[LOGO] KPMG
The Global Leader
SMITH BARNEY VARIABLE ACCOUNT FUNDS
ANNUAL REPORT
December 31, 1996
This report is authorized for distribution to shareholders and to others only
when accompanied or preceded by a current prospectus of the Fund.
<PAGE>
SMITH BARNEY VARIABLE ACCOUNT FUNDS
Dear Shareholder:
We are pleased to provide the annual report for the year ended December 31, 1996
for the Smith Barney Variable Account Funds. This letter will we review the
performance of the financial markets in 1996 and briefly discuss the portfolio
strategies employed by each Portfolio. In addition, by now you should have
received a letter from Nationwide Insurance regarding the consolidation of the
investment portfolios in Smith Barney Variable Account Funds into substantially
similar existing funds. As of the date of this letter, we are currently in the
process of finalizing an Application for a Securities and Exchange Commission
Order of Substitution to consolidate these portfolios.
MARKET AND ECONOMIC OVERVIEW
The stock market continued its impressive climb in 1996, soaring to record
levels by year end, while the bond market struggled because of investor concerns
that the U.S. economy was overheating. The economy in 1996, which had moderate
inflation, stable to lower interest rates, and strong corporate earnings growth,
proved to be quite favorable not only for the domestic equity markets, but
worldwide equity markets as well. Over the year, Standard and Poor's 500 Index
("S&P 500"), a capitalization weighted-index of 500 widely held common stocks,
gained 22.95% , driven primarily by the strong appreciation of
large-capitalization stocks. In its only action all year, the Federal Reserve
Board lowered the discount rate from 5.25% to 5%. ( The discount rate is the
interest rate the Federal Government charges banks for overnight loans.) The
rate of inflation, as measured by the Consumer Price Index ("CPI"), remained a
modest 3% in 1996. Investors also signaled their approval of the continuance of
a divided federal government and the recently elected Republican majority in
Congress with a vigorous post-election rally in financial markets.
Disappointing earnings reports from the technology and healthcare sectors caused
many investors to believe these stocks had become overvalued and unable to
sustain their spectacular recent growth rates, and that triggered a mid-year
correction. In our view, this correction has been healthy for the stock market
because it removed some excessive speculation and paved the way for more
sustainable economic growth. Seeking stability and liquidity, investors
gravitated towards blue chip and large-capitalization stocks. The Dow Jones
Industrial Average (the "Dow"), a price-weighted average of 30 actively traded
blue chip stocks, rose 26% for the year, closing at 6448.
Conversely, the domestic bond market experienced significant volatility as
reports of a stronger than expected U.S. economy were released throughout the
year. Bond prices fluctuated while investors monitored key economic indicators.
Jobless claims rose slightly in January, attributable mostly to an especially
harsh winter on the east coast, and then dropped steadily to its lowest point in
years. At the end of the year, the unemployment rate was approximately 5.3%.
Higher employment, coupled with a surge in consumer spending, lead many bond
investors to think the economy was growing faster than expected, which would
cause inflation ultimately to rise. Although U.S. Treasuries performed well in
the fall, especially in the months of October and November, renewed fears of
inflation and the specter of a possible rate hike by the Federal Reserve
-1-
<PAGE>
pushed down prices of the benchmark 30-year Treasury bonds, driving its yield up
0.70% to finish the year at 6.64%.
Stock markets in Germany and Great Britain posted gains comparable to those in
the United States while Japan's financial markets continued to falter. On the
other hand, emerging market debt investments flourished during the reporting
period. For example, The J.P. Morgan Emerging Markets Bond Index (a basket of
popular debt instruments from representative countries in Europe, Asia, Africa,
and Latin America) jumped 40% for the year, making emerging market bonds one of
the few investments that exceeded the performance of stocks in 1996.
Looking ahead to 1997, we anticipate a continuation of this favorable economic
environment for financial assets. We believe that large-capitalization growth
stocks, which significantly outperformed other segments of the market in 1996,
should hold their gains but experience less appreciation in 1997. On the other
hand, small and mid-capitalization stocks, which were relatively flat in 1996,
should show better performance. With respect to the fixed-income market, we do
not anticipate any major development that will cause the market to move
dramatically in either direction. In our view, the bulk of any returns in
fixed-income investments will probably come from coupon interest and not price
appreciation.
INCOME AND GROWTH PORTFOLIO
In selecting stocks for the Income and Growth Portfolio, we typically choose
large-capitalization companies that have an above-market dividend yield and
assets undervalued by the marketplace. We look to find a fundamental improvement
underway, such as a new product development or new management, the positive
effect of which has not yet been reflected in the stock price.
We seek to employ a conservative, highly disciplined and bottom-up approach to
investing. This means that individual stock selection is more influential to the
overall performance of the Portfolio rather than the present or future condition
of the economy, financial markets or particular market sectors. For the year
ended December 31, 1996, the Income and Growth Portfolio generated an annual
total return of 21.02%, outperforming its Lipper Analytical Services Peer Group
Average (a major fund tracking organization) of 16.08%.
During the spring and summer of 1996, concerns about the pace of economic growth
caused an increase in volatility in the bond market. A generally positive stock
market was interrupted in July when earnings disappointments by a few prominent
corporations caused some investors to believe their stock prices had become
overvalued and this resulted in a relatively sharp sell-off. In retrospect,
those investor concerns proved unfounded which set the stage for the stock
market's current rally.
An additions to the Income and Growth Portfolio during the reporting period that
demonstrates its value approach to investing is Bristol-Myers. Considered a
conservatively managed "sleeper" in the drug industry with no new exciting drugs
in the pipeline, Bristol-Myers has a solid balance sheet and one of the highest
yielding stocks in the sector.
What initially caught our attention was the fact that the company's new
cost-conscious management team, which has been recently streamlined into three
separate divisions, had managed Bristol-Myers well despite intense competition
from generic drug makers and the patent expiration
-2-
<PAGE>
of Capoten (a blood pressure control medication and one of Bristol-Myer's most
popular and profitable products). In addition, its drug Pravachol, used for
treatment of high cholesterol, appears to decrease significantly the chances of
getting a first heart attack. Bristol-Myers recently received FDA approval for
this additional new use of the drug. Since receiving this approval, sales have
already increased dramatically. Moreover, Bristol-Myers owns non-core businesses
in other areas such as Clairol ( a hair products company) and Nutritional &
Medical Devices Group. We believe that Bristol-Myers' senior management may
eventually restructure the company and sell some of these non-strategic, lower
margin assets. That should ultimately increase its long-term attractiveness.
U.S. GOVERNMENT /HIGH QUALITY SECURITIES PORTFOLIO
The U.S. Government/ High Quality Securities Portfolio seeks high current income
and security of principal from a portfolio made up primarily of U.S. government
obligations and other high-quality fixed income investments. For the year ended
December 31, 1996, the U.S. Government/ High Quality Securities Portfolio had a
total return of 3.34%.
In our view, one of the most important events for the market in 1996 was the
unexpected strength of the U.S. economy during the first half of the year and
weaker economic growth during the second half. In addition to President
Clinton's re-election and Congress maintaining its Republican majority, other
significant market events in 1996 include the U.S. Treasury's plans to introduce
inflation-indexed securities, the Boskin Report that suggests inflation may be
roughly 1% lower than previously reported, and Russian President Boris Yeltsin
surviving both medically and politically.
Looking ahead to 1997, we believe there may be some possible (although not
necessarily probable) market challenges on the horizon such as:
-- Data that indicates moderate to weaker economic growth
-- Continued partisan ethics probes that negatively impact our political
leaders
-- U.S. dollar coming under short-term pressure because of a failure to
put in place a credible fiscal plan
-- Renewed tension in the Middle East -- possibly oil related
-- Political problems resurfacing in Russia
In our opinion, the yield on the 30 Year U.S. Treasury bond should remain in a
broad range of 6%-7%. However, if any of the above expected 1997 events take
place, the yield could temporarily rise above the 7% level. Ultimately, we
believe this would represent a buying opportunity because U.S. economic
fundamentals do not, in our view, warrant higher rates.
RESERVE ACCOUNT PORTFOLIO
The Reserve Account Portfolio invests in money market instruments to help
provide stability, and in longer-term securities (not to exceed five years for
U.S. Government securities, and three years for corporate debt obligations) to
provide enhanced return. For the year ended December 31, 1996, the Reserve
Account Portfolio had a total return of 1.57%.
For defensive purposes, the Portfolio also employs an immunization strategy.
(The Portfolio's immunization strategy involves the use of proprietary
technology that helps provide support to the
-3-
<PAGE>
manager in avoiding negative quarterly returns.) While minor day-to-day price
fluctuations are unavoidable, this strategy should produce sufficient income
during adverse market conditions to offset any potential decline in the prices
of the Portfolio's longer term securities. In extremely uncertain or volatile
periods of interest rates, it is possible for the Portfolio to be fully invested
in short-term money market instruments. Unlike money market funds, which
generally seek to maintain a stable net asset value (NAV) of $1.00 per share,
the Reserve Account Portfolio's NAV does fluctuate with market conditions.
Volatility in the market and the speed of that volatility has risen during the
reporting period. In our view, a primary factor behind this higher (and faster)
market volatility has been the increasingly important influence of big hedge
funds, foreign investors and central banks. In this type of environment, the
Portfolio's immunization strategy, although challenged, has enabled it to avoid
quarterly negative returns this past year.
In closing, we thank you for your investment in the Smith Barney Variable
Account Funds and look forward to serving your investment needs in 1997.
Sincerely,
/s/ Heath B. McLendon
Heath B. McLendon
Chairman and Chief Executive Officer
January 29, 1997
-4-
<PAGE>
-----------------------------------------------------------------------------
Income and Growth Portfolio
-----------------------------------------------------------------------------
-----------------------------------------------------------------------------
Historical Performance
-----------------------------------------------------------------------------
Net Asset Value
-----------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
==========================================================================
12/31/96 $15.24 $14.69 $0.56 $3.24 21.02%
--------------------------------------------------------------------------
12/31/95 13.05 15.24 0.44 0.94 27.56
--------------------------------------------------------------------------
12/31/94 14.93 13.05 0.39 1.02 (3.12)
--------------------------------------------------------------------------
12/31/93 14.36 14.93 0.57 1.45 18.61
--------------------------------------------------------------------------
12/31/92 13.76 14.36 0.50 0.48 11.48
--------------------------------------------------------------------------
12/31/91 10.93 13.76 0.58 0.00 31.34
--------------------------------------------------------------------------
12/31/90 12.66 10.93 0.66 0.00 (8.37)
--------------------------------------------------------------------------
Inception* to 12/31/89 12.50 12.66 0.18 0.00 2.68**
==========================================================================
Total $3.88 $7.13
==========================================================================
IT IS THE FUND'S POLICY TO DISTRIBUTE DIVIDENDS AND CAPITAL GAINS, IF ANY,
ANNUALLY.
-----------------------------------------------------------------------------
Average Annual Total Return
-----------------------------------------------------------------------------
==========================================================================
Year Ended 12/31/96 21.02%
--------------------------------------------------------------------------
Five Years Ended 12/31/96 14.61
--------------------------------------------------------------------------
Inception* to 12/31/96 12.73
==========================================================================
--------------------------------------------------------------------------
Cumulative Total Return
--------------------------------------------------------------------------
==========================================================================
Inception* to 12/31/96 144.38%
==========================================================================
(1) Assumes reinvestment of all dividends and capital gain distributions.
* The inception date for the Income and Growth Portfolio is July 20, 1989.
** Total return is not annualized, as it may not be representative of the
total return for the year.
-5-
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance (unaudited)
- --------------------------------------------------------------------------------
Growth of $10,000 Invested in Shares of
the Income and Growth Portfolio
vs. Standard & Poor's 500 Index*
================================================================================
July 1989 -- December 1996
[GRAPH APPEARS HERE]
INCOME AND GROWTH STANDARD & POORS
PORTFOLIO 500
FUND INDEX
---- -----
7/20/89 10,000 10,000
12/89 10,268 10,362
12/90 9,408 10,040
12/91 12,357 13,092
12/92 13,776 14,088
12/93 16,340 15,581
12/94 15,831 15,786
12/95 20,160 21,709
12/31/96 24,438 26,691
* Hypothetical illustration of $10,000 invested in shares at inception on July
20, 1989, assuming reinvestment of dividends and capital gains, if any, at net
asset value through December 31, 1996. The Standard & Poor's 500 Index is an
index of widely held common stocks listed on the New York and American Stock
Exchange and the over-the-counter markets. Figures for the index include
reinvestment of dividends. the index is unmanaged and is not subject to the
same management and trading expenses as a mutual fund.
All figures represent past performance and are not a guarantee of future
results. Investment returns and principal value will fluctuate, and redemption
value may be more or less than the original cost.
-6-
<PAGE>
-----------------------------------------------------------------------------
U.S. Government/High Quality Securities Portfolio
-----------------------------------------------------------------------------
-----------------------------------------------------------------------------
Historical Performance
-----------------------------------------------------------------------------
Net Asset Value
-----------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
==========================================================================
12/31/96 $13.66 $12.90 $1.22 $0.00 3.34%
--------------------------------------------------------------------------
12/31/95 12.46 13.66 0.94 0.00 17.20
--------------------------------------------------------------------------
12/31/94 13.35 12.46 0.84 0.00 (0.35)
--------------------------------------------------------------------------
12/31/93 13.44 13.35 0.87 0.02 5.91
--------------------------------------------------------------------------
12/31/92 13.45 13.44 0.89 0.05 6.91
--------------------------------------------------------------------------
12/31/91 12.74 13.45 0.87 0.02 12.58
--------------------------------------------------------------------------
12/31/90 12.54 12.74 0.82 0.00 8.11
--------------------------------------------------------------------------
Inception* to 12/31/89 12.50 12.54 0.34 0.00 3.01**
==========================================================================
Total $6.79 $0.09
==========================================================================
IT IS THE FUND'S POLICY TO DISTRIBUTE DIVIDENDS AND CAPITAL GAINS, IF ANY,
ANNUALLY.
--------------------------------------------------------------------------
Average Annual Total Return
--------------------------------------------------------------------------
==========================================================================
Year Ended 12/31/96 3.34%
--------------------------------------------------------------------------
Five Years Ended 12/31/96 6.45
--------------------------------------------------------------------------
Inception* to 12/31/96 7.52
==========================================================================
--------------------------------------------------------------------------
Cumulative Annual Total Return
--------------------------------------------------------------------------
==========================================================================
Inception* to 12/31/96 71.32%
==========================================================================
(1) Assumes reinvestment of all dividends and capital gain distributions.
* The inception date for the U.S. Government/High Quality Securities
Portfolio is July 31, 1989.
* Total return is not annualized, as it may not be representative of the
total return for the year.
-7-
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance (unaudited)
- --------------------------------------------------------------------------------
GROWTH OF $10,000 INVESTED IN SHARES OF
THE U.S. GOVERNMENT/HIGH QUALITY SECURITIES PORTFOLIO
VS. LEHMAN BROTHERS GNMA MUTUAL FUND INDEX*
================================================================================
July 1989 -- December 1996
[GRAPH APPEARS HERE]
U.S GOVERNMENT/
HIGH QUALITY
SECURITIES LEHMAN BROTHERS
PORTFOLIO GNMA MUTUAL FUND
FUND INDEX
---- -----
7/31/89 10000 10000
12/89 10301 10354
12/90 11136 11449
12/91 12537 11633
12/92 13404 12495
12/93 14196 13317
12/94 14146 13118
12/95 16579 15353
12/31/96 17132 16203
* Hypothetical illustration of $10,000 invested in shares at inception on July
31, 1989, assuming reinvestment of dividends and capital gains, if any at net
asset value through December 31, 1996. The Lehman Brothers GNMA Mutual Fund
Index is composed of 15-year and 30-year fixed-rate securities backed by
mortgage pools of the Government National Mortgage Association. The index is
unmanaged and is not subject to the same management and trading expenses of a
mutual fund.
All figures represent past performance and are not a guarantee of future
results. Investment returns and principal value will fluctuate, and redemption
value may be more or less than the original cost.
-8-
<PAGE>
-----------------------------------------------------------------------------
Reserve Account Portfolio
-----------------------------------------------------------------------------
-----------------------------------------------------------------------------
Historical Performance
-----------------------------------------------------------------------------
Net Asset Value
------------------
Beginning End Income Capital Gain Total
Year Ended of Year of Year Dividends Distributions Returns(1)
===========================================================================
12/31/96 $12.71 $10.99 $1.92 $0.00 1.57%
---------------------------------------------------------------------------
12/31/95 12.39 12.71 0.74 0.05 8.83
---------------------------------------------------------------------------
12/31/94 12.75 12.39 0.58 0.03 1.99
---------------------------------------------------------------------------
12/31/93 12.86 12.75 0.69 0.01 4.59
---------------------------------------------------------------------------
12/31/92 13.08 12.86 0.78 0.07 4.82
---------------------------------------------------------------------------
12/31/91 12.66 13.08 0.89 0.03 10.64
---------------------------------------------------------------------------
12/31/90 12.55 12.66 0.93 0.00 8.30
---------------------------------------------------------------------------
Inception* to 12/31/89 12.50 12.55 0.36 0.00 3.26**
===========================================================================
Total $6.89 $0.19
===========================================================================
IT IS THE FUND'S POLICY TO DISTRIBUTE DIVIDENDS AND CAPITAL GAINS, IF ANY,
ANNUALLY.
---------------------------------------------------------------------------
Average Annual Total Return
---------------------------------------------------------------------------
===========================================================================
Year Ended 12/31/96 1.57%
---------------------------------------------------------------------------
Five Years Ended 12/31/96 4.33
---------------------------------------------------------------------------
Inception* to 12/31/96 5.89
===========================================================================
---------------------------------------------------------------------------
Cumulative Total Return
---------------------------------------------------------------------------
===========================================================================
Inception* to 12/31/96 52.91%
===========================================================================
(1) Assumes reinvestment of all dividends and capital gain distributions.
* The inception date for the Reserve Account Portfolio is August 2, 1989.
** Total return is not annualized, as it may not be representative of the
total return for the year.
-9-
<PAGE>
- --------------------------------------------------------------------------------
Historical Performance (unaudited)
- --------------------------------------------------------------------------------
GROWTH OF $10,00 INVESTED IN SHARES OF
THE RESERVE ACCOUNT PORTFOLIO
VS. SALOMON BROTHERS 1-YEAR TREASURY INDEX*
================================================================================
August 1989 -- December 1996
[GRAPH]
RESERVE ACCOUNT SALOMON BROTHERS
PORTFOLIO 1-YEAR TREASURY
FUND INDEX
------ --------
8/2/89 10,000 10,000
12/89 10,326 10,331
12/90 11,183 11,254
12/91 12,373 12,238
12/92 12,969 12,828
12/93 13,563 13,319
12/94 13,833 13,670
12/95 15,054 14,776
12/31/96 15,291 15,615
* Hypothetical illustration of $10,000 invested in shares at inception on
August 2, 1989, assuming reinvestment of dividends and capital gains, if any,
at net asset value through December 31, 1996. The Salomon Brothers 1-Year
Treasury Index is composed of one 1-Year United States Treasury Bond whose
return is tracked until its maturity. The index is unmanaged and is not
subject to the same management and trading expenses as a mutual fund.
All figures represent past performance and are not guarantee of future
results. Investment returns and principal value will fluctuate, and
redemption value may be more or less than the original cost.
-10-
<PAGE>
- --------------------------------------------------------------------------------
Schedules of Investments December 31, 1996
- --------------------------------------------------------------------------------
INCOME AND GROWTH PORTFOLIO
SHARES SECURITY VALUE
================================================================================
COMMON STOCKS - 90.4%
AEROSPACE MANUFACTURING - 3.8%
6,000 Daimler Benz AG ADR $411,000
6,000 United Technologies Corp. 396,000
- --------------------------------------------------------------------------------
807,000
- --------------------------------------------------------------------------------
CHEMICALS - 5.6%
40,000 Lawter International Inc. 505,000
18,000 Olin Corp. 677,250
- --------------------------------------------------------------------------------
1,182,250
- --------------------------------------------------------------------------------
CONGLOMERATES - 3.0%
5,000 National Service Industries Inc 186,875
10,000 Tenneco Inc. 451,250
- --------------------------------------------------------------------------------
638,125
- --------------------------------------------------------------------------------
ELECTRIC UTILITIES - 7.6%
10,000 CMS Energy Corp. 336,250
10,000 Dominion Resources Inc. 385,000
20,000 Entergy Corp. 555,000
8,000 Texas Utilities Co. 326,000
- --------------------------------------------------------------------------------
1,602,250
- --------------------------------------------------------------------------------
ELECTRICAL EQUIPMENT - 7.4%
8,000 Emerson Electric Co. 774,000
8,000 General Electric Co. 791,000
- --------------------------------------------------------------------------------
1,565,000
- --------------------------------------------------------------------------------
ENERGY OIL INTEGRATED - INTERNATIONAL - 8.2%
9,000 Chevron Corp. 585,000
6,000 Mobil Corp. 733,500
10,000 Unocal Corp. 406,250
- --------------------------------------------------------------------------------
1,724,750
- --------------------------------------------------------------------------------
ENERGY - REFINING AND MACHINERY - 1.7%
8,000 Ashland Inc. 351,000
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
-11-
<PAGE>
- --------------------------------------------------------------------------------
Schedules of Investments (continued) December 31, 1996
- --------------------------------------------------------------------------------
INCOME AND GROWTH PORTFOLIO
SHARES SECURITY VALUE
================================================================================
FINANCIAL SERVICES - 11.6%
9,400 Chase Manhattan Corp. $838,950
27,000 Commonwealth Bank of Australia ADR@ 774,828
9,000 Household International Inc. 830,250
- --------------------------------------------------------------------------------
2,444,028
- --------------------------------------------------------------------------------
HOSPITAL RELATED - 2.9%
15,000 Baxter International Inc. 615,000
- --------------------------------------------------------------------------------
INSURANCE - MULTI-LINE - 4.1%
9,270 Allstate Insurance Corp. 536,501
5,000 ITT Hartford Group Inc. 337,500
- --------------------------------------------------------------------------------
874,001
- --------------------------------------------------------------------------------
METALS & MINING - 3.2%
15,000 Cleveland Cliffs Inc. 680,625
- --------------------------------------------------------------------------------
NATURAL - GAS PIPELINE - 2.9%
930 El Paso Natural Gas Co. 46,965
15,000 Williams Cos., Inc. 562,500
- --------------------------------------------------------------------------------
609,465
- --------------------------------------------------------------------------------
NATURAL - GAS UTILITIES - 1.4%
10,000 Brooklyn Union Gas Co. 301,250
- --------------------------------------------------------------------------------
NEWSPAPER - 0.7%
4,000 New York Times Co., Class A Shares 152,000
- --------------------------------------------------------------------------------
OIL WELL EQUIPMENT & SERVICES - 2.9%
20,000 Dresser Industries Inc. 620,000
- --------------------------------------------------------------------------------
PAPER PRODUCTS - 4.2%
10,000 International Paper Co. 403,750
5,000 Kimberly-Clark Corp. 476,250
- --------------------------------------------------------------------------------
880,000
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
-12-
<PAGE>
- --------------------------------------------------------------------------------
Schedules of Investments (continued) December 31, 1996
- --------------------------------------------------------------------------------
INCOME AND GROWTH PORTFOLIO
SHARES SECURITY VALUE
================================================================================
PHARMACEUTICALS - 9.1%
13,000 American Home Products Corp. $762,125
4,000 Bristol-Myers Squibb Co. 435,000
10,000 Eli Lilly & Co. 730,000
- --------------------------------------------------------------------------------
1,927,125
- --------------------------------------------------------------------------------
PHOTOGRAPHY - 3.8%
10,000 Eastman Kodak Co. 802,500
- --------------------------------------------------------------------------------
R.E.I.T. - 1.7%
7,000 Crescent Real Estate Equities Inc. 369,250
- --------------------------------------------------------------------------------
SHIPBUILDING - 0.1%
2,000 Newport News Shipbuilding Inc.+ 30,000
- --------------------------------------------------------------------------------
TELEPHONE - 2.2%
10,000 GTE Corp. 455,000
- --------------------------------------------------------------------------------
TRANSPORTATION - RAILROAD - 2.3%
8,000 Union Pacific Corp. 481,000
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost - $14,218,065) 19,111,619
================================================================================
PREFERRED STOCKS - 2.0%
HEALTHCARE - 1.2%
8,500 FHP International Corp., Series A 259,250
- --------------------------------------------------------------------------------
METALS & MINING - 0.8%
5,000 Freeport McMoRan Copper & Gold, Series B 160,000
- --------------------------------------------------------------------------------
TOTAL PREFERRED STOCKS
(Cost - $404,928) 419,250
================================================================================
See Notes to Financial Statements.
-13-
<PAGE>
- --------------------------------------------------------------------------------
Schedules of Investments (continued) December 31, 1996
- --------------------------------------------------------------------------------
INCOME AND GROWTH PORTFOLIO
FACE
AMOUNT SECURITY VALUE
================================================================================
CONVERTIBLE DEBENTURES - 1.8%
ENERGY - 1.8%
$400,000 Oryx Energy Co., 7.500% due 5/15/14 (Cost - $558,000) $388,000
================================================================================
REPURCHASE AGREEMENT - 5.8%
1,229,000 Citibank, 6.893% due 1/2/97; Proceeds
at maturity - $1,229,471; (Fully collateralized
by U.S. Treasury Bills due 12/31/98;
Market value - $1,253,616) (Cost $1,229,000) 1,229,000
================================================================================
TOTAL INVESTMENTS - 100%
(Cost - $16,409,993**) $21,147,869
================================================================================
+ Non-income producing security.
@ Security exempt from registration under Rule 144A of Securities Act of 1933.
This security may be resold in transactions that are exempt from
registration, generally to qualified institutional buyers.
** Aggregate cost for Federal income tax purposes is substantially the same.
See Notes to Financial Statements
-14-
<PAGE>
- -------------------------------------------------------------------------------
Schedules of Investments (continued) December 31, 1996
- -------------------------------------------------------------------------------
U.S. GOVERNMENT/HIGH QUALITY SECURITIES PORTFOLIO
FACE
AMOUNT SECURITY VALUE
================================================================================
U.S. GOVERNMENT & AGENCY OBLIGATIONS - 77.0%
$250,000 U.S. Treasury Note, 6.500% due 4/30/99 $253,080
200,000 U.S. Treasury Bond, 7.250% due 5/15/16 211,366
492,024 FNMA Certificates, 7.500% due 7/1/11* 499,093
147,261 GNMA Certificates I, 8.000% due 6/15/17* 150,344
57,245 GNMA Certificates I, 10.000% due 3/15/20* 62,773
276,455 GNMA Certificates I, 8.500% due 4/15/21* 286,563
256,930 GNMA Certificates I, 9.000% due 1/15/22* 270,739
466,573 GNMA Certificates I, 7.000% due 7/15/24* 456,509
- --------------------------------------------------------------------------------
TOTAL U.S. GOVERNMENT & AGENCY
OBLIGATIONS (Cost - $2,098,809) 2,190,467
================================================================================
CORPORATE NOTES - 8.9%
250,000 Shell Oil Corp, 6.950% due 12/15/98 (Cost-$264,973) 254,375
================================================================================
SHORT-TERM INVESTMENT - 14.1%
400,000 Federal Home Loan Bank, 6.850% due 2/25/97
(Cost - $398,375) 400,784
================================================================================
TOTAL INVESTMENTS - 100%
(Cost - $2,762,157**) $2,845,626
================================================================================
* Date shown represents the last date in a range of maturity dates.
** Aggregate cost for Federal income tax purposes is substantially the same.
See Notes to Financial Statements.
-15-
<PAGE>
- --------------------------------------------------------------------------------
Statements of Assets and Liabilities December 31, 1996
- --------------------------------------------------------------------------------
U.S. GOV'T./
INCOME AND HIGH QUALITY RESERVE
GROWTH SECURITIES ACCOUNT
PORTFOLIO PORTFOLIO PORTFOLIO
================================================================================
ASSETS:
Investments, at value (Cost --
$16,409,993, $2,762,157 and $ --,
repectively) $21,147,869 $2,845,626 --
Cash 525 14,800 $422,282
Dividends and interest receivable 36,727 26,267 --
Receivable from investment manager -- -- 23,134
Other assets -- -- 38
- --------------------------------------------------------------------------------
TOTAL ASSETS 21,185,121 2,886,693 445,454
- --------------------------------------------------------------------------------
LIABILITIES:
Payable for securities purchased 301,850 -- --
Management fees payable 10,406 1,121 --
Payable for Fund shares purchased 747 103 --
Accrued expenses 60,313 9,289 10,914
- --------------------------------------------------------------------------------
TOTAL LIABILITIES 373,316 10,513 10,914
- --------------------------------------------------------------------------------
TOTAL NET ASSETS $20,811,805 $2,876,180 $434,540
================================================================================
NET ASSETS:
Par value of shares of beneficial
interest $1,416 $223 $40
Capital paid in excess of par value 14,764,940 2,683,063 406,714
Undistributed net investment income 96,749 2,604 68
Accumulated net realized gain from
security transactions 1,210,824 106,821 27,718
Net unrealized appreciation of
investments 4,737,876 83,469 --
- --------------------------------------------------------------------------------
TOTAL NET ASSETS $20,811,805 $2,876,180 $434,540
================================================================================
SHARES OUTSTANDING 1,416,734 222,969 39,529
- --------------------------------------------------------------------------------
NET ASSET VALUE $14.69 $12.90 $10.99
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
-16-
<PAGE>
- --------------------------------------------------------------------------------
Statements of Operations For the Year Ended December 31, 1996
- --------------------------------------------------------------------------------
U.S. GOV'T./
INCOME HIGH QUALITY RESERVE
GROWTH SECURITIES ACCOUNT
PORTFOLIO PORTFOLIO PORTFOLIO
================================================================================
INVESTMENT INCOME:
Interest $93,456 $288,212 $77,606
Dividends 770,056 -- --
Less: Foreign withholding tax (6,298) -- --
- --------------------------------------------------------------------------------
TOTAL INVESTMENT INCOME 857,214 288,212 77,606
- --------------------------------------------------------------------------------
EXPENSES:
Management fees (Note 2) 164,890 17,828 5,864
Audit and legal 12,858 9,150 14,146
Shareholder and system servicing
fees 8,280 7,500 9,000
Trustees' fees 7,540 2,000 3,500
Custody 3,618 250 3,000
Other 6,417 2,130 3,000
- --------------------------------------------------------------------------------
TOTAL EXPENSES 203,603 38,858 38,510
Less: Management fee waiver and
expense reimbursement (Note 2) -- -- (25,545)
- --------------------------------------------------------------------------------
NET EXPENSES 203,603 38,858 12,965
- --------------------------------------------------------------------------------
NET INVESTMENT INCOME 653,611 249,354 64,641
- --------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS (NOTE 3):
Realized Gain From Security
Transactions (excluding short-term
securities):
Proceeds from sales 21,489,635 2,104,791 2,201,873
Cost of securities sold 16,601,647 1,959,537 2,174,155
- --------------------------------------------------------------------------------
NET REALIZED GAIN 4,887,988 145,254 27,718
- --------------------------------------------------------------------------------
Change in Net Unrealized Appreciation
of Investments:
Beginning of year 5,242,474 372,348 59,786
End of year 4,737,876 83,469 -
- --------------------------------------------------------------------------------
DECREASE IN NET UNREALIZED
APPRECIATION (504,598) (288,879) (59,786)
- --------------------------------------------------------------------------------
NET GAIN (LOSS) ON INVESTMENT 4,383,390 (143,625) (32,068)
- --------------------------------------------------------------------------------
INCREASE IN NET ASSETS FROM
OPERATIONS $5,037,001 $105,729 $32,573
================================================================================
See Notes to Financial Statements.
-17-
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets
- --------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31,
------------------------
INCOME AND GROWTH PORTFOLIO 1996 1995
================================================================================
OPERATIONS:
Net investment income $653,611 $797,586
Net realized gain 4,887,988 1,668,197
Increase (decrease) in net unrealized
appreciation (504,598) 4,535,318
- --------------------------------------------------------------------------------
INCREASE IN NET ASSETS FROM OPERATIONS 5,037,001 7,001,101
- --------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (635,559) (795,426)
Net realized gains (3,677,164) (1,680,874)
- --------------------------------------------------------------------------------
DECREASE IN NET ASSETS FROM
DISTRIBUTIONS TO SHAREHOLDERS (4,312,723) (2,476,300)
- --------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 5):
Net proceeds from sale of shares 184,240 217,148
Net asset value of shares issued for
reinvestment of dividends 4,311,352 2,476,300
Cost of shares reacquired (14,190,110) (4,920,184)
- --------------------------------------------------------------------------------
DECREASE IN NET ASSETS FROM FUND SHARE
TRANSACTIONS (9,694,518) (2,226,736)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS (8,970,240) 2,298,065
NET ASSETS:
Beginning of year 29,782,045 27,483,980
- --------------------------------------------------------------------------------
END OF YEAR* $20,811,805 $29,782,045
================================================================================
* Includes undistributed net investment
income of: $96,749 $2,307
================================================================================
See Notes to Financial Statements.
-18-
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets (continued)
- --------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31,
------------------------
U.S. GOV'T./HIGH QUALITY SECURITIES PORTFOLIO 1996 1995
================================================================================
OPERATIONS:
Net investment income $249,354 $313,405
Net realized gain 145,254 1,765
Increase (decrease) in net unrealized appreciation (288,879) 462,218
- --------------------------------------------------------------------------------
INCREASE IN NET ASSETS FROM OPERATIONS 105,729 777,388
- --------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (248,660) (313,396)
- --------------------------------------------------------------------------------
DECREASE IN NET ASSETS FROM
DISTRIBUTIONS TO SHAREHOLDERS (248,660) (313,396)
- --------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 5):
Net proceeds from sale of shares 86,439 221,967
Net asset value of shares issued for
reinvestment of dividends 248,660 313,396
Cost of shares reacquired (2,171,515) (982,509)
- --------------------------------------------------------------------------------
DECREASE IN NET ASSETS FROM FUND SHARE
TRANSACTIONS (1,836,416) (447,146)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS (1,979,347) 16,846
NET ASSETS:
Beginning of year 4,855,527 4,838,681
- --------------------------------------------------------------------------------
END OF YEAR * $2,876,180 $4,855,527
================================================================================
* Includes undistributed net investment income of: $2,604 $23
================================================================================
See Notes to Financial Statements.
-19-
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets (continued)
- --------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31,
------------------------
RESERVE ACCOUNT PORTFOLIO 1996 1995
================================================================================
OPERATIONS:
Net investment income $64,641 $124,809
Net realized gain 27,718 9,219
Increase (decrease) in net unrealized appreciation (59,786) 66,127
- --------------------------------------------------------------------------------
INCREASE IN NET ASSETS FROM OPERATIONS 32,573 200,155
- --------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (64,625) (126,558)
Net realized gains -- (9,058)
- --------------------------------------------------------------------------------
DECREASE IN NET ASSETS FROM
DISTRIBUTIONS TO SHAREHOLDERS (64,625) (135,616)
- --------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 5):
Net proceeds from sale of shares 256,384 361,578
Net asset value of shares issued for
reinvestment of dividends 64,625 135,616
Cost of shares reacquired (2,169,900) (773,814)
- --------------------------------------------------------------------------------
DECREASE IN NET ASSETS FROM FUND SHARE
TRANSACTIONS (1,848,891) (276,620)
- --------------------------------------------------------------------------------
DECREASE IN NET ASSETS (1,880,943) (212,081)
NET ASSETS:
Beginning of year 2,315,483 2,527,564
- --------------------------------------------------------------------------------
END OF YEAR * $434,540 $2,315,483
================================================================================
* Includes undistributed
(over distributed) net investment income of: $68 $(156)
================================================================================
See Notes to Financial Statements
-20-
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
Smith Barney Variable Funds ("Fund"), a Massachusetts business trust, is
registered under the Investment Company Act of 1940, as amended, as a
diversified, open-end management investment company. The Fund is sold
exclusively for use with Variable Annuity Contracts. The Fund consists of three
separate investment portfolios ("Portfolios"): Income and Growth, U.S.
Government/High Quality Securities and Reserve Account Portfolios. Shares of the
Fund are offered only to insurance company separate accounts that fund certain
annuity and variable life insurance contracts.
The significant accounting policies consistently followed by the Fund are:
(a) security transactions are accounted for on trade date; (b) securities traded
on national securities markets are valued at the closing prices on such markets;
securities for which no sales price was reported and U.S. Government and Agency
obligations are valued at the mean between bid and ask prices; (c) securities
maturing within 60 days are valued at cost plus accreted discount, or minus
amortized premium, which approximates market value; (d) dividend income is
recorded on the ex-dividend date; foreign dividends are recorded on the
ex-dividend date or as soon as practical after the Fund determines the existence
of a dividend declaration after exercising reasonable due diligence; (e)
interest income, adjusted for accretion of original issue discount, is recorded
on the accrual basis; (f) gains or losses on the sale of securities are
calculated by using the specific identification method; (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 character of income and gains distributed are determined in accordance
with income tax regulations which may differ from generally accepted accounting
principles. As of December 31, 1996, reclassifications were made to the Fund's
capital accounts to reflect permanent book/tax differences and income and gains
available for distribution under income tax regulations. Accordingly, for the
Income and Growth Portfolio, a portion of accumulated net investment loss
amounting to $76,390 was reclassified to paid-in-capital. In addition, for the
U.S. Government/High Quality Securities Portfolio, a portion of accumulated net
realized gain and accumulated net investment loss amounting to $16 and $1,887,
respectively, was reclassified to paid-in-capital. For the Reserve Account
Portfolio, a portion of accumulated net realized gains and accumulated net
investment loss amounting to $164 and $208, respectively, was reclassified to
paid-in-capital. Net investment income, net realized gains and net assets were
not affected by the change; and (j) 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.
-21-
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
2. MANAGEMENT AGREEMENT AND TRANSACTIONS WITH AFFILIATED PERSONS
Smith Barney Mutual Funds Management Inc. ("SBMFM") acts as investment
manager to the Fund. The Income and Growth, U.S. Government/High Quality
Securities and Reserve Account Portfolios pay SBMFM a management fee calculated
at the annual rates of 0.60%, 0.45% and 0.45%, respectively on average daily net
assets. These fees are calculated daily and paid monthly. For the Reserve
Account Portfolio, SBMFM waived all of its management fees and reimbursed
expenses of $19,681 for the year ended December 31, 1996.
Smith Barney Inc. ("SB"), a subsidiary of Smith Barney Holdings Inc., acts as
distributor of the Fund shares and primary broker for its portfolio agency
transactions. For the year ended December 31, 1996, SB received brokerage
commissions of $16,187.
All officers and two Trustees of the Fund are employees of SB.
3. INVESTMENTS
During the year ended December 31, 1996, the aggregate cost of purchases and
proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
<TABLE>
<CAPTION> U.S. GOVT./
INCOME AND HIGH QUALITY RESERVE
GROWTH SECURITIES ACCOUNT
PORTFOLIO PORTFOLIO PORTFOLIO
=================================================================================
<S> <C> <C> <C>
Purchases $7,737,070 $507,367 --
- ---------------------------------------------------------------------------------
Sales 21,489,635 2,104,791 $2,201,873
=================================================================================
</TABLE>
At December 31, 1996, the aggregate gross unrealized appreciation and
depreciation of investments were as follows:
<TABLE>
<CAPTION> U.S. GOVT./
INCOME AND HIGH QUALITY RESERVE
GROWTH SECURITIES ACCOUNT
PORTFOLIO PORTFOLIO PORTFOLIO
===========================================================================================
<S> <C> <C> <C>
Gross unrealized appreciation* $4,984,190 $94,066 --
Gross unrealized depreciation* (246,314) (10,597) --
- -------------------------------------------------------------------------------------------
Net unrealized appreciation* $4,737,876 $83,469 --
===========================================================================================
</TABLE>
* Substantially the same for Federal income tax purposes.
4. REPURCHASE AGREEMENTS
The Fund purchases (and its custodian takes possession of) U.S. Government
securities from banks and securities dealers subject to agreements to resell the
securities to the seller at a future date (generally, the next business day) at
an agreed-upon higher repurchase price. The Fund requires maintenance of the
market value of the collateral in amounts at least equal to the repurchase
price.
-22-
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
5.SHARES OF BENEFICIAL INTEREST
At December 31, 1996, the Fund had an unlimited number of shares of
beneficial interest authorized with a par value of $0.001 per share. Each share
represents an equal proportionate interest and has an equal entitlement to any
dividends and distributions made by the Portfolio.
Transactions in shares of each Portfolio were as follows:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, 1996 DECEMBER 31, 1995
========================================================================================
<S> <C> <C>
INCOME AND GROWTH PORTFOLIO
Shares sold 10,768 15,292
Shares issued on reinvestment 289,939 163,142
Shares redeemed (838,437) (330,447)
- -----------------------------------------------------------------------------------------
Net Decrease (537,730) (152,013)
=========================================================================================
U.S. GOV'T./HIGH QUALITY SECURITIES PORTFOLIO
Shares sold 6,349 16,901
Shares issued on reinvestment 19,216 22,959
Shares redeemed (158,102) (72,806)
- ----------------------------------------------------------------------------------------
Net Decrease (132,537) (32,946)
========================================================================================
RESERVE ACCOUNT PORTFOLIO
Shares sold 20,010 27,933
Shares issued on reinvestment 5,881 10,670
Shares redeemed (168,547) (60,357)
- ----------------------------------------------------------------------------------------
Net Decrease (142,656) (21,754)
========================================================================================
</TABLE>
-23-
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
FOR A SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH YEAR:
<TABLE>
<CAPTION>
INCOME AND GROWTH PORTFOLIO 1996 1995 1994 1993 1992
===================================================================================================
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $15.24 $13.05 $14.93 $14.36 $13.76
- ---------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM OPERATIONS:
Net investment income 0.57 0.45 0.39 0.57 0.49
Net realized and unrealized gain (loss) 2.68 3.12 (0.86) 2.02 1.09
- ---------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations 3.25 3.57 (0.47) 2.59 1.58
- ---------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
Net investment income (0.56) (0.44) (0.39) (0.57) (0.50)
Net realized gains (3.24) (0.94) (1.02) (1.45) (0.48)
- ---------------------------------------------------------------------------------------------------
Total Distributions (3.80) (1.38) (1.41) (2.02) (0.98)
- ---------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $14.69 $15.24 $13.05 $14.93 $14.36
- ---------------------------------------------------------------------------------------------------
TOTAL RETURN 21.02% 27.56% (3.12)% 18.61% 11.48%
- ---------------------------------------------------------------------------------------------------
NET ASSETS, END OF YEAR (000s) $20,812 $29,782 $27,484 $30,638 $26,501
- ---------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses 0.74% 0.77% 0.75% 0.75% 0.84%
Net investment income 2.39 2.77 2.49 3.59 3.43
- ---------------------------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE 30% 46% 40% 70% 57%
- ---------------------------------------------------------------------------------------------------
AVERAGE COMMISSIONS PER SHARE PAID
ON EQUITY SECURITY TRANSACTIONS (1) $0.07 $0.07 -- -- --
===================================================================================================
</TABLE>
(1) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
-24-
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
FOR A SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH YEAR:
U.S. GOV'T./HIGH QUALITY
SECURITIES PORTFOLIO 1996 1995 1994 1993 1992
================================================================================
NET ASSET VALUE, BEGINNING OF YEAR $13.66 $12.46 $13.35 $13.44 $13.45
- --------------------------------------------------------------------------------
INCOME (LOSS) FROM OPERATIONS:
Net investment income (1) 1.22 0.94 0.84 0.88 0.88
Net realized and unrealized gain
(loss) (0.76) 1.20 (0.89) (0.08) 0.05
- --------------------------------------------------------------------------------
Total Income (Loss) From Operations (0.46) 2.14 (0.05) 0.80 0.93
- --------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
Net investment income (1.22) (0.94) (0.84) (0.87) (0.89)
Net realized gains -- -- -- (0.02) (0.05)
- --------------------------------------------------------------------------------
Total Distributions (1.22) (0.94) (0.84) (0.89) (0.94)
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $12.90 $13.66 $12.46 $13.35 $13.44
- --------------------------------------------------------------------------------
TOTAL RETURN 3.34% 17.20% (0.35)% 5.91% 6.91%
- --------------------------------------------------------------------------------
NET ASSETS, END OF YEAR (000s) $2,876 $4,856 $4,838 $5,450 $5,516
- --------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses (1) 0.98% 0.87% 0.76% 0.74% 0.93%
Net investment income 6.30 6.36 5.87 6.09 6.34
- --------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE 13% 0% 36% 4% 11%
================================================================================
(1) The Manager waived a portion of its fees as follows: $0.02 per share
(0.10% of average net assets) in 1992 with respect to the U.S. Gov't./High
Quality Securities Portfolio; subject to a voluntary waiver of the
fee to the extent that the aggregate expenses of any Portfolio exceed 1.00%
of the average daily net assets for any year.
-25-
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (continued)
- --------------------------------------------------------------------------------
FOR A SHARE OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH YEAR:
RESERVE ACCOUNT PORTFOLIO 1996 1995 1994 1993 1992
================================================================================
NET ASSET VALUE, BEGINNING OF YEAR $12.71 $12.39 $12.75 $12.86 $13.08
- --------------------------------------------------------------------------------
INCOME FROM OPERATIONS:
Net investment income (1) 1.92 0.73 0.59 0.69 0.78
Net realized and unrealized gain
(loss) (1.72) 0.38 (0.34) (0.10) (0.15)
- --------------------------------------------------------------------------------
Total Income From Operations 0.20 1.11 0.25 0.59 0.63
- --------------------------------------------------------------------------------
LESS DISTRIBUTIONS FROM:
Net investment income (1.92) (0.74) (0.58) (0.69) (0.78)
Net realized gains -- (0.05) (0.03) (0.01) (0.07)
- --------------------------------------------------------------------------------
Total Distributions (1.92) (0.79) (0.61) (0.70) (0.85)
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $10.99 $12.71 $12.39 $12.75 $12.86
- --------------------------------------------------------------------------------
TOTAL RETURN 1.57% 8.83% 1.99% 4.59% 4.82%
- --------------------------------------------------------------------------------
NET ASSETS END OF YEAR
(000s) $435 $2,315 $2,528 $2,615 $2,974
- --------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses (1) 1.00% 0.97% 0.86% 0.98% 1.01%
Net investment income 4.98 5.30 4.77 4.90 5.41
- --------------------------------------------------------------------------------
PORTFOLIO TURNOVER RATE 0% 17% 81% 0% 18%
================================================================================
(1) The Manager waived all or a portion of its fees as follows: $0.15 per
share (0.45% of average net assets) in 1996, $0.01 per share (0.05% of
average net assets) in 1993 and $0.03 per share (0.34% of average net
assets) in 1992 with respect to the Reserve Account Portfolio, subject to a
voluntary waiver of the fee to the extent that the aggregate expenses of any
Portfolio exceed 1.00% of the average daily net assets for any year. In
addition, the manager reimbursed the Portfolio for $19,681 in expenses for
the year ended December 31, 1996.
In addition, if such fees were not waived and expenses reimbursed the per
share decrease in net investment income and expense ratio would have been
$0.65 and 2.97%, respectively for the year ended December 31, 1996.
-26-
<PAGE>
[KPMG PEAT MARWICK LLP LETTERHEAD]
THE SHAREHOLDERS AND TRUSTEES OF
SMITH BARNEY VARIABLE ACCOUNT FUNDS:
We have audited the accompanying statements of assets and liabilities,
including the schedules of investments, of the Income and Growth, U.S.
Government/High Quality Securities and the Reserve Account Portfolios of Smith
Barney Variable Account Funds as of December 31, 1996, the related statements of
operations for the year then ended, the statements of changes in net assets for
each of the years in the two-year period then ended and the financial highlights
for each of the years in the five-year period then ended. These financial
statements and financial highlights are the responsibility of the Funds'
management. Our responsibility is to express an opinion on these financial
statements and financial highlights based on our audits.
We conducted our audits 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
December 31, 1996, by correspondence with the custodian. As to securities
purchased but not received, 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 audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of the
Income and Growth, U.S. Government/High Quality Securities and the Reserve
Account Portfolios of Smith Barney Variable Account Funds as of December 31,
1996, the results of their operations for the year then ended, the changes in
their net assets for each of the years in the two-year period then ended and
the financial highlights for each of the years in the five-year period then
ended, in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
February 12, 1997
-27-
<PAGE>
- --------------------------------------------------------------------------------
Tax Information (unaudited)
- --------------------------------------------------------------------------------
The amount of long-term capital gains paid by the Income and Growth
Portfolio to its shareholders for the fiscal year ended December 31, 1996 was
$3,677,164.
-28-
