Investment Commentary

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Market Environment

The third quarter showed continued signs of global economic stabilization, and risk assets remained attractive with cash rates close to zero. As a result, the credit-sensitive sectors of the fixed-income market, such as high-yield, emerging-market debt and investment-grade corporate bonds, performed well as investor appetite for risk continued to rise. Credit spreads tightened sharply in the quarter, as yields on U.S. Treasury securities moved lower. Yields on developed market foreign government bonds declined and the U.S. dollar lost value against most currencies in the third quarter. Oil prices pushed higher as investors started to believe that the worst of the decline in global demand may have passed.

Contributors¹

The high-yield bond sector was the best-performing sector of the fund in the third quarter. Spreads on high-yield debt narrowed by 240 basis points (bp), ending the quarter at 779 bp. Positive flows into the high-yield market, combined with an increase in risk appetite, held the door open for a wave of new issuance that was easily absorbed by the market. Holdings in investment-grade corporate bonds, an allocation newly added to the fund in the first quarter, also performed well in the third quarter.

The fund’s emerging market holdings in the foreign government bond sector was the next best-performing sector of the fund, contributing positively to total return. Spreads on emerging market debt narrowed by 99 bp, ending the quarter at 338 bp, as commodity prices continued to rebound and investors’ risk appetite increased.

The fund’s developed market nondollar holdings in the foreign government bond sector also contributed positively to total return, as yields on foreign government bonds, such as european bonds, declined. Currency exposure added to total return as the U.S. dollar declined against most currencies in the quarter.

The U.S. government bond sector of the fund also added to total return, as yields on U.S. Treasury securities declined. This decline in yields was in response to policymakers’ decision to keep rates low for the foreseeable future and not to remove the stimulus too soon.

Detractors¹

The fund’s relative underperformance in the third quarter stems from a combination of three factors. First, within the high-yield and emerging-market sectors of the fund, the underweight to the lowest quality (CCC) assets was a drag on total return as the lowest quality assets continued to outperform strongly. Second, the fund is underweight in asset-backed and commercial mortgage-backed securities relative to peers. While these assets were among the worst performers in 2008, they have staged an impressive comeback in 2009. Finally, and most importantly, Columbia Strategic Income Fund remains diversified across the three main sectors of fixed income — U.S. government, foreign governments and high-yield corporate bonds.

Outlook

The fund outperformed many of its multisector bond fund peers in 2008 by adhering to the strategy of maintaining diversification across the three sectors of the bond market (U.S. government, foreign governments and high-yield corporate bonds), and by positioning the fund’s sector allocation in a way that tilted the interest rate and credit risk balance more toward interest rate risk (U.S. government and developed-market government securities). The fund’s allocation to U.S. Treasury securities was greater than most peers during a time when credit spreads, even high-quality credit, widened to historical highs amid the worst financial crisis since the Great Depression. We began to shift the allocation of assets toward the credit-sensitive sectors (high-yield corporate and emerging-market government securities) of the market in the first quarter of 2009 and continued to add to these sectors in the second and third quarters.

At the end of 2008, the balance of risk in the fund was clearly biased toward the interest rate sensitive sectors (U.S. government and developed market foreign governments), while a combination of the high-yield and emerging-market debt sectors represented just 38.6% of the fund. As of September 2009, these same two sectors plus the allocation to investment-grade corporate bonds was 57.4% of the fund, representing a shift of almost 19% of assets. The balance of risk in the fund is now tilted toward the credit-sensitive sectors.

We continue to be cautiously optimistic and plan to continue to take advantage of opportunities to add exposure to high-yield bonds and risk assets, in general. Our optimism stems from the following:

• The severity of the economic downturn is now widely recognized.
  
  
• Risk-asset (high-yield and emerging-market securities) valuations remain attractive despite aggressive spread tightening in the second and third quarters.
  
  
• We believe that the unprecedented aggressiveness of both fiscal and monetary policy, in response to the crises in the United States and abroad, will spark sustainable economic growth at some point.

Our caution stems from the pace and magnitude of spread tightening year-to-date, the still present (but less obvious) threat of deflation as deleveraging continues, the continued lack of willingness of banks to lend, rising defaults, the increased role of government and the rise in protectionism. Recent economic data suggests that stabilization is near. The negative momentum in growth has decelerated, but the impact and severity of the economic downturn is likely to be evident for some months to come. The technical forces behind the significant rally in risk assets pushed valuations beyond levels justified by economic fundamentals and have increased the risk of a pullback. We look to take advantage of any setback in high yield and emerging markets by adding exposure. Emerging markets remain hostage to developments in the larger, more developed countries. It is not wise to assume that any one emerging economy or region can pull the entire world out of recession.

We believe that a trend change for a stronger U.S. dollar will only take hold when investors perceive a bottoming in U.S. growth and when an end to overly accommodative monetary policy is at hand. The U.S. economy will likely lead the global economy to recovery. However, until then, we do not expect U.S. yields or the U.S. dollar to rise too much from current levels.

We believe the fund is positioned for a bottoming in the U.S. and global economies. We expect to continue to shift the fund’s positioning to benefit more from economic stabilization and recovery, and from a sustainable increase in investor appetite for higher-yielding assets, which should follow.

Please read and consider the investment objectives, risks, charges and expenses for any fund carefully before investing. For a prospectus, which contains this and other important information about the fund, contact your Columbia Management representative or financial advisor or go to www.columbiamanagement.com.

Effective June 19, 2009, the fund added a secondary benchmark, which is a custom composite consisting of 35% Barclays Capital U.S. Aggregate Bond Index, 35% JPMorgan Global High Yield Index, 15% Citigroup Non-U.S. World Government Bond Index-Unhedged and 15% JPMorgan Emerging Markets Bond Index Global Diversified. The fund’s primary benchmark remains the Barclays Capital U.S. Government/Credit Bond Index.

Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that the forecasts will come to pass. The views and opinions expressed are those of the portfolio managers and analysts of the affiliated advisors of Columbia Management Group, are subject to change without notice at any time, may not come to pass and may differ from views expressed by other Columbia Management associates or other divisions of Bank of America. These materials are provided for informational purposes only and should not be used or construed as a recommendation of any security or sector.

There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that securities sold have not been repurchased. It should not be assumed that any securities transaction or holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions made in the future will be profitable or will equal the investment performance of the securities discussed herein.

Columbia Management Group, LLC (“Columbia Management”) is the investment management division of Bank of America Corporation. Columbia Management entities furnish investment management services and products for institutional and individual investors. Columbia Funds are distributed by Columbia Management Distributors, Inc., member FINRA and SIPC. Columbia Management Distributors, Inc. is part of Columbia Management and an affiliate of Bank of America Corporation.