Item 1. BUSINESS
(a) General Development of Business. Dean Witter Diversified
Futures Fund II L.P. (the "Partnership") is a Delaware limited
partnership organized to engage primarily in the speculative
trading of commodity futures and forward contracts, physical
commodities, and other commodity interests.
The general partner for the Partnership is Demeter Management
Corporation ("Demeter"). The non-clearing commodity broker is
Dean Witter Reynolds, Inc. ("DWR"). The clearing commodity
brokers are Morgan Stanley & Co. Incorporated ("MS & Co.") and
Morgan Stanley & Co. International Limited ("MSIL"), which
provide clearing and execution services. Prior to May 2000, Carr
Futures Inc. provided clearing and execution services to the
Partnership. The trading manager is Dean Witter Futures &
Currency Management Inc. ("DWFCM" or the "Trading Manager").
Demeter, DWR, MS & Co., MSIL and DWFCM are wholly-owned
subsidiaries of Morgan Stanley Dean Witter & Co. ("MSDW").
The Partnership's net asset value per unit of limited partnership
interest ("Unit(s)") as of December 31, 2000 was $3,075.90,
representing an increase of 20.3 percent from the net asset value
per Unit of $2,556.25 at December 31, 1999. For a more detailed
description of the Partnership's business, see subparagraph (c).
(b) Financial Information about Segments. For financial
information reporting purposes, the Partnership is deemed to
engage in one industry segment, the speculative trading of
futures and forwards. 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 and forwards, pursuant
to trading instructions provided by the Trading Manager. For a
detailed description of the different facets of the Partnership's
business, see those portions of the Partnership's Prospectus
dated October 28, 1988 (the "Prospectus"), incorporated by
reference in this Form 10-K, set forth below:
Facets of Business
1. Summary 1. "Summary of the Prospectus" (Pages 2-7).
2. Commodity Markets 2. "The Commodities Markets" (Pages 57-67).
3. Partnership's Commodity 3. "Trading Policies" (Pages Trading Arrangements and 29-38). "The Trading Policies Manager" (Pages 29-38).
4. Management of the Part- 4. "The Management Agreement" nership (Pages 39-41). "The General Partner" (Pages 41-56) and "The Commodity Broker" (Pages 56-57). "The Limited Partnership Agreement" (Pages 68-73).
5. Taxation of the Partner- 5. "Federal Income Tax Aspects" ship's Limited Partners and "State and Local Income Tax Aspects" (Pages 75-83).
(d) Financial Information about Geographic Areas
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 and
forwards 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
Similar class actions were filed in 1996 in California and New
York State courts. Each of these actions were dismissed in 1999.
However, in the New York State class action is still pending
because, plaintiffs appealed the trial court's dismissal of their
case on March 3, 2000.
On September 18 and 20, 1996, purported class actions were filed
in the Supreme Court of the State of New York, New York County,
on behalf of all purchasers of interests in limited partnership
commodity pools sold by DWR. Named defendants include DWR,
Demeter, DWFCM, MSDW, the Partnership, certain limited
partnership commodity pools of which Demeter is the general
partner and certain Trading Managers to those pools. 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
sought 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. However, on March 3, 2000, plaintiffs appealed the
trial court's dismissal of their case.
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, 2000 was
approximately 395.
(c) Distributions
No distributions have been made by the Partnership since it
commenced trading operations on January 18, 1989. 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.
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 MS & Co. and MSIL as clearing brokers in
separate futures and forwards trading accounts established for
the 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 currency. 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 of Units in the future
will affect the amount of funds available for investments in
futures and forwards in subsequent periods. It is not possible
to estimate the amount and therefore the impact of future
redemptions of Units.
Results of Operations.
General. The Partnership's results depend on its Trading Manager
and the ability of the Trading Manager's trading programs to take
advantage of price movements or other profit opportunities in the
futures and forwards markets. The following presents a summary
of the Partnership's operations for the three years ended
December 31, 2000 and a general discussion of its trading
activities during each period. It is important to note, however,
that the Trading Manager trades 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
Manager 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 Manager's trading
activities on behalf of the Partnership as a whole and how the
Partnership has performed in the past.
At December 31, 2000, the Partnership's total capital was
$8,347,840, an increase of $294,026 from the Partnership's total
capital of $8,053,814 at December 31, 1999. For the year ended
December 31, 2000, the Partnership generated net income of
$1,452,113, and total redemptions aggregated $1,158,087.
For the year ended December 31, 2000, the Partnership recorded
total trading revenues, including interest income, of $2,174,535
and posted an increase in net asset value per Unit. In the
energy sector, profits of approximately 17.5% resulted primarily
from long positions in the natural gas and crude oil futures
markets. Natural gas saw its price rise to record levels in
2000. Recent low inventory levels, sluggish supply and cold
winter weather combined to push prices to such high levels. In
the crude oil market, gains were realized from long positions
earlier in the year as prices rose to nine-year highs on a
combination of cold weather, declining inventories and increasing
demand. In addition, concerns about future output levels from
the world's leading producer countries added to the upward price
momentum. Later in the year, however, profits resulted from
short positions as the price of crude oil futures fell on
expectations that Iraqi oil exports would resume and on fears
that the slowdown in the economy would curb demand while at the
same time increase supply. In the currency markets, gains of
approximately 13.5% were recorded primarily from short positions
in the euro, Swiss franc and Swedish krona as the value of these
European currencies weakened relative to the U.S. dollar amid
skepticism about Europe's economic outlook. Strong economic data
out of the U.S. and interest rate hikes in the U.S. also boosted
the dollar and, subsequently, added to the euro's difficulties.
Later in the year as the bullish trend in the U.S. dollar
reversed, additional gains were recorded from long positions in
the euro, Swiss franc and Swedish krona versus the U.S. dollar as
a result of new confidence in the European economy and overall
skepticism regarding the U.S. economy. Profits of approximately
1.7% were recorded in the agricultural markets primarily from
short positions in the corn market during the middle of the year
as the price of corn trended lower on favorable weather
conditions that resulted in good prospects for high crop yields.
A portion of these gains was offset by losses experienced in the
metals, stock index and soft commodities markets. The majority of
losses, approximately 7.1%, were experienced in the metals
markets primarily from aluminum futures. From a technical
standpoint, the price of aluminum traded in a very volatile
pattern throughout the year leaving, little opportunity for the
development of trends. In addition, long positions in this
market, particularly in the second half of the year, resulted in
losses as prices declined after concerns mounted that demand
would weaken amid a cooling of the U.S. economy. Losses of
approximately 5.0% were recorded in the global stock index
futures markets. The S&P 500 Index traded in a very choppy
pattern resulting in losses for both long and short positions.
Contributing to this price pattern was uncertainty over the state
of the U.S. economy. Total expenses for the year were $722,422,
resulting in net income of $1,452,113. The net asset value of a
unit increased from $2,556.25 at December 31, 1999 to $3,075.90
at December 31, 2000.
At December 31, 1999, the Partnership's total capital was
$8,053,814, a decrease of $2,521,152 from the Partnership's total
capital of $10,574,966 at December 31, 1998. For the year ended
December 31, 1999, the Partnership generated a net loss of
$948,607, and total redemptions aggregated $1,572,545.
For the year ended December 31, 1999, the Partnership recorded
total trading losses, net of interest income, of $65,754 and
posted a decrease in net asset value per Unit. The Partnership
experienced losses in the global interest rate futures markets,
approximately 8.92%, primarily from short Australian interest
rate futures positions as prices increased during July and August
on the temporary strength in U.S. bonds and weaker-than-expected
business spending data out of Australia. Additional losses were
recorded from short Japanese bond futures positions as prices
increased during the first and third quarters. In the currency
markets, losses of approximately 7.08% were recorded primarily
from Australian dollar positions. Throughout a majority of the
first quarter, losses were experienced from long Australian
dollar positions as its value dropped significantly relative to
the U.S. dollar on speculation regarding potential currency
devaluations in the Asian region. Early in the third quarter,
additional losses were recorded from long positions in this
currency due to depressed commodities prices, emerging market
concerns and on-going talks that China may eventually devalue its
currency. Newly established short positions in the Australian
dollar resulted in losses during September as its value
strengthened relative to the U.S. dollar following the rally in
gold prices. Offsetting currency gains of 3.76% were recorded
from Japanese yen positions, primarily long positions. During
the third quarter, gains were recorded from long positions in the
Japanese yen as the value of the yen climbed to a 44-month
high versus the U.S. dollar due to continued optimism over
Japan's economic recovery. The energy markets produced gains of
approximately 7.39%. During March, gains were recorded from long
positions in oil futures as prices moved significantly higher on
news that both OPEC and non-OPEC countries had reached an
agreement to cut total output beginning April 1st. Gains were
also recorded in this market complex during the third quarter
after OPEC ministers confirmed that they would uphold their
global cutbacks until April of next year. Total expenses for the
year were $882,853, resulting in a net loss of $948,607. The net
asset value of a Unit decreased from $2,824.45 at December 31,
1998 to $2,556.25 at December 31, 1999.
At December 31, 1998, the Partnership's total capital was
$10,574,966, a decrease of $913,260 from the Partnership's total
capital of $11,488,226 at December 31, 1997. For the year ended
December 31, 1998, the Partnership generated net income of
$543,088, and total redemptions aggregated $1,456,348.
For the year ended December 31, 1998, the Partnership recorded
total trading revenues, including interest income, of $1,559,110
and posted an increase in net asset value per Unit. Gains of
approximately 13.65% were recorded in the global interest rate
futures markets from bond futures in most major world countries
throughout the year. The most significant gains were recorded in
German, by approximately 5.66%, U.S., by approximately 4.06% and
Japanese bond futures, by approximately 2.99% from primarily long
positions during August and September as investors sought the
safety of fixed income investments from notable volatility in the
global financial markets. Additional profits were recorded from
short Japanese government bond futures positions during December
as prices declined amid a surge in Japanese bond yields, which
was attributed to news that Japan's Ministry of Finance would end
outright purchases of government debt. Total expenses for the
year were $1,016,022, resulting in net income of $543,088. The
net asset value of a Unit increased from $2,684.43 at December
31, 1997 to $2,824.45 at December 31, 1998.
The Partnership's overall performance record represents varied
results of trading in different futures and forwards markets.
For a further description of 2000 trading results, refer to the
letter to the Limited Partners in the accompanying Annual Report
to Limited Partners for the year ended December 31, 2000, 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 and forwards in a
portfolio of agricultural commodities, energy products, foreign
currencies, interest rates, precious and base metals, soft
commodities, and stock indices. 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 Manager was 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 Manager's internal controls, the
Trading Manager 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 Manager and Demeter monitor the Partnership's trading
activities to ensure compliance with the trading policies.
Demeter may require the Trading Manager 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 and forwards
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 ultimate 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, with respect to forward contract trading, the Partnership
trades with only those counterparties which Demeter, together
with DWR, have determined to be creditworthy. The Partnership
presently deals with MS & Co. as the sole counterparty on 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, 2000, which is incorporated by reference
to Exhibit 13.01 of this Form 10-K.
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 and forwards. 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 and forwards traded by the Partnership involve
varying degrees of related 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 and forwards are settled daily through variation
margin.
The Partnership's risk exposure in the market sectors traded by
the Trading Manager 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 Manager in their daily risk management
activities.
The Partnership's Value at Risk in Different Market Sectors
The following table indicates the VaR associated with the
Partnership's open positions as a percentage of total net assets
by primary market risk category as of December 31, 2000 and 1999.
As of both December 31, 2000 and 1999, the Partnership's total
capitalization was approximately $8 million.
Primary Market December 31, 2000 December 31, 1999 Risk Category Value at Risk Value at Risk
Interest Rate (2.79)% (0.22)%
Currency (1.64) (0.79)
Commodity (1.07) (0.80)
Equity (0.25) (0.16)
Aggregate Value at Risk (3.29)% (1.24)%
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, 2000 and 1999 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 and forwards,
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 December 31, 2000 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, 2000 through December 31, 2000.
Primary Market Risk Category High Low Average
Interest Rate (2.79)% (0.57)% (1.62)%
Currency (2.78) (1.46) (1.88)
Commodity (2.40) (1.07) (1.80)
Equity (1.16) - (0.37)
Aggregate Value at Risk (3.29) (2.63)% (3.12)%
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
usually 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, give 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, 2000 and 1999, and for the end of
the four quarterly reporting periods during calendar year 2000.
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. At December 31, 2000,
the Partnership's cash balance at DWR was approximately 86% of
its total net asset value. 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 to be
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 Manager 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 as of December 31, 2000 by market sector. It may be
anticipated however, that these market exposures will vary
materially over time.
Interest Rate. The largest market exposure at December 31, 2000
was in the interest rate complex. Exposure was spread across
European, United States, Japanese 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 which
have the most effect on the Partnership are in short- to
intermediate-term as opposed to long-term rates as most of the
speculative interest rate futures positions held by the
Partnership are in short-term and medium-term instruments.
Currency. The next most significant market exposure of the
Partnership at December 31, 2000 was in the foreign exchange
complex. The currency exposure is to exchange rate fluctuations,
primarily those 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. The
Partnership's major exposures were in the euro currency crosses
and 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 U.S. dollars.
Commodity.
Energy. At December 31, 2000 the Partnership's next largest
exposure was in the energy complex. The largest exposure was in
natural gas, followed by crude oil and brent crude. Price
movement in these markets results from political developments in
Middle Eastern and OPEC and non-OPEC oil producing countries.
Weather patterns and other economic fundamentals also affect
prices. It is possible that volatility will remain high and that
significant profits and losses, which have been experienced in
the past, will continue to be experienced in this market.
Natural gas has exhibited volatility in prices resulting from
weather patterns and supply and demand factors and may continue
in this choppy pattern.
Soft Commodities and Agriculturals . At December 31, 2000 the
Partnership had exposure in the markets that comprise these
sectors. Exposure was in the corn, soybean, cotton, cocoa and
coffee markets. Supply and demand inequalities, severe weather
disruption and market expectations affect price movements in
these markets.
Metals. The Partnership's smallest exposure as of the end of the
fourth quarter was in the metals complex. The only positions
were in the LME nickel market. Prices in this market are
influenced by general economic conditions and warehouse stocks.
Equity. There was a relatively small exposure to stock indices
as of December 31, 2000. The Partnership trades these markets in
the United States and Japan and had small positions in both
markets. Stock indices are affected by the same factors that
influence the underlying equity issues such as the monetary and
fiscal policies of government, profit outlook and general
economic conditions.
Qualitative Disclosures Regarding Non-Trading Risk Exposure
The following was the only non-trading risk exposure of the
Partnership at December 31, 2000:
Foreign Currency Balances. The Partnership's primary
foreign currency balances were in British Pounds. The
Partnership controls the non-trading risk of these balances
by regularly converting these balances back into U.S.
dollars upon liquidation of the respective position.
Qualitative Disclosures Regarding Means of Managing Risk Exposure
The Partnership and the Trading Manager, 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 market sectors and trading
approaches, and monitoring the performance of the Trading Manager
daily. In addition, the Trading Manager establishes diversi-
fication guidelines, often set in terms of the maximum margin to
be committed to positions in any one market sector or market-
sensitive instrument.
Demeter monitors and controls the risk of the Partnership's non-
trading instrument, cash. Cash is the only Partnership
investment directed by Demeter, rather than the Trading Manager.
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:
Summary of Quarterly Results (Unaudited)
Net Income/ (Loss) Per Quarter Net Unit of Limited Ended Revenue Income/(Loss) Partnership Interest
March 31 $ 480,364 $ 277,550 $ 88.09 June 30 305,012 133,298 44.73 September 30 (452,279) (597,100) (207.80) December 31 1,841,438 1,638,365 594.63
Total $ 2,174,535 $ 1,452,113 $ 519.65
March 31 $ (411,324) $ (641,891) $(171.44) June 30 209,318 (35,816) (10.07) September 30 472,679 248,044 72.28 December 31 (336,427) (518,944) (158.97)
Total $ (65,754) $ (948,607) $(268.20)
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 40, 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. 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 previously served 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 47, 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 55, 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 59, 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.
Richard A. Beech, age 49, 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.
Raymond A. Harris, age 44, 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.
Anthony J. DeLuca, age 38, became a Director of Demeter on
September 14, 2000. Mr. DeLuca is also a Director of DWFCM. Mr.
DeLuca was appointed the Controller of Asset Management for MSDW
in June 1999. Prior to that, Mr. DeLuca was a partner at the
accounting firm of Ernst & Young LLP, where he had MSDW as a
major client. Mr. DeLuca had worked continuously at Ernst &
Young LLP ever since 1984, after he graduated from Pace
University with a B.B.A. degree in Accounting.
Raymond E. Koch, age 45, is Chief Financial Officer of Demeter.
Effective July 10, 2000, Mr. Koch replaced Mr. Raibley as Chief
Financial Officer of Demeter. Mr. Koch began his career at MSDW
in 1988, has overseen the Managed Futures Accounting function
since 1992, and is currently First Vice President, Director of
Managed Futures and Realty Accounting. From November 1979 to
June 1988, Mr. Koch held various positions at Thomson McKinnon
Securities, Inc. culminating as Manager, Special Projects in the
Capital Markets Division. From August 1977 to November 1979 he
was an auditor, specializing in financial services at Deloitte
Haskins and Sells. Mr. Koch received his B.B.A. in accounting
from Iona College in 1977, an M.B.A. in finance from Pace
University in 1984 and is a Certified Public Accountant.
Lewis A. Raibley, III, age 38, served as Vice President, Chief
Financial Officer, and a Director of Demeter and DWFCM until his
resignation from MSDW on July 1, 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 - As of
December 31, 2000, 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, 2000,
Demeter owned 104 Units of General Partnership Interest
representing a 3.83 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, 2000, 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 $444,258 for the year ended December 31, 2000.
In its capacity as the Partnership's trading manager, DWFCM
received management fees of $231,777 and incentive fee of $21,098
for the year ended December 31, 2000.
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
auditors, all appearing in the accompanying Annual Report to
Limited Partners for the year ended December 31, 2000, 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, 2000, 1999 and 1998.
- Statements of Financial Condition as of December 31, 2000 and 1999.
- Statements of Operations, Changes in Partners' Capital, and Cash Flows for the years ended December 31, 2000, 1999 and 1998.
- 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, 2000 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 DIVERSIFIED FUTURES FUND II L.P. (Registrant)
BY: Demeter Management Corporation, General Partner
March 30, 2001 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, 2001 Robert E. Murray, Director, Chairman of the Board and President
/s/ Mitchell M. Merin March 30, 2001 Mitchell M. Merin, Director
/s/ Joseph G. Siniscalchi March 30, 2001 Joseph G. Siniscalchi, Director
/s/ Edward C. Oelsner III March 30, 2001 Edward C. Oelsner III, Director
/s/ Richard A. Beech March 30, 2001 Richard A. Beech, Director
/s/ Raymond A. Harris March 30, 2001 Raymond A. Harris, Director
/s/ Anthony J. DeLuca March 30, 2001 Anthony J. DeLuca, Director
/s/ Raymond E. Koch March 30, 2001 Raymond E. Koch, Chief Financial Officer and Principal Accounting Officer
EXHIBIT INDEX
ITEM
3.01 Limited Partnership Agreement of the Partnership, dated as of October 28, 1988 is incorporated by reference to Exhibit 3.01 and Exhibit 3.02 of the Partnership's Registration Statement on Form S-1. File No. 24662)
10.01 Management Agreement among the Partnership, Demeter Management Corporation and Dean Witter Futures & Currency Management Inc. dated as of October 28, 1988 is incorporated by reference to Exhibit 10.02 of the Partnership's Registration Statement on Form S-1. (File No. 24462)
10.03 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 10.03 of the Partnership's quarterly report on Form 10-Q for the quarter ended March 31, 2000, File No. 0-17446.
10.04 Customer Agreement dated as of December 1, 1997, between the Partnership, Carr Futures, Inc., and Dean Witter Reynolds Inc. is incorporated by reference to Exhibit 10.04 of the Partnership's quarterly report on Form 10-Q for the quarter ended March 31, 2000, File No. 0-17446.
10.05 International Foreign Exchange Master Agreement dated as of August 1, 1997, between the Partnership and Carr Futures, Inc. is incorporated by reference to Exhibit 10.05 of the Partnership's quarterly report on Form 10-Q for the quarter ended March 31, 2000, File No. 0-17446.
10.06 Customer Agreement, dated as of May 1, 2000 between Morgan Stanley & Co. Incorporated, the Partnership and Dean Witter Reynolds Inc. is incorporated by reference to Exhibit 10.06 of the Partnership's quarterly Report on Form 10-Q for the quarter ended June 30, 2000. (File No. 0-17446).
13.01 Annual Report to Limited Partners for the year ended December 31, 2000 is filed herewith.
Diversified Futures Fund II
December 31, 2000 Annual Report
MORGAN STANLEY DEAN WITTER
Dean Witter Diversified Futures Fund II L.P. Historical Fund Performance
Presented below is the percentage change in Net Asset Value per Unit from the start of each calendar year the Fund has traded. Also provided is the incep- tion-to-date return and the annualized return since inception for the Fund. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
Demeter Management Corporation Two World Trade Center 62nd Floor New York, NY 10048 Telephone (212) 392-8899
Dean Witter Diversified Futures Fund II L.P. Annual Report
Dear Limited Partner:
This marks the twelfth annual report for the Dean Witter Diversified Futures Fund II L.P. (the "Fund"). The Fund began the year at a Net Asset Value per Unit of $2,556.25 and increased by 20.3% to $3,075.90 on December 31, 2000. A review of trading results for the year is provided in the Annual Report of the Trading Manager located on the next page of this report.
Should you have any questions concerning this report, please feel free to con- tact 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 Diversified Futures Fund II L.P.
Annual Report of the Trading Manager
The Fund posted gains in 2000 as a result of strong trends in the energy, cur- rency, and grain futures markets. In the energy sector, profits resulted from long positions in the natural gas and crude oil futures markets. Natural gas saw its price rise to record levels in 2000. Recent low inventory levels, sluggish supply and cold winter weather combined to push prices to such high levels. In the crude oil market, gains were realized from long positions ear- lier in the year as prices rose to nine-year highs on a combination of cold weather, declining inventories and increasing demand. In addition, concerns about future output levels from the world's leading producer countries added to the upward price momentum. Later in the year, however, profits resulted from short positions as the price of crude oil futures fell on expectations that Iraqi oil exports would resume and on fears that the slowdown in the economy would curb demand while at the same time supply was increasing. In the currency markets, gains were recorded from short positions in the euro, Swiss franc and Swedish krona as the value of these European currencies weakened relative to the U.S. dollar amid skepticism about Europe's economic outlook. Strong economic data out of the U.S. and interest rate hikes in the U.S. also boosted the dollar and, subsequently, added to the euro's difficulties. Later in the year as the bullish trend in the U.S. dollar reversed, additional gains were recorded from long positions in the euro, Swiss franc and Swedish krona versus the U.S. dollar as a result of new confidence in the European economy and an overall skepticism regarding the U.S. economy. Profits were also re- corded from short positions in the corn market during the middle of the year as the price of corn trended lower on favorable weather conditions that re- sulted in good prospects for high crop yields.
A portion of these gains was offset by losses experienced in the metals, stock index and soft commodity futures markets. The majority of losses in the metals markets were experienced in the aluminum market. From a technical standpoint, the price of aluminum traded in a very volatile pattern throughout the year leaving little opportunity for the development of trends. In addition, long positions in this market, particularly in the second half
of the year, resulted in losses as price declined after concerns mounted that demand would weaken amid a cooling of the U.S. economy. Losses were also re- corded in the global stock index futures markets. The S&P 500 Index traded in a very choppy pattern resulting in losses for both long and short positions. Contributing to this price pattern was uncertainty over the state of the U.S. economy.
We appreciate your continued investment in Diversified Futures Fund II L.P.
Dean Witter Futures & Currency Management Inc.
Dean Witter Diversified Futures Fund II L.P. Independent Auditors' Report
The Limited Partners and the General Partner:
We have audited the accompanying statements of financial condition of Dean Witter Diversified Futures Fund II L.P. (the "Partnership") as of December 31, 2000 and 1999 and the related statements of operations, changes in partners' capital, and cash flows for each of the three years in the period ended Decem- ber 31, 2000. These financial statements are the responsibility of the Part- nership's management. Our responsibility is to express an opinion on these fi- nancial statements based on our audits.
We conducted our audits in accordance with auditing standards generally ac- cepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the finan- cial statements are free of material misstatement. An audit includes examin- ing, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting princi- ples used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits pro- vide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material re- spects, the financial position of Dean Witter Diversified Futures Fund II L.P. at December 31, 2000 and 1999 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
New York, New York February 16, 2001
Dean Witter Diversified Futures Fund II L.P. Statements of Financial Condition
The accompanying notes are an integral part of these financial statements.
Dean Witter Diversified Futures Fund II L.P. Statements of Operations
Statements of Changes in Partners' Capital For the Years Ended December 31, 2000, 1999 and 1998
The accompanying notes are an integral part of these financial statements.
Dean Witter Diversified Futures Fund II L.P. Statements of Cash Flows
The accompanying notes are an integral part of these financial statements.
Dean Witter Diversified Futures Fund II L.P. Notes to Financial Statements
1. Summary of Significant Accounting Policies
Organization--Dean Witter Diversified Futures Fund II L.P. (the "Partnership") is a limited partnership organized to engage primarily in the speculative trading of commodity futures and forward contracts, physical commodities, and other commodity interests (collectively, "futures interests").
The general partner for the Partnership is Demeter Management Corporation ("Demeter"). The non-clearing commodity broker is Dean Witter Reynolds Inc. ("DWR"). Morgan Stanley & Co., Inc. ("MS&Co.") and Morgan Stanley & Co. Inter- national Limited ("MSIL") provide clearing and execution services. Prior to May 2000, Carr Futures Inc. ("Carr") provided clearing and execution services to the Partnership. The trading manager is Dean Witter Futures & Currency Man- agement Inc. ("DWFCM" or the "Trading Manager"). Demeter, DWR, DWFCM, MS&Co. and MSIL are wholly-owned subsidiaries of Morgan Stanley Dean Witter & Co. ("MSDW").
Effective February 19, 1998, Morgan Stanley, Dean Witter, Discover & Co. changed its corporate name to Morgan Stanley Dean Witter & Co.
Demeter is required to maintain a 1% minimum interest in the equity of the 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 ac- counting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the reported amounts in the financial statements and related disclosures. Management be- lieves that the estimates utilized in the preparation of the financial state- ments are prudent and reasonable. Actual results could differ from those esti- mates.
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 op- erations. Monthly, DWR pays the Partnership interest income based upon 80% of its average daily Net Assets for the month at a prevailing rate for U.S. Trea- sury bills. For purposes of such interest payments, Net Assets do not include monies due the Partnership on futures interests, but not actually received.
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.
Dean Witter Diversified Futures Fund II L.P. Notes to Financial Statements--(Continued)
Equity in Futures Interests Trading Accounts--The Partnership's asset "Equity in futures interests trading accounts," reflected in the statements of finan- cial condition, consists of (A) cash on deposit with DWR, MS&Co. and MSIL to be used as margin for trading and (B) net unrealized gains or losses on open contracts, which are valued at market, and calculated as the difference be- tween original contract value and market value.
The Partnership, in the normal course of business, enters into various con- tracts with MS&Co. and MSIL acting as its commodity brokers. Pursuant to bro- kerage agreements with MS&Co. and MSIL, to the extent that such trading re- sults in unrealized gains or losses, the amounts are offset and reported on a net basis in the Partnership's statements of financial condition.
The Partnership has offset the fair value amounts recognized for forward con- tracts executed with the same counterparty as allowable under terms of the master netting agreement with MS&Co., the sole counterparty on such contracts. The Partnership has consistently applied its right to offset.
Brokerage Commissions and Related Transaction Fees and Costs--Brokerage com- missions are accrued at 80% of DWR's published non-member rates on a half-turn basis. Transaction fees and costs are accrued on a half-turn basis. Brokerage commissions and transaction fees combined are capped at 13/20 of 1% per month (a maximum 7.8% annual rate) of the Partnership's Net Assets as of the last day of each month.
Operating Expenses--The Partnership incurs monthly management fees and may in- cur incentive fees. Demeter and/or DWR bear 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 the Partnership's revenues and expenses for income tax purposes.
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 end of the last day of any calendar quarter, upon five business days advance notice by redemption form to Demeter.
Dissolution of the Partnership--The Partnership will terminate on December 31, 2025 or at an earlier date if certain conditions set forth in the Limited Partnership Agreement occur.
Dean Witter Diversified Futures Fund II L.P. Notes to Financial Statements--(Continued)
2. Related Party Transactions
The Partnership pays brokerage commissions to DWR as described in Note 1. The Partnership's cash is on deposit with DWR, MS&Co., and MSIL in futures inter- ests trading accounts to meet margin requirements as needed. DWR pays interest on these funds as described in Note 1.
Demeter, on behalf of the Partnership and itself, has entered into a Manage- ment Agreement with DWFCM to make all trading decisions for the Partnership.
Compensation to DWFCM by the Partnership consists of a management fee and an incentive fee as follows:
Management Fee--The monthly management fee is accrued daily at the rate of 1/4 of 1% (a 3% annual rate), of adjusted Net Assets, as defined in the Management Agreement, at each month-end.
Incentive Fee--The Partnership pays an annual incentive fee to DWFCM equal to 15% of the trading profits earned by the Partnership as of the end of each an- nual incentive period ending January 31. Trading profits represent the amount by which profits from futures and forwards trading exceed losses after broker- age commissions, management fees and transaction fees and costs are deducted. Such incentive fee is accrued in each month in which trading profits occur. In those months in which trading profits are negative, previous accruals, if any, during the incentive period are reduced.
3. Financial Instruments
The Partnership trades commodity futures and forward contracts, physical com- modities, and other commodity interests. Futures and forwards represent con- tracts for delayed delivery of an instrument at a specified date and price. Risk arises from changes in the value of these contracts and the potential in- ability 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 Deriv- ative Instruments and Hedging Activities" effective for fiscal years beginning after June 15, 2000, as amended by SFAS No. 137. The Partnership adopted the provisions of SFAS No. 133 beginning with the fiscal year ended December 31, 1998. SFAS No. 133 superceded SFAS Nos. 119 and 105, which required the dis- closure of average aggregate fair values and contract/notional values, respec- tively, of derivative financial instruments for an entity that carries its as- sets at fair value. SFAS No. 133 was
Dean Witter Diversified Futures Fund II L.P. Notes to Financial Statements--(Continued)
further amended by SFAS No. 138, which clarifies issues surrounding interest rate risk, foreign currency denominations, normal purchases and sales and net hedging. The application of SFAS No. 133, as amended by SFAS No. 137 and SFAS No. 138, did not have a significant effect on the Partnership's financial statements.
SFAS No. 133 defines a derivative as a financial instrument or other contract that has all three of the following characteristics:
(1) One or more underlying notional amounts or payment provisions; (2) Requires no initial net investment or a smaller initial net investment than would be required relative to changes in market factors; (3) Terms require or permit net settlement.
Generally derivatives include futures, forwards, swaps or option contracts, or other financial instruments with similar characteristics such as caps, floors and collars.
The net unrealized gains on open contracts are reported as a component of "Eq- uity in futures interests trading accounts" on the statements of financial condition and totaled $1,044,574 and $293,674 at December 31, 2000 and 1999, respectively.
Of the $1,044,574 net unrealized gain on open contracts at December 31, 2000, $718,718 related to exchange-traded futures contracts and $325,856 related to off-exchange-traded forward currency contracts.
Of the $293,674 net unrealized gain on open contracts at December 31, 1999, $262,869 related to exchange-traded futures contracts and $30,805 related to off-exchange-traded forward currency contracts.
Exchange-traded futures contracts held by the Partnership at December 31, 2000 and 1999 mature through June 2002 and September 2000, respectively. Off- exchange-traded forward currency contracts held by the Partnership at December 31, 2000 and 1999 mature through March 2001 and March 2000, respectively.
The Partnership has credit risk associated with counterparty nonperformance. The credit risk associated with the instruments in which the Partnership is involved is limited to the amounts reflected in the Partnership's statements of financial condition.
The Partnership also has credit risk because DWR, MS&Co., and MSIL act as the futures commission merchants or the
Dean Witter Diversified Futures Fund II L.P. Notes to Financial Statements--(Continued)
counterparties with respect to most of the Partnership's assets. Exchange- traded futures contracts are marked to market on a daily basis, with varia- tions in value settled on a daily basis. DWR, MS&Co. and MSIL each as a futures commission merchant for the Partnership's exchange-traded futures con- tracts, 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 contracts, including an amount equal to the net unrealized gain on all open futures contracts, which funds, in the aggregate totaled $8,160,332 and $8,305,359 at December 31, 2000 and 1999, respectively. With respect to the Partnership's off-exchange-traded forward currency contracts, there are no daily settlements of variations in value nor is there any re- quirement that an amount equal to the net unrealized gain on open forward con- tracts be segregated. With respect to those off-exchange-traded forward cur- rency contracts, the Partnership is at risk to the ability of MS&Co., the sole counterparty on all of such contracts, to perform. The Partnership has a net- ting agreement with MS&Co. This agreement, which seeks to reduce both the Partnership's and MS&Co.'s exposure on off-exchange-traded forward currency contracts, should materially decrease the Partnership's credit risk in the event of MS&Co.'s bankruptcy or insolvency.
4. Legal Matters
Similar class actions were filed in 1996 in California and New York State courts. Each of the actions were dismissed in 1999. However, the New York state class action discussed below is still pending because plaintiffs ap- pealed the final court's dismissal of their case on March 3, 2000.
On September 18 and 20, 1996, purported class actions were filed in the Su- preme Court of the State of New York, New York County, on behalf of all pur- chasers of interests in limited partnership commodity pools sold by DWR. Named defendants include DWR, Demeter, DWFCM, MSDW, the Partnership, certain limited partnership commodity pools of which Demeter is the general partner and cer- tain trading managers to those pools. 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 fidu- ciary duty, and negligent misrepresentation in the sale and operation of the various limited partnership commodity pools. The complaints sought 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 Decem- ber 1998.
Dean Witter Diversified Futures Fund II L.P. Notes to Financial Statements--(Concluded)
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. However, on March 3, 2000, plaintiffs appealed the trial court's dismissal of their case.
MORGAN STANLEY DEAN WITTER & CO. Two World Trade Center 62nd Floor New York, NY 10048
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