<PAGE> 1
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MERRILL LYNCH VARIABLE
-------------------------------------------------------------------------
SERIES FUNDS, INC.
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<TABLE>
<CAPTION>
PAGE
----
<S> <C>
American Balanced Fund................ 1
Basic Value Focus Fund................ 15
Capital Focus Fund.................... 30
Developing Capital Markets Focus
Fund................................ 44
Domestic Money Market Fund............ 64
Global Bond Focus Fund................ 76
Global Growth Focus Fund.............. 91
Global Strategy Focus Fund............ 108
Global Utility Focus Fund............. 126
Government Bond Fund.................. 141
High Current Income Fund.............. 152
Index 500 Fund........................ 171
International Equity Focus Fund....... 188
Natural Resources Focus Fund.......... 212
Prime Bond Fund....................... 227
Quality Equity Fund................... 243
Reserve Assets Fund................... 258
Special Value Focus Fund.............. 269
</TABLE>
Annual Report
December 31, 1998
<PAGE> 2
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
DECEMBER 31, 1998--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
THE ENVIRONMENT
During 1998, stock and bond market volatility reflected shifting investor
perceptions regarding global economic prospects. Investor optimism early in the
year gave way to expectations of deteriorating corporate profits and signs of a
weakening economy by late summer. Further concerns arose from the precarious
state of the Russian and other emerging markets economies. As a result, world
stock markets declined in the July-September period. At the same time, the
uncertain economic picture and the resulting flight to quality by investors
pushed the 30-year US Treasury bond to record low yields. Yields also declined
on sovereign bonds of other major industrialized countries. In contrast,
corporate bonds, mortgage-backed securities and emerging markets debt
underperformed US Treasury securities by a wide margin.
The US Federal Reserve Board and other central banks responded to the
uncertain economic outlook through a series of monetary policy easings that
served to restore investor confidence as 1998 drew toward a close. Stock markets
around the world rallied, with total returns for the unmanaged Standard & Poor's
500 (S&P 500) Index rising 21.3% and the unmanaged Morgan Stanley Capital
International World Index (Ex-US) increasing 20.5% during the fourth quarter of
1998. However, as 1999 began, uncertainty regarding global economic prospects
again began to cloud the investment outlook. At the same time, with
stronger-than-expected economic results, prospects dimmed for further Federal
Reserve Board monetary policy easings in the near future. The notable exception
to the more subdued investment outlook in the United States was the
unprecedented popularity of Internet-related stocks.
The weakening of the US dollar relative to the Japanese yen was one of the
year's more surprising developments. Since a stronger yen would have a negative
impact on the important export sector of Japan's fragile economy, the Japanese
central bank intervened in the currency markets in January. For the overall
global economy, the deepening recession in Japan is of great concern. At the
same time, the difficulties in emerging economies such as Russia and Brazil
remain. Further progress in easing strains within the global financial system
would likely provide an important element of stability to the volatile
investment environment.
FISCAL YEAR IN REVIEW
As of December 31, 1998, the Fund's asset allocation was: US stocks, 55% of
net assets; US bonds, 40%; and cash and cash reserves, 5%.
During the fourth quarter of 1998, a strong rebound in the US equity market
offset the significant correction that took place during the previous three
months. Throughout the fiscal year ended December 31, 1998, the US equity sector
had a positive impact on the Fund's total return. However, the US stock market
was characterized by significant outperformance for a narrow group of
large-capitalization equities. During the fourth quarter, we increased our
representation in equities of this type, although the Fund was underweighted for
much of 1998 in this narrow group of common stocks that dominated the
performance of the benchmark S&P 500 Index. While the total return on US bonds
lagged that of US equities for 1998 as a whole, the Fund's fixed-income
commitments positively contributed to overall performance, particularly in the
third quarter of 1998 when there was a significant correction in the US stock
market.
PORTFOLIO MATTERS
Beginning in September 1998, a shift toward an increasingly accommodative
monetary policy by the Federal Reserve Board led us to become more positive
toward US equities. After reducing the Fund's allocation to US equities from 62%
of net assets as of June 30, 1998 to 47% as of September 30, 1998, the weighting
in US common stocks was expanded to 55% of net assets by December 31, 1998. In
increasing our US equity exposure, we emphasized the shares of companies that we
believed offered a high degree of earnings visibility through 1999 despite an
expected slowdown in economic activity. New positions in the Fund included
commitments in the technology sector, such as Intel Corporation, Microsoft
Corporation, and Motorola, Inc., and, in healthcare, through Johnson & Johnson.
As of December 31, 1998, consumer staples, technology and financial services
represented the largest sector weightings among our US equity commitments.
Over the six-month period ended December 31, 1998, we expanded the Fund's
commitment to US bonds from 31% of net assets to 40%. The duration of our bond
holdings was slightly extended from 5.2 years as of June 30, 1998 to 5.4 years
as of December 31, 1998. The easing of the crisis atmosphere in global finan-
1
<PAGE> 3
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cial markets during the fourth quarter of 1998 reduced the appeal of US
fixed-income securities as "safe haven" investments. However, we believe that
the overall trend in intermediate-term and longer-term US interest rates is
likely to continue downward in the coming months, reflecting the lack of
inflationary pressure in the US economy.
IN CONCLUSION
We appreciate your investment in American Balanced Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to sharing our investment
outlook and strategies with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Thomas R. Robinson
Thomas R. Robinson
Senior Vice President and Portfolio Manager
February 5, 1999
2
<PAGE> 4
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
Merrill Lynch Variable Series Funds, Inc.
American Balanced Fund
Total Return Based on a $10,000 Investment-Class A Shares
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Standard & Poor's 500 Index and a
Weighted Index. Beginning and ending values are:
<TABLE>
<CAPTION>
12/88 12/98
----- -----
<S> <C> <C>
American Balanced Fund+--
Class A Shares* $10,000 $29,232
Standard & Poor's 500 Index++ $10,000 $57,962
Weighted Index+++ $10,000 $29,664
</TABLE>
<TABLE>
<C> <S>
* Assuming transaction costs and other operating expenses,
including advisory fees. Does not include insurance-related fees
and expenses.
+ American Balanced Fund invests in a balanced portfolio of fixed-
income and equity securities.
++ This unmanaged broad-based Index is comprised of US common stocks.
+++ This unmanaged Index, which is an equally weighted blend of
the Three-Month Treasury Bill Index, the Merrill Lynch US
Corporate and Government Master Index and the S&P 500 Index, is
comprised of US Treasury bills maturing in up to three months,
investment-grade bonds and common stocks.
Past performance is not predictive of future performance.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/98 +13.56%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/98 +11.05
- --------------------------------------------------------------------------------
Ten Years Ended 12/31/98 +11.32
- --------------------------------------------------------------------------------
3
<PAGE> 5
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
RECENT PERFORMANCE RESULTS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
12 MONTH 6 MONTH
TOTAL RETURN TOTAL RETURN
- -----------------------------------------------------------------------------------------
<S> <C> <C>
Class A Shares +13.56% +1.89%
- -----------------------------------------------------------------------------------------
</TABLE>
* Total investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the ex-dividend date. Insurance-related
fees and expenses are not reflected in these returns. Past results shown
should not be considered a representation of future performance.
4
<PAGE> 6
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD COMMON STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
AEROSPACE 36,500 GenCorp, Inc. .............. $ 1,076,212 $ 910,219 0.5%
5,400 United Technologies
Corporation............... 422,854 587,250 0.3
------------ ------------ -----
1,499,066 1,497,469 0.8
- -----------------------------------------------------------------------------------------------------------------------
AUTO--RELATED 20,250 The Hertz Corporation (Class
A)........................ 722,168 923,906 0.5
- -----------------------------------------------------------------------------------------------------------------------
AUTOMOBILE PARTS 29,900 Federal-Mogul Corporation... 1,289,609 1,779,050 1.0
- -----------------------------------------------------------------------------------------------------------------------
AUTOMOTIVE 13,200 General Motors
Corporation............... 925,939 944,625 0.5
- -----------------------------------------------------------------------------------------------------------------------
AUTOMOTIVE & EQUIPMENT 38,050 +Avis Rent A Car, Inc. ..... 893,668 920,334 0.5
- -----------------------------------------------------------------------------------------------------------------------
BANKING 48,000 The Bank of New York
Company, Inc. ............ 722,792 1,932,000 1.0
12,871 BankAmerica Corporation..... 633,565 773,869 0.4
------------ ------------ -----
1,356,357 2,705,869 1.4
- -----------------------------------------------------------------------------------------------------------------------
BANKING & FINANCIAL 30,600 First Union Corporation..... 1,525,967 1,860,863 1.0
52,900 Heller Financial, Inc. ..... 1,497,148 1,553,938 0.8
17,400 Mellon Bank Corporation..... 1,115,441 1,196,250 0.7
29,700 Providian Financial
Corporation............... 1,248,715 2,227,500 1.2
------------ ------------ -----
5,387,271 6,838,551 3.7
- -----------------------------------------------------------------------------------------------------------------------
BEVERAGES 38,000 PepsiCo, Inc. .............. 1,455,646 1,555,625 0.8
- -----------------------------------------------------------------------------------------------------------------------
BROADCAST--MEDIA 12,100 +Fox Entertainment Group,
Inc. (Class A)............ 272,250 304,769 0.2
- -----------------------------------------------------------------------------------------------------------------------
BROADCASTING/CABLE 48,900 +Tele-Communications, Inc.
(Class A)................. 905,376 2,704,781 1.5
105,700 +Tele-Communications TCI
Ventures Group
(Class A)................. 1,066,303 2,490,556 1.3
------------ ------------ -----
1,971,679 5,195,337 2.8
- -----------------------------------------------------------------------------------------------------------------------
CHEMICALS 10,450 du Pont (E.I.) de Nemours
and Company............... 651,331 554,503 0.3
15,800 Morton International,
Inc. ..................... 443,380 387,100 0.2
------------ ------------ -----
1,094,711 941,603 0.5
- -----------------------------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES 24,980 +Quintiles Transnational
Corp. .................... 1,161,643 1,331,746 0.7
- -----------------------------------------------------------------------------------------------------------------------
COMMUNICATIONS 40,800 +MCI WorldCom, Inc. ........ 1,289,280 2,927,400 1.6
- -----------------------------------------------------------------------------------------------------------------------
COMPUTER SERVICES 25,650 +Cisco Systems, Inc. ....... 1,043,485 2,380,641 1.3
- -----------------------------------------------------------------------------------------------------------------------
COMPUTERS 61,900 COMPAQ Computer
Corporation............... 2,091,249 2,595,931 1.4
10,200 +Dell Computer
Corporation............... 643,383 746,513 0.4
4,100 +EMC Corporation............ 284,871 348,500 0.2
11,700 International Business
Machines Corporation...... 1,227,611 2,161,575 1.1
------------ ------------ -----
4,247,114 5,852,519 3.1
- -----------------------------------------------------------------------------------------------------------------------
CONGLOMERATES 72,200 The Dial Corporation........ 1,486,826 2,084,775 1.1
- -----------------------------------------------------------------------------------------------------------------------
COSMETICS & TOILETRIES 11,050 Kimberly-Clark
Corporation............... 507,898 602,225 0.3
- -----------------------------------------------------------------------------------------------------------------------
ELECTRONIC COMPONENTS 9,500 General Electric Company.... 728,371 969,594 0.5
14,400 Intel Corporation........... 1,647,981 1,706,400 0.9
15,900 +Micron Technology, Inc. ... 605,080 803,944 0.4
26,750 Motorola, Inc. ............. 1,412,931 1,633,422 0.9
24,600 PECO Energy Company......... 840,362 1,023,975 0.6
------------ ------------ -----
5,234,725 6,137,335 3.3
- -----------------------------------------------------------------------------------------------------------------------
ENTERTAINMENT 84,700 +Premier Parks Inc. ........ 2,399,573 2,562,175 1.4
- -----------------------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES 13,000 Associates First Capital
Corporation (Class A)..... 447,457 550,875 0.3
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
5
<PAGE> 7
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD COMMON STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FOOD 32,900 +Keebler Foods Company...... $ 948,933 $ 1,237,862 0.7%
17,900 Nabisco Holdings Corp.
(Class A)................. 640,768 742,850 0.4
------------ ------------ -----
1,589,701 1,980,712 1.1
- -----------------------------------------------------------------------------------------------------------------------
HARDWARE TOOLS 27,800 The Black & Decker
Corporation............... 1,166,410 1,558,538 0.8
- -----------------------------------------------------------------------------------------------------------------------
INSURANCE 20,300 Allmerica Financial
Corporation............... 1,253,949 1,174,863 0.6
32,300 The Equitable Companies
Incorporated.............. 1,731,827 1,869,363 1.0
27,900 UNUM Corporation............ 1,022,660 1,628,662 0.9
------------ ------------ -----
4,008,436 4,672,888 2.5
- -----------------------------------------------------------------------------------------------------------------------
MACHINERY 8,500 Case Corporation............ 227,389 185,406 0.1
37,000 Ingersoll-Rand Company...... 1,265,961 1,736,687 0.9
------------ ------------ -----
1,493,350 1,922,093 1.0
- -----------------------------------------------------------------------------------------------------------------------
MANUFACTURING 31,000 Tyco International Ltd. .... 1,630,395 2,338,562 1.3
- -----------------------------------------------------------------------------------------------------------------------
MEDICAL EQUIPMENT 30,100 Beckman Coulter Inc. ....... 1,798,853 1,632,925 0.9
- -----------------------------------------------------------------------------------------------------------------------
MEDICAL SERVICES 64,300 +HEALTHSOUTH Corporation.... 1,055,317 992,631 0.5
- -----------------------------------------------------------------------------------------------------------------------
MEDICAL TECHNOLOGY 13,550 Johnson & Johnson........... 1,077,394 1,136,506 0.6
- -----------------------------------------------------------------------------------------------------------------------
METAL 5,400 Aluminum Co. of America..... 418,712 402,638 0.2
- -----------------------------------------------------------------------------------------------------------------------
NATURAL GAS 33,900 Enron Corporation........... 1,574,391 1,934,419 1.0
- -----------------------------------------------------------------------------------------------------------------------
OIL--INTEGRATED 10,800 Mobil Corporation........... 845,864 940,950 0.5
23,100 Shell Transport & Trading
Company (ADR)(a).......... 848,682 859,031 0.5
------------ ------------ -----
1,694,546 1,799,981 1.0
- -----------------------------------------------------------------------------------------------------------------------
OIL SERVICES 15,900 Schlumberger Limited........ 1,134,511 733,387 0.4
- -----------------------------------------------------------------------------------------------------------------------
PETROLEUM 32,000 Unocal Corporation.......... 1,218,447 934,000 0.5
- -----------------------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 21,200 Bristol-Myers Squibb
Company................... 2,037,333 2,836,825 1.5
28,100 Warner-Lambert Company...... 1,357,206 2,112,769 1.1
------------ ------------ -----
3,394,539 4,949,594 2.6
- -----------------------------------------------------------------------------------------------------------------------
PRINTING & 51,200 +World Color Press, Inc. ... 1,614,462 1,558,400 0.8
PUBLISHING
- -----------------------------------------------------------------------------------------------------------------------
RADIO AND TELEVISION 77,700 +Capstar Broadcasting
Corporation (Class A)..... 1,476,300 1,777,388 1.0
- -----------------------------------------------------------------------------------------------------------------------
RAILROADS 50,100 Burlington Northern Santa Fe
Corp. .................... 1,419,488 1,690,875 0.9
- -----------------------------------------------------------------------------------------------------------------------
RETAIL 39,000 Lowe's Companies, Inc. ..... 1,414,780 1,996,312 1.1
25,900 +Safeway Inc. .............. 823,804 1,578,281 0.8
20,400 Wal-Mart Stores, Inc. ...... 857,778 1,661,325 0.9
------------ ------------ -----
3,096,362 5,235,918 2.8
- -----------------------------------------------------------------------------------------------------------------------
RETAIL--DRUG STORES 49,100 Rite Aid Corporation........ 1,005,513 2,433,519 1.3
- -----------------------------------------------------------------------------------------------------------------------
SAVINGS & LOAN ASSOCIATIONS 54,600 GreenPoint Financial
Corp. .................... 2,190,825 1,917,825 1.0
- -----------------------------------------------------------------------------------------------------------------------
SCIENTIFIC EQUIPMENT 21,150 Millipore Corporation....... 450,646 601,453 0.3
- -----------------------------------------------------------------------------------------------------------------------
SOFTWARE 24,500 +BMC Software, Inc. ........ 575,301 1,091,781 0.6
7,300 +Keane, Inc. ............... 256,517 291,544 0.1
6,600 +Microsoft Corporation...... 771,116 914,512 0.5
------------ ------------ -----
1,602,934 2,297,837 1.2
- -----------------------------------------------------------------------------------------------------------------------
STEEL 21,600 +Bethlehem Steel
Corporation............... 228,606 180,900 0.1
8,000 USX-U.S. Steel Group........ 218,779 184,000 0.1
------------ ------------ -----
447,385 364,900 0.2
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
6
<PAGE> 8
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD COMMON STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
TELECOMMUNICATIONS 5,800 +3Com Corporation........... $ 230,609 $ 259,912 0.1%
34,600 Ameritech Corporation....... 1,655,424 2,192,775 1.2
32,200 GTE Corporation............. 1,622,813 2,171,488 1.2
------------ ------------ -----
3,508,846 4,624,175 2.5
- -----------------------------------------------------------------------------------------------------------------------
TOYS 10,600 Mattel, Inc. ............... 245,453 241,812 0.1
- -----------------------------------------------------------------------------------------------------------------------
TRAVEL & LODGING 22,100 Royal Caribbean Cruises
Ltd. ..................... 519,336 817,700 0.4
- -----------------------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 21,500 Public Service Enterprise
Group Incorporated........ 835,420 860,000 0.4
18,600 Texas Utilities Company..... 832,423 868,387 0.5
------------ ------------ -----
1,667,843 1,728,387 0.9
- -----------------------------------------------------------------------------------------------------------------------
UTILITIES--GAS 53,900 El Paso Energy
Corporation............... 1,452,864 1,876,394 1.0
- -----------------------------------------------------------------------------------------------------------------------
WASTE MANAGEMENT 26,000 Waste Management, Inc....... 1,110,949 1,212,250 0.7
- -----------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS 79,750,573 103,404,536 55.3
- -----------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT FIXED-INCOME INVESTMENTS
- -----------------------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES $ 3,000,000 General Electric Capital
Corp., 8.75% due
5/21/2007................. 3,431,200 3,662,220 1.9
- -----------------------------------------------------------------------------------------------------------------------
US GOVERNMENT AGENCY 1,953,169 Federal Home Loan Mortgage
MORTGAGE-BACKED Corporation, #10036, 7.50%
OBLIGATIONS** due 6/01/2007............. 1,990,402 2,009,904 1.1
- -----------------------------------------------------------------------------------------------------------------------
US GOVERNMENT & AGENCY Federal National Mortgage
OBLIGATIONS Association:
7,760,000 5.625% due 3/15/2001........ 7,783,338 7,873,994 4.2
8,110,000 5.75% due 4/15/2003......... 8,154,200 8,325,402 4.4
10,470,000 5.75% due 2/15/2008......... 10,418,393 10,841,371 5.8
17,085,000 US Treasury Bonds, 6.625%
due 2/15/2027............. 19,531,407 20,208,309 10.8
US Treasury Notes:
4,800,000 6% due 8/15/1999............ 4,813,125 4,838,976 2.6
16,000,000 6.125% due 9/30/2000........ 16,331,875 16,392,480 8.8
------------ ------------ -----
67,032,338 68,480,532 36.6
- -----------------------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS 72,453,940 74,152,656 39.6
- -----------------------------------------------------------------------------------------------------------------------
SHORT-TERM SECURITIES
- -----------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER* 3,162,000 General Motors Acceptance
Corp., 5.13% due
1/04/1999................. 3,160,198 3,160,198 1.7
5,160,000 Lexington Parker Capital
Company, LLC, 5.45% due
1/05/1999................. 5,156,094 5,156,094 2.8
- -----------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES 8,316,292 8,316,292 4.5
- -----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS........... $160,520,805 185,873,484 99.4
============
OTHER ASSETS LESS
LIABILITIES............... 1,210,987 0.6
------------ -----
NET ASSETS.................. $187,084,471 100.0%
============ =====
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
* Commercial Paper is traded on a discount basis; the interest rates shown
reflect the discount rates paid at the time of purchase by the Fund.
** Mortgage-Backed Obligations are subject to principal paydowns as a result of
prepayments or refinancing of the underlying mortgage instrument. As a
result, the average life may be substantially less than the original
maturity.
+ Non-income producing security.
(a) American Depositary Receipts (ADR).
See Notes to Financial Statements.
7
<PAGE> 9
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$160,520,805) (Note
1a)....................................................... $185,873,484
Cash........................................................ 996
Receivables:
Interest.................................................. $1,274,431
Dividends................................................. 86,948
Capital shares sold....................................... 7,643 1,369,022
----------
Prepaid expenses and other assets........................... 14,570
------------
Total assets................................................ 187,258,072
------------
- ---------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Investment adviser (Note 2)............................... 85,226
Capital shares redeemed................................... 45,578 130,804
----------
Accrued expenses and other liabilities...................... 42,797
------------
Total liabilities........................................... 173,601
------------
- ---------------------------------------------------------------------------------------
NET ASSETS.................................................. $187,084,471
============
- ---------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 1,117,539
Paid-in capital in excess of par............................ 140,256,937
Undistributed investment income--net........................ 4,504,394
Undistributed realized capital gains on investments--net.... 15,852,922
Unrealized appreciation on investments--net................. 25,352,679
------------
NET ASSETS.................................................. $187,084,471
============
- ---------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $187,084,471 and 11,175,390
shares outstanding........................................ $ 16.74
============
- ---------------------------------------------------------------------------------------
</TABLE>
+ The Fund is also authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
8
<PAGE> 10
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1c & 1d):
Interest and discount earned................................ $ 4,729,511
Dividends (net of $453 foreign withholding tax)............. 946,919
-----------
Total income................................................ 5,676,430
-----------
- ---------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $1,043,157
Accounting services (Note 2)................................ 38,782
Printing and shareholder reports............................ 30,928
Custodian fees.............................................. 26,030
Professional fees........................................... 19,688
Transfer agent fees (Note 2)................................ 5,115
Directors' fees and expenses................................ 4,313
Pricing services............................................ 563
Other....................................................... 3,451
----------
Total expenses.............................................. 1,172,027
-----------
Investment income--net...................................... 4,504,403
-----------
- ---------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN ON INVESTMENTS--NET (NOTES 1B, 1D
& 3):
Realized gain on investments--net........................... 16,072,309
Change in unrealized appreciation on investments--net....... 3,510,679
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $24,087,391
===========
- ---------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
9
<PAGE> 11
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
----------------------------
INCREASE (DECREASE) IN NET ASSETS: 1998 1997
- ------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 4,504,403 $ 6,345,486
Realized gain on investments--net........................... 16,072,309 15,251,840
Change in unrealized appreciation on investments--net....... 3,510,679 9,866,947
------------ ------------
Net increase in net assets resulting from operations........ 24,087,391 31,464,273
------------ ------------
- ------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1E):
Investment income--net:
Class A................................................... (6,345,486) (3,604,297)
Realized gain on investments--net:
Class A................................................... (15,410,418) (20,656,058)
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (21,755,904) (24,260,355)
------------ ------------
- ------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net decrease in net assets derived from capital share
transactions.............................................. (9,994,020) (24,503,928)
------------ ------------
- ------------------------------------------------------------------------------------------
NET ASSETS:
Total decrease in net assets................................ (7,662,533) (17,300,010)
Beginning of year........................................... 194,747,004 212,047,014
------------ ------------
End of year*................................................ $187,084,471 $194,747,004
============ ============
- ------------------------------------------------------------------------------------------
* Undistributed investment income--net................... $ 4,504,394 $ 6,345,477
============ ============
- ------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
10
<PAGE> 12
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE
BEEN DERIVED FROM INFORMATION PROVIDED IN THE CLASS A
FINANCIAL STATEMENTS. --------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year....................... $ 16.59 $ 16.01 $ 15.17 $ 13.08 $ 14.08
-------- -------- -------- -------- --------
Investment income--net................................... .40 .54 .53 .59 .48
Realized and unrealized gain (loss) on
investments--net....................................... 1.60 1.87 .89 2.06 (1.06)
-------- -------- -------- -------- --------
Total from investment operations......................... 2.00 2.41 1.42 2.65 (.58)
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net................................. (.54) (.27) (.56) (.56) (.37)
Realized gain on investments--net...................... (1.31) (1.56) (.02) -- --
In excess of realized gain on investments--net......... -- -- -- -- (.05)
-------- -------- -------- -------- --------
Total dividends and distributions........................ (1.85) (1.83) (.58) (.56) (.42)
-------- -------- -------- -------- --------
Net asset value, end of year............................. $ 16.74 $ 16.59 $ 16.01 $ 15.17 $ 13.08
======== ======== ======== ======== ========
- --------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share....................... 13.56% 17.11% 9.73% 20.81% (4.19%)
======== ======== ======== ======== ========
- --------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses................................................. .62% .60% .60% .61% .63%
======== ======== ======== ======== ========
Investment income--net................................... 2.37% 3.17% 3.39% 4.22% 3.95%
======== ======== ======== ======== ========
- --------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)................... $187,084 $194,747 $212,047 $212,912 $158,951
======== ======== ======== ======== ========
Portfolio turnover....................................... 102.47% 136.71% 236.50% 38.40% 35.36%
======== ======== ======== ======== ========
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
See Notes to Financial Statements.
11
<PAGE> 13
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Class A and
Class B Shares have equal voting, dividend, liquidation and other rights, except
that only shares of the respective classes are entitled to vote on matters
concerning only that class and Class B Shares bear certain expenses related to
the distribution of such shares. American Balanced Fund (the "Fund") is
classified as "diversified," as defined in the Investment Company Act of 1940.
The Fund's financial statements are prepared in accordance with generally
accepted accounting principles which may require the use of management accruals
and estimates. The following is a summary of significant accounting policies
followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written or purchased are valued at the last sale price in the
case of exchange-traded options. In the case of options traded in the
over-the-counter market, valuation is the last asked price (options written) or
the last bid price (options purchased). Short-term securities are valued at
amortized cost, which approximates market value. Securities and assets for which
market quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Board of Directors of
the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity and debt markets. Losses may arise due to
changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Options--The Fund may write covered call options. When the Fund writes an
option, an amount equal to the premium received by the Fund is reflected as an
asset and an equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option written. When
a security is purchased or sold through an exercise of an option, the related
premium paid (or received) is added to (or deducted from) the basis of the
security acquired or deducted from (or added to) the proceeds of the security
sold. When an option expires (or the Fund enters into a closing transaction),
the Fund realizes a gain or loss on the option to the extent of the premiums
received or paid (or gain or loss to the extent the cost of the closing
transaction exceeds the premium paid or received).
Written options are non-income producing investments.
(c) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends, and
capital gains at various rates.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(e) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain
12
<PAGE> 14
- --------------------------------------------------------------------------------
other services necessary to the operations of the funds. For such services, the
Fund pays a monthly fee at the annual rate of 0.55% of the average daily value
of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1998, Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("MLPF&S"), a subsidiary of ML & Co., earned $27,695 in commissions
on the execution of portfolio security transactions
For the year ended December 31, 1998, Merrill Lynch Security Pricing Service,
an affiliate of MLPF&S, earned $263 for providing security price quotations to
compute the Fund's net asset value.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Merrill Lynch Funds Distributor, a division of Princeton Funds Distributor,
Inc. ("PFD"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
is the Fund's distributor.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1998 were $179,918,349 and $210,287,784, respectively.
Net realized gains (losses) for the year ended December 31, 1998 and net
unrealized gains as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains
- --------------------------------------------------------------------
<S> <C> <C>
Long-term investments................. $16,072,518 $25,352,679
Short-term investments................ (209) --
----------- -----------
Total................................. $16,072,309 $25,352,679
=========== ===========
- --------------------------------------------------------------------
</TABLE>
At December 31, 1998, net unrealized appreciation for Federal income tax
purposes aggregated $25,229,906, of which $27,096,872 related to appreciated
securities and $1,866,966 related to depreciated securities. At December 31,
1998, the aggregate cost of investments for Federal income tax purposes was
$160,643,578.
4. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share transactions were
$9,994,020 and $24,503,928 for the years ended December 31, 1998 and December
31, 1997, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1998 Shares Amount
- ------------------------------------------------------------------
<S> <C> <C>
Shares sold............................ 107,140 $ 1,675,752
Shares issued to shareholders in
reinvestment of dividends and
distributions......................... 1,472,980 21,755,904
---------- ------------
Total issued........................... 1,580,120 23,431,656
Shares redeemed........................ (2,146,975) (33,425,676)
---------- ------------
Net decrease........................... (566,855) $ (9,994,020)
========== ============
- ------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- ------------------------------------------------------------------
<S> <C> <C>
Shares sold............................ 62,221 $ 951,862
Shares issued to shareholders in
reinvestment of dividends and
distributions......................... 1,723,037 24,260,354
---------- ------------
Total issued........................... 1,785,258 25,212,216
Shares redeemed........................ (3,285,875) (49,716,144)
---------- ------------
Net decrease........................... (1,500,617) $(24,503,928)
========== ============
- ------------------------------------------------------------------
</TABLE>
5. SUBSEQUENT EVENT:
On January 4, 1999, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.600672 per Class A Share and a long-term capital
gains distribution in the amount of $1.231936 per Class A Share payable on
January 11, 1999 to shareholders of record as of December 31, 1998.
13
<PAGE> 15
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
AMERICAN BALANCED FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of American Balanced Fund of Merrill Lynch Variable
Series Funds, Inc. as of December 31, 1998, the related statements of operations
for the year then ended and changes in net assets for each of the years in the
two-year period then ended, and the financial highlights for each of the years
in the five-year period then ended. These financial statements and the financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and the financial
highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1998 by correspondence with the custodian. An audit also includes assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of American Balanced
Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1998, the
results of its operations, the changes in its net assets, and the financial
highlights for the respective stated periods in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
14
<PAGE> 16
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
DECEMBER 31, 1998--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
INVESTMENT ENVIRONMENT
During the 12 months ended December 31, 1998, the total return for the
unmanaged Standard & Poor's (S&P) 500 Index was an impressive +28.6%. However,
the year was characterized by substantial volatility. In July, the market soared
to new highs as investors' concerns over the economic crisis in Asia gave way to
enthusiasm that any depressing effect from Asia would serve to sustain the
scenario of steady economic growth coupled with low inflation. However, this
notion was abruptly dismissed as the S&P 500 Index fell nearly 20% from its July
high by the beginning of the fourth quarter of 1998. The correction reflected
investors' conclusions that Asia's economic troubles were indeed having a very
tangible negative impact on the US economy and corporate earnings as well as on
other developing economies around the world.
During the second quarter of 1998, gross domestic product growth slowed to
1.8% from a more robust 5.5% earlier in the year. The US manufacturing sector
was negatively impacted by weak industrial production. In addition, corporate
profits slid 1.5% in the second quarter of 1998, the first year-over-year
decline in nearly a decade. Moreover, commodity prices were battered as export
demand for oil, copper, grain and other products weakened. In response to the
faltering economic outlook, the Federal Reserve Board lowered interest rates by
75 basis points (0.75%) in a series of three consecutive cuts with an ensuing
reacceleration of the economy. The positive psychology surrounding this swift
and decisive action drove the stock market on an unabated path to a new high at
year-end, rebounding almost 30% from its summer low.
While this sequence of events led to an impressive advance for the stock
market in general, there were several notable underlying market dynamics that
were masked by an isolated study of the narrow S&P 500 Index. For example,
investors had a distaste for cyclical stocks such as Aluminum Company of America
and International Paper Company, whose earnings are tied to the economic cycle.
Concurrently, the seemingly insatiable demand for consumer growth stocks such as
the Coca-Cola Co., Johnson & Johnson and General Electric Co., with their more
stable earnings records, remained strong. This dichotomy is evidenced by the
wide divergence of performance between the unmanaged Morgan Stanley Consumer
Index, which rose 25.4%, compared to the unmanaged Morgan Stanley Cyclical
Index, which was unchanged for the 12-month period ended December 31, 1998.
Despite the fact that value stocks continued to trade at depressed
price/earnings multiples, investors continued to bid up the already extended
multiples for growth stocks possessing more predictable earnings streams.
The very narrow performance of the market is another significant dynamic. Only
a handful of stocks drove a substantial portion of the gains posted for the
year. More specifically, a mere ten stocks contributed almost 50% of the gain in
the S&P 500. The relative performance of indexes representative of the broader
markets also illustrates this dynamic. For example, the unmanaged Value Line
Composite Index, a broad index comprised of over 1,500 stocks, lost 3.8% during
the year.
Finally, the lackluster showing by the unmanaged Russell 2000 Small-Cap Index,
which declined 3.5% of its value for the year ended December 31, 1998, is
noteworthy. Investors shunned small-capitalization stocks in favor of large,
high-multiple, stable growth stocks, which were deemed to better weather an
economic downturn while also being bigger beneficiaries of a low-interest rate,
low-inflationary environment. Investor conclusions generally vacillated between
these two notions throughout the quarter.
FISCAL YEAR IN REVIEW
The year ended December 31, 1998 proved to be another very difficult one for
our value style of investing, probably the most difficult since the 1990
recession. Against this backdrop, the Fund's Class A and Class B Shares had
total returns of +9.44% and +9.28%, respectively, for the year ended December
31, 1998, compared to the total return of +28.6% for the unmanaged S&P 500 Index
for the same one-year period. The fact that cyclically oriented companies
continued to trade at depressed valuation levels translated to an overweighted
position in basic materials and capital goods holdings in the Fund throughout
the year, a positioning which hurt Fund performance. Although holdings such as
ASARCO Incorporated traded at depressed valuation levels, investors generally
refused to bid their valuations higher in recognition of the largest valuation
dichotomy with growth stocks in decades. Likewise, the inherent value in
small-capitalization and medium-capitalization companies attracted us and
resulted in an
15
<PAGE> 17
- --------------------------------------------------------------------------------
average market cap for the Fund of $24.5 billion, compared to approximately
$92.1 billion for the S&P 500 Index. Despite more attractive valuation levels,
the Fund's small-capitalization and medium-capitalization exposure impeded
relative performance during the year. Another area of weakness was energy and
energy-related holdings, which came under pressure as a fall-off in demand from
weakened global economies combined with unusual weather patterns to depress the
price of the commodity. As positions in Sonat Inc., Royal Dutch Petroleum
Company, Diamond Offshore Drilling, Inc., Halliburton Company, Unocal
Corporation and others continued to underperform, the Fund's weighting in this
sector increased relative to the S&P 500 Index.
The Fund's technology exposure went from underweighted in the first half of
the year to overweighted in the fall, when this sector was near its low. The
Fund was well-positioned to take advantage of the subsequent turnaround in
technology issues as companies finally began to meet or exceed earnings
expectations in the third quarter of 1998. Stocks such as Hewlett-Packard
Company, Novell, Inc., Motorola, Inc., LSI Logic Corporation and Seagate
Technology, Inc. posted impressive gains off of their lows. Several of the
Fund's largest holdings at the beginning of the year, including Pharmacia &
Upjohn, Inc., Novell, Inc., Eastman Kodak Company and Pharmaceutical Product
Development, Inc., were eventually scaled back or eliminated as the companies
proved successful in executing their turnaround plans.
IN CONCLUSION
In adherence to its strict value philosophy, the Fund remains appropriately
positioned in our view with an average price/earnings ratio of 21.7 times, a
price/book multiple of 2.0 times and an above-average dividend yield of 1.5%. We
continue to believe that our bottom-up, value approach to stock selection will
reward shareholders with a long-term investment horizon.
Thank you for your investment in Basic Value Focus Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to serving your investment
needs in the months and years ahead.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Kevin M. Rendino
Kevin Rendino
Senior Vice President and Portfolio Manager
February 5, 1999
16
<PAGE> 18
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A AND CLASS B SHARES
- --------------------------------------------------------------------------------
[VARIABLE SERIES BASIC VALUE FOCUS GRAPH]
Basic Value Focus Fund
Total Return Based on a $10,000 Investment-Class A and Class B Shares.
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Standard & Poor's 500 Index.
Beginning and ending values are:
<TABLE>
<CAPTION>
7/01/93** 12/98
--------- -----
<S> <C> <C>
Class A Shares* $10,000 $22,410
Standard & Poor's 500 Index++ $10,000 $30,951
</TABLE>
A line graph depicting the growth of an investment in the Fund's Class B Shares
compared to growth of an investment in the Standard & Poor's 500 Index.
Beginning and ending values are:
<TABLE>
<CAPTION>
11/03/97++ 12/98
---------- ------
<S> <C> <C>
Basic Value Focus Fund+--
Class B Shares* $10,000 $10,894
Standard & Poor's 500 Index++ $10,000 $13,329
</TABLE>
<TABLE>
<C> <S>
* Assuming transaction costs and other operating expenses,
including advisory fees. Does not include insurance-related
fees and expenses.
** Commencement of operations.
+ Basic Value Focus Fund invests primarily in equities that
Fund management believes are undervalued.
++ This unmanaged broad-based Index is comprised of common
stocks.
</TABLE>
Past performance is not predictive of future performance.
17
<PAGE> 19
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/98 + 9.44%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/98 +15.40
- --------------------------------------------------------------------------------
Inception (7/01/93) to 12/31/98 +15.80
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS B SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/98 +9.28%
- --------------------------------------------------------------------------------
Inception (11/03/97) to 12/31/98 +7.67
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
RECENT PERFORMANCE RESULTS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
12 MONTH 6 MONTH
TOTAL RETURN TOTAL RETURN
- -----------------------------------------------------------------------------------------
<S> <C> <C>
Class A Shares +9.44% -3.74%
- -----------------------------------------------------------------------------------------
Class B Shares +9.28 -3.81
- -----------------------------------------------------------------------------------------
</TABLE>
* Total investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the ex-dividend date. Insurance-related fees
and expenses are not reflected in these returns. Past results shown should not
be considered a representation of future performance.
18
<PAGE> 20
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD STOCKS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
LOW PRICE TO BOOK VALUE
- ----------------------------------------------------------------------------------------------------------------------
METALS--NON-FERROUS 640,000 ASARCO Incorporated......... $ 16,469,720 $ 9,640,000 1.3%
HEALTH MAINTENANCE 250,000 Aetna Inc. ................. 19,629,994 19,656,250 2.6
ORGANIZATIONS
FINANCIAL SERVICES--CAPTIVE 600,000 The CIT Group, Inc. (Class
A)........................ 16,208,298 19,087,500 2.5
PAPER & FOREST PRODUCTS 300,000 Champion International
Corporation............... 12,701,713 12,150,000 1.6
TECHNOLOGY 1,300,000 +Exabyte Corporation(a)..... 13,064,889 6,987,500 0.9
TELECOMMUNICATIONS 1,500,000 +Glenayre Technologies,
Inc. ..................... 13,256,350 6,562,500 0.9
SEMICONDUCTORS 2,059,700 +Integrated Device
Technology, Inc. ......... 16,617,070 12,551,297 1.7
ELECTRONIC COMPONENTS 800,000 +LSI Logic Corporation...... 15,387,476 12,900,000 1.7
SOFTWARE 1,200,000 +Mentor Graphics
Corporation............... 11,553,748 10,050,000 1.3
TELECOMMUNICATIONS 300,000 Motorola, Inc. ............. 16,260,780 18,318,750 2.4
INFORMATION PROCESSING 300,000 +NCR Corporation............ 8,616,753 12,525,000 1.7
SOFTWARE 1,000,000 +Novell, Inc. .............. 9,253,879 18,125,000 2.4
COMPUTER SERVICES 1,554,300 +Scitex Corporation Ltd.
(Ordinary)................ 15,748,370 18,165,881 2.4
COMPUTER SERVICES 300,000 +Seagate Technology,
Inc. ..................... 6,845,259 9,075,000 1.2
BEVERAGE & ENTERTAINMENT 600,000 The Seagram Company
Ltd. ..................... 21,849,247 22,800,000 3.0
INFORMATION PROCESSING 1,200,000 +Silicon Graphics, Inc. .... 15,077,846 15,450,000 2.0
OIL--DOMESTIC 500,000 Sonat Inc. ................. 20,332,534 13,531,250 1.8
STEEL 1,150,000 +WHX Corporation(a)......... 11,661,962 11,571,875 1.5
------------ ------------ -----
260,535,888 249,147,803 32.9
- ----------------------------------------------------------------------------------------------------------------------
BELOW-AVERAGE PRICE/EARNINGS RATIO
- ----------------------------------------------------------------------------------------------------------------------
BANKING & FINANCIALS 400,000 Associates First Capital
Corporation (Class A)..... 14,029,840 16,950,000 2.2
FARMING & CONSTRUCTION 150,000 Caterpillar Inc. ........... 8,178,877 6,900,000 0.9
EQUIPMENT
BANKING & FINANCIALS 200,000 The Chase Manhattan
Corporation............... 9,059,820 13,612,500 1.8
MEDICAL SERVICES 500,000 Columbia/HCA Healthcare
Corporation............... 15,139,601 12,375,000 1.6
FARMING & CONSTRUCTION 150,000 Deere & Company............. 7,580,195 4,968,750 0.7
EQUIPMENT
OIL SERVICES 400,000 Diamond Offshore Drilling,
Inc. ..................... 14,882,163 9,475,000 1.2
CHEMICALS 200,000 du Pont (E.I.) de Nemours
and Company............... 11,815,695 10,612,500 1.4
AUTOMOTIVE 150,000 General Motors
Corporation............... 8,740,972 10,734,375 1.4
OIL SERVICES 300,000 Halliburton Company......... 10,554,260 8,887,500 1.2
CHEMICALS 600,000 Hercules Incorporated....... 25,933,412 16,425,000 2.2
COMPUTER SERVICES 250,000 Hewlett-Packard Company..... 15,834,289 17,078,125 2.3
INFORMATION PROCESSING 40,000 International Business
Machines Corporation...... 2,847,450 7,390,000 1.0
HOUSEHOLD FURNITURE & 150,000 Koninklijke (Royal) Philips
APPLIANCES Electronics N.V. (NY
Registered Shares)........ 10,207,452 10,153,125 1.3
AEROSPACE & DEFENSE 125,000 Northrop Grumman
Corporation............... 9,226,407 9,140,625 1.2
TOBACCO 350,000 Philip Morris Companies
Inc. ..................... 14,456,303 18,725,000 2.5
FARMING & CONSTRUCTION 125,000 Potash Corporation of
EQUIPMENT Saskatchewan Inc. ........ 9,487,956 7,984,375 1.0
OIL & GAS PRODUCERS 800,000 Rowan Companies, Inc. ...... 10,716,622 8,000,000 1.1
RETAIL 200,000 Sears, Roebuck and Co. ..... 9,022,895 8,500,000 1.1
RAILROADS 500,000 Union Pacific Corporation... 27,039,742 22,531,250 3.0
RETAIL 800,000 +Venator Group, Inc. ....... 14,163,748 5,150,000 0.7
------------ ------------ -----
248,917,699 225,593,125 29.8
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
19
<PAGE> 21
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD STOCKS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ABOVE-AVERAGE YIELD
- ----------------------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 200,000 AT&T Corp. ................. $ 9,467,211 $ 15,050,000 2.0%
OIL--DOMESTIC 200,000 Atlantic Richfield
Company................... 14,888,215 13,050,000 1.7
AEROSPACE & DEFENSE 300,000 The Boeing Co. ............. 10,221,340 9,787,500 1.3
UTILITIES 400,000 Cinergy Corp. .............. 13,681,343 13,750,000 1.8
ENGINEERING & CONSTRUCTION 650,000 Foster Wheeler
Corporation............... 10,458,356 8,571,875 1.1
FOODS 275,000 General Mills, Inc. ........ 18,610,079 21,381,250 2.8
COSMETICS & TOILETRIES 350,000 Kimberly-Clark
Corporation............... 16,851,945 19,075,000 2.5
BANKING & FINANCIALS 100,000 Mellon Bank Corporation..... 6,487,250 6,875,000 0.9
BANKING & FINANCIALS 200,000 National City Corporation... 13,659,428 14,500,000 1.9
OIL--INTERNATIONAL 250,000 Royal Dutch Petroleum
Company (NY Registered
Shares)................... 14,021,805 11,968,750 1.6
ELECTRONIC COMPONENTS 256,200 Thomas & Betts
Corporation............... 11,233,150 11,096,663 1.5
OIL--DOMESTIC 500,000 Unocal Corporation.......... 19,034,053 14,593,750 1.9
------------ ------------ -----
158,614,175 159,699,788 21.0
- ----------------------------------------------------------------------------------------------------------------------
SPECIAL SITUATIONS
- ----------------------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 350,000 +3Com Corporation........... 8,850,726 15,684,375 2.1
- ----------------------------------------------------------------------------------------------------------------------
TOTAL STOCKS 676,918,488 650,125,091 85.8
- ----------------------------------------------------------------------------------------------------------------------
FACE AMOUNT SHORT-TERM SECURITIES
- ----------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER* $10,000,000 Concord Minutemen Capital
Co. LLC, 5.58% due
1/05/1999................. 9,992,250 9,992,250 1.3
10,000,000 Delaware Funding Corp.,
5.33% due 1/19/1999....... 9,971,870 9,971,870 1.3
7,764,000 General Electric Capital
Corp., 5% due 1/04/1999... 7,759,687 7,759,687 1.0
21,000,000 Lexington Parker Capital
Company, LLC, 5.45% due
1/05/1999................. 20,984,104 20,984,104 2.8
15,000,000 Riverwoods Funding Corp.,
5.45% due 1/08/1999....... 14,981,833 14,981,833 2.0
10,811,000 Variable Funding Capital
Corp., 5.52% due
1/14/1999................. 10,787,792 10,787,792 1.4
------------ ------------ -----
74,477,536 74,477,536 9.8
- ----------------------------------------------------------------------------------------------------------------------
US GOVERNMENT AGENCY 34,000,000 Federal National Mortgage
OBLIGATIONS* Association, 5.08% due
1/04/1999................. 33,980,809 33,980,809 4.5
- ----------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES 108,458,345 108,458,345 14.3
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS........... $785,376,833 758,583,436 100.1
============
LIABILITIES IN EXCESS OF
OTHER ASSETS.............. (679,203) (0.1)
------------ -----
NET ASSETS.................. $757,904,233 100.0%
============ =====
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
+ Non-income producing security.
* Commercial Paper and certain US Government Agency Obligations are traded on a
discount basis; the interest rates shown reflect the discount rates paid at
the time of purchase by the Fund.
(a) Investments in companies 5% or more of whose outstanding securities are held
by the Fund (such companies are defined as "Affiliated Companies" in Section
2(a)(3) of the Investment Company Act of 1940) are as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
NET SHARE NET DIVIDEND
INDUSTRY AFFILIATE ACTIVITY COST INCOME
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Technology Exabyte Corporation 420,800 $2,261,596 +
Steel WHX Corporation 100,000 1,305,088 +
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
+ Non-income producing security.
Categories of companies shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
20
<PAGE> 22
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost -- $785,376,833)
(Note 1a)................................................. $758,583,436
Cash........................................................ 91
Receivables:
Dividends................................................. $680,854
Securities sold........................................... 148,307
Capital shares sold....................................... 65,244 894,405
--------
Prepaid expenses and other assets........................... 52,183
------------
Total assets................................................ 759,530,115
------------
- -------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Securities purchased...................................... 916,855
Investment adviser (Note 2)............................... 385,147
Capital shares redeemed................................... 156,961
Distributor (Note 2)...................................... 1,542 1,460,505
--------
Accrued expenses and other liabilities...................... 165,377
------------
Total liabilities........................................... 1,625,882
------------
- -------------------------------------------------------------------------------------
NET ASSETS.................................................. $757,904,233
============
- -------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized......................................... $ 5,142,473
Class B Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized......................................... 23,097
Paid-in capital in excess of par............................ 652,318,847
Undistributed investment income--net........................ 9,493,624
Undistributed realized capital gains on investments--net.... 117,719,589
Unrealized depreciation on investments--net................. (26,793,397)
------------
NET ASSETS.................................................. $757,904,233
============
- -------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $754,519,489 and 51,424,728
shares outstanding........................................ $ 14.67
============
Class B--Based on net assets of $3,384,744 and 230,974
shares outstanding........................................ $ 14.65
============
- -------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
21
<PAGE> 23
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1c & 1D):
Dividends (net of $122,880 foreign withholding tax)......... $ 10,538,388
Interest and discount earned................................ 3,902,735
------------
Total income................................................ 14,441,123
------------
- --------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $4,516,100
Accounting services (Note 2)................................ 155,516
Printing and shareholder reports............................ 86,508
Custodian fees.............................................. 70,024
Professional fees........................................... 45,322
Registration fees (Note 1e)................................. 41,582
Directors' fees and expenses................................ 15,120
Transfer agent fees (Note 2)................................ 5,219
Distribution fees--Class B (Note 2)......................... 2,248
Amortization of organization expenses (Note 1e)............. 720
Pricing services............................................ 703
Other....................................................... 8,434
----------
Expenses.................................................... 4,947,496
------------
Investment income--net...................................... 9,493,627
------------
- --------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET (NOTES
1B, 1D & 3):
Realized gain on investments--net........................... 118,772,730
Change in unrealized appreciation/depreciation on
investments--net.......................................... (68,783,241)
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 59,483,116
============
- --------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
22
<PAGE> 24
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
----------------------------
INCREASE (DECREASE) IN NET ASSETS: 1998 1997
- ------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 9,493,627 $ 7,897,496
Realized gain on investments--net........................... 118,772,730 96,532,191
Change in unrealized appreciation/depreciation on
investments--net.......................................... (68,783,241) (914,299)
------------- ------------
Net increase in net assets resulting from operations........ 59,483,116 103,515,388
------------- ------------
- ------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1f):
Investment income--net:
Class A................................................... (7,893,414) (3,224,650)
Class B................................................... (4,057) --
Realized gain on investments--net:
Class A................................................... (96,299,982) (54,136,801)
Class B................................................... (49,914) --
------------- ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (104,247,367) (57,361,451)
------------- ------------
- ------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase in net assets derived from capital share
transactions.............................................. 130,995,545 100,588,838
------------- ------------
- ------------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 86,231,294 146,742,775
Beginning of year........................................... 671,672,939 524,930,164
------------- ------------
End of year*................................................ $ 757,904,233 $671,672,939
============= ============
- ------------------------------------------------------------------------------------------
* Undistributed investment income--net...................... $ 9,493,624 $ 7,897,468
============= ============
- ------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
23
<PAGE> 25
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE
BEEN DERIVED FROM INFORMATION PROVIDED IN THE CLASS A
FINANCIAL STATEMENTS. ------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1998+ 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year................... $ 15.84 $ 14.74 $ 13.10 $ 11.10 $ 10.95
-------- -------- -------- -------- --------
Investment income--net............................... .19 .19 .17 .18 .17
Realized and unrealized gain on investments--net..... 1.10 2.52 2.37 2.49 .08
-------- -------- -------- -------- --------
Total from investment operations..................... 1.29 2.71 2.54 2.67 .25
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net............................. (.19) (.09) (.18) (.19) (.10)
Realized gain on investments--net.................. (2.27) (1.52) (.72) (.48) --
-------- -------- -------- -------- --------
Total dividends and distributions.................... (2.46) (1.61) (.90) (.67) (.10)
-------- -------- -------- -------- --------
Net asset value, end of year......................... $ 14.67 $ 15.84 $ 14.74 $ 13.10 $ 11.10
======== ======== ======== ======== ========
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share................... 9.44% 20.62% 20.69% 25.49% 2.36%
======== ======== ======== ======== ========
- --------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses............................................. .66% .65% .66% .66% .72%
======== ======== ======== ======== ========
Investment income--net............................... 1.26% 1.36% 1.37% 1.68% 2.08%
======== ======== ======== ======== ========
- --------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)............... $754,519 $671,325 $524,930 $306,463 $164,307
======== ======== ======== ======== ========
Portfolio turnover................................... 113.44% 95.52% 68.41% 74.10% 60.55%
======== ======== ======== ======== ========
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding.
See Notes to Financial Statements.
24
<PAGE> 26
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
FINANCIAL HIGHLIGHTS (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS B
--------------------------------------------
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FROM FOR THE YEAR FOR THE PERIOD
INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. ENDED NOVEMBER 3, 1997+ TO
INCREASE (DECREASE) IN NET ASSET VALUE: DECEMBER 31, 1998++ DECEMBER 31, 1997
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period......................... $ 15.84 $15.89
------- ------
Investment income--net....................................... .16 .01
Realized and unrealized gain (loss) on investments--net...... 1.10 (.06)
------- ------
Total from investment operations............................. 1.26 (.05)
------- ------
Less dividends and distributions:
Investment income--net..................................... (.18) --
Realized gain on investments--net.......................... (2.27) --
------- ------
Total dividends and distributions............................ (2.45) --
------- ------
Net asset value, end of period............................... $ 14.65 $15.84
======= ======
- -------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share........................... 9.28% (0.31%)++
======= ======
- -------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses..................................................... .82% .82%*
======= ======
Investment income--net....................................... 1.12% 1.27%*
======= ======
- -------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)..................... $ 3,385 $ 348
======= ======
Portfolio turnover........................................... 113.44% 95.52%
======= ======
- -------------------------------------------------------------------------------------------------------------
</TABLE>
*Annualized.
**Total investment returns exclude insurance-related fees and expenses.
+ Commencement of operations.
++ Aggregate total investment return.
++ Based on average shares outstanding.
See Notes to Financial Statements.
25
<PAGE> 27
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Class A and
Class B Shares have equal voting, dividend, liquidation and other rights, except
that only shares of the respective classes are entitled to vote on matters
concerning only that class and Class B Shares bear certain expenses related to
the distribution of such shares. Basic Value Focus Fund (the "Fund") is
classified as "diversified," as defined in the Investment Company Act of 1940.
The Fund's financial statements are prepared in accordance with generally
accepted accounting principles which may require the use of management accruals
and estimates. The following is a summary of significant accounting policies
followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written are valued at the last sale price in the case of
exchange-traded options. In the case of options traded in the over-the-counter
market, valuation is the last asked price. Short-term securities are valued at
amortized cost, which approximates market value. Securities and assets for which
market quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Board of Directors of
the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity and debt markets. Losses may arise due to
changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Options--The Fund may write covered call options. When the Fund writes an
option, an amount equal to the premium received by the Fund is reflected as an
asset and an equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option written. When
a security is purchased or sold through an exercise of an option, the related
premium received is added to (or deducted from) the basis of the security
acquired or deducted from (or added to) the proceeds of the security sold. When
an option expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums received (or
gain or loss to the extent the cost of the closing transaction exceeds the
premium received).
Written options are non-income producing investments.
(c) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(e) Deferred organization expenses--Deferred organization expenses are charged
to expense on a straight-line basis over a period not exceeding five years.
(f) Dividends and distributions to shareholders--Dividends and distributions
paid by the Fund are recorded on the ex-dividend dates.
26
<PAGE> 28
- --------------------------------------------------------------------------------
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner. The Company has also entered into a Distribution
Agreement and Distribution Plan with Merrill Lynch Funds Distributor ("MLFD" or
"Distributor"), a division of Princeton Funds Distributor, Inc. ("PFD"), which
is a wholly-owned subsidiary of Merrill Lynch Group, Inc.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.60% of the average daily value of the Fund's net assets.
Pursuant to the Distribution Plan adopted by the Company, pursuant to Rule
12b-1 under the Investment Company Act of 1940, the Fund pays the Distributor an
ongoing distribution fee each month at the annual rate of 0.15% of the average
daily value of the Fund's Class B net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1998, Merrill Lynch, Pierce, Fenner & Smith
Incorporated, a subsidiary of ML & Co., earned $54,664 in commissions on the
execution of portfolio security transactions.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1998 were $771,745,216 and $764,348,340, respectively.
Net realized gains (losses) for the year ended December 31, 1998 and net
unrealized losses as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------
Realized Unrealized
Gains(Losses) Losses
- -------------------------------------------------------------------
<S> <C> <C>
Long-term investments................ $118,773,312 $(26,793,397)
Short-term investments............... (582) --
------------ ------------
Total................................ $118,772,730 $(26,793,397)
============ ============
- -------------------------------------------------------------------
</TABLE>
At December 31, 1998, net unrealized depreciation for Federal income tax
purposes aggregated $28,391,695, of which $60,479,565 related to appreciated
securities and $88,871,260 related to depreciated securities. At December 31,
1998, the aggregate cost of investments for Federal income tax purposes was
$786,975,131.
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions was
$130,995,545 and $100,588,838 for the years ended December 31, 1998 and December
31, 1997, respectively.
Transactions in capital shares for each class were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Dollar
Ended December 31, 1998 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 7,186,093 $105,551,625
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 7,700,916 104,193,396
---------- ------------
Total issued......................... 14,887,009 209,745,021
Shares redeemed...................... (5,839,387) (81,723,213)
---------- ------------
Net increase......................... 9,047,622 $128,021,808
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Dollar
Ended December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 9,505,073 $141,108,871
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 4,361,868 57,361,452
---------- ------------
Total issued......................... 13,866,941 198,470,323
Shares redeemed...................... (7,112,265) (98,226,048)
---------- ------------
Net increase......................... 6,754,676 $100,244,275
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
Class B Shares for the Year Dollar
Ended December 31, 1998 Shares Amount
- ------------------------------------------------------------------
<S> <C> <C>
Shares sold............................ 215,927 $3,077,684
Shares issued to shareholders in
reinvestment of dividends and
distributions......................... 3,989 53,970
------- ----------
Total issued........................... 219,916 3,131,654
Shares redeemed........................ (10,907) (157,917)
------- ----------
Net increase........................... 209,009 $2,973,737
======= ==========
- ------------------------------------------------------------------
</TABLE>
27
<PAGE> 29
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- -------------------------------------------------------------------
Class B Shares for the Period Dollar
November 3, 1997+ to December 31, 1997 Shares Amount
- -------------------------------------------------------------------
<S> <C> <C>
Shares sold........................... 24,431 $ 383,980
Shares redeemed....................... (2,466) (39,417)
---------- ------------
Net increase.......................... 21,965 $ 344,563
========== ============
- -------------------------------------------------------------------
</TABLE>
+ Commencement of operations.
5. SUBSEQUENT EVENT:
On January 4, 1999, the Company's Board of Directors declared an ordinary
dividend in the amount of $1.121357 per Class A Share and $1.111624 per Class B
Share and a long-term capital gains distribution in the amount of $1.372343 per
share for each of the two classes payable on January 11, 1999 to shareholders of
record as of December 31, 1998.
28
<PAGE> 30
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
BASIC VALUE FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Basic Value Focus Fund of Merrill Lynch Variable
Series Funds, Inc. as of December 31, 1998, the related statements of operations
for the year then ended and changes in net assets for each of the years in the
two-year period then ended, and the financial highlights for each of the years
in the five-year period then ended. These financial statements and the financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and the financial
highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1998 by correspondence with the custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Basic Value Focus
Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1998, the
results of its operations, the changes in its net assets, and the financial
highlights for the respective stated periods in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
29
<PAGE> 31
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CAPITAL FOCUS FUND
ANNUAL REPORT--DECEMBER 31, 1998
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
During the six-month period ended December 31, 1998, a series of dynamic
global business, economic and political developments precipitated significant
volatility in US financial asset prices. Beginning in late summer, the
combination of slowing economic growth, weak corporate profits performance and
renewed political turmoil drove stock prices lower.
While the consumer sector of the economy remained robust, the industrial
sector deteriorated as the Asian economic crisis began to impair US economic
activity. The implosion in the Russian economy and financial markets exacerbated
ongoing deterioration in emerging markets in Asia and Latin America in August,
further restraining expectations for growth in US corporate profits. With equity
prices and valuations still at or near record highs, the US equity market
offered precious little room for such disappointments. There was a significant
decline in stock prices, with the unmanaged Standard & Poor's 500 (S&P 500)
Index declining 14.6% in August and almost 20% from its July peak. This
significant decline in the broad market indexes masked even more serious
declines within various segments of the market as the average New York Stock
Exchange listed stock declined over 30%.
A modest recovery ensued in early fall based on expectations for a more
accommodative monetary policy, as investors correctly anticipated Federal
Reserve Board action to lower interest rates in order to alleviate these growing
economic pressures. With the risk of deflation superceding that of inflation in
many investors' minds, the lower interest rate structure was expected to
facilitate more growth-oriented policies and precipitate a more stable economic
environment.
By late fall, the Federal Reserve Board had lowered interest rates for the
third time and this lower interest rate structure, combined with accelerating
money supply growth, provided tremendous fuel with which to drive financial
asset prices higher. Furthermore, an upward revision to third-quarter gross
domestic product growth to 3.9%, and continued high levels of auto, housing and
retail sales, suggested recessionary fears were misplaced and a hospitable
economic environment could be sustained. Finally, most observers continued to
expect modest growth in US corporate profits in 1999.
At year-end, accelerating financial market liquidity, continued robust real
consumer spending and some evidence of improvement in economic conditions in
selected developing countries such as South Korea, completed the recovery,
propelling the broad market indexes to new highs near period-end. For the six
months ended December 31, 1998, the US stock market, as measured by the
unmanaged S&P 500 Index, had a +9.2% total return. The US bond market was a
significant beneficiary of these developments as investors' appetite for safety
and security in this volatile environment, coupled with expectations for
moderating economic growth and continued benign inflation, produced a strong
advance in US Treasury security prices and sent long-term Government bond yields
to near record low levels. The benchmark unmanaged Merrill Lynch Domestic Bond
Master Index generated a +4.65% total return while cash equivalents earned a
+2.56% total return for the six months ended December 31, 1998.
While we are encouraged by this more proactive posture on the part of the
monetary authorities and expect lower interest rates and rapid money supply
growth to provide strong support, we believe that the ramifications of the
volatility in the emerging markets economies have yet to be fully incorporated
into corporate earnings expectations and, in turn, stock prices. Consequently,
we remain concerned about the equity market's ability to continue to advance
from current levels. The stock market's recovery from the early October lows
has driven price/earnings and price/book value multiples back to record levels.
Meanwhile, after-tax corporate profits fell 1.8% during the third quarter and
at a 5.4% pace over the past year. Record-high valuations, combined with
deteriorating corporate profits, does not represent a formula for significant
stock price appreciation, in our opinion. Also, bonds continue to represent
good value, with inflation-adjusted interest rates at historically
above-average levels and inflation pressures expected to remain benign.
Consequently, we continue to maintain a significant bond weighting in the Fund,
with our investment position at period-end showing 61.6% of net assets invested
in equities, 31.8% in fixed- income securities and 6.6% in cash and cash
equivalents.
FISCAL YEAR IN REVIEW
The remarkable recovery of the US equity market masks a significant disparity
of performance within the market. While total return for the unmanaged S&P 500
Index advanced by 28.58% for the year ended December 31, 1998, this gain was
heavily concentrated in the 30 largest companies in the Index, which rose an
average of 39% for the year and accounted for 46% of
30
<PAGE> 32
- --------------------------------------------------------------------------------
the Index's gain. Equally weighting the 500 stocks in the Index produced a far
more modest 13% return for 1998. This concentration of performance in the
ultra-large capitalization companies is further evident by the more restrained
+17.68% total returns of the unmanaged S&P Mid-Cap Index and the 2.55% decline
in 1998 by the unmanaged Russell 2000 Index of smaller companies. Indeed, almost
twice as many New York Stock Exchange listed stocks declined in price for the
12-month period than advanced in price, and the average stock remained 26% below
its 52-week high. Since the Fund maintains only a nominal representation among
the large consumer, pharmaceutical and technology companies that account for the
bulk of the top 30 stocks because of the extremely high valuations they command,
this detracted from our relative equity returns for the 12-month period.
Furthermore, our value style of investing underperformed the growth style of
investing for the year, further constraining our performance. The unmanaged
Russell 1000 Value Index rose 27.02% for 1998 compared to the Russell 1000
Growth Index, which provided a gain of 38.71% for the year. We continue to
believe our stock selection methodologies are sound and have the potential to
provide superior risk-adjusted equity returns over time.
Within the equity component of the Fund, we continued to diversify our
holdings to better control risk, adding 12 new investments and eliminating 10
stocks from the Fund. We established a position in Monsanto Company, the
pharmaceutical/agricultural chemical company, where a significant decline in the
share price created an attractive buying opportunity. We believe Monsanto offers
an attractive risk/reward profile and represents an attractive addition to the
Fund.
During the last six months, we sold our position in Wal-Mart Stores, Inc., the
nation's largest retailer. The company was a big winner over the past few years,
appreciating over 70% in 1997 and a further 80% in 1998. Now selling at over 33
times the fiscal year 2000 earnings per share estimate, the stock's premium
valuation has been restored. We bought Wal-Mart when business was weak, earnings
growth was negative, and valuations were at relatively low levels. With business
now strong, earnings growth accelerating and the valuation approaching all-time
highs, we believe the stock is fairly valued, so we decided to sell and look to
redeploy proceeds into more attractive investment opportunities.
IN CONCLUSION
Capital Focus Fund seeks to invest in above-average companies whose stocks
sell at below-average valuation levels. On average, the stocks in the Fund have
generated comparable returns on shareholders' equity and have stronger balance
sheets while offering faster earnings growth than the average company as
measured by the S&P 500. However, these same stocks sell at an average
price/earnings ratio of 18.5 times estimated 1999 earnings per share compared to
27.9 times for the S&P 500, at 3.6 times book value per share compared to 6.5
times for the S&P 500, and provide an above-average dividend yield. We believe
this formula will produce superior risk-adjusted equity returns over time.
We appreciate your investment in Capital Focus Fund of Merrill Lynch Variable
Series Funds, Inc., and we look forward to sharing our investment outlook and
strategies with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Kurt Schansinger
Kurt Schansinger
Senior Vice President and Portfolio Manager
February 5, 1999
31
<PAGE> 33
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CAPITAL FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
Capital Focus Fund
Total Return Based on a $10,000 Investment-Class A Shares
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Standard & Poor's 500 Index and the
Merrill Lynch Domestic Fixed-Income Master Index. Beginning and ending values
are:
<TABLE>
<CAPTION>
6/05/98** 12/98
--------- -----
<S> <C> <C>
Capital Focus Fund+ --
Class A Shares* $10,000 $ 9,760
Standard & Poor's 500 Index++ $10,000 $11,128
Merrill Lynch Domestic
Fixed-Income Master Index+++ $10,000 $10,556
</TABLE>
<TABLE>
<C> <S>
* Assuming transaction costs and other operating expenses,
including advisory fees. Does not include insurance-related
fees and expenses.
** Commencement of operations.
+ The Fund utilizes a fully managed investment policy through
investments in equity, debt (including money market) and
convertible securities.
++ This unmanaged broad-based Index is comprised of common
stocks.
+++ This unmanaged Index is comprised of the entire universe of
domestic investment-grade bonds, including US Treasury
bonds, corporate bonds and mortgages.
Past performance is not predictive of future results.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CAPITAL FOCUS FUND
AGGREGATE TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Inception (6/05/98) through 12/31/98 -2.40%
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CAPITAL FOCUS FUND
RECENT PERFORMANCE RESULTS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SINCE INCEPTION
TOTAL RETURN
- -------------------------------------------------------------------------------
<S> <C>
Class A Shares -2.40%
</TABLE>
- --------------------------------------------------------------------------------
* Total investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the ex-dividend date. Insurance-related
fees and expenses are not reflected in these returns. The Fund commenced
operations on 6/05/98. Past results shown should not be considered a
representation of future performance.
32
<PAGE> 34
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CAPITAL FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE VALUE PERCENT OF
INDUSTRY AMOUNT BONDS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
CHEMICALS $500,000 Airgas, Inc., 7.14% due
3/08/2004...................... $ 500,935 $ 528,250 2.0%
500,000 Monsanto Company, 5.75% due
12/01/2005(a).................. 498,675 498,854 1.8
----------- ----------- -----
999,610 1,027,104 3.8
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN GOVERNMENT 400,000 Republic of Argentina, 8.75% due
OBLIGATIONS 7/10/2002(a)................... 352,000 327,000 1.2
250,000 Republic of Colombia, 7.625% due
2/15/2007...................... 226,094 208,750 0.8
500,000 United Mexican States, 8.625% due
3/12/2008...................... 441,750 465,000 1.7
----------- ----------- -----
1,019,844 1,000,750 3.7
- -----------------------------------------------------------------------------------------------------------------------
INDUSTRIALS 500,000 Triton Energy Ltd., 8.75% due
4/15/2002...................... 454,770 445,000 1.6
- -----------------------------------------------------------------------------------------------------------------------
INFORMATION SYSTEMS 250,000 Reynolds & Reynolds Company,
6.12% due 3/02/2001............ 250,000 248,303 0.9
- -----------------------------------------------------------------------------------------------------------------------
MEDIA/PUBLISHING 500,000 News America Inc., 6.75% due
1/09/2038...................... 513,250 511,705 1.9
- -----------------------------------------------------------------------------------------------------------------------
NATURAL GAS SUPPLIERS 500,000 The Coastal Corporation, 6.50%
due 6/02/2008.................. 498,340 512,525 1.9
- -----------------------------------------------------------------------------------------------------------------------
OIL FIELD EQUIPMENT 250,000 R & B Falcon Corporation, 6.75%
due 4/15/2005.................. 245,688 237,645 0.9
- -----------------------------------------------------------------------------------------------------------------------
OIL--INTEGRATED 300,000 Occidental Petroleum Corp., 6.50%
due 4/01/2005.................. 299,007 293,733 1.1
- -----------------------------------------------------------------------------------------------------------------------
TRANSPORTATION--AIR 250,000 Northwest Airlines, Inc., 7.875%
due 3/15/2008.................. 223,685 233,355 0.9
- -----------------------------------------------------------------------------------------------------------------------
TRAVEL & LODGING 500,000 Royal Caribbean Cruises Ltd.,
7.25% due 8/15/2006............ 522,790 508,190 1.9
- -----------------------------------------------------------------------------------------------------------------------
US TREASURY NOTES & BONDS US Treasury Notes & Bonds:
750,000 5.875% due 7/31/1999............. 752,324 755,040 2.8
500,000 5.875% due 11/15/2005............ 535,859 533,360 2.0
250,000 5.625% due 2/15/2006............. 251,113 263,673 1.0
500,000 3.625% due 1/15/2008............. 497,942 497,538 1.8
500,000 6% due 2/15/2026................. 508,594 545,390 2.0
----------- ----------- -----
2,545,832 2,595,001 9.6
- -----------------------------------------------------------------------------------------------------------------------
UTILITIES--COMMUNICATION 500,000 WorldCom Inc., 6.40% due
8/15/2005...................... 501,645 519,660 1.9
- -----------------------------------------------------------------------------------------------------------------------
YANKEE CORPORATES*** 500,000 Enersis S.A., 6.60% due
12/01/2026(1).................. 479,003 466,595 1.7
- -----------------------------------------------------------------------------------------------------------------------
TOTAL BONDS 8,553,464 8,599,566 31.8
- -----------------------------------------------------------------------------------------------------------------------
SHARES
HELD COMMON STOCKS
- -----------------------------------------------------------------------------------------------------------------------
AEROSPACE 3,600 Lockheed Martin Corporation...... 366,890 305,100 1.1
- -----------------------------------------------------------------------------------------------------------------------
APPAREL 11,600 +Fruit of the Loom, Inc. (Class
A)............................. 327,856 160,225 0.6
- -----------------------------------------------------------------------------------------------------------------------
AUTOMOBILE PARTS 6,700 Federal-Mogul Corporation........ 397,248 398,650 1.5
- -----------------------------------------------------------------------------------------------------------------------
AUTOMOTIVE 10,000 LucasVarity PLC (ADR)*........... 352,632 335,000 1.2
- -----------------------------------------------------------------------------------------------------------------------
BANKING 6,900 The Chase Manhattan Corporation.. 322,434 469,631 1.7
- -----------------------------------------------------------------------------------------------------------------------
BUILDING MATERIALS 14,500 Masco Corporation................ 402,288 416,875 1.5
- -----------------------------------------------------------------------------------------------------------------------
CHEMICALS 5,800 duPont (E.I.) de Nemours and
Company........................ 393,086 307,762 1.2
7,600 Monsanto Company................. 328,197 361,000 1.3
----------- ----------- -----
721,283 668,762 2.5
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
33
<PAGE> 35
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CAPITAL FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD COMMON STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
DIVERSIFIED COMPANIES 11,000 Corning Incorporated............. $ 382,961 $ 495,000 1.8%
13,500 GenCorp Inc. .................... 334,496 336,656 1.3
6,300 Rockwell International
Corporation.................... 294,792 305,944 1.1
4,600 United Technologies
Corporation.................... 415,839 500,250 1.9
----------- ----------- -----
1,428,088 1,637,850 6.1
- -----------------------------------------------------------------------------------------------------------------------
DRUG STORES 11,000 Rite Aid Corporation............. 429,401 545,188 2.0
- -----------------------------------------------------------------------------------------------------------------------
ELECTRICAL EQUIPMENT 4,200 General Electric Company......... 364,547 428,662 1.6
2,500 Koninklijke (Royal)
Philips Electronics N.V.
(NY Registered Shares)......... 173,588 169,219 0.6
----------- ----------- -----
538,135 597,881 2.2
- -----------------------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES 5,600 Federal National Mortgage
Association.................... 358,107 414,400 1.5
2,900 Transamerica Corporation......... 333,093 334,950 1.3
----------- ----------- -----
691,200 749,350 2.8
- -----------------------------------------------------------------------------------------------------------------------
FOOD & BEVERAGE 8,800 Diageo PLC (ADR)*................ 400,890 407,000 1.5
- -----------------------------------------------------------------------------------------------------------------------
FOOTWEAR 7,900 Nike, Inc. (Class B)............. 340,101 320,444 1.2
- -----------------------------------------------------------------------------------------------------------------------
HOSPITAL MANAGEMENT 12,500 +Tenet Healthcare Corporation.... 359,611 328,125 1.2
- -----------------------------------------------------------------------------------------------------------------------
HOTELS & CASINOS 8,900 +Sun International Hotels
Ltd. .......................... 378,995 404,394 1.5
- -----------------------------------------------------------------------------------------------------------------------
INSURANCE 8,800 The Allstate Corporation......... 396,623 339,900 1.3
4,000 American International Group,
Inc............................ 359,624 386,500 1.4
9,400 Citigroup Inc.................... 496,984 465,300 1.7
5,600 Excel Limited (Class A).......... 417,972 420,000 1.6
13,500 Fremont General Corporation...... 330,006 334,125 1.2
12,200 Horace Mann Educators
Corporation.................... 356,414 347,700 1.3
9,500 ITT Industries, Inc.............. 352,353 377,625 1.4
10,400 Provident Companies, Inc......... 362,518 431,600 1.6
----------- ----------- -----
3,072,494 3,102,750 11.5
- -----------------------------------------------------------------------------------------------------------------------
LEISURE/HOTELS 10,000 Carnival Corporation (Class A)... 345,984 480,000 1.8
19,000 +Harrah's Entertainment, Inc. ... 370,484 298,062 1.1
----------- ----------- -----
716,468 778,062 2.9
- -----------------------------------------------------------------------------------------------------------------------
NATURAL GAS SUPPLIERS 11,000 The Coastal Corporation.......... 375,425 384,313 1.4
10,200 El Paso Energy Corporation....... 351,430 355,087 1.3
11,100 The Williams Companies, Inc. .... 336,714 346,181 1.3
----------- ----------- -----
1,063,569 1,085,581 4.0
- -----------------------------------------------------------------------------------------------------------------------
OIL--INTEGRATED 10,500 Unocal Corporation............... 372,374 306,469 1.1
10,200 YPF Sociedad Anonima (ADR)*...... 297,860 284,963 1.1
----------- ----------- -----
670,234 591,432 2.2
- -----------------------------------------------------------------------------------------------------------------------
PAPER & FOREST PRODUCERS 7,800 Kimberly-Clark Corporation....... 367,515 425,100 1.6
- -----------------------------------------------------------------------------------------------------------------------
RAILROADS 11,600 Kansas City Southern Industries,
Inc............................ 477,584 570,575 2.1
7,900 Union Pacific Corporation........ 345,804 355,994 1.3
----------- ----------- -----
823,388 926,569 3.4
- -----------------------------------------------------------------------------------------------------------------------
RESTAURANTS 5,000 McDonald's Corporation........... 333,637 383,125 1.4
- -----------------------------------------------------------------------------------------------------------------------
SEMICONDUCTORS 6,900 Motorola, Inc.................... 353,656 421,331 1.6
- -----------------------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 11,700 Frontier Corporation............. 326,337 397,800 1.5
- -----------------------------------------------------------------------------------------------------------------------
WASTE MANAGEMENT 8,300 Waste Management, Inc............ 410,031 386,987 1.4
- -----------------------------------------------------------------------------------------------------------------------
WIRELESS COMMUNICATIONS-- 17,600 +Nextel Communications, Inc...... 331,931 415,800 1.5
DOMESTIC PAGING & CELLULAR
- -----------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS 15,926,312 16,659,012 61.6
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
34
<PAGE> 36
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CAPITAL FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE VALUE PERCENT OF
AMOUNT SHORT-TERM SECURITIES COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
COMMERCIAL PAPER** $752,000.. The CIT Group Holdings, Inc.,
5.10% due 1/04/1999............ $ 751,574 $ 751,574 2.8%
- -----------------------------------------------------------------------------------------------------------------------
US GOVERNMENT AGENCY 800,000.. Federal National Mortgage
OBLIGATIONS** Association, 4.70% due
1/08/1999...................... 799,164 799,164 2.9
- -----------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES 1,550,738 1,550,738 5.7
- -----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS................ $26,030,514 26,809,316 99.1
===========
OTHER ASSETS LESS LIABILITIES.... 255,413 0.9
----------- -----
NET ASSETS....................... $27,064,729 100.0%
=========== =====
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
* American Depositary Receipts (ADR).
** Commercial Paper and certain US Government Agency Obligations are traded on a
discount basis; the interest rates shown reflect the discount rates paid at
the time of purchase by the Fund.
*** Corresponding industry groups for foreign securities, which are denominated
in US dollars:
(1) Industrial.
+ Non-income producing security.
(a) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
See Notes to Financial Statements.
35
<PAGE> 37
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CAPITAL FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$26,030,514) (Note
1a)....................................................... $26,809,316
Cash........................................................ 19
Receivables:
Interest.................................................. $178,587
Capital shares sold....................................... 90,591
Dividends................................................. 12,690 281,868
--------
Deferred organization expenses (Note 1f).................... 7,067
Prepaid expenses and other assets........................... 1,477
-----------
Total assets................................................ 27,099,747
-----------
- ------------------------------------------------------------------------------------
LIABILITIES:
Payable to investment adviser (Note 2)...................... 13,055
Accrued expenses and other liabilities...................... 21,963
-----------
Total liabilities........................................... 35,018
-----------
- ------------------------------------------------------------------------------------
NET ASSETS.................................................. $27,064,729
===========
- ------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 277,162
Paid-in capital in excess of par............................ 26,185,094
Undistributed investment income--net........................ 259,215
Accumulated realized capital losses on investments--net
(Note 5).................................................. (435,558)
Unrealized appreciation on investments--net................. 778,816
-----------
NET ASSETS.................................................. $27,064,729
===========
- ------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $27,064,729 and 2,771,624
shares outstanding........................................ $ 9.76
===========
- ------------------------------------------------------------------------------------
</TABLE>
+ The Fund is also authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
36
<PAGE> 38
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CAPITAL FOCUS FUND
STATEMENT OF OPERATIONS FOR THE PERIOD JUNE 5, 1998+ TO DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Interest and discount earned................................ $ 268,520
Dividends (net of $104 foreign withholding tax)............. 78,419
---------
Total income................................................ 346,939
---------
- ---------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $61,312
Custodian fees.............................................. 8,362
Registration fees (Note 1f)................................. 4,624
Accounting services (Note 2)................................ 4,528
Transfer agent fees (Note 2)................................ 3,042
Pricing services............................................ 2,750
Printing and shareholders reports........................... 954
Amortization of organization expenses (Note 1f)............. 933
Directors' fees and expenses................................ 114
Professional fees........................................... 74
Other....................................................... 1,031
-------
Total expenses.............................................. 87,724
---------
Investment income--net...................................... 259,215
---------
- ---------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET (NOTES
1b, 1c, 1e & 3):
Realized loss on investments--net........................... (435,558)
Unrealized appreciation on:
Investments--net.......................................... 778,802
Foreign currency transactions--net........................ 14 778,816
------- ---------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 602,473
=========
- ---------------------------------------------------------------------------------
</TABLE>
+ Commencement of operations.
See Notes to Financial Statements.
37
<PAGE> 39
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CAPITAL FOCUS FUND
STATEMENT OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE PERIOD
JUNE 5, 1998+
INCREASE IN NET ASSETS: TO DEC. 31, 1998
- --------------------------------------------------------------------------------
<S> <C>
OPERATIONS:
Investment income--net...................................... $ 259,215
Realized loss on investments--net........................... (435,558)
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 778,816
-----------
Net Increase in net assets resulting from operations........ 602,473
-----------
- --------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase in net assets derived from capital share
transactions.............................................. 17,462,256
-----------
- --------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 18,064,729
Beginning of period......................................... 9,000,000
-----------
End of period*.............................................. $27,064,729
===========
- --------------------------------------------------------------------------------
* Undistributed investment income--net...................... $ 259,215
===========
- --------------------------------------------------------------------------------
</TABLE>
+ Commencement of operations.
See Notes to Financial Statements.
38
<PAGE> 40
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CAPITAL FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE ----------------
BEEN DERIVED FROM INFORMATION PROVIDED IN THE FOR THE PERIOD
FINANCIAL STATEMENTS. JUNE 5, 1998+
INCREASE (DECREASE) IN NET ASSET VALUE: TO DEC. 31, 1998
- ------------------------------------------------------------------------------
<S> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period........................ $ 10.00
-------
Investment income--net...................................... .09
Realized and unrealized loss on investments and foreign
currency transactions--net................................ (.33)
-------
Total from investment operations............................ (.24)
-------
Net asset value, end of period.............................. $ 9.76
=======
- ------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.......................... (2.40%)++
=======
- ------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses.................................................... .86%*
=======
Investment income--net...................................... 2.54%*
=======
- ------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).................... $27,065
=======
Portfolio turnover.......................................... 29.48%
=======
- ------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of operations.
++ Aggregate total investment return.
See Notes to Financial Statements.
39
<PAGE> 41
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CAPITAL FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company
("MLLIC"), ML Life Insurance Company of New York (indirect wholly-owned
subsidiaries of Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance
companies that are not affiliated with ML & Co., for their separate accounts to
fund benefits under certain variable annuity and variable life insurance
contracts. Prior to commencement of operations on June 5, 1998, the Fund had no
operations other than those relating to organizational matters and the issuance
of 900,000 Class A shares of the Fund to MLLIC for $9,000,000. Class A and Class
B Shares have equal voting, dividend, liquidation and other rights, except that
only shares of the respective classes are entitled to vote on matters concerning
only that class and Class B Shares bear certain expenses related to the
distribution of such shares. Capital Focus Fund (the "Fund") is classified as
"diversified," as defined in the Investment Company Act of 1940. The Fund's
financial statements are prepared in accordance with generally accepted
accounting principles which may require the use of management accruals and
estimates. The following is a summary of significant accounting policies
followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written are valued at the last sale price in the case of
exchange-traded options. In the case of options traded in the over-the-counter
market, valuation is the last asked price. Short-term securities are valued at
amortized cost, which approximates market value. Futures contracts are valued at
the settlement price at the close of the applicable exchange. Securities and
assets for which market quotations are not readily available are valued at fair
value as determined in good faith by or under the direction of the Board of
Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity, debt and currency markets. Losses may arise due
to changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Options--The Fund may write covered call options. When the Fund writes an
option, an amount equal to the premium received by the Fund is reflected as an
asset and an equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option written. When
a security is purchased or sold through an exercise of an option, the related
premiums paid or received is added to (or deducted from) the basis of the
security acquired or deducted from (or added to) the proceeds of the security
sold. When an option expires (or the Fund enters into a closing transaction),
the Fund realizes a gain or loss on the option to the extent of the premiums
received (or gain or loss to the extent the cost of the closing transaction
exceeds the premium received).
Written options are non-income producing investments.
- - Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts.
(c) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets or liabilities expressed in
foreign currencies into US dollars. Realized and unrealized gains or losses from
investments include the effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal
40
<PAGE> 42
- --------------------------------------------------------------------------------
Revenue Code applicable to regulated investment companies and to distribute
substantially all of its taxable income to its shareholders. Therefore, no
Federal income tax provision is required. Under the applicable foreign tax law,
a withholding tax may be imposed on interest, dividends and capital gains at
various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently recorded
when the Fund has determined the ex-dividend date. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Deferred organization expenses and prepaid registration fees--Deferred
organization expenses are charged to expense on a straight-line basis over a
period not exceeding five years. Prepaid registration fees are charged to
expense as the related shares are issued.
(g) Dividends and distributions to shareholders--Dividends and distributions
paid by the Fund are recorded on the ex-dividend dates.
2. INVESTMENT ADVISORY AGREEMENT AND
TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.60% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the period June 5, 1998 to December 31, 1998, Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of ML & Co., earned $366 in
commissions on the execution of portfolio security transactions.
During the period June 5, 1998 to December 31, 1998, Merrill Lynch Security
Pricing Service, an affiliate of MLPF&S, earned $57 for providing security price
quotations to compute the Fund's net asset value.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Merrill Lynch Funds Distributor, a division of Princeton Funds Distributor,
Inc. ("PFD"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
is the Fund's distributor.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
period June 5, 1998 to December 31, 1998 were $29,603,786 and $4,688,416,
respectively.
Net realized gains (losses) for the period June 5, 1998 to December 31, 1998
and net unrealized gains as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains
- --------------------------------------------------------------------
<S> <C> <C>
Long-term investments................. $(435,594) $778,802
Short-term investments................ 36 --
Foreign currency transactions......... -- 14
--------- --------
Total................................. $(435,558) $778,816
========= ========
- --------------------------------------------------------------------
</TABLE>
At December 31, 1998, net unrealized appreciation for Federal income tax
purposes aggregated $771,629, of which $1,530,037 related to appreciated
securities and $758,408 related to depreciated securities. At December 31, 1998,
the aggregate cost of investments for Federal income tax purposes was
$26,037,687.
41
<PAGE> 43
- --------------------------------------------------------------------------------
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions was
$17,462,256 for the period June 5, 1998 to December 31, 1998.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Period Dollar
June 5, 1998+ to December 31, 1998 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold............................ 1,915,432 $17,861,244
Shares redeemed........................ (43,808) (398,988)
--------- -----------
Net increase........................... 1,871,624 $17,462,256
========= ===========
- -----------------------------------------------------------------
</TABLE>
+ Prior to June 5, 1998 (commencement of operations), the Fund issued 900,000
shares to MLLIC for $9,000,000.
5. CAPITAL LOSS CARRYFORWARD:
At December 31, 1998, the Fund had a net capital loss carryforward of
approximately $368,000, all of which expires in 2006. This amount will be
available to offset like amounts of any future taxable gains.
6. SUBSEQUENT EVENT:
On January 4, 1999, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.093525 per Class A Share payable on January 11, 1999
to shareholders of record as of December 31, 1998.
42
<PAGE> 44
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CAPITAL FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
CAPITAL FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Capital Focus Fund of Merrill Lynch Variable
Series Funds, Inc. as of December 31, 1998, the related statements of
operations, changes in net assets and the financial highlights for the period
June 5, 1998 (commencement of operations) to December 31, 1998. These financial
statements and the financial highlights are the responsibility of the Fund's
management. Our responsibility is to express an opinion on these financial
statements and the financial highlights based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements and the financial highlights
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. Our
procedures included confirmation of securities owned at December 31, 1998 by
correspondence with the custodian. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Capital Focus Fund
of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1998, the
results of its operations, the changes in its net assets, and the financial
highlights for the period June 5, 1998 (commencement of operations) to December
31, 1998 in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
43
<PAGE> 45
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
DECEMBER 31, 1998--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
FISCAL YEAR IN REVIEW
During the 12-month period ended December 31, 1998, total returns for Merrill
Lynch Developing Capital Markets Focus Fund Class A and Class B Shares were
- -29.39% and -29.51%, respectively. The total return for the unmanaged Morgan
Stanley Capital International Emerging Markets Free (MSCI EMF) Index declined
25.34% during the same period. Detrimental to performance were the Fund's
overweighted position in Turkey, down 52.51%, and slightly underweighted
position in South Korea, up 141.51%. Also hurting performance was the Fund's
stock selection in Brazil. Beneficial to performance were the Fund's
overweighted position in Greece (+78.11%) for most of the period, and
underweighted position in South Africa (-27.56%). The Fund's performance was
also enhanced by selling almost all our holdings in Russia (-82.99%) before the
devaluation occurred. (References to securities markets of all countries in this
letter to shareholders correspond to those countries' market weightings in the
MSCI EMF Index.)
PORTFOLIO MATTERS
During the six months ended December 31, 1998, global equity markets were
buffeted by a number of developments pointing to a rapid deterioration of the
world's economic performance. Key developments that led to this were the
currency devaluation and unstable politics in Russia, the anticipation of
deflationary pressures on US corporate earnings, and the absence of recovery in
Japanese and other Asian economies. Although the emerging markets stock markets
rallied sharply during the last three months of 1998, most of them recorded
steep declines for the overall six-month period, with notable exceptions in
Asia: Indonesia, South Korea and Thailand. However, these three countries led
the Asian markets' crisis in 1997, and hence rebounded off low levels during
1998. The total returns for the MSCI EMF Index declined 7.98% for the six-month
period ended December 31, 1998, compared to an increase of 6.60% for the MSCI
World Index, a proxy for the US and international stock markets combined, and a
gain of 10.5% for the MSCI USA Index.
In Latin America, all of the equity markets, with the exception of Argentina,
Chile and Venezuela, experienced double-digit declines for the six-month period
ended December 31, 1998. Among these markets, Brazil remained the focus of
investor attention. As the largest economy and capital market in the region,
Brazil receives the brunt of investor anxiety or enthusiasm. The Brazilian
market declined by 28.17% for the six months ended December 31, 1998. Positive
developments, such as the re-election of President Cardoso in October, the
launching of an International Monetary Fund (IMF) rescue package for Brazil for
$42 billion in November, and a series of global interest rate cuts, were not
enough to remove the concerns investors have about Brazil's fiscal and funding
problems and its overvalued currency. The Brazilian market appreciated by 27.6%
from August through November. However, the exuberance that investors
demonstrated in the Brazilian market during that period was quickly undone in
December when a significant piece of legislation regarding social security
reform stalled in the congress. While such things as the IMF package indicate a
short-term solution to Brazil's woes, the fact remains that the country is very
highly leveraged and is still in need of deep fiscal reform. For this reason,
even minor setbacks take on large proportions.
In this environment, we are finding a number of stocks with compelling
valuations. One of our favorite Brazilian stocks is Tele Norte Leste
Participacoes S.A., one of the three wire line companies spun off from the
Telebras break-up last year. Not only is it the largest fixed-line company in
Latin America, it is also the least expensive by a wide margin on a per line
basis. Investors are concerned because the company is not controlled by a
foreign telecommunications company and their concession area, the north and
northeast of Brazil, is very poor. Our analysis suggests that the operating
characteristics are not that different from those of other wire line companies
in terms of revenues per line and cash flow per line. The region is poor, but it
is very underpenetrated. Gross domestic product (GDP) per capita, when taking
the entire concession area, is half of the Sao Paolo concession area. We believe
that there is potential for growth, and the company has a very strong balance
sheet. Once cash is netted out, the company has no debt. Furthermore, the
company has American Depositary Receipts that are very liquid and trade on the
New York Stock Exchange.
In Asia, there was a great divergence in performance among the stock markets,
as Indonesia, South Korea and Thailand were up sharply, while others, such as
China, India and Malaysia, were notably down. Disconcerting to investors was the
appearance of market con-
44
<PAGE> 46
- --------------------------------------------------------------------------------
trols in one form or another in many of these countries.
The best-performing market, not only in the Asian region but throughout
emerging markets, was South Korea, whose declining interest rates, stabilizing
currency, growing current account surplus and ample liquidity boosted stock
prices by 128.36% for the six-month period. The month of December was especially
strong as South Korea, on record trading volume, rose 37.06%.
One of the Fund's largest holdings at the end of December was Samsung
Electronics Co., Ltd., the leading dynamic random access memory company in the
world, accounting for 18% of the world's production. Consolidation in this
industry has been ongoing since the middle of last year to eliminate the excess
capacity that has been plaguing the industry since 1996. Demand remains healthy,
largely from personal computer sales in the United States and Europe, which
offset the losses from Japan and the rest of Asia. In addition, the company is
reorganizing its operations and intends to exit the automobile business, which
has been a major cash drain. As of December 1998, other businesses, including
thin film transistors liquid crystal display, which are mostly used as screens
for notebook personal computers and cellular handsets, were performing very
well, with strong demand coming from the United States.
During the six-month period ended December 31, 1998, the market in Thailand
rose by 64.16%. Plummeting interest rates prompted local investors to return to
the market first, soon followed by international investors. Some economists
believe that Thailand has moved past its worst period of economic contraction,
and may show positive growth by mid-1999 after an estimated GDP decline of 8%
for 1998.
In the Middle East/Africa region, the Turkish market was down 44.6% for the
six-month period ended December 31, 1998. Initial declines in this market
through August 31, 1998 were a result of the contagion effect from Russia, since
Turkey and Russia are trading partners. In order to defend the currency, Turkish
monetary authorities raised interest rates. Real interest rates remain quite
high as a consequence of the government's full treasury bill repayment schedule.
During the final three months of 1998, investors witnessed a political
corruption scandal, which ultimately brought down the Turkish government. An
interim government has been appointed, but volatility in the market remained
high.
During the six-month period ended December 31, 1998, the South African market
declined 15.59%. South Africa remains vulnerable as long as commodity prices
remain depressed and investors lack confidence in the currency.
In Israel, which declined 12.27% for the six months ended December 31, 1998,
rising inflation and poor corporate earnings results continued to pressure the
market. One of our chief Israeli holdings is Teva Pharmaceutical Industries
Ltd., a fully integrated international pharmaceutical company and the
third-largest generic drug producer in the United States. Since June 1998, the
company has received a number of US Food and Drug Administration approvals,
including its proprietary product, Copaxone, which is used by patients with
multiple sclerosis.
In emerging Europe, Greece was the only market to show a gain--up 22.93% for
the six-month period ended December 31, 1998. Greece continued to perform well,
based on investor expectations that it will be successful in meeting the
criteria for inclusion in the European Monetary Union.
An important holding in the Fund was National Bank of Greece S.A. (NBG), one
of the largest retail banks in the country. This bank, which has a market share
of 40% in deposits and 25% in lending, is undergoing a major restructuring since
new management took over in 1996. It has strengthened its balance sheet, making
significant provisions against loan losses and raising additional capital, and
is reducing costs as well.
During the six-month period ended December 31, 1998, markets in many Eastern
European countries were negatively affected by the perception of close ties to
Russia. Poland and Hungary declined by 19.17%, and 8.05% respectively.
IN CONCLUSION
The last six months has underscored the sustained fragility of emerging
markets. The period has also demonstrated that as markets become more global,
the missteps in one market can have very serious spillover effects in other
markets, which on the surface would seem to be totally unrelated. For this
reason, we continue to remind our shareholders that investing in these markets
requires a high tolerance for volatility. With this in mind, we thank you for
your investment in Developing Capital Markets Focus Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to
45
<PAGE> 47
- --------------------------------------------------------------------------------
reviewing our outlook and strategy with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Grace Pineda
Grace Pineda
Senior Vice President and Portfolio Manager
February 5, 1999
46
<PAGE> 48
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A & CLASS B SHARES
- --------------------------------------------------------------------------------
Developing Capital Markets Focus Fund
Total Return Based on a $10,000 Investment-Class A & Class B
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Morgan Stanley Capital International
EAFE Index and the Morgan Stanley Capital International Emerging Markets Free
Index. Beginning and ending values are:
<TABLE>
<CAPTION>
5/02/94** 12/98
--------- -----
<S> <C> <C>
Developing Capital Markets
Focus Fund+ -- Class A Shares* $10,000 $ 6,866
Morgan Stanley Capital
International EAFE Index++ $10,000 $14,389
Morgan Stanley Capital
International Emerging Markets
Free Index+++ $10,000 $ 6,898
</TABLE>
A line graph depicting the growth of an investment in the Fund's Class B Shares
compared to growth of an investment in the Morgan Stanley Capital International
EAFE Index and the Morgan Stanley Capital International Emerging Markets Free
Index. Beginning and ending values are:
<TABLE>
<CAPTION>
11/03/97** 12/98
---------- -----
<S> <C> <C>
Developing Capital Markets
Focus Fund+ -- Class B Shares* $10,000 $ 6,988
Morgan Stanley Capital
International EAFE Index++ $10,000 $11,981
Morgan Stanley Capital
International Emerging Markets
Free Index+++ $10,000 $ 7,420
</TABLE>
* Assuming transaction costs and other operating expenses, including advisory
fees. Does not include insurance-related fees and expenses.
** Commencement of operations.
+ Developing Capital Markets Focus Fund primarily invests in securities,
principally equities, of issuers in countries having smaller capital markets.
++ This unmanaged Index measures the total returns of developed foreign stock
markets in Europe, Asia and the Far East, calculated in US dollars. The starting
date for the Index in the Class A Shares graph is from 4/30/94 and in the Class
B Shares graph from 10/31/97.
+++ This unmanaged Index measures the total returns of emerging foreign stock
markets in Europe, Asia and the Far East. The starting date for the Index in the
Class A Shares graph is from 4/30/94 and in the Class B Shares graph from
10/31/97.
Past performance is not predictive of future performance.
47
<PAGE> 49
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/98 -29.39%
- --------------------------------------------------------------------------------
Inception (5/02/94) through 12/31/98 - 7.74
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS B SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/98 -29.51%
- --------------------------------------------------------------------------------
Inception (11/03/97) through 12/31/98 -26.60
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
RECENT PERFORMANCE RESULTS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
12 MONTH 6 MONTH
TOTAL RETURN TOTAL RETURN
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Class A Shares -29.39% -14.61%
- ------------------------------------------------------------------------------------------
Class B Shares -29.51 -14.74
- ------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the ex-dividend date. Insurance-related fees
and expenses are not reflected in these returns. Past results shown should not
be considered a representation of future performance.
48
<PAGE> 50
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES HELD/ VALUE PERCENT OF
AFRICA INDUSTRY FACE AMOUNT INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
SOUTH AFRICA BANKING 17,689 Nedcor Limited.............. $ 381,161 $ 300,936 0.5%
-----------------------------------------------------------------------------------------------------
BEVERAGE & 68,130 South African Breweries
TOBACCO Limited................... 1,178,659 1,149,795 1.8
256 South African Breweries
Limited (ADR)(a).......... 7,229 4,313 0.0
----------- ----------- -----
1,185,888 1,154,108 1.8
-----------------------------------------------------------------------------------------------------
FOREIGN Republic of South Africa:
GOVERNMENT ZAL 3,300,000 12% due 2/28/2005........... 560,008 477,119 0.7
OBLIGATIONS ZAL 2,800,000 13% due 8/31/2010........... 479,057 403,699 0.6
----------- ----------- -----
1,039,065 880,818 1.3
-----------------------------------------------------------------------------------------------------
FOREST PRODUCTS 124,960 Nampak Limited.............. 189,011 190,267 0.3
-----------------------------------------------------------------------------------------------------
HEALTH INSURANCE 111,660 +Sanlam Limited............. 117,733 111,128 0.2
-----------------------------------------------------------------------------------------------------
INSURANCE 1,305,352 FirstRand Limited........... 1,886,720 1,425,716 2.2
17,023 Liberty Life Association of
Africa Limited............ 496,838 234,580 0.4
----------- ----------- -----
2,383,558 1,660,296 2.6
-----------------------------------------------------------------------------------------------------
RETAIL 50,350 Pepkor Limited.............. 160,134 209,863 0.3
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN AFRICA 5,456,550 4,507,416 7.0
- ----------------------------------------------------------------------------------------------------------------------------
EUROPE
- ----------------------------------------------------------------------------------------------------------------------------
GREECE BANKING 6,819 National Bank of Greece
S.A. ..................... 1,015,996 1,534,823 2.4
-----------------------------------------------------------------------------------------------------
BEVERAGE 20,163 Hellenic Bottling Co. ...... 588,360 622,755 1.0
-----------------------------------------------------------------------------------------------------
CELLULAR 3,590 +Panfon Hellenic
TELEPHONES Telecom Co. .............. 64,710 96,195 0.1
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 19,261 +Hellenic Telecommunication
Organization S.A.
(ADR)(a).................. 233,001 251,356 0.4
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN GREECE 1,902,067 2,505,129 3.9
- ----------------------------------------------------------------------------------------------------------------------------
HUNGARY BANKING 7,966 OTP Bank Reszvenytarsasag
(GDR)(b).................. 290,566 392,724 0.6
-----------------------------------------------------------------------------------------------------
HEALTH/PERSONAL 9,548 Gedeon Richter Ltd.
CARE (GDR)(b).................. 742,072 408,177 0.6
-----------------------------------------------------------------------------------------------------
OIL & GAS 44,631 Mol Magyar Olay-es Gazipari
PRODUCERS Reszvenytarsasag
(GDR)(b).................. 1,172,538 1,231,816 1.9
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 93,829 Magyar TavKozlesi
Reszvenytarsasag
(MATAV)................... 574,284 536,602 0.9
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN HUNGARY 2,779,460 2,569,319 4.0
- ----------------------------------------------------------------------------------------------------------------------------
ITALY BEVERAGE 216,729 +Coca-Cola Beverages PLC.... 571,889 382,069 0.6
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN ITALY 571,889 382,069 0.6
- ----------------------------------------------------------------------------------------------------------------------------
POLAND AUTOMOTIVE 30,769 Debica S.A. ................ 701,873 456,487 0.7
-----------------------------------------------------------------------------------------------------
BANKING 121,503 Wielkopolski Bank
Kredytowy S.A. ........... 1,106,782 766,110 1.2
-----------------------------------------------------------------------------------------------------
COMPUTERS 42,177 +ComputerLand Poland
S.A. ..................... 937,061 517,435 0.8
-----------------------------------------------------------------------------------------------------
ELECTRICAL & 117,815 Elektrim Spolka
ELECTRONICS Akcyjna S.A. ............. 1,277,736 1,277,310 2.0
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN POLAND 4,023,452 3,017,342 4.7
- ----------------------------------------------------------------------------------------------------------------------------
PORTUGAL TELECOMMUNICATIONS 9,692 Portugal Telecom S.A. ...... 441,541 444,380 0.7
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
PORTUGAL 441,541 444,380 0.7
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
49
<PAGE> 51
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
EUROPE SHARES HELD/ VALUE PERCENT OF
(CONCLUDED) INDUSTRY FACE AMOUNT INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
RUSSIA ELECTRICAL 32,000 +Lenenergo.................. $ 31,680 $ 160 0.0%
COMPONENTS &
DISTRIBUTION
-----------------------------------------------------------------------------------------------------
ENERGY SOURCES 275,000 Irkutskenergo............... 34,733 11,412 0.0
-----------------------------------------------------------------------------------------------------
NATURAL GAS 13,480 Gazprom (ADR)(a)(d)......... 212,310 114,917 0.2
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 82,300 +Bashinformsvyaz............ 220,980 20,575 0.0
31,142 Nizhnovsvyazinform.......... 164,974 9,343 0.0
6,000 Tyumentelecom............... 40,770 2,160 0.0
----------- ----------- -----
426,724 32,078 0.0
-----------------------------------------------------------------------------------------------------
UTILITIES-- 199,692 Bashkirenergo............... 117,784 3,994 0.0
ELECTRICAL & GAS
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN RUSSIA 823,231 162,561 0.2
- ----------------------------------------------------------------------------------------------------------------------------
TURKEY BANKING 26,728,016 Yapi ve Kredi Bankasi
A.S. ..................... 496,580 309,548 0.5
-----------------------------------------------------------------------------------------------------
BUILDING PRODUCTS 7,647,720 Akcansa Cimento A.S. ....... 222,981 128,611 0.2
-----------------------------------------------------------------------------------------------------
RETAIL STORES 685,255 Migros Turk T.A.S. ......... 639,987 684,907 1.0
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN TURKEY 1,359,548 1,123,066 1.7
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN EUROPE 11,901,188 10,203,866 15.8
- ----------------------------------------------------------------------------------------------------------------------------
LATIN
AMERICA
- ----------------------------------------------------------------------------------------------------------------------------
ARGENTINA OIL & GAS 23,700 YPF Sociedad Anonima
PRODUCERS (ADR)(a).................. 625,673 662,119 1.0
-----------------------------------------------------------------------------------------------------
OIL & RELATED 61,101 Perez Companc S.A. (Class
B)........................ 313,845 258,703 0.4
-----------------------------------------------------------------------------------------------------
REAL ESTATE 9,165 +IRSA Inversiones y
Representaciones S.A.
(GDR)(b).................. 257,363 254,910 0.4
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
ARGENTINA 1,196,881 1,175,732 1.8
- ----------------------------------------------------------------------------------------------------------------------------
BRAZIL BANKING 320,507 Banco Itau S.A.
(Preferred)............... 197,943 156,536 0.2
-----------------------------------------------------------------------------------------------------
BEVERAGE 1,216,542 Companhia Cervejaria Brahma
(Preferred)............... 708,866 531,734 0.8
-----------------------------------------------------------------------------------------------------
FOREIGN Republic of Brazil:
GOVERNMENT US$ 840,821 Floating Rate 'C' Brady
OBLIGATIONS Bonds, 6.79% due
4/15/2014(c).............. 506,826 500,288 0.8
US$ 1,527,000 Floating Rate 'L' Brady
Bonds, 5.50% due
4/15/2024(c).............. 1,079,319 893,295 1.4
US$ 1,905,000 Global Bonds, 10.125% due
5/15/2027................. 1,479,690 1,266,825 1.9
----------- ----------- -----
3,065,835 2,660,408 4.1
-----------------------------------------------------------------------------------------------------
METALS--STEEL 44,020 Companhia Vale do Rio
Doce (Preferred).......... 930,668 564,826 0.9
Brl 10,296 Companhia Vale do Rio Doce,
0% due 12/31/2049(e)...... 0 0 0.0
----------- ----------- -----
930,668 564,826 0.9
-----------------------------------------------------------------------------------------------------
OIL & RELATED 6,392,814 Petroleo Brasileiro S.A.--
Petrobras (Preferred)..... 1,451,852 725,013 1.1
-----------------------------------------------------------------------------------------------------
</TABLE>
50
<PAGE> 52
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
LATIN
AMERICA SHARES HELD/ VALUE PERCENT OF
(CONTINUED) INDUSTRY FACE AMOUNT INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BRAZIL TELECOMMUNICATIONS 12,883,000 +Embratel Participacoes
(CONCLUDED) S.A. ..................... $ 136,872 $ 111,980 0.2%
12,330,000 +Tele Norte Leste
Participacoes S.A. ....... 95,177 101,049 0.2
37,805 +Tele Norte Leste
Participacoes S.A.
(ADR)(a).................. 631,211 470,200 0.7
12,311 +Telecomunicacoes
Brasileiras S.A.--Telebras
(ADR)(a).................. 973,061 894,856 1.4
915,000 Telerj Celular S.A.
(Preferred 'B')........... 75,785 21,587 0.0
20,103,000 +Telesp Participacoes
S.A. ..................... 296,851 257,944 0.4
----------- ----------- -----
2,208,957 1,857,616 2.9
-----------------------------------------------------------------------------------------------------
UTILITIES-- 36,826,000 +Centrais Eletricas
ELECTRICAL & GAS Basileiras
S.A.--Eletrobras.......... 1,043,073 634,090 1.0
56,459,353 Companhia Energetica de
Minas Gerais S.A. (CEMIG)
(Preferred)............... 1,992,523 1,074,971 1.7
90 Companhia Paranaense
de Energia--Copel
(ADR)(a).................. 917 641 0.0
----------- ----------- -----
3,036,513 1,709,702 2.7
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN BRAZIL 11,600,634 8,205,835 12.7
- ----------------------------------------------------------------------------------------------------------------------------
CHILE BANKING 4,889 Banco Santander Chile
(ADR)(a).................. 63,850 71,502 0.1
-----------------------------------------------------------------------------------------------------
UTILITIES-- 17,455 Empresa Nacional de
ELECTRICAL & GAS Electricidad S.A. (Endesa)
(ADR)(a).................. 176,169 198,551 0.3
7,756 Enersis S.A. (ADR)(a)....... 183,799 200,202 0.3
----------- ----------- -----
359,968 398,753 0.6
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN CHILE 423,818 470,255 0.7
- ----------------------------------------------------------------------------------------------------------------------------
MEXICO BANKING 72,266 +Grupo Financiero Banorte,
S.A. de C.V. (Class B).... 116,075 62,141 0.1
-----------------------------------------------------------------------------------------------------
BEVERAGE 43,874 Panamerican Beverages, Inc.
(Class A) (US Registered
Shares)................... 1,280,311 957,002 1.5
-----------------------------------------------------------------------------------------------------
BROADCAST--MEDIA 38,447 +Grupo Televisa, S.A. de
C.V. (GDR)(b)............. 1,263,204 949,160 1.5
-----------------------------------------------------------------------------------------------------
BUILDING 63,125 Cemex, S.A. de C.V. 'B'..... 293,380 158,052 0.2
MATERIALS
25,049 Cemex, S.A. de C.V. 'B'
(ADR)(a).................. 210,861 123,855 0.2
3,717 Cemex, S.A. de C.V.-CPO..... 13,959 8,028 0.0
----------- ----------- -----
518,200 289,935 0.4
-----------------------------------------------------------------------------------------------------
FOREIGN United Mexican States:
GOVERNMENT US$ 1,668,000 Brady Bonds, Series W-A,
OBLIGATIONS 6.25% due
12/31/2019(c)............. 1,234,693 1,292,700 2.0
US$ 1,525,000 Global Bonds, 11.50% due
5/15/2026................. 1,495,731 1,616,500 2.5
----------- ----------- -----
2,730,424 2,909,200 4.5
-----------------------------------------------------------------------------------------------------
HEALTH/PERSONAL 311,819 Kimberly-Clark de Mexico,
CARE S.A. de C.V. 'A'.......... 1,201,028 992,080 1.5
-----------------------------------------------------------------------------------------------------
</TABLE>
51
<PAGE> 53
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
LATIN
AMERICA SHARES HELD/ VALUE PERCENT OF
(CONCLUDED) INDUSTRY FACE AMOUNT INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
MEXICO LEISURE 166,300 Grupo Carso, S.A. de C.V.
(CONCLUDED) (Series 'A1')............. $ 508,378 $ 566,110 0.9%
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 41,063 Telefonos de Mexico S.A.
(ADR)(a).................. 1,929,842 1,999,255 3.1
-----------------------------------------------------------------------------------------------------
TELEVISION 8,300 TV Azteca, S.A. de C.V.
(ADR)(a).................. 114,378 55,506 0.1
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN MEXICO 9,661,840 8,780,389 13.6
- ----------------------------------------------------------------------------------------------------------------------------
PERU FINANCIAL 7,200 Credicorp Ltd. S.A. ........ 65,153 64,800 0.1
SERVICES
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN PERU 65,153 64,800 0.1
- ----------------------------------------------------------------------------------------------------------------------------
VENEZUELA FOREIGN US$ 573,000 Republic of Venezuela,
GOVERNMENT Global Bonds, 9.25% due
OBLIGATIONS 9/15/2027................. 337,567 349,530 0.6
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 17,353 Compania Anonima Nacional
Telefonos de Venezuela
(CANTV) (ADR)(a).......... 280,175 309,100 0.5
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
VENEZUELA 617,742 658,630 1.1
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
LATIN AMERICA 23,566,068 19,355,641 30.0
- ----------------------------------------------------------------------------------------------------------------------------
MIDDLE
EAST
- ----------------------------------------------------------------------------------------------------------------------------
EGYPT BANKING 9,517 Commercial International
Bank...................... 86,732 75,325 0.1
59,127 Commercial International
Bank (GDR)(b)............. 928,338 453,800 0.7
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN EGYPT 1,015,070 529,125 0.8
- ----------------------------------------------------------------------------------------------------------------------------
ISRAEL BANKING 366,520 Bank Hapoalim Ltd........... 1,018,719 664,843 1.0
548,390 Bank Leumi Le-Israel........ 1,034,873 776,771 1.2
----------- ----------- -----
2,053,592 1,441,614 2.2
-----------------------------------------------------------------------------------------------------
DRUGS 13,598 Teva Pharmaceutical
Industries Ltd.
(ADR)(a).................. 532,403 553,269 0.9
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN ISRAEL 2,585,995 1,994,883 3.1
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE
MIDDLE EAST 3,601,065 2,524,008 3.9
- ----------------------------------------------------------------------------------------------------------------------------
PACIFIC
BASIN/ASIA
- ----------------------------------------------------------------------------------------------------------------------------
CHINA AUTOMOBILES 1,136,000 Qingling Motor Company,
Ltd. ..................... 520,723 199,429 0.3
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 208,000 Eastern Communication Co.,
Ltd. (Class B)............ 78,241 89,440 0.1
-----------------------------------------------------------------------------------------------------
UTILITIES-- 732,000 Beijing Datang Power
ELECTRICAL & GAS Generation Company
Limited................... 318,105 219,688 0.4
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN CHINA 917,069 508,557 0.8
- ----------------------------------------------------------------------------------------------------------------------------
HONG KONG CEMENT 4,191,000 +Anhui Conch Cement Co. Ltd.
(H Shares)................ 625,267 470,662 0.7
-----------------------------------------------------------------------------------------------------
TRANSPORTATION 3,194,000 Sichuan Expressway Co. ..... 346,870 280,360 0.4
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN HONG
KONG 972,137 751,022 1.1
- ----------------------------------------------------------------------------------------------------------------------------
INDIA BUILDING 21,642 Gujarat Ambuja Cements
MATERIALS & Ltd.(GDR)(b).............. 124,442 144,460 0.2
COMPONENTS
-----------------------------------------------------------------------------------------------------
COMPUTER SOFTWARE 34,400 Pentafour Software & Exports
Ltd. ..................... 626,367 572,928 0.9
-----------------------------------------------------------------------------------------------------
</TABLE>
52
<PAGE> 54
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC
BASIN/ASIA VALUE PERCENT OF
(CONTINUED) INDUSTRY SHARES HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INDIA FINANCIAL 52,685 ICICI Ltd. (GDR)(b)......... $ 518,947 $ 351,672 0.5%
(CONCLUDED) SERVICES
-----------------------------------------------------------------------------------------------------
FOOD & HOUSEHOLD 21,100 Hindustan Lever Limited..... 847,784 827,436 1.3
PRODUCTS
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 42,000 Mahanagar Telephone Nigam
Ltd. ..................... 314,461 181,386 0.3
10,407 Videsh Sanchar Nigam Ltd.
(GDR)(b).................. 123,532 128,787 0.2
----------- ----------- -----
437,993 310,173 0.5
-----------------------------------------------------------------------------------------------------
UTILITIES-- 62,769 BSES Ltd. (GDR)(b).......... 826,132 808,151 1.3
ELECTRICAL & GAS
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN INDIA 3,381,665 3,014,820 4.7
- ----------------------------------------------------------------------------------------------------------------------------
INDONESIA CEMENT 512,500 P.T. Semen Gresik
(Persero)................. 409,316 545,353 0.8
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 104,945 P.T. Indosat (Persero)
(ADR)(a).................. 1,873,231 1,279,017 2.0
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
INDONESIA 2,282,547 1,824,370 2.8
- ----------------------------------------------------------------------------------------------------------------------------
MALAYSIA++ BANKING 109,800 Malayan Banking Berhad...... 202,543 203,567 0.3
-----------------------------------------------------------------------------------------------------
FOOD 143,000 Nestle (Malaysia) Berhad.... 989,482 523,353 0.8
-----------------------------------------------------------------------------------------------------
NATURAL GAS 192,000 Petronas Gas Berhad......... 679,866 397,571 0.6
-----------------------------------------------------------------------------------------------------
OIL & RELATED 162,700 Petronas Dagangan Berhad.... 224,526 147,296 0.2
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 190,000 Telekom Malaysia Berhad..... 496,527 457,476 0.7
-----------------------------------------------------------------------------------------------------
TOBACCO 161,800 Rothmans of Pall Mall
(Malaysia) Berhad......... 1,026,131 872,653 1.4
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
MALAYSIA 3,619,075 2,601,916 4.0
- ----------------------------------------------------------------------------------------------------------------------------
SOUTH KOREA ELECTRONIC 24,043 Samsung Display Devices Co.,
COMPONENT Ltd. ..................... 897,649 1,188,125 1.9
-----------------------------------------------------------------------------------------------------
ELECTRONIC 28,175 Samsung Electronics Co.,
INSTRUMENTS Ltd. ..................... 1,142,039 1,894,769 2.9
-----------------------------------------------------------------------------------------------------
STEEL 11,300 Pohang Iron & Steel Company,
Ltd. ..................... 592,624 692,407 1.1
24,780 Pohang Iron & Steel Company,
Ltd. (ADR)(a)............. 377,895 418,162 0.6
----------- ----------- -----
970,519 1,110,569 1.7
-----------------------------------------------------------------------------------------------------
UTILITIES-- 59,060 Korea Electric Power
ELECTRICAL & GAS Corporation............... 1,404,385 1,466,657 2.3
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SOUTH KOREA 4,414,592 5,660,120 8.8
- ----------------------------------------------------------------------------------------------------------------------------
TAIWAN BANKING 1,711,800 +E. Sun Commercial Bank..... 1,191,175 739,634 1.2
-----------------------------------------------------------------------------------------------------
BUILDING PRODUCTS 276,000 Asia Cement Corporation..... 240,660 259,956 0.4
-----------------------------------------------------------------------------------------------------
CEMENT 342,000 Taiwan Cement Corporation... 298,779 295,542 0.5
-----------------------------------------------------------------------------------------------------
ELECTRONIC 151,600 +Mosel Vitelic, Inc. ....... 159,596 143,730 0.2
COMPONENT
-----------------------------------------------------------------------------------------------------
HEALTH INSURANCE 242,000 Cathay Life Insurance Co.,
Ltd. ..................... 827,569 782,344 1.2
-----------------------------------------------------------------------------------------------------
PLASTICS 422,520 +Formosa Plastic
Corporation............... 758,726 614,670 0.9
-----------------------------------------------------------------------------------------------------
SEMICONDUCTORS 388,000 +Taiwan Semiconductor
Manufacturing Company..... 825,261 856,326 1.3
-----------------------------------------------------------------------------------------------------
STEEL 661,000 China Steel Corporation..... 431,005 398,614 0.6
-----------------------------------------------------------------------------------------------------
</TABLE>
53
<PAGE> 55
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC
BASIN/ASIA VALUE PERCENT OF
(CONCLUDED) INDUSTRY SHARES HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
TAIWAN TRANSPORT 259,400 +Yang Ming Marine Transport
(CONCLUDED) SERVICES Corp. .................... $ 208,252 $ 178,201 0.3%
-----------------------------------------------------------------------------------------------------
VENTURE CAPITAL 208,000 +China Development
Industrial Bank Inc. ..... 412,747 381,473 0.6
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN TAIWAN 5,353,770 4,650,490 7.2
- ----------------------------------------------------------------------------------------------------------------------------
THAILAND BANKING 187,800 +Bangkok Bank Public Company
Limited
'Foreign'................. 400,908 388,552 0.6
334,300 +Thai Farmers Bank Public
Company Limited
'Foreign'................. 1,040,962 590,212 0.9
----------- ----------- -----
1,441,870 978,764 1.5
-----------------------------------------------------------------------------------------------------
TELEVISION 195,900 BEC World Public Company
Limited 'Foreign'......... 1,442,910 1,080,828 1.7
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
THAILAND 2,884,780 2,059,592 3.2
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE
PACIFIC BASIN/ASIA 23,825,635 21,070,887 32.6
- ----------------------------------------------------------------------------------------------------------------------------
SHORT-TERM FACE
SECURITIES AMOUNT ISSUE
- ----------------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER* US$ 2,396,000 General Electric Capital
Corp., 5% due 1/04/1999... 2,394,669 2,394,669 3.7
1,000,000 Metropolitan Life Insurance
Company, 5.25% due
1/13/1999................. 998,104 998,104 1.5
1,000,000 Xerox Credit Corp., 5% due
1/08/1999................. 998,889 998,889 1.6
----------- ----------- -----
4,391,662 4,391,662 6.8
- ----------------------------------------------------------------------------------------------------------------------------
FOREIGN GOVERNMENT Trl 834,000,000,000 Turkish Treasury Bill,
OBLIGATIONS* 115.05% due 7/21/1999..... 1,699,156 1,656,303 2.6
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SHORT-
TERM SECURITIES 6,090,818 6,047,965 9.4
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS........... $74,441,324 63,709,783 98.7
===========
OTHER ASSETS LESS
LIABILITIES............... 842,864 1.3
----------- -----
NET ASSETS.................. $64,552,647 100.0%
=========== =====
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Commercial Paper and certain Foreign Government Obligations are traded on a
discount basis; the interest rates shown reflect the discount rates paid at the
time of purchase by the Fund.
+ Non-income producing security.
++ On October 21, 1998, the Company's Board of Directors decided to discount the
current Malaysian exchange rate of 3.80 by 12%. This is due to the capital
controls implemented by the Malaysian government, which froze the Malaysian
ringgit at 3.80 until September 1, 1999. This discount will be amortized on a
daily basis from 12% to zero through September 1, 1999.
(a) American Depositary Receipts (ADR).
(b) Global Depositary Receipts (GDR).
(c) Brady Bonds are securities which have been issued to refinance commercial
bank loans and other debt. The risk associated with these instruments is the
amount of any uncollateralized principal or interest payments since there is a
high default rate of commercial bank loans by countries issuing these
securities.
(d) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(e) Received through a bonus issue from Companhia Vale do Rio Doce. As of
December 31, 1998, the bonds have not commenced trading and the coupon rate has
not been determined.
See Notes to Financial Statements.
54
<PAGE> 56
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$74,441,324) (Note
1a)....................................................... $ 63,709,783
Foreign cash (Note 1c)...................................... 345,807
Receivables:
Securities sold........................................... $732,806
Interest.................................................. 162,866
Dividends................................................. 153,471
Capital shares sold....................................... 5,056 1,054,199
--------
Prepaid expenses and other assets........................... 36,833
------------
Total assets................................................ 65,146,622
------------
- -------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Securities purchased...................................... 318,462
Capital shares redeemed................................... 81,018
Investment adviser (Note 2)............................... 54,273
Distributor (Note 2)...................................... 133 453,886
--------
Accrued expenses and other liabilities...................... 140,089
------------
Total liabilities........................................... 593,975
------------
- -------------------------------------------------------------------------------------
NET ASSETS.................................................. $ 64,552,647
============
- -------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares Common Stock, $0.10 par value, 100,000,000
shares authorized......................................... $ 1,000,824
Class B Shares Common Stock, $0.10 par value, 100,000,000
shares authorized......................................... 3,756
Paid-in capital in excess of par............................ 120,787,523
Undistributed investment income--net........................ 1,416,656
Accumulated realized capital losses on investments and
foreign currency transactions--net (Note 5)............... (47,921,494)
Unrealized depreciation on investments and foreign currency
transactions--net......................................... (10,734,618)
------------
NET ASSETS.................................................. $ 64,552,647
============
- -------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $64,311,509 and 10,008,237
shares outstanding........................................ $ 6.43
============
Class B--Based on net assets of $241,138 and 37,559 shares
outstanding............................................... $ 6.42
============
- -------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
55
<PAGE> 57
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Dividends (net of $174,572 withholding tax on foreign
dividends)................................................ $ 2,645,267
Interest and discount earned................................ 1,355,143
------------
Total income................................................ 4,000,410
------------
- -----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $ 1,126,826
Custodian fees.............................................. 347,190
Accounting services (Note 2)................................ 21,396
Printing and shareholder reports............................ 20,401
Professional fees........................................... 12,090
Pricing services............................................ 11,813
Transfer agent fees (Note 2)................................ 5,111
Directors' fees and expenses................................ 3,044
Distribution fees--Class B (Note 2)......................... 209
Other....................................................... 53,662
------------
Total expenses before reimbursement......................... 1,601,742
Reimbursement of expenses (Note 2).......................... (193,001)
------------
Total expenses after reimbursement.......................... 1,408,741
------------
Investment income--net...................................... 2,591,669
------------
- -----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET (NOTES 1b, 1c, 1e & 3):
Realized loss from:
Investments--net.......................................... (43,326,090)
Foreign currency transactions--net........................ (422,087) (43,748,177)
------------
Change in unrealized depreciation on:
Investments--net.......................................... (1,683,209)
Foreign currency transactions--net........................ 1,388 (1,681,821)
------------ ------------
Net realized and unrealized loss on investments and foreign
currency transactions..................................... (45,429,998)
------------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $(42,838,329)
============
- -----------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
56
<PAGE> 58
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
----------------------------
INCREASE (DECREASE) IN NET ASSETS: 1998 1997
- ------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 2,591,669 $ 1,501,958
Realized loss on investments and foreign currency
transactions--net......................................... (43,748,177) (1,024,097)
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ (1,681,821) (13,340,095)
------------ ------------
Net decrease in net assets resulting from operations........ (42,838,329) (12,862,234)
------------ ------------
- ------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS (NOTE 1f):
Investment income--net:
Class A................................................... (1,752,375) (1,771,806)
Class B................................................... (388) --
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders.............................................. (1,752,763) (1,771,806)
------------ ------------
- ------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase (decrease) in net assets derived from capital
share transactions........................................ (32,339,010) 60,517,887
------------ ------------
- ------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... (76,930,102) 45,883,847
Beginning of year........................................... 141,482,749 95,598,902
------------ ------------
End of year*................................................ $ 64,552,647 $141,482,749
============ ============
- ------------------------------------------------------------------------------------------
* Undistributed investment income--net (Note 1g)............ $ 1,416,656 $ 973,652
============ ============
- ------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
57
<PAGE> 59
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE CLASS A
BEEN DERIVED FROM INFORMATION PROVIDED IN THE ----------------------------------------------------------
FINANCIAL STATEMENTS.
FOR THE YEAR
ENDED FOR THE PERIOD
DECEMBER 31, MAY 2, 1994+
----------------------------------------- TO DEC. 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 1998++ 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.................... $ 9.22 $ 10.05 $ 9.32 $ 9.51 $ 10.00
------- -------- ------- ------- -------
Investment income--net.................................. .18 .11 .20 .20 .09
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net.................... (2.86) (.75) .76 (.30) (.58)
------- -------- ------- ------- -------
Total from investment operations........................ (2.68) (.64) .96 (.10) (.49)
------- -------- ------- ------- -------
Less dividends from investment income--net.............. (.11) (.19) (.23) (.09) --
------- -------- ------- ------- -------
Net asset value, end of period.......................... $ 6.43 $ 9.22 $ 10.05 $ 9.32 $ 9.51
======= ======== ======= ======= =======
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share...................... (29.39%) (6.53%) 10.59% (1.08%) (4.90%)++
======= ======== ======= ======= =======
- ------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement.......................... 1.25% 1.25% 1.25% 1.25% 1.29%*
======= ======== ======= ======= =======
Expenses................................................ 1.42% 1.42% 1.31% 1.36% 1.35%*
======= ======== ======= ======= =======
Investment income--net.................................. 2.30% 1.15% 2.42% 2.73% 2.18%*
======= ======== ======= ======= =======
- ------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)................ $64,312 $141,451 $95,599 $55,209 $36,676
======= ======== ======= ======= =======
Portfolio turnover...................................... 121.06% 93.62% 87.33% 62.53% 29.79%
======= ======== ======= ======= =======
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of operations.
++ Based on average shares outstanding.
++ Aggregate total investment return.
See Notes to Financial Statements.
58
<PAGE> 60
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
FINANCIAL HIGHLIGHTS (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS B
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE -----------------------------------
BEEN DERIVED FROM INFORMATION PROVIDED IN THE FOR THE FOR THE PERIOD
FINANCIAL STATEMENTS. YEAR ENDED NOV. 3, 1997+
INCREASE (DECREASE) IN NET ASSET VALUE: DEC. 31, 1998++ TO DEC. 31, 1997
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period........................ $ 9.22 $ 9.30
-------- -------
Investment income--net...................................... .17 .01
Realized and unrealized loss on investments and foreign
currency transactions--net................................ (2.86) (.09)
-------- -------
Total from investment operations............................ (2.69) (.08)
-------- -------
Less dividends from investment income--net.................. (.11) --
-------- -------
Net asset value, end of period.............................. $ 6.42 $ 9.22
======== =======
- -------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.......................... (29.51%) (.86%)++
======== =======
- -------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement.............................. 1.40% 1.39%*
======== =======
Expenses.................................................... 1.72% 1.58%*
======== =======
Investment income--net...................................... 2.37% 1.16%*
======== =======
- -------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).................... $ 241 $ 32
======== =======
Portfolio turnover.......................................... 121.06% 93.62%
======== =======
- -------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment return excludes insurance-related fees and expenses.
+ Commencement of operations.
++ Based on average shares outstanding.
++ Aggregate total investment return.
See Notes to Financial Statements.
59
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies, that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Class A and
Class B Shares have equal voting, dividend, liquidation and other rights, except
that only shares of the respective classes are entitled to vote on matters
concerning only that class and Class B Shares bear certain expenses related to
the distribution of such shares. Developing Capital Markets Focus Fund (the
"Fund") is classified as "non-diversified," as defined in the Investment Company
Act of 1940. The Fund's financial statements are prepared in accordance with
generally accepted accounting principles which may require the use of management
accruals and estimates. The following is a summary of significant accounting
policies followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written or purchased are valued at the last sale price in the
case of exchange-traded options. In the case of options traded in the
over-the-counter market, valuation is the last asked price (options written) or
the last bid price (options purchased). Futures contracts are valued at the
settlement price at the close of the applicable exchange. Short-term securities
are valued at amortized cost, which approximates market value. Securities and
assets for which market quotations are not readily available are valued at fair
value as determined in good faith by or under the direction of the Board of
Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity, debt and currency markets. Losses may arise due
to changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Funds' records. However, the effect on operations is recorded from the date the
Fund enters into such contracts.
- - Options--The Fund may write and purchase call and put options. When the Fund
writes an option, an amount equal to the premium received by the Fund is
reflected as an asset and an equivalent liability. The amount of the liability
is subsequently marked to market to reflect the current market value of the
option written. When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or deducted from)
the basis of the security acquired or deducted from (or added to) the proceeds
of the security sold. When an option expires (or the Fund enters into a closing
transaction), the Fund realizes a gain or loss on the option to the extent of
the premiums received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts for the purpose of hedging the
market risk on existing securities or the intended purchase of securities.
Futures contracts are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon entering into a contract, the
Fund deposits and maintains as collateral such initial margin as required by the
exchange on which the transaction is effected. Pursuant to the contract, the
Fund agrees to receive from or pay to the broker an amount of cash equal to the
daily fluctuation in value of the contract. Such receipts or payments are known
as variation margin and are recorded by the Fund as unrealized gains or losses.
When the contract is closed, the Fund records a
60
<PAGE> 62
- --------------------------------------------------------------------------------
realized gain or loss equal to the difference between the value of the contract
at the time it was opened and the value at the time it was closed.
- - Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-US dollar denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets and liabilities expressed in
foreign currencies into US dollars. Realized and unrealized gains or losses from
investments include the effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently recorded
when the Fund has determined the ex-dividend date. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(g) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $398,996 have been reclassified between accumulated net
realized capital losses and undistributed net investment income. These
reclassifications have no effect on net assets or net asset values per share.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner. The Company has also entered into a Distribution
Agreement and Distribution Plan with Merrill Lynch Funds Distributor ("MLFD" or
"Distributor"), a division of Princeton Funds Distributor, Inc. ("PFD"), which
is a wholly-owned subsidiary of Merrill Lynch Group, Inc.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 1.00% of the average daily value of the Fund's net assets.
Pursuant to the Distribution Plan adopted by the Company in accordance with
Rule 12b-1 under the Investment Company Act of 1940, the Fund pays the
Distributor an ongoing distribution fee each month at the annual rate of 0.15%
of the average daily value of the Fund's Class B net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA. For
the year ended December 31, 1998, MLAM earned fees of $1,126,826, of which
$193,001 was voluntarily waived.
For the year ended December 31, 1998, Merrill Lynch, Pierce, Fenner & Smith
Incorporated, a subsidiary of ML & Co., earned $85,837 in commissions on the
execution of portfolio security transactions
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
61
<PAGE> 63
- --------------------------------------------------------------------------------
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1998 were $116,982,564 and $138,450,859, respectively.
Net realized losses for the year ended December 31, 1998 and net unrealized
losses as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Realized Unrealized
Losses Losses
- --------------------------------------------------------------------
<S> <C> <C>
Long-term investments................ $(43,325,397) $(10,688,688)
Short-term investments............... (693) (42,853)
Foreign currency transactions........ (422,087) (3,077)
------------ ------------
Total................................ $(43,748,177) $(10,734,618)
============ ============
- --------------------------------------------------------------------
</TABLE>
At December 31, 1998, net unrealized depreciation for Federal income tax
purposes aggregated $13,190,217, of which $2,326,797 related to appreciated
securities and $15,517,014 related to depreciated securities. At December 31,
1998, the aggregate cost of investments for Federal income tax purposes was
$76,900,000.
4. CAPITAL SHARE TRANSACTIONS:
Net increase (decrease) in net assets derived from capital share transactions
were $(32,339,010) and $60,517,887 for the years ended December 31, 1998 and
December 31, 1997, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1998 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 1,743,089 $ 14,442,991
Shares issued to shareholders in
reinvestment of dividends........... 192,358 1,752,375
---------- ------------
Total issued......................... 1,935,447 16,195,366
Shares redeemed...................... (7,267,433) (48,795,775)
---------- ------------
Net decrease......................... (5,331,986) $(32,600,409)
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 7,394,743 $ 77,069,163
Shares issued to shareholders in
reinvestment of dividends........... 176,082 1,736,172
---------- ------------
Total issued......................... 7,570,825 78,805,335
Shares redeemed...................... (1,738,665) (18,318,396)
---------- ------------
Net increase......................... 5,832,160 $ 60,486,939
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class B Shares for the Year Ended Dollar
December 31, 1998 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 38,950 $ 290,926
Shares issued to shareholders in
reinvestment of dividends........... 43 388
---------- ------------
Total issued......................... 38,993 291,314
Shares redeemed...................... (4,882) (29,915)
---------- ------------
Net increase......................... 34,111 $ 261,399
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
Class B Shares for the Period Dollar
November 3, 1997+ to December 31, 1997 Shares Amount
- ------------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 5,548 $ 50,330
Shares redeemed...................... (2,100) (19,382)
---------- ------------
Net increase......................... 3,448 $ 30,948
========== ============
- ------------------------------------------------------------------
+ Commencement of operations.
</TABLE>
5. CAPITAL LOSS CARRYFORWARD:
At December 31, 1998, the Fund had net capital loss carryforward of
approximately $41,479,000, of which $2,024,000 expires in 2003, $90,000 expires
in 2004 and $39,365,000 expires in 2006. This amount will be available to offset
like amounts of any future taxable gains.
6. COMMITMENTS:
At December 31, 1998, the Fund had entered into foreign exchange contracts,
under which it agreed to purchase and sell various foreign currencies with a
value of approximately $30,000 and $640,000, respectively.
7. SUBSEQUENT EVENT:
On January 4, 1999, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.150059 per Class A Share and $.144495 per Class B
Share, payable on January 11, 1999 to shareholders of record as of December 31,
1998.
62
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
DEVELOPING CAPITAL MARKETS FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Developing Capital Markets Focus Fund of Merrill
Lynch Variable Series Funds, Inc. as of December 31, 1998, the related
statements of operations for the year then ended and changes in net assets for
each of the years in the two-year period then ended, and the financial
highlights for each of the years in the four-year period then ended and the
period May 2, 1994 (commencement of operations) to December 31, 1994. These
financial statements and the financial highlights are the responsibility of the
Fund's management. Our responsibility is to express an opinion on these
financial statements and the financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1998 by correspondence with the custodian and brokers; where replies were
not received from brokers, we performed other auditing procedures. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Developing Capital
Markets Focus Fund of Merrill Lynch Variable Series Funds, Inc. as of December
31, 1998, the results of its operations, the changes in its net assets, and the
financial highlights for the respective stated periods in conformity with
generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
63
<PAGE> 65
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
ANNUAL REPORT--DECEMBER 31, 1998
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1998, the Domestic Money Market Fund's Class A
Shares had a net annualized yield of 5.05%.* For the six-month period ended
December 31, 1998, the Fund's Class A Shares had a net annualized yield of
4.99%.* The Fund's Class A Shares' 7-day yield as of December 31, 1998 was
4.71%. The average portfolio maturity was 69 days at December 31, 1998, compared
to 75 days at June 30, 1998.
THE ENVIRONMENT
During 1998, stock and bond market volatility reflected shifting investor
perceptions regarding global economic prospects. Investor optimism early in the
year gave way to expectations of deteriorating corporate profits and signs of a
weakening economy by late summer. Further concerns arose from the precarious
state of the Russian and other emerging market economies. As a result, world
stock markets declined in the July--September period. At the same time, the
uncertain economic picture and the resulting flight to quality by investors
pushed the 30-year US Treasury bond to record low yields. Yields also declined
in sovereign bond markets of other major industrialized countries. In contrast,
corporate bonds, mortgage-backed securities and emerging markets debt
underperformed US Treasury securities by a wide margin.
The US Federal Reserve Board and other central banks responded to the
uncertain economic outlook through a series of monetary policy easings that
served to restore investor confidence as 1998 drew toward a close. Stock markets
around the world rallied, with total returns for the unmanaged Standard & Poor's
500 Index rising 21.3% and the unmanaged Morgan Stanley Capital International
World Index (Ex-US) increasing 20.5% during the fourth quarter of 1998. However,
as 1999 began, uncertainty regarding global economic prospects again began to
cloud the investment outlook. At the same time, with stronger-than-expected
economic results, prospects dimmed for further Federal Reserve Board monetary
policy easings in the near future. The notable exception to the more subdued
investment outlook in the United States was the unprecedented popularity of
Internet-related stocks.
The weakening of the US dollar relative to the Japanese yen was one of the
year's more surprising developments. Since a stronger yen would have a negative
impact on the important export sector of Japan's fragile economy, the Japanese
central bank intervened in the currency markets in January. For the overall
global economy, the deepening recession in Japan is of great concern. At the
same time, the difficulties in emerging economies such as Russia and Brazil
remain. Further progress in easing strains within the global financial system
would likely provide an important element of stability to the volatile
investment environment.
PORTFOLIO MATTERS
For the year ended December 31, 1998, the Fund maintained an average life
ranging from a low of 63 days to a high of 87 days. Throughout most of the year,
the Fund maintained an average life toward the higher end of the allowed band.
During the 12-month period, short-term interest rates rallied over 100 basis
points (1.00%).
The constructive investment strategy that we implemented in early 1998 was
based primarily on the growing crisis in the overseas markets. Despite a
relatively strong domestic economy, we firmly believed that the Federal Reserve
Board would give precedence to the economic turmoil that occurred in Asia and
eventually spread to Russia. We took advantage of this situation by maintaining
the Fund's average life toward the higher end of our investment horizon. This
strategy proved to be effective as the Federal Reserve Board cut interest rates
in late September, in mid-October, and again in mid-November for a total of 75
basis points.
During 1998, yield spreads between domestic and foreign money market
securities remained relatively wide. This was primarily caused by credit
concerns as investors avoided certain foreign issues. Additionally, there was a
relatively light supply of domestic issuance.
Looking ahead, we believe that monetary policy will be driven more by economic
data than by global market considerations. While the economic picture is not
completely clear at present, we believe the economy is more likely to weaken
than strengthen in 1999.
- ---------------
* Based on a constant investment throughout the period, with dividends
compounded daily, and reflecting a net return to the investor after all
expenses.
64
<PAGE> 66
- --------------------------------------------------------------------------------
The Fund's composition at the end of December and as of our last report to
shareholders is detailed below:
<TABLE>
<CAPTION>
- ------------------------------------------------------
12/31/98 6/30/98
- ------------------------------------------------------
<S> <C> <C>
Bank Notes....................... 14.7% 17.2%
Certificates of Deposit.......... -- 2.0
Commercial Paper................. 39.8 44.3
Corporate Notes.................. 17.7 14.1
Funding Agreements............... 2.8 3.0
Master Notes..................... 2.0 2.4
Repurchase Agreements............ 0.6 --
US Government, Agency &
Instrumentality
Obligations--Discount.......... 7.1 0.8
US Government, Agency &
Instrumentality
Obligations--Non-Discount...... 14.9 16.6
Other Assets Less Liabilities.... 0.4 --
Liabilities in Excess of Other
Assets......................... -- (0.4)
----- -----
Total............................ 100.0% 100.0%
======== =======
- ------------------------------------------------------
</TABLE>
IN CONCLUSION
We appreciate your investment in Domestic Money Market Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to sharing our investment
outlook with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Jacqueline Rogers
Jacqueline Rogers
Vice President and Portfolio Manager
February 5, 1999
65
<PAGE> 67
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE INTEREST MATURITY VALUE
AMOUNT ISSUE RATE* DATE (Note 1a)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BANK NOTES--14.7% $ 4,000,000 American Express Centurion Bank+...... 5.504% 2/12/99 $ 4,000,000
1,000,000 American Express Centurion Bank+...... 5.511 3/19/99 1,000,000
1,900,000 Comerica Bank+........................ 5.531 2/02/99 1,899,942
1,400,000 Comerica Bank+........................ 5.457 2/09/99 1,399,933
4,000,000 FCC National Bank+.................... 4.80 2/23/99 3,999,627
1,900,000 FCC National Bank..................... 5.65 3/03/99 1,898,776
2,000,000 First National Bank of Chicago........ 5.52 2/16/99 1,997,613
1,000,000 First National Bank of Chicago+....... 4.80 2/23/99 999,907
1,800,000 First Tennessee Bank N.A.............. 5.82 4/30/99 1,803,532
600,000 First USA Bank N.A.................... 6.50 12/23/99 607,662
1,700,000 First Union National Bank+............ 4.91 8/30/99 1,700,000
4,000,000 First Union National Bank+............ 4.71 9/01/99 4,000,000
3,000,000 Huntington National Bank+............. 5.451 1/20/99 2,999,936
1,900,000 LaSalle National Bank................. 5.55 2/05/99 1,899,237
4,600,000 LaSalle National Bank................. 5.55 2/08/99 4,597,865
1,000,000 LaSalle National Bank................. 5.55 2/16/99 999,003
1,000,000 LaSalle National Bank................. 5.55 2/22/99 999,596
9,000,000 NationsBank N.A.+..................... 4.83 8/24/99 8,997,767
8,000,000 PNC Bank N.A.+........................ 4.82 1/29/99 7,999,618
6,200,000 PNC Bank N.A.+........................ 5.235 11/03/99 6,195,970
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL BANK NOTES (COST--$60,002,329) 59,995,984
- ---------------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER--39.8% 4,793,000 Apreco, Inc........................... 5.40 2/24/99 4,756,673
9,879,000 Apreco, Inc........................... 5.13 3/15/99 9,784,107
5,000,000 Asset Securitization Cooperative
Corp. .............................. 5.15 3/05/99 4,958,833
3,243,000 Asset Securitization Cooperative
Corp. .............................. 5.10 3/19/99 3,210,069
1,736,000 Asset Securitization Cooperative
Corp. .............................. 5.10 4/16/99 1,711,554
7,000,000 Avco Financial Services Inc........... 5.07 4/05/99 6,912,059
6,000,000 Bankers Trust New York Corporation.... 5.50 1/15/99 5,989,092
4,935,000 Concord Minutemen Capital Co. LLC..... 5.25 1/22/99 4,921,305
8,077,000 Concord Minutemen Capital Co. LLC..... 5.26 1/22/99 8,054,586
7,000,000 Concord Minutemen Capital Co. LLC..... 5.30 1/26/99 6,976,258
226,000 Countrywide Funding Corp.............. 5.50 1/11/99 225,758
9,000,000 Countrywide Funding Corp.............. 5.30 2/11/99 8,949,650
8,357,000 Edison Asset Securitization, LLC...... 5.30 1/15/99 8,342,956
5,000,000 Edison Asset Securitization, LLC...... 5.10 3/17/99 4,950,600
4,750,000 Edison Funding Co..................... 5.40 3/19/99 4,701,766
2,500,000 Finova Capital Corp................... 5.53 2/04/99 2,488,483
4,000,000 General Electric Capital Corp......... 5.47 2/18/99 3,973,250
5,000,000 General Electric Capital Corp......... 5.47 3/04/99 4,959,519
2,900,000 General Motors Acceptance Corp........ 5.49 1/26/99 2,890,164
1,040,000 International Securitization Corp..... 5.45 2/11/99 1,034,127
3,750,000 Knight-Ridder, Inc.................... 5.15 4/20/99 3,695,123
7,500,000 Lehman Brothers Holdings Inc.......... 5.42 2/25/99 7,433,808
5,000,000 Lehman Brothers Holdings Inc.......... 5.50 2/25/99 4,955,872
5,230,000 Lexington Parker Capital Company,
LLC................................. 5.45 2/05/99 5,205,128
9,000,000 Lexington Parker Capital Company,
LLC................................. 5.22 3/04/99 8,927,135
3,686,000 Mont Blanc Capital Corp............... 5.23 3/04/99 3,656,158
5,917,000 Monte Rosa Capital Corp. ............. 5.43 2/19/99 5,876,551
4,000,000 Monte Rosa Capital Corp. ............. 5.15 3/12/99 3,963,224
2,200,000 Morgan Stanley, Dean Witter & Co...... 5.584 1/22/99 2,200,000
1,000,000 Morgan Stanley, Dean Witter, Discover
& Co................................ 5.52 2/08/99 1,000,000
3,910,000 Park Avenue Receivables Corp.......... 5.47 2/08/99 3,889,663
381,000 Park Avenue Receivables Corp.......... 5.45 2/10/99 378,905
4,117,000 Park Avenue Receivables Corp.......... 5.22 2/19/99 4,088,856
7,681,000 Park Avenue Receivables Corp.......... 5.15 3/19/99 7,603,004
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL COMMERCIAL PAPER (COST--$162,646,460) 162,664,236
- ---------------------------------------------------------------------------------------------------------------------------
CORPORATE NOTES--17.7% 4,000,000 Asset-Backed Securities Investment
Trust (ABSIT) 1997-F+++............. 5.495 9/15/99 4,000,000
1,040,000 Associates Corp. of North America..... 6.75 6/28/99 1,046,729
</TABLE>
66
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE INTEREST MATURITY VALUE
AMOUNT ISSUE RATE* DATE (Note 1a)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
CORPORATE NOTES (CONCLUDED) $ 500,000 Associates Corp. of North America..... 7.35 % 7/06/99 $ 505,314
2,000,000 Associates Corp. of North America..... 6.625 7/15/99 2,015,120
1,088,000 Associates Corp. of North America..... 6.75 10/15/99 1,100,969
3,030,000 Beneficial Corp....................... 8.375 12/29/99 3,119,385
1,300,000 The CIT Group Holdings, Inc.+......... 4.89 1/12/99 1,299,986
3,000,000 The CIT Group Holdings, Inc........... 6.25 3/22/99 3,007,050
1,300,000 The CIT Group Holdings, Inc.+......... 4.80 5/24/99 1,299,659
2,750,000 The CIT Group Holdings, Inc.+......... 4.79 6/28/99 2,748,951
3,000,000 Citicorp+............................. 5.45 11/23/99 3,002,550
1,400,000 General Electric Capital Corp.+....... 4.82 6/03/99 1,399,718
2,000,000 General Electric Capital Corp.+....... 5.277 9/03/99 2,000,580
2,500,000 General Motors Acceptance Corp........ 7.75 1/15/99 2,503,946
2,000,000 General Motors Acceptance Corp........ 7.15 4/30/99 2,012,140
1,400,000 General Motors Acceptance Corp.+...... 5.315 6/04/99 1,400,224
1,500,000 General Motors Acceptance Corp........ 6.55 6/04/99 1,508,025
3,425,000 General Motors Acceptance Corp........ 7.375 6/09/99 3,455,688
2,000,000 General Motors Acceptance Corp........ 8.625 6/15/99 2,029,320
500,000 General Motors Acceptance Corp........ 7.25 6/22/99 504,550
1,000,000 General Motors Acceptance Corp........ 5.75 1/05/00 1,004,590
1,400,000 General Motors Acceptance Corp.+...... 5.411 12/01/00 1,400,000
900,000 General Motors Acceptance Corp.+...... 5.28 2/27/01 899,730
3,000,000 Goldman Sachs Group, L.P.+............ 5.25 3/26/99 3,000,600
700,000 Goldman Sachs Group, L.P.+............ 5.348 1/12/00 699,300
2,000,000 Household Finance Corp................ 6.58 5/17/99 2,009,720
1,000,000 Household Finance Corp.+.............. 5.352 9/13/99 999,170
2,750,000 IBM Credit Corp....................... 6.625 4/19/99 2,761,385
7,000,000 Liberty Lighthouse US Capital
Co. LLC+............................ 5.30 10/08/99 6,998,455
600,000 Morgan Stanley, Dean Witter, Discover
& Co.+.............................. 5.298 1/15/99 600,000
2,000,000 Morgan Stanley, Dean Witter, Discover
& Co................................ 5.625 3/01/99 1,997,062
4,000,000 National Rural Utilities Cooperative
Finance Corp.+...................... 5.17 9/21/99 3,998,080
5,000,000 PepsiCo, Inc.+........................ 5.209 8/19/99 4,989,000
52,701 Premier Auto Trust 1998-3+++.......... 5.62 2/08/99 52,701
900,000 Xerox Capital Europe PLC+............. 5.578 8/20/99 898,380
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL CORPORATE NOTES (COST--$72,251,774) 72,268,077
- ---------------------------------------------------------------------------------------------------------------------------
FUNDING 5,000,000 Allstate Life Insurance Co.+.......... 5.172 6/30/99 5,000,000
AGREEMENTS--2.8% 5,000,000 Jackson National Life Insurance
Co.+................................ 5.567 5/03/99 5,000,000
1,500,000 Security Life Of Denver+.............. 5.816 2/23/99 1,500,000
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL FUNDING AGREEMENTS (COST--$11,500,000) 11,500,000
- ---------------------------------------------------------------------------------------------------------------------------
MASTER NOTES--2.0% 8,000,000 Goldman Sachs Group, L.P.+............ 5.547 1/20/99 8,000,000
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL MASTER NOTES (COST--$8,000,000) 8,000,000
- ---------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT AGENCY & 72,000 Federal Home Loan Mortgage
INSTRUMENTALITY Corporation......................... 5.18 2/03/99 71,689
OBLIGATIONS--
DISCOUNT--7.1% 25,000 Federal Home Loan Mortgage
Corporation......................... 5.10 2/26/99 24,814
2,747,000 Federal Home Loan Mortgage
Corporation......................... 4.86 3/22/99 2,718,680
4,000,000 Federal Home Loan Mortgage
Corporation......................... 4.85 3/26/99 3,956,620
805,000 Federal National Mortgage
Association......................... 5.10 3/15/99 797,455
88,000 Federal National Mortgage
Association......................... 4.92 3/26/99 87,046
4,000,000 Federal National Mortgage
Association......................... 4.68 6/09/99 3,918,013
4,000,000 Federal National Mortgage
Association......................... 4.59 7/08/99 3,902,772
</TABLE>
67
<PAGE> 69
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE INTEREST MATURITY VALUE
AMOUNT ISSUE RATE* DATE (Note 1a)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
US GOVERNMENT AGENCY & $ 2,000,000 Federal National Mortgage
INSTRUMENTALITY Association......................... 4.54 % 9/09/99 $ 1,935,107
OBLIGATIONS--DISCOUNT
(CONCLUDED)
1,000,000 Student Loan Marketing
Association......................... 4.62 6/30/99 976,744
5,100,000 US Treasury Bills..................... 3.69 4/22/99 5,032,833
4,800,000 US Treasury Bills..................... 3.80 10/14/99 4,635,483
1,000,000 US Treasury Bills..................... 3.81 10/14/99 965,725
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL US GOVERNMENT AGENCY & INSTRUMENTALITY
OBLIGATIONS--DISCOUNT (COST--$29,064,865) 29,022,981
- ---------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT AGENCY & 500,000 Federal Home Loan Bank................ 6.08 6/30/99 502,665
INSTRUMENTALITY 11,400,000 Federal Home Loan Bank+............... 5.168 9/02/99 11,396,236
OBLIGATIONS--
NON-DISCOUNT--14.9% 1,400,000 Federal Home Loan Bank................ 5.705 3/23/00 1,401,120
800,000 Federal Home Loan Mortgage
Corporation......................... 5.875 5/19/00 801,600
1,300,000 Federal Home Loan Mortgage
Corporation......................... 5.18 11/24/00 1,295,086
6,000,000 Federal National Mortgage
Association+........................ 5.028 1/21/99 5,999,860
11,300,000 Federal National Mortgage
Association+........................ 5.028 3/03/99 11,299,236
2,750,000 Federal National Mortgage
Association+........................ 5.108 4/09/99 2,749,642
4,000,000 Federal National Mortgage
Association+........................ 5.043 7/30/99 3,998,113
5,000,000 Federal National Mortgage
Association+........................ 5.103 8/19/99 4,997,714
2,000,000 Federal National Mortgage
Association+........................ 5.08 9/24/99 2,000,800
2,300,000 Federal National Mortgage
Association+........................ 5.138 10/27/99 2,299,122
1,000,000 Federal National Mortgage
Association......................... 5.07 12/14/00 995,700
1,900,000 Student Loan Marketing Association.... 4.50 8/02/99 1,897,150
4,000,000 Student Loan Marketing Association+... 5.083 2/04/00 3,998,958
3,900,000 US Treasury Notes..................... 7.125 9/30/99 3,968,858
600,000 US Treasury Notes..................... 4.50 9/30/00 598,875
600,000 US Treasury Notes..................... 4.625 11/30/00 600,562
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL US GOVERNMENT AGENCY & INSTRUMENTALITY
OBLIGATIONS--NON-DISCOUNT (COST--$60,797,021) 60,801,297
- ---------------------------------------------------------------------------------------------------------------------------
REPURCHASE 2,688,000 Nomura Securities International, Inc.,
AGREEMENTS**--0.6% purchased on 12/31/1998 to yield
5.10% to 1/04/1999.................. 2,688,000
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL REPURCHASE AGREEMENTS (COST--$2,688,000) 2,688,000
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(COST--$406,950,449)--99.6%........... 406,940,575
OTHER ASSETS LESS LIABILITIES--0.4%... 1,576,665
------------
NET ASSETS--100.0%.................... $408,517,240
============
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Commercial Paper and certain US Government & Agency Obligations are traded on
a discount basis; the interest rates shown reflect the discount rates paid at
the time of purchase by the Fund. Other securities bear interest at the rates
shown, payable at fixed dates or upon maturity. The interest rates on variable
rate securities are adjusted periodically based upon appropriate indexes; the
interest rates shown are the rates in effect at December 31, 1998.
** Repurchase Agreements are fully collateralized by US Government Obligations.
+ Variable Rate Notes.
++ Subject to principal paydowns.
See Notes to Financial Statements.
68
<PAGE> 70
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$406,950,449*) (Note
1a)....................................................... $406,940,575
Cash........................................................ 12,267
Receivables:
Interest.................................................. $2,404,931
Capital shares sold....................................... 4,419 2,409,350
----------
Prepaid expenses and other assets........................... 32,709
------------
Total assets................................................ 409,394,901
------------
- ---------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Capital shares redeemed................................... 589,886
Investment adviser (Note 2)............................... 190,870 780,756
----------
Accrued expenses and other liabilities...................... 96,905
------------
Total liabilities........................................... 877,661
------------
- ---------------------------------------------------------------------------------------
NET ASSETS.................................................. $408,517,240
============
- ---------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value,
1,300,000,000 shares authorized+.......................... $ 40,852,711
Paid-in capital in excess of par............................ 367,674,403
Unrealized depreciation on investments--net................. (9,874)
------------
NET ASSETS.................................................. $408,517,240
============
- ---------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $408,517,240 and 408,527,114
shares outstanding........................................ $ 1.00
============
- ---------------------------------------------------------------------------------------
</TABLE>
* Cost for Federal income tax purposes. As of December 31, 1998, net unrealized
depreciation for Federal income tax purposes amounted to $9,874, of which
$98,111 related to appreciated securities and $107,985 related to depreciated
securities.
+ The Fund is also authorized to issue 1,300,000,000 Class B Shares.
See Notes to Financial Statements.
69
<PAGE> 71
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTE 1d):
Interest and discount earned................................ $19,707,780
- ----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $1,765,415
Accounting services (Note 2)................................ 63,465
Printing and shareholder reports............................ 58,406
Professional fees........................................... 28,516
Registration fees........................................... 23,790
Custodian fees.............................................. 21,081
Directors' fees and expenses................................ 7,365
Transfer agent fees (Note 2)................................ 5,113
Interest expense............................................ 642
Other....................................................... 4,215
----------
Total expenses.............................................. 1,978,008
-----------
Investment income--net...................................... 17,729,772
-----------
- ----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET (NOTE
1d):
Realized gain on investments--net........................... 47,278
Change in unrealized appreciation/depreciation on
investments--net.......................................... (19,258)
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $17,757,792
===========
- ----------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
70
<PAGE> 72
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
----------------------------
INCREASE (DECREASE) IN NET ASSETS: 1998 1997
- ------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $17,729,772 $ 15,851,341
Realized gain on investments--net........................... 47,278 13,669
Change in unrealized appreciation/depreciation on
investments--net.......................................... (19,258) 28,848
------------ ------------
Net increase in net assets resulting from operations........ 17,757,792 15,893,858
------------ ------------
- ------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1e):
Investment income--net: Class A............................. (17,729,772) (15,851,341)
Realized gain on investments--net: Class A.................. (47,278) (13,669)
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (17,777,050) (15,865,010)
------------ ------------
- ------------------------------------------------------------------------------------------
CLASS A CAPITAL SHARE TRANSACTIONS (NOTE 3):
Net proceeds from sale of shares............................ 289,645,200 242,312,822
Net asset value of shares issued to shareholders in
reinvestment of dividends and distributions (Note 1e)..... 17,785,712 15,869,707
------------ ------------
307,430,912 258,182,529
Cost of shares redeemed..................................... (216,946,151) (214,915,654)
------------ ------------
Net increase in net assets derived from Class A capital
share transactions........................................ 90,484,761 43,266,875
------------ ------------
- ------------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 90,465,503 43,295,723
Beginning of year........................................... 318,051,737 274,756,014
------------ ------------
End of year................................................. $408,517,240 $318,051,737
============ ============
- ------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
71
<PAGE> 73
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE CLASS A
BEEN DERIVED FROM INFORMATION PROVIDED IN THE --------------------------------------------------------
FINANCIAL STATEMENTS. FOR THE YEAR ENDED
DECEMBER 31,
--------------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year....................... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
-------- -------- -------- -------- --------
Investment income--net................................... .0506 .0511 .0504 .0547 .0386
Realized and unrealized gain (loss) on
investments--net....................................... --+ .0001 (.0005) .0012 (.0007)
-------- -------- -------- -------- --------
Total from investment operations......................... .0506 .0512 .0499 .0559 .0379
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net................................. (.0508) (.0511) (.0504) (.0547) (.0386)
Realized gain on investments--net...................... --+ --+ (.0001) (.0002) --
-------- -------- -------- -------- --------
Total dividends and distributions........................ (.0508) (.0511) (.0505) (.0549) (.0386)
-------- -------- -------- -------- --------
Net asset value, end of year............................. $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share....................... 5.20% 5.24% 5.13% 5.64% 3.93%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement........................... .56% .54% .54% .55% .50%
======== ======== ======== ======== ========
Expenses................................................. .56% .54% .54% .55% .57%
======== ======== ======== ======== ========
Investment income--net, and realized gain on
investments--net....................................... 5.03% 5.12% 4.97% 5.50% 4.02%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)................... $408,517 $318,052 $274,756 $303,912 $363,199
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Amount is less than $.0001 per share.
See Notes to Financial Statements.
72
<PAGE> 74
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
NOTES TO FINANCIALS STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Class A and
Class B Shares have equal voting, dividend, liquidation and other rights, except
that only shares of the respective classes are entitled to vote on matters
concerning only that class and Class B Shares bear certain expenses related to
the distribution of such shares. Domestic Money Market Fund (the "Fund") is
classified as "diversified," as defined in the Investment Company Act of 1940.
The Fund's financial statements are prepared in accordance with generally
accepted accounting principles which may require the use of management accruals
and estimates. The following is a summary of significant accounting policies
followed by the Fund.
(a) Valuation of investments--Portfolio securities with remaining maturities
of greater than sixty days are valued at the most recent bid price or yield
equivalent as obtained from dealers that make markets in such securities. As
securities transition from sixty-one to sixty days to maturity, the difference
between the valuation existing on the sixty-first day before maturity and
maturity value is amortized on a straight-line basis to maturity. Securities
maturing sixty days or less from their date of acquisition are valued at
amortized cost, which approximates market value. For the purposes of valuation,
the maturity of a variable rate security is deemed to be the next coupon date on
which the interest rate is to be adjusted. Other investments for which market
quotations are not readily available are valued at their fair value as
determined in good faith by or under the direction of the Company's Board of
Directors.
(b) Repurchase agreements--The Fund invests in US Government securities
pursuant to repurchase agreements. Under such agreements, the counterparty
agrees to repurchase the security at a mutually agreed upon time and price. The
Fund takes possession of the underlying securities, marks to market such
securities and, if necessary, receives additional securities daily to ensure
that the contract is fully collateralized.
(c) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Interest income (including amortization of premium and discount) is recognized
on the accrual basis. Realized gains and losses on security transactions are
determined on the identified cost basis.
(e) Dividends and distributions to shareholders--The Fund declares dividends
daily and reinvests monthly such dividends (net of non-resident alien tax and
back-up withholding tax withheld) in additional Fund shares at net asset value.
Dividends and distributions are declared from the total of net investment income
and net realized gain or loss on investments.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee at
the annual rate of 0.50% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
73
<PAGE> 75
- --------------------------------------------------------------------------------
Merrill Lynch Funds Distributor, a division of Princeton Funds Distributor,
Inc. ("PFD"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
is the Fund's distributor.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Fund are officers and/or directors of
MLAM, PSI, FDS, PFD, and/or ML & Co.
3. CAPITAL SHARE TRANSACTIONS:
The number of shares sold and redeemed during the years corresponds to the
amounts included in the Statements of Changes in Net Assets with respect to net
proceeds from sale of shares and cost of shares redeemed, respectively, since
shares are recorded at $1.00 per share.
74
<PAGE> 76
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
DOMESTIC MONEY MARKET FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Domestic Money Market Fund of Merrill Lynch
Variable Series Funds, Inc. as of December 31, 1998, the related statements of
operations for the year then ended and changes in net assets for each of the
years in the two-year period then ended, and the financial highlights for each
of the years in the five-year period then ended. These financial statements and
the financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and the
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1998 by correspondence with the custodian and broker. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Domestic Money
Market Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31,
1998, the results of its operations, the changes in its net assets, and the
financial highlights for the respective stated periods in conformity with
generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
75
<PAGE> 77
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
ANNUAL REPORT--DECEMBER 31, 1998
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
FISCAL YEAR IN REVIEW
For the fiscal year ended December 31, 1998, the Global Bond Focus Fund's
Class A Shares had a total return of +12.62%, compared to a +15.31% total return
for the unmanaged J.P. Morgan Global Government Bond Index.
The Fund's fiscal year began with global markets still feeling the
deflationary and recessionary impact of the Asian financial crisis. At this
time, most of the Fund's investments were in corporate bonds, since we believed
they would offer attractive total returns relative to government securities.
However, Fund performance was negatively affected as corporate bond yields
relative to government issues widened during the "flight to quality" that began
in August when Russia devaluated the ruble. Also, our investment in
mortgage-backed securities hurt performance because as interest rates declined,
the price of the securities would not appreciate beyond a certain point because
of mortgage refinancings and paydowns.
During the 12-month period, our Japanese currency exposure was hedged back
into US dollars, and our Japanese investments had a lower duration relative to
the benchmark unmanaged J.P. Morgan Global Government Bond Index. We took this
position because we believed that the yen would weaken relative to the US dollar
and that Japanese interest rates could not decline much further. The currency
strategy worked in our favor for most of the fiscal year, but hampered
performance during the latter part of the period as the yen strengthened
relative to the US dollar. On the other hand, the lower duration of our Japanese
investments relative to the Index benefitted the Fund as interest rates rose by
100 basis points (1.00%) or more in longer-dated securities during the fourth
quarter of 1998.
During the global financial crisis of August and September, we began to
improve the quality and liquidity of the Fund's holdings by buying fewer
corporate bonds and more sovereign debt. In addition, as countries began to
lower interest rates in September and October, we extended the duration of the
Fund in order to seek to enhance returns.
The Fund's performance was enhanced through our overweighted duration in the
European Monetary Union (EMU) countries relative to the benchmark index as
interest rates declined prior to conversion to the euro. For non-EMU countries,
we believed the United Kingdom possessed solid prospects for increased returns
given the cuts in British interest rates and its inverted yield curve. We were
confident that long-term interest rates would decline sharply given the
country's economic weakness. Our exposure was primarily in securities with
maturities under eight years, which rallied during the final quarter of 1998. In
addition, we determined that our positions in variable rate securities in Greece
would underperform in this lower interest rate environment. We traded these
securities for fixed-rate securities in the ten-year sector, which appreciated
as interest rates fell and Greek withholding tax on these securities was
eliminated.
THE ENVIRONMENT
The most significant development in global fixed-income markets during 1998
was the flight to quality that began in August, triggered by the financial
crises in Russia and Brazil. Although decisive fiscal and monetary policy moves
worldwide helped stabilize global markets and began to shrink risk premiums
within a relatively short time frame, bond markets had not returned to
pre-August levels by the end of the year. From this quick return in confidence,
it appeared clear that reductions in interest rates would continue as long as
markets were in disarray and global recessionary pressures persisted. In
general, the market returned to a more stable posture by year-end, but with some
volatility prompted by the exceptional strength of the US stock market, the
ongoing problems in Brazil, and the US/UK air strikes in Iraq. On the plus side,
inflationary pressures were still non-existent as commodity prices came down to
historic lows and growth began to moderate and taper off throughout the world.
In this environment, we anticipate that we may maintain a conservative strategy
regarding quality, but we may extend maturities if we believe interest rates are
likely to decline in the coming months.
MARKET REVIEW
During the six months ended December 31, 1998, US Government bond prices
appreciated dramatically. The long-term bond yields traded down from 5.70% in
May to 5.10% by December. However, this decline in interest rates was very
volatile. Third-quarter gross domestic product (GDP) growth was 3.9%, displaying
that growth in the United States was still robust, but at a lower GDP rate than
in the first quarter of 1998 (4.8%). Lower interest rates were making housing
more affordable and unemployment was subdued as well. Commodity prices were
reaching historic lows, especially oil, which traded below $10 per barrel.
76
<PAGE> 78
- --------------------------------------------------------------------------------
As of December 31,1998, our US investments had an average duration of 9.4
years, since we expected the global recession to impact the US economy by the
first half of 1999. We also believe that additional flights to quality could
occur prompted by events in Brazil or in other emerging markets. In this
environment, we believe it is important to focus on good-quality investments
that offer a high degree of liquidity. Currently, we are not concerned about
inflation, and we see no evidence that the global deflationary forces will
subside in the near term.
In Canada, GDP growth was lower than expected in the third quarter of 1998,
signifying that the economy was continuing to slow. The Bank of Canada raised
interest rates 100 basis points in August to support the declining Canadian
dollar, but this further dampened the domestic demand. In September, the bank
reversed its position somewhat and eased interest rates by 25 basis points, and
also cut interest rates in October and November. If this trend continues,
Canadian interest rates could decline at least another 100 basis points over the
next six months.
The dominant story in Europe was the EMU and the 11 countries converging their
currencies and interest rates as of January 1, 1999. The convergence rate was
posted at 3.30%, and countries were working toward that rate during the latter
part of 1998. Along the way, some countries voiced the need to lower the target
rate in order to stimulate demand and growth in their respective economies and
to raise employment. The resulting interest rate cuts reflected concerns among
central banks that the global economy may be headed for a recession.
During the six-month period ended December 31, 1998, we maintained our
position in Greece, a country that is expected to enter the EMU in the next
round. Greece has managed its economy with responsible fiscal measures, and we
anticipate lower interest rates there. We are also positive toward the United
Kingdom and its prospect for entering the EMU. The inverted shape of the UK
yield curve and high level of unemployment dictate taking positions with
maturities of ten years or less.
Over the six months ended December 31, 1998, New Zealand and Australian
currencies were hurt by falling commodity prices and Japan's recession. Since
both countries are net exporters of commodities, the decline in prices hurt
their economies. However, as the crisis subsided in early October, these
currencies began to rally. As of December 31, 1998, we held an unhedged position
in New Zealand.
In Japan, the yen started the six-month period by getting progressively
weaker, hitting a low of Y147.26/US dollar on August 11, 1998. The yen then
proceeded to appreciate and reached its strongest point in October after the
announcement that a banking reform bill had passed. By December 31, 1998, the
yen had reached Y112.75/US dollar. Looking ahead, we do not expect to see
interest rates falling much further in Japan, but the economy is still resistant
to improvement. We are underweighted in Japan relative to the benchmark index,
and our position is hedged given our expectation that the yen is likely to
resume its weakening trend relative to the US dollar level over the next six
months.
IN CONCLUSION
We appreciate your investment in Global Bond Focus Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to sharing our investment
outlook and strategies with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Harry Escobar
Harry Escobar
Portfolio Manager
February 5, 1998
- ---------------------------------------------------------
Effective December 2, 1998, Harry Escobar assumed the responsibilities for the
day-to-day management of Global Bond Focus Fund of Merrill Lynch Variable Series
Funds, Inc. Mr. Escobar has been a Director of Merrill Lynch Asset Management,
L.P. since August 1998. Prior thereto, he was national sales manager for Lehman
Brothers' Middle Market Sales Group from 1991 to 1998.
- ---------------------------------------------------------
77
<PAGE> 79
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
Global Bond Focus Fund
Total Return Based on a $10,000 Investment-Class A Shares
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the JP Morgan Global Government Bond
Index and the Merrill Lynch US Treasury/Agency 1-10 Year Index. Beginning and
ending values are:
<TABLE>
<CAPTION>
7/01/93** 12/98
--------- -----
<S> <C> <C>
Global Bond Focus Fund+ -- Class A Shares* $10,000 $14,681
JP Morgan Global Government Bond Index++ $10,000 $15,408
Merrill Lynch US Treasury/Agency 1-10
Years Index+++ $10,000 $14,017
</TABLE>
<TABLE>
<C> <S>
* Assuming transaction costs and other operating expenses,
including advisory fees. Does not include insurance-related
fees and expenses.
** Commencement of operations.
+ Global Bond Focus Fund invests in US and foreign government
and corporate bonds denominated in various securities.
++ This unmanaged Index is comprised of government bonds in the
13 largest bond markets, including the United States.
+++ This unmanaged Index is comprised of intermediate-term
Government bonds maturing in one year--ten years.
Past performance is not predictive of future performance.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/98 +12.62%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/98 +6.75
- --------------------------------------------------------------------------------
Inception (7/01/93) through 12/31/98 +7.23
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
RECENT PERFORMANCE RESULTS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
12 MONTH 6 MONTH
TOTAL RETURN TOTAL RETURN
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Class A Shares +12.62% +7.29%
</TABLE>
- --------------------------------------------------------------------------------
<TABLE>
<C> <S>
* Total investment returns are based on changes in net asset
values for the periods shown, and assume reinvestment of all
dividends and capital gains distributions at net asset value on
the payable date. Insurance-related fees and expenses are not
reflected in these returns. Past results shown should not be
considered a representation of future performance.
</TABLE>
78
<PAGE> 80
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE VALUE PERCENT OF
AFRICA INDUSTRY AMOUNT FIXED-INCOME INVESTMENTS COST (NOTE 1A) NET ASSETS
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
SOUTH AFRICA SUPRANATIONAL Y 315,000,000 African Development
Bank, 6.20% due
6/18/2002............. $ 3,029,061 $ 3,265,333 4.7%
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
AFRICA 3,029,061 3,265,333 4.7
- ---------------------------------------------------------------------------------------------------------------------------
NORTH AMERICA
- ---------------------------------------------------------------------------------------------------------------------------
CANADA FOREIGN GOVERNMENT NZ$ 4,200,000 Canada Government Bond,
OBLIGATIONS 6.625% due
10/03/2007............ 2,542,374 2,259,876 3.2
------------------------------------------------------------------------------------------------------
SUPRANATIONAL C$ 2,030,000 Interamerican
Development Bank,
7.25% due 11/03/2003.. 1,432,602 1,433,925 2.1
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN CANADA 3,974,976 3,693,801 5.3
- ---------------------------------------------------------------------------------------------------------------------------
UNITED STATES BANKING US$ 4,600,000 Comerica Bank, 7.875%
due 9/15/2026......... 4,972,858 5,378,918 7.8
50,000 Mellon Capital II,
7.995% due
1/15/2027............. 49,192 55,593 0.1
----------- ----------- -----
5,022,050 5,434,511 7.9
------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES 2,000,000 Association Corp. N.A.,
7.375% due 6/11/2007.. 2,101,400 2,149,246 3.1
DM 3,700,000 Ford Motor Credit Co.,
5.25% due 6/16/2008... 2,073,994 2,297,731 3.3
----------- ----------- -----
4,175,394 4,446,977 6.4
------------------------------------------------------------------------------------------------------
GAMING US$ 21,001 Jazz Casino Co. LLC:
0% due
11/15/2009+++......... 0 0 0.0
215,500 5.867% due
11/15/2009++.......... 103,025 100,208 0.1
----------- ----------- -----
103,025 100,208 0.1
------------------------------------------------------------------------------------------------------
INDUSTRIAL 2,500,000 Phelps Dodge
Corporation, 7.125%
due 11/01/2027........ 2,488,000 2,449,625 3.5
------------------------------------------------------------------------------------------------------
US GOVERNMENT 1,760,000 Federal National
AGENCY OBLIGATIONS Mortgage Association,
5.25% due 1/15/2003... 1,750,650 1,772,091 2.6
------------------------------------------------------------------------------------------------------
US TREASURY BONDS 1,400,000 US Treasury Bonds &
& NOTES Notes:
4.75% due 11/15/2008.. 1,416,406 1,410,934 2.0
3,650,000 5.25% due 11/15/2028.... 3,697,603 3,736,688 5.4
----------- ----------- -----
5,114,009 5,147,622 7.4
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN THE
UNITED STATES 18,653,128 19,351,034 27.9
- ---------------------------------------------------------------------------------------------------------------------------
SHARES
HELD COMMON STOCKS & WARRANTS
- ---------------------------------------------------------------------------------------------------------------------------
UNITED STATES BROADCASTING/CABLE 4,700 American Telecasting,
Inc. (Warrants) **.... 11,222 47 0.0
------------------------------------------------------------------------------------------------------
GAMING 6,089 +JCC Holding Company.... 24,356 20,550 0.0
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS &
WARRANTS IN THE UNITED
STATES 35,578 20,597 0.0
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
NORTH AMERICA 22,663,682 23,065,432 33.2
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
79
<PAGE> 81
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC FACE VALUE PERCENT OF
BASIN INDUSTRY AMOUNT FIXED-INCOME INVESTMENTS COST (NOTE 1A) NET ASSETS
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
JAPAN FOREIGN GOVERNMENT Y 398,000,000 Japanese Government Bond
OBLIGATIONS #155, 4.60% due
3/20/2003............. $ 3,817,045 $ 3,997,050 5.8%
------------------------------------------------------------------------------------------------------
SUPRANATIONAL 65,000,000 Asian Development Bank,
5.625% due 2/18/2002.. 750,697 655,263 0.9
20,000,000 International Bank for
Reconstruction &
Development, 4.50% due
6/20/2000............. 173,986 187,523 0.3
----------- ----------- -----
924,683 842,786 1.2
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE
PACIFIC BASIN 4,741,728 4,839,836 7.0
- ---------------------------------------------------------------------------------------------------------------------------
WESTERN EUROPE
- ---------------------------------------------------------------------------------------------------------------------------
DENMARK BANKING US$ 2,100,000 Den Danske Bank, 7.40%
due 6/15/2010*........ 2,172,030 2,163,504 3.1
------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES Dkr 10,657,000 Nykredit A/S, 6% due
10/01/2026............ 1,485,870 1,673,092 2.4
------------------------------------------------------------------------------------------------------
FOREIGN GOVERNMENT 3,000,000 Kingdom of Denmark, 7%
OBLIGATIONS due 12/15/2004........ 478,193 542,047 0.8
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN DENMARK 4,136,093 4,378,643 6.3
- ---------------------------------------------------------------------------------------------------------------------------
FINLAND FOREIGN Fim 7,000,000 Finnish Government Bond,
GOVERNMENT 7.25% due 4/18/2006... 1,459,146 1,664,947 2.4
OBLIGATIONS
Y 246,000,000 Republic of Finland, 6%
due 1/29/2002......... 2,388,085 2,503,636 3.6
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN FINLAND 3,847,231 4,168,583 6.0
- ---------------------------------------------------------------------------------------------------------------------------
FRANCE FOREIGN Frf 3,550,000 Government of France
GOVERNMENT OAT:
OBLIGATIONS 8.50% due 10/25/2008.. 803,550 870,556 1.3
ECU 590,000 8.25% due 4/25/2022..... Frf1,005,447 1,035,726 1.5
----------- ----------- -----
1,808,997 1,906,282 2.8
------------------------------------------------------------------------------------------------------
TELECOMMUNI- Frf 8,500,000 France Telecom, 5.75%
CATIONS due 4/25/2007......... 1,519,598 1,683,361 2.4
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN FRANCE 3,328,595 3,589,643 5.2
- ---------------------------------------------------------------------------------------------------------------------------
GERMANY ASSET-BACKED DM 3,150,000 European Credit Card,
SECURITIES Series A, 5.25% due
6/18/2008............. 1,939,825 1,980,567 2.9
------------------------------------------------------------------------------------------------------
FOREIGN 450,000 Bundesrepublic
GOVERNMENT Deutschland:
OBLIGATIONS 6.75% due 4/22/2003... 311,821 306,303 0.4
625,000 7.50% due 11/11/2004.... 452,947 451,230 0.7
500,000 6.25% due 4/26/2006..... 337,334 346,699 0.5
400,000 German Unity Fund, 8%
due 1/21/2002......... 298,229 272,317 0.4
3,750,000 Land Baden-
Wuerttemberg, 5.75%
due 1/19/2028......... 2,035,079 2,462,710 3.5
----------- ----------- -----
3,435,410 3,839,259 5.5
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN GERMANY 5,375,235 5,819,826 8.4
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
80
<PAGE> 82
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE FACE VALUE PERCENT OF
(CONCLUDED) INDUSTRY AMOUNT FIXED-INCOME INVESTMENTS COST (NOTE 1A) NET ASSETS
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
GREECE FOREIGN Grd 366,000,000 Hellenic Republic, 8.60%
GOVERNMENT due 3/26/2008......... $ 1,419,454 $ 1,455,370 2.1%
OBLIGATIONS
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN GREECE 1,419,454 1,455,370 2.1
- ---------------------------------------------------------------------------------------------------------------------------
ITALY FOREIGN Lit 6,045,000,000 Buoni Poliennali Del
GOVERNMENT Tesoro (Italian
OBLIGATIONS Government Bond), 10%
due 8/01/2003......... 4,252,375 4,638,888 6.7
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN ITALY 4,252,375 4,638,888 6.7
- ---------------------------------------------------------------------------------------------------------------------------
SWEDEN FOREIGN Skr 8,500,000 Swedish Government Bond,
GOVERNMENT 10.25% due
OBLIGATIONS 5/05/2000............. 1,411,881 1,140,862 1.6
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN SWEDEN 1,411,881 1,140,862 1.6
- ---------------------------------------------------------------------------------------------------------------------------
UNITED KINGDOM FINANCIAL SERVICES L 1,500,000 Scottish Life Finance,
9% due 11/29/2049..... 2,528,895 2,756,588 4.0
------------------------------------------------------------------------------------------------------
FOREIGN 800,000 United Kingdom Gilt:
GOVERNMENT 7% due 11/06/2001..... 1,299,561 1,411,240 2.1
OBLIGATIONS
300,000 8% due 6/10/2003........ 490,794 569,578 0.8
530,000 8.50% due 12/07/2005.... 945,081 1,093,650 1.6
150,000 9% due 7/12/2011........ 252,237 357,359 0.5
----------- ----------- -----
2,987,673 3,431,827 5.0
------------------------------------------------------------------------------------------------------
INDUSTRIAL 1,000,000 BAA PLC, 7.875% due
2/10/2007............. 1,758,300 1,902,586 2.7
320,000 BOC Group PLC, 7.25% due
6/07/2002............. 531,453 554,810 0.8
----------- ----------- -----
2,289,753 2,457,396 3.5
------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 400,000 Vodafone Group PLC,
7.875% due
11/06/2001............ 669,126 693,062 1.0
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN THE
UNITED KINGDOM 8,475,447 9,338,873 13.5
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
WESTERN EUROPE 32,246,311 34,530,688 49.8
- ---------------------------------------------------------------------------------------------------------------------------
SHORT-TERM SECURITIES
- ---------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT AGENCY OBLIGATIONS*** US$ 1,969,000 Federal Home Loan
Mortgage Corporation,
4.70% due 1/04/1999... 1,968,229 1,968,229 2.8
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SHORT-TERM SECURITIES 1,968,229 1,968,229 2.8
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS....... $64,649,011 67,669,518 97.5
===========
UNREALIZED DEPRECIATION
ON FORWARD FOREIGN
EXCHANGE CONTRACTS--
NET ****.............. (484,777) (0.7)
OTHER ASSETS LESS
LIABILITIES........... 2,231,539 3.2
----------- -----
NET ASSETS.............. $69,416,280 100.0%
=========== =====
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
+ Non-income producing security.
++ Represents a pay-in-kind security which may pay interest/dividends in
additional face amount/shares.
+++ Represents an obligation by Jazz Casino Co. LLC to pay a semi-annual amount
to the Fund through 11/15/2009. The payments are based upon varying interest
rates and the amounts, which may be paid-in-kind, are contingent upon the
earnings before income taxes, depreciation and amortization of Jazz Casino LLC
on a fiscal year basis.
* The security may be offered and sold to "qualified institutional buyers" under
Rule 144A of the Securities Act of 1933.
81
<PAGE> 83
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED)
- --------------------------------------------------------------------------------
** Warrants entitle the Fund to purchase a predetermined number of shares of
Common Stock and are non-income producing. The purchase price and number of
shares are subject to adjustment under certain conditions until the expiration
date.
*** Certain US Government Agency Obligations are traded on a discount basis; the
interest rates shown reflect the discount rates paid at the time of purchase by
the Fund.
**** Forward foreign exchange contracts as of December 31, 1998 were as follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
UNREALIZED
APPRECIATION
(DEPRECIATION)
FOREIGN CURRENCY PURCHASED EXPIRATION DATE (Note 1b)
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
DM 15,022,808 January 1999 $ 30,878
L 681,564 January 1999 2,562
- ----------------------------------------------------------------------------------------------------------------------
TOTAL (US$ COMMITMENT--$10,127,671) 33,440
---------
- ----------------------------------------------------------------------------------------------------------------------
FOREIGN CURRENCY SOLD
- ----------------------------------------------------------------------------------------------------------------------
DM 14,709,874 January 1999 (181,772)
L 2,006,391 January 1999 (11,296)
Y 1,046,924,450 January 1999 (325,149)
- ----------------------------------------------------------------------------------------------------------------------
TOTAL (US$ COMMITMENT--$20,978,483) (518,217)
---------
- ----------------------------------------------------------------------------------------------------------------------
TOTAL UNREALIZED DEPRECIATION ON FORWARD FOREIGN EXCHANGE CONTRACTS--NET $(484,777)
=========
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
82
<PAGE> 84
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$64,649,011) (Note
1a)....................................................... $67,669,518
Foreign cash (Note 1c)...................................... 658,562
Cash........................................................ 518
Receivables:
Interest.................................................. $1,622,468
Dividends................................................. 24,831
Securities sold........................................... 9,082 1,656,381
----------
Prepaid expenses and other assets........................... 5,292
-----------
Total assets................................................ 69,990,271
-----------
- ------------------------------------------------------------------------------------------
LIABILITIES:
Unrealized depreciation on forward foreign exchange
contracts (Note 1b)....................................... 484,777
Payables:
Investment adviser (Note 2)............................... 35,646
Capital shares redeemed................................... 25,109 60,755
----------
Accrued expenses and other liabilities...................... 28,459
-----------
Total liabilities........................................... 573,991
-----------
- ------------------------------------------------------------------------------------------
NET ASSETS.................................................. $69,416,280
===========
- ------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 200,000,000
shares authorized+........................................ $ 701,009
Paid-in capital in excess of par............................ 68,118,155
Undistributed investment income--net........................ 81,521
Accumulated realized capital losses on investments and
foreign currency transactions--net (Note 6)............... (2,069,643)
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 2,585,238
-----------
NET ASSETS.................................................. $69,416,280
===========
- ------------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $69,416,280 and 7,010,090
shares outstanding........................................ $ 9.90
===========
- ------------------------------------------------------------------------------------------
</TABLE>
+ The Fund is also authorized to issue 200,000,000 Class B Shares.
See Notes to Financial Statements.
83
<PAGE> 85
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Interest and discount earned (net of $5,454 foreign
withholding tax).......................................... $4,597,159
Other income................................................ 37,614
----------
Total income................................................ 4,634,773
----------
- -----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $ 430,336
Printing and shareholder reports............................ 31,717
Custodian fees.............................................. 27,163
Professional fees........................................... 18,032
Accounting services (Note 2)................................ 14,573
Transfer agent fees (Note 2)................................ 5,118
Directors' fees and expenses................................ 1,694
Amortization of organization expenses (Note 1f)............. 789
Pricing services............................................ 502
Other....................................................... 5,055
----------
Total expenses.............................................. 534,979
----------
Investment income--net...................................... 4,099,794
----------
- -----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET (NOTES 1b, 1c, 1e & 3):
Realized gain from:
Investments--net.......................................... 1,253,811
Foreign currency transactions--net........................ 188,301 1,442,112
----------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... 3,693,929
Foreign currency transactions--net........................ (729,763) 2,964,166
---------- ----------
Net realized and unrealized gain on investments and foreign
currency transactions..................................... 4,406,278
----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $8,506,072
==========
- -----------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
84
<PAGE> 86
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-------------------------------
INCREASE (DECREASE) IN NET ASSETS: 1998 1997
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 4,099,794 $ 4,925,061
Realized gain (loss) on investments and foreign currency
transactions--net......................................... 1,442,112 (4,766,749)
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ 2,964,166 657,214
------------ ------------
Net increase in net assets resulting from operations........ 8,506,072 815,526
------------ ------------
- -----------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS (NOTE 1G):
Investment income--net:
Class A................................................... (3,660,200) (2,532,863)
In excess of investment income--net:
Class A................................................... (540,914) (276,658)
Return of capital:
Class A................................................... -- (2,511,049)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders.............................................. (4,201,114) (5,320,570)
------------ ------------
- -----------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net decrease in net assets derived from capital share
transactions.............................................. (10,995,882) (13,177,662)
------------ ------------
- -----------------------------------------------------------------------------------------------
NET ASSETS:
Total decrease in net assets................................ (6,690,924) (17,682,706)
Beginning of year........................................... 76,107,204 93,789,910
------------ ------------
End of year*................................................ $ 69,416,280 $ 76,107,204
============ ============
- -----------------------------------------------------------------------------------------------
*Undistributed (accumulated distributions in excess of)
investment income--net (Note 1h)........................... $ 81,521 $ (439,594)
============ ============
- -----------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
85
<PAGE> 87
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED CLASS A
FROM INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. ----------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1998+ 1997+ 1996+ 1995+ 1994
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year......................... $ 9.32 $ 9.76 $ 9.79 $ 9.17 $ 10.38
------- ------- ------- ------- --------
Investment income--net..................................... .55 .56 .78 .85 .76
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net....................... .58 (.40) (.03) .61 (1.19)
------- ------- ------- ------- --------
Total from investment operations........................... 1.13 .16 .75 1.46 (.43)
------- ------- ------- ------- --------
Less dividends and distributions:
Investment income--net................................... (.47) (.29) (.78) (.84) (.76)
In excess of investment income--net...................... (.08) (.03) -- -- --
Return of capital........................................ -- (.28) -- -- --
In excess of realized gain on investments--net........... -- -- -- -- (.02)
------- ------- ------- ------- --------
Total dividends and distributions.......................... (.55) (.60) (.78) (.84) (.78)
------- ------- ------- ------- --------
Net asset value, end of year............................... $ 9.90 $ 9.32 $ 9.76 $ 9.79 $ 9.17
======= ======= ======= ======= ========
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share......................... 12.62% 1.95% 8.02% 16.69% (4.21%)
======= ======= ======= ======= ========
- -------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses................................................... .75% .73% .69% .68% .75%
======= ======= ======= ======= ========
Investment income--net..................................... 5.72% 6.11% 7.95% 8.99% 8.01%
======= ======= ======= ======= ========
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)..................... $69,416 $76,107 $93,790 $81,845 $ 75,150
======= ======= ======= ======= ========
Portfolio turnover......................................... 127.93% 568.76% 267.13% 132.57% 117.58%
======= ======= ======= ======= ========
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
*Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding.
See Notes to Financial Statements.
86
<PAGE> 88
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Class A and
Class B Shares have equal voting, dividend, liquidation and other rights, except
that only shares of the respective classes are entitled to vote on matters
concerning only that class and Class B Shares bear certain expenses related to
the distribution of such shares. Global Bond Focus Fund (the "Fund") is
classified as "non-diversified," as defined in the Investment Company Act of
1940. The Fund's financial statements are prepared in accordance with generally
accepted accounting principles which may require the use of management accruals
and estimates. The following is a summary of significant accounting policies
followed by the Fund.
(a) Valuation of investments-- Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written or purchased are valued at the last sale price in the
case of exchange-traded options. In the case of options traded in the
over-the-counter market, valuation is the last asked price (options written) or
the last bid price (options purchased). Futures contracts are valued at the
settlement price at the close of the applicable exchange. Short-term securities
are valued at amortized cost, which approximates market value. Securities and
assets for which market quotations are not readily available are valued at fair
value as determined in good faith by or under the direction of the Board of
Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity, debt and currency markets. Losses may arise due
to changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts.
- - Options--The Fund may write and purchase call and put options. When the Fund
writes an option, an amount equal to the premium received by the Fund is
reflected as an asset and an equivalent liability. The amount of the liability
is subsequently marked to market to reflect the current market value of the
option written. When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or deducted from)
the basis of the security acquired or deducted from (or added to) the proceeds
of the security sold. When an option expires (or the Fund enters into a closing
transaction), the Fund realizes a gain or loss on the option to the extent of
the premiums received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts for the purpose of hedging the
market risk on existing securities or the intended purchase of securities.
Futures contracts are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon entering into a contract, the
Fund deposits and maintains as collateral such initial margin as required by the
exchange on which the transaction is effected. Pursuant to the contract, the
Fund agrees to receive from or pay to the broker an amount of cash equal to the
daily fluctuation in value of the contract. Such receipts or payments are known
as variation margin and are recorded by the Fund as unrealized gains or losses.
87
<PAGE> 89
- --------------------------------------------------------------------------------
When the contract is closed, the Fund records a realized gain or loss equal to
the difference between the value of the contract at the time it was opened and
the value at the time it was closed.
- - Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-US dollar denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets and liabilities expressed in
foreign currencies into US dollars. Realized and unrealized gains or losses from
investments include the effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently recorded
when the Fund has determined the ex-dividend date. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Deferred organization expenses--Deferred organization expenses are charged
to expense on a straight-line basis over a period not exceeding five years.
(g) Dividends and distributions--Dividends from net investment income are
declared and paid monthly. Distributions from capital gains are recorded on the
ex-dividend dates. Distributions in excess of net investment income are due
primarily to differing tax treatments for foreign currency transactions. A
portion of the net investment income dividends paid by the Fund during the year
ended December 31, 1997 is characterized as a return of capital.
(h) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $188,301 have been reclassified between accumulated net
realized capital losses and undistributed net investment income and $434,134 has
been reclassified between paid-in capital in excess of par and undistributed net
investment income. These reclassifications have no effect on net assets or net
asset value per share.
2. INVESTMENT ADVISORY AGREEMENT AND
TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.60% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Merrill Lynch Funds Distributor, a division of Princeton Funds Distributor,
Inc. ("PFD"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
is the Fund's distributor.
Accounting services are provided to the Fund by MLAM at cost.
88
<PAGE> 90
- --------------------------------------------------------------------------------
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1998 were $83,906,811 and $96,658,933, respectively.
Net realized gains (losses) for the year ended December 31, 1998 and net
unrealized gains (losses) as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains (Losses)
- ----------------------------------------------------------------------
<S> <C> <C>
Long-term investments................ $1,168,724 $3,020,507
Short-term investments............... 146 --
Financial futures contracts.......... 84,941 --
Foreign currency options purchased... (84,381)
Foreign currency options written..... 18,085 --
Foreign currency transactions........ (61,139) 49,508
Forward foreign exchange contracts... 315,736 (484,777)
---------- ----------
Total................................ $1,442,112 $2,585,238
========== ==========
- ----------------------------------------------------------------------
</TABLE>
Transactions in options written for the year ended December 31, 1998 were as
follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Nominal Value Covered by Premiums
Call Options Written Written Options Received
- --------------------------------------------------------------------
<S> <C> <C>
Outstanding call options
written, beginning of year... -- --
Options written............... 268,569,999 $ 286,872
Options exercised............. (3,835,000) (2,685)
Options closed................ (24,970,000) (29,564)
Options expired............... (239,764,999) (254,623)
------------ ---------
Outstanding call options
written, end of year......... -- $ --
============ =========
- --------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Nominal Value Covered by Premiums
Put Options Written Written Options Received
- --------------------------------------------------------------------
<S> <C> <C>
Outstanding put options
written, beginning of year... -- --
Options written............... 1,723,235,000 $ 156,887
Options exercised............. (47,835,000) (38,650)
Options expired............... (1,675,400,000) (118,237)
-------------- ---------
Outstanding put options
written, end of year......... -- $ --
============== =========
- --------------------------------------------------------------------
</TABLE>
At December 31, 1998, net unrealized appreciation for Federal income tax
purposes aggregated $2,963,313, of which $3,746,976 related to appreciated
securities and $783,663 related to depreciated securities. At December 31, 1998,
the aggregate cost of investments for Federal income tax purposes was
$64,706,205.
4. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share transactions were
$10,995,882 and $13,177,662 for the years ended December 31, 1998 and December
31, 1997, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1998 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 626,457 $ 6,051,402
Shares issued to shareholders in
reinvestment of dividends........... 443,154 4,201,100
---------- ------------
Total issued......................... 1,069,611 10,252,502
Shares redeemed...................... (2,228,768) (21,248,384)
---------- ------------
Net decrease......................... (1,159,157) $(10,995,882)
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 493,520 $ 4,682,144
Shares issued to shareholders in
reinvestment of dividends........... 578,466 5,320,557
---------- ------------
Total issued......................... 1,071,986 10,002,701
Shares redeemed...................... (2,511,890) (23,180,363)
---------- ------------
Net decrease......................... (1,439,904) $(13,177,662)
========== ============
- -----------------------------------------------------------------
</TABLE>
5. COMMITMENTS:
At December 31, 1998, the Fund had entered into foreign exchange contracts, in
addition to the contracts listed on the Schedule of Investments, under which it
had agreed to purchase various foreign currencies with an approximate value of
$200.
6. CAPITAL LOSS CARRYFORWARD:
At December 31, 1998, the Fund had a net capital loss carryforward of
approximately $1,604,000, all of which expires in 2005. This amount will be
available to offset like amounts of any future taxable gains.
7. SUBSEQUENT EVENT:
On January 4, 1999, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.043229 per Class A Share payable on January 11, 1999
to shareholders of record as of December 31, 1998.
89
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
GLOBAL BOND FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Global Bond Focus Fund of Merrill Lynch Variable
Series Funds, Inc. as of December 31, 1998, the related statements of operations
for the year then ended and changes in net assets for each of the years in the
two-year period then ended, and the financial highlights for each of the years
in the five-year period then ended. These financial statements and the financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and the financial
highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1998 by correspondence with the custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Global Bond Focus
Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1998, the
results of its operations, the changes in its net assets, and the financial
highlights for the respective stated periods in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
90
<PAGE> 92
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
DECEMBER 31, 1998--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
THE ENVIRONMENT
During 1998, stock and bond market volatility reflected shifting investor
perceptions regarding global economic prospects. Investor optimism early in the
year gave way to expectations of deteriorating corporate profits and signs of a
weakening economy by late summer. Further concerns arose from the precarious
state of the Russian and other emerging markets economies. As a result, world
stock markets declined in the July-September period. At the same time, the
uncertain economic picture and the resulting flight to quality by investors
pushed the 30-year US Treasury bond to record low yields. Yields also declined
in sovereign bond markets of other major industrialized countries. In contrast,
corporate bonds, mortgage-backed securities and emerging markets debt
underperformed US Treasury securities by a wide margin.
The US Federal Reserve Board and other central banks responded to the
uncertain economic outlook through a series of monetary policy easings that
served to restore investor confidence as 1998 drew toward a close. Stock markets
around the world rallied, with total returns for the unmanaged Standard & Poor's
500 Index rising 21.3% and the unmanaged Morgan Stanley Capital International
World Index (Ex-US) increasing 20.5% during the fourth quarter of 1998. However,
as 1999 began, uncertainty regarding global economic prospects again began to
cloud the investment outlook. At the same time, with stronger-than-expected
economic results, prospects dimmed for further Federal Reserve Board monetary
policy easings in the near future. The notable exception to the more subdued
investment outlook in the United States was the unprecedented popularity of
Internet-related stocks.
The weakening of the US dollar relative to the Japanese yen was one of the
year's more surprising developments. Since a stronger yen would have a negative
impact on the important export sector of Japan's fragile economy, the Japanese
central bank intervened in the currency markets in January. For the overall
global economy, the deepening recession in Japan is of great concern. At the
same time, the difficulties in emerging economies such as Russia and Brazil
remain. Further progress in easing strains within the global financial system
would likely provide an important element of stability to the volatile
investment environment.
PORTFOLIO MATTERS
Global Growth Focus Fund commenced operations on June 5, 1998. By June 30,
1998, the Fund had $5.7 million in net assets, more than 92% of which was
invested in a diversified portfolio of equity securities of companies in 13
foreign countries and the United States. We continued to focus on relatively
large-capitalization, high-quality companies where we anticipated above-average
rates of growth in earnings in upcoming years.
During the remainder of 1998, our strategy and focus for the Fund did not
change. In addition to the US equity market, we focused on equity markets in
developed countries with significant weightings in the United Kingdom and the
Continental European markets of Germany, the Netherlands, Switzerland, France
and Italy.
FISCAL YEAR IN REVIEW
The Fund's Class A Shares had total returns of +8.20% and +21.98% for the
period since inception (June 5, 1998) to December 31, 1998 and for the quarter
ended December 31, 1998, respectively. Equity investments in five of the top six
industry categories were the primary contributors to the Fund's positive
performance. Our investments in the banking and financial, telecommunications,
insurance, pharmaceuticals, retailing and specialty retailing industries also
contributed substantially to overall performance. We placed the largest industry
weightings in sectors that usually experience reasonably good comparative
investment returns during periods of economic slowdown. In retrospect, this
strategy proved to be beneficial as the manufacturing sectors in the United
States, Canada and Western Europe gradually approached recessionary conditions
during the second half of 1998. It appeared that declines in profits in the
steel, chemicals, paper and industrial equipment businesses in the United States
and Europe can be attributed to the continued recessions in Asian countries and
the substantial increases in exports from Asian producers at very competitive
prices. At this time, we do not anticipate any recovery in these manufacturing
sectors until the second half of 1999.
Beginning in September 1998, the broad-based and significant easing of
monetary policy by many central banks around the world facilitated a recovery in
global stock markets. We remained positive about the outlook for stock
investments during the fourth quarter of 1998, and held this view as we entered
1999.
91
<PAGE> 93
- --------------------------------------------------------------------------------
IN CONCLUSION
We appreciate your investment in Global Growth Focus Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to sharing our investment
outlook and strategies with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Lawrence R. Fuller
Lawrence R. Fuller
Senior Vice President and Portfolio Manager
February 5, 1999
92
<PAGE> 94
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
Global Growth Focus Fund
Total Return Based on a $10,000 Investment-Class A Shares
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Morgan Stanley Capital International
World Index. Beginning and ending values are:
<TABLE>
<CAPTION>
6/30/98** 12/98
--------- -----
<S> <C> <C>
Global Growth Focus Fund+ -- Class A Shares* $10,000 $10,650
Morgan Stanley Capital International World
Index++ $10,000 $10,660
</TABLE>
<TABLE>
<C> <S>
* Assuming transaction costs and other operating expenses,
including advisory fees. Does not include insurance-related
fees and expenses.
** The Fund commenced operations on 6/05/98. For purposes of
fair comparison of the Fund's performance relative to the
Index, the graph begins on 6/30/98.
+ The Fund invests in a diversified portfolio of equity
securities of issuers located in various foreign countries
and the United States, placing particular emphasis on
companies that have exhibited above-average growth rates in
earnings.
++ This unmanaged market capitalization-weighted Index is
comprised of a representative sampling of large-, medium-, and
small-capitalization companies in 22 countries, including the
United States.
Past performance is not predictive of future results.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
AGGREGATE TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Inception (6/05/98) to 12/31/98 +8.20%
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
RECENT PERFORMANCE RESULTS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SINCE INCEPTION
TOTAL RETURN
- -------------------------------------------------------------------------------
<S> <C>
Class A Shares +8.20%
</TABLE>
- --------------------------------------------------------------------------------
* Total investment returns are based on changes in net asset value for the
period shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the ex-dividend date. Insurance-related
fees and expenses are not reflected in these returns. The Fund commenced
operations on 6/05/98. Past results shown should not be considered a
representation of future performance.
93
<PAGE> 95
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NORTH SHARES VALUE PERCENT OF
AMERICA INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
CANADA BANKING & 1,402 Bank of Montreal.................. $ 78,175 $ 56,343 0.3%
FINANCIAL 3,445 Canadian Imperial Bank of
Commerce........................ 104,108 85,267 0.4
1,844 National Bank of Canada........... 35,270 29,786 0.2
1,106 Royal Bank of Canada.............. 66,432 55,145 0.3
----------- ----------- -----
283,985 226,541 1.2
------------------------------------------------------------------------------------------------------
COMMUNICATIONS 200 +Newbridge Networks Corporation... 4,564 6,070 0.0
EQUIPMENT 150 Northern Telecom Ltd. ............ 8,361 7,484 0.0
----------- ----------- -----
12,925 13,554 0.0
------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 1,500 +MetroNet Communications Corp.
(Class B)....................... 43,535 49,500 0.2
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN CANADA 340,445 289,595 1.4
- --------------------------------------------------------------------------------------------------------------------------
UNITED STATES ADVERTISING 314 The Interpublic Group of
Companies, Inc. ................ 18,891 25,042 0.1
------------------------------------------------------------------------------------------------------
BANKING & 2,725 Bank One Corporation.............. 137,301 139,145 0.7
FINANCIAL 4,000 BankAmerica Corporation........... 260,125 240,500 1.2
1,160 Citigroup Inc..................... 76,478 57,420 0.3
3,000 Mellon Bank Corporation........... 180,391 206,250 1.1
1,164 State Street Corporation.......... 72,929 80,971 0.4
----------- ----------- -----
727,224 724,286 3.7
------------------------------------------------------------------------------------------------------
BEVERAGES 2,700 The Coca-Cola Company............. 221,228 180,562 0.9
------------------------------------------------------------------------------------------------------
BROADCASTING 1,000 CBS Corporation................... 25,235 32,750 0.2
643 +Chancellor Media Corporation..... 26,655 30,743 0.2
2,500 +Clear Channel Communications,
Inc. ........................... 115,593 136,250 0.7
2,500 +Infinity Broadcasting Corp.
(Class A)....................... 54,805 68,438 0.3
----------- ----------- -----
222,288 268,181 1.4
------------------------------------------------------------------------------------------------------
CHEMICALS 2,500 du Pont (E.I.) de Nemours &
Company......................... 157,489 132,656 0.7
------------------------------------------------------------------------------------------------------
COMMUNICATIONS 600 +Ascend Communications, Inc. ..... 28,394 39,450 0.2
EQUIPMENT 5,300 +Cisco Systems, Inc. ............. 312,315 491,906 2.5
300 +FORE Systems, Inc. .............. 7,539 5,475 0.0
100 Lucent Technologies Inc. ......... 9,256 11,000 0.1
----------- ----------- -----
357,504 547,831 2.8
------------------------------------------------------------------------------------------------------
COMPUTERS 8,000 COMPAQ Computer Corporation....... 269,140 335,500 1.7
1,500 +Dell Computer Corporation........ 86,211 109,781 0.6
1,000 International Business Machines
Corporation..................... 187,314 184,750 0.9
500 +Network Appliance, Inc. ......... 13,781 22,375 0.1
----------- ----------- -----
556,446 652,406 3.3
------------------------------------------------------------------------------------------------------
COSMETICS 2,000 The Gillette Company.............. 90,606 96,625 0.5
------------------------------------------------------------------------------------------------------
ELECTRICAL 130 Emerson Electric Co. ............. 7,969 8,133 0.1
EQUIPMENT 4,084 General Electric Company.......... 346,526 416,823 2.1
----------- ----------- -----
354,495 424,956 2.2
------------------------------------------------------------------------------------------------------
ELECTRONICS 2,200 Intel Corporation................. 194,303 260,700 1.3
700 Texas Instruments Incorporated.... 40,873 59,894 0.3
----------- ----------- -----
235,176 320,594 1.6
------------------------------------------------------------------------------------------------------
ENERGY 2,500 El Paso Energy Corporation........ 89,086 87,031 0.4
------------------------------------------------------------------------------------------------------
ENTERTAINMENT 130 +Viacom, Inc. (Class A)........... 7,579 9,563 0.1
5,400 The Walt Disney Company........... 175,504 162,000 0.8
----------- ----------- -----
183,083 171,563 0.9
------------------------------------------------------------------------------------------------------
</TABLE>
94
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NORTH
AMERICA SHARES VALUE PERCENT OF
(CONTINUED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
UNITED STATES FINANCIAL SERVICES 200 American Express Company.......... $ 21,880 $ 20,450 0.1%
(CONTINUED) 700 Federal Home Loan Mortgage
Corporation..................... 41,044 45,106 0.2
1,200 Federal National Mortgage
Association..................... 77,065 88,800 0.5
369 Franklin Resources, Inc. ......... 18,527 11,808 0.1
369 Morgan Stanley Dean Witter &
Co. ............................ 31,250 26,199 0.1
----------- ----------- -----
189,766 192,363 1.0
------------------------------------------------------------------------------------------------------
FOOD MERCHANDISING 184 Albertson's, Inc. ................ 9,410 11,718 0.0
250 +Fred Meyer, Inc. ................ 11,269 15,063 0.1
----------- ----------- -----
20,679 26,781 0.1
------------------------------------------------------------------------------------------------------
FOODS 1,000 ConAgra, Inc. .................... 25,935 31,500 0.2
130 Wrigley (Wm.) Jr. Company......... 12,772 11,643 0.0
----------- ----------- -----
38,707 43,143 0.2
------------------------------------------------------------------------------------------------------
HOME FURNISHINGS 646 Ethan Allen Interiors, Inc........ 31,168 26,486 0.1
------------------------------------------------------------------------------------------------------
HOTELS 462 Marriott International, Inc.
(Class A)....................... 15,119 13,398 0.1
------------------------------------------------------------------------------------------------------
HOUSEHOLD PRODUCTS 130 Colgate-Palmolive Company......... 11,783 12,074 0.1
74 Kimberly-Clark Corporation........ 3,569 4,033 0.0
221 The Procter & Gamble Company...... 19,593 20,180 0.1
----------- ----------- -----
34,945 36,287 0.2
------------------------------------------------------------------------------------------------------
INFORMATION 1,300 +America Online, Inc. ............ 109,332 188,175 1.0
PROCESSING 572 First Data Corporation............ 18,834 18,125 0.1
----------- ----------- -----
128,166 206,300 1.1
------------------------------------------------------------------------------------------------------
INSURANCE 1,000 Aetna Inc. ....................... 68,310 78,625 0.4
1,600 American International Group,
Inc. ........................... 142,920 154,600 0.8
----------- ----------- -----
211,230 233,225 1.2
------------------------------------------------------------------------------------------------------
MEDICAL TECHNOLOGY 100 +Boston Scientific Corporation.... 3,791 2,681 0.0
100 Guidant Corporation............... 8,252 11,025 0.1
93 Johnson & Johnson................. 6,908 7,800 0.0
----------- ----------- -----
18,951 21,506 0.1
------------------------------------------------------------------------------------------------------
OIL SERVICES 300 Baker Hughes Incorporated......... 9,461 5,306 0.0
200 Diamond Offshore Drilling,
Inc. ........................... 7,541 4,737 0.0
204 Schlumberger Limited.............. 14,755 9,410 0.1
----------- ----------- -----
31,757 19,453 0.1
------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 1,683 Bristol-Myers Squibb Company...... 187,335 225,206 1.2
2,500 Merck & Co., Inc. ................ 347,077 369,219 1.9
2,875 Pfizer Inc. ...................... 310,982 360,633 1.8
----------- ----------- -----
845,394 955,058 4.9
------------------------------------------------------------------------------------------------------
PHOTOGRAPHY 111 Eastman Kodak Company............. 8,133 7,992 0.0
------------------------------------------------------------------------------------------------------
PUBLISHING 1,061 Gannett Co., Inc. ................ 74,847 70,225 0.4
------------------------------------------------------------------------------------------------------
RESTAURANTS 111 McDonald's Corporation............ 7,600 8,505 0.0
------------------------------------------------------------------------------------------------------
RETAIL STORES 1,000 +Federated Department Stores,
Inc. ........................... 52,019 43,562 0.2
4,500 Wal-Mart Stores, Inc. ............ 289,256 366,469 1.9
----------- ----------- -----
341,275 410,031 2.1
------------------------------------------------------------------------------------------------------
SEMICONDUCTORS 230 +Applied Materials, Inc. ......... 6,879 9,818 0.0
------------------------------------------------------------------------------------------------------
SOFTWARE-- 3,000 +Microsoft Corporation............ 320,337 415,688 2.1
COMPUTER 3,000 +PeopleSoft, Inc. ................ 115,996 56,625 0.3
----------- ----------- -----
436,333 472,313 2.4
------------------------------------------------------------------------------------------------------
</TABLE>
95
<PAGE> 97
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NORTH
AMERICA SHARES VALUE PERCENT OF
(CONCLUDED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
UNITED STATES SPECIALTY 800 +Abercrombie & Fitch Co. (Class
(CONCLUDED) RETAILING A).............................. $ 31,957 $ 56,600 0.3%
3,300 CVS Corporation................... 141,280 181,500 0.9
1,500 The Gap, Inc. .................... 63,571 84,375 0.4
1,000 Lowe's Companies, Inc. ........... 43,908 51,188 0.3
6,400 +Staples, Inc. ................... 202,042 279,600 1.4
500 +Tommy Hilfiger Corporation....... 27,007 30,000 0.2
3,000 Walgreen Co. ..................... 137,412 175,688 0.9
----------- ----------- -----
647,177 858,951 4.4
------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 2,700 +AT&T Corp. ...................... 197,205 203,175 1.0
1,200 Ameritech Corporation............. 68,528 76,050 0.4
4,500 GTE Corporation................... 268,077 303,469 1.5
2,700 +MCI WorldCom, Inc. .............. 141,153 193,725 1.0
500 +Nextel Communications, Inc....... 11,318 11,813 0.1
3,000 Sprint Corporation (Fon Group).... 196,778 252,375 1.3
3,400 +Sprint Corporation (PCS Group) 57,170 78,625 0.4
----------- ----------- -----
940,229 1,119,232 5.7
------------------------------------------------------------------------------------------------------
TOYS 738 Mattel, Inc. ..................... 29,150 16,836 0.1
------------------------------------------------------------------------------------------------------
TRAVEL & LODGING 3,000 Carnival Corporation (Class A).... 128,422 144,000 0.7
------------------------------------------------------------------------------------------------------
WASTE MANAGEMENT 500 Waste Management, Inc. ........... 23,492 23,313 0.1
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE UNITED
STATES 7,422,935 8,546,949 43.5
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN NORTH AMERICA 7,763,380 8,836,544 44.9
- --------------------------------------------------------------------------------------------------------------------------
PACIFIC
BASIN
- --------------------------------------------------------------------------------------------------------------------------
AUSTRALIA TELECOMMUNICATIONS 13,300 +Cable & Wireless Optus Limited... 24,748 27,978 0.2
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN AUSTRALIA 24,748 27,978 0.2
- --------------------------------------------------------------------------------------------------------------------------
JAPAN AUTOMOBILES 2,000 Honda Motor Co., Ltd. ............ 72,922 65,809 0.3
2,000 Toyota Motor Corporation.......... 50,019 54,457 0.3
----------- ----------- -----
122,941 120,266 0.6
------------------------------------------------------------------------------------------------------
COMPUTERS 2,000 Fujitsu Limited................... 21,902 26,696 0.1
------------------------------------------------------------------------------------------------------
LEISURE 300 Sony Corporation.................. 28,942 21,898 0.1
------------------------------------------------------------------------------------------------------
PHOTOGRAPHY 1,000 Fuji Photo Film................... 38,187 37,251 0.2
------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 15 Nippon Telegraph & Telephone
Corporation (NTT)............... 132,076 116,008 0.6
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN JAPAN 344,048 322,119 1.6
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE PACIFIC
BASIN 368,796 350,097 1.8
- --------------------------------------------------------------------------------------------------------------------------
WESTERN
EUROPE
- --------------------------------------------------------------------------------------------------------------------------
DENMARK TELECOMMUNICATIONS 1,400 TeleDanmark A/S (Class B)......... 138,440 189,029 1.0
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN DENMARK 138,440 189,029 1.0
- --------------------------------------------------------------------------------------------------------------------------
FINLAND COMMUNICATIONS 300 Nokia Oyj (Class A)............... 22,906 36,496 0.2
EQUIPMENT
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN FINLAND 22,906 36,496 0.2
- --------------------------------------------------------------------------------------------------------------------------
FRANCE BROADCASTING & 75..... Societe Television Francaise 1.... 13,652 13,353 0.1
PUBLISHING
------------------------------------------------------------------------------------------------------
COSMETICS 17 L'Oreal S.A. ..................... 9,219 12,289 0.1
------------------------------------------------------------------------------------------------------
ELECTRONICS 106 +STMicroelectronics............... 7,138 8,345 0.0
------------------------------------------------------------------------------------------------------
</TABLE>
96
<PAGE> 98
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE SHARES VALUE PERCENT OF
(CONTINUED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
FRANCE FOODS 150 Groupe Danone (ADR)(a)............ $ 40,329 $ 42,944 0.2%
(CONCLUDED) 50 Promodes.......................... 31,306 36,359 0.2
----------- ----------- -----
71,635 79,303 0.4
------------------------------------------------------------------------------------------------------
INFORMATION 500 Cap Gemini S.A. .................. 72,337 80,251 0.4
PROCESSING
------------------------------------------------------------------------------------------------------
INSURANCE 1,700 AXA-UAP S.A....................... 181,088 246,390 1.2
------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 400 Rhone-Poulenc S.A. ............... 19,354 20,584 0.1
------------------------------------------------------------------------------------------------------
RETAIL STORES 100 Carrefour S.A. ................... 63,102 75,492 0.4
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN FRANCE 437,525 536,007 2.7
- --------------------------------------------------------------------------------------------------------------------------
GERMANY APPAREL 184 Adidas-Salomon AG................. 32,258 19,990 0.1
------------------------------------------------------------------------------------------------------
AUTOMOBILES 1,508 +DaimlerChrysler AG............... 130,471 148,850 0.8
------------------------------------------------------------------------------------------------------
BANKING & 5,750 Commerzbank AG.................... 184,975 181,888 0.9
FINANCIAL 2,750 Deutsche Bank AG.................. 209,037 161,847 0.8
4,400 Dresdner Bank AG.................. 217,287 184,874 1.0
----------- ----------- -----
611,299 528,609 2.7
------------------------------------------------------------------------------------------------------
CHEMICALS 1,031 BASF AG........................... 44,207 39,359 0.2
1,066 Bayer AG.......................... 46,272 44,502 0.2
1,366 Hoechst AG........................ 69,807 56,657 0.3
----------- ----------- -----
160,286 140,518 0.7
------------------------------------------------------------------------------------------------------
ELECTRONICS 1,229 Siemens AG........................ 84,757 79,302 0.4
------------------------------------------------------------------------------------------------------
INSURANCE 555 Allianz AG........................ 174,256 203,544 1.0
------------------------------------------------------------------------------------------------------
MULTI-INDUSTRY 425 Mannesmann AG..................... 39,551 48,724 0.3
646 VEBA AG........................... 44,772 38,659 0.2
----------- ----------- -----
84,323 87,383 0.5
------------------------------------------------------------------------------------------------------
RETAIL STORES 2,025 Metro AG.......................... 129,798 161,660 0.8
------------------------------------------------------------------------------------------------------
SOFTWARE--COMPUTER 830 SAP AG (Systeme, Anwendungen,
Produkte in der
Datenverarbeitung)
(Preferred)..................... 495,868 396,168 2.0
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN GERMANY 1,903,316 1,766,024 9.0
- --------------------------------------------------------------------------------------------------------------------------
IRELAND BANKING & 12,700 Allied Irish Banks PLC............ 179,870 226,421 1.2
FINANCIAL
------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 750 Esat Telecom Group PLC (ADR)(a)... 25,125 28,219 0.1
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN IRELAND 204,995 254,640 1.3
- --------------------------------------------------------------------------------------------------------------------------
ITALY BANKING & 40,000 +Banca di Roma.................... 69,612 67,756 0.4
FINANCIAL 8,000 Unicredito Italiano S.p.A......... 39,048 47,405 0.2
----------- ----------- -----
108,660 115,161 0.6
------------------------------------------------------------------------------------------------------
INSURANCE 4,300 Assicurazioni Generali............ 151,964 179,492 0.9
46,500 Istituto Nazionale delle
Assicurazioni (INA)............. 114,733 122,790 0.6
----------- ----------- -----
266,697 302,282 1.5
------------------------------------------------------------------------------------------------------
REAL ESTATE 46,500 +Unione Immobiliare S.p.A. ....... 20,848 24,249 0.1
INVESTMENT TRUST
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN ITALY 396,205 441,692 2.2
- --------------------------------------------------------------------------------------------------------------------------
NETHERLANDS HOUSEHOLD PRODUCTS 2,000 Unilever N.V. .................... 145,785 170,881 0.9
1,900 Unilever N.V. (NY Registered
Shares)......................... 138,133 157,581 0.8
----------- ----------- -----
283,918 328,462 1.7
------------------------------------------------------------------------------------------------------
</TABLE>
97
<PAGE> 99
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE SHARES VALUE PERCENT OF
(CONTINUED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NETHERLANDS INSURANCE 3,975 AEGON N.V. ....................... $ 367,044 $ 487,961 2.5%
(CONCLUDED) 2,767 ING Groep N.V. ................... 147,611 168,657 0.8
----------- ----------- -----
514,655 656,618 3.3
------------------------------------------------------------------------------------------------------
LEISURE 258 Koninklijke (Royal) Philips
Electronics N.V. ................. 23,218 17,305 0.1
------------------------------------------------------------------------------------------------------
RETAIL STORES 5,500 Koninklijke Ahold N.V. ........... 171,632 203,194 1.0
------------------------------------------------------------------------------------------------------
SOFTWARE--COMPUTER 320 +Baan Company, N.V. .............. 13,128 3,254 0.0
------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 1,300 +Equant N.V. ..................... 48,628 90,463 0.5
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE
NETHERLANDS 1,055,179 1,299,296 6.6
- --------------------------------------------------------------------------------------------------------------------------
SPAIN BANKING & 2,213 Banco Bilbao Vizcaya, S.A. ....... 41,088 35,048 0.2
FINANCIAL
1,015 Banco Santander, S.A. ............ 27,079 20,147 0.1
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SPAIN 68,167 55,195 0.3
- --------------------------------------------------------------------------------------------------------------------------
SWEDEN COMMUNICATIONS 100 Telefonaktiebolaget LM Ericsson
EQUIPMENT (Class B)....................... 3,276 2,387 0.0
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SWEDEN 3,276 2,387 0.0
- --------------------------------------------------------------------------------------------------------------------------
SWITZERLAND FOODS 100 Nestle S.A. (Registered Shares)... 211,313 217,851 1.1
------------------------------------------------------------------------------------------------------
INSURANCE 230 Zurich Allied AG.................. 134,807 170,426 0.9
------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 150 Novartis AG (Registered Shares)... 255,352 295,082 1.5
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SWITZERLAND 601,472 683,359 3.5
- --------------------------------------------------------------------------------------------------------------------------
UNITED BANKING & 6,400 Barclays PLC...................... 161,664 137,944 0.7
FINANCIAL
KINGDOM 900 HSBC Holdings PLC................. 23,203 24,398 0.1
15,000 Lloyds TSB Group PLC.............. 206,752 213,293 1.1
12,600 National Westminster Bank PLC
(Ordinary)...................... 216,437 242,869 1.2
----------- ----------- -----
608,056 618,504 3.1
------------------------------------------------------------------------------------------------------
BROADCAST 4,788 British Sky Broadcasting Group PLC
("BSkyB")....................... 35,725 36,351 0.2
------------------------------------------------------------------------------------------------------
CHEMICALS 300 Imperial Chemical Industries
PLC............................. 4,792 2,599 0.0
------------------------------------------------------------------------------------------------------
ELECTRICAL 1,000 Siebe PLC......................... 4,831 3,942 0.0
EQUIPMENT
------------------------------------------------------------------------------------------------------
HOUSEHOLD PRODUCTS 2,766 Unilever PLC...................... 31,469 31,005 0.2
------------------------------------------------------------------------------------------------------
INFORMATION 3,836 Reuters Group PLC................. 44,040 40,256 0.2
PROCESSING
------------------------------------------------------------------------------------------------------
INSURANCE 8,100 CGU PLC........................... 135,231 126,763 0.7
20,000 Guardian Royal Exchange PLC....... 108,506 111,927 0.6
15,400 Royal & Sun Alliance Insurance
Group PLC....................... 152,055 125,690 0.6
----------- ----------- -----
395,792 364,380 1.9
------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 7,000 Glaxo Wellcome PLC................ 212,377 240,750 1.2
2,121 SmithKline Beecham PLC............ 25,378 29,630 0.2
3,500 Zeneca Group PLC.................. 141,500 152,332 0.8
----------- ----------- -----
379,255 422,712 2.2
------------------------------------------------------------------------------------------------------
PUBLISHING 2,766 Pearson PLC....................... 51,539 54,880 0.3
------------------------------------------------------------------------------------------------------
</TABLE>
98
<PAGE> 100
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE SHARES VALUE PERCENT OF
(CONCLUDED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
UNITED RETAIL STORES 2,766 The Boots Company PLC............. $ 47,519 $ 47,082 0.2%
KINGDOM 1,000 J Sainsbury PLC................... 8,758 8,012 0.0
(CONCLUDED) 7,240 Somerfield PLC.................... 48,382 48,404 0.3
15,490 Tesco PLC......................... 48,039 44,116 0.2
----------- ----------- -----
152,698 147,614 0.7
------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 21,055 +COLT Telecom Group PLC........... 224,447 313,924 1.6
5,464 Cable & Wireless PLC.............. 74,466 67,154 0.3
23,000 Vodafone Group PLC................ 319,203 373,333 1.9
----------- ----------- -----
618,116 754,411 3.8
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE UNITED
KINGDOM 2,326,313 2,476,654 12.6
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN WESTERN
EUROPE 7,157,794 7,740,779 39.4
- --------------------------------------------------------------------------------------------------------------------------
SHORT-TERM FACE
SECURITIES AMOUNT ISSUE
- --------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT $3,346,000 Federal Home Loan Mortgage
AGENCY OBLIGATIONS* Corporation, 4.50%
due 1/04/1999................... 3,344,327 3,344,327 17.0
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SHORT-TERM SECURITIES 3,344,327 3,344,327 17.0
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS................. $18,634,297 20,271,747 103.1
===========
LIABILITIES IN EXCESS OF OTHER
ASSETS.......................... (614,415) (3.1)
----------- -----
NET ASSETS........................ $19,657,332 100.0%
=========== =====
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
* US Government Agency Obligations are traded on a discount basis; the interest
rate shown reflects the discount rate paid at the time of purchase by the
Fund.
+ Non-income producing security.
(a) American Depositary Receipts (ADR).
See Notes to Financial Statements.
99
<PAGE> 101
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$18,634,297) (Note
1a)....................................................... $20,271,747
Cash........................................................ 788
Foreign cash (Note 1c)...................................... 4,530
Receivables:
Capital shares sold....................................... $ 50,649
Dividends................................................. 10,954 61,603
--------
Deferred organization expenses (Note 1f).................... 9,275
Prepaid expenses and other assets........................... 960
-----------
Total assets................................................ 20,348,903
-----------
- ------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Securities purchased...................................... 657,084
Investment adviser (Note 2)............................... 11,360 668,444
--------
Accrued expenses and other liabilities...................... 23,127
-----------
Total liabilities........................................... 691,571
-----------
- ------------------------------------------------------------------------------------
NET ASSETS.................................................. $19,657,332
===========
- ------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 181,676
Paid-in capital in excess of par............................ 17,801,811
Undistributed investment income--net........................ 43,956
Accumulated realized capital losses on investments and
foreign currency transactions--net........................ (7,600)
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 1,637,489
-----------
NET ASSETS.................................................. $19,657,332
===========
- ------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $19,657,332 and 1,816,757
shares outstanding........................................ $ 10.82
===========
- ------------------------------------------------------------------------------------
</TABLE>
+ The Fund is also authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
100
<PAGE> 102
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
STATEMENT OF OPERATIONS FOR THE PERIOD JUNE 5, 1998+ TO DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Interest and discount earned................................ $ 64,266
Dividends (net of $3,249 foreign withholding tax)........... 46,540
----------
Total income................................................ 110,806
----------
- -------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $ 49,823
Registration fees........................................... 4,817
Accounting services (Note 2)................................ 3,429
Transfer agent fees (Note 2)................................ 2,949
Custodian fees.............................................. 2,860
Pricing services............................................ 1,750
Amortization of organization expenses (Note 1f)............. 1,225
Printing and shareholder reports............................ 677
Professional fees........................................... 71
Directors' fees and expenses................................ 64
Other....................................................... 1,035
----------
Total expenses.............................................. 68,700
----------
Investment income--net...................................... 42,106
----------
- -------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET (NOTES 1b, 1c, 1e & 3):
Realized gain (loss):
Investments--net.......................................... (7,600)
Foreign currency transactions--net........................ 1,850 (5,750)
----------
Unrealized appreciation on:
Investments--net.......................................... 1,637,450
Foreign currency transactions--net........................ 39 1,637,489
---------- ----------
Net realized and unrealized gain on investments and foreign
currency transactions..................................... 1,631,739
----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $1,673,845
==========
- -------------------------------------------------------------------------------------
</TABLE>
+Commencement of operations.
See Notes to Financial Statements.
101
<PAGE> 103
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
STATEMENT OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE PERIOD
JUNE 5, 1998+ TO
INCREASE (DECREASE) IN NET ASSETS: DECEMBER 31, 1998
- ---------------------------------------------------------------------------------
<S> <C>
OPERATIONS:
Investment income--net...................................... $ 42,106
Realized loss on foreign currency transactions--net......... (5,750)
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 1,637,489
-----------
Net increase in net assets resulting from operations........ 1,673,845
-----------
- ---------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase in net assets derived from capital share
transactions.............................................. 14,983,487
-----------
- ---------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 16,657,332
Beginning of period......................................... 3,000,000
-----------
End of period*.............................................. $19,657,332
===========
- ---------------------------------------------------------------------------------
* Undistributed investment income--net (Note 1h)............ $ 43,956
===========
- ---------------------------------------------------------------------------------
</TABLE>
+ Commencement of operations.
See Notes to Financial Statements.
102
<PAGE> 104
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A++
-----------------
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FROM FOR THE PERIOD
INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. JUNE 5, 1998+ TO
INCREASE (DECREASE) IN NET ASSET VALUE: DECEMBER 31, 1998
- ---------------------------------------------------------------------------------
<S> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period......................... $ 10.00
-------
Investment income--net....................................... .03
Realized and unrealized gain on investments and foreign
currency transactions--net................................. .79
-------
Total from investment operations............................. .82
-------
Net asset value, end of period............................... $ 10.82
=======
- ---------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share........................... 8.20%++
=======
- ---------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses..................................................... 1.03%*
=======
Investment income--net....................................... .63%*
=======
- ---------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)..................... $19,657
=======
Portfolio turnover........................................... 15.25%
=======
- ---------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+Commencement of operations.
++Based on average shares outstanding.
++ Aggregate total investment return.
See Notes to Financial Statements.
103
<PAGE> 105
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company
("MLLIC"), ML Life Insurance Company of New York (indirect wholly-owned
subsidiaries of Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance
companies, that are not affiliated with ML & Co., for their separate accounts to
fund benefits under certain variable annuity and variable life insurance
contracts. Prior to commencement of operations on June 5, 1998, the Fund had no
operations other than those relating to organizational matters and the issuance
of 300,000 Class A Shares of the Fund to MLLIC for $3,000,000. Class A and Class
B Shares have equal voting, dividend, liquidation and other rights, except that
only shares of the respective classes are entitled to vote on matters concerning
only that class and Class B Shares bear certain expenses related to the
distribution of such shares. Global Growth Focus Fund (the "Fund") is classified
as "diversified," as defined in the Investment Company Act of 1940. The Fund's
financial statements are prepared in accordance with generally accepted
accounting principles which may require the use of management accruals and
estimates. The following is a summary of significant accounting policies
followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written or purchased are valued at the last sale price in the
case of exchange-traded options. In the case of options traded in the
over-the-counter market, valuation is the last asked price (options written) or
the last bid price (options purchased). Short-term securities are valued at
amortized cost, which approximates market value. Futures contracts are valued at
the settlement price at the close of the applicable exchange. Securities and
assets for which market quotations are not readily available are valued at fair
value as determined in good faith by or under the direction of the Board of
Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity, debt and currency markets. Losses may arise due
to changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts.
- - Options--The Fund may write and purchase call and put options. When the Fund
writes an option, an amount equal to the premium received by the Fund is
reflected as an asset and an equivalent liability. The amount of the liability
is subsequently marked to market to reflect the current market value of the
option written. When a security is purchased or sold through an exercise of an
option, the related premium paid or received is added to (or deducted from) the
basis of the security acquired or deducted from (or added to) the proceeds of
the security sold. When an option expires (or the Fund enters into a closing
transaction), the Fund realizes a gain or loss on the option to the extent of
the premiums received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts for the purpose of hedging the
market risk on existing securities or the intended purchase of securities.
Futures contracts are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon entering into a contract, the
Fund deposits and maintains as collateral such initial margin as required by the
exchange on which the transaction is effected. Pursuant to the contract, the
Fund agrees to receive from or pay to the broker an amount of cash equal to the
daily fluctuation in
104
<PAGE> 106
- --------------------------------------------------------------------------------
value of the contract. Such receipts or payments are known as variation margin
and are recorded by the Fund as unrealized gains or losses. When the contract is
closed, the Fund records a realized gain or loss equal to the difference between
the value of the contract at the time it was opened and the value at the time it
was closed.
- - Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-US dollar denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets and liabilities expressed in
foreign currencies into US dollars. Realized and unrealized gains or losses from
investments include the effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently recorded
when the Fund has determined the ex-dividend date. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Deferred organization expenses--Deferred organization expenses are charged
to expense on a straight-line basis over a period not exceeding five years.
(g) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(h) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $1,850 have been reclassified between accumulated net
realized capital losses and undistributed net investment income. These
reclassifications have no effect on net assets or net asset value per share.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.75% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the period June 5, 1998 to December 31, 1998, Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of ML & Co., earned $2,491
in commissions on the execution of portfolio security transactions.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Merrill Lynch Funds Distributor, a division of Princeton Funds Distributor,
Inc. ("PFD"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
is the Fund's Distributor.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
105
<PAGE> 107
- --------------------------------------------------------------------------------
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
period June 5, 1998 to December 31, 1998 were $16,875,923 and $1,577,711,
respectively.
Net realized gains (losses) for the period June 5, 1998 to December 31, 1998
and net unrealized gains as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains
- --------------------------------------------------------------------
<S> <C> <C>
Long-term investments.................. $(7,511) $1,637,450
Short-term investments................. (89) --
Foreign currency transactions.......... 1,850 39
------- ----------
Total.................................. $(5,750) $1,637,489
======= ==========
- --------------------------------------------------------------------
</TABLE>
At December 31, 1998, net unrealized appreciation for Federal income tax
purposes aggregated $1,626,882, of which $2,303,277 related to appreciated
securities and $676,395 related to depreciated securities. At December 31, 1998,
the aggregate cost of investments for Federal income tax purposes was
$18,644,865.
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions was
$14,983,487 for the period June 5, 1998 to December 31, 1998.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Period Dollar
June 5, 1998+ to December 31, 1998 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold............................ 1,598,261 $15,794,079
Shares redeemed........................ (81,504) (810,592)
--------- -----------
Net increase........................... 1,516,757 $14,983,487
========= ===========
- -----------------------------------------------------------------
</TABLE>
+ Prior to June 5, 1998 (commencement of operations), the Fund issued 300,000
shares to MLLIC for $3,000,000.
5. SUBSEQUENT EVENT:
On January 4, 1999, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.025830 per Class A Share payable on January 11, 1999
to shareholders of record as of December 31, 1998.
106
<PAGE> 108
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
GLOBAL GROWTH FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Global Growth Focus Fund of Merrill Lynch
Variable Series Funds, Inc. as of December 31, 1998, the related statements of
operations, changes in net assets and the financial highlights for the period
June 5, 1998 (commencement of operations) to December 31, 1998. These financial
statements and the financial highlights are the responsibility of the Fund's
management. Our responsibility is to express an opinion on these financial
statements and the financial highlights based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements and the financial highlights
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. Our
procedures included confirmation of securities owned at December 31, 1998 by
correspondence with the custodian and brokers. An audit also includes assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audit provides a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Global Growth Focus
Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1998, the
results of its operations, the changes in its net assets, and the financial
highlights for the period June 5, 1998 (commencement of operations) to December
31, 1998 in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
107
<PAGE> 109
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
DECEMBER 31, 1998--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
THE ENVIRONMENT
During 1998, stock and bond market volatility reflected shifting investor
perceptions regarding global economic prospects. Investor optimism early in the
year gave way to expectations of deteriorating corporate profits and signs of a
weakening economy by late summer. Further concerns arose from the precarious
state of the Russian and other emerging markets economies. As a result, world
stock markets declined in the July - September period. At the same time, the
uncertain economic picture and the resulting flight to quality by investors
pushed the 30-year US Treasury bond to record low yields. Yields also declined
on sovereign bonds of other major industrialized countries. In contrast,
corporate bonds, mortgage-backed securities and emerging markets debt
underperformed US Treasury securities by a wide margin.
The US Federal Reserve Board and other central banks responded to the
uncertain economic outlook through a series of monetary policy easings that
served to restore investor confidence as 1998 drew toward a close. Stock markets
around the world rallied, with total returns for the unmanaged Standard & Poor's
500 Index rising 21.3% and the unmanaged Morgan Stanley Capital International
(MSCI) World Index (Ex-US) increasing 20.5% in the fourth quarter of 1998.
However, as 1999 began, uncertainty regarding global economic prospects again
began to cloud the investment outlook. At the same time, with
stronger-than-expected economic results, prospects dimmed for further Federal
Reserve Board monetary policy easings in the near future. The notable exception
to the more subdued investment outlook in the United States was the
unprecedented popularity of Internet-related stocks.
The weakening of the US dollar relative to the Japanese yen was one of the
year's more surprising developments. Since a stronger yen would have a negative
impact on the important export sector of Japan's fragile economy, the Japanese
central bank intervened in the currency markets in January. For the overall
global economy, the deepening recession in Japan is of great concern. At the
same time, the difficulties in emerging economies such as Russia and Brazil
remain. Further progress in easing strains within the global financial system
would likely provide an important element of stability to the volatile
investment environment.
FISCAL YEAR IN REVIEW
As of December 31, 1998, the asset allocation for Global Strategy Focus Fund
was: US stocks, 40% of net assets; foreign stocks, 28%; US bonds, 13%; foreign
bonds, 18%; and cash reserves, 1%.
During the fourth quarter of 1998, a strong rebound in the US and foreign
equity markets offset the significant corrections that took place in the
previous three months. Throughout the fiscal year ended December 31, 1998, US
equities again provided the highest total returns relative to foreign equities
and US and foreign fixed-income securities. Consequently, our decision to
increase US equity representation during 1998 at the expense of foreign equities
and cash reserves had a positive impact on overall performance. In the foreign
equity sector, the overweighting of Europe relative to Japan and emerging
markets had a favorable effect on performance as European equity markets
outperformed Japan and the majority of emerging markets during the year.
However, both the US and European stock markets were characterized by
significant outperformance for a narrow group of large-capitalization equities.
During the fourth quarter of 1998, we increased our representation in equities
of this type, although the Fund was underweighted for much of 1998 in those
equities that dominated the performance of the unmanaged benchmark S&P 500 Index
and the unmanaged MSCI Europe, Australia, Far East Index (EAFE). Our US and
foreign bond commitments positively contributed to overall performance,
particularly in the third quarter of 1998 when there was significant US and
foreign equity market weakness.
PORTFOLIO MATTERS
Beginning in September 1998, a shift toward an increasingly accommodative
monetary policy by the Federal Reserve Board led us to become more positive
toward US equities. Consequently, we increased the Fund's allocation to US
common stocks from 30% of net assets to 40% during the six months ended December
31, 1998. In increasing our US equity exposure, we emphasized the shares of
companies that we believed potentially offered a high degree of earnings
visibility through 1999 despite an expected slowdown in economic activity. New
positions in the Fund included commitments in the technology sector, such as
Intel Corporation, Microsoft Corporation, and Motorola, Inc., and, in
healthcare, through Johnson & Johnson. As of December 31, 1998, consumer
staples, tech-
108
<PAGE> 110
- --------------------------------------------------------------------------------
nology and financial services represented the largest sector weightings among
our US equity commitments.
During the six-month period ended December 31, 1998, we reduced our foreign
equity weighting from 43% of net assets to 28%. Also, we continued to emphasize
European equities as well as focus on companies with more predictable earnings
streams where the risk of earnings disappointment seemed low despite slower
economic growth. In recent months, we increased our representation in such
industries as telecommunications, telecommunications equipment, food and
healthcare. Our commitment to Japanese equities remained underweighted relative
to the MSCI EAFE Index. We remained cautious toward emerging markets, which led
us to eliminate our remaining commitment to Latin American equities during the
second half of 1998.
Within the US bond sector, the average duration was 6.0 years as of December
31, 1998 as compared to 5.2 years as of June 30, 1998. The easing of the crisis
atmosphere in global financial markets during the fourth quarter of 1998 reduced
the appeal of US fixed-income securities as a "safe-haven" investment. However,
the overall trend in intermediate-term and longer-term US interest rates may
continue downward in coming months, reflecting our belief that there is a lack
of inflationary pressures in the US economy. Among the Fund's foreign bond
commitments, we eliminated a position in Swedish bonds during the second half of
1998, limiting our foreign bond commitments to Germany and the United Kingdom.
We continued to hedge our UK stock and bond positions back into US dollars as we
believe there will be a weakness in the British pound in the coming months.
However, we have eliminated our hedges on Continental European equities and
bonds as well as Japanese equities because we believe an easier monetary policy
by the Federal Reserve Board could lead to near-term weakness in the US dollar
compared to these currencies.
IN CONCLUSION
We appreciate your investment in Global Strategy Focus Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to sharing our investment
outlook and strategies with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Thomas R. Robinson
Thomas R. Robinson
Senior Vice President and Portfolio Manager
February 5, 1999
109
<PAGE> 111
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
[GLOBAL STRATEGY FOCUS FUND GRAPH]
<TABLE>
<CAPTION>
VARIABLE
SERIES GLOBAL MORGAN
STRATEGY STANLEY WORLD WEIGHTED
FUND* INDEX INDEX***
<S> <C> <C> <C>
2/28/92** 10000 10000 10000
DEC-92 10262 9832 10386
DEC-93 12420 12045 11752
DEC-94 12239 12656 12540
DEC-95 13537 15278 14628
DEC-96 15320 17337 15402
DEC-97 17149 20070 15931
DEC-98 18670 24955 18581
</TABLE>
<TABLE>
<C> <S>
* Assuming transaction costs and other operating expenses,
including advisory fees. Does not include insurance-related
fees and expenses.
** Commencement of operations.
+ Global Strategy Focus Fund invests primarily in a portfolio
of equity and fixed-income securities of US and foreign
issuers.
++ This unmanaged market capitalization-weighted Index is
comprised of a representative sampling of stocks of large-,
medium-, and small-capitalization companies in 22 countries,
including the United States.
+++ This unmanaged Index, which is an equally weighted blend of
the Morgan Stanley Capital International World Index, the
Salomon Brothers World Government Bond Index and the Salomon
Brothers World Money Market Index, is comprised of a
representative sampling of stocks of large-, medium-, and
small-capitalization companies in 22 countries, government
bonds and money market securities in the major markets,
including the United States.
Past performance is not predictive of future performance.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/98 +8.87%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/98 +8.49
- --------------------------------------------------------------------------------
Inception (2/28/92) to 12/31/98 +9.56
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
RECENT PERFORMANCE RESULTS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
12 MONTH 6 MONTH
TOTAL RETURN TOTAL RETURN
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Class A Shares +8.87% -1.54%
</TABLE>
- --------------------------------------------------------------------------------
* Total investment returns are based on changes in net asset
values for the periods shown, and assume reinvestment of all
dividends and capital gains distributions at net asset value
on the ex-dividend date. Insurance-related fees and expenses
are not reflected in these returns. Past results shown
should not be considered a representation of future
performance.
110
<PAGE> 112
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD US STOCKS COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
AEROSPACE 113,600 GenCorp Inc. .............. $ 3,118,598 $ 2,832,900 0.4%
- ------------------------------------------------------------------------------------------------------------------------
AEROSPACE & DEFENSE 15,300 United Technologies
Corporation.............. 1,206,104 1,663,875 0.2
- ------------------------------------------------------------------------------------------------------------------------
AUTO--RELATED 106,750 +Avis Rent A Car, Inc. .... 2,705,800 2,582,016 0.3
45,800 The Hertz Corporation
(Class A)................ 1,827,966 2,089,625 0.3
------------ ------------ -----
4,533,766 4,671,641 0.6
- ------------------------------------------------------------------------------------------------------------------------
AUTOMOBILE PARTS 87,700 Federal-Mogul
Corporation.............. 3,834,090 5,218,150 0.7
- ------------------------------------------------------------------------------------------------------------------------
AUTOMOTIVE 43,800 General Motors
Corporation.............. 3,087,774 3,134,438 0.4
- ------------------------------------------------------------------------------------------------------------------------
BANKING 43,148 BankAmerica Corporation.... 2,811,545 2,594,274 0.4
156,000 The Bank of New York
Company, Inc. ........... 1,355,812 6,279,000 0.8
------------ ------------ -----
4,167,357 8,873,274 1.2
- ------------------------------------------------------------------------------------------------------------------------
BANKING & FINANCIAL 88,200 First Union Corporation.... 4,418,469 5,363,663 0.7
149,200 Heller Financial, Inc. .... 4,082,354 4,382,750 0.6
67,200 Mellon Bank Corporation.... 4,257,915 4,620,000 0.6
89,550 Providian Financial
Corporation.............. 3,972,810 6,716,250 0.9
------------ ------------ -----
16,731,548 21,082,663 2.8
- ------------------------------------------------------------------------------------------------------------------------
BEVERAGES 93,600 PepsiCo, Inc. ............. 3,518,767 3,831,750 0.5
- ------------------------------------------------------------------------------------------------------------------------
BROADCAST--MEDIA 34,800 +Fox Entertainment Group,
Inc. (Class A)........... 783,000 876,525 0.1
- ------------------------------------------------------------------------------------------------------------------------
BROADCASTING/CABLE 139,900 Tele-Communications, Inc.
(Class A)................ 3,232,772 7,738,219 1.0
297,800 +Tele-Communications TCI
Ventures Group (Class
A)....................... 3,130,828 7,016,912 0.9
------------ ------------ -----
6,363,600 14,755,131 1.9
- ------------------------------------------------------------------------------------------------------------------------
CHEMICALS 30,800 du Pont (E.I.) de Nemours
and Company.............. 1,919,392 1,634,325 0.2
90,600 Morton International,
Inc. .................... 2,612,520 2,219,700 0.3
------------ ------------ -----
4,531,912 3,854,025 0.5
- ------------------------------------------------------------------------------------------------------------------------
COMMUNICATION EQUIPMENT 116,800 +MCI WorldCom, Inc. ....... 3,690,121 8,380,400 1.1
- ------------------------------------------------------------------------------------------------------------------------
COMPUTER SERVICES 72,300 +Cisco Systems, Inc. ...... 3,078,797 6,710,344 0.9
33,600 International Business
Machines Corporation..... 3,128,158 6,207,600 0.8
------------ ------------ -----
6,206,955 12,917,944 1.7
- ------------------------------------------------------------------------------------------------------------------------
COMPUTER SOFTWARE 68,900 +BMC Software, Inc. ....... 2,045,457 3,070,356 0.4
- ------------------------------------------------------------------------------------------------------------------------
COMPUTERS 179,500 COMPAQ Computer
Corporation.............. 6,231,269 7,527,781 1.0
20,050 +EMC Corporation........... 1,432,906 1,704,250 0.2
------------ ------------ -----
7,664,175 9,232,031 1.2
- ------------------------------------------------------------------------------------------------------------------------
CONGLOMERATES 210,600 The Dial Corporation....... 4,336,549 6,081,075 0.8
- ------------------------------------------------------------------------------------------------------------------------
CONSUMER--ELECTRONICS 53,100 +Dell Computer
Corporation.............. 3,372,388 3,886,256 0.5
- ------------------------------------------------------------------------------------------------------------------------
DATA PROCESSING 21,700 +Keane, Inc. .............. 762,523 866,644 0.1
- ------------------------------------------------------------------------------------------------------------------------
ELECTRICAL EQUIPMENT 71,300 PECO Energy Company........ 2,435,708 2,967,862 0.4
- ------------------------------------------------------------------------------------------------------------------------
ELECTRONIC COMPONENTS 27,800 General Electric Company... 2,153,142 2,837,338 0.4
- ------------------------------------------------------------------------------------------------------------------------
ELECTRONICS 42,500 Intel Corporation.......... 4,682,279 5,036,250 0.7
46,500 +Micron Technology,
Inc. .................... 1,773,741 2,351,156 0.3
------------ ------------ -----
6,456,020 7,387,406 1.0
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
111
<PAGE> 113
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD US STOCKS COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ENTERTAINMENT 260,900 +Premier Parks Inc. ....... $ 6,972,318 $ 7,892,225 1.0%
89,100 Royal Caribbean Cruises
Ltd. .................... 2,212,389 3,296,700 0.5
------------ ------------ -----
9,184,707 11,188,925 1.5
- ------------------------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES 74,400 Associates First Capital
Corporation (Class A).... 2,730,062 3,152,700 0.4
- ------------------------------------------------------------------------------------------------------------------------
FOOD DISTRIBUTION 57,200 Nabisco Holdings Corp.
(Class A)................ 2,071,500 2,373,800 0.3
- ------------------------------------------------------------------------------------------------------------------------
FOODS 110,700 +Keebler Foods Company..... 3,091,753 4,165,087 0.5
- ------------------------------------------------------------------------------------------------------------------------
HARDWARE & TOOLS 89,300 The Black & Decker
Corporation.............. 3,842,002 5,006,381 0.7
- ------------------------------------------------------------------------------------------------------------------------
HOTELS 63,200 +3Com Corporation.......... 2,605,720 2,832,150 0.4
- ------------------------------------------------------------------------------------------------------------------------
INSURANCE 58,550 Allmerica Financial
Corporation.............. 3,609,736 3,388,581 0.5
93,100 Equitable Companies
Incorporated (The)....... 4,874,619 5,388,163 0.7
81,800 UNUM Corporation........... 2,978,993 4,775,075 0.6
------------ ------------ -----
11,463,348 13,551,819 1.8
- ------------------------------------------------------------------------------------------------------------------------
MACHINERY 24,400 Case Corporation........... 652,734 532,225 0.1
108,100 Ingersoll-Rand Company..... 3,660,838 5,073,944 0.6
------------ ------------ -----
4,313,572 5,606,169 0.7
- ------------------------------------------------------------------------------------------------------------------------
MANUFACTURING 46,700 Millipore Corporation...... 994,884 1,328,031 0.2
86,400........... Tyco International Ltd. ... 4,493,228 6,517,800 0.8
------------ ------------ -----
5,488,112 7,845,831 1.0
- ------------------------------------------------------------------------------------------------------------------------
MEDICAL EQUIPMENT 59,300 Beckman Coulter Inc. ...... 3,546,406 3,217,025 0.4
- ------------------------------------------------------------------------------------------------------------------------
MEDICAL SPECIALTIES 112,800 +HEALTHSOUTH Corporation... 2,125,552 1,741,350 0.2
79,000 Warner-Lambert Company..... 3,802,659 5,939,812 0.8
------------ ------------ -----
5,928,211 7,681,162 1.0
- ------------------------------------------------------------------------------------------------------------------------
MEDICAL TECHNOLOGY 32,150 Johnson & Johnson.......... 2,529,029 2,696,581 0.3
- ------------------------------------------------------------------------------------------------------------------------
METALS 25,850 Aluminum Co. of America.... 1,940,029 1,927,441 0.2
- ------------------------------------------------------------------------------------------------------------------------
NATURAL GAS 88,300 Enron Corporation.......... 3,677,363 5,038,619 0.7
- ------------------------------------------------------------------------------------------------------------------------
OIL--INTEGRATED 31,200 Mobil Corporation.......... 2,443,474 2,718,300 0.4
- ------------------------------------------------------------------------------------------------------------------------
OIL SERVICES 50,000 Schlumberger Limited....... 3,098,508 2,306,250 0.3
- ------------------------------------------------------------------------------------------------------------------------
PAPER & FOREST PRODUCTS 31,000 Kimberly-Clark
Corporation.............. 1,426,058 1,689,500 0.2
- ------------------------------------------------------------------------------------------------------------------------
PETROLEUM 83,400 Unocal Corporation......... 2,983,006 2,434,237 0.3
- ------------------------------------------------------------------------------------------------------------------------
PHARMACEUTICAL--DIVERSIFIED 61,200 Bristol-Myers Squibb
Company.................. 5,939,907 8,189,325 1.1
- ------------------------------------------------------------------------------------------------------------------------
PRINTING & PUBLISHING 144,900 +World Color Press,
Inc. .................... 4,371,298 4,410,394 0.6
- ------------------------------------------------------------------------------------------------------------------------
RADIO & TELEVISION 203,400 +Capstar Broadcasting
Corporation (Class A).... 3,864,600 4,652,775 0.6
- ------------------------------------------------------------------------------------------------------------------------
RAILROADS 137,000 Burlington Northern Santa
Fe Corp. ................ 3,974,569 4,623,750 0.6
- ------------------------------------------------------------------------------------------------------------------------
RETAIL 120,000 Lowe's Companies, Inc. .... 4,295,271 6,142,500 0.8
74,900 +Safeway Inc. ............. 2,629,573 4,564,219 0.6
59,400 Wal-Mart Stores, Inc. ..... 2,639,573 4,837,387 0.6
------------ ------------ -----
9,564,417 15,544,106 2.0
- ------------------------------------------------------------------------------------------------------------------------
RETAIL--DRUG STORES 141,710 Rite Aid Corporation....... 2,823,305 7,023,502 0.9
- ------------------------------------------------------------------------------------------------------------------------
SAVINGS & LOAN 155,900 GreenPoint Financial
ASSOCIATIONS Corp. ................... 6,058,045 5,475,988 0.7
- ------------------------------------------------------------------------------------------------------------------------
SEMICONDUCTORS 68,400 Motorola, Inc. ............ 3,626,727 4,176,675 0.5
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
112
<PAGE> 114
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD US STOCKS COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
SERVICES 57,360 +Quintiles Transnational
Corp. ................... $ 2,678,433 $ 3,058,005 0.4%
- ------------------------------------------------------------------------------------------------------------------------
SOFTWARE--COMPUTER 18,700 +Microsoft Corporation..... 2,185,477 2,591,119 0.3
- ------------------------------------------------------------------------------------------------------------------------
STEEL 92,300 +Bethlehem Steel
Corporation.............. 895,233 773,013 0.1
23,100 USX-US Steel Group......... 631,725 531,300 0.1
------------ ------------ -----
1,526,958 1,304,313 0.2
- ------------------------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 92,900 GTE Corporation............ 4,728,622 6,264,944 0.8
- ------------------------------------------------------------------------------------------------------------------------
TOYS 31,200 Mattel, Inc. .............. 722,464 711,750 0.1
- ------------------------------------------------------------------------------------------------------------------------
UTILITIES--COMMUNICATIONS 99,900 Ameritech Corporation...... 4,812,354 6,331,163 0.8
- ------------------------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 68,600 Public Service Enterprise
Group Incorporated....... 2,665,361 2,744,000 0.3
79,000 Texas Utilities Company.... 3,592,287 3,688,312 0.5
------------ ------------ -----
6,257,648 6,432,312 0.8
- ------------------------------------------------------------------------------------------------------------------------
UTILITIES--GAS 190,900 El Paso Energy
Corporation.............. 5,086,965 6,645,706 0.9
- ------------------------------------------------------------------------------------------------------------------------
WASTE MANAGEMENT 76,000 Waste Management, Inc. .... 3,306,346 3,543,500 0.5
- ------------------------------------------------------------------------------------------------------------------------
TOTAL US STOCKS 234,890,549 304,832,988 39.8
- ------------------------------------------------------------------------------------------------------------------------
COUNTRY FOREIGN STOCKS++
- ------------------------------------------------------------------------------------------------------------------------
AUSTRIA 41,100 Mayr-Melnhof Karton AG
(31)..................... 2,069,711 1,920,102 0.3
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
AUSTRIA 2,069,711 1,920,102 0.3
- ------------------------------------------------------------------------------------------------------------------------
CANADA 17,900 Magna International, Inc.
(Class A) (2)............ 1,310,897 1,109,800 0.1
227,700 Teleglobe Inc. (38)........ 6,159,224 8,197,200 1.1
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN CANADA 7,470,121 9,307,000 1.2
- ------------------------------------------------------------------------------------------------------------------------
DENMARK 6,200 ISS International Service
System A/S (Class B)
(20)..................... 404,569 403,458 0.1
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
DENMARK 404,569 403,458 0.1
- ------------------------------------------------------------------------------------------------------------------------
FINLAND 154,500 +Amer Group Ltd. (12)...... 2,865,185 1,597,596 0.2
36,100 Nokia Oyj (Class A) (9).... 3,618,265 4,391,641 0.6
71,700 Orion-Yhtyma Oyj (Class B)
(32)..................... 1,931,144 1,721,982 0.2
80,000 Sampro Insurance Company
(Class A) (23)........... 3,698,893 3,037,379 0.4
193,460 +Sponda Oyj (34)........... 1,375,996 1,127,394 0.2
33,700 UPM-Kymmene Oyj (31)....... 752,437 938,958 0.1
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
FINLAND 14,241,920 12,814,950 1.7
- ------------------------------------------------------------------------------------------------------------------------
FRANCE 47,100 AXA (23)................... 5,343,105 6,826,453 0.9
3,250 Cap Gemini S.A. (22)....... 495,744 521,633 0.1
43,800 Elf Aquitaine S.A. (29).... 5,293,488 5,062,859 0.7
35,100 France Telecom S.A. (38)... 2,463,949 2,788,555 0.4
9,000 Groupe Danone (18)......... 2,362,876 2,576,628 0.3
73,000 +STMicroelectronics N.V.
(NY Registered Shares)
(37)..................... 4,564,232 5,698,562 0.7
78,500 Scor S.A. (23)............. 2,821,981 5,190,071 0.7
63,800 Thomson-CSF S.A. (14)...... 2,398,301 2,739,814 0.3
16,400 Vivendi (41)............... 3,384,984 4,255,015 0.5
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN FRANCE 29,128,660 35,659,590 4.6
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
113
<PAGE> 115
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
COUNTRY HELD FOREIGN STOCKS++ COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
GERMANY 21,400 +DaimlerChrysler AG (3).... $ 1,674,032 $ 2,113,025 0.3%
52,900 Henkel KGaA (Preferred)
(8)...................... 2,254,747 4,731,152 0.6
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
GERMANY 3,928,779 6,844,177 0.9
- ------------------------------------------------------------------------------------------------------------------------
IRELAND 180,000 Bank of Ireland (4)........ 3,807,064 3,942,545 0.5
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
IRELAND 3,807,064 3,942,545 0.5
- ------------------------------------------------------------------------------------------------------------------------
ITALY 2,784,000 +Banca di Roma (4)......... 6,129,895 4,715,789 0.6
468,400 +Mondadori (Arnoldo)
Editore S.p.A. (34)...... 3,947,288 6,191,494 0.8
440,000 Telecom Italia S.p.A.
(38)..................... 3,337,168 3,753,176 0.5
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN ITALY 13,414,351 14,660,459 1.9
- ------------------------------------------------------------------------------------------------------------------------
JAPAN 36,000 Fuji Photo Film (33)....... 1,338,979 1,341,020 0.2
237,000 Fujikura Ltd. (14)......... 1,375,519 1,273,809 0.2
116,000.......... Fujitsu Limited (16)....... 1,318,847 1,548,381 0.2
41,000 Ito-Yokado Co., Ltd.
(36)..................... 2,267,865 2,872,727 0.4
67,000 Kao Corporation (11)....... 1,333,391 1,515,299 0.2
70,000 Marui Co., Ltd. (27)....... 1,343,234 1,350,333 0.2
147,000 Matsushita Electric
Industrial Company, Ltd.
(16)..................... 2,329,936 2,606,235 0.3
234,000 Minebea Co., Ltd. (25)..... 2,447,411 2,685,552 0.3
640 NTT Mobile Communication
Network, Inc.(a) (38).... 2,111,854 2,639,468 0.3
287 Nippon Telegraph &
Telephone Corporation
(NTT) (16)............... 2,437,594 2,219,636 0.3
121,000 Olympus Optical Co., Ltd.
(12)..................... 1,363,168 1,394,049 0.2
18,000 Orix Corporation (17)...... 1,323,236 1,347,406 0.2
24,000 Rohm Company Ltd. (16)..... 2,351,533 2,190,333 0.3
211,000 Tokio Marine & Fire
Insurance Co., Ltd.
(23)..................... 2,347,248 2,526,386 0.3
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN JAPAN 25,689,815 27,510,634 3.6
- ------------------------------------------------------------------------------------------------------------------------
NETHERLANDS 32,400 Unilever N.V. (26)......... 2,324,221 2,768,273 0.4
26,900 Wolters Kluwer N.V. (6).... 4,113,407 5,753,750 0.7
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE
NETHERLANDS 6,437,628 8,522,023 1.1
- ------------------------------------------------------------------------------------------------------------------------
NORWAY 103,800 Merkantildata ASA (10)..... 793,621 1,022,123 0.1
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN NORWAY 793,621 1,022,123 0.1
- ------------------------------------------------------------------------------------------------------------------------
SINGAPORE 17,400 +Flextronics International
Ltd. (15)................ 1,216,723 1,487,700 0.2
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SINGAPORE 1,216,723 1,487,700 0.2
- ------------------------------------------------------------------------------------------------------------------------
SPAIN 172,000 +Dinamia Capital Privado-
Sociedad de Capital
Riesgo, S.A. (42)........ 3,233,132 1,967,340 0.3
133,000 Endesa S.A. (40)........... 3,485,249 3,519,955 0.5
89,100 Metrovacesa, S.A. (35)..... 2,777,112 2,690,498 0.3
79,600 Telefonica S.A. (38)....... 3,468,790 3,535,412 0.4
79,600 Telefonica S.A. (Rights)(b)
(38)..................... 0 70,596 0.0
273,600 Uralita, S.A. (7).......... 3,839,161 3,042,782 0.4
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SPAIN 16,803,444 14,826,583 1.9
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
114
<PAGE> 116
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
COUNTRY HELD FOREIGN STOCKS++ COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
SWEDEN 58,100 Autoliv, Inc. (2).......... $ 1,943,840 $ 2,091,479 0.3%
127,091 Bure Investment AB (24).... 1,159,589 1,807,994 0.2
163,200 Castellum AB (35).......... 1,696,428 1,776,590 0.2
16,400 Custos AB (Class A) (12)... 422,398 324,600 0.0
65,500 Custos AB (Class B) (12)... 1,726,494 1,284,266 0.2
85,000 Fastighets AB Tornet
(35)..................... 1,403,051 1,246,011 0.2
68,500 ForeningsSparbanken AB
(4)...................... 875,497 1,779,485 0.2
161,500 Haldex AB (2).............. 2,872,988 1,638,215 0.2
325,700 Nordbanken Holding AB
(4)...................... 2,207,706 2,095,104 0.3
130,000 Spectra-Physics AB (Class
A) (21).................. 3,966,604 1,535,788 0.2
205,800 Telefonaktiebolaget LM
Ericsson (ADR)* (38)..... 5,253,963 4,913,475 0.7
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SWEDEN 23,528,558 20,493,007 2.7
- ------------------------------------------------------------------------------------------------------------------------
SWITZERLAND 1,143 Nestle S.A. (Registered
Shares) (18)............. 2,351,866 2,490,033 0.3
1,896 Novartis AG (Registered
Shares) (13)............. 3,500,765 3,729,836 0.5
12,000 +Swisscom AG (Registered)
(38)..................... 3,217,264 5,027,322 0.7
9,000 Valora Holding AG (27)..... 2,432,589 2,436,066 0.3
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SWITZERLAND 11,502,484 13,683,257 1.8
- ------------------------------------------------------------------------------------------------------------------------
UNITED KINGDOM 259,200 Bank of Scotland (4)....... 2,872,037 3,090,811 0.4
607,400 Billiton PLC (12).......... 1,467,162 1,204,624 0.2
345,300 British Aerospace PLC
(1)...................... 2,759,866 2,925,898 0.4
102,000 British Petroleum Company
PLC (29)................. 1,459,211 1,522,485 0.2
420,500 Devro PLC (18)............. 2,810,818 1,209,847 0.1
474,886 Diageo PLC (5)............. 5,358,733 5,402,115 0.7
107,000 Glaxo Wellcome PLC (32).... 3,419,099 3,680,041 0.5
110,200 HSBC Holdings PLC (4)...... 2,921,559 2,987,360 0.4
211,500 Lloyds TSB Group PLC (4)... 2,809,887 3,007,425 0.4
565,400 LucasVarity PLC (2)........ 2,037,432 1,885,335 0.2
155,800 National Westminster Bank
PLC (Ordinary) (4)....... 2,822,370 3,003,096 0.4
124,200 Rio Tinto PLC (Registered)
(28)..................... 1,532,255 1,443,834 0.2
67,400 Shell Transport & Trading
Company (ADR)* (30)...... 2,476,095 2,506,437 0.3
2,023,000 Thomson Travel Group PLC
(39)..................... 6,322,640 5,517,700 0.7
87,600 Zeneca Group PLC (13)...... 3,521,087 3,812,643 0.5
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE
UNITED KINGDOM 44,590,251 43,199,651 5.6
- ------------------------------------------------------------------------------------------------------------------------
TOTAL FOREIGN STOCKS 205,027,699 216,297,259 28.2
- ------------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT FOREIGN BONDS++
- ------------------------------------------------------------------------------------------------------------------------
GERMANY DM 77,800,000 Bundes Obligation, 4.75%
due 11/20/2001 (19)...... 48,283,731 48,688,043 6.4
Bundesrepublik Deutschland
(19):
48,600,000 6% due 9/15/2003........... 32,200,835 32,508,908 4.2
25,300,000 4.75% due 7/04/2008........ 16,409,378 16,229,358 2.1
16,000,000 5.625% due 1/04/2028....... 9,123,503 10,812,005 1.4
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
GERMANY 106,017,447 108,238,314 14.1
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
115
<PAGE> 117
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE VALUE PERCENT OF
COUNTRY AMOUNT FOREIGN BONDS++ COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
UNITED KINGDOM
United Kingdom Treasury
Gilt (19):
L 4,300,000 8% due 12/07/2000.......... $ 7,266,604 $ 7,553,235 1.0%
12,400,000 7.25% due 12/07/2007....... 20,870,937 24,953,152 3.3
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE
UNITED KINGDOM 28,137,541 32,506,387 4.3
- ------------------------------------------------------------------------------------------------------------------------
TOTAL FOREIGN BONDS 134,154,988 140,744,701 18.4
- ------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT OBLIGATIONS
- ------------------------------------------------------------------------------------------------------------------------
Federal National Mortgage
Association:
US$ 11,720,000 5.625% due 3/15/2001....... 11,765,146 11,892,167 1.6
17,080,000 5.75% due 4/15/2003........ 17,192,019 17,533,645 2.3
25,840,000 5.75% due 2/15/2008........ 25,757,229 26,756,545 3.5
US Treasury Notes:
2,000,000 6% due 8/15/1999........... 2,005,469 2,016,240 0.3
7,000,000 6.125% due 9/30/2000....... 7,173,906 7,171,710 0.9
15,470,000 6.50% due 5/31/2002........ 15,955,855 16,332,917 2.1
16,510,000 US Treasury Bonds, 6.625%
due 2/15/2027............ 18,845,717 19,528,193 2.5
- ------------------------------------------------------------------------------------------------------------------------
TOTAL US GOVERNMENT
OBLIGATIONS 98,695,341 101,231,417 13.2
- ------------------------------------------------------------------------------------------------------------------------
SHORT-TERM SECURITIES
- ------------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER** 3,506,000 General Motors Acceptance
Corp., 5.13% due
1/04/1999................ 3,504,501 3,504,501 0.5
- ------------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES 3,504,501 3,504,501 0.5
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS.......... $676,273,078 766,610,866 100.1
============
UNREALIZED APPRECIATION ON
FORWARD FOREIGN
EXCHANGE CONTRACTS+++.... 167,866 0.0
LIABILITIES IN EXCESS OF
OTHER ASSETS............. (752,920) (0.1)
------------ -----
NET ASSETS................. $766,025,812 100.0%
============ =====
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
* American Depositary Receipts (ADR).
** Commercial Paper is traded on a discount basis; the interest rate shown
reflects the discount rate paid at the time of purchase by the Fund.
(a) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(b) The rights may be exercised until 1/30/99.
+ Non-income producing security.
++ Corresponding industry groups for foreign stocks and bonds:
<TABLE>
<S> <C> <C>
(1) Aerospace & Defense (14) Electrical Equipment (28) Metals & Mining
(2) Auto--Parts (15) Electronic Components (29) Oil & Related
(3) Automobile (16) Electronics (30) Oil -- Integrated
(4) Banking (17) Finance (31) Paper & Forest Products
(5) Beverages (18) Foods (32) Pharmaceutical
(6) Broadcasting & Publishing (19) Government (Bonds) (33) Photography
(7) Building Materials (20) Industrial--Services (34) Printing & Publishing
(8) Chemicals (21) Industrial Components (35) Real Estate
(9) Communication Equipment (22) Information Processing (36) Retail Stores
(10) Computer Software (23) Insurance (37) Semiconductor Capital Equipment
(11) Cosmetics (24) Investment Management (38) Telecommunications
(12) Diversified (25) Machine Tools & Machinery (39) Travel & Lodging
(13) Drugs (26) Manufacturing (40) Utilities--Electric
(27) Merchandising (41) Utilities--Water
(42) Venture Capital
</TABLE>
116
<PAGE> 118
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
+++ Forward foreign exchange contracts as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------
UNREALIZED
APPRECIATION
EXPIRATION (DEPRECIATION)
FOREIGN CURRENCY SOLD DATE (NOTE 1B)
- ------------------------------------------------------------------------
<S> <C> <C> <C> <C>
C$ 13,000,000 February 1999 $ (70,191)
L 23,300,000 January 1999 (108,229)
L 20,600,000 February 1999 346,286
- ------------------------------------------------------------------------
TOTAL UNREALIZED APPRECIATION ON FORWARD FOREIGN
EXCHANGE CONTRACTS--NET (US$ COMMITMENT--$81,599,290) $ 167,866
==========
- ------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
117
<PAGE> 119
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$676,273,078) (Note
1a)....................................................... $766,610,866
Unrealized appreciation on forward foreign exchange
contracts (Note 1b)....................................... 167,866
Receivables:
Interest.................................................. $3,435,119
Dividends................................................. 950,765
Capital shares sold....................................... 1,764 4,387,648
----------
Prepaid expenses and other assets........................... 52,404
------------
Total assets................................................ 771,218,784
------------
- -----------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Custodian bank............................................ 4,427,956
Investment adviser (Note 2)............................... 411,927
Capital shares redeemed................................... 174,318 5,014,201
----------
Accrued expenses and other liabilities...................... 178,771
------------
Total liabilities........................................... 5,192,972
------------
- -----------------------------------------------------------------------------------------
NET ASSETS.................................................. $766,025,812
============
- -----------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 200,000,000
shares authorized+........................................ $ 5,714,415
Paid-in capital in excess of par............................ 661,859,805
Undistributed investment income--net........................ 4,350,766
Undistributed realized capital gains on investments and
foreign currency transactions--net........................ 3,533,136
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 90,567,690
------------
NET ASSETS.................................................. $766,025,812
============
- -----------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $766,025,812 and 57,144,148
shares outstanding........................................ $ 13.41
============
- -----------------------------------------------------------------------------------------
</TABLE>
+ The Fund is also authorized to issue 200,000,000 Class B Shares.
See Notes to Financial Statements.
118
<PAGE> 120
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Interest and discount earned................................ $15,624,038
Dividends (net of $842,508 foreign withholding tax)......... 10,078,670
Other income................................................ 36,439
-----------
Total income................................................ 25,739,147
-----------
- -----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $ 5,364,685
Custodian fees.............................................. 229,206
Accounting services (Note 2)................................ 156,181
Printing and shareholder reports............................ 106,320
Professional fees........................................... 60,015
Directors' fees and expenses................................ 18,868
Pricing services............................................ 7,721
Transfer agent fees (Note 2)................................ 5,117
Other....................................................... 14,891
------------
Total expenses.............................................. 5,963,004
-----------
Investment income--net...................................... 19,776,143
-----------
- -----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET (NOTES 1b, 1c, 1e & 3):
Realized gain (loss) from:
Investments--net.......................................... 13,876,342
Foreign currency transactions--net........................ (12,748,846) 1,127,496
------------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... 46,741,091
Foreign currency transactions--net........................ 474,053 47,215,144
------------ -----------
Net realized and unrealized gain on investments and foreign
currency transactions..................................... 48,342,640
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $68,118,783
===========
- -----------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
119
<PAGE> 121
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE
YEAR ENDED
DECEMBER 31,
-----------------------------
INCREASE (DECREASE) IN NET ASSETS: 1998 1997
- -------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 19,776,143 $ 20,985,143
Realized gain on investments and foreign currency
transactions--net......................................... 1,127,496 106,726,204
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ 47,215,144 (27,730,460)
------------- ------------
Net increase in net assets resulting from operations........ 68,118,783 99,980,887
------------- ------------
- -------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1f):
Investment income--net:
Class A................................................... (32,818,349) (18,926,819)
Realized gain on investments--net:
Class A................................................... (100,559,993) (26,410,838)
In excess of realized gain on investments--net:
Class A................................................... (8,809,833) --
------------- ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (142,188,175) (45,337,657)
------------- ------------
- -------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net decrease in net assets derived from capital share
transactions.............................................. (29,551,610) (55,199,234)
------------- ------------
- -------------------------------------------------------------------------------------------
NET ASSETS:
Total decrease in net assets................................ (103,621,002) (556,004)
Beginning of year........................................... 869,646,814 870,202,818
------------- ------------
End of year*................................................ $ 766,025,812 $869,646,814
============= ============
- -------------------------------------------------------------------------------------------
* Undistributed investment income--net (Note 1g)............ $ 4,350,766 $ 29,735,941
============= ============
- -------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
120
<PAGE> 122
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
----------------------------------------------------
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FOR THE YEAR ENDED DECEMBER 31,
FROM INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. ----------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year.......................... $ 14.71 $ 13.87 $ 12.55 $ 11.73 $ 12.17
-------- -------- -------- -------- --------
Investment income--net...................................... .34 .35 .28 .39 .30
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net........................ .76 1.21 1.33 .82 (.48)
-------- -------- -------- -------- --------
Total from investment operations............................ 1.10 1.56 1.61 1.21 (.18)
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net.................................... (.55) (.30) (.29) (.39) (.21)
Realized gain on investments--net......................... (1.70) (.42) -- --+ (.04)
In excess of realized gain on investments--net............ (.15) -- -- -- (.01)
-------- -------- -------- -------- --------
Total dividends and distributions........................... (2.40) (.72) (.29) (.39) (.26)
-------- -------- -------- -------- --------
Net asset value, end of year................................ $ 13.41 $ 14.71 $ 13.87 $ 12.55 $ 11.73
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share.......................... 8.87% 11.94% 13.17% 10.60% (1.46%)
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses.................................................... .72% .73% .71% .72% .77%
======== ======== ======== ======== ========
Investment income--net...................................... 2.40% 2.33% 2.68% 3.33% 2.85%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)...................... $766,026 $869,647 $870,203 $540,242 $515,407
======== ======== ======== ======== ========
Portfolio turnover.......................................... 120.59% 108.66% 173.44% 27.23% 21.03%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Amount is less than $.01 per share.
See Notes to Financial Statements.
121
<PAGE> 123
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies, that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Class A and
Class B Shares have equal voting, dividend, liquidation and other rights, except
that only shares of the respective classes are entitled to vote on matters
concerning only that class and Class B Shares bear certain expenses related to
the distribution of such shares. Global Strategy Focus Fund (the "Fund") is
classified as "non-diversified," as defined in the Investment Company Act of
1940. The Fund's financial statements are prepared in accordance with generally
accepted accounting principles which may require the use of management accruals
and estimates. The following is a summary of significant accounting policies
followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written or purchased are valued at the last sale price in the
case of exchange-traded options. In the case of options traded in the
over-the-counter market, valuation is the last asked price (options written) or
the last bid price (options purchased). Short-term securities are valued at
amortized cost, which approximates market value. Futures contracts are valued at
the settlement price at the close of the applicable exchange. Securities and
assets for which market quotations are not readily available are valued at fair
value as determined in good faith by or under the direction of the Board of
Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity, debt and currency markets. Losses may arise due
to changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts.
- - Options--The Fund may write and purchase call and put options. When the Fund
writes an option, an amount equal to the premium received by the Fund is
reflected as an asset and an equivalent liability. The amount of the liability
is subsequently marked to market to reflect the current market value of the
option written. When a security is purchased or sold through an exercise of an
option, the related premium paid or received is added to (or deducted from) the
basis of the security acquired or deducted from (or added to) the proceeds of
the security sold. When an option expires (or the Fund enters into a closing
transaction), the Fund realizes a gain or loss on the option to the extent of
the premiums received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts for the purpose of hedging the
market risk on existing securities or the intended purchase of securities.
Futures contracts are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon entering into a contract, the
Fund deposits and maintains as collateral such initial margin as required by the
exchange on which the transaction is effected. Pursuant to the contract, the
Fund agrees to receive from or pay to the broker an amount of cash equal to the
daily fluctuation in value of the contract. Such receipts or payments are known
as variation margin and are recorded
122
<PAGE> 124
- --------------------------------------------------------------------------------
by the Fund as unrealized gains or losses. When the contract is closed, the Fund
records a realized gain or loss equal to the difference between the value of the
contract at the time it was opened and the value at the time it was closed.
- - Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-US dollar denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) Foreign currency transactions--Trans-
actions denominated in foreign currencies are recorded at the exchange rate
prevailing when recognized. Assets and liabilities denominated in foreign
currencies are valued at the exchange rate at the end of the period. Foreign
currency transactions are the result of settling (realized) or valuing
(unrealized) assets and liabilities expressed in foreign currencies into US
dollars. Realized and unrealized gains or losses from investments include the
effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently recorded
when the Fund has determined the ex-dividend date. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(g) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $12,342,969 have been reclassified between undistributed
net realized capital gains and undistributed net investment income. These
reclassifications have no effect on net assets or net asset value per share.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.65% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1998, Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("MLPF&S"), a subsidiary of ML & Co., earned $160,026 in
commissions on the execution of portfolio security transactions
For the year ended December 31, 1998, Merrill Lynch Security Pricing Service,
an affiliate of MLPF&S, earned $155 for providing security price quotations to
compute the Fund's net asset value.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Merrill Lynch Funds Distributor, a division of Princeton Funds Distributor,
Inc. ("PFD"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
is the Fund's distributor.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
123
<PAGE> 125
- --------------------------------------------------------------------------------
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1998 were $945,959,372 and $1,015,220,647, respectively.
Net realized gains (losses) for the year ended December 31, 1998 and net
unrealized gains as of December 31, 1998 were as follows:
- ---------------------------------------------------------
<TABLE>
<CAPTION>
Realized
Gains Unrealized
(Losses) Gains
- -----------------------------------------------------------------------------
<S> <C> <C>
Long-term investments............................ $ 13,878,129 $90,337,788
Short-term investments........................... (1,787) --
Foreign currency transactions.................... (291,525) 62,036
Forward foreign exchange contracts............... (12,457,321) 167,866
------------ -----------
Total............................................ $ 1,127,496 $90,567,690
============ ===========
- -----------------------------------------------------------------------------
</TABLE>
At December 31, 1998, net unrealized appreciation for Federal income tax
purposes aggregated $90,093,980, of which $109,600,523 related to appreciated
securities and $19,506,543 related to depreciated securities. At December 31,
1998, the aggregate cost of investments for Federal income tax purposes was
$676,516,886.
4. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share transactions were
$29,551,610 and $55,199,234 for the years ended December 31, 1998 and December
31, 1997, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
Class A for the Year Ended Dollar
December 31, 1998 Shares Amount
- ----------------------------------------------------------------------------
<S> <C> <C>
Shares sold................................... 234,661 $ 3,070,103
Shares issued to shareholders in reinvestment
of dividends and distributions............... 11,480,542 142,188,175
----------- -------------
Total issued.................................. 11,715,203 145,258,278
Shares redeemed............................... (13,691,765) (174,809,888)
----------- -------------
Net decrease.................................. (1,976,562) $ (29,551,610)
=========== =============
- ----------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
Class A for the Year Ended Dollar
December 31, 1997 Shares Amount
- ----------------------------------------------------------------------------
<S> <C> <C>
Shares sold................................... 1,193,286 $ 17,737,325
Shares issued to shareholders in reinvestment
of dividends and distributions............... 3,479,483 45,337,657
----------- -------------
Total issued.................................. 4,672,769 63,074,982
Shares redeemed............................... (8,275,362) (118,274,216)
----------- -------------
Net decrease.................................. (3,602,593) $ (55,199,234)
=========== =============
- ----------------------------------------------------------------------------
</TABLE>
5. SUBSEQUENT EVENT:
On January 4, 1999, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.117408 per Class A Share payable on January 11, 1999
to shareholders of record as of December 31, 1998.
124
<PAGE> 126
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
GLOBAL STRATEGY FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Global Strategy Focus Fund of Merrill Lynch
Variable Series Funds, Inc. as of December 31, 1998, the related statements of
operations for the year then ended and changes in net assets for each of the
years in the two-year period then ended, and the financial highlights for each
of the years in the five-year period then ended. These financial statements and
the financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and the
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1998 by correspondence with the custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Global Strategy
Focus Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1998,
the results of its operations, the changes in its net assets, and the financial
highlights for the respective stated periods in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
125
<PAGE> 127
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
DECEMBER 31, 1998--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
THE ENVIRONMENT
During 1998, stock and bond market volatility reflected shifting investor
perceptions regarding global economic prospects. Investor optimism early in the
year gave way to expectations of deteriorating corporate profits and signs of a
weakening economy by late summer. Further concerns arose from the precarious
state of the Russian and other emerging markets economies. As a result, world
stock markets declined in the July--September period. At the same time, the
uncertain economic picture and the resulting flight to quality by investors
pushed the 30-year US Treasury bond to record low yields. Yields also declined
in sovereign bond markets of other major industrialized countries. In contrast,
corporate bonds, mortgage-backed securities and emerging markets debt
underperformed US Treasury securities by a wide margin.
The US Federal Reserve Board and other central banks responded to the
uncertain economic outlook through a series of monetary policy easings that
served to restore investor confidence as 1998 drew toward a close. Stock markets
around the world rallied, with total returns for the unmanaged Standard & Poor's
500 Index rising 21.3% and the unmanaged Morgan Stanley Capital International
World Index (Ex-US) increasing 20.5% during the fourth quarter of 1998. However,
as 1999 began, uncertainty regarding global economic prospects again began to
cloud the investment outlook. At the same time, with stronger-than-expected
economic results, prospects dimmed for further Federal Reserve Board monetary
policy easings in the near future. The notable exception to the more subdued
investment outlook in the United States was the unprecedented popularity of
Internet-related stocks.
The weakening of the US dollar relative to the Japanese yen was one of the
year's more surprising developments. Since a stronger yen would have a negative
impact on the important export sector of Japan's fragile economy, the Japanese
central bank intervened in the currency markets in January. For the overall
global economy, the deepening recession in Japan is of great concern. At the
same time, the difficulties in emerging economies such as Russia and Brazil
remain. Further progress in easing strains within the global financial system
would likely provide an important element of stability to the volatile
investment environment.
FISCAL YEAR IN REVIEW
As of December 31, 1998, Global Utility Focus Fund maintained 46% of net
assets in telecommunications, 36% in electric utilities, 13% in natural gas and
4% in water utilities. Cash reserves ended the year at 2% of net assets.
Throughout the 12-month period, the telecommunications sector dominated the
Fund's foreign holdings, and in the Fund's domestic holdings, the electric
utility sector was the largest. At December 31, 1998, the Fund had equity
holdings in 17 countries outside of the United States.
During the year ended December 31, 1998, we continued to move away from
emerging markets and remained focused in the United States and Europe. According
to the benchmark unmanaged Financial Times/Standard & Poor's--Actuaries World
Utility Index, Europe and the United States were the two best-performing utility
equity markets in 1998. The Asian financial crisis that started in the latter
part of 1997 continued into the first half of 1998. This factor, coupled with
concerns over the economic health of Brazil, resulted in extreme market
volatility. Overall, company fundamentals and attractive valuation levels
supported our investment strategy.
Toward the end of 1998, we began to see a resurgence in equity offerings in
the utility sector. Valuation levels of the offerings appeared to be attractive
relative to company fundamentals and, as a result, the Fund participated in
several of the offerings.
During the 12 months ended December 31, 1998, we reduced our weighting in the
natural gas sector in the US-based holdings, while maintaining holdings in both
the telecommunications and electric sectors. The defensive characteristics of
the domestic utility sector proved to be beneficial to the Fund's performance
during the market volatility that occurred this summer. In the fall of 1998,
when the broad market rebounded, investors moved away from the more defensive
domestic electric holdings and into companies with faster earnings growth.
However, the domestic telecommunications sector was a beneficiary of
repositioning, and the group was the best-performing utility sector in the
fourth quarter of 1998. The performance of the natural gas sector continued to
be dominated by weather, and temperatures were above normal levels in several
parts of the country during the critical time of storage replenishing.
Consequently, this negatively affected the Fund's total return for the 12-month
period ended December 31, 1998.
126
<PAGE> 128
- --------------------------------------------------------------------------------
IN CONCLUSION
The investment outlook remains favorable for the utility sector. Domestically,
we believe that earnings growth is propelling the telecommunications industry.
It appears restructuring and potential merger and acquisition activity are
driving the performance of the electric sector. Overseas, cost-cutting,
increased use of technology and higher penetration for services are providing a
generally positive outlook for the utility sector, in our view.
We thank you for your interest in Global Utility Focus Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to discussing our performance
and investment strategy with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Walter D. Rogers
Walter D. Rogers
Senior Vice President and Portfolio Manager
February 5, 1999
127
<PAGE> 129
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FINANCIAL
FINANCIAL TIMES/STANDARD
GLOBAL UTILITY TIMES/STANDARD &
FOCUS & POOR'SACTUARIES
FUND'CLASS A POOR'SACTUARIES WORLD UTILITY
SHARES* WORLD INDEX" INDEX"'
<S> <C> <C> <C>
7/01/93** 10000 10000 10000
DEC-93 10685 10595 10450
DEC-94 9776 11213 9758
DEC-95 12154 13411 11912
DEC-96 13729 15184 12913
DEC-97 17285 17521 16275
DEC-98 21444 21557 22243
</TABLE>
* Assuming transaction costs and other operating expenses, including advisory
fees. Does not include insurance-related fees and expenses.
** Commencement of operations.
+ Global Utility Focus Fund invests at least 65% of total assets in equity and
debt securities of domestic and foreign firms that, in the opinion of the
Investment Adviser, are involved in electricity, telecommunications, gas or
water.
++ This unmanaged market capitalization-weighted Index is comprised of nearly
2,200 equities from 24 countries in 12 regions, including the United States. The
starting date is June 30, 1993.
+++ This unmanaged market capitalization-weighted Index is comprised of utility
stocks from any of the 24 countries that make up the Financial Times/Standard &
Poor's--Actuaries World Index.
Past performance is not predictive of future performance.
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/98 +24.06%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/98 +14.95
- --------------------------------------------------------------------------------
Inception (7/01/93) through 12/31/98 +14.87
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
RECENT PERFORMANCE RESULTS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
12 MONTH 6 MONTH
TOTAL RETURN TOTAL RETURN
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Class A Shares +24.06% +13.09%
</TABLE>
- --------------------------------------------------------------------------------
* Total investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the ex-dividend date. Insurance-related fees
and expenses are not reflected in these returns. Past results shown should not
be considered a representation of future performance.
128
<PAGE> 130
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
COUNTRY INDUSTRY HELD COMMON STOCKS & WARRANTS COST (NOTE 1A) NET ASSETS
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
AUSTRALIA TELECOMMUNICATIONS 257,600 +Cable & Wireless Optus
Limited........................ $ 350,913 $ 541,892 0.4%
------------------------------------------------------------------------------------------------------
UTILITIES--GAS 434,496 Australian Gas Light Company
Limited........................ 1,238,060 3,132,164 2.1
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN
AUSTRALIA 1,588,973 3,674,056 2.5
- -------------------------------------------------------------------------------------------------------------------------
AUSTRIA UTILITIES--GAS 8,560 EVN AG......................... 944,383 1,211,390 0.8
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN AUSTRIA 944,383 1,211,390 0.8
- -------------------------------------------------------------------------------------------------------------------------
BRAZIL TELECOMMUNICATIONS 10,300 Embratel Participacoes S.A.
(ADR)*......................... 218,398 143,556 0.1
1,030 Tele Celular Sul Participacoes
S.A. (ADR)*.................. 16,579 17,961 0.0
3,433 Tele Centro Oeste Celular
Participacoes S.A. (ADR)*.... 10,362 10,084 0.0
2,060 Tele Centro Sul Participacoes
S.A. (ADR)*.................. 120,518 86,134 0.1
206 Tele Leste Celular
Participacoes S.A. (ADR)*.... 5,548 5,845 0.0
515 Tele Nordeste Celular
Participacoes S.A. (ADR)*.... 7,652 9,528 0.0
206 Tele Norte Celular
Participacoes S.A. (ADR)*.... 3,204 4,648 0.0
10,300 Tele Norte Leste Participacoes
S.A. (ADR)*.................. 158,618 128,106 0.1
2,060 Tele Sudeste Celular
Participacoes S.A. (ADR)*.... 65,679 42,616 0.0
10,300 Telecomunicacoes Brasileiras
S.A.--Telebras (ADR)*........ 797 1,127 0.0
515 Telemig Celular Participacoes
S.A. (ADR)*.................. 14,985 10,944 0.0
4,120 Telesp Celular Participacoes
S.A. (ADR)*.................. 132,633 72,100 0.0
10,300 Telesp Participacoes S.A.
(ADR)* ........................ 388,972 227,888 0.2
----------- ------------ -----
1,143,945 760,537 0.5
------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 100,000 Companhia Paranaense de
Energia-Copel S.A. (ADR)*.... 1,800,000 712,500 0.5
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN BRAZIL 2,943,945 1,473,037 1.0
- -------------------------------------------------------------------------------------------------------------------------
CANADA TELECOMMUNICATIONS 42,000 BC Telecom, Inc. .............. 789,852 1,143,490 0.8
------------------------------------------------------------------------------------------------------
UTILITIES--GAS 70,100 TransCanada Pipelines Co.,
Limited........................ 1,045,275 1,033,975 0.7
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN CANADA 1,835,127 2,177,465 1.5
- -------------------------------------------------------------------------------------------------------------------------
CHILE UTILITIES--ELECTRIC 33,300 Enersis S.A. (ADR)*............ 717,575 859,556 0.6
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN CHILE 717,575 859,556 0.6
- -------------------------------------------------------------------------------------------------------------------------
DENMARK TELECOMMUNICATIONS 64,000 Tele Danmark A/S (ADR)*........ 1,520,595 4,344,000 3.0
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN DENMARK 1,520,595 4,344,000 3.0
- -------------------------------------------------------------------------------------------------------------------------
FINLAND TELECOMMUNICATIONS 6,236 Sonera Group OYJ............... 54,835 110,123 0.1
------------------------------------------------------------------------------------------------------
UTILITIES--OIL & 74,000 Fortum OYJ..................... 469,329 450,113 0.3
GAS
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN FINLAND 524,164 560,236 0.4
- -------------------------------------------------------------------------------------------------------------------------
FRANCE UTILITIES--WATER 16,984 Vivendi S.A.(a) ............... 1,939,819 4,406,535 3.0
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN FRANCE 1,939,819 4,406,535 3.0
- -------------------------------------------------------------------------------------------------------------------------
GERMANY TELECOMMUNICATIONS 8,100 Deutsche Telekom AG............ 154,054 266,435 0.2
2,010 Mannesmann AG.................. 179,264 230,438 0.2
----------- ------------ -----
333,318 496,873 0.4
------------------------------------------------------------------------------------------------------
</TABLE>
129
<PAGE> 131
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
COUNTRY INDUSTRY HELD COMMON STOCKS & WARRANTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
GERMANY UTILITIES--ELECTRIC 15,000 RWE AG............................ $ 674,750 $ 821,579 0.6%
(CONCLUDED)
1,500 VIAG AG........................... 661,615 879,652 0.6
20,000 Veba AG........................... 652,699 1,196,879 0.8
----------- ------------ -----
1,989,064 2,898,110 2.0
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN GERMANY 2,322,382 3,394,983 2.4
- ----------------------------------------------------------------------------------------------------------------------------
ITALY TELECOMMUNICATIONS 651,600 Telecom Italia Mobile S.p.A. ..... 620,263 4,809,147 3.3
405,333 Telecom Italia S.p.A. ............ 950,865 3,457,468 2.4
761,900 Telecom Italia S.p.A. (Registered
Non-Convertible).................. 1,629,934 4,793,563 3.3
----------- ------------ -----
3,201,062 13,060,178 9.0
------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 138,000 AEM S.p.A......................... 130,809 331,016 0.2
------------------------------------------------------------------------------------------------------
UTILITIES--GAS 513,400 Italgas Torino S.p.A. ............ 1,581,576 2,778,199 1.9
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN ITALY 4,913,447 16,169,393 11.1
- ----------------------------------------------------------------------------------------------------------------------------
JAPAN TELECOMMUNICATIONS 110 Nippon Telegraph & Telephone
Corporation....................... 938,962 850,732 0.6
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN JAPAN 938,962 850,732 0.6
- ----------------------------------------------------------------------------------------------------------------------------
MEXICO TELECOMMUNICATIONS 14,500 Telefonos de Mexico, S.A. de C.V.
(Telemex) (ADR)*................ 914,790 705,969 0.5
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN MEXICO 914,790 705,969 0.5
- ----------------------------------------------------------------------------------------------------------------------------
NEW ZEALAND TELECOMMUNICATIONS 20,100 Telecom Corporation of New Zealand
Limited (ADR)*.................. 477,195 717,319 0.5
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN NEW ZEALAND 477,195 717,319 0.5
- ----------------------------------------------------------------------------------------------------------------------------
PHILIPPINES TELECOMMUNICATIONS 43,600 Philippine Long Distance Telephone
Company (ADR)*.................. 1,270,791 1,130,875 0.8
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THE
PHILIPPINES 1,270,791 1,130,875 0.8
- ----------------------------------------------------------------------------------------------------------------------------
PORTUGAL TELECOMMUNICATIONS 65,720 Portugal Telecom S.A. (ADR)*...... 1,417,539 2,932,755 2.0
------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 29,940 EDP-Electricidade de Portugal,
S.A. (ADR)* .................... 1,333,900 1,334,201 0.9
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN PORTUGAL 2,751,439 4,266,956 2.9
- ----------------------------------------------------------------------------------------------------------------------------
SPAIN TELECOMMUNICATIONS 43,554 Telefonica S.A. (ADR)*(e)......... 1,681,058 5,896,123 4.1
------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 145,600 Endesa S.A. (ADR)*................ 1,634,684 3,931,200 2.7
7,500 Hidroelectrica del Cantabrico,
S.A............................. 251,742 414,936 0.3
131,000 Iberdrola I, S.A.................. 879,896 2,448,124 1.7
----------- ------------ -----
2,766,322 6,794,260 4.7
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN SPAIN 4,447,380 12,690,383 8.8
- ----------------------------------------------------------------------------------------------------------------------------
UNITED KINGDOM TELECOMMUNICATIONS 57,000 British Telecommunications PLC.... 406,712 858,384 0.6
10,000 British Telecommunications PLC
(ADR)*.......................... 741,450 1,516,875 1.0
88,284 Cable & Wireless PLC.............. 1,126,481 1,085,038 0.8
30,000 Vodafone Group PLC (ADR)*......... 859,933 4,833,750 3.3
----------- ------------ -----
3,134,576 8,294,047 5.7
------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 167,500 National Power PLC................ 1,238,839 1,442,989 1.0
95,139 Powergen.......................... 705,721 1,249,983 0.9
----------- ------------ -----
1,944,560 2,692,972 1.9
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THE UNITED
KINGDOM 5,079,136 10,987,019 7.6
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
130
<PAGE> 132
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
COUNTRY INDUSTRY HELD COMMON STOCKS & WARRANTS COST (NOTE 1A) NET ASSETS
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
UNITED STATES TELECOMMUNICATIONS 17,000 AT&T Corp. .................... $ 683,145 $ 1,279,250 0.9%
30,000 +Airtouch Communications,
Inc. ........................ 738,952 2,163,750 1.5
51,600 Ameritech Corporation.......... 1,030,404 3,270,150 2.2
47,616 Bell Atlantic Corporation...... 1,184,107 2,705,184 1.9
64,000 BellSouth Corporation.......... 985,120 3,192,000 2.2
42,000 Frontier Corporation........... 969,520 1,428,000 1.0
33,500 GTE Corporation................ 1,124,815 2,259,156 1.5
40,000 +MCI WorldCom, Inc. ........... 1,323,316 2,870,000 2.0
46,600 SBC Communications Inc. ....... 982,372 2,498,925 1.7
21,000 Sprint Corporation............. 531,544 1,766,625 1.2
10,500 +Sprint Corporation (PCS
Group)....................... 68,289 242,812 0.2
24,900 U S West, Inc.(f).............. 606,619 1,609,163 1.1
----------- ------------ -----
10,228,203 25,285,015 17.4
------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 65,600 Allegheny Energy, Inc. ........ 1,689,846 2,263,200 1.6
25,000 American Electric Power
Company, Inc. ............... 1,092,125 1,176,563 0.8
55,500 BEC Energy(b).................. 1,472,300 2,285,906 1.6
38,192 Cinergy Corp. ................. 885,217 1,312,850 0.9
49,300 Consolidated Edison, Inc. ..... 1,597,050 2,606,737 1.8
31,500 DTE Energy Company............. 989,953 1,350,562 0.9
31,000 Duke Energy Corporation........ 1,172,492 1,985,937 1.4
31,000 Edison International........... 544,360 864,125 0.6
33,800 Energy East Corporation(c)..... 932,936 1,909,700 1.3
54,300 Entergy Corporation............ 1,905,240 1,690,087 1.2
21,500 FPL Group, Inc. ............... 985,059 1,324,937 0.9
47,200 GPU, Inc. ..................... 1,343,992 2,085,650 1.4
26,200 Houston Industries
Incorporated................. 450,312 841,675 0.6
89,100 NIPSCO Industries, Inc. ....... 1,405,792 2,711,981 1.9
44,000 New Century Energies, Inc. .... 1,312,146 2,145,000 1.5
73,800 PECO Energy Company............ 2,081,262 3,071,925 2.1
72,800 PacifiCorp. ................... 1,401,416 1,533,350 1.1
50,200 The Southern Company........... 1,041,077 1,458,937 1.0
23,000 TECO Energy, Inc. ............. 605,130 648,313 0.4
42,000 Texas Utilities Company........ 1,438,834 1,960,875 1.3
----------- ------------ -----
24,346,539 35,228,310 24.3
------------------------------------------------------------------------------------------------------
UTILITIES--GAS 28,800 The Coastal Corporation........ 449,913 1,006,200 0.7
36,800 El Paso Energy Corporation..... 660,653 1,281,100 0.9
15,000 Enron Corporation.............. 690,791 855,937 0.6
33,000 KeySpan Energy (Warrants)(g)... 855,855 1,023,000 0.7
26,100 National Fuel Gas Company...... 788,314 1,179,394 0.8
25,000 New Jersey Resources
Corporation.................. 656,623 987,500 0.7
50,000 Sempra Energy(d)............... 1,184,750 1,268,750 0.9
16,600 Sonat Inc. .................... 551,950 449,237 0.3
42,000 Washington Gas Light Company... 871,676 1,139,250 0.8
55,800 The Williams Companies,
Inc. ........................ 606,825 1,740,263 1.2
----------- ------------ -----
7,317,350 10,930,631 7.6
------------------------------------------------------------------------------------------------------
UTILITIES--WATER 33,300 Philadelphia Suburban
Corporation.................. 722,194 984,431 0.7
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS & WARRANTS
IN THE UNITED STATES 42,614,286 72,428,387 50.0
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN COMMON
STOCKS & WARRANTS 77,744,389 142,048,291 98.0
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
131
<PAGE> 133
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE VALUE PERCENT OF
AMOUNT SHORT-TERM SECURITIES COST (NOTE 1A) NET ASSETS
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
COMMERCIAL PAPER** $1,431,000 General Motors Acceptance
Corp., 5.13% due 1/04/1999..... $ 1,430,184 $ 1,430,184 1.0%
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SHORT-
TERM SECURITIES 1,430,184 1,430,184 1.0
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS.............. $79,174,573 143,478,475 99.0
===========
OTHER ASSETS LESS
LIABILITIES.................... 1,499,677 1.0
------------ -----
NET ASSETS..................... $144,978,152 100.0%
============ =====
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
* American Depositary Receipts (ADR).
** Commercial Paper is traded on a discount basis; the interest rate shown
reflects the discount rate paid at the time of purchase by the Fund.
(a) Formerly Generale des Eaux.
(b) Formerly Boston Edison Co.
(c) Formerly New York State Electric Gas Corp.
(d) Acquired through merger of Pacific Enterprises and Enova Corp.
(e) Formerly Telefonica de Espana, S.A. (ADR).
(f) Formerly US West Communications Group.
(g) Warrants entitle the Fund to purchase a predetermined number of shares of
common stock and are non-income producing. The purchase price and number of
shares are subject to adjustments under certain conditions until the expiration
date.
+ Non-income producing security.
See Notes to Financial Statements.
132
<PAGE> 134
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$79,174,573) (Note
1a)....................................................... $143,478,475
Cash........................................................ 636
Receivables:
Securities sold........................................... $1,289,374
Dividends................................................. 317,125
Capital shares sold....................................... 4,335 1,610,834
----------
Deferred organization expenses (Note 1f).................... 684
Prepaid expenses and other assets........................... 9,344
------------
Total assets................................................ 145,099,973
------------
- ---------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Investment adviser (Note 2)............................... 71,617
Capital shares redeemed................................... 18,415 90,032
----------
Accrued expenses............................................ 31,789
------------
Total liabilities........................................... 121,821
------------
- ---------------------------------------------------------------------------------------
NET ASSETS.................................................. $144,978,152
============
- ---------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 848,803
Paid-in capital in excess of par............................ 74,519,126
Undistributed investment income--net........................ 544,558
Undistributed realized capital gains on investments and
foreign currency transactions--net........................ 4,759,506
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 64,306,159
------------
NET ASSETS.................................................. $144,978,152
============
- ---------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $144,978,152 and 8,488,025
shares outstanding........................................ $ 17.08
============
- ---------------------------------------------------------------------------------------
</TABLE>
+ The Fund is also authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
133
<PAGE> 135
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Dividends (net of $211,003 foreign withholding tax)......... $ 4,043,136
Interest and discount earned................................ 201,695
-----------
Total income................................................ 4,244,831
-----------
- ---------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $ 829,080
Custodian fees.............................................. 35,944
Accounting services (Note 2)................................ 29,213
Printing and shareholder reports............................ 19,463
Professional fees........................................... 12,798
Transfer agent fees (Note 2)................................ 5,119
Directors' fees and expenses................................ 2,999
Pricing services............................................ 2,922
Amortization of organization expenses (Note 1f)............. 867
Other....................................................... 3,516
-----------
Total expenses.............................................. 941,921
-----------
Investment income--net...................................... 3,302,910
-----------
- ---------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET (NOTES 1b, 1c, 1e & 3):
Realized gain (loss) from:
Investments--net.......................................... 4,759,506
Foreign currency transactions--net........................ (20,739) 4,738,767
-----------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... 21,823,721
Foreign currency transactions--net........................ 4,107 21,827,828
----------- -----------
Net realized and unrealized gain on investments and foreign
currency transactions..................................... 26,566,595
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $29,869,505
===========
- ---------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
134
<PAGE> 136
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
----------------------------
INCREASE (DECREASE) IN NET ASSETS: 1998 1997
- ------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 3,302,910 $ 4,352,605
Realized gain on investments and foreign currency
transactions--net......................................... 4,738,767 9,206,804
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ 21,827,828 17,640,203
------------ ------------
Net increase in net assets resulting from operations........ 29,869,505 31,199,612
------------ ------------
- ------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1g):
Investment income--net:
Class A................................................... (3,589,798) (4,603,931)
Realized gain on investments--net:
Class A................................................... (6,606,938) --
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (10,196,736) (4,603,931)
------------ ------------
- ------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net decrease in net assets derived from capital shares
transactions.............................................. (12,900,783) (30,827,316)
------------ ------------
- ------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... 6,771,986 (4,231,635)
Beginning of year........................................... 138,206,166 142,437,801
------------ ------------
End of year*................................................ $144,978,152 $138,206,166
============ ============
- ------------------------------------------------------------------------------------------
* Undistributed investment income--net (Note 1h)............ $ 544,558 $ 852,184
============ ============
- ------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
135
<PAGE> 137
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE
BEEN DERIVED FROM INFORMATION PROVIDED IN THE CLASS A
FINANCIAL STATEMENTS. --------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1998+ 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year....................... $ 14.84 $ 12.19 $ 11.30 $ 9.45 $ 10.66
-------- -------- -------- -------- --------
Investment income--net................................... .36 .43 .46 .45 .35
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net..................... 2.99 2.66 .95 1.79 (1.25)
-------- -------- -------- -------- --------
Total from investment operations......................... 3.35 3.09 1.41 2.24 (.90)
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net................................. (.40) (.44) (.52) (.39) (.29)
Realized gain on investments--net...................... (.71) -- -- -- --
In excess of realized gain on investments--net......... -- -- -- -- (.02)
-------- -------- -------- -------- --------
Total dividends and distributions........................ (1.11) (.44) (.52) (.39) (.31)
-------- -------- -------- -------- --------
Net asset value, end of year............................. $ 17.08 $ 14.84 $ 12.19 $ 11.30 $ 9.45
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share....................... 24.06% 25.90% 12.96% 24.33% (8.51%)
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses................................................. .68% .67% .66% .66% .73%
======== ======== ======== ======== ========
Investment income--net................................... 2.39% 3.21% 3.90% 4.44% 3.68%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)................... $144,978 $138,206 $142,438 $148,225 $126,243
======== ======== ======== ======== ========
Portfolio turnover....................................... 5.20% 7.70% 11.39% 11.05% 9.52%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding.
See Notes to Financial Statements.
136
<PAGE> 138
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Class A and
Class B Shares have equal voting, dividend, liquidation and other rights, except
that only shares of the respective classes are entitled to vote on matters
concerning only that class and Class B Shares bear certain expenses related to
the distribution of such shares. Global Utility Focus Fund (the "Fund") is
classified as "diversified," as defined in the Investment Company Act of 1940.
The Fund's financial statements are prepared in accordance with generally
accepted accounting principles which may require the use of management accruals
and estimates. The following is a summary of significant accounting policies
followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written or purchased are valued at the last sale price in the
case of exchange-traded options. In the case of options traded in the
over-the-counter market, valuation is the last asked price (options written) or
the last bid price (options purchased). Futures contracts are valued at the
settlement price at the close of the applicable exchange. Short-term securities
are valued at amortized cost, which approximates market value. Securities and
assets for which market quotations are not readily available are valued at fair
value as determined in good faith by or under the direction of the Board of
Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity, debt and currency markets. Losses may arise due
to changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts.
- - Options--The Fund may write call and put options and purchase put options.
When the Fund writes an option, an amount equal to the premium received by the
Fund is reflected as an asset and an equivalent liability. The amount of the
liability is subsequently marked to market to reflect the current market value
of the option written. When a security is purchased or sold through an exercise
of an option, the related premium paid (or received) is added to (or deducted
from) the basis of the security acquired or deducted from (or added to) the
proceeds of the security sold. When an option expires (or the Fund enters into a
closing transaction), the Fund realizes a gain or loss on the option to the
extent of the premiums received or paid (or gain or loss to the extent the cost
of the closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts for the purpose of hedging the
market risk on existing securities or the intended purchase of securities.
Futures contracts are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon entering into a contract, the
Fund deposits and maintains as collateral such initial margin as required by the
exchange on which the transaction is effected. Pursuant to the contract, the
Fund agrees to receive from or pay to the broker an amount of cash equal to the
daily fluctuation in value of the contract. Such receipts or payments are known
as variation margin and are recorded by the Fund as unrealized gains or losses.
When the contract is closed, the Fund records a realized gain or loss equal to
the difference between the value of the contract at the time it
137
<PAGE> 139
- --------------------------------------------------------------------------------
was opened and the value at the time it was closed.
- - Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-US dollar denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) Foreign currency transactions--Trans-
actions denominated in foreign currencies are recorded at the exchange rate
prevailing when recognized. Assets and liabilities denominated in foreign
currencies are valued at the exchange rate at the end of the period. Foreign
currency transactions are the result of settling (realized) or valuing
(unrealized) assets and liabilities expressed in foreign currencies into US
dollars. Realized and unrealized gains or losses from investments include the
effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently recorded
when the Fund has determined the ex-dividend date. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Deferred organization expenses--Deferred organization expenses are charged
to expense on a straight-line basis over a period not exceeding five years.
(g) Dividends and distributions--Dividends from net investment income are
declared and paid quarterly. Distributions of capital gains are recorded on the
ex-dividend date.
(h) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $20,738 have been reclassified between undistributed net
realized capital gains and undistributed net investment income. These
reclassifications have no effect on net assets or net asset value per share.
2. INVESTMENT ADVISORY AGREEMENT AND
TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.60% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1998, Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("MLPF&S"), a subsidiary of ML & Co., earned $4,117 in commissions
on the execution of portfolio security transactions for the Fund.
For the year ended December 31, 1998, Merrill Lynch Security Pricing Service,
an affiliate of MLPF&S, earned $29 for providing security price quotations to
compute the Fund's net asset value.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Merrill Lynch Funds Distributor, a division of Princeton Funds Distributor,
Inc. ("PFD"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
is the Fund's distributor.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
138
<PAGE> 140
- --------------------------------------------------------------------------------
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1998 were $6,980,476 and $25,977,923, respectively.
Net realized gains (losses) for the year ended December 31, 1998 and net
unrealized gains as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains
- --------------------------------------------------------------------
<S> <C> <C>
Long-term investments................. $4,759,506 $64,303,902
Foreign currency transactions......... (20,739) 2,257
---------- -----------
Total................................. $4,738,767 $64,306,159
========== ===========
- --------------------------------------------------------------------
</TABLE>
At December 31, 1998, net unrealized appreciation for Federal income tax
purposes aggregated $64,303,902, of which $66,606,931 related to appreciated
securities and $2,303,029 related to depreciated securities. At December 31,
1998, the aggregate cost of investments for Federal income tax purposes was
$79,174,573.
4. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share transactions were
$12,900,783 and $30,827,316 for the years ended December 31, 1998 and December
31, 1997, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1998 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 539,702 $ 8,222,908
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 707,068 10,196,735
---------- ------------
Total issued......................... 1,246,770 18,419,643
Shares redeemed...................... (2,073,134) (31,320,426)
---------- ------------
Net decrease......................... (826,364) $(12,900,783)
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 926,005 $ 12,113,010
Shares issued to shareholders in
reinvestment of dividends........... 358,250 4,603,931
---------- ------------
Total issued......................... 1,284,255 16,716,941
Shares redeemed...................... (3,656,796) (47,544,257)
---------- ------------
Net decrease......................... (2,372,541) $(30,827,316)
========== ============
</TABLE>
<TABLE>
<S> <C> <C>
- -----------------------------------------------------------------
</TABLE>
5. SUBSEQUENT EVENT:
On January 4, 1999, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.082080 per Class A Share and a long-term capital
gains distribution in the amount of $.543759 per Class A Share payable on
January 11, 1999 to shareholders of record as of December 31, 1998.
139
<PAGE> 141
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
GLOBAL UTILITY FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Global Utility Focus Fund of Merrill Lynch
Variable Series Funds, Inc. as of December 31, 1998, the related statements of
operations for the year then ended and changes in net assets for each of the
years in the two-year period then ended, and the financial highlights for each
of the years in the five-year period then ended. These financial statements and
the financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and the
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1998 by correspondence with the custodian. An audit also includes assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Global Utility Focus
Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1998, the
results of its operations, the changes in its net assets, and the financial
highlights for the respective stated periods in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
140
<PAGE> 142
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
DECEMBER 31, 1998--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
FISCAL YEAR IN REVIEW
Although the overall trend in US interest rates has been toward a downward
shift in the entire Treasury yield curve for the year ended December 31, 1998,
the long end of the curve underperformed the front end with the five-year sector
recording the best overall performance. Specifically, the five-year sector fell
125 basis points (1.25%) during the year, compared to a 105 basis point and 80
basis point decline for the 10-year and 30-year sectors, respectively.
Similarly, all fixed-income markets exhibited a significant degree of
volatility, with yield spread relationships among the various types of bonds
dramatically widening during the third quarter of 1998, only to recoup much of
the widening during the final quarter. Federal agency securities likewise
exhibited dramatic swings in spread relationships, and agency callable
securities were among the most affected. Mortgage-backed securities (MBS) also
experienced some volatility as the strong performance in the Treasury market
accelerated prepayment speeds.
For the 12-month period ended December 31, 1998, the Fund's total return was
+8.76%, compared to a total return of +9.85% for the unmanaged Merrill Lynch US
Treasury/Agency Master Index. With respect to the Fund's overall performance,
the Fund fell modestly short of the Index, since its largest issuer weighting
cannot exceed 55% of net assets. Specifically, pursuant to the US Treasury
Department regulations, diversification standards must be met by investment
company portfolios contained as an investment vehicle within a variable annuity
policy. As a result, the Fund was limited to a 55% sector allocation in US
Treasury securities, with the remaining assets invested in Federal agency
securities. The Merrill Lynch US Treasury/ Agency Master Index had an 84%
allocation to the Treasury market. Nevertheless, the Fund was able to recoup
much of the gap via an overweighted position in Federal National Mortgage
Association benchmark issues and Federal Home Loan Mortgage Corporation
reference notes and an underweighted position in callable securities relative to
the Index.
Looking ahead, we expect the financial markets to remain extremely volatile
with liquidity remaining at a premium. Although we do not expect the US economy
to enter a deep recessionary environment, we do believe that the Federal Reserve
Board may find it necessary to move back to a more accommodative posture as we
head into the second quarter of 1999 and the domestic economy begins to slow.
The Federal Reserve Board is clearly concerned about the global credit crunch
that has developed as well as the negative implications that could arise as the
global financial markets deleverage. Accordingly, we believe we may continue to
emphasize liquidity and high-quality issues in the Fund's investment strategy
process.
IN CONCLUSION
We appreciate your investment in Government Bond Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to sharing our investment
outlook and strategy with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Christopher G. Ayoub
Christopher G. Ayoub
Senior Vice President and Portfolio Manager
/s/ Jay C. Harbeck
Jay C. Harbeck
Senior Vice President and Portfolio Manager
January 29, 1999
- ---------------------------------------------------------
As of January 29, 1999, Jay C. Harbeck retired as Senior Vice President and
Portfolio Manager of Government Bond Fund. His colleagues at Merrill Lynch Asset
Management, L.P. join the Company's Board of Directors in wishing Mr. Harbeck
well in his retirement.
- ---------------------------------------------------------
141
<PAGE> 143
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
Government Bond Fund
Total Return Based on a $10,000 Investment-Class A Shares
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Merrill Lynch US Treasury/Agency
Master Index and the Merrill Lynch US Treasury 7-10 Years Index. Beginning and
ending values are:
<TABLE>
<CAPTION>
5/02/94** 12/98
--------- -----
<S> <C> <C>
Government Bond
Fund+ -- Class A Shares* $10,000 $14,238
Merrill Lynch US Treasury/Agency
Master Index++ $10,000 $14,728
Merrill Lynch US Treasury
7-10 Years Index+++ $10,000 $15,493
</TABLE>
<TABLE>
<C> <S>
* Assuming transaction costs and other operating expenses,
including advisory fees. Does not include insurance-related
fees and expenses.
** Commencement of operations.
+ Government Bond Fund invests in debt securities issued or
guaranteed by the US Government, its agencies or
instrumentalities.
++ This unmanaged Index is comprised of all US Government
agency notes and bonds and US Treasury securities of more
than one year.
+++ This unmanaged Index is comprised of intermediate-term US
Government bonds and US Treasury securities maturing in 7-10
years.
Past performance is not predictive of future performance.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/98 +8.76%
- --------------------------------------------------------------------------------
Inception (5/02/94) through 12/31/98 +7.87
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
RECENT PERFORMANCE RESULTS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
12 MONTH 6 MONTH
TOTAL RETURN TOTAL RETURN
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Class A Shares +8.76% +4.77%
</TABLE>
- --------------------------------------------------------------------------------
* Total investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the payable date. Insurance-related fees
and expenses are not reflected in these returns. Past results shown should not
be considered a representation of future performance.
142
<PAGE> 144
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE VALUE
AMOUNT ISSUE COST (NOTE 1A)
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
US GOVERNMENT & AGENCY OBLIGATIONS
- ----------------------------------------------------------------------------------------------------------------------
FEDERAL FARM CREDIT Federal Farm Credit Bank:
BANK--2.7% $ 2,000,000 6.27% due 7/10/2002...................... $ 2,013,620 $ 2,071,560
7,000,000 6.40% due 10/09/2007..................... 7,075,390 7,481,250
- ----------------------------------------------------------------------------------------------------------------------
TOTAL FEDERAL FARM CREDIT BANK 9,089,010 9,552,810
- ----------------------------------------------------------------------------------------------------------------------
FEDERAL HOME LOAN Federal Home Loan Bank:
BANK--9.9% 13,575,000 6.055% due 7/28/2000..................... 13,634,730 13,791,386
11,000,000 5.125% due 9/15/2003..................... 11,105,050 10,996,590
4,635,000 6.175% due 4/17/2008..................... 4,606,031 4,717,549
5,000,000 5.80% due 9/02/2008...................... 5,119,550 5,175,000
- ----------------------------------------------------------------------------------------------------------------------
TOTAL FEDERAL HOME LOAN BANK 34,465,361 34,680,525
- ----------------------------------------------------------------------------------------------------------------------
FEDERAL HOME Federal Home Loan Mortgage Corporation:
LOAN MORTGAGE 10,000,000 7.125% due 7/21/1999..................... 10,212,200 10,112,500
CORPORATION--12.7% 4,000,000 5.75% due 7/15/2003...................... 4,099,160 4,103,120
5,000,000 8.065% due 1/27/2005..................... 5,540,700 5,714,050
3,000,000 7.14% due 9/13/2006...................... 3,064,440 3,326,730
4,000,000 7.935% due 9/13/2006..................... 4,018,750 4,075,640
12,000,000 5.75% due 4/15/2008...................... 12,425,415 12,406,920
5,000,000 5.50% due 2/15/2028+..................... 4,775,781 4,784,450
- ----------------------------------------------------------------------------------------------------------------------
TOTAL FEDERAL HOME LOAN MORTGAGE
CORPORATION 44,136,446 44,523,410
- ----------------------------------------------------------------------------------------------------------------------
FEDERAL NATIONAL Federal National Mortgage Association:
MORTGAGE 2,000,000 8.90% due 6/12/2000...................... 2,171,480 2,107,500
ASSOCIATION--11.4% 1,045,000 7.50% due 2/11/2002...................... 1,088,232 1,117,983
5,000,000 6% due 11/04/2002........................ 5,011,960 5,143,750
5,000,000 5.75% due 4/15/2003...................... 5,185,300 5,132,800
4,000,000 7.40% due 7/01/2004...................... 4,157,540 4,407,480
500,000 7.85% due 9/10/2004...................... 499,297 509,140
4,000,000 7.65% due 3/10/2005...................... 4,498,040 4,494,360
5,500,000 6.417% due 3/25/2007+.................... 5,555,000 5,605,325
10,960,857 6.175% due 8/01/2008+.................... 11,002,389 11,324,734
- ----------------------------------------------------------------------------------------------------------------------
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION 39,169,238 39,843,072
- ----------------------------------------------------------------------------------------------------------------------
GOVERNMENT 3,500,000 Government National Mortgage
NATIONAL MORTGAGE Association, Series 1998-14,
ASSOCIATION--1.0% 6.375% due 11/20/2026+................... 3,473,203 3,532,795
- ----------------------------------------------------------------------------------------------------------------------
TOTAL GOVERNMENT NATIONAL MORTGAGE
ASSOCIATION 3,473,203 3,532,795
- ----------------------------------------------------------------------------------------------------------------------
PRIVATE EXPORT Private Export Funding Corporation:
FUNDING CORPORATION--6.1% 3,895,000 5.50% due 3/15/2001...................... 3,847,286 3,928,341
3,335,000 7.01% due 4/30/2004...................... 3,643,588 3,622,977
11,000,000 6.31% due 9/30/2004...................... 11,108,350 11,607,530
2,000,000 7.11% due 4/15/2007...................... 2,145,460 2,219,680
- ----------------------------------------------------------------------------------------------------------------------
TOTAL PRIVATE EXPORT FUNDING CORPORATION 20,744,684 21,378,528
- ----------------------------------------------------------------------------------------------------------------------
STUDENT LOAN 8,000,000 Student Loan Marketing Association,
MARKETING ASSOCIATION--2.3% 7.50% due 3/08/2000...................... 8,266,160 8,227,520
- ----------------------------------------------------------------------------------------------------------------------
TOTAL STUDENT LOAN MARKETING ASSOCIATION 8,266,160 8,227,520
- ----------------------------------------------------------------------------------------------------------------------
TENNESSEE VALLEY Tennessee Valley Authority:
AUTHORITY--5.2% 5,000,000 5.375% due 11/13/2008.................... 5,005,200 5,013,300
5,000,000 6.25% due 12/15/2017..................... 5,270,200 5,185,950
7,000,000 6.75% due 11/01/2025..................... 7,966,770 7,906,570
- ----------------------------------------------------------------------------------------------------------------------
TOTAL TENNESSEE VALLEY AUTHORITY 18,242,170 18,105,820
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
143
<PAGE> 145
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE VALUE
AMOUNT ISSUE COST (NOTE 1A)
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
US GOVERNMENT & AGENCY OBLIGATIONS
- ----------------------------------------------------------------------------------------------------------------------
US TREASURY BONDS & US Treasury Bonds:
NOTES--36.1% $ 2,000,000 10.625% due 8/15/2015.................... $ 2,826,250 $ 3,176,240
1,500,000 9.25% due 2/15/2016...................... 1,862,344 2,152,035
2,500,000 7.50% due 11/15/2016..................... 2,999,609 3,105,475
7,500,000 8.875% due 8/15/2017..................... 9,044,297 10,564,425
1,000,000 8.75% due 5/15/2020...................... 1,216,406 1,420,160
1,500,000 8.125% due 5/15/2021..................... 1,892,930 2,023,590
9,500,000 8.125% due 8/15/2021..................... 11,135,078 12,836,875
6,000,000 7.50% due 11/15/2024..................... 6,390,937 7,775,640
3,000,000 6.50% due 11/15/2026..................... 2,861,641 3,488,430
3,000,000 6.375% due 8/15/2027..................... 3,256,406 3,448,110
8,000,000 6.125% due 11/15/2027.................... 8,684,062 8,954,960
3,000,000 5.50% due 8/15/2028...................... 3,201,250 3,140,160
US Treasury Notes:
1,000,000 5.875% due 8/31/1999..................... 1,000,937 1,007,810
4,000,000 7.75% due 12/31/1999..................... 4,181,562 4,119,360
5,000,000 8.50% due 11/15/2000..................... 5,409,766 5,340,600
3,000,000 5.625% due 2/28/2001..................... 3,022,266 3,060,000
4,500,000 6.375% due 3/31/2001..................... 4,604,766 4,664,520
3,000,000 7.875% due 8/15/2001..................... 3,195,937 3,234,360
3,000,000 6.25% due 10/31/2001..................... 3,044,062 3,125,610
5,000,000 7.50% due 11/15/2001..................... 5,140,469 5,376,550
7,000,000 6.625% due 4/30/2002..................... 7,445,703 7,407,960
3,000,000 7.50% due 5/15/2002...................... 3,302,812 3,257,340
1,500,000 6.375% due 8/15/2002..................... 1,497,422 1,582,260
3,000,000 5.25% due 8/15/2003...................... 2,988,516 3,076,410
7,500,000 5.75% due 8/15/2003...................... 7,965,352 7,831,650
4,000,000 11.875% due 11/15/2003................... 5,235,469 5,220,640
1,500,000 5.50% due 2/15/2008...................... 1,540,313 1,589,535
4,250,000 5.625% due 5/15/2008..................... 4,664,883 4,534,877
- ----------------------------------------------------------------------------------------------------------------------
TOTAL US TREASURY BONDS & NOTES 119,611,445 126,515,582
- ----------------------------------------------------------------------------------------------------------------------
TOTAL US GOVERNMENT & AGENCY
OBLIGATIONS--87.4% 297,197,717 306,360,062
- ----------------------------------------------------------------------------------------------------------------------
SHORT-TERM SECURITIES
- ----------------------------------------------------------------------------------------------------------------------
REPURCHASE 17,400,000 Warburg Dillon Read LLC, purchased on
AGREEMENTS**--5.0% 12/31/1998 to yield 4.75% to 1/04/1999... 17,400,000 17,400,000
- ----------------------------------------------------------------------------------------------------------------------
US GOVERNMENT AGENCY 10,185,000 Federal Home Loan Mortgage Corporation,
OBLIGATIONS*--6.2% 4.70% due 1/14/1999...................... 10,166,384 10,166,384
11,663,000 Federal National Mortgage Association,
4.50% due 1/05/1999...................... 11,655,711 11,655,711
------------ ------------
21,822,095 21,822,095
- ----------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES--11.2% 39,222,095 39,222,095
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS--98.6%................... $336,419,812 345,582,157
============
OTHER ASSETS LESS LIABILITIES--1.4%........ 4,833,489
------------
NET ASSETS--100.0%......................... $350,415,646
============
</TABLE>
- --------------------------------------------------------------------------------
* Certain US Government Agency Obligations are traded on a discount basis; the
interest rates shown reflect the discount rates paid at the time of purchase
by the Fund.
** Repurchase Agreements are fully collateralized by US Government Obligations.
+ Subject to principal paydowns.
See Notes to Financial Statements.
144
<PAGE> 146
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$336,419,812) (Note
1a)....................................................... $345,582,157
Cash........................................................ 127
Receivables:
Interest.................................................. $4,745,459
Capital shares sold....................................... 295,120 5,040,579
----------
Prepaid expenses and other assets........................... 25,452
------------
Total assets................................................ 350,648,315
------------
- --------------------------------------------------------------------------------------
LIABILITIES:
Investment adviser payable (Note 2)......................... 146,149
Accrued expenses and other liabilities...................... 86,520
------------
Total liabilities........................................... 232,669
------------
- --------------------------------------------------------------------------------------
NET ASSETS.................................................. $350,415,646
============
- --------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 3,221,948
Paid-in capital in excess of par............................ 336,111,076
Undistributed investment income--net........................ 1,579,841
Undistributed realized capital gains on investments--net.... 340,436
Unrealized appreciation on investments--net................. 9,162,345
------------
NET ASSETS.................................................. $350,415,646
============
- --------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $350,415,646 and 32,219,483
shares outstanding........................................ $ 10.88
============
- --------------------------------------------------------------------------------------
</TABLE>
+ The Fund is also authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
145
<PAGE> 147
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
STATEMENT OF OPERATIONS AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTE 1D):
Interest and discount earned................................ $14,809,597
Other income................................................ 78,432
-----------
Total income................................................ 14,888,029
-----------
- --------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $1,195,999
Accounting services (Note 2)................................ 50,411
Printing and shareholder reports............................ 27,398
Custodian fees.............................................. 22,571
Professional fees........................................... 16,623
Registration fees........................................... 13,855
Transfer agent fees (Note 2)................................ 5,119
Directors' fees and expenses................................ 4,190
Pricing services............................................ 3,341
Other....................................................... 2,667
----------
Total expenses.............................................. 1,342,174
-----------
Investment income--net...................................... 13,545,855
-----------
- --------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN ON INVESTMENTS--NET (NOTES 1D &
3):
Realized gain on investments--net........................... 1,052,590
Change in unrealized appreciation on investments--net....... 4,754,422
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $19,352,867
===========
- --------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
146
<PAGE> 148
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
---------------------------
INCREASE (DECREASE) IN NET ASSETS: 1998 1997
- -----------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 13,545,855 $ 8,463,282
Realized gain on investments--net........................... 1,052,590 974,626
Change in unrealized appreciation on investments--net....... 4,754,422 3,456,357
------------ ------------
Net increase in net assets resulting from operations........ 19,352,867 12,894,265
------------ ------------
- -----------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1e):
Investment income--net:
Class A................................................... (12,902,841) (8,011,058)
Realized gain on investments--net:
Class A................................................... (687,846) (820,212)
In excess of realized gain on investments--net:
Class A................................................... -- (24,308)
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (13,590,687) (8,855,578)
------------ ------------
- -----------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase in net assets derived from capital share
transactions.............................................. 164,833,095 86,200,892
------------ ------------
- -----------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 170,595,275 90,239,579
Beginning of year........................................... 179,820,371 89,580,792
------------ ------------
End of year*................................................ $350,415,646 $179,820,371
============ ============
- -----------------------------------------------------------------------------------------
* Undistributed investment income--net...................... $ 1,579,841 $ 936,827
============ ============
- -----------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
147
<PAGE> 149
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE ----------------------------------------------------------------
BEEN DERIVED FROM INFORMATION PROVIDED IN THE
FINANCIAL STATEMENTS. FOR THE PERIOD
FOR THE YEAR ENDED DECEMBER 31, MAY 2, 1994+ TO
--------------------------------------------- DECEMBER 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period............... $ 10.60 $ 10.40 $ 10.79 $ 9.97 $ 10.00
-------- -------- ------- ------- -------
Investment income--net............................. .59 .63 .65 .62 .25
Realized and unrealized gain (loss) on
investments--net................................. .31 .25 (.36) .81 (.07)
-------- -------- ------- ------- -------
Total from investment operations................... .90 .88 .29 1.43 .18
-------- -------- ------- ------- -------
Less dividends and distributions:
Investment income--net........................... (.60) (.63) (.64) (.61) (.21)
Realized gain on investments--net................ (.02) (.05) (.04) -- --
In excess of realized gain on investments--net... -- --++ -- -- --
-------- -------- ------- ------- -------
Total dividends and distributions.................. (.62) (.68) (.68) (.61) (.21)
-------- -------- ------- ------- -------
Net asset value, end of period..................... $ 10.88 $ 10.60 $ 10.40 $ 10.79 $ 9.97
======== ======== ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share................. 8.76% 8.88% 2.86% 14.83% 1.79%++
======== ======== ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement..................... .56% .51% .15% .00% .00%*
======== ======== ======= ======= =======
Expenses........................................... .56% .57% .59% .66% .80%*
======== ======== ======= ======= =======
Investment income--net............................. 5.66% 6.26% 6.39% 6.28% 4.66%*
======== ======== ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)........... $350,416 $179,820 $89,581 $40,996 $17,811
======== ======== ======= ======= =======
Portfolio turnover................................. 43.10% 117.65% 21.23% 45.39% 103.03%
======== ======== ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of operations.
++ Amount is less than $.01 per share.
++ Aggregate total investment return.
See Notes to Financial Statements.
148
<PAGE> 150
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies, that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Class A and
Class B Shares have equal voting, dividend, liquidation and other rights, except
that only shares of the respective classes are entitled to vote on matters
concerning only that class and Class B Shares bear certain expenses related to
the distribution of such shares. Government Bond Fund (the "Fund") is classified
as "diversified," as defined in the Investment Company Act of 1940. The Fund's
financial statements are prepared in accordance with generally accepted
accounting principles which may require the use of management accruals and
estimates. The following is a summary of significant accounting policies
followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Short-term securities are valued at amortized cost, which approximates
market value. Securities and assets for which market quotations are not readily
available are valued at fair value as determined in good faith by or under the
direction of the Board of Directors of the Company.
(b) Repurchase agreements--The Fund invests in US Government securities
pursuant to repurchase agreements. Under such agreements, the counterparty
agrees to repurchase the security at a mutually agreed upon time and price. The
Fund takes possession of the underlying securities, marks to market such
securities and, if necessary, receives additional securities daily to ensure
that the contract is fully collateralized.
(c) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Interest income (including amortization of premium and discount) is recognized
on the accrual basis. Realized gains and losses on security transactions are
determined on the identified cost basis.
(e) Dividends and distributions--Dividends from net investment income are
declared and paid monthly. Distributions of capital gains are recorded on the
ex-dividend dates. Distributions in excess of realized capital gains are due
primarily to differing tax treatments for post-October losses.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee at
the annual rate of 0.50% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1998, Merrill Lynch Security Pricing Service,
an affiliate of Merrill Lynch, Pierce, Fenner & Smith Incorporated, earned
$2,880 for providing security
149
<PAGE> 151
- --------------------------------------------------------------------------------
price quotations to compute the Fund's net asset value.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Merrill Lynch Funds Distributor, a division of Princeton Funds Distributor,
Inc. ("PFD"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
is the Fund's distributor.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1998 were $229,204,935 and $96,088,242, respectively.
Net realized gains (losses) for the year ended December 31, 1998 and net
unrealized gains as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains
- ------------------------------------------------------------------
<S> <C> <C>
Long-term investments............... $1,052,733 $9,162,345
Short-term investments.............. (143) --
---------- ----------
Total............................... $1,052,590 $9,162,345
========== ==========
- ------------------------------------------------------------------
</TABLE>
At December 31, 1998, net unrealized appreciation for Federal income tax
purposes aggregated $9,159,845, of which $10,264,570 related to appreciated
securities and $1,104,725 related to depreciated securities. At December 31,
1998, the aggregate cost of investments for Federal income tax purposes was
$336,422,312.
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions were
$164,833,095 and $86,200,892 for the years ended December 31, 1998 and December
31, 1997, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1998 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 14,779,601 $159,800,815
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 1,267,563 13,590,688
---------- ------------
Total issued......................... 16,047,164 173,391,503
Shares redeemed...................... (799,020) (8,558,408)
---------- ------------
Net increase......................... 15,248,144 $164,833,095
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Class A Shares for the Year Ended December Dollar
31, 1997 Shares Amount
- --------------------------------------------------------------------
<S> <C> <C>
Shares sold............................. 7,848,272 $80,971,426
Shares issued to shareholders in
reinvestment of dividends and
distributions.......................... 854,723 8,855,578
--------- -----------
Total issued............................ 8,702,995 89,827,004
Shares redeemed......................... (348,658) (3,626,112)
--------- -----------
Net increase............................ 8,354,337 $86,200,892
========= ===========
- --------------------------------------------------------------------
</TABLE>
5. LOANED SECURITIES:
At December 31, 1998, the Fund held US Treasury Bonds having an aggregate value
of approximately $4,691,000 as collateral for portfolio securities loaned having
a market value of approximately $4,535,000.
6. SUBSEQUENT EVENT:
On January 4, 1999, the Company's Board of Directors declared an ordinary income
dividend in the amount of $0.049038 per Class A Share payable on January 11,
1999 to shareholders of record as of December 31, 1998.
150
<PAGE> 152
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
GOVERNMENT BOND FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Government Bond Fund of Merrill Lynch Variable
Series Funds, Inc. as of December 31, 1998, the related statements of operations
for the year then ended and changes in net assets for each of the years in the
two-year period then ended, and the financial highlights for each of the years
in the four-year period then ended and the period May 2, 1994 (commencement of
operations) to December 31, 1994. These financial statements and the financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and the financial
highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1998 by correspondence with the custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Government Bond Fund
of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1998, the
results of its operations, the changes in its net assets, and the financial
highlights for the respective stated periods in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
151
<PAGE> 153
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
DECEMBER 31, 1998--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
During 1998, stock and bond market volatility reflected shifting investor
perceptions regarding global economic prospects. Investor optimism early in the
year gave way to expectations of deteriorating corporate profits and signs of a
weakening economy by late summer. Further concerns arose from the precarious
state of the Russian and other emerging market economies. As a result, world
stock markets declined in the July--September period. At the same time, the
uncertain economic picture and the resulting flight to quality by investors
pushed the 30-year US Treasury bond to record low yields. Yields also declined
in sovereign bond markets of other major industrialized countries. In contrast,
corporate bonds, mortgage-backed securities and emerging markets debt
underperformed Treasury securities by a wide margin.
FISCAL YEAR IN REVIEW
During a year of exceptional gyrations in global financial markets, the
high-yield market fared poorly. Events which contributed to 1998's volatility
included Russia's default on its sovereign debt, the economic meltdown in many
Pacific Rim nations, most notably Indonesia, and the collapse and bailout of a
prominent US hedge fund. After a massive sell-off and flight to quality in the
third quarter of 1998, three successive interest rate cuts by the Federal
Reserve Board in the fall boosted investor confidence in both the equity and
fixed-income markets. The high-yield markets rebounded in the fourth quarter,
particularly in the month of November, but ended up lagging the strong returns
posted by the US Treasury and equity markets. Specifically, the unmanaged Credit
Suisse First Boston High Yield Index registered a total return of +0.58% for the
year, compared to the US Treasury return of +12.25% and the total returns in the
unmanaged Standard & Poor's 500 Index's remarkable advance of 28.58%.
During the 12-month period ended December 31, 1998, a record volume of new
issues came to the high-yield market despite a month-long hiatus in the third
quarter caused by soaring spreads and cash outflows from mutual funds. New
issues totaled $138.9 billion (691 issues) for the year, up moderately from
1997's total of $126.0 billion (706 issues). Credits in the
media/telecommunications sector were the most active, accounting for close to
40% of new-issue volume. Many of the issuers in this capital-hungry sector are
build-out stage enterprises with little or no cash flow.
A recent study of corporate defaults by a major high-yield underwriter
revealed that the rate rose to 1.16% in 1998, up from 0.99% in 1997, but still
well below the 1977-1998 average of 2.30%. We would expect this upward trend to
continue in the new year, as 1998 saw an increasing percentage of new issuance
in the B- or lower category. Moreover, it marked the first year since 1995 that
rating-agency downgrades outnumbered upgrades. Finally, our expectation of a
softening economy in 1999 is also likely to contribute to the uptick in
defaults.
During the year ended December 31, 1998, the Fund's Class A Shares had a total
return of -3.09%. The Fund underperformed the Credit Suisse First Boston High
Yield Index, largely because of the Fund's heavier weightings in emerging
markets, which were pummeled by political and economic turmoil in Russia, Asia
and Latin America. Also, the Fund's performance was negatively affected by our
overweighted position in the energy sector, the worst-performing sector in the
Index. Deterioration in selected credits was also a factor.
Our holdings in emerging markets are mostly strong corporate credits with
significant positions in their home markets. Accordingly, we believe the default
risk on these securities is low. Oil prices were at a 12-year low in 1998, and
natural gas prices, day rates and rig utilization in the service sector have
also been weak. As a result, several of our energy bonds traded at distressed
levels. However, the number of private equity infusions and mergers that have
been announced in recent months is a positive sign. In that regard, investment
grade-rated Nabors Industries Inc., the largest US driller of land-based oil and
natural gas wells, announced in mid-January 1999 that it would acquire Pool
Energy Services Co., a Fund holding. Pool's bond shot up about ten points on the
news.
During the second half of 1998, we were cautious in our purchasing activity
because of liquidity concerns, particularly in the third quarter. In the primary
market, our major purchases included the bonds of Allied Waste North America,
the third-largest solid waste management company in the United States; Ball
Corp., the largest beverage can producer in North America; Chancellor Media
Corp., a diversified media company that owns the nation's largest group of radio
stations; Cogentrix Energy Inc., an independent power producer; and
152
<PAGE> 154
- --------------------------------------------------------------------------------
Metromedia Fiber Network, a builder of fiber optic infrastructure in the local
loop. We sold our Metromedia Fiber Network bonds after they surged over four
points in their first day of trading, since we believed they were fully valued.
We view the other four credits, all of which have senior or implied senior
ratings of at least Ba2/BB-, as core holdings. All have performed quite well in
the aftermarket.
In the secondary market, we added to some of our existing holdings, including
Orange PLC, an operator of a digital wireless network in the United Kingdom, and
Tekni-Plex, Inc., a vertically integrated manufacturer of plastic packaging.
Tekni-Plex was a particularly timely transaction, since the bond climbed
approximately nine points since our purchase. We took advantage of the November
rally by trimming our steel holdings, and sold our WCI Steel Inc. position at an
attractive price. Shortly thereafter, the company reported lower earnings for
its fiscal fourth quarter. We also sold our position in AEP Industries, Inc., a
somewhat cyclical packaging company that has reported results below the guidance
provided by management on the roadshow.
Looking ahead, we believe that the high-yield market in the first half of 1999
will continue to be volatile because of equity market fluctuations,
political/economic news in emerging markets, concerns about corporate earnings
in the face of a slowing US economy, and possible supply/demand imbalances.
Nevertheless, we believe high-yield securities remain an attractive asset class.
Moreover, investors appear to be discounting both a dramatic slowdown in the
North American economy and a sharp increase in default statistics. In our view,
neither of these is likely. Accordingly, we believe the high-yield market offers
good value at current levels. With a heavy new-issue calendar looming, we intend
to selectively add higher-quality, more recession-resistant credits to the Fund.
At year-end, communications and media remained our largest broad industry
category, totaling 29.3% of net assets. Of the more narrowly classified sectors,
the largest industries were: energy, 7.6% of net assets; domestic cable, 6.1%;
packaging, 4.4%; utilities, 4.1%; and broadcasting, 3.3%. Non-US bonds comprised
19.2% of the Fund, with emerging markets issues (primarily Latin American
corporates) accounting for 10.0% of net assets. At December 31, 1998, the
average portfolio maturity was seven years, one month, and cash and cash
equivalents stood at 4.2% of net assets.
IN CONCLUSION
We thank you for your continued interest in High Current Income Fund of
Merrill Lynch Variable Series Funds, Inc., and we look forward to sharing our
investment outlook and strategy with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Robert F. Murrary
Robert F. Murray
Vice President and Portfolio Manager
February 5, 1999
153
<PAGE> 155
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
High Current Income Fund
Total Return Based on a $10,000 Investment-Class A Shares
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Credit Suisse First Boston High
Yield Index. Beginning and ending values are:
<TABLE>
<CAPTION>
12/98 12/98
----- -----
<S> <C> <C>
High Current Income Fund+
- -- Class A Shares* $10,000 $26,826
Credit Suisse First Boston High
Yield Index++ $10,000 $27,744
</TABLE>
* Assuming transaction costs and other operating expenses, including advisory
fees. Does not include insurance-related fees and expenses.
+ High Current Income Fund invests principally in fixed-income securities, which
are rated in the lower rating categories of the established rating services or
in unrated securities of comparable quality.
++ This unmanaged market-weighted Index of high-yield debt securities is
comprised of 423 securities rated BBB or lower.
Past performance is not predictive of future performance.
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PERIOD COVERED % RETURN
- ----------------------------------------------------------------------
<S> <C>
Year Ended 12/31/98 - 3.09%
- ----------------------------------------------------------------------
Five Years Ended 12/31/98 + 6.23
- ----------------------------------------------------------------------
Ten Years Ended 12/31/98 +10.37
- ----------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
RECENT PERFORMANCE RESULTS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
12 MONTH 6 MONTH
TOTAL RETURN TOTAL RETURN
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Class A Shares -3.09% -6.08%
- ------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the payable date. Insurance-related fees and
expenses are not reflected in these returns. Past results shown should not be
considered a representation of future performance.
154
<PAGE> 156
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT ISSUE COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
AEROSPACE & DEFENSE--0.6% B B2 $ 3,000,000 L-3 Communications Corp.,
Series B, 10.375% due
5/01/2007................. $ 3,000,000 $ 3,292,500
- ---------------------------------------------------------------------------------------------------------------------------
AIRLINES--0.9% BB Ba2 4,000,000 USAir Inc., 10.375% due
3/01/2013................. 3,935,000 4,630,760
- ---------------------------------------------------------------------------------------------------------------------------
AUTOMOTIVE--1.8% B+ B3 5,000,000 Breed Technologies Inc.,
9.25% due 4/15/2008(e).... 5,000,000 4,375,000
B B2 2,000,000 Collins & Aikman Products,
11.50% due 4/15/2006...... 2,000,000 2,080,000
B+ B2 3,000,000 Venture Holdings Trust,
9.50% due 7/01/2005....... 2,914,664 2,985,000
------------- -------------
9,914,664 9,440,000
- ---------------------------------------------------------------------------------------------------------------------------
BROADCASTING-- B B1 3,000,000 Chancellor Media Corp.,
RADIO & TV--3.3% 9% due 10/01/2008(e)...... 3,000,000 3,165,000
CCC+ B3 2,000,000 Cumulus Media, Inc.,
10.375% due 7/01/2008..... 2,000,000 2,120,000
CCC+ B3 3,000,000 Paxson Communications
Corporation, 11.625% due
10/01/2002................ 3,223,750 3,045,000
B- B3 1,278,000 SFX Broadcasting Inc.,
Series B, 10.75% due
5/15/2006................. 1,271,610 1,418,580
B- B3 2,500,000 Salem Communications Corp.,
9.50% due 10/01/2007...... 2,551,250 2,575,000
Sinclair Broadcast Group
Inc.:
B B2 2,000,000 10% due 9/30/2005........... 1,993,750 2,120,000
B B2 3,000,000 8.75% due 12/15/2007........ 2,988,240 3,030,000
------------- -------------
17,028,600 17,473,580
- ---------------------------------------------------------------------------------------------------------------------------
BUILDING MATERIALS--0.6% B+ B1 3,000,000 Nortek, Inc., 9.125% due
9/01/2007................. 2,975,760 3,090,000
- ---------------------------------------------------------------------------------------------------------------------------
CABLE--4.8% CCC Ca 2,838,901 American Telecasting, Inc.,
13.646% due
6/15/2004(d).............. 2,665,607 482,613
B- B3 1,500,000 Avalon Cable of Michigan,
9.375% due
12/01/2008(e)............. 1,500,000 1,533,750
Century Communications
Corporation:
BB- Ba3 3,000,000 9.50% due 3/01/2005......... 2,953,750 3,390,000
BB- Ba3 2,500,000 8.375% due 12/15/2007....... 2,454,475 2,675,000
B B2 4,000,000 Intermedia Capital Partners
L.P., 11.25% due
8/01/2006................. 3,997,500 4,500,000
BB+ Ba3 5,000,000 Lenfest Communications,
Inc., 8.375% due
11/01/2005................ 4,627,500 5,400,000
B B1 4,000,000 Olympus Communications
L.P./Capital Corp.,
Series B, 10.625%
due 11/15/2006............ 4,000,000 4,400,000
BB+ Ba2 2,000,000 TCI Communications Finance
Inc., 9.65% due
3/31/2027................. 2,052,500 2,469,680
------------- -------------
24,251,332 24,851,043
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
155
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT ISSUE COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
CABLE-- Australis Media Ltd.(c)(g):
INTERNATIONAL--2.9% D C $ 136,859 1.75%/15.75% due
5/15/2003................. $ 75,292 $ 1,369
NR* NR* 8,000,000 1.75%/15.75% due
5/15/2003(h).............. 5,575,080 80,000
NTL, Inc.:
B- B3 2,000,000 10% due 2/15/2007........... 1,955,000 2,050,000
B- B3 5,500,000 Series B, 10.98% due
2/01/2006(d).............. 4,440,156 4,510,000
B+ B1 7,000,000 TeleWest Communications PLC,
11.45% due
10/01/2007(d)............. 5,639,417 5,827,500
B B3 5,000,000 United International
Holdings, Series B, 10.75%
due 2/15/2008(d).......... 3,259,208 2,700,000
------------- -------------
20,944,153 15,168,869
- ---------------------------------------------------------------------------------------------------------------------------
CAPITAL GOODS--3.2% B+ B1 4,000,000 Bucyrus International,
9.75% due 9/15/2007....... 4,000,000 2,970,000
B B2 4,000,000 Columbus McKinnon Corp.,
8.50% due 4/01/2008....... 3,989,360 3,760,000
B- B3 4,500,000 International Wire Group,
Inc., 11.75% due
6/01/2005................. 4,490,625 4,736,250
B B3 4,750,000 Morris Materials Handling,
9.50% due 4/01/2008....... 4,705,000 3,515,000
B- B3 2,000,000 Terex Corp., 8.875% due
4/01/2008................. 1,965,000 1,960,000
------------- -------------
19,149,985 16,941,250
- ---------------------------------------------------------------------------------------------------------------------------
CHEMICALS--2.3% BB- Ba3 3,100,000 Agricultural, Minerals and
Chemicals Inc., 10.75%
due 9/30/2003............. 3,119,125 3,162,000
B- B3 5,000,000 Great Lakes Carbon Corp.,
Series B, 11.75% due
5/15/2008(a).............. 5,000,000 5,037,500
BB- Ba3 3,500,000 ISP Holdings Inc., 9.75% due
2/15/2002................. 3,500,000 3,718,750
------------- -------------
11,619,125 11,918,250
- ---------------------------------------------------------------------------------------------------------------------------
COMPUTER SERVICES-- CCC Caa1 3,000,000 Dictaphone Corp., 11.75% due
ELECTRONICS--2.0% 8/01/2005................. 2,943,750 2,250,000
B B2 4,000,000 Hadco Corp., 9.50% due
6/15/2008................. 3,986,400 3,960,000
B- B3 4,000,000 PSINet, Inc., 10% due
2/15/2005................. 4,000,000 3,960,000
------------- -------------
10,930,150 10,170,000
- ---------------------------------------------------------------------------------------------------------------------------
CONGLOMERATES--1.0% B- B3 2,000,000 Eagle-Picher Industries,
9.375% due 3/01/2008...... 1,996,720 1,880,000
Sequa Corp.:
BB Ba2 750,000 9.625% due 10/15/1999....... 740,625 765,000
B+ B1 2,500,000 9.375% due 12/15/2003....... 2,512,813 2,543,750
------------- -------------
5,250,158 5,188,750
- ---------------------------------------------------------------------------------------------------------------------------
CONSUMER PRODUCTS--0.7% B+ B1 2,500,000 Playtex Products, Inc.,
Series B, 8.875% due
7/15/2004................. 2,520,625 2,618,750
B- B3 1,500,000 Syratech Corp., 11% due
4/15/2007................. 1,230,000 1,215,000
------------- -------------
3,750,625 3,833,750
- ---------------------------------------------------------------------------------------------------------------------------
DIVERSIFIED--1.0% B- B2 2,000,000 Koppers Industries, Inc.,
9.875% due 12/01/2007..... 2,000,000 1,960,000
B+ B3 4,000,000 RBX Corp, 12% due
1/15/2003................. 4,022,500 3,240,000
------------- -------------
6,022,500 5,200,000
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
156
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT ISSUE COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ENERGY--7.6% B- B3 $ 2,000,000 Bellwether Exploration,
10.875% due 4/01/2007..... $ 2,000,000 $ 2,020,000
B B2 4,500,000 Benton Oil and Gas Co.,
11.625% due 5/01/2003..... 4,500,000 2,610,000
Chesapeake Energy Corp.:
B B3 2,000,000 9.125% due 4/15/2006........ 1,995,100 1,480,000
B B3 1,500,000 Series B, 9.625% due
5/01/2005................. 1,500,000 1,125,000
B+ B3 2,500,000 Clark USA Inc., Series B,
10.875% due 12/01/2005.... 2,738,125 2,325,000
B B2 4,000,000 Energy Corp. of America,
9.50% due 5/15/2007....... 4,000,000 3,700,000
B+ B1 2,000,000 Hvide Marine, Inc., 8.375%
due 2/15/2008............. 2,000,000 1,600,000
B- B3 2,200,000 KCS Energy Inc., 8.875% due
1/15/2008................. 2,178,000 1,540,000
BB+ Ba3 2,000,000 Market Hub Partners,
8.25% due 3/01/2008....... 2,030,000 2,030,000
B B3 5,000,000 Northern Offshore ASA,
10% due 5/15/2005(e)...... 5,000,000 2,600,000
Parker Drilling Co.:
B+ B1 1,750,000 9.75% due 11/15/2006........ 1,758,750 1,575,000
B+ B1 2,000,000 Series D, 9.75% due
11/15/2006................ 2,076,660 1,780,000
NR* B2 3,000,000 Petroleo Brasileiro S.A.,
10% due 10/17/2006(e)..... 3,000,312 2,775,000
B+ B2 1,500,000 Pool Energy Services Co.,
8.625% due 4/01/2008...... 1,500,000 1,417,500
CCC Caa2 3,500,000 Southwest Royalties Inc.,
10.50% due 10/15/2004..... 3,368,730 1,400,000
BB- B1 3,000,000 Tesoro Petroleum Corp.,
Series B, 9% due
7/01/2008................. 2,982,870 2,910,000
CCC Caa2 14,365,000 TransAmerican Energy Corp.,
Series B, 13.127% due
6/15/2002(d).............. 13,494,190 4,022,200
B- B2 1,500,000 United Refining Co.,
Series B, 10.75% due
6/15/2007................. 1,507,500 1,005,000
B B2 2,500,000 Universal Compression Inc.,
9.875% due
2/15/2008(d).............. 1,679,811 1,500,000
------------- -------------
59,310,048 39,414,700
- ---------------------------------------------------------------------------------------------------------------------------
ENTERTAINMENT--1.1% B- B3 5,000,000 Six Flags Theme Parks,
Series A, 12.25% due
6/15/2005................. 5,000,000 5,525,000
- ---------------------------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES--0.6% CCC+ Caa3 2,000,000 Amresco Inc., Series 98-A,
9.875% due 3/15/2005...... 2,005,000 1,400,000
NR* Baa2 2,000,000 IBJ Preferred Capital Co.
LLC, 8.79% due
12/29/2049(e)............. 1,992,500 1,720,000
------------- -------------
3,997,500 3,120,000
- ---------------------------------------------------------------------------------------------------------------------------
FOOD & BEVERAGE--0.9% B+ B1 4,500,000 Chiquita Brands
International Inc., 9.125%
due 3/01/2004............. 4,448,750 4,601,250
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
157
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT ISSUE COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
GAMING--2.6% BB- B1 $ 2,000,000 Boyd Gaming Corporation,
9.50% due 7/15/2007....... $ 1,978,000 $ 1,980,000
D Caa1 4,000,000 GB Property Funding Corp.,
10.875% due
1/15/2004(c).............. 3,590,000 2,480,000
Jazz Casino Co. LLC:
NR* NR* 1,939,500 5.867% due 11/15/2009(a).... 927,223 901,867
NR* NR* 189,000 New Contingent Notes due
11/15/2009(i)............. 0 0
B B2 6,000,000 Trump Atlantic City
Associates/Funding Inc.,
11.25% due 5/01/2006...... 5,935,000 5,280,000
B- B3 3,000,000 Venetian Casino/LV Sands,
12.25% due 11/15/2004..... 3,015,000 2,835,000
------------- -------------
15,445,223 13,476,867
- ---------------------------------------------------------------------------------------------------------------------------
HEALTH SERVICES--3.4% B+ Ba3 4,000,000 Beverly Enterprises Inc., 9%
due 2/15/2006............. 3,740,000 4,080,000
BBB Ba2 2,000,000 Columbia HCA/Healthcare
Corp., 7.15% due
3/30/2004................. 1,920,000 1,950,240
B- B2 2,000,000 Extendicare Health Services,
9.35% due 12/15/2007...... 2,000,000 1,900,000
B+ Ba3 3,000,000 Fresenius Medical Capital
Trust II, 7.875% due
2/01/2008................. 3,000,000 2,970,000
B- B3 2,000,000 Magellan Health Services,
9% due 2/15/2008.......... 2,000,000 1,760,000
B- B3 2,500,000 Mariner Post - Acute
Network, 9.50% due
11/01/2007................ 2,488,850 1,925,000
B+ B2 3,000,000 Quest Diagnostic Inc.,
10.75% due 12/15/2006..... 3,000,000 3,330,000
------------- -------------
18,148,850 17,915,240
- ---------------------------------------------------------------------------------------------------------------------------
HOTELS--0.4% BB Ba2 2,000,000 HMH Properties, Inc., Series
C, 8.45% due 12/01/2008... 1,993,280 2,000,000
- ---------------------------------------------------------------------------------------------------------------------------
INDEPENDENT POWER B+ Ba1 5,000,000 The AES Corporation, 10.25%
PRODUCERS--2.8% due 7/15/2006............. 5,400,000 5,400,000
BB- Ba2 4,000,000 Calpine Corporation, 8.75%
due 7/15/2007............. 4,005,882 4,040,000
BB+ Ba1 2,500,000 Cogentrix Energy Inc., 8.75%
due 10/15/2008(e)......... 2,487,950 2,675,000
B B2 250,000 Midland Funding II, Series
A, 11.75% due 7/23/2005... 250,000 289,975
BB Ba2 3,000,000 Monterrey Power, S.A. de
C.V., 9.625% due
11/15/2009(e)............. 2,994,480 2,340,000
------------- -------------
15,138,312 14,744,975
- ---------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL-- Anthony Crane Rentals(e):
SERVICES--2.9% B B3 1,000,000 10.375% due 8/01/2008....... 1,000,000 960,000
B NR* 10,000,000 13.375% due 8/01/2009(d).... 5,523,657 4,400,000
Neff Corp.:
B B3 3,000,000 10.25% due 6/01/2008........ 3,000,000 2,940,000
B B3 1,000,000 10.25% due
6/01/2008(e).............. 985,160 980,000
BB+ Ba3 2,000,000 Protection One Alarm, 8.125%
due
1/15/2009(e).............. 2,000,000 2,000,000
CCC+ Caa1 8,000,000 Thermadyne Holdings Corp.,
12.50% due
6/01/2008(d).............. 4,683,617 3,800,000
------------- -------------
17,192,434 15,080,000
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
158
<PAGE> 160
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT ISSUE COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
MACHINERY--0.7% B- B3 $ 4,000,000 Numatics Inc., 9.625% due
4/01/2008................. $ 4,000,000 $ 3,740,000
- ---------------------------------------------------------------------------------------------------------------------------
MEDIA & COMMUNICATIONS-- BB- Ba3 3,000,000 Antenna TV S.A., 9% due
8/01/2007................. 2,937,738 2,550,000
INTERNATIONAL--3.5% BB- B1 3,000,000 Comtel Brasileira Ltd.,
10.75% due 9/26/2004(e)... 3,000,000 2,355,000
BB- B2 5,000,000 Globo Communicacoes e
Participacoes, Ltd.,
10.50% due
12/20/2006(e)............. 5,101,250 3,212,500
BB Ba2 4,000,000 Grupo Televisa, S.A. de
C.V., Series A, 11.375%
due 5/15/2003............. 4,025,000 3,950,000
B- B3 2,500,000 Satelites Mexicanos S.A.,
Series B, 10.125% due
11/01/2004................ 2,500,000 2,000,000
BBB- Ba3 4,000,000 Telefonica de Argentina
S.A., 11.875%
due 11/01/2004............ 3,917,780 4,200,000
------------- -------------
21,481,768 18,267,500
- ---------------------------------------------------------------------------------------------------------------------------
METALS & MINING--2.4% B- Caa1 3,000,000 AEI Resources Inc., 11.50%
due 12/15/2006(e)......... 3,000,000 2,962,500
CCC+ B2 4,500,000 Kaiser Aluminum & Chemical
Corp., 12.75% due
2/01/2003................. 4,770,000 4,410,000
B B2 5,000,000 P & L Coal Holdings Corp.,
9.625% due 5/15/2008...... 4,985,700 5,050,000
------------- -------------
12,755,700 12,422,500
- ---------------------------------------------------------------------------------------------------------------------------
PACKAGING--4.4% BB- B1 4,500,000 Ball Corp, 8.25% due
8/01/2008(e).............. 4,500,000 4,680,000
B- B3 4,500,000 Indesco International, 9.75%
due 4/15/2008............. 4,490,000 4,230,000
B B2 4,000,000 Portola Packaging Inc.,
10.75% due 10/01/2005..... 4,000,000 4,100,000
B B1 1,000,000 Silgan Corp., 9% due
6/01/2009................. 1,000,000 1,012,500
B NR* 2,810,000 Silgan Holdings, Inc.,
13.25% due 7/15/2006(a)... 3,142,137 3,147,200
B- B3 5,500,000 Tekni-Plex, Inc., 9.25% due
3/01/2008................. 5,476,250 5,747,500
------------- -------------
22,608,387 22,917,200
- ---------------------------------------------------------------------------------------------------------------------------
PAPER & FOREST B B3 4,000,000 Ainsworth Lumber Company,
PRODUCTS--3.3% 12.50% due 7/15/2007(a)... 3,899,898 3,980,000
B B2 3,000,000 Bear Island Paper LLC,
Series B, 10% due
12/01/2007................ 3,000,000 3,000,000
B- B2 2,000,000 Container Corp. of America,
Series B, 10.75% due
5/01/2002................. 2,190,000 2,080,000
B+ B1 5,000,000 Doman Industries Limited,
Series B, 9.25% due
11/15/2007................ 5,000,000 3,700,000
CCC+ Caa1 4,000,000 Pindo Deli Financial
Mauritius, 10.75% due
10/01/2007................ 3,987,920 2,175,000
B+ B1 2,000,000 S.D. Warren Co., Series B,
12% due 12/15/2004........ 2,000,000 2,170,000
------------- -------------
20,077,818 17,105,000
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
159
<PAGE> 161
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT ISSUE COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
PRINTING & B+ B1 $ 4,000,000 Garden State Newspapers,
PUBLISHING--2.3% Series B, 8.75% due
10/01/2009................ $ 3,976,600 $ 4,000,000
BB- B1 5,000,000 Hollinger International
Publishing, 9.25% due
2/01/2006................. 4,961,250 5,250,000
B B3 1,000,000 Premier Graphics Inc.,
11.50% due
12/01/2005(e)............. 1,000,000 995,000
BB- Ba3 2,000,000 Primedia, Inc., 7.625% due
4/01/2008................. 1,988,500 1,960,000
------------- -------------
11,926,350 12,205,000
- ---------------------------------------------------------------------------------------------------------------------------
PRODUCT B- B3 4,000,000 AmeriServ Food Company,
DISTRIBUTION--0.7% 10.125% due 7/15/2007..... 4,000,000 3,460,000
- ---------------------------------------------------------------------------------------------------------------------------
RESTAURANTS--0.4% BB- NR* 2,000,000 FM 1993A Corp., Series B,
9.75% due 11/01/2003...... 1,972,075 2,060,000
- ---------------------------------------------------------------------------------------------------------------------------
RETAIL SPECIALTY--0.3% D Caa 4,500,000 Bradlees, Inc., 11% due
8/01/2002(c).............. 4,466,562 90,000
NR* NR* 1,579,000 Cumberland Farms, Inc.,
10.50% due 10/01/2003..... 1,545,446 1,563,210
------------- -------------
6,012,008 1,653,210
- ---------------------------------------------------------------------------------------------------------------------------
STEEL--2.0% NR* B2 5,000,000 CSN Iron S.A., 9.125% due
6/01/2007(e).............. 4,850,000 3,087,500
B B2 3,500,000 Weirton Steel Corp., 10.75%
due 6/01/2005............. 3,346,250 3,150,000
BB- B2 4,500,000 Wheeling-Pittsburgh Corp.,
9.25% due 11/15/2007...... 4,469,255 4,207,500
------------- -------------
12,665,505 10,445,000
- ---------------------------------------------------------------------------------------------------------------------------
SUPERMARKETS--0.7% BB Ba3 2,000,000 Disco S.A., 9.875% due
5/15/2008................. 1,986,840 1,705,000
B- B3 2,000,000 Pueblo Xtra International
Inc., 9.50% due
8/01/2003................. 1,844,329 1,890,000
------------- -------------
3,831,169 3,595,000
- ---------------------------------------------------------------------------------------------------------------------------
TELEPHONY-- COMPETITIVE B+ B2 3,000,000 GCI Inc., 9.75% due
LOCAL 8/01/2007................. 3,000,000 2,970,000
EXCHANGE --2.7% B B2 3,000,000 Intermedia Communication
Inc., 8.60% due
6/01/2008................. 3,000,000 2,850,000
B B3 4,000,000 Level 3 Communications,
9.125% due 5/01/2008...... 3,877,500 3,950,000
B B3 3,500,000 Metronet Communications,
9.95% due
6/15/2008(d).............. 2,270,621 2,143,750
NR* B3 3,000,000 Nextlink Communications,
9.45% due
4/15/2008(d).............. 2,019,008 1,710,000
B- B2 500,000 Time Warner Telecom LLC,
9.75% due 7/15/2008....... 500,000 525,000
------------- -------------
14,667,129 14,148,750
- ---------------------------------------------------------------------------------------------------------------------------
TEXTILES--0.9% B+ B3 2,800,000 Anvil Knitwear Inc., Series
B, 10.875% due
3/15/2007................. 2,906,625 1,680,000
B B3 2,000,000 Galey & Lord, Inc., 9.125%
due 3/01/2008............. 2,002,500 1,740,000
D Caa3 4,000,000 Polysindo International
Finance Co., 9.375% due
7/30/2007(c).............. 3,601,250 1,280,000
------------- -------------
8,510,375 4,700,000
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
160
<PAGE> 162
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT ISSUE COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
TRANSPORTATION--3.6% BB- NR* $ 5,000,000 Autopistas del Sol S.A.,
10.25% due 8/01/2009(e)... $ 4,971,250 $ 3,787,500
BB Ba3 6,000,000 GS Superhighway Holdings,
10.25% due 8/15/2007...... 5,956,875 2,820,000
B NR* 4,500,000 MRS Logistica S.A., 10.625%
due 8/15/2005(e).......... 4,449,375 2,283,750
BB- B1 4,000,000 Sea Containers Ltd.,
Series A, 12.50% due
12/01/2004................ 4,380,000 4,290,000
B- B3 5,700,000 Transtar Holdings L.P.,
Series B, 11.067% due
12/15/2003(d)............. 5,240,895 5,472,000
------------- -------------
24,998,395 18,653,250
- ---------------------------------------------------------------------------------------------------------------------------
UTILITIES--4.1% NR* NR* 2,500,000 CIA Saneamento Basico, 10%
due 7/28/2005(e).......... 2,340,000 1,700,000
BB+ Baa3 1,000,000 Empresa Elec del Norte,
10.50% due 6/15/2005(e)... 1,000,000 680,000
B+ B2 5,000,000 Espirito Santo--Escelsa, 10%
due 7/15/2007............. 4,973,750 3,062,500
BB NR* 3,000,000 Inversora de Electrica, 9%
due 9/16/2004(e).......... 3,000,000 2,212,500
BBB- Ba3 4,000,000 Metrogas S.A., 12% due
8/15/2000................. 3,935,000 4,130,000
BBB- Ba2 2,481,000 Niagara Mohawk Power Corp.,
8.77% due 1/01/2018....... 2,631,110 2,821,964
BBB- Baa3 2,943,600 TransGas de Occidente S.A.,
9.79% due
11/01/2010(e)(f).......... 2,943,600 2,422,383
+Tucson Electric & Power
Co.(f):
NR* NR* 3,400,687 10.21% due 1/01/2009........ 3,287,974 3,967,105
NR* NR* 500,000 10.732% due 1/01/2013....... 461,050 599,510
------------- -------------
24,572,484 21,595,962
- ---------------------------------------------------------------------------------------------------------------------------
WASTE MANAGEMENT--1.6% BB Ba2 4,000,000 Allied Waste North America,
7.375% due 1/01/2004(e)... 3,994,120 4,040,000
D Ca 3,500,000 Mid-American Waste Systems,
Inc., 12.25% due
2/15/2003(c).............. 1,313,074 105,000
B+ B2 4,000,000 Safety-Kleen Services, 9.25%
due 6/01/2008............. 4,000,000 4,120,000
------------- -------------
9,307,194 8,265,000
- ---------------------------------------------------------------------------------------------------------------------------
WIRELESS COMMUNICATIONS-- CCC+ B2 2,000,000 Cencall Communications
DOMESTIC--3.2% Corporation, 8.803% due
1/15/2004(d).............. 1,997,340 1,960,000
BB+ Ba3 3,000,000 Comcast Cellular Holdings,
Series B, 9.50% due
5/01/2007................. 2,995,110 3,180,000
CCC+ B2 10,000,000 Nextel Communications
Inc., 13.128% due
8/15/2004(d).............. 8,360,453 9,700,000
B B2 2,000,000 Paging Network, Inc., 10%
due 10/15/2008............ 1,997,500 1,900,000
------------- -------------
15,350,403 16,740,000
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
161
<PAGE> 163
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT ISSUE COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
WIRELESS COMMUNICATIONS-- CCC+ Caa1 $ 7,505,000 McCaw International Ltd.,
INTERNATIONAL--2.5% 12.484% due
4/15/2007(d).............. $ 5,078,478 $ 4,071,462
B- B3 8,000,000 Millicom International
Cellular S.A., 13.31% due
6/01/2006(d).............. 5,869,683 5,600,000
B+ Ba3 3,500,000 Orange PLC, 8% due
8/01/2008................. 3,386,875 3,535,000
------------- -------------
14,335,036 13,206,462
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
CORPORATE BONDS--86.7% 512,518,245 452,256,618
- ---------------------------------------------------------------------------------------------------------------------------
SHARES
HELD PREFERRED STOCKS
- ---------------------------------------------------------------------------------------------------------------------------
BROADCASTING-- CCC+ Caa 2,139 Cumulus Media, Inc.
RADIO & TV--0.4% (Series A, 13.75%)(a)(c).. 2,142,995 2,278,035
- ---------------------------------------------------------------------------------------------------------------------------
CABLE--DOMESTIC--1.3% BB- B2 62,265 CSC Holdings Inc.
(Series M)(a)(c).......... 4,427,500 6,942,547
- ---------------------------------------------------------------------------------------------------------------------------
CABLE-- B- NR* 3,753 NTL, Inc.
INTERNATIONAL--0.8% (Series B)(a)(c).......... 3,803,925 3,978,180
- ---------------------------------------------------------------------------------------------------------------------------
CAPITAL GOODS--0.3% B- B3 2,063 Clark Material
Handling(a)(c)............ 2,049,455 1,619,455
- ---------------------------------------------------------------------------------------------------------------------------
ENERGY--1.1% B+ Caa 2,236 +Clark USA Inc.(a)(c)....... 2,229,710 1,878,240
BB+ Ba1 160,000 Coastal Finance I........... 4,000,000 3,940,000
+TCR Holdings, Inc.:
NR* NR* 23,076 (Class B)................... 1,385 1,385
NR* NR* 12,692 (Class C)................... 711 711
NR* NR* 33,460 (Class D)................... 1,773 1,773
NR* NR* 69,227 (Class E)................... 4,361 4,361
------------- -------------
6,237,940 5,826,470
- ---------------------------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES--0.6% BB+ Ba1 120,000 California Federal Bank
(Series A)................ 3,030,000 3,037,500
- ---------------------------------------------------------------------------------------------------------------------------
PRINTING & B B2 20,000 Primedia, Inc.
PUBLISHING--0.4% (Series B)(c)............. 1,988,000 1,925,000
- ---------------------------------------------------------------------------------------------------------------------------
STEEL--0.6% BB+ Baa3 120,000 USX Capital LLC (Series
A)........................ 3,000,000 3,000,000
- ---------------------------------------------------------------------------------------------------------------------------
TELEPHONY-COMPETITIVE CCC+ Caa 3,815 +Intermedia Communications
LOCAL EXCHANGE--0.7% Inc. (Series B)
(Convertible)(a)(c)....... 3,843,528 3,843,613
- ---------------------------------------------------------------------------------------------------------------------------
WIRELESS COMMUNICATIONS-- CCC+ Caa 2,339 Nextel Communications Inc.
DOMESTIC--0.5% (Series D)(a)(c).......... 2,369,870 2,385,780
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
PREFERRED STOCKS--6.7% 32,893,213 34,836,580
- ---------------------------------------------------------------------------------------------------------------------------
COMMON STOCKS
- ---------------------------------------------------------------------------------------------------------------------------
ENERGY--0.2% 86,526 CHI Energy, Inc.(c)......... 1,257,994 1,124,838
- ---------------------------------------------------------------------------------------------------------------------------
ENTERTAINMENT--0.2% 93,747 On Command Corporation(c)... 2,744,654 849,582
- ---------------------------------------------------------------------------------------------------------------------------
GAMING--0.0% 54,802 JCC Holding Company(c)...... 219,208 184,957
- ---------------------------------------------------------------------------------------------------------------------------
WIRELESS COMMUNICATIONS-- 9,295 Nextel Communications,
DOMESTIC--0.0% Inc.(c)................... 149,988 219,594
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
COMMON STOCKS--0.4% 4,371,844 2,378,971
- ---------------------------------------------------------------------------------------------------------------------------
TRUSTS & WARRANTS
- ---------------------------------------------------------------------------------------------------------------------------
CABLE--DOMESTIC--0.0% 23,350 American Telecasting, Inc.
(Warrants)(b)............. 4,776 234
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
162
<PAGE> 164
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
INDUSTRY HELD TRUSTS & WARRANTS COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ENTERTAINMENT--0.0% 29,830 On Command Corporation
(Warrants)(b)............. $ 238,640 $ 104,405
- ---------------------------------------------------------------------------------------------------------------------------
GAMING--0.0% 250 +Goldriver Hotel & Casino
Finance Corp. (Liquidating
Trust)(c)................. 6,000 0
- ---------------------------------------------------------------------------------------------------------------------------
SUPERMARKETS--0.0% 2,809 Grand Union Co.
(Warrants)(b)............. 28 6,847
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN TRUSTS
& WARRANTS--0.0% 249,444 111,486
- ---------------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT SHORT-TERM SECURITIES
- ---------------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER**--2.3% $11,868,000 General Motors
Acceptance Corp., 5.13%
due 1/04/1999............. 11,861,235 11,861,235
- ---------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT AGENCY 10,000,000 Federal Home Loan Mortgage
OBLIGATIONS**--1.9% Corporation, 5.08% due
1/04/1999................. 9,994,356 9,994,356
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SHORT-
TERM SECURITIES--4.2% 21,855,591 21,855,591
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS--98.0%.... $ 571,888,337 511,439,246
=============
OTHER ASSETS LESS
LIABILITIES--2.0%......... 10,460,375
-------------
NET ASSETS--100.0%.......... $ 521,899,621
=============
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
*
Not Rated.
**
Commercial Paper and certain US Government Agency Obligations are traded on a
discount basis; the interest rates shown reflect the discount rates paid at the
time of purchase by the Fund.
(a)
Represents a pay-in-kind security which may pay interest/dividends in additional
face amount/shares.
(b)
Warrants entitle the Fund to purchase a predetermined number of shares of Common
Stock and are non-income producing. The purchase price and number of shares are
subject to adjustment under certain conditions until the expiration date.
(c)
Non-income producing security.
(d)
Represents a zero coupon or step bond; the interest rate shown is the effective
yield at the time of purchase by the Fund.
(e)
The security may be offered and sold to "qualified institutional buyers" under
Rule 144A of the Securities Act of 1933.
(f)
Subject to principal paydowns.
(g)
Represents a step bond. Coupon payments are paid-in-kind, in which the Fund
receives additional face amount at an annual rate of 1.75% until May 15, 2000.
Subsequently, the Fund will receive cash coupon payments at an annual rate of
15.75% until maturity.
(h)
Each $1,000 face amount contains one warrant of Australis Media Ltd.
(i)
Represents an obligation by Jazz Casino Co. LLC to pay a semi-annual amount to
the Fund through 11/15/2009. The payments are based upon varying interest rates
and the amounts, which may be paid-in-kind, are contingent upon the earnings
before income taxes, depreciation and amortization of Jazz Casino LLC on a
fiscal year basis.
+
Restricted securities as to resale. The value of the Fund's investment in
restricted securities was approximately $10,297,000, representing 1.97% of net
assets.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
VALUE
ISSUE ACQUISITION DATE COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Clark USA Inc............................................... 9/26/1997-9/14/1998 $2,229,710 $ 1,878,240
Goldriver Hotel & Casino Finance Corp. (Liquidating
Trust)...................................................... 8/31/1992 6,000 0
Intermedia Communications Inc. (Series B) (Convertible)..... 3/04/1997-12/11/1998 3,843,528 3,843,613
TCR Holdings, Inc. (Class B)................................ 12/10/1998 1,385 1,385
TCR Holdings, Inc. (Class C)................................ 12/10/1998 711 711
TCR Holdings, Inc. (Class D)................................ 12/10/1998 1,773 1,773
TCR Holdings, Inc. (Class E)................................ 12/10/1998 4,361 4,361
Tucson Electric & Power Co.:
10.21% due 1/01/2009...................................... 6/16/1993-6/01/1998 3,287,974 3,967,105
10.732% due 1/01/2013..................................... 3/01/1993 461,050 599,510
- ---------------------------------------------------------------------------------------------------------------
TOTAL $9,836,492 $10,296,698
========== ===========
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
163
<PAGE> 165
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$571,888,337) (Note
1a)....................................................... $511,439,246
Cash........................................................ 896
Receivables:
Interest.................................................. $10,561,902
Capital shares sold....................................... 170,967
Dividends................................................. 43,126 10,775,995
-----------
Prepaid expenses and other assets........................... 40,463
------------
Total assets................................................ 522,256,600
------------
- ----------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Investment adviser (Note 2)............................... 207,392
Capital shares redeemed................................... 906 208,298
-----------
Accrued expenses and other liabilities...................... 148,681
------------
Total liabilities........................................... 356,979
------------
- ----------------------------------------------------------------------------------------
NET ASSETS.................................................. $521,899,621
============
- ----------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 5,162,376
Paid-in capital in excess of par............................ 587,486,183
Undistributed investment income--net........................ 4,498,544
Accumulated realized capital losses on investments--net
(Note 6).................................................. (12,844,071)
Accumulated distributions in excess of realized capital
gains on investments--net (Note 1d)....................... (1,954,320)
Unrealized depreciation on investments--net................. (60,449,091)
------------
NET ASSETS.................................................. $521,899,621
============
- ----------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $521,899,621 and 51,623,761
shares outstanding........................................ $ 10.11
============
- ----------------------------------------------------------------------------------------
</TABLE>
+The Fund is also authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
164
<PAGE> 166
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTE 1c):
Interest and discount earned................................ $ 53,083,737
Dividends................................................... 3,004,953
Other income................................................ 512,677
------------
Total income................................................ 56,601,367
------------
- ---------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $2,630,447
Accounting services (Note 2)................................ 117,064
Printing and shareholder reports............................ 76,416
Custodian fees.............................................. 55,229
Professional fees........................................... 32,870
Registration fees........................................... 19,198
Pricing services............................................ 13,120
Directors' fees and expenses................................ 12,392
Transfer agent fees (Note 2)................................ 5,119
Other....................................................... 6,341
----------
Total expenses.............................................. 2,968,196
------------
Investment income--net...................................... 53,633,171
------------
- ---------------------------------------------------------------------------------------
REALIZED & UNREALIZED LOSS ON INVESTMENTS--NET (NOTES 1c &
3):
Realized loss on investments--net........................... (14,546,617)
Change in unrealized depreciation on investments--net....... (58,641,664)
------------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $(19,555,110)
============
- ---------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
165
<PAGE> 167
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
----------------------------
INCREASE (DECREASE) IN NET ASSETS: 1998 1997
- ------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 53,633,171 $ 43,711,637
Realized gain (loss) on investments--net.................... (14,546,617) 8,171,656
Change in unrealized appreciation/depreciation on
investments--net.......................................... (58,641,664) (2,363,743)
------------ ------------
Net increase (decrease) in net assets resulting from
operations................................................ (19,555,110) 49,519,550
------------ ------------
- ------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1d):
Investment income--net:
Class A................................................... (53,722,935) (42,928,118)
Realized gain on investments--net:
Class A................................................... -- (972,470)
In excess of realized gain on investments--net:
Class A................................................... (1,954,320) --
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (55,677,255) (43,900,588)
------------ ------------
- ------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase in net assets derived from capital share
transactions.............................................. 43,185,871 133,712,235
------------ ------------
- ------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... (32,046,494) 139,331,197
Beginning of year........................................... 553,946,115 414,614,918
------------ ------------
End of year*................................................ $521,899,621 $553,946,115
============ ============
- ------------------------------------------------------------------------------------------
* Undistributed investment income--net (Note 1e)............ $ 4,498,544 $ 4,466,281
============ ============
- ------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
166
<PAGE> 168
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN
DERIVED FROM INFORMATION PROVIDED IN THE FINANCIAL CLASS A
STATEMENTS. ----------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1998+ 1997+ 1996+ 1995 1994
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year..................... $ 11.52 $ 11.39 $ 11.25 $ 10.61 $ 12.06
-------- -------- -------- -------- --------
Investment income--net................................. 1.05 1.05 1.08 1.09 1.05
Realized and unrealized gain (loss) on
investments--net..................................... (1.40) .14 .12 .65 (1.47)
-------- -------- -------- -------- --------
Total from investment operations....................... (.35) 1.19 1.20 1.74 (.42)
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net............................... (1.02) (1.04) (1.06) (1.10) (1.03)
Realized gain on investments--net.................... -- (.02) -- -- --
In excess of realized gain on investments--net....... (.04) -- -- -- --
-------- -------- -------- -------- --------
Total dividends and distributions...................... (1.06) (1.06) (1.06) (1.10) (1.03)
-------- -------- -------- -------- --------
Net asset value, end of year........................... $ 10.11 $ 11.52 $ 11.39 $ 11.25 $ 10.61
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share..................... (3.09%) 11.00% 11.27% 17.21% (3.59%)
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses............................................... .53% .54% .54% .55% .61%
======== ======== ======== ======== ========
Investment income--net................................. 9.52% 9.11% 9.50% 9.92% 9.73%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)................. $521,900 $553,946 $414,615 $356,352 $255,719
======== ======== ======== ======== ========
Portfolio turnover..................................... 33.63% 53.63% 48.92% 41.60% 51.88%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding.
See Notes to Financial Statements.
167
<PAGE> 169
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies, which
are not affiliated with ML & Co., for their separate accounts to fund benefits
under certain variable annuity and variable life insurance contracts. Class A
and Class B Shares have equal voting, dividend, liquidation and other rights,
except that only shares of the respective classes are entitled to vote on
matters concerning only that class and Class B Shares bear certain expenses
related to the distribution of such shares. High Current Income Fund (the
"Fund") is classified as "diversified," as defined in the Investment Company Act
of 1940. The Fund's financial statements are prepared in accordance with
generally accepted accounting principles which may require the use of management
accruals and estimates. The following is a summary of significant accounting
policies followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Short-term securities are valued at amortized cost, which approximates
market value. Securities and assets for which market quotations are not readily
available are valued at fair value as determined in good faith by or under the
direction of the Board of Directors of the Company.
(b) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required.
(c) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(d) Dividends and distributions to shareholders--Dividends from net investment
income are declared and paid monthly. Distributions from capital gains are
recorded on the ex-dividend dates. Distributions in excess of realized capital
gains are due primarily to differing tax treatments for post-October losses.
(e) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $122,027 have been reclassified between accumulated net
realized capital losses and undistributed net investment income. These
reclassifications have no effect on net assets or net asset value per share.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
based upon the aggregate daily value of net assets of the Fund and the Company's
Prime Bond Fund at the following annual rates: 0.55% of such average daily net
assets not exceeding $250 million; 0.50% of such average daily net assets in
excess of $250 million but not more than $500 million; 0.45% of such average
daily net assets in excess of $500 million but not more than $750 million; and
0.40% of such average daily net assets in excess of $750 million. For the year
ended December 31, 1998, the aggregate average daily net assets of the Fund and
Prime Bond Fund was approximately $1,121,651,000.
168
<PAGE> 170
- --------------------------------------------------------------------------------
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1998, Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("MLPF&S"), a subsidiary of ML & Co., earned $2,500 in commissions
on the execution of portfolio security transactions
For the year ended December 31, 1998, Merrill Lynch Security Pricing Service,
an affiliate of MLPF&S, earned $5,613 for providing security price quotations to
compute the Fund's net asset value.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Merrill Lynch Funds Distributor, a division of Princeton Funds Distributor,
Inc. ("PFD"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
is the Fund's distributor.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1998 were $241,032,460 and $173,825,395, respectively.
Net realized losses for the year ended December 31, 1998 and net unrealized
losses as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
Realized Unrealized
Losses Losses
- ------------------------------------------------------------------
<S> <C> <C>
Long-term investments................ $(14,546,241) $(60,449,091)
Short-term investments............... (376) --
------------ ------------
Total................................ $(14,546,617) $(60,449,091)
============ ============
- ------------------------------------------------------------------
</TABLE>
At December 31, 1998, net unrealized depreciation for Federal income tax
purposes aggregated $61,216,971, of which $14,970,919 related to appreciated
securities and $76,187,890 related to depreciated securities. At December 31,
1998, the aggregate cost of investments for Federal income tax purposes was
$572,656,217.
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions were
$43,185,871 and $133,712,235 for the years ended December 31, 1998 and December
31, 1997, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A for the Year Ended Dollar
December 31, 1998 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 6,122,173 $ 67,979,206
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 4,927,513 53,722,935
---------- ------------
Total issued......................... 11,049,686 121,702,141
Shares redeemed...................... (7,492,123) (78,516,270)
---------- ------------
Net increase......................... 3,557,563 $ 43,185,871
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 9,559,388 $109,578,509
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 3,761,677 42,928,115
---------- ------------
Total issued......................... 13,321,065 152,506,624
Shares redeemed...................... (1,644,648) (18,794,389)
---------- ------------
Net increase......................... 11,676,417 $133,712,235
========== ============
- -----------------------------------------------------------------
</TABLE>
5. CAPITAL LOSS CARRYFORWARD:
At December 31, 1998, the Fund had a net capital loss carryforward of
approximately $3,029,000, all of which expires in 2006. This amount will be
available to offset like amounts of any future taxable gains.
6. SUBSEQUENT EVENT:
On January 4, 1999, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.088651 per Class A Share, payable on January 11,
1999 to shareholders of record as of December 31, 1998.
169
<PAGE> 171
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
HIGH CURRENT INCOME FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of High Current Income Fund of Merrill Lynch
Variable Series Funds, Inc. as of December 31, 1998, the related statements of
operations for the year then ended and changes in net assets for each of the
years in the two-year period then ended, and the financial highlights for each
of the years in the five-year period then ended. These financial statements and
the financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and the
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1998 by correspondence with the custodian. An audit also includes assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of High Current Income
Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1998, the
results of its operations, the changes in its net assets, and the financial
highlights for the respective stated periods in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
170
<PAGE> 172
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
DECEMBER 31, 1998--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
FISCAL YEAR IN REVIEW
The Standard & Poor's 500 Composite (S&P 500) Index exceeded all expectations
and had another extraordinary year in 1998. The S&P 500 Index registered a total
return of +28.58% for the year ended December 31, 1998. This strong performance
occurred in spite of heightened levels of market volatility stemming from
concerns over the impact of global financial and currency crises. Such concerns
resulted in a substantial market sell-off in the summer of 1998. However, three
interest rate cuts by the US Federal Reserve Board in late September,
mid-October, and mid-November prompted an explosive fourth-quarter rally,
resulting in an unprecedented fourth consecutive year with an annual return in
excess of 20%. Despite the narrowness of the gains within the Index's universe
of component stocks, which were centered around its largest capitalization
growth stocks, the total return for the year created the Index's best five years
in its recorded history from 1926, and its best ten-year period since 1959. In
addition, 1998 became the eighth straight year in which the Index had a positive
total return. For the three-year and five-year periods ended December 31, 1998,
the S&P 500 had compound annual returns of +28.23% and +24.05%, respectively.
The third quarter of 1998 followed a strong first half, where May was the only
negative return month. However, after reaching another all-time high of 1,186.75
on July 17, 1998, renewed concerns regarding Asia combined with weakening
earnings prospects for domestic companies and sent the S&P 500 on a rapid
descent through the end of the month. By July 31, 1998, the Index had dropped
more than 66 points, finishing July at a level of 1,120.67. Fear of the
spreading economic crisis in many emerging markets of the world gripped
financial markets in the United States, as extreme levels of volatility
continued throughout August. During that month, the S&P 500 Index suffered its
worst one-month decline since October 1987, and its ninth-largest one-month
decline since 1929. The S&P 500 Index declined by 14.58% in August, culminated
by a 70-point drop on August 31, 1998. This brought the Index back to 957.28,
nearly 230 points off its peak of July 17, marking its first close below 1,000
since January 30, 1998. The month of September began with a strong rally as the
Index gained nearly 37 points on the first day of the month, retracing a good
part of its losses on the prior day. Extreme levels of volatility continued
throughout the month, with gains or losses of 20 to 30 points becoming
commonplace. Overall, the Index produced a strong gain of 6.24% during
September, but the month was capped-off by a 32-point drop on the last day of
trading. This was investors' response to the Federal Reserve Board's 25 basis
point reduction (0.25%) in the Federal Funds rate on the prior day, which was
viewed at that time as inadequate. The Index finished the third quarter at
1,017.01, with a total return for the three-month period ended September 30,
1998 of -9.95%.
Despite the increasing turmoil of financial markets throughout the world, it
was once again the largest-capitalization multinational stocks in the United
States that fared better than other capitalization groups throughout the summer
decline. One more round of selling hit the equity market during early October as
the S&P 500 Index lost nearly 100 points in the first two weeks of the month,
reflecting continued investor uncertainty. By October 8, 1998, the S&P 500 Index
had declined to 959.44, just two points above the low of August 31. This formed
the base of a powerful rally as the Federal Reserve Board surprised investors
with an additional interest rate cut on October 15, which catapulted the S&P 500
Index to a 42-point rise that day. Coordinated interest rate cuts by central
banks around the world boosted equity markets globally, and created the backdrop
for an extended seven-week advance off the October lows. Investors displayed
renewed confidence in the Federal Reserve Board's ability to manage the global
economic crisis after it reduced interest rates for a third time on November 17,
1998. This momentum carried the S&P 500 Index back to record-breaking territory
by the end of November. Following a brief pause in the market's advance during
the first two weeks of December, the Index gained an additional 90 points to
reach a new all-time high of 1,231.93 by December 30, 1998. Overall, the
tumultuous summer decline was more than entirely reversed during the fourth
quarter of 1998, as the S&P 500 Index posted a 270-point advance between early
October and the end of the year.
For the year ended December 31, 1998, the Fund's Class A Shares had a total
return of +28.28%, compared to the unmanaged S&P 500 Index's total return of
+28.58% for the same 12-month period. The Fund's objective is to provide
investment results that correspond to the aggregate price and yield performance
(before expenses) of the S&P 500 Index. The cumulative tracking deviation of the
Fund's
171
<PAGE> 173
- --------------------------------------------------------------------------------
Class A Shares for the year relative to the total return of the S&P 500 was
- -0.30%.
Net assets of the Fund grew from $215.23 million on December 31, 1997 to
$403.22 million by December 31, 1998, as the Fund continued to experience
consistently positive daily net cash inflows during the second half of the year.
Nearly all of the Fund's assets are held in the form of a fully replicating
portfolio of all 500 stocks in the Index. Incremental cash inflows are typically
invested through the use of S&P 500 futures contracts. As the inventory of
futures contracts increases, the Fund looks for opportune times to swap out of
its holdings of futures contracts and replace them with incremental positions of
all 500 stocks in the Index. At December 31, 1998, the Fund's equity portfolio
was valued at $396.47 million, and the Fund held a long position of 21 S&P 500
March 1999 futures contracts. Through its holdings of equities and futures
contracts, it is the Fund's goal to be 100% invested in the S&P 500 Index at all
times.
A number of new equity positions were added to the Fund during the second half
of 1998, as Standard & Poor's revised the constituents of the Index. Such
activity typically results from mergers and acquisitions involving constituents
of the Index, which continued at a rapid pace throughout the second half of
1998. In this period, the Fund added the following equities to the portfolio:
Fred Meyer, Inc., Dollar General Corporation, Electronic Data Systems
Corporation, Kohl's Corporation, Regions Financial Corporation, Provident
Companies, Inc., RJR Nabisco Holdings Corp., HCR Manor Care, Inc., BMC Software,
Inc., Union Planters Corporation, AES Corporation, PeopleSoft, Inc., Paychex,
Inc., Coca-Cola Enterprises Inc., Staples, Inc., Danaher Corporation, New
Century Energies, Inc., Safeway Inc., Sprint Corporation (PCS Group), Carnival
Corporation, Solectron Corporation, Compuware Corporation, Firstar Corporation
and America Online, Inc.
IN CONCLUSION
We appreciate your investment in Index 500 Fund of Merrill Lynch Variable
Series Funds, Inc., and we look forward to assisting you with your investment
needs in the months and years ahead.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Eric S. Mitofsky
Eric S. Mitofsky
Senior Vice President and Portfolio Manager
February 5, 1999
172
<PAGE> 174
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
Index 500 Fund
Total Return Based on a $10,000 Investment-Class A Shares
A line graph depicting the growth of an investment in the Fund's Class A
Shares compared to growth of an investment in the S&P 500 Index.
Beginning and ending values are:
<TABLE>
<CAPTION>
12/13/96** 12/98
---------- -----
<S> <C> <C>
Index 500 Fund+--
Class A Shares* $10,000 $17,324
S&P 500 Index++ $10,000 $17,446
</TABLE>
* Assuming transaction costs and other operating expenses, including advisory
fees. Does not include insurance-related fees and expenses.
** Commencement of operations.
+ The Fund may invest in all 500 stocks in the S&P 500 Index in approximately
the same proportions as in the S&P 500 Index, in a statistically selected
sample of the 500 stocks in the S&P 500 Index, or in related options and
futures contracts.
++ This unmanaged market-weighted Index is comprised of 500 common stocks issued
by companies in a wide range of businesses and which collectively represent a
substantial portion of all common stocks publicly traded in the United States.
Past performance is not predictive of future performance.
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/98 +28.28%
- --------------------------------------------------------------------------------
Inception (12/13/96) to 12/31/98 +30.76
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
RECENT PERFORMANCE RESULTS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
12 MONTH 6 MONTH
TOTAL RETURN TOTAL RETURN
- --------------------------------------------------------------------------------
<S> <C> <C>
Class A Shares +28.28% +9.16%
- --------------------------------------------------------------------------------
</TABLE>
* Total investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the ex-dividend date. Insurance-related fees
and expenses are not reflected in these returns. Past results shown should not
be considered a representation of future performance.
173
<PAGE> 175
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (Note 1a)
- ------------------------------------------------------
<S> <C> <C>
+3Com Corporation.............. 14,221 $ 637,279
+The AES Corporation........... 7,148 338,637
ALLTEL Corporation............. 10,839 648,308
+ALZA Corporation.............. 3,422 178,799
AMP Incorporated............... 8,673 451,538
+AMR Corporation............... 7,203 427,678
ASARCO Incorporated............ 1,572 23,678
+AT&T Corp. ................... 71,581 5,386,470
Abbott Laboratories............ 60,162 2,947,938
Adobe Systems Incorporated..... 2,637 123,280
Adolph Coors Company........... 1,438 81,157
+Advanced Micro Devices,
Inc. ........................ 5,739 166,072
Aeroquip-Vickers, Inc. ........ 1,108 33,171
Aetna Inc. .................... 5,667 445,568
Air Products and Chemicals,
Inc. ........................ 9,171 366,840
+Airtouch Communications,
Inc. ........................ 22,678 1,635,651
Alberto-Culver Company (Class
B)........................... 2,184 58,285
Albertson's, Inc. ............. 9,726 619,425
Alcan Aluminium Ltd............ 9,008 243,779
Allegheny Teledyne
Incorporated................. 7,762 158,636
Allergan Inc. ................. 2,584 167,314
AlliedSignal Inc. ............. 22,242 985,599
The Allstate Corporation....... 32,526 1,256,317
Aluminum Co. of America........ 7,277 542,591
Amerada Hess Corporation....... 3,605 179,349
Ameren Corporation............. 5,425 231,580
+America Online, Inc. ......... 16,985 2,713,233
American Electric Power
Company, Inc. ............... 7,541 354,898
American Express Company....... 17,922 1,832,524
American General Corporation... 10,030 782,340
American Greetings Corporation
(Class A).................... 2,799 114,934
American Home Products
Corporation.................. 52,249 2,942,272
American International Group,
Inc. ........................ 41,623 4,021,822
American Stores Company........ 10,878 401,806
Ameritech Corporation.......... 43,735 2,771,706
+Amgen Inc. ................... 10,063 1,052,212
Anadarko Petroleum
Corporation.................. 4,736 146,224
+Andrew Corporation............ 3,412 56,298
Anheuser-Busch Companies,
Inc. ........................ 18,946 1,243,331
Aon Corporation................ 6,742 373,338
Apache Corporation............. 3,904 98,820
+Apple Computer, Inc. ......... 5,336 218,442
+Applied Materials, Inc. ...... 14,650 625,372
Archer-Daniels-Midland
Company...................... 23,518 404,216
Armstrong World Industries,
Inc. ........................ 1,586 95,656
+Ascend Communications,
Inc. ........................ 8,552 562,294
Ashland Inc. .................. 3,008 145,512
Associates First Capital
Corporation (Class A)........ 28,648 1,213,959
Atlantic Richfield Company..... 12,709 829,262
Autodesk, Inc. ................ 1,863 79,527
Automatic Data Processing,
Inc. ........................ 11,976 960,325
+AutoZone, Inc. ............... 6,027 198,514
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (Note 1a)
- ------------------------------------------------------
<S> <C> <C>
Avery Dennison Corporation..... 4,638 $ 209,000
Avon Products, Inc. ........... 10,437 461,837
BB&T Corporation............... 11,661 470,084
The B.F. Goodrich Company...... 2,947 105,724
+BMC Software, Inc. ........... 8,544 380,742
Baker Hughes Incorporated...... 12,960 229,230
Ball Corporation............... 1,200 54,900
Baltimore Gas and Electric
Company...................... 5,892 181,915
The Bank of New York Company,
Inc. ........................ 30,154 1,213,699
Bank One Corporation........... 46,421 2,370,372
BankAmerica Corporation........ 68,607 4,124,996
BankBoston Corporation......... 11,631 452,882
Bankers Trust Corporation...... 3,811 325,602
Barrick Gold Corporation....... 14,765 287,917
Battle Mountain Gold Company... 9,106 37,562
Bausch & Lomb Incorporated..... 2,189 131,340
Baxter International Inc. ..... 11,310 727,374
The Bear Stearns Companies
Inc. ........................ 4,505 168,374
Becton, Dickinson and Company.. 9,797 418,209
Bell Atlantic Corporation...... 61,541 3,496,298
BellSouth Corporation.......... 77,524 3,866,509
Bemis Company, Inc. ........... 2,083 79,024
+Berkshire Hathaway Inc. (Class
B)........................... 1 1,856
Bestfoods...................... 11,328 603,216
+Bethlehem Steel Corporation... 5,136 43,014
Biomet, Inc. .................. 4,411 177,543
The Black & Decker
Corporation.................. 3,482 195,210
The Boeing Co.................. 39,608 1,292,211
Boise Cascade Corporation...... 2,205 68,355
+Boston Scientific
Corporation.................. 15,576 417,631
Briggs & Stratton
Corporation.................. 956 47,680
Bristol-Myers Squibb Company... 39,418 5,274,621
Brown-Forman Corporation....... 2,722 206,021
Browning Ferris................ 6,886 195,821
Brunswick Corporation.......... 3,808 94,248
Burlington Northern Santa Fe
Corp. ....................... 18,596 627,615
Burlington Resources Inc. ..... 6,988 250,258
CBS Corporation................ 27,992 916,738
CIGNA Corporation.............. 8,185 632,803
COMPAQ Computer
Corporation.................. 67,391 2,826,210
C.R. Bard, Inc. ............... 2,125 105,188
CSX Corporation................ 8,644 358,726
CVS Corporation................ 15,429 848,595
+Cabletron Systems, Inc. ...... 6,515 54,563
Campbell Soup Company.......... 17,795 978,725
Capital One Financial
Corporation.................. 2,606 299,690
Cardinal Health, Inc. ......... 7,957 603,737
Carnival Corporation (Class
A)........................... 23,670 1,136,160
Carolina Power & Light
Company...................... 5,971 281,010
Case Corporation............... 2,888 62,994
Caterpillar Inc. .............. 14,219 654,074
+Cendant Corporation........... 33,818 644,656
Centex Corporation............. 2,350 105,897
</TABLE>
174
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (Note 1a)
- ------------------------------------------------------
<S> <C> <C>
Central and South West
Corporation.................. 8,407 $ 230,667
+Ceridian Corporation.......... 2,868 200,222
Champion International
Corporation.................. 3,786 153,333
The Charles Schwab
Corporation.................. 15,857 890,965
The Chase Manhattan
Corporation.................. 33,529 2,282,068
Chevron Corporation............ 25,904 2,148,413
The Chubb Corporation.......... 6,459 419,028
Cincinnati Financial
Corporation.................. 6,604 241,871
Cinergy Corp. ................. 6,283 215,978
Circuit City Stores--Circuit
City Group................... 3,963 197,902
+Cisco Systems, Inc. .......... 62,597 5,809,784
Citigroup Inc. ................ 90,065 4,458,217
+Clear Channel Communications,
Inc. ........................ 10,441 569,034
Clorox Company................. 4,087 477,413
The Coastal Corporation........ 8,425 294,348
The Coca-Cola Company.......... 97,702 6,533,821
Coca-Cola Enterprises Inc. .... 15,537 555,448
Colgate-Palmolive Company...... 11,608 1,078,093
Columbia Energy Group.......... 3,277 189,247
Columbia/HCA Healthcare
Corporation.................. 25,573 632,932
Comcast Corporation (Class A).. 14,604 857,072
Comerica Incorporated.......... 6,160 420,035
Computer Associates
International, Inc. ......... 21,338 909,532
+Computer Sciences
Corporation.................. 6,258 403,250
+Compuware Corporation......... 6,470 505,469
ConAgra, Inc. ................. 19,398 611,037
Conseco, Inc. ................. 12,465 380,962
Consolidated Edison, Inc. ..... 9,266 489,940
Consolidated Natural Gas
Company...................... 3,758 202,932
+Consolidated Stores
Corporation.................. 4,333 87,472
Cooper Industries, Inc. ....... 4,101 195,566
Cooper Tire & Rubber Company... 3,005 61,415
Corning Incorporated........... 9,155 411,975
+Costco Companies, Inc. ....... 8,540 616,481
Countrywide Credit Industries,
Inc. ........................ 4,400 220,825
Crane Co. ..................... 2,718 82,050
Crestar Financial
Corporation.................. 4,452 320,544
Crown Cork & Seal Company,
Inc. ........................ 4,850 149,441
Cummins Engine Company, Inc. .. 1,661 58,965
Cyprus Amax Minerals Company... 3,605 36,050
DTE Energy Company............. 5,738 246,017
Dana Corporation............... 6,530 266,914
Danaher Corporation............ 5,302 287,965
Darden Restaurants, Inc. ...... 5,516 99,288
+Data General Corporation...... 1,944 31,954
Dayton Hudson Corporation...... 17,399 943,896
Deere & Company................ 9,455 313,197
+Dell Computer Corporation..... 50,485 3,694,871
Delta Air Lines, Inc. ......... 5,655 294,060
Deluxe Corporation............. 3,201 117,037
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (Note 1a)
- ------------------------------------------------------
<S> <C> <C>
Dillard's, Inc. ............... 4,234 $ 120,140
Dollar General Corporation..... 7,322 172,982
Dominion Resources, Inc. ...... 7,746 362,125
Dover Corporation.............. 8,809 322,630
The Dow Chemical Company....... 8,774 797,886
Dow Jones & Company, Inc. ..... 3,688 177,485
du Pont (E.I.) de Nemours and
Company...................... 44,631 2,368,232
Duke Energy Corporation........ 14,309 916,670
Dun & Bradstreet Corporation... 6,624 209,070
EG & G, Inc. .................. 1,821 50,647
+EMC Corporation............... 19,894 1,690,990
Eastern Enterprises............ 887 38,806
Eastman Chemical Company....... 3,133 140,202
Eastman Kodak Company.......... 12,842 924,624
Eaton Corporation.............. 2,829 199,975
Ecolab Inc. ................... 5,107 184,810
Edison International........... 14,014 390,640
Electronic Data Systems
Corporation.................. 19,534 981,583
Eli Lilly and Company.......... 43,643 3,878,772
Emerson Electric Co. .......... 17,454 1,091,966
Engelhard Corporation.......... 5,697 111,091
Enron Corporation.............. 13,111 748,146
Entergy Corporation............ 9,759 303,749
Equifax Inc. .................. 5,856 200,202
Exxon Corporation++............ 96,379 7,047,714
+FDX Corporation............... 5,813 517,357
+FMC Corporation............... 1,311 73,416
FPL Group, Inc. ............... 7,181 442,529
Federal Home Loan Mortgage
Corp......................... 26,876 1,731,822
Federal National Mortgage
Association.................. 41,068 3,039,032
+Federated Department Stores,
Inc. ........................ 8,123 353,858
Fifth Third Bancorp............ 10,616 757,053
First Data Corporation......... 17,547 556,021
First Union Corporation........ 39,276 2,388,472
Firstar Corporation............ 8,090 754,392
FirstEnergy Corp. ............. 9,395 305,925
Fleet Financial Group, Inc. ... 22,501 1,005,513
Fleetwood Enterprises, Inc. ... 1,364 47,399
Fluor Corporation.............. 3,004 127,858
Ford Motor Company............. 48,015 2,817,880
Fort James Corporation......... 8,730 349,200
Fortune Brands, Inc. .......... 6,779 214,386
Foster Wheeler Corporation..... 1,605 21,166
Franklin Resources, Inc. ...... 10,009 320,288
+Fred Meyer, Inc. ............. 6,124 368,971
Freeport-McMoRan Copper & Gold,
Inc. (Class B)............... 6,562 68,491
Frontier Corporation........... 6,780 230,520
+Fruit of the Loom, Inc. (Class
A)........................... 2,848 39,338
GPU, Inc. ..................... 5,065 223,810
GTE Corporation................ 38,259 2,580,091
Gannett Co., Inc. ............. 11,163 738,851
The Gap, Inc. ................. 22,972 1,292,175
+Gateway 2000, Inc. ........... 6,196 317,158
</TABLE>
175
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (Note 1a)
- ------------------------------------------------------
<S> <C> <C>
General Dynamics Corporation... 5,023 $ 294,473
General Electric Company++..... 129,901 13,258,021
+General Instrument
Corporation.................. 6,595 223,818
General Mills, Inc. ........... 6,063 471,398
General Motors Corporation..... 25,924 1,855,186
Genuine Parts Company.......... 7,131 238,443
Georgia-Pacific Group.......... 3,488 204,266
Gillette Company............... 43,975 2,124,542
Golden West Financial
Corporation.................. 2,260 207,214
The Goodyear Tire & Rubber
Company...................... 6,221 313,772
The Great Atlantic & Pacific
Tea Company, Inc. ........... 1,510 44,734
Great Lakes Chemical
Corporation.................. 2,341 93,640
Guidant Corporation............ 5,976 658,854
H & R Block, Inc. ............. 3,986 179,370
HBO & Company.................. 18,433 528,797
+HCR Manor Care, Inc. ......... 4,394 129,074
+HEALTHSOUTH Corporation....... 16,747 258,532
H.J. Heinz Company............. 14,348 812,456
Halliburton Company............ 17,429 516,334
Harcourt General, Inc. ........ 2,802 149,031
Harnischfeger Industries,
Inc. ........................ 1,893 19,285
+Harrah's Entertainment,
Inc. ........................ 3,996 62,687
Harris Corporation............. 3,161 115,772
The Hartford Financial Services
Group, Inc. ................. 9,250 507,594
Hasbro, Inc. .................. 5,212 188,283
Helmerich & Payne, Inc. ....... 1,975 38,266
Hercules Incorporated.......... 3,987 109,144
Hershey Foods Corporation...... 5,664 352,230
Hewlett-Packard Company........ 41,113 2,808,532
Hilton Hotels Corporation...... 10,314 197,255
The Home Depot, Inc. .......... 61,965 3,791,483
Homestake Mining Company....... 9,443 86,758
Honeywell Inc. ................ 4,999 376,487
Household International,
Inc. ........................ 19,139 758,383
Houston Industries
Incorporated................. 11,277 362,274
+Humana Inc. .................. 6,592 117,420
Huntington Bancshares
Incorporated................. 8,379 251,894
IKON Office Solutions, Inc. ... 5,361 45,903
IMS Health Incorporated........ 6,349 478,953
ITT Industries, Inc. .......... 4,114 163,531
Illinois Tool Works Inc. ...... 9,875 572,750
Inco Limited................... 6,574 69,438
Ingersoll-Rand Company......... 6,549 307,394
Intel Corporation.............. 66,083 7,834,966
International Business Machines
Corporation.................. 36,975 6,831,131
International Flavors &
Fragrances Inc. ............. 4,248 187,708
International Paper Company.... 12,176 545,637
The Interpublic Group of
Companies, Inc. ............. 5,510 439,423
J.P. Morgan & Co.,
Incorporated................. 6,930 728,083
Jefferson - Pilot
Corporation.................. 4,204 315,300
Johnson & Johnson.............. 53,267 4,467,770
Johnson Controls, Inc. ........ 3,350 197,650
Jostens, Inc. ................. 1,401 36,689
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (Note 1a)
- ------------------------------------------------------
<S> <C> <C>
+KLA-Tencor Corporation........ 3,440 $ 149,210
Kaufman and Broad Home
Corporation.................. 1,536 44,160
Kellogg Company................ 16,067 548,286
Kerr-McGee Corporation......... 1,892 72,369
KeyCorp........................ 18,045 577,440
Kimberly-Clark Corporation..... 21,481 1,170,715
+King World Productions,
Inc. ........................ 2,900 85,369
+Kmart Corporation............. 19,511 298,762
Knight-Ridder, Inc. ........... 3,123 159,663
+Kohl's Corporation............ 6,260 384,599
+The Kroger Co. ............... 10,140 613,470
+LSI Logic Corporation......... 5,576 89,913
Laidlaw Inc. .................. 13,069 131,507
Lehman Brothers Holdings,
Inc. ........................ 4,598 202,599
The Limited, Inc............... 8,989 261,805
Lincoln National Corporation... 3,979 325,532
Liz Claiborne, Inc. ........... 2,560 80,800
Lockheed Martin Corporation.... 7,744 656,304
Loews Corporation.............. 4,546 446,644
Longs Drug Stores
Corporation.................. 1,538 57,675
Louisiana-Pacific
Corporation.................. 4,315 79,018
Lowe's Companies, Inc. ........ 13,940 713,554
Lucent Technologies Inc. ...... 52,110 5,732,100
MBIA, Inc. .................... 3,933 257,857
MBNA Corporation............... 29,802 743,187
+MCI WorldCom, Inc. ........... 72,681 5,214,862
MGIC Investment Corporation.... 4,341 172,826
Mallinckrodt Inc. ............. 2,828 87,138
Marriott International, Inc.
(Class A).................... 9,912 287,448
Marsh & McLennan Companies,
Inc. ........................ 10,200 596,062
Masco Corporation.............. 13,465 387,119
Mattel, Inc. .................. 11,402 260,108
The May Department Stores
Company...................... 9,261 559,133
Maytag Corporation............. 3,567 222,046
McDermott International,
Inc. ........................ 2,346 57,917
McDonald's Corporation......... 26,820 2,055,082
The McGraw-Hill Companies,
Inc. ........................ 3,930 400,369
The Mead Corporation........... 4,114 120,592
+MediaOne Group, Inc. ......... 24,059 1,130,773
Medtronic, Inc. ............... 19,439 1,443,346
Mellon Bank Corporation........ 10,305 708,469
Mercantile Bancorporation
Inc. ........................ 6,238 287,728
Merck & Co., Inc. ............. 47,193 6,969,816
Meredith Corporation........... 2,092 79,234
Merrill Lynch & Co., Inc.++ ... 14,062 938,638
+Micron Technology, Inc. ...... 8,425 425,989
+Microsoft Corporation++....... 98,850 13,709,259
Milacron Inc. ................. 1,554 29,914
Millipore Corporation.......... 1,717 48,827
Minnesota Mining and
Manufacturing Company........ 15,910 1,131,599
+Mirage Resorts,
Incorporated................. 7,106 106,146
Mobil Corporation.............. 30,947 2,696,257
Monsanto Company............... 24,836 1,179,710
Moore Corporation Ltd. ........ 3,488 38,368
</TABLE>
176
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (Note 1a)
- ------------------------------------------------------
<S> <C> <C>
Morgan Stanley Dean Witter &
Co. ......................... 22,900 $ 1,625,900
Morton International, Inc. .... 4,810 117,845
Motorola, Inc. ................ 23,792 1,452,799
NACCO Industries, Inc. (Class
A)........................... 322 29,624
NICOR, Inc. ................... 1,892 79,937
Nalco Chemical Company......... 2,611 80,941
National City Corporation...... 13,112 950,620
+National Semiconductor
Corporation.................. 6,587 88,925
National Service Industries,
Inc. ........................ 1,642 62,396
+Navistar International
Corporation.................. 2,658 75,753
New Century Energies, Inc. .... 4,531 220,886
+The New York Times Company
(Class A).................... 7,229 250,756
Newell Co. .................... 6,444 265,815
Newmont Mining Corporation..... 6,601 119,231
+Nextel Communications,
Inc. ........................ 11,396 269,230
Niagara Mohawk Power
Corporation.................. 7,402 119,357
Nike, Inc. (Class B)........... 11,394 462,169
Nordstrom, Inc. ............... 5,896 204,517
Norfolk Southern Corporation... 14,999 475,281
Northern States Power Company.. 6,049 167,860
Northern Telecom Limited....... 25,843 1,295,380
Northern Trust Corporation..... 4,411 385,135
Northrop Grumman Corporation... 2,728 199,485
+Novell, Inc. ................. 14,005 253,841
Nucor Corporation.............. 3,473 150,207
ONEOK, Inc. ................... 1,216 43,928
Occidental Petroleum
Corporation.................. 13,713 231,407
Omnicom Group Inc. ............ 6,726 390,108
+Oracle Corporation............ 38,556 1,662,727
+Oryx Energy Company........... 4,204 56,491
Owens Corning.................. 2,137 75,730
+Owens-Illinois, Inc. ......... 6,156 188,527
PACCAR Inc. ................... 3,095 127,282
PECO Energy Company............ 8,882 369,713
PG&E Corporation............... 15,138 476,847
PNC Bank Corp. ................ 11,913 644,791
PP&L Resources, Inc. .......... 5,962 166,191
PPG Industries, Inc. .......... 7,014 408,565
PacifiCorp. ................... 11,773 247,969
Pall Corporation............... 4,914 124,386
+Parametric Technology
Corporation.................. 10,788 176,654
Parker-Hannifin Corporation.... 4,318 141,415
Paychex, Inc. ................. 6,481 333,366
Penney (J.C.) Company, Inc. ... 10,029 470,109
Peoples Energy Corporation..... 1,384 55,187
+ PeopleSoft, Inc. ............ 9,237 174,926
The Pep Boys--Manny, Moe &
Jack......................... 2,505 39,297
PepsiCo, Inc. ................. 58,164 2,381,089
The Perkin-Elmer Corporation... 1,944 189,662
Pfizer Inc. ................... 51,447 6,453,383
Pharmacia & Upjohn, Inc. ...... 20,120 1,139,295
Phelps Dodge Corporation....... 2,326 118,335
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (Note 1a)
- ------------------------------------------------------
<S> <C> <C>
Philip Morris Companies
Inc.++....................... 96,515 $ 5,163,553
Phillips Petroleum Company..... 10,094 430,257
Pioneer Hi-Bred International,
Inc. ........................ 9,574 258,498
Pitney Bowes, Inc. ............ 10,840 716,118
Placer Dome Inc. .............. 9,902 113,873
Polaroid Corporation........... 1,748 32,666
Potlatch Corporation........... 1,140 42,038
Praxair, Inc. ................. 6,268 220,947
The Procter & Gamble Company... 52,598 4,802,855
The Progressive Corporation.... 2,838 480,686
Provident Companies, Inc. ..... 5,356 222,274
Providian Financial
Corporation.................. 5,649 423,675
Public Service Enterprise Group
Incorporated................. 9,047 361,880
Pulte Corporation.............. 1,708 47,504
Quaker Oats Company............ 5,402 321,419
RJR Nabisco Holdings Corp. .... 12,865 381,930
R.R. Donnelley & Sons Company.. 5,384 235,887
Ralston-Ralston Purina Group... 12,373 400,576
Raychem Corporation............ 3,135 101,300
Raytheon Company (Class B)..... 13,358 711,314
+Reebok International Ltd...... 2,209 32,859
Regions Financial
Corporation.................. 8,767 353,420
Republic New York Corporation.. 4,276 194,825
Reynolds Metals Company........ 2,555 134,617
+Rio Hotel & Casino, Inc. ..... 976 15,494
Rite Aid Corporation........... 10,214 506,231
Rockwell International
Corporation.................. 7,577 367,958
Rohm and Haas Company.......... 6,600 198,825
+Rowan Companies, Inc. ........ 3,323 33,230
Royal Dutch Petroleum Company
(NY Registered Shares)....... 84,961 4,067,508
Rubbermaid Incorporated........ 5,924 186,236
Russell Corporation............ 1,436 29,169
Ryder Systems, Inc. ........... 2,841 73,866
SAFECO Corporation............. 5,401 231,905
SBC Communications Inc. ....... 77,564 4,159,370
SLM Holding Corporation........ 6,569 315,312
SUPERVALU INC.................. 4,756 133,168
SYSCO Corporation.............. 13,244 363,382
+Safeway Inc. ................. 19,274 1,174,509
Sara Lee Corporation........... 36,210 1,020,669
Schering-Plough Corporation.... 58,258 3,218,755
Schlumberger Limited........... 21,641 998,191
Scientific-Atlanta, Inc. ...... 2,970 67,753
+Seagate Technology, Inc. ..... 9,722 294,091
The Seagram Company Ltd........ 15,611 593,218
+Sealed Air Corporation........ 3,292 168,098
Sears, Roebuck and Co. ........ 15,187 645,448
Sempra Energy.................. 9,542 242,128
Service Corporation
International................ 10,194 388,009
Shared Medical Systems
Corporation.................. 1,011 50,424
The Sherwin-Williams
Company...................... 6,851 201,248
Sigma-Aldrich Corporation...... 3,983 117,001
</TABLE>
177
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (Note 1a)
- ------------------------------------------------------
<S> <C> <C>
+Silicon Graphics, Inc. ....... 7,478 $ 96,279
Snap-On Incorporated........... 2,342 81,531
+Solectron Corporation......... 4,660 433,089
Sonat Inc. .................... 4,360 117,993
The Southern Company........... 27,620 802,706
Southwest Airlines Co. ........ 13,306 298,553
Spring Industries, Inc. (Class
A)........................... 732 30,332
Sprint Corporation (Fon
Group)....................... 17,075 1,436,434
Sprint Corporation (PCS
Group)....................... 16,467 380,799
+St. Jude Medical, Inc. ....... 3,326 92,089
The St. Paul Companies, Inc.... 9,356 325,121
The Stanley Works.............. 3,518 97,625
+Staples, Inc. ................ 12,349 539,497
State Street Corporation....... 6,357 442,209
Summit Bancorp................. 6,887 300,876
+Sun Microsystems, Inc. ....... 15,087 1,291,824
SunAmerica, Inc. .............. 8,606 698,162
Sunoco, Inc. .................. 3,705 133,612
SunTrust Banks, Inc. .......... 8,277 633,191
Synovus Financial Corp. ....... 10,596 258,278
The TJX Companies, Inc. ....... 12,772 370,388
TRW Inc. ...................... 4,747 266,722
Tandy Corporation.............. 3,924 161,620
Tektronix, Inc. ............... 1,850 55,616
+Tele-Communications, Inc.
(Class A).................... 21,326 1,179,594
+Tellabs, Inc. ................ 7,661 525,257
Temple-Inland, Inc. ........... 2,203 130,665
+Tenet Healthcare
Corporation.................. 12,274 322,193
Tenneco Inc. .................. 6,723 229,002
Texaco Inc. ................... 21,235 1,122,801
Texas Instruments
Incorporated................. 15,454 1,322,283
Texas Utilities Company........ 11,192 522,527
Textron, Inc. ................. 6,281 476,963
+Thermo Electron Corp. ........ 6,297 106,655
Thomas & Betts Corporation..... 2,248 97,367
Time Warner, Inc. ............. 48,640 3,018,720
The Times Mirror Company (Class
A)........................... 3,155 176,680
The Timken Company............. 2,470 46,621
Torchmark Corporation.......... 5,544 195,773
+Toys "R" Us, Inc. ............ 10,353 174,707
Transamerica Corporation....... 2,480 286,440
Tribune Company................ 4,708 310,728
+Tricon Global Restaurants,
Inc. ........................ 6,043 302,905
Tupperware Corporation......... 2,288 37,609
Tyco International Ltd. ....... 25,532 1,926,070
U S West, Inc. ................ 19,921 1,287,395
UNUM Corporation............... 5,475 319,603
+US Airways Group, Inc. ....... 3,464 180,128
U.S. Bancorp................... 28,769 1,021,300
UST Inc. ...................... 7,372 257,099
USX-Marathon Group............. 12,185 367,073
USX-U.S. Steel Group........... 3,491 80,293
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (Note 1a)
- ------------------------------------------------------
<S> <C> <C>
Unicom Corporation............. 8,590 $ 331,252
Unilever N.V. (NY Registered
Shares)...................... 25,353 2,102,714
Union Camp Corporation......... 2,747 185,423
Union Carbide Corporation...... 5,268 223,890
Union Pacific Corporation...... 9,781 440,756
Union Pacific Resources Group
Inc. ........................ 9,944 90,118
Union Planters Corporation..... 5,394 244,416
+Unisys Corporation............ 10,078 347,061
United HealthCare
Corporation.................. 7,383 317,930
United Technologies
Corporation.................. 8,952 973,530
Unocal Corporation............. 9,558 278,974
V. F. Corporation.............. 4,754 222,844
+Viacom, Inc. (Class B)........ 13,789 1,020,386
+W.R. Grace & Co. ............. 2,914 45,713
W. W. Grainger, Inc. .......... 3,764 156,676
Wachovia Corporation........... 8,037 702,735
Wal-Mart Stores, Inc. ......... 89,308 7,273,020
Walgreen Co. .................. 19,770 1,157,781
The Walt Disney Company........ 81,184 2,435,520
Warner-Lambert Company......... 32,531 2,445,925
Washington Mutual, Inc. ....... 23,479 896,604
Waste Management, Inc. ........ 22,769 1,061,605
Wells Fargo Company............ 64,091 2,559,634
Wendy's International, Inc. ... 4,933 107,601
Westvaco Corporation........... 4,014 107,625
Weyerhaeuser Company........... 7,886 400,707
Whirlpool Corporation.......... 2,991 165,627
Willamette Industries, Inc. ... 4,395 147,233
The Williams Companies, Inc.... 16,958 528,878
Winn-Dixie Stores, Inc. ....... 5,886 264,134
Worthington Industries,
Inc. ........................ 3,666 45,825
Wrigley (Wm.) Jr. Company...... 4,591 411,181
Xerox Corporation.............. 12,999 1,533,882
- ------------------------------------------------------
TOTAL COMMON STOCKS
(COST--$311,095,993)--98.3% 396,470,512
- ------------------------------------------------------
</TABLE>
<TABLE>
<S> <C> <C>
SHORT-TERM OBLIGATIONS-- FACE
COMMERCIAL PAPER* AMOUNT
- ------------------------------------------------------
General Motors Acceptance
Corp., 5.13% due
1/04/1999................ $ 8,438,000 8,434,393
- ------------------------------------------------------
TOTAL SHORT-TERM
OBLIGATIONS
(COST--$8,434,393)--2.1% 8,434,393
- ------------------------------------------------------
TOTAL INVESTMENTS (COST--
$319,530,386)--100.4%...... 404,904,905
VARIATION MARGIN ON
FINANCIAL FUTURES
CONTRACTS**--0.0%........ 12,414
LIABILITIES IN EXCESS OF
OTHER ASSETS--(0.4%)..... (1,699,906)
------------
NET ASSETS--100.0%......... $403,217,413
============
</TABLE>
- --------------------------------------------------------------------------------
* Commercial Paper is traded on a discount basis; the interest rate shown
reflects the discount rate paid at the time of purchase by the Fund.
178
<PAGE> 180
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED)
- --------------------------------------------------------------------------------
** Financial futures contracts purchased as of December 31, 1998 were as
follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------
NUMBER OF EXPIRATION VALUE
CONTRACTS ISSUE DATE (NOTES 1A & 1B)
- ------------------------------------------------------------
<S> <C> <C> <C>
21 S&P 500 Stock Index March 1999 $6,538,875
- ------------------------------------------------------------
TOTAL FINANCIAL FUTURES CONTRACTS PURCHASED
(CONTRACT PRICE--$6,433,566) $6,538,875
==========
- ------------------------------------------------------------
</TABLE>
+ Non-income producing security.
++ Portion of holdings pledged as collateral for financial futures contracts.
++ An affiliate of the Fund.
See Notes to Financial Statements.
179
<PAGE> 181
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$319,530,386) (Note
1a)....................................................... $404,904,905
Cash........................................................ 56
Receivables:
Securities sold........................................... $2,361,047
Capital shares sold....................................... 515,183
Dividends................................................. 409,962
Variation margin (Note 1b)................................ 12,414 3,298,606
----------
Deferred organization expenses (Note 1f).................... 6,083
Prepaid expenses and other assets........................... 24,270
------------
Total assets................................................ 408,233,920
------------
- --------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Securities purchased...................................... 4,743,479
Investment adviser (Note 2)............................... 97,219
Capital shares redeemed................................... 21,155 4,861,853
----------
Accrued expenses and other liabilities...................... 154,654
------------
Total liabilities........................................... 5,016,507
------------
- --------------------------------------------------------------------------------------
NET ASSETS.................................................. $403,217,413
============
- --------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 2,484,540
Paid-in capital in excess of par............................ 306,089,930
Undistributed investment income--net........................ 4,385,855
Undistributed realized capital gains on investments--net.... 4,777,260
Unrealized appreciation on investments--net................. 85,479,828
------------
NET ASSETS.................................................. $403,217,413
============
- --------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $403,217,413 and 24,845,404
shares outstanding........................................ $ 16.23
============
- --------------------------------------------------------------------------------------
</TABLE>
+ The Fund is also authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
180
<PAGE> 182
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Dividends (net of $25,743 foreign withholding tax).......... $ 4,511,335
Interest and discount earned................................ 1,039,852
-----------
Total income................................................ 5,551,187
-----------
- ---------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $ 965,368
Accounting services (Note 2)................................ 73,293
Registration fees........................................... 34,467
Printing and shareholder reports............................ 31,503
Custodian fees.............................................. 28,723
Professional fees........................................... 16,531
Directors' fees and expenses................................ 5,177
Transfer agent fees (Note 2)................................ 5,121
Amortization of organization expenses (Note 1f)............. 2,086
Pricing services............................................ 135
Other....................................................... 2,921
----------
Total expenses.............................................. 1,165,325
-----------
Investment income--net...................................... 4,385,862
-----------
- ---------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET (NOTES
1b, 1c, 1E & 3):
Realized gain (loss) from:
Investments--net.......................................... 5,356,612
Foreign currency transactions--net........................ (6) 5,356,606
----------
Change in unrealized appreciation on investments--net....... 65,816,752
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $75,559,220
===========
- ---------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
181
<PAGE> 183
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
----------------------------
INCREASE (DECREASE) IN NET ASSETS: 1998 1997
- --------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 4,385,862 $ 2,775,837
Realized gain on investments and foreign currency
transactions--net......................................... 5,356,606 9,912,879
Change in unrealized appreciation on investments--net....... 65,816,752 19,509,942
------------ ------------
Net increase in net assets resulting from operations........ 75,559,220 32,198,658
------------ ------------
- --------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1g):
Investment income--net:
Class A................................................... (2,775,835) (16,872)
Realized gain on investments--net:
Class A................................................... (10,487,182) (4,850)
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (13,263,017) (21,722)
------------ ------------
- --------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase in net assets derived from capital share
transactions.............................................. 125,686,790 172,305,644
------------ ------------
- --------------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 187,982,993 204,482,580
Beginning of year........................................... 215,234,420 10,751,840
------------ ------------
End of year*................................................ $403,217,413 $215,234,420
============ ============
- --------------------------------------------------------------------------------------------
* Undistributed investment income--net...................... $ 4,385,855 $ 2,775,828
============ ============
- --------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
182
<PAGE> 184
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
---------------------------------------------
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FROM FOR THE YEAR
INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. ENDED FOR THE PERIOD
DECEMBER 31, DEC. 13, 1996+
------------------------ TO
INCREASE (DECREASE) IN NET ASSET VALUE: 1998 1997 DEC. 31, 1996
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period......................... $ 13.48 $ 10.17 $ 10.00
-------- -------- -------
Investment income--net....................................... .18 .17 .02
Realized and unrealized gain on investments--net............. 3.40 3.16 .15
-------- -------- -------
Total from investment operations............................. 3.58 3.33 .17
-------- -------- -------
Less dividends and distributions:
Investment income--net..................................... (.17) (.02) --
Realized gain on investments--net.......................... (.66) --++ --
-------- -------- -------
Total dividends and distributions............................ (.83) (.02) --
-------- -------- -------
Net asset value, end of period............................... $ 16.23 $ 13.48 $ 10.17
======== ======== =======
- --------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share........................... 28.28% 32.81% 1.68%++++
======== ======== =======
- --------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement............................... .36% .34% .00%*
======== ======== =======
Expenses..................................................... .36% .40% .60%*
======== ======== =======
Investment income--net....................................... 1.36% 2.01% 3.08%*
======== ======== =======
- --------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)..................... $403,217 $215,234 $10,752
======== ======== =======
Portfolio turnover........................................... 11.92% 36.85% .04%
======== ======== =======
- --------------------------------------------------------------------------------------------------------------
</TABLE>
+ Commencement of operations.
++ Amount is less than $.01 per share.
++++ Aggregate total investment return.
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
See Notes to Financial Statements.
183
<PAGE> 185
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc.("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Class A and
Class B Shares have equal voting, dividend, liquidation and other rights, except
that only shares of the respective classes are entitled to vote on matters
concerning only that class and Class B Shares bear certain expenses related to
the distribution of such shares. Index 500 Fund (the "Fund") is classified as
"non-diversified," as defined in the Investment Company Act of 1940. The Fund's
financial statements are prepared in accordance with generally accepted
accounting principles which may require the use of management accruals and
estimates. The following is a summary of significant accounting policies
followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
sale price prior to the time of valuation. Securities traded in the NASDAQ
National Market System are valued at the last sale price prior to the time of
valuation. Portfolio securities which are traded both in the over-the-counter
market and on a stock exchange are valued according to the broadest and most
representative market. Options written or purchased are valued at the last sale
price in the case of exchange-traded options. In the case of options traded in
the over-the-counter market, valuation is the last asked price (options written)
or the last bid price (options purchased). Futures contracts are valued at the
settlement price at the close of the applicable exchange. Short-term securities
are valued at amortized cost, which approximates market value. Securities and
assets for which market quotations are not readily available are valued at fair
value as determined in good faith by or under the direction of the Board of
Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity markets. Losses may arise due to changes in the
value of the contract or if the counterparty does not perform under the
contract.
- - Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts for the purpose of hedging the
market risk on existing securities or the intended purchase of securities.
Futures contracts are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon entering into a contract, the
Fund deposits and maintains as collateral such initial margin as required by the
exchange on which the transaction is effected. Pursuant to the contract, the
Fund agrees to receive from or pay to the broker an amount of cash equal to the
daily fluctuation in value of the contract. Such receipts or payments are known
as variation margin and are recorded by the Fund as unrealized gains or losses.
When the contract is closed, the Fund records a realized gain or loss equal to
the difference between the value of the contract at the time it was opened and
the value at the time it was closed.
- - Options--The Fund is authorized to purchase and write covered call and put
options. When the Fund writes an option, an amount equal to the premium received
by the Fund is reflected as an asset and an equivalent liability. The amount of
the liability is subsequently marked to market to reflect the current market
value of the option written. When a security is purchased or sold through an
exercise of an option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from (or added to)
the proceeds of the security sold. When an option expires (or the Fund enters
into a closing transaction), the Fund realizes a gain or loss on the option to
the extent of the premiums received or paid (or gain or loss to the extent the
cost of the closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
(c) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized)
184
<PAGE> 186
- --------------------------------------------------------------------------------
or valuing (unrealized) assets and liabilities expressed in foreign currencies
into US dollars. Realized and unrealized gains or losses from investments
include the effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Deferred organization expenses--Deferred organization expenses are charged
to expense on a straight-line basis over a period not exceeding five years.
(g) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
2. INVESTMENT ADVISORY AGREEMENT AND
TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.30% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Merrill Lynch Funds Distributor, a division of Princeton Funds Distributor,
Inc. ("PFD"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
is the Fund's distributor.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1998 were $150,547,878 and $35,960,010, respectively.
Net realized gains (losses) for the year ended December 31, 1998 and net
unrealized gains as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
Realized
Gains Unrealized
(Losses) Gains
- ------------------------------------------------------------------
<S> <C> <C>
Long-term investments................. $ 6,526,860 $ 85,374,519
Financial futures contracts........... (1,170,248) 105,309
Foreign currency transactions......... (6) --
----------- ------------
Total................................. $ 5,356,606 $ 85,479,828
=========== ============
- ------------------------------------------------------------------
</TABLE>
At December 31, 1998, net unrealized appreciation for Federal income tax
purposes aggregated $84,660,214, of which $95,962,681 related to appreciated
securities and $11,302,467 related to depreciated securities. At December 31,
1998, the aggregate cost of investments for Federal income tax purposes was
$320,244,691.
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions was
$125,686,790 and $172,305,644 for the years ended December 31, 1998 and December
31, 1997, respectively.
185
<PAGE> 187
- --------------------------------------------------------------------------------
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1998 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 13,011,352 $183,963,924
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 1,043,297 13,263,016
---------- ------------
Total issued......................... 14,054,649 197,226,940
Shares redeemed...................... (5,178,470) (71,540,150)
---------- ------------
Net increase......................... 8,876,179 $125,686,790
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 19,361,582 $225,105,550
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 2,149 21,722
---------- ------------
Total issued......................... 19,363,731 225,127,272
Shares redeemed...................... (4,451,853) (52,821,628)
---------- ------------
Net increase......................... 14,911,878 $172,305,644
========== ============
- -----------------------------------------------------------------
</TABLE>
5. SUBSEQUENT EVENT:
On January 4, 1999, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.176526 per Class A Share and a long-term capital
gains distribution in the amount of $.225168 per Class A Share payable on
January 11, 1999 to shareholders of record as of December 31, 1998.
186
<PAGE> 188
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
INDEX 500 FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Index 500 Fund of Merrill Lynch Variable Series
Funds, Inc. as of December 31, 1998, the related statements of operations for
the year then ended and changes in net assets for each of the years in the
two-year period then ended and the financial highlights for each of the years in
the two-year period then ended and the period December 13, 1996 (commencement of
operations) to December 31, 1996. These financial statements and the financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and the financial
highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1998 by correspondence with the custodian and brokers; where replies were
not received from brokers, we performed other auditing procedures. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Index 500 Fund of
Merrill Lynch Variable Series Funds, Inc. as of December 31, 1998, the results
of its operations, the changes in its net assets, and the financial highlights
for the respective stated periods in conformity with generally accepted
accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
187
<PAGE> 189
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
DECEMBER 31, 1998--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
FISCAL YEAR IN REVIEW
During the 12-month period ended December 31, 1998, nearly all developed
equity markets rose, while the majority of emerging markets declined. For the 12
months ended December 31, 1998, the total return for the Fund's new benchmark,
the unmanaged Morgan Stanley Capital International (MSCI) World Index (Ex-US),
rose by 18.76%, while International Equity Focus Fund's Class A Shares had a
total return of +7.80%. During the year, the Fund's benchmark was changed from
the Financial Times/Standard & Poor's--Actuaries World (Ex-US) Index to the
Morgan Stanley Capital International World Index (Ex-US). We believe that the
new Index provides a better comparison for the Fund's relative performance.
The Fund's underperformance relative to the Index was largely caused by our
exposure to emerging markets in the early part of the year and, to a lesser
extent, by our underweighted position in European currencies during the second
half of 1998. During the 12-month period ended December 31, 1998, the Fund
underwent significant restructuring. In particular, we substantially reduced our
exposure to emerging markets and Asian developed markets. As these asset classes
were relative underperformers for most of 1998, the reduction in exposure proved
to be positive for the Fund's returns. Nevertheless, our overweighted position
in emerging markets during the early part of the year was detrimental to Fund
performance relative to the new benchmark index. In the first half of the year,
the Fund's cash reserves accounted for approximately 12% of net assets. During
the second half, the Fund became more fully invested, with cash reserves
declining to approximately 3% by fiscal year-end. Again, this was a beneficial
change as developed equity markets outperformed cash over the year.
ECONOMIC AND INVESTMENT ENVIRONMENT
High volatility in equity markets and exchange rates characterized the
12-month period ended December 31, 1998. Most developed markets outside of Asia
were strong in the early months of 1998, as investors focused on the positive
impacts on growth (via lower inflation and bond yields) of the deflationary
forces coming from Asia. By July, Federal Reserve Board Chairman Alan Greenspan
was sufficiently concerned by the continuing above-trend growth of the US
economy to warn that the next move in US interest rates was likely to be upward.
This marked the peak for the year in the MSCI World Index (Ex-US).
The months of August and September saw dramatic declines in global markets,
triggered by Russia's moratorium on debt repayments and the devaluation of the
Russian ruble. This initiated an extremely sharp widening in credit spreads
across a wide range of markets, and raised concerns about the health of the
global financial system in light of the near collapse of a major hedge fund.
With sentiment in equity markets damaged, investor attention in North America
and Europe focused on the negative impact that the deflationary forces coming
from Asia would have on corporate profit margins.
The latter part of the year was marked by a series of interest rate cuts in
virtually all of the world's economies, led by the US Federal Reserve Board.
Equity markets rallied strongly in the final quarter of the year as liquidity
conditions improved. Within Continental Europe, some of the interest rate cuts
were also part of the process of economic "convergence" required by the
introduction of the single European currency, the euro, which took place on
January 1, 1999. The preparations for the launch of the euro created favorable
market conditions in a number of the peripheral economies of Europe, notably
Italy and Spain, where previously high interest rates were reduced to come into
line with the lower rates in the core markets, such as Germany and France. As a
result of this move and a perceived greater insulation from the effects of the
emerging markets crisis, European markets posted exceptionally strong results
for the 12 months ended December 31, 1998. The Continental European component of
the MSCI World Index (Ex-US) returned +33.9% over the period. Within this
region, the best-performing markets were Finland (+122%), Belgium (+68%), Italy
(+53%) and Spain (+50%). (References to securities markets of all countries in
this letter to shareholders correspond to those countries' market weightings in
the MSCI World (Ex-US) Index (unless otherwise noted) and are measured in US
dollars.
Among emerging markets, Russian equities declined by 83% for the year ended
December 31, 1998. The inability of the Russian government to honor its debts
brought into focus other debt-laden countries whose economies were also heavily
dependent on oil or other commodities. Latin American equity markets fell by
35.1% as measured by the MSCI Emerging Markets Index. At the end of 1998, some
Asian emerging markets showed real signs of recovery
188
<PAGE> 190
- --------------------------------------------------------------------------------
as interest rates fell, governments started to restructure their financial
sectors, and currencies stabilized or appreciated. The most significant of these
was South Korea, which produced a return of +141% over the 12 months ended
December 31, 1998.
The declining trend in global industrial output growth, underway since
mid-1997, paused during the fourth quarter of 1998, with improvement in some
Asian economies offsetting deterioration elsewhere. Although policy makers have
eased monetary conditions since September, there is a strong risk of renewed
pressure on industrial companies' profit margins in the early months of 1999.
Latin America remains a particular concern in light of a sharp tightening of
fiscal policy in Brazil being implemented at a time when the economy is already
beginning to contract.
Even if the outlook for 1999 global economic growth were to improve, a
significant degree of spare capacity in many key industries will be maintained
for some time. Therefore, secular trends toward lower inflation rates and bond
yields will likely remain in place unless there is a massive change in emphasis
in fiscal policy in the major economies. Against the backdrop of weak commodity
prices, consumer spending is holding up considerably better than corporate
spending across the developed world. We believe that this trend is likely to be
accentuated before it reverses, which continues to argue against large holdings
in markets with a concentration of cyclical industries, such as Germany. For
Europe as a whole, but Germany in particular, the fortunes of the dollar will
remain key, with more downside than upside risk in 1999, in our view.
The Japanese equity market had a roller-coaster ride during the year,
finishing the period with a total return of +5.2%, well below the average for
developed markets. Despite the announcement of numerous economic stimulus
packages by the government, the Japanese economy continued to languish. The yen
was extremely volatile, ranging from 147.7 against the US dollar in August to
111.5 in October. A key factor in the yen's appreciation was the unwinding of
short-yen positions by leveraged funds.
During the three months ended December 31, 1998, we reduced our Japanese
equity exposure. The United Kingdom became the single largest country exposure
in the Fund, rising to about 21% of net assets for most of the final quarter of
the year. Over the December quarter, we also reversed our overweighted positions
in Continental European basic materials and other heavy cyclical sectors that
had been held for much of the year. New positions were taken in sectors with
more predictable growth patterns, such as telecommunications and software
services. We expect these sectors to perform better in an environment of low
nominal economic growth. We also increased exposure to the European defense
sector in anticipation of a series of major consolidations, mirroring the trend
in the US market. In Japan, we maintained overweighted positions in export
technology sectors, and increased our already overweighted position in
pharmaceuticals at the expense of financial sector stocks.
Outside of Japan, we remain very selective in the Asian markets in which we
invest. For example, we strongly prefer Singapore to Hong Kong since real
interest rates are now much lower in Singapore (we believe this is unlikely to
change while the Hong Kong/US dollar peg still exists). Moreover, Singapore
stands to benefit more from signs of cyclical improvement in the semiconductor
industry, an industry where capacity has been taken out in recent months.
IN CONCLUSION
Volatility in global equity markets remains high, even as many markets have
rebounded following the corrections of recent months. It is still too early to
expect a significant moderation in the current levels of volatility while much
of the world stands poised on the brink of falling price levels at a time when
many economies and sectors are struggling with large debts and/or overcapacity.
However, there are some grounds for optimism in the coordinated support that the
developed countries have provided to the troubled emerging economies, and in the
efforts that some of these emerging countries have made to stabilize their own
economic and financial systems. Looking ahead, our strategy is to remain very
selective, taking opportunities to reinvest in those markets that demonstrate
the ability to balance productive efficiency and pricing power which, in turn,
we anticipate should result in corporate earnings growth.
189
<PAGE> 191
- --------------------------------------------------------------------------------
We thank you for your continued interest in International Equity Focus Fund of
Merrill Lynch Variable Series Funds, Inc., and we look forward to reviewing our
strategy and performance with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Clive D. Lang
Clive Lang
Portfolio Manager
February 5, 1999
190
<PAGE> 192
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
International Equity Focus Fund
Total Return Based on a $10,000 Investment-Class A Shares
A line graph depicting the growth of an investment in the Fund's Class A
Shares compared to growth of an investment in the Financial Times-Standard &
Poor's-Actuaries World (Ex-US) Index and the Morgan Stanley Capital
International World (Ex-Us) Index. Beginning and ending values are:
<TABLE>
<CAPTION>
7/01/93** 12/98
--------- -----
<S> <C> <C>
International Equity
Focus Fund+--Class A Shares* $10,000 $12,833
Financial Times/Standard & Poor's--
Actuaries World (Ex-US) Index++ $10,000 $15,915
Morgan Stanley Capital International
World (Ex-US) Index+++ $10,000 $16,697
</TABLE>
* Assuming transaction costs and other operating expenses, including advisory
fees. Does not include insurance-related fees and expenses.
** Commencement of operations.
+ International Equity Focus Fund invests in a portfolio of securities
from foreign countries, both developed and developing, throughout the
world.
++ This unmanaged capitalization-weighted Index is comprised of over 1,800
companies in 24 countries, excluding the United States.
+++ This unmanaged market capitalization-weighted Index is comprised of a
representative sampling of stocks of 1,178 companies in 22 countries, excluding
the United States. The starting date for the Index is from 6/30/93.
Past performance is not predictive of future performance.
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/98 +7.80%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/98 +3.07
- --------------------------------------------------------------------------------
Inception (7/01/93) through 12/31/98 +4.64
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
RECENT PERFORMANCE RESULTS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
12 MONTH 6 MONTH
TOTAL RETURN TOTAL RETURN
- --------------------------------------------------------------------------------
<S> <C> <C>
Class A Shares +7.80% -2.55%
</TABLE>
- --------------------------------------------------------------------------------
* Total investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the ex-dividend date. Insurance-related fees
and expenses are not reflected in these returns. Past results shown should not
be considered a representation of future performance.
191
<PAGE> 193
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES HELD/ VALUE PERCENT OF
AFRICA INDUSTRY FACE AMOUNT INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
SOUTH AFRICA FOREIGN ZAL 12,000,000 Republic of South Africa,
GOVERNMENT BONDS 13% due 8/31/2010........... $ 1,773,138 $ 1,730,140 0.9%
-----------------------------------------------------------------------------------------------------
INSURANCE 15,000 Liberty Life Association of
Africa Limited............ 407,119 206,703 0.1
-----------------------------------------------------------------------------------------------------
METALS-- 23,500 Minorco S.A. (Minerals &
NONFERROUS Resources Corporation
Limited).................. 388,858 367,013 0.2
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN AFRICA 2,569,115 2,303,856 1.2
- ----------------------------------------------------------------------------------------------------------------------------
MIDDLE EAST
- ----------------------------------------------------------------------------------------------------------------------------
ISRAEL MULTI-INDUSTRY 26,667 Koor Industries Limited..... 623,421 465,006 0.3
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE
MIDDLE EAST 623,421 465,006 0.3
- ----------------------------------------------------------------------------------------------------------------------------
NORTH AMERICA
- ----------------------------------------------------------------------------------------------------------------------------
CANADA AEROSPACE & 19,020 Bombardier Inc. (Class B)... 276,207 272,546 0.1
MILITARY
TECHNOLOGY
-----------------------------------------------------------------------------------------------------
BANKING 6,370 Bank of Montreal............ 305,116 255,995 0.1
15,990 National Bank of Canada..... 234,809 258,290 0.1
------------ ------------ -----
539,925 514,285 0.2
-----------------------------------------------------------------------------------------------------
BEVERAGES & 6,820 The Seagram Company
TOBACCO Ltd. ..................... 259,522 258,754 0.1
-----------------------------------------------------------------------------------------------------
BROADCASTING & 2,590 The Thomson Corporation..... 60,901 60,562 0.0
PUBLISHING
-----------------------------------------------------------------------------------------------------
ELECTRICAL & 9,600 Northern Telecom Ltd. ...... 532,275 478,968 0.3
ELECTRONICS
-----------------------------------------------------------------------------------------------------
ENERGY SOURCES 4,060 Enbridge Inc. .............. 175,941 186,433 0.1
8,950 Poco Petroleums
Limited(d)................ 92,103 74,617 0.0
4,870 Suncor Energy, Inc. ........ 157,102 145,913 0.1
------------ ------------ -----
425,146 406,963 0.2
-----------------------------------------------------------------------------------------------------
FINANCIAL 11,480 Power Corporation of
SERVICES Canada.................... 233,674 248,249 0.1
-----------------------------------------------------------------------------------------------------
FOREST PRODUCTS & 13,070 Abitibi-Consolidated Inc.... 122,969 120,885 0.1
PAPER
-----------------------------------------------------------------------------------------------------
GOLD MINES 13,020 Placer Dome Inc............. 184,480 148,831 0.1
-----------------------------------------------------------------------------------------------------
MACHINERY & 6,530 United Dominion Industries
ENGINEERING Limited................... 202,792 134,402 0.1
-----------------------------------------------------------------------------------------------------
MERCHANDISING 6,880 Canadian Tire Corp. ........ 194,362 180,369 0.1
-----------------------------------------------------------------------------------------------------
METALS--NONFERROUS 13,120 Inco Limited................ 139,804 138,438 0.1
10,310 Rio Algom Limited........... 138,889 110,131 0.0
------------ ------------ -----
278,693 248,569 0.1
-----------------------------------------------------------------------------------------------------
MULTI-INDUSTRY 6,310 Imasco Limited.............. 120,905 134,395 0.1
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 8,140 BCE Inc..................... 323,920 306,715 0.2
5,700 Teleglobe Inc. ............. 171,545 204,195 0.1
------------ ------------ -----
495,465 510,910 0.3
-----------------------------------------------------------------------------------------------------
UTILITIES-- 10,780 TransCanada PipeLines
ELECTRICAL & GAS Limited................... 159,688 157,631 0.1
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN CANADA 4,087,004 3,876,319 2.0
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
192
<PAGE> 194
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NORTH
AMERICA SHARES HELD/ VALUE PERCENT OF
(CONCLUDED) INDUSTRY FACE AMOUNT INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
UNITED STATES US GOVERNMENT US$ 3,000,000 United States Treasury
OBLIGATIONS Bond, 5.25% due
11/15/2028................ $ 3,005,625 $ 3,071,250 1.6%
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE
UNITED STATES 3,005,625 3,071,250 1.6
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN NORTH
AMERICA 7,092,629 6,947,569 3.6
- ----------------------------------------------------------------------------------------------------------------------------
PACIFIC BASIN
- ----------------------------------------------------------------------------------------------------------------------------
AUSTRALIA BANKING 47,600 Australia and New Zealand
Banking Group Ltd. ....... 269,864 311,782 0.2
17,400 Commonwealth Bank of
Australia................. 209,126 247,182 0.1
55,000 National Australia Bank..... 794,671 829,795 0.4
70,500 Westpac Banking Corp.
Ltd. ..................... 441,973 472,155 0.2
------------ ------------ -----
1,715,634 1,860,914 0.9
-----------------------------------------------------------------------------------------------------
BEVERAGES & 100,000 Foster's Brewing Group
TOBACCO Limited................... 239,091 271,079 0.1
18,400 Rothmans Holdings, Ltd. .... 128,917 132,031 0.1
------------ ------------ -----
368,008 403,110 0.2
-----------------------------------------------------------------------------------------------------
BROADCASTING & 120,000 Cable & Wireless Optus
PUBLISHING Limited(d)................ 163,469 252,434 0.1
44,000 The News Corporation
Limited................... 280,659 290,900 0.2
95,200 The News Corporation Limited
(Preferred)............... 520,515 579,775 0.3
------------ ------------ -----
964,643 1,123,109 0.6
-----------------------------------------------------------------------------------------------------
BUSINESS & PUBLIC 8,700 Brambles Industries
SERVICES Limited................... 183,238 212,094 0.1
-----------------------------------------------------------------------------------------------------
CHEMICALS 24,000 Orica Ltd. ................. 141,119 124,966 0.1
-----------------------------------------------------------------------------------------------------
CONSTRUCTION & 19,300 Leighton Holdings Ltd. ..... 75,245 82,857 0.0
HOUSING
-----------------------------------------------------------------------------------------------------
ENERGY SOURCES 50,000 Broken Hill Proprietary Co.,
Ltd. ..................... 401,418 368,563 0.2
35,000 Woodside Petroleum Limited.. 196,909 156,698 0.1
------------ ------------ -----
598,327 525,261 0.3
-----------------------------------------------------------------------------------------------------
GOLD MINES 144,000 Newcrest Mining(d).......... 214,489 199,769 0.1
146,000 Normandy Mining Limited..... 133,329 135,208 0.1
------------ ------------ -----
347,818 334,977 0.2
-----------------------------------------------------------------------------------------------------
INSURANCE 33,800 AMP Limited(d).............. 418,090 428,583 0.2
45,700 GIO Australia Holdings,
Ltd. ..................... 110,686 150,229 0.1
59,700 QBE Insurance Group Ltd. ... 234,943 247,144 0.1
------------ ------------ -----
763,719 825,956 0.4
-----------------------------------------------------------------------------------------------------
LEISURE & TOURISM 16,000 Tabcorp Holdings............ 99,021 98,128 0.1
-----------------------------------------------------------------------------------------------------
MERCHANDISING 30,000 Coles Myers Limited......... 130,608 157,311 0.1
-----------------------------------------------------------------------------------------------------
METALS--NONFERROUS 270,000 M.I.M. Holdings Limited..... 129,896 119,225 0.1
40,000 WMC Limited................. 128,276 120,697 0.1
------------ ------------ -----
258,172 239,922 0.2
-----------------------------------------------------------------------------------------------------
REAL ESTATE 18,000 Lend Lease Corp. ........... 195,971 242,867 0.1
40,000 Westfield Holdings
Limited................... 189,875 203,370 0.1
------------ ------------ -----
385,846 446,237 0.2
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 180,400 Telstra Corporation
Limited(d)................ 643,974 844,178 0.4
-----------------------------------------------------------------------------------------------------
</TABLE>
193
<PAGE> 195
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC BASIN VALUE PERCENT OF
(CONTINUED) INDUSTRY SHARES HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
AUSTRALIA UTILITIES-- 35,800 Australian Gas Light Company
(CONCLUDED) ELECTRICAL & GAS Limited................... $ 210,912 $ 258,072 0.1%
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
AUSTRALIA 6,886,284 7,537,092 3.9
- ----------------------------------------------------------------------------------------------------------------------------
CHINA TELECOMMUNICATIONS 40,900 China Telecom (Hong Kong)
Limited (ADR)(a)(d)....... 1,387,942 1,421,275 0.7
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN CHINA 1,387,942 1,421,275 0.7
- ----------------------------------------------------------------------------------------------------------------------------
HONG KONG LEISURE & TOURISM 110,000 Shanghai Industrial Holdings
Limited................... 275,890 222,218 0.1
-----------------------------------------------------------------------------------------------------
MULTI-INDUSTRY 140 Hutchison Whampoa Limited... 892 989 0.0
-----------------------------------------------------------------------------------------------------
UTILITIES-- 70,900 Hong Kong and China Gas
ELECTRICAL & GAS Company Ltd............... 109,755 90,148 0.0
35,450 Hong Kong and China Gas
Company Ltd.
(Warrants)(c)............. 0 2,334 0.0
------------ ------------ -----
109,755 92,482 0.0
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN HONG
KONG 386,537 315,689 0.1
- ----------------------------------------------------------------------------------------------------------------------------
JAPAN APPLIANCES & 46,000 Pioneer Electronic
HOUSEHOLD Corporation............... 1,028,858 773,126 0.4
DURABLES 13,400 Sony Corporation............ 1,195,627 978,111 0.5
------------ ------------ -----
2,224,485 1,751,237 0.9
-----------------------------------------------------------------------------------------------------
AUTOMOBILES 41,000 Toyota Motor Corporation.... 1,102,054 1,116,364 0.6
-----------------------------------------------------------------------------------------------------
BANKING 86,000 Mitsubishi Trust & Banking
Corp. .................... 1,029,147 554,519 0.3
-----------------------------------------------------------------------------------------------------
BEVERAGES & 145 Japan Tobacco, Inc. ........ 1,051,616 1,453,216 0.8
TOBACCO
-----------------------------------------------------------------------------------------------------
BROADCASTING & 16,000 Nippon Broadcasting System,
PUBLISHING Incorporated.............. 896,875 641,419 0.3
2,400 Nippon Television Network
Corp. .................... 723,841 708,825 0.4
------------ ------------ -----
1,620,716 1,350,244 0.7
-----------------------------------------------------------------------------------------------------
BUILDING MATERIALS & 64,000 Sekisui Chemical Co.,
Ltd. ..................... 336,861 431,397 0.2
COMPONENTS
-----------------------------------------------------------------------------------------------------
BUSINESS & 327 NTT Data Corporation........ 1,508,455 1,627,024 0.8
PUBLIC SERVICES 94,000 Ricoh Co., Ltd. ............ 1,016,548 868,718 0.5
------------ ------------ -----
2,525,003 2,495,742 1.3
-----------------------------------------------------------------------------------------------------
CHEMICALS 118,000 Kaneka Corp. ............... 661,677 886,439 0.5
36,000 Shin-Etsu Chemical Co.,
Ltd. ..................... 805,545 868,470 0.5
------------ ------------ -----
1,467,222 1,754,909 1.0
-----------------------------------------------------------------------------------------------------
CONSTRUCTION & 120,000 Nishimatsu Construction Co.
HOUSING Ltd. ..................... 605,194 702,439 0.4
-----------------------------------------------------------------------------------------------------
DATA PROCESSING & 96,000 Fujitsu Limited............. 1,037,908 1,281,419 0.7
REPRODUCTION
-----------------------------------------------------------------------------------------------------
ELECTRICAL & 89,000 Hitachi Ltd. ............... 729,522 552,550 0.3
ELECTRONICS 70,000 Uniden Corp. ............... 734,493 589,180 0.3
------------ ------------ -----
1,464,015 1,141,730 0.6
-----------------------------------------------------------------------------------------------------
ELECTRONIC 66,000 Anritsu Corp. .............. 943,123 535,610 0.3
COMPONENTS & 4,800 Keyence Corporation......... 543,832 591,752 0.3
INSTRUMENTATION 20,000 Murata Manufacturing Co.,
Ltd. ..................... 612,824 831,929 0.4
45 NTT Mobile Communication
Network, Inc.(e).......... 1,484,897 1,855,876 1.0
11,000 Rohm Company Ltd. .......... 1,095,147 1,003,902 0.5
14,000 TDK Corporation............. 1,003,914 1,282,661 0.7
------------ ------------ -----
5,683,737 6,101,730 3.2
-----------------------------------------------------------------------------------------------------
</TABLE>
194
<PAGE> 196
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC BASIN VALUE PERCENT OF
(CONTINUED) INDUSTRY SHARES HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
JAPAN FINANCIAL 20,000 Jafco Co., Ltd. ............ $ 1,232,991 $ 539,246 0.3%
(CONCLUDED) INVESTMENT
COMPANY
-----------------------------------------------------------------------------------------------------
FINANCIAL 190,000 Daiwa Securities Co.,
Ltd. ..................... 887,061 650,466 0.3
SERVICES 96,000,000 Sanwa Finance
(Preferred)(d)............ 765,025 672,639 0.3
------------ ------------ -----
1,652,086 1,323,105 0.6
-----------------------------------------------------------------------------------------------------
HEALTH & PERSONAL 94,000 Fujisawa Pharmaceutical Co.,
CARE Ltd. ..................... 982,679 1,333,925 0.7
38,000 Sankyo Co., Ltd. ........... 966,524 832,461 0.4
40,000 Taisho Pharmaceuticals
Co. ...................... 994,590 1,103,326 0.6
------------ ------------ -----
2,943,793 3,269,712 1.7
-----------------------------------------------------------------------------------------------------
INDUSTRIAL 38,000 Bridgestone Corporation..... 906,920 864,479 0.4
COMPONENTS 171,000 Fujikura Ltd. .............. 1,238,936 919,078 0.5
156,000 NSK Ltd. ................... 790,351 583,876 0.3
------------ ------------ -----
2,936,207 2,367,433 1.2
-----------------------------------------------------------------------------------------------------
MERCHANDISING 20,000 Ito-Yokado Co., Ltd. ....... 943,914 1,401,330 0.7
51,000 Uny Co., Ltd. .............. 794,557 934,058 0.5
------------ ------------ -----
1,738,471 2,335,388 1.2
-----------------------------------------------------------------------------------------------------
METALS--STEEL 354,000 Nippon Steel Corporation.... 892,676 643,636 0.3
-----------------------------------------------------------------------------------------------------
MISCELLANEOUS 1,000 Toyo Seikan Kaisha, Ltd. ... 30,312 17,011 0.0
MATERIALS &
COMMODITIES
-----------------------------------------------------------------------------------------------------
MULTI-INDUSTRY 51,000 Ibiden Co., Ltd. ........... 708,371 814,191 0.4
-----------------------------------------------------------------------------------------------------
NON INDEX 463,474 Nikkei (Warrants)(c)........ 604,238 368,313 0.2
-----------------------------------------------------------------------------------------------------
REAL ESTATE 98,000 Mitsui Fudosan Co., Ltd. ... 1,067,090 743,148 0.4
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 126 Nippon Telegraph & Telephone
Corporation (NTT)......... 1,192,086 974,474 0.5
-----------------------------------------------------------------------------------------------------
TRANSPORTATION-- 185 East Japan Railway Co....... 866,471 1,035,344 0.5
ROAD & RAIL 130,000 Nippon Express Co., Ltd. ... 886,503 733,304 0.4
30,000 Tobu Railway Co., Ltd. ..... 108,407 87,805 0.0
241,000 Tokyu Corp. ................ 1,490,742 634,829 0.3
------------ ------------ -----
3,352,123 2,491,282 1.2
-----------------------------------------------------------------------------------------------------
WHOLESALE & 155,000 Mitsui & Co. ............... 986,872 867,450 0.4
INTERNATIONAL
TRADE
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN JAPAN 39,485,274 36,889,335 19.1
- ----------------------------------------------------------------------------------------------------------------------------
MALAYSIA++ FINANCIAL 285 Rashid Hussain BHD
SERVICES (Warrants)(c)............. 376 67 0.0
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
MALAYSIA 376 67 0.0
- ----------------------------------------------------------------------------------------------------------------------------
NEW ZEALAND ELECTRICAL & 25,150 PDL Holdings Limited........ 95,983 70,353 0.0
ELECTRONICS
-----------------------------------------------------------------------------------------------------
MERCHANDISING 137,700 Lane Walker Rudkin
Industries, Ltd........... 130,524 93,028 0.1
-----------------------------------------------------------------------------------------------------
REAL ESTATE 260,350 Wrightson Ltd............... 156,965 57,713 0.0
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN NEW
ZEALAND 383,472 221,094 0.1
- ----------------------------------------------------------------------------------------------------------------------------
SINGAPORE EQUITY BASKET 75,000 MSCI Singapore OPALS (Class
B)(f)..................... 2,414,900 2,893,500 1.5
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SINGAPORE 2,414,900 2,893,500 1.5
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
195
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC BASIN VALUE PERCENT OF
(CONCLUDED) INDUSTRY SHARES HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
SOUTH KOREA APPLIANCES & 7,400 Samsung Electronics
HOUSEHOLD (GDR)(b)(d)(e)............ $ 331,250 $ 286,750 0.2%
DURABLES
-----------------------------------------------------------------------------------------------------
EQUITY BASKET 4,500 MSCI South Korea OPALS
(Class B)(f).............. 173,880 343,305 0.2
-----------------------------------------------------------------------------------------------------
INSURANCE 274 Samsung Fire & Marine
Insurance (Rights)(g)..... 0 52,791 0.0
900 Samsung Fire & Marine
Insurance................. 240,522 337,500 0.2
------------ ------------ -----
240,522 390,291 0.2
-----------------------------------------------------------------------------------------------------
METALS--STEEL 21,000 Pohang Iron & Steel Company,
Ltd. (ADR)(a)............. 320,250 354,375 0.2
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 22,949 SK Telecommunications Co.,
Ltd. (ADR)(a)(e).......... 331,774 233,797 0.1
-----------------------------------------------------------------------------------------------------
UTILITIES-- 6,100 Korea Electric Power
ELECTRICAL & GAS Corporation............... 260,588 151,483 0.1
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SOUTH
KOREA 1,658,264 1,760,001 1.0
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE
PACIFIC BASIN 52,603,049 51,038,053 26.4
- ----------------------------------------------------------------------------------------------------------------------------
WESTERN EUROPE
- ----------------------------------------------------------------------------------------------------------------------------
DENMARK EQUITY BASKET 14,800 MSCI Denmark OPALS (Class
B)(e)(f).................. 2,098,887 2,261,736 1.2
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN DENMARK 2,098,887 2,261,736 1.2
- ----------------------------------------------------------------------------------------------------------------------------
FINLAND EQUITY BASKET 10,700 MSCI Finland OPALS (Class
B)(f)..................... 2,104,287 2,623,961 1.4
-----------------------------------------------------------------------------------------------------
FOREST PRODUCTS 23,584 Enso OY (Class A)........... 202,347 211,013 0.1
& PAPER 12,710 Stora Enso Oyj.............. 110,201 112,227 0.1
------------ ------------ -----
312,548 323,240 0.2
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN FINLAND 2,416,835 2,947,201 1.6
- ----------------------------------------------------------------------------------------------------------------------------
FRANCE AEROSPACE & MILITARY 8,000 Thomson-CSF S.A............. 256,207 343,550 0.2
TECHNOLOGY
-----------------------------------------------------------------------------------------------------
AUTOMOBILES 2,017 Peugeot S.A................. 380,380 312,184 0.2
-----------------------------------------------------------------------------------------------------
BANKING 5,600 Compagnie Financiere de
Paribas................... 455,983 486,682 0.3
3,000 Societe Generale (Class A).. 383,144 485,802 0.3
------------ ------------ -----
839,127 972,484 0.6
-----------------------------------------------------------------------------------------------------
BEVERAGES & 3,200 Pernod Ricard............... 205,699 207,848 0.1
TOBACCO
-----------------------------------------------------------------------------------------------------
BROADCASTING & 1,200 Canal Plus.................. 218,774 327,446 0.2
PUBLISHING
-----------------------------------------------------------------------------------------------------
BUILDING MATERIALS & 3,900 Compagnie de St. Gobain..... 614,733 550,593 0.3
COMPONENTS 4,500 Lafarge Cooper (Ordinary)... 436,776 427,559 0.2
------------ ------------ -----
1,051,509 978,152 0.5
-----------------------------------------------------------------------------------------------------
BUSINESS & 5,500 Suez Lyonnaise des Eaux..... 1,044,854 1,129,780 0.6
PUBLIC SERVICES 5,800 Vivendi..................... 1,326,198 1,504,822 0.8
------------ ------------ -----
2,371,052 2,634,602 1.4
-----------------------------------------------------------------------------------------------------
ELECTRICAL & 4,247 Alcatel Alsthom Cie Generale
ELECTRONICS d'Electricite S.A......... 708,941 519,790 0.3
7,000 Schneider S.A............... 406,146 424,607 0.2
------------ ------------ -----
1,115,087 944,397 0.5
-----------------------------------------------------------------------------------------------------
</TABLE>
196
<PAGE> 198
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE VALUE PERCENT OF
(CONTINUED) INDUSTRY SHARES HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
FRANCE ENERGY SOURCES 8,730 Elf Aquitaine S.A. ......... $ 1,168,155 $ 1,009,104 0.5%
(CONCLUDED) 10,200
Total S.A. (Class B)........ 1,122,142 1,033,013 0.5
------------ ------------ -----
2,290,297 2,042,117 1.0
-----------------------------------------------------------------------------------------------------
EQUITY BASKET 22,400 MSCI France OPALS (Class
B)(f)..................... 3,720,483 4,403,392 2.3
-----------------------------------------------------------------------------------------------------
FINANCIAL 700 Financiere et Industrielle
SERVICES Gaz et Eaux............... 40,245 37,200 0.0
-----------------------------------------------------------------------------------------------------
FOOD & HOUSEHOLD 1,600 Groupe Danone............... 379,887 458,067 0.2
PRODUCTS
-----------------------------------------------------------------------------------------------------
HEALTH & PERSONAL 880 L'Oreal S.A................. 436,976 636,141 0.3
CARE 12,500 Rhone-Poulenc S.A. ......... 600,650 643,262 0.3
------------ ------------ -----
1,037,626 1,279,403 0.6
-----------------------------------------------------------------------------------------------------
INSURANCE 12,250 AXA......................... 1,460,097 1,775,458 0.9
-----------------------------------------------------------------------------------------------------
MERCHANDISING 400 Carrefour S.A. ............. 278,510 301,966 0.2
4,300 Pinault-Printemps-Redoute
S.A. ..................... 674,097 821,729 0.4
680 Promodes S.A................ 409,394 494,484 0.3
------------ ------------ -----
1,362,001 1,618,179 0.9
-----------------------------------------------------------------------------------------------------
MULTI-INDUSTRY 5,000 Lagardere S.C.A. ........... 213,955 212,482 0.1
-----------------------------------------------------------------------------------------------------
RECREATION/OTHER 2,900 LVMH (Louis Vuitton Moet
CONSUMER GOODS Hennessy)................. 607,269 573,908 0.3
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 10,382 France Telecom S.A. ........ 647,635 824,809 0.4
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN FRANCE 18,197,330 19,945,678 10.4
- ----------------------------------------------------------------------------------------------------------------------------
GERMANY AUTOMOBILES 16,739 DaimlerChrysler AG(d)....... 1,276,979 1,652,800 0.9
4,350 Volkswagen AG............... 237,872 347,269 0.2
------------ ------------ -----
1,514,851 2,000,069 1.1
-----------------------------------------------------------------------------------------------------
BANKING 14,050 Deutsche Bank AG............ 1,058,254 826,892 0.4
10,100 HypoVereinsbank............. 759,362 791,146 0.4
------------ ------------ -----
1,817,616 1,618,038 0.8
-----------------------------------------------------------------------------------------------------
BUSINESS & PUBLIC 375 SAP AG (Systeme,
SERVICES Anwendungen, Produkte in
der Datenverarbeitung).... 170,502 162,065 0.1
-----------------------------------------------------------------------------------------------------
CHEMICALS 15,500 BASF AG..................... 718,985 591,717 0.3
17,350 Bayer AG.................... 701,738 724,305 0.4
------------ ------------ -----
1,420,723 1,316,022 0.7
-----------------------------------------------------------------------------------------------------
ELECTRICAL & 11,100 Siemens AG.................. 741,136 716,236 0.4
ELECTRONICS
-----------------------------------------------------------------------------------------------------
INSURANCE 3,000 Axa Colonia Konzern AG...... 341,151 340,336 0.2
3,325 Allianz AG.................. 885,247 1,219,433 0.6
------------ ------------ -----
1,226,398 1,559,769 0.8
-----------------------------------------------------------------------------------------------------
MERCHANDISING 550 Karstadt AG................. 262,810 287,215 0.2
2,300 Metro AG (VORZ)............. 87,622 110,858 0.1
3,400 Metro AG.................... 206,118 271,429 0.1
------------ ------------ -----
556,550 669,502 0.4
-----------------------------------------------------------------------------------------------------
METALS--STEEL 1,250 Thyssen AG.................. 304,048 231,918 0.1
-----------------------------------------------------------------------------------------------------
MULTI-INDUSTRY 750 Preussag.................... 260,322 338,986 0.2
-----------------------------------------------------------------------------------------------------
RECREATION/OTHER 2,175 Adidas-Salomon AG........... 244,376 236,300 0.1
CONSUMER GOODS
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 19,300 Deutsche Telekom AG......... 548,888 634,838 0.3
5,700 Mannesmann AG............... 609,364 653,481 0.3
------------ ------------ -----
1,158,252 1,288,319 0.6
-----------------------------------------------------------------------------------------------------
TRANSPORTATION--AIRLINES 12,800 Deutsche Lufthansa AG....... 319,620 282,737 0.1
-----------------------------------------------------------------------------------------------------
</TABLE>
197
<PAGE> 199
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE VALUE PERCENT OF
(CONTINUED) INDUSTRY SHARES HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
GERMANY UTILITIES-- 14,500 RWE AG...................... $ 740,310 $ 794,193 0.4%
(CONCLUDED) ELECTRICAL & GAS 13,500 VEBA AG..................... 847,820 807,893 0.4
------------ ------------ -----
1,588,130 1,602,086 0.8
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN GERMANY 11,322,524 12,022,047 6.2
- ----------------------------------------------------------------------------------------------------------------------------
GREECE BEVERAGES & 1,500 Hellenic Bottling Co........ 49,732 46,329 0.0
TOBACCO
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 6,500 Hellenic Telecommunication
Organization S.A. (OTE)... 185,771 173,008 0.1
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN GREECE 235,503 219,337 0.1
- ----------------------------------------------------------------------------------------------------------------------------
HUNGARY BANKING 5,000 OTP Bank Reszvenytarsasag
(GDR)(b).................. 241,200 246,500 0.1
-----------------------------------------------------------------------------------------------------
ENERGY SOURCES 9,500 MOL Magyar Olaj-es Gazipari
Reszvenytarsasag
(GDR)(b).................. 254,918 262,200 0.1
-----------------------------------------------------------------------------------------------------
HEALTH & PERSONAL 2,690 EGIS Reszvenytarsasag(d).... 95,700 61,236 0.0
CARE
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN HUNGARY 591,818 569,936 0.2
- ----------------------------------------------------------------------------------------------------------------------------
IRELAND BANKING 39,127 Bank of Ireland............. 853,459 857,000 0.4
-----------------------------------------------------------------------------------------------------
BUILDING MATERIALS & 15,603 CRH PLC..................... 170,576 264,683 0.1
COMPONENTS
-----------------------------------------------------------------------------------------------------
INSURANCE 30,240 Irish Life PLC.............. 299,943 285,659 0.2
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN IRELAND 1,323,978 1,407,342 0.7
- ----------------------------------------------------------------------------------------------------------------------------
ITALY EQUITY BASKET 53,300 MSCI Italy OPALS (Class
B)(e)(f).................. 5,775,514 6,798,415 3.5
-----------------------------------------------------------------------------------------------------
MULTI-INDUSTRY 537,587 MontEdison S.p.A.(d)........ 400,883 713,856 0.4
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 369,718 Telecom Italia S.p.A. ...... 1,763,571 2,326,114 1.2
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN ITALY 7,939,968 9,838,385 5.1
- ----------------------------------------------------------------------------------------------------------------------------
NETHERLANDS APPLIANCES & 20,227 Koninklijke (Royal) Philips
HOUSEHOLD Electronics N.V. ......... 1,317,790 1,356,722 0.7
DURABLES
-----------------------------------------------------------------------------------------------------
BANKING 65,000 ABN AMRO Holding N.V. ...... 1,373,278 1,366,782 0.7
-----------------------------------------------------------------------------------------------------
BEVERAGES & 16,000 Heineken N.V. .............. 869,552 962,470 0.5
TOBACCO
-----------------------------------------------------------------------------------------------------
BROADCASTING & 4,600 Wolters Kluwer N.V. ........ 895,164 983,913 0.5
PUBLISHING
-----------------------------------------------------------------------------------------------------
ENERGY SOURCES 18,500 Royal Dutch Petroleum
Company................... 888,770 920,814 0.5
-----------------------------------------------------------------------------------------------------
FINANCIAL SERVICES 38,000 ING Groep N.V. ............. 2,073,581 2,316,210 1.2
-----------------------------------------------------------------------------------------------------
FOOD & HOUSEHOLD 16,500 Unilever N.V. .............. 1,325,884 1,409,768 0.7
PRODUCTS
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE
NETHERLANDS 8,744,019 9,316,679 4.8
- ----------------------------------------------------------------------------------------------------------------------------
NORWAY BUSINESS & PUBLIC 14,721 Merkantildata ASA........... 176,253 144,958 0.1
SERVICES
-----------------------------------------------------------------------------------------------------
ENERGY SOURCES 18,192 Saga Petroleum ASA.......... 268,656 166,001 0.1
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN NORWAY 444,909 310,959 0.2
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
198
<PAGE> 200
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE VALUE PERCENT OF
(CONTINUED) INDUSTRY SHARES HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
POLAND BANKING 9,000 BIG Bank Gdanski S.A.
(GDR)(b).................. $ 201,336 $ 122,850 0.1%
8,500 Bank Rozwoju Eksportu
S.A. ..................... 281,710 196,434 0.1
------------ ------------ -----
483,046 319,284 0.2
-----------------------------------------------------------------------------------------------------
MULTI-INDUSTRY 12,000 Elektrim Spolka Akcyjna
S.A. ..................... 166,037 130,100 0.1
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN POLAND 649,083 449,384 0.3
- ----------------------------------------------------------------------------------------------------------------------------
PORTUGAL EQUITY BASKET 17,500 MSCI Portugal OPALS (Class
B)(e)(f).................. 1,083,416 1,364,475 0.7
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
PORTUGAL 1,083,416 1,364,475 0.7
- ----------------------------------------------------------------------------------------------------------------------------
SPAIN BANKING 35,000 Banco Central
Hispanoamerico............ 382,224 415,112 0.2
29,500 Banco Santander, S.A. ...... 564,018 585,556 0.3
------------ ------------ -----
946,242 1,000,668 0.5
-----------------------------------------------------------------------------------------------------
CONSTRUCTION & 5,900 Dragados & Construcciones,
HOUSING S.A. ..................... 191,884 217,196 0.1
3,250 Fomento de Construcciones y
Contratas, S.A. .......... 199,206 241,342 0.1
------------ ------------ -----
391,090 458,538 0.2
-----------------------------------------------------------------------------------------------------
ENERGY SOURCES 6,900 Repsol, S.A.(d)............. 381,357 367,657 0.2
-----------------------------------------------------------------------------------------------------
EQUITY BASKET 10,700 MSCI Spain OPALS (Class
B)(e)(f).................. 1,039,398 1,367,567 0.7
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 21,000 Telefonica S.A. ............ 960,556 932,709 0.5
21,000 Telefonica, S.A.
(Rights)(g)............... 0 18,625 0.0
------------ ------------ -----
960,556 951,334 0.5
-----------------------------------------------------------------------------------------------------
UTILITIES-- 45,000 Endesa, S.A. ............... 1,105,502 1,190,962 0.6
ELECTRICAL & GAS
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SPAIN 4,824,145 5,336,726 2.7
- ----------------------------------------------------------------------------------------------------------------------------
SWEDEN APPLIANCES & 27,298 Electrolux AB............... 313,524 471,074 0.2
HOUSEHOLD
DURABLES
-----------------------------------------------------------------------------------------------------
AUTOMOBILES 6,349 Volvo AB (B Shares)......... 205,791 146,084 0.1
-----------------------------------------------------------------------------------------------------
EQUITY BASKET 14,300 MSCI Sweden OPALS (Class
B)(f)..................... 2,988,699 2,819,817 1.5
-----------------------------------------------------------------------------------------------------
FOREST PRODUCTS & 9,471 Mo och Domsjo AB (Class B)
PAPER Free...................... 302,406 206,788 0.1
-----------------------------------------------------------------------------------------------------
INSURANCE 24,704 Skandia Forsakrings AB...... 170,012 378,943 0.2
-----------------------------------------------------------------------------------------------------
METALS--NONFERROUS 29,721 Avesta-Sheffield AB......... 326,708 83,827 0.0
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SWEDEN 4,307,140 4,106,533 2.1
- ----------------------------------------------------------------------------------------------------------------------------
SWITZERLAND BANKING 4,700 Credit Suisse Group
(Registered).............. 738,149 736,248 0.4
3,900 UBS AG...................... 1,098,768 1,199,126 0.6
------------ ------------ -----
1,836,917 1,935,374 1.0
-----------------------------------------------------------------------------------------------------
EQUITY BASKET 2,000 MSCI Switzerland OPALS
(Class B)(f).............. 656,663 743,560 0.4
-----------------------------------------------------------------------------------------------------
FOOD & HOUSEHOLD 700 Nestle S.A. (Registered
PRODUCTS Shares)................... 1,464,922 1,524,954 0.8
-----------------------------------------------------------------------------------------------------
HEALTH & PERSONAL 1,200 Novartis AG (Registered
CARE Shares)................... 2,246,181 2,360,656 1.2
175 Roche Holding AG............ 2,061,986 2,136,976 1.1
------------ ------------ -----
4,308,167 4,497,632 2.3
-----------------------------------------------------------------------------------------------------
</TABLE>
199
<PAGE> 201
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE VALUE PERCENT OF
(CONTINUED) INDUSTRY SHARES HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
SWITZERLAND INSURANCE 250 Schweiz Ruckverschere....... $ 626,104 $ 652,277 0.3%
(CONCLUDED) 800
Zurich Allied AG............ 518,481 592,787 0.3
------------ ------------ -----
1,144,585 1,245,064 0.6
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 4,000 Swisscom AG
(Registered)(d)........... 1,362,380 1,675,774 0.9
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SWITZERLAND 10,773,634 11,622,358 6.0
- ----------------------------------------------------------------------------------------------------------------------------
UNITED AEROSPACE & 188,200 British Aerospace PLC....... 1,397,022 1,594,712 0.8
KINGDOM MILITARY 170,000 Rolls-Royce PLC............. 704,443 703,990 0.4
------------ ------------ -----
2,101,465 2,298,702 1.2
TECHNOLOGY
-----------------------------------------------------------------------------------------------------
BANKING 36,600 Abbey National.............. 684,076 783,390 0.4
102,000 Bank of Scotland............ 1,144,968 1,216,292 0.6
65,761 HSBC Holdings PLC........... 1,664,576 1,782,684 0.9
97,500 Lloyds TSB Group PLC........ 1,220,658 1,386,402 0.7
61,759 National Westminster Bank
PLC (Ordinary)............ 1,149,997 1,190,425 0.6
------------ ------------ -----
5,864,275 6,359,193 3.2
-----------------------------------------------------------------------------------------------------
BEVERAGES & 105,000 British American Tobacco
TOBACCO PLC(d).................... 915,315 922,896 0.5
22,500 Cadbury Schweppes PLC....... 342,010 383,552 0.2
65,000 Diageo PLC.................. 667,134 739,414 0.4
------------ ------------ -----
1,924,459 2,045,862 1.1
-----------------------------------------------------------------------------------------------------
BUILDING 101,500 Hanson PLC.................. 545,296 805,620 0.4
MATERIALS &
COMPONENTS
-----------------------------------------------------------------------------------------------------
BUSINESS & 25,000 Reuters Group PLC........... 253,522 262,354 0.1
PUBLIC SERVICES 112,500 Shanks & McEwan Group PLC... 359,618 395,714 0.2
82,800 United Utilities PLC........ 1,110,150 1,147,080 0.6
------------ ------------ -----
1,723,290 1,805,148 0.9
-----------------------------------------------------------------------------------------------------
CHEMICALS 35,000 Imperial Chemical Industries
PLC....................... 346,496 303,266 0.2
-----------------------------------------------------------------------------------------------------
CONSTRUCTION & 32,500 Jarvis PLC.................. 381,981 361,059 0.2
HOUSING
-----------------------------------------------------------------------------------------------------
ELECTRONIC 53,000 Williams PLC................ 337,683 300,792 0.2
COMPONENTS &
INSTRUMENTATION
-----------------------------------------------------------------------------------------------------
ENERGY SOURCES 156,500 British Petroleum Company
PLC....................... 2,248,471 2,335,969 1.2
4,337 British Petroleum Company
PLC (ADR)(a)(d)........... 339,051 388,704 0.2
50,714 Shell Transport & Trading
Co., PLC.................. 310,229 311,435 0.2
------------ ------------ -----
2,897,751 3,036,108 1.6
-----------------------------------------------------------------------------------------------------
EQUITY BASKET 25,700 MSCI United Kingdom OPALS
(Class B)(f).............. 5,131,490 5,621,104 2.9
-----------------------------------------------------------------------------------------------------
FINANCIAL SERVICES 45,000 Provident Financial PLC..... 712,264 662,330 0.3
-----------------------------------------------------------------------------------------------------
FOOD & HOUSEHOLD 157,200 Unilever PLC................ 1,422,159 1,762,101 0.9
PRODUCTS
-----------------------------------------------------------------------------------------------------
HEALTH & PERSONAL 39,800 Glaxo Wellcome PLC.......... 1,089,111 1,368,838 0.7
CARE 101,000 Nycomed Amersham PLC........ 690,029 695,409 0.4
168,000 SmithKline Beecham PLC...... 1,940,609 2,346,967 1.2
9,000 Zeneca Group PLC............ 338,711 391,710 0.2
------------ ------------ -----
4,058,460 4,802,924 2.5
-----------------------------------------------------------------------------------------------------
</TABLE>
200
<PAGE> 202
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE VALUE PERCENT OF
(CONCLUDED) INDUSTRY SHARES HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
UNITED INSURANCE 152,000 Guardian Royal Exchange
KINGDOM PLC....................... $ 787,281 $ 850,642 0.4%
(CONCLUDED) 49,000
Prudential Corporation
PLC....................... 727,759 739,539 0.4
43,000 Royal & Sun Alliance
Insurance Group PLC....... 455,666 350,952 0.2
------------ ------------ -----
1,970,706 1,941,133 1.0
-----------------------------------------------------------------------------------------------------
INVESTMENT TRUST 424,000 Fleming Japanese Investment
Trust PLC(d).............. 1,038,318 948,433 0.5
-----------------------------------------------------------------------------------------------------
LEISURE & TOURISM 112,500 J.D. Wetherspoon PLC........ 390,309 334,907 0.2
-----------------------------------------------------------------------------------------------------
MERCHANDISING 31,500 Dixons Group PLC............ 391,602 442,938 0.2
115,000 J Sainsbury PLC............. 968,750 921,378 0.5
75,500 Kingfisher PLC.............. 603,309 816,794 0.4
150,000 Marks & Spencer PLC......... 1,103,075 1,028,419 0.5
125,000 Next PLC.................... 1,042,454 1,026,964 0.5
245,000 Tesco PLC................... 730,816 697,774 0.4
------------ ------------ -----
4,840,006 4,934,267 2.5
-----------------------------------------------------------------------------------------------------
MULTI-INDUSTRY 190,000 BTR PLC..................... 743,135 391,826 0.2
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 128,000 Cable & Wireless
Communications PLC........ 1,561,312 1,573,160 0.8
45,000 Cable & Wireless PLC(d)..... 379,516 410,869 0.2
26,000 Vodafone Group PLC.......... 364,030 422,028 0.2
------------ ------------ -----
2,304,858 2,406,057 1.2
-----------------------------------------------------------------------------------------------------
TRANSPORTATION--AIRLINES 55,100 British Airways PLC......... 611,560 371,358 0.2
-----------------------------------------------------------------------------------------------------
TRANSPORTATION--SHIPPING 67,500 The Peninsular and Oriental
Steam Navigation Company
(Deferred Stock).......... 691,946 797,602 0.4
-----------------------------------------------------------------------------------------------------
UTILITIES-- 103,000 Scottish Power PLC.......... 894,100 1,057,773 0.5
ELECTRICAL & GAS
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE
UNITED KINGDOM 40,932,007 43,347,565 22.3
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN WESTERN
EUROPE 115,885,196 125,066,341 64.6
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
201
<PAGE> 203
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHORT-TERM FACE VALUE PERCENT OF
SECURITIES AMOUNT INVESTMENTS COST (NOTE 1a) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
COMMERCIAL US$ 3,251,000 General Motors Acceptance
PAPER* Corp., 5.13% due
1/04/1999................. $ 3,249,147 $ 3,249,147 1.7%
-----------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
COMMERCIAL PAPER 3,249,147 3,249,147 1.7
- ----------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT US$ 2,000,000 United States Treasury Bill,
OBLIGATIONS* 4.28% due 3/04/1999(h).... 1,985,020 1,984,600 1.0
----------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN US
GOVERNMENT OBLIGATIONS 1,985,020 1,984,600 1.0
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SHORT-
TERM SECURITIES 5,234,167 5,233,747 2.7
- ----------------------------------------------------------------------------------------------------------------------------
OPTIONS NOMINAL VALUE COVERED BY OPTIONS PREMIUMS
PURCHASED PURCHASED ISSUE PAID
- ----------------------------------------------------------------------------------------------------------------------------
CURRENCY PUT OPTIONS 8,000,000 Japanese Yen, expiring
PURCHASED October 1999 at Y150...... 71,600 34,400 0.0
----------------------------------------------------------------------------------------------------------
TOTAL OPTIONS PURCHASED 71,600 34,400 0.0
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS 184,079,177 191,088,972 98.8
- ----------------------------------------------------------------------------------------------------------------------------
OPTIONS NOMINAL VALUE COVERED BY OPTIONS PREMIUMS
WRITTEN WRITTEN RECEIVED
- ----------------------------------------------------------------------------------------------------------------------------
CURRENCY CALL 8,000,000 Japanese Yen, expiring
OPTIONS WRITTEN October 1999 at Y96.45.... (71,600) (168,000) (0.1)
----------------------------------------------------------------------------------------------------------
TOTAL OPTIONS WRITTEN (71,600) (168,000) (0.1)
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS, NET OF
OPTIONS WRITTEN........... $184,007,577 190,920,972 98.7
============
TIME DEPOSIT+............... 2,471,564 1.3
VARIATION MARGIN ON
FINANCIAL FUTURES
CONTRACTS**............... (18,942) 0.0
UNREALIZED APPRECIATION ON
FORWARD FOREIGN EXCHANGE
CONTRACTS***.............. 7,166 0.0
OTHER ASSETS LESS
LIABILITIES............... 76,043 0.0
------------ -----
NET ASSETS.................. $193,456,803 100.0%
============ =====
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) American Depositary Receipts (ADR).
(b) Global Depositary Receipts (GDR).
(c) Warrants entitle the Fund to purchase a predetermined number of shares of
Common Stock and are non-income producing. The purchase price and number of
shares are subject to adjustment under certain conditions until the expiration
date.
(d) Non-income producing security.
(e) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(f) Optimized Portfolio As Listed Securities (OPALS) are investments that are
exchange quoted and provide an equivalent investment exposure to that of the
specific Morgan Stanley Capital International (MSCI) country index.
(g) The rights may be exercised until 1/29/1999.
(h) Security held as collateral in connection with open financial futures
contracts.
+ Time Deposit bears interest at 7.687% and matures on 2/01/1999.
++ On October 21, 1998, the Company's Board of Directors decided to discount the
current Malaysian exchange rate of 3.80 by 12%. This is due to the capital
controls implemented by the Malaysian government, which froze the Malaysian
ringgit at 3.80 until September 1, 1999. The discount will be amortized on a
daily basis from 12% to zero through September 1, 1999.
* Commercial Paper and certain US Government Obligations are traded on a
discount basis; the interest rates shown reflect the discount rates paid at the
time of purchase by the Fund.
202
<PAGE> 204
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
** Financial futures contracts purchased as of December 31, 1998 were as
follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------
NUMBER OF EXPIRATION VALUE
CONTRACTS ISSUE EXCHANGE DATE (NOTES 1A & 1B)
- -----------------------------------------------------------------------
<S> <C> <C> <C> <C>
34 Taiwan MSCI SIMEX January 1999 $ 883,320
45 OMX OMX January 1999 392,730
4 MIB 30 FIB March 1999 856,842
14 Hang Seng Hang Seng January 1999 914,430
- -----------------------------------------------------------------------
TOTAL FINANCIAL FUTURES CONTRACTS PURCHASED (TOTAL
CONTRACT PRICE--$3,032,852) $3,047,322
==========
- -----------------------------------------------------------------------
Financial futures contracts sold as of December 31, 1998 were as
follows:
- -----------------------------------------------------------------------
NUMBER OF EXPIRATION VALUE
CONTRACTS ISSUE EXCHANGE DATE (NOTES 1A & 1B)
- -----------------------------------------------------------------------
19 Nikkei Index CME March 1999 $1,301,500
22 SFE--Ordinary SFE--Ordinary March 1999 965,395
- -----------------------------------------------------------------------
TOTAL FINANCIAL FUTURES CONTRACTS SOLD (TOTAL CONTRACT
PRICE--$2,356,806) $2,266,895
==========
- -----------------------------------------------------------------------
</TABLE>
*** Forward foreign exchange contracts as of December 31, 1998 were
as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------
UNREALIZED
APPRECIATION
FOREIGN CURRENCY EXPIRATION (DEPRECIATION)
PURCHASED DATE (NOTE 1B)
- -------------------------------------------------------------------
<S> <C> <C> <C>
DM 3,370,470 January 1999 $ 23,942
- -------------------------------------------------------------------
(US$ COMMITMENT - $2,000,000) 23,942
--------
- -------------------------------------------------------------------
FOREIGN CURRENCY SOLD
- -------------------------------------------------------------------
A$ 4,384,003 January 1999 110,774
L 838,590 January 1999 (7,262)
Y 230,770,000 March 1999 (93,303)
KRW 1,595,000,000 March 1999 (27,783)
SGD 651,800 February 1999 798
- -------------------------------------------------------------------
(US$ COMMITMENT--$7,856,147) (16,776)
--------
- -------------------------------------------------------------------
UNREALIZED APPRECIATION ON FORWARD
FOREIGN EXCHANGE CONTRACTS--NET $ 7,166
========
- -------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
203
<PAGE> 205
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$184,007,577) (Note
1a)....................................................... $191,054,572
Options purchased, at value (cost--$71,600) (Notes 1a &
1b)....................................................... 34,400
Unrealized appreciation on forward foreign exchange
contracts (Note 1b)....................................... 7,166
Foreign cash (Note 1c)...................................... 98,217
Foreign time deposits (Note 1c)............................. 2,471,564
Receivables:
Dividends................................................. $624,053
Capital shares sold....................................... 126,649
Interest.................................................. 125,810
Forward foreign exchange contracts (Note 1b).............. 10,273 886,785
--------
Prepaid expenses and other assets......................... 27,361
------------
Total assets................................................ 194,580,065
------------
- -------------------------------------------------------------------------------------
LIABILITIES:
Options written, at value (premiums received--$71,600)
(Notes 1a & 1b)........................................... 168,000
Payables:
Forward foreign exchange contracts (Note 1b).............. 500,243
Investment adviser (Note 2)............................... 120,989
Capital shares redeemed................................... 79,927
Variation margin (Note 1b)................................ 18,942 720,101
--------
Accrued expenses and other liabilities...................... 235,161
------------
Total liabilities........................................... 1,123,262
------------
- -------------------------------------------------------------------------------------
NET ASSETS.................................................. $193,456,803
============
- -------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 1,811,142
Paid-in capital in excess of par............................ 209,376,682
Undistributed investment income--net........................ 6,882,157
Accumulated realized capital losses on investments and
foreign currency transactions--net........................ (1,260,558)
Accumulated distributions in excess of realized capital
gains on investments and foreign currency
transactions--net (Note 1g)............................... (30,361,238)
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 7,008,618
------------
NET ASSETS.................................................. $193,456,803
============
- -------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $193,456,803 and 18,111,424
shares outstanding........................................ $ 10.68
============
- -------------------------------------------------------------------------------------
</TABLE>
+ The Fund is also authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
204
<PAGE> 206
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Dividends (net of $606,125 foreign withholding tax)......... $ 6,459,657
Interest and discount earned................................ 2,788,053
------------
Total income................................................ 9,247,710
------------
- -----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $ 2,370,652
Custodian fees.............................................. 253,936
Printing and shareholder reports............................ 51,609
Pricing services............................................ 48,835
Accounting services (Note 2)................................ 40,977
Professional fees........................................... 35,383
Directors' fees and expenses................................ 9,215
Transfer agent fees (Note 2)................................ 5,120
Amortization of organization expenses (Note 1f)............. 688
------------
Total expenses.............................................. 2,816,415
------------
Investment income--net...................................... 6,431,295
------------
- -----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET (NOTES 1b, 1c, 1e & 3):
Realized loss from:
Investments--net.......................................... (24,976,674)
Foreign currency transactions--net........................ (307,138) (25,283,812)
------------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... 54,420,874
Foreign currency transactions--net........................ (426,059) 53,994,815
------------ ------------
Net realized and unrealized gain on investments and foreign
currency transactions..................................... 28,711,003
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 35,142,298
============
- -----------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
205
<PAGE> 207
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE
YEAR ENDED
DECEMBER 31,
-----------------------------
INCREASE (DECREASE) IN NET ASSETS: 1998 1997
- -------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 6,431,295 $ 6,934,157
Realized gain (loss) on investments and foreign currency
transactions--net......................................... (25,283,812) 27,216,905
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ 53,994,815 (58,787,070)
------------- ------------
Net increase (decrease) in net assets resulting from
operations................................................ 35,142,298 (24,636,008)
------------- ------------
- -------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1G):
Investment income--net:
Class A................................................... (3,758,390) (6,787,677)
Realized gain on investments--net:
Class A................................................... (1,207,095) (2,626,115)
In excess of realized gain on investments--net:
Class A................................................... (30,361,238) --
------------- ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (35,326,723) (9,413,792)
------------- ------------
- -------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase (decrease) in net assets derived from capital
share transactions........................................ (231,581,631) 110,192,830
------------- ------------
- -------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... (231,766,056) 76,143,030
Beginning of year........................................... 425,222,859 349,079,829
------------- ------------
End of year*................................................ $ 193,456,803 $425,222,859
============= ============
- -------------------------------------------------------------------------------------------
* Undistributed investment income--net (Note 1h)............ $ 6,882,157 $ 2,948,694
============= ============
- -------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
206
<PAGE> 208
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE
BEEN DERIVED FROM INFORMATION PROVIDED IN THE CLASS A
FINANCIAL STATEMENTS. -----------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1998+ 1997+ 1996+ 1995 1994
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year.............. $ 10.80 $ 11.63 $ 11.06 $ 10.90 $ 11.03
-------- -------- -------- -------- --------
Investment income--net.......................... .21 .20 .23 .20 .19
Realized and unrealized gain (loss) on
investments and foreign currency
transactions--net............................. .56 (.71) .49 .37 (.13)
-------- -------- -------- -------- --------
Total from investment operations................ .77 (.51) .72 .57 .06
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net........................ (.09) (.23) (.15) (.01) (.18)
Realized gain on investments--net............. (.03) (.09) -- (.17) (.01)
In excess of realized gain on
investments--net............................ (.77) -- -- (.23) --
-------- -------- -------- -------- --------
Total dividends and distributions............... (.89) (.32) (.15) (.41) (.19)
-------- -------- -------- -------- --------
Net asset value, end of year.................... $ 10.68 $ 10.80 $ 11.63 $ 11.06 $ 10.90
======== ======== ======== ======== ========
- -----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share.............. 7.80% (4.55%) 6.62% 5.48% .55%
======== ======== ======== ======== ========
- -----------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses........................................ .89% .90% .89% .89% .97%
======== ======== ======== ======== ========
Investment income--net.......................... 2.03% 1.69% 1.96% 1.95% 1.09%
======== ======== ======== ======== ========
- -----------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands).......... $193,457 $425,223 $349,080 $265,602 $247,884
======== ======== ======== ======== ========
Portfolio turnover.............................. 126.23% 127.96% 49.87% 100.02% 58.84%
======== ======== ======== ======== ========
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding.
See Notes to Financial Statements.
207
<PAGE> 209
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Class A and
Class B Shares have equal voting, dividend, liquidation and other rights, except
that only shares of the respective classes are entitled to vote on matters
concerning only that class and Class B Shares bear certain expenses related to
the distribution of such shares. International Equity Focus Fund (the "Fund") is
classified as "diversified," as defined in the Investment Company Act of 1940.
The Fund's financial statements are prepared in accordance with generally
accepted accounting principles which may require the use of management accruals
and estimates. The following is a summary of significant accounting policies
followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written or purchased are valued at the last sale price in the
case of exchange-traded options. In the case of options traded in the
over-the-counter market, valuation is the last asked price (options written) or
the last bid price (options purchased). Futures contracts are valued at the
settlement price at the close of the applicable exchange. Short-term securities
are valued at amortized cost, which approximates market value. Securities and
assets for which market quotations are not readily available are valued at fair
value as determined in good faith by or under the direction of the Board of
Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity, debt and currency markets. Losses may arise due
to changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts.
- - Options--The Fund may write and purchase call and put options. When the Fund
writes an option, an amount equal to the premium received by the Fund is
reflected as an asset and an equivalent liability. The amount of the liability
is subsequently marked to market to reflect the current market value of the
option written. When a security is purchased or sold through an exercise of an
option, the related premium paid or received is added to (or deducted from) the
basis of the security acquired or deducted from (or added to) the proceeds of
the security sold. When an option expires (or the Fund enters into a closing
transaction), the Fund realizes a gain or loss on the option to the extent of
the premiums received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts for the purpose of hedging the
market risk on existing securities or the intended purchase of securities.
Futures contracts are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon entering into a contract, the
Fund deposits and maintains as collateral such initial margin as required by the
exchange on which the transaction is effected. Pursuant to the contract, the
Fund agrees to receive from or pay to the broker an amount of cash equal to the
daily fluctuation in value of the contract. Such receipts or payments are known
as variation margin and are recorded by the Fund as unrealized gains or losses.
When the contract is closed, the Fund records a realized gain or loss equal to
the difference between the value of the contract at the time it
208
<PAGE> 210
- --------------------------------------------------------------------------------
was opened and the value at the time it was closed.
- - Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-US dollar denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) Foreign currency transactions--Trans-
actions denominated in foreign currencies are recorded at the exchange rate
prevailing when recognized. Assets and liabilities denominated in foreign
currencies are valued at the exchange rate at the end of the period. Foreign
currency transactions are the result of settling (realized) or valuing
(unrealized) assets and liabilities expressed in foreign currencies into US
dollars. Realized and unrealized gains or losses from investments include the
effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently recorded
when the Fund has determined the ex-dividend date. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Deferred organization expenses--Deferred organization expenses are charged
to expense on a straight-line basis over a period not exceeding five years.
(g) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates. Distributions in excess of realized
capital gains are due primarily to differing tax treatments for futures
transactions and post-October losses.
(h) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $1,260,558 have been reclassified between accumulated
net realized capital losses and undistributed net investment income. These
reclassifications have no effect on net assets or net asset value per share.
2. INVESTMENT ADVISORY AGREEMENT AND
TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.75% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1998, Merrill Lynch, Pierce, Fenner & Smith
Incorporated, a subsidiary of ML & Co., earned $38,410 in commissions on the
execution of portfolio security transactions.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Merrill Lynch Funds Distributor, a division of Princeton Funds Distributor,
Inc. ("PFD"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
is the Fund's distributor.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
209
<PAGE> 211
- --------------------------------------------------------------------------------
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1998 were $331,484,048 and $523,343,536, respectively.
Net realized gains (losses) for the year ended December 31, 1998 and net
unrealized gains (losses) as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains (Losses)
- ---------------------------------------------------------------------
<S> <C> <C>
Investments:
Long-term.......................... $(22,267,576) $ 7,047,415
Short-term......................... 13,091 (420)
Financial futures contracts........ (212,684) 104,381
Options written.................... (1,772,879) --
Options purchased.................. (736,626) --
------------ ------------
Total investments................... (24,976,674) 7,151,376
------------ ------------
Currency transactions:
Options written.................... 46,135 (96,400)
Options purchased.................. 880,975 (37,200)
Foreign currency transactions...... (1,277,240) (16,324)
Forward foreign exchange
contracts........................ 42,992 7,166
------------ ------------
Total currency transactions......... (307,138) (142,758)
------------ ------------
Total............................... $(25,283,812) $ 7,008,618
============ ============
- ---------------------------------------------------------------------
Transactions in options written for the year ended December 31,
1998, were as follows:
</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------
Nominal Value
Covered by Premiums
Call Options Written Written Options Received
- ---------------------------------------------------------------
<S> <C> <C>
Outstanding call options
written, beginning of
year......................... -- --
Options written............... 8,665,080 $ 148,529
Options expired............... (665,080) (76,929)
---------- ------------
Outstanding call options
written, end of year......... 8,000,000 $ 71,600
========== ============
- ---------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------
Nominal Value
Covered by Premiums
Put Options Written Written Options Received
- ---------------------------------------------------------------
<S> <C> <C>
Outstanding put options
written, beginning of year... 1,868,261 $ 280,239
Options closed................ (1,868,261) (280,239)
---------- ------------
Outstanding put options
written, end of year......... -- $ --
========== ============
- ---------------------------------------------------------------
</TABLE>
At December 31, 1998, net unrealized appreciation for Federal income tax
purposes aggregated $6,077,154, of which $17,627,340 related to appreciated
securities and $11,550,186 related to depreciated securities. At December 31,
1998, the aggregate cost of investments, net of options written for Federal
income tax purposes was $184,977,418.
4. CAPITAL SHARE TRANSACTIONS:
Net increase (decrease) in net assets derived from capital share transactions
were $(231,581,631) and $110,192,830 for the years ended December 31, 1998 and
December 31, 1997, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1998 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold........................ 3,679,012 $ 38,581,146
Shares issued to shareholders in
reinvestment of dividends and
distributions..................... 3,547,854 35,326,722
----------- -------------
Total issued....................... 7,226,866 73,907,868
Shares redeemed.................... (28,489,652) (305,489,499)
----------- -------------
Net decrease....................... (21,262,786) $(231,581,631)
=========== =============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold........................ 11,676,001 $ 137,644,281
Shares issued to shareholders in
reinvestment of dividends and
distributions..................... 835,399 9,413,792
----------- -------------
Total issued....................... 12,511,400 147,058,073
Shares redeemed.................... (3,164,784) (36,865,243)
----------- -------------
Net increase....................... 9,346,616 $ 110,192,830
=========== =============
- -----------------------------------------------------------------
</TABLE>
5. CAPITAL LOSS CARRYFORWARD:
At December 31, 1998, the Fund had a net capital loss carryforward of
approximately $28,034,000, all of which expires in 2006. This amount will be
available to offset like amounts of any future taxable gains.
6. SUBSEQUENT EVENT:
On January 4, 1999, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.405816 per Class A Share payable on January 11, 1999
to shareholders of record as of December 31, 1998.
210
<PAGE> 212
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
INTERNATIONAL EQUITY FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of International Equity Focus Fund of Merrill Lynch
Variable Series Funds, Inc. as of December 31, 1998, the related statements of
operations for the year then ended and changes in net assets for each of the
years in the two-year period then ended, and the financial highlights for each
of the years in the five-year period then ended. These financial statements and
the financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and the
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1998 by correspondence with the custodian and brokers; where replies were
not received from brokers, we performed other auditing procedures. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of International Equity
Focus Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1998,
the results of its operations, the changes in its net assets, and the financial
highlights for the respective stated periods in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
211
<PAGE> 213
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
DECEMBER 31, 1998--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
FISCAL YEAR IN REVIEW
Throughout the six months ended December 31, 1998, the share prices of natural
resource companies continued to be pressured by eroding commodity prices. In
early December, the CRB Index of 17 commodities reached a 21-year low. This
deflationary environment, now in its seventeenth month, posed continued
challenges for Natural Resources Focus Fund. However, the total return generated
by the Fund continued to exceed that of the Lipper Natural Resource Fund's
average on a quarter and year-to-date basis. The primary factors driving the
improved relative performance were holdings benefiting from consolidation in the
metals and oil industries, as well as what we believe were higher relative cash
positions in our portfolio compared to other resource funds. The extremely mild
fall resulted in record natural gas storage levels that impacted gas-oriented
exploration and production stocks. In addition, while Asian stock markets have
recovered, we have not seen definitive signs of a rebound in Asian economies.
During the six months ended December 31, 1998, we continued to focus our
efforts on seeking companies with attractive valuations and strong financial
positions, since we believed that this was the best strategy to follow. At the
same time, we hoped that these same companies will prove to be attractive
consolidation candidates.
Throughout the six-month period ended December 31, 1998, the energy sector
provided mixed results. Oil prices slumped at the end of November, as
Organization of Petroleum Exporting Countries (OPEC) members failed to make
additional production cuts at their November meeting. In addition, Venezuela
appears to have significantly exceeded its oil production quota prior to its
recent national elections. Industry analysts appeared to have missed this excess
production as it was shipped in smaller tankers, and not the VLCC (Very Large
Crude Carriers) that are typically monitored. This resulted in crude prices
returning to the lows last seen in 1986. We were able to mitigate some of the
negative oil pricing effects by our partial sales of positions in British
Petroleum Company PLC and Amoco Corporation. Index-related buying in Europe,
which provided an opportunity for the Fund to reduce these positions, had buoyed
the shares of both companies.
The Fund also benefited from the announcement that Exxon Corporation would
seek to merge with portfolio holding Mobil Corporation. We believe that upon
regulatory approval, such a combination will provide substantial cost savings
and consolidation efficiencies. Given these factors and a significant arbitrage
discount, we maintained our entire Mobil Corp. position. In fact, the initial
decline in Exxon Corp. shares brought the stock to a point where it traded in-
line with other major integrated oils in terms of its price/earnings multiple.
Given Exxon's record for capital discipline, we initiated a position in the
company, as we believed that there was limited downside risk in the shares.
However, the consolidation trend has not been universally favorable for the
Fund. Our holding in Total S.A. suffered a 20% decline after it announced its
intention to acquire Petrofina. While we were disappointed with management's
explanation for the acquisition, the share price decline would seem to discount
any dilution from the transaction. Fortunately, we were able to reduce our
holding immediately after the acquisition was announced. The Fund also reduced
its position in Petro-Canada, and made a profitable trade in the shares of
Valero Energy Corp.
The unseasonably warm weather this fall worked against our positions in
natural gas-leveraged stocks. The industry injected additional gas into storage
throughout the month of November, which is typically the start of the storage
withdrawal season. Natural gas in storage reached levels 600 billion cubic feet
above those of 1997, and peaked at a record level exceeding 3 trillion cubic
feet. This surplus, combined with the delayed onset of the heating season, makes
it highly unlikely that storage will be drawn down to normal levels, or that gas
prices will compare favorably with year-ago levels. The shares of our
gas-leveraged oil and gas production stocks have declined in sympathy and trade
at levels that we believe discount the current environment. We remain committed
to our thesis that the natural gas industry will face increasingly tight
capacity utilization. The dramatically reduced exploration and development
activity expected next year should reinforce this trend, as budgets now being
announced by both major and independent energy concerns are down significantly
from 1998 levels. Given the short life of North American reserves, we believe
there is a high probability that significantly higher gas prices will result by
the heating season of 1999-2000. We have concentrated our holdings in
financially strong companies, with reserve lives that are generally above the
average of their peers.
212
<PAGE> 214
- --------------------------------------------------------------------------------
Therefore, we believe that we are well-positioned for an improved natural gas
environment. We reduced positions in our oil service holdings. While we had
hoped that stocks oriented to deep-water drilling and construction would be
better positioned to weather expectations for low oil prices, the extent of
reduced drilling budgets clearly overwhelmed any positive fundamentals in the
group. They ultimately proved to be detrimental to the Fund's total return.
Throughout the period, the Fund continued to reduce its exposure to the metals
and mining sector. We reduced our holdings in Savage Resources Ltd. after Savage
received a takeover bid from Pasminco Ltd. The shares immediately rose to a
substantial premium to the offer price in anticipation of a potential higher
bidder, so we chose to sell the majority of our position at this premium price.
We also sold holdings in British Steel PLC and Sumitomo Metal Industries, Ltd.
in the steel sector. Steel order patterns and prices continued to erode with
excess global industry capacity. In addition, we were not optimistic that
recently announced trade sanctions will have a lasting positive impact for steel
companies, given the fungible nature of the commodity. We also sold the
remainder of our Rio Tinto PLC holding as we expected that negative commodity
pricing will ultimately affect the valuation of this bellwether stock in the
mining industry. We did increase our holding in Smurfit-Stone Container
Corporation in the paper and forest product area, since we expect the company to
be a prime beneficiary of reduced containerboard capacity.
The Fund continued to carry a high relative weighting in gold stocks, despite
ongoing sales of many of the smaller exploration-oriented holdings. The
September run in gold stocks on a modest rebound in the price of gold was
sufficient to make gold one of the best-performing sectors in our resource
universe. During the period of appreciation in the group, we sold three-quarters
of our position in Newmont Mining Corp. Newmont's financial leverage has been
increasing, and some of its mines are nearing the end of their economic lives.
Gold has again failed to act as a safe haven during the recent Brazilian
turmoil. Despite the falling gold price, new supply continues to be developed.
Our investment in gold-mining stocks is the one exception to our investment
emphasis on industries subject to improving capacity utilization trends. In
1998, we remained invested in these stocks on the basis that fiscal stimulus
might be necessary to jump start world economies, and that depreciation of world
currencies might result in the reemergence of inflation. Our position in
gold-mining stocks did not materially hurt performance in 1998, since several of
our holdings rebounded from their late-1997 lows. However, our lackluster
enthusiasm for gold continues to wane. As we find other natural resource stocks
that we believe offer more visible appreciation potential and concrete valuation
support, we may pare our gold holdings.
The inability to generate a positive total return for the Fund during the
fiscal year was frustrating, but nearly unavoidable in the current environment.
The average total return for all resource funds in the Lipper Natural Resource
Universe was a -23.9%. Natural Resources Focus Fund was able to exceed the
average, with a total return for the Fund's Class A Shares of -15.3%. After the
dismal environment of 1998, we are optimistic that natural resource stocks may
generate positive returns in 1999. We believe that our focus on seeking
financially strong, attractively valued stocks in industries that we believe are
subject to improving capacity utilization trends will enable our investors to
participate should these gains materialize.
213
<PAGE> 215
- --------------------------------------------------------------------------------
IN CONCLUSION
We appreciate your investment in Natural Resources Focus Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to sharing our investment
outlook and strategies with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Robert M. Shearer
Robert M. Shearer
Senior Vice President and Portfolio Manager
February 5, 1999
214
<PAGE> 216
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
[NATURAL RESOURCES FOCUS FUND GRAPH]
Natural Resources Focus Fund
Total Return Based on a $10,000 Investment-Class A Shares.
A line graph depicting the gowth of an investment in the Fund's Class A Shares
compared to growth of an ivestment in the Standard & Poor's industrials Index,
the Lipper Natural Resources Average and the Consumer Price Index. Beginning
and ending values are:
<TABLE>
<CAPTION>
12/88 12/98
----- ------
<S> <C> <C>
Natural Resources Focus Fund+--
Class A Shares* $10,000 $12,097
Standard & Poor's Industrials
Index++ $10,000 $58,368
Lipper Natural Resources
Average+++ $10,000 $18,464
Consumer Price Index++++ $10,000 $13,618
</TABLE>
* Assuming transaction costs and other operating expenses, including advisory
fees. Does not include insurance-related fees and expenses.
+ Natural Resources Focus Fund invests primarily in a portfolio of equity
securities of domestic and foreign companies with substantial natural resource
assets.
++ This unmanaged Index measures the pattern of movements of the common stocks
of 400 large industrial companies and their weighting by capitalization.
+++ This unmanaged Index is comprised of all US mutual funds classified by
Lipper Analytical Services as natural resource-related funds.
++++ This unmanaged Index is the most widely used Index of price changes over
time and is designed to measure changes in the typical market basket of
purchases by urban consumers.
Past performance is not predictive of future performance.
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PERIOD COVERED % RETURN
- ----------------------------------------------------------------------
<S> <C>
Year Ended 12/31/98 -15.30%
- ----------------------------------------------------------------------
Five Years Ended 12/31/98 - 0.79
- ----------------------------------------------------------------------
Ten Years Ended 12/31/98 + 1.92
- ----------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
RECENT PERFORMANCE RESULTS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
12 MONTH 6 MONTH
TOTAL RETURN TOTAL RETURN
- --------------------------------------------------------------------------------
<S> <C> <C>
Class A Shares -15.30% -12.87%
- --------------------------------------------------------------------------------
</TABLE>
* Total investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the ex-dividend date. Insurance-related fees
and expenses are not reflected in these returns. Past results shown should not
be considered a representation of future performance.
215
<PAGE> 217
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD COMMON STOCKS COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ALUMINUM 2,689 Aluminum Co. of America.......... $ 144,983 $ 200,499 1.3%
3,600 Pechiney, S.A. (A Shares)........ 145,041 117,559 0.7
----------- ----------- -----
290,024 318,058 2.0
- ------------------------------------------------------------------------------------------------------------------------
CHEMICALS 5,400 Air Products and Chemicals,
Inc. .......................... 154,427 216,000 1.4
3,100 du Pont (E.I.) de Nemours and
Company........................ 72,002 164,494 1.0
5,300 Imperial Chemical Industries PLC
(ADR)*......................... 259,138 185,169 1.2
----------- ----------- -----
485,567 565,663 3.6
- ------------------------------------------------------------------------------------------------------------------------
DIVERSIFIED RESOURCES 20,000 Asahi Glass Company, Limited..... 240,000 124,346 0.8
COMPANIES 4,800 Ashland Inc. .................... 203,468 232,200 1.5
----------- ----------- -----
443,468 356,546 2.3
- ------------------------------------------------------------------------------------------------------------------------
GOLD 145,337 Acacia Resources Limited......... 239,893 215,261 1.4
17,500 Ashanti Goldfields Company Ltd.
(GDR)**........................ 434,367 154,438 1.0
23,500 Cambior Inc. .................... 315,479 114,798 0.7
131,500 Delta Gold NL.................... 237,845 200,009 1.3
4,100 +Getchell Gold Corporation....... 144,731 111,725 0.7
64,995 Great Central Mines Limited...... 164,202 46,638 0.3
67,600 +Miramar Mining Corporation...... 345,062 57,240 0.4
3,464 Newmont Mining Corporation....... 127,510 62,568 0.4
169,000 Normandy Mining Limited.......... 190,999 156,508 1.0
39,000 Placer Dome Inc.................. 819,544 448,500 2.9
199,000 Resolute Limited................. 412,978 140,354 0.9
----------- ----------- -----
3,432,610 1,708,039 11.0
- ------------------------------------------------------------------------------------------------------------------------
INTEGRATED OIL COMPANIES 3,000 Amerada Hess Corporation......... 166,956 149,250 0.9
4,700 Amoco Corporation................ 126,690 283,762 1.8
2,800 +British Petroleum Company PLC
(ADR)*......................... 106,834 250,950 1.6
3,600 Chevron Corporation.............. 299,201 298,575 1.9
7,900 ENI (ADR)*....................... 369,325 535,225 3.4
8,200 Elf Aquitaine S.A. (ADR)*........ 302,991 464,325 3.0
2,200 Exxon Corporation................ 156,990 160,875 1.0
3,900 Mobil Corporation................ 307,434 339,787 2.2
17,100 Petro-Canada..................... 187,922 181,687 1.2
3,500 Phillips Petroleum Company....... 160,852 149,187 1.0
3,800 Texaco Inc....................... 223,709 200,925 1.3
4,600 Total S.A. (Class B)............. 281,092 465,869 3.0
7,200 USX-Marathon Group............... 226,800 216,900 1.4
6,600 YPF Sociedad Anonima (ADR)*...... 113,421 184,387 1.2
----------- ----------- -----
3,030,217 3,881,704 24.9
- ------------------------------------------------------------------------------------------------------------------------
METALS & MINING 323,741 +Centaur Mining and Exploration
Limited........................ 445,290 73,464 0.5
31,700 Industrias Penoles, S.A. ........ 139,878 94,924 0.6
177,200 M.I.M. Holdings Limited.......... 242,497 78,247 0.5
44,325 Minsur S.A. ..................... 111,555 69,122 0.4
35,000 Mitsubishi Materials
Corporation.................... 173,212 58,980 0.4
14,000 Noranda, Inc. ................... 187,697 139,061 0.9
14,800 Outokumpu OYJ.................... 263,036 135,905 0.9
1,500 Phelps Dodge Corporation......... 87,489 76,312 0.5
100 Stillwater Mining Company........ 3,369 4,100 0.0
23,000 Sumitomo Metal Mining Co. ....... 191,265 74,865 0.5
11,500 Trelleborg AB (Class B).......... 148,886 93,891 0.6
126,900 WMC Limited...................... 734,286 382,913 2.5
26,300 +Zimbabwe Platinum Mines
Limited........................ 14,555 5,162 0.0
----------- ----------- -----
2,743,015 1,286,946 8.3
- ------------------------------------------------------------------------------------------------------------------------
OIL & GAS PRODUCERS 10,800 Alberta Energy Company Ltd. ..... 234,892 232,137 1.5
5,700 Anadarko Petroleum Corporation... 152,633 175,988 1.1
7,600 Apache Corporation............... 202,753 192,375 1.2
4,612 Burlington Resources Inc. ....... 118,201 165,167 1.1
13,800 Cabot Oil & Gas Corporation...... 214,554 207,000 1.3
</TABLE>
216
<PAGE> 218
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD COMMON STOCKS COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
OIL & GAS PRODUCERS 12,900 +Canadian Hunter Exploration
Ltd. .......................... $ 88,509 $ 84,023 0.6%
(CONCLUDED) 10,400 +Chieftan International, Inc. ... 233,254 149,500 1.0
5,625 Devon Energy Corporation......... 187,521 172,617 1.1
15,300 Enron Oil & Gas Company.......... 314,632 263,925 1.7
33,800 +Gulf Canada Resources Limited
(Ordinary)..................... 266,175 99,287 0.6
14,400 +Northrock Resources Ltd. ....... 118,257 110,206 0.7
14,000 +Oryx Energy Company............. 248,986 188,125 1.2
13,000 Synder Oil Corporation........... 259,742 173,062 1.1
8,900 Unocal Corporation............... 322,227 259,769 1.7
7,500 Vastar Resources, Inc. .......... 316,450 323,906 2.1
----------- ----------- -----
3,278,786 2,797,087 18.0
- ------------------------------------------------------------------------------------------------------------------------
OIL SERVICES 4,700 Coflexip S.A. (ADR)*............. 91,760 151,575 1.0
4,900 McDermott International, Inc. ... 171,287 120,969 0.8
5,900 +Noble Drilling Corporation...... 185,985 76,331 0.5
8,200 +Stolt Comex Seaway, S.A. ....... 203,059 54,325 0.3
4,100 +Stolt Comex Seaway, S.A.
(ADR)*......................... 50,429 22,550 0.2
12,900 +TransCoastal Marine Services,
Inc. .......................... 236,000 38,297 0.3
4,200 Transocean Offshore Inc. ........ 134,218 112,613 0.7
6,400 +Weatherford International,
Inc. .......................... 273,186 124,000 0.8
----------- ----------- -----
1,345,924 700,660 4.6
- ------------------------------------------------------------------------------------------------------------------------
PAPER & FOREST PRODUCTS 8,466 Aracruz Celulose S.A. (ADR)*..... 135,818 67,728 0.4
4,400 Bowater Incorporated............. 201,531 182,325 1.2
4,000 Champion International
Corporation.................... 208,741 162,000 1.0
6,104 Nexfor Inc. ..................... 32,189 24,053 0.2
39,600 +Slocan Forest Products Ltd. .... 401,080 98,013 0.6
17,480 +Smurfit-Stone Container
Corporation.................... 219,080 275,310 1.8
----------- ----------- -----
1,198,439 809,429 5.2
- ------------------------------------------------------------------------------------------------------------------------
PLANTATIONS 136,000 Golden Hope Plantations BHD...... 240,608 134,257 0.9
90,000 Kuala Lumpur Kepong BHD.......... 120,553 140,855 0.9
----------- ----------- -----
361,161 275,112 1.8
- ------------------------------------------------------------------------------------------------------------------------
REFINING 7,100 Sunoco, Inc. .................... 196,376 256,044 1.7
5,976 Ultramar Diamond Shamrock
Corporation.................... 202,960 144,918 0.9
----------- ----------- -----
399,336 400,962 2.6
- ------------------------------------------------------------------------------------------------------------------------
STEEL 2,300 Koninklijke Nederlandsche
Hoogovens en Staalfabrieken
N.V. .......................... 80,353 63,668 0.4
64,000 Nippon Steel Corporation......... 214,851 116,364 0.8
----------- ----------- -----
295,204 180,032 1.2
- ------------------------------------------------------------------------------------------------------------------------
WOOD PRODUCTS 26,800 +Riverside Forest Products
Limited........................ 352,710 139,647 0.9
- ------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS 17,656,461 13,419,885 86.4
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
217
<PAGE> 219
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE VALUE PERCENT OF
AMOUNT SHORT-TERM INVESTMENTS COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
US GOVERNMENT AGENCY
OBLIGATIONS*** $2,149,000 Federal Home Loan Mortgage
Corporation, 4.70% due
1/04/1999...................... $ 2,147,878 $ 2,147,878 13.8%
- ------------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM INVESTMENTS 2,147,878 2,147,878 13.8
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS................ $19,804,339 15,567,763 100.2
===========
LIABILITIES IN EXCESS OF OTHER
ASSETS......................... (27,685) (0.2)
----------- -----
NET ASSETS....................... $15,540,078 100.0%
=========== =====
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
* American Depositary Receipts (ADR).
** Global Depositary Receipts (GDR).
*** US Government Agency Obligations are traded on a discount basis; the
interest rate shown reflects the discount rate paid at the time of purchase by
the Fund.
+ Non-income producing security.
See Notes to Financial Statements.
218
<PAGE> 220
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$19,804,339) (Note
1a)....................................................... $15,567,763
Cash........................................................ 395
Receivables:
Dividends................................................. $ 28,123
Securities sold........................................... 27,302 55,425
--------
Prepaid expenses and other assets........................... 1,393
-----------
Total assets................................................ 15,624,976
-----------
- --------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Securities purchased...................................... 58,708
Investment adviser (Note 2)............................... 8,480
Capital shares redeemed................................... 5,109 72,297
--------
Accrued expenses and other liabilities...................... 12,601
-----------
Total liabilities........................................... 84,898
-----------
- --------------------------------------------------------------------------------------
NET ASSETS.................................................. $15,540,078
===========
- --------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 203,094
Paid-in capital in excess of par............................ 21,650,088
Undistributed investment income--net........................ 231,997
Accumulated distributions in excess of realized gains on
investments and foreign currency transactions--net (Note
1f)....................................................... (2,308,824)
Unrealized depreciation on investments and foreign currency
transactions--net......................................... (4,236,277)
-----------
NET ASSETS.................................................. $15,540,078
===========
- --------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $15,540,078 and 2,030,937
shares outstanding........................................ $ 7.65
===========
- --------------------------------------------------------------------------------------
</TABLE>
+ The Fund is also authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
219
<PAGE> 221
---------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
-------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Dividends (net of $30,801 foreign withholding tax).......... $ 395,746
Interest and discount earned................................ 69,720
-----------
Total income................................................ 465,466
-----------
- ---------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $ 135,222
Custodian fees.............................................. 16,885
Professional fees........................................... 6,956
Pricing services............................................ 6,504
Transfer agent fees (Note 2)................................ 5,117
Printing and shareholder reports............................ 5,081
Accounting services (Note 2)................................ 4,585
Directors' fees and expenses................................ 562
Other....................................................... 1,853
-----------
Total expenses.............................................. 182,765
-----------
Investment income--net...................................... 282,701
-----------
- ---------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET (NOTES 1b, 1c, 1e & 3):
Realized loss from:
Investments--net.......................................... (2,055,332)
Foreign currency transactions--net........................ (5,914) (2,061,246)
-----------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... (1,339,625)
Foreign currency transactions--net........................ 684 (1,338,941)
----------- -----------
Net realized and unrealized loss on investments and foreign
currency transactions..................................... (3,400,187)
-----------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $(3,117,486)
===========
- ---------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
220
<PAGE> 222
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
---------------------------
INCREASE (DECREASE) IN NET ASSETS: 1998 1997
- -----------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 282,701 $ 366,478
Realized gain (loss) on investments and foreign currency
transactions--net......................................... (2,061,246) 3,472,408
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ (1,338,941) (7,588,129)
----------- ------------
Net decrease in net assets resulting from operations........ (3,117,486) (3,749,243)
----------- ------------
- -----------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1f):
Investment income--net:
Class A................................................... (450,433) (223,099)
Realized gain on investments--net:
Class A................................................... (1,396,020) (2,977,040)
In excess of realized gain on investments--net:
Class A................................................... (2,282,798) --
----------- ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (4,129,251) (3,200,139)
----------- ------------
- -----------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net decrease in net assets derived from capital share
transactions.............................................. (4,192,551) (11,268,247)
----------- ------------
- -----------------------------------------------------------------------------------------
NET ASSETS:
Total decrease in net assets................................ (11,439,288) (18,217,629)
Beginning of year........................................... 26,979,366 45,196,995
----------- ------------
End of year*................................................ $15,540,078 $ 26,979,366
=========== ============
- -----------------------------------------------------------------------------------------
* Undistributed investment income--net (Note 1g)............ $ 231,997 $ 373,737
=========== ============
- -----------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
221
<PAGE> 223
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE
BEEN DERIVED FROM INFORMATION PROVIDED IN THE CLASS A
FINANCIAL STATEMENTS. ---------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1998+ 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year......................... $ 10.66 $ 13.12 $ 11.95 $ 10.82 $ 10.82
------- ------- ------- ------- -------
Investment income--net..................................... .12 .14 .18 .20 .17
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net....................... (1.50) (1.68) 1.40 1.15 (.02)
------- ------- ------- ------- -------
Total from investment operations........................... (1.38) (1.54) 1.58 1.35 .15
------- ------- ------- ------- -------
Less dividends and distributions:
Investment income--net................................... (.18) (.06) (.20) (.19) (.15)
Realized gain on investments--net........................ (.55) (.86) (.21) (.03) --
In excess of realized gain on investments--net........... (.90) -- -- -- --
------- ------- ------- ------- -------
Total dividends and distributions.......................... (1.63) (.92) (.41) (.22) (.15)
------- ------- ------- ------- -------
Net asset value, end of year............................... $ 7.65 $ 10.66 $ 13.12 $ 11.95 $ 10.82
======= ======= ======= ======= =======
- --------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share......................... (15.30%) (12.52%) 13.52% 12.65% 1.44%
======= ======= ======= ======= =======
- --------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses................................................... .88% .81% .78% .78% .87%
======= ======= ======= ======= =======
Investment income--net..................................... 1.36% .99% 1.43% 1.75% 1.91%
======= ======= ======= ======= =======
- --------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)..................... $15,540 $26,979 $45,197 $43,102 $39,715
======= ======= ======= ======= =======
Portfolio turnover......................................... 29.65% 20.93% 31.11% 30.15% 10.94%
======= ======= ======= ======= =======
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding.
See Notes to Financial Statements.
222
<PAGE> 224
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Class A and
Class B Shares have equal voting, dividend, liquidation and other rights, except
that only shares of the respective classes are entitled to vote on matters
concerning only that class and Class B Shares bear certain expenses related to
the distribution of such shares. Natural Resources Focus Fund (the "Fund") is
classified as "non-diversified," as defined in the Investment Company Act of
1940. The Fund's financial statements are prepared in accordance with generally
accepted accounting principles which may require the use of management accruals
and estimates. The following is a summary of significant accounting policies
followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written or purchased are valued at the last sale price in the
case of exchange-traded options. In the case of options traded in the
over-the-counter market, valuation is the last asked price (options written) or
the last bid price (options purchased). Futures contracts are valued at the
settlement price at the close of the applicable exchange. Short-term investments
are valued at amortized cost, which approximates market value. Securities and
assets for which market quotations are not readily available are valued at fair
value as determined in good faith by or under the direction of the Board of
Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity, debt and currency markets. Losses may arise due
to changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts.
- - Options--The Fund may write and purchase call and put options. When the Fund
writes an option, an amount equal to the premium received by the Fund is
reflected as an asset and an equivalent liability. The amount of the liability
is subsequently marked to market to reflect the current market value of the
option written. When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or deducted from)
the basis of the security acquired or deducted from (or added to) the proceeds
of the security sold. When an option expires (or the Fund enters into a closing
transaction), the Fund realizes a gain or loss on the option to the extent of
the premiums received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts for the purpose of hedging the
market risk on existing securities or the intended purchase of securities.
Futures contracts are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon entering into a contract, the
Fund deposits and maintains as collateral such initial margin as required by the
exchange on which the transaction is effected. Pursuant to the contract, the
Fund agrees to receive from or pay to the broker an amount of cash equal to the
daily fluctuation in value of the contract. Such receipts or payments are known
as variation margin and are recorded by the Fund as unrealized gains or losses.
When the contract is closed, the Fund records a realized gain or loss equal to
the difference between the value of the contract at the time it
223
<PAGE> 225
- --------------------------------------------------------------------------------
was opened and the value at the time it was closed.
- - Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-US dollar denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) Foreign currency transactions--Trans-
actions denominated in foreign currencies are recorded at the exchange rate
prevailing when recognized. Assets and liabilities denominated in foreign
currencies are valued at the exchange rate at the end of the period. Foreign
currency transactions are the result of settling (realized) or valuing
(unrealized) assets and liabilities expressed in foreign currencies into US
dollars. Realized and unrealized gains or losses from investments include the
effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently recorded
when the Fund has determined the ex-dividend date. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates. Distributions in excess of realized
capital gains are due primarily to differing tax treatments for post-October
losses.
(g) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $26,026 have been reclassified between accumulated
distributions in excess of net realized capital gains and undistributed net
investment income and $34 has been adjusted between undistributed net investment
income and paid-in capital in excess of par. These reclassifications have no
effect on net assets or net asset value per share.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.65% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1998, Merrill Lynch, Pierce, Fenner & Smith
Incorporated, a subsidiary of ML & Co., earned $2,546 in commissions on the
execution of portfolio security transactions
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Merrill Lynch Funds Distributor, a division of Princeton Funds Distributor,
Inc. ("PFD"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
is the Fund's distributor.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended
224
<PAGE> 226
- --------------------------------------------------------------------------------
December 31, 1998 were $5,758,242 and $14,960,966, respectively.
Net realized losses for the year ended December 31, 1998 and net unrealized
gains (losses) as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Realized Unrealized
Losses Gains (Losses)
- --------------------------------------------------------------------
<S> <C> <C>
Long-term Investments................. $(2,055,332) $(4,236,576)
Foreign currency transactions......... (5,914) 299
----------- -----------
Total................................. $(2,061,246) $(4,236,277)
=========== ===========
- --------------------------------------------------------------------
</TABLE>
At December 31, 1998, net unrealized depreciation for Federal income tax
purposes aggregated $4,236,576, of which $1,433,240 related to appreciated
securities and $5,669,816 related to depreciated securities. At December 31,
1998, the aggregate cost of investments for Federal income tax purposes was
$19,804,339.
4. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share transactions were
$4,192,551 and $11,268,247 for the years ended December 31, 1998 and December
31, 1997, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1998 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold............................. 15,178 $ 129,809
Shares issued to shareholders in
reinvestment of dividends and
distributions.......................... 456,271 4,129,251
-------- -----------
Total issued............................ 471,449 4,259,060
Shares redeemed......................... (971,059) (8,451,611)
-------- -----------
Net decrease............................ (499,610) $(4,192,551)
======== ===========
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 25,316 $ 321,714
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 264,256 3,200,139
---------- ------------
Total issued......................... 289,572 3,521,853
Shares redeemed...................... (1,202,808) (14,790,100)
---------- ------------
Net decrease......................... (913,236) $(11,268,247)
========== ============
- -----------------------------------------------------------------
</TABLE>
5. COMMITMENTS:
At December 31, 1998, the Fund had entered into foreign exchange contracts under
which it agreed to purchase and sell various foreign currencies with values of
approximately $59,000 and $27,000, respectively.
6. CAPITAL LOSS CARRYFORWARD:
At December 31, 1998, the Fund had a net capital loss carryforward of
approximately $1,939,000, all of which expires in 2006. This amount will be
available to offset like amounts of any future taxable gains.
7. SUBSEQUENT EVENT:
On January 4, 1999, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.114568 per Class A Share payable on January 11, 1999
to shareholders of record as of December 31, 1998.
225
<PAGE> 227
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
NATURAL RESOURCES FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Natural Resources Focus Fund of Merrill Lynch
Variable Series Funds, Inc. as of December 31, 1998, the related statements of
operations for the year then ended and changes in net assets for each of the
years in the two-year period then ended, and the financial highlights for each
of the years in the five-year period then ended. These financial statements and
the financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and the
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1998 by correspondence with the custodian and brokers; where replies were
not received from brokers, we performed other auditing procedures. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Natural Resources
Focus Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1998,
the results of its operations, the changes in its net assets, and the financial
highlights for the respective stated periods in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
226
<PAGE> 228
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
DECEMBER 31, 1998--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
THE ENVIRONMENT
During 1998, stock and bond market volatility reflected shifting investor
perceptions regarding global economic prospects. Investor optimism early in the
year gave way to expectations of deteriorating corporate profits and signs of a
weakening economy by late summer. Further concerns arose from the precarious
state of the Russian and other emerging market economies. As a result, world
stock markets declined in the July--September period. At the same time, the
uncertain economic picture and the resulting flight to quality by investors
pushed the 30-year US Treasury bond to record low yields. Yields also declined
in sovereign bond markets of other major industrialized countries. In contrast,
corporate bonds, mortgage-backed securities and emerging markets debt
underperformed US Treasury securities by a wide margin.
The US Federal Reserve Board and other central banks responded to the
uncertain economic outlook through a series of monetary policy easings that
served to restore investor confidence as 1998 drew toward a close. Stock markets
around the world rallied, with total returns for the unmanaged Standard & Poor's
500 Index rising 21.3% and the unmanaged Morgan Stanley Capital International
World Index (Ex-US) increasing 20.5% during the fourth quarter of 1998. However,
as 1999 began, uncertainty regarding global economic prospects again began to
cloud the investment outlook. At the same time, with stronger-than-expected
economic results, prospects dimmed for further Federal Reserve Board monetary
policy easings in the near future. The notable exception to the more subdued
investment outlook in the United States was the unprecedented popularity of
Internet-related stocks.
The weakening of the US dollar relative to the Japanese yen was one of the
year's more surprising developments. Since a stronger yen would have a negative
impact on the important export sector of Japan's fragile economy, the Japanese
central bank intervened in the currency markets in January. For the overall
global economy, the deepening recession in Japan is of great concern. At the
same time, the difficulties in emerging economies such as Russia and Brazil
remain. Further progress in easing strains within the global financial system
would likely provide an important element of stability to the volatile
investment environment.
FISCAL YEAR IN REVIEW
Although the overall trend in US interest rates has been toward a downward
shift in the entire US Treasury yield curve for the year ended December 31,
1998, the long end of the curve underperformed the front end with the five-year
sector recording the best overall performance. Similarly, all fixed-income
markets exhibited a significant degree of volatility, with yield spread
relationships among the various types of bonds dramatically widening during the
third quarter of 1998 only to recoup much of the widening during the fourth
quarter. With respect to the investment-grade corporate bond market, yield
spreads relative to US Treasury securities were initially impacted by the
significant increase in new corporate issuance, followed by the overwhelming
pressure that arose from the global liquidity crisis and the deleveraging of
financial markets. By year-end, yield spread relationships had retraced
approximately 50%-75% from the widest levels reached in 1998.
For the 12-month period ended December 31, 1998, the Fund's Class A Shares had
a total return of +7.85%, compared to a total return of +8.72% for the unmanaged
Merrill Lynch Corporate Master Index. Industry selection within the corporate
bond market benefited the Fund as we underweighted those groups that experienced
the greatest amount of spread widening, including brokerage firms, Yankee
issues, money center banks, cyclicals and companies with significant exposure to
the Pacific Basin. Furthermore, the Fund maintained a 3%-5% position in US
Treasury securities, a sector that outperformed corporate bonds during the year.
During the year, the Fund's overall performance was helped by its limited
position (15% underweighted relative to the Index) in BBB- rated corporate
securities, a sector that produced the lowest returns in the investment-grade
universe. However, by the end of the third quarter of 1998, we increased the
Fund's allocation to the BBB sector, given its attractive relative value.
Conversely, overall performance was somewhat negatively impacted by the
underperformance of the Fund's holdings of commercial mortgage-backed
securities, home equity loans and other asset-backed securities relative to
corporate debt, although these securities have recently performed better. The
Fund's nearly 7% position in floating rate securities also negatively affected
performance as price appreciation fell short of expectations.
227
<PAGE> 229
- --------------------------------------------------------------------------------
Going forward, we expect the financial markets to remain extremely volatile
with liquidity remaining at a premium. We believe that the Federal Reserve Board
will not seek to alter monetary policy in the near term despite an economy that
remains extremely strong. Foremost, the Federal Reserve Board remains clearly
concerned about the overall state of the global economy as highlighted by the
difficult situation that Brazil is currently facing and the effect that higher
US interest rates would have on these economies. Furthermore, the inflation
horizon remains very clear, and should remain under control given the extent to
which the economy has evolved into a very efficient, technologically driven
system. We expect corporate yield spreads to exhibit modest improvement into the
second quarter of 1999. However, we will hedge our investment outlook by
continuing to emphasize liquidity and high-quality issues in the investment
strategy process.
IN CONCLUSION
We appreciate your investment in Prime Bond Fund of Merrill Lynch Variable
Series Funds, Inc., and we look forward to sharing our investment outlook and
strategies with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Christopher G. Ayoub
Christopher G. Ayoub
Senior Vice President and Portfolio Manager
/s/ Jay C. Harbeck
Jay C. Harbeck
Senior Vice President and Portfolio Manager
January 29, 1999
- ---------------------------------------------------------
On January 29, 1999, Jay C. Harbeck retired as Senior Vice President and
Portfolio Manager of Prime Bond Fund. His colleagues at Merrill Lynch Asset
Management, L.P. join the Company's Board of Directors in wishing Mr. Harbeck
well in his retirement.
- ---------------------------------------------------------
228
<PAGE> 230
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
Prime Bond Fund
Total Return Based on a $10,000 Investment-Class A Shares
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Merrill Lynch Corporate Master Index.
Beginning and ending values are:
<TABLE>
<CAPTION>
12/88 12/98
----- -----
<S> <C> <C>
Prime Bond Fund+--
Class A Shares* $10,000 $23,254
Merrill Lynch Corporate
Master Index++ $10,000 $25,910
</TABLE>
*Assuming transaction costs and other operating expenses, including advisory
fees. Does not include insurance-related fees and expenses.
+Prime Bond Fund invests primarily in long-term corporate bonds rated A or
better by either Standard & Poor's Corp. or Moody's Investors Service, Inc.
++This unmanaged broad-based Index is comprised of all
industrialized bonds rated BBB3 or higher, of all maturities.
Past performance is not predictive of future performance.
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/98 +7.85%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/98 +6.50
- --------------------------------------------------------------------------------
Ten Years Ended 12/31/98 +8.81
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
RECENT PERFORMANCE RESULTS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
12 MONTH 6 MONTH
TOTAL RETURN TOTAL RETURN
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Class A Shares +7.85% +3.52%
</TABLE>
- --------------------------------------------------------------------------------
* Total investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the payable date. Insurance-related fees and
expenses are not reflected in these returns. Past results shown should not be
considered a representation of future performance.
229
<PAGE> 231
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT CORPORATE BONDS & NOTES COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSET-BACKED AAA Aaa $ 3,000,000 Aames Mortgage Trust, Series
SECURITIES+--9.5% 1998-C, Class A2A, 5.912%
due 9/15/2028............... $ 3,000,000 $ 3,001,530
NR* Baa2 6,000,000 Bistro Trust 1998-1000, 6.58%
due 3/26/2001++............. 5,999,760 6,088,080
AA Aa2 3,200,000 CIT Group Home Equity Loan
Trust, 6.44% due
11/15/2027.................. 3,198,785 3,215,104
AAA Aaa 4,000,000 Citibank Credit Card Master
Trust I, Class A, 5.363% due
12/10/2008.................. 3,998,440 3,892,080
AAA Aaa 8,000,000 Federal Home Loan Mortgage
Corporation, Series 2063,
Class PN, 6% due
10/15/2018.................. 8,126,875 8,044,960
AAA Aaa 4,486,525 Federal National Mortgage
Association, 6.448% due
12/25/2012.................. 4,497,742 4,444,464
A A2 6,000,000 First Dominion Funding I,
Series 1A, Class B, 6.431%
due 7/10/2013++............. 5,977,422 5,640,000
AAA Aaa 1,315,241 General Motors Acceptance
Corp. Grantor Trust, Series
1997-A, Class A, 6.50% due
4/15/2002................... 1,314,874 1,326,644
AAA Aaa 6,000,000 Government National Mortgage
Association, Series 1998-14,
6.375% due 11/20/2026....... 5,954,062 6,056,220
AAA Aaa 5,500,000 IMC Home Equity Loan Trust,
Series 1998-3, Class A5,
6.36% due 8/20/2022......... 5,498,934 5,551,810
NR* A2 4,500,000 Mortgage Capital Funding,
Inc., Series 1998-MC2, Class
C, 6.726% due 6/18/2008..... 4,545,000 4,598,086
BBB- Baa1 6,000,000 York Funding Ltd., Series
1998-1A, Class III, 6.50%
due 6/15/2005++............. 5,996,250 4,860,000
------------ ------------
58,108,144 56,718,978
- ---------------------------------------------------------------------------------------------------------------------------
BANKS & THRIFTS--8.9% BBB+ A3 2,500,000 BB&T Corporation, 7.25% due
6/15/2007................... 2,488,325 2,727,025
Bank of New York Company,
Inc.:
A A2 4,000,000 7.625% due 7/15/2002.......... 4,306,000 4,276,680
A A2 2,000,000 7.875% due 11/15/2002......... 2,213,400 2,165,840
A Aa3 500,000 Boatman's Bancshares, 9.25%
due 11/01/2001.............. 547,990 548,470
A A2 2,000,000 First Interstate, Series C,
11.25% due 3/27/2001........ 2,354,060 2,247,200
BBB+ A1 1,000,000 First Union Institution, 8.04%
due 12/01/2026.............. 1,060,960 1,101,370
BBB+ a2 8,000,000 Fleet Capital Trust II, 7.92%
due 12/11/2026.............. 7,922,070 8,884,000
BBB+ A3 3,000,000 Great Western Bank, 9.875% due
6/15/2001................... 3,325,350 3,279,450
BBB+ a2 1,000,000 HSBC Americas Capital Trust,
7.808% due 12/15/2026++..... 988,460 954,029
A- A3 3,000,000 HSBC Americas Inc., 7% due
11/01/2006.................. 2,974,800 3,141,540
A- A2 1,750,000 Key Bank USA N.A., 7.55% due
9/15/2006................... 1,899,572 1,934,607
BBB A1 4,000,000 KeyCorp Capital I, 6.427% due
7/01/2028++................. 3,959,760 3,856,800
BBB+ Baa1 5,000,000 MBNA America Bank N.A., 5.543%
due 6/10/2004++............. 4,922,850 4,756,750
</TABLE>
230
<PAGE> 232
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT CORPORATE BONDS & NOTES COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BANKS & THRIFTS A- a2 $ 3,000,000 Mellon Capital II, 7.995% due
(CONCLUDED) 1/15/2027................... $ 2,860,410 $ 3,335,580
A A3 4,500,000 Mellon Financial Co., 6.375%
due 2/15/2010............... 4,518,180 4,728,330
A Aa3 5,000,000 NationsBank Corp., 6.50% due
8/15/2003................... 4,755,150 5,173,400
------------ ------------
51,097,337 53,111,071
- ---------------------------------------------------------------------------------------------------------------------------
FINANCE--7.0% AA- Aa3 10,000,000 Associates Corp. of North
America, 6.45% due
10/15/2001.................. 10,269,000 10,254,300
A A2 1,500,000 Beneficial Corporation, Series
I, 6.80% due 9/16/2003...... 1,500,000 1,555,332
A aa3 6,100,000 CIT Capital Trust I, 7.70% due
2/15/2027................... 6,072,184 6,373,969
A+ Aa3 4,490,000 CIT Group Holdings, Inc.,
7.125% due 6/17/2002........ 4,704,083 4,717,733
Commercial Credit Co.:
A+ Aa3 3,250,000 10% due 5/01/1999............. 3,626,350 3,292,542
A+ Aa3 1,500,000 6.75% due 7/01/2007........... 1,534,980 1,600,335
BBB Baa2 5,000,000 Erac USA Finance Company,
6.375% due 5/15/2003++...... 4,996,550 4,964,535
A- Baa1 2,500,000 Finova Capital Corp., 6.25%
due 11/01/2002.............. 2,490,425 2,522,200
A+ Aa3 6,000,000 Norwest Financial, Inc.,
6.625% due 7/15/2004........ 5,973,540 6,293,580
------------ ------------
41,167,112 41,574,526
- ---------------------------------------------------------------------------------------------------------------------------
FINANCE--OTHER--10.0% A+ aa3 2,000,000 Citigroup Capital II, 7.75%
due 12/01/2036.............. 2,003,400 2,147,606
AA- Aa2 1,000,000 Citigroup Inc., 9.50% due
3/01/2002................... 1,084,200 1,114,530
BBB- Baa2 3,000,000 Commercial Net Lease Realty,
7.125% due 3/15/2008........ 2,991,870 2,775,960
A+ A1 3,500,000 Dean Witter, Discover & Co.,
6.75% due 8/15/2000......... 3,486,805 3,559,220
Donaldson, Lufkin & Jenrette
Inc.:
A- A3 5,500,000 6.875% due 11/01/2005......... 5,477,000 5,741,505
A- A3 1,500,000 6.50% due 6/01/2008........... 1,493,775 1,542,375
A A2 1,500,000 Equitable Life Assurance
Society of the US, 7.70% due
12/01/2015++................ 1,489,740 1,645,425
BBB- Baa3 2,000,000 Hospitality Properties Trust,
7% due 3/01/2008............ 1,996,400 1,847,320
A Baa1 4,000,000 Lehman Brothers Holdings,
Inc., 6.50% due
10/01/2002.................. 3,996,200 4,000,452
A Baa1 1,000,000 Lehman Brothers Inc., 7.36%
due 12/15/2003.............. 1,020,170 1,034,630
AA Aa2 6,500,000 MBIA, Inc., 7.15% due
7/15/2027................... 6,484,075 6,963,450
A+ Aa3 500,000 Morgan Stanley, Dean Witter,
Discover & Co., 6.125% due
10/01/2003.................. 503,710 506,195
Paine Webber Group Inc.:
BBB+ Baa1 3,000,000 9.25% due 12/15/2001.......... 3,501,570 3,242,610
BBB+ Baa1 2,000,000 8.875% due 3/15/2005.......... 2,012,540 2,246,200
A+ A2 4,500,000 Prudential Insurance Co.,
6.375% due 7/23/2006++...... 4,480,110 4,633,763
Salomon Smith Barney Holdings:
A Aa3 2,000,000 5.875% due 2/01/2001.......... 1,993,680 2,008,708
A Aa3 2,000,000 6.625% due 11/15/2003......... 1,988,320 2,051,782
BBB+ Baa1 4,250,000 Simon Debartolo Group LP,
7.375% due 6/15/2018........ 4,233,735 3,959,725
</TABLE>
231
<PAGE> 233
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT CORPORATE BONDS & NOTES COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
FINANCE--OTHER BBB Baa2 $ 6,200,000 Spieker Properties LP, 7.35%
(CONCLUDED) due 12/01/2017.............. $ 6,255,658 $ 5,862,385
BBB Baa3 3,000,000 Storage USA, 7.45% due
7/01/2018................... 2,996,460 2,734,206
------------ ------------
59,489,418 59,618,047
- ---------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL--CONSUMER Anheuser-Busch Companies:
GOODS--5.7% A+ A1 2,500,000 8.75% due 12/01/1999.......... 2,839,090 2,581,050
A+ A1 5,000,000 7.375% due 7/01/2023.......... 5,127,300 5,416,800
A A3 5,500,000 Avon Products Inc., 6.25% due
5/01/2018++................. 5,493,180 5,637,065
A+ A3 1,000,000 Coca-Cola Enterprises, 5.75%
due 11/01/2008.............. 993,330 1,007,400
BBB- Baa3 4,000,000 Flowers Industries Inc., 7.15%
due 4/15/2028............... 3,978,800 3,837,920
A+ A1 3,500,000 Hershey Foods Co., 8.80% due
2/15/2021................... 4,690,735 4,616,605
AA Aa2 3,310,000 Kimberly-Clark Corp., 6.375%
due 1/01/2028............... 3,282,726 3,445,942
A A1 3,000,000 Pepsico, Inc., 5.75% due
1/02/2003................... 2,984,820 3,029,799
A A2 4,000,000 Phillip Morris Companies,
Inc., 9% due 1/01/2001...... 4,071,540 4,270,560
------------ ------------
33,461,521 33,843,141
- ---------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL-- AA Aa2 2,000,000 BP America Inc., 9.375% due
ENERGY--2.3% 11/01/2000.................. 2,204,960 2,147,260
AA- Aa3 3,000,000 Dresser Industries, Inc.,
7.60% due 8/15/2096......... 2,991,270 3,537,840
Occidental Petroleum Corp.:
BBB Baa2 4,500,000 6.50% due 4/01/2005........... 4,474,350 4,405,995
BBB Baa2 2,000,000 (MOPPRS), 6.40% due
4/01/2013................... 1,997,860 2,001,214
A+ A1 1,500,000 Texaco Capital Inc., 9% due
12/15/1999.................. 1,731,670 1,553,475
------------ ------------
13,400,110 13,645,784
- ---------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL-- A A2 3,500,000 AlliedSignal Inc., 6.20% due
MANUFACTURING--10.8% 2/01/2008................... 3,495,310 3,560,550
BBB+ A3 5,500,000 Applied Materials, Inc.,
7.125% due 10/15/2017....... 5,462,380 5,324,220
A+ A2 2,000,000 Danaher Corp., 6% due
10/15/2008.................. 1,989,260 1,992,600
AA+ Aa1 3,000,000 Emerson Electric Co., 5% due
10/15/2008.................. 2,990,820 2,909,550
Ford Motor Credit Company:
A A1 3,000,000 8.20% due 2/15/2002........... 3,197,310 3,235,680
A A1 2,500,000 7.75% due 3/15/2005........... 2,497,725 2,771,825
A A1 3,000,000 5.35% due 8/27/2006++......... 2,997,920 2,992,500
A A1 2,000,000 8.90% due 1/15/2032........... 2,471,480 2,665,620
AAA Aaa 3,245,000 General Electric Capital
Corp., 8.125% due
5/15/2012................... 3,449,052 4,008,256
General Motors Acceptance
Corp.:
A A2 5,000,000 7.70% due 4/15/2016........... 5,455,750 5,711,450
A A2 4,000,000 8.80% due 3/01/2021........... 4,689,040 5,154,720
BBB- Baa2 1,500,000 Georgia-Pacific Group, 7.25%
due 6/01/2028............... 1,492,545 1,511,130
A- Baa1 2,000,000 Goodrich (B.F.) Co., 7% due
4/15/2038................... 1,988,220 2,001,820
A+ A1 4,000,000 International Business
Machines Corp., 6.50% due
1/15/2028................... 4,125,360 4,198,360
A A2 2,000,000 Lucent Technologies Inc.,
6.50% due 1/15/2028......... 2,072,360 2,124,340
BBB+ A3 2,500,000 Martin Marietta Corp., 6.50%
due 4/15/2003............... 2,515,325 2,566,750
</TABLE>
232
<PAGE> 234
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT CORPORATE BONDS & NOTES COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INDUSTRIAL--
MANUFACTURING (CONCLUDED)
A A1 $ 6,910,000 PPG Industries Inc., 6.50% due
11/01/2007.................. $ 6,888,855 $ 7,215,491
BBB Baa1 3,500,000 Raytheon Company, 6.50% due
7/15/2005................... 3,536,820 3,680,044
A A2 500,000 Xerox Corporation, 5.50% due
11/15/2003.................. 501,145 503,320
------------ ------------
61,816,677 64,128,226
- ---------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL-- A A2 2,500,000 Bass America, Inc., 8.125% due
SERVICES--12.2% 3/31/2002................... 2,668,930 2,664,525
A A2 4,000,000 Carnival Corp., 7.70% due
7/15/2004................... 4,208,480 4,333,200
BBB- Baa3 3,000,000 Comcast Cable Communications,
6.20% due 11/15/2008........ 2,992,050 3,055,140
A- Baa1 8,000,000 Computer Associates
International, Series B,
6.25% due 4/15/2003......... 7,984,960 7,969,664
Dillard Department Stores,
Inc.:
BBB Baa1 3,000,000 9.125% due 8/01/2011.......... 3,240,150 3,582,960
BBB Baa1 1,500,000 7.85% due 10/01/2012.......... 1,677,420 1,624,980
A A2 1,782,349 +Disney-Custom Repackaged
Asset Vehicle-403, 6.85% due
1/10/2007++................. 1,781,155 1,849,187
A+ A1 7,000,000 Electronic Data Systems Corp.,
6.85% due 5/15/2000++....... 6,994,470 7,143,675
AAA Aaa 3,000,000 Johnson & Johnson, 8.72% due
11/01/2024.................. 3,000,000 3,582,810
A A2 615,000 May Department Stores Co.,
8.30% due 7/15/2026......... 702,742 713,960
AAA Aaa 1,500,000 Merck & Co. Inc., 5.95% due
12/01/2028.................. 1,487,550 1,497,375
A A2 4,000,000 Nordstrom, Inc., 6.95% due
3/15/2028................... 4,051,840 4,210,800
A- A2 7,000,000 Sears Roebuck Acceptance
Corp., Series III, 6.82% due
10/17/2002.................. 7,014,280 7,290,430
BBB- Baa3 2,500,000 TCI Communications Inc., 8.75%
due 8/01/2015............... 2,932,650 3,105,725
BBB Baa2 4,000,000 Time Warner Entertainment Co.,
8.375% due 3/15/2023........ 4,618,120 4,855,920
BBB Baa3 5,500,000 Time Warner Inc., 6.625% due
5/15/2029................... 5,448,245 5,596,030
BBB+ Baa3 1,000,000 USA Waste Services, 7% due
7/15/2028................... 988,870 1,032,830
AA Aa2 7,000,000 Wal-Mart Stores, Inc., 8.50%
due 9/15/2024............... 7,036,810 8,082,480
------------ ------------
68,828,722 72,191,691
- ---------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL-- Southwest Airlines Co.:
TRANSPORTATION--1.5% A- A3 3,000,000 9.40% due 7/01/2001........... 3,420,210 3,249,810
A- A3 4,000,000 8% due 3/01/2005.............. 3,980,450 4,389,560
A- A3 1,000,000 7.875% due 9/01/2007.......... 992,600 1,117,880
------------ ------------
8,393,260 8,757,250
- ---------------------------------------------------------------------------------------------------------------------------
UTILITIES-- BBB Baa3 3,500,000 AT&T Capital Corp., Series F,
COMMUNICATIONS--7.4% 7.50% due 11/15/2000........ 3,496,745 3,542,840
A A3 7,725,000 Frontier Corp., 6% due
10/15/2013++................ 7,873,444 7,808,816
AA- A2 6,000,000 GTE California, Inc., Series
C, 8.07% due 4/15/2024...... 6,412,380 6,660,720
</TABLE>
233
<PAGE> 235
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT CORPORATE BONDS & NOTES COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
UTILITIES--
COMMUNICATIONS
(CONCLUDED)
GTE Corp.:
A Baa1 $ 1,500,000 9.375% due 12/01/2000......... $ 1,647,090 $ 1,608,855
A Baa1 1,500,000 6.84% due 4/15/2018........... 1,541,970 1,599,555
AAA Aa1 3,000,000 Indiana Bell Telephone Co.,
Inc., 7.30% due 8/15/2026... 3,030,280 3,481,110
MCI WorldCom Inc.:
BBB+ Baa2 2,500,000 7.75% due 4/01/2007........... 2,722,350 2,824,125
BBB+ Baa2 5,300,000 6.125% due 4/15/2012.......... 5,285,849 5,380,666
Southwestern Bell
Telecommunications Corp.:
AA Aa3 1,000,000 6.125% due 3/01/2000.......... 1,005,000 1,009,960
AA Aa3 1,000,000 6.625% due 4/01/2005.......... 958,450 1,063,400
AA Aa3 2,000,000 6.375% due 11/15/2007......... 2,009,520 2,129,460
Sprint Capital Corp.:
A- Baa1 1,500,000 5.70% due 11/15/2003.......... 1,499,745 1,505,355
A- Baa1 3,000,000 6.125% due 11/15/2008......... 2,997,780 3,065,490
A- A3 2,400,000 US West Capital Funding Inc.,
6.50% due 11/15/2018........ 2,386,224 2,455,920
------------ ------------
42,866,827 44,136,272
- ---------------------------------------------------------------------------------------------------------------------------
UTILITIES-- AAA Aaa 8,000,000 Cleveland Electric/Toledo
ELECTRIC--7.5% Edison, Series B, 7.13% due
7/01/2007................... 8,392,720 8,677,440
AA- Aa3 5,950,000 Florida Power Corp., 6.875%
due 2/01/2008............... 6,504,480 6,461,581
A A1 3,000,000 Mississippi Power Co., Series
B,
6.05% due 5/01/2003......... 3,067,440 3,081,720
AA- A1 3,500,000 Pacific Gas and Electric
Company, Series 93C, 6.25%
due 8/01/2003............... 3,565,275 3,621,485
A- A3 2,000,000 Pennsylvania Power & Light
Co.,
6.125% due 5/01/2006........ 1,998,800 2,029,740
A- A3 4,000,000 Public Service Electric & Gas
Co., 6.50% due 6/01/2000.... 3,998,315 4,049,760
A- A3 6,000,000 Rochester Gas & Electric,
Series B, 5.84% due
12/22/2008.................. 6,000,000 5,960,628
BBB Baa3 2,000,000 Texaco Utilities, 5.94% due
10/15/2011.................. 2,000,000 2,011,660
A A2 7,500,000 Virginia Electric & Power Co.,
Series B, 8.625% due
10/01/2024.................. 7,416,540 8,629,875
------------ ------------
42,943,570 44,523,889
- ---------------------------------------------------------------------------------------------------------------------------
YANKEE CORPORATES**--8.2% AA- Aa2 1,500,000 ABN AMRO Bank N.V., 7.125% due
6/18/2007(1)................ 1,499,265 1,616,475
BBB- Baa3 5,000,000 Abitibi-Consolidated Inc.,
6.95% due 4/01/2008(3)...... 4,990,300 4,834,500
BBB A3 1,500,000 AmVescap PLC, 6.375% due
5/15/2003(1)................ 1,497,285 1,499,455
A+ A1 6,000,000 Australia & New Zealand
Banking Group Ltd., 7.55%
due 9/15/2006(1)............ 5,990,880 6,478,680
A- Baa1 3,000,000 Enersis S.A., 6.90% due
12/01/2006(3)............... 2,992,260 2,727,510
BBB+ Baa3 8,000,000 Fairfax Financial Holdings
Ltd., 7.375% due
4/15/2018(1)................ 7,982,560 7,745,840
A A1 2,000,000 Ford Capital B.V., 9.50% due
6/01/2010(1)................ 2,217,880 2,614,900
A+ A1 5,500,000 Grand Metropolitan Investment
PLC, 6.50% due
9/15/1999(1)................ 5,615,810 5,550,765
AAA Aaa 1,500,000 International Bank for
Reconstruction &
Development, 5.625% due
3/17/2003(1)................ 1,494,975 1,517,445
A A2 5,000,000 Norsk Hydro A/S, 6.70% due
1/15/2018(3)................ 4,974,400 4,994,540
</TABLE>
234
<PAGE> 236
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT CORPORATE BONDS & NOTES COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
YANKEE
CORPORATES
(CONCLUDED)
A+ Aa3 $ 2,000,000 Sony Corporation, 6.125% due
3/04/2003(3)................ $ 1,995,760 $ 2,043,080
Tyco International Group
S.A.(3):
A- Baa1 2,500,000 5.875% due 11/01/2004++....... 2,498,975 2,484,588
A- Baa1 3,500,000 7% due 6/15/2028.............. 3,474,765 3,570,875
BBB+ Baa2 1,000,000 WPP Finance (USA) Corp.,
6.625% due 7/15/2005(1)..... 993,090 1,014,486
------------ ------------
48,218,205 48,693,139
- ---------------------------------------------------------------------------------------------------------------------------
YANKEE SOVEREIGN**--2.1% AA+ Aa2 3,000,000 Canada Government Bond, 5.25%
due 11/05/2008(2)........... 2,999,310 3,003,750
AA- A1 1,000,000 Province of Manitoba, 5.50%
due 10/01/2008(2)........... 993,620 1,009,210
AA- Aa3 1,000,000 Province of Ontario, 5.50% due
10/01/2008(2)............... 994,080 1,003,850
Province of Quebec(2):
A+ A2 3,500,000 8.80% due 4/15/2003........... 3,944,780 3,927,455
A+ A2 3,500,000 Series NN, 7.125% due
2/09/2024................... 3,645,635 3,821,720
------------ ------------
12,577,425 12,765,985
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL CORPORATE
BONDS & NOTES--93.1% 542,368,328 553,707,999
- ---------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT OBLIGATIONS
- ---------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT US Treasury Bonds & Notes:
OBLIGATIONS--4.0% AAA Aaa 1,900,000 7.25% due 5/15/2004........... 2,103,656 2,129,482
AAA Aaa 2,000,000 7% due 7/15/2006.............. 2,301,563 2,277,180
AAA Aaa 10,580,000 6.125% due 11/15/2027......... 11,822,631 11,842,935
AAA Aaa 7,000,000 5.50% due 8/15/2028........... 7,412,188 7,327,040
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL US GOVERNMENT
OBLIGATIONS--4.0% 23,640,038 23,576,637
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
SHORT-TERM SECURITIES
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
REPURCHASE 7,743,000 Warburg Dillon Read LLC,
AGREEMENTS***--1.3% purchased on 12/31/1998 to
yield 4.75% to 1/04/1999.... 7,743,000 7,743,000
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM
SECURITIES--1.3% 7,743,000 7,743,000
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS--98.4%...... $573,751,366 585,027,636
============
OTHER ASSETS LESS
LIABILITIES--1.6%........... 9,272,922
------------
NET ASSETS--100.0%............ $594,300,558
============
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Not Rated.
** Corresponding industry groups for foreign securities, which are denominated
in US dollars:
(1) Financial Institution
(2) Government Entity
(3) Industrial
*** Repurchase Agreements are fully collateralized by US Government & Agency
Obligations.
+ Subject to principal paydowns.
++ The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
++ Floating rate note.
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
235
<PAGE> 237
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$573,751,366) (Note
1a)....................................................... $585,027,636
Cash........................................................ 706
Receivables:
Interest.................................................. $9,331,718
Capital shares sold....................................... 231,427
Loaned securities (Note 6)................................ 2,329 9,565,474
----------
Prepaid expenses and other assets........................... 45,578
------------
Total assets................................................ 594,639,394
------------
- ---------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Investment adviser (Note 2)............................... 209,726
Capital shares redeemed................................... 8,216 217,942
----------
Accrued expenses and other liabilities...................... 120,894
------------
Total liabilities........................................... 338,836
------------
- ---------------------------------------------------------------------------------------
NET ASSETS.................................................. $594,300,558
============
- ---------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 4,853,155
Paid-in capital in excess of par............................ 583,921,667
Undistributed investment income--net........................ 3,079,720
Accumulated realized capital losses on investments--net
(Note 5).................................................. (8,830,254)
Unrealized appreciation on investments--net................. 11,276,270
------------
NET ASSETS.................................................. $594,300,558
============
- ---------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $594,300,558 and 48,531,554
shares outstanding........................................ $ 12.25
============
- ---------------------------------------------------------------------------------------
</TABLE>
+ The Fund is also authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
236
<PAGE> 238
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTE 1d):
Interest and discount earned................................ $38,008,236
Other income................................................ 75,612
-----------
Total income................................................ 38,083,848
-----------
- --------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $2,330,935
Accounting services (Note 2)................................ 107,616
Printing and shareholder reports............................ 80,457
Custodian fees.............................................. 50,907
Professional fees........................................... 40,799
Directors' fees and expenses................................ 11,867
Pricing services............................................ 9,396
Registration fees........................................... 8,859
Transfer agent fees (Note 2)................................ 5,119
Other....................................................... 6,870
----------
Total expenses.............................................. 2,652,825
-----------
Investment income--net...................................... 35,431,023
-----------
- --------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET (NOTES
1d & 3):
Realized gain on investments--net........................... 7,560,501
Change in unrealized appreciation on investments--net....... (1,000,179)
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $41,991,345
===========
- --------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
237
<PAGE> 239
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
----------------------------
INCREASE (DECREASE) IN NET ASSETS: 1998 1997
- --------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 35,431,023 $ 34,680,688
Realized gain (loss) on investments--net.................... 7,560,501 (659,507)
Change in unrealized appreciation/depreciation on
investments--net.......................................... (1,000,179) 8,588,890
------------ ------------
Net increase in net assets resulting from operations........ 41,991,345 42,610,071
------------ ------------
- --------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS (NOTE 1E):
Investment income--net:
Class A................................................... (35,531,406) (34,630,429)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders.............................................. (35,531,406) (34,630,429)
------------ ------------
- --------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase (decrease) in net assets derived from capital
share transactions........................................ 60,070,576 (18,603,327)
------------ ------------
- --------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... 66,530,515 (10,623,685)
Beginning of year........................................... 527,770,043 538,393,728
------------ ------------
End of year*................................................ $594,300,558 $527,770,043
============ ============
- --------------------------------------------------------------------------------------------
*Undistributed investment income--net....................... $ 3,079,720 $ 3,180,103
============ ============
- --------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
238
<PAGE> 240
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE
BEEN DERIVED FROM INFORMATION PROVIDED IN THE CLASS A
FINANCIAL STATEMENTS. -----------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year.................... $ 12.11 $ 11.91 $ 12.45 $ 11.12 $ 12.64
-------- -------- -------- -------- --------
Investment income--net................................ .77 .78 .80 .82 .77
Realized and unrealized gain (loss) on investments--
net................................................. .15 .20 (.55) 1.34 (1.36)
-------- -------- -------- -------- --------
Total from investment operations...................... .92 .98 .25 2.16 (.59)
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net.............................. (.78) (.78) (.79) (.83) (.76)
In excess of realized gain on investments--net...... -- -- -- -- (.17)
-------- -------- -------- -------- --------
Total dividends and distributions..................... (.78) (.78) (.79) (.83) (.93)
-------- -------- -------- -------- --------
Net asset value, end of year.......................... $ 12.25 $ 12.11 $ 11.91 $ 12.45 $ 11.12
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share.................... 7.85% 8.64% 2.21% 20.14% (4.80%)
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses.............................................. .48% .47% .49% .50% .54%
======== ======== ======== ======== ========
Investment income--net................................ 6.35% 6.62% 6.67% 7.00% 6.74%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)................ $594,301 $527,770 $538,394 $489,838 $391,234
======== ======== ======== ======== ========
Portfolio turnover.................................... 103.24% 89.22% 91.88% 90.12% 139.89%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
See Notes to Financial Statements.
239
<PAGE> 241
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Class A Shares
and Class B Shares have equal voting, dividend, liquidation and other rights,
except that only shares of the respective classes are entitled to vote on
matters concerning only that class and Class B Shares bear certain expenses
related to the distribution of such shares. Prime Bond Fund (the "Fund") is
classified as "diversified," as defined in the Investment Company Act of 1940.
The Fund's financial statements are prepared in accordance with generally
accepted accounting principles which may require the use of management accruals
and estimates. The following is a summary of significant accounting policies
followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Short-term securities are valued at amortized cost, which approximates
market value. Securities and assets for which market quotations are not readily
available are valued at fair value as determined in good faith by or under the
direction of the Board of Directors of the Company.
(b) Repurchase agreements--The Fund invests in US Government securities
pursuant to repurchase agreements. Under such agreements, the counterparty
agrees to repurchase the security at a mutually agreed upon time and price. The
Fund takes possession of the underlying securities, marks to market such
securities and, if necessary, receives additional securities daily to ensure
that the contract is fully collateralized.
(c) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Interest income (including amortization of premium and discount) is recognized
on the accrual basis. Realized gains and losses on security transactions are
determined on the identified cost basis.
(e) Dividends and distributions--Dividends from net investment income are
declared and paid monthly. Distributions of capital gains are recorded on the
ex-dividend date.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and portfolios
and provides the necessary personnel, facilities, equipment and certain other
services necessary to the operations of the funds. For such services, the Fund
pays a monthly fee based upon the aggregate daily value of net assets of the
Fund and the Company's High Current Income Fund at the following annual rates:
0.50% of such average daily net assets not exceeding $250 million; 0.45% of such
average daily net assets in excess of $250 million but not more than $500
million; 0.40% of such average daily net assets in excess of $500 million but
not more than $750 million; and 0.35% of such average daily net assets in excess
of $750 million. For the year ended December 31, 1998, the aggregate average
daily net assets of the Fund and the Company's High Current Income Fund was
approximately $1,121,651,000.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed
240
<PAGE> 242
- --------------------------------------------------------------------------------
on Class B Shares, to 1.25% of its average daily net assets. Any such expenses
in excess of 1.25% of average daily net assets will be reimbursed to the Fund by
MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1998, the Fund paid Merrill Lynch Pricing
Service, an affiliate of Merrill Lynch, Pierce, Fenner & Smith, Incorporated,
$8,190 for providing security price quotations to compute the net asset value of
the Fund.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Merrill Lynch Funds Distributor, a division of Princeton Funds Distributor,
Inc. ("PFD"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
is the Fund's distributor.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1998 were $616,144,800 and $556,855,502, respectively.
Net realized gains for the year ended December 31, 1998 and net unrealized
gains as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
Realized Unrealized
Gains Gains
- ------------------------------------------------------------------
<S> <C> <C>
Long-term investments................... $7,560,501 $11,276,270
---------- -----------
Total................................... $7,560,501 $11,276,270
========== ===========
- ------------------------------------------------------------------
</TABLE>
At December 31, 1998, net unrealized appreciation for Federal income tax
purposes aggregated $11,221,870, of which $17,731,715 related to appreciated
securities and $6,509,845 related to depreciated securities. At December 31,
1998, the aggregate cost of investments for Federal income tax purposes was
$573,805,766.
4. CAPITAL SHARE TRANSACTIONS:
Net increase (decrease) in net assets derived from capital share transactions
were $60,070,576 and $(18,603,327) for the years ended December 31, 1998 and
December 31, 1997, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1998 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 5,551,338 $ 67,504,987
Shares issued to shareholders in
reinvestment of dividends........... 2,934,639 35,531,406
---------- ------------
Total issued......................... 8,485,977 103,036,393
Shares redeemed...................... (3,540,230) (42,965,817)
---------- ------------
Net increase......................... 4,945,747 $ 60,070,576
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 3,589,337 $ 42,528,752
Shares issued to shareholders in
reinvestment of dividends........... 2,931,101 34,630,429
---------- ------------
Total issued......................... 6,520,438 77,159,181
Shares redeemed...................... (8,146,214) (95,762,508)
---------- ------------
Net decrease......................... (1,625,776) $(18,603,327)
========== ============
- -----------------------------------------------------------------
</TABLE>
5. CAPITAL LOSS CARRYFORWARD:
At December 31, 1998, the Fund had a net capital loss carryforward of
approximately $8,649,000, of which $7,112,000 expires in 2002, $856,000 expires
in 2003 and $681,000 expires in 2005. This amount will be available to offset
like amounts of any future taxable gains.
6. LOANED SECURITIES:
At December 31, 1998, the Fund held US Treasury bonds having an aggregate value
of approximately $3,256,000 as collateral for portfolio securities loaned having
a market value of approximately $3,140,000.
7. SUBSEQUENT EVENT:
On January 4, 1999, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.063458 per Class A Share payable on January 11, 1999
to shareholders of record as of December 31, 1998.
241
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
PRIME BOND FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Prime Bond Fund of Merrill Lynch Variable Series
Funds, Inc. as of December 31, 1998, the related statements of operations for
the year then ended and changes in net assets for each of the years in the
two-year period then ended, and the financial highlights for each of the years
in the five-year period then ended. These financial statements and the financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and the financial
highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1998 by correspondence with the custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Prime Bond Fund of
Merrill Lynch Variable Series Funds, Inc. as of December 31, 1998, the results
of its operations, the changes in its net assets, and the financial highlights
for the respective stated periods in conformity with generally accepted
accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
242
<PAGE> 244
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
DECEMBER 31, 1998--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
THE ENVIRONMENT
During 1998, stock and bond market volatility reflected shifting investor
perceptions regarding global economic prospects. Investor optimism early in the
year gave way to expectations of deteriorating corporate profits and signs of a
weakening economy by late summer. Further concerns arose from the precarious
state of the Russian and other emerging markets economies. As a result, world
stock markets declined in the July--September period. At the same time, the
uncertain economic picture and the resulting flight to quality by investors
pushed the 30-year US Treasury bond to record low yields. Yields also declined
in sovereign bond markets of other major industrialized countries. In contrast,
corporate bonds, mortgage-backed securities and emerging markets debt
underperformed US Treasury securities by a wide margin.
The US Federal Reserve Board and other central banks responded to the
uncertain economic outlook through a series of monetary policy easings that
served to restore investor confidence as 1998 drew toward a close. Stock markets
around the world rallied, with total returns for the unmanaged Standard & Poor's
500 Index rising 21.3% and the unmanaged Morgan Stanley Capital International
World Index (Ex-US) increasing 20.5% during the fourth quarter of 1998. However,
as 1999 began, uncertainty regarding global economic prospects again began to
cloud the investment outlook. At the same time, with stronger-than-expected
economic results, prospects dimmed for further Federal Reserve Board monetary
policy easings in the near future. The notable exception to the more subdued
investment outlook in the United States was the unprecedented popularity of
Internet-related stocks.
The weakening of the US dollar relative to the Japanese yen was one of the
year's more surprising developments. Since a stronger yen would have a negative
impact on the important export sector of Japan's fragile economy, the Japanese
central bank intervened in the currency markets in January. For the overall
global economy, the deepening recession in Japan is of great concern. At the
same time, the difficulties in emerging economies such as Russia and Brazil
remain. Further progress in easing strains within the global financial system
would likely provide an important element of stability to the volatile
investment environment.
FISCAL YEAR IN REVIEW
As of December 31, 1998, the Fund's asset allocation was: US stocks, 89% of
net assets; foreign stocks, 10%; and cash reserves, 1%.
The maintenance of a relatively low cash position throughout much of 1998
proved to be beneficial to the Fund's overall performance. Despite a significant
correction in the US stock market during the third quarter of 1998, a strong
rebound during the remainder of the year resulted in the fourth consecutive year
of exceptional returns for US equities. However, the US stock market was
characterized by a significant outperformance for a narrow group of large-
capitalization equities. During the fourth quarter, we increased our
representation in equities of this type, although the Fund was underweighted for
much of 1998 in this narrow group of common stocks that dominated the
performance of the benchmark Standard & Poor's 500 Index. In the foreign equity
sector, the overweighting of European equities had a positive impact on
performance, since European equity markets outperformed Japan and the majority
of equity markets during 1998. However, as was the case in the United States, a
narrow group of larger-capitalization equities significantly outperformed the
European markets as a whole, and the Fund was underweighted in these equities
during much of 1998.
PORTFOLIO MATTERS
With a US equity allocation of 85% of net assets at June 30, 1998, the Fund's
weighting in US common stocks was expanded to 90% of net assets by December 31,
1998. Beginning in September 1998, a shift toward an increasingly accommodative
monetary policy by the Federal Reserve Board led us to become more positive
toward US equities. In increasing our US equity exposure, we emphasized the
shares of companies that we believed offered a high degree of earnings
visibility through 1999 despite an expected slowdown in economic activity. New
positions in the Fund included commitments in the technology sector, such as
Intel Corporation, Microsoft Corporation, and Motorola, Inc., and in healthcare,
through Johnson & Johnson. As of December 31, 1998, consumer staples, technology
and financial services represented the largest sector weightings among our US
equity commitments.
Over the six-month period ended December 31, 1998, we reduced the Fund's
commitment to foreign equities from 14% of net assets to 10%. We continued to
limit representation to
243
<PAGE> 245
- --------------------------------------------------------------------------------
companies that we believe offer potential for above-average appreciation
relative to US and foreign markets. The majority of our foreign equity
commitments are in European companies, with a position in Canada through
Teleglobe Inc. and in Singapore through Flextronics International Ltd.
IN CONCLUSION
We appreciate your investment in Quality Equity Fund of Merrill Lynch Variable
Series Funds, Inc., and we look forward to sharing our investment outlook and
strategies with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Thomas R. Robinson
Thomas R. Robinson
Senior Vice President and Portfolio Manager
February 5, 1999
244
<PAGE> 246
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
Quality Equity Fund
Total Return Based on a $10,000 Investment-Class A Shares
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Standard & Poor's 500 Index.
Beginning and ending values are:
<TABLE>
<CAPTION>
12/98 12/98
----- -----
<S> <C> <C>
Quality Equity Fund+ --
Class A Shares* $10,000 $41,168
Standard & Poor's 500 Index++ $10,000 $57,962
</TABLE>
* Assuming transaction costs and other operating expenses, including advisory
fees. Does not include insurance-related fees and expenses.
+ Quality Equity Fund, which uses a fully managed investment policy, invests
primarily in common stocks of large-capitalization companies, as well as
investment-grade debt and convertible securities.
++ This unmanaged broad-based Index is comprised of common stocks.
Past performance is not predictive of future performance.
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/98 +15.58%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/98 +15.35
- --------------------------------------------------------------------------------
Ten Years Ended 12/31/98 +15.20
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
RECENT PERFORMANCE RESULTS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
12 MONTH 6 MONTH
TOTAL RETURN TOTAL RETURN
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Class A Shares +15.58% +0.63%
- ------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the ex-dividend date. Insurance-related fees
and expenses are not reflected in these returns. Past results shown should not
be considered a representation of future performance.
245
<PAGE> 247
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
AEROSPACE & DEFENSE 260,000 GenCorp Inc. ................ $ 7,589,255 $ 6,483,750 0.7%
38,800 United Technologies
Corporation................ 3,069,068 4,219,500 0.5
------------ ------------ -----
10,658,323 10,703,250 1.2
- -----------------------------------------------------------------------------------------------------------------------
AUTOMOBILE PARTS 221,400 Federal-Mogul Corporation.... 9,509,262 13,173,300 1.5
- -----------------------------------------------------------------------------------------------------------------------
AUTOMOBILE RENTAL & LEASING 289,300 +Avis Rent-A-Car, Inc........ 6,617,064 6,997,444 0.8
129,850 The Hertz Corporation (Class
A)......................... 5,189,321 5,924,406 0.7
------------ ------------ -----
11,806,385 12,921,850 1.5
- -----------------------------------------------------------------------------------------------------------------------
AUTOMOTIVE 121,400 General Motors Corporation... 8,579,751 8,687,688 1.0
- -----------------------------------------------------------------------------------------------------------------------
BANKING 327,100 The Bank of New York Company,
Inc. ...................... 2,943,074 13,165,775 1.5
131,336 BankAmerica Corporation...... 6,236,159 7,896,577 0.9
------------ ------------ -----
9,179,233 21,062,352 2.4
- -----------------------------------------------------------------------------------------------------------------------
BANKING & FINANCIAL 225,900 First Union Corporation...... 11,179,673 13,737,544 1.6
139,400 Mellon Bank Corporation...... 8,690,283 9,583,750 1.1
------------ ------------ -----
19,869,956 23,321,294 2.7
- -----------------------------------------------------------------------------------------------------------------------
BEVERAGES 235,300 PepsiCo, Inc. ............... 9,142,854 9,632,594 1.1
- -----------------------------------------------------------------------------------------------------------------------
BROADCASTING--MEDIA 90,900 +Fox Entertainment Group,
Inc. (Class A)............. 2,045,250 2,289,544 0.3
- -----------------------------------------------------------------------------------------------------------------------
CHEMICALS 78,150 du Pont (E.I.) de Nemours and
Company.................... 4,870,271 4,146,834 0.5
232,200 Morton International,
Inc. ...................... 6,695,970 5,688,900 0.6
------------ ------------ -----
11,566,241 9,835,734 1.1
- -----------------------------------------------------------------------------------------------------------------------
COMPUTER SERVICES 186,900 Cisco Systems, Inc. ......... 7,483,900 17,346,656 2.0
- -----------------------------------------------------------------------------------------------------------------------
COMPUTERS 433,000 COMPAQ Computer
Corporation................ 14,209,496 18,158,937 2.1
113,100 Dell Computer Corporation.... 7,124,397 8,277,506 1.0
52,150 +EMC Corporation............. 3,726,320 4,432,750 0.5
71,600 International Business
Machines Corporation....... 7,457,161 13,228,100 1.5
------------ ------------ -----
32,517,374 44,097,293 5.1
- -----------------------------------------------------------------------------------------------------------------------
CONSUMER PRODUCTS 533,200 The Dial Corporation......... 10,888,428 15,396,150 1.8
- -----------------------------------------------------------------------------------------------------------------------
DATA PROCESSING 55,000 +Keane, Inc. ................ 1,932,662 2,196,563 0.3
- -----------------------------------------------------------------------------------------------------------------------
ELECTRICAL EQUIPMENT 70,700 General Electric Company..... 5,349,161 7,215,819 0.8
182,800 PECO Energy Company.......... 6,244,759 7,609,050 0.9
------------ ------------ -----
11,593,920 14,824,869 1.7
- -----------------------------------------------------------------------------------------------------------------------
ELECTRONICS 109,050 Intel Corporation............ 12,067,525 12,922,425 1.5
114,700 +Micron Technology, Inc. .... 4,353,276 5,799,519 0.7
------------ ------------ -----
16,420,801 18,721,944 2.2
- -----------------------------------------------------------------------------------------------------------------------
ENTERTAINMENT 598,800 Premier Parks Inc. .......... 16,915,316 18,113,700 2.1
183,800 Royal Caribbean Cruises
Ltd. ...................... 4,252,936 6,800,600 0.8
------------ ------------ -----
21,168,252 24,914,300 2.9
- -----------------------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES 191,800 Associates First Capital
Corporation (Class A)...... 6,934,942 8,127,525 0.9
384,500 Heller Financial, Inc. ...... 10,810,290 11,294,687 1.3
248,700 Providian Financial
Corporation................ 11,440,945 18,652,500 2.2
------------ ------------ -----
29,186,177 38,074,712 4.4
- -----------------------------------------------------------------------------------------------------------------------
FOOD DISTRIBUTION 145,700 Nabisco Holdings Corp. (Class
A)......................... 5,277,734 6,046,550 0.7
- -----------------------------------------------------------------------------------------------------------------------
FOODS 284,000 +Keebler Foods Company....... 8,069,510 10,685,500 1.2
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--CANADA* 329,000 Teleglobe Inc.(12) .......... 8,899,447 11,844,000 1.4
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
246
<PAGE> 248
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FOREIGN--FINLAND* 44,300 Nokia Oyj (Class A)(3)....... $ 4,067,131 $ 5,389,189 0.6%
68,900 UPM-Kymmene Oyj(9)........... 1,792,427 1,919,710 0.2
------------ ------------ -----
5,859,558 7,308,899 0.8
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--FRANCE* 13,600 Cap Gemini S.A.(6)........... 2,074,497 2,182,833 0.2
85,800 +STMicroelectronics N.V. (NY
Registered Shares)(11)..... 7,353,767 6,697,763 0.8
------------ ------------ -----
9,428,264 8,880,596 1.0
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--IRELAND* 107,000 Bank of Ireland(1)........... 1,958,889 2,343,624 0.3
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--SINGAPORE* 65,200 +Flextronics International
Ltd.(5) ................... 4,559,214 5,574,600 0.6
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--SWEDEN* 410,200 Telefonaktiebolaget LM
Ericsson(ADR)**(12)........ 10,417,546 9,793,525 1.1
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--SWITZERLAND* 4,196 Novartis AG (Registered
Shares)(4)................. 7,827,654 8,254,426 1.0
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--UNITED KINGDOM* 219,052 Diageo PLC (ADR)**(2)........ 10,470,181 10,131,155 1.2
197,500 Bank of Scotland(1).......... 1,921,536 2,355,074 0.3
471,400 British Petroleum Company
PLC(8)..................... 6,720,536 7,036,268 0.8
125,200 Glaxo Wellcome PLC(10)....... 3,960,692 4,305,992 0.5
171,600 Shell Transport & Trading
Company (ADR)**(7)......... 6,304,196 6,381,375 0.7
102,400 Zeneca Group PLC(4).......... 4,050,536 4,456,789 0.5
------------ ------------ -----
33,427,677 34,666,653 4.0
- -----------------------------------------------------------------------------------------------------------------------
HARDWARE & TOOLS 204,900 The Black & Decker
Corporation................ 8,137,206 11,487,206 1.3
- -----------------------------------------------------------------------------------------------------------------------
INSTRUMENTS--SCIENTIFIC 135,600 Millipore Corporation........ 2,888,571 3,856,125 0.5
- -----------------------------------------------------------------------------------------------------------------------
INSURANCE 150,100 Allmerica Financial
Corporation................ 9,440,302 8,687,037 1.0
237,600 The Equitable Companies
Incorporated............... 12,625,833 13,751,100 1.6
187,000 UNUM Corporation............. 6,725,726 10,916,125 1.3
------------ ------------ -----
28,791,861 33,354,262 3.9
- -----------------------------------------------------------------------------------------------------------------------
MACHINERY 62,400 Case Corporation............. 1,669,248 1,361,100 0.2
274,700 Ingersoll-Rand Company....... 8,261,132 12,893,731 1.5
------------ ------------ -----
9,930,380 14,254,831 1.7
- -----------------------------------------------------------------------------------------------------------------------
MANUFACTURING 215,600 Tyco International Ltd. ..... 11,149,255 16,264,325 1.9
- -----------------------------------------------------------------------------------------------------------------------
MEDICAL 187,000 Beckman Coulter Inc. ........ 11,178,860 10,144,750 1.2
- -----------------------------------------------------------------------------------------------------------------------
MEDICAL SERVICES 292,068 +HEALTHSOUTH Corporation..... 6,259,368 4,508,800 0.5
- -----------------------------------------------------------------------------------------------------------------------
MEDICAL TECHNOLOGY 117,850 Johnson & Johnson............ 9,521,595 9,884,669 1.1
- -----------------------------------------------------------------------------------------------------------------------
METALS 40,450 Aluminum Co. of America...... 3,137,409 3,016,053 0.4
- -----------------------------------------------------------------------------------------------------------------------
NATURAL GAS 410,400 El Paso Energy Corporation... 10,461,716 14,287,050 1.7
- -----------------------------------------------------------------------------------------------------------------------
NETWORKING 177,200 +3Com Corporation............ 7,225,923 7,940,775 0.9
- -----------------------------------------------------------------------------------------------------------------------
OIL & GAS PRODUCERS 252,500 Enron Corporation............ 11,205,557 14,408,281 1.7
- -----------------------------------------------------------------------------------------------------------------------
OIL--INTEGRATED 79,500 Mobil Corporation............ 6,226,352 6,926,438 0.8
- -----------------------------------------------------------------------------------------------------------------------
OIL SERVICES 118,800 Schlumberger Limited......... 6,860,138 5,479,650 0.6
- -----------------------------------------------------------------------------------------------------------------------
PAPER & FOREST PRODUCTS 140,600 Kimberly-Clark Corporation... 6,682,782 7,662,700 0.9
- -----------------------------------------------------------------------------------------------------------------------
PETROLEUM 271,000 Unocal Corporation........... 10,503,446 7,909,813 0.9
- -----------------------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 142,000 Bristol-Myers Squibb
Company.................... 13,499,186 19,001,375 2.2
202,300 Warner-Lambert Company....... 9,647,013 15,210,431 1.8
------------ ------------ -----
23,146,199 34,211,806 4.0
- -----------------------------------------------------------------------------------------------------------------------
PRINTING/PUBLISHING 373,000 +World Color Press, Inc. .... 11,602,841 11,353,188 1.3
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
247
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
RADIO & TELEVISION 570,300 +Capstar Broadcasting
Corporation (Class A)...... $ 10,835,700 $ 13,045,612 1.5%
- -----------------------------------------------------------------------------------------------------------------------
RAILROADS 344,400 Burlington Northern Santa Fe
Corp. ..................... 10,692,933 11,623,500 1.4
- -----------------------------------------------------------------------------------------------------------------------
RETAIL 197,500 Safeway Inc. ................ 6,156,977 12,035,156 1.4
164,100 Wal-Mart Stores, Inc. ....... 6,785,630 13,363,894 1.5
------------ ------------ -----
12,942,607 25,399,050 2.9
- -----------------------------------------------------------------------------------------------------------------------
RETAIL SPECIALTY 300,000 Lowe's Companies, Inc. ...... 10,809,478 15,356,250 1.8
361,800 Rite Aid Corporation......... 6,427,100 17,931,713 2.1
------------ ------------ -----
17,236,578 33,287,963 3.9
- -----------------------------------------------------------------------------------------------------------------------
SAVINGS & LOAN ASSOCIATIONS 397,000 GreenPoint Financial
Corp. ..................... 15,934,733 13,944,625 1.6
- -----------------------------------------------------------------------------------------------------------------------
SEMICONDUCTORS 249,900 Motorola, Inc. .............. 13,397,192 15,259,519 1.8
- -----------------------------------------------------------------------------------------------------------------------
SERVICES 162,400 +Quintiles Transnational
Corp. ..................... 7,568,840 8,657,950 1.0
- -----------------------------------------------------------------------------------------------------------------------
SOFTWARE 178,100 BMC Software, Inc. .......... 3,346,585 7,936,581 0.9
48,650 +Microsoft Corporation....... 5,689,562 6,741,066 0.8
------------ ------------ -----
9,036,147 14,677,647 1.7
- -----------------------------------------------------------------------------------------------------------------------
STEEL 159,200 +Bethlehem Steel
Corporation................ 1,684,909 1,333,300 0.1
59,000 USX-U.S. Steel Group......... 1,613,497 1,357,000 0.2
------------ ------------ -----
3,298,406 2,690,300 0.3
- -----------------------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 223,000 GTE Corporation.............. 11,366,502 15,038,562 1.7
300,300 +MCI WorldCom, Inc. ......... 9,271,601 21,546,525 2.5
322,569 Tele-Communications, Inc.
(Class A).................. 7,253,992 17,842,098 2.1
767,462 +Tele-Communications TCI
Ventures Group (Class A)... 7,094,315 18,083,323 2.1
------------ ------------ -----
34,986,410 72,510,508 8.4
- -----------------------------------------------------------------------------------------------------------------------
TOYS 79,600 Mattel, Inc. ................ 1,843,210 1,815,875 0.2
- -----------------------------------------------------------------------------------------------------------------------
UTILITIES--COMMUNICATION 256,100 Ameritech Corporation........ 12,345,296 16,230,337 1.9
- -----------------------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 176,400 Public Service Enterprise
Group Incorporated......... 6,853,768 7,056,000 0.8
138,500 Texas Utilities Company...... 6,198,373 6,466,219 0.8
------------ ------------ -----
13,052,141 13,522,219 1.6
- -----------------------------------------------------------------------------------------------------------------------
WASTE MANAGEMENT 193,000 Waste Management, Inc. ...... 8,189,493 8,998,625 1.0
- -----------------------------------------------------------------------------------------------------------------------
TOTAL STOCKS 675,543,407 861,212,918 99.8
- -----------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT SHORT-TERM SECURITIES
- -----------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER*** $2,261,000 General Motors Acceptance
Corp., 5.13% due
1/04/1999.................. 2,259,711 2,259,711 0.3
- -----------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES 2,259,711 2,259,711 0.3
- -----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS............ $677,803,118 863,472,629 100.1
============
UNREALIZED DEPRECIATION ON
FORWARD FOREIGN EXCHANGE
CONTRACTS****.............. (95,244) 0.0
LIABILITIES IN EXCESS OF
OTHER ASSETS............... (480,308) (0.1)
------------ -----
NET ASSETS................... $862,897,077 100.0%
============ =====
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
248
<PAGE> 250
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED)
- --------------------------------------------------------------------------------
* Corresponding industry groups for foreign securities:
(1) Banking
(2) Beverages
(3) Communications Equipment
(4) Drugs
(5) Electronics Components
(6) Information Processing
(7) Oil--Integrated
(8) Oil--Related
(9) Paper & Forest Products
(10) Pharmaceuticals
(11) Semiconductors
(12) Telecommunications
** American Depositary Receipts (ADR).
*** Commercial Paper is traded on a discount basis; the interest rate shown
reflects the discount rate paid at the time of purchase by the Fund.
**** Forward foreign exchange contracts as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------
UNREALIZED
APPRECIATION
FOREIGN (DEPRECIATION)
CURRENCY SOLD EXPIRATION DATE (NOTE 1B)
- -------------------------------------------------
<S> <C> <C> <C>
C$ 16,300,000 February 1999 $(88,009)
L 13,500,000 January 1999 (62,708)
L 3,300,000 February 1999 55,473
- -------------------------------------------------
TOTAL UNREALIZED DEPRECIATION ON FORWARD FOREIGN
EXCHANGE CONTRACTS--NET (US$
COMMITMENT--$38,455,045)
$(95,244)
========
- -------------------------------------------------
</TABLE>
+ Non-income producing security.
See Notes to Financial Statements.
249
<PAGE> 251
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$677,803,118) (Note
1a)....................................................... $863,472,629
Cash........................................................ 826
Receivables:
Dividends................................................. $722,439
Capital shares sold....................................... 13,752 736,191
--------
Prepaid expenses and other assets........................... 57,492
------------
Total assets................................................ 864,267,138
------------
- -------------------------------------------------------------------------------------
LIABILITIES:
Unrealized depreciation on forward foreign exchange
contracts (Note 1b)....................................... 95,244
Payables:
Capital shares redeemed................................... 835,276
Investment adviser (Note 2)............................... 305,142 1,140,418
--------
Accrued expenses and other liabilities...................... 134,399
------------
Total liabilities........................................... 1,370,061
------------
- -------------------------------------------------------------------------------------
NET ASSETS.................................................. $862,897,077
============
- -------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 2,263,398
Paid-in capital in excess of par............................ 587,325,449
Undistributed investment income--net........................ 7,715,643
Undistributed realized capital gains on investments and
foreign currency transactions--net........................ 80,017,868
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 185,574,719
------------
NET ASSETS.................................................. $862,897,077
============
- -------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $862,897,077 and 22,633,976
shares outstanding........................................ $ 38.12
============
- -------------------------------------------------------------------------------------
</TABLE>
+ The Fund is also authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
250
<PAGE> 252
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1D & 1E):
Dividends (net of $232,247 foreign withholding tax)......... $ 10,360,399
Interest and discount earned................................ 1,902,504
Other income................................................ 184,756
------------
Total income................................................ 12,447,659
------------
- ----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $ 3,758,987
Accounting services (Note 2)................................ 170,271
Printing and shareholder reports............................ 104,394
Custodian fees.............................................. 87,606
Professional fees........................................... 58,183
Directors' fees and expenses................................ 19,230
Transfer agent fees (Note 2)................................ 5,127
Pricing services............................................ 2,559
Other....................................................... 9,933
-----------
Total expenses.............................................. 4,216,290
------------
Investment income--net...................................... 8,231,369
------------
- ----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET (NOTES 1b, 1c, 1e & 3):
Realized gain (loss) from:
Investments--net.......................................... 81,220,643
Foreign currency transactions--net........................ (508,259) 80,712,384
-----------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... 36,328,354
Foreign currency transactions--net........................ (102,254) 36,226,100
----------- ------------
Net realized and unrealized gain on investments and foreign
currency transactions..................................... 116,938,484
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $125,169,853
============
- ----------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
251
<PAGE> 253
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-----------------------------
INCREASE (DECREASE) IN NET ASSETS: 1998 1997
- -------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 8,231,369 $ 9,621,453
Realized gain on investments and foreign currency
transactions--net......................................... 80,712,384 113,655,662
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ 36,226,100 50,541,550
------------- ------------
Net increase in net assets resulting from operations........ 125,169,853 173,818,665
------------- ------------
- -------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1F):
Investment income--net:
Class A................................................... (8,061,972) (5,217,029)
Realized gain on investments--net:
Class A................................................... (115,958,721) (37,207,312)
------------- ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (124,020,693) (42,424,341)
------------- ------------
- -------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net decrease in net assets derived from capital share
transactions.............................................. (13,316,065) (50,605,570)
------------- ------------
- -------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... (12,166,905) 80,788,754
Beginning of year........................................... 875,063,982 794,275,228
------------- ------------
End of year*................................................ $ 862,897,077 $875,063,982
============= ============
- -------------------------------------------------------------------------------------------
* Undistributed investment income--net (Note 1g)............ $ 7,715,643 $ 8,054,505
============= ============
- -------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
252
<PAGE> 254
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE
BEEN DERIVED FROM INFORMATION PROVIDED IN THE CLASS A+
FINANCIAL STATEMENTS. -----------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year.................. $ 38.42 $ 32.83 $ 32.76 $ 27.74 $ 29.02
-------- -------- -------- -------- --------
Investment income--net.............................. .34 .41 .58 .58 .38
Realized and unrealized gain (loss) on investments
and foreign currency transactions--net............ 4.80 6.94 4.44 5.48 (.74)
-------- -------- -------- -------- --------
Total from investment operations.................... 5.14 7.35 5.02 6.06 (.36)
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net............................ (.35) (.22) (.66) (.45) (.25)
Realized gain on investments--net................. (5.09) (1.54) (4.29) (.59) (.67)
-------- -------- -------- -------- --------
Total dividends and distributions................... (5.44) (1.76) (4.95) (1.04) (.92)
-------- -------- -------- -------- --------
Net asset value, end of year........................ $ 38.12 $ 38.42 $ 32.83 $ 32.76 $ 27.74
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share.................. 15.58% 23.70% 17.90% 22.61% (1.20%)
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses............................................ .49% .48% .49% .51% .54%
======== ======== ======== ======== ========
Investment income--net.............................. .95% 1.16% 1.89% 1.94% 1.39%
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands).............. $862,897 $875,064 $794,275 $644,551 $464,360
======== ======== ======== ======== ========
Portfolio turnover.................................. 100.29% 100.08% 88.30% 140.32% 60.57%
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding.
See Notes to Financial Statements.
253
<PAGE> 255
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Class A and
Class B Shares have equal voting, dividend, liquidation and other rights, except
that only shares of the respective classes are entitled to vote on matters
concerning only that class and Class B Shares bear certain expenses related to
the distribution of such shares. Quality Equity Fund (the "Fund") is classified
as "diversified," as defined in the Investment Company Act of 1940. The Fund's
financial statements are prepared in accordance with generally accepted
accounting principles which may require the use of management accruals and
estimates. The following is a summary of significant accounting policies
followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written are valued at the last sale price in the case of
exchange-traded options. In the case of options traded in the over-the-counter
market, valuation is the last asked price. Short-term securities are valued at
amortized cost, which approximates market value. Securities and assets for which
market quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Board of Directors of
the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity, debt and currency markets. Losses may arise due
to changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts.
- - Options--The Fund may write covered call options. When the Fund writes an
option, an amount equal to the premium received by the Fund is reflected as an
asset and an equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option written. When
a security is purchased or sold through an exercise of an option, the related
premium received is added to (or deducted from) the basis of the security
acquired or deducted from (or added to) the proceeds of the security sold. When
an option expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums received (or
gain or loss to the extent the cost of the closing transaction exceeds the
premium received).
Written options are non-income producing investments.
(c) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets and liabilities expressed in
foreign currencies into US dollars. Realized and unrealized gains or losses from
investments include the effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
254
<PAGE> 256
- --------------------------------------------------------------------------------
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently recorded
when the Fund has determined the ex-dividend date. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(g) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $508,259 have been reclassified between undistributed
net realized capital gains and undistributed net investment income. These
reclassifications have no effect on net assets or net asset value per share.
2. INVESTMENT ADVISORY AGREEMENT AND
TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner. MLAM is responsible for the management of the Company's
funds and provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the funds.
For such services, the Fund pays a monthly fee at the following annual rates:
0.500% of the Fund's average daily net assets not exceeding $250 million; 0.450%
of average daily net assets in excess of $250 million but not exceeding $300
million; 0.425% of average daily net assets in excess of $300 million but not
exceeding $400 million; and 0.400% of average daily net assets in excess of $400
million.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1998, Merrill Lynch, Pierce, Fenner & Smith
Incorporated, a subsidiary of ML & Co., earned $196,521 in commissions on the
execution of portfolio security transactions.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Merrill Lynch Funds Distributor, a division of Princeton Funds Distributor,
Inc. ("PFD"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
is the Fund's distributor.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1998 were $832,942,405 and $945,144,595, respectively.
Net realized gains (losses) for the year ended December 31, 1998 and net
unrealized gains (losses) as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains (Losses)
- ----------------------------------------------------------------------
<S> <C> <C>
Long-term investments................ $81,221,108 $185,669,511
Short-term investments............... (465) --
Forward foreign exchange contracts... (425,514) (95,244)
Foreign currency transactions........ (82,745) 452
----------- ------------
Total................................ $80,712,384 $185,574,719
=========== ============
- ----------------------------------------------------------------------
</TABLE>
At December 31, 1998, net unrealized appreciation for Federal income tax
purposes aggregated $185,669,511, of which $200,941,344 related to appreciated
securities and $15,271,833 related to depreciated securities. At December 31,
1998, the aggregate cost of investments for Federal income tax purposes was
$677,803,118.
4. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share transactions were
$13,316,065 and $50,605,570 for the years ended December 31, 1998 and December
31, 1997, respectively.
255
<PAGE> 257
- --------------------------------------------------------------------------------
Transactions in capital shares were as follows:
- ---------------------------------------------------------
<TABLE>
<CAPTION>
Class A Shares for the Year Ended Dollar
December 31, 1998 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 384,573 $ 13,339,188
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 3,754,789 124,020,693
---------- -------------
Total issued......................... 4,139,362 137,359,881
Shares redeemed...................... (4,278,868) (150,675,946)
---------- -------------
Net decrease......................... (139,506) $ (13,316,065)
========== =============
- -----------------------------------------------------------------
</TABLE>
- ---------------------------------------------------------
<TABLE>
<CAPTION>
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 762,740 $ 26,562,888
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 1,378,757 42,424,341
---------- -------------
Total issued......................... 2,141,497 68,987,229
Shares redeemed...................... (3,562,259) (119,592,799)
---------- -------------
Net decrease......................... (1,420,762) $ (50,605,570)
========== =============
- -----------------------------------------------------------------
</TABLE>
5. SUBSEQUENT EVENT:
On January 4, 1999, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.341407 per Class A Share and a long-term capital
gains distribution in the amount of $3.535300 per Class A Share payable on
January 11, 1999 to shareholders of record as of December 31, 1998.
256
<PAGE> 258
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
QUALITY EQUITY FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Quality Equity Fund of Merrill Lynch Variable
Series Funds, Inc. as of December 31, 1998, the related statements of operations
for the year then ended and changes in net assets for each of the years in the
two-year period then ended, and the financial highlights for each of the years
in the five-year period then ended. These financial statements and the financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and the financial
highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1998 by correspondence with the custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Quality Equity Fund
of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1998, the
results of its operations, the changes in its net assets, and the financial
highlights for the respective stated periods in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
257
<PAGE> 259
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
DECEMBER 31, 1998--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1998, the Reserve Assets Fund's Class A Shares
had a net annualized yield of 4.96%.* For the six-month period ended December
31, 1998, the Reserve Assets Fund's Class A Shares had a net annualized yield of
4.89%.* The Fund's Class A Shares' 7-day yield as of December 31, 1998 was
4.95%. The average portfolio maturity was 69 days at December 31, 1998, compared
to 76 days at June 30, 1998.
THE ENVIRONMENT
During 1998, stock and bond market volatility reflected shifting investor
perceptions regarding global economic prospects. Investor optimism early in the
year gave way to expectations of deteriorating corporate profits and signs of a
weakening economy by late summer. Further concerns arose from the precarious
state of the Russian and other emerging market economies. As a result, world
stock markets declined in the July-September period. At the same time, the
uncertain economic picture and the resulting flight to quality by investors
pushed the 30-year US Treasury bond to record low yields. Yields also declined
in sovereign bond markets of other major industrialized countries. In contrast,
corporate bonds, mortgage-backed securities and emerging markets debt
underperformed US Treasury securities by a wide margin.
The US Federal Reserve Board and other central banks responded to the
uncertain economic outlook through a series of monetary policy easings that
served to restore investor confidence as 1998 drew toward a close. Stock markets
around the world rallied, with total returns for the unmanaged Standard & Poor's
500 Index rising 21.3% and the unmanaged Morgan Stanley Capital International
World Index (Ex-US) increasing 20.5% during the fourth quarter of 1998. However,
as 1999 began, uncertainty regarding global economic prospects again began to
cloud the investment outlook. At the same time, with stronger-than-expected
economic results, prospects dimmed for further Federal Reserve Board monetary
policy easings in the near future. The notable exception to the more subdued
investment outlook in the United States was the unprecedented popularity of
Internet-related stocks.
The weakening of the US dollar relative to the Japanese yen was one of the
year's more surprising developments. Since a stronger yen would have a negative
impact on the important export sector of Japan's fragile economy, the Japanese
central bank intervened in the currency markets in January. For the overall
global economy, the deepening recession in Japan is of great concern. At the
same time, the difficulties in emerging economies such as Russia and Brazil
remain. Further progress in easing strains within the global financial system
would likely provide an important element of stability to the volatile
investment environment.
PORTFOLIO MATTERS
For the year ended December 31, 1998, the Fund maintained an average life
ranging from a low of 65 days to a high of 88 days. Throughout most of the year,
the Fund maintained an average life toward the higher end of the allowed band.
During the 12-month period, short-term interest rates rallied over 100 basis
points (1.00%).
Our constructive investment strategy that we implemented in early 1998 was
based primarily on the growing crisis in the overseas markets. Despite a
relatively strong domestic economy, we firmly believed that the Federal Reserve
Board would give precedence to the economic turmoil that occurred in Asia and
eventually spread to Russia. We took advantage of this situation by maintaining
the Fund's average life toward the higher end of our investment horizon. This
strategy proved to be effective as the Federal Reserve Board cut interest rates
in September, in mid-October, and again in mid-November for a total of 75 basis
points.
Looking ahead, we believe that monetary policy will be driven more by economic
data than by global market considerations. While the economic picture is not
completely clear at present, we believe the economy is more likely to weaken
rather than strengthen in 1999.
- ---------------
* Based on a constant investment throughout the period, with dividends
compounded daily, and reflecting a net return to the investor after all
expenses.
258
<PAGE> 260
- --------------------------------------------------------------------------------
The Fund's composition at the end of December and as of our last report to
shareholders is detailed below.
<TABLE>
<CAPTION>
- -------------------------------------------------------
Issue 12/31/98 6/30/98
- -------------------------------------------------------
<S> <C> <C>
Bank Notes....................... 13.1% 15.0%
Certificates of Deposit.......... -- 1.1
Certificates of
Deposit--Yankee................ -- 2.0
Commercial Paper................. 34.5 45.0
Corporate Notes.................. 24.7 15.2
Funding Agreements............... 4.7 4.5
Repurchase Agreements............ 3.0 --
US Government, Agency &
Instrumentality
Obligations--Discount.......... 6.6 0.5
US Government, Agency &
Instrumentality
Obligations--Non-Discount...... 12.9 16.8
Other Assets Less Liabilities.... 0.5 --
Liabilities in Excess of Other
Assets......................... -- (0.1)
----- -----
Total............................ 100.0% 100.0%
===== =====
- -------------------------------------------------------
</TABLE>
IN CONCLUSION
We appreciate your investment in Reserve Assets Fund of Merrill Lynch Variable
Series Funds, Inc., and we look forward to sharing our investment outlook with
you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Jacqueline Rogers
Jacqueline Rogers
Vice President and Portfolio Manager
February 5, 1999
259
<PAGE> 261
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE INTEREST MATURITY VALUE
AMOUNT ISSUE RATE* DATE (NOTE 1A)
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BANK NOTES--13.1% $ 200,000 American Express Centurion Bank+........ 5.511% 3/19/99 $ 200,000
100,000 Comerica Bank+.......................... 5.531 2/02/99 99,997
100,000 Comerica Bank+.......................... 5.457 2/09/99 99,995
100,000 FCC National Bank....................... 5.65 3/03/99 99,908
200,000 First National Bank of Chicago.......... 5.52... 2/16/99 199,742
200,000 First Tennessee Bank N.A. .............. 5.82 4/30/99 200,392
100,000 First USA Bank, N.A. ................... 6.50 12/23/99 101,277
100,000 First Union National Bank+.............. 4.91 8/30/99 100,000
200,000 First Union National Bank+.............. 4.71 9/01/99 200,000
100,000 Huntington National Bank+............... 5.451 1/20/99 99,998
100,000 LaSalle National Bank................... 5.55 2/05/99 99,943
400,000 LaSalle National Bank................... 5.55 2/08/99 400,153
100,000 LaSalle National Bank................... 5.55 2/22/99 99,932
500,000 PNC Bank N.A.+.......................... 4.82 1/29/99 499,976
300,000 PNC Bank N.A.+.......................... 5.235 11/03/99 299,805
- ------------------------------------------------------------------------------------------------------------------------
TOTAL BANK NOTES (COST--$2,801,104) 2,801,118
- ------------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER--34.5% 378,000 Apreco, Inc. ........................... 5.13 3/15/99 374,369
250,000 Asset Securitization Cooperative
Corp. ................................ 5.20 3/01/99 247,970
250,000 Asset Securitization Cooperative
Corp. ................................ 5.15 3/05/99 247,942
289,000 Atlantis One Funding Corp. ............. 5.45 2/11/99 287,368
250,000 Atlantis One Funding Corp. ............. 5.35 3/15/99 247,599
500,000 Atlantis One Funding Corp. ............. 5.30 4/30/99 491,993
250,000 Bankers Trust New York Corporation...... 5.50 1/15/99 249,545
250,000 CS First Boston Inc. ................... 5.50 2/16/99 248,402
250,000 Countrywide Home Loans, Inc. ........... 5.30 2/11/99 248,601
250,000 Edison Asset Securitization, LLC........ 5.40 3/19/99 247,461
275,000 Eureka Securitization Inc. ............. 5.40 2/12/99 273,406
500,000 Finova Capital Corp. ................... 5.53 2/04/99 497,696
150,000 General Electric Capital Corp. ......... 5.47 2/18/99 148,997
91,000 General Motors Acceptance Corp. ........ 5.49 1/26/99 90,691
400,000 Greyhawk Capital Corp. ................. 5.12 2/12/99 397,682
292,000 Greyhawk Capital Corp. ................. 5.41 2/12/99 290,308
250,000 Greyhawk Capital Corp. ................. 5.32 2/18/99 248,328
564,000 International Securitization Corp. ..... 5.30 2/22/99 559,893
250,000 Knight-Ridder, Inc. .................... 5.15 4/20/99 246,342
573,000 Lehman Brothers Holdings Inc. .......... 5.50 2/25/99 567,943
250,000 Mont Blanc Capital Corp. ............... 5.35 1/26/99 249,152
100,000 Mont Blanc Capital Corp. ............... 5.28 2/03/99 99,560
100,000 Morgan Stanley, Dean Witter & Co. ...... 5.52 2/08/99 100,000
100,000 Westdeutsche Landesbank Girozentrale.... 5.20 2/25/99 99,227
300,000 Windmill Funding Corp. ................. 5.18 3/24/99 296,748
300,000 Windmill Funding Corp. ................. 5.19 3/24/99 296,748
- ------------------------------------------------------------------------------------------------------------------------
TOTAL COMMERCIAL PAPER (COST--$7,352,844) 7,353,971
- ------------------------------------------------------------------------------------------------------------------------
CORPORATE NOTES--24.7% 1,000,000 Abbey National Treasury Services Plc+... 4.83 8/17/99 999,513
100,000 Associates Corp. of North America+...... 6.75 6/28/99 100,647
100,000 Associates Corp. of North America....... 6.625 7/15/99 100,756
100,000 Associates Corp. of North America+...... 6.75 10/15/99 101,192
100,000 Beneficial Corp.+....................... 8.375 12/29/99 102,950
100,000 The CIT Group Holdings, Inc.+........... 4.89 1/12/99 99,999
100,000 The CIT Group Holdings, Inc.+........... 6.25 3/22/99 100,235
250,000 The CIT Group Holdings, Inc.+........... 4.79 6/28/99 249,905
100,000 Chase Manhattan Corp.+.................. 5.16 3/25/99 99,998
200,000 General Electric Capital Corp.+......... 4.82 6/03/99 199,960
200,000 General Motors Acceptance Corp.+........ 7.375 5/26/99 201,660
100,000 General Motors Acceptance Corp.+........ 5.315 6/04/99 99,999
100,000 General Motors Acceptance Corp.+........ 6.55 6/04/99 100,535
100,000 General Motors Acceptance Corp.+........ 7.375 6/09/99 100,896
200,000 General Motors Acceptance Corp.+........ 8.625 6/15/99 202,932
</TABLE>
260
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE INTEREST MATURITY VALUE
AMOUNT ISSUE RATE* DATE (NOTE 1A)
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
CORPORATE NOTES $ 100,000 General Motors Acceptance Corp.+........ 5.411% 12/01/00 $ 100,000
(CONCLUDED) 100,000 General Motors Acceptance Corp.+........ 5.28 2/27/01 99,970
100,000 Goldman Sachs Group, L.P.+.............. 5.348 1/12/00 99,900
250,000 IBM Credit Corp.+....................... 6.625 4/19/99 251,035
250,000 Liberty Lighthouse US Capital Co.
LLC+.................................. 5.30 10/08/99 249,945
100,000 Morgan Stanley, Dean Witter & Co.+...... 5.298 1/15/99 100,000
3,513 Premier Auto Trust 1998-3++............. 5.62 2/08/99 3,513
1,000,000 Restructured Asset Securities with
Enhanced Returns, Series
1998-MM-7-1+.......................... 5.534 8/13/99 1,000,000
500,000 Toyota Motor Credit Corp.+.............. 5.545 9/23/99 499,544
- ------------------------------------------------------------------------------------------------------------------------
TOTAL CORPORATE NOTES (COST--$5,263,153) 5,265,084
- ------------------------------------------------------------------------------------------------------------------------
FUNDING AGREEMENTS--4.7%.... 1,000,000 Jackson National Life Insurance Co.+.... 5.567 5/03/99 1,000,000
- ------------------------------------------------------------------------------------------------------------------------
TOTAL FUNDING AGREEMENTS (COST--$1,000,000) 1,000,000
- ------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT, AGENCY & 81,000 Federal National Mortgage Association... 4.92 3/26/99 80,122
INSTRUMENTALITY 200,000 Federal National Mortgage Association... 4.68 6/09/99 195,901
OBLIGATIONS--
DISCOUNT--6.6% 200,000 Federal National Mortgage Association... 4.59 7/08/99 195,139
100,000 Federal National Mortgage Association... 4.54 9/09/99 96,755
100,000 Student Loan Marketing Association...... 4.62 6/30/99 97,674
300,000 US Treasury Bills....................... 3.69 4/22/99 296,049
400,000 US Treasury Bills....................... 3.80 10/14/99 386,290
50,000 US Treasury Bills....................... 3.81 10/14/99 48,286
- ------------------------------------------------------------------------------------------------------------------------
TOTAL US GOVERNMENT, AGENCY & INSTRUMENTALITY
OBLIGATIONS--DISCOUNT (COST--$1,399,204) 1,396,216
- ------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT, AGENCY & 100,000 Federal Home Loan Bank+................. 5.168 9/02/99 99,967
INSTRUMENTALITY 100,000 Federal Home Loan Bank.................. 5.705 3/23/00 100,080
OBLIGATIONS--
NON-DISCOUNT--12.9% 700,000 Federal National Mortgage
Association+.......................... 5.028 3/03/99 699,953
250,000 Federal National Mortgage
Association+.......................... 5.108 4/09/99 249,967
560,000 Federal National Mortgage
Association+.......................... 4.818 5/25/99 558,804
200,000 Federal National Mortgage
Association+.......................... 5.043 7/30/99 199,906
100,000 Federal National Mortgage Association... 5.08 9/24/99 100,040
200,000 Federal National Mortgage Association... 5.07 12/14/00 199,140
100,000 Student Loan Marketing Association+..... 4.50 8/02/99 99,850
250,000 Student Loan Marketing Association+..... 5.083 2/04/00 249,935
100,000 US Treasury Notes....................... 7.125 9/30/99 101,766
100,000 US Treasury Notes....................... 4.625 11/30/00 100,094
- ------------------------------------------------------------------------------------------------------------------------
TOTAL US GOVERNMENT, AGENCY & INSTRUMENTALITY
OBLIGATIONS--NON-DISCOUNT (COST--$2,759,551) 2,759,502
- ------------------------------------------------------------------------------------------------------------------------
REPURCHASE 648,000 Nomura Securities International, Inc.,
AGREEMENTS**--3.0% purchased on 12/31/1998 to yield 5.10%
to 1/04/1999.......................... 648,000
- ------------------------------------------------------------------------------------------------------------------------
TOTAL REPURCHASE AGREEMENTS (COST--$648,000) 648,000
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(COST--$21,223,856)--99.5%.............. 21,223,891
OTHER ASSETS LESS LIABILITIES--0.5%..... 114,235
-----------
NET ASSETS--100.0%...................... $21,338,126
===========
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Commercial Paper and certain US Government, Agency & Instrumentality
Obligations are traded on a discount basis; the interest rates shown reflect the
discount rates paid at the time of purchase by the Fund. Other securities bear
interest at the rates shown, payable at fixed dates or upon maturity. The
interest rates on variable rate securities are adjusted periodically based upon
appropriate indexes; the interest rates shown are the rates in effect at
December 31, 1998.
** Repurchase Agreements are fully collateralized by US Government Obligations.
+ Variable Rate Notes.
++ Subject to principal paydowns.
See Notes to Financial Statements.
261
<PAGE> 263
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$21,223,856*) (Note
1a)....................................................... $21,223,891
Cash........................................................ 2,037
Receivables:
Interest.................................................. $134,784
Capital shares sold....................................... 11,043
Principal paydowns........................................ 265 146,092
--------
Prepaid expenses and other assets........................... 1,758
-----------
Total assets................................................ 21,373,778
-----------
- -------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Capital shares redeemed................................... 10,678
Investment adviser (Note 2)............................... 9,793 20,471
--------
Accrued expenses and other liabilities...................... 15,181
-----------
Total liabilities........................................... 35,652
-----------
- -------------------------------------------------------------------------------------
NET ASSETS.................................................. $21,338,126
===========
- -------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 500,000,000
shares authorized+........................................ $ 2,133,809
Paid-in capital in excess of par............................ 19,204,282
Unrealized appreciation on investments--net................. 35
-----------
NET ASSETS.................................................. $21,338,126
===========
- -------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $21,338,126 and 21,338,090
shares outstanding........................................ $ 1.00
===========
- -------------------------------------------------------------------------------------
</TABLE>
* Cost for Federal income tax purposes. As of December 31, 1998, net unrealized
appreciation for Federal income tax purposes amounted to $35, of which $5,523
related to appreciated securities and $5,488 related to depreciated
securities.
+ The Fund is also authorized to issue 500,000,000 Class B Shares.
See Notes to Financial Statements.
262
<PAGE> 264
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTE 1D):
Interest and discount earned................................ $1,232,951
- ------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $109,945
Custodian fees.............................................. 13,956
Accounting services (Note 2)................................ 6,448
Professional fees........................................... 5,876
Printing and shareholder reports............................ 5,752
Transfer agent fees (Note 2)................................ 5,116
Directors' fees and expenses................................ 502
Other....................................................... 1,604
--------
Total expenses.............................................. 149,199
----------
Investment income--net...................................... 1,083,752
----------
- ------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET (NOTE
1D):
Realized gain on investments--net........................... 6,717
Change in unrealized appreciation on investments--net....... (453)
----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $1,090,016
==========
- ------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
263
<PAGE> 265
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR
ENDED DECEMBER 31,
----------------------------
INCREASE (DECREASE) IN NET ASSETS: 1998 1997
- --------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 1,083,752 $ 1,081,759
Realized gain on investments--net........................... 6,717 1,873
Change in unrealized appreciation/depreciation on
investments--net.......................................... (453) 740
------------ ------------
Net increase in net assets resulting from operations........ 1,090,016 1,084,372
------------ ------------
- --------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1e):
Investment income--net:
Class A................................................... (1,083,752) (1,081,759)
Realized capital gain on investments--net:
Class A................................................... (6,717) (1,873)
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (1,090,469) (1,083,632)
------------ ------------
- --------------------------------------------------------------------------------------------
CLASS A CAPITAL SHARE TRANSACTIONS (NOTE 3):
Net proceeds from sale of shares............................ 9,448,388 8,423,689
Net asset value of shares issued to shareholders in
reinvestment of dividends and distributions (Note 1e)..... 1,090,589 1,083,837
------------ ------------
10,538,977 9,507,526
Cost of shares redeemed..................................... (10,302,620) (11,291,415)
------------ ------------
Net increase (decrease) in net assets derived from capital
share transactions........................................ 236,357 (1,783,889)
------------ ------------
- --------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... 235,904 (1,783,149)
Beginning of year........................................... 21,102,222 22,885,371
------------ ------------
End of year................................................. $ 21,338,126 $ 21,102,222
============ ============
- --------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
264
<PAGE> 266
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FROM CLASS A
INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. ---------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year........................... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
------- ------- ------- ------- -------
Investment income--net....................................... .0496 .0506 .0501 .0543 .0371
Realized and unrealized gain (loss) on investments--net...... .0003 .0001 (.0005) .0018 (.0009)
------- ------- ------- ------- -------
Total from investment operations............................. .0499 .0507 .0496 .0561 .0362
------- ------- ------- ------- -------
Less dividends and distributions:
Investment income--net..................................... (.0496) (.0506) (.0501) (.0543) (.0362)
Realized gain on investments--net.......................... (.0003) (.0001) (.0001) (.0004) --+
------- ------- ------- ------- -------
Total dividends and distributions............................ (.0499) (.0507) (.0502) (.0547) (.0362)
------- ------- ------- ------- -------
Net asset value, end of year................................. $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
======= ======= ======= ======= =======
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share........................... 5.10% 5.19% 5.13% 5.61% 3.79%
======= ======= ======= ======= =======
- -------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses..................................................... .68% .62% .61% .61% .65%
======= ======= ======= ======= =======
Investment income and realized gain on investments--net...... 4.96% 5.06% 4.96% 5.47% 3.75%
======= ======= ======= ======= =======
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)....................... $21,338 $21,102 $22,885 $25,550 $32,196
======= ======= ======= ======= =======
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Amount is less than $.0001 per share.
See Notes to Financial Statements.
265
<PAGE> 267
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Class A and
Class B Shares have equal voting, dividend, liquidation and other rights, except
that only shares of the respective classes are entitled to vote on matters
concerning only that class and Class B Shares bear certain expenses related to
the distribution of such shares. Reserve Assets Fund (the "Fund") is classified
as "diversified," as defined in the Investment Company Act of 1940. The Fund's
financial statements are prepared in accordance with generally accepted
accounting principles which may require the use of management accruals and
estimates. The following is a summary of significant accounting policies
followed by the Fund.
(a) Valuation of investments--Portfolio securities with remaining maturities
of greater than sixty days are valued at the most recent bid price or yield
equivalent as obtained from dealers that make markets in such securities. As
securities transition from sixty-one to sixty days to maturity, the difference
between the valuation existing on the sixty-first day before maturity and
maturity value is amortized on a straight-line basis to maturity. Securities
maturing sixty days or less from their date of acquisition are valued at
amortized cost, which approximates market value. For the purposes of valuation,
the maturity of a variable rate security is deemed to be the next coupon date on
which the interest rate is to be adjusted. Other investments for which market
quotations are not readily available are valued at their fair value as
determined in good faith by or under the direction of the Company's Board of
Directors.
(b) Repurchase agreements--The Fund invests in US Government securities
pursuant to repurchase agreements. Under such agreements, the counterparty
agrees to repurchase the security at a mutually agreed upon time and price. The
Fund takes possession of the underlying securities, marks to market such
securities and, if necessary, receives additions to such securities daily to
ensure that the contract is fully collateralized.
(c) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute all of its taxable income to its shareholders. Therefore, no Federal
income tax provision is required.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Interest income (including amortization of discount) is recognized on the
accrual basis. Realized gains and losses on security transactions are determined
on the identified cost basis.
(e) Dividends and distributions--The Fund declares dividends daily and
reinvests monthly such dividends (net of non-resident alien tax and back-up
withholding tax) in additional shares of beneficial interest at net asset value.
Dividends and distributions are declared from the total of net investment income
and net realized gain or loss on investments.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the following annual rates: 0.500% of the Fund's average daily net assets not
exceeding $500 million; 0.425% of average daily net assets in excess of $500
million but not exceeding $750 million; 0.375% of average daily net assets in
excess of $750 million but not exceeding $1 billion; 0.350% of average daily net
assets in excess of $1 billion but not exceeding $1.5 billion; 0.325% of average
daily net assets in excess of $1.5 billion but not exceeding $2 billion; 0.300%
of average daily net assets in excess of $2 billion but not exceeding $2.5
billion and 0.275% of average daily net assets in excess of $2.5 billion.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the
266
<PAGE> 268
- --------------------------------------------------------------------------------
Fund, exclusive of any distribution fees imposed on Class B Shares, to 1.25% of
its average daily net assets. Any such expenses in excess of 1.25% of average
daily net assets will be reimbursed to the Fund by MLAM which, in turn, will be
reimbursed by MLLA.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Merrill Lynch Funds Distributor, a division of Princeton Funds Distributor,
Inc. ("PFD"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
is the Fund's distributor.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
3. CAPITAL SHARE TRANSACTIONS:
The number of shares sold and redeemed during the periods corresponds to the
amounts included in the Statements of Changes in Net Assets with respect to net
proceeds from sale of shares and cost of shares redeemed, respectively, since
shares are recorded at $1.00 per share.
267
<PAGE> 269
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
RESERVE ASSETS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Reserve Assets Fund of Merrill Lynch Variable
Series Funds, Inc. as of December 31, 1998, the related statements of operations
for the year then ended and changes in net assets for each of the years in the
two-year period then ended, and the financial highlights for each of the years
in the five-year period then ended. These financial statements and the financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and the financial
highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1998 by correspondence with the custodian and broker. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Reserve Assets Fund
of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1998, the
results of its operations, the changes in its net assets, and the financial
highlights for the respective stated periods in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
268
<PAGE> 270
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
DECEMBER 31, 1998--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
THE ENVIRONMENT
During 1998, stock and bond market volatility reflected shifting investor
perceptions regarding global economic prospects. Investor optimism early in the
year gave way to expectations of deteriorating corporate profits and signs of a
weakening economy by late summer. Further concerns arose from the precarious
state of the Russian and other emerging market economies. As a result, world
stock markets declined in the July--September period. At the same time, the
uncertain economic picture and the resulting flight to quality by investors
pushed the 30-year US Treasury bond to record low yields. Yields also declined
in sovereign bond markets of other major industrialized countries. In contrast,
corporate bonds, mortgage-backed securities and emerging markets debt
underperformed US Treasury securities by a wide margin.
The US Federal Reserve Board and other central banks responded to the
uncertain economic outlook through a series of monetary policy easings that
served to restore investor confidence as 1998 drew toward a close. Stock markets
around the world rallied, with total returns for the unmanaged Standard & Poor's
500 Index (S&P 500) rising 21.3% and the unmanaged Morgan Stanley Capital
International World Index (Ex-US) increasing 20.5% during the fourth quarter of
1998. However, as 1999 began, uncertainty regarding global economic prospects
again began to cloud the investment outlook. At the same time, with
stronger-than-expected economic results, prospects dimmed for further Federal
Reserve Board monetary policy easings in the near future. The notable exception
to the more subdued investment outlook in the United States was the
unprecedented popularity of Internet-related stocks.
The weakening of the US dollar relative to the Japanese yen was one of the
year's more surprising developments. Since a stronger yen would have a negative
impact on the important export sector of Japan's fragile economy, the Japanese
central bank intervened in the currency markets in January. For the overall
global economy, the deepening recession in Japan is of great concern. At the
same time, the difficulties in emerging economies such as Russia and Brazil
remain. Further progress in easing strains within the global financial system
would likely provide an important element of stability to the volatile
investment environment.
FISCAL YEAR IN REVIEW
For the 12 months ended December 31, 1998, Special Value Focus Fund
underperformed the unmanaged Russell 2000 Index. Total returns for the Fund's
Class A and Class B Shares were -6.50% and -6.52%, respectively, compared to a
total return of -2.55% for the unmanaged Russell 2000 Index over the same
period. Sector positioning contributed positively to the Fund's full year
investment results, but the weak performance of certain investments outweighed
favorable positions.
The Russell 2000 Index of small-capitalization stocks exhibited extreme
volatility during the 12 months ended December 31, 1998. The Index attained an
all-time high in April, then declined sharply through early October. By
comparison, the decline in large-capitalization stocks was more restrained, as
investors abandoned small-capitalization stocks for the perceived safety of more
liquid issues. The S&P 500 Composite Index posted a total return of +28.58% for
the year, surpassing the unmanaged Russell 2000 Index by more than 31 percentage
points.
The Fund's annual performance was hindered by holdings in Danka Business
Systems PLC and Midway Games, Inc. Shares of Danka Business Systems PLC, a
distributor of office equipment including copiers and fax machines, declined
after the company experienced a slowdown in equipment sales. We added to the
Fund's investment in Danka on stock price weakness, and expect financial results
to improve based on cost-cutting efforts and a sales force restructuring. Shares
of Midway Games, Inc., a designer and manufacturer of video games, were also
weak as the company's results fell short of analysts' consensus earnings
expectations for the year. We continue to hold the stock based on our
expectation for improved results from upcoming product releases.
Within the Russell 2000 Index, the energy, transportation and producer
durables sectors posted declines for the year, while the technology and
utilities sectors advanced. The Fund's sector positioning had a positive effect
on full-year investment results. The portfolio was overweighted in the
technology sector, which outperformed the benchmark index. However, the benefit
was offset by investments in the economically sensitive energy and materials
processing sectors. Relative to the Russell 2000 Index, the Fund's
underweighting in financial services stocks benefited overall investment
results.
269
<PAGE> 271
- --------------------------------------------------------------------------------
Despite general weakness in small-capitalization issues, shares of VISX,
Incorporated, the Fund's largest position, appreciated sharply during the year.
The company develops and markets proprietary technologies and systems for laser
vision correction. Shares of VISX appreciated nearly 300% during the year based
on strong growth in laser procedures and the settlement of a long-standing legal
dispute. We significantly reduced the Fund's holdings in VISX, as the shares
surpassed our valuation target. Shares of Micro Warehouse, Inc., a catalog
retailer of personal computers and software, also made a positive contribution
to Fund performance. The stock appreciated sharply as earnings benefited from a
corporate restructuring, and Internet-based sales accelerated.
As small-capitalization stocks faltered during the year, we actively
accumulated investments where we believed the long-term earnings growth
prospects were favorable. Severe price declines in our universe of
small-capitalization stocks provided ample opportunities to increase existing
positions and acquire new investments at attractive absolute valuation levels.
At the same time, we reduced the Fund's exposure to cyclical stocks and
increased exposure to interest rate-sensitive industries, including housing,
insurance and real estate investment trusts.
PORTFOLIO MATTERS
After declining sharply through the end of September, the Russell 2000 Index
of small-capitalization stocks recovered sharply in the final weeks of 1998. The
Index bottomed on October 8, then rose 36% off its low. Special Value Focus
Fund's performance paralleled the benchmark index for the final three months of
the year. However, the small-cap rally late in the fourth quarter did not fully
erase the year's decline.
Individual stocks that contributed most to the Fund's results in the December
quarter included some of the same issues that most hindered performance in the
previous quarter. The shares of Structural Dynamics Research Corporation, a
provider of design automation tools to the auto and aerospace industries,
declined sharply in the September quarter following the launch of a new product
by the company's primary competitor. We increased the Fund's position based on
the stock price weakness and our belief that the shares provided a compelling
risk/reward profile. The share price then recovered sharply in the December
quarter, rising 76% as investors assessed the competition and regained
confidence in the earnings outlook.
CHS Electronics, Inc., an international distributor of microcomputers and
related products, also exhibited stock price weakness in the third quarter on
investors' fears about slowing demand for personal computers and softer sales to
Latin American markets. The pullback provided an opportunity to increase the
Fund's position at attractive prices, and the shares more than doubled off their
October lows. The sharp recovery, combined with the large size of the position,
made CHS Electronics, Inc. a primary contributor to Fund performance in the
period.
Significant changes to the Fund's portfolio included increases to positions in
real estate investment trusts, healthcare and insurance stocks, and reductions
in software, contract manufacturing and computer storage stocks. The Fund's
technology holdings appreciated 40% in the quarter but, through sales of
selected stocks, the Fund's overall technology exposure held at the previous
quarter-end level of approximately 26% of net assets. One notable deletion was
the sale of Storage Technology Corp., a provider of computer tape and disc
storage devices. Shares of Storage Technology Corp. reached our price target
following news of an agreement to manufacture storage products for Dell Computer
Corp.
IN CONCLUSION
The performance gap between small- and large-cap stocks has rarely been wider
than in 1998, when the total return provided by the Russell 2000 Index trailed
that of the S&P 500 by more than 31 percentage points. Despite the
underperformance of small-capitalization stocks, we believe that investors
should have representation in this asset class. In the past, periods of
prolonged small-capitalization underperformance have preceded some of the most
powerful rallies. We believe that the disparity between small-capitalization and
large-capitalization stock valuations is unsustainable, particularly given the
favorable earnings growth prospects for smaller companies. Over the long term,
share prices tend to follow earnings, and price-to-earnings multiples relative
to large-capitalization stocks currently favor small-capitalization stocks by a
wide margin compared to historical averages.
270
<PAGE> 272
- --------------------------------------------------------------------------------
We thank you for your continued investment in Special Value Focus Fund of
Merrill Lynch Variable Series Funds, Inc., and we look forward to reviewing our
outlook and strategy with you again in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Daniel V. Szemis
Daniel V. Szemis
Senior Vice President and Co-Portfolio Manager
/s/ R. Elise Baum
R. Elise Baum
Vice President and Co-Portfolio Manager
February 5, 1999
271
<PAGE> 273
.......................................................................
MERRILL LYNCH VARIABLE SERIRS FUNDS, INC.-- SPECIAL VALUE FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A AND CLASS B SHARES
.......................................................................
Special Value Focus Fund
Total Return Based on a $10, 000 Investment-Class A and Class B Shares
A line graph depicting the growth of an investment in the Fund's Class A
Shares compared to growth of an investment in the Russell 2000 Small Stock
Index. Beginning and ending values are:
<TABLE>
<CAPTION>
12/88 12/98
----- -----
<S> <C> <C>
Special Value Focus Fund+--
Class A Shares* $10,000 $27,393
Russell 2000 Small Stock Index++ $10,000 $33,716
</TABLE>
A line graph depicting the growth of an investment in the Fund's
Class B Shares compared to growth of an investment in the Russell
2000 Small Stock Index. Beg inning and ending values are:
<TABLE>
<CAPTION>
10/23/97++ 12/98
---------- -----
<S> <C> <C>
Special Value Focus Fund+--
Class B Shares+ $10,000 $8,304
Russell 2000 Small Stock Index++ $10,000 $9,504
</TABLE>
*Assuming transaction costs and other operating expenses, including
advisory fees. Does not include insurance-related fees and expenses.
** Comencement of operations.
*Special Value Focus Fund invests primarily in common stocks of small
companies and emerging growth companies regardless of size.
**This unmanaged Index is comprised of approximately 2, 000
smaller-capitalization common stocks from various industrial sectors.
Past performance is not predictive of future performance.
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN-- CLASS A SHARES
- -------------------------------------------------------------------------------
SPECIAL VALUE FOCUS FUND GRAPH
** Commencement of operations.
+ Special Value Focus Fund invests primarily in common stocks of small companies
and emerging growth companies regardless of size.
++ This unmanaged index is comprised of approximately 2,000
smaller-capitalization common stocks from various industrial sectors.
Past performance is not predictive of future performance.
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/98 - 6.50%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/98 + 8.85
- --------------------------------------------------------------------------------
Ten Years Ended 12/31/98 +10.60
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS B SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/98 - 6.52%
- --------------------------------------------------------------------------------
Inception (10/23/97) through 12/31/98 -14.47
- --------------------------------------------------------------------------------
272
<PAGE> 274
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
RECENT PERFORMANCE RESULTS*
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
12 MONTH 6 MONTH
TOTAL RETURN TOTAL RETURN
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Class A Shares -6.50% -14.82%
- ------------------------------------------------------------------------------------------
Class B Shares -6.52 -14.90
- ------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the ex-dividend date. Insurance-related fees
and expenses are not reflected in these returns. Past results shown should not
be considered a representation of future performance.
273
<PAGE> 275
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
SECTOR* HELD COMMON STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
AUTO & TRANSPORTATION
- -----------------------------------------------------------------------------------------------------------------------
126,900 Air Express International
Corporation................. $ 3,014,500 $ 2,760,075 0.6%
250,000 Circle International Group,
Inc. ....................... 6,453,195 5,062,500 1.1
208,300 +Forward Air Corporation...... 3,052,147 3,827,513 0.9
36,000 +Gentex Corporation........... 450,857 720,000 0.2
208,300 +Landair Corporation.......... 1,315,580 1,536,212 0.3
115,700 Meritor Automotive, Inc. ..... 2,502,653 2,451,394 0.5
880,300 +Miller Industries, Inc. ..... 6,701,316 3,961,350 0.9
217,500 Walbro Corporation............ 4,191,063 1,359,375 0.3
------------ ------------ -----
27,681,311 21,678,419 4.8
- -----------------------------------------------------------------------------------------------------------------------
CONSUMER DISCRETIONARY
- -----------------------------------------------------------------------------------------------------------------------
950,700 +APAC TeleServices, Inc....... 7,745,793 3,594,834 0.8
446,900 +Boise Cascade Office Products
Corp. ...................... 6,425,989 6,033,150 1.3
600,300 +Caribiner International,
Inc. ....................... 9,911,977 5,477,738 1.2
568,400 Danka Business Systems PLC
(ADR)**..................... 5,237,786 2,380,175 0.5
230,200 Dover Downs Entertainment,
Inc. ....................... 2,868,975 2,776,788 0.6
161,000 +HA-LO Industries, Inc. ...... 3,433,385 6,057,625 1.4
715,700 Heilig-Meyers Company......... 9,893,330 4,786,244 1.1
183,200 +ITI Technologies, Inc. ...... 4,425,974 5,679,200 1.3
167,300 +Micro Warehouse, Inc. ....... 1,990,690 5,646,375 1.3
742,767 +Midway Games, Inc. .......... 11,641,415 8,170,437 1.8
768,900 +Paxson Communications
Corporation................. 8,302,931 7,064,269 1.6
256,000 +SITEL Corporation............ 2,288,618 624,000 0.1
218,500 +Sodak Gaming, Inc. .......... 2,634,082 1,802,625 0.4
109,000 Unitog Company................ 2,449,350 3,133,750 0.7
289,200 +WMS Industries, Inc. ........ 1,216,329 2,132,850 0.5
------------ ------------ -----
80,466,624 65,360,060 14.6
- -----------------------------------------------------------------------------------------------------------------------
ENERGY
- -----------------------------------------------------------------------------------------------------------------------
142,400 +Barrett Resources
Corporation................. 4,129,091 3,417,600 0.8
312,100 +Benton Oil and Gas Company... 4,636,227 936,300 0.2
176,100 +Forcenergy Inc. ............. 3,946,536 462,263 0.1
167,200 +Key Energy Services, Inc. ... 2,607,891 783,750 0.2
198,900 +Louis Dreyfus Natural Gas
Corp. ...................... 3,755,967 2,834,325 0.6
781,800 +Newpark Resources, Inc. ..... 8,001,531 5,326,012 1.2
50,000 +Plains Resources, Inc. ...... 748,212 718,750 0.2
112,700 Santa Fe International
Corporation................. 1,413,424 1,648,238 0.4
114,100 +Stone Energy Corporation..... 3,769,773 3,280,375 0.7
243,000 Tom Brown, Inc. .............. 4,341,362 2,430,000 0.5
------------ ------------ -----
37,350,014 21,837,613 4.9
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
274
<PAGE> 276
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
SECTOR* HELD COMMON STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FINANCIAL SERVICES
- -----------------------------------------------------------------------------------------------------------------------
47,350 American National Insurance
Company..................... $ 4,420,316 $ 3,906,375 0.9%
109,000 Brandywine Realty Trust....... 1,939,138 1,948,375 0.4
74,800 Camden Property Trust......... 1,925,656 1,944,800 0.4
220,178 Charter One Financial,
Inc. ....................... 5,400,050 6,096,178 1.4
67,800 FelCor Lodging Trust Inc. .... 1,485,943 1,563,638 0.4
136,000 HCC Insurance Holdings,
Inc. ....................... 2,370,980 2,397,000 0.5
40,500 Kimco Realty Corporation...... 1,491,148 1,607,344 0.4
62,400 Meditrust Corporation......... 939,358 943,800 0.2
52,600 National Data Corporation..... 1,889,524 2,560,963 0.6
187,100 PXRE Corporation.............. 4,954,722 4,689,194 1.0
109,000 Peoples Heritage Financial
Group, Inc. ................ 2,221,083 2,180,000 0.5
147,800 +Primark Corporation.......... 3,736,326 4,009,075 0.9
247,400 +Scottish Annuity & Life
Holdings, Ltd. ............. 3,665,093 3,401,750 0.8
------------ ------------ -----
36,439,337 37,248,492 8.4
- -----------------------------------------------------------------------------------------------------------------------
HEALTHCARE
- -----------------------------------------------------------------------------------------------------------------------
137,300 +COR Therapeutics, Inc. ...... 1,501,776 1,827,806 0.4
115,000 +DVI, Inc. ................... 2,419,522 2,084,375 0.5
260,700 EndoSonics Corporation........ 1,813,268 2,590,706 0.6
217,000 +Genome Therapeutics Corp..... 1,852,452 576,406 0.1
24,000 +Gilead Sciences, Inc. ....... 552,523 984,000 0.2
445,600 +HCIA, Inc. .................. 5,471,158 1,893,800 0.4
242,850 +Magainin Pharmaceuticals,
Inc. ....................... 2,567,638 758,906 0.2
196,600 +Magellan Health Services,
Inc. ....................... 5,058,630 1,646,525 0.4
980,700 +MedPartners, Inc. ........... 7,773,054 5,148,675 1.1
291,000 +NABI, Inc. .................. 2,103,909 782,062 0.2
160,000 +NeoRx Corporation............ 1,034,843 215,000 0.0
76,000 +Neurogen Corporation......... 1,014,405 1,301,500 0.3
77,200 +Pharmacopeia, Inc. .......... 1,391,292 704,450 0.1
175,000 +Scios, Inc. ................. 1,232,798 1,815,625 0.4
85,500 +Sierra Health Services,
Inc. ....................... 1,774,125 1,800,844 0.4
172,600 +VISX, Incorporated........... 3,693,348 15,091,712 3.4
------------ ------------ -----
41,254,741 39,222,392 8.7
- -----------------------------------------------------------------------------------------------------------------------
INTEGRATED OILS
- -----------------------------------------------------------------------------------------------------------------------
182,400 +Basin Exploration, Inc. ..... 2,978,856 2,291,400 0.5
- -----------------------------------------------------------------------------------------------------------------------
MATERIALS & PROCESSING
- -----------------------------------------------------------------------------------------------------------------------
279,100 +ACX Technologies, Inc. ...... 6,446,134 3,698,075 0.8
158,600 A.M. Castle & Company......... 3,483,722 2,379,000 0.5
300,000 Apogee Enterprises, Inc. ..... 3,514,041 3,337,500 0.7
243,900 +Citation Corporation......... 3,594,622 3,048,750 0.7
411,400 Commonwealth Industries,
Inc. ....................... 7,950,098 3,805,450 0.8
103,100 +Dan River, Inc. (Class A).... 1,556,497 1,211,425 0.3
8,300 Foamex International, Inc. ... 109,575 99,600 0.0
74,000 +Giant Cement Holding,
Inc. ....................... 1,556,300 1,831,500 0.4
43,283 Inland Steel Industries,
Inc. ....................... 1,257,902 730,401 0.2
233,800 +Insituform Technologies, Inc.
(Class A)................... 1,967,006 3,375,487 0.8
177,600 Intermet Corporation.......... 3,003,154 2,286,600 0.5
124,800 +Novamerican Steel, Inc. ..... 1,448,747 1,045,200 0.2
246,000 +Paxar Corporation............ 3,532,266 2,198,625 0.5
131,600 Quanex Corporation............ 3,255,864 2,969,225 0.7
101,300 +Ryerson Tull, Inc. (Class
A).......................... 1,562,721 987,675 0.2
</TABLE>
275
<PAGE> 277
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
SECTOR* HELD COMMON STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
MATERIALS & PROCESSING
(CONCLUDED)
- -----------------------------------------------------------------------------------------------------------------------
334,400 +Shiloh Industries, Inc. ..... $ 6,537,952 $ 4,305,400 1.0%
22,500 +Steel Dynamics, Inc. ........ 260,221 264,375 0.1
143,400 +Wolverine Tube, Inc. ........ 4,161,308 3,011,400 0.7
------------ ------------ -----
55,198,130 40,585,688 9.1
- -----------------------------------------------------------------------------------------------------------------------
MISCELLANEOUS
- -----------------------------------------------------------------------------------------------------------------------
674,800 +Metromedia International
Group, Inc. ................ 7,777,566 3,669,225 0.8
- -----------------------------------------------------------------------------------------------------------------------
PRODUCER DURABLES
- -----------------------------------------------------------------------------------------------------------------------
101,000 AGCO Corporation.............. 3,164,545 795,375 0.2
125,700 +Allen Telecom, Inc. ......... 2,050,370 840,619 0.2
196,450 Applied Industrial
Technologies, Inc. ......... 4,768,850 2,725,744 0.6
373,200 +Brown & Sharpe Manufacturing
Company (Class A)........... 4,914,080 2,985,600 0.7
90,000 +DONCASTERS PLC (ADR)**....... 2,167,473 1,456,875 0.3
249,300 +ESCO Electronics
Corporation................. 4,362,030 2,259,281 0.5
64,000 Kennametal, Inc. ............. 2,875,932 1,360,000 0.3
208,700 Oakwood Homes Corporation..... 4,288,226 3,169,631 0.7
81,600 Ryland Group, Inc. ........... 1,329,716 2,356,200 0.5
202,000 Stewart & Stevenson Services,
Inc. ....................... 5,046,027 1,906,375 0.4
67,300 +Toll Brothers, Inc. ......... 1,625,992 1,518,456 0.4
57,000 +Triumph Group, Inc. ......... 1,627,920 1,824,000 0.4
------------ ------------ -----
38,221,161 23,198,156 5.2
- -----------------------------------------------------------------------------------------------------------------------
TECHNOLOGY
- -----------------------------------------------------------------------------------------------------------------------
122,600 +Alpha Industries, Inc. ...... 1,811,716 4,428,925 1.0
307,000 +Anixter International,
Inc. ....................... 5,262,575 6,235,937 1.4
264,900 +Bell Industries, Inc. ....... 3,891,980 3,013,238 0.7
113,500 +Black Box Corporation........ 3,410,193 4,249,156 0.9
113,500 +Boole & Babbage, Inc. ....... 1,951,551 3,319,875 0.7
89,100 +Brite Voice Systems, Inc. ... 736,788 712,800 0.2
742,200 +CHS Electronics, Inc. ....... 12,548,124 12,571,013 2.8
100,000 +CP Clare Corporation......... 1,272,312 506,250 0.1
78,900 +Cylink Corporation........... 1,137,344 283,547 0.1
323,200 +DII Group, Inc. ............. 7,794,400 7,393,200 1.7
526,600 +DSP Communications, Inc. .... 7,984,083 8,063,563 1.8
507,902 +Harbinger Corporation........ 4,506,377 4,063,216 0.9
227,600 +Harmonic Lightwaves, Inc. ... 3,077,972 4,281,725 1.0
90,000 +Information Resources,
Inc. ....................... 1,306,961 911,250 0.2
152,260 +Learning Company, Inc. (The)... 3,100,238 3,949,244 0.9
656,200 +Mentor Graphics
Corporation................. 6,748,146 5,495,675 1.2
308,600 +Network Equipment
Technologies, Inc. ......... 4,760,887 3,182,437 0.7
423,600 +Phoenix Technologies Ltd. ... 5,704,313 3,653,550 0.8
252,500 +Planar Systems, Inc. ........ 2,984,425 1,720,156 0.4
186,000 +Platinum Technology, Inc. ... 2,917,847 3,568,875 0.8
122,300 +Rational Software
Corporation................. 1,897,300 3,225,662 0.7
188,500 +Read-Rite Corporation........ 1,776,089 2,780,375 0.6
93,500 +Sterling Commerce, Inc. ..... 3,154,307 4,207,500 0.9
715,551 +Structural Dynamics Research
Corporation................. 14,707,596 14,132,132 3.2
633,900 +Sybase, Inc. ................ 8,675,349 4,675,012 1.0
225,200 Telxon Corporation............ 5,200,463 3,138,725 0.7
115,000 +TriQuint Semiconductor,
Inc. ....................... 2,338,199 2,228,125 0.5
------------ ------------ -----
120,657,535 115,991,163 25.9
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
276
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1998 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
SECTOR* HELD COMMON STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
UTILITIES
- -----------------------------------------------------------------------------------------------------------------------
316,600 +Applied Digital Access,
Inc. ....................... $ 2,460,145 $ 831,075 0.2%
- -----------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS 450,485,420 371,913,683 83.1
- -----------------------------------------------------------------------------------------------------------------------
<CAPTION>
FACE
AMOUNT SHORT-TERM SECURITIES
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
COMMERCIAL PAPER*** Block Financial Corp.:
$ 5,000,000 5.25% due 1/19/1999........... 4,986,146 4,986,146 1.1
5,000,000 5.35% due 1/29/1999........... 4,978,451 4,978,451 1.1
19,361,000 General Motors Acceptance
Corp., 5.13% due 1/04/1999.. 19,349,964 19,349,964 4.3
17,000,000 International Securitization
Corp., 5.63% due 1/14/1999.. 16,962,779 16,962,779 3.8
8,000,000 Lexington Parker Capital
Company, LLC, 5.45% due
1/05/1999................... 7,993,945 7,993,945 1.8
Metropolitan Life Insurance
Company:
5,000,000 5.30% due 1/06/1999........... 4,995,583 4,995,583 1.1
10,000,000 5.25% due 1/13/1999........... 9,981,042 9,981,042 2.2
------------ ------------ -----
69,247,910 69,247,910 15.4
- -----------------------------------------------------------------------------------------------------------------------
US GOVERNMENT AGENCY 6,000,000 Federal Home Loan Mortgage
OBLIGATIONS*** Corporation, 5.08% due
1/06/1999................... 5,994,920 5,994,920 1.4
- -----------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES 75,242,830 75,242,830 16.8
- -----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS............. $525,728,250 447,156,513 99.9
============
OTHER ASSETS LESS
LIABILITIES................. 628,042 0.1
------------ -----
NET ASSETS.................... $447,784,555 100.0%
============ =====
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
* Holdings are classified into the economic sectors found in the Russell 2000
Index.
** American Depositary Receipts (ADR).
*** Commercial Paper and certain US Government Agency Obligations are traded on
a discount basis; the interest rates shown reflect the discount rates paid at
the time of purchase by the Fund.
+ Non-income producing security.
See Notes to Financial Statements.
277
<PAGE> 279
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$525,728,250) (Note
1a)....................................................... $447,156,513
Receivables:
Securities sold........................................... $2,793,208
Dividends................................................. 149,232
Capital shares sold....................................... 53,683 2,996,123
----------
Prepaid expenses and other assets........................... 28,466
------------
Total assets................................................ 450,181,102
------------
- ---------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Securities purchased...................................... 1,910,804 .
Investment adviser (Note 2)............................... 272,488
Capital shares redeemed................................... 89,534
Distributor (Note 2)...................................... 673 2,273,499
----------
Accrued expenses and other liabilities...................... 123,048
------------
Total liabilities........................................... 2,396,547
------------
- ---------------------------------------------------------------------------------------
NET ASSETS.................................................. $447,784,555
============
- ---------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized......................................... $ 2,238,117
Class B Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized......................................... 6,389
Paid-in capital in excess of par............................ 479,549,023
Undistributed investment income--net........................ 625,420
Undistributed realized capital gains on investments--net.... 43,937,343
Unrealized depreciation on investments--net................. (78,571,737)
------------
NET ASSETS.................................................. $447,784,555
============
- ---------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $446,510,234 and 22,381,168
shares outstanding........................................ $ 19.95
============
Class B--Based on net assets of $1,274,321 and 63,893 shares
outstanding............................................... $ 19.94
============
- ---------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
278
<PAGE> 280
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1c & 1d):
Interest and discount earned................................ $ 2,770,882
Dividends (net of $11,987 foreign withholding tax).......... 1,727,180
------------
Total income................................................ 4,498,062
------------
- ---------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $3,594,897
Accounting services (Note 2)................................ 93,825
Printing and shareholder reports............................ 64,382
Custodian fees.............................................. 58,107
Professional fees........................................... 36,644
Directors' fees and expenses................................ 10,889
Transfer agent fees (Note 2)................................ 4,702
Pricing services............................................ 765
Distribution fees--Class B (Note 2)......................... 1,113
Other....................................................... 7,303
----------
Total expenses.............................................. 3,872,627
------------
Investment income--net...................................... 625,435
------------
- ---------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET (NOTES
1b, 1d & 3):
Realized gain on investments--net........................... 44,232,014
Change in unrealized depreciation on investments--net....... (71,727,863)
------------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $(26,870,414)
============
- ---------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
279
<PAGE> 281
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-----------------------------
INCREASE (DECREASE) IN NET ASSETS: 1998 1997
- -------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 625,435 $ 1,476,791
Realized gain on investments--net........................... 44,232,014 109,665,458
Change in unrealized appreciation/depreciation on
investments--net.......................................... (71,727,863) (60,400,517)
------------- ------------
Net increase (decrease) in net assets resulting from
operations................................................ (26,870,414) 50,741,732
------------- ------------
- -------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1e):
Investment income--net:
Class A................................................... (1,476,063) (1,422,649)
Class B................................................... (726) --
Realized gain on investments--net:
Class A................................................... (109,791,778) (22,153,543)
Class B................................................... (56,535) --
------------- ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (111,325,102) (23,576,192)
------------- ------------
- -------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase in net assets derived from capital share
transactions.............................................. 104,118,352 1,666,914
------------- ------------
- -------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... (34,077,164) 28,832,454
Beginning of year........................................... 481,861,719 453,029,265
------------- ------------
End of year*................................................ $ 447,784,555 $481,861,719
============= ============
- -------------------------------------------------------------------------------------------
*Undistributed investment income--net....................... $ 625,420 $ 1,476,774
============= ============
- -------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
280
<PAGE> 282
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE
BEEN DERIVED FROM INFORMATION PROVIDED IN THE CLASS A+
FINANCIAL STATEMENTS. --------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year..................... $ 27.75 $ 26.22 $ 27.98 $ 19.26 $ 20.96
-------- -------- -------- -------- --------
Investment income--net................................. .03 .09 .13 .17 .05
Realized and unrealized gain (loss) on
investments--net..................................... (1.41) 2.80 1.84 8.64 (1.56)
-------- -------- -------- -------- --------
Total from investment operations....................... (1.38) 2.89 1.97 8.81 (1.51)
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net............................... (.09) (.08) (.14) (.09) --
Realized gain on investments--net.................... (6.33) (1.28) (3.59) -- (.19)
-------- -------- -------- -------- --------
Total dividends and distributions...................... (6.42) (1.36) (3.73) (.09) (.19)
-------- -------- -------- -------- --------
Net asset value, end of year........................... $ 19.95 $ 27.75 $ 26.22 $ 27.98 $ 19.26
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share..................... (6.50%) 11.72% 8.11% 45.90% (7.27%)
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses............................................... .81% .80% .81% .81% .83%
======== ======== ======== ======== ========
Investment income--net................................. .13% .32% .50% .72% .27%
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)................. $446,510 $481,614 $453,029 $339,921 $170,044
======== ======== ======== ======== ========
Portfolio turnover..................................... 56.29% 147.06% 80.84% 96.79% 88.48%
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding.
See Notes to Financial Statements.
281
<PAGE> 283
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
FINANCIAL HIGHLIGHTS (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS B++
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE -------------------------------------------
BEEN DERIVED FROM INFORMATION PROVIDED IN THE FOR THE FOR THE PERIOD
FINANCIAL STATEMENTS. YEAR ENDED OCTOBER 23, 1997+ TO
INCREASE (DECREASE) IN NET ASSET VALUE: DECEMBER 31, 1998 DECEMBER 31, 1997
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period........................ $ 27.74 $ 31.23
------- --------
Investment income (loss)--net............................... --+++ (.01)
Realized and unrealized loss on investments--net............ (1.39) (3.48)
------- --------
Total from investment operations............................ (1.39) (3.49)
------- --------
Less dividends and distributions:
Investment income--net.................................... (.08) --
Realized gain on investments--net......................... (6.33) --
------- --------
Total dividends and distributions........................... (6.41) --
------- --------
Net asset value, end of period.............................. $ 19.94 $ 27.74
======= ========
- ----------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.......................... (6.52%) (11.18%)++
======= ========
- ----------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS
Expenses.................................................... .97% .96%*
======= ========
Investment income (loss)--net............................... .02% (.24%)*
======= ========
- ----------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).................... $ 1,275 $ 248
======= ========
Portfolio turnover.......................................... 56.29% 147.06%
======= ========
- ----------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of operations.
++ Based on average shares outstanding.
+++ Amount is less than $.01 per share.
++ Aggregate total investment return.
See Notes to Financial Statements.
282
<PAGE> 284
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 18 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies, that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Class A and
Class B Shares have equal voting, dividend, liquidation and other rights, except
that only shares of the respective classes are entitled to vote on matters
concerning only that class and Class B Shares bear certain expenses related to
the distribution of such shares. Special Value Focus Fund (the "Fund") is
classified as "diversified," as defined in the Investment Company Act of 1940.
The Fund's financial statements are prepared in accordance with generally
accepted accounting principles which may require the use of management accruals
and estimates. The following is a summary of significant accounting policies
followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written are valued at the last sale price in the case of
exchange-traded options. In the case of options traded in the over-the-counter
market, valuation is the last asked price. Short-term securities are valued at
amortized cost, which approximates market value. Securities and assets for which
market quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Board of Directors of
the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity and debt markets. Losses may arise due to
changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Options--The Fund may write covered call options. When the Fund writes an
option, an amount equal to the premium received by the Fund is reflected as an
asset and an equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option written. When
a security is purchased or sold through an exercise of an option, the related
premium received is added to (or deducted from) the basis of the security
acquired or deducted from (or added to) the proceeds of the security sold. When
an option expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums received (or
gain or loss to the extent the cost of the closing transaction exceeds the
premium received).
Written options are non-income producing investments.
(c) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends, and
capital gains at various rates.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(e) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner. The Company has also entered into a Distribution
Agreement and Distribution Plan with Merrill Lynch Funds Distributor ("MLFD" or
"Distributor"), a division of Princeton Funds Distributor,
283
<PAGE> 285
- --------------------------------------------------------------------------------
Inc. ("PFD"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.75% of the average daily value of the Fund's net assets.
Pursuant to the Distribution Plan adopted by the Company, in accordance with
Rule 12b-1 under the Investment Company Act of 1940, the Fund pays the
Distributor an ongoing distribution fee each month at the annual rate of 0.15%
of the average daily value of the Fund's Class B net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1998, Merrill Lynch, Pierce, Fenner & Smith
Incorporated, a subsidiary of ML & Co., earned $41,035 in commissions on the
execution of portfolio security transactions.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, FDS, PFD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1998 were $240,273,433 and $276,492,646, respectively.
Net realized gains for the year ended December 31, 1998 and net unrealized
losses as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
Realized Unrealized
Gains Losses
- ------------------------------------------------------------------
<S> <C> <C>
Long-term investments................. $44,232,014 $(78,571,737)
----------- ------------
Total................................. $44,232,014 $(78,571,737)
=========== ============
- ------------------------------------------------------------------
</TABLE>
At December 31, 1998, net unrealized depreciation for Federal income tax
purposes aggregated $79,698,932, of which $40,702,723 related to appreciated
securities and $120,401,655 related to depreciated securities. At December 31,
1998, the aggregate cost of investments for Federal income tax purposes was
$526,855,445.
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions were
$104,118,352 and $1,666,914 for the years ended December 31, 1998 and December
31, 1997, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1998 Shares Amount
- --------------------------------------------------------------------
<S> <C> <C>
Shares sold............................ 3,050,526 $ 58,185,991
Shares issued to shareholders in
reinvestment of dividends and
distributions......................... 5,216,495 111,267,844
---------- ------------
Total issued........................... 8,267,021 169,453,835
Shares redeemed........................ (3,241,298) (66,488,266)
---------- ------------
Net increase........................... 5,025,723 $102,965,569
========== ============
- --------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- --------------------------------------------------------------------
<S> <C> <C>
Shares sold............................ 2,566,273 $ 68,132,882
Shares issued to shareholders in
reinvestment of dividends and
distributions......................... 960,725 23,576,192
---------- ------------
Total issued........................... 3,526,998 91,709,074
Shares redeemed........................ (3,446,348) (90,294,889)
---------- ------------
Net increase........................... 80,650 $ 1,414,185
========== ============
- --------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Class B Shares for the Year Ended Dollar
December 31, 1998 Shares Amount
- --------------------------------------------------------------------
<S> <C> <C>
Shares sold............................ 66,283 $ 1,367,600
Shares issued to shareholders in
reinvestment of dividends and
distributions......................... 2,686 57,259
---------- ------------
Total issued........................... 68,969 1,424,859
Shares redeemed........................ (14,012) (272,076)
---------- ------------
Net increase........................... 54,957 $ 1,152,783
========== ============
- --------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Class B Shares for the Period Dollar
October 23, 1997+ to December 31, 1997 Shares Amount
- --------------------------------------------------------------------
<S> <C> <C>
Shares sold............................ 10,276 $ 291,595
Shares redeemed........................ (1,340) (38,866)
---------- ------------
Net increase........................... 8,936 $ 252,729
========== ============
- --------------------------------------------------------------------
+ Commencement of operations.
</TABLE>
5. SUBSEQUENT EVENT:
On January 4, 1999, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.825503 per Class A Share, and $.808089 per Class B
Share, and a long-term capital gains distribution in the amount of $1.210183 per
share for each of the two classes, payable on January 11, 1999 to shareholders
of record as of December 31, 1998.
284
<PAGE> 286
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
SPECIAL VALUE FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Special Value Focus Fund of Merrill Lynch
Variable Series Funds, Inc. as of December 31, 1998, the related statements of
operations for the year then ended and changes in net assets for each of the
years in the two-year period then ended, and the financial highlights for each
of the years in the five-year period then ended. These financial statements and
the financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and the
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1998 by correspondence with the custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Special Value Focus
Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1998, the
results of its operations, the changes in its net assets, and the financial
highlights for the respective stated periods in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 10, 1999
285
<PAGE> 287
- --------------------------------------------------------------------------------
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<PAGE> 288
- --------------------------------------------------------------------------------
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<PAGE> 289
- --------------------------------------------------------------------------------
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<PAGE> 290
- ---------------------------------------------------------
MERRILL LYNCH
VARIABLE SERIES FUNDS, INC.
- ---------------------------------------------------------
PRINCIPAL OFFICE OF THE FUNDS
Box 9011
Princeton, NJ 08543-9011
DISTRIBUTOR
Princeton Funds Distributor, Inc.
CUSTODIAN
For all Funds except Developing Capital
Markets Focus Fund:
The Bank of New York
110 Washington Street
New York, NY 10286
For Developing Capital Markets Focus Fund:
Brown Brothers Harriman & Co.
40 Water Street
Boston, MA 02109
TRANSFER AGENT
Financial Data Services, Inc.
4800 Deer Lake Drive East
Jacksonville, FL 32246-6484
(800) 637-3863
DIRECTORS AND OFFICERS
Arthur Zeikel
President
Joe Grills
Director
Walter Mintz
Director
Robert S. Salomon Jr.
Director
Melvin R. Seiden
Director
Stephen B. Swensrud
Director
Terry K. Glenn
Executive Vice President
Christopher G. Ayoub
Senior Vice President
Lawrence R. Fuller
Senior Vice President
Jay C. Harbeck
Senior Vice President
Norman R. Harvey
Senior Vice President
Vincent T. Lathbury III
Senior Vice President
Kevin J. McKenna
Senior Vice President
Eric S. Mitofsky
Senior Vice President
Joseph T. Monagle Jr.
Senior Vice President
Grace Pineda
Senior Vice President
Kevin M. Rendino
Senior Vice President
Thomas R. Robinson
Senior Vice President
Walter D. Rogers
Senior Vice President
Kurt Schansinger
Senior Vice President
Robert M. Shearer
Senior Vice President
Daniel V. Szemis
Senior Vice President
R. Elise Baum
Vice President
Donald C. Burke
Vice President
Robert F. Murray
Vice President
Jacqueline L. Rogers
Vice President
Gerald M. Richard
Treasurer
<PAGE> 291
- --------------------------------------------------------------------------------
This report is not authorized for use as an offer of sale or a solicitation of
an offer to buy shares of the Funds unless accompanied or preceded by the Funds'
current prospectus. Past performance results shown in this report should not be
considered a representation of future performance. Investment return and
principal value of non-money market fund shares will fluctuate so that shares,
when redeemed, may be worth more or less than their original cost. An investment
in the Domestic Money Market Fund and Reserve Assets Fund is not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other Government
agency. Although the money market Funds seek to preserve your investment at
$1.00 per share, it is possible to lose money by investing in the Funds.
Statements and other information herein are as dated and are subject to change.
Merrill Lynch Variable Series Funds, Inc.
Box 9011
Princeton, NJ
08543-9011
#16897-12/98
