INVESTMENT ADVISER
REPORT TO SHAREHOLDERS
Legg Mason Fund Adviser, Inc. FOR THE QUARTER ENDED
Baltimore, MD DECEMBER 31, 1995
BOARD OF DIRECTORS
Raymond A. Mason, Chairman
John F. Curley, Jr., President
Richard G. Gilmore
Charles F. Haugh THE
Arnold L. Lehman LEGG MASON
Dr. Jill E. McGovern SPECIAL
T. A. Rodgers TRUST, INC.
Edward A. Taber, III PRIMARY CLASS
TRANSFER AND SHAREHOLDER SERVICING AGENT
Boston Financial Data Services
Boston, MA
CUSTODIAN
State Street Bank & Trust Company
Boston, MA
COUNSEL
Kirkpatrick & Lockhart LLP
Washington, DC
PUTTING YOUR FUTURE FIRST
INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P.
Baltimore, MD
THIS REPORT IS NOT TO BE DISTRIBUTED UNLESS PRECEDED OR
ACCOMPANIED BY A PROSPECTUS.
LEGG MASON WOOD WALKER, INCORPORATED
111 South Calvert Street
P.O. Box 1476, Baltimore, MD 21203-1476
410 (Bullet) 539 (Bullet) 0000
[recycled logo] PRINTED ON RECYCLED PAPER
LMF-009 [Legg Mason Funds logo]
<PAGE>
TO OUR SHAREHOLDERS,
The Special Investment Trust ended 1995 with a 22.5% total return
(share appreciation plus reinvested distributions), somewhat ahead of
a 22.3% return on the broad-based Value Line index of 1700 stocks, but
trailing a 37.5% return on Standard & Poor's index of 500
large-company stocks. In the quarter ended December 31, total returns
on the Special Investment Trust and the Value Line index were
basically flat, -0.2% and +0.7%, respectively, while Standard & Poor's
500 stock index gained 6%.
On a longer-term basis, an investment of $10,000 in the Trust when
it was established in December, 1985 would have grown to $32,486 by
December 31, 1995 (assuming reinvestment of dividends and other
distributions), an average annual return of 12.5%.
The Trust continues to invest primarily in common stocks of small
and medium-sized companies which, based on our research and analysis,
appear to be undervalued in relation to their earnings, book value
and/or future prospects. We believe that buying such stocks when they
are out-of-favor, having the patience to wait until their value is
recognized by others, and being willing to sell when others become
enthusiastic buyers, should continue to produce favorable LONG-TERM
investment results.
Beginning on page two, Bill Miller, the Trust's portfolio manager,
comments on the investment outlook.
In December, the Board of Directors declared a short-term capital
gain distribution of $.31 per share and an ordinary income dividend of
$.031 per share. Under Internal Revenue Service regulations,
short-term capital gain distributions on mutual fund shares are
treated as ordinary income dividends for tax purposes. Thus, the
Trust's short-term capital gain distribution is included with ordinary
income dividends on your 1995 tax reporting statement.
Sincerely,
/s/ John F. Curley, Jr.
John F. Curley, Jr.
President
February 5, 1996
<PAGE>
PORTFOLIO MANAGER'S COMMENTS
Your fund had a good absolute, and a mediocre relative, year in 1995. We
were up 22.5% for the twelve months ending December 31, but those results
trailed the major indices and the returns of other funds that invest in small
and medium-sized companies. After six consecutive years when our results
exceeded the S&P 500 and our competition, we have now had two sub-par years in a
row.
Although back-to-back disappointing years are not unusual in the money
management business, and indeed are common if you stay at this long enough, they
remain frustrating. It would be nice, albeit false, to say we know this year
will see a return to the kinds of results we generated from 1988-1993. We do not
know what this year will bring. We do believe, though, that the fund's portfolio
is focused and contains excellent value. Over the long term that should provide
first rate results. The very early line this year is encouraging, as your fund
is both up (most funds are down) and in the top quartile of competitive funds as
January draws to a close.
Last year was an exceptional year for stocks as all of the key drivers to
equity prices were positive. Interest rates fell sharply at the long end, and
the Federal Reserve Board began to lower short-term rates over the summer.
Corporate profits rose strongly as the economy exhibited solid growth with
modest inflation.
We are quite optimistic about the outlook for small and mid-sized companies
this year. Big stocks beat small stocks again in 1995. The Dow and the S&P 500
were up over 36%, while the Russell 2000 and Value Line index, both representing
smaller companies, were up 28% and 22% respectively. Performance tends to go in
waves, and the big stock wave may be waning. At year's end, professional
investors had the greatest concentration of assets in large companies since the
mid 1970s. That period was followed by significant outperformance of small
stocks over large stocks.
The trigger for better relative results rests with the Federal Reserve. When
they cut interest rates last summer, small stocks immediately responded -- as
did your fund -- outperforming the major indices in the third quarter. This
outperformance peaked around mid-September, as worries about the strength of the
economy led investors back into more defensive names. Those worries persist.
Last year the key question was interest rates; we knew earnings were going
to be okay. If rates could come down in 1995, stocks were likely to go up. This
year the issue is earnings, or more generally, the strength of the economy.
The consensus is that the economy is slowing, that the direction of interest
rates remains lower, and that corporate earnings are likely to be up in the 5-8%
range. Growth is generally estimated to be 2-2.5% for 1996. This should lead to
stocks providing a total return of about 9-10%, or roughly in line with their
long-term historical average. That was our thinking as well, up until a few
weeks ago.
We now believe that the consensus estimates for economic growth and
corporate profits are too high. In the fourth quarter the GDP may have expanded
less than 1%, providing little momentum as we enter the new year. The continuing
budget stalemate in Washington means that government purchases are getting off
to a slow start, and companies are already beginning to issue profits warnings
due to weak government business. The powerful winter storms that swept the East
Coast in January disrupted business activity generally and retail sales in
particular. Finally, we are hearing from companies that business is at best
sluggish, and pricing power non-existent.
It looks now as if the economy may only expand at 1-1.5% this year, and that
corporate earnings could disappoint the optimists. In this kind of environment,
short-term interest rates may move sharply lower and long-term rates modestly
lower. We think that short-term interest rates could be about 4% by year end,
with long rates between 5.25% and 5.75%. Inflation should remain quite subdued.
With profits under pressure, the heavy lifting in the stock market will have
to come from interest rates. If the Federal Reserve is too cautious about
reducing rates, stocks could have a moderate correction if earnings fears begin
to become more widespread. In general, though, we think the environment for
financial assets looks fine. We believe stocks will again outperform bonds and
cash.
2
<PAGE>
The equity environment will also be affected by what promises to be a lively
election year. Despite the rancorous debate about budget policy, the direction
of Federal expenditures as a percentage of GDP is clear: lower. The government
is 25% of GDP and has a huge impact on the economy and markets. What goes on in
Washington matters. Perhaps the most interesting early development this election
year is the surprising strength of Steve Forbes in the Republican Presidential
field. His advocacy of a 17% flat tax to replace the current income tax system
is producing a healthy debate on how the government ought to satisfy its revenue
needs.
The Forbes flat tax is one of several dramatic alternatives to the tax code
currently floating around. Whatever its ultimate merits, it would be a major
positive to capital markets, since it exempts the returns from savings and
investment from taxation at the individual level (they would still be taxed at
the corporate level). This raises the after-tax return on investment and, other
things equal, would sharply boost investment and the stock market, while
lowering interest rates. If the Forbes message catches on, 1996 could be a
surprisingly strong year for the markets.
During the fourth quarter we continued to pare back our holdings. The
objective is to provide greater focus to the fund and greater intensity to our
research efforts. In the future, we expect the number of securities we own to
fluctuate around the current number, with something of a downward bias.
Of the new purchases made last quarter, the most significant was ORION
CAPITAL, which is now our fourth largest position. ORION is a property casualty
insurance company with excellent management and strong positions in a variety of
specialty lines. The company trades at under 9x this year's expected earnings, a
sharp discount to its peers, and has been repurchasing stock. Among our other
new purchases is LIFE PARTNERS, a life insurance company whose shares now trade
below book value. We believe this $13 stock has earnings power that will
approach $2.00 per share next year. The shares traded about $20 in late 1994 and
early 1995 before adverse mortality experience caused analysts to lower
estimates. Another severely depressed stock we began buying last quarter and
have continued to buy is PLAYERS INTERNATIONAL, a gaming company with properties
in Louisiana, Illinois, and Nevada. PLAYERS also has a joint venture with
Harrah's near St. Louis that should open later this year. Concerns about the
regulatory environment and new competition in Louisiana have combined to push
the stock price from the low $20's last year to under $9 now. The company is
trading at the lowest multiples of any gaming stock and has also been
repurchasing its shares. We believe the stock is worth twice the current price.
Over the past year or so many shareholders have dropped us notes of
encouragement and support as our results have lagged those we have generally
been able to achieve in the past. These fund holders have indicated that they
are long-term, value investors and that they have confidence in our approach. We
very much appreciate those sentiments. As long-time shareholders know, the
management of this fund maintains a significant investment in it. We are working
hard to find the best investments which will build value for all shareholders.
As always, we appreciate your support and welcome your comments.
Bill Miller, CFA
February 5, 1996
DJIA 5407.59
3
<PAGE>
PERFORMANCE INFORMATION
LEGG MASON SPECIAL INVESTMENT TRUST, INC.
TOTAL RETURN FOR ONE, FIVE AND TEN YEARS AS OF DECEMBER 31, 1995
The returns shown are based on historical results and are not intended
to indicate future performance. The investment return and principal value
of an investment in the fund will fluctuate so that an investor's shares,
when redeemed, may be worth more or less than their original cost. Average
annual returns tend to smooth out variations in the fund's return, so they
differ from actual year-to-year results. No adjustment has been made for
any income taxes payable by shareholders.
The fund has two classes of shares: Primary Class and Navigator Class.
The Navigator Class, offered only to certain institutional investors, pays
fund expenses similar to those paid by the Primary Class, except that
transfer agency fees and shareholder servicing expenses are determined
separately for each class and the Navigator Class does not incur Rule
12b-1 distribution fees.
Total returns as of December 31, 1995 were as follows:
<TABLE>
<CAPTION>
Cumulative Average Annual
Total Return Total Return
<S> <C> <C>
Primary Class:
One Year +22.50% +22.50%
Five Years +112.63 +16.29
Ten Years +224.86 +12.50
Navigator Class:
One Year +23.83% +23.83%
Life of Class(dagger) +23.44 +21.42
</TABLE>
(dagger)NAVIGATOR CLASS INCEPTION -- DECEMBER 1, 1994.
4
<PAGE>
SELECTED PORTFOLIO PERFORMANCE
<TABLE>
<CAPTION>
Biggest gainers for the 4th quarter 1995*
<C> <S> <C>
1. Enhance Financial Services Group Inc. +29.9%
2. Peoples Heritage Financial Group, Inc. +24.7%
3. PennCorp Financial Group, Inc. +23.0%
4. Federal National Mortgage Association +19.9%
5. Republic of Argentina
Par Bonds 5.00% 3-31-23 +17.5%
6. Magellan Health Services, Inc. +17.1%
7. Somatix Therapy Corporation Warrants +14.3%
8. Walden Residential Properties, Inc. +10.6%
9. Bell & Howell Holdings Company +9.8%
10. WorldCom, Inc. +9.7%
</TABLE>
* SECURITIES HELD FOR THE ENTIRE QUARTER.
<TABLE>
<CAPTION>
Biggest laggers for the 4th quarter 1995*
<C> <S> <C>
1. Salant Corporation Class B Warrants -66.7%
2. Boomtown Inc. -46.7%
3. Johnstown America Industries, Inc. -38.5%
4. Salant Corporation -34.0%
5. Mego Financial Corporation Warrants -33.3%
6. Sunrise Medical, Inc. -32.7%
7. Grupo Mexicano de Desarrollo S.A. ADR -32.3%
8. Grupo Financiero Serfin S.A. de C.V. ADR -27.0%
9. Hollywood Park, Inc. -17.9%
10. CMAC Investment Corporation -16.4%
</TABLE>
PORTFOLIO CHANGES
Securities Added
Argyle Television, Inc.
Life Partners Group, Inc.
Orion Capital Corporation
Players International, Inc.
Stratosphere Corporation
Ultimate Electronics, Inc.
Securities Sold
BankAmerica Corporation Warrants
Banyan Systems Incorporated
California Federal Bank, F.S.B. -- Participation
Interests
Chic by H.I.S, Inc.
Consorcio G Grupo Dina S.A. de C.V. ADS
Exabyte Corporation
Graff Pay-Per-View Inc.
Grupo Financiero Bancomer S.A. de C.V. ADS
Harrah's Jazz Company
1st Mortgage Note
14.25% 11-15-01
Playtex Products, Inc.
Regency Realty Corporation
Shawmut National Corporation
Spectrum Holobyte, Inc.
Starwood Lodging Trust
Telefonos de Mexico S.A. ADR
5
<PAGE>
PORTFOLIO OF INVESTMENTS
LEGG MASON SPECIAL INVESTMENT TRUST, INC.
DECEMBER 31, 1995 (UNAUDITED)
<TABLE>
<CAPTION>
(Amounts in Thousands) Shares Value
<S> <C> <C>
COMMON STOCKS AND EQUITY INTERESTS -- 92.6%
Advertising -- 3.8%
WPP Group P.L.C. 10,200 $ 25,979
WPP Group P.L.C. ADR 89 2,259
28,238
Apparel -- 0.2%
Salant Corporation 450 1,744A
Salant Corporation Class B Warrants 285 4A
1,748
Banking -- 3.8%
BankAmerica Corporation 100 6,475
Grupo Financiero Serfin S.A. de C.V. ADR 1,583 5,342A
Peoples Heritage Financial Group, Inc. 720 16,380
28,197
Biotechnology -- 2.6%
Biogen, Inc. 88 5,381A
Somatix Therapy Corporation 1,900 11,400A,C
Somatix Therapy Corporation Warrants 152 305A
Targeted Genetics Corporation 400 2,250A
19,336
Broadcast Media -- 0.5%
Argyle Television, Inc. 225 3,937
Computer Services and Systems -- 11.6%
America Online, Inc. 1,180 44,250A
Bell & Howell Holdings Company 300 8,400A
InaCom Corp. 805 11,371A,C
Storage Technology Corporation 900 21,487A
85,508
Construction -- 0.2%
Grupo Mexicano de Desarrollo S.A. ADR 540 1,417A
Energy -- 1.6%
California Energy Company, Inc. 600 11,700A
Entertainment -- 10.6%
Boomtown Inc. 900 4,500A,C
Circus Circus Enterprises, Inc. 750 20,906A
Hollywood Park, Inc. 1,700 17,106A,C
Mirage Resorts, Incorporated 400 13,800A
Players International, Inc. 1,386 14,810A
Stratosphere Corporation 700 6,913A
78,035
Finance -- 9.2%
Federal National Mortgage Association 100 $ 12,412
Mego Financial Corporation Warrants 300 1,688A
Pioneer Group, Inc. 750 20,437
Piper Jaffray Incorporated 299 4,109
The Bear Stearns Companies Inc. 450 8,944
United Asset Management Corporation 525 20,147
67,737
Health Care -- 9.8%
Magellan Health Services, Inc. 975 23,400A
Physician Corporation of America 925 15,725A
Sunrise Medical, Inc. 625 11,562
Value Health, Inc. 801 22,014A
72,701
Insurance -- 13.9%
CMAC Investment Corporation 400 17,600
Enhance Financial Services Group Inc. 517 13,760
John Alden Financial Corp. 925 19,309
Leucadia National Corporation 100 2,500
Life Partners Group, Inc. 925 12,603
Orion Capital Corporation 580 25,171
PennCorp Financial Group, Inc. 404 11,873
102,816
Manufacturing -- 1.9%
Briggs & Stratton Corporation 82 3,570
Danaher Corporation 236 7,493
Johnstown America Industries, Inc. 560 2,800A,C
13,863
Miscellaneous -- 1.8%
Olsen & Associates AG 300 2,601A,D
Stewart Enterprises, Inc. 285 10,545
13,146
</TABLE>
6
<PAGE>
<TABLE>
<CAPTION>
(Amounts in Thousands) Shares Value
<S> <C> <C>
Multi-Industry -- 1.4%
Asarco, Inc. 177 $ 5,658
UNR Industries, Inc. 530 4,571
10,229
Real Estate -- 2.2%
Resource Mortgage Capital
Corporation 400 8,000
Summit Properties, Inc. 200 3,975
Walden Residential Properties, Inc. 217 4,536
16,511
Savings and Loan -- 8.5%
California Federal Bank, F.S.B. 900 14,175A
Standard Federal Bancorporation 650 25,594C
Washington Mutual, Inc. 795 22,955
62,724
Services -- 3.5%
Ideon Group Incorporated 2,554 25,854C
Specialty Retail -- 5.1%
Home Shopping Network, Inc. 3,025 27,225A
Mac Frugal's Bargains(Bullet)Close-outs
Inc. 608 8,506A
Ultimate Electronics, Inc. 205 1,538A
37,269
Telecommunications -- 0.4%
WorldCom, Inc. 90 3,172A
Total Common Stocks and Equity
Interests
(Identified Cost -- $545,231) 684,138
PREFERRED STOCK -- 0.3%
Mego Financial Corporation
Series A 12% Cum.
(Identified Cost -- $2,000) 200 2,000C,D
CORPORATE BOND -- 0.6%
Grupo Mexicano de Desarrollo S.A. ADR
8.25% 2-17-01
(Identified Cost -- $3,850) $11,000 $ 4,675B
SOVEREIGN OBLIGATION -- 2.7%
Republic of Argentina Par Bonds
5.00%E 3-31-23
(Identified Cost -- $13,460) 35,000 19,972
REPURCHASE AGREEMENT -- 3.7%
Morgan Stanley & Co. Incorporated
5.9% dated 12-29-95, to be
repurchased at $27,242 on
1-2-96 (Collateral: $15,235
Federal Home Loan Mortgage
Corporation Mortgage-backed
securities, 9% due 4-1-21,
value $16,137 and $11,251
Federal National Mortgage
Association Mortgage-backed
securities, 7.5% due 3-1-10,
value $11,644)
(Identified Cost -- $27,224) 27,224 27,224
Total Investments -- 99.9%
(Identified Cost -- $591,765) 738,009
Other Assets Less Liabilities -- 0.1% 906
NET ASSETS -- 100.0% $738,915
NET ASSET VALUE PER SHARE:
PRIMARY CLASS $22.81
NAVIGATOR CLASS $22.91
</TABLE>
A NON-INCOME PRODUCING
B RULE 144A SECURITY -- A SECURITY PURCHASED PURSUANT TO RULE 144A UNDER
THE SECURITIES ACT OF 1933 WHICH MAY NOT BE RESOLD SUBJECT TO THAT RULE
EXCEPT TO QUALIFIED INSTITUTIONAL BUYERS.
C AFFILIATED 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.
D PRIVATE PLACEMENT
E COUPON INCREASES 0.25% ANNUALLY UNTIL MARCH 31, 1999, THEREAFTER REMAINS
FIXED AT 6.0% UNTIL MATURITY.
7
