Quarterly Report
June 30, 1998
Legg Mason
Value Trust, Inc.
Special Investment
Trust, Inc.
Total Return Trust, Inc.
The Art of Investing
Investment Adviser
Legg Mason Fund Adviser, Inc.
Baltimore, MD
Board of Directors
Raymond A. Mason, Chairman
John F. Curley, Jr., President
Richard G. Gilmore
Charles F. Haugh
Arnold L. Lehman
Dr. Jill E. McGovern
T. A. Rodgers
Edward A. Taber, III
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
Independent Accountants
PricewaterhouseCoopers LLP
Baltimore, MD
This report is not to be distributed unless preceded or accompanied by a
prospectus.
Legg Mason Wood Walker, Incorporated
-----------------------------------------
100 Light Street
P.O. Box 1476, Baltimore, MD 21203-1476
410 o 539 o 0000
LMF-002
8/97
<PAGE>
To Our Shareholders,
We are pleased to provide you with this report for the Legg Mason Value
Trust, Special Investment Trust and Total Return Trust for the quarter ended
June 30, 1998.
The following table summarizes key statistics for the Primary Class of shares
of each Fund, as of June 30:
<TABLE>
<CAPTION>
3 Month 6 Month 12 Month
Total Return* Total Return* Total Return*
------------- ------------- -------------
<S><C>
Value Trust 5.23% 23.33% 38.48%
Growth Funds** 1.85 15.11 25.38
Standard & Poor's 500 Composite Index 3.30 17.71 30.16
Total Return Trust -1.53 4.05 23.31
Growth and Income Funds*** .27 12.11 22.86
Special Investment Trust -.86 10.67 22.29
Mid Cap Funds**** -1.40 10.66 22.22
Russell 2000 Index -4.66 4.93 16.51
</TABLE>
As the table indicates, the Value Trust and Special Investment Trust
outperformed similar funds and relevant market indices during recent periods.
Total Return Trust, despite lower returns in the 3 and 6 month periods,
outperformed the average growth and income fund over the 12 months through June
30.
On the following pages, Bill Miller, the portfolio manager for Value Trust
and Special Investment Trust, and Nancy Dennin, the portfolio manager for Total
Return Trust, discuss the Funds and the investment outlook.
Sincerely,
/s/ John F. Curley, Jr.
John F. Curley, Jr.
President
July 28, 1998
- -------------------------------------------------------------------------------
* Total return measures investment performance in terms of appreciation or
depreciation in net asset value per share plus dividends and any capital
gain distributions. It assumes that dividends and distributions were
reinvested at the time they were paid.
** All growth funds (1,061) as measured by Lipper Analytical Services, Inc.
*** All growth and income funds (788) as measured by Lipper Analytical
Services, Inc.
**** All funds investing in securities of companies with medium-sized
capitalizations (341) as measured by Lipper Analytical Services, Inc.
<PAGE>
Portfolio Managers' Comments
Value Trust
Second Quarter 1998
"It is odd to watch with what feverish ardor the Americans pursue
prosperity and how they are ever tormented by the shadowy suspicion that they
may not have chosen the shortest route to get it.... They clutch everything
but hold nothing fast, and so lose their grip as they hurry after some new
delight."
Alexis de Tocqueville (1835)
How Much is Too Much; or When to Sell?
One of the common questions we get from pension consultants, brokers, and
shareholders is "when are you going to sell your Dell or America Online ("AOL")?
In the Value Trust, the average cost of our Dell position, acquired in early
1996, is about $4.00 per share. The shares trade today at about $115. The
average cost of our AOL position is about $20; the stock trades now around $125
per share. At the end of the second quarter, Dell made up over 8% of the assets
in Value Trust, AOL just over 7%. In the Special Investment Trust, where we've
owned AOL for a longer period, the stock makes up a whopping 16% of assets at
June 30.
There are several issues implicit in the question of when to sell. First is
the generic strategy question: what general criteria drive the process of
deciding when to sell? The second has its origin in the usual behavior of money
managers, whose average portfolio turnover approximates 100% per year. In a
world where investors appear to be frenetically trading shares in response to or
in anticipation of short-term price moves, multi-year holding periods are
atypical. Investing in a company for many years, instead of speculating on a
stock's price action, has become unusual enough to warrant an explanation. Why
have you held the stock for such a long time and when are you going to sell?
Third is the question of risk. How much of a portfolio's assets should be
concentrated in a single holding? How large can a holding become without
subjecting the portfolio to undue risk?
A variant of the first question has to do with strategy. We are value
investors who invest in shares of companies trading at large discounts to our
assessment of the intrinsic value of the business. How can a company's stock go
up 25x in a few years and still be trading at a discount to intrinsic value? How
can anything selling at 75x trailing earnings (Dell) or 100x estimated earnings
(AOL) possibly be considered a value? Haven't the shares gone from value to
growth to outright speculation?
Our selling strategy is simple: we sell when a company's share price has
reached fair value; we sell to replace an existing holding with a better
bargain, and we sell when our original investment case is no longer applicable.
"Fair value" means that the market has, in our opinion, correctly priced the
stock. It understands and has adequately discounted the future free cash flows
of the business so that we can no longer earn an excess return by holding the
shares. Put differently, fair value means that the risk adjusted rate of return
available by holding the shares long-term is no greater than that of the market
as a whole, and may be less. Second, if we are fully invested and our research
uncovers a security we believe has more value than something we already own, we
will replace the lesser bargain with the greater. Finally, we sometimes find
that our analysis was wrong, either because we uncover new information, or
because we interpret our existing information differently, or because the world
changes--new legislation is passed, new regulations are promulgated, the
competitive landscape changes, and so on. We will sell securities when we
believe we are wrong, whether the share price is above or below our purchase
price.
2
<PAGE>
In general, we try to keep our portfolios positioned in a diversified, but
focused, group of companies that we believe trade at discounts to intrinsic
value and therefore offer the opportunity for above average risk adjusted rates
of return.
There is no time limit on investing. We do not sell because we've owned
shares for some period of time. Price and value are two different and
independent variables. We do not sell because a stock's price has gone up, or
down, a lot. We value businesses, not stocks--we compare the value of the
business to what the market says it is worth. If we believe the discount is
sufficient, we purchase the shares. We invest in companies, we do not speculate
on share price changes. Thus we do not react to earnings reports, or analyst
opinion changes, or try to guess whether the Fed will change rates next month,
or whether the GDP number will be higher or lower than expectations.
When we look at Dell, for example, which has a market capitalization of over
$60 billion, our analysis focuses on whether Dell's business is worth more or
less than $60 billion, and not on whether the stock is likely to outperform, or
whether computer sales this month will be slower or faster than expected.
Elsewhere in this report, Lisa Rapuano, assistant portfolio manager of the
Special Investment Trust, takes a more detailed look at how we analyze the value
of AOL.
When the market prices two companies at the same price/earnings ratio, then,
other things equal (e.g. assuming the same capital structure), it believes the
businesses have the same value expressed as a multiple of earnings. But other
things are rarely equal. Dell and Gateway compete in the personal computer area.
Dell trades at over 40x next year's earnings, Gateway at under 20x. Is Gateway
cheaper than Dell? If Dell earns over 200% on each dollar of invested capital,
as it does, isn't it worth more than Gateway, which earns 40%? How much more? If
it's 5x as profitable, is it worth 5x as much? If its price/earnings ratio is
only 2x that of Gateway, is it then a bargain? This is not meant to suggest an
answer, just to note that businesses have different values and those values are
hardly captured by a single number on a linear scale such as price/earnings
ratios. We are delighted, though, when people persist in thinking price/earnings
ratios tell most of the story about value, since it gives us an opportunity to
make better investment decisions by doing a more thorough job of analysis.
That still leaves the question of how much is too much? This is a question of
risk versus reward. When does a stock become so large a portion of a portfolio
that the portfolio's returns depend too much on that security's performance? We
typically own 40 or so stocks, and our top ten names constitute about 40% of our
assets. We think that the fewer the names the better. Even if our largest
holding were 10%, that means that 90% of our returns would be sourced elsewhere.
The Chicago Bulls have five sources of points operating at any one time, but
Michael Jordan's play usually determines their results. Should they trade him
for a rookie so they won't be so dependent on him? If he does poorly, in all
likelihood, so will they. When will they replace him? Probably when they
determine he can no longer produce the results given what they are paying for
him. That same criterion is helpful in thinking about stocks.
Warren Buffett has been justly celebrated for his investment genius and has
been a consistent proponent of portfolio concentration. Our new colleague Robert
Hagstrom, author of The Warren Buffet Way, and manager of the Legg Mason Focus
Trust, calculated that Coca Cola, which made up 12% of Buffett's common stock
portfolio shortly after he purchased it in 1988, now makes up about 37% of his
portfolio. Should he sell it, trading as it is at over 50x next year's earnings?
Is Buffett no longer a value investor because he continues to hold Coke,
Gillette, and Disney, all of which sell at price/earnings ratios and price to
book value ratios far above the market's current levels, which are historically
among the highest ever?
3
<PAGE>
Portfolio Managers' Comments--Continued
You may have read recently about the estate left by Don Othmer, a professor
of chemical engineering at a small school called Brooklyn Polytechnic and his
wife, Mig. In the late 1950's they put all of their money with Warren Buffett
and it all subsequently went into one stock, Berkshire Hathaway. Had they
consulted other advisors, they no doubt would have been told they had way too
much in one stock, and they would, as many investors do, have continuously cut
back their position as it went up to diversify into other investments. They also
would not have been worth $800 million when their estate was settled.
In 1956, J.L. Kelly, Jr. published a paper in mathematical information theory
that dealt with the transmission of information over a phone line. In it Kelly
devised a formula that subsequently was shown to have general applicability for
any problem that seeks to maximize a growth rate per unit of investment. Using
Kelly's formula, we can calculate that if Buffett has 37% of his portfolio in
Coke, he believes his probability of being right about Coke is 70%. More
generally, Kelly's formula would indicate that the growth rate of a portfolio is
maximized with no more than 5 stocks, assuming the returns of each security are
independent and one believes the probability of outperformance is greater than
50%. Kelly's formula, which is not well known among investors (it also serves as
the basis of fixed fractional betting strategies among gamblers), provides a
clue about why the largest fortunes are made by concentrating, not by
diversifying, and also would suggest that the new category of focus funds is
likely to prove quite rewarding to investors, assuming managers can generally
distinguish their best ideas from the rest.
The questions of how much is too much and of when to sell have no perfect
answers; they depend on imperfect information and on judgments which are often
wrong. We cannot promise we will be right about these issues, but we do promise
to think carefully, critically, and diligently about them, and to use our best
judgment to try to add value to your investment.
We have not attempted to be exhaustive in these remarks on selling and on
concentration, but to provide some insight into our thinking on these
complicated subjects. As always, we appreciate your support and welcome your
comments.
Bill Miller, CFA
----------------------------------------------
Special Investment Trust
Our cumulative results for various periods ended June 30, 1998 are listed in
the table below:
<TABLE>
<CAPTION>
3 months 1 year 3 years 5 years
- --------------------------------------------------------------------------------------------
<S><C>
Special Investment Trust -0.86% 22.29% 88.62% 115.52%
Lipper Small Company Funds -4.11 17.68 72.69 118.97
Lipper Mid Cap Funds -1.40 22.22 75.53 118.80
S&P 500 Composite Index 3.30 30.16 120.94 182.48
Russell 2000 Index -4.66 16.51 67.90 110.43
</TABLE>
As you can see, we had a modestly down second quarter. We outperformed the
Russell 2000, an index of smaller companies, as well as the Lipper indices of
small and mid-cap oriented funds. We trailed the S&P 500, whose results were
again driven by the mega-capitalization stocks. Our one and three year
performance also outpaced all the indices except the S&P 500, and our five year
record passed the Russell 2000, but is still slightly behind other small and
mid-cap funds and the S&P 500.
4
<PAGE>
We added no new positions in the second quarter, but eliminated several as
part of an ongoing process of pruning positions that are small as a percentage
of the Fund. These positions, listed elsewhere in the report, each represented
less than 0.8% of the portfolio. For comparison, we believe a typical new
position in the Fund should be at least 2%.
Our top holdings in Special Investment Trust have been performing very well,
and particularly noteworthy is the appreciation of our largest holding, America
Online ("AOL"). Given its notable performance and large position, we thought
that some comments on how we value this business, and businesses in general,
would be interesting to shareholders. AOL presents a good opportunity to
illustrate how we approach the valuation puzzle for all of our companies.
One of the questions we are often asked is: "How can Legg Mason Funds own AOL
and still employ a value-driven investment philosophy?" The answer is simple. As
John Burr Williams pointed out in 1938 in his ground breaking book The Theory of
Investment Value, the intrinsic value of any company is the present value of the
future free cash flows of that company. We believe the future free cash flows of
AOL are larger than implied by the present value of the business. The growth
generated by the online and Internet markets, AOL's dominant market share, the
high profitability level we think they will achieve and the relatively small
capital investment needed to achieve this growth and profitability, all lead to
very attractive long-term economics for the business.
The most important issue in determining the value of a company is to
understand the business model and what the future growth and profitability of
the company may be. In AOL's case, the Internet/online business is just
beginning to achieve mass market penetration, is growing at a rate close to 100%
per year, and AOL has a very large (over 50%) market share. This is a business
that appears to benefit from what economist Brian Arthur calls increasing
returns. Increasing returns is a term Arthur uses to describe businesses whose
economics get better as they grow, as opposed to the decreasing returns that
classical economists believe most businesses encounter. Leaders in increasing
returns businesses are often able to achieve near unassailable competitive
positions.
As a result of their leadership in the subscriber base, and their mass market
audience, AOL is able to make highly profitable advertising and electronic
commerce deals. A good example is the Tel-Save long distance agreement. Tel-Save
paid AOL $100 million in cash, gave AOL an ownership stake in the company, and
agreed to further profit sharing if Tel-Save exceeds certain goals. AOL allowed
Tel-Save to market to their members and present billing on-line, and the members
received very inexpensive long distance telephone service. Because the cost of
AOL's contribution is effectively nothing, the incremental profit of this to AOL
is very, very high. One way we think about the electronic commerce business is
to compare it to the advent of the "800 number." It was a new way to do
business, and the inventor of the concept, AT&T, sold 800 number service to
businesses, but did not benefit from any of the commerce that 800 numbers
generated. AOL has a distribution channel that may actually be bigger than 800
numbers are now, and they have the market position to charge a small toll on
every transaction that takes place. It is a potentially huge market.
We've already seen a dramatic improvement in the profitability of the company
as they add more high margin business like advertising and electronic commerce,
and we believe this will continue.
With the understanding that the AOL business model is very powerful, and is
on track to become incredibly profitable, we can intelligently analyze the value
of the business. To do so, we use a multi-factor valuation methodology, which
means that we use any and every tool to evaluate what a business might be worth.
We have found in our valuation work on all of our companies that a single
5
<PAGE>
Portfolio Managers' Comments--Continued
factor valuation model--for example using just low P/E's or high growth
rates--rarely allows one to identify truly mispriced securities.
For AOL, we believe that the traditional P/E ratio is not a useful measure
because of the future growth, expansion of margins and reduced capital needed in
the future. So, we calculate value through a myriad of other methodologies
including discounted cash flow, future market size and market share analysis,
return on invested capital, price/sales ratios, and relative value versus other
large, growing and profitable companies.
In addition to valuing the business using the above approaches, we also do a
detailed analysis of each business line to determine what we think it is worth
to an informed buyer. The first part of AOL's business is its advertising and
commerce business. This business generated about $300 million in revenue over
the last twelve months, up from just $75 million a year ago. We estimate this
business has 90% profit margins and has high barriers to entry because it
depends on having a large number of subscribers. How does this compare to how
other similar businesses are valued? Microsoft, for example, has operating
margins over 50% and grew 28% in sales last quarter. The market value of
Microsoft is at 20x trailing sales and 70x trailing earnings. We believe the AOL
advertising and commerce business should be similarly valued.
Another business line is the pure subscriber business, where members pay
$21.95 per month for access to the Internet and to proprietary content and
community-based services such as chat rooms on AOL. We compare this to other
subscriber businesses like cellular phones, cable, paging, and newspapers. There
are big differences in the economics of these businesses, and there are big
differences in how they are valued, but we think that a careful evaluation of
these differences gives a very good idea of what an AOL subscriber is worth.
In addition to the subscriber and electronic commerce businesses, we add the
value of AOL's large portfolio of public and private investments. AOL owns a
significant percentage of several companies, including Tel-Save, mentioned
above, Excite, N2K, Digital Courier and others. We can look at the public value
where available and view the private market portfolio as an additional source of
value that we can not quite quantify.
These valuation techniques do not yield a single, specific target price, but
a range of values that currently come out between $110-175 per share. We were
recently very encouraged to see that our valuation is similar to what AT&T
reportedly was willing to pay for the entire business, but that the management
and board of AOL believed the business was worth far more and pursued a
partnership with AT&T instead of an outright sale.
The first time we did this analysis in 1996, our value range centered around
$45, so it is important to note that this is not a static exercise, but a
dynamic one. The value has grown dramatically over time and we believe it will
continue to grow. While we can not predict exactly what will happen in this
evolving and exciting business, we believe that AOL has the right model and will
reward shareholders. This is what has led us to hold on far longer than most
"value" investors would have, and so far that has been a rewarding decision.
As always, we appreciate your support and your comments are always welcome.
Lisa Rapuano, CFA
Bill Miller, CFA
6
<PAGE>
Total Return Trust
As shown below, your Fund has underperformed its peer group and the major
market averages in 1998, although it has outperformed its peer group over the
last one, three and five year periods ended June 30, 1998 (returns are
cumulative).
<TABLE>
<CAPTION>
3 Months 6 Months 1 Year 3 Years 5 Years
- --------------------------------------------------------------------------------------------------
<S><C>
Total Return Trust -1.53% 4.05% 23.31% 110.00% 145.85%
Lipper Growth & Income Funds 0.27 12.11 22.86 94.58 138.96
S&P 500 Composite Index 3.30 17.71 30.16 120.94 182.48
Dow Jones Industrial Average 2.14 14.14 18.67 108.94 186.05
</TABLE>
These numbers mask the strong polarization of equity returns in the first
half of the year. The relative performance of high P/E stocks for the six months
ended June 30, 1998 was the best of the last 20 years, and nearly the best of
the prior 50 years, according to a recently completed study by Sanford
Bernstein. Companies in the top quintile of forward P/E ratios of 29x or greater
outperformed the S&P 500 by 9.4% in the first half of the year, while those in
the bottom three quintiles trailed the market by 6.6%.
The returns by market capitalization follow a similar pattern. The largest
fifty stocks in the S&P 500 advanced 22.5% in the first half, while the next 450
gained 12.2%. Even more striking, Bernstein's 5,000 stock universe was up only
9.0% in the first half, and down 4.7% in the second quarter. This was also among
the most extreme performance differentials of the last five decades.
While, as always, we are agnostic about the near-term direction of the
market, it is unreasonable to expect this extreme polarization to continue. It
is also unreasonable to expect the market to continue to rise at rates that
exceed the growth of underlying business values. Reasonable expectations for
stock returns going forward would seem to be in the 10% range, rather than the
spectacular returns of the past few years.
In our opinion, your Fund is positioned to do well in this environment.
Relatively high income producing securities should do quite well in an
environment of more modest returns. The portfolio's REIT's average current yield
of 7.0% provides a large part of our expected annual market return! We added to
our REIT exposure in the second quarter by purchasing Crescent Real Estate
Equities and Starwood Hotels & Resorts.
Given the underperformance of the REITs so far in 1998, astute managements,
such as Crescent's, are recapitalizing their balance sheets to unlock the
inherent value of their companies. Crescent plans to increase its dividend 66%,
raise up to $930 million in a rights offering following the planned fourth
quarter closing of the Stations Casino acquisition, and put its gaming assets
into a new partnership. We believe the value of Crescent is well in excess of
its current stock price.
Starwood Hotels & Resorts is one of a handful of REITs that has a "paired
share" corporate structure. Very simply, a paired share REIT format allows a
company to both own and operate real estate. Congress will soon vote on
legislation to discontinue the paired share format, which we believe is
7
<PAGE>
Portfolio Managers' Comments--Continued
likely to pass. If it does, we expect Starwood to convert to a regular tax
paying corporation, which for a variety of reasons, should result in the stock
significantly appreciating.
As most of our long-term shareholders are aware, we normally focus our stock
selection process on securities that produce current income. Periodically
though, we will purchase a non-income producing security. In every case, we
attempt to buy stocks at substantial discounts to the worth of the underlying
companies.
During the second quarter, we purchased Toys "R" Us, which has many of the
criteria we look for in an investment, except current yield. A new,
shareholder-driven CEO, has been appointed after several years of disappointing
results. The company has adopted the "Economic Value Added" approach to managing
the business, where, simplistically, every unit must earn an adequate return on
its invested capital. They are repurchasing stock (a very adequate substitute
for a dividend), insiders are buying stock after being steady sellers for over a
year, and the stock is selling at a significant discount to its intrinsic value,
in our opinion. Very seldom has a stock with these attributes not performed well
over our investment horizon of three to five years.
We also purchased shares of United Asset Management ("UAM") during the
quarter. UAM is a holding company for a number of investment management
subsidiaries that in aggregate manage over $210 billion in assets. The company's
new President is very shareholder oriented, senior management has incentive to
improve the cash return on equity, and the stock sells at a discount to both its
peer group and on a private market value basis.
We sold our remaining position in John Alden, as the arbitrage narrowed
between the stock price and its acquisition price. Both Masco and Unicom reached
our price targets, and were sold.
Our disciplined, value approach usually entails some underperformance in
enthusiastic markets. This should be counter-balanced by better results in more
sluggish periods. Despite the generally strong results of the past few years, it
is not a prime objective of this Fund to outperform each and every quarter. The
Fund is managed to deliver sound long-term results, consistent with our risk
profile.
As always, we appreciate your support, and welcome your comments.
Nancy Dennin, CFA
July 28, 1998
DJIA 8934.78
8
<PAGE>
Performance Information
Total Return for One, Five, Ten Years and Life of Funds, as of June 30, 1998
The returns shown on these pages are based on historical results and
are not intended to indicate future performance. The investment return and
principal value of an investment in any of these Funds 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 a Fund's return, so they differ from actual year-to-year results. No
adjustment has been made for any income taxes payable by shareholders.
Total returns as of June 30, 1998 for each Fund, and the S&P 500 Composite
Index are shown in the table below.
Each 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.
Average annual and cumulative total returns as of June 30, 1998 were as
follows:
<TABLE>
<CAPTION>
Special S&P 500
Value Investment Total Return Composite
Trust Trust Trust Index
- ----------------------------------------------------------------------------------------------------------------
<S><C>
Average Annual Total Return
Primary Class:
One Year +38.48% +22.29% +23.31% +30.16%
Five Years +29.39 +16.60 +19.71 +23.08
Ten Years +18.96 +16.63 +15.13 +18.54
Life of Class--Value Trust(A) +20.75 +18.92
Life of Class--Special Investment Trust(B) +14.84 +17.77
Life of Class--Total Return Trust(C) +12.91 +18.06
Navigator Class:
One Year +39.89 +23.57 +24.63 +30.16
Life of Class(D) +41.47 +24.68 +28.56 +32.18
Cumulative Total Return
Primary Class:
One Year +38.48% +22.29% +23.31% +30.16%
Five Years +262.66 +115.52 +145.85 +182.48
Ten Years +467.54 +365.71 +308.98 +447.80
Life of Class--Value Trust(A) +2,023.23 +1,560.24
Life of Class--Special Investment Trust(B) +464.81 +673.29
Life of Class--Total Return Trust(C) +362.77 +711.99
Navigator Class:
One Year +39.89 +23.57 +24.63 +30.16
Life of Class(D) +246.68 +120.44 +146.02 +165.59
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
(A) Inception of Value Trust--April 16, 1982.
(B) Inception of Special Investment Trust--December 30, 1985.
(C) Inception of Total Return Trust--November 21, 1985.
(D) Commencement of sale of Navigator Shares for each Fund--December 1,
1994.
9
<PAGE>
Performance Information--Continued
Value Trust
Illustration of an Assumed Investment of $10,000 made on April 16, 1982
(inception of the Value Trust Primary Class)
(Graph Appears Here; Plot Points Appear Below)
Value of original
shares purchased
Value of shares plus shares acquired
acquired through through reinvestment
reinvestment of of capital gain
income dividends distributions
---------------- --------------------
4/16/82 $ 10,000 $ 10,000
3/31/83 16,400.97 16,160
3/31/84 19,425.44 18,870.5
3/31/85 24,682.58 23,582.98
3/31/86 34,509.72 32,555.48
3/31/87 37,924.3 35,503.58
3/31/88 34,729.33 32,267.83
3/31/89 41,109.15 37,650.23
3/31/90 44,289.55 39,890.82
3/31/91 43,013.79 37,701.34
3/31/92 51,413.83 44,210.32
3/31/93 59,003.27 50,183.93
3/31/94 62,337.34 52,789.39
3/31/95 68,426.55 57,816.96
3/31/96 97,226.16 82,355.78
3/31/97 129,881.47 110,379.07
3/31/98 201,761 172,947
6/30/98 212,324 182,582
--------------------------------
Selected Portfolio Performance*
Strong performers for the 2nd quarter 1998
----------------------------------------------
1. America Online, Inc. +55.2%
2. Ford Motor Company +37.1%
3. Dell Computer Corporation +37.0%
4. Chrysler Corporation +35.6%
5. Nokia Oyj +34.5%
6. MCI Communications Corporation +17.4%
7. Philips Electronics N.V. +15.7%
8. Storage Technology Corporation +14.1%
9. Chase Manhattan Corporation +12.0%
10. The Bear Stearns Companies, Inc. +10.7%
* Securities held for the entire quarter.
Weak performers for the 2nd quarter 1998
----------------------------------------------
1. Western Digital Corporation -32.7%
2. PennCorp Financial Group, Inc. -29.0%
3. RJR Nabisco Holdings Corp. -24.2%
4. Toys "R" Us, Inc. -21.6%
5. Circus Circus Enterprises, Inc. -19.4%
6. Conseco, Inc. -17.4%
7. Telefonos de Mexico S.A. ADR -14.8%
8. Hilton Hotels Corporation -10.6%
9. Lloyds TSB Group plc -10.0%
10. Columbia/HCA Healthcare
Corporation -9.7%
Portfolio Changes
Securities added during the 2nd quarter 1998
----------------------------------------------
H.F. Ahmanson & Company
General Re Corporation
Securities sold during the 2nd quarter 1998
----------------------------------------------
Coltec Industries Inc.
Reebok International Ltd.
10
<PAGE>
Special Investment Trust
Illustration of an Assumed Investment of $10,000 made on December 30, 1985
(inception of the Special Investment Trust Primary Class)
(Graph Appears Here; Plot Points Appear Below)
Value of original
shares purchased
Value of shares plus shares acquired
acquired through through reinvestment
reinvestment of of capital gain
income dividends distributions
---------------- --------------------
12/30/85 $10,000 $10,000
3/31/86 11,530 11,530
3/31/87 13,073 13,050.76
3/31/88 11,219.7 11,106.84
3/31/89 13,125.95 12,981.74
3/31/90 15,142.97 14,889.53
3/31/91 18,391.89 17,776.51
3/31/92 22,154.2 21,249.28
3/31/93 24,481.5 23,528.14
3/31/94 29,708.01 28,511.3
3/31/95 27,814.8 26,706.89
3/31/96 35,733.08 34,291
3/31/97 39,870.52 38,344.53
3/31/98 56,969 54,898
6/30/98 56,481 54,587
--------------------------------
Selected Portfolio Performance*
Strong performers for the 2nd quarter 1998
----------------------------------------------
1. America Online, Inc. +55.2%
2. Cell Genesys, Inc. +29.3%
3. Northeast Utilities System +18.3%
4. WPPGroup plc +15.2%
5. InaCom Corp. +14.9%
6. Storage Technology Corporation +14.1%
7. The Bear Stearns Companies, Inc. +10.7%
8. Gateway 2000, Inc. +7.9%
9. Hollywood Park, Inc. +7.5%
10. Calenergy Company, Inc. +6.4%
* Securities held for the entire quarter.
Weak performers for the 2nd quarter 1998
- ----------------------------------------------------
1. Philip Services Corp. -60.5%
2. Hadco Corp. -41.2%
3. Mego Financial Corp. -34.1%
4. LASER Mortgage Management, Inc. -33.3%
5. Western Digital Corporation -32.7%
6. PennCorp Financial Group, Inc. -29.0%
7. Sybase, Inc. -27.8%
8. Madge Networks N.V. -23.2%
9. Sun Healthcare Group Inc. -21.5%
10. Circus Circus Enterprises, Inc. -19.4%
Portfolio Changes
Securities added during the 2nd quarter 1998
----------------------------------------------
None
Securities sold during the 2nd quarter 1998
----------------------------------------------
Capital Automotive REIT
Catellus Development Corporation
Hospitality Properties Trust
Mego Mortgage Corporation
Ryder System, Inc.
Shoney's, Inc.
Sunrise Medical, Inc.
Vencor, Inc.
11
<PAGE>
Performance Information--Continued
Total Return Trust
Illustration of an Assumed Investment of $10,000 made on November 21, 1985
(inception of the Total Return Trust Primary Class)
(Graph Appears Here; Plot Points Appear Below)
Value of original
shares purchased
Value of shares plus shares acquired
acquired through through reinvestment
reinvestment of of capital gain
income dividends distributions
---------------- --------------------
11/21/85 $10,000 $10,000
3/31/86 10,780 10,780
3/31/87 11,884.09 11,673.03
3/31/88 10,675 10,295.43
3/31/89 12,293 11,689.85
3/31/90 12,720.53 11,874.31
3/31/91 12,714.62 11,498.61
3/31/92 15,714.56 13,884.21
3/31/93 18,839.3 16,234.03
3/31/94 19,701.15 16,637.21
3/31/95 19,916.82 16,637.21
3/31/96 26,535.98 21,341.73
3/31/97 32,992.2 26,102.28
3/31/98 46,995 37,430
6/30/98 46,277 36,931
--------------------------------
Selected Portfolio Performance*
Strong performers for the 2nd quarter 1998
----------------------------------------------
1. Ford Motor Company +37.1%
2. Chrysler Corporation +35.6%
3. Chase Manhattan Corporation +12.0%
4. The Bear Stearns Companies, Inc. +10.7%
5. International Business Machines
Corporation +10.5%
6. Tanger Factory Outlet Centers, Inc. +8.8%
7. Tupperware Corporation +5.6%
8. BankAmerica Corporation +4.6%
9. United States Treasury Bonds
6% 2/15/26 +4.1%
10. Edison International +0.6%
* Securities held for the entire quarter.
Weak performers for the 2nd quarter 1998
----------------------------------------------
1. RJR Nabisco Holdings Corp. -24.2%
2. Briggs & Stratton Corporation -18.3%
3. Hercules, Inc. -16.7%
4. UST, Inc. -16.3%
5. AK Steel Holding Corporation -15.4%
6. Telefonos de Mexico S.A. ADR -14.8%
7. Olin Corporation -11.2%
8. Ultramar Diamond Shamrock
Corporation -10.5%
9. Lloyds TSB Group plc -10.0%
10. LaSalle Re Holdings Ltd. -9.7%
Portfolio Changes
Securities added during the 2nd quarter 1998
----------------------------------------------
Crescent Real Estate Equities Company
Starwood Hotels & Resorts
Toys "R" Us, Inc.
United Asset Management Corporation
Securities sold during the 2nd quarter 1998
----------------------------------------------
John Alden Financial Corporation
Masco Corporation
Unicom Corporation
12
<PAGE>
Portfolio of Investments
June 30, 1998 (Unaudited)
(Amounts in Thousands)
Legg Mason Value Trust, Inc.
<TABLE>
<CAPTION>
Shares/Par Value
- -----------------------------------------------------------------------------------------------------
<S><C>
Common Stocks and Equity Interests -- 89.4%
Automotive -- 4.6%
Chrysler Corporation 2,700 $ 152,212
Ford Motor Company 550 32,450
General Motors Corporation 1,200 80,175
----------
264,837
----------
Banking -- 13.8%
BankAmerica Corporation 800 69,150
BankBoston Corporation 1,700 94,562
Chase Manhattan Corporation 2,800 211,400
Citicorp 1,200 179,100
Fleet Financial Group, Inc. 669 55,874
Lloyds TSB Group plc 8,011 112,156
Zions Bancorporation 1,403 74,524
----------
796,766
----------
Computer Services and Systems -- 19.0%
Compaq Computer Corporation 5,690 161,454
Dell Computer Corporation 5,300 491,906(A)
International Business Machines Corporation 1,275 146,386
Seagate Technology, Inc. 2,000 47,625(A)
Storage Technology Corporation 4,687 203,290(A)
Western Digital Corporation 4,000 47,250(A)
----------
1,097,911
----------
Electrical Equipment -- 1.9%
Philips Electronics N.V. 1,320 112,200
----------
Entertainment -- 2.7%
Circus Circus Enterprises, Inc. 5,200 88,075(A,B)
MGM Grand, Inc. 2,230 70,384(A)
----------
158,459
----------
Finance -- 9.1%
Fannie Mae 3,200 194,400
Freddie Mac 2,000 94,125
MBNA Corporation 4,245 140,099
The Bear Stearns Companies, Inc. 1,654 94,057
----------
522,681
----------
Food, Beverage and Tobacco -- 4.0%
PepsiCo, Inc. 950 39,128
Philip Morris Companies, Inc. 2,900 114,188
RJR Nabisco Holdings Corp. 3,300 78,375
----------
231,691
----------
</TABLE>
13
<PAGE>
Portfolio of Investments--Continued
Legg Mason Value Trust, Inc.--Continued
<TABLE>
<CAPTION>
Shares/Par Value
- -----------------------------------------------------------------------------------------------------
<S><C>
Food Merchandising -- 1.8%
The Kroger Co. 2,400 $ 102,900(A)
----------
Health Care -- 3.4%
Columbia/HCA Healthcare Corporation 3,600 104,850
Foundation Health Systems, Inc. 3,368 88,834(A)
----------
193,684
----------
Hotels & Motels -- 1.7%
Hilton Hotels Corporation 3,500 99,750
----------
Insurance -- 4.4%
Ambac Financial Group, Inc. 766 44,811
Conseco, Inc. 725 33,894
General Re Corporation 400 101,400
MBIA, Inc. 510 38,186
PennCorp Financial Group, Inc. 1,645 33,716(B)
----------
252,007
----------
Manufacturing -- 1.5%
Danaher Corporation 2,400 88,050
----------
Media -- 7.4%
America Online, Inc. 4,025 426,650(A)
----------
Motion Pictures & Services -- 0.5%
Metro-Goldwyn-Mayer, Inc. 1,200 26,400(A)
----------
Pharmaceuticals -- 1.7%
Amgen Inc. 1,500 98,063(A)
----------
Real Estate -- 2.6%
Starwood Hotels & Resorts 3,100 149,769
----------
Retail Sales -- 1.6%
Toys "R" Us, Inc. 3,800 89,538(A)
----------
Savings and Loan -- 2.2%
H.F. Ahmanson & Company 554 39,298
Washington Mutual, Inc. 1,988 86,332
----------
125,630
----------
</TABLE>
14
<PAGE>
<TABLE>
<CAPTION>
Shares/Par Value
- -----------------------------------------------------------------------------------------------------
<S><C>
Telecommunications -- 5.5%
MCI Communications Corporation 2,555 $ 148,509
Nokia Oyj 1,400 101,587
Telefonos de Mexico S.A. ADR 1,425 68,489
----------
318,585
----------
Total Common Stocks and Equity Interests
(Identified Cost -- $2,593,719) 5,155,571
- -----------------------------------------------------------------------------------------------------
U.S. Government Obligations -- 1.0%
United States Treasury Bonds, 6.625% due 2/15/27
(Identified Cost-- $50,631) $ 50,000 56,461
- -----------------------------------------------------------------------------------------------------
Repurchase Agreements -- 9.9%
Lehman Brothers, Inc.
5.95%, dated 6/30/98, to be repurchased at $573,002 on 7/1/98
(Collateral: $580,836 Freddie Mac Mortgage-backed securities,
7% due 11/1/27-3/1/28, value $592,279)
(Identified Cost-- $572,907) 572,907 572,907
- -----------------------------------------------------------------------------------------------------
Total Investments-- 100.3% (Identified Cost-- $3,217,257) 5,784,939
Other Assets Less Liabilities-- (0.3%) (19,198)
----------
Net assets-- 100.0% $5,765,741
==========
Net asset value per share:
Primary Class $51.70
======
Navigator Class $52.33
======
- -----------------------------------------------------------------------------------------------------
</TABLE>
(A) Non-income producing
(B) Affiliated Companies--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. At June 30, 1998, the total
market value of Affiliated Companies was $121,791 and the identified cost
was $191,956.
15
<PAGE>
Portfolio of Investments
June 30, 1998 (Unaudited)
(Amounts in Thousands)
Legg Mason Special Investment Trust, Inc.
<TABLE>
<CAPTION>
Shares/Par Value
- -----------------------------------------------------------------------------------------------------
<S><C>
Common Stocks and Equity Interests -- 94.8%
Advertising -- 5.3%
WPP Group plc 13,250 $ 86,890
---------
Banking -- 2.2%
Peoples Heritage Financial Group, Inc. 1,500 35,438
---------
Biotechnology -- 0.6%
Cell Genesys, Inc. 1,173 10,044(A)
---------
Computer Services and Systems -- 21.8%
Bell & Howell Company 975 25,167(A)
Gateway 2000, Inc. 1,800 91,125(A)
ICG Communications 949 34,701(A)
InaCom Corp. 1,100 34,925(A,B)
Madge Networks N.V. 2,436 11,572(A,B)
Quantum Corporation 1,900 39,425(A)
Storage Technology Corporation 2,000 86,750(A)
Western Digital Corporation 2,700 31,894(A)
---------
355,559
---------
Computer Software -- 1.4%
Sybase, Inc. 3,265 22,753(A)
---------
Electronics - Semiconductor -- 1.8%
Hadco Corp. 1,255 29,257(A,B)
---------
Energy -- 4.7%
Calenergy Company, Inc. 850 25,553(A)
Northeast Utilities System 3,000 50,812(A)
---------
76,365
---------
Entertainment -- 8.3%
Circus Circus Enterprises, Inc. 1,800 30,488(A)
Hollywood Entertainment Corp. 3,324 45,084(A,B)
Hollywood Park, Inc. 2,515 31,752(A,B)
Mirage Resorts, Incorporated 685 14,599(A)
Players International, Inc. 2,485 12,347(A,B)
---------
134,270
---------
Environmental Services-- 1.8%
Philip Services Corp. 7,100 29,287(A,B)
---------
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
Shares/Par Value
- -----------------------------------------------------------------------------------------------------
<S><C>
Finance -- 8.0%
Amerin Corporation 1,660 $ 48,451(A,B)
Mego Financial Corp. 643 2,211(A)
The Bear Stearns Companies, Inc. 551 31,352
United Asset Management Corporation 1,850 48,216
---------
130,230
---------
Food, Beverage and Tobacco -- 2.0%
Cott Corporation 4,400 31,900(A,B)
---------
Health Care -- 3.5%
Magellan Health Services, Inc. 1,263 32,036(A)
Sun Healthcare Group Inc. 1,750 25,594(A)
---------
57,630
---------
Insurance -- 10.4%
CMAC Investment Corporation 442 27,183
Enhance Financial Services Group, Inc. 1,110 37,462
John Alden Financial Corporation 300 6,600
Orion Capital Corporation 1,180 65,933
PennCorp Financial Group, Inc. 1,600 32,800(B)
---------
169,978
---------
Manufacturing -- 0.8%
Danaher Corporation 343 12,584
---------
Media -- 17.6%
America Online, Inc. 2,480 262,880(A)
USA Networks,Inc. 900 22,618(A)
---------
285,498
---------
Miscellaneous -- 0.1%
Olsen & Associates AG 300 1,981(A,C)
---------
Networking Products -- 2.3%
Cabletron Systems, Inc. 2,800 37,625(A)
---------
</TABLE>
17
<PAGE>
Portfolio of Investments--Continued
Legg Mason Special Investment Trust, Inc.--Continued
<TABLE>
<CAPTION>
Shares/Par Value
- -----------------------------------------------------------------------------------------------------
<S><C>
Real Estate -- 2.2%
Dynex Capital, Inc. 1,473 $ 16,383
LASER Mortgage Management, Inc. 1,795 19,521(B)
----------
35,904
----------
Total Common Stocks and Equity Interests
(Identified Cost-- $993,048) 1,543,193
- -----------------------------------------------------------------------------------------------------
Repurchase Agreements -- 5.1%
Lehman Brothers, Inc.
5.95%, dated 6/30/98, to be repurchased at $83,404 on 7/1/98
(Collateral: $48,091 Freddie Mac Mortgage-backed securities,
7% due 11/1/27, value $49,038; $36,510 Fannie Mae
Mortgage-backed securities, 7% due 11/1/27, value $37,195)
(Identified Cost-- $83,390) $ 83,390 83,390
- -----------------------------------------------------------------------------------------------------
Total Investments-- 99.9% (Identified Cost-- $1,076,438) 1,626,583
Other Assets Less Liabilities-- 0.1% 938
----------
Net assets-- 100.0% $1,627,521
==========
Net asset value per share:
Primary Class $32.95
======
Navigator Class $34.14
======
- -----------------------------------------------------------------------------------------------------
</TABLE>
(A) Non-income producing
(B) Affiliated Companies--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. At June 30, 1998,
the total market value of Affiliated Companies was $326,896 and the
identified cost was $403,733.
(C) Private placement
18
<PAGE>
Portfolio of Investments
June 30, 1998 (Unaudited)
(Amounts in Thousands)
Legg Mason Total Return Trust, Inc.
<TABLE>
<CAPTION>
Shares/Par Value
- -----------------------------------------------------------------------------------------------------
<S><C>
Common Stocks and Equity Interests -- 91.7%
Aerospace/Defense -- 1.1%
Northrop Grumman Corporation 80 $ 8,250
--------
Automotive -- 6.4%
Chrysler Corporation 125 7,047
Ford Motor Company 315 18,585
General Motors Corporation 310 20,712
--------
46,344
--------
Banking -- 16.0%
BankAmerica Corporation 220 19,016
Chase Manhattan Corporation 340 25,670
Fleet Financial Group, Inc. 210 17,535
Lloyds TSB Group plc 2,222 31,115
Union Planters Corporation 392 23,060
--------
116,396
--------
Chemicals -- 3.8%
Hercules, Inc. 230 9,459
Olin Corporation 443 18,447
--------
27,906
--------
Computer Services and Systems -- 5.3%
International Business Machines Corporation 335 38,462
--------
Consumer Products -- 2.5%
Tupperware Corporation 646 18,169
--------
Electric Utilities -- 5.5%
Edison International 650 19,216
Illinova Corporation 700 21,000
--------
40,216
--------
Finance -- 5.5%
Fannie Mae 117 7,108
The Bear Stearns Companies, Inc. 397 22,563
United Asset Management Corporation 391 10,183
--------
39,854
--------
</TABLE>
19
<PAGE>
Portfolio of Investments--Continued
Legg Mason Total Return Trust, Inc.--Continued
<TABLE>
<CAPTION>
Shares/Par Value
- -----------------------------------------------------------------------------------------------------
<S><C>
Food, Beverage and Tobacco -- 4.7%
RJR Nabisco Holdings Corp. 650 $ 15,437
UST, Inc. 685 18,495
---------
33,932
---------
Insurance -- 9.3%
American Financial Group Inc. 420 18,191
Enhance Financial Services Group, Inc. 611 20,608
IPC Holdings Limited 463 14,035
LaSalle Re Holdings Ltd. 404 15,312
---------
68,146
---------
Manufacturing -- 4.9%
Briggs & Stratton Corporation 956 35,772
---------
Oil Refining & Marketing -- 1.8%
Ultramar Diamond Shamrock Corporation 416 13,136
---------
Real Estate -- 14.6%
Crescent Real Estate Equities Company 145 4,876
Dynex Capital, Inc. 820 9,127
Mid-America Apartment Communities, Inc. 445 11,704
National Golf Properties, Inc. 531 15,948
Nationwide Health Properties, Inc. 600 14,325
Regency Realty Corporation 505 12,678
Starwood Hotels &Resorts 269 12,996
Tanger Factory Outlet Centers, Inc. 423 13,401
Walden Residential Properties, Inc. 450 11,025
---------
106,080
---------
Retail Sales -- 4.1%
J.C. Penney Company, Inc. 210 15,186
Toys "R"Us, Inc. 606 14,288(A)
---------
29,474
---------
Savings and Loan -- 1.8%
Washington Federal, Inc. 486 13,434
---------
Steel Products -- 3.1%
AK Steel Holding Corporation 682 12,196
British Steel plc 472 10,738
---------
22,934
---------
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
Shares/Par Value
- -----------------------------------------------------------------------------------------------------
<S><C>
Telecommunications -- 1.3%
Telefonos de Mexico S.A. ADR 200 $ 9,612
---------
Total Common Stocks and Equity Interests
(Identified Cost-- $495,105) 668,117
- -----------------------------------------------------------------------------------------------------
Corporate Bonds -- 0.4%
Hutchinson Technology, Inc.
6% due 3/15/05 (Identified Cost -- $2,500) $ 2,500 2,900
- -----------------------------------------------------------------------------------------------------
U.S. Government Obligations -- 3.1%
United States Treasury Bonds, 6% due 2/15/26
(Identified Cost-- $19,121) 22,000 22,887
- -----------------------------------------------------------------------------------------------------
Repurchase Agreements -- 4.6%
Lehman Brothers, Inc.
5.95%, dated 6/30/98, to be repurchased at $33,795 on 7/1/98
(Collateral: $35,132 Freddie Mac Mortgage-backed securities,
6% due 5/1/13, value $34,940)
(Identified Cost-- $33,789) 33,789 33,789
- -----------------------------------------------------------------------------------------------------
Total Investments-- 99.8% (Identified Cost-- $550,515) 727,693
Other Assets Less Liabilities-- 0.2% 1,393
---------
Net assets --100.0% $729,086
========
Net asset value per share:
Primary Class $23.50
======
Navigator Class $23.72
======
- -----------------------------------------------------------------------------------------------------
</TABLE>
(A) Non-income producing.
21
<PAGE>
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<PAGE>
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