INVESTMENT ADVISER
Legg Mason Fund Adviser, Inc. REPORT TO SHAREHOLDERS
Baltimore, MD FOR THE QUARTER ENDED
DECEMBER 31, 1995
BOARD OF DIRECTORS
Raymond A. Mason, Chairman
John F. Curley, Jr., President
Richard G. Gilmore THE
Charles F. Haugh LEGG MASON
Arnold L. Lehman TOTAL
Dr. Jill E. McGovern RETURN
T. A. Rodgers TRUST, INC.
Edward A. Taber, III PRIMARY CLASS
TRANSFER AND SHAREHOLDER SERVICING AGENT
Boston Financial Data Services
Boston, MA
CUSTODIAN
State Street Bank & Trust Company
Boston, MA
COUNSEL
Kirkpatrick & Lockhart LLP
Washington, DC PUTTING YOUR FUTURE FIRST
INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P.
Baltimore, MD
THIS REPORT IS NOT TO BE DISTRIBUTED UNLESS PRECEDED OR
ACCOMPANIED BY A PROSPECTUS.
LEGG MASON WOOD WALKER, INCORPORATED
111 South Calvert Street
P.O. Box 1476, Baltimore, MD 21203-1476
410 (Bullet) 539 (Bullet) 0000
[recycled logo] PRINTED ON RECYCLED PAPER
LMF-006 [Legg Mason Funds logo]
<PAGE>
TO OUR SHAREHOLDERS,
In the three months ended December 31, 1995, the Total Return
Trust's net asset value per share rose from $15.17 to $15.29. The
latter figure is after payment in December of an ordinary income
dividend of $.10 per share. Assuming reinvestment of the dividend, the
Trust's total return (appreciation plus reinvested distributions and
dividends) in the quarter was 2.6%. Total returns on the Value Line
Index of 1,700 stocks and Standard & Poor's 500 stock composite index
were 0.7% and 6% during the same period. In the twelve months through
December 31, the Trust's total return was 30.4%, compared to total
returns of 22.3% and 37.5% on the Value Line and Standard & Poor's
indices.
The Trust continues to invest primarily in dividend-paying common
stocks which we believe are undervalued. Our objective is to earn
long-term returns which preserve and increase the purchasing power of
your investment after taxes and inflation. While there are no
certainties in investing, we believe that ownership of a diversified
portfolio of value stocks continues to offer good prospects of
achieving that objective on a long-term basis.
On the following pages, Bill Miller and Nancy Dennin, the Trust's
portfolio managers, comment on the investment outlook.
Sincerely,
/s/ John F. Curley, Jr.
John F. Curley, Jr.
President
February 5, 1996
<PAGE>
PORTFOLIO MANAGERS' COMMENTS
Your fund's results for the fourth quarter and full year 1995 are shown
below with comparable data for the leading market indices:
<TABLE>
<CAPTION>
Total Lipper
Return S&P Growth & Income
Trust 500 Dow Jones Index
<S> <C> <C> <C> <C>
4th quarter 2.58% 6.02% 7.50% 4.53%
1995 30.36% 37.53% 36.94% 30.82%
</TABLE>
The Total Return Trust had a good year, rising over 30%, in line with its
growth & income peer group, although the fund trailed the S&P 500 and the Dow
Jones Industrial Average.
The bond market also registered strong results in 1995, posting a 31% total
return. Since 1928, bond market total returns have been 31% or more only two
other times, while stock market total returns have been 37% or more only seven
other times.
Given the strong performance of equities last year, many market seers are
forecasting a correction. While we have no doubt the market will experience
periodic setbacks, we don't believe a major correction is imminent. Stocks now
sell at about the average price/earnings ratio of the past 70 years. Yet
inflation is below its long-term average of 3.1%, while interest rates, both
short-term and long-term, are above their historic averages. The market is still
demanding a premium in rates to compensate for its fear of inflation and has not
increased stock valuations in response to the prospect of continued low
inflation.
When the Federal Reserve cut the Fed funds rate in December 1995, it cited
the lower inflation environment as the reason behind the cut. Lower inflation is
a positive for financial assets, and the longer the asset's duration, the
greater the benefit. The gradual acceptance in the marketplace of a sustained
low inflation environment should push interest rates lower and the market P/E
higher. Quantitatively, at a 3% inflation rate the justifiable market P/E is
19x, compared to the current multiple of 15x 1996 estimated earnings.
Conversely, the current multiple implies an inflation rate of about 3.75%.
We characterize 1996 as "1995 Lite." We expect the economy, corporate
profits, stocks, and bonds to be up this year, although not by as much as they
were last year. The economy entered 1995 on a strong note, only to soften as the
year progressed. For all of 1995, real GDP growth, on a chain-weighted basis,
the government's new calculation methodology, was approximately 2.3%, and is
expected to slow this year to 1-2%.
Corporate profits were robust, up an estimated 18% last year. Profits are
expected to be up about 8% in 1996, ahead of the 6.2% annual earnings growth
experienced over the last 40 years. We think that may be too optimistic, and
that corporate profits in general are likely to prove disappointing. Companies
that report earnings below expectations will most likely see their stocks come
under pressure. We hope to take advantage of any excessive price declines caused
by the market's obsession with near-term results.
We expect interest rates to trend down this year, with short rates declining
more than long rates, as the Federal Reserve lowers the Fed funds rate during
the year. The bond market has priced in a 60 basis point (100 basis points = 1%)
decline in short rates, a conservative reduction in our opinion.
Assuming no P/E multiple expansion, stocks should be up about 10% this year
on a total return basis, outperforming bonds. Quantitative work suggests the
probability of stocks outperforming bonds is currently 68%, the highest level in
over two years.
During the quarter we added three securities, AMERICAN FINANCIAL GROUP,
INC., FORD MOTOR COMPANY, and NORDBANKEN, and sold eight, reducing total
holdings to about forty.
AMERICAN FINANCIAL GROUP, INC., is engaged primarily in specialty and
multi-line property and casualty insurance. On our purchase price, the stock was
trading at a discount to its peers, at only 10.8x 1995 and 9.1x 1996 estimated
earnings, with a 3.4% yield.
FORD MOTOR COMPANY, with a 5% yield, sells not only at a discount to the
market, but at a substantial discount to the value of its underlying assets, in
our opinion. Valuing Ford's financial services group at the same multiple as
publicly traded consumer finance companies results in a value approaching the
current market price of the entire company.
2
<PAGE>
NORDBANKEN is a Swedish bank that was recently partially privatized by the
Swedish government. Sweden experienced a banking crisis in the early 1990s,
similar to the U.S. crisis in 1990. After a major restructuring, NORDBANKEN is
now considered to have the cleanest loan portfolio of any Swedish bank. At its
public offering price, the stock yielded 8.7%, and traded at only 5.8x and 5.3x
1995 and 1996 estimated earnings.
As we have mentioned in recent quarterly reports, our Mexican securities
were a drag on the fund's performance in 1995. As we have also mentioned in
recent reports, in addition to evaluating the risk of each security in the
portfolio, we are focused on reducing the embedded macro risk in order to
further reduce the volatility of the fund's results to events such as the
Mexican peso devaluation. We continue to be quite positive on the prospects for
the Mexican market longer term; however, we will limit the fund's exposure in
emerging markets, including Mexico, to an aggregate 5%.
Even after the strong returns the equity market experienced in 1995, we
continue to find attractively priced securities. However, investors should not
expect the kinds of returns recently experienced to continue. Nevertheless, with
valuations reasonable, inflation well controlled, and the economy growing, the
stock market should continue to be a rewarding place to invest.
We would like to thank our shareholders, both new and old, for their
confidence. As always, we appreciate your support and welcome your comments and
suggestions.
Nancy Dennin, CFA
Bill Miller, CFA
February 5, 1996
DJIA 5407.59
3
<PAGE>
PERFORMANCE INFORMATION
LEGG MASON TOTAL RETURN TRUST, INC.
TOTAL RETURN FOR ONE, FIVE, TEN YEARS AND LIFE OF FUND, AS OF DECEMBER 31, 1995
The returns shown below are based on historical results and are not
intended to indicate future performance. The investment return and
principal value of an investment in the fund will fluctuate so that an
investor's shares, when redeemed, may be worth more or less than their
original cost. Average annual returns tend to smooth out variations in the
fund's return, so they differ from actual year-to-year results. No
adjustment has been made for any income taxes payable by shareholders.
The fund has two classes of shares: Primary Class and Navigator Class.
The Navigator Class, offered only to certain institutional investors, pays
fund expenses similar to those paid by the Primary Class, except that
transfer agency fees and shareholder servicing expenses are determined
separately for each class and the Navigator Class does not incur Rule
12b-1 distribution fees.
The fund's total returns as of December 31, 1995 were as follows:
<TABLE>
<CAPTION>
Cumulative Average Annual
Total Return Total Return
<S> <C> <C>
Primary Class:
One Year 30.36% 30.36%
Five Years 121.83 17.27
Ten Years 144.45 9.35
Life of Class(dagger) 146.65 9.34
Navigator Class:
One Year 31.68% 31.68%
Life of Class(double dagger) 27.65 25.23
</TABLE>
(dagger) Primary Class inception-November 21, 1985.
(double dagger) Navigator Class inception-December 1, 1994.
4
<PAGE>
SELECTED PORTFOLIO PERFORMANCE
<TABLE>
<CAPTION>
Biggest gainers for the 4th quarter 1995*
<C> <S> <C>
1. Enhance Financial Services Group Inc. +29.9%
2. Lloyds TSB Group plc +27.3%
3. Federal National Mortgage Association +19.9%
4. Masco Corporation +14.1%
5. Williams Companies, Inc. +12.5%
6. Walden Residential Properties, Inc. +10.6%
7. PepsiCo, Inc. +9.6%
8. Irvine Apartment Communities, Inc. +9.2%
9. Ultramar Corporation +8.4%
Philip Morris Companies Inc. +8.4%
</TABLE>
* SECURITIES HELD FOR THE ENTIRE QUARTER.
<TABLE>
<CAPTION>
Biggest laggers for the 4th quarter 1995*
<C> <S> <C>
1. Witco Corporation -16.7%
2. Mexican Cetes 6.0% 2-29-96 -11.5%
3. John Alden Financial Corp. -7.7%
4. The Bear Stearns Companies Inc. -7.6%
5. DeBartolo Realty Corporation -7.1%
6. Grupo Mexicano de Desarrollo
S.A. ADR
8.25% 2-17-01 -6.6%
7. RJR Nabisco Holdings Corp.
Series C Depositary Shares -5.6%
8. Bankers Trust New York Corporation -5.3%
9. J.C. Penney Company, Inc. -4.0%
10. International Business Machines
Corporation -2.8%
</TABLE>
PORTFOLIO CHANGES
Securities Added Securities Sold
American Financial Group Incorporated Aetna Life and Casualty Company
Ford Motor Company Allstate Corporation
Nordbanken Ab ADR Baxter International Inc.
Harrah's Jazz Company
1st Mortgage Note
14.25% 11-15-01
Kmart Corporation
MBNA Corporation
Sears, Roebuck and Co.
Torchmark Incorporated
5
<PAGE>
PORTFOLIO OF INVESTMENTS
LEGG MASON TOTAL RETURN TRUST , INC.
DECEMBER 31, 1995 (UNAUDITED)
<TABLE>
<CAPTION>
(Amounts in Thousands) Shares Value
<S> <C> <C>
COMMON STOCKS AND EQUITY INTERESTS -- 90.8%
Automotive -- 5.5%
Chrysler Corporation 157 $ 8,694
Ford Motor Company 175 5,075
13,769
Banking -- 14.9%
BankAmerica Corporation 122 7,895
Bankers Trust New York Corporation 78 5,187
Lloyds TSB Group plc 2,065 10,616
Nordbanken Ab ADR 101 3,484A,B
The Chase Manhattan Corporation 165 10,003
37,185
Chemicals -- 9.1%
duPont (E.I.) de Nemours 112 7,826
Olin Corporation 115 8,539
Witco Corporation 212 6,186
22,551
Computer Services and Systems -- 3.1%
International Business Machines
Corporation 85 7,799
Construction Materials -- 2.5%
Masco Corporation 200 6,275
Finance -- 6.1%
Federal National Mortgage
Association 63 7,820
The Bear Stearns Companies Inc. 369 7,332
15,152
Food, Beverage and Tobacco -- 6.4%
PepsiCo, Inc. 125 6,984
Philip Morris Companies Inc. 100 9,050
16,034
Gas and Pipeline Utilities -- 3.0%
Williams Companies, Inc. 170 7,459
Insurance -- 9.0%
American Financial Group
Incorporated 175 5,359
Cigna Corporation 61 6,257
Enhance Financial Services Group
Inc. 305 8,128
John Alden Financial Corp. 127 2,643
22,387
Oil Services -- 2.4%
Ultramar Corporation 230 5,923
Real Estate -- 15.6%
Columbus Realty Trust 100 $ 1,937
DeBartolo Realty Corporation 131 1,697
Irvine Apartment Communities, Inc. 95 1,829
National Golf Properties, Inc. 346 7,915
Nationwide Health Properties, Inc. 70 2,940
Regency Realty Corporation 373 6,426C
Resource Mortgage Capital
Corporation 272 5,440
Summit Properties, Inc. 223 4,438
Walden Residential Properties,
Inc. 300 6,262
38,884
Retail Sales -- 2.3%
J.C. Penney Company, Inc. 20 5,715
Savings and Loan -- 8.9%
Great Western Financial
Corporation 180 4,590
Standard Federal Bancorporation 247 9,726
Washington Federal, Inc. 301 7,700
22,016
Telecommunications -- 2.0%
Telefonos de Mexico S.A. ADR 152 4,845
Total Common Stocks and Equity
Interests
(Identified Cost -- $175,469) 225,994
PREFERRED EQUITY REDEMPTION CUMULATIVE STOCK -- 3.1%
RJR Nabisco Holdings Corp. Series
C Depositary Shares
(Identified Cost -- $7,823) 1,205 7,682
Principal
Amount
CORPORATE BOND -- 0.9%
Grupo Mexicano de Desarrollo
S.A. ADR
8.25% 2-17-01
(Identified Cost -- $1,700) $ 5,000 2,125
</TABLE>
6
<PAGE>
<TABLE>
<CAPTION>
Principal
(Amounts in Thousands) Amount Value
<S> <C> <C>
SHORT-TERM INVESTMENTS -- 4.4%
Repurchase Agreement -- 2.7%
Morgan Stanley & Co.
Incorporated
5.9% dated 12-29-95, to be
repurchased at
$6,848 on 1-2-96
(Collateral: $7,146
Federal National Mortgage
Association Mortgage-
backed securities, 5.5% due
7-1-09, value $6,991) $ 6,844 $ 6,844
Sovereign Obligation -- 1.7%
Mexican Cetes
6.0% 2-29-96 mxp35,000 4,183
Total Short-term Investments
(Identified Cost -- $11,643) 11,027
Total Investments -- 99.2%
(Identified Cost -- $196,635) 246,828
Other Assets Less Liabilities -- 0.8% 1,865
NET ASSETS -- 100.0% $248,693
NET ASSET VALUE PER SHARE:
PRIMARY CLASS $15.29
NAVIGATOR CLASS $15.31
</TABLE>
A NON-INCOME PRODUCING
B RULE 144A SECURITY -- A SECURITY PURCHASED PURSUANT TO RULE 144A UNDER
THE SECURITIES ACT OF 1933 WHICH MAY NOT BE RESOLD SUBJECT TO THAT RULE
EXCEPT TO QUALIFIED INSTITUTIONAL BUYERS.
C AFFILIATED COMPANY -- AS DEFINED IN THE INVESTMENT COMPANY ACT OF 1940,
AN "AFFILIATED COMPANY" REPRESENTS FUND OWNERSHIP OF AT LEAST 5% OF THE
OUTSTANDING VOTING SECURITIES OF THE ISSUER.
MXP MEXICAN PESO (NEW)
7
