Item 1. BUSINESS
(a) General Development of Business. Dean Witter Cornerstone Fund
II (the "Partnership") is a New York limited partnership
organized to engage in the speculative trading of futures and
forward contracts on foreign currencies and other commodity
interests (collectively, "futures interests"). The Partnership
is one of the Dean Witter Cornerstone Funds, comprised of the
Partnership, Dean Witter Cornerstone Fund III, and Dean Witter
Cornerstone Fund IV.
The general partner is Demeter Management Corporation
("Demeter"). The non-clearing commodity broker is Dean Witter
Reynolds Inc. ("DWR"), and an unaffiliated clearing commodity
broker, Carr Futures Inc. ("Carr"), provides clearing and
execution services. Both Demeter and DWR are wholly-owned
subsidiaries of Morgan Stanley Dean Witter & Co. ("MSDW"). The
trading managers to the Partnership are Northfield Trading L.P.
and John W. Henry & Company, Inc. (collectively, the "Trading
Managers").
The Partnership's Net Asset Value per unit of limited partnership
interest ("Unit(s)") at December 31, 1999, was $3,964.87,
representing a decrease of 5.4 percent from the Net Asset Value
per Unit of $4,192.04 at December 31, 1998. For a more detailed
description of the Partnership's business see subparagraph (c).
(b) Financial Information about Industry Segments. For financial
information reporting purposes the Partnership is deemed to
engage in one industry segment, the speculative trading of
futures interests. The relevant financial information is
presented in Items 6 and 8.
(c) Narrative Description of Business. The Partnership is in the
business of speculative trading of futures interests, pursuant to
trading instructions provided by the Trading Managers. For a
detailed description of the different facets of the Partnership's
business, see those portions of the Partnership's prospectus,
dated August 28, 1996, (the "Prospectus") together with the
supplement to the Prospectus dated October 14, 1998, (the
"Supplement") incorporated by reference in this Form 10-K, set
forth below.
Facets of Business
1. Summary 1. "Summary of the Prospectus" (Pages 1-9 of the Prospec- tus and pages S-15 - S-34 of the Supplement).
2. Commodity Markets 2. "The Commodities Markets" (Pages 80-84 of the Prospectus).
3.Partnership's Commodity 3."Investment Program, Use of Trading Arrangements and Proceeds and Trading Poli- Policies cies" (Pages 45-47 of the Prospectus) and "The Trading Managers" (Pages 51-74 of the Prospectus and Pages S-18 - S-29 of the Supplement).
4. Management of the 4. "The Cornerstone Funds" Partnership (Pages 19-24 of the Prospectus and Pages S-1 - S-4 of the Supplement). "The General Partner" (Pages 77-79 of the Prospectus and Pages S-29 - S-31 of the Supplement) and "The Commodity Brokers" (Pages 79-80 of the Prospectus and Pages S-31 - S-32 of the Supplement). "The Limited Partnership Agreements" (Pages 86-90 of the Prospectus).
5. Taxation of the Partnership's 5. "Material Federal Income Limited Partners Tax Considerations" and "State and Local Income Tax Aspects" (Pages 92-99 of the Prospectus and Page S-34 of the Supplement).
(d) Financial Information About Foreign and Domestic Operations and Export Sales.
The Partnership has not engaged in any operations in foreign
countries; however, the Partnership (through the commodity
brokers) enters into forward contract transactions where foreign
banks are the contracting party and trades in futures interests
on foreign exchanges.
Item 2.
Item 2. PROPERTIES
The executive and administrative offices are located within the
offices of DWR. The DWR offices utilized by the Partnership are
located at Two World Trade Center, 62nd Floor, New York, NY
10048.
Item 3.
Item 3. LEGAL PROCEEDINGS
The class actions first filed in 1996 in California and in New
York State courts were each dismissed in 1999. However, in the
New York State class action, plaintiffs appealed the trial
court's dismissal of their case on March 3, 2000.
On September 6, 10, and 20, 1996, and on March 13, 1997,
purported class actions were filed in the Superior Court of the
State of California, County of Los Angeles, on behalf of all
purchasers of interests in limited partnership commodity pools
sold by DWR. Named defendants include DWR, Demeter, Dean Witter
Futures & Currency Management Inc. ("DWFCM"), MSDW, the
Partnership, certain limited partnership commodity pools of which
Demeter is the general partner (all such parties referred to
hereafter as the "Morgan Stanley Dean Witter Parties") and
certain trading advisors to those pools. On June 16, 1997, the
plaintiffs in the above actions filed a consolidated amended
complaint, alleging, among other things, that the defendants
committed fraud, deceit, negligent misrepresentation, various
violations of the California Corporations Code, intentional and
negligent breach of fiduciary duty, fraudulent and unfair
business practices, unjust enrichment, and conversion in the sale
and operation of the various limited partnership commodity pools.
The complaints seek unspecified amounts of compensatory and
punitive damages and other relief. The court entered an order
denying class certification on
August 24, 1999. On September 24, 1999, the court entered an
order dismissing the case without prejudice on consent. Similar
purported class actions were also filed on September 18 and 20,
1996, in the Supreme Court of the State of New York, New York
County, and on November 14, 1996 in the Superior Court of the
State of Delaware, New Castle County, against the Morgan Stanley
Dean Witter Parties and certain trading advisors on behalf of all
purchasers of interests in various limited partnership commodity
pools, including the Partnership, sold by DWR. A consolidated and
amended complaint in the action pending in the Supreme Court of
the State of New York was filed on August 13, 1997, alleging that
the defendants committed fraud, breach of fiduciary duty, and
negligent misrepresentation in the sale and operation of the
various limited partnership commodity pools. The complaints seek
unspecified amounts of compensatory and punitive damages and
other relief. The New York Supreme Court dismissed the New York
action in November 1998, but granted plaintiffs leave to file an
amended complaint, which they did in early December 1998. The
defendants filed a motion to dismiss the amended complaint with
prejudice on February 1, 1999. By decision dated December 21,
1999, the New York Supreme Court dismissed the case with
prejudice.
In addition, on December 16, 1997, upon motion of the plaintiffs,
the action pending in the Superior Court of the State of Delaware
was voluntarily dismissed without prejudice.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
Item 5.
Item 5. MARKET FOR THE REGISTRANT'S PARTNERSHIP UNITS AND RELATED SECURITY HOLDER MATTERS
(a) Market Information
There is no established public trading market for Units of the
Partnership.
(b) Holders
The number of holders of Units at December 31, 1999 was
approximately 2,427.
(c) Distributions
No distributions have been made by the Partnership since it
commenced trading operations on January 2, 1985. Demeter has sole
discretion to decide what distributions, if any, shall be made to
investors in the Partnership. Demeter currently does not intend
to make any distribution of Partnership profits.
(d) Use of Proceeds
The offering for the Partnership originally commenced on May 31,
1984. Effective September 30, 1994, the Partnership, Dean Witter
Cornerstone Fund III and Dean Witter Cornerstone Fund IV were
closed to new investors. Units have been sold since then solely
in "Exchanges" with existing investors, at 100% of Net Asset
Value per Unit. DWR paid all expenses in connection with the
offering of Units without reimbursement. Therefore, 100% of the
proceeds of Exchanges have been applied to working capital of the
Partnership in accordance with the "Investment Programs, Use of
Proceeds and Trading Policies" section of the prospectus.
Through December 31, 1999 the Partnership has sold
41,706.006 Units and the Cornerstone Funds have sold an aggregate
of 235,434.717 Units, leaving 14,565.283 Units remaining
available for sale at January 1, 2000. The aggregate price of
Units sold through December 31, 1999 with respect to the
Partnership is $65,653,269.
Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Liquidity - The Partnership deposits its assets with DWR as non-
clearing broker and Carr as clearing broker in separate futures
trading accounts established for each Trading Manager, which
assets are used as margin to engage in trading. The assets are
held in either non-interest-bearing bank accounts or in
securities and instruments permitted by the Commodity Futures
Trading Commission ("CFTC") for investment of customer segregated
or secured funds. The Partnership's assets held by the commodity
brokers may be used as margin solely for the Partnership's
trading. Since the Partnership's sole purpose is to trade in
futures and forwards, it is expected that the Partnership will
continue to own such liquid assets for margin purposes.
The Partnership's investment in futures and forwards, may, from
time to time, be illiquid. Most U.S. futures exchanges limit
fluctuations in prices during a single day by regulations
referred to as "daily price fluctuations limits" or "daily
limits". Trades may not be executed at prices beyond the daily
limit. If the price for a particular futures contract has
increased or decreased by an amount equal to the daily limit,
positions in that futures contract can neither be taken nor
liquidated unless traders are willing to effect trades at or
within the limit. Futures prices have occasionally moved the
daily limit for several consecutive days with little or no
trading. These market conditions
could prevent the Partnership from promptly liquidating its
futures contracts and result in restrictions on redemptions.
There is no limitation on daily price moves in trading forward
contracts on foreign currencies. The markets for some world
currencies have low trading volume and are illiquid, which may
prevent the Partnership from trading in potentially profitable
markets or prevent the Partnership from promptly liquidating
unfavorable positions in such markets and subjecting it to
substantial losses. Either of these market conditions could
result in restrictions on redemptions.
The Partnership has never had illiquidity affect a material
portion of its assets.
Capital Resources. The Partnership does not have, or expect to
have, any capital assets. Redemptions and exchanges of
additional Units in the future will affect the amount of funds
available for investments in futures interests in subsequent
periods. It is not possible to estimate the amount and therefore
the impact of future redemptions.
Results of Operations.
General. The Partnership's results depend on its Trading
Managers and the ability of each Trading Manager's trading
programs to take advantage of price movements or other profit
opportunities in the futures, forwards, and options markets. The
following presents a summary of the Partnership's operations for
the three years ended December 31, 1999 and a general discussion
of its trading activities during each period. It is important to
note, however, that the Trading Managers trade in various markets
at different times and that prior activity in a particular market
does not mean that such market will be actively traded by the
Trading Managers or will be profitable in the future.
Consequently, the results of operations of the Partnership are
difficult to discuss other than in the context of its Trading
Managers' trading activities on behalf of the Partnership and how
the Partnership has performed in the past.
At December 31, 1999, the Partnership's total capital was
$26,708,981, a decrease of $4,687,748 from the Partnership's
total capital of $31,396,729 at December 31, 1998. For the year
ended December 31, 1999, the Partnership generated a net loss of
$1,597,851, total subscriptions aggregated $10,614 and total
redemptions aggregated $3,100,511.
For the year ended December 31, 1999, the Partnership recorded
total trading revenues, including interest income, of $1,381,603
and, after expenses, posted
a decrease in Net Asset Value per Unit. Overall, the Partnership
experienced a net loss for 1999. Losses of approximately 7.19%
resulted primarily from the lack of sustained price trends and
short-term volatility in global interest rate futures
particularly Japanese government bond futures. Short positions
in Japanese government bond futures were particularly
unprofitable during March as prices surged higher in response to
the Bank of Japan's aggressive easing of monetary policy and
again during September as prices rallied on the strength of the
Japanese yen and expectations of additional monetary easing in
that country. In the metals markets, losses of approximately
5.84% were recorded primarily during the third quarter from short
positions in gold futures as gold prices reversed sharply higher
following the Bank of England's second gold auction and an
announcement by several European central banks of their plans to
restrict sales of their gold reserves for five years. A portion
of these losses was offset by profits of approximately 8.09%
recorded in the energy markets as the Partnership's Advisors were
able to take advantage of price trends in markets such as crude
oil. Long futures positions in crude oil proved profitable as
oil prices trended higher from $12 a barrel in February to over
$25 a barrel in November. Additional gains of approximately
2.60% in the euro and 0.98% in the Swiss franc were recorded
primarily from short positions in these currencies as their
values weakened relative to the U.S. dollar during the first six
months of the year and again during the fourth quarter.
Additional profits of approximately 4.91% were recorded from the
Japanese yen, primarily long positions as the value of the
yen strengthened versus the U.S. dollar during the latter half of
1999 on increased optimism regarding the Japanese economy. Total
expenses for the year were $2,979,454, resulting in a net loss of
$1,597,851. The value of a Unit decreased from $4,192.04 at
December 31, 1998 to $3,964.87 at December 31, 1999.
At December 31, 1998, the Partnership's total capital was
$31,396,729, an increase of $908,988 from the Partnership's total
capital of $30,487,741 at December 31, 1997. For the year ended
December 31, 1998, the Partnership generated net income of
$3,596,543, total subscriptions aggregated $38,137 and total
redemptions aggregated $2,725,692.
For the year ended December 31, 1998, the Partnership recorded
total trading revenues, including interest income, of $6,826,329
and posted an increase in Net Asset Value per Unit. The
Partnership recorded its fourth consecutive year of double-digit
returns with the most significant gains of approximately 10.39%
being recorded in the global bond futures markets as long
positions profited from a "flight-to-quality" during the third
quarter as stock prices plunged and uncertainty plagued the
global economic community. The Partnership also profited
significantly in the interest rate futures markets primarily
during December from short positions in Japanese government bond
futures as prices declined sharply following a spike higher in
Japanese interest rates.
Additional gains of approximately 4.65% were recorded in the
energy markets primarily during July from short futures positions
in crude oil as prices fell on speculation that further
production cuts would not occur. Trading in currencies was also
profitable for the Partnership as gains of approximately 3.33%
were recorded primarily from short positions in the South African
rand during June due to a devaluation in that nation's currency
versus the U.S. dollar and from long Japanese yen positions
during October as the yen's value strengthened amid optimism for
economic reform in Japan. Total expenses for the year were
$3,229,786, resulting in net income of $3,596,543. The value of
a Unit increased from $3,724.92 at December 31, 1997 to $4,192.04
at December 31, 1998.
At December 31, 1997, the Partnership's total capital was
$30,487,741, an increase of $1,441,571 from the Partnership's
total capital of $29,046,170, at December 31, 1996. For the year
ended December 31, 1997, the Partnership generated net income of
$4,916,164, total subscriptions aggregated $314,932 and total
redemptions aggregated $3,789,525.
For the year ended December 31, 1997, the Partnership recorded
total trading revenues, including interest income, of $8,279,346
and posted an increase in Net Asset Value per Unit. 1997 was a
profitable year for the Partnership as the Partnership took
advantage of strong price trends in the currency markets. Gains
of approximately 19.31% were recorded in the currency markets
primarily
due to the strengthening of the U.S. dollar relative to the
Japanese yen and German mark early in the year. Additional gains
were recorded from the U.S. dollar versus the Japanese yen and
most Pacific Rim currencies during the fourth quarter, which
contributed in large part to the Partnership's overall success.
Additional profits of approximately 3.99% were recorded in the
global interest rate futures markets primarily from long
positions during July as prices in these markets made a strong
upward move. Total expenses for the year were $3,363,182,
resulting in net income of $4,916,164. The value of a Unit
increased from $3,155.36 at December 31, 1996 to $3,724.92 at
December 31, 1997.
The Partnership's overall performance record represents varied
results of trading in different futures interests markets. For a
further description of 1999 trading results, refer to the letter
to the Limited Partners in the accompanying Annual Report to
Limited Partners for the year ended December 31, 1999, which is
incorporated by reference to Exhibit 13.01 of this Form 10-K.
The Partnership's gains and losses are allocated among its
partners for income tax purposes.
Credit Risk.
Financial Instruments. The Partnership is a party to financial
instruments with elements of off-balance sheet market and credit
risk. The Partnership may trade futures, forwards, and options
to gain long biased exposure to
global stock markets and global bond markets, as well as long and
short exposure to a component of managed futures contracts in
agricultural commodities, energy products, foreign currencies,
precious and base metals, and soft commodities. In entering into
these contracts, the Partnership is subject to the market risk
that such contracts may be significantly influenced by market
conditions, such as interest rate volatility, resulting in such
contracts being less valuable. If the markets should move
against all of the positions held by the Partnership at the same
time, and if the Trading Managers were unable to offset positions
of the Partnership, the Partnership could lose all of its assets
and investors would realize a 100% loss.
In addition to the Trading Managers' internal controls, the
Trading Managers must comply with the trading policies of the
Partnership. These trading policies include standards for
liquidity and leverage with which the Partnership must comply.
The Trading Managers and Demeter monitor the Partnership's
trading activities to ensure compliance with the trading
policies. Demeter may require the Trading Managers to modify
positions of the Partnership if Demeter believes they violate the
Partnership's trading policies.
In addition to market risk, in entering into futures, forwards,
and options contracts there is a credit risk to the Partnership
that the counterparty on a contract will not be able to meet its
obligations to the Partnership. The
ultimae counterparty or guarantor of the Partnership for futures
contracts traded in the United States and the foreign exchanges
on which the Partnership trades is the clearinghouse associated
with such exchange. In general, a clearinghouse is backed by the
membership of the exchange and will act in the event of non-
performance by one of its members or one of its member's
customers, which should significantly reduce this credit risk.
For example, a clearinghouse may cover a default by drawing upon
a defaulting member's mandatory contributions and/or non-
defaulting members' contributions to a clearinghouse guarantee
fund, established lines or letters of credit with banks, and/or
the clearinghouse's surplus capital and other available assets of
the exchange and clearinghouse, or assessing its members. In
cases where the Partnership trades off-exchange forward contracts
with a counterparty, the sole recourse of the Partnership will be
the forward contracts counterparty.
There is no assurance that a clearinghouse or exchange will meet
its obligations to the Partnership, and Demeter and the commodity
brokers will not indemnify the Partnership against a default by
such parties. Further, the law is unclear as to whether a
commodity broker has any obligation to protect its customers from
loss in the event of an exchange or clearinghouse defaulting on
trades effected for the broker's customers. Any such obligation
on the part of a broker appears even less clear where the default
occurs in a non-U.S. jurisdiction.
Demeter deals with these credit risks of the Partnership in
several ways. First, it monitors the Partnership's credit
exposure to each exchange on a daily basis, calculating not only
the amount of margin required for it but also the amount of its
unrealized gains at each exchange, if any. The commodity brokers
inform the Partnership, as with all their customers, of its net
margin requirements for all its existing open positions, but do
not break that net figure down, exchange by exchange. Demeter,
however, has installed a system which permits it to monitor the
Partnership's potential margin liability, exchange by exchange.
As a result, Demeter is able to monitor the Partnership's
potential net credit exposure to each exchange by adding the
unrealized trading gains on that exchange, if any, to the
Partnership's margin liability thereon.
Second, the Partnership's trading policies limit the amount of
its Net Assets that can be committed at any given time to futures
contracts and require, in addition, a minimum amount of
diversification in the Partnership's trading, usually over
several different products. One of the aims of such trading
policies has been to reduce the credit exposure of the
Partnership to a single exchange and, historically, the
Partnership's exposure to any one exchange has typically amounted
to only a small percentage of its total Net Assets. On those
relatively few occasions where the Partnership's credit exposure
may climb above that level, Demeter deals with the situation on a
case by case basis, carefully weighing whether the increased
level of credit exposure
remains appropriate. Material changes to the trading policies
may be made only with the prior written approval of the limited
partners owning more than 50% of Units then outstanding.
Third, Demeter has secured, with respect to Carr acting as the
clearing broker for the Partnership, a guarantee by Credit
Agricole Indosuez, Carr's parent, of the payment of the "net
liquidating value" of the transactions (futures and forward
contracts) in the Partnership's account.
With respect to forward contract trading, the Partnership trades
with only those counterparties which Demeter, together with DWR,
have determined to be creditworthy. At the date of this filing,
the Partnership deals only with Carr as its counterparty on
forward contracts. The guarantee by Carr's parent, discussed
above, covers these forward contracts.
See "Financial Instruments" under Notes to Financial Statements
in the Partnership's Annual Report to Limited Partners for the
year ended December 31, 1999, which is incorporated by reference
to Exhibit 13.01 of this Form
10-K.
Year 2000. Commodity pools, like financial and business
organizations and individuals around the world, depend on the
smooth functioning of computer systems. The Year 2000 issue
arose since many of the world's computer systems
(including those in non-information technology systems)
traditionally recorded years in a two-digit format. If not
addressed, such computer systems may have been unable to properly
interpret dates beyond the year 1999, which may have led to
business disruptions in the U.S. and internationally. Such
disruptions could have adversely affected the handling or
determination of futures trades and prices and other services for
the Partnership. Accordingly, Demeter has fully participated in
a firmwide initiative established by MSDW to address issues
associated with the Year 2000. As part of this initiative, MSDW
reviewed its global software and hardware infrastructure for
mainframe, server and desktop computing environments and engaged
in extensive remediation and testing. The Year 2000 initiative
also encompassed the review of agencies, vendors and facilities
for Year 2000 compliance.
Since 1995, MSDW prepared actively for the Year 2000 issue to
ensure that it would have the ability to respond to any critical
business process failure, to prevent the loss of workspace and
technology, and to mitigate any potential financial loss or
damage to its global franchise. Where necessary, contingency
plans were expanded or developed to address specific Year 2000
risk scenarios, supplementing existing business policies and
practices. In conjunction with MSDW's Year 2000 preparations,
Demeter monitored the progress of Carr and each Trading Manager
throughout 1999 in their Year 2000 compliance and, where
applicable, tested its external interfaces, with Carr and the
Trading Managers. In addition, Demeter, the commodity brokers,
the Trading
Managers and all U.S. futures exchanges were subjected to
monitoring by the CFTC of their Year 2000 preparedness, and the
major foreign futures exchanges engaged in market-wide testing of
their Year 2000 compliance during 1999.
MSDW and Demeter consider the transition into the Year 2000
successful from the perspective of their internal systems and
global external interactions. Over the millennial changeover
period, no material issues were encountered, and MSDW, Demeter
and the Partnership conducted business as usual.
Risks Associated With the Euro. On January 1, 1999, eleven
countries in the European Union established fixed conversion
rates on their existing sovereign currencies and converted to a
common single currency (the euro). During a three-year
transition period, the sovereign currencies will continue to
exist but only as a fixed denomination of the euro. Conversion
to the euro prevents the Trading Managers from trading those
sovereign currencies and thereby limits their ability to take
advantage of potential market opportunities that might otherwise
have existed had separate currencies been available to trade.
This could adversely affect the performance results of the
Partnership.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Introduction
The Partnership is a commodity pool involved in the speculative
trading of futures interests. The market-sensitive instruments
held by the Partnership
are acquired for speculative trading purposes only and, as a
result, all or substantially all of the Partnership's assets are
at risk of trading loss. Unlike an operating company, the risk
of market-sensitive instruments is central, not incidental, to
the Partnership's main business activities.
The futures interests traded by the Partnership involve varying
degrees of market risk. Market risk is often dependent upon
changes in the level or volatility of interest rates, exchange
rates, and prices of financial instruments and commodities.
Fluctuations in market risk based upon these factors result in
frequent changes in the fair value of the Partnership's open
positions, and, consequently, in its earnings and cash flow.
The Partnership's total market risk is influenced by a wide
variety of factors, including the diversification among the
Partnership's open positions, the volatility present within the
markets, and the liquidity of the markets. At different times,
each of these factors may act to increase or decrease the market
risk associated with the Partnership.
The Partnership's past performance is not necessarily indicative
of its future results. Any attempt to numerically quantify the
Partnership's market risk is limited by the uncertainty of its
speculative trading. The Partnership's speculative trading may
cause future losses and volatility (i.e. "risk of
ruin") that far exceed the Partnership's experiences to date or
any reasonable expectations based upon historical changes in
market value.
Quantifying the Partnership's Trading Value at Risk
The following quantitative disclosures regarding the
Partnership's market risk exposures contain "forward-looking
statements" within the meaning of the safe harbor from civil
liability provided for such statements by the Private Securities
Litigation Reform Act of 1995 (set forth in Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange
Act of 1934). All quantitative disclosures in this section are
deemed to be forward-looking statements for purposes of the safe
harbor, except for statements of historical fact.
The Partnership accounts for open positions using mark-to-market
accounting principles. Any loss in the market value of the
Partnership's open positions is directly reflected in the
Partnership's earnings, whether realized or unrealized, and its
cash flow. Profits and losses on open positions of exchange-
traded futures interests are settled daily through variation
margin.
The Partnership's risk exposure in the market sectors traded by
the Trading Managers is estimated below in terms of Value at Risk
("VaR"). The VaR model used by the Partnership includes many
variables that could change the market value of the Partnership's
trading portfolio. The Partnership estimates VaR
using a model based upon historical simulation with a confidence
level of 99%. Historical simulation involves constructing a
distribution of hypothetical daily changes in the value of a
trading portfolio. The VaR model takes into account linear
exposures to price and interest rate risk. Market risks that are
incorporated in the VaR model include equity and commodity
prices, interest rates, foreign exchange rates, and correlation
among these variables. The hypothetical changes in portfolio
value are based on daily percentage changes observed in key
market indices or other market factors ("market risk factors") to
which the portfolio is sensitive. The historical observation
period of the Partnership's VaR is approximately four years. The
one-day 99% confidence level of the Partnership's VaR corresponds
to the negative change in portfolio value that, based on observed
market risk factors, would have been exceeded once in 100 trading
days.
VaR models, including the Partnership's, are continuously
evolving as trading portfolios become more diverse and modeling
techniques and systems capabilities improve. Please note that
the VaR model is used to numerically quantify market risk for
historic reporting purposes only and is not utilized by either
Demeter or the Trading Managers in their daily risk management
activities.
The Partnership's Value at Risk in Different Market Sectors
The following tables indicates the VaR associated with the
Partnership's open
positions as a percentage of total Net Assets by primary market
risk category at December 31, 1999 and 1998. At December 31,
1999 and 1998, the Partnership's total capitalization was
approximately $27 million and $31 million, respectively.
Primary Market December 31, 1999 December 31, 1998 Risk Category Value at Risk Value at Risk
Currency (1.04)% (.85)%
Interest Rate (.54) (.87)
Equity (.36) (.22)
Commodity (.58) (.61)
Aggregate Value at Risk (1.32)% (1.34)%
Aggregate Value at Risk represents the aggregate VaR of all the
Partnership's open positions and not the sum of the VaR of the
individual Market Categories listed above. Aggregate VaR will be
lower as it takes into account correlation among different
positions and categories.
The table above represents the VaR of the Partnership's open
positions at December 31, 1999 and 1998 only and is not
necessarily representative of either the historic or future risk
of an investment in the Partnership. Because the Partnership's
only business is the speculative trading of futures interests,
the composition of its trading portfolio can change significantly
over any given time period, or even within a single trading day.
Any changes
in open positions could positively or negatively materially
impact market risk as measured by VaR.
The table below supplements the year end VaR by presenting the
Partnership's high, low and average VaR, as a percentage of total
net assets for the four quarterly reporting periods from January
1, 1999 through December 31, 1999.
Primary Market Risk Category High Low
Average
Currency (2.41)% (1.04)% (1.88)%
Interest Rate (1.11) (.54) (.91)
Equity (.65) (.28) (.45)
Commodity (.98) (.58) (.73)
Aggregate Value at Risk (2.72)% (1.32)% (2.25)%
Limitations on Value at Risk as an Assessment of Market Risk
The face value of the market sector instruments held by the
Partnership is typically many times the applicable margin
requirements. Margin requirements generally range between 2% and
15% of contract face value. Additionally, the use of leverage
causes the face value of the market sector instruments held by
the Partnership to typically be many times the total
capitalization of the Partnership. The value of the
Partnership's open positions thus creates a "risk of ruin" not
typically found in other investments. The relative size of the
positions held may cause the Partnership to incur losses greatly
in excess
of VaR within a short period of time, given the effects of the
leverage employed and market volatility. The VaR tables above,
as well as the past performance of the Partnership, gives no
indication of such "risk of ruin". In addition, VaR risk measures
should be viewed in light of the methodology's limitations, which
include the following:
past changes in market risk factors will not always result
in accurate predictions of the distributions and correlations of
future market movements;
changes in portfolio value in response to market movements
may differ from those of the VaR model;
VaR results reflect past trading positions while future risk
depends on future positions;
VaR using a one-day time horizon does not fully capture the
market risk of positions that cannot be liquidated or hedged
within one day; and
the historical market risk factor data used for VaR
estimation may provide only limited insight into losses that
could be incurred under certain unusual market movements.
The VaR tables above present the results of the Partnership's VaR
for each of the Partnership's market risk exposures and on an
aggregate basis at December 31, 1999 and for the end of the four
quarterly reporting periods during calendar year 1999. Since VaR
is based on historical data, VaR should not be viewed as
predictive of the Partnership's future financial performance or
its
ability to manage or monitor risk. There can be no assurance
that the Partnership's actual losses on a particular day will not
exceed the VaR amounts indicated above or that such losses will
not occur more than 1 in 100 trading days.
Non-Trading Risk
The Partnership has non-trading market risk on its foreign cash
balances not needed for margin. These balances and any market
risk they may represent are immaterial. The Partnership also
maintains a substantial portion (approximately 86%) of its
available assets in cash at DWR. A decline in short-term
interest rates will result in a decline in the Partnership's cash
management income. This cash flow risk is not considered
material.
Materiality, as used throughout this section, is based on an
assessment of reasonably possible market movements and any
associated potential losses, taking into account the leverage,
optionality and multiplier features of the Partnership's market-
sensitive instruments.
Qualitative Disclosures Regarding Primary Trading Risk Exposures
The following qualitative disclosures regarding the Partnership's
market risk exposures - except for (A) those disclosures that are
statements of historical fact and (B) the descriptions of how the
Partnership manages its primary
market risk exposures - constitute forward-looking statements
within the meaning of Section 27A of the Securities Act and
Section 21E of the Securities Exchange Act. The Partnership's
primary market risk exposures as well as the strategies used and
to be used by Demeter and the Trading Managers for managing such
exposures are subject to numerous uncertainties, contingencies
and risks, any one of which could cause the actual results of the
Partnership's risk controls to differ materially from the
objectives of such strategies. Government interventions,
defaults and expropriations, illiquid markets, the emergence of
dominant fundamental factors, political upheavals, changes in
historical price relationships, an influx of new market
participants, increased regulation and many other factors could
result in material losses as well as in material changes to the
risk exposures and the risk management strategies of the
Partnership. Investors must be prepared to lose all or
substantially all of their investment in the Partnership.
The following were the primary trading risk exposures of the
Partnership at December 31, 1999, by market sector. It may be
anticipated however, that these market exposures will vary
materially over time.
Currency. The primary market exposure in the Partnership at
December 31, 1999 was in the currency sector. The Partnership's
currency exposure is to exchange rate fluctuations, primarily
fluctuations which disrupt the historical pricing relationships
between different currencies and currency
pairs. Interest rate changes as well as political and general
economic conditions influence these fluctuations. The
Partnership trades in a large number of currencies, including
cross-rates - i.e., positions between two currencies other than
the U.S. dollar. For the fourth quarter of 1999, the
Partnership's major exposures were in outright U.S. dollar
positions. (Outright positions consist of the U.S. dollar vs.
other currencies. These other currencies include the major and
minor currencies). Demeter does not anticipate that the risk
profile of the Partnership's currency sector will change
significantly in the future. The currency trading VaR figure
includes foreign margin amounts converted into U.S. dollars with
an incremental adjustment to reflect the exchange rate risk
inherent to the dollar-based Partnership in expressing VaR in a
functional currency other than dollars.
Interest Rate. The second largest market exposure at December
31, 1999 was in the interest rate complex. Exposure was spread
across the Japanese, U.S., German and Australian interest rate
sectors. Interest rate movements directly affect the price of
the sovereign bond futures positions held by the Partnership and
indirectly affect the value of its stock index and currency
positions. Interest rate movements in one country as well as
relative interest rate movements between countries materially
impact the Partnership's profitability. The Partnership's primary
interest rate exposure is generally to interest rate fluctuations
in the United States and the other G-7 countries. The G-7
countries consist of France, U.S., Britain, Germany,
Japan, Italy and Canada. However, the Partnership also takes
futures positions in the government debt of smaller nations -
e.g. Australia. Demeter anticipates that G-7 and Australian
interest rates will remain the primary interest rate exposure of
the Partnership for the foreseeable future. The changes in
interest rates, which have the most effect on the Partnership,
are changes in long-term, as opposed to short-term, rates. Most
of the speculative futures positions held by the Partnership are
in medium to long-term instruments. Consequently, even a
material change in short-term rates would have little effect on
the Partnership, were the medium to long-term rates to remain
steady.
Equity. The Partnership's primary equity exposure is to equity
price risk in the G-7 countries. The stock index futures traded
by the Partnership are by law limited to futures on broadly based
indices. At December 31, 1999, the Partnership's primary
exposures were in the All Ordinaries (Australia) and Nikkei
(Japan) stock indices. The Partnership is primarily exposed to
the risk of adverse price trends or static markets in the U.S.
and Japanese indices. (Static markets would not cause major
market changes but would make it difficult for the Partnership to
avoid being "whipsawed" into numerous small losses).
Commodity.
Energy. On December 31, 1999, the Partnership's energy exposure
was in the crude and heating oil markets. Price movements in
these markets result from political developments in the Middle
East, weather patterns, and other economic fundamentals. As oil
prices have increased approximately 100% this year, and, given
that the agreement by OPEC to cut production is approaching
expiration in March 2000, it is possible that volatility will
remain on the high end. Significant profits and losses have been
and are expected to continue to be experienced in this market.
Soft Commodities and Agriculturals. On December 31, 1999, the
Partnership had a reasonable amount of exposure in the markets
that comprise these sectors. Most of the exposure, however, was
in the coffee, sugar and corn markets. Supply and demand
inequalities, severe weather disruption and market expectations
affect price movements in these markets.
Metals. The Partnership's primary metals market exposure is to
fluctuations in the price of gold and silver. Although certain
Trading Managers will from time to time trade base metals such as
aluminum and copper, the principal market exposures of the
Partnership have consistently been in precious metals, gold and
silver. A reasonable amount of exposure was evident in the gold
market as the price of gold retreated during the fourth quarter.
However,
silver prices have remained volatile over this period, and the
Trading Managers have taken substantial positions as perceived
market opportunities developed. Demeter anticipates that gold
and silver will remain the primary metals market exposure for the
Partnership.
Qualitative Disclosures Regarding Non-Trading Risk Exposure
The following was the only non-trading risk exposure of the
Partnership at December 31, 1999:
Foreign Currency Balances. The Partnership's primary foreign
currency balances are in Australian dollars. The Partnership
controls the non-trading risk of these balances by regularly
converting these balances back into dollars upon liquidation of
the respective position.
Qualitative Disclosures Regarding Means of Managing Risk Exposure
The Partnership and the Trading Managers, separately, attempt to
manage the risk of the Partnership's open positions in
essentially the same manner in all market categories traded.
Demeter attempts to manage market exposure by diversifying the
Partnership's assets among different Trading Managers, each of
whose strategies focus on different market sectors and trading
approaches, and monitoring the performance of the Trading
Managers daily. In addition, the Trading Managers establish
diversification guidelines, often set in terms of
the maximum margin to be committed to positions in any one market
section or market-sensitive instrument.
Demeter monitors and controls the risk of the Partnership's non-
trading instrument, cash, which is the only Partnership
investment directed by Demeter rather than the Trading Managers.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements are incorporated by reference to the
Partnership's Annual Report, which is filed as Exhibit 13.01
hereto.
Supplementary data specified by Item 302 of Regulation S-K
(selected quarterly financial data) is not applicable.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
There are no directors or executive officers of the Partnership.
The Partnership is managed by Demeter.
Directors and Officers of the General Partner
The directors and officers of Demeter are as follows:
Robert E. Murray, age 39, is Chairman of the Board, President and
a Director of Demeter. Mr. Murray is also Chairman of the Board,
President and a Director of DWFCM. Effective as of the close of
business on January 31, 2000, Mr. Murray replaced Mr. Hawley as
Chairman of the Board of Demeter and DWFCM. Mr. Murray is
currently a Senior Vice President of DWR's Managed Futures
Department. Mr. Murray began his career at DWR in 1984 and is
currently the Director of the Managed Futures Department. In this
capacity, Mr. Murray is responsible for overseeing all aspects of
the firm's Managed Futures Department. Mr. Murray currently
serves as Vice Chairman and a Director of the Managed Funds
Association, an industry association for investment professionals
in futures, hedge funds and other alternative investments. Mr.
Murray graduated from Geneseo State University in May 1983 with a
B.A. degree in Finance.
Mitchell M. Merin, age 46, is a Director of Demeter. Mr. Merin
is also a Director of DWFCM. Mr. Merin was appointed the Chief
Operating Officer of Individual Asset Management for MSDW in
December 1998 and the President and Chief Executive Officer of
Morgan Stanley Dean Witter Advisors in February 1998. He has
been an Executive Vice President of DWR since 1990, during which
time he has been director of DWR's Taxable Fixed Income and
Futures divisions, Managing Director in Corporate Finance and
Corporate Treasurer. Mr. Merin received his Bachelor's degree
from Trinity College in Connecticut and his M.B.A. degree in
finance and accounting from the Kellogg Graduate School of
Management of Northwestern University in 1977.
Joseph G. Siniscalchi, age 54, is a Director of Demeter. Mr.
Siniscalchi joined DWR in July 1984 as a First Vice President,
Director of General Accounting and served as a Senior Vice
President and Controller for DWR's Securities Division through
1997. He is currently Executive Vice President and Director of
the Operations Division of DWR. From February 1980 to July 1984,
Mr. Siniscalchi was Director of Internal Audit at Lehman Brothers
Kuhn Loeb, Inc.
Edward C. Oelsner, III, age 57, is a Director of Demeter. Mr.
Oelsner is currently an Executive Vice President and head of the
Product Development Group at Morgan Stanley Dean Witter Advisors,
an affiliate of DWR. Mr. Oelsner joined DWR in 1981 as a Managing
Director in DWR's Investment Banking
Department specializing in coverage of regulated industries and,
subsequently, served as head of the DWR Retail Products Group.
Prior to joining DWR, Mr. Oelsner held positions at The First
Boston Corporation as a member of the Research and Investment
Banking Departments from 1967 to 1981. Mr. Oelsner received his
M.B.A. in Finance from the Columbia University Graduate School of
Business in 1966 and an A.B. in Politics from Princeton
University in 1964.
Lewis A. Raibley, III, age 37, is Vice President, Chief Financial
Officer, and a Director of Demeter. Mr. Raibley is also a
Director of DWFCM. Mr. Raibley is currently Senior Vice
President and Controller in the Individual Asset Management Group
of MSDW. From July 1997 to May 1998, Mr. Raibley served as
Senior Vice President and Director in the Internal Reporting
Department of MSDW and prior to that, from 1992 to 1997, he
served as Senior Vice President and Director in the Financial
Reporting and Policy Division of Dean Witter Discover & Co. He
has been with MSDW and its affiliates since June 1986.
Richard A. Beech, age 48, is a Director of Demeter. Mr. Beech
has been associated with the futures industry for over 23 years.
He has been at DWR since August 1984 where he is presently Senior
Vice President and head of Branch Futures. Mr. Beech began his
career at the Chicago Mercantile Exchange, where he became the
Chief Agricultural Economist doing market analysis, marketing and
compliance. Prior to joining DWR, Mr. Beech also had
worked at two investment banking firms in operations, research,
managed futures and sales management.
Ray Harris, age 43, is a Director of Demeter. Mr. Harris is
currently Executive Vice President, Planning and Administration
for Morgan Stanley Dean Witter Asset Management and has worked at
DWR or its affiliates since July 1982, serving in both financial
and administrative capacities. From August 1994 to January 1999,
he worked in two separate DWR affiliates, Discover Financial
Services and Novus Financial Corp., culminating as Senior Vice
President. Mr. Harris received his B.A. degree from Boston
College and his M.B.A. in finance from the University of Chicago.
Mark J. Hawley, age 56, served as Chairman of the Board and a
Director of Demeter and DWFCM throughout 1999. Mr. Hawley joined
DWR in February 1989 as Senior Vice President and served as
Executive Vice President and Director of DWR's Product Management
for Individual Asset Management throughout 1999. In this
capacity, Mr. Hawley was responsible for directing the activities
of the firm's Managed Futures, Insurance, and Unit Investment
Trust Business. From 1978 to 1989, Mr. Hawley was a member of
the senior management team at Heinold Asset Management, Inc., a
commodity pool operator, and was responsible for a variety of
projects in public futures funds. From 1972 to 1978, Mr. Hawley
was a Vice President in charge of institutional block trading for
the Mid-West at Kuhn Loeb & Company. Mr. Hawley resigned
effective January 31, 2000.
All of the foregoing directors have indefinite terms.
Item 11.
Item 11. EXECUTIVE COMPENSATION
The Partnership has no directors and executive officers. As a
limited partnership, the business of the Partnership is managed
by Demeter, which is responsible for the administration of the
business affairs of the Partnership but receives no compensation
for such services.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
(a) Security Ownership of Certain Beneficial Owners - At
December 31, 1999, there were no persons known to be beneficial
owners of more than 5 percent of the Units.
(b) Security Ownership of Management - At December 31, 1999,
Demeter owned 117.400 Units of General Partnership Interest
representing a 1.74 percent interest in the Partnership.
(c) Changes in Control - None
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Refer to Note 2 - "Related Party Transactions" of "Notes to
Financial Statements", in the accompanying Annual Report to
Limited Partners for the year
ended December 31, 1999, which is incorporated by reference to
Exhibit 13.01 of this Form 10-K. In its capacity as the
Partnership's retail commodity broker, DWR received commodity
brokerage commissions (paid and accrued by the Partnership) of
$1,579,871 for the year ended December 31, 1999.
PART IV
Item 14.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K
(a) 1. Listing of Financial Statements
The following financial statements and report of independent
public auditors, all appearing in the accompanying Annual
Report to Limited Partners for the year ended December 31,
1999, are incorporated by reference to Exhibit 13.01 of this
Form 10-K:
- - Report of Deloitte & Touche LLP, independent auditors, for the years ended December 31, 1999, 1998 and 1997.
- - Statements of Financial Condition as of December 31, 1999 and 1998.
- - Statements of Operations, Changes in Partners' Capital, and Cash Flows for the years ended December 31, 1999, 1998 and 1997.
- - Notes to Financial Statements.
With the exception of the aforementioned information and the
information incorporated in Items 7, 8, and 13, the Annual
Report to Limited Partners for the year ended December 31,
1999 is not deemed to be filed with this report.
2. Listing of Financial Statement Schedules
No financial statement schedules are required to be filed
with this report.
(b) Reports on Form 8-K
No reports on Form 8-K have been filed by the Partnership
during the last quarter of the period covered by this
report.
(c) Exhibits
Refer to Exhibit Index on Page E-1.
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DEAN WITTER CORNERSTONE FUND II
(Registrant)
BY: Demeter Management Corporation, General Partner
March 30, 2000 BY: /s/ Robert E. Murray Robert E. Murray, Director, Chairman of the Board and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Demeter Management Corporation.
BY: /s/ Robert E. Murray ____ March 30, Robert E. Murray, Director, Chairman of the Board and President
/s/ Joseph G. Siniscalchi ___ March 30, Joseph G. Siniscalchi, Director
/s/ Edward C. Oelsner III ___ March 30, Edward C. Oelsner III, Director
/s/ Mitchell M. Merin _ March 30, 2000 Mitchell M. Merin, Director
/s/ Richard A. Beech _ March 30, 2000 Richard A. Beech, Director
/s/ Ray Harris March 30, Ray Harris, Director
/s/ Lewis A. Raibley, III __ March 30, Lewis A. Raibley, III, Director, Chief Financial Officer and Principal Accounting Officer
EXHIBIT INDEX
ITEM
3.01 Limited Partnership Agreement of the Partnership, dated as of December 7, 1983, as amended as of May 11, 1984 is incorporated by reference to Exhibit 3.01 to Partnership's Annual Report on Form 10- K for the fiscal year ended September 30, 1984 (File No. 0-13298).
10.01 Management Agreement among the Partnership, Demeter and JWH dated November 15, 1983 is incorporated by reference to Exhibit 10.03 to Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1984 (File No. 0- 13298).
10.02 Dean Witter Cornerstone Funds Exchange Agreement, dated as of May 31, 1984 is incorporated by reference to Exhibit 10.04 to Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1984 (File No. 0-13298).
10.03 Management Agreement among the Partnership, Demeter and Northfield Trading L.P. dated as of April 16, 1997 is incorporated by reference to Exhibit 10.03 to Partnership's Annual Report on Form 10-K for the fiscal year ended December 31, 1997 (File No. 0-13298).
10.04 Amended and Restated Customer Agreement, dated as of December 1, 1997, between the Partnership and Dean Witter Reynolds Inc. is incorporated by reference to Exhibit 10.04 to Partnership's Annual Report on Form 10-K for the fiscal year ended December 31 1998 (File No. 0-13298).
10.05 Customer Agreement, dated as of December 1, 1997, among the Partnership, Carr Futures, Inc. and Dean Witter Reynolds Inc. is incorporated by reference to Exhibit 10.05 to Partnership's Annual Report on Form 10-K for the fiscal year ended December 31, 1998 (File No. 0-13298).
10.06 International Foreign Exchange Master Agreement, dated as of August 1, 1997, between the Partnership and Carr Futures, Inc. is incorporated by reference to Exhibit 10.06 to Partnership's Annual Report on From 10-K for the fiscal year ended December 31, 1998 (File No. 0-13298).
13.01 Annual Report to Limited Partners for the year ended December 31, 1999 is filed herewith.
Cornerstone Funds
December 31, 1999 Annual Report
MORGAN STANLEY DEAN WITTER
Demeter Management Corporation Two World Trade Center 62nd Floor New York, NY 10048 Telephone (212) 392-8899
Dean Witter Cornerstone Funds Annual Report
Dear Limited Partner:
This marks the fifteenth annual report for Cornerstone Funds II and III and the thirteenth for Cornerstone Fund IV. The Net Asset Value per Unit for each of the three Cornerstone Funds on December 31, 1999 was as follows:
Since their inception in 1985, Cornerstone Funds II and III have increased by 306.7% (a compound annualized return of 9.8%) and 212.4% (a compound annualized return of 7.9%) respectively. Since its inception in 1987, Cornerstone Fund IV has increased by 380.4% (a compound annualized return of 13.2%).
Overall, each of the three Cornerstone Funds experienced a net loss for 1999. The overall losses for Cornerstone Funds II and III resulted primarily from the lack of sustained price trends and short-term volatility in the international interest rate futures, particularly Japanese government bond futures, and met- als markets. A portion of these losses was offset by profits as the Funds' Ad- visors were able to take advantage of price trends in markets such as crude oil. Long futures positions in crude oil proved profitable for Cornerstone Funds II and III as oil prices trended higher from $12 a barrel in February to over $25 a barrel in November. Additional gains were recorded in Cornerstone Fund II from short positions in the euro and Swiss franc as the value of these European currencies weakened relative to the U.S. dollar during the first six months of the year and again during the fourth quarter. Additional profits were recorded in Cornerstone Fund II from long Japanese yen positions as the value of the yen strengthened versus
the U.S. dollar during the latter half of 1999 on increased optimism regarding the Japanese economy. Cornerstone Fund III was able to mitigate overall losses for the year with profits recorded from long positions in U.S. and European stock index futures as prices trended higher late in the year. Cornerstone Fund IV's overall losses resulted primarily from trendless movement in the value of the British pound throughout a majority of the year. Losses were also incurred from short Singapore dollar positions during June and December as the value of this Pacific Rim currency moved higher versus the U.S. dollar as the Japanese yen strengthened. These losses were mitigated by gains recorded from short po- sitions in the euro and Swiss franc and long positions in the Japanese yen.
While we are disappointed that the Cornerstone Funds had a difficult year in 1999, we remind investors that managed futures funds such as the Cornerstone Funds are designed to provide diversification and non-correlation, that is the ability to perform independently, of global equities and bonds. Managed futures have historically performed independently of traditional investments, such as stocks and bonds. This is referred to as non-correlation, or the potential for managed futures to perform when traditional markets such as stocks and bonds may experience difficulty performing. Of course, managed futures funds will not automatically be profitable during unfavorable periods for these traditional investments and vice versa. The degree of non-correlation of any given managed futures fund will vary, particularly as a result of market conditions, and some funds will have significantly lesser degrees of non-correlation (i.e., greater correlation) with stocks and bonds than others. 1999 proved to be another strong year for equities, due in large part to continued growth and stability in most major world economies accompanied by low inflation. This environment, while strong for equities, provided few major sustained price trends in the world's futures and currency markets, and as such, proved to be a difficult trading environment for the money managers in these Funds whose trading strate- gies rely on the existence of longer-term price trends for trading opportuni- ties. Nevertheless, we remain confident in the role that managed futures in- vestments play
in the overall investment portfolio, and we believe this confidence is well- founded based on the longer-term diversified non-correlated returns of this al- ternative investment. Demeter Management Corporation, as General Partner to the Funds, has been and continues to be an active investor with more than $18 mil- lion invested among the 24 managed futures funds to which we act as General Partner.
Additionally, Demeter Management Corporation determined to adjust the alloca- tion of Net Assets among the trading managers within Cornerstone Fund III. Ef- fective with the September 30, 1999 closing of Cornerstone Fund III, the Net Assets managed by Abraham Trading Co. (approximately $7.3 million, or 20% of Net Assets) was reallocated to Welton Investment Corporation. Additionally, any net proceeds or redemptions received via monthly exchanges into or out of Cor- nerstone Fund III will be allocated 50% to Welton Investment Corporation and 50% to Sunrise Capital Management, Inc.
Finally, the current exchange privilege among the Cornerstone Funds (a "Series Exchange") will be terminated effective with the April 30, 2000 monthly clos- ing. The decision to terminate the Series Exchange privilege was made in view of the limited use of that procedure and by a desire to reduce certain adminis- trative expenses paid by the Cornerstone Funds in order to maintain an effec- tive registration statement, as well as the availability of alternative invest- ment vehicles, such as the Morgan Stanley Dean Witter Spectrum Series and the Morgan Stanley Dean Witter Charter Series. Limited Partners retain the ability to execute an exchange from a Cornerstone Fund into either the Morgan Stanley Dean Witter Spectrum Series or the Morgan Stanley Dean Witter Charter Series (a "Non-Series Exchange"), subject to certain restrictions set forth in the appli- cable prospectus. The Non-Series Exchange privilege is provided to Limited Partners at no additional cost. Limited Partners of the Cornerstone Funds are reminded that, subject to certain restrictions, they have the right to redeem their Units on a
monthly basis, and that Limited Partners of the Cornerstone Funds may vote to take certain actions with respect to the operation of the Cornerstone Funds, as more fully set forth in Section 17 of the Limited Partnership Agreement on page A-16 of the Prospectus.
Should you have any questions concerning this report, please feel free to contact Demeter Management Corporation at Two World Trade Center, 62nd Floor, New York, NY 10048, or your Morgan Stanley Dean Witter Financial Advisor.
I hereby affirm, that to the best of my knowledge and belief, the information contained in this report is accurate and complete. Past performance is not a guarantee of future results.
Sincerely,
/s/ Robert E. Murray
Robert E. Murray Chairman Demeter Management Corporation General Partner
Dean Witter Cornerstone Funds Independent Auditors' Report
The Limited Partners and the General Partner of Dean Witter Cornerstone Fund II Dean Witter Cornerstone Fund III Dean Witter Cornerstone Fund IV:
We have audited the accompanying statements of financial condition of Dean Wit- ter Cornerstone Fund II, Dean Witter Cornerstone Fund III and Dean Witter Cor- nerstone Fund IV (collectively, the "Partnerships") as of December 31, 1999 and 1998 and the related statements of operations, changes in partners' capital, and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Partnerships' management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing stan- dards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of materi- al misstatement. An audit includes examining, on a test basis, evidence sup- porting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement pre- sentation. We believe that our audits provide a reasonable basis for our opin- ion.
In our opinion, such financial statements present fairly, in all material re- spects, the financial position of Dean Witter Cornerstone Fund II, Dean Witter Cornerstone Fund III and Dean Witter Cornerstone Fund IV at December 31, 1999 and 1998 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with gener- ally accepted accounting principles.
/s/ Deloitte & Touche LLP
February 14, 2000 (March 3, 2000 as to Note 6) New York, New York
Dean Witter Cornerstone Fund II Statements of Financial Condition
Statements of Operations For the Years Ended December 31, 1999, 1998 and 1997
The accompanying notes are an integral part of these financial statements.
Dean Witter Cornerstone Fund III Statements of Financial Condition
Statements of Operations For the Years Ended December 31, 1999, 1998 and 1997
The accompanying notes are an integral part of these financial statements.
Dean Witter Cornerstone Fund IV Statements of Financial Condition
Statements of Operations For the Years Ended December 31, 1999, 1998 and 1997
The accompanying notes are an integral part of these financial statements.
Dean Witter Cornerstone Funds
Statements of Changes in Partners' Capital For the Years Ended December 31, 1999, 1998 and 1997
The accompanying notes are an integral part of these financial statements.
Dean Witter Cornerstone Funds
Statements of Changes in Partners' Capital For the Years Ended December 31, 1999, 1998 and 1997
The accompanying notes are an integral part of these financial statements.
Dean Witter Cornerstone Fund II Statements of Cash Flows
The accompanying notes are an integral part of these financial statements.
Dean Witter Cornerstone Fund III Statements of Cash Flows
The accompanying notes are an integral part of these financial statements.
Dean Witter Cornerstone Fund IV Statements of Cash Flows
The accompanying notes are an integral part of these financial statements.
Dean Witter Cornerstone Funds Notes to Financial Statements
1. Summary of Significant Accounting Policies
Organization--Dean Witter Cornerstone Fund II ("Cornerstone II"), Dean Witter Cornerstone Fund III ("Cornerstone III"), and Dean Witter Cornerstone Fund IV ("Cornerstone IV"), (individually, a "Partnership", or collectively, the "Part- nerships") are limited partnerships organized to engage in the speculative trading of futures, options and forward contracts on foreign currencies and other commodity interests (collectively, "futures interests").
The general partner for each Partnership is Demeter Management Corporation ("Demeter"). The non-clearing commodity broker is Dean Witter Reynolds Inc. ("DWR") and an unaffiliated clearing commodity broker, Carr Futures Inc. ("Carr"), provides clearing and execution services. Demeter and DWR are wholly- owned subsidiaries of Morgan Stanley Dean Witter & Co. ("MSDW").
On May 31, 1997, Morgan Stanley Group Inc. was merged with and into Dean Wit- ter, Discover & Co. ("DWD"). At that time, DWD changed its corporate name to Morgan Stanley, Dean Witter, Discover & Co. ("MSDWD"). Effective February 19, 1998, MSDWD changed its corporate name to Morgan Stanley Dean Witter & Co.
Demeter is required to maintain a 1% minimum interest in the equity of each Partnership and income (losses) are shared by Demeter and the limited partners based upon their proportional ownership interests.
Use of Estimates--The financial statements are prepared in accordance with gen- erally accepted accounting principles, which require management to make esti- mates and assumptions that affect the reported amounts in the financial state- ments and related disclosures. Management believes that the estimates utilized in the preparation of the financial statements are prudent and reasonable. Ac- tual results could differ from those estimates.
Revenue Recognition--Futures interests are open commitments until settlement date. They are valued at market on a daily basis and the resulting net change in unrealized gains and losses is reflected in the change in unrealized profit (loss) on open contracts from one period to the next in the statements of oper- ations. Monthly, DWR pays each Partnership interest income based upon 80% of its average daily Net Assets at a rate equal to the average yield on 13-week U.S. Treasury bills issued. For purposes of such interest payments in Dean Wit- ter Cornerstone Fund IV, Net Assets do not include monies due the Partnership on futures interests, but not actually received.
Dean Witter Cornerstone Funds Notes to Financial Statements--(Continued)
Net Income (Loss) per Unit--Net income (loss) per unit of limited partnership interest ("Unit(s)") is computed using the weighted average number of Units outstanding during the period.
Equity in Futures Interests Trading Accounts--The Partnerships' asset "Equity in futures interests trading accounts," reflected in the statements of finan- cial condition, consists of (A) cash on deposit with DWR and Carr to be used as margin for trading; (B) net unrealized gains or losses on open contracts, which are valued at market and calculated as the difference between original contract value and market value, and (C) net option premiums, which represent the net of all monies paid and/or received for such option premiums.
The Partnerships, in their normal course of business, enter into various con- tracts with Carr acting as their commodity broker. Pursuant to brokerage agree- ments with Carr, to the extent that such trading results in unrealized gains or losses, these amounts are offset and reported on a net basis on the Partner- ships' statements of financial condition.
The Partnerships have offset the fair value amounts recognized for forward contracts executed with the same counterparty as allowable under terms of the master netting agreement with Carr, the sole counterparty on such contracts. The Partnerships have consistently applied their right to offset.
Brokerage Commissions and Related Transaction Fees and Costs--Brokerage commis- sions for each Partnership are accrued at 80% of DWR's published non-member rates on a half-turn basis. Related transaction fees and costs are accrued on a half-turn basis. Brokerage commissions and transaction fees combined for each Partnership are capped at 13/20 of 1% per month (a 7.8% maximum annual rate) of the adjusted Net Assets allocated to each trading program employed by the Part- nerships' trading managers.
Operating Expenses--Each Partnership has entered into an exchange agreement pursuant to which certain common administrative expenses (i.e., legal, audit- ing, accounting, filing fees and other related expenses) are shared by each of the Partnerships based upon the number of outstanding Units of each Partnership during the month in which such expenses are incurred. In addition, the Partner- ships incur monthly management fees and may incur incentive fees. Demeter bears all other operating expenses.
Income Taxes--No provision for income taxes has been made in the accompanying financial statements, as partners are individually responsible for reporting income or loss based upon their respective share of each Partnership's revenues and expenses for income tax purposes.
Dean Witter Cornerstone Funds Notes to Financial Statements--(Continued) Distributions--Distributions, other than redemptions of Units, are made on a pro-rata basis at the sole discretion of Demeter. No distributions have been made to date.
Redemptions--Limited Partners may redeem some or all of their Units at 100% of the Net Asset Value per Unit as of the last day of any month upon fifteen days advance notice by redemption form to Demeter.
Exchanges--Limited Partners may transfer their investment among the Partner- ships (subject to certain restrictions outlined in the Limited Partnership Agreements) without paying additional charges.
The current exchange privilege among the Cornerstone funds (a "Series Ex- change") will be terminated effective with the April 30, 2000 monthly closing. Limited partners will retain the ability to execute an exchange from a Corner- stone fund into other funds outside the Cornerstone Series (a "Non-Series Ex- change") subject to certain restrictions set forth in the applicable limited partnership agreements.
Dissolution of the Partnership--Each Partnership will terminate on September 30, 2025 regardless of its financial condition at such time, upon a decline in Net Assets to less than $250,000, a decline in the Net Asset Value per Unit to less than $250, or under certain other circumstances defined in each Limited Partnership Agreement.
2. Related Party Transactions
Each Partnership pays brokerage commissions to DWR as described in Note 1. Each Partnership's cash is on deposit with DWR and Carr in futures interests trading accounts to meet margin requirements as needed. DWR pays interest on these funds as described in Note 1.
3. Trading Managers
Demeter, on behalf of each Partnership, retains certain commodity trading man- agers to make all trading decisions for the Partnerships. The trading managers for each Partnership as of December 31, 1999 were as follows:
Dean Witter Cornerstone Fund II Northfield Trading L.P. John W. Henry & Company, Inc.
Dean Witter Cornerstone Fund III Welton Investment Corporation ("Welton") Sunrise Capital Management, Inc. ("Sunrise")
Dean Witter Cornerstone Fund IV John W. Henry & Company, Inc. Sunrise Capital Management, Inc.
Commencing with the September 30, 1999 closing, the Net Assets previously man- aged by Abraham Trading
Dean Witter Cornerstone Funds Notes to Financial Statements--(Continued) Co. were reallocated to Welton. Additionally, any net proceeds or redemptions received via monthly exchanges into or out of Cornerstone III will be allocated equally between Welton and Sunrise.
Compensation to the trading managers by the Partnerships consists of a manage- ment fee and an incentive fee as follows:
Management Fee--Each Partnership's management fee is accrued at the rate of 1/3 of 1% per month (a 4% annual rate) of the Net Assets under management by each trading manager at each month end.
Incentive Fee--Each Partnership pays an annual incentive fee equal to 15% of the new appreciation in Net Assets, as defined in the Limited Partnership Agreements, as of the end of each annual incentive period ending December 31, except for Dean Witter Cornerstone Fund IV, which pays incentive fees at the end of each annual incentive period ending May 31. New appreciation represents the amount by which Net Assets are increased by profits from futures, forward and options trading exceed losses after brokerage commissions, management fees, transaction fees and costs and common administrative expenses are deducted. Such incentive fee is accrued in each month in which new appreciation occurs. In those months in which new appreciation is negative, previous accruals, if any, during the incentive period will be reduced. In those instances in which a Limited Partner redeems an investment, the incentive fee (if earned through a redemption date) is to be paid on those redemptions to the trading manager in the month of such redemption.
4. Financial Instruments
The Partnerships trade futures, options and forward contracts on foreign cur- rencies and other commodity interests. Futures and fowards represent contracts for delayed delivery of an instrument at a specified date and price. Risk aris- es from changes in the value of these contracts and the potential inability of counterparties to perform under the terms of the contracts. There are numerous factors which may significantly influence the market value of these contracts, including interest rate volatility.
In June 1998, the Financial Accounting Standards Board ("FASB") issued State- ment of Financial Accounting Standard ("SFAS") No. 133, "Accounting for Deriva- tive Instruments and Hedging Activities" effective for fiscal years beginning after June 15, 1999. In June 1999, the FASB issued SFAS No. 137, "Accounting for DerivativeInstruments and Hedging Activities--Deferral of the Effective Date of SFAS No. 133," which defers the required implementation of SFAS No. 133 until fiscal years beginning after June 15, 2000. However, each Partnership had previously elected to adopt the provisions of
Dean Witter Cornerstone Funds Notes to Financial Statements--(Continued) SFAS No. 133 beginning with the fiscal year ended December 31, 1998. SFAS No. 133 supersedes SFAS No. 119 and No. 105, which required the disclosure of aver- age aggregate fair values and contract/notional values, respectively, of deriv- ative financial instruments for an entity which carries its assets at fair val- ue. The application of SFAS No. 133 does not have a significant effect on the Partnerships' financial statements.
The net unrealized gains (losses) on open contracts are reported as a component of "Equity in futures interests trading accounts" on the statements of financial condition and totaled at De- cember 31, 1999 and 1998, respectively, $1,156,415 and $2,056,152 for Corner- stone II, $1,425,611 and $2,102,810 for Cornerstone III and $281,510 and $(2,827,252) for Cornerstone IV.
For Cornerstone II, of the $1,156,415 net unrealized gain on open contracts at December 31, 1999, $1,130,189 related to exchange-traded futures contracts and $26,226 related to off-exchange-traded forward currency contracts. Of the $2,056,152 net unrealized gain on open contracts at December 31, 1998, $2,421,869 related to exchange-traded futures contracts and $(365,717) related to off-exchange-traded forward currency contracts.
For Cornerstone III, all of the $1,425,611 net unrealized gain on open con- tracts at December 31, 1999 related to exchange-traded futures and futures- styled options contracts. Of the $2,102,810 net unrealized gain on open con- tracts at December 31, 1998, $2,250,314 related to exchange-traded futures con- tracts and $(147,504) related to off-exchange-traded forward currency con- tracts.
For Cornerstone IV, the $281,510 net unrealized gain on open contracts at De- cember 31, 1999 and the $(2,827,252) net unrealized loss on open contracts at December 31, 1998 related to off-exchange-traded forward currency contracts.
Exchange-traded contracts and off-exchange-traded forward currency contracts held by the Partnerships at December 31, 1999 and 1998 mature as follows:
Dean Witter Cornerstone Funds Notes to Financial Statements--(Continued)
The Partnerships have credit risk associated with counterparty nonperformance. The credit risk associated with the instruments in which the Partnerships are involved is limited to the amounts reflected in the Partnerships' statements of financial condition.
The Partnerships also have credit risk because DWR and Carr act as the futures commission merchants or the counterparties, with respect to most of the Part- nerships' assets. Exchange-traded futures and futures-styled options contracts are marked to market on a daily basis, with variations in value settled on a daily basis. Each of DWR and Carr, as a futures commission merchant for each Partnership's exchange-traded futures and futures-styled options contracts, are required, pursuant to regulations of the Commodity Futures Trading Commission, to segregate from their own assets, and for the sole benefit of their commodity customers, all funds held by them with respect to exchange-traded futures and futures-styled options contracts, including an amount equal to the net unrealized gain (loss) on all open futures and futures-styled options con- tracts, which funds, in the aggregate, totaled at December 31, 1999 and 1998 respectively, $26,934,277 and $32,371,440 for Cornerstone II, $33,694,399 and $40,755,289 for Cornerstone III, and $104,055,664 and $119,800,551 for Corner- stone IV. With respect to each Partnership's off-exchange-traded forward cur- rency contracts, there are no daily settlements of variations in value nor is there any requirement that an amount equal to the net unrealized gain (loss) on open forward contracts be segregated. With respect to those off-exchange-traded forward currency contracts, the Partnerships are at risk to the ability of Carr, the sole counterparty on all such contracts, to perform. Each Partnership has a netting agreement with Carr. These agreements, which seek to reduce both the Partnerships' and Carr's exposure on off-exchange-traded forward cur-rency contracts, should materially decrease the Partnerships' credit risk in the event of Carr's bankruptcy or insolvency. Carr's parent, Credit Agricole Indosuez, has guaranteed to the Partnerships payment of the net liquidating value of the transactions in the Partnerships' accounts with Carr (including foreign currency contracts).
5. Legal Matters
The class actions first filed in 1996 in California and in New York State courts were each dismissed in 1999. On September 6, 10, and 20, 1996, and on March 13, 1997, purported class actions were filed in the Superior Court of the State of California, County of Los Angeles, on behalf of all purchasers of in- terests in limited partner-ship commodity pools sold by DWR. Named defendants include DWR, Demeter, Dean Witter Futures & Currency Management Inc., MSDW, the Partnerships, certain limited partnership commodity pools of which Demeter is the general partner (all such parties referred
Dean Witter Cornerstone Funds Notes to Financial Statements--(Concluded) to hereafter as the "Morgan Stanley Dean Witter Parties") and certain trading advisors to those pools. On June 16, 1997, the plaintiffs in the above actions filed a consolidated amended complaint, alleging, among other things, that the defendants committed fraud, deceit, negligent misrepresentation, various viola- tions of the California Corporations Code, intentional and negligent breach of fiduciary duty, fraudulent and unfair business practices, unjust enrichment, and conversion in the sale and operation of the various limited partnerships commodity pools. The complaints seek unspecified amounts of compensatory and punitive damages and other relief. The court entered an order denying class certification on August 24, 1999. On September 24, 1999, the court entered an order dismissing the case without prejudice on consent. Similar purported class actions were also filed on September 18, and 20, 1996, in the Supreme Court of the State of New York, New York County, and on November 14, 1996 in the Superi- or Court of the State of Delaware, New Castle County, against the Morgan Stan- ley Dean Witter Parties and certain trading advisors on behalf of all purchas- ers of interests in various limited partnership commodity pools, including the Partnerships, sold by DWR. A consolidated and amended complaint in the action pending in the Supreme Court of the State of New York was filed on August 13, 1997, alleging that the defendants committed fraud, breach of fiduciary duty, and negligent misrepresentation in the sale and operation of the various limit- ed partnership commodity pools. The complaints seek unspecified amounts of com- pensatory and punitive damages and other relief. The New York Supreme Court dismissed the New York action in November 1998, but granted plaintiffs leave to file an amended complaint, which they did in early December 1998. The defen- dants filed a motion to dismiss the amended complaint with prejudice on Febru- ary 1, 1999. By decision dated December 21, 1999, the New York Supreme Court dismissed the case with prejudice.
In addition, on December 16, 1997, upon motion of the plaintiffs, the action pending in the Supreme Court of the State of Delaware was voluntarily dismissed without prejudice.
6. Subsequent Event
On March 3, 2000, the plaintiffs in the New York action referred to in Note 5 filed an appeal of the order dismissing the consolidated complaint.
MORGAN STANLEY DEAN WITTER & CO. Presorted Two World Trade Center First Class Mail 62nd Floor U.S. Postage Paid New York, NY 10048 Brooklyn, NY Permit No. 148