FRANKLIN TEMPLETON
VARIABLE INSURANCE
PRODUCTS TRUST
FORMERLY, FRANKLIN[REGISTERED TRADEMARK] VALUEMARK[REGISTERED TRADEMARK] FUNDS
CLASS 1 AND CLASS 2 [FRANKLIN TEMPLETON LOGO]
STATEMENT OF ADDITIONAL INFORMATION 777 MARINERS ISLAND BLVD., P.O. BOX 7777
MAY 1, 1999, AS SUPPLEMENTED SAN MATEO, CA 94403-7777 1-800/342-3863
DECEMBER 16, 1999
The following series or funds ("funds") of Franklin Templeton Variable Insurance
Products Trust ("Trust"), formerly Franklin Valuemark Funds, are sold only to
insurance companies for use as investment options in variable annuity or
variable life insurance contracts:
Franklin Large Cap Growth Securities Fund
(Large Cap Fund) - Class 1 and 2
(previously the Franklin Capital Growth Fund)
Franklin Global Health Care Securities Fund
(Global Health Care Fund) - Class 1 and 2
Franklin Global Communications Securities Fund
(Global Communications Fund) - Class 1 and 2
(formerly Franklin Global Utilities Securities Fund)
Franklin Growth and Income Fund
(Growth and Income Fund) - Class 1 and 2
Franklin High Income Fund
(High Income Fund) - Class 1 and 2
Franklin Income Securities Fund
(Income Securities Fund) - Class 1 and 2
Franklin Money Market Fund
(Money Fund) - Class 1 and 2
Franklin Natural Resources Securities Fund
(Natural Resources Fund) - Class 1 and 2
Franklin Real Estate Fund
(Real Estate Fund) - Class 1 and 2
Franklin Rising Dividends Securities Fund
(Rising Dividends Fund) - Class 1 and 2
Franklin Small Cap Fund
(Small Cap Fund) - Class 1 and 2
Franklin U.S. Government Fund
(Government Fund) - Class 1 and 2
Franklin Value Securities Fund
(Value Fund) - Class 1 and 2
Franklin Zero Coupon Funds, 2000, 2005, and 2010 -
(Zero Coupon Funds) - Class 1 and 2
Mutual Discovery Securities Fund
(Mutual Discovery Fund) - Class 1 and 2
Mutual Shares Securities Fund
(Mutual Shares Fund) - Class 1 and 2
Templeton Developing Markets Equity Fund
(Developing Markets Fund) - Class 1 and 2
Templeton Global Asset Allocation Fund
(Asset Allocation Fund) - Class 1 and 2
Templeton Global Growth Fund
(Global Growth Fund) - Class 1 and 2 Templeton
Global Income Securities Fund
(Global Income Fund) - Class 1 and 2
Templeton International Equity Fund
(International Equity Fund) - Class 1 and 2
Templeton International Smaller Companies Fund
(International Smaller Companies Fund) - Class 1 and 2
Templeton Pacific Growth Fund
(Pacific Growth Fund) - Class 1 and 2
This Statement of Additional Information (SAI) is not a prospectus. It contains
information in addition to the information in the funds' prospectuses. The
funds' prospectuses, dated May 1, 1999, as supplemented November 1, 1999, which
we may amend from time to time, contain the basic information you should know
before investing in the funds. You should read this SAI together with the funds'
prospectuses.
The audited financial statements and auditor's report in the funds' Annual
Report to Shareholders, for the fiscal year ended December 31, 1998 are
incorporated by reference (are legally a part of this SAI).
For a free copy of a current prospectus or annual report call 1-800/342-3863.
MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS:
o ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE
FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT;
o ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK;
o ARE SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL.
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CONTENTS PAGE
Goals and Strategies ....................................... 3
Fund Seeking Capital Preservation And Income ............ 3
Funds Seeking Income .................................... 3
Funds Seeking Growth and Income ......................... 6
Funds Seeking Capital Growth ............................ 11
Non-Fundamental Policies
Affecting Multiple Funds ................................... 19
Securities and Investment Techniques,
Generally ................................................. 19
Risks ...................................................... 36
Fundamental Investment Restrictions ........................ 46
Officers and Trustees ...................................... 48
Management and Other Services .............................. 50
Portfolio Transactions ..................................... 53
Distributions and Taxes .................................... 55
Organization, Voting Rights and
Principal Holders ......................................... 55
Pricing Shares ............................................. 57
The Underwriter ............................................ 58
Performance ................................................ 59
Miscellaneous Information .................................. 64
Description of Bond Ratings ................................ 65
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GOALS AND STRATEGIES
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FUND SEEKING CAPITAL PRESERVATION AND INCOME
MONEY FUND
The fund's investment goal is high current income, consistent with liquidity and
capital preservation. The fund also tries to maintain a stable share price of
$1.00.
The fund seeks to achieve its investment goal by investing in high-quality,
short-term money market securities of domestic and foreign issuers, including:
o U.S. Government securities with fixed, floating or variable interest rates;
o repurchase agreements;
o obligations, with fixed, floating or variable interest rates, issued or
guaranteed by U.S. banks with assets of at least one billion dollars,
including certificates of deposit, bank notes, loan participation interests,
commercial paper, unsecured promissory notes, time deposits, and bankers'
acceptances;
o obligations of foreign branches of foreign banks, U.S. branches of foreign
banks ("Yankee Dollar Investments"), and foreign branches of U.S. banks
("Eurodollar Investments"), all of which include certificates of deposit,
bank notes, loan participation interests, commercial paper, unsecured
promissory notes, time deposits, and bankers' acceptances, where the parent
bank has more than five billion dollars in total assets at the time of
purchase;
o commercial paper;
o other short-term securities, with fixed, floating or variable interest rates,
issued or guaranteed by U.S. corporations, or securities issued by foreign
entities;
o taxable municipal securities, up to 10% of the fund's assets; and
o unrated notes, paper, securities or other instruments that the manager
determines to be of comparable high quality.
Because the fund limits its investments to high-quality securities, it will
generally earn lower yields than a portfolio with lower quality securities that
are subject to greater risk. Accordingly, the yield to shareholders in the fund
will likely be lower.
BANK OBLIGATIONS The fund may invest in obligations of U.S. branches of foreign
banks, which are considered domestic banks. The fund will only make these
investments if the branches have a federal or state charter to do business in
the U.S. and are subject to U.S. regulatory authorities. The fund may invest up
to 25% of its assets in obligations of foreign branches of U.S. or foreign
banks. The fund may also invest in time deposits, which are non-negotiable
deposits maintained in a banking institution for a specified period of time at a
stated interest rate. The fund may invest up to 10% of its assets in time
deposits with maturities in excess of seven calendar days.
DIVERSIFICATION With respect to diversification, the fund may not invest more
than 5% of its total assets in securities of a single issuer, other than U.S.
Government secu rities, although it may invest more than 5% of its total assets
in securities of a single issuer that are rated in the highest rating category
for a period of up to three business days after purchase. The fund also must not
invest more than (a) the greater of 1% of its total assets or $1 million in
securities issued by a single issuer that are rated in the second highest rating
category; and (b) 5% of its total assets in securities rated in the second
highest rating category.
OTHER INVESTMENT POLICIES The fund may also:
o buy U.S. Government securities on a when-issued or delayed delivery basis,
o lend portfolio securities up to 30% of its assets, and
o enter into repurchase agreements.
FUNDS SEEKING INCOME
HIGH INCOME FUND
The fund's principal investment goal is to earn a high level of current income.
Its secondary goal is capital appreciation.
Under normal market conditions, the fund will invest primarily in debt
securities. The fund may invest in debt securities in any rating category,
including high yield, lower-rated debt securities ("junk bonds"), or in unrated
debt securities, but does not intend to invest more than 5% in the lowest rating
categories, i.e., rated below Caa by Moody's or CCC by S&P; or, if unrated,
comparable securities in the view of the manager. The fund will not purchase
defaulted securities. The fund may also buy lower rated zero-coupon, deferred
interest and pay-in-kind securities.
Ratings assigned by the rating agencies are based largely on the issuer's
historical financial condition and the rating agencies' investment analysis at
the time of the rating. Credit quality in the high yield debt market, however,
can change suddenly and unexpectedly, and credit ratings may not reflect the
issuer's current financial condition. For these reasons, the manager does not
rely principally on the ratings assigned by rating agencies, but performs its
own independent investment analysis of securities being considered for the
fund's portfolio.
FOREIGN SECURITIES The fund may invest up to 20% of its assets in foreign
securities, including emerging markets. However, the fund will limit its
investments in emerging markets to 10% of its assets.
OTHER INVESTMENT POLICIES The fund is also permitted to:
o acquire loan participations;
o purchase debt securities on a "when-issued" basis;
o write covered call options;
o lend its portfolio securities up to 30% of its assets; and
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o enter into repurchase agreements and forward currency exchange contracts,
participate in interest rate swaps, invest in restricted securities, and
invest in trade claims.
GOVERNMENT FUND
The fund's investment goal is income.
Under normal market conditions, the fund will invest in a portfolio limited to
U.S. Government securities. These securities include U.S. Treasury bonds, notes
and bills, and securities issued by U.S. Government agencies.
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION ("GNMA") OBLIGATIONS ("GINNIE MAES")
Ginnie Maes differ from other bonds in that principal may be paid back on an
unscheduled basis rather than returned in a lump sum at maturity. GNMA's
guarantee of payment of principal and interest on Ginnie Maes is backed by the
full faith and credit of the U.S. Government. GNMA may borrow U.S. Treasury
funds to the extent needed to make payments under its guarantee.
Payments to holders of Ginnie Maes consist of the monthly distributions of
interest and principal less GNMA's and issuers' fees. The fund will reinvest the
return of principal in securities that may have different interest rates than
the Ginnie Mae.
Principal payments are passed through to the Ginnie Mae holders, such as the
fund, when mortgages in the pool underlying a Ginnie Mae are prepaid by
borrowers or as a result of foreclosure. Accordingly, a Ginnie Mae'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 Ginnie Mae.
OTHER MORTGAGE SECURITIES The fund may also invest in fixed-rate mortgage-backed
securities, adjustable-rate mortgage-backed securities ("ARMS"), or a hybrid of
the two. In addition to ARMS, the fund 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"), and obligations of the Tennessee Valley Authority (TVA).
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.
The ARMS in which the fund invests are issued primarily by GNMA, the Federal
National Mortgage Association ("FNMA"), and the Federal Home Loan Mortgage
Corporation ("FHLMC"), and are actively traded in the secondary market. ARMS
issued by GNMA are collateralized by underlying mortgages that are fully
guaranteed by the Federal Housing Administration or the Veterans Administration.
ARMS issued by the FNMA or the FHLMC are collateralized by conventional
residential mortgages conforming to standard underwriting size and maturity
constraints.
ARMS allow the fund 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 fund will not, however, benefit from increases in interest rates to the
extent that interest rates rise to the point where the current coupon of
adjustable rate mortgages in the fund exceeds 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 bonds. See
"Securities and Investment Techniques, Adjustable Rate Mortgage Securities" for
additional details.
OTHER INVESTMENT POLICIES The fund may invest in certain other types of
pass-through debt securities, issued or guaranteed by U.S. Government agencies
or instrumentalities. The fund may also:
o enter into covered mortgage "dollar rolls,"
o lend portfolio securities up to 30% of its assets, and
o engage in repurchase agreements.
ZERO COUPON FUNDS:
MATURING IN DECEMBER OF 2000, 2005, 2010
Each fund's investment goal is to provide as high an investment return as is
consistent with the preservation of capital.
STRIPPED SECURITIES Under normal market conditions, each fund will invest
primarily in "stripped securities," a term used collectively for Stripped
Treasury Securities, Stripped Government Securities, Stripped Corporate
Securities and Stripped Eurodollar Obligations, all described below. The
stripped securities in which each fund will invest consist of:
o Zero coupon securities issued by the U.S. Treasury, including treasury bills,
debt securities issued by the U.S. Treasury which have been stripped of their
interest coupons or which were issued without interest coupons, and interest
coupons that have been stripped from debt securities issued by the U.S.
Treasury ("Stripped Treasury Securities"). The funds do not anticipate that
these securities will exceed 55% of a fund's assets.
o Other zero coupon securities issued by the U.S. Government and its agencies
and instrumentalities ("Stripped Government Securities").
o Debt securities denominated in U.S. dollars that are issued by foreign
issuers, often subsidiaries of domestic corporations ("Stripped Eurodollar
Obligations").
o To a lesser extent, zero coupon securities issued by domestic corporations
which consist of corporate debt securities without interest coupons, and, if
available, interest coupons that have been stripped from corporate
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debt securities, and receipts and certificates for such stripped debt
securities and stripped coupons (collectively, "Stripped Corporate
Securities");
Stripped securities, like other debt securities, are subject to certain risks,
including credit and market risks. To the extent the funds invest in stripped
securities other than Stripped Treasury Securities, these investments will be
rated at least A by nationally recognized statistical rating agencies, or
unrated securities that the manager determines are of comparable quality. Debt
securities rated A are regarded as having an adequate capacity to pay principal
and interest but are vulnerable to adverse economic conditions and have some
speculative characteristics. The funds will also attempt to minimize the impact
of individual credit risks by diversifying their portfolio investments. The
availability of stripped securities, other than Stripped Treasury Securities,
may be limited at times; during such periods, because the funds must meet
annuity tax diversification rules, they may invest in other types of
fixed-income securities.
Because each fund will be primarily invested in zero coupon securities,
investors who hold shares to maturity will experience a return consisting
primarily of the amortization of discount on the underlying securities in the
fund. However, the net asset value of a fund's shares increases or decreases
with changes in the market value of that fund's investments.
FOREIGN SECURITIES Although each fund reserves the right to invest up to 10% of
its assets in foreign securities, each fund typically limits these investments
to less than 10% of its assets and to dollar denominated obligations.
STRUCTURED NOTES Although each fund reserves the right to invest up to 10%, each
fund currently does not intend to invest more than 5% of its assets in certain
structured notes, which are comparable to zero coupon bonds in terms of credit
quality, interest rate volatility, and yield.
OTHER INVESTMENT POLICIES To provide income for expenses, redemption payments,
and cash dividends, each fund may invest up to 20% of its assets in money market
instruments. The manager intends to have less than 20% of a fund's assets in
these instruments, under normal circumstances. The funds may also lend portfolio
securities up to 30% of its assets and enter into repurchase agreements.
TAX CONSIDERATIONS Under federal income tax law, a portion of the difference
between the purchase price of the zero coupon securities and their face value
("original issue discount") is considered to be income to the Zero Coupon Funds
each year, even though the funds will not receive cash payments representing the
discount from these securities. This original issue discount will comprise a
part of the net taxable investment income of the funds which must be
"distributed" to the insurance company, as shareholder each year, whether or not
such distributions are paid in cash. To the extent such distributions are paid
in cash, the fund may have to generate the required cash from interest earned on
non-zero coupon securities or possibly from the disposition of zero coupon
securities.
GLOBAL INCOME FUND
The fund's investment goal is high current income, consistent with preservation
of capital. Capital appreciation is a secondary consideration.
Under normal market conditions, the fund will invest primarily in the debt
securities of governments and their political subdivisions and agencies,
supranational organizations, and companies located anywhere in the world,
including emerging markets. The fund selects investments to provide a high
current yield and currency stability, or a combination of yield, capital
appreciation, and currency appreciation consistent with the fund's goal. As a
global fund, the fund may invest in securities issued in any currency and may
hold foreign currency.
The fund may invest in debt 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.
The fund is further authorized to invest in "semi- governmental securities,"
which are debt securities issued by entities owned by either a national, state,
or equivalent government or are securities of a government jurisdiction that are
not backed by its full faith and credit and general taxing powers.
Under normal market conditions, the fund will have at least 25% of its assets
invested in debt securities issued or guaranteed by foreign governments. The
fund considers securities issued by central banks that are guaranteed by their
national governments to be government securities.
The fund may invest in long-term or short-term debt securities, such as bonds,
debentures, notes, convertible debt securities, and commercial paper. These debt
securities 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 securities and common stock
are offered as a unit).
FOREIGN SECURITIES Under normal circumstances, at least 65% of the fund's assets
will be invested in issuers located in at least three countries, one of which
may be the U.S.
The fund normally invests its assets principally within Australia, Canada,
Japan, New Zealand, the U.S., and
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Western Europe, and in securities denominated in the currencies of these
countries or denominated in multinational currency units such as the euro or
European Currency Unit (ECU). The fund may also invest a substantial portion of
its assets in securities and currency in emerging markets countries. The manager
intends to manage the fund's exposure to various currencies, and may from time
to time use forward currency exchange contracts or options on currencies for
hedging purposes.
MATURITY The fund may invest in debt securities with varying maturities. Under
current market conditions, it is expected that the dollar-weighted average
maturity of the fund's investments, i.e., the average life span of all of the
fund's investments, will not exceed 15 years. Generally, the portfolio's average
maturity will be shorter when the manager expects interests rates worldwide or
in a particular country to rise, and longer when the manager expects interest
rates to fall.
NON-DIVERSIFICATION RISK Because the fund is not diversified, there is no
restriction under the Investment Company Act of 1940 on the percentage of its
assets that it may invest at any time in the securities of any issuer.
Nevertheless, the fund's non-diversified status may expose it to greater risk or
volatility than diversified funds with otherwise similar investment policies,
since the fund may invest a larger portion of its assets in securities of a
small number of issuers.
OTHER INVESTMENT POLICIES In order to hedge currency risk, the fund may, but is
not required to, use forward and futures contracts and interest rate swaps. The
fund may also:
o acquire loan participations;
o lend its portfolio securities up to 30% of its assets;
o enter into repurchase, reverse repurchase, and "when-issued" transactions;
o invest in preferred stock; o invest in structured notes;
o purchase and sell call and put options on U.S. or foreign securities; and
o enter into futures contracts for the purchase or sale of U.S. Treasury or
foreign securities or based upon financial indices.
FUNDS SEEKING GROWTH AND INCOME
GLOBAL COMMUNICATIONS FUND
BEFORE NOVEMBER 15, 1999, THE FUND'S NAME WAS "FRANKLIN GLOBAL UTILITIES
SECURITIES FUND," AND BEFORE MAY 1, 1998, THE FUND'S NAME WAS "UTILITY EQUITY
FUND." The fund's investment goals are capital appre ciation and current income.
Under normal market conditions, the fund will invest primarily in companies
engaged in providing communication services and communication equipment. The
fund will normally invest in common stocks that the manager expects to pay
dividends.
The fund may invest in stocks and debt securities of companies of any nation,
developed or emerging. The fund will normally invest at least 65% of its assets
in issuers located in at least three different countries, and generally expects
to invest a higher percentage of its assets in U.S. securities than issuers
located in any other single country.
FOREIGN SECURITIES As a non-fundamental policy, the fund will limit its
investments in securities of Russian issuers to 5% of assets.
CONCENTRATION. The fund may invest more than 25% of its total assets in any
sector of the global utilities industry, and invests substantially in
communications companies. Investing in a fund, like this fund, that concentrates
its investments in a limited group of related industries involves increased
risks.
OTHER INVESTMENT POLICIES The fund may invest up to 5% of its assets in debt
securities, including convertible bonds issued by public utility issuers. These
debt securities may be rated Ba or lower by Moody's or BB or lower by S&P, or
unrated securities that the manager determines to be of comparable quality. The
fund 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 fund may invest up to 5% of its assets in enhanced
convertible securities. The fund may also write covered call options, lend its
portfolio securities up to 30% of its assets, and enter into repurchase
transactions.
GROWTH AND INCOME FUND
The fund's principal investment goal is capital appreciation. Its secondary goal
is to provide current income.
Under normal market conditions, the fund will invest primarily in equity
securities that the manager believes have the potential to increase in value.
The fund 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, i.e., directly from the dealer.
The fund 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 or equity securities. In pursuing its secondary goal of
current income, the fund may also purchase convertible securities, including
bonds or preferred stocks, enhanced convertible securities, debt securities, and
money market instruments.
FOREIGN SECURITIES The fund may invest up to 30% of its total assets in foreign
securities, including Depositary Receipts and emerging markets, but currently
intends to limit such investments to 20%.
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REITS The fund currently intends to invest no more than 15% of its assets in
equity real estate investment trusts ("REITs").
OTHER INVESTMENT POLICIES The fund may invest up to approximately 10-15% of its
assets in common stocks with current dividend yields at or below the average
dividend yield of the Standard & Poor's 500 Index. The fund currently does not
intend to invest more than 10% of its assets in convertible securities, which
may carry special risks as described below. In addition, the fund currently does
not intend to invest more than 5% of its assets in debt securities, including
convertible debt 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. The
fund may also:
o write covered call and put options;
o purchase call and put options on securities and indices of securities,
including "forward conversion" transactions;
o lend its portfolio securities up to 30% of its assets; and
o enter into repurchase transactions.
INCOME SECURITIES FUND
The fund's investment goal is to maximize income while maintaining prospects for
capital appreciation.
Under normal market conditions, the fund will invest primarily in a diversified
portfolio of debt and equity securities. The assets of the fund 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. These investments may include
zero coupon, deferred interest or pay-in-kind bonds, or preferred stocks. The
manager has the discretion to choose the percentage of assets that can be
invested in a particular type of security. As market conditions change, the
fund's portfolio may be entirely invested in debt securities or, conversely, in
common stocks.
The fund may invest in debt securities rated in any rating category, including
high yield, lower-rated debt securities ("junk bonds"), or if unrated,
determined by the manager to be comparable. The fund may invest up to 5% of its
assets in defaulted debt securities. These securities are considered
speculative.
FOREIGN SECURITIES The fund may invest up to 25% of its total assets in foreign
securities, including Depositary Receipts and emerging markets.
OTHER INVESTMENT POLICIES The fund currently does not intend to invest more than
5% of its assets in loan par ticipations and other related direct or indirect
bank securities. The fund may invest up to 5% of its assets in trade claims.
Both loan participations and trade claims carry a high degree of risk. In
addition, the fund does not intend to invest more than 5% of its assets in
enhanced convertible securities. The fund may also:
o lend its portfolio securities up to 30% of its assets;
o enter into repurchase transactions;
o purchase debt securities on a "when-issued" or "delayed-delivery" basis; and
o write covered call options on securities.
REAL ESTATE FUND
The fund's principal goal is capital appreciation. Its secondary goal is current
income.
Under normal market conditions the fund will invest primarily in equity real
estate investment trusts ("REITs"). The fund will generally invest in real
estate securities of companies listed on a securities exchange or traded
over-the-counter. As used by the fund, "real estate securities" will include
equity, debt securities, and convertible securities of companies having the
following characteristics and limitations:
o 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 form 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.
o Companies that have at least 50% of their assets or revenues attributable to
the ownership, construction, management or other services, or sale of
residential, commercial or industrial real estate. These companies would
include real estate operating companies, real estate services and home
builders.
SMALL AND MID-CAP COMPANIES The fund will typically invest predominately in
securities issued by mid-cap or small-cap U.S. companies, which is reflective of
the industry itself. Mid-cap companies have market capital izations of $5
billion or less and small-cap companies, $1.5 billion or less. 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.
CONCENTRATION. The fund may invest more than 25% of its total assets in any
sector of the real estate industry described above. Because the fund
concentrates its investments in the real estate industry, adverse developments
in that industry will have a greater impact on the
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fund, and your investment, than a fund with broader diversification.
The manager believes, however, that diversifying the fund's assets into
different types of real estate investments will help mitigate, although it
cannot eliminate, the inherent risks of such industry concentration. Moreover,
the real estate market historically has not correlated with 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.
In addition to fund's investments in real estate securities, it may also invest
a portion of its assets in debt or equity securities of issuers 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. These 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. Also, the fund may invest in companies whose
principal business is unrelated to the real estate industry but who have at
least 50% of their assets in real estate holdings and the manager believes are
undervalued relative to the price of those companies' securities.
LOWER-RATED SECURITIES As an operating policy, the fund will not invest more
than 10% of its net assets in convertible debt securities or debt securities
rated Ba or lower by Moody's or, if unrated, the manager determines are of
comparable quality. Generally, however, the fund will not acquire any
investments rated lower than B by Moody's or, if unrated, the manager determines
are of comparable quality.
FOREIGN SECURITIES The fund may invest up to 10% in foreign securities,
including emerging markets.
OTHER INVESTMENT POLICIES The fund may also:
o write covered call options;
o lend its portfolio securities up to 30% of its assets;
o engage in repurchase transactions; and
o invest in enhanced convertible securities.
RISING DIVIDENDS FUND
The fund's investment goal is long-term capital appreciation. The fund will
attempt to attain current income incidental to capital appreciation.
Preservation of capital, while not a goal, is also an important consideration.
Under normal market conditions, the fund will, as a fundamental policy, invest
at least 65% of its net assets in financially sound companies that have paid
consistently rising dividends. The fund believes that the securities of such
companies, because of their dividend record, have a strong potential to increase
in value.
The remaining 35% of the fund's assets typically are invested in dividend-paying
equity securities with similar characteristics that may not meet all of the
specialized as defined in the fund's prospectus. 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 fund.
Following these policies, the fund will invest predominantly in large- or
mid-cap companies with market capitalizations greater than $1.5 billion, and to
a lesser extent in small-cap companies.
OTHER INVESTMENT POLICIES The fund may invest up to 10% of its net assets in
foreign securities, including emerging markets. The fund may also lend its
portfolio securities up to 30% of its assets, enter into repurchase
transactions, and write covered call options.
VALUE FUND
The fund's investment goal is long-term total return. Income, though not a goal,
is a secondary consideration.
Under normal market conditions, the fund will invest primarily in companies that
the manager believes are selling substantially below the underlying value of
their assets or their private market value. The fund may invest in common and
preferred stocks, securities convertible into common stocks, warrants, secured
and unsecured debt securities, and notes. The fund 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.
The fund may purchase securities based on information regarding company stock
buy-backs and company insiders' purchases and sales. The fund 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 fund may benefit, the manager may itself seek to influence or
control management.
COMPANIES EMERGING FROM BANKRUPTCY The fund may buy securities of companies
emerging from bankruptcy. These securities may have special risks. 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 securities and may also have difficulty finding
additional financing. In addition, reduced liquidity
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in the secondary market may make it difficult for the fund to sell the
securities or to value them based on actual trades.
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. Also, the manager may not buy these securities at their
lowest possible prices or sell them at their highest prices.
FOREIGN SECURITIES The fund may invest up to 25% of its total assets in foreign
securities, including Depositary Receipts, but currently does not intend to
invest more than 15%. The fund presently does not intend to invest more than 5%
of its assets in emerging markets securities.
CONVERTIBLE SECURITIES The fund may invest in convertible securities, enhanced
convertible securities and synthetic convertibles. The fund applies the same
rating criteria and investment policies to convertible debt securities as its
investments in debt securities. Convertible preferred stocks are equity
securities that generally carry a higher degree of market risk than debt
securities, and often may be regarded as speculative in nature. The fund's
investments in enhanced convertible securities may provide higher dividend
income but may carry additional risks, including reduced liquidity.
LOWER-RATED SECURITIES The fund may invest up to 25% of its assets in debt
securities rated below BBB by S&P or Baa by Moody's, or in unrated debt
securities that the manager determines to be comparable. 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. Therefore, these securities involve
special risks. Debt securities rated D by S&P are in default and may be
considered speculative.
NON-DIVERSIFICATION RISK Because the fund is not diversified, there is no
restriction under the Investment Company Act of 1940 on the percentage of its
assets that it may invest at any time in the securities of any issuer.
Nevertheless, the fund's non-diversified status may expose it to greater risk or
volatility than diversified funds with otherwise similar investment policies,
since the fund may invest a larger portion of its assets in securities of a
small number of issuers.
OTHER INVESTMENT POLICIES The fund may also sell short securities it does not
own up to 5% of its assets. The fund may also sell securities "short against the
box" without limit. The fund may also:
o lend its portfolio securities up to 33 1/3% of its assets;
o invest in zero coupon securities, pay-in-kind bonds, structured notes,
mortgage-backed and asset-backed securities;
o purchase loan participations and trade claims both of which carry a high
degree of risk;
o purchase and sell exchange-listed and over-the-counter put and call options
on securities and financial indices;
o purchase and sell futures contracts or related options with respect to
securities and indices; and
o invest in restricted or illiquid securities.
MUTUAL SHARES FUND
The fund's principal goal is capital appreciation. Its secondary goal is income.
Under normal market conditions, the fund invests primarily in domestic equity
securities that the manager believes are significantly undervalued, as well as
debt securities of any quality. Debt includes notes, bonds, or debentures, as
well as distressed mortgage obligations and other debt secured by real property.
The manager does not establish percentage limits for the fund's investment in
equity securities, debt securities or money market instruments.
The fund may invest in securities that are traded on U.S. or foreign exchanges,
the 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 fund may hold significant cash positions, consistent with its
policy on temporary investments, until suitable investment opportunities are
available.
SMALL COMPANIES The fund may invest in securities from any size issuer,
including smaller capitalization companies. It will tend to invest, however, in
securities of issuers with market capitalizations in excess of $500 million.
REORGANIZING COMPANIES The fund 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. The fund may participate in such
transactions. The fund does not presently anticipate investing more than 50% of
its assets in such investments, but is not restricted to that amount.
INDEBTEDNESS The fund may also invest in other forms of secured or unsecured
indebtedness or participations ("indebtedness"). These include without
limitation loan participations and trade claims of debtor companies involved in
reorganization or financial restructuring. Some of the indebtedness may have
very long maturities or is illiquid.
CONTROL The fund purchases securities for investment purposes and not for the
purpose of influencing or controlling management of the issuer. However, the
manager may seek to influence or control management if it perceives that the
fund may benefit. The fund may also invest in other entities that purchase
securities for the purpose of influencing or controlling management. These
entities may invest in a potential takeover or leveraged buyout or invest in
other entities engaged in such practices.
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LOWER-RATED SECURITIES The fund may invest in debt securities in any rating
category including lower rated debt securities ("junk bonds") or in unrated debt
securities. In general, the fund will invest in these instruments for the same
reasons as equity securities, i.e., the manager believes that the securities are
available 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 fund
expects to invest in debt securities issued by reorganizing or restructuring
companies, or companies that recently emerged from, or are facing the prospect
of a financial restructuring. It is under these circumstances, which usually
involve unrated or lower 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
fund may invest without limit in defaulted debt securities, subject to the
fund's restriction on investments in illiquid securities. Defaulted debt
securities may be considered speculative. The purchase of debt of a troubled
company always involves a risk 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.
FOREIGN SECURITIES Although the fund reserves the right to purchase securities
in any foreign country without percentage limitation, the fund's current
investment strategy is to invest primarily in domestic securities, with
approximately 15-20% of its assets in foreign securities, including Depositary
Receipts. Depositary Receipts are discussed more fully under "Foreign
Securities, Depositary Receipts" below. The fund presently does not intend to
invest more than 5% of its assets in securities of emerging 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.
CURRENCY HEDGING The fund may use the following currency hedging techniques:
investments in foreign currency futures contracts, options on foreign currencies
or currency futures, forward foreign currency exchange contracts ("forward
contracts") and currency swaps.
CLOSED-END INVESTMENT COMPANIES While the fund 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. The fund
may not purchase more than 3% of the voting securities of another investment
company. In addition, the fund 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
they indirectly bear a proportionate share of the expenses of these investment
companies, including operating costs, and investment advisory and administrative
fees.
SHORT SALES The fund may also sell short securities it does not own up to 5% of
its assets. The fund may also sell securities "short against the box" without
limit.
OTHER INVESTMENT POLICIES The fund may also:
o lend its portfolio securities up to 33 1/3% of its assets;
o enter into repurchase transactions;
o purchase securities on a "when-issued" or "delayed delivery" basis;
o 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; and
o purchase and sell financial futures contracts and related options.
ASSET ALLOCATION FUND
The fund's investment goal is high total return.
Under normal market conditions, the fund will invest in equity securities of
companies in any nation, debt securities of companies and governments of any
nation, and money market instruments.
The fund will adjust its investments among these three market segments in an
attempt to capitalize on total return potential with changing economic
conditions throughout the world. The fund may invest in each of the market
segments without limitation. Except as noted below under "Fundamental Investment
Restrictions", the manager has complete discretion in determining the amount of
equity securities, debt securities, or money market instruments in which the
fund may invest.
The fund will normally invest its assets in at least three countries, except
during defensive periods.
EQUITY SECURITIES Equity securities in which the fund may invest may include
common and preferred stocks, securities (bonds or preferred stock) convertible
into common stock ("convertible securities"), warrants, equity real estate
investment trusts ("REITs"), and Depositary Receipts. Depositary Receipts may
not be denominated in the same currency as the underlying securities.
DEBT SECURITIES Debt securities in which the fund may invest may include issues
of both domestic and foreign governments or companies, such as bonds,
debentures, notes, commercial paper, collateralized mortgage obligations
("CMOs") and securities issued or guaranteed by governments or government
agencies or instrumentalities. U.S. Government securities include, specifically,
Government National Mortgage Association mortgage-backed certificates ("Ginnie
Mae"). The fund may invest
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in preferred stocks and certain debt securities, rated or unrated, such as
convertible bonds and bonds selling at a discount. Debt securities 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.
The average maturity of debt security's in the fund's portfolio is medium-term
(about 5 to 15 years), but will fluctuate depending on the manager's outlook on
the country and future interest rate changes.
LOWER-RATED SECURITIES As an operating policy established by the Board, the fund
will not invest more than 25% of its assets in debt securities rated BBB or
lower by S&P or Baa or lower by Moody's or in unrated securities that the
manager determines to be comparable. This limit includes defaulted debt
securities. The Board 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 securities would be consistent with the
interests of the fund and its shareholders.
MONEY MARKET INSTRUMENTS The fund may invest in money market instruments. In
addition, the fund 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
fund may also invest in commercial paper rated Prime-1 or Prime-2 by Moody's or
A-1 or A-2 by S&P or, unrated commercial paper issued by companies having an
outstanding debt issue currently rated Aaa or Aa by Moody's or AAA or AA by S&P.
CURRENCY HEDGING With respect to debt securities the fund may employ the
following currency hedging techniques: foreign currency futures contracts,
forward foreign currency exchange contracts ("forward contracts"), and options
on foreign currencies.
OTHER INVESTMENT POLICIES The fund has an unlimited ability to purchase exchange
listed securities in any foreign country, developed or emerging. The fund has a
limited ability to purchase unlisted foreign securities. However, as a
non-fundamental policy, the fund will limit its investments in securities of
Russian issuers to 5% of assets. The fund may also:
o invest in illiquid and restricted securities;
o purchase securities on a "when-issued" basis;
o enter into repurchase transactions; and
oh lend its portfolio securities up to 33 1/3% of its assets.
As non-fundamental investment policies, which may be changed by the Board
without shareholder approval, the fund will not invest more than 15% of its
total assets in securities of foreign issuers which are not listed on a
recognized United States or foreign securities exchange, or more than 10% of
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, unrated securities that
the managers determine are of comparable investment quality.
FUNDS SEEKING CAPITAL GROWTH
GLOBAL HEALTH CARE FUND
The fund's investment goal is capital appreciation.
Under normal market conditions, the fund will invest primarily in equity
securities of companies in the health care industry.
HEALTH CARE COMPANIES derive at least 50% of their earnings or revenues from, or
have devoted at least 50% of their assets to, health care activities, based on
their 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.
Many major developments in health care come from foreign companies. Therefore,
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 than may be present in domestic 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
fund 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.
FOREIGN SECURITIES The fund will mix its investments globally by investing at
least 70% of its assets in securities of issuers in at least three different
countries, which may include the U.S. These investments may include issuers
located in developed and emerging markets. The fund will not invest more than
40% of its net assets in any one country (other than the U.S.). From time to
time, the fund 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
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fund, it may invest in securities issued in any currency including multinational
currency units such as the euro or European Currency Unit, and may hold
currency. The fund may buy Depositary Receipts. The fund currently does not
intend to invest more than 10% of its assets in securities of emerging markets.
As a non-fundamental policy, the fund will limit its investments in securities
of Russian issuers to 5% of its assets.
CONCENTRATION. The fund may invest more than 25% of its total assets in any
sector of the global health care industry described above. Investing in a fund
that con centrates its investments in a specialized market sector involves
increased risks.
The fund may invest a substantial portion of its total assets in small
capitalization companies with market capitalizations less than $1.5 billion.
DEBT SECURITIES The fund may invest up to 30% of its assets in debt securities
issued by domestic or foreign corporations or governments. To the extent the
fund invests in debt securities, changes in interest rates in any country where
the fund has investments will affect the value of the fund 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 of similar quality. Securities rated below BBB are
considered to be below investment grade. The manager does not currently expect
investments in such lower rated debt securities to exceed 5% of the fund's
assets.
NON-DIVERSIFICATION RISK Because the fund is not diversified, there is no
restriction under the Investment Company Act of 1940 on the percentage of its
assets that it may invest at any time in the securities of any issuer.
Nevertheless, the fund's non-diversified status may expose it to greater risk or
volatility than diversified funds with otherwise similar investment policies,
since the fund may invest a larger portion of its assets in securities of a
small number of issuers.
OTHER INVESTMENT POLICIES The fund may engage in short sale transactions, in
which the fund sells a security it does not own to a purchaser at a specified
price. The fund's equity securities holdings may include rights and warrants.
The fund may also:
o make temporary defensive investments;
o write covered put and call options on securities or financial indices;
o purchase put and call options on securities or financial indices;
o purchase and sell futures contracts or related options with respect to
securities, indices and currencies;
o invest in restricted or illiquid securities;
o lend portfolio securities up to 33 1/3% of its assets;
o enter into repurchase or reverse repurchase agreements; enter into foreign
currency exchange contracts; and
o borrow money.
LARGE CAP FUND
Before 12/15/99, the fund's name was the Franklin Capital Growth Fund.
The fund's investment goal is capital appreciation. Current income is only a
secondary consideration in selecting portfolio securities.
Under normal market conditions, the fund will invest primarily in equity
securities of U.S. large-cap growth companies ($8.5 billion or more). Some of
these securities may yield little or no current income. The fund's assets may be
invested in shares of common stock traded on any national securities exchange or
over-the-counter, and in convertible securities. The fund may also keep a
significant portion of its assets in cash from time to time.
LOWER-RATED SECURITIES The fund does not intend to invest more than 5% of its
assets in debt securities, including convertible debt securities, rated Ba or
lower by Moody's or BB or lower by S&P, or unrated securities the manager
determines to be comparable.
FOREIGN SECURITIES. The fund may invest up to 10% of its assets in foreign
securities, including Depositary Receipts and emerging market issuers.
OTHER INVESTMENT POLICIES The fund may invest in convertible preferred stocks,
which are equity securities. The fund may also:
o write covered call options;
o purchase put options on securities;
o lend its portfolio securities up to 30% of its assets;
o enter into repurchase transactions; and
o invest in restricted or illiquid securities.
NATURAL RESOURCES FUND
PRIOR TO MAY 1, 1997, THE NATURAL RESOURCES FUND WAS KNOWN AS THE PRECIOUS
METALS FUND AND HAD DIFFERENT INVESTMENT GOALS AND POLICIES. The fund's
investment goal is capital appreciation. Its secondary goal is current income.
Under normal market conditions, the fund will invest primarily in equity
securities of 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
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production; forest products; farming products; paper products; chemicals;
building materials; energy services and technology; environmental services; and
energy generation and distribution.
While the fund normally expects to invest primarily in equity securities, the
manager may vary the mixture of common stocks, preferred stocks and debt
securities depending on how each category will contribute to meeting the fund's
investment goal.
CONCENTRATION. The fund may invest more than 25% of its total assets in any
sector of the natural resources industry described above. Because the fund
concentrates its investments in the natural resources sector, its 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 fund may from time to time invest up to 25% of its
assets in any industry or group of industries within the natural resources
sector. This strategy may expose the fund to greater investment risk than a more
diversified strategy within the sector.
NATURAL RESOURCES RISKS. Certain of the natural resources industries'
commodities are subject to limited pricing flexibility as a result of similar
supply and demand factors. Other commodities have 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, the value of an
individual company's securities may 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 SECURITIES While the fund will normally invest a greater percentage of
its assets in U.S. securities than in securities of issuers in any other single
country, the fund may invest 50% or more of its assets in foreign securities,
including emerging markets.
SMALLER COMPANIES The fund may invest without limitation in small capitalization
companies, which have market capitalizations of $1.5 billion or less at the time
of purchase. These may include investments in small mining or oil and gas
exploration concerns the manager believes may have significant potential for
appreciation, but are subject to the risk that their exploration efforts will
not be successful. The fund will not invest more than 10% of its assets in
securities of companies with less than three years of continuous operation.
REITS The fund may invest up to 10% of its total assets in real estate
investment trusts (REITs), which may be in or outside the natural resources
sector.
DEBT SECURITIES The fund may invest in debt securities issued by domestic or
foreign corporations or governments.
The fund may invest, without percentage limitation, in debt securities rated as
"investment grade" by Moody's or S&P, or in unrated debt securities that the
manager determines are of similar quality. The fund may also invest up to 15% of
its assets in debt securities 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
unrated debt securities that the manager determines are of similar quality. The
manager does not currently expect investments in lower rated debt securities to
exceed 5% of the fund's assets.
OTHER INVESTMENT POLICIES The fund may invest up to 35% of its assets in equity
or debt securities 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 fund may
also:
o make temporary defensive investments;
o purchase debt securities on a "when-issued" or "delayed delivery" basis;
o write covered call options;
o lend its portfolio securities up to 30% of its assets;
o enter into repurchase transactions;
o borrow money; and
o invest in restricted or illiquid securities.
SMALL CAP FUND
The fund's investment objective is long-term capital growth.
Under normal market conditions, the fund will invest primarily in equity
securities of small capitalization growth companies, with market capitalizations
of less than $1.5 billion at the time of purchase. Investments in small
capitalization companies ("small-cap companies") may involve greater risks and
greater volatility than investments in larger and more established companies.
The fund may not be appropriate for short-term investors, and an investment in
the portfolio should not be considered a complete investment program.
The securities of small-cap companies are traded on U.S.
and foreign stock exchanges and in the over-the-counter market. As an operating
policy the fund 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 fund currently does not intend to invest more than 10% of its assets in
convertible securities.
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FOREIGN SECURITIES Although the fund may invest up to 25% of its assets in
foreign securities, including those of emerging markets issuers and Depositary
Receipts, it does not intend to invest more than 10%. The fund presently does
not intend to invest more than 5% of its assets in emerging markets securities.
OTHER INVESTMENTS Although the fund's assets will be invested primarily in
equity securities of small-cap companies, the fund 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 fund may invest in equity
securities of larger companies which the fund'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
appreciation.
DEBT SECURITIES The fund may also invest in debt securities that 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 fund's goal of capital growth. The fund may invest in debt securities rated
B or above by Moody's or S&P, or in unrated securities the manager determines
are of comparable quality. Currently, however, the fund does not intend to
invest more than 5% of its assets in debt securities (including convertible debt
securities) rated lower than BBB by S&P or Baa by Moody's or in unrated
securities the manager determines to be of comparable quality.
REITS The fund currently does not intend to invest more than 10% of its assets
in real estate investment trusts ("REITs"), including small company REITs.
OTHER INVESTMENT POLICIES The fund may also:
o write covered put and call options on securities or financial indices;
o purchase put and call options on securities or financial indices;
o purchase and sell futures contracts or related options with respect to
securities, indices and currencies;
o invest in restricted or illiquid securities;
o lend portfolio securities up to 30% of its assets;
o borrow money; and
o enter into repurchase or reverse repurchase agreements.
MUTUAL DISCOVERY FUND
The fund's investment goal is capital appreciation.
Under normal market conditions, the fund invests in domestic and foreign equity
securities that the manager believes to be significantly undervalued, as well as
debt securities of any quality. Debt securities may include securities or
indebtedness issued by corporations or governments in any form. Debt includes
notes, bonds, or debentures, as well as distressed mortgage obligations and
other debt secured by real property. The manager does not establish percentage
limits for the fund's investment in equity securities, debt securities or money
market instruments.
SMALL COMPANIES The fund may 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. These securities have market capitalizations of
less than $1.5 billion.
The fund may invest in securities that are traded on U.S. or foreign exchanges,
the 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 fund may hold significant cash positions, consistent with its
policy on temporary investments, until suitable investment opportunities are
available.
REORGANIZING COMPANIES The fund 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. The fund may participate
in such transactions. The fund does not presently anticipate investing more than
50% of its assets in such investments, but is not restricted to that amount.
INDEBTEDNESS The fund may also invest in other forms of secured or unsecured
indebtedness or participations ("indebtedness"). These include without
limitation loan participations and trade claims of debtor companies involved in
reorganization or financial restructuring. Some of the indebtedness may have
very long maturities or is illiquid.
CONTROL The fund purchases securities for investment purposes and not for the
purpose of influencing or controlling management of the issuer. However, the
manager may seek to influence or control management if it perceives that the
fund may benefit. The fund may also invest in other entities that purchase
securities for the purpose of influencing or controlling management. These
entities may invest in a potential takeover or leveraged buyout or invest in
other entities engaged in such practices.
FOREIGN SECURITIES The fund presently does not intend to invest more than 5% of
its assets in securities of emerging market countries including Eastern European
countries and Russia. Foreign investments may include both voting and non-voting
securities, sovereign debt and participation in foreign government deals.
CURRENCY HEDGING To the extent that hedging is available, the fund may use the
following currency hedging techniques: foreign currency futures contracts,
options on foreign currencies or currency futures, forward foreign currency
exchange contracts and currency swaps.
LOWER-RATED SECURITIES The fund may invest in debt securities in any rating
category including lower rated debt securities ("junk Bonds") or in unrated debt
securities. In
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general, the fund will invest in these instruments for the same reasons as
equity securities, i.e., the manager believes that the securities may be
acquired 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 fund
expects to invest in debt securities issued by reorganizing or restructuring
companies, or companies that 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
fund may invest without limit in defaulted debt securities, subject to the
fund's restriction on investments in illiquid securities. Defaulted debt
securities may be considered speculative. The purchase of debt of a troubled
company always involves a risk 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.
CLOSED-END INVESTMENT COMPANIES While the fund 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. The fund
may not purchase more than 3% of the voting securities of another investment
company. In addition, the fund 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
they indirectly bear a proportionate share of the expenses of these investment
companies, including operating costs, and investment advisory and administrative
fees.
SHORT SALES The fund may also sell short securities it does not own up to 5% of
its assets. The fund may also sell securities "short against the box" without
limit.
OTHER INVESTMENT POLICIES The fund may also:
o lend its portfolio securities up to 33 1/3% of its assets;
o enter into repurchase transactions;
o purchase securities on a "when-issued" or "delayed delivery" basis;
o invest in restricted or illiquid securities;
o purchase and sell exchange-listed and over-the-counter put and call options
on securities, equity and fixed-income indices and other financial
instruments; and
o purchase and sell futures contracts and related options.
DEVELOPING MARKETS FUND
The fund's investment goal is long-term capital appreciation.
Under normal market conditions, the fund will invest primarily in emerging
market equity securities that are issued by emerging market companies. Emerging
market countries include: (i) countries that are generally considered low or
middle income countries by the International Bank for Reconstruction and
Development (commonly known as the World Bank) and the International Finance
Corporation; or (ii) countries that are classified by United Nations or
otherwise regarded by their authorities as emerging, or (iii) countries with a
market capitalization of less than 3% of the Morgan Stanley Capital World Index.
Emerging market companies are (i) companies whose principal securities trading
markets are in emerging market countries, or (ii) companies that derive a
significant share of their total revenue from either goods or services produced
or sales made in emerging market countries, or (iii) companies that have a
significant portion of their assets in emerging market countries, or (iv)
companies that are linked to currencies of emerging market countries, or (v)
companies that are organized under the laws of, or with principal offices in,
emerging market countries.
The manager will determine eligibility based on publicly available information
and inquiries to the companies. The fund will at all times, except during
defensive periods, maintain investments in at least three countries having
emerging markets. The fund has the ability to purchase securities in any foreign
country, developed or emerging. However, as a non-fundamental policy, the fund
will limit its investments in securities of Russian issuers to 5% of assets.
From time to time, the fund may hold significant cash positions until suitable
investment opportunities are available, consistent with its policy on temporary
investments.
The fund seeks to benefit from economic and other developments in emerging
markets. The investment goal of the fund 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 emerging 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 countries, particularly the
emerging market countries in the process of developing more market-oriented
economies, may experience relatively high rates of economic growth. Other
countries, although having relatively mature emerging 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.
DEBT SECURITIES For capital appreciation, the fund may invest up to 35% of its
assets in fixed-income debt securities which are rated at least C by Moody's or
S&P or unrated debt securities that the manager determines to be of comparable
quality. These securities include bonds,
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notes, debentures, commercial paper, certificates of deposit, time deposits and
bankers' acceptances. As a current policy established by the Board, however, the
fund will not invest more than 5% of its assets in debt securities rated BBB or
lower by S&P or Baa or lower by Moody's (the lowest category of "investment
grade" rating). The Board may consider an increase in these percentages if
economic conditions change such that a higher level of investment in high risk,
lower quality debt securities would be in the interests of the fund and its
shareholders.
Certain debt securities 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 SECURITIES As a fundamental policy, the fund may invest up to 10%
of its assets in defaulted debt securities, which may be considered speculative.
CURRENCY HEDGING With respect to debt securities the fund may employ the
following currency hedging techniques: foreign currency futures contracts,
forward foreign currency exchange contracts ("forward contracts"), and options
on foreign currencies. Further, the fund will not enter into forward contracts
if, as a result, the fund will have more than 20% of its assets committed to
these contracts.
OTHER INVESTMENT POLICIES The fund may also:
o lend its portfolio securities up to 33 1/3% of its assets;
o engage in repurchase transactions;
o borrow money for investment purposes;
o for hedging purposes only, enter into transactions in options on securities
and securities indices and futures contracts and related options;
o purchase convertible securities and warrants; and
o invest in restricted or illiquid securities.
The fund may not commit more than 5% of its assets to initial margin deposits on
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 fund's assets. Presently, the fund cannot use these strategies to a
significant extent in the markets in which the fund will principally invest.
GLOBAL GROWTH FUND
The fund's investment goal is long-term capital growth. Any income the fund
earns will be incidental.
Under normal market conditions, the fund will invest primarily in equity
securities of companies of any nation, including the U.S. and emerging markets.
As a non- fundamental policy, the fund will limit its investments in securities
of Russian issuers to 5% of assets. Although the fund generally invests in
common stock, it may also invest in preferred stocks and certain debt
securities, rated or unrated, such as convertible bonds and bonds selling at a
discount. The fund 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 fund will typically invest predominantly in equity
securities issued by large-cap or mid-cap companies, with market capitalizations
greater than $1.5 billion. It may also invest to a lesser degree in smaller
companies, which are subject to different and greater risks.
DEBT SECURITIES For capital appreciation, the fund may invest in debt securities
(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 (the lowest rating category) or unrated debt securities the manager
determines to be of comparable quality. As a policy established by the Board,
however, the fund will not invest more than 5% of its assets in debt securities
rated BBB or lower by S&P or Baa or lower by Moody's. The Board may consider a
change if economic conditions change such that a higher level of investment in
high risk, lower quality debt securities would be consistent with the goal of
the fund.
These debt securities 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 SECURITIES As a fundamental policy, the fund may invest up to 10%
of its assets in defaulted debt securities, which may be considered speculative.
CURRENCY HEDGING With respect to debt securities, the fund may employ the
currency hedging techniques: foreign currency futures contracts, forward foreign
currency exchange contracts ("forward contracts"), and options on foreign
currencies.
OTHER INVESTMENT POLICIES The fund may purchase and sell stock index futures
contracts up to in the aggregate 20% of its assets. It 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 fund may purchase and sell put and
call options on securities indices.
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The fund may also:
o invest up to 5% of its assets in securities issued by any one company or
foreign government (exclusive of U.S. Government securities)
o invest up to 5% of its assets in warrants (exclusive of warrants acquired in
units or attached to securities);
o invest up to 10% of its assets in securities with a limited trading market,
i.e., "illiquid securities";
o enter into repurchase agreements;
o lend its portfolio securities up to 30% of its assets; and
o invest in restricted securities.
INTERNATIONAL EQUITY FUND
The fund's investment goal is long-term capital growth.
Under normal market conditions, the fund will invest primarily in equity
securities of companies located outside the U.S., including emerging markets.
The funds investments include common and preferred stock, securities (bonds or
preferred stock) convertible into common stock, warrants, and Depositary
Receipts.
The fund will purchase equity securities that trade in non-U.S. markets, 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 fund's assets could be invested in U.S.
companies.
In selecting portfolio securities, the fund attempts to take advantage of the
difference between economic trends and the anticipated performance of securities
and their markets in various countries. The fund 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 fund will typically invest predominantly in equity securities
issued by large-cap or mid-cap companies, with market capitalizations greater
than $1.5 billion. It may also invest to a lesser degree in smaller companies,
which are subject to different and greater risks.
Normally, the fund will invest at least 65% of its assets in securities traded
in at least three foreign countries. As a non-fundamental policy, the fund will
limit its investments in securities of Russian issuers to 5% of assets.
DEBT SECURITIES The fund may invest up to 35% of its assets in debt securities.
The fund may invest up to 10% of its assets in debt obligations rated Ba or
lower by Moody's or BB or lower by S&P, or unrated securities the manager
determines to be of comparable quality.
The fund may seek capital appreciation by investing in debt securities that
increase in value through changes in relative foreign currency exchange rates,
changes in relative interest rates or improvement in the creditworthiness of the
issuer. These debt securities may consist of U.S. and foreign government
securities and corporate debt obligations, including Yankee bonds, Eurobonds,
and Depositary Receipts.
OTHER INVESTMENT POLICIES. The fund may:
o invest up to 10% of its net assets in illiquid securities;
o invest up to 10% of its net assets in warrants, including such warrants that
are not listed on an exchange;
o write covered call and put options on securities;
o purchase call and put options on securities;
o buy puts and write calls in "forward conversion" transactions;
o engage in "spread" and "straddle" transactions;
o purchase and write call and put options on stock indices;
o 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;
o purchase and sell interest rate futures contracts and related options;
o purchase and sell stock index futures contracts and related options;
o lend its portfolio securities up to 33 1/3% of its assets;
o engage in repurchase agreements; and
o invest in enhanced convertible securities.
INTERNATIONAL SMALLER COMPANIES FUND
The fund's investment goal is long-term capital appreciation.
Under normal market conditions, the fund will invest primarily in equity
securities of smaller companies located outside the U.S., including emerging
markets. Small-cap companies have market capitalizations of less than $1
billion. The manager believes that international small cap companies may provide
attractive investment opportunities, because these securities comprise a
majority of the world's equity securities. These companies also 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 U.S. small-cap stocks and
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.
As an operating policy, the fund will not invest more than 10% of its assets in
securities of companies with less than three years of continuous operation.
As a non-fundamental policy, the fund will limit its investments in securities
of Russian issuers to 5% of assets.
The fund may, from time to time, hold significant cash positions until suitable
investment opportunities are available, consistent with its policy on temporary
investments.
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DEBT SECURITIES The fund may invest up to 35% of its assets in:
o equity securities of larger issuers outside the U.S.;
o equity securities of larger or smaller issuers within the U.S., although the
fund does not expect these investments to exceed 5% of assets; or
o debt securities issued by companies or governments in any nation which are
rated at least C by Moody's or S&P or unrated debt securities the manager
determines are comparable.
As a current policy, however, the fund will not invest more than 5% of its
assets in debt securities rated lower than BBB by S&P or Baa by Moody's. These
investments may cause the fund's performance to vary from those of international
smaller equity markets.
DEFAULTED DEBT SECURITIES. The fund may invest up to 10% of its assets in
defaulted debt obligations, which may be considered speculative.
CURRENCY HEDGING With respect to debt securities, the fund may employ the
following currency hedging techniques: foreign currency futures contracts,
forward foreign currency exchange contracts ("forward contracts"), and options
on foreign currencies. Further, the fund will not enter into forward contracts
if, as a result, the fund would have more that 20% of its assets committed to
these contracts.
OTHER INVESTMENT POLICIES The fund may invest no more than 5% of its assets in
securities of any one issuer. This restriction does not include U.S. Government
securities. The fund may invest up to 5% of its assets in warrants, including
those not listed on an exchange.
For hedging purposes only, the fund may enter into:
o transactions in options on securities, securities indices, and foreign
currencies; and
o 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 fund.
The fund may also enter into repurchase agreements, invest in illiquid
securities, and lend its portfolio securities up to 30% of its assets.
As a non-fundamental investment policy, which may be changed by the Board
without shareholder approval, the fund may not invest more than 5% of its 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 fund in units
or attached to securities are not included in this restriction.
PACIFIC GROWTH FUND
The Templeton Pacific Growth Fund seeks to provide long-term growth of capital.
Under normal market conditions, the fund will invest primarily in equity
securities which trade on markets in the Pacific Rim, including emerging
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. Normally, the fund will
invest at least 65% of its assets in securities traded in at least three foreign
countries, including the listed countries. The fund may, from time to time, hold
significant cash positions until suitable investment opportunities are
available, consistent with its policy on temporary investments.
Although the fund will not invest more than 25% of its assets in any one
industry or the government of any one country, the fund may invest more than 25%
of its assets in the securities of issuers in any given country.
OTHER INVESTMENTS The fund may invest up to 35% of its assets in the securities
of issuers domiciled outside of the Pacific Rim or in investment grade debt
securities.
The fund may seek capital appreciation by investing in debt securities that
increase in value through changes in relative foreign currency exchange rates,
changes in relative interest rates or improvement in the creditworthiness of the
issuer. These debt obligations may consist of U.S. and foreign government
securities and corporate debt obligations, including Yankee bonds, Eurobonds,
and Depositary Receipts.
OTHER INVESTMENT POLICIES The fund may:
o invest up to 10% of its net assets in illiquid securities;
o invest no more than 10% of its net assets in warrants, including those not
listed on an exchange (this is the fund's current intention and is not a
fundamental policy);
o write covered call and put options on securities;
o purchase call and put options on securities;
o buy puts and write calls in "forward conversion" transactions;
o engage in "spread" and "straddle" transactions;
o purchase and write call and put options on stock indices;
o 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;
o purchase and sell interest rate futures contracts and related options;
o purchase and sell stock index futures contracts and related options;
o purchase convertible securities;
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o lend its portfolio securities up to 33 1/3% of its assets; and
o engage in repurchase agreements.
NON-FUNDAMENTAL POLICIES AFFECTING MULTIPLE FUNDS
It is the present policy of each fund, except the Mutual Discovery Fund and
Mutual Shares Fund, (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 funds (including the Mutual Discovery Fund and Mutual Shares Fund) may
participate with other investment companies in the Franklin Group of
Funds[Registered Trademark] 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 fund's policy to invest in interests (other than publicly traded equity
securities) in oil, gas or other mineral exploration or development programs.
SECURITIES AND INVESTMENT TECHNIQUES, GENERALLY
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THIS SECTION DESCRIBES CERTAIN TYPES OF SECURITIES AND INVESTMENT TECHNIQUES
THAT MAY BE USED BY A FUND, IF THE FUND IS AUTHORIZED TO DO SO IN THE DISCUSSION
IN ITS INDIVIDUAL FUND SECTION IN THIS SAI. IF THERE IS A CONFLICT BETWEEN THIS
SECTION AND THE INDIVIDUAL FUND SECTION WITH RESPECT TO INVESTMENTS, THE
INDIVIDUAL FUND SECTION CONTROLS AND SHOULD BE RELIED UPON.
All policies and percentage limitations are considered at the time of purchase
of an investment and refer to a fund's total assets, unless another purpose is
indicated. A fund will not necessarily use the strategies described to the full
extent permitted unless the managers believe that doing so will help a fund
reach its objectives. Further, not all instruments or strategies will be used at
all times.
In the event of a corporate restructuring or bankruptcy reorganization of a
company whose securities are owned by a fund, the fund may receive securities
different from those originally purchased. For example, a fund might receive
common stock that is not dividend paying, bonds with a lower coupon or more
junior status, convertible securities or even conceivably real estate. The fund
is not obligated to sell such investments 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.
Each fund is also subject to investment restrictions that are described under
the heading "Fundamental Investment Restrictions" in this SAI. The investment
goal of each fund and its listed investment restrictions are "fundamental
policies" of each fund, which means that they may not be changed without a
majority vote of shareholders of the fund. With the exception of a fund's
investment goal and those restrictions specifically identified as fundamental,
all investment policies and practices described in the prospectus and in this
SAI are not fundamental, which means that the Board of Trustees may change them
without shareholder approval.
BORROWING Most funds may borrow in excess of 5% only from banks for temporary or
emergency purposes. Certain funds may borrow up to 331 1/3% of their total net
assets to make investments or for other purposes. See "Fundamental Investment
Restrictions" for more information about the funds' policies with respect to
borrowing.
Under federal securities laws, a fund may borrow from banks only and 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 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 fund'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.
CONCENTRATION. Unless otherwise disclosed in the individual fund sections above,
the funds will not invest more than 25% of their assets in any one particular
industry (excluding the U.S. Government). Pursuant to the 1940 Act, these
policies may not be changed without shareholder approval.
CONVERTIBLE SECURITIES Certain funds may invest in convertible securities. A
convertible security is generally a debt obligation or preferred stock that may
be converted within a specified period of time into a certain amount of common
stock of the same or a different issuer. A convertible security provides a
fixed-income stream and, through its conversion feature, the potential for the
security to increase in value if there is an increase in the value of the
underlying common stock.
A convertible security tends to increase in market value when interest rates
decline and decrease in value when interest rates rise. The value of a
convertible security also 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 both interest rate and market movements can
influence its value, 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.
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A convertible security is usually issued either by an operating company or by an
investment bank. A convertible security issued by an operating company is
generally 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. However, 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. The parity price is the price at which the
common stock underlying the convertible security may be obtained; the call price
is the price of the bond, including any premium related to the conversion
feature. A convertible security issued by an investment bank is an obligation of
and is convertible through the issuing investment bank.
The convertible debt securities in which the funds may invest are subject to the
same rating criteria and investment policies as the funds' investments in debt
securities.The issuer of a convertible security may be important in determining
the security's true value, because the holder of a convertible security will
have recourse only to the issuer. In addition, the issuer may redeem a
convertible security after a specified date and under circumstances established
at the time the security is issued.
A convertible preferred stock is treated like a preferred stock for the fund's
financial reporting, credit rating, and investment limitation purposes. A
preferred stock is subordinated to the issuer's debt obligations in the event of
insolvency. An issuer's failure to make a dividend payment is generally not an
event of default entitling a 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 that way for corporate tax purposes.
ENHANCED CONVERTIBLE SECURITIES. In addition to "plain vanilla" convertibles a
number of different structures have been created to fit the characteristics of
specific investors and issuers.
Certain funds may invest in convertible preferred stocks that offer enhanced
yield features, such as Preferred Equity Redemption Cumulative Stocks ("PERCS"),
which provide an investor, such as a fund, with the opportunity to earn higher
dividend income than is available on a company's common stock. PERCS are
preferred stocks that generally feature 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 they are issued, 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, after three
years PERCS convert into one share of the issuer's common stock if the issuer's
common stock is trading at a price below that set by the capital appreciation
limit, and into less than one full share if the issuer's common stock is trading
at a price above that set by the capital appreciation limit. The amount of that
fractional share of common stock is determined by dividing the price set by the
capital appreciation limit by the market price of the issuer's common stock.
PERCS can be called, i.e., required to be returned to the issuer, at any time
prior to maturity, and hence do not provide call protection. If called early,
however, 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.
Certain funds may also invest in other classes of enhanced convertible
securities. These include but are not limited to:
o ACES (Automatically Convertible Equity Securities),
o PEPS (Participating Equity Preferred Stock),
o PRIDES (Preferred Redeemable Increased Dividend Equity Securities),
o SAILS (Stock Appreciation Income Linked Securities),
o TECONS (Term Convertible Notes),
o QICS (Quarterly Income Cumulative Securities) and
o DECS (Dividend Enhanced Convertible Securities).
ACES, PEPS, PRIDES, SAILS, TECONS, QICS and DECS all have the following
features:
o they are issued by a company whose common stock will be received in the event
the convertible preferred stock is converted;
o unlike PERCS, they do not have a capital appreciation limit;
o they seek to provide the investor with high current in come with some
prospect of future capital appreciation;
o they are typically issued with three or four-year maturities;
o they typically have some built-in call protection for the first two to three
years;
o 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 necessarily convert into either cash or a specified number of shares of
common stock.
Similarly, there may be enhanced convertible debt obligations issued by the
operating company that convert to its common stock or the shares of a different
issuer. Names such as ELKS (Equity Linked Securities) or similar names may
identify these securities. Typically they share most of the 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, which is the agreement that describes
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the security. A fund may invest in additional types of convertible securities
not specifically described here, as long as such investments are consistent with
its objectives and policies.
SYNTHETIC CONVERTIBLE SECURITIES. Certain funds may invest a portion of their
assets in "synthetic convertible" securities. A synthetic convertible is created
by combining distinct securities that together possess fixed income payments 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 fund's investment policy regarding those
securities.
Synthetic convertible securities differ from a true convertible security in the
following respects:
o The value of a synthetic convertible is the sum of the values of its
fixed-income and convertibility components, which means that the values of a
synthetic convertible and a true convertible security will respond
differently to market fluctuations.
o Typically, the two components of a synthetic convertible represent one
issuer, but a fund may combine components representing distinct issuers, or
to combine a fixed income security with a call option on a stock index, when
the manager determines that such a combination would better promote a fund's
investment objectives.
o The component parts of a synthetic convertible security may be purchased
simultaneously or separately.
o 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.
DEBT SECURITIES A debt security typically has a fixed payment schedule that
obligates the issuer to pay interest to the lender and to return the lender's
money over a certain time period. These securities include bonds, notes,
debentures, and commercial paper, which differ in the length of the issuer's
payment schedule, with bonds carrying the longest repayment schedule and
commercial paper the shortest.
The market value of debt securities generally varies in response to changes in
interest rates and the financial condition of each issuer. During periods of
declining interest rates, the value of debt securities generally increases.
During periods of rising interest rates, the value of such securities generally
declines. These changes in market value of securities owned by the fund will be
reflected in the fund's net asset value per share.
RATINGS. Various investment services publish ratings of some of the debt
securities in which the funds may invest. Higher yields are ordinarily available
from securities in the lower rating categories, such as securities rated Ba or
lower by Moody's or BB or lower by S&P or from unrated securities deemed by a
fund's manager to be of comparable quality. These ratings represent the opinions
of the rating services with respect to the issuer's ability to pay interest and
repay principal. They do not purport to reflect other risk, such as the risk of
fluctuations in market value and are not absolute standards of quality. However,
lower rated securities typically are riskier than investment grade securities.
Bonds which are rated C by Moody's are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing. Bonds rated C by S&P are obligations on
which no interest is being paid. Please see the appendix for a discussion of the
ratings.
If the rating on an issue held in a fund's portfolio is changed by the rating
service or the security goes into default, this event will be considered by the
fund in its evaluation of the overall investment merits of that security but
will not generally result in an automatic sale of the security.
Regardless of rating levels, all debt securities considered for purchase
(whether rated or unrated) will be carefully analyzed by the manager to assess
whether, at the time of purchase, the planned investment offers potential
returns which are reasonable in light of the risks involved.
BANK OBLIGATIONS, or instruments secured by bank obligations, include fixed,
floating or variable rate CDs, letters of credit, time deposits, bank notes and
bankers' acceptances. Certificates of deposit are negotiable certificates issued
against funds deposited in a commercial bank for a definite period of time and
earning a specified return. Bankers' acceptances are negotiable drafts or bills
of exchange normally drawn by an importer or exporter to pay for specific
merchandise and which are "accepted" by a bank, meaning, in effect, that the
bank unconditionally agrees to pay the face value of the instrument upon
maturity. For funds permitted to invest in bank obligations, such obligations
include dollar-denominated certificates of deposit and bankers' acceptances of
foreign and domestic banks having total assets in excess of $1 billion,
certificates of deposit of federally insured savings and loan associations
having total assets in excess of $1 billion, or cash and time deposits with
banks in the currency of any major nation. Time deposits are non-negotiable
deposits that are held in a banking institution for a specified time at a stated
interest rate.
Certain funds may invest in obligations of U.S. banks, foreign branches of U.S.
banks, foreign branches of foreign banks, and U.S. branches of foreign banks
that have a
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federal or state charter to do business in the U.S. and are subject to U.S.
regulatory authorities.
COMMERCIAL PAPER typically refers to short-term obligations of banks,
corporations and other borrowers with maturities of up to 270 days. A fund may
invest in domestic or foreign commercial paper. Investments in commercial paper
are generally limited to obligations rated Prime-1 or Prime-2 by Moody's or A-1
or A-2 by S&P or if unrated, 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
for a description of commercial paper ratings. Certain funds may also invest in
lower rated commercial paper to the extent permitted by their policies on lower
rated debt securities generally.
DEFERRED INTEREST AND PAY-IN-KIND BONDS Certain funds may buy bonds issued at a
discount that defer the payment of interest until a later date, or which pay
interest through the issuance of additional bonds, known as pay-in-kind bonds.
See "Risks, Lower-rated securities" for more information about these bonds.
MORTGAGE-BACKED SECURITIES
ADJUSTABLE RATE MORTGAGE SECURITIES ("ARMS"). Certain funds may invest in ARMS.
ARMS, like traditional mortgage securities, are interests in pools of mortgage
loans. The interest rates on the mortgages underlying ARMS are reset
periodically. The adjustable interest rate feature of the mortgages underlying
the mortgage securities in which the funds invest generally will act as a buffer
to reduce sharp changes in a fund's net asset value in response to normal
interest rate fluctuations. As the interest rates are reset, the yields of the
securities will gradually align themselves to reflect changes in market rates so
that their market value will remain relatively stable compared to fixed-rate
securities. As a result, a fund's net asset value should fluctuate less
significantly than if the fund invested in more traditional long-term,
fixed-rate securities. During periods of extreme fluctuation in interest rates,
however, a fund's net asset value will fluctuate.
Because the interest rates on the mortgages underlying ARMS are reset
periodically, a fund may participate in increases in interest rates, resulting
in both higher current yields and lower price fluctuations. This differs from
fixed-rate mortgages, which generally decline in value during periods of rising
interest rates. A fund, however, will not benefit from increases in interest
rates to the extent that interest rates exceed the maximum allowable annual or
lifetime reset limits (or "cap rates") for a particular mortgage security. Since
most mortgage securities held by the funds will generally have annual reset
limits or caps of 100 to 200 basis points, short-term fluctuations in interest
rates above these levels could cause these mortgage securities to "cap out" and
behave more like long-term, fixed-rate debt securities. If prepayments of
principal are made on the underlying mortgages during periods of rising interest
rates, a fund generally will be able to reinvest these amounts in securities
with a higher current rate of return.
During periods of rising interest rates, changes in the interest rates on
mortgages underlying ARMS lag behind changes in the market rate. This may result
in a lower net asset value until the interest rate resets to market rates. Thus,
you could suffer some principal loss if you sell your shares of a fund before
the interest rates on the underlying mortgages in the underlying portfolio reset
to market rates. Also, a fund's net asset value could vary to the extent that
current yields on mortgage-backed securities are different from market yields
during interim periods between coupon reset dates. A portion of the ARMS in
which the funds may invest may not reset for up to five years.
During periods of declining interest rates, the interest rates may reset
downward, resulting in lower yields to a fund. As a result, the value of ARMS is
unlikely to rise during periods of declining interest rates to the same extent
as the value of fixed-rate securities. As with other mortgage-backed securities,
declining interest rates may result in accelerated prepayments of mortgages, and
a fund may have to reinvest the proceeds from the prepayments at the lower
prevailing interest rates.
For certain types of ARMS, the rate of amortization of principal, as well as
interest payments, change in accordance with movements in a pre-specified,
published interest rate index. The amount of interest due to an ARMS holder is
calculated by adding a specified additional amount, the "margin," to the index,
subject to limitations or "caps" on the maximum and minimum interest that is
charged to the mortgagor during the life of the mortgage or to maximum and
minimum changes to that interest rate during a given period.
Mortgage loan pools offering pass-through investments in addition to those
described above may be created in the future. The mortgages underlying these
securities may be alternative mortgage instruments, that is, mortgage
instruments whose principal or interest payments may vary or whose terms to
maturity may differ from customary long-term, fixed-rate mortgages. As new types
of mortgage securities are developed and offered to investors, a fund may invest
in them if they are consistent with the fund's goal, policies, and quality
standards.
ADJUSTABLE RATE SECURITIES ("ARS"). Certain funds will invest in ARS. ARS are
debt securities with interest rates that are adjusted periodically pursuant to a
pre-set formula and interval. Movements in the relevant index on which
adjustments are based, as well as the applicable spread relating to the ARS,
will affect the interest paid on ARS and, therefore, the current income earned
by a fund by investing in ARS. (See "Resets.")
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The interest rates on ARS are readjusted periodically to an amount above the
chosen interest rate index. These readjustments occur at intervals ranging from
one to sixty months. The degree of volatility in the market value of the
securities held by a fund and of the net asset value of the fund's shares will
be a function primarily of the length of the adjustment period and the degree of
volatility in the applicable indices. It will also be a function of the maximum
increase or decrease of the interest rate adjustment on any one adjustment date,
in any one year, and over the life of the securities. These maximum increases
and decreases are typically referred to as "caps" and "floors," respectively. A
fund does not seek to maintain an overall average cap or floor, although the
manager will consider caps or floors in selecting ARS for a fund.
While the funds investing in ARS do not attempt to maintain a stable net asset
value per share, during periods when short-term interest rates move within the
caps and floors of the securities held by a fund, the fluctuation in market
value of the ARS held by the fund is expected to be relatively limited, since
the interest rates on the ARS generally adjust to market rates within a short
period of time. In periods of substantial short-term volatility in interest
rates, the value of a fund's holdings may fluctuate more substantially because
the caps and floors of its ARS may not permit the interest rates to adjust to
the full extent of the movements in the market rates during any one adjustment
period. In the event of dramatic increases in interest rates, the lifetime caps
on the ARS may prevent the securities from adjusting to prevailing rates over
the term of the loan. In this case, the market value of the ARS may be
substantially reduced, with a corresponding decline in a fund's net asset value.
COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS"). Certain funds may invest in CMOs
issued and guaranteed by U.S. Government agencies or instrumentalities and in
CMOs issued by certain financial institutions and other mortgage lenders.
CMOs are debt instruments issued by special purpose entities that are secured by
pools of mortgage loans or other mortgage-backed securities. Principal and
interest on the underlying collateral are paid to the issuer of the CMOs to make
required payments on these securities. In effect, CMO's "pass-through" the
monthly payments made by individual borrowers on their mortgage loans. Timely
payment of interest and principal (but not 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 obligations itself
is not guaranteed.
A CMO is a mortgage-backed security that separates mortgage pools into short-,
medium-, and long-term components. Each component pays a fixed rate of interest
to security holders at regular intervals. These components enable an investor,
such as a fund, to predict more accurately the pace at which principal is
returned.
CMOs purchased by a fund may be:
(1) collateralized by pools of mortgages in which each mortgage is guaranteed as
to payment of principal and interest by an agency or instrumentality of the U.S.
Government; or
(2) collateralized by pools of mortgages in which payment of principal and
interest are guaranteed by the issuer, an entity specifically created for this
purpose, and the guarantee is collateralized by U.S. Government securities.
If the collateral securing the obligations is insufficient to make payment on
the obligation, a holder could sustain a loss. In addition, a fund may buy CMOs
without insurance or guarantees if, in the opinion of the manager, the sponsor
is creditworthy. The ratings of the CMOs will be consistent with the ratings
criteria of the fund. 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.
RESETS. The interest rates paid on ARMS, ARS, and CMOs generally are readjusted
at intervals of one year or less to an increment over some predetermined
interest rate index, although some securities in which the funds may invest may
have intervals as long as five years. There are three main categories of
indices: those based on LIBOR, those based on U.S. Treasury securities, and
those derived from a calculated measure such as a cost of funds index or a
moving average of mortgage rates. Commonly used indices include:
o the one-, three-, and five-year constant-maturity Treasury rates;
o the three-month Treasury bill rate;
o the 180-day Treasury bill rate;
o rates on longer-term Treasury securities;
o the 11th District Federal Home Loan Bank Cost of Funds; the National Median
Cost of Funds;
o the one-, three-, six-month, or one-year LIBOR; the prime rate of a specific
bank; or
o commercial paper rates.
Some indices, such as the one-year constant-maturity Treasury rate, closely
mirror changes in market interest rate levels. Others, such as the 11th District
Federal Home Loan Bank Cost of Funds, tend to lag behind changes in market
interest rate levels and tend to be somewhat less volatile.
CAPS AND FLOORS. The underlying mortgages that collateralize ARMS and CMOs will
frequently have caps and floors that limit the maximum amount by which the loan
rate to the borrower may change up or down (a) per reset
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or adjustment interval and (b) 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.
STRIPPED MORTGAGE SECURITIES. Certain funds may invest in stripped mortgage
securities, which are derivative multi-class mortgage securities. The stripped
mortgage securities in which a fund may invest will only be issued or guaranteed
by the U.S. Government, its agencies or instrumentalities. Stripped mortgage
securities have greater market volatility than other types of mortgage
securities in which a fund invests.
Stripped mortgage securities are usually structured with two classes, each
receiving different proportions of the interest and principal distributions on a
pool of mortgage assets. A common type of stripped mortgage security has one
class that receives some of the interest and most of the principal from the
mortgage assets, while the other class receives most of the interest and the
remainder of the principal. In the most extreme case, one class receives all of
the interest (the interest-only or "IO" class), while the other class receives
the entire 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
underlying mortgage assets. A rapid rate of principal payments may have a
material adverse effect on the yield to maturity of any IO class held by a fund.
If the underlying mortgage assets experience greater than anticipated
prepayments of principal, the fund may fail to recoup its initial investment
fully, 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 a fund, through several investment banking firms acting as brokers or
dealers. These securities were only recently developed, and traditional trading
markets have not yet been established for all stripped mortgage securities.
Accordingly, some of these securities may be illiquid. The staff of the SEC has
indicated that only government-issued IO or PO securities that are backed by
fixed-rate mortgages may be deemed to be liquid, if procedures with respect to
determining liquidity are established by a fund's board. The Board may, in the
future, adopt procedures that would permit a fund 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 fund's net assets. This
position may be changed in the future, without notice to shareholders, in
response to the SEC staff's continued reassessment of this matter, as well as to
changing market conditions.
INVERSE FLOATERS. Certain funds may invest in inverse floaters. Inverse floaters
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.
ASSET-BACKED SECURITIES. Certain funds may invest in asset-backed securities,
including adjustable-rate asset-backed securities that have interest rates that
reset at periodic intervals. Asset-backed securities are similar to
mortgage-backed securities. The underlying assets, however, may include
receivables on home equity and credit card loans, and automobile, mobile home,
and recreational vehicle loans and leases. Asset-backed securities are issued in
either a pass-through structure (similar to a mortgage pass-through structure)
or a pay-through structure (similar to a CMO structure). There may be other
types of asset-backed securities that are developed in the future in which a
fund may invest. In general, collateral supporting asset-backed securities has
shorter maturities than mortgage loans and historically has been less likely to
experience substantial prepayment.
MUNICIPAL SECURITIES Certain funds may invest in "municipal securities." These
securities are issued by state and local governments, their agencies and
authorities, as well as by the District of Columbia and U.S. territories and
possessions, to borrow money for various public or private projects. The issuer
pays a fixed or variable rate of interest, and must repay the amount borrowed
(the "principal") at maturity. Municipal securities generally pay interest free
from federal income tax.
STRIPPED SECURITIES are the separate income and principal components of a debt
security. Once the securities have been stripped they are referred to as zero
coupon securities. Stripped securities do not make periodic payments of interest
prior to maturity and the stripping of the interest coupons causes them to be
offered at a discount from their face amount. This results in the security being
subject to greater fluctuations in response to changing interest rates than
interest-paying securities of similar maturities. Certain funds may purchase the
following stripped securities: U.S. Treasury STRIPS; Stripped Government
Securities; Stripped Obligations of the Financing Corporation ("FICO STRIPS");
Stripped Corporate Securities; and, Stripped Eurodollar Obligations
U.S. TREASURY STRIPS ("SEPARATE TRADING OF REGISTERED INTEREST AND PRINCIPAL OF
SECURITIES"). Are considered U.S. Treasury securities for purposes of a fund's
investment policies. Their risks are similar to those of other U.S. Government
securities, although they may be more volatile. The U.S. Treasury has
facilitated transfers of ownership of zero coupon securities by accounting
separately for the
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beneficial ownership of particular interest coupon and principal payments on
Treasury securities through the Federal Reserve book-entry record-keeping
system.
STRIPPED GOVERNMENT SECURITIES are 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."
FICO STRIPS represent 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.
STRIPPED CORPORATE SECURITIES are zero coupon securities issued by domestic
corporations which consist of corporate debt obligations without interest
coupons, and, if available, interest coupons that have been stripped from
corporate debt obligations, and receipts and certificates for these stripped
debt obligations and stripped coupons.
STRIPPED EURODOLLAR OBLIGATIONS are stripped debt obligations denominated in
U.S. dollars that are issued by foreign issuers, often subsidiaries of domestic
corporations.
STRUCTURED NOTES are derivative instruments that entitle a holder to receive
some portion of the principal or interest payments that 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 of the change in an identified or "linked"
equity security, currency, interest rate, index or other financial indicator.
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. If permitted by a fund's policies, the
Templeton managers may occasionally invest under 5% of a fund's net assets in
structured notes that are linked to a benchmark, on a non-leveraged, one-to-one
basis.
U.S. GOVERNMENT SECURITIES Certain funds may invest in U.S. Government
securities including: (1) U.S. Treasury obligations with varying interest rates,
maturities and dates of issuance, such as U.S. Treasury bills (maturities of one
year or less), U.S. Treasury notes (original maturities of one to ten years) and
U.S. Treasury bonds (generally original maturities of greater than ten years);
and (2) obligations issued or guaranteed by U.S. Government agencies and
instrumentalities such as the Government National Mortgage Association, the
Export-Import Bank and the Farmers Home Administration. Some of the funds'
investments will include obligations that are supported by the full faith and
credit of the U.S. Government. In the case of U.S. Government obligations that
are not backed by the full faith and credit of the U.S. Government (e.g.,
obligations of the Federal National Mortgage Association (FNMA) or a Federal
Home Loan Bank), the fund must look principally to the agency issuing or
guaranteeing the obligation for ultimate repayment and may not be able to assert
a claim against the U.S. itself in the event the agency or instrumentality does
not meet its commitments.
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION OBLIGATIONS ("GINNIE MAES"). The
Government National Mortgage Association's guarantee of payment of principal and
interest on Ginnie Maes is backed by the full faith and credit of the U.S.
Government. The Government National Mortgage Association may borrow U.S.
Treasury funds to the extent needed to make payments under its guarantee.
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 that 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 from the time they are issued.
ZERO COUPON BONDS Certain funds may invest in zero coupon bonds issued or
guaranteed by the U.S. Government, its agencies or instrumentalities. Zero
coupon bonds are debt obligations that are issued at a significant discount from
the value set forth on the face of the bond. The original discount approximates
the total amount of interest the bonds will accumulate and compounds over the
period until maturity or the first interest accumulation date at a rate of
interest reflecting the market rate of the security at the time of issuance. A
fund will be deemed to have received income on such investments for tax and
accounting purposes. That income is distributable to shareholders even though no
cash is received at the time of accrual, which may require the liquidation of
other portfolio securities to satisfy the fund's distribution obligations.
DERIVATIVE SECURITIES are those securities whose values are dependent upon the
performance of one or more securities or indices. Certain funds may invest in
the following "derivative securities":
o adjustable rate mortgage securities;
o adjustable rate securities;
o collateralized mortgage obligations;
o convertible securities with enhanced yield features such as PERCS, ACES,
DECS, and PEPS;
o forward contracts;
o futures contracts;
o inverse floaters;
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o mortgage pass-throughs, including multiclass pass-throughs, stripped mortgage
securities, and other asset-backed securities;
o options;
o spreads and straddles;
o swaps;
o synthetic convertible securities; and
o uncovered mortgage dollar rolls.
Derivatives are used for "hedging", which means that they help manage risks
relating to interest rates, currency fluctuations and other market factors. They
may also be used to increase liquidity or to invest in a particular stock or
bond in a more efficient or less expensive way.
CURRENCY RATE SWAPS Certain funds may participate in currency rate swaps. A
currency rate swap is the transfer between two counterparties of their
respective rights to receive payments in specified currencies.
CURRENCY TECHNIQUES AND HEDGING Certain funds may enter into forward currency
exchange contracts ("forward contracts") and currency futures contracts and
options on these futures contracts, although the fund has no present intention
of using any of these techniques except forward contracts. The funds typically
engage in these practices for hedging purposes, or in other words for the
purpose of protecting against declines in the value of a fund's portfolio
securities and the income on these securities. A fund 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.
FORWARD CURRENCY EXCHANGE CONTRACTS. Certain funds may enter into forward
currency exchange contracts to attempt to minimize the risk to the fund from
adverse changes in the relationship between currencies or to enhance income. A
forward contract involves an obligation to buy or sell a specific currency at a
future date, that 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 fund may either accept or make delivery of the currency specified at the
maturity of a forward 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.
A fund 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.
Certain funds 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 correlation
between the two currencies.
A fund may also enter into a forward contract, for example, when it enters into
a contract for the purchase or sale of a security denominated in a foreign
currency in order to "lock in" the U.S. dollar price of that security.
Additionally, for example, when a fund believes that a foreign currency may
suffer a substantial decline against the U.S. dollar, it may enter into a
forward contract to sell an amount of that foreign currency approximating the
value of some or all of the fund's portfolio securities denominated in such
foreign currency. Similarly, when a fund believes that the U.S. dollar may
suffer a substantial decline against a foreign currency, it may enter into a
forward contract to buy that foreign currency for a fixed dollar amount.
A fund sets aside or segregates sufficient cash, cash equivalents, or readily
marketable debt securities held by its custodian bank as deposits for
commitments created by open forward contracts. The fund will cover any
commitments under these contracts to sell currency by owning or acquiring the
underlying currency (or an absolute right to acquire such currency). The
segregated account will be marked-to-market daily. The ability of a fund to
enter into forward contracts is limited only to the extent forward contracts
would, in the opinion of the manager, impede portfolio management or the ability
of the fund to honor redemption requests.
Forward contracts may limit potential gain from a positive change in the
relationship between the U.S. dollar and foreign currencies or between foreign
currencies. Unanticipated changes in currency exchange rates also may result in
poorer overall performance for the fund than if it had not entered into such
contracts.
The funds generally will not enter into a forward contract with a term of
greater than one year.
CURRENCY FUTURES CONTRACTS. Certain funds may enter into currency futures
contracts traded on regulated commodity exchanges, including non-U.S. exchanges.
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 fund may use currency futures contracts to hedge against
anticipated future changes in exchange rates which otherwise might adversely
affect the value of the fund's portfolio securities
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or adversely affect the prices of securities that a fund intends to purchase at
a later date.
A fund may either accept or make delivery of the currency specified at the
maturity of a currency 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 currency futures contracts are effected on
the exchange on which the contract was entered into (or on a linked exchange).
OPTIONS ON FOREIGN CURRENCIES. Certain funds may buy and write put and call
options on foreign currencies (traded on U.S. and foreign exchanges or
over-the-counter) for hedging purposes to protect against declines in the U.S.
dollar value of foreign portfolio securities and against increases in the U.S.
dollar cost of foreign securities or other assets to be acquired. As in the case
of other kinds of options, however, the writing of an option on foreign currency
will constitute only a partial hedge, up to the amount of the premium received.
A fund could be required to buy or sell foreign currencies at disadvantageous
exchange rates, thereby incurring losses. The purchase of an option on foreign
currency may constitute an effective hedge against fluctuations in exchange
rates although, in the event of rate movements adverse to a fund's position, the
fund may loose the entire amount of the premium plus related transaction costs.
INTEREST RATE SWAPS Certain funds may participate in interest rate swaps. A swap
is an agreement between two parties to exchange sets of cash flows over a period
in the future. Most corporate and government bonds pay fixed coupons, and are
exposed to the risk of rising interest rates. Swapping fixed payments for
floating payments, an interest rate swap is a vehicle to hedge interest rate
risk.
An example of an interest rate swap might be where one obligation has an
interest rate fixed to maturity while the other has an interest rate that
changes with changes in a designated benchmark, such as the London Interbank
Offered Rate ("LIBOR"), prime, commercial paper, or other benchmarks. The
obligations to make repayment of principal on the underlying securities are not
transferred. Similarly, the right to receive such payments is not transferred.
These 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 the 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 that has a floating-rate obligation
that substantially mirrors the obligation desired by the first entity. 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.
The funds intend to participate in interest rate swaps involving obligations
held in a fund's portfolio on which it is receiving payments of principal and
interest. A fund might do this, for example, in order to gain or reduce its
exposure to fixed interest rate payments under certain market conditions. To the
extent, however, a fund does not own the underlying obligation, the fund will
maintain, in a segregated account with its custodian bank, cash or marketable
securities with an aggregate value equal to the amount of the fund's outstanding
swap obligation.
Interest rate swaps permit the party seeking a floating rate obligation the
opportunity to acquire the 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 a fixed rate obligation, also frequently
at a price lower than is available in the capital markets. The success of the
transaction depends in large part on the availability of fixed rate obligations
at a low enough coupon rate to cover the cost involved.
OPTIONS, FUTURES AND OPTIONS ON FINANCIAL FUTURES Although the funds have no
present intention of investing in options, futures and options on financial
futures, certain funds have the authority to enter into these transactions.
Unless otherwise noted in a fund's policies, the value of the underlying
securities on which options may be written at any one time will not exceed 15%
of the fund's assets. Nor will a fund purchase put or call options if the
aggregate premium paid for such options would exceed 5% of its assets at the
time of purchase. Unless otherwise noted in a fund's policies, none of the
fund's permitted to purchase 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 fund and the
premiums paid on options on futures contracts would exceed 5% of the market
value of the fund's assets.
Certain funds may write (sell) covered put and call options and buy put and call
options on securities listed on a national securities exchange and in the
over-the-counter ("OTC") market. Additionally, a fund may "close out" options it
has entered into.
A call option gives the option holder the right to buy the underlying security
from the option writer at the option exercise price at any time prior to the
expiration of the option. A put option gives the option holder the right to sell
the underlying security to the option writer at the option exercise price at any
time prior to the expiration of the option. The OTC market is the
dealer-to-dealer market in securities, in this case, option securities in which
the fund may buy or sell.
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WRITING COVERED CALL AND PUT OPTIONS ON SECURITIES. Certain funds may write
options to generate additional income and to hedge their portfolios against
market or exchange rate movements. The writer of covered calls gives up the
potential for capital appreciation above the exercise price of the option should
the underlying stock rise in value. If the value of the underlying stock rises
above the exercise price of the call option, the security may be "called away"
and a fund required to sell shares of the stock at the exercise price. A fund
will realize a gain or loss from the sale of the underlying security depending
on whether the exercise price is greater or less than the purchase price of the
stock. Any gain will be increased by the amount of the premium received from the
sale of the call; any loss will be decreased by the amount of the premium
received. If a covered call option expires unexercised, a fund will realize a
gain in the amount of the premium received. If, however, the stock price
decreases, the hedging benefit of the covered call option is limited to the
amount of the premium received.
A call option written by a fund is "covered" if:
o the fund owns the underlying security that is subject to the call; or
o the fund 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 bank) upon conversion or exchange of
other securities held in its portfolio.
A call option is also covered if a fund holds a call on the same security and in
the same principal amount as the call written where the exercise price of the
call held:
(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 in
exercise prices is maintained by a fund in cash and marketable securities in
a segregated account with its custodian bank.
Certain funds may write options in connection with "buy-and-write" transactions;
that is, a fund may purchase a security and then write a call option against
that security. The exercise price of the call will depend upon the expected
price movement of the underlying security. The exercise price of a call option
may be below ("in-the-money"), equal to ("at-the-money"), or above
("out-of-the-money") the current value of the underlying security at the time
the option is written.
The writer of covered puts retains the risk of loss should the underlying
security decline in value. If the value of the underlying stock declines below
the exercise price of the put option, the security may be "put to" a fund and
the fund required to buy the stock at the exercise price. A fund will incur an
unrealized loss to the extent that the current market value of the underlying
security is less than the exercise price of the put option. However, the loss
will be offset at least in part by the premium received from the sale of the
put. If a put option written by a fund expires unexercised, the fund will
realize a gain in the amount of the premium received.
A put option written by the fund is "covered" if the fund maintains cash and
marketable securities with a value equal to the exercise price in a segregated
account with its custodian bank, 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 writer of an option may have no control over when the underlying securities
must be sold, in the case of a call option, or purchased, in the case of a put
option, since the writer may be assigned an exercise notice at any time prior to
the termination of the obligation. Whether or not an option expires unexercised,
the writer retains the amount of the premium. This amount may, in the case of a
covered call option, be offset by a decline in the market value of the
underlying security during the option period. If a call option is exercised, the
writer experiences a profit or loss from the sale of the underlying security. If
a put option is exercised, the writer must fulfill the obligation to buy the
underlying security at the exercise price, which will usually exceed the market
value of the underlying security at that time.
If the writer of an option wants to terminate its obligation, the writer may
effect a "closing purchase transaction" by buying an option of the same series
as the option previously written. The effect of the purchase is that the
clearing corporation will cancel the writer's position. However, a writer may
not effect a closing purchase transaction after being notified of the exercise
of an option. Likewise, the holder of an option may liquidate its position by
effecting a "closing sale transaction" by selling an option of the same series
as the option previously purchased. There is no guarantee that either a closing
purchase or a closing sale transaction may be made at the time desired by a
fund. Effecting a closing transaction allows the cash or proceeds from the sale
of any securities subject to the option to be used for other fund investments.
A fund will realize a profit from a closing transaction if the cost of the
transaction is less than the premium received from writing the option or is more
than the premium paid to purchase the option. A fund will realize a loss from a
closing transaction if the cost of the transaction is more than the premium
received from writing the option. Because increases in the market price of a
call option will generally reflect increases in the market price of the
underlying security, any loss resulting from the closing transaction of a
written call option is likely to be offset in
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whole or in part by appreciation of the underlying security owned by the fund.
BUYING CALL AND PUT OPTIONS ON SECURITIES. The premium paid by the buyer of an
option will reflect, among other things, the relationship of the exercise price
to the market price and the volatility of the underlying security, the remaining
term of the option, supply and demand and interest rates.
A fund may buy call options on securities that it intends to buy in order to
limit the risk of a substantial increase in the market price of the security
before the purchase is effected. A fund may also buy call options on securities
held in its portfolio and on which it has written call options.
Certain funds may buy put options. As the holder of a put option, a fund has the
right to sell the underlying security at the exercise price at any time during
the option period. A fund may enter into closing sale transactions with respect
to such options, exercise them or permit them to expire.
A fund may buy a put option on an underlying security ("a protective put") owned
by the fund as a hedging technique in order to protect against an anticipated
decline in the value of the security. Such hedge protection is provided only
during the life of the put option when a fund, as the holder of the put option,
is able to sell the underlying security at the put exercise price, regardless of
any decline in the underlying security's market price or currency's exchange
value. For example, a put option may be purchased in order to protect unrealized
appreciation of a security when the manager finds it desirable to continue to
hold the security because of tax considerations. The premium paid for the put
option and any transaction costs would reduce any short-term capital gain that
may be available for distribution when the security is eventually sold.
Certain funds may also buy put options at a time when they do not own the
underlying security. If a fund buys a put option on a security it does not own,
the fund seeks to benefit from a decline in the market price of the underlying
security. If the put option is not sold when it has remaining value, and if the
market price of the underlying security remains equal to or greater than the
exercise price during the life of the put option, the fund will lose its entire
investment in the put option. In order for the purchase of a put option to be
profitable, the market price of the underlying security must decline
sufficiently below the exercise price to cover the premium and transaction
costs, unless the put option is sold in a closing sale transaction.
OVER-THE-COUNTER ("OTC") OPTIONS. Certain funds may write covered put and call
options and buy put and call options that trade in the OTC market to the same
extent that they may engage in exchange traded options. OTC options differ from
exchange traded options in certain material respects.
OTC options are arranged directly with dealers and not with a clearing
corporation. Thus, there is a risk of non-performance by the dealer. Because
there is no exchange, pricing is typically done based on information from market
makers. OTC options are available for a greater variety of securities and in a
wider range of expiration dates and exercise prices, however, than exchange
traded options and the writer of an OTC option is paid the premium in advance by
the dealer.
There can be no assurance that a continuous liquid secondary market will exist
for any particular OTC option at any specific time. A fund may be able to
realize the value of an OTC option it has purchased only by exercising it or
entering into a closing sale transaction with the dealer that issued it. A fund
may suffer a loss if it is not able to exercise or sell its position on a timely
basis. When a fund writes an OTC option, it generally can close out that option
prior to its expiration only by entering into a closing purchase transaction
with the dealer with which the fund originally wrote the option. If a fund 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 security until
the option expires or it delivers the underlying security upon exercise.
The funds understand the current position of the staff of the SEC to be that
purchased OTC options are illiquid securities and that the assets used to cover
the sale of an OTC option are considered illiquid. The funds and the manager
disagree with this position. Nevertheless, pending a change in the staff's
position, the funds will treat OTC options and "cover" assets as subject to a
fund's limitation on illiquid securities.
OPTIONS ON STOCK INDICES. Certain funds may also buy and sell both call and put
options on stock indices in order to hedge against the risk of market or
industry-wide stock price fluctuations or to increase income to the funds. Call
and put options on stock indices are similar to options on securities except
that, rather than the right to buy or sell stock 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 (or less, in the case of puts) than 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 stock options, all settlements are in cash, and
gain or loss depends on the price movements of the underlying index rather than
the price movements of an individual stock.
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When a fund writes an option on a stock index, the fund may cover the option by
owning securities whose price changes, in the opinion of the manager, are
expected to be similar to those of the index, or in such other manner as may be
in accordance with the rules of the exchange on which the option is traded and
applicable laws and regulations. The funds may also cover by establishing a
segregated account containing cash or marketable securities with its custodian
bank in an amount at least equal to the market value of the underlying stock
index. The fund will maintain the account while the option is open or it will
otherwise cover the transaction.
FORWARD CONVERSIONS. In a forward conversion, a fund buys securities and writes
call options and buys put options on such securities. By purchasing puts, a fund
protects the underlying security from depreciation in value. By selling calls on
the same security, a fund receives premiums which may offset part or all of the
cost of purchasing the puts while foregoing the opportunity for appreciation in
the value of the underlying security. A fund will not exercise a put it has
purchased while a call option on the same security is outstanding.
Although it is generally intended that the exercise price of put and call
options would be identical, situations might occur in which some option
positions are acquired with different exercise prices. Therefore, a fund's
return may depend in part on movements in the price of the underlying security.
SPREAD AND STRADDLE OPTIONS TRANSACTIONS. In "spread" transactions, a fund buys
and writes a put or buys and writes a call on the same underlying security with
the options having different exercise prices and/or expiration dates. In
"straddles," a fund purchases or writes combinations of put and call options on
the same security. When a fund engages in spread and straddle transactions, it
seeks to profit from differences in the option premiums paid and received and in
the market prices of the related options positions when they are closed out or
sold. Because these transactions require a fund to buy and/or write more than
one option simultaneously, the fund's ability to enter into such transactions
and to liquidate its positions when necessary or deemed advisable may be more
limited than if the fund was to buy or sell a single option. Similarly, costs
incurred by a fund in connection with these transactions will in many cases be
greater than if the fund was to buy or sell a single option.
FUTURES CONTRACTS. Certain funds may enter into contracts to buy or sell futures
contracts based upon financial instruments ("financial futures"). Financial
futures contracts are commodity contracts that obligate the purchase or seller
to take or make delivery of a specified quantity of a financial instrument, such
as a security, or the cash value of a securities index during a specified future
period at a specified price. A "sale" of a futures contract means the
acquisition of a contractual obligation to deliver the securities called for by
the contract at a specified price on a specified date. A "purchase" of a futures
contract means the acquisition of a contractual obligation to acquire the
securities called for by the contract at a specified price on a specified date.
Futures contracts have been designed by exchanges that have been designated
"contracts markets" by the Commodity Futures Trading Commission and must be
executed through a futures commission merchant, or brokerage firm, that 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. The exchanges
guarantee performance of the contracts as between the clearing members of the
exchange.
A fund may enter into futures contracts 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 fund may also enter into futures
contracts on corporate securities and non-U.S. Government debt securities, but
such futures contracts are not currently available.
At the same time a futures contract is purchased or sold, the fund must allocate
cash or securities as a deposit payment ("initial deposit"). Daily thereafter,
the futures contract is valued and the payment of "variation margin" may be
required since each day the fund would provide or receive cash that reflects any
decline or increase in the contract's value.
In addition, the fund must deposit in a segregated account additional cash or
liquid securities to ensure the futures contracts are unleveraged. The value of
assets held in the segregated account must be equal to the daily value of all
outstanding futures contracts less any amount deposited as margin.
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 financial futures contracts by their terms call for the actual delivery
or acquisition of securities, or the cash
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value of the index, in most cases the contractual obligation is fulfilled before
the date of the contract without having to make or take delivery of the
securities or cash. The obligation to make or take delivery is ended by buying
(or selling, as the case may be) on an exchange an identical financial futures
contract calling for delivery in the same month. All transactions in the futures
market are made, offset or fulfilled through a clearinghouse associated with the
exchange on which the contracts are traded. The fund will incur brokerage fees
when it buys or sells financial futures.
A fund will not engage in transactions in futures contracts for speculation.
Futures contracts will be used as a hedge against changes resulting from market
conditions in the values of its securities or securities that it intends to buy
or to attempt to protect a fund from fluctuations in price of portfolio
securities without actually buying or selling the underlying security. When a
fund buys futures contracts or related call options, marketable instruments
equal to the difference between the fluctuating market value of such futures
contract and the aggregate value of the initial and variation margin payments
made by the fund will be deposited in a segregated account with the custodian
bank to collateralize such long positions.
OPTIONS ON FUTURES CONTRACTS. Certain funds 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 price of the
option compared to either the price of the futures contract upon which it is
based or the price of the underlying securities or currency, the option may be
less risky than direct ownership of the futures contract or the underlying
securities or currency. As with the purchase of futures contracts, when a fund
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 fund writes a call option on a futures contract and the futures price at
expiration of the option is below the exercise price, the fund 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 fund's holdings. If the
futures price at expiration of the option is higher than the exercise price, the
fund will retain the full amount of the option premium, which may provide a
partial hedge against any increase in the price of securities that the fund
intends to purchase. If a put or call option a fund has written is exercised,
the fund will incur a loss that 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
fund's losses from existing options on futures may be affected by changes in the
value of its portfolio securities.
STOCK INDEX FUTURES AND OPTIONS ON THESE FUTURES
Certain funds may buy and sell stock index futures contracts and options on
stock index futures contracts. In general, these funds may invest in index
futures for hedging purposes.
STOCK INDEX FUTURES. A stock index futures contract obligates the seller to
deliver (and the buyer 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. No physical delivery of the underlying stocks in the index is
made.
A fund may sell stock index futures contracts in anticipation of or during a
market decline to attempt to offset a possible decrease in market value of its
equity securities. When a fund is not fully invested in stocks and anticipates a
significant market advance, it may buy stock index futures in order to gain
rapid market exposure that may in part or entirely offset increases in the cost
of common stocks that it intends to buy.
OPTIONS ON STOCK INDEX FUTURES. Certain funds may buy and sell call and put
options on stock index futures to hedge against risks of market price
fluctuations. The need to hedge against these risks will depend on the extent of
diversification of the fund's common stock portfolio and the sensitivity of such
investments to factors influencing the stock market as a whole.
Call and put options on stock index futures are similar to options on securities
except that, rather than the right to buy or sell stock at a specified price,
options on stock index futures give the holder the right to receive cash. Upon
exercise of the option, the writer of the option will deliver to the holder of
the option the accumulated balance in the writer's futures margin account
representing the amount that the market price of the futures contract, at
exercise, exceeds, in the case of a call, or is less than, in the case of a put,
the exercise price of the option on the futures contract. If an option is
exercised on the last trading day before the expiration date of the option, the
settlement will be made entirely in cash equal to the difference between the
exercise price of the option and the closing price of the futures contract on
the expiration date.
INTEREST RATE FUTURES AND RELATED OPTIONS. Certain funds may buy and sell
interest rate futures contracts and options on these futures contracts. A fund
will 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.
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Certain funds may also buy and write put and call options on interest rate
futures and enter into closing transactions with respect to such options.
DIVERSIFICATION Each fund, except the Global Health Care Fund, Global Income
Fund, and the Value Fund will operate as a diversified fund under federal
securities law. Each diversified fund may not, with respect to 75% of its total
assets, purchase the securities of any one issuer (except U.S. Government
securities) if more than 5% of the value of the fund's assets would be invested
in such issuer.
In addition, each fund 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.
A fund's investments in U.S. Government securities are not subject to these
limitations.
In the case of funds investing in obligations of U.S. Government agencies or
instrumentalities, each agency or instrumentality is treated as a separate
issuer for purposes of the above rules.
EQUITY SECURITIES represent ownership interests in individual companies and give
shareholders a claim in the company's earnings and assets. Equity securities
generally take the form of common stock or preferred stock, as well as
securities convertible into common stocks. Equity securities may also include
warrants, or rights. Warrants or rights give the holder the right to buy a
common stock at a given time for a specified price.
FOREIGN SECURITIES Certain funds may invest in foreign securities, if the
investments are consistent with their objectives and comply with their
concentration and diversification policies. The funds may buy the securities of
foreign issuers directly in foreign markets, both in developed and developing
countries. The securities of foreign issuers may be denominated in foreign
currency. The funds may also buy foreign securities that are traded in the U.S.
Investments in foreign securities may offer potential benefits not available
from investments solely in securities of domestic issuers or dollar denominated
securities. These benefits may include the opportunity to invest in foreign
issuers that appear, in the opinion of the manager, to offer:
o A better outlook for long-term capital appreciation or current earnings than
investments in domestic issuers;
o An opportunity to invest in foreign nations whose economic policies or
business cycles are different from those of the U.S.; and,
o 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.
Investments in foreign securities where delivery takes place outside the U.S.
will be made in compliance with any applicable U.S. and foreign currency
restrictions and tax and other laws limiting the amount and types of foreign
investments. A fund could experience investment losses if there are changes of:
o governmental administrations;
o economic or monetary policies in the U.S. or abroad;
o circumstances in dealings between nations; or,
o currency convertibility or exchange rates.
The funds do not consider securities that they acquire outside of the U.S. and
that are publicly traded in the U.S. or on a foreign securities market to be
illiquid assets if (a) the fund reasonably believes it can readily dispose of
the securities for cash in the U.S. or foreign market, or (b) current market
quotations are readily available.
Certain funds may invest in debt securities issued by foreign corporations,
governments and their instrumentalities, and by 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 the World Bank, the
European Development Bank and the Asian Development Bank.
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 individual
analysis.
Certain funds may invest in countries that do not permit direct investment. For
example, some countries, such as South Korea, Chile and India, have authorized
the formation of closed-end investment companies to facilitate indirect foreign
investment in their capital markets. In order to gain investment access to these
countries, a fund may invest up to 10% of its assets in shares of such
closed-end investment companies and up to 5% of its assets in any one closed-end
investment company as long as the investment does not represent more than 3% of
the voting stock of the acquired investment company. If a fund acquires shares
of closed-end investment companies, shareholders would bear both their share of
expenses of the fund (including management and advisory fees) and, indirectly,
the expenses of such closed-end investment companies.
DEPOSITARY RECEIPTS. Certain funds may invest in Depositary Receipts. American
Depositary Receipts (ADRs) are typically issued by a U.S. bank or trust company
and evidence ownership of underlying securities issued by a foreign corporation.
European Depositary Receipts (EDRs) and Global Depositary Receipts (GDRs) are
typically issued by foreign banks or trust companies, although
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they may be issued by U.S. banks or trust companies, and evidence ownership of
underlying securities issued by either a foreign or a U.S. corporation.
Generally, depositary receipts in registered form are designed for use in the
U.S. securities market and depositary receipts in bearer form are designed for
use in securities markets outside the U.S. Depositary Receipts may not
necessarily be denominated in the same currency as the underlying securities
into which they may be converted.
Depositary Receipts may be issued by 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 the availability of such information and the market value of the
Depositary Receipts.
Depositary Receipts also involve the same risks as direct investments in foreign
securities, as discussed below. For purposes of a fund's investment policies,
the fund will consider its investments in depositary receipts to be investments
in the underlying securities.
EMERGING MARKETS. Emerging market countries include: (i) countries that are
generally considered low or middle income countries by the International Bank
for Reconstruction and Development (commonly known as the World Bank) and the
International Finance Corporation; or (ii) countries that are classified by
United Nations or otherwise regarded by their authorities as emerging, or (iii)
countries with a stock market capitalization of less than 3% of the Morgan
Stanley Capital World Index.
ILLIQUID SECURITIES Each fund may invest in securities that cannot be offered to
the public for sale without first being registered under the Securities Act of
1933 ("restricted securities"), or in other securities which, in the opinion of
the Board, may be illiquid. See "Fundamental Investment Restrictions" for more
information about the fund's policies with respect to illiquid securities.
Illiquid securities are generally securities that cannot be sold within seven
days in the normal course of business at approximately the amount at which a
fund has valued them. Subject to each fund's percentage limitation on illiquid
securities, the Board has authorized each fund to invest in restricted
securities where such investment is consistent with each fund's investment
objective. The Board has authorized these securities to be considered liquid to
the extent the investment manager determines on a daily basis 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. In spite of
the managers' determinations in this regard, the Board will remain responsible
for such determinations and will consider appropriate action, consistent with a
fund's objectives and policies, if the security should become illiquid after
purchase. In determining whether a restricted security is properly considered a
liquid security, the investment manager and the Board will take into account the
following factors: (i) the frequency of trades and quotes for the security; (ii)
the number of dealers willing to purchase or sell the security and the number of
other potential purchasers; (iii) dealer undertakings to make a market in the
security; and (iv) the nature of the security and the nature of the marketplace
trades (e.g., the time needed to dispose of the security, the method of
soliciting offers, and the mechanics of transfer). To the extent a fund invests
in restricted securities that are deemed liquid, the general level of
illiquidity in the fund may be increased if qualified institutional buyers
become uninterested in purchasing these securities or the market for these
securities contracts.
LOAN PARTICIPATIONS Certain funds may invest in loan participations and other
related direct or indirect bank obligations. These instruments are interests in
floating or variable rate senior loans to U.S. corporations, partnerships and
other entities. Generally, these instruments are sold without a guarantee by the
lending institution, and are subject to the credit risks of both the borrower
and the lending institution. While loan participations generally trade at par
value, a fund will also be able to acquire loan participations that sell at a
discount because of the borrower's credit problems. To the extent the borrower's
credit problems are resolved, such loan participations may appreciate in value.
The manager may acquire loan participations for a fund when it believes that
over the long term appreciation will occur. Most loan participations in which
the funds intend to invest are illiquid and, to that extent, will be included in
a fund's limitation on illiquid investments described under "Illiquid
securities." An investment in these securities carries substantially the same
risks as those for defaulted debt securities. Interest payments on these
securities may be reduced, deferred, suspended or eliminated and principal
payments may likewise be reduced, deferred, suspended or canceled, causing the
loss of the entire amount of the investment.
LOANS OF PORTFOLIO SECURITIES To generate additional income, each fund may lend
certain of its portfolio securities to qualified banks and broker-dealers. For
each loan, the borrower must maintain with the fund's custodian
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collateral (consisting of any combination of cash, securities issued by the U.S.
government and its agencies and instrumentalities, or irrevocable letters of
credit) with a value at least equal to 102% of the current market value of the
loaned securities. The fund retains all or a portion of the interest received on
investment of the cash collateral or receives a fee from the borrower. The fund
also continues to receive any distributions paid on the loaned secu rities. The
fund may terminate a loan at any time and obtain the return of the securities
loaned within the normal settlement period for the security involved.
Where voting rights with respect to the loaned securities pass with the lending
of the securities, the managers intend to call the loaned securities to vote
proxies, or to use other practicable and legally enforceable means to obtain
voting rights, when the managers have knowledge that, in their opinion, a
material event affecting the loaned securities will occur or the managers
otherwise believe it necessary to vote. As with other extensions of credit,
there are risks of delay in recovery or even loss of rights in collateral in the
event of default or insolvency of the borrower. Each fund will loan its
securities only to parties who meet creditworthiness standards approved by the
fund's board of trustees, i.e., banks or broker-dealers that the manager has
determined present no serious risk of becoming involved in bankruptcy
proceedings within the time frame contemplated by the loan.
MORTGAGE DOLLAR ROLLS Certain funds may enter into mortgage "dollar rolls" in
which a fund 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 period
between the sale and repurchase (the "roll period"), the fund forgoes principal
and interest paid on the mortgage-backed securities. The fund 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 mortgage 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 fund will not enter into any dollar rolls that are not
covered rolls. The fund could suffer a loss if the contracting party fails to
perform the future transaction, with the result that the fund may not be able to
buy back the mortgage-backed securities it initially sold. The funds intend to
enter into mortgage dollar rolls only with government securities dealers
recognized by the Federal Reserve Board or with member banks of the Federal
Reserve System.
PORTFOLIO TURNOVER Because the investment outlook of the type of securities in
which each fund may purchase may change as a result of unexpected developments
in national or international securities markets, or in economic, monetary or
political relationships, a manager will consider the economic effects 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 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 funds 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 funds 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 funds may have higher turnover rates because of maturing debt
securities, rebalancing of the portfolio to keep interest rate risk and 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 appro priate
investment for a fund, 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 fund are disclosed in the section entitled
"Financial Highlights" of the fund's prospectus. 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
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its portfolio securities during the year. Except for certain funds noted in the
prospectus, the funds 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 INVESTMENT TRUSTS ("REITS") typically invest directly in real estate
and/or in mortgages and loans collateralized by real estate. Certain funds may
invest in "Equity" or "Mortgage" REITs." Equity" REITs are real estate companies
that own and manage income-producing properties such as apartments, hotels,
shopping centers or office buildings. The income, primarily rent from these
properties, is generally passed on to investors in the form of dividends. These
companies provide experienced property management and generally concentrate on a
specific geographic region or property type. "Mortgage" REITs make loans to
commercial real estate developers and earn income from interest payments.
REPURCHASE AGREEMENTS The funds generally will have a portion of their assets in
cash or cash equivalents for a variety of reasons, including waiting for a
special investment opportunity or taking a defensive position. To earn income on
this portion of its assets, a fund may enter into repurchase agreements. Under a
repurchase agreement, the fund agrees to buy securities guaranteed as to payment
of principal and interest by the U.S. government or its agencies from a
qualified bank or broker-dealer and then to sell the securities back to the bank
or broker-dealer after a short period of time (generally, less than seven days)
at a higher price. The bank or broker-dealer must transfer to the fund's
custodian securities with an initial market value of at least 102% of the dollar
amount invested by the fund in each repurchase agreement. The manager will
monitor the value of such securities daily to determine that the value equals or
exceeds the repurchase price.
Repurchase agreements may involve risks in the event of default or insolvency of
the bank or broker-dealer, including possible delays or restrictions upon the
fund's ability to sell the underlying securities. A fund will enter into
repurchase agreements only with parties who meet certain creditworthiness
standards, i.e., banks or broker-dealers that the manager has determined present
no serious risk of becoming involved in bankruptcy proceedings within the time
frame contemplated by the repurchase transaction.
REVERSE REPURCHASE AGREEMENTS. Certain funds may also enter into reverse
repurchase agreements, which are the opposite of repurchase agreements but
involve similar mechanics and risks. A fund sells securities to a bank or dealer
and agrees to repurchase them at a mutually agreed price and date. Cash or
liquid high-grade debt securities having an initial market value, including
accrued interest, equal to at least 102% of the dollar amount sold by the fund
are segregated, i.e., set aside, as collateral and marked-to-market daily to
maintain coverage of at least 100%. Reverse repurchase agreements involve the
risk that the market value of the securities retained by a fund may decline
below the price of the securities the fund has sold but is obligated to
repurchase under the agreement. A default by the purchaser might cause the fund
to experience a loss or delay in the liquidation costs. The funds intend to
enter into reverse repurchase agreements with domestic or foreign banks or
securities dealers. The manager will evaluate the creditworthiness of these
entities prior to engaging in such transactions and it will conduct these
activities under the general supervision of the Board.
SHORT SALES Certain funds may make short sales of securities. In a short sale a
fund does not immediately deliver the securities sold and does not immediately
receive the proceeds from the sale. To fulfill its obligation to deliver the
securities sold short, the fund must borrow the security sold short and deliver
it to the broker through which it made the sale. A fund's obligation to replace
the borrowed security will be secured by collateral, usually cash, U.S.
Government securities or other marketable securities. A fund may make a short
sale when the manager believes the price of the stock may decline and when, for
tax or other reasons, the manager does not currently want to sell the stock or
convertible security it owns. In this case, any decline in the value of a fund's
portfolio securities would be reduced by a gain in the short sale transaction.
Conversely, any increase in the value of a fund's portfolio securities would be
reduced by a loss in the short sale transaction.
Certain funds may also make short sales "against the box" without limitation. In
this type of short sale, a fund owns an equal amount of the securities subject
to the short sale or owns securities that are convertible or exchangeable,
without payment of further consideration, into an equal amount of such security.
SMALLER COMPANIES Certain funds may invest in the securities of companies with a
market capitalization of $1.5 billion or less. Smaller companies are often
overlooked by investors or undervalued in relation to their earnings power.
Because smaller companies generally are not as well known to the investing
public and have less of an investor following than larger companies, they may
provide greater opportunities for long-term capital growth as a result of
relative inefficiencies in the marketplace. These 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 earnings growth and be
financially sound.
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TEMPORARY INVESTMENTS When the manager believes that the securities trading
markets or the economy are experiencing excessive volatility, that is, sharp
price movements over relatively short time periods, or a prolonged general
decline, or other adverse conditions exist, it may invest the funds' portfolios
in a temporary defensive manner. Under such circumstances, the funds (other than
the Money Market Fund) may invest up to 100% of their assets in high quality
money market instruments. These include government securities, bank obligations,
the highest quality commercial paper and repurchase agreements.
In addition, certain funds may also invest in short-term (less than twelve
months to maturity) fixed-income securities, non-U.S. currency, short-term
instruments denominated in non-U.S. currencies, or 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.
Partly because the managers act independently of each other, the cash positions
of the funds may vary significantly. When a fund's investments in cash or cash
equivalents increase, it may not participate in market advances or declines to
the same extent as it would if the fund were fully invested in stocks or bonds.
Any decision to make a substantial withdrawal for a sustained period of time
from a fund's investment goals will be reviewed by the Board.
TRADE CLAIMS Certain funds may invest a portion of their assets in trade claims.
Trade claims are purchased from creditors of companies in financial difficulty.
For buyers, such as a fund, 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.
U.S. TREASURY ROLLS Certain funds may enter into "U.S. Treasury rolls" in which
the fund 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. Two
potential advantages of this strategy are (1) the fund can regularly and
incrementally adjust its weighted average maturity of its portfolio securities
(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.
During the period before the settlement date, the fund continues to earn
interest on the securities it is selling. It does not earn interest on the
securities that it is purchasing until after the settlement date. The fund could
suffer an opportunity loss if the counterparty to the roll failed to perform its
obligations on the settlement date, and if market conditions changed adversely.
The fund intends, however, 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.
WHEN-ISSUED, DELAYED DELIVERY AND TO-BE-ANNOUNCED ("TBA") TRANSACTIONS Certain
funds may purchase securities on a "when-issued," "delayed delivery" or "TBA"
basis. These transactions are arrangements under which a fund may purchase
securities with payment and delivery scheduled for a future time, generally
within 30 to 60 days. These transactions are subject to market fluctuation and
are subject to the risk that the value or yields at delivery may be more or less
than the purchase price or yields available when the transaction was entered
into. Although the funds will generally purchase these securities on a
when-issued or TBA basis with the intention of acquiring such securities, they
may sell such securities before the settlement date if it is deemed advisable.
When a fund is the buyer in such a transaction, it will maintain, in a
segregated account with its custodian bank, cash or market able securities
having an aggregate value equal to the amount of such purchase commitments until
payment is made. The creation and maintenance of these accounts have the effect
of limiting the extent to which a fund may engage in these transactions. To the
extent a fund engages in when-issued, delayed delivery or TBA transactions, it
will do so only for the purpose of acquiring portfolio securities consistent
with the fund's investment objectives and policies, and not for the purpose of
investment leverage. In when-issued, delayed delivery and TBA transactions, a
fund relies on the seller to complete the transaction. The other party's failure
to do so may cause a fund to miss a price or yield considered advantageous.
Securities purchased on a when-issued, delayed delivery or TBA basis do not
generally earn interest until their scheduled delivery date. The funds are not
subject to any percentage limit on the amount of their assets that may be
invested in when-issued, delayed delivery or TBA purchase obligations.
RISKS
- --------------------------------------------------------------------------------
The value of your shares will increase as the value of the securities owned by a
fund increases and will decrease as the value of the fund's investments
decrease. In this way, you participate in any change in the value of the
securities
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owned by the fund. In addition to the factors that affect the value of any
particular security that the fund owns, the value of fund shares may also change
with movements in the stock and bond markets as a whole.
CONVERTIBLE SECURITIES have risk characteristics of both equity and debt
securities. Its value may rise and fall with the market value of the underlying
stock or, like a debt security, vary with changes in interest rates and the
credit quality of the issuer. A convertible security tends to perform more like
a stock when the underlying stock price is high (because it is assumed it will
be converted) and more like a debt security when the underlying stock price is
low (because it is assumed it will not be converted). Because its value can be
influenced by many different factors, a convertible security is not as sensitive
to interest rate changes as a similar non-convertible debt security, and
generally has less potential for gain or loss than the underlying stock.
A fund 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 fund's ability to
dispose of particular securities, when necessary, to meet a fund'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 fund to obtain market
quotations based on actual trades for purposes of valuing a fund's portfolio.
The funds, however, intend to acquire liquid securities, though there can be no
assurances that this will be achieved.
DEBT SECURITIES
ASSET-BACKED SECURITIES have risks similar to mortgage-backed securities.
However, these 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, i.e., a
lien on the item purchased by the consumer, 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.
GINNIE MAE 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
Ginnie Mae will generally decline. In a period of declining interest rates, it
is more likely that mortgages contained in Ginnie Mae 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
Ginnie Maes as compared to the increases experienced by noncallable debt
securities over the same periods. In addition, any premium paid on the purchase
of a Ginnie Mae will be lost if the obligation is prepaid. Of course, price
changes of Ginnie Maes and other securities held by the funds will have a direct
impact on the net asset value per share of the funds.
INTEREST RATE To the extent a fund invests in debt securities, changes in
interest rates in any country where the fund is invested will affect the value
of the fund's portfolio and its share price. Rising interest rates, which often
occur during times of inflation or a growing economy, are likely to have a
negative effect on the value of the fund's shares. Of course, interest rates
throughout the world have increased and decreased, sometimes very dramatically,
in the past. These changes are likely to occur again in the future at
unpredictable times.
LOWER-RATED SECURITIES Certain funds may invest in non-investment grade
securities, including such securities issued by foreign companies and
governments. Because these funds may invest in securities below investment
grade, an investment in any of these funds is subject to a higher degree of risk
than an investment in a fund that invests primarily in higher-quality
securities. You should consider the increased risk of loss to principal that is
present with an investment in higher risk securities, such as those in which
certain funds invest. Accordingly, an investment in any fund should not be
considered a complete investment program and should be carefully evaluated for
its appropriateness in light of your overall investment needs and goals.
The market value of high yield, lower-quality fixed-income securities, commonly
known as junk bonds, tends to reflect individual developments affecting the
issuer to a greater degree than the market value of higher-quality securities,
which react primarily to fluctuations in the general level of interest rates.
Lower-quality securities also tend to be more sensitive to economic conditions
than higher-quality securities.
Adverse publicity and investor perceptions, whether or not based on fundamental
analysis, may decrease the values and liquidity of lower-rated debt securities,
especially in a thinly traded market. Analysis of the creditworthiness of
issuers of lower-rated debt securities may be more complex than for issuers of
higher rated securities, and the ability of a fund to achieve its investment
goal may, to the extent of investment in lower-rated debt securities, be more
dependent upon such credit worthiness analysis than would be the case if the
fund were investing in higher rated securities.
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Issuers of high yield, fixed-income securities are often highly leveraged and
may not have more traditional methods of financing available to them. Therefore,
the risk associated with buying the securities of these issuers is generally
greater than the risk associated with higher-quality securities. For example,
during an economic downturn or a sustained period of rising interest rates,
issuers of lower-quality securities may experience financial stress and may not
have sufficient cash flow to make interest payments. The issuer's ability to
make timely interest and principal payments may also be adversely affected by
specific developments affecting the issuer, including the issuer's inability to
meet specific projected business forecasts or the unavailability of additional
financing.
The risk of loss due to default may also be considerably greater with
lower-quality securities because they are generally unsecured and are often
subordinated to other creditors of the issuer. If the issuer of a security in a
fund's portfolio defaults, the fund may have unrealized losses on the security,
which may lower the fund's net asset value. Defaulted securities tend to lose
much of their value before they default. Thus, a fund's net asset value may be
adversely affected before an issuer defaults. In addition, a fund may incur
additional expenses if it must try to recover principal or interest payments on
a defaulted security.
High yield, fixed-income securities frequently have call or buy-back features
that allow an issuer to redeem the securities from a fund. Although these
securities are typically not callable for a period of time, usually for three to
five years from the date of issue, if an issuer calls its securities during
periods of declining interest rates, the manager may find it necessary to
replace the securities with lower-yielding securities, which could result in
less net investment income for a fund. The premature disposition of a high yield
security due to a call or buy-back feature, the deterioration of an issuer's
creditworthiness, or a default by an issuer may make it more difficult for a
fund to manage the timing of its income. To generate cash for distributions, a
fund may have to sell portfolio securities that it otherwise may have continued
to hold or use cash flows from other sources, such as the sale of fund shares.
Lower-quality, fixed-income securities may not be as liquid as higher-quality
securities. Reduced liquidity in the secondary market may have an adverse impact
on market price of a security and on a fund's ability to sell a security in
response to a specific economic event, such as a deterioration in the
creditworthiness of the issuer, or if necessary to meet the fund's liquidity
needs. Reduced liquidity may also make it more difficult to obtain market
quotations based on actual trades for purposes of valuing a fund's portfolio.
Certain funds may buy high yield, fixed-income securities that are sold without
registration under the federal securities laws and therefore carry restrictions
on resale. While many high yielding securities have been sold with registration
rights, covenants and penalty provisions for delayed registration, if a fund is
required to sell restricted securities before the securities have been
registered, it may be deemed an underwriter of the securities under the
Securities Act of 1933, which entails special responsibilities and liabilities.
A fund may also incur special costs in disposing of restricted securities,
although the fund will generally not incur any costs when the issuer is
responsible for registering the securities.
Certain funds may buy high yield, fixed-income securities during an initial
underwriting. These securities involve special risks because they are new
issues. The manager will carefully review their credit and other
characteristics. The funds have no arrangement with its underwriter or any other
person concerning the acquisition of these securities.
The high yield securities market is relatively new and much of its growth before
1990 paralleled a long economic expansion. The recession that began in 1990
disrupted the market for high yield securities and adversely affected the value
of outstanding securities, as well as the ability of issuers of high yield
securities to make timely principal and interest payments. Although the economy
has improved and high yield securities have performed more consistently since
that time, the adverse effects previously experienced may reoccur. For example,
the highly publicized defaults on some high yield securities during 1989 and
1990 and concerns about a sluggish economy that continued into 1993 depressed
the prices of many of these securities. While market prices may be temporarily
depressed due to factors such as these, the ultimate price of any security
generally reflects the true operating results of the issuer. Factors adversely
impacting the market value of high yield securities may lower a fund's net asset
value. A fund relies on the manager's judgment, analysis and experience in
evaluating the creditworthiness of an issuer. In this evaluation, the manager
takes 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.
The credit risk factors above also apply to lower-quality zero coupon, deferred
interest and pay-in-kind securities. These securities have an additional risk,
however, because unlike securities that pay interest throughout the time until
maturity, a fund will not receive any cash until the cash payment date. If the
issuer defaults, a fund may not obtain any return on its investment.
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Zero coupon or deferred interest securities are debt obligations that make no
periodic interest payments before maturity or a specified date when the
securities begin paying current interest (the "cash payment date"), and
therefore are generally issued and traded at a discount from their face amount
or par value. The discount varies depending on the time remaining until maturity
or the cash payment date, as well as prevailing interest rates, liquidity of the
security, and the perceived credit quality of the issuer. The discount, in the
absence of financial difficulties of the issuer, typically decreases as the
final maturity or cash payment date approaches.
The value of zero coupon securities is generally more volatile than the value of
other fixed-income securities that pay interest periodically. Zero-coupon
securities are also likely to respond to changes in interest rates to a greater
degree than other fixed-income securities having similar maturities and credit
quality.
Certain of the high yielding, fixed-income securities in which the funds may
invest may be purchased at a discount. When held to maturity or retired, these
securities may include an element of capital gain. Capital losses may be
realized when securities purchased at a premium, that is, in excess of their
stated or par value, 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 securities.
The tables below show the percentage of the Global Income, Asset Allocation,
High Income and Income Securities Funds' assets invested in securities rated by
S&P or Moody's in the rating categories shown. A credit rating by a rating
agency evaluates the safety of principal and interest based on an evaluation of
the security's credit quality, but does not consider the market risk or the risk
of fluctuation in the price of the security. The information shown is based on a
dollar-weighted average of each fund's portfolio composition based on month-end
assets for each of the 12 months in the fiscal year ended December 31, 1998.
INCOME
SECURITIES
MOODY'S RATINGS FUND (%)
- --------------------------------------------
Aaa 11.1
Aa .0
A .1
Baa 3.8
Ba 8.9
B 20.4
Caa 1 4.9
Ca .0
C .0
1. 2.63%of these securities, which are unrated by Moody's, have been included in
the Caa rating category.
GLOBAL GLOBAL ASSET
INCOME ALLOCATION HIGH INCOME
S&P RATINGS FUND (1)(%) FUND (2)(%) FUND (3)(%)
- -------------------------------------------------------------
AAA 79.9 29.5 .0
AA .0 .0 .0
A .0 .0 .0
BBB .0 .0 2.4
BB 14.7 5.6 15.9
B 5.5 4.6 72.7
CCC .0 .0 7.7
CC .0 .0 .9
C .0 .0 .4
1. .9% of these securities, which are unrated by S&P, have been included in the
BB category.
2. 1.0% of these securities, which are unrated by S&P have been included in the
B category.
3. 5.2% of the securities are unrated by S&P. Of this amount, .3% has been
included in BBB, .9% in BB and 4.0% in B.
DEFAULTED DEBT. Certain funds may buy debt securities of issuers that are not
currently paying interest, as well as issuers who are in default, and may keep
an issue that has defaulted. A fund will buy defaulted debt securities if, in
the opinion of the manager, they may present an opportunity for later price
recovery, the issuer may resume interest payments, or other advantageous
developments appear likely in the near future. In general, securities that
default lose much of their value before the actual default so that the security,
and thus the fund's net asset value, would be impacted before the default.
Defaulted debt securities may be illiquid and, as such, will be part of the
percentage limits discussed under "Investment Restrictions."
MORTGAGE-BACKED SECURITIES differ from conventional bonds in that the principal
is paid back over the life of the certificate rather than at maturity. As a
result, funds invested in these securities will receive monthly scheduled
payments of principal and interest on its investment in these securities, and
may receive unscheduled principal payments representing prepayments on the
underlying mortgages. When a fund reinvests the payments and any unscheduled
prepayments of principal it receives, it may receive a rate of interest that is
lower than the rate on the existing security. For this reason, mortgage-backed
securities may be less effective than other types of U.S. Government securities
as a means of "locking in" long-term interest rates.
The market value of mortgage-backed securities, like other U.S. Government
securities in the funds, will generally vary inversely with changes in market
interest rates, declining when interest rates rise and rising when interest
rates decline. However, mortgage-backed securities, while having comparable risk
of decline in value during periods of rising rates, may have less potential for
capital appreciation than other investments of comparable maturities due to the
likelihood of increased prepayments of mortgages as interest rates decline. To
the extent these securities are purchased at a premium, mortgage foreclosures
and unscheduled principal prepayments may result in
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some loss of a fund's principal investment to the extent of the premium paid.
SBA 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.
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, that is, the
securities may not be sold as readily as other securities, 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, i.e., a change or a reversal in the
direction of the market. The Board of Trustees will monitor the liquidity of
structured notes. Notes determined to be illiquid will be subject to a fund's
percentage limits on illiquid securities.
DERIVATIVE SECURITIES
FORWARD CONTRACTS, CURRENCY FUTURES CONTRACTS AND OPTIONS ON FOREIGN CURRENCIES
Successful use of forward contracts, currency futures contracts and options on
foreign currencies depends on the manager's ability to properly predict
movements in the foreign currency markets. There may be an imperfect correlation
between movements in the foreign currency on which a forward contract, currency
futures contract, or option on a foreign currency is based and movements in the
foreign currency.
Forward contracts are not traded on contract markets regulated by the CFTC or by
the SEC. The ability of a fund to use forward contracts could be restricted to
the extent that Congress authorizes the CFTC or the SEC to regulate such
transactions. Forward contracts are traded through financial institutions acting
as market makers. Also, a hedging strategy may not be successful if the fund is
unable to sell its forward contract, currency futures contract, or option on a
foreign currency with the market maker from which it bought the security.
If a fund retains a portfolio security and enters into a closing transaction,
the fund will have a gain or a loss to the extent that the forward contract
prices have increased or decreased. If a fund enters into a closing transaction,
it may subsequently enter into a new forward contract to sell the foreign
currency. If forward prices decline between the date that a fund enters into a
forward contract for the sale of a foreign currency and the date it enters into
an offsetting contract for the purchase of the foreign currency, the fund will
realize a gain. If forward prices increase, a fund will suffer a loss.
The purchase and sale of exchange-traded foreign currency options are subject to
the risks of the availability of a liquid secondary market, as well as the risks
of adverse market movements, possible intervention by governmental authorities,
and the effects of other political and economic events.
Futures contracts on currencies and options on foreign currencies may be traded
on foreign exchanges. These transactions are subject to the risk of governmental
actions affecting trading in or the prices of foreign currencies. The value of
such positions could also be adversely affected by (i) other foreign political
and economic factors, (ii) less available data than in the U.S. on which to base
trading decisions, (iii) delays in a fund's ability to act upon economic events
occurring in foreign markets during non-business hours in the U.S., (iv) the
imposition of exercise and settlement terms and procedures, and margin
requirements different from those in the U.S., and (v) lesser trading volume.
FUTURES CONTRACTS A purchase or sale of a futures contract may result in losses
in excess of the amount invested. A fund may not be able to properly hedge its
securities where a liquid secondary market is unavailable for the futures
contract the fund wishes to close. 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
held by the fund. Although the manager believes that the use of futures
contracts will benefit certain funds, if the manager's investment judgment about
the general direction of interest or currency ex change rates is incorrect, a
fund's overall performance would be poorer than if it had not entered into any
such contract. For example, if a fund has hedged against the possibility of an
increase in interest rates that would adversely affect the price of bonds held
in its portfolio and interest rates decrease instead, the fund will lose part or
all of the benefit of the increased value of the bonds which it has hedged
because it will have offsetting losses in its futures positions. Similarly, if a
fund sells a foreign currency futures contract and the U.S. dollar value of the
currency unexpectedly increases, the fund will lose the
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beneficial effect of the increase on the value of the security denominated in
that currency. In addition, in such situations, if a fund has insufficient cash,
it may have to sell bonds from its portfolio to meet daily variation margin
requirements. Sales of bonds may be, but are not necessarily, at increased
prices that reflect the rising market. A fund may have to sell securities at a
time when it may be disadvantageous to do so.
The ordinary spreads between prices in the cash and futures markets, due to
differences in the nature of those markets, are subject to distortions. First,
all participants in the futures market are subject to initial deposit and
variation margin requirements. Rather than meeting additional variation margin
requirements, investors may close futures contracts through offsetting
transactions that could distort the normal relationship between the cash 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 producing distortion. Third, from
the point of view of speculators, the margin deposit requirements in the futures
market are less onerous than margin requirements in the securities market.
Therefore, increased participation by speculators in the futures market may
cause temporary price distortions. Due to the possibility of distortion, a
correct forecast of general interest rate trends by the manager may still not
result in a successful transaction.
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The daily limit establishes
the maximum amount that the price of a futures contract may vary either up or
down from the previous day's settlement price. Once the daily limit has been
reached in a futures contract subject to the limit, no more trades may be made
on that day at a price beyond that limit. The daily limit governs only price
movements during a particular trading day and, therefore, does not limit
potential losses because the limit may work to prevent the liquidation of
unfavorable positions. For example, futures prices have occasionally moved to
the daily limit for several consecutive trading days with little or no trading,
thereby preventing prompt liquidation of positions and subjecting some holders
of futures contracts to substantial losses.
The funds which are authorized to engage in futures transactions intend to
purchase or sell futures only on exchanges or boards of trade where there
appears to be an active secondary market, but there is no assurance that a
liquid secondary market will exist for any particular contract or at any
particular time. In addition, many of the futures contracts available may be
relatively new instruments without a significant trading history. As a result,
there can be no assurance that an active secondary market will develop or
continue to exist. A fund may not be able to achieve a perfect correlation
between its futures positions and portfolio positions in corporate fixed-income
securities because futures contracts based on these securities are not currently
available.
Futures contracts that are purchased on foreign exchanges may not be as liquid
as those purchased on CTFC-designated contract markets. In addition, foreign
futures contracts may be subject to varied regulatory oversight.
INTEREST RATE AND CURRENCY SWAPS A fund will only enter into interest rate swaps
on a net basis, which means that the fund will receive or pay, 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, a
fund's risk of loss with respect to interest rate swaps is limited to the net
amount of interest payments that the fund must make. If the other party to an
interest rate swap defaults, a fund's risk of loss consists of the net amount of
interest payments that the fund is 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, a fund could lose the entire principal value of a currency swap if
the other party defaults.
The use of interest rate and currency swaps is a highly specialized activity
that 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 a fund would be less favorable than it would have
been if this investment technique were not used. OPTIONS ON FUTURES CONTRACTS
The amount of risk a fund assumes when it purchases an option on a futures
contract is the premium paid for the option plus related transaction costs. In
writing options on futures, a fund's loss is potentially unlimited and may
exceed the amount of the premium received. Also, a fund may not be able to
properly hedge its securities where a liquid secondary market is unavailable for
the option the fund wishes to close. 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 fund will purchase a put option on a futures
contract only to hedge the fund's portfolio against the risk of rising interest
rates or the decline in the value of securities denominated in a foreign
currency.
OPTIONS ON SECURITIES The fund's options investments involve certain risks. The
effectiveness of an options
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strategy depends on the degree to which price movements in the underlying
securities correlate with price movements in the relevant portion of the fund's
portfolio. In addition, the fund bears the risk that the prices of its portfolio
securities will not move in the same amount as the option it has purchased, or
that there may be a negative correlation that would result in a loss on both the
securities and the option. If the manager is not successful in using options in
managing a fund's investments, the fund's performance will be worse than if the
manager did not employ such strategies.
When trading options on foreign exchanges or in the over-the-counter market,
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 purchaser of an option can lose the amount of the premium plus related
transaction costs. Moreover, a fund as an option writer could lose amounts
substantially in excess of its initial investment, due to the margin and
collateral requirements associated with option writing.
Options on securities traded on national securities ex changes 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 fund to liquidate open
positions at a profit prior to exercise or expiration, or to limit losses in the
event of adverse market movements.
Although a fund 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 and a fund may have difficulty effecting closing transactions in
particular options. Therefore, the fund would have to exercise its options in
order to realize any profit and would incur transaction costs upon the sale of
underlying securities where a buyer exercises put or call options. If a fund 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 security until
the option expires or it delivers the underlying security 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 STOCK INDICES A fund's ability to hedge effectively all or a portion
of its securities through transactions in options on stock indexes depends on
the degree to which price movements in the underlying index or underlying
securities correlate with price movements in the relevant portion of the fund's
portfolio. Inasmuch as these securities will not duplicate the components of any
index, the correlation will not be perfect. Consequently, a fund bears the risk
that the prices of the securities being hedged will not move in the same amount
as the hedging instrument. It is also possible that there may be a negative
correlation between the index and the hedged securities that would result in a
loss on both the securities and the hedging instrument. Accordingly, successful
use by a fund of options on stock indexes, will be subject to the manager's
ability to predict correctly movements in the direction of the securities
markets generally or of a particular segment. This requires different skills and
techniques than predicting changes in the price of individual stocks.
Positions in stock index options may be closed out only on an exchange that
provides a secondary market. There can be no assurance that a liquid secondary
market will exist for any particular stock index option at any specific time.
Thus, it may not be possible to close an option position. The inability to close
options positions could have an adverse impact on the fund's ability to
effectively hedge its securities.
FOREIGN SECURITIES Certain funds have an unlimited ability to purchase
securities in any foreign country, developed or developing, if they are listed
on a stock exchange, as well as a limited ability to purchase such securities if
they are unlisted. While foreign securities may offer significant opportunities
for gain, they also involve additional risks that can increase the potential for
losses in the fund. These risks can be significantly greater for investments in
emerging markets. Investments in Depositary Receipts also involve some or all of
the risks described below.
There may be less publicly available information about foreign companies
compared to the reports and ratings published about companies in the U.S.
Foreign companies are not generally subject to uniform accounting or financial
reporting standards, and auditing practices and requirements may not be
comparable to those applicable to U.S. companies. A fund, therefore, may
encounter difficulty in obtaining market quotations for purposes of valuing its
portfolio and calculating its net asset value.
Certain countries' financial markets and services are less developed than those
in the U.S. or other major economies.
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In many foreign countries there is less government supervision and regulation of
stock exchanges, brokers, custodians and listed companies than in the U.S. There
is an increased risk, therefore, of uninsured loss due to lost, stolen, or
counterfeit stock certificates. Foreign markets have substantially less volume
than the New York Stock Exchange and securities of some foreign companies are
less liquid and more volatile than securities of comparable U.S. companies.
Commission rates in foreign countries, which are generally fixed rather than
subject to negotiation as in the U.S., are likely to be higher. Custodial
services, and other costs relating to investment in foreign markets, including
developing markets, are generally higher than in the U.S. Settlement practices
may be cumbersome and result in delays that may affect portfolio liquidity, that
is, it may affect a fund's ability to sell its securities. The funds may have
greater difficulty voting proxies, exercising shareholder rights, pursuing legal
remedies, and obtaining judgments with respect to foreign investments in foreign
courts than with respect to domestic issuers in U.S. courts.
A fund's investments in foreign securities may increase the risks with respect
to the liquidity of the fund's portfolio. This could inhibit the fund's ability
to meet a large number of shareholder redemption requests in the event of
economic or political turmoil in a country in which the fund has a substantial
portion of its assets invested or deterioration in relations between the U.S.
and the foreign country.
Many debt securities of foreign issuers, and especially emerging market issuers,
are not rated by U.S. rating agencies and their selection depends on the
manager's internal analysis.
EMERGING MARKETS. Investments in companies domiciled in emerging countries may
be subject to potentially higher risks, making these investments more volatile,
than investments in developed countries. These risks include (i) less social,
political and economic stability; (ii) the risk that the small size of the
markets for such securities and the low or nonexistent volume of trading may
result in a lack of liquidity and in greater price volatility; (iii) the
existence of certain national policies which may restrict each fund's investment
opportunities, including restrictions on investment in issuers or industries
deemed sensitive to national interests; (iv) foreign taxation; (v) the absence
of developed legal structures governing private or foreign investment or
allowing for judicial redress for injury to private property; (vi) the absence,
until recently in many devel oping countries, of a capital market structure or
market-oriented economy; and (vii) the possibility that recent favorable
economic developments in some emerging countries may be slowed or reversed by
unanticipated political or social events in such countries.
In addition, many countries in which the funds may invest have experienced
substantial, and in some periods extremely high, rates of inflation for many
years. Inflation and rapid fluctuations in inflation rates have had and may
continue to have negative effects on the economies and securities markets of
certain countries. Moreover, the economies of some emerging countries may differ
favorably or unfavorably from the U.S. economy in such respects as growth of
gross domestic product, rate of inflation, currency depreciation, capital
reinvestment, resource self-sufficiency and balance of payments position.
Investments in emerging countries may involve risks of nationalization,
expropriation and confiscatory taxation. For example, 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 expropriation, each fund could lose a substantial portion of any
investments it has made in the affected countries. Further, no accounting
standards exist in certain emerging countries. Finally, even though the
currencies of some emerging countries, such as certain Eastern European
countries may be convertible into U.S. dollars, the conversion rates may be
artificial to the actual market values and may be adverse to a funds'
shareholders.
Repatriation, that is, the return to an investor's homeland, of investment
income, capital and proceeds of sales by foreign investors may require
governmental registration or approval in some developing countries. Delays in or
a refusal to grant any required governmental registration or approval for such
repatriation could adversely affect the funds. Further, the economies of
emerging 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.
RUSSIAN SECURITIES. Investing in Russian companies involves a high degree of
risk and special considerations not typically associated with investing in the
U.S. securities markets, and should be considered highly speculative. Such risks
include, together with Russia's continuing political and economic instability
and the slow-paced development of its market economy, the following:
(a) delays in settling portfolio transactions and the risk of loss arising out
of Russia's 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;
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(c) the pervasiveness of corruption, insider-trading, and crime in the Russian
economic system;
(d) currency exchange rate volatility and the lack of available currency hedging
instruments such as the techniques discussed under "Currency techniques and
hedging" in this SAI;
(e) higher rates of inflation (including the risk of social unrest associated
with periods of hyper-inflation);
(f) controls on foreign investment and local practices disfavoring foreign
investors, and limitations on repatriation of invested capital, profits and
dividends;
(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, a return to
the centrally planned economy that existed prior to the dissolution of the
Soviet Union, or the nationalization of privatized enterprises;
(h) the risks of investing in securities with substantially less liquidity and
in issuers having significantly smaller market capitalizations, when
compared to securities and issuers in more developed markets;
(i) the difficulties associated in obtaining accurate market valuations of many
Russian securities, based partly on the limited amount of publicly available
information;
(j) the financial condition of Russian companies, including large amounts of
inter-company debt which may create a payments crisis on a national scale;
(k) dependency on exports and the corresponding importance of international
trade;
(l) the risk that the Russian tax system will not be reformed to prevent
inconsistent, retroactive and/or exorbitant taxation or, in the alternative,
the risk that a reformed tax system may result in the inconsistent and
unpredictable enforcement of the new tax laws;
(m) possible difficulty in identifying a purchaser of secu rities held by the
funds due to the underdeveloped nature of the securities markets;
(n) the possibility that pending legislation could restrict the levels of
foreign investment in certain industries, thereby limiting the number of
investment opportunities in Russia;
(o) the risk that pending legislation would confer to Russian courts the
exclusive jurisdiction to resolve disputes between foreign investors and the
Russian government, instead of bringing such disputes before an
internationally-accepted third-country arbitrator; and
(p) the difficulty in obtaining information about the financial condition of
Russian issuers, in light of the different disclosure and accounting
standards applicable to Russian companies.
There is little long-term historical data on Russian securities markets because
they are relatively new and a substantial proportion of securities transactions
in Russia is 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 nor are they licensed with any
governmental entity and it is possible for the funds to lose their registration
through fraud, negligence or even mere oversight. While each fund will endeavor
to ensure that its interest continues to be appropriately recorded by 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 funds of their ownership
rights or improperly dilute their interests. In addition, while applicable
Russian regulations impose liability on registrars for losses resulting from
their errors, it may be difficult for the funds to enforce any rights they 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 500 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. In addition, so-called "financial-industrial groups" have emerged in
recent years that seek to deter outside investors from interfering in the
management of companies they control. These practices may prevent the funds 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 fund
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if a potential purchaser is deemed unsuitable, which may expose the fund to
potential loss on the investment.
CURRENCY Many of the investments in certain funds are denominated in foreign
currencies. Changes in foreign currency exchange rates will affect the value of
what certain funds own, and those funds' share price. In addition, changes in
foreign currency exchange rates will affect a fund's income and distributions to
shareholders. To the extent that the manager intends to hedge currency risk in
certain funds, the funds endeavor to buy and sell foreign currencies on as
favorable a basis as practicable. Some price spread in currency exchange (to
cover service charges) may be incurred, particularly when a fund changes
investments from one country to another or when proceeds of the sale of shares
in U.S. dollars are used for the purchase of securities in foreign countries.
Some countries may adopt policies that would prevent the funds from transferring
cash out of the country or withhold portions of interest and dividends at the
source.
The funds may be affected either unfavorably or favorably by fluctuations in the
relative rates of exchange between the currencies of different nations, by
exchange control regulations, and by indigenous economic and political
developments. Some countries in which the funds may invest may also have fixed
or managed currencies that are not free-floating against the U.S. dollar.
Certain currencies may not be internationally traded.
Certain currencies have experienced a steady devaluation relative to the U.S.
dollar. Any devaluations in the currencies in which a fund's portfolio
securities are denominated may have a detrimental impact on the fund. Where the
exchange rate for a currency declines materially after a fund's income has been
accrued and translated into U.S. dollars, a fund may need to redeem portfolio
securities to make required distributions. Similarly, if an exchange rate
declines between the time a fund incurs expenses in U.S. dollars and the time
such expenses are paid, the fund will have to convert a greater amount of the
currency into U.S. dollars in order to pay the expenses.
Through the funds' flexible policy, management endeavors to avoid unfavorable
consequences and to take advantage of favorable developments in particular
nations where, from time to time, it places the funds' investments.
The exercise of this flexible policy may include decisions to purchase
securities with substantial risk characteristics and other decisions such as
changing the emphasis on investments from one nation to another and from one
type of security to another. Some of these decisions may later prove profitable
and others may not. No assurance can be given that profits, if any, will exceed
losses.
The board of trustees considers the degree of risk involved through the holding
of portfolio securities in domestic and foreign securities depositories.
However, in the absence of willful misfeasance, bad faith, or gross negligence
on the part of the funds' manager, any losses resulting from the holding of the
funds' portfolio securities in foreign countries and/or with securities
depositories will be at the risk of the shareholders. No assurance can be given
that the board of trustees' appraisal of the risks will always be correct or
that such exchange control restrictions or political acts of foreign governments
might not occur.
EURO On January 1, 1999, the European Monetary Union (EMU) introduced 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. While the implementation of the
euro could have a negative effect on a fund, the fund's manager and its
affiliated services providers are taking steps they believe are reasonably
designed to address the euro issue.
REAL ESTATE Because certain funds invest in the real estate industry, a fund
could own real estate directly as a result of a default on debt securities it
may own. Receipt of rental income or income from the disposition of real
property by a fund may adversely affect its ability to retain its tax status as
a regulated investment company.
REPURCHASE AGREEMENTS The use of repurchase agreements involves certain risks.
For example, if the other party to the agreement defaults on its obligation to
repurchase the underlying security at a time when the value of the security has
declined, a fund may incur a loss upon disposition of the security. If the other
party to the agreement becomes insolvent and subject to liquidation or
reorganization under the bankruptcy code or other laws, a court may determine
that the underlying security is collateral for a loan by a fund not within the
control of a fund, and therefore the realization by the fund on the collateral
may be automatically stayed. Finally, it is possible that the fund may not be
able to substantiate its interest in the underlying security and may be deemed
an unsecured creditor of the other party to the agreement. While the manager
acknowledges these risks, it is expected that if repurchase agreements are
otherwise deemed useful to a fund, these risks can be controlled through careful
monitoring procedures.
REVERSE REPURCHASE AGREEMENTS are considered borrowings by the funds and as such
are subject to the investment limitations discussed under "Fundamental
Investment Restrictions." These transactions may increase the volatility of a
fund's income or net asset value. The fund carries the risk that any securities
purchased with the proceeds of the transaction will depreciate or not generate
enough income to cover the fund's obligations under the reverse
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repurchase transaction. These transactions also increase the interest and
operating expenses of a fund.
SHORT SALES Short sales carry risks of loss if the price of the security sold
short increases after the sale. In this situation, when a fund replaces a
borrowed security by buying the security in the securities markets, the fund may
pay more for the security than it has received from the purchaser in the short
sale. A fund may, however profit from a change in the value of the security sold
short, if the price decreases.
SMALLER COMPANIES Historically, smaller company stocks have been more volatile
in price than larger company 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 smaller companies to changing economic conditions.
Besides exhibiting greater volatility, smaller 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
fund that invests a substantial portion of its net assets in smaller company
stocks may be more volatile than the shares of a fund that invests solely in
larger company stocks.
TRADE CLAIMS An investment in trade claims is speculative and carries a high
degree of risk. There can be no guarantee that the debtor 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 of
trade claims may have a lower priority in terms of payment than most other
creditors in a bankruptcy proceeding.
FUNDAMENTAL INVESTMENT RESTRICTIONS
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Each fund has adopted the following restrictions as fundamental policies. This
means they may only be changed if the change is approved by (i) more than 50% of
the fund's outstanding shares or (ii) 67% or more of the fund's shares present
at a shareholder meeting if more than 50% of the fund's outstanding shares are
represented at the meeting in person or by proxy, whichever is less.
Each fund 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 fund 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 (except 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 33 1/3% of the value of the fund's total assets including the amount
borrowed. Each of these funds may also pledge, mortgage or hypothecate its
assets to secure borrowings to an extent not greater than 15% of the fund's
total assets. Arrangements with respect to margin for futures contracts, forward
contracts and related options are not deemed to be 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 fund 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 funds 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 Communications Fund, Natural Resources Fund, or the Real Estate
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 Large Cap 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
46
<PAGE>
respective assets in such companies, the Natural Re sources 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 fund 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 funds 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 funds 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 Large Cap 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 fund;
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 fund'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 funds 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.
Generally, the policies and restrictions discussed in this SAI and in the
prospectuses apply when a fund makes an investment. In most cases, the fund is
not required to sell a security because circumstances change and the security no
longer meets one or more of a fund's policies or restrictions. If a percentage
restriction or limitation is met at the time of investment, a later increase or
decrease in the percentage due to a change in the value or liquidity
47
<PAGE>
of portfolio securities will not be considered a violation of the restriction or
limitation.
OFFICERS AND TRUSTEES
- --------------------------------------------------------------------------------
The trust has a board of trustees. The board is responsible for the overall
management of the trust, including general supervision and review of each fund'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 board
also monitors each fund to ensure no material conflicts exist among share
classes, among different insurance companies or between owners of variable
annuity and variable life insurance contracts. While none is expected, the board
will act appropriately to resolve any material conflict that may arise.
The name, age and address of the officers and board members, as well as their
affiliations, positions held with the trust, and principal occupations during
the past five years are shown below.
Frank H. Abbott, III (78)
1045 Sansome Street, San Francisco, CA 94111
TRUSTEE
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).
Harris J. Ashton (66)
191 Clapboard Ridge Road, Greenwich, CT 06830
TRUSTEE
Director, RBC Holdings, Inc. (bank holding company) and Bar-S Foods (meat
packing company); director or trustee, as the case may be, of 48 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).
Edward J. Bonach (45)
Allianz Life Insurance Company
1750 Hennepin Avenue, Minneapolis, MN 55403-2195
TRUSTEE
Senior Vice President and Chief Financial Officer, Allianz Life Insurance
Company of North America; President and Chief Executive Officer, Canadian
American Financial Corporation; and Director, Preferred Life Insurance Company
of New York and Life USA Holding, Inc.
Robert F. Carlson (71)
2120 Lambeth Way, Carmichael, CA 95608
TRUSTEE
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, member,
Corporate Board, Blue Shield of California, and Chief Counsel, California
Department of Transportation.
S. Joseph Fortunato (66)
Park Avenue at Morris County, P.O. Box 1945
Morristown, NJ 07962-1945
TRUSTEE
Member of the law firm of Pitney, Hardin, Kipp & Szuch; director or trustee, as
the case may be, of 50 of the investment companies in the Franklin Templeton
Group of Funds.
*Charles B. Johnson (66)
777 Mariners Island Blvd., San Mateo, CA 94404
CHAIRMAN OF THE BOARD AND TRUSTEE
President, Chief Executive Officer and Director, Franklin Resources, Inc.;
Chairman of the Board and Director, Franklin Advisers, 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 49 of the investment
companies in the Franklin Templeton Group of Funds.
*Charles E. Johnson (42)
500 East Broward Blvd., Fort Lauderdale, FL 33394-3091
PRESIDENT AND TRUSTEE
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 33 of the investment companies in
the Franklin Templeton Group of Funds.
*Rupert H. Johnson, Jr. (58)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND TRUSTEE
Executive Vice President and Director, Franklin Resources, Inc. and Franklin
Templeton Distributors, Inc.; President and Director, Franklin Advisers, Inc.
and Franklin Investment Advisory Services, Inc.; Senior Vice President, Franklin
Advisory Services, LLC; 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 52 of the investment companies
in the Franklin Templeton Group of Funds.
48
<PAGE>
Frank W.T. LaHaye (70)
20833 Stevens Creek Blvd., Suite 102, Cupertino, CA 95014
TRUSTEE
General Partner, Miller & LaHaye, which is the General Partner of Peregrine
Ventures II (venture capital firm); 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),
Digital Transmission Systems, Inc. (wireless communications) and Director,
Quarterdeck Corporation (software firm); and General Partner, Peregrine
Associates, which was the General Partner of Peregrine Ventures (venture capital
firm).
Gordon S. Macklin (70)
8212 Burning Tree Road, Bethesda, MD 20817
TRUSTEE
Director, Fund American Enterprises Holdings, Inc. (holding company), Martek
Biosciences Corporation, MCI WorldCom (information services), MedImmune, Inc.
(biotechnology), Spacehab, Inc. (aerospace services) and Real 3D (software);
director or trustee, as the case may be, of 48 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.
Harmon E. Burns (54)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT
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 Investment Advisory
Services, Inc. and 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 52 of the investment companies
in the Franklin Templeton Group of Funds.
Martin L. Flanagan (38)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
Senior Vice President and Chief Financial Officer, Franklin Resources, Inc.,
Franklin/Templeton Investor Services, Inc. and Franklin Mutual Advisers, LLC,
Executive Vice President, Chief Financial Officer 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, LLC and Franklin Investment Advisory Services, Inc.; President and
Director, Franklin Templeton 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 52 of the investment companies in the
Franklin Templeton Group of Funds.
Deborah R. Gatzek (50)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND SECRETARY
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, LLC. and Franklin Mutual Advisers,LLC;
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.
Diomedes Loo-Tam (60)
777 Mariners Island Blvd., San Mateo, CA 94404
TREASURER AND PRINCIPAL ACCOUNTING OFFICER
Senior Vice President, Franklin Templeton Services, Inc.; and officer of 32 of
the investment companies in the Franklin Templeton Group of Funds.
Edward V. McVey (61)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT
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.
*This board member is considered an "interested person" under federal securities
laws.
Note: Charles B. Johnson and Rupert H. Johnson, Jr.
are brothers and the father and uncle, respectively, of Charles E. Johnson.
The trust pays noninterested board members $675 per month plus $550 per meeting
attended. Board members who serve on the audit committee of the trust and other
funds in the Franklin Templeton Group of Funds receive a flat fee of $2,000 per
committee meeting attended, a portion of which is allocated to the trust.
Members of a committee are not compensated for any committee meeting held on the
day of a board meeting. Noninterested board members may also serve as directors
or trustees of other funds in the Franklin Templeton Group of Funds and may
receive fees from these funds for their services. The fees payable to
noninterested board members by the trust are subject to reductions resulting
from fee caps limiting the amount of fees payable to board members who serve on
other boards within the Franklin Templeton Group of Funds. The following table
provides the total fees paid to noninterested board members by the trust and by
the Franklin Templeton Group of Funds.
49
<PAGE>
NUMBER OF
BOARDS IN
TOTAL FEES THE FRANKLIN
RECEIVED FROM TEMPLETON
TOTAL FEES THE FRANKLIN GROUP
RECEIVED TEMPLETON OF FUNDS
FROM THE GROUP OF ON WHICH
NAME TRUST (1)($) FUNDS (2)($) EACH SERVES (3)
- --------------------------------------------------------------------------------
Frank H. Abbott 9,573 166,614 27
Harris Ashton 10,004 361,157 48
Robert F. Carlson 11,142 78,052 9
S. Joseph Fortunato 9,551 367,835 50
Frank W.T. LaHaye 10,123 171,536 27
Gordon Macklin 10,004 361,157 48
1. For the fiscal year ended December 31, 1998. During the period from January
1, 1998 through May 31, 1998, fees at the rate of $550 per month and $182 per
board meeting attended were in effect.
2. For the calendar year ended December 31, 1998.
3. 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 163 U.S. based
funds or series.
Noninterested board members 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 fund or other funds in the Franklin
Templeton Group of Funds. Certain officers or board members who are shareholders
of Franklin Resources, Inc. 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 funds in the Franklin Templeton Group of
Funds, as is consistent with their individual financial goals. In February 1998,
this policy was formalized through adoption of a requirement that each board
member 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 until the value of such investments equals or exceeds
five times the annual fees paid such board member. Investments in the name of
family members or entities controlled by a board member constitute fund holdings
of such board member for purposes of this policy, and a three year phase-in
period applies to such investment requirements for newly elected board members.
In implementing such policy, a board member's fund holdings existing on February
27, 1998, are valued as of such date with subsequent investments valued at cost.
MANAGEMENT AND OTHER SERVICES
- --------------------------------------------------------------------------------
MANAGERS AND SERVICES PROVIDED Franklin Advisers, Inc. is the manager of each
fund, except Asset Allocation Fund, Global Growth Fund, International Smaller
Companies Fund, Developing Markets Fund, Mutual Discovery Fund, Mutual Shares
Fund, Rising Dividends Fund and Value Fund. The manager for Rising Dividends
Fund and Value Securities Fund is Franklin Advisory Services, LLC. The manager
for Mutual Discovery Fund and Mutual Shares Fund is Franklin Mutual Advisers,
LLC. The manager of the International Smaller Companies Fund is Templeton
Investment Counsel, Inc. The manager for the Asset Allocation Fund and Global
Growth Fund is Templeton Global Advisors Limited. The manager for the Developing
Markets Fund is Templeton Asset Management Ltd. The managers are directly or
indirectly wholly owned by Franklin Resources, Inc. (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.
The managers provide investment research and portfolio management services, and
select the securities for the funds to buy, hold or sell. The managers also
select the brokers who execute the funds' portfolio transactions. The managers
provide periodic reports to the board, which reviews and supervises the
managers' investment activities. To protect the funds, the managers and their
officers, directors and employees are covered by fidelity insurance. Templeton
Asset Management Ltd. and Templeton Global Advisors Limited render their
services to the funds from outside the U.S.
The Templeton organization has been investing globally since 1940. It has
offices in Argentina, Australia, Bahamas, Bermuda, Brazil, the British Virgin
Islands, Canada, China, Cyprus, France, Germany, Hong Kong, India, Italy, Japan,
Korea, Luxembourg, Mauritius, the Netherlands, Poland, Russia, Singapore, South
Africa, Spain, Sweden, Switzerland, Taiwan, United Kingdom, Vietnam and the U.S.
The managers and their affiliates manage numerous other investment companies and
accounts. The managers may give advice and take action with respect to any of
the other funds they manage, or for their own account, that may differ from
action taken by a manager on behalf of a fund. Similarly, with respect to the
funds, the managers are not obligated to recommend, buy or sell, or to refrain
from recommending, buying or selling any security that the managers and access
persons, as defined by applicable federal securities laws, may buy or sell for
their own account or for the accounts of any other fund. The managers are not
obligated to refrain from investing in securities held by the funds or other
funds they manage. Of course, any transactions for the accounts of the managers
50
<PAGE>
and other access persons will be made in compliance with the trust's code of
ethics.
Under the trust's code of ethics, employees of the Franklin Templeton Group who
are access persons may engage in personal securities transactions subject to the
following general restrictions and procedures: (i) the trade must receive
advance clearance from a compliance officer and must be completed by the close
of the business day following the day clearance is granted; (ii) copies of all
brokerage confirmations and statements must be sent to a compliance officer;
(iii) all brokerage accounts must be disclosed on an annual basis; and (iv)
access persons involved in preparing and making investment decisions must, in
addition to (i), (ii) and (iii) above, file annual reports of their securities
holdings each January and inform the compliance officer (or other designated
personnel) if they own a security that is being considered for a fund or other
client transaction or if they are recommending a security in which they have an
ownership interest for purchase or sale by a fund or other client.
Templeton Investment Counsel, Inc. is the sub-adviser to the Asset Allocation
Fund, the Global Income Fund, the International Equity Fund and the Pacific
Fund. The sub-adviser has agreements with the managers and provides the managers
with investment management advice and assistance. The sub-adviser's activities
are subject to the board's review and control, as well as the managers'
instructions and supervision.
MANAGEMENT FEES Each Fund pays the manager a fee equal to an annual rate as
follows:
MONEY FUND, GROWTH AND INCOME FUND, NATURAL RE SOURCES FUND, REAL ESTATE FUND,
GLOBAL COMMUNICATIONS FUND, HIGH INCOME FUND, GLOBAL INCOME FUND, INCOME SECU
RITIES FUND, U.S. GOVERNMENT FUND, ZERO COUPON FUND - 2000, ZERO COUPON FUND -
2005 AND ZERO COUPON FUND - 2010:
o 0.625% of the value of net assets up to an including $100 million;
o 0.50% of the value of net assets over $100 million up to and including $250
million;
o 0.45% of the value of net assets over $250 million up to and including $10
billion;
o 0.44% of the value of net assets over $10 billion up to and including $12.5
billion; plus
o 0.42% of the value of net assets over $12.5 billion up to and including $15
billion; plus
o 0.40% of the value of net assets over $15 billion.
RISING DIVIDENDS FUND, SMALL CAP FUND, LARGE CAP FUND:
o 0.75% of the value of net assets up to $500 million;
o 0.625% of the value of net assets over $500 million up to and including $1
billion; and
o 0.50% of the value of net assets in excess of $1 billion.
PACIFIC GROWTH FUND, INTERNATIONAL EQUITY FUND, GLOBAL GROWTH FUND:
o 1.00% of the value of net assets up to $100 million;
o 0.90% of the value of net assets over $100 million up to and including $250
million;
o 0.80% of the value of net assets over $250 million up to and including $500
million; and
o 0.75% of the value of net assets over $500 million.
DEVELOPING MARKETS EQUITY FUND:
o 1.25% of the value of net assets.
GLOBAL ASSET ALLOCATION FUND:
o 0.65% of the value of net assets up to and including $200 million;
o 0.585% of the value of net assets over $200 million up to and including $1.3
billion;
o 0.52% of the value of net assets over $1.3 billion.
INTERNATIONAL SMALLER COMPANIES FUND:
o 0.85% of the value of net assets up to and including $200 million;
o 0.765% of the value of the fund's net assets over $200 million up to and
including $1.3 billion;
o 0.68% of the value of the fund's net assets over $1.3 billion.
GLOBAL HEALTH CARE FUND AND VALUE FUND:
o 0.60% of the value of net assets up to an including $200 million;
o 0.50% of the value of net assets up to and including $1.3 billion; and
o 0.40% of value of net assets over $1.3 billion.
MUTUAL DISCOVERY FUND:
o 0.80% of the value of net assets.
MUTUAL SHARES FUND:
o 0.60% of the value of net assets.
The fees are computed daily according to the terms of the management agreements.
Each class of a fund's shares pays its proportionate share of the fee.
For the last three fiscal years ended December 31, the funds paid the following
management fees:
MANAGEMENT FEES PAID($)
-----------------------------------------
1998 1997 1996
- --------------------------------------------------------------------------------
Money Fund (1) 1,671,303 1,740,190 1,781,802
Global Income Fund 959,858 1,133,609 1,262,055
High Income Fund 2,439,509 2,305,480 1,985,566
Government Fund 3,530,641 3,775,626 3,162,073
Zero Coupon Fund - 2000 (1) 377,990 442,683 494,949
Zero Coupon Fund - 2005 (1) 292,474 290,964 299,714
Zero Coupon Fund - 2010 (1) 326,495 293,620 291,798
Income Securities Fund 6,133,729 6,348,820 6,130,804
Rising Dividends Fund 5,508,829 4,942,390 3,785,807
Global Communications Fund 4,965,295 5,139,011 6,097,507
Growth and Income Fund 6,301,582 5,667,415 4,643,546
51
<PAGE>
MANAGEMENT FEES PAID($)
-----------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
Natural Resources Fund 388,527 584,675 754,383
Real Estate Fund 1,911,113 1,988,023 1,335,653
Small Cap Fund 2,365,309 1,878,273 694,975
International Equity Fund 8,900,761 9,676,740 7,945,053
Pacific Growth Fund 1,142,027 2,608,312 3,343,850
Asset Allocation Fund 585,747 526,125 272,732
Developing Markets Fund 2,633,409 4,277,977 2,887,400
Global Growth Fund 6,409,332 5,894,743 4,016,061
International Smaller
Companies Fund 259,908 239,272 56,389 (2)
Large Cap Fund 1,140,016 558,503 86,028 (2)
Mutual Discovery Fund 1,904,631 930,954 11,033 (3)
Mutual Shares Fund 2,841,641 1,265,341 11,822 (3_
Global Health Care Fund 18,1194 -- --
Value Fund 17,9684 -- --
1. Under an agreement by the manager to limit its management fees, the fund's
fees before any advance waiver were ($):
1998 1997 1996
- -------------------------------------------------------------------------------
Money Fund 1,986,485 2,072,982 2,225,389
Zero Coupon Fund - 2000 639,490 724,202 790,492
Zero Coupon Fund - 2005 498,204 485,690 503,611
Zero Coupon Fund - 2010 552,900 491,457 490,108
2. For the period from May 1, 1996 to December 31, 1996.
3. For the period from November 6, 1996 to December 31, 1996.
4. For the period from May 1, 1998 to December 31, 1998.
The managers pay the sub-advisers fees equal to an annual rate of:
TEMPLETON INVESTMENT COUNSEL FOR ITS SERVICES TO GLOBAL INCOME FUND,
INTERNATIONAL EQUITY FUND AND PACIFIC GROWTH FUND:
o 0.35% of the value of the net assets up to and including $100 million;
o 0.25% of the value of net assets over $100 million up to and including $250
million; and
o 0.20% of the value of net assets over $250 million.
TEMPLETON INVESTMENT COUNSEL FOR ITS SERVICES TO ASSET ALLOCATION FUND:
o 0.25% of the value of the fund's net assets up to and including $200 million;
o 0.225%of the value of the fund's net assets over $200 million up to and
including $1.3 billion;
o 0.20% of the value of the fund's net assets over $1.3 billion.
The managers pay the above fees from the management fees they receive from the
funds. For the last three fiscal years, the managers paid the following
sub-advisory fees:
SUB-ADVISORY FEES PAID($)
-----------------------------------------
1998 1997 1996
- --------------------------------------------------------------------------------
Asset Allocation Fund 175,133 202,084 85,148
Global Income Fund 517,646 646,108 847,462
International Equity Fund 3,367,480 3,558,654 3,798,617
Pacific Growth Fund 561,199 1,184,097 1,807,040
ADMINISTRATOR AND SERVICES PROVIDED Franklin Templeton Services, Inc. (FT
Services) provides certain administrative services and facilities for each fund.
FT Services has direct agreements with Asset Allocation Fund, Global Health Care
Fund, International Smaller Companies Fund, Mutual Discovery Fund, Mutual Shares
Fund and Value Securities Fund. FT Services has subcontracts with the managers
of all other funds. FT Services is wholly owned by Resources and is an affiliate
of the funds' managers and principal underwriter.
The administrative services FT Services provides include preparing and
maintaining books, records, and tax and financial reports, and monitoring
compliance with regulatory requirements.
ADMINISTRATION FEES The funds, in the case of the Asset Allocation Fund, Global
Health Care Fund, International Smaller Companies Fund, Mutual Discovery Fund,
Mutual Shares Fund and Value Fund, and the managers for all other funds, pay FT
Services a monthly fee for each fund equal to an annual rate of:
o 0.15% of the fund's average daily net assets up to $200 million;
o 0.135% of average daily net assets over $200 million up to $700 million;
o 0.10% of average daily net assets over $700 million up to $1.2 billion; and
o 0.075% of average daily net assets over $1.2 billion.
During the last two fiscal years ended December 31, the funds or the managers,
as applicable, paid FT services the following administration fees:
ADMINISTRATION FEES PAID($)
-------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
Money Fund 550,742 577,131 152,857 (1)
Global Income Fund 250,588 301,966 82,850 (1)
High Income Fund 687,089 646,500 148,800 (1)
Government Fund 1,004,140 1,058,686 261,201 (1)
Zero Coupon Fund - 2000 152,304 179,811 49,454 (1)
Zero Coupon Fund - 2005 119,555 116,587 31,111 (1)
Zero Coupon Fund - 2010 132,677 117,989 30,053 (1)
Income Securities Fund 1,555,839 1,591,448 394,864 (1)
Rising Dividends Fund 1,054,751 952,330 198,779 (1)
Global Communications Fund 1,323,099 1,361,793 373,517 (1)
Growth and Income Fund 1,583,739 1,468,417 333,729 (1)
Natural Resources Fund 93,364 140,730 42,587 (1)
Real Estate Fund 528,864 551,077 103,035 (1)
Small Cap Fund 455,754 367,289 56,349 (1)
International Equity Fund 1,379,045 1,475,635 334,867 (1)
Pacific Growth Fund 174,507 410,919 131,691 (1)
Asset Allocation Fund 135,172 121,436 18,668 (1)
Developing Markets Fund 307,396 517,561 93,551 (1)
Global Growth Fund 1,048,256 912,622 85,979 (1)
International Smaller
Companies Fund 45,867 42,916 5,014 (1)
Large Cap Fund 227,544 111,486 12,231 (1)
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ADMINISTRATION FEES PAID($)
------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
Mutual Discovery Fund 351,377 174,554 1,720 (2)
Mutual Shares Fund 669,378 314,146 2,971 (2)
Global Health Care Fund 4,471 (3) -- --
Value Fund 4,433 (3) -- --
1. For the period from October 1, 1996 to December 31, 1996.
2. For the period from November 6, 1996 to December 31, 1996.
3. For the period from May 1, 1998 to December 31, 1998.
SHAREHOLDER SERVICING AND TRANSFER AGENT Franklin/Templeton Investor Services,
Inc. (Investor Services) is the fund's shareholder servicing agent and acts as
the fund's transfer agent and dividend-paying agent. Investor Services is
located at 777 Mariners Island Blvd., P.O. Box 7777, San Mateo, CA 94403-7777.
CUSTODIANS Bank of New York, Mutual Funds Division,
90 Washington Street, New York, NY 10286, acts as custodian of the funds'
securities and other assets. In addition, The Chase Manhattan Bank, at its
principal office at MetroTech Center, Brooklyn, NY 11245, and at the offices of
its branches and agencies throughout the world, acts as custodian of the assets
of Global Income Fund, Developing Markets Fund, Global Growth Fund, Asset
Allocation Fund, International Equity Fund and Pacific Growth Fund. As foreign
custody manager, the bank selects and monitors foreign sub-custodian banks,
selects and evaluates non-compulsory foreign depositories, and furnishes
information relevant to the selection of compulsory depositories.
AUDITOR PricewaterhouseCoopers LLP, 333 Market Street, San Francisco CA 94105,
is the trust's independent auditor. The auditor gives an opinion on the
financial statements included in the trust's Annual Report to Shareholders and
reviews the trust's registration statement filed with the U.S. Securities and
Exchange Commission (SEC).
RESEARCH SERVICES The managers may receive services from various affiliates. The
services may include information, analytical reports, computer screening
studies, statistical data, and factual resumes pertaining to securities eligible
for purchase by the funds. Such supplemental research, when utilized, is subject
to analysis by the managers before being incorporated into the investment
advisory process.
PORTFOLIO TRANSACTIONS
- --------------------------------------------------------------------------------
The managers select brokers and dealers to execute the funds' portfolio
transactions in accordance with criteria set forth in the management agreements
and any directions that the board may give.
When placing a portfolio transaction, the 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 is negotiated between
the managers and the broker executing the transaction. The determination and
evaluation of the reasonableness of the brokerage commissions paid are based to
a large degree on the professional opinions of the persons responsible for
placement and review of the transactions. These opinions are based on the
experience of these individuals in the securities industry and information
available to them about the level of commissions being paid by other
institutional investors of comparable size. The 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 manager's overall responsibilities to client accounts over
which they exercise investment discretion. The services that 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 funds. They
must, however, be of value to the managers in carrying out their overall
responsibilities to their clients.
To the extent a fund invests in bonds or participates in other principal
transactions at net prices, the fund incurs little or no brokerage costs. The
fund deals directly with the selling or buying principal or market maker without
incurring charges for the services of a broker on its behalf, unless it is
determined that a better price or execution may be obtained by using the
services of a broker.
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 prices. The funds 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.
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<PAGE>
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 allows 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 trust shares, as well as shares of other funds in the Franklin Templeton
Group of Funds, may also be considered a factor in the selection of
broker-dealers to execute a fund's portfolio transactions.
Because Franklin Templeton Distributors, Inc. (Distributors) is a member of the
National Association of Securities Dealers, Inc., it may sometimes receive
certain fees when the fund tenders portfolio securities pursuant to a
tender-offer solicitation. To recapture brokerage for the benefit of the fund,
any portfolio securities tendered by the fund will be tendered through
Distributors if it is legally permissible to do so. In turn, the next management
fee payable to the 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 a fund and one or more other investment
companies or clients supervised by the manager are considered at or about the
same time, transactions in these securities will be allocated among the several
investment companies and clients in a manner deemed equitable to all by the
manager, taking into account the respective sizes of the funds and the amount of
securities to be purchased or sold. In some cases this procedure could have a
detrimental effect on the price or volume of the security so far as the fund is
concerned. In other cases it is possible that the ability to participate in
volume transactions may improve execution and reduce transaction costs to the
fund.
During the last three fiscal years ended December 31, the funds paid the
following brokerage commissions:
BROKERAGE COMMISSIONS ($)
-----------------------------------------
1998 1997 1996
- --------------------------------------------------------------------------------
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 0
Zero Coupon Fund - 2005 0 0 0
Zero Coupon Fund - 2010 0 0 0
Income Securities Fund 135,052 130,787 211,977
Rising Dividends Fund 687,070 615,127 485,120
Global Communications Fund 1,260,209 987,011 1,277,007
Growth and Income Fund 978,165 1,277,652 848,162
Natural Resources Fund 221,927 347,537 149,263
Real Estate Fund 360,482 213,815 89,985
Small Cap Fund 205,822 242,801 183,601
International Equity Fund 247,053 1,842,559 1,015,004
Pacific Growth Fund 267,116 487,776 487,464
Asset Allocation Fund 102,075 131,597 62,209
Developing Markets Fund 622,952 1,147,089 604,200
Global Growth Fund 965,410 860,436 0
International Smaller
Companies Fund 26,352 109,554 10,847
Large Cap Fund 97,932 57,736 44,722
Mutual Discovery Fund 752,153 247,576 20,812
Mutual Shares Fund 856,291 310,461 31,174
Global Health Care Fund 7,679 -- --
Value Fund 23,936 -- --
Because the funds may, from time to time, invest in broker-dealers, it is
possible that a fund will own more than 5% of the voting securities of one or
more broker-dealers through whom such fund places portfolio brokerage
transactions. In such circumstances, the broker-dealer would be considered an
affiliated person of the fund. To the extent that the fund places brokerage
transactions through such a broker-dealer at a time when the broker-dealer is
considered to be an affiliate of the fund, the fund will be required to adhere
to certain rules relating to the payment of commissions to an affiliated
broker-dealer. These rules require the fund to adhere to procedures adopted by
the board relating to ensuring that the commissions paid to such broker-dealers
do not exceed what would otherwise be the usual and customary broker's
commissions for similar transactions.
The following table identifies each fund which held securities of its regular
brokers or dealers during 1998, the names of each such broker or dealer, and the
value, if any, of such securities as of December 31, 1998.
DECEMBER 31,
FUND NAME REGULAR BROKER OR DEALER 1998 VALUE($)
- --------------------------------------------------------------------------
Money Fund Bank of America NT & SA 5,000,000
Swiss Bank Corp., New York Branch 4,999,381
J.P. Morgan & Co. Inc. 4,975,822
Merrill Lynch & Co., Inc. 4,930,017
UBS AG, New York Branch 10,000,000
Growth & Income J.P. Morgan & Co., Inc. 12,702,056
Global Growth Fund Morgan Stanley Dean Witter & Co. 7,320,100
Mutual Discovery BankAmerica Corp. 645,622
Fund Lehman Brothers Holdings, Inc. 1,855,031
Morgan Stanley Dean Witter & Co. 734,563
Mutual Shares Fund BankAmerica Corp. 1,471,740
Lehman Brothers Holdings Co. 4,027,312
Morgan Stanley Dean Witter & Co. 9,485,600
The Mutual Discovery Fund and the Mutual Shares Fund may receive research
services from persons who act as brokers or dealers for the funds. The
discussion below relates in general to these brokers or dealers who, pursuant to
various arrangements, pay for certain computer hardware and software and other
research and brokerage
54
<PAGE>
services to the manager and/or the funds for transactions effected by it for the
fund. Commission soft dollars may be used only for brokerage and research
services provided by brokers to whom commissions are paid and under no
circumstances will cash payments be made by any such broker to the funds'
manager. To the extent that commission soft dollars do not result in the
provision of any "brokerage and research services" by brokers to whom such
commissions are paid, the commissions, nevertheless, are the property of such
broker. Although, potentially, the manager could be influenced to place fund
brokerage transactions with a broker in order to generate soft dollars for the
manager's benefit, the manager believes that the requirement that it achieve
best execution on fund portfolio transactions, and the fund's negotiated
commission structure with brokers, mitigate these concerns as the cost of
transactions effected through brokers, before consideration of any soft dollar
benefits that may be received, generally will be comparable to that available
elsewhere. During the fiscal year ended December 31, 1998, the funds did not pay
any brokerage commissions to brokers who provided research services.
DISTRIBUTIONS AND TAXES
- --------------------------------------------------------------------------------
EFFECT OF FOREIGN INVESTMENTS ON DISTRIBUTIONS Most foreign exchange gains
realized on the sale of debt securities are treated as ordinary income by a
fund. Similarly, foreign exchange losses realized by a fund on the sale of debt
securities are generally treated as ordinary losses by a fund. These gains when
distributed will be treated as ordinary dividends, and any losses will reduce a
fund's ordinary income otherwise available for distribution. This treatment
could increase or reduce a fund's ordinary income distributions, and may cause
some or all of a fund's previously distributed income to be classified as a
return of capital.
A fund may be subject to foreign withholding taxes on income from certain of its
foreign securities.
ELECTION TO BE TAXED AS A REGULATED INVESTMENT COMPANY Each fund has elected to
be treated as a regulated investment company under Subchapter M of the Internal
Revenue Code, has qualified as such for its most recent fiscal year, and intends
to so qualify during the current fiscal year. As regulated investment companies,
the funds generally pay no federal income tax on the income and gains they
distribute. To ensure that individuals holding the Contracts whose assets are
invested in a fund will not be subject to federal income tax on distributions
made by the fund prior to receipt of payments under the Contracts, each fund
intends to comply with the additional requirements of Section 817(h) of the
Internal Revenue Code relating to diversification of its assets. The board
reserves the right not to maintain the qualification of a fund as a regulated
investment company if it determines such course of action to be beneficial to
shareholders. In such case, the fund will be subject to federal, and possibly
state, corporate taxes on its taxable income and gains.
EXCISE TAX DISTRIBUTION REQUIREMENTS To avoid federal excise taxes, the Internal
Revenue Code requires a fund to make certain minimum distributions by December
31 of each year. Federal excise taxes will not apply to a fund in a given
calendar year, however, if all of its shareholders at all times during the
calendar year are segregated asset accounts of life insurance companies where
the shares are held in connection with variable products.
INVESTMENT IN COMPLEX SECURITIES A fund may invest in complex securities. These
investments may be subject to numerous special and complex tax rules. These
rules could affect whether gains and losses recognized by a fund are treated as
ordinary income or capital gain, accelerate the recognition of income to a fund
and/or defer a fund's ability to recognize losses, and, in limited cases,
subject a fund to U.S. federal income tax on income from certain of its foreign
securities. In turn, these rules may affect the amount, timing or character of
the income distributed by a fund.
ORGANIZATION, VOTING RIGHTS AND PRINCIPAL HOLDERS
- --------------------------------------------------------------------------------
The Trust is an open-end management investment company, commonly called a mutual
fund. The Trust was organized as a Massachusetts business trust on April 26,
1988 and is registered with the SEC. Each fund, except the Global Health Care
Fund, Global Income Fund and the Value Fund, is a diversified series of the
Trust.
The shareholders of a Massachusetts business trust could, under certain
circumstances, be held personally liable as partners for its obligations. The
Agreement and Declaration of Trust, however, 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 series' (fund's) assets for any shareholder held personally liable for
obligations of that fund 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 fund or the trust and shall satisfy
any judgment thereon. All such rights are limited to the assets of the fund. 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. Furthermore, the activities
of the fund as an investment company, as distinguished from an operating
company, would not likely give rise to liabilities in excess of the fund's total
55
<PAGE>
assets. Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to the unlikely circumstance in which both
inadequate insurance exists and the fund itself is unable to meet its
obligations.
The trust currently offers two classes of shares for each series, class 1 and
class 2. All shares purchased before the initial offering of class 2 shares on
December 28, 1998 are considered class 1 shares. After that date, all shares are
designated either class 1 or class 2. Additional classes of shares may be
offered in the future. The full title of each series and class is:
Franklin Large Cap Growth Fund - Class 1
(prior to 12/15/99, the Franklin Capital Growth Fund)
Franklin Large Cap Growth Fund - Class 2
Franklin Global Health Care Securities Fund - Class 1
Franklin Global Health Care Securities Fund - Class 2
Franklin Global Communications Securities Fund - Class 1
(prior to 11/15/99, the Franklin Global Utilities Securities Fund)
(prior to 5/1/98, the Utility Equity Fund)
Franklin Global Communications Securities Fund - Class 2
Franklin Growth and Income Fund - Class 1
(prior to 5/1/95, the Equity Growth Fund)
Franklin Growth and Income Fund - Class 2
Franklin High Income Fund - Class 1
Franklin High Income Fund - Class 2
Franklin Income Securities Fund Class 1
Franklin Income Securities Fund Class 2
Franklin Money Market Fund - Class 1
Franklin Money Market Fund - Class 2
Franklin Natural Resources Securities Fund - Class 1
(prior to 5/1/97, the Precious Metals Fund)
Franklin Natural Resources Securities Fund - Class 2
Franklin Real Estate Fund - Class 1
Franklin Real Estate Fund - Class 2
Franklin Rising Dividend Securities Fund - Class 1
Franklin Rising Dividend Securities Fund - Class 2
Franklin Small Cap Fund - Class 1
Franklin Small Cap Fund - Class 2
Franklin U.S. Government Fund - Class 1
Franklin U.S. Government Fund - Class 2
Franklin Value Securities Fund - Class 1
Franklin Value Securities Fund - Class 2
Franklin Zero Coupon Fund - 2000 - Class 1
Franklin Zero Coupon Fund - 2000 - Class 2
Franklin Zero Coupon Fund - 2005 - Class 1
Franklin Zero Coupon Fund - 2005 - Class 2
Franklin Zero Coupon Fund - 2010 - Class 1
Franklin Zero Coupon Fund - 2010 - Class 2
Mutual Discovery Securities Fund - Class 1
Mutual Discovery Securities Fund - Class 2
Mutual Shares Securities Fund - Class 1
Mutual Shares Securities Fund - Class 2
Templeton Developing Markets Equity Fund - Class 1
Templeton Developing Markets Equity Fund - Class 2
Templeton Global Asset Allocation Fund - Class 1
Templeton Global Asset Allocation Fund - Class 2
Templeton Global Growth Fund - Class 1
Templeton Global Growth Fund - Class 2
Templeton Global Income Securities Fund Class 1
(prior to 5/1/96, the Global Income Fund)
Templeton Global Income Securities Fund Class 2
Templeton International Equity Fund - Class 1
Templeton International Equity Fund - Class 2
Templeton International Smaller Companies Fund - Class 1
Templeton International Smaller Companies Fund - Class 2
Templeton Pacific Growth Fund - Class 1
Templeton Pacific Growth Fund - Class 2
Shares of each class represent proportionate interests in a fund's assets and
are identical except that each fund's class 2 shares will bear the expenses of
the class 2 distribution plan. (See "The Underwriter" below for a description of
these plans. On matters that affect a fund as a whole, each class has the same
voting and other rights and preferences as any other class. On matters that
affect only one class, only shareholders of that class may vote. Each class
votes 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 series
have the same voting and other rights and preferences as the other classes and
series of the trust for matters that affect the trust as a whole. Additional
series may be offered in the future.
The trust has noncumulative voting rights. For board member elections, this
gives holders of more than 50% of the shares voting the ability to elect all of
the members of the board. If this happens, holders of the remaining shares
voting will not be able to elect anyone to the board.
The trust does not intend to hold annual shareholder meetings. The trust or a
series of the trust may hold special meetings, however, for matters requiring
shareholder approval. A meeting may also be called by the board to consider the
removal of a board member if requested in writing by shareholders holding at
least 10% of the outstanding shares. In certain circumstances, we are required
to help shareholders communicate with other shareholders about the removal of a
board member. A special meeting may also be called by the board in its
discretion.
As of April 1, 1999, Allianz Life Variable Account A, Allianz Life Variable
Account B and Preferred Life Variable Account C owned, 0.33%, 92.32% and 7.35%,
respectively, of the issued and outstanding shares of the Trust.
As of April 1, 1999, Board members and officers, as a group, owned less than 1%,
of record or beneficially, of the outstanding shares of trust.
56
<PAGE>
PRICING SHARES
- --------------------------------------------------------------------------------
When they buy and sell shares, the trust's insurance company shareholders pay
and receive the net asset value per share. The value of a mutual fund is
determined by deducting the fund's liabilities from the total assets of the
portfolio. The net asset value per share is determined by dividing the net asset
value of the fund by the number of shares outstanding. Each fund follows the
procedures described below.
The fund calculates the NAV per share of each class each business day at the
close of trading on the New York Stock Exchange (NYSE) (normally 1:00 p.m.
pacific time). The fund does not calculate the NAV on days the NYSE is closed
for trading, which include New Year's Day, Martin Luther King Jr. Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day.
FUNDS OTHER THAN MONEY FUND When determining its NAV, a fund values cash and
receivables at their realizable amounts, and records interest as accrued and
dividends on the ex-dividend date. If market quotations are readily available
for portfolio securities listed on a securities exchange or on the NASDAQ
National Market System, the fund values those securities at the last quoted sale
price of the day or, if there is no reported sale, within the range of the most
recent quoted bid and ask prices. The fund values over-the-counter portfolio
securities within the range of the most recent quoted bid and ask prices. If
portfolio securities trade both in the over-the-counter market and on a stock
exchange, the fund values them according to the broadest and most representative
market as determined by the manager.
The fund values portfolio securities underlying actively traded call options at
their market price as determined above. The current market value of any option
the fund holds is its last sale price on the relevant exchange before the fund
values its assets. If there are no sales that day or if the last sale price is
outside the bid and ask prices, the fund values options within the range of the
current closing bid and ask prices if the fund believes the valuation fairly
reflects the contract's market value.
The fund determines the value of a foreign security as of the close of trading
on the foreign exchange on which the security is traded or as of the close of
trading on the NYSE, if that is earlier. The value is then converted into its
U.S. dollar equivalent at the foreign exchange rate in effect at noon, New York
time, on the day the value of the foreign security is determined. If no sale is
reported at that time, the foreign security is valued within the range of the
most recent quoted bid and ask prices.
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 NYSE on each day that the NYSE is open. Trading in European or Far
Eastern securities generally, or in a particular country or countries, may not
take place on every NYSE business day. Furthermore, trading takes place in
various foreign markets on days that are not business days for the NYSE and on
which the fund's NAV is not calculated. Thus, the calculation of the fund's NAV
does not take place contemporaneously with the determination of the prices of
many of the portfolio securities used in the calculation and, if events
materially affecting the values of these foreign securities occur, the
securities will be valued at fair value as determined by management 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 before
the close of the NYSE. The value of these securities used in computing the NAV
is determined as of such times. Occasionally, events affecting the values of
these securities may occur between the times at which they are determined and
the close of the NYSE that will not be reflected in the computation of the NAV.
If events materially affecting the values of these securities occur during this
period, the securities will be valued at their fair value as determined in good
faith by the board.
Other securities for which market quotations are readily available are valued at
the current market price, which may be obtained from a pricing service, based on
a variety of factors including recent trades, institutional size trading in
similar types of securities (considering yield, risk and maturity) and/or
developments related to specific issues. Securities and other assets for which
market prices are not readily available are valued at fair value as determined
following procedures approved by the board. With the approval of the board, the
fund may use a pricing service, bank or securities dealer to perform any of the
above described functions.
MONEY FUND The valuation of the fund'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 fund would receive if it sold the instrument. During
periods of declining interest rates, the daily yield on fund shares may tend to
be higher than the same computation made by a fund
57
<PAGE>
with identical investments utilizing a method of valuation based upon market
prices and estimates of market prices for all of its portfolio instruments. The
fund's use of amortized cost may result in a lower aggregate value on a
particular day, a prospective investor in the fund would be able to obtain a
somewhat higher yield than would result from an investment in a fund using only
market values, and existing shareholders would receive less investment income.
The opposite would apply in a period of rising interest rates.
The fund's use of amortized cost which helps it to maintain its net asset value
per share of $1 is allowed by an SEC rule. Under the rule the fund must:
o maintain a dollar-weighted average portfolio maturity of 90 days or less;
o only purchase instruments having remaining maturities of 397 calendar days or
less; and
o invest only in those U.S. dollar-denominated instruments that the board
determines present minimal credit risks and that are, as required by the
federal securities laws,
o rated in one of the two highest rating categories as determined by
nationally recognized statistical rating agencies,
o instruments deemed comparable in quality to such rated instruments, or
o 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 SEC rules may have stated maturities of more than 397 days.
The board has established procedures designed to stabilize, to the extent
reasonably possible, the fund's price per share as computed for the purpose of
sales and redemptions at $1. These procedures include review of the fund's
holdings by the board, at such intervals as it may deem appropriate, to
determine if the fund's NAV calculated by using available market quotations
deviates from $1 per share based on amortized cost. The extent of any deviation
will be examined by the board. If the deviation exceeds 1/2 of 1%, the board
will consider what action needs to be initiated. If the board determine that a
deviation exists which may result in material dilution or other unfair results
to investors or existing shareholders, it will take such corrective action that
it may regard as necessary and appropriate. This action may include,
o selling portfolio instruments before maturity to realize capital gains or
losses or to shorten average portfolio maturity,
o withholding dividends,
o redeeming shares in kind, or
o establishing a net asset value per share by using available market
quotations.
THE UNDERWRITER
- --------------------------------------------------------------------------------
Distributors acts as the principal underwriter in the continuous public offering
of the trust's shares.
DISTRIBUTORS is located at 777 Mariners Island Blvd., San Mateo, CA 94404.
Distributors pays the expenses of the distribution of fund shares, except to the
extent these expenses are borne by the Insurance Companies. These expenses
include 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 class 2 rule 12b-1
plans, as discussed below. Except as noted below, Distributors receives no other
compensation from the trust for acting as underwriter.
DISTRIBUTION AND SERVICE (12B-1) FEES Each fund's class 2 has a separate
distribution or "rule 12b-1" plan. Under each fund's plan, the fund may pay up
to a maximum of 0.35% per year of the average daily net assets attributable to
its class 2 shares. The board, however, has set the current rate at 0.25% per
year, effective July 1, 1999. From January 6, 1999 to June 30, 1999, the fees
were set 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, plus any other payments deemed to be made
pursuant to a plan, exceed the amount permitted to be paid under the rules of
the National Association of Securities Dealers, Inc.
Each plan has been approved in accordance with the provisions of rule 12b-1. The
plans are renewable annually by a vote of the board, including a majority vote
of the board members who are not interested persons of the trust and who have no
direct or indirect financial interest in the operation of the plans, cast in
person at a meeting called for that purpose. It is also required that the
selection and nomination of such board members be done by the non-interested
members of the board. The class 2 plans and any related agreement may be
terminated at any time, without penalty, by vote of a majority of the
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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 a 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 fund'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.
Distributors is required to report in writing to the board at least quarterly on
the amounts and purpose of any payment made under the plans and any related
agreements, as well as to furnish the board with such other information as may
reasonably be requested in order to enable the board to make an informed
determination of whether the plans should be continued.
For the fiscal year ended December 31, 1998, the funds did not pay any fees
pursuant to the plans.
PERFORMANCE
- --------------------------------------------------------------------------------
Performance quotations are subject to SEC rules. These rules require the use of
standardized performance quo tations or, alternatively, that every
non-standardized performance quotation furnished by a fund be accompanied by
certain standardized performance information computed as required by the SEC.
Average annual total return and current yield quotations used by a fund are
based on the standardized methods of computing performance mandated by the SEC.
If a rule 12b-1 plan is adopted, performance figures reflect fees from the date
of the plan's implementation. An explanation of these and other methods used by
the fund to compute or express performance 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 funds 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 to shareholders only for the limited
historical period used.
Standardized fund performance for class 2 shares reflects a "blended" figure,
combining: (a) for periods prior to class 2's inception on 1/6/99, historical
results of class 1 shares, and (b) for periods after 1/6/99, class 2's results
reflecting an additional 12b-1 fee expense which also affects all future
performance. Historical performance data for class 2 shares, based on class 1
performance, will generally not be restated to include 12b-1 fees, although each
fund may restate these figures consistent with SEC rules.
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 account was completely redeemed at the
end of each period and the deduction of all applicable fund charges and fees. It
does NOT, however, include any fees or sales charges imposed by the variable
insurance contract for which the fund is an investment option. If they had been
included, performance would be lower. The average annual total returns for each
fund for the periods ended December 31, 1998, are reflected in the Trust's
Annual Report to Shareholders for the fiscal year ended December 31, 1998, which
is incorporated herein by reference.
The following SEC formula was used to calculate the figures:
n
P(1+T) = ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at the
beginning of each period at the end of each period
CUMULATIVE TOTAL RETURN Like average annual total return, the calculation for
cumulative total return assumes income dividends and capital gain distributions
are reinvested at net asset value. It does NOT include any fees or sales charges
imposed by the variable insurance contract for which the fund is an investment
option. Cumulative total return, however, is based on the actual return for a
specified period rather than on the average return over the periods indicated in
the annual report. The cumulative total returns for the indicated periods ended
December 31. 1998, were:
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ONE FIVE FROM
INCEPTION YEAR YEAR INCEPTION
DATE (%) (%) (%)
- --------------------------------------------------------------------------------
Money Fund 01/24/89 5.22 27.89 64.90
Global Income Fund 01/24/89 7.08 31.09 105.45
High Income Fund 01/24/89 .99 50.10 143.04
Government Fund 03/14/89 7.44 38.75 118.18
Zero Coupon Fund - 2000 03/14/89 7.50 32.71 137.06
Zero Coupon Fund - 2005 03/14/89 12.53 48.57 186.74
Zero Coupon Fund - 2010 03/14/89 14.45 65.04 220.28
Income Securities Fund 01/24/89 1.64 51.93 187.98
Rising Dividends Fund 01/27/92 6.92 119.82 132.97
Global Communications Fund 01/24/89 11.19 75.31 224.36
Growth and Income Fund 01/24/89 8.33 105.67 200.84
Natural Resources Fund 01/24/89 -25.38 -36.93 -2.42
Real Estate Fund 01/24/89 -16.82 61.26 164.91
Small Cap Fund 11/01/95 -.98 -- 53.53
International Equity Fund 01/27/92 5.56 61.74 102.94
Pacific Growth Fund 01/27/92 -13.13 -39.12 -11.06
Asset Allocation Fund 05/01/95 -.04 -- 43.05
Developing Markets Fund 03/15/94 -21.61 -- -14.52
Global Growth Fund 03/15/94 8.98 -- 74.42
International Smaller
Companies Fund 05/01/96 -12.27 -- -2.79
Large Cap Fund 05/01/96 20.29 -- 61.67
Mutual Discovery Fund 11/08/96 -5.00 -- 15.67
Mutual Shares Fund 11/08/96 .09 -- 21.96
Global Health Care Fund 05/01/98 -- -- 7.10
Value Fund 05/01/98 -- -- -22.10
YIELD, MONEY FUND
CURRENT YIELD Current yield shows the income per share earned by the fund. It is
calculated by determining the net change, excluding capital changes, in the
value of a hypothetical pre-existing account having a balance of one share at
the beginning of the period, subtracting a hypothetical charge reflecting
deductions from shareholder accounts, and dividing the difference by the value
of the account at the beginning of the base period to obtain the base period
return. The result is then annualized by multiplying the base period return by
(365/7). It does NOT include any fees or sales charges imposed by the variable
insurance contract for which the fund is an investment option. The fund's
current yield for the seven day period ended December 31, 1998, was 4.78%
EFFECTIVE YIELD. The fund's effective yield is calculated in the same manner as
its current yield, except the annualization of the return for the seven day
period reflects the results of compounding. The fund's effective yield for the
seven day period ended December 31, 1998, was 4.90%
This figure was obtained using the following SEC formula:
365/7
Effective Yield = [(Base Period Return + 1) ] - 1
YIELD, OTHER THAN MONEY FUND From time to time, the current yields of the funds
may be published in advertisements and communications to Contract Owners. The
current yield for each fund will be calculated by dividing the annualization of
the income earned by the fund 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 fund over different periods of
time may also be advertised. Except as stated above, each fund will use the same
methods for calculating its performance.
A distribution rate for each fund may also be published in communications
preceded or accompanied by a copy of the trust's current prospectus. The fund's
current distribution rate will be calculated by dividing the annualization of
the total distributions made by that fund 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 fund will also be
published along with publication of its distribution rate.
Hypothetical performance information may also be prepared for sales literature
or advertisements. See the appropriate insurance company separate account
prospectus and SAI.
VOLATILITY Occasionally statistics may be used to show the fund's volatility or
risk. Measures of volatility or risk are generally used to compare the fund's
net asset value or performance to a market index. One measure of volatility is
beta. Beta is the volatility of a fund relative to the total market, as
represented by an index considered representative of the types of securities in
which the fund invests. A beta of more than 1.00 indicates volatility greater
than the market and a beta of less than 1.00 indicates volatility less than the
market. Another measure of volatility or risk is standard deviation. Standard
deviation is used to measure variability of net asset value or total return
around an average over a specified period of time. The idea is that greater
volatility means greater risk undertaken in achieving performance.
COMPARISONS To help you better evaluate how an investment in the fund may
satisfy your investment goal, advertisements and other materials about the fund
may discuss certain measures of fund performance as reported by various
financial publications. Materials may also compare performance (as calculated
above) to performance as reported by other investments, indices, and averages.
These comparisons may include, but are not limited to, the following examples:
o CONSUMER PRICE INDEX - (or Cost of Living Index), published by the Bureau of
Labor Statistics - a statistical measure of change, over time, in the price
of goods and services in major expenditures groups.
o CREDIT SUISSE FIRST BOSTON HIGH YIELD (CSFB HY) INDEX - The index is an
unmanaged, trader-priced portfolio constructed to mirror the high yield debt
market. The index
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has several modules representing different sectors of the high yield market
including a cash paying module, a zerofix module, a pay-in-kind module, and a
defaulted module. The modular nature of the index allows customization of
data to meet client needs. The index is divided into other categories
including industry, rating, seniority, liquidity, market value, security
price range, yield range and other sector divisions. The CSFB HY Index
follows a total of 250 sectors. CS First Boston has maintained the index
since January 1986. While the index is priced and run weekly, monthly returns
are typically used for performance attribution.
o FINANCIAL TIMES/ S&P ACTUARIES WORLD (ENERGY 50%/BASIC INDUSTRIES 50%)
COMPOSITE INDEX - Franklin Templeton customizes this index using 50% of the
Financial Times/S&P Actuaries World Energy Index and 50% of the Financial
Times/S&P Actuaries World Basic Industries Index. Both indices are compiled
by the Financial Times, Goldman Sachs & Co. and Wood Mackenzie & Co., Ltd. in
conjunction with the Institute of Actuaries and the Faculty of Actuaries. The
index includes electric utilities, waterworks supply and telephone utilities.
The indices are weighted arithmetic averages of the market prices of the
elements that make them up. They also adjust for the intervening price
changes of these elements.
o FINANCIAL TIMES/ S&P ACTUARIES WORLD UTILITIES INDEX - This index is compiled
by the Financial Times, Goldman Sachs & Co. and Wood Mackenzie & Co., Ltd. in
conjunction with the Institute of Actuaries and the Faculty of Actuaries. The
utilities sector includes electric utilities, waterworks supply, natural gas
utilities and telephone companies. The indices are weighted arithmetic
averages of the market prices of the elements that make them up. They also
adjust for the intervening price changes of these elements. This is a total
return index in $U.S.
o INTERNATIONAL FINANCE CORPORATION'S (IFC) INVESTABLE COMPOSITE INDEX - The
index tracks the emerging stock markets of three world regions based on
market capitalization weighting. Those regions are Latin America, Asia and
Europe/Mideast/Africa. As of the end of 12/31/98, the regional weights of the
IFC Composite Index were distributed accordingly: Asia, 28%; Latin America,
34%; and Europe/Mideast/Africa, 38%.
o JP MORGAN GLOBAL GOVERNMENT BOND INDEX (UNHEDGED) - The index comprises 13
markets, including Australia, Belgium, Canada, Denmark, France, Germany,
Italy, Japan, Netherlands, Spain, Sweden, the U.K. and the U.S. Each
country's weight is determined by the total market capitalization in $U.S. of
all the bonds in that country's traded index. The J.P. Morgan Global
Government Bond Total Return Index includes only actively traded, fixed-rate
bonds with a remaining maturity of one year or longer. The index is unhedged
and expressed in terms of $U.S.
o LEHMAN BROTHERS GOVERNMENT/CORPORATE BOND INDEX - The index includes
securities in the Lehman Brothers Government and Corporate indices. These
securities must have at least $100 million par amount outstanding and must be
rated investment grade (Baa3 or better) by Moody's Investors Service. If a
Moody's rating is not available, the Standard & Poor's or Fitch rating is
used. These must be fixed-rate securities, although they can carry a coupon
that steps up or changes according to a predetermined schedule, and they must
be dollar-denominated and non-convertible.
o LEHMAN BROTHERS INTERMEDIATE GOVERNMENT BOND INDEX - This index includes
securities issued by the U.S. government or its agencies with maturities from
one up to, but not including, 10 years. These securities must have at least
$100 million par amount outstanding and must be rated investment grade (Baa3
or better) by Moody's Investors Service. If a Moody's rating is not
available, the Standard & Poor's or Fitch rating is used. These must be
fixed-rate securities, although they can carry a coupon that steps up or
changes according to a predetermined schedule, and they must be
dollar-denominated and non-convertible.
o LIPPER GROWTH & INCOME FUNDS OBJECTIVE AVERAGE - This is an equally weighted
average calculation of performance figures for all funds within the Lipper
Growth and Income Funds Objective Category, which is defined as all mutual
funds that combine a growth of earnings orientation and an income requirement
for level and/or rising dividends. As of 9/23/98, there were 30 funds in this
category.
o LIPPER INCOME FUNDS OBJECTIVE AVERAGE - This is an equally weighted average
calculation of performance figures for all funds within the Lipper Income
Funds Objective Category, which is defined as all mutual funds that normally
seek a high level of current income through investing in income-producing
stocks, bonds and money market instruments. As of 12/31/98, there were 99
funds in this category.
o MERRILL LYNCH TREASURY ZERO COUPON 1-, 5-, 10-, 20-YEAR BOND TOTAL RETURN
INDICES - The indices include zero coupon bonds that pay no interest and are
issued at a discount from redemption price.
o MORGAN STANLEY CAPITAL INTERNATIONAL (MSCI) ALL COUNTRY WORLD FREE INDEX -
The index represents both developed and emerging markets around the world.
"Free" in the title reflects the actual buying opportunities for global
investors by taking into account local market restrictions on share ownership
by foreigners. The MSCI indices define the local market for each country
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<PAGE>
by constructing a matrix of all listed securities, sorting the matrix by
industry, and seeking to capture 60% of the market capitalization for each
group by selecting the most investable stocks in each industry. The index
applies full market capitalization weights to each included stock.
o MORGAN STANLEY CAPITAL INTERNATIONAL (MSCI) ALL COUNTRY - WORLD EX-U.S. FREE
INDEX - The index comprises 48 countries around the world, both developed and
emerging markets, except the U.S. "Free" in the title reflects the actual
buying opportunities for global investors by taking into account local market
restrictions on share ownership by foreigners. The MSCI indices define the
local market for each country by constructing a matrix of all listed
securities, sorting the matrix by industry, and seeking to capture 60% of the
market capitalization for each group by selecting the most investable stocks
in each industry. The index applies full market capitalization weights to
each included stock.
o MORGAN STANLEY CAPITAL INTERNATIONAL (MSCI) EMERGING MARKETS FREE INDEX -
This is a market capitalization-weighted equity index comprising 26 of the 48
countries in the MSCI universe. "Free" denotes investment opportunities in
the developing world available to foreign investors. EMF performance data is
calculated in $US and local currency. The MSCI indices define the local
market for each country by constructing a matrix of all listed securities,
sorting the matrix by industry, and seeking to capture 60% of the market cap
for each group by selecting the most investable stocks in each industry. The
index applies full market cap weights to each included stock.
o MORGAN STANLEY CAPITAL INTERNATIONAL (MSCI) PACIFIC INDEX - The index
comprises five developed market countries or regions in the Pacific:
Australia, Hong Kong, Japan, New Zealand and Singapore. The MSCI indices
define the local market for each country by constructing a matrix of all
listed securities, sorting the matrix by industry, and seeking to capture 60%
of the market capitalization for each group by selecting the most investable
stocks in each industry. The index applies full market capitalization weights
to each included stock.
o MORGAN STANLEY CAPITAL INTERNATIONAL (MSCI) WORLD INDEX - The index comprises
the developed markets of 23 countries around the world. The MSCI indices
define the local market for each country by constructing a matrix of all
listed securities, sorting the matrix by industry, and seeking to capture 60%
of the market cap for each group by selecting the most investable stocks in
each industry. The index applies full market cap weights to each included
stock.
o RUSSELL 1000 INDEX - Published by Frank Russell Company, the index measures
the performance of the 1,000 largest companies in the Russell 3000 Index,
representing 89% of the market capitalization of the Russell 3000. The
Russell 3000 contains the 3,000 largest companies incorporated in the U.S.
and its territories. As of the latest reconstitution, the average market
capitalization of the companies in the Russell 1000 was approximately $9.9
billion; the median market capitalization was approximately $3.7 billion. The
smallest company in the index had an approximate market capitalization of
$1,404.7 million.
o RUSSELL 2500 INDEX - Published by Frank Russell Company, the index measures
the performance of the 2,500 smallest companies in the Russell 3000 Index,
representing approximately 22% of the total market capitalization of the
companies in the Russell 3000. The Russell 3000 contains the 3,000 largest
companies incorporated in the U.S. and its territories. As of the latest
reconstitution, the average market capitalization of the Russell 2500 was
approximately $931 million; the median market capitalization was
approximately $630 million. The largest company in the index had an
approximate market capitalization of $3.7 billion.
o SALOMON GLOBAL EX-U.S. LESS THAN $1 BILLION INDEX - This is a
total-capitalization weighted index that includes all developed and emerging
countries, except the U.S., and includes companies with a total market
capitalization below U.S. $1 billion.
o SALOMON WORLD EX-U.S. EXTENDED MARKET INDEX (EMI) - This is a comprehensive
float-weighted equity index consisting of every company with an investable
market capitalization of over $100 million in 22 countries, except the U.S.
The broad market index (BMI) is segregated into the primary market index
(PMI) and extended market index (EMI), consisting of large and small
capitalization issues, respectively.
o STANDARD & POOR'S[Registered Trademark] 500 STOCK INDEX (S&P 500) - The S&P
500 consists of 500 widely held domestic common stocks, consisting of four
broad sectors: industrials, utilities, financials and transportation. It is a
market value-weighted index, where the stock price is multiplied by the
number of shares outstanding, with each stock affecting the index in
proportion to its market value. This index, calculated by Standard & Poor's,
is a total return index with dividends reinvested.
o STANDARD & POOR'S HEALTH CARE COMPOSITE INDEX - This is a
capitalization-weighted index of all of the stocks in the Standard & Poor's
500 that are involved in the business of health care related products or
services. The index was developed with a base level of 100 as of January 14,
1987.
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o WILSHIRE MID CAP COMPANY GROWTH INDEX - This index overlaps the top 750 and
the next 1,750 of Wilshire Asset Management's Wilshire 2500 universe (the top
2,500 companies and 99% of the market capitalization of the Wilshire 5000).
Wilshire includes companies that have market capitalizations ranging from
$300 million to $1.3 billion. The portfolio contains from 125-500 securities.
o WILSHIRE REAL ESTATE SECURITIES INDEX - This is a market
capitalization-weighted index of publicly traded real estate securities, such
as real estate investment trusts (REITs), Real Estate Operating Companies
(REOCs) and partnerships. The index is composed of companies whose charter is
the equity ownership and operation of commercial real estate. The index
rebalances monthly and returns are calculated on a buy-and-hold basis.
o WILSHIRE SMALL COMPANY VALUE INDEX - The index is created by screening the
bottom 1,750 large companies of Wilshire Asset Management's Wilshire 2500
universe (the top companies and 99% of the market capitalization of the
Wilshire 5000). These companies have market capitalizations of at least $70
million. Wilshire excludes companies with high price/earnings ratios, low
yields, or high price/book ratios. The portfolio contains from 125-500
securities.
o DOW JONES[Registered Trademark] COMPOSITE AVERAGE AND ITS COMPONENT AVERAGES
- This is a price-weighted average of 65 stocks that trade on the New York
Stock Exchange. The average is a combination of the Dow Jones Industrial
Average (30 blue-chip stocks that are generally leaders in their industry),
the Dow Jones Transportation Average (20 transportation stocks), and the Dow
Jones Utilities Average (15 utility stocks involved in the production of
electrical energy).
o THE NEW YORK STOCK EXCHANGE COMPOSITE OR COMPONENT INDICES - This is an
unmanaged index of all industrial, utilities, transportation, and finance
stocks listed on the NYSE.
o WILSHIRE 5000 EQUITY INDEX - This represents the return on the market value
of all common equity securities for which daily pricing is available.
Comparisons of performance assume reinvestment of dividends.
o LIPPER - MUTUAL FUND PERFORMANCE ANALYSIS - This measures total return and
average current yield for the mutual fund industry and rank individual mutual
fund performance over specified time periods, assuming reinvestment of all
distributions, exclusive of any applicable sales charges.
o CDA MUTUAL FUND REPORT, published by CDA Investment Technologies, Inc. - This
analyzes price, current yield, risk, total return, and average rate of return
(average annual compounded growth rate) over specified time periods for the
mutual fund industry.
o MUTUAL FUND SOURCE BOOK, published by Morningstar, Inc. - This analyzes
price, yield, risk, and total return for mutual funds.
o Financial publications: THE WALL STREET JOURNAL, and BUSINESS WEEK, FINANCIAL
WORLD, FORBES, FORTUNE, and MONEY magazines - provide performance statistics
over specified time periods.
o STOCKS, BONDS, BILLS, AND INFLATION, published by Ibbotson Associates -
historical measure of yield, price, and total return for common and small
company stock, long-term government bonds, Treasury bills, and inflation.
o SAVINGS AND LOAN HISTORICAL INTEREST RATES - as published in the U.S. Savings
& Loan League Fact Book.
o Historical data supplied by the research departments of CS First Boston
Corporation, the J. P. Morgan companies, Salomon Brothers, Merrill Lynch,
Lehman Brothers and Bloomberg L.P.
o MORNINGSTAR - information published by Morningstar, Inc., including
Morningstar proprietary mutual fund ratings. The ratings reflect
Morningstar's assessment of the historical risk-adjusted performance of a
fund over specified time periods relative to other funds within its category.
o SALOMON BROTHERS BROAD BOND INDEX OR ITS COMPONENT INDICES - This measures
yield, price and total return for Treasury, agency, corporate and mortgage
bonds.
o LEHMAN BROTHERS AGGREGATE BOND INDEX OR ITS COMPONENT INDICES - This measures
yield, price and total return for Treasury, agency, corporate, mortgage and
Yankee bonds.
o SALOMON BROTHERS COMPOSITE HIGH YIELD INDEX OR ITS COMPONENT INDICES - This
measures yield, price and total return for the Long-Term High-Yield Index,
Intermediate-Term High-Yield Index, and Long-Term Utility High-Yield Index.
o The manager's and its affiliates' market share of international equities
managed in mutual funds prepared or published by Strategic Insight or a
similar statistical organization.
o The gross national product and populations, including age characteristics,
literacy rates, foreign investment improvements due to a liberalization of
securities laws and a reduction of foreign exchange controls, and improving
communication technology, of various countries as published by various
statistical organizations.
o Rankings by DALBAR Surveys, Inc. with respect to mutual fund shareholder
services.
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o Allegorical stories illustrating the importance of persistent long-term
investing.
o A description of the Templeton organization's investment management
philosophy and approach, including its worldwide search for undervalued or
"bargain" securities and its diversification by industry, nation and type of
stocks or other securities.
o Comparison of the characteristics of various emerging markets, including
population, financial and economic conditions.
o Quotations from the Templeton organization's founder, Sir John Templeton,*
advocating the virtues of diversification and long-term investing.
*Sir John Templeton sold the Templeton organization to Franklin Resources, Inc.
in October 1992 and resigned from the board on April 16, 1995. He is no longer
involved with the investment management process.
From time to time, advertisements or information for a fund may include a
discussion of certain attributes or benefits to be derived from an investment in
the fund. The advertisements or information may include symbols, headlines, or
other material that highlights or summarizes the information discussed in more
detail in the communication.
Advertisements or information may also compare a fund's performance to the
return on certificates of deposit (CDs) or other investments. You should be
aware, however, that an investment in the fund involves the risk of fluctuation
of principal value, a risk generally not present in an investment in a CD issued
by a bank. For example, as the general level of interest rates rise, the value
of the fund's fixed-income investments, if any, as well as the value of its
shares that are based upon the value of such portfolio investments, can be
expected to decrease. Conversely, when interest rates decrease, the value of the
fund's shares can be expected to increase. CDs are frequently insured by an
agency of the U.S. government. An investment in the fund is not insured by any
federal, state or private entity.
In assessing comparisons of performance, you should keep in mind that the
composition of the investments in the reported indices and averages is not
identical to the fund's portfolio, the indices and averages are generally
unmanaged, and the items included in the calculations of the averages may not be
identical to the formula used by the fund to calculate its figures. In addition,
there can be no assurance that the fund will continue its performance as
compared to these other averages.
MISCELLANEOUS INFORMATION
- --------------------------------------------------------------------------------
The Information Services & Technology division of Resources established a Year
2000 Project Team in 1996. This team has been making necessary software changes
to help the computer systems that service the fund and its shareholders to be
Year 2000 compliant. After completing these modifications, comprehensive tests
are conducted in one of Resources' U.S. test labs to verify their effectiveness.
Resources continues to seek reasonable assurances from all major hardware,
software or data-services suppliers that they will be Year 2000 compliant on a
timely basis. Resources is also developing a con tingency plan, including
identification of those mission critical systems for which it is practical to
develop a contingency plan. However, in an operation as complex and
geographically distributed as Resources' business, the alternatives to use of
normal systems, especially mission critical systems, or supplies of electricity
or long distance voice and data lines are limited.
FUND SIMILARITY The investment objectives and policies of certain funds are
similar but not identical to those of certain public Franklin Templeton Funds
indicated in the following table. 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 funds will differ from the
performance of the corresponding Franklin Templeton Funds:
FRANKLIN TEMPLETON VARIABLE
INSURANCE PRODUCTS TRUST FRANKLIN TEMPLETON FUNDS
- --------------------------------------------------------------------------------
FRANKLIN STRATEGIC SERIES:
Large Cap Fund - Franklin Large Cap Growth Fund
Global Health Care Fund - Franklin Global Health Care Fund
Global Communications Fund - Franklin Global Communications Fund
FRANKLIN INVESTORS SECURITIES TRUST
Growth and Income Fund Franklin Equity Income Fund
FRANKLIN HIGH INCOME TRUST
High Income Fund - AGE High Income Fund
FRANKLIN CUSTODIAN FUNDS, INC.:
Income Securities Fund - Income Series
Money Fund Franklin Money Fund
FRANKLIN MUTUAL SERIES FUND INC.:
Mutual Shares Fund - Mutual Shares Fund
Mutual Discovery Fund - Mutual Discovery Fund
FRANKLIN STRATEGIC SERIES:
Natural Resources Fund - Franklin Natural Resources Fund
FRANKLIN REAL ESTATE SECURITIES TRUST:
Real Estate 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
Developing Markets Fund Templeton Developing Markets Trust
TEMPLETON VARIABLE PRODUCTS SERIES FUND
Asset Allocation Fund - Templeton Asset Allocation Fund
Global Growth Fund Templeton Growth Fund, Inc.
FRANKLIN INVESTORS SECURITIES TRUST:
Global Income Fund - Franklin Global Government Income Fund
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FRANKLIN TEMPLETON VARIABLE
INSURANCE PRODUCTS TRUST FRANKLIN TEMPLETON FUNDS
- --------------------------------------------------------------------------------
FRANKLIN TEMPLETON INTERNATIONAL TRUST:
Pacific Growth Fund - Templeton Pacific Growth Fund
FRANKLIN CUSTODIAN FUNDS, INC.:
Government Fund U.S. Government Securities Series
FRANKLIN VALUE INVESTORS TRUST
Value Fund - Franklin Value Fund
DESCRIPTION OF BOND RATINGS
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CORPORATE BOND RATINGS
MOODY'S INVESTORS SERVICE, INC. (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 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 that 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 that 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. These
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. These 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 that are speculative to a high degree.
These 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.
STANDARD & POOR'S RATINGS GROUP (S&P[Registered Trademark])
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 a 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 these bonds will likely have some quality and protective
characteristics, they 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.
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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.
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. The
relative degree of safety, however, 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.
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