FRANKLIN VALUEMARK FUNDS -
CLASS 2 SHARES
PROSPECTUS
DECEMBER 28, 1998
777 Mariners Island Blvd., P.O. Box 7777
San Mateo, CA 94403-7777 1-800/342-3863
Franklin Valuemark Funds (the "Trust") is an investment company, organized as
a Massachusetts business trust, and consisting of twenty-five separate
investment portfolios or funds, each of which has different investment
objectives. Shares of the portfolios are sold only to insurance company
separate accounts to fund the benefits of variable life insurance policies or
variable annuity contracts ("Contracts") owned by their respective
policyholders or contractholders. Certain portfolios may not be available in
connection with a particular policy or contract or in a particular state.
Investors should consult the separate account prospectus of the specific
insurance product that accompanies this Trust prospectus for information on
any applicable restrictions or limitations with respect to a separate
account's investments in the portfolios.
This prospectus contains information that investors should know before
investing in these portfolios, including the risks associated with investing
in each portfolio. Please keep it for future reference. The Trust has a
statement of additional information ("SAI") dated December 28, 1998, which
may be amended from time to time. It contains more information about the
portfolio's procedures and policies. It has been filed with the Securities
and Exchange Commission and is incorporated by reference into this
prospectus. For a free copy, call 1-800/342-3863 or write the Trust at the
address shown.
Each portfolio has two classes of shares: Class 1 and Class 2. Twenty-two of
the twenty-five portfolios' Class 2 shares are currently available under the
Franklin Valuemark Charter Variable Annuity Contract described in the
prospectus accompanying this Trust's prospectus (each a "Portfolio" or
"Portfolios"). For more information about the Trust's classes, see "General
Information - Trust Organization, Voting Privileges and Other Rights."
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES OR
INSURANCE COMMISSION HAS APPROVED OR DISAPPROVED THESE SECURITIES OR PASSED
UPON THE ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
SHARES OF THE PORTFOLIOS ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK; AND ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT
INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE
U.S. GOVERNMENT. SHARES OF THE PORTFOLIOS INVOLVE INVESTMENT RISKS, INCLUDING
THE POSSIBLE LOSS OF PRINCIPAL.
THIS PROSPECTUS IS NOT AN OFFERING OF THE SECURITIES HEREIN DESCRIBED IN ANY
STATE, JURISDICTION OR COUNTRY, IN WHICH THE OFFERING IS UNAUTHORIZED. NO
SALES REPRESENTATIVE, DEALER, OR OTHER PERSON IS AUTHORIZED TO GIVE ANY
INFORMATION OR MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS.
SUMMARY OF PORTFOLIO OBJECTIVES
PORTFOLIO SEEKING STABILITY
OF PRINCIPAL AND INCOME
MONEY MARKET FUND ("MONEY FUND")1 seeks high current income, consistent with
capital preservation and liquidity. The Portfolio will pursue its objective
by investing exclusively in high quality money market instruments. An
investment in the Money Fund is neither insured nor guaranteed by the U.S.
Government. The Portfolio attempts to maintain a stable net asset value of
$1.00 per share, although no assurances can be given that the Portfolio will
be able to do so.
PORTFOLIOS SEEKING CURRENT INCOME
HIGH INCOME FUND1,2 seeks a high level of current income, with capital
appreciation as a secondary objective, by investing in debt obligations and
dividend-paying common and preferred stocks. Debt obligations include lower
rated obligations (commonly referred to as "junk bonds") which involve
increased risks related to the creditworthiness of their issuers.
TEMPLETON GLOBAL INCOME SECURITIES FUND ("GLOBAL INCOME FUND")1 seeks a high
level of current income, consistent with preservation of capital, with
capital appreciation as a secondary consideration, through investing in
foreign and domestic debt obligations, including up to 25% in lower rated
debt obligations (commonly referred to as "junk bonds"), and related currency
transactions. Investing in a non-diversified portfolio of global securities,
including those of developing markets issuers, involves increased
susceptibility to the special risks associated with foreign investing.
U.S. GOVERNMENT SECURITIES FUND ("GOVERNMENT FUND") seeks current income and
safety of capital by investing exclusively in obligations issued or
guaranteed by the U.S. government or its agencies or instrumentalities.
PORTFOLIOS SEEKING GROWTH AND INCOME
GLOBAL UTILITIES SECURITIES FUND ("GLOBAL UTILITY FUND")1 seeks both capital
appreciation and current income by investing primarily in securities of
issuers engaged in the public utilities industry. The Portfolio may invest in
securities of issuers in any nation, including nations with developing
markets. Investing in a portfolio which concentrates in a specialized market
sector involves increased risks. Foreign investing also involves special
risks. Prior to May 1, 1998, the Portfolio was named the Utility Equity Fund
and invested primarily in securities of domestic issuers in the public
utility industry.
GROWTH AND INCOME FUND1 seeks capital appreciation, with current income
return as a secondary objective, by investing primarily in U.S. common
stocks. The Portfolio may invest in foreign securities.
INCOME SECURITIES FUND1,2 seeks to maximize income while maintaining
prospects for capital appreciation by investing primarily in a diversified
portfolio of domestic debt obligations and/or equity securities. Debt
obligations include lower rated obligations (commonly referred to as "junk
bonds") which involve increased risks related to the creditworthiness of
their issuers. The Portfolio may invest in foreign securities.
MUTUAL SHARES SECURITIES FUND ("MUTUAL SHARES FUND")1,2 seeks capital
appreciation, with income as a secondary objective. The Portfolio invests
primarily in domestic equity securities trading at prices below their
intrinsic values. The Portfolio may also invest in securities of companies
involved in corporate restructuring, mergers, bankruptcies and liquidations,
as well as debt securities of any quality, including "junk bonds," and
defaulted securities, all of which involve increased risks related to the
creditworthiness of their issuers.
REAL ESTATE SECURITIES FUND ("REAL ESTATE FUND") seeks capital appreciation,
with current income return as a secondary objective, by concentrating its
investments in publicly traded securities of U.S. companies in the real
estate industry. Investing in a portfolio which concentrates in a specialized
market sector involves increased risks.
RISING DIVIDENDS FUND seeks capital appreciation, primarily through
investment in the equity securities of companies that have paid consistently
rising dividends over the past ten years. Preservation of capital is also an
important consideration. The Portfolio seeks current income incidental to
capital appreciation.
TEMPLETON GLOBAL ASSET ALLOCATION FUND ("ASSET ALLOCATION FUND")1 seeks a
high level of total return through a flexible policy of investing in equity
securities, debt obligations, including up to 25% in lower rated debt
obligations (commonly referred to as "junk bonds"), and money market
instruments of issuers in any nation, including developing markets nations.
The mix of investments among the three market segments will be adjusted in an
attempt to capitalize on the total return potential produced by changing
economic conditions throughout the world. Foreign investing involves special
risks.
VALUE SECURITIES FUND ("VALUE FUND")1 seeks long-term total return. The
Portfolio invests primarily in equity securities, including common stocks and
securities convertible into common stocks.
PORTFOLIOS SEEKING CAPITAL GROWTH
CAPITAL GROWTH FUND ("GROWTH FUND")1 seeks capital appreciation, with current
income as a secondary consideration. The Portfolio invests primarily in
equity securities, including common stocks and securities convertible into
common stocks.
GLOBAL HEALTH CARE SECURITIES FUND ("GLOBAL HEALTH CARE FUND")1 seeks capital
appreciation, by concentrating its investments in equity securities issued by
health care companies located throughout the world. Investing in a
non-diversified portfolio concentrating in a specialized market sector
involves increased risks. Foreign investing also involves special risks.
MUTUAL DISCOVERY SECURITIES FUND ("MUTUAL DISCOVERY FUND")1, 2 seeks capital
appreciation. The Portfolio invests primarily in domestic and foreign equity
securities, including securities of smaller capitalization companies, trading
at prices below their intrinsic values. The Portfolio may also invest in
securities of companies involved in corporate restructuring, mergers,
bankruptcies and liquidations, as well as debt securities of any quality,
including "junk bonds,"and defaulted securities, all of which involve
increased risks related to the creditworthiness of their issuers. Foreign
investing involves special risks.
NATURAL RESOURCES SECURITIES FUND ("NATURAL RESOURCES FUND")1 seeks capital
appreciation with current income as a secondary objective, by concentrating
its investments in securities issued by companies in or related to the
natural resources sector.
SMALL CAP FUND1 seeks long-term capital growth. The Portfolio seeks to
accomplish its objective by investing primarily in equity securities of
smaller capitalization growth companies. The Portfolio may also invest in
foreign securities, including those of developing markets issuers. Because of
the Portfolio's investments in smaller capitalization companies, an
investment in the Portfolio may involve greater risks and higher volatility.
TEMPLETON DEVELOPING MARKETS EQUITY FUND ("DEVELOPING MARKETS FUND")1 seeks
long-term capital appreciation. The Portfolio seeks to achieve this objective
by investing primarily in equities of issuers in countries having developing
markets. The Portfolio is subject to the heightened foreign securities
investment risks that accompany foreign developing markets and an investment
in the Portfolio may be considered speculative.
TEMPLETON GLOBAL GROWTH FUND ("GLOBAL GROWTH FUND")1 seeks long-term capital
growth. The Portfolio hopes to achieve its objective through a flexible
policy of investing in stocks and debt obligations of companies and
governments of any nation, including developing markets. The realization of
income, if any, is only incidental to accomplishment of the Portfolio's
objective of long-term capital growth. Foreign investing involves special
risks.
TEMPLETON INTERNATIONAL EQUITY FUND ("INTERNATIONAL EQUITY FUND")1 seeks
long-term growth of capital. Under normal conditions, the International
Equity Fund will invest at least 65% of its total assets in an
internationally mixed portfolio of foreign equity securities which trade on
markets in countries other than the U.S., including developing markets, and
are (i) issued by companies domiciled in countries other than the U.S., or
(ii) issued by companies that derive at least 50% of either their revenues or
pre-tax income from activities outside of the U.S. Foreign investing involves
special risks.
TEMPLETON INTERNATIONAL SMALLER COMPANIES FUND ("INTERNATIONAL SMALLER
COMPANIES FUND")1 seeks long-term capital appreciation. The Portfolio seeks
to achieve this objective by investing primarily in equity securities of
smaller companies outside the U.S., including developing markets. Foreign
investing involves special risks and smaller company investments may involve
higher volatility. An investment in the Portfolio should not be considered a
complete investment program.
TEMPLETON PACIFIC GROWTH FUND ("PACIFIC FUND")1 seeks long-term growth of
capital, primarily through investing at least 65% of its total assets in
equity securities which trade on markets in the Pacific Rim, including
developing markets, and are (i) issued by companies domiciled in the Pacific
Rim or (ii) issued by companies that derive at least 50% of either their
revenues or pre-tax income from activities in the Pacific Rim. Investing in a
portfolio of geographically concentrated foreign securities, including
developing markets, involves increased susceptibility to the special risks of
foreign investing and an investment in the Portfolio may be considered
speculative.
1THE ASSET ALLOCATION, CAPITAL GROWTH, DEVELOPING MARKETS, GLOBAL GROWTH,
GLOBAL HEALTH CARE, GLOBAL INCOME, GLOBAL UTILITY, GROWTH AND INCOME, HIGH
INCOME, INCOME SECURITIES, INTERNATIONAL EQUITY, INTERNATIONAL SMALLER
COMPANIES, MONEY, MUTUAL DISCOVERY, MUTUAL SHARES, PACIFIC, NATURAL
RESOURCES, SMALL CAP AND VALUE FUNDS MAY INVEST MORE THAN 10% OF THEIR TOTAL
ASSETS IN FOREIGN SECURITIES WHICH ARE SUBJECT TO SPECIAL AND ADDITIONAL
RISKS RELATED TO CURRENCY FLUCTUATIONS, MARKET VOLATILITY, AND ECONOMIC,
SOCIAL, AND POLITICAL UNCERTAINTY; INVESTING IN DEVELOPING MARKETS INVOLVES
SIMILAR BUT HEIGHTENED RISKS RELATED TO THE RELATIVELY SMALL SIZE AND LESSER
LIQUIDITY OF THESE MARKETS. SEE "HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN
TRANSACTIONS."
2THE HIGH INCOME, INCOME SECURITIES, MUTUAL DISCOVERY AND MUTUAL SHARES FUNDS
MAY INVEST UP TO 100% OF THEIR RESPECTIVE TOTAL ASSETS IN DEBT OBLIGATIONS
RATED BELOW INVESTMENT GRADE, COMMONLY KNOWN AS "JUNK BONDS," OR IN
OBLIGATIONS WHICH HAVE NOT BEEN RATED BY ANY RATING AGENCY. INVESTMENTS RATED
BELOW INVESTMENT GRADE INVOLVE GREATER RISKS, INCLUDING PRICE VOLATILITY AND
RISK OF DEFAULT, THAN INVESTMENTS IN HIGHER RATED OBLIGATIONS. INVESTORS
SHOULD CAREFULLY CONSIDER THE RISKS ASSOCIATED WITH AN INVESTMENT IN THESE
PORTFOLIOS IN LIGHT OF THE SECURITIES IN WHICH THEY INVEST. SEE "HIGHLIGHTED
RISK CONSIDERATIONS, LOWER RATED DEBT OBLIGATIONS."
TABLE OF CONTENTS
CONTENTS Page
INTRODUCTION 5
GENERAL INVESTMENT
CONSIDERATIONS 5
PORTFOLIO INVESTMENT
OBJECTIVES AND POLICIES 6
PORTFOLIO SEEKING STABILITY OF
PRINCIPAL AND INCOME 6
Money Market Fund 6
PORTFOLIOS SEEKING CURRENT
INCOME 8
High Income Fund 8
Templeton Global Income
Securities Fund 9
U.S. Government Securities Fund 10
PORTFOLIOS SEEKING GROWTH AND
INCOME 12
Global Utilities Securities Fund
(formerly Utility Equity Fund) 12
Growth and Income Fund 13
Income Securities Fund 14
Mutual Shares Securities Fund 16
Real Estate Securities Fund 18
Rising Dividends Fund 19
Templeton Global Asset Allocation
Fund 20
Value Securities Fund 21
PORTFOLIOS SEEKING CAPITAL GROWTH 23
Capital Growth Fund 23
Global Health Care Securities
Fund 24
Mutual Discovery Securities Fund 26
Natural Resources Securities Fund 28
Small Cap Fund 30
Templeton Developing
Markets Equity Fund 31
Templeton Global Growth Fund 33
Templeton International Equity
Fund 34
Templeton International
Smaller Companies Fund 35
Templeton Pacific Growth Fund 36
HIGHLIGHTED RISK
CONSIDERATIONS 37
Foreign Transactions 37
General Considerations 37
Investments in Developing
Markets 38
Certain Restrictions 39
Euro Risk 40
Currency Risks and their
Management 40
Interest Rate and Currency Swaps 41
Investments in Depositary
Receipts 42
Lower Rated Debt Obligations 42
Defaulted Debt Obligations 44
The Portfolios' Investments 44
Asset Composition Table 45
INVESTMENT METHODS AND
RISKS COMMON TO MORE
THAN ONE PORTFOLIO 45
Borrowing 45
Concentration 46
Convertible Securities 46
Debt Obligations 47
Corporate Debt Obligations 47
Money Market Instruments 47
U.S. Government Securities 47
Zero Coupon Bonds 48
Deferred Interest and
Pay-in-Kind Bonds 48
Derivatives 48
Diversification 49
Loan Participations 49
Loans of Portfolio Securities 49
Options and Futures Contracts 50
Portfolio Turnover 50
Repurchase and Reverse
Repurchase Agreements 50
Restricted and Illiquid
Securities 51
"Rolls" 51
Small Capitalization Issuers 51
Structured Notes 52
Temporary Investments 52
Trade Claims 52
Warrants 53
"When-Issued" and "Delayed
Delivery" Transactions 53
Year 2000 53
Investment Restrictions 53
MANAGEMENT 53
Trustees and Officers 53
Managers 53
Management Services and Fees 54
Subadvisor 55
Portfolio Transactions 55
Year 2000 Problem 55
Portfolio Administrator 55
Operating Expenses 56
Portfolio Operations 56
Biographical Information 57
PURCHASE, REDEMPTION AND
EXCHANGE OF SHARES 63
Distributor 63
Distribution Plan 63
Purchases of Shares 63
Redemptions of Shares 64
Exchanges of Shares 64
INCOME DIVIDENDS AND CAPITAL
GAINS DISTRIBUTIONS 64
DETERMINATION OF
NET ASSET VALUE 65
TAX CONSIDERATIONS 65
HOW THE TRUST MEASURES
PERFORMANCE 65
GENERAL INFORMATION 66
Reports 66
Transfer Agent 66
Trust Organization, Voting
Privileges and Other Rights 66
APPENDIX 67
Description of Bond Ratings 67
Description of Commercial Paper
Ratings 68
INTRODUCTION
Franklin Valuemark Funds is an open-end management investment company, or
mutual fund, organized as a Massachusetts business trust on April 26, 1988
and is registered with the Securities and Exchange Commission ("SEC"). The
Trust currently consists of twenty-five separate investment portfolios or
funds, each of which is, in effect, a separate mutual fund. The Trust issues
two classes of shares of beneficial interest for each portfolio: Class 1 and
Class 2. This prospectus offers only Class 2 shares.
An investor, by investing in a class of shares of a Portfolio, becomes
entitled to a pro rata share of all dividends and distributions arising from
the Portfolio's investment income and capital appreciation attributable to
that class. Likewise, an investor shares pro rata in any Portfolio investment
losses attributable to that class. For more information about the share
classes, see "Purchase, Redemption and Exchange of Shares," "Determination of
Net Asset Value," "General Information - Trust Organization, Voting
Privileges and Other Rights" below.
Shares of the Trust are currently offered on a continuous basis at their net
asset value only to separate accounts (the "Variable Accounts") of Allianz
Life Insurance Company of North America, or its wholly owned subsidiary
Preferred Life Insurance Company of New York, or their affiliates ("Insurance
Companies"), to fund the benefits under variable life insurance policies and
variable annuity contracts (collectively the "Contracts") issued by the
Insurance Companies. The Variable Accounts are divided into sub-accounts (the
"Contract Sub-Accounts"), each of which will invest in one of the Portfolios,
as directed by the owners of the Contracts (collectively the "Contract
Owners"). Some of the current Portfolios in the Trust may not be available in
connection with a particular Contract or in a particular state. Contract
Owners should consult the accompanying prospectus describing the specific
Contract or the appropriate Insurance Company for information on available
Portfolios and any applicable limitations with respect to their investment
options.
GENERAL INVESTMENT CONSIDERATIONS
Each Portfolio has one or more investment objectives and related investment
policies and uses various investment strategies to pursue these objectives.
There can be no assurance that any Portfolio will achieve its investment
objective. The investment objectives of each Portfolio are "fundamental
policies" which means they may not be changed without shareholder approval.
Certain investment restrictions described here or in the SAI may also be
identified as "fundamental." The investment strategies, policies, and
restrictions designed to realize the stated objectives, however, are
typically not fundamental and may be changed without shareholder approval.
Investors should not consider any one Portfolio alone to be a complete
investment program and should evaluate each Portfolio in relation to their
personal financial situation, goals, and tolerance for risk. All of the
Portfolios are subject to the risk of changing economic conditions, as well
as the risk related to the ability of the Managers to make changes in the
securities composition of the Portfolio in anticipation of changes in
economic, business, and financial conditions. As with any security, a risk of
loss of all or a portion of the principal amount invested accompanies an
investment in the shares of any of the Portfolios.
The different types of securities and investment techniques used by each
Portfolio all have attendant risks of varying degrees and are described in
the pages that follow. As an overview, investors should bear in mind with
respect to equity securities, there can be no assurance of capital
appreciation and there is a substantial risk of decline. With respect to debt
obligations, there exists the risk that the issuer of a security may not be
able to meet its obligations on interest or principal payments at the time
required by the instrument or at all. In addition, the value of debt
obligations generally rises and falls inversely with prevailing current
interest rates. Increased rates of interest which frequently accompany higher
inflation and/or a growing economy are likely to have a negative effect on
the value of shares of Portfolios which invest in debt obligations. In
addition to the factors which affect the value of individual securities, a
Contract Owner may anticipate that the value of the shares of a Portfolio
will fluctuate with movements in the broader equity and bond markets as well.
A decline in the stock market of any country in which a Portfolio is invested
or changes in currency valuations may also affect the price of shares of a
Portfolio. History reflects both increases and decreases in interest rates,
worldwide stock markets, and currency valuations, and these may reoccur.
While only a few of the Portfolios elect to "concentrate," that is, invest
more than 25% of their total assets in specialized industry sectors, many of
the Portfolios do nonetheless, from time to time, invest significantly in
certain industries. Of course, these Portfolios are still diversified for
federal securities and tax law purposes and so will be issuer-diversified
within each industry. To the extent a Portfolio is less broadly diversified
across industries, the value of its securities can be more affected by
adverse developments or volatility in that industry sector. For example, the
technology sector as a whole has historically been volatile, and issues from
this sector tend to be subject to abrupt or erratic price movements.
As stated in the descriptions of the individual Portfolios below, an
investment in certain of the Portfolios involves special additional risks as
a result of their ability to invest a substantial portion of their assets in
high yield, high risk, lower rated debt obligations ("junk bonds"), foreign
investments including those of "developing markets" issuers located in
emerging nations generally as defined by the World Bank, derivative
instruments or complex securities, or to concentrate in specialized industry
sectors. These and other types of investments and investment methods common
to more than one Portfolio are described in greater detail, including the
risks of each, in "Highlighted Risk Considerations," "Investment Methods and
Risks," and the SAI.
All policies and percentage limitations are considered at the time of
purchase and refer to total assets, unless otherwise specified. Each of the
Portfolios will not necessarily use the strategies described to the full
extent permitted unless the Managers believe that doing so will help a
Portfolio reach its objectives, and not all instruments or strategies will be
used at all times. In the event of a corporate restructuring or bankruptcy
reorganization of an issuer whose securities are owned by a Portfolio, the
Portfolio may receive securities different from those originally purchased,
e.g., common stock that is not dividend paying, bonds with a lower coupon or
more junior status, convertible securities or even conceivably real estate.
The Portfolio is not obligated to sell such securities immediately, if the
Manager believes, based on its own analysis, that the longer term outlook is
favorable and there is the potential for a higher total return by holding
such investments.
PORTFOLIO INVESTMENT OBJECTIVES AND POLICIES
PORTFOLIO SEEKING STABILITY
OF PRINCIPAL AND INCOME
MONEY MARKET FUND
The investment objective of the Money Market Fund is to obtain as high a
level of current income (in the context of the type of investments available
to the Portfolio) as is consistent with capital preservation and liquidity.
The Portfolio will seek to maintain a $1.00 per share net asset value, but
there is no guarantee that it will be successful in doing so.
The Portfolio follows certain procedures required by federal securities laws
with respect to the quality, maturity and diversification of its investments.
These procedures are designed to help maintain a stable $1.00 share price.
The Portfolio limits its investments to U.S. dollar denominated instruments
which the Board of Trustees determines present minimal credit risks and which
are, as required by federal securities laws, rated in one of the two highest
rating categories as determined by nationally recognized statistical rating
organizations ("NRSROs"), or which if unrated are of comparable quality, with
remaining maturities of 397 calendar days or less ("Eligible Securities").
Because the Portfolio will limit its investments to high quality securities,
it will experience generally lower yields than if the Portfolio purchased
securities of lower quality and correspondingly greater risk.
Eligible Securities include the following:
1. securities issued or guaranteed as to principal and interest by the U.S.
Government, its agencies, authorities or instrumentalities ("U.S. Government
Securities");
2. obligations issued or guaranteed by U.S. banks with assets of at least one
billion dollars, foreign branches of U.S. banks ("Eurodollar Investments"),
U.S. branches of foreign banks ("Yankee Dollar Investments"), and foreign
branches of foreign banks (including certificates of deposit, bank notes,
loan participation interests, commercial paper, unsecured promissory notes,
time deposits, and bankers' acceptances), provided that where the obligation
is issued by a branch, the parent bank has more than five billion dollars in
total assets at the time of purchase ("Bank Obligations");
3. commercial paper (unsecured promissory notes including variable amount
master demand notes) issued by domestic or foreign issuers;
4. other short-term obligations issued or guaranteed by U.S. corporations, or
obligations issued by foreign entities ("Corporate Obligations");
5. taxable municipal securities, the interest on which is not exempt from
federal income tax, issued by or on behalf of states, territories, and
possessions of the U.S. and the District of Columbia and their political
subdivisions, agencies, and instrumentalities, up to 10% of the Portfolio's
assets;
6. unrated notes, paper, obligations or other instruments that the Manager
determines to be of comparable high quality; and
7. repurchase agreements with respect to any of the foregoing obligations.
U.S. Government Securities, Bank and Corporate Obligations may have fixed,
floating, or variable interest rates. NRSROs include Standard & Poor's
Corporation ("S&P"), Moody's Investors Service, Inc. ("Moody's"), Fitch
Investors Service, Inc., Duff and Phelps, Inc., IBCA Limited and its
affiliate IBCA Inc., and Thompson BankWatch. See the Appendix for an
explanation of ratings by S&P and Moody's.
PORTFOLIO MATURITY. All instruments in which the Portfolio invests will
mature within 397 calendar days or less of the time that they are acquired.
The average maturity of the Portfolio's securities based on their dollar
value will not exceed 90 days at the time of each investment. If the
disposition of a portfolio security results in a dollar-weighted average
portfolio maturity in excess of 90 days, the Portfolio will invest its
available cash in such manner as to reduce its dollar-weighted average
portfolio maturity to 90 days or less as soon as is reasonably practicable.
FOREIGN INVESTMENTS. The Portfolio may invest up to 25% of its assets in
obligations of foreign branches of U.S. or foreign banks. The Portfolio's
investments in foreign obligations, although always dollar denominated,
involve risks related to market volatility, economic, social, and political
uncertainty, that are different from investments in similar obligations of
domestic entities. INVESTMENTS IN FOREIGN SECURITIES, PARTICULARLY IN
DEVELOPING MARKETS, INVOLVES SPECIAL AND ADDITIONAL RISKS. SEE "HIGHLIGHTED
RISK CONSIDERATIONS, FOREIGN TRANSACTIONS" and the SAI.
OTHER INVESTMENT POLICIES. Investments in obligations of U.S. branches of
foreign banks, which are considered domestic banks, may only be made if such
branches have a federal or state charter to do business in the U.S. and are
subject to U.S. regulatory authorities. The Portfolio may invest up to 10% of
its assets in time deposits with maturities in excess of seven calendar days.
(Time deposits are non-negotiable deposits maintained in a banking
institution for a specified period of time at a stated interest rate.)
The Portfolio will not invest more than 5% of its assets in Eligible
Securities of a single issuer, other than U.S. Government Securities, rated
in the highest category by the requisite number of rating agencies, except
that the Portfolio may exceed that limit as permitted by SEC rules for a
period of up to three business days; and the Portfolio will not invest (a)
the greater of 1% of the Portfolio's assets or $1 million in Eligible
Securities issued by a single issuer rated in the second highest category, or
(b) more than 5% of its assets in Eligible Securities of all issuers rated in
the second highest category.
Under the policies discussed in "Investment Methods and Risks" and in the
SAI, the Portfolio may acquire U.S. Government Securities on a when-issued or
delayed delivery basis, lend portfolio securities, enter into repurchase
agreements, and engage in other activities specifically identified for this
Portfolio.
PORTFOLIOS SEEKING CURRENT INCOME
HIGH INCOME FUND
The principal investment objective of the High Income Fund is to earn a high
level of current return. As a secondary objective, the Portfolio seeks
capital appreciation to the extent consistent with its principal objective.
SELECTION OF PORTFOLIO SECURITIES. The Portfolio may invest in both debt
obligations and dividend-paying common or preferred stocks, including high
risk securities, and will seek to invest in whatever type of investment is
offering the highest yield and expected total return without excessive risk
at the time of purchase. Yield and expected return are the primary criteria
the Portfolio uses in selecting securities.
In the event of a corporate restructuring or bankruptcy reorganization of an
issuer whose securities are owned by the Portfolio, the Portfolio may receive
securities different from those originally purchased, e.g., common stock that
is not dividend paying, bonds with a lower coupon or more junior status, or
convertible securities. The Portfolio is not obligated to sell such
securities immediately, if the Manager believes, based on its own analysis,
that the longer term outlook is favorable and there is the potential for a
higher total return by holding such investments.
The Portfolio may also invest in lower rated zero-coupon, deferred interest
and pay-in-kind obligations, which may involve special risk considerations.
SEE "INVESTMENT METHODS AND RISKS."
CREDIT QUALITY. When purchasing debt obligations, the Portfolio may invest in
obligations in any rating category (including obligations in the lowest
rating categories) or in unrated obligations, depending upon prevailing
market and economic conditions. BECAUSE OF THE PORTFOLIO'S POLICY OF
INVESTING IN HIGHER YIELDING, HIGHER RISK DEBT OBLIGATIONS, AN INVESTMENT IN
THE PORTFOLIO IS ACCOMPANIED BY A HIGHER DEGREE OF RISK THAN IS PRESENT WITH
AN INVESTMENT IN HIGHER RATED, LOWER YIELDING OBLIGATIONS. ACCORDINGLY,
INVESTORS CONSIDERING THE PORTFOLIO SHOULD EVALUATE THEIR OVERALL INVESTMENT
GOALS AND TOLERANCE FOR RISK.
The lower rated obligations in which the Portfolio may invest (sometimes
referred to as "junk bonds") are considered by S&P and Moody's, on balance,
as predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal in accordance with the terms of the obligation
and therefore entail special risks. It is the Portfolio's current intention
not to invest more than 5% in debt obligations, including convertible bonds,
in the lowest rating categories, i.e., rated below Caa by Moody's or CCC by
S&P; or, if unrated, comparable obligations in the view of the Manager. The
Portfolio will not purchase issues that are in default. SEE "HIGHLIGHTED RISK
CONSIDERATIONS, LOWER RATED DEBT OBLIGATIONS," "INVESTMENT METHODS AND
RISKS," the SAI for additional information, the Appendix for a discussion of
the rating categories, and the "Asset Composition Table" for information
about the ratings of the debt obligations in the Portfolio during 1997.
These ratings, which represent the opinions of the rating services, do not
reflect the risk of market fluctuations nor are they absolute credit
standards. Ratings will be considered but will not be a determining or
limiting factor. Rather than relying principally on the ratings assigned by
rating services, the Manager conducts its own investment analysis based on
such factors as: anticipated cash flow; interest or dividend coverage; asset
coverage; earnings prospects; the experience and managerial strength of the
issuer; responsiveness to changes in interest rates and business conditions;
debt obligations maturity schedules and borrowing requirements; and the
issuer's changing financial condition and public recognition thereof.
In the event the rating on an issue held in the Portfolio is changed by the
rating service or the obligation goes into default, such event will be
considered by the Portfolio in its evaluation of the overall investment
merits of that security but will not necessarily result in an automatic sale
of the security.
Certain of the high yield obligations in which the Portfolio may invest may
be purchased at a discount. Such investments, when held to maturity or
retired, may include an element of gain (which may be treated as ordinary
income or capital gain for tax purposes). The Portfolio does not intend to
hold obligations for the purpose of achieving such gains, but generally will
hold them as long as current yields on these investments remain attractive.
Capital losses may be realized when obligations purchased at a premium are
held to maturity or are called or redeemed at a price lower than their
purchase price. Capital gains or losses also may be realized upon the sale of
obligations.
Because a substantial portion of this Portfolio's investments at any
particular time may consist of lower rated debt obligations, changes in the
level of interest rates, among other things, will likely have an increased
effect on the value of the Portfolio's holdings and thus the value of the
Portfolio's shares.
FOREIGN INVESTMENTS. The Portfolio may invest up to 20% of its assets in
foreign securities, including those of developing markets issuers. However,
the Portfolio will limit its investments in securities of developing markets
issuers to 10% of its assets. The Portfolio's investments in foreign
securities involve risks related to currency fluctuations, market volatility,
and economic, social, and political uncertainty that are different from
investments in similar obligations of domestic entities. INVESTMENTS IN
FOREIGN SECURITIES, PARTICULARLY IN DEVELOPING MARKETS, INVOLVE SPECIAL AND
ADDITIONAL RISKS. SEE "HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN TRANSACTIONS"
and the SAI.
OTHER INVESTMENT POLICIES. Under the policies discussed in "INVESTMENT
METHODS AND RISKS," "HIGHLIGHTED RISK CONSIDERATIONS," and the SAI, the
Portfolio may also acquire loan participations, purchase debt obligations on
a "when-issued" basis, write covered call options, loan its portfolio
securities, enter into repurchase transactions and forward currency exchange
contracts, participate in interest rate swaps, invest in restricted
securities, invest in trade claims which carry a high degree of risk, and
engage in other activities specifically identified for this Portfolio.
TEMPLETON GLOBAL INCOME SECURITIES FUND
The investment objective of the Templeton Global Income Securities Fund is to
provide high current income, consistent with preservation of capital, with
capital appreciation as a secondary consideration.
PORTFOLIO INVESTMENTS. The Portfolio will pursue its objectives by investing
at least 65% of its net assets in both domestic and foreign debt obligations
including those in developing markets and related foreign currency
transactions. Investments will be selected to provide a high current yield
and currency stability, or a combination of yield, capital appreciation, or
currency appreciation consistent with the Portfolio's objectives. As a global
Portfolio, it may invest in securities issued in any currency and may hold
foreign currencies. The Manager intends to manage the Portfolio's exposure to
various currencies, and may from time to time make use of forward currency
exchange contracts or options on currencies for hedging purposes. INVESTORS
SHOULD CONSIDER CAREFULLY THE SUBSTANTIAL RISKS INVOLVED IN INVESTING IN
FOREIGN SECURITIES, RISKS THAT ARE HEIGHTENED FOR INVESTMENTS IN DEVELOPING
MARKETS. SEE "HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN TRANSACTIONS."
The Portfolio may invest in debt obligations or equity securities of any type
of issuer, including domestic and foreign corporations, domestic and foreign
banks (with assets in excess of one billion dollars), other business
organizations, and domestic and foreign governments and their political
subdivisions, including the U.S. government, its agencies, and authorities or
instrumentalities, and supranational organizations.
Under normal market conditions, the Portfolio will have at least 25% of its
assets invested in debt obligations issued or guaranteed by foreign
governments. Securities issued by central banks which are guaranteed by their
national governments are considered to be government securities. Bonds of
foreign governments or their agencies which may be purchased by the Portfolio
may be less secure than those of U.S. government issuers.
The Portfolio is also authorized to invest in debt obligations of
supranational entities. A supranational entity is an entity designated or
supported by the national government of one or more countries to promote
economic reconstruction or development. Examples of supranational entities
include, among others, the World Bank, the European Investment Bank and the
Asian Development Bank. The Portfolio is further authorized to invest in
"Semi-Governmental Securities," which are debt obligations issued by entities
owned by either a national, state or equivalent government or are obligations
of one of such government jurisdictions which are not backed by its full
faith and credit and general taxing powers.
Other debt obligations of both domestic and foreign issuers in which the
Portfolio may invest include all types of long-term or short-term debt
obligations, such as bonds, debentures, notes, convertible debt obligations,
and commercial paper. These debt obligations may involve equity features,
such as conversion or exchange rights or warrants for the acquisition of
stock of the same or a different issuer; participation based on revenues,
sales or profits; or the purchase of common stock in a unit transaction
(where an issuer's debt obligations and common stock are offered as a unit).
CREDIT QUALITY. The Portfolio may invest in high yield, high risk, lower
rated debt obligations, including convertible bonds, that are rated at least
B by Moody's or S&P or, if unrated, are at least of comparable quality as
determined by the Manager. Many debt obligations of foreign issuers, and
especially developing markets issuers, are either (i) rated below investment
grade, or (ii) not rated by U.S. rating agencies so that their selection
depends on the Manager's internal analysis. Securities rated BB or lower
(sometimes referred to as "junk bonds") are regarded as predominately
speculative with respect to the issuer's capacity to pay interest and repay
principal in accordance with the terms of the obligation and therefore
involve special risks; investments in such securities will not exceed 30% of
the Portfolio's net assets. SEE "HIGHLIGHTED RISK CONSIDERATIONS, LOWER RATED
DEBT OBLIGATIONS," "INVESTMENT METHODS AND RISKS," the SAI for additional
information, the Appendix for a discussion of the rating categories, and the
"Asset Composition Table" for information about the ratings of the debt
obligations in the Portfolio during 1997.
COUNTRIES OF PRINCIPAL INVESTMENT. Under normal circumstances, at least 65%
of the Portfolio's assets will be invested in the securities of issuers
located in at least three countries, one of which may be the U.S. Securities
of issuers within a given country may be denominated in the currency of that
or another country, or in multinational currency units such as the European
Currency Unit ("ECU"). The Portfolio will allocate its assets among
securities of various issuers, geographic regions, and currencies in a manner
which is consistent with its objectives, based upon relative interest rates
among currencies, the outlook for changes in interest rates, and anticipated
changes in worldwide exchange rates. In considering these factors, a
country's economic and political conditions, such as inflation rate, growth
prospects, global trade patterns and government policies will be evaluated.
It is currently anticipated that the Portfolio's assets will be invested
principally within Australia, Canada, Japan, New Zealand, the U.S.,
Scandinavia, and Western Europe, and in securities denominated in the
currencies of these countries or denominated in multinational currency units
such as the ECU. The Portfolio may also invest a substantial portion of its
assets in securities and currency in developing markets countries.
Investments in foreign securities, especially developing markets, involve
special and additional risks related to currency fluctuations, market
volatility and economic, social, and political uncertainty that are different
from investments in similar obligations of domestic entities. See
"HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN TRANSACTIONS" and the SAI.
PORTFOLIO MATURITY. The Portfolio may invest in debt obligations with varying
maturities. Under current market conditions, it is expected that the
dollar-weighted average maturity of the Portfolio's debt obligations
investments will not exceed 15 years. Generally, the average maturity of the
Portfolio's debt obligations portfolio will be shorter when interest rates
worldwide or in a particular country are expected to rise, and longer when
interest rates are expected to fall.
OTHER INVESTMENT POLICIES. With respect to currency risk, the Portfolio may,
but is not required to, use currency forwards, futures contracts, and
interest rate swaps, to hedge income or capital. Under the policies discussed
in "INVESTMENT METHODS AND RISKS COMMON TO MORE THAN ONE PORTFOLIO,"
"HIGHLIGHTED RISK CONSIDERATIONS," and in the SAI, the Portfolio may also
acquire loan participations; loan its portfolio securities; enter into
repurchase, reverse repurchase, and "when-issued" transactions; invest in
preferred stock; invest in structured notes; purchase and sell call and put
options on U.S. or foreign securities; enter into futures contracts for the
purchase or sale of U.S. Treasury or foreign securities or based upon
financial indices; and engage in other activities specifically identified for
this Portfolio.
RISKS AND OTHER CONSIDERATIONS RELATED TO NON-DIVERSIFICATION. The Portfolio
is non-diversified under federal securities laws, and may concentrate its
investments in a smaller number of issuers. This flexibility may at times be
important to the Portfolio's investment strategy since the number of issuers
of foreign debt obligations is limited and foreign government securities are
not considered "government securities" for diversification purposes under
federal securities laws. While the Portfolio is still subject to the
diversification requirements under the federal tax code and the 25% limit on
concentration of investments in a single industry, changes in the value of a
single issuer's securities or interest rate fluctuations, may have a greater
effect on the Portfolio's investments and its share price. The risks of
investing in foreign securities could also be magnified. SEE "INVESTMENT
METHODS AND RISKS."
U.S. GOVERNMENT SECURITIES FUND
The investment objective of the U.S. Government Securities Fund is to earn
income through investments in a portfolio limited to securities which are
obligations of the U.S. government, its agencies or instrumentalities.
PORTFOLIO INVESTMENTS. The Portfolio pursues its objective by investing in
all types of U.S. Government Securities, including obligations issued or
guaranteed by U.S. government agencies and instrumentalities. These
obligations may also include fixed-rate mortgage backed securities,
adjustable-rate mortgage-backed securities ("ARMS"), or a hybrid of the two.
SEE "INVESTMENT METHODS AND RISKS, DEBT OBLIGATIONS." Some government agency
obligations or guarantees are supported by the full faith and credit of the
U.S. government, while others are supported principally by the issuing agency
and may not permit recourse against the U.S. Treasury if the issuing agency
does not meet its commitments.
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION. The Portfolio anticipates that a
significant portion of its assets will consist of Government National
Mortgage Association ("Association") mortgage-backed certificates ("GNMAs")
and similar mortgage-backed securities issued or guaranteed by other
agencies. GNMAs are mortgage-backed securities representing part ownership of
a pool of mortgage loans. GNMAs differ from other bonds in that principal may
be paid back on an unscheduled basis rather than returned in a lump sum at
maturity. The Portfolio purchases GNMAs for which principal and interest are
guaranteed.
The Association's guarantee of payment of principal and interest on GNMAs is
backed by the full faith and credit of the U.S. government. The Association
may borrow U.S. Treasury funds to the extent needed to make payments under
its guarantee. Of course, this guarantee does not extend to the market value
or yield of the GNMAs or the net asset value or performance of the Portfolio,
which will fluctuate daily with market conditions.
Payments to holders of GNMAs consist of the monthly distributions of interest
and principal less the Association's and issuers' fees. The portion of the
monthly payment which represents a return of principal will be reinvested by
the Portfolio in securities which may bear interest at a rate higher or lower
than the obligation from which the principal payment was received.
When mortgages in the pool underlying a GNMA are prepaid by borrowers or as a
result of foreclosure, such principal payments are passed through to the GNMA
holders, such as the Portfolio. Accordingly, a GNMA's life is likely to be
substantially shorter than the stated maturity of the mortgages in the
underlying pool. Because of such variation in prepayment rates, it is not
possible to accurately predict the life of a particular GNMA.
GNMA yields (interest income as a percentage of price) have historically
exceeded the current yields on other types of U.S. Government Securities with
comparable maturities. The effects of interest rate fluctuations and
unpredictable prepayments of principal, however, can greatly change realized
yields. As with most bonds, in a period of rising interest rates, the value
of a GNMA will generally decline. In a period of declining interest rates,
however, it is more likely that mortgages contained in GNMA pools will be
prepaid thus reducing the effective yield. This potential for prepayment
during periods of declining interest rates may reduce the general upward
price increases of GNMAs as compared to noncallable debt securities over the
same periods. Moreover, any premium paid on the purchase of a GNMA will be
lost if the obligation is prepaid. Of course, price changes of GNMAs and
other securities held by the Portfolio will have a direct impact on the net
asset value per share of the Portfolio.
ADJUSTABLE RATE SECURITIES. In addition to ARMS, the Portfolio may also
invest in adjustable rate U.S. Government Securities, which may include
securities backed by other types of assets, including business loans
guaranteed by the U.S. Small Business Administration ("SBA").
The ARMS in which the Portfolio invests are issued primarily by the
Association, the Federal National Mortgage Association ("FNMA"), and the
Federal Home Loan Mortgage Corporation ("FHLMC"), and are actively traded in
the secondary market. The underlying mortgages which collateralize ARMS
issued by the Association are fully guaranteed by the Federal Housing
Administration or the Veterans Administration, while those collateralizing
ARMS issued by the FNMA or the FHLMC are typically conventional residential
mortgages conforming to standard underwriting size and maturity constraints.
ARMS allow the Portfolio to participate in increases in interest rates
through periodic adjustments in
the coupon rates of the underlying mortgages, resulting in both higher
current yields and lower price fluctuations.
The Portfolio will not, however, benefit from increases in interest rates to
the extent that interest rates rise to the point where they cause the current
coupon of adjustable rate mortgages held to exceed the maximum annual or
lifetime reset limits (or "cap rates"). Fluctuations in interest rates above
these levels could cause such ARMS to behave more like long-term, fixed-rate
debt obligations. See the SAI for additional details.
OTHER INVESTMENT POLICIES. The Portfolio may also invest in certain other
types of pass-through debt instruments, issued or guaranteed by U.S.
government agencies or instrumentalities. Under the policies discussed in
"INVESTMENT METHODS AND RISKS" and in the SAI, the Portfolio may enter into
covered mortgage "dollar rolls," loan portfolio securities, engage in
repurchase agreements, and engage in other activities specifically identified
for this Portfolio.
PORTFOLIOS SEEKING GROWTH
AND INCOME
GLOBAL UTILITIES SECURITIES FUND
(FORMERLY UTILITY EQUITY FUND)
EFFECTIVE MAY 1, 1998, THE PORTFOLIO'S NAME CHANGED FROM "UTILITY EQUITY
FUND" TO "GLOBAL UTILITIES SECURITIES FUND," AND THE PORTFOLIO BECAME
AUTHORIZED TO INVEST WITHOUT LIMIT IN FOREIGN SECURITIES. THE PORTFOLIO'S
INVESTMENT OBJECTIVES AND OTHER POLICIES AND RESTRICTIONS DID NOT CHANGE.
WHEN REVIEWING THEIR INVESTMENTS OR CONSIDERING NEW PURCHASES OR TRANSFERS TO
THE PORTFOLIO, CONTRACT OWNERS MAY WISH TO TAKE THESE CHANGES INTO ACCOUNT
AND TO CONSULT WITH THEIR INVESTMENT REPRESENTATIVES.
The investment objectives of the Global Utilities Securities Fund are to seek
both capital appreciation and current income. The Portfolio pursues its
objective by concentrating its investments in the securities of public
utilities companies of any nation.
PORTFOLIO INVESTMENTS. The Portfolio pursues its objectives by investing,
under normal conditions, at least 65% of the Portfolio's assets in securities
of issuers engaged in the public utilities industry. The public utilities
industry includes companies which are, in the Manager's opinion, engaged in
the ownership or operation or manufacture of facilities, equipment or
components used to generate, transmit or distribute electricity, telephone
communications, cable and internet services, wireless telecommunications, gas
or water. The Portfolio will normally invest in common stocks which are
expected to yield dividends.
The Portfolio may invest in stocks and debt obligations of companies of any
nation, developed or developing. The Portfolio will normally invest at least
65% of its assets in issuers domiciled in at least three different countries,
one of which may be the U.S. Under normal circumstances, the Portfolio is
expected to invest a higher percentage of its assets in U.S. securities than
in the securities of issuers located in any other single country. The
Portfolio's Manager believes that a global utilities portfolio may benefit
from a wider selection of investment opportunities and greater
diversification than a portfolio which invests primarily in securities of
domestic utility companies.
The Portfolio will typically invest predominantly in equity securities issued
by large-capitalization or mid-capitalization companies, which have market
capitalizations of $1 billion or more. It may also invest a substantial
portion of its assets in smaller capitalization companies, which may be
subject to different and greater risks. See "Small Cap Investments" below.
RISKS OF FOREIGN INVESTING. Foreign securities involve greater risks than
similar domestic securities due to currency fluctuations, market volatility,
and economic, social, and political uncertainty. Investments in foreign
developing markets involve heightened risks related to the smaller size and
lesser liquidity of these markets. However, as a non-fundamental policy, the
Portfolio will limit its investments in securities of Russian issuers to 5%
of assets. INVESTMENTS IN FOREIGN SECURITIES, PARTICULARLY IN DEVELOPING
MARKETS, INVOLVE SPECIAL AND ADDITIONAL RISKS WHICH ARE DISCUSSED IN THE
PROSPECTUS UNDER "HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN SECURITIES" and
the SAI.
RISKS ASSOCIATED WITH UTILITIES INVESTMENTS. Utility companies in the U.S.
and in foreign countries have generally been subject to substantial
government regulation. Major changes in government policies, ranging from
increased regulation or expropriation to deregulation, privatization or
increased competition, may dramatically increase or reduce opportunities for
companies in these industries. For example, while certain companies may
develop more profitable opportunities, others may be forced to defend their
core businesses and may be less profitable.
Electric utility companies have historically been subject to price
regulation, risks associated with increases in fuel and other operating
costs, difficulty in obtaining natural gas for resale, declines in the prices
of alternative fuels, high interest costs on borrowings or reduced ability to
borrow particularly during inflationary periods, costs associated with
compliance with environmental, nuclear facility and other safety regulations
and changes in the regulatory climate, and general effects of energy
conservation. Increased scrutiny of electric utilities might result in higher
costs and higher capital expenditures, with the risk that regulators may
disallow inclusion of these costs in rate authorizations. Alternatively,
increased competition in some areas, while permitting many companies to
expand, may reduce or limit the prices the utility companies can charge. Gas
transmission and distribution companies continue to undergo significant
changes as well. Many companies have diversified into oil and gas exploration
and development, making returns more sensitive to energy prices. The water
supply industry is highly fragmented due to local ownership. Generally, these
companies are more mature and expect little or no per capita volume growth.
Increasing competition due to past regulatory changes in the telephone
communications industry continues and, whereas certain companies have
benefited, many companies may be adversely affected in the future. The cable
television industry is regulated in most countries and, although such
companies typically have a local monopoly, emerging technologies and
pro-competitive legislation are combining to threaten these monopolies and
could change the future outlook. The wireless telecommunications and internet
service industries and certain equipment and component manufacturing
businesses, may be in early developmental stages and predominantly
characterized by emerging, rapidly growing companies, or be subject to risks
related to rapidly changing technology.
Finally, many utility stocks may be particularly sensitive to interest rate
movements because investors may value such stocks based upon their yields
rather than their potential growth. Accordingly, these stocks may behave like
bonds, rising in value during periods of falling interest rates and falling
in value during periods of rising interest rates. Utility stocks may also,
however, be affected by factors which affect equity securities generally.
INDUSTRY CONCENTRATION RISK. Because the Portfolio concentrates its
investments in a limited group of related industries, it may be more
susceptible to adverse developments in those industries and thus present
greater risk than a portfolio with greater industry diversification.
SMALL CAP INVESTMENTS. Smaller or relatively new or unseasoned companies can
be particularly sensitive to changing economic conditions, and their growth
prospects are less certain then those of larger, more established companies.
For example, smaller companies may have limited financial resources, product
lines or market share; they may lack depth of management; or they may not
find an established market for their products or services. In addition, the
prices of smaller company stocks may, to a degree, fluctuate independently
from larger company stocks. SEE "INVESTMENT METHODS AND RISKS, SMALL CAP
ISSUERS" and the SAI for more information.
OTHER INVESTMENT POLICIES. The Portfolio may invest up to 5% of its assets in
debt obligations, including convertible bonds issued by public utility
issuers, regardless of their ratings, which means the assets of the Portfolio
may be invested in securities rated Ba or lower by Moody's or BB or lower by
S&P, or unrated securities determined by the Manager to be of comparable
quality. SEE "HIGHLIGHTED RISK CONSIDERATIONS, LOWER RATED DEBT OBLIGATIONS,"
"INVESTMENT METHODS AND RISKS, DEBT OBLIGATIONS," AND THE APPENDIX. The
Portfolio currently intends to invest no more than 5% of its assets in
preferred stocks or convertible preferred stocks issued by public utility
issuers. Subject to these limits, the Portfolio may invest up to 5% of its
assets in enhanced convertible securities. Under the policies discussed in
"INVESTMENT METHODS AND RISKS," "HIGHLIGHTED RISK CONSIDERATIONS," and in the
SAI, the Portfolio may also write covered call options, loan its portfolio
securities, enter into repurchase transactions, and engage in other
activities specifically identified for this Portfolio.
GROWTH AND INCOME FUND
The principal investment objective of the Growth and Income Fund is capital
appreciation. The Portfolio's secondary objective is to provide current
income return.
PORTFOLIO INVESTMENTS. The Portfolio pursues capital appreciation by
investing in securities the Manager believes have the potential to increase
in value. The Portfolio will normally invest in the U.S. stock market by
investing in a broadly diversified portfolio of common stocks which may be
traded on a securities exchange or over-the-counter. Stocks and other equity
securities representing ownership interests in corporations, have
historically outperformed other asset classes over the long term but tend to
fluctuate more dramatically over the short term.
The Portfolio seeks current income through the receipt of dividends or
interest from its investments, and the payment of dividends may therefore be
a consideration in purchasing debt obligations or securities for the
Portfolio. In pursuing its secondary objective of current income, the
Portfolio may also purchase convertible securities, including bonds or
preferred stocks, enhanced convertible securities, debt obligations, and
Money Market Instruments.
SELECTION OF PORTFOLIO INVESTMENTS. The investment strategy of the Portfolio
is to generally invest in undervalued issues believed to have attractive
long-term growth prospects. The Portfolio's Manager uses relative yield
analysis to target companies that have current relative yields near the upper
end of their historical ranges. In doing so, the Manager hopes to identify
undervalued stocks, in pursuit of the Portfolio's primary objective of
capital appreciation. Relative yield, as used here, is a company's stock
yield divided by the market yield (as defined by the S&P 500). In
implementing the Portfolio's relative yield strategy, the Portfolio generally
restricts its investment to stocks which, in the opinion of the Manager,
yield at least 100% of the yield of the S&P 500, thereby enabling the Manager
to pursue its secondary objective, namely current income. In addition to
relative yield analysis, the Portfolio employs other valuation methods
including, but not limited to, quantitative and fundamental analysis. This
strategy generally results in the Portfolio investing predominantly in mid-
and larger capitalization issuers.
FOREIGN INVESTMENTS. Although the Portfolio reserves the right to invest up
to 30% of its assets in foreign securities not publicly traded in the U.S.,
the Portfolio's current investment strategy is to limit such investments to
no more than 20% of the Portfolio's assets, including ADRs. The Portfolio's
investments in foreign securities involve risks related to currency
fluctuations, market volatility, and economic, social, and political
uncertainty that are different from investing in similar obligations of
domestic entities. Investments in foreign developing markets involve
heightened risks related to the smaller size and lesser liquidity of these
markets. INVESTMENTS IN FOREIGN SECURITIES, PARTICULARLY IN DEVELOPING
MARKETS, INVOLVE SPECIAL AND ADDITIONAL RISKS. SEE "HIGHLIGHTED RISK
CONSIDERATIONS, FOREIGN TRANSACTIONS" and the SAI.
REITS. The Portfolio currently intends to invest no more than 15% of its
assets in equity real estate investment trusts ("REITs"). REITs may provide
an attractive alternative to direct investments in real estate, but are
subject to risks related to the skill of their management, changes in value
of the properties owned by the REITs, the quality of any credit extended by
the REITs, and general economic and other factors. See "Real Estate
Securities Fund" for more information.
OTHER INVESTMENT POLICIES. Although the Portfolio may invest in convertible
securities, it currently does not intend to invest more than 10% of its
assets in such securities which may carry special risks as described below.
In addition, the Portfolio currently does not intend to invest more than 5%
of its assets in debt obligations, including convertible debt obligations,
rated Ba or lower by Moody's or BB or lower by S&P, or unrated securities
determined by the Manager to be of comparable quality. Under the policies
discussed in "HIGHLIGHTED RISK CONSIDERATIONS," "INVESTMENT METHODS AND
RISKS" and in the SAI, the Portfolio may also write covered call and put
options; purchase call and put options on securities and indices of
securities, including "forward conversion" transactions; loan its portfolio
securities; enter into repurchase transactions; and engage in other
activities specifically identified for this Portfolio.
INCOME SECURITIES FUND
The investment objective of the Income Securities Fund is to maximize income
while maintaining prospects for capital appreciation.
PORTFOLIO INVESTMENTS. The Portfolio will pursue its objective by investing
in a diversified portfolio of domestic and foreign debt obligations, which
may include lower rated obligations (commonly referred to as "junk bonds"),
as well as equity securities, selected with particular consideration of
current income production along with capital appreciation. The assets of the
Portfolio may be held in cash or invested in securities traded on any
national securities exchange, in Money Market Instruments, or in securities
issued by a corporation, association or similar legal entity having gross
assets valued at not less than $1 million as shown by its latest published
annual report. Such investments may include zero coupon, deferred interest or
pay-in-kind bonds, or preferred stocks. SEE "INVESTMENT METHODS AND RISKS."
There are no restrictions as to the proportion of investments which may be
made in any particular type of security and such determination is entirely
within the Manager's discretion. As market conditions change, it is
conceivable that all of the assets of the Portfolio might be invested in debt
obligations or, conversely, in common stocks. As a fundamental policy,
however, the Portfolio will not concentrate its investments in a single
industry in excess of 25% of its assets.
Certain of the high yield obligations in which the Portfolio may invest may
be purchased at a discount. Such investments, when held to maturity or
retired, may include an element of gain (which may be treated as ordinary
income or capital gain for tax purposes). Capital losses may be realized when
obligations purchased at a premium are held to maturity or are called or
redeemed at a price lower than their purchase price. Capital gains or losses
also may be realized upon the sale of obligations.
CREDIT QUALITY. When purchasing debt obligations, the Portfolio may invest in
obligations in any rating category (including obligations in the lowest
rating categories) or unrated obligations, depending upon prevailing market
and economic conditions. BECAUSE OF THE PORTFOLIO'S POLICY OF INVESTING IN
HIGHER YIELDING, HIGHER RISK DEBT OBLIGATIONS, AN INVESTMENT IN THE PORTFOLIO
IS ACCOMPANIED BY A HIGHER DEGREE OF RISK THAN IS PRESENT WITH AN INVESTMENT
IN HIGHER RATED, LOWER YIELDING OBLIGATIONS. ACCORDINGLY, INVESTORS
CONSIDERING THE PORTFOLIO SHOULD EVALUATE THEIR OVERALL INVESTMENT GOALS AND
TOLERANCE FOR RISK.
Currently, however, the Portfolio intends generally to invest in securities
that are rated at least Caa by Moody's or CCC by S&P, or, if unrated,
comparable obligations in the view of the Manager, except for defaulted
securities discussed below. The lower rated obligations in which the
Portfolio may invest are considered by S&P and Moody's, on balance, as
predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal in accordance with the terms of the obligation
and therefore entail special risks. SEE "HIGHLIGHTED RISK CONSIDERATIONS,
LOWER RATED DEBT OBLIGATIONS," "INVESTMENT METHODS AND RISKS," the SAI for
additional information, the Appendix for a discussion of the rating
categories, and the "Asset Composition Table" for information about the
ratings of the debt obligations in the Portfolio during 1997.
These ratings, which represent the opinions of the rating services, do not
reflect the risk of market fluctuations nor are they absolute credit
standards. Ratings will be considered but will not be a determining or
limiting factor. Rather than relying principally on the ratings assigned by
rating services, the Manager conducts its own investment analysis.
In the event the rating on an issue held in the Portfolio is changed by the
rating service or the obligation goes into default, such event will be
considered by the Manager in its evaluation of the overall investment merits
of that security but will not necessarily result in an automatic sale of the
security.
Because a substantial portion of this Portfolio's investments at any
particular time may consist of lower rated debt obligations, individual
developments affecting each issuer, among other things, will likely have an
increased effect on the market value of the Portfolio's holdings and thus the
value of the Portfolio's shares.
DEFAULTED DEBT OBLIGATIONS. The Portfolio may invest up to 5% of its assets
in defaulted debt obligations which may be considered speculative.
FOREIGN INVESTMENTS. The Portfolio may invest up to 25% of its assets in
foreign securities, including those of developing markets issuers. The
Portfolio may also invest in sponsored or unsponsored Depositary Receipts.
The Portfolio's investments in foreign securities involve risks related to
currency fluctuations, market volatility, and economic, social, and political
uncertainty that are different from investments in similar obligations of
domestic entities. Investments in foreign developing markets involve
heightened risks related to the smaller size and lesser liquidity of these
markets. INVESTMENTS IN FOREIGN SECURITIES, PARTICULARLY IN DEVELOPING
MARKETS, INVOLVE SPECIAL AND ADDITIONAL RISKS. SEE "HIGHLIGHTED RISK
CONSIDERATIONS, FOREIGN TRANSACTIONS" and the SAI.
OTHER INVESTMENT POLICIES. The Portfolio currently intends to invest no more
than 5% of its assets in loan participations and other related direct or
indirect bank obligations and up to 5% of its assets in trade claims, both of
which carry a high degree of risk; and currently intends to invest no more
than 5% of its assets in enhanced convertible securities. Under the policies
discussed in "INVESTMENT METHODS AND RISKS," "HIGHLIGHTED RISK
CONSIDERATIONS," and in the SAI, the Portfolio may also loan its portfolio
securities; enter into repurchase transactions; purchase debt obligations on
a "when-issued" or "delayed-delivery" basis; write covered call options on
securities; and engage in other activities specifically identified for this
Portfolio.
MUTUAL SHARES SECURITIES FUND
The principal investment objective of the Mutual Shares Securities Fund is
capital appreciation, with income as a secondary objective.
PORTFOLIO INVESTMENTS. Under normal market conditions, the Portfolio invests
primarily in domestic equity securities, including common and preferred
stocks and securities convertible into common stocks, as well as debt
obligations of any quality. Debt obligations may include securities or
indebtedness issued by corporations or governments in any form, including
notes, bonds, or debentures, as well as distressed mortgage obligations and
other debt secured by real property. The Manager has no pre-set limits as to
the percentages which may be invested in equity securities, debt securities
or Money Market Instruments. The Portfolio may invest in securities from any
size issuer, including smaller capitalization companies, which may be subject
to different and greater risks. SEE "INVESTMENT METHODS AND RISKS, SMALL
CAPITALIZATION ISSUERS." It will tend to invest, however, in securities of
issuers with market capitalizations in excess of $500 million. It may invest
in securities that are traded on U.S. or foreign exchanges, NASDAQ national
market or in the over-the-counter market. It may invest in any industry
sector, although it will not concentrate in any one industry. From time to
time, the Portfolio may hold significant cash positions, consistent with its
policy on temporary investments, until suitable investment opportunities are
available.
The Portfolio also seeks to invest in securities of companies involved in
mergers, consolidations, liquidations and reorganizations or as to which
there exist tender or exchange offers, and may participate in such
transactions. The Portfolio does not presently anticipate investing more than
50% of its assets in such investments, but is not restricted to that amount.
There can be no assurance that any such transaction proposed at the time of
the Portfolio's investment will be consummated or will be consummated on the
terms and within the time period contemplated. The Portfolio may also invest
in other forms of secured or unsecured indebtedness or participations
("Indebtedness"), including without limitation, loan participations and trade
claims, of debtor companies involved in reorganization or financial
restructuring, some of which may have very long maturities. Some of the
Indebtedness is illiquid.
SELECTION OF PORTFOLIO INVESTMENTS. The Portfolio's general policy is to
invest in securities which, in the opinion of the Manager, are available at
prices less than their intrinsic values. The Manager's opinions are based
upon analysis and research, taking into account, among other factors, the
relationship of book value to market value of the securities, cash flow, and
multiples of earnings of comparable securities. These factors are not applied
formulaically, as the Manager examines each security separately; the Manager
has no general criteria as to asset size, earnings or industry type which
would make a security unsuitable for purchase by the Portfolio.
The Portfolio purchases securities for investment purposes and not for the
purpose of influencing or controlling management of the issuer. However, in
certain circumstances when the Manager perceives that the Portfolio may
benefit, the Manager may itself seek to influence or control management or
may cause the Portfolio to invest in other entities that purchase securities
for the purpose of influencing or controlling management, such as investing
in a potential takeover or leveraged buyout or investing in other entities
engaged in such practices.
CREDIT QUALITY. Debt obligations (including Indebtedness) in which the
Portfolio invests may be rated or unrated and, if rated, ratings may range
from the very highest to the very lowest categories (currently C for Moody's
and D for S&P). Medium and lower-rated debt obligations are commonly referred
to as "junk bonds." In general, it will invest in these instruments for the
same reasons underlying its investments in equity securities, i.e., that the
instruments are available, in the Manager's opinion, at prices less than
their intrinsic values. Consequently, the Manager's own analysis of a debt
instrument exercises a greater influence over the investment decision than
the stated coupon rate or credit rating. The Portfolio expects to invest in
debt obligations issued by reorganizing or restructuring companies, or
companies which recently emerged from, or are facing the prospect of a
financial restructuring. It is under these circumstances, which usually
involve unrated or low rated securities that are often in, or are about to,
default, that the Manager seeks to identify securities which are sometimes
available at prices which it believes are less than their intrinsic values.
The purchase of Indebtedness of a troubled company always involves a risk as
to the creditworthiness of the issuer and the possibility that the investment
may be lost. However, the debt securities of reorganizing or restructuring
companies typically rank senior to the equity securities of such companies.
Higher yields are generally available from securities in the higher risk,
lower rating categories of S&P or Moody's; however, the values of lower rated
securities generally fluctuate more than those of higher rated securities and
involve greater risk of loss of income and principal. Moreover, securities
rated BB or lower by S&P or Ba or lower by Moody's are predominantly
speculative with respect to the issuer's ability to pay principal and
interest and may be in default. These securities may also be less liquid than
higher rated securities, or have no established markets, thereby increasing
the degree to which judgment plays a role in valuing such securities. BECAUSE
OF THE PORTFOLIO'S POLICY OF INVESTING IN LOWER-RATED OR UNRATED, HIGHER RISK
DEBT OBLIGATIONS, AN INVESTMENT IN THE PORTFOLIO IS ACCOMPANIED BY A HIGHER
DEGREE OF RISK THAN IS PRESENT WITH AN INVESTMENT IN HIGHER RATED
OBLIGATIONS. ACCORDINGLY, INVESTORS CONSIDERING THE PORTFOLIO SHOULD EVALUATE
THEIR OVERALL INVESTMENT GOALS AND TOLERANCE FOR RISK. SEE "HIGHLIGHTED RISK
CONSIDERATIONS, LOWER RATED DEBT OBLIGATIONS" AND THE APPENDIX.
DEFAULTED DEBT OBLIGATIONS. The Portfolio may invest without limit in
defaulted debt obligations, subject to the Portfolio's restriction on
investments in illiquid securities. Defaulted debt obligations may be
considered speculative. See the discussion above under "Credit Quality" for
the circumstances under which the Portfolio generally invests in defaulted
debt obligations.
FOREIGN INVESTMENTS. Although the Portfolio reserves the right to purchase
securities in any foreign country without percentage limitation, the
Portfolio's current investment strategy is to invest primarily in domestic
securities, with approximately 15-20% of its assets in foreign securities,
including sponsored or unsponsored Depositary Receipts. The Portfolio
presently does not intend to invest more than 5% of its assets in securities
of developing markets, including Eastern European countries and Russia.
Foreign investments may include both voting and non-voting securities,
sovereign debt and participation in foreign government deals. The Portfolio's
investments in foreign securities involve risks related to currency
fluctuations, market volatility, and economic, social and political
uncertainty that are different from investing in similar obligations of
domestic entities. INVESTMENTS IN FOREIGN SECURITIES, PARTICULARLY IN
DEVELOPING MARKETS, INVOLVE SPECIAL AND ADDITIONAL RISKS. SEE "HIGHLIGHTED
RISK CONSIDERATIONS, FOREIGN TRANSACTIONS" below and in the SAI.
CURRENCY TECHNIQUES. The Portfolio generally expects it will hedge against
currency risks to the extent that hedging is available. Currency hedging
techniques may include investments in foreign currency futures contracts,
options on foreign currencies or currency futures, forward foreign currency
exchange contracts ("forward contracts") and currency swaps, all of which
involve specialized risks. SEE "HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN
TRANSACTIONS."
OTHER INVESTMENT POLICIES. While the Portfolio may not purchase securities of
registered open-end investment companies or affiliated investment companies,
it may invest from time to time in other investment company securities
subject to the limitation that it will not purchase more than 3% of the
voting securities of another investment company. In addition, the Portfolio
will not invest more than 5% of its assets in the securities of any single
investment company and will not invest more than 10% of its assets in
investment company securities. Investors should recognize that an investment
in the securities of such investment companies results in layering of
expenses such that investors indirectly bear a proportionate share of the
expenses of such investment companies, including operating costs, and
investment advisory and administrative fees. The Portfolio may also sell
short securities it does not own up to 5% of its assets. Short sales have
risks of loss if the price of the security sold short increases after the
sale, but the Portfolio can profit if the price decreases. The Portfolio may
also sell securities "short against the box" (i.e., securities which the
Portfolio owns or has the immediate and unconditional right to acquire at no
additional cost) without limit. See the SAI for further details concerning
short sales.
Under the policies discussed in "INVESTMENT METHODS AND RISKS," "HIGHLIGHTED
RISK CONSIDERATIONS," and in the SAI, the Portfolio may also loan its
portfolio securities; enter into repurchase transactions; purchase securities
and debt obligations on a "when-issued" or "delayed delivery" basis; invest
in restricted or illiquid securities; purchase and sell exchange-listed and
over-the-counter put and call options on securities, equity and fixed-income
indices and other financial instruments; purchase and sell financial futures
contracts and options thereon; and engage in other activities specifically
identified for this Portfolio.
REAL ESTATE SECURITIES FUND
The principal objective of the Real Estate Securities Fund is capital
appreciation, with a secondary objective of earning current income on its
investments.
PORTFOLIO INVESTMENTS. The Portfolio pursues its principal objective by
investing primarily in securities of companies operating in the real estate
industry. Under normal circumstances, therefore, at least 65% of the
Portfolio's assets will be invested in "real estate securities" (defined
below), primarily equity real estate investment trusts ("REITs"). The
Portfolio will generally invest in real estate securities of companies listed
on a securities exchange or traded over-the-counter. As used by the
Portfolio, investments deemed to be "real estate securities" will include
equity, debt obligations, and convertible securities of companies having the
following characteristics and will be subject to the following limitations:
1. Companies qualifying as a REIT for federal income tax purposes. In order
to qualify as a REIT, a company must derive at least 75% of its gross income
from real estate sources (rents, mortgage interest, gains from the sale of
real estate assets), and at least 95% from real estate sources, plus
dividends, interest and gains from the sale of securities. Real property,
mortgage loans, cash and certain securities must comprise 75% of a company's
assets. In order to qualify as a REIT, a company must also make distributions
to shareholders aggregating annually at least 95% of its REIT taxable income.
2. Companies having at least 50% of their assets
related to, or deriving at least 50% of their revenues from, the ownership,
construction, management or other services, or sale of residential,
commercial or industrial real estate. Such companies would include real
estate operating companies, real estate services and home builders.
The Portfolio will typically invest predominately in securities issued by
mid-cap or smaller cap U.S. companies which have market capitalizations of $5
billion and $1 billion or less, respectively, because that is reflective of
the industry itself. Small cap REITs can be subject to different and greater
risks than mid or larger cap issuers. Small cap REITs may have greater
regional concentration and less diversification in terms of the regions,
clients and types of properties available for investment.
RISKS RELATED TO CONCENTRATION. The Portfolio may invest more than 25% of its
total assets in any sector of the real estate industry described above. The
Portfolio's policy of concentrating in the securities of companies in the
real estate industry and the other investment policies referenced above are
fundamental policies that cannot be changed without shareholder approval. Due
to the Portfolio's concentration in the real estate industry, adverse
developments in that industry will have a greater impact on the Portfolio,
and consequently shareholders, than a portfolio with broader diversification.
Special considerations to an investment in the Portfolio include those risks
associated with the direct ownership of real estate: declines in the value of
real estate, risks related to general and local economic conditions,
over-building and increased competition, increases in property taxes and
operating expenses, changes in zoning laws, casualty or condemnation losses,
limitations on rents, changes in neighborhood values, the appeal of
properties to tenants, and increases in interest rates. The value of
securities of companies which service the real estate industry may also be
affected by such risks.
In addition to the risks discussed above, equity REITs may be affected by any
changes in the value of the underlying property owned by such REITs, while
mortgage REITs may be affected by the quality of any credit extended. Equity
and mortgage REITs are dependent on the REIT management team's skill, may not
be diversified, and are subject to the risks of financing projects. The
Portfolio could conceivably own real estate directly as a result of a default
on debt obligations it may own. Changes in prevailing interest rates also may
inversely affect the value of the debt obligations in which the Portfolio
will invest.
The Portfolio's Manager believes, however, that diversification of the
Portfolio's assets into different types of real estate investments will help
mitigate, although it cannot eliminate, the inherent risks of such industry
concentration. Moreover, there has historically been a low correlation
between the real estate market and the broader equity market. While there can
be no guarantee that historical trends will continue in the future,
investments in real estate securities may be a useful way of diversifying
one's overall portfolio.
REAL ESTATE RELATED INVESTMENTS. In addition to the Portfolio's investments
in real estate securities, the Portfolio may also invest a portion of its
assets in debt obligations or equity securities of issuers engaged in
businesses whose products and services are closely related to the real estate
industry, and publicly traded on an exchange or in the over-the-counter
market. Such issuers may include manufacturers and distributors of building
supplies; financial institutions that issue or service mortgages, such as
savings and loan associations or mortgage bankers; and companies whose
principal business is unrelated to the real estate industry but who have
significant real estate holdings (at least 50% of their respective assets)
believed to be undervalued relative to the price of those companies'
securities.
CREDIT QUALITY. As an operating policy, the Portfolio will not invest more
than 10% of its net assets in convertible debt obligations or debt
obligations rated Ba or lower by Moody's or, if unrated, deemed by the
Manager to be of comparable quality. Generally, however, the Portfolio will
not acquire any investments rated lower than B by Moody's or, if unrated,
deemed to be of comparable quality by the Manager. Lower rated obligations
(commonly referred to as "junk bonds") are considered by the rating agencies
to have increased risks related to the creditworthiness of their issuers. SEE
"HIGHLIGHTED RISK CONSIDERATIONS, LOWER RATED DEBT OBLIGATIONS" and the SAI.
OTHER INVESTMENT POLICIES. The Portfolio may invest up to 10% in foreign
securities, including developing markets, which involve special risks
including currency fluctuations and political uncertainty. SEE "HIGHLIGHTED
RISK CONSIDERATIONS, FOREIGN TRANSACTIONS" and the SAI. Under the policies
discussed in "INVESTMENT METHODS AND RISKS," and in the SAI, the Portfolio
may also write covered call options, loan its portfolio securities, engage in
repurchase transactions, invest in enhanced convertible securities, and
engage in other activities specifically identified for this Portfolio.
RISING DIVIDENDS FUND
The investment objectives of the Rising Dividends Fund are capital
appreciation and current income incidental to capital appreciation. In
seeking capital appreciation, the Portfolio invests with a long-term
investment horizon. Preservation of capital, while not an objective, is also
an important consideration.
SELECTION OF PORTFOLIO INVESTMENTS. The Portfolio seeks to achieve its
investment objectives by investing, as a fundamental policy, at least 65% of
its net assets in financially sound companies that have paid consistently
rising dividends based on the investment philosophy that the securities of
such companies, because of their dividend record, have a strong potential to
increase in value. As a fundamental policy, under normal market conditions,
at least 65% of the Portfolio is invested in the securities of companies that
meet the following specialized criteria:
1. consistent dividend increases - a company should have increased its
dividend in at least eight out of the last ten years with no year showing a
decrease;
2. substantial dividend increases - a company must have increased its
dividend at least 100% over the past ten years;
3. reinvested earnings - dividend payout should be less than 65% of current
earnings (except for utility companies);
4. strong balance sheet - long-term debt obligations should be no more than
30% of total capitalization (except for utility companies); and
5. attractive price - the current price should either be in the lower half of
the stock's price/earnings ratio range for the past ten years or less than
the average current market price/earnings ratio of the stocks comprising the
S&P 500 Stock Index.
The remaining 35% of the Portfolio's assets typically are invested in
dividend-paying equity securities with similar characteristics that may not
meet all of the specialized criteria listed above. The Portfolio's
investments may include common stocks, convertible securities, or rights or
warrants to subscribe for or purchase common stocks.
The Manager also considers other factors, such as return on shareholder's
equity, rate of earnings growth and anticipated price/earnings ratios, in
selecting investments for the Portfolio. In addition, because capital
preservation is an important consideration, the Manager generally also
reviews a company's stability and the strength of its balance sheet in
selecting among eligible growth companies.
Following these policies, the Portfolio will typically invest predominantly
in equity securities issued by large-cap or mid-cap U.S. companies, which
have market capitalizations of $1 billion or more. It may also invest to a
lesser but significant degree in smaller capitalization companies, which are
subject to different and greater risks. SEE "INVESTMENT METHODS AND RISKS,
SMALL CAPITALIZATION ISSUERS."
OTHER INVESTMENT POLICIES. The Portfolio may invest up to 10% of its net
assets in foreign securities, including developing markets, which involve
special risks including currency fluctuations and political uncertainty. SEE
"HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN TRANSACTIONS" and the SAI. Under
the policies discussed in "INVESTMENT METHODS AND RISKS," and in the SAI, the
Portfolio may also loan its portfolio securities, enter into repurchase
transactions, write covered call options, and engage in other activities
specifically identified for this Portfolio.
TEMPLETON GLOBAL ASSET ALLOCATION FUND
The investment objective of the Templeton Global Asset Allocation Fund is to
seek a high level of total return through a flexible policy of investing in
the following market segments: equity securities of issuers in any nation,
debt obligations of companies and governments of any nation, and Money Market
Instruments.
PORTFOLIO INVESTMENTS. The mix of investments among these three market
segments will be adjusted in an attempt to capitalize on total return
potential produced by changing economic conditions throughout the world.
There are no minimum or maximum percentages as to the amount of the
Portfolio's assets which may be invested in each of the market segments.
Except as noted below and under "Investment Restrictions" in the SAI, the
Manager has complete discretion in determining the amount of equity
securities, debt obligations, or Money Market Instruments in which the
Portfolio may invest.
The Portfolio seeks to achieve its objective by seeking investment
opportunities in all types of securities issued by companies or governments
of any nation, including developing markets nations. The Portfolio will
normally be invested in at least three countries, except during defensive
periods. INVESTORS SHOULD CONSIDER CAREFULLY THE SUBSTANTIAL RISKS INVOLVED
IN INVESTING IN FOREIGN SECURITIES, RISKS THAT ARE HEIGHTENED FOR INVESTMENTS
IN DEVELOPING MARKETS. SEE "HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN
TRANSACTIONS."
EQUITY SECURITIES. Equity securities in which the Portfolio may invest
consistent with its investment objective and policies may include common and
preferred stock, securities (bonds or preferred stock) convertible into
common stock ("convertible securities"), warrants, equity real estate
investment trusts ("REITs"), and securities representing underlying
international securities such as Depositary Receipts. The Portfolio may
purchase sponsored or unsponsored Depositary Receipts, such as ADRs, EDRs,
and GDRs, which will be deemed to be investments in the underlying securities
for purposes of the Portfolio's investment policies. Depositary receipts may
not necessarily be denominated in the same currency as the underlying
securities and they involve the risks of other investments in foreign
securities, as discussed in "Highlighted Risk Considerations, Foreign
Transactions."
DEBT OBLIGATIONS. Debt obligations in which the Portfolio may invest
consistent with its investment objective and policies may include many types
of debt obligations of both domestic and foreign governments or companies,
such as bonds, debentures, notes, commercial paper, collateralized mortgage
obligations ("CMOs") and obligations issued or guaranteed by governments or
government agencies or instrumentalities including, specifically, Government
National Mortgage Association ("GNMA") mortgage-backed certificates. The
yields provided by GNMA securities have historically exceeded the yields on
other types of U.S. Government Securities with comparable maturities;
unpredictable prepayments of principal, however, can greatly change realized
yields. SEE "INVESTMENT METHODS AND RISKS." The Portfolio has the flexibility
to invest in preferred stocks and certain debt obligations, rated or unrated,
such as convertible bonds and bonds selling at a discount. Debt obligations
can provide the potential for capital appreciation based on various factors
such as changes in interest rates, economic and market conditions,
improvement in an issuer' ability to repay principal and pay interest, and
ratings upgrades.
CREDIT QUALITY. The Portfolio may invest in medium grade and lower quality
debt obligations that are rated between BBB and as low as CC by S&P, and
between Baa and as low as Ca by Moody's or, if unrated, are of equivalent
investment quality as determined by the Manager. Bonds rated BB or lower 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. Issues of bonds rated Ca may often be in default.
Higher yields are generally available from securities in the higher risk,
lower rating categories of S&P or Moody's (commonly referred to as "junk
bonds"); however, the values of lower rated securities generally fluctuate
more than those of higher rated securities and involve greater risk of loss
of income and principal. SEE "HIGHLIGHTED RISK CONSIDERATIONS, LOWER RATED
DEBT OBLIGATIONS," "INVESTMENT METHODS AND RISKS," the SAI for additional
information, and the Appendix for a discussion of the rating categories.
As an operating policy established by the Board of Trustees, however, the
Portfolio will not invest more than 25% of its assets in debt obligations
rated BBB or lower by S&P or Baa or lower by Moody's or if unrated,
determined by the Manager to be of comparable quality. Such limit would
include defaulted debt obligations. Many debt obligations of foreign issuers,
and especially developing markets issuers, are either (i) rated below
investment grade or (ii) not rated by U.S. rating agencies so that their
selection depends on the Manager's internal analysis. The Board of Trustees
may consider an increase in this operating policy if, in its judgment,
economic conditions change such that a higher level of investment in high
risk, lower quality debt obligations would be consistent with the interests
of the Portfolio and its shareholders.
MONEY MARKET INSTRUMENTS. The Portfolio may invest in Money Market
Instruments. In addition, the Portfolio may hold cash and time deposits with
banks in the currency of any major nation and invest in certificates of
deposit of federally insured savings and loan associations having total
assets in excess of $1 billion. The Portfolio may also invest in commercial
paper limited to obligations rated Prime-1 or Prime-2 by Moody's or A-1 or
A-2 by S&P or, if not rated by Moody's or S&P, issued by companies having an
outstanding debt issue currently rated Aaa or Aa by Moody's or AAA or AA by
S&P. See the Appendix.
DEFAULTED DEBT OBLIGATIONS. The Portfolio may invest up to 10% of its assets
in defaulted debt obligations, which may be considered speculative.
FOREIGN SECURITIES. The Portfolio has an unlimited right to purchase
securities in any foreign country, developed or emerging, if they are listed
on an exchange, as well as a limited right to purchase such securities if
they are unlisted. However, as a non-fundamental policy, the Portfolio will
limit its investments in securities of Russian issuers to 5% of assets. The
Portfolio's investments in foreign securities involve risks related to
currency fluctuations, market volatility, and economic, social, and political
uncertainty that are different from investing in similar obligations of
domestic entities. Investments in foreign developing markets involve
heightened risks related to the smaller size and lesser liquidity of these
markets. INVESTORS SHOULD CONSIDER CAREFULLY THE SUBSTANTIAL RISKS INVOLVED
IN INVESTING IN FOREIGN SECURITIES, RISKS THAT ARE HEIGHTENED FOR INVESTMENTS
IN DEVELOPING MARKETS. SEE "HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN
TRANSACTIONS."
CURRENCY TECHNIQUES. The Portfolio may, but with respect to equity securities
does not currently intend, to employ certain active currency hedging
techniques. Such techniques may include investments in foreign currency
futures contracts, forward foreign currency exchange contracts ("forward
contracts"), and options on foreign currencies, all of which involve
specialized risks. SEE "HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN
TRANSACTIONS."
OTHER INVESTMENT POLICIES. Under the policies discussed in "INVESTMENT
METHODS AND RISKS," "HIGHLIGHTED RISK CONSIDERATIONS," and in the SAI, the
Portfolio may also invest in illiquid and restricted securities, purchase
securities on a "when-issued" basis, enter into repurchase transactions, loan
its portfolio securities, and engage in other activities specifically
identified for this Portfolio.
VALUE SECURITIES FUND
The investment objective of the Value Securities Fund is long-term total
return. Income, though not an objective, is a secondary consideration.
PORTFOLIO INVESTMENTS. Under normal market conditions, the Portfolio will
invest at least 65% of its assets in companies of various sizes, which in the
opinion of the Manager, are selling substantially below the underlying value
of their assets or their private market value. Private market value is what a
sophisticated investor would pay for the entire company. From time to time,
the Portfolio may be predominantly invested in smaller capitalization
companies ("small cap companies").
In determining whether to buy or hold securities, the Manager will consider a
variety of factors, including: low price to earnings ratio relative to the
market, industry group or earnings growth; low price relative to book value
or cash flow; valuable franchises, patents, trademarks, trade names,
distribution channels, or market share for particular products or services,
tax loss carryforwards, or other intangibles that may not be reflected in
stock prices; ownership of understated or underutilized tangible assets such
as land, timber or minerals; underutilized cash or investment assets; and
unusually high current income. These criteria and others, alone and in
combination, may identify companies that are attractive to financial or
strategic acquirers (i.e. takeover candidates), or companies that have
suffered sharp price declines but in the Manager's opinion, still have
significant potential ("fallen angels"). Purchases may include companies in
cyclical businesses, turnarounds and companies emerging from bankruptcy.
Purchase decisions may also be influenced by company stock buy-backs and its
insiders' purchases and sales. The Portfolio purchases securities for
investment purposes and not for the purpose of influencing or controlling
management of the issuer. In rare cases, however, when the Manager perceives
that the Portfolio may benefit, the Manager may itself seek to influence or
control management.
The securities in which the Portfolio may invest include common and preferred
stocks, securities convertible into common stocks, warrants, secured and
unsecured debt securities, and notes. The Portfolio may, from time to time,
hold significant Money Market Instruments, up to 100% of its total assets,
until suitable investment opportunities meeting its value standards become
available, consistent with its policy on temporary investments.
RISKS ASSOCIATED WITH VALUE INVESTING. Securities of a company may be
undervalued as a result of overreaction by investors to unfavorable news
about a company, an industry, or the stock market in general, or as a result
of a market decline, poor economic conditions, tax-loss selling or actual or
anticipated unfavorable developments affecting a company. Often these
companies are attempting to recover from business setbacks or adverse events
(turnarounds), cyclical downturns, or in certain cases, bankruptcy. There can
be no assurance that such companies or their stocks will recover from these
events in a timely manner or at all. Cyclical stocks in which the Portfolio
may invest tend to increase in value more quickly during economic upturns
than noncyclical stocks, but also tend to lose value more quickly in economic
downturns. As with all investments, there is always the possibility when
investing in these securities that the Manager may be incorrect in its
assessment of a particular industry or company, or that the Manager may not
buy these securities at their lowest possible prices or sell them at their
highest.
There can be special risks when the Portfolio buys securities of companies
emerging from bankruptcy. Companies emerging from bankruptcy may have some
difficulty retaining customers and suppliers who prefer transacting with
solvent organizations. If new management is installed in a company emerging
from bankruptcy, the management may be considered untested; if the existing
management is retained, the management may be considered incompetent.
Further, even when a company has emerged from bankruptcy with a lower level
of debt, it may still retain a relatively weak balance sheet. During economic
downturns these companies may not have sufficient cash flow to pay their debt
obligations and may also have difficulty finding additional financing. In
addition, reduced liquidity in the secondary market may make it difficult for
the Portfolio to sell the securities or to value them based on actual trades.
The Portfolio's policy of investing in securities that may be out of favor,
including turnarounds, cyclicals and companies emerging from bankruptcy,
companies reporting poor earnings, and companies whose share prices have
declined sharply or that are not widely followed, differs from the approach
followed by many other portfolios. The Manager believes, however, that these
securities may provide a greater total investment return than securities
whose prices appear to reflect anticipated favorable developments.
RISKS ASSOCIATED WITH SMALL CAP INVESTMENTS. The Portfolio may invest without
minimum or maximum limitation in smaller cap companies which have market
capitalizations of $1 billion or less at the time of purchase. Securities of
smaller companies, particularly if they are unseasoned, present greater risks
than securities of larger, more established companies. The smaller companies
in which the Portfolio may invest are often not well known, may often trade
at a discount and may not be followed by research organizations. The
companies may have relatively small revenues, limited product lines and a
small share of the market for their products or services. Small cap companies
may lack depth of management, they may be unable to internally generate funds
necessary for growth or potential development or to generate such funds
through external financing on favorable terms, or they may be developing or
marketing new products or services for which markets are not yet established
and may never become established. Due to these and other factors, small cap
companies may suffer significant losses as well as realize substantial
growth, and investments in such companies tend to be more volatile and
therefore, speculative. In addition, the prices of smaller cap companies'
stocks may fluctuate independently of larger company stocks. SEE "INVESTMENT
METHODS AND RISKS."
FOREIGN INVESTMENTS. Although the Portfolio may invest up to 25% of its
assets in foreign securities, including those of developing markets issuers
and sponsored or unsponsored Depositary Receipts, it currently has no
intention of investing more than 15% of its assets in such securities. The
Portfolio presently does not intend to invest more than 5% of its assets in
developing markets securities. The Portfolio's investment in foreign
securities involve risks related to currency fluctuations, market volatility,
and economic, social, and political uncertainty that are different from
investing in similar domestic securities. INVESTMENTS IN FOREIGN SECURITIES,
PARTICULARLY IN DEVELOPING MARKETS, INVOLVE SPECIAL ADDITIONAL RISKS. SEE
"HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN SECURITIES" below and in the SAI.
CONVERTIBLE SECURITIES. The Portfolio may invest in convertible securities
and synthetic convertibles. The convertible debt obligations in which the
Portfolio may invest are subject to the same rating criteria and investment
policies as the Portfolio's investments in debt obligations. Convertible
preferred stocks are equity securities, generally carry a higher degree of
market risk than debt obligations, and often may be regarded as speculative
in nature. The Portfolio may also invest in enhanced convertible securities
which may provide higher dividend income but which may carry additional
risks, including reduced liquidity. SEE "HIGHLIGHTED RISK CONSIDERATIONS" and
"INVESTMENT METHODS AND RISKS."
CREDIT QUALITY AND DEFAULTED DEBT OBLIGATIONS. The Portfolio may invest up to
25% of its assets in debt obligations rated below BBB or lower by S&P or Baa
by Moody's, or in unrated debt obligations of comparable quality as
determined by the Manager. Such securities, sometimes called "junk bonds,"
are regarded as predominantly speculative with respect to the issuer's
capacity to pay interest and repay principal in accordance with the terms of
the obligation and therefore, involve special risks. Debt obligations rated D
by S&P are in default and may be considered speculative. SEE "HIGHLIGHTED
RISK CONSIDERATIONS, LOWER RATED DEBT OBLIGATIONS" and the APPENDIX.
RISKS AND OTHER CONSIDERATIONS RELATED TO NON-DIVERSIFICATION. The Portfolio
is non-diversified under federal securities laws, but is still subject to the
diversification requirements under the federal tax code and the 25% limit on
concentration of investments in a single industry. Because the Portfolio is
non-diversified and may concentrate its investments in a smaller number of
issuers, and because economic, political or regulatory developments may have
a greater impact on the Portfolio, the value of the Portfolio's shares may
fluctuate more widely than those of a diversified portfolio. SEE "INVESTMENT
METHODS AND RISKS."
OTHER INVESTMENT POLICIES. The Portfolio may also sell short securities it
does not own up to 5% of its assets. Short sales have risks of loss if the
price of the security sold short increases after the sale, but the Portfolio
can profit if the price decreases. The Portfolio may also sell securities
"short against the box" (i.e., securities which the Portfolio owns or has the
immediate and unconditional right to acquire at no additional cost) without
limit. See the SAI for further details concerning short sales. Under the
policies discussed in "INVESTMENT METHODS AND RISKS," "HIGHLIGHTED RISK
CONSIDERATIONS," and in the SAI, the Portfolio may also loan its portfolio
securities; invest in zero coupon securities, pay-in-kind bonds, structured
notes, mortgage-backed and asset-backed securities; purchase loan
participations and trade claims both of which carry a high degree of risk;
purchase and sell exchange-listed and over-the-counter put and call options
on securities and financial indices; purchase and sell futures contracts or
related options with respect to securities and indices; invest in restricted
or illiquid securities; and engage in other activities specifically
identified for this Portfolio.
PORTFOLIOS SEEKING CAPITAL GROWTH
CAPITAL GROWTH FUND
The primary investment objective of the Capital Growth Fund is capital
appreciation. Current income is only a secondary consideration in selecting
portfolio securities.
Under normal market conditions, the Portfolio will invest primarily (at least
65% of assets) in equity securities, including common and preferred stocks,
or securities convertible into common stocks, which are believed to offer
favorable possibilities for capital appreciation, but some of which may yield
little or no current income. The Portfolio's assets may be invested in shares
of common or capital stock traded on any national securities exchange or
over-the-counter, and in convertible securities. The Portfolio may also keep
a significant portion of its assets in cash from time to time. Stocks and
other equity securities representing ownership interests in corporations have
historically outperformed other asset classes over the long term, but have
tended to fluctuate more dramatically over the short term. The Manager seeks
to address such risks through extensive research and emphasis on more
globally-competitive companies.
The Manager will generally make long-term investments in equity securities
which have been selected based upon fundamental and quantitative analysis.
Following these policies, the Portfolio will typically invest predominantly
in equity securities issued by large-cap or mid-cap U.S. companies, which
have market capitalizations of $1 billion or more. It may also invest to a
lesser degree in smaller capitalization companies, which may be subject to
different and greater risks, but there is no present intention of investing
more than 20% of the Portfolio's assets in such securities. SEE "INVESTMENT
OBJECTIVES AND RISKS, SMALL CAPITALIZATION ISSUERS."
TECHNOLOGY COMPANIES. Consistent with its investment objective, the Portfolio
expects to have a portion of its assets invested in securities of companies
involved in computing technologies or computing technology-related companies.
The technology sector as a whole has historically been volatile, and issues
from this sector tend to be subject to abrupt or erratic price movements.
FOREIGN SECURITIES. As an operating policy, the Portfolio currently intends
to invest no more than 15% of its assets in foreign securities, including
Depositary Receipts and those of developing markets issuers. The Portfolio's
investments in foreign securities involve risks related to currency
fluctuations and political uncertainty. Investments in foreign developing
markets involve heightened risks related to the smaller size and lesser
liquidity of these markets. INVESTMENTS IN FOREIGN SECURITIES, PARTICULARLY
IN DEVELOPING MARKETS, INVOLVE SPECIAL AND ADDITIONAL RISKS. SEE "HIGHLIGHTED
RISK CONSIDERATIONS, FOREIGN TRANSACTIONS" and the SAI.
OTHER INVESTMENTS. The Portfolio currently intends to invest no more than 5%
of its assets in debt obligations, including convertible debt obligations,
rated Ba or lower by Moody's or BB or lower by S&P, or unrated securities
determined by the Manager to be of comparable quality. SEE "HIGHLIGHTED RISK
CONSIDERATIONS, LOWER RATED DEBT OBLIGATIONS," "INVESTMENT METHODS AND RISKS,
DEBT OBLIGATIONS," AND THE APPENDIX. The Portfolio may invest in convertible
preferred stocks, which are equity securities, generally carry a higher
degree of market risk than debt obligations, and often may be regarded as
speculative in nature. SEE "HIGHLIGHTED CONSIDERATIONS" and "INVESTMENT
METHODS AND RISKS." Under the policies discussed in "INVESTMENT METHODS AND
RISKS" and in the SAI, the Portfolio may also write covered call options;
purchase put options on securities; loan its portfolio securities; enter into
repurchase transactions; invest in restricted or illiquid securities; and
engage in other activities specifically identified for this Portfolio.
GLOBAL HEALTH CARE SECURITIES FUND
The investment objective of the Global Health Care Securities Fund is capital
appreciation. The Portfolio seeks to achieve its objective by concentrating
its investments in the equity securities of health care companies located
throughout the world.
PORTFOLIO INVESTMENTS. Under normal market conditions, the Portfolio will
invest at least 70% of its assets in equity securities, including common
stocks, preferred stocks, securities convertible into common stocks, rights
and warrants, of health care companies. A "health care" company is one that
derives at least 50% of its earnings or revenues from, or has devoted at
least 50% of its assets to, health care activities, based upon the company's
most recently reported fiscal year. Health care activities include research,
development, production or distribution of products and services in
industries such as pharmaceutical, biotechnology, health care facilities,
medical supplies, medical technology, medical services, managed care
companies, health care related information systems and personal health care
products.
The outlook for the Portfolio is to be in a position to benefit from
potential future technological advances and increasing worldwide demand in
the health care sector. Many major developments in health care come from
foreign companies. Thus, in the opinion of the Manager, a portfolio of global
health care company securities may provide greater potential for investment
participation in present and future opportunities that may present themselves
in health care related industries. The Manager also believes that the U.S.
health care industry may be subject to increasing regulation and government
control. By investing in foreign, as well as U.S., health care companies, the
Manager believes that the Portfolio will be able to minimize the impact of
U.S. government regulation on its portfolio. By investing in multiple
countries, the risk of a single government's actions on the portfolio is also
reduced.
RISKS OF INVESTING IN THE HEALTH CARE INDUSTRY. Due to the Portfolio's policy
of concentrating its investments in the health care industry, the Portfolio's
shares may be subject to greater risk of adverse developments in that
industry than an investment in a portfolio which invests its assets across a
broader spectrum of industries. Specifically, the activities of health care
companies may be funded or subsidized by federal and state governments and a
discontinuance of such subsidization could adversely affect their
profitability. Securities held by the Portfolio may be affected by government
policies on health care reimbursements, regulatory approval for new drugs and
medical instruments, and other similar matters. Health care companies are
also subject to the risk of a legislative reform of the health care system.
Health care companies may face product liability lawsuits, and their products
and services are subject to rapid obsolescence. THE PORTFOLIO MAY NOT BE
APPROPRIATE FOR SHORT-TERM INVESTORS, AND IS NOT INTENDED TO BE A COMPLETE
INVESTMENT PROGRAM.
SMALL CAP INVESTMENTS. The Portfolio may invest a substantial portion of its
assets in companies which have market capitalizations of $1 billion or less
at the time of purchase ("small cap companies"). These may include
investments in relatively new or unseasoned companies in their early stages
of development or in new and emerging industries which are believed to have
above average potential for rapid growth. Securities of smaller or unseasoned
companies present greater risks than securities of larger, more established
companies. The companies may have relatively small revenues, limited product
lines, and may have a small share of the market for their products or
services. Small cap companies may lack depth of management, they may be
unable to internally generate funds necessary for growth or potential
development or to generate such funds through external financing on favorable
terms, or they may be developing or marketing new products or services for
which markets are not yet established and may never become established. Due
to these and other factors, small cap companies may suffer significant losses
as well as realize substantial growth, and investments in such companies tend
to be more volatile and are therefore speculative. Besides exhibiting greater
volatility, the prices of these stocks may fluctuate independently of larger
company stocks. SEE "INVESTMENT METHODS AND RISKS, SMALL CAPITALIZATION
ISSUERS."
FOREIGN INVESTMENTS. The Portfolio will mix its investments globally by
investing at least 70% of its assets in securities of issuers in at least
three different countries including the U.S. Such investments may include
issuers located in developed and developing countries. The Portfolio will not
invest more than 40% of its net assets in any one country (other than the
U.S.). From time to time, the Portfolio may invest a significant portion of
its assets in securities of U.S. issuers, the prices of which may fluctuate
independently from comparable foreign securities. As a global Portfolio, it
may invest in securities issued in any currency including multinational
currency units such as the European Currency Unit, and may hold currency, as
well as buy sponsored or unsponsored Depositary Receipts. The Portfolio
currently does not intend to invest more than 10% of its assets in securities
of developing markets. As a non-fundamental policy, the Portfolio will limit
its investments in securities of Russian issuers to 5% of its assets. The
Portfolio's investments in foreign securities involve risks related to
currency fluctuations, market volatility, and economic, social, and political
uncertainty that are different from investing in similar obligations of
domestic entities. Investments in foreign developing markets involve
heightened risks related to the smaller size and lesser liquidity of these
markets. INVESTORS SHOULD CONSIDER THE SUBSTANTIAL RISKS INVOLVED IN
INVESTING IN FOREIGN SECURITIES, RISKS THAT ARE HEIGHTENED FOR INVESTMENTS IN
DEVELOPING MARKETS. SEE "HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN
TRANSACTIONS" below and in the SAI.
RISKS AND OTHER CONSIDERATIONS RELATED TO NON-DIVERSIFICATION. The Portfolio
is non-diversified under federal securities laws, but is still subject to the
diversification requirements under the federal tax code. Because the
Portfolio is non-diversified and may concentrate its investments in a smaller
number of issuers, and because economic, political or regulatory developments
may have a greater impact on the Portfolio, the value of the Portfolio's
shares may fluctuate more widely than those of a diversified portfolio. SEE
"INVESTMENT METHODS AND RISKS."
DEBT OBLIGATIONS AND CREDIT QUALITY. The Portfolio may invest up to 30% of
its assets in debt obligations issued by domestic or foreign corporations or
governments. To the extent the Portfolio invests in debt securities, changes
in interest rates in any country where the Portfolio is invested will affect
the value of the Portfolio and its share price. The Fund will invest in debt
securities rated B or above by Moody's or S&P, or in unrated securities that
are of similar quality. Securities rated below BBB are considered to be below
investment grade, and the Manager does not currently expect investments in
such lower rated debt obligations to exceed 5% of the Portfolio's assets. SEE
"HIGHLIGHTED RISK CONSIDERATIONS, LOWER RATED DEBT OBLIGATIONS," "INVESTMENT
METHODS AND RISKS, DEBT OBLIGATIONS," and the APPENDIX.
OTHER INVESTMENT POLICIES. The Portfolio may engage in short sale
transactions, in which the Portfolio sells a security it does not own to a
purchaser at a specified price. Short sales have risks of loss if the price
of the security sold short increases after the sale, but the Portfolio can
profit if the price decreases. See the SAI for further details concerning
short sales. Under the policies discussed in "INVESTMENT METHODS AND RISKS,"
"HIGHLIGHTED RISK CONSIDERATIONS," and in the SAI, the Portfolio may also
make temporary defensive investments; write covered put and call options on
securities or financial indices; purchase put and call options on securities
or financial indices; purchase and sell futures contracts or related options
with respect to securities, indices and currencies; invest in restricted or
illiquid securities; lend portfolio securities; enter into repurchase or
reverse repurchase agreements; enter into foreign currency exchange
contracts; borrow money; and engage in other activities specifically
identified for this Portfolio.
MUTUAL DISCOVERY SECURITIES FUND
The investment objective of the Mutual Discovery Securities Fund is capital
appreciation.
PORTFOLIO INVESTMENTS. Under normal market conditions, the Portfolio invests
in domestic and foreign equity securities, including common and preferred
stocks and securities convertible into common stocks, as well as debt
obligations of any quality. Debt obligations may include securities or
indebtedness issued by corporations or governments in any form, including
notes, bonds, or debentures, as well as distressed mortgage obligations and
other debt secured by real property. The Manager has no pre-set limits as to
the percentages which may be invested in equity securities, debt securities
or Money Market Instruments. The Portfolio can invest in securities from any
size issuer, and may from time to time invest a substantial portion of its
assets in securities of smaller capitalization issuers, which have market
capitalizations of less than $1 billion. Securities of foreign or small cap
issuers may be subject to different and greater risks, as discussed below.
The Portfolio may invest in securities that are traded on U.S. or foreign
exchanges, NASDAQ national market or in the over-the-counter market. It may
invest in any industry sector, although it will not concentrate in any one
industry. From time to time, the Portfolio may hold significant cash
positions until suitable investment opportunities are available, consistent
with its policy on temporary investments.
The Portfolio also seeks to invest in securities of domestic and foreign
companies involved in mergers, consolidations, liquidations and
reorganizations or as to which there exist tender or exchange offers, and may
participate in such transactions. The Portfolio does not presently anticipate
investing more than 50% of its assets in such investments, but is not
restricted to that amount. There can be no assurance that any such
transaction proposed at the time of the Portfolio's investment will be
consummated or will be consummated on the terms and within the time period
contemplated. The Portfolio may also invest in other forms of secured or
unsecured indebtedness or participations ("Indebtedness"), including without
limitation loan participations and trade claims, of debtor companies involved
in reorganization or financial restructuring, some of which may have very
long maturities. Some of the Indebtedness is illiquid.
SELECTION OF PORTFOLIO INVESTMENTS. The Portfolio's general policy is to
invest in securities which, in the opinion of its Manager, are available at
prices less than their intrinsic values. The Manager's opinions are based
upon analysis and research, taking into account, among other factors, the
relationship of book value to market value of the securities, cash flow, and
multiples of earnings of comparable securities. These factors are not applied
formulaically, as the Manager examines each security separately; the Manager
has no general criteria as to asset size, earnings or industry type which
would make a security unsuitable for purchase by the Portfolio.
The Portfolio generally purchases securities for investment purposes and not
for the purpose of influencing or controlling management of the issuer.
However, in certain circumstances when the Manager perceives that the
Portfolio may benefit, the Manager may itself seek to influence or control
management or may cause the Portfolio to invest in other entities that
purchase securities for the purpose of influencing or controlling management,
such as investing in a potential takeover or leveraged buyout or investing in
other entities engaged in such practices.
FOREIGN INVESTMENTS. The Portfolio may purchase securities in any foreign
country, developed or undeveloped, and currently expects to invest up to 50%
or more of its assets in foreign securities, including sponsored or
unsponsored Depositary Receipts. The Portfolio presently does not intend to
invest more than 5% of its assets in securities of developing markets
including Eastern European countries and Russia. Foreign investments may
include both voting and non-voting securities, sovereign debt and
participation in foreign government deals. The Portfolio's investments in
foreign securities involve risks related to currency fluctuations, market
volatility, and economic, social, and political uncertainty that are
different from investing in similar domestic securities. Investments in
foreign developing markets involve heightened risks related to the smaller
size and lesser liquidity of those markets. INVESTORS SHOULD CONSIDER
CAREFULLY THE SUBSTANTIAL RISKS INVOLVED IN INVESTING IN FOREIGN SECURITIES,
RISKS THAT ARE HEIGHTENED IN DEVELOPING MARKETS. SEE "HIGHLIGHTED RISK
CONSIDERATIONS, FOREIGN TRANSACTIONS" BELOW AND IN THE SAI.
CURRENCY TECHNIQUES. The Portfolio generally expects to hedge against
currency risks to the extent that hedging is available. Currency hedging
techniques may include investments in foreign currency futures contracts,
options on foreign currencies or currency futures, forward foreign currency
exchange contracts ("forward contracts") and currency swaps, all of which
involve specialized risks. SEE "HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN
TRANSACTIONS."
RISKS ASSOCIATED WITH SMALL CAP INVESTMENTS. Securities of smaller companies,
particularly if they are unseasoned, present greater risks than securities of
larger, more established companies. The smaller companies in which the
Portfolio may invest are often not well known, may often trade at a discount
and may not be followed by institutions. The companies may have relatively
small revenues, limited product lines, and a small share of the market for
their products or services. Small cap companies may lack depth of management,
they may be unable to internally generate funds necessary for growth or
potential development or to generate such funds through external financing on
favorable terms, or they may be developing or marketing new products or
services for which markets are not yet established and may never become
established. Due to these and other factors, small cap companies may suffer
significant losses as well as realize substantial growth, and investments in
such companies tend to be more volatile and are therefore speculative.
Besides exhibiting greater volatility, the prices of small cap company stocks
may fluctuate independently of larger company stocks. SEE "INVESTMENT METHODS
AND RISKS."
CREDIT QUALITY. Debt obligations (including Indebtedness) in which the
Portfolio invests may be rated or unrated and, if rated, ratings may range
from the very highest to the very lowest categories (currently C for Moody's
and D for S&P). Medium and lower-rated debt obligations are commonly referred
to as "junk bonds." In general, it will invest in these instruments for the
same reasons underlying its investments in equity securities, i.e., that the
instruments are available, in the Manager's opinion, at prices less than
their intrinsic values. Consequently, the Manager's own analysis of a debt
instrument exercises a greater influence over the investment decision than
the stated coupon rate or credit rating. The Portfolio expects to invest in
debt obligations issued by reorganizing or restructuring companies, or
companies which recently emerged from, or are facing the prospect of, a
financial restructuring. It is under these circumstances, which usually
involve unrated or low rated securities that are often in, or are about to,
default, that the Manager seeks to identify securities which are sometimes
available at prices which it believes are less than their intrinsic values.
The purchase of Indebtedness of a troubled company always involves a risk as
to the creditworthiness of the issuer and the possibility that the investment
may be lost. However, the debt securities of reorganizing or restructuring
companies typically rank senior to the equity securities of such companies.
Higher yields are generally available from securities in the higher risk,
lower rating categories of S&P or Moody's. However, the values of lower rated
securities generally fluctuate more than those of higher rated securities and
involve greater risk of loss of income and principal. Moreover, securities
rated BB or lower by S&P or Ba or lower by Moody's are predominantly
speculative with respect to the issuer's ability to pay principal and
interest and may be in default. These securities may also be less liquid than
higher rated securities, or have no established markets, thereby increasing
the degree to which judgment plays a role in valuing such securities. BECAUSE
OF THE PORTFOLIO'S POLICY OF INVESTING IN LOWER-RATED OR UNRATED, HIGHER RISK
DEBT OBLIGATIONS, AN INVESTMENT IN THE PORTFOLIO IS ACCOMPANIED BY A HIGHER
DEGREE OF RISK THAN IS PRESENT WITH AN INVESTMENT IN HIGHER RATED
OBLIGATIONS. ACCORDINGLY, INVESTORS CONSIDERING THE PORTFOLIO SHOULD EVALUATE
THEIR OVERALL INVESTMENT GOALS AND TOLERANCE FOR RISK. SEE "HIGHLIGHTED RISK
CONSIDERATIONS, LOWER RATED DEBT OBLIGATIONS" and the APPENDIX.
DEFAULTED DEBT OBLIGATIONS. The Portfolio may invest without limit in
defaulted debt obligations, subject to the Portfolio's restriction on
investments in illiquid securities. Defaulted debt obligations may be
considered speculative. See the discussion above under "Credit Quality" for
the circumstances under which the Portfolio generally invests in defaulted
debt obligations.
OTHER INVESTMENT POLICIES. While the Portfolio may not purchase securities of
registered open-end investment companies or affiliated investment companies,
it may invest from time to time in other investment company securities
subject to the limitation that it will not purchase more than 3% of the
voting securities of another investment company. In addition, the Portfolio
will not invest more than 5% of its assets in the securities of any single
investment company and will not invest more than 10% of its assets in
investment company securities. Investors should recognize that an investment
in the securities of such investment companies results in layering of
expenses such that investors indirectly bear a proportionate share of the
expenses of such investment companies, including operating costs, and
investment advisory and administrative fees. The Portfolio may also sell
short securities it does not own up to 5% of its assets. Short sales have
risks of loss if the price of the security sold short increases after the
sale, but the Portfolio can profit if the price decreases. The Portfolio may
also sell securities "short against the box" (i.e., securities which the
Portfolio owns or has the immediate and unconditional right to acquire at no
additional cost) without limit. See the SAI for further details concerning
short sales.
Under the policies discussed in "INVESTMENT METHODS AND RISKS," "HIGHLIGHTED
RISK CONSIDERATIONS," and in the SAI, the Portfolio may also loan its
portfolio securities; enter into repurchase transactions; purchase securities
and debt obligations on a "when-issued" or "delayed delivery" basis; invest
in restricted or illiquid securities; purchase and sell exchange-listed and
over-the-counter put and call options on securities, equity and fixed-income
indices and other financial instruments; purchase and sell financial futures
contracts and options thereon; and engage in other activities specifically
identified for this Portfolio.
NATURAL RESOURCES SECURITIES FUND
The Natural Resources Securities Fund's investment objective is capital
appreciation with current income as a secondary objective. The Portfolio
seeks to achieve its objective by concentrating its investments in securities
issued by companies in or related to the natural resources sector.
PORTFOLIO INVESTMENTS. Under normal market conditions, the Portfolio will
invest primarily (at least 65% of assets) in securities issued by companies
in or related to the natural resources sector. Companies in the natural
resources sector may own, produce, refine, process or market natural
resources, or provide support services for natural resources companies (e.g.,
develop technologies or provide services, supplies or equipment related to
natural resources). The natural resources sector includes, but is not limited
to, the following industries: integrated oil; oil and gas exploration and
production; gold and precious metals; steel and iron ore production; aluminum
production; forest products; farming products; paper products; chemicals;
building materials; energy services and technology; environmental services;
and energy generation and distribution.
The Portfolio may invest in common stocks (including preferred or debt
securities convertible into common stocks), preferred stocks and debt
obligations. While the Portfolio normally expects to invest primarily in
equity securities, the mixture of common stocks, preferred stocks and debt
obligations may vary from time to time based upon the Manager's assessment as
to whether investments in each category will contribute to meeting the
Portfolio's investment objective.
The Portfolio may also invest up to 10% of its assets in real estate
investment trusts ("REITs"), which may be in or outside the natural resources
sector. REITs may provide an attractive alternative to direct investments in
real estate, but are subject to risks related to the skill of their
management, changes in value of the property owned by the REITs, the quality
of any credit extended by the REITs, and general economic and other factors.
See "Real Estate Securities Fund" for more information.
SELECTION OF PORTFOLIO INVESTMENTS. The Portfolio's Manager searches for
companies that will prosper throughout economic cycles. In searching for such
companies, the Manager tends to focus on what it believes are highly
profitable companies with skilled management, strong growth profiles and
solid financials, as well as companies with sustainable advantages either
through strategic asset bases or technological expertise. As with all
investments, there is always the possibility that the Manager may be
incorrect in its assessment of securities selected or that the issuing
companies may not perform as expected.
RISKS OF INVESTING IN NATURAL RESOURCES SECTOR. Due to the Portfolio's policy
of concentrating its investments in the natural resources sector, the
Portfolio's shares may be subject to greater risk of adverse developments in
those industries than an investment in a portfolio with greater industry
diversification. In addition, at the Manager's discretion, the Portfolio may
from time to time invest up to 25% of its assets in any industry or group of
industries within the natural resources sector; such a strategy may expose
the Portfolio to greater investment risk than a more diversified strategy
within the sector.
Certain of the natural resources industries' commodities are subject to
limited pricing flexibility as a result of similar supply and demand factors.
Others are subject to broad price fluctuations, reflecting the volatility of
certain raw materials' prices and the instability of supplies of other
resources. These factors can affect the overall profitability of an
individual company operating within the natural resources sector. While the
Manager may strive to diversify among the industries within the natural
resources sector to reduce this volatility, there will be occasions where the
value of an individual company's securities will prove more volatile than the
broader market. In addition, many of these companies operate in areas of the
world where they are subject to unstable political environments, currency
fluctuations and inflationary pressures.
FOREIGN INVESTMENTS. While the Portfolio will normally invest a greater
percentage of its assets in securities of U.S. issuers than in securities of
issuers in any other single country, the Portfolio may invest 50% or more of
its assets in foreign securities, including Depositary Receipts, of issuers
in both developed and developing markets. Foreign securities include both
equity securities and debt obligations. The Portfolio's investments in
foreign securities involve risks related to currency fluctuations, market
volatility, and economic, social, and political uncertainty that are
different from investing in similar obligations of domestic entities.
Investments in foreign developing markets involve heightened risks related to
the smaller size and lesser liquidity of these markets. INVESTORS SHOULD
CONSIDER CAREFULLY THE SUBSTANTIAL RISKS INVOLVED IN INVESTING IN FOREIGN
SECURITIES, RISKS THAT ARE HEIGHTENED FOR INVESTMENTS IN DEVELOPING MARKETS.
SEE "HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN TRANSACTIONS."
SMALL CAP INVESTMENTS. The Portfolio may invest without minimum or maximum
limitation in small capitalization companies ("small cap companies") which
have market capitalizations of $1 billion or less at the time of purchase.
These may include investments in small mining or oil and gas exploration
concerns which are believed to have significant potential for appreciation,
but are subject to the risk that their exploration efforts will not be
successful. The Portfolio will not invest more than 10% of its assets in
securities of companies with less than three years of continuous operation.
Due to these and other factors, small cap and unseasoned companies may suffer
significant losses as well as realize substantial growth, and investments in
such companies tend to be more volatile and are therefore speculative.
Besides exhibiting greater volatility, the prices of these stocks may
fluctuate independently of larger company stocks. SEE "INVESTMENT METHODS AND
RISKS."
DEBT OBLIGATIONS AND CREDIT QUALITY. The Portfolio may invest in debt
obligations issued by domestic or foreign corporations or governments.
The Portfolio may invest, without percentage limitation, in debt obligations
rated as "investment grade" by Moody's or S&P, or in unrated debt obligations
of similar quality as determined by the Manager. The Portfolio may also
invest up to 15% of its assets in debt obligations rated BB or lower by S&P
or Ba or lower by Moody's, so long as they are not rated lower than B by
Moody's or S&P, or in unrated debt obligations of similar quality as
determined by the Manager. The Manager does not currently expect investments
in lower rated debt obligations to exceed 5% of the Portfolio's assets. SEE
"HIGHLIGHTED RISK CONSIDERATIONS, LOWER RATED DEBT OBLIGATIONS," "INVESTMENT
METHODS AND RISKS, DEBT OBLIGATIONS," AND THE APPENDIX.
OTHER INVESTMENT POLICIES. The Portfolio may invest up to 35% of its assets
in equity securities or debt obligations of foreign or domestic issuers
outside the natural resources sector. Some of these issuers may be in
industries related to the natural resources sector and, therefore, may be
subject to similar risks. The Portfolio may invest up to 5% of its assets in
commodities (including gold bullion or gold coins) or futures on commodities
related to the natural resources sector as defined above. Under the policies
discussed in "INVESTMENT METHODS AND RISKS," "HIGHLIGHTED RISK
CONSIDERATIONS," and in the SAI, the Portfolio may also make temporary
defensive investments, purchase debt obligations on a "when-issued" or
"delayed delivery" basis, write covered call options, loan its portfolio
securities, enter into repurchase transactions, borrow money, invest in
restricted or illiquid securities, and engage in other activities
specifically identified for this Portfolio.
SMALL CAP FUND
The investment objective of the Small Cap Fund is long-term capital growth.
The Portfolio seeks to accomplish its objective by investing primarily in
equity securities of small capitalization growth companies. Investments in
small capitalization companies may involve greater risks and greater
volatility than investments in larger and more established companies.
PORTFOLIO INVESTMENTS. Under normal market conditions, the Portfolio will
invest at least 65% of its assets in equity securities of small
capitalization growth companies ("small cap companies"). A small cap company
generally has a market capitalization of less than $1.5 billion at the time
of the Portfolio's investment and, in the opinion of the Portfolio's Manager,
is positioned for rapid growth in revenues, earnings or assets. Market
capitalization is defined as the total market value of a company's
outstanding common stock. The securities of small cap companies are traded on
U.S. or foreign stock exchanges and over-the-counter. As an operating policy
the Portfolio will not invest more than 10% of its assets in securities
issued by companies with less than three years of continuous operation.
Equity securities of small cap companies may consist of common stock,
preferred stock, warrants for the purchase of common stock, and convertible
securities. The Portfolio currently does not intend to invest more than 10%
of its assets in convertible securities, which are discussed below in
"Investment Methods and Risks, Convertible Securities."
SELECTION OF PORTFOLIO INVESTMENTS. The Portfolio has been designed to
provide investors with potentially greater long-term rewards by investing in
securities of small cap companies which may offer the potential for
significant capital appreciation since they may be overlooked by investors or
undervalued in relation to their earnings power. Small cap companies
generally are not as well known to the investing public and have less of an
investor following than larger companies, and therefore may provide greater
opportunities for long-term capital growth as a result of relative
inefficiencies in the marketplace. Such companies may be undervalued because
they are part of an industry that is out of favor with investors, although
the individual companies may have high rates of earning growth and be
financially sound. Selection of small cap company equity securities for the
Portfolio will be based on characteristics such as the financial strength of
the company, the expertise of management, the growth potential of the company
within its industry and the growth potential of the industry itself. Small
cap companies often pay no dividends, and current income is not a factor in
the selection of stocks. The Manager uses a disciplined approach to stock
selection, blending fundamental and quantitative analysis.
RISKS ASSOCIATED WITH SMALL CAP INVESTMENTS. The Portfolio will primarily
invest in relatively new or unseasoned companies which are in their early
stages of development, or small cap companies positioned in new and emerging
industries where the opportunity for rapid growth is expected to be above
average. Securities of smaller or unseasoned companies present greater risks
than securities of larger, more established companies. The companies may have
relatively small revenues, limited product lines, and may have a small share
of the market for their products or services. Small cap companies may lack
depth of management, they may be unable to internally generate funds
necessary for growth or potential development or to generate such funds
through external financing on favorable terms, or they may be developing or
marketing new products or services for which markets are not yet established
and may never become established. Due to these and other factors, small cap
companies may suffer significant losses as well as realize substantial
growth, and investments in such companies tend to be more volatile and are
therefore speculative. Besides exhibiting greater volatility, the prices of
small cap company stocks may, to a degree, fluctuate independently of larger
company stocks. SEE "INVESTMENT METHODS AND RISKS, SMALL CAPITALIZATION
ISSUERS." THE PORTFOLIO MAY NOT BE APPROPRIATE FOR SHORT-TERM INVESTORS, AND
AN INVESTMENT IN THE PORTFOLIO SHOULD NOT BE CONSIDERED A COMPLETE INVESTMENT
PROGRAM.
FOREIGN INVESTMENTS. Although the Portfolio may invest up to 25% of its
assets in foreign securities, including those of developing markets issuers
and sponsored or unsponsored Depositary Receipts, it currently has no
intention of investing more than 15%. The Portfolio presently does not intend
to invest more than 5% of its assets in developing markets securities. The
Portfolio's investments in foreign securities involve risks related to
currency fluctuations, market volatility, and economic, social, and political
uncertainty that are different from investing in similar domestic securities.
INVESTMENTS IN FOREIGN SECURITIES, PARTICULARLY IN DEVELOPING MARKETS,
INVOLVE SPECIAL AND ADDITIONAL RISKS. SEE "HIGHLIGHTED RISK CONSIDERATIONS,
FOREIGN TRANSACTIONS" below and in the SAI.
OTHER INVESTMENTS. Although the Portfolio's assets will be invested primarily
in equity securities of small cap companies, the Portfolio may invest up to
35% of its assets in other instruments, which may cause its performance to
vary from that of the small capitalization equity markets. The Portfolio may
invest in equity securities of larger capitalization companies which the
Portfolio's Manager believes have strong growth potential, or in equity
securities of relatively well-known, larger companies in mature industries
which the Manager believes have the potential for capital appreciation.
The Portfolio may also invest in debt securities which the Manager believes
have the potential for capital appreciation as a result of improvement in the
creditworthiness of the issuer. The receipt of income is incidental to the
Portfolio's objective of capital growth. The Portfolio may invest in debt
securities rated B or above by Moody's or S&P, or in unrated securities the
Manager has determined are of comparable quality. Currently, however, the
Portfolio does not intend to invest more than 5% of its assets in debt
obligations (including convertible debt securities) rated lower than BBB by
S&P or Baa by Moody's or, if unrated, determined by the Manager to be of
comparable quality. SEE "HIGHLIGHTED RISK CONSIDERATIONS, LOWER RATED DEBT
OBLIGATIONS," "INVESTMENT METHODS AND RISKS, DEBT OBLIGATIONS," and the
APPENDIX.
The Portfolio currently does not intend to invest more than 10% of its assets
in real estate investment trusts ("REITs"), which are described in "Real
Estate Securities Fund," above, including small capitalization REITs.
OTHER INVESTMENT POLICIES. Under the policies discussed in "INVESTMENT
METHODS AND RISKS," "HIGHLIGHTED RISK CONSIDERATIONS," and the SAI, the
Portfolio may also write covered put and call options on securities or
financial indices; purchase put and call options on securities or financial
indices; purchase and sell futures contracts or related options with respect
to securities, indices and currencies; invest in restricted or illiquid
securities; lend portfolio securities; borrow money; enter into repurchase or
reverse repurchase agreements; and engage in other activities specifically
identified for this Portfolio.
TEMPLETON DEVELOPING MARKETS EQUITY FUND
The investment objective of the Templeton Developing Markets Equity Fund is
long-term capital appreciation.
The Portfolio seeks to achieve this objective by investing primarily in
equity securities of issuers in countries having developing markets as
defined under "Highlighted Risk Considerations, Foreign Transactions." It is
currently expected that under normal conditions at least 65% of the
Portfolio's assets will be invested in such securities. The Portfolio will at
all times, except during defensive periods, maintain investments in at least
three countries having developing markets. The Portfolio has the right to
purchase securities in any foreign country, developed or developing. However,
as a non-fundamental policy, the Portfolio will limit its investments in
securities of Russian issuers to 5% of assets. Investments in foreign
developing markets, including certain Eastern European countries and Russia,
involve heightened risks related to the small size and lesser liquidity of
these markets. These developing markets risks are in addition to the special
risks associated with foreign investing, including currency fluctuations,
market volatility, and economic, social, and political uncertainty. AN
INVESTMENT IN THE PORTFOLIO MAY BE CONSIDERED SPECULATIVE, AND MAY NOT BE
APPROPRIATE FOR SHORT-TERM INVESTORS. INVESTORS SHOULD CONSIDER CAREFULLY THE
SUBSTANTIAL AND HEIGHTENED RISKS INVOLVED IN INVESTING IN FOREIGN DEVELOPING
MARKETS SECURITIES. SEE "HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN
TRANSACTIONS" and the SAI. From time to time, the Portfolio may hold
significant cash positions until suitable investment opportunities are
available, consistent with its policy on temporary investments.
INVESTMENTS IN DEVELOPING MARKETS. "Developing market equity securities" for
purposes of the Portfolio means any of the following: (i) equity securities
of companies the principal securities trading market for which is a
developing market country, (ii) equity securities, traded in any market, of
companies that derive 50% or more of their total revenue from either goods or
services produced in such developing market countries or sales made in such
developing market countries, or (iii) equity securities of companies
organized under the laws of, and with a principal office in, a developing
market country. "Equity securities" refers to common stock, preferred stock,
warrants or rights to subscribe to or purchase such securities and sponsored
or unsponsored Depositary Receipts such as American Depositary Receipts,
European Depositary Receipts, and Global Depositary Receipts. Determinations
as to eligibility will be made by the Investment Manager based on publicly
available information and inquiries to the companies. Depositary Receipts may
not necessarily be denominated in the same currency as the underlying
securities into which they may be converted and they involve the risks of
other investments in foreign securities, as discussed in "HIGHLIGHTED RISK
CONSIDERATIONS, FOREIGN TRANSACTIONS."
The Portfolio seeks to benefit from economic and other developments in
developing markets. The investment objective of the Portfolio reflects the
belief that investment opportunities may result from an evolving long-term
international trend favoring more market-oriented economies, a trend that may
especially benefit certain countries having developing markets. This trend
may be facilitated by local or international political, economic or financial
developments that could benefit the capital markets of such countries.
Certain such countries, particularly the emerging market countries which may
be in the process of developing more market-oriented economies, may
experience relatively high rates of economic growth. Other countries,
although having relatively mature developing markets, may also be in a
position to benefit from local or international developments encouraging
greater market orientation and diminishing governmental intervention in
economic affairs.
OTHER INVESTMENTS. For capital appreciation, the Portfolio may invest up to
35% of its assets in fixed-income debt obligations (defined as bonds, notes,
debentures, commercial paper, certificates of deposit, time deposits and
bankers' acceptances) which are rated at least C by Moody's or S&P or unrated
debt obligations deemed to be of comparable quality by the Manager. SEE
"HIGHLIGHTED RISK CONSIDERATIONS, LOWER RATED DEBT OBLIGATIONS." As a current
policy established by the Board of Trustees, however, the Portfolio will not
invest more than 5% of its assets in debt obligations rated BBB or lower by
S&P or Baa or lower by Moody's (the lowest category of "investment grade"
rating). The Board of Trustees may consider an increase in the above
percentages if economic conditions change such that a higher level of
investment in high risk, lower quality debt obligations would be consistent
with the interests of the Portfolio and its shareholders.
Certain debt obligations can provide the potential for capital appreciation
based on various factors such as changes in interest rates, economic and
market conditions, improvement in an issuer's ability to repay principal and
pay interest, and ratings upgrades. Additionally, convertible bonds offer the
potential for capital appreciation through the conversion feature, which
enables the holder of the bond to benefit from increases in the market price
of the securities into which they are convertible.
DEFAULTED DEBT OBLIGATIONS. As a fundamental policy the Portfolio may invest
up to 10% of its assets in defaulted debt obligations which may be considered
speculative.
CURRENCY TECHNIQUES. The Portfolio may, but with respect to equity securities
does not currently intend, to employ certain active currency hedging
techniques. Such techniques may include investments in foreign currency
futures contracts, forward foreign currency exchange contracts ("forward
contracts"), and options on foreign currencies, all of which involve
specialized risks. Further, the Portfolio will not enter into forward
contracts if, as a result, the Portfolio will have more than 20% of its
assets committed to the consummation of such contracts. SEE "HIGHLIGHTED RISK
CONSIDERATIONS, FOREIGN TRANSACTIONS."
OTHER INVESTMENT POLICIES. The Portfolio may invest up to 10% of its assets
in securities of closed end investment companies to facilitate foreign
investment. Under the policies discussed in "HIGHLIGHTED RISK
CONSIDERATIONS," "INVESTMENT METHODS AND RISKS" and the SAI, the Portfolio
may also loan its portfolio securities; engage in repurchase transactions;
borrow money for investment purposes; for hedging purposes only, enter into
transactions in options on securities and securities indices and futures
contracts and related options; purchase convertible securities and warrants;
invest in restricted or illiquid securities; and engage in other activities
specifically identified for this Portfolio. The Portfolio may not commit more
than 5% of its assets to initial margin deposits on futures contracts and
related options, and the value of the underlying securities on which futures
contracts will be written at any one time will not exceed 25% of the assets
of the Portfolio. Presently, some of the above strategies cannot be used to a
significant extent by the Portfolio in the markets in which the Portfolio
will principally invest.
TEMPLETON GLOBAL GROWTH FUND
The Templeton Global Growth Fund's investment objective is long-term capital
growth; any income realized will be incidental.
PRINCIPAL PORTFOLIO INVESTMENTS. The Portfolio seeks to achieve its objective
through a flexible policy of investing in stocks and debt obligations of
companies and governments of any nation. The Portfolio has the right to
purchase securities in any foreign country, developed or emerging. However,
as a non-fundamental policy, the Portfolio will limit its investments in
securities of Russian issuers to 5% of assets. Although the Portfolio
generally invests in common stock, it may also invest in preferred stocks and
certain debt obligations, rated or unrated, such as convertible bonds and
bonds selling at a discount. The Portfolio may, from time to time, hold
significant cash positions until suitable investment opportunities are
available, consistent with its policy on temporary investments.
Following these policies, the Portfolio will typically invest predominantly
in equity securities issued by large-cap or mid-cap companies, which have
market capitalizations of $1 billion or more. It may also invest to a lesser
degree in smaller capitalization companies, which are subject to different
and greater risks. SEE "COMMON INVESTMENT OBJECTIVES AND RISKS, SMALL
CAPITALIZATION ISSUERS."
Investments in foreign securities involve risks related to currency
fluctuations, market volatility, and economic, social, and political
uncertainty that are different from investing in similar obligations of
domestic entities. Investments in foreign developing markets including
certain Eastern European countries and Russia, involve heightened risks
related to the smaller size and lesser liquidity of these markets. INVESTORS
SHOULD CONSIDER CAREFULLY THE SUBSTANTIAL RISKS INVOLVED IN INVESTING IN
FOREIGN SECURITIES, RISKS THAT ARE HEIGHTENED FOR INVESTMENTS IN DEVELOPING
MARKETS. SEE "HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN TRANSACTIONS."
OTHER INVESTMENTS. For capital appreciation, the Portfolio may invest in debt
obligations (defined as bonds, notes, debentures, commercial paper,
certificates of deposit, time deposits and bankers' acceptances) which are
rated at least C by Moody's or S&P or unrated debt obligations deemed to be
of comparable quality by the Manager. SEE "HIGHLIGHTED RISK CONSIDERATIONS,
LOWER RATED DEBT OBLIGATIONS" and the APPENDIX. As a policy established by
the Board of Trustees, however, the Portfolio will not invest more than 5% of
its assets in debt obligations rated BBB or lower by S&P or Baa or lower by
Moody's. The Board of Trustees may consider a change if economic conditions
change such that a higher level of investment in high risk, lower quality
debt obligations would be consistent with the objective of the Portfolio.
These debt obligations can provide the potential for capital appreciation
based on various factors such as changes in interest rates, economic and
market conditions, improvement in an issuer's ability to repay principal and
pay interest, and ratings upgrades. Additionally, convertible bonds offer the
potential for capital appreciation through the conversion feature, which
enables the holder of the bond to benefit from increases in the market price
of the securities into which they are convertible.
DEFAULTED DEBT OBLIGATIONS. As a fundamental policy, the Portfolio may invest
up to 10% of its assets in defaulted debt obligations which may be considered
speculative.
CURRENCY TECHNIQUES. The Portfolio may, but with respect to equity securities
does not currently intend, employ certain active currency hedging techniques.
Such techniques may include investments in foreign currency futures
contracts, forward foreign currency exchange contracts ("forward contracts"),
and options on foreign currencies, all of which involve specialized risks.
SEE "HIGHLIGHTED RISK CONSIDERATIONS, FOREIGN TRANSACTIONS."
OTHER INVESTMENT POLICIES. The Portfolio may also purchase and sell stock
index futures contracts up to an aggregate amount not exceeding 20% of its
assets and may not at any time commit more than 5% of its assets to initial
margin deposits on futures contracts. In addition, in order to increase its
return or to hedge all or a portion of its portfolio investments, the
Portfolio may purchase and sell put and call options on securities indices.
These specialized investment techniques involve additional risks as described
in "COMMON INVESTMENT METHODS AND RISKS" and the SAI.
The Portfolio may invest up to 5% of its assets in
securities issued by any one company or foreign government, exclusive of U.S.
Government Securities. The Portfolio may invest up to 5% of its assets in
warrants (exclusive of warrants acquired in units or attached to securities)
and up to 10% of its assets
in securities with a limited trading market, i.e., "illiquid securities."
Under the policies discussed in
"INVESTMENT METHODS AND RISKS," "HIGHLIGHTED RISK CONSIDERATIONS," and in the
SAI, the Portfolio may also enter into repurchase agreements, lend its
portfolio securities, invest in restricted securities, and engage in other
activities specifically identified for this Portfolio.
TEMPLETON INTERNATIONAL EQUITY FUND
The investment objective of the Templeton International Equity Fund is to
seek long-term growth of capital.
PRINCIPAL PORTFOLIO INVESTMENTS. Under normal conditions, the Portfolio will
invest at least 65% of its assets in an internationally diversified portfolio
of equity securities consisting of common and preferred stock, securities
(bonds or preferred stock) convertible into common stock, warrants and
securities representing underlying international securities such as ADRs and
EDRs ("Equity Securities").
Such Equity Securities purchased by the Portfolio will trade on markets in
countries other than the U.S. and be issued by (i) companies domiciled in
countries other than the U.S., or (ii) companies that derive at least 50% of
either their revenues or pre-tax income from activities outside of the U.S.
Thus, it is possible, although not anticipated, that up to 35% of the
Portfolio's assets could be invested in U.S. companies.
In selecting portfolio securities, the Portfolio attempts to take advantage
of the difference between economic trends and the anticipated performance of
securities and securities markets in various countries. The Portfolio may,
from time to time, hold significant cash positions until suitable investment
opportunities are available, consistent with its policy on temporary
investments. Following these policies, the Portfolio will typically invest
predominantly in equity securities issued by large-cap or mid-cap U.S.
companies, which have market capitalizations of $1 billion or more. It may
also invest to a lesser degree in smaller capitalization companies, which are
subject to different and greater risks. SEE "INVESTMENT METHODS AND RISKS,
SMALL CAPITALIZATION ISSUERS."
The Portfolio has the right to purchase securities in any foreign country,
developed or emerging. Normally, the Portfolio will invest at least 65% of
its assets in securities traded in at least three foreign countries. As a
non-fundamental policy, the Portfolio will limit its investments in
securities of Russian issuers to 5% of assets. The Portfolio's investments in
foreign securities involve risks related to currency fluctuations, market
volatility, and economic, social, and political uncertainty that are
different from investing in similar obligations of domestic entities.
Investments in foreign developing markets including certain Eastern European
countries and Russia, involve heightened risks related to the smaller size
and lesser liquidity of these markets. INVESTORS SHOULD CONSIDER CAREFULLY
THE SUBSTANTIAL RISKS INVOLVED IN INVESTING IN FOREIGN SECURITIES, RISKS THAT
ARE HEIGHTENED FOR INVESTMENTS IN DEVELOPING MARKETS. SEE "HIGHLIGHTED RISK
CONSIDERATIONS, FOREIGN TRANSACTIONS."
OTHER INVESTMENTS. Up to 35% of the Portfolio's assets may be invested in
debt obligations of which up to 10% may be debt obligations rated Ba or lower
by Moody's or BB or lower by S&P or that are not rated but determined by the
Manager to be of comparable quality. Lower rated obligations (commonly
referred to as "junk bonds") are considered by the rating agencies to have
increased risks related to the creditworthiness of their issuers. SEE
"HIGHLIGHTED RISK CONSIDERATIONS, LOWER RATED DEBT OBLIGATIONS" and the
APPENDIX. The balance may be invested in debt obligations rated Baa or better
by Moody's, or BBB or better by S&P or that are not rated but determined by
the Manager to be of comparable quality.
The Portfolio may seek capital appreciation by investing in such debt
obligations which would occur through changes in relative foreign currency
exchange rates, changes in relative interest rates or improvement in the
creditworthiness of an issuer. These debt obligations may consist of U.S. and
foreign government securities and corporate debt obligations, including
Yankee bonds, Eurobonds, and Depositary Receipts. SEE "INVESTMENT METHODS AND
RISKS."
OTHER INVESTMENT POLICIES. The Portfolio may invest up to 10% of its net
assets in illiquid securities. The Portfolio may also invest up to 10% of its
net assets in warrants, including such warrants that are not listed on an
exchange. Under the policies discussed in "INVESTMENT METHODS AND RISKS,"
"HIGHLIGHTED RISK CONSIDERATIONS," and in the SAI, the Portfolio may also
write covered call and put options on securities, purchase call and put
options on securities, buy puts and write calls in "forward conversion"
transactions, engage in "spread" and "straddle" transactions, purchase and
write call and put options on stock indices, enter into contracts for the
purchase or sale for future delivery of U.S. Treasury or foreign securities
or futures contracts based upon financial indices, purchase and sell interest
rate futures contracts and related options, purchase and sell stock index
futures contracts and related options, lend its portfolio securities, engage
in repurchase agreements, invest in enhanced convertible securities, and
engage in other activities specifically identified for this Portfolio.
TEMPLETON INTERNATIONAL SMALLER COMPANIES FUND
The investment objective of the Templeton International Smaller Companies
Fund is to seek long-term capital appreciation. The Portfolio seeks to
achieve this objective by investing primarily in equity securities of smaller
companies outside the U.S., including developing markets countries.
PORTFOLIO INVESTMENTS. Under normal market conditions, the Portfolio expects
to invest at least 65% of its assets in equity securities of companies of any
foreign nation (including developing markets nations) whose market
capitalizations do not exceed $1 billion at the time of purchase, generally
considered "small cap companies." The Portfolio may, from time to time, hold
significant cash positions until suitable investment opportunities are
available, consistent with its policy on temporary investments. The Manager
believes that international small cap companies may provide attractive
investment opportunities, because these securities make up most of the
world's equity securities and because they are frequently overlooked by
investors or undervalued in relation to their perceived earning power. In
addition, such securities may provide investors with the opportunity to
increase the diversification of their overall investment portfolios, because
these securities' market performance may differ from that of U.S. small cap
stocks and from that of large-cap stocks of any nation. Equity securities of
small cap companies may include common stock, preferred stock, warrants for
the purchase of common stock, and convertible securities. SEE "INVESTMENT
METHODS AND RISKS, CONVERTIBLE SECURITIES."
RISK FACTORS. Securities of smaller companies, particularly if they are
unseasoned, present greater risks than securities of larger, more established
companies. The companies may have relatively small revenues, limited product
lines, and a small share of the market for their products or services. Small
cap companies may lack depth of management, they may be unable to internally
generate funds necessary for growth or potential development or to generate
such funds through external financing on favorable terms, or they may be
developing or marketing new products or services for which markets are not
yet established and may never become established. Due to these and other
factors, small cap companies may suffer significant losses as well as realize
substantial growth, and investments in such companies tend to be more
volatile and are therefore speculative. Besides exhibiting greater
volatility, small cap company stocks may fluctuate independently of larger
company stocks. As an operating policy, the Portfolio will not invest more
than 10% of its assets in securities of companies with less than three years
of continuous operation. SEE "INVESTMENT METHODS AND RISKS." THE PORTFOLIO
MAY NOT BE APPROPRIATE FOR SHORT-TERM INVESTORS, AND AN INVESTMENT IN THE
PORTFOLIO SHOULD NOT BE CONSIDERED A COMPLETE INVESTMENT PROGRAM.
The Portfolio has the right to purchase securities in any foreign country,
developed or emerging. However, as a non-fundamental policy, the Portfolio
will limit its investments in securities of Russian issuers to 5% of assets.
The Portfolio's investments in foreign securities, especially those in
developing markets, involve risks related to currency fluctuations, market
volatility, and economic, social, and political uncertainty that are
different from investing in similar obligations of domestic entities.
Investments in foreign developing markets, including certain Eastern European
countries and Russia, involve heightened risks related to the small size and
lesser liquidity of these markets. INVESTORS SHOULD CONSIDER CAREFULLY THE
SUBSTANTIAL RISKS INVOLVED IN INVESTING IN FOREIGN SECURITIES, RISKS THAT ARE
HEIGHTENED FOR INVESTMENTS IN DEVELOPING MARKETS. SEE "HIGHLIGHTED RISK
CONSIDERATIONS, FOREIGN TRANSACTIONS."
OTHER INVESTMENTS. The Portfolio may invest up to 35% of its assets in:
equity securities of larger capitalization issuers outside the U.S.; equity
securities of larger or smaller capitalization issuers within the U.S.,
although such investments are not currently expected to exceed 5% of assets;
or debt obligations issued by companies or governments in any nation which
are rated at least C by Moody's or S&P or unrated debt obligations deemed to
be of comparable quality by the Manager. As a current policy, however, the
Portfolio will not invest more than 5% of its assets in debt obligations
rated lower than BBB by S&P or Baa by Moody's. SEE "HIGHLIGHTED RISK
CONSIDERATIONS, LOWER RATED DEBT OBLIGATIONS." These investments may cause
the Portfolio's performance to vary from those of international smaller
capitalization equity markets.
DEFAULTED DEBT OBLIGATIONS. The Portfolio may invest up to 10% of its assets
in defaulted debt obligations, which may be considered speculative.
CURRENCY TECHNIQUES. The Portfolio may, but with respect to equity securities
does not currently intend, to employ certain active currency management
techniques. Such techniques may include investments in foreign currency
futures contracts, forward foreign currency exchange contracts ("forward
contracts"), and options on foreign currencies, all of which involve
specialized risks. Further, the Portfolio will not enter into forward
contracts if, as a result, the Portfolio would have more that 20% of its
assets committed to the consummation of such contracts. SEE "HIGHLIGHTED RISK
CONSIDERATIONS, FOREIGN TRANSACTIONS" and the SAI.
OTHER INVESTMENT POLICIES. The Portfolio may invest no more than 5% of its
assets in securities of any one issuer, exclusive of U.S. Government
Securities. The Portfolio may invest up to 5% of its assets in warrants,
including such warrants that are not listed on an exchange. For hedging
purposes only, the Portfolio may enter into: transactions in options on
securities, securities indices, and foreign currencies; forward foreign
currency contracts; and futures contracts and related options. The value of
the underlying securities on which futures contracts will be written at any
one time will not exceed 25% of the assets of the Portfolio. SEE "INVESTMENT
METHODS AND RISKS, OPTIONS AND FUTURES CONTRACTS" and the SAI. Under the
policies discussed in "INVESTMENT METHODS AND RISKS," "HIGHLIGHTED RISK
CONSIDERATIONS," and in the SAI, the Portfolio may also enter into repurchase
agreements, invest in illiquid securities, lend its portfolio securities, and
engage in other activities specifically identified for this Portfolio.
TEMPLETON PACIFIC GROWTH FUND
The Templeton Pacific Growth Fund seeks to provide long-term growth of
capital.
Under normal conditions, the Portfolio will invest at least 65% of its assets
in Equity Securities as defined in the International Equity Fund discussion
above which trade on markets in the Pacific Rim, including developing markets
and which are (i) issued by companies domiciled in the Pacific Rim or (ii)
issued by companies that derive at least 50% of either their revenues or
pre-tax income from activities in the Pacific Rim. For purposes of the
Portfolio's 65% investment policy, the countries in the Pacific Rim include
Australia, China, Hong Kong, India, Indonesia, Japan, Korea, Malaysia, New
Zealand, Pakistan, the Philippines, Singapore and Thailand. Normally, the
Portfolio will invest at least 65% of its assets in securities traded in at
least three foreign countries, including the countries listed herein. The
Portfolio may, from time to time, hold significant cash positions until
suitable investment opportunities are available, consistent with its policy
on temporary investments.
Although the Portfolio will not invest more than 25% of its assets in any one
industry or the government of any one country, the Portfolio may invest more
than 25% of its assets in the securities of issuers in one or more countries.
Investors should consider the greater risk of this policy versus the safety
that may come with an investment that involves a wider range of geographic
localities and countries. In addition, the correlation among the Singapore,
Malaysia, Thailand, and Hong Kong markets is very high. Because these markets
comprise such a substantial portion of the Portfolio, the Portfolio has less
geographical diversification than a broad-based international portfolio and
thus its volatility is higher. AN INVESTMENT IN THE PORTFOLIO MAY BE
CONSIDERED SPECULATIVE, AND MAY NOT BE APPROPRIATE FOR SHORT-TERM INVESTORS.
INVESTORS SHOULD CONSIDER CAREFULLY THE SUBSTANTIAL AND HEIGHTENED RISKS
INVOLVED IN INVESTING IN DEVELOPING MARKETS SECURITIES. SEE "HIGHLIGHTED RISK
CONSIDERATIONS, FOREIGN TRANSACTIONS" and the SAI.
OTHER INVESTMENTS. The Portfolio may invest up to 35% of its assets in the
securities of issuers domiciled outside of the Pacific Rim. The investments
may consist of, for example (i) securities of issuers in countries that are
not located in the Pacific Rim but are linked by tradition, economic markets,
cultural similarities or geography to the countries in the Pacific Rim; and
(ii) securities of issuers located elsewhere in the world which have
operations in the Pacific Rim or which stand to benefit from political and
economic events in the Pacific Rim. For example, the Portfolio may invest in
a company outside of the Pacific Rim when the Managers believe at the time of
investment that the value of the company's securities may be enhanced by
conditions or developments in the Pacific Rim even though the company's
production facilities are located outside of the Pacific Rim.
Up to 35% of the Portfolio's assets may be invested in investment grade debt
obligations rated Baa or better by Moody's, or BBB or better by S&P or, if
unrated, determined by the Manager to be of comparable quality. However, the
Portfolio's Manager currently does not intend to hold any significant
positions in debt obligations.
The Portfolio may seek capital appreciation by investing in such debt
obligations which would occur through changes in relative foreign currency
exchange rates, changes in relative interest rates or improvement in the
creditworthiness of an issuer. These debt obligations may consist of U.S. and
foreign government securities and corporate debt obligations, including
Yankee bonds, Eurobonds, and Depositary Receipts. The issuers of such debt
obligations may or may not be domiciled in the Pacific Rim. SEE "INVESTMENT
METHODS AND RISKS."
OTHER INVESTMENT POLICIES. The Portfolio may invest up to 10% of its net
assets in illiquid securities. Currently the Portfolio intends to invest no
more than 10% of its net assets in warrants, including such warrants that are
not listed on an exchange. Under the policies discussed in "INVESTMENT
METHODS AND RISKS," "HIGHLIGHTED RISK CONSIDERATIONS," and in the SAI, the
Portfolio may also write covered call and put options on securities, purchase
called put options on securities, buy puts and write calls in "forward
conversion" transactions, engage in "spread" and "straddle" transactions,
purchase and write call and put options on stock indices, enter into
contracts for the purchase or sale for future delivery of U.S. Treasury or
foreign securities or futures contracts based upon financial indices,
purchase and sell interest rate futures contracts and related options,
purchase and sell stock index futures contracts and related options, purchase
convertible securities, lend its portfolio securities, engage in repurchase
agreements, and engage in other activities specifically identified for this
Portfolio.
HIGHLIGHTED RISK CONSIDERATIONS
FOREIGN TRANSACTIONS
Foreign securities include all of the following, 1) securities of companies
organized outside the U.S. ("foreign issuers"), whether or not publicly
traded in the U.S., 2) securities that are principally traded outside the
U.S., 3) securities denominated in foreign currency ("non-dollar
securities"). Investments in foreign securities may offer potential benefits
not available from investments solely in securities of domestic issuers or
dollar denominated securities. Such benefits may include the opportunity to
invest in foreign issuers that appear, in the opinion of the Managers, to
offer better opportunity for long-term capital appreciation or current
earnings than investments in domestic issuers, the opportunity to invest in
foreign countries with economic policies or business cycles different from
those of the U.S. and the opportunity to reduce fluctuations in portfolio
value by taking advantage of foreign securities markets that do not
necessarily move in a manner parallel to U.S. markets.
GENERAL CONSIDERATIONS. Investing in non-dollar securities or in the
securities of foreign issuers involves significant risks that are not
typically associated with investing in U.S. dollar denominated securities or
in securities of domestic issuers. These risks, which may involve possible
losses, include political, social or economic instability in the country of
the issuer, the difficulty of predicting international trade patterns, the
possibility of the imposition of exchange controls, expropriation, limits on
removal of currency or other assets, foreign investment controls on daily
stock market movements, nationalization of assets, foreign withholding and
income taxation and foreign trading practices (including higher trading
commissions, custodial charges and delayed settlements). Changes of
governmental administrations or of economic or monetary policies, in the U.S.
or abroad, or changed circumstances in dealings between nations or currency
convertibility or exchange rates could result in investment losses for a
Portfolio. In addition, there may be less publicly available information
about a foreign company than about a U.S. domiciled company. Foreign
companies generally are not subject to uniform accounting, auditing and
financial reporting standards comparable to those applicable to U.S. domestic
companies. Further, the Portfolio may encounter difficulties or be unable to
pursue legal remedies and obtain judgments in foreign courts. The Portfolio
may also encounter difficulties or be unable to vote proxies, exercise
shareholder rights, pursue legal remedies and obtain judgments in foreign
courts. There is generally less government supervision and regulation of
business and industry practices, securities exchanges, brokers and listed
companies abroad than in the U.S. This is especially true in developing
markets. There is an increased risk, therefore, of uninsured loss due to
lost, stolen, or counterfeit stock certificates. Confiscatory taxation or
diplomatic developments could also affect investment in those countries. Many
debt obligations of foreign issuers, and especially developing markets
issuers, are not rated by U.S. rating agencies and their selection depends on
the Manager's internal analysis.
Investments in foreign securities where delivery takes place outside the U.S.
will be made in compliance with applicable U.S. and foreign currency
restrictions and other laws limiting the amount and types of foreign
investments.
Many debt obligations of foreign issuers, and especially developing market
issuers, are either (i) rated below investment grade, or (ii) not rated by
U.S. rating agencies so that their selection depends on the Manager's
internal analysis. Foreign debt securities may be subject to greater
fluctuations in price than U.S. corporate obligations or U.S. Government
Securities. The markets on which such securities trade may have less volume
and liquidity, and may be more volatile than securities markets in the U.S.
Under certain market conditions, these investments may be less liquid than
U.S. Corporate Obligations and are certainly less liquid than U.S. Government
Securities. Finally, in the event of a default of any such foreign debt
obligations, it may be more difficult for a Portfolio to obtain or to enforce
a judgment against the issuers of such securities.
Securities which are acquired by a Portfolio outside the U.S. and which are
publicly traded in the U.S. or on a foreign securities exchange or in a
foreign securities market are not considered to be an illiquid asset so long
as the Portfolio acquires and holds the security with the intention of
reselling the security in the foreign trading market, the Portfolio
reasonably believes it can readily dispose of the security for cash in the
U.S. or foreign market, and current market quotations are readily available.
While the Portfolios which may acquire foreign securities intend to acquire
securities of foreign issuers only where there are public trading markets for
such securities (with the exception of the illiquid securities which may be
purchased if so stated in the individual Portfolio section), such
investments, nevertheless, may tend to reduce the liquidity of the
Portfolios' investment securities due to internal problems in such foreign
countries or to deteriorating relations between the U.S. and such countries.
Transaction costs on foreign securities exchanges may be higher than in the
U.S., and foreign securities settlements may, in some instances, be subject
to delays and related administrative uncertainties. The operating expense
ratio of a Portfolio with a significant non-U.S. portfolio can be expected to
be higher than those of Portfolios investing exclusively in domestic
securities because of its additional expenses, such as custodial costs,
valuation costs and communication costs, although they are expected to be
similar to expenses of other investment companies investing in a mix of U.S.
securities and securities of one or more foreign countries.
Brokerage commissions, custodial services, and other costs relating to
investment in foreign markets, including developing markets, are generally
higher than in the U.S. Such 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 Portfolio are
uninvested and no return is earned thereon. The inability of a Portfolio to
make intended security purchases due to settlement problems could cause a
Portfolio to miss attractive investment opportunities. Inability to dispose
of a security due to settlement problems could result either in losses to the
Portfolio due to subsequent declines in value of the security or, if the
Portfolio has entered into a contract to sell the security, could result in
possible liability to the purchaser.
INVESTMENTS IN DEVELOPING MARKETS. These countries are located in the
Asia-Pacific region, Eastern Europe, Central and South America and Africa.
Countries generally considered to have developing markets are all countries
that are considered to be developing or emerging countries by the
International Bank for Reconstruction and Development (more commonly referred
to as the World Bank) and the International Finance Corporation, as well as
countries that are classified by the United Nations or otherwise regarded by
their authorities as developing. Currently, developed countries include, but
are not limited to, Australia, Austria, Belgium, Canada, Denmark, Finland,
France, Germany, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway,
Spain, Sweden, Switzerland, the United Kingdom and the U.S.
The Portfolios investing in developing markets seek to benefit from economic
and other developments in developing markets. Such investments reflect the
Managers' belief that investment opportunities may result from an evolving
long-term international trend favoring more market-oriented economies, a
trend that may especially benefit certain countries having developing
markets. This trend may be facilitated by local or international political,
economic or financial developments that could benefit the capital markets of
such countries. Certain such countries, particularly the emerging market
countries which may be in the process of developing more market-oriented
economies, may experience relatively high rates of economic growth. Other
countries, although having relatively mature developing markets, may also be
in a position to benefit from local or international developments encouraging
greater market orientation and diminishing governmental intervention in
economic affairs.
Investments in developing or emerging markets, including certain Eastern
European countries are subject to all of the risks of foreign investing
generally but have additional and heightened risks related to the small size
and lesser liquidity of these markets, making investments in such markets
particularly volatile. While short-term volatility can be disconcerting,
declines of as much as 40% to 50% are not unusual in emerging markets. In
fact, the Hong Kong market has increased 1268% in the last 15 years, but has
suffered five declines of more than 20% during that time. Many smaller Asian
markets suffered severe declines in 1997, including several which fell over
70%.
Among the special risks associated with investment in developing or emerging
markets, including certain Eastern European countries are political or
economic uncertainty. Political and economic structures in many of these
countries may be undergoing significant evolution and rapid development, and
such countries may lack the social, political and economic stability
characteristic of more developed countries. Certain of these countries may
have in the past failed to recognize private property rights and have at
times nationalized or expropriated the assets of private companies. As a
result, the risks of foreign investment generally, including the risks of
nationalization or expropriation of assets, may be heightened. In addition,
unanticipated political or social developments may affect the values of the
Portfolios' investments in those countries and the availability to a
Portfolio of additional investments in those countries.
The small size and inexperience of the securities markets in certain of these
countries and the limited volume of trading in securities in those countries
may also make the Portfolios' investments in such countries less liquid and
more volatile than investments in Japan or most Western European countries,
and these Portfolios may be required to establish special custody or other
arrangements before making certain investments in those countries. Russia's
system of share registration and custody creates certain risks of loss
(including the risk of total loss) that are not normally associated with
investments in other securities markets. These risks and other risks
associated with the Russian securities market are discussed more fully in the
SAI under "Highlighted Risk Considerations" and investors should read the
section in detail. There may be little financial or accounting information
available with respect to issuers located in certain of such countries, and
it may be difficult as a result to assess the value or prospects of an
investment in such issuers. The laws of some foreign countries may limit the
ability of these Portfolios to invest in securities of certain issuers
located in those countries.
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 Portfolios 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 continue 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.
Hong Kong reverted to the sovereignty of China on July 1, 1997. As with any
major political transfer of power, this could result in political, social,
economic, market or other developments in Hong Kong, China or other countries
that could affect the value of Portfolio investments.
CERTAIN RESTRICTIONS. Some of the countries in which the Portfolios invest
may not permit direct investment. Investments in such countries may only be
permitted through government approved investment vehicles. Investing through
such vehicles may involve frequent or layered fees or expenses and may, as
well, be subject to limitations under federal securities laws. Consistent
with federal securities laws and subject to applicable fundamental investment
restrictions, each Portfolio may invest up to 10% of its assets in shares of
other investment companies and up to 5% of its assets in any one investment
company as long as the investment does not represent more than 3% of the
voting stock of the acquired investment company.
The Asset Allocation, Developing Markets, Global Growth, Global Health Care,
Global Income, Global Utility, International Equity, International Smaller
Companies, Mutual Discovery, Mutual Shares, Natural Resources, and Pacific
Funds, to the extent consistent with their investment objectives and
policies, reserve the right to invest more than 25% of their respective
assets in the securities of issuers in any single foreign country. Investors
should consider the greater risk of such policy versus the safety that comes
with an investment that does not involve potential geographic concentration
and should compare these Portfolios with other investment vehicles before
making an investment decision.
There may be other applicable policies or restrictions on a Portfolio's
investments in foreign securities. SEE "CURRENCY RISKS AND THEIR MANAGEMENT,"
"INVESTMENT OBJECTIVES AND POLICIES," "INVESTMENT METHODS AND RISKS" and the
SAI.
EURO RISK. On January 1, 1999, the European Monetary Union (EMU) plans to
introduce a new single currency, the euro, which will replace the national
currency for participating member countries. If a Portfolio holds investments
in countries with currencies replaced by the euro, the investment process,
including trading, foreign exchange, payments, settlements, cash accounts,
custody and accounting will be impacted.
Because this change to a single currency is new and untested, the
establishment of the euro may result in market volatility. For the same
reason, it is not possible to predict the impact of the euro on the business
or financial condition of European issuers which a Portfolio may hold, and
their impact on the value of Portfolio shares. To the extent a Portfolio
holds non-U.S. dollar (euro or other) denominated securities, it will still
be exposed to currency risk due to fluctuations in those currencies versus
the U.S. dollar.
CURRENCY RISKS AND THEIR MANAGEMENT. The relative performance of foreign
currencies in which securities held by a Portfolio are denominated is an
important factor in each Portfolio's overall performance. The Managers intend
to manage a Portfolio's exposure to various currencies to take advantage of
different yield, risk, and return characteristics that different currencies,
currency denominations, and countries can provide for U.S. investors.
Unless otherwise indicated in the specific Portfolio description, the
Managers generally do not actively hedge currency positions with respect to
equity securities, believing that the costs outweigh the potential benefits.
The Managers may, however, hedge where they believe it would be appropriate.
To hedge exposure to currency fluctuations or to increase income to a
Portfolio, each of the Portfolios which may invest in Foreign Securities may,
but is not required to, enter into forward foreign currency exchange
contracts, currency futures contracts, and options on such futures contracts,
as well as purchase put or call options and write covered put and call
options on currencies traded in U.S. or foreign markets. Other currency
management strategies allow the Managers to hedge portfolio securities, to
shift investment exposure from one currency to another, or to attempt to
profit from anticipated declines in the value of a foreign currency relative
to the U.S. dollar. Some of these strategies will require a Portfolio to
segregate liquid assets to cover its obligations. There is no assurance that
the Managers' hedging strategies will be successful.
If a security is denominated in foreign currency, the value of the security
to a Portfolio will be affected by changes in currency exchange rates and in
exchange control regulations, and costs will be incurred in connection with
conversions between currencies. A change in the value of any foreign currency
against the U.S. dollar will result in a corresponding change in the U.S.
dollar value of a Portfolio's securities denominated in that currency. Such
changes will also affect a Portfolio's income and distributions to
shareholders. In addition, although the Portfolio will receive income on
foreign securities in such currencies, the Portfolio will be required to
compute and distribute its income in U.S. dollars. Therefore, if the exchange
rate for any such currency declines materially after a Portfolio's income has
been accrued and translated into U.S. dollars, the Portfolio could be
required to liquidate portfolio securities to make required distributions.
Similarly, if an exchange rate declines between the time a Portfolio incurs
expenses in U.S. dollars and the time such expenses are paid, the amount of
such currency required to be converted into U.S. dollars in order to pay such
expenses in U.S. dollars will be greater.
A Portfolio will use forward currency exchange contracts in the normal course
of business to lock in an exchange rate in connection with purchases and
sales of securities denominated in foreign currencies. A forward currency
exchange contract involves an obligation to purchase or sell a specific
currency at a future date, which may be any fixed number of days from the
date of the contract agreed upon by the parties, at a price set at the time
of the contract. These contracts are traded in the interbank market conducted
directly between currency traders (usually large commercial banks). A
currency futures contract is a standardized contract for the future delivery
of a specified amount of currency at a future date at a price set at the time
of the contract. A Portfolio may enter into currency futures contracts traded
on regulated commodity exchanges, including non-U.S. exchanges.
A Portfolio will normally conduct its foreign currency exchange transactions
either on a spot (i.e., cash) basis at the spot rate prevailing in the
foreign currency exchange market, or through entering into forward contracts
to purchase or sell foreign currencies. A Portfolio will generally not enter
into a forward contract with a term of greater than one year. Some price
spread on currency exchange transactions (to cover service charges) will be
incurred when the Portfolio converts assets from one currency to another. A
Portfolio may either accept or make delivery of the currency specified at the
maturity of a forward or futures contract or, prior to maturity, enter into a
closing transaction involving the purchase or sale of an offsetting contract.
Closing transactions with respect to forward contracts are usually effected
with the currency trader who is a party to the original forward contract.
Closing transactions with respect to futures contracts and options thereon
are effected on the exchange on which the contract was entered into (or on a
linked exchange).
A Portfolio will not enter into such forward currency exchange contracts or
currency futures contracts or purchase or write such options or maintain a
net exposure to such contracts where the completion of the contracts would
obligate the Portfolio to deliver an amount of currency other than U.S.
dollars in excess of the value of the securities or other assets denominated
in that currency or, in the case of cross-hedging, in a currency closely
correlated to that currency.
A Portfolio will generally enter into forward contracts only under two
circumstances. First, when the Portfolio enters into a contract for the
purchase or sale of a security denominated in a foreign currency, it may
desire to "lock in" the U.S. dollar price of the security in relation to
another currency by entering into a forward contract to buy the amount of
foreign currency needed to settle the transaction. Second, when the Managers
believe that the currency of a particular foreign country may suffer or enjoy
a substantial movement against another currency, the Portfolio may enter into
a forward contract to sell or buy the former foreign currency (or another
currency which acts as a proxy for that currency) approximating the value of
some or all of the Portfolio's securities denominated in such foreign
currency. This second investment practice is generally referred to as
"cross-hedging." Although forward contracts will be used primarily to protect
the Portfolio from adverse currency movements, they also involve the risk
that anticipated currency movements will not be accurately predicted.
As in the case of other kinds of options, the writing of an option on a
foreign currency constitutes only a partial hedge, up to the amount of the
premium received, and a Portfolio could be required to purchase or sell
foreign currencies at disadvantageous exchange rates, thereby incurring
losses. The purchase of an option on a foreign currency may constitute an
effective hedge against fluctuations in exchange rates although, in the event
of rate movements adverse to a Portfolio's position, it may forfeit the
entire amount of the premium plus related transaction costs.
A liquid secondary market for any futures or options contract may not be
available when a futures or options position is sought to be closed. In
addition, there may be an imperfect correlation between movements in the
securities or foreign currency on which the futures or options contract is
based and movements in the securities or currency in the Portfolio.
Successful use of futures or options contracts is further dependent on the
Managers' ability to correctly predict movements in the securities or foreign
currency markets and no assurance can be given that its judgment will be
correct. Successful use of options on securities or stock indices is subject
to similar risk considerations. In addition, by writing covered call options,
the Portfolio gives up the opportunity, while the option is in effect, to
profit from any price increase in the underlying security above the option
exercise price. SEE "INVESTMENT METHODS AND RISKS" for additional information.
INTEREST RATE AND CURRENCY SWAPS. Interest rate swaps involve the exchange by
the Portfolio with another party of their respective commitments to pay or
receive interest, such as an exchange of fixed rate payments for floating
rate payments. Currency swaps involve the exchange of their respective rights
to make or receive payments in specified currencies. Since interest rate and
currency swaps are individually negotiated, these Portfolios expect to
achieve an acceptable degree of correlation between their portfolio
investments and their interest rate or currency swap positions.
A Portfolio will only enter into interest rate swaps on a net basis, which
means that the two payment streams are netted out, with the Portfolio
receiving or paying, as the case may be, only the net amount of the two
payments. Interest rate swaps do not involve the delivery of securities,
other underlying assets or principal. Accordingly, the risk of loss with
respect to interest rate swaps is limited to the net amount of interest
payments that the Portfolio is contractually obligated to make. If the other
party to an interest rate swap defaults, the Portfolio's risk of loss
consists of the net amount of interest payments that the Portfolio is
contractually entitled to receive. In contrast, currency swaps usually
involve the delivery of the entire principal value of one designated currency
in exchange for the other designated currency. Therefore, the entire
principal value of a currency swap is subject to the risk that the other
party to the swap will default on its contractual delivery obligations.
The use of interest rate and currency swaps is a highly specialized activity
which involves investment techniques and risks different from those
associated with ordinary portfolio securities transactions. If the Managers
are incorrect in their forecasts of market values, interest rates and
currency exchange rates, the investment performance of the Portfolio would be
less favorable than it would have been if this investment technique were not
used.
INVESTMENTS IN DEPOSITARY RECEIPTS. Many securities of foreign issuers are
represented by American Depositary Receipts ("ADRs"), European Depositary
Receipts ("EDRs"), and Global Depositary Receipts ("GDRs") (collectively
"Depositary Receipts"). ADRs evidence ownership of, and represent the right
to receive, securities of foreign issuers deposited in a domestic bank or
trust company or a foreign correspondent bank. EDRs and GDRs are typically
issued by foreign banks or trust companies, although they also may be issued
by U.S. banks or trust companies, and evidence ownership of underlying
securities issued by either a foreign or a United States 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.
Prices of ADRs are quoted in U.S. dollars, and ADRs are traded in the U.S. on
exchanges or over-the-counter. While ADRs do not eliminate all the risk
associated with foreign investments, by investing in ADRs rather than
directly in the stock of foreign issuers, a Portfolio will avoid currency
risks during the settlement period for either purchases or sales. In general,
there is a large, liquid market in the United States for ADRs quoted on a
national securities exchange or on NASDAQ. The information available for ADRs
is subject to the accounting, auditing and financial reporting standards of
the domestic market or exchange on which they are traded, which standards are
more uniform and more exacting than those to which many foreign issuers may
be subject. EDRs and GDRs may not necessarily be denominated in the same
currency as the underlying securities.
Depositary Receipts may be issued under 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 do not eliminate all the risk inherent in investing in
the securities of foreign issuers. To the extent that a Portfolio acquires
Depositary Receipts through banks which do not have a contractual
relationship with the foreign issuer of the security underlying the
Depositary Receipt to issue and service such Depositary Receipts, there may
be an increased possibility that the Portfolio would not become aware of and
be able to respond to corporate actions such as stock splits or rights
offerings involving the foreign issuer in a timely manner. For purposes of
each Portfolio's investment policies, a Portfolio's investments in Depositary
Receipts will be deemed to be investments in the underlying securities.
LOWER RATED DEBT OBLIGATIONS. Debt obligations are subject to the risk of an
issuer's inability to meet principal and interest payments on the obligations
(credit risk) and may also be subject to price volatility due to such factors
as interest rate sensitivity, market perception of the creditworthiness of
the issuer and general market liquidity (market risk). Lower rated or unrated
obligations are more likely to react to developments affecting market and
credit risk than are more highly rated obligations, which react primarily to
movements in the general level of interest rates. The Managers consider both
credit risk and market risk in making investment decisions as to corporate
debt obligations for a Portfolio.
Debt obligations rated BB or below by S&P or Ba or below by Moody's (or
comparable unrated obligations), commonly called "junk bonds," are considered
by S&P and Moody's, on balance, speculative and payments of principal and
interest thereon may be questionable. They will generally involve more credit
risk than obligations in the higher rating categories. The market value of
junk bonds tends to reflect individual developments affecting the issuer to a
greater extent than the market value of higher rated obligations, which react
primarily to fluctuations in the general level of interest rates. Lower rated
obligations tend to be more sensitive to economic conditions and are
considered by the rating agencies, on balance, to be predominantly
speculative with respect to the issuer's capacity to pay interest and repay
principal in accordance with the terms of the obligation and generally will
involve more credit risk than securities in the higher rating categories.
Bonds rated BBB by S&P or Baa by Moody's ratings which are considered
investment grade, also possess some speculative characteristics. Unrated debt
obligations are not necessarily of lower quality than rated securities, but
they may not be attractive to as many buyers.
Issuers of high yielding debt obligations are often highly leveraged and may
not have more traditional methods of financing available to them. Therefore,
the risk associated with acquiring such obligations is generally greater than
with higher rated obligations. For example, during an economic downturn or a
sustained period of rising interest rates, highly leveraged issuers of high
yielding obligations may experience financial stress. During these periods,
such issuers may not have sufficient cash flow to meet their interest payment
obligations. Specific developments affecting the issuer, such as the
inability to meet projected business forecasts, or the unavailability of
additional financing, may adversely affect the issuer's ability to service
its debt obligations. The risk of loss due to default by the issuer may be
significantly greater for the holders of high yielding obligations because
such securities are generally unsecured and are often subordinated to other
creditors of the issuer.
High yielding debt obligations frequently have call or buy-back features
which permit an issuer to call or repurchase the obligations from a
Portfolio. Although such obligations are typically not callable for a period
from three to five years after their issuance, when calls are exercised by
the issuer during periods of declining interest rates, the Manager may find
it necessary to replace such obligations with lower yielding obligations
which could result in less net investment income to the Portfolio. The
premature disposition of a high yielding obligation due to a call or buy-back
feature, the deterioration of the issuer's creditworthiness, or a default may
also make it more difficult for a Portfolio to manage the timing of its
receipt of income, which may have tax implications. A Portfolio may be
required under the Code and U.S. Treasury regulations to accrue income for
income tax purposes on defaulted obligations and to distribute such income to
the Portfolio's shareholders even though the Portfolio is not currently
receiving interest or principal payments on such obligations. In order to
generate cash to satisfy any or all of these distribution requirements, a
Portfolio may be required to dispose of securities that it otherwise would
have continued to hold or to use cash flows from other sources such as the
sale of Portfolio shares.
A Portfolio may have difficulty disposing of certain high yielding
obligations because there may be a thin trading market for a particular
obligation at any given time. The market for lower rated, debt obligations
generally tends to be concentrated among a smaller number of dealers than is
the case for obligations which trade in a broader secondary retail market.
Generally, purchasers of these obligations are predominantly dealers and
other institutional buyers, rather than individuals. To the extent the
secondary trading market for a particular high yielding, debt obligation does
exist, it is generally not as liquid as the secondary market for higher rated
obligations. Reduced liquidity in the secondary market may have an adverse
impact on market price, a Portfolio's ability to dispose of particular
issues, when necessary, to meet the Portfolio's liquidity needs or in
response to a specific economic event, such as a deterioration in the
creditworthiness of the issuer. Reduced liquidity may also make it more
difficult for the Portfolio to obtain market quotations based on actual
trades for purposes of valuing the Portfolio. Current values for these high
yield issues are obtained from pricing services and/or a limited number of
dealers and may be based upon factors other than actual sales. SEE
"ADDITIONAL INFORMATION REGARDING VALUATION AND REDEMPTION OF SHARES OF THE
PORTFOLIOS," in the SAI.
Some high yielding, debt obligations are sold without registration under the
federal securities laws and therefore carry restrictions on resale. While
many high yielding obligations have been sold with registration rights,
covenants, and penalty provisions for delayed registration, if a Portfolio is
required to sell such restricted securities before the securities have been
registered, it may be deemed an underwriter of such securities under the
Securities Act of 1933, which entails special responsibilities and
liabilities. A Portfolio may incur special costs in disposing of such
securities; however, the Portfolio will generally incur no costs when the
issuer is responsible for registering the securities.
Some high yielding debt obligations may involve special risks because they
are new issues. The Portfolios have no arrangement with the securities
underwriters or any other person concerning the acquisition of such
securities, and the Manager will carefully review the credit and other
characteristics pertinent to such new issues.
The high yield securities market is relatively new and much of its growth
prior to 1990 paralleled a long economic expansion. The recession that began
in 1990 disrupted the market for high yielding securities and adversely
affected the value of outstanding securities and the ability of issuers of
such securities to meet their obligations. Although the economy has improved
considerably and high yielding securities have performed more consistently
since that time, there is no assurance that the adverse effects previously
experienced will not reoccur. For example, the highly publicized defaults of
some high yield issuers during 1989 and 1990 and concerns regarding a
sluggish economy which continued into 1993, depressed the prices for many of
these securities. While market prices may be temporarily depressed due to
these factors, the ultimate price of any security will generally reflect the
operating results of the issuer. In addition, a Portfolio may incur
additional expenses to the extent it is required to seek recovery upon a
default in the payment of principal or interest on its portfolio holdings. A
Portfolio will rely on the Manager's judgment, analysis and experience in
evaluating the creditworthiness of an issuer. In this evaluation, the Manager
will take into consideration, among other things, the issuer's financial
resources, its sensitivity to economic conditions and trends, its operating
history, the quality of the issuer's management and regulatory matters.
Investments may also be evaluated in the context of economic and political
conditions in the issuer's domicile, such as the inflation rate, growth
prospects, global trade patterns and government policies. In the event the
rating on an issue held in a Portfolio is changed by the rating service, such
change will be considered by the Portfolio in its evaluation of the overall
investment merits of that security but will not necessarily result in an
automatic sale of the security.
Defaulted Debt Obligations. Certain Portfolios, if so stated in the
individual Portfolio section, may purchase debt obligations of issuers not
currently paying interest as well as issuers who are in default. In general,
a Portfolio will purchase a defaulted debt obligation only if, in the opinion
of the Manager, the issuer is expected to resume interest payments or other
advantageous developments appear likely in the future.
A Portfolio may also invest in debt obligations which are in default or about
to default, where the Manager believes that the debt obligation's price is
less than its intrinsic value, due to a recent or pending restructuring of
the issuer or other factors.
Current prices for defaulted bonds are generally significantly lower than
their purchase price, and a Portfolio may have unrealized losses on such
defaulted obligations which are reflected in the price of the Portfolio's
shares. In general, debt obligations which default lose much of their value
in the time period prior to the actual default so that the Portfolio's net
assets are impacted prior to the default. A Portfolio may retain an issue
which has defaulted because such issue may present an opportunity for
subsequent price recovery.
A Portfolio may be required under the Internal Revenue Code of 1986, as
amended (the "Code"), to accrue income for tax purposes on defaulted
obligations, even though it is not currently receiving interest or principal
payments on such obligations. This imputed income must be "distributed" to
the insurance company shareholders each year, whether or not such
distributions are paid in cash. To the extent such distributions are paid in
cash, a Portfolio may be required to dispose of securities that it otherwise
would have continued to hold or to use cash flows from other sources such as
sales of Portfolio shares.
THE PORTFOLIOS' INVESTMENTS. BECAUSE OF CERTAIN OF THE PORTFOLIOS' POLICIES
OF INVESTING IN HIGHER YIELDING, HIGHER RISK DEBT OBLIGATIONS, AN INVESTMENT
IN SUCH A PORTFOLIO IS ACCOMPANIED BY A HIGHER DEGREE OF RISK THAN IS PRESENT
WITH AN INVESTMENT IN A PORTFOLIO THAT INVESTS IN HIGHER RATED, LOWER
YIELDING DEBT OBLIGATIONS. ACCORDINGLY, AN INVESTMENT IN ANY SUCH PORTFOLIO
SHOULD BE CAREFULLY EVALUATED FOR ITS APPROPRIATENESS IN LIGHT OF THE
INVESTOR'S OVERALL INVESTMENT NEEDS AND GOALS. Persons on fixed incomes, such
as retired persons, should also consider the increased risk of loss of
principal which is present with an investment in higher risk obligations.
At December 31, 1997, the Income Securities Fund held one position in
obligations which were in default on their contractual provisions.
ASSET COMPOSITION TABLE. A credit rating by a rating agency evaluates only
the safety of principal and interest of debt obligations, and does not
consider the market value risk associated with an investment in such an
obligation. The table below shows the percentage of Global Income, Asset
Allocation, High Income and Income Securities Funds' assets invested in debt
securities rated in each of the specific rating categories shown and those
that are not rated by the rating agency but deemed by the Manager to be of
comparable credit quality. The information was prepared based on a 12 month
dollar weighted average of the respective portfolio compositions in the
fiscal year ended December 31, 1997. No other Portfolio had a 12-month dollar
weighted average of more than 5% of its assets in debt obligations rated
below investment grade or determined by the Manager to be of comparable
credit quality. The Appendix to this prospectus includes a description of
each rating category.
INCOME
MOODY'S SECURITIES FUND
Aaa 8.33%
Aa 0.54%
A 0.00%
Baa 4.08%
Ba 2.87%
B 30.60%
Caa 3.86%*
Ca 0.30%
C 0.15%
*2.70% of these securities, which are unrated by Moody's, have been included
in the Caa rating category.
GLOBAL ASSET GLOBAL HIGH INCOME
S&P ALLOCATION FUND INCOME FUND FUND
AAA 66.61% 80.76% 0.00%
AA 0.02% 0.11% 0.00%
BBB+ 0.00% 0.00% 0.41%
BBB 0.00% 0.00% 1.32%
BBB- 0.05% 0.00% 3.80%
BB+ 1.85%** 0.34% 6.19%
BB 13.15%** 12.32%*** 4.99%
BB- 9.64% 5.02% 12.06%****
B+ 4.11% 0.00% 16.86%****
B 3.63%** 0.00% 30.45%****
B- 0.94%** 0.00% 19.37%****
CCC+ 0.00% 0.00% 2.15%****
CCC 0.00% 0.00% 1.23%
CCC- 0.00% 0.00% 1.17%
**Securities, which are unrated by S&P, have been included as follows: 0.73%
BB+, 0.35% BB, 2.86% B, 0.94% B-.
***0.11% of these securities, which are unrated by S&P, have been included in
the BB rating category.
****Securities, which are unrated by S&P, have been included as follows:
0.48% BB-, 0.14% B+, 1.13% B, 1.08% B-, 0.31% CCC+.
It should be noted that the above ratings are not necessarily indicative of
ratings of bonds at the time of purchase.
INVESTMENT METHODS AND RISKS
COMMON TO MORE THAN ONE PORTFOLIO
Certain types of investments and investment techniques are authorized for
more than one Portfolio, only if so stated in the descriptions of the
individual Portfolios. These are described below and in the SAI in greater
detail. Each of the Portfolios will not necessarily use the authorized
strategies described to the full extent permitted unless the Managers believe
that doing so will help a Portfolio reach its objectives, and not all
instruments or methods will be used at all times. See "Table of Contents" in
front for a complete listing and page numbers.
BORROWING
AS A MATTER OF FUNDAMENTAL POLICY, ALL OF THE PORTFOLIOS EXCEPT THE ASSET
ALLOCATION, DEVELOPING MARKETS, GLOBAL HEALTH CARE, INTERNATIONAL SMALLER
COMPANIES, MUTUAL DISCOVERY, MUTUAL SHARES, SMALL CAP AND VALUE FUNDS, MAY
BORROW MONEY UP TO 5% OF THE VALUE OF THEIR RESPECTIVE ASSETS AND NO SUCH
BORROWING MAY BE FOR DIRECT INVESTMENT IN SECURITIES. The Portfolios may also
borrow from banks for temporary or short-term purposes. The Portfolios
currently define temporary or short-term purposes to include: (i) short-term
(i.e., no longer than five business days) credits for clearance of portfolio
transactions; (ii) borrowing in order
to meet redemption requests or to finance failed
settlements of portfolio trades without immediately liquidating portfolio
securities or other assets; and (iii) borrowing in order to fulfill
commitments or plans to purchase additional securities pending the
anticipated sale of other portfolio securities or assets in the near term. AS
A FUNDAMENTAL POLICY, THE ASSET ALLOCATION, DEVELOPING MARKETS, GLOBAL HEALTH
CARE, INTERNATIONAL SMALLER COMPANIES, MUTUAL DISCOVERY, MUTUAL SHARES, SMALL
CAP AND VALUE FUNDS MAY BORROW UP TO 331/3% OF THE VALUE OF THEIR RESPECTIVE
TOTAL NET ASSETS FROM BANKS TO INCREASE THEIR HOLDINGS OF PORTFOLIO
SECURITIES OR FOR TEMPORARY PURPOSES.
Under federal securities laws, each Portfolio is required to maintain
continuous asset coverage of 300% with respect to such borrowings and to sell
(within three days) sufficient portfolio holdings to restore such coverage if
it should decline to less than 300% due to market fluctuations or otherwise,
even if such liquidations of a Portfolio's holdings may be disadvantageous
from an investment standpoint. Leveraging by means of borrowing will
exaggerate the effect of any increase or decrease in the value of portfolio
securities on a Portfolio's net asset value, and money borrowed will be
subject to interest and other costs (which may include commitment fees and/or
the cost of maintaining minimum average balances) which may or may not exceed
the income received from the securities purchased with borrowed funds. A
Portfolio will not purchase additional securities while its borrowings exceed
the above percentage of its total assets.
CONCENTRATION
THE GLOBAL HEALTH CARE FUND, REAL ESTATE FUND, GLOBAL UTILITY FUND, AND THE
NATURAL RESOURCES FUND WILL CONCENTRATE IN A PARTICULAR INDUSTRY OR SECTOR,
OR IN U.S. GOVERNMENT SECURITIES, AS INDICATED IN THE SEPARATE DISCUSSIONS
ABOVE FOR EACH RESPECTIVE PORTFOLIO. THE OTHER PORTFOLIOS WILL NOT INVEST
MORE THAN 25% OF THE VALUE OF THEIR RESPECTIVE ASSETS IN ANY ONE PARTICULAR
INDUSTRY (EXCLUDING THE U.S. GOVERNMENT). PURSUANT TO THE 1940 ACT, THESE
POLICIES WILL NOT BE CHANGED WITHOUT SHAREHOLDER APPROVAL.
CONVERTIBLE SECURITIES
WITH THE EXCEPTION OF THE MONEY FUND AND GOVERNMENT FUND, ALL PORTFOLIOS 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 a Portfolio may invest are subject
to the same rating criteria and investment policies as that Portfolio's
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.
However, unlike convertible debt obligations, 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 each Portfolio's financial reporting, credit rating, and investment
limitation purposes.
Certain Portfolios, consistent with their investment policies, may also
invest in enhanced or synthetic convertible securities. A detailed discussion
of these securities appears in the SAI. None of the Portfolios currently
expect to make significant use of these securities.
DEBT OBLIGATIONS
Debt obligations are subject to the risk of an issuer's inability to meet
principal and interest payments on the obligations (credit risk) and may also
be subject to price volatility due to such factors as interest rate
sensitivity, market perception of the creditworthiness of the issuer and
general market liquidity (market risk). The Managers consider both credit
risk and market risk in making investment decisions as to corporate debt
obligations for a Portfolio. Debt obligations in which the Portfolios may
invest will tend to decrease in value when prevailing interest rates rise and
increase in value when prevailing interest rates fall. Generally, long-term
debt obligations are more sensitive to interest rate fluctuations than
short-term obligations. Because a Portfolio's investments in debt obligations
are interest rate sensitive, a Portfolio's performance may be affected by the
Managers' ability to anticipate and respond to fluctuations in market
interest rates. Debt obligations include U.S. Government Securities, debt
obligations of states or municipalities or state or municipal government
agencies or instrumentalities or foreign sovereign entities, U.S. or foreign
corporate debt obligations, preferred stock, zero coupon bonds and mortgage-
or asset-backed securities.
CORPORATE DEBT OBLIGATIONS. See "Highlighted Risk Considerations - Lower
Rated Corporate Debt Obligations."
MONEY MARKET INSTRUMENTS. The investments described in the Money Fund,
without regard to required ratings, maturity, and other criteria under Rule
2a-7 of the 1940 Act governing money market portfolios which define them as
"Eligible Securities" for purposes of the Portfolio, are referred to
generally as "Money Market Instruments" in this prospectus.
U.S. GOVERNMENT SECURITIES. All of the Portfolios may purchase U.S.
Government Securities. U.S. Government Securities are marketable fixed,
floating and variable rate securities issued or guaranteed by the U.S.
Government, its agencies, authorities or instrumentalities. Some U.S.
Government Securities, such as U.S. Treasury bills (maturities of one year or
less), U.S. Treasury notes (maturities of one to ten years) and U.S. Treasury
bonds (generally maturities of more than ten years) which differ only in
their interest rates, maturities and times of issuance are supported by the
full faith and credit of the U.S. Government. Others, such as obligations
issued or guaranteed by U.S. Government agencies, authorities or
instrumentalities are supported either by (a) the full faith and credit of
the U.S. Government (such as securities of the Small Business
Administration), (b) the right of the issuer to borrow from the Treasury
(such as securities of the Federal Home Loan Banks), (c) the discretionary
authority of the U.S. Government to purchase the agency's obligations (such
as FNMA securities), or (d) only the credit of the issuer. No assurance can
be given that the U.S. Government will provide financial support to U.S.
Government agencies, authorities or instrumentalities in the future.
Securities guaranteed as to principal and interest by the U.S. Government,
its agencies, authorities or instrumentalities are considered to include (i)
securities for which the payment of principal and interest is backed by a
guarantee of, or an irrevocable letter of credit issued by, the U.S.
Government, its agencies, authorities or instrumentalities and (ii)
participation in loans made to foreign governments or their agencies that are
so guaranteed. The secondary market for certain of these participations is
limited. Such participations may therefore be regarded as illiquid.
Each Portfolio may also invest in separately traded principal and interest
components of securities guaranteed or issued by the U.S. Treasury if such
components are traded independently under the Separate Trading of Registered
Interest and Principal of Securities program ("STRIPS"). See "Zero Coupon
Bonds," below.
U.S. Government Securities include GNMA mortgage-backed certificates. The
yields provided by GNMAs have historically exceeded the yields on other types
of U.S. Government Securities with comparable maturities. Unpredictable
prepayments of principal, however, can greatly change realized yields. In a
period of declining interest rates, it is more likely that mortgages
contained in GNMA pools will be prepaid thus reducing the effective yield.
For more information, See "U.S. Government Securities Fund," above.
Small Business Administration ("SBA") securities are pools of loans to small
businesses which are guaranteed as to principal and interest by the SBA, and
supported by the full faith and credit of the U.S. Government. SBA loans
generally have variable interest rates which are set at a premium above the
prime rate, and generally have no interest rate caps or floors. The terms on
SBA loans currently range from 7 to 25 years at the time of issue. As with
mortgage-backed securities such as GNMAs, prepayments can greatly change
realized yields. While the prepayment rate of mortgage-backed securities has
generally been a function of market interest rates, the prepayment rate of
SBA securities has historically depended more on the purpose and term of the
loan and the rate of borrower default. Shorter-term SBA loans have had the
highest prepayment rates, particularly if the loans were for working capital;
long-term, real-estate backed SBA loans prepay much more slowly. SBA
securities are sometimes offered at a premium above their principal amount,
which increases the risks posed by prepayment.
These notes would have coupon resets that may cause the current coupon to
fall to, but not below, zero. Existing credit quality, duration and liquidity
standards would apply, so that the Portfolio may not invest in structured
notes unless the Manager believes that the notes pose no greater credit or
market risk than stripped notes; however, these notes may carry risks similar
to those of stripped securities. See "Investment Methods and Risks."
ZERO COUPON BONDS. Zero coupon bonds are debt obligations which are issued at
a significant discount from face value. The original discount approximates
the total amount of interest the bonds will accrue and compound over the
period until maturity or the first interest accrual date at a rate of
interest reflecting the market rate of the security at the time of issuance.
A zero coupon security pays no interest to its holder during its life and its
value (above its cost to a Portfolio) consists of the difference between its
face value at maturity and its cost.
One particular zero coupon security a Portfolio may purchase is the FICO
STRIP, each of which represents an interest in securities issued by the
Financing Corporation ("FICO"), whose sole purpose is to function as a
financing vehicle for recapitalizing the Federal Savings and Loan Insurance
Corporation ("FSLIC"). FICO STRIPS are not backed by the full faith and
credit of the U.S. Government but are generally treated as U.S. Government
Agency Securities.
The credit risk factors pertaining to lower rated debt obligations also apply
to lower rated zero coupon bonds. Such bonds carry an additional risk in
that, unlike bonds which pay interest throughout the period to maturity, the
Portfolio will realize no cash until the cash payment date and, if the issuer
defaults, the Portfolio may obtain no return at all on its investment.
DEFERRED INTEREST AND PAY-IN-KIND BONDS. While zero coupon bonds do not
require the periodic payment of interest, deferred interest bonds generally
provide for a period of delay before the regular payment of interest begins.
Although this period of delay is different for each deferred interest bond, a
typical period is approximately one-third of the bond's term to maturity.
Such investments benefit the issuer by mitigating its initial need for cash
to meet debt obligations service, but some also provide a higher rate of
return to attract investors who are willing to defer receipt of such cash.
Such investments experience greater volatility in market value due to changes
in interest rates than debt obligations which provide for regular payments of
interest. A Portfolio will accrue income on such investments for tax and
accounting purposes
Pay-in-kind bonds are securities which pay interest through the issuance of
additional bonds. A Portfolio will be deemed to receive interest over the
life of such bonds and be treated as if interest were paid on a current basis
for federal income tax purposes, although no cash interest payments are
received by the Portfolio until the cash payment date or until the bonds
mature. This accrued income from both deferred interest and pay-in-kind bonds
must be "distributed" to the insurance company shareholders each year,
whether or not such distributions are paid in cash. To the extent such
distributions are paid in cash, a Portfolio may be required to dispose of
portfolio securities that it otherwise would have continued to hold or to use
cash flows from other sources such as sales of Portfolio shares.
Lower-rated deferred interest and pay-in-kind bonds also share the special
credit risk considerations described under "Zero Coupon Bonds," above.
DERIVATIVES
As described in the individual Portfolio sections or the SAI, certain of the
Portfolios may use certain types of instruments, sometimes referred to as
"derivatives." Derivatives are used to help (a) manage risks relating to
interest rates, currency fluctuations and other market factors ("hedging");
(b) increase liquidity; and/or (c) invest in a particular stock or bond in a
more efficient or less expensive way. Derivatives are broadly defined as
financial instruments whose performance is derived, at least in part, from
the performance of an underlying asset, such as stock prices or indices of
securities, interest rates, currency exchange rates, or commodity prices.
Some, all, or the component parts of, the following instruments might be
considered derivatives or complex securities: adjustable rate mortgage
securities; adjustable rate securities; collateralized mortgage obligations;
convertible securities with enhanced yield features such as PERCS, ACES,
DECS, and PEPS; forward contracts; futures contracts; inverse floaters and
super floaters; mortgage pass-throughs, including multiclass pass-throughs,
stripped mortgage securities, and other asset-backed securities; options;
real estate mortgage investment conduits; re-securitized government project
loans; spreads and straddles; swaps; synthetic convertible securities; and
uncovered mortgage dollar rolls. These instruments and their risks are
discussed in this section, the individual Portfolio sections, and/or in the
SAI.
DIVERSIFICATION
Each Portfolio, except the Global Health Care Fund, Global Income Fund, and
the Value Fund will operate as a diversified portfolio under federal
securities law. Each diversified Portfolio 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 Portfolio's assets
would be invested in such issuer.
In addition, each Portfolio intends to diversify its investments to meet the
requirements under federal tax laws relating to regulated investment
companies and variable contracts issued by insurance companies. In order to
comply with the diversification requirements related to regulated investment
companies, each Portfolio will limit its investments so that, at the close of
each quarter of the taxable year, (i) with respect to 50% of the market value
of its assets, not more than 5% of the market value of its assets will be
invested in the securities of a single issuer and each Portfolio will not own
more than 10% of the outstanding voting securities of a single issuer. A
Portfolio's investments in U.S. Government Securities are not subject to
these limitations, and (ii) not more than 25% of the market value of each
Portfolio's assets will be invested in the securities of a single issuer.
In order to comply with the diversification requirements related to variable
contracts issued by insurance companies, each Portfolio will diversify its
investments such that (i) no more than 55% of the Portfolio's assets is
represented by any one investment; (ii) no more than 70% of the Portfolio's
assets is represented by any two investments; (iii) no more than 80% of the
Portfolio's assets is represented by any three investments; and (iv) no more
than 90% of the Portfolio's assets is represented by any four investments. In
the case of Portfolios 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.
LOAN PARTICIPATIONS
Certain Portfolios may acquire loan participations and other direct or
indirect bank obligations ("Loan Participations"), in which a Portfolio will
purchase from a lender a portion of a larger loan which it has made to a
borrower. Generally Loan Participations are sold without guarantee or
recourse to the lending institution, and are subject to the credit risks of
both the borrower and the lending institution. They may, however, enable a
Portfolio to acquire an interest in a loan from a financially strong borrower
which it could not do directly. While Loan Participations generally trade at
par value, certain Portfolios may buy Loan Participations that sell at a
discount because of the borrower's credit problems. To the extent the
borrower's credit problems are resolved, Loan Participations may appreciate
in value. Loan Participations may have speculative characteristics, and may
be illiquid and/or in default.
LOANS OF PORTFOLIO SECURITIES
Consistent with procedures approved by the Board of Trustees and subject to
the following conditions, the Portfolios may lend their portfolio securities
to qualified securities dealers or other institutional investors, if such
loans do not exceed 30% of the value of a Portfolio's total assets at the
time of the most recent loan (one-third of the Portfolio's assets in the case
of the Asset Allocation, Developing Markets, Global Health Care,
International Equity, Mutual Discovery, Mutual Shares, Pacific, and Value
Funds). The borrower must deposit with the Portfolio's custodian bank
collateral with an initial market value of at least 102% of the market value
of the securities loaned, including any accrued interest, with the value of
the collateral and loaned securities marked-to-market daily to maintain
collateral coverage of at least 100%. This collateral shall consist of cash,
U.S. Government Securities, or irrevocable letters of credit. The lending of
securities is a common practice in the securities industry. A Portfolio may
engage in security loan arrangements with the primary objective of increasing
the Portfolio's income either through investing the cash collateral in
short-term interest bearing obligations or by receiving a loan premium from
the borrower. Under the securities loan agreement, a Portfolio continues to
be entitled to all dividends or interest on any loaned securities. As with
any extension of credit, there are risks of delay in recovery and loss of
rights in the collateral should the borrower of the security fail financially.
OPTIONS AND FUTURES CONTRACTS
Certain Portfolios may invest in options and futures contracts and any
limitations noted in this section are qualified by the Portfolios' individual
policies as stated in the individual descriptions of each of the Portfolios.
UNLESS OTHERWISE NOTED IN A PORTFOLIO'S POLICIES, THE VALUE OF THE UNDERLYING
SECURITIES ON WHICH OPTIONS MAY BE WRITTEN AT ANY ONE TIME WILL NOT EXCEED
15% OF THE ASSETS OF THE PORTFOLIO. NOR WILL A PORTFOLIO PURCHASE PUT OR CALL
OPTIONS IF THE AGGREGATE PREMIUMS PAID FOR SUCH OPTIONS WOULD EXCEED 5% OF
ITS ASSETS AT THE TIME OF PURCHASE.
UNLESS OTHERWISE NOTED IN A PORTFOLIO'S POLICIES, NONE OF THE PORTFOLIOS
PERMITTED TO INVEST IN THESE CONTRACTS WILL PURCHASE OR SELL FUTURES
CONTRACTS OR OPTIONS ON FUTURES CONTRACTS IF IMMEDIATELY THEREAFTER THE
AGGREGATE AMOUNT OF INITIAL MARGIN DEPOSITS ON ALL THE FUTURES POSITIONS OF
THE PORTFOLIO AND PREMIUMS PAID ON OPTIONS ON FUTURES CONTRACTS WOULD EXCEED
5% OF THE MARKET VALUE OF THE ASSETS OF THE PORTFOLIO. SEE THE "INVESTMENT
OBJECTIVES AND POLICIES" of the specific Portfolio and the SAI for a
discussion of whether, and to what extent, the Portfolio may purchase these
investments.
In general, a Portfolio will use futures and options primarily for hedging
purposes, that is, in an attempt to reduce or control certain types of risks.
There is no guarantee, however, that these transactions will be successful.
In addition, these transactions may expose a Portfolio to risks related to
counterparty creditworthiness, illiquidity, and increased expenses. A
detailed discussion of these transactions and their risks appears in the SAI.
None of the Portfolios currently expect to make significant use of these
transactions, except to manage currency risk. See "Highlighted Risk
Considerations, Foreign Transactions."
PORTFOLIO TURNOVER
Each Portfolio may purchase and sell securities without regard to the length
of time the security has been held, and the frequency of Portfolio
transactions (turnover rate) will vary from year to year, depending on market
conditions. Portfolio turnover could be greater in periods of unusual market
movement and volatility. The Managers will weigh the potential benefits of
any short-term trading against the higher transaction costs associated with a
higher turnover rate.
It is anticipated that each Portfolio's annual turnover rate generally will
not exceed 100% except for the Global Income Fund which may exceed 100%
per year. The Global Income Fund's turnover rate of 181.61% in 1997 was
primarily due to bond maturities, and the rebalancing of the portfolio to
keep interest rate risk and country allocations at desired levels.
Higher portfolio turnover rates generally increase transaction costs, which
are Portfolio expenses, but would not create capital gains for investors
because of the tax-deferred status of variable annuity and variable life
insurance investments. Portfolio turnover rates for recent years are shown in
the "Financial Highlights." More information is in the SAI.
REPURCHASE AND REVERSE REPURCHASE AGREEMENTS
EACH PORTFOLIO MAY ENGAGE IN REPURCHASE TRANSACTIONS, IN WHICH THE PORTFOLIO
PURCHASES A U.S. GOVERNMENT SECURITY SUBJECT TO RESALE TO A BANK OR DEALER AT
A MUTUALLY AGREED UPON PRICE AND DATE. In a repurchase agreement, the
Portfolio buys U.S. Government Securities from a bank or broker-dealer at a
higher price on a specified date. The securities subject to resale are held
on behalf of the Portfolio by a custodian bank approved by the Board of
Trustees. The bank or broker-dealer must transfer to the custodian securities
with an initial market value of at least 102% of the repurchase price to help
secure the obligation to repurchase the securities at a later date. The
securities are then marked-to-market daily to maintain coverage of at least
100%. If the bank or broker-dealer does not repurchase the securities as
agreed, the Portfolio may experience a loss or delay in the liquidation of
the securities underlying the repurchase agreement and may also incur
liquidation costs. The Portfolio, however, intends to enter into repurchase
agreements only with banks or broker-dealers that are considered creditworthy
by the Managers.
Certain Portfolios authorized to do so may also enter into reverse repurchase
agreements which may involve additional risks. See the SAI, "Common
Investment Methods and Risks."
RESTRICTED AND ILLIQUID SECURITIES
It is a fundamental policy of the Portfolios to not invest more than 10% of
their respective net assets in illiquid investments, except that the Global
Health Care, International Smaller Companies, Mutual Discovery, Mutual Shares
and Value Funds may invest up to 15% in such investments. Illiquid
investments include most repurchase agreements of more than seven days
duration, currency and interest rate swaps, time deposits with a notice or
demand period of more than seven days, certain over-the-counter option
contracts, participation interests in loans, securities that are not readily
marketable and "restricted securities," i.e., securities that are not
registered or are offered in an exempt non-public offering under the
Securities Act of 1933 ("1933 Act"). Such restriction shall not apply to
restricted securities offered and sold to "qualified institutional buyers"
under Rule 144A under the 1933 Act or to foreign securities which are offered
or sold outside the United States where the Managers determine, based upon a
continuing review of the trading markets for the specific restricted
security, that such restricted securities are liquid. For additional details,
see the SAI.
The Board of Trustees has adopted guidelines and delegated to the Managers
the daily function of determining and monitoring the liquidity of restricted
securities. The Board of Trustees, however, will retain sufficient oversight
and be ultimately responsible for the determinations. To the extent a
Portfolio invests in restricted securities that are deemed liquid, the
general level of illiquidity in a Portfolio may be increased if qualified
institutional buyers become uninterested in purchasing these securities or
the market for these securities contracts.
The purchase price and subsequent valuation of restricted securities normally
reflect a discount from the price at which such securities would trade if
they were not restricted, since the restriction makes them less liquid. The
amount of the discount from the prevailing market prices is expected to vary,
depending upon the type of security, the character of the issuer, the party
who will bear the expenses of registering the restricted securities and
prevailing supply and demand conditions.
"ROLLS"
Portfolios that may purchase Treasury securities may also enter into "U.S.
Treasury rolls" in which the Portfolio sells outstanding U.S. Treasury
securities and buys back "when-issued" U.S. Treasury securities of slightly
longer maturity for simultaneous settlement on the settlement date of the
when-issued U.S. Treasury security. During the period prior to settlement
date, the Portfolio continues to earn interest on the securities it is
selling. It does not earn interest on the securities which it is purchasing
until after the settlement date. Two potential advantages of such a strategy
are 1) that the Portfolio can regularly and incrementally adjust its weighted
average maturity (which otherwise would constantly diminish with the passage
of time); and 2) in a normal yield curve environment (in which shorter
maturities yield less than longer maturities), a gain in yield to maturity
can be obtained along with the desired extension. The Portfolio could suffer
an opportunity loss if the counterparty to the roll failed to perform its
obligations on settlement date, in that market conditions may have changed
adversely. The Portfolio, however, intends to enter into U.S. Treasury rolls
only with government securities dealers recognized by the Federal Reserve
Board or with member banks of the Federal Reserve System.
Portfolios that may purchase mortgage-backed securities may enter into
mortgage "dollar rolls"in which the Portfolio sells mortgage-backed
securities for delivery in the current month and simultaneously contracts to
repurchase substantially similar (name, type, coupon and maturity) securities
on a specified future date. During the roll period, the Portfolio forgoes
principal and interest paid on the mortgage-backed securities. The Portfolio
is compensated by the difference between the current sales price and the
lower forward price for the future purchase (often referred to as the "drop")
as well as by the interest earned on the cash proceeds of the initial sale. A
"covered roll" is a specific type of dollar roll for which there is an
offsetting cash position or a cash equivalent security position which matures
on or before the forward settlement date of the dollar roll transaction and
is maintained in a segregated account. A Portfolio will not enter into any
dollar rolls that are not covered rolls.
SMALL CAPITALIZATION ISSUERS
Certain Portfolios may invest in relatively new or unseasoned companies which
are in their early stages of development, or small companies positioned in
new and emerging industries where the opportunity for rapid growth is
expected to be above average. These are typically companies which have a
market capitalization of less than $1 billion. Investing in securities of
small companies may offer greater potential for capital appreciation since
they are often overlooked by investors or undervalued in relation to their
earnings power. Securities of unseasoned companies may present greater risks
than securities of larger, more established companies. Small companies may
suffer significant losses as well as realize substantial growth, and
investments in such companies tend to be more volatile and are therefore
speculative.
Historically, the small capitalization stocks have been more volatile in
price than the larger capitalization stocks. Among the reasons for the
greater price volatility of these securities are the less certain growth
prospects of smaller firms, the lower degree of liquidity in the markets for
such stocks, and the greater sensitivity of small companies to changing
economic conditions. Besides exhibiting greater volatility, small company
stocks may, to a degree, fluctuate independently of larger company stocks.
Small company stocks may decline in price as large company stocks rise, or
rise in price as large company stocks decline. Investors should therefore
expect that the net asset value of a portfolio which invests a substantial
portion of its net assets in small company stocks may be more volatile than
the shares of a portfolio that invests solely in larger capitalization
stocks. For more information, refer to the "Small Cap Fund" description.
STRUCTURED NOTES
A structured note is a derivative instrument which entitles its holder to
receive some portion of the principal or interest payments which would be due
on a traditional debt obligation. A zero coupon bond, which is the right to
receive only the principal portion of a debt security, is a simple form of
structured note. A structured note's performance or value may be linked to a
change in return, interest rate, or value at maturity of the change in an
identified or "linked" equity security, currency, interest rate, index or
other financial indicator ("benchmark"). The holder's right to receive
principal or interest payments on a structured note may also vary in timing
or amount, depending upon changes in certain rates of interest or other
external events. Structured notes may be much more volatile than the
underlying instruments themselves, depending on the direction of interest
rates, and may present many of the same risks as investing in futures and
options. Certain structured notes without leverage characteristics may still
be considered risky and an investor could lose an amount equal to the amount
invested. As with any debt instruments, structured notes pose credit risk,
i.e., the issuer may be unable to make the required payments. Finally, some
structured notes may be illiquid, because few investors or dealers trade in
such securities or because the notes are complex and difficult to price. Such
potential illiquidity may be especially pronounced during severe bond market
corrections. The Board of Trustees will monitor the liquidity of structured
notes and notes determined to be illiquid will be subject to a Portfolio's
percentage limits on illiquid securities. If permitted by a Portfolio's
investment policies, the Templeton Managers may occasionally invest under 5%
of their respective Portfolio's assets in structured notes that are linked to
a benchmark, on a non-leveraged, one-to-one basis.
TEMPORARY INVESTMENTS
In any period of market weakness or of uncertain market or economic
conditions or while awaiting suitable investment opportunities, a Portfolio
(other than the Money Fund) may establish a temporary defensive position.
Such Portfolios may therefore invest up to 100% of their respective net
assets in high quality Money Market Instruments or in, for example, U.S.
Government Securities, bank obligations, and the highest quality commercial
paper, as described above. The Rising Dividends Fund may also invest in
short-term fixed-income securities. Any decision to make a substantial
withdrawal for a sustained period of time, from a Portfolio's "defined"
market(s) based on its investment objectives will be reviewed by the Board of
Trustees.
The Asset Allocation, Developing Markets, Global Health Care, Global Income,
Global Growth, Global Utility, International Equity, International Smaller
Companies, Mutual Discovery, Mutual Shares, and Pacific Funds may also invest
in non-U.S. currency and short-term instruments denominated in non-U.S.
currencies for temporary defensive purposes. The Developing Markets and
International Smaller Companies Funds may also invest in medium-term (not
more than five years to maturity) obligations issued or guaranteed by the
U.S. government or the governments of foreign countries, their agencies or
instrumentalities.
It is not possible to predict with any certainty when or for how long a
Portfolio will employ defensive strategies.
TRADE CLAIMS
Trade claims are purchased from creditors of companies in financial
difficulty. For purchasers such as a Portfolio, trade claims offer the
potential for profits since they are often purchased at a significantly
discounted value and, consequently, may generate capital appreciation if the
value of the claim increases as the debtor's financial position improves.
If the debtor is able to pay the full obligation on the face of the claim as
a result of a restructuring or an improvement in the debtor's financial
condition, trade claims offer the potential for higher income due to the
difference in the face value of the claim as compared to the discounted
purchase price.
An investment in trade claims is speculative and carries a high degree of
risk. There can be no guarantee that the debt issuer will ever be able to
satisfy the obligation on the trade claim. Trade claims are not regulated by
federal securities laws or the SEC. Currently, trade claims are regulated
primarily by bankruptcy laws. Because trade claims are unsecured, holders may
have a lower priority in terms of payment than most other creditors in a
bankruptcy proceeding.
WARRANTS
A warrant is typically a long-term option issued by a corporation which gives
the holder the privilege of buying a specified number of shares of the
underlying common stock at a specified exercise price at any time on or
before an expiration date.
Stock index warrants entitle the holder to receive, upon exercise, an amount
in cash determined by reference to fluctuations in the level of a specified
stock index. If a Portfolio does not exercise or dispose of a warrant prior
to its expiration, it will expire worthless.
"WHEN-ISSUED" AND "DELAYED DELIVERY" TRANSACTIONS
A Portfolio may purchase securities and debt obligations on a "when-issued"
or "delayed delivery" basis (in the case of GNMA Certificates, a
"To-Be-Announced" basis). Such securities are subject to market fluctuations
prior to delivery to the Portfolio and generally do not earn interest until
their scheduled delivery date. When the Portfolio is the buyer in such
transactions, it will segregate cash or liquid securities, having an
aggregate value equal to the amount of such purchase commitments until
payment is made. To the extent the Portfolio engages in when-issued and
delayed delivery transactions, it will do so only for the purpose of
acquiring portfolio securities consistent with the Portfolio's investment
objectives and policies, and not for the purpose of investment leverage.
Nonetheless, purchases of securities on such basis may involve more risk than
other types of purchases, for example, counterparty delivery risk. If the
seller fails to complete the transaction, the Portfolio may miss a price or
yield considered advantageous. See the SAI for additional information.
YEAR 2000
WHEN EVALUATING CURRENT AND POTENTIAL PORTFOLIO POSITIONS, YEAR 2000 IS ONLY
ONE OF THE FACTORS THE PORTFOLIOS MANAGERS CONSIDER.
THE MANAGERS WILL RELY UPON PUBLIC FILINGS AND OTHER STATEMENTS MADE BY
COMPANIES ABOUT THEIR YEAR 2000 READINESS. ISSUERS IN COUNTRIES OUTSIDE THE
U.S., PARTICULARLY IN EMERGING MARKETS, MAY NOT BE REQUIRED TO MAKE THE SAME
LEVEL OF DISCLOSURE ABOUT YEAR 2000 READINESS AS IS REQUIRED IN THE U.S. THE
MANAGERS, OF COURSE, CANNOT AUDIT EACH COMPANY AND ITS MAJOR SUPPLIERS TO
VERIFY THEIR YEAR 2000 READINESS.
If a company in which a Portfolio is invested is adversely affected by Year
2000 problems, it is likely that the price of its security will also be
adversely affected. A decrease in the value of one or more of a Portfolio's
holdings will have a similar impact on the price of the Portfolio's shares.
Please see "Year 2000 Problem" under "Management" for more information.
INVESTMENT RESTRICTIONS
Each Portfolio is subject to a number of additional investment restrictions,
some of which are fundamental policies and, like the investment objective of
each Portfolio, may be changed only with the approval of shareholders. For a
list of these additional restrictions and more information concerning the
policies discussed above, please see the SAI.
MANAGEMENT
TRUSTEES AND OFFICERS
The Board. The Trust's Board of Trustees (the "Board") oversees the
management of the Trust and elects its officers. The officers are responsible
for each Portfolio's day-to-day operations.
MANAGERS
The Manager for all Portfolios of the Trust, except the Asset Allocation,
Developing Markets, Global Growth, International Smaller Companies, Mutual
Discovery, Mutual Shares, Rising Dividends and Value Funds, is Franklin
Advisers, Inc. ("Advisers"), 777 Mariners Island Blvd., P.O. Box 7777, San
Mateo, California 94403-7777. In addition, Advisers employs Templeton
Investment Counsel, Inc. ("Templeton Florida"), Broward Financial Centre,
Suite 2100, Fort Lauderdale, Florida 33394, to act as subadviser to the
International Equity Fund, the Pacific Fund, and the Global Income Fund.
Franklin Advisory Services, Inc., One Parker Plaza, Sixteenth Floor, Fort
Lee, New Jersey, 07024 ("Franklin New Jersey") replaced Advisers as the
Manager for the Rising Dividends Fund on July 1, 1996, and also is the
Manager for the Value Fund. Advisers and Franklin New Jersey are both direct
wholly owned subsidiaries of Franklin Resources, Inc. There is no change in
the individuals primarily responsible for the day-to-day operations of the
Portfolio, and the material terms of the Portfolio's management agreement
with Franklin New Jersey, including fees, are the same as those of the prior
management agreement with Advisers.
The Manager for the Mutual Discovery and the Mutual Shares Funds is Franklin
Mutual Advisers, Inc. ("Franklin Mutual") 51 John F. Kennedy Parkway, Short
Hills, New Jersey, 07078. Michael F. Price is Chairman of the Board of
Directors of Franklin Mutual.
The Manager for the Asset Allocation and Global Growth Funds is Templeton
Global Advisors Limited ("Templeton Nassau") Lyford Cay Nassau, N. P.
Bahamas. Templeton Nassau employs Templeton Florida to act as subadviser to
the Asset Allocation Fund.
The Manager for the Developing Markets Fund is Templeton Asset Management
Ltd. ("Templeton Singapore") 7 Temasek Boulevard, #38-03, Suntec Tower One,
Singapore, 038987.
The Manager for the International Smaller Companies Fund is Templeton Florida.
Advisers, Franklin Mutual, Franklin New Jersey, Templeton Nassau, Templeton
Singapore, and Templeton Florida may be referred to as the "Manager" or
"Managers" throughout this prospectus and the SAI. The Managers also perform
similar services for other portfolios. The Managers are wholly owned by
Resources, a publicly owned company engaged in the financial services
industry through its subsidiaries. Charles B. Johnson and Rupert H. Johnson,
Jr. are the principal shareholders of Resources. Together the Managers and
their affiliates manage over $216 billion in assets. The Templeton
organization has been investing globally since 1940, with offices in
Argentina, Australia, Bahamas, Canada, France, Germany, Hong Kong, India,
Italy, Luxembourg, Poland, Russia, Scotland, Singapore, South Africa, U.S.,
and Vietnam. Please see "Investment Management and Other Services," "Policies
Regarding Brokers Used on Securities Transactions" and "Miscellaneous
Information" in the SAI for information on securities transactions and a
summary of the Trust's Code of Ethics.
MANAGEMENT SERVICES AND FEES. The Managers manage each Portfolio's assets and
make each Portfolio's investment decisions. Each Portfolio is obligated to
pay a management fee for these services. Portfolio Administration fees may be
paid directly by the Portfolio or indirectly by the Managers through the
management fees. See "Portfolio Administrator," below.
During the fiscal year ended December 31, 1997, the management and Portfolio
administration fees and total operating expenses, as a percentage of monthly
net assets and before any advance waiver, for each Portfolio which operated
throughout 1997+ were as follows:
1997
MANAGEMENT
AND PORTFOLIO 1997 TOTAL
ADMINISTRATION OPERATING
PORTFOLIO (EXCEPT NEW PORTFOLIOS) FEES EXPENSES
Asset Allocation Fund .80%* .94%
Capital Growth Fund .75% .77%
Developing Markets Fund 1.25% 1.42%
Global Growth Fund .83% .88%
Global Income Fund .56% .62%
Global Utility Fund
(formerly Utility Fund) .47% .50%
Government Fund .48% .50%
Growth and Income Fund .47% .49%
High Income Fund .50% .53%
Income Securities Fund .47% .50%
International Smaller
Companies Fund 1.00%* 1.06%
International Equity Fund .80% .89%
Natural Resources Fund
(formerly Metals Fund) .62% .69%
Money Fund* .51% .53%
Mutual Shares Fund .75%* .80%
Mutual Discovery Fund .95%* 1.06%
Pacific Fund .92% 1.03%
Real Estate Fund .51% .54%
Rising Dividends Fund .72% .74%
Small Cap Fund .75% .77%
+Since Class 2 shares are new, 1997 figures reflect expenses of Class 1
shares only. Class 2 shares have a Rule 12b-1 plan, which increases expenses.
See "Purchase, Redemption and Exchange of Shares."
*Includes a 0.15% Administration fee which is a direct expense of the
Portfolio.
The Global Health Care Fund is obligated to pay Advisers a monthly fee
computed at the annual rate of 0.60% of the Portfolio's average daily net
assets up to and including $200 million, plus 0.50% of the value of average
daily net assets over $200 million up to and including $1.3 billion, plus
0.40% of the value of average daily net assets over $1.3 billion. Under a
management agreement with Franklin New Jersey, the Value Fund is obligated to
pay the Manager a monthly fee equal to an annual rate of 0.60% of the value
of the Portfolio's average daily net assets up to and including $200 million,
0.50% of the value of the Portfolio's average daily net assets over $200
million up to and including $1.3 billion, and 0.40% of the value of the
Portfolio's average daily net assets over $1.3 billion. The Global Health
Care and Value Funds' management fees do not cover portfolio administration;
these Portfolios pay separate portfolio administration fees. See "Portfolio
Administrator" below.
In general, the fees which the Portfolios investing substantially in global
securities are obligated to pay the Managers are higher than advisory fees
paid by most other U.S. investment companies, primarily because investing in
equity securities of companies outside the U.S., and especially in developing
markets countries which are not widely followed by professional analysts,
requires the Managers to invest additional time and incur added expense in
developing specialized resources, including research sources.
Please refer to the SAI for further details regarding management fees.
SUBADVISOR. Templeton Florida is paid a fee by Advisers with respect to the
Global Income, International and Pacific Funds, and by Templeton Nassau with
respect to the Asset Allocation Fund, based on a percentage of each
Portfolio's average daily net assets. In all cases, Templeton Florida's fees
are not a separate expense of the respective Portfolios but are paid by the
Managers from the management fees they receive from their respective
management agreements with the Portfolios. Templeton Florida will pay all
expenses incurred by it in connection with its activities under the
subadvisory agreements with the Managers, other than the cost of securities
purchased for the Portfolios and brokerage commissions in connection with
such purchases.
PORTFOLIO TRANSACTIONS. Each Manager tries to obtain the best execution on
all transactions. If a Manager believes more than one broker or dealer can
provide the best execution, consistent with internal policies it may consider
research and related services and the sale of Portfolio shares, as well as
shares of other portfolios in the Franklin Templeton Group of Funds, when
selecting a broker or dealer. Please see "Brokerage Allocation" in the SAI
for more information.
YEAR 2000 PROBLEM. The Portfolios' business operations depend on a worldwide
network of computer systems that contain date fields, including securities
trading systems, securities transfer agent operations and stock market links.
Many of the systems currently use a two digit date field to represent the
date, and unless these systems are changed or modified, they may not be able
to distinguish the Year 1900 from the Year 2000 (commonly referred to as the
Year 2000 problem). In addition, the fact that the Year 2000 is a
non-standard leap year may create difficulties for some systems.
When the Year 2000 arrives, the Portfolios' operations could be adversely
affected if the computer systems used by the Managers, their service
providers and other third parties they does business with are not Year 2000
ready. For example, the Portfolios' portfolio holdings and operational areas
could be impacted, including securities trade processing, interest and
dividend payments, securities pricing, shareholder account services,
reporting, custody functions and others. The Portfolios could experience
difficulties in effecting transactions if any of their foreign subcustodians,
or if foreign broker-dealers or foreign markets are not ready for Year 2000.
The Managers and their affiliated service providers are making a concerted
effort to take steps they believe are reasonably designed to address their
Year 2000 problems. Of course, the Portfolios' ability to reduce the effects
of the Year 2000 problem is also very much dependent upon the efforts of
third parties over which the Portfolios and their Managers may have no
control.
PORTFOLIO ADMINISTRATOR
Franklin Templeton Services, Inc. ("FT Services"), 777 Mariners Island
Boulevard, San Mateo, California 94404, provides certain administrative
facilities and services for the Portfolios, including preparation and
maintenance of books and records, preparation of tax reports, preparation of
financial reports, and monitoring compliance with regulatory requirements.
FT Services is employed directly by the Asset Allocation, Global Health Care,
International Smaller Companies, Mutual Discovery, Mutual Shares and Value
Funds, and through subcontracts by the Managers of all the other Portfolios.
Where FT Services is employed directly by a Portfolio, it receives a monthly
fee equivalent on an annual basis to 0.15% of the average daily net assets of
the Portfolio, reduced to 0.135% of such assets in excess of $200 million, to
0.10% of such assets in excess of $700 million, and to 0.075% of such assets
in excess of $1.2 billion. Where it is employed through a subcontract with
the Manager, the same fees schedule applies; however, its fees are not
separate expenses of the Portfolio but are paid by the Manager from the
management fees received from the Portfolio.
Operating Expenses. Each Portfolio pays its own operating expenses. These
expenses include, but may not be limited to: the Managers' management fees;
Portfolio administration fees where they are separate from the management
fee; taxes, if any; custodian, legal, and auditing fees; the fees and
expenses of trustees who are not members of, affiliated with or interested
persons of the Managers; salaries of any personnel not affiliated with the
Managers; insurance premiums; trade association dues; expenses of obtaining
quotations for calculating the value of the Portfolio's net assets; printing
and other expenses which are not expressly assumed by the Managers. Expenses
incurred jointly by more than one Portfolio will be apportioned on a pro rata
basis.
PORTFOLIO OPERATIONS
The following persons are primarily responsible for the day-to-day management
of each Portfolio, other than the Money Fund.
CAPITAL GROWTH FUND
Conrad B. Herrmann
Kevin Carrington
Vivian J. Palmieri
GLOBAL HEALTH CARE SECURITIES FUND
Kurt von Emster
Evan McCulloch
Rupert H. Johnson, Jr.
GLOBAL UTILITIES SECURITIES FUND
(FORMERLY UTILITY EQUITY FUND)
Sally Edwards-Haff
Ian Link
GROWTH AND INCOME FUND
Frank Felicelli
Kent Shepherd
HIGH INCOME FUND
Jeff Holbrook
Chris Molumphy
R. Martin Wiskemann
INCOME SECURITIES FUND
Charles B. Johnson
Matthew F. Avery
Frederick G. Fromm
MUTUAL DISCOVERY SECURITIES FUND
Peter A. Langerman
Robert L. Friedman
David E. Marcus
MUTUAL SHARES SECURITIES FUND
Peter A. Langerman
Robert L. Friedman
Lawrence N. Sondike
David E. Marcus
NATURAL RESOURCES SECURITIES FUND
(FORMERLY PRECIOUS METALS FUND)
Suzanne Willoughby Killea
Ed Perks
REAL ESTATE SECURITIES FUND
Matthew F. Avery
Douglas Barton
RISING DIVIDENDS FUND
Donald G. Taylor
William Lippman
Bruce C. Baughman
Gerard P. Sullivan
Margaret McGee
SMALL CAP FUND
Edward B. Jamieson
Michael McCarthy
Aidan O'Connell
TEMPLETON DEVELOPING MARKETS EQUITY FUND
J. Mark Mobius, Ph.D.
H. Allan Lam
Tom Wu
Dennis Lim
Eddie Chow
Tek-Khoan Ong
TEMPLETON GLOBAL ASSET ALLOCATION FUND
Dale Winner
Thomas J. Dickson
Jeffrey A. Everett
Sean Farrington
TEMPLETON GLOBAL GROWTH FUND
Sean Farrington
Jeffrey A. Everett
Mark G. Holowesko
TEMPLETON GLOBAL INCOME SECURITIES FUND
Thomas J. Dickson
Neil S. Devlin
TEMPLETON INTERNATIONAL EQUITY FUND
Howard J. Leonard
Mark Beveridge
William Howard
TEMPLETON INTERNATIONAL
SMALLER COMPANIES FUND
Simon Rudolph
Peter Nori
Juan J. Benito
TEMPLETON PACIFIC GROWTH FUND
William T. Howard
Mark Beveridge
Gary Clemons
U.S. GOVERNMENT SECURITIES FUND
Jack Lemein
David Capurro
Roger Bayston
Tony Coffey
VALUE SECURITIES FUND
William Lippman
Gerard P. Sullivan
Bruce C. Baughman
Margaret McGee
BIOGRAPHICAL INFORMATION
Matthew F. Avery
Senior Vice President
Franklin Advisers, Inc.
Mr. Avery holds a Master of Business Administration degree from the
University of California at Los Angeles. He earned his Bachelor of Science
degree in Industrial Engineering from Stanford University. He has been in the
securities industry since 1982 and with the Franklin Templeton Group since
1987. Mr. Avery has managed the Income Securities Fund and the Real Estate
Fund from inception.
Douglas Barton
Vice President
Franklin Advisers, Inc.
Mr. Barton is a Chartered Financial Analyst and holds a Master of Business
Administration degree from California State University in Hayward and a
Bachelor of Science degree from California State University in Chico. Mr.
Barton has been with the Franklin Templeton Group since July 1988 and has
managed the Real Estate Fund since May 1998.
Bruce C. Baughman
Senior Vice President
Franklin Advisory Services, Inc.
Mr. Baughman holds a Master of Science degree in Accounting from New York
University. He earned his Bachelor of Arts degree from Stanford University.
Mr. Baughman has been with the Franklin Templeton Group since 1988. He has
managed the Rising Dividends Fund and the Value Fund from inception.
Roger Bayston
Portfolio Manager
Franklin Advisers, Inc.
Mr. Bayston is a Chartered Financial Analyst and holds a Master of Business
Administration degree from the University of California at Los Angeles. He
earned his Bachelor of Science degree from the University of Virginia. Mr.
Bayston has been with the Franklin Templeton Group since 1991. Mr. Bayston
has managed the Government Fund since 1993.
Juan J. Benito
Portfolio Manager
Templeton Investment Counsel, Inc.
Mr. Benito holds a Master of Business Administration degree from the Harvard
Business School. He earned his MS/BS in Engineering from the Polytechnical
University of Valencia, Spain. Before joining the Franklin Templeton Group in
1996, Mr. Benito was a management consultant and case team leader with
Monitor Company, a leading global strategy consulting firm in Cambridge,
Massachusetts. Mr. Benito has managed the International Smaller Companies
Fund since 1997.
Mark R. Beveridge
Senior Vice President
Templeton Investment Counsel Inc.
Mr. Beveridge is a Chartered Financial Analyst and holds a Bachelor of
Business Administration degree in Finance from the University of Miami. He
has been with the Franklin Templeton Group since 1985 and has managed the
International Equity and Pacific Funds since 1994, and the International
Smaller Companies Fund from inception.
David Capurro
Vice President
Franklin Advisers, Inc.
Mr. Capurro holds a Master of Business Administration degree in Finance from
California State University at Hayward. He earned his Bachelor of Science
degree in business administration at California State University at Hayward.
Mr. Capurro has been with the Franklin Templeton Group since 1983 and has
managed the Government Fund from inception.
Kevin Carrington
Portfolio Manager
Franklin Advisers, Inc.
Mr. Carrington is a Chartered Financial Analyst and holds a Bachelor of
Science degree in Business Administration from California State University at
Chico. He has been with the Franklin Templeton Group since 1992 and has
managed the Capital Growth Fund from inception.
Eddie Chow
Investment Analyst
Templeton Asset Management Ltd.
Mr. Chow holds a Master of Business Administration degree from the University
of Wisconsin-Milwaukee. Before joining the Franklin Templeton Group in 1994,
he worked for many years in the finance and banking industry. He has managed
the Developing Markets Fund since 1996.
Gary Clemons
Senior Vice President
Templeton Investment Counsel Inc.
Mr. Clemons holds a Master of Business Administration degree from the
University of Wisconsin at Madison. He earned his Bachelor of Science degree
in Earth Science from the University of Nevada
at Reno. Mr. Clemons was a research analyst for Structured Asset Management.
He has been with the Franklin Templeton Group since 1990 and has managed the
Pacific Fund since 1994.
T. Anthony Coffey
Portfolio Manager
Franklin Advisers, Inc.
Mr. Coffey is a Chartered Financial Analyst and holds a Master of Business
Administration degree from the University of California at Los Angeles.
He earned his Bachelor of Arts degree from Harvard University. Prior to
joining Franklin, Mr. Coffey
was an associate with the Analysis Group. He is a member of several
securities industry committees and associations and has been with the
Franklin Templeton Group since 1989. He has managed the Government Fund since
1996.
Neil S. Devlin
Chief Investment Officer and
Executive Vice President
of Templeton Global Bond Managers,
a division of Templeton
Investment Counsel Inc.
Mr. Devlin holds a Bachelor of Arts degree in Economics and Philosophy from
Brandeis University and is a Chartered Financial Analyst. Before joining the
Franklin Templeton Group in 1987, Mr. Devlin was a portfolio manager and a
bond analyst with Constitutional Capital Management of Boston and a bond
trader and research analyst for the Bank of New England. He has managed the
Global Income Fund since 1993.
Thomas J. Dickson
Portfolio Manager
Templeton Investment Counsel, Inc.
Mr. Dickson received his Bachelor of Science degree in Managerial Economics
from the University of California at Davis. Mr. Dickson joined the Franklin
Templeton Group in 1992. He has managed the Global Income Fund since 1994,
and the bond portion of the Asset Allocation Fund from inception.
Jeffrey A. Everett
Executive Vice President
Templeton Global Advisors Limited
Mr. Everett is a Chartered Financial Analyst and holds a Bachelor of Science
degree in Finance from Pennsylvania State University. Prior to joining
Templeton, he was an Investment Officer at First Pennsylvania Corporation and
a research coordinator for Centre Square Investment Group. He has been with
the Franklin Templeton Group since 1990 and has managed the Global Growth
Fund and the equity portion of the Asset Allocation Fund from inception.
Sally Edwards-Haff
Senior Vice President
Franklin Advisers, Inc.
Ms. Edwards-Haff is a Chartered Financial Analyst and holds a Bachelor of
Arts degree in Economics from the University of California at Santa Barbara.
Ms. Edwards-Haff is a member of several securities industry committees and
associations. She has been with the Franklin Templeton Group since 1986 and
has managed the Global Utility Fund (formerly the "Utility Fund") since 1990.
Sean Farrington
Vice President
Templeton Global Advisors Limited
Mr. Farrington, a Chartered Financial Analyst, has a Bachelor of Arts degree
in Economics from Harvard University. He is a member of a securities
association. He has been with the Templeton organization since 1991. He has
managed the Global Growth Fund since 1995, and the equity portion of the
Asset Allocation Fund from inception.
Frank Felicelli, CFA
Senior Vice President
Franklin Advisers, Inc.
Mr. Felicelli, a Chartered Financial Analyst, has a Master in Business
Administration from Golden Gate University and a Bachelor of Arts degree in
Economics from the University of Illinois. He is a member of several
securities industry-related committees and associations. Mr. Felicelli has
been in the industry since 1980 and with the Franklin Templeton Group since
1986. He has managed the Growth and Income Fund since 1995.
Robert L. Friedman
Chief Investment Officer
and Senior Vice President
Franklin Mutual Advisers, Inc.
Mr. Friedman has a Bachelor of Arts degree in Humanities from the John
Hopkins University and a Masters in Business Administration from the Wharton
School, University of Pennsylvania. Before November 1996, Mr. Friedman was a
research analyst for Heine Securities Corporation, the predecessor of
Franklin Mutual. He has been with the Franklin Templeton Group since November
1996 and has managed the Mutual Discovery Fund and Mutual Shares Fund from
inception.
Frederick G. Fromm
Vice President
Franklin Advisers, Inc.
Mr. Fromm holds a Bachelor of Arts degree in Business Economics from the
University of California, Santa Barbara. He has been with the Franklin
Templeton Group since 1992 and has managed the Income Securities Fund since
January 1998.
Conrad B. Herrmann, CFA
Vice President
Franklin Advisers, Inc.
Mr. Herrmann holds a Master of Business Administration degree from Harvard
University and a Bachelor of Arts degree from Brown University. Mr. Herrmann,
a Chartered Financial Analyst, has been with the Franklin Templeton Group
since 1989. He has managed the Capital Growth Fund from inception.
Jeff Holbrook
Portfolio Manager
Franklin Advisers, Inc.
Mr. Holbrook is a Chartered Financial Analyst and holds a Master of Business
Administration degree
in Finance from University of Chicago and a Bachelor of Science degree from
Brigham Young University. Mr. Holbrook has been with the Franklin Templeton
Group since July 1992. Mr. Holbrook is a member of several securities
industry-related associations. He has managed the High Income Fund since 1997.
Mark G. Holowesko
Director of Global Equity Research
Templeton Worldwide, Inc. and
President
Templeton Global Advisors Limited.
Mr. Holowesko is a Chartered Financial Analyst and Chartered Investment
Counselor. He holds a Master of Business Administration degree from Babson
College in Worcester, Massachusetts and a Bachelor of Arts degree in
Economics from the College of The Holy Cross, also in Worcester,
Massachusetts. He is a member of several securities industry associations.
Mr. Holowesko has been with the Franklin Templeton Group since 1985 and has
managed the Global Growth Fund from inception.
William T. Howard, Jr.
Senior Vice President
Templeton Investment Counsel, Inc.
Mr. Howard is a Chartered Financial Analyst and holds a Master of Business
Administration degree from Emory University. He earned his Bachelor of Arts
degree from Rhodes College. Before joining the Templeton Group in 1993, Mr.
Howard was the international portfolio manager and analyst with the State of
Tennessee Consolidated Retirement System. He has managed the Pacific Fund and
the Interntional Equity Fund since 1993.
Edward B. Jamieson
Executive Vice President
Franklin Advisers, Inc.
Mr. Jamieson holds a Masters degree in Accounting and Finance from the
University of Chicago Graduate School of Business and a Bachelor of Arts
degree from Bucknell University. He has been with the Franklin Templeton
Group since 1987 and has managed the Small Cap Fund from inception.
Charles B. Johnson
Chairman of the Board and Director
Franklin Advisers, Inc., Franklin Advisory Services
and Franklin Investment Advisory Services, Inc.
Mr. Johnson holds a Bachelor of Arts degree in Economics and Political
Science from Yale University. He has been with the Franklin Templeton Group
since 1957. Mr. Johnson is a member of several securities industry committees
and associations. He has managed the Income Securities Fund from inception.
Rupert H. Johnson, Jr.
President
Franklin Advisers, Inc.
Senior Vice President
Franklin Advisory Services and Franklin Investment Advisory Services, Inc.
Mr. Johnson is a graduate of Washington and Lee University. He has been with
the Franklin Templeton Group since 1965 and prior thereto was an officer with
the U.S. Marine Corps. Mr. Johnson has managed the Global Health Care
Securities Fund from inception.
Suzanne Willoughby Killea
Vice President
Franklin Advisers, Inc.
Ms. Killea holds a Master of Business Administration degree from Stanford
University, and a Bachelor of Arts degree from Princeton University. Ms.
Killea has been with the Franklin Templeton Group since 1991. Ms. Killea has
managed the Natural Resources Fund since 1994.
H. Allan Lam
Vice President
Templeton Investment Management
(Hong Kong) Limited.
Mr. Lam holds a Bachelors of Arts degree in Accounting from Rutgers
University. He has had extensive auditing experience with Deloitte Touche &
Tohmatsu and KPMG Peat Marwick. He has been with the Franklin Templeton Group
since 1987 and has managed the Developing Markets Fund from inception.
Peter A. Langerman
Senior Vice President and
Chief Operating Officer
Franklin Mutual Advisers, Inc.
Mr. Langerman has a Bachelor of Arts degree from Yale University, a Masters
in Science from New York University Graduate School of Business and a Juris
Doctor from Stanford University Law School. Before November 1996, he was a
research analyst for Heine Securities Corporation, the predecessor of
Franklin Mutual. He has been with the Franklin Templeton Group since November
1996 and has managed the Mutual Discovery Fund and the Mutual Shares Fund
from inception.
Jack Lemein
Executive Vice President
Franklin Advisers, Inc.
Mr. Lemein holds a Bachelor of Science degree in Finance from the University
of Illinois. Mr. Lemein has been in the securities industry since 1967. He is
a member of several securities industry-related committees and associations.
Mr. Lemein has been with the Franklin Templeton Group since 1984 and has
managed the Government Fund from inception.
Howard J. Leonard
Executive Vice President
Templeton Investment Counsel, Inc.
Mr. Leonard is a Chartered Financial Analyst and holds a bachelor of business
administration degree in Finance and Economics from Temple University. Before
joining the Franklin Templeton organization in 1989, Mr. Leonard was director
of investment research at First Pennsylvania Bank. Mr. Leonard has managed
the International Equity Fund since 1997.
Dennis Lim
Vice President
Templeton Asset Management Ltd.
Mr. Lim holds a Master of Science degree in Management (Finance Analysis),
from the University of Wisconsin-Milwaukee, (Beta Gamma Sigma, Delta Chapter
of Wisconsin). He earned a Bachelor of Science degree in Building Engineering
from the National University of Singapore. Prior to joining the Franklin
Templeton Group, in 1990, he worked for the Government of Singapore's
Ministry of National Development. He has managed the Developing Markets Fund
since 1996.
Ian Link
Vice President
Franklin Advisers, Inc.
Mr. Link is a Chartered Financial Analyst and holds a Bachelor of Arts degree
in Economics from the University of California at Davis. He is a member of
several securities industry-related committees and associations. Mr. Link has
been with the Franklin Templeton Group since 1989, and has managed the Global
Utility Fund (formerly the Utility Fund) since March 1995.
William Lippman
President
Franklin Advisory Services, Inc.
Mr. Lippman holds a Master of Business Administration degree from the
Graduate School of Business Administration of New York University. He earned
his Bachelor of Science degree in Business Administration from City College
New York. Mr. Lippman has been in the securities industry for over 30 years
and with the Franklin Templeton Group since 1988. He has managed the Rising
Dividends Fund and the Value Fund from inception.
David E. Marcus
Senior Vice President
Franklin Mutual Advisers, Inc.
Mr. Marcus holds a Bachelor of Science in Business Administration/Finance
from Northeastern University. Before November 1996, he was a research analyst
for Heine Securities Corporation, the predecessor of Franklin Mutual. He has
been with the Franklin Templeton Group since November 1996 and has managed
the Mutual Discovery Fund and the Mutual Shares Fund since March 1998.
Michael McCarthy
Vice President
Franklin Advisers, Inc.
Mr. McCarthy holds a Bachelor of Arts degree in History from the University
of California at Los Angeles. He has been with the Franklin Templeton Group
since 1992 and has managed the Small Cap Fund from inception.
Evan McCulloch
Vice President
Franklin Advisers, Inc.
Mr. McCulloch holds a Bachelor of Science degree in Economics from the
University of California at Berkeley. He has been with the Franklin Templeton
Group since 1992. Mr. McCulloch has managed the Global Health Care Fund from
inception.
Margaret McGee
Vice President
Franklin Advisory Services, Inc.
Ms. McGee holds a Bachelor of Arts degree from William Paterson College. She
has been in the securities industry since 1985 and with the Franklin
Templeton Group since 1988. She has managed the Rising Dividends Fund and the
Value Fund from inception.
J. Mark Mobius, Ph.D.
Managing Director and Portfolio Manager
Templeton Asset Management Ltd.
Dr. Mobius holds a Doctor of Philosophy degree in Economics and Political
Science from the Massachusetts Institute of Technology. He earned his
Bachelor's and Master's degrees from Boston University. He is a member of
several industry-related associations. Dr. Mobius joined the Franklin
Templeton Group in 1987 and has managed the Developing Markets Fund from
inception.
Chris Molumphy
Senior Vice President
Franklin Advisers, Inc.
Mr. Molumphy is a Chartered Financial Analyst and holds a Master of Business
Administration degree in Finance from the University of Chicago. He earned
his Bachelor of Arts degree in economics from Stanford University. Mr.
Molumphy is a member of several securities industry associations. He has been
with the Franklin Templeton Group since 1988 and has managed the High Income
Fund from inception.
Peter A. Nori
Vice President
Templeton Investment Counsel, Inc.
Mr. Nori is a Chartered Financial Analyst and holds both a Master of Business
Administration degree and a Bachelor of Science degree in Finance from the
University of San Francisco. After completing the Franklin management
training program, Mr. Nori joined Franklin portfolio research in 1990 as an
equity analyst. In 1994, Mr. Nori joined the Templeton organization. He has
managed the International Smaller Companies Fund since 1997.
Aidan O'Connell
Portfolio Manager
Franklin Advisers, Inc.
Mr. O'Connell holds a Master of Business Administration degree in Finance
from the University of Pennsylvania, a Master of Arts degree in International
Relations from Johns Hopkins University and a Bachelor of Arts degree from
Dartmouth College. Before joining the Franklin Templeton Group in May 1998,
Mr. O'Connell was at Hambrecht & Quist (1991-1997). Mr. O'Connell has managed
the Small Cap Fund since September 1998.
Tek-Khoan Ong
Portfolio Manager
Templeton Asset Management Ltd.
Mr. Ong holds a Masters of Business Administration degree from the Wharton
School, University of Pennsylvania, graduating with distinction and on the
director's list. He earned a Masters of Science degree in Computing Science
and a Bachelor of Science degree in Civil Engineering, with honors, both from
Imperial College, University of London, UK. Before joining the Franklin
Templeton Group in 1993, he worked for the Monetary Authority of Singapore
(Singapore's central bank) for five years. He has managed the Developing
Markets Fund since 1996.
Vivian J. Palmieri
Vice President
Franklin Advisers, Inc.
Mr. Palmieri holds a Bachelor of Arts degree in Economics from Williams
College. He has been with the Franklin Templeton Group since 1965 and has
managed the Capital Growth Fund from inception.
Edward D. Perks
Vice President
Franklin Advisers, Inc.
Mr. Perks holds a Bachelor of Arts in Economics and Political Science from
Yale University. Mr. Perks has been with the Franklin Templeton Group since
October 1992 and has managed the Natural Resources Fund since 1997.
Simon Rudolph
Vice President
Templeton Investment Counsel, Inc.
Mr. Rudolph is a Chartered Accountant and holds a Bachelor of Arts degree in
Economic History from Durham University in England. Mr. Rudolph has been a
securities analyst since 1986. Before joining the Franklin Templeton
organization in 1997, he was an executive director with Morgan Stanley. Mr.
Rudolph has managed the International Smaller Companies Fund since 1997.
Kent P. Shepherd
Vice President
Franklin Advisers, Inc.
Mr. Shepherd holds undergraduate degrees in Economics and Political Science
from Northwestern University and an MBA in International Finance from UCLA.
In addition, Mr. Shepherd is a Chartered Financial Analyst and a Chartered
Investment Counselor. Mr. Shepherd has been with the Franklin Templeton Group
since 1991. and has managed the Growth and Income Fund since August 1998.
Lawrence N. Sondike
Senior Vice President
Franklin Mutual Advisers, Inc.
Mr. Sondike has a Bachelor of Arts degree from Cornell University and a
Masters in Business Administration from New York University Graduate School
of Business. Before November 1996, he was a research analyst for Heine
Securities Corporation, the predecessor of Franklin Mutual. He has been with
the Franklin Templeton Group since November 1996, and has managed the Mutual
Shares Fund from inception.
Gerard P. Sullivan
Senior Vice President
Franklin Advisory Services, Inc.
Mr. Sullivan holds a Master of Business Administration in Finance and
Accounting from the Columbia Graduate School of Business and a Bachelor of
Arts degree in Political Science from Columbia University. Before joining the
Franklin Templeton Group, he was a Portfolio Manager for SunAmerica
Asset Management from February 1995 to February 1998 and prior to that he was
a Portfolio Manager for Texas Commerce Investment Management & Co. from July
1993 to February 1995. Mr. Sullivan has managed the Rising Dividends Fund
since March 1998 and the Value Securities Fund from inception.
Donald G. Taylor
Senior Vice President
Franklin Advisory Services, Inc.
Mr. Taylor holds a Bachelor of Science degree in Economics from the
University of Pennsylvania - the Wharton School. Mr. Taylor has been with the
Franklin Templeton Group since June 1996. Before 1996 Mr. Taylor was a
portfolio manager for Fidelity Management & Research Co. Mr. Taylor has
managed the Rising Dividends Fund since 1996.
Kurt von Emster
Vice President
Franklin Advisers, Inc.
Mr. von Emster is a Chartered Financial Analyst and holds a Bachelor of Arts
degree in Business and Economics from the University of California at Santa
Barbara. He has been with the Franklin Templeton Group since 1989. Mr. von
Emster has managed the Global Health Care Fund from inception.
Dale A. Winner
Portfolio Manager
Templeton Global Advisors Limited
Mr. Winner received his LLB from Reading University, England and has
successfully completed a Level III Chartered Financial Analyst examination.
Prior to joining the Franklin Templeton Group in 1995, Mr. Winner was a Trust
Officer at J.P. Morgan, Bahamas for two years and before that he was a credit
analyst at Mitsui Trust, London for 5 years. He has managed the equity
portion of the Asset Allocation Fund since 1997.
R. Martin Wiskemann
Executive Vice President
Franklin Advisers, Inc.
Mr. Wiskemann holds a degree in Business Administration from the
Handelsschule of the State of Zurich, Switzerland. He has been in the
securities business for more than 30 years, managing mutual fund equity and
fixed-income portfolios, and private investment accounts. He is a member of
several securities industry associations. He has been with the Franklin
Templeton Group since 1972 and has managed the High Income Fund from
inception.
Tom Wu
Director
Templeton Asset Management Ltd.
Mr. Wu holds a Master of Business Administration degree from the University
of Oregon. He earned a Bachelor of Social Science Degree in Economics from
the University of Hong Kong. Before joining the Franklin Templeton Group in
1987, he was a stockbroker at Vickers da Costa Hong Kong Ltd. He has managed
the Developing Markets Fund from inception.
PURCHASE, REDEMPTION
AND EXCHANGE OF SHARES
DISTRIBUTOR
The Trust's principal underwriter is Franklin Templeton Distributors, Inc.
("Distributors"), 777 Mariners Island Boulevard, San Mateo, CA 94404.
DISTRIBUTION PLAN
Class 2 of each Portfolio has a distribution plan or "Rule 12b-1 Plan," under
which it may pay Distributors, the Insurance Companies or others for
activities primarily intended to sell Class 2 shares or Contracts funded by
Class 2 shares. Payments made under a Plan may be used for, among other
things, the printing of prospectuses and reports used for sales purposes,
preparing and distributing sales literature and related expenses,
advertisements, education of contract owners or dealers and their
representatives, and other distribution related expenses including a prorated
portion of Distributors' or the Insurance Companies' overhead expenses
attributable to the distribution of these Contracts. Payments made under a
Plan may also be used to pay Insurance Companies, dealers or others for,
among other things, services fees as defined under National Association of
Securities Dealers, Inc. rules, furnishing personal services or such other
enhanced services as a Portfolio or a Contract may require, or maintaining
customer accounts and records. While the maximum amount payable under each
Portfolio's Class 2 Rule 12b-1 Plan is 0.35% per year of Class 2's average
daily net assets, the Board has set the current rate at 0.30% per year.
Please see the SAI for additional information.
PURCHASES OF SHARES
As noted in the Introduction, shares of each Portfolio are currently sold
only to the Variable Accounts of the Insurance Companies, to fund the
benefits under their Policies.
The Trust serves as an investment vehicle for both variable annuity and
variable life insurance contracts. Therefore, the Trust's Board monitors
events in order to identify any material conflicts between variable annuity
contract owners and variable life contract owners and will determine what
action, if any, should be taken in the event of such a conflict. Although the
Trust does not currently foresee any disadvantages to contract owners, an
irreconcilable material conflict may conceivably arise between contract
owners of different separate accounts investing in the Portfolio due to
differences in tax treatment, the management of investments, or other
considerations. If such a conflict were to occur, one of the Variable
Accounts might withdraw its investment in a Portfolio. This might force the
Portfolio to sell portfolio securities at disadvantageous prices.
The applicable Insurance Company Variable Account purchases shares of each
Portfolio using purchase payments allocated to one or more of the Contract
Sub-Accounts of each Variable Account, as selected by the Contract Owners.
Shares are purchased by the Variable Accounts at the net asset value of each
respective Portfolio next determined after the Portfolio receives the
purchase payment in good order and are credited to each Contract Sub-Account
in the form of full and fractional shares (rounded to the nearest 1/1000 of a
share).
The Portfolios do not issue share certificates. Initial and subsequent
payments allocated to a specific Portfolio are subject to the limits
applicable in the Contracts issued by the Insurance Company.
REDEMPTIONS OF SHARES
Each Insurance Company redeems shares of the applicable Portfolio to make
benefit or surrender payments under the terms of its Contracts. Redemptions
are processed on any day on which the Portfolios are open for business (each
day the New York Stock Exchange is open) and are effected at the Portfolio's
net asset value next determined after the Portfolio receives the appropriate
order from the Variable Accounts.
Payment for redeemed shares will be made within seven days after receipt of
the redemption order in proper form. However, under unusual circumstances,
the Trust may suspend redemptions or postpone payment for more than seven
days as permitted by federal securities law. Redemptions are taxable events,
and the amount received upon redemption of the shares of any of the
Portfolios may be more or less than the amount paid for the shares, depending
upon the fluctuations in the market value of the assets constituting the
investments of that Portfolio.
If a substantial portion of any Portfolio's shares should be redeemed within
a short period, the Portfolio might have to liquidate portfolio securities it
might otherwise hold and also incur the additional costs related to such
transactions.
EXCHANGES OF SHARES
Currently, Class 2 Shares of any one Portfolio may be exchanged for Class 2
shares of any other Portfolios in the Trust, all of which are described in
this prospectus, subject to the terms of the applicable Contract prospectus.
Exchanges are treated as a redemption of shares of one Portfolio and a
purchase of shares of one or more of the other Portfolios and are effected at
the respective net asset value per share of the class of each Portfolio on
the date of the exchange. Please refer to the Insurance Companies' Contract
prospectuses for more information concerning exchanges.
Neither the Trust nor the Variable Accounts are designed for professional
market timing organizations, other entities, or individuals using programmed,
large and/or frequent transfers. The Variable Accounts, in coordination with
the Trust, reserve the right to temporarily or permanently refuse exchange
requests if, in the Managers' judgment, a Portfolio would be unable to invest
effectively in accordance with its investment objectives and policies, or
would otherwise potentially be adversely affected. In particular, a pattern
of exchanges that coincide with a "market timing" strategy may be disruptive
to a Portfolio and therefore may be refused. Accounts under common ownership
or control may be aggregated for purposes of the transfer limits. Investors
should consult the Variable Account prospectus of the specific insurance
product that accompanies this Trust prospectus for information on other
specific limitations on the transfer privilege.
The Trust reserves the right to modify or discontinue its exchange program at
any time upon 60 days' notice to the Insurance Companies.
INCOME DIVIDENDS AND
CAPITAL GAINS DISTRIBUTIONS
Each Portfolio normally intends to pay annual dividends on its Class 1 and
Class 2 shares representing substantially all of its net investment income
attributable to its Class 1 and Class 2 shares and to distribute annually any
net realized capital gains attributable to its Class 1 and Class 2 shares.
Dividends and capital gains are calculated and distributed the same way for
each Portfolio and each class of shares, except for the Money Fund. The Money
Fund declares a dividend each day the Portfolio's net asset value is
calculated, equal to all of its daily net income, payable to the appropriate
Sub-Account of the Variable Account as of the close of business the preceding
day. The amount of dividend may fluctuate from day to day and may be omitted
on some days, depending on changes in the factors that comprise the
Portfolio's net income. The amount of any income dividends per share will
differ for each class, however, generally due to the difference in the
applicable Rule 12b-1 fees. Class 1 shares are not subject to Rule 12b-1 fees.
Any distributions made by a Portfolio will be automatically reinvested in
additional shares of the same class of the Portfolio, unless an election is
made on behalf of a shareholder to receive distributions in cash. Dividends
or distributions by the Portfolios will reduce the per share net asset value
by the per share amount so paid.
DETERMINATION OF NET ASSET VALUE
The net asset value per share of each class of a Portfolio is determined as
of the close of the New York Stock Exchange, normally 4:00 p.m., Eastern
time. The net asset value of all outstanding shares of each class of a
Portfolio is calculated on a pro rata basis. It is based on each class'
proportionate participation in a Portfolio, determined by the value of the
shares of each class. Class 2 shares will bear the rule 12b-1 fees payable
under its Rule 12b-1 plan. To calculate the net asset value per share of each
class, the assets of each class are valued and totaled, liabilities of the
class are subtracted, and the balance, called net assets, is divided by the
number of shares of the class outstanding.
The assets in each Portfolio are valued as described under "Additional
Information Regarding Valuation and Redemption of Shares of a Portfolio" in
the SAI.
TAX CONSIDERATIONS
Each Portfolio of the Trust is treated as a separate entity for federal
income tax purposes. Each Portfolio intends to qualify or continue to qualify
for treatment as a regulated investment company under Subchapter M of the
Code. By distributing all of its income, and meeting certain other
requirements relating to the sources of its income and diversification of its
assets, each Portfolio will not be subject to federal income taxes.
In order to ensure that individuals holding the Policies whose assets are
invested in a Portfolio will not be subject to federal income tax on
distributions made by the Portfolio prior to the receipt of payments under
the Policies, each Portfolio intends to comply with the additional
requirements of Section 817(h) of the Code relating to diversification of its
assets.
The Portfolios are not subject to any federal excise tax on undistributed
income because their shares are held exclusively by segregated asset accounts
of an insurance company in connection with variable contracts.
Foreign securities that meet the definition in the Code of a Passive Foreign
Investment Company (a "PFIC") may subject a Portfolio to an income tax and
interest charge with respect to such investments. To the extent possible, the
Portfolio will avoid such treatment by not investing in known PFIC securities
or by adopting other strategies for any PFIC securities it does purchase.
Foreign exchange gains and losses realized by the Portfolios in connection
with certain transactions involving foreign currencies, foreign currency
payables or receivables, foreign currency-denominated debt obligations,
foreign currency forward contracts, and options or futures contracts on
foreign currencies are subject to special tax rules which may cause such
gains and losses to be treated as ordinary income and losses rather than
capital gains and losses and may affect the amount and timing of the
Portfolios' income or loss from such transactions and, in turn, its
distributions to shareholders.
The Natural Resources Fund's ability to invest in gold bullion will be
limited by the requirements for qualification as a regulated investment
company. For example, no more than 10% of the Portfolio's annual gross income
may be derived from income from nonqualifying sources, including gain from
the disposition of gold bullion or gold derivative instruments.
Holders of Policies under which assets are invested in the Trust should refer
to the prospectus for the Policies for information regarding the tax aspects
of ownership of such Policies.
HOW THE TRUST MEASURES PERFORMANCE
Advertisements, sales literature, hypothetical personalized illustrations,
and communications with Contract Owners and others may cite the performance
of either class of a Portfolio calculated on a total return, current yield or
current distribution rate basis. Total return figures show the change in
value of a hypothetical past investment as a percentage of the investment,
assuming any dividends and capital gains are reinvested. Total return figures
will indicate the time periods used, whether figures are cumulative or
annualized and whether the effects of sales charges are included. Current
yield for each Portfolio (except the Money Fund) shows the annualization of
income per share earned by that Portfolio over a recent 30 day period, and is
shown as a percentage of the investment. The current distribution rate for a
Portfolio (other than the Money Fund) is usually computed by annualizing the
dividends paid per share during the most recent preceding
fiscal quarter and dividing that amount by the net asset value at the end of
the period. Unlike current yield, the current distribution rate may include
income distributions from sources other than dividends and interest received
by each Portfolio. Performance data will include uniformly computed
performance figures for comparative purposes.
From time to time, the Money Fund may advertise its current and effective
yield. The Money Fund's current yield refers to an annualization of the
income generated by an investment over a stated seven-day period, and is
shown as a percentage of the investment. The Money Fund's effective yield is
calculated similarly but, when annualized, the income earned is assumed to be
reinvested. The effective yield will be slightly higher than the yield
because of the compounding effect of this assumed reinvestment.
The investment results for each class of each Portfolio will vary.
Performance figures are always based on past performance and do not indicate
future results. Hypothetical performance information may also be prepared for
sales literature or advertisements. For a description of the methods used to
calculate performance for the Portfolios, see "Performance Information" in
the SAI.
For additional information, see the SAI "How the Trust Measures Performance"
and the appropriate insurance company separate account prospectus and SAI.
GENERAL INFORMATION
REPORTS
The Trust's fiscal year ends December 31. Annual Reports containing audited
financial statements of the Trust and Semi-Annual Reports containing
unaudited financial statements, as well as proxy materials, are sent to
Contract Owners, annuitants or beneficiaries, as appropriate. Inquiries may
be directed to the Trust by calling 1-800/342-3863 or writing to P.O. Box
7777, San Mateo, California 94403-7777.
TRANSFER AGENT
Franklin Templeton Investor Services, Inc., 777 Mariners Island Blvd., P.O.
Box 7777, San Mateo, California 94403-7777, a wholly-owned subsidiary of
Franklin Resources, Inc. and a transfer agent, maintains shareholder records,
processes purchases and redemptions of each Portfolio's shares, and serves as
each Portfolio's dividend-paying agent.
TRUST ORGANIZATION,
VOTING PRIVILEGES AND OTHER RIGHTS
The Trust, an open-end management investment company, commonly called a
mutual fund, was organized as a Massachusetts business trust and is
registered with the SEC. The Trust currently offers two classes of shares of
each Portfolio: Class 1 and Class 2. All shares purchased before the initial
offering of Class 2 shares of a Portfolio on December 28, 1998 are considered
Class 1 shares. After that date. all shares will be designated either Class 1
or Class 2. Class 2 shares have a Rule 12b-1 distribution plan and are
currently subject to fees of 0.30% per year of Class 2's average daily net
assets which will affect the performance of Class 2 shares. Class 1 shares do
not bear any Rule 12b-1 fees. Additional series and classes of shares may be
offered in the future.
Shares of each class represent proportionate interests in the assets of a
Portfolio and have the same voting and other rights and preferences as shares
of any other class of the Portfolio for matters that affect the Portfolio as
a whole. For matters that only affect one class, however, only shareholders
of that class may vote. Each class will vote separately on matters affecting
only that class, or expressly required to be voted on separately by state or
federal law. Shares of each class of a Portfolio have the same voting and
other rights and preferences as shares of the other classes and Portfolios of
the Trust for matters that affect the Trust as a whole.
The Trust has noncumulative voting rights. This gives holders of more than
50% of the shares voting the ability to elect all of the Trustees. If this
happens, holders of the remaining shares voting will not be able to elect any
Trustees.
The Trust does not intend to hold annual shareholder meetings. It may hold a
special meeting, however, for matters requiring shareholder approval. A
meeting may also be called by the Trustees, at their discretion, or by
shareholders holding at least 10% of the outstanding shares of any Portfolio
for the purpose of voting upon the election or of the removal of a Trustee.
In certain circumstances, the Trust is required to help a shareholder
communicate with other shareholders about the removal of a Trustee. For
information regarding voting privileges of Contract Owners, see the
accompanying insurance company separate account prospectus, under "Voting
Privileges."
APPENDIX
DESCRIPTION OF BOND RATINGS
MOODY'S
Aaa - Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as
"gilt-edged." Interest payments are protected by a large or exceptionally
stable margin and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
Aa - Bonds rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high
grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large, fluctuation of protective elements may be of
greater amplitude, or there may be other elements present which make the
long-term risks appear somewhat larger.
A - Bonds rated A possess many favorable investment attributes and are
considered upper medium grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present
which suggest a susceptibility to impairment sometime in the future.
Baa - Bonds rated Baa are considered medium grade obligations. They are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may
be lacking or may be characteristically unreliable over any great length of
time. Such bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
Ba - Bonds rated Ba are judged to have predominantly speculative elements and
their future cannot be considered well assured. Often the protection of
interest and principal payments is very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B - Bonds rated B generally lack characteristics of the desirable investment.
Assurance of interest and principal payments or of maintenance of other terms
of the contract over any long period of time may be small.
Caa - Bonds rated Caa are of poor standing. Such issues may be in default or
there may be present elements of danger with respect to principal or interest.
Ca - Bonds rated Ca represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked shortcomings.
C - Bonds rated C are the lowest rated class of bonds and can be regarded as
having extremely poor prospects of ever attaining any real investment
standing.
Note: +Moody's applies numerical modifiers 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond ratings. The modifier
1 indicates that the security ranks in the higher end of its generic rating
category; modifier 2 indicates a mid-range ranking; and modifier 3 indicates
that the issue ranks in the lower end of its generic rating category.
S&P
AAA - This is the highest rating assigned by S&P to a debt obligation and
indicates an extremely strong capacity to pay principal and interest.
AA - Bonds rated AA also qualify as high-quality debt obligations. Capacity
to pay principal and interest is very strong and, in the majority of
instances, differ from AAA issues only in small degree.
A - Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions.
BBB - Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit protection parameters,
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity to pay principal and interest for bonds in this
category than for bonds in the A category.
BB, B, CCC, CC - Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal in accordance with the terms of the obligations.
BB indicates the lowest degree of speculation and CC the highest degree of
speculation. While such bonds will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
C - Bonds rated C are typically subordinated debt to senior debt that is
assigned an actual or implied CCC- rating. The C rating may also reflect the
filing of a bankruptcy petition under circumstances where debt service
payments are continuing. The C1 rating is reserved for income bonds on which
no interest is being paid.
D - Debt rated D is in default and payment of interest and/or repayment of
principal is in arrears.
Plus (+) or minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Description of Commercial Paper Ratings
Moody's
Moody's commercial paper ratings are opinions of the ability of issuers to
repay punctually their promissory obligations not having an original maturity
in excess of nine months. Moody's employs the following designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers:
P-1 (Prime-1): Superior capacity for repayment.
P-2 (Prime-2): Strong capacity for repayment.
S&P
S&P's ratings are a current assessment of the likelihood of timely payment of
debt having an original maturity of no more than 365 days. Ratings are graded
into four categories, ranging from "A"for the highest quality obligations to
"D" for the lowest. Issues within the "A" category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety, as follows:
A-1: This designation indicates the degree of safety regarding timely payment
is very strong. A "plus" (+) designation indicates an even stronger
likelihood of timely payment.
A-2: Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as overwhelming as for issues
designated A-1.
A-3: Issues carrying this designation have a satisfactory capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse effects
of changes in circumstances than obligations carrying the higher designations.
FRANKLIN VALUEMARK FUNDS
STATEMENT OF ADDITIONAL INFORMATION
777 Mariners Island Blvd., P.O. Box 7777
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DECEMBER 28, 1998 San Mateo, CA 94403-7777
1-800/342-3863
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Contents Page
Introduction 2
Portfolio Investment
Objectives and Policies 2
Highlighted Risk Considerations 5
Foreign Securities 5
Currency Management Techniques 8
Zero Coupon Funds -
Special Considerations 9
Investment Methods and Risks
Common to More than One Portfolio 11
Convertible Securities 11
Illiquid Securities 13
Interest Rate Swaps 13
Inverse Floaters 13
Mortgage and Asset-Backed
Securities 13
Municipal Securities 16
Options and Futures 16
Portfolio Turnover 23
Real Estate Fund 24
Repurchase Agreements 24
Reverse Repurchase Agreements 24
Short Sales 25
When-Issued Securities 25
Fundamental Investment
Restrictions 26
Non-Fundamental Investment
Restrictions 27
Officers and Trustees 28
Investment Management and
Other Services 32
Fund Administrator 36
Transfer Agent 36
Custodians 36
Independent Auditors 37
Research Services 37
Policies Regarding Brokers
Used on Securities Transactions 37
The Trust's Underwriter 39
Class 2 Distribution Plans 39
Additional Information
Regarding Valuation and
Redemption of Shares of
the Portfolios 39
Calculation of Net Asset Value 39
Portfolios Other than Money Fund 40
Money Market Fund 40
Additional Information 41
Additional Information
Regarding Taxation 41
How the Trust Measures Performance43
Miscellaneous Information 44
Portfolio Similarity 44
Financial Statements 45
A prospectus for the Class 1 shares of the Portfolios of Franklin Valuemark
Funds (the "Trust"), dated May 1, 1998, or for the Class 2 shares of the
Portfolios of the Trust, dated December 28, 1998, each of which may be
amended or supplemented from time to time, contains the basic information you
should know before investing in any Portfolio. For a free copy call
1-800/342-3863.
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 prospectus for each class of the Portfolios. This SAI is intended to
provide you with additional information regarding the activities and
operations of the Trust and the Portfolios and should be read in conjunction
with the prospectus.
Mutual funds, annuities, and other investment products:
o are not federally insured by the Federal Deposit Insurance Corporation, the
Federal Reserve Board, or any other agency of the U.S. government;
o are not deposits or obligations of, or guaranteed or endorsed by, any bank;
o are subject to investment risks, including the possible loss of principal
INTRODUCTION
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The Trust is an open-end management investment company, or mutual fund,
organized as a Massachusetts business trust on April 26, 1988, and is
registered with the Securities and Exchange Commission ("SEC"). Shares of the
Trust are currently sold only to the separate accounts (the "Variable
Accounts") of Allianz Life Insurance Company of North America, or its wholly
owned subsidiary Preferred Life Insurance Company of New York, or their
affiliates ("Insurance Companies") to fund the benefits under variable life
insurance policies and variable annuity contracts (collectively the
"Contracts") issued by the Insurance Companies. The Variable Accounts are
divided into sub-accounts (the "Contract Sub-Accounts"), each of which will
invest in one of the Portfolios, as directed within the limitations described
in the appropriate Contracts, by the owners of the respective Contracts
issued by the Insurance Companies (collectively the "Contract Owners"). The
Trust issues two classes of shares of beneficial interest for each of its
twenty-five (25) series, Class 1 and Class 2 of: Money Market Fund, Growth
and Income Fund, Natural Resources Securities Fund, Real Estate Securities
Fund, Global Utilities Securities Fund, High Income Fund, Templeton Global
Income Securities Fund, Income Securities Fund, U.S. Government Securities
Fund, Zero Coupon Fund - 2000, Zero Coupon Fund - 2005, Zero Coupon Fund -
2010, Rising Dividends Fund, Templeton Pacific Growth Fund, Templeton
International Equity Fund, Templeton Developing Markets Equity Fund,
Templeton Global Growth Fund, Templeton Global Asset Allocation Fund, Small
Cap Fund, Capital Growth Fund, Templeton International Smaller Companies
Fund, Mutual Discovery Securities Fund, Mutual Shares Securities Fund, Global
Health Care Securities Fund and Value Securities Fund. Each Portfolio
maintains a totally separate and distinct investment portfolio. Some of the
Portfolios or classes may not be available in connection with a particular
Contract or in a particular state. Contract owners should consult the
insurance product prospectus accompanying the Trust prospectus which
describes the specific Contract or the appropriate Insurance Company for
information on available Portfolios and any applicable limitations with
respect to a separate account's investments in the Portfolios.
PORTFOLIO INVESTMENT OBJECTIVES AND POLICIES
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Each Portfolio has one or more investment objectives and related investment
policies and uses various investment techniques to pursue these objectives
and policies, all of which are described more completely in the Trust's
prospectus. There can be no assurance that any of the Portfolios will achieve
their investment objective or objectives. Investors should not consider any
one Portfolio alone to be a complete investment program and should evaluate
each Portfolio in relation to their personal financial situation, goals, and
tolerance for risk. All of the Portfolios are subject to the risk of changing
economic conditions, as well as the risk related to the ability of the
Managers to make changes in the portfolio composition of the Portfolio in
anticipation of changes in economic, business, and financial conditions. As
with any security, a risk of loss of all or a portion of the principal amount
invested accompanies an investment in the shares of any of the Portfolios.
SUMMARY OF PORTFOLIO OBJECTIVES
Portfolio Seeking Stability of
Principal and Income
Money Market Fund ("Money Fund")1 seeks high current income, consistent with
capital preservation and liquidity. The Portfolio will pursue its objective
by investing exclusively in high quality money market instruments. An
investment in the Money Fund is neither insured nor guaranteed by the U.S.
Government. The Portfolio attempts to maintain a stable net asset value of
$1.00 per share, although no assurances can be given that the Portfolio will
be able to do so.
Portfolios Seeking Current Income
High Income Fund2 seeks a high level of current income, with capital
appreciation as a secondary objective, by investing in debt obligations and
dividend-paying common and preferred stocks. Debt obligations include lower
rated obligations (commonly referred to as "junk bonds") which involve
increased risks related to the creditworthiness of their issuers.
Templeton Global Income Securities ("Global Income Fund")1 seeks a high level
of current income, consistent with preservation of capital, with capital
appreciation as a secondary consideration, through investing in foreign and
domestic debt obligations, including up to 25% in lower rated debt
obligations (commonly referred to as "junk bonds"), and related currency
transactions. Investing in a non-diversified portfolio of global securities
including those of developing markets issuers involves increased
susceptibility to the special risks associated with foreign investing. Prior
to May 1, 1996 the Portfolio was known as the Global Income Fund.
U.S. Government Securities Fund ("Government Fund") seeks current income and
safety of capital by investing exclusively in obligations issued or
guaranteed by the U.S. government or its agencies or instrumentalities.
Zero Coupon Funds, 2000, 2005, 2010, seek a high investment return consistent
with the preservation of capital, by investing primarily in zero coupon
securities. In response to interest rate changes, these securities may
experience greater fluctuations in market value than interest-paying
securities of similar maturities. The Portfolios may not be appropriate for
short-term investors or those who intend to withdraw money before the
maturity date.
Portfolios Seeking Growth and Income
Global Utilities Securities Fund ("Global Utility Fund")1 seeks both capital
appreciation and current income by investing primarily in securities of
issuers engaged in the public utilities industry. The Portfolio may invest in
securities of issuers of any nation, including nations with developing
markets. Investing in a portfolio which concentrates in a specialized market
sector involves increased risks. Foreign investing also involves special
risks. Prior to May 1, 1998, the Portfolio was named the Utility Equity Fund
and invested primarily in securities of domestic issuers in the public
utility industry.
Growth and Income Fund1 seeks capital appreciation, with current income
return as a secondary objective, by investing primarily in U.S. common
stocks. The Portfolio may invest in foreign securities. Prior to May 1, 1995,
the Growth and Income Fund was known as the Equity Growth Fund.
Income Securities Fund1,2 seeks to maximize income while maintaining
prospects for capital appreciation by investing primarily in a diversified
portfolio of domestic debt obligations and/or equity securities. Debt
obligations include lower rated obligations (commonly referred to as "junk
bonds") which involve increased risks related to the creditworthiness of
their issuers. The Portfolio may invest in foreign securities.
Mutual Shares Securities Fund ("Mutual Shares Fund")1,2 seeks capital
appreciation, with income as a secondary objective. The Portfolio invests
primarily in domestic equity securities trading at prices below their
intrinsic values. The Portfolio may also invest in securities of companies
involved in corporate restructuring, mergers, bankruptcies, and liquidations
as well as debt securities of any quality including "junk bonds," and
defaulted securities, all of which involve increased risks related to the
creditworthiness of their issuers. Foreign investing involves special risks.
Real Estate Securities Fund ("Real Estate Fund") seeks capital appreciation,
with current income return as a secondary objective, by concentrating its
investments in publicly traded securities of U.S. companies in the real
estate industry. Investing in a portfolio which concentrates in a specialized
market sector involves increased risks. Rising Dividends Fund seeks capital
appreciation, primarily through investment in the equity securities of
companies that have paid consistently rising dividends over the past ten
years. Preservation of capital is also an important consideration. The
Portfolio seeks current income incidental to capital appreciation.
Templeton Global Asset Allocation Fund ("Asset Allocation Fund")1 seeks a
high level of total return through a flexible policy of investing in equity
securities, debt obligations, including up to 25% in lower rated debt
obligations (commonly referred to as "junk bonds"), and money market
instruments of issuers in any nation, including developing markets nations.
The mix of investments among the three market segments will be adjusted in an
attempt to capitalize on the total return potential produced by changing
economic conditions throughout the world. Foreign investing involves special
risks.
Value Securities Fund ("Value Fund")1 seeks long-term total return. The
Portfolio invests primarily in equity securities, including common stocks and
securities convertible into common stocks.
Portfolios Seeking Capital Growth
Capital Growth Fund ("Growth Fund")1 seeks capital appreciation, with current
income as a secondary consideration. The Portfolio invests primarily in
equity securities, including common stocks and securities convertible into
common stocks.
Global Health Care Securities Fund ("Global Health Care Fund")1 seeks capital
appreciation, by concentrating its investments in equity securities issued by
health care companies located throughout the world. Investing in a
non-diversified portfolio concentrating in a specialized market sector
involves increased risks. Foreign investing also involves special risks.
Mutual Discovery Securities Fund ("Mutual Discovery Fund")1,2 seeks capital
appreciation. The Portfolio invests primarily in domestic and foreign equity
securities, including securities of small capitalization companies, trading
at prices below their intrinsic values. The Portfolio may also invest in
securities of companies involved in corporate restructuring, mergers,
bankruptcies, and liquidations as well as debt securities of any quality
including "junk bonds," and defaulted securities, all of which involve
increased risks related to the creditworthiness of their issuers. Foreign
investing involves special risks.
Natural Resources Securities Fund (Natural Resources Fund)1 seeks capital
appreciation, with current income return as a secondary objective. The
Portfolio seeks to achieve its objective by concentrating its investments in
securities issued by companies in or related to the natural resources sector.
Investing in a portfolio which concentrates in a specialized market sector
involves increased risks. Foreign investing also involves special risks.
Prior to May 1, 1997, the Natural Resources Fund was known as the Precious
Metals Fund and had different investment objectives and policies.
Small Cap Fund1 seeks long-term capital growth. The Portfolio seeks to
accomplish its objective by investing primarily in equity securities of small
capitalization growth companies. The Portfolio may also invest in foreign
securities, including those of developing markets issuers. Because of the
Portfolio's investments in small capitalization companies, an investment in
the Portfolio may involve greater risks and higher volatility and should not
be considered a complete investment program.
Templeton Developing Markets Equity Fund ("Developing Markets Fund")1 seeks
long-term capital appreciation. The Portfolio seeks to achieve this objective
by investing primarily in equities of issuers in countries having developing
markets. The Portfolio is subject to the heightened foreign securities
investment risks that accompany foreign developing markets and an investment
in the Portfolio may be considered speculative.
Templeton Global Growth Fund ("Global Growth Fund")1 seeks long-term capital
growth. The Portfolio hopes to achieve its objective through a flexible
policy of investing in stocks and debt obligations of companies and
governments of any nation, including developing markets. The realization of
income, if any, is only incidental to accomplishment of the Portfolio's
objective of long-term capital growth. Foreign investing involves special
risks.
Templeton International Equity Fund ("International Equity Fund")1 seeks
long-term growth of capital. Under normal conditions, the International
Equity Fund will invest at least 65% of its total assets in an
internationally mixed portfolio of foreign equity securities which trade on
markets in countries other than the U.S., including developing markets, and
are (i) issued by companies domiciled in countries other than the U.S., or
(ii) issued by companies that derive at least 50% of either their revenues or
pre-tax income from activities outside of the U.S. Foreign investing involves
special risks. Prior to October 15, 1993, the Templeton International Equity
Fund was known as the International Equity Fund. Foreign investing involves
special risks.
Templeton International Smaller Companies Fund ("International Smaller
Companies Fund")1 seeks long-term capital appreciation. The Portfolio seeks
to achieve this objective by investing primarily in equity securities of
smaller companies outside the U.S., including developing markets. Foreign
investing involves special risks and smaller company investments may involve
higher volatility. An investment in the Portfolio should not be considered a
complete investment program.
Templeton Pacific Growth Fund ("Pacific Fund")1 seeks long-term growth of
capital, primarily through investing at least 65% of its total assets in
equity securities which trade on markets in the Pacific Rim, including
developing markets, and are (i) issued by companies domiciled in the Pacific
Rim or (ii) issued by companies that derive at least 50% of either their
revenues or pre-tax income from activities in the Pacific Rim. Investing in a
portfolio of geographically concentrated foreign securities, including
developing markets, involves increased susceptibility to the special risks of
foreign investing and an investment in the Portfolio may be considered
speculative. Prior to October 15, 1993, the Templeton Pacific Growth Fund was
known as the Pacific Growth Fund.
1The Asset Allocation, Capital Growth, Developing Markets, Global Growth,
Global Health Care, Global Income, Global Utility, Growth and Income, Income
Securities, International Equity, International Smaller Companies, Money
Market, Mutual Discovery, Mutual Shares, Pacific, Natural Resources, Small
Cap and Value Funds may invest more than 10% of their total net assets in
foreign securities which are subject to special and additional risks related
to currency fluctuations, market volatility, and economic, social, and
political uncertainty; investing in developing markets involves similar but
heightened risks related to the relatively small size and lesser liquidity of
these markets. See "Highlighted Risk Considerations, Foreign Transactions."
2The High Income, Income Securities, Mutual Discovery and Mutual Shares Funds
may invest up to 100% of their respective net assets in debt obligations
rated below investment grade, commonly known as "junk bonds," or in
obligations which have not been rated by any rating agency. Investments rated
below investment grade involve greater risks, including price volatility and
risk of default, than investments in higher rated obligations. Investors
should carefully consider the risks associated with an investment in these
Portfolios in light of the securities in which they invest. See "Highlighted
Risk Considerations, Lower Rated Debt Obligations."
HIGHLIGHTED RISK CONSIDERATIONS
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As described more fully in the individual Portfolio sections in the Trust
prospectus and as supplemented below, an investment in certain of the
Portfolios involves special additional risks as a result of their ability to
invest a substantial portion of their assets in high yield, high risk, lower
rated debt obligations, foreign investments including those of "developing
markets" issuers located in emerging nations as defined by the World Bank,
specialized industry sectors, derivative instruments or complex securities.
These and other types of investments and investment techniques common to more
than one Portfolio, as stated in the individual Portfolio descriptions in the
Trust prospectus, are described in greater detail, including the risks of
each and any limitations, in the Trust prospectus, this section of the SAI
and in "Investment Methods and Risks."
All policies and percentage limitations are considered at the time of
purchase and refer to total assets, unless otherwise specified. Each of the
Portfolios will not necessarily use the strategies described to the full
extent permitted unless the Managers believe that doing so will help a
Portfolio reach its objectives, and not all instruments or strategies will be
used at all times.
Foreign Securities
Investors should consider carefully the substantial risks involved in
securities of companies and governments of foreign nations, which are in
addition to the usual risks associated with investing in U.S. issuers. There
is generally less government supervision and regulation of securities
exchanges, brokers, dealers and listed companies than in the U.S., thus
increasing the risk of delayed settlements of portfolio transactions or loss
of certificates for portfolio securities. Individual foreign economies may
differ favorably or unfavorably from the U.S. economy in such respects as
growth of gross national product, rate of inflation, capital reinvestment,
resource self-sufficiency and balance of payments position.
With respect to American Depositary Receipts ("ADRs") a Portfolio may
purchase the securities of foreign issuers directly in foreign markets if no
ADRs are available or the Managers believe these securities offer better
opportunities than the ADRs, with reasonable liquidity.
Even though the Portfolios authorized to invest in foreign securities intend
to acquire the securities of foreign issuers generally where there are public
trading markets, investments by a Portfolio in the securities of foreign
issuers may tend to increase the risks with respect to the liquidity of that
Portfolio's investments and that Portfolio's ability to meet large redemption
requests should there be economic or political turmoil in a country in which
the Portfolio has a substantial portion of its assets invested or should
relations between the U.S. and foreign countries deteriorate markedly.
Changes of governmental administrations or of economic or monetary policies,
in the U.S. or abroad, or changed circumstances in dealings between nations
could result in investment losses for a Portfolio and could affect adversely
that Portfolio's operations. A Portfolio's purchase of securities in foreign
countries will involve currencies of the U.S. and of foreign countries;
consequently, changes in exchange rates, currency, convertibility and
repatriation may favorably or adversely affect each Portfolio.
Securities which are acquired by a Portfolio outside the U.S. and which are
publicly traded in the U.S. or on a foreign securities exchange or in a
foreign securities market are not considered by the Portfolio to be illiquid
assets so long as the Portfolio acquires and holds the securities with the
intention of reselling the securities in the foreign trading market, the
Portfolio reasonably believes it can readily dispose of the securities for
cash in the U.S. or foreign market and current market quotations are readily
available. Investments may be in securities of foreign issuers, whether
located in developed or emerging countries.
Investments in foreign securities where delivery takes place outside the U.S.
will have to be made in compliance with any applicable U.S. and foreign
currency restrictions and tax laws (including laws imposing withholding taxes
on any dividend or interest income) and laws limiting the amount and types of
foreign investments. Changes of governmental administrations or of economic
or monetary policies, in the U.S. or abroad, or changed circumstances in
dealings between nations or currency convertibility or exchange rates could
result in investment losses for a Portfolio. Investments in foreign
securities may also subject a Portfolio to losses due to nationalization,
expropriation, holding and transferring assets through foreign subcustodians,
depositories and broker dealers, or differing accounting practices and
treatment.
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. The Portfolio,
therefore, may encounter difficulty in obtaining market quotations for
purposes of valuing its investments and calculating its net asset value.
Moreover, investors should recognize that foreign securities are often traded
with less frequency and volume and, therefore, may have greater price
volatility, than is the case with many U.S. securities. Notwithstanding the
fact that the Portfolios permitted to invest in foreign securities generally
intend to acquire the securities of foreign issuers where there are public
trading markets, investments by each Portfolio in the securities of foreign
issuers may tend to increase the risks with respect to the liquidity of a
Portfolio's investments and a Portfolio's ability to meet a large number of
shareholder redemption requests should there be economic or political turmoil
in a country in which a Portfolio has a substantial portion of its assets
invested or should relations between the U.S. and foreign countries
deteriorate markedly. Furthermore, the reporting and disclosure requirements
applicable to foreign issuers may differ from those applicable to domestic
issuers, and there may be difficulties in obtaining or enforcing judgments
against foreign issuers.
A Portfolio 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 Portfolio may invest may
also have fixed or managed currencies that are not free-floating against the
U.S. dollar. Further, certain currencies may not be internationally traded.
Certain of these currencies have experienced a steady devaluation relative to
the U.S. dollar. Any devaluations in the currencies in which a Portfolio's
investment securities are denominated may have a detrimental impact on the
Portfolio. The Managers endeavor to avoid unfavorable consequences and to
take advantage of favorable developments in particular nations where from
time to time they place a Portfolio's investments. The exercise of this
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.
Euro risk. On January 1, 1999, the European Monetary Union (EMU) plans to
introduce a new single currency, the euro, which will replace the national
currency for participating member countries. The transition and the
elimination of currency risk among EMU countries may change the economic
environment and behavior of investors, particularly in European markets.
Resources has created an interdepartmental team to handle all euro-related
changes to enable the Franklin Templeton Funds to process transactions
accurately and completely with minimal disruption to business activities.
While the implementation of the euro could have a negative effect on the
fund, the fund's manager and its affiliated services providers are taking
steps they believe are reasonably designed to address the euro issue.
Developing Markets. Certain Portfolios may invest in the obligations of
governments, government agencies and corporations of developing countries. As
many developing countries restructure their existing bank debt and economic
conditions improve, these obligations have become available and may offer the
Portfolios the potential for current U.S. dollar income. Such instruments are
not traded on any exchange. However, the Managers believe there may be a
market for such securities either in multinational companies wishing to
purchase such assets at a discount for further investment or from the issuing
governments which may decide to redeem their obligations at a discount.
The Portfolios 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 Portfolio 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 Portfolio 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 Portfolio's
investments in securities of issuers of that country. Although the Managers
place a Portfolio's investments only in foreign nations which they consider
as having relatively stable and friendly governments, there is the
possibility of cessation of trading on national exchanges, expropriation,
nationalization, confiscatory or other taxation, foreign exchange controls
(which may include suspension of the ability to transfer currency from a
given country), default in foreign government securities, political or social
instability or diplomatic developments which could affect investments in
securities of issuers in those nations.
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 Portfolio's investment opportunities, including restrictions on
investment in issuers or industries deemed sensitive to national interests;
(iv) foreign taxation; (v) the absence of developed structures governing
private or foreign investment or allowing for judicial redress for injury to
private property; (vi) the absence, until recently in certain Eastern
European countries, of a capital market structure or market-oriented economy;
and (vii) the possibility that recent favorable economic developments in
Eastern Europe may be slowed or reversed by unanticipated political or social
events in such countries.
In addition, many countries in which the Portfolio may invest have
experienced substantial, and in some periods extremely high, rates of
inflation for many years. Inflation and rapid fluctuations in inflation rates
have had and may continue to have negative effects on the economies and
securities markets of certain countries. Moreover, the economies of some
developing countries may differ favorably or unfavorably from the United
States economy in such respects as growth of gross domestic product, rate of
inflation, currency depreciation, capital reinvestment, resource
self-sufficiency and balance of payments position.
Investments in Eastern European countries may involve risks of
nationalization, expropriation and confiscatory taxation. The communist
governments of a number of Eastern European countries expropriated large
amounts of private property in the past, in many cases without adequate
compensation, and there can be no assurance that such expropriation will not
occur in the future. In the event of such expropriation, the Portfolio could
lose a substantial portion of any investments it has made in the affected
countries. Further, no accounting standards exist in Eastern European
countries. Finally, even though certain Eastern European Currencies may be
convertible into U.S. dollars, the conversion rates may be artificial to the
actual market values and may be adverse to Portfolio investors.
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 by foreign persons in a particular company, or limit the
investment of foreign persons to only a specific class of securities of a
company that may have less advantageous terms than securities of the company
available for purchase by nationals.
Authoritarian governments in certain Eastern European countries may require
that a governmental or quasi-governmental authority act as custodian of the
Portfolio's assets invested in such country. To the extent such governmental
or quasi-governmental authorities do not satisfy the requirements of the 1940
Act to act as foreign custodians of the Portfolio's cash and securities, the
Portfolio'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 securities of Russian issuers, for the Portfolios that are
permitted to invest in Russia, involves a high degree of risk and special
considerations not typically associated with investing in the United States
securities markets, and should be considered highly speculative. Such risks
include: (a) delays in settling portfolio transactions and risk of loss
arising out of Russia's unique system of share registration and custody; (b)
the risk that it may be impossible or more difficult than in other countries
to obtain and/or enforce a judgment; (c) pervasiveness of corruption and
crime in the Russian economic system; (d) currency exchange rate volatility
and the lack of available currency hedging instruments; (e) higher rates of
inflation (including the risk of social unrest associated with periods of
hyperinflation); (f) controls on foreign investment and local practices
disfavoring foreign investors and limitations on repatriation of invested
capital, profits and dividends, and on a Portfolio's ability to exchange
local currencies for U.S. dollars; (g) the risk that the government of Russia
or other executive or legislative bodies may decide not to continue to
support the economic reform programs implemented since the dissolution of the
Soviet Union and could follow radically different political and/or economic
policies to the detriment of investors, including non-market-oriented
policies such as the support of certain industries at the expense of other
sectors or investors, or a return to the centrally planned economy that
existed prior to the dissolution of the Soviet Union; (h) the financial
condition of Russian companies, including large amounts of intercompany debt
which may create a payments crisis on a national scale; (i) dependency on
exports and the corresponding importance of international trade; (j) the risk
that the Russian tax system will not be reformed to prevent inconsistent,
retroactive and/or exorbitant taxation; and (k) possible difficulty in
identifying a purchaser of securities held by a Portfolio due to the
underdeveloped nature of the securities markets.
There is little historical data on Russian securities markets because they
are relatively new and a substantial proportion of securities transactions in
Russia are privately negotiated outside of stock exchanges. Because of the
recent formation of the securities markets as well as the underdeveloped
state of the banking and telecommunications systems, settlement, clearing and
registration of securities transactions are subject to significant risks.
Ownership of shares (except where shares are held through depositories that
meet the requirements of the 1940 Act) is defined according to entries in the
company's share register and normally evidenced by extracts from the register
or by formal share certificates. However, there is no central registration
system for shareholders and these services are carried out by the companies
themselves or by registrars located throughout Russia. These registrars are
not necessarily subject to effective state supervision and it is possible for
a Portfolio to lose its registration through fraud, negligence or even mere
oversight. While a Portfolio investing in Russian securities will endeavor to
ensure that its interest continues to be appropriately recorded either itself
or through a custodian or other agent inspecting the share register and by
obtaining extracts of share registers through regular confirmations, these
extracts have no legal enforceability and it is possible that subsequent
illegal amendment or other fraudulent act may deprive the Portfolio 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 Portfolio 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 Portfolio from investing in the securities of certain
Russian companies deemed suitable by the Manager. Further, this also could
cause a delay in the sale of Russian company securities by a Portfolio if a
potential purchaser is deemed unsuitable, which may expose the Portfolio to
potential loss on the investment.
Currency Management Techniques
Forward Foreign Currency Exchange Contracts. A forward foreign currency
exchange contract ("forward contract") involves an obligation to purchase or
sell a specific currency at a future date, which may be any fixed number of
days from the date of the contract agreed upon by the parties, at a price set
at the time of the contract. A forward contract may be for a single price or
for a range of prices. These contracts are traded in the interbank market
conducted directly between currency traders (usually large commercial banks)
and their customers or between broker-dealers and their customers. A forward
contract generally has no deposit requirement, and no commissions are charged
at any stage for trades. Some forward contracts, however, have a cancellation
fee which a Portfolio must pay upon cancellation if such Portfolio determines
that canceling the contract is more favorable to the Portfolio than
completing the contract.
To complete or close a forward contract, a Portfolio may either accept or
make delivery of the currency specified in the contract at maturity, or enter
into a closing purchase transaction on or before the maturity date, which
involves the purchase or sale of an offsetting contract. Closing purchase
transactions with respect to forward contracts are usually effected with the
currency trader who is a party to the original forward contract.
A Portfolio may enter into forward contracts in several circumstances. For
example, when a Portfolio enters into a contract for the purchase or sale of
a security denominated in a foreign currency, or when the Portfolio
anticipates the receipt in a foreign currency of dividends or interest
payments on such a security which it holds, the Portfolio may desire to "lock
in" the dollar price of the security or the dollar equivalent of such
dividend or interest payment, as the case may be. In addition, when a Manager
believes that the currency of a particular foreign country may suffer a
substantial decline against the U.S. dollar, it may enter into a forward
contract to sell, for a fixed amount of dollars, the amount of foreign
currency approximating the value of some or all of the Portfolio's securities
denominated in such foreign currency.
A Portfolio may construct an investment position by combining a debt security
denominated in one currency with a forward contract calling for the exchange
of that currency for another currency. The investment position is not itself
a security but is a combined position (i.e., a debt security coupled with a
forward contract) that is intended to be similar in overall performance to a
debt security denominated in the currency purchased.
For example, an Italian lira-denominated position could be constructed by
purchasing a German mark-denominated debt security and simultaneously
entering into a forward contract to exchange an equal amount of marks for
lira at a future date and at a specified exchange rate. With such a
transaction, the Portfolio may be able to receive a return that is
substantially similar, from a yield and currency perspective, to a direct
investment in lira debt securities (which are relatively limited in size and
number), while also obtaining the benefits of liquidity available from German
mark-denominated debt securities, which may have a lower yield. The Portfolio
may experience slightly different results from its use of such combined
investment positions as compared to its purchase of a debt security
denominated in the particular currency subject to the forward contract. Such
difference may be enhanced or offset by premiums which may be available in
connection with the forward contract.
While a Portfolio may enter into forward contracts to reduce currency
exchange rate risks, changes in currency prices may result in a poorer
overall performance for the Portfolio than if it had not engaged in any such
transaction. Moreover, there may be an imperfect correlation between the
Portfolio's holding of securities denominated in a particular currency and
forward contracts entered into by the Portfolio. Such imperfect correlation
may prevent a Portfolio from achieving the intended hedge or expose the
Portfolio to the risk of foreign exchange loss.
Certain provisions of the Internal Revenue Code of 1986, as amended (the
"Code"), may limit the extent to which a Portfolio may enter into forward
contracts. Such transactions may also affect the character and timing of
income, gain or loss recognized by the Portfolio for U.S. federal income tax
purposes.
Certain Portfolios may engage in cross-hedging by using forward contracts in
one currency to hedge against fluctuations in the value of securities
denominated in a different currency, if the Managers determine that there is
a pattern of correlation between the two currencies. A Portfolio may also
purchase and sell forward contracts for non-hedging purposes when the
Managers anticipate that the foreign currency will appreciate or depreciate
in value, but securities denominated in that currency do not present
attractive investment opportunities and are not held in the Portfolio.
The Portfolio's custodian will segregate cash or liquid securities, as
permitted by applicable regulations, in an amount equal to the value of the
Portfolio's total assets committed to the consummation of forward contracts
requiring the Portfolio to purchase foreign currencies. If the value of the
segregated securities declines, additional cash or securities will be
segregated on a daily basis so that the value of the segregated securities
will equal the amount of the Portfolio's commitments with respect to such
contracts. The segregated securities will be marked-to-market on a daily
basis. Although forward contracts are not presently regulated by the
Commodity Futures Trading Commission (the "CFTC"), the CFTC may in the future
assert authority to regulate these contracts. In such event, a Portfolio's
ability to utilize forward contracts may be restricted.
A Portfolio generally will not enter into a forward contract with a term
greater than one year.
Although a Portfolio may enter into forward contracts to reduce currency
exchange rate risks, transactions in such contracts involve certain other
risks. Thus, while a Portfolio may benefit from such transactions,
unanticipated changes in currency prices may result in a poorer overall
performance for the Portfolio than if it had not engaged in any such
transactions. Moreover, there may be imperfect correlation between a
Portfolio's holdings of securities denominated in a particular currency and
forward contracts entered into by the Portfolio. Such imperfect correlation
may cause a Portfolio to sustain losses which will prevent the Portfolio from
achieving a complete hedge or expose the Portfolio to risk of foreign
exchange loss. The Portfolios may, but are not required, to hedge currency
risks.
Zero Coupon Funds - Special Considerations
As stated in the prospectus for Class 1 shares, each of the Zero Coupon Funds
will be primarily invested in Stripped Government Securities. These include
zero coupon securities issued by the U.S. government and its agencies and
instrumentalities, by a variety of tax-exempt issuers such as state and local
governments and their agencies and instrumentalities and by "mixed-ownership
government corporations." Zero coupon securities usually trade at a deep
discount from their face or par value and are subject to greater market value
fluctuations from changing interest rates than debt obligation of comparable
maturities which make current distributions of interest (cash). As a result,
the net asset value of shares of a Portfolio prior to its Target Date may
fluctuate over a greater range than shares of other mutual funds investing in
U.S. Treasury securities making current distributions of interest and having
similar maturities. The current net asset value of a Portfolio generally will
vary inversely with changes in current interest rates.
The Zero Coupon Funds' zero coupon securities investments will include:
Stripped Treasury Securities, Stripped Government Securities, Stripped
Corporate Securities and Stripped Eurodollar Obligations, as defined in the
prospectus. A holder will separate the interest coupons from the underlying
principal (the "corpus") of the security. A number of securities firms and
banks have stripped the interest coupons and resold them in custodial receipt
programs with a number of different names, including, in the case of stripped
Treasury securities, "Treasury Income Growth Receipts" ("TIGRS") and
Certificate of Accrual on Treasuries ("CATS"). The underlying U.S. Treasury
bonds and notes themselves are held in book-entry form at the Federal Reserve
Bank or, in the case of bearer securities (i.e., unregistered securities
which are owned ostensibly by the bearer or holder thereof), in trust on
behalf of the owners thereof. Counsel to the underwriters of these
certificates or other evidences of ownership of the U.S. Treasury securities
have stated that for federal tax and securities purposes, in their opinion,
purchasers of such certificates, such as the Portfolios, most likely will be
deemed the beneficial holders of the underlying U.S. government securities.
The U.S. Treasury has facilitated transfers of ownership of zero coupon
securities by accounting separately for the beneficial ownership of
particular interest coupon and corpus payments on Treasury securities through
the Federal Reserve book-entry record-keeping system. The Federal Reserve
program as established by the Treasury Department is known as "STRIPS" or
"Separate Trading of Registered Interest and Principal of Securities." Under
the STRIPS program, a Portfolio will be able to have its beneficial ownership
of zero coupon securities recorded directly in the book-entry record-keeping
system in lieu of having to hold certificates or other evidences of ownership
of the underlying U.S. Treasury securities. When U.S. Treasury obligations
have been stripped of their unmatured interest coupons by the holder, the
stripped coupons are sold separately or grouped with other coupons with like
maturity dates and sold in such bundled form. The principal or corpus is sold
at a deep discount because the buyer receives only the right to receive a
future fixed payment on the security and does not receive any rights to
periodic interest (cash) payments. Purchasers of stripped obligations
acquire, in effect, discount obligations that are economically identical to
the zero coupon securities that the Treasury sells itself. Other facilities
are available to facilitate the transfer of ownership of non-Treasury zero
coupon securities by accounting separately for the beneficial ownership of
particular interest coupon and corpus payments on such securities through a
book-entry record-keeping system.
Under normal circumstances, each Zero Coupon Fund will invest at least 65% of
its net assets in stripped securities. For short-term or emergency purchases,
the Zero Coupon Funds may purchase interest-paying U.S. government securities
and other money market instruments. The Zero Coupon Funds may enter into
repurchase agreements with respect to securities in which the Zero Coupon
Funds invest. These interest-paying securities produce income which may be an
efficient way to provide for expenses and redemptions to make benefit or
surrender payments, among other things.
Management of Reinvestment Risk and Anticipated Growth - The Zero Coupon
Funds seek to minimize unknown reinvestment risk. Reinvestment risk arises
from the uncertainty as to the total return which will be realized from
conventional interest-paying bonds due to the fact that periodic interest
(cash) will be reinvested in the future at interest rates unknown at the time
of the original purchase. With zero coupon securities, however, there are no
cash distributions to reinvest, so owners thereof bear no unknown
reinvestment risk if they hold a zero coupon security to maturity.
For a person who makes a direct investment in a zero coupon security (rather
than through a portfolio which invests in such instruments) and holds it to
maturity, the return or yield to maturity is certain regardless of whether
interim reinvestment rates rise or fall. (See table below).
Total Ending Value on a $1,000 Investment
- ------------------------------------------------------------------------------
Coupon Initial Yield (Realized Yield) if Reinvestment Rates are:
Interest Maturity to Maturity 3% 5% 7% 9% 11%
- ------------------------------------------------------------------------------
7% 10 Years 7% $1,809 $1,894 $1,990 $2,098 $2,220
(6.11%) (6.60%) (7.12%) (7.69%) (8.30%)
0% 10 Years 7% $1,990 $1,990 $1,990 $1,990 $1,990
(7.12%) (7.12%) (7.12%) (7.12%) (7.12%)
These results assume semi-annual compounding. For illustration purposes only,
the table above assumes these reinvestment rates would remain constant over
the life of the bond. The actual reinvestment rates and total returns of
coupon-paying bonds will vary with changing market conditions.
Due to the nature of Stripped Government Securities, which may comprise 80%
or more of the investments of each Zero Coupon Fund, the reinvestment risk
accompanying these Portfolios is expected to be less than would be the case
if these Portfolios were entirely invested in interest (cash)-paying
securities. Furthermore, the Portfolio's Manager will attempt to manage
reinvestment risk by maintaining each Portfolio's average duration within
twelve months of a Portfolio's Target Date.
Duration is a measure of the length of an investment which takes into
account, through present value analysis, the timing and amount of any
interest payments as well as the amount of the principal repayment. Duration
is commonly used by professional managers to help control reinvestment risk
by balancing investments with slightly longer and shorter maturities than the
investment horizon of the overall portfolio.
The investment return of a Zero Coupon Fund, if the investment is held to
maturity, will consist primarily of the amortization of discount on the
underlying securities owned by such Portfolio (i.e., the difference between
their purchase price and their maturity value) and will be realized on the
specified Target Date. Changes in the market value of the Portfolio's
securities will affect investment return should investors redeem prior to
maturity, as can the skill of the Manager in managing the Portfolio.
Liquidation and Distribution of Assets in Target Year - As securities in a
Zero Coupon Fund's portfolio mature or are sold throughout the Target Year,
the proceeds will be invested in Money Market Instruments. By December of
that year, substantially all of the assets of the Portfolio will consist of
such Money Market Instruments and other then-maturing securities. These
instruments will be sold or allowed to mature, the liabilities of the
Portfolio will be discharged or provision made therefor, and the net assets
will be reinvested at the direction of Contract owners in one of the other
Portfolios of the Trust or automatically reinvested as stated in the
prospectus. The estimated expenses of terminating and liquidating a Portfolio
will be accrued ratably over its Target Year. These expenses, which are
charged to income as are all expenses, are not expected to exceed
significantly the ordinary annual expenses incurred by the Portfolio and,
therefore, should have no significant additional effect on the maturity value
of the Portfolio.
INVESTMENT METHODS AND RISKS COMMON TO MORE THAN ONE PORTFOLIO
- ------------------------------------------------------------------------------
Certain types of investments and investment techniques authorized for more
than one Portfolio, as stated in the descriptions of the individual
Portfolios in the prospectus, are described below and in the prospectus. All
policies and percentage limitations are considered at the time of purchase,
and refer to total assets, unless otherwise noted. Each of the Portfolios
will not necessarily use the strategies described to the full extent
permitted unless the Managers believe that doing so will help a Portfolio
reach its objectives, and not all instruments or strategies will be used at
all times.
Convertible Securities
Enhanced Convertible Securities. Consistent with their respective investment
policies, certain Portfolios may invest in convertible preferred stocks that
offer enhanced yield features, such as Preferred Equity Redemption Cumulative
Stock ("PERCS"), which provide an investor, such as a Portfolio, with the
opportunity to earn higher dividend income than is available on a company's
common stock. A PERCS is a preferred stock which generally features a
mandatory conversion date, as well as a capital appreciation limit which is
usually expressed in terms of a stated price. Most PERCS expire three years
from the date of issue, at which time they are convertible into common stock
of the issuer (PERCS are generally not convertible into cash at maturity).
Under a typical arrangement, if after three years the issuer's common stock
is trading at a price below that set by the capital appreciation limit, each
PERCS would convert to one share of common stock. If, however, the issuer's
common stock is trading at a price above that set by the capital appreciation
limit, the holder of the PERCS would receive less than one full share of
common stock. The amount of that fractional share of common stock received by
the PERCS holder is determined by dividing the price set by the capital
appreciation limit of the PERCS by the market price of the issuer's common
stock. PERCS can be called at any time prior to maturity, and hence do not
provide call protection. However if called early the issuer must pay a call
premium over the market price to the investor. This call premium declines at
a preset rate daily, up to the maturity date of the PERCS.
Certain Portfolios may also invest in other classes of enhanced convertible
securities. These include but are not limited to ACES (Automatically
Convertible Equity Securities), PEPS (Participating Equity Preferred Stock),
PRIDES (Preferred Redeemable Increased Dividend Equity Securities), SAILS
(Stock Appreciation Income Linked Securities), TECONS (Term Convertible
Notes), QICS (Quarterly Income Cumulative Securities), and DECS (Dividend
Enhanced Convertible Securities). ACES, PEPS, PRIDES, SAILS, TECONS, QICS,
and DECS all have the following features: they are issued by a company, the
common stock of which will be received in the event the convertible preferred
stock is converted; unlike PERCS, they do not have a capital appreciation
limit; they seek to provide the investor with high current income with some
prospect of future capital appreciation; they are typically issued with three
to four-year maturities; they typically have some built-in call protection
for the first two to three years; investors have the right to convert them
into shares of common stock at a preset conversion ratio or hold them until
maturity, and upon maturity they will automatically convert to either cash or
a specified number of shares of common stock.
Similarly, there may be enhanced convertible debt obligations issued by an
operating company whose common stock is to be acquired in the event the
security is converted or by a different issuer, such as an investment bank.
These securities may be identified by names such as ELKS (Equity Linked
Securities) or similar names. Typically, they share most of the salient
characteristics of an enhanced convertible preferred stock but will be ranked
as senior or subordinated debt in the issuer's corporate structure according
to the terms of the debt indenture. There may be additional types of
convertible securities not identified here which are also similar to those
described above in which a Portfolio may invest, consistent with its
objectives and policies.
An investment in an enhanced convertible security or any other security may
involve additional risk to a Portfolio. A Portfolio may have difficulty
disposing of such securities because there may be a thin trading market for a
particular security at any given time. Reduced liquidity may have an adverse
impact on market price and a Portfolio's ability to dispose of particular
securities, when necessary, to meet the Portfolio's liquidity needs or in
response to a specific economic event, such as the deterioration in the
creditworthiness of an issuer. Reduced liquidity in the secondary market for
certain securities may also make it more difficult for a Portfolio to obtain
market quotations based on actual trades for purposes of valuing the
Portfolio's investments. Each Portfolio, however, intends to acquire liquid
securities, though there can be no assurances that this will be achieved.
Synthetic Convertibles. Certain Portfolios may invest a portion of their
assets in "synthetic convertible" securities. A synthetic convertible is
created by combining distinct securities which together possess the two
principal characteristics of a true convertible security, i.e., fixed income
and the right to acquire the underlying equity security. This combination is
achieved by investing in nonconvertible fixed-income securities and in
warrants or stock or stock index call options which grant the holder the
right to purchase a specified quantity of securities within a specified
period of time at a specified price or to receive cash in the case of stock
index options. Synthetic convertible securities are generally not considered
to be "Equity Securities" for purposes of each Portfolio's investment policy
regarding those securities.
Synthetic convertible securities differ from the true convertible security in
several respects. The value of a synthetic convertible is the sum of the
values of its fixed-income component and its convertibility component. Thus,
the values of a synthetic convertible and a true convertible security will
respond differently to market fluctuations. Further, although the Managers
expect normally to create synthetic convertibles whose two components
represent one issuer, the character of a synthetic convertible allows a
Portfolio to combine components representing distinct issuers, or to combine
a fixed income security with a call option on a stock index, when the
Managers determine that such a combination would better promote a Portfolio's
investment objectives. In addition, the component parts of a synthetic
convertible security may be purchased simultaneously or separately; and the
holder of a synthetic convertible faces the risk that the price of the stock,
or the level of the market index underlying the convertibility component will
decline.
Illiquid Securities
The Portfolios reserve the right to invest up to 10% of their net assets in
illiquid securities, except that the Global Health Care, International
Smaller Companies, Mutual Discovery, Mutual Shares and Value Funds reserve
the right to invest up to 15% in such investments. 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
Portfolio has valued the instrument. Subject to this limitation, the Board
has authorized each Portfolio to invest in restricted securities where such
investment is consistent with the Portfolio's investment objective and has
authorized such securities to be considered to be liquid to the extent the
Portfolio's 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 Portfolios' Managers to treat a restricted security as liquid on a
regular basis, including the 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 Portfolios'
Managers and the Board of Trustees (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
Portfolio invests in restricted securities that are deemed liquid, the
general level of illiquidity in the applicable Portfolio may be increased if
qualified institutional buyers become uninterested in purchasing these
securities or the market for these securities contracts.
Interest Rate Swaps
Certain of the Portfolios may also participate in interest rate swaps. An
interest rate swap is the transfer between two counterparties of interest
rate obligations, one of which has an interest rate fixed to maturity while
the other has an interest rate that changes in accordance with changes in a
designated benchmark (e.g., LIBOR, prime, commercial paper, or other
benchmarks). The obligations to make repayment of principal on the underlying
securities are not exchanged. Such transactions generally require the
participation of an intermediary, frequently a bank. The entity holding the
fixed-rate obligation will transfer the obligation to the intermediary, and
such entity will then be obligated to pay to the intermediary a floating rate
of interest, generally including a fractional percentage as a commission for
the intermediary. The intermediary also makes arrangements with a second
entity which has a floating-rate obligation which substantially mirrors the
obligation desired by the first party. In return for assuming a fixed
obligation, the second entity will pay the intermediary all sums that the
intermediary pays on behalf of the first entity, plus an arrangement fee and
other agreed upon fees. Interest rate swaps are generally entered into to
permit the party seeking a floating rate obligation the opportunity to
acquire such obligation at a lower rate than is directly available in the
credit market, while permitting the party desiring a fixed-rate obligation
the opportunity to acquire such a fixed-rate obligation, also frequently at a
price lower than is available in the capital markets. The success of such a
transaction depends in large part on the availability of fixed-rate
obligations at a low enough coupon rate to cover the cost involved.
Inverse Floaters
These are instruments with floating or variable interest rates that move in
the opposite direction, usually at an accelerated speed, to short-term
interest rates or interest rate indices. As with other mortgage-backed
securities, interest rate declines may result in accelerated prepayment of
mortgages and the proceeds from such prepayment must be reinvested at lower
prevailing interest rates. During periods of extreme fluctuations in interest
rates, the resulting fluctuation could affect the net asset value of a
Portfolio in proportion to the Portfolio's investment in inverse floaters. An
accelerated decline in interest rates creates a higher degree of volatility
and risk.
Mortgage and Asset-Backed Securities
This section contains additional information about adjustable rate mortgage
securities ("ARMS"), collateralized mortgage obligations ("CMOs"), which may
have "caps and floors" and "resets," asset-backed securities, and stripped
mortgage-backed securities.
Adjustable Rate Mortgage Securities ("ARMS"). ARMS are pass-through mortgage
securities which are collateralized by mortgages with adjustable rather than
fixed interest rates. The ARMS in which the Portfolios invest are issued
primarily by the Government National Mortgage Association ("GNMA"), the
Federal National Mortgage Association ("FNMA"), and the Federal Home Loan
Mortgage Corporation ("FHLMC"), and are actively traded in the secondary
market. The underlying mortgages which collateralize ARMS issued by GNMA are
fully guaranteed by the Federal Housing Administration ("FHA") or the
Veterans Administration ("VA"), while those collateralizing ARMS issued by
FHLMC or FNMA are typically conventional residential mortgages conforming to
standard underwriting size and maturity constraints.
Unlike fixed-rate mortgages, which generally decline in value during periods
of rising interest rates, adjustable rate mortgage securities may allow a
Portfolio to participate in increases in interest rates through periodic
adjustments in the coupon rates of the underlying mortgages, resulting in
both higher current yields and lower price fluctuations. Furthermore, if
prepayments of principal are made on the underlying mortgages during periods
of rising interest rates, a Portfolio generally will be able to reinvest such
amounts in securities with a higher current rate of return. A Portfolio will
not, however, benefit from increases in interest rates to the extent that
interest rates rise to the point where they cause the current coupon of
adjustable rate mortgages held as investments to exceed the maximum allowable
annual or lifetime reset limits (or "cap rates") for a particular mortgage.
The adjustable interest rate feature of the underlying mortgages generally
will act as a buffer to reduce sharp changes in the ARMS value in response to
normal interest rate fluctuations. As the coupon rates on the mortgages
underlying the ARMS are reset periodically, yields of portfolio securities
will gradually align themselves to reflect changes in market rates and should
cause the ARMS' values to fluctuate less dramatically than those of more
traditional long-term, fixed-rate debt obligations. During periods of rising
interest rates, however, changes in the coupon rate lag behind changes in the
market rate, resulting in lower ARMS values until the coupon resets to market
rates. Since most mortgage securities in the Portfolios will generally have
annual reset caps of 100 to 200 basis points, fluctuation in interest rates
above these levels could cause such mortgage securities to "cap out" and to
behave more like long-term, fixed-rate debt obligations.
ARMS differ from conventional bonds in that principal is paid back over the
life of the ARMS rather than at maturity. As a result, the holder of the ARMS
receives monthly scheduled payments of principal and interest, and may
receive unscheduled principal payments representing prepayments on the
underlying mortgages. When the holder reinvests the payments and any
unscheduled prepayments of principal it receives, it may receive a rate of
interest which is lower than the rate on the existing ARMS. For this reason,
ARMS may be less effective than other types of U.S. Government Securities as
a means of "locking in" long-term interest rates.
Collateralized Mortgage Obligations ("CMOs"). CMOs, considered derivative or
complex securities, are securities collateralized by pools of mortgage loans
created by commercial banks, savings and loan institutions, private mortgage
insurance companies, mortgage bankers, and other issuers in the U.S. Timely
payment of interest and principal (but not the market value) of these pools
is supported by various forms of insurance or guarantees issued by U.S.
Government agencies, private issuers, and mortgage poolers; however, the
obligation itself is not guaranteed. If the collateral securing the
obligations is insufficient to make payment on the obligation, a holder could
sustain a loss. In addition, a Portfolio may buy CMOs without insurance or
guarantees if, in the opinion of the Managers, the sponsor is creditworthy.
The ratings of the CMOs will be consistent with the ratings criteria of the
Portfolio. Prepayments of the mortgages included in the mortgage pool may
influence the yield of the CMO. Prepayments usually increase when interest
rates are decreasing, thereby decreasing the life of the pool. Reinvestment
of prepayments may be at a lower rate than that on the original CMO. As a
result, the value of CMOs decrease like other debt obligations when interest
rates rise, but when interest rates decline, they may not increase as much as
other debt obligations, due to the prepayment feature.
Resets. The interest rates paid on ARMS and CMOs generally are readjusted at
intervals of one year or less to an increment over some predetermined
interest rate index. There are several main categories of indices: those
based on U.S. Treasury securities, those based on the London Interbank Offer
Rate ("LIBOR"), and those derived from a calculated measure such as a cost of
funds index or a moving average of mortgage rates.
Caps and Floors. The underlying mortgages which collateralize ARMS and CMOs
will frequently have caps and floors which limit the maximum amount by which
the loan rate to the residential borrower may change up or down (1) per reset
or adjustment interval and (2) over the life of the loan. Some residential
mortgage loans restrict periodic adjustments by limiting changes in the
borrower's monthly principal and interest payments rather than limiting
interest rate changes. These payment caps may result in negative amortization
(that is, an increase in the principal due). In periods of rising interest
rates, certain coupons may be temporarily "capped out" resulting in declines
in the prices of those securities and, therefore, a negative effect on share
price. Conversely, in periods of declining interest rates, certain coupons
may be temporarily "floored out" resulting in an increase in the prices of
those securities and therefore, a positive effect on a Portfolio's share
price.
Asset-Backed Securities. Asset-backed securities represent participation in,
or are secured by and payable from, assets such as motor vehicle installment
sale contracts, installment loan contracts, leases of various types of real
and personal property, receivables from revolving credit (credit card)
agreements and other categories of receivables. Such securities are generally
issued by trusts and special purpose corporations.
Like mortgage-backed securities, asset-backed securities are often subject to
more rapid repayment than their stated maturity dates would indicate as a
result of the pass-through of prepayments of principal on the underlying
loans. During periods of declining interest rates, prepayment of loans
underlying asset-backed securities can be expected to accelerate, and thus
impair a Portfolio's ability to reinvest the returns of principal at
comparable yields. Accordingly, the market values of such securities will
vary with changes in market interest rates generally and in yield
differentials among various kinds of U.S. Government Securities and
mortgage-backed and asset-backed securities. Asset-backed securities present
certain additional risks that are not presented by mortgage-backed securities
because asset-backed securities generally do not have the benefit of a
security interest in collateral that is comparable to mortgage assets. There
is the possibility that, in some cases, recoveries on repossessed collateral
may not be available to support payments on these securities.
Stripped Mortgage-Backed Securities. Stripped mortgage securities are
derivative multi-class mortgage securities. Stripped mortgage securities may
be issued by agencies or instrumentalities of the U.S. government, or by
private originators of, or investors in, mortgage loans, including savings
and loan associations, mortgage banks, commercial banks, investment banks and
special purpose subsidiaries of the foregoing. Stripped mortgage securities
have greater market volatility than other types of mortgage securities in
which a Portfolio may invest.
Stripped mortgage securities are usually structured with two classes that
receive different proportions of the interest and principal distributions on
a pool of mortgage assets. A common type of stripped mortgage security will
have one class receiving some of the interest and most of the principal from
the mortgage assets, while the other class will receive most of the interest
and the remainder of the principal. In the most extreme case, one class will
receive all of the interest (the interest-only or "IO" class), while the
other class will receive all of the principal (the principal-only or "PO"
class). The yield to maturity on an IO class is extremely sensitive not only
to changes in prevailing interest rates but also to the rate of principal
payments (including prepayments) on the related underlying mortgage assets,
and a rapid rate of principal payments may have a material adverse effect on
a Portfolio's yield to maturity. If the underlying mortgage assets experience
greater than anticipated prepayments of principal, a Portfolio may fail to
fully recoup its initial investment in these securities even if the
securities are rated in the highest rating categories, AAA or Aaa, by S&P or
Moody's, respectively.
Stripped mortgage securities are purchased and sold by institutional
investors, such as the Portfolios, through several investment banking firms
acting as brokers or dealers. As these securities were only recently
developed, traditional trading markets have not yet been established for all
such securities. Accordingly, some of these securities may generally be
illiquid. The staff of the SEC (the "Staff") has indicated that only
government-issued IO or PO securities which are backed by fixed-rate
mortgages may be deemed to be liquid, if procedures with respect to
determining liquidity are established by a portfolio's board. The Board may,
in the future, adopt procedures which would permit a Portfolio to acquire,
hold, and treat as liquid government-issued IO and PO securities. At the
present time, however, all such securities will continue to be treated as
illiquid and will, together with any other illiquid investments, not exceed
10% of a Portfolio's net assets. Such position may be changed in the future,
without notice to shareholders, in response to the Staff's continued
reassessment of this matter as well as to changing market conditions.
Municipal Securities
Municipal securities are debt obligations issued by local and state
governments that provide interest income which can be either taxable or tax
exempt. Municipal securities include both municipal bonds (those securities
with maturities of five years or more) and municipal notes (those with
maturities of less than five years). Generally, municipal securities are used
to raise money for various public purposes such as constructing public
facilities and making loans to public institutions. Taxable municipal bonds
are generally issued to provide funding for privately operated facilities.
Municipal notes are issued to meet the short-term funding requirements of
local, regional, and state governments. General obligation municipal
securities are secured by the issuer's pledge of full faith, credit and
taxing power. Revenue or special tax bonds are payable from the revenues
derived from a particular facility or, in some cases, from a special excise
or other tax, but not from general tax revenue.
Options and Futures
Certain Portfolios, as described in the Trust's prospectus, may write covered
put or call options, purchase put and call options, or engage in futures
transactions.
Writing Options. All options written by a Portfolio will be "covered." Call
options written by a Portfolio give the holder the right to buy the
underlying securities from the Portfolio at a stated exercise price. Put
options written by a Portfolio give the holder the right to sell the
underlying security to the Portfolio at a stated exercise price.
A call option written by a Portfolio is "covered" if that Portfolio owns the
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 is also covered if a Portfolio 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 (a) is equal to or less than the exercise price of the call
written or (b) is greater than the exercise price of the call written if the
difference is maintained by a Portfolio in cash and high grade debt
obligations in a segregated account with its custodian.
A put option written by a Portfolio is "covered" if the Portfolio segregates
cash and liquid securities, as permitted by applicable regulations, with a
value equal to the exercise price 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. The premium paid by the purchaser of an option will
reflect, among other things, the relationship of the exercise price to the
market price and volatility of the underlying security, the remaining term of
the option, supply and demand, and interest rates.
The writing of covered put options involves certain risks. For example, if
the market price of the underlying security rises or otherwise is above the
exercise price, the put option will expire worthless and the Portfolio's gain
will be limited to the premium received. If the market price of the
underlying security declines or otherwise is below the exercise price, a
Portfolio may attempt to close the position or take delivery of the security
at the exercise price, and the Portfolio's return will be the premium
received from the put options minus the amount by which the market price of
the security is below the exercise price.
The writer of an option that wishes to terminate its obligation may effect a
"closing purchase transaction." This is accomplished by buying an option of
the same series as the option previously written. The effect of the purchase
is that the writer's position will be canceled by the clearing corporation.
However, a writer may not effect a closing purchase transaction after being
notified of the exercise of an option. Likewise, an investor who is the
holder of an option may liquidate its position by effecting a "closing sale
transaction." This is accomplished by selling an option of the same series as
the option previously purchased. If a secondary market does not exist, it
might not be possible to effect closing sale transactions in particular
options held by a Portfolio, with the result that the Portfolio would have to
exercise the options in order to realize any profit. The premium which a
Portfolio will pay in executing a closing purchase transaction may be higher
or lower than the premium it received when writing the option, depending in
large part upon the relative price of the underlying security at the time of
each transaction. If a Portfolio is unable to effect a closing purchase
transaction with respect to options it has written in a secondary market, it
will not be able to sell the underlying security or other asset covering the
option until the option expires or it delivers the underlying security or
asset upon exercise.
Purchasing Options. Put options on particular securities may be purchased to
protect against a decline in the market value of the underlying security
below the exercise price less the premium paid for the option. A put option
gives the holder the right to sell the underlying security at the option
exercise price at any time during the option period. The ability to purchase
put options will allow a Portfolio to protect the unrealized gain in an
appreciated security in its portfolio without actually selling the security.
In addition, a Portfolio will continue to receive interest or dividend income
on the security. A Portfolio may sell a put option which it has previously
purchased prior to the sale of the securities underlying such option. Such
sales will result in a net gain or loss, depending on whether the amount
received on the sale is more or less than the premium and other transaction
costs paid for the put option that is sold. Such gain or loss may be wholly
or partially offset by a change in the value of the underlying security which
the Portfolio owns or has the right to acquire.
Call options on securities may be purchased to limit the risk of a
substantial increase in the market price of such security. A Portfolio may
also purchase call options on securities held in its portfolio and on which
it has written a call option. A call option gives the holder the right to buy
the underlying securities from the option writer at a stated exercise price.
Prior to its expiration, a call option may be sold in a closing sale
transaction. Profit or loss from such a sale will depend on whether the
amount received is more or less than the premium paid for the call option
plus the related transaction costs. When a Portfolio writes a call option on
one of its portfolio securities and the underlying securities do not reach a
price level which would make the exercise of the option profitable to the
holder of the option, the option will generally expire without being
exercised. However, if the underlying securities rise in price and the option
is exercised, the Portfolio will not participate in any increase in the price
of the underlying securities beyond the exercise price of the option.
Options on Stock Indices. Call and put options on stock indices may be
purchased and written to hedge against the risk of market or industry-wide
stock price fluctuations or to increase income to the Portfolio. Call and put
options on stock indices are similar to options on securities except that,
rather than the right to purchase or sell particular securities at a
specified price, options on a stock index give the holder the right to
receive, upon exercise of the option, an amount of cash if the closing level
of the underlying stock index is greater than (or less than, in the case of
puts) the exercise price of the option. This amount of cash is equal to the
difference between the closing price of the index and the exercise price of
the option, expressed in dollars multiplied by a specified number. Thus,
unlike options on individual securities, all settlements are in cash, and
gain or loss depends on price movements in the stock market generally (or in
a particular industry or segment of the market) rather than price movements
in individual securities. When a Portfolio writes an option on a stock index,
it will segregate cash or liquid securities, as permitted by applicable
regulations, with its custodian in an amount at least equal to the market
value of the option and will continue this segregation while the option is
open or will otherwise cover the transaction.
Combining Option Transactions. Certain Portfolios may also (i) buy puts and
write calls on the same portfolio security in "forward conversion"
transactions; (ii) engage in "spread" transactions in which a Portfolio
purchases and writes a put or call option on the same security with the
options having different exercise prices and/or expiration dates; (iii)
engage in "straddles" in which the Portfolio may purchase or write
combinations of put and call options on the same security; and (iv) purchase
a security and then write a call option against that security in a
"buy-and-write" transaction. Spread and straddle transactions may involve a
limited degree of investment leverage, and a Portfolio will not engage in
spreads or straddles if, as a result, more than 5% of its net assets will be
invested in such option transactions.
Special Risks Associated With Options. Options on securities traded on
national securities exchanges are within the jurisdiction of the SEC, as are
other securities traded on such exchanges. As a result, many of the
protections provided to traders on organized exchanges will be available with
respect to such transactions. In particular, all option positions entered
into on a national securities exchange are cleared and guaranteed by the
Options Clearing Corporation, thereby reducing the risk of counterparty
default. Further, a liquid secondary market in options traded on a national
securities exchange may be more readily available than in the
over-the-counter market, potentially permitting a Portfolio to liquidate open
positions at a profit prior to exercise or expiration, or to limit losses in
the event of adverse market movements. Over-the-counter options and the
assets used to cover such options will be considered illiquid securities and
will not, together with any other illiquid securities, exceed 10% of a
Portfolio's net assets.
An exchange traded options position may be closed out only on an options
exchange which provides a secondary market for an option of the same series.
Although a Portfolio will generally purchase or write only those options for
which there appears to be an active secondary market, there is no assurance
that a liquid secondary market on an exchange will exist for any particular
option, or at any particular time. For some options, no secondary market on
an exchange may exist. In such event, it might not be possible to effect
closing transactions in particular options, with the result that a Portfolio
would have to exercise its options in order to realize any profit and would
incur transaction costs upon the sale of underlying securities pursuant to
the exercise of put options. If a Portfolio as a covered call option writer
is unable to effect a closing purchase transaction in a secondary market, it
will not be able to sell the underlying currency (or security denominated in
that currency) until the option expires or it delivers the underlying
currency upon exercise. There is no assurance that higher than anticipated
trading activity or other unforeseen events might not, at times, render
certain of the facilities of the Options Clearing Corporation inadequate, and
thereby result in the institution by an exchange of special procedures which
may interfere with the timely execution of customers' orders.
Options on securities may be traded over-the-counter. In an over-the-counter
trading environment, many of the protections afforded to exchange
participants will not be available. For example, there are no daily price
fluctuation limits, and adverse market movements could therefore continue to
an unlimited extent over a period of time. The Portfolio, when it is the
purchaser of an option, is at risk only to the full extent of the premium it
has paid for the option. The Portfolio, when it is the writer of an option,
is at risk for the difference between the price at which the option is
exercisable and the market price of the underlying security, minus the amount
of the premium received.
The amount of the premiums which a Portfolio may pay or receive may be
adversely affected as new or existing institutions, including other
investment companies, engage in or increase their option purchasing and
writing activities.
The risks of transactions in options on foreign exchanges are similar to the
risks of investing in foreign securities. In addition, a foreign exchange may
impose different exercise and settlement terms and procedures and margin
requirements than a U.S. exchange.
FUTURES CONTRACTS. Certain of the Portfolios may enter into contracts for the
purchase or sale for future delivery of debt securities or currency ("futures
contracts"), or may purchase and sell financial futures contracts. As long as
required by regulatory authorities, each Portfolio will limit its use of
futures contracts to hedging transactions in order to avoid being a commodity
pool. A "sale" of a futures contract means the acquisition and assumption of
a contractual right and obligation to deliver the securities or currency
called for by the contract at a specified price on a specified settlement
date. A "purchase" of a futures contract means the acquisition and assumption
of a contractual right and obligation to acquire the securities or currency
called for by the contract at a specified price on a specified date. U.S.
futures contracts have been designed by exchanges which have been designated
"contract markets" by the CFTC and must be executed through a futures
commission merchant or brokerage firm, which is a member of the relevant
contract market. Existing contract markets for futures contracts on debt
securities include the Chicago Board of Trade, the New York Cotton Exchange,
the Mid-America Commodity Exchange (the "MCE"), and International Money
Market of the Chicago Mercantile Exchange (the "IMM"). Existing contract
markets for futures contracts on currency include the MCE, the IMM and the
London International Financial Futures Exchange. Futures contracts trade on
these markets, and, through their clearing corporations, the exchanges
guarantee performance of the contracts as between the clearing members of the
exchange. A Portfolio may enter into futures contracts which are based on
foreign currencies, interest rates, or on debt securities that are backed by
the full faith and credit of the U.S. government, such as long-term U.S.
Treasury bonds, Treasury notes, Government National Mortgage Association
modified pass-through mortgage-backed securities, and three-month U.S.
Treasury bills. A Portfolio may also enter into futures contracts which are
based on corporate securities and non-U.S. government debt securities, but
such futures contracts are not currently available.
At the time a futures contract is purchased or sold, the Portfolio must
deposit cash or securities in a segregated account ("initial deposit") with
the Portfolio's custodian. It is expected that the initial deposit would be
approximately 1% to 5% of a contract's face value. Thereafter, the futures
contract is valued daily and the payment of "variation margin" may be
required since each day the Portfolio would pay or receive cash that reflects
any decline or increase in the contract's value.
At the time of delivery of securities on the settlement date of a contract,
adjustments are made to recognize differences in value arising from the
delivery of securities with a different interest rate from that specified in
the contract. In some (but not many) cases, securities called for by a
futures contract may not have been issued when the contract was written.
Although futures contracts by their terms call for the actual delivery or
acquisition of currency or securities, in most cases the contractual
obligation is terminated before the settlement date of the contract without
having to make or take delivery of the securities. The termination of a
contractual obligation is accomplished by buying (or selling, as the case may
be) on a commodities exchange an identical offsetting futures contract
calling for delivery in the same month. Such a transaction, which is effected
through a member of an exchange, cancels the obligation to make or take
delivery of the underlying currency or security. Since all transactions in
the futures market are made, offset or fulfilled through a clearing house
associated with the exchange on which the contracts are traded, the
Portfolios will incur brokerage fees when they purchase or sell futures
contracts.
The purpose of the purchase or sale of a futures contract by the Portfolios
is to attempt to protect the Portfolios from fluctuations in interest or
currency exchange rates without actually buying or selling long-term,
fixed-income securities or currency. For example, if a Portfolio owns
long-term bonds and interest rates were expected to increase, such Portfolio
might enter into futures contracts for the sale of debt securities. Such a
sale would have much the same effect as selling an equivalent value of the
long-term bonds owned by a Portfolio. If interest rates did increase, the
value of the debt securities owned by a Portfolio would decline, but the
value of the futures contracts to such Portfolio would increase at
approximately the same rate, thereby keeping the net asset value of the
Portfolio from declining as much as it otherwise would have. A Portfolio
could accomplish similar results by selling bonds with long maturities and
investing in bonds with short maturities when interest rates are expected to
increase. However, since the futures market is often more liquid than the
cash (securities) market, the use of futures contracts as an investment
technique allows a Portfolio to maintain a defensive position without having
to sell its portfolio securities. Similarly, if a Portfolio expects that a
foreign currency in which its securities are denominated will decline in
value against the U.S. dollar, the Portfolio may sell futures contracts on
that currency. If the foreign currency does decline in value, the decrease in
value of the security denominated in that currency will be offset by an
increase in the value of the Portfolio's futures position.
Alternatively, when it is expected that interest rates may decline, futures
contracts may be purchased in an attempt to hedge against the anticipated
purchase of long-term bonds at higher prices. Since the fluctuations in the
value of futures contracts should be similar to that of long-term bonds, the
Portfolio could take advantage of the anticipated rise in the value of
long-term bonds without actually buying them until the market had stabilized.
At that time, the futures contracts could be liquidated and such Portfolio
could then buy long-term bonds on the cash (securities) market. Similarly, if
a Portfolio intends to acquire a security or other asset denominated in a
currency that is expected to appreciate against the U.S. dollar, the
Portfolio may purchase futures contracts on that currency. If the value of
the foreign currency does appreciate, the increase in the value of the
futures position will offset the increased U.S. dollar cost of acquiring the
asset denominated in that currency. To the extent a Portfolio enters into
futures contracts for this purpose, the assets in the segregated asset
account maintained to cover the Portfolio's purchase obligations with respect
to such futures contracts will consist of cash, cash equivalents or high
quality debt securities from its portfolio in an amount equal to the
difference between the fluctuating market value of such futures contracts and
the aggregate value of the initial and variation margin payments made by the
Portfolio with respect to such futures contracts.
The ordinary spreads between prices in the cash (securities or foreign
currency) and futures markets, due to differences in the natures of those
markets, are subject to distortions. First, all participants in the futures
markets are subject to initial deposit and variation margin requirements.
Rather than meeting additional variation margin requirements, investors may
close futures contracts through offsetting transactions which could distort
the normal relationship between the cash (securities or foreign currency) and
futures markets. Second, the liquidity of the futures market depends on
participants entering into offsetting transactions rather than making or
taking delivery. To the extent participants decide to make or take delivery,
liquidity in the futures market could be reduced, thus causing distortions.
Due to the possibility of such distortion, a correct forecast of general
interest rate trends by the Manager may still not result in a successful
hedging transaction.
In addition, futures contracts entail certain risks. Although the Managers
believe that the use of such contracts will benefit a Portfolio, if the
Manager's investment judgment about the general direction of interest or
currency exchange rates is incorrect, a Portfolio's overall performance would
be poorer than if it had not entered into any such contract. For example, if
the Portfolio has hedged against the possibility of an increase in interest
rates which would adversely affect the price of bonds held in its portfolio
and interest rates decrease instead, the Portfolio will lose part or all of
the benefit of the increased value of its bonds which it has hedged because
it will have offsetting losses in its futures positions. Similarly, if a
Portfolio sells a foreign currency futures contract and the U.S. dollar value
of the currency unexpectedly increases, the Portfolio will lose the
beneficial effect of such increase on the value of the security denominated
in that currency. In addition, in such situations, if the Portfolio has
insufficient cash, it may have to sell bonds from its portfolio to meet daily
variation margin requirements. Such sales of bonds may be, but will not
necessarily be, at increased prices which reflect the rising market. Such
Portfolio may have to sell securities at a time when it may be
disadvantageous to do so.
Options on Futures Contracts. Certain of the Portfolios are permitted to
purchase and write options on futures contracts for hedging purposes only.
The purchase of a call option on a futures contract is similar in some
respects to the purchase of a call option on an individual security or
currency. Depending on the pricing of the option compared to either the price
of the futures contract upon which it is based or the price of the underlying
debt securities or currency, it may or may not be less risky than direct
ownership of the futures contract of the underlying debt securities or
currency. As with the purchase of futures contracts, when the Portfolio is
not fully invested, it may purchase a call option on a futures contract to
hedge against a market advance due to declining interest rates or
appreciation in the value of a foreign currency against the U.S. dollar.
If a Portfolio writes a call option on a futures contract and the futures
price at expiration of the option is below the exercise price, the Portfolio
will retain the full amount of the option premium, which may provide a
partial hedge against any decline that may have occurred in the value of the
Portfolio's holdings. If the futures price at expiration of the option is
higher than the exercise price, such Portfolio will retain the full amount of
the option premium, which may provide a partial hedge against any increase in
the price of securities which the Portfolio intends to purchase. If a put or
call option a Portfolio has written is exercised, the Portfolio will incur a
loss which will be reduced by the amount of the premium it received.
Depending on the degree of correlation between changes in the value of its
portfolio securities and changes in the value of its futures positions, a
Portfolio's losses from existing options on futures may to some extent be
reduced or increased by changes in the value of its portfolio securities.
The amount of risk a Portfolio assumes when it purchases an option on a
futures contract is the premium paid for the option plus related transaction
costs. In addition to the correlation risks discussed above, the purchase of
an option also entails the risk that changes in the value of the underlying
futures contract will not be fully reflected in the value of the option
purchased. A Portfolio will purchase a put option on a futures contract only
to hedge the Portfolio's investments against the risk of rising interest
rates or the decline in the value of securities denominated in a foreign
currency.
A Portfolio's ability to engage in the options and futures strategies
described above will depend on the availability of liquid markets in such
instruments. Markets in options and futures are relatively new and still
developing, and it is impossible to predict the amount of trading interest
that may exist in various types of options or futures. Therefore, no
assurance can be given that the Portfolio will be able to utilize these
instruments effectively for the purposes set forth above. Furthermore, a
Portfolio's ability to engage in options and futures transactions may be
limited by tax considerations.
A Portfolio will engage in transactions in future contracts and related
options only to the extent such transactions are consistent with the
requirements of the Code for maintaining its qualification as a regulated
investment company for federal income tax purposes (see "Tax Considerations"
in the prospectus).
A Portfolio investing in such investments may not purchase or sell futures
contracts or purchase or sell related options, except for closing purchase or
sale transactions, if immediately thereafter the sum of the amount of margin
deposits on a Portfolio's outstanding futures and related options positions
and the amount of premiums paid for outstanding options on futures would
exceed 5% of the market value of the Portfolio's total assets. These
transactions involve brokerage costs, require margin deposits and, in the
case of contracts and options obligating a Portfolio to purchase securities
or currencies, require the Portfolio to segregate assets to cover such
contracts and options.
While transactions in futures contracts and options on futures may reduce
certain risks, such transactions themselves entail certain other risks. Thus,
while a Portfolio may benefit from the use of futures and options on futures,
unanticipated changes in interest rates, securities prices or currency
exchange rates may result in a poorer overall performance for the Portfolio
than if it had not entered into any futures contracts or options
transactions. In the event of an imperfect correlation between a futures
position and portfolio position which is intended to be protected, the
desired protection may not be obtained and the Portfolio may be exposed to
risk of loss.
Perfect correlation between a Portfolio's futures positions and portfolio
positions may be difficult to achieve because no futures contracts based on
corporate fixed-income securities are currently available. In addition, it is
not possible to hedge fully or perfectly against currency fluctuations
affecting the value of securities denominated in foreign currencies because
the value of such securities is likely to fluctuate as a result of
independent factors not related to currency fluctuations.
Financial Futures Contracts. A Portfolio permitted to do so under its
investment policies may, for bona fide hedging purposes or for other
appropriate risk management purposes permitted under regulations promulgated
by the Commodity Futures Trading Commission ("CFTC"), purchase or sell
futures contracts on interest rates, financial indices, currencies and stock
indices, and U.S. government securities, and may purchase and write on a
covered basis put and call options on futures contracts. Investment decisions
relating to futures contracts and options thereon will be based upon, among
other considerations, the composition of a Portfolio's investments and the
Managers' expectations concerning interest rates and the currency and
securities markets. In addition, for hedging purposes or to increase income
to a Portfolio, the Portfolio may purchase put and call options and write
covered put and call options on securities, currencies and securities indices
traded on U.S. exchanges and, to the extent permitted by law, foreign
exchanges, as well as over-the-counter.
For bona fide hedging purposes or for other appropriate risk management
purposes pursuant to the Commodity Exchange Act, as amended, and the rules
promulgated thereunder by the CFTC, a Portfolio may enter into contracts for
the purchase or sale for future delivery of U.S. Treasury or foreign
securities. Each Portfolio may similarly enter into futures contracts based
upon financial indices. A Portfolio may enter into financial futures
contracts, stock index futures contracts, foreign currency futures contracts
and options on any of the foregoing. These futures contracts are referred to
collectively as "financial futures." Financial futures are commodity
contracts that obligate the long or short holder to take or make delivery of
a specified quantity of a financial instrument, such as U.S. Treasury or
other securities or foreign currencies, or the cash value of a securities
index during a specified future period at a specified price. A "sale" of
these types of futures contracts means the acquisition of a contractual
obligation to deliver the securities or the cash value of the index called
for by the contract at a specified price on a specified date. A "purchase" of
these types of futures contracts means the acquisition of a contractual
obligation to acquire the securities or the cash value of the index called
for by the contract at a specified price on a specified date.
At the same time a futures contract is purchased or sold, a Portfolio must
allocate cash or securities as a deposit payment ("initial deposit"). The
futures contract is valued daily thereafter and the payment of some amount of
"variation margin" may be required, reflecting any decline or increase in the
contract's value.
To the extent a Portfolio enters into contracts for the purchase or sale for
future delivery of financial futures and to the extent required by SEC rules,
it will maintain, with its custodian bank, assets in a segregated account to
cover its obligations with respect to such contracts. These assets will
consist of cash, cash equivalents or high quality debt obligations from the
Portfolio's investments, in an amount equal to the difference between the
fluctuating market value of such futures contracts and the aggregate value of
the initial and variation margin payments made by the Portfolio with respect
to such futures contracts.
Interest Rate Futures Contracts. Certain Portfolios may purchase and sell
interest rate futures contracts and options thereon traded on domestic
exchanges and, to the extent such contracts have been approved by the CFTC
for sale to customers in the U.S., on foreign exchanges.
A Portfolio may enter into interest rate futures contracts in order to
protect its portfolio securities from fluctuations in interest rates without
necessarily buying or selling the underlying fixed-income securities. For
example, if a Portfolio owns bonds, and interest rates are expected to
increase, it might sell futures contracts on debt obligations having
characteristics similar to those held in the portfolio. Such a sale would
have much the same effect as selling an equivalent value of the bonds owned
by the Portfolio. If interest rates did increase, the value of the debt
obligations in the portfolio would decline, but the value of the futures
contracts to the Portfolios would increase at approximately the same rate,
thereby keeping the net asset value of the Portfolio from declining as much
as it otherwise would have. A Portfolio could accomplish similar results by
selling bonds with longer maturities and investing in bonds with shorter
maturities when interest rates are expected to increase. However, since the
futures market may be more liquid than the cash market, the use of futures
contracts as a risk management technique allows a Portfolio to maintain a
defensive position without having to sell its portfolio securities.
Similarly, when it is expected that interest rates may decline, a Portfolio
may purchase interest rate futures contracts in an attempt to hedge against
having to make future anticipated purchases of bonds at the higher prices
expected to prevail in the future. Since the fluctuations in the value of
appropriately selected futures contracts should be similar to that of the
bonds that will be purchased, the Portfolio could take advantage of the
anticipated rise in the cost of the bonds without actually buying them until
the market had stabilized. At that time, the Portfolio could make the
intended purchase of the bonds in the cash market and the futures contracts
could be liquidated.
Options on Interest Rate Futures Contracts. A Portfolio may also purchase
call and put options and write covered call and put options on interest rate
futures contracts traded on domestic exchanges and, to the extent such
contracts have been approved by the CFTC for sale to customers in the U.S.,
on foreign exchanges to hedge against risks associated with shifts in
interest rates and may enter into closing transactions with respect to such
options.
Stock Index Futures Contracts. Certain Portfolios may purchase and sell stock
index futures contracts and options on stock index futures contracts traded
on domestic exchanges and, to the extent such contracts have been approved by
the CFTC for sale to customers in the U.S., on foreign exchanges. A stock
index futures contract obligates the seller to deliver (and the purchaser to
take) an amount of cash equal to a specific dollar amount times the
difference between the value of a specific stock index at the close of the
last trading day of the contract and the price at which the agreement is
made. Open futures contracts are valued on a daily basis and a Portfolio may
be obligated to provide or receive cash reflecting any decline or increase in
the contract's value. No physical delivery of the underlying stocks in the
index is made in the future.
A Portfolio may sell stock index futures contracts in anticipation of or
during a market decline in an attempt to offset the decrease in market value
of its securities that might otherwise result. When a Portfolio is not fully
invested in stocks and anticipates a significant market advance, it may
purchase stock index futures in order to gain rapid market exposure that may
offset increases in the cost of common stocks that it intends to purchase.
Options on Stock Index Futures Contracts. Call and put options on stock index
futures may be purchased or sold to hedge against risks of market-side price
movements. Such options may be traded on domestic exchanges and, to the
extent such contracts have been approved by the CFTC for sale to customers in
the U.S., on foreign exchanges. The need to hedge against such risks will
depend on the extent of diversification of a Portfolio's common stock
investments and the sensitivity of such investments to factors influencing
the stock market as a whole.
Risks in Investing in Options and Futures Contracts and Related Options. The
purchase and sale of futures contracts and options thereon, as well as the
purchase and writing of options on securities and securities indices and
currencies, involve risks different from those involved with direct
investments in securities. A liquid secondary market for any futures or
options contract may not be available when a futures or options position is
sought to be closed and the inability to close such positions could leave an
adverse impact on a Portfolio's ability to effectively hedge its securities
on foreign currency exposure. In addition, there may be an imperfect
correlation between movements in the securities or foreign currency on which
the futures or options contract is based and movements in the securities or
currency in the Portfolio's investments. Successful use of futures or options
contracts is further dependent on the Managers' ability to correctly predict
movements in the securities or foreign currency markets and no assurance can
be given that its judgment will be correct. Successful use of options on
securities or stock indices is subject to similar risk considerations. In
addition, by writing covered call options, the Portfolio gives up the
opportunity, while the option is in effect, to profit from any price increase
in the underlying security above the option exercise price.
While utilization of options, futures contracts and similar instruments may
be advantageous to the Portfolios, if the Managers are not successful in
employing such instruments in managing each Portfolio's investments, each
Portfolio's performance will be worse than if they did not employ such
strategies. In addition, each Portfolio will pay commissions and other costs
in connection with such investments, which may increase each Portfolio's
expenses and reduce its return. In writing options on futures, each
Portfolio's loss is potentially unlimited and may exceed the amount of the
premium received.
The risk of loss in trading foreign futures contracts and foreign options can
be substantial. Investors should be aware of the following: (i) participation
in foreign futures contracts and foreign options transactions involves the
execution and clearing of trades on, or subject to, the rules of a foreign
board of trade; and (ii) applicable foreign law which will vary, depending on
where the foreign futures or options transaction occurs. For these reasons, a
Portfolio might not be afforded certain of the protective measures provided
by the Commodity Exchange Act, the CFTC's regulations and the rules of the
National Futures Association and any domestic exchange. In addition, the
price of any foreign futures or foreign options contract and, therefore, the
potential profit and loss thereon, may be affected by any variance in the
foreign exchange rate between the time a particular order is placed and the
time it is liquidated, offset or exercised.
In certain cases the options and futures markets provide investment or risk
management opportunities that are not available from direct investments in
securities. In addition, some strategies can be performed more effectively
and at lower cost by utilizing the options and futures markets rather than
purchasing or selling portfolio securities. However, there are risks involved
in these transactions as discussed above.
Any Portfolio's investment in options, futures contracts, forward contracts,
options on futures contracts or stock indices, and foreign currencies and
securities may be limited by the requirements of the Code for qualification
as a regulated investment company. These securities require the application
of complex and special rules and elections, more information about which is
included below under "Additional Information Regarding Taxation."
Portfolio Turnover
Because the investment outlook of the type of securities which each Portfolio
may purchase may change as a result of unexpected developments in national or
international securities markets, or in economic, monetary or political
relationships, a Portfolio's Manager will consider the economic effect of
portfolio turnover but generally not treat portfolio turnover as a limiting
factor in making investment decisions. Investment decisions affecting
turnover may include changes in investment strategies or nonfundamental
investment policies, including changes in management personnel, as well as
individual portfolio transactions.
Moreover, turnover may be increased by certain factors wholly outside the
control of the Managers. For example, during periods of rapidly declining
interest rates, such as the U.S. experienced in 1991 through 1993, the rate
of mortgage prepayments may increase rapidly, resulting in the return of
principal to portfolios which invest in mortgage securities, thus increasing
"sales" of portfolio securities. Similarly, the rate of bond calls by issuers
of fixed-income securities may increase as interest rates decline, thereby
forcing the "sale" of called bonds by portfolios which invest in fixed-income
securities and subsequent purchase of replacement investments. In other
periods, increased merger and acquisition activity, or increased rates of
bankruptcy or default, may create involuntary transactions for portfolios
which hold affected stocks and bonds, especially high-yield bonds. Global or
international fixed income securities portfolios may have higher turnover
rates because of maturing debt securities, rebalancing of the portfolio to
keep interest rate risk at desired levels and the rebalancing of the
portfolio to keep country allocations at desired levels; if the Manager's
allocation target changes, additional turnover may result.
In addition, redemptions or exchanges by investors may require the
liquidation of portfolio securities. Changes in particular portfolio holdings
may be made whenever it is considered that a security is no longer the most
appropriate investment for a Portfolio, or that another security appears to
have a relatively greater opportunity, and will be made without regard to the
length of time a security has been held.
The portfolio turnover rates for each Portfolio are disclosed in the
prospectus for the Portfolios, in the section entitled "Financial
Highlights." Portfolio turnover is a measure of how frequently a portfolio's
securities are bought and sold. As required by the SEC, annual portfolio
turnover is calculated generally as the dollar value of the lesser of a
portfolio's purchases or sales of portfolio securities during a given year,
divided by the monthly average value of the portfolio's securities during
that year (excluding securities whose maturity or expiration at the time of
acquisition were less than one year). For example, a portfolio reporting a
100% portfolio turnover rate would have purchased and sold securities worth
as much as the monthly average value of its portfolio securities during the
year. Except for certain Portfolios noted in the prospectus, the Portfolios
generally do not expect their annual turnover rates to exceed 100%. Because
so many variable factors are beyond the control of the Managers, it is not
possible to estimate future turnover rates with complete accuracy. Higher
portfolio turnover rates generally increase transaction costs, which are
portfolio expenses, but would not create taxable capital gains for investors
because of the tax-deferred status of variable annuity and life insurance
investments.
REAL ESTATE FUND
Real Estate Related Investments. In addition to the Portfolio's investments
in real estate securities, as defined in the Trust prospectus, the Portfolio
may also invest a portion of its assets in debt obligations or equity
securities of issuers engaged in businesses whose products and services are
closely related to the real estate industry, and publicly traded on an
exchange or in the over-the-counter market, including principal mortgage
pools, CMOs, and related instruments which are publicly traded (including,
without limitation, pools containing GNMA and FNMA mortgages). The Portfolio
will invest no more than 55% of its assets in either GNMA or FNMA securities
and no more than 70% of its assets in GNMA and FNMA securities, in the
aggregate. In addition, the Portfolio does not invest in the "residual
interests" of real estate mortgage investment conduits ("REMICs").
REPURCHASE AGREEMENTS
Each Portfolio may enter into repurchase agreements. A repurchase agreement
is an agreement in which the seller of a security agrees to repurchase the
security sold at a mutually agreed upon time and price. Under the 1940 Act, a
repurchase agreement is deemed to be the loan of money by the Portfolio to
the seller, collateralized by the underlying security. The resale price is
normally in excess of the purchase price, reflecting an agreed upon interest
rate. The interest rate is effective for the period of time in which the
Portfolio is invested in the agreement and is not related to the coupon rate
on the underlying security. The period of these repurchase agreements will
usually be short, from overnight to one week, and at no time will a Portfolio
invest in repurchase agreements for more than one year. However, the
securities which are subject to repurchase agreements may have maturity dates
in excess of one year from the effective date of the repurchase agreements.
The transaction requires the initial collateralization of the seller's
obligation by securities with a market value, including accrued interest,
equal to at least 102% of the dollar amount invested by the Portfolio, with
the value marked-to-market daily to maintain 100% coverage. A default by the
seller might cause the Portfolio to experience a loss or delay in the
liquidation of the collateral securing the repurchase agreement. The
Portfolios might also incur disposition costs in liquidating the collateral.
The Portfolios may not enter into a repurchase agreement with more than seven
days duration if, as a result, the market value of the Portfolios' net
assets, together with investments in other securities deemed to be not
readily marketable, would be invested in such repurchase agreements in excess
of the Portfolios' policy on investments in illiquid securities. The
Portfolios intend to enter into repurchase agreements only with financial
institutions such as broker-dealers and banks which are deemed creditworthy
by their respective Managers. The securities held subject to resale (the
collateral) will be held on behalf of a Portfolio by a custodian approved by
the Board and will be held pursuant to a written agreement.
REVERSE REPURCHASE AGREEMENTS
Certain Portfolios may enter into reverse repurchase agreements with banks
and broker-dealers. Reverse repurchase agreements involve sales by a
Portfolio of assets concurrently with an agreement by the Portfolio to
repurchase the same assets at a later date at a fixed price. During the
reverse repurchase agreement period, the Portfolio continues to receive
dividend or interest payments on these securities.
When effecting reverse repurchase transactions, each Portfolio will establish
a segregated account with its custodian bank in which it will maintain cash,
U.S. Government securities or other liquid high grade debt obligations 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 Portfolio may decline below the price of the
securities the Portfolio 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 Portfolio'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 Portfolio's
obligation to repurchase the securities. Reverse repurchase agreements are
considered borrowings by the Portfolios and as such are subject to the
investment limitations discussed below under "Fundamental Investment
Restrictions" or in the prospectus under "Investment Methods and Risks,
Common to More Than One Portfolio."
These transactions may increase the volatility of a Portfolio's income or net
asset value. The Portfolio carries the risk that any securities purchased
with the proceeds of the transaction will depreciate or not generate enough
income to cover the Portfolio's obligations under the reverse repurchase
transaction. These transactions also increase the interest and operating
expenses of a Portfolio.
SHORT SALES
Certain Portfolios may make short sales of securities. A short sale is a
transaction in which the Portfolio sells a security it does not own in
anticipation that the market price of that security will decline. Each
Portfolio expects to make short sales (i) as a form of hedging to offset
potential declines in long positions in similar securities, (ii) in order to
maintain flexibility and (iii) for profit.
When a Portfolio 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 Portfolio 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 Portfolio'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 Portfolio 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 Portfolio replaces the borrowed security, the
Portfolio will incur a loss; conversely, if the price declines, the Portfolio
will realize a gain. Any gain will be decreased, and any loss increased, by
the transaction costs described above. Although the Portfolio's gain is
limited to the price at which it sold the security short, its potential loss
is theoretically unlimited.
The Mutual Discovery and Mutual Series 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 Portfolio's total
assets or the Portfolio's aggregate short sales of a particular class of
securities exceeds 25% of the outstanding securities of that class. These
Portfolios may also make short sales "against the box" without respect to
such limitations. In this type of short sale, at the time of the sale, the
Portfolios own or have the immediate and unconditional right to acquire at no
additional cost the identical security.
WHEN-ISSUED SECURITIES
Securities when originally issued are sometimes offered on a "when-issued"
basis. When so offered, the price, which is generally expressed in yield
terms, is fixed at the time the commitment to purchase is made, but delivery
and payment for the when-issued securities take place at a later date.
Normally, the settlement date occurs within one month of the purchase of such
securities; during the period between purchase and settlement, no payment is
made by the purchaser to the issuer and no interest accrues to the purchaser.
To the extent that assets of a Portfolio are not vested prior to the
settlement of a purchase of securities, the Portfolio will earn no income;
however, it is intended that each Portfolio will be fully invested to the
extent practicable and subject to the policies stated above. While
when-issued securities may be sold prior to the settlement date, it is
intended that each Portfolio will purchase such securities with the purpose
of actually acquiring them, unless a sale appears desirable for investment
reasons. At the time the Portfolio makes the commitment to purchase a
security on a when-issued basis, it will record the transaction and reflect
the value of the security in determining its net asset value. The market
value of when-issued securities may be more or less than the purchase price.
The Trust does not believe that the net asset value or income of any of the
Portfolios will be adversely affected by their purchase of securities on a
when-issued basis. The Trust will establish for each Portfolio a segregated
account with its custodian bank in which it will maintain cash and/or high
grade marketable securities equal in value to commitments for when-issued
securities. Such segregated securities will either mature or, if necessary,
be sold on or before the settlement date. There are no restrictions on the
percentage of net assets of any Portfolio which may be invested in
when-issued securities at any given time.
FUNDAMENTAL INVESTMENT RESTRICTIONS
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Each Portfolio has adopted the following restrictions as fundamental policies
(except as otherwise indicated), which means that they may not be changed
without the approval of a majority of that Portfolio's shares. In order to
change any of these restrictions, the lesser of (i) holders of 67% or more of
a Portfolio's voting securities present at a meeting of shareholders if the
holders of more than 50% of its voting securities are represented at the
meeting or (ii) holders of more than 50% of that Portfolio's outstanding
voting securities must vote to make the change.
Each of the Portfolios MAY NOT:
1. with respect to 75% of its total assets, except for the Global Income,
Global Health Care and Value Funds, purchase the securities of any one issuer
(other than cash, cash items and obligations of the U.S. government) if
immediately thereafter, and as a result of the purchase, the Portfolio would
(a) have more than 5% of the value of its total assets invested in the
securities of such issuer or (b) hold more than 10% of any or all classes of
the securities of any one issuer;
2. borrow money in an amount in excess of 5% of the value of its total
assets, except from banks for temporary or emergency purposes, and not for
direct investment in securities (excepting the Asset Allocation, Developing
Markets, Global Health Care, International Smaller Companies, Mutual
Discovery, Mutual Shares, Small Cap and Value Funds). The Asset Allocation,
Developing Markets, Global Health Care, International Smaller Companies,
Mutual Discovery, Mutual Shares, Small Cap and Value Funds may borrow money
from banks in an amount not exceeding 331/3% of the value of the Portfolio's
total assets including the amount borrowed. Each of these Portfolios may also
pledge, mortgage or hypothecate its assets to secure borrowings to an extent
not greater than 15% of the Portfolio's total assets. Arrangements with
respect to margin for futures contracts, forward contracts and related
options are not deemed to be a pledge of assets.
3. lend its assets, except through the purchase or acquisition of bonds,
debentures or other debt securities of any type customarily purchased by
institutional investors, or through loans of portfolio securities, or to the
extent the entry into a repurchase agreement may be deemed a loan;
4. underwrite securities of other issuers, except as noted in number 6 below
and except insofar as a Portfolio may be technically deemed an underwriter
under the federal securities laws in connection with the disposition of
portfolio securities;
5. purchase illiquid securities, including illiquid securities which, at the
time of acquisition, could be disposed of publicly by the Portfolios only
after registration under the Securities Act of 1933, if as a result more than
10% of their net assets would be invested in such illiquid securities (not
applicable to the Global Health Care, International Smaller Companies, Mutual
Discovery, Mutual Shares or Value Funds);
6. invest in securities for the purpose of exercising management or control
of the issuer (not applicable to the Mutual Discovery, Mutual Shares or Value
Funds);
7. invest more than 25% of its assets (measured at the time of the most
recent investment) in any single industry (not applicable to the Global
Health Care Fund, Global Utility Fund, Natural Resources Fund, or the Real
Estate Securities Fund);
8. invest in companies which have a record of less than three years of
continuous operation, including the operations of any predecessor companies,
except that the Real Estate Fund, the Capital Growth Fund, the Growth and
Income Fund, the Global Income Fund, the International Equity Fund, the
Pacific Fund, the Global Growth Fund, and the Developing Markets Fund may
invest up to 5% of their respective assets in such companies, the Natural
Resources Fund may invest up to 10% of its assets in such companies, and such
limitation shall not apply to the Asset Allocation Fund, Global Health Care
Fund, International Smaller Companies Fund, Mutual Discovery Fund, Mutual
Shares Fund, Small Cap Fund or the Value Fund;
9. maintain a margin account with a securities dealer or effect short sales,
with the exceptions that (i) the Growth and Income Fund and the Income
Securities Fund may effect short sales if the Portfolio owns securities
equivalent in kind and amount to those sold, (ii) Mutual Discovery, Mutual
Shares, Global Health Care and Value Funds may engage in short sales to the
extent described in the prospectus and SAI, and (iii) the Natural Resources
Fund, the Global Health Care Fund, the Global Income Fund, the Global Growth
Fund, the Developing Markets Fund, the Asset Allocation Fund, the
International Equity Fund, the International Smaller Companies Fund, the
Pacific Fund, the Mutual Discovery Fund, the Mutual Shares Fund, the Value
Fund and the Small Cap Fund may make initial deposits and pay variation
margin in connection with futures contracts;
10. invest in commodities or commodity pools, except that (i) certain
Portfolios may purchase and sell Forward Contracts in amounts necessary to
effect transactions in foreign securities, (ii) the Global Health Care Fund,
the Global Income Fund, the International Equity Fund, the International
Smaller Companies Fund, the Pacific Growth Fund, the Global Growth Fund, the
Developing Markets Fund, the Asset Allocation Fund, the Mutual Discovery
Fund, the Mutual Shares Fund, the Value Fund and the Small Cap Fund may enter
into Futures Contracts and may invest in foreign currency and (iii) the
Natural Resources Fund may invest in commodities and commodity futures
contracts with respect to commodities related to the natural resources sector
as defined in the prospectus. Securities or other instruments backed by
commodities are not considered commodities or commodity contracts for the
purpose of this restriction;
11. invest directly in real estate, although certain Portfolios may invest in
real estate investment trusts or other publicly traded securities engaged in
the real estate industry. First mortgage loans or other direct obligations
secured by real estate are not considered real estate for purposes of this
restriction;
12. invest in the securities of other open-end investment companies (except
that securities of another open-end investment company may be acquired
pursuant to a plan of reorganization, merger, consolidation or acquisition).
This restriction is not applicable to the Capital Growth Fund, the Global
Health Care Fund, the International Equity Fund, the International Smaller
Companies Fund, the Mutual Discovery Fund, the Mutual Shares Fund, the
Pacific Fund, the Asset Allocation Fund, the Value Fund or the Developing
Markets Fund;
13. invest in assessable securities or securities involving unlimited
liability on the part of the Portfolio;
14. invest an aggregate of more than 10% of its assets in securities with
legal or contractual restrictions on resale, securities which are not readily
marketable (including over-the-counter options and assets used to cover such
options), and repurchase agreements with more than seven days to maturity
(this restriction does not apply to the Asset Allocation, Global Health Care,
Value, Mutual Discovery or Mutual Shares Funds);
15. purchase or retain any security if any officer, director or security
holder of the issuer is at the same time an officer, trustee or employee of
the Trust or of the Portfolio's Manager and such person owns beneficially
more than one-half of 1% of the securities and all such persons owning more
than one-half of 1% own more than 5% of the outstanding securities of the
issuer; or
16. invest its assets in a manner which does not comply with the investment
diversification requirements of Section 817(h) of the Code.
17. invest more than 10% of its assets in illiquid securities (including
illiquid equity securities, repurchase agreements of more than seven days
duration, over-the-counter options and assets used to cover such options, and
other securities which are not readily marketable), as more fully described
in the prospectus and SAI. This policy shall not apply to the Global Health
Care, International Smaller Companies, Mutual Discovery, Mutual Shares or
Value Funds.
18. The Global Growth and Developing Markets Funds may not invest more than
5% of their respective assets in warrants, whether or not listed on the New
York or American Exchange, including no more than 2% of their respective
total assets which may be invested in warrants that are not listed on those
exchanges. Warrants acquired by the Portfolios in units or attached to
securities are not included in this restriction.
19. The Global Growth Fund and Developing Markets Fund will not invest more
than 15% of their respective assets in securities of foreign issuers that are
not listed on a recognized U.S. or foreign securities exchange, including no
more than 10% in illiquid investments.
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS
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In addition to these fundamental policies, it is the present policy of each
Portfolio, except the Mutual Discovery and Mutual Shares Funds, (which may be
changed without the approval of a majority of its outstanding shares) not to
pledge, mortgage or hypothecate its assets as security for loans (except to
the extent of allowable temporary loans), nor to engage in joint or joint and
several trading accounts in securities, except that the Portfolios (including
the Mutual Discovery and Mutual Shares Funds) may participate with other
investment companies in the Franklin Group of Funds(R) in a joint account to
engage in certain large repurchase transactions and may combine orders to
purchase or sell securities with orders from other persons to obtain lower
brokerage commissions. It is not any Portfolio's policy to invest in
interests (other than publicly traded equity securities) in oil, gas or other
mineral exploration or development programs.
As non-fundamental investment policies, which may be changed by the Board
without shareholder approval, the Asset Allocation Fund will not invest more
than 15% of its total assets in securities of foreign issuers which are not
listed on a recognized United States or foreign securities exchange, or more
than 10% of their total assets in (a) securities with a limited trading
market, (b) securities subject to legal or contractual restrictions as to
resale, (c) repurchase agreements not terminable within seven days, and (d)
debt obligations rated Baa or lower by Moody's Investors Service, Inc. or BBB
or lower by Standard & Poor's Corporation or, if unrated, are of comparable
investment quality as determined by the Managers.
The International Smaller Companies Fund may not invest more than 5% of its
respective assets in warrants, whether or not listed on the New York or
American Exchange, including no more than 2% of its total assets which may be
invested in warrants that are not listed on those exchanges. Warrants
acquired by the Portfolio in units or attached to securities are not included
in this restriction.
Whenever any investment policy or investment restriction states a maximum
percentage of a Portfolio'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 Portfolio's acquisition
of such security or property.
OFFICERS AND TRUSTEES
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The Board has the responsibility for the overall management of the Trust,
including general supervision and review of each Portfolio's 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.
POSITIONS AND OFFICES
NAME, AGE AND ADDRESS WITH THE TRUST PRINCIPAL OCCUPATION DURING THE PAST
FIVE YEARS
Frank H. Abbott, III (77) Trustee
1045 Sansome Street
San Francisco, CA 94111
President and Director, Abbott
Corporation (an investment company);
director or trustee, as the case may
be, of 27 of the investment
companies in the Franklin Templeton
Group of Funds; and formerly,
Director, MotherLode Gold Mines
Consolidated (gold mining) and
Vacu-Dry Co. (food processing).
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Lowell C. Anderson (61) Trustee
Allianz Life Insurance Company
1750 Hennepin Avenue South
Minneapolis, MN 55403-2195
Chairman, President and Chief
Executive Officer, Allianz Life
Insurance Company of North America
(privately owned company formerly
North American Life & Casualty
Company); and Director, Preferred
Life Insurance Company of New York.
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Harris J. Ashton (66) Trustee
191 Clapboard Ridge Road
Greenwich, CT 06830
Director, RBC Holdings, Inc. (a bank
holding company) and Bar-S Foods (a
meat packing company); director or
trustee, as the case may be, of 49
of the investment companies in the
Franklin Templeton Group of Funds;
and formerly, President, Chief
Executive Officer and Chairman of
the Board, General Host Corporation
(nursery and craft centers).
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Robert F. Carlson (70) Trustee
2120 Lambeth Way
Carmichael, CA 9560
Member and past President, Board of
Administration, California Public
Employees Retirement Systems
(CALPERS); director or trustee, as
the case may be, of nine of the
investment companies in the Franklin
Templeton Group of Funds; and
formerly, member and Chairman of the
Board, Sutter Community Hospitals,
Sacramento, CA, member, Corporate
Board, Blue Shield of California,
and Chief Counsel, California
Department of Transportation.
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S. Joseph Fortunato (66) Trustee
Park Avenue at Morris County
P.O. Box 1945
Morristown, NJ 07962-1945
Member of the law firm of Pitney,
Hardin, Kipp & Szuch; director or
trustee, as the case may be, of 51
of the investment companies in the
Franklin Templeton Group of Funds.
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*Charles B. Johnson (66) Chairman of
777 Mariners Island Blvd. the Board
San Mateo, CA 94404 and Trustee
President, Chief Executive Officer
and Director, Franklin Resources,
Inc.; Chairman of the Board and
Director, Franklin Advisers, Inc.,
Franklin Advisory Services, Inc.,
Franklin Investment Advisory
Services, Inc. and Franklin
Templeton Distributors, Inc.;
Director, Franklin/Templeton
Investor Services, Inc. and Franklin
Templeton Services, Inc.; officer
and/or director or trustee, as the
case may be, of most of the other
subsidiaries of Franklin Resources,
Inc. and of 50 of the investment
companies in the Franklin Templeton
Group of Funds.
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*Charles E. Johnson (42) President
500 East Broward Blvd. and Trustee
Fort Lauderdale, FL
33394-3091
Senior Vice President and Director,
Franklin Resources, Inc.; Senior
Vice President, Franklin Templeton
Distributors, Inc.; President and
Director, Templeton Worldwide, Inc.;
Chairman and Director, Templeton
Investment Counsel, Inc.; Vice
President, Franklin Advisers, Inc.;
officer and/or director of some of
the other subsidiaries of Franklin
Resources, Inc.; and officer and/or
director or trustee, as the case may
be, of 34 of the investment
companies in the Franklin Templeton
Group of Funds.
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*Rupert H. Johnson, Jr. (58) Vice President.
777 Mariners Island Blvd and Trustee
San Mateo, CA 94404
Executive Vice President and
Director, Franklin Resources, Inc.
and Franklin Templeton Distributors,
Inc.; President and Director,
Franklin Advisers, Inc.; Senior Vice
President and Director, Franklin
Advisory Services, Inc. and Franklin
Investment Advisory Services, Inc.;
Director, Franklin/Templeton
Investor Services, Inc.; and officer
and/or director or trustee, as the
case may be, of most of the other
subsidiaries of Franklin Resources,
Inc. and of 53 of the investment
companies in the Franklin Templeton
Group of Funds.
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Frank W.T. LaHaye (69) Trustee
20833 Stevens Creek Blvd.,
Suite 102
Cupertino, CA 95014
General Partner, Miller & LaHaye,
which is the General Partner of
Peregrine Ventures II (venture
capital firm); Chairman of the Board
and Director, Quarterdeck
Corporation (software firm);
Director, Digital Transmission
Systems, Inc. (wireless
communications); director or
trustee, as the case may be, of 27
of the investment companies in the
Franklin Templeton Group of Funds;
and formerly, Director, Fischer
Imaging Corporation (medical imaging
systems) and General Partner,
Peregrine Associates, which was the
General Partner of Peregrine
Ventures (venture capital firm).
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Gordon S. Macklin (70) Trustee
8212 Burning Tree Road
Bethesda, MD 20817
Director, Fund American Enterprises
Holdings, Inc., MCI WorldCom,
MedImmune, Inc. (biotechnology),
Spacehab, Inc. (aerospace services)
and Real 3D (software); director or
trustee, as the case may be, of 49
of the investment companies in the
Franklin Templeton Group of Funds;
and formerly, Chairman, White River
Corporation (financial services) and
Hambrecht and Quist Group
(investment banking), and President,
National Association of Securities
Dealers, Inc.
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Harmon E. Burns (54) Vice President
777 Mariners Island Blvd.
San Mateo, CA 94404
Executive Vice President and
Director, Franklin Resources, Inc.,
Franklin Templeton Distributors,
Inc. and Franklin Templeton
Services, Inc.; Executive Vice
President, Franklin Advisers, Inc.;
Director, Franklin/Templeton
Investor Services, Inc.; and officer
and/or director or trustee, as the
case may be, of most of the other
subsidiaries of Franklin Resources,
Inc. and of 53 of the investment
companies in the Franklin Templeton
Group of Funds.
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Martin L. Flanagan (38) Vice President
777 Mariners Island Blvd. and Chief
San Mateo, CA 94404 Financial Officer
Senior Vice President and Chief
Financial Officer, Franklin
Resources, Inc.; Executive Vice
President and Director, Templeton
Worldwide, Inc.; Executive Vice
President, Chief Operating Officer
and Director, Templeton Investment
Counsel, Inc.; Executive Vice
President and Chief Financial
Officer, Franklin Advisers, Inc.;
Chief Financial Officer, Franklin
Advisory Services, Inc. and Franklin
Investment Advisory Services, Inc.;
President and Director, Franklin
Templeton Services, Inc.; Senior
Vice President and Chief Financial
Officer, Franklin/Templeton Investor
Services, Inc.; officer and/or
director of some of the other
subsidiaries of Franklin Resources,
Inc.; and officer and/or director or
trustee, as the case may be, of 53
of the investment companies in the
Franklin Templeton Group of Funds.
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Deborah R. Gatzek (49) Vice President
777 Mariners Island Blvd. and Secretary
San Mateo, CA 94404
Senior Vice President and General
Counsel, Franklin Resources, Inc.;
Senior Vice President, Franklin
Templeton Services, Inc. and
Franklin Templeton Distributors,
Inc.; Executive Vice President,
Franklin Advisers, Inc.; Vice
President, Franklin Advisory
Services, Inc.; Vice President,
Chief Legal Officer and Chief
Operating Officer, Franklin
Investment Advisory Services, Inc.;
and officer of 53 of the investment
companies in the Franklin Templeton
Group of Funds.
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Diomedes Loo-Tam (59) Treasurer and
777 Mariners Island Blvd. Principal
San Mateo, CA 94404 Accounting
Officer
Senior Vice President, Franklin
Templeton Services, Inc.; and
officer of 32 of the investment
companies in the Franklin Templeton
Group of Funds.
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Edward V. McVey (60) Vice President
777 Mariners Island Blvd.
San Mateo, CA 94404
Senior Vice President and National
Sales Manager, Franklin Templeton
Distributors, Inc.; and officer of
28 of the investment companies in
the Franklin Templeton Group of
Funds.
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*This Board member is considered an "interested person" under the 1940 Act.
The table above shows the officers and Board members who are affiliated with
the Distributors, the Managers and the Insurance Companies. Nonaffiliated
members of the Board are currently paid fees of $550 per month plus $183 per
meeting attended. Members of the Board serving on the audit committee of the
Trust and other investment companies in the Franklin Templeton Group of Funds
receive a flat fee of $2,000 per committee meeting attended, a portion of
which is allocated to the Trust. As shown above the nonaffiliated Board
members also serve as directors or trustees of other investment companies in
the Franklin Templeton Group of Funds. They may receive fees from these funds
for their services. The fees payable to nonaffiliated Board members by the
Trust are subject to reductions resulting from fee caps limiting the amount
of fees payable to Board members who serve on other boards within the
Franklin Templeton Group of Funds. The following table provides the total
fees paid to nonaffiliated Board members by the Trust and by other funds in
the Franklin Templeton Group of Funds for the fiscal year ended December 31,
1997.
Aggregate Number of Franklin Total Compensation from
Compensation Templeton Funds Boards Franklin Templeton Funds
Name from Trust on Which Each Serves** including the Trust
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Frank H. Abbott $8,616.63 28 $165,937
Harris Ashton 8,616.63 50 344,642
Robert F. Carlson 9 17,680
S. Joseph Fortunato 8,616.63 52 361,562
David Garbellano*** 5,866.65 31 91,317
Frank W.T. LaHaye 8,433.30 28 141,433
Gordon Macklin 8,616.63 50 337,292
Figures rounded to the nearest dollar.
**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 54 registered investment companies, with
approximately 168 U.S. based funds or series.
***The Board noted with deep regret the passing of David W. Garbellano in
late 1997. The Board appointed Robert F. Carlson to fill the vacancy in
January 1998.
Nonaffiliated members of the Board are reimbursed for expenses incurred in
connection with attending board meetings, paid pro rata by each fund in the
Franklin Templeton Group of Funds for which they serve as director or
trustee. No officer or Board member received any other compensation,
including pension or retirement benefits, directly or indirectly from the
Trust or other funds in the Franklin Templeton Group of Funds. Certain
officers or Board members who are shareholders of Resources may be deemed to
receive indirect remuneration by virtue of their participation, if any, in
the fees paid to its subsidiaries.
Board members historically have followed a policy of having substantial
investments in one or more of the Franklin Templeton Funds, as is consistent
with their individual financial goals. In February 1998, this policy was
formally adopted. Each board member is required to invest one-third of fees
received for serving as a director or trustee of a Templeton fund in shares
of one or more Templeton funds and one-third of fees received for serving as
a director or trustee of a Franklin fund in shares of one or more Franklin
funds. This is required until the value of such investments equals or exceeds
five times the board member's annual fees. For purposes of this policy, a
board member's investments include those in the name of family members or
entities controlled by the board member and, for investments made after
February 27, 1998, are valued at cost. Investments that existed on February
27, 1998, were valued as of that date. There is a three year phase-in period
for newly elected board members
As of November 27, 1998, no officer or trustee of the Trust owned of record
or beneficially shares of any Portfolio 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 are the father
and uncle, respectively, of Charles E. Johnson.
INVESTMENT MANAGEMENT AND OTHER SERVICES
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The Manager for all Portfolios of the Trust, except the Asset Allocation
Fund, Global Growth Fund, International Smaller Companies Fund, Developing
Markets Fund, Mutual Discovery Fund, Mutual Shares Fund, Rising Dividends
Fund and the Value Fund is Franklin Advisers, Inc. ("Advisers"), 777 Mariners
Island Blvd., P.O. Box 7777, San Mateo, California 94403-7777. In addition,
Advisers employs Templeton Investment Counsel, Inc. ("Templeton Florida"),
Broward Financial Centre, Suite 2100, Fort Lauderdale, Florida 33394, to act
as subadviser to the International Equity Fund, the Pacific Fund, and the
Global Income Fund. The Manager for the Rising Dividends Fund and the Value
Securities Fund is Franklin Advisory Services, Inc. ("Franklin New Jersey"),
One Parker Plaza, Sixteenth Floor, Ft. Lee, New Jersey 07024. The Manager for
the Mutual Discovery and Mutual Shares Funds is Franklin Mutual Advisers,
Inc. ("Franklin Mutual") 51 John F. Kennedy Parkway, Short Hills, New Jersey
07078. The Manager of the International Smaller Companies Fund is Templeton
Florida. The Manager for the Asset Allocation and Global Growth Funds is
Templeton Global Advisers Limited, formerly known as Templeton, Galbraith &
Hansberger, Ltd. ("Templeton Nassau"), Lyford Cay Nassau, N.P. Bahamas. The
Manager for Developing Markets Fund is Templeton Asset Management Ltd.
("Templeton Singapore"), 7 Temasek Boulevard, #38-03, Suntec Tower One,
Singapore. Templeton Nassau employs Templeton Florida to act as subadviser to
the Asset Allocation Fund. Advisers, Templeton Nassau, Templeton Singapore,
Templeton Florida, Franklin New Jersey and Franklin Mutual may be referred to
as the "Manager" or "Managers" throughout the SAI and prospectus.
The Managers also provide management services to numerous other investment
companies or portfolios and other accounts pursuant to management agreements
with each portfolio or other account. The Managers may give advice and take
action with respect to any of the other portfolios or accounts they manage,
or for their own accounts, which may differ from action taken by the Managers
on behalf of the Portfolios. Similarly, with respect to the Portfolios, the
Managers are not obligated to recommend, purchase or sell, or to refrain from
recommending, purchasing or selling any security that the Managers and access
persons, as defined by the 1940 Act, may purchase or sell for their own
accounts or for the accounts of any other portfolio or account. Furthermore,
the Managers are not obligated to refrain from investing in securities held
by the Portfolio or other portfolios or accounts which they manage or
administer. Of course, any transactions for the accounts of the Managers and
other access persons will be made in compliance with the Portfolio's Code of
Ethics. Please see "Miscellaneous Information."
Each Portfolio, except the Global Health Care Fund, the International Equity
Fund, the Pacific Fund, the Rising Dividends Fund, the Small Cap Fund, the
International Smaller Companies Fund, the Capital Growth Fund, the Mutual
Discovery Fund, the Mutual Shares Fund, the Global Growth Fund, the
Developing Markets Fund, the Value Fund and the Asset Allocation Fund, is
obligated to pay Advisers a fee as compensation for its services. This fee is
paid monthly and accrues daily based upon each Portfolio's average net assets
at the annual rate of 0.625% of the value of its average daily net assets up
to and including $100 million; 0.50% of the value of average daily net assets
over $100 million up to and including $250 million; 0.45% of the value of
average daily net assets over $250 million up to and including $10 billion;
0.44% of the value of average daily net assets over $10 billion up to and
including $12.5 billion; 0.42% of the value of average daily net assets over
$12.5 billion up to and including $15 billion; and 0.40% of the value of
average daily net assets over $15 billion.
Templeton Florida, as subadviser for the Global Income Fund under a contract
with Advisers, receives a monthly fee from Advisers at the annual rate of
0.35% of the value of the Portfolio's average daily net assets up to and
including $100 million; 0.25% of average daily net assets over $100 million
up to and including $250 million; 0.20% of the value of net assets over $250
million.
The International Equity Fund and the Pacific Fund are each obligated to pay
Advisers a monthly fee, based upon each Portfolio's average daily net assets,
at the annual rate of 1% of the value of average daily net assets up to and
including $100 million; 0.90% of the average daily net assets over $100
million up to and including $250 million; 0.80% of average daily net assets
over $250 million up to and including $500 million and 0.75% of average net
assets over $500 million. Templeton Florida, as the subadviser for the
International Equity Fund and the Pacific Fund under a contract with
Advisers, receives a monthly fee from Advisers at the annual rate of 0.50% of
the value of average daily net assets up to and including $100 million; 0.40%
of the average daily net assets over $100 million up to and including $250
million; 0.30% of average daily net assets over $250 million up to and
including $500 million and 0.25% of average net assets over $500 million.
The Capital Growth Fund, and the Small Cap Fund are each obligated to pay
Advisers a monthly fee, based upon each Portfolio's average daily net assets,
computed at the annual rate of 0.75 of 1% of average daily net assets on the
first $500 million of average daily net assets; 0.625 of 1% on the next $500
million of average daily net assets; and 0.50 of 1% on average daily net
assets in excess of $1 billion.
The Global Health Care Fund is obligated to pay Advisers a monthly fee, based
upon its average daily net assets, computed at the annual rate of 0.60 of 1%
of average daily net assets on the first $200 million of average daily net
assets; 0.50 of 1% up to and including $1.3 billion of average daily net
assets; and 0.40 of 1% on average daily net assets in excess of $1.3 billion.
The Rising Dividends Fund is obligated to pay Franklin New Jersey a monthly
fee, based upon its average daily net assets, computed at the annual rate of
0.75 of 1% of average daily net assets on the first $500 million of average
daily net assets; 0.625 of 1% on the next $500 million of average daily net
assets; and 0.50 of 1% on average daily net assets in excess of $1 billion.
The Value Fund is obligated to pay Franklin New Jersey a monthly fee, based
upon its average daily net assets, computed at the annual rate of 0.60 of 1%
of average daily net assets on the first $200 million of average daily net
assets; 0.50 of 1% up to and including $1.3 billion of average daily net
assets; and 0.40 of 1% on average daily net assets in excess of $1.3 billion.
The Mutual Discovery Fund and Mutual Shares Fund are obligated to pay
Franklin Mutual a monthly fee, based upon each Portfolio's average daily net
assets, computed at the annual rate of .80 of 1% and .60 of 1%, respectively,
of average daily net assets.
Under the management agreement with Templeton Nassau, the Global Growth Fund
is obligated to pay Templeton Nassau a monthly fee equal to an annual rate of
1.0% of the value of its average daily net assets up to and including $100
million; 0.90% of the value of average daily net assets over $100 million up
to and including $250 million; 0.80% of the value of the average daily net
assets over $250 million up to and including $500 million; and 0.75% of the
value of the average daily net assets over $500 million.
Under the management agreement with Templeton Singapore, the Developing
Markets Fund is obligated to pay Templeton Singapore a monthly fee equal to
an annual rate of 1.25% of the value of its average daily net assets.
Under the management agreement with Templeton Nassau, the Asset Allocation
Fund is obligated to pay the Manager a monthly fee equal to an annual rate of
0.65% of the value of its average daily net assets up to and including $200
million, 0.585% of the value of the average daily net assets over $200
million up to and including $1.3 billion; and 0.52% of the value of the
average daily net assets over $1.3 billion.
Templeton Florida, as subadviser for the Asset Allocation Fund under a
contract with Templeton Nassau, receives a monthly fee from Templeton Nassau
at the annual rate of 0.25% of the value of the Portfolio's average daily net
assets up to and including $200 million; 0.225% of average daily net assets
over $200 million up to and including $1.3 billion; and 0.20% of the value of
net assets over $1.3 billion.
Under a management agreement with Templeton Florida, the International
Smaller Companies Fund is obligated to pay the Manager a monthly fee equal to
an annual rate of 0.85% of the value of its average daily net assets up to
and including $200 million, 0.765% of the value of the average daily net
assets over $200 million up to and including $1.3 billion; and 0.68% of the
value of the average daily net assets over $1.3 billion.
The Managers may determine in advance to limit the management fees or to
assume responsibility for the payment of certain operating expenses relating
to the operations of any Portfolio, which may have the effect of decreasing
the total expenses and increasing the yield of such Portfolio. Any such
action is voluntary and may be terminated by the Managers at any time unless
otherwise indicated. For at least to the end of the fiscal year, December 31,
1998, Advisers has agreed to limit its management fees and, if necessary, to
assume responsibility for payment of each Zero Coupon Fund operating expenses
so that each Portfolio's total expenses will not exceed 0.40% of each
Portfolio's average net assets. With respect to the Money Fund, during 1997,
Advisers limited its management fees such that aggregate expenses, including
management fees of 0.43%, represented 0.45% of the Money Fund's average daily
net assets.
Except as indicated below, the management and subadvisory agreements with the
Managers are in effect until April 30, 1999, and may continue thereafter
provided they are approved for periods not to exceed one year by (i) the
Trust's Board or the vote of a majority of the outstanding shares of that the
affected Portfolio, and (ii) a majority of the Trustees who are not parties
to the Agreements or interested persons of any such party (other than as
Trustees).
The management agreements for the Mutual Discovery and Mutual Shares Funds
are in effect for an initial period of two years. These management agreements
may continue from year to year thereafter under the same provisions mentioned
above. The management agreement with respect to any Portfolio may be
terminated without penalty at any time by the Portfolio or by the Managers on
60 days' written notice and will automatically terminate in the event of its
assignment, as defined in the 1940 Act.
Pursuant to the management agreements and subadvisory agreements, the
Managers provide investment research and Portfolio management services,
including the selection of securities for each Portfolio to purchase, hold or
sell, and the selection of brokers through whom each such Portfolio's
transactions are executed. The Managers' activities are subject to the review
and supervision of the Board, and Templeton Florida as subadviser to certain
Portfolios is subject to the overview of each Portfolio's respective Manager,
to whom the Managers render periodic reports of each Portfolio's investment
activities. The Managers, or in certain cases, the Fund Administrator,
provide each Portfolio with executive and administrative personnel, office
space and facilities, and pay certain additional administrative expenses
incurred in connection with the operation of each Portfolio. Each Portfolio
bears all of its expenses not assumed by the Managers or Fund Administrator.
Each class pays its proportionate share of a Portfolio's management fees. The
Managers are covered by fidelity insurance on their officers, directors and
employees for the protection of the Trust. See the Statement of Operations in
the financial statements included in the Annual Report to Shareholders for
the year ended December 31, 1997, for additional details of these expenses.
The table below sets forth on a per Portfolio basis the management fees that
would have been accrued by the Managers and Fund Administrators and the
management fees actually paid by the Portfolios for the fiscal years ended
December 31, 1997, 1996 and 1995.
Management Management
and Fund and Fund
Administration Administration
Fees Accrued Fees Paid
- ------------------------------------------------------------------------------
1997
Money Fund $2,072,982 $1,740,190
Global Income Fund 1,133,609 1,133,609
High Income Fund 2,305,480 2,305,480
Government Fund 3,775,626 3,775,626
Zero Coupon Fund - 2000 724,202 442,683
Zero Coupon Fund - 2005 485,690 290,964
Zero Coupon Fund - 2010 491,457 293,620
Income Securities Fund 6,348,820 6,348,820
Rising Dividends Fund 4,942,390 4,942,390
Global Utility Fund (formerly the Utility Equity Fund) 5,139,011 5,139,011
Growth and Income Fund 5,667,415 5,667,415
Natural Resources Fund (formerly the Precious Metals Fund)
584,675 584,675
Real Estate Fund 1,988,023 1,988,023
Small Cap Fund 1,878,273 1,878,273
International Equity Fund 9,676,740 9,676,740
Pacific Fund 2,608,312 2,608,312
Asset Allocation Fund 526,125 526,125
Developing Markets 4,277,977 4,277,977
Global Growth 5,894,743 5,894,743
International Smaller Companies Fund 239,272 239,272
Growth Fund 558,503 558,503
Mutual Discovery Fund 930,954 930,954
Mutual Shares Fund 1,265,341 1,265,341
Management Management
and Fund and Fund
Administration Administration
Fees Accrued Fees Paid
- ------------------------------------------------------------------------------
1996
Money Fund $2,225,389 $1,781,802
Global Income Fund 1,262,055 1,262,055
High Income Fund 1,985,566 1,985,566
Government Fund 3,162,073 3,162,073
Zero Coupon Fund - 2000 790,492 494,949
Zero Coupon Fund - 2005 503,611 299,714
Zero Coupon Fund - 2010 490,108 291,798
Income Securities Fund 6,130,804 6,130,804
Rising Dividends Fund 3,785,807 3,785,807
Global Utility Fund (formerly the Utility Equity Fund) 6,097,507 6,097,507
Growth and Income Fund 4,643,546 4,643,546
Natural Resources Fund (formerly the Precious Metals Fund)
754,383 754,383
Real Estate Fund 1,335,653 1,335,653
Small Cap Fund 694,975 694,975
International Equity Fund 7,945,053 7,945,053
Pacific Fund 3,343,850 3,343,850
Asset Allocation Fund 272,732 272,732
Developing Markets 2,887,400 2,887,400
Global Growth 4,016,061 4,016,061
International Smaller Companies Fund 56,389 56,389
Growth Fund 86,028 86,028
Mutual Discovery Fund 11,033 11,033
Mutual Shares Fund 11,822 11,822
Management Management
and Fund and Fund
Administration Administration
Fees Accrued Fees Paid
- ------------------------------------------------------------------------------
1995
Money Fund $2,295,252 $1,700,943
Global Income Fund 1,354,128 1,354,128
High Income Fund 1,700,257 1,700,257
Government Fund 3,038,772 3,038,772
Zero Coupon Fund - 2000 721,943 439,204
Zero Coupon Fund - 2005 425,696 249,803
Zero Coupon Fund - 2010 398,959 233,644
Income Securities Fund 5,335,780 5,335,780
Rising Dividends Fund 2,858,740 2,858,740
Global Utility Fund (formerly the Utility Equity Fund) 6,002,369 6,002,369
Growth and Income Fund 3,283,721 3,283,721
Natural Resources Fund (formerly the Precious Metals Fund)
702,034 702,034
Real Estate Fund 1,110,443 1,110,433
Small Cap Fund 9,054 9,054
International Equity Fund 6,748,353 6,748,353
Pacific Fund 3,148,402 3,148,402
Asset Allocation Fund 52,421 52,421
Developing Markets 1,636,864 1,636,864
Global Growth Fund 2,309,970 2,309,970
Please refer to the "Officers and Trustees" table which indicates officers
and trustees who are affiliated persons of the Trust, the Managers and the
Insurance Companies.
DEFENSIVE DISTRIBUTION PLANS
Each Portfolio's management agreement includes a distribution or "Rule 12b-1"
plan (the "Defensive Plan"). However, no payments are to be made by any
Portfolio as a result of the Defensive Plan. The Portfolios do not make any
payments other than payments for which the Portfolios are otherwise obligated
to make pursuant to the applicable then effective management agreements, the
Class 2 Distribution Plan for each Portfolio (see "Class 2 Distribution
Plans" below) or as incurred in the ordinary course of their business. To the
extent payments are nevertheless deemed indirectly to be payments for the
financing of any activity primarily intended to result in the sale of shares
issued by the Portfolio within the context of rule 12b-1, such payments shall
be deemed to have been made pursuant to the Defensive Plan. In connection
with their approval of the applicable management agreements, the Board,
including a majority of the non-interested trustees, determined that, in the
exercise of their reasonable business judgment and in light of their
fiduciary duties, there is a reasonable likelihood that the implementation of
the respective Defensive Plans will benefit each Portfolio and the Contract
Owners whose purchase payments have indirectly been invested in each
Portfolio.
FUND ADMINISTRATOR
Franklin Templeton Services, Inc. ("FT Services"), 777 Mariners Island
Boulevard, San Mateo, California 94404 serves as Fund Administrator. It
provides certain administrative facilities and services for the Portfolios,
including preparation and maintenance of books and records, preparation of
tax reports, preparation of financial reports, and monitoring compliance with
regulatory requirements.
FT Services is employed directly by the Asset Allocation, Global Health Care,
International Smaller Companies, Mutual Discovery, Mutual Shares and Value
Funds, and through subcontracts by the Managers of all the other Portfolios.
TRANSFER AGENT
Franklin Templeton Investor Services, Inc., a wholly owned subsidiary of
Resources, maintains shareholder's records, processes purchases and
redemptions of each Portfolio's shares and acts as the Trust's transfer agent
and dividend-paying agent.
CUSTODIANS
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
Trust. In addition, Chase Manhattan Bank, Chase MetroTech Center, Brooklyn,
New York 11245, also acts as custodian for the Global Growth, Developing
Markets, Asset Allocation, and International Smaller Companies Funds. The
Custodians do not participate in decisions relating to the purchase and sale
of portfolio securities.
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP, 333 Market Street, San Francisco, California
94105, is the Trust's independent auditor. During the fiscal year ended
December 31, 1997, the auditor's 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 in
this Statement of Additional Information.
RESEARCH SERVICES
Research services may be provided to the Managers by various affiliates. Such
services may include information, analytical reports, computer screening
studies, statistical data, and factual resumes pertaining to securities
eligible for purchase by the Portfolios. Such supplemental research, when
utilized, is subject to analysis by the Managers before being incorporated
into the investment advisory process.
POLICIES REGARDING BROKERS USED ON SECURITIES TRANSACTIONS
- ------------------------------------------------------------------------------
The Managers select brokers and dealers to execute portfolio transactions in
accordance with criteria set forth in the respective management and
subadvisory agreements referenced herein and any directions that the Board
may give.
When placing a portfolio transaction, the 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 each
Portfolio is negotiated between the Portfolio's Manager 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 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 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 Managers may pay certain brokers commissions that are higher than those
another broker may charge, if the 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 Managers' overall responsibilities to client
accounts over which they exercise investment discretion. The services the
brokers may provide to the 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 Managers in carrying out their
investment advisory responsibilities. These services may not always directly
benefit the Portfolios. They must, however, be of value to the Managers in
carrying out their overall responsibilities to their clients.
To the extent Portfolios invest in bonds or other principal transactions
which occur at net prices, the 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. Transactions 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 Managers receive from dealers effecting
transactions in portfolio securities. The allocation of transactions in order
to obtain additional research services permits the 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 Managers and their
affiliates may use this research and data in their investment advisory
capacities with other clients. If the Trust's officers are satisfied that the
best execution is obtained, the sale of Portfolio shares, as well as shares
of other portfolios in the Franklin Templeton Group of Funds, may also be
considered a factor in the selection of broker dealers to execute a
Portfolio's transactions.
Because Franklin Templeton Distributors, Inc. ("Distributors"), an affiliate
of the Managers and the Trust's underwriter, is a member of the National
Association of Securities Dealers, Inc., it may sometimes receive certain
fees when a Portfolio tenders portfolio securities pursuant to a tender-offer
solicitation. As a means of recapturing brokerage for the benefit of a
Portfolio, any portfolio securities tendered by the Portfolio will be
tendered through Distributors if it is legally permissible to do so. In turn,
the next management fee payable to the Manager 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 certain of the Portfolios and other
portfolios or other investment companies or clients supervised by the
Managers or their affiliates are considered at or about the same time,
transactions in such securities will be allocated among the several
investment companies and clients in a manner deemed equitable to all, by the
Managers, taking into account the respective sizes of the Portfolios or
clients and the amount of securities to be purchased or sold. It is
recognized that it is possible that in some cases this procedure could have a
detrimental effect on the price or volume of the security, in so far as a
particular Portfolio is concerned. However, in other cases it is possible
that the ability to participate in volume transactions may improve execution
and reduce transaction costs to the Portfolios.
During the past three fiscal years ended December 31, 1997, or since
inception, each Portfolio paid brokerage commissions as follows:
Portfolio 1995 1996 1997
- ------------------------------------------------------------------------------
Money Fund $ 0$ 0 $ 0
Global Income Fund 0 0 0
High Income Fund 0 0 0
Government Fund 0 0 0
Zero Coupon Fund - 2000 0 0
Zero Coupon Fund - 2005 0 0 0
Zero Coupon Fund - 2010 0 0 0
Growth and Income Fund 2,368,736 848,162 1,277,652
Income Securities Fund 175,429 211,977 130,787
Real Estate Fund 182,818 89,985 213,815
Rising Dividends Fund 272,848 485,120 615,127
Asset Allocation Fund 24,490 62,209 131,597
Global Utility Fund
(formerly the Utility Equity Fund) 652,221 1,277,007 987,011
Natural Resources Fund
(formerly the Precious Metals Fund) 111,982 149,263 347,537
Small Cap Fund 9,622 183,601 242,801
Developing Markets Fund 589,426 604,200 1,147,089
Global Growth Fund 956,434 -- 860,436
International Equity Fund 824,409 1,015,004 1,842,559
Pacific Growth Fund 1,040,361 487,464 487,776
International Smaller Companies Fund -- 10,847 109,554
Capital Growth Fund -- 44,722 57,736
Mutual Discovery Fund -- 20,812 247,576
Mutual Shares Fund -- 31,174 310,461
As of December 31, 1997, the Money Fund owned securities issued by Merrill
Lynch & Company, and Morgan Stanley & Co. Inc., the Growth and Income Fund
owned securities issued by J.P. Morgan Securities Inc., the Global Growth
Fund owned securities issued by A.G. Edwards, Inc., and Morgan Stanley & Co.
Inc., the Asset Allocation Fund owned securities issued by Merrill Lynch &
Company, and Morgan Stanley & Co. Inc., the Mutual Discovery Securities Fund
owned securities issued by Morgan Stanley & Co. Inc., and the Mutual Shares
Securities Fund owned securities issued by Morgan Stanley & Co. Inc., and
Lehman Brothers, Inc., which were valued in the aggregate at $9,914,000,
$14,985,000, $13,082,000, $5,807,000, $6,096,000, $445,000, $1,183,000,
$384,000, $6,208,000 and $561,000, respectively. Except as stated above, no
Portfolio owned any securities issued by its regular broker-dealers as of the
end of such fiscal year.
THE TRUST'S UNDERWRITER
- ------------------------------------------------------------------------------
Pursuant to an underwriting agreement, Distributors acts as principal
underwriter in a continuous public offering of each class of each Portfolio's
shares. The underwriting agreement will continue in effect for successive
annual periods if its continuance is specifically approved at least annually
by a vote of the Board or by a vote of the holders of a majority of the
Trust's outstanding voting securities, and in either event by a majority vote
of the Board members who are not parties to the underwriting agreement or
interested persons of any such party (other than as members of the Board),
cast in person at a meeting called for that purpose. The underwriting
agreement terminates automatically in the event of its assignment and may be
terminated by either party on 90 days' written notice.
Distributors pays the expenses of the distribution of Trust shares, except to
the extent these expenses are borne by the Investment Companies, including
advertising expenses and the costs of printing sales material and
prospectuses used to offer shares to the public. The Trust pays the expenses
of preparing and printing amendments to its registration statements and
prospectuses (other than those necessitated by the activities of
Distributors) and of sending prospectuses to existing shareholders.
Distributors may be entitled to receive payment under the Rule 12b-1 plan for
the Class 2 shares of each Portfolio, as discussed below. Distributors
receives no other compensation from the Portfolios for acting as underwriter.
Class 2 Distribution Plans
As of December 28, 1998, the Trust has adopted a distribution plan or "Rule
12b-1" Plan in respect to its Class 2 shares ("Class 2 Plan") pursuant to
rule 12b-1 of the 1940 Act. Under the Class 2 Plans, each Portfolio may pay
up to a maximum of 0.35% per year of the average daily net assets
attributable to their respective Class 2 shares. The Board, however, has set
the current rate at 0.30% per year. These fees may be used to compensate
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 Class 2 Plan has been approved in accordance with the provisions of Rule
12b-1. The Class 2 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 ("non-interested trustees"), 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 Class 2 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 Class 2 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 relevant Portfolio's 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 Class 2
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.
ADDITIONAL INFORMATION REGARDING VALUATION AND REDEMPTION OF SHARES OF THE
PORTFOLIOS
- ------------------------------------------------------------------------------
CALCULATION OF NET ASSET VALUE
As noted in the prospectus, the net asset value of Trust shares will
generally be calculated only on days when the New York Stock Exchange (the
"Exchange") is open for trading, even though trading in the portfolio
securities of a Portfolio may occur on other days in other markets or
over-the-counter. As of the date of this Statement of Additional Information,
the Trust is informed that the Exchange will be closed in observance of the
following holidays: New Year's Day, Presidents' Day, Martin Luther King Jr.
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day
and Christmas.
PORTFOLIOS OTHER THAN MONEY FUND
For the purpose of determining the aggregate net assets of each Portfolio
(except the Money Fund), cash and receivable 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 NASDAQ 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 for which market quotations are readily available are valued
within the range of the most recent bid and ask prices as obtained from one
or more dealers that make markets in the securities. Portfolio securities
which are traded both in the over-the-counter market and on a securities
exchange are valued according to the broadest and most representative market
as determined by the 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 Portfolio is its last sales
price on the relevant exchange prior to the time when assets are valued.
Lacking any sales that day or if the last sale 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 Portfolio should have an open option position
as 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 Exchange, 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 which affect
the values of foreign securities and foreign exchange rates may occur between
the times at which values and rates are determined and the close of the
Exchange and will, therefore, not be reflected in the computation of a
Portfolio's net asset value. If events materially affecting the value of
these foreign securities occur during such periods, then these securities
will be valued in accordance with procedures established by the Board.
Trading in securities on European and Far Eastern securities exchanges and
over-the-counter markets is normally completed well before the close of
business of the Exchange on each day on which the Exchange is open. Trading
in European or Far Eastern securities generally, or in a particular country
or countries, may not take place on every Exchange business day. Furthermore,
trading takes place in various foreign markets on days which are not business
days for the Exchange and on which the Portfolios' net asset value are not
calculated. Thus, such calculation does not take place contemporaneously with
the determination of the prices of many of the portfolio securities used in
such calculation and, if events materially affecting the value of these
foreign securities occur, they will be valued at fair market value as
determined by the Managers and approved in good faith 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 these securities used in computing
the net asset value of the Portfolios' shares is determined as of such times.
Occasionally, events affecting the values of such securities may occur
between the times at which they are determined and the close of the Exchange
that will not be reflected in the computation of the Portfolios' net asset
values. If events materially affecting the values of these securities occur
during such 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, the Portfolio may utilize a pricing service, bank or securities
dealer to perform any of the above described functions.
All Money Market Instruments owned by Portfolios, other than the Money Market
Fund, are valued at current market, as discussed above.
MONEY MARKET FUND
The valuation of the Portfolio's securities (including any securities held in
the segregated account maintained for when-issued securities) is based upon
their amortized cost, which does not take into account unrealized capital
gains or losses. This 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 Portfolio would receive if it sold the
instrument. During periods of declining interest rates, the daily yield on
shares of the Portfolio computed as described above may tend to be higher
than a like computation made by a portfolio with identical investments
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 Portfolio resulted in a lower aggregate portfolio value
on a particular day, a prospective investor in the Portfolio would be able to
obtain a somewhat higher yield than would result from investment in a
portfolio utilizing solely market values, and existing investors in the
Portfolio would receive less investment income. The opposite would apply in a
period of rising interest rates.
The Portfolio's use of amortized cost which helps the Portfolio maintain its
net asset value per share of $1 is permitted by a Rule adopted by the SEC.
Under this rule the Portfolio must adhere to certain conditions. The
Portfolio must maintain a dollar-weighted average portfolio maturity of 90
days or less, only purchase instruments having remaining maturities of 397
calendar days or less, and invest only in those U.S. dollar-denominated
instruments that the Board determines present minimal credit risks and which
are, as required by the federal securities laws, rated in one of the two
highest rating categories as determined by nationally recognized statistical
rating agencies, instruments deemed comparable in quality to such rated
instruments, or instruments, the issuers of which, with respect to an
outstanding issue of short-term debt that is comparable in priority and
protection, have received a rating within the two highest categories of
nationally recognized statistical rating agencies. Securities subject to
floating or variable interest rates with demand features in compliance with
applicable rules of the SEC may have stated maturities in excess of one year.
The trustees have established procedures designed to stabilize, to the extent
reasonably possible, the Portfolio's price per share as computed for the
purpose of sales and redemptions at $1. These procedures include review of
the Portfolio's holdings by the trustees, at such intervals as they may deem
appropriate, to determine whether the Portfolio'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 trustees.
If deviation exceeds 1/2 of 1%, the trustees will promptly consider what
action, if any, will be initiated. In the event the trustees determine that a
deviation exists which may result in material dilution or other unfair
results to investors or existing shareholders, they will take such corrective
action that they regard as necessary and appropriate, which may include
selling portfolio instruments before maturity to realize 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.
ADDITIONAL INFORMATION
- ------------------------------------------------------------------------------
ADDITIONAL INFORMATION REGARDING TAXATION
As stated in the prospectus, each Portfolio intends to be treated as a
regulated investment company under Subchapter M of the Code.
Any Portfolio's investment in options, futures contracts and forward
contracts, including transactions involving actual or deemed short sales or
foreign exchange gains or losses are subject to many complex and special tax
rules. For example, over-the-counter options on debt securities and equity
options, including options on stock and on narrow-based stock indexes, will
be subject to tax under Section 1234 of the Code, generally producing a
long-term or short-term capital gain or loss upon exercise, lapse, or closing
out of the option or sale of the underlying stock or security. By contrast,
the Portfolio treatment of certain other options, futures and forward
contracts entered into by a Portfolio is generally governed by Section 1256
of the Code. These "Section 1256" positions generally include listed options
on debt securities, options on broad-based stock indexes, options on
securities indexes, options on futures contracts, regulated futures contacts
and certain foreign currency contacts and options thereon.
Absent a tax election to the contrary, each such Section 1256 position held
by a Portfolio will be marked-to-market (i.e., treated as if it were sold for
fair market value) on the last business day of the Portfolio's fiscal year,
and all gain or loss associated with fiscal year transactions and
mark-to-market positions at fiscal year end (except certain foreign currency
gain or loss covered by Section 988 of the Code) will generally be treated as
60% long-term capital gain or loss and 40% short-term capital gain or loss.
The effect of Section 1256 mark-to-market rules may be to accelerate income
or to convert what otherwise would have been long-term capital gains into
short-term capital gains or short-term capital losses into long-term capital
losses within the Portfolio. The acceleration of income on Section 1256
positions may require the Portfolio to accrue taxable income without the
corresponding receipt of cash. In order to generate cash to satisfy the
distribution requirements of the Code, the Portfolio may be required to
dispose of portfolio securities that it otherwise would have continued to
hold or to use cash flows from other sources such as the sale of Portfolio
shares. In these ways, any or all of these rules may affect both the amount,
character and timing of income distributed to shareholders by the Portfolio.
When a Portfolio holds an option or contract which substantially diminishes
the Portfolio's risk of loss with respect to another position of the
Portfolio (as might occur in some hedging transactions), this combination of
positions could be treated as a "straddle" for tax purposes, resulting in
possible deferral of losses, adjustments in the holding periods of Portfolio
securities and conversion of short-term capital losses into long-term capital
losses. Certain tax elections exist for mixed straddles (i.e., straddles
comprised of at least one Section 1256 position and at least one non-Section
1256 position) which may reduce or eliminate the operation of these straddle
rules.
In order for a Portfolio to qualify as a regulated investment company, at
least 90% of the Portfolio's annual gross income must consist of dividends,
interest and certain other types of qualifying income, and no more than 30%
of its annual gross income may be derived from the sale or other disposition
of securities or certain other instruments held for less than 3 months.
Foreign exchange gains, derived by a Portfolio with respect to the
Portfolio's business investing in stock or securities, or options or futures
with respect to such stock or securities constitute income for purposes of
this 90% limitation.
Currency speculation or the use of currency forward contracts or other
currency instruments for non-hedging purposes may generate gains deemed to be
not directly related to a Portfolio's principal business of investing in
stock or securities and related options or futures. Under current law,
non-directly-related gains arising from foreign currency positions or
instruments held for less than 3 months are treated as derived from the
disposition of securities held less than 3 months in determining the
Portfolio's compliance with the 30% limitation. The Portfolios will limit
their activities involving foreign exchange gains to the extent necessary to
comply with these requirements.
The federal income tax treatment of interest rate and currency swaps is
unclear in certain respects and may in some circumstances result in the
realization of income not qualifying under the 90% test described above or be
deemed to be derived from the disposition of securities held less than three
months in determining a Portfolio's compliance with the 30% limitation. The
Portfolios will limit their interest rate and currency swaps to the extent
necessary to comply with these requirements.
If a Portfolio owns shares in a foreign corporation that constitutes a
"passive foreign investment company" (a "PFIC") for federal income tax
purposes and the Portfolio does not elect to treat the foreign corporation as
a "qualified electing fund" within the meaning of the Code, the Portfolio may
be subject to U.S. federal income on a portion of any "excess distribution"
it receives from the PFIC or any gain it derives from the disposition of such
shares, even if such income is distributed as a taxable dividend by the
Portfolio to its U.S. shareholders. The Portfolio may also be subject to
additional interest charges in respect of deferred taxes arising from such
distributions or gains. Any federal income tax paid by a Portfolio as a
result of its ownership on shares of a PFIC will not give rise to a deduction
or credit to the Portfolio or to any shareholder. A PFIC means any foreign
corporation if, for the taxable year involved, either (i) it derives at least
75 percent of its income from "passive income" (including, but not limited
to, interest, dividends, royalties, rents and annuities), or (ii) on average,
at least 50 percent of the value (or adjusted basis, if elected) of the
assets held by the corporation produce "passive income."
On April 1, 1992, proposed U.S. Treasury regulations were issued regarding a
special mark-to-market election for regulated investment companies. Under
these regulations, the annual mark-to-market gain, if any, on shares held by
a Portfolio in a PFIC would be treated as an excess distribution received by
the Portfolio in the current year, eliminating the deferral and the related
interest charge. Such excess distribution amounts are treated as ordinary
income, which the Portfolio will be required to distribute to shareholders
even though the Portfolio has not received any cash to satisfy this
distribution requirement. These regulations would be effective for taxable
years ending after the promulgation of the proposed regulations as final
regulations.
HOW THE TRUST MEASURES PERFORMANCE
Performance quotations are subject to SEC rules. These rules require the use
of standardized performance quotations or, alternatively, that every
non-standardized performance quotation furnished by a Portfolio be
accompanied by certain standardized performance information computed as
required by the SEC. Average annual total return and current yield quotations
used by a Portfolio are based on the standardized methods of computing
performance mandated by the SEC. An explanation of these and other methods
used by a portfolio to compute or express performance follows.
Because the Trust only offers its shares to Insurance Company separate
accounts for use in variable annuity and variable life insurance contracts,
to the extent required by SEC rules, the advertised performance of the
Portfolios will be displayed no more prominently than standardized
performance of the applicable insurance company separate accounts/contracts.
For information about how an Insurance Company may advertise such
performance, please consult the contract prospectus which accompanies the
Trust prospectus.
Regardless of the method used, past performance does not guarantee future
results, and is an indication of the return only for the limited historical
period used.
Average annual total return is determined by finding the average annual rates
of return over the periods indicated below that would equate an initial
hypothetical $1,000 investment to its ending redeemable value. The
calculation assumes income dividends and capital gain distributions are
reinvested at net asset value. The quotation assumes the investment was
completely redeemed at the end of each period and the deduction of all
applicable charges and fees. If a change is made to the sales charge
structure, historical performance information will be restated to reflect the
maximum sales charge currently in effect.
The total return performance for each portfolio's Class 2 shares for the
periods prior December 28, 1998, when the Trust's Class 2 shares commenced
operations, will represent the historical results of Class 1 Shares.
Performance of Class 2 shares for the periods after December 28, 1998 will
reflect Class 2's higher annual fees and expenses resulting from its Rule
12b-1 plan. Historical performance data for Class 2 shares, based on Class 1
performance, will generally not be restated to include 12b-1 fees, although
each portfolio may restate these figures consistent with SEC rules.
The average annual total returns for each portfolio as of the end of the most
recent fiscal year are set forth in the Trust's most recent Annual Report,
which is incorporated herein by reference. See "Financial Statements," below.
From time to time, the "yield" and "effective yield" of the Money Fund may be
advertised. Both yield figures will be based on historical earnings and are
not intended to indicate future performance. The "yield" of the Money Fund
refers to the income generated by an investment in the Money Fund over a
seven-day period (which period will be stated in the advertisement). This
income is then "annualized." That is, the amount of income generated by the
investment during that week is assumed to be generated each week over a
52-week period and is shown as a percentage of the investment. The "effective
yield" is calculated similarly but, when annualized, the income earned by an
investment in the Money Fund is assumed to be reinvested. The "effective
yield" will be slightly higher than the "yield" because of the compounding
effect of this assumed reinvestment.
From time to time, the current yields of the Portfolios, other than the Money
Fund, may be published in advertisements and communications to Contract
Owners. The current yield for each Portfolio will be calculated by dividing
the annualization of the income earned by the Portfolio during a recent
30-day period by the net asset value per share at the end of such period. In
addition, aggregate, cumulative and average total return information for each
Portfolio over different periods of time may also be advertised. Except as
stated above, each class of each Portfolio's shares will use the same methods
for calculating its performance.
A distribution rate for each Portfolio may also be published in
communications preceded or accompanied by a copy of the Portfolios' current
prospectus. The current distribution rate for a Portfolio will be calculated
by dividing the annualization of the total distributions made by that
Portfolio during the most recent preceding fiscal quarter by the net asset
value per share at the end of such period. The current distribution rate may
differ from current yield because the distribution rate will be for a
different period of time and may contain items of capital gain and other
items of income, while current yield reflects only earned income. Uniformly
computed yield and total return figures for each Portfolio will also be
published along with publication of its distribution rate.
Hypothetical performance information may also be prepared for sales
literature or advertisements. See "Performance Data" in the appropriate
insurance company separate account prospectus and "Calculation of Performance
Data" in the appropriate insurance company separate account SAI.
Miscellaneous Information
The organizational expenses of certain series of the Trust are being
amortized on a straight-line basis over a period of five years from the
commencement of the offering of any such Portfolio's shares. Contract owners
allocating payments to shares of a Portfolio after the effective date of the
Trust's Registration Statement under the Securities Act of 1933 will be
bearing such expenses during the amortization period only as such charges are
accrued daily against the investment income of that Portfolio.
As of November 24, 1998, Allianz Life Variable Account A, Allianz Life
Variable Account B and Preferred Life Variable Account C owned, 0.31%, 92.15%
and 7.54%, respectively, of the issued and outstanding shares of the Trust.]
Contract owners will be informed of each Portfolio's progress through
periodic reports. Financial statements certified by independent public
auditors will be available at least annually.
Employees of the Franklin Templeton Group who are access persons under the
1940 Act are permitted to engage in personal securities transactions subject
to the following general restrictions and procedures: (i) the trade must
receive advance clearance from a compliance officer and must be completed by
the close of the business day following the day clearance is granted; (ii)
copies of all brokerage confirmations 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.
The shareholders of a Massachusetts business trust could, under certain
circumstances, be held personally liable as partners for its obligations.
However, the Trust's Agreement and Declaration of Trust contains an express
disclaimer of shareholder liability for acts or obligations of the Trust. The
Declaration of Trust also provides for indemnification and reimbursement of
expenses out of each Portfolio's assets for any shareholder held personally
liable for obligations of that Portfolio or the Trust. The Declaration of
Trust provides that the Trust shall, upon request, assume the defense of any
claim made against any shareholder for any act or obligation of a Portfolio
or the Trust and shall satisfy any judgment thereon. All such rights are
limited to the assets of the Portfolio of which a shareholder holds shares.
The Declaration of Trust further provides that the Trust may maintain
appropriate insurance (for example, fidelity bonding and errors and omissions
insurance) for the protection of the Trust, its shareholders, trustees,
officers, employees and agents to cover possible tort and other liabilities.
Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which both inadequate
insurance exists and the Portfolio itself is unable to meet its obligations.
The Trust is registered with the SEC as a management investment company. Such
registration does not involve supervision of the management or policies of
the Portfolios by the SEC. The prospectus and this SAI omit certain of the
information contained in the Registration Statement filed with the SEC,
copies of which may be obtained from the SEC upon payment of the prescribed
fee.
PORTFOLIO SIMILARITY
The investment objectives and policies of certain Portfolios are similar but
not identical to those of certain public Franklin Templeton Funds indicated
in the table below. Because of differences in portfolio size, the investments
held, the timing of purchases of similar investments, cash flows, minor
differences in certain investment policies, insurance product related tax
diversification requirements, state insurance regulations, and additional
administrative and insurance costs associated with insurance company separate
accounts, the investment performance of the Franklin Valuemark Funds will
differ from the performance of the corresponding Franklin Templeton Funds.
Franklin Valuemark Funds Franklin Templeton Funds
Franklin Custodian Funds, Inc.:
Capital Growth Fund - Growth Series
Franklin Strategic Series:
Global Health Care Securities Fund - Franklin Global Health Care Fund
Franklin Strategic Series:
Global Utilities Securities Fund - Franklin Global Utilities Fund
(formerly Utility Equity Fund)
High Income Fund AGE High Income Fund, Inc.
Franklin Custodian Funds, Inc.:
Income Securities Fund - Income Series
Money Market Fund Franklin Money Fund
Franklin Mutual Series Fund Inc.:
Mutual Shares Securities Fund Mutual Shares Fund
Mutual Discovery Securities Fund Mutual Discovery Fund
Franklin Strategic Series:
Natural Resources Fund - Franklin Natural Resources Fund
(formerly Precious Metals Fund)
Franklin Real Estate Securities Trust:
Real Estate Securities Fund - Franklin Real Estate Securities Fund
Franklin Managed Trust:
Rising Dividends Fund - Franklin Rising Dividends Fund
Franklin Strategic Series:
Small Cap Fund - Franklin Small Cap Growth Fund
Templeton Developing Markets Equity Fund Templeton Developing Markets Trust
Templeton Variable Products Series
Fund:
Templeton Global Asset Allocation Fund - Templeton Asset Allocation Fund
Templeton Global Growth Fund Templeton Growth Fund, Inc.
Franklin Investors Securities Trust:
Templeton Global Income Securities Fund - Franklin Global Government Income
Fund
Franklin Templeton International Trust:
Templeton Pacific Growth Fund - Templeton Pacific Growth Fund
Franklin Custodian Funds, Inc.:
U.S. Government Securities Fund U.S. Government Securities Series
Franklin Value Investors Trust
Value Securities Fund - Franklin Value Fund
FINANCIAL STATEMENTS
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The audited financial statements contained in the Trust's Annual Report for
the fiscal year ended December 31, 1997, including the auditor's report, and
the unaudited financial statements contained in the Trust's Semi Annual
Report to Shareholders, for the six-month period ended June 30, 1998, are
incorporated herein by reference.
FVF2 SAI 12/98
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