trader may look only to
the broker for performance of the contract. In addition, unless the Fund hedges
against fluctuations in the exchange rate between the U.S. dollar and the cur-
rencies in which trading is done on foreign exchanges, any profits that the
Fund might realize in trading could be eliminated by adverse changes in the
exchange rate, or the Fund could incur losses as a result of those changes.
 
  Foreign Currency. Although the foreign currency market may not necessarily be
more volatile than the market in other commodities, the foreign currency market
offers less protection against defaults in the forward trading of currencies
than is available when trading in currencies occurs on an exchange. Because a
forward currency contract is not guaranteed by an exchange or clearing house, a
default on the contract would deprive the Fund of unrealized profits or force
the Fund to cover its commitments for purchase or resale, if any, at the cur-
rent market price.
 
 PORTFOLIO TRANSACTIONS
  Securities and commodities transactions on behalf of the Fund will be exe-
cuted by a number of brokers and dealers, including Smith Barney. The Fund may
use Smith Barney in connection with a purchase or sale of securities when SBMFM
believes that the charge for the transaction does not exceed usual and custom-
ary levels. The Fund also may use Smith Barney as a commodities broker in con-
nection with entering into futures contracts and commodity options. Smith Bar-
ney has agreed to charge the Fund commodity commissions at rates comparable to
those charged by Smith Barney to its most favored clients for comparable trades
in comparable accounts.
 
  In selecting a broker for a transaction, including Smith Barney or its affil-
iates, the primary consideration is prompt and effective execution of orders at
the most favorable price. Subject to that primary consideration, dealers may be
selected for research, statistical or other services to enable SBMFM to supple-
ment its own research and analysis with the views and information of other
securities firms.
 
                                                                              19
<PAGE>
 
VALUATION OF SHARES
 
 
  The net asset value per share of Class Z shares is determined as of the close
of regular trading on the New York Stock Exchange, Inc. (the "NYSE"), on each
day that the NYSE is open, by dividing the value of the Fund's net assets
attributable to Class Z by the number of shares of the Class outstanding. The
per share net asset value of Class Z shares may be higher than those of other
Classes because of the lower expenses attributable to Class Z shares.
 
  Generally, the Fund's investments are valued at market value or, in the
absence of a market value with respect to any securities, at fair value as
determined by or under the direction of the Trust's Board of Trustees. Portfo-
lio securities which are traded primarily on foreign exchanges are generally
valued at the preceding closing values of such securities on their respective
exchanges, except that when an occurrence subsequent to the time a value was so
established is likely to have changed such value, then the fair market value of
those securities will be determined by consideration of other factors by or
under the direction of the Board of Trustees or its delegates. A security that
is traded primarily on an exchange is valued at the last sale price on that
exchange or, if there were no sales during the day, at the current quoted bid
price. Over-the-counter securities are valued on the basis of the bid price at
the close of business on each day. Investments in U.S. government securities
(other than short-term securities) are valued at the average of the quoted bid
and asked prices in the over-the-counter market. Short-term investments that
mature in 60 days or less are valued at amortized cost whenever the Trustees
determine that amortized cost reflects fair value of those investments. An
option generally is valued at the last sale price or, in the absence of the
last sale price, the last offer price. The value of a futures contract equals
the unrealized gain or loss on the contract, which is determined by marking the
contract to the current settlement price for a like contract acquired on the
day on which the futures contract is being valued. A settlement price may not
be used if the market makes a limit move with respect to a particular commodity
or if the underlying securities market experiences significant price fluctua-
tions after the determination of the settlement price. In such event, the
futures contract will be valued at a fair market price to be determined by or
under the direction of the Board of Trustees. Further information regarding the
Trust's valuation policies with respect to the Fund is contained in the State-
ment of Additional Information.
 
DIVIDENDS, DISTRIBUTIONS AND TAXES
 
 
 DIVIDENDS AND DISTRIBUTIONS
  The Fund will be treated separately from the Trust's other funds in determin-
ing the amounts of dividends from investment income and distributions of capi-
tal gains payable to shareholders. Dividends and distributions will be rein-
vested automatically for each shareholder's account at net asset value in addi-
tional Class Z shares
 
20
<PAGE>
 
DIVIDENDS, DISTRIBUTIONS AND TAXES (CONTINUED)
 
of the Fund, unless the shareholder instructs the Fund to pay dividends and
distributions in cash. Dividends from net investment income, if any, of the
Fund will be declared monthly and will be paid on the last Friday of the month.
Distributions of any net long-term capital gains earned by the Fund will be
made annually after the close of the fiscal year in which they are earned. Dis-
tributions of short-term capital gains may be paid more frequently with divi-
dends from net investment income. The Fund is subject to a 4% nondeductible
excise tax measured with respect to certain undistributed amounts of net
investment income and capital gains. If it is in the best interests of share-
holders, the Fund expects to make such additional distributions shortly before
December 31 in each year as may be necessary to avoid the application of this
tax.
   
  If, for any full fiscal year, the Fund's total distributions exceed net
investment income and net realized capital gains, the excess distributions gen-
erally will be treated as a tax-free return of capital (up to the amount of the
shareholder's tax basis in his or her shares). The amount treated as a tax-free
return of capital will reduce a shareholder's adjusted basis in his or her
shares. Pursuant to the requirements of the Investment Company Act of 1940, as
amended (the "1940 Act"), and other applicable laws, a notice will accompany
any distribution paid from sources other than net investment income. In the
event the Fund distributes amounts in excess of its net investment income and
net realized capital gains, such distributions may have the effect of decreas-
ing the Fund's total assets, which may increase the Fund's expense ratio.     
 
 TAXES
   
  The Fund will be treated as a separate taxpayer with the result that, for
Federal income tax purposes, the amount of investment income and capital gains
earned by the Fund will be determined on a fund by fund basis, rather than on a
Trust-wide basis. The Fund has qualified and intends to continue to qualify
each year as a regulated investment company under Subchapter M of the Internal
Revenue Code of 1986, as amended. To meet those requirements, the Fund may need
to restrict the degree to which it engages in short-term trading and transac-
tions in options. If the Fund qualifies as a regulated investment company and
meets certain distribution requirements, the Fund will not be subject to Fed-
eral income tax on its net investment income and net capital gains that it dis-
tributes to its shareholders.     
 
  Dividends paid by the Fund from investment income and distributions of short-
term capital gains will be taxable to shareholders as ordinary income for Fed-
eral income tax purposes, whether received in cash or reinvested in additional
shares. Distributions of long-term capital gain will be taxable to shareholders
as long-term capital gain, whether paid in cash or reinvested in additional
shares, and regardless of the length of time the investor has held his or her
shares of the Fund.
 
                                                                              21
<PAGE>
 
   
DIVIDENDS, DISTRIBUTIONS AND TAXES (CONTINUED)     
 
 
  Income received by the Fund from sources within foreign countries may be sub-
ject to withholding and other foreign taxes. The payment of these taxes will
reduce the amount of dividends and distributions paid to the Fund's sharehold-
ers. Each shareholder of the Fund will receive a statement annually from the
Trust, which will set forth separately the aggregate dollar amount of dividends
and capital gains distributed to the shareholder by the Fund with respect to
the prior calendar year.
 
  Shareholders should consult their plan document or tax advisors about the tax
consequences associated with participating in a Qualified Plan or Smith Barney
UIT.
   
PURCHASE, EXCHANGE AND REDEMPTION OF SHARES     
 
 
  Purchases of the Fund's Class Z shares must be made in accordance with the
terms of a Qualified Plan or Smith Barney UIT. Purchases are effected at the
net asset value next determined after a purchase order is received by Smith
Barney (the "trade date"). Payment is due to Smith Barney on the third business
day (the "settlement date") after the trade date. Investors who make payment
prior to the settlement date may designate a temporary investment (such as a
money market fund of the Smith Barney Mutual Funds) for such payment until set-
tlement date. The Fund reserves the right to reject any purchase order and to
suspend the offering of shares for a period of time. There are no minimum
investment requirements for Class Z shares; however, the Fund reserves the
right to vary this policy at any time.
 
  Purchase orders received by the Fund or Smith Barney prior to the close of
regular trading on the NYSE, currently 4:00 p.m., New York time, on any day
that the Fund's calculates its net asset value, are priced according to the net
asset value determined on that day. See "Valuation of Shares." Certificates for
Fund shares are issued upon request to the Trust's transfer agent.
 
  Shareholders may redeem their shares on any day the Fund calculates its net
asset value. See "Valuation of Shares." Redemption requests received in proper
form prior to the close of regular trading on the NYSE are priced at the net
asset value per share determined on that day. Redemption requests received
after the close of regular trading on the NYSE are priced at the net asset
value as next determined. Shareholders acquiring Class Z shares through a Smith
Barney Qualified Plan or a Smith Barney UIT should consult the terms of their
respective plans for redemption provisions.
   
  Holders of Class Z shares should consult their Qualified Plans for informa-
tion about exchange options.     
       
22
<PAGE>
 
   
PERFORMANCE     
 
 
 YIELD
  From time to time, the Fund advertises the 30 day "yield" of its Class Z
shares. The Fund's yield refers to the income generated by an investment in
the Fund over the 30 day period identified in the advertisement, and is com-
puted by dividing the net investment income per share earned by the Fund with
respect to the Class during the period by the maximum public offering price
per share on the last day of the period. This income is "annualized" by assum-
ing that 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 per-
centage 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 for Class Z shares in advertisements
and/or in other types of sales literature. These figures are based on histori-
cal 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 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 information 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
Class Z shares by annualizing the most recent monthly distribution and divid-
ing by the net asset value on the last day of the period for which current
dividend return is presented. The current dividend return may vary from time
to time depending on market conditions, the composition of its investment
portfolio and operating expenses. These factors and possible differences in
the methods used in calculating current dividend return should be considered
when comparing the Fund's current return to yields published for other invest-
ment companies and other investment vehicles. The Fund may also include com-
parative performance information in advertising or marketing the Class Z
shares. Such performance information may include data from Lipper Analytical
Services, Inc. and other financial publications.
   
  Class Z shares' average annual total return was as follows for the periods
indicated:     
     
  8.72% for the one-year period beginning August 1, 1995 through July 31,
  1996.     
     
  8.13% per annum during the period from commencement of operations (Novem-
  ber 6, 1992) through July 31, 1996.     
 
                                                                             23
<PAGE>
 
   
PERFORMANCE (CONTINUED)     
          
  Class Z shares' aggregate total return was as follows for the periods
indicated:     
     
  8.72% for the one-year period beginning on August 1, 1995 through July 31,
  1996.     
     
  33.92% for the period from commencement of operations (November 6, 1992)
  through July 31, 1996.     
 
MANAGEMENT OF THE TRUST AND THE FUND
 
 
 BOARD OF TRUSTEES
   
  Overall responsibility for management and supervision of the Fund rests with
the Trust's Board of Trustees. The Trustees approve all significant agreements
between the Trust and companies that furnish services to the Trust and the
Fund, including agreements with the Fund's distributor, investment adviser,
sub-investment adviser, administrator, custodian and transfer agent. The day-
to-day operations of the Fund are delegated to the Fund's investment adviser
and administrator and sub-investment adviser. The Statement of Additional
Information contains background information regarding each Trustee and execu-
tive officer of the Trust.     
 
 INVESTMENT ADVISER--SBMFM
   
  SBMFM, located at 388 Greenwich Street, New York, New York 10013, serves as
the Fund's investment adviser. SBMFM is a wholly owned subsidiary of Smith
Barney Holdings Inc. ("Holdings"). Holdings is a wholly owned subsidiary of
Travelers Group Inc. ("Travelers") a diversified financial services holding
company engaged, through its subsidiaries, principally in four business seg-
ments: Investment Services, Consumer Finance Services, Life Insurance Services
and Property & Casualty Insurance Services. SBMFM (through predecessor enti-
ties) has been in the investment counseling business since 1934 and is a reg-
istered investment adviser. SBMFM renders investment advice to investment com-
panies that had aggregate assets under management as of October 31, 1996 in
excess of $79 billion.     
 
  Subject to the supervision and direction of the Trust's Board of Trustees,
SBMFM manages the Fund's portfolio in accordance with the Fund's investment
objective and policies, makes investment decisions for the Fund, places orders
to purchase and sell securities and employs professional portfolio managers
and securities analysts who provide research service to the Fund. For invest-
ment advisory services rendered to the Fund, the Fund pays SBMFM a fee at the
annual rate of 0.45% of the value of the Fund's average daily net assets.
 
  From its fee, SBMFM pays Global Capital Management a fee of 0.10% of the
value of the Fund's average daily net assets for its services as sub-invest-
ment adviser.
 
24
<PAGE>
 
MANAGEMENT OF THE TRUST AND THE FUND (CONTINUED)
 
 
 SUB-INVESTMENT ADVISER--GLOBAL CAPITAL MANAGEMENT
   
  Global Capital Management, located at 10 Piccadilly, London W1V 9LA, United
Kingdom, serves as the Fund's sub-investment adviser pursuant to a sub-invest-
ment advisory agreement dated August 31, 1995. Global Capital Management has
been in the investment counseling business since 1988 and renders advice to
client companies with total assets under management, as of October 31, 1996,
in excess of $2.98 billion.     
 
  In its capacity as a sub-investment adviser, Global Capital Management is
responsible for and selects the Fund's investments in foreign securities and
selects the brokers and dealers that execute the Fund's investments in foreign
securities.
 
 PORTFOLIO MANAGEMENT
  John C. Bianchi and James E. Conroy, both Managing Directors of Smith Bar-
ney, have served as Vice Presidents and Investment Officers of the Fund since
it commenced operations. Along with Victor S. Filatov, an Investment Officer
of the Fund since March 21, 1994 and President of Global Capital Management,
they manage the day-to-day operations of the Fund, including making all domes-
tic investment decisions.
   
  Simon Hildreth, Managing Director of Smith Barney and a member of the
Investment Policy Committee of Global Capital Management serves as an Invest-
ment Officer of the Fund. Mr. Hildreth is responsible for managing the day-to-
day operations of the Fund's investments in foreign securities. Prior to 1994,
Mr. Hildreth was Director of Mercury Asset Management, a fund manager located
in the United Kingdom.     
   
  Management's discussion and analysis, and additional performance information
regarding the Fund during the fiscal year ended July 31, 1996 are included in
the Annual Report dated July 31, 1996. A copy of the Annual Report may be
obtained upon request and without charge from a Smith Barney Financial Consul-
tant or by writing or calling the Fund at the address or phone number listed
on page one of this Prospectus.     
 
 ADMINISTRATOR--SBMFM
  SBMFM also serves as the Fund's administrator and oversees all aspects of
the Fund's administration and operation. For administration services rendered
to the Fund, the Fund pays SBMFM a fee at the annual rate of .20% of the value
of the Fund's average daily net assets.
 
 DISTRIBUTOR--SMITH BARNEY
  Smith Barney is located at 388 Greenwich Street, New York, New York 10013,
and serves as the Fund's distributor. Smith Barney is a wholly owned subsidi-
ary of Travelers.
 
                                                                             25
<PAGE>
 
   
ADDITIONAL INFORMATION     
 
 
  The Trust was organized on March 12, 1985 under the laws of the Commonwealth
of Massachusetts and is a business entity commonly known as a "Massachusetts
business trust."
   
  The Trust offers shares of beneficial interest of separate series having a
par value of $.001 per share. Shares of beneficial interest of the Fund are
currently classified into five Classes--A, B, C, Y and Z. Each Class represents
an identical pro rata interest in the Fund's investment portfolio. As a result,
the Classes have the same rights, privileges and preferences, except with
respect to: (a) the designation of each Class; (b) the effect of the respective
sales charges, if any, for each Class; (c) the distribution and/or service
fees, if any, borne by each Class pursuant to a Plan adopted by the Fund pursu-
ant to Rule 12b-1 under the 1940 Act; (d) the expenses allocable exclusively to
each Class; (e) voting rights on matters exclusively affecting a single Class;
(f) the exchange privilege of each Class; and (g) the conversion feature of the
Class B shares. The Trust's Board of Trustees does not anticipate that there
will be any conflicts among the interests of the holders of different Classes
of shares of the Fund. The Trustees, on an ongoing basis, will consider whether
any such conflict exists and, if so, take appropriate action.     
   
  When matters are submitted for shareholder vote, shareholders of each Class
of each Fund will have one vote for each full share owned and a proportionate,
fractional vote for any fractional share held of that Class. Shares of the
Trust will be voted generally on a Trust-wide basis on all matters except mat-
ters affecting the interests of one Fund or one Class of shares.     
 
  Normally there will be no meetings of shareholders for the purpose of elect-
ing Trustees unless and until such time as less than a majority of the Trustees
holding office have been elected by shareholders. Shareholders of record of no
less than two-thirds of the outstanding shares of the Trust may remove a
Trustee through a declaration in writing or by vote cast in person or by proxy
at a meeting called for that purpose. The Trustees 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.
 
  The Fund sends its shareholders a semi-annual report and an audited annual
report, which include listings of the investment securities held by the Fund at
the end of the period covered. In an effort to reduce the Fund's printing and
mailing costs, the Trust plans to consolidate the mailing of the Fund's semi-
annual and annual reports by household. This consolidation means that a house-
hold having multiple accounts with the identical address of record will receive
a single copy of each report. In addition, the Trust also plans to consolidate
the mailing of the Fund's Prospectus so that a shareholder having multiple
accounts (that is, individual, IRA and/or Self-Employed Retirement Plan
accounts) will receive a single Pro-
 
26
<PAGE>
 
ADDITIONAL INFORMATION (CONTINUED)
   
spectus annually. Shareholders who do not want this consolidation to apply to
their accounts should contact a Smith Barney Financial Consultant or the Fund's
transfer agent, First Data Investor Services Group, Inc. "First Data".     
   
  Morgan Guaranty Trust Company of New York, located at 60 Wall Street, New
York, NY 10260, serves as custodian of the Fund's investments. Effective Decem-
ber 6, 1996, The Chase Manhattan Bank, located at Chase Metrotech Center,
Brooklyn, New York 11245, will serve as custodian of the Fund's investments.
       
  First Data, located at Exchange Place, Boston, Massachusetts 02109, serves as
the Trust's transfer agent.     
 
  Shareholders may seek information regarding the Fund from their Smith Barney
Financial Consultants.
 
                                                                              27
<PAGE>
 
 
                                              SMITH BARNEY

                                              ----------------------------------
                                              A Member of TravelersGroup  [LOGO]
 
 
 
 
 
 
 
 
                                  SMITH BARNEY DIVERSIFIED STRATEGIC INCOME FUND
 
 
                                                            388 Greenwich Street
                                                        New York, New York 10013
                                                                
                                                             FD 01216 11/96     



SMITH BARNEY INCOME FUNDS
PART B

Smith Barney
INCOME FUNDS

388 Greenwich Street
New York, New York 10013
(212) 723-9218


Statement of Additional Information	
November 28, 1996


	This Statement of Additional Information expands upon and supplements 
the information contained in the current Prospectuses of Smith Barney Income 
Funds (the "Trust"), relating to seven investment funds offered by the Trust: 
Smith Barney Convertible Fund (the "Convertible Fund"), Smith Barney 
Diversified Strategic Income Fund (the "Diversified Strategic Income Fund"), 
Smith Barney Exchange Reserve Fund (the "Exchange Reserve Fund"), Smith Barney 
High Income Fund (the "High Income Fund"), Smith Barney Premium Total Return 
Fund (the "Premium Total Return Fund"), Smith Barney Tax-Exempt Income Fund 
(the "Tax-Exempt Income Fund"), and Smith Barney Utilities Fund (the 
"Utilities Fund") (each a "Fund" and together the "Funds"), each dated 
November 28, 1996, as amended or supplemented from time to time (the 
"Prospectuses"), and should be read in conjunction with the Prospectuses. The 
Prospectuses may be obtained from any Smith Barney Financial Consultant or by 
writing or calling the Trust at the address or telephone number set forth 
above. This Statement of Additional Information, although not in itself a 
prospectus, is incorporated by reference into the Prospectuses in its 
entirety.


CONTENTS

	For ease of reference, the same section headings are used in both the 
Prospectuses and this Statement of Additional Information, except where shown 
below:



Management of the Trust and the Funds		 2
Investment Objectives and Management Policies.	 	 8
Purchase of Shares		26
Redemption of Shares		28
Distributor..		29
Valuation of Shares		31
Exchange Privilege		31
Performance Data (See in the Prospectuses "Performance" or "Yield 
Information")		32
Taxes (See in the Prospectuses "Dividends, Distributions and Taxes")	
	37
Additional Information		40
Financial Statements		41
Appendix		A-1


MANAGEMENT OF THE TRUST AND THE FUNDS

The executive officers of the Trust are employees of certain of the 
organizations that provide services to the Trust. These organizations are the 
following:

Name							Service

Smith Barney Inc. 					Distributor
  ("Smith Barney")

PFS Distributors						Distributor to Exchange 
Reserve Fund
  ("PFS")

Smith Barney Mutual Funds Management Inc. 		Investment adviser to 
the Convertible,
  ("SBMFM")						High Income Fund, Diversified
							Strategic Income Fund, Tax-Exempt
							Income Fund, Utilities Fund and
							Exchange Reserve Fund

Smith Barney Strategy Advisers Inc.			Investment adviser to Premium
  ("Strategy Advisers")					Total Return Fund 

Smith Barney Global Capital Management Inc.		Sub-investment adviser 
to Diversified 
  ("Global Capital Management")				Strategic Income 
Fund

Boston Partners Asset Management, L.P.			Sub-investment adviser 
to
  ("Boston Partners")					Premium Total 
Return Fund

SBMFM							Administrator

PNC Bank, National Association				Custodian to 
("PNC Bank")						Convertible, High
							Income Fund, Premium Total
							Return Fund, Tax-Exempt
							 Income	 Fund,
							Utilities Fund and Exchange
							 Reserve Fund

Chase Manhattan Bank of New York* 			Custodian to Diversified 
Strategic 
  ("Chase")						Income Fund

First Data Investors Services Group, Inc.			Transfer Agent
  ("First Data"), a subsidiary of First Data
  Corporation

	These organizations and the functions they perform for the Trust are 
discussed in the Prospectuses and in this Statement of Additional Information. 


Trustees and Executive Officers of the Trust

The Trustees and executive officers of the Trust, together with information as 
to their principal business occupations during the past five years, are shown 
below. The executive officers of the Trust are employees of organizations that 
provide services to the Funds. Each Trustee who is an "interested person" of 
the Trust, as defined in the Investment Company Act of 1940, as amended (the 
"1940 Act"), is indicated by an asterisk. 

Lee Abraham, Trustee (Age 69). Retired; formerly Chairman and Chief Executive 
Officer of Associated Merchandising Corporation, a major retail merchandising 
and sourcing organization. His address is 35 Old Forge Road, Wilton, 
Connecticut 06897.

Antoinette C. Bentley, Trustee (Age 59). Retired; formerly Senior Vice 
President and Associate General Counsel of Crum and Forster, Inc., an 
insurance holding company. Her address is 24 Fowler Road, Far Hills, New 
Jersey 07931.

Allan J. Bloostein, Trustee (Age 66). Consultant; formerly Vice Chairman of 
the Board of and Consultant to The May Department Stores Company; Director of 
Crystal Brands, Inc., Melville Corp. and R.G. Barry Corp. His address is 27 
West 67th Street, New York, New York 10023.

Richard E. Hanson, Jr., Trustee (Age 55). Headmaster, prior to July 1, 1994, 
Headmaster, Lawrence Country Day School-Woodmere Academy, Woodmere, New York; 
prior to July 1, 1990, Headmaster of Woodmere Academy. His address is 2865 
Lenox Road, N.E., Apt. 507, Atlanta, GA  30324-2855.

*Heath B. McLendon, Chairman of the Board and Investment Officer (Age 63). 
Managing Director of Smith Barney, Chairman of the Board of Strategy Advisers 
and President of SBMFM; prior to July 1993, Senior Executive Vice President of 
Shearson Lehman Brothers Inc. ("Shearson Lehman Brothers"), Vice Chairman of 
Asset Management. His address is 388 Greenwich Street, New York, New York 
10013.

Madelon DeVoe Talley, Trustee (Age 64). Author; Governor at Large of the 
National Association of Securities Dealers, Inc. Her address is 876 Park 
Avenue, New York, New York 10021.

Jessica M. Bibliowicz, President (Age 37). Executive Vice President of Smith 
Barney and Chairman of the Board of SBMFM and Director of 12 investment 
companies associated with Smith Barney; Prior to 1994, Director of Sales and 
Marketing for Prudential Mutual Funds; prior to 1990, First Vice President, 
Asset Management Division of Shearson Lehman Brothers. Ms. Bibliowicz serves 
as President of 42 Smith Barney Mutual Funds. Her address is 388 Greenwich 
Street, New York, New York 10013. 

John C. Bianchi, Vice President and Investment Officer (Age 41). Managing 
Director of Smith Barney; prior to July 1993, Managing Director of Shearson 
Lehman Advisors. His address is 388 Greenwich Street, New York, New York 
10013.

James E. Conroy, Vice President and Investment Officer (Age 45). Managing 
Director of Smith Barney; prior to July 1993, Managing Director of Shearson 
Lehman Advisors. His address is 388 Greenwich Street, New York, New York 
10013.

Simon Hildreth, Investment Officer (Age 44). Managing Director of Smith Barney 
and a member of the Investment Policy Committee of Global Capital Mangement, 
prior to 1994, Director of Mercury Asset Management, a fund manager located in 
the United Kingdom.

Jack S. Levande, Vice President and Investment Officer (Age 50). Managing 
Director of Smith Barney; prior to July 1993, Managing Director of Shearson 
Lehman Advisors. His address is 388 Greenwich Street, New York, New York 
10013.

Lawrence T. McDermott, Vice President and Investment Officer (Age 48). 
Managing Director of Smith Barney; prior to July 1993, Managing Director of 
Shearson Lehman Advisors. His address is 388 Greenwich Street, New York, New 
York 10013.

George E. Mueller, Jr., Investment Officer (Age 56). Managing Director of 
Smith Barney; prior to July 1993, Managing Director of Shearson Lehman 
Advisors. His address is 388 Greenwich Street, New York, New York 10013.

Harry Rosenbluth, Investment Officer (Age 40). Principal of Boston Partners; 
prior to 1995, Vice President of The Boston Company Advisors; Senior Vice 
President of The Boston Company Institutional Investors, Inc. His address is 
300 Drake's Landing Road, Greenbrae, California 94904.

Robert E. Swab, Investment Officer (Age 40). Vice President of Smith Barney; 
prior to 1995, Co-Portfolio Manager of Convertible Fund. His address is 388 
Greenwich Street, New York, New York 10013.

Phyllis M. Zahorodny, Vice President and Investment Officer (Age 38). Managing 
Director of Smith Barney; prior to July 1993, Managing Director of Shearson 
Lehman Advisors. Her address is 388 Greenwich Street, New York, New York 
10013.

Lewis E. Daidone, Senior Vice President and Treasurer (Age 39). Managing 
Director and Chief Financial Officer of Smith Barney Mutual Funds; Director 
and Senior Vice President of SBMFM. Mr. Daidone serves as Senior Vice 
President and Treasurer of 42 Smith Barney Mutual Funds. His address is 388 
Greenwich Street, New York, New York 10013.

Christina T. Sydor, Secretary (Age 45). Managing Director of Smith Barney; 
General Counsel and Secretary of SBMFM. Ms. Sydor serves as Secretary of 42 
Smith Barney Mutual Funds. Her address is 388 Greenwich Street, New York, New 
York 10013.

	Each Trustee also serves as a director, trustee and/or general partner 
of certain other mutual funds for which Smith Barney serves as distributor. 
Global Capital Management, SBMFM and Strategy Advisers (the "Advisers") are 
"affiliated persons" of the Trust as defined in the 1940 Act by virtue of 
their positions as investment advisers to the Funds. As of October 31, 1996, 
the Trustees and officers of the Funds, as a group, owned less than 1% of the 
outstanding shares of beneficial interest of each Fund.

	No officer, director or employee of Smith Barney or any Smith Barney 
parent or subsidiary receives any compensation from the Trust for serving as 
an officer or Trustee of the Trust. The Trust pays each Trustee who is not an 
officer, director or employee of Smith Barney or any of their affiliates a fee 
of $17,000 per annum plus $3,250 per meeting attended and reimburses them for 
travel and out-of-pocket expenses. For the fiscal year ended July 31, 1996, 
such travel and out-of-pocket expenses totalled $1,616.47.

	For the fiscal year ended July 31, 1996, the Trustees of the Trust were 
paid the following compensation:



								Aggregate Compensation
				Aggregate Compensation	from the Smith Barney
	Trustee (*)		from the Funds **		Mutual Funds


Lee Abraham (9)				$43,000			       $43,000
Antoinette C. Bentley (9)			  43,000			         
43,000
Allen J. Bloostein (15)			  43,000			         88,000
Richard E. Hanson, Jr. (9)			  43,000			         
43,000
Heath B. McLendon (42)			       0   			             0   
Madelon DeVoe Talley (10)+		  29,250			         54,750

___________________________________
  *	Number of directorships/trusteeships held with other Smith Barney Mutual 
Funds.
**	The aggregate remuneration paid to the Trustees by the Trust for the 
fiscal year ended July 31, 1996 amounted to $     (including 
reimbursement for travel and out-of-pocket expenses).
+	Pursuant to the Trust's deferred compensation plan, the indicated 
Trustee has elected to defer the payment of some or all of her 
compensation.


Investment Advisers, Sub-Investment Adviser and Administrator
Each Adviser serves as investment adviser to one or more Funds pursuant to a 
separate written agreement with the relevant Fund (an "Advisory Agreement"). 
SBMFM serves as investment adviser to its relevant Funds pursuant to a 
transfer of the investment advisory agreement, effective November 7, 1994, 
from its affiliate, Mutual Management Corp. (Mutual Management Corp. and SBMFM 
are both wholly owned subsidiaries of Smith Barney Holdings Inc. ("Holdings"). 
Strategy Advisers is a wholly owned subsidiary of SBMFM and Global Capital 
Management is an indirect wholly owned subsidiary of Holdings. Holdings is a 
wholly owned subsidiary of Travelers Group Inc. The Advisory Agreements were 
most recently approved by the Board of Trustees, including a majority of the 
Trustees who are not "interested persons" of the Trust or the Advisers 
("Independent Trustees"), on August 7, 1996.  SBMFM also serves as 
administrator to each Fund pursuant to a separate written agreement dated May 
4, 1994 (the "Administration Agreement") which was most recently approved by 
the Board of Trustees, including a majority of the Independent Trustees, on 
August 7, 1996. Boston Partners serves as sub-investment adviser to Premium 
Total Return Fund, pursuant to a written agreement dated August 15, 1995, 
which was most recently approved by the Fund's Board of Trustees, including a 
majority of the Independent Trustees on August 7, 1996. Global Capital 
Management also serves as sub-investment adviser to Diversified Strategic 
Income Fund, pursuant to a written agreement dated March 21, 1994 which was 
most recently approved by the Fund's Board of Trustees, including a majority 
of the Independent Trustees, on August 7, 1996. Prior to March 21, 1994, 
Lehman Brothers Global Asset Management Limited ("LBGAM") acted in the 
capacity as the Fund's sub-investment adviser. 

	Certain of the services provided to the Trust by the Advisers and Boston 
Partners are described in the Prospectuses under "Management of the Trust and 
the Fund." Each Adviser, SBMFM, as administrator, and Boston Partners, as 
sub-adviser, pay the salaries of all officers and employees who are employed 
by both it and the Trust, and maintain office facilities for the Trust. In 
addition to those services, SBMFM furnishes the Trust with statistical and 
research data, clerical help and accounting, data processing, bookkeeping, 
internal auditing and legal services and certain other services required by 
the Trust, prepares reports to the Funds' shareholders and prepares tax 
returns, reports to and filings with the Securities and Exchange Commission 
(the "SEC") and state Blue Sky authorities. The Advisers and Boston Partners 
bear all expenses in connection with the performance of their services.

	As compensation for investment advisory services, each Fund pays its 
investment adviser a fee computed daily and paid monthly at the following 
annual rates:




Fund
Investment Advisory 
Fee As a Percentage of 
Average Net Assets


Convertible Fund	
0.50%

Diversified Strategic Income Fund	
0.45%

Exchange Reserve Fund	
0.30%

High Income Fund	
0.50%

Premium Total Return Fund
0.55%

Tax-Exempt Income Fund	
0.40%

Utilities Fund	
0.45%


	For the fiscal years ended July 31, 1994, 1995 and 1996, the Funds paid 
investment advisory fees to their respective Advisers as follows:

Fund					         1994	       1995	   	      1996

Convertible Fund				$    425,505	$   415,666	$     
417,942
Diversified Strategic Income Fund		   8,761,857	11,112,553	  
11,818,108
Exchange Reserve Fund			      622,203	     547,990	       
448,925
High Income Fund				   3,771,643	  3,706,659	    
4,506,352
Premium Total Return Fund			   8,506,930	10,627,086	  
13,381,076
Tax-Exempt Income Fund			   4,561,779	  4,033,479	    
3,771,279
Utilities Fund				 10,896,883	  7,885,332	    8,094,511

	As compensation for administrative services, each Fund pays SBMFM a fee 
computed daily and paid monthly at the annual rate of 0.20% of the Fund's 
average daily net assets.  For the fiscal years ended July 31, 1994, 1995 and 
1996, the Funds paid administrative fees to The Boston Company Advisors, Inc. 
or SBMFM:


				The Boston Company
	Advisors, Inc.	   SBMFM		    SBMFM	    SBMFM
	For the 		For the 			For the Fiscal	For the 
Fiscal
	Period from	Period from		Year from	Year from
	8/1/93 through	5/4/94 through		8/1/94 through	8/1/95 
through
Fund	5/3/94	7/31/94		7/31/95		7/31/96
Convertible Fund			     145,717		    24,485		     166,266	          
167,177
Diversified Strategic Income Fund	  4,289,630		  717,145		  4,938,912	       
5,252,493
Exchange Reserve Fund		$   341,472	 	$  73,330		$   365,327	$        
299,283
High Income Fund			  1,297,678		  210,979		  1,482,663	       
1,802,541
Premium Total Return Fund		$2,639,140		$454,284		$3,930,566	$     
2,299,990
Tax-Exempt Income Fund		  1,971,064		  309,826		  2,016,740	       
1,885,640
Utilities Fund			  4,256,098		  586,961		  3,542,538	       
3,597,560

	For the period ended March 20, 1994, Diversified Strategic Income Fund 
paid LBGAM $1,562,892, in sub-investment advisory fees. For the period from 
March 21, 1994 through July 31, 1994 and the fiscal years ended July 31, 1995 
and 1996, Diversified Strategic Income Fund paid Global Capital Management 
$940,496, $1,234,728 and $2,626,246, respectively, in sub-investment advisory 
fees.

	Each Adviser and SBMFM, as administrator, have agreed that if in any 
fiscal year the aggregate expenses of the Fund that it serves (including fees 
payable pursuant to its Advisory Agreement and Administration Agreement, but 
excluding interest, taxes, brokerage, distribution and service fees and, if 
permitted by the relevant state securities commission, extraordinary expenses) 
exceed the expense limitation of any state having jurisdiction over the Fund, 
the Adviser and SBMFM will, to the extent required by state law, reduce their 
fees by the amount of such excess expenses, such amount to be allocated 
between them in the proportion that their respective fees bear to the 
aggregate of the fees paid by the Fund. Such fee reduction, if any, will be 
estimated and reconciled on a monthly basis. The most restrictive state 
expense limitation applicable to any Fund is 2.5% of the first $30 million of 
the Fund's average daily net assets, 2% of the next $70 million of the average 
daily net assets and 1.5% of the remaining average daily net assets of the 
Fund. No such fee reduction was required for the fiscal years ended July 31, 
1994, 1995 and 1996.

	The Trust bears expenses incurred in its operation, including: taxes, 
interest, brokerage fees and commissions, if any; fees of Trustees who are not 
officers, directors, shareholders or employees of Smith Barney or SBMFM; SEC 
fees and state Blue Sky qualification fees; charges of custodians; transfer 
and dividend disbursing agent fees; certain insurance premiums; outside 
auditing and legal expenses; costs of maintaining corporate existence; costs 
of investor services (including allocated telephone and personnel expenses); 
costs of preparing and printing of prospectuses for regulatory purposes and 
for distribution to existing shareholders; costs of shareholders' reports and 
shareholder meetings; and meetings of the officers or Board of Trustees of the 
Trust.

Counsel and Auditors

	Willkie Farr & Gallagher serves as legal counsel to the Trust. The 
Trustees who are not "interested persons" of the Fund have selected Stroock & 
Stroock & Lavan as their legal counsel. 

	KPMG Peat Marwick LLP, 345 Park Avenue, New York, New York 10154 has 
been selected as the Trust's independent auditor to examine and report on the 
Trust's financial statements and highlights for the fiscal year ending July 
31, 1996. Prior to October 20, 1994, Coopers & Lybrand L.L.P., independent 
accountants, served as auditors of the Trust and rendered an opinion on the 
Trust's financial statements for the fiscal year ended July 31, 1994.

	In the interest of economy and convenience, certificates representing 
shares in the Trust are not physically issued except upon specific request 
made by a shareholder to First Data. First Data maintains a record of each 
shareholder's ownership of Trust shares. Shares do not have cumulative voting 
rights, which means that holders of more than 50% of the shares voting for the 
election of Trustees can elect all of the Trustees. Shares are transferable 
but have no preemptive or subscription rights. Shareholders generally vote by 
Fund, except with respect to the election of Trustees and the selection of 
independent public accountants.

	Massachusetts law provides that, under certain circumstances, 
shareholders could be held personally liable for the obligations of the Trust. 
However, the Trust Agreement disclaims shareholder liability for acts or 
obligations of the Trust and requires that notice of such disclaimer be given 
in each agreement, obligation or instrument entered into or executed by the 
Trust or a Trustee. The Trust Agreement provides for indemnification from the 
Trust's property for all losses and expenses of any shareholder held 
personally liable for the obligations of the Trust. Thus, the risk of a 
shareholder's incurring financial loss on account of shareholder liability is 
limited to circumstances in which the Trust would be unable to meet its 
obligations, a possibility that the Trust's management believes is remote. 
Upon payment of any liability incurred by the Trust, the shareholder paying 
the liability will be entitled to reimbursement from the general assets of the 
Trust. The Trustees intend to conduct the operations of the Trust in such a 
way so as to avoid, as far as possible, ultimate liability of the shareholders 
for liabilities of the Trust. 


INVESTMENT OBJECTIVES AND MANAGEMENT POLICIES

	The Prospectuses discuss the investment objectives of the Funds and the 
policies to be employed to achieve those objectives. This section contains 
supplemental information concerning the types of securities and other 
instruments in which the Funds may invest, the investment policies and 
portfolio strategies that the Funds may utilize and certain risks attendant to 
such investments, policies and strategies.

	U.S. Government Securities (All Funds). United States government 
securities include debt obligations of varying maturities issued or guaranteed 
by the United States government or its agencies or instrumentalities ("U.S. 
government securities"). U.S. government securities include not only direct 
obligations of the United States Treasury, but also securities issued or 
guaranteed by the Federal Housing Administration, Farmers Home Administration, 
Export-Import Bank of the United States, Small Business Administration, 
Government National Mortgage Association ("GNMA"), General Services 
Administration, Central Bank for Cooperatives, Federal Intermediate Credit 
Banks, Federal Land Banks, Federal National Mortgage Association ("FNMA"), 
Maritime Administration, Tennessee Valley Authority, District of Columbia 
Armory Board, Student Loan Marketing Association, International Bank for 
Reconstruction and Development and Resolution Trust Corporation. Certain U.S. 
government securities, such as those issued or guaranteed by GNMA, FNMA and 
Federal Home Loan Mortgage Corporation ("FHLMC"), are mortgage-related 
securities. Because the United States government is not obligated by law to 
provide support to an instrumentality that it sponsors, a Fund will invest in 
obligations issued by such an instrumentality only if its Adviser determines 
that the credit risk with respect to the instrumentality does not make its 
securities unsuitable for investment by the Fund.

	Bank Obligations (All Funds). Domestic commercial banks organized under 
Federal law are supervised and examined by the Comptroller of the Currency and 
are required to be members of the Federal Reserve System and to be insured by 
the Federal Deposit Insurance Corporation (the "FDIC"). Domestic banks 
organized under state law are supervised and examined by state banking 
authorities but are members of the Federal Reserve System only if they elect 
to join. Most state banks are insured by the FDIC (although such insurance may 
not be of material benefit to a Fund, depending upon the principal amount of 
certificates of deposit ("CDs") of each held by the Fund) and are subject to 
Federal examination and to a substantial body of Federal law and regulation. 
As a result of Federal and state laws and regulations, domestic branches of 
domestic banks are, among other things, generally required to maintain 
specified levels of reserves, and are subject to other supervision and 
regulation designed to promote financial soundness.

	Obligations of foreign branches of U.S. banks, such as CDs and time 
deposits ("TDs"), may be general obligations of the parent bank in addition to 
the issuing branch, or may be limited by the terms of a specific obligation 
and governmental regulation. Obligations of foreign branches of U.S. banks and 
foreign banks are subject to different risks than are those of U.S. banks or 
U.S. branches of foreign banks. These risks include foreign economic and 
political developments, foreign governmental restrictions that may adversely 
affect payment of principal and interest on the obligations, foreign exchange 
controls and foreign withholding and other taxes on interest income. Foreign 
branches of U.S. banks are not necessarily subject to the same or similar 
regulatory requirements that apply to U.S. banks, such as mandatory reserve 
requirements, loan limitations and accounting, auditing and financial 
recordkeeping requirements. In addition, less information may be publicly 
available about a foreign branch of a U.S. bank than about a U.S. bank. CDs 
issued by wholly owned Canadian subsidiaries of U.S. banks are guaranteed as 
to repayment of principal and interest, but not as to sovereign risk, by the 
U.S. parent bank. 

	Obligations of U.S. branches of foreign banks may be general obligations 
of the parent bank in addition to the issuing branch, or may be limited by the 
terms of a specific obligation and by Federal and state regulation as well as 
governmental action in the country in which the foreign bank has its head 
office. A U.S. branch of a foreign bank with assets in excess of $1 billion 
may or may not be subject to reserve requirements imposed by the Federal 
Reserve System or by the state in which the branch is located if the branch is 
licensed in that state. In addition, branches licensed by the Comptroller of 
the Currency and branches licensed by certain states ("State Branches") may or 
may not be required to: (a) pledge to the regulator by depositing assets with 
a designated bank within the state, an amount of its assets equal to 5% of its 
total liabilities; and (b) maintain assets within the state in an amount equal 
to a specified percentage of the aggregate amount of liabilities of the 
foreign bank payable at or through all of its agencies or branches within the 
state. The deposits of State Branches may not necessarily be insured by the 
FDIC. In addition, there may be less publicly available information about a 
U.S. branch of a foreign bank than about a U.S. bank.

	In view of the foregoing factors associated with the purchase of CDs and 
TDs issued by foreign banks and foreign branches of U.S. banks, a Fund's 
Adviser will carefully evaluate such investments on a case-by-case basis.

	Exchange Reserve Fund may purchase a CD issued by a bank, savings and 
loan association or other banking institution with less than $1 billion in 
assets (a "Small Issuer CD") so long as the issuer is a member of the FDIC or 
Office of Thrift Supervision and is insured by the Savings Association 
Insurance Fund ("SAIF") and so long as the principal amount of the Small 
Issuer CD is fully insured and is no more than $100,000. Exchange Reserve Fund 
will at any one time hold only one Small Issuer CD from any one issuer. 
Savings and loan associations whose CDs may be purchased by the Funds are 
members of the Federal Home Loan Bank and are insured by the SAIF. As a 
result, such savings and loan associations are subject to regulation and 
examination.

	When-Issued Securities and Delayed-Delivery Transactions (High Income, 
Premium Total Return, Diversified Strategic Income and Tax-Exempt Income 
Funds). To secure an advantageous price or yield, these Funds may purchase 
certain securities on a when-issued basis or purchase or sell securities for 
delayed delivery. A Fund will enter into such transactions for the purpose of 
acquiring portfolio securities and not for the purpose of leverage. Delivery 
of the securities in such cases occurs beyond the normal settlement periods, 
but no payment or delivery is made by a Fund prior to the reciprocal delivery 
or payment by the other party to the transaction. In entering into a 
when-issued or delayed-delivery transaction, a Fund will rely on the other 
party to consummate the transaction and may be disadvantaged if the other 
party fails to do so.

	U.S. government securities and Municipal Securities (as defined below) 
normally are subject to changes in value based upon changes, real or 
anticipated, in the level of interest rates and, although to a lesser extent 
in the case of U.S. government securities, the public's perception of the 
creditworthiness of the issuers. In general, U.S. government securities and 
Municipal Securities tend to appreciate when interest rates decline and 
depreciate when interest rates rise. Purchasing these securities on a 
when-issued or delayed-delivery basis, therefore, can involve the risk that 
the yields available in the market when the delivery takes place may actually 
be higher than those obtained in the transaction itself. Similarly, the sale 
of U.S. government securities for delayed delivery can involve the risk that 
the prices available in the market when the delivery is made may actually be 
higher than those obtained in the transaction itself.

	In the case of the purchase by a Fund of securities on a when-issued or 
delayed-delivery basis, a segregated account in the name of the Fund 
consisting of cash or equity and debt securities of any grade, provided such 
securities have been determined by the adviser to be liquid and unencumbered 
pursuant to guidelines established by the Trustees equal to the amount of the 
when-issued or delayed-delivery commitments will be established at PNC Bank, 
or Chase in the case of Diversified Strategic Income Fund.  For the purpose of 
determining the adequacy of the securities in the accounts, the deposited 
securities will be valued at market or fair value. If the market or fair value 
of the securities declines, additional cash or securities will be placed in 
the account daily so that the value of the account will equal the amount of 
such commitments by the Fund involved. On the settlement date, a Fund will 
meet its obligations from then-available cash flow, the sale of securities 
held in the segregated account, the sale of other securities or, although it 
would not normally expect to do so, from the sale of the securities purchased 
on a when-issued or delayed-delivery basis (which may have a value greater or 
less than the Fund's payment obligations).

	Lending of Portfolio Securities (Premium Total Return, Utilities, 
Convertible, High Income and Diversified Strategic Income Funds). These Funds 
have the ability to lend portfolio securities to brokers, dealers and other 
financial organizations. Such loans, if and when made, may not exceed 20% of a 
Fund's total assets taken at value. A Fund will not lend portfolio securities 
to Smith Barney unless it has applied for and received specific authority to 
do so from the SEC. Loans of portfolio securities will be collateralized by 
cash, letters of credit or U.S. government securities which are maintained at 
all times in an amount at least equal to the current market value of the 
loaned securities. From time to time, a Fund may pay a part of the interest 
earned from the investment of collateral received for securities loaned to the 
borrower and/or a third party which is unaffiliated with the Fund and is 
acting as a "finder".

	By lending its securities, a Fund can increase its income by continuing 
to receive interest on the loaned securities as well as by either investing 
the cash collateral in short-term instruments or obtaining yield in the form 
of interest paid by the borrower when U.S. government securities are used as 
collateral. A Fund will comply with the following conditions whenever its 
portfolio securities are loaned: (a) the Fund must receive at least 100% cash 
collateral or equivalent securities from the borrower; (b) the borrower must 
increase such collateral whenever the market value of the securities loaned 
rises above the level of such collateral; (c) the Fund must be able to 
terminate the loan at any time; (d) the Fund must receive reasonable interest 
on the loan, as well as any dividends, interest or other distributions on the 
loaned securities, and any increase in market value; (e) the Fund may pay only 
reasonable custodian fees in connection with the loan; and (f) voting rights 
on the loaned securities may pass to the borrower; provided, however, that if 
a material event adversely affecting the investment in the loaned securities 
occurs, the Trust's Board of Trustees must terminate the loan and regain the 
right to vote the securities. The risks in lending portfolio securities, as 
with other extensions of secured credit, consist of a possible delay in 
receiving additional collateral or in the recovery of the securities or 
possible loss of rights in the collateral should the borrower fail 
financially. Loans will be made to firms deemed by each Fund's Adviser to be 
of good standing and will not be made unless, in the judgment of the Adviser, 
the consideration to be earned from such loans would justify the risk.

	Options on Securities (Premium Total Return, Convertible, Utilities, 
Diversified Strategic Income and High Income Funds). These Funds may engage in 
transactions in options on securities, which, depending on the Fund, may 
include the writing of covered put options and covered call options, the 
purchase of put and call options and the entry into closing transactions. 

	The principal reason for writing covered call options on securities is 
to attempt to realize, through the receipt of premiums, a greater return than 
would be realized on the securities alone. Diversified Strategic Income Fund, 
however, may engage in option transactions only to hedge against adverse price 
movements in the securities that it holds or may wish to purchase and the 
currencies in which certain portfolio securities may be denominated. In return 
for a premium, the writer of a covered call option forfeits the right to any 
appreciation in the value of the underlying security above the strike price 
for the life of the option (or until a closing purchase transaction can be 
effected). Nevertheless, the call writer retains the risk of a decline in the 
price of the underlying security. Similarly, the principal reason for writing 
covered put options is to realize income in the form of premiums. The writer 
of a covered put option accepts the risk of a decline in the price of the 
underlying security. The size of the premiums that a Fund may receive may be 
adversely affected as new or existing institutions, including other investment 
companies, engage in or increase their option-writing activities.

	Options written by a Fund normally will have expiration dates between 
one and nine months from the date written. The exercise price of the options 
may be below, equal to or above the market values of the underlying securities 
at the times the options are written. In the case of call options, these 
exercise prices are referred to as "in-the-money," "at-the-money" and 
"out-of-the-money," respectively. A Fund with option-writing authority may 
write (a) in-the-money call options when its Adviser expects that the price of 
the underlying security will remain flat or decline moderately during the 
option period, (b) at-the-money call options when its Adviser expects that the 
price of the underlying security will remain flat or advance moderately during 
the option period and (c) out-of-the-money call options when its Adviser 
expects that the price of the underlying security may increase but not above a 
price equal to the sum of the exercise price plus the premiums received from 
writing the call option. In any of the preceding situations, if the market 
price of the underlying security declines and the security is sold at this 
lower price, the amount of any realized loss will be offset wholly or in part 
by the premium received. Out-of-the-money, at-the-money and in-the-money put 
options (the reverse of call options as to the relation of exercise price to 
market price) may be utilized in the same market environments that such call 
options are used in equivalent transactions.

	So long as the obligation of a Fund as the writer of an option 
continues, the Fund may be assigned an exercise notice by the broker-dealer 
through which the option was sold, requiring the Fund to deliver, in the case 
of a call, or take delivery of, in the case of a put, the underlying security 
against payment of the exercise price. This obligation terminates when the 
option expires or the Fund effects a closing purchase transaction. A Fund can 
no longer effect a closing purchase transaction with respect to an option once 
it has been assigned an exercise notice. To secure its obligation to deliver 
the underlying security when it writes a call option, or to pay for the 
underlying security when it writes a put option, a Fund will be required to 
deposit in escrow the underlying security or other assets in accordance with 
the rules of the Options Clearing Corporation (the "Clearing Corporation") or 
similar foreign clearing corporation and of the securities exchange on which 
the option is written.

	The Diversified Strategic Income Fund may purchase and sell put, call 
and other types of option securities that are traded on domestic or foreign 
exchanges or the over-the-counter market including, but not limited to, 
"spread" options, "knock-out" options, "knock-in" options and "average rate" 
or "look-back" options.

	"Spread" options are dependent upon the difference between the price of 
two securities or futures contracts, "Knock-out" options are canceled if the 
price of the underlying asset reaches a trigger level prior to expiration, 
"Knock-in" options only have value if the price of the underlying asset 
reaches a trigger level and, "average rate" or "look-back" options are options 
where at expiration, the option's strike price is set based on either the 
average, maximum or minimum price of the asset over the period of the option.

	The Diversified Strategic Income Fund may utilize up to 15% of its 
assets to purchase options and may do so at or about the same time that it 
purchases the underlying security or at a later time. In purchasing options on 
securities, the Fund will trade only with counterparties of high status in 
terms of credit quality and commitment to the market. 

	An option position may be closed out only where there exists a secondary 
market for an option of the same series on a recognized securities exchange or 
in the over-the-counter market. In light of this fact and current trading 
conditions, the Fund expects to purchase only call or put options issued by 
the Clearing Corporation. The Funds with option-writing authority expect to 
write options only on U.S. securities exchanges, except that the Diversified 
Strategic Income Fund also may write options on foreign exchanges and in the 
over-the-counter market.

	A Fund may realize a profit or loss upon entering into a closing 
transaction. In cases in which a Fund has written an option, it will realize a 
profit if the cost of the closing purchase transaction is less than the 
premium received upon writing the original option and will incur a loss if the 
cost of the closing purchase transaction exceeds the premium received upon 
writing the original option. Similarly, when a Fund has purchased an option 
and engages in a closing sale transaction, whether the Fund realizes a profit 
or loss will depend upon whether the amount received in the closing sale 
transaction is more or less than the premium that the Fund initially paid for 
the original option plus the related transaction costs.

	Although a Fund generally will purchase or write only those options for 
which its Adviser believes there is an active secondary market so as to 
facilitate closing transactions, there is no assurance that sufficient trading 
interest to create a liquid secondary market on a securities exchange will 
exist for any particular option or at any particular time, and for some 
options no such secondary market may exist. A liquid secondary market in an 
option may cease to exist for a variety of reasons. In the past, for example, 
higher than anticipated trading activity or order flow, or other unforeseen 
events, have at times rendered inadequate certain of the facilities of the 
Clearing Corporation and U.S. and foreign securities exchanges and resulted in 
the institution of special procedures, such as trading rotations, restrictions 
on certain types of orders or trading halts or suspensions in one or more 
options. There can be no assurance that similar events, or events that may 
otherwise interfere with the timely execution of customers' orders, will not 
recur. In such event, it might not be possible to effect closing transactions 
in particular options. If as a covered call option writer a Fund is unable to 
effect closing purchase transaction in a secondary market, it will not be able 
to sell the underlying security until the option expires or it delivers the 
underlying security upon exercise.

	Securities exchanges generally have established limitations governing 
the maximum number of calls and puts of each class which may be held or 
written, or exercised within certain time periods, by an investor or group of 
investors acting in concert (regardless of whether the options are written on 
the same or different securities exchanges or are held, written or exercised 
in one or more accounts or through one or more brokers). It is possible that 
the Funds with authority to engage in options transactions and other clients 
of their respective Advisers and certain of their affiliates may be considered 
to be such a group. A securities exchange may order the liquidation of 
positions found to be in violation of these limits and it may impose certain 
other sanctions.

	In the case of options written by a Fund that are deemed covered by 
virtue of the Fund's holding convertible or exchangeable preferred stock or 
debt securities, the time required to convert or exchange and obtain physical 
delivery of the underlying common stocks with respect to which the Fund has 
written options may exceed the time within which the Fund must make delivery 
in accordance with an exercise notice. In these instances, a Fund may purchase 
or borrow temporarily the underlying securities for purposes of physical 
delivery. By so doing, the Fund will not bear any market risk because the Fund 
will have the absolute right to receive from the issuer of the underlying 
security an equal number of shares to replace the borrowed stock, but the Fund 
may incur additional transaction costs or interest expenses in connection with 
any such purchase or borrowing.

	Additional risks exist with respect to certain of the U.S. government 
securities for which a Fund may write covered call options. If a Fund writes 
covered call options on mortgage-backed securities, the securities that it 
holds as cover may, because of scheduled amortization or unscheduled 
prepayments, cease to be sufficient cover. The Fund will compensate for the 
decline in the value of the cover by purchasing an appropriate additional 
amount of those securities.

	Stock Index Options (Premium Total Return and Utilities Funds). The 
Premium Total Return and Utilities Funds may purchase and write put and call 
options on U.S. stock indexes listed on U.S. exchanges for the purpose of 
hedging its portfolio. A stock index fluctuates with changes in the market 
values of the stocks included in the index. Some stock index options are based 
on a broad market index such as the New York Stock Exchange Composite Index or 
a narrower market index such as the Standard & Poor's 100. Indexes also are 
based on an industry or market segment such as the AMEX Oil and Gas Index or 
the Computer and Business Equipment Index.

	Options on stock indexes are similar to options on stock except that (a) 
the expiration cycles of stock index options are monthly, while those of stock 
options currently are quarterly, and (b) the delivery requirements are 
different. Instead of giving the right to take or make delivery of stock at a 
specified price, an option on a stock index gives the holder the right to 
receive a cash "exercise settlement amount" equal to (a) the amount, if any, 
by which the fixed exercise price of the option exceeds (in the case of a put) 
or is less than (in the case of a call) the closing value of the underlying 
index on the date of exercise, multiplied by (b) a fixed "index multiplier". 
Receipt of this cash amount will depend upon the closing level of the stock 
index upon which the option is based being greater than, in the case of a 
call, or less than, in the case of a put, the exercise price of the option. 
The amount of cash received will be equal to such difference between the 
closing price of the index and the exercise price of the option expressed in 
dollars times a specified multiple. The writer of the option is obligated, in 
return for the premium received, to make delivery of this amount. The writer 
may offset its position in stock index options prior to expiration by entering 
into a closing transaction on an exchange or it may let the option expire 
unexercised.

	The effectiveness of purchasing or writing stock index options as a 
hedging technique will depend upon the extent to which price movements in the 
portion of a securities portfolio being hedged correlate with price movements 
of the stock index selected. Because the value of an index option depends upon 
movements in the level of the index rather than the price of a particular 
stock, whether the Premium Total Return and Utilities Funds will realize a 
gain or loss from the purchase or writing of options on an index depends upon 
movements in the level of stock prices in the stock market generally or, in 
the case of certain indexes, in an industry or market segment, rather than 
movements in the price of a particular stock. Accordingly, successful use by a 
Fund of options on stock indexes will be subject to its Adviser's ability to 
predict correctly movements in the direction of the stock market generally or 
of a particular industry. This requires different skills and techniques than 
predicting changes in the prices of individual stocks.

	The Premium Total Return and Utilities Funds will engage in stock index 
options transactions only when determined by their respective Advisers to be 
consistent with the Funds' efforts to control risk. There can be no assurance 
that such judgment will be accurate or that the use of these portfolio 
strategies will be successful. When a Fund writes an option on a stock index, 
the Fund will establish a segregated account with PNC Bank in an amount equal 
to the market value of the option and will maintain the account while the 
option is open.

	Mortgage-Related Securities (Diversified Strategic Income and Exchange 
Reserve Funds). The average maturity of pass-through pools of mortgage-related 
securities varies with the maturities of the underlying mortgage instruments. 
In addition, a pool's stated maturity may be shortened by unscheduled payments 
on the underlying mortgages. Factors affecting mortgage prepayments include 
the level of interest rates, general economic and social conditions, the 
location of the mortgaged property and age of the mortgage. Because prepayment 
rates of individual pools vary widely, it is not possible to accurately 
predict the average life of a particular pool. Common practice is to assume 
that prepayments will result in an average life ranging from 2 to 10 years for 
pools of fixed-rate 30-year mortgages. Pools of mortgages with other 
maturities or different characteristics will have varying average life 
assumptions.

	Mortgage-related securities may be classified as private, governmental 
or government-related, depending on the issuer or guarantor. Private 
mortgage-related securities represent pass-through pools consisting 
principally of conventional residential mortgage loans created by 
non-governmental issuers, such as commercial banks, savings and loan 
associations and private mortgage insurance companies. Governmental 
mortgage-related securities are backed by the full faith and credit of the 
United States. GNMA, the principal guarantor of such securities, is a wholly 
owned United States government corporation within the Department of Housing 
and Urban Development. Government-related mortgage-related securities are not 
backed by the full faith and credit of the United States government. Issuers 
of such securities include FNMA and FHLMC. FNMA is a government-sponsored 
corporation owned entirely by private stockholders, which is subject to 
general regulation by the Secretary of Housing and Urban Development. 
Pass-through securities issued by FNMA are guaranteed as to timely payment of 
principal and interest by FNMA. FHLMC is a corporate instrumentality of the 
United States, the stock of which is owned by the Federal Home Loan Banks. 
Participation certificates representing interests in mortgages from FHLMC's 
national portfolio are guaranteed as to the timely payment of interest and 
ultimate collection of principal by FHLMC.

	Private, U.S. governmental or government-related entities create 
mortgage loan pools offering pass-through investments in addition to those 
described above. The mortgages underlying these securities may be alternative 
mortgage instruments, that is, mortgage instruments whose principal or 
interest payments may vary or whose terms to maturity may be shorter than 
previously customary. As new types of mortgage-related securities are 
developed and offered to investors, Diversified Strategic Income Fund, 
consistent with its investment objective and policies, will consider making 
investments in such new types of securities.

	Currency Transactions (Diversified Strategic Income and High Income 
Funds). The Funds' dealings in forward currency exchange transactions will be 
limited to hedging involving either specific transactions or portfolio 
positions. Transaction hedging is the purchase or sale of forward currency 
contracts with respect to specific receivables or payables of the Fund 
generally arising in connection with the purchase or sale of its securities. 
Position hedging, generally, is the sale of forward currency contracts with 
respect to portfolio security positions denominated or quoted in the currency. 
A Fund may not position hedge with respect to a particular currency to an 
extent greater than the aggregate market value at any time of the security or 
securities held in its portfolio denominated or quoted in or currently 
convertible (such as through exercise of an option or consummation of a 
forward currency contract) into that particular currency. If a Fund enters 
into a transaction hedging or position hedging transaction, it will cover the 
transaction through one or more of the following methods: (a) ownership of the 
underlying currency or an option to purchase such currency; (b) ownership of 
an option to enter into an offsetting forward currency contract; (c) entering 
into a forward contract to purchase currency being sold or to sell currency 
being purchased, provided that such covering contract is itself covered by any 
one of these methods unless the covering contract closes out the first 
contract; or (d) depositing into a segregated account with the custodian or a 
sub-custodian of the Fund cash or readily marketable securities in an amount 
equal to the value of the Fund's total assets committed to the consummation of 
the forward currency contract and not otherwise covered. In the case of 
transaction hedging, any securities placed in the account must be liquid debt 
securities. In any case, if the value of the securities placed in the 
segregated account declines, additional cash or securities will be placed in 
the account so that the value of the account will equal the above amount. 
Hedging transactions may be made from any foreign currency into dollars or 
into other appropriate currencies.

	At or before the maturity of a forward contract, a Fund either may sell 
a portfolio security and make delivery of the currency, or retain the security 
and offset its contractual obligation to deliver the currency by purchasing a 
second contract pursuant to which the relevant Fund will obtain, on the same 
maturity date, the same amount of the currency which it is obligated to 
deliver. If a Fund retains the portfolio security and engages in an offsetting 
transaction, the Fund, at the time of execution of the offsetting transaction, 
will incur a gain or loss to the extent movement has occurred in forward 
contract prices. Should forward prices decline during the period between a 
Fund's entering into a forward contract for the sale of a currency and the 
date that it enters into an offsetting contract for the purchase of the 
currency, the Fund will realize a gain to the extent that the price of the 
currency it has agreed to sell exceeds the price of the currency it has agreed 
to purchase. Should forward prices increase, the Fund will suffer a loss to 
the extent the price of the currency it has agreed to purchase exceeds the 
price of the currency it has agreed to sell.

	The cost to a Fund of engaging in currency transactions varies with 
factors such as the currency involved, the length of the contract period and 
the market conditions then prevailing. Because transactions in currency 
exchange are usually conducted on a principal basis, no fees or commissions 
are involved. The use of forward currency contracts does not eliminate 
fluctuations in the underlying prices of the securities, but it does establish 
a rate of exchange that can be achieved in the future. In addition, although 
forward currency contracts limit the risk of loss due to a decline in the 
value of the hedged currency, at the same time, they limit any potential gain 
that might result should the value of the currency increase.

	If a devaluation is generally anticipated, the Diversified Strategic 
Income and High Income Funds may not be able to contract to sell the currency 
at a price above the devaluation level they anticipate.

	Foreign Currency Options (Diversified Strategic Income Funds) The High 
Income Fund may only purchase put and call options on foreign currencies, 
whereas the Diversified Strategic Income Fund may purchase or write put and 
call options on foreign currencies for the purpose of hedging against changes 
in future currency exchange rates. Foreign currency options generally have 
three, six and nine month expiration cycles. Put options convey the right to 
sell the underlying currency at a price which is anticipated to be higher than 
the spot price of the currency at the time the option expires. Call options 
convey the right to buy the underlying currency at a price which is expected 
to be lower than the spot price of the currency at the time that the option 
expires.

	The Fund may use foreign currency options under the same circumstances 
that it could use forward currency exchange transactions. A decline in the 
dollar value of a foreign currency in which a Fund's securities are 
denominated, for example, will reduce the dollar value of the securities, even 
if their value in the foreign currency remains constant. In order to protect 
against such diminutions in the value of securities that it holds, the Fund 
may purchase put options on the foreign currency. If the value of the currency 
does decline, the Fund will have the right to sell the currency for a fixed 
amount in dollars and will thereby offset, in whole or in part, the adverse 
effect on its securities that otherwise would have resulted. Conversely, if a 
rise in the dollar value of a currency in which securities to be acquired are 
denominated is projected, thereby potentially increasing the cost of the 
securities, the Fund may purchase call options on the particular currency. The 
purchase of these options could offset, at least partially, the effects of the 
adverse movements in exchange rates. The benefit to the Fund derived from 
purchases of foreign currency options, like the benefit derived from other 
types of options, will be reduced by the amount of the premium and related 
transaction costs. In addition, if currency exchange rates do not move in the 
direction or to the extent anticipated, the Fund could sustain losses on 
transactions in foreign currency options that would require it to forego a 
portion or all of the benefits of advantageous changes in the rates.

	Foreign Government Securities (Diversified Strategic Income Fund and 
High Income Fund). Among the foreign government securities in which this Fund 
may invest are those issued by countries with developing economies, which are 
countries in the initial stages of their industrialization cycles. Investing 
in securities of countries with developing economies involves exposure to 
economic structures that are generally less diverse and less mature, and to 
political systems that can be expected to have less stability, than those of 
developed countries. The markets of countries with developing economies 
historically have been more volatile than markets of the more mature economies 
of developed countries, but often have provided higher rates of return to 
investors.

	Municipal Securities (Tax-Exempt Income Fund). Municipal securities 
generally are understood to include debt obligations issued to obtain funds 
for various public purposes, including the construction of a wide range of 
public facilities, refunding of outstanding obligations, payment of general 
operating expenses and extensions of loans to public institutions and 
facilities ("Municipal Securities"). Private activity bonds that are issued by 
or on behalf of public authorities to finance privately operated facilities 
are considered to be Municipal Securities if the interest paid thereon 
qualifies as excluded from gross income (but not necessarily from alternative 
minimum taxable income) for Federal income tax purposes in the opinion of bond 
counsel to the issuer.

	Municipal bonds may be issued to finance life care facilities. Life care 
facilities are an alternative form of long-term housing for the elderly which 
offer residents the independence of condominium life style and, if needed, the 
comprehensive care of nursing home services. Bonds to finance these facilities 
have been issued by various state industrial development authorities. Because 
the bonds are secured only by the revenues of each facility and not by state 
or local government tax payments, they are subject to a wide variety of risks, 
including a drop in occupancy levels, the difficulty of maintaining adequate 
financial reserves to secure estimated actuarial liabilities, the possibility 
of regulatory cost restrictions applied to health care delivery and 
competition from alternative health care or conventional housing facilities.

	Municipal leases are Municipal Securities that may take the form of a 
lease or an installment purchase contract issued by state and local 
governmental authorities to obtain funds to acquire a wide variety of 
equipment and facilities such as fire and sanitation vehicles, computer 
equipment and other capital assets. These obligations have evolved to make it 
possible for state and local government authorities to acquire property and 
equipment without meeting constitutional and statutory requirements for the 
issuance of debt. Thus, municipal leases have special risks not normally 
associated with municipal bonds. These obligations frequently contain 
"non-appropriation" clauses providing that the governmental issuer of the 
obligation has no obligation to make future payments under the lease or 
contract unless money is appropriated for such purposes by the legislative 
body on a yearly or other periodic basis. In addition to the 
"non-appropriation" risk, municipal leases represent a type of financing that 
has not yet developed the depth of marketability associated with municipal 
bonds; moreover, although the obligations will be secured by the leased 
equipment, the disposition of the equipment in the event of foreclosure might 
prove to be difficult. In order to limit the risks, Tax-Exempt Income Fund 
proposes to purchase either (a) municipal leases rated in the four highest 
categories by Moody's Investors Service, Inc. ("Moody's") or Standard & Poor's 
Ratings Group ("S&P") or (b) unrated municipal leases purchased principally 
from domestic banks or other responsible third parties which enter into an 
agreement with the Fund providing the seller will either remarket or 
repurchase the municipal lease within a short period after demand by the Fund.

	Temporary Investments (Tax-Exempt Income Fund). When the Tax-Exempt 
Income Fund is maintaining a defensive position, the Fund may invest in 
short-term investments ("Temporary Investments") consisting of: (a) the 
following tax-exempt securities: (i) tax-exempt notes of municipal issuers 
having, at the time of purchase, a rating of MIG 1 through MIG 4 by Moody's or 
rated SP-1 or SP-2 by S&P or, if not rated, of issuers having an issue of 
outstanding Municipal Securities rated within the four highest grades by 
Moody's or S&P; (ii) tax-exempt commercial paper having, at the time of 
purchase, a rating not lower than A-2 by S&P or Prime-2 by Moody's; and (iii) 
variable rate demand notes rated at the time of purchase within the two 
highest ratings by any major rating service or determined to be of comparable 
quality to instruments with such rating; and (b) the following taxable 
securities: (i) U.S. government securities, including repurchase agreements 
with respect to such securities; (ii) other debt securities rated within the 
four highest grades by Moody's or S&P; (iii) commercial paper rated in the 
highest grade by either of these rating services; and (iv) certificates of 
deposit of domestic banks with assets of $1 billion or more. Among the 
tax-exempt notes in which the Fund may invest are Tax Anticipation Notes, Bond 
Anticipation Notes and Revenue Anticipation Notes which are issued in 
anticipation of receipt of tax funds, proceeds of bond placements or other 
revenues, respectively. At no time will more than 20% of the Fund's total 
assets be invested in Temporary Investments unless the Fund has adopted a 
defensive investment policy in anticipation of a market decline. The Fund 
intends, however, to purchase tax-exempt Temporary Investments pending the 
investment of the proceeds of the sale of shares of the Fund and of its 
portfolio securities, or in order to have highly liquid securities available 
to meet anticipated redemptions.

	Investing in Utilities (Utilities Fund). Each of the risks referred to 
in Utilities Fund's Prospectus could adversely affect the ability and 
inclination of public utilities to declare or pay dividends and the ability of 
holders of common stock to realize any value from the assets of the issuer 
upon liquidation or bankruptcy. Moreover, price disparities within selected 
utility groups and discrepancies in relation to averages and indices have 
occurred frequently for reasons not directly related to the general movements 
or price trends of utility common stocks. Causes of these discrepancies 
include changes in the overall demand for and supply of various securities 
(including the potentially depressing effect of new stock offerings), and 
changes in investment objectives, market expectations or cash requirements of 
other purchasers and sellers of securities.

	Ratings as Investment Criteria (All Funds). In general, the ratings of 
nationally recognized statistical rating organizations ("NRSROs") represent 
the opinions of these agencies as to the quality of securities that they rate. 
Such ratings, however, are relative and subjective, and are not absolute 
standards of quality and do not evaluate the market value risk of the 
securities. These ratings will be used by the Funds as initial criteria for 
the selection of portfolio securities, but the Funds also will rely upon the 
independent advice of their respective Advisers to evaluate potential 
investments. Among the factors that will be considered are the long-term 
ability of the issuer to pay principal and interest and general economic 
trends. The Appendix to this Statement of Additional Information contains 
further information concerning the rating categories of NRSROs and their 
significance.

	Subsequent to its purchase by a Fund, an issue of securities may cease 
to be rated or its rating may be reduced below the minimum required for 
purchase by the Fund. In addition, it is possible that an NRSRO might not 
change its rating of a particular issue to reflect subsequent events. None of 
these events will require sale of such securities by a Fund, but the Fund's 
Adviser will consider such events in its determination of whether the Fund 
should continue to hold the securities. In addition, to the extent that the 
ratings change as a result of changes in such organizations or their rating 
systems, or due to a corporate reorganization, a Fund will attempt to use 
comparable ratings as standards for its investments in accordance with its 
investment objective and policies.

	Futures Activities (Diversified Strategic Income, High Income, Utilities 
and Tax-Exempt Income Funds). These Funds may enter into futures contracts 
and/or options on futures contracts that are traded on a United States 
exchange or board of trade. These investments may be made by a Fund solely for 
the purpose of hedging against the effects of changes in the value of its 
portfolio securities due to anticipated changes in interest rates, currency 
values and/or market conditions, and not for purposes of speculation. In the 
case of Tax-Exempt Income Fund, investments in futures contracts will be made 
only in unusual circumstances, such as when the Fund's Adviser anticipates an 
extreme change in interest rates or market conditions. See "Taxes" below.

	Futures Contracts. The purpose of the acquisition or sale of a futures 
contract by a Fund is to mitigate the effects of fluctuations in interest 
rates or currency or market values, depending on the type of contract, on 
securities or their values without actually buying or selling the securities. 
For example, if Tax-Exempt Income Fund owns long-term bonds and tax-exempt 
rates are expected to increase, the Fund might enter into a short position in 
municipal bond index futures contracts. Such a sale would have much the same 
effect as the Fund's selling some of the long-term bonds in its portfolio. If 
tax-exempt rates increase as anticipated, the value of certain long-term 
Municipal Securities in the Fund would decline, but the value of the Fund's 
futures contracts would increase at approximately the same rate, thereby 
keeping the net asset value of the Fund from declining as much as it otherwise 
would have. Of course, because the value of portfolio securities will far 
exceed the value of the futures contracts sold by a Fund, an increase in the 
value of the futures contracts could only mitigate -- but not totally offset 
-- the decline in the value of the Fund.

	The Diversified Strategic Income Fund may enter into futures contracts 
or related options on futures contracts that are traded on a domestic or 
foreign exchange or in the over-the-counter market. These investments may be 
made solely for the purpose of hedging against changes in the value of its 
portfolio securities due to anticipated changes in interest rates, currency 
values and/or market conditions when the transactions are economically 
appropriate to the reduction of risks inherent in the management of the Fund 
and not for purposes of speculation. The ability of the Fund to trade in 
futures contracts may be limited by the requirements of the Internal Revenue 
Code of 1986 as amended (the "Code"), applicable to a regulated investment 
company. 

	No consideration is paid or received by a Fund upon entering into a 
futures contract. Initially, a Fund will be required to deposit with its 
custodian an amount of cash or cash equivalents equal to approximately 1% to 
10% of the contract amount (this amount is subject to change by the board of 
trade on which the contract is traded and members of such board of trade may 
charge a higher amount). This amount, known as initial margin, is in the 
nature of a performance bond or good faith deposit on the contract and is 
returned to a Fund upon termination of the futures contract, assuming that all 
contractual obligations have been satisfied. Subsequent payments, known as 
variation margin, to and from the broker, will be made daily as the price of 
the securities, currency or index underlying the futures contract fluctuates, 
making the long and short positions in the futures contract more or less 
valuable, a process known as "marking-to-market". At any time prior to 
expiration of a futures contract, a Fund may elect to close the position by 
taking an opposite position, which will operate to terminate the Fund's 
existing position in the contract.

	Several risks are associated with the use of futures contracts as a 
hedging device. Successful use of futures contracts by a Fund is subject to 
the ability of its Adviser to predict correctly movements in interest rates, 
stock or bond indices or foreign currency values. These predictions involve 
skills and techniques that may be different from those involved in the 
management of the portfolio being hedged. In addition, there can be no 
assurance that there will be a correlation between movements in the price of 
the underlying securities, currency or index and movements in the price of the 
securities which are the subject of the hedge. 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 or currency values.

	Although the Funds with authority to engage in futures activity intend 
to enter into futures contracts only if there is an active market for such 
contracts, there is no assurance that an active market will exist for the 
contracts at any particular time. Most futures exchanges and boards of trade 
limit the amount of fluctuation permitted in futures contract prices during a 
single trading day. Once the daily limit has been reached in a particular 
contract, no trades may be made that day at a price beyond that limit. It is 
possible that futures contract prices could move to the daily limit for 
several consecutive trading days with little or no trading, thereby preventing 
prompt liquidation of futures positions and subjecting some futures traders to 
substantial losses. In such event, and in the event of adverse price 
movements, a Fund would be required to make daily cash payments of variation 
margin, and an increase in the value of the portion of the portfolio being 
hedged, if any, may partially or completely offset losses on the futures 
contract. As described above, however, there is no guarantee that the price of 
the securities being hedged will, in fact, correlate with the price movements 
in a futures contract and thus provide an offset to losses on the futures 
contract.

	If a Fund has hedged against the possibility of a change in interest 
rates or currency or market values adversely affecting the value of securities 
held in its portfolio and rates or currency or market values move in a 
direction opposite to that which the Fund has anticipated, the Fund will lose 
part or all of the benefit of the increased value of securities which it has 
hedged because it will have offsetting losses in its futures positions. In 
addition, in such situations, if the Fund had insufficient cash, it may have 
to sell securities to meet daily variation margin requirements at a time when 
it may be disadvantageous to do so. These sales of securities may, but will 
not necessarily, be at increased prices which reflect the change in interest 
rates or currency values, as the case may be.

	Options on Futures Contracts. An option on an interest rate futures 
contract, as contrasted with the direct investment in such a contract, gives 
the purchaser the right, in return for the premium paid, to assume a position 
in the underlying interest rate futures contract at a specified exercise price 
at any time prior to the expiration date of the option. An option on a foreign 
currency futures contract, as contrasted with the direct investment in such a 
contract, gives the purchaser the right, but not the obligation, to assume a 
long or short position in the relevant underlying future currency at a 
predetermined exercise price at a time in the future. Upon exercise of an 
option, the delivery of the futures position by the writer of the option to 
the holder of the option will be accompanied by delivery of the accumulated 
balance in the writer's futures margin account, which represents the amount by 
which the market price of the futures contract exceeds, in the case of a call, 
or is less than, in the case of a put, the exercise price of the option on the 
futures contract. The potential for loss related to the purchase of an option 
on futures contracts is limited to the premium paid for the option (plus 
transaction costs). Because the value of the option is fixed at the point of 
sale, there are no daily cash payments to reflect changes in the value of the 
underlying contract; however, the value of the option does change daily and 
that change would be reflected in the net asset value of a Fund investing in 
the option.

	Several risks are associated with options on futures contracts. The 
ability to establish and close out positions on such options will be subject 
to the existence of a liquid market. In addition, the purchase of put or call 
options on interest rate and foreign currency futures will be based upon 
predictions by a Fund's Adviser as to anticipated trends in interest rates and 
currency values, as the case may be, which could prove to be incorrect. Even 
if the expectations of an Adviser are correct, there may be an imperfect 
correlation between the change in the value of the options and of the 
portfolio securities or the currencies being hedged.

	Foreign Investments. Investors should recognize that investing in 
foreign companies involves certain considerations which are not typically 
associated with investing in U.S. issuers. Since the Fund will be investing in 
securities denominated in currencies other than the U.S. dollar, and since the 
Fund may temporarily hold funds in bank deposits or other money market 
investments denominated in foreign currencies, the Fund may be affected 
favorably or unfavorably by exchange control regulations or changes in the 
exchange rate between such currencies and the dollar. A change in the value of 
a foreign currency relative to the U.S. dollar will result in a corresponding 
change in the dollar value of the Fund's assets denominated in that foreign 
currency. Changes in foreign currency exchange rates may also affect the value 
of dividends and interest earned, gains and losses realized on the sale of 
securities and net investment income and gain, if any, to be distributed to 
shareholders by the Fund.

	The rate of exchange between the U.S. dollar and other currencies is 
determined by the forces of supply and demand in the foreign exchange markets. 
Changes in the exchange rate may result over time from the interaction of many 
factors directly or indirectly affecting economic conditions and political 
developments in other countries. Of particular importance are rates of 
inflation, interest rate levels, the balance of payments and the extent of 
government surpluses or deficits in the Unites States and the particular 
foreign country, all of which are in turn sensitive to the monetary, fiscal 
and trade policies pursued by the governments of the United States and other 
foreign countries important to international trade and finance. Governmental 
intervention may also play a significant role. National governments rarely 
voluntarily allow their currencies to float freely in response to economic 
forces. Sovereign governments use a variety of techniques, such as 
intervention by a country's central bank or imposition of regulatory controls 
or taxes, to affect the exchange rates of their currencies.

	Many of the securities held by the Fund will not be registered with, nor 
the issuers thereof be subject to reporting requirements of, the SEC. 
Accordingly, there may be less publicly available information about the 
securities and about the foreign company or government issuing them than is 
available about a domestic company or government entity. Foreign issuers are 
generally not subject to uniform financial reporting standards, practices and 
requirements comparable to those applicable to U.S. issuers. In addition, with 
respect to some foreign countries, there is the possibility of expropriation 
or confiscatory taxation, limitations on the removal of funds or other assets 
of the Fund, political or social instability, or domestic developments which 
could affect U.S. investments in those countries. Moreover, individual foreign 
economies may differ favorably or unfavorably from the U.S. economy in such 
respects as growth of gross national product, rate of inflation, capital 
reinvestment, resource self-sufficiency and balance of payments positions. The 
Fund may invest in securities of foreign governments (or agencies or 
instrumentalities thereof), and many, if not all, of the foregoing 
considerations apply to such investments as well.

	Securities of some foreign companies are less liquid and their prices 
are more volatile than securities of comparable domestic companies. Certain 
foreign countries are known to experience long delays between the trade and 
settlement dates of securities purchased or sold. Due to the increased 
exposure to the Fund of market and foreign exchange fluctuations brought about 
by such delays, and due to the corresponding negative impact on Fund 
liquidity, the Fund will avoid investing in countries which are known to 
experience settlement delays which may expose the Fund to unreasonable risk of 
loss.

	The interest payable on the Fund's foreign securities may be subject to 
foreign withholding taxes, and while investors may be able to claim some 
credit or deductions for such taxes with respect to their allocated shares of 
such foreign tax payments, the general effect of these taxes will be to reduce 
the Fund's income. Additionally, the operating expenses of the Fund can be 
expected to be higher than those of an investment company investing 
exclusively in U.S. securities, since the expenses of the Fund, such as 
custodial costs, valuation costs and communication costs, as well as the rate 
of the investment advisory fees, though similar to such expenses of some other 
international funds, are higher than those costs incurred by other investment 
companies.

	The Fund may also purchase American Depository Receipts ("ADRs"), 
European Depository Receipts ("EDRs") and Global Depository Receipts ("GDRs") 
or other securities representing underlying shares of foreign companies.  ADRs 
are publicly traded on exchanges or over-the-counter in the United States and 
are issued through "sponsored" or "unsponsored" arrangements.  In a sponsored 
ADR arrangement, the foreign issuer assumes the obligation to pay some or all 
of the depository's transaction fees, whereas under an unsponsored 
arrangement, the foreign issuer assumes no obligation and the depository's 
transaction fees are paid by the ADR holders.  In addition, less information 
is available in the United States about an unsponsored ADR than about a 
sponsored ADR, and the financial information about a company may not be as 
reliable for an unsponsored ADR as it is for a sponsored ADR.  The Fund may 
invest in ADRs through both sponsored and unsponsored arrangements.

	Short Sales (Utilities Fund). Utilities Fund may from time to time sell 
securities short, but the value of securities sold short will not exceed 5% of 
the value of the Fund's assets. In addition, the Fund may not (a) sell short 
the securities of a single issuer to the extent of more than 2% of the value 
of the Fund's net assets and (b) sell short the securities of any class of an 
issuer to the extent of more than 2% of the outstanding securities of the 
class at the time of the transaction. A short sale is a transaction in which 
the Fund sells securities that it does not own (but has borrowed) in 
anticipation of a decline in the market price of the securities.

	When the Fund makes a short sale, the proceeds it receives from the sale 
are retained by a broker until the Fund replaces the borrowed securities. To 
deliver the securities to the buyer, the Fund must arrange through a broker to 
borrow the securities and, in so doing, the Fund becomes obligated to replace 
the securities borrowed at their market price at the time of replacement, 
whatever that price may be. The Fund may have to pay a premium to borrow the 
securities and must pay any dividends or interest payable on the securities 
until they are replaced.

	The Fund's obligation to replace the securities borrowed in connection 
with a short sale will be secured by collateral deposited with the broker that 
consists of cash or U.S. government securities. In addition, the Fund will 
place in a segregated account with its custodian an amount of cash or U.S. 
government securities equal to the difference, if any, between (a) the market 
value of the securities sold at the time they were sold short and (b) any cash 
or U.S. government securities deposited as collateral with the broker in 
connection with the short sale (not including the proceeds of the short sale). 
Until it replaces the borrowed securities, the Fund will maintain the 
segregated account daily at a level so that the amount deposited in the 
account plus the amount deposited with the broker (not including the proceeds 
from the short sale) (a) will equal the current market value of the securities 
sold short and (b) will not be less than the market value of the securities at 
the time they were sold short. 

	Short Sales Against the Box (Premium Total Return, Convertible and 
Utilities Funds). These Funds may enter into a short sale of common stock such 
that when the short position is open the Fund involved owns an equal amount of 
preferred stocks or debt securities, convertible or exchangeable without 
payment of further consideration, into an equal number of shares of the common 
stock sold short. This kind of short sale, which is described as "against the 
box", will be entered into by a Fund for the purpose of receiving a portion of 
the interest earned by the executing broker from the proceeds of the sale. The 
proceeds of the sale will be held by the broker until the settlement date when 
the Fund delivers the convertible securities to close out its short position. 
Although prior to delivery a Fund will have to pay an amount equal to any 
dividends paid on the common stock sold short, the Fund will receive the 
dividends from the preferred stock or interest from the debt securities 
convertible into the stock sold short, plus a portion of the interest earned 
from the proceeds of the short sale. The Funds will deposit, in a segregated 
account with their custodian, convertible preferred stock or convertible debt 
securities in connection with short sales against the box.




Investment Restrictions

The investment restrictions numbered 1 through 14 below (other than 
restriction number 10 as applied to Utilities Fund) have been adopted by the 
Trust with respect to the Funds as fundamental policies. Under the 1940 Act, a 
fundamental policy may not be changed without the vote of a majority of the 
outstanding voting securities of a Fund, as defined in the 1940 Act. Majority 
is defined in the 1940 Act as the lesser of (a) 67% or more of the shares 
present at a shareholder meeting, if the holders of more than 50% of the 
outstanding shares of the Trust are present or represented by proxy, or (b) 
more than 50% of the outstanding shares. Investment restrictions 15 through 
20, and number 10 as applied to Utilities Fund, may be changed by vote of a 
majority of the Board of Trustees at any time.

	The investment policies adopted by the Trust prohibit a Fund from:

	1.  Purchasing the securities of any issuer (other than U.S. 
government securities) if as a result more than 5% of the value of 
the Fund's total assets would be invested in the securities of the 
issuer, except that up to 25% of the value of the Fund's total 
assets may be invested without regard to this 5% limitation.

	2.  Purchasing (a) more than 10% of the voting securities of any 
one issuer, (b) more than 10% of the securities of any class of 
any one issuer or (c) more than 10% of the outstanding debt 
securities of any one issuer, except that limitation (c) does not 
apply to the Exchange Reserve and Diversified Strategic Income 
Funds and limitations (b) and (c) do not apply to the Utilities 
Fund; provided that this limitation shall not apply to investment 
in U.S. government securities.

	3.  Purchasing securities on margin, except that the Fund may 
obtain any short-term credits necessary for the clearance of 
purchases and sales of securities. For purposes of this 
restriction, the deposit or payment of initial or variation margin 
in connection with futures contracts or related options will not 
be deemed to be a purchase of securities on margin by any Fund 
permitted to engage in transactions in futures contracts or 
related options.

	4.  Making short sales of securities or maintaining a short 
position except that (a) the Premium Total Return, Utilities and 
Convertible Funds may engage in such activities if, at all times 
when a short position is open, the relevant Fund owns an equal 
amount of the securities convertible into or exchangeable, without 
payment of any further consideration, for securities of the same 
issuer as, and at least equal in amount to, the securities sold 
short, and if, with respect to the Premium Total Return and 
Convertible Funds, not more than 10% of the relevant Fund's net 
assets (taken at current value) is held as collateral for such 
sales at any one time and (b) Utilities Fund may make short sales 
or maintain a short position to the extent of 5% of its net 
assets.

	5.  Borrowing money, except that (a) the Fund may borrow from 
banks for temporary or emergency (not leveraging) purposes, 
including the meeting of redemption requests that might otherwise 
require the untimely disposition of securities, in an amount not 
exceeding 10% (20% for Utilities Fund) of the value of the Fund's 
total assets (including the amount borrowed) valued at market less 
liabilities (not including the amount borrowed) at the time the 
borrowing is made, (b) Diversified Strategic Income Fund may enter 
into reverse repurchase agreements and forward roll transactions 
and (c) one or more Funds may enter into futures contracts. Except 
for Diversified Strategic Income Fund, whenever borrowings 
described in (a) exceed 5% of the value of a Fund's total assets, 
the Fund will not make any additional investments. Immediately 
after any borrowing (including reverse repurchase agreements and 
forward roll transactions), Diversified Strategic Income Fund will 
maintain an asset coverage of at least 300% with respect to all 
its borrowings.

	6.  Pledging, hypothecating, mortgaging or otherwise encumbering 
more than 10% of the value of the Fund's total assets. For 
purposes of this restriction, (a) the deposit of assets in escrow 
in connection with the writing of covered put or call options and 
the purchase of securities on a when-issued or delayed-delivery 
basis and (b) collateral arrangements with respect to (i) the 
purchase and sale of stock options, options on foreign currencies 
and options on stock indexes and (ii) initial or variation margin 
for futures contracts, will not be deemed to be pledges of a 
Fund's assets.

	7.  Underwriting the securities of other issuers, except insofar 
as the Fund may be deemed an underwriter under the Securities Act 
of 1933, as amended, by virtue of disposing of portfolio 
securities.

	8.  Purchasing or selling real estate or interests in real estate, 
except that the Fund may purchase and sell securities that are 
secured by real estate and may purchase securities issued by 
companies that invest or deal in real estate.

	9.  Investing in commodities, except that (a) the High Income, 
Diversified Strategic Income, Utilities and Tax-Exempt Income 
Funds may invest in futures contracts and options on futures 
contracts as described in their Prospectuses and (b) upon 60 days' 
notice given to its shareholders, the Premium Total Return and 
Convertible Funds may engage in hedging transactions involving 
futures contracts and related options, including stock index 
futures contracts and financial futures contracts.

	10.  Investing in oil, gas or other mineral exploration or 
development programs, except that the Premium Total Return, 
Convertible, Diversified Strategic Income, Utilities and High 
Income Funds may invest in the securities of companies that invest 
in or sponsor those programs.

	11.  Making loans to others, except through the purchase of 
qualified debt obligations, the entry into repurchase agreements 
and, with respect to Funds other than the Exchange Reserve Fund, 
loans of portfolio securities consistent with the Fund's 
investment objective. 

	12.  Investing in securities of other investment companies 
registered or required to be registered under the 1940 Act, except 
as they may be acquired as part of a merger, consolidation, 
reorganization, acquisition of assets or an offer of exchange.

	13.  Purchasing any securities which would cause more than 25% of 
the value of the Fund's total assets at the time of purchase to be 
invested in the securities of issuers conducting their principal 
business activities in the same industry, except that Exchange 
Reserve Fund and Utilities Fund will invest in excess of 25% of 
their respective assets in the securities of companies within the 
banking industry and utility industry, respectively; provided that 
there shall be no limit on the purchase of (a) U.S. government 
securities or (b) for Funds other than the Exchange Reserve and 
Utilities Funds, Municipal Securities issued by governments or 
political subdivisions of governments.

	14.  Writing or selling puts, calls, straddles, spreads or 
combinations thereof, except, with respect to Funds other than 
Exchange Reserve Fund, as permitted under the Fund's investment 
objective and policies.

	15.  With respect to all Funds except the Exchange Reserve Fund, 
purchasing restricted securities, illiquid securities (such as 
repurchase agreements with maturities in excess of seven days and, 
in the case of Exchange Reserve Fund, time deposits maturing from 
two business days through six months) or other securities that are 
not readily marketable if more than 10% or, in the case of the 
High Income and Diversified Strategic Income Funds, 15% of the 
total assets of the Fund would be invested in such securities.  
With respect to the Exchange Reserve fund, (i) securities subject 
to Rule 144A of the securities act of 1933, as amended (the "1933 
Act"), provided at least two dealers make a market in such 
securities and (i) certain privately issued commercial papers 
eligible for resale without registration pursuant to section 4(2) 
of the 1933 act will not be subject to this restriction

	16.  Purchasing any security if as a result the Fund would then 
have more than 5% of its total assets invested in securities of 
companies (including predecessors) that have been in continuous 
operation for fewer than three years; provided that in the case of 
private activity bonds purchased for Tax-Exempt Income Fund, this 
restriction shall apply to the entity supplying the revenues from 
which the issue is to be paid.

	17.  Making investments for the purpose of exercising control or 
management.

	18.  Purchasing or retaining securities of any company if, to the 
knowledge of the Trust, any of the Trust's officers or Trustees or 
any officer or director of an Adviser individually owns more than 
1/2 of 1% of the outstanding securities of such company and 
together they own beneficially more than 5% of the securities.

	19.  Investing in warrants (except as permitted under a Fund's 
investment objective and policies or other than warrants acquired 
by the Fund as part of a unit or attached to securities at the 
time of purchase) if, as a result, the investments (valued at the 
lower of cost or market) would exceed 5% of the value of the 
Fund's net assets of which not more than 2% of the Fund's net 
assets may be invested in warrants not listed on a recognized 
United States or foreign stock exchange to the extent permitted by 
applicable state securities laws.

	20.  With respect to Utilities Fund only, purchasing in excess of 
5% of the voting securities of a public utility or public utility 
holding company, so as to become a public utility holding company 
as defined in the Public Utility Holding Company Act of 1935, as 
amended. 

	The Trust has adopted two additional investment restrictions applicable 
to Exchange Reserve Fund, the first of which is a fundamental policy, which 
prohibit Exchange Reserve Fund from:

	1.	Investing in common stocks, preferred stocks, warrants, 
other equity securities, corporate bonds or debentures, state 
bonds, municipal bonds or industrial revenue bonds.

	2.	Investing more than 10% of its assets in variable rate 
master demand notes providing for settlement upon more than seven 
days' notice by the Fund.

	For purposes of the investment restrictions described above, the issuer 
of a Municipal Security is deemed to be the entity (public or private) 
ultimately responsible for the payment of the principal of and interest on the 
security. For purposes of investment restriction number 13, private activity 
bonds (other than those issued for charitable, educational and certain other 
purposes), the payment of principal and interest on which is the ultimate 
responsibility of companies within the same industry, are grouped together as 
an industry. The Trust may make commitments more restrictive than the 
restrictions listed above with respect to a Fund so as to permit the sale of 
shares of the Fund in certain states. Should the Trust determine that any such 
commitment is no longer in the best interests of the Fund and its 
shareholders, the Trust will revoke the commitment by terminating the sale of 
shares of the Fund in the state involved. The percentage limitations contained 
in the restrictions listed above apply at the time of purchases of securities.

Portfolio Turnover

The Funds do not intend to seek profits through short-term trading. 
Nevertheless, the Funds will not consider portfolio turnover rate a limiting 
factor in making investment decisions.

	Under certain market conditions, a Fund authorized to engage in 
transactions in options may experience increased portfolio turnover as a 
result of its investment strategies. For instance, the exercise of a 
substantial number of options written by a Fund (due to appreciation of the 
underlying security in the case of call options on securities or depreciation 
of the underlying security in the case of put options on securities) could 
result in a turnover rate in excess of 100%. A portfolio turnover rate of 100% 
also would occur, for example, if all of a Fund's securities that are included 
in the computation of turnover were replaced once during a period of one year. 
A Fund's turnover rate is calculated by dividing the lesser of purchases or 
sales of its portfolio securities for the year by the monthly average value of 
the portfolio securities. Securities or options with remaining maturities of 
one year or less on the date of acquisition are excluded from the calculation.

	Certain other practices which may be employed by a Fund also could 
result in high portfolio turnover. For example, portfolio securities may be 
sold in anticipation of a rise in interest rates (market decline) or purchased 
in anticipation of a decline in interest rates (market rise) and later sold. 
In addition, a security may be sold and another of comparable quality 
purchased at approximately the same time to take advantage of what a Fund's 
Adviser believes to be a temporary disparity in the normal yield relationship 
between the two securities. These yield disparities may occur for reasons not 
directly related to the investment quality of particular issues or the general 
movement of interest rates, such as changes in the overall demand for, or 
supply of, various types of securities. 

	For the fiscal years ended July 31, 1995 and 1996, the portfolio 
turnover rates were as follows:

	Fund					1995		1996

Convertible Fund					48%		59%
Diversified Strategic Income Fund			83%		90%
High Income Fund					60%		72%
Premium Total Return Fund				63%		58%
Tax-Exempt Income Fund				38%		44%
Utilities Fund					36%		58%

	For regulatory purposes, the turnover rate of Exchange Reserve Fund is 
zero.

Portfolio Transactions

Most of the purchases and sales of securities for a Fund, whether transacted 
on a securities exchange or over-the-counter, will be effected in the primary 
trading market for the securities, except for Eurobonds which are principally 
traded over-the-counter. The primary trading market for a given security is 
generally located in the country in which the issuer has its principal office. 
Decisions to buy and sell securities for a Fund are made by its Adviser, which 
also is responsible for placing these transactions, subject to the overall 
review of the Board of Trustees. With respect to Diversified Strategic Income 
Fund, decisions to buy and sell domestic securities for the Fund are made by 
SBMFM, which is also responsible for placing these transactions; the 
responsibility to make investment decisions with respect to foreign securities 
and to place these transactions rests with Global Capital Management. Although 
investment decisions for each Fund are made independently from those of the 
other accounts managed by its Adviser, investments of the type that the Fund 
may make also may be made by those other accounts. When a Fund and one or more 
other accounts managed by its Adviser are prepared to invest in, or desire to 
dispose of, the same security, available investments or opportunities for 
sales will be allocated in a manner believed by the Adviser to be equitable to 
each. In some cases, this procedure may adversely affect the price paid or 
received by a Fund or the size of the position obtained or disposed of by the 
Fund.

	Transactions on domestic stock exchanges and some foreign stock 
exchanges involve the payment of negotiated brokerage commissions. On 
exchanges on which commissions are negotiated, the cost of transactions may 
vary among different brokers. Commissions generally are fixed on most foreign 
exchanges. There is generally no stated commission in the case of securities 
traded in U.S. or foreign over-the-counter markets, but the prices of those 
securities include undisclosed commissions or mark-ups. The cost of securities 
purchased from underwriters includes an underwriting commission or concession, 
and the prices at which securities are purchased from and sold to dealers 
include a dealer's mark-up or mark-down. U.S. government securities generally 
are purchased from underwriters or dealers, although certain newly issued U.S. 
government securities may be purchased directly from the United States 
Treasury or from the issuing agency or instrumentality. The following table 
sets forth certain information regarding each Fund's payment of brokerage 
commissions:



				 Premium							Diversified
				    Total				 High				 Strategic
			Fiscal	   Return	Convertible	Income		Utilities 	  
Income
			 Year	    Fund		   Fund		 Fund		  Fund	 	  
Fund

Total Brokerage		1994	  1,767,577	  60,818		  96,670		  2,006,028
	106,421
Commissions		1995	  3,517,469	  39,798		  97,439		  2,134,306	     0
			1996	  3,935,585	  16,920	 	   32,621	  2,446,072	  50,196

Commissions paid to	1994	    280,686	     0		      0		   174,858	      
0
Shearson Lehman	1995	    694,467	   600		      0		   162,924	      
0
or Smith Barney		1996	    628,778	     0		      0		     91,818	      
0

% of Total Brokerage	1995	    19.75%	   1.51%		      0%		     7.63%	      
0%
Commissions paid to	1996	    15.98		      0		      0		     
3.75		      0
Smith Barney

% of Total 		1995	    20.02%	   1.69%		      0%		     8.21%	      
0%
Transactions involving 	1996	    16.26		       0		      0		     
2.72		      0
Commissions paid to 
Smith Barney

	In selecting brokers or dealers to execute securities transactions on 
behalf of a Fund, the Fund's Adviser seeks the best overall terms available. 
In assessing the best overall terms available for any transaction, each 
Adviser will consider the factors that it deems relevant, including the 
breadth of the market in the security, the price of the security, the 
financial condition and execution capability of the broker or dealer and the 
reasonableness of the commission, if any, for the specific transaction and on 
a continuing basis. In addition, each Advisory Agreement between the Trust and 
an Adviser authorizes the Adviser, in selecting brokers or dealers to execute 
a particular transaction and in evaluating the best overall terms available, 
to consider the brokerage and research services (as those terms are defined in 
Section 28(e) of the Securities Exchange Act of 1934, as amended) provided to 
the Trust, the other Funds and/or other accounts over which the Adviser or its 
affiliates exercise investment discretion. The fees under the Advisory 
Agreements and the Sub-Advisory and/or Administration Agreements are not 
reduced by reason of their receiving such brokerage and research services. 
Further, Smith Barney will not participate in commissions brokerage given by 
the Fund to other brokers or dealers and will not receive any reciprocal 
brokerage business resulting therefrom. The Trust's Board of Trustees 
periodically will review the commissions paid by the Funds to determine if the 
commissions paid over representative periods of time were reasonable in 
relation to the benefits inuring to the Trust.

	To the extent consistent with applicable provisions of the 1940 Act and 
the rules and exemptions adopted by the SEC thereunder, the Board of Trustees 
has determined that transactions for a Fund may be executed through Smith 
Barney and other affiliated broker-dealers if, in the judgment of the Fund's 
Adviser, the use of such broker-dealer is likely to result in price and 
execution at least as favorable as those of other qualified broker-dealers, 
and if, in the transaction, such broker-dealer charges the Fund a rate 
consistent with that charged to comparable unaffiliated customers in similar 
transactions. In addition, under rules recently adopted by the SEC, Smith 
Barney may directly execute such transactions for the Funds on the floor of 
any national securities exchange, provided (a) the Trust's Board of Trustees 
has expressly authorized Smith Barney to effect such transactions, and (b) 
Smith Barney annually advises the Trust of the aggregate compensation it 
earned on such transactions. Over-the-counter purchases and sales are 
transacted directly with principal market makers except in those cases in 
which better prices and executions may be obtained elsewhere. The Funds will 
not purchase any security, including U.S. government securities or Municipal 
Securities, during the existence of any underwriting or selling group relating 
thereto of which Smith Barney is a member, except to the extent permitted by 
the SEC.

	The Funds may use Smith Barney as a commodities broker in connection 
with entering into futures contracts and options on futures contracts. Smith 
Barney has agreed to charge the Funds commodity commissions at rates 
comparable to those charged by Smith Barney to its most favored clients for 
comparable trades in comparable accounts.


PURCHASE OF SHARES

Volume Discounts

The schedule of sales charges on Class A shares described in the Prospectuses 
applies to purchases made by any "purchaser", which is defined to include the 
following: (a) an individual; (b) an individual's spouse and his or her 
children purchasing shares for his or her own account; (c) a trustee or other 
fiduciary purchasing shares for a single trust estate or single fiduciary 
account; (d) a pension, profit-sharing or other employee benefit plan 
qualified under Section 401(a) of the Code and qualified employee benefit 
plans of employers who are "affiliated persons" of each other within the 
meaning of the 1940 Act; (e) tax-exempt organizations enumerated in Section 
501(c)(3) or (13) of the Code; (f) any other organized group of persons, 
provided that the organization has been in existence for at least six months 
and was organized for a purpose other than the purchase of investment company 
securities at a discount; or (g) a trustee or other professional fiduciary 
(including a bank, or an investment adviser registered with the SEC under the 
Investment Advisers Act of 1940) purchasing shares of the Fund for one or more 
trust estates or fiduciary accounts. Purchasers who wish to combine purchase 
orders to take advantage of volume discounts on Class A shares should contact 
a Smith Barney Financial Consultant. 

Combined Right of Accumulation

Reduced sales charges, in accordance with the schedules in the Prospectuses, 
apply to any purchase of Class A shares if the aggregate investment in Class A 
shares of the relevant Fund and in Class A shares of other funds of the Smith 
Barney Mutual Funds that are offered with a sales charge, including the 
purchase being made, of any "purchaser" (as defined above) is $25,000 or more. 
The reduced sales charge is subject to confirmation of the shareholder's 
holdings through a check of appropriate records. The Trust reserves the right 
to terminate or amend the combined right of accumulation at any time after 
written notice to shareholders. For further information regarding the rights 
of accumulation, shareholders should contact a Smith Barney Financial 
Consultant.

Determination of Public Offering Prices

The Trust offers shares of the Funds to the public on a continuous basis. The 
public offering price for a Class A, Class Y and Class Z share of a Fund is 
equal to the net asset value per share at the time of purchase, plus for Class 
A shares an initial sales charge based on the aggregate amount of the 
investment. The public offering price for a Class B and Class C share (and 
Class A share purchases, including applicable rights of accumulation, equaling 
or exceeding $500,000), is equal to the net asset value per share at the time 
of purchase and no sales charge is imposed at the time of purchase. A 
contingent deferred sales charge ("CDSC"), however, is imposed on certain 
redemptions of Class B and Class C shares and of Class A shares when purchased 
in amounts exceeding $500,000. The method of computation of the public 
offering price is shown in the Funds' financial statements incorporated by 
reference in their entirety into this Statement of Additional Information.


REDEMPTION OF SHARES

Detailed information on how to redeem shares of a Fund is included in its 
Prospectus. The right of redemption of shares of a Fund may be suspended or 
the date of payment postponed (a) for any periods during which the New York 
Stock Exchange, Inc. (the "NYSE") is closed (other than for customary weekend 
and holiday closings), (b) when trading in the markets the Fund normally 
utilizes is restricted, or an emergency exists, as determined by the SEC, so 
that disposal of the Fund's investments or determination of its net asset 
value is not reasonably practicable or (c) for such other periods as the SEC 
by order may permit for the protection of the Fund's shareholders.

	Distributions in Kind. If the Board of Trustees of the Trust determines 
that it would be detrimental to the best interests of the remaining 
shareholders of a Fund to make a redemption payment wholly in cash, the Trust 
may pay, in accordance with SEC rules, any portion of a redemption in excess 
of the lesser of $250,000 or 1% of the Fund's net assets by distribution in 
kind of portfolio securities in lieu of cash. Securities issued as a 
distribution in kind may incur brokerage commissions when shareholders 
subsequently sell those securities.

	Automatic Cash Withdrawal Plan. An automatic cash withdrawal plan (the 
"Withdrawal Plan") is available to shareholders who own shares of a Fund with 
a value of at least $10,000 ($5,000 for retirement plan accounts) and who wish 
to receive specific amounts of cash monthly or quarterly. Withdrawals of at 
least $50 may be made under the Withdrawal Plan by redeeming as many shares of 
the Fund as may be necessary to cover the stipulated withdrawal payment. Any 
applicable CDSC will not be waived on amounts withdrawn by shareholders that 
exceed 1.00% per month of the value of a shareholder's shares 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 value of a shareholder's shares at 
the time the Withdrawal Plan commences). To the extent that withdrawals exceed 
dividends, distributions and appreciation of a shareholder's investment in the 
Fund, there will be a reduction in the value of the shareholder's investment 
and continued withdrawal payments may reduce the shareholder's investment and 
ultimately exhaust it. Withdrawal payments should not be considered as income 
from investment in a Fund. Furthermore, as it generally would not be 
advantageous to a shareholder to make additional investments in a Fund at the 
same time he or she is participating in the Withdrawal Plan with respect to 
that Fund, purchases by such shareholders of additional shares in the Fund in 
amounts less than $5,000 will not ordinarily be permitted.

	Shareholders who wish to participate in the Withdrawal Plan and who hold 
their shares in certificate form must deposit their share certificates of the 
Fund from which withdrawals will be made with First Data, as agent for 
Withdrawal Plan members. All dividends and distributions on shares in the 
Withdrawal Plan are reinvested automatically at net asset value in additional 
shares of the Fund involved. All applications for participation in the 
Withdrawal Plan must be received by First Data as Plan Agent no later than the 
eighth day of each month to be eligible for participation beginning with that 
month's withdrawal. For additional information regarding the Withdrawal Plan, 
contact your Smith Barney Financial Consultant.


DISTRIBUTOR

Smith Barney serves as the Trust's distributor on a best efforts basis 
pursuant to a distribution agreement (the "Distribution Agreement").

	PFS serves as one of the Trust's distributors with respect to the 
Exchange Reserve Fund pursuant to a Distribution Agreement dated November 20, 
1995.

	When payment is made by the investor before the settlement date, unless 
otherwise directed by the investor, the funds will be held as a free credit 
balance in the investor's brokerage account, and Smith Barney may benefit from 
the temporary use of the funds. The investor may designate another use for the 
funds prior to settlement date, such as an investment in a money market fund 
(other than the Exchange Reserve Fund) of the Smith Barney Mutual Funds. If 
the investor instructs Smith Barney to invest the funds in a Smith Barney 
money market fund, the amount of the investment will be included as part of 
the average daily net assets of both the relevant Fund and the Smith Barney 
money market fund, and affiliates of Smith Barney that serve the funds in an 
investment advisory or administrative capacity will benefit from the fact they 
are receiving fees from both such investment companies for managing these 
assets computed on the basis of their average daily net assets. The Trust's 
Board of Trustees has been advised of the benefits to Smith Barney resulting 
from these settlement procedures and will take such benefits into 
consideration when reviewing the Advisory, Administration and Distribution 
Agreements for continuance.

	For the fiscal year ended July 31, 1996, Smith Barney and/or PFS 
incurred distribution expenses totaling approximately $62,460,648, consisting 
of approximately $3,277,497 for advertising $897,058 for printing and mailing 
prospectuses, $30,622,377 for support services and overhead expenses, 
$27,032,487 to Smith Barney or PFS Financial Consultants and $631,227 for 
accruals for interest on the excess of Smith Barney and/or PFS expenses 
incurred in the distribution of the Fund's shares over the sum of the 
distribution fees and CDSC received by Smith Barney and/or PFS.

Distribution Arrangements

	Shares of the Trust are distributed on a best efforts basis by Smith 
Barney as sales agent of the Trust pursuant to the Distribution Agreement. To 
compensate Smith Barney for the services it provides and for the expense it 
bears under the Distribution Agreement, the Trust has adopted a services and 
distribution plan (the "Plan") pursuant to Rule 12b-1 under the 1940 Act. 
Under the Plan, each Fund, except Exchange Reserve Fund, pays Smith Barney a 
service fee, accrued daily and paid monthly, calculated at the annual rate of 
 .25% (.15% in the case of Tax-Exempt Income Fund) of the value of the Fund's 
average daily net assets attributable to its Class A, Class B and Class C 
shares. In addition, each Fund except the Exchange Reserve Fund, pays Smith 
Barney, with respect to the its Class B and Class C shares a distribution fee.  
The Exchange Reserve Fund pays PFS, with respect to its Class B shares a 
distribution fee.  The distribution fee is primarily intended to compensate 
Smith Barney and/or PFS for its initial expense of paying Financial 
Consultants a commission upon sales of those shares. The Class B and Class C 
share's distribution fees, accrued daily and paid monthly, are calculated at 
the annual rate of .50% for Class B shares and 0.45% for Class C shares (0.50% 
for Class C shares in the case of Exchange Reserve Fund and 0.55% for Class C 
shares in the case of Tax-Exempt Fund) of the value of a Fund's average daily 
net assets attributable to the shares of the respective Class. 

	For the fiscal year ended July 31, 1994, 1995 and 1996, Smith Barney 
received $61,281,027, $52,644,615 and $57,460,253, respectively, in the 
aggregate from the Trust under the Plan.

	The following expenses were incurred during the periods indicated:


Sales Charges (paid to Smith Barney).

						     Class A
					Fiscal Year		Fiscal Year		Fiscal Year
					Ended 7/31/94		Ended 7/31/95		Ended 
7/31/96
Name of Fund

Convertible Fund			    14,561			      8,900			  
49,000
Diversified Strategic Income Fund	  818,088			  471,500		
	792,000
High Income Fund			  507,890			  457,100		
	593,000
Premium Total Return Fund		$546,635			$594,400		
	968,000
Tax-Exempt Income Fund		  176,786			    68,794			  
47,000
Utilities Fund				  364,556 		  150,600			228,000


CDSC (paid to Smith Barney).

						     Class B
					Fiscal Year		Fiscal Year		Fiscal Year
					Ended 7/31/94		Ended 7/31/95		Ended 
7/31/96

Name of Fund

Convertible Fund			$     87,160		$   126,500		     
95,000
Diversified Strategic Income Fund	  5,301,256		  6,000,000		4,015,000
Exchange Reserve Fund			  1,188,817		  1,429,000		   
765,000
High Income Fund			     743,718		  1,000,000		   
915,000
Premium Total Return Fund		  2,133,023		  1,765,800		2,905,000
Tax-Exempt Income Fund		  1,570,424		  1,649,382		   929,000
Utilities Fund				$8,429,876 		$4,738,800		3,393,000



Service Fees and Distribution Fees

						        Fund Level
					Fiscal Year		Fiscal Year		Fiscal Year
					Ended 7/31/94		Ended 7/31/95		Ended 
7/31/96

Name of Fund

Convertible Fund			$     627,147		       468,685		     
433,951
Diversified Strategic Income Fund	  18,336,425		  17,817,988	
	18,641,336
Exchange Reserve Fund			    1,036,758		       913,444	
	     748,208
High Income Fund			    4,307,795		    4,029,911		  
4,893,170
Premium Total Return Fund		  11,322,934		$12,565,954	
	15,646,147
Tax-Exempt Income Fund		    7,323,768		    5,456,482		  
4,945,112
Utilities Fund				  17,767,182		  12,305,595	
	12,152,329

	Under its terms, the Plan continues from year to year, provided such 
continuance is approved annually by vote of the Board of Trustees, including a 
majority of the Independent Trustees who have no direct or indirect financial 
interest in the operation of the Plan. The Plan may not be amended to increase 
the amount to be spent for the services provided by Smith Barney or PFS 
without shareholder approval, and all amendments of the Plan must be approved 
by the Trustees in the manner described above. The Plan may be terminated with 
respect to a Class at any time, without penalty, by vote of a majority of the 
Independent Trustees or, with respect to any Fund, by vote of a majority of 
the outstanding voting securities of the Class (as defined in the 1940 Act). 
Pursuant to the Plan, Smith Barney and PFS will provide the Board of Trustees 
with periodic reports of amounts expended under the Plan and the purpose for 
which such expenditures were made.


VALUATION OF SHARES

Each Class' net asset value per share is calculated on each day, Monday 
through Friday, except days on which the NYSE is closed. The NYSE currently is 
scheduled to be closed on New Year's Day, Presidents' Day, Good Friday, 
Memorial Day, Independence Day, Labor Day, Thanksgiving and Christmas, and on 
the preceding Friday or subsequent Monday when one of these holidays falls on 
a Saturday or Sunday, respectively. Because of the differences in distribution 
fees and Class-specific expenses, the per share net asset value of each Class 
may differ. The following is a description of procedures used by a Fund in 
valuing its assets. 

	Because of the need to obtain prices as of the close of trading on 
various exchanges throughout the world, the calculation of the net asset value 
of Funds investing in foreign securities may not take place contemporaneously 
with the determination of the prices of many of their respective portfolio 
securities used in such calculation. A security which is listed or traded on 
more than one exchange is valued at the quotation on the exchange determined 
to be the primary market for such security. All assets and liabilities 
initially expressed in foreign currency values will be converted into U.S. 
dollar values at the mean between the bid and offered quotations of such 
currencies against U.S. dollars as last quoted by any recognized dealer. If 
such quotations are not available, the rate of exchange will be determined in 
good faith by the Trust's Board of Trustees. In carrying out the Board's 
valuation policies, SBMFM, as administrator, may consult with an independent 
pricing service (the "Pricing Service") retained by the Trust.

	Debt securities of United States issuers (other than U.S. government 
securities and short-term investments), including Municipal Securities held by 
Tax-Exempt Income Fund, are valued by SBMFM, as administrator, after 
consultation with the Pricing Service approved by the Trust's Board of 
Trustees. When, in the judgment of the Pricing Service, quoted bid prices for 
investments are readily available and are representative of the bid side of 
the market, these investments are valued at the mean between the quoted bid 
prices and asked prices. Investments for which, in the judgment of the Pricing 
Service, there are no readily obtainable market quotations are carried at fair 
value as determined by the Pricing Service. The procedures of the Pricing 
Service are reviewed periodically by the officers of the Trust under the 
general supervision and responsibility of the Board of Trustees.


EXCHANGE PRIVILEGE

Except as noted below, shareholders of any of the Smith Barney Mutual Funds 
may exchange all or part of their shares for shares of the same Class of other 
Smith Barney Mutual Funds, to the extent such shares are offered for sale in 
the shareholder's state of residence, on the basis of relative net asset value 
per share at the time of exchange as follows:

	A.  Class A shares of any fund purchased with a sales charge may 
be exchanged for Class A shares of any of the other funds.  Class 
A shares of any fund may be exchanged without a sales charge for 
shares of the funds that are offered without a sales charge. Class 
A shares of any fund purchased without a sales charge may be 
exchanged for shares sold with a sales charge.

	B.  Class A shares of any fund acquired by a previous exchange of 
shares purchased with a sales charge may be exchanged for Class A 
shares of any of the other funds.

	C.  Class B shares of any fund may be exchanged without a sales 
charge. Class B shares of a Fund exchanged for Class B shares of 
another fund will be subject to the higher applicable CDSC of the 
two funds and, for purposes of calculating CDSC rates and 
conversion periods, will be deemed to have been held since the 
date the shares being exchanged were deemed to be purchased.

	Dealers other than Smith Barney must notify First Data of the investor's 
prior ownership of Class A shares of Smith Barney High Income Fund and the 
account number in order to accomplish an exchange of shares of Smith Barney 
High Income Fund under paragraph B above.

	The exchange privilege enables shareholders to acquire shares of the 
same Class in a fund with different investment objectives when they believe 
that a shift between funds is an appropriate investment decision. This 
privilege is available to shareholders residing in any state in which the fund 
shares being acquired may legally be sold. Prior to any exchange, the 
shareholder should obtain and review a copy of the current prospectus of each 
fund into which an exchange is being considered. Prospectuses may be obtained 
from a Smith Barney Financial Consultant.

	Upon receipt of proper instructions and all necessary supporting 
documents, shares submitted for exchange are redeemed at the then-current net 
asset value and, subject to any applicable CDSC, the proceeds are immediately 
invested, at a price as described above, in shares of the fund being acquired. 
Smith Barney reserves the right to reject any exchange request. The exchange 
privilege may be modified or terminated at any time after written notice to 
shareholders.


PERFORMANCE DATA

From time to time, the Trust may quote yield or total return of the Funds in 
advertisements or in reports and other communications to shareholders. The 
Trust may include comparative performance information in advertising or 
marketing each Fund's shares. Such performance information may include the 
following industry and financial publications: Barron's, Business Week, CDA 
Investment Technologies, Inc., Changing Times, Forbes, Fortune, Institutional 
Investor, Investors Daily, Money, Morningstar Mutual Fund Values, The New York 
Times, USA Today and The Wall Street Journal. To the extent any advertisement 
or sales literature of a Fund describes the expenses or performance of Class 
A, Class B, Class C or Class Y, it will also disclose such information for the 
other Classes.

Yield

Exchange Reserve Fund. The current yield for the Fund is computed by (a) 
determining the net change in the value of a hypothetical pre-existing account 
in the Fund having a balance of one share at the beginning of a 
seven-calendar-day period for which yield is to be quoted, (b) dividing the 
net change by the value of the account at the beginning of the period to 
obtain the base period return and (c) annualizing the results (i.e., 
multiplying the base period return by 365/7). The net change in the value of 
the account reflects the value of additional shares purchased with dividends 
declared on the original share and any such additional shares, but does not 
include realized gains and losses or unrealized appreciation and depreciation. 
In addition, the Fund may calculate a compound effective annualized yield by 
adding 1 to the base period return (calculated as described above), raising 
the sum to a power equal to 365/7 and subtracting 1.

	For the seven-day period ended July 31, 1996, the annualized yield was 
4.44%, and the compound effective yield was 4.53%. As of July 31, 1996, the 
Fund's average portfolio maturity was 37 days. 

	Other Funds. The 30-day yield figure of a Fund other than Exchange 
Reserve Fund is calculated according to a formula prescribed by the SEC. The 
formula can be expressed as follows:

	YIELD =2 [ ( a-bcd+1)6--1]

	Where:	a = dividends and interest earned during the period.
		b = expenses accrued for the period (net of waiver and 
reimbursement).
		c = the average daily number of shares outstanding during the 
period that were entitled to receive dividends.
		d = the maximum offering price per share on the last day of the 
period.

	For the purpose of determining the interest earned (variable "a" in the 
formula) on debt obligations that were purchased by a Fund at a discount or 
premium, the formula generally calls for amortization of the discount or 
premium; the amortization schedule will be adjusted monthly to reflect changes 
in the market values of the debt obligations.

	Investors should recognize that, in periods of declining interest rates, 
a Fund's yield will tend to be somewhat higher than prevailing market rates, 
and in periods of rising interest rates the Fund's yield will tend to be 
somewhat lower. In addition, when interest rates are falling, the inflow of 
net new money to the Fund from the continuous sale of its shares will likely 
be invested in portfolio instruments producing lower yields than the balance 
of such Fund's investments, thereby reducing the current yield of the Fund. In 
periods of rising interest rates, the opposite can be expected to occur.

Average Annual Total Return

The "average annual total return" figures for each Fund, other than Exchange 
Reserve Fund, are 
computed according to a formula prescribed by the SEC. The formula can be 
expressed as follows:

	P (1+T)n = ERV

Where:		P =a hypothetical initial payment of $1,000.
		T = average annual total return.
		n = number of years.
		ERV = Ending Redeemable Value of a hypothetical $1,000 investment 
made at the beginning of the 1-, 5- or 10-year period at the end 
of the 1-, 5- or 10-year period (or fractional portion thereof), 
assuming reinvestment of all dividends and distributions.

	The average annual total returns (with fees waived and without sales 
charge) of the Fund's Class A shares were as follows for the periods 
indicated:

								Per Annum For
								the Period From
					One Year		Commencement
					Period Ended		of Operations*
Name of Fund				7/31/96			Through 7/31/96

Convertible Fund				7.41%			  8.63%
Diversified Strategic Income Fund		8.39%			  7.78%
High Income Fund				8.95%			10.24%
Premium Total Return Fund			14.76%			12.51%
Tax-Exempt Income Fund			6.29%			  6.40%
Utilities Fund				9.21%			  7.64%

	* The Fund commenced selling Class A shares on November 6, 1992.

	The average annual total returns (with fees waived and without CDSC) of 
the Fund's Class B shares were as follows for the periods indicated:

								Per Annum	Per Annum For
								For the		the Period 
From
					One Year		Five Year	Commencement 
					Period Ended		Period Ended	of 
Operations
					7/31/96			7/31/96	
	Through 7/31/96

Name of Fund

Convertible Fund (5)			  6.91%			  9.45%		  
7.88%
Diversified Strategic Income Fund (3) (6)	  7.80%			  8.44%	
	  8.90%
High Income Fund (2) (6)			  8.41%			12.17%	
	  8.61%
Premium Total Return Fund (1)    		14.21%			12.17%	
	12.63%
Tax-Exempt Income Fund (1) (6)		  5.74%			6.72%		  
8.21%
Utilities Fund (4)				  8.78%			8.51%		  
9.67%

(1) Fund commenced operations on September 16, 1985. 
(2) Fund commenced operations on September 2, 1986. 
(3) Fund commenced operations on December 28, 1989. 
(4) Fund commenced operations on March 28, 1988. 
(5) Fund commenced operations on September 9, 1986.
(6) Prior to November 6, 1992 the maximum CDSC imposed on redemptions was 
5.00%.

	The average annual total returns (with fees waived) of the Fund's Class 
C shares were as follows for the periods indicated:


	Class C Shares:
									Per Annum For
									the Period From
						One Year		Commencement of
						Period Ended		Operations Through
Name of Fund					7/31/96			7/31/96

Convertible Fund***				  6.82%				11.01%
Diversified Strategic Income Fund*****		  7.82%				  
6.37%
High Income Fund****				  8.56%				10.36%
Premium Total Return Fund*			14.30%				11.83%
Tax-Exempt Income Fund**				  5.69%			
	11.24%
Utilities Fund******				  8.80%				  
5.32%

     *	The Fund commenced selling Class C shares (previously designated 
as Class D shares) on June 1, 1993.
    **	The Fund commenced selling Class C shares (previously designated 
as Class D shares) on November 17, 1994 
   ***	The Fund commenced selling Class C shares (previously designated 
as Class D shares) on November 7, 1994
  ****	The Fund commenced selling Class C shares (previously designated 
as Class D shares) on August 24, 1994.
 *****	The Fund commenced selling Class C shares (previously designated 
as Class D shares) on March 19, 1993.
******	The Fund commenced selling Class C shares (previously designated 
as Class D shares) on February 4, 1993. 

	A Class' total return figures calculated in accordance with the above 
formula assume that the maximum sales charge or maximum applicable CDSC, as 
the case may be, has been deducted for the hypothetical $1,000 initial 
investment at the time of purchase.

Aggregate Total Return

The aggregate total return figures for each Fund, other than Exchange Reserve 
Fund, represent the cumulative change in the value of an investment in the 
Class for the specified period and are computed by the following formula:
	ERV - P
	P

	Where:	P       = a hypothetical initial payment of $10,000.
		ERV = Ending Redeemable Value of a hypothetical $10,000 investment 
made at the beginning of the 1-, 5- or 10-year period at the end 
of the 1-, 5- or 10-year period (or fractional portion thereof), 
assuming reinvestment of all dividends and distributions. 

	The aggregate total returns (with fees waived) of the Class B shares of 
the Funds indicated were as follows for the periods indicated:
        No Load                                                      
Load                                

				One Year	Five Year	Period from	  One Year	Five Year        Period 
from
				Period		Period		Commencement	  Period	
	Period	         Commencement
				Ended		Ended		of Operations	  Ended		Ended	          
of Operations
				July 31,		July 31,		through		  July 31,	
	July 31,	          through
				1996*		1996		July 31, 1996	   1996**		1996	          
July 31,1996


Convertible(5)		  6.91%		%	 	112.09% 		1.91%		56.07%	
	112.09%
Diversified Strategic 
         Income (3)(6)		  7.80%		57.07%	 	  75.51% 		3.30%	
	48.96%		  75.51%
High Income (2)(6)		  8.41%		49.96%	 	126.79% 		3.91%	
	76.54%		126.79%
Premium Total Return(1)	14.21%		77.54%	 	200.70% 		9.21%	
	78.25%		264.68%
Tax-Exempt Income(1)(6)	  5.74%		79.25%	 	103.62% 		1.26%	
	37.44%		  35.94%
Utilities(4) 			  8.78%		38.44%	 	116.04% 		3.78%	
	49.43%		116.64%


*		Figures do not include the effect of the maximum sales charge or maximum 
applicable CDSC. 
If they had been included, it would have the effect of lowering the returns 
shown.
**		Figures include the effect of the maximum sales charge or maximum 
applicable CDSC. 

(1) Fund commenced operations on September 16, 1985.
(2) Fund commenced operations on September 2, 1986.
(3) Fund commenced operations on December 28, 1989.
(4) Fund commenced operations on March 28, 1988.
(5) Fund commenced operations on September 9, 1986.
(6) Prior to November 6, 1992 the maximum CDSC imposed on redemptions was 5%.






	The aggregate total returns (with fees waived) of the Class A and Class C 
shares of the Funds 
indicated were as follows for the periods indicated:

               No Load                Load                    
No Load                          Load    
 
								Period from		Period from
				One Year	One Year	November 6, 1992	November 6, 1992
				Period Ended	Period Ended	through			through
				July 31, 1996*	July 31, 1996**	July 31, 1996*		July 31, 1996**
Convertible
	Class A			  7.41%		  2.06%		36.15%#		29.32%
	Class C	(3) 		  6.82%		  5.82%		19.83%#		19.83%#

Diversified Strategic Income
	Class A			  8.39%		  3.51%		32.25%#		32.25%
	Class C(5) 		  7.82%		  6.82%		23.14%#		28.96%#

High Income
	Class A			  8.95%		  4.08%		43.90%#		37.42%
	Class C	(4)		  8.56%		  7.56%		21.04%#		21.04%#

Premium Total Return
	Class A			14.76%		  9.02%		55.30%#		47.52%
	Class C	(1) 		14.30%		13.30%		42.48%#		42.48%

Tax-Exempt Income
	Class A			  6.27%		  2.01%		26.09%#		21.02%
	Class C	(2) 		  5.69%		  4.69%		19.90%#		19.90%#

Utilities
	Class A			9.21%		 %		31.66%#		25.05%
	Class C(6) 		8.80%		 %		19.80%#		19.80%#

                                                   
 *	Figures do not include the effect of the maximum sales charge or maximum 
applicable CDSC. 
**	Figures include the effect of the maximum sales charge or maximum 
applicable CDSC.
(1)	The Fund commenced selling Class C shares (previously designated as 
Class D shares) on June 1, 1993.
(2)	The Fund commenced selling Class C shares (previously designated as 
Class D shares) on November 17, 1994.
(3)	The Fund commenced selling Class C shares (previously designated as 
Class D shares) on November 7, 1994.
(4)	The Fund commenced selling Class C shares (previously designated as 
Class D shares) on August 24, 1994.
(5)	The Fund commenced selling Class C shares (previously designated as 
Class D shares) on March 19, 1993.
(6)	The Fund commenced selling Class C shares (previously designated as 
Class D shares) on February 4, 1993.
 #	Since inception date.

	It is important to note that the yield and total return figures set 
forth above are based on historical earnings and are not intended to indicate 
future performance. 

	A Class' performance will vary from time to time depending upon market 
conditions, the composition of the relevant Fund's portfolio and operating 
expenses and the expenses exclusively attributable to that Class. 
Consequently, any given performance quotation should not be considered 
representative of the Class' performance for any specified period in the 
future. Because performance will vary, it may not provide a basis for 
comparing an investment in the Class with certain bank deposits or other 
investments that pay a fixed yield for a stated period of time. Investors 
comparing a Class' performance with that of other mutual funds should give 
consideration to the quality and maturity of the respective investment 
company's portfolio securities.

TAXES

The following is a summary of certain Federal income tax considerations that 
may affect the Trust and its shareholders. This summary is not intended as a 
substitute for individual tax advice and investors are urged to consult their 
own tax advisors as to the tax consequences of an investment in any Fund of 
the Trust.

Tax Status of the Funds

Each Fund will be treated as a separate taxable entity for Federal income tax 
purposes.

	Each Fund has qualified and the Trust intends that each Fund continue to 
qualify separately each year as a "regulated investment company" under the 
Code. A qualified Fund will not be liable for Federal income taxes to the 
extent its taxable net investment income and net realized capital gains are 
distributed to its shareholders, provided that each Fund distributes at least 
90% of its net investment income. One of the several requirements for 
qualification is that a Fund receive at least 90% of its gross income each 
year from dividends, interest, payments with respect to securities loans and 
gains from the sale or other disposition of equity or debt securities or 
foreign currencies, or other income (including but not limited to gains from 
options, futures, or forward contracts) derived with respect to the Fund's 
investment in such stock, securities, or currencies. The Trust does not expect 
any Fund to have difficulty meeting this test.

	To qualify as a regulated investment company, a Fund also must earn less 
than 30% of its gross income from the disposition of securities held for less 
than three months. The 30% test will limit the extent to which a Fund may sell 
securities held for less than three months; effect short sales of securities 
held for less than three months; write options which expire in less than three 
months; and effect closing transactions with respect to call or put options 
that have been written or purchased within the preceding three months. (If a 
Fund purchases a put option for the purpose of hedging an underlying portfolio 
security, the acquisition of the option is treated as a short sale of the 
underlying security unless the option and the security are acquired on the 
same date.) Finally, as discussed below, this requirement also may limit 
investments by certain Funds in options on stock indexes, options on 
nonconvertible debt securities, futures contracts and options on futures 
contracts, and foreign currencies (or options, futures or forward contracts on 
foreign currencies) but only to the extent that such foreign currencies are 
not directly related to the Trust's principal business of investing in 
securities.

Taxation of Investment by the Funds

Gains or losses on sales of securities by a Fund generally will be long-term 
capital gains or losses if the Fund has held the securities for more than one 
year. Gains or losses on sales of securities held for not more than one year 
generally will be short-term. If a Fund acquires a debt security at a 
substantial discount, a portion of any gain upon sale or redemption will be 
taxed as ordinary income, rather than capital gain, to the extent that it 
reflects accrued market discount.

	Options and Futures Transactions. The tax consequences of options 
transactions entered into by a Fund will vary depending on the nature of the 
underlying security, whether the option is written or purchased, and whether 
the "straddle" rules, discussed separately below, apply to the transaction. 
When a Fund writes a call or put option on an equity or convertible debt 
security, it will receive a premium that will, subject to the straddle rules, 
be treated as follows for tax purposes. If the option expires unexercised, or 
if the Fund enters into a closing purchase transaction, the Fund will realize 
a gain (or loss if the cost of the closing purchase transaction exceeds the 
amount of the premium) without regard to any unrealized gain or loss on the 
underlying security. Any such gain or loss will be a short-term capital gain 
or loss, except that any loss on a "qualified" covered call stock option that 
is not treated as a part of a straddle may be treated as long-term capital 
loss. If a call option written by a Fund is exercised, the Fund will recognize 
a capital gain or loss from the sale of the underlying security, and will 
treat the premium as additional sales proceeds. Whether the gain or loss will 
be long-term or short-term will depend on the holding period of the underlying 
security. If a put option written by a Fund is exercised, the amount of the 
premium will reduce the tax basis of the security that the Fund then 
purchases.

	If a put or call option that a Fund has purchased on an equity or 
convertible debt security expires unexercised, the Fund will realize capital 
loss equal to the cost of the option. If the Fund enters into a closing sale 
transaction with respect to the option, it will realize a capital gain or loss 
(depending on whether the proceeds from the closing transaction are greater or 
less than the cost of the option). The gain or loss will be short-term or 
long-term, depending on the Fund's holding period in the option. If the Fund 
exercises such a put option, it will realize a short-term capital gain or loss 
(long-term if the Fund holds the underlying security for more than one year 
before it purchases the put) from the sale of the underlying security measured 
by the sales proceeds decreased by the premium paid. If the Fund exercises 
such a call option, the premium paid for the option will be added to the tax 
basis of the security purchased.

	One or more Funds may invest in section 1256 contracts, and the Code 
imposes a special "mark-to-market" system for taxing these contracts. These 
contracts generally include options on nonconvertible debt securities 
(including United States government securities), options on stock indexes, 
futures contracts, options on futures contracts and certain foreign currency 
contracts. Options on foreign currency, futures contracts on foreign currency 
and options on foreign currency futures will qualify as "section 1256" 
contracts if the options or futures are traded on or subject to the rules of a 
qualified board or exchange. Generally, most of the foreign currency options 
and foreign currency futures and related options in which certain Funds may 
invest will qualify as section 1256 contracts. In general, gain or loss on 
section 1256 contracts will be taken into account for tax purposes when 
actually realized (by a closing transaction, by exercise, by taking delivery 
or by other termination). In addition, any section 1256 contracts held at the 
end of a taxable year will be treated as sold at their year-end fair market 
value (that is, marked to the market), and the resulting gain or loss will be 
recognized for tax purposes. Provided that section 1256 contracts are held as 
capital assets and are not part of a straddle, both the realized and the 
unrealized year-end gain or loss from these investment positions (including 
premiums on options that expire unexercised) will be treated as 60% long-term 
and 40% short-term capital gain or loss, regardless of the period of time 
particular positions actually are held by a Fund. 

	A portion of the mark-to-market gain on instruments held for less than 
three months at the close of a Fund's taxable year may represent a gain on 
securities held for less than three months for purposes of the 30% test 
discussed above. Accordingly, a Fund may have to restrict its fourth-quarter 
transactions in section 1256 contracts.

	Straddles. While the mark-to-market system is limited to section 1256 
contracts, the Code contains other rules applicable to transactions which 
create positions which offset positions in section 1256 or other investment 
contracts. Those rules, applicable to "straddle" transactions, are intended to 
eliminate any special tax advantages for such transactions. "Straddles" are 
defined to include "offsetting positions" in actively-traded personal 
property. Under current law, it is not clear under what circumstances one 
investment made by a Fund, such as an option or futures contract, would be 
treated as "offsetting" another investment also held by the Fund, such as the 
underlying security (or vice versa) and, therefore, whether the Fund would be 
treated as having entered into a straddle. In general, investment positions 
may be "offsetting" if there is a substantial diminution in the risk of loss 
from holding one position by reason of holding one or more other positions 
(although certain "qualified" covered call stock options written by a Fund may 
be treated as not creating a straddle). Also, the forward currency contracts 
entered into by a Fund may result in the creation of "straddles" for Federal 
income tax purposes.

	If two (or more) positions constitute a straddle, a realized loss from 
one position (including a mark-to-market loss) must be deferred to the extent 
of unrecognized gain in an offsetting position. Also, the holding period rules 
described above may be modified to recharacterize long-term gain as short-term 
gain, or to recharacterize short-term loss as long-term loss, in connection 
with certain straddle transactions. Furthermore, interest and other carrying 
charges allocable to personal property that is part of a straddle must be 
capitalized. In addition, "wash sale" rules apply to straddle transactions to 
prevent the recognition of loss from the sale of a position at a loss where a 
new offsetting position is or has been acquired within a prescribed period. To 
the extent that the straddle rules apply to positions established by a Fund, 
losses realized by the Fund may be either deferred or recharacterized as 
long-term losses, and long-term gains realized by the Fund may be converted to 
short-term gains.

	If a Fund chooses to identify particular offsetting positions as being 
components of a straddle, a realized loss will be recognized, but only upon 
the liquidation of all of the components of the identified straddle. Special 
rules apply to the treatment of "mixed" straddles (that is, straddles 
consisting of a section 1256 contract and an offsetting position that is not a 
section 1256 contract). If a Fund makes certain elections, the section 1256 
contract components of such straddles will not be subject to the "60%/40%" 
mark-to-market rules. If any such election is made, the amount, the nature (as 
long-or short-term) and the timing of the recognition of the Fund's gains or 
losses from the affected straddle positions will be determined under rules 
that will vary according to the type of election made.

	Section 988. Foreign currency gain or loss from transactions in (a) bank 
forward contracts not traded in the interbank market and (b) futures contracts 
traded on a foreign exchange may be treated as ordinary income or loss under 
the Code section 988. A Fund may elect to have section 988 apply to section 
1256 contracts. Pursuant to that election, foreign currency gain or loss from 
these transactions would be treated entirely as ordinary income or loss when 
realized. A Fund will make the election necessary to gain such treatment if 
the election is otherwise in the best interests of the Fund. 

Taxation of the Trust's Shareholders

Dividends paid by a Fund from investment income and distributions of 
short-term capital gains will be taxable to shareholders as ordinary income 
for Federal income tax purposes, whether received in cash or reinvested in 
additional shares. Distributions of long-term capital gains will be taxable to 
shareholders as long-term capital gain, whether paid in cash or reinvested in 
additional shares, and regardless of the length of time that the shareholder 
has held his or her shares of the Fund.

	Dividends of investment income (but not capital gains) from any Fund 
generally will qualify for the Federal dividends-received deduction for 
domestic corporate shareholders to the extent that such dividends do not 
exceed the aggregate amount of dividends received by the Fund from domestic 
corporations. If securities held by a Fund are considered to be 
"debt-financed" (generally, acquired with borrowed funds), are held by the 
Fund for less than 46 days (91 days in the case of certain preferred stock), 
or are subject to certain forms of hedges or short sales, the portion of the 
dividends paid by the Fund which corresponds to the dividends paid with 
respect to such securities will not be eligible for the corporate 
dividends-received deduction.

	If a shareholder (a) incurs a sales charge in acquiring or redeeming 
Fund shares and (b) disposes of those shares and acquires within 90 days after 
the original acquisition, or (c) acquires within 90 days of the redemption, 
shares in a mutual fund for which the otherwise applicable sales charge is 
reduced by reason of a reinvestment right (i.e., exchange privilege), the 
original sales charge increases the shareholder's tax basis in the original 
shares only to the extent the otherwise applicable sales charge for the second 
acquisition is not reduced. The portion of the original sales charge that does 
not increase the shareholder's tax basis in the original shares would be 
treated as incurred with respect to the second acquisition and, as a general 
rule, would increase the shareholder's tax basis in the newly acquired shares. 
Furthermore, the same rule also applies to a disposition of the newly acquired 
or redeemed shares made within 90 days of the second acquisition. This 
provision prevents a shareholder from immediately deducting the sales charge 
by shifting his or her investment in a family of mutual funds.

	Capital Gains Distribution. As a general rule, a shareholder who redeems 
or exchanges his or her shares will recognize long-term capital gain or loss 
if the shares have been held for more than one year, and will recognize 
short-term capital gain or loss if the shares have been held for one year or 
less. However, if a shareholder receives a distribution taxable as long-term 
capital gain with respect to shares of a Fund and redeems or exchanges the 
shares before he or she has held them for more than six months, any loss on 
such redemption or exchange that is less than or equal to the amount of the 
distribution will be treated as a long-term capital loss.

	Backup Withholding. If a shareholder fails to furnish a correct taxpayer 
identification number, fails to fully report dividend or interest income, or 
fails to certify that he or she has provided a correct taxpayer identification 
number and that he or she is not subject to such withholding, then the 
shareholder may be subject to a 31% "backup withholding tax" with respect to 
(a) any taxable dividends and distributions and (b) any proceeds of any 
redemption of Trust shares. An individual's taxpayer identification number is 
his or her social security number. The backup withholding tax is not an 
additional tax and may be credited against a shareholder's regular Federal 
income tax liability.

	Tax-Exempt Income Fund. Because the Tax-Exempt Income Fund will 
distribute exempt-interest dividends, interest on indebtedness incurred by 
shareholders, directly or indirectly, to purchase or carry shares of the Fund 
will not be deductible for Federal income tax purposes. If a shareholder 
redeems or exchanges shares of the Fund with respect to which he receives an 
exempt-interest dividend before holding the shares for more than six months, 
no loss will be allowed on the redemption or exchange to the extent of the 
dividend received. Also, that portion of any dividend from the Fund which 
represents income from private activity bonds other than those issued for 
charitable, educational and certain other purposes held by the Fund may not 
retain its tax-exempt status in the hands of a shareholder who is a 
"substantial user" of a facility financed by such bonds or a person "related" 
to a substantial user. Investors should consult their own tax advisors to see 
whether they may be substantial users or related persons with respect to a 
facility financed by bonds in which the Fund may invest. Moreover, investors 
receiving social security or certain other retirement benefits should be aware 
that tax-exempt interest received from the Fund may under certain 
circumstances cause up to one-half of such retirement benefits to be subject 
to tax. If the Fund receives taxable investment income, it will designate as 
taxable the same percentage of each dividend as the actual taxable income 
bears to the total investment income earned during the period for which the 
dividend is paid. The percentage of each dividend designated as taxable, if 
any, may, therefore, vary. Dividends derived from interest from Municipal 
Securities which are exempt from Federal tax also may be exempt from personal 
income taxes in the state where the issuer is located, but in most cases will 
not be exempt under the tax laws of other states or local authorities. Annual 
statements will set forth the amount of interest from Municipal Securities 
earned by the Fund in each state or possession in which issuers of portfolio 
securities are located.


ADDITIONAL INFORMATION

	The Trust was organized as an unincorporated business trust under the 
laws of the Commonwealth of Massachusetts pursuant to a Master Trust Agreement 
dated March 12, 1985, as amended from time to time, and on November 5, 1992 
the Trust filed an Amended and Restated Master Trust Agreement (the "Trust 
Agreement"). The Trust commenced business as an investment company on 
September 16, 1985, under the name Shearson Lehman Special Portfolios. On 
February 21, 1986, December 6, 1988, August 27, 1990, November 5, 1992, July 
30, 1993 and October 14, 1994, the Trust changed its name to Shearson Lehman 
Special Income Portfolios, SLH Income Portfolios, Shearson Lehman Brothers 
Income Portfolios, Shearson Lehman Brothers Income Funds, Smith Barney 
Shearson Income Funds and Smith Barney Income Funds, respectively.

	PNC Bank is located at 17th and Chestnut Streets, Philadelphia, 
Pennsylvania 19103, and serves as the custodian for each of the Funds, except 
Diversified Strategic Income Fund. Chase, located at Chase Metrotech Center, 
Brooklyn, NY 11245 serves as the custodian for Diversified Strategic Income 
Fund. Under their respective custodian agreements with the respective Funds, 
each custodian is authorized to establish separate accounts for foreign 
securities owned by the appropriate Fund to be held with foreign branches of 
other U.S. banks as well as with certain foreign banks and securities 
depositories. For its custody services to the Trust, each custodian receives 
monthly fees based upon the month-end aggregate net asset value of the 
appropriate Fund, plus certain charges for securities transactions including 
out-of-pocket expenses, and costs of any foreign and domestic sub-custodians. 
The assets of the Trust are held under bank custodianship in compliance with 
the 1940 Act.

	First Data is located at Exchange Place, Boston, Massachusetts 02109, 
and serves as the Trust's transfer agent. Under the transfer agency agreement, 
First Data maintains the shareholder account records for the Trust, handles 
certain communications between shareholders and the Trust and distributes 
dividends and distributions payable by each Fund. For these services First 
Data receives from each Fund a monthly fee computed on the basis of the number 
of shareholder accounts maintained during the year for each Fund and is 
reimbursed for certain out-of-pocket expenses.

FINANCIAL STATEMENTS

The Funds' Annual Reports for the fiscal year ended July 31, 1996, accompany 
this Statement of Additional Information and are incorporated herein by 
reference in their entirety.



APPENDIX

Description of Ratings

Description of S&P Corporate Bond Ratings

	AAA

	Bonds rated AAA have the highest rating assigned by S&P to a debt 
obligation. Capacity to pay interest and repay principal is extremely strong.

	AA

	Bonds rated AA have a very strong capacity to pay interest and repay 
principal and differ from the highest rated issues only in small degree.

	A

	Bonds rated A have a strong capacity to pay interest and repay principal 
although they are somewhat more susceptible to the adverse effects of changes 
in circumstances and economic conditions than bonds in higher rated 
categories.

	BBB

	Bonds rated BBB are regarded as having an adequate capacity to pay 
interest and repay principal. Whereas they normally exhibit adequate 
protection parameters, adverse economic conditions or changing circumstances 
are more likely to lead to a weakened capacity to pay interest and repay 
principal for bonds in this category than for bonds in higher rated 
categories.

	BB, B and CCC

	Bonds rated BB and B are regarded, on balance, as predominantly 
speculative with respect to capacity to pay interest and repay principal in 
accordance with the terms of the obligation. BB represents a lower degree of 
speculation than B and CCC, the highest degrees of speculation. While such 
bonds will likely have some quality and protective characteristics, these are 
outweighed by large uncertainties or major risk exposures to adverse 
conditions.


Description of Moody's Corporate Bond Ratings

	Aaa

	Bonds which are rated Aaa are judged to be the best quality. They carry 
the smallest degree of investment risk and are generally referred to as 
"gilt-edge". Interest payments are protected by a large or exceptionally 
stable margin and principal is secure. While the various protective elements 
are likely to change, such changes as can be visualized are most unlikely to 
impair the fundamentally strong position of such issues.

	Aa

	Bonds which are rated Aa are judged to be of high quality by all 
standards. Together with the Aaa group they comprise what are generally known 
as high grade bonds. They are rated lower than the best bonds because margins 
of protection may not be as large as in Aaa securities, or fluctuation of 
protective elements may be of greater amplitude or there may be other elements 
present which make the long-term risks appear somewhat larger than in Aaa 
securities.

	A

	Bonds which are rated A possess favorable investment attributes and are 
to be considered as upper medium grade obligations. Factors giving security to 
principal and interest are considered adequate but elements may be present 
which suggest a susceptibility to impairment sometime in the future.

	Baa

	Bonds which are rated Baa are considered as medium grade obligations, 
i.e., they are neither highly protected nor poorly secured. Interest payments 
and principal security appear adequate for the present but certain protective 
elements may be lacking or may be characteristically unreliable over any great 
length of time. Such bonds lack outstanding investment characteristics and in 
fact have speculative characteristics as well.

	Ba

	Bonds which are rated Ba are judged to have speculative elements; their 
future cannot be considered as well assured. Often the protection of interest 
and principal payments may be very moderate and thereby not well safeguarded 
during both good and bad times over the future. Uncertainty of position 
characterizes bonds in this class.

	B

	Bonds which are rated B generally lack characteristics of desirable 
investments. Assurance of interest and principal payments or of maintenance of 
other terms of the contract over any long period of time may be small.

	Caa

	Bonds that are rated Caa are of poor standing. These issues may be in 
default or present elements of danger may exist with respect to principal or 
interest.
	Moody's applies the numerical modifier 1, 2 and 3 to each generic rating 
classification from Aa through B. The modifier 1 indicates that the security 
ranks in the higher end of its generic rating category; the modifier 2 
indicates a mid-range ranking; and the modifier 3 indicates that the issue 
ranks in the lower end of its generic rating category.


Description of S&P Municipal Bond Ratings

	AAA

	Prime -- These are obligations of the highest quality. They have the 
strongest capacity for timely payment of debt service.

	General Obligation Bonds -- In a period of economic stress, the issuers 
will suffer the smallest declines in income and will be least susceptible to 
autonomous decline. Debt burden is moderate. A strong revenue structure 
appears more than adequate to meet future expenditure requirements. Quality of 
management appears superior.

	Revenue Bonds -- Debt service coverage has been, and is expected to 
remain, substantial. Stability of the pledged revenues is also exceptionally 
strong due to the competitive position of the municipal enterprise or to the 
nature of the revenues. Basic security provisions (including rate covenant, 
earnings test for issuance of additional bonds, debt service reserve 
requirements) are rigorous. There is evidence of superior management.

	AA

	High Grade -- The investment characteristics of bonds in this group are 
only slightly less marked than those of the prime quality issues. Bonds rated 
AA have the second strongest capacity for payment of debt service.

	A

	Good Grade -- Principal and interest payments on bonds in this category 
are regarded as safe although the bonds are somewhat more susceptible to the 
adverse affects of changes in circumstances and economic conditions than bonds 
in higher rated categories. This rating describes the third strongest capacity 
for payment of debt service. Regarding municipal bonds, the ratings differ 
from the two higher ratings because:

	General Obligation Bonds -- There is some weakness, either in the local 
economic base, in debt burden, in the balance between revenues and 
expenditures, or in quality of management. Under certain adverse 
circumstances, any one such weakness might impair the ability of the issuer to 
meet debt obligations at some future date.

	Revenue Bonds -- Debt service coverage is good, but not exceptional. 
Stability of the pledged revenues could show some variations because of 
increased competition or economic influences on revenues. Basic security 
provisions, while satisfactory, are less stringent. Management performance 
appears adequate.

	BBB

	Medium Grade -- Of the investment grade ratings, this is the lowest. 
Bonds in this group are regarded as having an adequate capacity to pay 
interest and repay principal. Whereas they normally exhibit adequate 
protection parameters, adverse economic conditions or changing circumstances 
are more likely to lead to a weakened capacity to pay interest and repay 
principal for bonds in this category than for bonds in higher rated 
categories.

	General Obligation Bonds -- Under certain adverse conditions, several of 
the above factors could contribute to a lesser capacity for payment of debt 
service. The difference between A and BBB ratings is that the latter shows 
more than one fundamental weakness, or one very substantial fundamental 
weakness, whereas the former shows only one deficiency among the factors 
considered.

	Revenue Bonds -- Debt coverage is only fair. Stability of the pledged 
revenues could show substantial variations, with the revenue flow possibly 
being subject to erosion over time. Basic security provisions are no more than 
adequate. Management performance could be stronger.

	BB, B, CCC and CC

	Bonds rated BB, B, CCC and CC are regarded, on balance, as predominately 
speculative with respect to capacity to pay interest and repay principal in 
accordance with the terms of the obligation. BB includes the lowest degree of 
speculation and CC the highest degree of speculation. While such bonds will 
likely have some quality and protective characteristics, these are outweighed 
by large uncertainties or major risk exposures to adverse conditions.



	C

	The rating C is reserved for income bonds on which no interest is being 
paid.

	D

	Bonds rated D are in default, and payment of interest and/or repayment 
of principal is in arrears.

	S&P's letter ratings may be modified by the addition of a plus or a 
minus sign, which is used to show relative standing within the major rating 
categories, except in the AAA-Prime Grade category.


Description of S&P Municipal Note Ratings

Municipal notes with maturities of three years or less are usually given note 
ratings (designated SP-1, -2 or -3) to distinguish more clearly the credit 
quality of notes as compared to bonds. Notes rated SP-1 have a very strong or 
strong capacity to pay principal and interest. Those issues determined to 
possess overwhelming safety characteristics are given the designation of 
SP-1+. Notes rated SP-2 have satisfactory capacity to pay principal and 
interest.


Description of Moody's Municipal Bond Ratings

	Aaa

	Bonds which are rated Aaa are judged to be the best quality. They carry 
the smallest degree of investment risk and are generally referred to as "gilt 
edge". Interest payments are protected by a large or by an exceptionally 
stable margin and principal is secure. While the various protective elements 
are likely to change, such changes as can be visualized are most unlikely to 
impair the fundamentally strong position of such issues.

	Aa

	Bonds which are rated Aa are judged to be of high quality by all 
standards. Together with the Aaa group they comprise what are generally known 
as high grade bonds. They are rated lower than the best bonds because margins 
of protection may not be as large as in Aaa securities, or fluctuation of 
protective elements may be of greater amplitude, or there may be other 
elements present which make the long-term risks appear somewhat larger than in 
Aaa securities.

	A

	Bonds which are rated A possess many favorable investment attributes and 
are to be considered as upper medium grade obligations. Factors giving 
security to principal and interest are considered adequate, but elements may 
be present which suggest a susceptibility to impairment sometime in the 
future.

	Baa

	Bonds which are rated Baa are considered as medium grade obligations, 
i.e., they are neither highly protected nor poorly secured. Interest payments 
and principal security appear adequate for the present but certain protective 
elements may be lacking or may be characteristically unreliable over any great 
length of time. Such bonds lack outstanding investment characteristics and in 
fact have speculative characteristics as well.

	Ba

	Bonds which are rated Ba are judged to have speculative elements; their 
future cannot be considered as well assured. Often the protection of interest 
and principal payments may be very moderate and thereby not well safeguarded 
during both good and bad times over the future. Uncertainty of position 
characterize bonds in this class.

	B

	Bonds which are rated B generally lack characteristics of the desirable 
investment. Assurance of interest and principal payments or of maintenance of 
other terms of the contract over any long period of time may be small.

	Caa

	Bonds which are rated Caa are of poor standing. Such issues may be in 
default or there may be present elements of danger with respect to principal 
or interest.

	Ca

	Bonds which are rated Ca represent obligations which are speculative in 
a high degree. Such issues are often in default or have other marked 
shortcomings.

	C

	Bonds which are rated C are the lowest rated class of bonds, and issues 
so rated can be regarded as having extremely poor prospects of ever attaining 
any real investment standing.
	Moody's applies the numerical modifiers 1, 2 and 3 in each generic 
rating classification from Aa through B. The modifier 1 indicates that the 
security ranks in the higher end of its generic ratings category; the modifier 
2 indicates a mid-range ranking; and the modifier 3 indicates that the issue 
ranks in the lower end of its generic ratings category.


Description of Moody's Municipal Note Ratings

Moody's ratings for state and municipal notes and other short-term loans are 
designated Moody's Investment Grade (MIG) and for variable rate demand 
obligations are designated Variable Moody's Investment Grade (VMIG). This 
distinction recognizes the differences between short- and long-term credit 
risk. Loans bearing the designation MIG 1/VMIG 1 are the best quality, 
enjoying strong protection from established cash flows of funds for their 
servicing or from established and broad-based access to the market for 
refinancing, or both. Loans bearing the designation MIG 2/VMIG 2 are of high 
quality, with margins of protection ample, although not as large as the 
preceding group. Loans bearing the designation MIG 3/VMIG 3 are of favorable 
quality, with all security elements accounted for but lacking the undeniable 
strength of the preceding grades. Market access for refinancing, in 
particular, is likely to be less well established. Loans bearing the 
designation MIG 4/VMIG 4 are of adequate quality. Protection commonly regarded 
as required of an investment security is present and although not distinctly 
or predominantly speculative, there is specific risk.


Description of Commercial Paper Ratings

The rating A-1+ is the highest, and A-1 the second highest, commercial paper 
rating assigned by S&P. Paper rated A-1+ must have either the direct credit 
support of an issuer or guarantor that possesses excellent long-term operating 
and financial strength combined with strong liquidity characteristics 
(typically, such issuers or guarantors would display credit quality 
characteristics which would warrant a senior bond rating of A- or higher) or 
the direct credit support of an issuer or guarantor that possesses above 
average long-term fundamental operating and financing capabilities combined 
with ongoing excellent liquidity characteristics. Paper rated A-1 must have 
the following characteristics: liquidity ratios are adequate to meet cash 
requirements; long-term senior debt is rated A or better; the issuer has 
access to at least two additional channels of borrowing; basic earnings and 
cash flow have an upward trend with allowance made for unusual circumstances; 
typically, the issuer's industry is well established and the issuer has a 
strong position within the industry; and the reliability and quality of 
management are unquestioned.

	The rating Prime-1 is the highest commercial paper rating assigned by 
Moody's. Among the factors considered by Moody's in assigning ratings are the 
following: (a) evaluation of the management of the issuer; (b) economic 
evaluation of the issuer's industry or industries and an appraisal of 
speculative-type risks which may be inherent in certain areas; (c) evaluation 
of the issuer's products in relation to competition and customer acceptance; 
(d) liquidity; (e) amount and quality of long-term debt; (f) trend of earnings 
over a period of ten years; (g) financial strength of parent company and the 
relationships which exist with the issue; and (h) recognition by the 
management of obligations which may be present or may arise as a result of 
public interest questions and preparations to meet such obligations.

	Short-term obligations, including commercial paper, rated A-1+ by IBCA 
Limited or its affiliate IBCA Inc. are obligations supported by the highest 
capacity for timely repayment. Obligations rated A-1 have a very strong 
capacity for timely repayment. Obligations rated A-2 have a strong capacity 
for timely repayment, although such capacity may be susceptible to adverse 
changes in business, economic and financial conditions.

	Thomson BankWatch employs the rating "TBW-1" as its highest category, 
which indicates that the degree of safety regarding timely repayment of 
principal and interest is very strong. "TBW-2" is its second highest rating 
category. While the degree of safety regarding timely repayment of principal 
and interest is strong, the relative degree of safety is not as high as for 
issues rated "TBW-1".

	Fitch Investors Services, Inc. employs the rating F-1+ to indicate 
issues regarded as having the strongest degree of assurance of timely payment. 
The rating F-1 reflects an assurance of timely payment only slightly less in 
degree than issues rated F-1+, while the rating F-2 indicated a satisfactory 
degree of assurance of timely payment although the margin of safety is not as 
great as indicated by the F-1+ and F-1 categories. 

	Duff & Phelps Inc. employs the designation of Duff 1 with respect to top 
grade commercial paper and bank money instruments. Duff 1+ indicated the 
highest certainty of timely payment: short-term liquidity is clearly 
outstanding and safety is just below risk-free U.S. Treasury short-term 
obligations. Duff 1- indicates high certainty of timely payment. Duff 2 
indicates good certainty of timely payment: liquidity factors and company 
fundamentals are sound.

	Various NRSROs utilize rankings within ratings categories indicated by a 
+ or -. The Funds, in accordance with industry practice, recognize such 
ratings within categories as gradations, viewing for example S&P's rating of 
A-1+ and A-1 as being in S&P's highest rating category.








								Smith Barney
								INCOME FUNDS





							Statement of
							Additional Information
							November 28, 1996



Convertible Fund



Diversified Strategic Income Fund



Exchange Reserve Fund



High Income Fund



Premium Total Return Fund



Tax-Exempt Income Fund



Utilities Fund











Smith Barney
Income Funds
388 Greenwich Street
New York, New York 10013					SMITH BARNEY
								A Member of Travelers Groups



								FD 01217     11/96


* Effective December 8, 1996; prior to that date, Morgan Guaranty 
Bank of New York will continue to serve as 
custodian to the Diversified Strategic Income Fund.
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SMITH BARNEY INCOME FUNDS
PART C

Item 24.	Financial Statements and Exhibits

(a)	Financial Statements:

		Included in Part A:

			Financial Highlights

		Included in Part B:
   
		The Registrant's Annual Reports for the fiscal year ended July 31, 
1996 and the Report of Independent Auditors dated September 23, 
1996 are incorporated by reference to the Definitive 30b2-1 filed 
on October 7, 1996 as Accession #0000091155-96-000407.
    
		Included in Part C:

			Consent of Auditors     is filed herein.     

(b)	Exhibits

	All references are to the Registrant's registration statement on Form 
N-1A (the "Registration Statement") as filed with the Securities and Exchange 
Commission (the "SEC") on March 13, 1985 (File Nos. 2-96408 and 811-4254).

	(1)	Registrant's First Amended and Restated Master Trust Agreement 
dated November 5, 1993 and Amendment No. 1 to the Master Trust 
Agreement dated July 30, 1993 are incorporated by reference to 
Post-Effective Amendment No. 36.

	(2)	Registrant's By-Laws are incorporated by reference to the 
Registration Statement.

	(3)	Not Applicable.

	(4)	Registrant's form of stock certificates for Class A, Class B, 
Class C and Class Y shares of beneficial interest in each of its 
sub-trusts are incorporated by reference to Post-Effective 
Amendment No. 34 to the Registration Statement.

	(5)(a)	Transfer of Investment Advisory Agreements between the 
Registrant and Smith Barney Mutual Funds Management with respect 
to Smith Barney Diversified Strategic Income Fund, Smith Barney 
Utilities Fund, Smith Barney Convertible Securities Fund, Smith 
Barney High Income Fund, Smith Barney Tax-Exempt Income Fund and 
Smith Barney Exchange Reserve Fund are incorporated by reference 
to Post-Effective Amendment No. 40. 

	(b)	Investment Advisory Agreement between Registrant and Smith Barney 
Strategy Advisers Inc. with respect to Smith Barney Premium Total 
Return Fund is incorporated by reference to Post-Effective 
Amendment No. 41 to the Registration Statement.

	(c)	Sub-Investment Advisory Agreement among the Registrant, Smith 
Barney Strategy Advisers, Inc. and Boston Partners Asset 
Management, L.P with respect to Smith Barney Premium Total Return 
Fund is incorporated by reference to Post-Effective Amendment No. 
41 to the Registration Statement.

	(d)	Sub-Investment Advisory Agreement between the Registrant and Smith 
Barney Global Capital Management Inc. with respect to Smith Barney 
Diversified Strategic Income Fund is incorporated by reference to 
Post-Effective Amendment No. 40.
   
	(6)(a)	Distribution Agreement between the Registrant and Smith 
Barney Inc. is incorporated by reference to the Post-Effective 
Amendment No. 40.

     (b)	Distribution Agreement between the Registrant and PFS 
Distributors, Inc. is filed herein.    

	(7)	Not Applicable.

	(8)(a)	Custodian Agreement between the Registrant and PNC Bank, 
National Association ("PNC Bank") is incorporated by reference to 
Post-Effective Amendment No. 41 to the Registration Statement.
   
	(b)	A form of Custodian Agreement between the Registrant and Chase 
Manhattan Bank is filed herein.
    
	(9)(a)	Administration Agreement between the Registrant and SBMFM is 
incorporated by reference to Post-Effective Amendment No. 40.

	(b)	Transfer Agency and Registrar Agreement between the Registrant and 
First Data Investor Services Group, Inc., (formerly The 
Shareholder Services Group, Inc.) is incorporated by reference to 
Post-Effective Amendment No. 40 to the Registration Statement.

	(10)	Opinion of Counsel was filed with Registrant's 24f-2 Notice on 
   September 27, 1996 as accession number 0000764624-96000002.    

	(11)	   Consent of KPMG Peat Marwick LLP is filed herein.    

	(12)	Not Applicable.

	(13)	Not Applicable.

	(14)	Not Applicable.

	(15)(a)	Services and Distribution Plans pursuant to Rule 12b-1 
between the Registrant on behalf of Smith Barney Diversified 
Strategic Income Fund, Smith Barney Utilities Fund, Smith Barney 
Convertible Securities Fund, Smith Barney High Income Fund, Smith 
Barney Premium Total Return Fund, Smith Barney Tax-Exempt Income 
Fund and Smith Barney Exchange Reserve Fund are incorporated by 
reference to Post-Effective Amendment No. 40.

	(16)	Performance Data for Registrant is incorporated by reference to 
Post-Effective Amendments No. 14, 15 and 30 to the Registration 
Statement filed on September 30, 1988, December 30, 1988 and 
January 29, 1992, respectively.

	(17)	    Financial Data Schedule is filed herein    .

	(18)	Plan pursuant to Rule 18f-3 is incorporated by reference to Post-
Effective Amendment No. 41 to the Registration Statement.

Item 25		Persons Controlled by or Under Common Control with
		Registrant
		None.

Item 26		Number of Holders of Securities

	(1)					(2)
						Number of Record Holders
Title of Class					by Class as of    November 25, 
1996    

Beneficial Interest par value
$.001 per share

Fund
Class A
Class B
Class C
Class Y
Class Z

Convertible 
Securities
3,698
3,814
62
4
___

Diversified Strategic 
Income
Fund
14,474
110,586
2,523
5
5

Exchange Reserve Fund
___
7,213
490
0
___

High Income Fund
23,204
30,117
1,108
9
7

Premium Total Return 
Fund
39,833
128,175
2,731
3
___

Tax-Exempt Income
7,779
16,120
30
2
___

Utilities Fund
27,084
91,454
813
5
10


Item 27	Indemnification

The response to this item is incorporated by reference to Registrant's 
Post-Effective Amendment No. 2 to the Registration Statement.

Item 28(a)	Business and Other Connections of Investment Adviser

Investment Adviser - - Smith Barney Mutual Funds Management Inc. ("SBMFM")

SBMFM, formerly known as Smith, Barney Advisers, Inc. SBMFM was incorporated 
in December 1968 under the laws of the State of Delaware. SBMFM is a wholly 
owned subsidiary of Smith Barney Holdings Inc. ("Holdings") (formerly known as 
Smith Barney Shearson Holdings Inc.), which in turn is a wholly owned 
subsidiary of Travelers Group Inc. (formerly known as Primerica Corporation) 
("Travelers"). SBMFM is registered as an investment adviser under the 
Investment Advisers Act of 1940 (the "Advisers Act").

The list required by this Item 28 of officers and directors of SBMFM together 
with information as to any other business, profession, vocation or employment 
of a substantial nature engaged in by such officers and directors during the 
past two fiscal years, is incorporated by reference to Schedules A and D of 
FORM ADV filed by SBMFM pursuant to the Advisers Act (SEC File No. 801-14437).

Item 28(a)	Business and Other Connections of Investment Adviser

Investment Adviser - Smith Barney Strategy Advisers Inc. ("Strategy Advisers")

Strategy Advisers was incorporated on October 22, 1986 under the laws of the 
State of Delaware. On June 1, 1994, Strategy Advisers changed its name from 
Smith Barney-Shearson Strategy Advisers Inc. to its current name. Strategy 
Advisers is a wholly owned subsidiary of SBMFM. Strategy Advisers is 
registered as an investment adviser under the Investment Advisers Act of 1940 
(the "Advisers Act"). Strategy Advisers is also registered with the Commodity 
Futures Trading Commission (the "CFTC") as a commodity pool operator under the 
Commodity Exchange Act (the "CEA"), and is a member of the National Futures 
Association (the "NFA").

The list required by this Item 28 of officers and directors of SBMFM and 
Strategy Advisers, together with information as to any other business, 
profession, vocation or employment of a substantial nature engaged in by such 
officers and directors during the past two years, in incorporated b reference 
to Schedules A and D of FORM ADV filed by SBMFM on behalf of Strategy Advisers 
pursuant to the Advisers Act (SEC File No. 801-8314).

Item 28(b)	Business and Other Connections of Sub-Investment Adviser

Sub-Investment Adviser - Boston Partners Asset Management, L.P. ("Boston 
Partners")

Boston Partners was organized in April, 1995 under the laws of the State of 
Delaware as a Limited Partnership and provides a comprehensive range of 
financial products and services in domestic and selected international 
markets. Boston Partners is an investment adviser registered under the 
Investment Advisers Act of 1940 (the "Advisers Act") and provides investment 
advice to endowment plans, Taft Hartley Health and Welfare Plans, VEBAS and 
institutional clients. It also serves as investment adviser and sub-investment 
adviser to other investment companies.

The list required by this Item 28 of officers and directors of Boston 
Partners, together with information as to any other business profession, 
vocation or employment of a substantial nature engaged in by such officers and 
directors during the past two years, is incorporated by reference to Schedules 
A and D of FORM ADV filed by Boston Partners pursuant to the Advisers Act (SEC 
File No. 801-49059).

Item 28(b)	Business and Other Connections of Sub-Investment Adviser

Sub-Investment Adviser - Smith Barney Global Capital Management Inc. ("SBGCM")

SBGCM was incorporated on January 22, 1988 under the laws of the State of 
Delaware. SBGCM is an indirect wholly owned subsidiary of Holdings. SBGCM is 
an investment adviser registered with the Securities and Exchange Commission 
in the United States and with the Investment Management Regulatory  
Organization Limited in the United Kingdom. SBGCM conducts its operations 
primarily in the United Kingdom.

The list required by this Item 28 of officers and directors of SBGCM, together 
with information as to any other business, profession, vocation or employment 
of a substantial nature engaged in by such officers and directors during the 
past two years, is incorporated by reference to Schedules A and D of FORM ADV 
filed by SBGCM pursuant to the Advisers Act (SEC File No. 801-31824).

Item 29.     Principal Underwriters

Smith Barney Inc. ("Smith Barney") currently acts as distributor for Smith 
Barney Managed Municipals Fund Inc., Smith Barney California Municipals Fund 
Inc., Smith Barney Massachusetts Municipals Fund, Smith Barney Aggressive 
Growth Fund Inc., Smith Barney Appreciation Fund Inc.,    Smith Barney Concert 
Series Fund Inc.;     Smith Barney Principal Return Fund, Smith Barney Managed 
Governments Fund Inc., Smith Barney Income Funds, Smith Barney Equity Funds, 
Smith Barney Investment Funds Inc., Smith Barney     Natural Resources     
Fund Inc., Smith Barney Telecommunications Trust, Smith Barney Arizona 
Municipals Fund Inc., Smith Barney New Jersey Municipals Fund Inc., The USA 
High Yield Fund N.V., Garzarelli Sector Analysis Portfolio N.V., Smith Barney 
Fundamental Value Fund Inc., Smith Barney Series Fund, Consulting Group 
Capital Markets Funds, Smith Barney    Investment     Trust, Smith Barney 
Adjustable Rate Government Income Fund, Smith Barney Florida Municipals Fund, 
Smith Barney Oregon Municipals Fund, Smith Barney Funds, Inc., Smith Barney 
Muni Funds, Smith Barney World Funds, Inc., Smith Barney Money Funds, Inc., 
Smith Barney Tax Free Money Fund, Inc., Smith Barney Variable Account Funds, 
Smith Barney U.S. Dollar Reserve Fund (Cayman), Worldwide Special Fund, N.V., 
Worldwide Securities Limited, (Bermuda), Smith Barney International Fund 
(Luxembourg) and various series of unit investment trusts.

Smith Barney is a wholly owned subsidiary of Holdings. On June 1, 1994, Smith 
Barney changed its name from Smith Barney Shearson Inc. to its current name. 
The information required by this Item 29 with respect to each director, 
officer and partner of Smith Barney is incorporated by reference to Schedule A 
of FORM BD filed by Smith Barney pursuant to the Securities Exchange Act of 
1934 (SEC File No. 812-8510).

PFS Distributors (PFS) currently acts as distributor for: Smith Barney 
Appreciation Fund Inc.; Smith Barney Investment Funds; Common Sense Growth; 
Common Sense Growth/Income; Common Sense Government; Common Sense Money 
Market; Common Sense Municipal Bond; CSII Aggressive Opportunity A and B; CSII 
Growth A and B; CSII Growth/Income A and B;CSII Government A and B; CSII 
Emerging Growth A and B; CSII International Equity and B.

Item 30	Location of Accounts and Records

		(1)	Smith Barney Inc.
			388 Greenwich Street
			New York, New York  10013

		(2)	Smith Barney Income Funds
			388 Greenwich Street
			New York, New York  10013

		(3)	Smith Barney Mutual Funds Management Inc.
			388 Greenwich Street
			New York, New York  10013

		(4)	Boston Partners Asset Management, L.P.
			One Financial Center
			43rd floor
			Boston, Massachusetts  02111

		(5)	Smith Barney Global Capital Management Inc.
			10 Piccadilly
			London W1V 9LA
			England

		(6)	PNC Bank, National Association
			17th and Chestnut Streets
			Philadelphia, PA  19103

		(7)	    First Data Investor      Services Group, Inc.
			One Exchange Place
			Boston, Massachusetts  02109

		(8)	PFS Shareholder Services
			3100 Breckinridge Blvd., Bldg. 200
			Duluth, Georgia 30199-0062

Item 31	Management Services

	Not Applicable.

Item 32	Undertakings

	(a)	The Registrant hereby undertakes to call a meeting of its 
shareholders for the purpose of voting upon the question of 
removal of a trustee or trustees of Registrant when requested in 
to do so by the holders of at least 10% of Registrant's 
outstanding shares. Registrant undertakes further, in connection 
with the meeting, to comply with the provisions of Section 16(c) 
of the 1940 Act relating to communications with the shareholders 
of certain common-law trusts.


	SIGNATURES

	Pursuant to the requirements of the Securities Act of 1933, as amended, 
and the Investment Company Act of 1940, as amended, the Registrant, SMITH 
BARNEY INCOME FUNDS, has duly caused this Amendment to the Registration 
Statement to be signed on its behalf by the undersigned, thereunto duly 
authorized, all in the City of New York, State of New York on the 27th day 
of    November,     1996.

	SMITH BARNEY INCOME FUNDS

						By: /s/ Heath B. McLendon
						Heath B. McLendon, Chairman of the Board

	Pursuant to the requirements of the Securities Act of 1933, as amended, 
this Post-Effective Amendment to the Registration Statement has been signed 
below by the following persons in the capacities and on the dates indicated.

Signature				Title				Date


/s/ Heath B. McLendon		Chairman of the Board			11/27/96
Heath B. McLendon		(Chief Executive Officer)


/s/ Lewis E. Daidone			Senior Vice President and	11/27/96
Lewis E. Daidone			Treasurer (Chief Financial
					and Accounting Officer)


/s/ Lee Abraham*			Trustee				11/27/96
Lee Abraham


/s/ Antoinette C. Bentley*		Trustee				11/27/96
Antoinette C. Bentley


/s/ Allan J. Bloostein*			Trustee				11/27/96
Allan J. Bloostein


/s/ Madelon Devoe-Talley*		Trustee				11/27/96
Madelon Devoe-Talley


/s/ Richard E. Hanson*		Trustee					11/27/96
Richard E. Hanson



* Signed by    Heath B. McLendon,     their duly authorized attorney-in-fact, 
pursuant to power of attorney dated    September 4, 1996    .


/s/ Heath B. McLendon
Heath B. McLendon




EXHIBITS


 Exhibit No.	Description of Exhibits

6(b)		Distribution Agreement between the Registrant and PFS 
Distributors, Inc.
 
8(b)	A form of Custodian Agreement between the Registrant and Chase 
Manhattan Bank

11		Consent of Auditors

17		Financial Data Schedule

	 	Cover Letter to SEC







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