10-Q 1 sf15025q.txt CAP RETURN 2 -- JUNE 30, 2001 REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________________ to ______________________ Commission file number: 0-18418 PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 2, L.P. -------------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) Delaware 13-3533120 -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) One New York Plaza, 13th Floor New York, New York 10292 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (212) 778-7866 N/A -------------------------------------------------------------------------------- Former name, former address and former fiscal year, if changed since last report. Indicate by check CK whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes CK No __ Part I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 2, L.P. (a limited partnership) STATEMENTS OF FINANCIAL CONDITION (Unaudited)

The accompanying notes are an integral part of these statements. 2 PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 2, L.P. (a limited partnership) STATEMENTS OF OPERATIONS (Unaudited)

STATEMENT OF CHANGES IN PARTNERS' CAPITAL (Unaudited)

The accompanying notes are an integral part of these statements. 3 PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 2, L.P. (a limited partnership) NOTES TO FINANCIAL STATEMENTS JUNE 30, 2001 (Unaudited) A. General These financial statements have been prepared without audit. In the opinion of Prudential Securities Futures Management Inc. (the 'General Partner'), the financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to state fairly the financial position of Prudential-Bache Capital Return Futures Fund 2, L.P. (the 'Partnership') as of June 30, 2001 and the results of its operations for the six and three months ended June 30, 2001 and 2000. However, the operating results for the interim periods may not be indicative of the results expected for a full year. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. It is suggested that these financial statements be read in conjunction with the financial statements and notes thereto included in the Partnership's Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2000. Certain balances from 2000 have been reclassified to conform with the current financial statement presentation. Welton Investment Corporation ('Welton'), a trading manager to the Partnership, was terminated effective May 31, 2001 due to performance not meeting expectations relative to its peers. The assets previously managed by Welton (the 'Welton Assets'), which totalled approximately $2,189,000 as of June 30, 2001, were reallocated to commodities trading on July 8, 2001 as more fully discussed in Note E. The Welton Assets earned interest but were not subject to management fees or commissions during the period that the assets were not allocated to trading. B. Related Parties The General Partner is a wholly-owned subsidiary of Prudential Securities Incorporated ('PSI'). The General Partner and its affiliates perform services for the Partnership which include, but are not limited to: brokerage services; accounting and financial management; registrar, transfer and assignment functions; investor communications, printing and other administrative services. The costs incurred for these services for the six and three months ended June 30, 2001 and 2000 were:

The Partnership's assets are maintained either in trading or cash accounts with PSI, the Partnership's commodity broker, or, for margin purposes, with the various exchanges on which the Partnership is permitted to trade. The Partnership, acting through its trading managers, may execute over-the-counter, spot, forward and/or option foreign exchange transactions with PSI. PSI then engages in back-to-back trading with an affiliate, Prudential-Bache Global Markets Inc. ('PBGM'). PBGM attempts to earn a profit on such transactions. PBGM keeps its prices on foreign currency competitive with other interbank currency trading desks. All over-the-counter currency transactions are conducted between PSI and the Partnership pursuant to a line of credit. PSI may require that collateral be posted against the marked-to-market positions of the Partnership. 4 C. Derivative Instruments and Associated Risks The Partnership is exposed to various types of risk associated with the derivative instruments and related markets in which it invests. These risks include, but are not limited to, risk of loss from fluctuations in the value of derivative instruments held (market risk) and the inability of counterparties to perform under the terms of the Partnership's investment activities (credit risk). Market risk Trading in futures and forward (including foreign exchange) contracts involves entering into contractual commitments to purchase or sell a particular commodity at a specified date and price. The gross or face amount of the contracts, which is typically many times that of the Partnership's net assets being traded, significantly exceeds the Partnership's future cash requirements since the Partnership intends to close out its open positions prior to settlement. As a result, the Partnership is generally subject only to the risk of loss arising from the change in the value of the contracts. As such, the Partnership considers the 'fair value' of its futures and forward contracts to be the net unrealized gain or loss on the contracts. The market risk associated with the Partnership's commitments to purchase commodities is limited to the gross or face amount of the contracts held. However, when the Partnership enters into a contractual commitment to sell commodities, it must make delivery of the underlying commodity at the contract price and then repurchase the contract at prevailing market prices. Since the repurchase price to which a commodity can rise is unlimited, entering into commitments to sell commodities exposes the Partnership to unlimited risk. Trading in options involves the payment or receipt of a premium and the corresponding right or obligation, as the case may be, to either purchase or sell the underlying commodity for a specified price during a limited period of time. Purchasing options involves the risk that the underlying commodity does not change price as expected, so that the option expires worthless and the premium is lost. On the other hand, selling options involves unlimited risk because the Partnership is exposed to the potentially unlimited price movement in the underlying commodity. Market risk is influenced by a wide variety of factors including government programs and policies, political and economic events, the level and volatility of interest rates, foreign currency exchange rates, the diversification effects among the derivative instruments the Partnership holds and the liquidity and inherent volatility of the markets in which the Partnership trades. Credit risk When entering into futures, forward and options contracts, the Partnership is exposed to credit risk that the counterparty to the contract will not meet its obligations. The counterparty for futures and options contracts traded on United States and most foreign futures and options exchanges is the clearinghouse associated with such exchanges. In general, clearinghouses are backed by their corporate members who are required to share any financial burden resulting from the nonperformance by one of their members and, as such, should significantly reduce this credit risk. In cases where the clearinghouse is not backed by the clearing members (i.e., some foreign exchanges), it is normally backed by a consortium of banks or other financial institutions. On the other hand, the sole counterparty to the Partnership's forward transactions is PSI, the Partnership's commodity broker. The Partnership has entered into a master netting agreement with PSI and, as a result, presents unrealized gains and losses on open forward positions as a net amount in the statements of financial condition. The amount at risk associated with counterparty nonperformance of all of the Partnership's contracts is the net unrealized gain (plus premiums paid on options) included in the statements of financial condition. There can be no assurance that any counterparty, clearing member or clearinghouse will meet its obligations to the Partnership. The General Partner attempts to minimize both credit and market risks by requiring the Partnership and its trading managers to abide by various trading limitations and policies. The General Partner monitors compliance with these trading limitations and policies which include, but are not limited to: executing and clearing all trades with creditworthy counterparties, limiting the amount of margin or premium required for any one commodity or all commodities combined, and generally limiting transactions to contracts which are traded in sufficient volume to permit the taking and liquidating of positions. Additionally, pursuant to each Advisory Agreement among the Partnership, the General Partner and each trading manager, the General Partner shall automatically terminate a trading manager if the net asset value allocated to the trading manager declines by 33 1/3% since the commencement of its trading activities or from the value at the beginning of any year. Furthermore, the Amended and Restated Agreement of Limited Partnership provides 5 that the Partnership will liquidate its positions, and eventually dissolve, if the Partnership experiences a decline in the net asset value to less than 50% of the value at commencement of trading activities. In each case, the decline in net asset value is after giving effect for distributions and redemptions. The General Partner may impose additional restrictions (through modifications of trading limitations and policies) upon the trading activities of the trading managers as it, in good faith, deems to be in the best interest of the Partnership. PSI, when acting as the Partnership's futures commission merchant in accepting orders for the purchase or sale of domestic futures and options contracts, is required by Commodity Futures Trading Commission ('CFTC') regulations to separately account for and segregate as belonging to the Partnership all assets of the Partnership relating to domestic futures and options trading (subject to the recent opt out provisions discussed below) and is not allowed to commingle such assets with other assets of PSI. At June 30, 2001, such segregated assets totalled $10,378,755. Part 30.7 of the CFTC regulations also requires PSI to secure assets of the Partnership related to foreign futures and options trading which totalled $2,206,038 at June 30, 2001. There are no segregation requirements for assets related to forward trading. The CFTC recently promulgated rules that allow futures commission merchants to permit certain customers, including the Partnership, to opt out of segregation with regard to trading on certain exchanges, but PSI has not done so to date. If the Partnership were to opt out, its funds could be held in a broader and riskier range of investments. As of June 30, 2001, the Partnership's open futures and forward contracts mature within one year. At June 30, 2001 and December 31, 2000, the fair value of open futures, forward and options contracts was:

6 D. Financial Highlights

E. Subsequent Events During July 2001, the Partnership entered into agreements to reallocate the Welton Assets evenly between two of the Partnership's trading managers--Appleton Capital Management ('Appleton') and Eclipse Capital Management, Inc. ('Eclipse'). Appleton and Eclipse will receive monthly management fees on their portion of the reallocated assets equal to 1/6 of 1% (2% annually) as compared to management fees paid to Welton ranging between 1/6 of 1% (2% annually) and 1/3 of 1% (4% annually). Appleton and Eclipse will earn a quarterly incentive fee equal to 20% of the 'New High Net Trading Profits' (as defined in each advisory agreement among the Partnership, the General Partner and each trading manager) as compared to the range of 15% to 20% for Welton. Additionally, Appleton must recoup 100% (or $964,000) of Welton's cumulative trading losses associated with its portion of the reallocated assets and Eclipse must recoup only 50% (or $482,000) of its portion, before earning any incentive fees. 7 PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 2, L.P. (a limited partnership) ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity and Capital Resources The Partnership commenced trading operations on October 6, 1989 with gross proceeds of $101,010,000. After accounting for organizational and offering costs, the Partnership's net proceeds were $99,010,000. At June 30, 2001, 82% of the Partnership's total net assets was allocated to commodities trading. The remaining Partnership net assets were not allocated to commodities trading after Welton, one of the Partnership's trading managers, was terminated effective May 31, 2001 due to performance not meeting expectations relative to its peers. The Welton Assets were reallocated evenly between two of the Partnership's trading managers during July 2001 as further discussed in Note E to the financial statements. A significant portion of the net asset value as of June 30, 2001 was held in U.S. Treasury bills (which represented approximately 63% of the net asset value prior to redemptions payable) and cash, which are used as margin for the Partnership's trading in commodities. Inasmuch as the sole business of the Partnership is to trade in commodities, the Partnership continues to own such liquid assets to be used as margin. The percentage that U.S. Treasury bills bears to the total net assets varies each day, and from month to month, as the market values of commodity interests change. The balance of the net assets is held in cash. All interest earned on the Partnership's interest-bearing funds is paid to the Partnership. For the month of June 2001, the Partnership earned interest on the assets previously managed by Welton (the 'Welton Assets'). The commodities contracts are subject to periods of illiquidity because of market conditions, regulatory considerations and other reasons. For example, commodity exchanges limit fluctuations in certain commodity futures contract prices during a single day by regulations referred to as 'daily limits.' During a single day, no trades may be executed at prices beyond the daily limit. Once the price of a futures contract for a particular commodity has increased or decreased by an amount equal to the daily limit, positions in the commodity can neither be taken nor liquidated unless traders are willing to effect trades at or within the limit. Commodity futures prices have occasionally moved the daily limit for several consecutive days with little or no trading. Such market conditions could prevent the Partnership from promptly liquidating its commodity futures positions. Since the Partnership's business is to trade futures, forward and options contracts, its capital is at risk due to changes in the value of these contracts (market risk) or the inability of counterparties to perform under the terms of the contracts (credit risk). The Partnership's exposure to market risk is influenced by a number of factors including the volatility of interest rates and foreign currency exchange rates, the liquidity of the markets in which the contracts are traded and the relationships among the contracts held. The inherent uncertainty of the Partnership's speculative trading as well as the development of drastic market occurrences could result in monthly losses considerably beyond the Partnership's experience to date and could ultimately lead to a loss of all or substantially all of investors' capital. The general partner attempts to minimize these risks by requiring the Partnership and its trading managers to abide by various trading limitations and policies, which include limiting margin amounts, trading only in liquid markets and permitting the use of stop loss provisions. See Note C to the financial statements for a further discussion of the credit and market risks associated with the Partnership's futures, forward and options contracts. Redemptions recorded for the six and three months ended June 30, 2001 were $870,298 and $371,528, respectively, for the limited partners and $8,893 and $3,832, respectively, for the general partner, and from commencement of operations, October 6, 1989, through June 30, 2001, totalled $132,261,846 for the limited partners and $1,881,995 for the general partner. Future redemptions will impact the amount of funds available for investment in commodity contracts in subsequent periods. The Partnership does not have, nor does it expect to have, any capital assets. 8 Results of Operations The net asset value per Unit as of June 30, 2001 was $212.91, a decrease of 4.45% from the December 31, 2000 net asset value per Unit of $222.83 and a decrease of 7.45% from the March 31, 2001 net asset value per Unit of $230.06. Past performance is not necessarily indicative of future results. The Partnership had gross trading losses of approximately $21,000 and $780,000 during the six and three months ended June 30, 2001, respectively, compared to losses of $1,325,000 and $831,000 for the corresponding periods in the prior year. Due to the nature of the Partnership's trading activities, a period to period comparison of its trading results is not meaningful. However, a detailed discussion of the Partnership's current quarter trading results is presented below. Quarterly Market Overview The global economy remained sluggish during the second quarter of 2001 and as a result, U.S. and global stock markets continued their downward trend. In the U.S., heightened concerns regarding cutbacks in industrial production and future sales caused downward revisions of corporate earnings. Business investment and capital spending were weak and appeared to be decreasing further, reflecting in part the downtrend in manufacturing output. Labor demand weakened considerably and unemployment rose. Consumer spending held up relatively well despite deceleration in income, reduced household net worth, and deterioration in consumer sentiment. Economic activity in foreign industrial countries decelerated as well, due in part to softening of the U.S. economy, weakness in world high-tech markets and the downward adjustment in global equity prices. Expansion in Europe, including the United Kingdom, and Canada slowed significantly, while the Japanese economy slowed after a brief rebound late last year. In addition, economic growth in many developing countries softened, reflecting, in part, weaker external demand. In the U.S., overall inflation, as measured by the Consumer Price Index (CPI), increased slightly, but was held down by a deceleration in energy prices. As a result of weak global economies, equity markets continued to perform poorly during most of the quarter. In April, U.S. equity markets, particularly the NASDAQ, rallied briefly after the U.S. Federal Reserve (Fed) called an unscheduled meeting to lower interest rates before falling once again amid continuing softening economies and fears of weak corporate earnings. Markets rose briefly once again in June following the U.S. Federal Reserve's 25 basis point interest rate cut. This smaller than anticipated rate reduction seemed to signal a cessation of the Fed's recent series of aggressive rate cuts and caused many investors to exit the bond market and invest in equities. Interest rate instruments trended upward throughout most of the quarter as major central banks cut short-term interest rates in an attempt to bolster slowing economies. The U.S. Federal Reserve cut rates three times during the quarter lowering rates from 4.50% to 3.75%. The European Central Bank and the Bank of England cut interest rates by 25 basis points in May. This was the third interest rate reduction in five months for the Bank of England. Global bonds reversed downward towards quarter-end as the Fed cut rates by only 25 basis points, driving many investors out of interest rate instruments and into equities. In foreign exchange markets, the Japanese yen started the quarter strong before weakening against the U.S. dollar and other foreign currencies. This followed a government report that Japan's GDP shrank in the first quarter, generating fears that the Japanese economy may be slipping into recession. The Canadian dollar posted gains against the U.S. dollar as economic reports showed a 1.7% increase in exports to the U.S. in June. The British pound reached a 15 year low against the U.S. dollar in June amid concern that England would join the European Monetary Union. The euro declined against the U.S. dollar as well, amid signs of continuing weakness in the European economy. Energy prices fell in response to growing inventory levels of crude oil and related products. The American Petroleum Institute reported that the U.S. gasoline supply had reached its highest level in two years. Swelling energy inventories fed fears of an overall weakening demand for fuels in the slowing global economy. Additionally, the market fell when tropical storm Allison caused less damage along the Gulf Coast than was originally feared. Quarterly Partnership Performance The following is a summary of performance for the major sectors in which the Partnership traded: 9 Currencies (-): After a strong start, the Japanese yen declined against the U.S. dollar and many European currencies as the Japanese economy exhibited signs of weakness. Long Japanese yen and yen cross-rate positions resulted in losses. The euro declined against the U.S. dollar, Swiss franc and other foreign currencies amid fears of weakening European economies resulting in losses for euro cross-rate positions. Interest rates (-): Prices of most interest rate instruments trended upward throughout most of the quarter due to short-term interest rate cuts by major central banks in an attempt to bolster slowing economies. Short positions in U.S. government and euro bonds resulted in losses for the Partnership. Metals (-): Gold prices rallied to a ten month high in May before reversing course amid rumors that Russia would sell a portion of its gold reserve. Long gold positions incurred losses for the Partnership. Rate cuts by U.S. and European central banks stirred fears of inflation driving metal prices higher. Short positions in nickel, aluminum and copper incurred losses for the Partnership. Stock indices (-): Weak global economies and concerns regarding corporate earnings resulted in continued poor performance in the equity markets. London FTSE and Nikkei Dow positions resulted in losses for the Partnership. Energies (+): Short natural gas positions resulted in gains as increased inventories and weakening demand drove prices downward. Interest income is earned on the Partnership's investment in U.S. Treasury bills and varies monthly according to interest rates as well as the effect of trading performance and redemptions on the level of interest-bearing funds. Interest income from U.S. Treasury bills decreased by approximately $118,000 and $62,000, respectively, for the six and three months ended June 30, 2001 compared to the same periods in 2000. These declines in interest income were the result of fewer funds being invested in U.S. Treasury bills principally due to redemptions as well as lower interest rates during the six and three months ended June 30, 2001 versus the corresponding periods in 2000. Commissions paid to PSI are calculated on the Partnership's net asset value on the first day of each month and, therefore, vary monthly according to trading performance and redemptions. Commissions decreased by approximately $172,000 and $70,000, respectively, for the six and three months ended June 30, 2001 as compared to the same periods in 2000 principally due to the effect of redemptions on the monthly net asset values. Additionally, a portion of the Partnership's assets were not allocated to commodities trading during June 2001 (as more fully discussed in Notes A and E to the financial statements) and, therefore, were not subject to commissions for that month. All trading decisions are currently being made by Eclipse Capital Management, Inc., Trendlogic Associates, Inc. and Appleton Capital Management ('Appleton'). Welton made trading decisions on the Welton Assets until their termination, effective May 31, 2001. Management fees are calculated on the portion of the Partnership's net asset value allocated to each trading manager as of the end of each month and, therefore, are affected by trading performance and redemptions. Management fees decreased by approximately $45,000 and $20,000, respectively, for the six and three months ended June 30, 2001 as compared to the same periods in 2000 primarily due to the fluctuations in monthly net asset values as described in the discussion on commissions above. Additionally, the portion of assets which were not allocated to commodities trading during June 2001, as referred to in the discussion on commissions above, were not subject to management fees. Incentive fees are based on the 'New High Net Trading Profits' generated by each trading manager, as defined in each advisory agreement among the Partnership, the General Partner and each trading manager. Appleton generated sufficient trading profits during the first quarter of 2001 to earn incentive fees of approximately $61,000 for the six months ended June 30, 2001. No incentive fees were incurred by the Partnership during the six and three months ended June 30, 2000. General and Administrative expenses for the six and three months ended June 30, 2001 were relatively comparable to the corresponding periods in 2000. These expenses include reimbursements of costs incurred by the General Partner on behalf of the Partnership, in addition to accounting, audit, tax and legal fees as well as printing and postage costs related to reports sent to limited partners. 10 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information regarding quantitative and qualitative disclosures about market risk is not required pursuant to Item 305(e) of Regulation S-K. 11 PART II. OTHER INFORMATION Item 1. Legal Proceedings--There are no material legal proceedings pending by or against the Registrant or the General Partner. Item 2. Changes in Securities--None Item 3. Defaults Upon Senior Securities--None Item 4. Submission of Matters to a Vote of Security Holders--None Item 5. Other Information--None Item 6. Exhibits and Reports on Form 8-K: (a) Exhibits 4.1 Agreement of Limited Partnership of the Registrant, dated as of June 8, 1989 as amended and restated as of July 21, 1989 (incorporated by reference to Exhibits 3.1 and 4.1 to the Registrant's Annual Report on Form 10-K for the period ended December 31, 1989) 4.2 Subscription Agreement (incorporated by reference to Exhibit 4.2 to the Registrant's Registration Statement on Form S-1, File No. 33-29039) 4.3 Request for Redemption (incorporated by reference to Exhibit 4.3 to the Registrant's Registration Statement on Form S-1, File No. 33-29039) 10.19 Addendum to Advisory Agreement, dated July 6, 2001, among the Registrant, Prudential Securities Futures Management Inc. and Eclipse Capital Management, Inc. (filed herewith) 10.20 Addendum to Advisory Agreement, dated July 6, 2001, among the Registrant, Prudential Securities Futures Management Inc. and Appleton Capital Management (filed herewith) (b) Reports on Form 8-K-- No reports on Form 8-K were filed during the quarter. 12 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. Prudential-Bache Capital Return Futures Fund 2, L.P. By: Prudential Securities Futures ManagementInc. A Delaware corporation, General Partner By: /s/ Steven Carlino Date: August 14, 2001 ---------------------------------------- Steven Carlino Vice President and Treasurer 13 PRUDENTIAL BACHE CAPITAL RETURN FUTURES FUND 2, L.P. ADDENDUM TO ADVISORY AGREEMENT Addendum, effective as of the 6th day of July, 2001, to the Advisory Agreement, effective as of the 1st day of July, 1997 (the "Advisory Agreement"), by and among Prudential-Bache Capital Return Futures Fund 2, L.P., a Delaware limited partnership (the "Partnership"), Prudential Securities Futures Management Inc., a Delaware corporation (the "General Partner") and Eclipse Capital Management, Inc., a Kentucky corporation (the "Advisor"). 1. The Partnership will reallocate approximately $1,100,000 of the assets of the Partnership (the "Reallocated Assets") previously under the management of another trading advisor (the "Prior Advisor") to the Advisor as of the effective date of this Addendum, and the Advisor hereby consents to such reallocation. 2. For all purposes, including fee calculations, the assets currently allocated to the Advisor ("Current Assets") and the Reallocated Assets will be treated as a single amount. 3. Notwithstanding any other provision of this Addendum or of the Advisory Agreement which may be interpreted to the contrary, in addition to any cumulative losses attributable to the Current Assets ("Current Losses"), it is the intent of the parties that approximately $482,000, which is equal to 50% of the total cumulative losses existing as of the date of this Addendum attributable to the Reallocated Assets and accumulated while they were under the management of the Prior Advisor (the "Reallocated Losses") will be reallocated to the Advisor. Therefore, the full amount of Current Losses and the Reallocated Losses must be recouped consistent with the calculations and provisions of Section 5 of the Advisory Agreement before the next Incentive Fee under the Advisory Agreement will be due and owing on any assets allocated to the Advisor. 4. This Addendum shall be incorporated into, and become a part of, the Advisory Agreement. All capitalized terms used herein and not defined shall have the meaning given to them in the Advisory Agreement. IN WITNESS WHEREOF, this Addendum has been executed for and on behalf of the undersigned. PRUDENTIAL-BACHE CAPITAL RETURN PRUDENTIAL SECURITIES FUTURES FUND 2, L.P. INCORPORATED By: PRUDENTIAL SECURITIES FUTURES By: /s/ Guy Scarpaci MANAGEMENT INC. ----------------------------------- Guy Scarpaci, Senior Vice President By: /s/ Eleanor L. Thomas ----------------------------- Eleanor L. Thomas, President ECLIPSE CAPITAL MANAGEMENT, INC. By: /s/ Thomas W. Moller ----------------------------- Name: Thomas W. Moller Title: President PRUDENTIAL BACHE CAPITAL RETURN FUTURES FUND 2, L.P. ADDENDUM TO ADVISORY AGREEMENT Addendum, effective as of the 6th day of July, 2001, to the Advisory Agreement, effective as of the 1st day of September, 1998 (the "Advisory Agreement"), by and among Prudential-Bache Capital Return Futures Fund 2, L.P., a Delaware limited partnership (the "Partnership"), Prudential Securities Futures Management Inc., a Delaware corporation (the "General Partner") and Appleton Capital Management Limited (formerly known as Gaiacorp Ireland Limited), an Irish company (the "Advisor"). 1. The Partnership will reallocate approximately $1,100,000 of the assets of the Partnership (the "Reallocated Assets") previously under the management of another trading advisor (the "Prior Advisor") to the Advisor as of the effective date of this Addendum, and the Advisor hereby consents to such reallocation. 2. For all purposes, including fee calculations, the assets currently allocated to the Advisor ("Current Assets") and the Reallocated Assets will be treated as a single amount. 3. Notwithstanding any other provision of this Addendum or of the Advisory Agreement which may be interpreted to the contrary, in addition to any cumulative losses of the Partnership being carried forward for purposes of calculating the Advisor's Incentive Fee ("Current Losses"), it is the intent of the parties that approximately $970,000, which is equal to 100% of the total cumulative losses existing as of the date of this Addendum attributable to the Reallocated Assets and accumulated while they were under the management of the Prior Advisor (the "Reallocated Losses") will be reallocated to the Advisor. Therefore, the full amount of Current Losses and the Reallocated Losses must be recouped consistent with the calculations and provisions of Section 5 of the Advisory Agreement before the next Incentive Fee under the Advisory Agreement will be due and owing on any assets allocated to the Advisor. 4. This Addendum shall be incorporated into, and become a part of, the Advisory Agreement. All capitalized terms used herein and not defined shall have the meaning given to them in the Advisory Agreement. IN WITNESS WHEREOF, this Addendum has been executed for and on behalf of the undersigned. PRUDENTIAL-BACHE CAPITAL RETURN PRUDENTIAL SECURITIES FUTURES FUND 2, L.P. INCORPORATED By: PRUDENTIAL SECURITIES FUTURES By: /s/ Guy Scarpaci MANAGEMENT INC., ---------------------------------- Guy Scarpaci, Senior Vice President By: /s/ Eleanor L. Thomas ---------------------------- Eleanor L. Thomas, President APPLETON CAPITAL MANAGEMENT LIMITED By: /s/ Louise McKenna ---------------------------- Name: Louise McKenna Title: Compliance Officer

PRUDENTIAL BACHE CAPITAL RETURN FUTURES FUND 2 L P 10-Q