Investment Adviser
Legg Mason Fund Adviser, Inc.
Baltimore, MD
Board of Directors Quarterly Report
Raymond A. Mason, Chairman December 31, 1997
John F. Curley, Jr., President
Richard G. Gilmore Legg Mason
Charles F. Haugh
Arnold L. Lehman Value Trust, Inc.
Dr. Jill E. McGovern
T. A. Rodgers Special Investment
Edward A. Taber, III Trust, Inc.
Transfer and Shareholder Servicing Agent Total Return Trust, Inc.
Boston Financial Data Services
Boston, MA
Custodian The Art of Investing
State Street Bank & Trust Company
Boston, MA [LEGG MASON LOGO]
Counsel FUNDS
Kirkpatrick & Lockhart LLP
Washington, DC
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
-------------------------------------------------
100 Light Street
P.O. Box 1476, Baltimore, MD 21203-1476
410 (bullet) 539 (bullet) 0000
LMF-002
8/97
<PAGE>
To Our Shareholders,
We are pleased to provide you with reports for Legg Mason Value Trust,
Special Investment Trust, and Total Return Trust for the quarter and calendar
year ended December 31, 1997.
As the table below indicates, the performance of both Value Trust and Total
Return Trust was very strong in 1997. The Funds earned total returns* of 37.1%
and 37.5%, respectively, comfortably ahead of the 33.4% return on Standard &
Poor's 500 stock composite index and the 23.8% return on the Value Line index of
1700 common stocks. In the case of Value Trust, this was the seventh consecutive
year in which the Fund's investment results outpaced the strong performance of
the Standard & Poor's 500 Composite Index. According to Lipper Analytical
Services, Inc., the Value Trust is the only General Equity Fund to have earned
this distinction. However, Bill Miller, the Fund's portfolio manager, is the
first to caution shareholders that they cannot and should not expect similar
results every year).
Special Investment Trust, which invests principally in common stocks of small
and mid-sized companies, earned a total return of 22.1% in 1997, close to the
22.4% return on the Russell 2000 index (an index which, like the fund, is
composed of stocks of small and mid-sized companies).
For the periods ended December 31, 1997:
3 Month 12 Month
Total Return* Total Return*
------------- -------------
Value Trust -3.6% +37.1%
Total Return Trust +4.1% +37.5%
Special Investment Trust -4.0% +22.1%
S&P 500 Composite Index +2.9% +33.4%
Value Line Index of 1700 stocks -2.2% +23.8%
Russell 2000 Index -3.4% +22.4%
Investment results for each of the Funds over longer periods of time are
shown in the "Performance Information" section of this report.
On the following pages, Bill Miller, the portfolio manager for the Value
Trust and Special Investment Trust and Nancy Dennin, the portfolio manager for
the Total Return Trust, discuss the funds and the investment outlook.
Sincerely,
/s/ John F. Curley, Jr.
_______________________
John F. Curley, Jr.
President
January 30, 1998
- ----------
*Total return measures investment performance in terms of appreciation or
depreciation in net asset value per share plus dividends and capital gain
distributions. It assumes that dividends and distributions were reinvested at
the time they were paid. Total return percentages and other information
regarding the Legg Mason funds in this letter are for the Primary Class of
shares of the funds.
<PAGE>
Portfolio Managers' Comments
Market Commentary
Fourth Quarter 1997
In 1997, stocks rose over 33% and completed the best 3 year period in
history, averaging gains of over 31% per year, besting the previous three year
high which occurred from 1926-1928. The troika of up 20% years has never
occurred before in the 101 year history of the Dow Jones Industrial Average, nor
have we ever had 7 consecutive up years in a row. Rounding out the hat trick,
stocks also posted the best 10 year stretch in history.
Congenital pessimists or historical determinists will no doubt point to the
past as prologue, noting that the 1929-1932 stretch was the worst in market
history. The more spiritually inclined among those with a bearish disposition
will recall the biblical seven fat years followed by seven lean years. Bears
even have a friend in Herman Melville, who's epic (and today forgotten) poem
Clarel sounds the following warning to those who see a benign future:
Nay, nay; your future's too sublime
The Past, the Past is half of time,
The proven half.
These loomings aside, we remain reasonably optimistic about the outlook for
stocks in l998. The factors that have supported equities for most of the past
15 years are still intact: falling inflation, declining interest rates, solid
economic growth, high corporate profitability, and fiscal and monetary
discipline. Valuations, though, largely reflect these positive factors, and we
think they are unlikely to expand from the current multiple of about 20x 1998
estimated earnings. The market looks fairly valued to us given the structure of
interest rates and the outlook for corporate profits.
Put differently, the direction of stock prices will be a function of the
path of profits and interest rates. There is little margin of safety at today's
prices for bad news, which is why stocks are lurching around in response to the
marginal items on the tape. If a company with an otherwise solid record misses a
quarter, its stock gets pummeled. If the news out of Asia sounds grim, the
market sells off. We see no reason why this pattern should not continue for
some time.
We think reasonable expectations for equity returns are in the 8-10% range,
about in line with profits growth, but well below the 19% average annual returns
earned over the past 15 years. Those abnormally high returns were fueled by low
initial valuations due to the inflation of the 1970's and the early 1980's
recession, coupled with an economic expansion that has had only 9 months of
recession in 15 years. Bond investors likewise should see returns far below the
16% per year they earned from 1981 through the previous peak in bonds in
September of 1993.
Bond yields have recently fallen to all time lows on the 30-year treasury,
surpassing the l993 price peaks. The impact of Asia's currency crisis, coupled
with 1.7% inflation in the US, have fueled the strong bond market. Investors
have earned 25% returns in bonds since yields peaked in the Spring following
the Fed's 25 basis point tightening (100 basis points = 1%). At that time the
conventional wisdom was that rates would be higher now, yet another instance of
the general tendency to overemphasize the impact of short-term trends and
information.
The source of greatest consternation and uncertainty in markets now is Asia,
and how that situation will develop over the next few months. The answer is
nobody knows. The problem began when Thailand's currency came under pressure
due to the country's high external debt and worsening economic situation brought
on by over-investment in under-earning capacity. After the Thai currency peg
came undone, investors quickly realized that most of the other economies of
southeast Asia were likewise characterized
2
<PAGE>
by an asset base that was overbuilt, under-earning, and debt financed at short
maturities in US dollars. The so-called Asian miracle now looks like just
another debt financed investment bubble, except on a grander scale than usually
encountered. MIT economist Paul Krugman, was one of the few to correctly
identify the fallacy behind Asia's remarkable growth and was roundly ridiculed,
even by fellow economists. In general, the economics profession consistently
urges more savings and investment as the path to growth; by following this
formula, Asia is now in collapse. Savings and investment only lead to growth
when the rates of return on savings and investment are greater than the cost of
capital. This is a notion still not well understood by economists. When the
local currencies collapsed, debt that was high but not punishing at one exchange
rate suddenly ballooned to crushing levels. We have only begun to see the
bankruptcies and economic travail that will result as these new realities feed
back into the local economies.
The situation is quite similar to the Mexican crisis of late l994-l995.
Then, the Fed began tightening in February 1994, and followed that by several
more interest rate hikes in quick succession. People sold pesos for dollars as
rates rose in the US, finally forcing Mexico to devalue and float the currency.
(Under a fixed rate regime the government has to balance the supply and demand
for currency with its own reserves. A massive move to sell the local currency
depletes those reserves.) That shock threw Mexico into deep recession, and
destabilized most of the economies in Latin America for the next year.
This time, the Fed only tightened once in the Spring, but inflation has
continued to fall, leading to a rise in real interest rates: a de facto
continuous tightening. The collapse of gold, the sharp rise in the dollar, the
fall in oil and other commodities, all are indicative of a monetary policy that
is too tight. People have reacted the same way they did in l994, selling the
most vulnerable currencies for dollars.
Looking longer term, interest rates have been falling irregularly but
persistently since they peaked in late l981. The last bottom in rates was l993,
when long bonds yielded 5.78% and short rates were 2.6%. Subsequently, both
long and short rates rose for three years. Now long rates have dropped to new
lows while short rates hover over 5%. We think the next important move in short
rates is down, and perhaps down to levels approaching the 1993 low.
We believe that the Asian crisis is unlikely to resolve itself until the Fed
eases, and that when monetary policy is eased, it will be the beginning of a
long decline in short-term interest rates. This, of course, is unabashedly
positive for equities, assuming corporate profits are still intact.
If we are right that future rates of return will be much lower than those of
the past 15 years, that inflation will stay low, and that the Asian crisis will
be resolved only through Fed easing, a few implications for investment strategy
follow: 1) Yield will be a much more important component of returns than it has
been in the past decade or so. 2) Missing earnings estimates will become more
frequent and will be punished more severely. Good companies whose prices have
collapsed due to disappointments will be quite rewarding to investors who are
able to value them properly. 3) Companies which can demonstrate consistent
growth will see their valuations rise, no matter what their industry. Fifteen
years ago people thought Coke was fully priced at a single digit multiple, given
its stodgy nature and plodding growth. Now it is regarded as a quintessential
growth stock at about 40x earnings. 4) Merger and acquisition activity will
accelerate from today's frenetic pace since money will be cheap and growth hard
to come by. Companies will buy growth if they can't generate it internally. 5)
Pressure on corporate management to take steps to increase shareholder value
will also be intense. We hope to take advantage of these factors over the
coming year.
All in all, we think l998 will be tougher than previous years, but with some
luck, it may still prove quite rewarding.
3
<PAGE>
Portfolio Managers' Comments--Continued
Value Trust
Fourth Quarter 1997
Our results for the fourth calendar quarter, as well as the one, three, and
five year periods ending December 31, l997 are outlined in the table below:
3 months 1 year 3 years 5 years
- -------------------------------------------------------------------------------
Value Trust -3.62% 37.05% 167.05% 201.24%
Lipper Growth Funds -1.15% 25.30% 97.08% 117.56%
S&P 500 Composite Index 2.87% 33.36% 125.61% 151.62%
Dow Jones Industrial Average -0.01% 24.91% 120.50% 170.88%
As the table indicates, we gave back some relative to the market in the
fourth quarter, but still managed to outperform the S&P 500 for the year. This
is the seventh consecutive year we have bested the index. According to Lipper
Analytical Services, Inc., we are the only general equity fund that has been
able to beat the index in each of the past seven years.
The market has gotten increasingly efficient as the years have gone by, and
money managers have had a tougher and tougher time beating it. Their
difficulties are compounded by the capitalization weighted nature of the index:
bigger companies have a bigger impact on the index's results than do smaller
companies. If you had owned an equal dollar amount of every company in the S&P
500, you would still have underperformed the index the past several years.
We are increasingly asked what we do differently from other managers that
might account for the results achieved over the past few years. It is easy to
identify our points of departure; whether they account for our outperformance is
another issue. Someone who flipped heads seven times in a row would probably
believe he was in possession of a superior coin flipping process.
Our approach consists of three main features: 1) We are investors, not
speculators. We do not try to guess the direction of the market, which
industries are likely to perform well, or which stocks are likely to come into
favor or outperform. While most market participants are focused on outlook and
trend, we are focused on value. As investors, our time horizon is much longer
than other mutual fund managers. The average fund turns over 90% of its
portfolio each year. Our turnover is about 10-20%, implying an average holding
period of 5-10 years, versus a little over 1 year for the average mutual fund.
2) We do intensive research on our holdings and try to buy companies whose
prices represent large discounts to our assessment of the intrinsic value of the
business. We use an economic value approach to our analytic process, which
involves going well beyond simple accounting-based measures of value such as
price/earnings ratios or price to book value ratios. In addition to all the
quantitative tools in the professional investor's tool kit, we focus on
corporate capital allocation, competitive positioning and strategy, and spend a
lot of time with company managements trying to understand industry and company
dynamics. 3) We run a tightly focused portfolio, usually limiting ourselves to
35 or 40 stocks, compared to the more than 100 stocks that populate the average
fund's portfolio. We pay no attention to industry or sector weightings in the
popular indices, seeing no reason to own any industry or company whose long-term
prospects are unattractive, just because someone has put them in the S&P 500.
We expect to continue to invest this way whether or not our results
outperform or underperform some benchmark. Since no one outperforms forever, you
may be sure we will underperform for some periods, and those periods may be
strung together for an uncomfortably long time, as they were in
4
<PAGE>
the late 1980s. We are confident the long-term results will remain satisfactory,
on both a relative and an absolute basis.
As noted above, we gave back some relative gains in the fourth quarter.
Investors spooked by Asian turmoil sold banks and technology stocks, the former
on fears of loan losses and spread compression due to the flattening yield
curve; the latter due to fears of future earnings weakness due to diminished
Asian demand. Banks and technology stocks have been among the strongest groups
in the market and investors apparently decided to pocket profits while they
still had them. We added to our positions in both groups during the quarter,
believing that the problems in Asia are long-term positives for both sectors,
despite the very real near-term concerns. US banks are relatively unexposed to
Asian problems compared to banks in Japan and Europe. The real devastation will
be among local banks, many of which will fail. Banks such as Citicorp will pick
up significant market share and should be able to take advantage of new lending
opportunities at wider spreads. Technology companies will benefit as excess
capacity is rung out of the sector.
We bought several new names in the quarter, most of them well known. Ford is
a storehouse of value, trading at 8x earnings with lots of excess cash and
assets than can be monetized. Digital Equipment in the high 30s is trading at
half of what we think it's worth. It has sold off capital intensive or money
losing divisions and, in our opinion, is poised to begin to grow for the first
time in years. It reminds us of IBM when we bought it several years ago.
Metro-Goldwyn-Mayer came public and we must have been the only buyer,
considering how poorly it traded. We think it is worth $24 or so on assets,
with a value that should grow at 10% a year or more. Hilton lost the takeover
battle for ITT, and we decided to buy both. The latter provided a nice arbitrage
into Starwood Lodging, while Hilton we found attractive in its own right. We
think Hilton, currently trading in the high 20s, is worth over $40 per share.
As always, we appreciate your support and welcome your comments.
Bill Miller, CFA
-------------------------------------------------
Special Investment Trust
Fourth Quarter 1997
Our results for various periods ended December 31, 1997 are listed in the
table below:
3 months 1 year 3 years 5 years
- -------------------------------------------------------------------------------
Special Investment Trust -4.01% 22.12% 92.46% 107.66%
Lipper Small Company Funds -4.97% 20.75% 86.62% 116.85%
Lipper Mid Cap Funds -3.41% 19.63% 84.83% 105.11%
S&P 500 Composite Index 2.87% 33.36% 125.61% 151.62%
Russell 2000 Index -3.35% 22.36% 83.10% 113.70%
As you can see, we underperformed slightly in the fourth quarter, and
outperformed the indices of funds in the small and mid-cap area for the year.
We were slightly behind the Russell 2000 index of smaller companies for 1997,
ahead of it for the three years and modestly behind for five. Our five
5
<PAGE>
Portfolio Managers' Comments--Continued
year numbers are still being impacted by our poor showing in l994, which is
absent now from the three year figures.
Our fourth quarter was heavily impacted by a sharp decline in the price of
our disk drive companies, Western Digital and Quantum, whose share prices fell
as the extent of the current overcapacity in drives became evident. Mego
Mortgage shares fell a greater percentage in the quarter, but it is such a small
holding that its impact was minimal compared to that of the drive companies.
We think that the problems in the drive industry are part of the normal
cyclical characteristics of that business, exacerbated by the situation in Asia
which has led to companies such as Fujitsu dumping drives. The stocks have
stabilized recently and we have been adding to positions in anticipation of a
better supply/demand balance by the end of the year. If we are right about the
supply/demand picture, these companies could provide exceptional rates of return
over the next few years. If Western Digital can get back to its old highs over
the next two years the stock would more than triple.
We sold three names in the fourth quarter and added six. Gone are Imation,
Novell, and Ultrafem. All three are companies we concluded were unlikely to
achieve returns that we initially thought possible. The new companies are a
disparate group. Three are real estate related, Catellus, Hospitality
Properties, and Laser Mortgage. Catellus is among the largest landowners in
California and is actively developing its properties, which we think will add
significant value. Hospitality Properties is a REIT that focuses on hotels. It
has a solid yield, and is growing its cash flow at a rate that should provide
attractive returns for us. Laser Mortgage is a REIT that is more affected by the
yield curve than by real estate markets. It trades at book value and has
declared a dividend that annualizes to over a 10% yield.
Hollywood Entertainment is the second largest company in the video rental
business behind Blockbuster. This is a high cash on cash return business that
should benefit from a slowing in new capacity as well as the impact of new
technology such as DVD. Philip Services is one of the largest environmental
services companies, has been growing at 20% per year, yet now trades at 10x
earnings due to a variety of concerns that appear to be temporary. Finally, we
bought a small position in Oxford Health, after it collapsed from $80 per share
in the fourth quarter. It now trades around $16. We think it is worth $25 to
$30, assuming it can surmount its current profit difficulties, which we think
likely.
We are often asked when small companies will finally begin to perform better
than large companies and whether or not small and mid-size companies offer
better value than their larger brethren. Large companies have significantly
outperformed small companies for years; we have no idea when this might reverse.
We do think that much better values are available in smaller companies than in
larger ones and that will eventually be reflected in better price performance. A
glimpse of that was evident in the third quarter, when small stocks, and your
fund, were quite strong. The effects of the turmoil in Asia, though, led to a
flight to quality, and a sell-off in smaller names in the fourth quarter. If we
are right that merger and acquisition activity will be an important incremental
source of return this year, and that smaller companies offer better value, that
may provide some fillip to the relative returns of smaller stocks versus those
in the S&P 500.
As always, we appreciate your support and welcome your comments.
-------------------------------------------------
Bill Miller, CFA
6
<PAGE>
Total Return Trust
Fourth Quarter 1997
As shown below, your fund had an excellent fourth quarter, and has performed
exceptionally well over the one, three, and five year periods ended December 31,
1997:
3 months 1 year 3 years 5 years
- --------------------------------------------------------------------------------
Total Return Trust 4.11% 37.50% 135.07% 149.08%
Lipper Growth and Income Funds 0.83% 27.14% 102.81% 125.21%
S&P 500 Composite Index 2.87% 33.36% 125.61% 151.62%
Dow Jones Industrial Average -0.01% 24.91% 120.50% 170.88%
- --------------------------------------------------------------------------------
While we are obviously extremely pleased with these results, it is highly
unlikely this type of performance can be repeated in the future. 1997 marked
the third year in a row the major indices returned over 20%, a feat that has
never occurred before in the 101 year history of the Dow Jones Industrial
Average. Last year also marked a record seventh consecutive year the Dow
industrial Average has advanced, and the more than 300% gain in the index since
1987 was the best 10 year stretch in its history.
As 1998 begins however, these records are quickly becoming a distant memory.
The major indices were down about 4% in the first week of the year, and the
financial press is now discussing the worst weekly point drop for the Dow in its
history. The market has sold off as investors are once again focused on the
crisis in Asia, and the potential ramifications to the US (please see Market
Commentary section for more detail).
We believe trading in the first couple of weeks of the new year is indicative
of what we'll see throughout the year--increased volatility--with the end result
being 8-10% equity returns for the major indices, comprised of 6-8% earnings
growth, plus the dividend yield.
In this context, we expect the turnover of the Fund's holdings to slightly
increase from its current 27%** rate. However, our investment philosophy has,
and will, not change. We keep a tightly focused portfolio of 35-40 securities,
invested in companies that we believe are selling at discounts to their
intrinsic value, and we continue to set price targets for our holdings when we
purchase them. As the market goes from periods of euphoria to periods of
hysteria, we expect more of our holdings to hit their price targets, and more
investment opportunities to emerge.
Your Fund's results in the fourth quarter benefited from two of its electric
utility holdings, both based in Illinois, as well as several of its financial
holdings as shown in the "strong performers/weak performers" list elsewhere in
the report. The two electric utilities, Unicom Corp. and Illinova Corp.
exemplify our investment approach. Both of these stocks came under pressure in
the Spring of 1997, after the Illinois legislature failed to approve a bill
allowing for broad restructuring of the electric utility industry. After
analyzing the situation, we believed it highly likely the legislature would
approve a bill when it reconvened in the Fall. On November 14th, the Illinois
House of Representatives approved a bill similar to the one that was defeated in
the Spring, and the stocks responded accordingly.
7
<PAGE>
Portfolio Managers' Comments--Continued
Federal National Mortgage Association ("FannieMae") is a stock we have owned
since 1990. When we originally purchased FannieMae, part of our investment case
was that the company's earnings would be less cyclical going forward, leading to
P/E multiple expansion. At the time of our purchase, FannieMae's multiple was
in the single digits. Today, the company sells for 18.5x 1998 estimated
earnings, still a very reasonable multiple given its double digit growth rate.
FannieMae is the only S&P 500 company to achieve eleven consecutive years of
double digit earnings growth.
John Alden, the Fund's best performer in the third quarter, was the worst
performer in the fourth. The stock ran up on takeover speculation late in the
third quarter. When an acquisition failed to materialize, the stock sold off.
We believe there continues to be a fairly good chance the company will be
acquired. However, absent a takeover, the stock is still attractive, selling at
a substantial discount to the overall market. John Alden is trading at 11x 1998
estimated earnings, and only 1.1x book value. In contrast, the S&P 500 is
trading at 18.8x 1998 estimated earnings.
During the fourth quarter, we purchased two new securities, AK Steel and
Fleet Financial, and sold three, Bank United, Ogden Corp. and Washington Mutual,
that reached our price targets.
AK Steel is the sixth largest integrated steelmaker in the United States.
The company is the leading manufacturer of high-strength, low-carbon flat-rolled
steel products, the largest segment of the domestic steel market. The stock has
declined over 30% from its 52 week high, as investors have worried about the
impact of the Asian crisis on the company. We believe the bad news is already
reflected in its stock price which trades at only 9.5x 1998 estimated earnings,
1.1x book value, and has a 3% yield.
Fleet Financial has developed the largest consumer banking franchise in New
England, largely through acquisitions. The company announced several additional
acquisitions in 1997 that broaden its product line, including Quick & Reilly, a
national discount brokerage firm, Columbia Management, an Oregon-based asset
management company, and Advanta's consumer credit card operations.
The stock is trading at almost a 20% discount to its regional bank peer
group, as investors are concerned about integration risk related to its recent
acquisitions. In our opinion, Fleet will be able to assimilate these
acquisitions without much difficulty, and over the next 12-18 months the stock
should sell at least at parity with its peers.
As always, we greatly appreciate the support of our shareholders, and welcome
any comments or questions.
Nancy Dennin, CFA
January 29, 1998
DJIA 7,973.02
- ----------
**December 31, 1997 annualized portfolio turnover rate.
8
<PAGE>
Performance Information
Total Return for One, Five, Ten Years and Life of Funds, as of December 31, 1997
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 December 31, 1997 for each Fund, the Value Line
Geometric Average ("Value Line") and the S&P 500 Stock 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 December 31, 1997
were as follows:
<TABLE>
<CAPTION>
Special S&P 500
Value Investment Total Return Value Line Composite
Trust Trust Trust Index Index
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C>
Average Annual Total Return
Primary Class:
One Year +37.05% +22.12% +37.50% +23.81% +33.36%
Five Years +24.68 +15.74 +20.02 +14.08 +20.27
Ten Years +18.96 +18.17 +16.77 +11.51 +18.05
Life of Class--Value Trust(A) +19.86 +11.48 +18.22
Life of Class--Special Investment Trust(B) +14.53 +9.50 +16.91
Life of Class--Total Return Trust(C) +13.11 +9.44 +17.30
Navigator Class:
One Year +38.49 +23.44 +38.96 +23.81 +33.36
Life of Class(D) +39.53 +24.79 +31.92 +20.63 +30.19
Cumulative Total Return
Primary Class:
One Year +37.05% +22.12% +37.50% +23.81% +33.36%
Five Years +201.24 +107.66 +149.08 +93.26 +151.62
Ten Years +467.72 +430.88 +371.45 +197.37 +425.66
Life of Class--Value Trust(A) +1,621.56 +451.22 +1,286.53
Life of Class--Special Investment Trust(B) +410.38 +197.16 +551.65
Life of Class--Total Return Trust(C) +344.77 +198.04 +590.30
Navigator Class:
One Year +38.49 +23.44 +38.96 +23.81 +33.36
Life of Class(D) +179.72 +98.14 +135.24 +78.31 +125.61
- ---------------------------------------------------------------------------------------------------------------------------
</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
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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)
[GRAPHIC APPEARS HERE - PLOT POINTS 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 10000 10000
3/31/83 16400.97 16160
3/31/84 19425.44 18870.5
3/31/85 24682.58 23582.98
3/31/86 34509.72 32555.48
3/31/87 37924.3 35503.58
3/31/88 34729.33 32267.83
3/31/89 41109.15 37650.23
3/31/90 44289.55 39890.82
3/31/91 43013.79 37701.34
3/31/92 51413.83 44210.32
3/31/93 59003.27 50183.93
3/31/94 62337.34 52789.39
3/31/95 68426.55 57816.96
3/31/96 97226.16 82355.78
3/31/97 129881.47 110379.07
12/31/97 172156 147569
-------------------------------------------------
Selected Portfolio Performance*
Strong performers for the 4th quarter 1997
- --------------------------------------------------------------------------------
1. MCI Communications Corporation +45.7%
2. Storage Technology Corporation +29.5%
3. Kroger Co. +22.4%
4. Fannie Mae +21.4%
5. Zions Bancorporation +21.0%
6. Freddie Mac +19.0%
7. America Online, Inc. +18.2%
8. Fleet Financial Group, Inc. +14.3%
9. AMBAC Inc. +13.1%
10. Amgen, Inc. +12.9%
* Securities held for the entire quarter.
Weak performers for the 4th quarter 1997
- --------------------------------------------------------------------------------
1. Western Digital Corporation -59.9%
2. Seagate Technology, Inc. -46.7%
3. Reebok International Ltd. -40.8%
4. Foundation Health Systems, Inc. -30.1%
5. Philips Electronics N.V. -28.0%
6. Nokia Corporation ADS -25.4%
7. Compaq Computer Corporation -24.5%
8. Circus Circus Enterprises, Inc. -18.6%
9. MGM Grand, Inc. -17.0%
10. Dell Computer Corporation -13.3%
Portfolio Changes
Securities added during the 4th quarter 1997
- --------------------------------------------------------------------------------
Digital Equipment Corporation
Ford Motor Company
Hilton Hotels Corporation
ITT Corporation
Metro-Goldwyn-Mayer, Inc.
Securities sold during the 4th quarter 1997
- --------------------------------------------------------------------------------
None
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)
[GRAPHIC APPEARS HERE - PLOT POINTS 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 10000 10000
3/31/86 11530 11530
3/31/87 13073 13050.76
3/31/88 11219.7 11106.84
3/31/89 13125.95 12981.74
3/31/90 15142.97 14889.53
3/31/91 18391.89 17776.51
3/31/92 22154.2 21249.28
3/31/93 24481.5 23528.14
3/31/94 29708.01 28511.3
3/31/95 27814.8 26706.89
3/31/96 35733.08 34291
3/31/97 39870.52 38344.53
12/31/97 51038 49183
-------------------------------------------------
Selected Portfolio Performance*
Strong performers for the 4th quarter 1997
- --------------------------------------------------------------------------------
1. NETCOM On-Line
Communication Services, Inc. +97.9%
2. MacFrugal's Bargains
(bullet) Close-Outs Inc. +34.8%
3. Storage Technology Corporation +29.5%
4. HSN, Inc. +26.8%
5. Northeast Utilities System +22.7%
6. America Online, Inc. +18.2%
7. Hollywood Park, Inc. +16.2%
8. PennCorp Financial Group, Inc. +15.1%
9. CMAC Investment Corporation +12.6%
10. Danaher Corporation +8.8%
* Securities held for the entire quarter.
Weak performers for the 4th quarter 1997
- --------------------------------------------------------------------------------
1. Mego Mortgage Corporation -69.9%
2. Western Digital Corporation -59.9%
3. Madge Networks N.V. -48.3%
4. Quantum Corporation -47.6%
5. Shoney's, Inc. -35.4%
6. Salant Corporation -33.3%
7. Magellan Health Services, Inc. -32.3%
8. Players International, Inc. -28.2%
9. Bell & Howell Company -25.4%
10. InaCom Corp. -24.5%
Portfolio Changes
Securities added during the 4th quarter 1997
- --------------------------------------------------------------------------------
Catellus Development Corporation
Hollywood Entertainment Corp.
Hospitality Properties Trust
LASER Mortgage Management, Inc.
Oxford Health Plans, Inc.
Philip Services Corp.
Securities sold during the 4th quarter 1997
- --------------------------------------------------------------------------------
Imation Corporation
Novell Inc.
Ultrafem, 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)
[GRAPHIC APPEARS HERE - PLOT POINTS 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 10000 10000
3/31/86 10780 10780
3/31/87 11884.09 11673.03
3/31/88 10675 10295.43
3/31/89 12293 11689.85
3/31/90 12720.53 11874.31
3/31/91 12714.62 11498.61
3/31/92 15714.56 13884.21
3/31/93 18839.3 16234.03
3/31/94 19701.15 16637.21
3/31/95 19916.82 16637.21
3/31/96 26535.98 21341.73
3/31/97 32992.2 26102.28
12/31/97 44477 35424
-------------------------------------------------
Selected Portfolio Performance*
Strong performers for the 4th quarter 1997
- --------------------------------------------------------------------------------
1. Unicom Corporation +31.6%
2. Illinova Corporation +24.9%
3. Union Planters Corporation +21.6%
4. Fannie Mae +21.4%
5. UST, Inc. +20.9%
6. Masco Corporation +11.1%
7. IPC Holdings Limited +9.1%
8. RJR Nabisco Holdings Corp. +9.1%
9. Enhance Financial Services
Group, Inc. +8.7%
10. Telefonos de Mexico S.A. ADR +8.3%
* Securities held for the entire quarter.
Weak performers for the 4th quarter 1997
- --------------------------------------------------------------------------------
1. John Alden Financial Corporation -22.6%
2. Kmart Corporation, 7.75%, Cv Pfd. -11.8%
3. American Financial Group Inc. -9.4%
4. Dynex Capital, Inc. -7.4%
5. Chase Manhattan Corporation -7.2%
6. Northrop Grumman Corporation -5.3%
7. Chrysler Corporation -4.4%
8. General Motors Corporation -4.2%
9. Mid-America Apartment
Communities, Inc. -3.8%
10. Lloyds TSB Group plc -3.1%
Portfolio Changes
Securities added during the 4th quarter 1997
- --------------------------------------------------------------------------------
AK Steel Holding Corporation
Fleet Financial Group, Inc.
Securities sold during the 4th quarter 1997
- --------------------------------------------------------------------------------
Bank United Corp.
Ogden Corporation
Washington Mutual, Inc.
12
<PAGE>
Portfolio of Investments
December 31, 1997 (Unaudited)
(Amounts in Thousands)
Legg Mason Value Trust, Inc.
Shares/Par Value
- ------------------------------------------------------------------------------
Common Stocks and Equity Interests -- 90.5%
Aerospace/Defense -- 0.1%
Raytheon Company 77 $ 3,774
----------
Automotive -- 4.5%
Chrysler Corporation 2,000 70,375
Ford Motor Company 550 26,778
General Motors Corporation 1,200 72,750
----------
169,903
----------
Banking -- 15.6%
BankAmerica Corporation 800 58,400
BankBoston Corporation 850 79,847
Chase Manhattan Corporation 1,200 131,400
Citicorp 850 107,472
Fleet Financial Group, Inc. 669 50,144
Lloyds TSB Group plc 7,907 102,872
Zions Bancorporation 1,403 63,652
----------
593,787
----------
Computer Services and Systems -- 20.2%
Compaq Computer Corporation 1,775 100,177
Dell Computer Corporation 2,650 222,600(A)
Digital Equipment Corporation 1,625 60,125(A)
International Business Machines Corporation 1,350 141,159
Seagate Technology, Inc. 2,000 38,500(A)
Storage Technology Corporation 2,343 145,144(A)
Western Digital Corporation 3,875 62,242(A)
----------
769,947
----------
Electrical Equipment -- 1.5%
Philips Electronics N.V. 975 58,988
----------
Entertainment -- 4.2%
Circus Circus Enterprises, Inc. 5,100 104,550(A)
MGM Grand, Inc. 1,551 55,933(A)
----------
160,483
----------
Finance -- 12.4%
American Express Company 150 13,388
Fannie Mae 3,200 182,600
Freddie Mac 2,000 83,875
MBNA Corporation 4,245 115,953
The Bear Stearns Companies, Inc. 1,654 78,553
----------
474,369
----------
13
<PAGE>
Portfolio of Investments--Continued
Legg Mason Value Trust, Inc.--Continued
Shares/Par Value
- ------------------------------------------------------------------------------
Food, Beverage and Tobacco -- 4.9%
PepsiCo, Inc. 850 $ 30,972
Philip Morris Companies, Inc. 1,550 70,234
RJR Nabisco Holdings Corp. 2,300 86,250
----------
187,456
----------
Food Merchandising -- 2.3%
Kroger Co. 2,400 88,650(A)
----------
Footwear -- 0.5%
Reebok International Ltd. 675 19,448(A)
----------
Health Care -- 2.6%
Columbia/HCA Healthcare Corporation 1,400 41,475
Foundation Health Systems, Inc. 2,550 57,056(A)
----------
98,531
----------
Hotels & Motels -- 2.2%
Hilton Hotels Corporation 2,310 68,723
ITT Corporation 200 16,575(A)
----------
85,298
----------
Insurance -- 2.5%
AMBAC Inc. 766 35,236
Conseco Inc. 575 26,127
MBIA, Inc. 510 34,074
----------
95,437
----------
Manufacturing -- 2.0%
Danaher Corporation 1,200 75,750
----------
Media -- 4.7%
America Online, Inc. 2,013 179,490(A)
----------
Motion Pictures & Services -- 0.6%
Metro-Goldwyn-Mayer, Inc. 1,200 24,000(A)
----------
Multi-Industry -- 0.6%
Coltec Industries Inc. 967 22,413(A)
----------
Pharmaceuticals -- 2.5%
Amgen Inc. 1,475 79,834(A)
Warner-Lambert Company 115 14,260
----------
94,094
----------
14
<PAGE>
Shares/Par Value
- ------------------------------------------------------------------------------
Savings and Loan -- 1.0%
Washington Mutual, Inc. 600 $ 38,288
----------
Telecommunications -- 5.6%
MCI Communications Corporation 2,000 85,625
Nokia Corporation ADS 700 49,000
Telefonos de Mexico S.A. ADR 1,425 79,889
----------
214,514
----------
Total Common Stocks and Equity Interests
(Identified Cost -- $1,797,826) 3,454,620
- ---------------------------------------------------------------------------
U.S. Government Obligations -- 1.4%
United States Treasury Notes, 8.125%, 2/15/98 $ 230 231
United States Treasury Bonds, 6.625%, 2/15/27 50,000 54,281
----------
Total U.S. Government Obligations
(Identified Cost -- $50,862) 54,512
- ---------------------------------------------------------------------------
Repurchase Agreements -- 7.8%
Prudential Securities, Inc.
6.75, dated 12/31/97, to be repurchased
at $245,475 on 1/2/98 (Collateral: $101,683
Freddie Mac, Mortgage-backed securities,
6.50%-11%, due 7/1/19-12/1/27, value $105,621;
$48,396 Fannie Mae, Mortgage-backed
securities, 6.50%-9.50%, due 12/1/04-12/1/26,
value $49,614; and $94,835 Government National
Mortgage Association, Mortgage-backed
securities, 7%-9%, due 12/15/21-11/15/27,
value $98,226) 245,383 245,383
J.P. Morgan Securities, Inc.
6%, dated 12/31/97, to be repurchased
at $53,619 on 1/2/98 (Collateral: $53,147
United States Treasury Notes, 6.25%,
due 7/31/98, value $54,736) 53,602 53,602
----------
Total Repurchase Agreements
(Identified Cost -- $298,985) 298,985
- ---------------------------------------------------------------------------
Total Investments -- 99.7%
(Identified Cost -- $2,147,673) 3,808,117
Other Assets Less Liabilities -- 0.3% 11,889
----------
Net assets -- 100.0% $3,820,006
==========
Net asset value per share:
Primary Class $42.74
======
Navigator Class $43.04
======
- ------------------------------------------------------------------------------
(A) Non-income producing
15
<PAGE>
Portfolio of Investments
December 31, 1997 (Unaudited)
(Amounts in Thousands)
Legg Mason Special Investment Trust, Inc.
Shares/Par Value
- ------------------------------------------------------------------------------
Common Stocks and Equity Interests -- 96.9%
Advertising -- 4.1%
WPP Group plc 13,250 $ 58,978
----------
Apparel -- 0.1%
Salant Corporation 450 788(A)
----------
Banking -- 2.4%
Peoples Heritage Financial Group, Inc. 750 34,500
----------
Biotechnology -- 0.7%
Cell Genesys, Inc. 1,097 9,324(A)
----------
Computer Services and Systems -- 18.8%
Bell & Howell Company 975 23,583(A)
Gateway 2000, Inc. 1,800 58,725(A)
InaCom Corp. 1,000 28,062(A,B)
Madge Networks N.V. 2,436 9,440(A,B)
NETCOM On-Line Communication Services, Inc. 1,100 26,400(A,B)
Quantum Corporation 1,800 36,112(A)
Storage Technology Corporation 1,000 61,938(A)
Western Digital Corporation 1,500 24,094(A)
----------
268,354
----------
Energy -- 5.8%
Calenergy Company, Inc. 790 22,713(A)
Northeast Utilities System 3,000 35,438
Philip Services Corp. 1,653 23,760(A)
----------
81,911
----------
Entertainment -- 10.3%
Circus Circus Enterprises, Inc. 2,000 41,000(A)
Hollywood Entertainment Corp. 3,216 34,165(A,B)
Hollywood Park, Inc. 2,338 51,425(A,B)
Mirage Resorts, Incorporated 548 12,462(A)
Players International, Inc. 2,485 7,921(A,B)
----------
146,973
----------
Finance -- 7.8%
Amerin Corporation 1,655 46,340(A,B)
Mego Financial Corporation 643 2,975(A,C)
The Bear Stearns Companies, Inc. 551 26,184
United Asset Management Corporation 1,425 34,823
----------
110,322
----------
16
<PAGE>
Shares/Par Value
- ------------------------------------------------------------------------------
Food, Beverage and Tobacco -- 2.4%
Cott Corporation Quebec 4,100 $ 34,594(B)
----------
Health Care -- 5.1%
Magellan Health Services, Inc. 950 20,425(A)
Oxford Health Plans, Inc. 375 5,836(A)
Sun Healthcare Group Inc. 1,725 33,422(A)
Sunrise Medical, Inc. 822 12,694(A)
----------
72,377
----------
Insurance -- 14.7%
CMAC Investment Corporation 700 42,263
Enhance Financial Services Group, Inc. 555 33,023
John Alden Financial Corporation 1,361 32,674
Orion Capital Corporation 1,180 54,796
PennCorp Financial Group, Inc. 1,300 46,394
----------
209,150
----------
Manufacturing -- 2.1%
Briggs & Stratton Corporation 340 16,521
Danaher Corporation 216 13,635
----------
30,156
----------
Media -- 8.8%
America Online, Inc. 1,400 124,863(A)
----------
Miscellaneous -- 0.1%
Olsen & Associates AG 300 2,053(A,C)
----------
Real Estate -- 4.4%
Catellus Development Corporation 475 9,500(A)
Dynex Capital, Inc. 1,473 19,604
Hospitality Properties Trust 316 10,385
LASER Mortgage Management, Inc. 1,500 21,750(B)
Mego Mortgage Corporation 306 1,244
----------
62,483
----------
Restaurants -- 0.5%
Shoney's, Inc. 2,050 6,534(A)
----------
Savings and Loan -- 2.2%
Washington Mutual, Inc. 500 31,906
----------
17
<PAGE>
Portfolio of Investments--Continued
Legg Mason Special Investment Trust, Inc.--Continued
Shares/Par Value
- ------------------------------------------------------------------------------
Speciality Retail -- 6.6%
HSN, Inc. 1,380 $ 71,070(A)
MacFrugal's Bargains (bullet) Close-outs Inc. 565 23,236(A)
----------
94,306
----------
Total Common Stocks and Equity Interests
(Identified Cost -- $899,586) 1,379,572
- ---------------------------------------------------------------------------
Repurchase Agreement -- 2.9%
J.P. Morgan Securities, Inc.
6%, dated 12/31/97, to be repurchased
at $41,705 on 1/2/98 (Collateral: $32,807
United States Treasury Bonds,
13.375%, due 8/15/2001, value $42,649)
(Identified Cost -- $41,691) $41,691 41,691
- ---------------------------------------------------------------------------
Total Investments -- 99.8%
(Identified Cost -- $941,277) 1,421,263
Other Assets Less Liabilities -- 0.2% 2,523
----------
Net assets -- 100.0% $1,423,786
==========
Net asset value per share:
Primary Class $32.27
======
Navigator Class $33.17
======
- ------------------------------------------------------------------------------
(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 December 31, 1997, the total
market value of Affiliated Companies was $260,097 and the identified cost
was $242,063.
(C) Private placement
18
<PAGE>
Portfolio of Investments
December 31, 1997 (Unaudited)
(Amounts in Thousands)
Legg Mason Total Return Trust, Inc.
Shares/Par Value
- --------------------------------------------------------------------------------
Common Stocks and Equity Interests -- 88.7%
Aerospace/Defense -- 2.2%
Raytheon Company 15 $ 723
Northrop Grumman Corporation 110 12,650
----------
13,373
----------
Automotive -- 7.3%
Chrysler Corporation 450 15,834
Ford Motor Company 315 15,337
General Motors Corporation 230 13,944
----------
45,115
----------
Banking -- 14.9%
BankAmerica Corporation 175 12,775
Chase Manhattan Corporation 160 17,520
Fleet Financial Group, Inc. 180 13,489
Lloyds TSB Group plc 2,194 28,539
Union Planters Corporation 290 19,702
----------
92,025
----------
Chemicals -- 4.2%
Hercules, Inc. 230 11,514
Olin Corporation 310 14,545
----------
26,059
----------
Computer Services and Systems --4.9%
International Business Machines Corporation 290 30,323
----------
Construction Materials -- 1.4%
Masco Corporation 165 8,394
----------
Consumer Products -- 2.7%
Tupperware Corporation 600 16,725
----------
Electric Utilities -- 4.2%
Illinova Corporation 745 20,068
Unicom Corporation 200 6,150
----------
26,218
----------
Energy -- 2.2%
Edison International 500 13,594
----------
Finance --5.1%
Fannie Mae 222 12,668
The Bear Stearns Companies, Inc. 397 18,845
----------
31,513
----------
19
<PAGE>
Portfolio of Investments--Continued
Legg Mason Total Return Trust, Inc.--Continued
Shares/Par Value
- --------------------------------------------------------------------------------
Food, Beverage and Tobacco -- 6.0%
RJR Nabisco Holdings Corp. 445 $ 16,687
UST, Inc. 550 20,316
----------
37,003
----------
Insurance -- 12.0%
American Financial Group Inc. 420 16,931
Enhance Financial Services Group, Inc. 305 18,165
IPC Holdings Limited 463 14,903
John Alden Financial Corporation 415 9,960
LaSalle Re Holdings Ltd. 404 14,301
----------
74,260
----------
Real Estate -- 14.4%
Dynex Capital, Inc. 800 10,655
Mid-America Apartment Communities, Inc. 445 12,705
National Golf Properties, Inc. 426 13,978
Nationwide Health Properties, Inc. 600 15,300
Regency Realty Corporation 423 11,712
Tanger Factory Outlet Centers, Inc. 423 12,925(A)
Walden Residential Properties, Inc. 450 11,475
----------
88,750
----------
Retail Sales -- 2.1%
J.C. Penney Company, Inc. 210 12,666
----------
Savings and Loan -- 2.3%
Washington Federal, Inc. 442 13,899
----------
Steel Products -- 1.0%
AK Steel Holding Corporation 342 6,054
----------
Telecommunications -- 1.8%
Telefonos de Mexico S.A. ADR 200 11,213
----------
Total Common Stocks and Equity Interests
(Identified Cost--$362,805) 547,184
- -----------------------------------------------------------------------------
Preferred Shares -- 0.5%
Kmart Corporation, 7.75%, Cv.
(Identified Cost--$2,706) 57 2,963
- -----------------------------------------------------------------------------
U.S. Government Obligations -- 3.6%
United States Treasury Bonds, 6%, 2/15/26
(Identified Cost--$19,121) $22,000 21,973
- -----------------------------------------------------------------------------
20
<PAGE>
Shares/Par Value
- --------------------------------------------------------------------------------
Repurchase Agreement -- 6.7%
J.P. Morgan Securities, Inc.
6%, dated 12/31/97, to be repurchased
at $41,294 on 1/2/98 (Collateral: $40,930
United States Treasury Notes, 6.25%,
due 7/31/98, value $42,153)
(Identified Cost--$41,281) $41,281 $ 41,281
- -----------------------------------------------------------------------------
Total Investments -- 99.5%
(Identified Cost--$425,913) 613,401
Other Assets Less Liabilities -- 0.5% 3,230
----------
Net assets --100.0% $ 616,631
==========
Net asset value per share:
Primary Class $23.31
======
Navigator Class $23.48
======
- --------------------------------------------------------------------------------
(A) 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 December 31, 1997, the total
market value of Affiliated Companies was $12,925 and the identified cost was
$11,294.
21
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