TEMPLETON
INSTITUTIONAL
FUNDS, INC.
FOREIGN EQUITY SERIES - SERVICE SHARES
STATEMENT OF ADDITIONAL INFORMATION
MAY 1, 2000
[FRANKLIN TEMPLETON BUTTERBALL LOGO]
P.O. BOX 33030, ST. PETERSBURG, FL 33733-8030
1-800/321-8563 (INSTITUTIONAL SERVICES)
- -------------------------------------------------------------------------------
This Statement of Additional Information (SAI) is not a prospectus. It contains
information in addition to the information in the fund's prospectus. The fund's
prospectus, dated May 1, 2000, which we may amend from time to time, contains
the basic information you should know before investing in the fund. You should
read this SAI together with the fund's prospectus.
The audited financial statements and auditor's report in the fund's Annual
Report to Shareholders, for the fiscal year ended December 31, 1999, are
incorporated by reference (are legally a part of this SAI).
For a free copy of the current prospectus or annual report, contact your
investment representative or call 1-800/321-8563.
CONTENTS
Goal and Strategies.................. 2
Risks................................ 11
Officers and Directors............... 15
Management and Other Services........ 19
Portfolio Transactions............... 20
Distributions and Taxes.............. 21
Organization, Voting Rights and
Principal Holders.................... 23
Buying and Selling Shares............ 24
Pricing Shares....................... 26
The Underwriter...................... 27
Performance.......................... 28
Miscellaneous Information............ 30
Description of Bond Ratings.......... 30
- -------------------------------------------------------------------------------
MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS:
O ARE NOT 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.
- -------------------------------------------------------------------------------
Z954 SAI 05/00
GOAL AND STRATEGIES
- -------------------------------------------------------------------------------
The fund's investment goal is long-term capital growth. This goal is
fundamental, which means it may not be changed without shareholder approval.
The fund seeks long-term capital growth through a flexible policy of investing
primarily in equity securities and debt obligations of companies and governments
outside the U.S. including emerging markets securities. Under normal market
conditions, the fund invests primarily in the equity securities of companies
located outside the U.S., including emerging markets. The fund normally invests
at least 65% of its total assets in foreign equity securities. The fund may also
invest up to 35% of its total assets in debt securities when, in the judgment of
the manager, they offer greater potential for capital appreciation than is
available through investment in stocks. In selecting securities for the fund,
the manager attempts to identify those companies that offer above-average
opportunities for capital appreciation in various countries and industries where
economic and political factors, including currency movements, are favorable to
capital growth.
The fund may invest up to 5% of its assets in warrants (not counting warrants
acquired in units or attached to other securities), and up to 10% of its net
assets in illiquid securities. The fund will not invest more than 5% of its
total assets in any of the following: (i) debt securities rated at the time of
purchase lower than BBB by S&P or Baa by Moody's, (ii) structured investments,
and (iii) securities of Russian issuers. The fund may borrow up to one-third of
the value of its total assets and may lend portfolio securities with an
aggregate market value of up to one-third of its total assets. The fund may
purchase and sell put and call options on securities or indices, provided that
(i) the value of the underlying securities on which options may be written at
any one time will not exceed 25% of the fund's total assets, and (ii) the fund
will not purchase put or call options if the aggregate premium paid for such
options would exceed 5% of its total assets. The fund may enter into forward
foreign currency contracts and may purchase and write put and call options on
foreign currencies. For hedging purposes only, the fund may buy and sell
financial futures contracts, stock index futures contracts, foreign currency
futures contracts and options on any of these futures contracts, provided that
(i) the fund will not commit more than 5% of its total assets to initial margin
deposits on futures contracts and related options, and (ii) the value of the
underlying securities on which futures contracts will be written at any one time
will not exceed 25% of the total assets of the fund. The fund may invest in
securities issued by smaller companies.
The following is a description of the various types of securities the fund may
buy.
EQUITY SECURITIES The purchaser of an equity security typically receives an
ownership interest in the company as well as certain voting rights. The owner of
an equity security may participate in a company's success through the receipt of
dividends which are distributions of earnings by the company to its owners.
Equity security owners may also participate in a company's success or lack of
success through increases or decreases in the value of the company's shares as
traded in the public trading market for such shares. Equity securities generally
take the form of common stock or preferred stock. Preferred stockholders
typically receive greater dividends but may receive less appreciation than
common stockholders and may have greater voting rights as well. Equity
securities may also include convertible securities, warrants or rights.
Convertible securities typically are debt securities or preferred stocks which
are convertible into common stock after certain time periods or under certain
circumstances. Warrants or rights give the holder the right to purchase a common
stock at a given time for a specified price. A warrant is typically a long-term
option issued by a corporation that gives the holder the privilege of buying a
specified number of shares of the underlying common stock at a specified
exercise price at any time on or before the expiration date. Stock index
warrants entitle the holder to receive, upon exercise, an amount in cash
determined by reference to fluctuations in the level of a specified stock index.
If the fund does not exercise or dispose of a warrant before its expiration, it
will expire worthless.
DEPOSITARY RECEIPTS Depositary receipts are certificates that give their holders
the right to receive securities (a) of a foreign issuer deposited in a U.S. bank
or trust company (American Depositary Receipts, "ADRs"); or (b) of a foreign or
U.S. issuer deposited in a foreign bank or trust company (Global Depositary
Receipts, "GDRs" or European Depositary Receipts, "EDRs"). Generally, depositary
receipts in registered form are designed for use in the U.S. securities market
and depositary receipts in bearer form are designed for use in securities
markets outside the U.S. Depositary receipts may not necessarily be denominated
in the same currency as the underlying securities into which they may be
converted. Depositary receipts may be issued pursuant to sponsored or
unsponsored programs. In sponsored programs, an issuer has made arrangements to
have its securities traded in the form of depositary receipts. In unsponsored
programs, the issuer may not be directly involved in the creation of the
program. Although regulatory requirements with respect to sponsored and
unsponsored programs are generally similar, in some cases it may be easier to
obtain financial information from an issuer that has participated in the
creation of a sponsored program. Accordingly, there may be less information
available regarding issuers of securities underlying unsponsored depositary
receipts and there may not be a correlation between such information and the
market value of the depositary receipts. Depositary receipts also involve the
risks of investments in foreign securities, as discussed below. For purposes of
the fund's investment policies, the fund's investments in depositary receipts
will be deemed to be investments in the underlying securities.
DEBT SECURITIES A debt security typically has a fixed payment schedule which
obligates the issuer to pay interest to the lender and to return the lender's
money over a certain time period. A company typically meets its payment
obligations associated with its outstanding debt securities before it declares
and pays any dividend to holders of its equity securities. Bonds, notes,
debentures and commercial paper 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.
Conversely, during periods of rising interest rates, the value of such
securities generally declines. These changes in market value will be reflected
in the fund's net asset value.
The fund is not limited as to the type of debt securities in which it may
invest. For example, bonds may include Eurobonds, Global Bonds, Yankee Bonds,
bonds sold under SEC Rule 144A, restructured external debt such as Brady Bonds,
as well as restructured external debt that has not undergone a Brady-style debt
exchange, or other types of instruments structured or denominated as bonds.
Issuers of debt securities may include the U.S. government, its agencies or
instrumentalities; a foreign government, its agencies or instrumentalities;
supranational organizations; local governments, their agencies or
instrumentalities; U.S. or foreign corporations; and U.S. or foreign banks,
savings and loan associations, and bank holding companies. Eurobonds are debt
instruments issued by banks or companies through the international market with
terms of more than five years. Eurobonds are generally issued in bearer form,
carry a fixed or floating rate of interest, and typically amortize principal
through a bullet payment with semiannual interest payments in the currency in
which the bond was issued. Yankee bonds are foreign bonds denominated in U.S.
dollars and registered with the Securities and Exchange Commission for sale in
the U.S. A Global Bond is a certificate representing the total debt of an issue.
Such bonds are created to control the primary market distribution of an issue in
compliance with selling restrictions in certain jurisdictions or because
definitive bond certificates are not available. A global bond is also known as a
global certificate.
Debt securities purchased by the fund may be rated below BBB by S&P or Baa by
Moody's or, if unrated, of comparable quality as determined by the fund's
manager. The fund will limit its investment in such debt securities to 5% of its
total assets. The board may consider a change in this operating policy if, in
its judgment, economic conditions change such that a different level of
investment in high risk, lower quality debt securities would be consistent with
the interests of the fund and their shareholders. The fund may buy debt
securities rated as low as C by Moody's or S&P (or comparable unrated securities
as determined by the fund's manager). Debt securities rated C by Moody's are the
lowest rated class of bonds and may be regarded as having extremely poor
prospects of ever attaining any real investment standing. Debt securities rated
C by S&P are typically subordinated to senior debt which is vulnerable to
default and is dependent on favorable conditions to meet timely payment of
interest and repayment of principal. Debt securities rated C are therefore risky
and speculative investments.
The fund may invest a portion of its assets, and may invest without limit for
defensive purposes, in commercial paper which, at the date of investment, must
be rated Prime-1 by Moody's or A-1 by S&P or, if not rated, be issued by a
company which at the date of investment has an outstanding debt issue rated Aaa
or Aa by Moody's or AAA or AA by S&P.
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. The fund may invest in debt or preferred
securities which have equity features, such as conversion or exchange rights, or
which carry warrants to purchase common stock or other equity interests. Such
equity features may enable the holder of the bond or preferred security to
benefit from increases in the market price of the underlying equity.
To the extent the fund invests in debt securities, it may accrue and report
interest on high yield bonds structured as zero coupon bonds or pay-in-kind
securities as income even though it receives no corresponding cash payment until
a later time, generally the security's maturity date. In order to qualify for
beneficial tax treatment, the fund must distribute substantially all of its net
investment income to shareholders on an annual basis (see Distributions and
Taxes). Thus, the fund may have to dispose of its portfolio securities under
disadvantageous circumstances to generate cash, or leverage itself by borrowing
cash, so that it may satisfy the distribution requirement.
STRUCTURED INVESTMENTS Included among the issuers of debt securities in which
the fund may invest are entities organized and operated solely for the purpose
of restructuring the investment characteristics of various securities. These
entities are typically organized by investment banking firms which receive fees
in connection with establishing each entity and arranging for the placement of
its securities. This type of restructuring involves the deposit with or purchase
by an entity, such as a corporation or trust, of specified instruments (such as
Brady Bonds) and the issuance by that entity of one or more classes of
securities ("structured investments") backed by, or representing interests in,
the underlying instruments. The cash flows on the underlying instruments may be
apportioned among the newly issued structured investments to create securities
with different investment characteristics such as varying maturities, payment
priorities or interest rate provisions; the extent of the payments made with
respect to structured investments is dependent on the extent of the cash flows
on the underlying instruments. Because structured investments of the type in
which the fund anticipates investing typically involve no credit enhancement,
their credit risk will generally be equivalent to that of the underlying
instruments.
The fund is permitted to invest in a class of structured investments that is
either subordinated or unsubordinated to the right of payment of another class.
Subordinated structured investments typically have higher yields and present
greater risks than unsubordinated structured investments. Although the purchase
of subordinated structured investments would have a similar economic effect to
that of borrowing against the underlying securities, the purchase will not be
deemed to be leveraged for purposes of the limitations placed on the extent of
assets that may be used for borrowing activities. Certain issuers of structured
investments may be deemed to be "investment companies" as defined in the
Investment Company Act of 1940 (1940 Act). As a result, the fund's investment in
these structured investments may be limited by the restrictions contained in the
1940 Act. Structured investments are typically sold in private placement
transactions, and there currently is no active trading market for structured
investments. To the extent such investments are illiquid, they will be subject
to the fund's restrictions on investments in illiquid securities. The fund will
limit its investment in structured investments to 5% of its total assets.
MORTGAGE-BACKED SECURITIES Mortgage-backed securities represent an ownership
interest in a pool of residential and commercial mortgage loans. Generally,
these securities are designed to provide monthly payments of interest and
principal to the investor. The mortgagee's monthly payments to his/her lending
institution are passed through to investors such as the fund. Most issuers
provide guarantees of payments, regardless of whether the mortgagor actually
makes the payment. The guarantees made by issuers or poolers are supported by
various forms of credit, collateral, guarantees or insurance, including
individual loan, title, pool and hazard insurance purchased by the issuer. The
pools are assembled by various governmental, government-related and private
organizations. The fund may invest in securities issued or guaranteed by the
Government National Mortgage Association (GNMA), Federal Home Loan Mortgage
Corporation (FHLMC), Fannie Mae, and other government agencies. If there is no
guarantee provided by the issuer, mortgage-backed securities purchased by the
fund will be those which at the time of purchase are rated investment grade by
one or more NRSRO, or, if unrated, are deemed by the manager to be of investment
grade quality.
REPURCHASE AGREEMENTS The fund generally will have a portion of its 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, the 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. The 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.
LOANS OF PORTFOLIO SECURITIES The fund may lend certain of its portfolio
securities to qualified securities dealers and other institutional investors.
These loans many not exceed up to one-third of its total assets, measured at the
time of the most recent loan. Each loan must be secured with collateral
(consisting of cash, securities issued by the U.S. government and its agencies
and instrumentalities, or irrevocable letters of credit) in an amount at least
equal (on a daily marked-to-market basis) of the current market value of the
loaned securities. The fund may retain all or a portion of the interest received
on investment of the cash collateral or receives a fee from the borrower. The
fund effectively receives any distributions paid on the loaned securities. 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 manager intends to call the loaned securities to vote
proxies, or to use other practicable and legally enforceable means to obtain
voting rights, when the manager has knowledge that, in its opinion, a material
event affecting the loaned securities will occur or the manager otherwise
believes 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. The fund will loan its securities only to
parties who meet creditworthiness standards approved by the fund's board of
directors, 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.
BORROWING The fund may borrow up to one-third of the value of its total assets
from banks to increase its holdings of portfolio securities to meet redemption
requests, to pay expenses or for other temporary needs. Under the 1940 Act, the
fund is required to maintain continuous asset coverage of 300% with respect to
such borrowings and to sell (within three days) sufficient portfolio holdings to
restore such coverage if it should decline to less than 300% due to market
fluctuations or otherwise, even if such liquidations of the fund's holdings may
be disadvantageous from an investment standpoint. Leveraging by means of
borrowing may exaggerate the effect of any increase or decrease in the value of
portfolio securities on the 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 or gains received from the securities purchased with borrowed funds.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES The fund may purchase securities on
a when-issued or delayed delivery basis. Securities purchased on a when-issued
or delayed delivery basis are purchased for delivery beyond the normal
settlement date at a stated price and yield. No income accrues to the purchaser
of a security on a when-issued or delayed delivery basis prior to delivery. Such
securities are recorded as an asset and are subject to changes in value based
upon changes in the general level of interest rates. The fund will only make
commitments to purchase securities on a when-issued or delayed delivery basis
with the intention of actually acquiring the securities, but may sell them
before the settlement date to attempt to "lock" in gains or avoid losses, or if
otherwise deemed advisable by the manager.
Purchasing a security on a when-issued or delayed delivery basis can involve a
risk that the market price at the time of delivery may be lower than the
agreed-upon purchase price, and therefore there could be an unrealized loss at
the time of delivery. In addition, while an issuer of when-issued securities has
made a commitment to issue the securities as of a specified future date, there
can be no assurance that the securities will be issued and that the trade will
settle. In the event settlement does not occur, any appreciation in the value of
the when-issued security would be lost, including the amount of any appreciation
"locked" in by the sale of an appreciated security prior to settlement. The fund
will establish a segregated account in which it will maintain liquid assets in
an amount at least equal in value to the fund's net commitments to purchase
securities on a when-issued or delayed delivery basis. If the value of these
assets declines, the fund will place additional liquid assets in the account on
a daily basis so that the value of the assets in the account is equal to the
amount of such commitments.
TEMPORARY INVESTMENTS When the manager believes market or economic conditions
are unfavorable for investors, the manager may invest up to 100% of the fund's
assets in a temporary defensive manner or hold a substantial portion of the
fund's portfolio in cash. Unfavorable market or economic conditions may include
excessive volatility or a prolonged general decline in the securities markets,
the securities in which the fund normally invests, or the economies of the
countries where the fund invests.
Temporary defensive investments generally may include money market securities,
denominated in U.S. dollars or in the currency of any foreign country, issued by
entities organized in the United States or any foreign country: short-term (less
than twelve months to maturity) and medium-term (not greater than five years to
maturity) obligations issued or guaranteed by the U.S. government or the
governments of foreign countries, their agencies or instrumentalities; finance
company and corporate commercial paper, and other short-term corporate
obligations, in each case rated Prime-1 by Moody's or A or better by S&P or, if
unrated, of comparable quality as determined by the fund's manager; obligations
(including certificates of deposit, time deposits and bankers' acceptances) of
banks having total assets in excess of $1 billion; and repurchase agreements
with banks and broker-dealers with respect to such securities. In addition, for
temporary defensive purposes, the fund may invest up to 25% of its total assets
in obligations (including certificates of deposit, time deposits and bankers'
acceptances) of U.S. foreign banks; provided that the fund will limit its
investment in time deposits for which there is a penalty for early withdrawal to
10% of its total assets. The manager also may invest in these types of
securities or hold cash while looking for suitable investment opportunities or
to maintain liquidity.
ILLIQUID INVESTMENTS The fund's policy is not to invest more than 10% of net
assets, at the time of purchase, in 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 the fund has valued them.
Illiquid securities also include securities which are not publicly traded or
which cannot be readily resold because of legal or contractual restrictions, or
which are not otherwise readily marketable (including repurchase agreements
having more than seven days remaining to maturity).
The manager, based on a continuing review of the trading markets, may consider
certain restricted securities which may otherwise be deemed to be illiquid, that
are offered and sold to "qualified institutional buyers," to be liquid. The
board has adopted guidelines and delegated to the manager the daily function of
determining and monitoring the liquidity of restricted securities. The board,
however, will oversee and be ultimately responsible for the determinations. If
the 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.
FUTURES CONTRACTS Although the fund has the authority to buy and sell financial
futures contracts, it presently has no intention of entering into such
transactions. For hedging purposes only (including anticipatory hedges where the
manager seeks to anticipate an intended shift in maturity, duration or asset
allocation), the fund may buy and sell covered financial futures contracts,
stock index futures contracts, foreign currency futures contracts and options on
any of the foregoing. A financial futures contract is an agreement between two
parties to buy or sell a specified debt security at a set price on a future
date. An index futures contract is an agreement to take or make delivery of an
amount of cash based on the difference between the value of the index at the
beginning and at the end of the contract period. A futures contract on a foreign
currency is an agreement to buy or sell a specified amount of a currency for a
set price on a future date. When the fund enters into a futures contract, it
must make an initial deposit, known as "initial margin," as a partial guarantee
of its performance under the contract. As the value of the security, index or
currency fluctuates, either party to the contract is required to make additional
margin payments, known as "variation margin," to cover any additional obligation
it may have under the contract. In addition, when the fund enters into a futures
contract, it will segregate assets or "cover" its position in accordance with
the 1940 Act. Although some financial futures contracts call for making or
taking delivery of the underlying securities, in most cases these obligations
are closed out before the settlement date. The closing of a contractual
obligation is accomplished by purchasing or selling an identical offsetting
futures contract. Other financial futures contracts by their terms call for cash
settlements.
The fund may not commit more than 5% of its total 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 total assets of the fund.
At the time the fund purchases a futures contract, an amount of cash, U.S.
government securities or other highly liquid debt securities equal to the market
value of the futures contract will be deposited in a segregated account with the
fund's custodian. When writing a futures contract, the fund will maintain with
its custodian liquid assets that, when added to the amounts deposited with a
futures commission merchant or broker as margin, are equal to the market value
of the instruments underlying the contract. Alternatively, the fund may "cover"
its position by owning the instruments underlying the contract (or, in the case
of an index futures contract, a portfolio with a volatility substantially
similar to that of the index on which the futures contract is based), or holding
a call option permitting the fund to purchase the same futures contract at a
price no higher than the price of the contract written by the fund (or at a
higher price if the difference is maintained in liquid assets with the fund's
custodian).
OPTIONS ON SECURITIES OR INDICES Although the fund has the authority to write
(I.E., sell) covered put and call options in order to hedge a portion of its
portfolio and/or to generate income to offset operating expenses and buy put and
call options on securities or securities indices in order to hedge against
market shifts, it presently has no intention of entering into such transactions.
Options purchased or written by the fund will be traded on U.S. and foreign
exchanges or in the over-the-counter markets.
An option on a security is a contract that gives the purchaser of the option, in
return for the premium paid, the right to buy a specified security (in the case
of a call option) or to sell a specified security (in the case of a put option)
from or to the writer of the option at a designated price during the term of the
option. An option on a securities index gives the purchaser of the option, in
return for the premium paid, the right to receive from the seller cash equal to
the difference between the closing price of the index and the exercise price of
the option.
The fund may write a call or put option only if the option is "covered." A call
option on a security written by the fund is "covered" if the fund owns the
underlying security covered by the call or has an absolute and immediate right
to acquire that security without additional cash consideration (or for
additional consideration that is segregated) upon conversion or exchange of
other securities held in its portfolio. A call option on a security is also
covered if the fund holds a call on the same security and in the same principal
amount as the call written where the exercise price of the call held (a) is
equal to or less than the exercise price of the call written or (b) is greater
than the exercise price of the call written if the difference is maintained by
the fund in cash or segregated liquid assets. A put option on a security written
by the fund is "covered" if the fund maintains cash or liquid assets with a
value equal to the exercise price in a segregated account, 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 fund will cover call options on stock indices that it writes by owning
securities whose price changes, in the opinion of the fund's manager, are
expected to be similar to those of the index, or in such other manner as may be
in accordance with the rules of the exchange on which the option is traded and
applicable laws and regulations. Nevertheless, where the fund covers a call
option on a stock index through ownership of securities, such securities may not
match the composition of the index. In that event, the fund will not be fully
covered and could be subject to risk of loss in the event of adverse changes in
the value of the index. The fund will cover put options on stock indices that it
writes by segregating assets equal to the option's exercise price, or in such
other manner as may be in accordance with the rules of the exchange on which the
option is traded and applicable laws and regulations.
The fund will receive a premium from writing a put or call option, which
increases the fund's gross income in the event the option expires unexercised or
is closed out at a profit. If the value of a security or an index on which the
fund has written a call option falls or remains the same, the fund will realize
a profit in the form of the premium received (less transaction costs) that could
offset all or a portion of any decline in the value of the portfolio securities
being hedged. If the value of the underlying security or index rises, however,
the fund will realize a loss in its call option position, which will reduce the
benefit of any unrealized appreciation in the fund's investments. By writing a
put option, the fund assumes the risk of a decline in the underlying security or
index. To the extent that the price changes of the portfolio securities being
hedged correlate with changes in the value of the underlying security or index,
writing covered put options on indices or securities will increase the fund's
losses in the event of a market decline, although such losses will be offset in
part by the premium received for writing the option.
The fund may also purchase put options to hedge its investments against a
decline in value. By purchasing a put option, the fund will seek to offset a
decline in the value of the portfolio securities being hedged through
appreciation of the put option. If the value of the fund's investments does not
decline as anticipated, or if the value of the option does not increase, the
fund's loss will be limited to the premium paid for the option plus related
transaction costs. The success of this strategy will depend, in part, on the
accuracy of the correlation between the changes in value of the underlying
security or index and the changes in value of the fund's security holdings being
hedged.
The fund may purchase call options on individual securities to hedge against an
increase in the price of securities that the fund anticipates purchasing in the
future. Similarly, the fund may purchase call options on a securities index to
attempt to reduce the risk of missing a broad market advance, or an advance in
an industry or market segment, at a time when the fund holds uninvested cash or
short-term debt securities awaiting investment. When purchasing call options,
the fund will bear the risk of losing all or a portion of the premium paid if
the value of the underlying security or index does not rise.
There can be no assurance that a liquid market will exist when the fund seeks to
close out an option position. Trading could be interrupted, for example, because
of supply and demand imbalances arising from a lack of either buyers or sellers,
or the options exchange could suspend trading after the price has risen or
fallen more than the maximum specified by the exchange. Although the fund may be
able to offset to some extent any adverse effects of being unable to liquidate
an option position, the fund may experience losses in some cases as a result of
such inability.
The value of the underlying securities on which options may be written at any
one time will not exceed 25% of the total assets of the fund. The fund will not
purchase put or call options if the aggregate premium paid for such options
would exceed 5% of its total assets at the time of purchase.
FOREIGN CURRENCY HEDGING TRANSACTIONS In order to hedge against foreign currency
exchange rate risks, the fund may enter into forward foreign currency exchange
contracts and foreign currency futures contracts, as well as purchase put or
call options on foreign currencies, as described below. The fund may also
conduct its foreign currency exchange transactions on a spot (I.E., cash) basis
at the spot rate prevailing in the foreign currency exchange market.
The fund may enter into forward foreign currency exchange contracts ("forward
contracts") to attempt to minimize the risk to the fund from adverse changes in
the relationship between the U.S. dollar and foreign currencies. The fund will
generally not enter into forward contracts with terms of greater than one year.
A forward contract is an obligation to purchase or sell a specific currency for
an agreed price at a future date which is individually negotiated and privately
traded by currency traders and their customers. The fund may enter into a
forward contract, for example, when it enters into a contract for the purchase
or sale of a security denominated in a foreign currency in order to "lock in"
the U.S. dollar price of the security. In addition, for example, when the fund
believes that a foreign currency may suffer a substantial decline against the
U.S. dollar, it may enter into a forward contract to sell an amount of that
foreign currency approximating the value of some or all of the fund's portfolio
securities denominated in such foreign currency, or when the fund believes that
the U.S. dollar may suffer a substantial decline against a foreign currency, it
may enter into a forward contract to buy that foreign currency for a fixed
dollar amount. This second investment practice is generally referred to as
"cross-hedging." The fund's forward transactions may call for the delivery of
one foreign currency in exchange for another foreign currency and may at times
not involve currencies in which its portfolio securities are then denominated.
The fund has no specific limitation on the percentage of assets it may commit to
forward contracts, subject to its stated investment goal and policies, except
that the fund will not enter into a forward contract if the amount of assets set
aside to cover the contract would impede portfolio management or the fund's
ability to meet redemption requests. Because in connection with the fund's
forward foreign currency transactions an amount of the fund's assets equal to
the amount of the purchase will be held aside or segregated to be used to pay
for the commitment, the fund will always have those liquid assets available
sufficient to cover any commitments under these contracts or to limit any
potential risk. In addition, when the fund sells a forward contract, it will
cover its obligation under the contract by segregating liquid assets, or by
owning securities denominated in the corresponding currency and with a market
value equal to or greater than the fund's obligation. The segregated assets will
be marked-to-market on a daily basis. While these contracts are not presently
regulated by the Commodity Futures Trading Commission, it may in the future
assert authority to regulate forward contracts. In such event, the fund's
ability to utilize forward contracts in the manner set forth above may be
restricted. Forward contracts may limit potential gain from a positive change in
the relationship between the U.S. dollar and foreign currencies. Unanticipated
changes in currency prices may result in poorer overall performance for the fund
than if it had not engaged in such contracts.
The fund may purchase and write put and call options on foreign currencies for
the purpose of protecting against declines in the dollar value of foreign
portfolio securities and against increases in the dollar cost of foreign
securities to be acquired. As is the case with 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, and the fund could be required
to purchase or sell foreign currencies at disadvantageous exchange rates,
thereby incurring losses. The purchase of an option on foreign currency may
constitute an effective hedge against fluctuation in exchange rates, although,
in the event of rate movements adverse to the fund's position, the fund may
forfeit the entire amount of the premium plus related transaction costs. Options
on foreign currencies written or purchased by the fund will be traded on U.S.
and foreign exchanges or over-the-counter.
The fund may enter into exchange-traded contracts for the purchase or sale for
future delivery of foreign currencies ("foreign currency futures"). This
investment technique will be used only to hedge against anticipated future
changes in exchange rates which otherwise might adversely affect the value of
the fund's portfolio securities or adversely affect the prices of securities
that the fund intends to purchase at a later date. The successful use of foreign
currency futures will usually depend on the ability of the fund's manager to
forecast currency exchange rate movements correctly. Should exchange rates move
in an unexpected manner, the fund may not achieve the anticipated benefits of
foreign currency futures or may realize losses.
CONVERTIBLE SECURITIES As with a straight fixed-income security, a convertible
security tends to increase in market value when interest rates decline and
decrease in value when interest rates rise. Like a common stock, 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 its value can be influenced by both interest
rate and market movements, a convertible security is not as sensitive to
interest rates as a similar fixed-income security, nor is it as sensitive to
changes in share price as its underlying stock.
A convertible security is usually issued either by an operating company or by an
investment bank. When issued by an operating company, a convertible security
tends to be senior to common stock, but subordinate to other types of
fixed-income securities issued by that company. When a convertible security,
issued by an operating company is "converted," the operating company often
issues new stock to the holder of the convertible security but, if the parity
price of the convertible security is less than the call price, the operating
company may pay out cash instead of common stock. If the convertible security is
issued by an investment bank, the security is an obligation of and is
convertible through the issuing investment bank. The issuer of a convertible
security may be important in determining the security's true value. This is
because the holder of a convertible security will have recourse only to the
issuer.
The fund uses the same criteria to rate a convertible debt security that it uses
to rate a more conventional debt security. 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
all debt obligations in the event of insolvency, and an issuer's failure to make
a dividend payment is generally not an event of default entitling the preferred
shareholder to take action. A preferred stock generally has no maturity date, so
that its market value is dependent on the issuer's business prospects for an
indefinite period of time. In addition, distributions from preferred stock are
dividends, rather than interest payments, and are usually treated as such for
corporate tax purposes.
The fund may invest in convertible preferred stocks that offer enhanced yield
features, such as Preferred Equity Redemption Cumulative Stock ("PERCS"), which
provide an investor with the opportunity to earn higher dividend income than is
available on a company's common stock. A PERCS is a preferred stock which
generally features a mandatory conversion date, as well as a capital
appreciation limit which is usually expressed in terms of a stated price. Most
PERCS expire three years from the date of issue, at which time they are
convertible into common stock of the issuer (PERCS are generally not convertible
into cash at maturity). Under a typical arrangement, if after three years the
issuer's common stock is trading at a price below that set by the capital
appreciation limit, each PERCS would convert to one share of common stock. If,
however, the issuer's common stock is trading at a price above that set by the
capital appreciation limit, the holder of the PERCS would receive less than one
full share of common stock. The amount of that fractional share of common stock
received by the PERCS holder is determined by dividing the price set by the
capital appreciation limit of the PERCS by the market price of the issuer's
common stock. PERCS can be called at any time prior to maturity, and hence do
not provide call protection. However if called early the issuer must pay a call
premium over the market price to the investor. This call premium declines at a
preset rate daily, up to the maturity date of the PERCS.
The fund may also invest in other classes of enhanced convertible securities.
These include but are not limited to ACES (Automatically Convertible Equity
Securities), PEPS (Participating Equity Preferred Stock), PRIDES (Preferred
Redeemable Increased Dividend Equity Securities), SAILS (Stock Appreciation
Income Linked Securities), TECONS (Term Convertible Notes), QICS (Quarterly
Income Cumulative Securities), and DECS (Dividend Enhanced Convertible
Securities). ACES, PEPS, PRIDES, SAILS, TECONS, QICS, and DECS all have the
following features: they are issued by the company, the common stock of which
will be received in the event the convertible preferred stock is converted;
unlike PERCS they do not have a capital appreciation limit; they seek to provide
the investor with high current income with some prospect of future capital
appreciation; they are typically issued with three or four-year maturities; they
typically have some built-in call protection for the first two to three years;
investors have the right to convert them into shares of common stock at a preset
conversion ratio or hold them until maturity; and, upon maturity, they will
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 whose common stock is to be acquired in the event the security
is converted or by a different issuer, such as an investment bank. These
securities may be identified by names such as ELKS (Equity Linked Securities) or
similar names. Typically they share most of the salient characteristics of an
enhanced convertible preferred stock but will be ranked as senior or
subordinated debt in the issuer's corporate structure according to the terms of
the debt indenture. There may be additional types of convertible securities not
specifically referred to herein which may be similar to those described above in
which the fund may invest, consistent with its goal and policies.
An investment in an enhanced convertible security or any other security may
involve additional risks to the fund. The 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 the fund's ability to dispose of particular securities, when
necessary, to meet the 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 the fund to obtain market quotations based on actual
trades for purposes of valuing the fund's portfolio. The fund, however, intends
to acquire liquid securities, though there can be no assurances that this will
be achieved.
CONCENTRATION AND DIVERSIFICATION The fund reserves the right to invest more
than 25% of its assets in any one country, but will not invest more than 25% of
its total assets in any one industry (excluding the U.S. government). Under
normal circumstances, the fund will invest at least 65% of its assets in issuers
domiciled in at least three different nations (one of which may be the United
States). The fund may invest no more than 5% of its total assets in securities
issued by any one company or government, exclusive of U.S. government
securities.
PORTFOLIO TURNOVER The fund invests for long-term growth of capital and does not
intend to place emphasis upon short-term trading profits. Accordingly, the fund
expects to have a portfolio turnover rate of less than 50%.
INVESTMENT RESTRICTIONS The 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.
The fund MAY NOT:
1. Invest in real estate or mortgages on real estate (although the fund may
invest in marketable securities secured by real estate or interests therein or
issued by companies or investment trusts which invest in real estate or
interests therein); invest in other open-end investment companies except as
permitted by the 1940 Act; invest in interests (other than debentures or equity
stock interests) in oil, gas or other mineral exploration or development
programs; or purchase or sell commodity contracts (except futures contracts as
described in this SAI).
2. Purchase or retain securities of any company in which directors or officers
of Templeton Institutional Funds, Inc. or the fund's manager, individually
owning more than 1/2 of 1% of the securities of such company, in the aggregate
own more than 5% of the securities of such company.
3. Purchase any security (other than obligations of the U.S. government, its
agencies or instrumentalities) if, as a result, as to 75% of the fund's total
assets (i) more than 5% of the fund's total assets would then be invested in
securities of any single issuer, or (ii) the fund would then own more than 10%
of the voting securities of any single issuer.
4. Act as an underwriter; issue senior securities except as set forth in
investment restriction 6 below; or purchase on margin or sell short (but the
fund may make margin payments in connection with options on securities or
securities indices and foreign currencies; futures contracts and related
options; and forward contracts and related options).
5. Loan money apart from the purchase of a portion of an issue of publicly
distributed bonds, debentures, notes and other evidences of indebtedness,
although the fund may buy from a bank or broker-dealer U.S. government
obligations with a simultaneous agreement by the seller to repurchase them
within no more than seven days at the original purchase price plus accrued
interest and loan its portfolio securities.
6. Borrow money, except that the fund may borrow money from banks in an amount
not exceeding 33 1/3% of the value of its total assets (including the amount
borrowed).
7. Invest more than 5% of the value of its total assets in securities of issuers
which have been in continuous operation less than three years.
8. Invest more than 5% of its total assets in warrants, whether or not listed on
the NYSE or the American Stock 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.
9. Invest more than 25% of its total assets in a single industry.(1)
10. Participate on a joint or a joint and several basis in any trading account
in securities.
1. The SEC considers each foreign government to be a separate industry.
The fund also may be subject to investment limitations imposed by foreign
jurisdictions in which the fund sells its shares.
If a bankruptcy or other extraordinary event occurs concerning a particular
security the fund owns, the fund may receive stock, real estate, or other
investments that the fund would not, or could not, buy. If this happens, the
fund intends to sell such investments as soon as practicable while trying to
maximize the return to shareholders.
Generally, the policies and restrictions discussed in this SAI and in the
prospectus apply when the 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 the 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 of
portfolio securities or the amount of assets will not be considered a violation
of the restriction or limitation.
If the fund receives from an issuer of securities held by the fund subscription
rights to purchase securities of that issuer, and if the fund exercises such
subscription rights at a time when the fund's portfolio holdings of securities
of that issuer would otherwise exceed the limits set forth in Investment
Restrictions 3 or 9 above, it will not constitute a violation if, prior to
receipt of securities upon exercise of such rights, and after announcement of
such rights, the fund has sold at least as many securities of the same class and
value as it would receive on exercise of such rights.
RISKS
- -------------------------------------------------------------------------------
Shareholders should understand that all investments involve risk and there can
be no guarantee against loss resulting from an investment in the fund, nor can
there be any assurance that the fund's investment goal will be attained. As with
any investment in securities, the value of, and income from, an investment in
the fund can decrease as well as increase, depending on a variety of factors
which may affect the values and income generated by the fund's portfolio
securities, including general economic conditions and market factors.
Additionally, investment decisions made by the manager will not always be
profitable or prove to have been correct. In addition to the factors which
affect the value of individual securities, a shareholder may anticipate that the
value of the shares of the fund will fluctuate with movements in the broader
equity and bond markets, as well. A decline in the stock market of any country
or region in which the fund is invested in equity securities may also be
reflected in declines in the price of the shares of the fund. Changes in
prevailing rates of interest in any of the countries or regions in which the
fund is invested in fixed income securities will likely affect the value of such
holdings and thus the value of fund shares. Increased rates of interest which
frequently accompany inflation and/or a growing economy are likely to have a
negative effect on the value of the fund's shares. In addition, changes in
currency valuations will affect the price of the shares of the fund. History
reflects both decreases and increases in stock markets and interest rates in
individual countries and throughout the world and in currency valuations, and
these may occur unpredictably in the future. The fund is not intended as a
complete investment program.
FOREIGN SECURITIES RISK You should consider carefully the substantial risks
involved in securities of companies and governments of foreign nations, which
are in addition to the usual risks inherent in domestic investments. There may
be less publicly available information about foreign companies comparable to the
reports and ratings published about companies in the U.S. Foreign companies are
not generally subject to uniform accounting or financial reporting standards,
and auditing practices and requirements may not be comparable to those
applicable to U.S. companies. The fund, therefore, may encounter difficulty in
obtaining market quotations for purposes of valuing its portfolio and
calculating its net asset value. Foreign markets have substantially less volume
than the New York Stock Exchange (NYSE) 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. In many foreign
countries there is less government supervision and regulation of stock
exchanges, brokers and listed companies than in the U.S.
EMERGING MARKETS. Investments in companies domiciled in developing countries may
be subject to potentially higher risks than investments in developed countries.
These risks include (i) less social, political and economic stability; (ii) the
small current size of the markets for such securities and the currently low or
nonexistent volume of trading, which result in a lack of liquidity and in
greater price volatility; (iii) certain national policies that may restrict the
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 developing countries, of a capital market
structure or market-oriented economy; and (vii) the possibility that recent
favorable economic developments in some developing countries may be slowed or
reversed by unanticipated political or social events in such countries.
In addition, many countries in which the fund may invest have experienced
substantial, and in some periods extremely high, rates of inflation for many
years. Inflation and rapid fluctuations in inflation rates have had and may
continue to have negative effects on the economies and securities markets of
certain countries. Moreover, the economies of some developing countries may
differ favorably or unfavorably from the U.S. economy in such respects as growth
of gross domestic product, rate of inflation, currency depreciation, capital
reinvestment, resource self-sufficiency and balance of payments position.
Investments in developing 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 such expropriation, the fund could lose a substantial portion of any
investments it has made in the affected countries. Further, no accounting
standards exist in certain developing countries. Finally, even though the
currencies of some developing 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 fund shareholders.
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 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;
(c) 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; (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, and on
the fund's ability to exchange local currencies for U.S. dollars; (g) the risk
that the government of Russia or other executive or legislative bodies may
decide not to continue to support the economic reform programs implemented since
the dissolution of the Soviet Union and could follow radically different
political and/or economic policies to the detriment of investors, including
non-market-oriented policies such as the support of certain industries at the
expense of other sectors or investors, 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 securities held by
the fund 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 are privately negotiated outside of stock exchanges. Because of the
recent formation of the securities markets as well as the underdeveloped state
of the banking and telecommunications systems, settlement, clearing and
registration of securities transactions are subject to significant risks.
Ownership of shares (except where shares are held through depositories that meet
the requirements of the 1940 Act) is defined according to entries in the
company's share register and normally evidenced by extracts from the register or
by formal share certificates. However, there is no central registration system
for shareholders and these services are carried out by the companies themselves
or by registrars located throughout Russia. These registrars are not necessarily
subject to effective state supervision nor are they licensed with any
governmental entity and it is possible for the fund to lose its registration
through fraud, negligence or even mere oversight. While the fund will endeavor
to ensure that its interest continues to be appropriately recorded either itself
or through a custodian or other agent inspecting the share register and by
obtaining extracts of share registers through regular confirmations, these
extracts have no legal enforceability and it is possible that subsequent illegal
amendment or other fraudulent act may deprive the fund of its ownership rights
or improperly dilute its interests. In addition, while applicable Russian
regulations impose liability on registrars for losses resulting from their
errors, it may be difficult for the fund to enforce any rights it may have
against the registrar or issuer of the securities in the event of loss of share
registration. Furthermore, although a Russian public enterprise with more than
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 fund 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 the fund if a potential purchaser is deemed unsuitable, which may
expose the fund to potential loss on the investment.
CURRENCY The fund's management endeavors to buy and sell foreign currencies on
as favorable a basis as practicable. Some price spread on currency exchange (to
cover service charges) may be incurred, particularly when the 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.
Also, some countries may adopt policies which would prevent the fund from
transferring cash out of the country, withhold portions of interest and
dividends at the source. There is the possibility of cessation of trading on
national exchanges, expropriation, nationalization or confiscatory taxation,
withholding and other foreign tax on income or other amounts, foreign exchange
controls (which may include suspension of the ability to transfer currency from
a given country), default in foreign government securities, political or social
instability, or diplomatic developments that could affect investments in
securities of issuers in those nations.
The fund may be affected either unfavorably or favorably by fluctuations in the
relative rates of exchange between the currencies of different nations, by
exchange control regulations and by indigenous economic and political
developments. Some countries in which the fund may invest may also have fixed or
managed currencies that are not free-floating against the U.S. dollar. Further,
certain currencies may not be internationally traded.
Certain of these currencies have experienced a steady devaluation relative to
the U.S. dollar. Any devaluations in the currencies in which the fund's
portfolio securities are denominated may have a detrimental impact on the fund.
Through the fund's 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 fund's investments.
The exercise of this flexible policy may include decisions to purchase
securities with substantial risk characteristics and other decisions such as
changing the emphasis on investments from one nation to another and from one
type of security to another. Some of these decisions may later prove profitable
and others may not. No assurance can be given that profits, if any, will exceed
losses.
EURO On January 1, 1999, the European Economic and Monetary Union (EMU)
introduced a new single currency called the euro. By July 1, 2002, the euro,
which will be implemented in stages, will have replaced the national currencies
of the following member countries: Austria, Belgium, Finland, France, Germany,
Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain.
Currently, the exchange rate of the currencies of each of these countries is
fixed to the euro. The euro trades on currency exchanges and is available for
non-cash transactions. The participating countries currently issue sovereign
debt exclusively in euro. By July 1, 2002, euro-denominated bills and coins will
replace the bills and coins of the above countries.
The new European Central Bank has control over each country's monetary policies.
Therefore, the participating countries no longer control their own monetary
policies by directing independent interest rates for their currencies. The
national governments of the participating countries, however, have retained the
authority to set tax and spending policies and public debt levels.
The change to the euro as a single currency is new and untested. It is not
possible to predict the impact of the euro on currency values or on the business
or financial condition of European countries and issuers, and issuers in other
regions, whose securities the fund may hold, or the impact, if any, on fund
performance. In the first six months of the euro's existence, the exchange rates
of the euro versus many of the world's major currencies steadily declined. In
this environment, U.S. and other foreign investors experienced erosion of their
investment returns on their euro-denominated securities. 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 the fund,
the fund's manager and its affiliated service providers are taking steps they
believe are reasonably designed to address the euro issue.
INTEREST RATE RISK To the extent the 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, consequently, its share price. Rising interest
rates, which often occur during times of inflation or a growing economy, are
likely to cause the face value of a debt security to decrease, having a negative
effect on the value of the fund's shares. Of course, interest rates have
increased and decreased, sometimes very dramatically, in the past. These changes
are likely to occur again in the future at unpredictable times.
CREDIT RISK This is the possibility that an issuer will be unable to make
interest payments or repay principal. Changes in an issuer's financial strength
or in a security's credit rating may affect its value and, thus, impact the
value of fund shares.
LOW-RATED SECURITIES RISK 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.
Although they may offer higher yields than do higher rated securities, low rated
and unrated debt securities generally involve greater volatility of price and
risk of principal and income, including the possibility of default by, or
bankruptcy of, the issuers of the securities. In addition, the markets in which
low rated and unrated debt securities are traded are more limited than those in
which higher rated securities are traded. The existence of limited markets for
particular securities may diminish the fund's ability to sell the securities at
fair value either to meet redemption requests or to respond to a specific
economic event such as a deterioration in the creditworthiness of the issuer.
Reduced secondary market liquidity for certain low rated or unrated debt
securities may also make it more difficult for the fund to obtain accurate
market quotations for the purposes of valuing the fund's portfolio. Market
quotations are generally available on many low rated or unrated securities only
from a limited number of dealers and may not necessarily represent firm bids of
such dealers or prices for actual sales.
Adverse publicity and investor perceptions, whether or not based on fundamental
analysis, may decrease the values and liquidity of low rated debt securities,
especially in a thinly traded market. Analysis of the creditworthiness of
issuers of low rated debt securities may be more complex than for issuers of
higher rated securities, and the ability of the fund to achieve its investment
goal may, to the extent of investment in low rated debt securities, be more
dependent upon such creditworthiness analysis than would be the case if the fund
were investing in higher rated securities.
Low rated debt securities may be more susceptible to real or perceived adverse
economic and competitive industry conditions than investment grade securities.
The prices of low rated debt securities have been found to be less sensitive to
interest rate changes than higher rated investments, but more sensitive to
adverse economic downturns or individual corporate developments. A projection of
an economic downturn or of a period of rising interest rates, for example, could
cause a decline in low rated debt securities prices because the advent of a
recession could lessen the ability of a highly leveraged company to make
principal and interest payments on its debt securities. If the issuer of low
rated debt securities defaults, the fund may incur additional expenses to seek
recovery. The fund will not invest more than 5% of its total assets in defaulted
debt securities, which may be illiquid.
MORTGAGE-BACKED SECURITIES RISK Mortgage securities differ from conventional
debt securities because principal is paid back over the life of the security
rather than at maturity. The fund may receive unscheduled prepayments of
principal prior to the security's maturity date due to voluntary prepayments,
refinancing or foreclosure on the underlying mortgage loans. To the fund this
means a loss of anticipated interest, and a portion of its principal investment
represented by any premium the fund may have paid. Mortgage prepayments
generally increase with falling interest rates and decrease with rising interest
rates. An unexpected rise in interest rates could reduce the rate of principal
prepayments on mortgage securities and extend the life of these securities. This
could cause the price of these securities and the funds share price to fall and
would make these securities more sensitive to interest rate changes. This is
called "extension risk."
SMALLER COMPANIES RISK Historically, smaller company securities have been more
volatile in price than larger company securities, especially over the
short-term. Among the reasons for the greater price volatility are the less
certain growth prospects of smaller companies, the lower degree of liquidity in
the markets for such securities, and the greater sensitivity of smaller
companies to changing economic conditions.
In addition, small companies may lack depth of management, they may be unable to
generate funds necessary for growth or development, or they may be developing or
marketing new products or services for which markets are not yet established and
may never become established.
Therefore, while smaller companies may offer greater opportunities for capital
growth than larger, more established companies, they also involve greater risks
and should be considered speculative.
DERIVATIVE SECURITIES RISK The fund's ability to reduce or eliminate its futures
and related options positions will depend upon the liquidity of the secondary
markets for such futures and options. The fund intends to purchase or sell
futures and related options 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. Use of stock index futures and related options for hedging may
involve risks because of imperfect correlations between movements in the prices
of the futures or related options and movements in the prices of the securities
being hedged. Successful use of futures and related options by the fund for
hedging purposes also depends upon the manager's ability to predict correctly
movements in the direction of the market, as to which no assurance can be given.
REPURCHASE AGREEMENT RISK 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, the 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 the fund
not within the control of the 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.
LEVERAGE RISK Leveraging by means of borrowing may exaggerate the effect of any
increase or decrease in the value of portfolio securities on the 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.
OFFICERS AND DIRECTORS
- -------------------------------------------------------------------------------
Templeton Institutional Funds, Inc. (Company) has a board of directors. The
board is responsible for the overall management of the fund, including general
supervision and review of the fund's investment activities. The board, in turn,
elects the officers of the fund who are responsible for administering the fund's
day-to-day operations. The board also monitors the fund to ensure no material
conflicts exist among share classes. 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 fund, and principal occupations during the
past five years are shown below.
Harris J. Ashton (67)
191 Clapboard Ridge Road, Greenwich, CT 06830
DIRECTOR
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) (until 1998).
*Nicholas F. Brady (70)
16 North Washington Street,
Easton, MD 21601
DIRECTOR
Chairman, Templeton Emerging Markets Investment Trust PLC, Templeton Latin
America Investment Trust PLC, Darby Overseas Investments, Ltd. and Darby
Emerging Markets Investments LDC (investment firms) (1994-present); Director,
Templeton Global Strategy Funds, Amerada Hess Corporation (exploration and
refining of oil and gas), C2, Inc. (operating and investment business), and H.J.
Heinz Company (processed foods and allied products); director or trustee, as the
case may be, of 19 of the investment companies in the Franklin Templeton Group
of Funds; and FORMERLY, Secretary of the United States Department of the
Treasury (1988-1993), Chairman of the Board, Dillon, Read & Co., Inc.
(investment banking) (until 1988) and U.S. Senator, New Jersey (April
1982-December 1982).
Frank J. Crothers (55)
P.O. Box N-3238,
Nassau, Bahamas
DIRECTOR
Chairman, Caribbean Electric Utility Services Corporation and Atlantic Equipment
& Power Ltd.; Vice Chairman, Caribbean Utilities Co., Ltd.; President, Provo
Power Corporation; director of various other business and non-profit
organizations; and director or trustee, as the case may be, of 11 of the
investment companies in the Franklin Templeton Group of Funds.
S. Joseph Fortunato (67)
Park Avenue at Morris County,
P.O. Box 1945
Morristown, NJ 07962-1945
DIRECTOR
Member of the law firm of Pitney, Hardin, Kipp & Szuch; and director or trustee,
as the case may be, of 50 of the investment companies in the Franklin Templeton
Group of Funds.
John Wm. Galbraith (78)
360 Central Avenue, Suite 1300,
St. Petersburg, FL 33701
DIRECTOR
President, Galbraith Properties, Inc. (personal investment company); Director
Emeritus, Gulf West Banks, Inc. (bank holding company) (1995-present); director
or trustee, as the case may be, of 18 of the investment companies in the
Franklin Templeton Group of Funds; and FORMERLY, Director, Mercantile Bank
(1991-1995), Vice Chairman, Templeton, Galbraith & Hansberger Ltd. (1986-1992),
and Chairman, Templeton Funds Management, Inc. (1974-1991).
Andrew H. Hines, Jr. (77)
One Progress Plaza, Suite 290,
St. Petersburg, FL 33701
DIRECTOR
Consultant, Triangle Consulting Group; Executive-in-Residence, Eckerd College
(1991-present); director or trustee, as the case may be, of 20 of the investment
companies in the Franklin Templeton Group of Funds; and FORMERLY, Chairman and
Director, Precise Power Corporation (1990-1997), Director, Checkers Drive-In
Restaurant, Inc. (1994-1997), and Chairman of the Board and Chief Executive
Officer, Florida Progress Corporation (holding company in the energy area)
(1982-1990) and director of various of its subsidiaries.
Edith E. Holiday (48)
3239 38th Street, N.W.,
Washington, DC 20016
DIRECTOR
Director, Amerada Hess Corporation (exploration and refining of oil and gas)
(1993-present), Hercules Incorporated (chemicals, fibers and resins)
(1993-present), Beverly Enterprises, Inc. (health care) (1995-present, H.J.
Heinz Company (processed foods and allied products) (1994-present) and RTI
International Metals, Inc. (manufacture and distribution of titanium) (July
1999-present); director or trustee, as the case may be, of 25 of the investment
companies in the Franklin Templeton Group of Funds; and FORMERLY, Assistant to
the President of the United States and Secretary of the Cabinet (1990-1993),
General Counsel to the United States Treasury Department (1989-1990), and
Counselor to the Secretary and Assistant Secretary for Public Affairs and Public
Liaison-United States Treasury Department (1988-1989).
*Charles B. Johnson (67)
777 Mariners Island Blvd.,
San Mateo, CA 94404
VICE PRESIDENT AND DIRECTOR
Chairman of the Board, Chief Executive Officer, Member - Office of the Chairman
and Director, Franklin Resources, Inc.; Chairman of the Board and Director,
Franklin Investment Advisory Services, Inc.; Chairman of the Board, Franklin
Advisers, Inc.; Vice President, 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.
Betty P. Krahmer (70)
2201 Kentmere Parkway,
Wilmington, DE 19806
DIRECTOR
Director or trustee of various civic associations; director or trustee, as the
case may be, of 19 of the investment companies in the Franklin Templeton Group
of Funds; and FORMERLY, Economic Analyst, U.S. government.
Gordon S. Macklin (71)
8212 Burning Tree Road,
Bethesda, MD 20817
DIRECTOR
Director, Martek Biosciences Corporation, MCI WorldCom, Inc. (information
services), MedImmune, Inc. (biotechnology), Overstock.com (internet services);
White Mountains Insurance Group, Ltd. (holding company) and Spacehab, Inc.
(aerospace services); director or trustee, as the case may be, of 47 of the
investment companies in the Franklin Templeton Group of Funds; and FORMERLY,
Chairman, White River Corporation (financial services) (until 1998), Hambrecht &
Quist Group (investment banking) (until 1992), and President, National
Association of Securities Dealers, Inc. (until 1987).
Fred R. Millsaps (71)
2665 NE 37th Drive,
Fort Lauderdale, FL 33308
DIRECTOR
Manager of personal investments (1978-present); director of various business and
nonprofit organizations; director or trustee, as the case may be, of 20 of the
investment companies in the Franklin Templeton Group of Funds; and formerly,
Chairman and Chief Executive Officer, Landmark Banking Corporation (1969-1978),
Financial Vice President, Florida Power and Light (1965-1969), and Vice
President, Federal Reserve Bank of Atlanta (1958-1965).
Constantine Dean Tseretopoulos (46)
Lyford Cay Hospital,
P.O. Box N-7776,
Nassau, Bahamas
DIRECTOR
Physician, Lyford Cay Hospital (1987-present); director of various nonprofit
organizations; director or trustee, as the case may be, of 11 of the investment
companies in the Franklin Templeton Group of Funds; and FORMERLY, Cardiology
Fellow, University of Maryland (1985-1987) and Internal Medicine Intern, Greater
Baltimore Medical Center (1982-1985).
James R. Baio (46)
500 East Broward Blvd.,
Fort Lauderdale, FL 33394-3091
TREASURER
Certified Public Accountant; Senior Vice President, Templeton Worldwide, Inc.,
Templeton Global Investors, Inc. and Templeton Funds Trust Company; officer of
20 of the investment companies in the Franklin Templeton Group of Funds; and
FORMERLY, Senior Tax Manager, Ernst & Young (certified public accountants)
(1977-1989).
Harmon E. Burns (55)
777 Mariners Island Blvd.,
San Mateo, CA 94404
VICE PRESIDENT
Vice Chairman, Member-Office of the Chairman and Director, Franklin Resources,
Inc.; Executive Vice President and Director, 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 (39)
777 Mariners Island Blvd.,
San Mateo, CA 94404
VICE PRESIDENT
President, Member-Office of the President, Chief Financial Officer and Chief
Operating Officer, Franklin Resources, Inc.; Senior Vice President, Chief
Financial Officer and Director, Franklin/Templeton Investor Services, Inc.;
Senior Vice President and Chief Financial Officer; 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.; Executive Vice President and Chief Financial
Officer, Franklin Advisory Services, Inc. and Franklin Investment Advisory
Services, LLC; 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.
David P. Goss (52)
777 Mariners Island Blvd.,
San Mateo, CA 94404
VICE PRESIDENT
President, Chief Executive Officer and Director, Franklin Select Realty Trust,
Property Resources, Inc., Property Resources Equity Trust, Franklin Real Estate
Management, Inc. and Franklin Properties, Inc.; officer and director of some of
the other subsidiaries of Franklin Resources, Inc.; officer of 53 of the
investment companies in the Franklin Templeton Group of Funds; and FORMERLY,
President, Chief Executive Officer and Director, Franklin Real Estate Income
Fund and Franklin Advantage Real Estate Income Fund (until 1996).
Barbara J. Green (52)
777 Mariners Island Blvd.,
San Mateo, CA 94404
SECRETARY AND VICE PRESIDENT
Vice President and Deputy General Counsel, Franklin Resources, Inc.; Senior Vice
President, Templeton Worldwide, Inc. and Templeton Global Investors, Inc.;
officer of some of the other subsidiaries of Franklin Resources, Inc. and of 53
of the investment companies in the Franklin Templeton Group of Funds; and
FORMERLY, Deputy Director, Division of Investment Management, Executive
Assistant and Senior Advisor to the Chairman, Counselor to the Chairman, Special
Counsel and Attorney Fellow, U.S. Securities and Exchange Commission (1986-
1995), Attorney, Rogers & Wells (until 1986), and Judicial Clerk, U.S. District
Court (District of Massachusetts) (until 1979).
Mark G. Holowesko (40)
Lyford Cay,
Nassau, Bahamas
VICE PRESIDENT
President, Templeton Global Advisors Limited; Chief Investment Officer, Global
Equity Group; Executive Vice President and Director, Templeton Worldwide, Inc.;
officer of 19 of the investment companies in the Franklin Templeton Group of
Funds; and FORMERLY, Investment Administrator, RoyWest Trust Corporation
(Bahamas) Limited (1984-1985).
Charles E. Johnson (43)
777 Mariners Island Blvd.,
San Mateo, CA 94404
VICE PRESIDENT
President, Member-Office of the President and Director, Franklin Resources,
Inc.; Senior Vice President, Franklin Templeton Distributors, Inc.; President
and Director, Templeton Worldwide, Inc. and Franklin Advisers, Inc.; Director,
Templeton Investment Counsel, Inc.; President, Franklin Investment Advisory
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 33 of the investment companies in the Franklin Templeton Group of
Funds.
Rupert H. Johnson, Jr. (59)
777 Mariners Island Blvd.,
San Mateo, CA 94404
VICE PRESIDENT
Vice Chairman, Member-Office of the Chairman and Director, Franklin Resources,
Inc.; Executive Vice President and Director, Franklin Templeton Distributors,
Inc.; Director, Franklin Advisers, Inc., Franklin Investment Advisory Services,
Inc. and Franklin/Templeton Investor Services, Inc.; Senior Vice President,
Franklin Advisory Services, LLC; 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.
John R. Kay (59)
500 East Broward Blvd.,
Fort Lauderdale, FL 33394-3091
VICE PRESIDENT
Vice President, Templeton Worldwide, Inc.; Assistant Vice President, Franklin
Templeton Distributors, Inc.; officer of 24 of the investment companies in the
Franklin Templeton Group of Funds; and FORMERLY, Vice President and Controller,
Keystone Group, Inc.
Elizabeth M. Knoblock (45)
500 East Broward Blvd.,
Fort Lauderdale, FL 33394-3091
VICE PRESIDENT - COMPLIANCE
General Counsel, Secretary and Senior Vice President, Templeton Investment
Counsel, Inc.; Senior Vice President, Templeton Global Investors, Inc.; officer
of other subsidiaries of Franklin Resources, Inc. and of 23 of the investment
companies in the Franklin Templeton Group of Funds; and FORMERLY, Vice President
and Associate General Counsel, Kidder Peabody & Co. Inc. (1989-1990), Assistant
General Counsel, Gruntal & Co., Inc. (1988), Vice President and Associate
General Counsel, Shearson Lehman Hutton Inc. (1988), Vice President and
Assistant General Counsel, E.F. Hutton & Co. Inc. (1986-1988), and Special
Counsel, Division of Investment Management, U.S. Securities and Exchange
Commission (1984-1986).
J. Mark Mobius (63)
Two Exchange Square, 39th Floor,
Suite 3905-08,
Hong Kong
VICE PRESIDENT
Portfolio Manager of various Templeton advisory affiliates; Managing Director,
Templeton Asset Management Ltd.; Executive Vice President and Director;
Templeton Global Advisors Limited; officer of eight of the investment companies
in the Franklin Templeton Group of Funds; and FORMERLY, President, International
Investment Trust Company Limited (investment manager of Taiwan R.O.C. Fund)
(1986-1987) and Director, Vickers da Costa, Hong Kong (1983-1986).
Donald F. Reed (55)
1 Adelaide Street East, Suite 2101
Toronto, Ontario Canada M5C 3B8
PRESIDENT
Executive Vice President and Director, Templeton Worldwide, Inc.; Chairman,
Chief Executive Officer and Director, Templeton Investment Counsel, Inc.;
President, Chief Executive Officer and Director, Templeton Management Limited;
officer and/or director, as the case may be, of some of the other subsidiaries
of Franklin Resources, Inc.; Co-founder and Director, International Society of
Financial Analysts; Chairman, Canadian Council of Financial Analysts; and
FORMERLY, President and Director, Reed Monahan Nicholishen Investment Counsel
(1982-1989).
Murray L. Simpson (62)
777 Mariners Island Blvd.,
San Mateo, CA 94404
VICE PRESIDENT
Executive Vice President and General Counsel, Franklin Resources, Inc.; officer
and/or director of some of the subsidiaries of Franklin Resources, Inc.; officer
of 53 of the investment companies in the Franklin Templeton Group of Funds; and
FORMERLY, Chief Executive Officer and Managing Director, Templeton Franklin
Investment Services (Asia) Limited (until January 2000) and Director, Templeton
Asset Management, Ltd. (until 1999).
*This board member is considered an "interested person" under federal securities
laws. Mr. Brady's status as an interested person results from his business
affiliations with Franklin Resources, Inc. and Templeton Global Advisors
Limited. Mr. Brady and Franklin Resources, Inc. are both limited partners of
Darby Overseas Partners, L.P. (Darby Overseas). In addition, Darby Overseas and
Templeton Global Advisors Limited are limited partners of Darby Emerging Markets
Fund, L.P.
NOTE: Charles B. Johnson and Rupert H. Johnson, Jr. are brothers and the father
and uncle, respectively, of Charles E. Johnson.
The Company pays noninterested board members and Mr. Brady an annual retainer of
$12,000 and a fee of $900 per board meeting attended. Board members who serve on
the audit committee of the Company and other funds in the Franklin Templeton
Group of Funds receive a flat fee of $2,000 per committee meeting attended, a
portion of which is allocated to the Company. Members of a committee are not
compensated for any committee meeting held on the day of a board meeting.
Noninterested board members also may serve as directors or trustees of other
funds in the Franklin Templeton Group of Funds and may receive fees from these
funds for their services. The following table provides the total fees paid to
noninterested board members and Mr. Brady by the Company and by the Franklin
Templeton Group of Funds.
<TABLE>
<CAPTION>
NUMBER OF
BOARDS IN
TOTAL FEES THE FRANKLIN
RECEIVED FROM TEMPLETON
TOTAL FEES THE FRANKLIN GROUP
RECEIVED TEMPLETON OF FUNDS
FROM THE GROUP ON WHICH
NAME COMPANY(1) ($) OF FUNDS(2) ($) EACH SERVES(3)
- ------------------- ---------------------- --------------------- ------------------
<S> <C> <C> <C>
Harris J. Ashton 16,500 365,165 48
Nicholas F. Brady 16,500 138,700 19
Frank J. Crothers 20,632 72,400 11
S. Joseph Fortunato 16,500 363,238 50
John Wm. Galbraith 17,030 144,200 18
Andrew H. Hines, Jr. 17,004 203,700 20
Edith E. Holiday 16,500 237,265 25
Betty P. Krahmer 16,500 138,700 19
Gordon S. Macklin 16,500 363,165 48
Fred R. Millsaps 17,341 201,700 20
Constantine D.
Tseretopoulos 19,611 70,400 11
</TABLE>
1. For the fiscal year ended December 31, 1999.
2. For the calendar year ended December 31, 1999.
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 53 registered investment companies, with approximately 155
U.S. based funds or series.
Noninterested board members and Mr. Brady 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
- -------------------------------------------------------------------------------
MANAGER AND SERVICES PROVIDED The fund's manager is Templeton Investment
Counsel, Inc. The manager is a wholly owned subsidiary of 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 manager provides investment research and portfolio management services, and
selects the securities for the fund to buy, hold or sell. The manager also
selects the brokers who execute the fund's portfolio transactions. The manager
provides periodic reports to the board, which reviews and supervises the
manager's investment activities. To protect the fund, the manager and its
officers, directors and employees are covered by fidelity insurance.
The Templeton organization has been investing globally since 1940. The manager
and its affiliates have offices in Argentina, the Bahamas, Brazil, Canada,
Peoples Republic of China, Cyprus, France, Germany, Hong Kong, India, Italy,
Japan, Korea, Luxembourg, Mauritius, the Netherlands, Poland, Russia, Singapore,
South Africa, Spain, Sweden, Switzerland, Taiwan, Turkey, United Kingdom,
Venezuela and the U.S.
The manager and its affiliates manage numerous other investment companies and
accounts. The manager may give advice and take action with respect to any of the
other funds it manages, or for its own account, that may differ from action
taken by the manager on behalf of the fund. Similarly, with respect to the fund,
the manager is not obligated to recommend, buy or sell, or to refrain from
recommending, buying or selling any security that the manager and access
persons, as defined by applicable federal securities laws, may buy or sell for
its or their own account or for the accounts of any other fund. The manager is
not obligated to refrain from investing in securities held by the fund or other
funds it manages.
The fund, its manager and principal underwriter has each adopted a code of
ethics, as required by federal securities laws. Under the code of ethics,
employees who are designated as access persons may engage in personal securities
transactions, including transactions involving securities that are being
considered for the fund or that are currently held by the fund, subject to
certain general restrictions and procedures. The personal securities
transactions of access persons of the fund, its manager and principal
underwriter will be governed by the code of ethics. The code of ethics is on
file with, and available from, the U.S. Securities and Exchange Commission
(SEC).
MANAGEMENT FEES The fund pays the manager a monthly fee equal to an annual rate
of 0.70% of the value of its average daily net assets during the year.
Each class of the fund's shares pays its proportionate share of the fee.
For the last three fiscal years ended December 31, the fund paid the following
management fees:
MANAGEMENT FEES PAID ($)
-------------------------
1999 32,611,710
1998 30,272,145
1997 23,912,568
ADMINISTRATOR AND SERVICES PROVIDED Franklin Templeton Services, Inc. (FT
Services) has an agreement with the Company to provide certain administrative
services and facilities for the fund. FT Services is wholly owned by Resources
and is an affiliate of the fund's manager 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 Company pays FT Services a monthly fee equal to an
annual rate of:
- - 0.15% of the fund's combined average daily net assets up to $200 million;
- - 0.135% of average daily net assets over $200 million up to $700 million;
- - 0.10% of average daily net assets over $700 million up to $1.2 billion; and
- - 0.075% of average daily net assets over $1.2 billion.
During the last three fiscal years ended December 31, the Company paid FT
Services the following administration fees:
ADMINISTRATION FEES PAID ($)
-----------------------------------
1999 3,896,265
1998 3,636,696
1997 2,903,341
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 100 Fountain Parkway, St. Petersburg, FL 33716-1205. Please send all
correspondence to Investor Services to P.O. Box 33030, St. Petersburg, FL
33733-8030
For its services, Investor Services receives a fixed fee per account. The fund
also will reimburse Investor Services for certain out-of-pocket expenses, which
may include payments by Investor Services to entities, including affiliated
entities, that provide sub-shareholder services, recordkeeping and/or transfer
agency services to beneficial owners of the fund. The amount of reimbursements
for these services per benefit plan participant fund account per year will not
exceed the per account fee payable by the fund to Investor Services in
connection with maintaining shareholder accounts.
CUSTODIAN 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 fund's assets. 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, 1177 Avenue of the Americas, New York, NY
10036, is the fund's independent auditor. The auditor gives an opinion on the
financial statements included in the fund's Annual Report to Shareholders and
reviews the fund's registration statement filed with the SEC.
PORTFOLIO TRANSACTIONS
- ------------------------------------------------------------------------------
The manager selects brokers and dealers to execute the fund's portfolio
transactions in accordance with criteria set forth in the management agreement
and any directions that the board may give.
When placing a portfolio transaction, the manager seeks 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 manager and the broker executing the transaction. The determination and
evaluation of the reasonableness of the brokerage commissions paid are based to
a large degree on the professional opinions of the persons responsible for
placement and review of the transactions. These opinions are based on the
experience of these individuals in the securities industry and information
available to them about the level of commissions being paid by other
institutional investors of comparable size. The manager 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
manager, 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 manager may pay certain brokers commissions that are higher than those
another broker may charge, if the manager determines in good faith that the
amount paid is reasonable in relation to the value of the brokerage and research
services it receives. This may be viewed in terms of either the particular
transaction or the manager's overall responsibilities to client accounts over
which it exercises investment discretion. The services that brokers may provide
to the manager 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 manager in carrying out its investment advisory
responsibilities. These services may not always directly benefit the fund. They
must, however, be of value to the manager in carrying out its overall
responsibilities to its clients.
It is not possible to place a dollar value on the special executions or on the
research services the manager receives from dealers effecting transactions in
portfolio securities. The allocation of transactions to obtain additional
research services allows the manager to supplement its own research and analysis
activities and to receive the views and information of individuals and research
staffs of other securities firms. As long as it is lawful and appropriate to do
so, the manager and its affiliates may use this research and data in their
investment advisory capacities with other clients. If the fund's officers are
satisfied that the best execution is obtained, the sale of fund shares, as well
as shares of other funds in the Franklin Templeton Group of Funds, also may be
considered a factor in the selection of broker-dealers to execute the 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 the 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.
Sale or purchase of securities, without payment of brokerage commissions, fees
(except customary transfer fees) or other remuneration in connection therewith,
may be effected between any of the fund, or between funds and private clients,
under procedures adopted by the Company's Board pursuant to Rule 17a-7 under the
1940 Act.
During the last three fiscal years ended December 31, the fund paid the
following brokerage commissions:
BROKERAGE COMMISSIONS ($)
----------------------------------
1999 1,502,739
1998 3,863,065
1997 2,666,430
For the fiscal year ended December 31, 1999, Templeton Institutional Funds Inc.
- - Foreign Equity Series paid brokerage commissions of $1,742,821 from aggregate
portfolio transactions of $671,683,936 to brokers who provided research
services.
As of December 31, 1999, the fund did not own securities of its regular
broker-dealers.
DISTRIBUTIONS AND TAXES
- -------------------------------------------------------------------------------
The fund calculates dividends and capital gains the same way for each class. The
amount of any income dividends per share will differ, however, generally due to
the difference in any distribution and service (Rule 12b-1) fees of each class.
Distributions are subject to approval by the board. The fund does not pay
"interest" or guarantee any fixed rate of return on an investment in its shares.
DISTRIBUTIONS OF NET INVESTMENT INCOME The fund receives income generally in the
form of dividends and interest on its investments. This income, less expenses
incurred in the operation of the fund, constitutes the fund's net investment
income from which dividends may be paid to you. Any distributions by the fund
from such income will be taxable to you as ordinary income, whether you receive
them in cash or in additional shares.
DISTRIBUTIONS OF CAPITAL GAINS The fund may derive capital gains and losses in
connection with sales or other dispositions of its portfolio securities.
Distributions from net short-term capital gains will be taxable to you as
ordinary income. Distributions from net long-term capital gains will be taxable
to you as long-term capital gain, regardless of how long you have held your
shares in the fund. Any net capital gains realized by the fund generally will be
distributed once each year, and may be distributed more frequently, if
necessary, to reduce or eliminate excise or income taxes on the fund.
EFFECT OF FOREIGN INVESTMENTS ON DISTRIBUTIONS Most foreign exchange gains
realized on the sale of debt securities are treated as ordinary income by the
fund. Similarly, foreign exchange losses realized on the sale of debt securities
generally are treated as ordinary losses. These gains when distributed will be
taxable to you as ordinary dividends, and any losses will reduce the fund's
ordinary income otherwise available for distribution to you. This treatment
could increase or decrease the fund's ordinary income distributions to you, and
may cause some or all of the fund's previously distributed income to be
classified as a return of capital.
The fund may be subject to foreign withholding taxes on income from certain
foreign securities. If more than 50% of the fund's total assets at the end of
the fiscal year are invested in securities of foreign corporations, the fund may
elect to pass-through to you your pro rata share of foreign taxes paid by the
fund. If this election is made, the year-end statement you receive from the fund
will show more taxable income than was actually distributed to you. However, you
will be entitled to either deduct your share of such taxes in computing your
taxable income or (subject to limitations) claim a foreign tax credit for such
taxes against your U.S. federal income tax. The fund will provide you with the
information necessary to complete your individual income tax return if it makes
this election.
INFORMATION ON THE TAX CHARACTER OF DISTRIBUTIONS The fund will inform you of
the amount of your ordinary income dividends and capital gains distributions at
the time they are paid, and will advise you of their tax status for federal
income tax purposes shortly after the close of each calendar year. If you have
not held fund shares for a full year, the fund may designate and distribute to
you, as ordinary income or capital gain, a percentage of income that is not
equal to the actual amount of such income earned during the period of your
investment in the fund.
ELECTION TO BE TAXED AS A REGULATED INVESTMENT COMPANY The fund has elected to
be treated as a regulated investment company under Subchapter M of the Internal
Revenue Code. The fund has qualified as a regulated investment company for its
most recent fiscal year, and intends to continue to qualify during the current
fiscal year. As a regulated investment company, the fund generally pays no
federal income tax on the income and gains it distributes to you. The board
reserves the right not to maintain the qualification of the 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, and distributions to you
will be taxed as ordinary dividend income to the extent of the fund's earnings
and profits.
EXCISE TAX DISTRIBUTION REQUIREMENTS To avoid federal excise taxes, the Internal
Revenue Code requires the fund to distribute to you by December 31 of each year,
at a minimum, the following amounts: 98% of its taxable ordinary income earned
during the calendar year; 98% of its capital gain net income earned during the
twelve month period ending October 31; and 100% of any undistributed amounts
from the prior year. The fund intends to declare and pay these distributions in
December (or to pay them in January, in which case you must treat them as
received in December) but can give no assurances that its distributions will be
sufficient to eliminate all taxes.
REDEMPTION OF FUND SHARES Redemptions (including redemption in kind) and
exchanges of fund shares are taxable transactions for federal and state income
tax purposes. If you redeem your fund shares, or exchange your fund shares for
shares of a different Franklin Templeton Fund, the IRS will require that you
report any gain or loss on your redemption or exchange. If you hold your shares
as a capital asset, the gain or loss that you realize will be capital gain or
loss and will be long-term or short-term, generally depending on how long you
hold your shares.
Beginning after the year 2005 (2000 for certain shareholders), gains from the
sales of fund shares held for more than five years may be subject to a reduced
tax rate.
Any loss incurred on the redemption or exchange of shares held for six months or
less will be treated as a long-term capital loss to the extent of any long-term
capital gains distributed to you by the fund on those shares.
All or a portion of any loss that you realize upon the redemption of your fund
shares will be disallowed to the extent that you buy other shares in the fund
(through reinvestment of dividends or otherwise) within 30 days before or after
your share redemption. Any loss disallowed under these rules will be added to
your tax basis in the new shares you buy.
DEFERRAL OF BASIS If you redeem some or all of your shares in the fund, and then
reinvest the sales proceeds in the fund or in another Franklin Templeton Fund
within 90 days of buying the original shares, the sales charge that would
otherwise apply to your reinvestment may be reduced or eliminated. The IRS will
require you to report any gain or loss on the redemption of your original shares
in the fund. In doing so, all or a portion of the sales charge that you paid for
your original shares in the fund will be excluded from your tax basis in the
shares sold (for the purpose of determining gain or loss upon the sale of such
shares). The portion of the sales charge excluded will equal the amount that the
sales charge is reduced on your reinvestment. Any portion of the sales charge
excluded from your tax basis in the shares sold will be added to the tax basis
of the shares you acquire from your reinvestment.
U.S. GOVERNMENT SECURITIES States grant tax-free status to dividends paid to you
from interest earned on certain U.S. government securities, subject in some
states to minimum investment or reporting requirements that must be met by the
fund. Investments in Government National Mortgage Association or Federal
National Mortgage Association securities, bankers' acceptances, commercial paper
and repurchase agreements collateralized by U.S. government securities generally
do not qualify for tax-free treatment. The rules on exclusion of this income are
different for corporations.
DIVIDENDS-RECEIVED DEDUCTION FOR CORPORATIONS Because the fund's income is
derived primarily from investments in foreign rather than domestic securities,
generally none of its distributions will be eligible for the corporate
dividends-received deduction. None of the dividends paid by the fund for the
most recent calendar year qualified for such deduction, and it is anticipated
that none of the current year's dividends will so qualify.
INVESTMENT IN COMPLEX SECURITIES The 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 the fund are
treated as ordinary income or capital gain, accelerate the recognition of income
to the fund (possibly causing the fund to sell securities to raise the cash for
necessary distributions) and/or defer the fund's ability to recognize losses,
and, in limited cases, subject the fund to U.S. federal income tax on income
from certain foreign securities. These rules may affect the amount, timing or
character of the income distributed to you by the fund.
ORGANIZATION, VOTING RIGHTS AND PRINCIPAL HOLDERS
- -------------------------------------------------------------------------------
The fund is a diversified series of Templeton Institutional Funds Inc.
(Company), which is an open-end management investment company, commonly called a
mutual fund. The Company was organized as a Maryland corporation on July 6,
1990, and is registered with the SEC.
The fund currently offers two classes of shares, Primary Shares and Service
Shares. The fund may offer additional classes of shares in the future. The full
title of each class is:
- - Foreign Equity Series - Primary Shares
- - Foreign Equity Series - Service Shares
Shares of each class represent proportionate interests in the fund's assets. On
matters that affect the 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 Company for matters that affect the Company as a whole. Additional series
may be offered in the future.
The Company 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 Company does not intend to hold annual shareholder meetings. The Company or
a fund may hold special meetings, however, for matters requiring shareholder
approval. A meeting may 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 you
communicate with other shareholders about the removal of a board member. A
special meeting also may be called by the board in its discretion.
As of April 3, 2000, the principal shareholders of the fund, beneficial or of
record, were:
NAME AND ADDRESS PERCENTAGE (%)
- ------------------------------------------------------------
FOREIGN EQUITY - SERVICE SHARES
Franklin Resources Inc.(1)
Corporate Accounting
Attn: Michael Corcoran
555 Airport Road Blvd., 4th Fl,
Burlingame, CA 94010 100
1. NOTE: Charles B. Johnson and Rupert H. Johnson, Jr., who are officers and/or
directors of the fund, may be considered beneficial holders of the fund shares
held by Franklin Resources, Inc. (Resources). As principal shareholders of
Resources, they may be able to control the voting of Resources' shares of the
fund.
From time to time, the number of fund shares held in the "street name" accounts
of various securities dealers for the benefit of their clients or in centralized
securities depositories may exceed 5% of the total shares outstanding.
As of April 3, 2000, the officers and board members, as a group, owned of record
and beneficially less than 1% of the outstanding shares of each class. The board
members may own shares in other funds in the Franklin Templeton Group of Funds.
BUYING AND SELLING SHARES
- ------------------------------------------------------------------------------
The fund continuously offers its shares through securities dealers who have an
agreement with Franklin Templeton Distributors, Inc. (Distributors). A
securities dealer includes any financial institution that, either directly or
through affiliates, has an agreement with Distributors to handle customer orders
and accounts with the fund. This reference is for convenience only and does not
indicate a legal conclusion of capacity. Banks and financial institutions that
sell shares of the fund may be required by state law to register as securities
dealers.
For investors outside the U.S., the offering of fund shares may be limited in
many jurisdictions. An investor who wishes to buy shares of the fund should
determine, or have a broker-dealer determine, the applicable laws and
regulations of the relevant jurisdiction. Investors are responsible for
compliance with tax, currency exchange or other regulations applicable to
redemption and purchase transactions in any jurisdiction to which they may be
subject. Investors should consult appropriate tax and legal advisors to obtain
information on the rules applicable to these transactions.
All checks, drafts, wires and other payment mediums used to buy or sell shares
of the fund must be denominated in U.S. dollars. We may, in our sole discretion,
either (a) reject any order to buy or sell shares denominated in any other
currency or (b) honor the transaction or make adjustments to your account for
the transaction as of a date and with a foreign currency exchange factor
determined by the drawee bank.
When you buy shares, if you submit a check or a draft that is returned unpaid to
the fund we may impose a $10 charge against your account for each returned item.
If you buy shares through the reinvestment of dividends, the shares will be
purchased at the net asset value determined on the business day following the
dividend record date (sometimes known as the "ex-dividend date"). The processing
date for the reinvestment of dividends may vary and does not affect the amount
or value of the shares acquired.
GROUP PURCHASES As described in the prospectus, members of a qualified group may
add the group's investments together for minimum investment purposes.
A qualified group is one that:
o Was formed at least six months ago,
o Has a purpose other than buying fund shares,
o Has more than 10 members,
o Can arrange for meetings between our representatives and group members,
o Agrees to include Franklin Templeton Fund sales and other materials in
publications and mailings to its members at reduced or no cost to
Distributors,
o Agrees to arrange for payroll deduction or other bulk transmission of
investments to the fund, and
o Meets other uniform criteria that allow Distributors to achieve cost savings
in distributing shares.
DEALER COMPENSATION Distributors and/or its affiliates may provide financial
support to securities dealers that sell shares of the Franklin Templeton Group
of Funds. This support is based primarily on the amount of sales of fund shares
and/or total assets with the Franklin Templeton Group of Funds. The amount of
support may be affected by: total sales; net sales; levels of redemptions; the
proportion of a securities dealer's sales and marketing efforts in the Franklin
Templeton Group of Funds; a securities dealer's support of, and participation
in, Distributors' marketing programs; a securities dealer's compensation
programs for its registered representatives; and the extent of a securities
dealer's marketing programs relating to the Franklin Templeton Group of Funds.
Financial support to securities dealers may be made by payments from
Distributors' resources, from Distributors' retention of underwriting
concessions and, in the case of funds that have Rule 12b-1 plans, from payments
to Distributors under such plans. In addition, certain securities dealers may
receive brokerage commissions generated by fund portfolio transactions in
accordance with the rules of the National Association of Securities Dealers,
Inc.
Distributors routinely sponsors due diligence meetings for registered
representatives during which they receive updates on various Franklin Templeton
Funds and are afforded the opportunity to speak with portfolio managers.
Invitation to these meetings is not conditioned on selling a specific number of
shares. Those who have shown an interest in the Franklin Templeton Funds,
however, are more likely to be considered. To the extent permitted by their
firm's policies and procedures, registered representatives' expenses in
attending these meetings may be covered by Distributors.
EXCHANGE PRIVILEGE If you request the exchange of the total value of your
account, declared but unpaid income dividends and capital gain distributions
will be reinvested in the fund and exchanged into the new fund at net asset
value when paid. Backup withholding and information reporting may apply.
If a substantial number of shareholders should, within a short period, sell
their fund shares under the exchange privilege, the fund might have to sell
portfolio securities it might otherwise hold and incur the additional costs
related to such transactions. On the other hand, increased use of the exchange
privilege may result in periodic large inflows of money. If this occurs, it is
the fund's general policy to initially invest this money in short-term,
interest-bearing money market instruments, unless it is believed that attractive
investment opportunities consistent with the fund's investment goal exist
immediately. This money will then be withdrawn from the short-term,
interest-bearing money market instruments and invested in portfolio securities
in as orderly a manner as is possible when attractive investment opportunities
arise.
The proceeds from the sale of shares of an investment company generally are not
available until the seventh day following the sale. The funds you are seeking to
exchange into may delay issuing shares pursuant to an exchange until that
seventh day. The sale of fund shares to complete an exchange will be effected at
net asset value at the close of business on the day the request for exchange is
received in proper form.
REDEMPTIONS IN KIND The fund has committed itself to pay in cash (by check) all
requests for redemption by any shareholder of record, limited in amount,
however, during any 90-day period to the lesser of $250,000 or 1% of the value
of the fund's net assets at the beginning of the 90-day period. This commitment
is irrevocable without the prior approval of the U.S. Securities and Exchange
Commission (SEC). In the case of redemption requests in excess of these amounts,
the board reserves the right to make payments in whole or in part in securities
or other assets of the fund, in case of an emergency, or if the payment of such
a redemption in cash would be detrimental to the existing shareholders of the
fund. In these circumstances, the securities distributed would be valued at the
price used to compute the fund's net assets and you may incur brokerage fees in
converting the securities to cash. The fund does not intend to redeem illiquid
securities in kind. If this happens, however, you may not be able to recover
your investment in a timely manner.
SUBSTANTIAL REDEMPTIONS A number of fund shareholders are institutions with
significant shareholdings that may be redeemed at any time. If a substantial
number or amount of redemptions should occur within a relatively short period of
time, a fund may have to sell portfolio securities it would otherwise hold and
incur the additional transactions costs. The sale of portfolio securities may
result in the recognition of capital gains, which will be distributed annually
and generally will be taxable to shareholders as ordinary income or capital
gains. Shareholders are notified annually regarding the federal tax status of
distributions they receive (see Distribution and Taxes).
SHARE CERTIFICATES We will credit your shares to your fund account. We do not
issue share certificates unless you specifically request them. This eliminates
the costly problem of replacing lost, stolen or destroyed certificates. If a
certificate is lost, stolen or destroyed, you may have to pay an insurance
premium of up to 2% of the value of the certificate to replace it.
Any outstanding share certificates must be returned to the fund if you want to
sell or exchange those shares or if you would like to start a systematic
withdrawal plan. The certificates should be properly endorsed. You can do this
either by signing the back of the certificate or by completing a share
assignment form. For your protection, you may prefer to complete a share
assignment form and to send the certificate and assignment form in separate
envelopes.
GENERAL INFORMATION If dividend checks are returned to the fund marked "unable
to forward" by the postal service, we will consider this a request by you to
change your dividend option to reinvest all distributions. The proceeds will be
reinvested in additional shares at net asset value until we receive new
instructions.
Distribution or redemption checks sent to you do not earn interest or any other
income during the time the checks remain uncashed. Neither the fund nor its
affiliates will be liable for any loss caused by your failure to cash such
checks. The fund is not responsible for tracking down uncashed checks, unless a
check is returned as undeliverable.
In most cases, if mail is returned as undeliverable we are required to take
certain steps to try to find you free of charge. If these attempts are
unsuccessful, however, we may deduct the costs of any additional efforts to find
you from your account. These costs may include a percentage of the account when
a search company charges a percentage fee in exchange for its location services.
Sending redemption proceeds by wire or electronic funds transfer (ACH) is a
special service that we make available whenever possible. By offering this
service to you, the fund is not bound to meet any redemption request in less
than the seven day period prescribed by law. Neither the fund nor its agents
shall be liable to you or any other person if, for any reason, a redemption
request by wire or ACH is not processed as described in the prospectus.
Franklin/Templeton Investor Services, Inc. (Investor Services) may pay certain
financial institutions that maintain omnibus accounts with the fund on behalf of
numerous beneficial owners for recordkeeping operations performed with respect
to such owners. For each beneficial owner in the omnibus account, the fund may
reimburse Investor Services an amount not to exceed the per account fee that the
fund normally pays Investor Services. These financial institutions also may
charge a fee for their services directly to their clients.
If you buy or sell shares through your securities dealer, we use the net asset
value next calculated after your securities dealer receives your request, which
is promptly transmitted to the fund. If you sell shares through your securities
dealer, it is your dealer's responsibility to transmit the order to the fund in
a timely fashion. Your redemption proceeds will not earn interest between the
time we receive the order from your dealer and the time we receive any required
documents. Any loss to you resulting from your dealer's failure to transmit your
redemption order to the fund in a timely fashion must be settled between you and
your securities dealer.
Certain shareholder servicing agents may be authorized to accept your
transaction request.
For institutional accounts, there may be additional methods of buying or selling
fund shares than those described in this SAI or in the prospectus.
In the event of disputes involving multiple claims of ownership or authority to
control your account, the fund has the right (but has no obligation) to: (a)
freeze the account and require the written agreement of all persons deemed by
the fund to have a potential property interest in the account, before executing
instructions regarding the account; (b) interplead disputed funds or accounts
with a court of competent jurisdiction; or (c) surrender ownership of all or a
portion of the account to the IRS in response to a notice of levy.
PRICING SHARES
- -------------------------------------------------------------------------------
When you buy shares, you pay the offering price. The offering price is the net
asset value (NAV) per share plus any applicable sales charge, calculated to two
decimal places using standard rounding criteria.
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.
The fund calculates the NAV per share of each class each business day at the
close of trading on the New York Stock Exchange (normally 1:00 p.m. Pacific
time). The fund does not calculate the NAV on days the New York Stock Exchange
(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.
When determining its NAV, the 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.
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.
THE UNDERWRITER
- -------------------------------------------------------------------------------
Franklin Templeton Distributors, Inc. (Distributors) acts as the principal
underwriter in the continuous public offering of the fund's shares. Distributors
is located at 777 Mariners Island Blvd., San Mateo, CA 94404.
Distributors pays the expenses of the distribution of fund shares, including
advertising expenses and the costs of printing sales material and prospectuses
used to offer shares to the public. The fund pays the expenses of preparing and
printing amendments to its registration statements and prospectuses (other than
those necessitated by the activities of Distributors) and of sending
prospectuses to existing shareholders.
DISTRIBUTION AND SERVICE (12B-1) FEES The fund has a distribution or "Rule
12b-1" plan for its Service Shares. Under the plan, the fund shall pay or may
reimburse Distributors or others for the expenses of activities that are
primarily intended to sell Service Shares. These expenses may include, among
others, distribution or service fees paid to securities dealers or others who
have executed a servicing agreement with the fund, Distributors or its
affiliates; a prorated portion of Distributors' overhead expenses; and the
expenses of printing prospectuses and reports used for sales purposes, and
preparing and distributing sales literature and advertisements.
Payments by the fund under the plan may not exceed 0.35% per year of average
daily net assets, payable quarterly. Expenses not reimbursed in any quarter may
be reimbursed in future quarters or years. This includes expenses not reimbursed
because they exceeded the applicable limit under the plan.
The terms and provisions of the plan relating to required reports, term, and
approval are consistent with Rule 12b-1.
In no event shall the aggregate asset-based sales charges, which include
payments made under the plan, plus any other payments deemed to be made pursuant
to the plan, exceed the amount permitted to be paid under the rules of the
National Association of Securities Dealers, Inc.
To the extent fees are for distribution or marketing functions, as distinguished
from administrative servicing or agency transactions, certain banks will not be
entitled to participate in the plan as a result of applicable federal law
prohibiting certain banks from engaging in the distribution of mutual fund
shares. These banking institutions, however, are permitted to receive fees under
the plan for administrative servicing or for agency transactions. If you are a
customer of a bank that is prohibited from providing these services, you would
be permitted to remain a shareholder of the fund, and alternate means for
continuing the servicing would be sought. In this event, changes in the services
provided might occur and you might no longer be able to avail yourself of any
automatic investment or other services then being provided by the bank. It is
not expected that you would suffer any adverse financial consequences as a
result of any of these changes.
The plan has been approved in accordance with the provisions of Rule 12b-1. The
plan is renewable annually by a vote of the board, including a majority vote of
the board members who are not interested persons of the fund and who have no
direct or indirect financial interest in the operation of the plan, 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 noninterested
members of the fund's board. The plan and any related agreement may be
terminated at any time, without penalty, by vote of a majority of the
noninterested board members on not more than 60 days' written notice, by
Distributors on not more than 60 days' written notice, by any act that
constitutes an assignment of the management agreement with the manager or by
vote of a majority of the outstanding shares of the class. Distributors or any
dealer or other firm may also terminate their respective distribution or service
agreement at any time upon written notice.
The plan and any related agreements may not be amended to increase materially
the amount to be spent for distribution expenses without approval by a majority
of the outstanding shares of the class, and all material amendments to the plan
or any related agreements shall be approved by a vote of the noninterested board
members, 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 plan 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 plan should be continued.
PERFORMANCE
- -------------------------------------------------------------------------------
Performance quotations are subject to SEC rules. These rules require the use of
standardized performance quotations or, alternatively, that every
non-standardized performance quotation furnished by the fund be accompanied by
certain standardized performance information computed as required by the SEC.
Average annual total return quotations used by the fund are based on the
standardized methods of computing performance mandated by the SEC. An
explanation of these and other methods used by the fund to compute or express
performance follows. Regardless of the method used, past performance does not
guarantee future results, and is an indication of the return to shareholders
only for the limited historical period used.
Before May 1, 1999, only a single class of fund shares was offered without Rule
12b-1 expenses. Returns shown are a restatement of the original class to include
the Rule 12b-1 fees applicable to Service Shares as though in effect from the
fund's inception.
AVERAGE ANNUAL TOTAL RETURN 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 charges
and fees. If a change is made to the sales charge structure, historical
performance information will be restated to reflect the maximum initial sales
charge currently in effect.
The average annual total returns for the indicated periods ended December 31,
1999, were:
SINCE INCEPTION
1 YEAR (%) 5 YEARS (%) (10/18/90) (%)
- ------------------------------------------------------------
Service Shares 27.34 16.51 14.07
The following SEC formula was used to calculate these figures:
P(1+T)(n) = 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, cumulative total
return assumes income dividends and capital gain distributions are reinvested at
net asset value. Cumulative total return, however, is based on the actual return
for a specified period rather than on the average return over the periods
indicated above. The cumulative total returns for the indicated periods ended
December 31, 1999, were:
SINCE INCEPTION
1 YEAR (%) 5 YEARS (%) (10/18/90) (%)
- -----------------------------------------------------------------
Service Shares 27.34 114.70 235.78
VOLATILITY Occasionally statistics may be used to show the fund's volatility or
risk. Measures of volatility or risk are generally used to compare the fund's
net asset value or performance to a market index. One measure of volatility is
beta. Beta is the volatility of a fund relative to the total market, as
represented by an index considered representative of the types of securities in
which the fund invests. A beta of more than 1.00 indicates volatility greater
than the market and a beta of less than 1.00 indicates volatility less than the
market. Another measure of volatility or risk is standard deviation. Standard
deviation is used to measure variability of net asset value or total return
around an average over a specified period of time. The idea is that greater
volatility means greater risk undertaken in achieving performance.
OTHER PERFORMANCE QUOTATIONS Sales literature referring to the use of the fund
as a potential investment for IRAs, business retirement plans, and other
tax-advantaged retirement plans may quote a total return based upon compounding
of dividends on which it is presumed no federal income tax applies.
The fund may include in its advertising or sales material information relating
to investment goals and performance results of funds belonging to the Franklin
Templeton Group of Funds. Franklin Resources, Inc. is the parent company of the
advisors and underwriter of the Franklin Templeton Group of Funds.
COMPARISONS To help you better evaluate how an investment in the fund may
satisfy your investment goal, advertisements and other materials about the fund
may discuss certain measures of fund performance as reported by various
financial publications. Materials also may 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:
(i) unmanaged indices so that you may compare the fund's results with those of a
group of unmanaged securities widely regarded by investors as representative of
the securities market in general; (ii) other groups of mutual funds tracked by
Lipper(R) Inc., a widely used independent research firm that ranks mutual funds
by overall performance, investment goals and assets, or tracked by other
services, companies, publications, or persons who rank mutual funds on overall
performance or other criteria; and (iii) the Consumer Price Index (measure for
inflation) to assess the real rate of return from an investment in the fund.
Unmanaged indices may assume the reinvestment of dividends but generally do not
reflect deductions for administrative and management costs and expenses.
From time to time, the fund and the manager also may refer to the following
information:
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 performance of U.S. equity and debt markets relative to foreign
markets prepared or published by Morgan Stanley Capital International or a
similar financial organization.
o The capitalization of U.S. and foreign stock markets as prepared or
published by the International Finance Corporation, Morgan
Stanley Capital International or a similar financial organization.
o The geographic and industry distribution of the fund's portfolio and the
fund's top ten holdings.
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 To assist investors in understanding the different returns and risk
characteristics of various investments, the fund may show historical returns
of various investments and published indices (E.G., Ibbotson Associates,
Inc. Charts and Morgan Stanley Capital International EAFE(R) Index).
o The major industries located in various jurisdictions as published by the
Morgan Stanley Index.
o Rankings by DALBAR Surveys, Inc. with respect to mutual fund shareholder
services.
o Allegorical stories illustrating the importance of persistent long-term
investing.
o The fund's portfolio turnover rate and its ranking relative to industry
standards as published by Lipper(R) Inc. or Morningstar, Inc.
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 the fund may include a
discussion of certain attributes or benefits to be derived from an investment in
the fund. The advertisements or information may include symbols, headlines, or
other material that highlights or summarizes the information discussed in more
detail in the communication.
Advertisements or information also may compare the 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. CDs are frequently insured by an agency of the U.S. government. An
investment in the fund is not insured by any federal, state or private entity.
In assessing comparisons of performance, you should keep in mind that the
composition of the investments in the reported indices and averages is not
identical to the fund's portfolio, the indices and averages are generally
unmanaged, and the items included in the calculations of the averages may not be
identical to the formula used by the fund to calculate its figures. In addition,
there can be no assurance that the fund will continue its performance as
compared to these other averages.
MISCELLANEOUS INFORMATION
- -------------------------------------------------------------------------------
The fund may help you achieve various investment goals such as accumulating
money for retirement, saving for a down payment on a home, college costs and
other long-term goals. The Franklin College Costs Planner may help you in
determining how much money must be invested on a monthly basis to have a
projected amount available in the future to fund a child's college education.
(Projected college cost estimates are based upon current costs published by the
College Board.) The Franklin Retirement Planning Guide leads you through the
steps to start a retirement savings program. Of course, an investment in the
fund cannot guarantee that these goals will be met.
The Company is a member of the Franklin Templeton Group of Funds, one of the
largest mutual fund organizations in the U.S., and may be considered in a
program for diversification of assets. Founded in 1947, Franklin is one of the
oldest mutual fund organizations and now services approximately 3 million
shareholder accounts. In 1992, Franklin, a leader in managing fixed-income
mutual funds and an innovator in creating domestic equity funds, joined forces
with Templeton, a pioneer in international investing. The Mutual Series team,
known for its value-driven approach to domestic equity investing, became part of
the organization four years later. Together, the Franklin Templeton Group has
over $229 billion in assets under management for more than 5 million U.S. based
mutual fund shareholder and other accounts. The Franklin Templeton Group of
Funds offers 103 U.S. based open-end investment companies to the public. The
fund may identify itself by its Nasdaq symbol or CUSIP number.
Currently, there are more mutual funds than there are stocks listed on the New
York Stock Exchange. While many of them have similar investment goals, no two
are exactly alike. Shares of the fund are generally sold through securities
dealers, whose investment representatives are experienced professionals who can
offer advice on the type of investments suitable to your unique goals and needs,
as well as the risks associated with such investments.
You will receive the fund's financial reports every six months. If you would
like to receive an interim report of the fund's portfolio holdings, please call
1-800/DIAL BEN(R).
DESCRIPTION OF BOND RATINGS
- -------------------------------------------------------------------------------
CORPORATE BOND RATINGS
MOODY'S INVESTORS SERVICE, INC. (MOODY'S)
INVESTMENT GRADE
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.
BELOW INVESTMENT GRADE
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(R))
INVESTMENT GRADE
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.
BELOW INVESTMENT GRADE
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 also may reflect the filing of a
bankruptcy petition under circumstances where debt service payments are
continuing. The C1 rating is reserved for income bonds on which no interest is
being paid.
D: Debt rated D is in default and payment of interest and/or repayment of
principal is in arrears.
Plus (+) or minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
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.
