FRANKLIN BOND FUND - ADVISOR CLASS
FRANKLIN INVESTORS SECURITIES TRUST
STATEMENT OF
ADDITIONAL INFORMATION
AUGUST 3, 1998
777 MARINERS ISLAND BLVD., P.O. BOX 7777
SAN MATEO, CA 94403-7777 1-800/DIAL BEN
TABLE OF CONTENTS
How Does the Fund Invest Its Assets?.................... 2
What Are the Risks
of Investing in the Fund? ............................. 11
Investment Restrictions ................................ 14
Officers and Trustees .................................. 14
Investment Management
and Other Services..................................... 18
How Does the Fund Buy
Securities for Its Portfolio? ......................... 19
How Do I Buy, Sell
and Exchange Shares? .................................. 20
How Are Fund Shares Valued? ............................ 22
Additional Information on
Distributions and Taxes ............................... 23
The Fund's Underwriter ................................. 27
How Does the Fund
Measure Performance? .................................. 27
Miscellaneous Information .............................. 29
Useful Terms and Definitions ........................... 30
When reading this SAI, you will see certain terms beginning with capital
letters. This means the term is explained under "Useful Terms and Definitions."
The fund is a diversified series of Franklin Investors Securities Trust (the
"Trust"), an open-end management investment company. The Prospectus, dated
August 3, 1998, which we may amend from time to time, contains the basic
information you should know before investing in the fund. For a free copy, call
1-800/DIAL BEN.
This SAI describes the fund's Advisor Class shares. The fund currently offers
another share class with a different sales charge and expense structure, which
affects performance. To receive more information about the fund's other share
class, contact your investment representative or call 1-800/DIAL BEN.
THIS SAI IS NOT A PROSPECTUS. IT CONTAINS INFORMATION IN ADDITION TO AND IN MORE
DETAIL THAN SET FORTH IN THE PROSPECTUS. THIS SAI IS INTENDED TO PROVIDE YOU
WITH ADDITIONAL INFORMATION REGARDING THE ACTIVITIES AND OPERATIONS OF THE FUND,
AND SHOULD BE READ IN CONJUNCTION WITH THE PROSPECTUS.
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MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS:
o ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE
FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT;
o ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK;
o ARE SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL.
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HOW DOES THE FUND INVEST ITS ASSETS?
WHAT IS THE FUND'S GOAL?
The investment goal of the fund is to provide a high level of current income
consistent with the preservation of capital, with capital appreciation over the
long term as a secondary objective. This goal is fundamental, which means that
it may not be changed without shareholder approval.
The following gives more detailed information about the fund's investment
policies and the types of securities that it may buy. Please read this
information together with the section "How Does the Fund Invest Its Assets?" in
the Prospectus.
MORE INFORMATION ABOUT
THE KINDS OF SECURITIES THE FUND BUYS
DEBT SECURITIES. A debt security typically has a fixed payment schedule which
obligates the issuer to pay interest to the lender and to return the lender's
money over a certain period of time. A company typically meets its payment
obligations associated with its outstanding debt securities before it declares
and pays any dividends to holders of its equity securities. Bonds, notes,
debentures and commercial paper differ in the length of the issuer's payment
schedule, with bonds carrying the longest repayment schedule and commercial
paper the shortest.
The market value of debt securities generally varies in response to changes in
interest rates and the financial condition of each issuer. During periods of
declining interest rates, the value of debt securities generally increases.
Conversely, during periods of rising interest rates, the value of these
securities generally declines. These changes in market value will be reflected
in the fund's Net Asset Value.
MORTGAGE-BACKED SECURITIES. The fund may invest in mortgage-backed securities
issued or guaranteed by the Government National Mortgage Association ("GNMA"),
the Federal National Mortgage Association ("FNMA") and the Federal Home Loan
Mortgage Corporation ("FHLMC"), as well as mortgage-backed securities issued or
guaranteed by foreign governments or governmental agencies or by private
institutions.
A mortgage-backed security is an interest in a pool of mortgage loans. The
primary issuers or guarantors of these securities are GNMA, FNMA and FHLMC. GNMA
creates mortgage-backed securities from pools of government guaranteed or
insured (Federal Housing Authority or Veterans Administration) mortgages
originated by mortgage bankers, commercial banks, and savings and loan
associations. FNMA and FHLMC issue mortgage securities from pools of
conventional and federally insured and/or guaranteed residential mortgages
obtained from various entities, including savings and loan associations, savings
banks, commercial banks, credit unions, and mortgage bankers. The principal and
interest on GNMA securities are guaranteed by GNMA and backed by the full faith
and credit of the U.S. government. Mortgage securities from FNMA and FHLMC are
not backed by the full faith and credit of the U.S. government. FNMA guarantees
full and timely payment of all interest and principal, and FHLMC guarantees
timely payment of interest and the ultimate collection of principal. Securities
issued by FNMA are supported by the agency's right to borrow money from the U.S.
Treasury under certain circumstances. Securities issued by FHLMC are supported
only by the credit of the agency. There is no guarantee that the government
would support government agency securities and, accordingly, they may involve a
risk of non-payment of principal and interest. Nonetheless, because FNMA and
FHLMC are instrumentalities of the U.S. government, these securities are
generally considered to be high quality investments having minimal credit risks.
Most mortgage-backed securities are pass-through securities, which means that
they provide investors with monthly payments consisting of a pro rata share of
both regular interest and principal payments, as well as unscheduled early
prepayments, on the underlying mortgage pool. The fund invests in both
"modified" and "straight" pass-through securities. For "modified pass-through"
type mortgage securities, principal and interest are guaranteed, whereas such
guarantee is not available for "straight pass-through" securities.
Guarantees as to the timely payment of principal and interest do not extend to
the value or yield of mortgage-backed securities nor do they extend to the value
of the fund's shares. In general, the value of fixed-income securities varies
with changes in market interest rates. Fixed-rate mortgage securities generally
decline in value during periods of rising interest rates, whereas coupon rates
of adjustable rate mortgage securities move with market interest rates, and thus
their value tends to fluctuate to a lesser degree. In view of these factors, the
ability of the fund to obtain a high level of total return may be limited under
varying market conditions.
COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS"), REAL ESTATE MORTGAGE INVESTMENT
CONDUITS ("REMICS") AND MULTI-CLASS PASS-THROUGHS. The fund may invest in
certain debt obligations that are collateralized by mortgage loans or mortgage
pass-through securities. These obligations may be issued or guaranteed by U.S.
government agencies or issued by certain financial institutions and other
mortgage lenders. CMOs and REMICs are debt instruments issued by special purpose
entities and are secured by pools of mortgages backed by residential and various
types of commercial properties. Multi-class pass-through securities are equity
interests in a trust composed of mortgage loans or other mortgage-backed
securities. Payments of principal and interest on the underlying collateral
provides the funds to pay debt service on the CMO or REMIC or make scheduled
distributions on the multi-class pass-through securities.
CMOs are collateralized by pools of mortgage loans created by commercial banks,
savings and loan institutions, private mortgage insurance companies, mortgage
bankers and other issuers in the U.S. Timely payment of interest and principal
(but not the market value and yield) of some of these pools is supported by
various forms of insurance or guarantees issued by private issuers, those who
pool the mortgage assets and, in some cases, by U.S. government agencies.
Prepayments of the mortgages underlying a CMO, which usually increase when
interest rates decrease, will generally reduce the life of the mortgage pool,
thus impacting the CMO's yield. Under these circumstances, the reinvestment of
prepayments will generally be at a rate lower than the rate applicable to the
original CMO.
With a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of a CMO, often referred to as a "tranche," is issued at a specified
coupon rate or adjustable rate and has a stated maturity or final distribution
date. Principal prepayments on collateral underlying a CMO, however, may cause
it to be retired substantially earlier than the stated maturities or final
distribution dates. Interest is paid or accrues on all classes of a CMO on a
monthly, quarterly or semiannual basis. The principal and interest on the
underlying mortgages may be allocated among several classes of a series in many
ways. In a common structure, payments of principal, including any principal
prepayments, on the underlying mortgages are applied to the classes of a series
of a CMO in the order of their respective stated maturities or final
distribution dates, so that no payment of principal will be made on any class of
a CMO until all other classes having an earlier stated maturity or final
distribution date have been paid in full. Some of the CMOs in which the fund may
invest may be less liquid than other types of mortgage securities. A lack of
liquidity in the market for CMOs could result in the fund's inability to dispose
of such securities at an advantageous price under certain circumstances.
To the extent any privately issued CMOs in which the fund invests are considered
by the SEC to be an investment company, the fund will limit its investments in
such securities in a manner consistent with the provisions of the 1940 Act.
REMICs, which are authorized under the Tax Reform Act of 1986, are private
entities formed for the purpose of holding a fixed pool of mortgages secured by
an interest in real property. REMICs are similar to CMOs in that they issue
multiple classes of securities. As with CMOs, the mortgages that collateralize
the REMICs in which the fund may invest include mortgages backed by GNMAs or
other mortgage pass-throughs issued or guaranteed by the U.S. government, its
agencies or instrumentalities or issued by private entities, which are not
guaranteed by any government agency.
Yields on privately-issued CMOs have been historically higher than the yields
on CMOs issued or guaranteed by U.S. government agencies. However, the risk
of loss due to default on such instruments is higher since they are not
guaranteed by the U.S. government.
STRIPPED MORTGAGE-BACKED SECURITIES. The fund may invest in stripped
mortgage-backed securities to achieve a higher yield than may be available from
fixed-rate mortgage securities. The stripped mortgage-backed securities in which
the fund may invest will not be limited to those issued or guaranteed by
agencies or instrumentalities of the U.S. government, although such securities
are more liquid than privately issued stripped mortgage-backed securities.
Stripped mortgage-backed securities are usually structured with two classes,
each receiving different proportions of the interest and principal distributions
on a pool of mortgage assets. Typically, one class will receive some of the
interest and most of the principal from the mortgage assets, while the other
class will receive most of the interest and the remainder of the principal. In
the most extreme case, one class will receive all of the interest (the
interest-only or "IO" class), while the other class will receive all of the
principal (the principal-only or "PO" class). The yield to maturity of an IO and
PO class is extremely sensitive not only to changes in prevailing interest rates
but also to the rate of principal payments (including prepayments) on the
related underlying mortgage assets.
Stripped mortgage-backed securities have greater market volatility than other
types of mortgage securities in which the fund invests and are purchased and
sold by institutional investors, such as the fund, through several investment
banking firms acting as brokers or dealers. Some of these securities may be
illiquid. The staff of the SEC has indicated that only government-issued IO or
PO securities that are backed by fixed-rate mortgages may be deemed to be
liquid, if procedures with respect to determining liquidity are established by a
fund's Board. The Board may, in the future, adopt procedures that would permit
the fund to acquire, hold, and treat as liquid government-issued IO and PO
securities. At the present time, however, all such securities will be treated as
illiquid and will, together with any other illiquid investments, not exceed 15%
of the fund's net assets. This position may be changed in the future, without
notice to shareholders, in response to the staff's continued reassessment of
this matter, as well as to changing market conditions.
As new types of mortgage-backed securities are developed and offered to
investors, the fund may invest in them if they are consistent with the fund's
objectives, policies and quality standards.
OTHER STRUCTURED INVESTMENTS. In addition to CMOs and stripped mortgage-backed
securities, the fund may invest in other structured investments such as
collateralized loan obligations and collateralized bond obligations. These
securities typically are issued in one or more classes that are backed by or
represent an interest in certain underlying instruments with the cash flows on
the underlying instruments apportioned among the classes to create securities
with different investment characteristics such as varying maturities, payment
priorities or interest rate provisions. The fund may invest in structured
investments that are either subordinated or unsubordinated to the right of
payment of another class. Subordinated structured investments typically have
higher yields and present greater risks than unsubordinated structured
investments. Although the fund's purchase of subordinated structured investments
would have a similar economic effect to that of borrowing against the underlying
securities, the purchase will not be deemed to be leverage for purposes of the
limitations placed on the extent of the fund's assets that may be used for
borrowing activities.
Certain issuers of structured investments may be deemed to be "investment
companies" as defined in the 1940 Act. As a result, the fund's investment in
these structured investments may be limited by the restrictions contained in the
1940 Act. Structured investments are often sold in private placement
transactions. To the extent such investments are illiquid, they will be subject
to the fund's restrictions on investments in illiquid securities.
ADJUSTABLE RATE MORTGAGE SECURITIES. The fund may invest in adjustable rate
mortgage securities ("ARMs"). ARMs, like traditional mortgage-backed securities,
are an interest in a pool of mortgage loans and are issued or guaranteed by a
federal agency or by private issuers. Unlike fixed-rate mortgages, which
generally decline in value during periods of rising interest rates, the interest
rates on the mortgages underlying ARMs are reset periodically and thus allow the
fund to participate in increases in interest rates, resulting in both higher
current yields and lower price fluctuations. During periods of declining
interest rates, of course, the coupon rates may readjust downward, resulting in
lower current yields. Because of this feature, the value of an ARM is unlikely
to rise during periods of declining interest rates to the same extent as a
fixed-rate instrument. The rate of amortization of principal, as well as
interest payments, for certain types of ARMs change in accordance with movements
in a pre-specified, published interest rate index. There are several categories
of indices, including those based on U.S. Treasury securities, those derived
from a calculated measure, such as a cost of funds index, or a moving average of
mortgage rates and actual market rates. The amount of interest due to an ARM
security holder is calculated by adding a specified additional amount, the
"margin," to the index, subject to limitations or "caps" on the maximum and
minimum interest that is charged to the mortgagor during the life of the
mortgage or to maximum and minimum changes to that interest rate during a given
period. The interest rates paid on the ARMs in which the fund may invest are
generally readjusted at intervals of one year or less, although instruments with
longer resets such as three, five, seven and ten years are also permissible
investments.
The underlying mortgages that collateralize the ARMs in which the fund may
invest will frequently have caps and floors which limit the maximum amount by
which the loan rate to the residential borrower may change up or down (1) per
reset or adjustment interval and (2) over the life of the loan. Some residential
mortgage loans restrict periodic adjustments by limiting changes in the
borrower's monthly principal and interest payments rather than limiting interest
rate changes. These payment caps may result in negative amortization, which can
extend the average life of the securities. Since most ARMs in the fund's
portfolio will generally have annual reset limits or caps of 100 to 200 basis
points, fluctuations in interest rates above these levels could cause the
mortgage securities to "cap out" and to behave more like long-term, fixed-rate
debt securities.
ASSET-BACKED SECURITIES. The fund may invest in asset-backed securities. The
assets underlying these securities may include, but are not limited to,
receivables on home equity and credit card loans, and automobile, mobile home
and recreational vehicle loans and leases. There may be other types of
asset-backed securities that are developed in the future in which the fund may
invest. Asset-backed securities are issued in either a pass-through structure
(similar to a mortgage pass-through structure) or in a pay-through structure
(similar to a CMO structure). In general, asset-backed securities contain
shorter maturities than bonds or mortgage loans. The rate of principal payment
on asset-backed securities generally depends on the rate of principal payments
received on the underlying assets. The payment rate may be affected by various
economic and other factors. Therefore, the yield may be difficult to predict,
and actual yield to maturity may be more or less than the anticipated yield to
maturity.
The credit quality of most asset-backed securities depends primarily on the
credit quality of the underlying assets, how well the issuers of the securities
are insulated from the credit risk of the originator or affiliated entities, and
the amount of credit support provided to the securities. Asset-backed securities
entail certain risks not presented by mortgage-backed securities as they do not
have the benefit of the same type of security interests in the underlying
collateral. Credit card receivables are generally unsecured and a number of
state and federal consumer credit laws give debtors the right to set off certain
amounts owed on the credit cards, thereby reducing the outstanding balance. In
the case of automobile receivables, there is a risk that the holders may not
have either a proper or first security interest in all of the obligations
backing such receivables due to the large number of vehicles involved in a
typical issuance and the technical requirements imposed under state laws.
Therefore, recoveries on repossessed collateral may not always be available to
support payments on securities backed by these receivables.
Asset-backed securities are often backed by a pool of assets representing the
obligations of a number of different parties. To lessen the effect of failures
by obligors on the underlying assets to make payments, asset-backed securities
may contain elements of credit support. Credit support falls into two
categories: (i) liquidity protection and (ii) protection against losses from the
default by an obligor on the underlying assets. Liquidity protection refers to
advances, generally provided by the entity administering the pool of assets, to
ensure that the receipt of payments due on the underlying pool is timely.
Protection against losses from the default by an obligor enhances the likelihood
of payments of the obligations on at least some of the assets in the pool. This
protection may be provided through guarantees, insurance policies, or letters of
credit obtained by the issuer or sponsor from third parties, through various
means of structuring the transaction, or through a combination of these
approaches. The fund will not pay any additional fees for credit support,
although the existence of credit support may increase the price of a security.
Examples of credit support arising out of the structure of the transaction
include "senior subordinated securities" (multiple class securities with one or
more classes that are subordinate to the other classes with respect to the
payment of principal and interest, with the result that defaults on the
underlying assets are borne first by the holders of the subordinated class),
creation of "reserve funds" (where cash or investments, sometimes funded from a
portion of the payments on the underlying assets, are held in reserve against
future losses), and "over-collateralization" (where the scheduled payments on,
or the principal amount of, the underlying assets exceeds that required to make
payments on the securities and pay any servicing or other fees). The degree of
credit support provided is generally based on historical information respecting
the level of credit risk associated with the underlying assets. Delinquencies or
losses in excess of those anticipated could adversely affect the return on an
investment in the securities.
WHEN ISSUED AND DELAYED DELIVERY TRANSACTIONS. The fund may buy U.S. government
obligations on a "when issued" or "delayed delivery" basis. These transactions
are arrangements under which the fund buys securities that have been authorized
but not yet issued with payment for and delivery of the security scheduled for a
future time, generally in 30 to 60 days. Purchases of U.S. government securities
on a when issued or delayed delivery basis are subject to the risk that the
value or yields at delivery may be more or less than the purchase price or the
yields available when the transaction was entered into. Although the fund will
generally buy U.S. government securities on a when issued basis with the
intention of holding the securities, it may sell the securities before the
settlement date if it is deemed advisable. When the fund is the buyer in this
type of transaction, it will maintain, in a segregated account with its
custodian bank, cash or high-grade marketable securities having an aggregate
value equal to the amount of the fund's purchase commitments until payment is
made. To the extent the fund engages in when issued and delayed delivery
transactions, it will do so only for the purpose of acquiring portfolio
securities consistent with its investment objectives and policies, and not for
the purpose of investment leverage. In when issued and delayed delivery
transactions, the fund relies on the seller to complete the transaction. The
seller's failure to do so may cause the fund to miss a price or yield considered
advantageous to the fund. Securities purchased on a when issued or delayed
delivery basis do not generally earn interest until their scheduled delivery
date. Entering into a when issued or delayed delivery transaction is a form of
leverage that may affect changes in Net Asset Value to a greater extent.
MORTGAGE DOLLAR ROLLS. The fund may enter into mortgage dollar rolls in which
the fund sells mortgage-backed securities for delivery in the current month and
simultaneously contracts to repurchase substantially similar (name, type, coupon
and maturity) securities on a specified future date. During the period between
the sale and repurchase, the fund forgoes principal and interest paid on the
mortgage-backed securities. The fund is compensated by the difference between
the current sale price and the lower price for the future purchase (often
referred to as the "drop"), as well as by the interest earned on the cash
proceeds of the initial sale. A "covered roll" is a specific type of mortgage
dollar roll for which there is an offsetting cash position or a cash equivalent
security position. The fund could suffer a loss if the contracting party fails
to perform the future transaction in that the fund may not be able to buy back
the mortgage-backed securities it initially sold. The fund intends to enter into
mortgage dollar rolls only with government securities dealers recognized by the
Federal Reserve Board or with member banks of the Federal Reserve System.
FUTURES CONTRACTS. The fund may enter into contracts for the purchase or sale
for future delivery of financial futures and foreign currency futures and
options on these contracts. Financial futures contracts are commodity contracts
that obligate the long or short holder to take or make delivery of a specified
quantity of a financial instrument, such as a security, or the cash value of a
securities index during a specified future period at a specified price. A "sale"
of a futures contract means the acquisition of a contractual obligation to
deliver the securities called for by the contract at a specified price on a
specified date. A "purchase" of a futures contract means the acquisition of a
contractual obligation to acquire the securities called for by the contract at a
specified price on a specified date. Futures contracts have been designed by
exchanges that have been designated "contracts markets" by the Commodity Futures
Trading Commission ("CFTC") and must be executed through a futures commission
merchant, or brokerage firm, which is a member of the relevant contract market.
At the time of delivery of securities on the settlement date of a contract,
adjustments are made to recognize differences in value arising from the delivery
of securities with different interest rates from that specified in the contract.
In some (but not many) cases, securities called for by a futures contract may
not have been issued when the contract was written.
Although futures contracts by their terms call for the actual delivery or
acquisition of securities, in most cases the contractual obligation is fulfilled
before the date of the contract without having to make or take delivery of the
securities. The termination of a contractual obligation is accomplished by
buying (or selling, as the case may be) on a commodities exchange an identical
futures contract calling for delivery in the same month. Such a transaction,
which is effected through a member of an exchange, cancels the obligation to
make or take delivery of the securities. Since all transactions in the futures
market are made, offset or fulfilled through a clearinghouse associated with the
exchange on which the contracts are traded, the fund will incur brokerage fees
when it buys or sells futures contracts.
To the extent the fund enters into a futures contract, it will deposit in a
segregated account with its custodian bank cash or U.S. Treasury obligations
equal to a specified percentage of the value of the futures contract (the
"initial margin"), as required by the relevant contract market and futures
commission merchant. The futures contract will be marked to the market daily.
Should the value of the futures contract decline relative to the fund's
position, the fund will be required to pay the futures commission merchant an
amount equal to such change in value. The fund may also cover its futures
position by holding a call option on the same futures contract permitting the
fund to purchase the instrument or currency at a price no higher than the price
established in the futures contract which it sold.
Generally, the purpose of the acquisition or sale of a futures contract is to
attempt to protect the fund from fluctuations in the price of portfolio
securities without actually buying or selling the underlying security, although
the fund may engage in futures and related options to earn additional income.
For example, if the fund owns long-term bonds, and interest rates were expected
to increase, the fund might enter into futures contracts for the sale of debt
securities. Such a sale would have much the same effect as selling an equivalent
value of the long-term bonds owned by the fund. If interest rates did increase,
the value of the debt securities owned by the fund would decline, but the value
of the futures contracts to the fund would increase at approximately the same
rate, thereby keeping the Net Asset Value of the fund from declining as much as
it otherwise would have. The fund could accomplish similar results by selling
bonds with long maturities and investing in bonds with short maturities when
interest rates are expected to increase. However, since the futures market is
often more liquid than the cash (securities) market, the use of futures
contracts as an investment technique allows the fund to maintain a defensive
position without having to sell its portfolio securities. Similarly, if the fund
expects that a foreign currency in which its securities are denominated will
decline in value against the U.S. dollar, the fund may sell futures contracts on
that currency. If the foreign currency does decline in value, the decrease in
value of the security denominated in that currency will be offset by an increase
in the value of the fund's futures position.
Alternatively, when it expects that interest rates may decline, the fund may
purchase futures contracts in an attempt to hedge against the anticipated
purchase of long-term bonds at higher prices. Since the fluctuations in the
value of futures contracts should be similar to that of long-term bonds, the
fund could take advantage of the anticipated rise in the value of long-term
bonds without actually buying them until the market had stabilized. At that
time, the futures contracts could be liquidated and the fund could then buy
long-term bonds on the cash (securities) market. Similarly, if the fund intends
to acquire a security or other asset denominated in a currency that is expected
to appreciate against the U.S. dollar, the fund may purchase futures contracts
on that currency. If the value of the foreign currency does appreciate, the
increase in the value of the futures position will offset the increased U.S.
dollar cost of acquiring the asset denominated in that currency.
The ordinary spreads between prices in the cash and futures markets, due to
differences in the nature of those markets, are subject to distortions. First,
all participants in the futures market are subject to initial deposit and
variation margin requirements. Rather than meeting additional variation margin
requirements, investors may close futures contracts through offsetting
transactions which could distort the normal relationship between the cash and
futures markets. Second, the liquidity of the futures market depends on
participants entering into offsetting transactions rather than making or taking
delivery. To the extent participants decide to make or take delivery, liquidity
in the futures market could be reduced, thus causing distortion. Third, from the
point of view of speculators, the margin deposit requirements in the futures
market are less onerous than margin requirements in the securities market.
Therefore, increased participation by speculators in the futures market may
cause temporary price distortions. Due to the possibility of distortion, a
correct forecast of general interest rate trends by Advisers may still not
result in a successful transaction.
OPTIONS ON FUTURES CONTRACTS. The fund may buy and sell (write) options on
futures contracts. Depending on the pricing of the option compared to either the
price of the futures contract upon which it is based or the price of the
underlying debt securities or currency, it may or may not be less risky than
direct ownership of the futures contract of the underlying debt securities or
currency.
If the fund writes a call option on a futures contract and the futures price at
expiration of the option is below the exercise price, the fund will retain the
full amount of the option premium, which may provide a partial hedge against any
decline that may have occurred in the value of the fund's portfolio holdings. If
the futures price at expiration of the option is higher than the exercise price,
the fund will retain the full amount of the option premium, which may provide a
partial hedge against any increase in the price of securities which the fund
intends to purchase. If a put or call option the fund has written is exercised,
the fund will incur a loss, which will be reduced by the amount of the premium
it received. The fund may lose the entire amount of the premium (plus related
transaction costs) paid for options it has purchased if the option expires
worthless. Depending on the degree of correlation between changes in the value
of its portfolio securities and changes in the value of its futures positions,
the fund's losses from existing options on futures may to some extent be reduced
or increased by changes in the value of its portfolio securities.
The fund's ability to engage in the options on futures strategies described
above will depend on the availability of liquid markets in such instruments.
Markets in options on futures are relatively new and still developing, and it is
impossible to predict the amount of trading interest that may exist in various
types of options on futures. Therefore, no assurance can be given that the fund
will be able to utilize these instruments effectively for the purposes set forth
above. Furthermore, the fund's ability to engage in options on futures
transactions may be limited by tax considerations.
OPTIONS ON FOREIGN CURRENCIES. The fund may purchase and write options on
foreign currencies for hedging purposes in a manner similar to that in which
futures contracts on foreign currencies, or forward contracts, will be utilized.
For example, a decline in the dollar value of a foreign currency in which
portfolio securities are denominated will reduce the dollar value of such
securities, even if their value in the foreign currency remains constant. In
order to protect against such reductions in the value of portfolio securities,
the fund may purchase put options on the foreign currency. If the value of the
currency does decline, the fund will have the right to sell such currency for a
fixed amount in dollars and will thereby offset, in whole or in part, the
adverse effect on its portfolio which otherwise would have resulted.
Conversely, where a rise in the dollar value of a currency in which securities
to be acquired are denominated is projected, thereby increasing the cost of the
securities, the fund may purchase call options on such currency. The purchase of
options could offset, at least partially, the effects of the adverse movements
in currency exchange rates. As with other types of options, however, the benefit
the fund derives from purchases of foreign currency options will be reduced by
the amount of the premium and related transaction costs. In addition, where
currency exchange rates do not move in the direction or to the extent
anticipated, the fund could sustain losses on transactions in foreign currency
options that would require the fund to forego a portion or all of the benefits
of advantageous changes in such rates.
The fund may also write options on foreign currencies for hedging purposes. For
example, where the fund anticipates a decline in the dollar value of foreign
currency-denominated securities due to adverse fluctuations in currency exchange
rates the fund could, instead of purchasing a put option, write a call option on
the relevant currency. If the expected decline occurs, the option will most
likely not be exercised, and the diminution in value of portfolio securities
will be offset by the amount of the premium received.
Similarly, instead of purchasing a call option to hedge against an anticipated
increase in the dollar cost of securities to be acquired, the fund could write a
put option on the relevant currency. If currency exchange rates increase as
projected, the put option will expire unexercised and the premium received will
offset the increased cost. As with other types of options, however, the writing
of a foreign currency option will constitute only a partial hedge up to the
amount of the premium received, and only if rates move in the expected
direction. If this does not occur, the option may be exercised and the fund
would be required to purchase or sell the underlying currency at a loss, which
may not be fully offset by the amount of the premium received. As a result of
writing options on foreign currencies, the fund may also be required to forego
all or a portion of the benefits that might otherwise have been obtained from
favorable changes in currency exchange rates.
All call options written on foreign currencies will be covered. A call option on
foreign currencies written by the fund is "covered" if the fund owns (or has an
absolute right to acquire) the underlying foreign currency covered by the call.
A call option is also covered if the fund has a call on the same foreign
currency in the same principal amount as the call equal to or less than the
exercise price of the call written or (b) is greater than the exercise price of
the call written if the difference is maintained by the fund in cash and U.S.
government securities in a segregated account with its custodian.
The fund proposes to take advantage of investment opportunities in the area of
futures contracts and options on futures contracts that are not presently
contemplated for use by the fund or that are not currently available but which
may be developed in the future, to the extent such opportunities are both
consistent with the fund's investment objective and policies and are legally
permissible transactions for the fund. These opportunities, if they arise, may
involve risks that are different from those involved in the options and futures
activities described above.
FORWARD CURRENCY EXCHANGE CONTRACTS. The fund may enter into forward currency
exchange contracts ("Forward Contract(s)") to attempt to minimize the risk to
the fund from adverse changes in the relationship between currencies. A Forward
Contract is an obligation to buy or sell a specific currency for an agreed price
at a future date which is individually negotiated and privately traded by
currency traders and their customers.
The fund may construct an investment position by combining a debt security
denominated in one currency with a Forward Contract calling for the exchange of
that currency for another currency. The investment position is not itself a
security but is a combined position (i.e., a debt security coupled with a
Forward Contract) that is intended to be similar in overall performance to a
debt security denominated in the same currency.
For example, an Italian lira-denominated position could be constructed by buying
a German mark-denominated debt security and simultaneously entering into a
Forward Contract to exchange an equal amount of marks for lira at a future date
and at a specified exchange rate. With such a transaction, the fund may be able
to receive a return that is substantially similar from a yield and currency
perspective to a direct investment in lira debt securities while achieving other
benefits from holding the underlying security. The fund may experience slightly
different results from its use of such combined investment positions as compared
to its purchase of a debt security denominated in the particular currency
subject to the Forward Contract. This difference may be enhanced or offset by
premiums that may be available in connection with the Forward Contract.
The fund may also enter into a Forward Contract, for example, when it enters
into a contract for the purchase or sale of a security denominated in a foreign
currency in order to "lock in" the U.S. dollar price of that security.
Additionally, for example, when the fund believes that a foreign currency may
suffer a substantial decline against the U.S. dollar, it may enter into a
Forward Contract to sell an amount of that foreign currency approximating the
value of some or all of the fund's portfolio securities denominated in such
foreign currency; or when the fund believes that the U.S. dollar may suffer a
substantial decline against a foreign currency, it may enter into a Forward
Contract to buy that foreign currency for a fixed dollar amount.
The fund usually effects forward currency exchange contracts on a spot (i.e.,
cash) basis at the spot rate prevailing in the foreign exchange market. Some
price spread on currency exchange (to cover service charges) will be incurred
when the fund converts assets from one currency to another.
To limit potential risks in connection with the purchase of currency under
Forward Contracts, cash, cash equivalents or readily marketable debt securities
equal to the amount of the purchase will be held in segregated accounts with the
fund's custodian bank to be used to pay for the commitment, or the fund will
cover any commitments under these contracts to sell currency by owning the
underlying currency (or an absolute right to acquire such currency). The
segregated account will be marked-to-market daily.
SHORT SELLING. In a short sale, the fund sells a security it does not own in
anticipation of a decline in the market value of that security. To complete the
transaction, the fund must borrow the security to make delivery to the buyer.
The fund is then obligated to replace the security borrowed by purchasing it at
the market price at the time of replacement. Until the security is replaced, the
fund must pay the lender any dividends or interest that accrues during the
period of the loan. To borrow the security, the fund may also be required to pay
a premium, which would increase the cost of the security sold. The proceeds of
the short sale will be retained by the broker, to the extent necessary to meet
margin requirements, until the short position is closed out.
The fund will incur a loss as a result of the short sale if the price of the
security increases between the date of the short sale and the date on which the
fund replaces the borrowed security, and the fund will realize a gain if the
security declines in price between those same dates. The amount of any gain will
be decreased, and the amount of any loss increased, by the amount of any
premium, dividends or interest the fund is required to pay in connection with
the short sale.
The fund will place in a segregated account with its custodian bank an amount
equal to the difference between (a) the market value of the securities sold
short at the time they were sold short and (b) any cash or securities required
to be deposited as collateral with the broker in connection with the short sale
(not including the proceeds from the short sale). The segregated account will be
marked-to-market daily and at no time will the amount deposited in the
segregated account and with the broker as collateral be less than the market
value of the securities at the time they sold short. Under amendments made by
the Revenue act of 1997, entering into a short sale could cause immediate
recognition of gain (but not loss) on the date the constructive sale of an
appreciated financial position is entered.
ILLIQUID AND RESTRICTED SECURITIES. The fund may invest up to 15% of its net
assets in illiquid securities. Illiquid securities are securities that cannot be
disposed of within seven days in the normal course of business at approximately
the amount at which the fund has valued the securities and include, among other
things, repurchase agreements of more than seven days duration and other
securities which are not readily marketable. Investments in savings deposits are
generally considered illiquid and will, together with other illiquid
investments, not exceed 15% of the fund's total net assets. Notwithstanding this
limitation, the fund may invest in securities that cannot be offered to the
public for sale without first being registered under the Securities Act of 1933,
as amended (the "1933 Act") ("restricted securities"), where such investment is
consistent with the fund's investment objective and Advisers determines that
there is a liquid institutional or other market for such securities. For
example, restricted securities that may be freely transferred among qualified
institutional buyers pursuant to Rule 144A under the 1933 Act and for which a
liquid institutional market has developed will be considered liquid even though
such securities have not been registered pursuant to the 1933 Act.
The Board will review any determination by Advisers to treat a restricted
security as a liquid security on an ongoing basis, including Advisers'
assessment of current trading activity and the availability of reliable price
information. In determining whether a restricted security is properly considered
a liquid security, Advisers and the Board will take into account the following
factors: (i) the frequency of trades and quotes for the security; (ii) the
number of dealers willing to purchase or sell the security and the number of
other potential purchasers; (iii) dealer undertakings to make a market in the
security; and (iv) the nature of the security and the nature of the marketplace
trades (e.g., the time needed to dispose of the security, the method of
soliciting offers, and the mechanics of transfer). To the extent the fund
invests in restricted securities that are deemed liquid, the general level of
illiquidity in the fund may be increased if qualified institutional buyers
become uninterested in purchasing these securities or the market for these
securities contracts.
REPURCHASE AGREEMENTS. Repurchase agreements are contracts under which the buyer
of a security simultaneously commits to resell the security to the seller at an
agreed-upon price and date. Under a repurchase agreement, the seller is required
to maintain the value of the securities subject to repurchase at not less than
their repurchase price. Advisers will monitor the value of such securities daily
to determine that the value equals or exceeds the repurchase price. Repurchase
agreements may involve risks in the event of default or insolvency of the
seller, including possible delays or restrictions upon the fund's ability to
dispose of the underlying securities. The fund will enter into repurchase
agreements only with parties who meet the creditworthiness standards approved by
the Board, i.e. banks or broker dealers which have been determined by Advisers
to present no serious risk of becoming involved in bankruptcy proceedings within
the time frame contemplated by the repurchase transaction. Each bank or
broker-dealer is treated as the issuer for purchases of the tax diversification
test for qualification as a regulated investment company.
LOANS OF PORTFOLIO SECURITIES. The fund may lend to banks and broker-dealers
portfolio securities with an aggregate market value of up to one-third of its
total assets. Such loans must be secured by collateral (consisting of any
combination of cash, U.S. government securities or irrevocable letters of
credit) in an amount at least equal (on a daily marked-to-market basis) to the
current market value of the securities loaned. The fund retains all or a portion
of the interest received on investment of the cash collateral or receives a fee
from the borrower. The fund may terminate the loans at any time and obtain the
return of the securities loaned within five business days. The fund will
continue to receive any interest or dividends paid on the loaned securities and
will continue to have voting rights with respect to the securities. However, as
with other extensions of credit, there are risks of delay in recovery or even
loss of rights in collateral should the borrower fail.
BORROWING. The fund does not borrow money, except that the fund may borrow for
temporary or emergency purposes in an amount not to exceed 30% of its total
assets (including the amount borrowed).
WHAT ARE THE RISKS
OF INVESTING IN THE FUND?
HIGH YIELD FIXED-INCOME SECURITIES. Because the fund may invest in fixed-income
securities below investment grade, an investment in the fund is subject to a
higher degree of risk than an investment in a fund that invests primarily in
higher-quality securities. You should consider the increased risk of loss to
principal that is present with an investment in higher risk securities, such as
those in which the fund invests. Accordingly, an investment in the fund should
not be considered a complete investment program and should be carefully
evaluated for its appropriateness in light of your overall investment needs and
goals.
The market value of high yield, lower-quality fixed-income securities, commonly
known as junk bonds, tends to reflect individual developments affecting the
issuer to a greater degree than the market value of higher-quality securities,
which react primarily to fluctuations in the general level of interest rates.
Lower-quality securities also tend to be more sensitive to economic conditions
than higher-quality securities.
Issuers of high yield, fixed-income securities are often highly leveraged and
may not have more traditional methods of financing available to them. Therefore,
the risk associated with buying the securities of these issuers is generally
greater than the risk associated with higher-quality securities. For example,
during an economic downturn or a sustained period of rising interest rates,
issuers of lower-quality securities may experience financial stress and may not
have sufficient cash flow to make interest payments. The issuer's ability to
make timely interest and principal payments may also be adversely affected by
specific developments affecting the issuer, including the issuer's inability to
meet specific projected business forecasts or the unavailability of additional
financing.
The risk of loss due to default may also be considerably greater with
lower-quality securities because they are generally unsecured and are often
subordinated to other creditors of the issuer. If the issuer of a security in
the fund's portfolio defaults, the fund may have unrealized losses on the
security, which may lower the fund's Net Asset Value. Defaulted securities tend
to lose much of their value before they default. Thus, the fund's Net Asset
Value may be adversely affected before an issuer defaults. In addition, the fund
may incur additional expenses if it must try to recover principal or interest
payments on a defaulted security.
High yield, fixed-income securities frequently have call or buy-back features
that allow an issuer to redeem the securities from the fund. Although these
securities are typically not callable for a period of time, usually for three to
five years from the date of issue, if an issuer calls its securities during
periods of declining interest rates, Advisers may find it necessary to replace
the securities with lower-yielding securities, which could result in less net
investment income for the fund. The premature disposition of a high yield
security due to a call or buy-back feature, the deterioration of an issuer's
creditworthiness, or a default by an issuer may make it more difficult for the
fund to manage the timing of its income. Under the Code and U.S. Treasury
regulations, the fund may have to accrue income on defaulted securities and
distribute the income to shareholders for tax purposes, even though the fund is
not currently receiving interest or principal payments on the defaulted
securities. To generate cash to satisfy these distribution requirements, the
fund may have to sell portfolio securities that it otherwise may have continued
to hold or use cash flows from other sources, such as the sale of fund shares.
Lower-quality, fixed-income securities may not be as liquid as higher-quality
securities. Reduced liquidity in the secondary market may have an adverse impact
on market price of a security and on the fund's ability to sell a security in
response to a specific economic event, such as a deterioration in the
creditworthiness of the issuer, or if necessary to meet the fund's liquidity
needs. Reduced liquidity may also make it more difficult to obtain market
quotations based on actual trades for purposes of valuing the fund's portfolio.
The fund may buy high yield, fixed-income securities that are sold without
registration under the federal securities laws and therefore carry restrictions
on resale. While many high yielding securities have been sold with registration
rights, covenants and penalty provisions for delayed registration, if the fund
is required to sell restricted securities before the securities have been
registered, it may be deemed an underwriter of the securities under the
Securities Act of 1933, which entails special responsibilities and liabilities.
The fund may also incur special costs in disposing of restricted securities,
although the fund will generally not incur any costs when the issuer is
responsible for registering the securities.
The fund may buy high yield, fixed-income securities during an initial
underwriting. These securities involve special risks because they are new
issues. Advisers will carefully review their credit and other characteristics.
The fund has no arrangement with its underwriter or any other person concerning
the acquisition of these securities.
The high yield securities market is relatively new and much of its growth before
1990 paralleled a long economic expansion. The recession that began in 1990
disrupted the market for high yield securities and adversely affected the value
of outstanding securities, as well as the ability of issuers of high yield
securities to make timely principal and interest payments. Although the economy
has improved and high yield securities have performed more consistently since
that time, the adverse effects previously experienced may reoccur. For example,
the highly publicized defaults on some high yield securities during 1989 and
1990 and concerns about a sluggish economy that continued into 1993 depressed
the prices of many of these securities. While market prices may be temporarily
depressed due to these factors, the ultimate price of any security generally
reflects the true operating results of the issuer. Factors adversely impacting
the market value of high yield securities may lower the fund's Net Asset Value.
The fund relies on Advisers' judgment, analysis and experience in evaluating the
creditworthiness of an issuer. In this evaluation, Advisers takes into
consideration, among other things, the issuer's financial resources, its
sensitivity to economic conditions and trends, its operating history, the
quality of the issuer's management and regulatory matters.
The credit risk factors above also apply to lower-quality zero-coupon, deferred
interest and pay-in-kind securities. These securities have an additional risk,
however, because unlike securities that pay interest throughout the time until
maturity, the fund will not receive any cash until the cash payment date. If the
issuer defaults, the Fund may not obtain any return on its investment.
Zero-coupon or deferred interest securities are debt obligations that make no
periodic interest payments before maturity or a specified date when the
securities begin paying current interest (the "cash payment date"), and
therefore are generally issued and traded at a discount from their face amount
or par value. The discount varies depending on the time remaining until maturity
or the cash payment date, as well as prevailing interest rates, liquidity of the
security, and the perceived credit quality of the issuer. The discount, in the
absence of financial difficulties of the issuer, typically decreases as the
final maturity or cash payment date approaches.
The value of zero-coupon securities is generally more volatile than the value of
other fixed-income securities that pay interest periodically. Zero-coupon
securities are also likely to respond to changes in interest rates to a greater
degree than other fixed-income securities having similar maturities and credit
quality.
Current federal income tax law requires a holder of a zero-coupon security to
report as income each year the portion of original issue discount on the
security that accrues that year, even though the holder receives no cash
payments of interest during the year. Pay-in-kind securities pay interest by
issuing more bonds. The fund is deemed to receive interest over the life of
these bonds and is treated as if the interest were paid on a current basis for
federal income tax purposes, although the fund does not receive any cash
interest payments until maturity or the cash payment date. Accordingly, during
times when the fund does not receive any cash interest payments on its
zero-coupon, deferred interest or pay-in-kind securities, it may have to sell
portfolio securities to meet distribution requirements and these sales may be
subject to the risk factors discussed above. The fund is not limited in the
amount of its assets that may be invested in these types of securities.
MORTGAGE-BACKED SECURITIES. To the extent mortgage securities are purchased at a
premium, unscheduled principal prepayments, including prepayments resulting from
mortgage foreclosures, may result in some loss of the holder's principal
investment to the extent of the premium paid. On the other hand, if mortgage
securities are purchased at a discount, both a scheduled payment of principal
and an unscheduled prepayment of principal will increase current and total
returns and will accelerate the recognition of income which, when distributed to
you, will be taxable as ordinary income.
FUTURES CONTRACTS. Futures contracts entail risks. Although the fund believes
that use of such contracts will benefit the fund, if Advisers' investment
judgment about pertinent market movements is incorrect, the fund's overall
performance would be poorer than if it had not entered into any such contract.
For example, if the fund has hedged against the possibility of an increase in
interest rates which would adversely affect the price of bonds held in its
portfolio and interest rates decrease instead, the fund will lose part or all of
the benefit of the increased value of its bonds which it has hedged because it
will have offsetting losses in its futures positions. Similarly, if the fund
sells a foreign currency futures contract and the U.S. dollar value of the
currency unexpectedly increases, the fund will lose the beneficial effect of the
increase on the value of the security denominated in that currency. In addition,
in such situations, if the fund has insufficient cash, it may have to sell
securities from its portfolio to meet daily variation margin requirements. These
sales may be, but will not necessarily be, at increased prices which reflect the
rising market. The fund may have to sell securities at a time when it may be
disadvantageous to do so.
The fund's ability to hedge effectively all or a portion of its securities
through transactions in financial futures and related options also depends on
the degree to which price movements in the underlying index or underlying
securities correlate with price movements in the relevant portion of the fund's
portfolio. Inasmuch as these securities will not duplicate the components of any
index or underlying securities, the correlation will not be perfect.
Consequently, the fund bears the risk that the prices of the securities being
hedged will not move in the same amount as the hedging instrument. It is also
possible that there may be a negative correlation between the index or other
securities underlying the hedging instrument and the hedged securities which
would result in a loss on both the securities and the hedging instrument.
Positions in financial futures and related options may be closed out only on an
exchange that provides a secondary market. There can be no assurance that a
liquid secondary market will exist for any particular futures contract or
related option at any specific time. Thus, it may not be possible to close a
futures or option position. The inability to close futures or options positions
could have an adverse impact on the fund's ability to effectively hedge its
securities. The fund will enter into a futures or option position only if there
appears to be a liquid secondary market for such futures or option.
The CFTC and the various exchanges have established limits referred to as
"speculative position limits" on the maximum net long or net short position that
any person may hold or control in a particular futures contract. Trading limits
are imposed on the maximum number of contracts that any person may trade on a
particular trading day. An exchange may order the liquidation of positions found
to be in violation of these limits and it may impose other sanctions or
restrictions. The fund does not believe that these trading and positions limits
will have an adverse impact on the fund's futures strategies.
OPTIONS ON FUTURES. The amount of risk the fund assumes when it purchases an
option on a futures contract is the premium paid for the option plus related
transaction costs. In addition to the correlation risks discussed above, the
purchase of an option also entails the risk that changes in the value of the
underlying futures contract will not be fully reflected in the value of the
option purchased.
ADDITIONAL RISKS OF FORWARD CONTRACTS, OPTIONS ON FOREIGN CURRENCIES, AND
OPTIONS ON FUTURES CONTRACTS. Forward Contracts are not traded on contract
markets regulated by the CFTC or by the SEC. The ability of the fund to use
Forward Contracts could be restricted to the extent that Congress authorized the
CFTC or the SEC to regulate such transactions. Forward Contracts are traded
through financial institutions acting as market makers.
The fund may enter into forward currency exchange contracts in order to limit
the risk from adverse changes in the relationship between currencies. However,
these contracts may limit potential gain from a positive change in the
relationship between the U.S. dollar and foreign currencies or between foreign
currencies. Unanticipated changes in currency exchange rates also may result in
poorer overall performance for the fund than if it had not entered into such
contracts.
The purchase and sale of exchange-traded foreign currency options are subject to
the risks of the availability of a liquid secondary market, as well as the risks
of adverse market movements, margins of options written, the nature of the
foreign currency market, possible intervention by governmental authorities, and
the effects of other political and economic events.
Futures contracts on currencies, options on futures contracts, and options on
foreign currencies may be traded on foreign exchanges. These transactions are
subject to the risk of governmental actions affecting trading in or the prices
of foreign currencies. The value of such positions could also be adversely
affected by (i) other foreign political and economic factors, (ii) less
available data than in the U.S. on which to base trading decisions, (iii) delays
in the fund's ability to act upon economic events occurring in foreign markets
during non-business hours in the U.S., (iv) the imposition of exercise and
settlement terms and procedures, and margin requirements different from those in
the U.S., and (v) lesser trading volume.
INVESTMENT RESTRICTIONS
The fund has adopted the following restrictions as fundamental policies. These
restrictions may not be changed without the approval of a majority of the
outstanding voting securities of the fund. Under the 1940 Act, this means the
approval of (i) more than 50% of the outstanding shares of the fund or (ii) 67%
or more of the shares of the fund present at a shareholder meeting if more than
50% of the outstanding shares of the fund are represented at the meeting in
person or by proxy, whichever is less. The fund MAY NOT:
1. Borrow money, except that the fund may borrow money for temporary or
emergency purposes (not for leveraging or investment) in an amount not exceeding
30% of the value of the fund's total assets (including the amount borrowed).
2. Act as an underwriter except to the extent the fund may be deemed to be an
underwriter when disposing of securities it owns or when selling its own shares.
3. Make loans to other persons except (a) through the lending of its portfolio
securities, (b) through the purchase of debt securities, loan participations
and/or engaging in direct corporate loans in accordance with its investment
objectives and policies, and (c) to the extent the entry into a repurchase
agreement is deemed to be a loan.
4. Purchase or sell real estate and commodities, except that the fund may
purchase or sell securities of real estate investment trusts, may purchase or
sell currencies, may enter into futures contracts on securities, currencies, and
other indices or any other financial instruments, and may purchase and sell
options on such futures contracts.
5. Issue securities senior to the fund's presently authorized shares of
beneficial interest. Except that this restriction shall not be deemed to
prohibit the fund from (a) making any permitted borrowings, mortgages or
pledges, or (b) entering into options, futures contracts, forward contracts or
repurchase transactions.
6. Concentrate (invest more than 25% of its total assets) in securities of
issuers in a particular industry (other than securities issued or guaranteed by
the U.S. government or any of its agencies or instrumentalities).
7. Purchase the securities of any one issuer (other than the U.S. government or
any of its agencies or instrumentalities), if immediately after such investment
(a) more than 5% of the value of the fund's total assets would be invested in
such issuer or (b) more than 10% of the outstanding voting securities of such
issuer would be owned by the fund, except that up to 25% of the value of such
fund's total assets may be invested without regard to such 5% and 10%
limitations.
If a bankruptcy or other extraordinary event occurs concerning a particular
security owned by the fund, the fund may receive stock, real estate, or other
investments that the fund would not, or could not, buy. In this case, the fund
intends to dispose of the investment as soon as practicable while maximizing the
return to shareholders.
If a percentage restriction is met at the time of investment, a later increase
or decrease in the percentage due to a change in the value or liquidity of
portfolio securities or the amount of assets will not be considered a violation
of any of the foregoing restrictions.
OFFICERS AND TRUSTEES
The Board has the responsibility for the overall management of the fund,
including general supervision and review of its investment activities. The
Board, in turn, elects the officers of the fund who are responsible for
administering the fund's day-to-day operations. The affiliations of the officers
and Board members and their principal occupations for the past five years are
shown below. Members of the Board who are considered "interested persons" of the
fund under the 1940 Act are indicated by an asterisk (*).
Positions and Offices Principal Occupation During
Name, Age and Address with the Trust the Past Five Years
- ------------------------------------------------------------------------------
Frank H. Abbott, III (77)
1045 Sansome Street
San Francisco, CA 94111
Trustee
President and Director, Abbott Corporation (an investment company); director or
trustee, as the case may be, of 27 of the investment companies in the Franklin
Templeton Group of Funds; and FORMERLY, Director, MotherLode Gold Mines
Consolidated (gold mining) and Vacu-Dry Co. (food processing).
Harris J. Ashton (66)
191 Clapboard Ridge Road
Greenwich, CT 06830
Trustee
Director, RBC Holdings, Inc. (a bank holding company) and Bar-S Foods (a meat
packing company); director or trustee, as the case may be, of 49 of the
investment companies in the Franklin Templeton Group of Funds; and formerly,
President, Chief Executive Officer and Chairman of the Board, General Host
Corporation (nursery and craft centers).
S. Joseph Fortunato (66)
Park Avenue at Morris County
P.O. Box 1945
Morristown, NJ 07962-1945
Trustee
Member of the law firm of Pitney, Hardin, Kipp & Szuch; director or trustee, as
the case may be, of 51 of the investment companies in the Franklin Templeton
Group of Funds; and FORMERLY, Director, General Host Corporation (nursery and
craft centers).
Edith E. Holiday (46)
3239 38th Street, N.W.
Washington, DC 20016
Trustee
Director of Amerada Hess Corporation and Hercules Incorporated (1993-present);
Director, Beverly Enterprises, Inc. (1995-present) and H.J. Heinz Company
(1994-present); director or trustee, as the case may be, of 25 of the investment
companies in the Franklin Templeton Group of Funds; FORMERLY, Chairman
(1995-1997) and Trustee (1993-1997), National Child Research Center, Assistant
to the President of the United States and Secretary of the Cabinet (1990-1993),
General Counsel to the United States Treasury Department (1989-1990), and
Counselor to the Secretary and Assistant Secretary for Public Affairs and Public
Liaison-United States Treasury Department (1988-1989).
*Edward B. Jamieson (50)
777 Mariners Island Blvd.
San Mateo, CA 94404
President and
Trustee
Executive Vice President and Portfolio Manager, Franklin Advisers, Inc.; and
officer and trustee of four of the investment companies in the Franklin
Templeton Group of Funds.
*Charles B. Johnson (65)
777 Mariners Island Blvd.
San Mateo, CA 94404
Chairman
of the Board
and Trustee
President, Chief Executive Officer and Director, Franklin Resources, Inc.;
Chairman of the Board and Director, Franklin Advisers, Inc., Franklin Advisory
Services, Inc., Franklin Investment Advisory Services, Inc. and Franklin
Templeton Distributors, Inc.; Director, Franklin/Templeton Investor Services,
Inc. and Franklin Templeton Services, Inc.; officer and/or director or trustee,
as the case may be, of most of the other subsidiaries of Franklin Resources,
Inc. and of 50 of the investment companies in the Franklin Templeton Group of
Funds; and FORMERLY, Director, General Host Corporation (nursery and craft
centers).
*Rupert H. Johnson, Jr. (57)
777 Mariners Island Blvd.
San Mateo, CA 94404
Vice President
and Trustee
Executive Vice President and Director, Franklin Resources, Inc. and Franklin
Templeton Distributors, Inc.; President and Director, Franklin Advisers, Inc.;
Senior Vice President and Director, Franklin Advisory Services, Inc. and
Franklin Investment Advisory Services, Inc.; Director, Franklin/Templeton
Investor Services, Inc.; and officer and/or director or trustee, as the case may
be, of most of the other subsidiaries of Franklin Resources, Inc. and of 53 of
the investment companies in the Franklin Templeton Group of Funds.
Frank W.T. LaHaye (69)
20833 Stevens Creek Blvd.,
Suite 102
Cupertino, CA 95014
Trustee
General Partner, Miller & LaHaye, which is General Partner of Peregrine Ventures
II (venture capital firm); Chairman of the Board and Director, Quarterdeck
Corporation (software firm); Director, Digital Transmission Systems, Inc.
(wireless communications); director or trustee, as the case may be, of 27 of the
investment companies in the Franklin Templeton Group of Funds; and FORMERLY,
Director, Fischer Imaging Corporation (medical imaging systems) and General
Partner, Peregrine Associates, which was the General Partner of Peregrine
Ventures (venture capital firm).
Gordon S. Macklin (70)
8212 Burning Tree Road
Bethesda, MD 20817
Trustee
Director, Fund American Enterprises Holdings, Inc., MCI Communications
Corporation, MedImmune, Inc. (biotechnology), Spacehab, Inc. (aerospace
services) and Real 3D (software); director or trustee, as the case may be, of 49
of the investment companies in the Franklin Templeton Group of Funds; and
FORMERLY, Chairman, White River Corporation (financial services) and Hambrecht
and Quist Group and President, National Association of Securities Dealers, Inc.
Harmon E. Burns (53)
777 Mariners Island Blvd.
San Mateo, CA 94404
Vice President
Executive Vice President and Director, Franklin Resources, Inc., Franklin
Templeton Distributors, Inc. and Franklin Templeton Services, Inc.; Executive
Vice President, Franklin Advisers, Inc.; Director, Franklin/Templeton Investor
Services, Inc.; officer and/or director or trustee, as the case may be, of most
of the other subsidiaries of Franklin Resources, Inc. and of 53 of the
investment companies in the Franklin Templeton Group of Funds.
Martin L. Flanagan (38)
777 Mariners Island Blvd.
San Mateo, CA 94404
Vice President
and Chief
Financial Officer
Senior Vice President and Chief Financial Officer, Franklin Resources, Inc.;
Executive Vice President and Director, Templeton Worldwide, Inc.; Executive Vice
President, Chief Operating Officer and Director, Templeton Investment Counsel,
Inc.; Executive Vice President and Chief Financial Officer, Franklin Advisers,
Inc.; Chief Financial Officer, Franklin Advisory Services, Inc. and Franklin
Investment Advisory Services, Inc.; President and Director, Franklin Templeton
Services, Inc.; Senior Vice President and Chief Financial Officer, Franklin/
Templeton Investor Services, Inc.; officer and/or director of some of the other
subsidiaries of Franklin Resources, Inc. and officer and/or director or trustee,
as the case may be, of 53 of the investment companies in the Franklin Templeton
Group of Funds.
Deborah R. Gatzek (49)
777 Mariners Island Blvd.
San Mateo, CA 94404
Vice President
and Secretary
Senior Vice President and General Counsel, Franklin Resources, Inc.; Senior Vice
President, Franklin Templeton Services, Inc. and Franklin Templeton
Distributors, Inc.; Executive Vice President, Franklin Advisers, Inc.; Vice
President, Franklin Advisory Services, Inc.; Vice President, Chief Legal Officer
and Chief Operating Officer, Franklin Investment Advisory Services, Inc.; and
officer of 53 of the investment companies in the Franklin Templeton Group of
Funds.
Charles E. Johnson (42)
500 East Broward Blvd.
Fort Lauderdale, FL 33394-3091
Vice President
Senior Vice President and Director, Franklin Resources, Inc.; Senior Vice
President, Franklin Templeton Distributors, Inc.; President and Director,
Templeton Worldwide, Inc.; President, Chief Executive Officer, Chief Investment
Officer and Director, Franklin Institutional Services Corporation; Chairman and
Director, Templeton Investment Counsel, Inc.; Vice President, Franklin Advisers,
Inc.; officer and/or director of some of the other subsidiaries of Franklin
Resources, Inc.; and officer and/or director or trustee, as the case may be, of
34 of the investment companies in the Franklin Templeton Group of Funds.
Diomedes Loo-Tam (59)
777 Mariners Island Blvd.
San Mateo, CA 94404
Treasurer and
Principal
Accounting
Officer
Senior Vice President, Franklin Templeton Services, Inc.; and officer of 32 of
the investment companies in the Franklin Templeton Group of Funds.
Edward V. McVey (61)
777 Mariners Island Blvd.
San Mateo, CA 94404
Vice President
Senior Vice President and National Sales Manager, Franklin Templeton
Distributors, Inc.; and officer of 28 of the investment companies in the
Franklin Templeton Group of Funds.
The table above shows the officers and Board members who are affiliated with
Distributors and Advisers. Nonaffiliated members of the Board are currently paid
$625 per month plus $600 per meeting attended. As shown above, the nonaffiliated
Board members also serve as directors or trustees of other investment companies
in the Franklin Templeton Group of Funds. They may receive fees from these funds
for their services. The following table provides the total fees paid to
nonaffiliated Board members by the Trust and by other funds in the Fran klin
Templeton Group of Funds.
Total Fees Number of
Received from Boards in the
Total Fees the Franklin Franklin Templeton
Received Templeton Group Group of Funds on
Name from the Trust*** of Funds**** Which Each Serves*****
- --------------------------------------------------------------------------------
Frank H. Abbott, III $21,275 $165,937 27
Harris J. Ashton 21,275 344,642 49
S. Joseph Fortunato 21,275 361,562 51
David W. Garbellano* 16,650 91,317 N/A
Edith Holiday** 0 72,875 25
Frank W.T. LaHaye 20,350 141,433 27
Gordon S. Macklin 21,275 337,292 49
*Deceased, September 27, 1997.
**Elected to the Board, January 15, 1998.
***For the fiscal year ended October 31, 1997.
****For the calendar year ended December 31, 1997.
*****We base the number of boards on the number of registered investment
companies in the Franklin Templeton Group of Funds. This number does not include
the total number of series or funds within each investment company for which the
Board members are responsible. The Franklin Templeton Group of Funds currently
includes 55 registered investment companies, with approximately 170 U.S. based
funds or series.
Nonaffiliated members of the Board are reimbursed for expenses incurred in
connection with attending board meetings, paid pro rata by each fund in the
Franklin Templeton Group of Funds for which they serve as director or trustee.
No officer or Board member received any other compensation, including pension or
retirement benefits, directly or indirectly from the fund or other funds in the
Franklin Templeton Group of Funds. Certain officers or Board members who are
shareholders of Resources may be deemed to receive indirect remuneration by
virtue of their participation, if any, in the fees paid to its subsidiaries.
Many of the Board members own shares in other funds in the Franklin Templeton
Group of Funds. Charles B. Johnson and Rupert H. Johnson, Jr. are brothers
and the father and uncle, respectively, of Charles E. Johnson.
INVESTMENT MANAGEMENT AND OTHER SERVICES
INVESTMENT MANAGER AND SERVICES PROVIDED. The fund's investment manager is
Advisers. Advisers provides investment research and portfolio management
services, including the selection of securities for the fund to buy, hold or
sell and the selection of brokers through whom the fund's portfolio transactions
are executed. Advisers' activities are subject to the review and supervision of
the Board to whom Advisers renders periodic reports of the fund's investment
activities. Advisers and its officers, directors and employees are covered by
fidelity insurance for the protection of the fund.
Advisers and its affiliates act as investment manager to numerous other
investment companies and accounts. Advisers may give advice and take action with
respect to any of the other funds it manages, or for its own account, that may
differ from action taken by Advisers on behalf of the fund. Similarly, with
respect to the fund, Advisers is not obligated to recommend, buy or sell, or to
refrain from recommending, buying or selling any security that Advisers and
access persons, as defined by the 1940 Act, may buy or sell for its or their own
account or for the accounts of any other fund. Advisers is not obligated to
refrain from investing in securities held by the fund or other funds that it
manages. Of course, any transactions for the accounts of Advisers and other
access persons will be made in compliance with the fund's Code of Ethics. Please
see "Miscellaneous Information - Summary of Code of Ethics."
Under an agreement with Advisers, Investment Counsel is the fund's sub-advisor.
Investment Counsel provides Advisers with investment management advice and
assistance.
INVESTMENT ADVISORY AGREEMENTS. The investment advisory and sub-advisory
agreements are in effect until July 16, 2000. They may continue in effect for
successive annual periods if their continuance is specifically approved at least
annually by a vote of the Board or by a vote of the holders of a majority of the
fund's outstanding voting securities, and in either event by a majority vote of
the Board members who are not parties to either agreement or interested persons
of any such party (other than as members of the Board), cast in person at a
meeting called for that purpose. The investment advisory agreement may be
terminated without penalty at any time by the Board or by a vote of the holders
of a majority of the fund's outstanding voting securities on 60 days' written
notice to Advisers, or by Advisers on 60 days' written notice to the fund, and
will automatically terminate in the event of its assignment, as defined in the
1940 Act. The sub-advisory agreement may be terminated without penalty at any
time by the Board or by vote of the holders of a majority of the fund's
outstanding voting securities, or by either Advisers or Investment Counsel on
not less than 60 days' written notice, and will automatically terminate in the
event of its assignment, as defined in the 1940 Act.
ADMINISTRATIVE SERVICES. FT Services provides certain administrative services
and facilities for the fund. These include preparing and maintaining books,
records, and tax and financial reports, and monitoring compliance with
regulatory requirements. FT Services is a wholly owned subsidiary of Resources.
SHAREHOLDER SERVICING AGENT. Investor Services, a wholly owned subsidiary of
Resources, is the fund's shareholder servicing agent and acts as the fund's
transfer agent and dividend-paying agent. Investor Services is compensated on
the basis of a fixed fee per account. The fund may also reimburse Investor
Services for certain out-of-pocket expenses, which may include payments by
Investor Services to entities, including affiliated entities, that provide
sub-shareholder services, recordkeeping and/or transfer agency services to
beneficial owners of the fund. The amount of reimbursements for these services
per benefit plan participant fund account per year may not exceed the per
account fee payable by the fund to Investor Services in connection with
maintaining shareholder accounts.
CUSTODIAN. Bank of New York, Mutual Funds Division, 90 Washington Street, New
York, New York 10286, acts as custodian of the securities and other assets of
the fund. The custodian does not participate in decisions relating to the
purchase and sale of portfolio securities.
AUDITORS. PricewaterhouseCoopers, 333 Market Street, San Francisco,
California 94105, are the fund's independent auditors.
HOW DOES THE FUND BUY
SECURITIES FOR ITS PORTFOLIO?
Advisers selects brokers and dealers to execute the fund's portfolio
transactions in accordance with criteria set forth in the management agreement
and any directions that the Board may give.
When placing a portfolio transaction, Advisers seeks to obtain prompt execution
of orders at the most favorable net price. For portfolio transactions on a
securities exchange, the amount of commission paid by the fund is negotiated
between Advisers and the broker executing the transaction. The determination and
evaluation of the reasonableness of the brokerage commissions paid are based to
a large degree on the professional opinions of the persons responsible for
placement and review of the transactions. These opinions are based on the
experience of these individuals in the securities industry and information
available to them about the level of commissions being paid by other
institutional investors of comparable size. Advisers will ordinarily place
orders to buy and sell over-the-counter securities on a principal rather than
agency basis with a principal market maker unless, in the opinion of Advisers, a
better price and execution can otherwise be obtained. Purchases of portfolio
securities from underwriters will include a commission or concession paid by the
issuer to the underwriter, and purchases from dealers will include a spread
between the bid and ask price.
Advisers may pay certain brokers commissions that are higher than those another
broker may charge, if Advisers determines in good faith that the amount paid is
reasonable in relation to the value of the brokerage and research services it
receives. This may be viewed in terms of either the particular transaction or
Advisers' overall responsibilities to client accounts over which it exercises
investment discretion. The services that brokers may provide to Advisers
include, among others, supplying information about particular companies,
markets, countries, or local, regional, national or transnational economies,
statistical data, quotations and other securities pricing information, and other
information that provides lawful and appropriate assistance to Advisers in
carrying out its investment advisory responsibilities. These services may not
always directly benefit the fund. They must, however, be of value to Advisers in
carrying out its overall responsibilities to its clients.
It is not possible to place a dollar value on the special executions or on the
research services Advisers receives from dealers effecting transactions in
portfolio securities. The allocation of transactions in order to obtain
additional research services permits Advisers to supplement its own research and
analysis activities and to receive the views and information of individuals and
research staffs of other securities firms. As long as it is lawful and
appropriate to do so, Advisers and its affiliates may use this research and data
in their investment advisory capacities with other clients. If the fund's
officers are satisfied that the best execution is obtained, the sale of fund
shares, as well as shares of other funds in the Franklin Templeton Group of
Funds, may also be considered a factor in the selection of broker-dealers to
execute the fund's portfolio transactions.
Because Distributors is a member of the NASD, it may sometimes receive certain
fees when the fund tenders portfolio securities pursuant to a tender-offer
solicitation. As a means of recapturing brokerage for the benefit of the fund,
any portfolio securities tendered by the fund will be tendered through
Distributors if it is legally permissible to do so. In turn, the next management
fee payable to Advisers will be reduced by the amount of any fees received by
Distributors in cash, less any costs and expenses incurred in connection with
the tender.
If purchases or sales of securities of the fund and one or more other investment
companies or clients supervised by Advisers are considered at or about the same
time, transactions in these securities will be allocated among the several
investment companies and clients in a manner deemed equitable to all by
Advisers, taking into account the respective sizes of the funds and the amount
of securities to be purchased or sold. In some cases this procedure could have a
detrimental effect on the price or volume of the security so far as the fund is
concerned. In other cases it is possible that the ability to participate in
volume transactions may improve execution and reduce transaction costs to the
fund.
HOW DO I BUY, SELL AND EXCHANGE SHARES?
ADDITIONAL INFORMATION ON BUYING SHARES
The fund continuously offers its shares through Securities Dealers who have an
agreement with Distributors. Securities laws of states where the fund offers its
shares may differ from federal law. Banks and financial institutions that sell
shares of the fund may be required by state law to register as Securities
Dealers.
When you buy shares, if you submit a check or a draft that is returned unpaid to
the fund we may impose a $10 charge against your account for each returned item.
OTHER PAYMENTS TO SECURITIES DEALERS. Distributors and/or its affiliates provide
financial support to various Securities Dealers that sell shares of the Franklin
Templeton Group of Funds. This support is based primarily on the amount of sales
of fund shares. The amount of support may be affected by: total sales; net
sales; levels of redemptions; the proportion of a Securities Dealer's sales and
marketing efforts in the Franklin Templeton Group of Funds; a Securities
Dealer's support of, and participation in, Distributors' marketing programs; a
Securities Dealer's compensation programs for its registered representatives;
and the extent of a Securities Dealer's marketing programs relating to the
Franklin Templeton Group of Funds. Financial support to Securities Dealers may
be made by payments from Distributors' resources, from Distributors' retention
of underwriting concessions and, in the case of funds that have Rule 12b-1
plans, from payments to Distributors under such plans. In addition, certain
Securities Dealers may receive brokerage commissions generated by fund portfolio
transactions in accordance with the NASD's rules.
Distributors routinely sponsors due diligence meetings for registered
representatives during which they receive updates on various Franklin Templeton
Funds and are afforded the opportunity to speak with portfolio managers.
Invitation to these meetings is not conditioned on selling a specific number of
shares. Those who have shown an interest in the Franklin Templeton Funds,
however, are more likely to be considered. To the extent permitted by their
firm's policies and procedures, a registered representatives' expenses in
attending these meetings may be covered by Distributors.
REINVESTMENT DATE. Shares acquired through the reinvestment of dividends will be
purchased at the Net Asset Value determined on the business day following the
dividend record date (sometimes known as the "ex-dividend date"). The processing
date for the reinvestment of dividends may vary and does not affect the amount
or value of the shares acquired.
ADDITIONAL INFORMATION ON EXCHANGING SHARES
If you request the exchange of the total value of your account, declared but
unpaid income dividends and capital gain distributions will be exchanged into
the new fund and will be invested at Net Asset Value. Backup withholding and
information reporting may apply. Information regarding the possible tax
consequences of an exchange is included in the tax section in this SAI and in
the Prospectus.
If a substantial number of shareholders should, within a short period, sell
their shares of the fund under the exchange privilege, the fund might have to
sell portfolio securities it might otherwise hold and incur the additional costs
related to such transactions. On the other hand, increased use of the exchange
privilege may result in periodic large inflows of money. If this occurs, it is
the fund's general policy to initially invest this money in short-term,
interest-bearing money market instruments, unless it is believed that attractive
investment opportunities consistent with the fund's investment goal exist
immediately. This money will then be withdrawn from the short-term, money market
instruments and invested in portfolio securities in as orderly a manner as is
possible when attractive investment opportunities arise.
The proceeds from the sale of shares of an investment company are generally not
available until the seventh day following the sale. The funds you are seeking to
exchange into may delay issuing shares pursuant to an exchange until that
seventh day. The sale of fund shares to complete an exchange will be effected at
Net Asset Value at the close of business on the day the request for exchange is
received in proper form. Please see "May I Exchange Shares for Shares of Another
Fund?" in the Prospectus.
ADDITIONAL INFORMATION ON SELLING SHARES
SYSTEMATIC WITHDRAWAL PLAN. There are no service charges for establishing or
maintaining a systematic withdrawal plan. Payments under the plan will be made
from the redemption of an equivalent amount of shares in your account, generally
on the 25th day of the month in which a payment is scheduled. If the 25th falls
on a weekend or holiday, we will process the redemption on the next business
day.
Redeeming shares through a systematic withdrawal plan may reduce or exhaust the
shares in your account if payments exceed distributions received from the fund.
This is especially likely to occur if there is a market decline. If a withdrawal
amount exceeds the value of your account, your account will be closed and the
remaining balance in your account will be sent to you. Because the amount
withdrawn under the plan may be more than your actual yield or income, part of
the payment may be a return of your investment.
The fund may discontinue a systematic withdrawal plan by notifying you in
writing and will automatically discontinue a systematic withdrawal plan if all
shares in your account are withdrawn or if the fund receives notification of the
shareholder's death or incapacity.
THROUGH YOUR SECURITIES DEALER. If you sell shares through your Securities
Dealer, it is your dealer's responsibility to transmit the order to the fund in
a timely fashion. Any loss to you resulting from your dealer's failure to do so
must be settled between you and your Securities Dealer.
REDEMPTIONS IN KIND. The fund has committed itself to pay in cash (by check) all
requests for redemption by any shareholder of record, limited in amount,
however, during any 90-day period to the lesser of $250,000 or 1% of the value
of the fund's net assets at the beginning of the 90-day period. This commitment
is irrevocable without the prior approval of the SEC. In the case of redemption
requests in excess of these amounts, the Board reserves the right to make
payments in whole or in part in securities or other assets of the fund, in case
of an emergency, or if the payment of such a redemption in cash would be
detrimental to the existing shareholders of the fund. In these circumstances,
the securities distributed would be valued at the price used to compute the
fund's net assets and you may incur brokerage fees in converting the securities
to cash. The fund does not intend to redeem illiquid securities in kind. If this
happens, however, you may not be able to recover your investment in a timely
manner.
GENERAL INFORMATION
If dividend checks are returned to the fund marked "unable to forward" by the
postal service, we will consider this a request by you to change your dividend
option to reinvest all distributions. The proceeds will be reinvested in
additional shares at Net Asset Value until we receive new instructions.
Distribution or redemption checks sent to you do not earn interest or any other
income during the time the checks remain uncashed. Neither the fund nor its
affiliates will be liable for any loss caused by your failure to cash such
checks. The fund is not responsible for tracking down uncashed checks, unless a
check is returned as undeliverable.
In most cases, if mail is returned as undeliverable we are required to take
certain steps to try to find you free of charge. If these attempts are
unsuccessful, however, we may deduct the costs of any additional efforts to find
you from your account. These costs may include a percentage of the account when
a search company charges a percentage fee in exchange for its location services.
All checks, drafts, wires and other payment mediums used to buy or sell shares
of the fund must be denominated in U.S. dollars. We may, in our sole discretion,
either (a) reject any order to buy or sell shares denominated in any other
currency or (b) honor the transaction or make adjustments to your account for
the transaction as of a date and with a foreign currency exchange factor
determined by the drawee bank.
SPECIAL SERVICES. Investor Services may pay certain financial institutions that
maintain omnibus accounts with the fund on behalf of numerous beneficial owners
for recordkeeping operations performed with respect to such owners. For each
beneficial owner in the omnibus account, the fund may reimburse Investor
Services an amount not to exceed the per account fee that the fund normally pays
Investor Services. These financial institutions may also charge a fee for their
services directly to their clients.
Certain shareholder servicing agents may be authorized to accept your
transaction request.
HOW ARE FUND SHARES VALUED?
We calculate the Net Asset Value per share as of the close of the NYSE, normally
1:00 p.m. Pacific time, each day that the NYSE is open for trading. As of the
date of this SAI, the fund is informed that the NYSE observes the following
holidays: New Year's Day, Martin Luther King Jr. Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day.
For the purpose of determining the aggregate net assets of the fund, cash and
receivables are valued at their realizable amounts. Interest is recorded as
accrued and dividends are recorded on the ex-dividend date. Portfolio securities
listed on a securities exchange or on the NASDAQ National Market System for
which market quotations are readily available are valued at the last quoted sale
price of the day or, if there is no such reported sale, within the range of the
most recent quoted bid and ask prices. Over-the-counter portfolio securities are
valued within the range of the most recent quoted bid and ask prices. Portfolio
securities that are traded both in the over-the-counter market and on a stock
exchange are valued according to the broadest and most representative market as
determined by Advisers.
Portfolio securities underlying actively traded call options are valued at their
market price as determined above. The current market value of any option held by
the fund is its last sale price on the relevant exchange before the time when
assets are valued. Lacking any sales that day or if the last sale price is
outside the bid and ask prices, options are valued within the range of the
current closing bid and ask prices if the valuation is believed to fairly
reflect the contract's market value.
The value of a foreign security is determined as of the close of trading on the
foreign exchange on which it is traded or as of the close of trading on the
NYSE, if that is earlier. The value is then converted into its U.S. dollar
equivalent at the foreign exchange rate in effect at noon, New York time, on the
day the value of the foreign security is determined. If no sale is reported at
that time, the foreign security is valued within the range of the most recent
quoted bid and ask prices. Occasionally events that affect the values of foreign
securities and foreign exchange rates may occur between the times at which they
are determined and the close of the exchange and will, therefore, not be
reflected in the computation of the Net Asset Value. If events materially
affecting the values of these foreign securities occur during this period, the
securities will be valued in accordance with procedures established by the
Board.
Generally, trading in corporate bonds, U.S. government securities and money
market instruments is substantially completed each day at various times before
the close of the NYSE. The value of these securities used in computing the Net
Asset Value is determined as of such times. Occasionally, events affecting the
values of these securities may occur between the times at which they are
determined and the close of the NYSE that will not be reflected in the
computation of the Net Asset Value. If events materially affecting the values of
these securities occur during this period, the securities will be valued at
their fair value as determined in good faith by the Board.
Other securities for which market quotations are readily available are valued at
the current market price, which may be obtained from a pricing service, based on
a variety of factors including recent trades, institutional size trading in
similar types of securities (considering yield, risk and maturity) and/or
developments related to specific issues. Securities and other assets for which
market prices are not readily available are valued at fair value as determined
following procedures approved by the Board. With the approval of the Board, the
fund may use a pricing service, bank or Securities Dealer to perform any of the
above described functions.
ADDITIONAL INFORMATION
ON DISTRIBUTIONS AND TAXES
DISTRIBUTIONS
DISTRIBUTIONS OF NET INVESTMENT INCOME. The fund receives income generally in
the form of interest, and original issue, market and acquisition discount, and
other income derived from its investments. This income, less expenses incurred
in the operation of the fund, constitutes its net investment income from which
dividends may be paid to you. Any distributions by the fund from such income
will be taxable to you as ordinary income, whether you take them in cash or in
additional shares.
DISTRIBUTIONS OF CAPITAL GAINS. The fund may derive capital gains and losses in
connection with sales or other dispositions of its portfolio securities.
Distributions derived from the excess of net short-term capital gain over net
long-term capital loss will be taxable to you as ordinary income. Distributions
paid from long-term capital gains realized by the fund will be taxable to you as
long-term capital gain, regardless of how long you have held your shares in the
fund. Any net short-term or long-term capital gains realized by the fund (net of
any capital loss carryovers) generally will be distributed once each year, and
may be distributed more frequently, if necessary, in order to reduce or
eliminate federal excise or income taxes on the fund.
Under the Taxpayer Relief Act of 1997 (the "1997 Act"), the fund is required to
report the capital gain distributions paid to you from gains realized on the
sale of portfolio securities using the following categories:
"28% RATE GAINS": gains resulting from securities sold by the fund after July
28, 1997 that were held for more than one year but not more than 18 months, and
securities sold by the fund before May 7, 1997 that were held for more than one
year. These gains will be taxable to individual investors at a maximum rate of
28%.
"20% RATE GAINS": gains resulting from securities sold by the fund after July
28, 1997 that were held for more than 18 months, and under a transitional rule,
securities sold by the fund between May 7 and July 28, 1997 (inclusive) that
were held for more than one year. These gains will be taxable to individual
investors at a maximum rate of 20% for individual investors in the 28% or higher
federal income tax brackets, and at a maximum rate of 10% for investors in the
15% federal income tax bracket.
The 1997 Act also provides for a new maximum rate of tax on capital gains of 18%
for individuals in the 28% or higher federal income tax brackets and 8% for
individuals in the 15% federal income tax bracket for "qualified 5-year gains."
For individuals in the 15% bracket, qualified 5-year gains are net gains on
securities held for more than 5 years which are sold after December 31, 2000.
For individuals who are subject to tax at higher rates, qualified 5-year gains
are net gains on securities which are purchased after December 31, 2000 and are
held for more than 5 years. Taxpayers subject to tax at the higher rates may
also make an election for shares held on January 1, 2001 to recognize gain on
their shares in order to qualify such shares as qualified 5-year property.
The fund will advise you after the end of each calendar year of the amount of
its capital gain distributions paid during the calendar year that qualify for
these maximum federal tax rates. Additional information on reporting these
distributions on your personal income tax returns is available in Franklin
Templeton's Tax Information Handbook. This handbook has been revised to include
1997 Act tax law changes. Please call Fund Information to request a copy.
Questions concerning each investor's personal tax reporting should be addressed
to the investor's personal tax advisor.
CERTAIN DISTRIBUTIONS PAID IN JANUARY. Distributions which are declared in
October, November or December and paid to you in January of the following year,
will be treated for tax purposes as if they had been received by you on December
31 of the year in which they were declared. The fund will report this income to
you on your Form 1099-DIV for the year in which these distributions were
declared.
EFFECT OF FOREIGN INVESTMENTS ON DISTRIBUTIONS. Most foreign exchange gains
realized on the sale of debt instruments are treated as ordinary income by the
fund. Similarly, foreign exchange losses realized by the fund on the sale of
debt instruments are generally treated as ordinary losses by the fund. These
gains when distributed will be taxable to you as ordinary dividends, and any
losses will reduce the fund's ordinary income otherwise available for
distribution to you. This treatment could increase or reduce the fund's ordinary
income distributions to you, and may cause some or all of the fund's previously
distributed income to be classified as a return of capital.
INFORMATION ON THE TAX CHARACTER OF DISTRIBUTIONS. The fund will inform you of
the amount and character of your distributions at the time they are paid, and
will advise you of the tax status for federal income tax purposes of such
distributions shortly after the close of each calendar year. If you have not
held fund shares for a full year, you may have designated and distributed to you
as ordinary income or capital gain a percentage of income that is not equal to
the actual amount of such income earned during the period of your investment in
the fund.
TAXES
ELECTION TO BE TAXED AS A REGULATED INVESTMENT COMPANY. The fund has elected to
be treated as a regulated investment company under Subchapter M of the Code, has
qualified as such for its most recent fiscal year, and intends to so qualify
during the current fiscal year. The Board reserves the right not to maintain the
qualification of the fund as a regulated investment company if it determines
such course of action to be beneficial to you. In such case, the fund will be
subject to federal, and possibly state, corporate taxes on its taxable income
and gains, and distributions to you will be taxed as ordinary dividend income to
the extent of the fund's available earnings and profits.
In order to qualify as a regulated investment company for tax purposes, the fund
must meet certain specific requirements, including:
o The fund must maintain a diversified portfolio of securities, wherein no
security (other than U.S. government securities and securities of other
regulated investment companies) can exceed 25% of the fund's total assets,
and, with respect to 50% of the fund's total assets, no investment (other
than cash and cash items, U.S. government securities and securities of other
regulated investment companies) can exceed 5% of the fund's total assets;
o The fund must derive at least 90% of its gross income from dividends,
interest, payments with respect to securities loans, and gains from the sale
or disposition of stock, securities or foreign currencies, or other income
derived with respect to its business of investing in such stock, securities,
or currencies; and
o The fund must distribute to its shareholders at least 90% of its net
investment income and net tax-exempt income for each of its fiscal years.
EXCISE TAX DISTRIBUTION REQUIREMENTS. The Code requires the fund to distribute
at least 98% of its taxable ordinary income earned during the calendar year and
98% of its capital gain net income earned during the twelve month period ending
October 31 (in addition to undistributed amounts from the prior year) to you by
December 31 of each year in order to avoid federal excise taxes. The fund
intends to declare and pay sufficient dividends in December (or in January that
are treated by you as received in December) but does not guarantee and can give
no assurances that its distributions will be sufficient to eliminate all such
taxes.
REDEMPTION OF FUND SHARES. Redemptions and exchanges of fund shares are taxable
transactions for federal and state income tax purposes. The tax law requires
that you recognize a gain or loss in an amount equal to the difference between
your tax basis and the amount you received in exchange for your shares, subject
to the rules described below. If you hold your shares as a capital asset, the
gain or loss that you realize will be capital gain or loss, and will be
long-term for federal income tax purposes if you have held your shares for more
than one year at the time of redemption or exchange. Any loss incurred on the
redemption or exchange of shares held for six months or less will be treated as
a long-term capital loss to the extent of any long-term capital gains
distributed to you by the fund on those shares. The holding periods and
categories of capital gain that apply under the 1997 Act are described above in
the "Distributions" section.
All or a portion of any loss that you realize upon the redemption of your fund
shares will be disallowed to the extent that you purchase other shares in the
fund (through reinvestment of dividends or otherwise) within 30 days before or
after your share redemption. Any loss disallowed under these rules will be added
to your tax basis in the new shares you purchase.
DEFERRAL OF BASIS. All or a portion of the sales charge that you paid for your
shares in the fund will be excluded from your tax basis in any of the shares
sold within 90 days of their purchase (for the purpose of determining gain or
loss upon the sale of such shares) if you reinvest the sales proceeds in the
fund or in another of the Franklin Templeton Funds, and the sales charge that
would otherwise apply to your reinvestment is reduced or eliminated. The portion
of the sales charge excluded from your tax basis in the shares sold will equal
the amount that the sales charge is reduced on your reinvestment. Any portion of
the sales charge excluded from your tax basis in the shares sold will be added
to the tax basis of the shares you acquire from your reinvestment.
U.S. GOVERNMENT OBLIGATIONS. Many states grant tax-free status to dividends paid
to you from interest earned on direct obligations of the U.S. government,
subject in some states to minimum investment requirements that must be met by
the fund. Investments in GNMA/FNMA securities, bankers' acceptances, commercial
paper and repurchase agreements collateralized by U.S. government securities do
not generally qualify for tax-free treatment. At the end of each calendar year,
the fund will provide you with the percentage of any dividends paid that may
qualify for tax-free treatment on your personal income tax return. You should
consult with your own tax advisor to determine the application of your state and
local laws to these distributions. Because the rules on exclusion of this income
are different for corporations, corporate shareholders should consult with their
corporate tax advisors about whether any of their distributions may be exempt
from corporate income or franchise taxes.
DIVIDENDS-RECEIVED DEDUCTION FOR CORPORATIONS. Because the fund's income is
derived primarily from interest rather than dividends, no portion of its
distributions generally will be eligible for the intercorporate
dividends-received deduction.
INVESTMENT IN COMPLEX SECURITIES. The fund's investment in options, futures
contracts and forward contracts, and options on these contracts, including
transactions involving actual or deemed short sales or foreign exchange gains or
losses are subject to many complex and special tax rules. Over-the-counter
options on debt securities and equity options, including options on stock and on
narrow-based stock indexes, will be subject to tax under section 1234 of the
Code, generally producing a long-term or short-term capital gain or loss upon
exercise, lapse, or closing out of the option or sale of the underlying stock or
security. Certain other options, futures and forward contracts entered into by
the fund generally are governed by section 1256 of the Code. These "section
1256" positions generally include listed options on debt securities, options on
broad-based stock indexes, options on securities indexes, options on futures
contracts, regulated futures contracts and certain foreign currency contracts
and options thereon.
Absent a tax election to the contrary, each such section 1256 position held by
the fund will be marked-to-market (i.e., treated as if it were sold for fair
market value) on the last business day of the fund's fiscal year (and on other
dates as prescribed by the Code), and all gain or loss associated with fiscal
year transactions and marked-to-market positions at fiscal year end (except
certain currency gain or loss covered by section 988 of the Code) will generally
be treated as 60% long-term capital gain or loss and 40% short-term capital gain
or loss. Under legislation pending in technical corrections to the 1997 Act, the
60% long-term capital gain portion will qualify as 20% rate gain and will be
subject to tax to individual investors at a maximum rate of 20% for investors in
the 28% or higher federal income tax brackets, or at a maximum rate of 10% for
investors in the 15% federal income tax bracket. While foreign currency is
marked-to-market at year end, gain or loss realized as a result will always be
ordinary. The effect of the section 1256 marked-to-market rules may be to
accelerate income or to convert what otherwise would have been long-term capital
gains into short-term capital gains or short-term capital losses into long-term
capital losses within the fund. The acceleration of income on section 1256
positions may require the fund to accrue taxable income without the
corresponding receipt of cash. In order to generate cash to satisfy the
distribution requirements of the Code, the fund may be required to dispose of
portfolio securities that it otherwise would have continued to hold or to use
cash flows from other sources such as the sale of fund shares. In these ways,
any or all of these rules may affect the amount, character and timing of income
distributed to you by the fund.
When the fund holds an option or contract which substantially diminishes the
fund's risk of loss with respect to another position of the fund (as might occur
in some hedging transactions), this combination of positions could be treated as
a "straddle" for tax purposes, possibly resulting in deferral of losses,
adjustments in the holding periods and conversion of short-term capital losses
into long-term capital losses. The fund may make certain tax elections for mixed
straddles (i.e., straddles comprised of at least one section 1256 position and
at least one non-section 1256 position) which may reduce or eliminate the
operation of these straddle rules.
The 1997 Act has also added new provisions for dealing with transactions that
are generally called "Constructive Sale Transactions." Under these rules, the
fund must recognize gain (but not loss) on any constructive sale of an
appreciated financial position in stock, a partnership interest or certain debt
instruments. The fund generally will be treated as making a constructive sale
when it: 1) enters into a short sale on the same property, 2) enters into an
offsetting notional principal contract, or 3) enters into a futures or forward
contract to deliver the same or substantially similar property. Other
transactions (including certain financial instruments called collars) will be
treated as constructive sales as provided in Treasury regulations to be
published. There are also certain exceptions that apply for transactions that
are closed before the end of the 30th day after the close of the taxable year.
Distributions paid to you by the fund of ordinary income and short-term capital
gains arising from the fund's investments, including investments in options,
forwards, and futures contracts and options on these contracts, will be taxable
to you as ordinary income. The fund will monitor its transactions in such
options and contracts and may make certain other tax elections in order to
mitigate the effect of the above rules.
INVESTMENTS IN FOREIGN CURRENCIES AND FOREIGN SECURITIES. The fund is authorized
to invest in foreign currency denominated securities. Such investments, if made,
will have the following additional tax consequences:
Realized gains or losses attributable to fluctuations in foreign currency
exchange rates which occur between the time the fund accrues income, or accrues
expenses which are denominated in a foreign currency, and the time the fund
actually collects such income or pays such expenses generally are treated as
ordinary income or loss. Similarly, on the disposition of debt securities
denominated in a foreign currency and on the disposition of certain options,
futures, and forward contracts, realized gain or loss attributable to
fluctuations in the value of foreign currency between the date of acquisition of
the security or contract and the date of its disposition are also treated as
ordinary gain or loss. These gains or losses, referred to under the Code as
"section 988" gains or losses, may increase or decrease the amount of the fund's
net investment company taxable income, which, in turn, will affect the amount of
income to be distributed to you by the fund.
If the fund's section 988 losses exceed the fund's other net investment company
taxable income during a taxable year, the fund generally will not be able to
make ordinary dividend distributions to you for that year, or distributions made
before the losses were realized will be recharacterized as return of capital
distributions for federal income tax purposes, rather than as an ordinary
dividend or capital gain distribution. If a distribution is treated as a return
of capital, your tax basis in your fund shares will be reduced by a like amount
(to the extent of such basis), and any excess of the distribution over your tax
basis in your fund shares will be treated as capital gain to you. If the fund
has a net post-October loss in any fiscal year, Section 988 losses realized
after October 31 but before the close of the fund's fiscal year may be "pushed
forward" to the next fiscal year at the election of the fund under Treasury
regulations.
CONVERSION TRANSACTIONS. Gains realized by a fund from transactions that are
deemed to be "conversion transactions" under the Code, and that would otherwise
produce capital gain may be recharacterized as ordinary income to the extent
that such gain does not exceed an amount defined as the "applicable imputed
income amount". A conversion transaction is any transaction in which
substantially all of the fund's expected return is attributable to the time
value of the fund's net investment in such transaction, and any one of the
following criteria are met:
1) there is an acquisition of property with a substantially contemporaneous
agreement to sell the same or substantially identical property in the
future;
2) the transaction is an applicable straddle;
3) the transaction was marketed or sold to the fund on the basis that it would
have the economic characteristics of a loan but would be taxed as capital
gain; or
4) the transaction is specified in Treasury regulations to be promulgated in
the future.
The applicable imputed income amount, which represents the deemed return on the
conversion transaction based upon the time value of money, is computed using a
yield equal to 120 percent of the applicable federal rate, reduced by any prior
recharacterizations under this provision or the provisions of Section 263(g) of
the Code dealing with capitalized carrying costs.
INVESTMENTS IN ORIGINAL ISSUE DISCOUNT (OID) AND MARKET DISCOUNT (MD) BONDS. The
fund's investments in zero coupon bonds, bonds issued or acquired at a discount,
delayed interest bonds, or bonds that provide for payment of interest-in-kind
(PIK) may cause the fund to recognize income and make distributions to you prior
to its receipt of cash payments. Zero coupon and delayed interest bonds are
normally issued at a discount and are therefore generally subject to tax
reporting as OID obligations. The fund is required to accrue as income a portion
of the discount at which these securities were issued, and to distribute such
income each year (as ordinary dividends) in order to maintain its qualification
as a regulated investment company and to avoid income reporting and excise taxes
at the fund level. PIK bonds are subject to similar tax rules concerning the
amount, character and timing of income required to be accrued by the fund. Bonds
acquired in the secondary market for a price less than their stated redemption
price, or revised issue price in the case of a bond having OID, are said to have
been acquired with market discount. For MD bonds, the fund may elect to accrue
market discount on a current basis, in which case the fund will be required to
distribute any such accrued market discount. If the fund does not elect to
accrue market discount into income currently, gain recognized on sale will be
recharacterized as ordinary income instead of capital gain to the extent of any
accumulated market discount on the obligation.
DEFAULTED OBLIGATIONS. The fund may be required to accrue income on defaulted
obligations and to distribute such income to you even though it is not currently
receiving interest or principal payments on such obligations. In order to
generate cash to satisfy these distribution requirements, the fund may be
required to dispose of portfolio securities that it otherwise would have
continued to hold or to use cash flows from other sources such as the sale of
fund shares.
THE FUND'S UNDERWRITER
Pursuant to an underwriting agreement, Distributors acts as principal
underwriter in a continuous public offering of the fund's shares. The
underwriting agreement will continue in effect for successive annual periods if
its continuance is specifically approved at least annually by a vote of the
Board or by a vote of the holders of a majority of the fund's outstanding voting
securities, and in either event by a majority vote of the Board members who are
not parties to the underwriting agreement or interested persons of any such
party (other than as members of the Board), cast in person at a meeting called
for that purpose. The underwriting agreement terminates automatically in the
event of its assignment and may be terminated by either party on 90 days'
written notice.
Distributors pays the expenses of the distribution of fund shares, including
advertising expenses and the costs of printing sales material and prospectuses
used to offer shares to the public. The fund pays the expenses of preparing and
printing amendments to its registration statements and prospectuses (other than
those necessitated by the activities of Distributors) and of sending
prospectuses to existing shareholders.
Distributors does not receive compensation from the fund for acting as
underwriter of the fund's Advisor Class shares.
HOW DOES THE FUND MEASURE PERFORMANCE?
Performance quotations are subject to SEC rules. These rules require the use of
standardized performance quotations or, alternatively, that every
non-standardized performance quotation furnished by the fund be accompanied by
certain standardized performance information computed as required by the SEC.
Average annual total return and current yield quotations used by the fund are
based on the standardized methods of computing performance mandated by the SEC.
If a Rule 12b-1 plan is adopted, performance figures reflect fees from the date
of the plan's implementation.
An explanation of these and other methods used by the fund to compute or express
performance follows. Regardless of the method used, past performance does not
guarantee future results, and is an indication of the return to shareholders
only for the limited historical period used.
TOTAL RETURN
AVERAGE ANNUAL TOTAL RETURN. Average annual total return is determined by
finding the average annual rates of return over the periods indicated below that
would equate an initial hypothetical $1,000 investment to its ending redeemable
value. The calculation assumes income dividends and capital gain distributions
are reinvested at Net Asset Value. The quotation assumes the account was
completely redeemed at the end of each period and the deduction of all
applicable charges and fees. If a change is made to the sales charge structure,
historical performance information will be restated to reflect the maximum
front-end sales charge currently in effect.
These figures will be calculated according to the SEC formula:
n
P(1+T) = ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at the
beginning of each period at the end of each period
CUMULATIVE TOTAL RETURN. Like average annual total return, cumulative total
return assumes income dividends and capital gain distributions are reinvested at
Net Asset Value. Cumulative total return, however, will be based on the actual
return for a specified period rather than on the average return.
YIELD
Current Yield. Current yield shows the income per share earned by the fund. It
will be calculated by dividing the net investment income per share earned during
a 30-day base period by the Net Asset Value per share on the last day of the
period and annualizing the result. Expenses accrued for the period include any
fees charged to all shareholders during the base period.
This figure will be obtained using the following SEC formula:
6
Yield = 2 [(a-b + 1) - 1]
---
cd
where:
a = interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = The average daily number of shares outstanding during the period that
were entitled to receive dividends
d = the Net Asset Value per share on the last day of the period
CURRENT DISTRIBUTION RATE
Current yield, which will be calculated according to a formula prescribed by the
SEC, is not indicative of the amounts which were or will be paid to shareholders
of the fund. Amounts paid to shareholders are reflected in the quoted current
distribution rate. The current distribution rate is usually computed by
annualizing the dividends paid per share during a certain period and dividing
that amount by the current Net Asset Value. The current distribution rate
differs from the current yield computation because it may include distributions
to shareholders from sources other than dividends and interest, such as premium
income from option writing and short-term capital gains, and is calculated over
a different period of time.
VOLATILITY
Occasionally statistics may be used to show the fund's volatility or risk.
Measures of volatility or risk are generally used to compare the fund's Net
Asset Value or performance to a market index. One measure of volatility is beta.
Beta is the volatility of a fund relative to the total market, as represented by
an index considered representative of the types of securities in which the fund
invests. A beta of more than 1.00 indicates volatility greater than the market
and a beta of less than 1.00 indicates volatility less than the market. Another
measure of volatility or risk is standard deviation. Standard deviation is used
to measure variability of Net Asset Value or total return around an average over
a specified period of time. The idea is that greater volatility means greater
risk undertaken in achieving performance.
OTHER PERFORMANCE QUOTATIONS
Sales literature referring to the use of the fund as a potential investment for
Individual Retirement Accounts (IRAs), Business Retirement Plans, and other
tax-advantaged retirement plans may quote a total return based upon compounding
of dividends on which it is presumed no federal income tax
applies.
The fund may include in its advertising or sales material information relating
to investment goals and performance results of funds belonging to the Franklin
Templeton Group of Funds. Resources is the parent company of the advisors and
underwriter of the Franklin Templeton Group of Funds.
COMPARISONS
To help you better evaluate how an investment in the fund may satisfy your
investment goal, advertisements and other materials about the fund may discuss
certain measures of fund performance as reported by various financial
publications. Materials may also compare performance (as calculated above) to
performance as reported by other investments, indices, and averages. These
comparisons may include, but are not limited to, the following examples:
a) Salomon Brothers Broad Bond Index or its component indices - measures yield,
price and total return for Treasury, agency, corporate and mortgage bonds.
b) Lehman Brothers Aggregate Bond Index or its component indices - measures
yield, price and total return for Treasury, agency, corporate, mortgage and
Yankee bonds.
c) Lehman Brothers Municipal Bond Index or its component indices - measures
yield, price and total return for the municipal bond market.
d) Bond Buyer 20 Index - an index of municipal bond yields based upon yields of
20 general obligation bonds maturing in 20 years.
e) Bond Buyer 40 Index - an index composed of the yield to maturity of 40 bonds.
The index attempts to track the new-issue market as closely as possible, so it
changes bonds twice a month, adding all new bonds that meet certain requirements
and deleting an equivalent number according to their secondary market trading
activity. As a result, the average par call date, average maturity date, and
average coupon rate can and have changed over time. The average maturity
generally has been about 29-30 years.
f) Financial publications: The Wall Street Journal, and Business Week, Financial
World, Forbes, Fortune, and Money magazines - provide performance statistics
over specified time periods.
g) Salomon Brothers Composite High Yield Index or its component indices measures
yield, price and total return for the Long-Term High-Yield Index,
Intermediate-Term High-Yield Index, and Long-Term Utility High-Yield Index.
h) Historical data supplied by the research departments of CS First Boston
Corporation, the J. P. Morgan companies, Salomon Brothers, Merrill Lynch,
Lehman Brothers and Bloomberg L.P.
i) Morningstar - information published by Morningstar, Inc., including
Morningstar proprietary mutual fund ratings. The ratings reflect Morningstar's
assessment of the historical risk-adjusted performance of a fund over specified
time periods relative to other funds within its category.
j) Lipper - Mutual Fund Performance Analysis and Lipper - Fixed Income Fund
Performance Analysis - measure total return and average current yield for the
mutual fund industry and rank individual mutual fund performance over specified
time periods, assuming reinvestment of all distributions, exclusive of any
applicable sales charges.
From time to time, advertisements or information for the fund may include a
discussion of certain attributes or benefits to be derived from an investment in
the fund. The advertisements or information may include symbols, headlines, or
other material that highlights or summarizes the information discussed in more
detail in the communication.
Advertisements or information may also compare the fund's performance to the
return on CDs or other investments. You should be aware, however, that an
investment in the fund involves the risk of fluctuation of principal value, a
risk generally not present in an investment in a CD issued by a bank. For
example, as the general level of interest rates rise, the value of the fund's
fixed-income investments, as well as the value of its shares that are based upon
the value of such portfolio investments, can be expected to decrease.
Conversely, when interest rates decrease, the value of the fund's shares can be
expected to increase. CDs are frequently insured by an agency of the U.S.
government. An investment in the fund is not insured by any federal, state or
private entity.
In assessing comparisons of performance, you should keep in mind that the
composition of the investments in the reported indices and averages is not
identical to the fund's portfolio, the indices and averages are generally
unmanaged, and the items included in the calculations of the averages may not be
identical to the formula used by the fund to calculate its figures. In addition,
there can be no assurance that the fund will continue its performance as
compared to these other averages.
MISCELLANEOUS INFORMATION
The fund may help you achieve various investment goals such as accumulating
money for retirement, saving for a down payment on a home, college costs and
other long-term goals. The Franklin College Costs Planner may help you in
determining how much money must be invested on a monthly basis in order to have
a projected amount available in the future to fund a child's college education.
(Projected college cost estimates are based upon current costs published by the
College Board.) The Franklin Retirement Planning Guide leads you through the
steps to start a retirement savings program. Of course, an investment in the
fund cannot guarantee that these goals will be met.
The fund is a member of the Franklin Templeton Group of Funds, one of the
largest mutual fund organizations in the U.S., and may be considered in a
program for diversification of assets. Founded in 1947, Franklin, one of the
oldest mutual fund organizations, has managed mutual funds for over 50 years and
now services more than 3 million shareholder accounts. In 1992, Franklin, a
leader in managing fixed-income mutual funds and an innovator in creating
domestic equity funds, joined forces with Templeton, a pioneer in international
investing. The Mutual Series team, known for its value-driven approach to
domestic equity investing, became part of the organization four years later.
Together, the Franklin Templeton Group has over $239 billion in assets under
management for more than 6 million U.S. based mutual fund shareholder and other
accounts. The Franklin Templeton Group of Funds offers 119 U.S. based open-end
investment companies to the public. The fund may identify itself by its NASDAQ
symbol or CUSIP number.
From time to time, the number of fund shares held in the "street name" accounts
of various Securities Dealers for the benefit of their clients or in centralized
securities depositories may exceed 5% of the total shares outstanding.
As a shareholder of a Massachusetts business trust, you could, under certain
circumstances, be held personally liable as a partner for its obligations. The
fund's Agreement and Declaration of Trust, however, contains an express
disclaimer of shareholder liability for acts or obligations of the fund. The
Declaration of Trust also provides for indemnification and reimbursement of
expenses out of the fund's assets if you are held personally liable for
obligations of the fund. The Declaration of Trust provides that the fund shall,
upon request, assume the defense of any claim made against you for any act or
obligation of the fund and satisfy any judgment thereon. All such rights are
limited to the assets of the fund. The Declaration of Trust further provides
that the fund may maintain appropriate insurance (for example, fidelity bonding
and errors and omissions insurance) for the protection of the fund, its
shareholders, trustees, officers, employees and agents to cover possible tort
and other liabilities. Furthermore, the activities of the fund as an investment
company, as distinguished from an operating company, would not likely give rise
to liabilities in excess of the fund's total assets. Thus, the risk of you
incurring financial loss on account of shareholder liability is limited to the
unlikely circumstances in which both inadequate insurance exists and the fund
itself is unable to meet its obligations.
In the event of disputes involving multiple claims of ownership or authority to
control your account, the fund has the right (but has no obligation) to: (a)
freeze the account and require the written agreement of all persons deemed by
the fund to have a potential property interest in the account, before executing
instructions regarding the account; (b) interplead disputed funds or accounts
with a court of competent jurisdiction; or (c) surrender ownership of all or a
portion of the account to the IRS in response to a Notice of Levy.
SUMMARY OF CODE OF ETHICS. Employees of the Franklin Templeton Group who are
access persons under the 1940 Act are permitted to engage in personal securities
transactions subject to the following general restrictions and procedures: (i)
the trade must receive advance clearance from a compliance officer and must be
completed by the close of the business day following the day clearance is
granted; (ii) copies of all brokerage confirmations and statements must be sent
to a compliance officer; (iii) all brokerage accounts must be disclosed on an
annual basis; and (iv) access persons involved in preparing and making
investment decisions must, in addition to (i), (ii) and (iii) above, file annual
reports of their securities holdings each January and inform the compliance
officer (or other designated personnel) if they own a security that is being
considered for a fund or other client transaction or if they are recommending a
security in which they have an ownership interest for purchase or sale by a fund
or other client.
USEFUL TERMS AND DEFINITIONS
1940 ACT - Investment Company Act of 1940, as amended
ADVISERS - Franklin Advisers, Inc., the fund's investment manager
BOARD - The Board of Trustees of the Trust
CD - Certificate of deposit
CLASS I AND ADVISOR CLASS - The fund offers two classes of shares, designated
"Class I" and "Advisor Class." The two classes have proportionate interests in
the fund's portfolio. They differ, however, primarily in their sales charge and
expense structures.
CODE - Internal Revenue Code of 1986, as amended
DISTRIBUTORS - Franklin/Templeton Distributors, Inc., the fund's principal
underwriter
FRANKLIN TEMPLETON GROUP - Franklin Resources, Inc., a publicly owned holding
company, and its various subsidiaries
FRANKLIN TEMPLETON GROUP OF FUNDS - All U.S. registered investment companies
in the Franklin Group of Funds(R) and the Templeton Group of Funds
FT SERVICES - Franklin Templeton Services, Inc., the fund's administrator
INVESTMENT COUNSEL - Templeton Investment Counsel, Inc., the fund's
sub-advisor
INVESTOR SERVICES - Franklin/Templeton Investor Services, Inc., the fund's
shareholder servicing and transfer agent
IRS - Internal Revenue Service
MOODY'S - Moody's Investors Service, Inc.
NASD - National Association of Securities Dealers, Inc.
NET ASSET VALUE (NAV) - The value of a mutual fund is determined by deducting
the fund's liabilities from the total assets of the portfolio. The net asset
value per share is determined by dividing the net asset value of the fund by the
number of shares outstanding.
NYSE - New York Stock Exchange
PROSPECTUS - The prospectus for Advisor Class shares of the fund dated August 3,
1998, which we may amend from time to time
RESOURCES - Franklin Resources, Inc.
SAI - Statement of Additional Information
S&P - Standard & Poor's Corporation
SEC - U.S. Securities and Exchange Commission
SECURITIES DEALER - A financial institution that, either directly or through
affiliates, has an agreement with Distributors to handle customer orders and
accounts with the fund. This reference is for convenience only and does not
indicate a legal conclusion of capacity.
WE/OUR/US - Unless a different meaning is indicated by the context, these terms
refer to the fund and/or Investor Services, Distributors, or other wholly owned
subsidiaries of Resources.
