ANNUAL REPORT
================================================================================
1996
1996
1996
1996
1996
The Inefficient-
Market
Fund, Inc.
---------------------------------------
December 31, 1996
<PAGE>
- ---------------------------------
The Inefficient-Market Fund, Inc.
- ---------------------------------
Dear Shareholder:
We are pleased to provide you with the annual report for the year ended December
31, 1996, for The Inefficient-Market Fund, Inc. In this letter, we comment on
the market environment during the year and briefly review the Fund's investment
strategy. A detailed summary of the Fund's performance and current holdings can
be found in the appropriate sections that follow in the annual report.
Fund Performance Update
For the full year 1996, The Inefficient-Market Fund had a total return of 20.56%
on net asset value (NAV), assuming reinvestment of dividends and capital gain
distributions. The Fund's performance compared favorably to the Russell 2500
Index, which gained 19.03% on a total return basis over the same period. (The
Russell 2500 Index is a value-weighted index representing small and mid-sized
companies.) During 1996, the Standard and Poor's 500 Index (S&P 500), a widely
recognized index weighted in favor of stocks of large companies, had a total
return of 22.96%. As of December 31, 1996, the Fund's NAV was $12.30 and its
American Stock Exchange (AMEX) closing price was $11.50.
Economic and Market Overview
During 1996, the financial markets were jolted repeatedly by concerns over the
strength of the U.S. economy and the direction of Federal Reserve Board policy.
When investors gained confidence that the economy was continuing on a path of
moderate, non-inflationary growth, the stock market advanced strongly and posted
another year of outstanding performance. After a weak start in January, the
stock market moved broadly higher through early Spring. Small-company shares
advanced strongly in April and May, led by the technology sector. In late June
and early July, when the yield on the 30-year U.S. Treasury bond rose over 7.0%,
the stock market experienced a widespread sell-off. Growth stocks within the
small company universe in particular experienced sharp declines during the early
summer sell-off. At the end of July, large company stocks quickly recovered
their losses when the bond market stabilized. However, small company stocks
continued to struggle. When the national employment data confirmed that the U.S.
economy was slowing in the third quarter, the bond market rallied. Against the
backdrop of lower bond yields, low inflation and surprisingly resilient
corporate earnings, the stock market gained momentum during the Autumn, with
large company issues leading the way.
1
<PAGE>
As measured by the S&P 500, the U.S. stock market has provided a cumulative
total return of nearly 70% over the past two years, capping a six-year bull
market that began in October of 1990. Notwithstanding the strong overall
environment for equities, 1996 marked the third consecutive year of
underperformance by small and mid-sized company stocks relative to "blue chip"
equity indices such as the Dow Jones Industrial Average and the S&P 500. The
underperformance of small company stocks can be explained in part by the sharper
falloff in earnings growth experienced by smaller companies during 1995 and
1996. The lagging performance also reflected a backing away by investors from
higher risk growth stocks in a period of rising interest rates and increased
market volatility.
Given the frequent alarms raised in 1996 about slowing earnings growth,
investors showed an understandable preference for industry sectors with visible
earnings momentum. In the energy sector, analysts' earnings estimates and share
prices moved sharply higher in response to firmer prices for oil and natural
gas. Stocks in the finance sector also performed exceptionally well despite
emerging credit quality concerns. In the consumer sector, specialty and
broad-line retail stocks were up strongly in response to higher than expected
levels of consumer spending. Performance in the technology sector was mixed.
Computer product and semiconductor stocks were strong, but shares in the
telecommunications equipment and semiconductor equipment groups traded lower.
Industrial cyclical stocks underperformed, as soft domestic and export demand
led to declining commodity prices for paper, copper, aluminum, steel and
fertilizer products. The weakest overall sector was health care, with the HMO
group declining sharply on repeated earnings disappointments.
Fund Portfolio Review
The Inefficient-Market Fund is managed by the Travelers Investment Management
Company (TIMCO). TIMCO's approach to equity management is designed to provide
diversified exposure to the small and mid-sized capitalization segments of the
U.S. stock market. TIMCO selects stocks based on a disciplined quantitative
screening process that seeks attractive relative value and earnings growth. In
order to achieve consistent relative performance, TIMCO manages the Fund to
mirror the overall risk, sector weightings and growth or value style
characteristics of the Russell 2500 Index.
During 1996, stock selection in the health care sector made the largest positive
contribution to The Inefficient-Market Fund's relative performance.
Specifically, our positions in the medical devices and services groups, such as
U.S. Surgical, Guidant and Lincare Holdings helped boost the Fund's performance.
Our investments in consumer discretionary companies such as Lands' End, Tiffany,
Dollar General and Vons also contributed positively to the
2
<PAGE>
Fund's performance. The other area where the Fund performed well was the
financial services sector. In particular, SunAmerica, Reinsurance Group of
America, Green Tree Financial and FINOVA were top performers for the Fund.
Market Outlook
As we enter the seventh year of the current business expansion and equity bull
market, many questions arise about the outlook for interest rates and the
vulnerability of corporate earnings to rising costs. Late in the business cycle,
individual stock selection becomes increasingly important in a fund with a small
company emphasis because the small capitalization segment of the stock market is
comprised of less mature companies with relatively high exposure to cyclical
industries. We continue to focus on companies that offer improving fundamentals
and relative earnings gains at discounted stock prices. In the health care
sector, we are emphasizing Watson Pharmaceutical and Dura Pharmaceuticals, both
generic drug manufacturers with a growing pipeline of proprietary products. In
the consumer area, we have positions in a number of retailers that combine
above-average earnings growth and low relative valuations, including Lands' End
and Borders Group. Our screening process has also guided us toward companies
that are driving industry consolidation and have undervalued growth potential
such as Accustaff and MedPartners.
Closing Comments
We anticipate that at a shareholder meeting scheduled for April 18, 1997, the
Board of Directors of The Inefficient-Market Fund will present the shareholders
with a proposal to convert The Inefficient-Market Fund from a closed-end to an
open-end investment company structure. If approved, this proposed change to the
Fund's structure is tentatively scheduled to take place in June 1997.
In closing, thank you for investing in The Inefficient-Market Fund, Inc. We look
forward to continuing to help you achieve your financial goals.
Sincerely,
/s/ Heath B. McLendon
Heath B. McLendon
Chairman and Chief Executive Officer
February 7, 1997
3
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments December 31, 1996
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
COMMON STOCKS -- 99.6%
================================================================================
Autos & Transportation -- 4.7%
7,200 Alexander & Baldwin Inc. $ 180,000
7,800 Avondale Industries Inc.* 167,700
14,500 Cavalier Homes Inc. 166,750
10,400 Comair Holdings Inc. 249,600
6,900 Continental Airlines Inc., Class B Shares 194,925
3,000 GATX Corp. 145,500
8,200 Gentex Corp.* 165,025
2,200 Intermet Corp. 35,475
6,400 Lear Seating Corp.* 218,400
10,900 Mascotech Inc. 178,488
6,800 Oakwood Homes Corp. 155,550
7,300 Swift Transportation Co. Inc.* 171,550
7,800 US Freightways Corp. 214,013
5,900 Wisconsin Central Transportation Corp.* 233,788
- --------------------------------------------------------------------------------
2,476,764
- --------------------------------------------------------------------------------
Consumer Discretionary -- 17.3%
11,500 Accustaff Inc. 242,938
5,900 A. H. Belo Corp. 205,763
3,400 Alberto Culver Co., Class B Shares 163,200
11,600 Bed Bath & Beyond Inc.* 281,300
4,700 Blyth Industries Inc.* 214,438
8,100 Borders Group* 290,588
7,200 Boston Chicken, Inc.*+ 258,300
10,900 Callaway Golf Co. 313,375
5,300 CKE Restaurants, Inc. 190,800
19,500 Claire's Stores Inc. 253,500
9,700 Corrections Corp. of America* 297,063
7,775 Dollar General Corp. 248,800
5,000 Doubletree Corp.*+ 225,000
5,900 Emmis Broadcasting Corp., Class A Shares* 193,225
15,100 General Nutrition Co.* 254,813
4,855 Harman International Industries, Inc. 270,059
6,200 Harte-Hanks Communications Inc. 172,050
9,800 Heritage Media Corp., Class A Shares 110,250
1,508 Homestead Village Inc.* 27,150
6,885 HSN Inc.*+ 163,519
4,700 International Game Technology 85,775
6,450 Just for Feet Inc.*+ 169,313
6,700 Landry's Seafood Restaurants, Inc.* 143,213
10,200 Lands' End, Inc.* 270,300
11,000 Maytag Corp. 217,250
4,800 Miller, Inc. 271,800
7,200 Mohawk Industries, Inc.* 158,400
5,600 Nautica Enterprises, Inc.* 141,400
See Notes to Financial Statements.
4
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) December 31, 1996
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
Consumer Discretionary -- 17.3% (continued)
14,450 Officemax, Inc.* $ 153,531
8,400 Outback Steakhouse, Inc.* 224,700
7,600 Performance Food Group Co. 117,800
6,700 Promus Hotel Corp.* 198,488
3,400 Pulitzer Publishing Co. 157,675
6,300 Regis Corp. 102,375
7,400 Rite Aid Corp. 294,150
1,600 Scholastic Corp.* 107,600
6,400 SFX Broadcasting Inc.* 190,400
9,300 Showboat, Inc. 160,425
8,500 SITEL Corp.* 120,063
3,500 St. John Knits, Inc. 152,250
6,100 Stewart Enterprises Inc. 207,400
7,400 The Mens Wearhouse, Inc.* 181,300
5,500 Tiffany & Co. 201,438
9,200 US1 Industries Inc.* 316,250
4,000 USA Detergents Inc.*+ 166,500
3,500 Viking Office Products, Inc.* 93,406
7,450 Wolverine Worldwide, Inc. 216,050
- --------------------------------------------------------------------------------
9,195,383
- --------------------------------------------------------------------------------
Consumer Staples -- 2.2%
7,400 Dean Foods Co. 238,650
8,700 Dole Food Co., Inc. 294,713
4,300 Interstate Bakeries, Corp. 211,238
7,400 Richfood Holdings Inc. 179,450
7,200 Universal Corp. 231,300
- --------------------------------------------------------------------------------
1,155,351
- --------------------------------------------------------------------------------
Financial Services -- 15.8%
4,150 Allied Group, Inc. 135,394
3,500 AMBAC Inc. 232,313
5,000 American Bankers Insurance Group, Inc. 255,625
7,000 AmSouth Bancorp. 338,625
6,600 Anchor Bancorp Inc. 235,950
4,100 Bay View Capital Corp. 173,738
2,800 CCB Financial Corp. 191,100
6,200 Centura Banks Inc. 276,675
11,300 City National Corp. 244,363
800 CMAC Investment Corp. 29,400
6,100 Colonial BancGroup Inc. 244,000
1,600 Crestar Financial Corp. 119,000
11,700 Dime Bancorp. Inc.* 172,575
5,300 Donaldson, Lufkin & Jenrette, Inc. 190,800
7,900 Everest Reinsurance Holdings, Inc. 227,125
6,900 Executive Risk, Inc. 255,300
See Notes to Financial Statements.
5
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- --------------------------------------------------------------------------------
Schedule of Investments (continued) December 31, 1996
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
Financial Services -- 15.8% (continued)
3,700 FINOVA Group, Inc. $ 237,725
6,600 First Tennessee National Corp. 247,500
5,000 First Virginia Banks, Inc. 239,375
8,500 Great Financial Corp. 247,563
10,200 HCC Insurance Holdings Inc. 244,800
9,900 Lehman Brothers Holdings, Inc. 310,613
6,400 Mercantile Bankshares Co. 204,800
6,333 Mutual Risk Management Ltd. 234,333
2,315 Old Kent Financial Corp. 110,541
9,600 Old Republic International Corp. 256,800
9,100 Olympic Financial Ltd.* 130,813
5,500 Penncorp Financial Group Inc. 198,000
4,300 PMI Group Inc. 238,113
4,000 Relistar Financial Corp. 231,000
7,900 Signet Banking Corp. 242,925
7,900 Silicon Valley Bancshares 254,775
6,700 TIG Holdings, Inc. 226,963
3,200 Transatlantic Holdings, Inc. 257,600
5,800 Union Planters Corp. 226,200
5,800 Vesta Insurance Group Inc. 181,975
2,700 Washington Mutual, Inc. 116,944
2,800 Zions Bancorp 291,200
3,800 Zurich Reinsurance Centre Holdings, Inc. 118,750
- --------------------------------------------------------------------------------
8,371,291
- --------------------------------------------------------------------------------
Healthcare -- 9.9%
2,800 ALZA Corp.* 72,450
7,300 American Homepatient Inc.* 198,925
8,200 American Medical Response, Inc. 266,500
5,300 AmeriSource Health Corp. 255,725
6,400 Apria Healthcare Group Inc.* 120,000
6,600 Arbor Health Care Co.* 171,600
2,900 Biogen, Inc.* 112,375
14,100 Capstone Pharmacy Services, Inc.* 160,388
7,200 Centocor, Inc.* 257,400
15,100 Creative Biomolecules Inc.* 156,663
7,200 Dura Pharmaceuticals Inc.* 343,800
8,400 Genzyme Corp.* 182,700
10,250 Health Management Associates, Inc.* 230,625
6,500 HealthCare COMPARE Corp.* 275,438
6,400 Living Centers of America* 177,600
15,800 MedPartners/Mullikin, Inc.* 331,800
9,200 Renal Treatment Centers, Inc.* 234,600
5,700 STERIS Corp.* 247,950
10,600 Stryker Corp.+ 316,675
6,200 U.S. Surgical Corp. 244,125
See Notes to Financial Statements.
6
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- --------------------------------------------------------------------------------
Schedule of Investments (continued) December 31, 1996
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
Healthcare -- 9.9% (continued)
12,300 UroMed Corp.*+ $ 119,925
7,100 Vencor Inc.* 224,538
10,500 VISX Inc.*+ 232,313
7,600 Watson Pharmaceuticals, Inc.* 341,525
- --------------------------------------------------------------------------------
5,275,640
- --------------------------------------------------------------------------------
Integrated Oils -- 1.4%
3,500 Ashland Inc. 153,563
4,900 Murphy Oil Corp. 272,563
12,700 Tesoro Petroleum Corp.* 177,800
1,700 Tosco Corp. 134,513
- --------------------------------------------------------------------------------
738,439
- --------------------------------------------------------------------------------
Materials & Processing -- 13.7%
6,300 Alumax Inc.* 210,263
3,800 Armstrong World Industries Inc. 264,100
8,100 Avalon Properties, Inc. 232,875
8,000 BMC Industries, Inc. 252,000
5,500 Beacon Properties Corp. 201,438
6,900 Bemis Inc. 254,438
16,200 Bethlehem Steel Corp.* 145,800
5,200 Boise Cascade Corp. 165,100
10,000 Cabot Corp. 251,250
8,100 Cali Realty Corp. 250,088
10,300 Coeur d'Alene Mines Corp. 155,788
5,500 Commerical Metals Co. 165,688
9,200 Cytec Industries, Inc.* 373,750
5,800 Dexter Corp. 184,875
6,600 First Industrial Realty Trust Inc. 200,475
2,400 Georgia Gulf Corp. 64,500
7,200 Health Care Properties Investment, Inc. 252,000
4,300 Hughes Supply Inc. 185,438
16,600 International Specialty Products Inc.* 203,350
3,200 James River Corp. 106,000
7,700 Liberty Property Trust 198,275
4,700 Lone Star Industries 173,313
8,500 Meditrust Corp. 340,000
10,000 Nationwide Health Properties, Inc. 242,500
5,800 Olin Corp. 218,225
6,400 OM Group Inc. 172,800
1,300 Owens-Corning Fiberglass Corp. 55,413
5,900 Sealed Air Corp.* 245,588
11,000 Security Capital Pacific Trust 251,625
10,100 Shiloh Industries Inc.* 164,125
8,100 Simon DeBartolo Property Group, Inc. 251,100
6,400 Stone Container Corp. 95,200
See Notes to Financial Statements.
7
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) December 31, 1996
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
Materials & Processing -- 13.7% (continued)
14,200 Terra Industries, Inc. $ 209,450
3,500 Vornado Realty Trust 183,750
13,500 Walter Industries Inc.* 190,688
4,100 Wolverine Tube, Inc.* 144,525
- --------------------------------------------------------------------------------
7,255,793
- --------------------------------------------------------------------------------
Other Energy -- 4.4%
3,800 Chesapeake Energy Corp.*+ 211,375
3,000 Cooper Cameron Corp.* 229,500
10,100 Global Industries Ltd.* 188,113
13,400 Global Marine Inc.* 276,375
5,100 Louisiana Land & Exploration Co. 273,488
6,000 Noble Affiliates, Inc. 287,250
13,100 Noble Drilling Corp.* 260,363
15,200 Oryx Energy Co.* 376,200
3,500 Transocean Offshore Inc. 219,188
- --------------------------------------------------------------------------------
2,321,852
- --------------------------------------------------------------------------------
Producer Durables -- 6.2%
200 American Power Conversion* 5,450
6,900 Crane Co. 200,100
6,100 Danaher Corp. 284,413
9,000 Durrion Co. Inc. 244,125
2,800 Harnischfeger Industries, Inc. 134,750
6,300 Hubbell Inc., Class B Shares 272,475
7,600 Jacobs Engineering Group* 179,550
12,800 JLG Industries Inc. 204,800
4,400 Litton Industries Inc.* 209,550
2,100 Raychem Corp. 168,263
8,700 Robbins & Myers Inc. 217,500
6,200 Sundstrand Corp. 263,500
6,400 TETRA Technologies, Inc.* 161,600
11,300 Toll Brothers, Inc.* 220,350
7,500 United Waste Systems Inc.* 257,813
4,800 York International Corp. 268,200
- --------------------------------------------------------------------------------
3,292,439
- --------------------------------------------------------------------------------
Technology -- 15.4%
1,600 Altera Corp. 116,300
3,050 Andrew Corp.* 161,841
7,100 Applix Inc.* 155,313
6,300 Atmel Corp.* 208,688
26,500 Auspex Systems Inc.* 308,063
5,200 Avant Corp.* 165,100
6,800 BancTec, Inc.* 140,250
5,300 Brooktrout Technology, Inc.* 148,400
See Notes to Financial Statements.
8
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) December 31, 1996
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
Technology -- 15.4% (continued)
4,100 C-Cube Microsystems, Inc.* $ 151,444
4,100 Cadence Design Systems, Inc.* 162,975
4,300 CIDCO, Inc.* 75,250
18,200 Computervision Corp.* 168,350
3,400 Comverse Technology, Inc.* 128,563
10,450 Concord Efs, Inc.* 295,213
10,200 Credence Systems Corp.* 205,275
8,400 Datastream Systems Inc.* 151,200
1,700 Diebold Inc. 106,888
10,400 DSP Communications, Inc.* 201,500
6,000 Electronic Arts Inc.* 179,625
3,400 Electronics For Imaging Inc.* 279,650
8,100 Eltron International, Inc. 163,013
3,900 ENCAD Inc.* 160,875
3,400 Hadco Corp.* 166,600
3,200 In Focus Systems, Inc.* 69,200
13,200 International Rectifier Corp.* 201,300
5,200 Jack Henry & Associates 185,900
7,300 KEMET Corp.* 169,725
6,400 Lam Research Corp.* 180,000
10,200 Macromedia, Inc.* 183,600
2,800 Maxim Integrated Products Inc.* 121,100
6,000 McAfee Associates Inc.* 264,000
4,200 National Semiconductor Corp.* 102,375
6,100 Periphonics Corp.* 178,425
6,700 PictureTel Corp.* 174,200
5,700 Read-Rite Corp.* 143,925
7,700 S3 Inc.* 125,125
5,100 SCI Systems Inc.* 227,588
5,400 SPSS Inc.* 150,525
6,400 Shiva Corp.* 223,200
5,800 Storage Technology Inc.* 276,225
7,400 Structural Dynamics Research* 148,000
4,800 SunGard Data Systems, Inc.* 189,600
4,000 Symbol Technologies* 177,000
10,000 Systemsoft Corp.* 148,750
6,800 Tech Data Corp.* 186,150
9,300 Tencor Instruments Co.* 245,288
2,600 Xilinx Inc.* 95,713
- --------------------------------------------------------------------------------
8,167,290
- --------------------------------------------------------------------------------
Utilities -- 8.6%
5,800 AES Corp. 269,700
7,500 AGL Resources Inc. 158,438
4,800 Bay State Gas Co. 135,600
9,300 Brooklyn Union Gas Co. 280,163
See Notes to Financial Statements.
9
<PAGE>
- --------------------------------------------------------------------------------
Schedule of Investments (continued) December 31, 1996
- --------------------------------------------------------------------------------
SHARES SECURITY VALUE
================================================================================
Utilities -- 8.6% (continued)
7,500 Calenergy Inc.* $ 252,188
5,400 Century Telephone Enterprises Inc. 166,725
3,900 CILCORP Inc. 142,838
7,700 CMS Energy Corp. 258,913
4,000 DPL Inc. 98,000
8,300 DQE Inc. 240,700
9,200 ENSERCH Corp. 211,600
8,800 Illinova Corp. 242,000
6,700 LG&E Energy Corp. 164,150
7,400 Metricom Inc.*+ 111,000
5,400 National Fuel Gas Co. 222,750
5,800 NIPSCO Industries, Inc. 229,825
4,100 Northeast Utilities System 54,325
12,100 Paging Network Inc.* 184,525
8,500 Piedmont Natural Gas Co. 198,688
8,900 Pinnacle West Capital Corp. 282,575
4,100 Public Service Co. 159,388
4,200 Rochester Gas & Electric, Corp. 80,325
9,400 South Jersey Industries Inc. 229,125
7,400 Washington Gas Light Co. 167,392
- --------------------------------------------------------------------------------
4,540,933
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost -- $48,399,064) 52,791,175
================================================================================
WARRANT -- 0.0%
1,011 Homestead Village Inc., Expires 10/29/97*
(Cost -- $2,530) 8,214
================================================================================
FACE
AMOUNT SECURITY VALUE
================================================================================
REPURCHASE AGREEMENT -- 0.4%
$223,000 Chase Manhattan Bank, 6.490% due 1/2/97; Proceeds
at maturity -- $223,080; (Fully collateralized by
U.S. Treasury Notes, 5.875% due 10/31/98; Market
value -- $227,732) (Cost -- $223,000) 223,000
================================================================================
TOTAL INVESTMENTS -- 100%
(Cost -- $48,624,594**) $53,022,389
================================================================================
* Non-income producing security.
+ Security on loan (Note 8).
** Aggregate cost for Federal income tax purpose is substantially the same.
See Notes to Financial Statements.
10
<PAGE>
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities December 31, 1996
- --------------------------------------------------------------------------------
ASSETS:
Investments, at value (Cost -- $48,624,594) $53,022,389
Cash and cash equivalents 1,899,872
Receivable for securities sold 746,365
Dividends and interest receivable 41,515
- --------------------------------------------------------------------------------
Total Assets 55,710,141
- --------------------------------------------------------------------------------
LIABILITIES:
Payable for securities loaned 1,899,125
Payable for securities purchased 791,499
Management fees payable 33,350
Administration fees payable 11,274
Accrued expenses 63,750
- --------------------------------------------------------------------------------
Total Liabilities 2,798,998
- --------------------------------------------------------------------------------
Total Net Assets $52,911,143
================================================================================
NET ASSETS:
Par value of capital shares $ 4,384
Capital paid in excess of par value 48,742,718
Treasury stock, at cost (Note 5) (888,402)
Undistributed net investment income 20,277
Accumulated net realized gain from
security transactions and futures contracts 634,371
Net unrealized appreciation of investments 4,397,795
- --------------------------------------------------------------------------------
Total Net Assets
(Equivalent to $12.30 a share on 4,300,950 shares of
$0.001 par value outstanding, 100,000,000 shares authorized) $52,911,143
================================================================================
See Notes to Financial Statements.
11
<PAGE>
- --------------------------------------------------------------------------------
Statement of Operations For the Year Ended December 31, 1996
- --------------------------------------------------------------------------------
INVESTMENT INCOME:
Dividends $ 678,012
Interest 231,170
- --------------------------------------------------------------------------------
Total Investment Income 909,182
- --------------------------------------------------------------------------------
EXPENSES:
Management fees (Note 2) 416,104
Administration fees (Note 2) 138,701
Shareholder and system servicing fees 38,001
Shareholder communications 25,001
Audit and legal 16,027
Custody 14,000
Directors' fees 5,000
Other 20,605
- --------------------------------------------------------------------------------
Total Expenses 673,439
- --------------------------------------------------------------------------------
Net Investment Income 235,743
- --------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS
AND FUTURES CONTRACTS (NOTES3 AND 6):
Realized Gain From:
Security transactions (excluding short-term securities) 8,283,309
Futures contracts 128,266
- --------------------------------------------------------------------------------
Net Realized Gain 8,411,575
- --------------------------------------------------------------------------------
Change in Net Unrealized Appreciation of Investments:
Beginning of year 3,607,850
End of year 4,397,795
- --------------------------------------------------------------------------------
Increase in Net Unrealized Appreciation 789,945
- --------------------------------------------------------------------------------
Net Gain on Investments and Futures Contracts 9,201,520
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations $9,437,263
================================================================================
See Notes to Financial Statements.
12
<PAGE>
- --------------------------------------------------------------------------------
Statements of Changes in Net Assets For the Years Ended December 31,
- --------------------------------------------------------------------------------
1996 1995
================================================================================
OPERATIONS:
Net investment income $ 235,743 $ 466,652
Net realized gain 8,411,575 9,756,550
Increase in net unrealized appreciation 789,945 133,385
- --------------------------------------------------------------------------------
Increase in Net Assets From Operations 9,437,263 10,356,587
- --------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (193,543) (460,174)
Net realized gains (8,604,302) (8,377,613)
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Distributions to Shareholders (8,797,845) (8,837,787)
- --------------------------------------------------------------------------------
FUND SHARE TRANSACTIONS (NOTE 5):
Treasury stock acquired (274,104) (614,298)
- --------------------------------------------------------------------------------
Decrease in Net Assets From
Fund Share Transactions (274,104) (614,298)
- --------------------------------------------------------------------------------
Increase in Net Assets 365,314 904,502
NET ASSETS:
Beginning of year 52,545,829 51,641,327
- --------------------------------------------------------------------------------
End of year* $ 52,911,143 $ 52,545,829
================================================================================
* Includes undistributed (overdistributed)
net investment income of: $ 20,277 $ (21,923)
================================================================================
See Notes to Financial Statements.
13
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
The Inefficient-Market Fund, Inc. ("Fund"), a Maryland corporation, is
registered under the Investment Company Act of 1940, as amended, as a
non-diversified, closed-end management investment company.
The significant accounting policies consistently followed by the Fund are:
(a) security transactions are accounted for on trade date; (b) securities traded
on a national securities exchange or on the NASDAQ National Market System are
valued at closing prices on such exchange or market; securities for which no
sales prices are reported are valued at the mean between the most recently
quoted bid and ask prices; (c) securities maturing within 60 days or less are
valued at cost plus accreted discount, or minus amortized premium, which
approximates market value; (d) dividend income is recorded on the ex-dividend
date and interest income is recorded on the accrual basis; (e) dividends and
distributions to shareholders are recorded on the ex-dividend date; (f) expenses
are charged to the Fund; (g) gains or losses on the sale of securities are
calculated by using the specific identification method; (h) the Fund intends to
comply with the applicable provisions of the Internal Revenue Code of 1986, as
amended, pertaining to regulated investment companies and to make distributions
of taxable income sufficient to relieve it from substantially all Federal income
and excise taxes; (i) the character of income and gains distributed are
determined in accordance with income tax regulations which may differ from
generally accepted accounting principles; and (j) estimates and assumptions are
required to be made regarding assets, liabilities and changes in net assets
resulting from operations when financial statements are prepared. Changes in the
economic environment, financial markets and any other parameters used in
determining these estimates could cause actual results to differ.
2. MANAGEMENT AGREEMENT AND TRANSACTIONS WITH
AFFILIATED PERSONS
Travelers Investment Management Company ("TIMCO"), a subsidiary of Smith
Barney Holdings Inc. ("SBH"), acts as investment manager to the Fund. The Fund
pays TIMCO a fee calculated at the annual rate of 0.75% of the Fund's average
daily net assets. This fee is calculated daily and paid monthly.
Smith Barney Mutual Funds Management Inc. ("SBMFM"), another subsidiary of
SBH, acts as the Fund's administrator. As compensation for its services, the
Fund pays SBMFM a fee calculated at the annual rate of 0.25% of the Fund's
average daily net assets. This fee is calculated daily and paid monthly.
14
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
For the year ended December 31, 1996, Smith Barney Inc. ("SB"), also a
subsidiary of SBH, was paid brokerage commissions of $7,375 by the Fund on
agency portfolio transactions.
All officers and three Directors of the Fund are employees of SB.
3. INVESTMENTS
For the year ended December 31, 1996, the aggregate cost of purchases and
proceeds from sales of investments (including maturities, but excluding
short-term securities) were as follows:
================================================================================
Purchases $76,920,007
- --------------------------------------------------------------------------------
Sales 84,121,221
================================================================================
At December 31, 1996, aggregate gross unrealized appreciation and
depreciation of investments were as follows:
================================================================================
Gross unrealized appreciation $ 6,806,547*
Gross unrealized depreciation (2,408,752)*
- --------------------------------------------------------------------------------
Net unrealized appreciation $ 4,397,795*
================================================================================
* Substantially the same for Federal income tax purposes.
4. REPURCHASE AGREEMENTS
The Fund purchases (and its custodian takes possession of) U.S. Government
securities from banks and securities dealers subject to agreements to resell the
securities to the sellers at a future date (generally, the next business day) at
an agreed-upon higher repurchase price. The Fund requires daily maintenance of
the market value of the collateral in amounts at least equal to the repurchase
price.
5. CAPITAL SHARES
On June 8, 1995, the Fund commenced a share repurchase plan. As of December
31, 1996, 83,050 shares had been repurchased.
6. FUTURES CONTRACTS
Initial margin deposits made upon entering into futures contracts are
recognized as assets. The initial margin is segregated by the custodian and is
noted in the schedule of investments. During the period the futures contract is
open, changes in the value of the contract are recognized as unrealized gains or
losses by "marking to market" on a daily basis to reflect the market value of
the contract at the end of each day's trading. Variation margin payments are
received or made and recognized as assets due from or liabilities due to the
broker,
15
<PAGE>
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
depending upon whether unrealized gains or losses are incurred. When the
contract is closed, the Fund records a realized gain or loss equal to the
difference between the proceeds from (or cost of) the closing transaction and
the Fund's basis in the contract. The Fund enters into such contracts to hedge a
portion of its portfolio. The Fund bears the market risk that arises from
changes in the value of the financial instruments and securities indices
(futures contracts) and the credit risk should a counterparty fail to perform
under such contracts.
At December 31, 1996, there were no open futures contracts.
7. OPTION CONTRACTS
Premiums paid when put or call options are purchased by the Fund, represent
investments, which are marked-to-market daily. When a purchased option expires,
the Fund will realize a loss in the amount of the premium paid. When the Fund
enters into a closing sales transaction, the Fund will realize a gain or loss
depending on whether the proceeds from the closing sales transaction are greater
or less than the premium paid for the option. When the Fund exercises a put
option, it will realize a gain or loss from the sale of the underlying security
and the proceeds from such sale will be decreased by the premium originally
paid. When the Fund exercises a call option, the cost of the security which the
Fund purchases upon exercise will be increased by the premium originally paid.
At December 31, 1996, the Fund had no open purchased call or put option
contracts.
8. LENDING OF PORTFOLIO SECURITIES
The Fund has an agreement with its custodian whereby the custodian may lend
securities owned by the Fund to brokers, dealers and other financial
organizations, and receives a lenders fee, which is shared 60% by the Fund and
40% by the custodian. Fees earned by the Fund on securities lending are recorded
in interest income. Loans of securities by the Fund are collateralized by cash,
U.S. Government securities or high quality money market instruments that are
maintained at all times in an amount at least equal to the current market value
of the loaned securities, plus a margin which may vary between 2% and 5%
depending on the type of securities loaned. The custodian establishes and
maintains the collateral in a segregated account. The Fund maintains exposure
for the risk of any losses in the investment of amounts received as collateral.
At December 31, 1996, the Fund loaned common stocks having a value of
approximately $1,828,290 and received cash collateral of $1,899,125 for the
loan.
16
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
For a share of capital stock outstanding throughout each year:
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
==============================================================================================================
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year $ 12.15 $ 11.78 $ 12.50 $ 11.49 $ 10.34
- --------------------------------------------------------------------------------------------------------------
Income (Loss) From Operations:
Net investment income 0.05 0.11 0.05 0.01 0.05
Net realized and unrealized gain (loss) 2.14 2.31 (0.63) 1.01 1.15
- --------------------------------------------------------------------------------------------------------------
Total Income (Loss) From Operations 2.19 2.42 (0.58) 1.02 1.20
- --------------------------------------------------------------------------------------------------------------
Less Distributions From:
Net investment income (0.04) (0.11) (0.05) (0.01) (0.05)
Net realized gains(1) (2.00) (1.94) (0.09) -- --
- --------------------------------------------------------------------------------------------------------------
Total Distributions (2.04) (2.05) (0.14) (0.01) (0.05)
- --------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year $ 12.30 $ 12.15 $ 11.78 $ 12.50 $ 11.49
- --------------------------------------------------------------------------------------------------------------
Total Return,
Based on Market Value 39.57% 24.18% (8.46)% 6.44% 11.86%
- --------------------------------------------------------------------------------------------------------------
Total Return,
Based on Net Asset Value 20.56% 18.90% (4.36)% 8.90% 11.71%
- --------------------------------------------------------------------------------------------------------------
Net Assets, End of Year (000s) $ 52,911 $ 52,546 $ 51,641 $ 54,809 $ 50,374
- --------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
Expenses 1.21% 1.22% 1.22% 1.24% 1.36%
Net investment income 0.43 0.84 0.43 0.08 0.45
- --------------------------------------------------------------------------------------------------------------
Portfolio Turnover Rate 151% 177% 45% 87% 46%
- --------------------------------------------------------------------------------------------------------------
Market Price, End of Year $ 11.500 $ 9.813 $ 9.500 $ 10.500 $ 9.875
- --------------------------------------------------------------------------------------------------------------
Average commissions per share
paid on equity transactions(2) $ 0.05 $ 0.05 -- -- --
==============================================================================================================
</TABLE>
(1) Includes short-term realized gains distributions which are considered
ordinary income for Federal income tax purposes.
(2) As of September 1995, the SEC instituted new guidelines requiring the
disclosure of average commissions per share.
17
<PAGE>
- --------------------------------------------------------------------------------
Independent Auditors' Report
- --------------------------------------------------------------------------------
TO THE SHAREHOLDERS AND BOARD OF DIRECTORS
OF THE INEFFICIENT-MARKET FUND, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of The Inefficient-Market Fund, Inc. as of December
31, 1996, the related statement of operations for the year then ended, the
statement of changes in net assets for each of the years in the two-year period
then ended and the financial highlights for each of the years in the five-year
period then ended. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
December 31, 1996, by correspondence with the custodian. As to securities
purchased or sold but not received or delivered, we performed other appropriate
auditing procedures. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of The
Inefficient-Market Fund, Inc. as of December 31, 1996, the results of its
operations for the year then ended, the changes in its net assets for each of
the years in the two-year period then ended and the financial highlights for
each of the years in the five-year period then ended, in conformity with
generally accepted accounting principles.
KPMG Peat Marwick LLP
New York, New York
February 18, 1997
18
<PAGE>
- --------------------------------------------------------------------------------
Financial Data (unaudited)
- --------------------------------------------------------------------------------
For a share of capital stock outstanding throughout each period:
Dividend and
Price Price at NAV at Premium(+) Capital Gain
Period Range Month-End Month-End Discount(-) Distributions
================================================================================
1995
January $ 9 1/4 - 9 5/8 $ 9 3/8 $11.77 -20% --
February 9 3/8 - 9 7/8 9 3/4 12.31 -21 --
March 9 5/8 - 9 7/8 9 5/8 12.24 -21 --
April 9 3/4 - 10 9 13/16 12.24 -20 --
May 9 3/4 - 10 9 3/4 12.52 -22 --
June 9 3/4 - 10 3/8 10 1/8 12.99 -22 --
July 10 1/8 - 10 3/8 10 3/8 13.16 -21 --
August 10 3/8 - 10 1/2 10 3/8 13.46 -23 --
September 10 1/2 - 11 1/8 10 3/4 13.74 -22 --
October 10 1/2 - 11 10 1/2 13.46 -22 --
November 10 5/8 - 11 1/8 11 1/2 14.05 -22 --
December 9 1/2 - 11 1/2 9 13/16 12.15 -19 $2.05
1996
January 9 3/4 - 10 3/8 10 1/2 12.23 -18 --
February 10 - 10 5/8 10 5/8 12.62 -16 --
March 10 3/8 - 10 3/4 10 5/8 12.87 -17 --
April 10 5/8 - 11 1/2 11 1/2 13.45 -14 --
May 11 - 11 7/8 11 5/8 13.77 -16 --
June 11 3/8 - 11 3/4 11 3/8 13.44 -15 --
July 10 1/8 - 11 5/8 10 1/4 11.92 -14 0.60
August 10 1/2 - 10 3/4 10 5/8 12.72 -16 --
September 10 3/4 - 11 1/4 11 1/4 13.40 -16 --
October 11 3/8 - 12 1/4 11 3/4 13.08 -10 --
November 11 - 12 1/2 11 1/4 12.29 -10 1.40
December 11 - 11 7/8 11 1/2 12.30 -7 0.04
================================================================================
19
<PAGE>
- --------------------------------------------------------------------------------
Dividend Reinvestment Plan (unaudited)
- --------------------------------------------------------------------------------
Pursuant to the Fund's Dividend Reinvestment Plan ("Plan"), all distributions
are automatically reinvested by First Data Investor Services Group, Inc., as
plan agent ("Plan Agent"), in additional shares of its Common Stock ("Common
Shares") as provided below unless a stockholder elects to receive cash.
Distributions with respect to Common Shares registered in the name of a
broker-dealer or other nominee (i.e., in "street name") are reinvested by the
broker or nominee in additional Common Shares under the Plan, unless the service
is not provided by the broker or nominee. Investors who own Common Shares
registered in street name should consult their broker-dealer for details. All
distributions to stockholders who do not participate in the Plan are paid by
check mailed directly to the record holder by First Data Investor Services
Group, Inc., as dividend disbursing agent.
If the Fund declares a distribution payable either in Common Shares or in cash,
nonparticipants in the Plan receive cash, and Plan participants receive the
equivalent in Common Shares valued in the following manner: whenever the market
price is equal to or exceeds the net asset value per share at the time Common
Shares are valued for the purpose of determining the number of Common Shares
equivalent to the cash distribution, participants are issued Common Shares
valued at the greater of (1) the net asset value most recently determined or (2)
95% of the then current market price of the Common Shares.
If the net asset value of the Common Shares at the time of valuation exceeds the
market price of the Common Shares, or if the Fund declares a distribution
payable only in cash, the Plan Agent buys Common Shares in the open market, on
the American Stock Exchange or elsewhere, for the participants' accounts. The
Plan Agent applies all cash received as a distribution to purchase Common Shares
on the open market as soon as practicable after the record date of the
distribution, but in no event later than 45 days after such date, except when
necessary to comply with applicable provisions of the Federal securities laws.
If, following the commencement of purchases and before the Plan Agent has
completed its purchases, the market price exceeds the net asset value of the
Common Shares, the Plan Agent is permitted to cease purchasing shares on the
open market and the Fund may issue the remaining shares at a price equal to the
greater of (a) net asset value or (b) 95% of the then current market price. In a
case where the Plan Agent has terminated open market purchases and the Fund has
issued the remaining shares, the number of shares received by the participant in
respect of the cash dividend or distribution will be based on the weighted
average of prices paid for shares purchased in the open market and the price at
which the Fund issued the remaining shares.
20
<PAGE>
- --------------------------------------------------------------------------------
Dividend Reinvestment Plan (unaudited) (continued)
- --------------------------------------------------------------------------------
Participants in the Plan may withdraw from the Plan upon written notice to the
Plan Agent which must be received at least ten business days prior to the
distribution record date to become effective for that distribution. Shares in
the account of each Plan participant are held by the Plan Agent in
non-certificated form in the name of the Plan Agent or participant. When a
participant withdraws from the Plan or upon termination of the Plan as provided
below, certificates for whole Fund shares credited to his or her account under
the Plan are issued and a cash payment is made for any fraction of a Fund share
credited to such account.
The automatic reinvestment of distributions does not relieve participants to any
Federal income tax that may be payable on such distributions.
The Fund does not charge participants for reinvesting distributions. Any Plan
Agent's fees for the handling of reinvestment of distributions under the Plan
are paid by the Fund. There are no brokerage charges with respect to Common
Shares issued directly by the Fund as a result of distributions payable either
in stock or in cash. However, each participant pays a pro rata share of
brokerage commissions incurred with respect to the Plan Agent's open market
purchases in connection with the reinvestment of distributions.
Experience under the Plan may indicate that changes are desirable. Accordingly,
the Fund and the Plan Agent reserve the right to amend the Plan as applied to
any distribution paid subsequent to written notice of the change sent to all
stockholders of the Fund at least 90 days before the record date for the
distribution. The Plan also may be terminated by the Fund or the Plan Agent by
at least 30 days' written notice to all stockholders of the Fund. All
correspondence concerning the Plan should be directed to the Plan Agent at First
Data Investor Services Group, Inc., P.O. Box 1376, Boston, MA 02104.
- --------------------------------------------------------------------------------
Additional Shareholder Information (unaudited)
- --------------------------------------------------------------------------------
Notice is hereby given in accordance with Section 23(c) of the Investment
Company Act of 1940, as amended, that from time to time the Fund may purchase at
market prices shares of its common stock in the open market.
21
<PAGE>
- --------------------------------------------------------------------------------
Tax Information (unaudited)
- --------------------------------------------------------------------------------
The amount of long-term capital gains paid by the Fund to its shareholders
for the fiscal year ended December 31, 1996, was $2,069,782.
The Fund designates 9.82% of the ordinary dividends paid during the fiscal
year ended December 31, 1996 as qualifying for the corporate dividends received
deduction.
22
<PAGE>
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<PAGE>
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<PAGE>
The Inefficient-
Market Fund, Inc.
Directors
Jessica M. Bibliowicz
Joseph H. Fleiss
Donald R. Foley
Paul Hardin
Francis P. Martin, M.D.
Heath B. McLendon, Chairman
Roderick C. Rasmussen
Bruce D. Sargent
John P. Toolan
Officers
Heath B. McLendon
Chief Executive Officer
Jessica M. Bibliowicz
President
Lewis E. Daidone
Senior Vice President
and Treasurer
Kent A. Kelley
Vice President
Sandip A. Bhagat
Vice President
Thomas M. Reynolds
Controller
Christina T. Sydor
Secretary
Investment Manager
Travelers Investment
Management Company
Custodian
PNC Bank, N.A.
Shareholder Servicing Agent
First Data Investor Services Group, Inc.
P.O. Box 1376
Boston, MA 02104
This report is submitted for
the general information of the
shareholders of the The Inefficient-
Market Fund, Inc. It is not authorized
for distribution to prospective investors
unless accompanied or preceded by a
current Prospectus for the Fund, which
contains information concerning the
Fund's investment policies and expenses
as well as other pertinent information.
The Inefficient-
Market Fund, Inc.
388 Greenwich Street
New York, New York 10013
FD0849 2/97
