Investment Manager
Legg Mason Fund Adviser, Inc.
Baltimore, MD
Report to Shareholders
Investment Adviser For the Six Months Ended
Western Asset Management Company June 30, 1996
Pasadena, CA
Board of Directors
John F. Curley, Jr., Chairman
Edmund J. Cashman, Jr., Vice Chairman
Edward A. Taber, III, President
Richard G. Gilmore
Charles F. Haugh THE
Arnold L. Lehman LEGG MASON
Dr. Jill E. McGovern INVESTMENT
T. A. Rodgers GRADE
INCOME
Transfer and Shareholder Servicing Agent PORTFOLIO
Boston Financial Data Services
Boston, MA
Custodian
State Street Bank & Trust Company
Boston, MA Putting Your Future First
Counsel
Kirkpatrick & Lockhart LLP
Washington, DC
Independent Accountants [Legg Mason Logo]
Coopers & Lybrand L.L.P. FUNDS
Baltimore, MD
This report is not to be distributed unless preceded or
accompanied by a prospectus.
Legg Mason Wood Walker, Incorporated
- -------------------------------------------------------------------------------
111 South Calvert Street
P.O. Box 1476, Baltimore, MD 21203-1476
410 (bullet) 539 (bullet) 0000
[recycle logo] Printed on Recycled Paper
LMF-022
<PAGE>
To Our Shareholders,
The Legg Mason Investment Grade Income Portfolio is a mutual fund designed
for investors who wish to earn a high level of current income from a diversified
portfolio consisting principally of investment grade bonds and other debt
securities. Investment grade securities have received one of the four highest
ratings from Moody's Investors Service or Standard &Poor's Corporation, or are
considered by the fund's investment adviser to be of equivalent quality.
On June 30, 1996, the Portfolio had an annualized 30-day SEC yield of
6.51%, an average life of 9.51 years and net assets per share of $9.99. Net
assets per share were down from $10.44 on December 31, 1995, reflecting declines
in the value of our holdings in response to generally rising interest rates.
Total return for the six month period (not annualized) was -1.2% compared to
+12.7% in the same period last year (Total return measures investment
performance in terms of appreciation or depreciation in the Portfolio's net
assets per share, plus dividends and any capital gain distributions). The
Portfolio's total return in various periods since its inception is shown on page
3. As is the case with all bond funds, historical performance is not indicative
of future results, and the principal value of our holdings will continue to
fluctuate so that shares, when redeemed, may be worth more or less than their
original cost.
Many fund shareholders regularly add to their fund holdings by authorizing
automatic, monthly transfers from their bank checking or Legg Mason accounts.
Your Investment Executive will be happy to help you make these arrangements if
you would like to purchase fund shares in this convenient way.
Sincerely,
/s/ John F. Curley, Jr.
John F. Curley, Jr.
Chairman
August 15, 1996
<PAGE>
Portfolio Managers' Comments
In a continuation of the extraordinarily volatile conditions
experienced by the bond market in recent years, interest rates soared in
the first half of 1996, reversing over half the declines which occurred
over the course of 1995. Despite these very inhospitable market
conditions, the fund posted a total return of -1.23%, slightly exceeding
the Salomon Brothers Broad Investment Grade Index's return of -1.27%. This
was achieved through the use of multiple strategies and moderate exposure
to interest rate risk. Although the fund was positioned throughout the
period for falling interest rates, the negative impact of sharply higher
rates was more than offset by the fund's barbell exposure to maturities
and its overweight exposure to mortgage-backed and corporate securities.
Ever since the Fed tightened policy in 1994 in order to slow the
economy, the bond market has been obsessed by growth. Rates rose sharply
in 1996 as evidence mounted that the economy had picked up enough to cause
the Federal Reserve to tighten monetary policy. Early in the year, market
expectations centered around further reductions in short-term rates by the
Fed, but this soon reversed as market participants came to anticipate a
series of tightenings on the part of the central bank. Short and
intermediate-term interest rates rose more than long-term rates in this
environment, as fears of Fed tightening outweighed fears of a serious
deterioration in the long-term inflation fundamentals. This produced one
of the sharpest selloffs in the history of the bond market, but also led
to a situation where, on a risk-adjusted basis, long-term bonds actually
outperformed intermediate-term bonds.
By concentrating its interest rate risk in long-term bonds throughout
the period, the fund suffered relatively less than the broad market as
yields rose. The fund's mortgage-backed issues performed very well in this
environment, since the risk of prepayments fell as yields rose, and
spreads remained relatively attractive throughout. Corporate issues
performed well also, since improving prospects for the economy supported a
general improvement in quality spreads.
By the end of the period, the fund remained positioned for declining
interest rates, but had restructured its maturity exposure to emphasize
the middle part of the yield curve, in the expectation that short and
intermediate-term rates were likely to decline more than long-term rates
as yields fell. The fund remained overweight to the mortgage sector, and
modestly overweight to the corporate sector.
Although the economic data confirm that the economy has strengthened
this year, it is far from clear that it is on a path to overheating. For
the past six months, housing starts and auto sales have reached a plateau.
More recently, the growth rates of retail sales, consumer credit and the
monetary aggregates have slowed. To be sure, employment growth has picked
up moderately, as have wages. Yet capacity utilization is below critical
levels, and worldwide manufacturing activity is less than robust. For its
part, fiscal policy continues to be restrictive, since spending growth has
been restrained and tax burdens have reached post-war highs.
In our view, sound monetary fundamentals are still in place, and
higher interest rates will likely act to at least avert an overheating
economy. This contrasts distinctly with market expectations, since forward
interest rates currently assume the economy will grow fast enough to cause
the Fed to raise short-term rates several times by the end of the year. If
moderate growth and subdued inflation instead prevail, then Fed tightening
expectations will fade, and short and intermediate-term interest rates
should decline more than long-term rates.
Western Asset Management Company
August 15, 1996
2
<PAGE>
Performance Information
Legg Mason Income Trust, Inc.
Investment Grade Income Portfolio
Total Return for One, Five, Seven Years and Life of Fund, as of
June 30, 1996
The returns shown on this page are based on historical results and
are not intended to indicate future performance. The investment return and
principal value of an investment in the fund will fluctuate so that an
investor's shares, when redeemed, may be worth more or less than their
original cost. Average annual returns tend to smooth out variations in the
fund's return, so they differ from actual year-to-year results. No
adjustment has been made for any income taxes payable by shareholders.
The fund has two classes of shares: Primary Class and Navigator
Class. The Navigator Class, offered only to certain institutional
investors, pays fund expenses similar to those paid by the Primary Class,
except that transfer agency fees and shareholder servicing expenses are
determined separately for each class and the Navigator Class does not
incur Rule 12b-1 distribution fees.
The fund's total returns as of June 30, 1996 were as follows:
Cumulative Average Annual
Total Return Total Return
- --------------------------------------------------------------------------------
Primary Class:
One Year +5.27% +5.27%
Five Years +49.43 +8.37
Seven Years +71.87 +8.04
Life of Class(dagger) +105.37 +8.42
Navigator Class:
Life of Class(double dagger) +0.42% n/a
- --------------------------------------------------------------------------------
(dagger) Primary Class inception--August 6, 1987
(double dagger) Navigator Class inception--December 1, 1995
3
<PAGE>
Statement of Net Assets
Legg Mason Income Trust, Inc.
Investment Grade Income Portfolio
June 30, 1996 (Unaudited)
<TABLE>
<CAPTION>
Principal Principal
(Amounts in Thousands) Amount Value (Amounts in Thousands) Amount Value
- ----------------------------------------------------------- -----------------------------------------------------------
<S> <C>
Corporate Bonds and Notes -- 31.8%
Finance -- 3.3% Oil and Gas -- 2.9%
Associates Corporation, Louis Dreyfus Natural Gas
North America Corporation
8.15% 8/1/09 $ 1,000 $ 1,049 9.25% 6/15/04 $ 1,000 $ 1,024
Salomon Inc. Occidental Petroleum Corporation
6.75% 2/15/03 800 766 9.625% 7/1/99 1,500 1,500
Western Financial Savings 2,524
Bank F.S.B. Transportation -- 1.2%
8.50% 7/1/03 1,000 1,001 Delta Air Lines, Inc.
2,816 7.79% 12/1/98 l,000 1,018
Food and Beverage -- 1.5%
RJR Nabisco, Inc. Utilities -- 6.9%
8.75% 8/15/05 200 198 Connecticut Light and Power
8.75% 7/15/07 1,110 1,089 Company
1,287 7.875% 6/1/01 1,750 1,774
First PV Funding Corporation
Industrial -- 10.3% 10.15% 1/15/16 1,000 1,053
Kmart Corporation Niagara Mohawk Power Corporation
7.95% 2/1/23 2,000 1,520 7.75% 5/15/06 1,200 1,062
Lockheed Martin Corporation North Atlantic Energy Corporation
6.625% 6/15/98 1,030 1,034 9.05% 6/1/02 1,330 1,316
7.45% 6/15/04 620 629 System Energy Resources, Inc.
SPX Corporation 7.43% 1/15/11 788 750
11.75% 6/1/02 2,500 2,644 5,955
TCI Communications Incorporated Total Corporate Bonds and Notes
8.75% 8/1/15 1,530 1,504 (Identified Cost -- $27,539) 27,305
7.875% 2/15/26 530 467 -----------------------------------------------------------
Westpoint Stevens Inc. Asset-Backed Securities -- 6.1 %
8.75% 12/15/01 1,000 987 Advanta Home Equity Loan Trust
8,785 5.95% 3/25/09 1,185 1,099
Chevy Chase Home Loan Trust
Media and Entertainment -- 3.5% 7.15% 5/15/15 1,600 1,597
News America Holdings Incorporated ContiMortgage Home Equity Loan
8.875% 4/26/23 1,000 1,037 Trust
Time Warner Entertainment 8.60% 2/15/10 1,399 1,415
Company, L.P. Olympic Automobile Receivables
8.375% 7/15/33 1,420 1,364 Trust
Time Warner Incorporated 7.875% 7/15/01 1,128 1, 146
9.15% 2/1/23 605 625 Total Asset-backed Securities
3,026 (Identified Cost-- $5,322) 5,257
Multi-Industry -- 2.2% -----------------------------------------------------------
Loews Corporation
7.625% 6/1/23 2,000 1,894
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
Principal Principal
(Amounts in Thousands) Amount Value (Amounts in Thousands) Amount Value
- ----------------------------------------------------------- -----------------------------------------------------------
<S> <C>
Mortgage-Backed Securities -- 7.9% U.S. Government Agency Mortgage-backed
Fixed-rate Securities -- 4.0% Securities -- 28.6%
Asset Securitization Corporation Fixed-rate Securities -- 23.8%
6.92% 2/14/29 $ 1,193 $ 1,153 Federal Home Loan Mortgage
Nomura Asset Securities Corporation Corporation
7.12% 4/13/36 680 664 8.75% 10/1/01 $ 63 $ 65
PSB Financial Corporation II 6.00% 2/1/14 2,305 2,133
11.05% 12/1/15 912 969 6.50% 9/15/15 to 3/1/26 1,867 1,767
Resolution Trust Corporation 7.00% 8/1/24 to 5/1/26 11,050 10,673
10.00% 5/25/22 656 661 14,638
3,447
Federal National Mortgage
Variable-rate Securities(A) -- 3.0% Association
Resolution Trust Corporation 8.00% 4/25/06 1,000 1,036
8.21% 9/25/29 402 410 9.15% 9/25/18 315 323
11.091% 1/25/25 847 872 1,359
6.754%(B) 4/25/28 1,345 1,310
2,592 Government National Mortgage
Association
9.00% 7/15/16 to 6/15/17 1,664 1,759
Indexed Security(I) -- 0.9% 8.00% 7/1/26(E) 2,600 2,666
Resolution Trust Company 4,425
7.602% 5/25/19 743 709
Variable-rate Securities(A) -- 4.8%
Total Mortgage-backed Securities Federal Home Loan Mortgage
(Identified Cost -- $6,872) 6,748 Corporation
- ----------------------------------------------------------- 7.605% 9/1/24 1,382 1,441
U.S. Government and Agency Obligations -- 18.6%
Federal National Mortgage Government National Mortgage
Association Association
0%(C) 11/1/01 600 587 6.50% 1/20/25 2,598 2,616
Guaranteed Export Trust Total U.S. Government Agency
6.28% 6/15/04 941 922 Mortgage-backed Securities
(Identified Cost-- $24,383) 24,479
United States Treasury Bonds -----------------------------------------------------------
10.75% 8/15/05 1,300 1,650
0%(D) 8/15/20 17,270 3,113 Yankee Bonds(F) -- 7.6%
Hydro-Quebec
4,763 8.05% 7/7/24 1,200 1,272
United States Treasury Notes Province de Quebec
5.25% 12/31/97 580 574 7.125% 2/9/24 2,000 1,828
5.875% 4/30/98 1,930 1,922 5.67%(G) 2/27/26 1,075 1,036
6.375% 5/15/99 2,610 2,616 Societe Generale
6.875% 3/31/00 3,530 3,581 7.40% 6/1/06 1,000 999
6.25% 4/30/01 1,000 990 YPF Sociedad Anonima
9,683 7.50% 10/26/02 1,389 1,377
Total U.S. Government and Agency
Obligations Total Yankee Bonds
(Identified Cost-- $16,330) 15,955 (Identified Cost-- $6,767) 6,512
- ----------------------------------------------------------- -----------------------------------------------------------
</TABLE>
5
<PAGE>
Statement of Net Assets -- Continued
Legg Mason Income Trust, Inc.
Investment Grade Income Portfolio
(Amounts in Thousands) Shares Value
- -------------------------------------------------------------------------------
Preferred Stock -- 1.1 %
Time Warner Incorporated
10.25%(B) 7/1/16 1 $ 944
Total Preferred Stock
(Identified Cost-- $970) 944
- -------------------------------------------------------------------------------
Principal
Amount
Short-Term Investments -- 4.4%
Corporate Bonds and Notes -- 1.2%
Salomon Inc.
8.45% 2/17/97 $ 1,000 1,012
U. S. Government Obligation -- 1.2%
United States Treasury Bill
4.94% 7/11/96 1,000 999(H)
Repurchase Agreement -- 2.0%
J.P. Morgan Securities, Inc.
5.47% dated 6/28/96, to be
repurchased at $1,727 on 7/1/96
(Collateral: $1,735 Federal
National Mortgage Association
5.60% due 9/20/96, value $1,787) 1,726 1,726
Actual
Contracts
Option Purchased -- N.M.
Eurodollar Future Call
September 96 Strike Price $94.50 120 9
Total Short-term Investments
(Identified Cost-- $3,755) 3,746
- --------------------------------------------------------------------------------
Total Investments -- 106.1%
(Identified Cost-- $91,938) 90,946
Other Assets Less Liabilities -- (6.1)% (5,216)
Net assets-- 100.0% $85,730
(Amounts in Thousands)
- --------------------------------------------------------------------------------
Net assets consisting of:
Accumulated paid-in capital
applicable to:
8,562 Primary Class shares
outstanding $88,563
24 Navigator Class shares
outstanding 247
Undistributed net investment income 53
Accumulated realized loss on
investments, options and futures (2,265)
Unrealized depreciation of
investments, options and futures (868)
Net assets-- 100.0% $85,730
Net asset value per share:
Primary Class $9.99
Navigator Class $9.99
Net
Actual Appreciation
Date Contracts (Depreciation)
- --------------------------------------------------------------------------------
Options Written(J)
Treasury Note Call
Strike Price $105.00 August 96 39 $(26)
Treasury Bond Call
Strike Price $112.00 August 96 50 14
$(12)
Futures Contracts Bought(J)
Treasury Note Future Sept 96 56 76
Treasury Note Future Sept. 96 58 124
$200
Futures Contracts Sold(J)
Treasury Bond Future Sept. 96 23 $(64)
(A) The coupon rates shown on variable rate securities are the rates at June 30,
1996. These rates vary with the weighted average coupon of the underlying
loans.
(B) Rule 144a security - A security purchased pursuant to Rule 144a under the
Securities Act of 1933 which may not be resold subject to that rule
except to qualified institutional buyers.
(C) Zero-coupon bond - A bond with no periodic interest payments which is sold
at a discount to produce a current yield-to-maturity. This FNMA security
is a zero-coupon bond callable on November 1, 1996. If not called,
interest will accrue at 7.99% from November 1, 1996 until maturity.
(D) Stripped Security - Security with interest-only or principal-only payment
streams. This Treasury Bond is a principal-only security.
(E) When-issued Security - Security purchased on a delayed delivery basis. Final
settlement amount and maturity date have not yet been announced.
(F) Yankee Bond - Dollar-denominated bond issued in the U.S. by foreign
entities.
(G) The rate of interest earned on this security is fixed at 5.67% until
February 2001 and is 7.14% thereafter.
(H) Collateral to cover written option and futures contracts sold.
(I) Indexed Security - The rate of interest earned on this security is tied to
the Cost of Funds Index (COFI). The coupon rate shown is the rate at June
30, 1996.
(J) Options and Futures are described in detail in the notes to the financial
statements.
N.M. Not meaningful.
See notes to financial statements.
6
<PAGE>
Statement of Operations
Legg Mason Income Trust, Inc.
Investment Grade Income Portfolio
For the Six Months Ended June 30, 1996 (Unaudited)
<TABLE>
<CAPTION>
(Amounts in Thousands)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C>
Investment Income:
Interest $ 3,050
Dividends 25
Total income $ 3,075
Expenses:
Management fee 253
Distribution and service fees 211
Custodian fee 51
Transfer agent and shareholder servicing expense 45
Legal and audit fees 15
Registration fees 10
Reports to shareholders 11
Directors' fees 4
Other expenses 2
602
Less fees waived (209)
Total expenses, net of waivers 393
Net Investment Income 2,682
Net Realized and Unrealized Gain (Loss) on Investments:
Realized gain on investments, options and futures 277
Decrease in unrealized appreciation of investments, options and futures (4,109)
Net Realized and Unrealized Loss on Investments (3,832)
- ---------------------------------------------------------------------------------------------------------------------------
Decrease in Net Assets Resulting from Operations $(1,150)
</TABLE>
See notes to financial statements.
7
<PAGE>
Statement of Changes in Net Assets
Legg Mason Income Trust, Inc.
Investment Grade Income Portfolio
<TABLE>
<CAPTION>
For the For the
Six Months Ended Year Ended
(Amounts in Thousands) June 30, 1996 December 31, 1995
- ---------------------------------------------------------------------------------------------------------------------------
(Unaudited)
<S> <C>
Change in Net Assets:
Net investment income $ 2,682 $ 4,900
Net realized gain on investments, options and futures 277 969
Change in unrealized appreciation of investments, options and futures (4,109) 7,813
Change in net assets resulting from operations (1,150) 13,682
Distributions to shareholders from net investment income:
Primary Class (2,674) (4,899)
Navigator Class (8) (1)
Change in net assets from Fund share transactions:
Primary Class 3,680 10,657
Navigator Class -- 247
Change in net assets (152) 19,686
Net Assets:
Beginning of period 85,882 66,196
- ---------------------------------------------------------------------------------------------------------------------------
End of period (including undistributed net investment income
of $53 and $53, respectively) $85,730 $85,882
</TABLE>
See notes to financial statements.
8
<PAGE>
Financial Highlights
Legg Mason Income Trust, Inc.
Investment Grade Income Portfolio
Contained below is per share operating performance data for a share
of common stock outstanding, total investment return, ratios to average
net assets and other supplemental data. This information has been derived
from information provided in the financial statements.
<TABLE>
<CAPTION>
Navigator
Primary Class Class
- ---------------------------------------------------------------------------------------------------------------------------
For the Six For the Years Ended December 31, For the Six
Months Ended --------------------------------------------------- Months Ended
June 30, 1996 1995 1994 1993 1992 1991 June 30, 1996
- ---------------------------------------------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
<S> <C>
Per Share Operating Performance:
Net asset value, beginning of period $10.44 $9.27 $10.40 $10.71 $10.71 $ 9.97 $10.44
- ---------------------------------------------------------------------------------------------------------------------------
Net investment income 0.32(B) 0.65(B) 0.60(B) 0.62(B) 0.66(B) 0.76(B) 0.35(A)
Net realized and unrealized gain (loss)
on investments, options and futures (0.45) 1.17 (1.09) 0.33 0.25 0.77 (0.45)
- ---------------------------------------------------------------------------------------------------------------------------
Total from investment operations (0.13) 1.82 (0.49) 0.95 0.91 1.53 (0.10)
Distributions to shareholders:
Net investment income (0.32) (0.65) (0.60) (0.62) (0.66) (0.76) (0.35)
Net realized gain on investments -- -- (0.04) (0.63) (0.25) (0.03) --
In excess of net realized gain
on investments -- -- -- (0.01) -- -- --
- ---------------------------------------------------------------------------------------------------------------------------
Total distributions (0.32) (0.65) (0.64) (1.26) (0.91) (0.79) (0.35)
- ---------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $ 9.99 $10.44 $ 9.27 $10.40 $10.71 $10.71 $ 9.99
Total return (1.23)%(C) 20.1% (4.8)% 11.2% 6.8% 16.0% (0.99)%(C)
Ratios/Supplemental Data:
Ratios to average net assets:
Expenses 0.93%(B,D) 0.88%(B) 0.85%(B) 0.85%(B) 0.85%(B) 0.71%(B) 0.43%(A,)
Net investment income 6.4%(B,D) 6.5%(B) 6.1%(B) 5.6%(B) 6.1%(B) 7.3%(B) 6.9%(A,D)
Portfolio turnover rate 468.7%(D) 221.1% 200.1% 348.2% 316.7% 212.5% 468.7%(D)
Net assets, end of period
(in thousands) $85,493 $85,633 $66,196 $68,781 $48,033 $36,498 $237
</TABLE>
(A) Net of fees waived by the manager for expenses in excess of voluntary
expense limitations of 0.4% until April 30, 1996 and 0.5% until December
31, 1996.
(B) Net of fees waived and reimbursements made by the manager for expenses in
excess of voluntary expense limitations as follows: 0.65% until April
30, 1991; 0.7% until October 31, 1991; 0.8% until December 31, 1991; 0.85%
until April 30, 1995; 0.9% until April 30, 1996; and 1.0% until December
31, 1996.
(C) Not annualized
(D) Annualized
See notes to financial statements.
9
<PAGE>
Notes to Financial Statements
Legg Mason Income Trust, Inc.
Investment Grade Income Portfolio
(Amounts in Thousands) (Unaudited)
- -------------------------------------------------------------------------------
1. Significant Accounting Policies:
The Legg Mason Income Trust, Inc. ("Trust"), consisting of the
Investment Grade Income Portfolio ("Fund"), the U.S. Government
Intermediate-Term Portfolio, the U.S. Government Money Market Port-folio
and the High Yield Portfolio, is registered under the Investment Company
Act of 1940, as amended, as an open-end, diversified investment company.
The financial statements of the other portfolios of the Trust are included
in separate reports to shareholders.
The Investment Grade Income Portfolio consists of two classes of
shares:the Primary Class, offered since 1987, and the Navigator Class,
offered to certain institutional investors since December 1, 1995.
Expenses of the Fund are allocated proportionately to the two classes of
shares except for 12b-1 distri-bution fees, which are charged only on
Primary shares, and transfer agent and shareholder servicing expenses
which are determined separately for each class.
Security Valuation
Portfolio securities are valued based upon market quotations. When
market quotations are not readily available, securities are valued based
on prices received from recognized broker-dealers in the same or similar
securities. The amortized cost method of valuation is used for debt
obligations with 60 days or less remaining to maturity.
Investment Income and Dividends to Shareholders
Income and expenses are recorded on the accrual basis. Bond premiums
are amortized for financial reporting and tax purposes. Bond discounts,
other than original issue and zero-coupon bonds, are not amortized.
Dividends are declared daily and paid monthly. Dividends payable are
recorded on the dividend record date. At June 30, 1996, dividends payable
of $200 were accrued.
Security Transactions
Security transactions are recorded on the trade date. Realized gains
and losses from security transactions are reported on an identified cost
basis. At June 30, 1996 $10,277 was receivable for securities sold but not
yet delivered and $16,297 was payable for securities purchased but not yet
received.
Options and Futures
The current market value of a traded option is the last sale price
or, in the absence of a sale, the mean between the closing bid and asked
price. Futures contracts are marked to market daily using the closing
price on the principal exchange where the contracts are traded. Payments
(known as variation margin) are made or received daily in relation to
market fluctuations.
Repurchase Agreements
All repurchase agreements are fully collateralized by obligations
issued by the U.S. government or its agencies and such collateral is in
the possession of the Fund's custodian. The value of such collateral
includes accrued interest. Risks arise from the possible delay in recovery
or potential loss of rights in the collateral should the issuer of the
repurchase agreement fail financially.
Federal Income Taxes
No provision for federal income or excise taxes is required since the
Fund intends to continue to qualify as a regulated investment company and
distribute all of its taxable income to its shareholders.
2. Investment Transactions:
For the six months ended June 30, 1996, purchases and sales of U.S.
Government securities aggregated $123,545 and $131,252, respectively, and
purchases and sales of other securities (excluding short-term securities)
totaled $102,555 and $89,061, respectively.
At June 30, 1996, the cost of securities for federal income tax
purposes was $91,938. Aggregate gross unrealized appreciation for all
securities in which there was an excess of value over tax cost was $630
and aggregate gross unrealized depreciation for all securities in which
there was an excess of tax cost over value was $1,622. The Fund has unused
capital loss carryforwards for federal income tax purposes of $2,218 which
expire in 2002.
3. Options and Futures:
As part of the Fund's investment program, the Fund may utilize
options and futures. The nature and risk of these financial instruments
and the reasons for using them are set forth more fully in the Fund's
Prospectus and Statement of Additional Information.
A written call option gives an option holder the right to purchase
the underlying security at a specified price until a specified date. A
written put option gives an option holder the right to sell the underlying
security at a specified price until a specified date. Risks arise from the
possible illiquidity of
10
<PAGE>
(Amounts in Thousands)
- --------------------------------------------------------------------------------
the options market and from movements in security values. Call and put
options written by the Fund and related premiums received for the six
months ended June 30, 1996 were as follows:
Calls Puts
Actual Actual
Contracts Premiums Contracts Premiums
- --------------------------------------------------------------------------------
Options outstanding
December 31, 1995 -- $ -- -- $ --
Options written 7,248 385 6,972 163
Options closed (359) (281) (172) (132)
Options expired (6,800) (28) (6,800) (31)
- --------------------------------------------------------------------------------
Options outstanding
June 30, 1996 89 $ 76 -- $ --
- --------------------------------------------------------------------------------
The Fund has entered into futures contracts as a hedge against
anticipated changes in interest rates. Risks arise from the possible
illiquidity of the futures market and from the possibility that a change
in the value of a contract may not correlate with changes in interest
rates.
The open long and short futures positions and related appreciation or
depreciation at June 30, 1996 are described at the end of the "Statement
of Net Assets", page 6.
4. Realized Gain:
The components of net realized gain on investments, options and
futures for the six months ended June 30, 1996 were as follows:
Amount
- --------------------------------------------------------------------------------
Investments $100
Options 35
Futures 142
- --------------------------------------------------------------------------------
Net realized gain $277
- --------------------------------------------------------------------------------
5. Fund Share Transactions:
At June 30, 1996 there were 1,000,000 shares authorized at $.001 par
value for all portfolios of the Trust (including the Fund). Transactions
in Fund shares were as follows:
For the Six For the
Months Ended Year Ended
June 30, 1996 December 31, 1995
Primary Class Shares Amount Shares Amount
- --------------------------------------------------------------------------------
Sold 1,638 $ 16,586 2,728 $ 27,180
Reinvestment of
distributions 213 2,146 422 4,218
Repurchased (1,490) (15,052) (2,090) (20,741)
- --------------------------------------------------------------------------------
Net increase 361 $ 3,680 1,060 $ 10,657
- --------------------------------------------------------------------------------
For the Six December 1, 1995 (dagger)
Months Ended to
June 30, 1996 December 31, 1995
- --------------------------------------------------------------------------------
Navigator Class Shares Amount Shares Amount
- --------------------------------------------------------------------------------
Sold -- $-- 24 $247
Reinvestment of
distributions -- -- -- --
Repurchased -- -- -- --
- --------------------------------------------------------------------------------
Net increase -- $-- 24 $247
- --------------------------------------------------------------------------------
(dagger) Commencement of operations
6. Transactions with Affiliates:
The Fund has a management agreement with Legg Mason Fund Adviser,
Inc. ("Manager"), a corporate affiliate of Legg Mason Wood Walker,
Incorporated ("Legg Mason"), a member of the New York Stock Exchange and
the distributor for the Fund. Under this agreement, the Manager provides
the Fund with management and administrative services for which the Fund
pays a fee at an annual rate of 0.6% of average daily net assets of the
Fund. The agreement with the Manager provides that expense reimbursements
be made to the Fund for expenses which in any month are in excess of an
annual rate, based on average daily net assets, of 1.0% until December 31,
1996 or when the Fund reaches net assets of $100,000, whichever occurs
first. For the six months ended June 30, 1996, management fees of $209
were waived. At June 30, 1996, $6 was due to the Manager.
Western Asset Management Company ("Adviser"), a corporate affiliate
of the Manager and Legg Mason, serves as investment adviser to the Fund.
The Adviser is responsible for the actual investment activity of the Fund.
The Manager pays the Adviser a fee for its services at an annual rate
equal to 40% of the fee received by the Manager.
Legg Mason, as distributor of the Fund, receives an annual
distribution fee of 0.25% and an annual service fee of 0.25% of the Fund's
average daily net assets, calculated daily and payable monthly. At June
30, 1996, distribution and service fees of $34 were due to the
distributor. Legg Mason also has an agreement with the Fund's transfer
agent to assist with certain of its duties. For this assistance, Legg
Mason was paid $12 by the transfer agent for the six months ended June 30,
1996.
11
