LM INSTITUTIONAL FUND ADVISORS II, INC.
LM Value Institutional Portfolio
Brandywine Small Cap Value Portfolio
Semi-Annual Report
September 30, 1999
<PAGE>
PRESIDENT'S LETTER
LM Institutional Fund Advisors II, Inc.
October 15, 1999
Dear Shareholder:
We are pleased to provide you with the Semi-Annual Report for LM Institutional
Fund Advisors II covering the six months ended September 30, 1999.
The following table summarizes the Portfolios' Institutional Class performance
for the six-month period ended September 30, 1999. Detailed comments on the
performance of each Portfolio appear in the Portfolio Managers' comments on the
following pages.
Cumulative Total Returns
Six months ended 9/30/99
-----------------------
LM Value Institutional Portfolio -10.31%
S&P 500 Index 0.36%
Brandywine Small Cap Value Portfolio 11.31%
Russell 2000 Value Index 7.44%
With less than three months to go until the end of the year, attention has
increasingly focused on the Year 2000 issue. As you know, the Year 2000 issue is
a computer programming problem that affects the ability of computers to
correctly process dates of January 1, 2000, and beyond. Legg Mason's Year 2000
Committee has developed and is implementing a plan designed to ensure that the
Year 2000 date change will have no adverse impact on our ability to service our
shareholders. We are on target to complete this important project. Industry-wide
testing sponsored by the Securities Industry Association ("SIA") was conducted
in March and April of 1999, with Legg Mason, its brokerage subsidiaries and
primary vendors actively participating and achieving positive results.
Legg Mason's Year 2000 Project has four phases. The Inventory Phase and the
Assessment Phase are already complete. The Remediation Phase and the Testing
Phase are currently underway and on target. Renovation and replacement of
existing internal systems, where necessary, is also complete, and all of our
critical vendors have certified their Year 2000 compliance. Most noncritical
vendors have also certified their Year 2000 compliance, and we expect the
remaining vendors to certify their compliance in the next few weeks. Although
individual customer testing will not be available, we have successfully tested
models representing all forms of accounts maintained at Legg Mason, including
the Portfolios' shareholder accounts.
As always, we appreciate your support and welcome your comments and suggestions.
Sincerely,
/s/Joseph L. Orlando
Joseph L. Orlando
President
LM Institutional Advisors, Inc.
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<PAGE>
PORTFOLIO MANAGERS' COMMENTS
LM Institutional Fund Advisors II, Inc.
LM Value Institutional Portfolio
MARKET COMMENTARY
"If you can look into the seeds of time and say which grain will grow and which
will not, speak then to me..."
--Macbeth
"It is wrong always, everywhere, and for everyone to believe anything upon
insufficient evidence."
--W.K. Clifford
The Ethics of Belief
"... a rule of thinking which would absolutely prevent me from acknowledging
certain kinds of truths if those...truths were really there, would be an
irrational rule."
--William James
The Will to Believe
AMAZON AND THE ETHICS OF BELIEF
One of the most common questions we get is "how do you value Internet stocks?"
This question is not usually asked of momentum investors, sector rotators,
thematic investors, or even garden-variety growth stock investors, all of who
employ stock selection techniques that ignore, or at least minimize, valuation.
It is a legitimate question, though, for value investors whose strategy rests on
the purchase of stocks whose price is below some calculation of value.
Some would claim that you couldn't value Internet stocks, most of which have
minimal sales, no earnings, negative cash flow, and unknown business prospects.
These critics say the Internet is a classic bubble, a psychological phenomenon
born of irrational enthusiasm for the economic potential of on-line activity.
Such things end badly, and those who are participating in the madness are either
dupes or gamblers betting against the odds. In any case, it is no place for the
value investor.
Others are not so dogmatic, but point out that the early stage nature of these
businesses precludes analysis based on traditional metrics such as price to
earnings, book value, or cash flow. Companies which have reached the stage where
they are making money, such as Yahoo or America Online, sport market
capitalizations larger than any number of great American businesses including
General Motors, Caterpillar and Sears. Applying standard metrics to these "new
economy" companies does not yield anything approaching reasonable valuations. On
these bases they look wildly over-priced (and many good investors believe they
are).
Traditional metrics, when they work at all, work best with traditional
businesses. The value of these analytical tools is usually a function of the
historical data supporting their effectiveness. We have a lot of data about how
the market has valued long-standing businesses whose economics are well
understood, for example, foods and beverages, the big drug companies, retail
stores, and newspapers. We know which groups have performed well early in an
economic cycle, which have been most recession resistant, what historically
attractive and unattractive valuations have been, and how current profitability
compares with past results. All of this is absent from most Internet related
businesses, leaving the value investor at an apparent disadvantage to others who
employ less rigorous methods to select securities.
It's important to distinguish this situation from the related issue of valuing
technology companies. Many value investors have chosen to ignore technology
companies or maintain minimal exposure to them, despite long data trails and
compelling evidence that this sector has had the ability to create substantial,
long-lasting shareholder wealth. The reasons typically given are that technology
is difficult to understand, that it changes rapidly, and that the stocks are
usually too expensive according to standard valuation methods. All of these
reasons are weak.
Ben Graham once denied that reward and risk were correlated in the stock market.
(He was wrong.) He correctly said that reward was, or should be, related to the
amount of work one was willing to do. If technology is difficult, it is not
incomprehensible. Investors who rule out the largest sector of the stock market,
and the most important driver of economic growth and progress, because it takes
work to figure it out have little to cavil about when others get the
2
<PAGE>
PORTFOLIO MANAGERS' COMMENTS (CONTINUED)
LM Institutional Fund Advisors II, Inc.
LM Value Institutional Portfolio
rewards. Although technology changes reasonably rapidly, it doesn't follow that
such change is random or unpredictable. In many cases, it follows well-defined
paths. The economics of technology and information based businesses have been
explored by economists such as Brian Arthur and Hal Varian. Their work is
accessible to anyone who will take the time to study it.
Moreover, technology companies often create change and instability in other
unrelated businesses that are not themselves involved in technology. Amazon is
roiling the traditional book business; on-line brokers have forced even Merrill
Lynch to dramatically alter long-standing business practices. Ignoring
technology often leads to making bad investment decisions by not understanding
the risks to your non-technologically based, but vulnerable, businesses. Warren
Buffett found the pricing structure and demand dynamics of the encyclopedia
business totally up-ended by Microsoft's Encarta and CD-ROMs. Nobody wants the
traditional World Book anymore, a business he thought had an enduring franchise.
It is true that some of the best technology companies have rarely looked
attractive on traditional valuation methods, but that speaks more to the
weakness of those methods than to the fundamental risk-reward relationships of
those businesses. Had we understood valuation better we would have owned
Microsoft and Cisco. Microsoft has gone up about 1% per week on average since it
has been public. Companies don't outperform year in and year out for over a
decade unless they were mispriced to begin with, that is, undervalued. Paul
Johnson, a prominent networking analyst, wrote an open letter to Warren Buffett
a few years ago showing how Cisco met the criteria Buffett has so often
enumerated for his investments. There is no evidence Buffett read the letter,
but we read it and didn't buy Cisco. Johnson was right and we were wrong; not
because the stock went up a lot, but because it was significantly undervalued
and we missed that.
Undervaluation is not determined by a stock's price in relation to existing or
trailing earnings, book value, or cash flow, although these metrics may be
evidence of a price that is below intrinsic value. Undervaluation is determined
by the relation between a stock price and the present value of the free cash the
underlying business will generate over one's forecast time horizon.
The past is known, and the future is not, and the only guide to the future is
the past. That is why historical price to value relationships play such a
dominant role in most value investors' strategies. If one invested backward,
instead of forward, or if the world never changed, those past relationships
would be dispositive. One would not have to think about, analyze, or assess the
probabilities of change in order to generate satisfactory investment returns.
The stock market is a discounting mechanism. Its prices reflect the expected
value of the future, a future which at best will resemble, but not replicate,
the past. Potentially disruptive technologies such as the Internet may change
long-established economic relationships, providing an opportunity for those who
correctly discern the changing economic patterns before they are reflected in
market prices.
This, of course, is fiendishly difficult. Each individual possesses only the
tiniest fraction of the information available to the market. The regulators try
to assure that no one has material information before anyone else. Large changes
result in large opportunities for profit, attract large interest and often
generate enthusiasms that outrun prudence. In these cases, risk far outstrips
the probability of reward. Such appears to be the case with most Internet
securities today. Most, not all.
The value of the publicly traded Internet securities is just over $500 billion,
about 10% more than the market value of Microsoft, and about 6% of GDP. It seems
reasonable that if the Internet really does "change everything," as its
enthusiasts assert, the investment opportunity is probably greater than a single
digit per cent of GDP.
The market believes it knows where a lot of the opportunity is: the combined
market value of AOL, Yahoo, and Amazon is about 40% of the total value of all
Internet stocks.
3
<PAGE>
PORTFOLIO MANAGERS' COMMENTS (CONTINUED)
LM Institutional Fund Advisors II, Inc.
LM Value Institutional Portfolio
Two questions come to mind: first, do these values overstate or understate the
intrinsic value of the businesses; second, how would you know? The second
question is logically prior to the first. Answering it is easy in theory. If the
present value of, e.g., Amazon's future free cash flow is greater than $30
billion, Amazon is undervalued; if not, it is overvalued. How should one go
about figuring this out?
W.K. Clifford, and many others, would say you shouldn't. Clifford, a brilliant
mathematician who died at 34 in 1879, argued that making decisions without
adequate justification was not just ill-advised, but wrong. If Clifford were a
portfolio manager, he would argue that there is insufficient evidence on which
to make a judgment about Amazon. Its business model is unproven (some would say
unknown); it does nothing but report losses. The book business is mature, slow
growing, and fiercely competitive. Amazon's new initiatives, into toys,
electronics, and on-line auctions, are certain to add to the losses through
start-up costs. The company is spending heavily to build warehouses, which carry
both capital costs and execution risk. The new zShops effort, while promising,
further fragments management's attention. Finally, the value of Amazon not only
exceeds that of Borders by 30 times and Barnes and Noble by almost 20 times, it
is greater than that of Sears, Federated, Saks, and KMart combined! Such
evidence as there is would indicate one's efforts to find value are better
employed elsewhere.
Another 19th century thinker, William James, wrote an essay to counter Clifford
called "The Will to Believe." James argued in this seminal work that in many
cases one was justified in believing something well in advance of what others
may consider sufficient evidence. His argument carried the day philosophically,
which is why no one reads Clifford anymore, while every competently trained
student of the theory of knowledge has read and assimilated James.
James's argument was rich and detailed, but one of his points apposite to Amazon
was that the level of evidence one needs to believe something is a function of
how important it is not to be wrong. The evidence bar will be set higher the
more important it is not to make a mistake. If being right has high value, and
being wrong has low value, then the evidence needed for belief can be a lot
lower since being wrong is not very costly, and being right has a high payoff.
This is why people play the lottery, why they buy insurance, and why both are
reasonable. Some insurance events are so unlikely paying anything is usually not
advised, for example flight insurance. The lottery always has more players the
higher the payoff, since different people have different thresholds for betting
on unlikely events.
With Amazon, we believe the payoff for being right is high. We arrive at this
view by developing a model of each of Amazon's businesses, adjusting for capital
employed and time to maturity. We project free cash flows using a variety of
scenarios, and try to assess the relative probabilities of each. This gives a
range of possible values for the business. We then try to discern which scenario
most closely fits the current evidence. That gives the most probable current
intrinsic value.
The most you can lose is your purchase price. What is the threshold of evidence
necessary to make such a bet? How will you know if you're likely to win or lose
as Amazon's business develops? These are all epistemological questions. James
notes that for one type of thinker, the crux of such decisions is in their
principles or origin, while for another the importance is in the outcome.
One type of value investor requires the authority of the past in order to make a
bet on the future. Like Clifford, they have a high threshold of evidence and
wish to avoid the inevitable errors that attend trying to assess the expected
value of the future. The theory of value would indicate that all of an asset's
value derives from the future. Avoiding the analysis of possible futures, their
probabilities and expected payoffs, may constitute the greatest error of all.
4
<PAGE>
PORTFOLIO MANAGERS' COMMENTS (CONTINUED)
LM Institutional Fund Advisors II, Inc.
LM Value Institutional Portfolio
PORTFOLIO COMMENTARY
In the third calendar quarter, the U.S. stock market declined, as did our
Portfolio. Our results are summarized below:
<TABLE>
<CAPTION>
Average Annual Total Returns as of 9/30/99
3Q99* YTD* 1 year Inception**
----- ----- ------ ----------
<S> <C> <C> <C> <C>
LM Value Institutional Portfolio (Institutional Shares) -9.45% 6.33% 44.76% 41.77%
Lipper U.S. Diversified Equity Funds -5.37% 5.23% 27.19% 27.19%
S&P 500 Index -6.25% 5.36% 27.80% 27.80%
Dow Jones Industrial Average -5.39% 13.97% 34.01% 34.01%
</TABLE>
- ----------------
*CUMULATIVE
**PORTFOLIO INCEPTION IS 9/22/98; INDEX RETURNS SINCE INCEPTION ARE CALCULATED
FROM 9/30/98.
PAST PERFORMANCE IS NOT AN INDICATOR OF FUTURE RESULTS. INVESTMENT RETURNS AND
PRINCIPAL VALUE WILL FLUCTUATE, AND SHARES MAY BE WORTH MORE OR LESS AT
REDEMPTION THAN AT ORIGINAL PURCHASE. PERFORMANCE FIGURES INCLUDE REINVESTMENT
OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS. THE PORTFOLIO CURRENTLY OPERATES
UNDER AN EXPENSE LIMITATION. WITHOUT THIS LIMITATION, TOTAL RETURNS WOULD BE
LOWER. PLEASE REFER TO THE PROSPECTUS FOR DETAILS. THE LIPPER U.S. DIVERSIFIED
EQUITY FUNDS, S&P 500 INDEX AND DOW JONES INDUSTRIAL AVERAGE ARE UNMANAGED
INDEXES AND ARE GENERALLY CONSIDERED BROAD INDICATORS OF U.S. EQUITY MARKET
PERFORMANCE.
Our results, as you may know, bounce around quarter to quarter and don't
correlate terribly closely with those of the major indices, nor should they.
Investors who want index type results can always buy index funds. We hope to
provide better long-term returns through active management. Although we have
been able to achieve that over the life of the fund, past results are no
guarantee that we will succeed in our objective going forward.
This is the second consecutive quarter we have lagged the major indices after
handily exceeding them the prior two quarters. Deconstructing near-term results
has little predictive value in our opinion; the market is too efficient and the
results of long-term investment decisions are only evident long term.
The sensitivity of returns to initial measuring points is clear by comparing our
nine-month gain of 6.33% to our one-year return of 44.76%. Just looking at nine
months, one could say we were moderately ahead of the market and the average
U.S. diversified equity fund, but trailed the Dow, and that our absolute returns
were modest. Move the starting point back 90 days and our results are extremely
strong on both a relative and an absolute basis, which tells to both how good
our returns were in the fourth quarter of last year, and how depressed the
market was.
We believe it is extremely important for shareholders to have realistic
expectations about what might constitute reasonable returns from investing in
stocks. Since good data have been available, roughly beginning in the mid-1920s,
stocks have returned about 7% per year after inflation. They have also returned
about 350 basis points more than treasury bonds measured from similar beginning
valuations.(1)
Inflation expectations are now running about 2%, calculated by the difference
between treasuries and the treasury inflation indexed bonds. With 30-year
treasury bonds yielding 6.25%, both measurements would imply a projected average
long-term return in the 9% range going forward, assuming no decline in the
market's average price earnings ratio. This is not a trivial assumption, since
that ratio hovers around all time highs, and is substantially above the
long-term average of around 15x.
Returns of 9% are dramatically below what the market has achieved in the past
twenty years. In the early 1980s, equity valuations were depressed by high
inflation and recession. Today low inflation, record profits and profitability
have combined to produce near record prices and valuations.
- --------------
(1) THE HISTORICAL DIFFERENCE IN THE RETURNS OF STOCKS RELATIVE TO BONDS, KNOWN
AS THE EQUITY RISK PREMIUM, IS GENERALLY REGARDED AS THE AMOUNT NECESSARY TO
COMPENSATE INVESTORS FOR THE GREATER PERCEIVED RISK OF OWNING STOCKS.
5
<PAGE>
PORTFOLIO MANAGERS' COMMENTS (CONTINUED)
LM Institutional Fund Advisors II, Inc.
LM Value Institutional Portfolio
This is not to suggest that we are bearish, or even cautious about the
opportunities in stocks. We think stocks are likely to continue to provide the
highest rates of return among the major asset classes. It's just that the
nominal value of those returns is likely to be considerably lower than what has
been earned on average since the early 1980s.
This year the markets' returns have been dominated by the big technology stocks,
such as those in the Nasdaq 100, and the snap-back in the cyclicals from the
deeply oversold conditions of late last year. The Nasdaq 100 is up over 35% this
year, almost seven times the return of the S&P 500, which itself includes the
major contributors to the Nasdaq. Most chemical, aluminum, and paper stocks have
also handily outperformed, as have most of the big oil, gas, and energy service
names.
Looking at the S&P 500 as a whole, over 60% of the stocks are down for the year.
The median return in the index this year is -5.9%. The market remains quite
narrow. We are not complaining about this; as one strategist noted, the market
is a meritocracy, not a democracy. Our job is to identify attractive long-term
investment opportunities; it is not to try to guess near-term stock price
movements.
We have solid exposure to technology, none to deep cyclicals, and heavy exposure
to financials, a group whose long-term performance has been splendid, but which
has struggled this year as interest rates have risen. Until interest rates peak,
financials are likely to remain under pressure. Since the beginning of the year,
the NYSE Financial Index has declined 10.3% creating a substantial drag on our
results. Financials remain a core holding, as we believe they have faster
growth, higher returns on equity, and much lower valuations than the market as a
whole. Those characteristics are why the group has outperformed over the decade,
and why we are optimistic about its continued long-term performance.
We don't have any special insight into when the market weakness that began
several months ago will end. Rising energy and gold prices, coupled with
continued strong economic growth, have raised concerns about growing
inflationary pressure. The Fed has raised interest rates and threatens to do so
again. These factors have rightly dampened investor enthusiasm, which is
unlikely to reverse until these conditions change.
As equity prices decline opportunities emerge, so we are not distressed at this
turn of events. We are changing some of the relative weightings in the portfolio
to try to optimize future returns and are always on the lookout for new names.
We added Amazon to the Portfolio in the quarter, a subject discussed more fully
elsewhere in this report. We sold Hilton and Mirage. Hilton made what we
believed was a poor acquisition in buying Promus. They spent a lot and paid fair
value; we believe the deal is unlikely to substantially add to value. Mirage's
results continue to lag those of other Las Vegas operators, and we were
disturbed by the departure of CFO Dan Lee, who attempted to provide much needed
financial discipline.
Bill Miller, CFA Mary Chris Gay
President Vice President
Legg Mason Fund Adviser, Inc. Legg Mason Fund Adviser, Inc.
October 15, 1999
6
<PAGE>
PORTFOLIO MANAGERS' COMMENTS (CONTINUED)
LM Institutional Fund Advisors II, Inc.
LM Value Institutional Portfolio
STRONG PERFORMERS FOR THE SIX MONTHS ENDED SEPTEMBER 30, 1999*
-------------------------------------------------------------------
1. Nextel Communications, Inc. +85.2%
2. MGM Grand, Inc. +52.2%
3. MGIC Investment Corporation +36.2%
4. Metro-Goldwyn-Mayer, Inc. +33.3%
5. Gateway, Inc. +29.6%
6. Koninklijke (Royal) Philips Electronics N.V. +22.5%
7. Mandalay Resort Group +12.5%
8. Amgen, Inc. +8.8%
9. Telefonos de Mexico S.A. ADR +8.8%
10. WPP Group plc +7.3%
WEAK PERFORMERS FOR THE SIX MONTHS ENDED SEPTEMBER 30, 1999*
-------------------------------------------------------------------
1. The Kroger Co. -63.2%
2. Nokia Oyj -42.3%
3. Bank One Corporation -36.8%
4. International Business Machines Corporation -31.5%
5. Citigroup Inc. -31.1%
6. Storage Technology Corp. -30.9%
7. America Online, Inc. -28.8%
8. Washington Mutual, Inc. -28.4%
9. General Motors Corp. -27.6%
10. Berkshire Hathaway Inc. -- Class A -23.0%
*SECURITIES HELD THE ENTIRE SIX MONTHS
7
<PAGE>
PORTFOLIO MANAGERS' COMMENTS
LM Institutional Fund Advisors II, Inc.
Brandywine Small Cap Value Portfolio
For the period March 31 through September 30, 1999 the Portfolio rose 11.31%
while the Russell 2000 Value Index gained 7.44%, the Russell 2000 was up 8.20%,
and the S&P 500 returned 0.36%.
The U.S. equity market was volatile for the period, with strong small cap
returns in the second quarter followed by a sharp drop in the third quarter
across all segments of the market. In April, investors suddenly concluded that
the global economy was gathering strength and that the crisis regions of the
last two years had ceased deteriorating. This nascent global recovery, coupled
with continued vigor in the U.S., led investors to focus on the economically
sensitive stocks that would benefit from worldwide growth. The rush into these
relatively smaller, hugely undervalued stocks generated swift and extensive
price gains. As a result, small caps rallied with value stocks providing the
greatest returns.
In the third quarter, investor focus swung to the year-long rise in long-term
interest rates: over the last twelve months the long bond has risen from a low
of 4.7% in early October 1998 to over 6.0% at September-end. The other areas of
investor concern were the U.S. trade deficit, which continued to expand, and the
steep decline in the dollar versus the yen. These related events were viewed as
a potential signal of resurgent inflation. With these worries, investors backed
away from U.S. equities across the board as both large caps and small caps fell
and prices declined in almost all sectors. Value stocks were down somewhat more
than the rest of the equity market in the third quarter, as cyclical stocks
lagged and technology surged. The market has become more volatile this year with
larger swings up and down as well as rapid changes in market leadership.
One of the best performing sectors in small cap for the period was the energy
and oil services area. These stocks benefited when crude oil prices hit the
$25/barrel level at the end of the quarter after having dropped to $12 at the
end of 1998. Early in the year, we had increased our oil services holdings as
the low oil price levels drove the stocks to significant valuation discounts.
Although we do not forecast oil prices, our disciplined investment process leads
us to stocks we feel offer attractive valuations where fundamentals are more
likely to improve than deteriorate. In this case, oil prices were more likely to
rise than decline. Because we held a larger than benchmark weight in these
stocks, the sector provided a strong positive contribution to portfolio
performance. We have begun to reduce our holdings as many of these stocks have
reached our sell targets.
Economically sensitive industrials and basic materials stocks, such as the
steels and chemicals, also provided a positive contribution to the portfolio
versus the benchmarks. These stocks were at very low valuations due to investor
concerns about the world economy. With a brightening international economic
outlook, these stocks have had a strong rebound off their lows. Nevertheless,
these stocks remain at very attractive valuations, particularly compared to
large cap stocks and Internet-related companies.
The biggest negative impact on the Portfolio came from the home building sector.
Housing demand has been strong all year, but investors have been unwilling to
bid up stock prices in this sector. With the resulting low valuation, we
increased the Portfolio's holding in the area. However, with growing concern
about rising interest rates cutting off housing demand, these stocks have moved
down further despite their already low valuations.
Our less-than-benchmark technology weighting also hurt Portfolio performance.
Semiconductor, networking, and Internet stocks were expensively valued coming
into the year, so the Portfolio had little weighting in these industries.
However, these companies have been market favorites and delivered strong stock
performance, particularly in the third quarter.
Small cap value stocks remain at significant valuation discounts to the rest of
the U.S. equity markets. The sharp rally in these stocks in the second quarter
did little to erase this deep undervaluation. Corporate investors continue to
recognize and act upon these stocks' attractive valuations. Acquisitions,
leveraged buyouts, and stock buy-backs have been at very high levels for small
caps and the Portfolio throughout the year. At some point, this corporate
activity
8
<PAGE>
PORTFOLIO MANAGERS' COMMENTS (CONTINUED)
LM Institutional Fund Advisors II, Inc.
Brandywine Small Cap Value Portfolio
will influence investors, who have mostly ignored small cap value stocks over
the last twelve months. As we experienced in the second quarter, when investors
come to realize the opportunities these stocks represent, large, swift price
gains can result. Given the depth of their valuation discount, the rebound can
also be sustained over a much longer time period than just a single quarter.
Henry F. Otto Steven M. Tonkovich
Managing Director Managing Director
Brandywine Asset Management, Inc. Brandywine Asset Management, Inc.
October 15, 1999
STRONG PERFORMERS FOR THE SIX MONTHS ENDED SEPTEMBER 30, 1999*
--------------------------------------------------------------------
1. Pioneer-Standard Electronics, Inc. +120.0%
2. Wyman-Gordon Company +102.0%
3. AGCO Corporation +98.1%
4. Quanex Corporation +65.3%
5. Applied Industrial Technologies, Inc. +61.8%
6. Lone Star Industries, Inc. +60.9%
7. Armco Inc. +57.7%
8. Georgia Gulf Corporation +57.5%
9. Orion Capital Corporation +51.6%
10. Mark IV Industries, Inc. +51.2%
WEAK PERFORMERS FOR THE SIX MONTHS ENDED SEPTEMBER 30, 1999*
-------------------------------------------------------------------
1. Integrated Health Services, Inc. -71.6%
2. Resource Bancshares Mortgage Group, Inc. -61.4%
3. AMRESCO, INC. -61.0%
4. Cole National Corporation -57.9%
5. Genesis Health Ventures, Inc. -51.3%
6. Interface, Inc. -46.8%
7. Interpool, Inc. -43.5%
8. Goody's Family Clothing, Inc. -42.2%
9. Reliance Group Holdings, Inc. -41.3%
10. Intermet Corporation -36.7%
* SECURITIES HELD THE ENTIRE SIX MONTHS
9
<PAGE>
<TABLE>
<CAPTION>
STATEMENT OF NET ASSETS
LM Institutional Fund Advisors II, Inc.
LM Value Institutional Portfolio
September 30, 1999 (Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------
% OF SHARES/
NET ASSETS PAR VALUE
-----------------------------------------------------
<S> <C> <C> <C>
COMMON STOCKS AND EQUITY INTERESTS 97.6%
Advertising 2.6%
WPP Group plc 696,587 $ 6,479,367
------------
Automotive 2.0%
Delphi Automotive Systems Corporation 50,107 804,844
General Motors Corporation 67,623 4,256,022
------------
5,060,866
------------
Banking 15.1%
Bank One Corporation 203,126 7,071,324
BankAmerica Corporation 72,131 4,016,795
BankBoston Corporation 114,959 4,986,347
Citigroup Inc. 159,826 7,032,344
Fleet Financial Group, Inc. 32,421 1,187,419
Lloyds TSB Group plc 346,381 4,305,363
The Chase Manhattan Corporation 103,732 7,818,799
Zions Bancorporation 29,596 1,631,480
------------
38,049,871
------------
Computer Services and Systems 15.1%
Dell Computer Corporation 339,216 14,183,469(A)
First Data Corporation 47,356 2,077,745
Gateway, Inc. 256,968 11,419,015(A)
International Business Machines Corporation 57,480 6,976,635
Storage Technology Corporation 180,328 3,471,314(A)
------------
38,128,178
------------
Consumer Cyclicals 1.5%
Mattel, Inc. 193,853 3,683,207
------------
Electric 2.1%
Koninklijke (Royal) Philips Electronics N.V. 52,363 5,288,663(A)
------------
Entertainment 1.9%
Mandalay Resort Group 151,758 2,997,221(A)
MGM Grand, Inc. 34,993 1,791,204(A)
------------
4,788,425
------------
Finance 6.4%
Fannie Mae 112,705 7,065,195
Freddie Mac 58,607 3,047,564
MBNA Corporation 143,544 3,274,597
The Bear Stearns Companies, Inc. 71,004 2,729,216
------------
16,116,572
------------
Food, Beverage and Tobacco 1.7%
PepsiCo, Inc. 60,886 1,841,802
Philip Morris Companies, Inc. 74,416 2,544,097
------------
4,385,899
------------
10
<PAGE>
STATEMENT OF NET ASSETS (CONTINUED)
LM Institutional Fund Advisors II, Inc.
LM Value Institutional Portfolio
September 30, 1999 (Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------
% OF SHARES/
NET ASSETS PAR VALUE
-----------------------------------------------------
COMMON STOCKS AND EQUITY INTERESTS (CONTINUED)
Food-Retail 1.0%
The Kroger Co. 112,705 $ 2,486,554(A)
------------
Health Care 5.8%
Foundation Health Systems, Inc. 225,716 2,130,195(A)
McKesson HBOC, Inc. 216,394 6,275,426
United HealthCare Corporation 126,230 6,145,823
------------
14,551,444
------------
Hotels and Motels 1.7%
Starwood Hotels & Resorts Worldwide, Inc. 196,795 4,390,988
------------
Insurance 5.7%
Aetna Inc. 23,262 1,145,653
Ambac Financial Group, Inc. 17,437 826,078
Berkshire Hathaway Inc. - Class A 92 5,060,000(A)
MBIA, Inc. 10,269 478,792
MGIC Investment Corporation 142,009 6,780,930
------------
14,291,453
------------
Manufacturing 1.1%
Danaher Corporation 54,099 2,850,341
------------
Media 12.9%
America Online, Inc. 313,451 32,598,904(A)
------------
Motion Pictures and Services 0.4%
Metro-Goldwyn-Mayer, Inc. 61,916 1,083,530(A)
------------
Non-Hazardous Waste Disposal 2.4%
Waste Management Inc. 316,053 6,084,020
------------
Pharmaceuticals 2.2%
Amgen, Inc. 69,877 5,694,976(A)
------------
Retail Sales 1.9%
Toys "R" Us, Inc. 322,337 4,835,055(A)
------------
Retail-Internet 1.5%
Amazon.com Inc. 48,800 3,891,800(A)
------------
Savings and Loan 2.7%
Washington Mutual, Inc. 231,027 6,757,540
------------
11
<PAGE>
STATEMENT OF NET ASSETS (CONTINUED)
LM Institutional Fund Advisors II, Inc.
LM Value Institutional Portfolio
September 30, 1999 (Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------
% OF SHARES/
NET ASSETS PAR VALUE
-----------------------------------------------------
COMMON STOCKS AND EQUITY INTERESTS (CONTINUED)
Telecommunications 9.9%
MCI WorldCom, Inc. 94,672 $ 6,804,550(A)
Nextel Communications, Inc. 139,813 9,481,069(A)
Nokia Oyj 67,651 6,075,905
Telefonos de Mexico S.A. ADR 36,066 2,569,703
------------
24,931,227
------------
TOTAL COMMON STOCKS AND EQUITY INTERESTS
(IDENTIFIED COST - $257,401,535) 246,428,880
- ----------------------------------------------------------------------------------------------------------------------------
U.S. GOVERNMENT AND AGENCY OBLIGATIONS 4.3%
Freddie Mac Discount Notes 5.18% due 10/1/99 $ 11,020,000 11,020,000
------------
TOTAL U.S. GOVERNMENT AND AGENCY OBLIGATIONS
(IDENTIFIED COST - $11,020,000) 11,020,000
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(IDENTIFIED COST - $268,421,535) 101.9% 257,448,880
OTHER ASSETS LESS LIABILITIES (1.9)% (4,876,036)
------------
NET ASSETS CONSISTING OF:
Accumulated paid-in capital applicable to:
14,792,090 Institutional Shares outstanding $220,857,521
3,094,418 Financial Intermediary Shares outstanding 43,158,110
Undistributed net investment income 215,997
Accumulated net realized gain/(loss) on investments (684,651)
Unrealized appreciation/(depreciation) of investments and
foreign currency translations (10,974,133)
------------
NET ASSETS 100.0% $252,572,844
============
NET ASSET VALUE PER SHARE:
Institutional Class $ 14.12
============
Financial Intermediary Class $ 14.13
============
- ----------------------------------------------------------------------------------------------------------------------------
(A)Non-income producing
See Notes to Financial Statements
12
<PAGE>
STATEMENT OF NET ASSETS
LM Institutional Fund Advisors II, Inc.
Brandywine Small Cap Value Portfolio
September 30, 1999 (Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------
% OF SHARES/
NET ASSETS PAR VALUE
-----------------------------------------------------
COMMON STOCKS AND EQUITY INTERESTS 96.1%
Aerospace/Defense 0.5%
GenCorp Inc. 300 $ 5,494
Kaman Corporation 400 5,100
------------
10,594
------------
Apparel 3.7%
Footstar, Inc. 300 10,575(A)
Goody's Family Clothing, Inc. 400 3,225(A)
Kellwood Company 200 4,400
Nautica Enterprises, Inc. 1,300 20,962(A)
Oxford Industries, Inc. 400 8,625
The Cato Corporation 800 11,275
The Dress Barn, Inc. 600 11,006(A)
The Timberland Company 200 7,813(A)
Wolverine World Wide, Inc. 300 3,413
------------
81,294
------------
Automotive 3.8%
Arvin Industries, Inc. 600 18,562
Avis Rent A Car, Inc. 700 14,613(A)
Borg-Warner Automotive, Inc. 600 25,800
Meritor Automotive, Inc. 1,200 25,050
------------
84,025
------------
Chemicals 6.8%
A. Schulman, Inc. 1,700 29,431
Albemarle Corporation 1,400 28,175
CK Witco Corporation 1,400 20,387
Cytec Industries Inc. 600 14,400(A)
Ethyl Corporation 4,200 16,275
Georgia Gulf Corporation 1,600 28,200
NL Industries, Inc. 800 10,100
The General Chemical Group Inc. 1,000 3,438
------------
150,406
------------
Commercial/Industrial Services 2.2%
ADVO, Inc. 600 11,962(A)
CDI Corp. 500 13,656(A)
Franklin Covey Co. 200 1,538(A)
Knoll, Inc. 300 8,063(A)
Merrill Corporation 300 5,981
Personnel Group of America, Inc. 600 3,750(A)
Veritas DGC Inc. 200 3,850(A)
------------
48,800
------------
Computer Services and Systems 0.6%
Avant! Corporation 800 14,275(A)
------------
13
<PAGE>
STATEMENT OF NET ASSETS (CONTINUED)
LM Institutional Fund Advisors II, Inc.
Brandywine Small Cap Value Portfolio
September 30, 1999 (Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------
% OF SHARES/
NET ASSETS PAR VALUE
-----------------------------------------------------
COMMON STOCKS AND EQUITY INTERESTS (CONTINUED)
Construction and Building Materials 6.8%
Champion Enterprises, Inc. 1,500 $ 13,500(A)
Coachmen Industries, Inc. 400 6,150
D.R. Horton, Inc. 1,600 20,700
Del Webb Corporation 300 6,600(A)
Hughes Supply, Inc. 600 13,050
Kaufman and Broad Home Corporation 1,200 24,750
Lennar Corporation 900 14,344
Lone Star Industries, Inc. 400 19,950
Oakwood Homes Corporation 700 3,150
Pulte Corporation 300 6,525
Standard Pacific Corp. 400 4,100
The Ryland Group, Inc. 300 6,825
Toll Brothers, Inc. 300 5,719(A)
U.S. Home Corporation 200 5,562(A)
------------
150,925
------------
Electrical Equipment and Electronics 3.0%
AMETEK, Inc. 300 5,944
CellStar Corporation 1,300 9,750(A)
GTECH Holdings Corporation 300 6,431(A)
InaCom Corp. 800 7,350(A)
MagneTek, Inc. 1,600 14,300(A)
Pioneer-Standard Electronics, Inc. 1,600 23,100
------------
66,875
------------
Entertainment & Leisure 1.8%
Arctic Cat Inc. 2,100 20,081
Boyd Gaming Corporation 1,400 8,400(A)
Lakes Gaming, Inc. 525 5,053(A)
Prime Hospitality Corp. 800 6,400(A)
------------
39,934
------------
Financial Services 7.6%
Advanta Corp. 1,900 27,787
AMRESCO, INC. 1,500 4,500(A)
Arcadia Financial Ltd. 900 3,881(A)
Bank United Corp. 700 22,662
BankAtlantic Bancorp, Inc. 1,265 7,037
CORUS Bankshares, Inc. 100 2,563
Downey Financial Corp. 500 10,062
Enhance Financial Services Group Inc. 900 15,919
Fidelity National Financial, Inc. 500 7,594
First Citizens BancShares, Inc. 100 7,675
FirstFed Financial Corp. 400 6,950(A)
14
<PAGE>
STATEMENT OF NET ASSETS (CONTINUED)
LM Institutional Fund Advisors II, Inc.
Brandywine Small Cap Value Portfolio
September 30, 1999 (Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------
% OF SHARES/
NET ASSETS PAR VALUE
-----------------------------------------------------
COMMON STOCKS AND EQUITY INTERESTS (CONTINUED)
Financial Services (continued)
Interpool, Inc. 700 $ 5,338
Jefferies Group, Inc. 400 8,350
Pacific Century Financial Corporation 1,800 36,787
Resource Bancshares Mortgage Group, Inc. 300 1,491
------------
168,596
------------
Food, Beverage and Tobacco 2.1%
General Cigar Holdings, Inc. 400 2,700(A)
Herbalife International, Inc. 1,500 22,875
M&F Worldwide Corp. 500 4,000(A)
Schweitzer-Mauduit International, Inc. 100 1,294
Universal Corporation 600 15,675
------------
46,544
------------
Gas/Pipeline 2.1%
Friede Goldman International Inc. 400 4,050(A)
SEACOR SMIT Inc. 700 35,875(A)
Tidewater Inc. 300 7,650
------------
47,575
------------
Health Care 2.0%
Beverly Enterprises, Inc. 3,100 13,175(A)
Genesis Health Ventures, Inc. 1,800 4,275(A)
Integrated Health Services, Inc. 600 938(A)
Omnicare, Inc. 1,300 12,512
Quorum Health Group, Inc. 1,200 8,438(A)
Sierra Health Services, Inc. 400 4,050(A)
------------
43,388
------------
Industrial 7.1%
ACX Technologies, Inc. 900 8,550(A)
AGCO Corporation 4,600 59,800
Applied Industrial Technologies, Inc. 300 5,400
Flowserve Corporation 900 14,962
Gentek Incorporated 1,000 11,375
Milacron Inc. 2,000 35,500
Regal-Beloit Corporation 1,000 20,750
------------
156,337
------------
Insurance 10.3%
Acceptance Insurance Companies Inc. 1,100 14,025(A)
AmerUs Life Holdings, Inc. 400 8,475
Chartwell Re Corporation 100 1,444
Delphi Financial Group, Inc. 200 6,038(A)
Everest Reinsurance Holdings, Inc. 700 16,669
15
<PAGE>
STATEMENT OF NET ASSETS (CONTINUED)
LM Institutional Fund Advisors II, Inc.
Brandywine Small Cap Value Portfolio
September 30, 1999 (Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------
% OF SHARES/
NET ASSETS PAR VALUE
-----------------------------------------------------
COMMON STOCKS AND EQUITY INTERESTS (CONTINUED)
Insurance (continued)
Foremost Corporation of America 1,400 $ 33,600
Fremont General Corporation 1,800 17,100
Frontier Insurance Group, Inc. 500 4,375
Harleysville Group Inc. 600 8,437
LandAmerica Financial Group, Inc. 100 1,975
Liberty Financial Companies, Inc. 800 17,550
MMI Companies, Inc. 900 9,844
Nymagic, Inc. 500 6,500
Orion Capital Corporation 500 23,687
Reliance Group Holdings, Inc. 1,900 8,431
Selective Insurance Group, Inc. 1,500 28,312
The Commerce Group, Inc. 900 20,700
------------
227,162
------------
Metals 7.4%
Armco Inc. 8,100 56,700(A)
Carpenter Technology Corporation 300 7,350
Cleveland-Cliffs Inc. 600 18,675
Commercial Metals Company 400 11,500
Intermet Corporation 1,300 11,009
Metals USA, Inc. 600 6,113(A)
National Steel Corporation 2,200 15,262
Precision Castparts Corp. 400 12,200
Quanex Corporation 100 2,563
RTI International Metals, Inc. 200 2,000(A)
Texas Industries, Inc. 300 11,100
Wyman-Gordon Company 500 9,344(A)
------------
163,816
------------
Miscellaneous Manufacturing 4.4%
Bacou USA, Inc. 500 8,344(A)
Barnes Group Inc. 500 10,031
Columbus McKinnon Corporation 100 1,725
Fleetwood Enterprises, Inc. 700 14,131
Griffon Corporation 400 3,200(A)
Hexcel Corporation 1,800 10,463(A)
Justin Industries, Inc. 300 4,256
Lincoln Electric Holdings, Inc. 700 14,612
Mark IV Industries, Inc. 400 7,900
MascoTech, Inc. 600 9,713
Robbins & Myers, Inc. 100 1,550
Standex International Corporation 100 2,700
Westinghouse Air Brake Company 500 9,094
------------
97,719
------------
16
<PAGE>
STATEMENT OF NET ASSETS (CONTINUED)
LM Institutional Fund Advisors II, Inc.
Brandywine Small Cap Value Portfolio
September 30, 1999 (Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------
% OF SHARES/
NET ASSETS PAR VALUE
-----------------------------------------------------
COMMON STOCKS AND EQUITY INTERESTS (CONTINUED)
Process Industries 2.8%
Buckeye Technologies Inc. 1,100 $ 17,256(A)
Rock-Tenn Company 1,700 24,544
Silgan Holdings Inc. 1,000 20,000(A)
------------
61,800
------------
Restaurants 2.4%
CBRL Group, Inc. 1,800 27,900
CKE Restaurants, Inc. 1,100 7,975
Landry's Seafood Restaurants, Inc. 1,500 12,000(A)
Ryan's Family Steak Houses, Inc. 600 5,400(A)
------------
53,275
------------
Retail 4.7%
7-Eleven, Inc. 6,000 11,813(A)
Boise Cascade Office Products Corporation 2,800 30,450(A)
Central Garden & Pet Company 800 6,100(A)
Cole National Corporation 100 769(A)
Micro Warehouse, Inc. 500 6,031(A)
Musicland Stores Corporation 500 4,375(A)
OfficeMax, Inc. 3,200 18,600(A)
Pier 1 Imports, Inc. 1,400 9,450
The Neiman Marcus Group, Inc. 700 16,362(A)
------------
103,950
------------
Textiles 1.9%
Burlington Industries, Inc. 3,100 13,756(A)
Guilford Mills, Inc. 1,300 11,213
Interface, Inc. 1,000 5,125
Unifi, Inc. 1,000 11,000(A)
------------
41,094
------------
Transportation 8.5%
Airborne Freight Corporation 1,500 31,594
Alaska Air Group, Inc. 1,100 44,756(A)
America West Holdings Corporation 1,200 20,775(A)
Arnold Industries, Inc. 1,900 23,987
Consolidated Freightways Corporation 1,200 11,850(A)
Offshore Logistics, Inc. 1,100 11,344(A)
Roadway Express, Inc. 1,000 20,188
Yellow Corporation 1,400 23,187(A)
------------
187,681
------------
17
<PAGE>
STATEMENT OF NET ASSETS (CONTINUED)
LM Institutional Fund Advisors II, Inc.
Brandywine Small Cap Value Portfolio
September 30, 1999 (Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------
% OF SHARES/
NET ASSETS PAR VALUE
-----------------------------------------------------
COMMON STOCKS AND EQUITY INTERESTS (CONTINUED)
Utilities 3.6%
El Paso Electric Company 3,000 $ 27,000(A)
Public Service Company of New Mexico 2,100 38,325
R G S Energy Group Inc. 600 14,700
------------
80,025
------------
TOTAL COMMON STOCKS AND EQUITY INTERESTS
(IDENTIFIED COST - $2,390,106) 2,126,090
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(IDENTIFIED COST - $2,390,106) 96.1% 2,126,090
OTHER ASSETS LESS LIABILITIES 3.9% 85,515
------------
NET ASSETS CONSISTING OF:
Accumulated paid-in capital applicable to:
238,839 shares outstanding $2,352,601
Undistributed net investment income 6,497
Accumulated net realized gain/(loss) on investments 116,523
Unrealized appreciation/(depreciation) of investments (264,016)
------------
NET ASSETS 100.0% $2,211,605
==========
NET ASSET VALUE PER SHARE $ 9.26
==========
- ----------------------------------------------------------------------------------------------------------------------------
(A)Non-income producing
See Notes to Financial Statements
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
STATEMENT OF OPERATIONS
LM Institutional Fund Advisors II, Inc.
(Unaudited)
- -----------------------------------------------------------------------------------------------------------------
Six Months Ended September 30, 1999
--------------------------------------------------
LM Value Brandywine Small
Institutional Portfolio Cap Value Portfolio
----------------------- -------------------
<S> <C> <C>
INVESTMENT INCOME:
Dividends(A) $ 867,934 $ 15,740
Interest 489,066 508
----------- -----------
Total Income 1,357,000 16,248
----------- -----------
EXPENSES:
Management fee 671,548 7,364
Distribution and service fees 43,432 --
Transfer agent and shareholder servicing expense 24,513 6,386
Custodian fees 62,351 31,053
Directors' fees 5,000 5,000
Legal and audit fees 18,461 10,018
Registration fees 61,944 10,766
Reports to shareholders 500 253
Other expenses 42,252 30
----------- -----------
930,001 70,870
Less fees waived (47,137) (61,239)
----------- -----------
Total expenses, net of waivers 882,864 9,631
----------- -----------
NET INVESTMENT INCOME (LOSS) 474,136 6,617
----------- -----------
NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Realized gain (loss) on investments
and foreign currency transactions (593,629) 116,822
Change in unrealized appreciation
(depreciation) of investments and foreign
currency translations (29,360,427) 97,569
------------ ------------
NET REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS (29,954,056) 214,391
------------ ------------
CHANGE IN NET ASSETS RESULTING
FROM OPERATIONS $(29,479,920) $ 221,008
============ ============
- -----------------------------------------------------------------------------------------------------------------
(A)Net of foreign taxes withheld of $4,441 and $0, respectively.
See Notes to Financial Statements
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
STATEMENT OF CHANGES IN NET ASSETS
LM Institutional Fund Advisors II, Inc.
- --------------------------------------------------------------------------------------------------------------------------------
LM VALUE BRANDYWINE SMALL
INSTITUTIONAL PORTFOLIO CAP VALUE PORTFOLIO
-----------------------------------------------------------------------
SIX MONTHS ENDED FOR THE PERIOD SIX MONTHS ENDED FOR THE PERIOD
SEPT. 30, 1999 SEPT. 22, 1998 TO SEPT. 30, 1999 AUG. 17, 1998 TO
(UNAUDITED) MARCH 31, 1999(A) (UNAUDITED) MARCH 31, 1999(A)
---------------- -------------- -------------- -------------------
<S> <C> <C> <C> <C>
CHANGE IN NET ASSETS:
Net investment income $ 474,136 $ 172,536 $ 6,617 $ 8,290
Net realized gain (loss) on investments
and foreign currency transactions (593,629) 985,461 116,822 58,892
Change in unrealized appreciation
(depreciation) of investments and
foreign currency transations (29,360,427) 18,386,294 97,569 (361,585)
------------- ------------- ------------- -------------
Change in net assets resulting
from operations (29,479,920) 19,544,291 221,008 (294,403)
Distributions to shareholders:
From net investment income:
Institutional Class (352,396) (24,640) (3,187) (5,223)
Financial Intermediary Class (32,866) (18,963) -- --
From net realized gain on investments:
Institutional Class (939,018) -- (59,191) --
Financial Intermediary Class (139,275) -- -- --
Change in net assets from Fund share
transactions:
Institutional Class 119,234,487 101,608,034 107,378 2,230,223
Financial Intermediary Class 29,732,876 13,425,234 -- --
------------- ------------- ------------- -------------
Change in net assets 118,023,888 134,533,956 266,008 1,930,597
NET ASSETS:
Beginning of period 134,548,956 15,000 1,945,597 15,000
------------- ------------- ------------- -------------
End of period $ 252,572,844 $ 134,548,956 $ 2,211,605 $ 1,945,597
------------- ------------- ------------- -------------
Undistributed net investment
income $ 215,997 $ 127,123 $ 6,497 $ 3,067
============= ============= ============= =============
- --------------------------------------------------------------------------------------------------------------------------------
(A) Commencement of operations
See Notes to Financial Statements
</TABLE>
20
<PAGE>
[This page intentionally left blank]
<PAGE>
FINANCIAL HIGHLIGHTS
LM Institutional Fund Advisors II, Inc.
Contained below is per share operating data for a share of common stock
outstanding, total investment return, ratios to average net assets and other
supplemental data. This information has been derived from information in the
financial statements.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
--------------------------------------------
NET ASSET NET NET REALIZED TOTAL
VALUE, INVESTMENT AND UNREALIZED FROM
BEGINNING INCOME GAIN (LOSS) ON INVESTMENT
OF PERIOD (LOSS) INVESTMENTS OPERATIONS
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
LM VALUE INSTITUTIONAL PORTFOLIO
Institutional Class
Six Months Ended September 30, 1999* $15.85 $ 0.03(D) $(1.65) $(1.62)
Period Ended March 31, 1999(A) 10.00 0.04(D) 5.83 5.87
Financial Intermediary Class
Six Months Ended September 30, 1999* $15.86 $ 0.01(E) $(1.65) $(1.64)
Period Ended March 31, 1999(B) 10.71 0.03(E) 5.14 5.17
BRANDYWINE SMALL CAP VALUE PORTFOLIO
Institutional Class
Six Months Ended September 30, 1999* $ 8.55 $ 0.03(F) $ 0.95 $ 0.98
Period Ended March 31, 1999(C) 10.00 0.04(F) (1.47) (1.43)
- --------------------------------------------------------------------------------------------------------------
(A) For the period September 22, 1998 (commencement of operations) to March 31, 1999
(B) For the period October 22, 1998 (commencement of operations) to March 31, 1999
(C) For the period August 17, 1998 (commencement of operations) to March 31, 1999
(D) Net of fees waived by LMIA pursuant to a voluntary expense limitation of 0.75% until July 31, 2000. If no
fees had been waived by LMIA, the annualized ratio of expenses to average daily net assets for the period
September 22, 1998 to March 31, 1999 and for the six months ended September 30, 1999 would have been 1.08%
and 0.79%, respectively.
(E) Net of fees waived by LMIA pursuant to a voluntary expense limitation of 1.00% until July 31, 2000. If no
fees had been waived by LMIA, the annualized ratio of expenses to average daily net assets for the period
October 22, 1998 to March 31, 1999 and for the six months ended September 30, 1999 would have been 1.33%
and 1.07%, respectively.
(F) Net of fees waived by LMIA pursuant to a voluntary expense limitation of 0.85% until July 31, 2000. If no
fees had been waived by LMIA, the annualized ratio of expenses to average daily net assets for the period
August 17, 1998 to March 31, 1999 and for the six months ended September 30, 1999 would have been 6.47% and
6.26%, respectively.
(G) Not Annualized
(H) Annualized
* Unaudited
See Notes to Financial Statements
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS RATIOS/SUPPLEMENTAL DATA
- ----------------------------------------------- -----------------------------------------------------------------
NET
INVESTMENT
INCOME
FROM NET EXPENSES (LOSS)
FROM NET ASSET TO TO NET
NET REALIZED VALUE, AVERAGE AVERAGE PORTFOLIO ASSETS,
INVESTMENT GAIN ON TOTAL END OF TOTAL NET NET TURNOVER END OF
INCOME INVESTMENTS DISTRIBUTIONS PERIOD RETURN ASSETS ASSETS RATE PERIOD
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$(0.03) $(0.08) $(0.11) $14.12 (10.31)%(G) 0.75%(D,H) 0.46%(D,H) 8.7%(H) $208,854,173
(0.02) -- (0.02) 15.85 58.81%(G) 0.75%(D,H) 0.84%(D,H) 28.6%(H) 115,798,256
$(0.01) $(0.08) $(0.09) $14.13 (10.38)%(G) 1.00%(E,H) 0.22%(E,H) 8.7%(H) $ 43,718,671
(0.02) -- (0.02) 15.86 48.32%(G) 1.00%(E,H) 0.43%(E,H) 28.6%(H) 18,750,700
$(0.01) $(0.26) $(0.27) $9.26 11.31%(G) 0.85%(F,H) 0.58%(F,H) 70.5%(H) $ 2,211,605
(0.02) -- (0.02) 8.55 (14.38)%(G) 0.85%(F,H) 0.71%(F,H) 45.1%(H) 1,945,597
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
23
<PAGE>
NOTES TO FINANCIAL STATEMENTS
LM Institutional Fund Advisors II, Inc.
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES
LM Institutional Fund Advisors II, Inc. ("Corporation"), consisting of the LM
Value Institutional Portfolio ("Value Institutional") and the Brandywine Small
Cap Value Portfolio ("Brandywine Small Cap") (each a "Portfolio"), is registered
under the Investment Company Act of 1940, as amended, as an open-end management
investment company.
Each Portfolio consists of two classes of shares: Institutional Class, offered
since September 22, 1998 for Value Institutional and since August 17, 1998 for
Brandywine Small Cap, and Financial Intermediary Class, which commenced
operations October 22, 1998 for Value Institutional. The income and expenses for
each Portfolio are allocated proportionately to the two classes of shares based
on daily net assets, except for Rule 12b-1 distribution fees, which are charged
only to Financial Intermediary Class shares, and transfer agent and shareholder
servicing expenses, which are determined separately for each class.
SECURITY VALUATION
Securities traded on national securities exchanges are valued at the last quoted
sales price. Over-the-counter securities and listed securities, for which no
sales price is available, are valued at the mean between the latest bid and
asked prices. Securities for which market quotations are not readily available
are valued at fair value as determined by management and approved in good faith
by the Board of Directors. Fixed income securities with 60 days or less
remaining to maturity are valued using the amortized cost method, which
approximates current market value.
FOREIGN CURRENCY TRANSLATION
The Portfolios may invest in foreign securities. Foreign currency amounts are
translated into U.S. dollars on the following basis:
(i) market value of investment securities, assets and liabilities at the
closing daily rate of exchange, and
(ii) purchases and sales of investment securities, interest and dividend income
and expenses at the rate of exchange prevailing on the respective date of
such transactions.
The effect of changes in foreign exchange rates on realized and unrealized
security gains or losses is reflected as a component of such gains or losses.
INVESTMENT INCOME AND DISTRIBUTIONS TO SHAREHOLDERS
Dividend and interest income and expenses are recorded on the accrual basis. Net
investment income for dividend purposes consists of dividends and interest
earned, less expenses.
Dividends from net investment income and distributions from capital gains are
recorded on the ex-dividend date. Dividends from net investment income, if
available, will be paid quarterly for Value Institutional and annually for
Brandywine Small Cap. Distributions from net capital gains, if available, will
be made annually for both Value Institutional and Brandywine Small Cap.
Additional distributions will be made when necessary.
INVESTMENT TRANSACTIONS
Security transactions are recorded on the trade date. Realized gains and losses
from security transactions are reported on an identified cost basis for both
financial reporting and federal income tax purposes. At September 30, 1999,
$4,829,850 was payable for securities purchased but not yet received for Value
Institutional. At September 30, 1999, $454,306 was receivable for securities
sold but not yet delivered for Value Institutional.
REPURCHASE AGREEMENTS
All repurchase agreements are fully collateralized by obligations issued by the
U.S. Government or its agencies and such collateral is in the possession of the
Portfolios' custodian. The value of such collateral includes accrued interest.
Risks arise from the possible delay in recovery or potential loss of rights in
the collateral should the issuer of the repurchase agreement fail financially.
The Portfolios' investment advisers, acting under the supervision of their Board
of Directors, review the value of the collateral and the creditworthiness of
those banks and dealers with which the Portfolios' enter into repurchase
agreements to evaluate potential risks.
24
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
LM Institutional Fund Advisors II, Inc.
FEDERAL INCOME TAXES
No provision for federal income or excise taxes has been made since the
Portfolios intend to continue to qualify as regulated investment companies and
distribute all of their taxable income to their shareholders.
USE OF ESTIMATES
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts and disclosures in the financial statements. Actual
results could differ from those estimates.
2. PORTFOLIO TRANSACTIONS
For the period ended September 30, 1999, investment transactions (excluding
short-term investments) were as follows:
PROCEEDS
PURCHASES FROM SALES
--------- ----------
Value Institutional $164,280,147 $8,828,143
Brandywine Small Cap 879,441 811,272
At September 30, 1999, cost, aggregate gross unrealized appreciation and gross
unrealized depreciation based on the cost of securities for federal income tax
purposes for each Portfolio were as follows:
<TABLE>
<CAPTION>
COST APPRECIATION (DEPRECIATION) NET
---- ------------ -------------- ---
<S> <C> <C> <C> <C>
Value Institutional $268,421,535 $15,827,086 $(26,799,741) $(10,972,655)
Brandywine Small Cap 2,390,106 147,191 (411,207) (264,016)
</TABLE>
3. TRANSACTIONS WITH AFFILIATES
Each Portfolio has a management agreement with LM Institutional Advisors, Inc.
("Manager"). Pursuant to their respective agreements, the Manager provides the
Portfolios with management and administrative services for which each Portfolio
pays a fee, computed daily and payable monthly at an annual rate of 0.60% and
0.65% of the average daily net assets of Value Institutional and Brandywine
Small Cap, respectively.
The Manager has agreed to waive its fees and reimburse expenses in any month to
the extent a Portfolio's expenses during the month (exclusive of taxes,
interest, brokerage and extraordinary expense) exceed annual rates of that
Portfolio's average daily net assets as follows: 0.75% for Value Institutional
Institutional Class, 1.00% for Value Institutional Financial Intermediary Class
and 0.85% for Brandywine Small Cap, until July 31, 2000. For the period ended
September 30, 1999, management fees of $41,300 and $7,364 were waived and
expenses of $0 and $53,875 were reimbursed for Value Institutional and
Brandywine Small Cap, respectively. At September 30, 1999, $118,824 was due to
the Manager by Value Institutional and $13,149 was due from the Manager to
Brandywine Small Cap. Any amounts waived or reimbursed in a particular fiscal
year will be subject to repayment by a Portfolio to the Manager and the Advisers
to the extent that from time to time during the next three fiscal years, the
repayment will not cause a Portfolio's expenses to exceed the limit, if any,
imposed by the Manager and the Advisers at that time.
Legg Mason Fund Adviser, Inc. ("LMFA") serves as investment adviser to Value
Institutional. LMFA is responsible for the actual investment activity of the
Portfolio. The Manager pays LMFA a fee for its services at an annual rate equal
to 0.55% of the Portfolio's average daily net assets.
Brandywine Asset Management, Inc. ("Brandywine") serves as investment adviser to
Brandywine Small Cap. Brandywine is responsible for the actual investment
activity of the Portfolio. The Manager pays Brandywine a fee for its services at
an annual rate equal to 0.60% of the Portfolio's average daily net assets.
Legg Mason Wood Walker, Incorporated ("LMWW"), a member of the New York Stock
Exchange, serves as distributor of the Portfolios' shares. LMWW will receive
from each Portfolio an annual distribution fee of 0.25% of the average daily net
assets of the Financial Intermediary Class of each Portfolio, computed daily and
payable monthly. At September 30, 1999 distribution and service fees waived were
$5,837 and $7,986 was due to LMWW for Value Institutional.
25
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
LM Institutional Fund Advisors II, Inc.
No brokerage commissions were paid to LMWW or its affiliates during the period
ended September 30, 1999.
LMFA, Brandywine, LMWW and the Manager are wholly owned subsidiaries of Legg
Mason, Inc.
4. LINE OF CREDIT
Each Portfolio, along with certain other Legg Mason Funds, participate in a $200
million line of credit ("Credit Agreement") to be utilized as an emergency
source of cash in the event of unanticipated, large redemption requests by
shareholders. Pursuant to the Credit Agreement, each participating Portfolio is
liable only for principal and interest payments related to borrowings made by
that Portfolio. Borrowings under the line of credit bear interest at prevailing
short-term interest rates. For the period ended September 30, 1999, the
Portfolios had no borrowings under the line of credit.
5. FUND SHARE TRANSACTIONS
At September 30, 1999, there were seven billion shares authorized at $0.001 par
value for all portfolios of the Corporation. Share transactions were as follows:
<TABLE>
<CAPTION>
REINVESTMENT
SOLD OF DISTRIBUTIONS REPURCHASED
-------------------- ------------------- ---------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
VALUE INSTITUTIONAL:
Institutional Class
Six Months ended September 30, 1999 9,305,042 $146,982,459 12,311 $ 198,208 (1,832,107) $(27,946,180)
Period ended March 31, 1999(A) 7,697,105 $107,068,729 1,709 $ 20,661 (393,470) $ (5,481,356)
Financial Intermediary Class
Six Months ended September 30, 1999 2,145,646 $ 33,261,889 1,252 $ 20,184 (234,567) $ (3,549,197)
Period ended March 31, 1999(B) 1,283,831 $ 14,522,075 742 $ 8,987 (102,486) $ (1,105,828)
BRANDYWINE SMALL CAP:
Institutional Class
Six Months ended September 30, 1999 4,860 $ 45,000 6,320 $ 62,378 -- $ --
Period ended March 31, 1999(C) 225,568 $ 2,225,000 591 $ 5,223 -- $ --
- -------------------------------------------------------------------------------------------------------------------------------
NET CHANGE
--------------------
SHARES AMOUNT
------ ------
VALUE INSTITUTIONAL:
Institutional Class
Six Months ended September 30, 1999 7,485,246 $119,234,487
Period ended March 31, 1999(A) 7,305,344 $101,608,034
Financial Intermediary Class
Six Months ended September 30, 1999 1,912,331 $ 29,732,876
Period ended March 31, 1999(B) 1,182,087 $ 13,425,234
BRANDYWINE SMALL CAP:
Institutional Class
Six Months ended September 30, 1999 11,180 $ 107,378
Period ended March 31, 1999(C) 226,159 $ 2,230,223
- -----------------------------------------------------------------
</TABLE>
(A) September 22, 1998 (commencement of operations) to March 31, 1999
(B) October 22, 1998 (commencement of operations) to March 31, 1999
(C) August 17, 1998 (commencement of operations) to March 31, 1999
26
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<PAGE>
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<PAGE>
LM INSTITUTIONAL FUND ADVISORS II, INC.
Investment Manager
LM Institutional Advisors, Inc.
P.O. Box 17635
Baltimore, Maryland 21297-1635
1-888-425-6432
Investment Advisers
Legg Mason Fund Adviser, Inc.
100 Light Street
Baltimore, Maryland 21202
Brandywine Asset Management, Inc.
Three Christina Centre, Suite 1200
201 North Walnut Street
Wilmington, Delaware 19801
This report is not to be distributed unless preceded or accompanied by a
prospectus.
Legg Mason Wood Walker, Inc., Distributor
