TEMPLETON VARIABLE
PRODUCTS SERIES FUND
STATEMENT OF
ADDITIONAL INFORMATION [FRANKLIN TEMPLETON LOGO]
500 EAST BROWARD BOULEVARD
MAY 1, 1998 FORT LAUDERDALE, FLORIDA 33394-3091
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TABLE OF CONTENTS PAGE
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Introduction............................ 1
Investment Objectives and Policies...... 2
Investment Restrictions................. 13
Officers and Trustees................... 15
Investment Management and Other
Services.............................. 20
Brokerage Allocation.................... 22
Summary of Code of Ethics............... 24
Purchase, Redemption and Pricing of
Shares................................ 24
Redemptions in Kind..................... 26
Class 2 Distribution Plan............... 26
Tax Status.............................. 26
Description of Shares................... 29
Performance Information................. 29
Financial Statements.................... 31
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INTRODUCTION Templeton Variable Products Series Fund (the "Trust") was organized
as a Massachusetts business trust on February 25, 1988 and is registered under
the Investment Company Act of 1940 (the "1940 Act") as an open-end management
investment company. The Trust currently has ten diversified series of Shares:
Templeton Money Market ("Money Market") Fund, Templeton Bond ("Bond") Fund,
Templeton Stock ("Stock") Fund, Templeton Asset Allocation ("Asset Allocation")
Fund, Templeton Developing Markets ("Developing Markets") Fund, Franklin Growth
Investments ("Growth") Fund, Mutual Discovery Investments ("Mutual Discovery")
Fund, Mutual Shares Investments ("Mutual Shares") Fund, Franklin Small Cap
Investments Fund ("Small Cap") and Templeton International ("International")
Fund (collectively, the "Funds"). Each Fund, except the Money Market Fund, has
two classes of shares, Class 1 and Class 2. All shares of the Funds are sold
only to insurance company separate accounts to serve as the investment vehicle
for certain variable annuity and variable life insurance contracts. Not all of
the Funds or Classes are available as an investment vehicle for all contracts.
Please refer to the contract prospectus for information concerning the
availability of each class of each Fund.
THIS STATEMENT OF ADDITIONAL INFORMATION ("SAI") IS NOT A PROSPECTUS. IT
CONTAINS INFORMATION IN ADDITION TO, AND IN MORE DETAIL THAN SET FORTH IN, THE
PROSPECTUSES. THIS SAI IS INTENDED TO PROVIDE THE PROSPECTIVE INVESTOR WITH
ADDITIONAL INFORMATION REGARDING THE ACTIVITIES AND OPERATIONS OF THE TRUST AND
THE FUNDS AND SHOULD BE READ IN CONJUNCTION WITH THE PROSPECTUS FOR THE FUND AND
CLASS IN WHICH YOU MAY BE INTERESTED.
MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS:
- ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION,
THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT;
- ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY
BANK;
- ARE SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF
PRINCIPAL.
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INVESTMENT OBJECTIVES AND POLICIES
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INVESTMENT POLICIES. The investment objective and policies of each Fund are
described in each Fund's Prospectus under the heading "Investment Objective and
Policies."
CONVERTIBLE SECURITIES. Certain Funds may invest in convertible securities. A
convertible security is generally a debt obligation or preferred stock that may
be converted within a specified period of time into a certain amount of common
stock of the same or a different issuer. A convertible security provides a
fixed-income stream and the opportunity, through its conversion feature, to
participate in the capital appreciation resulting from a market price advance in
its underlying common stock. As with a straight fixed-income security, a
convertible security tends to increase in market value when interest rates
decline and decrease in value when interest rates rise. Similar to a common
stock, the value of a convertible security tends to increase as the market value
of the underlying stock rises, and it tends to decrease as the market value of
the underlying stock declines. Because its value can be influenced by both
interest rate and market movements, a convertible security is not as sensitive
to interest rates as a similar fixed-income security, nor is it as sensitive to
changes in share price as its underlying stock.
A convertible security is usually issued either by an operating company or by an
investment bank. When issued by an operating company, a convertible security
tends to be senior to common stock, but subordinate to other types of
fixed-income securities issued by that company. When a convertible security
issued by an operating company is "converted," the operating company often
issues new stock to the holder of the convertible security but, if the parity
price of the convertible security is less than the call price, the operating
company may pay out cash instead of common stock. If the convertible security is
issued by an investment bank, the security is an obligation of and is
convertible through the issuing investment bank.
The convertible debt obligations in which the Funds may invest are subject to
the same rating criteria and investment policies as the Funds' investments in
debt obligations. The issuer of a convertible security may be important in
determining the security's market value. This is because the holder of a
convertible security will have recourse only to the issuer. In addition, a
convertible security may be subject to redemption by the issuer, but only after
a specified date and under circumstances established at the time the security is
issued.
Unlike convertible debt obligations, however, convertible preferred stocks are
equity securities. As with common stocks, preferred stocks are subordinated to
all debt obligations in the event of insolvency, and an issuer's failure to make
a dividend payment is generally not an event of default entitling the preferred
shareholder to take action. A preferred stock generally has no maturity date, so
that its market value is dependent on the issuer's business prospects for an
indefinite period of time. In addition, distributions from preferred stock are
dividends, rather than interest payments, and are usually treated as such for
corporate tax purposes. For these reasons, convertible preferred stocks are
treated as preferred stocks for the Funds' financial reporting, credit rating,
and investment limitation purposes.
DEBT SECURITIES. Each Fund may invest in debt securities to the extent provided
in the Fund's prospectus. The market value of debt securities generally varies
in response to changes in interest rates and the financial condition of each
issuer. During periods of declining interest rates, the value of debt securities
generally increases. Conversely, during periods of rising interest rates, the
value of such securities generally declines. These changes in market value will
be reflected in a Fund's net asset value.
Bonds rated Ba or lower by Moody's Investors Service, Inc. ("Moody's") or BB or
lower by Standard & Poor's Ratings Service ("S&P") are predominantly speculative
with respect to the issuer's capacity to pay interest and repay principal in
accordance with the terms of the obligation and may be in default. Bonds which
are rated C by Moody's are the lowest rated class of bonds, and issues so rated
can be regarded as having extremely poor prospects of ever attaining any real
investment standing. Bonds rated C by S&P are obligations on which no interest
is being paid. For a full description of each debt securities rating, see the
Appendix.
Although they may offer higher yields than do higher rated securities, low rated
and unrated debt securities generally involve greater volatility of price and
risk of principal and income, including the possibility of default by, or
bankruptcy of, the issuers of the securities. In addition, the markets in which
low rated and unrated debt securities are traded are more limited than those in
which higher rated securities are traded. The existence of limited markets for
particular securities may diminish a Fund's ability to sell the securities at
fair value either to meet redemption requests or to respond to a specific
economic event such as a deterioration in the
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creditworthiness of the issuer. Reduced secondary market liquidity for certain
low rated or unrated debt securities may also make it more difficult for a Fund
to obtain accurate market quotations for the purposes of valuing a Fund's
portfolio. Market quotations are generally available on many low rated or
unrated securities only from a limited number of dealers and may not necessarily
represent firm bids of such dealers or prices for actual sales.
Adverse publicity and investor perceptions, whether or not based on fundamental
analysis, may decrease the values and liquidity of low rated debt securities,
especially in a thinly traded market. Analysis of the creditworthiness of
issuers of low rated debt securities may be more complex than for issuers of
higher rated securities, and the ability of a Fund to achieve its investment
objective may, to the extent of investment in low rated debt securities, be more
dependent upon such credit worthiness analysis than would be the case if the
Fund were investing in higher rated securities.
Low rated debt securities may be more susceptible to real or perceived adverse
economic and competitive industry conditions than investment grade securities.
The prices of low rated debt securities have been found to be less sensitive to
interest rate changes than higher rated investments, but more sensitive to
adverse economic downturns or individual corporate developments. A projection of
an economic downturn or of a period of rising interest rates, for example, could
cause a decline in low rated debt securities prices because the advent of a
recession could lessen the ability of a highly leveraged company to make
principal and interest payments on its debt securities. If the issuer of low
rated debt securities defaults, a Fund may incur additional expenses to seek
recovery.
DEPOSITARY RECEIPTS. Certain Funds may purchase sponsored or unsponsored
American Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs") and
Global Depositary Receipts ("GDRs") (collectively, "Depositary Receipts"). ADRs
are typically issued by a U.S. bank or trust company which evidence ownership of
underlying securities issued by a foreign corporation. EDRs and GDRs are
typically issued by foreign banks or trust companies, although they also may be
issued by United States ("U.S.") banks or trust companies, and evidence
ownership of underlying securities issued by either a foreign or a U.S.
corporation. Generally, Depositary Receipts in registered form are designed for
use in the U.S. securities market and Depositary Receipts in bearer form are
designed for use in securities markets outside the U.S. Depositary Receipts may
not necessarily be denominated in the same currency as the underlying securities
into which they may be converted. Depositary Receipts may be issued pursuant to
sponsored or unsponsored programs. In sponsored programs, an issuer has made
arrangements to have its securities traded in the form of Depositary Receipts.
In unsponsored programs, the issuer may not be directly involved in the creation
of the program. Although regulatory requirements with respect to sponsored and
unsponsored programs are generally similar, in some cases it may be easier to
obtain financial information from an issuer that has participated in the
creation of a sponsored program. Accordingly, there may be less information
available regarding issuers of securities underlying unsponsored programs and
there may not be a correlation between such information and the market value of
the Depositary Receipts. Depositary Receipts also involve the risks of other
investments in foreign securities, as discussed below. For purposes of the
Funds' investment policies, the Funds' investments in Depositary Receipts will
be deemed to be investments in the underlying securities.
DIVERSIFICATION. Each Fund intends to diversify its investments to meet the
requirements under Section 5 of the 1940 Act, under Section 851 of the Code
relating to regulated investment companies, and under Section 817 of the Code
relating to the treatment of variable contracts issued by insurance companies.
As diversified funds under the 1940 Act, each Fund may not, with respect to 75%
of its total assets, purchase the securities of any one issuer (except U.S.
Government Securities) if more than 5% of the value of the Fund's assets would
be invested in such issuer, or purchase more than 10% of any class of securities
of any one company, including more than 10% of its outstanding voting securities
(except for investments in obligations issued or guaranteed by the U.S.
government or its agencies or instrumentalities).
In order to comply with the diversification requirements under section 851 of
the Code, each Fund will limit its investments so that, at the close of each
quarter of the taxable year, (i) not more than 25% of the market value of each
Fund's total assets will be invested in the securities of a single issuer, and
(ii) with respect to 50% of the market value of its total assets, not more than
5% of the market value of its total assets will be invested in the securities of
a single issuer and each Fund will not own more than 10% of the outstanding
voting securities
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of a single issuer. A Fund's investments in U.S. Government Securities are not
subject to these limitations.
In order to comply with the Code's diversification requirements under Section
817, each Fund will diversify its investments such that (i) no more than 55% of
the Fund's assets is represented by any one investment; (ii) no more than 70% of
the Fund's assets is represented by any two investments; (iii) no more than 80%
of the Fund's assets is represented by any three investments; and (iv) no more
than 90% of the Fund's assets is represented by any four investments. In the
case of Funds investing in obligations of U.S. government agencies or
instrumentalities, each agency or instrumentality is treated as a separate
issuer for purposes of the above rules.
FOREIGN SECURITIES -- GENERAL. An investor should consider carefully the risks
involved in investing in securities issued by companies and governments of
foreign nations, which are in addition to the usual risks inherent in domestic
investments. These risks are often heightened for investments in developing
markets, including certain Eastern European countries. There is the possibility
of expropriation, nationalization or confiscatory taxation, taxation of income
earned in foreign nations (including, for example, withholding taxes on interest
and dividends) or other taxes imposed with respect to investments in foreign
nations, foreign exchange controls (which may include suspension of the ability
to transfer currency from a given country), foreign investment controls on daily
stock movements, default in foreign government securities, political or social
instability or diplomatic developments which could affect investments in
securities of issuers in foreign nations. In addition, in many countries there
is less publicly available information about issuers than is available in
reports about companies in the U.S. Foreign companies are not generally subject
to uniform accounting and auditing and financial reporting standards, and
auditing practices and requirements may not be comparable to those applicable to
U.S. companies. Further, the Fund may encounter difficulties or be unable to
vote proxies, exercise shareholder rights, pursue legal remedies, and obtain
judgments in foreign courts. Also, some countries may withhold portions of
interest and dividends at the source. These considerations generally are more of
a concern in developing countries, where the possibility of political
instability (including revolution) and dependence on foreign economic assistance
may be greater than in developed countries. Investments in companies domiciled
in developing countries therefore may be subject to potentially higher risks
than investments in developed countries. Brokerage commissions, custodial
services and other costs relating to investment in foreign countries are
generally more expensive than in the U.S.
Foreign securities markets also have different clearance and settlement
procedures, and in certain markets there have been times when settlements have
been unable to keep pace with the volume of securities transactions, making it
difficult to conduct such transactions. Delays in settlement could result in
temporary periods when assets of the Fund are uninvested and no return is earned
thereon. The inability of the Fund to make intended security purchases due to
settlement problems could cause the Fund to miss attractive investment
opportunities. Inability to dispose of portfolio securities due to settlement
problems could result either in losses to the Fund due to subsequent declines in
value of the portfolio security or, if the Fund has entered into a contract to
sell the security, could result in possible liability to the purchaser.
In many foreign countries there is less government supervision and regulation of
business and industry practices, stock exchanges, brokers and listed companies
than in the U.S. There is an increased risk, therefore, of uninsured loss due to
lost, stolen or counterfeit stock certificates. In addition, the foreign
securities markets of any of the countries in which the Fund may invest may also
be smaller, less liquid, and subject to greater price volatility than those in
the U.S. The Fund may invest in Eastern European countries, which involves
special risks that are described under "Investment Objectives and
Policies -- Risk Factors" in the SAI.
Prior governmental approval of foreign investments may be required under certain
circumstances in some developing countries, and the extent of foreign investment
in domestic companies may be subject to limitation in other developing
countries.
Foreign ownership limitations also may be imposed by the charters of individual
companies in developing countries to prevent, among other concerns, violation of
foreign investment limitations.
Repatriation of investment income, capital and proceeds of sales by foreign
investors may require governmental registration and/or approval in some
developing countries. The Fund could be adversely affected by delays in or a
refusal to grant any required governmental registration or approval for such
repatriation.
Further, the economies of developing countries generally are heavily dependent
upon international trade and, accordingly, have been and may con-
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tinue to be adversely affected by trade barriers, exchange controls, managed
adjustments in relative currency values and other protectionist measures imposed
or negotiated by the countries with which they trade. These economies also have
been and may continue to be adversely affected by economic conditions in the
countries with which they trade.
FOREIGN CURRENCY HEDGING TRANSACTIONS. In order to hedge against foreign
currency exchange rate risks, certain Funds may enter into forward foreign
currency exchange contracts, purchase put or call options on foreign currencies,
or enter into foreign currency futures contracts, as described below. The Funds
may also conduct their foreign currency exchange transactions on a spot (i.e.,
cash) basis at the spot rate prevailing in the foreign currency exchange market.
A Fund may enter into forward foreign currency exchange contracts ("forward
contracts") to attempt to minimize the risk to the Fund from adverse changes in
the relationship between the U.S. dollar and foreign currencies. A forward
contract is an obligation to purchase or sell a specific currency for an agreed
price at a future date which is individually negotiated and privately traded by
currency traders and their customers. A Fund may enter into a forward contract,
for example, when it enters into a contract for the purchase or sale of a
security denominated in a foreign currency in order to "lock in" the U.S. dollar
price of the security. In addition, for example, when a Fund believes that a
foreign currency may suffer a substantial decline against the U.S. dollar, it
may enter into a forward contract to sell an amount of that foreign currency
approximating the value of some or all of the Fund's portfolio securities
denominated in such foreign currency, or when a Fund believes that the U.S.
dollar may suffer a substantial decline against a foreign currency, it may enter
into a forward contract to buy that foreign currency for a fixed dollar amount.
This second investment practice is generally referred to as "cross-hedging."
Because in connection with a Fund's forward foreign currency transactions an
amount of the Fund's assets equal to the amount of the purchase will be held
aside or segregated to be used to pay for the commitment, a Fund will always
have cash or liquid securities available sufficient to cover any commitments
under these contracts or to limit any potential risk. The segregated account
will be marked-to-market on a daily basis. While these contracts are not
presently regulated by the Commodity Futures Trading Commission ("CFTC"), the
CFTC may in the future assert authority to regulate forward contracts. In such
event, a Fund's ability to utilize forward contracts in the manner set forth
above may be restricted. Forward contracts may limit potential gain from a
positive change in the relationship between the U.S. dollar and foreign
currencies. Unanticipated changes in currency prices may result in poorer
overall performance for a Fund than if it had not engaged in such contracts.
As is the case with other kinds of options, the writing of an option on foreign
currency will constitute only a partial hedge, up to the amount of the premium
received, and a Fund could be required to purchase or sell foreign currencies at
disadvantageous exchange rates, thereby incurring losses. The purchase of an
option on foreign currency may constitute an effective hedge against fluctuation
in exchange rates, although, in the event of rate movements adverse to a Fund's
position, the Fund may forfeit the entire amount of the premium plus related
transaction costs. Options on foreign currencies to be written or purchased by a
Fund will be traded on U.S. and foreign exchanges or over-the-counter.
A Fund may enter into exchange-traded contracts for the purchase or sale for
future delivery of foreign currencies ("foreign currency futures") only to hedge
against anticipated future changes in exchange rates which otherwise might
adversely affect the value of the Fund's portfolio securities or adversely
affect the prices of securities that a Fund intends to purchase at a later date.
The successful use of foreign currency futures will usually depend on the
ability of a Fund's Investment Manager to forecast currency exchange rate
movements correctly. Should exchange rates move in an unexpected manner, a Fund
may not achieve the anticipated benefits of foreign currency futures or may
realize losses.
FUTURES CONTRACTS. Certain Funds may purchase and sell futures contracts. These
may include contracts for future delivery of debt securities (such as U.S.
treasury bonds, notes and bills, commercial paper and certificates of deposit)
or currencies, and financial futures contracts on interest rates, financial
indices or stock indices. (See also "Foreign Currency Hedging Transactions," and
"Stock Index Futures Contracts").
As long as required by regulatory authorities, these Funds will limit their use
of futures contracts to hedging transactions in order to avoid being a commodity
pool. For example, they might use futures contracts to hedge against anticipated
changes in interest rates that might adversely affect either the value of the
Funds' securities or the price of the
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securities which the Funds intend to purchase. The Funds' hedging may include
sales of futures contracts as an offset against the effect of expected increases
in interest rates and purchases of futures contracts as an offset against the
effect of expected declines in interest rates. Although other techniques could
be used to reduce the Funds' exposure to interest rate fluctuations, they may be
able to hedge their exposure more effectively and perhaps at a lower cost by
using futures contracts.
At the time a Fund purchases or sells a futures contract, it is required to
deposit with its custodian (or broker, if legally permitted) a specified amount
of cash or liquid securities ("initial margin"). The margin required for a
futures contract is set by the exchange or board of trade on which the contract
is traded and may be modified during the term of the contract. The initial
margin is in the nature of a performance bond or good faith deposit on the
futures contract which is returned to the Fund upon termination of the contract,
assuming all contractual obligations have been satisfied. The Funds expect to
earn interest income on initial margin deposits. A futures contract held by a
Fund is valued daily at the official settlement price of the exchange on which
it is traded. Each day the Funds pay or receive cash, called "variation margin,"
equal to the daily change in value of the futures contract. This process is
known as "marking-to-market." Variation margin does not represent a borrowing or
loan by a Fund but is instead settlement between the Fund and the broker of the
amount one would owe the other if the futures contract expired. In computing
daily net asset value, a Fund will mark-to-market its open futures positions. In
addition, the Fund must deposit in a segregated account additional cash or
liquid securities to ensure the futures contracts are unleveraged. The value of
assets held in the segregated account must be equal to the daily market value of
all outstanding futures contracts less any amounts deposited as margin.
Although some financial futures contracts call for making or taking delivery of
the underlying securities, in most cases these obligations are closed out before
the settlement date. The closing of a contractual obligation is accomplished by
purchasing or selling an identical off setting futures contract. Other financial
futures contracts by their terms call for cash settlements.
ILLIQUID SECURITIES. Generally an "illiquid security" is any security that
cannot be disposed of promptly and in the ordinary course of business at
approximately the amount at which the Fund has valued the instrument. Subject to
this limitation, the Board has authorized certain Funds to invest in restricted
securities where such investment is consistent with the Fund's investment
objective and has authorized such securities to be considered to be liquid to
the extent the Fund's Investment Manager determines that there is a liquid
institutional or other market for such securities for example, restricted
securities which may be freely transferred among qualified institutional buyers
pursuant to Rule 144A under the Securities Act of 1933, as amended, and for
which a liquid institutional market has developed. The Board will review any
determination by the Fund's Investment Managers to treat a restricted security
as liquid on a regular basis, including the Investment Managers' assessment of
current trading activity and the availability of reliable price information. In
determining whether a restricted security is properly considered a liquid
security, the Funds' Investment Managers and the Board will take into account
the following factors: (i) the frequency of trades and quotes for the security;
(ii) the number of dealers willing to purchase or sell the security and the
number of other potential purchasers; (iii) dealer undertakings to make a market
in the security; and (iv) the nature of the security and the nature of the
marketplace trades (e.g., the time needed to dispose of the security, the method
of soliciting offers, and the mechanics of transfer). To the extent a Fund
invests in restricted securities that are deemed liquid, the general level of
illiquidity in the applicable Fund may be increased if qualified institutional
buyers become uninterested in purchasing these securities or the market for
these securities contracts.
OPTIONS ON SECURITIES OR INDICES. As indicated in the prospectus, certain Funds
may write covered call and put options and purchase call and put options on
securities or stock indices that are traded on U.S. and foreign exchanges and in
the over-the-counter markets.
An option on a security is a contract that gives the purchaser of the option, in
return for the premium paid, the right to buy a specified security (in the case
of a call option) or to sell a specified security (in the case of a put option)
from or to the writer of the option at a designated price during the term of the
option. An option on a securities index gives the purchaser of the option, in
return for the premium paid, the right to receive from the seller cash equal to
the difference between the closing price of the index and the exercise price of
the option.
A Fund may write a call or put option only if the option is "covered". A call
option on a security written by the Fund is "covered" if the Fund owns the
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underlying security covered by the call or has an absolute and immediate right
to acquire that security without additional cash consideration (or for
additional cash consideration held in a segregated account by its custodian)
upon conversion or exchange of other securities held in its portfolio. A call
option on a security is also "covered" if the Fund holds a call on the same
security and in the same principal amount as the call written where the exercise
price of the call held (1) is equal to or less than the exercise price of the
call written or (2) is greater than the exercise price of the call written if
the difference is maintained by the Fund in cash or liquid securities in a
segregated account with its custodian. A put option on a security written by the
Fund is "covered" if the Fund maintains cash or liquid securities with a value
equal to the exercise price in a segregated account with its custodian, or else
holds a put on the same security and in the same principal amount as the put
written where the exercise price of the put held is equal to or greater than the
exercise price of the put written.
Each Fund will cover call options on stock indices that it writes by owning
securities whose price changes, in the opinion of its Investment Manager, are
expected to be similar to those of the index, or in such other manner as may be
in accordance with the rules of the exchange on which the option is traded and
applicable laws and regulations. Nevertheless, where a Fund covers a call option
on a stock index through ownership of securities, such securities may not match
the composition of the index. In that event, a Fund will not be fully covered
and could be subject to risk of loss in the event of adverse changes in the
value of the index. A Fund will cover put options on stock indices that it
writes by segregating assets equal to the option's exercise price, or in such
other manner as may be in accordance with the rules of the exchange on which the
option is traded, and applicable laws and regulations.
A Fund will receive a premium from writing a put or call option, which increases
the Fund's gross income in the event the option expires unexercised or is closed
out at a profit. If the value of a security or an index on which the Fund has
written a call option falls or remains the same, the Fund will realize a profit
in the form of the premium received (less transaction costs) that could offset
all or a portion of any decline in the value of the portfolio securities being
hedged. If the value of the underlying security or index rises, however, the
Fund will realize a loss in its call option position, which will reduce the
benefit of any unrealized appreciation in the Fund's investments. By writing a
put option, the Fund assumes the risk of a decline in the underlying security or
index. To the extent that the price changes of the portfolio securities being
hedged correlate with changes in the value of the underlying security or index,
writing covered put options on indices or securities will increase the Fund's
losses in the event of a market decline, although such losses will be offset in
part by the premium received for writing the option.
A Fund may also purchase put options to hedge its investments against a decline
in value. By purchasing a put option, the Fund will seek to offset a decline in
the value of the portfolio securities being hedged through appreciation of the
put option. If the value of the Fund's investments does not decline as
anticipated, or if the value of the option does not increase, the Fund's loss
will be limited to the premium paid for the option plus related transaction
costs. The success of this strategy will depend, in part, on the correlation
between the changes in value of the underlying security or index and the changes
in value of the Fund's security holdings being hedged.
A Fund may purchase call options on individual securities to hedge against an
increase in the price of securities that the Fund anticipates purchasing in the
future. Similarly, the Fund may purchase call options on a securities index to
attempt to reduce the risk of missing a broad market advance, or an advance in
an industry or market segment, at a time when the Fund holds uninvested cash or
short-term debt securities awaiting investment. When purchasing call options,
the Fund will bear the risk of losing all or a portion of the premium paid if
the value of the underlying security or index does not rise.
There can be no assurance that a liquid market will exist when the Fund seeks to
close out an option position. Trading could be interrupted, for example, because
of supply and demand imbalances arising from a lack of either buyers or sellers,
or the options exchange could suspend trading after the price has risen or
fallen more than the maximum specified by the exchange. Although the Fund may be
able to offset to some extent any adverse effects of being unable to liquidate
an option position, the Fund may experience losses in some cases as a result of
such inability.
REVERSE REPURCHASE AGREEMENTS. Certain Funds may enter into reverse repurchase
agreements with banks and broker-dealers. Reverse repurchase agreements involve
sales by a Fund of portfolio assets concurrently with an agreement by the Fund
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to repurchase the same assets at a later date at a fixed price. During the
reverse repurchase agreement period, the Fund continues to receive dividend
payments on these securities.
When effecting reverse repurchase transactions, the Fund will establish a
segregated account with its custodian bank in which it will maintain cash or
liquid securities equal in value to its obligations with respect to reverse
repurchase agreements. Reverse repurchase agreements involve the risk that the
market value of the securities retained by a Fund may decline below the price of
the securities the Fund has sold but is obligated to repurchase under the
agreement. In the event the buyer of securities under a reverse repurchase
agreement files for bankruptcy or becomes insolvent, a Fund's use of the
proceeds of the agreement may be restricted pending a determination by the other
party, or its trustee or receiver, whether to enforce the Fund's obligation to
repurchase the securities. Reverse repurchase agreements are considered
borrowings by the Funds and as such are subject to the investment limitations
discussed under "Fundamental Investment Restrictions." These transactions may
increase the volatility of a Fund's income or net asset value. The Fund carries
the risk that any securities purchased with the proceeds of the transaction will
depreciate or not generate enough income to cover the Fund's obligations under
the reverse repurchase transaction. These transactions also increase the
interest and operating expenses of a fund.
SHORT SALES. Certain Funds may make short sales of securities as indicated in
the prospectus. A short sale is a transaction in which the Fund sells a security
it does not own in anticipation that the market price of that security will
decline. Each Fund expects to make short sales as a form of hedging to offset
potential declines in long positions in similar securities, to maintain
portfolio flexibility, and for profit.
When a Fund 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 Fund 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 Fund's 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
Fund 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 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 Fund replaces the borrowed security, the Fund will incur a
loss; conversely, if the price declines, the Fund will realize a gain. Any gain
will be decreased, and any loss increased, by the transaction costs described
above. Although the Fund's gain is limited to the price at which it sold the
security short, its potential loss is theoretically unlimited.
STOCK INDEX FUTURES CONTRACTS. Certain Funds may buy and sell index futures
contracts with respect to any stock index, and certain Funds may buy or sell
futures contracts with respect to any bond index, on a recognized stock exchange
or board of trade. These Funds may invest in index futures contracts for hedging
purposes only, and not for speculation. A Fund may engage in such transactions
only to an extent that the total contract value of the futures contracts do not
exceed 20% of the Fund's total assets at the time when such contracts are
entered into. Successful use of stock index futures is subject to the ability of
the Investment Managers to predict correctly movements in the direction of the
stock markets. No assurance can be given that the Investment Managers' judgment
in this respect will be correct.
A stock index futures contract is a contract to buy or sell units of a stock
index at a specified future date at a price agreed upon when the contract is
made. The value of a unit is the current value of the stock index. For example,
the Standard & Poor's Stock Index ("S&P 500 Index" or "Index") is composed of
500 selected common stocks, most of which are listed on the New York Stock
Exchange ("NYSE"). The S&P 500 Index assigns a relative weighing to the value of
one share of each of these 500 common stocks included in the Index, and the
Index fluctuates with changes in the market values of the shares of those common
stocks. In the case of the S&P 500 Index, contracts are to buy or sell 500
units. Thus, if the value of the Index were $150, one contract would be worth
$75,000 (500 units x $150). The stock index futures contract specifies that no
delivery of the actual stocks making up the index will take place. Instead,
settlement in cash must occur upon the termination of the contract, with the
settlement being the difference between the contract price and the actual level
of the stock index at
8
PAGE
the expiration of the contract. For example, if a Fund enters into a futures
contract to buy 500 units of the Index at a specified future date at a contract
price of $150 and the Index is at $154 on that future date, the Fund will gain
$2,000 (500 units x gain of $4 per unit). If a Fund enters into a futures
contract to sell 500 units of the stock index at a specified future date at a
contract price of $150 and the S&P 500 Index is at $154 on the future date, the
Fund will lose $2,000 (500 units x loss of $4 per unit).
During or in anticipation of a period of market appreciation, a Fund may enter
into a "long hedge" of common stock which it proposes to add to its portfolio by
purchasing stock index futures for the purpose of reducing the effective
purchase price of such common stock. To the extent that the securities which a
Fund proposes to purchase change in value in correlation with the stock index
contracted for, the purchase of futures contracts on that index would result in
gains to the Fund which could be offset against rising prices of such common
stock.
During or in anticipation of a period of market decline, A Fund may "hedge"
common stock in its portfolio by selling stock index futures for the purpose of
limiting the exposure of its portfolio to such decline. To the extent that a
Fund's portfolio of securities changes in value in correlation with a given
stock index, the sale of futures contracts on that index could substantially
reduce the risk to the portfolio of a market decline and, by so doing, provide
an alternative to the liquidation of securities positions in the portfolio with
resultant transaction costs.
STRUCTURED INVESTMENTS. Included among the issuers of debt securities in which
the Funds (except the Money Market Fund) may invest are entities organized and
operated solely for the purpose of restructuring the investment characteristics
of various securities. These entities are typically organized by investment
banking firms which receive fees in connection with establishing each entity and
arranging for the placement of its securities. This type of restructuring
involves the deposit with or purchase by an entity, such as a corporation or
trust, of specified instruments and the issuance by that entity of one or more
classes of securities ("Structured Investments") backed by, or representing
interests in, the underlying instruments. The cash flow on the underlying
instruments may be apportioned among the newly issued Structured Investments to
create securities with different investment characteristics such as varying
maturities, payment priorities or interest rate provisions; the extent of the
payments made with respect to Structured Investments is dependent on the extent
of the cash flow on the underlying instruments. Because Structured Investments
of the type in which such Funds anticipate investing typically involve no credit
enhancement, their credit risk will generally be equivalent to that of the
underlying instruments.
Certain Funds are permitted to invest in a class of Structured Investments that
is either subordinated or unsubordinated to the right of payment of another
class. Subordinated Structured Investments typically have higher yields and
present greater risks than unsubordinated Structured Investments. Although a
Fund's purchase of subordinated Structured Investments would have a similar
economic effect to that of borrowing against the underlying securities, the
purchase will not be deemed to be leverage for purposes of the limitations
placed on the extent of a Fund's assets that may be used for borrowing
activities.
Certain issuers of Structured Investments may be deemed to be "investment
companies" as defined in the 1940 Act. As a result, a Fund's investment in these
Structured Investments may be limited by the restrictions contained in the 1940
Act. Structured Investments are typically sold in private placement
transactions, and there currently is not an active trading market for Structured
Investments. To the extent such investments are illiquid, they will be subject
to a Fund's restrictions on investments in illiquid securities.
RISK FACTORS
- ---------------------------------------------------------
Each Fund, except the Money Market Fund, has the right to purchase securities in
any foreign country, developed or developing, if they are listed on an exchange,
as well as a limited right to purchase such securities if they are unlisted.
Investors should consider carefully the risks involved in securities of
companies and governments of foreign nations, which are in addition to the usual
risks inherent in domestic investments.
There may be less publicly available information about foreign companies
comparable to the reports and ratings published about companies in the U.S.
Foreign companies are not generally subject to uniform accounting, auditing and
financial reporting standards, and auditing practices and requirements may not
be comparable to those applicable to U.S. companies. Foreign markets have
substantially less volume than the NYSE, and securities of some foreign
companies are less liquid and more volatile than securities of comparable U.S.
companies. A
9
PAGE
Fund, therefore, may encounter difficulty in obtaining market quotations for
purposes of valuing its portfolio and calculating its net asset value. Although
the Funds (except the Money Market Fund) may invest up to 15% of their total
assets in unlisted securities or securities with a limited trading market, in
the opinion of management such securities do not present a significant liquidity
problem.
Commission rates in foreign countries, which are generally fixed rather than
subject to negotiation as in the U.S., are likely to be higher. In many foreign
countries there is less government supervision and regulation of stock
exchanges, brokers and listed companies than in the U.S.
Investments in companies domiciled in developing countries may be subject to
potentially higher risks than investments in developed countries. These risks
include (i) less social, political and economic stability; (ii) the small
current size of the markets for such securities and the currently low or
nonexistent volume of trading, which result in a lack of liquidity and in
greater price volatility; (iii) certain national policies which may restrict the
Funds' investment opportunities, including restrictions on investment in issuers
or industries deemed sensitive to national interests; (iv) foreign taxation; (v)
the absence of developed structures governing private or foreign investment or
allowing for judicial redress for injury to private property; (vi) the absence,
until recently in certain Eastern European countries, of a capital market
structure or market-oriented economy; and (vii) the possibility that recent
favorable economic developments in Eastern Europe may be slowed or reversed by
unanticipated political or social events in such countries.
In addition, many countries in which the Funds may invest have experienced
substantial, and in some periods extremely high, rates of inflation for many
years. Inflation and rapid fluctuations in inflation rates have had and may
continue to have negative effects on the economies and securities markets of
certain countries. Moreover, the economies of some developing countries may
differ favorably or unfavorably from the U.S. economy in such respects as growth
of gross domestic product, rate of inflation, currency depreciation, capital
reinvestment, resource self-sufficiency and balance of payments position.
Investments in Eastern European countries may involve risks of nationalization,
expropriation and confiscatory taxation. The communist governments of a number
of Eastern European countries expropriated large amounts of private property in
the past, in many cases without adequate compensation, and there can be no
assurance that such expropriation will not occur in the future. In the event of
such expropriation, the Funds could lose a substantial portion of any
investments they have made in the affected countries.
Further, no accounting standards exist in Eastern European countries. Finally,
even though certain Eastern European currencies may be convertible into U.S.
dollars, the conversion rates may be artificial to the actual market values and
may be adverse to the Funds' Shareholders.
Certain Eastern European countries, which do not have market economies, are
characterized by an absence of developed legal structures governing private and
foreign investments and private property. Certain countries require governmental
approval prior to investments by foreign persons, or limit the amount of
investment of foreign persons in a particular company, or limit the investment
of foreign persons to only a specific class of securities of a company that may
have less advantageous terms than securities of the company available for
purchase by nationals.
Authoritarian governments in certain Eastern European countries may require that
a governmental or quasi-governmental authority act as custodian of a Fund's
assets invested in such country. To the extent such governmental or
quasi-governmental authorities do not satisfy the requirements of the 1940 Act
to act as foreign custodians of a Fund's cash and securities, the Fund's
investment in such countries may be limited or may be required to be effected
through intermediaries. The risk of loss through governmental confiscation may
be increased in such countries.
Investing in Russian companies involves a high degree of risk and special
considerations not typically associated with investing in the U.S. securities
markets, and should be considered highly speculative. Such risks include: (1)
delays in settling portfolio transactions and risk of loss arising out of
Russia's system of share registration and custody; (2) the risk that it may be
impossible or more difficult than in other countries to obtain and/or enforce a
judgment; (3) pervasiveness of corruption and crime in the Russian economic
system; (4) currency exchange rate volatility and the lack of available currency
hedging instruments; (5) higher rates of inflation, including the risk of social
unrest associated with periods of hyper-inflation; (6) controls on foreign
investment and local practices disfavoring foreign investors and limitations on
repatriation of invested capital, profits and dividends, and on a
10
PAGE
Fund's ability to exchange local currencies for U.S. dollars; (7) the risk that
the government of Russia or other executive or legislative bodies may decide not
to continue to support the economic reform program simple minded since the
dissolution of the Soviet Union and could follow radically different political
and/or economic policies to the detriment of investors, including
non-market-oriented policies such as the support of certain industries at the
expense of other sectors or investors, or a return to the centrally planned
economy that existed prior to the dissolution of the Soviet Union; (8) the
financial condition of Russian companies, including large amounts of
inter-company debt which may create a payments crisis on a national scale; (9)
dependency on exports and the corresponding importance of international trade;
(10) the risk that the Russian tax system will not be reformed to prevent
inconsistent, retroactive and/or exorbitant taxation; and (11) possible
difficulty in identifying a purchaser of securities held by a Fund due to the
underdeveloped nature of the securities markets.
There is little historical data on Russian securities markets because they are
relatively new and a substantial proportion of securities transactions in Russia
are privately negotiated outside of stock exchanges. Because of the recent
formation of the securities markets as well as the underdeveloped state of the
banking and telecommunications systems, settlement, clearing and registration of
securities transactions are subject to significant risks. Ownership of shares
(except where shares are held through depositories that meet the requirements of
the 1940 Act) as defined according to entries in the company's share register
and normally evidenced by extracts from the register or by formal share
certificates. However, there is no central registration system for shareholders
and these services are carried out by the companies themselves or by registrars
located throughout Russia. These registrars are not necessarily subject to
effective state supervision and it is possible for a Fund to lose its
registration through fraud, negligence or even mere oversight. While each Fund
will endeavor to ensure that its interest continues to be appropriately recorded
either itself or through a custodian or other agent inspecting the share
register and by obtaining extracts of share registers through regular
confirmations, these extracts have no legal enforceability and it is possible
that a subsequent legal amendment or other fraudulent act may deprive a Fund of
its ownership rights or improperly dilute its interests. In addition, while
applicable Russian regulations impose liability on registrars for losses
resulting from their errors, it may be difficult for a Fund to enforce any
rights it may have against the registrar or issuer of the securities in the
event of loss of share registration. Furthermore, although a Russian public
enterprise with more than 1,000 shareholders is required by law to contract out
the maintenance of its shareholder register to an independent entity that meets
certain criteria, in practice this regulation has not always been strictly
enforced. Because of this lack of independence, management of a company may be
able to exert considerable influence over who can purchase and sell the
company's shares by illegally instructing the registrar to refuse to record
transactions in the share register. This practice may prevent a Fund from
investing in the securities of certain Russian companies deemed suitable by the
Investment Manager. Further, this also could cause a delay in the sale of
Russian companies securities by a Fund if a potential purchaser is deemed
unsuitable, which may expose the Fund to potential loss on the investment.
The Funds endeavor to buy and sell foreign currencies on as favorable a basis as
practicable. Some price spread on currency exchange (to cover service charges)
may be incurred, particularly when a Fund changes investment from one country to
another or when proceeds of the sale of Shares in U.S. dollars are used for the
purchase of securities in foreign countries. Also, some countries may adopt
policies which would prevent a Fund from transferring cash out of the country or
withhold portions of interest and dividends at the source, or impose other taxes
with respect to a Fund's investments in securities of issuers of that country.
There is the possibility of expropriation, nationalization or confiscatory
taxation, foreign exchange controls (which may include suspension of the ability
to transfer currency from a given country), default in foreign government
securities, political or social instability, or diplomatic developments which
could affect investments in securities of issuers in those nations.
Each Fund may be affected either unfavorably or favorably by fluctuations in the
relative rates of exchange between the currencies of different nations, by
exchange control regulations and by indigenous economic and political
developments. Some countries in which a Fund may invest may also have fixed or
managed currencies that are free floating against the U.S. dollar. Further,
certain currencies have experienced a steady devaluation relative to the U.S.
dollar. Any devaluations in the currencies in which a Fund's securities are
denominated may have a detrimental impact on the Fund.
11
PAGE
Through each Fund's flexible policy, the Investment Managers endeavor to avoid
unfavorable consequences and to take advantage of favorable developments in
particular nations where it places a Fund's investments. The exercise of this
flexible policy may include decisions to purchase securities with substantial
risk characteristics and other decisions such as changing the emphasis on
investments from one nation to another and from one type of security to another.
Some of these decisions may later prove profitable and others may not. No
assurance can be given that profits, if any, will exceed losses.
The Trustees consider at least annually the likelihood of the imposition by any
foreign government of exchange control restrictions which would affect the
liquidity of the Funds' assets maintained with custodians in foreign countries,
as well as the degree of risk from political acts of foreign governments to
which such assets may be exposed. The Trustees also consider the degree of risk
involved through the holding of portfolio securities in domestic and foreign
securities depositories (see "Investment Management and Other
Services -- Custodian"). However, in the absence of willful misfeasance, bad
faith or gross negligence on the part of the Investment Managers, or reckless
disregard of the obligations and duties under the Investment Management
Agreements, any losses resulting from the holding of a Fund's portfolio
securities in foreign countries and/or with securities depositories will be at
the risk of the Shareholders. No assurance can be given that the Trustees'
appraisal of the risks will always be correct or that such exchange control
restrictions or political acts of foreign governments might not occur.
There are several risks associated with the use of futures contracts and stock
index futures contracts as hedging techniques. A purchase or sale of a futures
contract may result in losses in excess of the amount invested. There can be
significant differences between the securities and futures markets that could
result in an imperfect correlation between the markets, causing a given hedge
not to achieve its objectives. The degree of imperfection of correlation depends
on circumstances such as variations in speculative market demand for futures,
including technical influences in futures trading, and differences between the
financial instruments being hedged and the instruments underlying the standard
contracts available for trading in such respects as interest rate levels,
maturities, and creditworthiness of issuers. A decision as to whether, when, and
how to hedge involves the exercise of skill and judgment, and even a well
conceived hedge may be unsuccessful to some degree because of market behavior or
unexpected interest rate trends.
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The daily limit establishes
the maximum amount that the price of a futures contract may vary either up or
down from the previous day's settlement price at the end of the current trading
session. Once the daily limit has been reached in a futures contract subject to
the limit, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day
and, therefore, does not limit potential losses because the limit may work to
prevent the liquidation of unfavorable positions. For example, futures prices
have occasionally moved to the daily limit for several consecutive trading days
with little or no trading, thereby preventing prompt liquidation of positions
and subjecting some holders of futures contracts to substantial losses.
There can be no assurance that a liquid market will exist at a time when a Fund
seeks to close out a futures position, and it would remain obligated to meet
margin requirements until the position is closed. The Funds which are authorized
to engage in futures transactions intend to purchase or sell futures only on
exchanges or boards of trade where there appears to be an active secondary
market, but there is no assurance that a liquid secondary market will exist for
any particular contract or at any particular time. In addition, many of the
futures contracts available may be relatively new instruments without a
significant trading history. As a result, there can be no assurance that an
active secondary market will develop or continue to exist.
Use of stock index futures for hedging may involve risks because of imperfect
correlations between movements in the prices of the stock index futures on the
one hand and movements in the prices of the securities being hedged or of the
underlying stock index on the other. Successful use of stock index futures by a
Fund for hedging purposes also depends upon the Investment Manager's ability to
predict correctly movements in the direction of the market, as to which no
assurance can be given.
The Funds may enter into a contract for the purchase or sale of a security
denominated in a foreign currency and may enter into a forward foreign currency
contract ("forward contract") in order to "lock in" the U.S. dollar price of the
security. In addition, when an Investment Manager believes that the currency of
a particular foreign country may suffer or enjoy a substantial movement against
12
PAGE
another currency, it may enter into a forward contract to sell or buy the amount
of the former foreign currency, approximating the value of some or all of the
Fund's portfolio securities denominated in such foreign currency. The projection
of short-term currency market movements is extremely difficult, and the
successful execution of a short-term hedging strategy is highly uncertain.
It is impossible to forecast with absolute precision the market value of
portfolio securities at the expiration of the contract. Accordingly, it may be
necessary for the Funds to purchase additional foreign currency on the spot
market (and bear the expense of such purchase) if the market value of the
security is less than the amount of foreign currency a Fund is obligated to
deliver and if a decision is made to sell the security and make delivery of the
foreign currency. Conversely, it may be necessary to sell on the spot market
some of the foreign currency received upon the sale of the portfolio security if
its market value exceeds the amount of foreign currency a Fund is obligated to
deliver.
If a Fund retains the portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss to the extent that there has
been movement in forward contract prices. If a Fund engages in an offsetting
transaction, it may subsequently enter into a new forward contract to sell the
foreign currency. Should forward prices decline during the period between a Fund
entering into a forward contract for the sale of a foreign currency and the date
it enters into an offsetting contract for the purchase of the foreign currency,
the Fund will realize a gain to the extent the price of the currency it has
agreed to sell exceeds the price of the currency it has agreed to purchase.
Should forward prices increase, a Fund will suffer a loss to the extent the
price of the currency it has agreed to purchase exceeds the price of the
currency it has agreed to sell.
INVESTMENT RESTRICTIONS
- ---------------------------------------------------------
The Funds have imposed upon themselves certain investment restrictions which,
together with their investment objectives, are fundamental policies except as
otherwise indicated. No changes in a Fund's investment objectives, policies or
investment restrictions (except those which are not fundamental policies) can be
made without the approval of the Shareholders of that Fund. For this purpose,
the provisions of the 1940 Act require the affirmative vote of the lesser of
either (a) 67% or more of the Fund's Shares present at a Shareholders' meeting
at which the holders of more than 50% of the outstanding Shares are present or
represented by proxy or (b) more than 50% of the outstanding Shares of the Fund.
In accordance with these restrictions, a Fund WILL NOT:
1. Invest in real estate or mortgages on real estate, or purchase or sell
commodity contracts, except that (i) the Bond, Asset Allocation, Developing
Markets, Growth, Mutual Discovery, Mutual Shares and Small Cap Funds may
invest in marketable securities secured by real estate or interests therein,
such as CMOs, or issued by companies or investment trusts which invest in
real estate or interests therein; and (ii) the Bond, Asset Allocation,
Developing Markets, International, Growth, Mutual Discovery, Mutual Shares
and Small Cap Funds may purchase and sell foreign currency futures and
financial futures; and (iii) the Stock, Asset Allocation, Developing
Markets, International, Growth, Mutual Discovery, Mutual Shares and Small
Cap Funds may purchase and sell stock index futures contracts; and (iv)
Templeton Bond Fund may purchase and sell bond index futures contracts.
2. With respect to 75% of its total assets, invest more than 5% of the total
value of its assets in the securities of any one issuer, or purchase more
than 10% of any class of securities of any one company, including more than
10% of its outstanding voting securities (except for investments in
obligations issued or guaranteed by the U.S. government or its agencies or
instrumentalities).
3. Act as an underwriter, or issue senior securities except as set forth in
Investment Restriction 5 below.
4. Lend money, except that all Funds may purchase publicly distributed bonds,
debentures, notes and other evidences of indebtedness and may buy from a
bank or broker-dealer U.S. Government obligations with a simultaneous
agreement by the seller to repurchase them at the original purchase price
plus accrued interest, and may lend their portfolio securities.
5. Borrow money for any purpose other than redeeming its Shares or purchasing
its Shares for cancellation, and then only as a temporary measure up to an
amount not exceeding 5% of the value of its total assets, except that the
Bond, Stock, Asset Allocation, and International Funds may borrow money in
amounts up to 30% of the value of its net assets. The Developing Markets,
Growth, Mutual Discovery, Mutual Shares and Small Cap Funds may borrow money
from banks in an amount up to 33 1/3% of
13
PAGE
the Fund's total assets (including the amount borrowed), but may not pledge,
mortgage or hypothecate its assets for any purpose, except to secure
borrowings and then only to an extent not greater than 15% of the Fund's
total assets. Arrangements with respect to margin for futures contracts,
forward contracts and related options are not deemed to be pledge of assets.
6. Invest more than 25% of its total assets in a single industry, except that
this limitation will not apply to investments in securities issued or
guaranteed by the U.S. government, its agencies or instrumentalities, or
repurchase agreements on such securities, and Templeton Money Market Fund
may invest in obligations issued by domestic banks (including certificates
of deposit, repurchase agreements, and bankers' acceptances) without regard
to this limitation.
As non-fundamental investment policies, which may be changed by the Board
without Shareholder approval, a Fund will not invest more than 15% of its total
assets in securities of foreign issuers which are not listed on a recognized
United States or foreign securities exchange, or more than 15% of its total
assets in (a) securities with a limited trading market, (b) securities subject
to legal or contractual restrictions as to resale, and (c) repurchase agreements
not terminable within seven days.
As a non-fundamental policy, the Growth, Small Cap, Mutual Discovery and Mutual
Shares Funds will not purchase or retain securities of any company in which
Trustees or officers of the Trust or of a Fund's Investment Manager,
individually owning more than 1/2 of 1% of these securities of such company, in
the aggregate own more than 5% of the securities of such company.
The Growth Investments Fund will not, as a non-fundamental policy, (i) invest
for purposes of control of an issuer, (ii) invest more than 5% in unseasoned
issuers, (iii) use margin accounts or (iv) invest more than 10% of its assets in
illiquid securities.
The Small Cap Investments Fund will not, as a non-fundamental policy, (i) invest
for purposes of control of an issuer, (ii) effect short sales or (iii) invest
more than 10% of its assets in illiquid securities.
The Mutual Discovery and Mutual Shares Investments Funds may make short sales,
but 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 the Fund's total
assets or the Fund's aggregate short sales of a particular class of securities
exceeds 25% of the outstanding securities of that class. These Funds may also
make short sales "against the box" without reference to such limitations. In
this type of short sale, at the time of the sale, the Funds own or have the
immediate and unconditional right to acquire at no additional cost the identical
security.
Whenever any investment policy or investment restriction states a maximum
percentage of a Fund's assets which may be invested in any security or other
property, it is intended that such maximum percentage limitation be determined
immediately after and as a result of the Fund's acquisition of such security or
property. The investment restrictions do not preclude a Fund from purchasing the
securities of any issuer pursuant to the exercise of subscription rights
distributed to a Fund by the issuer, unless such purchase would result in a
violation of investment restriction number 6, or the non-fundamental investment
policies discussed above.
14
PAGE
OFFICERS AND TRUSTEES
- --------------------------------------------------------------------------------
The Board of Trustees of the Trust (the "Board") has the responsibility for the
overall management of the Trust, including general supervision and review of its
investment activities. The Board, in turn, elects the officers of the Trust who
are responsible for administering the Trust'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 Trust under the 1940 Act are indicated by an
asterisk (*).
<TABLE>
<CAPTION>
Positions and Offices
Name, Address and Age with the Trust Principal Occupation During the Past Five Years
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
HARRIS J. ASHTON Trustee Director, RBC Holdings, Inc. (a bank holding company)
191 Clapboard Ridge and Bar-S Foods (a meat packing company); director or
Greenwich, CT 06830 trustee, as the case may be, of 50 of the investment
Age 65 companies in the Franklin Templeton Group of Funds; and
formerly President, Chief Executive Officer and Chairman
of the Board, General Host Corporation (nursery and
craft centers).
- ------------------------------------------------------------------------------------------------------------------
* NICHOLAS F. BRADY Trustee Chairman, Templeton Emerging Markets Investment Trust
The Bullitt House PLC, Templeton Latin America Investment Trust PLC, Darby
102 East Dover Street Overseas Investments, Ltd. And Darby Emerging markets
Easton, Maryland Investments LDC (investment firms) (1994-present);
Age 68 Chairman and Director, Templeton Central and Eastern
European Investment Company; Director, Templeton Global
Strategy Funds, Amerada Hess Corporation, Christiana
Companies, and the H.J. Heinz Company; director or
trustee as the case may be, of 21 of the investment
companies in the Franklin Templeton Group of Funds; and
formerly, Secretary of the United States Department of
Treasury (1988-1993) and Chairman of the Board, Dillon,
Read & Co., Inc. (investment banking) prior to 1988.
- ------------------------------------------------------------------------------------------------------------------
S. JOSEPH FORTUNATO Trustee Member of the law firm of Pitney, Hardin, Kipp & Szuch;
Park Avenue at Morris director or trustee, as the case may be, of 52 of the
County investment companies in the Franklin Templeton Group of
P.O. Box 1945 Funds; and formerly Director, General Host Corporation
Morristown, NJ 07962-1945 (nursery and craft centers).
Age 65
- ------------------------------------------------------------------------------------------------------------------
ANDREW H. HINES, JR. Trustee Consultant for the Triangle Consulting Group; Exec-
150 2nd Avenue N. utive-in-Residence of Eckerd College (1991-present);
St.Petersburg, FL 33701 director or trustee, as the case may be, of 22 of the
Age 75 investment companies in the Franklin Templeton Group of
Funds; and formerly, Director, Checkers Driving
Restaurant, Inc.; Chairman of the Board and Chief
Executive Officer, Florida Progress Corporation
(1982-1990) and director of various of its subsidiaries.
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
15
PAGE
<TABLE>
<CAPTION>
Positions and Offices
Name, Address and Age with the Trust Principal Occupation During the Past Five Years
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
EDITH E. HOLIDAY Trustee Director (1993-present), Amerada Hess Corporation and
3239 38th Street, N.W. Hercules Incorporated; Director, Beverly Enterprises,
Washington, DC 20016 Inc. (1995-present) and H.J. Heinz Company
Age 46 (1994-present); director or trustee, as the case may be,
of 25 of the investment companies in the Franklin
Templeton Group of Funds; and formerly, chairman
(1995-1997) and trustee (1993-1997), National Child
Research Center, assistant to the President of the
United States and Secretary of the Cabinet (1990-1993),
general counsel to the United States Treasury Department
(1989-1990) and counselor to the Secretary and Assistant
Secretary for Public Affairs and Public
Liaison -- United States Treasury Department
(1988-1989).
- ------------------------------------------------------------------------------------------------------------------
* CHARLES B. JOHNSON Vice President and President, Chief Executive Officer and Director,
777 Mariners Island Blvd. Trustee Franklin Resources, Inc.; Chairman of the Board and
San Mateo, CA 94404 Director, Franklin Advisers, Inc., Franklin Advisory
Age 65 Services, Inc., Franklin Investment Advisory Services,
Inc. and Franklin Templeton Distributors, Inc.;
Director, Franklin/Templeton Investor Services, Inc. and
Franklin Templeton Services, Inc. officer and/or
director or trustee, as the case may be, of most of the
other subsidiaries of Franklin Resources, Inc. and of 51
of the investment companies in the Franklin Templeton
Group of Funds; and formerly, Director, General Host
Corporation (nursery and craft centers).
- ------------------------------------------------------------------------------------------------------------------
BETTY P. KRAHMER Trustee Director or Trustee of various civic associations;
2201 Kentmere Parkway director or trustee, as the case may be, of 21 of the
Wilmington, Delaware investment companies in the Franklin Templeton Group of
Age 68 Funds; and formerly, Economic Analyst, U.S. government.
- ------------------------------------------------------------------------------------------------------------------
GORDON S. MACKLIN Trustee Chairman, White River Corporation (financial ser-
8212 Burning Tree Road vices); Director, Fund American Enterprises Holdings,
Bethesda, MD 20817 Inc., MCI Communications Corporation, CCC Information
Age 69 Services Group, Inc. (information services), MedImmune,
Inc. (biotechnology), Spacehab, Inc. (aerospace
services) and Real 3D (software); director or trustee,
as the case may be, of 50 of the investment companies in
the Franklin Templeton Group of Funds; and FORMERLY,
Chairman, Hambrecht and Quist Group, Director, H & Q
Healthcare Investors and Lockheed Martin Corporation and
President, National Association of Securities Dealers,
Inc.
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
16
PAGE
<TABLE>
<CAPTION>
Positions and Offices
Name, Address and Age with the Trust Principal Occupation During the Past Five Years
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
FRED R. MILLSAPS Trustee Manager of personal investments (1978-present); director
2665 NE 37th Drive of various business and nonprofit organizations;
Fort Lauderdale, FL 33394 director or trustee, as the case may be, of 22 of the
Age 69 investment companies in the Franklin Templeton Group of
Funds; and formerly, Chairman and Chief Executive
Officer of Landmark Banking Corporation (1969-1978),
Financial Vice President of Florida Power and Light
(1965-1969) and Vice President of the Federal Reserve
Bank of Atlanta (1958-1965).
- ------------------------------------------------------------------------------------------------------------------
CHARLES E. JOHNSON President Senior Vice President and Director, Franklin Resources,
500 East Broward Blvd. Inc.; Senior Vice President, Franklin Templeton
Fort Lauderdale, FL Distributors, Inc.; President and Director, Templeton
33394-3091 Worldwide, Inc.; President, Chief Executive Officer,
Age 41 Chief Investment Officer and Director, Franklin
Institutional Services Corporation; Chairman and
Director, Templeton Investment Counsel, Inc.; Vice
President, Franklin Advisers, Inc.; officer and/or
director of some of the subsidiaries of Franklin
Resources, Inc.; and officer and/or director or trustee,
as the case may be, of 35 of the investment companies in
the Franklin Templeton Group of Funds.
- ------------------------------------------------------------------------------------------------------------------
HARMON E. BURNS Vice President Executive Vice President and Director, Franklin
777 Mariners Island Blvd. Resources, Inc.; Executive Vice President and Director,
San Mateo, CA 94404 Franklin Templeton Distributors, Inc. and Franklin
Age 53 Templeton Services, Inc.; Executive Vice President,
Franklin Advisers, Inc.; Director, Franklin/Templeton
Investor Services, Inc.; and officer and/or director or
trustee, as the case may be, of most of the other
subsidiaries of Franklin Resources, Inc. and of 54 of
the investment companies in the Franklin Templeton Group
of Funds.
- ------------------------------------------------------------------------------------------------------------------
MARTIN L. FLANAGAN Vice President Senior Vice President and Chief Financial Officer,
777 Mariners Island Blvd. Franklin Resources, Inc.; Executive Vice President and
San Mateo, CA 94404 Director, Templeton Worldwide, Inc.; Executive Vice
Age 37 President, Chief Operating Officer and Director,
Templeton Investment Counsel, Inc.; Senior Vice
President and Treasurer, Franklin Advisers, Inc.;
Treasurer, Franklin Advisory Services, Inc.; Treasurer
and Chief Financial Officer, Franklin Investment
Advisory Services, Inc.; President, Franklin Templeton
Services, Inc.; Senior Vice President,
Franklin/Templeton Investor Services, Inc.; and officer
and/or director or trustee, as the case may be, of 56 of
the investment companies in the Franklin Templeton Group
of Funds.
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
17
PAGE
<TABLE>
<CAPTION>
Positions and Offices
Name, Address and Age with the Trust Principal Occupation During the Past Five Years
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
SAMUEL J. FORESTER, JR. Vice President Vice President of 10 of the investment companies in the
500 East Broward Blvd. Franklin Templeton Group of Funds; and formerly,
Fort Lauderdale, Florida President, Templeton Global Bond Managers, a division of
Age 49 Templeton Investment Counsel, Inc.; founder and partner
of Forester, Hairston Investment Management (1989-1990),
Managing Director (Mid-East Region), Merrill Lynch,
Pierce, Fenner & Smith Inc. (1987-1988) and Advisor for
Saudi Arabian Monetary Agency (1982-1987).
- ------------------------------------------------------------------------------------------------------------------
DEBORAH R. GATZEK Vice President Senior Vice President and General Counsel, Franklin
777 Mariners Island Blvd. Resources, Inc.; Senior Vice President, Franklin
San Mateo, CA 94404 Templeton Services, Inc. and Franklin Templeton
age 49 Distributors, Inc.; Vice President, Franklin Advisers,
Inc. and Franklin Advisory Services, Inc.; Vice Pres-
ident, Chief Legal Officer and Chief Operating Officer,
Franklin Investment Advisory Services, Inc.; and officer
of 54 of the investment companies in the Franklin
Templeton Group of Funds.
- ------------------------------------------------------------------------------------------------------------------
MARK G. HOLOWESKO Vice President President and Chief Investment Officer, Templeton Global
Lyford Cay Advisors Limited; Executive Vice President and Director,
Nassau, Bahamas Templeton Worldwide, Inc.; officer of 21 of the
Age 38 investment companies in the Franklin Templeton Group of
Funds; and formerly, Investment Administrator with
RoyWest Trust Corporation (Bahamas) Limited (1984-1985).
- ------------------------------------------------------------------------------------------------------------------
RUPERT H. JOHNSON, JR. Vice President Executive Vice President and Director, Franklin
777 Mariners Island Blvd. Resources, Inc. and Franklin Templeton Distributors,
San Mateo, CA 94404 Inc.; President and Director, Franklin Advisers, Inc.;
Age 57 Senior Vice President and Director, Franklin Advisory
Services, Inc. and Franklin Investment Advisory
Services, Inc.; Director, Franklin/Templeton Investor
Services, Inc.; and officer and/or director or trustee,
as the case may be, of most of the other subsidiaries of
Franklin Resources, Inc. and of 54 of the investment
companies in the Franklin Templeton Group of Funds.
- ------------------------------------------------------------------------------------------------------------------
JOHN R. KAY Vice President Vice President and Treasurer, Templeton Worldwide, Inc.;
500 East Broward Blvd. Assistant Vice President, Franklin Templeton
Fort Lauderdale, Florida Distributors, Inc.; officer of 25 of the investment
Age 57 companies in the Franklin Templeton Group of Funds; and
formerly, Vice President and Controller, Keystone Group,
Inc.
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
18
PAGE
<TABLE>
<CAPTION>
Positions and Offices
Name, Address and Age with the Trust Principal Occupation During the Past Five Years
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ELIZABETH M. KNOBLOCK Vice President, General Counsel, Secretary and Senior Vice President,
500 East Broward Blvd. Compliance Templeton Investment Counsel, Inc.; Senior Vice
Fort Lauderdale, Florida President, Templeton Global Investors, Inc.; officer of
Age 43 21 of the investment companies in the Franklin Templeton
Group of Funds; and formerly, Vice President and
Associate General Counsel, Kidder Peabody & Co. Inc.
(1989-1990), Assistant General Counsel, Gruntal & Co.,
Inc. (1988), Vice President and Associate General
Counsel, Shearson and Lehman Hutton Inc. (1986-1988),
and Special Counsel of the Division of Investment
Management of the U.S. Securities and Exchange
Commission (1984-1986).
- ------------------------------------------------------------------------------------------------------------------
THOMAS LATTA Vice President Vice President, Templeton Global Bond Managers, a
500 East Broward Blvd. division of Templeton Investment Counsel, Inc., and
Fort Lauderdale, Florida formerly, Portfolio Manager at Forester & Hairston
Age 37 (1988-1990) and investment advisor at Merrill Lynch
Capital Markets (1981-1988).
- ------------------------------------------------------------------------------------------------------------------
BARBARA J. GREEN Secretary Senior Vice President, Templeton Worldwide, Inc.; Senior
500 East Broward Blvd. Vice President, Templeton Global Investors, Inc.;
Fort Lauderdale, Florida officer of 21 of the investment companies in the
Age 50 Franklin Templeton Group of Funds; and formerly, Deputy
Director of the Division of Investment Management,
Executive Assistant and Senior Advisor to the Chairman,
Counselor to the Chairman, Special Counsel and Attorney
Fellow, U.S. Securities and Exchange Commission
(1986-1995), Attorney, Roger & Wells, and Judicial
Clerk, U.S. District Court (District of Massachusetts).
- ------------------------------------------------------------------------------------------------------------------
JAMES R. BAIO Treasurer Certified Public Accountant; Treasurer, Franklin Mutual
500 East Broward Blvd. Advisers, Inc.; Senior Vice President, Templeton
Fort Lauderdale, FL Worldwide, Inc., Templeton Global Investors, Inc. and
33394-3091 Templeton Funds Trust Company; and officer of 22 of the
Age 43 investment companies in the Franklin Templeton Group of
Funds; and formerly, Senior Tax Manager for Ernst &
Young (certified public accountants) (1977-1989).
</TABLE>
- --------------------------------------------------------------------------------
* These are Trustees who are "interested persons" of the Trust as that term is
defined in the 1940 Act. Charles B. Johnson is an interested person due to his
ownership interest in Franklin Resources, Inc. Mr. Brady and Franklin Resources,
Inc. are limited partners of Darby Overseas Partners, L.P. ("Darby Overseas").
Mr. Brady established Darby Overseas in February 1994, and is Chairman and a
shareholder of the corporate general partner of Darby Overseas. In addition,
Darby Overseas and Templeton Global Advisors Limited are limited partners of
Darby Emerging Markets Fund, L.P. The remaining Trustees are not interested
persons ("Independent Trustees").
The preceding table also shows the Officers and Trustees who are affiliated with
the Trust's Principal Underwriter and Investment Managers.
Nonaffiliated trustees and Mr. Brady are paid an annual retainer and/or fees for
attendance at Board and Committee meetings, the amount of which is based on the
level of assets in each fund. Accordingly, the Trust currently pays the
independent Trustees and Mr. Brady an annual retainer of $6,000.00 and a fee of
$500.00 per meeting attended of the Board and its Committees. As shown above,
some of the nonaffiliated Trustees also serve as directors, trustees or managing
general partners of other investment companies in the Franklin Templeton Group
of Funds.
The following table shows the total fees paid to the nonaffiliated Trustees and
Mr. Brady by the Trust
19
PAGE
and by all investment companies in the Franklin Templeton Group of Funds:
<TABLE>
<CAPTION>
TOTAL FEES NUMBER OF BOARDS IN
TOTAL FEES RECEIVED FROM THE THE FRANKLIN TEMPLETON
RECEIVED FROM FRANKLIN TEMPLETON GROUP OF FUNDS ON
NAME THE TRUST* GROUP OF FUNDS* WHICH EACH SERVES**
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Harris J. Ashton...................... $8,000 $344,642 50
Nicholas F. Brady..................... 8,000 119,675 21
S. Joseph Fortunato................... 8,000 361,562 52
Andrew H. Hines, Jr................... 9,984 144,175 22
Edith E. Holiday...................... 8,000 72,875 25
Betty P. Krahmer...................... 8,000 119,675 21
Gordon S. Macklin..................... 8,000 337,292 50
Fred R. Millsaps...................... 8,354 144,175 22
</TABLE>
* For the fiscal year ended December 31, 1997.
** We base the number of boards on the number of registered investment companies
in the Franklin Templeton Group of Funds. This number does not include the total
number of series or funds within each investment company for which the Board
members are responsible. The Franklin Templeton Group of Funds currently
includes 57 registered investment companies, with approximately 170 U.S. based
funds or series.
Nonaffiliated members of the Board and Mr. Brady are reimbursed for expenses
incurred in connection with attending board meetings, and paid pro rata by each
fund in the Franklin Templeton Group of Funds for which they serve as director
or trustee. No officer or Board member received any other compensation,
including pension or retirement benefits, directly or indirectly from the Fund
or other funds in the Franklin Templeton Group of Funds. Certain officers or
Board members who are shareholders of Resources, Inc. may be deemed to receive
indirect remuneration by virtue of their participation, if any, in the fees paid
to its subsidiaries.
As of April 1, 1998, the officers and Trustees did not own of record or
beneficially any shares of the Trust. Many of the Board members own shares in
other funds in the Franklin Templeton Group of Funds. Charles B. Johnson and
Rupert H. Johnson, Jr. are brothers and the father and uncle, respectively, of
Charles E. Johnson.
Principal Shareholders. Shares of the Fund are sold to and owned only by
insurance company separate accounts to serve as the investment vehicle for
variable annuity and life insurance contracts.
As of March 31, 1998, there were 10,893,216 Shares of Templeton Money Market
Fund outstanding; 2,952,641 Shares of Templeton Bond Fund outstanding;
33,946,400 Shares Class 1 of Templeton Stock Fund outstanding; 900,976 Shares of
Class 2 of Templeton Stock Fund outstanding; 34,195,771 Shares of Class 1 of
Templeton Asset Allocation Fund outstanding; 533,507 Shares of Class 2 of
Templeton Asset Allocation Fund outstanding; 49,213,960 Shares of Class 1 of
Templeton International Fund outstanding; 1,186,498 Shares of Class 2 of
Templeton International Fund outstanding; 28,648,740 Shares Class 1 of Templeton
Developing Markets Fund outstanding; 2,064,094 Shares Class 2 of Templeton
Developing Markets Fund outstanding. As of March 31, 1998, Phoenix Home Mutual
Life Insurance Company ("Phoenix Home Life") owned 100%, 51%, 43%, 20% and 12%,
respectively, of the outstanding Shares of Class 1 of Templeton Money Market
Fund, Templeton Bond Fund, Templeton Stock Fund, Templeton Asset Allocation
Fund, and Templeton International Fund, respectively. As of March 31, 1998, The
Travelers Insurance Company ("The Travelers") owned 56%, 48% and 35%,
respectively of the outstanding Shares of Class 1 of Templeton Stock Fund,
Templeton Bond Fund and Templeton Asset Allocation Fund, respectively. As of
March 31, 1998, the Variable Annuity Life Insurance Company ("VALIC") owned 78%
and 44% of the outstanding Shares of Class 1 of Templeton International Fund and
Templeton Asset Allocation Fund. As of March 31, 1998, IDS/American Express
("IDS/AMEX"), a Minnesota Corporation, on behalf of the Flexible Portfolio
Annuity, owned 90% of the outstanding Shares of Class 1 of Templeton Developing
Markets Fund. As of March 31, 1998, Hartford Insurance Group ("Hartford"), owned
5% of the outstanding Shares of Class 1 of Templeton Developing Markets Fund.
However, Phoenix Home Life, The Travelers, VALIC and IDS/AMEX will exercise
voting rights attributable to these Shares in accordance with voting
instructions received by owners of the contracts issued by Phoenix Home Life,
The Travelers, VALIC and IDS/AMEX. To this extent, Phoenix Home Life, The
Travelers, VALIC and IDS/AMEX do not exercise control over the Trust by virtue
of the voting rights from their ownership on Trust Shares. As of March 31, 1998,
Phoenix Home Mutual Life Insur-
20
PAGE
ance Company ("Phoenix Home Life") owned 100%, 88%, 69% and 52%, respectively,
of the outstanding Shares of Class 2 of Templeton Asset Allocation Fund,
Templeton Stock Fund, Templeton International Fund and Templeton Developing
Markets Fund, respectively. As of March 31, 1998, CUNA Mutual Life Insurance
("CUNA") owned 36% of the outstanding Shares of Class 2 of the Templeton
Developing Markets Fund. As of March 31, 1998, Union Central Life Insurance
("Union") owned 30% and 9% of the outstanding Shares of Class 1 of Templeton
International Fund and Templeton Stock Fund. As of March 31, 1998, Minnesota
Mutual Life Insurance Company ("MIMLIC") owned 10% of the outstanding Shares of
Class 2 of Templeton Developing Markets Fund. To the knowledge of management, as
of March 31, 1998, no other person owned of record or beneficially 5% or more of
the Shares of any of the Funds.
INVESTMENT MANAGEMENT AND
OTHER SERVICES
- ---------------------------------------------------------
Investment Managers and Services Provided. The Investment Manager of Money
Market Fund and Bond Fund is the Templeton Global Bond Managers division
("TGBM") of Templeton Investment Counsel, Inc. ("TICI"), a Florida corporation
with offices in Fort Lauderdale, Florida. The Investment Manager of Asset
Allocation Fund, Stock Fund, and International Fund is TICI. The Investment
Manager of Developing Markets Fund is Templeton Asset Management Ltd.
("Templeton Singapore"). The Investment Manager of Growth Fund and Small Cap
Fund is Franklin Advisers, Inc. ("Advisers"). The Investment Manager of Mutual
Discovery Fund and Mutual Shares Fund is Franklin Mutual Advisers, Inc. ("Mutual
Advisers"). The Investment Managers are indirect wholly owned subsidiaries of
Franklin Resources, Inc. ("Resources"), a publicly traded company whose shares
are listed on the NYSE.
The Investment Managers provide investment research and portfolio management
services, including the selection of securities for the Funds to buy, hold or
sell, and the selection of brokers through whom the Fund's portfolio
transactions are executed. Their activities are subject to the review and
supervision of the Board to whom they render periodic reports of the Funds'
investment activities. The Investment Managers are covered by fidelity insurance
on their officers, directors and employees for the protection of the Funds.
The Investment Managers also provide management services to numerous other
investment companies or funds and accounts pursuant to management agreements
with each fund or account. The Investment Managers may give advice and take
action with respect to any of the other funds and accounts they manage, or for
their own accounts, which may differ from the action taken by an Investment
Manager on behalf of a Fund. Similarly, with respect to a Fund, an Investment
Manager is not obligated to recommend, purchase or sell, or to refrain from
recommending, purchasing or selling any security that the Investment Manager and
access persons, as defined by the 1940 Act, may purchase or sell for its or
their own account or for the accounts of any other fund or accounts.
The Investment Managers are not obligated to refrain from investing in
securities held by a Fund or other funds which they manage or administer. Of
course, any transactions for the accounts of the investment Managers and other
access persons will be made in compliance with the Trust's Code of Ethics as
described in the section "Brokerage Allocation -- Summary of Code of Ethics."
The Investment Management Agreements will continue in effect through February
1998 and from year to year thereafter subject to approval annually by the Board
or by vote of a majority of the outstanding Shares of each Fund (as defined in
the 1940 Act) and also, in either event, the approval of a majority of those
Trustees who are not parties to the Management Agreements or interested persons
of any such party in person at a meeting called for the purpose of voting on
such approval.
Management Fees. For its services, Money Market Fund pays its Investment Manager
a monthly fee equal on an annual basis to 0.35% of its average daily net assets
up to $200 million; reduced to 0.30% of such net assets from $200 million up to
$1.3 billion; and further reduced to 0.25% of such net assets in excess of $1.3
billion.
Bond Fund pays its Investment Manager a monthly fee equal on an annual basis to
0.50% of its average daily net assets up to $200 million; reduced to 0.45% of
such net assets from $200 million up to $1.3 billion; and further reduced to
0.40% of such net assets in excess of $1.3 billion.
Asset Allocation Fund pays its Investment Manager a monthly fee equal on an
annual basis to 0.65% of its average daily net assets up to $200 million;
reduced to 0.585% of such net assets from $200 million up to $1.3 billion; and
further reduced to 0.52% of such net assets in excess of $1.3 billion.
21
PAGE
Stock and International Funds pay their Investment Manager a monthly fee equal
on an annual basis to 0.75% of its average daily net assets up to $200 million;
reduced to 0.675% of such net assets from $200 million up to $1.3 billion; and
further reduced to 0.60% of such net assets in excess of $1.3 billion.
Developing Markets Fund pays its Investment Manager a monthly fee equal on an
annual basis to 1.25% of its average daily net assets.
The Growth Fund is obligated to pay Advisers a monthly fee, based upon the
Fund's average daily net assets, computed at the annual rate of 0.60% of average
daily net assets on the first $200 million of average daily net assets; 0.50% of
such assets in excess of $200 million up to $1.2 billion; and 0.40% of such
assets in excess of $1.2 billion.
The Small Cap Fund is obligated to pay Advisers a monthly fee, based on the
Fund's average daily net assets, computed at the annual rate of 0.75% of average
daily net assets on the first $200 million of average daily net assets; 0.65% of
such assets in excess of $200 million up to $1.2 billion of average daily net
assets; and 0.55% of such assets in excess of $1.2 billion.
The Mutual Discovery Fund and Mutual Shares Fund are obligated to pay Franklin
Mutual a monthly fee, based upon each Fund's average daily net assets, computed
at the annual rate of 0.80% and 0.60%, respectively of average daily net assets.
During the fiscal years ended December 31, 1997, 1996 and 1995, the Funds paid
the following investment management fees:
<TABLE>
<CAPTION>
FUND NAME 1997 1996 1995
- -----------------------------------------------------------
<S> <C> <C> <C>
Money Market Fund.... $ 48,465 $ 55,132 $ 74,375
Bond Fund............ 164,371 162,273 156,062
Stock Fund........... 4,629,013 2,627,573 2,102,259
Asset Allocation
Fund............... 3,834,087 2,245,898 1,662,023
International Fund... 5,356,048 2,445,202 1,222,834
Developing Markets
Fund............... 1,859,449 293,918 NA
</TABLE>
The Investment Managers may determine in advance to limit the management fees or
to assume responsibility for the payment of certain operating expenses relating
to the operation of any Fund, which may have the effect of decreasing the total
expenses and increasing the total return of such Fund. Any such action is
voluntary and may be terminated by the Investment Managers at any time unless
otherwise indicated.
For the fiscal year ended December 31, 1996, management fees for the Developing
Markets Fund, before any advance waiver, totaled $313,283. Under an agreement by
the Investment Manager to limit its fees, the Fund paid management fees totaling
$293,918.
FUND ADMINISTRATOR. Templeton Funds Annuity Company ("TFAC") performs certain
administrative functions as Fund Administrator for the Trust. These include
preparing and maintaining books, records and tax and financial reports, and
monitoring compliance with regulatory requirements. TFAC is a wholly owned and
subsidiary of Resources.
For its services, the Fund Administrator receives a monthly fee equal on an
annual basis to 0.15% of the combined average daily net assets of the Trust (all
Funds); reduced to 0.135% of the Trust's aggregate net assets in excess of $200
million; further reduced to 0.10% annually of such net assets in excess of $700
million; and further reduced to 0.075% annually of such net assets in excess of
$1.2 billion. The fee is allocated among the Funds according to their respective
average daily net assets. During the fiscal years ended December 31, 1997, 1996,
and 1995, the Fund Administrator received fees of $2,426,200, $1,801,632 and
$1,380,760, respectively.
CUSTODIAN. The Chase Manhattan Bank, N.A. serves as Custodian of the Trust's
assets, which are maintained at the Custodian's principal office, MetroTech
Center, Brooklyn, New York, New York 11245 and at the offices of its branches
and agencies throughout the world. The Custodian has entered into agreements
with foreign sub-custodians approved by the Trustees pursuant to Rule 17f-5
under the 1940 Act. The Bank of New York, Mutual Funds Division, 90 Washington
Street, New York, New York 10286, acts as custodian of the securities and other
assets of the Growth and Small Cap Funds. The Custodians, their branches and
sub-custodians, generally domestically and frequently abroad, do not actually
hold certificates for the securities in their custody, but instead have book
records with domestic and foreign securities depositories, which in turn have
book records with the transfer agents of the issuers of the securities.
Compensation for the services of the Custodian is based on a schedule of charges
agreed on from time to time. The Custodians do not participate in decisions
relating to the purchase and sale of portfolio securities.
LEGAL COUNSEL. Dechert Price & Rhoads, 1775 Eye Street, N.W., Washington, D.C.
20006, is legal counsel for the Trust.
22
PAGE
INDEPENDENT AUDITORS. McGladrey & Pullen, LLP, 555 Fifth Avenue, New York, New
York 10017 are the independent auditors for the Trust. During the fiscal year
ended December 31, 1997, their audit services consisted of rendering an opinion
on the financial statements of the Trust included in the Trust's Annual Report
to Shareholders for the fiscal year ended December 31, 1997, and review of the
Trust's filing with the SEC.
REPORTS TO SHAREHOLDERS. The Trust's fiscal year ends on December 31.
Shareholders are provided at least semiannually with reports showing the Funds'
portfolios and other information, including an annual report with financial
statements audited by independent accountants. Shareholders who would like to
receive an interim quarterly report may phone the Fund Information Department at
1-800/DIAL BEN.
BROKERAGE ALLOCATION
- ---------------------------------------------------------
The Investment Managers select brokers and dealers to execute the Funds'
portfolio transactions in accordance with criteria set forth in the management
agreements and any directions that the Board may give.
When placing a portfolio transaction, the Investment Managers seek to obtain
prompt execution of orders at the most favorable net price. For portfolio
transactions on a securities exchange, the amount of commission paid by a Fund
is negotiated between the Investment Managers 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. The
Investment Managers 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 the Investment Managers, 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.
The Investment Managers may pay certain brokers commissions that are higher than
those another broker may charge, if the Investment Managers determine in good
faith that the amount paid is reasonable in relation to the value of the
brokerage and research services they receive. This may be viewed in terms of
either the particular transaction or the Investment Managers' overall
responsibilities to client accounts over which they exercise investment
discretion. The services that brokers may provide to the Investment Managers
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 the Investment
Managers in carrying out their investment advisory responsibilities. These
services may not always directly benefit a Fund. They must, however, be of value
to the Investment Managers in carrying out their overall responsibilities to
their clients.
Since most purchases by certain of the Portfolios are principal transactions at
net prices, these Portfolios incur little or no brokerage costs. The Portfolios
deal directly with the selling or buying principal or market maker without
incurring charges for the services of a broker on their behalf, unless it is
determined that a better price or execution may be obtained by using the
services of a broker. Purchase 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 prices. The
Portfolios seek to obtain prompt execution of orders at the most favorable net
price. Transaction may be directed to dealers in return for research and
statistical information, as well as for special services provided by the dealers
in the execution of orders.
It is not possible to place a dollar value on the special executions or on the
research services the Investment Managers receive from dealers effecting
transactions in portfolio securities. The allocation of transactions in order to
obtain additional research services permits the Investment Managers to
supplement their 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, the Investment Managers and their
affiliates may use this research and data in their investment advisory
capacities with other clients. If a Fund's officers are satisfied that the best
execution is obtained, the sale of Fund shares, as well as shares of other funds
in the Franklin Templeton Group of Funds, may also be considered a factor in the
selection of
23
PAGE
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 the Investment Managers will be reduced by the amount of any fees
received by Distributors in cash, less any costs and expenses incurred in
connection with the tender.
If purchases or sales of securities of a Fund and one or more other investment
companies or clients supervised by the Investment Managers are considered at or
about the same time, transactions in these securities will be allocated among
the several investment companies and clients in a manner deemed equitable to all
by the Investment Managers, taking into account the respective sizes of the
funds and the amount of securities to be purchased or sold. In some cases this
procedure could have a detrimental effect on the price or volume of the security
so far as a Fund is concerned. In other cases it is possible that the ability to
participate in volume transactions may improve execution and reduce transaction
costs to a Fund.
During the fiscal years ended December 31, 1997, 1996 and 1995, the Trust paid
brokerage commissions totaling $3,895,650, $2,594,403, and $1,525,000,
respectively.
The following table identifies each Fund which held securities of its regular
brokers or dealers during 1997, the names of each such broker or dealer, and the
value, if any, of such securities held by each Fund as of December 31, 1997.
<TABLE>
<CAPTION>
VALUE ON
FUND REGULAR BROKER OR DEALER 12/31/97
- ------------------------------------------------------------
<S> <C> <C>
Asset Allocation
Fund............... Credit Suisse Group $ 2,357,952
HSBC Holdings, PLC $ 5,777,571
Jardine Matheson $ 1,126,080
Holdings, Ltd.
Morgan Stanley, Dean $ 8,831,265
Witter Discover & Co.
Peregrine Investments $ 248,464
Holdings, Ltd.
Developing
Markets Fund....... HSBC Holdings, PLC $ 2,602,865
Jardine Matheson $ 44,120
Holdings, Ltd.
International
Fund............... Credit Suisse Group $ 1,546,198
HSBC Holdings, PLC $ 8,824,106
Jardine Matheson $ 2,924,687
Holdings, Ltd.
Peregrine Investments $ 853,142
Holdings Ltd.
Stock Fund........... Credit Suisse Group $ 6,184,791
Deutsche Bank, AG $ 8,950,750
HSBC Holdings, PLC $11,499,980
Jardine Matheson $ 2,679,382
Holdings, Ltd.
Morgan Stanley, Dean $ 7,328,045
Witter Discover & Co.
</TABLE>
Portfolio Turnover. It is anticipated that the rate of portfolio turnover as
defined above for Stock, Asset Allocation, International and Developing Markets
Funds will be less than 50%, and for the Bond, Mutual Discovery, Mutual Shares,
Small Cap and the Growth Funds less than 100%, under normal market conditions.
Portfolio turnover could be greater in periods of unusual market movement and
volatility. Bond Fund's portfolio turnover rates for the fiscal years ended
December 31, 1997 and 1996 were 154.23% and 141.19%, respectively. These rates
exceed the anticipated portfolio turnover rate for the Fund as a result of
changing interest rates and currency exposure considerations.
24
PAGE
Summary of Code of Ethics. Employees of Resources and/or its affiliates who are
access persons under the 1940 Act are permitted to engage in personal securities
transactions subject to the following general restrictions and procedures: (i)
the trade must receive advance clearance from a compliance officer and must be
completed by the close of the business day following the day clearance is
granted; (ii) copies of all brokerage confirmations and statements must be sent
to a compliance officer; (iii) all brokerage accounts must be disclosed on an
annual basis; and, (iv) access persons involved in preparing and making
investment decisions must, in addition to (i), (ii) and (iii) above, file annual
reports of their securities holdings each January and inform the compliance
officer (or other designated personnel) if they own a security that is being
considered for a fund or other client transaction or if they are recommending a
security in which they have an ownership interest for purchase or sale by a
portfolio or other client.
PURCHASE, REDEMPTION AND
PRICING OF SHARES
- ---------------------------------------------------------
The Prospectus describes the manner in which a Fund's Shares may be purchased
and redeemed. See "How to Buy Shares of the Funds" and "How to Sell Shares of
the Funds." Net asset value per Share is calculated separately for each Fund.
Net Asset Value per Share is determined as of the close of the NYSE (normally
4:00 p.m., New York time) every Monday through Friday (exclusive of national
business holidays). The Trust's offices will be closed, and net asset value will
not be calculated, on those days on which the NYSE is closed. As of the date of
this SAI, the fund is informed that the NYSE observes the following holidays:
New Year's Day, Martin Luther King Jr. Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
MONEY MARKET FUND. The valuation of the Money Market Fund's portfolio
securities, including any securities held in a separate account maintained for
when-issued securities, is based on the amortized cost of the securities, which
does not take into account unrealized capital gains or losses. This method
involves valuing an instrument at its cost and thereafter assuming a constant
amortization to maturity of any discount or premium, regardless of the impact of
fluctuating interest rates on the market value of the instrument. While this
method provides certainty in calculation, it may result in periods during which
value, as determined by amortized cost, is higher or lower than the price the
Fund would receive if it sold the instrument. During periods of declining
interest rates, the daily yield on shares of the Fund computed as described
above may tend to be higher than a like computation made by a fund with
identical investments but utilizing a method of valuation based upon market
prices and estimates of market prices for all of its portfolio instruments.
Thus, if the use of amortized cost by the Fund resulted in a lower aggregate
portfolio value on a particular day, a prospective investor in the Fund would be
able to obtain a somewhat higher yield than would result from an investment in a
fund utilizing only market values, and existing investors in the Fund would
receive less investment income. The opposite would be true in a period of rising
interest rates.
The Fund's use of amortized cost, which helps the Fund maintain its Net Asset
Value per share of $1, is permitted by a rule adopted by the SEC. Under this
rule, the Fund must adhere to certain conditions. The Fund must maintain a
dollar-weighted average portfolio maturity of 90 days or less and only buy
instruments having remaining maturities of 397 calendar days or less. The Fund
must also invest only in those U.S. dollar-denominated securities that the Board
determines present minimal credit risks and that are rated in one of the two
highest rating categories by nationally recognized rating services, or if
unrated are deemed comparable in quality, or are instruments issued by an issuer
that, with respect to an outstanding issue of short-term debt that is comparable
in priority and protection, has received a rating within the two highest rating
categories. Securities subject to floating or variable interest rates with
demand features that comply with applicable SEC rules may have stated maturities
in excess of one year.
The Board has established procedures designed to stabilize, to the extent
reasonably possible, the Fund's price per share at $1, as computed for the
purpose of sales and redemptions. These procedures include a review of the
Fund's holdings by the Board, at such intervals as it may deem appropriate, to
determine if the Fund's Net Asset Value calculated by using available market
quotations deviates from $1 per share based on amortized cost. The extent of any
deviation will be examined by the Board. If a deviation exceeds 1/2 of 1%, the
trustees will promptly consider what action, if any, will be initiated. If the
Board determines that a deviation exists that may result in material dilution or
other unfair results to investors or existing shareholders, it will take
corrective action that it regards as necessary and appropriate, which may
include selling portfolio instruments before maturity to real-
25
PAGE
ize capital gains or losses or to shorten average portfolio maturity,
withholding dividends, redeeming shares in kind, or establishing a Net Asset
Value per share by using available market quotations.
The Net Asset Value per share of each Fund except the Money Market Fund is
calculated as follows: the aggregate of all liabilities, including, without
limitation, the current market value of any outstanding options written by a
Fund, if any, accrued expenses and taxes and any necessary reserves, is deducted
from total gross value of all assets, and the difference is divided by the
number of shares of that Fund outstanding at the time. For the purpose of
determining the aggregate net assets of each Fund (except the Money Market
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 the Investment Managers.
Portfolio securities underlying actively traded options are valued at their
market price as determined above. The current market value of any option held by
a Fund is its last sale price on the relevant exchange prior to the time when
the assets are valued. Lacking any sales that day or if the last sales price is
outside the bid and ask prices, the options are valued within the range of the
current closing bid and ask prices if such valuation is believed to fairly
reflect the contract's market value. If a Fund should have an open position to a
security, the valuation of the contract will be within the range of the bid and
ask prices.
The value of a foreign security is determined as of the close of trading on the
foreign exchange on which it is traded or as of the close of trading on the
NYSE, if that is earlier. The value is then converted into its U.S. dollar
equivalent at the foreign exchange rate in effect at noon, New York time, on the
day the value of the foreign security is determined. If no sale is reported at
that time, the foreign security is valued within the range of the most recent
quoted bid and ask prices. Occasionally events that affect the values of foreign
securities and foreign exchange rates may occur between the times at which they
are determined and the close of the exchange and will, therefore, not be
reflected in the computation of the net asset value of each Fund. 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 prior to
the close of the Exchange. The value of 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 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, then 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, a
Fund may utilize a pricing service, bank or securities dealer to perform any of
the above described functions.
REDEMPTIONS IN KIND. Redemption proceeds are normally paid in cash; however each
Fund may pay the redemption price in whole or in part by a distribution in kind
of securities from the portfolio of the Fund, in lieu of cash, in conformity
with rules of the SEC. In such circumstances, the securities distributed would
be valued at the price used to compute the Fund's Net Asset Value. If Shares are
redeemed in kind, the redeeming Shareholder might incur brokerage costs in
converting the assets into cash. Each Fund is obligated to redeem Shares solely
in cash up to the lesser of $250,000 or 1% of its net assets during any 90-day
period for any one Shareholder.
CLASS 2 DISTRIBUTION PLANS
- ---------------------------------------------------------
Each Fund, except the Money Market Fund, has two classes of shares, Class 1 and
Class 2. Each
26
PAGE
Class 2 of the Trust has adopted a distribution plan or "Rule 12b-1" Plan
("Plan") pursuant to rule 12b-1 of the 1940 Act. Under the Plans, each Fund
offering Class 2 shares, except the Bond Fund, may pay up to a maximum of 0.25%
per year of the average daily net assets attributable to their respective Class
2 shares. Under the Bond Fund's Class 2 Plan, the Fund may pay up to a maximum
of 0.15% per year of the average daily net assets attributable to its Class 2
shares. These fees may be used to compensate the Trust's distributor,
Franklin/Templeton Distributors, Inc. ("Distributors"), the Insurance Companies
or others for distribution and related services and as a servicing fee.
The terms and provisions of the Plans, including terms and provisions 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, exceed the amount permitted to be paid under the rules of the
National Association of Securities Dealers, Inc.
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 Trust 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 a
management agreement with an Investment Manager, or by vote of a majority of the
outstanding shares of the class. Distributors, the Insurance Companies or others
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.
A Distributor 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.
For the fiscal year ended December 31, 1997, the total amounts paid by each Fund
pursuant to the Plans, which were used by Distributors as payment to Insurance
Companies for providing administrative and other services, as defined in the
Plans, on each Fund's Class 2 shares, were as follows:
<TABLE>
<CAPTION>
FUND DOLLAR AMOUNT
- -----------------------------------------------
<S> <C>
Stock Fund -- Class 2................. $14,095
International Fund -- Class 2......... 13,723
Developing Markets Fund -- Class 2.... 10,514
Asset Allocation Fund -- Class 2...... 8,750
</TABLE>
TAX STATUS
- ---------------------------------------------------------
Money Market Fund intends to declare dividends daily and to pay dividends
monthly. All other Funds normally intend to pay an annual dividend representing
substantially all of their net investment income and to distribute annually any
net realized capital gains. By so doing and meeting certain diversification of
assets and other requirements of the Internal Revenue Code of 1986, as amended
(the "Code"), and as described in the prospectus, each Fund intends to qualify
as a regulated investment company under the Code. The status of the Funds as
regulated investment companies does not involve government supervision or
management of their investment practices or policies. As a regulated investment
company, each Fund will be relieved of liability for U.S. federal income tax on
that portion of its net investment income and net realized capital gains which
it distributes to its Separate Account Shareholders.
Amounts not distributed on a timely basis in accordance with a calendar year
distribution requirement are also subject to a nondeductible 4% excise tax
unless the exception described below applies. To avoid the tax if it otherwise
applies, a Fund must distribute during each calendar year, (i) at least 98% of
its ordinary income (not taking into account any capital gains or losses) for
the calendar year, (ii) at least 98% of its capital gains in excess of its
capital losses for the twelve-month period ending on October 31 of the calendar
year (adjusted for certain ordinary losses), and (iii) all ordinary income and
capital gains for previous years that were not distributed during such years. To
avoid application of the excise tax, each Fund intends to make its
27
PAGE
distributions in accordance with the calendar year distribution requirement.
A distribution will be treated as paid on December 31 of the calendar if it is
declared by a Fund during October, November, or December of that year to
Shareholders of record on a date in such a month and paid by the Fund during
January of the following calendar year. Such distributions will be taxable to
Shareholders (a Separate Account) in the calendar year in which the
distributions are declared, rather than the calendar year in which the
distributions are received. The excise tax provisions described above will not
apply in a given calendar year to a Fund if all of its shareholders at all times
during the calendar year are segregated asset accounts of life insurance
companies where the shares are held in connection with variable contracts. (For
this purpose, any shares of a regulated investment company attributable to an
investment not exceeding $250,000 made in connection with the organization of
the company is not taken into account.) Accordingly, if this condition regarding
the ownership of Shares of each of the Funds is met, the excise tax will be in
applicable to that Fund even if the calendar year distribution requirement is
not met.
The Funds may invest in shares of foreign corporations which may be classified
under the Code as passive foreign investment companies ("PFICs"). In general, a
foreign corporation is classified as a PFIC if at least one-half of its assets
constitute investment-type assets or 75% or more of its gross income is
investment-type income. If a Fund receives an "excess distribution" with respect
to PFIC stock, the Fund itself may be subject to tax on a portion of the excess
distribution, whether or not the corresponding income is distributed by the Fund
to Shareholders. In general, under the PFIC rules, an excess distribution is
treated as having been realized ratably over the period during which a Fund held
the PFIC shares. A Fund itself will be subject to tax on the portion, if any, of
an excess distribution that is so allocated to prior Fund taxable years and an
interest factor will be added to the tax, as if the tax had been payable in such
prior taxable years. Certain distributions from a PFIC as well as gain from the
sale of PFIC shares are treated as excess distributions. Excess distributions
are characterized as ordinary income even though, absent application of the PFIC
rules, certain excess distributions might have been classified as capital gain.
The Funds may be eligible to elect alternative tax treatment with respect to
PFIC shares.
Under an election that currently is available in some circumstances, a Fund
generally would be required to include in its gross income its share of the
earnings of a PFIC on a current basis, regardless of whether distributions are
received from the PFIC in a given year. If this election were made, the special
rules, discussed above, relating to the taxation of excess distributions, would
not apply. In addition, another election may be available that would involve
marking to market the Fund's PFIC shares at the end of each taxable year (and on
certain other dates prescribed in the Code), with the result that unrealized
gains are treated as though they were realized. If this election were made, tax
at the Fund level under the PFIC rules would generally be eliminated, but the
Fund could, in limited circumstances, incur nondeductible interest charges. A
Fund's intention to qualify annually as a regulated investment company may limit
its elections with respect to PFIC shares.
Because the application of the PFIC rules may affect, among other things, the
character of gains, the amount of gain or loss and the timing of the recognition
of income with respect to PFIC shares, as well as subject a Fund itself to tax
on certain income from PFIC shares, the amount that must be distributed to
Shareholders, and which will be taxed to Shareholders as ordinary income or
long-term capital gain, may be increased or decreased substantially as compared
to a fund that did not invest in PFIC shares.
Income received by a Fund from sources within a foreign country may be subject
to withholding taxes and other taxes imposed by that country. Tax conventions
between certain countries and the U.S. may reduce or eliminate such taxes.
Under the Code, gains or losses attributable to fluctuations in exchange rates
which occur between the time a Fund accrues income or other receivables or
accrues expenses or other liabilities denominated in a foreign currency and the
time that Fund actually collects such receivables or pays such liabilities
generally are treated as ordinary income or ordinary loss. Similarly, on
disposition of debts securities denominated in a foreign currency and on
disposition of certain financial contracts and forward contracts, gains or
losses attributable to fluctuations in the value of foreign currency between the
date of acquisition of the security or contract and the date of disposition also
are treated as ordinary gain or loss. These gains or losses, referred to under
the Code as "Section 988" gains or losses, may increase or decrease the amount
of a Fund's net investment income to be distributed to its Shareholders as
ordinary income.
28
PAGE
Debt securities purchased by a Fund may be treated for federal income tax
purposes as having original issue discount.
Original issue discount essentially represents interest for federal income tax
purposes and can be defined generally as the excess of the stated redemption
price at maturity over the issue price. Original issue discount, whether or not
any income is actually received by a Fund, is treated for U.S. federal income
tax purposes as ordinary income earned by the Fund, and therefore is subject to
the distribution requirements of the Code. Generally, the amount of original
issue discount included in the income of a Fund each year is determined on the
basis of a constant yield to maturity which takes into account the compounding
of accrued but unpaid interest.
Some of the debt securities may be purchased by the Fund at a discount which
exceeds the original issue discount on such debt securities, if any. This
additional discount represents market discount for Federal income tax purposes.
The gain realized on the disposition of any taxable debt security having market
discount will be treated as ordinary income to the extent it does not exceed the
accrued market discount on such debt security. Generally, market discount
accrues on a daily basis for each day the debt security is held by the Fund at a
constant rate over the time remaining to the debt security's maturity or, at the
election of the Fund, at a constant yield to maturity which takes into account
the semiannual compounding of interest.
Certain options, futures contracts and forward contracts in which the Stock,
Bond, Asset Allocation, Developing Markets and International Funds may invest
are "section 1256 contracts." Gains or losses on section 1256 contracts
generally are considered 60% long-term and 40% short-term capital gains or
losses ("60-40"), except for certain foreign currency gains and losses which
will be treated as ordinary in character. Also, section 1256 contracts held by a
Fund at the end of each taxable year (and, in some cases, for purposes of the 4%
excise tax, on October 31 of each year) are "marked-to-market" with the result
that unrealized gains or losses are treated as though they were realized.
The hedging transactions undertaken by certain of the Funds may result in
"straddles" for federal income tax purposes. The straddle rules may affect the
character of gains (or losses) realized by a Fund. In addition, losses realized
by a Fund oppositions that are part of a straddle may be deferred under the
straddle rules, rather than being taken into account in calculating the taxable
income for the taxable year in which such losses are realized. Because only a
few regulations implementing the straddle rules have been promulgated, the tax
consequences to the Funds of hedging transactions are not entirely clear. The
hedging transactions may increase the amount of short-term capital gain realized
by the Funds which is taxed as ordinary income when distributed to Shareholders.
Each Fund may make one or more of the elections available under the Code which
are applicable to straddles. If the Fund makes any of the elections, the amount,
character and timing of the recognition of gains or losses from the affected
straddle positions will be determined under rules that vary according to the
elections made. The rules applicable under certain of the elections may operate
to accelerate the recognition of gains or losses from the affected straddle
positions.
Because application of the straddle rules may affect the character of gains or
losses, defer losses and/or accelerate the recognition of gains or losses from
the affected straddle positions, the amount which must be distributed to
Shareholders, and which will be taxed to shareholders as ordinary income or
long-term capital gain, may be increased or decreased substantially as compared
to a fund that did not engage in such hedging transactions.
The requirements under the Code relating to the qualification of a Fund as a
regulated investment company may limit the extent to which a Fund may engage in
futures and forward currency contracts.
Distributions of any net investment income and of any net realized short term
capital gains are treated as ordinary income for tax purposes in the hands of
the Separate Account Shareholder. The excess of any net long-term capital gains
over net short-term capital losses will, to the extent distributed and
designated by the distributing Fund as a capital gain dividend, be treated as
long-term capital gains in the hands of the Shareholder regardless of the length
of time a Separate Account may have held the Shares.
Reference is made to the prospectus for the applicable Contract for information
regarding the federal income tax treatment of distributions to owners of
contracts.
DESCRIPTION OF SHARES
- ---------------------------------------------------------
The Shares of each Fund have the same preferences, conversion and other rights,
voting powers, restrictions and limitations as to dividends, qualifications, and
terms and conditions of redemption, except as follows: all consideration
received from
29
PAGE
the sale of Shares of a Fund, together with all income, earnings, profits and
proceeds thereof, belongs to that Fund and is charged with liabilities in
respect to that Fund and of that Fund's part of general liabilities of the Trust
in the proportion that the total net assets of the Fund bear to the total net
assets of all Funds. In addition, Class 2 Shares of each Fund offering Class 2
Shares will bear the expense of the Class 2 Distribution plan as it applies to
each Fund. The net asset value of a Share of a class of a Fund is based on the
assets belonging to that Fund less the liabilities charged to that class of the
Fund, and dividends are paid on Shares of a class of a Fund only out of lawfully
available assets belonging to that class of the Fund. In the event of
liquidation or dissolution of the Trust, the Shareholders of each Fund will be
entitled, out of assets of the Fund available for distributions, to the assets
belonging to that particular Fund.
Under Massachusetts law, shareholders could, under certain circumstances, be
held personally liable for the obligations of the Trust. However, the
Declaration of Trust disclaims liability of the Shareholders, Trustees or
officers of the Trust for acts or obligations of the Trust, which, under the
terms of the Declaration of Trust, are binding only on the property of the
Trust, which, under the terms of the Declaration of Trust, are binding only on
the property of the Trust. The Declaration of the Trust provides for
indemnification out of Trust property for all loss and expense of any
Shareholder held personally liable for the obligations of the Trust. The risk of
a Shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which the Trust itself would be unable to meet its
obligations and, thus, should be considered remote.
PERFORMANCE INFORMATION
- ---------------------------------------------------------
Performance quotations are subject to SEC rules. These rules require the use of
standardized performance quotations or, alternatively, that every
non-standardized performance quotation be accompanied by certain standardized
performance information computed as required by the SEC. On May 1, 1997, each
Fund (except the Money Fund) began offering Class 2 shares and renamed its
existing shares as Class 1 shares. Any Class 2 performance shown for the periods
prior to May 1, 1997 represents the historical results of Class 1 Shares.
Performance of Class 2 shares for the periods after May 1, 1997 reflects Class
2's higher annual fees and expenses resulting from its Rule 12b-1 plan.
Historical performance data for Class 2 will generally not be restated to
include 12b-1 fees, although the Trust may restate these figures consistent with
SEC rules. 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.
The Trust may, from time to time, include the yield of Templeton Money Market
Fund or the total return of all other Funds in advertisements or reports to
Shareholders or prospective investors. Performance information for the Funds
will not be advertised unless accompanied by legally required comparable
performance information for a separate account to which the Funds offer their
Shares.
CURRENT YIELD. Current yield shows the income per share earned by the Money
Market Fund. It is calculated by determining the net change, excluding capital
changes, in the value of a hypothetical pre-existing account having a balance of
one share at the beginning of the period, subtracting a hypothetical charge
reflecting deductions from shareholder accounts, and dividing the difference by
the value of the account at the beginning of the base period to obtain the base
period return. The result is then annualized by multiplying the base period
return by (365/7). The Templeton Money Market Fund's current yield for the seven
day period ended December 31, 1997 was 5.27%.
Quotations of average annual total return for the Funds will be expressed in
terms of the average annual compounded rate of return for periods in excess of
one year or the total return for periods less than one year of a hypothetical
investment in the Funds over periods of one, five, or ten years (up to the life
of a Fund) calculated pursuant to the following formula:
30
PAGE
P (1+T)(n) = ERV
where:
<TABLE>
<S> <C> <C>
P = a hypothetical initial payment of
$1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a
hypothetical $1,000 payment made at
the beginning of each period at the
end of each period
</TABLE>
All total return figures reflect the deduction of the maximum initial sales
charge and deduction of a proportional share of Fund expenses on an annual
basis, and assume that all dividends and distributions are reinvested when paid.
The following table shows the average annual total returns for each Fund,
excluding the Templeton Money Market Fund, for the indicated periods ended
December 31, 1997:
<TABLE>
<CAPTION>
SINCE INCEPTION
FUND 1-YEAR 3-YEAR 5-YEAR INCEPTION DATE
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Bond Fund -- Class 1......................... 2.51% 8.84% 6.45% 7.40% 08/24/88
Stock Fund -- Class 1........................ 11.88% 19.73% 17.60% 13.30% 08/24/88
Stock Fund -- Class 2........................ 11.69% 19.63% 17.55% 13.28% 08/24/88*
Asset Allocation Fund -- Class 1............. 15.52% 18.94% 15.55% 12.64% 08/24/88
Asset Allocation Fund -- Class 2............. 15.37% 18.88% 15.52% 12.63% 08/24/88*
International Fund -- Class 1................ 13.95% 17.84% 18.70% 15.04% 05/01/92
International Fund -- Class 2................ 13.73% 17.76% 18.66% 15.01% 05/01/92*
Developing Markets -- Class 1................ -29.22% -19.78% 03/04/96
Developing Markets -- Class 2................ -29.33% -19.85% 03/04/96*
</TABLE>
Because Class 2 shares were not offered until May 1, 1997, performance shown for
periods prior to that date represents the historical results of Class 1 shares.
Performance of Class 2 shares for periods after May 1, 1997 reflect Class 2's
higher annual fees and expenses resulting from its rule 12b-1 plan. Maximum
annual plan expenses are 0.25%, except for the Bond Fund which is 0.15%.
Performance information for a Fund may be compared, in reports and promotional
literature, to: (i) unmanaged indices so that investors may compare the Fund's
results with those of a group of unmanaged securities widely regarded by
investors as representative of the securities market in general; (ii) other
groups of mutual funds tracked by Lipper Analytical Services, Inc., a widely
used independent research firm which ranks mutual funds by overall performance,
investment objectives and assets, or tracked by other services, companies,
publications, or persons who rank mutual funds on overall performance or other
criteria; and (iii) the Consumer Price Index (measure for inflation) to assess
the real rate of return from an investment in a Fund. Unmanaged indices may
assume the reinvestment of dividends but generally do not reflect deductions for
administrative and management costs and expenses.
Quotations of yield or total return for a Fund will not take into account
charges and deductions against any separate account to which the Funds' Shares
are sold or charges and deductions against variable insurance contracts,
although comparable performance information for a separate account will take
such charges into account. Performance information for a Fund reflects only the
performance of a hypothetical investment in a Fund during the particular time
period on which the calculations are based. Performance information should be
considered in light of a Fund's investment objective and policies,
characteristics and quality of the portfolio and the market conditions during
the given time period, and should not be considered as a representation of what
may be achieved in the future.
From time to time, each Fund and the Investment Managers may also refer to the
following information:
(1) The Investment Managers' and their affiliates' market share of
international equities managed in mutual funds prepared or published by
Strategic Insight or a similar statistical organization.
(2) The performance of U.S. equity and debt markets relative to foreign markets
prepared or published by Morgan Stanley Capital International(R) or a
similar financial organization.
(3) The capitalization of U.S. and foreign stock markets as prepared or
published by the International Finance Corporation, Morgan Stanley Capital
International(R) or a similar financial organization.
(4) The geographic and industry distribution of the Fund's portfolio and the
Fund's top ten holdings.
31
PAGE
(5) The gross national product and populations, including age characteristics,
literacy rates, foreign investment improvements due to a liberalization of
securities laws and a reduction of foreign exchange controls, and improving
communication technology, of various countries as published by various
statistical organizations.
(6) To assist investors in understanding the different returns and risk
characteristics of various investments, the Fund may show historical
returns of various investments and published indices (e.g., Ibbotson
Associates, Inc. Charts and Morgan Stanley EAFE -- Index).
(7) The major industries located in various jurisdictions as published by the
Morgan Stanley Index.
(8) Rankings by DALBAR Surveys, Inc. with respect to mutual fund shareholder
services.
(9) Allegorical stories illustrating the importance of persistent long-term
investing.
(10) The Fund's portfolio turnover rate and its ranking relative to industry
standards as published by Lipper Analytical Services, Inc. or Morningstar,
Inc.
(11) A description of the Templeton organization's investment management
philosophy and approach, including its worldwide search for undervalued or
"bargain" securities and its diversification by industry, nation and type
of stocks or other securities.
(12) The number of Shareholders in the Fund or the aggregate number of
shareholders of the open-end investment companies in the Franklin Templeton
Group of Funds or the dollar amount of fund and private account assets
under management.
(13) Comparison of the characteristics of various emerging markets, including
population, financial and economic conditions.
(14) Quotations from the Templeton organization's founder, Sir John Templeton,**
advocating the virtues of diversification and long-term investing,
including the following:
- "Never follow the crowd. Superior performance is possible only if you
invest differently from the crowd."
- "Diversify by company, by industry and by country."
- "Always maintain a long-term perspective."
- "Invest for maximum total real return."
- "Invest -- don't trade or speculate."
- "Remain flexible and open-minded about types of investment."
- "Buy low."
- "When buying stocks, search for bargains among quality stocks."
- "Buy value, not market trends or the economic outlook."
- "Diversify. In stocks and bonds, as in much else, there is safety in
numbers."
- "Do your homework or hire wise experts to help you."
- "Aggressively monitor your investments."
- "Don't panic."
- "Learn from your mistakes."
- "Outperforming the market is a difficult task."
- "An investor who has all the answers doesn't even understand all the
questions."
- "There's no free lunch."
- "And now the last principle: Do not be fearful or negative too often."
FINANCIAL STATEMENTS
- ---------------------------------------------------------
The audited financial statements contained in the Annual Report to Shareholders
of the Trust, for the fiscal year ended December 31, 1997, including the
auditors' report, are incorporated herein by reference.
** Sir John Templeton sold the Templeton organization to Resources in October
1992 and resigned from the Trust's Board on April 15, 1995. He is no longer
involved with the investment management process.
32
