FRANKLIN
MUTUAL SERIES
FUND INC.
STATEMENT OF
ADDITIONAL INFORMATION
NOVEMBER 1, 1996
AS AMENDED FEBRUARY 12, 1997
777 MARINERS ISLAND BLVD., P.O. BOX 7777
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SAN MATEO, CA 94403-7777 1-800/DIAL BEN
CONTENTS PAGE
Investment Objectives and Policies 2
Restrictions and Limitations. 10
Officers and Directors....... 11
Investment Management
and Other Services.......... 14
How does the Fund Buy
Securities for its Portfolio? 15
How Do I Buy, Sell and Exchange
Shares?..................... 16
How are Fund Shares Valued?.. 19
Additional Information on
Distributions and Taxes..... 20
The Fund's Underwriter....... 22
How does the Fund Measure
Performance?................ 23
Miscellaneous Information.... 27
Useful Terms and Definitions. 27
Financial Statements......... 28
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When reading this SAI, you will see certain terms beginning with capital
letters. This means the term is explained under "Useful Terms and Definitions."
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MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS:
O ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE
CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE
U.S. GOVERNMENT;
O ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY
BANK;
O ARE SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF
PRINCIPAL.
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The Franklin Mutual Series Fund Inc. (the "Fund") is an open-end
management investment company with five separate diversified series.
This SAI relates to the following classes of shares:
Mutual Shares Fund - Class I & Class II
Mutual Qualified Fund - Class I & Class II
Mutual Beacon Fund - Class I & Class II
Mutual European Fund - Class I & Class II
Mutual Discovery Fund - Class I & Class II
Each series may, separately or collectively, be referred to as the "series,"
"Fund" or "Funds."
The Prospectus, dated November 1, 1996, as amended February 12, 1997, and as may
be further amended from time to time, contains the basic information you should
know before investing in the Fund. For a free copy, call 1-800/DIAL BEN or write
the Fund at the address shown.
This SAI describes the Fund's Class I and Class II shares. The Fund currently
offers another class of shares with a different sales charge and expense
structure, which affects performance. This class is described in a separate SAI
and prospectus. For more information, contact your investment representative or
call 1-800/DIAL BEN.
THIS SAI IS NOT A PROSPECTUS. IT CONTAINS INFORMATION IN ADDITION TO AND IN MORE
DETAIL THAN SET FORTH IN THE PROSPECTUS. THIS SAI IS INTENDED TO PROVIDE YOU
WITH ADDITIONAL INFORMATION REGARDING THE ACTIVITIES AND OPERATIONS OF THE FUND,
AND SHOULD BE READ IN CONJUNCTION WITH THE PROSPECTUS.
INVESTMENT OBJECTIVES AND POLICIES
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As described in the Prospectus, the general investment policy of the Fund for
its series, Mutual Shares Fund ("Mutual Shares"), Mutual Qualified Fund
("Qualified"), Mutual Beacon Fund ("Beacon"), Mutual Discovery Fund
("Discovery"), and Mutual European Fund ("European"), is to invest in securities
if, in the opinion of Franklin Mutual, they are available at prices less than
their intrinsic value, as determined by Franklin Mutual after careful analysis
and research, taking into account, among other factors, the relationship of book
value to market value of the securities, cash flow, and multiples of earnings of
comparable securities. The Fund reserves freedom of action for each series to
invest in common stock, preferred stock, debt securities and other securities in
such proportions as the management deems advisable, but, without committing any
fixed portion of any series' assets, the management typically maintains a
portion of the assets of each series invested in debt securities and preferred
stocks (which may be convertible). In addition, the series may also invest in
restricted debt and equity securities, in foreign securities, and in other
investment company securities.
REPURCHASE AGREEMENTS
AND LOANS OF SECURITIES
Each series may invest in repurchase agreements with domestic banks or
broker-dealers. Repurchase agreements are considered loans by the series
collateralized by the underlying securities. As with loans of portfolio
securities which the series may make, these transactions must be fully
collateralized at all times. Franklin Mutual will monitor the creditworthiness
of the other party and will monitor the value of the collateral by marking to
market daily in order to confirm that its value is at least 100% of the agreed
upon sum to be paid to the series.
Repurchase agreements and lending of portfolio securities involve some credit
risk to the series. If the other party defaults on its obligations, the series
could be delayed or prevented from receiving payment or recovering its
collateral. Even if the series recovers the collateral in such a situation, the
series may receive less than its purchase price upon resale.
GENERAL CHARACTERISTICS OF OPTIONS
Put options and call options typically have similar structural characteristics
and operational mechanics regardless of the underlying instrument on which they
are purchased or sold. Thus, the following general discussion relates to each of
the particular types of options discussed in greater detail below. In addition,
many hedging transactions involving options require segregation of Fund assets
in special accounts, as described below under "Use of Segregated and Other
Special Accounts."
A put option gives the purchaser of the option, upon payment of a premium, the
right to sell, and the seller of the option, the obligation to buy, the
underlying security, commodity, index, currency or other instrument at the
exercise price. For instance, the Fund's purchase of a put option on a security
might be designed to protect its holdings in the underlying instrument (or, in
some cases, a similar instrument) against a substantial decline in the market
value by giving the Fund the right to sell such instrument at the option
exercise price. A call option, upon payment of a premium, gives the purchaser of
the option the right to buy, and the seller the obligation to sell, the
underlying instrument at the exercise price. The Fund's purchase of a call
option on a security, financial future, index, currency or other instrument
might be intended to protect the Fund against an increase in the price of the
underlying instrument that it intends to purchase in the future by fixing the
price at which it may purchase such instrument.
An American style put or call option may be exercised at any time during the
option period while a European style put or call option may be exercised only
upon expiration or during a fixed period prior thereto. The Fund is authorized
to purchase and sell exchange-listed options and over-the-counter options ("OTC
options"). Exchange-listed options are issued by a regulated intermediary such
as the Options Clearing Corporation ("OCC"), which guarantees the performance of
the obligations of the parties to such options. The discussion below uses the
OCC as a paradigm, but is also applicable to other financial intermediaries.
With certain exceptions, OCC-issued and exchange-listed options generally settle
by physical delivery of the underlying security or currency, although in the
future cash settlement may become available. Index options and Eurodollar
instruments are cash settled for the net amount, if any, by which the option is
"in-the-money" (i.e., where the value of the underlying instrument exceeds, in
the case of a call option, or is less than, in the case of a put option, the
exercise price of the option) at the time the option is exercised. Frequently,
rather than taking or making delivery of the underlying instrument through the
process of exercising the option, listed options are closed by entering into
offsetting option transactions.
The Fund's ability to close out its position as a purchaser or seller of an OCC
or exchange-listed put or call option is dependent, in part, upon the liquidity
of the option market. Among the possible reasons for the absence of a liquid
option market on an exchange are: (i) insufficient trading interest in certain
options; (ii) restrictions on transactions imposed by an exchange; (iii) trading
halts, suspensions or other restrictions imposed with respect to particular
classes or series of options or underlying securities including reaching daily
price limits; (iv) interruption of the normal operations of the OCC or an
exchange; (v) inadequacy of the facilities of an exchange or OCC to handle
current trading volume; or (vi) a decision by one or more exchanges to
discontinue the trading of options (or a particular class or series of options),
in which event the relevant market for that option on that exchange would cease
to exist, although outstanding options on that exchange would generally continue
to be exercisable in accordance with their terms.
The hours of trading for listed options may not coincide with the hours during
which the underlying financial instruments are traded. To the extent that the
option markets close before the markets for the underlying financial
instruments, significant price and rate movements can take place in the
underlying markets that cannot be reflected in the option markets.
OTC options are purchased from or sold to securities dealers, financial
institutions or other parties (each a "Counterparty," and collectively,
"Counterparties") through direct bilateral agreement with the Counterparty. In
contrast to exchange-listed options, which generally have standardized terms and
performance mechanics, all the terms of an OTC option, including such terms as
method of settlement, term, exercise price, premium, guarantees and security,
are set by negotiation of the parties. The Fund will only sell OTC options
(other than OTC currency options) that are subject to a buy-back provision
permitting the Fund to require the Counterparty to sell the option back to the
Fund at a formula price within seven days. The Fund expects generally to enter
into OTC options that have cash settlement provisions, although it is not
required to do so.
Unless the parties provide for it, there is no central clearing or guaranty
function in an OTC option. As a result, if the Counterparty fails to make or
take delivery of the security, currency or other instrument underlying an OTC
option it has entered into with the Fund or fails to make a cash settlement
payment due in accordance with the option, the Fund will lose any premium it
paid for the option as well as any anticipated benefit of the transaction.
Accordingly, Franklin Mutual must assess the creditworthiness of each such
Counterparty or any guarantor or credit enhancement of the Counterparty's credit
to determine the likelihood that the terms of the OTC option will be satisfied.
The Fund will engage in OTC option transactions only with U.S. government
securities dealers recognized by the Federal Reserve Bank of New York as
"primary dealers" or broker-dealers, domestic or foreign banks or other
financial institutions which have received (or the guarantors of the obligations
of which have received) a short-term credit rating of "A-l" from Standard &
Poor's Corporation ("S&P") or "P-l" from Moody's Investor Services ("Moody's"),
an equivalent rating from any nationally recognized statistical rating
organization ("NRSRO") or which Franklin Mutual determines is of comparable
credit quality. The staff of the SEC currently takes the position that OTC
options purchased by the Fund, and portfolio securities "covering" the amount of
the Fund's obligation pursuant to an OTC option sold by it (the cost of the
sell-back plus the in-the-money amount, if any) are illiquid, and are subject to
the Fund's limitations on investments in illiquid securities.
If the Fund sells a call option, the premium that it receives may serve as a
partial hedge, to the extent of the option premium, against a decrease in the
value of the underlying securities or instruments in its portfolio or will
increase the Fund's income. The sale of put options can also provide income.
The Fund may purchase and sell call options on securities, including U.S.
Treasury and agency securities, mortgage-backed securities, corporate debt
securities, equity securities (including convertible securities) and Eurodollar
instruments that are traded on U.S. and foreign securities exchanges and in the
over-the-counter markets and on securities indices, currencies and futures
contracts. All calls sold by the Fund must be "covered" (i.e., the Fund must own
the securities or futures contract subject to the call) or must meet the asset
segregation requirements described below as long as the call is outstanding.
Even though the Fund will receive the option premium to help protect it against
loss, a call sold by the Fund exposes the Fund during the term of the option to
possible loss of opportunity to realize appreciation in the market price of the
underlying security or instrument and may require the Fund to hold a security or
instrument which it might otherwise have sold.
The Fund may purchase and sell put options on securities including U.S. Treasury
and agency securities, mortgage-backed securities, corporate debt securities,
equity securities (including convertible securities) and Eurodollar instruments
(whether or not it holds the above securities in its portfolio) and on
securities indices, currencies and futures contracts other than futures on
individual corporate debt and individual equity securities. The Fund will not
sell put options if, as a result, more than 50% of the Fund's assets would be
required to be segregated to cover its potential obligations under such put
options other than those with respect to futures and options thereon. In selling
put options, there is a risk that the Fund may be required to buy the underlying
security at a disadvantageous price above the market price.
GENERAL CHARACTERISTICS OF FUTURES
The Fund may enter into financial futures contracts or purchase or sell put and
call options on such futures as a hedge against anticipated interest rate,
currency or equity market changes, for duration management and for risk
management purposes. Futures are generally bought and sold on the commodities
exchanges where they are listed with payment of initial and variation margin as
described below. The sale of a futures contract creates a firm obligation by the
Fund, as seller, to deliver to the buyer the specific type of financial
instrument called for in the contract at a specific future time for a specified
price (or, with respect to index futures and Eurodollar instruments, the net
cash amount). Options on futures contracts are similar to options on securities
except that an option on a futures contract gives the purchaser the right in
return for the premium paid to assume a position in a futures contract and
obligates the seller to deliver such option.
The Fund's use of financial futures and options thereon will in all cases be
consistent with applicable regulatory requirements and in particular the rules
and regulations of the Commodity Futures Trading Commission and will be entered
into only for a bona fide hedging, risk management (including duration
management) or other portfolio management purposes. Typically, maintaining a
futures contract or selling an option thereon requires the Fund to deposit with
a financial intermediary as security for its obligations an amount of cash or
other specified assets ("initial margin") which initially is typically 1% to 10%
of the face amount of the contract (but may be higher in some circumstances).
Additional cash or assets ("variation margin") may be required to be deposited
thereafter on a daily basis as the mark to market value of the contract
fluctuates. The purchase of an option on financial futures involves payment of a
premium for the option without any further obligation on the part of the Fund.
If the Fund exercises an option on a futures contract, it will be obligated to
post initial margin (and potential subsequent variation margin) for the
resulting futures positions just as it would for any position. Futures contracts
and options thereon are generally settled by entering into an offsetting
transaction, but there can be no assurance that the position can be offset prior
to settlement at an advantageous price nor that delivery will occur.
The Fund will not enter into a futures contract or related option (except for
closing transactions) if, immediately thereafter, the sum of the amount of its
initial margin and premiums on open futures contracts and options thereon would
exceed 5% of the Fund's total assets (taken at current value); however, in the
case of an option that is in-the-money at the time of the purchase, the
in-the-money amount may be excluded in calculating the 5% limitation. The
segregation requirements with respect to futures contracts and options thereon
are described below.
OPTIONS ON SECURITIES INDICES
AND OTHER FINANCIAL INDICES
The Fund may also purchase and sell call and put options on securities indices
and other financial indices and in so doing can achieve many of the same
objectives it would achieve through the sale or purchase of options on
individual securities or other instruments. Options on securities indices and
other financial indices are similar to options on a security or other instrument
except that, rather than settling by physical delivery of the underlying
instrument, they settle by cash settlement, i.e., an option on an index gives
the holder the right to receive, upon exercise of the option, an amount of cash
if the closing level of the index upon which the option is based exceeds, in the
case of a call, or is less than, in the case of a put, the exercise price of the
option (except if, in the case of an OTC option, physical delivery is
specified). This amount of cash is equal to the excess of the closing price of
the index over the exercise price of the option, which also may be multiplied by
a formula value. The seller of the option is obligated, in return for the
premium received, to make delivery of this amount. The gain or loss on an index
depends on price movements in the instruments making up the market, market
segment, industry or other composite on which the underlying index is based,
rather than price movements in individual securities, as is the case with
respect to options on securities.
CURRENCY TRANSACTIONS
The Fund may engage in currency transactions with Counterparties in order to
hedge the value of portfolio holdings denominated in particular currencies
against fluctuations in relative value between those currencies and the U.S.
dollar. Currency transactions include forward currency contracts,
exchange-listed currency futures, exchange-listed and OTC options on currencies,
and currency swaps. A forward currency contract involves a privately negotiated
obligation to purchase or sell (with delivery generally required) a specific
currency at a future date, which may be any fixed number of days from the date
of the contract agreed upon by the parties, at a price set at the time of the
contract. A currency swap is an agreement to exchange cash flows on a notional
amount of two or more currencies based on the relative value differential among
them.
The Fund will usually enter into swaps on a net basis, i.e., the two payment
streams are netted out in a cash settlement on the payment date or dates
specified in the instrument, with the Fund receiving or paying, as the case may
be, only the net amount of the two payments. Inasmuch as these swaps are entered
into for good faith hedging purposes, Franklin Mutual and the Fund believe such
obligations do not constitute senior securities under the 1940 Act and,
accordingly, will not treat them as being subject to its borrowing restrictions.
The Fund may enter into currency transactions with Counterparties which have
received (or the guarantors of the obligations of such Counterparties have
received) a credit rating of A-l or P-l by S&P or Moody's, respectively, or that
have an equivalent rating from an NRSRO or (except for OTC currency options) are
determined to be of equivalent credit quality by Franklin Mutual. If there is a
default by the Counterparty, the Fund may have contractual remedies pursuant to
the agreements related to the transaction. The swap market has grown
substantially in recent years with a large number of banks and investment
banking firms acting both as principals and as agents utilizing standardized
swap documentation. As a result, the swap market has become relatively liquid.
The Fund's dealings in forward currency contracts and other currency
transactions such as futures, options, options on futures and swaps will be
limited to either specific transactions or portfolio positions. Transaction
hedging is entering into a currency transaction with respect to specific assets
or liabilities of the Fund, which will generally arise in connection with the
purchase or sale of its portfolio securities or the receipt of income therefrom.
Position hedging is entering into a currency transaction with respect to
portfolio security positions denominated or generally quoted in that currency.
The Fund will not enter into a transaction to hedge currency exposure to an
extent greater, after netting all transactions intended to wholly or partially
offset other transactions, than the aggregate market value (at the time of
entering into the transaction) of the securities held in its portfolio that are
denominated or generally quoted in or whose value is based upon such foreign
currency or currently convertible into such currency other than with respect to
proxy hedging as described below.
The Fund may also cross-hedge currencies by entering into transactions to
purchase or sell one or more currencies that are expected to decline in value
relative to other currencies to which the Fund has or in which the Fund expects
to have portfolio exposure.
To reduce the effect of currency fluctuations on the value of existing or
anticipated holdings of portfolio securities, the Fund may also engage in proxy
hedging. Proxy hedging is often used when the currency to which the Fund's
portfolio is exposed is difficult to hedge or to hedge against the U.S. dollar.
Proxy hedging entails entering into a forward contract to sell a currency whose
changes in value are generally considered to be linked to a currency or
currencies in which some or all of the Fund's portfolio securities are or are
expected to be denominated, and to buy U.S. dollars. The amount of the contract
would not exceed the value of the Fund's securities denominated in linked
currencies. For example, if Franklin Mutual considers the Austrian schilling to
be linked to the German deutsche mark (the "D-mark"), the Fund holds securities
denominated in schillings and Franklin Mutual believes that the value of
schillings will decline against the U.S. dollar, Franklin Mutual may enter into
a contract to sell D-marks and buy dollars. Currency hedging involves some of
the same risks and considerations as other transactions with similar
instruments. Currency transactions can result in losses to the Fund if the
currency being hedged fluctuates in value to a degree or in a direction that is
not anticipated. Further, there is the risk that the perceived linkage between
various currencies may not be present during the particular time that the Fund
is engaging in proxy hedging. If the Fund enters into a currency hedging
transaction, the Fund will comply with the asset segregation requirements
described below.
RISKS OF CURRENCY TRANSACTIONS
Currency transactions are subject to risks different from those of other
portfolio transactions. Because currency control is of great importance to the
issuing governments and influences economic planning and policy, purchases and
sales of currency and related instruments can be negatively affected by
government exchange controls, blockages, and manipulations or exchange
restrictions imposed by governments. These can result in losses to the Fund if
it is unable to deliver or receive currency or funds in settlement of
obligations and could also cause hedges it has entered into to be rendered
useless, resulting in full currency exposure as well as incurring transaction
costs. Buyers and sellers of currency futures are subject to the same risks that
apply to the use of futures generally. Further, settlement of a currency futures
contract for the purchase of most currencies must occur at a bank based in the
issuing nation. Trading options on currency futures is relatively new, and the
ability to establish and close out positions on such options is subject to the
maintenance of a liquid market which may not always be available. Currency
exchange rates may fluctuate based on factors extrinsic to that country's
economy.
COMBINED TRANSACTIONS
The Fund may enter into multiple transactions, including multiple options
transactions, multiple futures transactions, multiple currency transactions
(including forward currency contracts) and any combination of futures, options
and currency transactions ("component transactions"), instead of a single
hedging Transaction, as part of a single or combined strategy when, in the
opinion of Franklin Mutual, it is in the best interests of the Fund to do so. A
combined transaction will usually contain elements of risk that are present in
each of its component transactions. Although combined transactions are normally
entered into based on Franklin Mutual's judgment that the combined strategies
will reduce risk or otherwise more effectively achieve the desired portfolio
management goal, it is possible that the combination will instead increase such
risks or hinder achievement of the portfolio management objective.
RISKS OF HEDGING TRANSACTIONS OUTSIDE THE U.S.
When conducted outside the U.S., hedging transactions may not be regulated as
rigorously as in the U.S., may not involve a clearing mechanism and related
guarantees, and are subject to the risk of governmental actions affecting
trading in, or the prices of, foreign securities, currencies and other
instruments. The value of such positions also could be adversely affected by:
(i) other complex foreign political, legal and economic factors, (ii) lesser
availability than in the U.S. of data on which to make trading decisions, (iii)
delays in the Fund's ability to act upon economic events occurring in foreign
markets during nonbusiness hours in the U.S., (iv) the imposition of different
exercise and settlement terms and procedures and margin requirements than in the
U.S., and (v) lower trading volume and liquidity.
USE OF SEGREGATED AND OTHER SPECIAL ACCOUNTS
Many hedging transactions, in addition to other requirements, require that the
Fund segregate liquid high grade assets with its custodian bank to the extent
Fund obligations are not otherwise "covered" through ownership of the underlying
security, financial instrument or currency. In general, either the full amount
of any obligation by the Fund to pay or deliver securities or assets must be
covered at all times by the securities, instruments or currency required to be
delivered, or, subject to any regulatory restrictions, an amount of cash or
liquid high grade securities at least equal to the current amount of the
obligation must be segregated with the custodian bank. The segregated assets
cannot be sold or transferred unless equivalent assets are substituted in their
place or it is no longer necessary to segregate them. For example, a call option
written by the Fund will require the Fund to hold the securities subject to the
call (or securities convertible into the needed securities without additional
consideration) or to segregate liquid high grade securities sufficient to
purchase and deliver the securities if the call is exercised. A call option sold
by the Fund on an index will require the Fund to own portfolio securities which
correlate with the index or to segregate liquid high grade assets equal to the
excess of the index value over the exercise price on a current basis. A put
option written by the Fund requires the Fund to segregate liquid high grade
assets equal to the exercise price.
A currency contract which obligates the Fund to buy or sell currency will
generally require the Fund to hold an amount of the currency or liquid
securities denominated in that currency equal to the Fund's obligations or to
segregate liquid high grade assets equal to the amount of the Fund's obligation.
However, the segregation requirement does not apply to currency contracts which
are entered in order to "lock in" the purchase or sale price of a trade in a
security denominated in a foreign currency pending settlement within the time
customary for such securities.
OTC options entered into by the Fund, including those on securities, currency,
financial instruments or indices and OCC-issued and exchange-listed index
options will generally provide for cash settlement. As a result, when the Fund
sells these instruments it will only segregate an amount of assets equal to its
accrued net obligations, as there is no requirement for payment or delivery of
amounts in excess of the net amount. These amounts will equal 100% of the
exercise price in the case of a noncash settled put, the same as an OCC
guaranteed listed option sold by the Fund, or the in-the-money amount plus any
sell-back formula amount in the case of a cash-settled put or call. In addition,
when the Fund sells a call option on an index at a time when the in-the-money
amount exceeds the exercise price, the Fund will segregate, until the option
expires or is closed out, cash or cash equivalents equal in value to such
excess. OCC-issued and exchange-listed options sold by the Fund other than those
above generally settle with physical delivery, or with an election of either
physical delivery or cash settlement, and the Fund will segregate an amount of
assets equal to the full value of the option. OTC options settling with physical
delivery, or with an election of either physical delivery or cash settlement,
will be treated the same as other options settling with physical delivery.
In the case of a futures contract or an option thereon, the Fund must deposit
initial margin and possible daily variation margin in addition to segregating
assets sufficient to meet its obligation to purchase or provide securities or
currencies, or to pay the amount owed at the expiration of an index-based
futures contract. Such assets may consist of cash, cash equivalents, liquid debt
or equity securities or other acceptable assets.
Hedging transactions may be covered by other means when consistent with
applicable regulatory policies. The Fund may also enter into offsetting
transactions so that its combined position, coupled with any segregated assets,
equals its net outstanding obligation in related options and hedging
transactions. For example, the Fund could purchase a put option if the strike
price of that option is the same or higher than the strike price of a put option
sold by the Fund. Moreover, instead of segregating assets if the Fund held a
futures or forward contract, it could purchase a put option on the same futures
or forward contract with a strike price as high or higher than the price of the
contract held. Other hedging transactions may also be offset in combinations. If
the offsetting transaction terminates at the time of or after the primary
transaction, no segregation is required, but if it terminates prior to such
time, assets equal to any remaining obligation would need to be segregated.
DEPOSITARY RECEIPTS
Each series of the Fund may invest in securities commonly known as American
Depositary Receipts ("ADRs"), and in European Depositary Receipts ("EDRs") or
other securities representing interests in securities of foreign issuers. ADRs
are certificates issued by a U.S. bank or trust company and represent the right
to receive securities of a foreign issuer deposited in a domestic bank or
foreign branch of a U.S. bank and traded on a U.S. exchange or in an
over-the-counter market. EDRs are receipts issued in Europe generally by a
non-U.S. bank or trust company that evidence ownership of non-U.S. or domestic
securities. Generally, ADRs are in registered form and EDRs are in bearer form.
There are no fees imposed on the purchase or sale of ADRs or EDRs although the
issuing bank or trust company may impose charges for the collection of dividends
and the conversion of ADRs and EDRs into the underlying securities. Investment
in ADRs has certain advantages over direct investment in the underlying non-U.S.
securities, since: (i) ADRs are U.S. dollar denominated investments which are
easily transferable and for which market quotations are readily available and
(ii) issuers whose securities are represented by ADRs are subject to the same
auditing, accounting and financial reporting standards as domestic issuers. EDRs
are not necessarily denominated in the currency of the underlying security.
MEDIUM AND LOWER RATED
CORPORATE DEBT SECURITIES
Each series may invest in securities that are rated in the medium to lowest
rating categories by S&P and Moody's, some of which may be so-called "junk
bonds." The series have historically invested in securities of distressed
issuers when the intrinsic values of such securities have, in the opinion of
Franklin Mutual, warranted such investment. Corporate debt securities rated Baa
are regarded by Moody's as being neither highly protected nor poorly secured.
Interest payments and principal security appears adequate to Moody's for the
present, but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such securities are
regarded by Moody's as lacking outstanding investment characteristics and having
speculative characteristics. Corporate debt securities rated BBB are regarded by
S&P as having adequate capacity to pay interest and repay principal. Such
securities are regarded by S&P as normally exhibiting adequate protection
parameters, although adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for securities in this rating category than in higher rated categories.
Corporate debt securities which are rated B are regarded by Moody's as generally
lacking characteristics of the desirable investment. In Moody's view, assurance
of interest and principal payments or of maintenance of other terms of the
security over any long period of time may be small. Corporate debt securities
rated BB, B, CCC, CC and C are regarded by S&P on balance as predominantly
speculative with respect to capacity to pay interest and repay principal in
accordance with the terms of the obligation. In S&P's view, although such
securities likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposures to adverse conditions.
BB and B are regarded by S&P as indicating the two lowest degrees of speculation
in this group of ratings. Securities rated D by S&P or C by Moody's are in
default and are not currently performing. The Fund will rely on Franklin
Mutual's judgment, analysis and experience in evaluating such debt securities.
In this evaluation, Franklin Mutual will take into consideration, among other
things, the issuer's financial resources, its sensitivity to economic conditions
and trends, its operating history, the quality of the issuer's management and
regulatory matters as well as the price of the security. Franklin Mutual may
also consider, although it does not rely primarily on, the credit ratings of
Moody's and S&P in evaluating lower rated corporate debt securities. Such
ratings evaluate only the safety of principal and interest payments, not market
value risk. Additionally, because the creditworthiness of an issuer may change
more rapidly than is able to be timely reflected in changes in credit ratings,
Franklin Mutual monitors the issuers of corporate debt securities held in the
Fund's portfolio. The credit rating assigned to a security is a factor
considered by Franklin Mutual in selecting a security for a series, but the
intrinsic value in light of market conditions and Franklin Mutual's analysis of
the fundamental values underlying the issuer are of at least equal significance.
Because of the nature of medium and lower rated corporate debt securities,
achievement by each series of its investment objective when investing in such
securities is dependent on the credit analysis of Franklin Mutual. If the series
purchased primarily higher rated debt securities, such risks would be
substantially reduced.
A general economic downturn or a significant increase in interest rates could
severely disrupt the market for medium and lower grade corporate debt securities
and adversely affect the market value of such securities. Securities in default
are relatively unaffected by such events or by changes in prevailing interest
rates. In addition, in such circumstances, the ability of issuers of medium and
lower grade corporate debt securities to repay principal and to pay interest, to
meet projected business goals and to obtain additional financing may be
adversely affected. Such consequences could lead to an increased incidence of
default for such securities and adversely affect the value of the corporate debt
securities in the Fund's portfolio. The secondary market prices of medium and
lower grade corporate debt securities are less sensitive to changes in interest
rates than are higher rated debt securities, but are more sensitive to adverse
economic changes or individual corporate developments. Adverse publicity and
investor perceptions, whether or not based on rational analysis, may also affect
the value and liquidity of medium and lower grade corporate debt securities,
although such factors also present investment opportunities when prices fall
below intrinsic values. Yields on debt securities in a series' portfolio that
are interest rate sensitive can be expected to fluctuate over time. In addition,
periods of economic uncertainty and changes in interest rates can be expected to
result in increased volatility of market price of any medium to lower grade
corporate debt securities in the series' portfolios and thus could have an
effect on the Net Asset Value of the series if other types of securities did not
show offsetting changes in values. The secondary market value of corporate debt
securities structured as zero coupon securities or payment in kind securities
may be more volatile in response to changes in interest rates than debt
securities which pay interest periodically in cash. Because such securities do
not pay current interest, but rather, income is accreted, to the extent that a
series does not have available cash to meet distribution requirements with
respect to such income, it could be required to dispose of portfolio securities
that it otherwise would not. Such disposition could be at a disadvantageous
price. Failure to satisfy distribution requirements could result in the series
failing to qualify as a pass-through entity under the Code. Investment in such
securities also involves certain other tax considerations.
Franklin Mutual values the series' investments pursuant to guidelines adopted
and periodically reviewed by the Board. See "Transactions, Procedures and
Special Requirements - The Price We Use When You Buy or Sell Shares" in the
Prospectus. To the extent that there is no established retail market for some of
the medium or low grade corporate debt securities in which the series may
invest, there may be thin or no trading in such securities and the ability of
Franklin Mutual to accurately value such securities may be adversely affected.
Further, it may be more difficult for a series to sell such securities in a
timely manner and at their stated value than would be the case for securities
for which an established retail market did exist. The effects of adverse
publicity and investor perceptions may be more pronounced for securities for
which no established retail market exists as compared with the effects on
securities for which such a market does exist. During periods of reduced market
liquidity and in the absence of readily available market quotations for medium
and lower grade corporate debt securities held in the Fund's portfolio, the
responsibility of Franklin Mutual to value the Fund's securities becomes more
difficult and Franklin Mutual's judgment may play a greater role in the
valuation of the Fund's securities due to a reduced availability of reliable
objective data. To the extent that the Fund purchases illiquid corporate debt
securities or securities which are restricted as to resale, the Fund may incur
additional risks and costs. Illiquid and restricted securities may be
particularly difficult to value and their disposition may require greater effort
and expense than more liquid securities. Further, a series may be required to
incur costs in connection with the registration of restricted securities in
order to dispose of such securities, although under Rule 144A under the
Securities Act of 1933 certain securities may be determined to be liquid
pursuant to procedures adopted by the Board under applicable guidelines.
SHORT SALES
Each series may make short sales of securities. A short sale is a transaction in
which the series sells a security it does not own in anticipation that the
market price of that security will decline. Each series expects to make short
sales as a form of hedging to offset potential declines in long positions in
similar securities, in order to maintain portfolio flexibility and for profit.
When a series makes a short sale, it must borrow the security sold short and
deliver it to the broker-dealer through which it made the short sale as
collateral for its obligation to deliver the security upon conclusion of the
sale. The series may have to pay a fee to borrow particular securities and is
often obligated to pay over any payments received on such borrowed securities.
The series' obligation to replace the borrowed security will be secured by
collateral deposited with the broker-dealer, usually cash, U.S. government
securities or other high grade liquid securities similar to those borrowed. The
series will also be required to deposit similar collateral with its custodian to
the extent, if any, necessary so that the value of both collateral deposits in
the aggregate is at all times equal to at least 100% of the current market value
of the security sold short.
If the price of the security sold short increases between the time of the short
sale and the time the series replaces the borrowed security, the series will
incur a loss; conversely, if the price declines, the series will realize a gain.
Any gain will be decreased, and any loss increased, by the transaction costs
described above. Although the series' gain is limited to the price at which it
sold the security short, its potential loss is theoretically unlimited.
The series will not make a short sale if, after giving effect to such sale, the
market value of all securities sold short exceeds 5% of the value of its total
assets or the series' aggregate short sales of a particular class of securities
exceeds 25% of the outstanding securities of that class. The series may also
make short sales "against the box" without respect to such limitations. In this
type of short sale, at the time of the sale, the series owns or has the
immediate and unconditional right to acquire at no additional cost the identical
security.
RESTRICTIONS AND LIMITATIONS
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MUTUAL SHARES, QUALIFIED, BEACON, DISCOVERY AND EUROPEAN FUNDAMENTAL
POLICIES
Mutual Shares, Qualified, Beacon, Discovery and European have each adopted the
following fundamental investment restrictions which may not be changed without
the affirmative vote of the holders of a majority of the outstanding voting
securities of such series, which means the lesser of (1) the holders of more
than 50% of the outstanding shares of voting stock of such securities or (2) 67%
of the shares if more than 50% of the shares are present at a meeting of
shareholders in person or by proxy. Unless otherwise noted, all percentage
restrictions are as of the time of investment after giving effect to the
transaction. Pursuant to such restrictions each series may not:
1. Purchase or sell commodities, commodity contracts (except in conformity with
regulations of the Commodities Futures Trading Commission such that the series
would not be considered a commodity pool), or oil and gas interests or real
estate. Securities or other instruments backed by commodities are not considered
commodities or commodity contracts for purposes of this restriction. Debt or
equity securities issued by companies engaged in the oil, gas, or real estate
businesses are not considered oil or gas interests or real estate for purposes
of this restriction. First mortgage loans and other direct obligations secured
by real estate are not considered real estate for purposes of this restriction.
2. Make loans, except to the extent the purchase of debt obligations of any type
are considered loans and except that the series may lend portfolio securities to
qualified institutional investors in compliance with requirements established
from time to time by the SEC and the securities exchanges on which such
securities are traded.
3. Issue securities senior to its stock or borrow money or utilize leverage in
excess of the maximum permitted by the 1940 Act which is currently 331/3% of
total assets (plus 5% for emergency or other short-term purposes) from banks on
a temporary basis from time to time to provide greater liquidity for redemptions
or for special circumstances.
4. Invest more than 25% of the value of its assets in a particular
industry (except that U.S. government securities are not considered an
industry).
5. Act as an underwriter except to the extent the series may be deemed to be an
underwriter when disposing of securities it owns or when selling its own shares.
6. Purchase the securities of any one issuer, other than the U.S. government or
any of its agencies or instrumentalities, if immediately after such purchase
more than 5% of the value of its total assets would be invested in such issuer,
or such series would own more than 10% of the outstanding voting securities of
such issuer, except that up to 25% of the value of such series' total assets may
be invested without regard to such 5% and 10% limitations.
7. Except as may be described in the Prospectus, engage in short sales,
purchase securities on margin or maintain a net short position.
If a percentage restriction is met at the time of investment, a later increase
or decrease in the percentage due to a change in the value or liquidity of
portfolio securities or the amount of assets will not be considered a violation
of any of the foregoing restrictions.
NON FUNDAMENTAL POLICIES, ALL SERIES
As a matter of policy that is not fundamental, the Fund has determined that no
series will invest more than 5% of its assets in warrants, and that no more than
2% of such assets may be invested in warrants which are not listed on the NYSE
or American Stock Exchange. Also, as a matter of policy, the series will not
purchase securities for purposes of short term trading and will not invest more
than 5% of their assets in securities of issuers (together with any
predecessors) in existence for less than three years, provided that the
aggregate percentage of assets invested in such issuers, combined with illiquid
investments, does not exceed 15%. The series will not purchase the securities of
any issuer of which any officer or director of the Fund owns more than 1/2 of 1%
of the outstanding securities or in which the officers and directors in the
aggregate own more than 5%. The series do not borrow for leveraging purposes.
In order to permit the sale of shares in certain states, the Fund may make
commitments more restrictive than the operating restrictions described above.
Should the Fund determine that any such commitment is no longer in the best
interests of a particular series and its shareholders, the Fund will revoke the
commitment by terminating sales of such series' shares in the state involved.
OFFICERS AND DIRECTORS
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The Board has the responsibility for the overall management of the Fund,
including general supervision and review of its investment activities. The
Board, in turn, elects the officers of the Fund who are responsible for
administering the Fund's day-to-day operations. The affiliations of the officers
and Board members and their principal occupations for the past five years are
shown below. Members of the Board who are considered "interested persons" of the
Fund under the 1940 Act are indicated by an asterisk (*).
POSITIONS HELD PRINCIPAL OCCUPATION
NAME, AGE AND ADDRESS WITH THE FUND DURING THE PAST FIVE YEARS
Edward I. Altman, Ph.D. (55)
New York University
44 West 4th Street
New York, NY 10012
Director
Max L. Heine Professor of Financing and Vice Director of NYU Salomon Center,
Stern School of Business, New York University; editor and author of numerous
financial publications; financial consultant.
Ann Torre Grant (38)
8065 Leesburg Pike
Suite 400
Vienna, VA 22182
Director
Executive Vice President and Chief Financial Officer, NHP Incorporated (owner
and manager of multifamily housing); prior to March 1995 she was Vice President
and Treasurer, U.S. Air, Inc.
Andrew H. Hines, Jr. (74)
150 2nd Avenue N.
St. Petersburg, FL 33701
Director
Consultant for the Triangle Consulting Group; Chairman of the Board and Chief
Executive Officer of Florida Progress Corporation (1982-February, 1990) and
Chairman and Director of Precise Power Corporation; Executive-in-Residence of
Eckerd College (1991-present); and a Director of Checkers Drive-In Restaurants,
Inc.
*Peter A. Langerman (41)
51 John F. Kennedy Pkwy.
Short Hills, NJ 07078
Director and Executive Vice President
Financial Analyst with Franklin Mutual Advisers, Inc.; held the same position
with Heine Securities Corporation, 6/86 to 10/96; Director of Sunbeam Oster
since 1990, Lancer Industries since 1994; Manager (Director) of MB Motori,
L.L.C. since 1994 and MWCR, L.L.C. since 1995.
*William J. Lippman (71)
One Parker Plaza
Fort Lee, NJ 07024
Director
Senior Vice President, Franklin Resources, Inc. and Franklin Management, Inc.;
President and Director, Franklin Advisory Services, Inc.; and officer and/or
director or trustee of seven of the investment companies in the Franklin
Templeton Group of Funds.
Bruce A. MacPherson (66)
1 Pequot Way
Canton, MA 02021
Director
President of A.A. MacPherson, Inc. Boston, MA (representative for
electrical manufacturers).
Fred R. Millsaps (67)
2665 NE 37th Drive
Fort Lauderdale, FL 33394
Director
Manager of Personal Investments (1978-present); Chairman and Chief Executive
Officer of Landmark Banking Corporation (1969-1978); Financial Vice President of
Florida Power and Light (1965-1969); Vice President of The Federal Reserve Bank
of Atlanta (1958-1965); and a director of various other business and nonprofit
organizations.
*Michael F. Price (45)
51 John F. Kennedy Pkwy.
Short Hills, NJ 07078
Chairman of the Board and President
President, Chief Executive Officer, and Director of Franklin Mutual Advisers,
Inc.; held the same positions with Heine Securities Corporation, 1/87 to 10/96;
Principal Executive Officer and majority owner of Compliance Solutions, Inc.
("Compliance Solutions") (a developer of compliance monitoring software for
money managers); Director and owner of Clearwater Securities, Inc.
("Clearwater") (a registered securities dealer).
Leonard Rubin (71)
2 Executive Drive, Suite 560
Fort Lee, NJ 07024
Director
Partner in LDR Equities, LLC (manages various personal investments); Vice
President, Trimtex Co. Inc. (manufactures and markets specialty fabrics); and
trustee of four of the investment companies in the Franklin Templeton Group of
Funds.
Barry F. Schwartz (47)
35 East 62nd Street
New York, NY 10021
Director
Executive Vice President and General Counsel, MacAndrews & Forbes Holdings,
Inc. (a diversified holding company).
Vaughn R. Sturtevant, M.D. (73)
6 Noyes Avenue
Waterville, ME 04901
Director
Practicing physician.
Robert E. Wade (50)
225 Hardwick Street
Belvidere, NJ 07823
Director
Practicing attorney.
Jeffrey A. Altman (30)
51 John F. Kennedy Pkwy.
Short Hills, NJ 07078
Vice President
Analyst and Trader with Franklin Mutual Advisers, Inc.; was employed by Heine
Securities Corporation, 8/88 to 10/96; Manager (Director), MB Metropolis, L.L.C.
since 1994; Manager (Director) of MB Motori, L.L.C., MWCR, L.L.C. and S.H.
Mortgage Acquisition L.L.C. since 1995; Trustee of Resurgence Properties Inc.;
and Chairman of the Board of Trustees, Value Property Trust.
James R. Baio (42)
500 East Broward Blvd.
Fort Lauderdale, FL 33701
Treasurer
Certified public accountant; Treasurer of the Templeton Funds; Senior Vice
President of Templeton Worldwide, Inc., Templeton Global Investors, Inc., and
Templeton Funds Trust Company.
Elizabeth N. Cohernour (46)
51 John F. Kennedy Pkwy.
Short Hills, NJ 07078
General Counsel and Secretary
Vice President and Assistant Secretary of Franklin Mutual Advisers, Inc.;
formerly Secretary and General Counsel of Heine Securities Corporation, 5/88 to
10/96; Secretary and General Counsel of Compliance Solutions and Clearwater.
Robert L. Friedman (37)
51 John F. Kennedy Pkwy.
Short Hills, NJ 07078
Vice President
Research Analyst with Franklin Mutual Advisers, Inc.; was employed by Heine
Securities Corporation, 8/88 to 10/96.
Raymond Garea (47)
51 John F. Kennedy Pkwy.
Short Hills, NJ 07078
Vice President
Research Analyst with Franklin Mutual Advisers, Inc.; was employed by Heine
Securities Corporation, 3/91 to 10/96; prior thereto he was a Vice President and
analyst with Donaldson, Lufkin & Jenrette; Manager (Director), MB Metropolis,
L.L.C. and S.H. Mortgage Acquisition L.L.C.
Lawrence N. Sondike (39)
51 John F. Kennedy Pkwy.
Short Hills, NJ 07078
Vice President
Research Analyst with Franklin Mutual Advisers, Inc.; was employed by Heine
Securities Corporation 3/84 to 10/96.
The Fund's independent Board members have standing audit, pension,
nominating and director's compensation and performance committees. The
audit committee is composed of Ms. Grant and Messrs. Altman and Wade.
The pension committee is composed of Messrs. Altman, Schwartz and
Sturtevant. The nominating committee is responsible for nominating
candidates for independent Board member positions and is composed of
Messrs. MacPherson and Schwartz. The Board members' compensation and
performance committee is composed of Ms. Grant and Messrs. Wade and
Sturtevant.
During the fiscal year ended December 31, 1995, the Fund paid its officers and
directors as a group, including reimbursement to the investment adviser for the
expenses of personnel who spend a substantial portion of their time on Fund
operations, aggregate compensation of $839,366. Nonaffiliated Board members are
currently paid $15,000 per year plus $750 per meeting attended. Board members
are paid $500 plus out-of-pocket expenses for each Committee meeting attended.
In 1993, the Board members approved a retirement plan which generally provides
payments to directors who have served 10 years and retire at age 70. At the time
of retirement, Directors are entitled to annual payments equal to one-half of
the retainer in effect as of the time of retirement. As shown above, some of the
nonaffiliated Board members also serve as directors, trustees or managing
general partners of investment companies in the Franklin Templeton Group of
Funds. They may receive fees from these funds for their services. The following
table provides the total fees paid to nonaffiliated Board members by the Fund
and by other funds in the Franklin Templeton Group of Funds.
NUMBER OF
TOTAL FEES BOARDS IN
RECEIVED FROM THE FRANKLIN
TOTAL FEES PENSION ANNUAL THE FRANKLIN TEMPLETON GROUP OF
RECEIVED FROM RETIREMENT BENEFITS TEMPLETON GROUP FUNDS ON WHICH
NAME THE FUND+ ACCRUED RETIREMENT OF FUNDS++ EACH SERVES**
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Edward I. Altman..$20,750 0 $7,500 0 1
Ann Torre Grant*..$20,750 0 $7,500 0 1
Bruce A.
MacPherson.... $18,750 0 $7,500 0 1
Barry F.
Schwartz*..... $18,750 0 $7,500 0 1
Vaughn R.
Sturtevant,
M.D. ..... $18,750 0 $7,500 0 1
Robert E. Wade*..$25,750 0 $7,500 0 1
Andrew H.
Hines, Jr. ..........0 0 0 $106,325 25
Fred R. Millsaps......0 0 0 $104,325 25
Leonard Rubin ........0 0 0 $ 15,600 4
+For the fiscal year ended December 31, 1995.
++For the calendar year ended December 31, 1995
*Not vested in retirement plan.
**We base the number of boards on the number of registered investment companies
in the Franklin Templeton Group of Funds. This number does not include the total
number of series or funds within each investment company for which the Board
members are responsible. The Franklin Templeton Group of Funds currently
includes 62 registered investment companies, with approximately 171 U.S. based
funds or series.
Nonaffiliated members of the Board are reimbursed for expenses
incurred in connection with attending board meetings, paid pro rata by each fund
in the Franklin Templeton Group of Funds for which they serve as director,
trustee or managing general partner. No officer or Board member received any
other compensation, including pension or retirement benefits, directly or
indirectly from the Fund or other funds in the Franklin Templeton Group of
Funds. Certain officers or Board members who are shareholders of Resources may
be deemed to receive indirect remuneration by virtue of their participation, if
any, in the fees paid to its subsidiaries. Certain officers and Board members of
the Fund are also officers of Compliance Solutions. The Fund is not charged for
the use of software designed by Compliance Solutions.
As of January 30, 1997, the officers and Board members, as a group, owned of
record and beneficially the following shares of the Fund: 68,536 shares of
Mutual Shares - Class Z; 51,529 shares of Qualified Class Z; 225,070 shares of
Beacon - Class Z; 390,105 shares of Discovery - Class Z, or less than 1% of the
total outstanding Class Z shares of those series. As of January 30, 1997, the
officers and board members, as a group, owned of record and beneficially
14,130,248 shares or 34% of the total outstanding Class Z shares of European.
Some of the Board members also own shares in other funds in the Franklin
Templeton Group of Funds.
INVESTMENT MANAGEMENT AND OTHER SERVICES
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INVESTMENT MANAGER AND SERVICES PROVIDED. The Fund's investment manger
is Franklin Mutual. On October 31, 1996, pursuant to an agreement
between Resources and Heine Securities, Inc. ("Heine"), the assets of
Heine were transferred to Franklin Mutual (the "Transaction") and the
Fund's name was changed from Mutual Series Fund Inc. to Franklin Mutual
Series Fund Inc.
Franklin Mutual provides investment research and portfolio management services,
including the selection of securities for the Fund to buy, hold or sell and the
selection of brokers through whom the Fund's portfolio transactions are
executed. Franklin Mutual's activities are subject to the review and supervision
of the Board to whom Franklin Mutual renders periodic reports of the Fund's
investment activities. Franklin Mutual is covered by fidelity insurance on its
officers, directors and employees for the protection of the Fund.
Franklin Mutual and its affiliates act as investment manager to numerous other
investment companies and accounts. They may give advice and take action with
respect to any of the other funds they manage, or for their own account, that
may differ from action taken by them on behalf of the Fund. Similarly, with
respect to the Fund, they are not obligated to recommend, buy or sell, or to
refrain from recommending, buying or selling any security that they and access
persons, as defined by the 1940 Act, may buy or sell for their own account or
for the accounts of any other fund. They are not obligated to refrain from
investing in securities held by the Fund or other funds that they manage or
administer. Of course, any transactions for their accounts and other access
persons will be made in compliance with the Fund's Code of Ethics. (Please see
"Miscellaneous Information - Summary of Code of Ethics.")
MANAGEMENT AGREEMENT. The management agreement is in effect until June 30, 1998.
It may continue in effect for successive annual periods if its continuance is
specifically approved at least annually by a vote of the Board or by a vote of
the holders of a majority of the Fund's outstanding voting securities, and in
either event by a majority vote of the Board members who are not parties to the
management agreement or interested persons of any such party (other than as
members of the Board), cast in person at a meeting called for that purpose. The
management agreement may be terminated without penalty at any time by the Board
or by a vote of the holders of a majority of the Fund's outstanding voting
securities, or by Franklin Mutual on 60 days' written notice, and will
automatically terminate in the event of its assignment, as defined in the 1940
Act.
ADMINISTRATIVE SERVICES. FT Services provides certain administrative services
and facilities for the Fund. These include preparing and maintaining books,
records, and tax and financial reports, and monitoring compliance with
regulatory requirements. FT Services is a wholly owned subsidiary of Resources.
PRIOR SERVICES. Before November 1, 1996, Heine served as the investment manager
under separate investment management agreements substantially the same in terms
as the agreements currently in effect with Franklin Mutual. During the fiscal
year ended December 31, 1995, an aggregate of $1,392,294 of administrative
expenses was incurred by Mutual Shares, $720,315 by Qualified, $886,843 by
Beacon and $412,166 by Discovery. Heine's net fee for the fiscal years ended
December 31, 1995, 1994 and 1993, was $27,500,952, $21,795,512 and $19,507,048,
respectively, for Mutual Shares; $14,607,723, $9,766,052 and $8,434,525,
respectively, for Qualified; $17,720,127, $9,511,199 and $4,848,218,
respectively, for Beacon; and $7,930,967, $5,737,128 and $2,294,912,
respectively, for Discovery.
SHAREHOLDER SERVICING AGENT. Investor Services, a wholly-owned subsidiary of
Resources, is the Fund's shareholder servicing agent and acts as the Fund's
transfer agent and dividend-paying agent. Investor Services is compensated on
the basis of a fixed fee per account.
CUSTODIAN. State Street Bank and Trust Company, 225 Franklin Street, Boston, MA
02110, acts as custodian of the securities and other assets of the Fund. The
custodian does not participate in decisions relating to the purchase and sale of
portfolio securities.
AUDITORS. Ernst & Young LLP, Boston, MA, are the Fund's independent
auditors.
HOW DOES THE FUND BUY
SECURITIES FOR ITS PORTFOLIO?
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Franklin Mutual selects brokers and dealers to execute each series' portfolio
transactions in accordance with criteria set forth in the management agreement
and any directions that the Board may give.
When placing a portfolio transaction, Franklin Mutual seeks to obtain prompt
execution of orders at the most favorable net price. For portfolio transactions
done on a securities exchange, the amount of commission paid by the series is
negotiated between Franklin Mutual and the broker executing the transaction. The
determination and evaluation of the reasonableness of the brokerage commissions
paid are based to a large degree on the professional opinions of the persons
responsible for placement and review of the transactions. These opinions are
based on the experience of these individuals in the securities industry and
information available to them about the level of commissions being paid by other
institutional investors of comparable size. Franklin Mutual will ordinarily
place orders to buy and sell over-the-counter securities on a principal rather
than agency basis with a principal market maker unless, in the opinion of
Franklin Mutual, a better price and execution can otherwise be obtained.
Purchases of portfolio securities from underwriters will include a commission or
concession paid by the issuer to the underwriter, and purchases from dealers
will include a spread between the bid and ask price.
Franklin Mutual may pay certain brokers commissions that are higher than those
another broker may charge, if Franklin Mutual determines in good faith that the
amount paid is reasonable in relation to the value of the brokerage and research
services it receives. This may be viewed in terms of either the particular
transaction or Franklin Mutual's overall responsibilities to client accounts
over which it exercises investment discretion. The services that brokers may
provide to Franklin Mutual include, among others, supplying information about
particular companies, markets, countries, or local, regional, national or
transnational economies, statistical data, quotations and other securities
pricing information, and other information that provides lawful and appropriate
assistance to Franklin Mutual in carrying out its investment advisory
responsibilities. These services may not always directly benefit the Fund. They
must, however, be of value to Franklin Mutual in carrying out its overall
responsibilities to its clients.
It is not possible to place a dollar value on the special executions or on the
research services Franklin Mutual receives from dealers effecting transactions
in portfolio securities. The allocation of transactions in order to obtain
additional research services permits Franklin Mutual to supplement its own
research and analysis activities and to receive the views and information of
individuals and research staffs of other securities firms. As long as it is
lawful and appropriate to do so, Franklin Mutual and its affiliates may use this
research and data in their investment advisory capacities with other clients. If
the Fund's officers are satisfied that the best execution is obtained,
consistent with internal policies, the sale of Fund shares, as well as shares of
other funds in the Franklin Templeton Group of Funds, may also be considered a
factor in the selection of broker-dealers to execute the Fund's portfolio
transactions.
Because Distributors is a member of the NASD, it may sometimes receive certain
fees when the Fund tenders portfolio securities pursuant to a tender-offer
solicitation. As a means of recapturing brokerage for the benefit of the Fund,
any portfolio securities tendered by the Fund will be tendered through
Distributors if it is legally permissible to do so. In turn, the next management
fee payable to Franklin Mutual will be reduced by the amount of any fees
received by Distributors in cash, less any costs and expenses incurred in
connection with the tender.
During the fiscal year ended December 31, 1995, Mutual Shares, Qualified, Beacon
and Discovery paid brokerage commissions totaling $8,028,205, $5,182,736,
$6,269,829 and $3,040,751, respectively.
Clearwater, an indirect affiliate of Franklin Mutual, is a registered securities
dealer and a member of the NASD. Transactions in some Fund portfolio securities
(particularly transactions involving floor brokers) were effected through
Clearwater prior to the Transaction. During 1995, Mutual Shares paid brokerage
commissions to Clearwater of $1,192,230; Qualified paid $640,588; Beacon paid
$764,323 and Discovery paid $217,609. The transactions constituted for Mutual
Shares 13.2%; Qualified 14.1%; Beacon 14.5% and Discovery 7.7% of the aggregate
dollar amount of brokerage transactions effected during 1995. These commissions
constituted for Mutual Shares 14.9%, for Qualified 12.4%, for Beacon 12.2% and
for Discovery 7.2% of the total commissions paid in 1995.
"SOFT DOLLAR" ARRANGEMENTS. The Fund receives research services from persons who
act as brokers or dealers for the Fund. The discussion below relates in general
to these brokers or dealers who pursuant to various arrangements pay for certain
computer hardware and software and other research and brokerage services to
Franklin Mutual and/or the Fund for transactions effected by it for the Fund.
Commission "soft dollars" may be used only for "brokerage and research services"
provided by brokers to whom commissions are paid and under no circumstances will
cash payments be made by any such broker to Franklin Mutual. To the extent that
commission "soft dollars" do not result in the provision of any "brokerage and
research services" by brokers to whom such commissions are paid, the
commissions, nevertheless, are the property of such broker. Although,
potentially, Franklin Mutual could be influenced to place Fund brokerage
transactions with a broker in order to generate "soft dollars" for Franklin
Mutual's benefit, Franklin Mutual believes that the requirement that it achieve
best execution on Fund portfolio transactions, and the Fund's negotiated
commission structure with brokers, mitigate these concerns as the cost of
transactions effected through brokers, before consideration of any "soft dollar"
benefits that may be received, generally will be comparable to that available
elsewhere. During fiscal 1995, 1994 and 1993, the Fund paid brokerage
commissions of $3,355,180, $2,267,683 and $1,640,278, respectively, to brokers
who provided research services. This amount represented 14.90%, 19.45% and
17.75%, respectively, of total commissions paid for the periods.
HOW DO I BUY, SELL AND EXCHANGE SHARES?
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ADDITIONAL INFORMATION ON BUYING SHARES
The Fund continuously offers its shares through Securities Dealers who have an
agreement with Distributors. Securities Dealers may at times receive the entire
sales charge. A Securities Dealer who receives 90% or more of the sales charge
may be deemed an underwriter under the Securities Act of 1933, as amended.
Securities laws of states where the Fund offers its shares may differ from
federal law. Banks and financial institutions that sell shares of the Fund may
be required by state law to register as Securities Dealers. Financial
institutions or their affiliated brokers may receive an agency transaction fee
in the percentages indicated in the table under "How Do I Buy Shares? - Purchase
Price of Fund Shares" in the Prospectus.
When you buy shares, if you submit a check or a draft that is returned unpaid to
the Fund we may impose a $10 charge against your account for each returned item.
Under agreements with certain banks in Taiwan, Republic of China, the Fund's
shares are available to these banks' trust accounts without a sales charge. The
banks may charge service fees to their customers who participate in the trusts.
A portion of these service fees may be paid to Distributors or one of its
affiliates to help defray expenses of maintaining a service office in Taiwan,
including expenses related to local literature fulfillment and communication
facilities.
Class I shares of the Fund may be offered to investors in Taiwan through
securities advisory firms known locally as Securities Investment Consulting
Enterprises. In conformity with local business practices in Taiwan, Class I
shares may be offered with the following schedule of sales charges:
SALES
SIZE OF PURCHASE - U.S. DOLLARS CHARGE
- -----------------------------------------------
Under $30,000............... 3.0%
$30,000 but less than $50,000 2.5%
$50,000 but less than $100,000 2.0%
$100,000 but less than $200,000 1.5%
$200,000 but less than $400,000 1.0%
$400,000 or more............ 0%
OTHER PAYMENTS TO SECURITIES DEALERS. Distributors may pay the following
commissions, out of its own resources, to Securities Dealers who initiate and
are responsible for purchases of Class I shares of $1 million or more: 1% on
sales of $1 million to $2 million, plus 0.80% on sales over $2 million to $3
million, plus 0.50% on sales over $3 million to $50 million, plus 0.25% on sales
over $50 million to $100 million, plus 0.15% on sales over $100 million.
Either Distributors or one of its affiliates may pay the following amounts, out
of its own resources, to Securities Dealers who initiate and are responsible for
purchases of Class I shares by certain retirement plans pursuant to a sales
charge waiver, as discussed in the Prospectus: 1% on sales of $500,000 to $2
million, plus 0.80% on sales over $2 million to $3 million, plus 0.50% on sales
over $3 million to $50 million, plus 0.25% on sales over $50 million to $100
million, plus 0.15% on sales over $100 million. Distributors may make these
payments in the form of contingent advance payments, which may be recovered from
the Securities Dealer or set off against other payments due to the dealer if
shares are sold within 12 months of the calendar month of purchase. Other
conditions may apply. All terms and conditions may be imposed by an agreement
between Distributors, or one of its affiliates, and the Securities Dealer.
These breakpoints are reset every 12 months for purposes of additional
purchases.
Distributors and/or its affiliates provide financial support to various
Securities Dealers that sell shares of the Franklin Templeton Group of Funds.
This support is based primarily on the amount of sales of fund shares. The
amount of support may be affected by: total sales; net sales; levels of
redemptions; the proportion of a Securities Dealer's sales and marketing efforts
in the Franklin Templeton Group of Funds; a Securities Dealer's support of, and
participation in, Distributors' marketing programs; a Securities Dealer's
compensation programs for its registered representatives; and the extent of a
Securities Dealer's marketing programs relating to the Franklin Templeton Group
of Funds. Financial support to Securities Dealers may be made by payments from
Distributors' resources, from Distributors' retention of underwriting
concessions and, in the case of funds that have Rule 12b-1 plans, from payments
to Distributors under such plans. In addition, certain Securities Dealers may
receive brokerage commissions generated by fund portfolio transactions in
accordance with the NASD's rules.
LETTER OF INTENT. You may qualify for a reduced sales charge when you buy Class
I shares, as described in the Prospectus. At any time within 90 days after the
first investment that you want to qualify for a reduced sales charge, you may
file with the Fund a signed shareholder application with the Letter of Intent
section completed. After the Letter is filed, each additional investment will be
entitled to the sales charge applicable to the level of investment indicated on
the Letter. Sales charge reductions based on purchases in more than one Franklin
Templeton Fund will be effective only after notification to Distributors that
the investment qualifies for a discount. Your holdings in the Franklin Templeton
Funds acquired more than 90 days before the Letter is filed, will be counted
towards completion of the Letter but will not be entitled to a retroactive
downward adjustment in the sales charge. Any redemptions you make during the 13
month period, except in the case of certain retirement plans, will be subtracted
from the amount of the purchases for purposes of determining whether the terms
of the Letter have been completed. If the Letter is not completed within the 13
month period, there will be an upward adjustment of the sales charge, depending
on the amount actually purchased (less redemptions) during the period. The
upward adjustment does not apply to certain retirement plans. If you execute a
Letter before a change in the sales charge structure of the Fund, you may
complete the Letter at the lower of the new sales charge structure or the sales
charge structure in effect at the time the Letter was filed.
As mentioned in the Prospectus, five percent (5%) of the amount of the total
intended purchase will be reserved in Class I shares of the Fund registered in
your name until you fulfill the Letter. This policy of reserving shares does not
apply to certain retirement plans. If total purchases, less redemptions, equal
the amount specified under the Letter, the reserved shares will be deposited to
an account in your name or delivered to you or as you direct. If total
purchases, less redemptions, exceed the amount specified under the Letter and is
an amount that would qualify for a further quantity discount, a retroactive
price adjustment will be made by Distributors and the Securities Dealer through
whom purchases were made pursuant to the Letter (to reflect such further
quantity discount) on purchases made within 90 days before and on those made
after filing the Letter. The resulting difference in Offering Price will be
applied to the purchase of additional shares at the Offering Price applicable to
a single purchase or the dollar amount of the total purchases. If the total
purchases, less redemptions, are less than the amount specified under the
Letter, you will remit to Distributors an amount equal to the difference in the
dollar amount of sales charge actually paid and the amount of sales charge that
would have applied to the aggregate purchases if the total of the purchases had
been made at a single time. Upon remittance, the reserved shares held for your
account will be deposited to an account in your name or delivered to you or as
you direct. If within 20 days after written request the difference in sales
charge is not paid, the redemption of an appropriate number of reserved shares
to realize the difference will be made. In the event of a total redemption of
the account before fulfillment of the Letter, the additional sales charge due
will be deducted from the proceeds of the redemption, and the balance will be
forwarded to you.
If a Letter is executed on behalf of certain retirement plans, the level and any
reduction in sales charge for these plans will be based on actual plan
participation and the projected investments in the Franklin Templeton Funds
under the Letter. These plans are not subject to the requirement to reserve 5%
of the total intended purchase, or to any penalty as a result of the early
termination of a plan, nor are these plans entitled to receive retroactive
adjustments in price for investments made before executing the Letter.
REINVESTMENT DATE. Shares acquired through the reinvestment of dividends will be
purchased at the Net Asset Value determined on the business day following the
dividend record date (sometimes known as the "ex-dividend date"). The processing
date for the reinvestment of dividends may vary and does not affect the amount
or value of the shares acquired.
ADDITIONAL INFORMATION ON EXCHANGING SHARES
If you request the exchange of the total value of your account, declared but
unpaid income dividends and capital gain distributions will be exchanged into
the new fund and will be invested at Net Asset Value. Backup withholding and
information reporting may apply. Information regarding the possible tax
consequences of an exchange is included in the tax section in this SAI and in
the Prospectus.
If a substantial number of shareholders should, within a short period, sell
their shares of the Fund under the exchange privilege, the Fund might have to
sell portfolio securities it might otherwise hold and incur the additional costs
related to such transactions. On the other hand, increased use of the exchange
privilege may result in periodic large inflows of money. If this occurs, it is
the Fund's general policy to initially invest this money in short-term,
interest-bearing money market instruments, unless it is believed that attractive
investment opportunities consistent with the Fund's investment objectives exist
immediately. This money will then be withdrawn from the short-term money market
instruments and invested in portfolio securities in as orderly a manner as is
possible when attractive investment opportunities arise.
The proceeds from the sale of shares of an investment company are generally not
available until the fifth business day following the sale. The funds you are
seeking to exchange into may delay issuing shares pursuant to an exchange until
that fifth business day. The sale of Fund shares to complete an exchange will be
effected at Net Asset Value at the close of business on the day the request for
exchange is received in proper form. Please see "May I Exchange Shares for
Shares of Another Fund?" in the Prospectus.
ADDITIONAL INFORMATION ON SELLING SHARES
SYSTEMATIC WITHDRAWAL PLAN. There are no service charges for establishing or
maintaining a systematic withdrawal plan. Once your plan is established, any
distributions paid by the Fund will be automatically reinvested in your account.
Payments under the plan will be made from the redemption of an equivalent amount
of shares in your account, generally on the 25th day of the month in which a
payment is scheduled.
Redeeming shares through a systematic withdrawal plan may reduce or exhaust the
shares in your account if payments exceed distributions received from the Fund.
This is especially likely to occur if there is a market decline. If a withdrawal
amount exceeds the value of your account, your account will be closed and the
remaining balance in your account will be sent to you. Because the amount
withdrawn under the plan may be more than your actual yield or income, part of
the payment may be a return of your investment.
The Fund may discontinue a systematic withdrawal plan by notifying you in
writing and will automatically discontinue a systematic withdrawal plan if all
shares in your account are withdrawn or if the Fund receives notification of the
shareholder's death or incapacity.
THROUGH YOUR SECURITIES DEALER. If you sell shares through your Securities
Dealer, it is your dealer's responsibility to transmit the order to the Fund in
a timely fashion. Any loss to you resulting from your dealer's failure to do so
must be settled between you and your Securities Dealer.
REDEMPTIONS IN KIND. The Fund has committed itself to pay in cash (by check) all
requests for redemption by any shareholder of record, limited in amount,
however, during any 90-day period to the lesser of $250,000 or 1% of the value
of the Fund's net assets at the beginning of the 90-day period. This commitment
is irrevocable without the prior approval of the SEC. In the case of redemption
requests in excess of these amounts, the Board reserves the right to make
payments in whole or in part in securities or other assets of the Fund, in case
of an emergency, or if the payment of such a redemption in cash would be
detrimental to the existing shareholders of the Fund. In these circumstances,
the securities distributed would be valued at the price used to compute the
Fund's net assets and you may incur brokerage fees in converting the securities
to cash. The Fund does not intend to redeem illiquid securities in kind. If this
happens, however, you may not be able to recover your investment in a timely
manner.
GENERAL INFORMATION
If dividend checks are returned to the Fund marked "unable to forward" by the
postal service, we will consider this a request by you to change your dividend
option to reinvest all distributions. The proceeds will be reinvested in
additional shares at Net Asset Value until we receive new instructions.
If mail is returned as undeliverable or we are unable to locate you or verify
your current mailing address, we may deduct the costs of our efforts to find you
from your account. These costs may include a percentage of the account when a
search company charges a percentage fee in exchange for its location services.
All checks, drafts, wires and other payment mediums used to buy or sell shares
of the Fund must be denominated in U.S. dollars. We may, in our sole discretion,
either (a) reject any order to buy or sell shares denominated in any other
currency or (b) honor the transaction or make adjustments to your account for
the transaction as of a date and with a foreign currency exchange factor
determined by the drawee bank.
SPECIAL SERVICES. The Franklin Templeton Institutional Services
Department provides specialized services, including recordkeeping, for
institutional investors. The cost of these services is not borne by the
Fund.
Investor Services may pay certain financial institutions that maintain omnibus
accounts with the Fund on behalf of numerous beneficial owners for recordkeeping
operations performed with respect to such owners. For each beneficial owner in
the omnibus account, the Fund may reimburse Investor Services an amount not to
exceed the per account fee that the Fund normally pays Investor Services. These
financial institutions may also charge a fee for their services directly to
their clients.
Certain shareholder servicing agents may be authorized to accept your
transaction request.
HOW ARE FUND SHARES VALUED?
- ---------------------------------------------------------------------------
We calculate the Net Asset Value per share of each class as of the scheduled
close of the NYSE, generally 4:00 p.m. Eastern time, each day that the NYSE is
open for trading. As of the date of this SAI, the Fund is informed that the NYSE
observes the following holidays: New Year's Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
For the purpose of determining the aggregate net assets of the Fund, cash and
receivables are valued at their realizable amounts. Interest is recorded as
accrued and dividends are recorded on the ex-dividend date. Portfolio securities
listed on a securities exchange or on the NASDAQ National Market System for
which market quotations are readily available are valued at the last quoted sale
price of the day or, if there is no such reported sale, within the range of the
most recent quoted bid and ask prices. Over-the-counter portfolio securities are
valued within the range of the most recent quoted bid and ask prices. Portfolio
securities that are traded both in the over-the-counter market and on a stock
exchange are valued according to the broadest and most representative market as
determined by Franklin Mutual.
Portfolio securities underlying actively traded call options are valued at their
market price as determined above. The current market value of any option held by
the Fund is its last sale price on the relevant exchange before the time when
assets are valued. Lacking any sales that day or if the last sale price is
outside the bid and ask prices, options are valued within the range of the
current closing bid and ask prices if the valuation is believed to fairly
reflect the contract's market value.
The value of a foreign security is determined as of the close of trading on the
foreign exchange on which it is traded or as of the scheduled close of trading
on the NYSE, if that is earlier. The value is then converted into its U.S.
dollar equivalent at the foreign exchange rate in effect at noon, New York time,
on the day the value of the foreign security is determined. If no sale is
reported at that time, the mean between the current bid and ask prices is used.
Occasionally events that affect the values of foreign securities and foreign
exchange rates may occur between the times at which they are determined and the
close of the exchange and will, therefore, not be reflected in the computation
of the Net Asset Value of each class. If events materially affecting the values
of these foreign securities occur during this period, the securities will be
valued in accordance with procedures established by the Board.
Generally, trading in corporate bonds, U.S. government securities and money
market instruments is substantially completed each day at various times before
the scheduled close of the NYSE. The value of these securities used in computing
the Net Asset Value of each class is determined as of such times. Occasionally,
events affecting the values of these securities may occur between the times at
which they are determined and the scheduled close of the NYSE that will not be
reflected in the computation of the Net Asset Value of each class. If events
materially affecting the values of these securities occur during this period,
the securities will be valued at their fair value as determined in good faith by
the Board.
Other securities for which market quotations are readily available are valued at
the current market price, which may be obtained from a pricing service, based on
a variety of factors including recent trades, institutional size trading in
similar types of securities (considering yield, risk and maturity) and/or
developments related to specific issues. Securities and other assets for which
market prices are not readily available are valued at fair value as determined
following procedures approved by the Board. With the approval of the Board, the
Fund may utilize a pricing service, bank or Securities Dealer to perform any of
the above described functions.
ADDITIONAL INFORMATION ON
DISTRIBUTIONS AND TAXES
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DISTRIBUTIONS
You may receive two types of distributions from the Fund:
1. INCOME DIVIDENDS. The Fund receives income generally in the form of
dividends, interest and other income derived from its investments. This income,
less the expenses incurred in the Fund's operations, is its net investment
income from which income dividends may be distributed. Thus, the amount of
dividends paid per share may vary with each distribution.
2. CAPITAL GAIN DISTRIBUTIONS. The Fund may derive capital gains or losses in
connection with sales or other dispositions of its portfolio securities.
Distributions by the Fund derived from net short-term and net long-term capital
gains (after taking into account any capital loss carryforward or post October
loss deferral) may generally be made twice each year. One distribution may be
made in December to reflect any net short-term and net long-term capital gains
realized by the Fund as of October 31 of that year. Any net short-term and net
long-term capital gains realized by the Fund during the remainder of the fiscal
year may be distributed following the end of the fiscal year. The Fund may make
one distribution derived from net short-term and net long-term capital gains in
any year or adjust the timing of its distributions for operational or other
reasons.
TAXES
As stated in the Prospectus, each series has elected and qualified to be treated
as a regulated investment company ("RIC") under Subchapter M of the Code. The
Board reserves the right not to maintain the qualification of a series as a RIC
if it determines this course of action to be beneficial to shareholders. In that
case, the series will be subject to federal and possibly state corporate taxes
on its taxable income and gains, and distributions to shareholders will be
taxable to the extent of the series' available earnings and profits.
Because each series intends to qualify and to distribute all of its net
investment income and capital gain to shareholders, it is expected that each
series will not be required to pay Federal income taxes.
A series normally will distribute substantially all of its net investment income
and net realized capital gain, if any, to shareholders in the form of dividends
to be paid from time to time as determined by the Board. Such dividends are
taxable whether paid in cash or additional shares of such series.
In the event that total distributions (including distributed or designated net
capital gain) for a taxable year exceed its investment company taxable income
and net capital gain, a portion of each distribution generally will be treated
as a return of capital. Distributions treated as a return of capital reduce a
shareholder's basis in its shares and could result in a capital gain tax either
when a distribution is in excess of basis or, more likely, when a shareholder
redeems its shares.
Shareholders of a series will be notified annually by the Fund as to the Federal
tax treatment of dividends and distributions paid during the calendar year.
Dividends and distributions may also be subject to state and local taxes. State
and local tax treatment may vary according to applicable laws. You can elect to
receive distributions in cash or in additional shares of such series. The price
of the additional shares is determined as of the date for the dividend payment.
(See "What Distributions Might I Receive from the Fund?" in the Prospectus.)
To maintain qualification as a RIC under the Code, each series of the Fund must
limit gains from the sale or other disposition of its portfolio securities
(including options, futures and forward contracts) held for less than three
months to less than 30% of its annual gross income. Generally, gains on foreign
currencies (and gains on options, futures, or forward contracts with respect to
foreign currencies) are not subject to this 30% short-short rule if directly
related to regular investments by a series in equity or debt securities.
Each series intends to declare and pay dividends and capital gain distributions
so as to avoid imposition of a 4% federal excise tax. To do so, each series
expects to distribute during the calendar year an amount at least equal to (i)
98% of its calendar year net investment income, (ii) 98% of its realized capital
gain (the excess of short and long-term capital gain over short and long-term
capital loss) for each one-year period ending October 31, and (iii) 100% of any
undistributed net investment income or realized capital gain from the prior
calendar year which has not been distributed by such series. Dividends declared
in October, November, or December and made payable to shareholders of record in
such a month would be deemed paid by the Series and taxable to shareholders on
December 31 of such year provided that such dividends are actually paid during
January of the following year. A series may make a deemed distribution with
respect to its net capital gain by paying the tax with respect to the net
capital gain and then designating, but not distributing, all or a portion of
such gain as a capital gain dividend. Such series' shareholders will treat such
designated amounts as a capital gain on their income tax returns, but they will
receive a credit or refund equal to federal income taxes paid by such series
with respect to such capital gain. In addition, shareholders will increase their
basis in the series' shares by 65% of the amount subject to tax. If a capital
gain dividend is paid with respect to any shares of a series which are sold at a
loss after being held for less than six months, any loss realized upon the sale
of such shares will be treated as a long-term capital loss to the extent of such
capital gain dividend. There are special rules for determining holding periods
for the purpose of the preceding sentence.
Dividends distributed by a series will only be eligible for the
dividends-received deduction available to corporate shareholders to the extent
of the portion of a series' gross income which consists of dividends received on
equity securities issued by domestic corporations with respect to which such
series meets the same holding period, risk of loss, and borrowing limitations
applicable to the series' shareholders. Section 246 of the Code permits the
dividends-received deduction to corporate shareholders only if the shares with
respect to which the dividends were paid have been held for more than 45 days.
If the holding period is not satisfied, the dividends-received deduction is
disallowed, regardless of whether the shares with respect to which the dividends
were paid have been sold or otherwise disposed of. The holding period
requirements are separately applicable to each block of shares acquired,
including each block of shares received in payment of the Fund's dividends. For
purposes of determining whether this holding period requirement has been met,
the day of acquisition and any day after the first 45 days after the date on
which such shares become ex-dividend must be disregarded. In addition, the
holding period is suspended during periods in which the stock is subject to
diminished risk of loss including, for example, because the holder has acquired
a put option or sold a call option (other than certain covered call options
where the exercise price is not substantially below the selling price) or
otherwise hedged his position.
The dividends-received deduction will also be reduced, for shareholders who
incur indebtedness in order to purchase shares of a series of the Fund, by the
percentage of the cost of such series' shares that is debt-financed. Generally,
this limitation applies only if the debt is directly attributable to the
purchase of shares. Whether debt is directly attributable to the purchase of
shares depends on the particular facts and circumstances of each situation and
accordingly shareholders are urged to consult their tax advisors.
Under section 1059 of the Code, a corporation which receives an "extraordinary
dividend" and disposes of the stock with respect to which such dividend was
paid, provided generally that such stock has not been held for at least two
years prior to the date of declaration, announcement or agreement about the
extraordinary dividend, is required to reduce its basis in such stock (but not
below zero) by the amount of the dividend which was not taxed because of the
dividends-received deduction with such basis reduction generally being treated
as having occurred immediately before the sale or disposition of such stock. To
the extent such untaxed amount exceeds the shareholder's basis, such excess will
be taxed as gain upon a sale or disposition of such stock. An extraordinary
dividend generally is any dividend that equals or exceeds 10% of the
shareholder's basis in the stock (5% in the case of preferred stock). For this
purpose, generally, all dividends within any 85-day period, and if such
dividends total more than 20% of the shareholder's basis in its stock, all
dividends within one year, must be aggregated for purposes of determining
whether such dividends constitute extraordinary dividends. The shareholder may
elect to determine the status of extraordinary dividends by reference to the
fair market value of the stock as of the date before the ex-dividend date,
rather than by reference to the adjusted basis of such stock (provided the
shareholder establishes the fair market value to the satisfaction of the
Commissioner of the IRS). In determining whether the above-mentioned two-year
holding period has been met, the same rules apply as are applicable to the
45-day holding period requirement for the dividends received deduction.
Corporations should note that 75% of the untaxed portion of the Fund's dividends
could be taken into account for purposes of the alternative minimum tax imposed
on corporations.
A series may in the future engage in various defensive hedging transactions.
Under various Code provisions such transactions might change the character of
recognized gains and losses, accelerate the recognition of certain gains and
losses, and defer the recognition of certain losses or deductions.
If more than 50% of the assets of a series of the Fund at the close of any
taxable year consists of stocks or securities of foreign corporations, the Fund
may elect to treat any foreign income taxes, such as withholding taxes on
interest or dividends, that are paid by the Fund with respect to the series as
paid by the shareholders of such series. If the Fund makes this election with
respect to a series, the series' shareholders will be entitled to credit their
pro rata share of the foreign taxes paid by the series against their U.S.
federal income tax liability, or to deduct such amounts from their U.S. taxable
income. No deduction for foreign taxes may be claimed by a shareholder who does
not itemize deductions. In addition, certain individual shareholders may be
subject to rules that limit or reduce their ability to deduct fully their pro
rata share of foreign taxes paid by the Fund. Since the Fund anticipates that
more than 50% of the value of the total assets of European will consist of
non-U.S. equity and debt securities, European shareholders are expected to be
eligible for a pass through of the foreign taxes paid by the Fund. Shareholders
of Mutual Shares, Qualified, Beacon and Discovery are not expected to be
eligible for a pass through of the foreign taxes paid by the Fund.
Treasury regulations provide that the dividends paid-deduction attributable to
an in-kind distribution of property is equal to the adjusted basis of such
property.
THE FUND'S UNDERWRITER
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Pursuant to an underwriting agreement, Distributors acts as principal
underwriter in a continuous public offering for each class of the Fund's shares.
The underwriting agreement will continue in effect for successive annual periods
if its continuance is specifically approved at least annually by a vote of the
Board or by a vote of the holders of a majority of the Fund's outstanding voting
securities, and in either event by a majority vote of the Board members who are
not parties to the underwriting agreement or interested persons of any such
party (other than as members of the Board), cast in person at a meeting called
for that purpose. The underwriting agreement terminates automatically in the
event of its assignment and may be terminated by either party on 90 days'
written notice.
Distributors pays the expenses of the distribution of Fund shares, including
advertising expenses and the costs of printing sales material and prospectuses
used to offer shares to the public. The Fund pays the expenses of preparing and
printing amendments to its registration statements and prospectuses (other than
those necessitated by the activities of Distributors) and of sending
prospectuses to existing shareholders.
THE RULE 12B-1 PLANS
Class I and Class II have separate distribution plans or "Rule 12b-1 plans" that
were adopted pursuant to Rule 12b-1 of the 1940 Act.
THE CLASS I PLAN. Under the Class I plan, the Fund may pay up to a maximum of
0.25% per year of Class I's average daily net assets, payable quarterly, for
expenses incurred in the promotion and distribution of Class I shares. In
addition, the Fund is permitted to pay Distributors up to an additional 0.10%
per year of Class I's average daily net assets for reimbursement of distribution
expenses.
THE CLASS II PLAN. Under the Class II plan, the Fund pays Distributors up to
0.75% per year of Class II's average daily net assets, payable quarterly, for
distribution and related expenses. These fees may be used to compensate
Distributors or others for providing distribution and related services and
bearing certain Class II expenses. All distribution expenses over this amount
will be borne by those who have incurred them without reimbursement by the Fund.
Under the Class II plan, the Fund also pays an additional 0.25% per year of each
series' Class II shares' average daily net assets, payable quarterly, as a
servicing fee.
THE CLASS I AND CLASS II PLANS. In addition to the payments that Distributors or
others are entitled to under each plan, each plan also provides that to the
extent the Fund, Franklin Mutual or Distributors or other parties on behalf of
the Fund, Franklin Mutual or Distributors make payments that are deemed to be
for the financing of any activity primarily intended to result in the sale of
shares of each class within the context of Rule 12b-1 under the 1940 Act, then
such payments shall be deemed to have been made pursuant to the plan. The terms
and provisions of each plan relating to required reports, term, and approval are
consistent with Rule 12b-1.
In no event shall the aggregate asset-based sales charges, which include
payments made under each plan, plus any other payments deemed to be made
pursuant to a plan, exceed the amount permitted to be paid under the rules of
the NASD.
To the extent fees are for distribution or marketing functions, as distinguished
from administrative servicing or agency transactions, certain banks will not be
entitled to participate in the plans as a result of applicable federal law
prohibiting certain banks from engaging in the distribution of mutual fund
shares. These banking institutions, however, are permitted to receive fees under
the plans for administrative servicing or for agency transactions. If you are a
customer of a bank that is prohibited from providing these services, you would
be permitted to remain a shareholder of the Fund, and alternate means for
continuing the servicing would be sought. In this event, changes in the services
provided might occur and you might no longer be able to avail yourself of any
automatic investment or other services then being provided by the bank. It is
not expected that you would suffer any adverse financial consequences as a
result of any of these changes.
Each plan has been approved in accordance with the provisions of Rule 12b-1. The
plans are renewable annually by a vote of the Board, including a majority vote
of the Board members who are not interested persons of the Fund and who have no
direct or indirect financial interest in the operation of the plans, cast in
person at a meeting called for that purpose. It is also required that the
selection and nomination of such Board members be done by the non-interested
members of the Board. The plans and any related agreement may be terminated at
any time, without penalty, by vote of a majority of the non-interested Board
members on not more than 60 days' written notice, by Distributors on not more
than 60 days' written notice, by any act that constitutes an assignment of the
management agreement with Franklin Mutual or by vote of a majority of the
outstanding shares of the class. Distributors or any dealer or other firm may
also terminate their respective distribution or service agreement at any time
upon written notice.
The plans and any related agreements may not be amended to increase materially
the amount to be spent for distribution expenses without approval by a majority
of the outstanding shares of the class, and all material amendments to the plans
or any related agreements shall be approved by a vote of the non-interested
members of the Board, cast in person at a meeting called for the purpose of
voting on any such amendment.
Distributors is required to report in writing to the Board at least quarterly on
the amounts and purpose of any payment made under the plans and any related
agreements, as well as to furnish the Board with such other information as may
reasonably be requested in order to enable the Board to make an informed
determination of whether the plans should be continued.
HOW DOES THE FUND MEASURE PERFORMANCE?
- ------------------------------------------------------------------------
Performance quotations are subject to SEC rules. These rules require the use of
standardized performance quotations or, alternatively, that every
non-standardized performance quotation furnished by the Fund be accompanied by
certain standardized performance information computed as required by the SEC.
Average annual total return and current yield quotations used by the Fund are
based on the standardized methods of computing performance mandated by the SEC.
If a Rule 12b-1 plan is adopted, performance figures reflect fees from the date
of the plan's implementation. An explanation of these and other methods used by
the Fund to compute or express performance for each class follows. Regardless of
the method used, past performance does not guarantee future results, and is an
indication of the return to shareholders only for the limited historical period
used.
Standardized historical performance data for Class I and Class II shares will be
restated to reflect the maximum initial front-end sales charge currently in
effect. For Class II shares such performance data will also take into account
the applicable contingent deferred sales charge in connection with redemptions
within eighteen months. Each class adopted a plan of distribution under Rule
12b-1, effective November 1, 1996, which will affect subsequent performance.
Historical performance data will not be restated to include Rule 12b-1 fees,
which will only be taken into account from the effective date of the Rule 12b-1
plan.
TOTAL RETURN
AVERAGE ANNUAL TOTAL RETURN. Average annual total return is determined by
finding the average annual rates of return over one-, five- and ten-year
periods, or fractional portion thereof, that would equate an initial
hypothetical $1,000 investment to its ending redeemable value. The calculation
assumes the maximum front-end sales charge is deducted from the initial $1,000
purchase, and income dividends and capital gain distributions are reinvested at
Net Asset Value. The quotation assumes the account was completely redeemed at
the end of each one-, five- and ten-year period and the deduction of all
applicable charges and fees. If a change is made to the sales charge structure,
historical performance information will be restated to reflect the maximum
front-end sales charge currently in effect. The restated average annual total
return for each class for the one-, five- and ten-year periods ended June 30,
1996, was:
CLASS I1 1 YEAR 5 YEARS 10 YEARS
- ------------------------------------------------------------------------
Mutual Shares 5.49% 16.77% 13.65%
Qualified 16.10% 17.37% 14.05%
Beacon 17.06% 17.17% 14.69%
Discovery 20.00% * N/A
European** N/A N/A N/A
CLASS II2 1 YEAR 5 YEARS 10 YEARS
- ------------------------------------------------------------------------
Mutual Shares 18.73% 17.61% 14.06%
Qualified 19.36% 18.22% 14.47%
Beacon 20.36% 18.01% 15.10%
Discovery 23.36% * N/A
European** N/A N/A N/A
1Includes the maximum front-end sales charge.
2Includes the maximum front-end sales charge and the contingent deferred sales
charge in connection with redemption within 18 months.
*Discovery commenced operations on December 31, 1992. The restated average
annual return for the three-year period ended June 30, 1996, was 19.23% for
Class I and 20.65% for Class II.
**European commenced operations on July 3, 1996.
These figures were calculated according to the SEC formula:
n
P(1+T) = ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at the
beginning of the one-, five- or ten-year periods at the end of the
one-, five- or ten-year periods (or fractional portion thereof)
CUMULATIVE TOTAL RETURN. Like average annual total return, cumulative total
return assumes the maximum front-end sales charge is deducted from the initial
$1,000 purchase, and income dividends and capital gain distributions are
reinvested at Net Asset Value. Cumulative total return, however, will be based
on the actual return for each class for a specified period rather than on the
average return over one-, five- and ten-year periods, or fractional portion
thereof. The restated cumulative total return for each class for the one-, five-
and ten-year periods ended June 30, 1996, was:
CLASS I1 1 YEAR 5 YEARS 10 YEARS
- ------------------------------------------------------------------------
Mutual Shares 15.49% 117.07% 259.57%
Qualified 16.10% 122.70% 272.35%
Beacon 17.06% 120.82% 293.66%
Discovery 20.00% * N/A
European** N/A N/A N/A
CLASS II2 1 YEAR 5 YEARS 10 YEARS
- ------------------------------------------------------------------------
Mutual Shares 18.73% 125.02% 272.77%
Qualified 19.36% 130.89% 286.06%
Beacon 20.36% 128.84% 308.08%
Discovery 23.36% * N/A
European** N/A N/A N/A
1Includes the maximum front-end sales charge.
2Includes the maximum front-end sales charge and the contingent deferred sales
charge in connection with redemption within 18 months.
*Discovery commenced operations on December 31, 1992. The restated cumulative
total returns for the three-year period ended June 30, 1996, are 69.43% for
Class I and 75.54% for Class II.
**European commenced operations on July 3, 1996.
YIELD
CURRENT YIELD. Current yield of each class shows the income per share earned by
the Fund. It is calculated by dividing the net investment income per share of
each class earned during a 30-day base period by the applicable maximum Offering
Price per share on the last day of the period and annualizing the result.
Expenses accrued for the period include any fees charged to all shareholders of
the class during the base period.
These figures will be obtained using the following SEC formula:
6
Yield = 2 [( a-b + 1 ) - 1]
----
cd
where:
a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the period
that were entitled to receive dividends
d = the maximum Offering Price per share on the last day of the period
CURRENT DISTRIBUTION RATE
Current yield, which is calculated according to a formula prescribed by the SEC,
is not indicative of the amounts which were or will be paid to shareholders of a
class. Amounts paid to shareholders are reflected in the quoted current
distribution rate. The current distribution rate is usually computed by
annualizing the dividends paid per share by a class during a certain period and
dividing that amount by the current maximum Offering Price. The current
distribution rate differs from the current yield computation because it may
include distributions to shareholders from sources other than dividends and
interest, such as premium income from option writing and short-term capital
gains and is calculated over a different period of time.
VOLATILITY
Occasionally statistics may be used to show the Fund's volatility or risk.
Measures of volatility or risk are generally used to compare the Fund's Net
Asset Value or performance to a market index. One measure of volatility is beta.
Beta is the volatility of a fund relative to the total market, as represented by
an index considered representative of the types of securities in which the fund
invests. A beta of more than 1.00 indicates volatility greater than the market
and a beta of less than 1.00 indicates volatility less than the market. Another
measure of volatility or risk is standard deviation. Standard deviation is used
to measure variability of Net Asset Value or total return around an average over
a specified period of time. The idea is that greater volatility means greater
risk undertaken in achieving performance.
OTHER PERFORMANCE QUOTATIONS
The Fund may also quote the performance of shares without a sales charge. Sales
literature and advertising may quote a current distribution rate, yield,
cumulative total return, average annual total return and other measures of
performance as described elsewhere in this SAI with the substitution of Net
Asset Value for the public Offering Price.
Sales literature referring to the use of the Fund as a potential investment for
Individual Retirement Accounts (IRAs), Business Retirement Plans, and other
tax-advantaged retirement plans may quote a total return based upon compounding
of dividends on which it is
presumed no federal income tax applies.
The Fund may include in its advertising or sales material information relating
to investment objectives and performance results of funds belonging to the
Franklin Templeton Group of Funds. Resources is the parent company of the
advisors and underwriter of the Franklin Templeton Group of Funds.
COMPARISONS
To help you better evaluate how an investment in the Fund may satisfy your
investment objective, advertisements and other materials about the Fund may
discuss certain measures of each class' performance as reported by various
financial publications. Materials may also compare performance (as calculated
above) to performance as reported by other investments, indices, and averages.
These comparisons may include, but are not limited to, the following examples:
a) Dow Jones Composite Average or its component averages - an unmanaged index
composed of 30 blue-chip industrial corporation stocks (Dow Jones Industrial
Average), 15 utilities company stocks (Dow Jones Utilities Average), and 20
transportation company stocks. Comparisons of
performance assume reinvestment of dividends.
b) Standard & Poor's 500 Stock Index or its component indices - an unmanaged
index composed of 400 industrial stocks, 40 financial stocks, 40 utilities
stocks, and 20 transportation stocks. Comparisons of performance assume
reinvestment of dividends.
c) The New York Stock Exchange composite or component indices - an unmanaged
index of all industrial, utilities, transportation, and finance stocks listed on
the NYSE.
d) Wilshire 5000 Equity Index - represents the return on the market value of all
common equity securities for which daily pricing is available. Comparisons of
performance assume reinvestment of dividends.
e) Lipper - Mutual Fund Performance Analysis and Lipper - Fixed Income Fund
Performance Analysis - measure total return and average current yield for the
mutual fund industry and rank individual mutual fund performance over specified
time periods, assuming reinvestment of all distributions, exclusive of any
applicable sales charges.
f) CDA Mutual Fund Report, published by CDA Investment Technologies, Inc. -
analyzes price, current yield, risk, total return, and average rate of return
(average annual compounded growth rate) over specified time periods for the
mutual fund industry.
g) Mutual Fund Source Book, published by Morningstar, Inc. - analyzes
price, yield, risk, and total return for mutual funds.
h) Financial publications: The Wall Street Journal, Business Week, Changing
Times, Financial World, Forbes, Fortune, and Money magazines provide performance
statistics over specified time periods.
i) Consumer Price Index (or Cost of Living Index), published by the U.S. Bureau
of Labor Statistics - a statistical measure of change, over time, in the price
of goods and services in major expenditure groups.
j) Stocks, Bonds, Bills, and Inflation, published by Ibbotson Associates -
historical measure of yield, price, and total return for common and small
company stock, long-term government bonds, Treasury bills, and inflation.
k) Savings and Loan Historical Interest Rates - as published in the
U.S. Savings & Loan League Fact Book.
l) Historical data supplied by the research departments of First Boston
Corporation, the J. P. Morgan companies, Salomon Brothers, Merrill
Lynch, Lehman Brothers and Bloomberg L.P.
m) Standard & Poor's 100 Stock Index - an unmanaged index based on the prices of
100 blue-chip stocks, including 92 industrials, one utility, two transportation
companies, and 5 financial institutions. The S&P 100 Stock Index is a smaller,
more flexible index for options trading.
n) Morningstar - information published by Morningstar, Inc., including
Morningstar proprietary mutual fund ratings. The ratings reflect Morningstar's
assessment of the historical risk adjusted performance of a fund over specified
time periods relative to other funds within its category.
o) Salomon Brothers Broad Bond Index or its component indices measures yield,
price, and total return for Treasury, agency, corporate and mortgage bonds.
p) Lehman Brothers Aggregate Bond Index or its component indices measures yield,
price and total return for Treasury, agency, corporate, mortgage and Yankee
bonds.
r) Salomon Brothers Composite High Yield Index or its component indices -
measures yield, price and total return for the Long-Term High-Yield Index,
Intermediate-Term High-Yield Index, and Long-Term Utility High-Yield Index.
From time to time, advertisements or information for the Fund may include a
discussion of certain attributes or benefits to be derived from an investment in
the Fund. The advertisements or information may include symbols, headlines, or
other material that highlights or summarizes the information discussed in more
detail in the communication.
Advertisements or information may also compare a class' performance to the
return on CDs or other investments. You should be aware, however, that an
investment in the Fund involves the risk of fluctuation of principal value, a
risk generally not present in an investment in a CD issued by a bank. For
example, as the general level of interest rates rise, the value of the Fund's
fixed-income investments, if any, as well as the value of its shares that are
based upon the value of such portfolio investments, can be expected to decrease.
Conversely, when interest rates decrease, the value of the Fund's shares can be
expected to increase. CDs are frequently insured by an agency of the U.S.
government. An investment in the Fund is not insured by any federal, state or
private entity.
In assessing comparisons of performance, you should keep in mind that the
composition of the investments in the reported indices and averages is not
identical to the Fund's portfolio, the indices and averages are generally
unmanaged, and the items included in the calculations of the averages may not be
identical to the formula used by the Fund to calculate its figures. In addition,
there can be no assurance that the Fund will continue its performance as
compared to these other averages.
MISCELLANEOUS INFORMATION
- ------------------------------------------------------------------------
The Fund may help you achieve various investment goals such as accumulating
money for retirement, saving for a down payment on a home, college costs and
other long-term goals. The Franklin College Costs Planner may help you in
determining how much money must be invested on a monthly basis in order to have
a projected amount available in the future to fund a child's college education.
(Projected college cost estimates are based upon current costs published by the
College Board.) The Franklin Retirement Planning Guide leads you through the
steps to start a retirement savings program. Of course, an investment in the
Fund cannot guarantee that these goals will be met.
The Fund is a member of the Franklin Templeton Group of Funds, one of the
largest mutual fund organizations in the U.S., and may be considered in a
program for diversification of assets. Founded in 1947, Franklin, one of the
oldest mutual fund organizations, has managed mutual funds for over 49 years and
now services more than 2.6 million shareholder accounts. In 1992, Franklin, a
leader in managing fixed-income mutual funds and an innovator in creating
domestic equity funds, joined forces with Templeton Worldwide, Inc., a pioneer
in international investing. The Fund, known for its value-driven approach to
domestic equity investing, became part of the organization four years later.
Together, the Franklin Templeton Group has over $179 billion in assets under
management for more than 4.9 million U.S. based mutual fund shareholder and
other accounts. The Franklin Templeton Group of Funds offers 120 U.S. based
open-end investment companies to the public. The Fund may identify itself by its
NASDAQ symbol or CUSIP number.
The Dalbar Surveys, Inc. broker-dealer survey has ranked Franklin
number one in service quality for five of the past eight years.
As of January 30, 1997, the principal shareholder of the Fund, beneficial or of
record, was as follows:
SHARES
NAME AND ADDRESS AMOUNT PERCENTAGE
- ------------------------------------------------------------------------
European - Class Z
Michael F. Price 13,923,586 33.29%
51 John F. Kennedy Pkwy shares
Short Hills, NJ 07078
From time to time, the number of Fund shares held in the "street name" accounts
of various Securities Dealers for the benefit of their clients or in centralized
securities depositories may exceed 5% of the total shares outstanding.
In the event of disputes involving multiple claims of ownership or authority to
control your account, the Fund has the right (but has no obligation) to: (a)
freeze the account and require the written agreement of all persons deemed by
the Fund to have a potential property interest in the account, before executing
instructions regarding the account; (b) interplead disputed funds or accounts
with a court of competent jurisdiction; or (c) surrender ownership of all or a
portion of the account to the IRS in response to a Notice of Levy.
SUMMARY OF CODE OF ETHICS. Franklin Mutual and the Fund have adopted Codes of
Ethics and related internal procedures (together referred to as the "Code of
Ethics") which govern the personal investing practices of Franklin Mutual's
employees. The Code of Ethics generally incorporates the recommendation of the
Investment Company Institute contained in the Report of the Advisory Group on
Personal Investing dated May 9, 1994. Specifically, employees of Franklin Mutual
may buy and sell securities for themselves as long as their trades have been
pre-cleared in accordance with the Code of Ethics. Transactions by Franklin
Mutual's employees which comply with the substantive and procedural provisions
of the Code of Ethics are permitted even if the security being purchased is one
of limited availability (such as investments in private placements), and is one
in which any particular series would be financially and legally able to invest.
USEFUL TERMS AND DEFINITIONS
1940 ACT - Investment Company Act of 1940, as amended
BOARD - The Board of Directors of the Fund
CD - Certificate of deposit
CLASS I, CLASS II AND CLASS Z - Each series offers three classes of shares,
designated "Class I," "Class II" and "Class Z." The three classes have
proportionate interests in the respective series' portfolio. They differ,
however, primarily in their sales charge and expense structures.
CODE - Internal Revenue Code of 1986, as amended
DISTRIBUTORS - Franklin/Templeton Distributors, Inc., the Fund's
principal underwriter
FRANKLIN MUTUAL - Franklin Mutual Advisers, Inc., the Fund's investment
manager
FRANKLIN TEMPLETON FUNDS - The U.S. registered mutual funds in the
Franklin Group of Funds(R) and the Templeton Group of Funds except
Franklin Valuemark Funds, Franklin Government Securities Trust,
Templeton Capital Accumulator Fund, Inc., Templeton Variable Annuity
Fund, and Templeton Variable Products Series Fund
FRANKLIN TEMPLETON GROUP - Franklin Resources, Inc., a publicly owned holding
company, and its various subsidiaries
FRANKLIN TEMPLETON GROUP OF FUNDS - All U.S. registered investment
companies in the Franklin Group of Funds(R) and the Templeton Group of
Funds
FT SERVICES - Franklin Templeton Services, Inc., the Fund's
administrator
INVESTOR SERVICES - Franklin/Templeton Investor Services, Inc., the Fund's
shareholder servicing and transfer agent
IRS - Internal Revenue Service
LETTER - Letter of Intent
NASD - National Association of Securities Dealers, Inc.
NET ASSET VALUE (NAV) - The value of a mutual fund is determined by deducting
the fund's liabilities from the total assets of the portfolio. The net asset
value per share is determined by dividing the net asset value of the fund by the
number of shares outstanding.
NYSE - New York Stock Exchange
OFFERING PRICE - The public offering price is based on the Net Asset Value per
share of the class and includes the front-end sales charge. The maximum
front-end sales charge is 4.50% for Class I and 1% for Class II.
PROSPECTUS - The prospectus for the Fund's Class I and Class II shares dated
November 1, 1996, as amended February 12, 1997, and as may be further amended
from time to time
RESOURCES - Franklin Resources, Inc.
SAI - Statement of Additional Information
SEC - U.S. Securities and Exchange Commission
SECURITIES DEALER - A financial institution that, either directly or through
affiliates, has an agreement with Distributors to handle customer orders and
accounts with the Fund. This reference is for convenience only and does not
indicate a legal conclusion of capacity.
U.S. - United States
WE/OUR/US - Unless a different meaning is indicated by the context, these terms
refer to the Fund and/or Investor Services, Distributors, or other wholly owned
subsidiaries of Resources.
FINANCIAL STATEMENTS
Except for the European Fund, the audited financial statements contained in the
Annual Report to Shareholders of each series for the fiscal year ended December
31, 1995, including the auditors' report, and the unaudited financial statements
contained in the Semi-Annual Report to Shareholders of each series for the
period ended June 30, 1996, are incorporated herein by reference. The financial
statements do not include information for Class I and Class II shares as these
shares were not publicly offered prior to the date of the financial statements.
The unaudited financial statements for the European Fund for the period ended
December 31, 1996, are as follows:
MUTUAL EUROPEAN FUND STATEMENT
OF ASSETS AND LIABILITIES
DECEMBER 31, 1996 (UNAUDITED)
ASSETS
Investments in Securities, at Value (cost $430,352,372)...........$458,823,937
Cash ..................................................................530,404
Receivables:
Investment Securities Sold.........................................6,800,225
Capital Stock Subscribed...........................................1,888,609
Dividends............................................................236,292
Interest.............................................................118,184
Fee Reimbursement.....................................................50,394
---------
TOTAL ASSETS.................................................468,448,045
-----------
LIABILITIES
Payables:
Investment Securities Purchased......................................5,023,495
Net Payable for Foreign
Currency Exchange Contracts........................................105,235
Investment Advisory Fee.............................................293,344
Capital Stock Repurchased...........................................449,841
Accrued Expenses
and Other Liabilities..............................................127,174
---------
TOTAL LIABILITIES..............................................5,999,089
---------
NET ASSETS APPLICABLE TO OUTSTANDING CAPITAL STOCK................$462,448,956
-------------
-------------
COMPOSITION OF NET ASSETS
Paid In Capital...................................................$430,067,727
Undistributed Net Investment Income....................................580,686
Accumulated Net Realized Gain on Investments and
Foreign Currency Transactions.......................................3,364,491
Net Unrealized Appreciation of Investments..........................28,531,515
Net Unrealized Depreciation of Foreign Currency
Exchange Contracts and Dividends.....................................(95,463)
--------
TOTAL NET ASSETS............................................$462,448,956
------------
------------
Class Z
Net Asset Value per Share (Offering and Redemption Price
per Share)
($450,495,190 / 39,546,933 shares outstanding).............$11.39
-------
-------
Class I
Net Asset Value per Share
($9,199,892 / 808,273 shares outstanding)...................$11.38
-------
-------
Maximum Offering Price
($11.38 / 95.5%)............................................$11.92
-------
-------
Class II
Net Asset Value per Share
($2,753,874 / 242,005 shares outstanding)...................$11.38
-------
-------
Maximum Offering Price
($11.38 / 99.0%)............................................$11.49
-------
-------
See notes to financial statements.
B-24
MUTUAL EUROPEAN FUND
STATEMENT OF OPERATIONS
FOR PERIOD JULY 3, 1996 (COMMENCEMENT OF OPERATIONS) TO DECEMBER 31,
1996 (UNAUDITED)
INVESTMENT INCOME:
Income:
Interest $2,724,820
Dividends
(Net of Foreign Withholding-- $76,402) 796,851
TOTAL INCOME $ 3,521,671
Expenses:
Investment Advisory Fee 949,616
Shareholder Servicing Costs 159,269
Administrative 80,467
Distribution Fee
Class I 3,373
Class II 1,008
Registration and Filing Fees 129,245
Shareholder Reports 21,180
Legal Fees 8,872
Insurance 370
Auditing Fees 8,500
Directors' Fees and Expenses 2,295
Miscellaneous 2,081
-----
TOTAL EXPENSES 1,366,276
Less Expenses Reimbursed (50,394)
---------
TOTAL EXPENSES LESS REIMBURSEMENT 1,315,882
----------
NET INVESTMENT INCOME 2,205,789
----------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS
Net Realized Gain on Investments and
Foreign Currency Transactions 4,653,655
Net Realized Loss on Securities Sold Short (139,150)
Change in Unrealized Appreciation of Investments
and Foreign Currency Transactions 28,436,052
----------
NET GAIN ON INVESTMENTS 32,950,557
----------
NET INCREASE IN NET ASSETS FROM OPERATIONS $35,156,346
-----------
-----------
See notes to financial statements.
MUTUAL EUROPEAN FUND
STATEMENT OF CHANGES IN NET ASSETS
FOR PERIOD JULY 3, 1996 (COMMENCEMENT OF OPERATIONS) TO DECEMBER 31,
1996 (UNAUDITED)
INCREASE/(DECREASE) IN NET ASSETS FROM OPERATIONS:
Net Investment Income $ 2,205,789
Net Realized Gain on Investments and
Foreign Currency Transactions 4,514,505
Change in Unrealized Appreciation of Investments 28,436,052
----------
NET INCREASE IN NET ASSETS
FROM OPERATIONS 35,156,346
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS FROM
Net Investment Income
Class Z (1,947,610)
Class I (25,784)
Class II (7,669)
Net Realized Gain on Investments
Class Z (779,044)
Class I (10,995)
Class II (4,015)
--------
TOTAL DISTRIBUTIONS TO SHAREHOLDERS (2,775,117)
-----------
CAPITAL STOCK TRANSACTIONS
Class Z 418,343,037
Class I 9,032,503
Class II 2,692,187
---------
NET INCREASE IN NET ASSETS 462,448,956
-----------
NET ASSETS:
Beginning of Period -
----------
End of Period-- Including Undistributed
Net Investment Income of $580,686 $462,448,956
-------------
-------------
See notes to financial statements.
MUTUAL EUROPEAN FUND
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996 (UNAUDITED)
NOTE A -- SIGNIFICANT ACCOUNTING POLICIES
Mutual European Fund is a portfolio of Franklin Mutual Series Fund Inc.
(the "Series Fund"), which is registered under the Investment Company Act of
1940 as a diversified, open-end management investment company. The Series Fund
currently consists of five portfolios: Mutual Qualified Fund, Mutual Shares
Fund, Mutual Beacon Fund, Mutual Discovery Fund and Mutual European Fund. Each
of these portfolios is considered to be a separate entity for financial
reporting and Federal income tax purposes. The financial statements and notes
include operations with respect to Mutual European Fund (the "Fund") only.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
may affect the reported amounts of assets and liabilities. Actual results could
differ from those estimates.
SECURITY VALUATION: Investments in securities and securities sold short
that are listed on an exchange or the NASDAQ national market or other securities
traded in the over-the-counter market are valued at the last reported sales
price on the day of valuation; however, if there are no sales on that day, such
securities are valued at the mean between the closing bid and asked prices.
Securities for which market quotations are not readily available are valued at
"fair value" as determined in good faith by management under the direction of
the Board of Directors. Fair value reflects what management believes is the bid
price for the securities and is based on estimates and assumptions deemed
relevant under the circumstances. Actual results could differ from these
estimates. Temporary investments are valued at the prevailing market value.
RESTRICTED SECURITIES: The Fund invests in securities which are restricted
as to public sale in accordance with the Securities Act of 1933. Such assets are
valued at fair value as determined in good faith by management under the
direction of the Board of Directors. It is the Fund's policy that no more than
15%, as determined at the time of investment, of the value of the Fund's assets
be invested in restricted securities.
FOREIGN SECURITIES: The value of foreign securities is converted into U.S.
dollars at the rate of exchange prevailing on the day of valuation. Purchases
and sales of foreign securities, as well as income and expenses relating to such
securities, are converted at the prevailing rate of exchange on the respective
date of such transactions.
FOREIGN EXCHANGE CONTRACTS: The Fund may engage in currency transactions
in order to hedge the value of portfolio holdings denominated in foreign
currencies against fluctuations in relative value. Foreign Exchange contracts
are valued at the forward rate, and are marked-to-market daily. The change in
market value is recorded by the Fund as an unrealized gain or loss. When the
contract is closed, the Fund records a realized gain or loss equal to the
difference between the value of the contract at the time it was opened and the
value at the time it was closed. The use of currency transactions can result in
the Fund incurring losses as a result of a number of factors including the
imposition of exchange controls, suspension of settlements, or the inability to
deliver or receive a specified currency. The Fund does not isolate that portion
of the results of operations resulting from changes in foreign exchange rates on
investments from the fluctuations arising from changes in market prices of
securities held. Such fluctuations are included with the net realized and
unrealized gain or loss from investments.
OPTIONS WRITTEN: When the Fund writes an option, the premium received is
recorded as a liability with subsequent daily adjustment to current market
value. When the Fund enters into a closing transaction or the option expires or
is exercised, the Fund realizes a gain or loss, and the liability is eliminated.
All securities covering outstanding options are held in a segregated account by
the custodian bank.
SECURITIES SOLD SHORT: The Fund is engaged in selling securities short,
which obligates the Fund to replace a security borrowed by purchasing the same
security at the current market value. The Fund would incur a loss if the price
of the security increases between the date of the short sale and the date on
which the Fund replaces the borrowed security. The Fund would realize a gain if
the price of the security declines between those dates.
The Fund is required to establish a margin account with the broker lending
the security sold short. While the short sale is outstanding, the broker retains
the proceeds of the short sale and the Fund must also maintain a cash deposit
with the broker having a value equal to a specified percentage of the value of
the securities sold short.
SECURITIES TRANSACTIONS AND INVESTMENT INCOME: Securities transactions are
recorded on a trade-date basis. Securities gains or losses are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend date or,
for certain foreign dividends, as soon as the Fund becomes aware of the
dividends. Interest income, including original issue discount, where applicable,
is recorded on the accrual basis, except for bonds trading "flat", in which case
interest is recorded when received.
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS: Income dividends and capital
gain distributions are determined in accordance with income tax regulations
which may differ from generally accepted accounting principles. These
differences are primarily due to differing treatments of income and gains on
various investment securities held by the Fund, timing differences and differing
characterization of distributions made by the Fund. Differences in the
recognition or classification of income between the financial statements and tax
earnings and profits which result in temporary over-distribution for financial
statement purposes are classified as distributions in excess of net investment
income or accumulated net realized gains.
FEDERAL INCOME TAXES: The Fund qualifies, and intends to continue to meet
the requirements for qualification, as a regulated investment company, as
defined in applicable sections of the Internal Revenue Code ("Code"). By
complying with code provisions, the Fund is relieved from Federal income tax
provided that substantially all of its taxable income is distributed to
shareholders. Therefore, no Federal income tax provision has been provided.
NOTE B -- MERGER OF HEINE SECURITIES CORPORATION AND FRANKLIN RESOURCES
On October 31, 1996, pursuant to an agreement between Franklin Resources,
Inc. ("FRI") and Heine Securities Corporation ("Heine"), the investment adviser,
the assets of Heine were acquired by Franklin Mutual Advisers, Inc. ("FMA"), a
subsidiary of FRI. Franklin Mutual became the investment adviser to the Series
Fund and the Series Fund's name changed from Mutual Series Fund Inc. to Franklin
Mutual Series Fund Inc.
NOTE C -- INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES
Certain officers of the Fund are also directors or officers of
FMA, Franklin Templeton Distributors, Inc. ("FTD") and Franklin
Templeton Investor Services, Inc. ("FTIS"), the Fund's investment
adviser, principal underwriter for Class I and II, and transfer agent,
respectively.
For the period ended December 31, 1996, the investment advisers received
fees of $949,616 for investment management and advisory services under the
investment advisory agreements. The fee was paid monthly based on average daily
net assets at the annual rate of eight-tenths of one percent. Prior to November
1, 1996, administrative personnel and services were provided at approximate cost
by Heine. On November 1, 1996 FTSI became the Fund's administrative manager. The
Fund pays FTSI monthly its allocated share of an administrative fee of 0.15% per
annum on the first $200 million of the Series Fund's aggregate average daily net
assets, 0.135% of the next $500 million, 0.10% of the next $500 million and
0.075% per annum of such average net assets in excess of $1.2 billion. The Fund
paid fees of $57,060 through December 31, 1996. In connection with the merger,
FRI and FMA have voluntarily agreed to limit the total expenses of the Fund to
be no higher than they were expected to be for the Fund's 1996 fiscal year based
on the projected annualized expense ratio had the merger between FRI and Heine
not taken place. This limitation expires on October 31, 1999. The amount of
reimbursement is set forth in the statement of operations. For the period ended
December 31, 1996, FTD paid net commissions of $1,291 from the sale of the
Fund's shares and FTIS received fees of $768.
Clearwater Securities, Inc. ("Clearwater"), is a registered securities
dealer which is owned by Michael F. Price, President of FMA. Through October 31,
1996, the Fund executed certain security transactions with Clearwater. Effective
November 1, 1996, security transactions are no longer executed with Clearwater.
For the period ended December 31, 1996, the Fund paid brokerage commissions
totaling $4,037 to Clearwater.
Under the distribution plans for Class I and Class II shares, the Fund
reimburses FTD quarterly for FTD's costs and expenses in connection with any
activity that is primarily intended to result in a sale of Fund shares, subject
to a maximum of 0.25% and 1.00% per annum of the average daily net assets of
Class I and Class II shares, respectively. Class II shares redeemed within 18
months are subject to a contingent deferred sales charge. There were no
contingent deferred sales charges paid to FTD for the period ended December 31,
1996.
NOTE D -- INVESTMENT TRANSACTIONS
Purchases and proceeds from the sale of investment securities (excluding
short-term investments) for the period ended December 31, 1996, aggregated
$305,035,611 and $53,054,797, respectively.
For Federal income tax purposes, the identified cost of investments at
December 31, 1996 was $430,352,372. Net unrealized appreciation for all
securities at December 31, 1996, based on Federal income tax cost, amounted to
$28,471,565 consisting of aggregate gross unrealized appreciation of $31,458,530
and aggregate gross unrealized depreciation of $2,986,965.
NOTE E -- RESTRICTED SECURITIES
A summary of the restricted securities held at December 31, 1996, follows:
ACQUISITION
NAME OF ISSUER DATE VALUE
- ------------------------------------------------------------------------
OPTION
Cityscape Financial Corp.,
Options 11/25/96 $2,079,000
-----------
TOTAL RESTRICTED SECURITIES:
(COST $1,760,000)
(0.45% OF NET ASSETS) $2,079,000
----------
----------
NOTE F -- FOREIGN CURRENCY EXCHANGE CONTRACTS
At December 31, 1996, the Fund had various contracts which
obligate the Fund to deliver currencies at specified future dates. Open
contracts were as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Net Unrealized
Appreciation/
Contracts to Deliver In Exchange for Settlement Date Value (Depreciation)
-------------- ------------- ------------ ------ -----------------
Sales
ATS 13,000,000 $1,193,044 2/11/97 $1,203,103 $(10,059)
CHF 11,038,884 8,427,880 3/10/97 8,303,415 124,465
DEM 7,509,263 4,983,475 3/18/97 4,904,617 78,858
DKK 28,421,515 4,929,969 4/24/97 4,854,501 75,468
ESP 219,197,466 1,674,450 2/18/97 1,686,453 (12,003)
FIM 29,600,419 6,681,810 3/3/97 6,460,505 221,305
FRF 253,395,085 49,335,517 2/28/97 49,031,130 304,387
GBP 8,687,454 14,495,599 2/18/97 14,866,934 (371,335)
GBP 9,000,000 14,926,950 3/18/97 15,390,315 (463,365)
GBP 2,380,240 3,778,707 5/16/97 4,063,374 (284,667)
GBP 9,000,000 14,882,400 6/18/97 15,348,969 (466,569)
GBP 8,246,568 13,605,188 8/18/97 14,038,191 (433,003)
ITL 6,099,425,918 4,006,562 1/2/97 4,023,368 (16,806)
ITL 6,099,425,918 3,956,427 7/2/97 3,997,760 (41,333)
NLG 27,233,423 16,269,384 3/17/97 15,850,111 419,273
NLG 4,197,815 2,459,536 6/10/97 2,457,389 2,147
NOK 150,511,892 23,227,144 6/9/97 23,773,588 (546,444)
PTE 975,400,000 6,246,177 1/17/97 6,288,584 (42,407)
SEK 35,286,738 5,368,408 1/21/97 5,178,066 190,342
SEK 31,178,095 4,716,675 2/18/97 4,580,882 135,793
SEK 185,798,461 27,993,227 5/15/97 27,406,608 586,619
SEK 55,552,42 8,416,395 7/21/97 8,219,545 196,850
SEK 50,303,818 7,602,784 8/15/97 7,451,037 151,747
$249,177,708 $249,378,445 $(200,737)
==================== ================ ================
PURCHASES
$3,107,592 FIN 14,034,621 3/3/97 $3,063,157 $(44,435)
1,472,245 GBP 909,374 5/16/97 1,552,417 80,172
3,982,648 ITL 6,099,425,918 1/2/97 4,023,368 40,720
2,874,719 SEK 19,719,998 1/21/97 2,893,764 19,045
---------- ---------- ------
$ 11,437,204 $11,532,706 95,502
============= =========== ------
$(105,235)
=============
</TABLE>
NOTE G -- CAPITAL STOCK
Effective November 1, 1996, the Fund offered three classes of shares:
Class Z, Class I and Class II. All Fund shares outstanding before that date were
designated Class Z shares. All classes of shares have the same rights, except
for their initial sales load, distribution fees, voting rights affecting a
single class and the exchange privilege of each class. At December 31, 1996,
there were 400 million shares authorized ($0.001 par value). Transactions in
capital stock were as follows:
CLASS Z
---------------------
FOR THE PERIOD
JULY 3, 1996
(COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1996
-----------------------
SHARES AMOUNT
------- -----------
Shares sold 42,171,939 $446,968,711
Shares issued in reinvestment
of dividends 229,503 2,586,502
Shares redeemed (2,854,509) (31,212,176)
------------- ------------
Net Increase 39,546,933 $418,343,037
============= =============
CLASS I
-------------------
FOR THE PERIOD
NOVEMBER 1, 1996
TO DECEMBER31, 1996
--------------------
SHARES AMOUNT
----------- ------------
Shares sold 813,014 $9,085,283
Shares issued in reinvestment
of dividends 2,838 31,814
Shares redeemed (7,579) (84,594)
----------- --------
Net Increase 808,273 $9,032,503
============= =============
CLASS II
--------------
FOR THE PERIOD
NOVEMBER 1, 1996
TO DECEMBER 31, 1996
SHARES AMOUNT
----------- ------------
Shares sold 242,959 $2,703,061
Shares issued in reinvestment of dividends 860 9,680
Shares redeemed (1,814) 20,554)
----------- --------------
Net Increase 242,005 $2,692,187
============= =============
Michael Price, President of the Fund's investment adviser, is the record owner
of 14,024,208 Class Z shares as of December 31, 1996.
MUTUAL EUROPEAN FUND
FINANCIAL HIGHLIGHTS (UNAUDITED)
(Selected data for a share of capital stock outstanding throughout each
(period)
CLASS Z CLASS I CLASS II
----------- ----------- ----------
FOR THE PERIOD FOR THE PERIOD FOR THE PERIOD
JULY 3, 1996(A) NOVEMBER 1, 1996(B) NOVEMBER 1, 1996(B)
TO DECEMBER 31, TO DECEMBER 31, TO DECEMBER 31,
1966 1996 1996
---------------- --------------- ---------------
NET ASSET VALUE,
Beginning of
Period $10.00 $ 10.84 $10.84
---------------- ------------ --------------
INCOME FROM
INVESTMENT
OPERATIONS:
Net Investment
Income .06 .03 .02
Net Gains
or Losses on
Securities
(realized and
unrealized) 1.40 .58 .58
---------- --------- --------
Total from
Investment
Operations 1.46 .61 .60
--------- ------- -------
LESS DISTRIBUTIONS:
Dividends
(from net
investment
income) .05 .05 .04
Distributions
(from capital
gains) .02 .02 .02
----------- ------- --------
Total
Distributions
.07 .06 .07
----------- ---------- ---------
NET ASSET
VALUE,
End of Year $ 11.39 $ 11.38 $11.38
================ =============== =============
Total
Return 14.61%+ 5.61%++ 5.52%+++
============= ============= =============
RATIOS/SUPPLEMENTAL DATA:
Net Assets,
End of Year
(millions) $ 450 $ 9 $ 3
Ratio of
Expenses to
Average
Net Assets 1.14%* 1.38%* 2.01%*
Ratio of
Expenses,
net of
reimbursement,
to average
net assets 1.09%* 1.32%* 1.94%*
Ratio of
Net
Investment
Income
to Average
Net Assets 1.84%* 1.44%* .79%*
Portfolio
Turnover
Rate 26.76% 26.76% 26.76%
Average
Commission
Rate $.023 $.023 $.023
+Not annualized for periods of less than one year.
++Total return does not reflect sales commissions. Not annualized for
periods of less than one year.
+++Total return does not reflect sales commissions or the contingent deferred
sales charge. Not annualized for periods of less than one year.
*Annualized.
(a)Commencement of operations.
(b)Commencement of offering of sales.
FRANKLIN MUTUAL SERIES FUND INC.
STATEMENT OF ADDITIONAL INFORMATION
NOVEMBER 1, 1996
AS AMENDED FEBRUARY 12, 1997
This Class Z Statement of Additional Information is not a prospectus and
should be read in conjunction with the Class Z Prospectus of Franklin Mutual
Series Fund Inc. (the "Fund") dated November 1, 1996, as amended February 12,
1997. Copies of the Prospectus and the most recent Annual Report of each series
of the Fund can be obtained without charge by calling the Fund at 1-800-553-3014
or by writing to Franklin Mutual Series Fund Inc., 51 John F. Kennedy Parkway,
Short Hills, NJ 07078, Attention: Shareholder Services.
TABLE OF CONTENTS
PAGE
Investment Objectives and Policies B-2
Restrictions and Limitations B-11
Management of the Fund B-13
Investment Adviser B-16
Redemption of Shares B-17
Investment Advisory and Administration
Agreements B-17
Portfolio Brokerage B-18
Taxes B-20
Calculation of Performance Data B-22
Custodian, Transfer Agent and Auditors B-22
Code of Ethics B-22
Financial Information B-23
INVESTMENT OBJECTIVES AND POLICIES
As described in the Prospectus, the general investment policy of the Fund
for its series, Mutual Shares Fund ("Mutual Shares"), Mutual Qualified Fund
("Qualified"), Mutual Beacon Fund ("Beacon"), Mutual Discovery Fund
("Discovery") and Mutual European Fund ("European"), is to invest in securities
if, in the opinion of Franklin Mutual Advisers, Inc., the series' investment
adviser ("Franklin Mutual" or the "Adviser"), they are available at prices less
than their intrinsic value, as determined by the Adviser after careful analysis
and research, taking into account, among other factors, the relationship of book
value to market value of the securities, cash flow, and multiples of earnings of
comparable securities. The Fund reserves freedom of action for each series to
invest in common stock, preferred stock, debt securities and other securities in
such proportions as the management deems advisable, but, without committing any
fixed portion of any series' assets, the management typically maintains a
portion of the assets of each series invested in debt securities and preferred
stocks (which may be convertible). In addition, the series may also invest in
restricted debt and equity securities, in foreign securities, and in other
investment company securities.
REPURCHASE AGREEMENTS AND LOANS OF SECURITIES
Each series may invest in repurchase agreements with domestic banks or
broker-dealers. Repurchase agreements are considered loans by the series
collateralized by the underlying securities. As with loans of portfolio
securities which the series may make, these transactions must be fully
collateralized at all times. The Adviser will monitor the creditworthiness of
the other party and will monitor the value of the collateral by marking to
market daily in order to confirm that its value is at least 100% of the agreed
upon sum to be paid to the series.
Repurchase agreements and lending of portfolio securities involve some
credit risk to the series. If the other party defaults on its obligations, the
series could be delayed or prevented from receiving payment or recovering its
collateral. Even if the series recovers the collateral in such a situation, the
series may receive less than its purchase price upon resale.
GENERAL CHARACTERISTICS OF OPTIONS
Put options and call options typically have similar structural
characteristics and operational mechanics regardless of the underlying
instrument on which they are purchased or sold. Thus, the following general
discussion relates to each of the particular types of options discussed in
greater detail below. In addition, many Hedging Transactions involving options
require segregation of Fund assets in special accounts, as described below under
"Use of Segregated and Other Special Accounts."
A put option gives the purchaser of the option, upon payment of a premium,
the right to sell, and the seller of the option, the obligation to buy, the
underlying security, commodity, index, currency or other instrument at the
exercise price. For instance, the Fund's purchase of a put option on a security
might be designed to protect its holdings in the underlying instrument (or, in
some cases, a similar instrument) against a substantial decline in the market
value by giving the Fund the right to sell such instrument at the option
exercise price. A call option, upon payment of a premium, gives the purchaser of
the option the right to buy, and the seller the obligation to sell, the
underlying instrument at the exercise price. The Fund's purchase of a call
option on a security, financial future, index, currency or other instrument
might be intended to protect the Fund against an increase in the price of the
underlying instrument that it intends to purchase in the future by fixing the
price at which it may purchase such instrument.
An American style put or call option may be exercised at any time during
the option period while a European style put or call option may be exercised
only upon expiration or during a fixed period prior thereto. The Fund is
authorized to purchase and sell exchange-listed options and over-the-counter
options ("OTC options"). Exchange-listed options are issued by a regulated
intermediary such as the Options Clearing Corporation ("OCC"), which guarantees
the performance of the obligations of the parties to such options. The
discussion below uses the OCC as a paradigm, but is also applicable to other
financial intermediaries.
With certain exceptions, OCC-issued and exchange-listed options generally
settle by physical delivery of the underlying security or currency, although in
the future cash settlement may become available. Index options and Eurodollar
instruments are cash settled for the net amount, if any, by which the option is
"in-the-money" (i.e., where the value of the underlying instrument exceeds, in
the case of a call option, or is less than, in the case of a put option, the
exercise price of the option) at the time the option is exercised. Frequently,
rather than taking or making delivery of the underlying instrument through the
process of exercising the option, listed options are closed by entering into
offsetting option transactions.
The Fund's ability to close out its position as a purchaser or seller of
an OCC or exchange-listed put or call option is dependent, in part, upon the
liquidity of the option market. Among the possible reasons for the absence of a
liquid option market on an exchange are: (i) insufficient trading interest in
certain options; (ii) restrictions on transactions imposed by an exchange; (iii)
trading halts, suspensions or other restrictions imposed with respect to
particular classes or series of options or underlying securities including
reaching daily price limits; (iv) interruption of the normal operations of the
OCC or an exchange; (v) inadequacy of the facilities of an exchange or OCC to
handle current trading volume; or (vi) a decision by one or more exchanges to
discontinue the trading of options (or a particular class or series of options),
in which event the relevant market for that option on that exchange would cease
to exist, although outstanding options on that exchange would generally continue
to be exercisable in accordance with their terms.
The hours of trading for listed options may not coincide with the hours
during which the underlying financial instruments are traded. To the extent that
the option markets close before the markets for the underlying financial
instruments, significant price and rate movements can take place in the
underlying markets that cannot be reflected in the option markets.
OTC options are purchased from or sold to securities dealers, financial
institutions or other parties (each a "Counterparty," and collectively,
"Counterparties") through direct bilateral agreement with the Counterparty. In
contrast to exchange-listed options, which generally have standardized terms and
performance mechanics, all the terms of an OTC option, including such terms as
method of settlement, term, exercise price, premium, guarantees and security,
are set by negotiation of the parties. The Fund will only sell OTC options
(other than OTC currency options) that are subject to a buy-back provision
permitting the Fund to require the Counterparty to sell the option back to the
Fund at a formula price within seven days. The Fund expects generally to enter
into OTC options that have cash settlement provisions, although it is not
required to do so.
Unless the parties provide for it, there is no central clearing or
guaranty function in an OTC option. As a result, if the Counterparty fails to
make or take delivery of the security, currency or other instrument underlying
an OTC option it has entered into with the Fund or fails to make a cash
settlement payment due in accordance with the option, the Fund will lose any
premium it paid for the option as well as any anticipated benefit of the
transaction. Accordingly, the Adviser must assess the creditworthiness of each
such Counterparty or any guarantor or credit enhancement of the Counterparty's
credit to determine the likelihood that the terms of the OTC option will be
satisfied.
The Fund will engage in OTC option transactions only with United States
government securities dealers recognized by the Federal Reserve Bank of New York
as "primary dealers" or broker-dealers, domestic or foreign banks or other
financial institutions which have received (or the guarantors of the obligations
of which have received) a short-term credit rating of "A-l" from Standard &
Poor's Corporation ("S&P") or "P-l" from Moody's Investor Services ("Moody's"),
an equivalent rating from any nationally recognized statistical rating
organization ("NRSRO") or which the Adviser determines is of comparable credit
quality. The staff of the SEC currently takes the position that OTC options
purchased by the Fund, and portfolio securities "covering" the amount of the
Fund's obligation pursuant to an OTC option sold by it (the cost of the
sell-back plus the in-the-money amount, if any) are illiquid, and are subject to
the Fund's limitations on investments in illiquid securities.
If the Fund sells a call option, the premium that it receives may serve as
a partial hedge, to the extent of the option premium, against a decrease in the
value of the underlying securities or instruments in its portfolio or will
increase the Fund's income. The sale of put options can also provide income.
The Fund may purchase and sell call options on securities, including U.S.
Treasury and agency securities, mortgage-backed securities, corporate debt
securities, equity securities (including convertible securities) and Eurodollar
instruments that are traded on U.S. and foreign securities exchanges and in the
over-the-counter markets and on securities indices, currencies and futures
contracts. All calls sold by the Fund must be "covered" (i.e., the Fund must own
the securities or futures contract subject to the call) or must meet the asset
segregation requirements described below as long as the call is outstanding.
Even though the Fund will receive the option premium to help protect it against
loss, a call sold by the Fund exposes the Fund during the term of the option to
possible loss of opportunity to realize appreciation in the market price of the
underlying security or instrument and may require the Fund to hold a security or
instrument which it might otherwise have sold.
The Fund may purchase and sell put options on securities including U.S.
Treasury and agency securities, mortgage-backed securities, corporate debt
securities, equity securities (including convertible securities) and Eurodollar
instruments (whether or not it holds the above securities in its portfolio) and
on securities indices, currencies and futures contracts other than futures on
individual corporate debt and individual equity securities. The Fund will not
sell put options if, as a result, more than 50% of the Fund's assets would be
required to be segregated to cover its potential obligations under such put
options other than those with respect to futures and options thereon. In selling
put options, there is a risk that the Fund may be required to buy the underlying
security at a disadvantageous price above the market price.
GENERAL CHARACTERISTICS OF FUTURES
The Fund may enter into financial futures contracts or purchase or sell
put and call options on such futures as a hedge against anticipated interest
rate, currency or equity market changes, for duration management and for risk
management purposes. Futures are generally bought and sold on the commodities
exchanges where they are listed with payment of initial and variation margin as
described below. The sale of a futures contract creates a firm obligation by the
Fund, as seller, to deliver to the buyer the specific type of financial
instrument called for in the contract at a specific future time for a specified
price (or, with respect to index futures and Eurodollar instruments, the net
cash amount). Options on futures contracts are similar to options on securities
except that an option on a futures contract gives the purchaser the right in
return for the premium paid to assume a position in a futures contract and
obligates the seller to deliver such option.
The Fund's use of financial futures and options thereon will in all cases
be consistent with applicable regulatory requirements and in particular the
rules and regulations of the Commodity Futures Trading Commission and will be
entered into only for a bona fide hedging, risk management (including duration
management) or other portfolio management purposes. Typically, maintaining a
futures contract or selling an option thereon requires the Fund to deposit with
a financial intermediary as security for its obligations an amount of cash or
other specified assets ("initial margin") which initially is typically 1% to 10%
of the face amount of the contract (but may be higher in some circumstances).
Additional cash or assets ("variation margin") may be required to be deposited
thereafter on a daily basis as the mark to market value of the contract
fluctuates. The purchase of an option on financial futures involves payment of a
premium for the option without any further obligation on the part of the Fund.
If the Fund exercises an option on a futures contract, it will be obligated to
post initial margin (and potential subsequent variation margin) for the
resulting futures positions just as it would for any position. Futures contracts
and options thereon are generally settled by entering into an offsetting
transaction, but there can be no assurance that the position can be offset prior
to settlement at an advantageous price nor that delivery will occur.
The Fund will not enter into a futures contract or related option (except
for closing transactions) if, immediately thereafter, the sum of the amount of
its initial margin and premiums on open futures contracts and options thereon
would exceed 5% of the Fund's total assets (taken at current value); however, in
the case of an option that is in-the-money at the time of the purchase, the
in-the-money amount may be excluded in calculating the 5% limitation. The
segregation requirements with respect to futures contracts and options thereon
are described below.
OPTIONS ON SECURITIES INDICES AND OTHER FINANCIAL INDICES
The Fund may also purchase and sell call and put options on securities
indices and other financial indices and in so doing can achieve many of the same
objectives it would achieve through the sale or purchase of options on
individual securities or other instruments. Options on securities indices and
other financial indices are similar to options on a security or other instrument
except that, rather than settling by physical delivery of the underlying
instrument, they settle by cash settlement, i.e., an option on an index gives
the holder the right to receive, upon exercise of the option, an amount of cash
if the closing level of the index upon which the option is based exceeds, in the
case of a call, or is less than, in the case of a put, the exercise price of the
option (except if, in the case of an OTC option, physical delivery is
specified). This amount of cash is equal to the excess of the closing price of
the index over the exercise price of the option, which also may be multiplied by
a formula value. The seller of the option is obligated, in return for the
premium received, to make delivery of this amount. The gain or loss on an index
depends on price movements in the instruments making up the market, market
segment, industry or other composite on which the underlying index is based,
rather than price movements in individual securities, as is the case with
respect to options on securities.
CURRENCY TRANSACTIONS
The Fund may engage in currency transactions with Counterparties in order
to hedge the value of portfolio holdings denominated in particular currencies
against fluctuations in relative value between those currencies and the U.S.
dollar. Currency transactions include forward currency contracts,
exchange-listed currency futures, exchange-listed and OTC options on currencies,
and currency swaps. A forward currency contract involves a privately negotiated
obligation to purchase or sell (with delivery generally required) a specific
currency at a future date, which may be any fixed number of days from the date
of the contract agreed upon by the parties, at a price set at the time of the
contract. A currency swap is an agreement to exchange cash flows on a notional
amount of two or more currencies based on the relative value differential among
them.
The Fund will usually enter into swaps on a net basis, i.e., the two
payment streams are netted out in a cash settlement on the payment date or dates
specified in the instrument, with the Fund receiving or paying, as the case may
be, only the net amount of the two payments. Inasmuch as these swaps are entered
into for good faith hedging purposes, the Adviser and the Fund believe such
obligations do not constitute senior securities under the Investment Company Act
of 1940, as amended ("1940 Act"), and, accordingly, will not treat them as being
subject to its borrowing restrictions. The Fund may enter into currency
transactions with Counterparties which have received (or the guarantors of the
obligations of such Counterparties have received) a credit rating of A-l or P-l
by S&P or Moody's, respectively, or that have an equivalent rating from an NRSRO
or (except for OTC currency options) are determined to be of equivalent credit
quality by the Adviser. If there is a default by the Counterparty, the Fund may
have contractual remedies pursuant to the agreements related to the transaction.
The swap market has grown substantially in recent years with a large number of
banks and investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. As a result, the swap market has
become relatively liquid.
The Fund's dealings in forward currency contracts and other currency
transactions such as futures, options, options on futures and swaps will be
limited to either specific transactions or portfolio positions. Transaction
hedging is entering into a currency transaction with respect to specific assets
or liabilities of the Fund, which will generally arise in connection with the
purchase or sale of its portfolio securities or the receipt of income therefrom.
Position hedging is entering into a currency transaction with respect to
portfolio security positions denominated or generally quoted in that currency.
The Fund will not enter into a transaction to hedge currency exposure to
an extent greater, after netting all transactions intended to wholly or
partially offset other transactions, than the aggregate market value (at the
time of entering into the transaction) of the securities held in its portfolio
that are denominated or generally quoted in or whose value is based upon such
foreign currency or currently convertible into such currency other than with
respect to proxy hedging as described below.
The Fund may also cross-hedge currencies by entering into transactions to
purchase or sell one or more currencies that are expected to decline in value
relative to other currencies to which the Fund has or in which the Fund expects
to have portfolio exposure.
To reduce the effect of currency fluctuations on the value of existing or
anticipated holdings of portfolio securities, the Fund may also engage in proxy
hedging. Proxy hedging is often used when the currency to which the Fund's
portfolio is exposed is difficult to hedge or to hedge against the U.S. dollar.
Proxy hedging entails entering into a forward contract to sell a currency whose
changes in value are generally considered to be linked to a currency or
currencies in which some or all of the Fund's portfolio securities are or are
expected to be denominated, and to buy U.S. dollars. The amount of the contract
would not exceed the value of the Fund's securities denominated in linked
currencies. For example, if the Adviser considers the Austrian schilling to be
linked to the German deutsche mark (the "D-mark"), the Fund holds securities
denominated in schillings and the Adviser believes that the value of schillings
will decline against the U.S. dollar, the Adviser may enter into a contract to
sell D-marks and buy dollars. Currency hedging involves some of the same risks
and considerations as other transactions with similar instruments. Currency
transactions can result in losses to the Fund if the currency being hedged
fluctuates in value to a degree or in a direction that is not anticipated.
Further, there is the risk that the perceived linkage between various currencies
may not be present during the particular time that the Fund is engaging in proxy
hedging. If the Fund enters into a currency hedging transaction, the Fund will
comply with the asset segregation requirements described below.
RISKS OF CURRENCY TRANSACTIONS
Currency transactions are subject to risks different from those of other
portfolio transactions. Because currency control is of great importance to the
issuing governments and influences economic planning and policy, purchases and
sales of currency and related instruments can be negatively affected by
government exchange controls, blockages, and manipulations or exchange
restrictions imposed by governments. These can result in losses to the Fund if
it is unable to deliver or receive currency or funds in settlement of
obligations and could also cause hedges it has entered into to be rendered
useless, resulting in full currency exposure as well as incurring transaction
costs. Buyers and sellers of currency futures are subject to the same risks that
apply to the use of futures generally. Further, settlement of a currency futures
contract for the purchase of most currencies must occur at a bank based in the
issuing nation. Trading options on currency futures is relatively new, and the
ability to establish and close out positions on such options is subject to the
maintenance of a liquid market which may not always be available. Currency
exchange rates may fluctuate based on factors extrinsic to that country's
economy.
COMBINED TRANSACTIONS
The Fund may enter into multiple transactions, including multiple options
transactions, multiple futures transactions, multiple currency transactions
(including forward currency contracts) and any combination of futures, options
and currency transactions ("component transactions"), instead of a single
Hedging Transaction, as part of a single or combined strategy when, in the
opinion of the Adviser, it is in the best interests of the Fund to do so. A
combined transaction will usually contain elements of risk that are present in
each of its component transactions. Although combined transactions are normally
entered into based on the Adviser's judgment that the combined strategies will
reduce risk or otherwise more effectively achieve the desired portfolio
management goal, it is possible that the combination will instead increase such
risks or hinder achievement of the portfolio management objective.
RISKS OF HEDGING TRANSACTIONS OUTSIDE THE UNITED STATES
When conducted outside the United States, Hedging Transactions may not be
regulated as rigorously as in the United States, may not involve a clearing
mechanism and related guarantees, and are subject to the risk of governmental
actions affecting trading in, or the prices of, foreign securities, currencies
and other instruments. The value of such positions also could be adversely
affected by: (i) other complex foreign political, legal and economic factors,
(ii) lesser availability than in the United States of data on which to make
trading decisions, (iii) delays in the Fund's ability to act upon economic
events occurring in foreign markets during nonbusiness hours in the United
States, (iv) the imposition of different exercise and settlement terms and
procedures and margin requirements than in the United States, and (v) lower
trading volume and liquidity.
USE OF SEGREGATED AND OTHER SPECIAL ACCOUNTS
Many Hedging Transactions, in addition to other requirements, require that
the Fund segregate liquid high grade assets with its custodian bank to the
extent Fund obligations are not otherwise "covered" through ownership of the
underlying security, financial instrument or currency. In general, either the
full amount of any obligation by the Fund to pay or deliver securities or assets
must be covered at all times by the securities, instruments or currency required
to be delivered, or, subject to any regulatory restrictions, an amount of cash
or liquid high grade securities at least equal to the current amount of the
obligation must be segregated with the custodian bank. The segregated assets
cannot be sold or transferred unless equivalent assets are substituted in their
place or it is no longer necessary to segregate them. For example, a call option
written by the Fund will require the Fund to hold the securities subject to the
call (or securities convertible into the needed securities without additional
consideration) or to segregate liquid high grade securities sufficient to
purchase and deliver the securities if the call is exercised. A call option sold
by the Fund on an index will require the Fund to own portfolio securities which
correlate with the index or to segregate liquid high grade assets equal to the
excess of the index value over the exercise price on a current basis. A put
option written by the Fund requires the Fund to segregate liquid high grade
assets equal to the exercise price.
A currency contract which obligates the Fund to buy or sell currency will
generally require the Fund to hold an amount of the currency or liquid
securities denominated in that currency equal to the Fund's obligations or to
segregate liquid high grade assets equal to the amount of the Fund's obligation.
However, the segregation requirement does not apply to currency contracts which
are entered in order to "lock in" the purchase or sale price of a trade in a
security denominated in a foreign currency pending settlement within the time
customary for such securities.
OTC options entered into by the Fund, including those on securities,
currency, financial instruments or indices and OCC-issued and exchange-listed
index options will generally provide for cash settlement. As a result, when the
Fund sells these instruments it will only segregate an amount of assets equal to
its accrued net obligations, as there is no requirement for payment or delivery
of amounts in excess of the net amount. These amounts will equal 100% of the
exercise price in the case of a noncash settled put, the same as an OCC
guaranteed listed option sold by the Fund, or the in-the-money amount plus any
sell-back formula amount in the case of a cash-settled put or call. In addition,
when the Fund sells a call option on an index at a time when the in-the-money
amount exceeds the exercise price, the Fund will segregate, until the option
expires or is closed out, cash or cash equivalents equal in value to such
excess. OCC-issued and exchange-listed options sold by the Fund other than those
above generally settle with physical delivery, or with an election of either
physical delivery or cash settlement and the Fund will segregate an amount of
assets equal to the full value of the option. OTC options settling with physical
delivery, or with an election of either physical delivery or cash settlement,
will be treated the same as other options settling with physical delivery.
In the case of a futures contract or an option thereon, the Fund must
deposit initial margin and possible daily variation margin in addition to
segregating assets sufficient to meet its obligation to purchase or provide
securities or currencies, or to pay the amount owed at the expiration of an
index-based futures contract. Such assets may consist of cash, cash equivalents,
liquid debt or equity securities or other acceptable assets.
Hedging Transactions may be covered by other means when consistent with
applicable regulatory policies. The Fund may also enter into offsetting
transactions so that its combined position, coupled with any segregated assets,
equals its net outstanding obligation in related options and Hedging
Transactions. For example, the Fund could purchase a put option if the strike
price of that option is the same or higher than the strike price of a put option
sold by the Fund. Moreover, instead of segregating assets if the Fund held a
futures or forward contract, it could purchase a put option on the same futures
or forward contract with a strike price as high or higher than the price of the
contract held. Other Hedging Transactions may also be offset in combinations. If
the offsetting transaction terminates at the time of or after the primary
transaction, no segregation is required, but if it terminates prior to such
time, assets equal to any remaining obligation would need to be segregated.
DEPOSITARY RECEIPTS
Each series of the Fund may invest in securities commonly known as
American Depositary Receipts ("ADRs"), and in European Depositary Receipts
("EDRs") or other securities representing interests in securities of foreign
issuers. ADRs are certificates issued by a United States bank or trust company
and represent the right to receive securities of a foreign issuer deposited in a
domestic bank or foreign branch of a United States bank and traded on a United
States exchange or in an over-the-counter market. EDRs are receipts issued in
Europe generally by a non-U.S. bank or trust company that evidence ownership of
non-U.S. or domestic securities. Generally, ADRs are in registered form and EDRs
are in bearer form. There are no fees imposed on the purchase or sale of ADRs or
EDRs although the issuing bank or trust company may impose charges for the
collection of dividends and the conversion of ADRs and EDRs into the underlying
securities. Investment in ADRs has certain advantages over direct investment in
the underlying non-U.S. securities, since: (i) ADRs are U.S. dollar denominated
investments which are easily transferable and for which market quotations are
readily available and (ii) issuers whose securities are represented by ADRs are
subject to the same auditing, accounting and financial reporting standards as
domestic issuers. EDRs are not necessarily denominated in the currency of the
underlying security.
MEDIUM AND LOWER RATED CORPORATE DEBT SECURITIES
Each series may invest in securities that are rated in the medium to
lowest rating categories by S&P and Moody's, some of which may be so-called
"junk bonds." The series have historically invested in securities of distressed
issuers when the intrinsic values of such securities have, in the opinion of the
Adviser, warranted such investment. Corporate debt securities rated Baa are
regarded by Moody's as being neither highly protected nor poorly secured.
Interest payments and principal security appears adequate to Moody's for the
present, but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such securities are
regarded by Moody's as lacking outstanding investment characteristics and having
speculative characteristics. Corporate debt securities rated BBB are regarded by
S&P as having adequate capacity to pay interest and repay principal. Such
securities are regarded by S&P as normally exhibiting adequate protection
parameters, although adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for securities in this rating category than in higher rated categories.
Corporate debt securities which are rated B are regarded by Moody's as
generally lacking characteristics of the desirable investment. In Moody's view,
assurance of interest and principal payments or of maintenance of other terms of
the security over any long period of time may be small. Corporate debt
securities rated BB, B, CCC, CC and C are regarded by S&P on balance as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. In S&P's view,
although such securities likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions. BB and B are regarded by S&P as indicating the
two lowest degrees of speculation in this group of ratings. Securities rated D
by S&P or C by Moody's are in default and are not currently performing. The Fund
will rely on the Adviser's judgment, analysis and experience in evaluating such
debt securities. In this evaluation, the Adviser will take into consideration,
among other things, the issuer's financial resources, its sensitivity to
economic conditions and trends, its operating history, the quality of the
issuer's management and regulatory matters as well as the price of the security.
The Adviser may also consider, although it does not rely primarily on, the
credit ratings of Moody's and S&P in evaluating lower rated corporate debt
securities. Such ratings evaluate only the safety of principal and interest
payments, not market value risk. Additionally, because the creditworthiness of
an issuer may change more rapidly than is able to be timely reflected in changes
in credit ratings, the Adviser monitors the issuers of corporate debt securities
held in the Fund's portfolio. The credit rating assigned to a security is a
factor considered by the Adviser in selecting a security for a series, but the
intrinsic value in light of market conditions and the Adviser's analysis of the
fundamental values underlying the issuer are of at least equal significance.
Because of the nature of medium and lower rated corporate debt securities,
achievement by each series of its investment objective when investing in such
securities is dependent on the credit analysis of the Adviser. If the series
purchased primarily higher rated debt securities, such risks would be
substantially reduced.
A general economic downturn or a significant increase in interest rates
could severely disrupt the market for medium and lower grade corporate debt
securities and adversely affect the market value of such securities. Securities
in default are relatively unaffected by such events or by changes in prevailing
interest rates. In addition, in such circumstances, the ability of issuers of
medium and lower grade corporate debt securities to repay principal and to pay
interest, to meet projected business goals and to obtain additional financing
may be adversely affected. Such consequences could lead to an increased
incidence of default for such securities and adversely affect the value of the
corporate debt securities in the Fund's portfolio. The secondary market prices
of medium and lower grade corporate debt securities are less sensitive to
changes in interest rates than are higher rated debt securities, but are more
sensitive to adverse economic changes or individual corporate developments.
Adverse publicity and investor perceptions, whether or not based on rational
analysis, may also affect the value and liquidity of medium and lower grade
corporate debt securities, although such factors also present investment
opportunities when prices fall below intrinsic values. Yields on debt securities
in a series' portfolio that are interest rate sensitive can be expected to
fluctuate over time. In addition, periods of economic uncertainty and changes in
interest rates can be expected to result in increased volatility of market price
of any medium to lower grade corporate debt securities in the series' portfolios
and thus could have an effect on the net asset value of the series if other
types of securities did not show offsetting changes in values. The secondary
market value of corporate debt securities structured as zero coupon securities
or payment in kind securities may be more volatile in response to changes in
interest rates than debt securities which pay interest periodically in cash.
Because such securities do not pay current interest, but rather, income is
accreted, to the extent that a series does not have available cash to meet
distribution requirements with respect to such income, it could be required to
dispose of portfolio securities that it otherwise would not. Such disposition
could be at a disadvantageous price. Failure to satisfy distribution
requirements could result in the series failing to qualify as a pass- through
entity under the Internal Revenue Code. Investment in such securities also
involves certain other tax considerations.
The Adviser values the series' investments pursuant to guidelines adopted
and periodically reviewed by the Board of Directors of the Fund (the "Board").
See "Determination of Net Asset Value" in the Prospectus. To the extent that
there is no established retail market for some of the medium or low grade
corporate debt securities in which the series may invest, there may be thin or
no trading in such securities and the ability of the Adviser to accurately value
such securities may be adversely affected. Further, it may be more difficult for
a series to sell such securities in a timely manner and at their stated value
than would be the case for securities for which an established retail market did
exist. The effects of adverse publicity and investor perceptions may be more
pronounced for securities for which no established retail market exists as
compared with the effects on securities for which such a market does exist.
During periods of reduced market liquidity and in the absence of readily
available market quotations for medium and lower grade corporate debt securities
held in the Fund's portfolio, the responsibility of the Adviser to value the
Fund's securities becomes more difficult and the Adviser's judgment may play a
greater role in the valuation of the Fund's securities due to a reduced
availability of reliable objective data. To the extent that the Fund purchases
illiquid corporate debt securities or securities which are restricted as to
resale, the Fund may incur additional risks and costs. Illiquid and restricted
securities may be particularly difficult to value and their disposition may
require greater effort and expense than more liquid securities. Further, a
series may be required to incur costs in connection with the registration of
restricted securities in order to dispose of such securities, although under
Rule 144A under the Securities Act of 1933 certain securities may be determined
to be liquid pursuant to procedures adopted by the Board under applicable
guidelines.
SHORT SALES
Each series may make short sales of securities. A short sale is a
transaction in which the series sells a security it does not own in anticipation
that the market price of that security will decline. Each series expects to make
short sales as a form of hedging to offset potential declines in long positions
in similar securities, in order to maintain portfolio flexibility and for
profit.
When a series makes a short sale, it must borrow the security sold short
and deliver it to the broker-dealer through which it made the short sale as
collateral for its obligation to deliver the security upon conclusion of the
sale. The series may have to pay a fee to borrow particular securities and is
often obligated to pay over any payments received on such borrowed securities.
The series' obligation to replace the borrowed security will be secured by
collateral deposited with the broker-dealer, usually cash, U.S. government
securities or other high grade liquid securities similar to those borrowed. The
series will also be required to deposit similar collateral with its custodian to
the extent, if any, necessary so that the value of both collateral deposits in
the aggregate is at all times equal to at least 100% of the current market value
of the security sold short.
If the price of the security sold short increases between the time of the
short sale and the time the series replaces the borrowed security, the series
will incur a loss; conversely, if the price declines, the series will realize a
gain. Any gain will be decreased, and any loss increased, by the transaction
costs described above. Although the series' gain is limited to the price at
which it sold the security short, its potential loss is theoretically unlimited.
The series will not make a short sale if, after giving effect to such
sale, the market value of all securities sold short exceeds 5% of the value of
its total assets or the series' aggregate short sales of a particular class of
securities exceeds 25% of the outstanding securities of that class. The series
may also make short sales "against the box" without respect to such limitations.
In this type of short sale, at the time of the sale, the series owns or has the
immediate and unconditional right to acquire at no additional cost the identical
security.
RESTRICTIONS AND LIMITATIONS
MUTUAL SHARES, QUALIFIED, BEACON, DISCOVERY AND EUROPEAN FUNDAMENTAL
POLICIES
Each of Mutual Shares, Qualified, Beacon, Discovery and European has
adopted the following fundamental investment restrictions which may not be
changed without the affirmative vote of the holders of a majority of the
outstanding voting securities of such series, which means the lesser of (1) the
holders of more than 50% of the outstanding shares of voting stock of such
securities or (2) 67% of the shares if more than 50% of the shares are present
at a meeting of shareholders in person or by proxy. Unless otherwise noted, all
percentage restrictions are as of the time of investment after giving effect to
the transaction. Pursuant to such restrictions each series may not:
1. Purchase or sell commodities, commodity contracts (except in conformity
with regulations of the Commodities Futures Trading Commission such that the
series would not be considered a commodity pool), or oil and gas interests or
real estate. Securities or other instruments backed by commodities are not
considered commodities or commodity contracts for purposes of this restriction.
Debt or equity securities issued by companies engaged in the oil, gas, or real
estate businesses are not considered oil or gas interests or real estate for
purposes of this restriction. First mortgage loans and other direct obligations
secured by real estate are not considered real estate for purposes of this
restriction.
2. Make loans, except to the extent the purchase of debt obligations of
any type are considered loans and except that the series may lend portfolio
securities to qualified institutional investors in compliance with requirements
established from time to time by the Securities and Exchange Commission and the
securities exchanges on which such securities are traded.
3. Issue securities senior to its stock or borrow money or utilize
leverage in excess of the maximum permitted by the Investment Company Act of
1940 which is currently 33 1/3% of total assets (plus 5% for emergency or other
short-term purposes) from banks on a temporary basis from time to time to
provide greater liquidity for redemptions or for special circumstances.
4. Invest more than 25% of the value of its assets in a
particular industry (except that U.S. government securities are not
considered an industry).
5. Act as an underwriter except to the extent the series may be deemed to
be an underwriter when disposing of securities it owns or when selling its own
shares.
6. Purchase the securities of any one issuer, other than the U.S.
government or any of its agencies or instrumentalities, if immediately after
such purchase more than 5% of the value of its total assets would be invested in
such issuer, or such series would own more than 10% of the outstanding voting
securities of such issuer, except that up to 25% of the value of such series'
total assets may be invested without regard to such 5% and 10% limitations.
7. Except as may be described in the prospectus, engage in short sales,
purchase securities on margin or maintain a net short position. If a percentage
restriction is met at the time of investment, a later increase or decrease in
the percentage due to a change in the value of portfolio securities or the
amount of assets will not be considered a violation of any of the foregoing
restrictions.
NON FUNDAMENTAL POLICIES, ALL SERIES
As a matter of policy that is not fundamental, the Fund has determined
that no series will invest more than 5% of its assets in warrants, and that no
more than 2% of such assets may be invested in warrants which are not listed on
the New York or American Stock Exchanges. Also, as a matter of policy, the
series will not purchase securities for purposes of short term trading and will
not invest more than 5% of their assets in securities of issuers (together with
any predecessors) in existence for less than three years, provided that the
aggregate percentage of assets invested in such issuers, combined with illiquid
investments, does not exceed 15%. The series will not purchase the securities of
any issuer of which any officer or director of the Fund owns more than 1/2 of 1%
of the outstanding securities or in which the officers and directors in the
aggregate own more than 5%. The series do not borrow for leveraging purposes.
The Fund has registered some or all of the shares intended to be sold
pursuant to the Class Z Prospectus and this Statement of Additional Information
under the securities laws of all states. Some states, as conditions of
registration, among other things, require that the Fund limit its investments in
or abstain from investing in certain kinds or classes of securities.
In order to permit the sale of shares in certain states, the Fund may make
commitments more restrictive than the operating restrictions described above.
Should the Fund determine that any such commitment is no longer in the best
interests of a particular series and its shareholders, the Fund will revoke the
commitment by terminating sales of such series' shares in the state involved.
MANAGEMENT OF THE FUND
The executive officers and directors of the Fund, their positions with the
Fund and their principal occupations during the past five years are shown below.
Members of the Board who are considered "interested persons" of the Fund under
the 1940 Act are indicated by an asterisk (*).
POSITION(S) HELD
NAME, AGE AND ADDRESS WITH REGISTRANT PRINCIPAL
OCCUPATION(S) DURING PAST 5 YEARS
- ------------------------------------------------------------------------
Edward I. Altman, Ph.D. (55)
New York University
44 West 4th Street
New York, NY 10012
Director
Max L. Heine Professor of Financing and Vice Director of NYU Salomon Center,
Stern School of Business, New York University, editor and author of numerous
financial publications; financial consultant.
Ann Torre Grant (38)
8065 Leesburg Pike
Suite 400
Vienna, VA 22182
Director
Executive Vice President and Chief Financial Officer, NHP Incorporated (owner
and manager of multifamily housing); prior to March 1995, she was Vice President
and Treasurer, U.S. Air, Inc.
Andrew H. Hines, Jr. (74)
150 2nd Avenue N.
St. Petersburg, FL 33701
Director
Consultant for the Triangle Consulting Group; Chairman of the Board and Chief
Executive Officer of Florida Progress Corporation (1982-February, 1990) and
Chairman and Director of Precise Power Corporation; Executive-in-Residence of
Eckerd College (1991-present); and a Director of Checkers Drive-In Restaurants,
Inc.
Peter A. Langerman* (41)
51 John F. Kennedy Pkwy.
Short Hills, NJ 07078
Director and Executive Vice President
Financial Analyst with Franklin Mutual Advisers, Inc.; held the same position
with Heine Securities Corporation, 6/86 to 10/96; Director of Sunbeam Oster
since 1990, Lancer Industries since 1994; Manager (Director) of MB Motori,
L.L.C. since 1994 and
MWCR, L.L.C. since 1995.
William J. Lippman* (71)
One Parker Plaza
Fort Lee, NJ 07024
Director
Senior Vice President, Franklin Resources, Inc., and Franklin Management, Inc.;
President and Director, Franklin Advisory Services, Inc.; and officer and/or
director or trustee of seven of the investment companies in the Franklin
Templeton Group of Funds.
Bruce A. MacPherson (66)
1 Pequot Way
Canton, MA 02021
Director
President of A.A. MacPherson, Inc. Boston, MA (representative for
electrical manufacturers).
Fred R. Millsaps (67)
2665 NE 37th Drive
Fort Lauderdale, FL 33394
Director
Manager of Personal Investments (1978-present); Chairman and Chief Executive
Officer of Landmark Banking Corporation (1969-1978); Financial Vice President of
Florida Power and Light (1965-1969); Vice President of The Federal Reserve Bank
of Atlanta (1958-1965); and a director of various other business and nonprofit
organizations.
Michael F. Price* (45)
51 John F. Kennedy Pkwy.
Short Hills, NJ 07078
Chairman of the Board and President
President, Chief Executive Officer, and Director of Franklin Mutual Advisers,
Inc.; held the same positions with Heine Securities Corporation, 1/87 to 10/96;
Principal Executive Officer and majority owner of Compliance Solutions, Inc.
("Compliance Solutions") (a developer of compliance monitoring software for
money managers); Director and owner of Clearwater Securities, Inc.
("Clearwater") (a registered securities dealer).
Leonard Rubin (71)
2 Executive Drive
Suite 560
Fort Lee, New Jersey 07024
Director
Partner in LDR Equities, LLC (manages various personal investments);
Vice President, Trimtex Co. Inc. (manufactures and markets specialty
fabrics); and trustee of four of the investment companies in the
Franklin Templeton Group of Funds.
Barry F. Schwartz (47)
35 East 62nd Street
New York, NY 10021
Director
Executive Vice President and General Counsel, MacAndrews &
Forbes Holdings, Inc. (a diversified holding company).
Vaughn R. Sturtevant, M.D. (73)
6 Noyes Avenue
Waterville, ME 04901
Director
Practicing physician.
Robert E. Wade (50)
225 Hardwick Street
Belvidere, NJ 07823
Director
Practicing attorney.
Jeffrey A. Altman (30)
51 John F. Kennedy Pkwy.
Short Hills, NJ 07078
Vice President
Analyst and Trader with Franklin Mutual Advisers, Inc.; was employed by
Heine Securities Corporation, 8/88 to 10/96; Manager (Director) MB
Metropolis, L.L.C. since 1994; Manager (Director) of MB Motori, L.L.C.,
MWCR, L.L.C. and S.H. Mortgage Acquisition L.L.C. Since 1995; Trustee
of Resurgence Properties Inc.; and Chairman of the Board of Trustees,
Value Property Trust.
James R. Baio (42)
500 East Broward Blvd.
Fort Lauderdale, Florida
Treasurer
Certified public accountant; Treasurer of the Templeton Funds; Senior Vice
President of Templeton Worldwide, Inc., Templeton Global Investors, Inc., and
Templeton Funds Trust Company.
Elizabeth N. Cohernour (46)
51 John F. Kennedy Pkwy.
Short Hills, NJ 07078
General Counsel and Secretary
Vice President and Assistant Secretary of Franklin Mutual Advisers, Inc.;
formerly Secretary and General Counsel of Heine Securities Corporation, 5/88 to
10/96; Secretary and General Counsel of Compliance Solutions and Clearwater.
Robert L. Friedman (37)
51 John F. Kennedy Pkwy.
Short Hills, NJ 07078
Vice President
Research Analyst with Franklin Mutual Advisers, Inc.; was employed by Heine
Securities Corporation, 8/88 to 10/96.
Raymond Garea (47)
51 John F. Kennedy Pkwy.
Short Hills, NJ 07078
Vice President
Research Analyst with Franklin Mutual Advisers, Inc.; was employed by Heine
Securities Corporation, 3/91 to 10/96; prior thereto, Vice President and Analyst
with Donaldson, Lufkin & Jenrette; Manager (Director) MB Metropolis, L.L.C. and
S.H. Mortgage Acquisition L.L.C.
Lawrence N. Sondike (39)
51 John F. Kennedy Pkwy.
Short Hills, NJ 07078
Vice President
Research Analyst with Franklin Mutual Advisers, Inc.; was employed by Heine
Securities Corporation 3/84 to 10/96.
The Fund's independent Board members have standing audit,
pension, nominating and director's compensation and performance
committees. The audit committee is composed of Ms. Grant and Messrs.
Altman and Wade. The pension committee is composed of Messrs. Altman,
Schwartz and Sturtevant. The nominating committee is responsible for
nominating candidates for independent Board member positions and is
composed of Messrs. MacPherson and Schwartz. The Board members'
compensation and performance committee is composed of Ms. Grant and
Messrs. Wade and Sturtevant.
As of January 30, 1997, the officers and Board members, as a group, owned
of record and beneficially the following shares of the Fund: 68,536 shares of
Mutual Shares - Class Z; 51,529 shares of Qualified - Class Z; 225,070 shares of
Beacon - Class Z; 390,105 shares of Discovery - Class Z, or less than 1% of the
total outstanding Class Z shares of that series. As of January 30, 1997, the
officers and board members, as a group, owned of record and beneficially
14,130,248 shares or 34% of the total outstanding Class Z shares of European.
Some of the Board members also own shares in other funds in the Franklin
Templeton Group of Funds (all U.S. registered investment companies in the
Franklin Group of Funds(R) and the Templeton Group of Funds).
As of January 30, 1997, the principal shareholder of the Fund, beneficial
or of record, was as follows:
NAME AND ADDRESS SHARE AMOUNT PERCENTAGE
EUROPEAN - CLASS Z
Michael F. Price
51 John F. Kennedy Pkwy
Short Hills, NJ 07078o 13,923,586 shares 33.29%
From time to time, the number of Fund shares held in the "street name"
accounts of various securities dealers for the benefit of their clients or in
centralized securities depositories may exceed 5% of the total shares
outstanding.
REMUNERATION OF OFFICERS AND DIRECTORS
During the fiscal year ended December 31, 1995, the Fund paid its officers
and directors as a group, including reimbursement to the investment adviser for
the expenses of personnel who spend a substantial portion of their time on Fund
operations, aggregate compensation of $839,366. Nonaffiliated Board members are
currently paid $15,000 per year plus $750 per meeting attended. Board members
are paid $500 plus out-of-pocket expenses for each Committee meeting attended.
In 1993, the Board members approved a retirement plan which generally provides
payments to directors who have served 10 years and retire at age 70. At the time
of retirement, Board members are entitled to annual payments equal to one-half
of the retainer in effect as of the time of retirement. As shown above, some of
the nonaffiliated Board members also serve as directors, trustees or managing
general partners of investment companies in the Franklin Templeton Group of
Funds. They may receive fees from these funds for their services. The following
table provides the total fees paid to nonaffiliated Board members by the Fund
and by other funds in the Franklin Templeton Group of Funds.
NUMBER OF
TOTAL FEE BOARDS IN
RECEIVED FROM THE FRANKLIN
TOTAL FEES PENSION ANNUAL THE FRANKLIN TEMPLETON GROUP OF
RECEIVED FROM RETIREMENT BENEFITS TEMPLETON GROUP FUNDS ON WHICH
NAME THE FUND+ ACCRUED RETIREMENT OF FUNDS++ EACH SERVES**
- ---------- ------------------ -------- ------------ ---------------
Edward I. Altman..$20,750 0 $7,500 0 1
Ann Torre Grant*..$20,750 0 $7,500 0 1
Bruce A.
MacPherson.... $18,750 0 $7,500 0 1
Barry F.
Schwartz*..... $18,750 0 $7,500 0 1
Vaughn R.
Sturtevant,
M.D. ..... $18,750 0 $7,500 0 1
Robert E. Wade*..$25,750 0 $7,500 0 1
Andrew H.
Hines, Jr. ..........0 0 0 $106,325 25
Fred R. Millsaps......0 0 0 $104,325 25
Leonard Rubin ........0 0 0 $ 15,600 4
+For fiscal year ended December 31, 1995.
++For the calendar year ended December 31, 1995.
*Not vested in retirement plan.
**We base the number of boards on the number of registered investment companies
in the Franklin Templeton Group of Funds. This number does not include the total
number of series or funds within each investment company for which the Board
members are responsible. The Franklin Templeton Group of Funds currently
includes 62 registered investment companies, with approximately 171 U.S. based
funds or series.
Nonaffiliated members of the Board are reimbursed for expenses incurred in
connection with attending board meetings, paid pro rata by each fund in the
Franklin Templeton Group of Funds for which they serve as director, trustee or
managing general partner. No officer or Board member received any other
compensation, including pension or retirement benefits, directly or indirectly
from the Fund or other funds in the Franklin Templeton Group of Funds. Certain
officers or Board members who are shareholders of Franklin Resources, Inc.
("Resources"), may be deemed to receive indirect remuneration by virtue of their
participation, if any, in the fees paid to its subsidiaries. Certain officers
and Board members of the Fund are also officers of Compliance Solutions. The
Fund is not charged for the use of software designed by Compliance Solutions.
INVESTMENT ADVISER
INVESTMENT MANAGER AND SERVICES PROVIDED. Franklin Mutual serves as the
Fund's investment manager. On October 31, 1996, pursuant to an agreement between
Resources and Heine Securities, Inc., ("Heine"), the assets of Heine were
transferred to Franklin Mutual (the "Transaction") and the Fund's name was
changed from Mutual Series Fund Inc. to Franklin Mutual Series Fund Inc.
The Adviser provides investment research and portfolio management
services, including the selection of securities for the Fund to buy, hold or
sell and the selection of brokers through whom the Fund's portfolio transactions
are executed. The Adviser's activities are subject to the review and supervision
of the Board to whom the Adviser renders periodic reports of the Fund's
investment activities. The Adviser is covered by fidelity insurance on its
officers, directors and employees for the protection of the Fund.
The Adviser and its affiliates act as investment manager to numerous other
investment companies and accounts. They may give advice and take action with
respect to any of the other funds they manage, or for their own account, that
may differ from action taken by them on behalf of the Fund. Similarly, with
respect to the Fund, they are not obligated to recommend, buy or sell, or to
refrain from recommending, buying or selling any security that they and access
persons, as defined by the 1940 Act, may buy or sell for their own account or
for the accounts of any other fund. They are not obligated to refrain from
investing in securities held by the Fund or other funds that they manage or
administer. Of course, any transactions for their accounts and other access
persons will be made in compliance with the Fund's Code of Ethics.
REDEMPTION OF SHARES
The Fund reserves the right to suspend the right of redemption and to
postpone the date of payment upon redemption for any period during which the New
York Stock Exchange is closed (other than weekend and holiday closings) or
trading on the New York Stock Exchange is restricted or during which (as
determined by the SEC by rule or regulation) an emergency exists as a result of
which disposal or evaluation of the Fund's portfolio securities is not
reasonably practicable, or for such other periods as the SEC by order permits.
REDEMPTIONS IN KIND. The Fund has committed itself to pay in cash (by
check) all requests for redemption by any shareholder of record, limited in
amount, however, during any 90-day period to the lesser of $250,000 or 1% of the
value of the Fund's net assets at the beginning of the 90-day period. This
commitment is irrevocable without the prior approval of the SEC. In the case of
redemption requests in excess of these amounts, the Board reserves the right to
make payments in whole or in part in securities or other assets of the Fund, in
case of an emergency, or if the payment of such a redemption in cash would be
detrimental to the existing shareholders of the Fund. In these circumstances,
the securities distributed would be valued at the price used to compute the
Fund's net assets and you may incur brokerage fees in converting the securities
to cash.
Net asset value per share will not be calculated on days the New York
Stock Exchange is not open, currently including the holidays of New Year's Day,
President's Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving and Christmas.
INVESTMENT ADVISORY AND ADMINISTRATION AGREEMENTS
MANAGEMENT FEES. The Adviser serves as investment adviser to each of the
series pursuant to separate investment advisory agreements. Under the
agreements, Mutual Shares, Qualified, Beacon, Discovery and European each pay
the Adviser a management fee equal to an annual rate of 0.60%, 0.60%, 0.60%,
0.80%, and 0.80%, respectively. The fee is computed at the close of business on
the last business day of each month. Each class pays its proportionate share of
the management fee.
MANAGEMENT AGREEMENT. The management agreement is in effect until June 30,
1998. It may continue in effect for successive annual periods if its continuance
is specifically approved at least annually by a vote of the Board or by a vote
of the holders of a majority of the Fund's outstanding voting securities, and in
either event by a majority vote of the Board members who are not parties to the
management agreement or interested persons of any such party (other than as
members of the Board), cast in person at a meeting called for that purpose. The
management agreement may be terminated without penalty at any time by the Board
or by a vote of the holders of a majority of the Fund's outstanding voting
securities, or by the Adviser on 60 days' written notice, and will automatically
terminate in the event of its assignment, as defined in the 1940 Act.
ADMINISTRATIVE SERVICES. FT Services provides certain administrative services
and facilities for the Fund. These include preparing and maintaining books,
records, and tax and financial reports, and monitoring compliance with
regulatory requirements. FT Services is a wholly owned subsidiary of Resources.
PRIOR SERVICES. Before November 1, 1996, Heine served as the investment manager
under separate investment management agreements substantially the same in terms
as the agreements currently in effect with Franklin Mutual. During the fiscal
year ended December 31, 1995, an aggregate of $1,392,294 of administrative
expenses was incurred by Mutual Shares, $720,315 by Qualified, $886,843 by
Beacon and $412,166 by Discovery. Heine's net fee for the fiscal years ended
December 31, 1995, 1994 and 1993, was $27,500,952, $21,795,512 and $19,507,048,
respectively for Mutual Shares; $14,607,723, $9,766,052 and $8,434,525,
respectively for Qualified; $17,720,127, $9,511,199 and $4,848,218, respectively
for Beacon; and $7,930,967, $5,737,128 and $2,294,912, respectively for
Discovery.
PORTFOLIO BROKERAGE
PLACEMENT OF PORTFOLIO BROKERAGE. As a general matter, purchases and sales
of portfolio securities of the Fund are placed by the Adviser with brokers and
dealers who in its opinion will provide the Fund with the best combination of
price (inclusive of brokerage commissions) and execution for its orders.
However, pursuant to the Fund's management agreement, consideration may be given
in the selection of broker-dealers for research provided and payment may be made
of a commission higher than that charged by another broker-dealer which does not
furnish research services or which furnishes research services deemed to be of
lesser value, so long as the criteria of Section 28(e) of the Securities
Exchange Act of 1934, as amended (the "1934 Act") are met. Section 28(e) of the
1934 Act was adopted in 1975 and specifies that a person with investment
discretion shall not be "deemed to have acted unlawfully or to have breached a
fiduciary duty" solely because such person has caused the account to pay a
higher commission than the lowest available under certain circumstances. To
obtain the benefit of Section 28(e), the person so exercising investment
discretion must make a good faith determination that the commissions paid are
"reasonable in relation to the value of the brokerage and research services
provided...viewed in terms of either that particular transaction or his overall
responsibilities with respect to the accounts as to which he exercises
investment discretion."
Currently, it is not possible to determine the extent to which commissions
that reflect an element of value for research services might exceed commissions
that would be payable for execution services alone, nor generally can the value
of research services to the Fund be measured, except to the extent such services
have a readily ascertainable market value. Research services furnished might be
useful and of value to the Adviser in serving other clients as well as the Fund,
but on the other hand any research service obtained by the Adviser from the
placement of portfolio brokerage of other clients might be useful and of value
to the Adviser in carrying out its obligation to the Fund.
As stated in the Prospectus, the Fund generally executes purchases and
sales of non-U.S. securities through market makers acting as principals or
through brokers on the exchanges or in markets in which they are principally
traded. Over-the-counter purchases and sales are normally made with principal
market makers except where, in the opinion of the Adviser, the best executions
are available elsewhere.
The Fund from time to time allocates brokerage commissions to firms which
furnish research and statistical information to the Adviser. The supplementary
research supplied by such firms is useful in varying degrees and is of
indeterminable value. Such research may, among other things, include advice
regarding economic factors and trends, advice as to occasional transactions in
specific securities, and similar information relating to securities.
If the Fund's officers are satisfied that the best execution is obtained,
consistent with internal policies, the sale of Fund shares, as well as shares of
other funds in the Franklin Templeton Group of Funds, may also be considered a
factor in the selection of broker-dealers to execute the Fund's portfolio
transactions.
A portion of the Fund's brokerage commissions are paid with respect to
agency over-the-counter securities transactions. The Fund effects
over-the-counter securities transactions on either a principal or agency basis.
Transactions effected on a principal basis generally include a mark-up but
no commission. In fiscal 1995 total brokerage commissions of $8,028,205,
$5,182,736, $6,269,829 and $3,040,751 were paid by Mutual Shares, Qualified,
Beacon and Discovery, respectively.
Clearwater, an indirect affiliate of the Adviser, is a registered
securities dealer and a member of the National Association of Securities Dealers
("NASD"). Transactions in some Fund portfolio securities (particularly
transactions involving floor brokers) were effected through Clearwater prior to
the Transaction. During 1995, Mutual Shares paid brokerage commissions to
Clearwater Securities of $1,192,230; Qualified paid $640,588; Beacon paid
$764,323 and Discovery paid $217,609. The transactions constituted for Mutual
Shares 13.2%; Qualified 14.1%; Beacon 14.5% and Discovery 7.7% of the aggregate
dollar amount of brokerage transactions effected during 1995. These commissions
constituted for Mutual Shares 14.9%, for Qualified 12.4%, for Beacon 12.2% and
for Discovery 7.2% of the total commissions paid in 1995.
"SOFT DOLLAR" ARRANGEMENTS. The Fund receives research services from
persons who act as brokers or dealers for the Fund. The discussion below relates
in general to these brokers or dealers who pursuant to various arrangements pay
for certain computer hardware and software and other research and brokerage
services to the Adviser and/or the Fund for transactions effected by it for the
Fund. Commission "soft dollars" may be used only for "brokerage and research
services" provided by brokers to whom commissions are paid and under no
circumstances will cash payments be made by any such broker to the Adviser. To
the extent that commission "soft dollars" do not result in the provision of any
"brokerage and research services" by brokers to whom such commissions are paid,
the commissions, nevertheless, are the property of such broker. Although,
potentially, the Adviser could be influenced to place Fund brokerage
transactions with a broker in order to generate "soft dollars" for the Adviser's
benefit, the Adviser believes that the requirement that it achieve best
execution on Fund portfolio transactions, and the Fund's negotiated commission
structure with brokers, mitigate these concerns as the cost of transactions
effected through brokers, before consideration of any "soft dollar" benefits
that may be received, generally will be comparable to that available elsewhere.
During fiscal 1995, 1994 and 1993, the Fund paid brokerage commissions of
$3,355,180, $2,267,683 and $1,640,278, respectively, to brokers who provided
research services. This amount represented 14.90%, 19.45% and 17.75%,
respectively, of total commissions paid for the periods.
TAXES
The Fund intends that each of its series will meet the requirements for
qualification as a regulated investment company ("RIC") under the Internal
Revenue Code of 1986, as amended (the "Code"). Because each series intends to
qualify and to distribute all of its net investment income and capital gain to
shareholders, it is expected that each series will not be required to pay
Federal income taxes.
A series normally will distribute substantially all of its net investment
income and net realized capital gain, if any, to shareholders in the form of
dividends to be paid from time to time as determined by the Board. Such
dividends are taxable whether paid in cash or additional shares of such series.
The Board presently intends to declare such dividends and distributions from
earnings semi-annually.
In the event that total distributions (including distributed or designated
net capital gain) for a taxable year exceed its investment company taxable
income and net capital gain, a portion of each distribution generally will be
treated as a return of capital. Distributions treated as a return of capital
reduce a shareholder's basis in its shares and could result in a capital gain
tax either when a distribution is in excess of basis or, more likely, when a
shareholder redeems its shares.
Shareholders of a series will be notified annually by the Fund as to the
Federal tax treatment of dividends and distributions paid during the calendar
year. Dividends and distributions may also be subject to state and local taxes.
State and local tax treatment may vary according to applicable laws.
Shareholders can elect to receive distributions in cash or in additional shares
of such series. The price of the additional shares is determined as of the date
for the dividend payment. (See "Shareholder Services - Reinvestment of
Distributions," in the Prospectus.)
To maintain qualification as a RIC under the Code, each series of the Fund
must limit gains from the sale or other disposition of its portfolio securities
(including options, futures and forward contracts) held for less than three
months to less than 30% of its annual gross income. Generally, gains on foreign
currencies (and gains on options, futures, or forward contracts with respect to
foreign currencies) are not subject to this 30% short- short rule if directly
related to regular investments by a series in equity or debt securities.
Each series intends to declare and pay dividends and capital gain
distributions so as to avoid imposition of a 4% federal excise tax. To do so,
each series expects to distribute during the calendar year an amount at least
equal to (i) 98% of its calendar year net investment income, (ii) 98% of its
realized capital gain (the excess of short and long-term capital gain over short
and long-term capital loss) for each one-year period ending October 31, and
(iii) 100% of any undistributed net investment income or realized capital gain
from the prior calendar year which has not been distributed by such series.
Dividends declared in October, November, or December and made payable to
shareholders of record in such a month would be deemed paid by the Series and
taxable to its shareholders on December 31 of such year provided that such
dividends are actually paid during January of the following year. A series may
make a deemed distribution with respect to its net capital gain by paying the
tax with respect to the net capital gain and then designating, but not
distributing, all or a portion of such gain as a capital gain dividend. Such
series' shareholders will treat such designated amounts as a capital gain on
their income tax returns, but they will receive a credit or refund equal to
federal income taxes paid by such series with respect to such capital gain. In
addition, shareholders will increase their basis in the series' shares by 65% of
the amount subject to tax. If a capital gain dividend is paid with respect to
any shares of a series which are sold at a loss after being held for less than
six months, any loss realized upon the sale of such shares will be treated as a
long-term capital loss to the extent of such capital gain dividend. There are
special rules for determining holding periods for the purpose of the preceding
sentence.
Dividends distributed by a series will only be eligible for the
dividends-received deduction available to corporate shareholders to the extent
of the portion of a series' gross income which consists of dividends received on
equity securities issued by domestic corporations with respect to which such
series meets the same holding period, risk of loss, and borrowing limitations
applicable to the series' shareholders. Section 246 of the Code permits the
dividends-received deduction to corporate shareholders only if the shares with
respect to which the dividends were paid have been held for more than 45 days.
If the holding period is not satisfied, the dividends-received deduction is
disallowed, regardless of whether the shares with respect to which the dividends
were paid have been sold or otherwise disposed of. The holding period
requirements are separately applicable to each block of shares acquired,
including each block of shares received in payment of the Fund's dividends. For
purposes of determining whether this holding period requirement has been met,
the day of acquisition and any day after the first 45 days after the date on
which such shares become ex-dividend must be disregarded. In addition, the
holding period is suspended during periods in which the stock is subject to
diminished risk of loss including, for example, because the holder has acquired
a put option or sold a call option (other than certain covered call options
where the exercise price is not substantially below the selling price) or
otherwise hedged his position.
The dividends-received deduction will also be reduced, for shareholders
who incur indebtedness in order to purchase shares of a series of the Fund, by
the percentage of the cost of such series' shares that is debt-financed.
Generally, this limitation applies only if the debt is directly attributable to
the purchase of shares. Whether debt is directly attributable to the purchase of
shares depends on the particular facts and circumstances of each situation and
accordingly shareholders are urged to consult their tax advisors.
Under section 1059 of the Code, a corporation which receives an
"extraordinary dividend" and disposes of the stock with respect to which such
dividend was paid, provided generally that such stock has not been held for at
least two years prior to the date of declaration, announcement or agreement
about the extraordinary dividend, is required to reduce its basis in such stock
(but not below zero) by the amount of the dividend which was not taxed because
of the dividends-received deduction with such basis reduction generally being
treated as having occurred immediately before the sale or disposition of such
stock. To the extent such untaxed amount exceeds the shareholder's basis, such
excess will be taxed as gain upon a sale or disposition of such stock. An
extraordinary dividend generally is any dividend that equals or exceeds 10% of
the shareholder's basis in the stock (5% in the case of preferred stock). For
this purpose, generally, all dividends within any 85-day period, and if such
dividends total more than 20% of the shareholder's basis in its stock, all
dividends within one year, must be aggregated for purposes of determining
whether such dividends constitute extraordinary dividends. The shareholder may
elect to determine the status of extraordinary dividends by reference to the
fair market value of the stock as of the date before the ex-dividend date,
rather than by reference to the adjusted basis of such stock (provided the
shareholder establishes the fair market value to the satisfaction of the
Commissioner of the IRS). In determining whether the above-mentioned two-year
holding period has been met, the same rules apply as are applicable to the
45-day holding period requirement for the dividends received deduction.
Corporations should note that 75% of the untaxed portion of the Fund's
dividends could be taken into account for purposes of the alternative minimum
tax imposed on corporations.
A series may in the future engage in various defensive hedging
transactions. Under various Code provisions such transactions might change the
character of recognized gains and losses, accelerate the recognition of certain
gains and losses, and defer the recognition of certain losses or deductions.
If more than 50% of the assets of a series of the Fund at the close of any
taxable year consists of stocks or securities of foreign corporations, the Fund
may elect to treat any foreign income taxes, such as withholding taxes on
interest or dividends, that are paid by the Fund with respect to the series, as
paid by the shareholders of such series. If the Fund makes this election with
respect to a series, the series' shareholders will be entitled to credit their
pro rata share of the foreign taxes paid by the series against their United
States federal income tax liability, or to deduct such amounts from their United
States taxable income. No deduction for foreign taxes may be claimed by a
shareholder who does not itemize deductions. In addition, certain individual
shareholders may be subject to rules that limit or reduce their ability to
deduct fully their pro rata share of foreign taxes paid by the Fund. Since the
Fund anticipates that more than 50% of the value of the total assets of European
will consist of non-U.S. equity and debt securities, European shareholders are
expected to be eligible for a pass through of the foreign taxes paid by the
Fund. Shareholders of Mutual Shares, Qualified, Beacon and Discovery are not
expected to be eligible for a pass through of the foreign taxes paid by the
Fund.
Treasury regulations provide that the dividends-paid deduction
attributable to an in-kind distribution of property is equal to the adjusted
basis of such property.
CALCULATION OF PERFORMANCE DATA
The Fund's average annual total return is computed according to the following
formula:
n
P(1+T) = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000
payment made at the beginning of the 1, 5, or 10 year
periods at the end of the 1, 5, or 10 year periods.
In making the computation described above, the Fund will assume that all
dividends and distributions by the Fund are reinvested at the Fund's net asset
value per share on the reinvestment date. The computation will also reflect any
charges made to all shareholder accounts, if any, during the computation period.
CUSTODIAN, TRANSFER AGENT AND AUDITORS
State Street Bank and Trust Company, Atlantic Division, 225 Franklin
Street, Boston, MA 02110, is the principal custodian for the assets of all the
series of the Fund. Franklin Templeton Investors Services, Inc. ("Investor
Services"), 777 Mariners Island Blvd., San Mateo, CA 94404, is the transfer
agent for all of the series of the Fund, and PFPC Inc., 400 Bellevue Parkway,
Wilmington, DE 19809-3710, provides similar services regarding Class Z shares
through a subcontract with Investors Services. Ernst & Young LLP, Boston, MA,
are the Fund's independent auditors.
SUMMARY OF CODE OF ETHICS
The Adviser and the Fund have adopted Codes of Ethics and related internal
procedures (together referred to as the "Code of Ethics") which govern the
personal investing practices of the Adviser's employees. The Code of Ethics
generally incorporates the recommendation of the Investment Company Institute
contained in the Report of the Advisory Group on Personal Investing dated May 9,
1994. Specifically, employees of the Adviser may buy and sell securities for
themselves as long as their trades have been pre-cleared in accordance with the
Code of Ethics. Transactions by the Adviser's employees which comply with the
substantive and procedural provisions of the Code of Ethics are permitted even
if the security being purchased is one of limited availability (such as
investments in private placements), and is one in which any particular series
would be financially and legally able to invest.
FINANCIAL INFORMATION
The audited financial statements contained in the Annual Report to
Shareholders of Mutual Shares, Qualified, Beacon and Discovery for the fiscal
year ended December 31, 1995, including the auditors' report, and the unaudited
financial statements contained in the Semi-Annual Report to Shareholders of
Mutual Shares, Qualified, Beacon and Discovery for the period ended June 30,
1996, are incorporated herein by reference. The unaudited financial statements
for European for the period ended December 31, 1996, are as follows:
MUTUAL EUROPEAN FUNDSTATEMENT
OF ASSETS AND LIABILITIES
DECEMBER 31, 1996 (UNAUDITED)
ASSETS
Investments in Securities, at Value (cost $430,352,372)...........$458,823,937
Cash ..................................................................530,404
Receivables:
Investment Securities Sold.........................................6,800,225
Capital Stock Subscribed...........................................1,888,609
Dividends............................................................236,292
Interest.............................................................118,184
Fee Reimbursement.....................................................50,394
---------
TOTAL ASSETS.................................................468,448,045
-----------
LIABILITIES
Payables:
Investment Securities Purchased......................................5,023,495
Net Payable for Foreign
Currency Exchange Contracts........................................105,235
Investment Advisory Fee.............................................293,344
Capital Stock Repurchased...........................................449,841
Accrued Expenses
and Other Liabilities..............................................127,174
---------
TOTAL LIABILITIES..............................................5,999,089
---------
NET ASSETS APPLICABLE TO OUTSTANDING CAPITAL STOCK................$462,448,956
-------------
-------------
COMPOSITION OF NET ASSETS
Paid In Capital...................................................$430,067,727
Undistributed Net Investment Income....................................580,686
Accumulated Net Realized Gain on Investments and
Foreign Currency Transactions.......................................3,364,491
Net Unrealized Appreciation of Investments..........................28,531,515
Net Unrealized Depreciation of Foreign Currency
Exchange Contracts and Dividends.....................................(95,463)
--------
TOTAL NET ASSETS............................................$462,448,956
------------
------------
Class Z
Net Asset Value per Share (Offering and Redemption Price
per Share)
($450,495,190 / 39,546,933 shares outstanding).............$11.39
-------
-------
Class I
Net Asset Value per Share
($9,199,892 / 808,273 shares outstanding)...................$11.38
-------
-------
Maximum Offering Price
($11.38 / 95.5%)............................................$11.92
-------
-------
Class II
Net Asset Value per Share
($2,753,874 / 242,005 shares outstanding)...................$11.38
-------
-------
Maximum Offering Price
($11.38 / 99.0%)............................................$11.49
-------
-------
See notes to financial statements.
MUTUAL EUROPEAN FUND
STATEMENT OF OPERATIONS
FOR PERIOD JULY 3, 1996 (COMMENCEMENT OF OPERATIONS) TO DECEMBER 31,
1996 (UNAUDITED)
INVESTMENT INCOME:
Income:
Interest $2,724,820
Dividends
(Net of Foreign Withholding-- $76,402) 796,851
TOTAL INCOME $ 3,521,671
Expenses:
Investment Advisory Fee 949,616
Shareholder Servicing Costs 159,269
Administrative 80,467
Distribution Fee
Class I 3,373
Class II 1,008
Registration and Filing Fees 129,245
Shareholder Reports 21,180
Legal Fees 8,872
Insurance 370
Auditing Fees 8,500
Directors' Fees and Expenses 2,295
Miscellaneous 2,081
-----
TOTAL EXPENSES 1,366,276
Less Expenses Reimbursed (50,394)
---------
TOTAL EXPENSES LESS REIMBURSEMENT 1,315,882
----------
NET INVESTMENT INCOME 2,205,789
----------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS
Net Realized Gain on Investments and
Foreign Currency Transactions 4,653,655
Net Realized Loss on Securities Sold Short (139,150)
Change in Unrealized Appreciation of Investments
and Foreign Currency Transactions 28,436,052
----------
NET GAIN ON INVESTMENTS 32,950,557
----------
NET INCREASE IN NET ASSETS FROM OPERATIONS $35,156,346
-----------
-----------
See notes to financial statements.
MUTUAL EUROPEAN FUND
STATEMENT OF CHANGES IN NET ASSETS
FOR PERIOD JULY 3, 1996 (COMMENCEMENT OF OPERATIONS) TO DECEMBER 31,
1996 (UNAUDITED)
INCREASE/(DECREASE) IN NET ASSETS FROM OPERATIONS:
Net Investment Income $ 2,205,789
Net Realized Gain on Investments and
Foreign Currency Transactions 4,514,505
Change in Unrealized Appreciation of Investments 28,436,052
----------
NET INCREASE IN NET ASSETS
FROM OPERATIONS 35,156,346
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS FROM
Net Investment Income
Class Z (1,947,610)
Class I (25,784)
Class II (7,669)
Net Realized Gain on Investments
Class Z (779,044)
Class I (10,995)
Class II (4,015)
--------
TOTAL DISTRIBUTIONS TO SHAREHOLDERS (2,775,117)
-----------
CAPITAL STOCK TRANSACTIONS
Class Z 418,343,037
Class I 9,032,503
Class II 2,692,187
---------
NET INCREASE IN NET ASSETS 462,448,956
-----------
NET ASSETS:
Beginning of Period -
----------
End of Period-- Including Undistributed
Net Investment Income of $580,686 $462,448,956
-------------
-------------
See notes to financial statements.
MUTUAL EUROPEAN FUND
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996 (UNAUDITED)
NOTE A -- SIGNIFICANT ACCOUNTING POLICIES
Mutual European Fund is a portfolio of Franklin Mutual Series Fund Inc.
(the "Series Fund"), which is registered under the Investment Company Act of
1940 as a diversified, open-end management investment company. The Series Fund
currently consists of five portfolios: Mutual Qualified Fund, Mutual Shares
Fund, Mutual Beacon Fund, Mutual Discovery Fund and Mutual European Fund. Each
of these portfolios is considered to be a separate entity for financial
reporting and Federal income tax purposes. The financial statements and notes
include operations with respect to Mutual European Fund (the "Fund") only.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
may affect the reported amounts of assets and liabilities. Actual results could
differ from those estimates.
SECURITY VALUATION: Investments in securities and securities sold short
that are listed on an exchange or the NASDAQ national market or other securities
traded in the over-the-counter market are valued at the last reported sales
price on the day of valuation; however, if there are no sales on that day, such
securities are valued at the mean between the closing bid and asked prices.
Securities for which market quotations are not readily available are valued at
"fair value" as determined in good faith by management under the direction of
the Board of Directors. Fair value reflects what management believes is the bid
price for the securities and is based on estimates and assumptions deemed
relevant under the circumstances. Actual results could differ from these
estimates. Temporary investments are valued at the prevailing market value.
RESTRICTED SECURITIES: The Fund invests in securities which are restricted
as to public sale in accordance with the Securities Act of 1933. Such assets are
valued at fair value as determined in good faith by management under the
direction of the Board of Directors. It is the Fund's policy that no more than
15%, as determined at the time of investment, of the value of the Fund's assets
be invested in restricted securities.
FOREIGN SECURITIES: The value of foreign securities is converted into U.S.
dollars at the rate of exchange prevailing on the day of valuation. Purchases
and sales of foreign securities, as well as income and expenses relating to such
securities, are converted at the prevailing rate of exchange on the respective
date of such transactions.
FOREIGN EXCHANGE CONTRACTS: The Fund may engage in currency transactions
in order to hedge the value of portfolio holdings denominated in foreign
currencies against fluctuations in relative value. Foreign Exchange contracts
are valued at the forward rate, and are marked-to-market daily. The change in
market value is recorded by the Fund as an unrealized gain or loss. When the
contract is closed, the Fund records a realized gain or loss equal to the
difference between the value of the contract at the time it was opened and the
value at the time it was closed. The use of currency transactions can result in
the Fund incurring losses as a result of a number of factors including the
imposition of exchange controls, suspension of settlements, or the inability to
deliver or receive a specified currency. The Fund does not isolate that portion
of the results of operations resulting from changes in foreign exchange rates on
investments from the fluctuations arising from changes in market prices of
securities held. Such fluctuations are included with the net realized and
unrealized gain or loss from investments.
OPTIONS WRITTEN: When the Fund writes an option, the premium received is
recorded as a liability with subsequent daily adjustment to current market
value. When the Fund enters into a closing transaction or the option expires or
is exercised, the Fund realizes a gain or loss, and the liability is eliminated.
All securities covering outstanding options are held in a segregated account by
the custodian bank.
SECURITIES SOLD SHORT: The Fund is engaged in selling securities short,
which obligates the Fund to replace a security borrowed by purchasing the same
security at the current market value. The Fund would incur a loss if the price
of the security increases between the date of the short sale and the date on
which the Fund replaces the borrowed security. The Fund would realize a gain if
the price of the security declines between those dates.
The Fund is required to establish a margin account with the broker lending
the security sold short. While the short sale is outstanding, the broker retains
the proceeds of the short sale and the Fund must also maintain a cash deposit
with the broker having a value equal to a specified percentage of the value of
the securities sold short.
SECURITIES TRANSACTIONS AND INVESTMENT INCOME: Securities transactions are
recorded on a trade-date basis. Securities gains or losses are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend date or,
for certain foreign dividends, as soon as the Fund becomes aware of the
dividends. Interest income, including original issue discount, where applicable,
is recorded on the accrual basis, except for bonds trading "flat", in which case
interest is recorded when received.
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS: Income dividends and capital
gain distributions are determined in accordance with income tax regulations
which may differ from generally accepted accounting principles. These
differences are primarily due to differing treatments of income and gains on
various investment securities held by the Fund, timing differences and differing
characterization of distributions made by the Fund. Differences in the
recognition or classification of income between the financial statements and tax
earnings and profits which result in temporary over-distribution for financial
statement purposes are classified as distributions in excess of net investment
income or accumulated net realized gains.
FEDERAL INCOME TAXES: The Fund qualifies, and intends to continue to meet
the requirements for qualification, as a regulated investment company, as
defined in applicable sections of the Internal Revenue Code ("Code"). By
complying with code provisions, the Fund is relieved from Federal income tax
provided that substantially all of its taxable income is distributed to
shareholders. Therefore, no Federal income tax provision has been provided.
NOTE B -- MERGER OF HEINE SECURITIES CORPORATION AND FRANKLIN RESOURCES
On October 31, 1996, pursuant to an agreement between Franklin Resources,
Inc. ("FRI") and Heine Securities Corporation ("Heine"), the investment adviser,
the assets of Heine were acquired by Franklin Mutual Advisers, Inc. ("FMA"), a
subsidiary of FRI. Franklin Mutual became the investment adviser to the Series
Fund and the Series Fund's name changed from Mutual Series Fund Inc. to Franklin
Mutual Series Fund Inc.
NOTE C -- INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES
Certain officers of the Fund are also directors or officers of
FMA, Franklin Templeton Distributors, Inc. ("FTD") and Franklin
Templeton Investor Services, Inc. ("FTIS"), the Fund's investment
adviser, principal underwriter for Class I and II, and transfer agent,
respectively.
For the period ended December 31, 1996, the investment advisers received
fees of $949,616 for investment management and advisory services under the
investment advisory agreements. The fee was paid monthly based on average daily
net assets at the annual rate of eight-tenths of one percent. Prior to November
1, 1996, administrative personnel and services were provided at approximate cost
by Heine. On November 1, 1996 FTSI became the Fund's administrative manager. The
Fund pays FTSI monthly its allocated share of an administrative fee of 0.15% per
annum on the first $200 million of the Series Fund's aggregate average daily net
assets, 0.135% of the next $500 million, 0.10% of the next $500 million and
0.075% per annum of such average net assets in excess of $1.2 billion. The Fund
paid fees of $57,060 through December 31, 1996. In connection with the merger,
FRI and FMA have voluntarily agreed to limit the total expenses of the Fund to
be no higher than they were expected to be for the Fund's 1996 fiscal year based
on the projected annualized expense ratio had the merger between FRI and Heine
not taken place. This limitation expires on October 31, 1999. The amount of
reimbursement is set forth in the statement of operations. For the period ended
December 31, 1996, FTD paid net commissions of $1,291 from the sale of the
Fund's shares and FTIS received fees of $768.
Clearwater Securities, Inc. ("Clearwater"), is a registered securities
dealer which is owned by Michael F. Price, President of FMA. Through October 31,
1996, the Fund executed certain security transactions with Clearwater. Effective
November 1, 1996, security transactions are no longer executed with Clearwater.
For the period ended December 31, 1996, the Fund paid brokerage commissions
totaling $4,037 to Clearwater.
Under the distribution plans for Class I and Class II shares, the Fund
reimburses FTD quarterly for FTD's costs and expenses in connection with any
activity that is primarily intended to result in a sale of Fund shares, subject
to a maximum of 0.25% and 1.00% per annum of the average daily net assets of
Class I and Class II shares, respectively. Class II shares redeemed within 18
months are subject to a contingent deferred sales charge. There were no
contingent deferred sales charges paid to FTD for the period ended December 31,
1996.
NOTE D -- INVESTMENT TRANSACTIONS
Purchases and proceeds from the sale of investment securities (excluding
short-term investments) for the period ended December 31, 1996, aggregated
$305,035,611 and $53,054,797, respectively.
For Federal income tax purposes, the identified cost of investments at
December 31, 1996 was $430,352,372. Net unrealized appreciation for all
securities at December 31, 1996, based on Federal income tax cost, amounted to
$28,471,565 consisting of aggregate gross unrealized appreciation of $31,458,530
and aggregate gross unrealized depreciation of $2,986,965.
NOTE E -- RESTRICTED SECURITIES
A summary of the restricted securities held at December 31, 1996, follows:
ACQUISITION
NAME OF ISSUER DATE VALUE
- ------------------------------------------------------------------------
OPTION
Cityscape Financial Corp.,
Options 11/25/96 $2,079,000
-----------
TOTAL RESTRICTED SECURITIES:
(COST $1,760,000)
(0.45% OF NET ASSETS) $2,079,000
----------
----------
NOTE F -- FOREIGN CURRENCY EXCHANGE CONTRACTS
At December 31, 1996, the Fund had various contracts which
obligate the Fund to deliver currencies at specified future dates. Open
contracts were as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Net Unrealized
Appreciation/
Contracts to Deliver In Exchange for Settlement Date Value (Depreciation)
-------------- ------------- ------------ ------ -----------------
Sales
ATS 13,000,000 $1,193,044 2/11/97 $1,203,103 $(10,059)
CHF 11,038,884 8,427,880 3/10/97 8,303,415 124,465
DEM 7,509,263 4,983,475 3/18/97 4,904,617 78,858
DKK 28,421,515 4,929,969 4/24/97 4,854,501 75,468
ESP 219,197,466 1,674,450 2/18/97 1,686,453 (12,003)
FIM 29,600,419 6,681,810 3/3/97 6,460,505 221,305
FRF 253,395,085 49,335,517 2/28/97 49,031,130 304,387
GBP 8,687,454 14,495,599 2/18/97 14,866,934 (371,335)
GBP 9,000,000 14,926,950 3/18/97 15,390,315 (463,365)
GBP 2,380,240 3,778,707 5/16/97 4,063,374 (284,667)
GBP 9,000,000 14,882,400 6/18/97 15,348,969 (466,569)
GBP 8,246,568 13,605,188 8/18/97 14,038,191 (433,003)
ITL 6,099,425,918 4,006,562 1/2/97 4,023,368 (16,806)
ITL 6,099,425,918 3,956,427 7/2/97 3,997,760 (41,333)
NLG 27,233,423 16,269,384 3/17/97 15,850,111 419,273
NLG 4,197,815 2,459,536 6/10/97 2,457,389 2,147
NOK 150,511,892 23,227,144 6/9/97 23,773,588 (546,444)
PTE 975,400,000 6,246,177 1/17/97 6,288,584 (42,407)
SEK 35,286,738 5,368,408 1/21/97 5,178,066 190,342
SEK 31,178,095 4,716,675 2/18/97 4,580,882 135,793
SEK 185,798,461 27,993,227 5/15/97 27,406,608 586,619
SEK 55,552,42 8,416,395 7/21/97 8,219,545 196,850
SEK 50,303,818 7,602,784 8/15/97 7,451,037 151,747
$249,177,708 $249,378,445 $(200,737)
==================== ================ ================
PURCHASES
$3,107,592 FIN 14,034,621 3/3/97 $3,063,157 $(44,435)
1,472,245 GBP 909,374 5/16/97 1,552,417 80,172
3,982,648 ITL 6,099,425,918 1/2/97 4,023,368 40,720
2,874,719 SEK 19,719,998 1/21/97 2,893,764 19,045
---------- ---------- ------
$ 11,437,204 $11,532,706 95,502
============= =========== ------
$(105,235)
=============
</TABLE>
NOTE G -- CAPITAL STOCK
Effective November 1, 1996, the Fund offered three classes of shares:
Class Z, Class I and Class II. All Fund shares outstanding before that date were
designated Class Z shares. All classes of shares have the same rights, except
for their initial sales load, distribution fees, voting rights affecting a
single class and the exchange privilege of each class. At December 31, 1996,
there were 400 million shares authorized ($0.001 par value). Transactions in
capital stock were as follows:
CLASS Z
---------------------
FOR THE PERIOD
JULY 3, 1996
(COMMENCEMENT OF OPERATIONS)
TO DECEMBER 31, 1996
-----------------------
SHARES AMOUNT
------- -----------
Shares sold 42,171,939 $446,968,711
Shares issued in reinvestment
of dividends 229,503 2,586,502
Shares redeemed (2,854,509) (31,212,176)
------------- ------------
Net Increase 39,546,933 $418,343,037
============= =============
CLASS I
-------------------
FOR THE PERIOD
NOVEMBER 1, 1996
TO DECEMBER31, 1996
--------------------
SHARES AMOUNT
----------- ------------
Shares sold 813,014 $9,085,283
Shares issued in reinvestment
of dividends 2,838 31,814
Shares redeemed (7,579) (84,594)
----------- --------
Net Increase 808,273 $9,032,503
============= =============
CLASS II
--------------
FOR THE PERIOD
NOVEMBER 1, 1996
TO DECEMBER 31, 1996
SHARES AMOUNT
----------- ------------
Shares sold 242,959 $2,703,061
Shares issued in reinvestment of dividends 860 9,680
Shares redeemed (1,814) 20,554)
----------- --------------
Net Increase 242,005 $2,692,187
============= =============
Michael Price, President of the Fund's investment adviser, is the record owner
of 14,024,208 Class Z shares as of December 31, 1996.
MUTUAL EUROPEAN FUND
FINANCIAL HIGHLIGHTS (UNAUDITED)
(Selected data for a share of capital stock outstanding throughout each
(period)
CLASS Z CLASS I CLASS II
----------- ----------- ----------
FOR THE PERIOD FOR THE PERIOD FOR THE PERIOD
JULY 3, 1996(A) NOVEMBER 1, 1996(B) NOVEMBER 1, 1996(B)
TO DECEMBER 31, TO DECEMBER 31, TO DECEMBER 31,
1966 1996 1996
---------------- --------------- ---------------
NET ASSET VALUE,
Beginning of
Period $10.00 $ 10.84 $10.84
---------------- ------------ --------------
INCOME FROM
INVESTMENT
OPERATIONS:
Net Investment
Income .06 .03 .02
Net Gains
or Losses on
Securities
(realized and
unrealized) 1.40 .58 .58
---------- --------- --------
Total from
Investment
Operations 1.46 .61 .60
--------- ------- -------
LESS DISTRIBUTIONS:
Dividends
(from net
investment
income) .05 .05 .04
Distributions
(from capital
gains) .02 .02 .02
----------- ------- --------
Total
Distributions
.07 .06 .07
----------- ---------- ---------
NET ASSET
VALUE,
End of Year $ 11.39 $ 11.38 $11.38
================ =============== =============
Total
Return 14.61%+ 5.61%++ 5.52%+++
============= ============= =============
RATIOS/SUPPLEMENTAL DATA:
Net Assets,
End of Year
(millions) $ 450 $ 9 $ 3
Ratio of
Expenses to
Average
Net Assets 1.14%* 1.38%* 2.01%*
Ratio of
Expenses,
net of
reimbursement,
to average
net assets 1.09%* 1.32%* 1.94%*
Ratio of
Net
Investment
Income
to Average
Net Assets 1.84%* 1.44%* .79%*
Portfolio
Turnover
Rate 26.76% 26.76% 26.76%
Average
Commission
Rate $.023 $.023 $.023
+Not annualized for periods of less than one year.
++Total return does not reflect sales commissions. Not annualized for
periods of less than one year.
+++Total return does not reflect sales commissions or the contingent deferred
sales charge. Not annualized for periods of less than one year.
*Annualized.
(a)Commencement of operations.
(b)Commencement of offering of sales.
