<PAGE>
[LOGO]
Dear Shareholder:
We are pleased to present the annual report for The Italy Fund, Inc. for the
year ended January 31, 1996. As of that date, the Fund's net asset value
(NAV) per share was $9.56 as compared to $8.89 as of October 31, 1995 and $9.62
as of July 31, 1995. In December 1995, the Fund paid a dividend of $0.02 per
share.
Expressed in U.S. dollar-denominated terms, the Fund's NAV declined by 2.7%.
Since its inception in 1986, The Italy Fund has consistently outperformed the
BCI Index. Expressed in lira terms, the Fund's NAV declined by 3.3% for the
three months ended January 31, 1996. This compares favorably with a 6.2% decline
over the same period in the Banco Commerciale Index (BCI Index), a widely
followed Italian index which includes all the securities listed on the Milan
Stock Exchange.
Political Overview
Instability continues to define Italian domestic politics. The last quarter
was dominated by speculation on how long Lamberto Dini's government would last.
After the Italian government's approval of the 1996 budget in December 1995, Mr.
Dini submitted his resignation to President Scalfaro, which was initially
rejected. After parliamentary debate in January, it soon became apparent there
would be no agreement reached regarding the continuation of Mr. Dini's
government, and he resigned on January 11, 1996.
This precipitated another Italian domestic political crisis which centered on
whether to reach an agreement on constitutional reforms and form a new
government to implement them, or alternatively, to hold early elections during
Italy's European Union (EU) presidency. (Italy took over the six-month rotating
presidency of EU at the beginning of 1996.) After nearly three weeks of
confusion and hard bargaining, President Scalfaro asked Mr. Antonio Maccanico to
form Italy's 55th government with a mandate to implement major constitutional
reforms.
In addition, since this letter was written, Mr. Maccanico was unable to form a
new government, and Italian elections are scheduled to be held on April 21,
1996. Candidates from the center-right party and the center-left party are
competing to form a new government. The key issue remains how to reform Italy's
electoral system.
Economic Overview
During 1995, Italy had one of the highest economic growth rates of any
industrialized nation in Europe as measured by Gross Domestic Product (GDP).
Helped by the weak lira in 1995, Italy had strong export growth and its GDP
growth rate of 3.3% was well above the European average of 2.6%. In addition,
GDP growth in Italy is expected to be positive in 1996, fueled by continued
strong growth in exports.
Inflation in Italy, which averaged 5% in 1995, rose primarily because of the
devaluation of the lira and the higher prices of many durable goods. We expect
Italy's inflation rate to continue at roughly 5% during 1996.
Under the guidance of former Prime Minister Lamberto Dini, guidelines for
public-sector finances for 1996 through 1998 were produced and the trends in
this area are encouraging. Although Italy's deficit is significantly higher than
the European average, and higher than the 3% Maastricht requirement to join the
European Monetary Union, Italy's budget deficit declined to 7.3% of GDP in 1995
and is expected to go down further in the coming months.
The Italian Stock Market
After trading in a narrow 8% range until the end of August 1995, the BCI Index
fell sharply towards the end of the year. Unfortunately, the negative comments
made by Germany's prime minister regarding Italy's chances of joining EMU
significantly weakened the Italian currency, and with it, the Italian bond
market. If this had not sufficiently damaged the image of the Italian stock
market, public confidence was further undermined by the "Mancuso affair," which
set off yet another Italian political crisis. (The Mancuso affair involved
former Justice Minister Mancuso's efforts to protect the human rights of
suspects before Italian
<PAGE>
[LOGO]
magistrates, which ultimately led to the public embarrassment of both Prime
Minister Dini and President Scalfaro.)
The Privatization of ENI
The current trend towards privatization of state-owned businesses in Italy is
expected to continue in the near future. However, many investors have been very
selective about what new issues to purchase, not only in Italy but throughout
Europe.
In addition to its effects on the Italian stock market, the issue of
privatizations is an important one for Italy because the monies gained from
these placements will be used to reduce the public deficit.
All of these recent developments help to explain the very disappointing
performance of the Italian stock market, which has seen the BCI Index decline by
6.2% during the fiscal year ended January 31, 1996.
Sector Performance
In terms of relative performance during the past three months, the best-
performing sectors in the Italian economy were defensive in nature and included
the food industry, the telecommunications industry, and the insurance and
banking industries, all of which did well after the rally in the Italian bond
market at the end of 1995. Conversely, cyclical sectors such as the metals and
steel industry underperformed during the period.
Current Outlook
As a consequence of the uncertainty surrounding Italian domestic politics, the
Italian stock market has experienced a significant correction. At a 17.5 times
1996 price-to-cash-earnings multiple and a 3.8 times price-to-cash flow
multiple, the Italian stock market, with the exception of Telecom Italia Mobile,
has some of the lowest relative stock valuations to be found in Europe today.
However, in our view, the determining factor for the Italian stock market's
future direction will be liquidity conditions, which had deteriorated in late
1995, but may finally be improving. Because no major placements are planned in
early 1996, we do not expect another ENI liquidity-squeeze situation to develop.
Moreover, demand for Italian stocks should improve because domestic mutual
funds, which were experiencing net redemption's over the last 16 months, began
to see significant investor purchases in December and January. These mutual fund
inflows should provide the Italian stock market with stronger price support.
In summary, momentum in the Italian stock market is at a turning point. As we
stated previously, if Mr. Maccanico succeeds in forming a government and
implements constitutional reforms, we believe Italy's financial markets will
react strongly and positively. And, if inflation in Italy remains moderate,
Italy's central bank could reduce interest rates. Lower rates, in our view,
would be very beneficial to both Italy's domestic econony and its budget deficit
as it will lower the cost of financing public debt.
Fund Investment Strategy
At the end of January, The Italy Fund had a very small cash position (less
than 1%) and had roughly 92% of its assets invested in stocks. The remaining 7%
was invested in Italian government bonds and convertible corporate bonds.
On the equities side, because of our positive outlook for interest rates, we
increased the Fund's exposure to the more interest-rate sensitive sectors of the
market and bought Istituto Immobiliare Italiano (also known as IMI, a leading
Italian bank) and INA (an Italian insurer) which was recently privatized.
During the period covered by this report, The Italy Fund bought shares of the
insurer, UNIPOL, a company that stands to benefit from Italy's growing pension
fund business and Banca Popolare Commericio e Industria, a regional bank active
in mutual fund management custodial services.
The Fund also acquired shares of three initial public offerings: ENI (a state-
owned energy company), La Doria (a leading Italian food-processing company)
2
<PAGE>
[LOGO]
and Pagnossin (a ceramics producer). The Fund also bought Olivetti, which could
in our view, turn out to be one of Italy's most interesting turnaround
situations. Lastly, The Italy Fund reduced its investment in Fiat, the
automobile manufacturer, a cyclical stock that we believe has limited upside
potential.
In closing, while uncertainties remain in the Italian financial markets and
domestic politics continue to be unsettling, we remain positive about the long-
term outlook of the Italian stock market.
Sincerely,
/s/ Heath B. McLendon
Heath B. McLendon
Chairman of the Board
/s/ Mario d'Urso
Mario d'Urso
President
/s/ Erich Stock
Erich Stock
Vice President and
Investment Officer
March 1, 1996
Special Shareholder Notice
A change has been made with respect to the portfolio manager of The Italy Fund
Inc. On April 1, 1996, Rein van der Does, an international economist and
Managing Director of Smith Barney, was appointed portfolio manager of The Italy
Fund. Mr. van der Does currently manages Smith Barney's World Funds: European
Portfolio and co-manages $2.5 billion in international portfolios. Mr. van der
Does moved to Smith Barney with the international equity portfolio team at the
beginning of 1990 from Drexel Burnham Lambert, where he was Director of
International Research and in charge of international portfolio strategy.
Eric Stock continues to be affiliated with Smith Barney and is now devoting
his energies to investment banking.
3
<PAGE>
[LOGO]
THE ITALY FUND'S SECTORIAL STRUCTURE
JANUARY 31, 1996 (UNAUDITED)
[PIE CHART APPEARS HERE]
- ------------------------------------------------------------
Banks 15.7 %
- ------------------------------------------------------------
Food & Retail 6.2 %
- ------------------------------------------------------------
Electromechanical & Autos 8.8 %
- ------------------------------------------------------------
Financials 6.1 %
- ------------------------------------------------------------
Property, Construction & Cement 4.4 %
- ------------------------------------------------------------
Chemicals & Petrochemicals 13.7 %
- ------------------------------------------------------------
Other 3.7 %
- ------------------------------------------------------------
Textiles 1.6 %
- ------------------------------------------------------------
Pharmaceuticals 1.1 %
- ------------------------------------------------------------
Paper & Publishing 0.9 %
- ------------------------------------------------------------
Communications 18.9 %
- ------------------------------------------------------------
Insurance 18.9 %
- ------------------------------------------------------------
BCI INDEX SECTORIAL STRUCTURE
JANUARY 31, 1996 (unaudited)
[PIE CHART APPEARS HERE]
- ------------------------------------------------------------
Banks 16.7 %
- ------------------------------------------------------------
Food & Retail 2.0 %
- ------------------------------------------------------------
Electromechanical & Autos 10.8 %
- ------------------------------------------------------------
Financials 4.4 %
- ------------------------------------------------------------
Property, Construction & Cement 2.6 %
- ------------------------------------------------------------
Chemicals & Petrochemicals 16.3 %
- ------------------------------------------------------------
Other 1.3 %
- ------------------------------------------------------------
Textiles 1.9 %
- ------------------------------------------------------------
Pharmaceuticals 0.3 %
- ------------------------------------------------------------
Paper & Publishing 1.2 %
- ------------------------------------------------------------
Communications 22.7 %
- ------------------------------------------------------------
Insurance 19.8 %
- ------------------------------------------------------------
4
<PAGE>
[LOGO]
THE ITALY FUND INC.
Schedule of Investments as of January 31, 1996
- --------------------------------------------------------------------------
SHARES SECURITY VALUE
- ----------------------- -------------------------------- -----------
[S] [C] [C]
COMMON STOCKS -- 92.8%
Automobiles -- 5.0%
900,000 Fiat S.p.A........................ $ 3,011,669
385,000 Magneti Marelli S.p.A............. 567,356
460,000 Sogefi S.p.A...................... 1,038,896
-----------
4,617,921
-----------
Banking -- 14.5%
624,998 Banca di Roma S.p.A............... 661,855
1,600,000 Banca Fideuram S.p.A.............. 2,004,517
60,000 Banca Nazionale Del Lavoro
di Risp *........................ 467,654
180,000 Banca Popolare di Bergamo/
Credito Varesino................ 2,667,026
30,000 Banca Popolare
Commercio e Industria........... 340,464
1,800,000 Credito Italiano S.p.A............ 2,227,980
190,000 Istituto Bancario San Paolo
di Torino....................... 1,208,657
400,000 Istituto Mobiliare Italiano....... 2,725,972
130,000 Mediobanca S.p.A.................. 909,429
-----------
13,213,554
-----------
Cement & Ceramics -- 2.3%
400,000 Italcementi S.p.A.
di Risp NC **................... 1,086,575
30,000 Pagnossin S.p.A. #................ 152,070
315,000 Unicem di Risp NC **.............. 881,368
-----------
2,120,013
-----------
Chemicals & Pharmaceuticals -- 2.0%
400,000 Enichem Augusta S.p.A............. 853,199
260,000 Recordati S.p.A.
di Risp NC **................... 929,737
-----------
1,782,936
-----------
Communications -- 18.9%
55,000 Ericsson S.p.A.................... 662,484
360,000 Sirti S.p.A....................... 2,160,678
810,000 Stet.............................. 2,526,042
1,375,000 Stet di Risp NC **................ 3,089,868
1,700,000 Telecom Italia Mobile
S.p.A. di Risp * #.............. 1,907,967
1,076,000 Telecom Italia Mobile
S.p.A. ORD #.................... 1,937,340
1,416,000 Telecom Italia S.p.A.............. 2,379,839
1,900,000 Telecom Italia S.p.A..............
di Risp *....................... 2,592,535
-----------
17,256,753
-----------
Computers -- 0.9%
1,350,000 Olivetti & Co. S.p.A.............. 840,489
-----------
Construction and Property -- 2.1%
950,041 Finanziaria Autogrill
S.p.A. #........................ 1,133,016
490,000 Vianini Lavori.................... 799,247
-----------
1,932,263
-----------
Food -- 4.5%
12,595 Eridania Beghin-Say............... 2,201,992
220,000 La Doria S.p.A. #................. 827,967
1,070,000 Parmalat Finanziaria S.p.A........ 1,029,724
-----------
4,059,683
-----------
Holding Companies -- 6.1%
850,000 Europa Investimenti #+............ 479,925
150,000 IFI S.p.A. Priviligio............. 1,538,676
330,600 IFIL.............................. 1,050,495
542,500 IFIL di Risp NC **................ 911,087
425,000 Montedison S.p.A. #............... 267,692
49,639 Quattrocentoduedue Cat B #+....... 342,553
690,000 SOPAF ORD......................... 742,378
241,500 SOPAF di Risp*.................... 195,442
-----------
5,528,248
-----------
Insurance -- 18.7%
200,000 Alleanza Assicurazioni
S.p.A........................... 1,919,072
140,000 Assicurazioni Generali
S.p.A........................... 3,503,250
1,450,000 INA Instituto Nazionale
Delle Assicurazioni............. 2,072,208
See Notes to Financial Statements.
5
<PAGE>
[LOGO]
THE ITALY FUND INC.
Schedule of Investments as of January 31, 1996 (continued)
- --------------------------------------------------------------------------
SHARES SECURITY VALUE
- ----------------------- -------------------------------- -----------
[S] [C] [C]
Insurance -- 18.7% (continued)
285,000 La Fondiaria S.p.A. #............. $ 1,423,570
115,000 La Previdente..................... 746,634
4,000 Milano Assicurazioni
S.p.A. #........................ 13,199
425,700 RAS S.p.A......................... 4,696,053
242,000 SAI S.p.A......................... 2,648,488
-----------
17,022,474
-----------
Mechanical Engineering -- 3.8%
431,000 Ansaldo Trasporti................. 631,358
180,000 Danieli & Co...................... 1,187,052
266,750 Danieli & Co di Risp NC **........ 843,258
355,000 Sasib di Risp NC **............... 832,268
-----------
3,493,936
-----------
Publishing -- 0.9%
100,000 Arnoldo Mondadori S.p.A........... 821,832
-----------
Retail -- 1.7%
186,136 La Rinascente S.p.A.
di Risp NC **................... 553,270
950,041 SME Soc Meridionale
Finanziaria S.p.A............... 977,458
-----------
1,530,728
-----------
Textiles -- 1.6%
100,000 Benetton Group S.p.A.............. 1,168,883
216,223 Simint S.p.A. #................... 256,510
-----------
1,425,393
-----------
Utilities -- 9.8%
1,800,000 Autostrade Priviligio C........... 2,083,438
460,000 Edison S.p.A...................... 2,283,551
630,000 Ente Nazionale Idrocarburi
S.p.A. #........................ 2,326,731
356,000 Italgas S.p.A..................... 1,174,309
756,000 Sondel............................ 1,114,080
-----------
8,982,109
-----------
TOTAL COMMON
STOCKS
(Cost -- $82,311,666)............. 84,628,332
-----------
WARRANTS -- 0.4%
Banking -- 0.3%
180,000 Banca Popolare di Bergamo
Warrants, Expire
12/31/00 #...................... $ 48,546
650,000 Credito Italiano S.p.A.
Warrants, Expire
12/31/97 #...................... 172,164
-----------
220,710
-----------
Other -- 0.1%
735,000 Costa Crociere S.p.A.
Warrants, Expire
11/30/99 #...................... 122,193
-----------
TOTAL WARRANTS
(Cost -- $211,879)................ 342,903
-----------
See Notes to Financial Statements.
6
<PAGE>
[LOGO]
THE ITALY FUND INC.
Schedule of Investments as of January 31, 1996 (continued)
- --------------------------------------------------------------------------
FACE
AMOUNT++ SECURITY VALUE
- ----------------------- -------------------------------- -----------
BONDS -- 6.8%
Banking -- 0.9%
900,000,000 Banca Popolare Di Bergamo
Convertible, 9.713%
due 12/31/00.................... $ 588,105
332,911,000 Mediobanca Convertible,
6.000% due 12/31/02............. 194,588
-----------
782,693
-----------
Insurance -- 0.2%
265,430,000 Mediobanca/Alleanza,
4.000% due 3/31/99.............. 198,406
-----------
Other -- 5.7%
5,000,000,000 BTP Italy, 10.500%
due 7/15/00..................... 3,250,627
1,653,750,000 Costa Crociere S.p.A.,
6.750% due 1/1/00............... 923,361
Other -- 5.7% (continued)
1,700,000,000 Italian Certificati di Credito
del Tesoro, 11.300%
due 4/1/02...................... $ 1,067,566
-----------
5,241,554
-----------
TOTAL BONDS
(Cost -- $6,152,415).............. 6,222,653
-----------
TOTAL INVESTMENTS
AT VALUE -- 100%
(Cost -- $88,675,960)+++.......... $91,193,888
===========
- -------------------------
* Risp -- Risparmio (savings shares).
** Risp NC -- Risparmio Non-Convertible
(non-convertible savings shares).
# Non-income producing security.
+ Security restricted as to resale (See Note 4).
++ Represents local currency.
+++ Aggregate cost for Federal income tax purposes is substantially the
same.
See Notes to Financial Statements.
7
<PAGE>
[LOGO]
THE ITALY FUND INC.
Statement of Assets and Liabilities
January 31, 1996
- --------------------------------------------------------------------------------
ASSETS:
Investments, at value (Cost--$88,675,960)................. $ 91,193,888
Foreign currency (Cost--$516,761)......................... 513,286
Cash...................................................... 42,486
Receivable for securities sold............................ 76,760
Dividends and interest receivable......................... 87,793
------------
Total Assets.............................................. 91,914,213
------------
LIABILITIES:
Payable for securities purchased.......................... 843,417
Management fees payable................................... 70,534
Dividends payable......................................... 1,680
Accrued expenses.......................................... 148,661
Other liabilities......................................... 9,312
-----------
Total Liabilities......................................... 1,073,604
-----------
Total Net Assets............................................... $90,840,609
===========
NET ASSETS consist of:
Par value of capital shares............................... $ 95,031
Capital paid in excess of par value....................... 94,936,689
Undistributed net investment income....................... 195,998
Accumulated net realized loss from security transactions.. (6,906,661)
Net unrealized appreciation of investments and foreign
currencies............................................... 2,519,552
-----------
Total Net Assets
(Equivalent to $9.56 a share on 9,503,089 shares of $0.01
par value outstanding; 20,000,000 shares authorized).... $90,840,609
===========
See Notes to Financial Statements.
8
<PAGE>
[LOGO]
THE ITALY FUND INC.
Statement of Operations
For the Year Ended January 31, 1996
- --------------------------------------------------------------------------------
INVESTMENT INCOME:
Dividends............................................... $ 1,825,628
Interest................................................ 871,382
Less: Foreign withholding tax........................... (334,857)
-----------
Total Investment Income................................. 2,362,153
-----------
EXPENSES:
Management fees (Note 2)................................ 826,121
Directors' fees......................................... 102,500
Audit and legal......................................... 94,900
Custody................................................. 64,257
Shareholder and system servicing fees .................. 38,000
Shareholder communications.............................. 32,000
Other................................................... 74,241
----------
Total Expenses.......................................... 1,232,019
Less: Custody earnings credit........................... (1,140)
----------
Net Expenses............................................ 1,230,879
----------
Net Investment Income........................................ 1,131,274
----------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
AND FOREIGN CURRENCIES (NOTE 3):
Realized Loss From:
Security transactions (excluding short-term
securities)......................................... (3,509,345)
Foreign currency transactions......................... (154,627)
-----------
Net Realized Loss....................................... (3,663,972)
-----------
Change in Net Unrealized Appreciation of Investments
and Foreign Currencies:
Beginning of year.................................... 2,303,315
End of year.......................................... 2,519,552
-----------
Increase in Net Unrealized Appreciation................. 216,237
-----------
Net Loss on Investments and Foreign Currencies............... (3,447,735)
-----------
Decrease in Net Assets From Operations....................... $(2,316,461)
===========
See Notes to Financial Statements.
9
<PAGE>
[ THE ITALY FUND INC. LOGO ]
THE ITALY FUND INC.
<TABLE>
<CAPTION>
Year Year
Ended Ended
Statements of Changes in Net Assets 1/31/96 1/31/95
- --------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Net investment income......................................... $ 1,131,274 $ 839,374
Net realized gain (loss)...................................... (3,663,972) 1,182,376
Increase (decrease) in net unrealized appreciation............ 216,237 (554,310)
----------- ---------
Increase (Decrease) in Net Assets From Operations............. (2,316,461) 1,467,440
----------- ---------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income......................................... (190,062) (581,844)
Overdistribution of net investment income..................... -- (1,056,493)
----------- ---------
Decrease in Net Assets From Distributions to Shareholders..... (190,062) (1,638,337)
----------- ---------
Decrease in Net Assets......................................... (2,506,523) (170,897)
NET ASSETS:
Beginning of year............................................. 93,347,132 93,518,029
----------- -----------
End of year*.................................................. $90,840,609 $93,347,132
=========== ===========
*Includes undistributed (overdistributed) net investment income
of: $ 195,998 $(1,010,697)
=========== ===========
</TABLE>
See Notes to Financial Statements.
10
<PAGE>
The Italy Fund Inc.
Notes to Financial Statements
- --------------------------------------------------------------------------------
1. Significant Accounting Policies
The Italy Fund Inc. ("Fund") is registered with the Securities and Exchange
Commission under the Investment Company Act of 1940, as amended, as a
diversified, closed-end investment company.
The significant accounting policies followed by the Fund are: (a) security
transactions are accounted for on trade date; (b) securities for which market
quotations are readily available are valued at the last sales price prior to the
time of determination, or, if no sales price is available at that time, at the
closing price quoted for the securities (but if bid and asked quotations are
available, at the mean between the last current bid and asked prices, rather
than the quoted closing price). Securities that are traded over-the-counter are
valued, if bid and asked quotations are available, at the mean between the
current bid and asked prices. If bid and asked quotations are not available,
then over-the-counter securities will be valued as determined in good faith by
the Board of Directors; (c) short-term investments and securities maturing
within 60 days are valued at cost plus accreted discount, or minus amortized
premium, which approximates value; (d) gains or losses on the sale of securities
are calculated by using the specific identification method; (e) interest income,
adjusted for amortization of premiums and accretion of discount, is recorded on
the accrual basis; (f) dividend income is recorded on the ex-dividend date
except that certain dividends from foreign securities are recorded as soon as
the Fund is informed of the ex-dividend date; (g) dividends and distributions to
shareholders are recorded on the ex-dividend date; (h) the accounting records
are maintained in U.S. dollars. All assets and liabilities denominated in
foreign currencies are translated into U.S. dollars based on the rate of
exchange of such currencies against U.S. dollars on the date of valuation.
Purchases and sales of securities, and income and expenses are translated at the
rate of exchange quoted on the respective date that such transactions are
recorded. Differences between income and expense amounts recorded and collected
or paid are adjusted when reported by the custodian bank; (i) the Fund intends
to comply with the applicable provisions of the Internal Revenue Code of 1986,
as amended, pertaining to regulated investment companies and to make
distributions of taxable income sufficient to relieve it from substantially all
Federal income and excise taxes; (j) the character of income and gains to be
distributed are determined in accordance with income tax regulations which may
differ from generally accepted accounting principles. Reclassifications were
made to the Fund's capital accounts to reflect permanent book/tax differences
and income and gains available for distributions under income tax regulations.
At January 31, 1996, a portion of overdistributed net investment income
amounting to $512,466 has been reclassified to paid-in capital. Net investment
income, net realized gains and net assets were not affected by this change; and
(k) estimates and assumptions are required to be made regarding assets,
liabilities and changes in net assets resulting from operations when financial
statements are prepared. Changes in the economic environment, financial markets
and any other parameters used in determining these estimates could cause actual
results to differ from these amounts.
In addition, the Fund may enter into forward exchange contracts in order to
hedge against foreign currency risk. These contracts are marked to market daily,
by recognizing the difference between the contract exchange rate and the current
market rate as an unrealized gain or loss. Realized gains or losses are
recognized when the contracts are settled.
As of January 31, 1996, there were no open forward foreign currency
contracts.
2. Management Agreement and
Transactions with Affiliated Persons
At December 15, 1995, Smith Barney Mutual Funds Management Inc. ("SBMFM"),
a subsidiary of Smith Barney Holdings, Inc., became the investment manager of
the Fund. Under the terms of the new management agreement, SBMFM receives a fee
calculated at an annual rate of 0.95% of the average daily net assets for all
management and administration services rendered to the Fund. This fee is
calculated daily and paid monthly.
Prior to December 15, 1995, Lehman Brothers Global Asset Management Limited
("Global Asset Management"), a subsidiary of Lehman Brothers Inc., acted as
investment adviser to the Fund. The Fund paid Global Asset Management an
advisory fee calculated at an annual rate of 0.75% of the average daily net
assets. This fee was calculated daily and paid monthly.
11
<PAGE>
[THE ITALY FUND INC. LOGO]
THE ITALY FUND INC.
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
For the period from February 13, 1995 to December 15, 1995, SBMFM acted as
the Fund's administrator for which the Fund paid a fee calculated at an annual
rate of 0.20% of the average daily net assets. This fee was calculated daily and
paid monthly.
For the period from January 31, 1995 to February 13, 1995, The Boston
Company Advisors, Inc., ("Boston Advisors"), an indirect wholly owned subsidiary
of Mellon Bank Corporation, acted as sub-administrator to the Fund. SBMFM paid
Boston Advisors a portion of its administration fee as agreed upon by the
parties from time to time. As of February 13, 1995 this relationship was
terminated.
For the year ended January 31, 1996, the Fund incurred total brokerage
commissions of $91,657, of which $33,314 was paid to Lehman Brothers Inc.
All officers (except two) and one Director of the Fund are employees of
Smith Barney Inc.
3. Securities Transactions
During the year ended January 31, 1996, the aggregate cost of purchases and
proceeds from sales of investment securities (excluding short-term securities)
when aggregated amounted to $51,086,070 and $48,842,557, respectively.
As of January 31, 1996, aggregate gross unrealized appreciation for all
securities in which there was an excess of value over tax cost amounted to
approximately $11,904,054 and aggregate gross unrealized depreciation for all
securities in which there was an excess of tax cost over value to approximately
$9,386,126 or net unrealized appreciation of $2,517,928.
4. Restricted Securities
Certain of the Fund's investments are valued at the direction of the Fund's
Board of Directors; these securities are restricted as to resale and have been
valued in good faith, taking into consideration the appropriate economic,
financial and other pertinent available information pertaining to the restricted
securities. The table below shows all securities valued by the Fund's Board of
Directors:
<TABLE>
<CAPTION>
Number of Acquisition 1/31/96 Value Per Percentage of
Security Shares Date Fair Value Unit Net Assets Cost
-------- --------- ----------- ---------- --------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C>
Europa Investimenti..... 850,000 7/02/91 $479,925 $0.56 0.5% $623,396
Quattrocentroduedue
Cat B................. 49,639 3/21/94 342,553 6.90 0.4 295,889
-------- --- --------
Total............... $822,478 0.9% $919,285
======== === ========
</TABLE>
5. Lending of Portfolio Securities
The Fund has the ability to lend its securities to brokers, dealers and
other financial organizations. Loans of securities by the Fund are
collateralized by cash, letters of credit or U.S. government securities that are
maintained at all times in an amount at least equal to the current market value
of the loaned securities.
At January 31, 1996, the Fund had no securities on loan to brokers.
12
<PAGE>
[THE ITALY FUND INC. LOGO]
THE ITALY FUND INC.
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
6. Capital Loss Carryforwards
At January 31, 1996, the Fund had, for Federal tax purposes, approximately
$6,602,000 of unused capital loss carryforwards available to offset future
capital gains. To the extent that these carryforward losses are used to offset
capital gains, it is probable that the gains so offset will not be distributed.
The amount and expiration of the carryforwards are indicated below. Expiration
occurs on January 31 of the year indicated:
2004 2005
-------- --------
Capital Loss Carryforward ........... $1,756,000 $4,846,000
7. Concentration of Risk
Because the Fund concentrates its investments in securities issued by
Italian corporations, its portfolio may be subject to special risks and
considerations not typically associated with investing in a broader range of
domestic securities. In addition, the Fund is more susceptible to factors
adversely affecting the Italian economy than a fund not concentrated in these
issuers to the same extent.
<TABLE>
<CAPTION>
Quarterly Results of Operations (unaudited)
- --------------------------------------------------------------------------------------------------------------------------
Net Realized Net Increase
Gain (Loss) on (Decrease) in
Investment Net Investment Investments and Net Assets
Income Income (Loss) Foreign Currencies From Operations
--------------------- --------------------- ---------------------- ------------------------
Quarter Ended Total Per Share Total Per Share Total Per Share Total Per Share
- ------------- --------- --------- -------- ---------- ----------- --------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
April 30, 1993...... $ 208,399 $ 0.03 $ (22,200) $ 0.00 $ (633,996) $ (0.10) $ 4,646,508 $ 0.73
July 31, 1993....... 1,164,578 0.19 946,601 0.14 (673,685) (0.10) 2,566,981 0.41
October 31, 1993.... 231,050 0.04 (51,313) (0.01) (330,679) (0.05) 1,139,682 0.17
January 31, 1994.... 163,184 0.03 (104,964) (0.01) (1,350,029) (0.21) 4,843,089 0.53
April 30, 1994...... 262,201 0.03 37,867 0.01 376,390 0.04 21,587,589 2.27
July 31, 1994....... 1,568,187 0.17 933,702 0.10 2,317,766 0.24 (12,011,879) (1.26)
October 31, 1994.... 275,691 0.03 19,893 0.00 578,197 0.06 (6,426,246) (0.68)
January 31, 1995.... 396,171 0.04 (152,088) (0.02) (2,089,977) (0.22) (1,682,024) (0.18)
April 30, 1995...... 252,540 0.03 (74,178) (0.01) (1,556,369) (0.16) (6,441,384) (0.68)
July 31, 1995....... 1,539,509 0.16 1,141,497 0.12 (1,724,100) (0.18) 4,471,408 0.47
October 31, 1995.... 287,963 0.03 (81,879) (0.01) (172,867) (0.02) (6,926,030) (0.72)
January 31, 1996.... 282,141 0.03 145,834 0.02 (210,636) (0.02) 6,579,545 0.69
</TABLE>
13
<PAGE>
[THE ITALY FUND INC. LOGO]
THE ITALY FUND INC.
Financial Highlights
- --------------------------------------------------------------------------------
Set forth below is per share operating performance data for a share of
common stock outstanding throughout each year; total return, ratios to average
net assets and other supplemental data also are provided. This information has
been derived from information provided in the financial statements and market
price data for the Fund's shares.
<TABLE>
<CAPTION>
1996 1995 1994# 1993 1992
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year.................. $9.82 $9.84 $8.43 $11.08 $11.37
-------- -------- -------- --------- ---------
Income (Loss) From Operations:
Net investment income ......................... 0.15 0.09 0.12 0.19 0.25
Net realized and unrealized gain (loss)........ (0.39) 0.06 1.72 (2.84) 0.03
-------- -------- -------- --------- ---------
Total Income (Loss) From Operations................. (0.24) 0.15 1.84 (2.65) 0.28
-------- -------- -------- --------- ---------
Dilution in NAV From Rights Offering................ -- -- (0.32) -- --
-------- -------- -------- --------- ---------
Offering Expenses Charged to Paid-in Capital........ -- -- (0.03) -- --
-------- -------- -------- --------- ---------
Less Distributions From:
Net investment income.......................... (0.02) (0.06) (0.07) -- (0.25)
Overdistribution of net investment income...... -- (0.11) -- -- --
Net realized gains............................. -- -- -- -- (0.24)
Capital........................................ -- -- (0.01) -- (0.08)
-------- -------- -------- --------- ---------
Total Distributions................................. (0.02) (0.17) (0.08) -- (0.57)
-------- -------- -------- --------- ---------
Net Asset Value, End of Year........................ $9.56 $9.82 $9.84 $8.43 $11.08
======== ======== ======== ========= =========
Market Value, End of Year........................... $8.25 $8.75 $12.38 $8.88 $9.50
======== ======== ======== ========= =========
Total Return........................................ (2.43)% (27.90)% 40.54%+ (6.58)% 1.00%
======== ======== ======== ========= =========
Net Assets, End of Year (000's)..................... $90,841 $93,347 $93,518 $53,384 $70,186
======== ======== ======== ========= =========
Ratios to Average Net Assets:
Net investment income.......................... 1.12% 0.85% 1.30% 2.04% 2.17%
Expenses*...................................... 1.42% 1.69% 1.69% 1.70% 1.53%
Supplemental Data:
Portfolio Turnover Rate........................ 58% 42% 46% 33% 24%
Average commissions paid on
equity security transactions(1).............. $0.00** -- -- -- --
</TABLE>
- ----------------------------
# Per share amounts have been calculated using the monthly average share
method, which more appropriately presents per share data for the period
since the use of the undistributed method does not accord with
results of operations.
+ The total return for the year ended January 31, 1994, adjusted for the
effect of the rights offering completed in January of 1994 is 45.85%
(unaudited).
* During the year ended January 31, 1996, the Fund earned credits from the
custodian which reduce service fees incurred. If the credits are taken into
consideration, the ratio of expenses to average net assets would be 1.41%.
** Amount represents less than $0.01 per share.
(1) New SEC disclosures guidelines require the average commissions per share be
calculated and presented for the current year only.
14
<PAGE>
[THE ITALY FUND INC. LOGO]
THE ITALY FUND INC.
Independent Auditors' Report
- --------------------------------------------------------------------------------
The Shareholders and Board of Directors of The Italy Fund Inc.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of The Italy Fund Inc. as of January 31, 1996, and
the related statements of operations, changes in net assets, and financial
highlights for the year then ended. These financial statements and financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and financial highlights
based on our audit. The statement of changes in net assets for the year ended
January 31, 1996 and the financial highlights for each of the years in the four-
year period then ended were audited by other auditors whose report thereon,
dated March 10, 1995, expressed an unqualified opinion on that statement of
changes in net assets and those financial highlights.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements and financial highlights are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. Our
procedures included confirmation of securities owned as of January 31, 1996, by
correspondence with the custodian. As to securities purchased and sold but not
received or delivered, we performed other appropriate auditing procedures. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of The Italy Fund Inc. as of
January 31, 1996, and the results of its operations, changes in its net assets
and financial highlights for the year then ended, in conformity with generally
accepted accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
March 21, 1996
15
<PAGE>
[THE ITALY FUND INC. LOGO]
THE ITALY FUND INC.
Additional Shareholder Information (unaudited)
- --------------------------------------------------------------------------------
On May 17, 1995, the Fund held its Annual Meeting of Shareholders for the
purpose of voting on the following matters:
1. To elect two (2) Directors of the Fund (Proposal 1).
2. To ratify the selection of KPMG Peat Marwick LLP as the independent
accountants of the Fund for the fiscal year ending January 31, 1996
(Proposal 2).
3. To approve the modification of the Fund's fundamental investment
restriction regarding the issuance of senior securities (Proposal 3).
4. To approve the modification of the Fund's fundamental investment
restriction regarding short positions to permit "short sales against
the box" and for hedging purposes (Proposal 4).
5. To approve the modification of the Fund's fundamental investment
restriction regarding margin purchases in connection with futures
contracts and related options (Proposal 5).
6. To approve the modification of the Fund's fundamental investment
restriction regarding commodities (Proposal 6).
Insufficient votes were received to vote on Proposals 3 through 6. The
results of the vote for Proposal 1 were as follows:
<TABLE>
<CAPTION>
% of % of
Directors Votes For Shares Voted Votes Against Shares Voted
--------- --------- ------------ ------------- ------------
<S> <C> <C> <C> <C>
A di. Montezemolo 4,768,075.897 98.09% 92,986.201 1.91%
H. McLendon 4,783,786.723 98.41% 77,275.375 1.59%
</TABLE>
The results of the vote for Proposal 2 were as follows:
<TABLE>
<CAPTION>
% of % of % of
Votes For Shares Voted Votes Against Shares Voted Votes Abstaining Shares Voted
--------- ------------ ------------- ------------ ---------------- ------------
<S> <C> <C> <C> <C> <C>
4,786,004.255 98.46% 28,840.550 0.59% 46,217.293 0.95%
</TABLE>
On December 15, 1995 the Fund held a special Meeting of Shareholders for
the purpose of voting on the following matter:
1. To consider and vote on a proposal to approve a management agreement
between the Fund and Smith Barney Mutual Funds Management Inc.
(Proposal 1).
The results of the vote for Proposal 1 were as follows:
<TABLE>
<CAPTION>
% of % of % of
Votes For Shares Voted Votes Against Shares Voted Votes Abstaining Shares Voted
-------- ------------ ------------- ------------ ---------------- ------------
<S> <C> <C> <C> <C> <C>
6,232,049.473 97.56% 124,253.159 1.95% 31,179.595 0.49%
</TABLE>
16
<PAGE>
[THE ITALY FUND INC. LOGO]
THE ITALY FUND INC.
Dividend Reinvestment and Cash Purchase Plan
- --------------------------------------------------------------------------------
Pursuant to the Fund's Dividend Reinvestment and Cash Purchase Plan (the
"Plan"), shareholders of the Fund whose shares are registered in their own name
may elect to have all distributions automatically reinvested in additional
shares of the Fund by First Data Investor Services Group, Inc., ("First Data"),
(formerly, "The Shareholder Services Group, Inc.") as agent under the Plan.
Distributions with respect to shares registered in the name of shareholders,
such as banks, brokers or nominees, which hold shares for others (that is, in
"street name"), may be reinvested by the broker or nominee in additional shares
under the Plan, but only if the service is provided by the broker or nominee.
Investors who own Fund shares registered in the street name should consult their
broker or nominee for details regarding reinvestment. Shareholders who do not
participate in the Plan will receive all distributions in cash paid in dollars
by check mailed directly to the shareholder by First Data as dividend paying
agent.
The number of shares of common stock participants in the Plan in lieu of a
cash dividend is determined in the following manner. Whenever the market price
of Fund shares is equal to or exceeds the net asset value of Fund shares at the
time such shares are valued for the purpose of determining the number of shares
equivalent to the cash dividend or distribution, participants will be issued
shares of the Fund at net asset value. If net asset value exceeds the market
price of Fund shares at such time, or if the Fund should declare a dividend or
other distribution payable only in cash, First Data will buy Fund shares in the
open market, on the New York Stock Exchange or elsewhere, beginning on the
record date for the dividend or distribution, until it has expended for such
purchases all of the cash that would otherwise be payable to the participants.
The number of purchased shares that will then be credited to the participants'
accounts is based on the average per share purchase price of Fund shares so
purchased, including brokerage commissions. Shares issued by the Fund are not
issued at a discount of more than 5 percent from the then current market value
of the Fund's shares. If the market price exceeds the net asset value of Fund
shares before First Data has completed its purchases, the average per share
purchase price paid by First Data may exceed the net asset value of the Fund's
shares, resulting in the acquisition of fewer shares than if the dividend or
distribution had been paid in shares issued by the Fund.
Participants in the Plan have the option of making additional semi-annual
cash payments to First Data in any amount from $100 to $3,000 for investment in
Fund shares. First Data uses all funds so received (as well as any dividends and
capital gains distributions received in cash) to purchase Fund shares in the
open market on or about February 15 and August 15 of each year.
Plan participants are not subject to any charge for reinvesting dividends
or capital gains distributions. Each Plan participant will, however, bear a pro
rata share of brokerage commissions incurred with respect to First Data's open
market purchases of Fund shares in connection with the reinvestment of dividends
or capital gains distributions.
The automatic reinvestment of dividends and capital gains distributions
does not relieve Plan participants of any income tax that may be payable on the
dividends or capital gains distributions. A participant in the Plan is treated
for federal income tax purposes as having received, on the dividend payment
date, a dividend or distribution in an amount equal to the cash that the
participant could have received instead of shares.
17
<PAGE>
[THE ITALY FUND INC. LOGO]
A shareholder may terminate participation in the Plan at any time by
notifying First Data in writing. A termination will be effective immediately if
notice is received by First Data not less than 10 days before any dividend or
distribution record date. Otherwise, the termination will be effective, with
respect to any subsequent dividends or distributions, on the first day after the
dividend or distribution has been credited to the participant's account in
additional shares of the Fund. Upon termination and according to a participant's
instructions, First Data will either (i) issue certificates for the shares
credited to a shareholder's Plan account together with a check representing any
fractional shares or (ii) sell such shares in the market.
Information concerning the Plan may be obtained from First Data at 1-800-
331-1710.
Portfolio Management
Erich Stock, who is Vice President and Investment Officer of the Fund, is
primarily responsible for management of the Fund's assets. Mr. Stock has served
the Fund in these capacities since the commencement of the Fund's operations.
- --------------------------------------------------------------------------------
Additional Information (unaudited)
Change in Independent Auditor: On February 15, 1995, based upon the
recommendation of the Audit Committee of the Fund, the Board of Directors
determined not to retain Coopers & Lybrand L.L.P. ("Coopers & Lybrand") as the
Fund's independent auditor and voted to appoint KPMG Peat Marwick LLP. During
the Fund's two most recent fiscal years, Coopers & Lybrand's audit reports
contained no adverse opinion or disclaimer of opinion; nor were the reports
qualified or modified as to uncertainty, audit scope, or accounting principles.
Further, during this same period there were no disagreements with Coopers &
Lybrand on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope procedure, which disagreements, if not resolved to
the satisfaction of Coopers & Lybrand, would have caused it to make reference to
the subject matter of such disagreements in connection with its audit reports.
The Fund has requested Coopers & Lybrand to provide a letter to the Securities
and Exchange Commission stating whether Coopers & Lybrand agrees with the
foregoing statements, and to provide the Fund with a copy of such letter. A copy
of this letter is available upon request by calling the Fund at (212) 723-9218.
----------------
Notice is hereby given in accordance with Section 23(c) of the Investment
Company Act of 1940, as amended, that from time to time the Fund may purchase at
market prices shares of its common stock in the open market.
18
<PAGE>
[THE ITALY FUND INC. LOGO]
THE ITALY FUND INC.
INVESTMENT ADVISER AND
ADMINISTRATOR
Smith Barney Mutual Funds Management Inc.
388 Greenwich Street
New York, New York 10013
ADVISORY BOARD
Andrea Farace
Pierre Henchoz
Ing. Dott. Ettore Lolli
Dott. Pietro Manes
Ambasciatore Egidio Ortona
DIRECTORS
Heath B. McLendon
Paolo M. Cucchi
Alessandro C. di Montezemolo
Dr. Paul Hardin
George Pavia
Mario d'Urso
OFFICERS
Heath B. McLendon
Chairman of the Board
Mario d'Urso
President
Lewis E. Daidone
Senior Vice President
and Treasurer
Erich Stock
Vice President and
Investment Officer
Irving P. David
Controller
Christina T. Sydor
Secretary
19
<PAGE>
THE ITALY FUND INC.
[THE ITALY FUND INC. LOGO]
This report is sent to the shareholders of The Italy Fund Inc. for their
information. It is not a Prospectus, circular or representation intended for use
in the purchase or sale of shares of the Fund or of any securities mentioned in
this report.
Comparisons between changes in the Fund's net asset value per share and changes
in The Banca Commerciale Italiana Index should be considered in light of the
Fund's investment policy and objectives, the characteristics and quality of the
Fund's investments, the size of the Fund and variations in the Lira/Dollar
exchange rate. This Index generally reflects ordinary shares (as opposed to
savings shares).
Annual
Report
January 31, 1996
THE ITALY FUND INC.
388 Greenwich Street
New York, New York 10013
(212) 816-4605
FD01090 3/96
