N-30D/A 1 f90322nv30dza.txt SCHWAB TAXABLE BOND FUNDS SEMIANNUAL REPORT Schwab Taxable Bond Funds SEMIANNUAL REPORT February 28, 2003 Schwab Short-Term Bond Market Fund Schwab Total Bond Market Fund [CHARLES SCHWAB LOGO] A smart, cost-effective way investors can use bonds in an asset allocation strategy. In this report Management's discussion................................................. 2 The president of SchwabFunds(R) and the funds' manager take a look at the factors that shaped fund performance during the report period. Fund performance and related data Fund and index performance data, fund facts, portfolio holdings and fund financials. Schwab Short-Term Bond Market Fund................................... 6 Ticker Symbol: SWBDX The fund seeks current income by tracking the performance of the Lehman Brothers Mutual Fund Short (1-5 Year) U.S. Government/Credit Index. Schwab Total Bond Market Fund........................................ 15 Ticker symbol: SWLBX The fund seeks current income by tracking the performance of the Lehman Brothers U.S. Aggregate Bond Index. Financial notes ........................................................ 26 Glossary ............................................................... 29 FROM THE CHAIRMAN [PHOTO OF CHARLES R. SCHWAB] Charles R. Schwab Chairman As this report goes to press, Americans are focusing on the war in Iraq. That's true for America's securities markets as well, since the war's potential implications for the world's economies and markets are huge. Fortunately, there are ways that you as an investor can position your portfolio to deal with uncertainty. One way is to focus on asset allocation and the role of each asset class in a diversified portfolio. The role of bond investments in a portfolio is to provide regular income and potentially to reduce the effects on the portfolio of volatility in stock investments. In fact, history shows that adding bond investments to a portfolio can reduce overall volatility while still delivering competitive returns. It's one main reason why our range of mutual funds includes a number of bond choices as well as stock and money market funds. As you read this report, you may notice that we've introduced a few changes. One change is that we've added a letter from Randy Merk, the president of the funds. Randy brings to the job a great deal of experience in financial services, and in mutual funds in particular. We're glad to have his expert leadership, and we welcome his insights in these reports. On behalf of SchwabFunds(R), I'd like to thank you for investing with us. Your continued trust and support mean a great deal to us, and it's our goal to respond to them by doing everything we can to help you meet your financial goals. Sincerely, /s/ Charles Schwab MANAGEMENT'S DISCUSSION September 1, 2002--February 28, 2003 [PHOTO OF RANDALL W. MERK] RANDALL W. MERK is President and CEO of Charles Schwab Investment Management, Inc. and is president of each of the funds covered in this report. He joined the firm in August of 2002 and has nearly a quarter-century of experience in the asset management industry. Dear Shareholder: As one of the newer members of the SchwabFunds(R) team, I've been impressed with the talent and integrity of the people here. Above all, I've been impressed with the dedication they show to understanding the needs and concerns of our shareholders. That dedication is particularly important right now. Times of market volatility and uncertainty about world events seem to demand a heightened level of diligence on the part of investment professionals. At SchwabFunds we are keenly aware of this, and we're working hard to uphold the best interests of our shareholders. There are many issues on the table for mutual funds at the moment. These include changes in corporate governance practices (many of which affect mutual funds), the requirements of the Sarbanes-Oxley Act, and new regulations affecting disclosures of proxy voting practices. These changes are still relatively new, and in some cases are not yet fully defined. However, they all have the potential to benefit shareholders, and I want to assure you that we'll keep you informed of the progress we are making with these issues. In the meantime, it is worth keeping in mind that many things about mutual fund investing remain unchanged. In particular, time-tested investment practices such as asset allocation and diversification remain as appropriate as ever. In closing, let me thank you for choosing SchwabFunds for your mutual fund investments. We're committed to helping you reach your financial goals in every way we can. If there is something more that we can do, I hope you'll let us know. Sincerely, /s/ Randall W. Merk Schwab Taxable Bond Funds 2 [PHOTO OF KIM DAIFOTIS] KIM DAIFOTIS, CFA, a vice president and senior portfolio manager of the investment adviser, has overall responsibility for management of the funds. He joined the firm in 1997, and has over 20 years of experience in fixed-income research and asset management. THE ECONOMY A PERIOD OF CONTINUED MODEST GROWTH FOR THE ECONOMY, BUT ALSO ONE OF UNCERTAINTY AND CONCERN. The report period saw the U.S. economy behaving more or less as it has since late 2001. Economic growth was weak but not negative, consumer spending retreated a bit but was still the economy's mainstay, and the spectre of deflation remained at bay. In Washington, the government pushed on the economy to try to get it moving again--the Federal Reserve by cutting interest rates yet further (by a half-point in November 2002), the president and Congress by advancing new fiscal and tax policies. However, this generally positive news was accompanied by a number of concerns, including geopolitical risks, ongoing corporate governance issues and the conspicuous absence of long-awaited improvements in economic output. With few signs that were truly encouraging and a host of issues whose outcome and effect on the economy were anything but clear, stock prices continued their long decline. THE MARKET BONDS CONTINUED TO OUTPERFORM OTHER MAJOR TYPES OF INVESTMENTS. Historically, times of trial and uncertainty tend to be bad for stocks and good for bonds, and this report period was no exception. The report period began with yields falling and prices rising, especially among Treasury and government agency issues. This trend had been in place during the YIELD CURVE: Average yields of AAA securities of six maturities [LINE GRAPH]
Maturity 9/1/2002 2/28/2003 3 Month 1.67 1.19 6 Month 1.66 1.18 2 Year 2.13 1.51 5 Year 3.22 2.66 10 Year 4.14 3.69 30 Year 4.93 4.67
THE YIELD CURVE GREW STEEPER DURING THE REPORT PERIOD AS RATES AT THE SHORT-MATURITY END OF THE SCALE CONTINUED TO FALL, PUSHED DOWN BY THE FEDERAL RESERVE'S NOVEMBER 2002 RATE CUT AND BY HIGH DEMAND FOR BONDS. This chart shows where yields stood at the beginning of the report period and at the end of the period. For debt securities of comparable quality, those with longer maturities typically pay higher interest rates, because they are presumed to carry higher risk. Data source: Bloomberg L.P. 3 MANAGEMENT'S DISCUSSION continued BOND INVESTORS WERE SAFETY-MINDED AS THE REPORT PERIOD OPENED, SEEKING SECURITIES WITH HIGHER CREDIT QUALITY, BUT SOON BEGAN BUYING FOR YIELD AS MUCH AS QUALITY. months leading into this report period, driven by declining short-term interest rates and high demand from investors moving assets out of stocks and corporate bonds. In November, corporate bond prices began to rally. The long flight to quality had pushed Treasury yields so low (and prices so high) that corporate bonds were offering a significant yield premium. Investors began to show interest in corporates again, perhaps figuring (as we did) that their risks had become adequately reflected in their comparatively low prices. As of the report date, the bond market seemed caught between two possible scenarios. Further economic weakness could mean continued low interest rates and high demand for quality bonds. But economic improvement could result in the opposite scenario, pushing yields up and prices down. In a textbook economic recovery, short-term interest rates rise, sometimes rather rapidly, while longer term rates, which tend to be more a reflection of long-term yield averages, are less dramatically affected. As of the end of the report period, this had not yet occurred. If it does, shorter-term bonds are likely to be under the most price pressure. THE FUNDS DURING THE REPORT PERIOD, BOTH FUNDS POSTED NET GAINS, REDUCED THEIR TRACKING ERROR AND EXCEEDED THE AVERAGE PERFORMANCE OF THEIR RESPECTIVE CATEGORIES (see details in performance sections, pages 6 and 15). One of our main tasks this report period was to look for ways to better insulate the funds from the type of credit risk that caused them to lag their benchmarks for the 12 months prior to this report period. The main step we took was to increase diversification. Both funds now hold more issues in their portfolios and have smaller positions in most issues. A second step was to slightly overweight bonds from industrial issuers and slightly underweight bonds from utilities issuers, compared to the benchmarks. Schwab Taxable Bond Funds 4 MANAGEMENT STRATEGIES IMPLEMENTED NEAR THE BEGINNING OF THE PERIOD HELPED EACH FUND PERFORM WELL IN ITS CATEGORY AND NARROW THE GAP WITH ITS BENCHMARK. The type of risk that contributed to the funds' earlier underperformance of their respective benchmarks--the sudden, surprise collapse of several highly rated bond issues (because of corporate scandals)--was almost without historical precedent. We believe this type of risk will continue to be rare, but it will also remain virtually impossible to predict. Accordingly, we see the funds' increased diversification and the potential for modest shifts in industry weightings to be the funds' best defense against future problems of this type. As the yield curve shows (see chart on page 3), the movement toward lower rates and higher prices was most pronounced at the short end of the curve, giving a substantial boost to returns for the SCHWAB SHORT-TERM BOND MARKET FUND. Maturities for longer bonds were also affected: in October 2002, 10-year Treasuries saw their lowest yields in approximately 40 years, dipping below 4% (see chart below). Most of the performance of the SCHWAB TOTAL BOND MARKET FUND resulted from yields, but rising prices still contributed approximately a third of total return. As of the end of the period, we believe that the likeliest scenario is the continuation of a modest economic recovery, and we have positioned the funds accordingly. The views expressed here are those of fund management as of the report date and may change subsequent to that date. YIELDS OF U.S. TREASURY SECURITIES: Effective yields of five- and ten-year Treasuries YIELDS REACHED LEVELS NOT SEEN IN OVER 40 YEARS, AS INVESTORS SOUGHT A SAFE HAVEN AND THE FEDERAL RESERVE CUT SHORT-TERM RATES ANOTHER HALF-POINT IN NOVEMBER 2002. Yields, or interest rates, represent the cost of borrowing money. Rapid economic growth, waning investor interest in bonds, an increase in the issuance of bonds, or the expectation of higher inflation can drive rates up, while the opposite conditions can push rates down. Data source: Bloomberg L.P. [LINE GRAPH]
5 Year 10 Year 31-Dec-92 5.99 6.69 Jan-93 5.55 6.36 Feb-93 5.21 6.02 Mar-93 5.24 6.02 Apr-93 5.11 6.01 May-93 5.37 6.15 Jun-93 5.05 5.78 Jul-93 5.15 5.81 Aug-93 4.79 5.45 Sep-93 4.77 5.38 Oct-93 4.85 5.43 Nov-93 5.16 5.82 Dec-93 5.21 5.79 Jan-94 5.02 5.64 Feb-94 5.57 6.13 Mar-94 6.23 6.74 Apr-94 6.64 7.04 May-94 6.76 7.15 Jun-94 6.95 7.32 Jul-94 6.73 7.11 Aug-94 6.8 7.17 Sep-94 7.28 7.6 Oct-94 7.49 7.81 Nov-94 7.79 7.91 Dec-94 7.83 7.82 Jan-95 7.51 7.58 Feb-95 7.04 7.2 Mar-95 7.07 7.2 Apr-95 6.88 7.06 May-95 6.05 6.28 Jun-95 5.97 6.2 Jul-95 6.16 6.43 Aug-95 6.07 6.28 Sep-95 6.02 6.18 Oct-95 5.81 6.02 Nov-95 5.52 5.74 Dec-95 5.38 5.57 Jan-96 5.24 5.58 Feb-96 5.73 6.1 Mar-96 6.09 6.33 Apr-96 6.41 6.67 May-96 6.63 6.85 Jun-96 6.46 6.71 Jul-96 6.57 6.79 Aug-96 6.73 6.94 Sep-96 6.46 6.7 Oct-96 6.07 6.34 Nov-96 5.83 6.04 Dec-96 6.21 6.42 Jan-97 6.25 6.49 Feb-97 6.39 6.55 Mar-97 6.75 6.9 Apr-97 6.57 6.72 May-97 6.5 6.66 Jun-97 6.38 6.5 Jul-97 5.9 6.01 Aug-97 6.22 6.34 Sep-97 5.99 6.1 Oct-97 5.71 5.83 Nov-97 5.84 5.87 Dec-97 5.71 5.74 Jan-98 5.38 5.51 Feb-98 5.59 5.62 Mar-98 5.62 5.65 Apr-98 5.64 5.67 May-98 5.55 5.55 Jun-98 5.47 5.45 Jul-98 5.5 5.49 Aug-98 4.8 4.98 Sep-98 4.22 4.42 Oct-98 4.23 4.61 Nov-98 4.48 4.71 Dec-98 4.54 4.65 Jan-99 4.55 4.65 Feb-99 5.22 5.29 Mar-99 5.1 5.24 Apr-99 5.21 5.35 May-99 5.58 5.62 Jun-99 5.65 5.78 Jul-99 5.79 5.9 Aug-99 5.87 5.97 Sep-99 5.75 5.88 Oct-99 5.96 6.02 Nov-99 6.11 6.19 Dec-99 6.34 6.44 Jan-00 6.68 6.67 Feb-00 6.6 6.41 Mar-00 6.31 6 Apr-00 6.54 6.21 May-00 6.52 6.27 Jun-00 6.19 6.03 Jul-00 6.15 6.03 Aug-00 5.97 5.73 Sep-00 5.85 5.8 Oct-00 5.81 5.75 Nov-00 5.43 5.47 Dec-00 4.98 5.11 Jan-01 4.77 5.11 Feb-01 4.66 4.9 Mar-01 4.56 4.92 Apr-01 4.89 5.34 May-01 4.91 5.38 Jun-01 4.95 5.41 Jul-01 4.53 5.05 Aug-01 4.38 4.83 Sep-01 3.8 4.59 Oct-01 3.48 4.23 Nov-01 4.06 4.75 Dec-01 4.3 5.05 Jan-02 4.37 5.04 Feb-02 4.19 4.88 Mar-02 4.81 5.4 Apr-02 4.41 5.09 May-02 4.36 5.05 Jun-02 4.03 4.8 Jul-02 3.45 4.46 Aug-02 3.22 4.14 Sep-02 2.56 3.6 Oct-02 2.73 3.89 Nov-02 3.27 4.21 Dec-02 2.74 3.82 Jan-03 2.93 3.96 28-Feb-03 2.66 3.69
5 SCHWAB SHORT-TERM BOND MARKET FUND PERFORMANCE as of 2/28/03 AVERAGE ANNUAL TOTAL RETURNS This chart compares performance of the fund with the Lehman Brothers Mutual Fund Short (1-5 Year) U.S. Government/Credit Index, the fund's benchmark index 1 and the Morningstar Short-Term Bond Fund category. As of the end of the report period, the fund's 30-day SEC yield was 2.46%. 2 [BAR CHART]
LEHMAN BROTHERS MUTUAL FUND SHORT (1-5 YEAR) U.S. CATEGORY FUND 2 GOVERNMENT/CREDIT INDEX BENCHMARK 1 AVERAGE 3 6 MONTHS 4 3.53 3.76 3.76 2.63 1 YEAR 7.02 8.12 8.12 5.13 5 YEARS 6.32 7.08 7.08 5.71 10 YEARS 5.56 6.28 6.43 5.55
PERFORMANCE OF A $10,000 INVESTMENT This graph shows performance over ten years of a hypothetical $10,000 investment in the fund, compared with a similar investment in two indices: the Lehman Brothers Mutual Fund Short (1-5 Year) U.S. Government/Credit Index and the fund's benchmark index. 1 $17,171 FUND 2 $18,395 BENCHMARK 1 $18,667 LEHMAN BROTHERS MUTUAL FUND SHORT (1-5 YEAR) U.S. GOVERNMENT/CREDIT INDEX [LINE GRAPH]
Lehman Brothers Mutual Fund Short (1-5 Year) U.S. Fund 2 Benchmark 1 Government/Credit Index 28-Feb-93 10000 10000 10000 Mar-93 10035 10031 10037 Apr-93 10126 10092 10115 May-93 10094 10068 10085 Jun-93 10234 10143 10195 Jul-93 10270 10166 10215 Aug-93 10413 10250 10338 Sep-93 10437 10283 10372 Oct-93 10473 10306 10399 Nov-93 10409 10308 10378 Dec-93 10456 10349 10421 Jan-94 10542 10413 10509 Feb-94 10371 10350 10404 Mar-94 10237 10297 10300 Apr-94 10148 10258 10240 May-94 10112 10272 10252 Jun-94 10124 10298 10269 Jul-94 10212 10390 10384 Aug-94 10238 10425 10418 Sep-94 10200 10401 10363 Oct-94 10208 10425 10376 Nov-94 10151 10381 10323 Dec-94 10161 10401 10345 Jan-95 10299 10542 10504 Feb-95 10435 10685 10685 Mar-95 10494 10745 10746 Apr-95 10582 10841 10859 May-95 10770 11026 11111 Jun-95 10813 11086 11177 Jul-95 10837 11130 11203 Aug-95 10914 11197 11283 Sep-95 10978 11252 11347 Oct-95 11068 11345 11456 Nov-95 11178 11442 11578 Dec-95 11268 11527 11678 Jan-96 11357 11625 11786 Feb-96 11285 11580 11706 Mar-96 11251 11572 11669 Apr-96 11248 11583 11660 May-96 11250 11609 11668 Jun-96 11338 11694 11771 Jul-96 11372 11739 11813 Aug-96 11393 11783 11843 Sep-96 11509 11890 11974 Oct-96 11653 12024 12142 Nov-96 11770 12113 12258 Dec-96 11720 12116 12227 Jan-97 11779 12174 12283 Feb-97 11795 12203 12307 Mar-97 11759 12193 12268 Apr-97 11866 12293 12387 May-97 11951 12379 12477 Jun-97 12044 12465 12576 Jul-97 12215 12601 12762 Aug-97 12186 12613 12744 Sep-97 12294 12709 12863 Oct-97 12406 12803 12979 Nov-97 12440 12835 13003 Dec-97 12526 12921 13098 Jan-98 12662 13045 13250 Feb-98 12641 13057 13250 Mar-98 12691 13103 13296 Apr-98 12748 13167 13362 May-98 12821 13247 13443 Jun-98 12892 13321 13518 Jul-98 12939 13377 13575 Aug-98 13116 13565 13765 Sep-98 13345 13818 14023 Oct-98 13390 13857 14062 Nov-98 13365 13846 14051 Dec-98 13399 13893 14098 Jan-99 13438 13962 14169 Feb-99 13313 13844 14048 Mar-99 13414 13948 14154 Apr-99 13428 13994 14201 May-99 13375 13938 14144 Jun-99 13404 13977 14183 Jul-99 13434 13991 14198 Aug-99 13465 14021 14229 Sep-99 13565 14134 14343 Oct-99 13587 14172 14381 Nov-99 13606 14196 14406 Dec-99 13606 14184 14394 Jan-00 13572 14156 14365 Feb-00 13678 14264 14475 Mar-00 13807 14369 14582 Apr-00 13803 14372 14585 May-00 13861 14415 14628 Jun-00 14047 14614 14830 Jul-00 14136 14718 14936 Aug-00 14268 14858 15077 Sep-00 14400 14996 15218 Oct-00 14464 15060 15283 Nov-00 14628 15224 15450 Dec-00 14846 15450 15678 Jan-01 15031 15685 15917 Feb-01 15131 15813 16047 Mar-01 15240 15943 16179 Apr-01 15265 15962 16198 May-01 15371 16056 16294 Jun-01 15442 16117 16356 Jul-01 15684 16378 16621 Aug-01 15814 16511 16755 Sep-01 16037 16782 17030 Oct-01 16170 16988 17240 Nov-01 15983 16885 17134 Dec-01 15930 16847 17097 Jan-02 15998 16910 17160 Feb-02 16043 17013 17265 Mar-02 15886 16841 17090 Apr-02 16050 17079 17331 May-02 16181 17213 17468 Jun-02 16262 17362 17618 Jul-02 16408 17570 17830 Aug-02 16586 17728 17990 Sep-02 16790 17960 18226 Oct-02 16795 17957 18222 Nov-02 16729 17933 18199 Dec-02 16979 18217 18486 Jan-03 17011 18228 18497 28-Feb-03 17171 18395 18667
All figures on this page assume dividends and distributions were reinvested. Index figures do not include trading and management costs, which would lower performance. Indices are unmanaged, and you cannot invest in them directly. The fund's share price and principal values change, and when you sell your shares they may be worth more or less than what you paid for them. Past performance doesn't indicate future results. 1 The fund changed its benchmark on 2/28/98, when it changed from being a government bond fund to its current strategy. Benchmark performance shown here is the Lehman Brothers Short (1-3 Year) U.S. Government Bond Index from fund inception through 2/28/98 and the Lehman Brothers Mutual Fund Short (1-5 Year) U.S. Government/Credit Index from 3/1/98 through the end of the report period. Benchmark performance for the one-year period is the Lehman Brothers Mutual Fund Short (1-5 Year) U.S. Government/Credit Index. 2 Fund performance reflects expense reductions by the fund's investment adviser (CSIM) and transfer agent and shareholder services agent (Schwab). Without these reductions, the fund's yield would have been 2.33%, and returns would have been lower. These returns do not reflect the deduction of taxes on fund distributions or the redemption of fund shares. 3 Source: Morningstar, Inc. As of 2/28/03, the total number of funds in the Short-Term Bond Fund category for the six-month, one-, five- and ten-year periods was 233, 221, 154 and 62, respectively. 4 Not annualized. Schwab Taxable Bond Funds 6 FUND FACTS as of 2/28/03 FUND CATEGORY
INTEREST RATE SENSITIVITY 1 CREDIT QUALITY 1 Short Medium Long High /X/ / / / / Medium / / / / / / Low / / / / / /
STATISTICS
FUND INDEX 2 --------------------------------------------------------- NUMBER OF HOLDINGS 100 2,261 --------------------------------------------------------- YIELD TO MATURITY 2.54% 2.41% --------------------------------------------------------- WEIGHTED AVERAGE RATE 5.44% 5.02% --------------------------------------------------------- WEIGHTED AVERAGE MATURITY 2.5 yrs 2.7 yrs --------------------------------------------------------- WEIGHTED AVERAGE DURATION 2.4 yrs 2.4 yrs --------------------------------------------------------- WEIGHTED AVERAGE CREDIT QUALITY AA AA --------------------------------------------------------- EXPENSE RATIO for the report period 0.41% 3 -- ---------------------------------------------------------
PORTFOLIO COMPOSITION These charts show three different views of the fund's portfolio: by type of security, credit quality of the security and by remaining maturity. All figures are shown as a percentage of the fund's investments. Holdings may have changed since the report date. BY SECURITY TYPE [PIE CHART] 58.8% U.S. GOVERNMENT SECURITIES 34.9% CORPORATE BONDS 3.3% COMMERCIAL PAPER & OTHER CORPORATE OBLIGATIONS 2.3% ASSET-BACKED OBLIGATIONS 0.7% OTHER INVESTMENTS
BY CREDIT QUALITY 4 [PIE CHART] 65.5% AAA 5.9% AA 11.5% A 13.8% BBB 3.3% BB
BY MATURITY [PIE CHART] 9.1% 0-6 MONTHS 57.2% 7-36 MONTHS 31.9% 37-60 MONTHS 1.8% MORE THAN 60 MONTHS
1 Source: Morningstar, Inc. Interest rate sensitivity and credit quality are two main components of bond performance. The assessment reflects the fund's portfolio as of 2/28/03, which may have changed since then, and is not a precise indication of risk or performance--past, present or future. Definitions of style box categories: Sensitivity (measured as duration): Short, up to 3.5 years; Medium, more than 3.5 years to less than six years; Long, six years or greater. Credit quality: High, AA or better; Medium, A or BBB; Low, BB or lower. 2 The Lehman Brothers Mutual Fund Short (1-5 Year) U.S. Government/Credit Index. 3 Guaranteed by Schwab and the investment adviser (excluding interest, taxes and certain non-routine expenses) not to exceed 0.45% until 11/15/03. For further detail, please reference the Statement of Operations on page 13. 4 Based on ratings by Standard & Poor's and Moody's. Where ratings are different, the chart uses the higher rating. 7 SCHWAB SHORT-TERM BOND MARKET FUND -- Financials Financial tables These tables provide additional data on the fund's performance, portfolio holdings and business operations. Complementing the tables is the financial notes section at the end of this report, which describes the fund's business structure, accounting practices and other matters. Because this is a semiannual report, information for the current period is unaudited. Look online at WWW.SCHWAB.COM/SCHWABFUNDS/HOW2READ for guides that are designed to help you read the financial tables in any SchwabFunds(R) shareholder report. FINANCIAL HIGHLIGHTS
9/1/02- 9/1/01- 9/1/00- 9/1/99- 9/1/98- 9/1/97- 2/28/03 8/31/02 8/31/01 8/31/00 8/31/99 8/31/98 ---------------------------------------------------------------------------------------------------------- PER-SHARE DATA ($) ---------------------------------------------------------------------------------------------------------- Net asset value at beginning of period 10.07 10.08 9.65 9.66 9.90 9.74 --------------------------------------------------------- Income from investment operations: Net investment income 0.18 0.50 0.59 0.57 0.50 0.56 Net realized and unrealized gains or losses 0.17 (0.02) 0.43 (0.01) (0.24) 0.17 --------------------------------------------------------- Total income from investment operations 0.35 0.48 1.02 0.56 0.26 0.73 Less distributions: Dividends from net investment income (0.18) (0.49) (0.59) (0.57) (0.50) (0.57) --------------------------------------------------------- Net asset value at end of period 10.24 10.07 10.08 9.65 9.66 9.90 --------------------------------------------------------- Total return (%) 3.53 1 4.88 10.84 5.97 2.66 7.64 RATIOS/SUPPLEMENTAL DATA (%) ---------------------------------------------------------------------------------------------------------- Ratio of net operating expenses to average net assets 0.41 2 0.35 0.35 0.35 3 0.35 0.46 Expense reductions reflected in above ratio 0.16 2 0.28 0.31 0.32 0.42 0.39 Ratio of net investment income to average net assets 3.65 2 4.95 5.90 5.91 5.11 5.58 Portfolio turnover rate 72 150 248 129 195 128 Net assets, end of period ($ x 1,000,000) 595 493 369 219 218 157
1 Not annualized. 2 Annualized. 3 Would have been 0.36% if certain non-routine expenses (proxy fees) had been included. See financial notes. 8 PORTFOLIO HOLDINGS As of February 28, 2003; unaudited. This section shows all the securities in the fund's portfolio and their market value, as of the report date. We use the symbol below to designate the top ten holdings; the number in the circle is the security's rank among the top ten. (1) Top ten holding For fixed rate obligations, the rate shown is the interest rate (the rate established when the obligation was issued) and the maturity date shown is the stated legal maturity. For variable-rate obligations, the rate shown is the rate as of the report date, and the maturity shown is the later of the next interest rate change date or demand date.
COST MARKET VALUE HOLDINGS BY CATEGORY ($X1, 000) ($X1, 000) -------------------------------------------------------- 58.8% U.S. GOVERNMENT SECURITIES 351,646 361,246 34.9% CORPORATE BONDS 208,275 214,455 2.3% ASSET BACKED OBLIGATIONS 14,441 14,497 0.5% MUNICIPAL BONDS 3,000 3,057 3.3% COMMERCIAL PAPER & OTHER CORPORATE OBLIGATIONS 20,098 20,100 0.2% OTHER INVESTMENT COMPANIES 958 958 -------------------------------------------------------- 100.0% TOTAL INVESTMENTS 598,418 614,313
SECURITY FACE VALUE MKT. VALUE RATE, MATURITY DATE ($ x 1,000) ($ x 1,000) U.S. GOVERNMENT SECURITIES 58.8% of investments U.S. TREASURY OBLIGATIONS 38.5% -------------------------------------------------- U.S. TREASURY NOTES 3.00%, 02/29/04 5,000 5,089 3.63%, 03/31/04 5,000 5,129 3.38%, 04/30/04 8,000 8,197 5.25%, 05/15/04 8,000 8,382 7.25%, 05/15/04 5,000 5,358 3.25%, 05/31/04 7,000 7,172 6.00%, 08/15/04 10,000 10,678 2.13%, 08/31/04 5,000 5,059 2.13%, 10/31/04 2,000 2,025
SECURITY SERIES FACE VALUE MKT. VALUE RATE, MATURITY DATE ($ x 1,000) ($ x 1,000) 5.88%, 11/15/04 4,000 4,302 (9) 7.88%, 11/15/04 10,000 11,091 (8) 2.00%, 11/30/04 11,000 11,113 1.75%, 12/31/04 6,000 6,034 (2) 1.63%, 01/31/05 18,000 18,050 (6) 7.50%, 02/15/05 10,000 11,159 1.50%, 02/28/05 10,000 9,998 6.75%, 05/15/05 6,150 6,835 (7) 6.50%, 08/15/05 10,000 11,159 5.88%, 11/15/05 9,000 9,969 (10) 5.63%, 02/15/06 10,000 11,074 4.63%, 05/15/06 10,000 10,809 6.88%, 05/15/06 3,500 4,025 (5) 7.00%, 07/15/06 10,000 11,587 6.50%, 10/15/06 9,000 10,341 6.25%, 02/15/07 5,000 5,742 3.00%, 11/15/07 7,000 7,125 (1) 3.00%, 02/15/08 19,000 19,295 ----------- 236,797 AGENCY OBLIGATIONS 20.3% -------------------------------------------------- FANNIE MAE 3.63%, 04/15/04 5,000 5,127 (3) 1.88%, 12/15/04 13,000 13,061 3.88%, 03/15/05 10,000 10,458 2.88%, 10/15/05 10,000 10,244 5.50%, 02/15/06 4,000 4,390 5.00%, 01/15/07 5,000 5,454 4.25%, 07/15/07 5,000 5,319 3.25%, 11/15/07 5,000 5,093 FREDDIE MAC 3.75%, 04/15/04 5,000 5,139 3.00%, 07/15/04 10,000 10,208 1.88%, 01/15/05 10,000 10,053 2.88%, 09/15/05 5,000 5,128 5.25%, 01/15/06 8,000 8,721 5.50%, 07/15/06 5,000 5,525 3.50%, 09/15/07 10,000 10,323 Series 2574 Class JM 5.00%, 07/31/06 10,000 10,206 ----------- 124,449
See financial notes. 9 SCHWAB SHORT-TERM BOND MARKET FUND -- Financials PORTFOLIO HOLDINGS As of February 28, 2003; unaudited. Continued
SECURITY FACE VALUE MKT. VALUE RATE, MATURITY DATE ($ x 1,000) ($ x 1,000) CORPORATE BONDS 34.9% of investments FIXED-RATE OBLIGATIONS 32.2% AB SPINTAB, 144A 7.50%, 08/14/49 5,000 5,593 ABITIBI CONSOLIDATED, INC. 6.95%, 04/01/08 5,000 5,179 AT&T WIRELESS SERVICES, INC. 7.35%, 03/01/06 2,000 2,132 BANK OF AMERICA CORP. 3.88%, 01/15/08 5,000 5,137 BOISE CASCADE CO. 9.98%, 03/27/03 5,000 5,015 BURLINGTON RESOURCES FINANCE, 144A 5.60%, 12/01/06 4,000 4,373 CAPITAL ONE BANK 6.88%, 02/01/06 4,000 4,050 CENDENT CORP., 144A 6.88%, 08/15/06 3,500 3,695 CINERGY CORP. 6.25%, 09/01/04 5,000 5,200 CONTINENTAL CABLEVISION 9.50%, 08/01/13 3,270 3,783 CVS CORP., 144A 3.88%, 11/01/07 2,000 2,045 DAIMLER-CHRYSLER N.A. HOLDINGS 6.40%, 05/15/06 3,000 3,244 DIAGEO CAPITAL, P.L.C. 3.50%, 11/19/07 4,000 4,063 DOLE FOODS CO. 7.00%, 05/15/03 2,000 2,020 EOP OPERATING, L.P. 6.50%, 01/15/04 5,000 5,180 ERAC U.S.A. FINANCE CO., 144A 6.95%, 03/01/04 6,640 6,889 FORD MOTOR CREDIT 6.88%, 02/01/06 4,000 4,065 FRANCE TELECOM 8.70%, 03/01/06 2,000 2,254
SECURITY SERIES FACE VALUE MKT. VALUE RATE, MATURITY DATE ($ x 1,000) ($ x 1,000) GENERAL ELECTRIC CAPITAL CORP. Series A 4.25%, 01/15/08 4,000 4,154 GENERAL MILLS, INC. 5.13%, 02/15/07 5,000 5,328 GOLDMAN SACHS GROUP, INC. 4.13%, 01/15/08 4,000 4,115 HOUSEHOLD FINANCE CORP. 6.40%, 06/17/08 5,000 5,547 INTERNATIONAL BANK FOR RECONSTRUCTION & DEVELOPMENT 4.00%, 01/10/05 6,000 6,272 KELLOGG COMPANY 6.00%, 04/01/06 3,500 3,840 LEHMAN BROTHERS HOLDINGS, INC. 8.25%, 06/15/07 4,000 4,759 NEWS AMERICA, INC. 6.63%, 01/09/08 4,000 4,362 NORDBANKEN AB, 144A 7.25%, 11/12/09 4,000 4,300 NORTHROP GRUMAN CORP. 9.38%, 10/15/24 5,580 6,303 PHILLIPS PETROLEUM CO. 8.50%, 05/25/05 2,000 2,269 PROTECTIVE LIFE U.S. FUNDING TRUST, 144A 5.50%, 05/14/04 5,000 5,195 PROVINCE OF ONTARIO 6.00%, 02/21/06 6,000 6,669 PULTE HOMES, INC. 8.38%, 08/15/04 3,000 3,183 RAYTHEON CO. 6.50%, 07/15/05 3,000 3,233 REPUBLIC OF ITALY 4.38%, 10/25/06 6,000 6,380 SOCGEN REAL ESTATE, L.L.C., 144A Series A 7.64%, 12/29/49 8,000 8,950 STARWOOD HOTELS & RESORTS WORLDWIDE, INC. 6.75%, 11/15/05 2,000 2,002 SVENSKA HANDELSBANKEN, 144A 7.13%, 03/07/49 5,000 5,575 TELUS CORP. 7.50%, 06/01/07 2,000 2,033
See financial notes. 10
SECURITY SERIES FACE VALUE MKT. VALUE RATE, MATURITY DATE ($ x 1,000) ($ x 1,000) TURNER BROADCASTING 8.40%, 02/01/24 5,000 5,519 TYCO INTERNATIONAL GROUP, SA 6.25%, 06/15/03 5,000 5,050 UNION PACIFIC CORP. 8.35%, 05/01/25 2,000 2,329 UNITED TELECOM 9.50%, 04/01/03 5,000 5,025 VERIZON GLOBAL FUNDING GROUP 4.00%, 01/15/08 5,000 5,057 WAL-MART STORES 4.38%, 07/12/07 3,000 3,184 WASTE MANAGEMENT, INC. 7.00%, 10/15/06 2,825 3,118 ----------- 197,668 VARIABLE RATE OBLIGATIONS 2.7% ----------------------------------------------------------------------- COUNTRYWIDE HOME LOAN Series K 1.90%, 05/10/03 5,000 4,980 FORD MOTOR CREDIT 3.23%, 04/25/03 4,900 4,831 GENERAL MOTORS ACCEPTANCE CORP. 3.34%, 06/04/03 5,000 5,000 MBNA CORP. Series F 3.09%, 05/27/03 2,000 1,976 ----------- 16,787 ASSET-BACKED OBLIGATIONS 2.3% of investments FIXED RATE OBLIGATIONS 1.6% ----------------------------------------------------------------------- ALTER MONETA RECEIVABLES, L.L.C. Series 2003-1 2.56%, 03/15/11 5,000 5,006 CAPITAL ONE MASTER TRUST Series 2000-2 Class A 7.20%, 03/01/03 5,000 5,491 ----------- 10,497 VARIABLE RATE OBLIGATIONS 0.7% ----------------------------------------------------------------------- BAYVIEW FINANCIAL ACQUISITION TRUST Series 2003-BA Class M1 2.84%, 02/25/06 4,000 4,000 MUNICIPAL BONDS 0.5% of investments FIXED RATE OBLIGATIONS 0.5% ----------------------------------------------------------------------- CALIFORNIA STATE DEPARTMENT OF WATER RESOURCES POWER SUPPLY REVENUE BOND Series 2002E 3.59%, 05/01/04 3,000 3,057 COMMERCIAL PAPER & OTHER CORPORATE OBLIGATIONS 3.3% of investments (4) AOL TIME WARNER, INC. 1.36%, 03/03/03 12,000 12,000 ATLANTIS TWO FUNDING CORP. 1.55%, 03/04/03 3,100 3,100 CONOCO PHILLIPS 1.50%, 03/04/03 5,000 5,000 ----------- 20,100
MKT. VALUE SECURITY AND NUMBER OF SHARES ($ x 1,000) OTHER INVESTMENT COMPANIES 0.2% of investments PROVIDENT INSTITUTIONAL FUNDS-- FED FUNDS PORTFOLIO 958,212 958
END OF PORTFOLIO HOLDINGS. For totals, please see the first page of holdings for this fund. See financial notes. 11 SCHWAB SHORT-TERM BOND MARKET FUND -- Financials Statement of ASSETS AND LIABILITIES As of February 28, 2003; unaudited. All numbers x 1,000 except NAV. ASSETS ----------------------------------------------------------------------------- Investments, at market value (including $218,574 of securities on loan) $614,313 a Collateral held for securities on loan 221,125 Receivables: Fund shares sold 1,931 Interest 5,952 Investments sold 15,403 Prepaid expenses + 52 ------------ TOTAL ASSETS 858,776 LIABILITIES ----------------------------------------------------------------------------- Collateral held for securities on loan 221,125 Payables: Fund shares redeemed 309 Dividends to shareholders 1,354 Investments bought 40,462 Investment adviser and administrator fees 5 Transfer agent and shareholder service fees 8 Accrued expenses + 18 ------------ TOTAL LIABILITIES 263,281 NET ASSETS ----------------------------------------------------------------------------- TOTAL ASSETS 858,776 TOTAL LIABILITIES - 263,281 ------------ NET ASSETS $595,495 NET ASSETS BY SOURCE Capital received from investors 587,748 Net investment income not yet distributed 202 Net realized capital losses (8,350) b Net unrealized capital gains 15,895 NET ASSET VALUE (NAV) SHARES NET ASSETS / OUTSTANDING = NAV $595,495 58,134 $10.24
a The fund's amortized cost for these securities was $598,418. Not counting short-term obligations and government securities, the fund paid $162,247 for securities during the report period, and received $151,404 from securities it sold or that matured. For long-term government securities, the fund paid $289,626 during the reporting period and received $214,964 for securities it sold or that matured. Included in the total purchases and sales amounts are $7,385 in transactions with other SchwabFunds(R). b These derive from investments and short sales. FEDERAL TAX DATA ------------------------------------------------------------------ PORTFOLIO COST $598,486 NET UNREALIZED GAINS AND LOSSES: Gains $ 15,967 Losses + (140) ------------ $ 15,827 AS OF AUGUST 31, 2002: UNDISTRIBUTED EARNINGS: Ordinary income $ 2,010 Long-term capital gains $ -- CAPITAL LOSSES UTILIZED $ 609 UNUSED CAPITAL LOSSES: Expires 08/31 of: Loss amount: 2003 $ 3,637 2004 2,216 2005 173 2008 + 1,241 ----------- $ 7,267 DEFERRED CAPITAL LOSSES $ 8,099
See financial notes. 12 Statement of OPERATIONS For September 1, 2002 through February 28, 2003; unaudited. All numbers x 1,000. INVESTMENT INCOME ------------------------------------------------------------------ Interest $ 10,936 Lending of securities + 122 ----------- TOTAL INVESTMENT INCOME 11,058 NET REALIZED GAINS ------------------------------------------------------------------ Net realized gains on investments sold 7,306 NET UNREALIZED GAINS ------------------------------------------------------------------ Net unrealized gains on investments 1,839 EXPENSES ------------------------------------------------------------------ Investment adviser and administrator fees 798 a Transfer agent and shareholder service fees 682 b Trustees' fees 5 c Custodian and portfolio accounting fees 24 Professional fees 14 Registration fees 5 Shareholder reports 29 Other expenses + 7 ----------- Total expenses 1,564 Expense reduction - 447 d ----------- NET EXPENSES 1,117 INCREASE IN NET ASSETS FROM OPERATIONS ------------------------------------------------------------------ TOTAL INVESTMENT INCOME 11,058 NET EXPENSES - 1,117 ----------- NET INVESTMENT INCOME 9,941 NET REALIZED GAINS 7,306 e NET UNREALIZED GAINS + 1,839 e ----------- INCREASE IN NET ASSETS FROM OPERATIONS $19,086
a Calculated as a percentage of average daily net assets: 0.30% of the first $500 million and 0.22% of assets beyond that. b Calculated as a percentage of average daily net assets: for transfer agent services, 0.05% of the fund's assets; for shareholder services, 0.20% of the fund's assets. c For the fund's independent trustees only. d This reduction was made by the investment adviser (CSIM). It reflects a guarantee by CSIM and Schwab to limit the operating expenses of this fund through at least November 15, 2003, to 0.45%of average daily net assets. Prior to November 16, 2002, this limit was 0.35%. This limit doesn't include interest, taxes and certain non-routine expenses. e These add up to a net gain on investments of $9,145. See financial notes. 13 SCHWAB SHORT-TERM BOND MARKET FUND -- Financials Statements of CHANGES IN NET ASSETS For the current and prior report periods. All numbers x 1,000. Figures for 9/1/02-2/28/03 are unaudited.
OPERATIONS --------------------------------------------------------------------------- 9/1/02-2/28/03 9/1/01-8/31/02 Net investment income $ 9,941 $20,801 Net realized gains or losses 7,306 (7,599) Net unrealized gains + 1,839 7,295 ----------------------------- INCREASE IN NET ASSETS FROM OPERATIONS 19,086 20,497 DISTRIBUTIONS PAID --------------------------------------------------------------------------- Dividends from net investment income $ 9,941 $20,466 a
TRANSACTIONS IN FUND SHARES -------------------------------------------------------------------------- 9/1/02-2/28/03 9/1/01-8/31/02 QUANTITY VALUE QUANTITY VALUE Shares sold 21,400 $ 216,770 38,164 $ 382,502 Shares reinvested 770 7,799 1,465 14,642 Shares redeemed + (13,028) (131,663) (27,201) (272,237) ---------------------------------------------- NET INCREASE 9,142 $ 92,906 12,428 $ 124,907
SHARES OUTSTANDING AND NET ASSETS -------------------------------------------------------------------------- 9/1/02-2/28/03 9/1/01-8/31/02 SHARES NET ASSETS SHARES NET ASSETS Beginning of period 48,992 $493,444 36,564 $368,506 Total increase + 9,142 102,051 12,428 124,938 b ---------------------------------------------- END OF PERIOD 58,134 $595,495 48,992 $493,444 c
a The tax-basis components of distributions paid for the prior report period were: Ordinary income $20,466 Long-term capital gains $ --
b Figures for shares represent shares sold plus shares reinvested, minus shares redeemed. Figures for net assets represent the changes in net assets from operations plus the changes in value from transactions in fund shares, minus distributions paid. c Includes net investment income not yet distributed in the amount of $202 at the end of the current and prior periods. See financial notes. 14 SCHWAB TOTAL BOND MARKET FUND PERFORMANCE as of 2/28/03 AVERAGE ANNUAL TOTAL RETURNS This chart compares performance of the fund with the Lehman Brothers U.S. Aggregate Bond Index, the fund's benchmark index 1 and the Morningstar Intermediate-Term Bond Fund category. As of the end of the report period, the fund's 30-day SEC yield was 2.96%. 2 [BAR CHART]
LEHMAN BROTHERS U.S. FUND 2 AGGREGATE BOND INDEX BENCHMARK 1 CATEGORY AVERAGE 3 6 MONTHS 4 4.77% 4.74% 4.74% 4.69% 1 YEAR 8.98% 9.91% 9.91% 8.21% 5 YEARS 7.10% 7.60% 7.60% 6.32% SINCE INCEPTION 3/5/93 6.99% 7.16% 7.21% n/a
PERFORMANCE OF A $10,000 INVESTMENT This graph shows performance since inception of a hypothetical $10,000 investment in the fund, compared with a similar investment in two indices: the Lehman Brothers U.S. Aggregate Bond Market Index and the fund's benchmark index. 1 $19,650 FUND 2 $19,861 BENCHMARK 1 $20,064 LEHMAN BROTHERS U.S. AGGREGATE BOND INDEX [LINE GRAPH]
Lehman Brothers U.S. Fund 2 Benchmark 1 Aggregate Bond Index 05-Mar-93 10000 10000 10000 Mar-93 9784 9979 9979 Apr-93 9890 10056 10048 May-93 9927 10045 10061 Jun-93 10314 10268 10244 Jul-93 10441 10330 10302 Aug-93 10863 10561 10482 Sep-93 10901 10601 10511 Oct-93 10952 10641 10550 Nov-93 10688 10524 10460 Dec-93 10738 10565 10517 Jan-94 10938 10710 10659 Feb-94 10544 10483 10474 Mar-94 10220 10247 10216 Apr-94 10112 10166 10134 May-94 10060 10153 10133 Jun-94 10027 10129 10110 Jul-94 10239 10316 10311 Aug-94 10233 10318 10324 Sep-94 10050 10172 10172 Oct-94 10036 10165 10163 Nov-94 10031 10147 10140 Dec-94 10122 10209 10210 Jan-95 10347 10399 10412 Feb-95 10647 10622 10660 Mar-95 10718 10689 10726 Apr-95 10887 10829 10875 May-95 11429 11266 11296 Jun-95 11445 11353 11379 Jul-95 11348 11311 11354 Aug-95 11566 11443 11491 Sep-95 11711 11553 11602 Oct-95 11931 11728 11753 Nov-95 12173 11911 11929 Dec-95 12395 12080 12096 Jan-96 12438 12154 12176 Feb-96 12075 11906 11964 Mar-96 11934 11807 11881 Apr-96 11766 11732 11814 May-96 11722 11712 11790 Jun-96 11885 11863 11948 Jul-96 11890 11893 11981 Aug-96 11830 11866 11960 Sep-96 12112 12063 12168 Oct-96 12451 12329 12439 Nov-96 12763 12543 12651 Dec-96 12537 12415 12534 Jan-97 12533 12429 12572 Feb-97 12556 12446 12604 Mar-97 12353 12314 12464 Apr-97 12606 12492 12651 May-97 12732 12599 12771 Jun-97 12918 12740 12923 Jul-97 13363 13102 13272 Aug-97 13152 12972 13159 Sep-97 13397 13167 13354 Oct-97 13687 13395 13548 Nov-97 13700 13463 13610 Dec-97 13778 13604 13747 Jan-98 13977 13809 13923 Feb-98 13938 13771 13912 Mar-98 13964 13818 13959 Apr-98 14035 13890 14032 May-98 14166 14022 14165 Jun-98 14263 14141 14286 Jul-98 14306 14171 14316 Aug-98 14575 14402 14549 Sep-98 14930 14739 14890 Oct-98 14844 14661 14811 Nov-98 14866 14744 14895 Dec-98 14937 14788 14940 Jan-99 15061 14893 15046 Feb-99 14770 14633 14783 Mar-99 14870 14713 14864 Apr-99 14874 14760 14911 May-99 14703 14630 14780 Jun-99 14649 14584 14733 Jul-99 14614 14522 14671 Aug-99 14594 14515 14664 Sep-99 14790 14684 14834 Oct-99 14832 14738 14889 Nov-99 14841 14736 14887 Dec-99 14782 14666 14816 Jan-00 14719 14617 14767 Feb-00 14886 14794 14945 Mar-00 15112 14989 15143 Apr-00 15019 14946 15099 May-00 14962 14938 15091 Jun-00 15300 15249 15405 Jul-00 15435 15388 15545 Aug-00 15666 15611 15771 Sep-00 15764 15709 15870 Oct-00 15852 15813 15975 Nov-00 16114 16072 16237 Dec-00 16420 16371 16539 Jan-01 16640 16638 16808 Feb-01 16784 16783 16955 Mar-01 16909 16867 17039 Apr-01 16855 16796 16968 May-01 16974 16897 17070 Jun-01 17069 16961 17135 Jul-01 17457 17341 17518 Aug-01 17653 17540 17720 Sep-01 17813 17744 17925 Oct-01 18132 18115 18300 Nov-01 17872 17865 18047 Dec-01 17760 17750 17932 Jan-02 17901 17894 18077 Feb-02 18017 18068 18253 Mar-02 17694 17768 17950 Apr-02 17942 18112 18298 May-02 18120 18266 18453 Jun-02 18259 18425 18614 Jul-02 18436 18648 18839 Aug-02 18740 18963 19157 Sep-02 19041 19271 19468 Oct-02 18902 19182 19378 Nov-02 18907 19176 19372 Dec-02 19320 19573 19773 Jan-03 19373 19591 19791 28-Feb-03 19650 19861 20064
All figures on this page assume dividends and distributions were reinvested. Index figures do not include trading and management costs, which would lower performance. Indices are unmanaged, and you cannot invest in them directly. The fund's share price and principal values change, and when you sell your shares they may be worth more or less than what you paid for them. Past performance doesn't indicate future results. 1 The fund changed its benchmark on 2/28/98, when it changed from being a government bond fund to its current strategy. Benchmark performance shown here is the Lehman Brothers General U.S. Government Bond Index from fund inception through 2/28/98 and the Lehman Brothers U.S. Aggregate Bond Index from 3/1/98 through the end of the report period. Benchmark performance for the one-year period is the Lehman U.S. Aggregate Bond Index. 2 Fund performance reflects expense reductions by the fund's investment adviser (CSIM) and transfer agent and shareholder services agent (Schwab). Without these reductions, the fund's yield would have been 2.87%, and returns would have been lower. These returns do not reflect the deduction of taxes on fund distributions or the redemption of fund shares. 3 Source: Morningstar, Inc. As of 2/28/03, the total number of funds in the Intermediate-Term Bond Fund category for the six-month, one- and five-year periods was 724, 697 and 428, respectively. 4 Not annualized. 15 SCHWAB TOTAL BOND MARKET FUND SCHWAB SHORT FUND FACTS as of 2/28/03 FUND CATEGORY
INTEREST RATE SENSITIVITY 1 CREDIT QUALITY 1 Short Medium Long High / / /X/ / / Medium / / / / / / Low / / / / / /
STATISTICS
FUND INDEX 2 --------------------------------------------------------- NUMBER OF HOLDINGS 159 7,117 --------------------------------------------------------- YIELD TO MATURITY 4.23% 3.94% --------------------------------------------------------- WEIGHTED AVERAGE RATE 5.39% 6.04% --------------------------------------------------------- WEIGHTED AVERAGE MATURITY 4.9 yrs 6.8 yrs --------------------------------------------------------- WEIGHTED AVERAGE DURATION 3.8 yrs 3.8 yrs --------------------------------------------------------- WEIGHTED AVERAGE CREDIT QUALITY AA AA --------------------------------------------------------- EXPENSE RATIO for the report period 0.41% 3 -- ---------------------------------------------------------
PORTFOLIO COMPOSITION These charts show three different views of the fund's portfolio: by type of security, credit quality of the security and by remaining maturity. All figures are shown as a percentage of the fund's investments. Holdings may have changed since the report date. BY SECURITY TYPE [PIE CHART] 52.1% U.S. GOVERNMENT SECURITIES 28.1% CORPORATE BONDS 13.7% COLLATERALIZED MORTGAGE OBLIGATIONS & ASSET-BACKED OBLIGATIONS 4.6% COMMERCIAL PAPER & OTHER CORPORATE OBLIGATIONS 1.5% OTHER INVESTMENTS
BY CREDIT QUALITY 4 [PIE CHART] 65.1% AAA 6.3% AA 9.8% A 13.0% BBB 1.8% BB 4.0% SHORT-TERM RATINGS OR UNRATED SECURITIES
BY MATURITY [PIE CHART] 15.9% 0-1 YEAR 75.1% 2-10 YEARS 4.6% 11-20 YEARS 4.0% 21-30 YEARS 0.4% MORE THAN 30 YEARS
1 Source: Morningstar, Inc. Interest rate sensitivity and credit quality are two main components of bond performance. The assessment reflects the fund's portfolio as of 2/28/03, which may have changed since then, and is not a precise indication of risk or performance--past, present or future. Definitions of style box categories: Sensitivity (measured as duration): Short, up to 3.5 years; Medium, more than 3.5 years to less than six years; Long, six years or greater. Credit quality: High, AA or better; Medium, A or BBB; Low, BB or lower. 2 The Lehman Brothers U.S. Aggregate Bond Index. 3 Guaranteed by Schwab and the investment adviser (excluding interest, taxes and certain non-routine expenses) not to exceed 0.45% until 11/15/03. For further detail, please reference the Statement of Operations on page 24. 4 Based on ratings by Standard & Poor's and Moody's. Where ratings are different, the chart uses the higher rating. Schwab Taxable Bond Funds 16 SCHWAB TOTAL BOND MARKET FUND -- Financials Financial tables These tables provide additional data on the fund's performance, portfolio holdings and business operations. Complementing the tables is the financial notes section at the end of this report, which describes the fund's business structure, accounting practices and other matters. Because this is a semiannual report, information for the current period is unaudited. Look online at WWW.SCHWAB.COM/SCHWABFUNDS/HOW2READ for guides that are designed to help you read the financial tables in any SchwabFunds(R) shareholder report. FINANCIAL HIGHLIGHTS
9/1/02- 9/1/01- 9/1/00- 9/1/99- 9/1/98- 9/1/97- 2/28/03 8/31/02 8/31/01 8/31/00 8/31/99 8/31/98 ------------------------------------------------------------------------------------------------------------- PER-SHARE DATA ($) ------------------------------------------------------------------------------------------------------------- Net asset value at beginning of period 10.22 10.24 9.65 9.58 10.18 9.75 ------------------------------------------------------------ Income from investment operations: Net investment income 0.19 0.47 0.60 0.61 0.55 0.60 Net realized and unrealized gains or losses 0.29 0.13 0.59 0.07 (0.53) 0.43 ------------------------------------------------------------ Total income from investment operations 0.48 0.60 1.19 0.68 0.02 1.03 Less distributions: Dividends from net investment income (0.19) (0.46) (0.60) (0.61) (0.55) (0.60) Distributions from net realized gains (0.09) (0.16) -- -- (0.07) -- ------------------------------------------------------------ Total distributions (0.28) (0.62) (0.60) (0.61) (0.62) (0.60) ------------------------------------------------------------ Net asset value at end of period 10.42 10.22 10.24 9.65 9.58 10.18 ------------------------------------------------------------ Total return (%) 4.77 1 6.18 12.68 7.36 0.14 10.83 RATIOS/SUPPLEMENTAL DATA (%) ------------------------------------------------------------------------------------------------------------- Ratio of net operating expenses to average net assets 0.41 2 0.35 0.35 0.35 3 0.35 0.31 Expense reductions reflected in above ratio 0.13 2 0.22 0.23 0.27 0.39 0.51 Ratio of net investment income to average net assets 3.75 2 4.66 6.00 6.42 5.55 5.86 Portfolio turnover rate 62 74 153 135 174 285 Net assets, end of period ($ x 1,000,000) 1,043 1,053 926 647 480 294
1 Not annualized. 2 Annualized. 3 Would have been 0.36% if non-routine expenses (proxy fees) had been included. See financial notes. 17 SCHWAB TOTAL BOND MARKET FUND -- Financials PORTFOLIO HOLDINGS As of February 28, 2003; unaudited. This section shows all the securities in the fund's portfolio and their market value, as of the report date. We use the symbols below to designate certain characteristics. With the top ten holdings, the number in the circle is the security's rank among the top ten. (1) Top ten holding = Delayed-delivery security For fixed rate obligations, the rate shown is the interest rate (the rate established when the obligation was issued) and the maturity date shown is the stated legal maturity. For variable-rate obligations, the rate shown is the rate as of the report date, and the maturity shown is the later of the next interest rate change date or demand date.
COST MARKET VALUE HOLDINGS BY CATEGORY ($ x 1,000) ($ x 1,000) ---------------------------------------------------------------------------- 52.1% U.S. GOVERNMENT SECURITIES 716,931 734,711 28.1% CORPORATE BONDS 381,884 395,839 13.7% COLLATERALIZED MORTGAGE OBLIGATIONS & ASSET-BACKED OBLIGATIONS 192,695 192,419 1.2% MUNICIPAL BONDS 16,980 17,123 4.6% COMMERCIAL PAPER & OTHER CORPORATE OBLIGATIONS 65,175 65,180 0.3% PREFERRED STOCK 3,500 3,896 0.0% OTHER INVESTMENT COMPANIES 628 628 --------------------------------------------------------------------------- 100.0% TOTAL INVESTMENTS 1,377,793 1,409,796
SECURITY FACE VALUE MKT. VALUE RATE, MATURITY DATE ($ x 1,000) ($ x 1,000) U.S. GOVERNMENT SECURITIES 52.1% of investments U.S. TREASURY OBLIGATIONS 18.3% ----------------------------------------------------------------------- U.S. TREASURY BONDS 9.88%, 11/15/15 5,000 7,834 7.25%, 05/15/16 10,000 13,027 9.00%, 11/15/18 5,000 7,586 8.00%, 11/15/21 11,000 15,624 7.25%, 08/15/22 5,000 6,636 6.13%, 11/15/27 5,000 5,963 6.13%, 08/15/29 1,000 1,197 6.25%, 05/15/30 5,000 6,098 5.38%, 02/15/31 15,500 17,190 U.S. TREASURY NOTES 1.63%, 01/31/05 5,000 5,014 3.00%, 02/15/08 5,000 5,078 3.63%, 03/31/04 5,000 5,129 3.38%, 04/30/04 5,000 5,123 5.25%, 05/15/04 4,000 4,191 3.25%, 05/31/04 5,000 5,123 6.00%, 08/15/04 8,500 9,076 13.75%, 08/15/04 10,000 11,792 2.13%, 10/31/04 5,000 5,062 7.50%, 02/15/05 10,000 11,159 5.63%, 02/15/06 8,000 8,859 4.63%, 05/15/06 10,000 10,809 6.50%, 10/15/06 11,000 12,639 6.25%, 02/15/07 5,000 5,742 6.63%, 05/15/07 5,000 5,841 3.25%, 08/15/07 1,500 1,547 6.13%, 08/15/07 4,000 4,611 3.00%, 11/15/07 3,500 3,562 5.63%, 05/15/08 3,000 3,415 4.75%, 11/15/08 7,000 7,678 6.50%, 02/15/10 5,000 6,016 5.00%, 08/15/11 2,000 2,215 4.88%, 02/15/12 1,000 1,097 4.38%, 08/15/12 7,800 8,243 4.00%, 11/15/12 16,000 16,417 3.88%, 02/15/13 11,500 11,673 ---------- 258,266 MORTGAGE-BACKED OBLIGATIONS 25.8% ----------------------------------------------------------------------- FANNIE MAE =(5) 5.50%, 03/01/18 20,000 20,837 = 6.50%, 03/01/18 17,000 18,031 = 7.00%, 03/01/18 17,000 18,153 =(7) 5.50%, 03/01/33 20,000 20,469 =(6) 6.00%, 03/01/33 20,000 20,806 =(2) 6.50%, 03/01/33 40,000 41,849 =(1) 7.00%, 03/01/33 48,000 50,640 = 7.50%, 03/01/33 15,000 15,984 FREDDIE MAC =(4) 6.00%, 03/01/18 28,000 29,374 = 6.00%, 03/01/33 18,000 18,725 =(3) 6.50%, 03/01/33 36,000 37,665
See financial notes. 18
SECURITY FACE VALUE MKT. VALUE RATE, MATURITY DATE ($ x 1,000) ($ x 1,000) GINNIE MAE = 6.00%, 03/01/33 14,000 14,639 = 6.50%, 03/01/33 14,000 14,748 =(9) 7.00%, 03/01/33 19,000 20,193 = 7.50%, 03/01/33 10,000 10,706 = 8.00%, 03/01/33 10,000 10,841 ---------- 363,660 AGENCY OBLIGATIONS 8.0% ----------------------------------------------------------------------- FANNIE MAE 5.13%, 02/13/04 5,000 5,180 3.50%, 09/15/04 5,000 5,147 3.88%, 03/15/05 7,500 7,844 6.00%, 12/15/05 5,000 5,545 5.50%, 02/15/06 15,000 16,461 4.25%, 07/15/07 5,000 5,319 6.00%, 05/15/08 5,000 5,716 6.63%, 09/15/09 2,500 2,958 4.38%, 09/15/12 10,000 10,229 7.25%, 05/15/30 2,500 3,221 FREDDIE MAC 3.00%, 07/15/04 4,000 4,083 4.25%, 06/15/05 5,000 5,286 2.88%, 09/15/05 5,000 5,128 4.88%, 03/15/07 5,000 5,451 7.00%, 03/15/10 5,000 6,074 5.75%, 01/15/12 5,000 5,667 5.13%, 07/15/12 5,000 5,421 4.50%, 01/15/13 5,000 5,158 6.25%, 07/15/32 2,500 2,897 ---------- 112,785 CORPORATE BONDS 28.1% of investments FIXED-RATE OBLIGATIONS 18.1% ----------------------------------------------------------------------- AB SPINTAB, 144A 7.50%, 08/14/06 6,300 7,047 ABITIBI CONSOLIDATED, INC. 8.55%, 08/01/10 4,000 4,410 ANDERSON EXPLORATION, LTD. 6.75%, 03/15/11 7,000 7,741 AT&T BROADBAND CORP. 9.46%, 11/15/22 5,000 6,323
SECURITY SERIES FACE VALUE MKT. VALUE RATE, MATURITY DATE ($ x 1,000) ($ x 1,000) AT&T WIRELESS SERVICES, INC. 8.75%, 03/01/31 2,000 2,132 BAE SYSTEMS ASSET TRUST, 144A Series 2001 Class B 7.16%, 12/15/11 5,882 6,195 BANK OF AMERICA CORP. 7.80%, 02/15/10 5,000 6,041 CAPITAL ONE BANK 6.65%, 03/15/04 3,050 3,097 CENDENT CORP., 144A 6.88%, 08/15/06 3,500 3,695 CODELCO, INC., 144A 6.38%, 11/30/12 5,000 5,336 DOLE FOODS CO. 7.00%, 05/15/03 3,000 3,030 ERAC U.S.A. FINANCE CO., 144A 7.35%, 06/15/08 7,000 7,989 FORD MOTOR CO. 7.45%, 07/16/31 5,000 4,216 FORD MOTOR CREDIT 6.88%, 02/01/06 6,000 6,098 FRANCE TELECOM 10.00%, 03/01/31 5,000 6,459 GENERAL ELECTRIC CAPITAL CORP. Series A 4.25%, 01/15/08 4,000 4,154 GENERAL MILLS, INC. 6.00%, 02/15/12 10,000 11,059 GOLDMAN SACHS GROUP, INC. 6.88%, 01/15/11 5,000 5,713 HOUSEHOLD FINANCE CORP. 6.40%, 06/17/08 10,000 11,093 INTERNATIONAL BANK FOR RECONSTRUCTION & DEVELOPMENT 4.00%, 01/10/05 6,000 6,272 LEHMAN BROTHERS HOLDINGS, INC. 8.25%, 06/15/07 5,000 5,948 LENNAR CORP. 7.63%, 03/01/09 5,000 5,650 NEWS AMERICA, INC. 7.28%, 06/30/28 2,500 2,658 7.63%, 11/30/28 1,250 1,382
See financial notes. 19 SCHWAB TOTAL BOND MARKET FUND -- Financials PORTFOLIO HOLDINGS As of February 28, 2003; unaudited. Continued
SECURITY SERIES FACE VALUE MKT. VALUE RATE, MATURITY DATE ($ x 1,000) ($ x 1,000) NEWS AMERICA HOLDINGS 9.50%, 07/15/24 2,500 3,205 PEMEX PROJECT FUNDING MASTER TRUST, 144A 7.38%, 12/15/14 5,000 5,100 PHILLIPS PETROLEUM CO. 9.38%, 02/15/11 5,000 6,531 PROVINCE OF ONTARIO 6.00%, 02/21/06 6,000 6,669 RAYTHEON CO. 6.50%, 07/15/05 7,000 7,543 REPUBLIC OF ITALY 4.38%, 10/25/06 6,000 6,380 SOCGEN REAL ESTATE, L.L.C., 144A Series A 7.64%, 12/29/49 5,000 5,594 STANDARD CHARTERED BANK, 144A 8.00%, 05/30/31 5,000 5,967 STARWOOD HOTELS & RESORTS WORLDWIDE, INC. 6.75%, 11/15/05 2,000 2,002 7.38%, 11/15/15 3,400 3,067 SVENSKA HANDELSBANKEN, 144A 7.13%, 03/07/07 15,000 16,725 TELUS CORP. 7.50%, 06/01/07 2,000 2,033 TENET HEALTHCARE CORP. 7.38%, 02/01/13 5,000 5,063 TIME WARNER ENTERTAINMENT CO. 8.38%, 07/15/33 5,000 5,900 TYCO INTERNATIONAL GROUP, SA 6.38%, 10/15/11 5,000 4,675 UNION PACIFIC CORP. 8.35%, 05/01/25 5,000 5,822 UNITED TELECOM 9.50%, 04/01/03 10,000 10,050 VERIZON NEW ENGLAND, INC. 6.50%, 09/15/11 7,000 7,894 WASTE MANAGEMENT, INC. 7.38%, 08/01/10 5,000 5,699 WEYERHAEUSER CO. 6.75%, 03/15/12 5,000 5,531 --------- 255,188
SECURITY SERIES FACE VALUE MKT. VALUE RATE, MATURITY DATE ($ x 1,000) ($ x 1,000) VARIABLE RATE OBLIGATIONS 10.0% ----------------------------------------------------------------------- ALLETE 2.22%, 04/21/03 16,000 15,980 BOISE CASCADE CO. Series A 3.38%, 04/15/03 10,000 9,880 CONAGRA FOODS, INC. 2.12%, 03/10/03 12,500 12,517 COUNTRYWIDE HOME LOAN, INC. 1.89%, 05/22/03 10,000 9,984 DAIMLERCHRYSLER FINANCIAL CO., L.L.C. 1.46%, 03/19/03 10,000 9,991 ERP OPERATING, L.P. 1.97%, 05/21/03 10,000 10,108 (8) FORD MOTOR CREDIT 3.23%, 04/25/03 20,500 20,211 GENERAL MOTORS ACCEPTANCE CORP. 3.34%, 06/04/03 10,000 10,000 GULF STATES UTILITIES, 144A 2.73%, 03/03/03 5,000 4,992 MBNA CORP. 3.09%, 05/27/03 2,000 1,976 Series F 2.36%, 03/12/03 5,000 4,934 NATIONAL CONSUMER COOPERATIVE BANK Series B 3.60%, 05/05/03 10,000 10,015 POPULAR N.A., INC. 3.03%, 04/15/03 10,000 10,060 WEYERHAEUSER CO. 144A 2.54%, 03/17/03 10,000 10,003 --------- 140,651
See financial notes. 20
SECURITY SERIES FACE VALUE MKT. VALUE RATE, MATURITY DATE ($ x 1,000) ($ x 1,000) COLLATERIZED MORTGAGE OBLIGATIONS & ASSET-BACKED OBLIGATIONS 13.7% of investments NON-U.S. GOVERNMENT AGENCY SECURITIES 11.9% FIXED-RATE OBLIGATIONS 1.2% ----------------------------------------------------------------------- CAPITAL ONE MASTER TRUST Series 2000-2 Class A 7.20%, 08/15/08 5,000 5,491 CITIBANK CREDIT CARD MASTER TRUST I Series 1999-5 A 6.10%, 05/15/08 5,000 5,517 MBNA CREDIT CARD MASTER NOTE TRUST Series 2002-A1 Class A1 4.95%, 06/15/09 5,000 5,405 --------- 16,413 VARIABLE RATE OBLIGATIONS 10.7% ----------------------------------------------------------------------- AIRPLANES PASS THROUGH TRUST Series 1R Class A8 1.72%, 03/15/03 15,000 14,980 ASSET BACKED SECURITIES CORP. HOME EQUITY LOAN TRUST Series 2003-HE1 Class A2 1.84%, 03/15/03 14,917 14,962 COUNTRYWIDE ASSET-BACKED CERTIFICATES Series 2002-5 Class AV2 1.76%, 03/25/03 9,745 9,757 Series 2002-6 Class AV1 1.77%, 03/25/03 16,819 16,819 Series 2001-3 Class M1 1.84%, 03/25/03 3,000 2,998 Series 2001-BC3 Class M1 1.89%, 03/25/03 5,000 4,894 Series 2002-3 Class M1 2.09%, 03/25/03 4,000 4,001 FIRST FRANKLIN MORTGAGE LOAN ASSET-BACKED CERTIFICATES Series 2002-FF3 Class A2 1.80%, 03/25/03 19,780 19,821 LONG BEACH MORTGAGE LOAN TRUST Series 2003-1 Class A2 1.74%, 03/25/03 5,000 5,004 (10) MASTER ASSET BACKED SECURITIES TRUST Series 2003-OPT1 Class A2 1.76%, 03/25/03 20,000 20,000 MMCA AUTOMOBILE TRUST Series 2002-5 Class A4 1.79%, 03/15/03 10,000 10,003 PEGASUS AVIATION LEASE SECURITIZATION Series 2001-1A Class A3 2.02%, 03/10/03 9,450 8,659 PROVIDENT BANK HOME EQUITY LOAN TRUST Series 1997-2 Class A5 1.57%, 03/25/03 3,755 3,747 RESIDENTIAL ASSET MORTGAGE PRODUCTS, INC. Series 2003-RS1 Class All 1.73%, 03/25/03 15,000 15,005 --------- 150,650 U.S. GOVERNMENT AGENCY SECURITIES 1.8% ----------------------------------------------------------------------- FANNIE MAE 6.50%, 09/01/22 14,373 15,150 FREDDIE MAC Series 2574 Class JM 5.00%, 03/01/33 10,000 10,206 --------- 25,356 MUNICIPAL BONDS 1.2% of investments FIXED-RATE OBLIGATIONS 0.5% ----------------------------------------------------------------------- CALIFORNIA STATE DEPARTMENT OF WATER RESOURCES POWER SUPPLY REVENUE BOND Series 2002E 3.59%, 05/01/04 7,000 7,132 VARIABLE RATE OBLIGATIONS 0.7% ----------------------------------------------------------------------- CALIFORNIA STATE REVENUE ANTICIPATION NOTES Series A 1.34%, 03/07/03 10,000 9,991
See financial notes. 21 SCHWAB TOTAL BOND MARKET FUND -- Financials PORTFOLIO HOLDINGS As of February 28, 2003; unaudited. Continued
SECURITY FACE VALUE MKT. VALUE RATE, MATURITY DATE ($ x 1,000) ($ x 1,000) COMMERCIAL PAPER & OTHER CORPORATE OBLIGATIONS 4.6% of investments ATLANTIS TWO FUNDING CORP. 1.55%, 03/04/03 15,500 15,499 CONOCO PHILLIPS 1.50%, 03/04/03 6,309 6,309 COUNTRYWIDE FUNDING CORP. 1.30%, 03/03/03 5,000 5,000 INTERNATIONAL PAPER CO. 1.33%, 03/25/03 12,500 12,490 SAFEWAY, INC. 1.32%, 03/14/03 9,566 9,562 VIACOM, INC. 1.40%, 03/04/03 3,000 3,000 1.35%, 03/07/03 10,000 9,998 WASHINGTON MUTUAL FINANCE CORP. 1.35%, 03/27/03 3,325 3,322 --------- 65,180
MKT. VALUE SECURITY AND NUMBER OF SHARES ($ x 1,000) PREFERRED STOCK 0.3% of investments COBANK 70,000 3,896 OTHER INVESTMENT COMPANIES 0.0% of investments PROVIDENT INSTITUTIONAL FUNDS-- FED FUNDS PORTFOLIO 627,532 628
END OF PORTFOLIO HOLDINGS. For totals, please see the first page of holdings for this fund. See financial notes. 22 Statement of ASSETS AND LIABILITIES As of February 28, 2003; unaudited. All numbers x 1,000 except NAV. ASSETS ---------------------------------------------------------------------------- Investments, at market value (including $244,183 of securities on loan) $1,409,796 a Collateral held for securities on loan 246,407 Receivables: Fund shares sold 639 Dividends 45 Interest 9,505 Investments sold 27,455 Prepaid expenses + 59 ------------- TOTAL ASSETS 1,693,906 LIABILITIES ---------------------------------------------------------------------------- Collateral held for securities on loan 246,407 Payables: Fund shares redeemed 824 Dividends to shareholders 2,505 Investments bought 401,023 Investment adviser and administration fees 10 Transfer agent and shareholder service fees 14 Accrued expenses + 22 ------------- TOTAL LIABILITIES 650,805 NET ASSETS ---------------------------------------------------------------------------- TOTAL ASSETS 1,693,906 TOTAL LIABILITIES - 650,805 ------------- NET ASSETS $1,043,101 NET ASSETS BY SOURCE Capital received from investors 991,581 Net investment income not yet distributed 402 Net realized capital gains 19,115 b Net unrealized capital gains 32,003
NET ASSET VALUE (NAV) SHARES NET ASSETS / OUTSTANDING = NAV $1,043,101 100,099 $10.42 a The fund's amortized cost for these securities was $1,377,793. Not counting short-term obligations and government securities, the fund paid $293,946 for securities during the reporting period, and received $250,414 from securities it sold or that matured. For long-term government securities, the fund paid $657,682 during the report period and received $387,018 for securities it sold or that matured. b These derive from investments, swap agreements and short sales. FEDERAL TAX DATA ------------------------------------------------------------------ PORTFOLIO COST $1,378,282 NET UNREALIZED GAINS AND LOSSES: Gains $ 33,960 Losses + (2,446) ------------- $ 31,514 AS OF AUGUST 31, 2002: UNDISTRIBUTED EARNINGS: Ordinary income $ 4,213 Long-term capital gains $ -- DEFERRED CAPITAL LOSSES $ 1,309
See financial notes. 23 SCHWAB TOTAL BOND MARKET FUND -- Financials Statement of OPERATIONS For September 1, 2002 through February 28, 2003; unaudited. All numbers x 1,000. INVESTMENT INCOME ------------------------------------------------------------------------- Interest $21,035 Lending of securities 172 Dividends + 142 ---------- TOTAL INVESTMENT INCOME 21,349 NET REALIZED GAINS ------------------------------------------------------------------------- Net realized gains on investments sold 29,871 NET UNREALIZED GAINS ------------------------------------------------------------------------- Net unrealized gains on investments 131 EXPENSES ------------------------------------------------------------------------- Investment adviser and administrator fees 1,328 a Transfer agent and shareholder service fees 1,284 b Trustees' fees 7 c Custodian and portfolio accounting fees 60 Professional fees 15 Registration fees (11) Shareholder reports 52 Other expenses + 10 ---------- Total expenses 2,745 Expense reduction - 649 d ---------- NET EXPENSES 2,096 INCREASE IN NET ASSETS FROM OPERATIONS ------------------------------------------------------------------------- TOTAL INVESTMENT INCOME 21,349 NET EXPENSES - 2,096 ---------- NET INVESTMENT INCOME 19,253 NET REALIZED GAINS 29,871 e NET UNREALIZED GAINS + 131 e ---------- INCREASE IN NET ASSETS FROM OPERATIONS $49,255
a Calculated as a percentage of average daily net assets: 0.30% of the first $500 million and 0.22% of assets beyond that. b Calculated as a percentage of average daily net assets: for transfer agent services, 0.05% of the fund's assets; for shareholder services, 0.20% of the fund's assets. c For the fund's independent trustees only. d This reduction was made by the investment adviser (CSIM). It reflects a guarantee by CSIM and the transfer agent and shareholder service agent (Schwab) to limit the operating expenses of this fund through at least November 15, 2003, to 0.45% of average daily net assets. Prior to November 16, 2002, this limit was 0.35%. This limit doesn't include interest, taxes and certain non-routine expenses. e These add up to a net gain on investments of $30,002. See financial notes. 24 Statements of CHANGES IN NET ASSETS For the current and prior report periods. All numbers x 1,000. Figures for 9/1/02-2/28/03 are unaudited.
OPERATIONS ------------------------------------------------------------------------ 9/1/02-2/28/03 9/1/01-8/31/02 Net investment income $19,253 $46,023 Net realized gains 29,871 4,299 Net unrealized gains + 131 10,232 --------------------------- INCREASE IN NET ASSETS FROM OPERATIONS 49,255 60,554 DISTRIBUTIONS PAID ------------------------------------------------------------------------ Dividends from net investment income 19,335 45,256 Distributions from net realized gains on investments + 9,120 15,184 --------------------------- TOTAL DISTRIBUTIONS PAID $28,455 $60,440 a
a The tax-basis components of distributions paid for the prior report period were: Ordinary income $60,440 Long-term capital gains $ --
TRANSACTIONS IN FUND SHARES ---------------------------------------------------------------------------------------- 9/1/02-2/28/03 9/1/01-8/31/02 QUANTITY VALUE QUANTITY VALUE Shares sold 19,044 $ 195,061 45,679 $ 460,968 Shares reinvested 2,630 26,949 5,324 53,370 Shares redeemed + (24,647) (252,591) (38,444) (388,007) --------------------------------------------------- NET INCREASE OR DECREASE (2,973) $ (30,581) 12,559 $ 126,331
SHARES OUTSTANDING AND NET ASSETS ------------------------------------------------------------------------------------------ 9/1/02-2/28/03 9/1/01-8/31/02 SHARES NET ASSETS SHARES NET ASSETS Beginning of period 103,072 $1,052,882 90,513 $ 926,437 Total increase or decrease + (2,973) (9,781) 12,559 126,445 b ----------------------------------------------------- END OF PERIOD 100,099 $1,043,101 103,072 $1,052,882 c
b Figures for shares represent shares sold plus shares reinvested, minus shares redeemed. Figures for net assets represent the changes in net assets from operations plus the changes in value from transactions in fund shares, minus distributions paid. c Includes net investment income not yet distributed in the amount of $402 and $484 for the current and prior period, respectively. Percent of fund shares owned by other SchwabFunds(R) as of the end of the current period: SCHWAB MARKETTRACK PORTFOLIOS(R) Growth Portfolio 6.9% Balanced Portfolio 15.1% Conservative Portfolio 13.8% SCHWAB ANNUITY PORTFOLIOS Growth Portfolio II 0.3%
See financial notes. 25 FINANCIAL NOTES unaudited BUSINESS STRUCTURE OF THE FUNDS EACH OF THE FUNDS DISCUSSED IN THIS REPORT IS A SERIES OF SCHWAB INVESTMENTS, A NO-LOAD, OPEN-END MANAGEMENT INVESTMENT COMPANY. The company is organized as a Massachusetts business trust and is registered under the Investment Company Act of 1940,as amended. The sidebar shows the funds in this report and their trust. THE FUNDS OFFER ONE SHARE CLASS. Shares are bought and sold at net asset value, or NAV, which is the price for all outstanding shares. Each share has a par value of 1/1,000 of a cent, and the trustees may issue as many shares as necessary. THE TRUST AND ITS FUNDS This list shows all of the funds included in Schwab Investments. The funds discussed in this report are highlighted. SCHWAB INVESTMENTS organized October 26, 1990 Schwab 1000 Fund(R) Schwab Short-Term Bond Market Fund Schwab Total Bond Market Fund Schwab California Short/Intermediate Tax-Free Bond Fund Schwab California Long-Term Tax-Free Bond Fund Schwab Short/Intermediate Tax-Free Bond Fund Schwab Long-Term Tax-Free Bond Fund Schwab YieldPlus Fund(R) FUND OPERATIONS Most of the funds' investments are described in the fund-by-fund sections earlier in this report. However, there are certain other investments and policies that may affect a fund's financials, as described below. Other policies concerning the funds' business operations also are described here. THE FUNDS DECLARE DIVIDENDS EVERY DAY THEY ARE OPEN FOR BUSINESS. These dividends, which are substantially equal to a fund's net investment income for that day, are paid out to shareholders once a month. The funds may make distributions from any net realized capital gains once a year. THE FUNDS MAY ENTER INTO SWAP AGREEMENTS. In these transactions, a fund and counterparty agree to swap payments that are based on two different rates. The counterparty is typically a large financial institution, and the term of the swap is specified in advance. For example, a fund may agree that for six months it will pay the counterparty the equivalent of the interest on a given amount invested at LIBOR (the London Interbank Offered Rate). In exchange, the counter-party might agree to pay a fund the equivalent of the same amount invested in a certain bond index during this same six months. Swap agreements carry certain risks. Because the net gains or losses stemming from a swap agreement depend on the movements of one rate relative to another, a fund could experience unanticipated losses if one or both rates failed to behave as expected. A fund also could lose money if a counterparty failed to honor the terms of a swap agreement. Schwab Taxable Bond Funds 26 THE FUNDS MAY LOAN SECURITIES TO CERTAIN BROKERS, DEALERS AND OTHER FINANCIAL INSTITUTIONS WHO PAY THE FUNDS NEGOTIATED FEES. The funds receive cash, letters of credit or U.S. Government securities as collateral on these loans. All of the cash collateral received is reinvested in high quality, short-term investments. The value of the collateral must be at least 102% of the market value of the loaned securities as of the first day of the loan, and at least 100% each day thereafter. THE FUNDS MAY BUY SECURITIES ON A DELAYED-DELIVERY BASIS. In these transactions, a fund agrees to buy a security for a stated price, with settlement generally occurring within two weeks. If the security's value falls before settlement occurs, a fund could end up paying more for the security than its market value at the time of settlement. The funds have set aside sufficient securities as collateral for those securities bought on a delayed-delivery basis. THE FUNDS MAY ALSO SELL SECURITIES SHORT (SELL SECURITIES THEY DO NOT OWN). When they do so, the funds also place assets worth at least 100% of the value of the short securities into segregated accounts, as collateral. If the market value of the short securities subsequently falls, the funds can realize a gain by closing the position. However, if the value rises, the funds typically would have to add to their collateral or close out their short position at a loss. The potential for losses associated with short positions is much greater than the original value of the securities sold short and may exceed amounts recorded in the Statements of Assets and Liabilities. THE SCHWAB TOTAL BOND MARKET INDEX FUND MAY ENTER INTO MORTGAGE DOLLAR ROLL TRANSACTIONS. In these transactions, the fund sells mortgage-backed securities for delivery in the current month and simultaneously agrees to buy back, on a given date in the future, securities of a similar type, coupon rate and maturity. THE FUNDS PAY FEES FOR VARIOUS SERVICES. Through their trust, the funds have agreements with Charles Schwab Investment Management, Inc. (CSIM) to provide investment advisory and administrative services and with Charles Schwab & Co., Inc. (Schwab) to provide transfer agent and shareholder services. Although these agreements specify certain fees for these services, CSIM and Schwab have made additional agreements with the funds that may limit the total expenses charged. The rates and limitations for these fees vary from fund to fund, and are described in each fund's Statement of Operations. TRUSTEES MAY INCLUDE PEOPLE WHO ARE OFFICERS AND/OR DIRECTORS OF THE INVESTMENT ADVISER OR SCHWAB. Federal securities law limits the percentage of such "interested persons" who may serve on a trust's board, and the trust was in compliance with these limitations throughout the report period. The trust did not pay any of these persons for their service as trustees, but it did pay non-interested persons (independent trustees), as noted in each fund's Statement of Operations. THE FUNDS MAY ENGAGE IN CERTAIN TRANSACTIONS INVOLVING AFFILIATES. For instance, a fund may let other SchwabFunds(R) buy and sell fund shares, particularly Schwab MarketTrack Portfolios(R). The funds may make direct transactions with certain other SchwabFunds when practical. When one fund is seeking to sell a security that another is seeking to buy, an interfund transaction can allow both funds to benefit by reducing transaction costs. This practice is limited to funds that share the same investment adviser, trustees and officers. THE FUNDS INTEND TO MEET FEDERAL INCOME AND EXCISE TAX REQUIREMENTS FOR REGULATED INVESTMENT COMPANIES. Accordingly, the funds distribute substantially all of their net investment income and realized net capital gains (if any) to their respective shareholders each year. As long as a fund meets the tax requirements, it is not required to pay federal income tax. 27 ACCOUNTING POLICIES The following are the main policies the funds use in preparing their financial statements. THE FUNDS VALUE THE SECURITIES IN THEIR PORTFOLIOS EVERY BUSINESS DAY. The funds use the following policies to value various types of securities: BONDS AND NOTES: valued at halfway between the most recent bid and asked quotes or, if such quotes are unavailable, at prices for securities of comparable maturity, credit quality and type. Valuations for bonds and notes are provided by an independent bond-pricing service. SECURITIES FOR WHICH NO QUOTED VALUE IS AVAILABLE, INCLUDING RESTRICTED SECURITIES: valued at fair value, as determined in good faith by the fund's investment adviser using guidelines adopted by the fund's Board of Trustees. SWAP AGREEMENTS: each open contract is valued at a formula that varies with the specific terms of the agreement. SHORT-TERM SECURITIES (60 DAYS OR LESS TO MATURITY): valued at amortized cost. IF A FUND SELLS SECURITIES SHORT, it records the proceeds received as an asset and the obligation to buy back the securities as a liability. At the time a short sale is initiated, the asset and the liability are of equal value and effectively cancel each other out. Subsequently, the fund values the liability side of the transaction according to the market price of the securities sold short, and values the asset side according to the value of the proceeds. When the fund closes out a short position (buys the security), it records the outcome as a realized gain or loss. Interest accrued on securities sold short is recorded as an expense on the fund's records. SECURITY TRANSACTIONS are recorded as of the date the order to buy or sell the security is executed. INTEREST INCOME is recorded as it accrues. If a fund bought a debt security at a discount (that is, for less than its face value) or a premium (more than face value),it amortizes the discount or premium from the current date up to maturity. The fund then increases (in the case of discounts) or reduces (in the case of premiums) the income it records from the security. If the security is callable (meaning that the issuer has the option to pay it off before its maturity date), then the fund amortizes the premium to the security's call date and price, rather than the maturity date and price. REALIZED GAINS AND LOSSES from security transactions are based on the identified costs of the securities involved. Gains and losses from paydowns on mortgage and asset backed securities are recorded as adjustments to interest income. EXPENSES that are specific to a fund are charged directly to that fund. Expenses that are common to all funds within the trust generally are allocated among the funds in proportion to their net assets. EACH FUND MAINTAINS ITS OWN ACCOUNT FOR PURPOSES OF HOLDING ASSETS AND ACCOUNTING, and is considered a separate entity for tax purposes. Within its account, each fund also keeps certain assets in segregated accounts, as may be required by securities law. THE ACCOUNTING POLICIES DESCRIBED ABOVE CONFORM WITH ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN THE UNITED STATES OF AMERICA. Notwithstanding this, shareholders should understand that in order to follow these principles, fund management has to make estimates and assumptions that affect the information reported in the financial statements. It's possible that once the results are known, they may turn out to be different from these estimates. Schwab Taxable Bond Funds 28 GLOSSARY Words and phrases that appear in financial reports often have specific meanings that are different from their everyday meanings. The glossary below tells you what is meant by the following terms when they are used in this report. ALTERNATIVE MINIMUM TAX (AMT) A federal income tax designed to limit the extent to which high-income taxpayers (including individuals, estates, trusts and corporations) can benefit from certain deductions and exemptions. For example, some types of income that are exempt from regular federal income tax are not exempt from the AMT. ASSET ALLOCATION The practice of dividing a portfolio among different asset classes, with each asset class assigned a particular percentage. ASSET-BACKED SECURITY A bond or other debt security that represents ownership in a pool of debt obligations such as credit card debt. ASSET CLASS A group of securities with similar structure and basic characteristics. Stocks, bonds and cash are the three main examples of asset classes. AVERAGE RATE The average rate of interest paid annually by the fixed-income securities in a fund or portfolio. BOND A security representing a loan from the investor to the issuer. A bond typically pays interest at a fixed rate (the "coupon rate") until a specified date (the "maturity date"), at which time the issuer returns the money borrowed ("principal" or "face value") to the bondholder. Because of their structure, bonds are sometimes called "fixed-income securities" or "debt securities." CALL An early repayment of a bond's principal by the issuer, usually done because the issuer is able to refinance its bond debt at a lower rate. CALL PROTECTION A term used in reference to a bond that cannot be called by the issuer before maturity, or at least for many years from the present date. A bond that offers call protection can more reliably be expected to provide a given yield over a given number of years than a bond that could be called (assuming both bonds are of the same credit quality). CAPITAL GAIN, CAPITAL LOSS The difference between the amount paid for an investment and its value at a later time. If the investment has been sold, the capital gain or loss is considered a realized gain or loss. If the investment is still held, the gain or loss is still "on paper" and is considered unrealized. COUPON, COUPON RATE The annual rate of interest paid until maturity by the issuer of a debt security. CREDIT QUALITY The capacity of an issuer to make its interest and principal payments. See chart below. CREDIT RISK The risk that a bond issuer may be unable to pay interest or principal to its bondholders. -------------------------------------------------------------------------------- CREDIT RATINGS MOST MAJOR BOND ISSUERS ARRANGE WITH A RECOGNIZED INDEPENDENT RATING ORGANIZATION, SUCH AS STANDARD & POOR'S (S&P) OR MOODY'S INVESTORS SERVICE, TO RATE THE CREDITWORTHINESS OF THEIR BONDS. THE SPECTRUM OF THESE RATINGS IS DIVIDED INTO TWO MAJOR CATEGORIES: INVESTMENT GRADE AND BELOW INVESTMENT GRADE (SOMETIMES CALLED "JUNK BONDS"). BONDS RATED BELOW INVESTMENT GRADE RANGE FROM THOSE THAT ARE CONSIDERED TO HAVE SOME VULNERABILITY TO DEFAULT TO THOSE THAT APPEAR ON THE BRINK OF DEFAULT OR ARE IN DEFAULT.
Credit Capacity to quality make payments ------- ------------- INVESTMENT GRADE BONDS AAA Strongest AA A BBB Adequate [UP AND DOWN ARROW SPANNING TABLE AND CHANGING DARK TO LIGHT FROM TOP TO BOTTOM] ----------------------------------------------------------------------- BELOW INVESTMENT GRADE BONDS BB Somewhat speculative B CCC CC C Highly speculative D In default -----------------------------------------------------------------------
29 DISCOUNT RATE The implied rate on a debt security that does not pay interest but is bought at a discount and redeemed at face value when it matures. DIVIDEND Money from earnings that is distributed to shareholders as a given amount per share. DURATION A measure of a bond investment's sensitivity to interest rates. Calculations of duration take into account the investment's yield, interest payments, maturity date and call features. Like maturity, duration is expressed in years, but typically is more accurate than maturity in determining the effect of interest rate movements on a bond investment's price. EXPENSE RATIO The amount that is taken from a mutual fund's assets each year to cover the fund's operating expenses. An expense ratio of 0.50% means that a fund's expenses amount to half of one percent of its average net assets a year. GENERAL OBLIGATION BOND A municipal bond that is secured by the issuer's full faith and credit, which typically is backed by the power of the issuer to levy taxes. INTEREST Payments to bondholders (usually made twice a year) as compensation for loaning the bond principal to the issuer. INTEREST RATE RISK The risk that a bond's value will fluctuate if market interest rates change or are expected to change. Bond prices tend to move in the opposite direction of interest rates: when interest rates rise, bond prices tend to fall. MARKET RISK Those elements of risk that are common to all securities in an asset class, and therefore cannot be significantly reduced by diversification within the asset class. Also known as "systematic risk." MATURITY The date a bond is scheduled to be "retired" and its principal amount returned to the bondholder. MORTGAGE-BACKED SECURITY A bond or other debt security that represents ownership in a pool of mortgage loans. MUNI, MUNICIPAL BOND, MUNICIPAL SECURITY Debt securities issued by a state, its counties, municipalities, authorities and other subdivisions, or the territories and possessions of the United States and the District of Columbia, including their subdivisions, agencies and instrumentalities and corporations. These securities may be issued to obtain money for various public purposes, including the construction of a wide range of public facilities such as airports, bridges, highways, housing, hospitals, mass transportation, public utilities, schools, streets, and water and sewer works. NET ASSET VALUE (NAV) The value of one share of a mutual fund. NAV is calculated by taking the fund's total assets, subtracting liabilities, and dividing by the number of shares outstanding. OUTSTANDING SHARES, SHARES OUTSTANDING When speaking of a company or mutual fund, indicates all shares currently held by investors. PREPAYMENT RISK The risk that a mortgage-backed security may be paid off early, typically because interest rates have fallen and the homeowners who hold the underlying mortgages have refinanced those mortgages at lower rates. In this type of situation, the investor who held the mortgage-backed security will usually have to settle for a lower rate when reinvesting the principal. REVENUE BOND A municipal bond that is issued to finance public works and is secured by revenue from a public works project (such as a highway or stadium) rather than the full faith and credit of the issuer. TAXABLE-EQUIVALENT YIELD The yield an investor would need to get from a taxable investment in order to match the yield paid by a given tax-exempt investment, once the effect of all applicable taxes is taken into account. For example, if your tax rate were 25%, a tax-exempt investment paying 4.5% would have a taxable-equivalent yield for you of 6.0% (4.5% / [1 - 0.25%] = 6.0%). TOTAL RETURN The percentage that an investor would have earned or lost on an investment in the fund assuming dividends and distributions were reinvested. WEIGHTED AVERAGE For mutual funds, an average that gives the same weight to each security as the security represents in the fund's portfolio. WEIGHTED AVERAGE MATURITY For mutual funds, the maturity of all the bonds in its portfolio, calculated as a weighted average. As a rule, the longer a fund's weighted average maturity, the greater its interest rate risk. YIELD The income paid out by an investment, expressed as a percentage of the investment's market value. YIELD TO MATURITY The annualized rate of return a bondholder could expect if the bond were held to maturity. In addition to interest payments, yield to maturity also factors in any difference between a bond's current price and its principal amount, or face value. Schwab Taxable Bond Funds 30 NOTES NOTES CONTACT SCHWAB SchwabFunds(R) offers you a complete family of mutual funds, each one based on a time-tested investment approach and using disciplined, clearly defined management strategies. Actively managed funds include multi-manager stock funds, a fund that uses long-short strategies, and a range of taxable and tax-free bond funds. Index funds include large-cap, small-cap and international stock funds. The list at right shows all currently available SchwabFunds. Whether you're an experienced investor or just starting out, SchwabFunds can help you achieve your financial goals. Please call 1-800-435-4000 for a free prospectus and brochure for any SchwabFund. Please read the prospectus carefully before you invest. This report must be preceded or accompanied by a current prospectus. METHODS FOR PLACING ORDERS The following information outlines how Schwab investors can place orders. If you are investing through a third-party investment provider, methods for placing orders may be different. INTERNET 1 www.schwab.com SCHWAB BY PHONE(TM) 2 Use our automated voice service or speak to a representative. Call 1-800-435-4000, day or night (for TDD service, call 1-800-345-2550). TELEBROKER(R) Automated touch-tone phone service at 1-800-272-4922. MAIL Write to SchwabFunds at: P.O. Box 3812 Englewood, CO 80155-3812 When selling or exchanging shares, be sure to include the signatures of at least one of the persons whose name is on the account. 1 Shares of Sweep Investments(TM)may not be purchased over the Internet. 2 Orders placed in person or through a telephone representative are subject to a service fee payable to Schwab. THE SCHWABFUNDS FAMILY STOCK FUNDS Schwab S&P 500 Fund Schwab 1000 Fund(R) Schwab Small-Cap Index Fund(R) Schwab Total Stock Market Index Fund(R) Schwab International Index Fund(R) Schwab Core Equity Fund(TM) Schwab Hedged Equity Fund(TM) Schwab Focus Funds Communications Focus Fund Financial Services Focus Fund Health Care Focus Fund Technology Focus Fund Schwab MarketMasters Funds(TM) U.S. MarketMasters Fund(TM) Small-Cap MarketMasters Fund(TM) International MarketMasters Fund(TM) Balanced MarketMasters Fund(TM) ASSET ALLOCATION FUNDS Schwab MarketTrack Portfolios(R) All Equity Portfolio Growth Portfolio Balanced Portfolio Conservative Portfolio BOND FUNDS Schwab YieldPlus Fund(R) Schwab Short-Term Bond Market Fund Schwab Total Bond Market Fund Schwab GNMA Fund Schwab Short/Intermediate Tax-Free Bond Fund Schwab Long-Term Tax-Free Bond Fund Schwab California Short/Intermediate Tax-Free Bond Fund Schwab California Long-Term Tax-Free Bond Fund SCHWAB MONEY FUNDS Schwab offers an array of money market funds that seek high current income consistent with safety and liquidity. 3 Choose from taxable or tax-advantaged alternatives. Many can be linked to your Schwab account to "sweep" cash balances automatically when you're between investments. Or, for your larger cash reserves, choose one of our Value Advantage Investments(R). 3 Investments in money market funds are neither insured nor guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency and, although they seek to preserve the value of your investment at $1 per share, it is possible to lose money. [CHARLES SCHWAB LOGO] INVESTMENT ADVISER Charles Schwab Investment Management, Inc. 101 Montgomery Street, San Francisco, CA 94104 DISTRIBUTOR SchwabFunds(R) P.O. Box 3812, Englewood, CO 80155-3812 This report is not authorized for distribution to prospective investors unless preceded or accompanied by a current prospectus. (C)2003 Charles Schwab & Co., Inc. All rights reserved. Member SIPC/NYSE. Printed on recycled paper. REG13480-06 REVISIONS HAVE BEEN MADE ON PAGES 15 AND 16 OF THIS REPORT AND AS A RESULT, IT IS BEING RE-MAILED TO YOU.