o FSS1 P-2
SUPPLEMENT DATED JANUARY 1, 2000
TO THE PROSPECTUS OF
FRANKLIN STRATEGIC SERIES
(FSS1 - FRANKLIN AGGRESSIVE GROWTH, BLUE CHIP, CALIFORNIA GROWTH, LARGE CAP
GROWTH,
MIDCAP GROWTH AND SMALL CAP GROWTH FUNDS)
DATED SEPTEMBER 1, 1999
The prospectus is amended as follows:
I. The first paragraph of the section "Income and Capital Gains
Distributions" on page 47 is replaced with the following:
Each fund intends to pay a dividend at least annually, representing
substantially all of its net investment income and any net realized capital
gains. The amount of these distributions will vary and there is no guarantee
any fund will pay dividends.
II. The following sentence is added after the minimum investments table on
page 54:
Please note that you may only buy shares of a fund eligible for sale in your
state or jurisdiction.
III. In the Selling Shares table on page 60 the section "By Wire" is replaced
with the following:
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[Insert graphic of three You can call or write to have redemption proceeds
lightning bolts] sent to a bank account. See the policies above for
selling shares by mail or phone.
BY ELECTRONIC FUNDS
TRANSFER (ACH)
Before requesting to have redemption proceeds sent
to a bank account, please make sure we have your
bank account information on file. If we do not have
this information, you will need to send written
instructions with your bank's name and address, a
voided check or savings account deposit slip, and a
signature guarantee if the ownership of the bank
and fund accounts is different.
If we receive your request in proper form by 1:00
p.m. Pacific time, proceeds sent by ACH generally
will be available within two to three business days.
- ------------------------------------------------------------------------------
IV. The section "Sales charge waivers" on page 54 is replaced with the
following:
SALES CHARGE WAIVERS Class A shares may be purchased without an initial sales
charge or CDSC by various individuals, institutions and retirement plans or
by investors who reinvest certain distributions and proceeds within 365 days.
Certain investors also may buy Class C shares without an initial sales
charge. The CDSC for each class may be waived for certain redemptions and
distributions. If you would like information about available sales charge
waivers, call your investment representative or call Shareholder Services at
1-800/632-2301. For information about retirement plans, you may call
Retirement Plan Services at 1-800/527-2020. A list of available sales charge
waivers also may be found in the Statement of Additional Information (SAI).
V. The section "Dealer compensation" on page 63 is replaced with the
following:
DEALER COMPENSATION Qualifying dealers who sell fund shares may receive sales
commissions and other payments. These are paid by Franklin Templeton
Distributors, Inc. (Distributors) from sales charges, distribution and
service (12b-1) fees and its other resources.
CLASS A CLASS B CLASS C
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COMMISSION (%) - 4.00 2.00
Investment under $50,000 5.00 - -
$50,000 but under $100,000 3.75 - -
$100,000 but under $250,000 2.80 - -
$250,000 but under $500,000 2.00 - -
$500,000 but under $1 million 1.60 - -
$1 million or more up to 1.00 1 - -
12B-1 FEE TO DEALER 0.25 2 0.25 3 1.00 4
A dealer commission of up to 1% may be paid on Class A NAV purchases by
certain retirement plans1 and on Class C NAV purchases. A dealer commission
of up to 0.25% may be paid on Class A NAV purchases by certain trust
companies and bank trust departments, eligible governmental authorities, and
broker-dealers or others on behalf of clients participating in comprehensive
fee programs.
1. During the first year after purchase, dealers may not be eligible to
receive the 12b-1 fee.
2. The Aggressive Growth Fund, Blue Chip Fund, Large Cap Fund and MidCap Fund
may each pay up to 0.35% to Distributors or others, out of which 0.10%
generally will be retained by Distributors for its distribution expenses.
3. Dealers may be eligible to receive up to 0.25% from the date of purchase.
After 8 years, Class B shares convert to Class A shares and dealers may then
receive the 12b-1 fee applicable to Class A.
4. Dealers may be eligible to receive up to 0.25% during the first year after
purchase and may be eligible to receive the full 12b-1 fee starting in the
13th month.
VI. The section "Statements and reports" on page 61 is replaced with the
following:
STATEMENTS AND REPORTS You will receive quarterly account statements that
show all your account transactions during the quarter. You also will receive
written notification after each transaction affecting your account (except
for distributions and transactions made through automatic investment or
withdrawal programs, which will be reported on your quarterly statement). You
also will receive the fund's financial reports every six months. To reduce
fund expenses, we try to identify related shareholders in a household and
send only one copy of the financial reports. If you need additional copies,
please call 1-800/DIAL BEN.
If there is a dealer or other investment representative of record on your
account, he or she also will receive copies of all notifications and
statements and other information about your account directly from the fund.
Please keep this supplement for future reference.
o FSS2 P-2
SUPPLEMENT DATED JANUARY 1, 2000
TO THE PROSPECTUS OF
FRANKLIN STRATEGIC SERIES
(FSS2 - FRANKLIN BIOTECHNOLOGY DISCOVERY, GLOBAL HEALTH CARE,
GLOBAL COMMUNICATIONS AND NATURAL RESOURCES FUNDS)
DATED SEPTEMBER 1, 1999
The prospectus is amended as follows:
I. The first paragraph of the section "Income and Capital Gains
Distributions" on page 50 is replaced with the following:
Each fund intends to pay a dividend at least annually, representing
substantially all of its net investment income and any net realized capital
gains. The amount of these distributions will vary and there is no guarantee
any fund will pay dividends.
II. The following sentence is added after the minimum investments table on
page 57:
Please note that you may only buy shares of a fund eligible for sale in your
state or jurisdiction.
III. In the Selling Shares table on page 63 the section "By Wire" is replaced
with the following:
- ------------------------------------------------------------------------------
[Insert graphic of three You can call or write to have redemption proceeds
lightning bolts] sent to a bank account. See the policies above for
selling shares by mail or phone.
BY ELECTRONIC FUNDS
TRANSFER (ACH)
Before requesting to have redemption proceeds sent
to a bank account, please make sure we have your
bank account information on file. If we do not have
this information, you will need to send written
instructions with your bank's name and address, a
voided check or savings account deposit slip, and a
signature guarantee if the ownership of the bank and
fund accounts is different.
If we receive your request in proper form by 1:00
p.m. Pacific time, proceeds sent by ACH generally
will be available within two to three business days.
- --------------------------------------------------------------------------------
IV. The section "Sales charge waivers" on page 56 is replaced with the
following:
SALES CHARGE WAIVERS Class A shares may be purchased without an initial sales
charge or CDSC by various individuals, institutions and retirement plans or
by investors who reinvest certain distributions and proceeds within 365 days.
Certain investors also may buy Class C shares without an initial sales
charge. The CDSC for each class may be waived for certain redemptions and
distributions. If you would like information about available sales charge
waivers, call your investment representative or call Shareholder Services at
1-800/632-2301. For information about retirement plans, you may call
Retirement Plan Services at 1-800/527-2020. A list of available sales charge
waivers also may be found in the Statement of Additional Information (SAI).
V. The section "Dealer compensation" on page 66 is replaced with the
following:
DEALER COMPENSATION Qualifying dealers who sell fund shares may receive sales
commissions and other payments. These are paid by Franklin Templeton
Distributors, Inc. (Distributors) from sales charges, distribution and
service (12b-1) fees and its other resources.
CLASS A CLASS B CLASS C
- -----------------------------------------------------------------------------
COMMISSION (%) - 4.00 2.00
Investment under $50,000 5.00 - -
$50,000 but under $100,000 3.75 - -
$100,000 but under $250,000 2.80 - -
$250,000 but under $500,000 2.00 - -
$500,000 but under $1 million 1.60 - -
$1 million or more up to 1.00 1 - -
12B-1 FEE TO DEALER 0.25 2 0.25 3 1.00 4
A dealer commission of up to 1% may be paid on Class A NAV purchases by
certain retirement plans1 and on Class C NAV purchases. A dealer commission
of up to 0.25% may be paid on Class A NAV purchases by certain trust
companies and bank trust departments, eligible governmental authorities, and
broker-dealers or others on behalf of clients participating in comprehensive
fee programs.
1. During the first year after purchase, dealers may not be eligible to
receive the 12b-1 fee.
2. The Biotechnology Fund and Natural Resources Fund may each pay up to 0.35%
to Distributors or others, out of which 0.10% generally will be retained by
Distributors for its distribution expenses. The Biotechnology Fund will not
reimburse Distributors the additional 0.10% during periods when the fund is
closed to new investors.
3. Dealers may be eligible to receive up to 0.25% from the date of purchase.
After 8 years, Class B shares convert to Class A shares and dealers may then
receive the 12b-1 fee applicable to Class A.
4. Dealers may be eligible to receive up to 0.25% during the first year after
purchase and may be eligible to receive the full 12b-1 fee starting in the
13th month.
VI. The section "Statements and reports" on page 64 is replaced with the
following:
STATEMENTS AND REPORTS You will receive quarterly account statements that
show all your account transactions during the quarter. You also will receive
written notification after each transaction affecting your account (except
for distributions and transactions made through automatic investment or
withdrawal programs, which will be reported on your quarterly statement). You
also will receive the fund's financial reports every six months. To reduce
fund expenses, we try to identify related shareholders in a household and
send only one copy of the financial reports. If you need additional copies,
please call 1-800/DIAL BEN.
If there is a dealer or other investment representative of record on your
account, he or she also will receive copies of all notifications and
statements and other information about your account directly from the fund.
Please keep this supplement for future reference.
o 194 P-1
SUPPLEMENT DATED JANUARY 1, 2000
TO THE PROSPECTUS OF
FRANKLIN STRATEGIC INCOME FUND
DATED SEPTEMBER 1, 1999
The prospectus is amended as follows:
I. The following sentence is added after the minimum investments table on
page 21:
Please note that you may only buy shares of a fund eligible for sale in your
state or jurisdiction.
- ------------------------------------------------------------------------------
[Insert graphic of You can call or write to have redemption proceeds sent
three lightning to a bank account. See the policies above for selling
bolts] shares by mail or phone.
BY ELECTRONIC FUNDS
TRANSFER (ACH)
Before requesting to have redemption proceeds sent to a
bank account, please make sure we have your bank account
information on file. If we do not have this information,
you will need to send written instructions with your
bank's name and address, a voided check or savings
account deposit slip, and a signature guarantee if the
ownership of the bank and fund accounts is different.
If we receive your request in proper form by 1:00 p.m.
Pacific time, proceeds sent by ACH generally will be
available within two to three business days.
- --------------------------------------------------------------------------------
III. The section "Sales charge waivers" on page 21 is replaced with the
following:
SALES CHARGE WAIVERS Class A shares may be purchased without an initial sales
charge or CDSC by various individuals, institutions and retirement plans or
by investors who reinvest certain distributions and proceeds within 365 days.
Certain investors also may buy Class C shares without an initial sales
charge. The CDSC for each class may be waived for certain redemptions and
distributions. If you would like information about available sales charge
waivers, call your investment representative or call Shareholder Services at
1-800/632-2301. For information about retirement plans, you may call
Retirement Plan Services at 1-800/527-2020. A list of available sales charge
waivers also may be found in the Statement of Additional Information (SAI).
IV. The section "Dealer compensation" on page 30 is replaced with the
following:
DEALER COMPENSATION Qualifying dealers who sell fund shares may receive sales
commissions and other payments. These are paid by Franklin Templeton
Distributors, Inc. (Distributors) from sales charges, distribution and
service (12b-1) fees and its other resources.
CLASS A CLASS B CLASS C
- ----------------------------------------------------------------------------
COMMISSION (%) - 3.00 2.00
Investment under $100,000 4.00 - -
$100,000 but under $250,000 3.25 - -
$250,000 but under $500,000 2.25 - -
$500,000 but under $1 million 1.85 - -
$1 million or more up to 0.75 1 - -
12B-1 FEE TO DEALER 0.25 0.15 2 0.65 3
A dealer commission of up to 1% may be paid on Class A NAV purchases by
certain retirement plans1 and on Class C NAV purchases. A dealer commission
of up to 0.25% may be paid on Class A NAV purchases by certain trust
companies and bank trust departments, eligible governmental authorities, and
broker-dealers or others on behalf of clients participating in comprehensive
fee programs.
1. During the first year after purchase, dealers may not be eligible to
receive the 12b-1 fee.
2. Dealers may be eligible to receive up to 0.15% from the date of purchase.
After 8 years, Class B shares convert to Class A shares and dealers may then
receive the 12b-1 fee applicable to Class A.
3. Dealers may be eligible to receive up to 0.15% during the first year after
purchase and may be eligible to receive the full 12b-1 fee starting in the
13th month.
V. The section "Statements and reports" on page 28 is replaced with the
following:
STATEMENTS AND REPORTS You will receive quarterly account statements that
show all your account transactions during the quarter. You also will receive
written notification after each transaction affecting your account (except
for distributions and transactions made through automatic investment or
withdrawal programs, which will be reported on your quarterly statement). You
also will receive the fund's financial reports every six months. To reduce
fund expenses, we try to identify related shareholders in a household and
send only one copy of the financial reports. If you need additional copies,
please call 1-800/DIAL BEN.
If there is a dealer or other investment representative of record on your
account, he or she also will receive copies of all notifications and
statements and other information about your account directly from the fund.
Please keep this supplement for future reference.
FRANKLIN
STRATEGIC SERIES
FRANKLIN AGGRESSIVE GROWTH FUND - CLASS A, B & C
FRANKLIN BLUE CHIP FUND - CLASS A
FRANKLIN CALIFORNIA GROWTH FUND - CLASS A, B & C
FRANKLIN LARGE CAP GROWTH FUND - CLASS A, B & C
FRANKLIN MIDCAP GROWTH FUND - CLASS A
FRANKLIN SMALL CAP GROWTH FUND - CLASS A & C
STATEMENT OF ADDITIONAL INFORMATION
SEPTEMBER 1, 1999, AS AMENDED JANUARY 1, 2000
[Insert Franklin Templeton Ben Head]
P.O. BOX 997151 SACRAMENTO, CA 95899-9983 1-800/DIAL BEN(R)
- ------------------------------------------------------------------------------
This Statement of Additional Information (SAI) is not a prospectus. It
contains information in addition to the information in the funds' prospectus.
The funds' prospectus, dated September 1, 1999, 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 funds' prospectus.
The audited financial statements and auditor's report in the trust's Annual
Report to Shareholders, for the fiscal year ended April 30, 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/DIAL BEN (1-800/342-5236).
CONTENTS
Goals and Strategies ........................ 2
Risks ....................................... 16
Officers and Trustees ....................... 19
Management and Other Services ............... 21
Portfolio Transactions ...................... 23
Distributions and Taxes ..................... 24
Organization, Voting Rights
and Principal Holders ...................... 26
Buying and Selling Shares ................... 27
Pricing Shares .............................. 33
The Underwriter ............................. 34
Performance ................................. 36
Miscellaneous Information ................... 40
Description of Ratings ...................... 40
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MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS:
o ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION,
THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT;
o ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY
BANK;
o ARE SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL.
- ------------------------------------------------------------------------------
FSS1 SAI 01/00
GOALS AND STRATEGIES
- ------------------------------------------------------------------------------
FRANKLIN AGGRESSIVE GROWTH FUND The fund's investment goal is capital
appreciation. This goal is fundamental, which means it may not be changed
without shareholder approval.
The fund normally invests primarily in equity securities of companies
demonstrating accelerating growth, increasing profitability, or above-average
growth or growth potential compared with the overall economy.
FRANKLIN BLUE CHIP FUND The fund's principal investment goal is long-term
capital appreciation. This goal is fundamental, which means it may not be
changed without shareholder approval.
The fund may also seek current income incidental to long-term capital
appreciation, although this is not a fundamental policy of the fund.
Under normal market conditions, the fund will invest at least 80%, and
intends to try to invest up to 100%, of its total assets in equity securities
of blue chip companies.
The fund may invest up to 10% of total assets in the equity securities of
blue chip companies not publicly traded in the U.S. This may include
companies in either developed or emerging markets. Certain companies in
emerging markets meet all the criteria of a blue chip company.
FRANKLIN CALIFORNIA GROWTH FUND The fund's investment goal is capital
appreciation. This goal is fundamental, which means it may not be changed
without shareholder approval.
The fund normally invests at least 65% of its assets in the equity and debt
securities of companies headquartered or conducting a majority of their
operations in the state of California. The fund may invest up to 35% of its
assets in the securities of companies headquartered or conducting a majority of
their operations outside of the state of California. In this way, the fund
tries to benefit from its research into companies and industries within or
beyond its primary region.
The fund expects to invest a significant portion of its assets in small and
medium size companies with market capitalization of up to $8 billion at the
time of its investment.
The fund may invest in securities of companies operating in the real estate
industry, including real estate investment trusts (REITs). The fund currently
intends to limit these investments to no more than 10% of total assets.
The fund may invest up to 35% of its total assets in debt securities. The
fund may invest in debt securities that the manager believes present an
opportunity for capital appreciation as a result of improvement in the
creditworthiness of the issuer. The receipt of income from debt securities is
incidental to the fund's investment goal. The fund may invest in both rated
and unrated debt securities. The fund may buy securities that are rated B by
Moody's Investors Service (Moody's) or Standard & Poor's Corporation (S&P) or
better, or unrated securities of comparable quality. The fund will not invest
more than 5% of its assets in securities rated below investment grade.
FRANKLIN LARGE CAP GROWTH FUND The fund's principal investment goal is
long-term capital appreciation. This goal is fundamental, which means it may
not be changed without shareholder approval.
The fund may also seek current income incidental to long-term capital
appreciation, although this is not a fundamental policy of the fund.
Under normal market conditions, the fund will invest at least 80%, and
intends to invest up to 100%, of its total assets in a diversified portfolio
of equity securities of large cap growth companies.
FRANKLIN MIDCAP GROWTH FUND The fund's investment goal is long-term capital
appreciation. This goal is fundamental, which means it may not be changed
without shareholder approval.
The fund normally invests primarily in equity securities of mid-cap growth
companies. Mid-cap growth companies are companies that have a market
capitalization range between $1 and $8 billion that the manager believes are
positioned for rapid growth in revenues or earnings and assets,
characteristics that may provide for significant capital appreciation.
The fund may invest up to 35% of its total assets in equity securities that
are outside the medium market capitalization range but with similar potential
for capital appreciation, or in corporate debt securities. The fund may buy
debt securities rated B or better by Moody's or S&P, or unrated securities of
comparable quality. The fund will not invest more than 5% of its total assets
in securities rated below investment grade.
The fund intends to limit its investment in foreign securities to 5% of its
total assets. The fund may buy securities of issuers in developed or emerging
markets.
FRANKLIN SMALL CAP GROWTH FUND 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 normally invests primarily in equity securities of small cap growth
companies. The fund may also invest up to 35% (measured at the time of
purchase) of its total assets in any combination of (a) equity securities of
larger capitalization companies that the manager believes have strong growth
potential, and (b) relatively well-known, larger companies in mature
industries that the manager believes have the potential for capital
appreciation, if the investment presents a favorable investment opportunity
consistent with the fund's investment goal.
The fund may from time to time make private investments in companies whose
securities are not publicly traded. These investments typically will take the
form of letter stock or convertible preferred stock. Because these securities
are not publicly traded, there is no secondary market for these securities.
The fund will treat these securities as illiquid.
Although the fund may invest up to 25% of its total assets in foreign
securities, including those of developing or emerging markets, the fund
currently intends to limit its investment in foreign securities to 10% of its
total assets.
The fund may invest up to 10% of its total assets in REITs. The fund will not
invest in securities issued without stock certificates or comparable stock
documents. The fund may not invest more than 10% of its net assets in
securities of issuers with less than three years continuous operation.
The fund may invest up to 5% of its total assets in corporate debt securities
that the manager believes have the potential for capital appreciation as a
result of improvement in the creditworthiness of the issuer. The receipt of
income from debt securities is incidental to the fund's investment goal. The
fund may buy both rated and unrated debt securities. The fund will invest in
securities rated B or better by Moody's or S&P or unrated securities of
comparable quality.
Below is more detailed information about some of the various types of
securities the funds may buy and the funds' investment policies and
restrictions.
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. Warrants or rights give the holder the right to purchase a common
stock at a given time for a specified price.
CONVERTIBLE SECURITIES Although each fund may invest in convertible
securities without limit, the Aggressive Growth Fund, Blue Chip Fund, and
Large Cap Fund currently intend to limit these investments to no more than 5%
of net assets. The California Fund, MidCap Fund, and Small Cap Fund may also
invest in enhanced convertible securities.
A convertible security is generally a debt obligation or preferred stock that
may be converted within a specified period of time into a certain amount of
common stock of the same or a different issuer. A convertible security
provides a fixed-income stream and the opportunity, through its conversion
feature, to participate in the capital appreciation resulting from a market
price advance in its underlying common stock. As with a straight fixed-income
security, a convertible security tends to increase in market value when
interest rates decline and decrease in value when interest rates rise. 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 both interest rate
and market movements can influence its value, a convertible security is not
as sensitive to interest rates as a similar fixed-income security, nor is it
as sensitive to changes in share price as its underlying stock.
When issued by an operating company, a convertible security tends to be
senior to common stock, but sub-ordinate 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. In addition, a convertible security
may be subject to redemption by the issuer, but only after a specified date
and under circumstances established at the time the security is issued.
While each 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.
ENHANCED CONVERTIBLE SECURITIES. In addition to "plain vanilla" convertibles,
a number of different structures have been created to fit the characteristics
of specific investors and issuers. Examples of these enhanced characteristics
for investors include yield enhancement, increased equity exposure or
enhanced downside protection. From an issuer's perspective, enhanced
structures are designed to meet balance sheet criteria, interest/
dividend payment deductibility and reduced equity dilution. The following are
descriptions of common structures of enhanced convertible securities.
Mandatorily convertible securities (e.g., ACES, DECS, PRIDES, SAILS-each
issuer has a different acronym for their version of these securities) are
considered the most equity like of convertible securities. At maturity these
securities are mandatorily convertible into common stock offering investors
some form of yield enhancement in return for some of the upside potential in
the form of a conversion premium. Typical characteristics of mandatories
include: issued as preferred stock, convertible at premium, pay fixed
quarterly dividend (typically 500 to 600 basis points higher than common
stock dividend), and are non-callable for the life of the security (usually
three to five years). An important feature of mandatories is that the number
of shares received at maturity is determined by the difference between the
price of the common stock at maturity and the price of the common stock at
issuance.
Enhanced convertible preferred securities (e.g., QUIPS, TOPrS, and TECONS)
are, from an investor's viewpoint, essentially convertible preferred
securities, i.e. they are issued as preferred stock convertible into common
stock at a premium and pay quarterly dividends. Through this structure the
company establishes a wholly owned special purpose vehicle whose sole purpose
is to issue convertible preferred stock. The proceeds of the convertible
preferred stock offering pass through to the company. The company then issues
a convertible subordinated debenture to the special purpose vehicle. This
convertible subordinated debenture has identical terms to the convertible
preferred issued to investors. Benefits to the issuer include increased
equity credit from rating agencies and the deduction of coupon payments for
tax purposes.
Exchangeable securities are often used by a company divesting a holding in
another company. The primary difference between exchangeables and standard
convertible structures is that the issuing company is a different company to
that of the underlying shares.
Yield enhanced stock (YES, also known as PERCS) mandatorily converts into
common stock at maturity and offers investors a higher current dividend than
the underlying common stock. The difference between these structures and
other mandatories is that the participation in stock price appreciation is
capped.
Zero-coupon and deep-discount convertible bonds (OID and LYONs) include the
following characteristics: no or low coupon payments, imbedded put options
allowing the investor to put them on select dates prior to maturity, call
protection (usually three to five years), and lower than normal conversion
premiums at issuance. A benefit to the issuer is that while no cash interest
is actually paid, the accrued interest may be deducted for tax purposes.
Because of their put options, these bonds tend to be less sensitive to
changes in interest rates than either long maturity bonds or preferred
stocks. The put options also provide enhanced downside protection while
retaining the equity participation characteristics of traditional convertible
bonds.
An investment in an enhanced convertible security or any other security may
involve additional risks. A fund may have difficulty disposing of such
securities because there may be a thin trading market for a particular
security at any given time. Reduced liquidity may have an adverse impact on
market price and 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
credit worthiness 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 funds, however, intend to acquire liquid securities, though
there can be no assurances that this will be achieved.
DEBT SECURITIES represent a loan of money by the purchaser of the securities
to the issuer. 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, 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 funds may buy both rated and unrated debt securities. Independent rating
organizations rate debt securities based upon their assessment of the
financial soundness of the issuer. Generally, a lower rating indicates higher
risk.
FOREIGN SECURITIES AND DEPOSITARY RECEIPTS Each fund may invest in foreign
securities. The Aggressive Growth, Blue Chip, and Large Cap funds intend to
limit their investments in foreign securities to no more than 10% of total
assets. The MidCap Fund intends to limit its investments in foreign
securities to no more than 5% if total assets. Although the Small Cap Fund
may invest up to 25% of total assets in foreign securities, it intends to
limit its investments to 10% of total assets.
The funds may buy foreign securities traded in the U.S. or directly in
foreign markets. The funds may buy American, European, and Global Depositary
Receipts. Depositary receipts are certificates typically issued by a bank or
trust company 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).
SMALL AND MID-CAP COMPANIES Market capitalization is defined as the total
market value of a company's outstanding stock. Small cap companies generally
have market capitalization of up to $1.5 billion at the time of the fund's
investment. Mid-cap companies generally have market capitalization of $1 to
$8 billion at the time of the fund's investment.
Small cap companies are often overlooked by investors or undervalued in
relation to their earnings power. Because small cap companies generally are
not as well known to the investing public and have less of an investor
following than larger companies, they may provide greater opportunities for
long-term capital growth as a result of inefficiencies in the marketplace.
These companies may be undervalued because they are part of an industry that
is out of favor with investors, although the individual companies may have
high rates of earnings growth and be financially sound.
Mid-cap companies may offer greater potential for capital appreciation than
larger companies, because mid-cap companies are often growing more rapidly
than larger companies, but tend to be more stable and established than small
cap or emerging companies.
REPURCHASE AGREEMENTS Each 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.
The Small Cap Fund may also enter into reverse repurchase agreements. Under a
reverse repurchase agreement, the fund agrees to sell a security in its
portfolio and then to repurchase the security at an agreed-upon price, date,
and interest payment. The fund will maintain cash or high-grade liquid debt
securities with a value equal to the value of the fund's obligation under the
agreement, including accrued interest, in a segregated account with the
fund's custodian bank. The securities subject to the reverse repurchase
agreement will be marked-to-market daily. Although reverse repurchase
agreements are borrowings under federal securities laws, the Small Cap Fund
does not treat them as borrowings for purposes of its investment restriction
#3 below, provided the segregated account is properly maintained.
LOANS OF PORTFOLIO SECURITIES To generate additional income, each fund may
lend certain of its portfolio securities to qualified banks and
broker-dealers. These loans may not exceed the following percentages of the
value of the fund's total assets, measured at the time of the most recent
loan: Aggressive Growth, Blue Chip, and Large Cap funds, 331/3%; California
Fund, 10%; and MidCap and Small Cap funds, 20%. For each loan, the borrower
must maintain with the fund's custodian collateral (consisting of any
combination of cash, securities issued by the U.S. government and its
agencies and instrumentalities, or irrevocable letters of credit) with a
value at least equal to 100% of the current market value of the loaned
securities. The fund retains all or a portion of the interest received on
investment of the cash collateral or receives a fee from the borrower. The
fund may terminate the loans at any time and obtain the return of the
securities loaned within five business days. The fund will continue to
receive any interest or dividends paid on the loaned securities and will
continue to have voting rights with respect to the securities. However, as
with other extensions of credit, there are risks of delay in recovery or even
loss of rights in collateral should the borrower fail.
SECURITIES INDUSTRY RELATED INVESTMENTS To the extent it is consistent with
their respective investment goals and certain limitations under the
Investment Company Act of 1940, as amended (1940 Act), the funds may invest
their assets in securities issued by companies engaged in securities related
businesses, including companies that are securities brokers, dealers,
underwriters or investment advisors. These companies are considered to be
part of the financial services industry. Generally, under the 1940 Act, a
fund may not acquire a security or any interest in a securities related
business to the extent such acquisition would result in the fund acquiring in
excess of 5% of a class of an issuer's outstanding equity securities or 10%
of the outstanding principal amount of an issuer's debt securities, or
investing more than 5% of the value of the fund's total assets in securities
of the issuer. In addition, any equity security of a securities-related
business must be a marginable security under Federal Reserve Board
regulations and any debt security of a securities-related business must be
investment grade as determined by the Board. The funds do not believe that
these limitations will impede the attainment of their investment goals.
WHEN-ISSUED OR DELAYED DELIVERY TRANSACTIONS The Blue Chip Fund may buy
equity securities on a "when-issued" or "delayed delivery" basis. These
transactions are arrangements whereby the fund buys securities with payment
and delivery scheduled for a future time, generally within 15 to 60 days.
If the fund buys securities on a when-issued basis, it will do so for the
purpose of acquiring securities consistent with its investment objective and
polices and not for investment leverage. The fund may sell securities
purchased on a when-issued basis before the settlement date, however, if the
manager believes it is advisable to do so.
When the fund is the buyer in one of these transactions, it relies on the
seller to complete the transaction. If the seller fails to do so, the fund
may miss an advantageous price or yield for the underlying security. When the
fund is the buyer, it will keep cash or high-grade marketable securities in a
segregated account with its custodian bank until payment is made. The amount
held in the account will equal the amount the fund must pay for the
securities at delivery.
STANDBY COMMITMENT AGREEMENTS The Blue Chip Fund may buy equity securities
under a standby commitment agreement. If the fund enters into a standby
commitment agreement, it will be obligated, for a set period of time, to buy
a certain amount of a security that may be issued and sold to the fund at the
option of the issuer. The price of the security is set at the time of the
agreement. The fund will receive a commitment fee typically equal to 0.5% of
the purchase price of the security. The fund will receive this fee regardless
of whether the security is actually issued.
The fund may enter into a standby commitment agreement to invest in the
security underlying the commitment at a yield or price that Advisers believes
is advantageous to the fund. The fund will not enter into a standby
commitment if the remaining term of the commitment is more than 45 days. If
the fund enters into a standby commitment, it will keep cash or high-grade
marketable securities in a segregated account with its custodian bank in an
amount equal to the purchase price of the securities underlying the
commitment.
The purchase of a security subject to a standby commitment agreement and the
related commitment fee will be recorded on the fund's books on the date the
security can reasonably be expected to be issued. The value of the security
will then be reflected in the calculation of the fund's net asset value. The
cost basis of the security will be adjusted by the amount of the commitment
fee. If the security is not issued, the commitment fee will be recorded as
income on the expiration date of the standby commitment.
OPTIONS, FUTURES, AND OPTIONS ON FUTURES A stock option is a contract that
provides the holder the right to buy or sell shares of the stock at a fixed
price, within a specified period of time. An option on a stock index is a
contract that allows the buyer of the option the right to receive from the
seller cash, in an amount equal to the difference between the index's closing
price and the option's exercise price. A futures contract is an obligation to
buy or sell a specified security or currency at a set price on a specified
future date. A stock 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 end of the contract period. Options, futures,
and options on futures are considered "derivative securities."
Each fund may buy and sell options on securities and (except the Blue Chip
Fund) securities indices. The funds may only buy options if the premiums paid
for such options total 5% or less of net assets.
Each fund (except the California Fund and MidCap Fund) may buy and sell
futures contracts for securities and currencies. Each fund (except the Blue
Chip Fund) may also buy and sell securities index futures and options on
securities index futures. Each fund may invest in futures contracts only to
hedge against changes in the value of its securities or those it intends to
buy. The funds will not enter into a futures contract if the amounts paid for
open contracts, including required initial deposits, would exceed 5% of net
assets.
OPTIONS. The funds may buy or write (sell) put and call options on securities
listed on a national securities exchange and in the over-the-counter (OTC)
market. All options written by the funds will be covered. The funds (except
the Blue Chip Fund) may also buy or write put and call options on securities
indices. Options written by the Aggressive Growth, Blue Chip, Large Cap, and
MidCap funds will be for portfolio hedging purposes only.
A call option written by the fund is covered if the fund (a) owns the underlying
security that is subject to the call or (b) has an absolute and immediate right
to acquire that security without additional cash consideration (or for
additional cash consideration held in a segregated account by its custodian
bank) upon conversion or exchange of other securities held in its portfolio. A
call option is also covered if 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 is (a) equal to or less than the exercise price of the call written or
(b) greater than the exercise price of the call written if the difference is
held in cash or high-grade debt securities in a segregated account with the
fund's custodian bank.
A put option written by the fund is covered if the fund maintains cash or
high-grade debt securities with a value equal to the exercise price of the
written put in a segregated account with its custodian bank. A put is also
covered if the fund holds a put on the same security and in the same
principal amount as the put written where the exercise price of the put held
is equal to or greater than the exercise price of the put written.
The premium paid by the buyer of an option will reflect, among other things,
the relationship of the exercise price to the market price and volatility of
the underlying security, the remaining term of the option, supply and demand,
and interest rates.
The writer of an option may have no control over when the underlying
securities must be sold, in the case of a call option, or purchased, in the
case of a put option, since the writer may be assigned an exercise notice at
any time prior to the termination of the obligation. Whether or not an option
expires unexercised, the writer retains the amount of the premium. This
amount may, in the case of a covered call option, be offset by a decline in
the market value of the underlying security during the option period. If a
call option is exercised, the writer experiences a profit or loss from the
sale of the underlying security. If a put option is exercised, the writer
must fulfill the obligation to buy the underlying security at the exercise
price, which will usually exceed the market value of the underlying security
at that time.
If the writer of an option wants to terminate its obligation, the writer may
effect a "closing purchase transaction" by buying an option of the same
series as the option previously written. The effect of the purchase is that
the clearing corporation will cancel the writer's position. However, a writer
may not effect a closing purchase transaction after being notified of the
exercise of an option. Likewise, the holder of an option may liquidate its
position by effecting a "closing sale transaction" by selling an option of
the same series as the option previously purchased. There is no guarantee
that either a closing purchase or a closing sale transaction may be made at
the time desired by the fund.
Effecting a closing transaction in the case of a written call option allows
the fund to write another call option on the underlying security with a
different exercise price, expiration date or both. In the case of a written
put option, a closing transaction allows the fund to write another covered
put option. Effecting a closing transaction also allows the cash or proceeds
from the sale of any securities subject to the option to be used for other
fund investments. If the fund wants to sell a particular security from its
portfolio on which it has written a call option, it will effect a closing
transaction prior to or at the same time as the sale of the security.
The fund will realize a profit from a closing transaction if the price of the
transaction is less than the premium received from writing the option or is
more than the premium paid to buy the option. Likewise, the fund will realize
a loss from a closing transaction if the price of the transaction is more
than the premium received from writing the option or is less than the premium
paid to buy the option. Increases in the market price of a call option will
generally reflect increases in the market price of the underlying security.
As a result, any loss resulting from the repurchase of a call option is
likely to be offset in whole or in part by appreciation of the underlying
security owned by the fund.
The writing of covered put options involves certain risks. For example, if
the market price of the underlying security rises or otherwise is above the
exercise price, the put option will expire worthless and the fund's gain will
be limited to the premium received. If the market price of the underlying
security declines or otherwise is below the exercise price, the fund may
elect to close the position or take delivery of the security at the exercise
price. The fund's return will be the premium received from the put option
minus the amount by which the market price of the security is below the
exercise price.
A fund may buy call options on securities it intends to buy in order to limit
the risk of a substantial increase in the market price of the security before
the purchase is effected. A fund may also buy call options on securities held
in its portfolio and on which it has written call options. Prior to its
expiration, a call option may be sold in a closing sale transaction. Profit
or loss from the sale will depend on whether the amount received is more or
less than the premium paid for the call option plus any related transaction
costs.
A fund may buy put options on securities in an attempt to protect against a
decline in the market value of the underlying security below the exercise
price less the premium paid for the option. The ability to buy put options
allows the fund to protect the unrealized gain in an appreciated security in
its portfolio without actually selling the security. In addition, the fund
continues to receive interest or dividend income on the security. The fund
may sell a put option it has previously purchased prior to the sale of the
security underlying the option. The sale of the option will result in a net
gain or loss depending on whether the amount received on the sale is more or
less than the premium and other transaction costs paid for the put option.
Any gain or loss may be wholly or partially offset by a change in the value
of the underlying security that the fund owns or has the right to acquire.
A fund may write covered put and call options and buy put and call options
that trade in the OTC market to the same extent that it may engage in
exchange traded options. Like exchange traded options, OTC options give the
holder the right to buy, in the case of OTC call options, or sell, in the
case of OTC put options, an underlying security from or to the writer at a
stated exercise price. However, OTC options differ from exchange traded
options in certain material respects.
OTC options are arranged directly with dealers and not with a clearing
corporation. Thus, there is a risk of non-performance by the dealer. Because
there is no exchange, pricing is typically done based on information from
market makers. OTC options are available for a greater variety of securities
and in a wider range of expiration dates and exercise prices, however, than
exchange traded options, and the writer of an OTC option is paid the premium
in advance by the dealer.
Call and put options on stock indices are similar to options on securities
except, rather than the right to buy or sell stock at a specified price,
options on a stock index give the holder the right to receive, upon exercise
of the option, an amount of cash if the closing level of the underlying stock
index is greater than (or less than, in the case of a put) the exercise price
of the option, expressed in dollars multiplied by a specified number. Thus,
unlike stock options, all settlements are in cash, and gain or loss depends
on price movements in the stock market generally (or in a particular industry
or segment of the market) rather than price movements in individual stocks.
When a fund writes an option on a stock index, the fund will establish a
segregated account with its custodian bank containing cash or high quality
fixed-income securities in an amount at least equal to the market value of
the underlying stock index. The fund will maintain the account while the
option is open or will otherwise cover the transaction.
FINANCIAL FUTURES. The funds (except the Blue Chip Fund) may enter into
contracts for the purchase or sale of futures contracts based upon financial
indices (financial futures). Financial futures contracts are commodity
contracts that obligate the long or short holder to take or make delivery of
the cash value of a securities index during a specified future period at a
specified price. A "sale" of a futures contract means the acquisition of a
contractual obligation to deliver such cash value called for by the contract
on a specified date. A "purchase" of a futures contract means the acquisition
of a contractual obligation to take delivery of the cash value called for by
the contract at a specified date. The purpose of the acquisition or sale of a
futures contract is to attempt to protect the fund from fluctuations in price
of portfolio securities without actually buying or selling the underlying
security. Futures contracts have been designed by exchanges designated
"contracts markets" by the Commodity Futures Trading Commission (CFTC) and
must be executed through a futures commission merchant, or brokerage firm,
which is a member of the relevant contract market.
The funds will not engage in transactions in futures contracts or related
options for speculation, but only as a hedge against changes resulting from
market conditions in the values of its securities or securities that they
intend to buy and, to the extent consistent therewith, to accommodate cash
flows. The funds will not enter into any stock index or financial futures
contract or related option if, immediately thereafter, more than one third of
total assets would be represented by futures contracts or related options. In
addition, the funds may not buy or sell futures contracts or buy or sell
related options if, immediately thereafter, the sum of the amount of initial
deposits on existing financial futures and premiums paid on options on
financial futures contracts would exceed 5% of total assets (taken at current
value). To the extent a fund enters into a futures contract or related call
option, it will maintain with its custodian bank, to the extent required by
the rules of the Securities and Exchange Commission (SEC), assets in a
segregated account to cover its obligations with respect to such contract
which will consist of cash, cash equivalents or high quality debt securities
from its portfolio in an amount equal to the market value of such futures
contract or related option.
STOCK INDEX FUTURES. The funds (other than the Blue Chip Fund) may buy and
sell stock index futures contracts. A stock index futures contract obligates
the seller to deliver (and the buyer to take) an amount of cash equal to a
specific dollar amount times the difference between the value of a specific
stock index at the close of the last trading day of the contract and the
price at which the agreement is made. No physical delivery of the underlying
stocks in the index is made.
The funds may sell stock index futures contracts in anticipation of or during
a market decline to attempt to offset the decrease in market value of their
equity securities that might otherwise result. When a fund is not fully
invested in stocks and anticipates a significant market advance, it may buy
stock index futures in order to gain rapid market exposure that may in part
or entirely offset increases in the cost of common stocks that it intends to
buy.
OPTIONS ON STOCK INDEX FUTURES. The funds (other than the Blue Chip Fund) may
buy and sell call and put options on stock index futures to hedge against
risks of market price movements. The need to hedge against these risks will
depend on the extent of diversification of the fund's common stock portfolio
and the sensitivity of such investments to factors influencing the stock
market as a whole.
Call and put options on stock index futures are similar to options on
securities except that, rather than the right to buy or sell stock at a
specified price, options on stock index futures give the holder the right to
receive cash. Upon exercise of the option, the delivery of the futures
position by the writer of the option to the holder of the option will be
accompanied by delivery of the accumulated balance in the writer's futures
margin account which represents the amount by which the market price of the
futures contract, at exercise, exceeds, in the case of a call, or is less
than, in the case of a put, the exercise price of the option on the futures
contract. If an option is exercised on the last trading day before the
expiration date of the option, the settlement will be made entirely in cash
equal to the difference between the exercise price of the option and the
closing price of the futures contract on the expi-
ration date.
BOND INDEX FUTURES AND RELATED OPTIONS. The California Fund and Small Cap
Fund may buy and sell futures contracts based on an index of debt securities
and options on such futures contracts to the extent they currently exist and,
in the future, may be developed. These funds reserve the right to conduct
futures and options transactions based on an index that may be developed in
the future to correlate with price movements in certain categories of debt
securities. The funds' investment strategies in employing futures contracts
based on an index of debt securities will be similar to that used in other
financial futures transactions.
The California Fund and Small Cap Fund may also buy and write put and call
options on bond index futures and enter into closing transactions with
respect to such options.
FUTURES CONTRACTS FOR SECURITIES AND CURRENCIES. The funds (except the
California Fund and MidCap Fund) may buy and sell futures contracts for
securities, and currencies. These funds may also enter into closing purchase
and sale transactions with respect to these futures contracts. The funds will
engage in futures transactions only for bona fide hedging or other
appropriate risk management purposes. All futures contracts entered into by
the funds are traded on U.S. exchanges or boards of trade licensed and
regulated by the CFTC or on foreign exchanges.
When securities prices are falling, a fund may offset a decline in the value
of its current portfolio securities through the sale of futures contracts.
When prices are rising, a fund can attempt to secure better prices than might
be available when it intends to buy securities through the purchase of
futures contracts. Similarly, a fund can sell futures contracts on a
specified currency in an attempt to protect against a decline in the value of
that currency and its portfolio securities denominated in that currency. A
fund can buy futures contracts on a foreign currency to fix the price in U.S.
dollars of a security denominated in that currency that the fund has
purchased or expects to buy.
Positions taken in the futures markets are not normally held to maturity, but
are liquidated through offsetting transactions that may result in a profit or
a loss. While the funds' futures contracts on securities and currencies will
usually be liquidated in this manner, the funds may instead make or take
delivery of the underlying securities or currencies whenever it appears
economically advantageous to do so. A clearing corporation associated with
the exchange on which futures on securities or currencies are traded
guarantees that, if still open, the sale or purchase will be performed on the
settlement date.
To the extent a fund enters into a futures contract, it will deposit in a
segregated account with its custodian bank cash or U.S. Treasury obligations
equal to a specified percentage of the value of the futures contract (the
initial margin), as required by the relevant contract market and futures
commission merchant. The futures contract will be marked-to-market daily.
Should the value of the futures contract decline relative to the fund's
position, the fund, if required by law, will pay the futures commission
merchant an amount equal to the change in value.
FUTURES CONTRACTS - GENERAL. Although financial futures contracts by their
terms call for the actual delivery or acquisition of securities, or the cash
value of the index, in most cases the contractual obligation is fulfilled
before the date of the contract without having to make or take delivery of
the securities or cash. A contractual obligation is offset by buying (or
selling, as the case may be) on a commodities exchange an identical financial
futures contract calling for delivery in the same month. This transaction,
which is effected through a member of an exchange, cancels the obligation to
make or take delivery of the securities or cash. Since all transactions in
the futures market are made, offset or fulfilled through a clearinghouse
associated with the exchange on which the contracts are traded, the funds
will incur brokerage fees when they buy or sell financial futures contracts.
FUTURE DEVELOPMENTS. The funds may take advantage of opportunities in the
area of options, futures, and options on futures and any other derivative
investments that are not presently contemplated for use by the funds or that
are not currently available but which may be developed, to the extent such
opportunities are consistent with the funds' investment goals and legally
permissible for the funds.
FORWARD CURRENCY EXCHANGE TRANSACTIONS In connection with the Blue Chip
Fund's investment in foreign securities, it may hold currencies other than
the U.S. dollar and enter into forward currency exchange transactions to
facilitate settlements and to protect against changes in exchange rates. In a
forward currency transaction, the fund agrees to buy or sell a foreign
currency at a set exchange rate. Payment and delivery of the currency occurs
on a future date. There is no assurance that these strategies will be
successful. The fund's investment in foreign currencies and forward currency
exchange transactions will not exceed 10% of its net assets. The Blue Chip
Fund may also enter into futures contracts for currencies as discussed above.
The Blue Chip Fund may enter into forward currency exchange transactions in
order (i) to "lock-in" the U.S. dollar price of a security in its portfolio
denominated in
a foreign currency; (ii) to sell an amount of a foreign currency
approximating the value of some or all of its portfolio securities
denominated in that foreign currency when the manager believes the foreign
currency may decline substantially against the U.S. dollar; or (iii) to buy a
foreign currency for a fixed dollar amount when the manager believes the U.S.
dollar may substantially decline against that foreign currency.
The value of securities denominated in a foreign currency may change during
the time between when a forward transaction is entered into and the time it
settles. It is therefore generally not possible to match precisely the
forward transaction amount and the value of the securities in the fund's
portfolio denominated in the currency involved. Using a forward currency
transaction to protect the value of the fund's portfolio securities against a
decline in the value of a currency does not eliminate fluctuations in the
underlying prices of the securities. It simply establishes a rate of exchange
that the fund can achieve at some future time. The precise projection of
short-term currency market movements is not possible and short-term hedging
provides a way to fix the dollar value of only a portion of the fund's
foreign securities.
To limit the potential risks of buying currency under forward currency
transactions, the Blue Chip Fund will keep cash, cash equivalents, or readily
marketable high-grade debt securities equal to the amount of the purchase in
a segregated account with its custodian bank to be used to pay for the
commitment. The fund will cover any commitments under these transactions to
sell currency by owning the underlying currency or an absolute right to
acquire the underlying currency. The segregated account will be
marked-to-market daily.
ILLIQUID SECURITIES Each fund's policy is not to invest more than 10% of its
net assets in illiquid securities. Generally, an illiquid security is any
security that cannot be disposed of within seven days in the ordinary course
of business at approximately the amount at which the fund has valued it.
Each fund does not consider securities that it acquires outside of the U.S.
and that are publicly traded in the U.S. or on a foreign securities market to
be illiquid assets if: (a) the fund reasonably believes it can readily
dispose of the securities for cash in the U.S. or foreign market, or (b)
current market quotations are readily available. Each fund will not acquire
the securities of foreign issuers outside of the U.S. if, at the time of
acquisition, the fund has reason to believe that it could not resell the
securities in a public trading market.
The funds' board of trustees has authorized the funds to invest in restricted
securities. To the extent the manager determines there is a liquid
institutional or other market for these securities, the fund considers them
to be liquid securities. An example of these securities are restricted
securities that may be freely transferred among qualified institutional
buyers pursuant to Rule 144A under the Securities Act of 1933, as amended,
and for which a liquid institutional market has developed. The funds' board
of trustees will review any determination by the manager to treat a
restricted security as a liquid security on an ongoing basis, including the
manager's assessment of current trading activity and the availability of
reliable price information. In determining whether a restricted security is
properly considered a liquid security, the manager and the funds' board of
trustees will take into account the following factors: (i) the frequency of
trades and quotes for the security; (ii) the number of dealers willing to buy
or sell the security and the number of other potential buyers; (iii) dealer
undertakings to make a market in the security; and (iv) the nature of the
security and the nature of the marketplace trades (e.g., the time needed to
dispose of the security, the method of soliciting offers, and the mechanics
of transfer). To the extent a fund invests in restricted securities that are
deemed liquid, the general level of illiquidity in the fund may increase if
qualified institutional buyers become uninterested in buying these securities
or the market for these securities contracts.
TEMPORARY INVESTMENTS When the manager believes that the securities trading
markets or the economy are experiencing excessive volatility or a prolonged
general decline, or other adverse conditions exist, it may invest the funds'
portfolios in a temporary defensive manner. Under such circumstances, the
funds may invest up to 100% of assets in short-term debt instruments. The
funds may also invest cash, including cash resulting from purchases and sales
of fund shares, temporarily in short-term debt instruments. Short-term debt
instruments include high-grade commercial paper, repurchase agreements, and
other money market equivalents. To the extent permitted by exemptions granted
under the 1940 Act and the fund's other investment policies and restrictions,
each fund may also invest in shares of one or more money market funds managed
by Franklin Advisers, Inc. or its affiliates.
INVESTMENT RESTRICTIONS Each fund has adopted the following restrictions as
fundamental policies. This means they may only be changed if the change is
approved by (i) more than 50% of a fund's outstanding shares or (ii) 67% or
more of a fund's shares present at a shareholder meeting if more than 50% of
a fund's outstanding shares are represented at the meeting in person or by
proxy, whichever is less.
The Aggressive Growth Fund MAY NOT:
1. Borrow money, except that the fund may borrow money from banks or
affiliated investment companies to the extent permitted by the 1940 Act,
or any exemptions therefrom that may be granted by the SEC, or for
temporary or emergency purposes and then in an amount not exceeding
331/3% of the value of the fund's total assets (including the amount
borrowed).
2. Act as an underwriter except to the extent the fund may be deemed to be
an underwriter when disposing of securities it owns or when selling its
own shares.
3. Make loans to other persons except (a) through the lending of its
portfolio securities, (b) through the purchase of debt securities, loan
participations and/or engaging in direct corporate loans in accordance
with its investment goal and policies, and (c) to the extent the entry
into a repurchase agreement is deemed to be a loan. The fund may also
make loans to affiliated investment companies to the extent permitted by
the 1940 Act or any exemptions therefrom that may be granted by the SEC.
4. Purchase or sell real estate and commodities, except that the fund may
buy or sell securities of real estate investment trusts may purchase or
sell currencies, may enter into forward contracts and futures contracts
on securities, currencies, and other indices or any other financial
instruments, and may purchase and sell options on such futures contracts.
5. Issue securities senior to the fund's presently authorized shares of
beneficial interest, except that this restriction shall not be deemed to
prohibit the fund from (a) making any permitted borrowings, loans,
mortgages or pledges, (b) entering into options, futures contracts,
forward contracts, repurchase transactions or reverse repurchase
transactions, or (c) making short sales of securities to the extent
permitted by the 1940 Act, and any rule or order thereunder, or SEC staff
interpretations thereof.
6. Concentrate (invest more than 25% of its total assets) in securities of
issuers in a particular industry (other than securities issued or
guaranteed by the U.S. government or any of its agencies or
instrumentalities or securities of other investment companies).
7. Buy the securities of any one issuer (other than the U.S. government or
any of its agencies or instrumentalities or securities of other
investment companies) if immediately after such investment (a) more than
5% of the value of the fund's total assets would be invested in such
issuer or (b) more than 10% of the outstanding voting securities of such
issuer would be owned by the fund, except that up to 25% of the value of
such fund's total assets may be invested without regard to such 5% and
10% limitations.
It is the present policy of the fund (which may be changed without
shareholder approval) that its borrowings under restriction #1 above may not
exceed 15% of the value of the fund's total assets (including the amount
borrowed).
The Blue Chip Fund MAY NOT:
1. Borrow money or mortgage or pledge any of its assets, except it may
borrow up to 15% of its total assets (including the amount borrowed) to
meet redemption requests that might otherwise require the untimely
disposition of portfolio securities or for other temporary or emergency
purposes and may pledge its assets in connection with these borrowings.
The fund may borrow from banks, other Franklin Templeton Funds or other
persons to the extent permitted by applicable law. The fund will not make
any additional investments while borrowings exceed 5% of its total assets.
2. Underwrite securities of other issuers, except insofar as the fund may be
technically deemed an underwriter under the federal securities laws in
connection with the disposition of portfolio securities. This does not
preclude the fund from obtaining short-term credit necessary for the
clearance of purchases and sales of its portfolio securities.
3. Invest directly in interests in real estate, oil, gas or other mineral
leases, exploration or development programs, including limited
partnership interests. This restriction does not preclude investments in
marketable securities of issuers engaged in these activities.
4. Loan money, except as is consistent with the fund's investment objective,
and except that the fund may (a) buy a portion of an issue of publicly
distributed bonds, debentures, notes and other evidences of indebtedness,
(b) enter into repurchase agreements, (c) lend its portfolio securities,
and (d) participate in an interfund lending program with other Franklin
Templeton Funds to the extent permitted by the 1940 Act and any rules or
orders thereunder.
5. Buy or sell commodities or commodity contracts, except that the fund may
enter into financial futures contracts, options thereon, and forward
contracts.
6. Invest more than 25% of the fund's assets (at the time of the most recent
investment) in any industry, except that all or substantially all of the
assets of the fund may be invested in another registered investment
company having the same investment objective and policies as the fund.
7. Issue securities senior to the fund's presently authorized shares of
beneficial interest, except that the fund may borrow as permitted by
these restrictions.
ADDITIONAL RESTRICTIONS. The Blue Chip Fund has adopted the following
additional restrictions. These restrictions are not fundamental and may be
changed without shareholder approval. Under these restrictions, the Blue Chip
Fund may not:
1. Invest in any company for the purpose of exercising control or
management, except that all or substantially all of the assets of the
fund may be invested in another registered investment company having the
same investment objective and policies as the fund.
2. Buy securities on margin or sell securities short, except that the fund
may make margin payments in connection with futures, options and currency
transactions.
3. Buy or retain securities of any company in which officers, trustees or
directors of the fund or the manager individually own more than one-half
of 1% of the securities of such company, and in the aggregate own more
than 5% of the securities of such company.
4. Buy securities of open-end or closed-end investment companies, except
that the fund may: (i) acquire securities of an open-end or closed-end
investment company in compliance with the 1940 Act; (ii) invest all or
substantially all of its assets in another registered investment company
having the same investment objective and policies as the fund; or (iii)
invest in shares of one or more money market funds managed by the manager
or its affiliates, to the extent permitted by exemptions granted under
the 1940 Act.
5. Invest more than 5% of its assets in securities of issuers with less than
three years continuous operation, including the operations of any
predecessor companies, except that all or substantially all of the assets
of the fund may be invested in another registered investment company
having the same investment objective and policies as the fund.
6. Hold or purchase the securities of any issuer if, as a result, in the
aggregate, more than 10% of the value of the fund's net assets would be
invested in (i) securities that are not readily marketable or (ii)
repurchase agreements maturing in more than seven days. The fund may,
however, invest all or substantially all of its assets in another
registered investment company having the same investment objective and
policies as the fund.
7. Invest directly in warrants (valued at the lower of cost or market) in
excess of 5% of the value of the fund's net assets. No more than 2% of
the value of the fund's net assets may be invested in warrants (valued at
the lower of cost or market) that are not listed on the NYSE or the
American Stock Exchange.
As a diversified fund, with respect to 75% of its total assets, the Blue Chip
Fund may not invest more than 5% in any one issuer nor may it own more than
10% of the outstanding voting securities of any one issuer, except that this
restriction does not apply to cash, cash items (including receivables),
government securities, and securities of other investment companies. All or
substantially all of the assets of the fund may be invested in another
registered investment company having the same investment objective and
policies as the fund.
The California Fund MAY NOT:
1. Make loans to other persons, except by the purchase of bonds, debentures
or similar obligations which are publicly distributed or of a character
usually acquired by institutional investors or through loans of the
fund's portfolio securities, or to the extent the entry into a repurchase
agreement may be deemed a loan.
2. Borrow money, except from banks in order to meet redemption requests that
might otherwise require the untimely disposition of portfolio securities
or for other temporary or emergency (but not investment) purposes, in an
amount up to 10% of the value of the fund's total assets (including the
amount borrowed) based on the lesser of cost or market, less liabilities
(not including the amount borrowed) at the time the borrowing is made.
While borrowings exceed 5% of the fund's total assets, the fund will not
make any additional investments.
3. Invest more than 25% of the fund's assets (at the time of the most recent
investment) in any single industry.
4. Underwrite securities of other issuers (does not preclude the fund from
obtaining such short-term credit as may be necessary for the clearance of
purchases and sales of its portfolio securities) or invest more than 10%
of its assets in securities with legal or contractual restrictions on
resale (although the fund may invest in such securities to the extent
permitted under the federal securities laws) or which are not readily
marketable, or which have a record of less than three years continuous
operation, including the operations of any predecessor companies, if more
than 5% of the fund's total assets would be invested in such companies.
5. Invest in securities for the purpose of exercising management or control
of the issuer.
6. Maintain a margin account with a securities dealer or invest in
commodities and commodity contracts (except that the fund may engage in
financial futures, including stock index futures, and options on stock
index futures) or lease or acquire any interests, including interest
issued by limited partnerships (other than publicly traded equity
securities) in oil, gas, or other mineral exploration or development
programs, or invest in excess of 5% of its total assets in options
unrelated to the fund's transactions in futures, including puts, calls,
straddles, spreads, or any combination thereof.
7. Effect short sales, unless at the time the fund owns securities
equivalent in kind and amount to those sold (which will normally be for
deferring recognition of gains or losses for tax purposes).
8. Invest directly in real estate, real estate limited partnerships or
illiquid securities issued by real estate investment trusts; the fund
may, however, invest in marketable securities issued by real estate
investment trusts.
9. Invest in the securities of other investment companies, except where
there is no commission other than the customary brokerage commission or
sales charge, or except that securities of another investment company may
be acquired pursuant to a plan of reorganization, merger, consolidation
or acquisition, and except where the fund would not own, immediately
after the acquisition, securities of other investment companies which
exceed in the aggregate i) more than 3% of the issuer's outstanding
voting stock, ii) more than 5% of the fund's total assets and iii)
together with the securities of all other investment companies held by
the fund, exceed, in the aggregate, more than 10% of the fund's total
assets. To the extent permitted by exemptions granted under the 1940 Act,
the fund may invest in shares of one or more money market funds managed
by the manager or its affiliates.
10. Purchase from or sell to its officers and trustees, or any firm of which
any officer or trustee is a member, as principal, any securities, but may
deal with such persons or firms as brokers and pay a customary brokerage
commission; or purchase or retain securities of any issuer if, to the
knowledge of the Trust, one or more of the officers or trustees of the
Trust, or its investment adviser, own beneficially more than one-half of
1% of the securities of such issuer and all such officers and trustees
together own beneficially more than 5% of such securities.
In addition to these fundamental policies, it is the present policy of the
California Fund (which may be changed without the approval of the
shareholders) not to pledge, mortgage or hypothecate its assets as securities
for loans, nor to engage in joint or joint and several trading accounts in
securities, except that it may: (i) participate in joint repurchase
arrangements; (ii) invest in shares of one or more money market funds managed
by Advisers or its affiliates, to the extent permitted by exemptions granted
under the 1940 Act; or (iii) combine orders to buy or sell with orders from
other persons to obtain lower brokerage commissions.
The Large Cap Fund MAY NOT:
1. Borrow money, except that the fund may borrow money from banks or
affiliated investment companies to the extent permitted by the 1940 Act,
or any exemptions therefrom which may be granted by the SEC, or for
temporary or emergency purposes and then in an amount not exceeding 33%
of the value of the fund's total assets (including the amount borrowed).
2. Act as an underwriter except to the extent the fund may be deemed to be
an underwriter when disposing of securities it owns or when selling its
own shares.
3. Make loans to other persons except (a) through the lending of its
portfolio securities, (b) through the purchase of debt securities, loan
participations and/or engaging in direct corporate loans in accordance
with its investment goal and policies, and (c) to the extent the entry
into a repurchase agreement is deemed to be a loan. The fund may also
make loans to affiliated investment companies to the extent permitted by
the 1940 Act or any exemptions therefrom that may be granted by the SEC.
4. Purchase or sell real estate and commodities, except that the fund may
buy or sell securities of real estate investment trusts and may enter
into financial futures contracts, options thereon, and forward contracts.
5. Issue securities senior to the fund's presently authorized shares of
beneficial interest, except that this restriction shall not be deemed to
prohibit the fund from (a) making any permitted borrowings, loans,
mortgages or pledges, (b) entering into options, futures contracts,
forward contracts or repurchase transactions, or (c) making short sales
of securities to the extent permitted by the 1940 Act and any rule or
order thereunder, or SEC staff interpretations thereof.
6. Concentrate (invest more than 25% of its total assets) in securities of
issuers in a particular industry (other than securities issued or
guaranteed by the U.S. government or any of its agencies or
instrumentalities or securities of other investment companies).
7. Buy the securities of any one issuer (other than the U.S. government or
any of its agencies or instrumentalities or securities of other
investment companies) if immediately after such investment (a) more than
5% of the value of the fund's total assets would be invested in such
issuer or (b) more than 10% of the outstanding voting securities of such
issuer would be owned by the fund, except that up to 25% of the value of
such fund's total assets may be invested without regard to such 5% and
10% limitations.
The MidCap Fund MAY NOT:
1. Borrow money or mortgage or pledge any of its assets, except it may
borrow up to 10% of its total assets (including the amount borrowed) to
meet redemption requests that might otherwise require the untimely
disposition of portfolio securities or for other temporary or emergency
purposes and may pledge its assets in connection with these borrowings.
The fund may borrow from banks, other Franklin Templeton Funds or other
persons to the extent permitted by applicable law. The fund will not
make any additional investments while borrowings exceed 5% of its total
assets.
2. Loan money, except as is consistent with the fund's investment
objective, and except that the fund may (a) buy a portion of an issue of
publicly distributed bonds, debentures, notes and other evidences of
indebtedness, (b) enter into repurchase agreements, (c) lend its
portfolio securities, and (d) participate in an interfund lending
program with other Franklin Templeton Funds to the extent permitted by
the 1940 Act and any rules or orders thereunder.
3. Invest in any company for purposes of exercising control or management,
except that all or substantially all of the assets of the fund may be
invested in another registered investment company having the same
investment objective and policies as the fund.
4. Buy any securities on margin or sell any securities short, except that
it may use such short-term credits as are necessary for the clearance of
transactions.
5. Purchase securities of other investment companies, except in connection
with a merger, consolidation, acquisition, or reorganization; provided
that all or substantially all of the assets of the fund may be invested
in another registered investment company having the same investment
objective and policies as the fund.
6. Invest more than 25% of the fund's assets (at the time of the most
recent investment) in any single industry except that, to the extent
this restriction is applicable, all or substantially all of the assets
of the fund may be invested in another registered investment company
having the same investment objective and policies as the fund.
7. Underwrite securities of other issuers, except insofar as the fund may
be technically deemed an underwriter under the federal securities laws
in connection with the disposition of portfolio securities. This does
not preclude the fund from obtaining short-term credit necessary for the
clearance of purchases and sales of its portfolio securities.
8. Buy or sell securities to the fund's officers and trustees, or any firm
of which any officer or trustee is a member, as principal, or retain
securities of any issuer if, to the knowledge of the fund, one or more
of the fund's officers, trustees, or investment adviser own beneficially
more than 1/2 of 1% of the securities of such issuer and all such
officers and trustees together own beneficially more than 5% of such
securities.
9. Acquire, lease or hold real estate, provided that this limitation shall
not prohibit the purchase of securities secured by real estate or
interests therein.
10. Buy or sell commodities or commodity contracts, except that the fund may
enter into financial futures contracts, including stock index futures,
and options on stock index futures, or interests in oil, gas, or other
mineral exploration or development programs, or invest in excess of 5%
of its total assets in options unrelated to the fund's transactions in
futures, including puts, calls, straddles, spreads, or any combination
thereof.
In addition to these fundamental policies, it is the present policy of the
fund (which may be changed without shareholder approval) not to invest in
real estate limited partnerships (investments in marketable securities issued
by real estate investment trusts are not subject to this restriction). The
MidCap Fund's restriction against investment in interests in oil, gas, or
other mineral leases, exploration or development does not include publicly
traded equity securities.
It is the present policy of the MidCap Fund, which may be changed without
shareholder approval, not to engage in joint or joint and several trading
accounts in securities, except that it may participate in joint repurchase
arrangements, or combine orders to buy or sell with orders from other persons
to obtain lower brokerage commissions. To the extent permitted by exemptions
granted under the 1940 Act, the MidCap Fund may invest in shares of one or
more money market funds managed by the manager or its affiliates. The MidCap
Fund may not invest in excess of 5% of its total assets, valued at the lower
of cost or market, in warrants, nor more than 2% of its total assets in
warrants not listed on either the NYSE or the American Stock Exchange.
The Small Cap Fund MAY NOT:
1. Purchase the securities of any one issuer (other than obligations of the
U.S., its agencies or instrumentalities) if immediately thereafter, and
as a result of the purchase, the fund would (a) have invested more than
5% of the value of its total assets in the securities of the issuer, or
(b) hold more than 10% of any voting class of the securities of any one
issuer;
2. Make loans to other persons, except by the purchase of bonds, debentures
or similar obligations which are publicly distributed or of a character
usually acquired by institutional investors or through loans of the
fund's portfolio securities, or to the extent the entry into a
repurchase agreement may be deemed a loan;
3. Borrow money (does not preclude the fund from obtaining such short-term
credit as may be necessary for the clearance of purchases and sales of
its portfolio securities), except in the form of reverse repurchase
agreements or from banks in order to meet redemption requests that might
otherwise require the untimely disposition of portfolio securities or
for other temporary or emergency (but not investment) purposes, in an
amount up to 10% of the value of the fund's total assets (including the
amount borrowed) based on the lesser of cost or market, less liabilities
(not including the amount borrowed) at the time the borrowing is made.
While borrowings exceed 5% of the fund's total assets, the fund will not
make any additional investments;
4. Invest more than 25% of the fund's assets (at the time of the most
recent investment) in any single industry;
5. Underwrite securities of other issuers or invest more than 10% of its
assets in securities with legal or contractual restrictions on resale
(although the fund may invest in such securities to the extent permitted
under the federal securities laws, for example, transactions between the
fund and Qualified Institutional Buyers subject to Rule 144A under the
Securities Act of 1933) or which are not readily marketable, or which
have a record of less than three years continuous operation, including
the operations of any predecessor companies, if more than 10% of the
fund's total assets would be invested in such companies;
6. Invest in securities for the purpose of exercising management or control
of the issuer;
7. Maintain a margin account with a securities dealer or invest in
commodities and commodity contracts (except that the fund may engage in
financial futures, including stock index futures, and options on stock
index futures) or lease or acquire any interests, including interests
issued by limited partnerships (other than publicly traded equity
securities) in oil, gas, or other mineral exploration or development
programs, or invest in excess of 5% of its total assets in options
unrelated to the fund's transactions in futures, including puts, calls,
straddles, spreads, or any combination thereof;
8. Effect short sales, unless at the time the fund owns securities
equivalent in kind and amount to those sold (which will normally be for
deferring recognition of gains or losses for tax purposes). The fund
does not currently intend to employ this investment technique;
9. Invest directly in real estate, real estate limited partnerships or
illiquid securities issued by real estate investment trusts (the fund
may, however, invest in marketable securities issued by real estate
investment trusts);
10. Invest in the securities of other investment companies, except where
there is no commission other than the customary brokerage commission or
sales charge, or except that securities of another investment company
may be acquired pursuant to a plan of reorganization, merger,
consolidation or acquisition, and except where the fund would not own,
immediately after the acquisition, securities of the investment
companies which exceed in the aggregate i) more than 3% of the issuer's
outstanding voting stock, ii) more than 5% of the fund's total assets,
and iii) together with the securities of all other investment companies
held by the fund, exceed, in the aggregate, more than 10% of the fund's
total assets. The fund may invest in shares of one or more money market
funds managed by the manager or its affiliates; and
11. Purchase from or sell to its officers and trustees, or any firm of which
any officer or trustee is a member, as principal, any securities, but
may deal with such persons or firms as brokers and pay a customary
brokerage commission; or purchase or retain securities of any issuer, if
to the knowledge of the Trust, one or more of the officers or trustees
of the Trust, or the manager, own beneficially more than one-half of 1%
of the securities of such issuer and all such officers and trustees
together own beneficially more than 5% of such securities.
In addition to these fundamental policies, it is the present policy of the
Small Cap Fund (which may be changed without the approval of the
shareholders) not to pledge, mortgage or hypothecate its assets as securities
for loans, nor to engage in joint or joint and several trading accounts in
securities, except that it may: (i) participate in joint repurchase
arrangements; (ii) invest in shares of one or more money market funds managed
by Advisers or its affiliates, to the extent permitted by exemptions granted
under the 1940 Act; or (iii) combine orders to buy or sell with orders from
other persons to obtain lower brokerage commissions.
If a bankruptcy or other extraordinary event occurs concerning a particular
security a 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 maximizing
the return to shareholders.
Generally, the policies and restrictions discussed in this SAI and in the
prospectus apply when a fund makes an investment. In most cases, the fund is
not required to sell a security because circumstances change and the security
no longer meets one or more of 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 will not be considered a violation of the
restriction or limitation.
RISKS
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FOREIGN SECURITIES The value of foreign (and U.S.) securities is affected by
general economic conditions and individual company and industry earnings
prospects. While foreign securities may offer significant opportunities for
gain, they also involve additional risks that can increase the potential for
losses in a fund. These risks can be significantly greater for investments in
emerging markets. Investments in depositary receipts also involve some or all
of the risks described below.
The political, economic, and social structures of some countries in which the
funds invest may be less stable and more volatile than those in the U.S. The
risks of investing in these countries include the possibility of the
imposition of exchange controls, expropriation, restrictions on removal of
currency or other assets, nationalization of assets, and punitive taxes.
There may be less publicly available information about a foreign company or
government than about a U.S. company or public entity. Certain countries'
financial markets and services are less developed than those in the U.S. or
other major economies. As a result, they may not have uniform accounting,
auditing, and financial reporting standards and may have less government
supervision of financial markets. Foreign securities markets may have
substantially lower trading volumes than U.S. markets, resulting in less
liquidity and more volatility than experienced in the U.S. Transaction costs
on foreign securities markets are generally higher than in the U.S. The
settlement practices may be cumbersome and result in delays that may affect
portfolio liquidity. The funds may have greater difficulty voting proxies,
exercising shareholder rights, pursuing legal remedies, and obtaining
judgments with respect to foreign investments in foreign courts than with
respect to domestic issuers in U.S. courts.
The funds' 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 a fund changes
investments from one country to another or when proceeds of the sale of
shares in U.S. dollars are used for the purchase of securities in foreign
countries. Also, some countries may adopt policies that would prevent a fund
from transferring cash out of the country or 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 taxes 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 foreign nations.
The funds may be affected either favorably or unfavorably 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.
LOWER-RATED SECURITIES 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 to principal and income, including the
possibility of default by, or bankruptcy of the issuers of the securities. In
addition, the markets in which low rated and unrated debt securities are
traded are more limited than those in which higher rated securities are
traded. The existence of limited markets for particular securities may
diminish a fund's ability to sell the securities at fair value either to meet
redemption requests or to respond to a specific economic event such as a
deterioration in the creditworthiness of the issuer. Reduced secondary market
liquidity for certain low rated or unrated debt securities may also make it
more difficult for a fund to obtain accurate market quotations for the
purposes of valuing 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. The ability of a 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 invested in higher rated securities.
Low rated debt securities may be more susceptible to real or perceived
adverse economic and competitive industry conditions than investment grade
securities. The prices of low rated debt securities have been found to be
less sensitive to interest rate changes than higher rated investments, but
more sensitive to adverse economic downturns or individual corporate
developments. A projection of an economic downturn or of a period of rising
interest rates, for example, could cause a decline in low rated debt
securities prices because the advent of a recession could lessen the ability
of a highly leveraged company to make principal and interest payments on its
debt securities. If the issuer of low rated debt securities defaults, a fund
may incur additional expenses to seek recovery.
BIOTECHNOLOGY COMPANIES The biotechnology industry is subject to extensive
government regulation. The industry will be affected by government regulatory
requirements, regulatory approval for new drugs and medical products, patent
considerations, product liability, and similar matters. For example, in the
past several years, the U.S. Congress has considered legislation concerning
healthcare reform and changes to the U.S. Food and Drug Administration's
(FDA) approval process. If such legislation is passed it may affect the
biotechnology industry. As these factors impact the biotechnology industry,
the value of your shares may fluctuate significantly over relatively short
periods of time.
Because the biotechnology industry is relatively new, investors may be quick
to react to developments that affect the industry. In the past, biotechnology
securities have exhibited considerable volatility in reaction to research and
other developments. In comparison to more developed industries, there may be
a thin trading market in biotechnology securities, and adverse developments
in the biotechnology industry may be more likely to result in decreases in
the value of biotechnology stocks.
Biotechnology companies are often small, start-up ventures whose products are
only in the research stage. Only a limited number of biotechnology companies
have reached the point of approval of products by the FDA and subsequent
commercial production and distribution of such products. Therefore, the
success of investments in the biotechnology industry is often based upon
speculation and expectations about future products, research progress, and
new product filings with regulatory authorities. Such investments are
speculative and may drop sharply in value in response to regulatory or
research setbacks.
HEALTH CARE COMPANIES The activities of health care companies may be funded
or subsidized by federal and state governments. If government subsidies are
discontinued, the profitability of these companies could be adversely
affected. Stocks of these companies will be affected by government policies
on health care reimbursements, regulatory approval for new drugs and medical
instruments, and similar matters. Health care companies are also subject to
legislative risk, which is the risk of a reform of the health care system
through legislation. Health care companies may face lawsuits related to
product liability issues. Also, many products and services provided by health
care companies are subject to rapid obsolescence. The value of an investment
in a fund may fluctuate significantly over relatively short periods of time.
YEAR 2000 On April 27, 1999, the U.S. General Accounting Office issued a
report on the readiness of Medicare and the health care sector for Year
2000. Among other things, this report noted that the health care industry
may be ill-prepared to deal with the potential disruptions brought about by
software problems caused by the change to the Year 2000. While the funds'
manager cannot audit each company in which the fund invests, its personnel
have reviewed the statements of preparedness of the companies owned by the
fund and, based upon these statements, does not expect significant
disruptions in these companies' business plans. The funds' manager will
continue to monitor the Year 2000 issue within the health care industry and
continue actively to incorporate Year 2000 preparedness as a factor in its
analysis of the funds' holdings.
UNSEASONED COMPANIES To the extent that a fund may invest in smaller
capitalization companies or other companies, it may place greater emphasis
upon investments in relatively new or unseasoned companies that are in their
early stages of development, or in new and emerging industries where the
opportunity for rapid growth is expected to be above average. Securities of
unseasoned companies present greater risks than securities of larger, more
established companies. Any investments in these types of companies, however,
will be limited in the case of issuers that have less than three years
continuous operation, including the operations of any predecessor companies,
to no more than 5% of the California Fund's total assets and to no more than
10% of the Small Cap Fund's net assets.
CALIFORNIA COMPANIES Since the California Fund mainly invests in California
companies' securities, its performance is dependent on economic, political
and other conditions within California. However, the fund tries to reduce the
effect on its portfolio of fluctuations in economic conditions in California
by investing a significant portion of its assets in companies whose financial
prospects are dependent on the global economy.
Below is a discussion of certain conditions that may affect California
companies. It is not a complete analysis of every material fact that may
affect the economic or political conditions within California and is subject
to change. The information below is based on data available to the fund from
historically reliable sources, but the fund has not independently verified it.
California's economy has been the largest of all the states in the nation.
Like many other states, however, California was significantly affected by the
national recession of the early 1990s, especially in the southern portion of
the state. Most of its job losses during its recession resulted from military
cutbacks and the downturn in the construction industry. Downsizing in the
state's aerospace industry, excess office capacity, and slow growth in
California's export market also contributed to the state's recession.
Since mid-1993, California's economic recovery has been fueled by growth in
the export, entertainment, tourism and computer services sectors. The state's
diverse employment base has reached prerecession levels with manufacturing
accounting for 14.5% of employment (based on 1997 state figures), trade
23.2%, services 30.8%, and government 16.3%. Despite strong employment
growth, California's unemployment rate has remained above the national
average. Recent economic problems in Asia have adversely affected the state's
high tech manufacturing and related industries, resulting in slower growth
than in previous years. Further weakening of the economies of California's
international trade partners could have a negative impact on the state.
REAL ESTATE SECURITIES Investments in real estate securities are subject to
the risks associated with the real estate industry. Economic, regulatory, and
social factors that affect the value of real estate will affect the value of
real estate securities. These factors include overbuilding and increased
competition, increases in property taxes and operating expenses, changes in
zoning laws, casualty or condemnation losses, variations in rental income,
changes in neighborhood values, the appeal of properties to tenants, and
increases in interest rates. REITs are subject to risks related to the skill
of their management, changes in value of the properties the REITs own, the
quality of any credit extended by the REITs, and general economic and other
factors.
DERIVATIVE SECURITIES The funds' transactions in options, futures, and
options on futures involve certain risks. These risks include, among others,
the risk that the effectiveness of a transaction depends on the degree that
price movements in the underlying securities, index, or currency correlate
with price movements in the relevant portion of the fund's portfolio. The
fund bears the risk that the prices of its portfolio securities will not move
in the same amount as the option or future it has purchased, or that there
may be a negative correlation that would result in a loss on both the
underlying securities and the derivative security.
In addition, adverse market movements could cause the fund to lose up to its
full investment in a call option contract and/or to experience substantial
losses on an investment in a futures contract. There is also the risk of loss
by the fund of margin deposits in the event of bankruptcy of a broker with
whom the fund has an open position.
Positions in exchange traded options and futures may be closed out only on an
exchange that provides a secondary market. There can be no assurance that a
liquid secondary market will exist for any particular option or futures
contract at any specific time. Thus, it may not be possible to close an
option or futures position. The inability to close options or futures
positions may have an adverse impact on the fund's ability to effectively
hedge its securities. Furthermore, if the fund is unable to close out a
position and if prices move adversely, the fund will have to continue to make
daily cash payments to maintain its required margin. If the fund does not
have sufficient cash to do this, it may have to sell portfolio securities at
a disadvantageous time. The funds will enter into an option or futures
position only if there appears to be a liquid secondary market for the
options or futures.
Similarly, there can be no assurance that a continuous liquid secondary
market will exist for any particular OTC option at any specific time.
Consequently, the fund may be able to realize the value of an OTC option it
has purchased only by exercising it or by entering into a closing sale
transaction with the dealer that issued it. When a fund writes an OTC option,
it generally can close out that option prior to its expiration only by
entering into a closing purchase transaction with the dealer to which the
fund originally wrote it.
FORWARD CURRENCY EXCHANGE TRANSACTIONS While the Blue Chip Fund may enter
into forward currency transactions to reduce currency exchange rate risks,
these transactions involve certain other risks. Forward currency exchange
transactions may limit the potential gain to the fund from a positive change
in the relationship between the U.S. dollar and foreign currencies or between
foreign currencies. Unanticipated changes in currency exchange rates may
result in poorer overall performance for the fund than if it had not entered
into these transactions. Furthermore, there may be imperfect correlation
between the fund's portfolio securities denominated in a particular currency
and forward currency transactions entered into by the fund. This may cause
the fund to sustain losses that will prevent it from achieving a complete
hedge or expose it to the risk of foreign exchange loss.
WHEN-ISSUED OR DELAYED DELIVERY TRANSACTIONS The securities underlying these
transactions are subject to market fluctuation prior to delivery and
generally do not earn interest until their scheduled delivery date. There is
the risk that the value or yield of the security at the time of delivery may
be more or less than the price paid for the security or the yield available
when the transaction was entered into.
STANDBY COMMITMENT AGREEMENTS There can be no assurance that the securities
underlying a standby commitment agreement will be issued. If issued, the
value of the security may be more or less than its purchase price. Since the
issuance of the security is at the option of the issuer, the Blue Chip Fund
may bear the risk of a decline in value of the security and may not benefit
if the security appreciates in value during the commitment period.
EURO RISK On January 1, 1999, the European Monetary Union (EMU) introduced a
new single currency, the euro, which will replace the national currency for
participating member countries. The transition and the elimination of
currency risk among EMU countries may change the economic environment and
behavior of investors, particularly in European markets. While the
implementation of the euro could have a negative effect on the funds, the
funds' manager and its affiliated services providers are taking steps they
believe are reasonably designed to address the euro issue.
OFFICERS AND TRUSTEES
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The trust has a board of trustees. The board is responsible for the overall
management of the trust, including general supervision and review of each
fund's investment activities. The board, in turn, elects the officers of the
trust who are responsible for administering the trust's day-to-day
operations. The board also monitors each fund to ensure no material conflicts
exist among share classes. While none is expected, the board will act
appropriately to resolve any material conflict that may arise.
The name, age and address of the officers and board members, as well as their
affiliations, positions held with the trust, and principal occupations during
the past five years are shown below.
Frank H. Abbott, III (78)
1045 Sansome Street, San Francisco, CA 94111
TRUSTEE
President and Director, Abbott Corporation (an investment company); director
or trustee, as the case may be, of 27 of the investment companies in the
Franklin Templeton Group of Funds; and FORMERLY, Director, MotherLode Gold
Mines Consolidated (gold mining) (until 1996) and Vacu-Dry Co. (food
processing) (until 1996).
Harris J. Ashton (67)
191 Clapboard Ridge Road, Greenwich, CT 06830
TRUSTEE
Director, RBC Holdings, Inc. (bank holding company) and Bar-S Foods (meat
packing company); director or trustee, as the case may be, of 48 of the
investment companies in the Franklin Templeton Group of Funds; and FORMERLY,
President, Chief Executive Officer and Chairman of the Board, General Host
Corporation (nursery and craft centers) (until 1998).
*Harmon E. Burns (54)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND TRUSTEE
Executive Vice President and Director, Franklin Resources, Inc., Franklin
Templeton Distributors, Inc. and Franklin Templeton Services, Inc.; Executive
Vice President, Franklin Advisers, Inc.; Director, Franklin Investment
Advisory Services, Inc. and Franklin/Templeton Investor Services, Inc.; and
officer and/or director or trustee, as the case may be, of most of the other
subsidiaries of Franklin Resources, Inc. and of 52 of the investment
companies in the Franklin Templeton Group of Funds.
S. Joseph Fortunato (67)
Park Avenue at Morris County, P.O. Box 1945
Morristown, NJ 07962-1945
TRUSTEE
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.
Edith E. Holiday (47)
3239 38th Street, N.W., Washington, DC 20016
TRUSTEE
Director, Amerada Hess Corporation (exploration and refining of natural gas)
(1993-present), Hercules Incorporated (chemicals, fibers and resins)
(1993-present), Beverly Enterprises, Inc. (health care) (1995-present) and
H.J. Heinz Company (processed foods and allied products) (1994-present);
director or trustee, as the case may be, of 24 of the investment companies in
the Franklin Templeton Group of Funds; and FORMERLY, Chairman (1995-1997) and
Trustee (1993-1997), National Child Research Center, Assistant to the
President of the United States and Secretary of the Cabinet (1990-1993),
General Counsel to the United States Treasury Department (1989-1990), and
Counselor to the Secretary and Assistant Secretary for Public Affairs and
Public Liaison-United States Treasury Department (1988-1989).
*Charles B. Johnson (66)
777 Mariners Island Blvd., San Mateo, CA 94404
CHAIRMAN OF THE BOARD AND TRUSTEE
President, Chief Executive Officer and Director, Franklin Resources, Inc.;
Chairman of the Board and Director, Franklin Advisers, Inc., Franklin
Investment Advisory Services, Inc. and Franklin Templeton Distributors, Inc.;
Director, Franklin/Templeton Investor Services, Inc. and Franklin Templeton
Services, Inc.; officer and/or director or trustee, as the case may be, of
most of the other subsidiaries of Franklin Resources, Inc. and of 49 of the
investment companies in the Franklin Templeton Group of Funds.
*Rupert H. Johnson, Jr. (59)
777 Mariners Island Blvd., San Mateo, CA 94404
PRESIDENT AND TRUSTEE
Executive Vice President and Director, Franklin Resources, Inc. and Franklin
Templeton Distributors, Inc.; President and Director, Franklin Advisers, Inc.
and Franklin Investment Advisory Services, Inc.; Senior Vice President,
Franklin Advisory Services, LLC; Director, Franklin/ Templeton Investor
Services, Inc.; and officer and/or director or trustee, as the case may be,
of most of the other subsidiaries of Franklin Resources, Inc. and of 52 of
the investment companies in the Franklin Templeton Group of Funds.
Frank W.T. LaHaye (70)
20833 Stevens Creek Blvd., Suite 102, Cupertino, CA 95014
TRUSTEE
General Partner, Miller & LaHaye, which is the General Partner of Peregrine
Ventures II (venture capital firm); director or trustee, as the case may be,
of 27 of the investment companies in the Franklin Templeton Group of Funds;
and FORMERLY, Director, Fischer Imaging Corporation (medical imaging
systems), Digital Transmission Systems, Inc. (wireless communications) and
Quarterdeck Corporation (software firm), and General Partner, Peregrine
Associates, which was the General Partner of Peregrine Ventures (venture
capital firm).
Gordon S. Macklin (71)
8212 Burning Tree Road, Bethesda, MD 20817
TRUSTEE
Director, Fund American Enterprises Holdings, Inc. (holding company), Martek
Biosciences Corporation, MCI WorldCom (information services), MedImmune, Inc.
(biotechnology), Spacehab, Inc. (aerospace services) and Real 3D (software);
director or trustee, as the case may be, of 48 of the investment companies in
the Franklin Templeton Group of Funds; and FORMERLY, Chairman, White River
Corporation (financial services) and Hambrecht and Quist Group (investment
banking), and President, National Association of Securities Dealers, Inc.
Martin L. Flanagan (39)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
Senior Vice President and Chief Financial Officer, Franklin Resources, Inc.,
Franklin/Templeton Investor Services, Inc. and Franklin Mutual Advisers, LLC;
Executive Vice President, Chief Financial Officer and Director, Templeton
Worldwide, Inc.; Executive Vice President, Chief Operating Officer and
Director, Templeton Investment Counsel, Inc.; Executive Vice President and
Chief Financial Officer, Franklin Advisers, Inc.; Chief Financial Officer,
Franklin Advisory Services, LLC and Franklin Investment Advisory Services,
Inc.; President and Director, Franklin Templeton Services, Inc.; officer
and/or director of some of the other subsidiaries of Franklin Resources,
Inc.; and officer and/or director or trustee, as the case may be, of 52 of
the investment companies in the Franklin Templeton Group of Funds.
Deborah R. Gatzek (50)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND SECRETARY
Senior Vice President and General Counsel, Franklin Resources, Inc.; Senior
Vice President, Franklin Templeton Services, Inc. and Franklin Templeton
Distributors, Inc.; Executive Vice President, Franklin Advisers, Inc.; Vice
President, Franklin Advisory Services, LLC and Franklin Mutual Advisers, LLC;
Vice President, Chief Legal Officer and Chief Operating Officer, Franklin
Investment Advisory Services, Inc.; and officer of 53 of the investment
companies in the Franklin Templeton Group of Funds.
Charles E. Johnson (43)
500 East Broward Blvd., Fort Lauderdale, FL 33394-3091
VICE PRESIDENT
Senior Vice President and Director, Franklin Resources, Inc.; Senior Vice
President, Franklin Templeton Distributors, Inc.; President and Director,
Templeton Worldwide, Inc.; Chairman and Director, Templeton Investment
Counsel, Inc.; Vice President, Franklin Advisers, Inc.; officer and/or
director of some of the other subsidiaries of Franklin Resources, Inc.; and
officer and/or director or trustee, as the case may be, of 33 of the
investment companies in the Franklin Templeton Group of Funds.
Diomedes Loo-Tam (60)
777 Mariners Island Blvd., San Mateo, CA 94404
TREASURER AND PRINCIPAL ACCOUNTING OFFICER
Senior Vice President, Franklin Templeton Services, Inc.; and officer of 32
of the investment companies in the Franklin Templeton Group of Funds.
Edward V. McVey (62)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT
Senior Vice President and National Sales Manager, Franklin Templeton
Distributors, Inc.; and officer of 28 of the investment companies in the
Franklin Templeton Group of Funds.
*This board member is considered an "interested person" under federal
securities laws.
Note: Charles B. Johnson and Rupert H. Johnson, Jr. are brothers and the
father and uncle, respectively, of Charles E. Johnson.
The trust pays noninterested board members $1,575 for each of the Trust's
eight regularly scheduled meetings plus $1,050 per meeting attended. Board
members who serve on the audit committee of the trust and other funds in the
Franklin Templeton Group of Funds receive a flat fee of $2,000 per committee
meeting attended, a portion of which is allocated to the trust. Members of a
committee are not compensated for any committee meeting held on the day of a
board meeting. Noninterested board members also may serve as directors or
trustees of other funds in the Franklin Templeton Group of Funds and may
receive fees from these funds for their services. The fees payable to
noninterested board members by the trust are subject to reductions resulting
from fee caps limiting the amount of fees payable to board members who serve
on other boards within the Franklin Templeton Group of Funds. The following
table provides the total fees paid to noninterested board members by the
trust and by the Franklin Templeton Group of Funds.
NUMBER OF
BOARDS IN
TOTAL FEES THE FRANKLIN
RECEIVED FROM TEMPLETON
TOTAL FEES THE FRANKLIN GROUP
RECEIVED TEMPLETON OF FUNDS
FROM THE GROUP ON WHICH EACH
NAME TRUST 1 ($) OF FUNDS 2 ($) SERVES 3
- --------------------------------------------------------------------------------
Frank H. Abbott, III 13,935 159,051 27
Harris J. Ashton 16,280 361,157 48
S. Joseph Fortunato 15,279 367,835 50
Edith E. Holiday 18,975 211,400 24
Frank W.T. LaHaye 16,035 163,753 27
Gordon Macklin 16,280 361,157 48
1. For the fiscal year ended April 30, 1999. During the period from April 30,
1998, through May 31, 1998, fees at the rate of $300 for each of the Trust's
eight meetings plus $300 per meeting attended were in effect.
2. For the calendar year ended December 31, 1998.
3. We base the number of boards on the number of registered investment
companies in the Franklin Templeton Group of Funds. This number does not
include the total number of series or funds within each investment company
for which the board members are responsible. The Franklin Templeton Group of
Funds currently includes 54 registered investment companies, with
approximately 162 U.S. based funds or series.
Noninterested board members are reimbursed for expenses incurred in
connection with attending board meetings, paid pro rata by each fund in the
Franklin Templeton Group of Funds for which they serve as director or
trustee. No officer or board member received any other compensation,
including pension or retirement benefits, directly or indirectly from the
fund or other funds in the Franklin Templeton Group of Funds. Certain
officers or board members who are shareholders of Franklin Resources, Inc.
may be deemed to receive indirect remuneration by virtue of their
participation, if any, in the fees paid to its subsidiaries.
Board members historically have followed a policy of having substantial
investments in one or more of the funds in the Franklin Templeton Group of
Funds, as is consistent with their individual financial goals. In February
1998, this policy was formalized through adoption of a requirement that each
board member invest one-third of fees received for serving as a director or
trustee of a Templeton fund in shares of one or more Templeton funds and
one-third of fees received for serving as a director or trustee of a Franklin
fund in shares of one or more Franklin funds until the value of such
investments equals or exceeds five times the annual fees paid such board
member. Investments in the name of family members or entities controlled by a
board member constitute fund holdings of such board member for purposes of
this policy, and a three year phase-in period applies to such investment
requirements for newly elected board members. In implementing such policy, a
board member's fund holdings existing on February 27, 1998, are valued as of
such date with subsequent investments valued at cost.
MANAGEMENT AND OTHER SERVICES
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MANAGER AND SERVICES PROVIDED Each fund's manager is Franklin Advisers, Inc.
(Advisers). 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 each fund to buy, hold or sell. The manager
also selects the brokers who execute the funds' portfolio transactions. The
manager provides periodic reports to the board, which reviews and supervises
the manager's investment activities. To protect the funds, the manager and
its officers, directors and employees are covered by fidelity insurance.
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 each fund. Similarly, with respect
to each 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. Of course, any transactions for the
accounts of the manager and other access persons will be made in compliance
with the funds' code of ethics.
Under the funds' code of ethics, employees of the Franklin Templeton Group
who are access persons may engage in personal securities transactions subject
to the following general restrictions and procedures: (i) the trade must
receive advance clearance from a compliance officer and must be completed by
the close of the business day following the day clearance is granted; (ii)
copies of all brokerage confirmations and statements must be sent to a
compliance officer; (iii) all brokerage accounts must be disclosed on an
annual basis; and (iv) access persons involved in preparing and making
investment decisions must, in addition to (i), (ii) and (iii) above, file
annual reports of their securities holdings each January and inform the
compliance officer (or other designated personnel) if they own a security
that is being considered for a fund or other client transaction or if they
are recommending a security in which they have an ownership interest for
purchase or sale by a fund or other client.
MANAGEMENT FEES The Aggressive Growth Fund and Large Cap Fund pay the manager a
fee computed at the close of business on the last business day of each month
according to the terms of the management agreement. Each class of each fund's
shares pays its proportionate share of the fee. The MidCap Fund pays the manager
a fee equal to an annual rate of 0.65% of the fund's average daily net assets.
The Blue Chip Fund pays the manager a fee equal to an annual rate of:
o 0.75% of the fund's average daily net assets up to and including $500
million;
o 0.625% of the fund's average daily net assets over $500 million up to and
including $1 billion; and
o 0.50% of the fund's average daily net assets over $1 billion
The California Fund and Small Cap Fund pay the manager a fee equal to an
annual rate of:
o 0.625 of 1% of the average daily net assets of the fund up to and
including $100 million;
o 0.50 of 1% of the value of the average daily net assets over $100
million, up to and including $250 million;
o 0.45 of 1% of the value of average daily net assets over $250 million up
to and including $10 billion;
o 0.44 of 1% of the value of average daily net assets over $10 billion up
to and including $12.5 billion;
o 0.42 of 1% of the value of average daily net assets over $12.5 billion up
to and including $15 billion; and
o 0.40 of 1% of the value of average daily net assets over $15 billion
The fee is computed at the close of business on the last business day of each
month according to the terms of the management agreement. Each class of a
fund's shares pays its proportionate share of the fee.
For the last three fiscal years ended April 30, the funds paid the following
management fees:
MANAGEMENT FEES PAID ($) 1
-----------------------------------------------
1999 1998 1997
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Blue Chip Fund 2 134,052 17,998 0
California Fund 4,066,764 2,866,217 953,389
MidCap Fund 199,753 135,485 68,022
Small Cap Fund 20,630,510 13,566,077 3,859,067
1. No information is provided for the Aggressive Growth Fund and Large Cap Fund
because the funds were not in operation during these periods.
2. For the fiscal years ended April 30, 1999, 1998 and 1997, management fees,
before any advance waiver, totaled $205,441, $91,184 and $25,008, respectively.
Under an agreement by the manager to limit its fees, the fund paid the
management fees shown.
ADMINISTRATOR AND SERVICES PROVIDED Franklin Templeton Services, Inc. (FT
Services) has an agreement with the manager to provide certain administrative
services and facilities for the Blue Chip Fund, California Fund, MidCap Fund
and Small Cap Fund. FT Services has an agreement with the Aggressive Growth
Fund and the Large Cap Fund to provide certain administrative services and
facilities for each fund. FT Services is wholly owned by Resources and is an
affiliate of the funds' 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 For the Blue Chip Fund, California Fund, MidCap Fund and
Small Cap Fund the manager pays FT Services a monthly fee equal to an annual
rate of:
o 0.15% of each fund's average daily net assets up to $200 million;
o 0.135% of average daily net assets over $200 million up to $700 million;
o 0.10% of average daily net assets over $700 million up to $1.2 billion;
and
o 0.075% of average daily net assets over $1.2 billion.
The Aggressive Growth Fund and Large Cap Fund pay FT Services a monthly fee
equal to an annual rate of 0.20% of each fund's average daily net assets.
During the last three fiscal years ended April 30, the manager paid FT
Services the following administration fees:
ADMINISTRATION FEES PAID ($) 1
-------------------------------------------------
1999 1998 1997 2
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Blue Chip Fund 41,211 15,838 3,786
California Fund 1,124,899 808,799 184,878
MidCap Fund 46,110 31,322 10,579
Small Cap Fund 3,971,753 2,794,347 717,201
1. No information is provided for the Aggressive Growth Fund and Large Cap Fund
because the funds were not in operation during these periods.
2. For the period October 1996 through April 30, 1997.
SHAREHOLDER SERVICING AND TRANSFER AGENT Franklin/ Templeton Investor
Services, Inc. (Investor Services) is each fund's shareholder servicing agent
and acts as the fund's transfer agent and dividend-paying agent. Investor
Services is located at 777 Mariners Island Blvd., San Mateo, CA 94404. Please
send all correspondence to Investor Services to P.O. Box 997151, Sacramento,
CA 95899-9983.
For its services, Investor Services receives a fixed fee per account. Each
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 Bank of New York, Mutual Funds Division, 90 Washington Street, New
York, NY 10286, acts as custodian of each fund's securities and other assets.
AUDITOR PricewaterhouseCoopers LLP, 333 Market Street, San Francisco, CA 94105,
is the funds' independent auditor. The auditor gives an opinion on the financial
statements included in the trust's Annual Report to Shareholders and reviews the
trust's registration statement filed with the U.S. Securities and Exchange
Commission (SEC).
PORTFOLIO TRANSACTIONS
- ------------------------------------------------------------------------------
The manager selects brokers and dealers to execute the funds' 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 funds. 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 in order
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 funds' 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 funds' 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 funds tender portfolio securities pursuant to a
tender-offer solicitation. To recapture brokerage for the benefit of the
funds, any portfolio securities tendered by a 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 funds 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 funds are concerned. In other cases it is possible
that the ability to participate in volume transactions may improve execution
and reduce transaction costs to the funds.
During the last three fiscal years ended April 30, the funds paid the
following brokerage commissions:
BROKERAGE COMMISSIONS PAID ($) 1
-----------------------------------------------
1999 1998 1997
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Blue Chip Fund 56,175 48,160 14,667
California Fund 17,062,207 594,357 222,569
MidCap Fund 53,633 31,590 23,231
Small Cap Fund 2,187,594 14,648,944 1,155,691
1. No information is provided for the Aggressive Growth Fund and Large Cap
Fund because the funds were not in operation during these periods.
The table below shows the brokerage commissions each fund paid of its
aggregate portfolio transactions to brokers who provided research services
for the fiscal year ended April 30, 1999:
COMMISSIONS PAID IN
CONNECTION WITH
RESEARCH SERVICES AGGREGATE PORTFOLIO
PROVIDED ($) 1 TRANSACTIONS ($) 1
- --------------------------------------------------------------------------------
Blue Chip Fund 55,840 39,550,375
California Fund 596,602 326,418,465
MidCap Fund 56,150 25,148,825
Small Cap Fund 2,645,470 1,092,883,339
1. No information is provided for the Aggressive Growth Fund and Large Cap
Fund because the funds were not in operation during these periods.
As of April 30, 1999, the Blue Chip Fund owned securities issued by the
following broker dealers: Charles Schwab & Co., Inc. valued in the aggregate
at $659,000, Merrill Lynch & Co., Inc. valued in the aggregate at $596,000
and Salomon Smith Barney valued in the aggregate at $764,000. The Small Cap
Fund owned securities issued by Hambrecht & Quist Group valued in the
aggregate at $14,100. Except as noted, the funds did not own any securities
issued by their regular broker-dealers as of the end of the fiscal year.
Because the funds may, from time to time, invest in broker-dealers, it is
possible that the funds will own more than 5% of the voting securities of one
or more broker-dealers through whom each fund places portfolio brokerage
transactions. In such circumstances, the broker-dealer would be considered an
affiliated person of the funds. To the extent the funds place brokerage
transactions through such a broker-dealer at a time when the broker-dealer is
considered to be an affiliate of the funds, the funds will be required to
adhere to certain rules relating to the payment of commissions to an
affiliated broker-dealer. These rules require the funds to adhere to
procedures adopted by the board relating to ensuring that the commissions
paid to such broker-dealers do not exceed what would otherwise be the usual
and customary brokerage commissions for similar transactions.
DISTRIBUTIONS AND TAXES
- ------------------------------------------------------------------------------
The funds calculate 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 the distribution and service (Rule 12b-1) fees of
each class. Distributions are subject to approval by the board. The funds do
not pay "interest" or guarantee any fixed rate of return on an investment in
their shares.
DISTRIBUTIONS OF NET INVESTMENT INCOME The funds receive income generally in
the form of dividends and interest on their investments. This income, less
expenses incurred in the operation of a fund, constitutes a fund's net
investment income from which dividends may be paid to you. Any distributions
by a fund from such income will be taxable to you as ordinary income, whether
you take them in cash or in additional shares.
DISTRIBUTIONS OF CAPITAL GAINS The funds may derive capital gains and losses
in connection with sales or other dispositions of their 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 a fund. Any net capital gains realized by a fund
generally will be distributed once each year, and may be distributed more
frequently, if necessary, in order 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 a
fund. Similarly, foreign exchange losses realized by a fund on the sale of
debt securities are generally treated as ordinary losses by the fund. These
gains when distributed will be taxable to you as ordinary dividends, and any
losses will reduce a fund's ordinary income otherwise available for
distribution to you. This treatment could increase or reduce a fund's
ordinary income distributions to you, and may cause some or all of a fund's
previously distributed income to be classified as a return of capital.
INFORMATION ON THE TAX CHARACTER OF DISTRIBUTIONS The funds 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, a 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 Aggressive Growth
Fund and Large Cap Fund intend to elect and qualify during the current fiscal
year to be treated as regulated investment companies under Subchapter M of
the Internal Revenue Code. The Blue Chip Fund, California Fund, MidCap Fund
and Small Cap Fund have elected to be treated as regulated investment
companies under Subchapter M of the Internal Revenue Code, have qualified as
such for their most recent fiscal years, and intend to so qualify during the
current fiscal year. As regulated investment companies, the funds generally
pay no federal income tax on the income and gains they distribute to you. The
board reserves the right not to maintain the qualification of a fund as a
regulated investment company if it determines such course of action to be
beneficial to shareholders. In such case, a 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 such fund's earnings and profits.
EXCISE TAX DISTRIBUTION REQUIREMENTS To avoid federal excise taxes, the
Internal Revenue Code requires a 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. Each fund intends to declare and
pay these amounts in December (or in January that are treated by you as
received in December) to avoid these excise taxes, but can give no assurances
that its distributions will be sufficient to eliminate all taxes.
REDEMPTION OF FUND SHARES Redemptions 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 a 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. 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
such 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 a fund, and
then reinvest the sales proceeds in such 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 gain or loss on the redemption of your
original shares in a fund. In doing so, all or a portion of the sales charge
that you paid for your original shares in a 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 OBLIGATIONS Many states grant tax-free status to dividends
paid to you from interest earned on direct obligations of the U.S.
government, subject in some states to minimum investment requirements that
must be met by a 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 do not generally qualify for tax-free treatment.
The rules on exclusion of this income are different for corporations.
DIVIDENDS-RECEIVED DEDUCTION FOR CORPORATIONS If you are a corporate
shareholder, you should note that 100% of the dividends paid by the Blue Chip
Fund, 31.71% of the dividends paid by the California Fund, 100% of the
dividends paid by the MidCap Fund and 37.50% of the dividends paid by the
Small Cap Fund for the most recent fiscal year qualified for the
dividends-received deduction. The Aggressive Growth Fund anticipates that a
portion of the dividends it pays will qualify for the dividends-received
deduction. Under normal market conditions the Large Cap Fund anticipates that
a significant portion of the dividends it pays will qualify for the dividends
received deduction. In some circumstances, you will be allowed to deduct
these qualified dividends, thereby reducing the tax that you would otherwise
be required to pay on these dividends. The dividends-received deduction will
be available only with respect to dividends designated by such fund as
eligible for such treatment. All dividends (including the deducted portion)
must be included in your alternative minimum taxable income calculation.
INVESTMENT IN COMPLEX SECURITIES The funds may invest in complex securities.
These investments may be subject to numerous special and complex tax rules.
These rules could affect whether gains and losses recognized by a fund are
treated as ordinary income or capital gain, accelerate the recognition of
income to a fund and/or defer a fund's ability to recognize losses, and, in
limited cases, subject a fund to U.S. federal income tax on income from
certain of its foreign securities. In turn, these rules may affect the
amount, timing or character of the income distributed to you by a fund.
ORGANIZATION, VOTING RIGHTS AND PRINCIPAL HOLDERS
- ------------------------------------------------------------------------------
Each fund, except the California Fund, is a diversified series of Franklin
Strategic Series, an open-end management investment company, commonly called
a mutual fund. The California Fund is a nondiversified series of Franklin
Strategic Series. The trust was organized as a Delaware business trust on
January 25, 1991, and is registered with the SEC.
Before July 12, 1993, the California Fund was named the Franklin California
250 Growth Fund. On that date, the fund's investment objective and various
investment policies were changed. Consistent with these changes, the fund's
name was changed to the Franklin California Growth Fund.
The MidCap Fund changed its name from FISCO MidCap Growth Fund to Franklin
Institutional MidCap Growth Fund on September 1, 1994, and to its current
name on April 18, 1996.
Certain Franklin Templeton Funds offer multiple classes of shares. The
different classes have proportionate interests in the same portfolio of
investment securities. They differ, however, primarily in their sales charge
structures and Rule 12b-1 plans.
The Aggressive Growth Fund and Large Cap Fund currently offer four classes of
shares, Class A, Class B, Class C and Advisor Class. The funds may offer
additional classes of shares in the future. The full title of each class is:
o Franklin Aggressive Growth Fund - Class A
o Franklin Aggressive Growth Fund - Class B
o Franklin Aggressive Growth Fund - Class C
o Franklin Aggressive Growth Fund - Advisor Class
o Franklin Large Cap Growth Fund - Class A
o Franklin Large Cap Growth Fund - Class B
o Franklin Large Cap Growth Fund - Class C
o Franklin Large Cap Growth Fund - Advisor Class
The California Fund currently offers three classes of
shares, Class A, Class B and Class C. Before January 1, 1999, Class A shares
of the California Fund were designated Class I and Class C shares of the
California Fund were designated Class II. The California Fund began offering
Class B shares on January 1, 1999. The fund may offer additional classes of
shares in the future. The full title of each class is:
o Franklin California Growth Fund - Class A
o Franklin California Growth Fund - Class B
o Franklin California Growth Fund - Class C
The Small Cap Fund currently offers three classes of shares, Class A, Class C
and Advisor Class. Before January 1, 1999, Class A shares were designated
Class I and Class C shares were designated Class II. The fund may offer
additional classes of shares in the future. The full title of each class is:
o Franklin Small Cap Growth Fund - Class A
o Franklin Small Cap Growth Fund - Class C
o Franklin Small Cap Growth Fund - Advisor Class
The Blue Chip Fund and MidCap Fund each offer only one share class. Because
the funds' sales charge structure and Rule 12b-1 plan are similar to those of
Class A shares, shares of the funds are considered Class A shares for
redemption, exchange and other purposes. Before January 1, 1999, Class A
shares were designated Class I. The funds may offer additional classes of
shares in the future.
Shares of each class represent proportionate interests in each fund's assets.
On matters that affect each fund as a whole, each class has the same voting
and other rights and preferences as any other class. On matters that affect
only one class, only shareholders of that class may vote. Each class votes
separately on matters affecting only that class, or expressly required to be
voted on separately by state or federal law. Shares of each class of a series
have the same voting and other rights and preferences as the other classes
and series of the trust for matters that affect the trust as a whole.
Additional series may be offered in the future.
The trust has noncumulative voting rights. For board member elections, this
gives holders of more than 50% of the shares voting the ability to elect all
of the members of the board. If this happens, holders of the remaining shares
voting will not be able to elect anyone to the board.
The trust does not intend to hold annual shareholder meetings. The trust or a
series of the trust may hold special meetings, however, for matters requiring
shareholder approval. A meeting may 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 June 8, 1999, the principal shareholders of the fund, beneficial or of
record, were:
NAME AND ADDRESS SHARE CLASS PERCENTAGE (%)
- ----------------------------------------------------------------------------
MIDCAP FUND
Franklin Resources, Inc.1
Corporate Accounting
Attn: Michael Corcoran
555 Airport Blvd., 4th Flr.
Burlingame, CA 94010 Class A 18
SMALL CAP FUND
First Union National Bank Ttee
FBO Willis Corroon Corporation
A/C 1040108756
1525 West WT Harris Blvd.
NC-1151
Charlotte, NC 28288 Advisor Class 6
The Northern Trust Company Trst
for the Nalco Chemical Co Ret Trst
50 S. LaSalle St.
Chicago, IL 60675 Advisor Class 6
Old Second National Bank of Aurora
C/O Trust Operations Division
37 South River St.
Aurora, IL 60506-4173 Advisor Class 7
Trust Company of Illinois
45 S. Park Blvd., Ste. 315
Glen Ellyn, IL 60137-6282 Advisor Class 7
1. Franklin Resources, Inc. is a Delaware Corporation.
Note: Charles B. Johnson and Rupert H. Johnson, Jr., who are officers and/or
trustees of the trust, 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 June 8, 1999, the officers and board members, as a group, owned of
record and beneficially less than 1% of the outstanding shares of each fund
and class. The board members may own shares in other funds in the Franklin
Templeton Group of Funds.
BUYING AND SELLING SHARES
- ------------------------------------------------------------------------------
The funds continuously offer their 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 a 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 funds 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. We may deduct any applicable banking
charges imposed by the bank from your account.
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.
INITIAL SALES CHARGES The maximum initial sales charge is 5.75% for Class A
and 1% for Class C. There is no initial sales charge for Class B.
The initial sales charge for Class A shares may be reduced for certain large
purchases, as described in the prospectus. We offer several ways for you to
combine your purchases in the Franklin Templeton Funds to take advantage of
the lower sales charges for large purchases. The Franklin Templeton Funds
include the U.S. registered mutual funds in the Franklin Group of Funds(R) and
the Templeton Group of Funds except Franklin Templeton Variable Insurance
Products Trust, Templeton Capital Accumulator Fund, Inc., and Templeton
Variable Products Series Fund.
CUMULATIVE QUANTITY DISCOUNT. For purposes of calculating the sales charge on
Class A shares, you may combine the amount of your current purchase with the
cost or current value, whichever is higher, of your existing shares in the
Franklin Templeton Funds. You also may combine the shares of your spouse,
children under the age of 21 or grandchildren under the age of 21. If you are
the sole owner of a company, you also may add any company accounts, including
retirement plan accounts. Companies with one or more retirement plans may add
together the total plan assets invested in the Franklin Templeton Funds to
determine the sales charge that applies.
LETTER OF INTENT (LOI). You may buy Class A shares at a reduced sales charge
by completing the letter of intent section of your account application. A
letter of intent is a commitment by you to invest a specified dollar amount
during a 13 month period. The amount you agree to invest determines the sales
charge you pay. By completing the letter of intent section of the
application, you acknowledge and agree to the following:
o You authorize Distributors to reserve 5% of your total intended purchase
in Class A shares registered in your name until you fulfill your LOI. Your
periodic statements will include the reserved shares in the total shares
you own, and we will pay or reinvest dividend and capital gain
distributions on the reserved shares according to the distribution option
you have chosen.
o You give Distributors a security interest in the reserved shares and
appoint Distributors as attorney-in-fact.
o Distributors may sell any or all of the reserved shares to cover any
additional sales charge if you do not fulfill the terms of the LOI.
o Although you may exchange your shares, you may not sell reserved shares
until you complete the LOI or pay the higher sales charge.
After you file your LOI with the fund, you may buy Class A shares at the
sales charge applicable to the amount specified in your LOI. Sales charge
reductions based on purchases in more than one Franklin Templeton Fund will
be effective only after notification to Distributors that the investment
qualifies for a discount. Any Class A purchases you made within 90 days
before you filed your LOI also may qualify for a retroactive reduction in the
sales charge. If you file your LOI with the fund before a change in the
fund's sales charge, you may complete the LOI at the lower of the new sales
charge or the sales charge in effect when the LOI was filed.
Your holdings in the Franklin Templeton Funds acquired more than 90 days
before you filed your LOI will be counted towards the completion of the LOI,
but they will not be entitled to a retroactive reduction in the sales charge.
Any redemptions you make during the 13 month period, except in the case of
certain retirement plans, will be subtracted from the amount of the purchases
for purposes of determining whether the terms of the LOI have been completed.
If the terms of your LOI are met, the reserved shares will be deposited to an
account in your name or delivered to you or as you direct. If the amount of
your total purchases, less redemptions, is more than the amount specified in
your LOI and is an amount that would qualify for a further sales charge
reduction, a retroactive price adjustment will be made by Distributors and
the securities dealer through whom purchases were made. The price adjustment
will be made on purchases made within 90 days before and on those made after
you filed your LOI and will be applied towards the purchase of additional
shares at the offering price applicable to a single purchase or the dollar
amount of the total purchases.
If the amount of your total purchases, less redemptions, is less than the
amount specified in your LOI, the sales charge will be adjusted upward,
depending on the actual amount purchased (less redemptions) during the
period. You will need to send Distributors an amount equal to the difference
in the actual dollar amount of sales charge paid and the amount of sales
charge that would have applied to the total purchases if the total of the
purchases had been made at one time. Upon payment of this amount, the
reserved shares held for your account will be deposited to an account in your
name or delivered to you or as you direct. If within 20 days after written
request the difference in sales charge is not paid, we will redeem an
appropriate number of reserved shares to realize the difference. If you
redeem the total amount in your account before you fulfill your LOI, we will
deduct the additional sales charge due from the sale proceeds and forward the
balance to you.
For LOIs filed on behalf of certain retirement plans, the level and any
reduction in sales charge for these plans will be based on actual plan
participation and the projected investments in the Franklin Templeton Funds
under the LOI. These plans are not subject to the requirement to reserve 5%
of the total intended purchase or to the policy on upward adjustments in
sales charges described above, or to any penalty as a result of the early
termination of a plan, nor are these plans entitled to receive retroactive
adjustments in price for investments made before executing the LOI.
GROUP PURCHASES. If you are a member of a qualified group, you may buy Class
A shares at a reduced sales charge that applies to the group as a whole. The
sales charge is based on the combined dollar value of the group members'
existing investments, plus the amount of the current purchase.
A qualified group is one that:
o Was formed at least six months ago,
o Has a purpose other than buying fund shares at a discount,
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.
A qualified group generally does not include a 403(b) plan that only allows
salary deferral contributions, although any such plan that purchased the
fund's Class A shares at a reduced sales charge under the group purchase
privilege before February 1, 1998, may continue to do so.
WAIVERS FOR INVESTMENTS FROM CERTAIN PAYMENTS. Class A shares may be
purchased without an initial sales charge or contingent deferred sales charge
(CDSC) by investors who reinvest within 365 days:
o Dividend and capital gain distributions from any Franklin Templeton Fund.
The distributions generally must be reinvested in the same share class.
Certain exceptions apply, however, to Class C shareholders who chose to
reinvest their distributions in Class A shares of the fund before November
17, 1997, and to Advisor Class or Class Z shareholders of a Franklin
Templeton Fund who may reinvest their distributions in the fund's Class A
shares. This waiver category also applies to Class B and C shares.
o Dividend or capital gain distributions from a real estate investment
trust (REIT) sponsored or advised by Franklin Properties, Inc.
o Annuity payments received under either an annuity option or from death
benefit proceeds, if the annuity contract offers as an investment option
the Franklin Templeton Variable Insurance Products Trust or the Templeton
Variable Products Series Fund. You should contact your tax advisor for
information on any tax consequences that may apply.
o Redemption proceeds from a repurchase of shares of Franklin Floating Rate
Trust, if the shares were continuously held for at least 12 months.
o If you immediately placed your redemption proceeds in a Franklin Bank CD
or a Franklin Templeton money fund, you may reinvest them as described
above. The proceeds must be reinvested within 365 days from the date the
CD matures, including any rollover, or the date you redeem your money fund
shares.
o Redemption proceeds from the sale of Class A shares of any of the
Templeton Global Strategy Funds if you are a qualified investor.
If you paid a CDSC when you redeemed your Class A shares from a Templeton
Global Strategy Fund, a new CDSC will apply to your purchase of fund
shares and the CDSC holding period will begin again. We will, however,
credit your fund account with additional shares based on the CDSC you
previously paid and the amount of the redemption proceeds that you
reinvest.
If you immediately placed your redemption proceeds in a Franklin Templeton
money fund, you may reinvest them as described above. The proceeds must be
reinvested within 365 days from the date they are redeemed from the money
fund.
o Distributions from an existing retirement plan invested in the Franklin
Templeton Funds
WAIVERS FOR CERTAIN INVESTORS. Class A shares also may be purchased without
an initial sales charge or CDSC by various individuals and institutions due
to anticipated economies in sales efforts and expenses, including:
o Trust companies and bank trust departments agreeing to invest in Franklin
Templeton Funds over a 13 month period at least $1 million of assets held
in a fiduciary, agency, advisory, custodial or similar capacity and over
which the trust companies and bank trust departments or other plan
fiduciaries or participants, in the case of certain retirement plans, have
full or shared investment discretion. We will accept orders for these
accounts by mail accompanied by a check or by telephone or other means of
electronic data transfer directly from the bank or trust company, with
payment by federal funds received by the close of business on the next
business day following the order.
o Any state or local government or any instrumentality, department,
authority or agency thereof that has determined the fund is a legally
permissible investment and that can only buy fund shares without paying
sales charges. Please consult your legal and investment advisors to
determine if an investment in the fund is permissible and suitable for you
and the effect, if any, of payments by the fund on arbitrage rebate
calculations.
o Broker-dealers, registered investment advisors or certified financial
planners who have entered into an agreement with Distributors for clients
participating in comprehensive fee programs
o Qualified registered investment advisors who buy through a broker-dealer
or service agent who has entered into an agreement with Distributors
o Registered securities dealers and their affiliates, for their investment
accounts only
o Current employees of securities dealers and their affiliates and their
family members, as allowed by the internal policies of their employer
o Officers, trustees, directors and full-time employees of the Franklin
Templeton Funds or the Franklin Templeton Group, and their family members,
consistent with our then-current policies
o Any investor who is currently a Class Z shareholder of Franklin Mutual
Series Fund Inc. (Mutual Series), or who is a former Mutual Series Class Z
shareholder who had an account in any Mutual Series fund on October 31,
1996, or who sold his or her shares of Mutual Series Class Z within the
past 365 days
o Investment companies exchanging shares or selling assets pursuant to a
merger, acquisition or exchange offer
o Accounts managed by the Franklin Templeton Group
o Certain unit investment trusts and their holders reinvesting
distributions from the trusts
o Group annuity separate accounts offered to retirement plans
o Chilean retirement plans that meet the requirements described under
"Retirement plans" below
In addition, Class C shares may be purchased without an initial sales charge
by any investor who buys Class C shares through an omnibus account with
Merrill Lynch Pierce Fenner & Smith, Inc. A CDSC may apply, however, if the
shares are sold within 18 months of purchase.
RETIREMENT PLANS. Retirement plans sponsored by an employer (i) with at least
100 employees, or (ii) with retirement plan assets of $1 million or more, or
(iii) that agrees to invest at least $500,000 in the Franklin Templeton Funds
over a 13 month period may buy Class A shares without an initial sales
charge. Retirement plans that are not qualified retirement plans (employer
sponsored pension or profit-sharing plans that qualify under section 401 of
the Internal Revenue Code, including 401(k), money purchase pension, profit
sharing and defined benefit plans), SIMPLEs (savings incentive match plans
for employees) or SEPs (employer sponsored simplified employee pension plans
established under section 408(k) of the Internal Revenue Code) must also meet
the group purchase requirements described above to be able to buy Class A
shares without an initial sales charge. We may enter into a special
arrangement with a securities dealer, based on criteria established by the
fund, to add together certain small qualified retirement plan accounts for
the purpose of meeting these requirements.
For retirement plan accounts opened on or after May 1, 1997, a CDSC may apply
if the retirement plan is transferred out of the Franklin Templeton Funds or
terminated within 365 days of the retirement plan account's initial purchase
in the Franklin Templeton Funds.
SALES IN TAIWAN. Under agreements with certain banks in Taiwan, Republic of
China, each fund's shares are available to these banks' trust accounts
without a sales charge. The banks may charge service fees to their customers
who participate in the trusts. A portion of these service fees may be paid to
Distributors or one of its affiliates to help defray expenses of maintaining
a service office in Taiwan, including expenses related to local literature
fulfillment and communication facilities.
Each fund's Class A shares may be offered to investors in Taiwan through
securities advisory firms known locally as Securities Investment Consulting
Enterprises. In conformity with local business practices in Taiwan, Class A
shares may be offered with the following schedule of sales charges:
SIZE OF PURCHASE - U.S. DOLLARS SALES CHARGE (%)
- -------------------------------------------------------------------------
Under $30,000 3.0
$30,000 but less than $50,000 2.5
$50,000 but less than $100,000 2.0
$100,000 but less than $200,000 1.5
$200,000 but less than $400,000 1.0
$400,000 or more 0
DEALER COMPENSATION Securities dealers may at times receive the entire sales
charge. A securities dealer who receives 90% or more of the sales charge may
be deemed an underwriter under the Securities Act of 1933, as amended.
Financial institutions or their affiliated brokers may receive an agency
transaction fee in the percentages indicated in the dealer compensation table
in the funds' prospectus.
Distributors may pay the following commissions, out of its own resources, to
securities dealers who initiate and are responsible for purchases of Class A
shares of $1 million or more: 1% on sales of $1 million to $2 million, plus
0.80% on sales over $2 million to $3 million, plus 0.50% on sales over $3
million to $50 million, plus 0.25% on sales over $50 million to $100 million,
plus 0.15% on sales over $100 million.
These breakpoints are reset every 12 months for purposes of additional
purchases.
Distributors or one of its affiliates may pay up to 1%, out of its own
resources, to securities dealers who initiate and are responsible for
purchases of Class A shares by certain retirement plans without an initial
sales charge. These payments may be made in the form of contingent advance
payments, which may be recovered from the securities dealer or set off
against other payments due to the dealer if shares are sold within 12 months
of the calendar month of purchase. Other conditions may apply. All terms and
conditions may be imposed by an agreement between Distributors, or one of its
affiliates, and the securities dealer.
In addition to the payments above, 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.
CONTINGENT DEFERRED SALES CHARGE (CDSC) If you invest $1 million or more in
Class A shares, either as a lump sum or through our cumulative quantity
discount or letter of intent programs, a CDSC may apply on any shares you
sell within 12 months of purchase. For Class C shares, a CDSC may apply if
you sell your shares within 18 months of purchase. The CDSC is 1% of the
value of the shares sold or the net asset value at the time of purchase,
whichever is less.
Certain retirement plan accounts opened on or after May 1, 1997, and that
qualify to buy Class A shares without an initial sales charge also may be
subject to a CDSC if the retirement plan is transferred out of the Franklin
Templeton Funds or terminated within 365 days of the account's initial
purchase in the Franklin Templeton Funds.
For Class B shares, there is a CDSC if you sell your shares within six years,
as described in the table below. The charge is based on the value of the
shares sold or the net asset value at the time of purchase, whichever is less.
IF YOU SELL YOUR CLASS B SHARES WITHIN THIS % IS DEDUCTED FROM
THIS MANY YEARS AFTER BUYING THEM YOUR PROCEEDS AS A CDSC
- --------------------------------------------------------------------------
1 Year 4
2 Years 4
3 Years 3
4 Years 3
5 Years 2
6 Years 1
7 Years 0
CDSC WAIVERS. The CDSC for any share class generally will be waived for:
o Account fees
o Sales of Class A shares purchased without an initial sales charge by
certain retirement plan accounts if (i) the account was opened before May
1, 1997, or (ii) the securities dealer of record received a payment from
Distributors of 0.25% or less, or (iii) Distributors did not make any
payment in connection with the purchase, or (iv) the securities dealer of
record has entered into a supplemental agreement with Distributors
o Redemptions of Class A shares by investors who purchased $1 million or
more without an initial sales charge if the securities dealer of record
waived its commission in connection with the purchase
o Redemptions by the funds when an account falls below the minimum required
account size
o Redemptions following the death of the shareholder or beneficial owner
o Redemptions through a systematic withdrawal plan set up before February
1, 1995
o Redemptions through a systematic withdrawal plan set up on or after
February 1, 1995, up to 1% monthly, 3% quarterly, 6% semiannually or 12%
annually of your account's net asset value depending on the frequency of
your plan
o Redemptions by Franklin Templeton Trust Company employee benefit plans or
employee benefit plans serviced by ValuSelect(R) (not applicable to Class B)
o Distributions from individual retirement accounts (IRAs) due to death or
disability or upon periodic distributions based on life expectancy (for
Class B, this applies to all retirement plan accounts, not only IRAs)
o Returns of excess contributions (and earnings, if applicable) from
retirement plan accounts
o Participant initiated distributions from employee benefit plans or
participant initiated exchanges among investment choices in employee
benefit plans (not applicable to Class B)
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 each 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 goals 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 are generally
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.
SYSTEMATIC WITHDRAWAL PLAN Our systematic withdrawal plan allows you to sell
your shares and receive regular payments from your account on a monthly,
quarterly, semiannual or annual basis. The value of your account must be at
least $5,000 and the minimum payment amount for each withdrawal must be at
least $50. For retirement plans subject to mandatory distribution
requirements, the $50 minimum will not apply. There are no service charges
for establishing or maintaining a systematic withdrawal plan.
Payments under the plan will be made from the redemption of an equivalent
amount of shares in your account, generally on the 25th day of the month in
which a payment is scheduled. If the 25th falls on a weekend or holiday, we
will process the redemption on the next business day. When you sell your
shares under a systematic withdrawal plan, it is a taxable transaction.
To avoid paying sales charges on money you plan to withdraw within a short
period of time, you may not want to set up a systematic withdrawal plan if
you plan to buy shares on a regular basis. Shares sold under the plan also
may be subject to a CDSC.
Redeeming shares through a systematic withdrawal plan may reduce or exhaust
the shares in your account if payments exceed distributions received from the
fund. This is especially likely to occur if there is a market decline. If a
withdrawal amount exceeds the value of your account, your account will be
closed and the remaining balance in your account will be sent to you. Because
the amount withdrawn under the plan may be more than your actual yield or
income, part of the payment may be a return of your investment.
You may discontinue a systematic withdrawal plan, change the amount and
schedule of withdrawal payments, or suspend one payment by notifying us by
mail or by phone at least seven business days before the end of the month
preceding a scheduled payment. The fund may discontinue a systematic
withdrawal plan by notifying you in writing and will automatically
discontinue a systematic withdrawal plan if all shares in your account are
withdrawn or if the fund receives notification of the shareholder's death or
incapacity.
REDEMPTIONS IN KIND Each 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.
Redemptions in kind are taxable transactions. 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.
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 funds nor their affiliates will be liable for any loss caused by
your failure to cash such checks. The funds are 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.
The wiring of redemption proceeds is a special service that we make available
whenever possible. By offering this service to you, the funds are not bound
to meet any redemption request in less than the seven day period prescribed
by law. Neither the funds nor their agents shall be liable to you or any
other person if, for any reason, a redemption request by wire 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 funds
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. When you sell shares,
you receive the NAV minus any applicable CDSC.
The value of a mutual fund is determined by deducting the fund's liabilities
from the total assets of the portfolio. The net asset value per share is
determined by dividing the net asset value of the fund by the number of
shares outstanding.
Each fund 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 funds do 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, each 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, each 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. Each 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, each fund values them according to the broadest and most
representative market as determined by the manager.
The fund values portfolio securities underlying actively traded call options
at their market price as determined above. The current market value of any
option the fund holds is its last sale price on the relevant exchange before
the fund values its assets. If there are no sales that day or if the last
sale price is outside the bid and ask prices, the fund values options within
the range of the current closing bid and ask prices if the fund believes the
valuation fairly reflects the contract's market value.
The fund determines the value of a foreign security as of the close of
trading on the foreign exchange on which the security is traded or as of the
close of trading on the NYSE, if that is earlier. The value is then converted
into its U.S. dollar equivalent at the foreign exchange rate in effect at
noon, New York time, on the day the value of the foreign security is
determined. If no sale is reported at that time, the foreign security is
valued within the range of the most recent quoted bid and ask prices.
Occasionally events that affect the values of foreign securities and foreign
exchange rates may occur between the times at which they are determined and
the close of the exchange and will, therefore, not be reflected in the
computation of the NAV. If events materially affecting the values of these
foreign securities occur during this period, the securities will be valued in
accordance with procedures established by the board.
Generally, trading in corporate bonds, U.S. government securities and money
market instruments is substantially completed each day at various times
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, each 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 each 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. Each 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.
The table below shows the aggregate underwriting commissions Distributors
received in connection with the offering of the funds' shares, the net
underwriting discounts and commissions Distributors retained after allowances
to dealers, and the amounts Distributors received in connection with
redemptions or repurchases of shares for the last three fiscal years ended
April 30,:
AMOUNT
RECEIVED IN
CONNECTION
WITH
TOTAL AMOUNT REDEMPTIONS
COMMISSIONS RETAINED BY AND
RECEIVED DISTRIBUTORS REPURCHASES
($) ($) ($)
- --------------------------------------------------------------------------------
1999
Blue Chip Fund 360,101 49,226 8
California Fund 3,857,071 433,509 125,886
MidCap Fund 290,614 38,279 12,053
Small Cap Fund 15,233,910 1,589,079 828,220
1998
Blue Chip Fund 226,140 25,642 0
California Fund 7,612,566 762,027 10,657
MidCap Fund 259,668 29,262 0
Small Cap Fund 30,947,759 2,943,926 64,163
1997
Blue Chip Fund 76,980 8,755 0
California Fund 4,836,624 518,921 1,701
MidCap Fund 140,519 16,023 0
Small Cap Fund 11,056,311 1,097,126 33,425
Distributors may be entitled to reimbursement under the Rule 12b-1 plans, as
discussed below. Except as noted, Distributors received no other compensation
from the fund for acting as underwriter.
DISTRIBUTION AND SERVICE (12B-1) fees Each class has a separate distribution
or "Rule 12b-1" plan. Under each plan, the fund shall pay or may reimburse
Distributors or others for the expenses of activities that are primarily
intended to sell shares of the class. 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.
The distribution and service (12b-1) fees charged to each class are based
only on the fees attributable to that particular class.
THE CLASS A PLAN. Payments by California Fund and Small Cap Fund under the
Class A plan may not exceed 0.25% per year of Class A's average daily net
assets, payable quarterly. All distribution expenses over this amount will be
borne by those who have incurred them.
Payments by the Aggressive Growth Fund, Blue Chip Fund, Large Cap Fund and
MidCap Fund under the Class A plan may not exceed 0.35% per year of Class A's
average daily net assets, payable quarterly. All distribution expenses over
this amount will be borne by those who have incurred them.
THE CLASS B AND C PLANS. Under the Class B and C plans, the funds pay
Distributors up to 0.75% per year of the class's average daily net assets,
payable monthly for the Aggressive Growth Fund, California Fund - Class B,
Large Cap Fund and Small Cap Fund and quarterly for the California Fund -
Class C, to pay Distributors or others for providing distribution and related
services and bearing certain expenses. All distribution expenses over this
amount will be borne by those who have incurred them. The fund also may pay a
servicing fee of up to 0.25% per year of the class's average daily net
assets, payable monthly for the Aggressive Growth Fund, California Fund -
Class B, Large Cap Fund and Small Cap Fund and quarterly for the California
Fund - Class C. This fee may be used to pay securities dealers or others for,
among other things, helping to establish and maintain customer accounts and
records, helping with requests to buy and sell shares, receiving and
answering correspondence, monitoring dividend payments from the funds on
behalf of customers, and similar servicing and account maintenance activities.
The expenses relating to each of the Class B and C plans also are used to pay
Distributors for advancing the commission costs to securities dealers with
respect to the initial sale of Class B and C shares. Further, the expenses
relating to the Class B plan may be used by Distributors to pay third party
financing entities that have provided financing to Distributors in connection
with advancing commission costs to securities dealers.
THE CLASS A, B AND C PLANS. In addition to the payments that Distributors or
others are entitled to under each plan, each plan also provides that to the
extent the fund, the manager or Distributors or other parties on behalf of
the fund, the manager or Distributors make payments that are deemed to be for
the financing of any activity primarily intended to result in the sale of
fund shares within the context of Rule 12b-1 under the Investment Company Act
of 1940, as amended, then such payments shall be deemed to have been made
pursuant to the plan. The terms and provisions of each 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 each plan, plus any other payments deemed to be made
pursuant to a plan, exceed the amount permitted to be paid under the rules of
the National Association of Securities Dealers, Inc.
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 plans 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 plans 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.
Each plan has been approved in accordance with the provisions of Rule 12b-1.
The plans are renewable annually by a vote of the board, including a majority
vote of the board members who are not interested persons of the fund and who
have no direct or indirect financial interest in the operation of the plans,
cast in person at a meeting called for that purpose. It is also required that
the selection and nomination of such board members be done by the
noninterested members of the funds' board. The plans 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. The Class A
plans also may be terminated by any act that constitutes an assignment of the
underwriting agreement with Distributors. Distributors or any dealer or other
firm also may terminate their respective distribution or service agreement at
any time upon written notice.
The plans and any related agreements may not be amended to increase
materially the amount to be spent for distribution expenses without approval
by a majority of the outstanding shares of the class, and all material
amendments to the plans or any related agreements shall be approved by a vote
of the 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 plans and any
related agreements, as well as to furnish the board with such other
information as may reasonably be requested in order to enable the board to
make an informed determination of whether the plans should be continued.
For the fiscal year ended April 30, 1999, Distributors' eligible expenditures
for advertising, printing, payments
to underwriters and broker-dealers and other expenses pursuant to the plans
and the amounts the funds paid Distributors under the plans were:
DISTRIBUTORS' AMOUNT PAID
ELIGIBLE BY THE
EXPENSES ($) 1 FUND ($) 1
- --------------------------------------------------------------------------------
Blue Chip Fund 110,997 82,281
California Fund
Class A 2,176,459 1,782,674
Class B 77,390 3,982
Class C 1,446,655 1,352,080
MidCap Fund 110,173 77,031
Small Cap Fund
Class A 10,974,973 9,218,844
Class C 8,380,334 6,923,739
1. No information is provided for the Aggressive Growth Fund and Large Cap
Fund because the funds were not in operation during these periods.
- ------------------------------------------------------------------------------
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 funds be accompanied
by certain standardized performance information computed as required by the
SEC.
Average annual total return quotations used by the funds are based on the
standardized methods of computing performance mandated by the SEC.
Performance figures reflect Rule 12b-1 fees from the date of the plan's
implementation. An explanation of these and other methods used by the funds
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.
Because the Aggressive Growth Fund and Large Cap Fund are new, they have no
performance history and thus no performance quotations have been provided.
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 the maximum initial sales charge is
deducted from the initial $1,000 purchase, and 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.
When considering the average annual total return quotations for Class A and C
shares, you should keep in mind that the maximum initial sales charge
reflected in each quotation is a one time fee charged on all direct
purchases, which will have its greatest impact during the early stages of
your investment. This charge will affect actual performance less the longer
you retain your investment in the fund. The average annual total returns for
the indicated periods ended April 30, 1999, were:
1 5 SINCE
INCEPTION YEAR YEARS INCEPTION
DATE (%) (%) (%)
- -------------------------------------------------------------------------
CLASS A
Blue Chip Fund 06/03/96 9.50 - 12.03
California Fund 10/30/91 0.29 22.92 18.96
MidCap Fund 08/17/93 -11.72 13.65 12.18
Small Cap Fund 02/14/92 -8.99 19.00 17.42
1 SINCE
INCEPTION YEAR INCEPTION
DATE (%) (%)
- -------------------------------------------------------------------------
CLASS C
California Fund 09/03/96 3.63 17.41
Small Cap Fund 10/02/95 -5.99 13.55
The following SEC formula was used to calculate these figures:
n
P(1+T) = ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at the
beginning of each period at the end of each period
CUMULATIVE TOTAL RETURN Like average annual total return, cumulative total
return assumes the maximum initial sales charge is deducted from the initial
$1,000 purchase, income dividends and capital gain distributions are
reinvested at net asset value, the account was completely redeemed at the end
of each period and the deduction of all applicable charges and fees.
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 April 30,
1999, were:
1 5 SINCE
INCEPTION YEAR YEARS INCEPTION
DATE (%) (%) (%)
- ----------------------------------------------------------------------------
CLASS A
Blue Chip Fund 06/03/96 9.50 - 39.12
California Fund 10/30/91 0.29 180.61 267.75
MidCap Fund 08/17/93 -11.72 89.57 92.60
Small Cap Fund 02/14/92 -8.99 138.64 218.18
1 SINCE
INCEPTION YEAR INCEPTION
DATE (%) (%)
- ----------------------------------------------------------------------------
CLASS C
California Fund 09/03/96 3.63 53.12
Small Cap Fund 10/02/95 -5.99 57.56
VOLATILITY Occasionally statistics may be used to show a fund's volatility or
risk. Measures of volatility or risk are generally used to compare a 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 The funds also may quote the performance of
shares without a sales charge. Sales literature and advertising may quote a
cumulative total return, average annual total return and other measures of
performance with the substitution of net asset value for the public offering
price.
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.
Each 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:
o Dow Jones(R) Composite Average and its component averages - a
price-weighted average of 65 stocks that trade on the New York Stock
Exchange. The average is a combination of the Dow Jones Industrial Average
(30 blue-chip stocks that are generally the leaders in their industry),
the Dow Jones Transportation Average (20 transportation stocks) and the
Dow Jones Utilities Average (15 utility stocks involved in the production
of electrical energy).
o Standard & Poor's(R) 500 Stock Index or its component indices - an
unmanaged capitalization-weighted index designed to measure performance of
the broad domestic economy through changes in the aggregate market value
of 500 stocks representing all major industries.
o The New York Stock Exchange composite or component indices - an unmanaged
index of all industrial, utilities, transportation, and finance stocks
listed on the NYSE.
o Wilshire 5000 Equity Index - represents the return on the market value of
all common equity securities for which daily pricing is available.
Comparisons of performance assume reinvestment of dividends.
o CDA Mutual Fund Report, published by CDA Investment Technologies, Inc. -
analyzes price, current yield, risk, total return, and average rate of
return (average annual compounded growth rate) over specified time periods
for the mutual fund industry.
o Mutual Fund Source Book, published by Morningstar, Inc. - analyzes price,
yield, risk, and total return for mutual funds.
o Consumer Price Index (or Cost of Living Index), published by the U.S.
Bureau of Labor Statistics - a statistical measure of change, over time,
in the price of goods and services in major expenditure groups.
o Historical data supplied by the research departments of CS First Boston
Corporation, the J. P. Morgan companies, Salomon Brothers, Merrill Lynch,
Lehman Brothers and Bloomberg L.P.
o Financial publications: THE WALL STREET JOURNAL, and BUSINESS WEEK,
FINANCIAL WORLD, FORBES, FORTUNE, and MONEY magazines - provide
performance statistics over specified time periods.
o Morningstar - information published by Morningstar, Inc., including
Morningstar proprietary mutual fund ratings. The ratings reflect
Morningstar's assessment of the historical risk-adjusted performance of a
fund over specified time periods relative to other funds within its
category.
ADDITIONAL COMPARISONS - AGGRESSIVE GROWTH FUND
o Lipper - Mutual Fund Performance Analysis and Lipper - Equity Fund
Performance Analysis - measure total return and average current yield for
the mutual fund industry and rank individual mutual fund performance over
specified time periods, assuming reinvestment of all distributions,
exclusive of any applicable sales charges.
o Stocks, Bonds, Bills, and Inflation, published by Ibbotson Associates -
historical measure of yield, price, and total return for common and small
company stock, long-term government bonds, Treasury bills, and inflation.
o Savings and Loan Historical Interest Rates - as published in the U.S.
Savings & Loan League Fact Book.
o Russell 3000(R) Growth Index - measures the performance of those Russell
3000 Index companies with higher price-to-book ratios and higher
forecasted growth values. The stocks in this index are also members of
either the Russell 1000 Growth or the Russell 2000 Growth indexes.
o Standard & Poor's(R) MidCap 400 Index - consists of 400 domestic stocks
chosen for market size (median market capitalization of $676 million),
liquidity and industry group representation. It is a market-value weighted
index, with each stock affecting the index in proportion to its market
value. This index, calculated by S&P, is a total return index with
dividends reinvested.
ADDITIONAL COMPARISONS - BLUE CHIP FUND
o Lipper - Mutual Fund Performance Analysis and Lipper - Fixed Income Fund
Performance Analysis - measure total return and average current yield for
the mutual fund industry and rank individual mutual fund performance over
specified time periods, assuming reinvestment of all distributions,
exclusive of any applicable sales charges.
o Stocks, Bonds, Bills, and Inflation, published by Ibbotson Associates -
historical measure of yield, price, and total return for common and small
company stock, long-term government bonds, Treasury bills, and inflation.
o Savings and Loan Historical Interest Rates - as published in the U.S.
Savings & Loan League Fact Book.
o Morgan Stanley Capital International World Index - an arithmetic average
(weighted by market value) index based in US dollars of the performance of
approximately 1,500 securities listed on the stock exchanges of 22
countries including the US, Europe, Canada, Australia, New Zealand and the
Far East with gross dividends reinvested.
ADDITIONAL COMPARISONS - CALIFORNIA FUND
o Lipper - Mutual Fund Performance Analysis and Lipper - Fixed Income Fund
Performance Analysis - measure total return and average current yield for
the mutual fund industry and rank individual mutual fund performance over
specified time periods, assuming reinvestment of all distributions,
exclusive of any applicable sales charges.
o Valueline Index - an unmanaged index which follows the stock of
approximately 1,700 companies.
o Bateman Eichler Hill Richards Western Stock Index - A managed index
representing 215 stocks of companies within the Western United States.
Seventy-five percent of the stocks are Californian companies, the
remaining 25% represent companies in: Arizona, Hawaii, Nevada, Oregon and
Washington.
o Russell 3000 Index - composed of 3,000 large U.S. companies by market
capitalization, representing approximately 98% of the U.S. equity market.
o Russell 2000 Small Stock Index - consists of the smallest 2,000 companies
in the Russell 3000 Index, representing approximately 11% of the Russell
3000 total market capitalization.
o Stocks, Bonds, Bills, and Inflation, published by Ibbotson Associates -
historical measure of yield, price, and total return for common and small
company stock, long-term government bonds, Treasury bills, and inflation.
o Franklin California 250 Growth Index - consists of the 250 largest
California based companies on an equal weighted basis in order to
approximately diversify and correlate with the business segment weightings
of the actual economy (as provided by the Gross State Product). By doing
so, the Index will have an orientation towards small cap growth companies,
mainly high tech and services related firms. The Index is equally weighted
as opposed to market weighted, meaning each company represents 0.4% of the
total index.
o Bloomberg California Index - a price-weighted index designed to measure
the performance of California's economy. The index was developed with a
base value of 100 as of December 30, 1994.
Additional Comparisons - Large Cap Fund
o Lipper - Mutual Fund Performance Analysis and Lipper - Equity Fund
Performance Analysis - measure total return and average current yield for
the mutual fund industry and rank individual mutual fund performance over
specified time periods, assuming reinvestment of all distributions,
exclusive of any applicable sales charges.
o Stocks, Bonds, Bills, and Inflation, published by Ibbotson Associates -
historical measure of yield, price, and total return for common and small
company stock, long-term government bonds, Treasury bills, and inflation.
o Savings and Loan Historical Interest Rates - as published in the U.S.
Savings & Loan League Fact Book.
o Russell 3000(R) Index measures the performance of the 3,000 largest US
companies based on total market capitalization.
o Russell 1000(R) Index measures the performance of the 1,000 largest
companies in the Russell 3000 Index.
o The Wilshire Top 2500 Index consists of the largest 2500 companies in the
Wilshire 5000.
ADDITIONAL COMPARISONS - MIDCAP FUND
o Lipper - Mutual Fund Performance Analysis and Lipper - Fixed Income Fund
Performance Analysis - measure total return and average current yield for
the mutual fund industry and rank individual mutual fund performance over
specified time periods, assuming reinvestment of all distributions,
exclusive of any applicable sales charges.
o The Wilshire 4500 Equity Index - a market value-weighted index of all
U.S. common equity securities with readily available price data (excluding
the S&P 500 securities which together with the 4500 comprise the Wilshire
5000). It is a total return index with dividends reinvested.
o The Wilshire Mid Cap 750 - overlaps both the top 750 and next 1750 of the
Wilshire 2500 universe (the top 2500 companies and 99% of the market
capitalization of the Wilshire 5000). Wilshire includes companies that
have market capitalizations ranging from $300 million to $1.3 billion. The
portfolio contains from 125 to 500 securities.
o The Russell 2000 Index - consists of the 2,000 smallest securities in the
Russell 3000 Index. Representing approximately 11% of the Russell 3000
total market capitalization, this is Russell's Small Cap Index.
o The Russell 2500 Index - consists of the bottom 500 securities in the
Russell Index, as ranked by total market capitalization, and all 2,000
securities in the Russell 2000 Index. This Index is a measure of small to
medium-small stock performance.
o The Russell 3000 Index - consists of 3,000 large U.S. companies, as
determined by market capitalization. This portfolio of securities
represents approximately 98% of the investable U.S. equity market.
o Valueline Index - an unmanaged index which follows the stock of
approximately 1700 companies.
o Standard & Poor's(R) 400 - consists of 400 domestic stocks chosen for
market size, liquidity and industry group representation. It is a
market-value weighted index, with each stock affecting the Index in
proportion to its market value. This index, calculated by S&P, is a total
return index with dividends reinvested.
o Total Return Performance - The example below may be used to illustrate
the fund's performance, when compared to the total return of the Wilshire
5000 Index, Standard and Poor's 500 Index and the Standard and Poor's
Midcap Index:
Annual Performance from 1989 through 1998
S&P S&P WILSHIRE
500 MIDCAP 5000
- -------------------------------------------------------------------------
1989 31.69 35.52 29.18
1990 -3.10 -5.13 -6.18
1991 30.47 50.10 34.21
1992 7.62 11.91 8.98
1993 10.08 13.95 11.30
1994 1.32 -3.58 -0.06
1995 37.58 30.95 36.47
1996 22.96 19.20 21.21
1997 33.36 32.25 31.29
1998 28.58 19.11 23.43
ADDITIONAL COMPARISONS - SMALL CAP FUND
o Lipper - Mutual Fund Performance Analysis and Lipper - Fixed Income Fund
Performance Analysis - measure total return and average current yield for
the mutual fund industry and rank individual mutual fund performance over
specified time periods, assuming reinvestment of all distributions,
exclusive of any applicable sales charges.
o Stocks, Bonds, Bills, and Inflation, published by Ibbotson Associates -
historical measure of yield, price, and total return for common and small
company stock, long-term government bonds, Treasury bills, and inflation.
o Savings and Loan Historical Interest Rates - as published in the U.S.
Savings & Loan League Fact Book.
o The Russell 2000 Index - consists of the 2,000 smallest securities in the
Russell 3000 Index. Representing approximately 11% of the Russell 3000
total market capitalization, this is Russell's Small Cap Index.
o The Russell 2500 Index - consists of the bottom 500 securities in the
Russell Index, as ranked by total market capitalization, and all 2,000
securities in the Russell 2000 Index. This Index is a measure of small to
medium-small stock performance.
o The Russell 3000 Index - consists of 3,000 large U.S. companies, as
determined by market capitalization. This portfolio of securities
represents approximately 98% of the investable U.S. equity market.
From time to time, advertisements or information for each 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 each fund's performance to the
return on certificates of deposit (CDs) or other investments. You should be
aware, however, that an investment in the fund involves the risk of
fluctuation of principal value, a risk generally not present in an investment
in a CD issued by a bank. For example, as the general level of interest rates
rise, the value of the fund's fixed-income investments, if any, as well as
the value of its shares that are based upon the value of such portfolio
investments, can be expected to decrease. Conversely, when interest rates
decrease, the value of the fund's shares can be expected to increase. CDs are
frequently insured by an agency of the U.S. government. An investment in a
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 any 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 a fund to calculate its figures. In
addition, there can be no assurance that a fund will continue their
performance as compared to these other averages.
MISCELLANEOUS INFORMATION
- ------------------------------------------------------------------------------
The funds 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 in order 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 funds cannot guarantee that these goals will be met.
The funds are members 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 more than 4 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 $227 billion in assets under management for
more than 7 million U.S. based mutual fund shareholder and other accounts.
The Franklin Templeton Group of Funds offers 112 U.S. based open-end
investment companies to the public. Each 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 funds 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.
The Information Services & Technology division of Franklin Resources, Inc.
(Resources) established a Year 2000 Project Team in 1996. This team has
already begun making necessary software changes to help the computer systems
that service the fund and its shareholders to be Year 2000 compliant. After
completing these modifications, comprehensive tests are conducted in one of
Resources' U.S. test labs to verify their effectiveness. Resources continues
to seek reasonable assurances from all major hardware, software or
data-services suppliers that they will be Year 2000 compliant on a timely
basis. Resources is also beginning to develop a contingency plan, including
identification of those mission critical systems for which it is practical to
develop a contingency plan. However, in an operation as complex and
geographically distributed as Resources' business, the alternatives to use of
normal systems, especially mission critical systems, or supplies of
electricity or long distance voice and data lines are limited.
You will receive the Small Cap 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 RATINGS
- ------------------------------------------------------------------------------
PREFERRED STOCKS RATINGS
STANDARD & POOR'S CORPORATION (S&P)
AAA: This is the highest rating that may be assigned by S&P to a preferred
stock issue and indicates an extremely strong capacity to pay the preferred
stock obligations.
AA: A preferred stock issue rated AA also qualifies as a high quality
fixed-income security. The capacity to pay preferred stock obligations is
very strong, although not as overwhelming as for issues rated AAA.
A: An issue rated A is backed by a sound capacity to pay the preferred stock
obligations, although it is somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions.
BBB: An issue rated BBB is regarded as backed by an adequate capacity to pay
the preferred stock obligations. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing circumstances
are more likely to lead to a weakened capacity to make payments for a
preferred stock in this category than for issues in the A category.
BB, B and CCC: Preferred stock rated BB, B, and CCC are regarded, on balance,
as predominately speculative with respect to the issuer's capacity to pay
preferred stock obligations. BB indicates the lowest degree of speculation
and CCC the highest degree of speculation. While these issues will likely
have some quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse conditions.
CC: The rating CC is reserved for a preferred stock issue in arrears on
dividends or sinking fund payments but that is currently paying.
C: A preferred stock rated C is a non-paying issue.
D: A preferred stock rated D is a non-paying issue with the issuer in default
on debt instruments.
NR: Indicates that no rating has been requested, that there is insufficient
information on which to base a rating, or that S&P does not rate a particular
type of obligation as a matter of policy.
Plus (+) or Minus (-): To provide more detailed indications of preferred
stock quality, 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.
CORPORATE BOND RATINGS
MOODY'S INVESTORS SERVICE, INC. (MOODY'S)
Aaa: Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as
"gilt-edged." Interest payments are protected by a large or exceptionally
stable margin, and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
Aa: Bonds rated Aa are judged to be high quality by all standards. Together
with the Aaa group, they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large, fluctuation of protective elements may be of greater
amplitude, or there may be other elements present that make the long-term
risks appear somewhat larger.
A: Bonds rated A possess many favorable investment attributes and are
considered upper medium-grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
that suggest a susceptibility to impairment sometime in the future.
Baa: Bonds rated Baa are considered medium-grade obligations. They are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may
be lacking or may be characteristically unreliable over any great length of
time. These bonds lack outstanding investment characteristics and, in fact,
have speculative characteristics as well.
Ba: Bonds rated Ba are judged to have predominantly speculative elements and
their future cannot be considered well assured. Often the protection of
interest and principal payments is very moderate and, thereby, not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B: Bonds rated B generally lack characteristics of the desirable investment.
Assurance of interest and principal payments or of maintenance of other terms
of the contract over any long period of time may be small.
Caa: Bonds rated Caa are of poor standing. These issues may be in default or
there may be present elements of danger with respect to principal or interest.
Ca: Bonds rated Ca represent obligations that are speculative to a high
degree. These issues are often in default or have other marked shortcomings.
C: Bonds rated C are the lowest rated class of bonds and can be regarded as
having extremely poor prospects of ever attaining any real investment
standing.
Note: Moody's applies numerical modifiers 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond ratings. The modifier
1 indicates that the security ranks in the higher end of its generic rating
category; modifier 2 indicates a mid-range ranking; and modifier 3 indicates
that the issue ranks in the lower end of its generic rating category.
S&P
AAA: This is the highest rating assigned by S&P to a debt obligation and
indicates an extremely strong capacity to pay principal and interest.
AA: Bonds rated AA also qualify as high-quality debt obligations. Capacity to
pay principal and interest is very strong and, in the majority of instances,
differ from AAA issues only in a small degree.
A: Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions.
BBB: Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit protection parameters,
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity to pay principal and interest for bonds in this
category than for bonds in the A category.
BB, B, CCC, CC: Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal in accordance with the terms of the obligations.
BB indicates the lowest degree of speculation and CC the highest degree of
speculation. While these bonds will likely have some quality and protective
characteristics, they are outweighed by large uncertainties or major risk
exposures to adverse conditions.
C: Bonds rated C are typically subordinated debt to senior debt that is
assigned an actual or implied CCC- rating. The C rating 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 short-term debt ratings are opinions of the ability of issuers to
repay punctually senior debt obligations. These obligations have an original
maturity not exceeding one year, unless explicitly noted. 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 for both short-term
debt and commercial paper, 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.
FRANKLIN
STRATEGIC SERIES
FRANKLIN BIOTECHNOLOGY DISCOVERY FUND - CLASS A
FRANKLIN GLOBAL HEALTH CARE FUND - CLASS A, B & C
FRANKLIN GLOBAL UTILITIES FUND - CLASS A, B & C
EFFECTIVE NOVEMBER 15, 1999, THE FUND'S NAME WAS
CHANGED TO "FRANKLIN GLOBAL COMMUNICATIONS FUND"
FRANKLIN NATURAL RESOURCES FUND - CLASS A
STATEMENT OF ADDITIONAL INFORMATION
SEPTEMBER 1, 1999, AS AMENDED JANUARY 1, 2000
[Insert Franklin Templeton Ben Head]
P.O. BOX 997151, SACRAMENTO, CA 95899-9983 1-800/DIAL BEN(R)
This Statement of Additional Information (SAI) is not a prospectus. It
contains information in addition to the information in the funds' prospectus.
The funds' prospectus, dated September 1, 1999, which we may amend from time
to time, contains the basic information you should know before investing in a
fund. You should read this SAI together with the funds' prospectus.
The audited financial statements and auditor's report in the trust's Annual
Report to Shareholders, for the fiscal year ended April 30, 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/DIAL BEN (1-800/342-5236).
CONTENTS
Goals and Strategies ........................ 2
Risks ....................................... 18
Officers and Trustees ....................... 25
Management and Other Services ............... 28
Portfolio Transactions ...................... 29
Distributions and Taxes ..................... 30
Organization, Voting Rights
and Principal Holders ...................... 32
Buying and Selling Shares ................... 33
Pricing Shares .............................. 39
The Underwriter ............................. 40
Performance ................................. 41
Miscellaneous Information ................... 44
Description of Ratings ...................... 45
- ------------------------------------------------------------------------------
MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS:
o ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION,
THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT;
o ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK;
o ARE SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL.
- ------------------------------------------------------------------------------
FSS2 SAI 01/00
GOALS AND STRATEGIES
- ------------------------------------------------------------------------------
FRANKLIN BIOTECHNOLOGY DISCOVERY FUND
(BIOTECHNOLOGY FUND)
The fund's investment goal is to seek capital appreciation. This goal is
fundamental, which means it may not be changed without shareholder approval.
Under normal market conditions, the fund invests primarily in securities of
biotechnology companies and discovery research firms located in the U.S. and
other countries. The fund normally invests at least 65% of its assets in
equity securities of biotechnology companies. The fund may also invest up to
35% of its assets in debt securities of any type of foreign or U.S. issuer.
The fund intends to invest less than 5% in debt securities rated below
investment grade.
FRANKLIN GLOBAL HEALTH CARE FUND (HEALTH CARE FUND)
The investment goal of the fund is to seek capital appreciation. This goal is
fundamental, which means it may not be changed without shareholder approval.
Under normal market conditions, the fund invests at least 70% of its total
assets in the equity securities of health care companies located throughout
the world. The fund may also invest up to 30% of its assets in domestic and
foreign debt securities. At present, the fund intends to invest less than 5%
in debt securities rated below investment grade.
FRANKLIN GLOBAL UTILITIES FUND (UTILITIES FUND)
The investment goal of the fund is to seek to provide total return, without
incurring undue risk. This goal is fundamental, which means it may not be
changed without shareholder approval. Total return consists of both capital
appreciation and current dividend and interest income.
Under normal market conditions, the fund invests at least 65% of its total
assets in the equity securities of U.S. and non-U.S. companies in the public
utilities industry. The fund normally invests at least 65% of its total
assets in issuers in at least three different countries. The fund expects to
invest more of its assets in U.S. securities than in securities of any other
single country, but the fund may invest more than 65% of its total assets in
foreign securities. The fund will limit its investments in Russian securities
to 5% of its total assets.
The fund may buy debt securities that are rated at least Caa by Moody's
Investors Service, Inc. (Moody's) or CCC by Standard & Poor's Corporation
(S&P), or unrated securities that it determines to be of comparable quality.
The fund will not invest more than 5% of its total assets in debt securities
rated below investment grade. Investment grade debt securities are rated in
the top four ratings categories by independent rating organizations such as
S&P or Moody's. The fund will only buy commercial paper rated A-1 or A-2 by
S&P or Prime-1 or Prime-2 by Moody's, or unrated commercial paper that it
determines to be of comparable quality.
The fund may invest in Treasury bills, notes and bonds, which are direct
obligations of the U.S. government, backed by the full faith and credit of
the U.S. Treasury, and in securities issued or guaranteed by federal
agencies. The fund may also invest in securities issued or guaranteed by
foreign governments and their agencies.
FRANKLIN NATURAL RESOURCES FUND
(NATURAL RESOURCES FUND)
The investment goal of the fund is to seek to provide high total return. This
goal is fundamental, which means it may not be changed without shareholder
approval. Total return consists of both capital appreciation and current
dividend and interest income.
Under normal market conditions, the fund invests at least 65% of its assets
in the equity and debt securities of U.S. and foreign companies in the
natural resources sector. The fund may also invest up to 35% of its assets
outside the natural resources sector, including in U.S. and foreign equity
and debt securities and up to 10% of its assets in real estate investment
trusts (REITs). The fund will only buy commercial paper rated A-1 or A-2 by
S&P or Prime-1 or Prime-2 by Moody's, or unrated commercial paper that it
determines to be of comparable quality.
Below is a description of the various types of securities the funds may buy
and information about the funds' investment policies.
EQUITY SECURITIES generally entitle the holder to participate in a company's
general operating results. 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, and rights. Convertible securities typically are debt
securities or preferred stocks which are convertible into common stock after
certain time periods or under certain conditions. Warrants or rights give the
holder the right to purchase a common stock at a given time for a specified
price.
DEBT SECURITIES A debt security typically has a fixed payment schedule that
obligates the issuer to pay interest to the lender and to return the lender's
money over a certain time period. 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
debt securities generally declines. These changes in market value will be
reflected in a fund's net asset value.
RATINGS. Various investment services publish ratings of some of the debt
securities in which a fund may invest. These ratings represent the opinions
of the rating services with respect to the issuer's ability to pay interest
and repay principal. They do not purport to reflect the risk of fluctuations
in market value and are not absolute standards of quality. Please see
"Description of Ratings" for a discussion of the ratings.
If the rating on an issue held in a fund's portfolio is changed by the rating
service or the security goes into default, the manager will consider the
event in its evaluation of the overall investment merits of the security but
will not automatically sell the security.
REPURCHASE AGREEMENTS Each 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.
The funds may also enter into reverse repurchase agreements. Under a reverse
repurchase agreement, a fund agrees to sell a security in its portfolio and
then to repurchase the security at an agreed-upon price, date, and interest
payment. The fund will maintain cash or high-grade liquid debt securities
with a value equal to the value of the fund's obligation under the agreement,
including accrued interest, in a segregated account with the fund's custodian
bank. The securities subject to the reverse repurchase agreement will be
marked-to-market daily. Although reverse repurchase agreements are borrowings
under the Investment Company Act of 1940, the funds do not treat these
arrangements as borrowings under their investment restrictions so long as the
segregated account is properly maintained.
SECURITIES LENDING The funds may lend to banks and broker-dealers portfolio
securities with an aggregate market value of up to 33% of the Natural
Resources Fund's total assets, one third of the Utilities Fund's total
assets, 20% of the Health Care Fund's total assets, or one third of the
Biotechnology Fund's total assets. Such loans must be secured by collateral
(consisting of any combination of cash, U.S. government securities, or
irrevocable letters of credit) in an amount at least equal (on a daily
marked-to-market basis) to the current market value of the securities loaned.
A fund retains all or a portion of the interest received on investment of the
cash collateral or receives a fee from the borrower. A fund may terminate the
loans at any time and obtain the return of the securities loaned within five
business days. A fund will continue to receive any interest or dividends paid
on the loaned securities and will continue to have voting rights with respect
to the securities. However, as with other extensions of credit, there are
risks of delay in recovery or even loss of rights in collateral should the
borrower fail.
BORROWING The funds do not borrow money or mortgage or pledge any of their
assets, except that each fund may enter into reverse repurchase agreements or
borrow for temporary or emergency purposes up to a specified limit. This
limit is 33 1/3% of total assets for the Biotechnology Fund, 10% of total
assets for the Health Care Fund, and 33% of total assets for the Natural
Resources Fund and the Utilities Fund. A fund will not make any additional
investments while its borrowings exceed 5% of its total assets.
GOVERNMENT SECURITIES - NATURAL RESOURCES FUND AND UTILITIES FUND Securities
issued or guaranteed by the U.S. government or its agencies or
instrumentalities, including U.S. Treasury bills, notes and bonds, as well as
certain agency securities and mortgage-backed securities issued by the
Government National Mortgage Association (GNMA), may carry guarantees which
are backed by the "full faith and credit" of the U.S. government. The
guarantee extends only to the payment of interest and principal due on the
securities and does not provide any protection from fluctuations in either
the securities' yield or value or to the yield or value of the fund's shares.
Other investments in agency securities are not necessarily backed by the
"full faith and credit" of the U.S. government. These include securities
issued by the Federal National Mortgage Association (FNMA), the Federal Home
Loan Mortgage Corporation, the Student Loan Marketing Association and the
Farm Credit Bank.
The Natural Resources Fund and the Utilities Fund may invest in debt
securities issued or guaranteed by foreign governments. These securities are
typically denominated in foreign currencies and are subject to the currency
fluctuation and other risks of foreign securities investments. The foreign
government securities in which the funds intend to invest generally will
include obligations issued by national, state, or local governments or
similar political subdivisions. Foreign government securities also include
debt obligations of supranational entities, including international
organizations designed or supported by governmental entities to promote
economic reconstruction or development and international banking institutions
and related government agencies. Examples include the International Bank of
Reconstruction and Development (the World Bank), the European Investment
Bank, the Asian Development Bank and the Inter-American Development Bank.
Foreign government securities also include debt securities of
"quasi-governmental agencies" and debt securities denominated in
multinational currency units. An example of a multinational currency unit is
the European Currency Unit. A European Currency Unit represents specified
amounts of the currencies of certain of the 12-member states of the European
Economic Community. Debt securities of quasi-governmental agencies are issued
by entities owned by either a national or local government or are obligations
of a political unit that is not backed by the national government's full
faith and credit and general taxing powers. Foreign government securities
also include mortgage-related securities issued or guaranteed by national or
local governmental instrumentalities, includ-ing quasi-governmental agencies.
UTILITY INDUSTRIES - UTILITIES FUND ONLY Under normal circumstances, the
Utilities Fund will invest at least 65% of its total assets in equity
securities of companies in the public utilities industry. These companies are
primarily engaged in the ownership, operation or manufacture of facilities or
equipment used to provide telephone communications, electricity, cable and
other pay television services, wireless telecommunications, natural gas or
water. "Primarily engaged," for this purpose, means that (1) more than 50% of
the company's assets are devoted to the ownership or operation of one or more
facilities as described above or (2) more than 50% of the company's operating
revenues are derived from the business or combination of businesses described
above.
The utility companies in which the Utilities Fund invests may be domestic or
foreign. To meet its objective, the fund may invest in domestic utility
companies that pay higher than average dividends, but have less potential for
capital appreciation. There can be no assurance that the historically
positive relative returns on utility securities will continue to occur in the
future. The manager believes that the average dividend yields of common
stocks issued by foreign utility companies have also historically exceeded
those of foreign industrial companies' common stocks. To meet its objective,
the Utilities Fund may invest in foreign utility companies that pay lower
than average dividends, but have a greater potential for capital appreciation.
HEALTH CARE COMPANIES - HEALTH CARE FUND ONLY Many major developments in
health care come from companies based abroad. Thus, in the opinion of the
manager, a portfolio of only U.S. based health care companies is not
sufficiently diversified to participate in global developments and
discoveries in the field of health care. The manager believes that health
care is becoming an increasingly globalized industry and that many important
investment opportunities exist abroad. Therefore, the manager believes that a
portfolio of global securities may provide a greater potential for investment
participation in present and future opportunities that may present themselves
in the health care related industries. The manager also believes that the
U.S. health care industry may be subject to increasing regulation and
government control, thus a global portfolio may reduce the risk of a single
government's actions on the portfolio. The Health Care Fund concentrates its
investments in a limited group of related industries and is not intended to
be a complete investment program.
FOREIGN SECURITIES The Biotechnology Fund anticipates that under normal
conditions, it will invest more of its assets in U.S. securities than in
securities of any other single country, although the fund may have more than
50% of its total assets in foreign securities. The fund may buy securities of
issuers in developing nations, but it has no present intention of doing so.
The Biotechnology Fund will not invest in securities of foreign issuers that
are issued without stock certificates or other evidences of ownership. The
Biotechnology Fund may invest in securities that are traded on U.S. or
foreign securities exchanges, the National Association of Securities Dealers
Automated Quotation System (NASDAQ) national market system, or in the U.S. or
foreign over-the-counter markets.
The Health Care Fund invests 70% of its assets in securities of issuers in at
least three different countries. The Health Care Fund will not invest more
than 40% of its net assets in any one country other than the U.S. The Health
Care Fund expects that a significant portion of its investments will be in
securities of domestic issuers. The Health Care Fund will not invest in
securities of foreign issuers without stock certificates or comparable
evidence of ownership.
The Natural Resources Fund expects to invest more of its assets in U.S.
securities than in securities of any other single country, but the fund may
invest more than 50% of its total assets in foreign securities.
The Utilities Fund normally invests at least 65% of its total assets in
issuers in at least three different countries. The Utilities Fund expects to
invest more of its assets in U.S. securities than in securities of any other
single country, but the fund may invest more than 65% of its total assets in
foreign securities. The Utilities Fund will limit its investments in Russian
securities to 5% of its total assets.
DEPOSITARY RECEIPTS. The Natural Resources Fund may invest in American
Depositary Receipts (ADRs), and the Utilities Fund, the Health Care Fund, and
the Biotechnology Fund may invest in ADRs, European Depositary Receipts
(EDRs) and Global Depositary Receipts (GDRs) of non-U.S. issuers. Such
depositary receipts are interests in a pool of a non-U.S. company's
securities that have been deposited with a bank or trust company. The bank or
trust company then sells interests in the pool to investors in the form of
depositary receipts. Depositary receipts can be unsponsored or sponsored by
the issuer of the underlying securities or by the issuing bank or trust
company.
ADRs are usually issued by an American bank or trust company and may be
registered for use in U.S. securities markets. Foreign banks or trust
companies typically issue EDRs and GDRs, although U.S. banks or trust
companies also may issue them. The funds consider investments in depositary
receipts to be investments in the equity securities of the issuers into which
the depositary receipts may be converted.
Prices of ADRs are quoted in U.S. dollars, and ADRs are traded in the U.S. on
exchanges or over-the-counter. While ADRs do not eliminate all the risks
associated with foreign investments, by investing in ADRs rather than
directly in the stock of foreign issuers, a fund will avoid currency risks
during the settlement period for either purchases or sales and certain
foreign securities markets trading risks. In general, there is a large,
liquid market in the U.S. for ADRs quoted on a national securities exchange
or on the NASDAQ. The information available for ADRs is subject to the
accounting, auditing, and financial reporting standards of the U.S. market or
exchange on which they are traded, which standards are more uniform and more
exacting than those to which many foreign issuers may be subject.
Depositary receipts may be issued under sponsored or unsponsored programs. In
sponsored programs, an issuer has made arrangements to have its securities
traded in the form of depositary receipts. In unsponsored programs, the
issuer may not be directly involved in the creation of the program. Although
regulatory requirements with respect to sponsored and unsponsored programs
are generally similar, in some cases it may be easier to obtain financial
information from an issuer that has participated in the creation of a
sponsored program. Accordingly, there may be less information available
regarding issuers of securities underlying unsponsored programs, and there
may not be a correlation between such information and the market value of the
depositary receipts.
CONVERTIBLE SECURITIES Each fund may invest in convertible securities. A
convertible security is generally a debt obligation or preferred stock that
may be converted within a specified period of time into a certain amount of
common stock of the same or a different issuer. A convertible security
provides a fixed-income stream and the opportunity, through its conversion
feature, to participate in the capital appreciation resulting from a market
price advance in its underlying common stock. As with a straight fixed-income
security, a convertible security tends to increase in market value when
interest rates decline and decrease in value when interest rates rise. 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 both interest rate
and market movements can influence its value, a convertible security is not
as sensitive to interest rates as a similar fixed-income security, nor is it
as sensitive to changes in share price as its underlying stock.
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. In addition, a convertible security
may be subject to redemption by the issuer, but only after a specified date
and under circumstances established at the time the security is issued.
While the funds use the same criteria to rate a convertible debt security
that they use to rate a more conventional debt security, a convertible
preferred stock is treated like a preferred stock for the funds' 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.
ENHANCED CONVERTIBLE SECURITIES - UTILITIES FUND ONLY.
In addition to "plain vanilla" convertibles, a number of different structures
have been created to fit the characteristics of specific investors and
issuers. Examples of these enhanced characteristics for investors include
yield enhancement, increased equity exposure or enhanced downside protection.
From an issuer's perspective, enhanced structures are designed to meet
balance sheet criteria, interest/dividend payment deductibility and reduced
equity dilution. The following are descriptions of common structures of
enhanced convertible securities.
Mandatorily convertible securities (e.g., ACES, DECS, PRIDES, SAILS-each
issuer has a different acronym for their version of these securities) are
considered the most equity like of convertible securities. At maturity these
securities are mandatorily convertible into common stock offering investors
some form of yield enhancement in return for some of the upside potential in
the form of a conversion premium. Typical characteristics of mandatories
include: issued as preferred stock, convertible at premium, pay fixed
quarterly dividend (typically 500 to 600 basis points higher than common
stock dividend), and are non-callable for the life of the security (usually
three to five years). An important feature of mandatories is that the number
of shares received at maturity is determined by the difference between the
price of the common stock at maturity and the price of the common stock at
issuance.
Enhanced convertible preferred securities (e.g., QUIPS, TOPRS, and TECONS)
are, from an investor's viewpoint, essentially convertible preferred
securities, i.e. they are issued as preferred stock convertible into common
stock at a premium and pay quarterly dividends. Through this structure the
company establishes a wholly owned special purpose vehicle whose sole purpose
is to issue convertible preferred stock. The offering proceeds pass-through
to the company who issues the special purpose vehicle a convertible
subordinated debenture with identical terms to the convertible preferred
issued to investors. Benefits to the issuer include increased equity credit
from rating agencies and the deduction of coupon payments for tax purposes.
A company divesting a holding in another company often uses exchangeable
securities. The primary difference between exchangeables and standard
convertible structures is that the issuing company is a different company to
that of the underlying shares.
Yield enhanced stock (YES, also known as PERCS) mandatorily converts into
common stock at maturity and offers investors a higher current dividend than
the underlying common stock. The difference between these structures and
other mandatories is that the participation in stock price appreciation is
capped.
Zero-coupon and deep-discount convertible bonds (OID and LYONs) include the
following characteristics: no or low coupon payments, imbedded put options
allowing the investor to put them on select dates prior to maturity, call
protection (usually three to five years), and lower than normal conversion
premiums at issuance. A benefit to the issuer is that while no cash interest
is actually paid, the accrued interest may be deducted for tax purposes.
Because of their put options, these bonds tend to be less sensitive to
changes in interest rates than either long maturity bonds or preferred
stocks. The put options also provide enhanced downside protection while
retaining the equity participation characteristics of traditional convertible
bonds.
An investment in an enhanced convertible security or any other security may
involve additional risks. 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 also
may make it more difficult for the fund to obtain market quotations based on
actual trades for purposes of valuing the fund's portfolio.
FUTURE DEVELOPMENTS. The fund may invest in other convertible securities or
enhanced convertible securities that are not presently contemplated for use
by the fund or that are not currently available but that may be developed, so
long as the opportunities are consistent with the fund's investment objective
and policies.
Certain issuers of convertible securities may be deemed to be "investment
companies" as defined in the Investment Company Act of 1940, as amended (1940
Act). As a result, the fund's investment in these securities may be limited
by the restrictions contained in the 1940 Act.
ILLIQUID INVESTMENTS Each fund's policy is not to invest more than 15% of its
net assets (10% in the case of the Health Care Fund) 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. The Natural Resources Fund may invest up to 5% of
its net assets in illiquid securities the disposition of which may be subject
to legal or contractual restrictions. The Natural Resources Fund and the
Utilities Fund currently intend to limit their investments in illiquid
securities, including illiquid securities with legal or contractual
restrictions on resale, except for Rule 144A restricted securities, and
including securities which are not readily marketable, to 10% of net assets.
A fund does not consider securities that it acquires outside the U.S. and
that are publicly traded in the U.S. or on a foreign securities exchange or
in a foreign securities market to be illiquid assets so long as the fund
acquires and holds the security with the intention of reselling the security
in the foreign trading market, the fund reasonably believes it can readily
dispose of the security for cash at approximately the amount at which the
fund has valued the security in the U.S. or foreign market, and current
market quotations are readily available.
Subject to these limitations, the board of trustees has authorized each fund
to invest in restricted securities where such investments are consistent with
the fund's investment objective and has authorized such securities to be
considered liquid to the extent the manager determines that there is a liquid
institutional or other market for the securities. An example of these
securities are restricted securities that may be freely transferred among
qualified institutional buyers under Rule 144A of the Securities Act of 1933,
as amended, and for which a liquid institutional market has developed. The
fund's board of trustees will review any determination by the manager to
treat a restricted security as a liquid security on an ongoing basis,
including the manager's assessment of current trading activity and the
availability of reliable price information. In determining whether a
restricted security is properly considered a liquid security, the manager and
the fund's board of trustees will take into account the following factors:
(i) the frequency of trades and quotes for the security; (ii) the number of
dealers willing to buy or sell the security and the number of other potential
buyers; (iii) dealer undertakings to make a market in the security; and (iv)
the nature of the security and marketplace trades (e.g., the time needed to
dispose of the security, the method of soliciting offers, and the mechanics
of transfer). To the extent a fund invests in restricted securities that are
deemed liquid, the general level of illiquidity in the fund may be increased
if qualified institutional buyers become uninterested in buying these
securities or the market for these securities contracts.
WHEN-ISSUED OR DELAYED DELIVERY TRANSACTIONS - NATURAL RESOURCES FUND AND
UTILITIES FUND The Natural Resources Fund and the Utilities Fund may buy
securities on a when-issued or delayed delivery basis. These transactions are
arrangements under which a fund buys securities with payment and delivery
scheduled for a future time. The securities are subject to market fluctuation
prior to delivery to the fund and generally do not earn interest until their
scheduled delivery date. Therefore, the value or yields at delivery may be
more or less than the purchase price or the yields available when the
transaction was entered into. Although the funds will generally buy these
securities on a when-issued basis with the intention of acquiring the
securities, they may sell the securities before the settlement date if it is
deemed advisable. When a fund is the buyer, it will maintain, in a segregated
account with its custodian bank, cash or high-grade marketable securities
having an aggregate value equal to the amount of its purchase commitments
until payment is made. In such an arrangement, the fund relies on the seller
to complete the transaction. The seller's failure to do so may cause the fund
to miss a price or yield considered advantageous. The funds are not subject
to any percentage limit on the amount of their assets that may be invested in
when-issued purchase obligations. To the extent a fund engages in when-issued
and delayed delivery transactions, it will do so only for the purpose of
acquiring portfolio securities consistent with its investment objective and
policies, and not for the purpose of investment leverage.
STANDBY COMMITMENT AGREEMENTS - NATURAL RESOURCES FUND AND UTILITIES FUND The
Natural Resources Fund and the Utilities Fund may, from time to time, enter
into standby commitment agreements. These agreements commit a fund, for a
stated period of time, to buy a stated amount of a security that may be
issued and sold to the fund at the option of the issuer. The price and coupon
of the security is fixed at the time of the commitment. When a fund enters
into the agreement, the fund is paid a commitment fee, regardless of whether
the security is ultimately issued, typically equal to approximately 0.5% of
the aggregate purchase price of the security that the fund has committed to
buy. The funds will enter into such agreements only for the purpose of
investing in the security underlying the commitment at a yield and/or price
that is considered advantageous.
The funds will not enter into a standby commitment with a remaining term in
excess of 45 days and will limit their investment in standby commitments so
that the aggregate purchase price of the securities subject to the
commitments with remaining terms exceeding seven days, together with the
value of other portfolio securities deemed illiquid, will not exceed the
respective fund's limit on holding illiquid investments, taken at the time of
acquisition of such commitment or security. Each fund will at all times
maintain a segregated account with its custodian bank of cash, cash
equivalents, U.S. government securities, or other high grade liquid debt
securities denominated in U.S. dollars or non-U.S. currencies in an aggregate
amount equal to the purchase price of the securities underlying the
commitment.
There can be no assurance that the securities subject to a standby commitment
will be issued, and the value of the security, if issued, on the delivery
date may be more or less than its purchase price. Since the issuance of the
security underlying the commitment is at the option of the issuer, a fund may
bear the risk of a decline in the value of the security and may not benefit
from an appreciation in the value of the security during the commitment
period.
The purchase of a security subject to a standby commitment agreement and the
related commitment fee will be recorded on the date on which the security can
reasonably be expected to be issued, and the value of the security will
thereafter be reflected in the calculation of the fund's net asset value. The
cost basis of the security will be adjusted by the amount of the commitment
fee. In the event the security is not issued, the commitment fee will be
recorded as income on the expiration date of the standby commitment.
DERIVATIVE SECURITIES - ALL FUNDS
Although the funds have authority to invest in various types of derivative
securities and engage in hedging transactions, the funds currently do not
intend to invest in derivative securities or engage in hedging transactions.
Hedging is a technique designed to reduce a potential loss to the fund as a
result of certain economic or market risks, including risks related to
fluctuations in interest rates, currency exchange rates between U.S. and
foreign currencies or between different foreign currencies, and broad or
specific market movements.
The BIOTECHNOLOGY FUND may engage in the following types of transactions:
purchase and sell exchange-listed and over-the-counter put and call options
on securities, equity and fixed-income indices and other financial
instruments; purchase and sell financial futures contracts and options
thereon; and enter into various currency transactions such as currency
forward contracts, currency futures contracts, currency swaps or options on
currencies or currency futures. The fund may also use these various
techniques for non-hedging purposes. For example, these techniques may be
used to produce income to the fund where the fund's participation in the
transaction involves the payment of a premium to the fund. The fund may also
use a hedging technique to bet on the fluctuation of certain indices,
currencies, or economic or market changes such as a reduction in interest
rates. No more than 5% of the fund's assets will be exposed to risks of such
types of instruments when entered into for non-hedging purposes.
The HEALTH CARE FUND may write (sell) covered put and call options and buy
put and call options on securities that trade on securities exchanges and in
the over-the-counter market. The fund may buy and sell futures and options on
futures with respect to securities and currencies. Additionally, the fund may
buy and sell futures and options to "close out" futures and options it may
have sold or bought. The fund may seek to protect capital through the use of
forward currency exchange contracts. The fund will not engage in transactions
in futures contracts or related options for speculation but only as a hedge
against changes resulting from market conditions in the values of its
securities or securities that it intends to buy. The fund will not enter into
any stock index or financial futures contract or related option if,
immediately thereafter, more than one-third of the fund's net assets would be
represented by futures contracts or related options. In addition, the fund
may not buy or sell futures contracts or buy or sell related options (except
for closing transactions) if, immediately thereafter, the sum of the amount
of margin deposits on its existing futures and related options positions and
premiums paid for related options would exceed 5% of the market value of the
fund's total assets. The fund will not engage in any stock options or stock
index options if the option premiums paid regarding its open option positions
exceed 5% of the value of the fund's total assets. The fund may buy foreign
currency futures contracts and options if not more than 5% of its assets are
then invested as initial or variation margin deposits on contracts or
options. In instances involving the purchase of futures contracts or related
call options, money market instruments equal to the market value of the
futures contract or related option will be deposited in a segregated account
with the fund's custodian bank to collateralize such long positions.
In order to hedge against currency exchange rate risks, the NATURAL RESOURCES
FUND may enter into forward currency exchange contracts and currency futures
contracts and options on such futures contracts, as well as buy put or call
options and write covered put and call options on currencies traded in U.S.
or foreign markets. The fund may also buy and sell forward contracts (to the
extent they are not deemed commodities) for non-hedging purposes when the
manager anticipates that the foreign currency will appreciate or depreciate
in value, but securities denominated in that currency do not present
attractive investment opportunities and are not held in the fund's portfolio.
The fund generally will not enter into a forward contract with a term of
greater than one year.
The UTILITIES FUND may engage in various portfolio strategies to seek to
hedge its portfolio against adverse movements in the equity, debt and
currency markets. The fund may deal in forward foreign currency exchange
transactions and foreign currency options and futures and options on such
futures. The fund will not buy foreign currency futures contracts if more
than 5% of its assets are then invested as initial or variation margin
deposits on such contracts or related options. The fund may also write (i.e.,
sell) covered put and call options on its portfolio securities, buy put and
call options on securities and engage in transactions in stock index options
and financial futures, including stock and bond index futures and related
options on such futures. The fund does not currently intend to write put
options. The fund will not enter into any stock index or financial futures
contract or related option if, immediately thereafter, more than one-third of
the fund's net assets would be represented by futures contracts or related
options. The fund will not enter into any futures contract or related options
(except for closing transactions) if, immediately thereafter, the sum of the
amount of its initial deposits and premiums on open contracts and options
would exceed 5% of its total assets (taken at current value). The fund will
not engage in any securities options or securities index options if the
option premiums paid regarding its open option positions exceed 5% of the
value of its total assets. Although certain risks are involved in options and
futures transactions, the manager believes that, because the fund will write
only covered options on portfolio securities, and engage in other options and
futures transactions only for hedging purposes, the options and futures
portfolio strategies of the fund will not subject the fund to the risks
frequently associated with the speculative use of options and futures
transactions. While the fund's use of hedging strategies is intended to
reduce the volatility of the net asset value of fund shares, the fund's net
asset value will fluctuate. There can be no assurance that the fund's hedging
transactions will be effective. Furthermore, the fund will only engage in
hedging activities from time to time and may not necessarily be engaging in
hedging activities when movement in the equity, debt and currency markets
occurs.
The funds' transactions in options, futures contracts, and forward contracts
may be limited by the requirements of the Internal Revenue Code for
qualification as a regulated investment company. These transactions are also
subject to special tax rules that may affect the amount, timing, and
character of certain distributions to shareholders. For more information,
please see "Distributions and Taxes."
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS - ALL FUNDS. The funds may enter
into forward foreign currency exchange contracts (Forward Contract(s)) to
attempt to minimize the risk to the fund from adverse changes in the
relationship between currencies or to enhance income. A Forward Contract is
an obligation to buy or sell a specific currency for an agreed price at a
future date and is individually negotiated and privately traded by currency
traders and their customers.
A fund may enter into a Forward Contract, for example, when it enters into a
contract for the purchase or sale of a security denominated in a foreign
currency in order to "lock-in" the U.S. dollar price of that security.
Additionally, when a fund believes that a foreign currency may suffer a
substantial decline against the U.S. dollar, it may enter into a Forward
Contract to sell an amount of that foreign currency approximating the value
of some or all of the fund's portfolio securities denominated in that foreign
currency. Similarly, when a fund believes that the U.S. dollar may suffer a
substantial decline against a foreign currency, it may enter into a Forward
Contract to buy that foreign currency for a fixed dollar amount.
To limit potential risks in connection with the purchase of currency under
Forward Contracts, cash, cash equivalents or readily marketable high grade
debt securities equal to the amount of the purchase will be held aside or in
a segregated account with the fund's custodian bank to be used to pay for the
commitment, or the fund will cover any commitments under these contracts to
sell currency by owning the underlying currency (or an absolute right to
acquire the currency). The segregated account will be marked-to-market on a
daily basis.
Forward Contracts may limit the potential gain from a positive change in the
relationship between the U.S. dollar and foreign currencies or between
foreign currencies. Unanticipated changes in currency exchange rates also may
result in poorer overall performance for a fund than if it had not entered
into Forward Contracts.
FOREIGN CURRENCY FUTURES - ALL FUNDS. The funds may buy and sell foreign
currency futures contracts to hedge against changes in the level of future
currency rates. These contracts involve an agreement to buy or sell a
specific currency at a future date at a price set in the contract. Assets
will be held aside or in a segregated account with the fund's custodian bank
as required to cover the fund's obligations under its foreign currency
futures contracts.
OPTIONS ON FOREIGN CURRENCIES - ALL FUNDS. The funds may buy and write put
and call options on foreign currencies traded on U.S. and foreign exchanges
or over-the-counter, for hedging purposes to protect against declines in the
U.S. dollar value of foreign portfolio securities or other assets to be
acquired. As with other kinds of options, the writing of an option on foreign
currency will only be a partial hedge, up to the amount of the premium
received, and a fund could be required to buy or sell foreign currencies at
disadvantageous exchange rates, thereby incurring losses. The purchase of an
option on foreign currency may be an effective hedge against fluctuations in
exchange rates although, in the event of rate movements adverse to the fund's
position, a fund may forfeit the entire amount of the premium plus related
transaction costs.
A decline in the dollar value of a foreign currency in which portfolio
securities are denominated will reduce the dollar value of the securities,
even if their value in the foreign currency remains constant. In order to
protect against such diminutions in the value of portfolio securities, the
funds may buy put options on the foreign currency. If the value of the
currency does decline, a fund will have the right to sell the currency for a
fixed amount in dollars and will thereby offset, in whole or part, the
adverse effect on its portfolio which otherwise would have resulted.
Conversely, where a rise in the dollar value of a currency in which
securities to be acquired are denominated is projected, thereby increasing
the cost of such securities, the funds may buy call options thereon. The
purchase of such options could offset, at least partially, the effects of the
adverse movements in exchange rates. As in the case of other types of
options, however, the benefit to a fund deriving from purchases of foreign
currency options will be reduced by the amount of the premium and related
transaction costs. In addition, where currency exchange rates do not move in
the direction or to the extent anticipated, a fund could sustain losses on
transactions in foreign currency options that would require it to forego a
portion or all of the benefits of advantageous changes in such rates.
The funds may write options on foreign currencies for the same types of
hedging purposes. For example, where a fund anticipates a decline in the
dollar value of foreign currency denominated securities due to adverse
fluctuations in exchange rates it could, instead of buying a put option,
write a call option on the relevant currency. If the expected decline occurs,
the option will most likely not be exercised, and the decline in value of
portfolio securities will be offset by the amount of the premium received.
Similarly, instead of buying a call option to hedge against an anticipated
increase in the dollar cost of securities to be acquired, a fund could write
a put option on the relevant currency which, if rates move in the manner
projected, will expire unexercised and allow the fund to hedge such increased
cost up to the amount of the premium. As in the case of other types of
options, however, the writing of a foreign currency option will constitute
only a partial hedge up to the amount of the premium, and only if rates move
in the expected direction. If this does not occur, the option may be
exercised and the fund would be required to buy or sell the underlying
currency at a loss, which may not be offset by the amount of the premium.
Through the writing of options on foreign currencies, a fund also may be
required to forego all or a portion of the benefits that might otherwise have
been obtained from favorable movements in exchange rates.
The funds may write covered call options on foreign currencies. A call option
written on a foreign currency is "covered" if the fund owns the underlying
foreign currency covered by the call or has an absolute and immediate right
to acquire that foreign currency without additional cash consideration (or
for additional cash consideration held in a segregated account by its
custodian bank) upon conversion or exchange of other foreign currency held in
its portfolio. A call option is also covered if the fund has a call on the
same foreign currency and in the same principal amount as the call written
where the exercise price of the call held is (a) equal to or less than the
exercise price of the call written or (b) greater than the exercise price of
the call written if the difference is maintained by the fund in cash, U.S.
government securities, or other high grade liquid debt securities in a
segregated account with its custodian bank.
The funds may also write call options on foreign currencies that are not
covered for cross-hedging purposes. A call option on a foreign currency is
for cross-hedging purposes if it is not covered, but is designed to provide a
hedge against a decline in the U.S. dollar value of a security which the fund
owns or has the right to acquire and which is denominated in the currency
underlying the option due to an adverse change in the exchange rate. In such
circumstances, a fund collateralizes the option by maintaining in a
segregated account with the fund's custodian bank, cash or U.S. government
securities or other high grade liquid debt securities in an amount not less
than the value of the underlying foreign currency in U.S. dollars
marked-to-market daily.
OPTIONS AND FINANCIAL FUTURES - ALL FUNDS EXCEPT NATURAL RESOURCES FUND. The
funds may write covered put and call options and buy put and call options on
stocks, stocks indices, and bonds that trade on securities exchanges and in
the over-the-counter market. The funds may buy and sell futures and options
on futures with respect to stock and bond indices. Additionally, the funds
may engage in "close-out" transactions with respect to futures and options.
WRITING CALL OPTIONS - ALL FUNDS EXCEPT NATURAL RESOURCES FUND. Call options
written by a fund give the holder the right to buy the underlying securities
from the fund at a stated exercise price. A call option written by a fund is
"covered" if the fund owns the underlying security that is subject to the
call or has an absolute and immediate right to acquire that security without
additional cash consideration (or for additional cash consideration held in a
segregated account by its custodian bank) upon conversion or exchange of
other securities held in its portfolio. A call option 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 is (a) equal to or
less than the exercise price of the call written or (b) greater than the
exercise price of the call written if the difference is maintained by the
fund in cash and high grade debt securities in a segregated account with its
custodian bank. The premium paid by the buyer of an option will reflect,
among other things, the relationship of the exercise price to the market
price and volatility of the underlying security, the remaining term of the
option, supply and demand, and interest rates.
With regard to certain options, the writer of an option may have no control
over when the underlying securities must be sold, in the case of a call
option, because the writer may be assigned an exercise notice at any time
before the termination of the obligation. Whether or not an option expires
unexercised, the writer retains the amount of the premium. This amount may,
in the case of a covered call option, be offset by a decline in the market
value of the underlying security during the option period. If a call option
is exercised, the writer experiences a profit or loss from the sale of the
underlying security.
The writer of an option that wishes to terminate its obligation may effect a
"closing purchase transaction" by buying an option of the same series as the
option previously written. The effect of the purchase is that the clearing
corporation will cancel the writer's position. A writer may not effect a
closing purchase transaction, however, after being notified of the exercise
of an option. Likewise, an investor who is the holder of an option may
liquidate its position by effecting a "closing sale transaction" by selling
an option of the same series as the option previously purchased. There is no
guarantee that either a closing purchase or a closing sale transaction can be
effected.
Effecting a closing transaction in the case of a written call option will
allow a fund to write another call option on the underlying security with
either a different exercise price or expiration date or both. Also, effecting
a closing transaction will allow the cash or proceeds from the concurrent
sale of any securities subject to the option to be used for other fund
investments. If a fund desires to sell a particular security from its
portfolio on which it has written a call option, it will effect a closing
transaction before or at the same time as the sale of the security.
A fund will realize a profit from a closing transaction if the price of the
transaction is less than the premium received from writing the option or is
more than the premium paid to buy the option. A fund will realize a loss from
a closing transaction if the price of the transaction is more than the
premium received from writing the option or is less than the premium paid to
buy the option. Because increases in the market price of a call option will
generally reflect increases in the market price of the underlying security,
any loss resulting from the repurchase of a call option is likely to be
offset in whole or in part by appreciation of the underlying security owned
by the fund.
BUYING CALL OPTIONS - ALL FUNDS EXCEPT NATURAL RESOURCES FUND. Each fund may
buy call options on securities that it intends to purchase in order to limit
the risk of a substantial increase in the market price of such security. Each
fund may also buy call options on securities held in its portfolio and on
which it has written call options. A call option gives the holder the right
to buy the underlying securities from the option writer at a stated exercise
price. Before its expiration, a call option may be sold in a closing sale
transaction. Profit or loss from the sale will depend on whether the amount
received is more or less than the premium paid for the call option plus
related transaction costs.
WRITING PUT OPTIONS - ALL FUNDS EXCEPT NATURAL RESOURCES FUND. The funds may
write covered put options. A put option gives the buyer of the option the
right to sell, and the writer (seller) the obligation to buy, the underlying
security at the exercise price during the option period. The option may be
exercised at any time before its expiration date. The operation of put
options in other respects, including their related risks and rewards, is
substantially identical to that of call options.
If a fund writes put options, it will do so on a covered basis. This means
that the fund would maintain, in a segregated account, cash, U.S. government
securities, or other liquid, high-grade debt securities in an amount not less
than the exercise price at all times while the put option is outstanding. The
rules of the clearing corporation currently require that such assets be
deposited in escrow to secure payment of the exercise price. A fund would
generally write covered put options when the manager wants to buy the
underlying security or currency for the fund's portfolio at a price lower
than the current market price of the security or currency. In this event, the
fund would write a put option at an exercise price that, reduced by the
premium received on the option, reflects the lower price it is willing to
pay. Since the fund would also receive interest on debt securities maintained
to cover the exercise price of the option, this technique could be used to
enhance current return during periods of market uncertainty. The risk in such
a transaction would be that the market price of the underlying security or
currency would decline below the exercise price less the premiums received.
BUYING PUT OPTIONS - ALL FUNDS EXCEPT NATURAL RESOURCES FUND. Each fund may
buy a put option on an underlying security or currency owned by the fund as a
hedging technique in order to protect against an anticipated decline in the
value of the security or currency (protective put). Such hedge protection is
provided only during the life of the put option when a fund, as the holder of
the put option, is able to sell the underlying security or currency at the
put exercise price, regardless of any decline in the underlying security's
market price or currency's exchange value. For example, a put option may be
purchased in order to protect unrealized appreciation of a security or
currency when the manager deems it desirable to continue to hold the security
or currency because of tax considerations. The premium paid for the put
option and any transaction costs would reduce any capital gain otherwise
available for distribution when the security or currency is eventually sold.
A fund may also buy put options at a time when the fund does not own the
underlying security or currency. By buying put options on a security or
currency it does not own, a fund seeks to benefit from a decline in the
market price of the underlying security or currency. If the put option is not
sold when it has remaining value, and if the market price of the underlying
security or currency remains equal to or greater than the exercise price
during the life of the put option, a fund will lose its entire investment in
the put option. In order for the purchase of a put option to be profitable,
the market price of the underlying security or currency must decline
sufficiently below the exercise price to cover the premium and transaction
costs, unless the put option is sold in a closing sale transaction.
The premium paid by a fund when buying a put option will be recorded as an
asset in the fund's statement of assets and liabilities. This asset will be
adjusted daily to the option's current market value, which will be the latest
sale price at the time at which the net asset value per share of the fund is
computed. The asset will be extinguished upon expiration of the option, the
writing of an identical option in a closing transaction, or the delivery of
the underlying security or currency upon the exercise of the option.
OVER-THE-COUNTER (OTC) OPTIONS - ALL FUNDS EXCEPT NATURAL RESOURCES FUND.
Each fund intends to write covered put and call options and buy put and call
options that trade in the over-the-counter market to the same extent that it
will engage in exchange traded options. OTC options, however, differ from
exchange traded options in certain material respects.
OTC options are arranged directly with dealers and not, as is the case with
exchange traded options, with a clearing corporation. Thus, there is a risk
of non-performance by the dealer. Because there is no exchange, pricing is
typically done by reference to information from market makers. OTC options
are available, however, for a greater variety of securities, and in a wider
range of expiration dates and exercise prices, than exchange traded options,
and the writer of an OTC option is paid the premium in advance by the dealer.
The funds understand the current position of the staff of the U.S. Securities
and Exchange Commission (SEC) to be that purchased OTC options are illiquid
securities and that the assets used to cover the sale of an OTC option are
considered illiquid. The funds and the manager disagree with this position.
Nevertheless, pending a change in the staff's position, each fund will treat
OTC options and "cover" assets as subject to the fund's limitation on
illiquid securities.
OPTIONS ON STOCK INDICES - ALL FUNDS EXCEPT NATURAL RESOURCES FUND. The funds
may buy call and put options on stock indices in order to hedge against the
risk of market or industry-wide stock price fluctuations. Call and put
options on stock indices are similar to options on securities except that,
rather than the right to buy or sell stock at a specified price, options on a
stock index give the holder the right to receive, upon exercise of the
option, an amount of cash if the closing level of the underlying stock index
is greater than (or less than, in the case of puts) the exercise price of the
option. This amount of cash is equal to the difference between the closing
price of the index and the exercise price of the option, expressed in dollars
multiplied by a specified number. Thus, unlike stock options, all settlements
are in cash, and gain or loss depends on price movements in the stock market
generally (or in a particular industry or segment of the market) rather than
price movements in individual stocks.
When a fund writes an option on a stock index, the fund will establish a
segregated account containing cash or high quality fixed-income securities
with its custodian bank in an amount at least equal to the market value of
the underlying stock index and will maintain the account while the option is
open or it will otherwise cover the transaction.
FUTURES CONTRACTS - ALL FUNDS EXCEPT NATURAL RESOURCES FUND. The funds may
enter into contracts for the purchase or sale for future delivery of
securities and in such contracts based upon financial indices (financial
futures). Financial futures contracts are commodity contracts that obligate
the long or short holder to take or make delivery of a specified quantity of
a financial instrument, such as a security, or the cash value of a securities
index during a specified future period at a specified price. A "sale" of a
futures contract means the acquisition of a contractual obligation to deliver
the securities called for by the contract at a specified price on a specified
date. A "purchase" of a futures contract means the acquisition of a
contractual obligation to acquire the securities called for by the contract
at a specified price on a specified date. Futures contracts have been
designed by exchanges that have been designated "contracts markets" by the
Commodity Futures Trading Commission (CFTC) and must be executed through a
futures commission merchant, or brokerage firm, which is a member of the
relevant contract market.
At the same time a futures contract is purchased or sold, a fund must
allocate cash or securities as a deposit payment (initial deposit). Daily
thereafter, the futures contract is valued and the payment of "variation
margin" may be required since each day the fund would provide or receive cash
that reflects any decline or increase in the contract's value.
Although futures contracts by their terms call for the actual delivery or
acquisition of securities, in most cases the contractual obligation is
fulfilled before the date of the contract without having to make or take
delivery of the securities. The offsetting of a contractual obligation is
accomplished by buying (or selling, as the case may be) on a commodities
exchange an identical futures contract calling for delivery in the same
month. Such a transaction, which is effected through a member of an exchange,
cancels the obligation to make or take delivery of the securities. Since all
transactions in the futures market are made, offset or fulfilled through a
clearinghouse associated with the exchange on which the contracts are traded,
a fund will incur brokerage fees when it buys or sells futures contracts.
A fund will generally not engage in transactions in futures contracts or
related options for speculation but only as a hedge against changes resulting
from market conditions in the values of its securities or securities that it
intends to buy. The purpose of the acquisition or sale of a futures contract
is to attempt to protect the fund from fluctuations in price of portfolio
securities without actually buying or selling the underlying security. To the
extent a fund enters into a futures contract, it will maintain with its
custodian bank, to the extent required by the rules of the SEC, assets in a
segregated account to cover its obligations with respect to such contract
which will consist of cash, cash equivalents, or high quality debt securities
from its portfolio in an amount equal to the difference between the
fluctuating market value of such futures contract and the aggregate value of
the initial and variation margin payments made by the fund with respect to
such futures contracts.
STOCK INDEX FUTURES - all funds except Natural Resources Fund. A stock index
futures contract obligates the seller to deliver (and the buyer to take) an
amount of cash equal to a specific dollar amount times the difference between
the value of a specific stock index at the close of the last trading day of
the contract and the price at which the agreement is made. No physical
delivery of the underlying stocks in the index is made.
Each fund may sell stock index futures contracts in anticipation of or during
a market decline to attempt to offset the decrease in market value of its
equity securities that might otherwise result. When a fund is not fully
invested in stocks and anticipates a significant market advance, it may
purchase stock index futures in order to gain rapid market exposure that may
in part or entirely offset increases in the cost of common stocks that it
intends to buy.
OPTIONS ON STOCK INDEX FUTURES - ALL FUNDS EXCEPT NATURAL RESOURCES FUND. The
funds may buy and sell call and put options on stock index futures to hedge
against risks of market-side price movements. The need to hedge against such
risks will depend on the extent of diversification of the fund's common stock
portfolio and the sensitivity of such investments to factors influencing the
stock market as a whole.
Call and put options on stock index futures are similar to options on
securities except that, rather than the right to buy or sell stock at a
specified price, options on stock index futures give the holder the right to
receive cash. Upon exercise of the option, the delivery of the futures
position by the writer of the option to the holder of the option will be
accompanied by delivery of the accumulated balance in the writer's futures
margin account which represents the amount by which the market price of the
futures contract, at exercise, exceeds, in the case of a call, or is less
than, in the case of a put, the exercise price of the option on the futures
contract. If an option is exercised on the last trading day before the
expiration date of the option, the settlement will be made entirely in cash
equal to the difference between the exercise price of the option and the
closing price of the futures contract on the expiration date.
BOND INDEX FUTURES AND RELATED OPTIONS - ALL FUNDS EXCEPT NATURAL RESOURCES
FUND. The funds may purchase and sell futures contracts based on an index of
debt securities and options on such futures contracts to the extent they
currently exist and, in the future, may be developed. The funds reserve the
right to conduct futures and options transactions based on an index which may
be developed in the future to correlate with price movements in certain
categories of debt securities. Each fund's investment strategy in employing
futures contracts based on an index of debt securities will be similar to
that used by it in other financial futures transactions.
The funds also may buy and write put and call options on bond index futures
and enter into closing transactions with respect to such options.
FUTURE DEVELOPMENTS - ALL FUNDS EXCEPT NATURAL RESOURCES FUND. Each fund may
take advantage of opportunities in the area of options and futures contracts
and options on futures contracts and any other derivative investments that
are not presently contemplated for use by the fund or which are not currently
available but which may be developed, to the extent such opportunities are
both consistent with the fund's investment goal and legally permissible for
the fund.
SHORT SALES The Biotechnology Fund may engage in two types of short sale
transactions, "naked short sales" and "short sales against the box." In a
naked short sale transaction, the fund sells a security that it does not own
to a purchaser at a specified price. In order to complete the short sale
transaction, the fund must (1) borrow the security to deliver the security to
the purchaser, and (2) buy the same security in the market in order to return
it to the borrower. In buying the security to replace the borrowed security,
the fund expects to buy the security in the market for less than the amount
it earned on the short sale, thereby yielding a profit. No securities will be
sold short if, after the sale, the total market value of all the
Biotechnology Fund's open naked short positions would exceed 50% of its
assets.
The Biotechnology Fund may also sell securities "short against the box"
without limit. In a short sale against the box, the fund actually holds in
its portfolio the securities which it has sold short. In replacing the
borrowed securities in the transaction, the fund may either buy securities in
the open market or use those in its portfolio.
PRIVATE INVESTMENTS Consistent with their respective investment goals and
policies, the Health Care Fund and the Biotechnology Fund may from time to
time make private investments in companies whose securities are not publicly
traded. These investments typically will take the form of letter stock or
convertible preferred stock. Because these securities are not publicly
traded, there is no secondary market for the securities. The Health Care Fund
and the Biotechnology Fund will treat these securities as illiquid.
TEMPORARY INVESTMENTS Each fund may invest its cash temporarily in short-term
debt instruments, including U.S. government securities, CDs, high-grade
commercial paper, repurchase agreements, and other money market equivalents,
and the shares of money market funds managed by the manager that invest
primarily in short-term debt securities. The funds will make these temporary
investments with cash they hold to maintain liquidity or pending investment.
In the event of a general decline in the market prices of stocks in which a
fund invests, or when the manager anticipates such a decline, the fund may
invest its portfolio in a temporary defensive manner. Under such
circumstances, a fund may invest up to 100% of its assets in short-term debt
instruments.
INVESTMENT RESTRICTIONS Each fund has adopted the following restrictions as
fundamental policies. This means they may only be changed if the change is
approved by (i) more than 50% of the fund's outstanding shares or
(ii) 67% or more of the fund's shares present at a shareholder meeting if
more than 50% of the fund's outstanding shares are represented at the meeting
in person or by proxy, whichever is less.
Biotechnology Fund may not:
1. Make loans to other persons, except by the purchase of bonds, debentures
or similar obligations which are publicly distributed or of a character
usually acquired by institutional investors or through loans of the fund's
portfolio securities, or to the extent the entry into a repurchase agreement
may be deemed a loan.
2. Borrow money, except in the form of reverse repurchase agreements or from
banks in order to meet redemption requests that might otherwise require the
untimely disposition of portfolio securities or for other temporary or
emergency (but not investment) purposes, in an amount up to 10% of the value
of the fund's total assets (including the amount borrowed) based on the
lesser of cost or market, less liabilities (not including the amount
borrowed) at the time the borrowing is made, and except to facilitate
portfolio transactions in which the fund is permitted to engage to the extent
such transactions may be deemed to constitute borrowing under this
restriction. While borrowings exceed 5% of the fund's total assets, the fund
will not make any additional investments.
3. Underwrite securities of other issuers or invest more than 15% of its
assets in illiquid securities.
4. Invest in securities for the purpose of exercising management or control
of the issuer.
5. Invest in the securities of other investment companies, except in
accordance with the federal securities laws. To the extent permitted by
exemptions granted under the Investment Company Act of 1940, as amended (1940
Act), the fund may invest in shares of one or more money market funds managed
by Franklin Advisers, Inc. (Advisers) or its affiliates.
6. Concentrate its investments in any industry except
that the fund will invest at least 25% of its total assets in equity
securities of biotechnology companies.
Biotechnology Fund presently has the following additional restrictions, which
are not fundamental and may be changed without shareholder approval.
Biotechnology Fund may not:
1. Pledge, mortgage or hypothecate the fund's assets as security for loans,
nor to engage in joint or joint and several trading accounts in securities,
except that it may: (i) participate in joint repurchase arrangements; (ii)
invest in shares of one or more money market funds managed by Advisers or its
affiliates, to the extent permitted by exemptions granted under the 1940 Act;
or (iii) combine orders to buy or sell with orders from other persons to
obtain lower brokerage commissions.
Health Care Fund may not:
1. Make loans to other persons, except by the purchase of bonds, debentures
or similar obligations which are publicly distributed or of a character
usually acquired by institutional investors or through loans of the fund's
portfolio securities, or to the extent the entry into a repurchase agreement
may be deemed a loan.
2. Borrow money (does not preclude the fund from obtaining such short-term
credit as may be necessary for the clearance of purchases and sales of its
portfolio securities), except in the form of reverse repurchase agreements or
from banks in order to meet redemption requests that might otherwise require
the untimely disposition of portfolio securities or for other temporary or
emergency (but not investment) purposes, in an amount up to 10% of the value
of the fund's total assets (including the amount borrowed) based on the
lesser of cost or market, less liabilities (not including the amount
borrowed) at the time the borrowing is made. While borrowings exceed 5% of
the fund's total assets, the fund will not make any additional investments.
3. Underwrite securities of other issuers or invest more than 10% of its
assets in securities with legal or contractual restrictions on resale
(although the fund may invest in such securities to the extent permitted
under the federal securities laws, for example, transactions between the fund
and Qualified Institutional Buyers subject to Rule 144A under the Securities
Act of 1933) or which are not readily marketable, or which have a record of
less than three years continuous operation, including the operations of any
predecessor companies, if more than 10% of the fund's total assets would be
invested in such companies.
4. Invest in securities for the purpose of exercising management or control
of the issuer.
5. Maintain a margin account with a securities dealer or invest in
commodities and commodity contracts (except that the fund may engage in
financial futures, including stock index futures, and options on stock index
futures) or lease or acquire any interests, including interests issued by
limited partnerships (other than publicly traded equity securities) in oil,
gas, or other mineral exploration or development programs, or invest in
excess of 5% of its total assets in options unrelated to the fund's
transactions in futures, including puts, calls, straddles, spreads, or any
combination thereof.
6. Effect short sales, unless at the time the fund owns securities equivalent
in kind and amount to those sold (which will normally be for deferring
recognition of gains or losses for tax purposes). The fund does not currently
intend to employ this investment technique.
7. Invest directly in real estate, real estate limited partnerships or
illiquid securities issued by real estate investment trusts (the fund may,
however, invest in marketable securities issued by real estate investment
trusts).
8. Invest in the securities of other investment companies, except where there
is no commission other than the customary brokerage commission or sales
charge, or except that securities of another investment company may be
acquired pursuant to a plan of reorganization, merger, consolidation or
acquisition, and except where the fund would not own, immediately after the
acquisition, securities of the investment companies which exceed in the
aggregate i) more than 3% of the issuer's outstanding voting stock, ii) more
than 5% of the fund's total assets and iii) together with the securities of
all other investment companies held by the fund, exceed, in the aggregate,
more than 10% of the fund's total assets. The fund may invest in shares of
one or more money market funds managed by Advisers or its affiliates
consistent with the terms of the exemptive order issued by the SEC.
9. Purchase from or sell to its officers and trustees, or any firm of which
any officer or trustee is a member, as principal, any securities, but may
deal with such persons or firms as brokers and pay a customary brokerage
commission; or purchase or retain securities of any issuer, if to the
knowledge of the trust, one or more of the officers or trustees of the trust,
or its investment adviser, own beneficially more than one-half of 1% of the
securities of such issuer and all such officers and trustees together own
beneficially more than 5% of such securities.
10. Concentrate in any industry except that the fund will invest at least 25%
of total assets in the group of health care industries consisting of
pharmaceuticals, biotechnology, health care services, medical supplies and
medical technology.
Health Care Fund presently has the following additional restrictions, which
are not fundamental and may be changed without shareholder approval.
Health Care Fund may not:
1. Pledge, mortgage or hypothecate the fund's assets
as security for loans, nor to engage in joint or joint and several trading
accounts in securities, except that it may: (i) participate in joint
repurchase arrangements; (ii) invest in shares of one or more money market
funds managed by Advisers or its affiliates, to the extent permitted by
exemptions granted under the 1940 Act; or (iii) combine orders to buy or sell
with orders from other persons to obtain lower brokerage commissions.
2. Invest in excess of 5% of its net assets, valued at the lower of cost or
market, in warrants, nor more than 2% of its net assets in warrants not
listed on either the New York Stock Exchange or the American Stock Exchange.
3. Buy the securities of any issuer if, as to 75% of the assets of the fund
at the time of the purchase, more than 10% of the voting securities of any
issuer would be held by the fund, except that this restriction does not apply
to cash, cash items (including receivables), government securities, and the
securities of other investment companies.
It is also the policy of Health Care Fund that it may, consistent with its
objective, invest a portion of its assets, as permitted by the 1940 Act and
the rules adopted thereunder, in securities or other obligations issued by
companies engaged in securities related businesses, including companies that
are securities brokers, dealers, underwriters or investment advisers.
Natural Resources Fund may not:
1. Make loans to other persons, except by the purchase of bonds, debentures
or similar obligations which are publicly distributed or of a character
usually acquired by institutional investors, or through loans of the fund's
portfolio securities, or to the extent the entry into a repurchase agreement
or similar transaction may be deemed a loan;
2. Borrow money or mortgage or pledge any of its assets, except in the form
of reverse repurchase agreements or from banks for temporary or emergency
purposes in an amount up to 33% of the value of the fund's total assets
(including the amount borrowed) based on the lesser of cost or market, less
liabilities (not including the amount borrowed) at the time the borrowing is
made. While borrowings exceed 5% of the fund's total assets, the fund will
not make any additional investments;
3. Underwrite securities of other issuers (does not preclude the fund from
obtaining such short-term credit as may be necessary for the clearance of
purchases and sales of its portfolio securities) or invest more than 5%
of its assets in illiquid securities with legal or contractual restrictions
on resale (although the fund may invest in Rule 144A restricted securities to
the full extent permitted under the federal securities laws); except that all
or substantially all of the assets of the fund may be invested in another
registered investment company having the same investment objective and
policies as the fund;
4. Invest in securities for the purpose of exercising management or control
of the issuer; except that all or substantially all of the assets of the fund
may be invested in another registered investment company having the same
investment objective and policies as the fund;
5. Effect short sales, unless at the time the fund owns securities equivalent
in kind and amount to those sold (which will normally be for deferring
recognition of gains or losses for tax purposes);
6. Invest directly in real estate, real estate limited partnerships or
illiquid securities issued by real estate investment trusts (the fund may,
however, invest up to 10% of its assets in marketable securities issued by
real estate investment trusts);
7. Invest directly in interests in oil, gas or other mineral leases,
exploration or development programs;
8. Invest in the securities of other investment companies, except where there
is no commission other than the customary brokerage commission or sales
charge, or except that securities of another investment company may be
acquired pursuant to a plan of reorganization, merger, consolidation or
acquisition, and except where the fund would not own, immediately after the
acquisition, securities of the investment companies which exceed in the
aggregate i) more than 3% of the issuer's outstanding voting stock, ii) more
than 5% of the fund's total assets and iii) together with the securities of
all other investment companies held by the fund, exceed, in the aggregate,
more than 10% of the fund's total assets; except that all or substantially
all of the assets of the fund may be invested in another registered
investment company having the same investment objective and policies as the
fund. Pursuant to available exemptions from the 1940 Act, the fund may invest
in shares of one or more money market funds managed by Advisers, or its
affiliates;
9. Purchase from or sell to its officers and trustees, or any firm of which
any officer or trustee is a member, as principal, any securities, but may
deal with such persons or firms as brokers and pay a customary brokerage
commission; or purchase or retain securities of any issuer if one or more of
the officers or trustees of the trust, or its investment adviser, own
beneficially more than one-half of 1% of the securities of such issuer and
all such officers and trustees together own beneficially more than 5% of such
securities;
10. Concentrate in any industry, except that under normal circumstances the
fund will invest at least 25% of total assets in the securities issued by
domestic and foreign companies operating within the natural resources sector;
except that all or substantially all of the assets of the fund may be
invested in another registered investment company having the same investment
objective and policies as the fund; and
11. Invest more than 10% of its assets in securities of companies which have
a record of less than three years continuous operation, including the
operations of any predecessor companies; except that all or substantially all
of the assets of the fund may be invested in another registered investment
company having the same investment objective and policies as the fund.
Natural Resources Fund presently has the following additional restrictions,
which are not fundamental and may be changed without shareholder approval.
Natural Resources Fund may not:
1. Engage in joint or joint and several trading accounts in securities,
except that it may: (i) participate in joint repurchase arrangements; (ii)
invest in shares of one or more money market funds managed by Advisers or its
affiliates, to the extent permitted by exemptions granted under the 1940 Act;
or (iii) combine orders to buy or sell with orders from other persons to
obtain lower brokerage commissions.
2. Invest in excess of 5% of its net assets, valued at the lower of cost or
market, in warrants, nor more than 2% of its net assets in warrants not
listed on either the New York Stock Exchange or the American Stock Exchange.
Utilities Fund may not:
1. Make loans to other persons, except by the purchase of bonds, debentures
or similar obligations which are publicly distributed or of a character
usually acquired by institutional investors, or through loans of the fund's
portfolio securities, or to the extent the entry into a repurchase agreement
may be deemed a loan;
2. Borrow money or mortgage or pledge any of its assets, except in the form
of reverse repurchase agreements or from banks for temporary or emergency
purposes in an amount up to 33% of the value of the fund's total assets
(including the amount borrowed) based on the lesser of cost or market, less
liabilities (not including the amount borrowed) at the time the borrowing is
made. While borrowings exceed 5% of the fund's total assets, the fund will
not make any additional investments;
3. Underwrite securities of other issuers (does not preclude the fund from
obtaining such short-term credit as may be necessary for the clearance of
purchases and sales of its portfolio securities) or invest more than 5% of
its assets in securities with legal or contractual restrictions on resale
(although the fund may invest in such securities to the extent permitted
under the federal securities laws) or which are not readily marketable, if
more than 15% of the fund's total assets would be invested in such companies;
4. Invest in securities for the purpose of exercising management or control
of the issuer;
5. Maintain a margin account with a securities dealer or invest in
commodities and commodity contracts (except that the fund may engage in
financial futures, including stock index futures, and options on stock index
futures) or lease or acquire any interests, including interests issued by
limited partnerships (other than publicly traded equity securities), in oil,
gas, or other mineral exploration or development programs, or invest in
excess of 5% of its total assets in options unrelated to the fund's
transactions in futures, including puts, calls, straddles, spreads, or any
combination thereof;
6. Effect short sales, unless at the time the fund owns securities equivalent
in kind and amount to those sold (which will normally be for deferring
recognition of gains or losses for tax purposes). The fund does not currently
intend to employ this investment technique;
7. Invest directly in real estate, real estate limited partnerships or
illiquid securities issued by real estate investment trusts (the fund may,
however, invest in marketable securities issued by real estate investment
trusts);
8. Invest in the securities of other investment companies, except where there
is no commission other than the customary brokerage commission or sales
charge, or except that securities of another investment company may be
acquired pursuant to a plan of reorganization, merger, consolidation or
acquisition, and except where the fund would not own, immediately after the
acquisition, securities of the investment companies which exceed in the
aggregate i) more than 3% of the issuer's outstanding voting stock, ii) more
than 5% of the fund's total assets and iii) together with the securities of
all other investment companies held by the fund, exceed, in the aggregate,
more than 10% of the fund's total assets. Pursuant to available exemptions
from the 1940 Act, the fund may invest in shares of one or more money market
funds managed by Advisers or its affiliates;
9. Purchase from or sell to its officers and trustees, or any firm of which
any officer or trustee is a member, as principal, any securities, but may
deal with such persons or firms as brokers and pay a customary brokerage
commission; or purchase or retain securities of any issuer if, to the
knowledge of the trust, one or more of the officers or trustees of the trust,
or its investment adviser, own beneficially more than one-half of 1% of the
securities of such issuer and all such officers and trustees together own
beneficially more than 5% of such securities;
10. Concentrate in any industry, except that the fund will invest at least
25% of total assets in the equity and debt securities issued by domestic and
foreign companies in the utilities industries; and
11. Invest more than 10% of its assets in securities of companies which have
a record of less than three years continuous operation, including the
operations of any predecessor companies.
Utilities Fund presently has the following additional restrictions, which are
not fundamental and may be changed without shareholder approval.
Utilities Fund may not:
1. Engage in joint or joint and several trading accounts in securities,
except that it may: (i) participate in joint repurchase arrangements; (ii)
invest in shares of one or more money market funds managed by Advisers or its
affiliates, to the extent permitted by exemptions granted under the 1940 Act;
or (iii) combine orders to buy or sell with orders from other persons to
obtain lower brokerage commissions.
2. Invest in excess of 5% of its net assets, valued at the lower of cost or
market, in warrants, nor more than 2% of its net assets in warrants not
listed on either the New York Stock Exchange or the American Stock Exchange.
It is also the policy of the fund that it may, consistent with its objective,
invest a portion of its assets, as permitted by the 1940 Act and the rules
adopted thereunder, in securities or other obligations issued by companies
engaged in securities related businesses, including such companies that are
securities brokers, dealers, underwriters or investment advisers.
If a bankruptcy or other extraordinary event occurs concerning a particular
security a 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 maximizing
the return to shareholders.
Generally, the policies and restrictions discussed in this SAI and in the
prospectus apply when a fund makes an investment. In most cases, the fund is
not required to sell a security because circumstances change and the security
no longer meets one or more of 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 will not be considered a violation of the
restriction or limitation.
RISKS
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FOREIGN SECURITIES You should consider carefully the substantial risks
involved in securities of companies 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 funds,
therefore, may encounter difficulty in obtaining market quotations for
purposes of valuing their portfolios and calculating their net asset values.
Foreign markets have substantially less volume than the New York Stock
Exchange, and securities of some foreign companies are less liquid and more
volatile than securities of comparable U.S. companies. Commission rates in
foreign countries, which are generally fixed rather than subject to
negotiation as in the U.S., are likely to be higher. In many foreign
countries there is less government supervision and regulation of stock
exchanges, brokers, and listed companies than in the U.S.
Investments in companies domiciled in developing countries may be subject to
potentially higher risks than investments in developed countries. These risks
include (i) less social, political, and economic stability; (ii) the small
current size of the markets for such securities and the currently low or
nonexistent volume of trading, which result in a lack of liquidity and in
greater price volatility; (iii) certain national policies which may restrict
a 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 certain Eastern European
countries, of a capital market structure or market-oriented economy; and
(vii) the possibility that recent favorable economic developments in Eastern
Europe may be slowed or reversed by unanticipated political or social events
in such countries.
In addition, many countries in which the funds may invest have experienced
substantial, and in some periods extremely high, rates of inflation for many
years. Inflation and rapid fluctuations in inflation rates have had and may
continue to have negative effects on the economies and securities markets of
certain countries. Moreover, the economies of some developing countries may
differ favorably or unfavorably from the U.S. economy in such respects as
growth of gross domestic product, rate of inflation, currency depreciation,
capital reinvestment, resource self-sufficiency, and balance of payments
position.
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 capitalization,
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 is privately negotiated outside of stock exchanges.
Because of the recent formation of the securities markets as well as the
underdeveloped state of the banking and telecommunications systems,
settlement, clearing, and registration of securities transactions are subject
to significant risks. Ownership of shares (except where shares are held
through depositories that meet the requirements of the Investment Company Act
of 1940) 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 a fund to lose its
registration through fraud, negligence, or even mere oversight. While each
fund will endeavor to ensure that its interest continues to be appropriately
recorded either itself or through a custodian or other agent inspecting the
share register and by obtaining extracts of share registers through regular
confirmations, these extracts have no legal enforceability, and it is
possible that 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 a 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 a fund if a potential purchaser is deemed unsuitable,
which may expose the fund to potential loss on the investment.
The manager 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 a fund changes
investments from one country to another or when proceeds of the sale of
shares in U.S. dollars are used for the purchase of securities in foreign
countries. Also, some countries may adopt policies that would prevent the
funds from transferring cash out of the country or withhold portions of
interest and dividends at the source. There is the possibility of cessation
of trading on national exchanges, expropriation, nationalization, or
confiscatory taxation, withholding, and other foreign taxes 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
foreign nations.
The funds may be affected either favorably or unfavorably by fluctuations in
the relative rates of exchange between the currencies of different nations,
by exchange control regulations, and by indigenous economic and political
developments. Some countries in which the funds may invest may also have
fixed or managed currencies that are not free-floating against the U.S.
dollar. Further, certain currencies may not be internationally traded.
Certain of these currencies have experienced a steady devaluation relative to
the U.S. dollar. Any devaluations in the currencies in which a fund's
portfolio securities are denominated may have a detrimental impact on the
fund. Through each 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.
The board of trustees considers at least annually the likelihood of the
imposition by any foreign government of exchange control restrictions which
would affect the liquidity of the funds' assets maintained with custodians in
foreign countries, as well as the degree of risk from political acts of
foreign governments to which such assets may be exposed. The board of
trustees also considers the degree of risk involved through the holding of
portfolio securities in domestic and foreign securities depositories.
However, in the absence of willful misfeasance, bad faith, or gross
negligence on the part of the manager, any losses resulting from the holding
of a fund's portfolio securities in foreign countries and/or with securities
depositories will be at the risk of the shareholders. No assurance can be
given that the appraisal of the risks by the fund's board of trustees will
always be correct or that such exchange control restrictions or political
acts of foreign governments might not occur.
While the Health Care Fund may invest in foreign securities, it is generally
not its intention to invest in foreign equity securities of an issuer that
meets the definition in the Internal Revenue Code of a passive foreign
investment company (PFIC). However, to the extent that the a fund invests in
these securities, the fund may be subject to both an income tax and an
additional tax in the form of an interest charge with respect to its
investment. To the extent possible, the Health Care fund will avoid the taxes
by not investing in PFIC securities or by adopting other tax strategies for
any PFIC securities it does buy.
DEPOSITARY RECEIPTS Depositary receipts reduce but do not eliminate all the
risk inherent in investing in the securities of non-U.S. issuers. To the
extent that a fund acquires depositary receipts through banks which do not
have a contractual relationship with the foreign issuer of the security
underlying the depositary receipt to issue and service such depositary
receipts, there may be an increased possibility that the fund would not
become aware of and be able to respond to corporate actions such as stock
splits or rights offerings involving the foreign issuer in a timely manner.
CURRENCY Some of the funds' investments may be denominated in foreign
currencies. Changes in foreign currency exchange rates will affect the value
of what the fund owns and the fund's share price. Generally, when the U.S.
dollar rises in value against a foreign currency, an investment in that
country loses value because that currency is worth fewer U.S. dollars.
EURO RISK. On January 1, 1999, the European Monetary Union (EMU) introduced a
new single currency, the euro, which will replace the national currency for
participating member countries. The transition and the elimination of
currency risk among EMU countries may change the economic environment and
behavior of investors, particularly in European markets. While the
implementation of the euro could have a negative effect on a fund, each
fund's manager and its affiliated services providers are taking steps they
believe are reasonably designed to address the euro issue.
HEDGING TRANSACTIONS A fund's ability to hedge effectively all or a portion
of its securities through transactions in options on securities and stock
indexes, stock index futures, financial futures and related options depends
on the degree to which price movements in the underlying index or underlying
debt securities correlate with price movements in the relevant portion of the
fund's portfolio. Inasmuch as such securities will not duplicate the
components of any index or underlying securities, the correlation will not be
perfect. Consequently, the fund bears the risk that the prices of the
securities being hedged will not move in the same amount as the hedging
instrument. It is also possible that there may be a negative correlation
between the index or other securities underlying the hedging instrument and
the hedged securities which would result in a loss on both the securities and
the hedging instrument. Accordingly, successful use by the funds of options
on securities and stock indexes, stock index futures, financial futures and
related options will be subject to the manager's ability to predict correctly
movements in the direction of the securities markets generally or of a
particular segment. This requires different skills and techniques than
predicting changes in the price of individual stocks.
In addition, adverse market movements could cause a fund to lose up to its
full investment in a call option contract and/or to experience substantial
losses on an investment in a futures contract. There is also the risk of loss
by a fund of margin deposits in the event of bankruptcy of a broker with whom
the fund has an open position in a futures contract or option.
Positions in stock index and securities options, stock index futures, and
financial futures and related options may be closed out only on an exchange
that provides a secondary market. There can be no assurance that a liquid
secondary market will exist for any particular option or futures contract or
related option at any specific time. Thus, it may not be possible to close an
option or futures position. If a fund were unable to close out a futures or
option position, and if prices moved adversely, the fund would have to
continue to make daily cash payments to maintain its required margin, and, if
the fund had insufficient cash, it might have to sell portfolio securities at
a disadvantageous time. In addition, a fund might be required to deliver the
stocks underlying futures or options contracts it holds. The inability to
close options or futures positions could also have an adverse impact on a
fund's ability to effectively hedge its securities. Each fund will enter into
an option or futures position only if there appears to be a liquid secondary
market for such options or futures.
There can be no assurance that a continuous liquid secondary market will
exist for any particular OTC option at any specific time. Consequently, a
fund may be able to realize the value of an OTC option it has purchased only
by exercising it or entering into a closing sale transaction with the dealer
that issued it. Similarly, when a fund writes an OTC option, it generally can
close out that option before its expiration only by entering into a closing
purchase transaction with the dealer to which the fund originally wrote it.
If a covered call option writer cannot effect a closing transaction, it
cannot sell the underlying security until the option expires or the option is
exercised. Therefore, a covered call option writer of an OTC option may not
be able to sell an underlying security even though it might otherwise be
advantageous to do so. Likewise, a secured put writer of an OTC option may be
unable to sell the securities pledged to secure the put for other investment
purposes while it is obligated as a put writer. Similarly, a buyer of a put
or call option might also find it difficult to terminate its position on a
timely basis in the absence of a liquid secondary market.
The CFTC and the various exchanges have established limits referred to as
"speculative position limits" on the maximum net long or net short position
that any person may hold or control in a particular futures contract. Trading
limits are also imposed on the maximum number of contracts that any person
may trade on a particular trading day. An exchange may order the liquidation
of positions found to be in violation of these limits and it may impose other
sanctions or restrictions. The funds do not believe that these trading and
positions limits will have an adverse impact on the funds' strategies for
hedging their securities.
The ordinary spreads between prices in the cash and futures markets, due to
differences in the natures of those markets, are subject to distortions.
First, all participants in the futures market are subject to initial deposit
and variation margin requirements. Rather than meeting additional variation
margin requirements, investors may close futures contracts through offsetting
transactions that could distort the normal relationship between the cash and
futures markets. Second, the liquidity of the futures market depends on
participants entering into offsetting transactions rather than making or
taking delivery. To the extent participants decide to make or take delivery,
liquidity in the futures market could be reduced, thus producing distortion.
Third, from the point of view of speculators, the margin deposit requirements
in the futures market are less onerous than margin requirements in the
securities market. Therefore, increased participation by speculators in the
futures market may cause temporary price distortions. Due to the possibility
of distortion, a correct forecast of general interest rate trends by the
manager may still not result in a successful transaction.
Although each fund believes that the use of futures contracts will benefit
the fund, if the manager's investment judgment about the general direction of
interest rates is incorrect, the fund's overall performance would be poorer
than if it had not entered into any such contract. For example, if a fund has
hedged against the possibility of an increase in interest rates that would
adversely affect the price of bonds held in its portfolio and interest rates
decrease instead, the fund will lose part or all of the benefit of the
increased value of its bonds which it has hedged because it will have
offsetting losses in its futures positions. In addition, in these situations,
if a fund has insufficient cash, it may have to sell securities from its
portfolio to meet daily variation margin requirements. These sales may be,
but will not necessarily be, at increased prices, which reflect the rising
market. A fund may have to sell securities at a time when it may be
disadvantageous to do so.
Each fund's sale of futures contracts and purchase of put options on futures
contracts will be solely to protect its investments against declines in
value. Each fund expects that normally it will buy securities upon
termination of long futures contracts and long call options on future
contracts, but under unusual market conditions it may terminate any of these
positions without a corresponding purchase of securities.
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS. While these contracts are not
presently regulated by the CFTC, the CFTC may in the future assert authority
to regulate forward contracts. In this event, the funds' ability to use
forward contracts may be restricted. The use of foreign currency forward
contracts will not eliminate fluctuations in the underlying U.S. dollar
equivalent value of, or rates of return on, a fund's foreign currency
denominated portfolio securities and the use of such techniques will subject
the fund to certain risks.
The matching of the increase in value of a forward contract and the decline
in the U.S. dollar equivalent value of the foreign currency denominated asset
that is the subject of the hedge generally will not be precise. In addition,
a fund may not always be able to enter into foreign currency forward
contracts at attractive prices and this will limit the fund's ability to use
such contracts to hedge or cross-hedge its assets. Also, with regard to the
funds' use of cross-hedges, there can be no assurance that historical
correlations between the movement of certain foreign currencies relative to
the U.S. dollar will continue. Thus, at any time, poor correlation may exist
between movements in the exchange rates of the foreign currencies in which a
fund's assets that are the subject of such cross-hedges are denominated.
FOREIGN CURRENCY FUTURES. By entering into these contracts, a fund is able to
protect against a loss resulting from an adverse change in the relationship
between the U.S. dollar and a foreign currency occurring between the trade
and settlement dates of the fund's securities transaction. These contracts
also tend to limit the potential gains that might result from a positive
change in such currency relationships.
OPTIONS ON FOREIGN CURRENCIES. Options on foreign currencies and forward
contracts are not traded on contract markets regulated by the CFTC or (with
the exception of certain foreign currency options) by the SEC. To the
contrary, such instruments are traded through financial institutions acting
as market makers, although foreign currency options are also traded on
certain national securities exchanges, such as the Philadelphia Stock
Exchange and the Chicago Board Options Exchange, subject to SEC regulation.
Similarly, options on currencies may be traded over-the-counter. In an OTC
trading environment, many of the protections afforded to exchange
participants will not be available. For example, there are no daily price
fluctuation limits, and adverse market movements could therefore continue to
an unlimited extent over a period of time. Although the purchaser of an
option cannot lose more than the amount of the premium plus related
transaction costs, this entire amount could be lost. Moreover, the option
writer and a trader of forward contracts could lose amounts substantially in
excess of their initial investments, due to the margin and collateral
requirements associated with such positions.
Options on foreign currencies traded on national securities exchanges are
within the jurisdiction of the SEC, as are other securities traded on these
exchanges. As a result, many of the protections provided to traders on
organized exchanges will be available with respect to such transactions. In
particular, all foreign currency option positions entered into on a national
securities exchange are cleared and guaranteed by the Options Clearing
Corporation (OCC), thereby reducing the risk of counterparty default.
Further, a liquid secondary market in options traded on a national securities
exchange may be more readily available than in the OTC market, potentially
permitting a fund to liquidate open positions at a profit before exercise or
expiration, or to limit losses in the event of adverse market movements.
The purchase and sale of exchange-traded foreign currency options, however,
are subject to the risks of the availability of a liquid secondary market
described above, as well as the risks regarding adverse market movements,
margining of options written, the nature of the foreign currency market,
possible intervention by governmental authorities and the effects of other
political and economic events. In addition, exchange-traded options on
foreign currencies involve certain risks not presented by the OTC market. For
example, exercise and settlement of such options must be made exclusively
through the OCC, which has established banking relationships in applicable
foreign countries for this purpose. As a result, the OCC may, if it
determines that foreign governmental restrictions or taxes would prevent the
orderly settlement of foreign currency option exercises, or would result in
undue burdens on the OCC or its clearing member, impose special procedures on
exercise and settlement, such as technical changes in the mechanics of
delivery of currency, the fixing of dollar settlement prices or prohibitions
on exercise.
In addition, forward contracts and options on foreign currencies may be
traded on foreign exchanges. Such transactions are subject to the risk of
governmental actions affecting trading in, or the prices of, foreign
currencies. The value of these positions also could be adversely affected by
(i) other complex foreign political and economic factors, (ii) lesser
availability than in the U.S. of data on which to make trading decisions,
(iii) delays in a fund's ability to act upon economic events occurring in
foreign markets during non-business hours in the U.S., (iv) the imposition of
different exercise and settlement terms and procedures and margin
requirements than in the U.S., and (v) less trading volume.
HIGH YIELD SECURITIES You should consider the increased risk of loss to
principal that is present with an investment in higher risk securities, such
as those in which the funds invest. Accordingly, an investment in a fund
should not be considered a complete investment program and should be
carefully evaluated for its appropriateness in light of your overall
investment needs and goals.
The market value of high yield, lower-quality fixed-income securities,
commonly known as junk bonds, tends to reflect individual developments
affecting the issuer to a greater degree than the market value of
higher-quality securities, which react primarily to fluctuations in the
general level of interest rates. Lower-quality securities also tend to be
more sensitive to economic conditions than higher-quality securities.
Issuers of high yield, fixed-income securities are often highly leveraged and
may not have more traditional methods of financing available to them.
Therefore, the risk associated with buying the securities of these issuers is
generally greater than the risk associated with higher-quality securities.
For example, during an economic downturn or a sustained period of rising
interest rates, issuers of lower-quality securities may experience financial
stress and may not have sufficient cash flow to make interest payments. The
issuer's ability to make timely interest and principal payments may also be
adversely affected by specific developments affecting the issuer, including
the issuer's inability to meet specific projected business forecasts or the
unavailability of additional financing.
The risk of loss due to default may also be considerably greater with
lower-quality securities because they are generally unsecured and are often
subordinated to other creditors of the issuer. If the issuer of a security in
a fund's portfolio defaults, the fund may have unrealized losses on the
security, which may lower the fund's net asset Value. Defaulted securities
tend to lose much of their value before they default. Thus, the fund's net
asset value may be adversely affected before an issuer defaults. In addition,
a fund may incur additional expenses if it must try to recover principal or
interest payments on a defaulted security.
High yield, fixed-income securities frequently have call or buy-back features
that allow an issuer to redeem the securities from a fund. These securities
are typically not callable for a period of time, usually for three to five
years from the date of issue. However, if an issuer calls its securities
during periods of declining interest rates, the manager may find it necessary
to replace the securities with lower-yielding securities, which could result
in less net investment income for a fund. The premature disposition of a high
yield security due to a call or buy-back feature, the deterioration of an
issuer's creditworthiness, or a default by an issuer may make it more
difficult for a fund to manage the timing of its income. Under the Internal
Revenue Code and U.S. Treasury regulations, a fund may have to accrue income
on defaulted securities and distribute the income to shareholders for tax
purposes, even though the fund is not currently receiving interest or
principal payments on the defaulted securities. To generate cash to satisfy
these distribution requirements, a fund may have to sell portfolio securities
that it otherwise may have continued to hold or use cash flows from other
sources, such as the sale of fund shares.
Lower quality, fixed-income securities may not be as liquid as higher-quality
securities. Reduced liquidity in the secondary market may have an adverse
impact on market price of a security and on a fund's ability to sell a
security in response to a specific economic event, such as a deterioration in
the creditworthiness of the issuer, or if necessary to meet the fund's
liquidity needs. Reduced liquidity may also make it more difficult to obtain
market quotations based on actual trades for purposes of valuing the fund's
portfolio.
The funds may buy high yield, fixed-income securities that are sold without
registration under the federal securities laws and therefore carry
restrictions on resale. While many high yielding securities have been sold
with registration rights, covenants, and penalty provisions for delayed
registration, if a fund is required to sell restricted securities before the
securities have been registered, it may be deemed an underwriter of the
securities under the Securities Act of 1933, which entails special
responsibilities and liabilities. A fund may also incur special costs in
disposing of restricted securities, although a fund will generally not incur
any costs when the issuer is responsible for registering the securities.
The funds may buy high yield, fixed-income securities during an initial
underwriting. These securities involve special risks because they are new
issues. The manager will carefully review their credit and other
characteristics. The funds have no arrangement with their underwriter or any
other person concerning the acquisition of these securities.
The high yield securities market is relatively new and much of its growth
before 1990 paralleled a long economic expansion. The recession that began in
1990 disrupted the market for high yield securities and adversely affected
the value of outstanding securities, as well as the ability of issuers of
high yield securities to make timely principal and interest payments.
Although the economy has improved and high yield securities have performed
more consistently since that time, the adverse effects previously experienced
may reoccur. For example, the highly publicized defaults on some high yield
securities during 1989 and 1990 and concerns about a sluggish economy that
continued into 1993 depressed the prices of many of these securities. While
market prices may be temporarily depressed due to these factors, the ultimate
price of any security generally reflects the true operating results of the
issuer. Factors adversely impacting the market value of high yield securities
may lower a fund's net asset value.
The funds rely on the manager's judgment, analysis and experience in
evaluating the creditworthiness of an issuer. In this evaluation, the manager
takes into consideration, among other things, the issuer's financial
resources, its sensitivity to economic conditions and trends, its operating
history, the quality of the issuer's management and regulatory matters.
UTILITY INDUSTRIES Utility companies in the U.S. and in foreign countries are
generally subject to regulation. In the U.S., most utility companies are
regulated by state and/or federal authorities. This regulation is intended to
ensure appropriate standards of service and adequate capacity to meet public
demand. Prices are also regulated, with the intention of protecting the
public while ensuring that the rate of return earned by utility companies is
sufficient to allow them to attract capital in order to grow and continue to
provide appropriate services. There can be no assurance that such pricing
policies or rates of return will continue in the future.
The nature of regulation of utility industries is evolving both in the U.S.
and in foreign countries. Changes in regulation in the U.S. increasingly
allow utility companies to provide services and products outside their
traditional geographic areas and lines of business, creating new areas of
competition within the industries. Furthermore, the manager believes that the
emergence of competition will result in utility companies potentially earning
more than their traditional regulated rates of return. Although certain
companies may develop more profitable opportunities, others may be forced to
defend their core businesses and may be less profitable. The manager seeks to
take advantage of favorable investment opportunities that are expected to
arise from these structural changes. Of course, there can be no assurance
that favorable developments will occur in the future.
Foreign utility companies are also subject to regulation, although such
regulation may or may not be comparable to that in the U.S. Foreign
regulatory systems vary from country to country and may evolve in ways
different from regulation in the U.S.
The Utilities Fund's investment policies are designed to enable it to
capitalize on evolving investment opportunities throughout the world. For
example, the rapid growth of certain foreign economies will necessitate
expansion of capacity in the utility industries in those countries. Although
many foreign utility companies currently are government-owned, the manager
believes that in order to attract significant capital for growth, foreign
governments are likely to seek global investors through the privatization of
their utility industries. Privatization, which refers to the trend toward
investor ownership of assets rather than government ownership, is expected to
occur in newer, faster-growing economies and also in more mature economies.
In addition, the economic unification of European markets is expected to
improve economic growth, reduce costs and increase competition in Europe,
which will result in opportunities for investment by the Utilities Fund in
European utility industries. Of course, there is no assurance that these
favorable developments will occur or that investment opportunities for the
fund in foreign markets will increase.
The revenues of domestic and foreign utility companies generally reflect the
economic growth and developments in the geographic areas in which they do
business. The manager takes into account anticipated economic growth rates
and other economic developments when selecting securities of utility
companies. Further descriptions of some of the anticipated opportunities and
risks of specific segments within the global utility industries are set forth
below.
ELECTRIC. The electric utility industry consists of companies that are
engaged principally in the generation, transmission, and sale of electric
energy, although many also provide other energy-related services. Domestic
electric utility companies in general have recently been favorably affected
by lower fuel and financing costs and the full or near completion of major
construction programs. In addition, many of these companies recently have
generated cash flows in excess of current operating expenses and construction
expenditures, permitting some degree of diversification into unregulated
businesses. Some electric utilities have also taken advantage of the right to
sell power outside of their traditional geographic areas. Electric utility
companies have historically been subject to the risks associated with
increases in fuel and other operating costs, high interest costs on borrowing
needed for capital construction programs, costs associated with compliance
with environmental, nuclear and other safety regulations and changes in the
regulatory climate. For example, in the U.S., the construction and operation
of nuclear power facilities are subject to increased scrutiny by, and
evolving regulations of, the Nuclear Regulatory Commission. Increased
scrutiny might result in higher operating costs and higher capital
expenditures, with the risk that regulators may disallow inclusion of these
costs in rate authorizations.
TELEPHONE COMMUNICATIONS. The telephone communications industry is a distinct
utility industry segment that is subject to different risks and
opportunities. Companies that provide telephone services and access to
telephone networks compose the largest portion of this segment. The telephone
industry is large and highly concentrated. Telephone companies in the U.S.
are still experiencing the effects of the break-up of American Telephone &
Telegraph Company, which occurred in 1984. Since that time the number of
local and long-distance companies and the competition among such companies
has increased. In addition, since 1984, companies engaged in telephone
communication services have expanded their non-regulated activities into
other businesses, including cellular telephone services, cable television,
data processing, equipment retailing and software services. This expansion
has provided significant opportunities for certain telephone companies to
increase their earnings and dividends at faster rates than have been allowed
in traditional regulated businesses. Increasing competition and other
structural changes, however, could adversely affect the profitability of such
utilities.
CABLE AND OTHER PAY TELEVISION SERVICES. Cable and pay television companies
produce and distribute programming over private networks. Cable television
continues to be a growth industry throughout most of the world. The industry
is regulated in most countries, but regulation is typically less restrictive
than regulation of the electric and telephone utility industries. Cable
companies usually enjoy local monopolies, although emerging technologies and
pro-competition legislation are presenting substantial challenges to these
monopolies and could slow growth rates.
WIRELESS TELECOMMUNICATIONS. The wireless telecommunications segment includes
those companies that provide alternative telephone and communications
services. These technologies may include cellular, paging, satellite,
microwave, and private communication networks, and other emerging
technologies. The wireless telecommunications industry is in the early
development stage and is characterized by emerging, rapidly growing companies.
GAS. Gas transmission companies and gas distribution companies are also
undergoing significant changes. In the U.S., interstate transmission
companies are regulated by the Federal Energy Regulatory Commission, which is
reducing its regulation of the industry. Many companies have diversified into
oil and gas exploration and development, making returns more sensitive to
energy prices. In the recent decade, gas utility companies have been
adversely affected by disruption in the oil industry and have also been
affected by increased concentration and competition.
WATER. Water supply utilities are companies that collect, purify, distribute,
and sell water. In the U.S. and around the world, the industry is highly
fragmented because local authorities own most of the supplies. Companies in
this industry are generally mature and are experiencing little or no per
capita volume growth.
GENERAL. There can be no assurance that the positive developments noted
above, including those relating to business growth and changing regulation,
will occur or that risk factors, other than those noted above, will not
develop in the future.
BIOTECHNOLOGY COMPANIES The Health Care Fund and the Biotechnology Fund may
invest in biotechnology companies. These companies are primarily small,
start-up ventures whose fortunes to date have risen mainly on the strength of
expectations about future products, not actual products. Although numerous
biotechnology products are in the research stage by many companies, only a
handful have reached the point of approval by the U.S. Food and Drug
Administration and subsequent commercial production and distribution. Shares
of biotechnology companies may advance on the strength of new product filings
with governmental authorities and research progress, but may also drop
sharply in response to regulatory or research setbacks.
ILLIQUID SECURITIES The sale of restricted or illiquid securities often
requires more time and results in higher brokerage charges or dealer
discounts and other selling expenses than the sale of securities eligible for
trading on national securities exchanges or in the OTC markets. Restricted
securities often sell at a price lower than similar securities that are not
subject to restrictions on resale.
144A SECURITIES Subject to its liquidity limitation, each fund may invest in
certain unregistered securities which may be sold under Rule 144A of the
Securities Act of 1933 (144A securities). Due to changing market or other
factors, 144A securities may be subject to a greater possibility of becoming
illiquid than securities that have been registered with the SEC for sale. In
addition, a fund's purchase of 144A securities may increase the level of the
security's illiquidity, as some institutional buyers may become uninterested
in purchasing such securities after the fund has purchased them.
REPURCHASE AGREEMENTS The use of repurchase agreements involves certain
risks. For example, if the other party to a repurchase 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
the 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. While the manager acknowledges these
risks, it is expected that if repurchase agreements are otherwise deemed
useful to the fund, these risks can be controlled through careful monitoring
procedures.
REITS REITs are subject to risks related to the skill of their management,
changes in value of the properties the REITs own, the quality of any credit
extended by the REITs, and general economic and other factors. An investment
in REITs includes the possibility of a decline in the value of real estate,
risks related to general and local economic conditions, overbuilding and
increased competition, increases in property taxes and operating expenses,
changes in zoning laws, casualty or condemnation losses, variations in rental
income, changes in neighborhood values, the appeal of properties to tenants,
and increases in interest rates. The value of securities of companies that
service the real estate industry will also be affected by these risks.
In addition, equity REITs are affected by changes in the value of the
underlying property owned by the trusts, while mortgage REITs are affected by
the quality of the properties to which they have extended credit. Equity and
mortgage REITs are dependent upon the REITs management skill. REITs may not
be diversified and are subject to the risks of financing projects.
OFFICERS AND TRUSTEES
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The trust has a board of trustees. The board is responsible for the overall
management of the trust, including general supervision and review of each
fund's investment activities. The board, in turn, elects the officers of the
trust who are responsible for administering the trust's day-to-day
operations. The board also monitors each fund to ensure no material conflicts
exist among share classes. While none is expected, the board will act
appropriately to resolve any material conflict that may arise.
The name, age and address of the officers and board members, as well as their
affiliations, positions held with the trust, and principal occupations during
the past five years are shown below.
Frank H. Abbott, III (78)
1045 Sansome Street, San Francisco, CA 94111
TRUSTEE
President and Director, Abbott Corporation (an investment company); director
or trustee, as the case may be, of 27 of the investment companies in the
Franklin Templeton Group of Funds; and FORMERLY, Director, MotherLode Gold
Mines Consolidated (gold mining) and Vacu-Dry Co. (food processing).
Harris J. Ashton (67)
191 Clapboard Ridge Road, Greenwich, CT 06830
TRUSTEE
Director, RBC Holdings, Inc. (bank holding company)
and Bar-S Foods (meat packing company); director or trustee, as the case may
be, of 48 of the investment companies in the Franklin Templeton Group of
Funds; and FORMERLY, President, Chief Executive Officer and Chairman of the
Board, General Host Corporation (nursery and craft centers) (until 1998).
*Harmon E. Burns (54)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND TRUSTEE
Executive Vice President and Director, Franklin Resources, Inc., Franklin
Templeton Distributors, Inc. and Franklin Templeton Services, Inc.; Executive
Vice President, Franklin Advisers, Inc.; Director, Franklin Investment
Advisory Services, Inc. and Franklin/Templeton Investor Services, Inc.; and
officer and/or director or trustee, as the case may be, of most of the other
subsidiaries of Franklin Resources, Inc. and of 52 of the investment
companies in the Franklin Templeton Group of Funds.
S. Joseph Fortunato (67)
Park Avenue at Morris County, P.O. Box 1945
Morristown, NJ 07962-1945
TRUSTEE
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.
Edith E. Holiday (47)
3239 38th Street, N.W., Washington, DC 20016
TRUSTEE
Director, Amerada Hess Corporation (exploration and refining of natural gas)
(1993-present), Hercules Incorporated (chemicals, fibers and resins)
(1993-present), Beverly Enterprises, Inc. (health care) (1995-present) and
H.J. Heinz Company (processed foods and allied products) (1994-present);
director or trustee, as the case may be, of 24 of the investment companies in
the Franklin Templeton Group of Funds; and FORMERLY, Chairman (1995-1997) and
Trustee (1993-1997), National Child Research Center, Assistant to the
President of the United States and Secretary of the Cabinet (1990-1993),
General Counsel to the United States Treasury Department (1989-1990), and
Counselor to the Secretary and Assistant Secretary for Public Affairs and
Public Liaison-United States Treasury Department (1988-1989).
*Charles B. Johnson (66)
777 Mariners Island Blvd., San Mateo, CA 94404
CHAIRMAN OF THE BOARD AND TRUSTEE
President, Chief Executive Officer and Director, Franklin Resources, Inc.;
Chairman of the Board and Director, Franklin Advisers, Inc., Franklin
Investment Advisory Services, Inc. and Franklin Templeton Distributors, Inc.;
Director, Franklin/Templeton Investor Services, Inc. and Franklin Templeton
Services, Inc.; officer and/or director or trustee, as the case may be, of
most of the other subsidiaries of Franklin Resources, Inc. and of 49 of the
investment companies in the Franklin Templeton Group of Funds.
*Rupert H. Johnson, Jr. (59)
777 Mariners Island Blvd., San Mateo, CA 94404
PRESIDENT AND TRUSTEE
Executive Vice President and Director, Franklin Resources, Inc. and Franklin
Templeton Distributors, Inc.; President and Director, Franklin Advisers, Inc.
and Franklin Investment Advisory Services, Inc.; Senior Vice President,
Franklin Advisory Services, LLC; Director, Franklin/Templeton Investor
Services, Inc.; and officer and/or director or trustee, as the case may be,
of most of the other subsidiaries of Franklin Resources, Inc. and of 52 of
the investment companies in the Franklin Templeton Group of Funds.
Frank W.T. LaHaye (70)
20833 Stevens Creek Blvd., Suite 102, Cupertino, CA 95014
TRUSTEE
General Partner, Miller & LaHaye, which is the General Partner of Peregrine
Ventures II (venture capital firm); director or trustee, as the case may be,
of 27 of the investment companies in the Franklin Templeton Group of Funds;
and FORMERLY, Director, Fischer Imaging Corporation (medical imaging
systems), Digital Transmission Systems, Inc. (wireless communications) and
Quarterdeck Corporation (software firm), and General Partner, Peregrine
Associates, which was the General Partner of Peregrine Ventures (venture
capital firm).
Gordon S. Macklin (71)
8212 Burning Tree Road, Bethesda, MD 20817
TRUSTEE
Director, Fund American Enterprises Holdings, Inc. (holding company), Martek
Biosciences Corporation, MCI WorldCom (information services), MedImmune, Inc.
(biotechnology), Spacehab, Inc. (aerospace services) and Real 3D (software);
director or trustee, as the case may be, of 48 of the investment companies in
the Franklin Templeton Group of Funds; and FORMERLY, Chairman, White River
Corporation (financial services) and Hambrecht and Quist Group (investment
banking), and President, National Association of Securities Dealers, Inc.
Martin L. Flanagan (39)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
Senior Vice President and Chief Financial Officer, Franklin Resources, Inc.,
Franklin/Templeton Investor Services, Inc. and Franklin Mutual Advisers, LLC;
Executive Vice President, Chief Financial Officer and Director, Templeton
Worldwide, Inc.; Executive Vice President, Chief Operating Officer and
Director, Templeton Investment Counsel, Inc.; Executive Vice President and
Chief Financial Officer, Franklin Advisers, Inc.; Chief Financial Officer,
Franklin Advisory Services, LLC and Franklin Investment Advisory Services,
Inc.; President and Director, Franklin Templeton Services, Inc.; officer
and/or director of some of the other subsidiaries of Franklin Resources,
Inc.; and officer and/or director or trustee, as the case may be, of 52 of
the investment companies in the Franklin Templeton Group of Funds.
Deborah R. Gatzek (50)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND SECRETARY
Senior Vice President and General Counsel, Franklin Resources, Inc.; Senior
Vice President, Franklin Templeton Services, Inc. and Franklin Templeton
Distributors, Inc.; Executive Vice President, Franklin Advisers, Inc.; Vice
President, Franklin Advisory Services, LLC and Franklin Mutual Advisers, LLC;
Vice President, Chief Legal Officer and Chief Operating Officer, Franklin
Investment Advisory Services, Inc.; and officer of 53 of the investment
companies in the Franklin Templeton Group of Funds.
Charles E. Johnson (43)
500 East Broward Blvd., Fort Lauderdale, FL 33394-3091
VICE PRESIDENT
Senior Vice President and Director, Franklin Resources, Inc.; Senior Vice
President, Franklin Templeton Distributors, Inc.; President and Director,
Templeton Worldwide, Inc.; Chairman and Director, Templeton Investment
Counsel, Inc.; Vice President, Franklin Advisers, Inc.; officer and/or
director of some of the other subsidiaries of Franklin Resources, Inc.; and
officer and/or director or trustee, as the case may be, of 33 of the
investment companies in the Franklin Templeton Group of Funds.
Diomedes Loo-Tam (60)
777 Mariners Island Blvd., San Mateo, CA 94404
TREASURER AND PRINCIPAL ACCOUNTING OFFICER
Senior Vice President, Franklin Templeton Services, Inc.; and officer of 32
of the investment companies in the Franklin Templeton Group of Funds.
Edward V. McVey (62)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT
Senior Vice President and National Sales Manager, Franklin Templeton
Distributors, Inc.; and officer of 28 of the investment companies in the
Franklin Templeton Group of Funds.
*This board member is considered an "interested person" under federal
securities laws.
Note: Charles B. Johnson and Rupert H. Johnson, Jr. are brothers and the
father and uncle, respectively, of Charles E. Johnson.
The trust pays noninterested board members $1,575 for each of the trust's
eight regularly scheduled meetings plus $1,050 per meeting attended. Board
members who serve on the audit committee of the trust and other funds in the
Franklin Templeton Group of Funds receive a flat fee of $2,000 per committee
meeting attended, a portion of which is allocated to the trust. Members of a
committee are not compensated for any committee meeting held on the day of a
board meeting. Noninterested board members 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 fees payable to
noninterested board members by the trust are subject to reductions resulting
from fee caps limiting the amount of fees payable to board members who serve
on other boards within the Franklin Templeton Group of Funds. The following
table provides the total fees paid to noninterested board members by the
trust and by the Franklin Templeton Group of Funds.
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 TRUST 1 OF FUNDS 2 EACH SERVES 3
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Frank H. Abbott, III $13,935 $159,051 27
Harris J. Ashton 16,280 361,157 48
S. Joseph Fortunato 15,279 367,835 50
Edith E. Holiday 18,975 211,400 24
Frank W.T. LaHaye 16,035 163,753 27
Gordon S. Macklin 16,280 361,157 48
1. For the fiscal year ended April 30, 1999. During the period from April 30,
1998, through May 31, 1998, fees at the rate of $300 for each of the trust's
eight meetings, plus $300 per meeting attended were in effect.
2. For the calendar year ended December 31, 1998.
3. We base the number of boards on the number of registered investment
companies in the Franklin Templeton Group of Funds. This number does not
include the total number of series or funds within each investment company
for which the board members are responsible. The Franklin Templeton Group of
Funds currently includes 54 registered investment companies, with
approximately 162 U.S. based funds or series.
Noninterested board members are reimbursed for expenses incurred in
connection with attending board meetings, paid pro rata by each fund in the
Franklin Templeton Group of Funds for which they serve as director or
trustee. No officer or board member received any other compensation,
including pension or retirement benefits, directly or indirectly from the
funds 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
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MANAGER AND SERVICES PROVIDED Each fund's manager is Franklin Advisers, Inc.
(Advisers). 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 funds to buy, hold or sell. The manager
also selects the brokers who execute each fund's portfolio transactions. The
manager provides periodic reports to the board, which reviews and supervises
the manager's investment activities. To protect the funds, the manager and
its officers, directors and employees are covered by fidelity insurance.
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 funds. Similarly, with respect
to the funds, 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 funds or other funds it manages. Of course, any transactions for the
accounts of the manager and other access persons will be made in compliance
with the funds' code of ethics.
Under the funds' code of ethics, employees of the Franklin Templeton Group
who are access persons may engage in personal securities transactions subject
to the following general restrictions and procedures: (i) the trade must
receive advance clearance from a compliance officer and must be completed by
the close of the business day following the day clearance is granted; (ii)
copies of all brokerage confirmations and statements must be sent to a
compliance officer; (iii) all brokerage accounts must be disclosed on an
annual basis; and (iv) access persons involved in preparing and making
investment decisions must, in addition to (i), (ii) and (iii) above, file
annual reports of their securities holdings each January and inform the
compliance officer (or other designated personnel) if they own a security
that is being considered for a fund or other client transaction or if they
are recommending a security in which they have an ownership interest for
purchase or sale by a fund or other client.
MANAGEMENT FEES. Each fund pays the manager a fee equal to an annual rate of:
o 0.625 of 1% of the value of average daily net assets up to and including
$100 million;
o 0.50 of 1% of the value of average daily net assets over $100 million up
to and including $250 million;
o 0.45 of 1% of the value of average daily net assets over $250 million up
to and including $10 billion;
o 0.44 of 1% of the value of average daily net assets over $10 billion up
to and including $12.5 billion;
o 0.42 of 1% of the value of average daily net assets over $12.5 billion up
to and including $15 billion;
o 0.40 of 1% of the value of average daily net assets over $15 billion.
The fee is computed at the close of business on the last business day of each
month according to the terms of the management agreement. Each class of the
funds' shares pays its proportionate share of the fee.
For the last three fiscal years ended April 30, the funds paid the following
management fees:
MANAGEMENT FEES PAID ($)
------------------------------------
1999 1998 1997
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Biotechnology Fund 445,914 161,268 1 N/A
Health Care Fund 824,463 1,141,626 873,754
Natural Resources Fund 2 52,805 159,204 83,520
Utilities Fund 1,225,638 1,179,477 1,007,080
1. For the period September 15, 1997 (inception date), to April 30, 1998,
management fees, before any advance waiver, totaled $196,583. Under an
agreement by the manager to waive or limit its fees, the fund paid the
management fees shown.
2. For the fiscal years ended April 30, 1999, 1998 and 1997, management fees,
before any advance waiver, totaled $256,117, $357,984 and $175,237,
respectively. Under an agreement by the manager to limit its fees, the fund
paid the management fees shown.
ADMINISTRATOR AND SERVICES PROVIDED Franklin Templeton Services, Inc. (FT
Services) has an agreement with Biotechnology Fund and the manager, on behalf
of Health Care Fund, Natural Resources Fund and Utilities Fund, to provide
certain administrative services and facilities for the funds. FT Services is
wholly owned by Resources and is an affiliate of the funds' 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 Biotechnology Fund and the manager (on behalf of the
remaining funds) pay FT Services a monthly fee equal to an annual rate of:
o 0.15% of a fund's average daily net assets up to $200 million;
o 0.135% of average daily net assets over $200 million up to $700 million;
o 0.10% of average daily net assets over $700 million up to $1.2 billion;
and
o 0.075% of average daily net assets over $1.2 billion.
During the last three fiscal years ended April 30, Biotechnology Fund and the
manager (on behalf of the remaining funds) paid FT Services the following
administration fees:
ADMINISTRATION FEES PAID ($)
----------------------------------
1999 1998 1997
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Biotechnology Fund 108,947 47,508 1 N/A
Health Care Fund 209,933 303,965 141,388
Natural Resources Fund 61,469 85,915 32,992
Utilities Fund 327,173 314,531 157,925
1. For the period September 15, 1997, to April 30, 1998.
SHAREHOLDER SERVICING AND TRANSFER AGENT Franklin/Templeton Investor
Services, Inc. (Investor Services) is the funds' shareholder servicing agent
and acts as the funds' transfer agent and dividend-paying agent. Investor
Services is located at 777 Mariners Island Blvd., San Mateo, CA 94404. Please
send all correspondence to Investor Services to P.O. Box 997151, Sacramento,
CA 95899-9983.
For its services, Investor Services receives a fixed fee per account. Each
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 Bank of New York, Mutual Funds Division, 90 Washington Street, New
York, NY 10286, acts as custodian of the funds' securities and other assets.
AUDITOR PricewaterhouseCoopers LLP, 333 Market Street, San Francisco, CA
94105, is the funds' independent auditor. The auditor gives an opinion on the
financial statements included in the trust's Annual Report to Shareholders
and reviews the trust's registration statement filed with the U.S. Securities
and Exchange Commission (SEC).
PORTFOLIO TRANSACTIONS
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The manager selects brokers and dealers to execute the funds' 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 funds. 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 in order
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 funds' 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 funds' 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 a fund tenders portfolio securities pursuant to a
tender-offer solicitation. To recapture brokerage for the benefit of a 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 funds 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 funds are concerned. In other cases it is possible
that the ability to participate in volume transactions may improve execution
and reduce transaction costs to the funds.
During the last three fiscal years ended April 30, the fund paid the
following brokerage commissions:
BROKERAGE COMMISSIONS PAID ($)
------------------------------------
1999 1998 1997
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Biotechnology Fund 28,350 61,003 1 N/A
Health Care Fund 246,149 178,330 200,754
Natural Resources Fund 143,235 154,303 120,604
Utilities Fund 468,206 229,415 339,618
1. For the period September 15, 1997, through April 30, 1998.
For the fiscal year ended April 30, 1999, the funds paid brokerage
commissions from aggregate portfolio transactions to brokers who provided
research services as follows:
AGGREGATE
BROKERAGE PORTFOLIO
COMMISSIONS TRANSACTIONS
($) ($)
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Biotechnology Fund 24,585 17,814,648
Health Care Fund 236,414 132,593,401
Natural Resources Fund 145,442 51,439,230
Utilities Fund 608,916 236,119,024
As of April 30, 1999, the funds did not own securities of their regular
broker-dealers.
Because the funds may, from time to time, invest in broker-dealers, it is
possible that a fund will own more than 5% of the voting securities of one or
more broker-dealers through whom such fund places portfolio brokerage
transactions. In such circumstances, the broker-dealer would be considered an
affiliated person of the fund. To the extent the fund places brokerage
transactions through such a broker-dealer at a time when the broker-dealer is
considered to be an affiliate of the fund, the fund will be required to
adhere to certain rules relating to the payment of commissions to an
affiliated broker-dealer. These rules require the fund to adhere to
procedures adopted by the board relating to ensuring that the commissions
paid to such broker-dealers do not exceed what would otherwise be the usual
and customary brokerage commissions for similar transactions.
DISTRIBUTIONS AND TAXES
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The funds calculate 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 the distribution and service (Rule 12b-1) fees of
each class. Distributions are subject to approval by the board. The funds do
not pay "interest" or guarantee any fixed rate of return on an investment in
their shares.
DISTRIBUTIONS OF NET INVESTMENT INCOME The funds receive income generally in
the form of dividends and interest on their investments. This income, less
expenses incurred in the operation of a fund, constitutes a fund's net
investment income from which dividends may be paid to you. Any distributions
by a fund from such income will be taxable to you as ordinary income, whether
you take them in cash or in additional shares.
DISTRIBUTIONS OF CAPITAL GAINS The funds may derive capital gains and losses
in connection with sales or other dispositions of their 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 a fund. Any net capital gains realized by a fund
generally will be distributed once each year, and may be distributed more
frequently, if necessary, in order 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 a
fund. Similarly, foreign exchange losses realized by a fund on the sale of
debt securities are generally treated as ordinary losses by the fund. These
gains when distributed will be taxable to you as ordinary dividends, and any
losses will reduce a fund's ordinary income otherwise available for
distribution to you. This treatment could increase or reduce a fund's
ordinary income distributions to you, and may cause some or all of a fund's
previously distributed income to be classified as a return of capital.
INFORMATION ON THE TAX CHARACTER OF DISTRIBUTIONS The funds 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, a 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 Each fund has elected
to be treated as a regulated invest-ment company under Subchapter M of the
Internal Revenue Code, has qualified as such for its most recent fiscal year,
and intends to so qualify during the current fiscal year. As regulated
investment companies, the funds generally pay no federal income tax on the
income and gains they distribute to you. The board reserves the right not to
maintain the qualification of a fund as a regulated investment company if it
determines such course of action to be beneficial to shareholders. In such
case, a 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 such fund's earnings and profits.
EXCISE TAX DISTRIBUTION REQUIREMENTS To avoid federal excise taxes, the
Internal Revenue Code requires a 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. Each fund intends to declare and
pay these amounts in December (or in January that are treated by you as
received in December) to avoid these excise taxes, but can give no assurances
that its distributions will be sufficient to eliminate all taxes.
REDEMPTION OF FUND SHARES Redemptions 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 a 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. 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
such 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 a fund, and
then reinvest the sales proceeds in such 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 gain or loss on the redemption of your
original shares in a fund. In doing so, all or a portion of the sales charge
that you paid for your original shares in a 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 OBLIGATIONS Many states grant tax-free status to dividends
paid to you from interest earned on direct obligations of the U.S.
government, subject in some states to minimum investment requirements that
must be met by a 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 do not generally qualify for tax-free treatment.
The rules on exclusion of this income are different for corporations.
DIVIDENDS-RECEIVED DEDUCTION FOR CORPORATIONS If you are a corporate
shareholder, you should note that 0.20% of the dividends paid by the
Biotechnology Fund, 71.28% of the dividends paid by the Global Utilities Fund
and 70.46% of the dividends paid by the Natural Resources Fund for the most
recent fiscal year qualified for the dividends-received deduction. In some
circumstances, you will be allowed to deduct these qualified dividends,
thereby reducing the tax that you would otherwise be required to pay on these
dividends. The dividends-received deduction will be available only with
respect to dividends designated by such fund as eligible for such treatment.
All dividends (including the deducted portion) must be included in your
alternative minimum taxable income calculation.
INVESTMENT IN COMPLEX SECURITIES The funds may invest in complex securities.
These investments may be subject to numerous special and complex tax rules.
These rules could affect whether gains and losses recognized by a fund are
treated as ordinary income or capital gain, accelerate the recognition of
income to a fund and/or defer a fund's ability to recognize losses, and, in
limited cases, subject a fund to U.S. federal income tax on income from
certain of its foreign securities. In turn, these rules may affect the
amount, timing or character of the income distributed to you by a fund.
ORGANIZATION, VOTING RIGHTS AND PRINCIPAL HOLDERS
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Each fund is a non-diversified series of Franklin Strategic Series, an
open-end management investment company, commonly called a mutual fund. The
trust was organized as a Delaware business trust on January 25, 1991, and is
registered with the SEC.
Biotechnology Fund currently offers one class of shares, Class A. Health Care
Fund and Utilities Fund currently offer three classes of shares, Class A,
Class B, and Class C and Natural Resources Fund offers two classes of shares,
Class A and Advisor Class. Before January 1, 1999, Class A shares were
designated Class I and Class C shares were designated Class II. Health Care
Fund and Utilities Fund began offering Class B shares on January 1, 1999. The
funds may offer additional classes of shares in the future. The full title of
each class is:
o Franklin Biotechnology Discovery Fund - Class A
o Franklin Global Health Care Fund - Class A
o Franklin Global Health Care Fund - Class B
o Franklin Global Health Care Fund - Class C
o Franklin Global Utilities Fund - Class A
o Franklin Global Utilities Fund - Class B
o Franklin Global Utilities Fund - Class C
o Franklin Natural Resources Fund - Class A
o Franklin Natural Resources Fund - Advisor Class
Shares of each class represent proportionate interests in each 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 trust for matters that affect the trust as a whole.
Additional series may be offered in the future.
The trust has noncumulative voting rights. For board member elections, this
gives holders of more than 50% of the shares voting the ability to elect all
of the members of the board. If this happens, holders of the remaining shares
voting will not be able to elect anyone to the board.
The trust does not intend to hold annual shareholder meetings. The trust or a
series of the trust may hold special meetings, however, for matters requiring
shareholder approval. A meeting may 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 June 8, 1999, the principal shareholders of the funds, beneficial or of
record, were:
PERCENTAGE
NAME AND ADDRESS SHARE CLASS (%)
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HEALTH CARE FUND
Franklin Resources, Inc. Class B 7.31
555 Airport Blvd.
Burlingame, CA 94010
PaineWebber Class B 44.51
FBO Keith Gordon
Roberta Gordon JTWROS
1960 Partridge Lane
Highland Park, IL 60035-2133
UTILITIES FUND
Franklin Resources, Inc. Class B 19.70
555 Airport Blvd.
Burlingame, CA 94010
Franklin Templeton Trust Company Class B 8.68
Custodian for the Rollover IRA
of
Anthony J. Messina
55 S. Hale St. 302
Palatine, IL 60067-6277
Key Clearing Corp. Class B 5.13
4900 Tiedeman Road
Brooklyn, OH 44144
Patricia H. Gulbrandsen Class B 12.96
9412 Hale Pl.
Silver Springs, MD 20910-1307
PaineWebber FBO CDN KF38125 Class B 9.91
FBO Michael W. Brady IRA
P.O Box 1108
New York, NY 10268-1108
Franklin Templeton Trust Company Class B 18.45
Custodian for the Rollover IRA
of
Barbara Cohrssen
2970 Pine St.
San Francisco, CA 94115
Note: Charles B. Johnson and Rupert H. Johnson, Jr., who are officers and/or
trustees of the trust, 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 funds.
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 June 8, 1999, the officers and board members, as a group, owned of
record and beneficially less than 1% of the outstanding shares of each fund
and class. The board members may own shares in other funds in the Franklin
Templeton Group of Funds.
BUYING AND SELLING SHARES
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The funds continuously offer their 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 funds. This reference is for convenience only
and does not indicate a legal conclusion of capacity. Banks and financial
institutions that sell shares of the funds 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 funds 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 funds 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. We may deduct any applicable banking
charges imposed by the bank from your account.
When you buy shares, if you submit a check or a draft that is returned unpaid
to a 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.
INITIAL SALES CHARGES The maximum initial sales charge is 5.75% for Class A
and 1% for Class C. There is no initial sales charge for Class B.
The initial sales charge for Class A shares may be reduced for certain large
purchases, as described in the prospectus. We offer several ways for you to
combine your purchases in the Franklin Templeton Funds to take advantage of
the lower sales charges for large purchases. The Franklin Templeton Funds
include the U.S. registered mutual funds in the Franklin Group of Funds(R) and
the Templeton Group of Funds except Franklin Templeton Variable Insurance
Products Trust, Templeton Capital Accumulator Fund, Inc., and Templeton
Variable Products Series Fund.
CUMULATIVE QUANTITY DISCOUNT. For purposes of calculating the sales charge on
Class A shares, you may combine the amount of your current purchase with the
cost or current value, whichever is higher, of your existing shares in the
Franklin Templeton Funds. You also may combine the shares of your spouse,
children under the age of 21 or grandchildren under the age of 21. If you are
the sole owner of a company, you also may add any company accounts, including
retirement plan accounts. Companies with one or more retirement plans may add
together the total plan assets invested in the Franklin Templeton Funds to
determine the sales charge that applies.
LETTER OF INTENT (LOI). You may buy Class A shares at a reduced sales charge
by completing the letter of intent section of your account application. A
letter of intent is a commitment by you to invest a specified dollar amount
during a 13 month period. The amount you agree to invest determines the sales
charge you pay. By completing the letter of intent section of the
application, you acknowledge and agree to the following:
o You authorize Distributors to reserve 5% of your total intended purchase
in Class A shares registered in your name until you fulfill your LOI. Your
periodic statements will include the reserved shares in the total shares
you own, and we will pay or reinvest dividend and capital gain
distributions on the reserved shares according to the distribution option
you have chosen.
o You give Distributors a security interest in the reserved shares and
appoint Distributors as attorney-in-fact.
o Distributors may sell any or all of the reserved shares to cover any
additional sales charge if you do not fulfill the terms of the LOI.
o Although you may exchange your shares, you may not sell reserved shares
until you complete the LOI or pay the higher sales charge.
After you file your LOI with the fund, you may buy Class A shares at the
sales charge applicable to the amount specified in your LOI. Sales charge
reductions based on purchases in more than one Franklin Templeton Fund will
be effective only after notification to Distributors that the investment
qualifies for a discount. Any Class A purchases you made within 90 days
before you filed your LOI also may qualify for a retroactive reduction in the
sales charge. If you file your LOI with the fund before a change in the
fund's sales charge, you may complete the LOI at the lower of the new sales
charge or the sales charge in effect when the LOI was filed.
Your holdings in the Franklin Templeton Funds acquired more than 90 days
before you filed your LOI will be counted towards the completion of the LOI,
but they will not be entitled to a retroactive reduction in the sales charge.
Any redemptions you make during the 13 month period, except in the case of
certain retirement plans, will be subtracted from the amount of the purchases
for purposes of determining whether the terms of the LOI have been completed.
If the terms of your LOI are met, the reserved shares will be deposited to an
account in your name or delivered to you or as you direct. If the amount of
your total purchases, less redemptions, is more than the amount specified in
your LOI and is an amount that would qualify for a further sales charge
reduction, a retroactive price adjustment will be made by Distributors and
the securities dealer through whom purchases were made. The price adjustment
will be made on purchases made within 90 days before and on those made after
you filed your LOI and will be applied towards the purchase of additional
shares at the offering price applicable to a single purchase or the dollar
amount of the total purchases.
If the amount of your total purchases, less redemptions, is less than the
amount specified in your LOI, the sales charge will be adjusted upward,
depending on the actual amount purchased (less redemptions) during the
period. You will need to send Distributors an amount equal to the difference
in the actual dollar amount of sales charge paid and the amount of sales
charge that would have applied to the total purchases if the total of the
purchases had been made at one time. Upon payment of this amount, the
reserved shares held for your account will be deposited to an account in your
name or delivered to you or as you direct. If within 20 days after written
request the difference in sales charge is not paid, we will redeem an
appropriate number of reserved shares to realize the difference. If you
redeem the total amount in your account before you fulfill your LOI, we will
deduct the additional sales charge due from the sale proceeds and forward the
balance to you.
For LOIs filed on behalf of certain retirement plans, the level and any
reduction in sales charge for these plans will be based on actual plan
participation and the projected investments in the Franklin Templeton Funds
under the LOI. These plans are not subject to the requirement to reserve 5%
of the total intended purchase or to the policy on upward adjustments in
sales charges described above, or to any penalty as a result of the early
termination of a plan, nor are these plans entitled to receive retroactive
adjustments in price for investments made before executing the LOI.
GROUP PURCHASES. If you are a member of a qualified group, you may buy Class
A shares at a reduced sales charge that applies to the group as a whole. The
sales charge is based on the combined dollar value of the group members'
existing investments, plus the amount of the current purchase.
A qualified group is one that:
o Was formed at least six months ago,
o Has a purpose other than buying fund shares at a discount,
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 funds, and
o Meets other uniform criteria that allow Distributors to achieve cost
savings in distributing shares.
A qualified group generally does not include a 403(b) plan that only allows
salary deferral contributions, although any such plan that purchased a fund's
Class A shares at a reduced sales charge under the group purchase privilege
before February 1, 1998, may continue to do so.
WAIVERS FOR INVESTMENTS FROM CERTAIN PAYMENTS. Class A shares may be
purchased without an initial sales charge or contingent deferred sales charge
(CDSC) by investors who reinvest within 365 days:
o Dividend and capital gain distributions from any Franklin Templeton Fund.
The distributions generally must be reinvested in the same share class.
Certain exceptions apply, however, to Class C shareholders who chose to
reinvest their distributions in Class A shares of a fund before November
17, 1997, and to Advisor Class or Class Z shareholders of a Franklin
Templeton Fund who may reinvest their distributions in a fund's Class A
shares. This waiver category also applies to Class B and C shares.
o Dividend or capital gain distributions from a real estate investment
trust (REIT) sponsored or advised by Franklin Properties, Inc.
o Annuity payments received under either an annuity option or from death
benefit proceeds, if the annuity contract offers as an investment option
the Franklin Templeton Variable Insurance Products Trust or the Templeton
Variable Products Series Fund. You should contact your tax advisor for
information on any tax consequences that may apply.
o Redemption proceeds from a repurchase of shares of Franklin Floating Rate
Trust, if the shares were continuously held for at least 12 months.
If you immediately placed your redemption proceeds in a Franklin Bank CD or a
Franklin Templeton money fund, you may reinvest them as described above. The
proceeds must be reinvested within 365 days from the date the CD matures,
including any rollover, or the date you redeem your money fund shares.
o Redemption proceeds from the sale of Class A shares of any of the
Templeton Global Strategy Funds if you are a qualified investor.
If you paid a CDSC when you redeemed your Class A shares from a Templeton
Global Strategy Fund, a new CDSC will apply to your purchase of fund shares
and the CDSC holding period will begin again. We will, however, credit your
fund account with additional shares based on the CDSC you previously paid and
the amount of the redemption proceeds that you reinvest.
If you immediately placed your redemption proceeds in a Franklin Templeton
money fund, you may reinvest them as described above. The proceeds must be
reinvested within 365 days from the date they are redeemed from the money
fund.
o Distributions from an existing retirement plan invested in the Franklin
Templeton Funds
WAIVERS FOR CERTAIN INVESTORS. Class A shares also may be purchased without
an initial sales charge or CDSC by various individuals and institutions due
to anticipated economies in sales efforts and expenses, including:
o Trust companies and bank trust departments agreeing to invest in Franklin
Templeton Funds over a 13 month period at least $1 million of assets held
in a fiduciary, agency, advisory, custodial or similar capacity and over
which the trust companies and bank trust departments or other plan
fiduciaries or participants, in the case of certain retirement plans, have
full or shared investment discretion. We will accept orders for these
accounts by mail accompanied by a check or by telephone or other means of
electronic data transfer directly from the bank or trust company, with
payment by federal funds received by the close of business on the next
business day following the order.
o Any state or local government or any instrumentality, department,
authority or agency thereof that has determined a fund is a legally
permissible investment and that can only buy fund shares without paying
sales charges. Please consult your legal and investment advisors to
determine if an investment in a fund is permissible and suitable for you
and the effect, if any, of payments by the fund on arbitrage rebate
calculations.
o Broker-dealers, registered investment advisors or certified financial
planners who have entered into an agreement with Distributors for clients
participating in comprehensive fee programs
o Qualified registered investment advisors who buy through a broker-dealer
or service agent who has entered into an agreement with Distributors
o Registered securities dealers and their affiliates, for their investment
accounts only
o Current employees of securities dealers and their affiliates and their
family members, as allowed by the internal policies of their employer
o Officers, trustees, directors and full-time employees of the Franklin
Templeton Funds or the Franklin Templeton Group, and their family members,
consistent with our then-current policies
o Any investor who is currently a Class Z shareholder of Franklin Mutual
Series Fund Inc. (Mutual Series), or who is a former Mutual Series Class Z
shareholder who had an account in any Mutual Series fund on October 31,
1996, or who sold his or her shares of Mutual Series Class Z within the
past 365 days
o Investment companies exchanging shares or selling assets pursuant to a
merger, acquisition or exchange offer
o Accounts managed by the Franklin Templeton Group
o Certain unit investment trusts and their holders reinvesting
distributions from the trusts
o Group annuity separate accounts offered to retirement plans
o Chilean retirement plans that meet the requirements described under
"Retirement plans" below
In addition, Class C shares may be purchased without an initial sales charge
by any investor who buys Class C shares through an omnibus account with
Merrill Lynch Pierce Fenner & Smith, Inc. A CDSC may apply, however, if the
shares are sold within 18 months of purchase.
RETIREMENT PLANS. Retirement plans sponsored by an employer (i) with at least
100 employees, or (ii) with retirement plan assets of $1 million or more, or
(iii) that agrees to invest at least $500,000 in the Franklin Templeton Funds
over a 13 month period may buy Class A shares without an initial sales
charge. Retirement plans that are not qualified retirement plans (employer
sponsored pension or profit-sharing plans that qualify under section 401 of
the Internal Revenue Code, including 401(k), money purchase pension, profit
sharing and defined benefit plans), SIMPLEs (savings incentive match plans
for employees) or SEPs (employer sponsored simplified employee pension plans
established under section 408(k) of the Internal Revenue Code) must also meet
the group purchase requirements described above to be able to buy Class A
shares without an initial sales charge. We may enter into a special
arrangement with a securities dealer, based on criteria established by the
funds, to add together certain small qualified retirement plan accounts for
the purpose of meeting these requirements.
For retirement plan accounts opened on or after May 1, 1997, a CDSC may apply
if the retirement plan is transferred out of the Franklin Templeton Funds or
terminated within 365 days of the retirement plan account's initial purchase
in the Franklin Templeton Funds.
SALES IN TAIWAN. Under agreements with certain banks in Taiwan, Republic of
China, the funds' shares are available to these banks' trust accounts without
a sales charge. The banks may charge service fees to their customers who
participate in the trusts. A portion of these service fees may be paid to
Distributors or one of its affiliates to help defray expenses of maintaining
a service office in Taiwan, including expenses related to local literature
fulfillment and communication facilities.
The funds' Class A shares may be offered to investors in Taiwan through
securities advisory firms known locally as Securities Investment Consulting
Enterprises. In conformity with local business practices in Taiwan, Class A
shares may be offered with the following schedule of sales charges:
SIZE OF PURCHASE - U.S. DOLLARS SALES CHARGE (%)
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Under $30,000 3.0
$30,000 but less than $50,000 2.5
$50,000 but less than $100,000 2.0
$100,000 but less than $200,000 1.5
$200,000 but less than $400,000 1.0
$400,000 or more 0
DEALER COMPENSATION Securities dealers may at times receive the entire sales
charge. A securities dealer who receives 90% or more of the sales charge may
be deemed an underwriter under the Securities Act of 1933, as amended.
Financial institutions or their affiliated brokers may receive an agency
transaction fee in the percentages indicated in the dealer compensation table
in the funds' prospectus.
Distributors may pay the following commissions, out of its own resources, to
securities dealers who initiate and are responsible for purchases of Class A
shares of $1 million or more: 1% on sales of $1 million to $2 million, plus
0.80% on sales over $2 million to $3 million, plus 0.50% on sales over $3
million to $50 million, plus 0.25% on sales over $50 million to $100 million,
plus 0.15% on sales over $100 million.
These breakpoints are reset every 12 months for purposes of additional
purchases.
Distributors or one of its affiliates may pay up to 1%, out of its own
resources, to securities dealers who initiate and are responsible for
purchases of Class A shares by certain retirement plans without an initial
sales charge. These payments may be made in the form of contingent advance
payments, which may be recovered from the securities dealer or set off
against other payments due to the dealer if shares are sold within 12 months
of the calendar month of purchase. Other conditions may apply. All terms and
conditions may be imposed by an agreement between Distributors, or one of its
affiliates, and the securities dealer.
In addition to the payments above, 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.
CONTINGENT DEFERRED SALES CHARGE (CDSC) If you invest $1 million or more in
Class A shares, either as a lump sum or through our cumulative quantity
discount or letter of intent programs, a CDSC may apply on any shares you
sell within 12 months of purchase. For Class C shares, a CDSC may apply if
you sell your shares within 18 months of purchase. The CDSC is 1% of the
value of the shares sold or the net asset value at the time of purchase,
whichever is less.
Certain retirement plan accounts opened on or after May 1, 1997, and that
qualify to buy Class A shares without an initial sales charge also may be
subject to a CDSC if the retirement plan is transferred out of the Franklin
Templeton Funds or terminated within 365 days of the account's initial
purchase in the Franklin Templeton Funds.
For Class B shares, there is a CDSC if you sell your shares within six years,
as described in the table below. The charge is based on the value of the
shares sold or the net asset value at the time of purchase, whichever is less.
IF YOU SELL YOUR CLASS B SHARES WITHIN THIS % IS DEDUCTED FROM
THIS MANY YEARS AFTER BUYING THEM YOUR PROCEEDS AS A CDSC
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1 Year 4
2 Years 4
3 Years 3
4 Years 3
5 Years 2
6 Years 1
7 Years 0
CDSC WAIVERS. The CDSC for any share class generally will be waived for:
o Account fees
o Sales of Class A shares purchased without an initial sales charge by
certain retirement plan accounts if (i) the account was opened before May
1, 1997, or (ii) the securities dealer of record received a payment from
Distributors of 0.25% or less, or (iii) Distributors did not make any
payment in connection with the purchase, or (iv) the securities dealer of
record has entered into a supplemental agreement with Distributors
o Redemptions of Class A shares by investors who purchased $1 million or
more without an initial sales charge if the securities dealer of record
waived its commission in connection with the purchase
o Redemptions by the funds when an account falls below the minimum required
account size
o Redemptions following the death of the shareholder or beneficial owner
o Redemptions through a systematic withdrawal plan set up before February
1, 1995
o Redemptions through a systematic withdrawal plan set up on or after
February 1, 1995, up to 1% monthly, 3% quarterly, 6% semiannually or 12%
annually of your account's net asset value depending on the frequency of
your plan
o Redemptions by Franklin Templeton Trust Company employee benefit plans or
employee benefit plans serviced by ValuSelect(R) (not applicable to Class B)
o Distributions from individual retirement accounts (IRAs) due to death or
disability or upon periodic distributions based on life expectancy (for
Class B, this applies to all retirement plan accounts, not only IRAs)
o Returns of excess contributions (and earnings, if applicable) from
retirement plan accounts
o Participant initiated distributions from employee benefit plans or
participant initiated exchanges among investment choices in employee
benefit plans (not applicable to Class B)
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, a 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 each 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 goals 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 are generally
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.
SYSTEMATIC WITHDRAWAL PLAN Our systematic withdrawal plan allows you to sell
your shares and receive regular payments from your account on a monthly,
quarterly, semiannual or annual basis. The value of your account must be at
least $5,000 and the minimum payment amount for each withdrawal must be at
least $50. For retirement plans subject to mandatory distribution
requirements, the $50 minimum will not apply. There are no service charges
for establishing or maintaining a systematic withdrawal plan.
Payments under the plan will be made from the redemption of an equivalent
amount of shares in your account, generally on the 25th day of the month in
which a payment is scheduled. If the 25th falls on a weekend or holiday, we
will process the redemption on the next business day. When you sell your
shares under a systematic withdrawal plan, it is a taxable transaction.
To avoid paying sales charges on money you plan to withdraw within a short
period of time, you may not want to set up a systematic withdrawal plan if
you plan to buy shares on a regular basis. Shares sold under the plan also
may be subject to a CDSC.
Redeeming shares through a systematic withdrawal plan may reduce or exhaust
the shares in your account if payments exceed distributions received from the
fund. This is especially likely to occur if there is a market decline. If a
withdrawal amount exceeds the value of your account, your account will be
closed and the remaining balance in your account will be sent to you. Because
the amount withdrawn under the plan may be more than your actual yield or
income, part of the payment may be a return of your investment.
You may discontinue a systematic withdrawal plan, change the amount and
schedule of withdrawal payments, or suspend one payment by notifying us by
mail or by phone at least seven business days before the end of the month
preceding a scheduled payment. The funds may discontinue a systematic
withdrawal plan by notifying you in writing and will automatically
discontinue a systematic withdrawal plan if all shares in your account are
withdrawn or if the fund receives notification of the shareholder's death or
incapacity.
REDEMPTIONS IN KIND Each 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.
Redemptions in kind are taxable transactions. The funds do 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.
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 a 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 funds
nor their affiliates will be liable for any loss caused by your failure to
cash such checks. The funds are 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.
The wiring of redemption proceeds is a special service that we make available
whenever possible. By offering this service to you, the funds are not bound
to meet any redemption request in less than the seven day period prescribed
by law. Neither the funds nor their agents shall be liable to you or any
other person if, for any reason, a redemption request by wire 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 funds
on behalf of numerous beneficial owners for recordkeeping operations
performed with respect to such owners. For each beneficial owner in the
omnibus account, a 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, each 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
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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. When you sell shares,
you receive the NAV minus any applicable CDSC.
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 funds calculate 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 funds do 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, each 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, each 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. Each 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, each fund values them according to the broadest and most
representative market as determined by the manager.
Each 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 funds' NAV is not calculated. Thus, the calculation of
the funds' 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 funds may use a pricing service, bank or securities dealer to
perform any of the above described functions.
THE UNDERWRITER
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Franklin Templeton Distributors, Inc. (Distributors) acts as the principal
underwriter in the continuous public offering of the funds' 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. Each 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.
The table below shows the aggregate underwriting commissions Distributors
received in connection with the offering of the funds' shares, the net
underwriting discounts and commissions Distributors retained after allowances
to dealers, and the amounts Distributors received in connection with
redemptions or repurchases of shares for the last three fiscal years ended
April 30:
AMOUNT
RECEIVED IN
CONNECTION
WITH
TOTAL AMOUNT REDEMPTIONS
COMMISSIONS RETAINED BY AND
RECEIVED DISTRIBUTORS REPURCHASES
($) ($) ($)
- --------------------------------------------------------------------------------
1999
Biotechnology Fund 952,419 121,172 2,150
Health Care Fund 419,582 43,356 37,292
Natural Resources 275,313 36,544 4,269
Fund
Utilities Fund 406,701 48,417 10,473
1998
Biotechnology Fund 1 2,427,478 272,305 0
Health Care Fund 1,264,914 123,956 0
Natural Resources 584,114 66,612 0
Fund
Utilities Fund 544,344 55,047 2,786
1997
Health Care Fund 3,331,378 362,830 0
Natural Resources 742,239 16,002 0
Fund
Utilities Fund 456,380 43,795 4,607
1. For the period September 15, 1997 to April 30, 1998.
Distributors may be entitled to reimbursement under the Rule 12b-1 plans, as
discussed below. Except as noted, Distributors received no other compensation
from the funds for acting as underwriter.
DISTRIBUTION AND SERVICE (12B-1) FEES Each class has a separate distribution
or "Rule 12b-1" plan. Under each plan, each fund shall pay or may reimburse
Distributors or others for the expenses of activities that are primarily
intended to sell shares of the class. 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.
The distribution and service (12b-1) fees charged to each class are based
only on the fees attributable to that particular class.
THE CLASS A PLAN. Payments by Biotechnology Fund and Natural Resources Fund
under the Class A plan may not exceed 0.35% per year of Class A's average
daily net assets, payable quarterly. Of this amount, each fund may reimburse
up to 0.35% to Distributors or others, out of which 0.10% generally will be
retained by Distributors for distribution expenses. Payments by Health Care
Fund and Utilities Fund under the Class A plan may not exceed 0.25% per year
of Class A's average daily net assets, payable quarterly. All distribution
expenses over this amount will be borne by those who have incurred them.
Health Care Fund's and Utilities Fund's Class A plan does not permit
unreimbursed expenses incurred in a particular year to be carried over to or
reimbursed in later years.
THE CLASS B AND C PLANS. Under the Class B and C plans, Health Care Fund and
Utilities Fund pay Distributors up to 0.75% per year of the class's average
daily net assets to pay Distributors or others for providing distribution and
related services and bearing certain expenses. All distribution expenses over
this amount will be borne by those who have incurred them. Under the Class B
plan, the fee is payable monthly. Under the Class C plan, the fee is payable
quarterly. Health Care Fund and Utilities Fund also may pay a servicing fee
of up to 0.25% per year of the class's average daily net assets. Under the
Class B plan, the fee is payable monthly. Under the Class C plan, the fee is
payable quarterly. This fee may be used to pay securities dealers or others
for, among other things, helping to establish and maintain customer accounts
and records, helping with requests to buy and sell shares, receiving and
answering correspondence, monitoring dividend payments from the fund on
behalf of customers, and similar servicing and account maintenance activities.
The expenses relating to each of the Class B and C plans also are used to pay
Distributors for advancing the commission costs to securities dealers with
respect to the initial sale of Class B and C shares. Further, the expenses
relating to the Class B plan may be used by Distributors to pay third party
financing entities that have provided financing to Distributors in connection
with advancing commission costs to securities dealers.
THE CLASS A, B AND C PLANS. In addition to the payments that Distributors or
others are entitled to under each plan, each plan also provides that to the
extent the fund, the manager or Distributors or other parties on behalf of
the fund, the manager or Distributors make payments that are deemed to be for
the financing of any activity primarily intended to result in the sale of
fund shares within the context of Rule 12b-1 under the Investment Company Act
of 1940, as amended, then such payments shall be deemed to have been made
pursuant to the plan. The terms and provisions of each 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 each plan, plus any other payments deemed to be made
pursuant to a plan, exceed the amount permitted to be paid under the rules of
the National Association of Securities Dealers, Inc.
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 plans 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 plans 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.
Each plan has been approved in accordance with the provisions of Rule 12b-1.
The plans are renewable annually by a vote of the board, including a majority
vote of the board members who are not interested persons of the fund and who
have no direct or indirect financial interest in the operation of the plans,
cast in person at a meeting called for that purpose. It is also required that
the selection and nomination of such board members be done by the
noninterested members of the fund's board. The plans 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. The Class A
plan of Health Care Fund and Utilities Fund also may be terminated by any act
that constitutes an assignment of the underwriting agreement with
Distributors. Distributors or any dealer or other firm also may terminate
their respective distribution or service agreement at any time upon written
notice.
The plans and any related agreements may not be amended to increase
materially the amount to be spent for distribution expenses without approval
by a majority of the outstanding shares of the class, and all material
amendments to the plans or any related agreements shall be approved by a vote
of the 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 plans and any
related agreements, as well as to furnish the board with such other
information as may reasonably be requested in order to enable the board to
make an informed determination of whether the plans should be continued.
For the fiscal year ended April 30, 1999, Distributors' eligible expenditures
for advertising, printing, payments to underwriters and broker-dealers and
other expenses pursuant to the plans and the amounts the funds paid
Distributors under the plans were:
DISTRIBUTORS' AMOUNT PAID
ELIGIBLE BY THE
EXPENSES ($) FUND ($)
- -------------------------------------------------------------------------
Biotechnology Fund 226,713 221,974
Health Care Fund
Class A 374,669 301,077
Class B 7,465 238
Natural Resources Fund 242,225 135,940
Utilities Fund
Class A 571,531 509,595
Class B 1,008 136
Class C 177,411 162,462
For the fiscal year ended April 30, 1999, the amounts paid by Health Care
Fund - Class C pursuant to the plan were:
($)
- -------------------------------------------------------------------------
Advertising 4,582
Printing and mailing prospectuses
other than to current shareholders 8,093
Payments to underwriters 2,400
Payments to broker-dealers 171,617
Other 4,940
------------------
Total 191,632
==================
PERFORMANCE
- ------------------------------------------------------------------------------
Performance quotations are subject to SEC rules. These rules require the use
of standardized performance quotations or, alternatively, that every
non-standardized performance quotation furnished by a fund be accompanied by
certain standardized performance information computed as required by the SEC.
Average annual total return and current yield quotations used by the funds
are based on the standardized methods of computing performance mandated by
the SEC. Performance figures reflect Rule 12b-1 fees from the date of the
plan's implementation. An explanation of these and other methods used by the
funds 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.
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 the maximum initial sales charge is
deducted from the initial $1,000 purchase, and 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.
When considering the average annual total return quotations for Class A and C
shares, you should keep in mind that the maximum initial sales charge
reflected in each quotation is a one time fee charged on all direct
purchases, which will have its greatest impact during the early stages of
your investment. This charge will affect actual performance less the longer
you retain your investment in the fund. The average annual total returns for
the indicated periods ended April 30, 1999, were:
SINCE
INCEPTION 1 YEAR 5 YEARS INCEPTION
DATE (%) (%) (%)
- ----------------------------------------------------------------------------
Biotechnology Fund 09/15/97 -16.55 - -6.34
Health Care Fund - Class A 02/14/92 -32.10 9.56 7.87
Health Care Fund - Class C 09/03/96 -29.83 - -5.77
Natural Resources Fund 06/05/95 -18.38 - 9.20
Utilities Fund - Class A 07/02/92 -1.97 14.05 14.57
Utilities Fund - Class C 05/01/95 1.21 - 17.71
The following SEC formula was used to calculate these figures:
n
P(1+T) = ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at
the beginning of each period at the end of each period
CUMULATIVE TOTAL RETURN Like average annual total return, cumulative total
return assumes the maximum initial sales charge is deducted from the initial
$1,000 purchase, income dividends and capital gain distributions are
reinvested at net asset value, the account was completely redeemed at the end
of each period and the deduction of all applicable charges and fees.
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 April 30,
1999, were:
SINCE
INCEPTION 1 YEAR 5 YEARS INCEPTION
DATE (%) (%) (%)
- ----------------------------------------------------------------------------
Biotechnology Fund 09/15/97 -16.55 - -10.08
Health Care Fund - Class A 02/14/92 -32.10 57.85 72.61
Health Care Fund - Class B 01/01/99 - - -21.71
Health Care Fund - Class C 09/03/96 -29.83 - -14.60
Natural Resources Fund 06/05/95 -18.38 - 41.03
Utilities Fund - Class A 07/02/92 -1.97 92.93 153.07
Utilities Fund - Class B 01/01/99 - - 2.82
Utilities Fund - Class C 05/01/95 1.21 - 92.00
CURRENT YIELD Current yield shows the income per share earned by the fund. It
is calculated by dividing the net investment income per share earned during a
30-day base period by the applicable maximum offering price per share on the
last day of the period and annualizing the result. Expenses accrued for the
period include any fees charged to all shareholders of the class during the
base period. The yields for the 30-day period ended April 30, 1999, were:
CURRENT
YIELD (%)
- ---------------------------------------------------------------------------
Natural Resources Fund 0.79
Utilities Fund - Class A 0.94
Utilities Fund - Class B 0.33
Utilities Fund - Class C 0.28
The following SEC formula was used to calculate these figures:
6
Yield = 2 [(a-b + 1) - 1]
---
cd
where:
a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the period that
were entitled to receive dividends
d = the maximum offering price per share on the last day of the period
CURRENT DISTRIBUTION RATE Current yield which is calculated according to a
formula prescribed by the SEC, is not indicative of the amounts which were or
will be paid to shareholders. Amounts paid to shareholders are reflected in
the quoted current distribution rate. The current distribution rate is
usually computed by annualizing the dividends paid per share by a class
during a certain period and dividing that amount by the current maximum
offering price. The current distribution rate differs from the current yield
computation because it may include distributions to shareholders from sources
other than dividends and interest, such as premium income from option writing
and short-term capital gains, and is calculated over a different period of
time. The current distribution rates for the 30-day period ended April 30,
1999, were:
CURRENT
DISTRIBUTION
RATE (%)
- -------------------------------------------------------------------------
Natural Resources Fund 0.83
Utilities Fund - Class A 1.05
Utilities Fund - Class C 0.46
VOLATILITY Occasionally statistics may be used to show a fund's volatility or
risk. Measures of volatility or risk are generally used to compare a 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 The funds also may quote the performance of
shares without a sales charge. Sales literature and advertising may quote a
cumulative total return, average annual total return and other measures of
performance with the substitution of net asset value for the public offering
price.
Sales literature referring to the use of the funds 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 funds may include in their 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 funds may
satisfy your investment goal, advertisements and other materials about the
funds 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:
o Dow Jones(R) Composite Average and its component averages - a
price-weighted average of 65 stocks that trade on the New York Stock
Exchange. The average is a combination of the Dow Jones Industrial Average
(30 blue-chip stocks that are generally leaders in their industry), the
Dow Jones Transportation Average (20 transportation stocks), and the Dow
Jones Utilities Average (15 utility stocks involved in the production of
electrical energy).
o Standard & Poor's(R) 500 Stock Index or its component indices - an
unmanaged capitalization-weighted index designed to measure performance of
the broad domestic economy through changes in the aggregate market value
of 500 stocks representing all major industries.
o The New York Stock Exchange composite or component indices - an unmanaged
index of all industrial, utilities, transportation, and finance stocks
listed on the NYSE.
o Wilshire 5000 Equity Index - represents the return on the market value of
all common equity securities for which daily pricing is available.
Comparisons of performance assume reinvestment of dividends.
o Lipper - Mutual Fund Performance Analysis and Lipper - Equity Fund
Performance Analysis - measure total return and average current yield for
the mutual fund industry and rank individual mutual fund performance over
specified time periods, assuming reinvestment of all distributions,
exclusive of any applicable sales charges.
o CDA Mutual Fund Report, published by CDA Investment Technologies, Inc. -
analyzes price, current yield, risk, total return, and average rate of
return (average annual compounded growth rate) over specified time periods
for the mutual fund industry.
o Mutual Fund Source Book, published by Morningstar, Inc. - analyzes price,
yield, risk, and total return for mutual funds.
o Financial publications: The WALL STREET JOURNAL, and BUSINESS WEEK,
CHANGING TIMES, FINANCIAL WORLD, FORBES, FORTUNE, and MONEY magazines -
provide performance statistics over specified time periods.
o Valueline Index - an unmanaged index which follows the stocks of
approximately 1,700 companies.
o Consumer Price Index (or Cost of Living Index), published by the U.S.
Bureau of Labor Statistics - a statistical measure of change, over time,
in the price of goods and services in major expenditure groups.
o Stocks, Bonds, Bills, and Inflation, published by Ibbotson Associates -
historical measure of yield, price, and total return for common and small
company stock, long-term government bonds, Treasury bills, and inflation.
o Savings and Loan Historical Interest Rates - as published in the U.S.
Savings & Loan League Fact Book.
o Historical data supplied by the research departments of CS First Boston
Corporation, the J. P. Morgan companies, Salomon Brothers, Merrill Lynch,
Lehman Brothers and Bloomberg L.P.
o Morgan Stanley Capital International World Indices, including, among
others, the Morgan Stanley Capital International Europe, Australia, Far
East Index (EAFE Index). The EAFE index is an unmanaged index of more than
1,000 companies of Europe, Australia and the Far East.
o Financial Times Actuaries Indices - including the FTA-World Index (and
components thereof), which are based on stocks in major world equity
markets.
o Morningstar - information published by Morningstar, Inc., including
Morningstar proprietary mutual fund ratings. The ratings reflect
Morningstar's assessment of the historical risk-adjusted performance of a
fund over specified time periods relative to other funds within its
category.
o The American Stock Exchange - an equal-dollar weighted index designed to
measure the performance of a cross section of companies in the
biotechnology industry that are primarily involved in the use of
biological processes to develop products or provide services.
From time to time, advertisements or information for the funds may include a
discussion of certain attributes or benefits to be derived from an investment
in the funds. 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 funds' performance to the
return on certificates of deposit (CDs) or other investments. You should be
aware, however, that an investment in the fund involves the risk of
fluctuation of principal value, a risk generally not present in an investment
in a CD issued by a bank. For example, as the general level of interest rates
rise, the value of the fund's fixed-income investments, if any, as well as
the value of its shares that are based upon the value of such portfolio
investments, can be expected to decrease. Conversely, when interest rates
decrease, the value of the fund's shares can be expected to increase. CDs are
frequently insured by an agency of the U.S. government. An investment in a
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 funds' 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 funds to calculate their figures. In
addition, there can be no assurance that the funds will continue their
performance as compared to these other averages.
MISCELLANEOUS INFORMATION
- ------------------------------------------------------------------------------
The funds 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 in order 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 a fund cannot guarantee that these goals will be met.
Each fund 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 more than 4 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 $227 billion in assets under management for
more than 7 million U.S. based mutual fund shareholder and other accounts.
The Franklin Templeton Group of Funds offers 112 U.S. based open-end
investment companies to the public. Each 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 funds 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.
The Information Services & Technology division of Franklin Resources, Inc.
(Resources) established a Year 2000 Project Team in 1996. This team has
already begun making necessary software changes to help the computer systems
that service the fund and its shareholders to be Year 2000 compliant. After
completing these modifications, comprehensive tests are conducted in one of
Resources' U.S. test labs to verify their effectiveness. Resources continues
to seek reasonable assurances from all major hardware, software or
data-services suppliers that they will be Year 2000 compliant on a timely
basis. Resources is also beginning to develop a contingency plan, including
identification of those mission critical systems for which it is practical to
develop a contingency plan. However, in an operation as complex and
geographically distributed as Resources' business, the alternatives to use of
normal systems, especially mission critical systems, or supplies of
electricity or long distance voice and data lines are limited.
DESCRIPTION OF RATINGS
- ------------------------------------------------------------------------------
CORPORATE BOND RATINGS
MOODY'S INVESTORS SERVICE, INC. (MOODY'S)
Aaa: Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as
"gilt-edged." Interest payments are protected by a large or exceptionally
stable margin, and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
Aa: Bonds rated Aa are judged to be high quality by all standards. Together
with the Aaa group, they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large, fluctuation of protective elements may be of greater
amplitude, or there may be other elements present that make the long-term
risks appear somewhat larger.
A: Bonds rated A possess many favorable investment attributes and are
considered upper medium-grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
that suggest a susceptibility to impairment sometime in the future.
Baa: Bonds rated Baa are considered medium-grade obligations. They are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may
be lacking or may be characteristically unreliable over any great length of
time. These bonds lack outstanding investment characteristics and, in fact,
have speculative characteristics as well.
Ba: Bonds rated Ba are judged to have predominantly speculative elements and
their future cannot be considered well assured. Often the protection of
interest and principal payments is very moderate and, thereby, not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B: Bonds rated B generally lack characteristics of the desirable investment.
Assurance of interest and principal payments or of maintenance of other terms
of the contract over any long period of time may be small.
Caa: Bonds rated Caa are of poor standing. These issues may be in default or
there may be present elements of danger with respect to principal or interest.
Ca: Bonds rated Ca represent obligations that are speculative to a high
degree. These issues are often in default or have other marked shortcomings.
C: Bonds rated C are the lowest rated class of bonds and can be regarded as
having extremely poor prospects of ever attaining any real investment
standing.
Note: Moody's applies numerical modifiers 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond ratings. The modifier
1 indicates that the security ranks in the higher end of its generic rating
category; modifier 2 indicates a mid-range ranking; and modifier 3 indicates
that the issue ranks in the lower end of its generic rating category.
STANDARD & POOR'S CORPORATION (S&P)
AAA: This is the highest rating assigned by S&P to a debt obligation and
indicates an extremely strong capacity to pay principal and interest.
AA: Bonds rated AA also qualify as high-quality debt obligations. Capacity to
pay principal and interest is very strong and, in the majority of instances,
differ from AAA issues only in a small degree.
A: Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions.
BBB: Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit protection parameters,
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity to pay principal and interest for bonds in this
category than for bonds in the A category.
BB, B, CCC, CC: Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal in accordance with the terms of the obligations.
BB indicates the lowest degree of speculation and CC the highest degree of
speculation. While these bonds will likely have some quality and protective
characteristics, they are outweighed by large uncertainties or major risk
exposures to adverse conditions.
C: Bonds rated C are typically subordinated debt to senior debt that is
assigned an actual or implied CCC- rating. The C rating 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.
SHORT-TERM DEBT & COMMERCIAL PAPER RATINGS
MOODY'S
Moody's short-term debt ratings are opinions of the ability of issuers to
repay punctually senior debt obligations. These obligations have an original
maturity not exceeding one year, unless explicitly noted. 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 for both short-term
debt and commercial paper, 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.
FRANKLIN STRATEGIC
INCOME FUND
FRANKLIN STRATEGIC SERIES - CLASS A, B & C
STATEMENT OF ADDITIONAL INFORMATION
SEPTEMBER 1, 1999, AS AMENDED JANUARY 1, 2000
- ------------------------------------------------------------------------------
[INSERT FRANKLIN TEMPLETON BEN HEAD]
P.O. BOX 997151, SACRAMENTO, CA 95899-9983 1-800/DIAL BEN(R)
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 September 1, 1999, 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 trust's Annual
Report to Shareholders, for the fiscal year ended April 30, 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/DIAL BEN (1-800/342-5236).
CONTENTS
Goals and Strategies ........................ 2
Risks ....................................... 12
Officers and Trustees ....................... 17
Management and Other Services ............... 20
Portfolio Transactions ...................... 21
Distributions and Taxes ..................... 22
Organization, Voting Rights
and Principal Holders ...................... 24
Buying and Selling Shares ................... 24
Pricing Shares .............................. 30
The Underwriter ............................. 31
Performance ................................. 32
Miscellaneous Information ................... 35
Description of Ratings ...................... 35
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MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS:
o ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION,
THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT;
o ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY
BANK;
o ARE SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL.
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GOALS AND STRATEGIES
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The fund's principal investment goal is to earn a high level of current
income. Its secondary goal is capital appreciation over the long term. These
goals are fundamental, which means they may not be changed without
shareholder approval.
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.
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 period of time. A company typically meets its payment
obligations associated with its outstanding debt securities before it
declares and pays any dividends to holders of its equity securities. Bonds,
notes, 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
these securities generally declines. To the extent the fund invests in debt
securities, these changes in market value will be reflected in its net asset
value.
MORTGAGE SECURITIES - GENERAL CHARACTERISTICS The fund may invest in mortgage
securities issued or guaranteed by the Government National Mortgage
Association ("GNMA"), the Federal National Mortgage Association ("FNMA") and
the Federal Home Loan Mortgage Corporation ("FHLMC"), adjustable rate
mortgage securities ("ARMs"), collateralized mortgage obligations ("CMOs"),
and stripped mortgage-backed securities, any of which may be privately
issued. The fund may also invest in asset-backed securities.
A mortgage security is an interest in a pool of mortgage loans. The primary
issuers or guarantors of mortgage securities are GNMA, FNMA and FHLMC. GNMA
creates mortgage securities from pools of government guaranteed or insured
(Federal Housing Authority or Veterans Administration) mortgages originated
by mortgage bankers, commercial banks, and savings and loan associations.
FNMA and FHLMC issue mortgage securities from pools of conventional and
federally insured and/or guaranteed residential mortgages obtained from
various entities, including savings and loan associations, savings banks,
commercial banks, credit unions, and mortgage bankers. The principal and
interest on GNMA securities are guaranteed by GNMA and backed by the full
faith and credit of the U.S. government. Mortgage securities from FNMA and
FHLMC are not backed by the full faith and credit of the U.S. government.
FNMA guarantees full and timely payment of all interest and principal, and
FHLMC guarantees timely payment of interest and the ultimate collection of
principal. Securities issued by FNMA are supported by the agency's right to
borrow money from the U.S. Treasury under certain circumstances. Securities
issued by FHLMC are supported only by the credit of the agency. There is no
guarantee that the government would support government agency securities and,
accordingly, they may involve a risk of non-payment of principal and
interest. Nonetheless, because FNMA and FHLMC are instrumentalities of the
U.S. government, these securities are generally considered to be high quality
investments having minimal credit risks.
Most mortgage securities are pass-through securities, which means that they
provide investors with monthly payments consisting of a pro rata share of
both regular interest and principal payments, as well as unscheduled early
prepayments, on the underlying mortgage pool. The fund invests in both
"modified" and "straight" pass-through securities. For "modified
pass-through" type mortgage securities, principal and interest are
guaranteed, whereas such guarantee is not available for "straight
pass-through" securities. CMOs and stripped mortgage securities are not
pass-through securities.
Guarantees as to the timely payment of principal and interest do not extend
to the value or yield of mortgage securities nor do they extend to the value
of the fund's shares. In general, the value of fixed-income securities varies
with changes in market interest rates. Fixed-rate mortgage securities
generally decline in value during periods of rising interest rates, whereas
interest rates of ARMS move with market interest rates, and thus their value
tends to fluctuate to a lesser degree. In view of these factors, the ability
of the fund to obtain a high level of total return may be limited under
varying market conditions.
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION CERTIFICATES ("GNMAS") GNMAS are
mortgage backed securities representing part ownership of a pool of mortgage
loans. GNMAs differ from bonds in that principal is scheduled to be paid back
by the borrower over the length of the loan rather than returned in a lump
sum at maturity. The fund may buy GNMAs for which principal and interest are
guaranteed. The fund may also buy "variable rate" GNMAs and may buy other
types that may be issued with the guarantee of the Government National
Mortgage Association ("GNMA").
The GNMA guarantee of principal and interest on GNMAs is backed by the full
faith and credit of the U.S. government. However, these securities do involve
certain risks. For example, when mortgages in the pool underlying GNMAs are
prepaid, the principal payments are passed through to the certificate holders
(such as the fund). Scheduled and unscheduled prepayments of principal may
greatly change realized yields. In a period of declining interest rates it is
more likely that mortgages contained in GNMA pools will be prepaid thus
reducing the effective yield. Moreover, any premium paid on the purchase of
GNMAs will be lost if the obligation is prepaid. In periods of falling
interest rates, this potential for pre-payment may reduce the general upward
price increase of GNMAs, which might otherwise occur. As with other debt
instruments, the price of GNMAs is likely to decrease in times of rising
interest rates. Price changes of GNMAs held by the fund have a direct impact
on the net asset value per share of the fund.
ADJUSTABLE RATE MORTGAGE SECURITIES ARMs, like traditional mortgage
securities, are an interest in a pool of mortgage loans and are issued or
guaranteed by a federal agency or by private issuers. Unlike fixed-rate
mortgages, which generally decline in value during periods of rising interest
rates, the interest rates on the mortgages underlying ARMs are reset
periodically and thus allow the fund to participate in increases in interest
rates, resulting in both higher current yields and lower price fluctuations.
During periods of declining interest rates, of course, the coupon rates may
readjust downward, resulting in lower current yields. Because of this
feature, the value of an ARM is unlikely to rise during periods of declining
interest rates to the same extent as a fixed-rate instrument. The rate of
amortization of principal, as well as interest payments, for certain types of
ARMs change in accordance with movements in a pre-specified, published
interest rate index. There are several categories of indices, including those
based on U.S. Treasury securities, those derived from a calculated measure,
such as a cost of funds index, or a moving average of mortgage rates and
actual market rates. The amount of interest due to an ARM security holder is
calculated by adding a specified additional amount, the "margin," to the
index, subject to limitations or "caps" on the maximum and minimum interest
that is charged to the mortgagor during the life of the mortgage or to
maximum and minimum changes to that interest rate during a given period. The
interest rates paid on the ARMs in which the fund may invest are generally
readjusted at intervals of one year or less, although instruments with longer
resets such as three years and five years are also permissible investments.
The underlying mortgages that collateralize the ARMs in which the fund may
invest will frequently have caps and floors which limit the maximum amount by
which the loan rate to the residential borrower may change up or down (1) per
reset or adjustment interval and (2) over the life of the loan. Some
residential mortgage loans restrict periodic adjustments by limiting changes
in the borrower's monthly principal and interest payments rather than
limiting interest rate changes. These payment caps may result in negative
amortization, which can extend the average life of the securities. Since most
ARMs in the fund's portfolio will generally have annual reset limits or caps
of 100 to 200 basis points, fluctuations in interest rates above these levels
could cause the mortgage securities to "cap out" and to behave more like
long-term, fixed-rate debt securities.
STRIPPED MORTGAGE-BACKED SECURITIES The fund may invest in stripped
mortgage-backed securities to achieve a higher yield than may be available
from fixed-rate mortgage securities. The stripped mortgage securities in
which the fund may invest will not be limited to those issued or guaranteed
by agencies or instrumentalities of the U.S. government, although such
securities are more liquid than privately issued stripped mortgage
securities. Stripped mortgage-backed securities are usually structured with
two classes, each receiving different proportions of the interest and
principal distributions on a pool of mortgage assets. Typically, one class
will receive some of the interest and most of the principal from the mortgage
assets, while the other class will receive most of the interest and the
remainder of the principal. In the most extreme case, one class will receive
all of the interest (the interest-only or "IO" class), while the other class
will receive all of the principal (the principal-only or "PO" class). The
yield to maturity of an IO or PO class is extremely sensitive not only to
changes in prevailing interest rates but also to the rate of principal
payments (including prepayments) on the related underlying mortgage assets.
Stripped mortgage-backed securities have greater market volatility than other
types of mortgage securities in which the fund invests and are purchased and
sold by institutional investors, such as the fund, through several investment
banking firms acting as brokers or dealers. As these securities were only
recently developed, traditional trading markets have not yet been established
for all stripped mortgage securities. Accordingly, some of these securities
may be illiquid. The staff of the SEC has indicated that only
government-issued IO or PO securities that are backed by fixed-rate mortgages
may be deemed to be liquid, if procedures with respect to determining
liquidity are established by a fund's board. The board may, in the future,
adopt procedures that would permit the fund to acquire, hold, and treat as
liquid government-issued IO and PO securities. At the present time, however,
all such securities will continue to be treated as illiquid and will,
together with any other illiquid investments, not exceed 10% of the fund's
net assets. This position may be changed in the future, without notice to
shareholders, in response to the staff's continued reassessment of this
matter, as well as to changing market conditions.
COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS"), REAL ESTATE MORTGAGE INVESTMENT
CONDUITS ("REMICS"), AND MULTI-CLASS PASS-THROUGHS The fund may invest in
certain debt obligations that are collateralized by mortgage loans or
mortgage pass-through securities. These obligations may be issued or
guaranteed by U.S. government agencies or issued by certain financial
institutions and other mortgage lenders. CMOs and REMICs are debt instruments
issued by special purpose entities and are secured by pools of mortgages
backed by residential and various types of commercial properties. Multi-class
pass-through securities are equity interests in a trust composed of mortgage
loans or other mortgage-backed securities. Payments of principal and interest
on the underlying collateral provides the funds to pay debt service on the
CMO or REMIC or make scheduled distributions on the multi-class pass-through
securities.
CMOs are fixed-income securities that are collateralized by pools of mortgage
loans created by commercial banks, savings and loan institutions, private
mortgage insurance companies, mortgage bankers and other issuers in the U.S.
The underlying mortgages are backed by residential and various types of
commercial properties. Timely payment of interest and principal (but not the
market value) of some of these pools is supported by various forms of
insurance or guarantees issued by private issuers, those who pool the
mortgage assets and, in some cases, by U.S. government agencies. The fund may
buy CMOs that are rated in any category by the rating agencies without
insurance or guarantee if, in the opinion of the manager, the sponsor is
creditworthy. Prepayments of the mortgages underlying a CMO, which usually
increase when interest rates decrease, will generally reduce the life of the
mortgage pool, thus impacting the CMO's yield. Under these circumstances, the
reinvestment of prepayments will generally be at a rate lower than the rate
applicable to the original CMO.
With a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of a CMO, often referred to as a "tranche," is issued at a
specified coupon rate or adjustable rate and has a stated maturity or final
distribution date. Principal prepayments on collateral underlying a CMO,
however, may cause it to be retired substantially earlier than the stated
maturities or final distribution dates. Interest is paid or accrues on all
classes of a CMO on a monthly, quarterly or semiannual basis. The principal
and interest on the underlying mortgages may be allocated among several
classes of a series in many ways. In a common structure, payments of
principal, including any principal prepayments, on the underlying mortgages
are applied to the classes of a series of a CMO in the order of their
respective stated maturities or final distribution dates, so that no payment
of principal will be made on any class of a CMO until all other classes
having an earlier stated maturity or final distribution date have been paid
in full.
To the extent any privately issued CMOs in which the fund invests are
considered by the U.S. Securities and Exchange Commission to be an investment
company, the fund will limit its investments in such securities in a manner
consistent with the provisions of the Investment Company Act of 1940, as
amended (the 1940 Act).
REMICs, which are authorized under the Tax Reform Act of 1986, are private
entities formed for the purpose of holding a fixed pool of mortgages secured
by an interest in real property. REMICs are similar to CMOs in that they
issue multiple classes of securities. As with CMOs, the mortgages that
collateralize the REMICs in which the fund may invest include mortgages
backed by GNMAs or other mortgage pass-throughs issued or guaranteed by the
U.S. government, its agencies or instrumentalities or issued by private
entities, which are not guaranteed by any government agency.
Yields on privately-issued CMOs have been historically higher than the yields
on CMOs issued or guaranteed by U.S. government agencies. However, the risk
of loss due to default on such instruments is higher since they are not
guaranteed by the U.S. government. The board believes that accepting the risk
of loss relating to privately issued CMOs that the fund acquires is justified
by the higher yield the fund will earn in light of the historic loss
experience on such instruments.
As new types of mortgage securities are developed and offered to investors,
the fund may invest in them if they are consistent with the fund's goals,
policies, and quality standards.
ASSET-BACKED SECURITIES The fund may invest in various asset-backed
securities rated in any category by the rating agencies. The underlying
assets may include, but are not limited to, receivables on home equity and
credit card loans, and automobile, mobile home, and recreational vehicle
loans and leases. There may be other types of asset-backed securities that
are developed in the future in which the fund may invest. Asset-backed
securities are issued in either a pass-through structure (similar to a
mortgage pass-through structure) or in a pay-through structure (similar to a
CMO structure). In general, asset-backed securities contain shorter
maturities than bonds or mortgage loans and historically have been less
likely to experience substantial prepayment.
Asset-backed securities entail certain risks not presented by mortgage-backed
securities, as they do not have the benefit of the same type of security
interests in the underlying collateral. Credit card receivables are generally
unsecured, and a number of state and federal consumer credit laws give
debtors the right to set off certain amounts owed on the credit cards,
thereby reducing the outstanding balance. In the case of automobile
receivables, there is a risk that the holders may not have either a proper or
first security interest in all of the obligations backing such receivables
due to the large number of vehicles involved in a typical issuance and the
technical requirements imposed under state laws. Therefore, recoveries on
repossessed collateral may not always be available to support payments on
securities backed by these receivables.
CONVERTIBLE SECURITIES The fund may invest in convertible securities. A
convertible security is generally a debt obligation or preferred stock that
may be converted within a specified period of time into a certain amount of
common stock of the same or a different issuer. A convertible security
provides a fixed-income stream and the opportunity, through its conversion
feature, to participate in the capital appreciation resulting from a market
price advance in its underlying common stock. As with a straight fixed-income
security, a convertible security tends to increase in market value when
interest rates decline and decrease in value when interest rates rise. 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 both interest rate
and market movements can influence its value, a convertible security is not
as sensitive to interest rates as a similar fixed-income security, nor is it
as sensitive to changes in share price as its underlying stock.
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. However, if
the parity price of the convertible security is less than the call price, the
operating company may pay out cash instead of common stock. 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. In addition, a convertible security
may be subject to redemption by the issuer, but only after a specified date
and under circumstances established at the time the security is issued.
While 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.
LOAN PARTICIPATIONS AND DEFAULTED DEBT SECURITIES Loan participations are
interests in floating or variable rate senior loans to U.S. corporations,
partnerships and other entities. The fund will acquire loan participations
selling at a discount to par value because of the borrower's credit problems.
To the extent the borrower's credit problems are resolved, the loan
participation may appreciate in value. The manager may acquire loan
participations for the fund when it believes, over the long term,
appreciation will occur. An investment in these securities, however, carries
substantially the same risks associated with an investment in defaulted debt
securities and may result in the loss of the fund's entire investment. The
fund will buy defaulted debt securities if, in the opinion of Advisers, it
appears the issuer may resume interest payments or other advantageous
developments appear likely in the near future.
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 to banks and broker-dealers
portfolio securities with an aggregate market value of up to one-third of its
total assets. Such loans must be secured by collateral (consisting of any
combination of cash, U.S. government securities or irrevocable letters of
credit) in an amount at least equal (on a daily marked-to-market basis) to
the current market value of the securities loaned. The fund retains all or a
portion of the interest received on investment of the cash collateral or
receives a fee from the borrower. The fund may terminate the loans at any
time and obtain the return of the securities loaned within five business
days. The fund will continue to receive any interest or dividends paid on the
loaned securities and will continue to have voting rights with respect to the
securities. However, as with other extensions of credit, there are risks of
delay in recovery or even loss of rights in collateral should the borrower
fail.
WHEN ISSUED AND DELAYED DELIVERY TRANSACTIONS The fund may buy U.S.
government obligations on a "when issued" or "delayed delivery" basis. These
transactions are arrangements under which the fund buys securities that have
been authorized but not yet issued with payment for and delivery of the
security scheduled for a future time, generally in 30 to 60 days. Purchases
of U.S. government securities on a when issued or delayed delivery basis are
subject to the risk that the value or yields at delivery may be more or less
than the purchase price or the yields available when the transaction was
entered into. Although the fund will generally buy U.S. government securities
on a when issued basis with the intention of holding the securities, it may
sell the securities before the settlement date if it is deemed advisable.
When the fund is the buyer in this type of transaction, it will maintain, in
a segregated account with its custodian bank, cash or high-grade marketable
securities having an aggregate value equal to the amount of the fund's
purchase commitments until payment is made. To the extent the fund engages in
when issued and delayed delivery transactions, it will do so only for the
purpose of acquiring portfolio securities consistent with its investment
goals and policies, and not for the purpose of investment leverage. In when
issued and delayed delivery transactions, the fund relies on the seller to
complete the transaction. The seller's failure to do so may cause the fund to
miss a price or yield considered advantageous to the fund. Securities
purchased on a when issued or delayed delivery basis do not generally earn
interest until their scheduled delivery date. Entering into a when issued or
delayed delivery transaction is a form of leverage that may affect changes in
net asset value to a greater extent.
MORTGAGE DOLLAR ROLLS The fund may enter into mortgage dollar rolls in which
the fund sells mortgage-backed securities for delivery in the current month
and simultaneously contracts to repurchase substantially similar (name, type,
coupon, and maturity) securities on a specified future date. During the
period between the sale and repurchase, the fund forgoes principal and
interest paid on the mortgage-backed securities. The fund is compensated by
the difference between the current sale price and the lower price for the
future purchase (often referred to as the "drop"), as well as by the interest
earned on the cash proceeds of the initial sale. A "covered roll" is a
specific type of mortgage dollar roll for which there is an offsetting cash
position or a cash equivalent security position. The fund could suffer a loss
if the contracting party fails to perform the future transaction in that the
fund may not be able to buy back the mortgage-backed securities it initially
sold. The fund intends to enter into mortgage dollar rolls only with
government securities dealers recognized by the Federal Reserve Board or with
member banks of the Federal Reserve System.
OPTIONS, FUTURES AND OPTIONS ON FINANCIAL FUTURES
CALL AND PUT OPTIONS ON SECURITIES. The fund may write (sell) covered put and
call options and buy put and call options that trade on securities exchanges
and in the over-the-counter market.
WRITING CALL OPTIONS. Call options written by the fund give the holder the right
to buy the underlying securities from the fund at a stated exercise price; put
options written by the fund give the holder the right to sell the underlying
security to the fund at a stated exercise price. A call option written by the
fund is "covered" if the fund owns the underlying security which is subject to
the call or has an absolute and immediate right to acquire that security without
additional cash consideration (or for additional cash consideration held in a
segregated account by its custodian) upon conversion or exchange of other
securities held in its portfolio. A call option is also covered if 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 and high
grade debt securities in a segregated account with its custodian bank. The
premium paid by the buyer of an option will reflect, among other things, the
relationship of the exercise price to the market price and volatility of the
underlying security, the remaining term of the option, supply and demand, and
interest rates.
In the case of a call option, the writer of an option may have no control
over when the underlying securities must be sold, in the case of a call
option, since, with regard to certain options, the writer may be assigned an
exercise notice at any time prior to the termination of the obligation.
Whether or not an option expires unexercised, the writer retains the amount
of the premium. This amount may, in the case of a covered call option, be
offset by a decline in the market value of the underlying security during the
option period. If a call option is exercised, the writer experiences a profit
or loss from the sale of the underlying security.
The writer of an option that wishes to terminate its obligation may effect a
"closing purchase transaction." This is accomplished by buying an option of
the same series as the option previously written. The effect of the purchase
is that the writer's position will be cancelled by the clearing corporation.
However, a writer may not effect a closing purchase transaction after being
notified of the exercise of an option. Likewise, an investor who is the
holder of an option may liquidate its position by effecting a "closing sale
transaction." This is accomplished by selling an option of the same series as
the option previously purchased. There is no guarantee that either a closing
purchase or a closing sale transaction can be effected.
Effecting a closing transaction in the case of a written call option will
permit the fund to write another call option on the underlying security with
either a different exercise price, expiration date or both. In addition,
effecting a closing transaction will permit the cash or proceeds from the
sale of any securities subject to the option to be used for other fund
investments. If the fund desires to sell a particular security from its
portfolio on which it has written a call option, it will effect a closing
transaction prior to or at the same time as the sale of the security.
The fund will realize a profit from a closing transaction if the price of the
transaction is less than the premium received from writing the option or is
more than the premium paid to buy the option; the fund will realize a loss
from a closing transaction if the price of the transaction is more than the
premium received from writing the option or is less than the premium paid to
buy the option. Because increases in the market price of a call option will
generally reflect increases in the market price of the underlying security,
any loss resulting from the repurchase of a call option is likely to be
offset in whole or in part by appreciation of the underlying security owned
by the fund.
BUYING CALL OPTIONS. The fund may buy call options on securities that it
intends to buy in order to limit the risk of a substantial increase in the
market price of the security. The fund may also buy call options on
securities held in its portfolio and on which it has written call options. A
call option gives the holder the right to buy the underlying securities from
the option writer at a stated exercise price. Prior to its expiration, a call
option may be sold in a closing sale transaction. Profit or loss from such a
sale will depend on whether the amount received is more or less than the
premium paid for the call option plus the related transaction costs.
WRITING PUT OPTIONS. Although the fund has no current intention of writing
covered put options, the fund reserves the right to do so.
A put option gives the buyer of the option the right to sell, and the writer
(seller) the obligation to buy, the underlying security or currency at the
exercise price during the option period. The option may be exercised at any
time prior to its expiration date. The operation of put options in other
respects, including their related risks and rewards, is substantially
identical to that of call options.
The fund would write put options only on a covered basis, which means that
the fund would maintain in a segregated account cash, U.S. government
securities, or other liquid, high-grade debt securities in an amount not less
than the exercise price at all times while the put option is outstanding. The
rules of the clearing corporation currently require that the assets be
deposited in escrow to secure payment of the exercise price. The fund would
generally write covered put options in circumstances where the manager wishes
to buy the underlying security or currency for the fund's portfolio at a
price lower than the current market price of the security or currency. In
such event, the fund would write a put option at an exercise price which,
reduced by the premium received on the option, reflects the lower price it is
willing to pay. Since the fund would also receive interest on debt securities
or currencies maintained to cover the exercise price of the option, this
technique could be used to enhance current return during periods of market
uncertainty. The risk in this type of transaction would be that the market
price of the underlying security or currency would decline below the exercise
price less the premiums received.
BUYING PUT OPTIONS. The fund may buy put options. As the holder of a put
option, the fund has the right to sell the underlying security or currency at
the exercise price at any time during the option period. The fund may enter
into closing sale transactions with respect to put options, exercise them, or
permit them to expire.
The fund may buy a put option on an underlying security or currency owned by
the fund (a "protective put") as a hedging technique in order to protect
against an anticipated decline in the value of the security or currency. This
hedge protection is provided only during the life of the put option when the
fund, as the holder of the put option, is able to sell the underlying
security or currency at the put exercise price, regardless of any decline in
the underlying security's market price or currency's exchange value. For
example, a put option may be purchased in order to protect unrealized
appreciation of a security or currency when the manager deems it desirable to
continue to hold the security or currency because of tax considerations. The
premium paid for the put option and any transaction costs would reduce any
capital gain otherwise available for distribution when the security or
currency is eventually sold.
The fund may also buy put options at a time when the fund does not own the
underlying security or currency. By buying put options on a security or
currency it does not own, the fund seeks to benefit from a decline in the
market price of the underlying security or currency. If the put option is not
sold when it has remaining value, and if the market price of the underlying
security or currency remains equal to or greater than the exercise price
during the life of the put option, the fund will lose its entire investment
in the put option. In order for the purchase of a put option to be
profitable, the market price of the underlying security or currency must
decline sufficiently below the exercise price to cover the premium and
transaction costs, unless the put option is sold in a closing sale
transaction.
The fund will commit no more than 5% of its assets to premiums when buying
put options. The premium paid by the fund when buying a put option will be
recorded as an asset in the fund's statement of assets and liabilities. This
asset will be adjusted daily to the options' current market value, which will
be the latest sale price at the time at which the net asset value per share
of the fund is computed, the close of the New York Stock Exchange, or, in the
absence of a sale, the latest bid price. The asset will be extinguished upon
expiration of the option, the writing of an identical option in a closing
transaction, or the delivery of the underlying security or currency upon the
exercise of the option.
OVER-THE-COUNTER OPTIONS ("OTC" OPTIONS). The fund may write covered put and
call options and buy put and call options that trade in the over-the-counter
market to the same extent that it will engage in exchange traded options.
Just as with exchange traded options, OTC call options give the option holder
the right to buy an underlying security from an option writer at a stated
exercise price; OTC put options give the holder the right to sell an
underlying security to an option writer at a stated exercise price. However,
OTC options differ from exchange traded options in certain material respects.
OTC options are arranged directly with dealers and not, as is the case with
exchange traded options, with a clearing corporation. Thus, there is a risk
of non-performance by the dealer. Because there is no exchange, pricing is
typically done by reference to information from market makers. However, OTC
options are available for a greater variety of securities, and in a wider
range of expiration dates and exercise prices, than exchange traded options;
and the writer of an OTC option is paid the premium in advance by the dealer.
OPTIONS ON STOCK INDICES. The fund may also buy call and put options on stock
indices in order to hedge against the risk of market or industry-wide stock
price fluctuations. Call and put options on stock indices are similar to
options on securities except that, rather than the right to buy or sell stock
at a specified price, options on a stock index give the holder the right to
receive, upon exercise of the option, an amount of cash if the closing level
of the underlying stock index is greater than (or less than, in the case of
puts) the exercise price of the option. This amount of cash is equal to the
difference between the closing price of the index and the exercise price of
the option, expressed in dollars multiplied by a specified number. Thus,
unlike stock options, all settlements are in cash, and gain or loss depends
on price movements in the stock market generally (or in a particular industry
or segment of the market) rather than price movements in individual stocks.
When the fund writes an option on a stock index, the fund will establish a
segregated account containing cash or high quality fixed-income securities
with its custodian bank in an amount at least equal to the market value of
the underlying stock index and will maintain the account while the option is
open or it will otherwise cover the transaction.
OPTIONS ON FOREIGN CURRENCIES. The fund may buy and write (sell) put and call
options on foreign currencies traded on U.S. exchanges or in the
over-the-counter markets. Like other kinds of options, the writing of an
option on foreign currency will be only a partial hedge, up to the amount of
the premium received, and the fund could be required to buy or sell foreign
currencies at disadvantageous exchange rates, thereby incurring losses. The
purchase of an option on foreign currency may be an effective hedge against
fluctuations 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.
FUTURES CONTRACTS. The fund may enter into contracts for the purchase or sale
for future delivery of securities and in such contracts based upon financial
indices ("financial futures"). Financial futures contracts are commodity
contracts that obligate the long or short holder to take or make delivery of
a specified quantity of a financial instrument, such as a security, or the
cash value of a securities index during a specified future period at a
specified price. A "sale" of a futures contract means the acquisition of a
contractual obligation to deliver the securities called for by the contract
at a specified price on a specified date. A "purchase" of a futures contract
means the acquisition of a contractual obligation to acquire the securities
called for by the contract at a specified price on a specified date. Futures
contracts have been designed by exchanges that have been designated
"contracts markets" by the Commodity Futures Trading Commission ("CFTC") and
must be executed through a futures commission merchant, or brokerage firm,
which is a member of the relevant contract market.
At the same time a futures contract is purchased or sold, the fund must
allocate cash or securities as a deposit payment ("initial deposit" or
"initial margin") as a partial guarantee of its performance under the
contract. Daily thereafter, the futures contract is valued and the payment of
"variation margin" may be required since each day the fund would provide or
receive cash that reflects any decline or increase in the contract's value.
In addition, when the fund enters into a futures contract, it will segregate
assets or "cover" its position in accordance with the 1940 Act.
Although futures contracts by their terms call for the actual delivery or
acquisition of securities, in most cases the contractual obligation is
fulfilled before the date of the contract without having to make or take
delivery of the securities. The offsetting of a contractual obligation is
accomplished by buying (or selling, as the case may be) on a commodities
exchange an identical futures contract calling for delivery in the same
month. Such a transaction, which is effected through a member of an exchange,
cancels the obligation to make or take delivery of the securities. Since all
transactions in the futures market are made, offset, or fulfilled through a
clearinghouse associated with the exchange on which the contracts are traded,
the fund will incur brokerage fees when it buys or sells futures contracts.
The fund will not engage in transactions in futures contracts or related
options for speculation but only as a hedge against changes resulting from
market conditions in the values of its securities or securities it intends to
buy. The fund will not enter into any stock index or financial futures
contract or related option if, immediately thereafter, more than one-third of
the fund's net assets would be represented by futures contracts or related
options. In addition, the fund may not buy or sell futures contracts or
related options if, immediately thereafter, the sum of the amount of margin
deposits on its existing futures and related options positions and premiums
paid for related options would exceed 5% of the market value of the fund's
total assets. In instances involving the purchase of futures contracts or
related call options, money market instruments equal to the market value of
the futures contract or related option will be deposited in a segregated
account with the custodian to collateralize such long positions.
The purpose of the acquisition or sale of a futures contract is to attempt to
protect the fund from fluctuations in the price of portfolio securities
without actually buying or selling the underlying security. To the extent the
fund enters into a futures contract, it will maintain with its custodian
bank, to the extent required by SEC rules, assets in a segregated account to
cover its obligations with respect to the contract which will consist of
cash, cash equivalents, or high quality debt securities from its portfolio in
an amount equal to the difference between the fluctuating market value of
such futures contract and the aggregate value of the initial and variation
margin payments made by the fund with respect to such futures contracts.
STOCK INDEX FUTURES. A stock index futures contract obligates the seller to
deliver (and the buyer to take) an amount of cash equal to a specific dollar
amount times the difference between the value of a specific stock index at
the close of the last trading day of the contract and the price at which the
agreement is made. No physical delivery of the underlying stocks in the index
is made.
The fund may sell stock index futures contracts in anticipation of or during
a market decline to attempt to offset the decrease in market value of its
equity securities that might otherwise result. When the fund is not fully
invested in stocks and anticipates a significant market advance, it may buy
stock index futures in order to gain rapid market exposure that may in part
or entirely offset increases in the cost of common stocks that it intends to
buy.
OPTIONS ON STOCK INDEX FUTURES. The fund may buy and sell call and put
options on stock index futures to hedge against risks of market-side price
movements. The need to hedge against such risks will depend on the extent of
diversification of the fund's common stock portfolio and the sensitivity of
such investments to factors influencing the stock market as a whole.
Call and put options on stock index futures are similar to options on
securities except that, rather than the right to buy or sell stock at a
specified price, options on stock index futures give the holder the right to
receive cash. Upon exercise of the option, the delivery of the futures
position by the writer of the option to the holder of the option will be
accompanied by delivery of the accumulated balance in the writer's futures
margin account, which represents the amount by which the market price of the
futures contract, at exercise, exceeds, in the case of a call, or is less
than, in the case of a put, the exercise price of the option on the futures
contract. If an option is exercised on the last trading day prior to the
expiration date of the option, the settlement will be made entirely in cash
equal to the difference between the exercise price of the option and the
closing price of the futures contract on the expiration date.
BOND INDEX FUTURES AND RELATED OPTIONS. The fund may buy and sell futures
contracts based on an index of debt securities and options on such futures
contracts to the extent they currently exist and, in the future, may be
developed. The fund reserves the right to conduct futures and options
transactions based on an index that may be developed in the future to
correlate with price movements in certain categories of debt securities. The
fund's investment strategy in employing futures contracts based on an index
of debt securities will be similar to that used by it in other financial
futures transactions. The fund may also buy and write put and call options on
such index futures and enter into closing transactions with respect to such
options.
FUTURE DEVELOPMENTS. The fund may take advantage of opportunities in the area
of options and futures contracts and options on futures contracts and any
other derivative investments which are not presently contemplated for use by
the fund or which are not currently available but which may be developed, to
the extent such opportunities are both consistent with the fund's investment
goals and legally permissible for the fund.
FORWARD CURRENCY EXCHANGE CONTRACTS The fund may enter into forward currency
exchange contracts ("Forward Contract(s)") to attempt to minimize the risk to
the fund from adverse changes in the relationship between currencies or to
enhance income. A Forward Contract is an obligation to buy 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 construct an investment position by combining a debt security
denominated in one currency with a Forward Contract calling for the exchange
of that currency for another currency. The investment position is not itself
a security but is a combined position (i.e., a debt security coupled with a
Forward Contract) that is intended to be similar in overall performance to a
debt security denominated in the same currency.
For example, an Italian lira-denominated position could be constructed by
buying a German mark-denominated debt security and simultaneously entering
into a Forward Contract to exchange an equal amount of marks for lira at a
future date and at a specified exchange rate. With such a transaction, the
fund may be able to receive a return that is substantially similar from a
yield and currency perspective to a direct investment in lira debt securities
while achieving other benefits from holding the underlying security. The fund
may experience slightly different results from its use of such combined
investment positions as compared to its purchase of a debt security
denominated in the particular currency subject to the Forward Contract. This
difference may be enhanced or offset by premiums that may be available in
connection with the Forward Contract.
The fund may also enter into a Forward Contract, for example, when it enters
into a contract for the purchase or sale of a security denominated in a
foreign currency in order to "lock in" the U.S. dollar price of that
security. Additionally, for example, when 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.
The fund usually effects forward currency exchange contracts on a spot (i.e.,
cash) basis at the spot rate prevailing in the foreign exchange market. Some
price spread on currency exchange (to cover service charges) will be incurred
when the fund converts assets from one currency to another.
To limit potential risks in connection with the purchase of currency under
Forward Contracts, cash, cash equivalents, or readily marketable debt
securities equal to the amount of the purchase will be held in segregated
accounts with the fund's custodian bank to be used to pay for the commitment,
or the fund will cover any commitments under these contracts to sell currency
by owning the underlying currency (or an absolute right to acquire such
currency). The segregated account will be marked-to-market daily. The ability
of the fund to enter into Forward Contracts is limited only to the extent
such Forward Contracts would, in the opinion of the manager, impede portfolio
management or the ability of the fund to honor redemption requests.
INTEREST RATE AND CURRENCY SWAPS An interest rate swap is the transfer
between two counterparties of interest rate obligations, one of which has an
interest rate fixed to maturity while the other has an interest rate that
changes in accordance with changes in a designated benchmark (e.g., LIBOR,
prime, commercial paper, or other benchmarks). The obligations to make
repayment of principal on the underlying securities are not exchanged. These
transactions generally require the participation of an intermediary,
frequently a bank. The entity holding the fixed-rate obligation will transfer
the obligation to the intermediary, and that entity will then be obligated to
pay to the intermediary a floating rate of interest, generally including a
fractional percentage as a commission for the intermediary. The intermediary
also makes arrangements with a second entity that has a floating-rate
obligation which substantially mirrors the obligation desired by the first
party. In return for assuming a fixed obligation, the second entity will pay
the intermediary all sums that the intermediary pays on behalf of the first
entity, plus an arrangement fee and other agreed upon fees. Interest rate
swaps are generally entered into to permit the party seeking a floating rate
obligation the opportunity to acquire such obligation at a lower rate than is
directly available in the credit market, while permitting the party desiring
a fixed-rate obligation the opportunity to acquire such a fixed-rate
obligation, also frequently at a price lower than is available in the credit
markets. The success of such a transaction depends in large part on the
availability of fixed-rate obligations at a low enough coupon rate to cover
the cost involved.
The fund will only enter into interest rate swaps on a net basis, which means
that the two payment streams are netted out, with the fund receiving or
paying, as the case may be, only the net amount of the two payments. Interest
rate swaps do not involve the delivery of securities, other underlying assets
or principal. Accordingly, the risk of loss with respect to interest rate
swaps is limited to the net amount of interest payments that the fund is
contractually obligated to make. If the other party to an interest rate swap
defaults, the fund's risk of loss consists of the net amount of interest
payments that the fund is contractually entitled to receive. In contrast,
currency swaps usually involve the delivery of the entire principal value of
one designated currency in exchange for the other designated currency.
Therefore, the entire principal value of a currency swap is subject to the
risk that the other party to the swap will default on its contractual
delivery obligations.
ILLIQUID SECURITIES It is the policy of the fund that illiquid securities
(including illiquid equity securities, illiquid defaulted debt securities,
loan participations, securities with legal or contractual restrictions on
resale, repurchase agreements of more than seven days duration, and other
securities which are not readily marketable) may not constitute more than 10%
of the value of the fund's total net assets. Generally, an "illiquid
security" is any security that cannot be disposed of promptly and in the
ordinary course of business at approximately the amount at which the fund has
valued the instrument. Subject to this limitation, the fund's board of
trustees has authorized the fund to invest in restricted securities where
such investment is consistent with the fund's investment goals and has
authorized such securities to be considered liquid to the extent the manager
determines that there is a liquid institutional or other market for such
securities - such as, restricted securities which may be freely transferred
among qualified institutional buyers pursuant to Rule 144A under the
Securities Act of 1933, as amended, and for which a liquid institutional
market has developed. The board will review on a monthly basis any
determination by the manager to treat a restricted security as liquid,
including the manager's assessment of current trading activity and the
availability of reliable price information. In determining whether a
restricted security is properly considered a liquid security, the manager and
the board will take into account the following factors: (i) the frequency of
trades and quotes for the security; (ii) the number of dealers willing to buy
or sell the security and the number of other potential buyers; (iii) dealer
undertakings to make a market in the security; and (iv) the nature of the
security and the nature of the marketplace trades (e.g., the time needed to
dispose of the security, the method of soliciting offers, and the mechanics
of transfer). To the extent the fund invests in restricted securities that
are deemed liquid, the general level of illiquidity may be increased if
qualified institutional buyers become uninterested in buying these securities
or the market for these securities contracts.
A restricted security is a security that has been purchased through a private
offering and cannot be sold without prior registration under the Securities
Act of 1933 unless the sale is pursuant to an exemption therefrom.
Notwithstanding the restriction on the sale of such securities, a secondary
market exists for many of these securities. As with other securities in the
fund's portfolio, if there are readily available market quotations for a
restricted security, it will be valued, for purposes of determining the
fund's net asset value, between the range of the bid and ask prices. To the
extent that no quotations are available, the securities will be valued at
fair value in accordance with procedures adopted by the board.
The fund's purchases of restricted securities can result in the receipt of
commitment fees. For example, the transaction may involve an individually
negotiated purchase of short-term increasing rate notes. Maturities for this
type of security typically range from one to five years. These notes are
usually issued as temporary or "bridge" financing to be replaced ultimately
with permanent financing for the project or transaction which the issuer
seeks to finance. Typically, at the time of commitment, the fund receives the
security and sometimes a cash commitment fee. Because the transaction could
possibly involve a delay between the time the fund commits to buy the
security and the fund's payment for and receipt of that security, the fund
will maintain, in a segregated account with its custodian bank, cash or
high-grade marketable securities having an aggregate value equal to the
amount of the purchase commitments until payment is made. The fund will not
buy restricted securities in order to generate commitment fees, although the
receipt of such fees will assist the fund in achieving its principal goal of
earning a high level of current income.
Notwithstanding the determinations in regard to the liquidity of restricted
securities, the board remains responsible for such determinations and will
consider appropriate action to maximize the fund's liquidity and its ability
to meet redemption demands if a security should become illiquid after its
purchase. To the extent 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 buying these
securities or the market for these securities contracts.
TEMPORARY INVESTMENTS The manager may take a temporary defensive position
when it believes the securities trading markets or the economy are
experiencing excessive volatility or a prolonged general decline, or other
adverse conditions exist. Under these circumstances, the fund may invest up
to 100% of its assets in short-term debt instruments, including U.S.
government securities, high-grade commercial paper, repurchase agreements and
other money market equivalents.
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 more than 25% of the value of the fund's total assets in one
particular industry; except that, to the extent this restriction is
applicable, all or substantially all of the assets of the fund may be
invested in another registered investment company having the same investment
goals and policies as the fund;
2. Underwrite securities of other issuers, except insofar as the fund may be
technically deemed an underwriter in connection with the disposition of
securities in its portfolio; except that all or substantially all of the
assets of the fund may be invested in another registered investment company
having the same investment goals and policies as the fund;
3. Make loans to other persons except on a temporary basis in connection with
the delivery or receipt of portfolio securities which have been bought or
sold, or by the purchase of bonds, debentures or similar obligations which
have been publicly distributed or of a character usually acquired by
institutional investors or through loans of the fund's portfolio securities,
or to the extent the entry into a repurchase agreement may be deemed a loan;
4. Borrow money in excess of 5% of the value of the fund's total assets, and
then only as a temporary measure for extraordinary or emergency purposes;
5. Sell securities short or buy on margin nor pledge or hypothecate any of
the fund's assets; except that the fund may enter into financial futures and
options on financial futures as discussed;
6. Buy or sell real estate (other than interests in real estate investment
trusts., commodities or commodity contracts; except that the fund may invest
in financial futures and related options on futures with respect to
securities, securities indices and currencies;
7. Invest in the securities of other investment companies, except where there
is no commission other than the customary brokerage commission or sales
charge, or except that securities of another investment company may be
acquired pursuant to a plan of reorganization, merger, consolidation or
acquisition; provided that all or substantially all of the assets of the fund
may be invested in another registered investment company having the same
investment goals and policies as the fund. To the extent permitted by
exemptions granted under the 1940 Act, the fund may invest in shares of one
or more money market funds managed by the manager or its affiliates;
8. Invest in securities for the purpose of exercising management or control
of the issuer, except that, to the extent this restriction is applicable, all
or substantially all of the assets of the fund may be invested in another
registered investment company having the same investment goals and policies
as the fund; and
9. Purchase from or sell to its officers and trustees, or any firm of which
any officer or trustee is a member, as principal, any securities, but may
deal with such persons or firms as brokers and pay a customary brokerage
commission; or purchase or retain securities of any issuer if, to the
knowledge of the fund, one or more of the officers or trustees of the fund,
or its investment adviser, own beneficially more than one-half of 1% of the
securities of such issuer and all such officers and trustees together own
beneficially more than 5% of such securities, except that, to the extent this
restriction is applicable, all or substantially all of the assets of the fund
may be invested in another registered investment company having the same
investment goals and policies as the fund, or except as permitted under
investment restriction Number 7 regarding the purchase of shares of money
market funds managed by the manager or its affiliates.
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 maximizing
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 will not be considered a violation of the
restriction or limitation.
RISKS
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HIGH YIELD SECURITIES Because the fund may invest in securities below
investment grade, an investment in the fund is subject to a higher degree of
risk than an investment in a fund that invests primarily in higher-quality
securities. You should consider the increased risk of loss to principal that
is present with an investment in higher risk securities, such as those in
which the fund invests. Accordingly, an investment in the fund should not be
considered a complete investment program and should be carefully evaluated
for its appropriateness in light of your overall investment needs and goals.
The market value of high yield, lower-quality fixed-income securities,
commonly known as junk bonds, tends to reflect individual developments
affecting the issuer to a greater degree than the market value of
higher-quality securities, which react primarily to fluctuations in the
general level of interest rates. Lower-quality securities also tend to be
more sensitive to economic conditions than higher-quality securities.
Issuers of high yield, fixed-income securities are often highly leveraged and
may not have more traditional methods of financing available to them.
Therefore, the risk associated with buying the securities of these issuers is
generally greater than the risk associated with higher-quality securities.
For example, during an economic downturn or a sustained period of rising
interest rates, issuers of lower-quality securities may experience financial
stress and may not have sufficient cash flow to make interest payments. The
issuer's ability to make timely interest and principal payments may also be
adversely affected by specific developments affecting the issuer, including
the issuer's inability to meet specific projected business forecasts or the
unavailability of additional financing.
The risk of loss due to default may also be considerably greater with
lower-quality securities because they are generally unsecured and are often
subordinated to other creditors of the issuer. If the issuer of a security in
the fund's portfolio defaults, the fund may have unrealized losses on the
security, which may lower the fund's net asset value. Defaulted securities
tend to lose much of their value before they default. Thus, the fund's net
asset value may be adversely affected before an issuer defaults. In addition,
the fund may incur additional expenses if it must try to recover principal or
interest payments on a defaulted security.
High yield, fixed-income securities frequently have call or buy-back features
that allow an issuer to redeem the securities from the fund. Although these
securities are typically not callable for a period of time, usually for three
to five years from the date of issue, if an issuer calls its securities
during periods of declining interest rates, the manager may find it necessary
to replace the securities with lower-yielding securities, which could result
in less net investment income for the fund. The premature disposition of a
high yield security due to a call or buy-back feature, the deterioration of
an issuer's creditworthiness, or a default by an issuer may make it more
difficult for the fund to manage the timing of its income. Under the Code and
U.S. Treasury regulations, the fund may have to accrue income on defaulted
securities and distribute the income to shareholders for tax purposes, even
though the fund is not currently receiving interest or principal payments on
the defaulted securities. To generate cash to satisfy these distribution
requirements, the fund may have to sell portfolio securities that it
otherwise may have continued to hold or use cash flows from other sources,
such as the sale of fund shares.
Lower quality, fixed-income securities may not be as liquid as higher-quality
securities. Reduced liquidity in the secondary market may have an adverse
impact on market price of a security and on the fund's ability to sell a
security in response to a specific economic event, such as a deterioration in
the creditworthiness of the issuer, or if necessary to meet the fund's
liquidity needs. Reduced liquidity may also make it more difficult to obtain
market quotations based on actual trades for purposes of valuing the fund's
portfolio.
The fund may buy high yield, fixed-income securities that are sold without
registration under the federal securities laws and therefore carry
restrictions on resale. While many high yielding securities have been sold
with registration rights, covenants, and penalty provisions for delayed
registration, if the fund is required to sell restricted securities before
the securities have been registered, it may be deemed an underwriter of the
securities under the Securities Act of 1933, which entails special
responsibilities and liabilities. The fund may also incur special costs in
disposing of restricted securities, although the fund will generally not
incur any costs when the issuer is responsible for registering the securities.
The fund may buy high yield, fixed-income securities during an initial
underwriting. These securities involve special risks because they are new
issues. The manager will carefully review their credit and other
characteristics. The fund has no arrangement with its underwriter or any
other person concerning the acquisition of these securities.
The high yield securities market is relatively new and much of its growth
before 1990 paralleled a long economic expansion. The recession that began in
1990 disrupted the market for high yield securities and adversely affected
the value of outstanding securities, as well as the ability of issuers of
high yield securities to make timely principal and interest payments.
Although the economy has improved and high yield securities have performed
more consistently since that time, the adverse effects previously experienced
may reoccur. For example, the highly publicized defaults on some high yield
securities during 1989 and 1990 and concerns about a sluggish economy that
continued into 1993 depressed the prices of many of these securities. While
market prices may be temporarily depressed due to these factors, the ultimate
price of any security generally reflects the true operating results of the
issuer. Factors adversely impacting the market value of high yield securities
may lower the fund's net asset value.
The fund relies on the manager's judgment, analysis, and experience in
evaluating the creditworthiness of an issuer. In this evaluation, the manager
takes into consideration, among other things, the issuer's financial
resources, its sensitivity to economic conditions and trends, its operating
history, the quality of the issuer's management, and regulatory matters.
The fund may invest without limit in securities rated below investment grade.
The following table provides a summary of the credit quality of the fund's
portfolio. These figures are dollar-weighted averages of month-end assets
during the fiscal year ended April 30, 1999.
AVERAGE WEIGHTED
S&P RATING PERCENTAGE OF ASSETS(%)
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AAA 28.6
AA 11.5 1
A 1.7 2
BBB 2.6
BB 21.6 3
B 29.8 4
CCC 3.4
1. 7.7% are unrated and have been included in the AA rating category.
2. 0.1% are unrated and have been included in the A rating category.
3. 2.5% are unrated and have been included in the BB rating category.
4. 3.4% are unrated and have been included in the B rating category.
MORTGAGE-BACKED SECURITIES To the extent mortgage securities are purchased at
a premium, unscheduled principal prepayments, including prepayments resulting
from mortgage foreclosures, may result in some loss of the holder's principal
investment to the extent of the premium paid. On the other hand, if mortgage
securities are purchased at a discount, both a scheduled payment of principal
and an unscheduled prepayment of principal will increase current and total
returns and will accelerate the recognition of income which, when distributed
to you, will be taxable as ordinary income.
Some of the CMOs in which the fund may invest may be less liquid than other
types of mortgage securities. A lack of liquidity in the market for CMOs
could result in the fund's inability to dispose of such securities at an
advantageous price under certain circumstances.
FOREIGN SECURITIES You should consider carefully the substantial risks
involved in securities of companies 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 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.
Investments in companies domiciled in developing countries may be subject to
potentially higher risks than investments in developed countries. These risks
include (i) less social, political, and economic stability; (ii) the small
current size of the markets for such securities and the currently low or
nonexistent volume of trading, which result in a lack of liquidity and in
greater price volatility; (iii) certain national policies which may restrict
the 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 certain Eastern European
countries, of a capital market structure or market-oriented economy; and
(vii) the possibility that recent favorable economic developments in Eastern
Europe may be slowed or reversed by unanticipated political or social events
in such countries.
In addition, many countries in which the 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.
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 capitalization,
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 is privately negotiated outside of stock exchanges.
Because of the recent formation of the securities markets as well as the
underdeveloped state of the banking and telecommunications systems,
settlement, clearing, and registration of securities transactions are subject
to significant risks. Ownership of shares (except where shares are held
through depositories that meet the requirements of the 1940 Act) is defined
according to entries in the company's share register and normally evidenced
by extracts from the register or by formal share certificates. However, there
is no central registration system for shareholders, and these services are
carried out by the companies themselves or by registrars located throughout
Russia. These registrars are not necessarily subject to effective state
supervision, nor are they licensed with any governmental entity, and it is
possible for the 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.
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 that would prevent the
fund from transferring cash out of the country or 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 taxes 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
foreign nations.
The fund may be affected either favorably or unfavorably 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.
The board considers at least annually the likelihood of the imposition by any
foreign government of exchange control restrictions which would affect the
liquidity of the fund's assets maintained with custodians in foreign
countries, as well as the degree of risk from political acts of foreign
governments to which such assets may be exposed. The board also considers the
degree of risk involved through the holding of portfolio securities in
domestic and foreign securities depositories. However, in the absence of
willful misfeasance, bad faith, or gross negligence on the part of the
manager, any losses resulting from the holding of the fund's portfolio
securities in foreign countries and/or with securities depositories will be
at the risk of the shareholders. No assurance can be given that the board's
appraisal of the risks will always be correct or that such exchange control
restrictions or political acts of foreign governments might not occur.
EURO On January 1, 1999, the European Monetary Union (EMU) introduced a new
single currency, the euro, which will replace the national currency for
participating member countries. The transition and the elimination of
currency risk among EMU countries may change the economic environment and
behavior of investors, particularly in European markets. While the
implementation of the euro could have a negative effect on the fund, the
fund's manager and its affiliated services providers are taking steps they
believe are reasonably designed to address the euro issue.
STOCK INDEX OPTIONS, STOCK INDEX FUTURES, FINANCIAL FUTURES, AND RELATED
OPTIONS The fund's ability to hedge effectively all or a portion of its
securities through transactions in options on stock indexes, stock index
futures, financial futures, and related options depends on the degree to
which price movements in the underlying index or underlying securities
correlate with price movements in the relevant portion of the fund's
portfolio. Inasmuch as these securities will not duplicate the components of
any index or underlying securities, the correlation will not be perfect.
Consequently, the fund bears the risk that the prices of the securities being
hedged will not move in the same amount as the hedging instrument. It is also
possible that there may be a negative correlation between the index or other
securities underlying the hedging instrument and the hedged securities which
would result in a loss on both the securities and the hedging instrument.
Accordingly, successful use by the fund of options on stock indexes, stock
index futures, financial futures, and related options will be subject to the
manager's ability to predict correctly movements in the direction of the
securities markets generally or of a particular segment. This requires
different skills and techniques than predicting changes in the price of
individual stocks.
Positions in stock index options, stock index futures, and financial futures,
and related options may be closed out only on an exchange that provides a
secondary market. There can be no assurance that a liquid secondary market
will exist for any particular stock index option or futures contract or
related option at any specific time. Thus, it may not be possible to close an
option or futures position. The inability to close options or futures
positions could have an adverse impact on the fund's ability to effectively
hedge its securities. The fund will enter into an option or futures position
only if there appears to be a liquid secondary market for such options or
futures.
There can be no assurance that a continuous liquid secondary market will
exist for any particular OTC option at any specific time. Consequently, the
fund may be able to realize the value of an OTC option it has purchased only
by exercising it or entering into a closing sale transaction with the dealer
that issued it. Similarly, when the fund writes an OTC option, it generally
can close out that option prior to its expiration only by entering into a
closing purchase transaction with the dealer to which the fund originally
wrote it. If a covered call option writer cannot effect a closing
transaction, it cannot sell the underlying security until the option expires
or the option is exercised. Therefore, a covered call option writer of an OTC
option may not be able to sell an underlying security even though it might
otherwise be advantageous to do so. Likewise, a secured put writer of an OTC
option may be unable to sell the securities pledged to secure the put for
other investment purposes while it is obligated as a put writer. Similarly, a
buyer of such put or call option might also find it difficult to terminate
its position on a timely basis in the absence of a secondary market.
The CFTC and the various exchanges have established limits referred to as
"speculative position limits" on the maximum net long or net short position
that any person may hold or control in a particular futures contract. Trading
limits are imposed on the maximum number of contracts that any person may
trade on a particular trading day. An exchange may order the liquidation of
positions found to be in violation of these limits and it may impose other
sanctions or restrictions. The fund does not believe that these trading and
positions limits will have an adverse impact on the fund's strategies for
hedging its securities.
The ordinary spreads between prices in the cash and futures markets, due to
differences in the nature of those markets, are subject to distortions.
First, all participants in the futures market are subject to initial deposit
and variation margin requirements. Rather than meeting additional variation
margin requirements, investors may close futures contracts through offsetting
transactions which could distort the normal relationship between the cash and
futures markets. Second, the liquidity of the futures market depends on
participants entering into offsetting transactions rather than making or
taking delivery. To the extent participants decide to make or take delivery,
liquidity in the futures market could be reduced, thus producing distortion.
Third, from the point of view of speculators, the margin deposit requirements
in the futures market are less onerous than margin requirements in the
securities market. Therefore, increased participation by speculators in the
futures market may cause temporary price distortions. Due to the possibility
of distortion, a correct forecast of general interest rate trends by the
manager may still not result in a successful transaction.
In addition, futures contracts entail risks. Although the fund believes that
use of such contracts will benefit the fund, if the manager's investment
judgment about the general direction of interest rates is incorrect, the
fund's overall performance would be poorer than if it had not entered into
any such contract. For example, if the fund has hedged against the
possibility of an increase in interest rates which would adversely affect the
price of bonds held in its portfolio and interest rates decrease instead, the
fund will lose part or all of the benefit of the increased value of its bonds
which it has hedged because it will have offsetting losses in its futures
positions. In addition, in such situations, if the fund has insufficient
cash, it may have to sell securities from its portfolio to meet daily
variation margin requirements. These sales may be, but will not necessarily
be, at increased prices which reflect the rising market. The fund may have to
sell securities at a time when it may be disadvantageous to do so.
The fund's sale of futures contracts and purchase of put options on futures
contracts will be solely to protect its investments against declines in
value. The fund expects that in the normal course it will buy securities upon
termination of long futures contracts and long call options on future
contracts, but under unusual market conditions it may terminate any of such
positions without a corresponding purchase of securities.
FORWARD CURRENCY CONTRACTS As noted above, the fund may enter into forward
currency contracts, in part in order to limit the risk from adverse changes
in the relationship between currencies. However, Forward Contracts may limit
potential gain from a positive change in the relationship between the U.S.
dollar and foreign currencies or between foreign currencies. Unanticipated
changes in currency exchange rates also may result in poorer overall
performance for the fund than if it had not entered into such contracts.
OFFICERS AND TRUSTEES
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The trust has a board of trustees. The board is responsible for the overall
management of the trust, including general supervision and review of the
fund's investment activities. The board, in turn, elects the officers of the
trust who are responsible for administering the trust's day-to-day
operations. The board also monitors 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 trust, and principal occupations during
the past five years are shown below.
Frank H. Abbott, III (78)
1045 Sansome Street, San Francisco, CA 94111
TRUSTEE
President and Director, Abbott Corporation (an investment company); director
or trustee, as the case may be, of 27 of the investment companies in the
Franklin Templeton Group of Funds; and FORMERLY, Director, MotherLode Gold
Mines Consolidated (gold mining) (until 1996) and Vacu-Dry Co. (food
processing) (until 1996).
Harris J. Ashton (67)
191 Clapboard Ridge Road, Greenwich, CT 06830
TRUSTEE
Director, RBC Holdings, Inc. (bank holding company) and Bar-S Foods (meat
packing company); director or trustee, as the case may be, of 48 of the
investment companies in the Franklin Templeton Group of Funds; and FORMERLY,
President, Chief Executive Officer and Chairman of the Board, General Host
Corporation (nursery and craft centers) (until 1998).
*Harmon E. Burns (54)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND TRUSTEE
Executive Vice President and Director, Franklin Resources, Inc., Franklin
Templeton Distributors, Inc. and Franklin Templeton Services, Inc.; Executive
Vice President, Franklin Advisers, Inc.; Director, Franklin Investment
Advisory Services, Inc. and Franklin/Templeton Investor Services, Inc.; and
officer and/or director or trustee, as the case may be, of most of the other
subsidiaries of Franklin Resources, Inc. and of 52 of the investment
companies in the Franklin Templeton Group of Funds.
S. Joseph Fortunato (67)
Park Avenue at Morris County, P.O. Box 1945
Morristown, NJ 07962-1945
TRUSTEE
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.
Edith E. Holiday (47)
3239 38th Street, N.W., Washington, DC 20016
TRUSTEE
Director, Amerada Hess Corporation (exploration and refining of natural gas)
(1993-present), Hercules Incorporated (chemicals, fibers and resins)
(1993-present), Beverly Enterprises, Inc. (health care) (1995-present) and
H.J. Heinz Company (processed foods and allied products) (1994-present);
director or trustee, as the case may be, of 24 of the investment companies in
the Franklin Templeton Group of Funds; and FORMERLY, Chairman (1995-1997) and
Trustee (1993-1997), National Child Research Center, Assistant to the
President of the United States and Secretary of the Cabinet (1990-1993),
General Counsel to the United States Treasury Department (1989-1990), and
Counselor to the Secretary and Assistant Secretary for Public Affairs and
Public Liaison-United States Treasury Department (1988-1989).
*Charles B. Johnson (66)
777 Mariners Island Blvd., San Mateo, CA 94404
CHAIRMAN OF THE BOARD AND TRUSTEE
President, Chief Executive Officer and Director, Franklin Resources, Inc.;
Chairman of the Board and Director, Franklin Advisers, Inc., Franklin
Investment Advisory Services, Inc. and Franklin Templeton Distributors, Inc.;
Director, Franklin/Templeton Investor Services, Inc. and Franklin Templeton
Services, Inc.; officer and/or director or trustee, as the case may be, of
most of the other subsidiaries of Franklin Resources, Inc. and of 49 of the
investment companies in the Franklin Templeton Group of Funds.
*Rupert H. Johnson, Jr. (59)
777 Mariners Island Blvd., San Mateo, CA 94404
PRESIDENT AND TRUSTEE
Executive Vice President and Director, Franklin Resources, Inc. and Franklin
Templeton Distributors, Inc.; President and Director, Franklin Advisers, Inc.
and Franklin Investment Advisory Services, Inc.; Senior Vice President,
Franklin Advisory Services, LLC; Director, Franklin/Templeton Investor
Services, Inc.; and officer and/or director or trustee, as the case may be,
of most of the other subsidiaries of Franklin Resources, Inc. and of 52 of
the investment companies in the Franklin Templeton Group of Funds.
Frank W.T. LaHaye (70)
20833 Stevens Creek Blvd., Suite 102, Cupertino, CA 95014
TRUSTEE
General Partner, Miller & LaHaye, which is the General Partner of Peregrine
Ventures II (venture capital firm); director or trustee, as the case may be,
of 27 of the investment companies in the Franklin Templeton Group of Funds;
and FORMERLY, Director, Fischer Imaging Corporation (medical imaging
systems), Digital Transmission Systems, Inc. (wireless communications) and
Quarterdeck Corporation (software firm), and General Partner, Peregrine
Associates, which was the General Partner of Peregrine Ventures (venture
capital firm).
Gordon S. Macklin (71)
8212 Burning Tree Road, Bethesda, MD 20817
TRUSTEE
Director, Fund American Enterprises Holdings, Inc. (holding company), Martek
Biosciences Corporation, MCI WorldCom (information services), MedImmune, Inc.
(biotechnology), Spacehab, Inc. (aerospace services) and Real 3D (software);
director or trustee, as the case may be, of 48 of the investment companies in
the Franklin Templeton Group of Funds; and FORMERLY, Chairman, White River
Corporation (financial services) and Hambrecht and Quist Group (investment
banking), and President, National Association of Securities Dealers, Inc.
Martin L. Flanagan (39)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
Senior Vice President and Chief Financial Officer, Franklin Resources, Inc.,
Franklin/Templeton Investor Services, Inc. and Franklin Mutual Advisers, LLC;
Executive Vice President, Chief Financial Officer and Director, Templeton
Worldwide, Inc.; Executive Vice President, Chief Operating Officer and
Director, Templeton Investment Counsel, Inc.; Executive Vice President and
Chief Financial Officer, Franklin Advisers, Inc.; Chief Financial Officer,
Franklin Advisory Services, LLC and Franklin Investment Advisory Services,
Inc.; President and Director, Franklin Templeton Services, Inc.; officer
and/or director of some of the other subsidiaries of Franklin Resources,
Inc.; and officer and/or director or trustee, as the case may be, of 52 of
the investment companies in the Franklin Templeton Group of Funds.
Deborah R. Gatzek (50)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND SECRETARY
Senior Vice President and General Counsel, Franklin Resources, Inc.; Senior
Vice President, Franklin Templeton Services, Inc. and Franklin Templeton
Distributors, Inc.; Executive Vice President, Franklin Advisers, Inc.; Vice
President, Franklin Advisory Services, LLC and Franklin Mutual Advisers, LLC;
Vice President, Chief Legal Officer and Chief Operating Officer, Franklin
Investment Advisory Services, Inc.; and officer of 53 of the investment
companies in the Franklin Templeton Group of Funds.
Charles E. Johnson (43)
500 East Broward Blvd., Fort Lauderdale, FL 33394-3091
VICE PRESIDENT
Senior Vice President and Director, Franklin Resources, Inc.; Senior Vice
President, Franklin Templeton Distributors, Inc.; President and Director,
Templeton Worldwide, Inc.; Chairman and Director, Templeton Investment
Counsel, Inc.; Vice President, Franklin Advisers, Inc.; officer and/or
director of some of the other subsidiaries of Franklin Resources, Inc.; and
officer and/or director or trustee, as the case may be, of 33 of the
investment companies in the Franklin Templeton Group of Funds.
Diomedes Loo-Tam (60)
777 Mariners Island Blvd., San Mateo, CA 94404
TREASURER AND PRINCIPAL ACCOUNTING OFFICER
Senior Vice President, Franklin Templeton Services, Inc.; and officer of 32
of the investment companies in the Franklin Templeton Group of Funds.
Edward V. McVey (62)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT
Senior Vice President and National Sales Manager, Franklin Templeton
Distributors, Inc.; and officer of 28 of the investment companies in the
Franklin Templeton Group of Funds.
*This board member is considered an "interested person" under federal
securities laws.
Note: Charles B. Johnson and Rupert H. Johnson, Jr. are brothers and the
father and uncle, respectively, of Charles E. Johnson.
The trust pays noninterested board members $1,575 per month plus $1,050 per
meeting attended. Board members who serve on the audit committee of the trust
and other funds in the Franklin Templeton Group of Funds receive a flat fee
of $2,000 per committee meeting attended, a portion of which is allocated to
the trust. Members of a committee are not compensated for any committee
meeting held on the day of a board meeting. Noninterested board members also
may serve as directors or trustees of other funds in the Franklin Templeton
Group of Funds and may receive fees from these funds for their services. The
fees payable to noninterested board members by the trust are subject to
reductions resulting from fee caps limiting the amount of fees payable to
board members who serve on other boards within the Franklin Templeton Group
of Funds. The following table provides the total fees paid to noninterested
board members by the trust and by the Franklin Templeton Group of Funds.
NUMBER OF
BOARDS IN
TOTAL FEES THE FRANKLIN
RECEIVED FROM TEMPLETON
TOTAL FEES THE FRANKLIN GROUP
RECEIVED TEMPLETON OF FUNDS
FROM THE OF GROUP ON WHICH
NAME TRUST 1 ($) FUNDS 2 ($) EACH SERVES 3
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Frank H. Abbott, III 13,935 159,051 27
Harris J. Ashton 16,280 361,157 48
S. Joseph Fortunato 15,279 367,835 50
Edith E. Holiday 18,975 211,400 24
Frank W.T. LaHaye 16,035 163,753 27
Gordon S. Macklin 16,280 361,157 48
1. For the fiscal year ended April 30, 1999. During the period from May 1,
1998, through May 31, 1998, fees at the rate of $300 for each of the trust's
eight meetings plus $300 per board meeting attended were in effect.
2. For the calendar year ended December 31, 1998.
3. We base the number of boards on the number of registered investment
companies in the Franklin Templeton Group of Funds. This number does not
include the total number of series or funds within each investment company
for which the board members are responsible. The Franklin Templeton Group of
Funds currently includes 54 registered investment companies, with
approximately 162 U.S. based funds or series.
Noninterested board members are reimbursed for expenses incurred in
connection with attending board meetings, paid pro rata by each fund in the
Franklin Templeton Group of Funds for which they serve as director or
trustee. No officer or board member received any other compensation,
including pension or retirement benefits, directly or indirectly from the
fund or other funds in the Franklin Templeton Group of Funds. Certain
officers or board members who are shareholders of Franklin Resources, Inc.
may be deemed to receive indirect remuneration by virtue of their
participation, if any, in the fees paid to its subsidiaries.
Board members historically have followed a policy of having substantial
investments in one or more of the funds in the Franklin Templeton Group of
Funds, as is consistent with their individual financial goals. In February
1998, this policy was formalized through adoption of a requirement that each
board member invest one-third of fees received for serving as a director or
trustee of a Templeton fund in shares of one or more Templeton funds and
one-third of fees received for serving as a director or trustee of a Franklin
fund in shares of one or more Franklin funds until the value of such
investments equals or exceeds five times the annual fees paid such board
member. Investments in the name of family members or entities controlled by a
board member constitute fund holdings of such board member for purposes of
this policy, and a three year phase-in period applies to such investment
requirements for newly elected board members. In implementing such policy, a
board member's fund holdings existing on February 27, 1998, are valued as of
such date with subsequent investments valued at cost.
MANAGEMENT AND OTHER SERVICES
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MANAGER AND SERVICES PROVIDED The fund's manager is Franklin Advisers, 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 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. Of course, any transactions for the
accounts of the manager and other access persons will be made in compliance
with the fund's code of ethics.
Under the fund's code of ethics, employees of the Franklin Templeton Group
who are access persons may engage in personal securities transactions subject
to the following general restrictions and procedures: (i) the trade must
receive advance clearance from a compliance officer and must be completed by
the close of the business day following the day clearance is granted; (ii)
copies of all brokerage confirmations and statements must be sent to a
compliance officer; (iii) all brokerage accounts must be disclosed on an
annual basis; and (iv) access persons involved in preparing and making
investment decisions must, in addition to (i), (ii) and (iii) above, file
annual reports of their securities holdings each January and inform the
compliance officer (or other designated personnel) if they own a security
that is being considered for a fund or other client transaction or if they
are recommending a security in which they have an ownership interest for
purchase or sale by a fund or other client.
The fund's sub-advisor is Templeton Investment Counsel, Inc., through its
Global Bond Managers division. The sub-advisor has an agreement with the
manager and provides the manager with investment management advice and
assistance. The sub-advisor also provides a continuous investment program for
the fund, including allocation of the fund's assets among the various
securities markets of the world and investment research and advice with
respect to securities and investments and cash equivalents in the fund. The
sub-advisor's activities are subject to the board's review and control, as
well as the manager's instruction and supervision.
MANAGEMENT FEES The fund pays the manager a fee equal to an annual rate of:
o 0.625 of 1% of the value of its average daily net assets up to and
including $100 million;
o 0.50 of 1% of the value of its average daily net assets over $100 million
and not over $250 million; and
o 0.45 of 1% of the value of its average daily net assets in excess of $250
million.
The fee is computed at the close of business on the last business day of each
month according to the terms of the management agreement. Each class of the
fund's shares pays its proportionate share of the fee.
For the last three fiscal years ended April 30, the fund paid the following
management fees:
MANAGEMENT
FEES PAID 1 ($)
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1999 328,135
1998 0
1997 0
1. For the fiscal years ended April 30, 1999, 1998 and 1997, management fees,
before any advance waiver, totaled $1,308,242, $527,061 and $129,938,
respectively. Under an agreement by the manager to waive or limit its fees, the
fund paid the management fees shown.
The manager pays the sub-advisor a fee equal to an annual rate of:
o 0.3125 of 1% of the value of its average daily net assets up to and
including $100 million;
o 0.25 of 1% of the value of its average daily net assets over $100 million
and not over $250 million; and
o 0.225 of 1% of the value of its average daily net assets in excess of
$250 million.
The manager pays this fee from the management fees it receives from the fund.
The sub-advisor will pay all expenses incurred in connection with its activities
under the subadvisory agreement with the manager other than the cost of
securities (including brokerage commissions, if any) purchases for the fund. For
the last three fiscal years ended April 30, the manager did not pay any
sub-advisory fees.
ADMINISTRATOR AND SERVICES PROVIDED Franklin Templeton Services, Inc. (FT
Services) has an agreement with the manager 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 manager pays FT Services a monthly fee equal to an
annual rate of:
0.15% of the fund's 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 $1.2 billion.
During the last three fiscal years ended April 30, the manager paid FT Services
the following administration fees:
ADMINISTRATION FEES
PAID ($)
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1999 350,136
1998 129,758
1997 1 21,855
1. For the period from October 1, 1996, through April 30, 1997.
SHAREHOLDER SERVICING AND TRANSFER AGENT Franklin/Templeton Investor Services,
Inc. (Investor Services) is the fund's shareholder servicing agent and acts as
the fund's transfer agent and dividend-paying agent. Investor Services is
located at 777 Mariners Island Blvd., San Mateo, CA 94404. Please send all
correspondence to Investor Services to P.O. Box 997151, Sacramento, CA
95899-9983.
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 Bank of New York, Mutual Funds Division, 90 Washington Street, New
York, NY 10286, acts as custodian of the fund's securities and other assets.
AUDITOR PricewaterhouseCoopers LLP, 333 Market Street, San Francisco, CA
94105, is the fund's independent auditor. The auditor gives an opinion on the
financial statements included in the trust's Annual Report to Shareholders
and reviews the trust's registration statement filed with the U.S. Securities
and Exchange Commission (SEC).
PORTFOLIO TRANSACTIONS
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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 in order
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.
During the last three fiscal years ended April 30, the fund paid the
following brokerage commissions:
BROKERAGE
COMMISSIONS ($)
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1999 10,085
1998 3,070
1997 2,435
For the fiscal year ended April 30, 1999, the fund paid brokerage commissions
of $750 from aggregate portfolio transactions of $845,222 to brokers who
provided research services.
As of April 30, 1999, the fund owned securities issued by Salomon Smith
Brothers Inc. and Morgan Stanley & Co. valued in the aggregate at $469,000
and $2,034,375, respectively. Except as noted, the fund did not own any
securities issued by its regular broker-dealers as of the end of the fiscal
year.
DISTRIBUTIONS AND TAXES
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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 the distribution and service (Rule 12b-1) fees of
each class. Distibutions 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 take 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, in order 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 by the fund on the sale of
debt securities are generally treated as ordinary losses by the fund. 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 reduce 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
of its 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, has qualified as such for its most recent fiscal year,
and intends to so 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 amounts in December (or in January that are treated by you as
received in December) to avoid these excise taxes, but can give no assurances
that its distributions will be sufficient to eliminate all taxes.
REDEMPTION OF FUND SHARES Redemptions 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 a 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. 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 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 OBLIGATIONS Many states grant tax-free status to dividends
paid to you from interest earned on direct obligations of the U.S.
government, subject in some states to minimum investment 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 do not generally qualify for tax-free treatment.
The rules on exclusion of this income are different for corporations.
DIVIDENDS-RECEIVED DEDUCTION FOR CORPORATIONS If you are a corporate
shareholder, you should note that 3.73% of the dividends paid by the fund for
the most recent fiscal year qualified for the dividends-received deduction.
In some circumstances, you will be allowed to deduct these qualified
dividends, thereby reducing the tax that you would otherwise be required to
pay on these dividends. The dividends-received deduction will be available
only with respect to dividends designated by the fund as eligible for such
treatment. All dividends (including the deducted portion) must be included in
your alternative minimum taxable income calculation.
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 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 of its foreign securities. In turn, these rules may affect the
amount, timing or character of the income distributed to you by the fund.
ORGANIZATION, VOTING RIGHTS AND PRINCIPAL HOLDERS
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The fund is a non-diversified series of Franklin Strategic Series, an
open-end management investment company, commonly called a mutual fund. The
trust was organized as a Delaware business trust on January 25, 1991, and is
registered with the SEC.
The fund currently offers four classes of shares, Class A, Class B, Class C
and Advisor Class. Before January 1, 1999, Class A shares were designated
Class I and Class C shares were designated Class II. The fund began offering
Class B shares on January 1, 1999 and Advisor Class shares on August 12,
1999. The fund may offer additional classes of shares in the future. The full
title of each class is:
o Franklin Strategic Income Fund - Class A
o Franklin Strategic Income Fund - Class B
o Franklin Strategic Income Fund - Class C
o Franklin Strategic Income Fund - Advisor Class
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 trust for matters that affect the trust as a whole.
Additional series may be offered in the future.
The trust has noncumulative voting rights. For board member elections, this
gives holders of more than 50% of the shares voting the ability to elect all
of the members of the board. If this happens, holders of the remaining shares
voting will not be able to elect anyone to the board.
The trust does not intend to hold annual shareholder meetings. The trust or a
series of the trust may hold special meetings, however, for matters requiring
shareholder approval. A meeting may 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.
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. To the best knowledge of the fund, no other person holds
beneficially or of record more than 5% of the outstanding shares of any class.
As of June 8, 1999, 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
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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. We may deduct any applicable banking
charges imposed by the bank from your account.
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.
INITIAL SALES CHARGES The maximum initial sales charge is 4.25% for Class A
and 1% for Class C. There is no initial sales charge for Class B.
The initial sales charge for Class A shares may be reduced for certain large
purchases, as described in the prospectus. We offer several ways for you to
combine your purchases in the Franklin Templeton Funds to take advantage of
the lower sales charges for large purchases. The Franklin Templeton Funds
include the U.S. registered mutual funds in the Franklin Group of Funds(R) and
the Templeton Group of Funds except Franklin Templeton Variable Insurance
Products Trust, Templeton Capital Accumulator Fund, Inc., and Templeton
Variable Products Series Fund.
CUMULATIVE QUANTITY DISCOUNT. For purposes of calculating the sales charge on
Class A shares, you may combine the amount of your current purchase with the
cost or current value, whichever is higher, of your existing shares in the
Franklin Templeton Funds. You also may combine the shares of your spouse,
children under the age of 21 or grandchildren under the age of 21. If you are
the sole owner of a company, you also may add any company accounts, including
retirement plan accounts. Companies with one or more retirement plans may add
together the total plan assets invested in the Franklin Templeton Funds to
determine the sales charge that applies.
LETTER OF INTENT (LOI). You may buy Class A shares at a reduced sales charge
by completing the letter of intent section of your account application. A
letter of intent is a commitment by you to invest a specified dollar amount
during a 13 month period. The amount you agree to invest determines the sales
charge you pay. By completing the letter of intent section of the
application, you acknowledge and agree to the following:
o You authorize Distributors to reserve 5% of your total intended purchase
in Class A shares registered in your name until you fulfill your LOI. Your
periodic statements will include the reserved shares in the total shares
you own, and we will pay or reinvest dividend and capital gain
distributions on the reserved shares according to the distribution option
you have chosen.
o You give Distributors a security interest in the reserved shares and
appoint Distributors as attorney-in-fact.
o Distributors may sell any or all of the reserved shares to cover any
additional sales charge if you do not fulfill the terms of the LOI.
o Although you may exchange your shares, you may not sell reserved shares
until you complete the LOI or pay the higher sales charge.
After you file your LOI with the fund, you may buy Class A shares at the
sales charge applicable to the amount specified in your LOI. Sales charge
reductions based on purchases in more than one Franklin Templeton Fund will
be effective only after notification to Distributors that the investment
qualifies for a discount. Any Class A purchases you made within 90 days
before you filed your LOI also may qualify for a retroactive reduction in the
sales charge. If you file your LOI with the fund before a change in the
fund's sales charge, you may complete the LOI at the lower of the new sales
charge or the sales charge in effect when the LOI was filed.
Your holdings in the Franklin Templeton Funds acquired more than 90 days
before you filed your LOI will be counted towards the completion of the LOI,
but they will not be entitled to a retroactive reduction in the sales charge.
Any redemptions you make during the 13 month period, except in the case of
certain retirement plans, will be subtracted from the amount of the purchases
for purposes of determining whether the terms of the LOI have been completed.
If the terms of your LOI are met, the reserved shares will be deposited to an
account in your name or delivered to you or as you direct. If the amount of
your total purchases, less redemptions, is more than the amount specified in
your LOI and is an amount that would qualify for a further sales charge
reduction, a retroactive price adjustment will be made by Distributors and
the securities dealer through whom purchases were made. The price adjustment
will be made on purchases made within 90 days before and on those made after
you filed your LOI and will be applied towards the purchase of additional
shares at the offering price applicable to a single purchase or the dollar
amount of the total purchases.
If the amount of your total purchases, less redemptions, is less than the
amount specified in your LOI, the sales charge will be adjusted upward,
depending on the actual amount purchased (less redemptions) during the
period. You will need to send Distributors an amount equal to the difference
in the actual dollar amount of sales charge paid and the amount of sales
charge that would have applied to the total purchases if the total of the
purchases had been made at one time. Upon payment of this amount, the
reserved shares held for your account will be deposited to an account in your
name or delivered to you or as you direct. If within 20 days after written
request the difference in sales charge is not paid, we will redeem an
appropriate number of reserved shares to realize the difference. If you
redeem the total amount in your account before you fulfill your LOI, we will
deduct the additional sales charge due from the sale proceeds and forward the
balance to you.
For LOIs filed on behalf of certain retirement plans, the level and any
reduction in sales charge for these plans will be based on actual plan
participation and the projected investments in the Franklin Templeton Funds
under the LOI. These plans are not subject to the requirement to reserve 5%
of the total intended purchase or to the policy on upward adjustments in
sales charges described above, or to any penalty as a result of the early
termination of a plan, nor are these plans entitled to receive retroactive
adjustments in price for investments made before executing the LOI.
GROUP PURCHASES. If you are a member of a qualified group, you may buy Class
A shares at a reduced sales charge that applies to the group as a whole. The
sales charge
is based on the combined dollar value of the group members' existing
investments, plus the amount of the current purchase.
A qualified group is one that:
o Was formed at least six months ago,
o Has a purpose other than buying fund shares at a discount,
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.
A qualified group generally does not include a 403(b) plan that only allows
salary deferral contributions, although any such plan that purchased the
fund's Class A shares at a reduced sales charge under the group purchase
privilege before February 1, 1998, may continue to do so.
WAIVERS FOR INVESTMENTS FROM CERTAIN PAYMENTS. Class A shares may be
purchased without an initial sales charge or contingent deferred sales charge
(CDSC) by investors who reinvest within 365 days:
o Dividend and capital gain distributions from any Franklin Templeton Fund.
The distributions generally must be reinvested in the same share class.
Certain exceptions apply, however, to Class C shareholders who chose to
reinvest their distributions in Class A shares of the fund before November
17, 1997, and to Advisor Class or Class Z shareholders of a Franklin
Templeton Fund who may reinvest their distributions in the fund's Class A
shares. This waiver category also applies to Class B and C shares.
o Dividend or capital gain distributions from a real estate investment
trust (REIT) sponsored or advised by Franklin Properties, Inc.
o Annuity payments received under either an annuity option or from death
benefit proceeds, if the annuity contract offers as an investment option
the Franklin Templeton Variable Insurance Products Trust or the Templeton
Variable Products Series Fund. You should contact your tax advisor for
information on any tax consequences that may apply.
o Redemption proceeds from a repurchase of shares of Franklin Floating Rate
Trust, if the shares were continuously held for at least 12 months.
o If you immediately placed your redemption proceeds in a Franklin Bank CD
or a Franklin Templeton money fund, you may reinvest them as described
above. The proceeds must be reinvested within 365 days from the date the
CD matures, including any rollover, or the date you redeem your money fund
shares.
o Redemption proceeds from the sale of Class A shares of any of the
Templeton Global Strategy Funds if you are a qualified investor.
If you paid a CDSC when you redeemed your Class A shares from a Templeton
Global Strategy Fund, a new CDSC will apply to your purchase of fund
shares and the CDSC holding period will begin again. We will, however,
credit your fund account with additional shares based on the CDSC you
previously paid and the amount of the redemption proceeds that you
reinvest.
If you immediately placed your redemption proceeds in a Franklin Templeton
money fund, you may reinvest them as described above. The proceeds must be
reinvested within 365 days from the date they are redeemed from the money
fund.
o Distributions from an existing retirement plan invested in the Franklin
Templeton Funds
WAIVERS FOR CERTAIN INVESTORS. Class A shares also may be purchased without
an initial sales charge or CDSC by various individuals and institutions due
to anticipated economies in sales efforts and expenses, including:
o Trust companies and bank trust departments agreeing to invest in Franklin
Templeton Funds over a 13 month period at least $1 million of assets held
in a fiduciary, agency, advisory, custodial or similar capacity and over
which the trust companies and bank trust departments or other plan
fiduciaries or participants, in the case of certain retirement plans, have
full or shared investment discretion. We will accept orders for these
accounts by mail accompanied by a check or by telephone or other means of
electronic data transfer directly from the bank or trust company, with
payment by federal funds received by the close of business on the next
business day following the order.
o Any state or local government or any instrumentality, department,
authority or agency thereof that has determined the fund is a legally
permissible investment and that can only buy fund shares without paying
sales charges. Please consult your legal and investment advisors to
determine if an investment in the fund is permissible and suitable for you
and the effect, if any, of payments by the fund on arbitrage rebate
calculations.
o Broker-dealers, registered investment advisors or certified financial
planners who have entered into an agreement with Distributors for clients
participating in comprehensive fee programs
o Qualified registered investment advisors who buy through a broker-dealer
or service agent who has entered into an agreement with Distributors
o Registered securities dealers and their affiliates, for their investment
accounts only
o Current employees of securities dealers and their affiliates and their
family members, as allowed by the internal policies of their employer
o Officers, trustees, directors and full-time employees of the Franklin
Templeton Funds or the Franklin Templeton Group, and their family members,
consistent with our then-current policies
o Any investor who is currently a Class Z shareholder of Franklin Mutual
Series Fund Inc. (Mutual Series), or who is a former Mutual Series Class Z
shareholder who had an account in any Mutual Series fund on October 31,
1996, or who sold his or her shares of Mutual Series Class Z within the
past 365 days
o Investment companies exchanging shares or selling assets pursuant to a
merger, acquisition or exchange offer
o Accounts managed by the Franklin Templeton Group
o Certain unit investment trusts and their holders reinvesting
distributions from the trusts
o Group annuity separate accounts offered to retirement plans
o Chilean retirement plans that meet the requirements described under
"Retirement plans" below
In addition, Class C shares may be purchased without an initial sales charge
by any investor who buys Class C shares through an omnibus account with
Merrill Lynch Pierce Fenner & Smith, Inc. A CDSC may apply, however, if the
shares are sold within 18 months of purchase.
RETIREMENT PLANS. Retirement plans sponsored by an employer (i) with at least
100 employees, or (ii) with retirement plan assets of $1 million or more, or
(iii) that agrees to invest at least $500,000 in the Franklin Templeton Funds
over a 13 month period may buy Class A shares without an initial sales
charge. Retirement plans that are not qualified retirement plans (employer
sponsored pension or profit-sharing plans that qualify under section 401 of
the Internal Revenue Code, including 401(k), money purchase pension, profit
sharing and defined benefit plans), SIMPLEs (savings incentive match plans
for employees) or SEPs (employer sponsored simplified employee pension plans
established under section 408(k) of the Internal Revenue Code) must also meet
the group purchase requirements described above to be able to buy Class A
shares without an initial sales charge. We may enter into a special
arrangement with a securities dealer, based on criteria established by the
fund, to add together certain small qualified retirement plan accounts for
the purpose of meeting these requirements.
For retirement plan accounts opened on or after May 1, 1997, a CDSC may apply
if the retirement plan is transferred out of the Franklin Templeton Funds or
terminated within 365 days of the retirement plan account's initial purchase
in the Franklin Templeton Funds.
SALES IN TAIWAN. Under agreements with certain banks in Taiwan, Republic of
China, the fund's shares are available to these banks' trust accounts without
a sales charge. The banks may charge service fees to their customers who
participate in the trusts. A portion of these service fees may be paid to
Distributors or one of its affiliates to help defray expenses of maintaining
a service office in Taiwan, including expenses related to local literature
fulfillment and communication facilities.
The fund's Class A shares may be offered to investors in Taiwan through
securities advisory firms known locally as Securities Investment Consulting
Enterprises. In conformity with local business practices in Taiwan, Class A
shares may be offered with the following schedule of sales charges:
SIZE OF PURCHASE - U.S. DOLLARS SALES CHARGE (%)
- -----------------------------------------------------------------------
Under $30,000 3.0
$30,000 but less than $100,000 2.0
$100,000 but less than $400,000 1.0
$400,000 or more 0
DEALER COMPENSATION Securities dealers may at times receive the entire sales
charge. A securities dealer who receives 90% or more of the sales charge may
be deemed an underwriter under the Securities Act of 1933, as amended.
Financial institutions or their affiliated brokers may receive an agency
transaction fee in the percentages indicated in the dealer compensation table
in the fund's prospectus.
Distributors may pay the following commissions, out of its own resources, to
securities dealers who initiate and are responsible for purchases of Class A
shares of $1 million or more: 0.75% on sales of $1 million to $2 million,
plus 0.60% on sales over $2 million to $3 million, plus 0.50% on sales over
$3 million to $50 million, plus 0.25% on sales over $50 million to $100
million, plus 0.15% on sales over $100 million.
These breakpoints are reset every 12 months for purposes of additional
purchases.
Distributors or one of its affiliates may pay up to 1%, out of its own
resources, to securities dealers who initiate and are responsible for
purchases of Class A shares by certain retirement plans without an initial
sales charge. These payments may be made in the form of contingent advance
payments, which may be recovered from the securities dealer or set off
against other payments due to the dealer if shares are sold within 12 months
of the calendar month of purchase. Other conditions may apply. All terms and
conditions may be imposed by an agreement between Distributors, or one of its
affiliates, and the securities dealer.
In addition to the payments above, Distributors and/or its affiliates may
provide financial support to various 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.
CONTINGENT DEFERRED SALES CHARGE (CDSC) If you invest $1 million or more in
Class A shares, either as a lump sum or through our cumulative quantity
discount or letter of intent programs, a CDSC may apply on any shares you
sell within 12 months of purchase. For Class C shares, a CDSC may apply if
you sell your shares within 18 months of purchase. The CDSC is 1% of the
value of the shares sold or the net asset value at the time of purchase,
whichever is less.
Certain retirement plan accounts opened on or after May 1, 1997, and that
qualify to buy Class A shares without an initial sales charge also may be
subject to a CDSC if the retirement plan is transferred out of the Franklin
Templeton Funds or terminated within 365 days of the account's initial
purchase in the Franklin Templeton Funds.
For Class B shares, there is a CDSC if you sell your shares within six years,
as described in the table below. The charge is based on the value of the
shares sold or the net asset value at the time of purchase, whichever is less.
IF YOU SELL YOUR CLASS B SHARES WITHIN THIS % IS DEDUCTED FROM
THIS MANY YEARS AFTER BUYING THEM YOUR PROCEEDS AS A CDSC
- --------------------------------------------------------------------------------
1 Year 4
2 Years 4
3 Years 3
4 Years 3
5 Years 2
6 Years 1
7 Years 0
CDSC WAIVERS. The CDSC for any share class generally will be waived for:
o Account fees
o Sales of Class A shares purchased without an initial sales charge by
certain retirement plan accounts if (i) the account was opened before May
1, 1997, or (ii) the securities dealer of record received a payment from
Distributors of 0.25% or less, or (iii) Distributors did not make any
payment in connection with the purchase, or (iv) the securities dealer of
record has entered into a supplemental agreement with Distributors
o Redemptions of Class A shares by investors who purchased $1 million or
more without an initial sales charge if the securities dealer of record
waived its commission in connection with the purchase
o Redemptions by the fund when an account falls below the minimum required
account size
o Redemptions following the death of the shareholder or beneficial owner
o Redemptions through a systematic withdrawal plan set up before February
1, 1995
o Redemptions through a systematic withdrawal plan set up on or after
February 1, 1995, up to 1% monthly, 3% quarterly, 6% semiannually or 12%
annually of your account's net asset value depending on the frequency of
your plan
o Redemptions by Franklin Templeton Trust Company employee benefit plans or
employee benefit plans serviced by ValuSelect(R) (not applicable to Class B)
o Distributions from individual retirement accounts (IRAs) due to death or
disability or upon periodic distributions based on life expectancy (for
Class B, this applies to all retirement plan accounts, not only IRAs)
o Returns of excess contributions (and earnings, if applicable) from
retirement plan accounts
o Participant initiated distributions from employee benefit plans or
participant initiated exchanges among investment choices in employee
benefit plans (not applicable to Class B)
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 goals 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 are generally
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.
SYSTEMATIC WITHDRAWAL PLAN Our systematic withdrawal plan allows you to sell
your shares and receive regular payments from your account on a monthly,
quarterly, semiannual or annual basis. The value of your account must be at
least $5,000 and the minimum payment amount for each withdrawal must be at
least $50. For retirement plans subject to mandatory distribution
requirements, the $50 minimum will not apply. There are no service charges
for establishing or maintaining a systematic withdrawal plan.
Payments under the plan will be made from the redemption of an equivalent
amount of shares in your account, generally on the 25th day of the month in
which a payment is scheduled. If the 25th falls on a weekend or holiday, we
will process the redemption on the next business day. When you sell your
shares under a systematic withdrawal plan, it is a taxable transaction.
To avoid paying sales charges on money you plan to withdraw within a short
period of time, you may not want to set up a systematic withdrawal plan if
you plan to buy shares on a regular basis. Shares sold under the plan also
may be subject to a CDSC.
Redeeming shares through a systematic withdrawal plan may reduce or exhaust
the shares in your account if payments exceed distributions received from the
fund. This is especially likely to occur if there is a market decline. If a
withdrawal amount exceeds the value of your account, your account will be
closed and the remaining balance in your account will be sent to you. Because
the amount withdrawn under the plan may be more than your actual yield or
income, part of the payment may be a return of your investment.
You may discontinue a systematic withdrawal plan, change the amount and
schedule of withdrawal payments, or suspend one payment by notifying us by
mail or by phone at least seven business days before the end of the month
preceding a scheduled payment. The fund may discontinue a systematic
withdrawal plan by notifying you in writing and will automatically
discontinue a systematic withdrawal plan if all shares in your account are
withdrawn or if the fund receives notification of the shareholder's death or
incapacity.
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.
Redemptions in kind are taxable transactions. 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.
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.
The wiring of redemption proceeds 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 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. When you sell shares,
you receive the NAV minus any applicable CDSC.
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.
The fund determines the value of a foreign security as of the close of
trading on the foreign exchange on which the security is traded or as of the
close of trading on the NYSE, if that is earlier. The value is then converted
into its U.S. dollar equivalent at the foreign exchange rate in effect at
noon, New York time, on the day the value of the foreign security is
determined. If no sale is reported at that time, the foreign security is
valued within the range of the most recent quoted bid and ask prices.
Occasionally events that affect the values of foreign securities and foreign
exchange rates may occur between the times at which they are determined and
the close of the exchange and will, therefore, not be reflected in the
computation of the NAV. If events materially affecting the values of these
foreign securities occur during this period, the securities will be valued in
accordance with procedures established by the board.
Generally, trading in corporate bonds, U.S. government securities and money
market instruments is substantially completed each day at various times
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.
The table below shows the aggregate underwriting commissions Distributors
received in connection with the offering of the fund's shares, the net
underwriting discounts and commissions Distributors retained after allowances
to dealers, and the amounts Distributors received in connection with
redemptions or repurchases of shares for the last three fiscal years ended
April 30:
AMOUNT
RECEIVED IN
CONNECTION
WITH
TOTAL AMOUNT REDEMPTIONS
COMMISSIONS RETAINED BY AND
RECEIVED DISTRIBUTORS REPURCHASES
($) ($) ($)
- --------------------------------------------------------------------------------
1999 2,507,064 147,305 16,052
1998 2,420,305 163,904 0
1997 330,506 23,568 0
Distributors may be entitled to reimbursement under the Rule 12b-1 plans, as
discussed below. Except as noted, Distributors received no other compensation
from the fund for acting as underwriter.
DISTRIBUTION AND SERVICE (12B-1) FEES Each class has a separate distribution
or "Rule 12b-1" plan. Under each plan, the fund shall pay or may reimburse
Distributors or others for the expenses of activities that are primarily
intended to sell shares of the class. 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.
The distribution and service (12b-1) fees charged to each class are based
only on the fees attributable to that particular class.
THE CLASS A PLAN. Payments by the fund under the Class A plan may not exceed
0.25% per year of Class A's average daily net assets, payable quarterly. All
distribution expenses over this amount will be borne by those who have
incurred them.
THE CLASS B AND C PLANS. Under the Class B and C plans, the fund pays
Distributors up to 0.50% per year of the class's average daily net assets,
payable monthly for Class B and quarterly for Class C, to pay Distributors or
others for providing distribution and related services and bearing certain
expenses. All distribution expenses over this amount will be borne by those
who have incurred them. The fund also may pay a servicing fee of up to 0.15%
per year of the class's average daily net assets, payable monthly for Class B
and quarterly for Class C. This fee may be used to pay securities dealers or
others for, among other things, helping to establish and maintain customer
accounts and records, helping with requests to buy and sell shares, receiving
and answering correspondence, monitoring dividend payments from the fund on
behalf of customers, and similar servicing and account maintenance activities.
The expenses relating to each of the Class B and C plans also are used to pay
Distributors for advancing the commission costs to securities dealers with
respect to the initial sale of Class B and C shares. Further, the expenses
relating to the Class B plan may be used by Distributors to pay third party
financing entities that have provided financing to Distributors in connection
with advancing commission costs to securities dealers.
THE CLASS A, B AND C PLANS. In addition to the payments that Distributors or
others are entitled to under each plan, each plan also provides that to the
extent the fund, the manager or Distributors or other parties on behalf of
the fund, the manager or Distributors make payments that are deemed to be for
the financing of any activity primarily intended to result in the sale of
fund shares within the context of Rule 12b-1 under the Investment Company Act
of 1940, as amended, then such payments shall be deemed to have been made
pursuant to the plan. The terms and provisions of each 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 each plan, plus any other payments deemed to be made
pursuant to a plan, exceed the amount permitted to be paid under the rules of
the National Association of Securities Dealers, Inc.
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 plans 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 plans 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.
Each plan has been approved in accordance with the provisions of Rule 12b-1.
The plans are renewable annually by a vote of the board, including a majority
vote of the board members who are not interested persons of the fund and who
have no direct or indirect financial interest in the operation of the plans,
cast in person at a meeting called for that purpose. It is also required that
the selection and nomination of such board members be done by the
noninterested members of the fund's board. The plans 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 also may terminate their respective distribution
or service agreement at any time upon written notice.
The plans and any related agreements may not be amended to increase
materially the amount to be spent for distribution expenses without approval
by a majority of the outstanding shares of the class, and all material
amendments to the plans or any related agreements shall be approved by a vote
of the 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 plans and any
related agreements, as well as to furnish the board with such other
information as may reasonably be requested in order to enable the board to
make an informed determination of whether the plans should be continued.
For the fiscal year ended April 30, 1999, Distributors' eligible expenditures
for advertising, printing, payments to underwriters and broker-dealers and
other expenses pursuant to the plans and the amounts the fund paid
Distributors under the plans were:
DISTRIBUTORS' AMOUNT
ELIGIBLE PAID BY THE
EXPENSES ($) FUND ($)
- ----------------------------------------------------------------------
Class A 1,034,619 541,169
Class B 100,759 4,063
Class C 407,730 130,387
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 and current yield quotations used by the
fund are based on the standardized methods of computing performance mandated
by the SEC. Performance figures reflect Rule 12b-1 fees from the date of the
plan's implementation. An explanation of these and other methods used by the
fund to compute or express performance follows. 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.
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 the maximum initial sales charge is
deducted from the initial $1,000 purchase, and 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.
When considering the average annual total return quotations for Class A and C
shares, you should keep in mind that the maximum initial sales charge
reflected in each quotation is a one time fee charged on all direct
purchases, which will have its greatest impact during the early stages of
your investment. This charge will affect actual performance less the longer
you retain your investment in the fund. The average annual total returns for
the indicated periods ended April 30, 1999, were:
SINCE
INCEPTION
1 YEAR (%) (5/24/94) (%)
- --------------------------------------------------------------------------------
Class A -0.21 10.02
SINCE
INCEPTION
1 YEAR (%) (5/1/98) (%)
- --------------------------------------------------------------------------------
Class C 1.62 1.62
The following SEC formula was used to calculate these figures:
n
P(1+T) = ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at the
beginning of each period at the end of each period
CUMULATIVE TOTAL RETURN Like average annual total return, cumulative total
return assumes the maximum initial sales charge is deducted from the initial
$1,000 purchase, income dividends and capital gain distributions are
reinvested at net asset value, the account was completely redeemed at the end
of each period and the deduction of all applicable charges and fees.
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 April 30,
1999, were:
SINCE
INCEPTION
1 YEAR (%) (5/24/94) (%)
- ----------------------------------------------------------------------------
Class A -0.21 60.17
SINCE
INCEPTION
1 YEAR (%) (5/1/98) (%)
- ----------------------------------------------------------------------------
Class C 1.62 1.62
CURRENT YIELD Current yield shows the income per share earned by the fund. It
is calculated by dividing the net investment income per share earned during a
30-day base period by the applicable maximum offering price per share on the
last day of the period and annualizing the result. Expenses accrued for the
period include any fees charged to all shareholders of the class during the
base period. The yields for the 30-day period ended April 30, 1999, were:
CLASS A (%) CLASS B (%) CLASS C (%)
- ----------------------------------------------------------------------------
7.53 7.47 7.39
The following SEC formula was used to calculate these figures:
6
Yield = 2 [(a-b + 1) - 1]
---
cd
where:
a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the period that
were entitled to receive dividends
d = the maximum offering price per share on the last day of the period
CURRENT DISTRIBUTION RATE Current yield, which is calculated according to a
formula prescribed by the SEC, is not indicative of the amounts which were or
will be paid to shareholders. Amounts paid to shareholders are reflected in
the quoted current distribution rate. The current distribution rate is
usually computed by annualizing the dividends paid per share by a class
during a certain period and dividing that amount by the current maximum
offering price. The current distribution rate differs from the current yield
computation because it may include distributions to shareholders from sources
other than dividends and interest, such as premium income from option writing
and short-term capital gains, and is calculated over a different period of
time. The current distribution rates for the 30-day period ended April 30,
1999, were:
CLASS A (%) CLASS B (%) CLASS C (%)
- -----------------------------------------------------------------------------
7.21 7.10 7.04
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 The fund also may quote the performance of
shares without a sales charge. Sales literature and advertising may quote a
cumulative total return, average annual total return and other measures of
performance with the substitution of net asset value for the public offering
price.
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:
o Dow Jones(R) Composite Average and its component averages - a
price-weighted average of 65 stocks that trade on the New York Stock
Exchange. The average is a combination of the Dow Jones Industrial Average
(30 blue-chip stocks that are generally leaders in their industry), the
Dow Jones Transportation Average (20 transportation stocks), and the Dow
Jones Utilities Average (15 utility stocks involved in the production of
electrical energy).
o Standard & Poor's(R) 500 Stock Index or its component indices - a
capitalization-weighted index designed to measure performance of the broad
domestic economy through changes in the aggregate market value of 500
stocks representing all major industries.
o The New York Stock Exchange composite or component indices - an unmanaged
index of all industrial, utilities, transportation, and finance stocks
listed on the NYSE.
o Wilshire 5000 Equity Index - represents the return on the market value of
all common equity securities for which daily pricing is available.
Comparisons of performance assume reinvestment of dividends.
o Lipper - Mutual Fund Performance Analysis and Lipper - Equity Fund
Performance Analysis - measure total return and average current yield for
the mutual fund industry and rank individual mutual fund performance over
specified time periods, assuming reinvestment of all distributions,
exclusive of any applicable sales charges.
o CDA Mutual Fund Report, published by CDA Investment Technologies, Inc. -
analyzes price, current yield, risk, total return, and average rate of
return (average annual compounded growth rate) over specified time periods
for the mutual fund industry.
o Mutual Fund Source Book, published by Morningstar, Inc. - analyzes price,
yield, risk, and total return for mutual funds.
o Financial publications: The Wall Street Journal, and Business Week,
Changing Times, Financial World, Forbes, Fortune, and Money magazines -
provide performance statistics over specified time periods.
o Consumer Price Index (or Cost of Living Index), published by the U.S.
Bureau of Labor Statistics - a statistical measure of change, over time,
in the price of goods and services in major expenditure groups.
o Stocks, Bonds, Bills, and Inflation, published by Ibbotson Associates -
historical measure of yield, price, and total return for common and small
company stock, long-term government bonds, Treasury bills, and inflation.
o Savings and Loan Historical Interest Rates - as published in the U.S.
Savings & Loan League Fact Book.
o Historical data supplied by the research departments of CS First Boston
Corporation, the J.P. Morgan companies, Salomon Brothers, Merrill Lynch,
Lehman Brothers and Bloomberg L.P.
o Morningstar - information published by Morningstar, Inc., including
Morningstar proprietary mutual fund ratings. The ratings reflect
Morningstar's assessment of the historical risk-adjusted performance of a
fund over specified time periods relative to other funds within its
category.
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. For example, as the general level of interest rates
rise, the value of the fund's fixed-income investments, as well as the value
of its shares that are based upon the value of such portfolio investments,
can be expected to decrease. Conversely, when interest rates decrease, the
value of the fund's shares can be expected to increase. CDs are frequently
insured by an agency of the U.S. government. An investment in the fund is not
insured by any federal, state or private entity.
In assessing comparisons of performance, you should keep in mind that the
composition of the investments in the reported indices and averages is not
identical to the fund's portfolio, the indices and averages are generally
unmanaged, and the items included in the calculations of the averages may not
be identical to the formula used by the fund to calculate its figures. In
addition, there can be no assurance that the fund will continue its
performance as compared to these other averages.
MISCELLANEOUS INFORMATION
- ------------------------------------------------------------------------------
The 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 in order 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 fund 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 more than 4 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 $227 billion in assets under management for
more than 7 million U.S. based mutual fund shareholder and other accounts.
The Franklin Templeton Group of Funds offers 112 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.
The Information Services & Technology division of Franklin Resources, Inc.
(Resources) established a Year 2000 Project Team in 1996. This team has
already begun making necessary software changes to help the computer systems
that service the fund and its shareholders to be Year 2000 compliant. After
completing these modifications, comprehensive tests are conducted in one of
Resources' U.S. test labs to verify their effectiveness. Resources continues
to seek reasonable assurances from all major hardware, software or
data-services suppliers that they will be Year 2000 compliant on a timely
basis. Resources is also beginning to develop a contingency plan, including
identification of those mission critical systems for which it is practical to
develop a contingency plan. However, in an operation as complex and
geographically distributed as Resources' business, the alternatives to use of
normal systems, especially mission critical systems, or supplies of
electricity or long distance voice and data lines are limited.
DESCRIPTION OF RATINGS
- ------------------------------------------------------------------------------
CORPORATE BOND RATINGS
MOODY'S INVESTORS SERVICE, INC. (MOODY'S)
Aaa: Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as
"gilt-edged." Interest payments are protected by a large or exceptionally
stable margin, and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
Aa: Bonds rated Aa are judged to be high quality by all standards. Together
with the Aaa group, they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large, fluctuation of protective elements may be of greater
amplitude, or there may be other elements present that make the long-term
risks appear somewhat larger.
A: Bonds rated A possess many favorable investment attributes and are
considered upper medium-grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
that suggest a susceptibility to impairment sometime in the future.
Baa: Bonds rated Baa are considered medium-grade obligations. They are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may
be lacking or may be characteristically unreliable over any great length of
time. These bonds lack outstanding investment characteristics and, in fact,
have speculative characteristics as well.
Ba: Bonds rated Ba are judged to have predominantly speculative elements and
their future cannot be considered well assured. Often the protection of
interest and principal payments is very moderate and, thereby, not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B: Bonds rated B generally lack characteristics of the desirable investment.
Assurance of interest and principal payments or of maintenance of other terms
of the contract over any long period of time may be small.
Caa: Bonds rated Caa are of poor standing. These issues may be in default or
there may be present elements of danger with respect to principal or interest.
Ca: Bonds rated Ca represent obligations that are speculative to a high
degree. These issues are often in default or have other marked shortcomings.
C: Bonds rated C are the lowest rated class of bonds and can be regarded as
having extremely poor prospects of ever attaining any real investment
standing.
Note: Moody's applies numerical modifiers 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond ratings. The modifier
1 indicates that the security ranks in the higher end of its generic rating
category; modifier 2 indicates a mid-range ranking; and modifier 3 indicates
that the issue ranks in the lower end of its generic rating category.
STANDARD & POOR'S CORPORATION (S&P)
AAA: This is the highest rating assigned by S&P to a debt obligation and
indicates an extremely strong capacity to pay principal and interest.
AA: Bonds rated AA also qualify as high-quality debt obligations. Capacity to
pay principal and interest is very strong and, in the majority of instances,
differ from AAA issues only in a small degree.
A: Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions.
BBB: Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit protection parameters,
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity to pay principal and interest for bonds in this
category than for bonds in the A category.
BB, B, CCC, CC: Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal in accordance with the terms of the obligations.
BB indicates the lowest degree of speculation and CC the highest degree of
speculation. While these bonds will likely have some quality and protective
characteristics, they are outweighed by large uncertainties or major risk
exposures to adverse conditions.
C: Bonds rated C are typically subordinated debt to senior debt that is
assigned an actual or implied CCC- rating. The C rating 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 for
commercial paper, 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.
