TEMPLETON VARIABLE ANNUITY FUND
THIS STATEMENT OF ADDITIONAL INFORMATION DATED MAY 1, 1996,
IS NOT A PROSPECTUS. IT SHOULD BE READ IN CONJUNCTION WITH THE
PROSPECTUS OF TEMPLETON VARIABLE ANNUITY FUND DATED MAY 1, 1996,
WHICH CAN BE OBTAINED WITHOUT COST UPON REQUEST TO
TEMPLETON VARIABLE ANNUITY FUND,
700 CENTRAL AVENUE, P.O. BOX 33030,
ST. PETERSBURG, FLORIDA 33733-8030
TOLL FREE TELEPHONE: (800) 774-5001
TABLE OF CONTENTS
PAGE
General Information and History.............................. 1
Investment Objective and Policies............................ 2
-Investment Policies ...................................... 2
-Debt Securities........................................... 2
-Structured Investments ........................... ....... 3
-Stock Index Futures Contracts ............................ 4
-Investment Restrictions................................... 5
-Risk Factors.............................................. 7
-Trading Policies.......................................... 11
-Personal Securities Transactions.......................... 11
Management of the Fund....................................... 11
Trustee Compensation......................................... 17
Principal Shareholder........................................ 17
Investment Management and Other Services..................... 18
-Investment Management Agreement........................... 18
-Management Fees........................................... 19
-Expense Limitation ....................................... 19
-The Investment Manager.................................... 20
-Business Manager.......................................... 20
-Custodian.......................................... ...... 21
-Legal Counsel............................................. 21
-Independent Accountants................................... 21
-Reports to Shareholders................................... 21
Brokerage Allocation......................................... 22
Purchase, Redemption and Pricing of Shares................... 24
Tax Status................................................... 25
Description of Shares........................................ 29
Performance Information...................................... 29
Financial Statements......................................... 32
GENERAL INFORMATION AND HISTORY
Templeton Variable Annuity Fund (the "Fund") was organized as a
Massachusetts business trust on February 5, 1987. The Fund is registered under
the Investment Company Act of 1940 (the "1940 Act") as an open-end diversified
management investment company. The Fund's Shares are currently sold only to
Templeton Funds Annuity Company ("TFAC") to be held by Templeton Funds
Retirement Annuity and Templeton Immediate Variable Annuity Separate Accounts
(the "Separate Accounts") for use as the sole investment vehicle for Templeton
Retirement Annuities and Templeton Immediate Variable Annuities (the
"Annuities"). The Fund's Shares may in the future be sold in connection with
other insurance products or as otherwise permitted by applicable regulations and
regulatory interpretations.
INVESTMENT OBJECTIVE AND POLICIES
INVESTMENT POLICIES. The investment objective and policies of
the Fund are described in the Fund's Prospectus under the heading "Investment
Objective and Policies."
DEBT SECURITIES. The Fund may invest in debt securities which are rated
at least Ca by Moody's Investors Service, Inc. ("Moody's"), or CC by Standard &
Poor's Corporation ("S&P"), or deemed to be of comparable quality by the Fund's
investment manager, Templeton Investment Counsel, Inc. (the "Investment
Manager"). As an operating policy, the Fund will invest no more than 5% of its
assets in debt securities rated lower than Baa by Moody's or BBB by S&P. 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 such
securities generally declines. These changes in market value will be reflected
in the Fund's net asset value. Bonds rated Ca by Moody's represent obligations
which are speculative in a high degree. Such issues are often in default or have
other marked shortcomings. Bonds rated CC by S&P are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligation. While such
bonds may have some quality and protective characteristics, these are outweighed
by large uncertainties or major risk exposures to adverse conditions.
Although they may offer higher yields than do higher rated securities,
low rated and unrated debt securities generally involve greater volatility of
price and risk of principal and income, including the possibility of default by,
or bankruptcy of, the issuers of the securities. In addition, the markets in
which low rated and unrated debt securities are traded are more limited than
those in which higher rated securities are traded. The existence of limited
markets for particular securities may diminish the Fund's ability to sell the
securities at fair value either to meet redemption requests or to respond to a
specific economic event such as a deterioration in the creditworthiness of the
issuer. Reduced secondary market liquidity for certain low rated or unrated debt
securities may also make it more difficult for the Fund to obtain accurate
market quotations for the purposes of valuing the Fund's portfolio. Market
quotations are generally available on many low rated or unrated securities only
from a limited number of dealers and may not necessarily represent firm bids of
such dealers or prices for actual sales.
Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of low rated debt
securities, especially in a thinly traded market. Analysis of the
creditworthiness of issuers of low rated debt securities may be more complex
than for issuers of higher rated securities, and the ability of the Fund to
achieve its investment objective may, to the extent of investment in low rated
debt securities, be more dependent upon such creditworthiness analysis than
would be the case if the Fund were investing in higher rated securities.
Low rated debt securities may be more susceptible to real or perceived
adverse economic and competitive industry conditions than investment grade
securities. The prices of low rated debt securities have been found to be less
sensitive to interest rate changes than higher rated investments, but more
sensitive to adverse economic downturns or individual corporate developments. A
projection of an economic downturn or of a period of rising interest rates, for
example, could cause a decline in low rated debt securities prices because the
advent of a recession could lessen the ability of a highly leveraged company to
make principal and interest payments on its debt securities. If the issuer of
low rated debt securities defaults, the Fund may incur additional expenses to
seek recovery.
The Fund may accrue and report interest on high yield bonds structured
as zero coupon bonds or pay-in-kind securities as income even though it receives
no cash interest until the security's maturity or payment date. In order to
qualify for beneficial tax treatment, the Fund must distribute substantially all
of its income to Shareholders (see "Tax Status"). Thus, the Fund may have to
dispose of its portfolio securities under disadvantageous circumstances to
generate cash so that it may satisfy the distribution requirement.
STRUCTURED INVESTMENTS. Included among the issuers of debt securities in
which the Fund may invest are entities organized and operated solely for the
purpose of restructuring the investment characteristics of various securities.
These entities are typically organized by investment banking firms which receive
fees in connection with establishing each entity and arranging for the placement
of its securities. This type of restructuring involves the deposit with or
purchase by an entity, such as a corporation or trust, of specified instruments
and the issuance by that entity of one or more classes of securities
("Structured Investments") backed by, or representing interests in, the
underlying instruments. The cash flow on the underlying instruments may be
apportioned among the newly issued Structured Investments to create securities
with different investment characteristics such as varying maturities, payment
priorities or interest rate provisions; the extent of the payments made with
respect to Structured Investments is dependent on the extent of the cash flow on
the underlying instruments. Because Structured Investments of the type in which
the Fund anticipates investing typically involve no credit enhancement, their
credit risk will generally be equivalent to that of the underlying instruments.
The Fund is permitted to invest in a class of Structured Investments that
is 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 typically sold in private
placement transactions, and there currently is not an active trading market for
Structured Investments. To the extent such investments are illiquid, they will
be subject to the Fund's restrictions on investments in illiquid securities.
STOCK INDEX FUTURES CONTRACTS. The Fund's investment policies also
permit it to buy and sell stock index futures contracts with respect to any
stock index traded on a recognized stock exchange or board of trade, to an
aggregate amount not exceeding 20% of the Fund's total assets at the time when
such contracts are entered into. Successful use of stock index futures is
subject to the Investment Manager's ability to predict correctly movements in
the direction of the stock markets. No assurance can be given that the
Investment Manager's judgment in this respect will be correct.
A stock index futures contract is a contract to buy or sell units of a
stock index at a specified future date at a price agreed upon when the contract
is made. The value of a unit is the current value of the stock index. For
example, the Standard & Poor's 500 Stock Index (the "S&P 500 Index") is composed
of 500 selected common stocks, most of which are listed on the New York Stock
Exchange ("NYSE"). The S&P 500 Index assigns relative weightings to the value of
one share of each of these 500 common stocks included in the Index, and the
Index fluctuates with changes in the market values of the shares of those common
stocks. In the case of the S&P 500 Index, contracts are to buy or sell 500
units. Thus, if the value of the S&P 500 Index were $150, one contract would be
worth $75,000 (500 units x $150). The stock index futures contract specifies
that no delivery of the actual stocks making up the index will take place.
Instead, settlement in cash must occur upon the termination of the contract,
with the settlement being the difference between the contract price and the
actual level of the stock index at the expiration of the contract. For example,
if the Fund enters into a futures contract to BUY 500 units of the S&P 500 Index
at a specified future date at a contract price of $150 and the S&P 500 Index is
at $154 on that future date, the Fund will gain $2,000 (500 units x gain of $4).
If the Fund enters into a futures contract to SE LL 500 units of the stock index
at a specified future date at a contract price of $150 and the S&P 500 Index is
at $154 on that future date, the Fund will lose $2,000 (500 units x loss of $4).
During or in anticipation of a period of market appreciation, the Fund
may enter into a "long hedge" of common stock which it proposes to add to its
portfolio by purchasing stock index futures for the purpose of reducing the
effective purchase price of such common stock. To the extent that the securities
which the Fund proposes to purchase change in value in correlation with the
stock index contracted for, the purchase of futures contracts on that index
would result in gains to the Fund which could be offset against rising prices of
such common stock.
During or in anticipation of a period of market decline, the Fund may
"hedge" common stock in its portfolio by selling stock index futures for the
purpose of limiting the exposure of its portfolio to such decline. To the extent
that the Fund's portfolio of securities changes in value in correlation with a
given stock index, the sale of futures contracts on that index could
substantially reduce the risk to the portfolio of a market decline and, by so
doing, provide an alternative to the liquidation of securities positions in the
portfolio with resultant transaction costs.
Parties to an index futures contract must make initial margin deposits
to secure performance of the contract, which currently range from 1-1/2% to 5%
of the contract amount. Initial margin requirements are determined by the
respective exchanges on which the futures contracts are traded. There also are
requirements to make variation margin deposits as the value of the futures
contract fluctuates.
At the time the Fund purchases a stock index futures contract, an
amount of cash, U.S. Government securities, or other highly liquid debt
securities equal to the market value of the contract will be deposited in a
segregated account with the Fund's custodian. When selling a stock index futures
contract, the Fund will maintain with its custodian liquid assets that, when
added to the amounts deposited with a futures commission merchant or broker as
margin, are equal to the market value of the instruments underlying the
contract. Alternatively, the Fund may "cover" its position by owning a portfolio
with a volatility substantially similar to that of the index on which the
futures contract is based, or holding a call option permitting the Fund to
purchase the same futures contract at a price no higher than the price of the
contract written by the Fund (or at a higher price if the difference is
maintained in liquid assets with the Fund's custodian).
INVESTMENT RESTRICTIONS. The Fund has imposed upon itself certain
fundamental investment restrictions which, together with its investment
objective and investment policy, are fundamental policies which may not be
changed without the approval of the Fund's Shareholders. For this purpose, the
provisions of the 1940 Act require the affirmative vote of the lesser of either
(A) 67% or more of the Shares of the Fund present at a Shareholders' meeting at
which more than 50% of the outstanding Shares of the Fund are present or
represented by proxy or (B) more than 50% of the outstanding Shares of the Fund.
A vote of the Shareholders satisfying these requirements will also satisfy the
requirements of the Fund's By-laws and the applicable provisions of
Massachusetts law.
A. FUNDAMENTAL INVESTMENT RESTRICTIONS. In accordance with these
restrictions, the Fund will not:
1. Invest in real estate or mortgages on real estate (although
the Fund may invest in marketable securities secured by real
estate or interests therein or issued by companies or
investment trusts which invest in real estate or interests
therein), or purchase or sell commodity contracts, except that
the Fund may purchase or sell stock index futures contracts.
2. With respect to 75% of its total assets, invest more than 5%
of the total value of its assets in the securities of any one
issuer, or purchase more than 10% of any class of securities
of any one company, including more than 10% of its outstanding
voting securities (except for investments in obligations
issued or guaranteed by the U.S. government or its agencies or
instrumentalities).
3. Act as an underwriter or issue senior securities.
4. Lend money, except that the Fund may purchase
publicly-distributed bonds, debentures, notes and other
evidences of indebtedness and may buy from a bank or
broker-dealer U.S. government obligations with a simultaneous
agreement by the seller to repurchase them at the original
purchase price plus accrued interest.
5. Borrow money, for any purpose other than redeeming its Shares
or purchasing its Shares for cancellation, and then only as a
temporary measure up to an amount not exceeding 5% of the
value of its total assets.
6. Invest more than 25% of the Fund's total assets in a single
industry.
B. NON-FUNDAMENTAL INVESTMENT RESTRICTIONS. As non-fundamental
policies, which may be changed by the Fund's Trustees without Shareholder
approval, the Fund will not invest more than 15% of its total assets in
securities of foreign issuers which are not listed on a recognized United States
or foreign securities exchange, or more than 10% of its total assets in (a)
securities with a limited trading market, (b) securities subject to legal or
contractual restrictions as to resale, and (c) repurchase agreements not
terminable within seven days. In addition, as a non-fundamental policy, the Fund
will not invest more than 5% of its assets in debt securities rated lower than
Baa by Moody's Investors Service, Inc. or BBB by Standard & Poor's Corporation.
When an investment restriction states a maximum percentage of the
Fund's assets which may be invested in any security or other property, it is
intended that such maximum percentage limitation be determined immediately after
and as a result of the Fund's acquisition of such security or property. Assets
are calculated as described in the Prospectus under the heading "How to Sell
Shares of the Fund." If the Fund receives from an issuer of securities held by
the Fund subscription rights to purchase securities of that issuer, and if the
Fund exercises such subscription rights at a time when the Fund's portfolio
holdings of securities of that issuer would otherwise exceed the limits set
forth in investment restrictions 2 or 6 above, it will not constitute a
violation if, prior to receipt of securities upon exercise of such rights, and
after announcement of such rights, the Fund has sold at least as many securities
of the same class and value as it would receive on exercise of such rights.
RISK FACTORS. The Fund has an unlimited right to purchase securities in
any foreign country, developed or developing, if they are listed on a stock
exchange, as well as a limited right to purchase such securities if they are
unlisted. Investors should consider carefully the substantial risks involved in
securities of companies and governments of foreign nations, which are in
addition to the usual risks inherent in domestic investments.
There may be less publicly available information about foreign
companies comparable to the reports and ratings published about companies in the
United States. Foreign companies are not generally subject to uniform
accounting, auditing and financial reporting standards, and auditing practices
and requirements may not be comparable to those applicable to United States
companies. The Fund, therefore, may encounter difficulty in obtaining market
quotations for purposes of valuing its portfolio and calculating its net asset
value. Foreign markets have substantially less volume than the New York Stock
Exchange and securities of some foreign companies are less liquid and more
volatile than securities of comparable United States companies. Commission rates
in foreign countries, which are generally fixed rather than subject to
negotiation as in the United States, are likely to be higher. In many foreign
countries there is less government supervision and regulation of stock
exchanges, brokers and listed companies than in the United States.
Investments in companies domiciled in developing countries may be
subject to potentially higher risks than investments in developed countries.
These risks include (i) less social, political and economic stability; (ii) the
small current size of the markets for such securities and the currently low or
nonexistent volume of trading, which result in a lack of liquidity and in
greater price volatility; (iii) certain national policies which may restrict the
Fund's investment opportunities, including restrictions on investment in issuers
or industries deemed sensitive to national interests; (iv) foreign taxation; (v)
the absence of developed structures governing private or foreign investment or
allowing for judicial redress for injury to private property; (vi) the absence,
until recently in certain Eastern European countries, of a capital market
structure or market-oriented economy; and (vii) the possibility that recent
favorable economic developments in Eastern Europe may be slowed or reversed by
unanticipated political or social events in such countries.
In addition, many countries in which the Fund may invest have
experienced substantial, and in some periods extremely high, rates of inflation
for many years. Inflation and rapid fluctuations in inflation rates have had and
may continue to have negative effects on the economies and securities markets of
certain countries. Moreover, the economies of some developing countries may
differ favorably or unfavorably from the United States economy in such respects
as growth of gross domestic product, rate of inflation, currency depreciation,
capital reinvestment, resource self-sufficiency and balance of payments
position.
Investments in Eastern European countries may involve risks of
nationalization, expropriation and confiscatory taxation. The communist
governments of a number of Eastern European countries expropriated large amounts
of private property in the past, in many cases without adequate compensation,
and there can be no assurance that such expropriation will not occur in the
future. In the event of such expropriation, the Fund could lose a substantial
portion of any investments it has made in the affected countries. Further, no
accounting standards exist in Eastern European countries. Finally, even though
certain Eastern European currencies may be convertible into U.S. dollars, the
conversion rates may be artificial to the actual market values and may be
adverse to the Fund's Shareholders.
Certain Eastern European countries, which do not have market economies,
are characterized by an absence of developed legal structures governing private
and foreign investments and private property. Certain countries require
governmental approval prior to investments by foreign persons, or limit the
amount of investment of foreign persons in a particular company, or limit the
investment of foreign persons to only a specific class of securities of a
company that may have less advantageous terms than securities of the company
available for purchase by nationals.
Authoritarian governments in certain Eastern European countries may
require that a governmental or quasi-governmental authority act as custodian of
the Fund's assets invested in such country. To the extent such governmental or
quasi-governmental authorities do not satisfy the requirements of the 1940 Act
to act as foreign custodians of the Fund's cash and securities, the Fund's
investment in such countries may be limited or may be required to be effected
through intermediaries. The risk of loss through governmental confiscation may
be increased in such countries.
Investing in Russian companies involves a high degree of risk and special
considerations not typically associated with investing in the United States
securities markets, and should be considered highly speculative. Such risks
include: (1) delays in settling portfolio transactions and risk of loss arising
out of Russia's system of share registration and custody; (2) the risk that it
may be impossible or more difficult than in other countries to obtain and/or
enforce a judgment; (3) pervasiveness of corruption and crime in the Russian
economic system; (4) currency exchange rate volatility and the lack of available
currency hedging instruments; (5) higher rates of inflation (including the risk
of social unrest associated with periods of hyper-inflation); (6) controls on
foreign investment and local practices disfavoring foreign investors and
limitations on repatriation of invested capital, profits and dividends, and on
the Fund's ability to exchange local currencies for U.S. dollars; (7) the risk
that the government of Russia or other executive or legislative bodies may
decide not to continue to support the economic reform programs implemented since
the dissolution of the Soviet Union and could follow radically different
political and/or economic policies to the detriment of investors, including
non-market-oriented policies such as the support of certain industries at the
expense of other sectors or investors, or a return to the centrally planned
economy that existed prior to the dissolution of the Soviet Union; (8) the
financial condition of Russian companies, including large amounts of
inter-company debt which may create a payments crisis on a national scale; (9)
dependency on exports and the corresponding importance of international trade;
(10) the risk that the Russian tax system will not be reformed to prevent
inconsistent, retroactive and/or exorbitant taxation; and (11) possible
difficulty in identifying a purchaser of securities held by the Fund due to the
underdeveloped nature of the securities markets.
There is little historical data on Russian securities markets because
they are relatively new and a substantial proportion of securities transactions
in Russia are privately negotiated outside of stock exchanges. Because of the
recent formation of the securities markets as well as the underdeveloped state
of the banking and telecommunications systems, settlement, clearing and
registration of securities transactions are subject to significant risks.
Ownership of shares (except where shares are held through depositories that meet
the requirements of the 1940 Act) is defined according to entries in the
company's share register and normally evidenced by extracts from the register or
by formal share certificates. However, there is no central registration system
for shareholders and these services are carried out by the companies themselves
or by registrars located throughout Russia. These registrars are not necessarily
subject to effective state supervision and it is possible for the Fund to lose
its registration through fraud, negligence or even mere oversight. While the
Fund will endeavor to ensure that its interest continues to be appropriately
recorded either itself or through a custodian or other agent inspecting the
share register and by obtaining extracts of share registers through regular
confirmations, these extracts have no legal enforceability and it is possible
that subsequent illegal amendment or other fraudulent act may deprive the Fund
of its ownership rights or improperly dilute its interests. In addition, while
applicable Russian regulations impose liability on registrars for losses
resulting from their errors, it may be difficult for the Fund to enforce any
rights it may have against the registrar or issuer of the securities in the
event of loss of share registration. Furthermore, although a Russian public
enterprise with more than 1,000 shareholders is required by law to contract out
the maintenance of its shareholder register to an independent entity that meets
certain criteria, in practice this regulation has not always been strictly
enforced. Because of this lack of independence, management of a company may be
able to exert considerable influence over who can purchase and sell the
company's shares by illegally instructing the registrar to refuse to record
transactions in the share register. This practice may prevent the Fund from
investing in the securities of certain Russian companies deemed suitable by the
Investment Manager. Further, this also could cause a delay in the sale of
Russian company securities by the Fund if a potential purchaser is deemed
unsuitable, which may expose the Fund to potential loss on the investment.
The Fund endeavors to buy and sell foreign currencies on as favorable a
basis as practicable. Some price spread on currency exchange (to cover service
charges) may be incurred, particularly when the Fund changes investments from
one country to another or when proceeds of the sale of Shares in U.S. dollars
are used for the purchase of securities in foreign countries. Also, some
countries may adopt policies which would prevent the Fund from transferring cash
out of the country, withhold portions of interest and dividends at the source,
or impose other taxes, with respect to the Fund's investments in securities of
issuers of that country. There is the possibility of expropriation, cessation of
trading on national exchanges, nationalization, confiscatory or other taxation,
foreign exchange controls (which may include suspension of the ability to
transfer currency from a given country), default in foreign government
securities, political or social instability or diplomatic developments that
could affect investments in securities of issuers in foreign nations.
The Fund may be affected either unfavorably or favorably by
fluctuations in the relative rates of exchange between the currencies of
different nations, by exchange control regulations and by indigenous economic
and political developments. Some countries in which the Fund may invest may also
have fixed or managed currencies that are not free-floating against the U.S.
dollar. Further, certain currencies may not be internationally traded. Certain
of these currencies have experienced a steady devaluation relative to the U.S.
dollar. Any devaluations in the currencies in which the Fund's portfolio
securities are denominated may have a detrimental impact on the Fund. Through
the Fund's flexible policy, management endeavors to avoid unfavorable
consequences and to take advantage of favorable developments in particular
nations where from time to time it places the Fund's investments. The exercise
of this flexible policy may include decisions to purchase securities with
substantial risk characteristics and other decisions such as changing the
emphasis on investments from one nation to another and from one type of security
to another. Some of these decisions may later prove profitable and others may
not. No assurance can be given that profits, if any, will exceed losses.
The Trustees consider at least annually the likelihood of the
imposition by any foreign government of exchange control restrictions which
would affect the liquidity of the Fund's assets maintained with custodians in
foreign countries, as well as the degree of risk from political acts of foreign
governments to which such assets may be exposed. The Trustees also consider the
degree of risk involved through the holding of portfolio securities in domestic
and foreign securities depositories (see "Investment Management and Other
Services--Custodian"). However, in the absence of willful misfeasance, bad faith
or gross negligence on the part of the Investment Manager, any losses resulting
from the holding of the Fund's portfolio securities in foreign countries and/or
with securities depositories will be at the risk of the Shareholders. No
assurance can be given that the Trustees' appraisal of the risks will always be
correct or that such exchange control restrictions or political acts of foreign
governments might not occur.
TRADING POLICIES. The Investment Manager and its affiliated companies
serve as investment manager to other investment companies and private clients.
Accordingly, the respective portfolios of certain of these funds and clients may
contain many or some of the same securities. When certain funds or clients are
engaged simultaneously in the purchase or sale of the same security, the trades
may be aggregated for execution and then allocated in a manner designed to be
equitable to each party. The larger size of the transaction may affect the price
of the security and/or the quantity which may be bought or sold for each party.
If the transaction is large enough, brokerage commissions may be negotiated
below those otherwise chargeable.
Sale or purchase of securities, without payment of brokerage
commissions, fees (except customary transfer fees) or other remuneration in
connection therewith, may be effected between any of these funds, or between
funds and private clients, under procedures adopted by the Fund's Board of
Trustees pursuant to Rule 17a-7 under the 1940 Act.
PERSONAL SECURITIES TRANSACTIONS. Access persons of the Franklin
Templeton Group, as defined in the SEC Rule 17(j) under the 1940 Act, who are
employees of Franklin Resources, Inc. or their subsidiaries, are permitted to
engage in personal securities transactions subject to the following general
restrictions and procedures: (1) The trade must receive advance clearance from a
Compliance Officer and must be completed within 24 hours after this clearance;
(2) Copies of all brokerage confirmations must be sent to the Compliance Officer
and within 10 days after the end of each calendar quarter, a report of all
securities transactions must be provided to the Compliance Officer; (3) In
addition to items (1) and (2), access persons involved in preparing and making
investment decisions must file annual reports of their securities holdings each
January and also 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.
MANAGEMENT OF THE FUND
The name, address, principal occupation during the past five years and
other information with respect to each of the Trustees and Executive Officers of
the Fund are as follows:
<TABLE>
<CAPITON>
NAME, ADDRESS AND PRINCIPAL OCCUPATION
OFFICES WITH FUND DURING PAST FIVE YEARS
<S> <C>
HARRIS J. ASHTON Chairman of the Board, president, and chief executive
Metro Center officer of General Host Corporation (nursery and craft
1 Station Place centers); and a director of RBC Holdings (U.S.A.) Inc. (a
Stamford, Connecticut bank holding company) and Bar-S Foods. Age 63.
Trustee
</TABLE>
<TABLE>
<CAPTION>
NAME, ADDRESS AND PRINCIPAL OCCUPATION
OFFICES WITH FUND DURING PAST FIVE YEARS
<S> <C>
NICHOLAS F. BRADY* Chairman of Templeton Emerging Markets Investment Trust
102 East Dover Street PLC; chairman of Templeton Latin America Investment Trust
Easton, Maryland PLC; chairman of Darby Overseas Investments, Ltd. (an
Trustee investment firm) (1994-present); director of the Amerada
Hess Corporation, Capital Cities/ABC, Inc., Christiana
Companies, and the H.J. Heinz Company; Secretary of the
United States Department of the Treasury (1988-January
1993); and chairman of the board of Dillon, Read & Co.
Inc. (investment banking) prior thereto. Age 65.
F. BRUCE CLARKE Retired; formerly, credit adviser for the Bank of Canada,
19 Vista View Blvd. Toronto. Age 86.
Thornhill, Ontario
Trustee
HASSO-G VON DIERGARDT-NAGLO Farmer; and president of Clairhaven Investments, Ltd. and
R.R. 3 other private investment companies. Age 79.
Stouffville, Ontario
Trustee
S. JOSEPH FORTUNATO Member of the law firm of Pitney, Hardin, Kipp & Szuch;
200 Campus Drive and a director of General Host Corporation. Age 63.
Florham Park, New Jersey
Trustee
JOHN Wm. GALBRAITH President of Galbraith Properties, Inc. (personal
360 Central Avenue investment company); director of Gulfwest Banks, Inc.
Suite 1300 (bank holding company) (1995-present) and Mercantile
St. Petersburg, Florida Bank (1991-present); vice chairman of Templeton,
Trustee Galbraith & Hansberger Ltd. (1986-1992); and chairman
of Templeton Funds Management, Inc. (1974-1991). Age 74.
</TALBE>
</TABLE>
<TABLE>
<CAPTION>
NAME, ADDRESS AND PRINCIPAL OCCUPATION
OFFICES WITH FUND DURING PAST FIVE YEARS
<S> <C>
ANDREW H. HINES, JR. Consultant for the Triangle Consulting Group; chairman of
150 2nd Avenue N. the board and chief executive officer of Florida Progress
St. Petersburg, Florida Corporation (1982-February 1990) and director of various
Trustee of its subsidiaries;
chairman and director
of Precise Power
Corporation;
executive-in-residence
of Eckerd College
(1991-present); and a
director of Checkers
Drive-In Restaurants,
Inc. Age 72.
CHARLES B. JOHNSON* President and director of Franklin Resources, Inc.;
777 Mariners Island Blvd. chairman of the board and director of Franklin Advisers,
San Mateo, California Inc. and Franklin Templeton Distributors, Inc.; director
Chairman of the Board and Vice
President of General
Host Corporation
(nursery and craft
centers), and
Templeton Global
Investors, Inc.; and
officer and director,
trustee or managing
general partner, as
the case may be, of
most other
subsidiaries of
Franklin Resources,
Inc. Age 63.
RUPERT H. JOHNSON, JR. Executive vice president, secretary and director,
777 Mariners Island Blvd. Franklin Resources, Inc.; executive vice president and
San Mateo, California director, Franklin Templeton Distributors, Inc.;
Trustee and Vice President
executive vice
president, Franklin
Advisers, Inc.;
director, Franklin
Templeton Investor
Services, Inc.;
officer and/or
director, as the
case may be, of
other subsidiaries
of Franklin
Resources, Inc. Age
55.
BETTY P. KRAHMER Director or trustee of various civic associations;
2201 Kentmere Parkway formerly, economic analyst, U.S. Government. Age 66.
Wilmington, Delaware
Trustee
</TABLE>
<TABLE>
<CAPTION>
NAME, ADDRESS AND PRINCIPAL OCCUPATION
OFFICES WITH FUND DURING PAST FIVE YEARS
<S> <C>
GORDON S. MACKLIN Chairman of White River Corporation (information
8212 Burning Tree Road services); director of Fund America Enterprises Holdings,
Bethesda, Maryland 20817 Inc., Lockheed Martin Corporation, MCI Communications
Trustee Corporation, Fusion
Systems Corporation,
Infovest Corporation,
and Medimmune, Inc.;
formerly chairman of
Hambrecht and Quist
Group; director, H&Q
Healthcare Investors;
and president of the
National Association
of Securities
Dealers, Inc. Age 67.
FRED R. MILLSAPS Manager of personal investments (1978-present); chairman
2665 NE 37th Drive and chief executive officer of Landmark Banking
Fort Lauderdale, Florida Corporation (1969-1978); financial vice president of
Trustee Florida Power and
Light (1965-1969);
vice president of The
Federal Reserve Bank
of Atlanta
(1958-1965); director
of various other
business and
nonprofit organizations.
Age 66.
CHARLES E. JOHNSON Senior vice president and director of Franklin
777 Mariners Island Blvd. Resources, Inc.; senior vice president of Franklin
San Mateo, California Templeton Distributors, Inc.; president and director of
President Franklin
Institutional
Service Corporation
and Templeton
Worldwide, Inc.;
chairman of the
board of Templeton
Investment Counsel,
Inc.; vice president
and/or director, as
the case may be, for
some of the
subsidiaries of
Franklin Resources,
Inc. Age 39.
</TABLE>
<TABLE>
<CAPTION>
NAME, ADDRESS AND PRINCIPAL OCCUPATION
OFFICES WITH FUND DURING PAST FIVE YEARS
<S> <C>
HARMON E. BURNS Executive vice president, secretary and director,
777 Mariners Island Blvd. Franklin Resources, Inc.; executive vice president and
San Mateo, California director, Franklin Templeton Distributors, Inc.;
Vice President executive
vice president,
Franklin Advisers,
Inc; director,
Franklin Templeton
Investor Services,
Inc.; officer and/or
director, as the case
may be, of other
subsidiaries of
Franklin Resources,
Inc. Age 51.
MARTIN L. FLANAGAN Senior vice president, treasurer, and chief financial
777 Mariners Island Blvd. officer of Franklin Resources, Inc.; executive vice
San Mateo, California president and director of Templeton Investment Counsel,
Vice President Inc.; director, president and chief executive officer of
Templeton Global Investors, Inc.; director or trustee and
president or vice president of various Templeton Funds;
accountant with Arthur Andersen & Company (1982-1983);
and a member of the International Society of Financial
Analysts and the American Institute of Certified Public
Accountants. Age 35.
DEBORAH R. GATZEK Senior Vice President, Legal, Franklin Resources, Inc.
777 Mariners Island Blvd. and Franklin Templeton Distributors, Inc.; vice
San Mateo, California president, Franklin Advisers, Inc. Age 47.
Vice President
MARK G. HOLOWESKO President and director of Templeton Global Advisors
Lyford Cay Limited; chief investment officer of the global equity
Nassau, Bahamas group for Templeton Worldwide, Inc.; president or vice
Vice President president of the Templeton
Funds; formerly,
investment administrator with
Roy West Trust
Corporation (Bahamas)
Limited (1984-1985).
Age 36.
</TABLE>
<TABLE>
<CAPTION>
NAME, ADDRESS AND PRINCIPAL OCCUPATION
OFFICES WITH FUND DURING PAST FIVE YEARS
<S> <C>
JOHN R. KAY Vice president of the Templeton Funds; vice president and
500 East Broward Blvd. treasurer of Templeton Global Investors, Inc. and
Fort Lauderdale, Florida Templeton Worldwide, Inc.; assistant vice president of
Vice President Franklin Templeton Distributors, Inc.; formerly, vice
president and controller, the Keystone Group, Inc. Age 55.
JAMES R. BAIO Certified public accountant; treasurer of the Templeton
500 East Broward Blvd. Funds; senior vice president of Templeton Worldwide,
Fort Lauderdale, Florida Inc., Templeton Global Investors, Inc., and Templeton
Treasurer Funds Trust Company; formerly, senior tax manager, Ernst
& Young (certified public accountants) (1977-1989). Age
41.
THOMAS M. MISTELE Senior vice president of Templeton Global Investors,
700 Central Avenue Inc.; vice president of Franklin Templeton Distributors,
St. Petersburg, Florida Inc.; secretary of the Templeton Funds; formerly,
Secretary attorney, Dechert Price & Rhoads (1985-1988) and
Freehill, Hollingdale & Page (1988); and judicial clerk,
U.S. District Court (Eastern District of Virginia)
(1984-1985). Age 42.
</TABLE>
-----------------------------------------------
* These are Trustees who are "interested persons" of the Trust as
that term is defined in the 1940 Act. Mr. Brady and Franklin
Resources, Inc. are limited partners of Darby Overseas Partners,
L.P. ("Darby Overseas"). Mr. Brady established Darby Overseas in
February, 1994, and is Chairman and a shareholder of the corporate
general partner of Darby Overseas. In addition, Darby Overseas and
Templeton Global Advisors Limited are limited partners of Darby
Emerging Markets Fund, L.P.
There are no family relationships between any of the Trustees, except that
Charles B. Johnson and Rupert H. Johnson, Jr. are brothers.
TRUSTEE COMPENSATION
All of the Trust's officers and Trustees also hold positions with other
investment companies in the Franklin Templeton Group. No compensation is paid by
the Trust to any officer or trustee who is an officer, trustee or employee of
the Investment Manager or its affiliates. Each Templeton Fund pays its
independent directors and trustees and Mr. Brady an annual retainer and/or fees
for attendance at Board and Committee meetings, the amount of which is based on
the level of assets in each fund. Accordingly, based upon the assets of the
Trust as of December 31, 1995, the Trust will pay the independent Trustees and
Mr. Brady an annual retainer of $100.00. The independent Trustees and Mr. Brady
are reimbursed for any expenses incurred in attending meetings, paid pro rata by
each Franklin Templeton Fund in which they serve. No pension or retirement
benefits are accrued as part of Trust expenses.
The following table shows the total compensation paid to the Trustees
by the Trust and by all investment companies in the Franklin Templeton Group for
the fiscal year ended December 31, 1995:
<TABLE>
<CAPTION>
NUMBER OF FRANKLIN TOTAL COMPENSATION FROM
AGGREGATE TEMPLETON FUND BOARDS ALL FUNDS IN FRANKLIN
COMPENSATION FROM ON WHICH TRUSTEE TEMPLETON GROUP*
THE TRUST* SERVES
NAME OF TRUSTEE
<S> <C> <C> <C>
Harris J. Ashton $ 100 56 $327,925
Nicholas F. Brady 100 24 98,225
F. Bruce Clarke 128 20 83,350
Hasso-G von Diergardt-Naglo 100 20 77,350
S. Joseph Fortunato 100 58 344,745
John Wm. Galbraith 75 23 70,100
Andrew H. Hines, Jr. 195 24 106,325
Betty P. Krahmer 100 24 93,475
Gordon S. Macklin 167 53 321,525
Fred R. Millsaps 105 24 104,325
</TABLE>
* For the fiscal year ended December 31, 1995.
PRINCIPAL SHAREHOLDER
As of March 29, 1996, TFAC, on behalf of the Separate Accounts, owned
of record 785,430 Shares (100%) of the Fund. However, TFAC will exercise voting
rights attributable to these Shares in accordance with voting instructions
received by holders of the Annuities or any other policies for which the Fund
serves as the underlying investment vehicle. To this extent, TFAC does not
exercise control over the Fund by virtue of the voting rights from its ownership
of Fund Shares.
INVESTMENT MANAGEMENT AND OTHER SERVICES
INVESTMENT MANAGEMENT AGREEMENT. The Investment Manager of the Fund is
Templeton Investment Counsel, Inc., a Florida corporation with offices in Fort
Lauderdale, Florida. The Investment Management Agreement, dated October 30,
1992, was approved by shareholders of the Fund on October 30, 1992, and was
amended and restated on February 25, 1994. It was last approved by the Board of
Trustees, including a majority of the Trustees who were not parties to the
Agreement or interested persons of any such party, at a meeting on February 23,
1996, and will continue through April 30, 1997. The Management Agreement will
continue from year to year thereafter, subject to approval annually by the Board
of Trustees or by vote of the holders of a majority of the outstanding shares of
the Fund (as defined in the 1940 Act) and also, in either event, with the
approval of a majority of those Trustees who are not parties to the Management
Agreement or interested persons of any such party in person at a meeting called
for the purpose of voting on such approval.
The Management Agreement requires the Investment Manager to manage the
investment and reinvestment of the Fund's assets. The Investment Manager is not
required to furnish any overhead items or facilities for the Fund, including
daily pricing or trading desk facilities, although such expenses are paid by
some investment advisers of some other investment companies.
The Management Agreement provides that the Investment Manager will
select brokers and dealers for execution of the Fund's portfolio transactions
consistently with the Fund's brokerage policy. (See "Brokerage Allocation.")
Although services provided by broker-dealers in accordance with the Fund's
brokerage policy may incidentally help reduce the expenses of or otherwise
benefit the Investment Manager and other investment advisory clients of the
Investment Manager and of its affiliates, as well as the Fund, the value of any
such services is indeterminable and is not used to offset the Investment
Manager's fee.
When the Investment Manager determines to buy or sell the same
securities for the Fund that the Investment Manager or certain of its affiliates
has selected for one or more of the Investment Manager's other clients or for
clients of its affiliates, the orders for all such securities trades may be
placed for execution by methods determined by the Investment Manager, with
approval by the Fund's Board of Trustees, to be impartial and fair, in order to
seek good results for all parties (see "Investment Practices and
Restrictions--Trading Policies"). Records of securities transactions of persons
who know when orders are placed by the Fund are available for inspection at
least four times annually by the compliance officer of the Fund so that the
non-interested Trustees (as defined in the 1940 Act) can be satisfied that the
procedures are generally fair and equitable for all parties.
The Investment Manager also provides management services to numerous
other investment companies or funds and accounts pursuant to management
agreements with each fund or account. The Investment Manager may give advice and
take action with respect to any of the other funds and accounts it manages, or
for its own account, which may differ from the action taken by the Investment
Manager on behalf of the Fund. Similarly, with respect to the Fund, the
Investment Manager is not obligated to recommend, purchase or sell, or to
refrain from recommending, purchasing or selling any security that the
Investment Manager and access persons, as defined by the 1940 Act, may purchase
or sell for its or their own account or for the accounts of any other fund or
accounts. Furthermore, the Investment Manager is not obligated to refrain from
investing in securities held by the Fund or other funds which it manages or
administers. Any transactions for the accounts of the Investment Manager and
other access persons will be made in compliance with the Fund's Code of Ethics
as described in the section "Investment Objective and Policies - Personal
Securities Transactions."
The Management Agreement provides that the Investment Manager shall
have no liability to the Fund or any Shareholder of the Fund for any error of
judgment, mistake of law, or any loss arising out of any investment or other act
or omission in the performance by the Investment Manager of its duties under the
Management Agreement, or for any loss or damage resulting from the imposition by
any government of exchange control restrictions which might affect the liquidity
of the Fund's assets, or from acts or omissions of custodians or securities
depositories, or from any wars or political acts of any foreign governments to
which such assets might be exposed, except for any liability, loss or damage
resulting from willful misfeasance, bad faith or gross negligence in the
performance of the Investment Manager's duties or by reason of reckless
disregard of its obligations and duties under the Management Agreement. The
Management Agreement will terminate automatically in the event of its
assignment, and may be terminated by the Fund at any time without payment of any
penalty on 60 days' written notice, with the approval of a majority of the
Fund's Trustees in office at the time or by vote of a majority of the
outstanding Shares of the Fund (as defined in the 1940 Act).
MANAGEMENT FEES. For its services, the Fund pays the Investment Manager
a monthly fee equal on an annual basis to 0.50% of its average daily net assets,
reduced to 0.45% of such net assets in excess of $200,000,000 and further
reduced to 0.40% of such net assets in excess of $1,300,000,000. During the
fiscal years ended December 31, 1995, 1994, and 1993, the Investment Manager
received fees of $67,417, $66,500, and $54,283, respectively.
EXPENSE LIMITATION. The Investment Manager has agreed in advance to
reduce its fee to the extent necessary to limit the total expenses (excluding
interest, taxes, brokerage commissions and extraordinary expenses) of the Fund
to an annual rate of 1.00% of the Fund's average net assets through May 1, 1997.
If such fee reduction is insufficient to so limit the Fund's total expenses, the
Fund's Business Manager has agreed to reduce its fee and to the extent
necessary, assume other Fund expenses, so as to so limit the Fund's total
expenses. As long as this expense limitation continues, it may lower the Fund's
expenses and increase its total return. After May 1, 1997, the expense
limitation may be terminated or revised at any time, at which time the Fund's
expenses may increase and its total return may be reduced depending on the total
assets of the Fund.
THE INVESTMENT MANAGER. The Investment Manager is an indirect
wholly owned subsidiary of Franklin Resources, Inc. ("Franklin"), a publicly
traded company whose shares are listed on the New York Stock Exchange. Charles
B. Johnson (a Trustee and Officer of the Fund) and Rupert H. Johnson, Jr. (a
Trustee and Officer of the Fund) are principal shareholders of Franklin and
own, respectively, approximately 20% and 16% of its outstanding shares.
Messrs. Charles B. Johnson and Rupert H. Johnson, Jr. are brothers.
BUSINESS MANAGER. Templeton Funds Annuity Company (the "Business
Manager"), 700 Central Avenue, P.O. Box 33030, St. Petersburg, Florida
33733-8030, telephone (813) 823-8712, performs certain administrative
functions as Business Manager for the Fund pursuant to a Business Management
Agreement dated October 30, 1992
The Business Management Agreement requires the Business Manager to be
responsible for various activities on behalf of the Fund, including:
o providing office space, telephone, office equipment and
supplies for the Fund;
o paying compensation of the Fund's officers for services
rendered as such;
o authorizing expenditures and approving bills for payment on
behalf of the Fund;
o preparation of annual and semi-annual reports, notices of
dividends, capital gains distributions and tax credits;
o daily pricing of the Fund's investment portfolio and preparing
and supervising publication of daily quotations of the bid and
asked prices of the Fund's Shares, earnings reports and other
financial data;
o monitoring relationships with organizations serving the
Fund, including its custodian and printers;
o providing trading desk facilities for the Fund;
o supervising compliance by the Fund with recordkeeping
requirements under the 1940 Act and regulations promulgated
thereunder, with state regulatory requirements, maintaining
books and records for the Fund (other than those maintained by
the custodian), and filing tax reports, other than the Fund's
income tax returns; and
o providing executive, clerical and secretarial help needed to
carry out its responsibilities.
For its services, the Business Manager receives a monthly fee equal on
an annual basis to 0.15% of the first $200,000,000 of the Fund's average daily
net assets, reduced to 0.135% annually of such net assets in excess of
$200,000,000, further reduced to 0.10% annually of such net assets in excess of
$700,000,000, and further reduced to 0.075% annually of such net assets in
excess of $1,200,000,000. Since the Business Manager's fee covers services often
provided by investment advisers to other funds, the Fund's combined expenses for
advisory and administrative services together may be higher than those of some
other investment companies. During the fiscal years ended December 31, 1995,
1994, and 1993, TFAC received business management fees of $20,222, $19,950, and
$16,285, respectively.
The Business Manager is relieved of liability to the Fund for any act
or omission in the course of its performance under the Business Management
Agreement in the absence of willful misfeasance, bad faith, gross negligence or
reckless disregard of its duties and obligations under the Agreement. The
Business Management Agreement may be terminated by the Fund at any time on 60
days' written notice without payment of penalty, provided that such termination
by the Fund shall be directed or approved by vote of a majority of the Trustees
(as defined in the 1940 Act), and shall terminate automatically and immediately
in the event of its assignment.
Templeton Funds Annuity Company is an indirect wholly-owned subsidiary
of Franklin.
CUSTODIAN. The Chase Manhattan Bank, N.A., pursuant to an Agreement
dated as of January 27, 1988, serves as custodian of the Fund's securities and
cash, which are kept at the custodian's principal office, MetroTech Center,
Brooklyn, New York 11245, and at the offices of its branches and agencies
throughout the world. Compensation for the services of the custodian is based on
a schedule of charges agreed on from time to time. The custodian generally
domestically, and frequently abroad, does not actually hold certificates for the
securities in its custody, but instead has book records with domestic and
foreign securities depositories, which in turn have book records with the
transfer agents of the issuers of the securities.
LEGAL COUNSEL. Dechert Price & Rhoads, 1500 K Street, N.W.,
Washington, D.C, 20005 is legal counsel for the Fund.
INDEPENDENT ACCOUNTANTS. The firm of McGladrey & Pullen, LLP, 555 Fifth
Avenue, New York, New York 10017, serves as independent accountants for the
Fund. Its audit services comprise examination of the Fund's financial statements
and review of the Fund's filings with the Securities and Exchange Commission and
the Internal Revenue Service.
REPORTS TO SHAREHOLDERS. The Fund's fiscal year ends on December 31.
Shareholders will be provided at least semiannually with reports showing the
portfolio of the Fund and other information, including an annual report with
financial statements audited by independent accountants.
BROKERAGE ALLOCATION
The Management Agreement provides that the Investment Manager is
responsible for selecting members of securities exchanges, brokers and dealers
(such members, brokers and dealers being hereinafter referred to as "brokers")
for the execution of the portfolio transactions of the Fund and, when
applicable, the negotiation of commissions in connection therewith. All
decisions and placements are made in accordance with the following principles:
1. Purchase and sale orders are usually placed with brokers
who are selected by the Investment Manager as able to achieve
"best execution" of such orders. "Best execution" means
prompt and reliable execution at the most favorable
security price, taking into account the other provisions
hereinafter set forth. The determination of what may
constitute best execution and price in the execution of a
securities transaction by a broker involves a number of
considerations, including, without limitation, the overall
direct net economic result to the Fund (involving both price
paid or received and any commissions and other costs paid),
the efficiency with which the transaction is effected, the
ability to effect the transaction at all where a large block
is involved, availability of the broker to stand ready to
execute possibly difficult transactions in the future, and
the financial strength and stability of the broker. Such
considerations are judgmental and are weighed by the
Investment Manager in determining the overall reasonableness
of brokerage commissions.
2. In selecting brokers for portfolio transactions, the
Investment Manager takes into account its past experience as
to brokers qualified to achieve "best execution," including
brokers who specialize in any foreign securities held by the
Fund.
3. The Investment Manager is authorized to allocate brokerage
business to brokers who have provided brokerage and research
services, as such services are defined in Section 28(e)of the
Securities Exchange Act of 1934 (the "1934 Act"), for the
Fund and/or other accounts, if any, for which the Investment
Manager exercises investment discretion (as defined in Section
3(a)(35) of the 1934 Act) and, for transactions as to which
fixed minimum commission rates are not applicable, to cause
the Fund to pay a commission for effecting a securities
transaction in excess of the amount another broker would
have charged for effecting that transaction, if the
Investment Manager in making the selection in question
determines in good faith that such amount of commission is
reasonable in relation to the value of the brokerage and
research services provided by such broker, viewed in terms
of either that particular transaction or the Investment
Manager's overall responsibilities with respect to the Fund
and the other accounts, if any, as to which it exercises
investment discretion. In reaching such determination, the
Investment Manager is not required to place or to attempt to
place a specific dollar value on the research or execution
services of a broker or on the portion of any commission
reflecting either of those services. In demonstrating that
such determinations were made in good faith, the Investment
Manager shall be prepared to show that all commissions were
allocated and paid for purposes contemplated by the Fund's
brokerage policy, that the research services provide
lawful and appropriate assistance to the Investment
Manager in the performance of its investment decision-making
responsibilities and that the commissions paid were
within a reasonable range. The determination that
commissions were within a reasonable range shall be
based on any available information as to the level of
commissions known to be charged by other brokers on
comparable transactions, but there shall be taken into
account the Fund's policies that: (i) obtaining a low
commission is deemed secondary to obtaining a favorable
securities price, since it is recognized that usually it
is more beneficial to the Fund to obtain a favorable
price than to pay the lowest commission and (ii) the quality,
comprehensiveness and frequency of research studies which are
provided for the Investment Manager are useful to the
Investment Manager in performing its advisory services
under its Management Agreement with the Fund. Research
services provided by brokers to the Investment Manager are
considered to be in addition to, and not in lieu of, services
required to be performed by the Investment Manager under
its Management Agreement with the Fund. Research fur-
nished by brokers through whom the Fund effects
securities transactions may be used by the Investment
Manager for any of its accounts, and not all such research
may be used by the Investment Manager for the Fund. When
execution of portfolio transactions is allocated to brokers
trading on exchanges with fixed brokerage commission rates,
account may be taken of various services provided by the
broker, including quotations outside the United States
for daily pricing of foreign securities held in the Fund's
portfolio.
4. Purchases and sales of portfolio securities within the United
States other than on a securities exchange shall be executed
with primary market makers acting as principal except where,
in the judgment of the Investment Manager, better prices and
execution may be obtained on a commission basis or from other
sources.
5. Sales of shares of investment companies registered under
the 1940 Act which have either the same investment adviser,
or an investment adviser affiliated with the Investment
Manager, made by a broker is one factor among others to be
taken into account in deciding to allocate portfolio
transactions (including agency transactions, principal
transactions, purchases in underwritings or tenders in
response to tender offers) for the account of the Fund to that
broker; provided that the broker shall furnish "best
execution" as defined in paragraph 1 above, and that such
allocation shall be within the scope of the Fund's other
policies as stated above; and provided further, that in
Every allocation made to a broker in which such
sale of shares is taken into account there shall be
no increase in the amount of the commissions or other
compensation paid to such broker beyond a reasonable
commission or other compensation determined, as set forth in
paragraph 3 above, on the basis of best execution
alone or best execution plus research services, without
taking account of or placing any value upon such sale of
shares.
Insofar as known to the Fund's management, no Trustee or officer of the
Fund, nor the Investment Manager or any person affiliated with any of them, has
any material direct or indirect interest in any broker employed by or on behalf
of the Fund. The total brokerage commissions on portfolio transactions for the
Fund during the fiscal years ended December 31, 1995, 1994, and 1993 were
$21,000, $19,000, and $12,220, respectively. All portfolio transactions are
allocated to broker-dealers only when their prices and execution, in the
judgment of the Investment Manager, are equal to the best available within the
scope of the Fund's policies. There is no fixed method used in determining which
broker-dealers receive which order or how many orders.
PURCHASE, REDEMPTION AND PRICING OF SHARES
The Prospectus describes the manner in which the Fund's Shares may be
purchased and redeemed. See "Sale and Redemption of Shares".
The net asset value of the Fund's Shares is determined as of the
scheduled closing time on the New York Stock Exchange (NYSE), (generally 4:00
p.m., New York time) every Monday through Friday (exclusive of national business
holidays), except on days during which no Shares are tendered for redemption and
no order to purchase or sell Shares is received by the Fund. The Fund's offices
will be closed and net asset value will not be calculated on those days on which
the NYSE is closed, which currently are: New Year's Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day.
Trading in securities on European and Far Eastern exchanges and
over-the-counter markets is normally completed well before the close of business
in New York on each day on which the NYSE is open. Trading of European or Far
Eastern securities generally, or in a particular country or countries, may not
take place on every New York business day. Furthermore, trading takes place in
various foreign markets on days which are not business days in New York and on
which the Fund's net asset value is not calculated. The Fund calculates net
asset value per Share, and therefore effects sales, redemptions and repurchases
of its Shares, as of the close of the NYSE once on each day on which that
Exchange is open. Such calculation does not take place contemporaneously with
the determination of the prices of many of the portfolio securities used in such
calculation and if events occur which materially affect the value of those
foreign securities, they will be valued at fair market value as determined by
the management and approved in good faith by the Board of Trustees.
The Board of Trustees may establish procedures under which the Fund may
suspend the right of redemption for the whole or any part of any period during
which (1) the NYSE is closed other than for customary weekend and holiday
closings, (2) trading on the NYSE is restricted, (3) an emergency exists, as
determined under rules and regulations of the Securities and Exchange
Commission, as a result of which disposal of securities owned by the Fund is not
reasonably practicable or it is not reasonably practicable for the Fund fairly
to determine the value of its net assets, or (4) for such other period as the
Securities and Exchange Commission may by order permit for the protection of the
holders of the Fund's Shares. Any subscription may be rejected by the Fund.
TAX STATUS
The Fund intends to qualify and elect to be taxed as a "regulated
investment company" under Subchapter M of the Internal Revenue Code (the
"Code"). In any fiscal year in which the Fund so qualifies and distributes at
least 90% of its investment company taxable income, the Fund will be relieved of
federal income tax on the investment company taxable income and net capital
gains distributed to its Shareholders, the Separate Accounts. However, because
the Separate Accounts are not separate entities and their operations form a part
of TFAC, TFAC will be liable for any federal income taxes which become payable
with respect to the income of the Separate Accounts. The Separate Accounts will
bear their allocable share of such liabilities. Under current law, no item of
dividend income, interest income or realized capital gain of the Separate
Accounts attributable, at a minimum, to appreciation after January 1, 1985, will
be taxed to TFAC to the extent it is applied to increase the reserves under the
Contracts.
Amounts not distributed on a timely basis in accordance with a calendar
year distribution requirement are also subject to a nondeductible 4% excise tax
unless the exception described below applies. To avoid the tax if it otherwise
applies, the Fund must distribute during each calendar year, (i) at least 98% of
its ordinary income (not taking into account any capital gains or losses) for
the calendar year, (ii) at least 98% of its capital gains in excess of its
capital losses for the twelve-month period ending on October 31 of the calendar
year (adjusted for certain ordinary losses), and (iii) all ordinary income and
capital gains for previous years that were not distributed during such years. To
avoid application of the excise tax, the Fund intends to make its distributions
in accordance with the calendar year distribution requirement. A distribution
will be treated as paid on December 31 of the calendar if it is declared by the
Fund during October, November, or December of that year to Shareholders of
record on a date in such a month and paid by the Fund during January of the
following calendar year. Such distributions will be taxable to Shareholders (a
Separate Account) in the calendar year in which the distributions are declared,
rather than the calendar year in which the distributions are received. The
excise tax provisions described above will not apply in a given calendar year to
the Fund if all of its Shareholders at all times during the calendar year are
segregated asset accounts of life insurance companies where the shares are held
in connection with variable contracts. (For this purpose, any shares of a
regulated investment company attributable to an investment not exceeding
$250,000 made in connection with the organization of the company is not taken
into account.) Accordingly, if this condition regarding the ownership of Shares
of the Fund is met, the excise tax will be inapplicable to the Fund even if the
calendar year distribution requirement is not met.
The Fund may invest in shares of foreign corporation which may be
classified under the Code as passive foreign investment companies ("PFICs"). In
general, a foreign corporation is classified as a PFIC if at least one-half of
its assets constitute investment-type assets or 75% or more of its gross income
is investment-type income. If the Fund receives a so-called "excess
distribution" with respect to PFIC stock, the Fund itself may be subject to tax
on a portion of the excess distribution, whether or not the corresponding income
is distributed by the Fund to Shareholders. In general, under the PFIC rules, an
excess distribution is treated as having been realized ratably over the period
during which the Fund held the PFIC shares. The Fund itself will be subject to
tax on the portion, if any, of an excess distribution that is so allocated to
prior Fund taxable years and an interest factor will be added to the tax, as if
the tax had been payable in such prior taxable years. Certain distributions from
a PFIC as well as gain from the sale of PFIC shares are treated as excess
distributions. Excess distributions are characterized as ordinary income even
though, absent application of the PFIC rules, certain excess distributions might
have been classified as capital gain.
The Fund may be eligible to elect alternative tax treatment with
respect to PFIC shares. Under an election that currently is available in some
circumstances, the Fund generally would be required to include in its gross
income its share of the earnings of a PFIC on a current basis, regardless of
whether distributions are received from the PFIC in a given year. If this
election were made, the special rules, discussed above, relating to the taxation
of excess distributions, would not apply. In addition, another election may be
available that would involve marking to market the Fund's PFIC shares at the end
of each taxable year (and on certain other dates prescribed in the Code), with
the result that unrealized gains are treated as though they were realized. If
this election were made, tax at the Fund level under the PFIC rules would
generally be eliminated, but the Fund could, in limited circumstances, incur
nondeductible interest charges. The Fund's intention to qualify annually as a
regulated investment company may limit its elections with respect to PFIC
shares.
Because the application of the PFIC rules may affect, among other
things, the character of gains, the amount of gain or loss and the timing of the
recognition of income with respect to PFIC shares, as well as subject the Fund
itself to tax on certain income from PFIC shares, the amount that must be
distributed to Shareholders, and which will be taxed to Shareholders as ordinary
income or long-term capital gain, may be increased or decreased substantially as
compared to a fund that did not invest in PFIC shares.
Income received by the Fund from sources within a foreign country may
be subject to withholding taxes and other taxes imposed by that country. Tax
conventions between certain countries and the U.S. may reduce or eliminate such
taxes.
Under the Code, gains or losses attributable to fluctuations in
exchange rates which occur between the time the Fund accrues income or other
receivables or accrues expenses or other liabilities denominated in a foreign
currency and the time that Fund actually collects such receivables or pays such
liabilities generally are treated as ordinary income or ordinary loss.
Similarly, on disposition of debt securities denominated in a foreign currency
and on disposition of certain types of financial contracts, gains or losses
attributable to fluctuations in the value of foreign currency between the date
of acquisition of the security or contract and the date of disposition also are
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 income to be distributed to its Shareholders as
ordinary income.
Debt securities purchased by the Fund may be treated for federal income
tax purposes as having original issue discount. Original issue discount
essentially represents interest for federal income tax purposes and can be
defined generally as the excess of the stated redemption price at maturity over
the issue price. Original issue discount, whether or not any income is actually
received by the Fund, is treated for U.S. federal income tax purposes as
ordinary income earned by the Fund, and therefore is subject to the distribution
requirements of the Code. Generally, the amount of original issue discount
included in the income of the Fund each year is determined on the basis of a
constant yield to maturity which takes into account the compounding of accrued
but unpaid interest.
Some of the debt securities may be purchase by the Fund at a discount
which exceeds the original issue discount on such debt securities, if any. This
additional discount represents market discount for Federal income tax purposes.
The gain realized on the disposition of any taxable debt security having market
discount will be treated as ordinary income to the extent it does not exceed the
accrued market discount on such debt security. Generally, market discount
accrues on a daily basis for each day the debt security is held by the Fund at a
constant rate over the time remaining to the debt security's maturity or, at the
election of the Fund, at a constant yield to maturity which takes into account
the semi-annual compounding of interest.
Certain futures contracts in which the Fund may invest are "section
1256 contacts." Gains or losses on section 1256 contracts generally are
considered 60% long-term and 40% short-term capital gains or losses ("60-40"),
except for certain foreign currency gains and losses which will be treated as
ordinary in character. Also, section 1256 contracts held by the Fund at the end
of each taxable year (and, in some cases, for purposes of the 4% excise tax, on
October 31 of each year) are "marked-to-market" with the result that unrealized
gains or losses are treated as though they were realized.
The hedging transactions undertaken by the Fund may result in
"straddles" for federal income tax purposes. The straddle rules may affect the
character of gains (or losses) realized by the Fund. In addition, losses
realized by the Fund on positions that are part of a straddle may be deferred
under the straddle rules, rather than being taken into account in calculating
the taxable income for the taxable year in which such losses are realized.
Because only a few regulations implementing the straddle rules have been
promulgated, the tax consequences to the Fund of hedging transactions are not
entirely clear. The hedging transactions may increase the amount of short-term
capital gain realized by the Fund which is taxed as ordinary income when
distributed to Shareholders.
The Fund may make one or more of the elections available under the Code
which are applicable to straddles. If the Fund makes any of the elections, the
amount, character and timing of the recognition of gains or losses from the
affected straddle positions will be determined under rules that vary according
to the elections made. The rules applicable under certain of the elections may
operate to accelerate the recognition of gains or losses from the affected
straddle positions.
Because application of the straddle rules may affect the character of
gains or losses, defer losses and/or accelerate the recognition of gains or
losses from the affected straddle positions, the amount which must be
distributed to Shareholders, and which will be taxed to Shareholders as ordinary
income or long-term capital gain, may be increased or decreased substantially as
compared to a fund that did not engage in such hedging transactions.
The requirements under the Code relating to the qualification of the
Fund as a regulated investment company may limit the extent to which the Fund
may engage in futures contracts.
Distributions of any investment company taxable income are treated as
ordinary income for tax purposes in the hands of the Separate Accounts, even
though distributed as additional Shares of the Fund rather than in cash.
Similarly, net capital gains (the excess of any net long-term capital gains over
net short-term capital losses) will be, to the extent distributed by the Fund
and designated by the Fund as capital gain dividends, treated as long-term
capital gains in the hands of the Separate Accounts, even though distributed as
additional Shares of the Fund, regardless of the length of time the Separate
Accounts may have held the Shares.
To comply with regulations under Section 817(h) of the Code, the Fund
must diversify its investments so that on the last day of each quarter of a
calendar year no more than 55% of the value of its assets is represented by any
one investment, no more than 70% is represented by any two investments, no more
than 80% is represented by any three investments, and no more than 90% is
represented by any four investments. Generally, securities of a single issuer
are treated as one investment. However, for this purpose, in the case of U.S.
Government securities, each U.S. Government agency or instrumentality is treated
as a separate issuer. Any security issued, guaranteed or insured (to the extent
so guaranteed or insured) by the United States or an instrumentality of the
United States is treated as a U.S. Government security.
Reference is made to the prospectus for the Separate Account for
information regarding the federal income tax treatment of distributions to the
Separate Account.
DESCRIPTION OF SHARES
The Shares have non-cumulative voting rights, so that the holders of a
plurality of the Shares voting for the election of Trustees at a meeting at
which 50% of the outstanding Shares are present can elect all the Trustees and,
in such event, the holders of the remaining Shares voting for the election of
Trustees will not be able to elect any person or persons to the Board of
Trustees.
The Declaration of Trust provides that the holders of not less than
two-thirds of the outstanding Shares of the Fund may remove a person serving as
Trustee either by declaration in writing or at a meeting called for such
purpose. The Trustees are required to call a meeting for the purpose of
considering the removal of a person serving as Trustee, if requested in writing
to do so by the holders of not less than 10% of the outstanding Shares of the
Fund.
Under Massachusetts law, Shareholders could, under certain
circumstances, be held personally liable for the obligations of the Fund.
However, the Declaration of Trust disclaims liability of the Shareholders,
Trustees or officers of the Fund for acts or obligations of the Fund, which are
binding only on the assets and property of the Fund. The Declaration of Trust
provides for indemnification out of Fund property for all loss and expense of
any Shareholder held personally liable for the obligations of the Fund. The risk
of a Shareholder incurring financial loss on account of Shareholder liability is
limited to circumstances in which the Fund itself would be unable to meet its
obligations and, thus, should be considered remote.
PERFORMANCE INFORMATION
The Fund may, from time to time, include its total return in
advertisements or reports to Shareholders or prospective investors. Performance
information for the Fund will not be advertised unless accompanied by comparable
performance information for a separate account to which the Fund offers its
Shares.
Quotations of average annual total return for the Fund will be
expressed in terms of the average annual compounded rate of return for periods
in excess of one year or the total return for periods less than one year of a
hypothetical investment in the Fund over a period of one year (or, if less, up
to the life of the Fund) calculated pursuant to the following formula: P(1 + T)n
= ERV (where P = a hypothetical initial payment of $1,000, T = the average
annual total return for periods of one year or more or the total return for
periods of less than one year, n = the number of years, and ERV = the ending
redeemable value of a hypothetical $1,000 payment made at the beginning of the
period). All total return figures reflect the deduction of a proportional share
of Fund expenses on an annual basis, and assume that all dividends and
distributions are reinvested when paid. The Fund's average annual total return
for the one- and five-year periods ended December 31, 1995 and for the period
from February 16, 1988 (commencement of operations) through December 31, 1995
were 25.49, 19.37% and 15.10%, respectively.
Performance information for the Fund may be compared, in reports and
promotional literature, to: (i) the Standard & Poor's 500 Stock Index, Dow Jones
Industrial Average, or other unmanaged indices so that investors may compare the
Fund's results with those of a group of unmanaged securities widely regarded by
investors as representative of the securities market in general; (ii) other
groups of mutual funds tracked by Lipper Analytical Services, Inc., a widely
used independent research firm which ranks mutual funds by overall performance,
investment objectives and assets, or tracked by other services, companies,
publications, or persons who rank mutual funds on overall performance or other
criteria; and (iii) the Consumer Price Index (measure for inflation) to assess
the real rate of return from an investment in the Fund. Unmanaged indices may
assume the reinvestment of dividends but generally do not reflect deductions for
administrative and management costs and expenses.
Quotations of total return for the Fund will not take into account
charges and deductions against any separate accounts to which the Fund's Shares
are sold or charges and deductions against Templeton Retirement Annuities,
Templeton Immediate Variable Annuities, or any other participations or policies
for which the Fund may serve as the underlying investment vehicle, although
comparable performance information for a separate account will take such charges
into account. Performance information for the Fund reflects only the performance
of a hypothetical investment in the Fund during the particular time period on
which the calculations are based. Performance information should be considered
in light of the Fund's investment objective and policies, characteristics and
quality of the portfolio and the market conditions during the given time period,
and should not be considered as a representation of what may be achieved in the
future.
From time to time, the Fund and the Investment Manager may also refer
to the following information:
(1) The Investment Manager's and its affiliates' market share of
international equities managed in mutual funds prepared or
published by Strategic Insight or a similar statistical
organization.
(2) The performance of U.S. equity and debt markets re-
lative to foreign markets prepared or published by Morgan
Stanley Capital International or a similar financial
organization.
(3) The capitalization of U.S. and foreign stock markets
as prepared or published by the International Finance Corp.,
Morgan Stanley Capital International or a similar financial
organization.
(4) The geographic distribution of the Fund's portfolio and the
Fund's top ten holdings.
(5) The gross national product and populations, including age
characteristics, of various countries as published by various
statistical organizations.
(6) To assist investors in understanding the different returns and
risk characteristics of various investments, the Fund may show
historical returns of various investments and published
indices (E.G., Ibbotson Associates, Inc. Charts and Morgan
Stanley EAFE - Index).
(7) The major industries located in various jurisdictions as
published by the Morgan Stanley Index.
(8) Rankings by DALBAR Surveys, Inc. with respect to mutual fund
shareholder services.
(9) Allegorical stories illustrating the importance of persistent
long-term investing.
(10) The Fund's portfolio turnover rate and its ranking relative
to industry standards as published by Lipper Analytical
Services, Inc. or Morningstar, Inc.
(11) A description of the Templeton organization's investment
management philosophy and approach, including its worldwide
search for undervalued or "bargain" securities and its
diversification by industry, nation and type of stocks or
other securities.
(12) The number of shareholders in the Fund or the aggregate
number of shareholders in the Franklin Templeton Group of
Funds or the dollar amount of fund and private account assets
under management.
(13) Comparison of the characteristics of various
emerging markets, including population and financial and
economic conditions.
(14) Quotations from the Templeton organization's founder, Sir John
Templeton*, advocating the virtues of diversification and
long-term investing, including the following:
o "Never follow the crowd. Superior performance
is possible only if you invest differently from
the crowd."
o "Diversify by company, by industry and by country."
o "Always maintain a long-term perspective."
o "Invest for maximum total real return."
o "Invest - don't trade or speculate."
o "Remain flexible and open-minded about types of
investment."
o "Buy low."
o "When buying stocks, search for bargains among
quality stocks."
o "Buy value, not market trends or the economic
outlook."
o "Diversify. In stocks and bonds, as in much else,
there is safety in numbers."
o "Do your homework or hire wise experts to help you."
o "Aggressively monitor your investments."
o "Don't panic."
o "Learn from your mistakes."
o "Outperforming the market is a difficult task."
o "An investor who has all the answers doesn't even
understand all the questions."
o "There's no free lunch."
o "And now the last principle: Do not be fearful or
negative too often."
FINANCIAL STATEMENTS
The financial statements contained in the Fund's December 31, 1995
Annual Report to Shareholders are incorporated herein by reference.
* Sir John Templeton sold the Templeton organization to Franklin
Resources, Inc. in October, 1992 and resigned from the Trust's Board on
April 16, 1995. He is no longer involved with the investment management
process.
