[Morgan Grenfell Logo]
Morgan Grenfell SMALLCap Fund, Inc.
Annual Report
1996
<PAGE>
- --------------------------------------------------------
1996 - A gain of +20.8% and a successful rights offering
- --------------------------------------------------------
A huge universe of potential investment opportunities
- --------------------------------------------------------
Long term experience in smaller company investing
- --------------------------------------------------------
TO OUR SHAREHOLDERS:
The stock market indices which are representative of both large and smaller
companies recorded another year of strong gains during 1996. The pattern of
performance throughout the year was one of strong gains for both asset classes
until early June, followed by a sharp correction until late July and then a
recovery period through year end. It was during these later two periods that
large companies outperformed smaller companies resulting in large cap stocks
being the "winner" for the third year in a row.
o The Fund's gain in net asset value of +20.8% for the full year was slightly
below the +21.3% gain for the S&P SmallCap 600 index and lagged the large
company S&P 500 and Dow Jones Industrial Average, which gained +23.0% and
+28.8%, respectively.
o During June, 1996, the Fund completed a nontransferable rights offering
which raised approximately $27 million. This offering increased the Fund's
total assets to over $100 million and will hopefully help increase investor
interest in the Fund.
A detailed discussion of the Fund's performance and portfolio structure is
contained in the "Review of 1996" section beginning on page three.
For the benefit of shareholders, and especially the Fund's new
shareholders, a description of the Fund's universe of investment opportunity and
how our smaller capitalization equities team is structured to find these
opportunities is presented below.
INVESTMENT UNIVERSE
The Fund's investment universe is comprised of companies representing the
lowest 20% of the market capitalization of all publicly-traded equities with a
minimum market capitalization of $10 million. At the end of 1996, this universe
represented approximately 6,000 companies ranging in size between $10 million
and $1.8 billion.
INVESTMENT TEAM
Morgan Grenfell Capital Management's Smaller Capitalization Equities
investment team is comprised of four experienced professionals. Three have
investment research/portfolio management responsibility and work with our fourth
member, a dedicated trader, to develop execution strategies. This unique
approach, which has been designed specifically for smaller company investing,
provides each member of the team with beginning-to-end involvement in the
investment process as well as bottom-line accountability.
1
<PAGE>
- ---------------------------------------------------
A specialized approach to smaller company investing
- ---------------------------------------------------
Stock Selection - the key to success in 1997
- ---------------------------------------------------
Our investment team, along with their primary economic sector
responsibilities, is listed below.
Smaller Capitalization
Equities Team Sector Responsibility
------------------------- ----------------------------------
David Baratta Consumer/Health Care
Audrey Jones Credit Sensitive/Transportation
Energy/Process Industries
Robert Kern Technology/Capital Goods
Michael Murphy Trading
Investment research specialization by economic sector provides the advantage
of an in-depth understanding of each economic sector and industries within these
sectors. This knowledge provides our team with the ability to make high quality
individual company investment decisions.
A traditional approach to fundamental investment research represents the
foundation of our investment product. Original investment research
encompasses not only the financial analysis of companies, but also entails
extensive travel by each member of the team to visit companies and discuss
business strategies with corporate managements.
A team approach, with investment expertise across all economic sectors,
provides the Fund with the ability to structure a broadly diversified
portfolio within the universe of smaller companies as well as the ability to
shift investment emphasis among sectors.
OUTLOOK
The economic environment and the relatively low level of inflation favored
financial assets during 1996. Entering 1997, these favorable conditions continue
to prevail and combined with the high level of positive cash flows into mutual
funds, the stock market is off to a strong start.
Although the large company stock market indices; i.e., the S&P 500 and Dow
Jones Industrial Average, are outperforming the smaller company benchmarks early
this year, we believe that the potential for investors to find the best
investment opportunities is still within the huge universe of smaller companies.
In our view the future growth potential of many of these companies is not
fully recognized by most investors, and our smaller capitalization equities team
is highly qualified to select the most attractive investment opportunities.
The forecast by some stock market strategists that 1997 will be a "Stock
Pickers" market is expected to favour our fundamental research approach to stock
selection.
/s/ Robert E. Kern, Jr.
President
Morgan Grenfell SMALLCap Fund
January, 1997
2
<PAGE>
- -----------------------------------------------------------------
Long term performance in excess of the S&P SmallCap 600 benchmark
- -----------------------------------------------------------------
A REVIEW OF 1996
PERFORMANCE
At the end of 1996, the Fund's net asset value was $12.23 per-share and when
adjusted for the $1.60 per-share distribution from capital gains and the rights
offering in June 1996, the increase in net asset value for the year was +20.8%.
Performance of the Fund and comparisons with the popular stock market
averages are presented in the table below.
<TABLE>
<CAPTION>
Smaller Companies Large Companies
MG SMALLCap --------------------- ---------------
Fund S&P Russell S&P
Period Net Asset Value SmallCap 600 2000 500 D.J.I.A.
- --------------------------------- ------------ -------- ------- --------
<S> <C> <C> <C> <C> <C>
1996 +20.8% +21.3% +16.49% +23.0% +28.8%
1995 +41.4 +30.0 +28.44 +37.4 +36.7
1994 -3.5 -4.8 -1.81 +1.3 +4.9
1993 +8.5 +18.8 +18.89 +10.1 +17.0
1992 +4.0 +21.0 +18.42 +7.6 +7.4
1991 +52.5 +48.5 +46.05 +30.5 +24.2
1990 -13.4 -23.7 -19.50 -3.1 -0.4
1989 +24.6 +13.9 +16.24 +31.6 +31.6
1988 +19.1 +19.5 +24.89 +16.5 +15.9
Total Return
From Inception +194.0% +148.2% +160.96% +244.2% +279.4%
(5/6/87-12/31/96)
</TABLE>
Performance of the Fund's net asset value was slightly below the S&P
SmallCap 600 index, which is representative of the smaller company universe.
Large companies outperformed smaller companies for the third year in a row
and achieved especially strong performance during the second half of 1996.
3
<PAGE>
- ----------------------------------------------------------------------------
Broad diversification across the smaller Company Universe
- ----------------------------------------------------------------------------
The Energy, Credit Sensitive and Technology sectors were the best performers
- ----------------------------------------------------------------------------
PORTFOLIO STRUCTURE
The following table presents the portfolio structure of the Fund by economic
sector and changes in portfolio structure during 1996.
<TABLE>
<CAPTION>
NO. MARKET %
ECONOMIC SECTOR COMPANIES VALUE PORTFOLIO
- ------------------------- ------------- ------------------ -------------
1995 1996 1995 1996 1995 1996 Change
------ ------ --------- -------- ------ ------ --------
<S> <C> <C> <C> <C> <C> <C> <C>
Technology 17 11 $18.7MM $ 23.6MM 21% 19% -2
Consumer 18 15 13.2 18.6 15 15 0
Energy 10 11 10.3 18.1 12 14 +2
Credit Sensitive 12 11 9.8 15.5 11 12 +1
Service Companies 8 11 9.4 14.8 10 12 +2
Health Care 12 8 9.4 8.4 11 6 -5
Transportation 4 4 1.9 4.8 2 4 +2
Process Industries 6 3 4.5 4.1 5 3 -2
Capital Goods 1 1 1.4 0.6 2 1 -1
- ------------------------- ------ ------ -------- ---------- ------ ------ --------
TOTAL EQUITIES 88 75 $78.6MM $108.6MM 89% 86% -3
Cash and Cash Equivalents 9.4 17.7 11 14 +3
- -------------------------- -------- ---------- ------ ------ --------
TOTAL FUND $88.0MM $126.3MM 100% 100% --
</TABLE>
During 1996 the Fund's best performing sectors were: Energy (+72%), Credit
Sensitive (+38%) and Technology (+37%). Investment in these sectors represented
about 45% of the Fund's total assets.
The Fund's portfolio remained broadly diversified throughout the year with
portfolio weightings within a range of 12% to 19% across five economic sectors
at year end.
Performance of the funds investments in the Consumer and Health Care sectors
was disappointing. The operating environment for many smaller companies in these
sectors was challenging. Both of these sectors were underweighted relative to
the benchmark S&P Small Cap 600 during 1996.
Cash reserves were 14% of total assets on 12/31/96. A significant portion of
these reserves were used to fund both the cash portion and stock repurchase
program associated with the capital gains distribution paid on January 27, 1997.
Following this distribution, cash reserves were approximately 5% of the Fund's
$111 million in total assets at the end of January.
4
<PAGE>
- -----------------------------------------------------------------------
The Fund's portfolio emphasizes successful emerging growth companies
- -----------------------------------------------------------------------
Capital Gains distributions totalling $1.60 per share
- -----------------------------------------------------------------------
TWENTY LARGEST HOLDINGS
December 31, 1996
<TABLE>
<CAPTION>
COMPANY SYMBOL LISTED BUSINESS FOCUS
- ------------------------ -------- ------ -----------------------------------
<S> <C> <C> <C>
Rational Software Corp. RATL OTC Computer Based Software
Devon Energy Corp. DVN AMEX Oil and Gas Producer
Lennar Corp. LEN NYSE Residential & Commercial Builder
Westpoint Stevens Inc. WPSN OTC Textile Products
Micrel Inc. MCRL OTC Analog Semiconductors
PRI Automation Inc. PRIA OTC Semiconductor Automation Equip.
Dime Bancorp Inc. DME NYSE New York Savings Bank
The Sports Authority Inc. TSA NYSE Sporting Goods Retailer
Delta and Pine Land Co. DLP NYSE Largest Cotton Seed Company
USFreightways Corp. USFC OTC Regional Motor Carrier
Sierra Semiconductor Co. SERA OTC Semiconductors, Communications
Actel Corp. ACTL OTC Field Programmable Gate Arrays
Analog Devices Inc. ADI NYSE Integrated Circuit Manufacturer
Sonic Corp. SONC OTC Drive-In Restaurants
United Meridian Corp. UMC NYSE Oil and Gas Producer
Henry Schein Inc. HSIC OTC Health Care Products Distributor
Triangle Pacific Corp. TRIP OTC Flooring & Kitchen Cabinets
BJ Services Co. BJS NYSE Oilfield Services
Synopsys Inc. SNPS OTC Integrated Circuit Design Software
NUCO2 Inc. NUCO OTC Bulk CO2 Services
</TABLE>
The top twenty holdings, which represent approximately 41% of the Fund's
total value, are comprised primarily of high quality emerging growth companies.
At the end of 1996, the average market capitalization of companies held in the
Fund was $917 million.
DIVIDENDS AND CAPITAL GAINS DISTRIBUTION
During 1996, the Fund declared capital gains distributions of $1.60 per
share. $1.11 of these distributions were taxed as long term capital gains and
$0.49 was taxed as short term capital gain (ordinary income). These dividends
were paid on January 27, 1997.
Entering 1997, the Fund has a net unrealized capital gain totaling
$23,860,143 or approximately $2.62 per share.
Net investment income represents dividends and interest income less expenses.
The Fund's investment objective is to seek capital appreciation; as a result,
focus will be on stocks with no significant yield. As in prior years, the Fund
had a net investment expense for 1996 and it is unlikely the Fund will pay a
dividend from net investment income.
5
<PAGE>
SCHEDULE OF INVESTMENTS
December 31, 1996
<TABLE>
<CAPTION>
COMMON STOCKS: 86.0%
-----------------------------
TECHNOLOGY: 18.7% MARKET
BUSINESS FOCUS SHARES VALUE
----------------------------- --------------------------------------- --------- -----------
<S> <C> <C> <C>
Rational Software Corp. Computer Software 93,400 $ 3,695,138
Micrel Inc. Analog Semiconductors 87,700 2,773,513
PRI Automation Inc. Semiconductor Automation Equip. 60,020 2,730,910
Sierra Semiconductor Co. Semiconductors, Communications 176,510 2,647,650
Actel Corp. Field Programmable Gate Arrays 107,200 2,546,000
Analog Devices Inc. Integrated Circuit Manufacturer 72,700 2,462,713
Synopsys Inc. CAE Software 42,650 1,972,562
Siebel Systems Inc. Salesforce Automation Software 56,200 1,517,400
Premiere Technologies Inc. Telecommunications Service Developer 57,070 1,426,750
Geoworks System & Application Software 47,990 1,175,755
SpeedFam International Inc. Semiconductor Mfg. Equipment 23,845 679,582
Perspective Biosystems Biotech Equipment and Supplies 1,797 12,467
------------
$23,640,440
CONSUMER: 14.8%
----------------------------
Westpoint Stevens Inc. Textile Products 93,800 $ 2,802,275
The Sports Authority Inc. Sporting Goods Retailer 125,175 2,722,556
Sonic Corp. Drive-In Restaurants 92,200 2,351,100
Furniture Brands Intl. Inc. Residential Furniture Manufacturer 138,800 1,943,200
Mohawk Industries Inc. Carpet Manufacturer 70,700 1,555,400
Williams Sonoma Inc. Fine Quality Cooking Equip. Retailer 31,300 1,138,538
*Central Parking Corp. Parking Facilities 32,700 1,095,450
Damark International Inc. General Merchandise 109,450 1,039,775
Service Merchandise Inc. Consumer Catalog Stores 213,700 908,225
Garden Ridge Corp. Specialty Home Accessories 102,290 882,251
Mondavi Robert Corp. Premium Quality Winery 18,100 660,650
Factory Card Outlet Corp. Party Supply Superstores 57,500 517,500
Rock Bottom Resturants Inc. Casual Dining Restaurants 39,700 411,888
Delias Catalog Merchandiser for Teen Apparel 16,800 333,900
Genesco Inc. Branded Men's and Women's Apparel 32,685 302,336
------------
$18,665,044
ENERGY: 14.3%
----------------------------
*Devon Energy Corp. Oil & Gas Producer 95,700 $ 3,325,575
United Meridian Corp. Oil & Gas Producer 46,500 2,406,375
BJ Services Co. Stimulation & Pumping Services 39,500 2,014,500
Seagull Energy Corp. Oil & Gas Producer 84,100 1,850,200
*Parker & Parsley Pete Co. Oil & Gas Producer 43,900 1,613,325
*Tidewater Inc. Marine Support Vessels 31,900 1,443,475
*Camco International Inc. Oil Field Services & Equipment 29,600 1,365,300
Seacor Holdings Inc. Marine Support Vessels 17,800 1,121,400
Marine Drilling Inc. Offshore Drilling Contractor 54,800 1,078,875
Benton Oil & Gas Co. Oil & Gas Producer 45,200 1,022,650
Triton Energy Corp. Oil & Gas Producer 18,000 873,000
------------
$18,114,675
CREDIT SENSITIVE: 12.3%
----------------------------
*Lennar Corp. Residential & Commer. Builders 109,000 $ 2,970,250
Dime Bancorp Inc. New York Savings Bank 184,900 2,727,275
Triangle Pacific Corp. Flooring & Kitchen Cabinets 86,700 2,086,219
Glendale Fed Bank Fed Svgs. California Savings & Loan 73,250 1,703,062
Credit Acceptance Corp. Auto Financing 51,700 1,214,950
*Bank UTD Corp. Texas Savings Bank 42,800 1,144,900
*Long Island Bancorp Inc. New York Savings Bank 29,900 1,015,000
*Paine Webber Group Inc. Financial Broker 29,250 822,656
Bank Plus Corp. California Savings Bank 65,000 747,500
First Alliance Corp. Nontraditional Mortgage Finance Co. 20,700 626,175
*Peoples Heritage Financial
Group Maine Savings Bank 17,318 484,904
------------
$15,542,891
6
<PAGE>
MARKET
HEALTH CARE: 6.6% BUSINESS FOCUS SHARES VALUE
---------------------------- --------------------------------------- --------- ------------
Henry Schein Inc. Healthcare Products Distributor 65,400 $ 2,248,125
Renal Care Group Inc. Dialysis Services. 50,700 1,603,388
Envoy Corp. Electronic Processing Services 42,100 1,578,750
Clintrials Research Inc. Clinical Research 53,650 1,220,537
America Medserve Corp. Pharmaceutical Services 54,750 848,625
Gensia Pharmaceuticals Inc. Pharmaceuticals 103,189 477,249
Quorum Health Group Inc. Hospital Management Company 10,000 297,500
Imnet Systems Inc. Electronic Information systems 3,600 87,300
-------------
$ 8,361,474
SERVICE COMPANIES: 11.7%
----------------------------
*Delta & Pine Land Co. Largest Cotton Seed Company 84,305 $ 2,697,760
NUCO2 Inc. Bulk CO2 Services 146,000 1,943,625
American Radio Systems Corp. Radio Broadcasting Company 66,500 1,812,125
Paging Network Inc. Paging Services 90,800 1,384,700
Mail Boxes Etc. Postal Service Centres 58,595 1,318,388
*Checkpoint Systems Retail Security Systems 52,500 1,299,375
Philip Environmental Inc. Environmental services 80,200 1,162,900
Ultrak Inc. Closed Circuit TV Producer 32,100 979,050
*Chancellor Broadcasting Radio Broadcasting 40,345 958,193
Daisytek International Corp. Non-Paper Office Supplies 16,300 668,300
Vanguard Cellular Systems Inc. Cellular Telephone Services 35,800 563,850
-------------
$ 14,788,266
PROCESS INDUSTRIES: 3.2%
----------------------------
*P.H. Glatfelter Co. Paper Manufacturer 84,100 $ 1,513,800
*Bowater Inc. Newsprint and Paper Producer 38,800 1,459,850
*Rayonier Inc. Forest Products & Specialty Pulp 29,000 1,112,875
-------------
$ 4,086,525
TRANSPORTATION: 3.8%
----------------------------
*USFreightways Corp. Regional Motor Carrier 96,900 $ 2,658,694
*Atlantic Southeast Airlines Air Carrier 45,300 990,937
*Royal Caribbean Cruises Cruise line 26,000 607,750
Midwest Express Holdings Inc. Regional Airline 14,800 532,800
-------------
$ 4,790,181
CAPITAL GOODS: 0.5%
----------------------------
Miller Industries Inc. Towing and Recovery Equip. 29,467 $ 589,350
-------------
$ 589,350
TOTAL COMMON STOCKS (Cost $84,718,703) $108,578,846
COMMERCIAL PAPER: 14.1%
----------------------------
American Express Corp. (Cost $17,700,000) 17,770,000
--------------
TOTAL INVESTMENTS: 100% (Cost $102,488,703) $126,348,846
==============
</TABLE>
*Income producing security.
See accompanying notes to financial statements
7
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1996
Assets:
Investments in securities at market value, cost $102,488,703 $126,348,846
Cash 763,505
Receivables
Investment Securities sold 79,622
Accrued income 23,502
------------
$127,215,475
Liabilities:
Capital Gain Distributions Payable $ 14,540,694
Payable for investment securities purchased 1,132,226
Accrued expenses 406,583
-----------
Total liabilities $ 16,079,503
Net assets $111,135,972
============
Net assets:
Common stock; $0.01 par value; 9,087,934 shares issued;
150,000,000 shares authorized $ 90,879
Capital in excess of par value 86,673,270
Net unrealized appreciation of investments 23,860,143
Undistributed net capital gains 511,680
------------
Net assets $111,135,972
============
Net asset value per share as of the close of business on
December 31, 1996 $ 12.23
============
See accompanying notes to financial statements
8
<PAGE>
STATEMENT OF OPERATIONS
For the Year Ended December 31, 1996
Investment income:
Interest $ 733,666
Cash dividends 338,600
Miscellaneous income 113,508
------------
$ 1,185,774
Expenses:
Investment advisory fees (Note 2) $ 1,011,473
Custodian and transfer agent fees 128,465
Professional fees 242,005
Shareholder communications 257,618
Directors' fees 52,144
Insurance 31,999
Regulatory fees 21,004
Miscellaneous 6,998
------------
$ 1,751,706
Net investment expense $ (565,932)
Realized and unrealized gain/(loss) on investments:
Proceeds from sales $160,912,231
Less-cost of securities sold 145,255,939
------------
Net realized gain on investments $ 15,656,292
Unrealized appreciation:
Beginning of year $ 19,672,203
End of year 23,860,143
------------
Net increase in unrealized appreciation on investments $ 4,187,940
------------
Net realized and unrealized gain on investments $ 19,844,232
------------
Net increase in net assets resulting from operations $ 19,278,300
============
See accompanying notes to financial statements
STATEMENT OF CHANGES IN NET ASSETS
For the Years Ended December 31, 1996 and 1995
<TABLE>
<CAPTION>
1996 1995
-------------- --------------
<S> <C> <C>
Increase (decrease) in net assets resulting from
operations:
Net investment expense $ (565,932) $ (21,332)
Net realized gain on investments 15,656,292 13,989,230
Net change in unrealized appreciation 4,187,940 11,580,154
------------ ------------
Net increase in net assets resulting from operations $ 19,278,300 $ 25,548,052
Distributions from net realized gains (14,540,694) (12,888,514)
Net proceeds from shares sold and reinvested 32,617,287 2,648,895
Cost of shares redeemed (618,155) -
------------ ------------
Increase in net assets $ 36,734,278 $ 15,308,433
------------ ------------
Net assets:
Beginning of year 74,401,694 59,093,261
------------ ------------
End of year $111,135,972 $ 74,401,694
============ ============
</TABLE>
See accompanying notes to financial statement
9
<PAGE>
NOTES TO FINANCIAL STATEMENTS
December 31, 1996
1. Significant Accounting Policies
Morgan Grenfell SMALLCap Fund, Inc. (the "Fund") was organized as a Maryland
corporation on January 16, 1987 and is registered under the Investment Company
Act of 1940, as amended, as a closed-end, diversified management investment
company. The Fund commenced operations on May 6, 1987.
The following is a summary of the significant accounting policies
consistently followed by the Fund in the preparation of its financial
statements. The policies are in conformity with generally accepted accounting
principles.
Portfolio valuation: Securities listed on an exchange and over-the-counter
securities quoted on the NASDAQ system are valued on the basis of the last
sale price on the last business day of the year. Over-the-counter securities
not quoted on the NASDAQ system are valued on the basis of the average bid
and asked prices on that date. Commercial paper is carried at cost, which
approximates market.
Securities transactions and investment income: Securities transactions are
recorded on a trade date basis. Dividend income is recorded on the
ex-dividend date and interest income is recorded on the accrual basis.
Realized gains and losses from securities transactions are recorded on the
basis of identified cost.
Federal income taxes: It is the policy of the Fund to qualify as a
regulated investment company by complying with provisions available to
certain investment companies, as defined in applicable sections of the
Internal Revenue Code, and to make distributions of income and securities
profits (after application of net capital loss carryovers) sufficient to
relieve it from all, or substantially all, Federal income taxes.
On the statement of assets and liabilities, as a result of certain
differences in the computation of net investment income and net realized
capital gains on investments under federal income tax rules and regulations
versus generally accepted accounting principles, a reclassification has been
made to decrease undistributed net capital gains and increase undistributed
net investment loss in the amount of $565,932. In addition $1,203,514 was
reclassified from undistributed net capital gains to capital in excess of par
value.
Use of estimates: The preparation of financial statements, in conforming
with generally accepted accounting principles, requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amount
of increase and decrease in assets from operations during the reporting
period. Actual results can differ from the estimates.
2. Investment Advisory Fee and Other Transactions with Affiliates
The Fund pays advisory fees for investment and advisory services to Morgan
Grenfell Capital Management Inc. ("MGCM"), a wholly-owned subsidiary of Deutsche
Morgan Grenfell. Under the terms of the investment advisory agreement, the
management fee is calculated at an annual rate of one percent of the Fund's
average daily net assets.
Certain individuals who are officers or directors, or both, of the Fund
are also officers or directors, or both, of MGCM.
3. Capital Share Transactions
In June 1996 the Fund commenced a rights offering. The Fund issued 2,672,921
shares of its common stock upon the completion of a non-transferable rights
offering, bringing the total outstanding shares to 9,087,934. The subscription
price was $10.71 per share (95% of the average last reported sales price of a
share of the Fund's common stock on the NYSE on June 14, 1996, the expiration
date, and the four preceding business days). The offering was over-subscribed
and net proceeds totaled approximately $27 million. As the subscription price
was less than the net asset value per share of the Fund's common stock on the
pricing date, the offer resulted in a dilution of the net asset value per share
for all shareholders.
During 1996, 1995, 1994, 1992 and 1990 the Fund issued 426,804, 256,925,
103,447, 441,639 and 229,642 shares, respectively, under the dividend
reinvestment plan.
4. Investment Transactions
The aggregate cost of securities purchased and the aggregate proceeds of
securities sold during the year ended December 31, 1996, excluding short-term
investments, were $169,182,410 and $160,912,231 respectively. At December 31,
1996, the cost of investments for Federal income tax purposes was substantially
the same as the cost for financial reporting purposes.
10
<PAGE>
5. Dividend Reinvestment Plan
Pursuant to the Fund's Dividend Reinvestment Plan (the "Plan"), all dividends
from net investment income and/or all capital gain distributions will be
reinvested by The Bank of New York, as agent for shareholders in administering
the Plan (the "Plan Agent"), in additional shares of the Fund. Registered
shareholders are deemed to participate in the Plan unless they elect to receive
all dividends from net investment income and/or all capital gains distributions
in the form of cash. Each registered shareholder at the time of purchase will
receive from the Plan Agent an authorization card to be signed and returned if
the shareholder elects to receive distributions from net investment income in
cash or elects not to receive capital gain distributions in the form of a stock
dividend. Shareholders whose shares are held in the name of a broker or nominee
or shareholders transferring such an account to a new broker should contact such
broker or nominee to elect to participate in the Plan or to receive their
distributions in cash.
Participating shareholders will receive dividends from net investment
income and/or all capital gain distributions in additional shares issued by
the Fund if the shares are trading at a premium; i.e., the net asset value
("NAV") is less than the then-current market price. In such event, the number
of additional shares to be issued by the Fund will be determined by valuing
such shares at the higher of (i) their net asset value or (ii) 95% of the
market price. If shares of the Fund are trading at a discount; i.e., the NAV
exceeds the then-current market price, the Plan Agent will, as agent for the
participants, apply such dividends or distributions to purchase shares in the
open market, on the New York Stock Exchange or elsewhere, for the
participants' accounts. In such case, the price of the shares to each
participating shareholder will be the average market price at which such
shares were purchased under the direction of the Plan Agent. There will be no
brokerage charges for shares directly issued by the Fund; however, brokerage
commissions incurred on open market purchases will be borne pro rata by each
participant. There is no direct service charge to participants in the Plan;
the fees of the Plan Agent will be borne by the Fund. However, the Fund
reserves the right to amend the Plan to include such a charge payable by the
participants or for other reasons.
Participants in the Plan may elect to withdraw from the Plan at any time
upon written notice to the Plan Agent and thereby elect to receive all
distributions from net investment income in cash and/or all capital gain
distributions either in the form of a stock dividend or in cash. The written
notice will not be effective with respect to distributions made within seven
days of its receipt by the Plan Agent. If notice is received after a record
date, a shareholder's request will be completed after the determination of
shares for that dividend has been credited to the shareholder's account.
Dividends and capital gain distributions are taxable whether paid in cash or
reinvested in additional shares, and the reinvestment of dividends and
capital gain distributions will not relieve participants of liability for any
U.S. income tax that may be payable (or required to be withheld) on such
dividends or distributions. Additional information about the Plan is
available by calling the Plan Agent's Shareholder Relations Department at
1-800-432-8224.
11
<PAGE>
SUPPLEMENTARY INFORMATION
Financial Highlights
Contained below is per-share operating performance data for a share of
common stock outstanding, total investment return, ratios to average net
assets, and other supplemental data for the nine years ended December 31,
1996, and for the period May 6, 1987 (commencement of operations) through
December 31, 1987. This information has been derived from information
provided in the financial statements and market price data for the Fund's
shares.
<TABLE>
<CAPTION>
Years Ended December 31
-------------------------------------------
1996 1995 1994 1993
--------- ---------- --------- ---------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $ 12.31 $ 10.21 $ 11.85 $ 11.97
Net investment expense (0.06) (0.00) (0.07) (0.08)
Net gain/(loss) on securities
(realized and unrealized) 2.18 4.23 (0.34) 1.10
-------- ------- ------- -------
Total from investment operations $ 2.12 $ 4.23 $ (0.41) $ 1.02
Less dividends and distributions:
Tax return of capital distribution (1.60) (2.13) (1.23) (1.14)
-------- ------- ------- -------
Total dividends and distributions $ (1.60) $ (2.13) $ (1.23) $ (1.14)
-------- ------- ------- -------
Dilution due to rights offering (0.60) -- -- --
--------
Net asset value, end of year $ 12.23 $ 12.31 $ 10.21 $ 11.85
======== ======= ======= =======
Market value per share, end of year $ 10.50 $12.625(2) $ 8.875 $10.875
TOTAL INVESTMENT RETURN:
Based on market value per share +17.5% +42.3% -7.1% -1.9%
Based on net asset value per share +20.8% +41.4% -3.5% +8.5%
RATIOS TO AVERAGE NET ASSETS:
Expenses 1.76% 1.51% 1.52% 1.39%
Net investment income (expense) (0.57%) (0.03%) (0.59%) (0.74%)
SUPPLEMENTAL DATA:
Net assets at end of year (000 omitted) $111,135 $74,402 $59,093 $67,321
Average net assets during
year (000 omitted) $ 99,372 $72,202 $66,064 $69,048
Portfolio turnover 162% 110% 105% 89%
Average commission per share* $ 0.1046 -- -- --
Total debt outstanding at end
of year (000 omitted) 0 -0- -0- -0-
Asset coverage per $1000 of
debt (000 omitted) N/A N/A N/A N/A
</TABLE>
(1) Annualized.
(2) The Fund declared a $2.133 capital gain distribution payable to
shareholders of record on December 29, 1995. The dividend was paid on
January 26, 1996 and the Fund's shares traded with the dividend until the
ex-dividend date, January 29, 1996.
* In the fiscal year beginning January 1, 1996, the fund is required to
disclose average commission per share for the purchase and sale of
investment securities.
12
<PAGE>
May 6, 1987
Years Ended December 31 (commencement of
- ------------------------------------------------ operations) through
1992 1991 1990 1989 1988 12/31/87
- -------- ------- -------- ------- ------- ---------------------
$ 12.30 $ 8.70 $ 10.80 $ 8.87 $ 7.45 $ 9.27
(0.09) (0.10) (0.11) (0.11) (0.11) (0.16)
0.58 4.67 (1.34) 2.29 1.53 (1.66)
- -------- ------- ------- ------- ------- --------
$ 0.49 $ 4.57 $ (1.45) $ 2.18 $ 1.42 $ (1.82)
(0.82) (0.97) (0.65) (0.25) -- --
- -------- ------- ------- ------- ------- --------
$ (0.82) $ (0.97) $ (0.65) $ (0.25) $ 0.00 $ 0.00
- -------- ------- ------- ------- -------
-- -- -- -- -- --
$ 11.97 $ 12.30 $ 8.70 $ 10.80 $ 8.87 $ 7.45
======== ======== ======= ======== ======= ========
$12.250 $12.875 $ 8.750 $ 9.625 $ 7.375 $ 6.000
+1.5% +58.0% -2.2% +34.2% +22.9% -40.0%
+4.0% +52.5% -13.4% +24.6% +19.1% -19.7%
1.44% 1.79% 2.01% 2.13% 2.56% 4.32%(1)
(0.83%) (0.85%) (1.05%) (1.10%) (1.30%) (1.80%)(1)
$68,013 $64,461 $45,581 $54,136 $44,462 $37,316
$64,644 $58,900 $51,121 $50,522 $43,422 $44,062
89% 70% 75% 80% 83% 98%(1)
-- -- -- -- -- --
-0- $ 1,060 $ 1,724 $ 2,324 $ 2,868 $ 3,360
N/A $ 60.8 $ 26.4 $ 23.3 $ 15.5 $ 11.1
13
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Shareholders
Morgan Grenfell SMALLCap Fund, Inc.:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of Morgan Grenfell SMALLCap Fund, Inc. as
of December 31, 1996, and the related statement of operations for the year then
ended, the statement of changes in net assets for each of the years in the
two-year period ended December 31, 1996, and the financial highlights for each
of the years in the nine-year period ended December 31, 1996 and for the period
May 6, 1987 (commencement of operations) through December 31, 1987. 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 audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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 include confirmation of securities owned as of
December 31, 1996, by correspondence with the custodian and brokers. 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 Morgan
Grenfell SMALLCap Fund, Inc., as of December 31, 1996, the result of its
operations for the year then ended, changes in net assets for each of the years
in the two-year period ended December 31, 1996 and the financial highlights for
each of the years in the nine-year period ended December 31, 1996, and for the
period May 6, 1987 (commencement of operations) through December 31, 1987, in
conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
New York, New York
January 31, 1997
14
<PAGE>
Morgan Grenfell Capital Management, Inc. (the Advisor to the Morgan Grenfell
SMALLCap Fund) is a subsidiary of Morgan Grenfell Asset Management Limited
(MGAM), which in turn is a subsidiary of Deutsche Morgan Grenfell (DMG) and
is responsible for the Deutsche Bank Group's institutional investment
management activities worldwide. Morgan Grenfell was founded in 1838 and is
one of the UK's leading merchant banks and asset management groups. Since
1990, Morgan Grenfell has been a wholly- owned subsidiary of Deutsche Bank,
AG, one of the largest financial institutions in the world. Currently MGAM
manages in excess of $110 billion for a wide range of pension, corporate,
insurance, local authority, government and private clients from more than 40
countries worldwide.
Shares of the Morgan Grenfell SMALLCap Fund are traded on the New York Stock
Exchange under the symbol "MGC."
In accordance with Section 23(c) of the Investment Company Act of 1940, the
Fund hereby serves notice that it may from time to time repurchase shares of
the Fund in the open market at the option of the Board of Directors.
SHAREHOLDER INFORMATION SERVICE
Information regarding the Fund's net asset value is available by calling
1-800-888-8060. Additional shareholder information can be obtained by calling
1-800-432-8224 through the Bank of New York's Shareholder Relations
Department. The Fund's net asset value is reported each week in The Wall
Street Journal and Barron's.
15
<PAGE>
MORGAN GRENFELL
SMALLCap FUND, INC. DIRECTORS AND OFFICERS
- --------------------------------------------------------------------------------
Michael Bullock Audrey M.T. Jones
CHAIRMAN AND DIRECTOR VICE PRESIDENT
Chief Investment Officer Executive Vice President
Morgan Grenfell Asset Morgan Grenfell Capital
Management, Ltd. Management, Inc.
Robert E. Kern, Jr. Mark G. Arthus
PRESIDENT AND DIRECTOR SECRETARY AND TREASURER
Executive Vice President Senior Vice President
Morgan Grenfell Capital Morgan Grenfell Capital
Management, Inc. Management, Inc.
Robert E. Greeley INDEPENDENT AUDITORS
DIRECTOR KPMG Peat Marwick, LLP
Partner 345 Park Avenue
Page Mill Asset Management Co. New York, NY 10286
Joseph J. Incandela TRANSFER AGENT & CUSTODIAN
DIRECTOR The Bank of New York
Partner/Managing Director 101 Barclay Street
Thomas H. Lee Company New York, NY 10154
Richard D. Wood INVESTMENT ADVISOR
DIRECTOR Morgan Grenfell Capital
Consultant Management, Inc.
885 Third Avenue
New York NY 10022
