MG
-------------
AM
Morgan Grenfell SMALLCap Fund, Inc.
------------------------------
Annual Report
1997
------------------------------
<PAGE>
<PAGE>
TO OUR SHAREHOLDERS:
Adetailed discussion of the Fund's performance and portfolio
structure is contained in the "Review of 1997" section beginning on page four.
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
1997, this universe represented over 6,000 companies ranging in size between
$10 million and $2.5 billion.
INVESTMENT TEAM
Morgan Grenfell Capital Management's Smaller Capitalization
Equities investment team is comprised of three co-managers. Each of these
portfolio managers has expertise, and stock selection responsibility, within
specific sectors of the small companies market. Collectively, the team
determines the allocation of the Fund's assets across sectors. The portfolio
managers are supported by a team of analysts and specialized trading
capability. 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.
Our investment team, along with their primary economic sector
responsibilities, is listed below.
Smaller Capitalization
Equities Team Sector Responsibility
- -------------------------- ----------------------------------
David Baratta Consumer/Capital Goods
Audrey Jones Credit Sensitive/Energy/
Process Industries/Transportation
John Callaghan Technology/Health Care
Investment management 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 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.
1
<PAGE>
OUTLOOK
The Small Cap Equity Team anticipated a narrowing of the valuation
discrepancy between large caps and small caps for much of 1997. It appeared to
have begun in the second and third quarters, but by year end the valuations of
small stocks relative to large stocks neared the lows seen following the crash
of 1987 and during the Gulf War in 1990.
The Federal Reserve Board has maintained its steady interest rate policy
while it remains vigilant to the threat of inflation. While most of the
monetary policy discussion during the year focused on inflation, FRB Chairman
Alan Greenspan has stated the that the Fed will be vigilant against deflation
as well. A low interest rate environment coupled with a healthy domestic
economy should bode well for small cap growth stocks.
Cash flows into equity mutual funds slowed during the fourth quarter,
especially into aggressive growth funds. Investors poured money into bond funds
as the Asian financial crisis led to economic uncertainty and a decline in
interest rates. However, the popularity of equity funds should continue as
individuals assume responsibility for their own retirement planning.
The structure of the U.S. economy, with its high level of entrepreneurial
activity and venture capital backing, is expected to continue to provide
investors with many attractive investment opportunities as early stage private
companies shift to public ownership. Restructuring and consolidation trends
create many opportunities for smaller company investors.
Our investment strategy is to continue to find companies with above
average growth rates selling at reasonable valuations. Our team will continue
to focus primarily on individual stock selection with the goal of providing
value-added performance relative to the universe of U.S. smaller companies.
The outlook remains positive. Small cap growth stocks are at near historic
lows relative to both large cap stocks and small cap value stocks. In addition,
small cap earnings continue to produce solid earnings. However, uncertainty
remains both domestically and globally as to the direction of the economy. With
uncertainty, the stock market is certain to be volatile. Among individual
securities, earnings disappointments continue to present the primary investment
risk.
2
<PAGE>
A REVIEW OF 1997
PERFORMANCE
At the end of 1997, the Fund's net asset value was $11.58 per-share and
when adjusted for the $2.34 per-share distribution from capital gains the
increase in net asset value for the year was +14.6%.
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>
1997 14.6% 25.6% 22.4% 33.4% 24.7%
1996 20.8% 21.3% 16.5% 23.0% 28.8%
1995 41.4% 30.0% 28.4% 37.4% 36.7%
1994 -3.5% -4.8% -1.8% 1.3% 4.9%
1993 8.5% 18.8% 18.9% 10.1% 17.0%
1992 4.0% 21.0% 18.4% 7.6% 7.4%
1991 52.5% 48.5% 46.1% 30.5% 24.2%
1990 -13.4% -23.7% -19.5% -3.1% -0.4%
1989 24.6% 13.9% 16.2% 31.6% 31.6%
1988 19.1% 19.5% 24.9% 16.5% 15.9%
Total Return
From Inception
(5/6/87-12/31/97) 235.9% 211.7% 219.4% 359.2% 373.1%
</TABLE>
The Morgan Grenfell SMALLCap Fund had another positive year. However, the
Fund's NAV return of 14.6% underperformed the S&P 600 index return of 25.6%.
The large, liquid stocks that comprise the S&P 500 index posted an even higher
return of 33.4% for the year. The S&P 600 and the S&P 500 are representative of
small- and large-cap companies, respectively. The overall bull market in
equities stalled during the fourth quarter as the Asian financial crisis
quelled investor enthusiasm.
Small cap stocks ultimately relinquished the lead they had taken over
large stocks during the second and third quarters. Similar to the first
quarter, small cap growth stocks were the worst performing domestic equity
asset class in the fourth quarter. The Russell 2000 Growth index of small cap
growth stocks declined 8.2% for the quarter and posted an annual return of only
13.0%. In the first quarter, it was fear of inflation which induced investors'
flight to large company stocks. In the fourth quarter, the Asian situation
produced a different fear--deflation--but the effect was the same. Investors
again sought shelter in stock with a high degree of liquidity.
3
<PAGE>
PORTFOLIO STRUCTURE
The following table presents the portfolio structure of the Fund by
economic sector and changes in portfolio structure during 1997:
<TABLE>
<CAPTION>
ECONOMIC NO. MARKET %
SECTOR COMPANIES VALUE PORTFOLIO
- -------------------- ------------- ------------------------- -------------
1996 1997 1996 1997 1996 1997 Change
------ ------ ------------ ------------ ------ ------ -------
<S> <C> <C> <C> <C> <C> <C> <C>
Consumer 15 19 $ 18.7MM $ 23.7MM 15 20 +5
Credit Sensitive 11 10 15.5 21.1 12 17 +5
Health Care 8 14 8.4 18.5 6 15 +9
Technology 11 11 23.6 11.1 19 9 -10
Service Companies 11 9 14.8 10.8 12 9 -3
Energy 11 6 18.1 10.3 14 8 -6
Transportation 4 4 4.8 4.9 4 4 0
Process Industries 3 3 4.1 3.9 3 3 0
Capital Goods 1 1 0.6 0.1 1 1 0
- -------------------- -- -- --------- --------- --- --- ---
TOTAL EQUITIES 75 77 $ 108.6MM $ 104.4MM 86% 86 0
Cash and Cash
Equivalents 17.7 16.4 14% 14 0
- -------------------- --------- --------- --- --- ---
TOTAL FUND $ 126.3MM $ 120.8MM 100% 100% 0
</TABLE>
Five of the Fund's nine economic sectors posted strong, double-digit
returns for the year: Credit Sensitive (+59%), Transportation (+41%), Consumer
(+19%), Process Industries (+13%), and Health Care (+10%). Low interest rates
and a healthy domestic economy helped these sectors. The other major sectors,
Technology (+1%) and Energy (-2%), were up handsomely most of the year, but
were hurt by a disappointing fourth quarter. Investors indiscriminately sold
Technology stocks as the Asian crisis unfolded. Fear of a worldwide economic
slowdown led investors to reduce their exposure to Energy stocks as well.
The Fund is broadly diversified across the main sectors of the U.S.
economy. As of December 31, 1997 there were 77 holdings in nine sectors. Three
sectors have weightings in excess of 10%: Consumer (20%), Credit Sensitive
(17%), and Health Care (15%). Cash was 14% of the Fund at year end. This
weighting was a tactical, not strategic, decision as the Fund raised cash to
pay out its annual dividend. The Fund aims to be fully invested. Indeed, cash
was 4% of the Fund on November 30, 1997 and 5% of the Fund on January 31, 1998.
4
<PAGE>
TWENTY LARGEST HOLDINGS
December 31, 1997
<TABLE>
<S> <C> <C> <C>
COMPANY SYMBOL LISTED BUSINESS FOCUS
- ----------------------------- -------- -------- -----------------------------------
Dime Bancorp Inc. DME NYSE New York Savings Bank
American Radio Systems AFM NYSE Radio Broadcasting Services
Trigon Healthcare Inc. TGH NYSE Managed Health Company
USFreightways Corp. USFC NASDAQ Regional Motor Carrier
LNR Property Corp. LNR NYSE Real Estate Investment Management
Furniture Brands Intl. Inc. FBN NYSE Residential Furniture Manufacturer
Triangle Pacific Corp. TRIP NASDAQ Hardwood Flooring
Westpoint Stevens Inc. WPSN NASDAQ Textile Products
Devon Energy Corp. DVN ASE Oil and Gas Exploration & Prodn.
Lennar Corp. LEN NYSE Residential & Commercial Builder
Henry Schein Inc. HSIC NASDAQ Health Care Products Distributor
Rental Service Corp. RSV NYSE Equipment Rental Company
Garden Ridge Corp. GRDG NASDAQ Speciality Home Accessories
B.J. Services Company BJS NYSE Stimulation & Pumping Services
Intuit Inc. INTU NASDAQ Financial Application Software
Golden State Bancorp Inc. GSB NYSE California Savings Bank
ATL Ultrasound Inc. ATLI NASDAQ Medical Ultrasound Equipment
Seagull Energy Corp. SGO NYSE Oil and Gas Exploration & Prodn.
Checkpoint Systems CKP NYSE Electronic Security Systems
Symantec Corp. SYMC NASDAQ Application and System Software
</TABLE>
The top twenty holdings, which represent approximately 40% of the Fund's
total value, are comprised primarily of high quality emerging growth companies.
At the end of 1997, the weighted average market capitalization of companies
held in the Fund was $1,162 million.
5
<PAGE>
SCHEDULE OF INVESTMENTS
December 31, 1997
<TABLE>
<S> <C> <C> <C>
COMMON STOCKS: 86.5%
- ------------------------------
MARKET
CONSUMER: 19.7% BUSINESS FOCUS SHARES VALUE
- ------------------------------ -------------------------------------------- ------- -----------
Furniture Brands Intl. Inc. Residential Furniture Manufacturer 125,500 $ 2,572,750
Westpoint Stevens Inc. Textile Products 53,900 2,546,775
Rental Service Corp. Equipment Rental Company 93,300 2,291,681
Garden Ridge Corp. Specialty Home Accessories 148,840 2,120,970
Viking Office Products Direct Marketer of Office Products 79,700 1,738,456
Mohawk Industries Carpet Manufacturer 78,700 1,726,481
Petsmart Inc. Pet Supplies Retailer 238,000 1,725,500
Regal Cinemas Inc. Theater Operator 57,800 1,611,175
Micro Warehouse Inc. Direct Marketer of Computers 110,900 1,545,669
Insight Enterprises Inc. Direct Marketer of Computers 32,450 1,192,538
Damark International A Direct Marketer of General Merchandise 119,250 1,162,688
Bally Total Fitness Commercial Operator of Fitness Centers 47,900 1,047,813
Equity Corp. International Funeral Home and Cemetery Operator 44,300 1,024,438
Scansource Inc. Distributor of Point of Sale Products 23,100 462,000
Factory Card Outlet Corp. Party Supply Superstores 51,300 355,894
Marketing Services Group Direct Marketing Services 49,600 235,600
Genesco Inc. Branded Apparel 15,685 199,984
Filene's Basement Corp. Designer Discount Retailer 44,400 177,600
Delia's Inc. Direct Marketer of Youth Apparel 1,050 23,361
-----------
$23,761,373
CREDIT SENSITIVE: 17.4%
- ------------------------------
* Dime Bancorp Inc. New York Savings Bank 184,900 $ 5,593,225
* LNR Property Corp. Real Estate Investment Management 109,000 2,575,125
Triangle Pacific Corp. Hardwood Flooring 75,300 2,550,788
* Lennar Corp. Residential & Commercial Builders 109,000 2,350,313
Golden State Bancorp Inc. California Savings Bank 52,550 1,964,056
* Bank United Corp. Texas Savings Bank 32,500 1,590,469
* Paine Webber Group Inc. Brokerage Company 43,875 1,516,430
* Long Island Bancorp New York Savings Bank 29,000 1,439,125
Bank Plus Corp. California Savings Bank 65,000 820,625
* Imperial Credit Comm. Mortgage Real Estate Investment Trust 45,400 663,974
-----------
$21,064,130
HEALTH CARE: 15.4%
- ------------------------------
Trigon Healthcare Inc. Managed Health Company 107,600 $ 2,811,050
Henry Schein Inc. Healthcare Products Distributor 66,000 2,310,000
ATL Ultrasound Inc. Medical Ultrasound Equipment 42,400 1,950,400
Sangstat Medical Corp. Medical Research Company 35,400 1,433,700
* Collagen Corp. Biomedical Devices 66,400 1,386,100
Quadramed Corp. Health Care Management Software 45,800 1,259,500
* Mentor Corp. Medical Products 31,000 1,131,500
Pathogenesis Corp. Medical Drug Development 29,200 1,084,050
Perrigo Company OTC Drug Manufacturer 80,100 1,071,338
Hologic Inc. Osteoporosis Diagnostics 47,400 980,588
Lincare Holdings Inc. Outpatient/Home Respiratory Therapy 16,100 917,700
Molecular Biosystems Inc. Ultrasound Imaging Agents 104,400 887,400
Steris Corp. Medical Sterilization Products 15,500 747,875
Cytyc Corp. Instruments/Medical Diagnostic Application 24,100 599,487
-----------
$18,570,688
TECHNOLOGY: 9.2%
- ------------------------------
Intuit Inc. Financial Application Software 50,000 $ 2,062,500
Symantec Corp. Application and System Software 83,700 1,836,169
Cognex Corp. Machine Vision Manufacturer 61,000 1,662,250
In Focus Systems Computer Periphery Equipment 41,100 1,248,413
Micrel Inc. Analog Power Integrated Circuits 39,500 1,106,000
Ortel Corp. Fiber Optic Signal Transmission Products 46,300 729,225
Xylan Corp. Networking Products/High Band Width 40,900 618,613
Dycom Industries Inc. Building & Maintenance of Telecom Systems 28,600 616,688
Pinnacle Systems Specialized Video Workstation & Software 21,400 521,625
Cree Research Inc. Silicon Carbide Electronic Devices 22,700 425,623
Intest Corp. Electronic Measurement Instruments 38,500 269,500
-----------
$11,096,606
</TABLE>
6
<PAGE>
<TABLE>
<S> <C> <C> <C>
MARKET
SERVICE COMPANIES: 9.0% BUSINESS FOCUS SHARES VALUE
- ------------------------------- ---------------------------------------------- ------- ------------
American Radio Systems Radio Broadcasting Services 52,800 $ 2,814,900
Checkpoint Systems Electronic Security Systems 105,000 1,837,500
Philip Services Corp. Metal Recovery and Processing Services 101,083 1,453,068
* Comsat Corp. Satellite Communications Services 55,700 1,350,725
Envoy Corp. Electronic Interchange Data Service 43,700 1,272,763
Consolidation Capital Conglomerate of Service Businesses 45,400 922,188
NUCO2 Inc. Bulk CO2 Services 42,450 466,950
Armor Holdings Security Services and Equipment 37,000 411,625
Imagemax Inc. Integrated Document Management Solutions 28,500 288,562
------------
$ 10,818,281
ENERGY: 8.5%
- -------------------------------
* Devon Energy Corp. Oil and Gas Exploration & Production 65,800 $ 2,533,300
B.J. Services Company Stimulation and Pumping Services 29,000 2,086,186
Seagull Energy Corp. Oil and Gas Exploration & Production 91,700 1,891,312
* Lomak Petroleum Inc. Oil and Gas Exploration & Production 92,100 1,496,624
Marine Drilling Co. Inc. Offshore Drilling Contractor 69,400 1,440,050
* Camco International Inc. Oil Field Services and Equipment 12,800 815,200
------------
$ 10,262,672
TRANSPORT: 4.0%
- -------------------------------
* USFreightways Corp. Regional Motor Carrier 80,700 $ 2,622,750
* ASA Holdings Inc. Air Carrier 45,300 1,288,219
* Royal Caribbean Cruises Cruise Line 16,200 863,663
Dynamex Inc. Same-Day Delivery Services 6,950 78,188
------------
$ 4,852,820
PROCESS: 3.2%
- -------------------------------
* P.H. Glatfelter Company Paper Manufacturer 78,000 $ 1,452,750
* Bowater Inc. Newsprint and Paper Producer 30,800 1,368,675
* Rayonier Inc. Forest Products & Specialty Pulp 24,200 1,030,013
------------
$ 3,851,438
CAPITAL GOODS: 0.1%
- -------------------------------
Brunswick Technologies Producer of Engineered Reinforcement Fabrics 10,800 $ 157,950
------------
TOTAL COMMON STOCKS: 86.5% (Cost $81,681,868) $104,435,958
COMMERCIAL PAPER: 13.5%
- -------------------------------
American Express Corp. (Cost $16,373,000) $ 16,373,000
------------
TOTAL INVESTMENTS: 100.0% (Cost $98,054,868) $120,808,958
============
</TABLE>
*Income producing security.
See accompanying notes to financial statements
7
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
<TABLE>
<S> <C>
Assets:
Investment in securities at market value,
cost $98,054,868; (including cash equivalents of $16,373,000) $120,808,958
Receivables:
Investment securities sold 1,612,315
Accrued income 33,342
------------
Total assets $122,454,615
Liabilities:
Capital gain distributions payable $ 19,889,321
Payable for investment securities purchased 133,689
Payable for shares repurchased 577,604
Accrued expenses 240,798
------------
Total liabilities $ 20,841,412
------------
Net assets $101,613,203
============
Net assets:
Common stock; $0.01 par value; 8,774,196 shares outstanding;
150,000,000 shares authorized $ 87,742
Treasury Stock (cost of 314,500 shares) (note 3) (3,883,946)
Capital in excess of par value 86,687,434
Net unrealized appreciation of investments 22,754,090
Undistributed net capital gains (4,032,117)
------------
Net assets applicable to 8,774,196 shares outstanding of beneficial
interest $101,613,203
============
Net asset value per share as of the close of business on
December 31, 1997 $ 11.58
============
</TABLE>
See accompanying notes to financial statements
8
<PAGE>
STATEMENT OF OPERATIONS
For the Year Ended December 31, 1997
<TABLE>
<S> <C> <C>
Investment Income:
Interest $ 516,041
Cash dividends 351,749
----------
Total Investment Income $ 867,790
Expenses:
Investment advisory fees (note 2) $1,169,641
Shareholder relations 199,774
Custodian and transfer agent fees 85,961
Regulatory fees 27,953
Legal fees 57,120
Audit fees 35,349
Directors' fees and expenses 29,886
Miscellaneous 15,286
Insurance 9,122
----------
Total Expenses $ (1,630,092)
------------
Net investment loss $ (762,302)
Realized and unrealized gain on investments:
Proceeds from sales $139,650,823
Less cost of securities sold 122,906,796
------------
Net realized gain on investments $ 16,744,027
Unrealized appreciation:
Beginning of year $ 23,860,143
End of year 22,754,090
------------
Net decrease in unrealized appreciation on investments $ (1,106,053)
Net realized and unrealized gain on investments $ 15,637,974
------------
Net increase in net assets resulting from operations $ 14,875,672
============
</TABLE>
See accompanying notes to financial statements
STATEMENTS OF CHANGES IN NET ASSETS
For the Years Ended December 31, 1997 and 1996
<TABLE>
<S> <C> <C>
1997 1996
---- ----
Increase in net assets resulting from operations:
Net investment loss $ (762,302) $ (565,932)
Net realized gain on investments 16,744,027 15,656,292
Net change in unrealized appreciation (1,106,053) 4,187,940
------------- -------------
Net increase in net assets resulting from operations $ 14,875,672 $ 19,278,300
Distributions from net realized gains (20,525,524) (14,540,694)
Net proceeds from shares sold and reinvested 11,029 32,614,827
Cost of shares redeemed -- (618,155)
Cost of treasury shares purchased (3,883,946) --
------------- -------------
Net (decrease)/increase in net assets $ (9,522,769) $ 36,734,278
Net assets:
Beginning of year 111,135,972 74,401,694
------------- -------------
End of year $ 101,613,203 $ 111,135,972
============= =============
</TABLE>
See accompanying notes to financial statements
9
<PAGE>
NOTES TO FINANCIAL STATEMENTS December 31, 1997
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 ("GAAP").
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 GAAP, a reclassification has been made to decrease undistributed net
capital gains and increase undistributed net investment loss in the amount of
$762,302. In addition ($3,197,739) was reclassified from undistributed net
capital gains to capital in excess of par value.
Use of estimates: The preparation of financial statements in conformity
with GAAP 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 could differ from those
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 Morgan
Grenfell PLC. 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
Treasury Stock
In December 1997, 314,500 of the Fund's shares of common stock were
purchased on the open market at a total cost of $3,883,946 in connection with
the Fund's Dividend Reinvestment Plan. These shares are reflected in the
financial statements of the Fund as Treasury Shares.
During 1997, 1996, 1995, 1994, 1992 and 1990 the Fund issued 764, 372,578,
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, 1997, excluding short-term
investments, were $122,906,796 and $139,650,823, respectively. At December 31,
1997, 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. During certain market
conditions, it may be impracticable or impossible to complete a market purchase
program at prices below net asset value, and, in such event, the Fund itself
may in its discretion issue the required shares at net asset value. 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.
6. Federal Income Tax Information (unaudited)
For the calendar year ended December 31, 1997, 2.6028% of the ordinary
income dividend paid by the Fund qualified for the Corporate Dividends Received
Deduction.
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 ten years ended December 31, 1997,
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
-----------------------------------------------------------
1997 1996 1995 1994
---------- -------- -------- ---------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $ 12.23 $ 12.31 $ 10.21 $ 11.85
Net investment loss ( 0.09) ( 0.06) ( 0.00) ( 0.07)
Net gain/(loss) on securities
(realized and unrealized) 1.78 2.18 4.23 ( 0.34)
---------- -------- -------- ---------
Total from investment operations $ 1.69 $ 2.12 $ 4.23 $ (0.41)
Less distributions:
Distributions from capital gains ( 2.34) ( 1.60) ( 2.13) ( 1.23)
---------- -------- -------- ---------
Total distributions $ (2.34) $ (1.60) $ (2.13) $ (1.23)
---------- -------- -------- ---------
Dilution due to rights offering -- ( 0.60) -- --
---------- -------- -------- ---------
Net asset value, end of period $ 11.58 $ 12.23 $ 12.31 $ 10.21
========== ======== ======== =========
Market value per share, end of period $ 11.125 $ 10.50 $ 12.625 $ 8.875
TOTAL INVESTMENT RETURN:
Based on net asset value per share +14.6 +20.8 +41.4 % -3.5 %
Based on market value per share +28.5 +17.5 +42.3 % -7.1 %
RATIOS TO AVERAGE NET ASSETS:
Expenses 1.42 % 1.76 % 1.51 % 1.52 %
Net investment income (loss) ( 0.66 %) ( 0.57 %) ( 0.03 %) ( 0.59 %)
SUPPLEMENTAL DATA:
Net assets at end of year (000 omitted) $ 101,613 $ 111,135 $ 74,402 $ 59,093
Average net assets during year (000 omitted) $ 114,953 $ 99,372 $ 72,202 $ 66,064
Portfolio turnover 101% 162% 110% 105%
Average commission per share** $ 0.0837 $ 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>
* Annualized.
** 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>
<TABLE>
<CAPTION>
May 6, 1987
Years Ended December 31 commencement of
- ------------------------------------------------------------------------------------------------- operations) through
1993 1992 1991 1990 1989 1988 12/31/87
- ---------- ---- ---- ---- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C>
$ 11.97 $ 12.30 $ 8.70 $ 10.80 $ 8.87 $ 7.45 $ 9.27
( 0.08) ( 0.09) ( 0.10) ( 0.11) ( 0.11) ( 0.11) ( 0.16)
1.10 0.58 4.67 ( 1.34) 2.29 1.53 ( 1.66)
- ---------- --------- -------- --------- -------- -------- --------
$ 1.02 $ 0.49 $ 4.57 $ (1.45) $ 2.18 $ 1.42 $ (1.82)
( 1.14) ( 0.82) ( 0.97) ( 0.65) ( 0.25) -- --
- ---------- --------- -------- --------- -------- -------- --------
$ (1.14) $ (0.82) $ (0.97) $ (0.65) $ (0.25) $ 0.00 $ 0.00
- ---------- --------- -------- --------- -------- -------- --------
-- -- -- -- -- -- --
- ---------- --------- -------- --------- -------- -------- --------
$ 11.85 $ 11.97 $ 12.30 $ 8.70 $ 10.80 $ 8.87 $ 7.45
========== ========= ======== ========= ======== ======== ========
$ 10.875 $ 12.250 $ 12.875 $ 8.750 $ 9.625 $ 7.375 $ 6.000
+8.5 % +4.0 % +52.5 % -13.4 % +24.6 % +19.1 % -19.7 %
-1.9 % +1.5 % +58.0 % -2.2 % +34.2 % +22.9 % -40.0 %
1.39% 1.44 % 1.79 % 2.01 % 2.13 % 2.56 % 4.32% *
( 0.74%) ( 0.83 %) ( 0.85 %) ( 1.05 %) ( 1.10 %) ( 1.30 %) (1.80%) *
$ 67,321 $ 68,013 $ 64,461 $ 45,581 $ 54,136 $ 44,462 $37,316
69,048 $ 64,644 $ 58,900 $ 51,121 $ 50,522 $ 43,422 $44,062
89% 89% 70% 75% 80% 83% 98%*
-- -- -- -- -- -- --
-0- -0- $ 1,060 $ 1,724 $ 2,324 $ 2,868 $ 3,360
N/A N/A $ 60.8 $ 26.4 $ 23.3 $ 15.5 $ 11.1
</TABLE>
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, 1997, and the related statement of operations for the year
then ended, the statements of changes in net assets for each of the years in
the two-year period ended December 31, 1997, and the financial highlights for
each of the years in the ten-year period ended December 31, 1997 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 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, 1997, by correspondence with the custodian. 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, 1997, the result of its
operations for the year then ended, changes in its net assets for each of the
years in the two-year period ended December 31, 1997 and the financial
highlights for each of the years in the ten-year period ended December 31,
1997, 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
February 13, 1998
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 $140 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. The Fund's net asset value is reported each week in The Wall
Street Journal and Barron's.
THE BANK OF NEW YORK
1-800-524-4458
Address Shareholder Inquires To:
Shareholder Relations Department - 11E
P.O. Box 11258
Church Street Station
New York, NY 10286
E-Mail Address: [email protected]
The Bank of New York's Stock Transfer Website:
http://stock.bankofny.com
Send Certificates For Transfer and Address Changes To:
Receive and Deliver Department - 11W
P.O. Box 11002
Church Street Station
New York, NY 10286
15
<PAGE>
MORGAN GRENFELL
SMALLCap FUND DIRECTORS AND OFFICERS
- ---------------------------------------------------------------------
Michael Bullock Audrey M.T. Jones
CHAIRMAN AND DIRECTOR EXECUTIVE VICE PRESIDENT
Chief Investment Officer Executive Vice President
Morgan Grenfell Asset Morgan Grenfell Capital
Management, Ltd. Management, Inc.
James E. Minnick Joan A. Binstock
PRESIDENT AND DIRECTOR TREASURER
President Executive Vice President
Morgan Grenfell Capital Chief Operating Officer
Management, Inc. Morgan Grenfell Capital
Management, Inc.
Robert E. Greeley
DIRECTOR James A. Capezzuto
President SECRETARY
Page Mill Asset Management Ltd. Legal Officer
Morgan Grenfell Capital
Joseph J. Incandela Management, Inc.
DIRECTOR
Partner/Managing Director INDEPENDENT AUDITORS
Thomas H. Lee Co. KPMG Peat Marwick, LLP
757 Third Avenue
Richard D. Wood New York, NY 10017
DIRECTOR
Consultant TRANSFER AGENT & CUSTODIAN
The Bank of New York
101 Barclay Street
David A. Baratta New York, NY 10154
EXECUTIVE VICE PRESIDENT
Executive Vice President INVESTMENT ADVISOR
Morgan Grenfell Capital Morgan Grenfell Capital
Management, Inc. Management, Inc.
885 Third Avenue
32nd Floor
New York, NY 10022
