Quarterly Report
December 31, 1998
Legg Mason
Value Trust, Inc.
Special Investment
Trust, Inc.
Total Return Trust, Inc.
[LEGG MASON FUNDS LOGO APPEARS HERE]
Investment Adviser
Legg Mason Fund Adviser, Inc.
Baltimore, MD
Board of Directors
Raymond A. Mason, Chairman
John F. Curley, Jr., President
Richard G. Gilmore
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
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100 Light Street
P.O. Box 1476, Baltimore, MD 21203-1476
410 o 539 o 0000
LMF-002
2/99
<PAGE>
To Our Shareholders,
The quarter ended December 31, 1998 was an excellent one for most US equity
mutual funds, with the average US equity fund earning 20.3% on a total return1
basis, in contrast to an average 15% loss in the prior quarter.
The following table summarizes key statistics for the Primary Class of shares
of the Legg Mason Value Trust, Special Investment Trust and Total Return Trust,
as of December 31:
3 Month 12 Month
Total Return(1) Total Return(1)
--------------- ---------------
Value Trust +35.9% +48.0%
Lipper Growth Funds(2) +22.7% +22.9%
Standard & Poor's 500 Composite Index +21.3% +28.6%
Special Investment Trust +40.1% +23.3%
Lipper Mid Cap Funds(3) +23.1% +12.3%
Russell 2000 Index +16.3% -2.6%
Total Return Trust +13.8% -0.4%
Lipper Growth and Income Funds(4) +17.8% +15.6%
As the above table indicates, the Value Trust and Special Investment Trust
had exceptionally strong results in the quarter and year. Total Return Trust,
after excellent investment performance in 1997, underperformed the average
Lipper Growth and Income Fund in 1998, in part because of its significant
investments in real estate investment trust stocks. In her letter beginning on
page 9, Nancy Dennin, Total Return Trust's portfolio manager, discusses why she
continues to be optimistic about the investment potential of REIT securities on
a long-term basis.
Bill Miller, the portfolio manager of Value Trust (and who, with Lisa
Rapuano, manages the Special Investment Trust) was recently the subject of a
major article in the Money and Business section of the New York Times. The
article pointed out that, in each of the past eight years, the Value Trust
(Primary shares) has outperformed the Standard and Poor's 500 Composite Index5.
It went on to say:
None of the thousands of other mutual fund managers currently plying
the trade has equaled that feat; barely 1 in 10, in fact, have beaten the
benchmark over the last three years. Anyone else aspiring to the mantle of
fund manager of the decade should note that not even Peter Lynch, the
legendary former overseer of the Fidelity Magellan fund, ever strung
together such a consistent record.
Fittingly, the Times article concludes by quoting Bill's cautionary warning
that "the probabilities favor (our) returns being a lot lower in the future" for
reasons he has discussed at length in earlier issues of this report.
We congratulate Bill, not only for the remarkable achievements which prompted
the favorable comments mentioned above, but also for his recent selection as
Domestic Equity Fund Manager of the Year 1998 by Morningstar, a well known
mutual fund evaluation service. The Morningstar award recognizes portfolio
managers "who demonstrate excellent investment skills, the courage to differ
from consensus, and the commitment to shareholders necessary to deliver
outstanding long-term performance."
Bill's latest thoughts on our Funds and the investment outlook begin on page
3.
<PAGE>
The Board of Directors recently approved the following dividends and
distributions for each Primary Class share, paid early in December:
Ordinary Long-Term Reinvestment
Income Gain Date
------ ---- ----
Value Trust -- $ .42 12/3/98
Special Investment Trust -- .0126 12/10/98
Total Return Trust $.055 .56 12/10/98
During 1998, attention increasingly focused on the Year 2000 issue. As you
may know, the Year 2000 issue is a computer programming problem that affects the
ability of computers to correctly process dates of January 1, 2000, and beyond.
The Funds' Year 2000 project is well underway, and is designed to ensure that
the Year 2000 date change will have no adverse impact on our ability to service
our clients. The Funds are committed to taking those steps necessary to protect
Fund investors including efforts to determine that the Year 2000 problem will
not affect such vital service functions as shareholder transaction processing
and recordkeeping. In addition, we are continuously monitoring the Year 2000
efforts of our vendors, and will perform tests with our critical vendors
throughout 1999. Although the Funds are taking steps to ensure that all of their
systems will function properly before, during, and after the Year 2000, the
Funds could be adversely affected by computer related problems related to the
Year 2000. Contingency plans to ensure that functions critical to the Funds'
operations will continue without interruption are under development. We are on
target to complete this important project and look forward to continue extensive
testing (including industry-wide testing) with our industry peers, regulators
and vendors throughout 1999.
Sincerely,
/s/ John F. Curley, Jr.
John F. Curley, Jr.
President
February 9, 1999
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(1) 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.
(2) All growth funds as measured by Lipper Analytical Services, Inc.
(3) All funds investing principally in securities of companies with medium-sized
capitalizations as measured by Lipper Analytical Services, Inc.
(4) All growth and income funds as measured by Lipper Analytical Services, Inc.
(5) The strong performance of both the Value Trust and the S&P 500 over the past
8 years occurred during a period of substantial economic growth and favorable
equity markets. There can be no assurance that similar conditions will prevail
in the months and years ahead. The S&P 500 is an unmanaged index of common stock
prices and includes reinvested dividends.
2
<PAGE>
Portfolio Managers' Comments
Fourth Quarter 1998
Value Trust
The Value Trust had one of its best years in l998, rising 48.04%. Our returns
were especially strong (+35.86% vs. the S&P 500's 21.30%) in the fourth quarter
rebound from the panic selling of late summer and early fall. As indicated in
our last quarterly report, we believed the decline in share prices resulting
from Russia's debt default and fears about the effects of global financial
instability on domestic profits had created an attractive investment
opportunity. We were surprised at the speed of the recovery in stock prices, but
benefited fully since we committed substantial cash reserves to the market at
what turned out to be quite favorable prices.
Our results substantially outpaced those of the major market indices, which
exhibited unusually wide variation in the past 12 months. The Russell 2000 Index
of mostly smaller companies fell 2.55%, while the large capitalization S&P 500
rose 28.58%. The price-weighted and more cyclically oriented Dow Jones Average
rose 18.15%. General equity funds were up 14.56%, with growth funds rising
almost 23% according to Lipper Analytical Services, Inc.
Some Thoughts on Indexing and Performance
Most money managers again failed to keep pace with the benchmark S&P 500,
which outperformed over 80% of active managers in 1998 and over 95% of active
managers over the past five years. Last year was a particularly hard year to
beat the market, since only 28% of the stocks in the S&P outperformed the index,
and those were concentrated mostly in the largest names. As evidenced by the
very poor returns of the Russell, to the extent active managers focused their
efforts on smaller companies, by charge or by choice, they had very little
chance to deliver index-beating returns.
The S&P 500 is the benchmark for most active managers; it is the
competition.1 It is also the cost of capital for active management. Just as
companies that invest above their cost of capital--which is the weighted average
cost of their debt and equity--add value for owners and those that do not
destroy shareholder value, so too with money managers. To the extent money
managers outperform the index, they are adding value for their shareholders; to
the extent that they underperform, they are destroying value relative to returns
that could be obtained by investing in an index fund. The rapid growth of
indexing over the past decade or so is a direct result of the inability of most
active managers to add value relative to what is misleadingly referred to as
passive investing.
Money managers are often quick to criticize companies that do not perform
well, and to offer management advice on how to do better. Companies that are
consistently beaten by the competition are rightly admonished and urged to adopt
strategies with a greater probability of success. Those companies that are
consistently superior are closely studied and their methods are often copied in
order to improve results.
Surprisingly, scant attention appears to be directed at the methods and
strategies of the S&P 500 despite its long-term record of superiority relative
to most active money managers. Data compiled by Tweedy Browne & Co. indicates
that since the beginning of l982, the S&P 500 has outperformed over 90% of all
surviving mutual funds. The proportion would of course be even higher if funds
that subsequently failed or were merged were included. A recent book, Indexing
for Maximum Investment Results2, contains the results of numerous studies of
active managers vs. index performance. The
- --------------------------------------------------------------------------------
1 It is not possible to invest directly in the S&P 500.
2 Neubert Alberts, Editor
3
<PAGE>
Portfolio Managers' Comments - Continued
results are consistent across a wide variety of time frames: index funds
routinely beat the overwhelming majority of active managers. Index funds do
particularly well relative to active managers in large capitalization stocks
such as those found in the S&P 500. Even with very broad market indices, such as
the Wilshire 5000, the superiority of indexing holds. From 1973 through l995,
there were only 8 years that active managers beat that index, and 6 of them
occurred prior to l983.
Two questions suggest themselves: why does indexing work, and can active
managers improve their results by careful study of the competition?
The answer to the first question is easy: indexing works because the market
is efficient. Academics refer to the notion of market efficiency as a
hypothesis, but they are just being overly fastidious. We can dispense with
trying to distinguish, as they do, between various forms of efficiency, and with
an unnecessary discussion of the various studies of possible market anomalies
and inefficiencies. For the purposes of real world investing, let's call a
market "pragmatically efficient" if it beats most active managers most of the
time. It is clear that the market for large capitalization US stocks is
pragmatically efficient.
An efficient market is one where stock prices reflect all available
information. Notice that this description does not say prices are correct, just
that in the aggregate they incorporate what is believed about the present value
of the future. The information available to the market is reflected in prices
through the collective behavior of the agents operating in it. These agents
encompass an ecology of objectives, time horizons, risk tolerances, and utility
functions. This leaves plenty of room for recurrent, exploitable anomalies such
as those that may arise due to systemic errors in probability assessment. But
any such opportunities are unlikely to be available to the average investor.
Average hitters can't win many batting titles.
The most important implication of a market that is efficient is that there is
no algorithmic or systematic way to outperform it. More simply, there is no
formula which can specify a portfolio that is likely, over time, to outperform
the market. Any such formula or mechanism would be copied and its advantage
arbitraged away as it quickly spread among investors. There may be formulations
or principles used by those who have outperformed, but such statements will not
specify a portfolio. We use just such formulations: we buy companies that trade
at large discounts to intrinsic value. Unfortunately, that simple description
doesn't specify any particular portfolio. (When asked the secret to hitting,
Stan Musial--I think--said, `wait for a good pitch, and then smash it.')
This means that all of the popular methods of stock selection: value, growth,
momentum, sector rotation, thematic investing, etc. are either too vague to be
useful, or if specific, as many purely quantitative methods are, likely to have
a short half-life.
Is active management just a loser's game, and passive indexing the only
viable investment strategy? Not at all. Just as poorly performing companies can
often improve their results by studying winning competitors, active managers can
improve theirs by deconstructing the sources of competitive advantage of the
index, in our case the S&P 500.
The first and most important feature of the S&P 500 is that it does not
employ a passive selection strategy. Managers of index funds employ such a
strategy, since they engage in no active stock selection. But the S&P 500 is an
actively selected index. Its stocks are chosen from the nearly 9000 publicly
traded securities on the New York, American and NASDAQ markets by a committee
using specific investment criteria.
4
<PAGE>
The returns of the S&P 500 are the best evidence of the long-term advantage
of active portfolio construction. It has consistently beaten broader, passively
constructed indices such as the Wilshire 5000, the Russell 2000, and the NYSE
Composite. That it has also beaten other active money managers is not an
argument against active management, it is an argument against the methods
employed by most active managers.
The S&P 500 is a long-term oriented, low turnover index employing a buy and
hold strategy, which is by nature tax efficient. It lets its winners run, and
selectively eliminates its losers. It never reduces a successful investment no
matter how far up the stock has run, and it does not arbitrarily impose size or
position limits on holdings, either by company or industry. Size is fixed at 500
names, and new names usually come into the index because of the merger or
acquisition of existing companies. Periodically, new names are added and others
eliminated in an attempt to replace companies that are marginal with those whose
position in the economy or an industry are deemed more important.
The overall index is positioned to represent the broad sweep of the US
economy. The stock selection committee at S&P consists of 9 analysts, and new
names are meant to be seasoned companies with a history of profitability,
financially sound, leaders in their industry or market, with a probability of
being in business over the next 10 to 20 years. Index turnover averaged 25 to 30
names in the l980s but has picked up to 40 or so in the past few years.
The contrast with the typical active manager is stark. The average mutual
fund is short-term oriented, has high turnover, is tax inefficient, and employs
a trading oriented investment style. Most funds systematically cut back winners
or rotate out of stocks that have done well into those expected to do better.
Position limits and industry weightings are usually rigidly maintained in the
name of either investing discipline or risk control. The number of holdings is
usually well over 100, but may vary significantly, both among funds and within
the same fund over time. The overall portfolio is constructed in accordance with
some style the manager erroneously believes is likely to outperform the
long-term, low turnover approach of the S&P 500.
Part of the success of the Value Trust is no doubt due to our not employing
methods that place us at a disadvantage to the S&P. We employ a long-term, low
turnover, buy and hold investment approach that as a by-product is tax
efficient. We employ no rigid industry, sector, or position limits, save only
those mandated by the broad mutual fund rules. We let our winners run and
eliminate those positions deemed to have poor long-term economic prospects. If
we have companies merged for cash, we will redeploy that capital into new names.
Operating similarly to the S&P in the ways noted above does not help us
outperform the index, although it probably has helped our results compared to
other managers whose methods have been different and suboptimal relative to the
index. Our results have improved in the past several years as our turnover rate
has fallen and as we have let our winners continue to run without cutting
positions back in the guise of risk control or portfolio balance. There is a
limit to all good things, though, and our positions in Dell and AOL are much
larger relative to our portfolio than the largest position in the S&P is
relative to that index. Those positions are at or near their peaks and we would
expect them to decline gradually over time.
Since the selection criteria for inclusion in the S&P 500 are not terribly
arcane, it is not superior stock selection that has led to its methods beating
most other active management styles. There are services out there that are
pretty good at identifying likely candidates for the index. America Online was
widely expected to be added, as happened at December 31, and Warren Buffett's
Berkshire Hathaway is another favorite for eventual inclusion.
5
<PAGE>
Portfolio Manager's Comments - Continued
What is the source of the S&P's superiority over active management styles? I
think it comes back to market efficiency. The market is pretty well aware of the
information that may affect the prospects of its constituent companies for the
next year or so. New information arrives unpredictably. Beyond the next year,
the complexities, uncertainties, and vagaries are such that no one is vouchsafed
any special insight into the future. Most of the activity that makes active
portfolio management active is wasted; it adds no value since it is engendered
by the mistaken belief that the manager possesses information the market is
unaware of, or that the market has mispriced. It does impose costs: trading
costs, market impact costs, and taxes. It is also often triggered by ineffective
psychological responses such as overweighting recent data, anchoring on
irrelevant criteria, and a whole host of other less than optimal decision
procedures currently being investigated by cognitive psychologists.
Money managers often wrongly decry the growth of indexing and complain that
it is a mindless strategy. While they may be right that pure factor based
indexing strategies, e.g., buy all companies with characteristics xyz, are
unlikely to add value over time (the evidence is not clear on this), they are
surely wrong to bemoan either the desire of investors for S&P 500 index funds or
their own inability to compete with the results of such funds. Investors are
rationally selecting an active money management style that is sensible, tax
efficient, has a long history, and works.
Portfolio Activity and Outlook
As usual, our portfolio activity in the quarter has been modest. We sold our
Daimler Chrysler subsequent to the closing of the merger, and we sold our
Columbia/HCA Healthcare. We believed that Daimler Chrysler was fully priced at
15x earnings, especially since GM was trading at 8x. Columbia was swapped into
WPP Group, plc the largest communications company in the world, and the owner of
ad agencies Ogilvy and Mather and J.Walter Thompson. WPP at the time was trading
at 14x earnings, earning 20% on capital, and growing nicely. It trades at a huge
discount to comparables such as Interpublic and Omnicom for reasons we believe
are unwarranted. Since the swap, WPP's shares have risen, while Columbia's have
declined. We also bought First Data, the largest merchant processing company;
and MGIC Investment, the largest independent private mortgage insurance company.
First Data has underperformed for years as returns on capital deteriorated. We
believe that is about to change. MGIC has suffered from slow growth in the
mortgage insurance market and recent competitive pressures from Fannie Mae. At
8x earnings, with excellent management, high returns, and active share
repurchase, it is just too cheap. We also bought a little Fred Meyer when the
arbitrage into Kroger became compelling.
We believe the next year in the market will be unpredictable, just like all
other years. The economy appears solid, though the profit cycle is extended and
profitability pressures are increasingly evident across a wide variety of
industries. Inflation is well controlled, real rates are high but not punishing,
and the Fed appears on hold for now. The budget surplus could hit $100 billion
this year. Brazil's floating of the currency appears to have been well tolerated
by the markets, although at the margin it will be negative for growth in this
hemisphere. Market values in the US stock market have outstripped business value
growth for some time, a trend we do not expect to continue. The combination of
modest profit growth, low inflation, a disciplined but not hostile Fed, and
continuing high demand for long dated financial assets should lead to
satisfactory results in l999.
Bill Miller, CFA
6
<PAGE>
Special Investment Trust
Our cumulative results for various periods ending December 31, 1998 are shown
below:
<TABLE>
<CAPTION>
3 Months 1 Year 3 Years 5 Years
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Special Investment Trust +40.13% +23.31% +93.73% +106.29%
Lipper Small Cap Funds +19.15% -0.36% +44.23% +85.37%
Lipper Mid Cap Funds +23.06% +12.32% +59.35% +104.06%
Russell 2000 Index +16.31% -2.55% +38.92% +75.19%
S&P 500 Composite Index +21.30% +28.58% +110.85% +193.91%
</TABLE>
What a difference a quarter makes! When we last wrote we had just completed
an excruciating third quarter, with negative returns in the three month and year
to date periods. However, as is often the case, the market rebounded off the
panic-induced lows. In the fourth quarter, your Fund's return of over 40% bested
the major indices and the averages of comparable funds. For the year, though we
did not keep pace with the S&P 500 Index of larger companies, we significantly
outperformed the Russell 2000 Index of smaller companies as well as the averages
of other funds specializing in small and mid cap companies.
While the sell-off in 1998 was quite painful and dramatic, we used the
opportunity to buy very attractive businesses at low valuations. It was
difficult to go against the grain in late summer, but we used cash we had raised
from fairly valued positions to aggressively buy throughout the market
correction. We were rewarded for these actions, as evidenced by the recovery we
sustained in our fourth quarter results.
Even with the recovery of the S&P 500 to new highs, the Russell 2000 and the
Russell Mid Cap indices remain below their previous highs. Individual companies
in these sectors continue to be available at very low valuations. In fact, on an
aggregate basis, the relative valuation of the smaller sectors of the market is
at or close to historical lows. For example, the valuation measures like P/E,
Price/Sales and Price/Book on the small and mid cap indices are approximately
0.5x to 0.8x those of the larger indices. The long-term average relationship is
for small and mid cap indices to be valued at 1.0x to 1.1x their larger
brethren. The current measures are all well below the previous trough in 1990,
and most have reached or surpassed the troughs they last saw in the late 1970's.
This trend of discounted valuations in the small and mid cap sectors has been
in place for some time now. It is simply much more extreme today. However, there
are some additional factors in the market that we believe may cause the
undervalued smaller companies to stage a comeback versus the powerful S&P 500
type names in 1999 and 2000.
The first factor is growth. Larger cap companies have sustained impressive
sales growth through the early nineties, keeping pace with the traditionally
faster growing small companies' high teens growth rates. The sectors began to
diverge in late 1997, and we now have sales growth rates in the large cap sector
decelerating to the 5% range. Anecdotal evidence of this slowdown is evident in
disappointing results coming from companies like Coca-Cola, Gillette and
Campbell's. Meanwhile, the small and mid cap company aggregate sales growth
rates have remained in the mid teens.
More vibrant growth in the smaller companies could be a catalyst to begin to
close the valuation gap with the larger names, but there is likely to be
something even more interesting going on. In the current economic environment of
slower GDP growth, low interest rates and low inflation, growth is both more
difficult and more valuable. It is obvious that lower economic growth makes
overall sales growth harder to come by, but what is less obvious is that this
scarce growth has a higher theoretical value. This value is higher not just
because it is scarce, but because of the low interest rate environment.
7
<PAGE>
Portfolio Managers' Comments -- Continued
The value of a company is the value of its future cash flows discounted at an
appropriate rate. When interest rates are low, the appropriate discount rate is
lower, and thus the value of a growing stream of cash flows begins to increase.
So, in an environment such as the current one, we should see much higher
valuation measures being attached to high growth companies than we see on slow
or no growth companies.
The list of other factors that may give the smaller sector a boost is long
and growing. Some of these factors are:
o Smaller stocks have a more domestic orientation. While global exposure has
previously been a boost to growth, current conditions may cause global exposure
to be a drag on growth potential.
o The US Federal Reserve's stance toward an easier monetary policy has
historically been associat- ed with an environment that is favorable to smaller
stocks.
o A slow initial public offering market in the last year may be keeping the
supply of small compa- nies low, while an increase in buying power and cash in
mutual funds may lead to increasing demand.
We cannot definitively say that any of these factors will be the magic bullet
that causes the smaller cap sector to wake up. However, we have a combination of
extremely discounted valuations and high growth, along with a list of other
factors that continues to grow. This background underscores our optimism as we
select individual companies that we think are mispriced.
We added five new equity positions in the quarter. Consolidated Stores is the
largest closeout retailer in the country with over 70% market share. The company
has been struggling lately as a result of a merchandising change, which has
depressed near-term results. Consolidated Stores generates free cash flow, earns
close to 40% cash on cash returns on a per store basis and trades at about 12x
what they should earn this year. We think that analysts are drastically
underestimating how much cash this company can generate and believe intrinsic
value is twice the current share price.
Modis Professional Services is an information technology and professional
staffing company. Modis used to be known as Accustaff, but they sold off their
commodity, slower growth staffing business and are now focusing on the higher
growth, higher return sectors of the market. Despite this, the company is being
valued at the extreme low end of the entire staffing universe at about 12x this
year's earnings and 6x EBITDA(1). They repurchased 18% of their stock in the
fourth quarter, demonstrating management's conviction that their company is not
being valued properly. If Modis' stock only returns to being valued as other
staffing companies are valued, we believe it is worth at least 50% more than
today's prices. If the company successfully transitions to being an information
technology company, we believe the value is closer to double its current market
capitalization.
Silicon Graphics, a computer software and systems developer, has undergone a
significant change in management strategy that we believe investors do not yet
fully appreciate. New management has cut costs significantly as they
restructured the company, selling off non-core assets and building up a large
cash position. The cash and the company's ownership stake in two businesses
slated for divestiture justify most of the current share price, giving us the
reinvigorated core business at a value we feel unsurpassed.
We also purchased very small positions in Remedy, a software company, and
Patriot American Hospitality, a hotel REIT, during the quarter.
Thank you for your continued support. We again welcome your questions and
comments.
Lisa O. Rapuano, CFA Bill Miller, CFA
- ---------------
(1) Earnings before interest, taxes, depreciation and amortization
8
<PAGE>
Total Return Trust
Cumulative results for the Fund are shown below:
<TABLE>
<CAPTION>
3 Months Ended Year Ended Year Ended 3 Years Ended
Dec. 31, 1998 Dec. 31, 1998 Dec. 31, 1997 Dec. 31, 1998
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total Return Trust +13.75% -0.39% +37.5% +79.61%
Lipper Growth &Income Funds +17.79% +15.59% +27.1% +79.05%
S&P500 Composite Index +21.30% +28.58% +33.4% +110.85%
Dow Jones Industrial Average +17.58% +18.15% +24.9% +90.25%
</TABLE>
As the above chart shows, the major market indices staged a powerful rally in
the fourth quarter, in sharp contrast to the double digit negative returns of
the third quarter.
The rally in the fourth quarter resulted in an unprecedented fourth
consecutive year of 20% plus returns for the S&P 500. Unfortunately, the Total
Return Trust greatly lagged the S&P 500 and, to a lesser extent, its peer group
last year, in sharp contrast to the Fund's outperformance in 1997.
The fourth quarter capped a year of greater volatility in the stock market,
after several years of relative calm. We expect volatility to continue at an
elevated pace as investors grapple with several issues, namely the longevity of
the economic expansion and the severe divergence of equity returns in 1998.
We are in the eighth year of economic expansion, an unprecedented record in
post war history. As we begin 1999, the economy appears to be strengthening, not
decelerating as most economists expected only a few months ago. As this
expansion continues to age, investors will most likely increasingly question the
longevity of the current expansion, and in turn the continued expansion of
corporate profits.
While the economic expansion will invariably end at some point, we continue
to believe the economic cycle in the US will be much more muted in the future
than it has been in the past, principally due to the technological advances
corporate America has made.
Better technology allows for better inventory management. Indeed, the
inventory to sales ratio is at its lowest level in the last fifty years. With
corporations much better equipped to manage their inventories, a slowdown in
demand will quickly lead to a slowdown in manufacturing, muting the effect on
the business cycle.
An effect of a muted business cycle is a higher multiple on companies'
earnings. Investors don't like uncertainty. With reduced economic volatility,
investors are willing to pay a higher multiple for a company's earnings stream,
as we have seen over the last several years.
What was unusual about the market's return in 1998 is that the S&P 500's
strong advance was concentrated in a few stocks. The S&P 500 is a market
capitalization weighted index. The performance of the largest market cap
companies in the index greatly weighs on the overall index's results. In 1998,
the largest 20 ("Nifty Twenty") market cap stocks outperformed the average S&P
500 stock by 27 percentage points, the greatest skewing of the last 30 years.
The earnings of the Nifty Twenty grew 15% last year, down from the 20% per
annum rate of the prior five years. In sharp contrast, the earnings of the
remaining 480 S&P 500 stocks fell by 6% in 1998, after growing at a 13% rate
previously. In my opinion, the extreme divergence in earnings
9
<PAGE>
Portfolio Managers' Comments -- Continued
growth will not continue as 1999 progresses. The shift in earnings growth led
to the biggest one-year growth stock rotation on record, with the current
valuation discount of smaller companies at a 50 year high.
As long-term Total Return Trust shareholders are aware, the Fund invests in a
combination of large, mid and small cap stocks. Approximately 60% of the Fund is
currently invested in large cap companies, with the balance in mid and small cap
stocks. At the end of 1997, about 50% of the Fund was invested in largecaps and
50% in small and mid caps. The flexibility to invest in a combination of large,
mid and small cap stocks has served the Fund well in the past, and I believe it
will in the future.
We took advantage of the heightened volatility in the second half of 1998 to
swap some of our holdings into securities that we believe offer greater
risk-adjusted return potential. The chart listing our purchases and sales in the
fourth quarter is shown elsewhere in this report.
We sold our position in Union Planters Corporation (a regional bank) and
purchased Citigroup and Bank One. All three stocks were under pressure in 1998
as investor concern mounted regarding the assimilation of recent acquisitions.
Citigroup has an unparalleled worldwide consumer franchise. While a merger
between two very large corporations such as Citibank and Travelers seldom
proceeds smoothly, we are confident the combined company's management will work
through the near-term challenges and ultimately generate returns greater than if
the companies had remained independent.
We continue to have a sizable position in Real Estate Investment Trusts
("REITs"). They are attractive on virtually every valuation measure we use:
funds from operations (FFO), adjusted funds from operations (AFFO), current
yield, relative yield and net asset value (NAV).
The average yield of the REIT's in the Fund is 7.5%, about in line with the
REIT universe. The spread between the REIT's yield and the 10 year Treasury is
about 275 basis points(1), higher than it was in 1990 at the height of the
commercial real estate recession.
On average, REIT's are trading at about a 12% discount to NAV vs. a 20%
premium a year ago. If the valuation differential between the public and private
market values of REIT's doesn't narrow soon, we expect to see a number of
transactions involving the sale of individual properties and purchase of REIT
shares, to take advantage of the arbitrage.
While we certainly don't like to experience periods of underperformance such
as 1998, we are quite enthusiastic about the Fund's prospects going forward. The
Total Return Trust trades at substantial discounts to the market on both 1999
and 2000 estimated earnings, at only 13x and 11x for the Fund vs. 26x and 25x
for the S&P 500.
As always, we appreciate your support and welcome your comments.
Nancy Dennin, CFA
February 9, 1999
DJIA 9133.03
- ----------------
(1) 100 basis points = 1%
10
<PAGE>
Performance Information
Total Return for One, Five, Ten Years and Life of Funds, as of December 31, 1998
The returns shown are based on historical results and are not intended
to indicate future performance. Total return measures investment
performance in terms of appreciation or depreciation in a Fund's 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. The investment return and principal value of an investment in
each 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 in-come taxes payable by shareholders.
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.
The Funds' total returns as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
Special S&P 500
Value Investment Total Return Composite
Trust Trust Trust Index
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Average Annual Total Return
Primary Class:
One Year +48.04% +23.31% -0.39% +28.58%
Five Years +32.01 +15.58 +16.81 +24.06
Ten Years +20.92 +18.52 +14.45 +19.21
Life of Class--Value Trust(A) +21.38 +18.94
Life of Class--Special Investment Trust(A) +15.18 +17.76
Life of Class--Total Return Trust(A) +12.02 +18.12
Navigator Class:
One Year +49.40 +24.50 +0.67 +28.58
Life of Class(B) +41.88 +24.72 +23.48 +29.65
Cumulative Total Return
Primary Class:
One Year +48.04% +23.31% -0.39% +28.58%
Five Years +300.83 +106.29 +117.48 +193.91
Ten Years +568.33 +446.40 +285.68 +479.63
Life of Class--Value Trust(A) +2,448.65 +1,713.37
Life of Class--Special Investment Trust(A) +529.34 +737.84
Life of Class--Total Return Trust(A) +343.01 +787.53
Navigator Class:
One Year +49.40 +24.50 +0.67 +28.58
Life of Class(B) +317.89 +146.68 +136.84 +182.51
- -----------------------------------------------------------------------------------------------------
</TABLE>
(A) Primary Class inception dates are:
Value Trust--April 16, 1982
Special Investment Trust--December 30, 1985
Total Return Trust--November 21, 1985
(B) Navigator Class inception dates for each fund--December 1, 1994
11
<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)
Selected Portfolio Performance*
Strong performers for the 4th quarter 1998
- --------------------------------------------------------------------------------
1. America Online, Inc. +187.6%
2. Danaher Corporation +81.0%
3. The Chase Manhattan Corporation +57.4%
4. Nokia Oyj +53.6%
5. Zions Bancorporation +52.8%
6. MCI WorldCom, Inc. +46.8%
7. International Business
Machines Corporation +44.3%
8. Western Digital Corporation +40.1%
9. Storage Technology Corporation +39.8%
10. PepsiCo, Inc. +39.1%
* Securities held for the entire quarter.
Weak performers for the 4th quarter 1998
- --------------------------------------------------------------------------------
1. PennCorp Financial Group, Inc. -54.3%
2. Starwood Hotels & Resorts -25.6%
3. Mirage Resorts, Incorporated -10.8%
4. Metro-Goldwyn-Mayer, Inc. -5.0%
5. Conseco, Inc. 0.0%
6. Toys "R" Us, Inc. +4.3%
7. Telefonos de Mexico S.A. ADR +10.0%
8. Dell Computer Corporation +11.3%
9. Hilton Hotels Corporation +12.1%
10. Washington Mutual, Inc. +13.2%
Portfolio Changes
Securities added during the 4th quarter 1998
- --------------------------------------------------------------------------------
First Data Corporation
Fred Meyer, Inc.
MGIC Investment Corporation
WPPGroup plc
Securities sold during the 4th quarter 1998
- --------------------------------------------------------------------------------
Daimler Chrysler Corporation
Columbia/HCA Healthcare Corporation
12
<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)
Selected Portfolio Performance*
Strong performers for the 4th quarter 1998
- --------------------------------------------------------------------------------
1. America Online, Inc. +187.6%
2. Hollywood Entertainment Corp. +100.0%
3. Cell Genesys, Inc. +88.2%
4. Symantec Corporation +64.9%
5. Bell & Howell Company +45.8%
6. Hadco Corp. +44.3%
7. Western Digital Corporation +40.1%
8. Storage Technology Corporation +39.8%
9. PhyCor, Inc. +36.3%
10. Quantum Corporation +33.9%
* Securities held for the entire quarter.
Weak performers for the 4th quarter 1998
- --------------------------------------------------------------------------------
1. PennCorp Financial Group, Inc. -54.3%
2. Dynex Capital, Inc. -45.2%
3. Cott Corporation -34.3%
4. LASER Mortgage Management, Inc. -27.5%
5. Cabletron Systems, Inc. -25.6%
6. Magellan Health Services, Inc. -22.5%
7. InaCom Corp. -21.2%
8. Hollywood Park, Inc. -19.9%
9. Northeast Utilities System -4.5%
10. Gateway 2000, Inc. -1.8%
Portfolio Changes
Securities added during the 4th quarter 1998
- --------------------------------------------------------------------------------
Consolidated Stores Corporation
ICO Global Communications, 15% due 8/01/05
Modis Professional Services, Inc.
Patriot American Hospitality, Inc.
Remedy Corporation
Silicon Graphics, Inc.
Securities sold during the 4th quarter 1998
- --------------------------------------------------------------------------------
ICO Global Communications (Holdings) Limited
USA Networks, Inc.
13
<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)
Selected Portfolio Performance*
Strong performers for the 4th quarter 1998
- --------------------------------------------------------------------------------
1. Brunswick Corporation +91.3%
2. The Chase Manhattan Corporation +57.4%
3. International Business
Machines Corporation +44.3%
4. AK Steel Holding Corporation +43.0%
5. Tupperware Corporation +39.9%
6. American Financial Group Inc. +35.5%
7. General Motors Corporation +30.9%
8. Lloyds TSB Group plc +26.8%
9. Ford Motor Company +25.0%
10. Fleet Financial Group, Inc. +21.7%
* Securities held for the entire quarter.
Weak performers for the 4th quarter 1998
- --------------------------------------------------------------------------------
1. British Steel plc -19.6%
2. LaSalle Re Holdings Limited -18.3%
3. Illinova Corporation -12.9%
4. Mid-America Apartment Communities, Inc. -12.3%
5. Walden Residential Properties, Inc. -11.1%
6. Tanger Factory Outlet Centers, Inc. -6.6%
7. Nationwide Health Properties, Inc. -4.2%
8. Regency Realty Corporation -3.0%
9. Olin Corporation -1.3%
10. Northrop Grumman Corporation +0.2%
Portfolio Changes
Securities added during the 4th quarter 1998
- --------------------------------------------------------------------------------
Bank One Corporation
Citigroup Inc.
IndyMac Mortgage Holdings
Millenium Chemicals Inc.
Nabisco Holdings Corp.
Patriot American Hospitality, Inc.
Unocal Corporation
Securities sold during the 4th quarter 1998
- --------------------------------------------------------------------------------
Crescent Real Estate Equities Company
RJR Nabisco Holdings Corp.
Starwood Hotels & Resorts
Ultramar Diamond Shamrock Corporation
Union Planters Corporation
14
<PAGE>
Portfolio of Investments
December 31, 1998 (Unaudited)
(Amounts in Thousands)
Legg Mason Value Trust, Inc.
<TABLE>
<CAPTION>
Shares/Par Value
- -------------------------------------------------------------------------------------------
<S> <C> <C>
Common Stocks and Equity Interests -- 95.2%
Advertising --2.2%
WPP Group plc 28,890 $ 175,554
- -------------------------------------------------------------------------------------------
Automotive --1.6%
Ford Motor Company 550 32,278
General Motors Corporation 1,300 93,031
- -------------------------------------------------------------------------------------------
125,309
- -------------------------------------------------------------------------------------------
Banking --14.0%
BankAmerica Corporation 2,097 126,106
BankBoston Corporation 4,000 155,750
Citigroup Inc. 4,725 233,888
Fleet Financial Group, Inc. 1,338 59,805
Lloyds TSB Group plc 11,466 162,870
The Chase Manhattan Corporation 4,500 306,281
Zions Bancorporation 1,403 87,500
- -------------------------------------------------------------------------------------------
1,132,200
- -------------------------------------------------------------------------------------------
Computer Services and Systems --18.2%
Compaq Computer Corporation 5,790 242,818
Dell Computer Corporation 9,300 680,644(A)
First Data Corporation 350 11,091
International Business Machines Corporation 1,275 235,556
Seagate Technology, Inc. 584 17,666(A)
Storage Technology Corporation 6,225 221,376(A,B)
Western Digital Corporation 4,000 60,250(A)
- -------------------------------------------------------------------------------------------
1,469,401
- -------------------------------------------------------------------------------------------
Electrical Equipment --2.1%
Philips Electronics N.V. 2,525 170,911
- -------------------------------------------------------------------------------------------
Entertainment --2.4%
Circus Circus Enterprises, Inc. 5,200 59,475(A,B)
MGM Grand, Inc. 2,570 69,711(A)
Mirage Resorts, Incorporated 4,300 64,231(A)
- -------------------------------------------------------------------------------------------
193,417
- -------------------------------------------------------------------------------------------
Finance --7.9%
Fannie Mae 3,200 236,800
Freddie Mac 2,000 128,875
MBNA Corporation 6,368 158,805
The Bear Stearns Companies, Inc. 3,000 112,125
- -------------------------------------------------------------------------------------------
636,605
- -------------------------------------------------------------------------------------------
</TABLE>
15
<PAGE>
Portfolio of Investments -- Continued
Legg Mason Value Trust, Inc. -- Continued
<TABLE>
<CAPTION>
Shares/Par Value
- ------------------------------------------------------------------------------------
<S> <C> <C>
Food, Beverage and Tobacco --3.1%
PepsiCo, Inc. 1,700 $ 69,594
Philip Morris Companies, Inc. 3,400 181,900
- ------------------------------------------------------------------------------------
251,494
- ------------------------------------------------------------------------------------
Food Merchandising --1.9%
Fred Meyer, Inc. 100 6,025(A)
The Kroger Co. 2,400 145,200(A)
- ------------------------------------------------------------------------------------
151,225
- ------------------------------------------------------------------------------------
Health Care --2.8%
Foundation Health Systems, Inc. 8,805 105,110(A,B)
United HealthCare Corporation 2,840 122,297
- ------------------------------------------------------------------------------------
227,407
- ------------------------------------------------------------------------------------
Hotels and Motels --1.2%
Hilton Hotels Corporation 5,025 96,103
- ------------------------------------------------------------------------------------
Insurance --6.4%
Ambac Financial Group, Inc. 800 48,150
Berkshire Hathaway Inc. 4 251,825
Conseco, Inc. 2,900 88,631
MBIA, Inc. 510 33,437
MGIC Investment Corporation 2,400 95,554
Penncorp Financial Group, Inc. 1,900 1,900(B)
- ------------------------------------------------------------------------------------
519,497
- ------------------------------------------------------------------------------------
Manufacturing --1.6%
Danaher Corporation 2,400 130,350
- ------------------------------------------------------------------------------------
Media --15.9%
America Online, Inc. 8,050 1,288,000(A)
- ------------------------------------------------------------------------------------
Motion Pictures andServices --0.4%
Metro-Goldwyn-Mayer, Inc. 2,747 36,223(A)
- ------------------------------------------------------------------------------------
Pharmaceuticals --1.9%
Amgen Inc. 1,500 156,844(A)
- ------------------------------------------------------------------------------------
Real Estate --1.8%
Starwood Hotels & Resorts 6,500 147,469
- ------------------------------------------------------------------------------------
Retail Sales --1.4%
Toys "R" Us, Inc. 6,763 114,126A
- ------------------------------------------------------------------------------------
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
Shares/Par Value
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Savings and Loan -- 2.5%
Washington Mutual, Inc. 5,400 $ 206,215
- ------------------------------------------------------------------------------------------------------------------------
Telecommunications -- 5.9%
MCI WorldCom, Inc. 3,178 228,033(A)
Nokia Oyj 1,400 168,613
Telefonos de Mexico S.A. ADR 1,600 77,900
- ------------------------------------------------------------------------------------------------------------------------
474,546
- ------------------------------------------------------------------------------------------------------------------------
Total Common Stocks and Equity Interests
(Identified Cost-- $3,882,977) 7,702,896
- ------------------------------------------------------------------------------------------------------------------------
Repurchase Agreements -- 4.3%
Goldman, Sachs & Company
5%, dated 12/31/98, to be repurchased at $115,628 on 1/4/99 (Collateral:
$85,056 Freddie Mac Mortgage-backed securities, 8% due 11/1/28, value
$88,600; $30,784 Fannie Mae
Mortgage-backed securities, 6.50% due 8/1/02, value $31,240) $115,565 115,565
J.P. Morgan Securities, Inc.
4.70%, dated 12/31/98, to be repurchased at $115,625 on 1/4/99
(Collateral: $103,932 United States Treasury Notes,
5.75-7.875% due 11/30/02 - 5/15/06, value $117,923) 115,564 115,564
Prudential Securities, Inc.
5%, dated 12/31/98, to be repurchased at $115,628 on 1/4/99 (Collateral:
$64,657 Freddie Mac Mortgage-backed securities, 8% due 3/1/27-7/1/28,
value $67,351; $51,161 Government National
Mortgage Association securities, 7% due 6/15/27, value $52,610) 115,564 115,564
- ------------------------------------------------------------------------------------------------------------------------
Total Repurchase Agreements (Identified Cost-- $ 346,693) 346,693
Total Investments-- 99.5% (Identified Cost-- $4,299,670) 8,049,589
Other Assets Less Liabilities-- 0.5% 44,374
- ------------------------------------------------------------------------------------------------------------------------
Net assets-- 100.0% $8,093,963
- ------------------------------------------------------------------------------------------------------------------------
Net asset value per share:
Primary Class $61.58
- ------------------------------------------------------------------------------------------------------------------------
Navigator Class $62.60
- ------------------------------------------------------------------------------------------------------------------------
</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 December 31,
1998, the total market value of Affiliated Companies was $387,861 and
the identified cost was $497,980.
17
<PAGE>
Portfolio of Investments
December 31, 1998 (Unaudited)
(Amounts in Thousands)
Legg Mason Special Investment Trust, Inc.
<TABLE>
<CAPTION>
Shares/Par Value
- -----------------------------------------------------------------------------------------
<S> <C> <C>
Common Stocks and Equity Interests -- 93.0%
Advertising -- 4.5%
WPP Group plc 13,250 $ 80,515
- -----------------------------------------------------------------------------------------
Banking -- 1.7%
Peoples Heritage Financial Group, Inc. 1,500 30,000
- -----------------------------------------------------------------------------------------
Biotechnology -- 0.4%
Cell Genesys, Inc. 1,225 7,350(A)
- -----------------------------------------------------------------------------------------
Business Services -- 2.1%
Modis Professional Services, Inc. 2,538 36,806(A)
- -----------------------------------------------------------------------------------------
Computer Services and Systems -- 22.3%
Bell & Howell Company 1,000 37,813(A)
Gateway 2000, Inc. 1,800 92,138(A)
ICGCommunications 1,708 36,711(A)
InaCom Corp. 2,109 31,374(A,B)
Quantum Corporation 720 15,300(A)
Remedy Corporation 378 5,274(A)
Silicon Graphics, Inc. 1,801 23,193(A)
Storage Technology Corporation 2,000 71,125(A)
Symantec Corporation 2,648 57,583(A)
Western Digital Corporation 2,061 31,045(A)
- -----------------------------------------------------------------------------------------
401,556
- -----------------------------------------------------------------------------------------
Computer Software -- 1.5%
Sybase, Inc. 3,700 27,403(A)
- -----------------------------------------------------------------------------------------
Electronics - Semiconductor -- 2.5%
Hadco Corp. 1,265 44,275(A,B)
- -----------------------------------------------------------------------------------------
Energy -- 4.4%
Calenergy Company, Inc. 1,150 39,891(A)
Northeast Utilities System 2,405 38,478(A)
- -----------------------------------------------------------------------------------------
78,369
- -----------------------------------------------------------------------------------------
Entertainment -- 7.2%
Circus Circus Enterprises, Inc. 2,050 23,447(A)
Hollywood Entertainment Corp. 2,584 70,417(A,B)
Hollywood Park, Inc. 2,515 20,906(A,B)
Players International, Inc. 2,485 15,376(A,B)
- -----------------------------------------------------------------------------------------
130,146
- -----------------------------------------------------------------------------------------
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
Shares/Par Value
- -----------------------------------------------------------------------------------------
<S> <C> <C>
Finance -- 5.1%
Amerin Corporation 1,860 $ 43,942(A,B)
Mego Financial Corp. 300 291(A)
United Asset Management Corporation 1,850 48,100
- -----------------------------------------------------------------------------------------
92,333
- -----------------------------------------------------------------------------------------
Food, Beverage and Tobacco -- 0.9%
Cott Corporation 4,700 16,597(B)
- -----------------------------------------------------------------------------------------
Health Care -- 3.1%
Magellan Health Services, Inc. 2,100 17,587(A,B)
PhyCor, Inc. 5,600 38,147(A,B)
- -----------------------------------------------------------------------------------------
55,734
- -----------------------------------------------------------------------------------------
Insurance -- 7.1%
CMAC Investment Corporation 700 32,156
Enhance Financial Services Group, Inc. 1,401 42,015
Orion Capital Corporation 1,318 52,461
PennCorp Financial Group, Inc. 1,800 1,800(B)
- -----------------------------------------------------------------------------------------
128,432
- -----------------------------------------------------------------------------------------
Media -- 23.6%
America Online, Inc. 2,646 423,360(A)
- -----------------------------------------------------------------------------------------
Miscellaneous -- 0.1%
Olsen & Associates AG 300 2,184(A,C)
- -----------------------------------------------------------------------------------------
Networking Products -- 1.7%
Cabletron Systems, Inc. 3,700 30,988(A)
- -----------------------------------------------------------------------------------------
Real Estate -- 1.5%
Dynex Capital, Inc. 1,857 8,589
LASER Mortgage Management, Inc. 1,795 9,760(B)
Patriot American Hospitality, Inc. 1,485 8,912
- -----------------------------------------------------------------------------------------
27,261
- -----------------------------------------------------------------------------------------
Specialty Retail -- 3.3%
Consolidated Stores Corporation 2,086 42,109(A)
Liz Claiborne, Inc. 525 16,570
- -----------------------------------------------------------------------------------------
58,679
- -----------------------------------------------------------------------------------------
Total Common Stocks and Equity Interests
(Identified Cost-- $1,116,648) 1,671,988
- -----------------------------------------------------------------------------------------
</TABLE>
19
<PAGE>
Portfolio of Investments -- Continued
Legg Mason Special Investment Trust, Inc. -- Continued
<TABLE>
<CAPTION>
Shares/Par Value
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Corporate Bonds and Notes -- 0.6%
ICO Global Communications, 15% due 8/1/05
(Identified Cost-- $8,700) $15,000 $ 11,250
- ------------------------------------------------------------------------------------------------------------------------
Repurchase Agreements -- 6.0%
Goldman, Sachs & Company
5%, dated 12/31/98, to be repurchased at $35,840 on 1/4/99
(Collateral: $35,906 Fannie Mae Mortgage-backed securities,
7.50% due 2/1/12, value $37,141) 35,820 35,820
J.P. Morgan Securities, Inc.
4.70%, dated 12/31/98, to be repurchased at $35,838 on 1/4/99
(Collateral: $35,429 United States Treasury Notes,
5.63% due 12/31/02, value $36,569) 35,819 35,819
Prudential Securities, Inc.
5%, dated 12/31/98, to be repurchased at $35,840 on 1/4/99
(Collateral: $36,117 Fannie Mae Mortgage-backed securities,
6.50%-7% due 7/1/28-1/1/29, value $36,722) 35,820 35,820
- ------------------------------------------------------------------------------------------------------------------------
Total Repurchase Agreements (Identified Cost-- $107,459) 107,459
- ------------------------------------------------------------------------------------------------------------------------
Total Investments-- 99.6% (Identified Cost-- $1,232,807) 1,790,697
Other Assets Less Liabilities-- 0.4% 6,716
- ------------------------------------------------------------------------------------------------------------------------
Net assets-- 100.0% $1,797,413
- ------------------------------------------------------------------------------------------------------------------------
Net asset value per share:
Primary Class $36.70
- ------------------------------------------------------------------------------------------------------------------------
Navigator Class $38.19
- ------------------------------------------------------------------------------------------------------------------------
</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 December 31,
1998, the total market value of Affiliated Companies was $310,181 and
the identified cost was $400,861.
(C) Private placement
20
<PAGE>
Portfolio of Investments
December 31, 1998 (Unaudited)
(Amounts in Thousands)
Legg Mason Total Return Trust, Inc.
<TABLE>
<CAPTION>
Shares/Par Value
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Common Stocks and Equity Interests -- 96.2%
Aerospace/Defense -- 3.2%
Northrop Grumman Corporation 285 $ 20,841
- ------------------------------------------------------------------------------------------------------------------------
Automotive -- 6.1%
Ford Motor Company 300 17,606
General Motors Corporation 310 22,184
- ------------------------------------------------------------------------------------------------------------------------
39,790
- ------------------------------------------------------------------------------------------------------------------------
Banking -- 18.2%
Bank One Corporation 200 10,213
BankAmerica Corporation 277 16,669
Citigroup Inc. 300 14,850
Fleet Financial Group, Inc. 360 16,088
Lloyds TSB Group plc 2,544 36,140
The Chase Manhattan Corporation 360 24,502
- ------------------------------------------------------------------------------------------------------------------------
118,462
- ------------------------------------------------------------------------------------------------------------------------
Chemicals -- 2.0%
Millennium Chemicals Inc. 284 5,639
Olin Corporation 269 7,613
- ------------------------------------------------------------------------------------------------------------------------
13,252
- ------------------------------------------------------------------------------------------------------------------------
Computer Services and Systems -- 9.5%
International Business Machines Corporation 335 61,891
- ------------------------------------------------------------------------------------------------------------------------
Consumer Products -- 4.6%
Brunswick Corporation 704 17,412
Tupperware Corporation 746 12,262
- ------------------------------------------------------------------------------------------------------------------------
29,674
- ------------------------------------------------------------------------------------------------------------------------
Electric Utilities -- 5.8%
Edison International 735 20,488
Illinova Corporation 690 17,250
- ------------------------------------------------------------------------------------------------------------------------
37,738
- ------------------------------------------------------------------------------------------------------------------------
Finance -- 4.1%
The Bear Stearns Companies, Inc. 377 14,081
United Asset Management Corporation 491 12,758
- ------------------------------------------------------------------------------------------------------------------------
26,839
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
21
<PAGE>
Portfolio of Investments -- Continued
Legg Mason Total Return Trust, Inc.--Continued
<TABLE>
<CAPTION>
Shares/Par Value
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Food, Beverage and Tobacco -- 4.4%
Nabisco Holdings Corp. 209 $ 8,674
UST, Inc. 583 20,325
- ------------------------------------------------------------------------------------------------------------------------
28,999
- ------------------------------------------------------------------------------------------------------------------------
Insurance -- 9.1%
American Financial Group Inc. 420 18,428
Enhance Financial Services Group, Inc. 711 21,318
IPC Holdings Limited 466 10,810
LaSalle Re Holdings Limited 416 9,047
- ------------------------------------------------------------------------------------------------------------------------
59,603
- ------------------------------------------------------------------------------------------------------------------------
Manufacturing -- 3.1%
Briggs &Stratton Corporation 409 20,409
- ------------------------------------------------------------------------------------------------------------------------
Oil Refining andMarketing -- 1.4%
Unocal Corporation 315 9,194
- ------------------------------------------------------------------------------------------------------------------------
Real Estate -- 13.0%
IndyMac Mortgage Holdings, Inc. 286 3,022
Mid-America Apartment Communities, Inc. 607 13,771
National Golf Properties, Inc. 561 16,228
Nationwide Health Properties, Inc. 600 12,937
Patriot American Hospitality, Inc. 987 5,919
Regency Realty Corporation 578 12,856
Tanger Factory Outlet Centers, Inc. 524 11,111(B)
Walden Residential Properties, Inc. 450 9,197
- ------------------------------------------------------------------------------------------------------------------------
85,041
- ------------------------------------------------------------------------------------------------------------------------
Retail Sales -- 4.9%
J.C. Penney Company, Inc. 341 15,989
Toys "R"Us, Inc. 930 15,687A
- ------------------------------------------------------------------------------------------------------------------------
31,676
- ------------------------------------------------------------------------------------------------------------------------
Savings and Loan -- 2.0%
Washington Federal, Inc. 486 12,978
- ------------------------------------------------------------------------------------------------------------------------
Steel Products -- 3.1%
AK Steel Holding Corporation 510 11,980
British Steel plc 547 8,000
- ------------------------------------------------------------------------------------------------------------------------
19,980
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
Shares/Par Value
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Telecommunications -- 1.7%
Telefonos de Mexico S.A. ADR 231 $ 11,252
- ------------------------------------------------------------------------------------------------------------------------
Total Common Stocks and Equity Interests
(Identified Cost-- $ 480,353) 627,619
- ------------------------------------------------------------------------------------------------------------------------
Repurchase Agreements -- 4.0%
Goldman, Sachs & Company
5%, dated 12/31/98, to be repurchased at $8,760 on 1/4/99
(Collateral: $8,918 Fannie Mae Mortgage-backed securities,
6.50% due 8/1/02, value $9,050) $8,756 8,756
J.P. Morgan Securities, Inc.
4.70%, dated 12/31/98, to be repurchased at $8,760 on 1/4/99
(Collateral: $8,660 United States Treasury Notes,
5.63% due 12/31/02, value $8,939) 8,755 8,755
Prudential Securities, Inc.
5%, dated 12/31/98, to be repurchased at $8,760 on 1/4/99
(Collateral: $8,845 Fannie Mae Mortgage-backed securities,
7% due 7/1/28, value $9,068) 8,755 8,755
- ------------------------------------------------------------------------------------------------------------------------
Total Repurchase Agreements (Identified Cost-- $26,266) 26,266
- ------------------------------------------------------------------------------------------------------------------------
Total Investments-- 100.2% (Identified Cost-- $506,619) 653,885
Other Assets Less Liabilities-- (0.2)% (1,284)
- ------------------------------------------------------------------------------------------------------------------------
Net assets --100.0% $652,601
- ------------------------------------------------------------------------------------------------------------------------
Net asset value per share:
Primary Class $21.64
- ------------------------------------------------------------------------------------------------------------------------
Navigator Class $21.78
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(A) Non-income producing.
(B) Affiliated Company--As defined in the Investment Company Act of 1940,
an "Affiliated Company" represents Fund ownership of at least 5% of
the outstanding voting securities of the issuer. At December 31, 1998,
the total market value of Affiliated Companies was $11,111 and the
identified cost was $13,449.
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