PROSPECTUS
FRANKLIN TEMPLETON
INTERNATIONAL TRUST
INVESTMENT STRATEGY
GLOBAL GROWTH
TEMPLETON FOREIGN SMALLER COMPANIES FUND - CLASS A, B & C
TEMPLETON PACIFIC GROWTH FUND - CLASS A & C
MARCH 1, 1999
[Insert Franklin Templeton Ben Head]
LIKE ALL MUTUAL FUND SHARES, THE SEC HAS NOT APPROVED OR DISAPPROVED THESE
SECURITIES OR PASSED UPON THE ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
CONTENTS
THE FUND
[BEGIN CALLOUT]
Information about each fund you should know before investing
[End callout]
2 Templeton Foreign Smaller Companies Fund
13 Templeton Pacific Growth Fund
24 Distributions and taxes; Year 2000 problem
YOUR ACCOUNT
[BEGIN CALLOUT]
Information about sales charges, account transactions and services
[End callout]
26 Choosing a Share Class
33 Buying Shares
35 Investor Services
38 Selling Shares
40 Account Policies
43 Questions
FOR MORE INFORMATION
[BEGIN CALLOUT]
Where to learn more about each fund
[End callout]
Back Cover
TEMPLETON FOREIGN
SMALLER COMPANIES FUND
[Insert graphic of bullseye and arrows] GOAL AND STRATEGIES
GOAL The fund's investment goal is long-term capital growth.
PRINCIPAL INVESTMENTS Under normal market conditions, the fund will invest
at least 65% of its total assets in equity securities of smaller companies
located outside the U.S. Smaller companies generally are those with market
capitalization of less than $1 billion. In some emerging markets, the fund
may invest in companies that qualify as small cap but still are among the
largest in the market.
Equity securities generally entitle the holder to participate in a company's
general operating results. These include common stocks and preferred stocks.
The fund also invests in American, Global, and European Depositary Receipts,
which are certificates typically issued by a bank or trust company that give
their holders the right to receive securities issued by a foreign or domestic
corporation.
[Begin callout]
The fund invests primarily in an internationally diversified portfolio of
smaller companies' common stocks.
[End callout]
The fund may invest up to 35% of its total assets in any combination of:
o equity securities of larger capitalized companies located outside the
U.S.;
o equity securities of U.S. companies. The fund presently does not expect
to invest more than 5% of its assets in these securities;
o both rated and unrated debt securities. Debt securities represent an
obligation of the issuer to repay a loan of money to it, and generally
provide for the payment of interest. These include bonds, notes and
debentures.
The fund may invest more than 25% of its assets in the securities of issuers
of any one country.
The Templeton investment philosophy is "bottom-up", value-oriented, and
long-term. In choosing equity investments, the fund's manager will focus on
the market price of a company's securities relative to its evaluation of a
company's long-term earnings, asset value and cash flow potential. A
company's historical value measures, including price/earnings ratios, profit
margins and liquidation value, will also be considered.
TEMPORARY INVESTMENTS The manager may take a temporary defensive position
when the securities trading markets or the economies of countries where the
fund invests are experiencing excessive volatility or a prolonged general
decline, or other adverse conditions exist. Under these circumstances, the
fund may be unable to pursue its investment goal because it may not invest or
may invest substantially less in international smaller companies' stocks.
[INSERT GRAPHIC OF CHART WITH LINE GOING UP AND DOWN] MAIN RISKS
[BEGIN CALLOUT]
Because the stocks the fund holds fluctuate in price, the value of your
investment in the fund will go up and down. This means you could lose money
over short or even extended periods.
[End callout]
STOCKS While stocks have historically outperformed other asset classes over
the long term, they tend to go up and down more dramatically over the shorter
term. These price movements may result from factors affecting individual
companies, industries or the securities market as a whole. Value stock prices
are considered "cheap" relative to the company's perceived value. They may
not increase in value, as anticipated by the manager, if other investors fail
to recognize the company's value and bid up the price or if they trade in
markets favoring faster-growing companies.
SMALLER COMPANIES Historically, smaller company securities have been more
volatile in price than larger company securities, especially over the
short-term. Among the reasons for the greater price volatility are the less
certain growth prospects of smaller companies, the lower degree of liquidity
in the markets for such securities and the greater sensitivity of smaller
companies to changing economic conditions.
In addition, smaller companies may lack depth of management, they may be
unable to generate funds necessary for growth or development or they may be
developing or marketing new products or services for which markets are not
yet established and may never become established.
Therefore, while smaller companies may offer greater opportunities for
capital growth than larger, more established companies, they also involve
greater risks and should be considered speculative.
FOREIGN SECURITIES Securities of companies and governments located outside
the U.S. may involve risks that can increase the potential for losses in the
fund. Investments in Depositary Receipts also involve some or all of the
following risks.
COUNTRY. General securities market movements in any country where the fund
has investments are likely to affect the value of the securities the fund
owns that trade in that country. These movements will affect the fund's share
price and fund performance.
The political, economic and social structures of some countries the fund
invests in 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, currency devaluations, foreign ownership
limitations, expropriation, restrictions on removal of currency or other
assets, nationalization of assets, punitive taxes and certain custody and
settlement risks.
The fund's investments in developing or emerging markets are subject to all
of the risks of foreign investing generally, and have additional heightened
risks due to a lack of established legal, business and social frameworks to
support securities markets. Foreign securities markets, including emerging
markets, may have substantially lower trading volumes than U.S. markets,
resulting in less liquidity and more volatility than experienced in the U.S.
While short-term volatility in these markets can be disconcerting, declines
in excess of 50% are not unusual.
COMPANY. Foreign companies are not subject to the same disclosure,
accounting, auditing and financial reporting standards and practices as U.S.
companies and their securities may not be as liquid as securities of similar
U.S. companies. Foreign stock exchanges, trading systems, brokers and
companies generally have less government supervision and regulation than in
the U.S. The fund 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 U.S.
companies in U.S. courts.
CURRENCY Many of the fund's investments are 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.
Devaluation of a currency by a country's government or banking authority also
will have a significant impact on the value of any securities denominated in
that currency. Currency markets generally are not as regulated as securities
markets.
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. If the fund holds investments in countries
with currencies replaced by the euro, the investment process, including
trading, foreign exchange, payments, settlements, cash accounts, custody and
accounting will be impacted.
Because this change to a single currency is new and untested, the
establishment of the euro may result in market volatility. For the same
reason, it is not possible to predict the impact of the euro on the business
or financial condition of European issuers which the fund may hold in its
portfolio, and their impact on fund performance. To the extent the fund holds
non-U.S. dollar (euro or other) denominated securities, it will still be
exposed to currency risk due to fluctuations in those currencies versus the
U.S. dollar.
ILLIQUID SECURITIES The fund may invest up to 10% of its net assets in
illiquid securities. Illiquid securities are generally those that cannot be
sold within seven days in the normal course of business for approximately the
amount at which the fund has valued them. A limited trading market can result
from political or economic conditions affecting previously established
securities markets, particularly in emerging market conditions.
INTEREST RATE When interest rates rise, debt security prices fall. The
opposite is also true; debt security prices go up when interest rates fall.
Generally, interest rates rise during times of inflation or a growing
economy, and fall during an economic slowdown or recession. Securities with
longer maturities usually are more sensitive to interest rate changes than
securities with shorter maturities.
CREDIT This is the possibility that an issuer will be unable to make
interest payments or repay principal. Changes in an issuer's financial
strength or in a security's credit rating may affect its value and, thus,
impact the value of fund shares.
YEAR 2000 When evaluating current and potential portfolio positions, Year
2000 is one of the factors the fund's manager considers.
The manager will rely upon public filings and other statements made by
companies about their Year 2000 readiness. Issuers in countries outside the
U.S., particularly in emerging markets, may not be required to make the same
level of disclosure about Year 2000 readiness as is required in the U.S. The
manager, of course, cannot audit each company and its major suppliers to
verify their Year 2000 readiness.
If a company in which the fund is invested is adversely affected by Year 2000
problems, it is likely that the price of its securities will also be
adversely affected. A decrease in the value of one or more of the fund's
portfolio holdings will have a similar impact on the fund's performance.
Please see page 25 for more information.
More detailed information about the fund, its policies, including temporary
investments, and risks can be found in the fund's Statement of Additional
Information (SAI).
[Begin callout]
Mutual fund shares are not deposits or obligations of, or guaranteed or
endorsed by, any bank, and are not federally insured by the Federal Deposit
Insurance Corporation, the Federal Reserve Board, or any other agency of the
U.S. government. Mutual fund shares involve investment risks, including the
possible loss of principal.
[End callout]
[Insert graphic of bull and bear] PERFORMANCE
This bar chart and table show the volatility of the fund's returns, which is
one indicator of the risks of investing in the fund. The bar chart shows
changes in the fund's returns from year to year over the past seven calendar
years. The table shows how the fund's average annual total returns compare to
those of a broad-based securities market index. Of course, past performance
cannot predict or guarantee future results.
CLASS A ANNUAL TOTAL RETURNS 1
[Insert bar graph]
0.89% 33.02% -0.11% 10.71% 24.18% 2.91% -6.52%
92 93 94 95 96 97 98
YEAR
[Begin callout]
BEST
QUARTER:
Q4 '93
16.09%
WORST
QUARTER:
Q3 '98
- -16.63%
[End callout]
AVERAGE ANNUAL TOTAL RETURNS
For the periods ended December 31, 1998
SINCE
INCEPTION
1 YEAR 5 YEARS (9/20/91)
- --------------------------------------------------------------------------------
Templeton Foreign Smaller Companies
Fund - Class A 2 -11.91% 4.48% 7.84%
MSCI EAFE Index 3 20.33% 9.50% 9.32%
SINCE
INCEPTION
(7/1/98)
- ----------------------------------------------------------------------------
Templeton Foreign Smaller Companies Fund - Class C 2 -13.05%
MSCI EAFE Index 3 3.66%
1. Figures do not reflect sales charges. If they did, returns would be lower.
2. Figures reflect sales charges.
All fund performance assumes reinvestment of dividends and capital gains.
3. Source: Standard and Poor's(R) Micropal. The unmanaged MSCI Europe Australia
Far East (EAFE) Index tracks the performance of approximately 1,000
securities in 20 countries. It includes reinvested dividends. One cannot
invest directly in an index, nor is an index representative of the fund's
portfolio.
[Insert graphic of percentage sign] FEES AND EXPENSES
This table describes the fees and expenses that you may pay if you buy and
hold shares of the fund.
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT)
CLASS A 1 CLASS B 2 CLASS C 1
- --------------------------------------------------------------------------------
Maximum sales charge (load) as a
percentage of offering price 5.75% 4.00% 1.99%
Load imposed on purchases 5.75% None 1.00%
Maximum deferred sales charge (load) None 3 4.00% 0.99%4
Exchange fee 5 $5.00 $5.00 $5.00
Please see "Choosing a Share Class" on page 26 for an explanation of how and
when these sales charges apply.
ANNUAL FUND OPERATING EXPENSES (EXPENSES DEDUCTED FROM FUND ASSETS)
CLASS A 1 CLASS B 2 CLASS C 1
- --------------------------------------------------------------------------------
Management fees 6 0.50% 0.50% 0.50%
Distribution and service (12b-1) fees 7 0.20% 1.00% 1.00%
Other expenses 0.80% 0.80% 0.80%
-------------------------------
Total annual fund operating expenses6 1.50% 2.30% 2.30%
===============================
1. Before January 1, 1999, Class A shares were designated Class I and Class C
shares were designated Class II. The fund began offering Class C shares on
July 1, 1998. Annual fund operating expenses for Class C are annualized.
2. The fund began offering Class B shares on January 1, 1999. Annual fund
operating expenses are based on the expenses for Class A for the fiscal year
ended October 31, 1998. The distribution and service (12b-1) fees are based
on the maximum fees allowed under Class B's Rule 12b-1 plan.
3. Except for investments of $1 million or more (see page 26) and purchases
by certain retirement plans without an initial sales charge.
4. This is equivalent to a charge of 1% based on net asset value.
5. This fee is only for market timers (see page 41).
6. For the fiscal year ended October 31, 1998, the manager had agreed in
advance to limit its management fees and to assume as its own expense certain
expenses otherwise payable by the fund. With this reduction, management fees
were 0.47% and total annual fund operating expenses were 1.47% for Class A.
The manager may end this arrangement at any time upon notice to the fund's
Board of Trustees.
7. Because of the distribution and service (12b-1) fees, over the long term
you may indirectly pay more than the equivalent of the maximum permitted
initial sales charge.
EXAMPLE
This example can help you compare the cost of investing in the fund with the
cost of investing in other mutual funds.
The example assumes you invest $10,000 for the periods shown and then sell
all of your shares at the end of those periods. The example also assumes your
investment has a 5% return each year and the fund's operating expenses remain
the same. Although your actual costs may be higher or lower, based on these
assumptions your costs would be:
1 YEAR 3 YEARS 5 YEARS 10 YEARS
- --------------------------------------------------------------------------------
CLASS A $719 1 $1,022 $1,346 $2,263
CLASS B
Assuming you sold your shares
at the end of the period $633 $1,018 $1,430 $2,435 2
Assuming you stayed in the fund $233 $ 718 $1,230 $2,435 2
CLASS C $429 3 $ 811 $1,318 $2,709
1. Assumes a contingent deferred sales charge (CDSC) will not apply.
2. Assumes conversion of Class B shares to Class A shares after eight years,
lowering your annual expenses from that time on.
3. For the same Class C investment, your costs would be $331 if you did not
sell your shares at the end of the first year. Your costs for the remaining
periods would be the same.
[INSERT GRAPHIC OF BRIEFCASE] MANAGEMENT
Franklin Advisers, Inc. (Advisers), 777 Mariners Island Blvd., San Mateo, CA
94404, is the fund's investment manager. Together, Advisers and its
affiliates manage over $220 billion in assets.
Under an agreement with Advisers, Templeton Investment Counsel, Inc.
(Investment Counsel), 500 East Broward Boulevard, Ft. Lauderdale, FL 33394,
is the fund's sub-advisor. Investment Counsel provides Advisers with
investment management advice and assistance.
The team responsible for the fund's management is:
SIMON RUDOLPH, SENIOR VICE PRESIDENT OF INVESTMENT COUNSEL
Mr. Rudolph has been a manager of the fund since 1997. He joined the Franklin
Templeton Group in 1997. Previously, he was an executive director with Morgan
Stanley.
PETER N. NORI CFA, SENIOR VICE PRESIDENT OF INVESTMENT COUNSEL
Mr. Nori has been a manager of the fund since 1997. He joined the Franklin
Templeton Group in 1987.
JUAN J. BENITO, VICE PRESIDENT OF INVESTMENT COUNSEL
Mr. Benito has been a manager of the fund since 1997. He joined the Franklin
Templeton Group in 1996. Previously, he was a management consultant and case
team leader with Monitor Company, a leading global strategy consulting firm.
The fund pays the manager a fee for managing the fund's assets and making its
investment decisions. For the fiscal year ended October 31, 1998, management
fees, before any advance waiver, were 0.50% of the fund's average daily net
assets. Under an agreement by the manager to limit its fees, the fund paid
0.47% of its average daily net assets to the manager. The manager may end
this arrangement at any time upon notice to the fund's Board of Trustees.
[INSERT GRAPHIC OF DOLLAR BILL] FINANCIAL HIGHLIGHTS
This table presents the fund's financial performance for the past five years.
This information has been audited by PricewaterhouseCoopers LLP.
CLASS A YEAR ENDED OCTOBER 31,
- --------------------------------------------------------------------------------
1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------
PER SHARE DATA ($)
Net asset value, beginning of year 15.06 14.18 13.23 13.83 12.28
------------------------------------
Net investment income .26 .27 .35 .25 .23
Net realized and unrealized
gains (losses) (2.08) 1.64 1.88 (.08) 1.54
------------------------------------
Total from investment operations (1.82) 1.91 2.23 .17 1.77
------------------------------------
Dividends from net investment income (.24) (.32) (.25) (.19) (.22)
Distributions from net realized gains (.67) (.71) (1.03) (.59) -
-----------------------------------
Total distributions (.91) (1.03) (1.28) (.77) (.22)
-------------------------------------
Net asset value, end of year 12.33 15.06 14.18 13.23 13.83
====================================
Total return (%)1 (12.64) 14.25 18.49 1.75 14.56
RATIOS/SUPPLEMENTAL DATA
Net assets, end of year ($ x 1,000) 113,964 121,619 67,967 50,947 57,854
Ratios to average net assets: (%)
Expenses 1.48 1.48 1.53 1.63 1.22
Expenses excluding waiver and
payments by affiliate 1.50 1.58 1.53 1.63 1.76
Net investment income 1.23 2.01 2.50 1.86 1.99
Portfolio turnover rate (%) 22.82 33.62 40.46 9.12 21.80
CLASS C
- --------------------------------------------------------------------------------
1998 2
- --------------------------------------------------------------------------------
PER SHARE DATA ($)
Net asset value, beginning of year 14.23
------------------------------------
Net investment income .01
Net realized and unrealized gains (1.92)
------------------------------------
Total from investment operations (1.91)
------------------------------------
Net asset value, end of year 12.32
====================================
Total return (%) 1 (13.42)
RATIOS/SUPPLEMENTAL DATA
Net assets, end of year ($ x 1,000) 450
Ratios to average net Assets: (%)
Expenses 2.54 3
Net investment income 1.08 3
Portfolio turnover rate (%) 22.82
1. Total return does not include sales charges, and is not annualized.
2. For the period from July 1, 1998 (effective date) through October 31, 1998.
3. Annualized.
TEMPLETON PACIFIC
GROWTH FUND
[Insert graphic of bullseye and arrows] GOAL AND STRATEGIES
GOAL The fund's investment goal is long-term capital growth.
PRINCIPAL INVESTMENTS Under normal market conditions, the fund will invest
at least 65% of its total assets in equity securities that trade on Pacific
Rim markets and are issued by companies that have their principal activities
in the Pacific Rim.
For purposes of the fund's investments, Pacific Rim countries include
Australia, China, Hong Kong, India, Indonesia, Japan, Malaysia, New Zealand,
Pakistan, Philippines, Singapore, South Korea and Thailand. At least 65% of
the fund's total assets will be invested in issuers in at least three of
these countries.
Equity securities generally entitle the holder to participate in a company's
general operating results. These include common stocks and preferred stocks.
The fund also invests in American and Global Depositary Receipts, which are
certificates typically issued by a bank or trust company that give their
holders the right to receive securities issued by a foreign or domestic
corporation.
[Begin callout]
The fund invests primarily in common stocks of Pacific Rim companies.
[End callout]
The fund may invest up to 35% of its total assets in any combination of:
o securities of issuers domiciled outside the Pacific Rim. These
investments may include securities of issuers that are linked by
tradition, economic markets, cultural similarities or geography to
countries in the Pacific Rim or that have operations in the Pacific Rim
or that stand to benefit from political and economic events in the
Pacific Rim;
o both rated and unrated debt and synthetic convertible securities. The
fund currently has no intention of investing more than 5% of its net
assets in synthetic convertible securities. Debt securities represent an
obligation of the issuer to repay a loan of money to it, and generally
provide for the payment of interest. These include bonds, notes and
debentures.
The fund may invest more than 25% of its assets in the securities of issuers
of any one country.
The Templeton investment philosophy is "bottom-up", value-oriented, and
long-term. In choosing equity investments, the fund's manager will focus on
the market price of a company's securities relative to its evaluation of a
company's long-term earnings, asset value and cash flow potential. A
company's historical value measures, including price/earnings ratios, profit
margins and liquidation value, will also be considered.
TEMPORARY INVESTMENTS The manager may take a temporary defensive position
when the securities trading markets or the economies of countries where the
fund invests are experiencing excessive volatility or a prolonged general
decline, or other adverse conditions exist. Under these circumstances, the
fund may be unable to pursue its investment goal because it may not invest or
may invest substantially less in Pacific Rim companies' stocks.
[INSERT GRAPHIC OF CHART WITH LINE GOING UP AND DOWN] MAIN RISKS
[BEGIN CALLOUT]
Because the stocks the fund holds fluctuate in price, the value of your
investment in the fund will go up and down. This means you could lose money
over short or even extended periods.
[End callout]
STOCKS While stocks have historically outperformed other asset classes over
the long term, they tend to go up and down more dramatically over the shorter
term. These price movements may result from factors affecting individual
companies, industries or the securities market as a whole. Value stock prices
are considered "cheap" relative to the company's perceived value. They may
not increase in value, as anticipated by the manager, if other investors fail
to recognize the company's value and bid up the price or if they trade in
markets favoring faster-growing companies.
FOREIGN SECURITIES Securities of companies and governments located outside
the U.S. may involve risks that can increase the potential for losses in the
fund. Investments in Depositary Receipts also involve some or all of the
following risks.
COUNTRY. General securities market movements in any country where the fund
has investments are likely to affect the value of the securities the fund
owns that trade in that country. These movements will affect the fund's share
price and fund performance.
The political, economic and social structures of some countries the fund
invests in 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, currency devaluations, foreign ownership
limitations, expropriation, restrictions on removal of currency or other
assets, nationalization of assets, punitive taxes and certain custody and
settlement risks.
The fund's investments in developing or emerging markets are subject to all
of the risks of foreign investing generally, and have additional heightened
risks due to a lack of established legal, business and social frameworks to
support securities markets. Foreign securities markets, including emerging
markets, may have substantially lower trading volumes than U.S. markets,
resulting in less liquidity and more volatility than experienced in the U.S.
While short-term volatility in these markets can be disconcerting, declines
in excess of 50% are not unusual.
Because the fund invests a significant amount of its assets in issuers
located in a particular region of the world, it may be subject to greater
risks and may experience greater volatility than a fund that is more broadly
diversified geographically.
COMPANY. Foreign companies are not subject to the same disclosure,
accounting, auditing and financial reporting standards and practices as U.S.
companies and their securities may not be as liquid as securities of similar
U.S. companies. Foreign stock exchanges, trading systems, brokers and
companies generally have less government supervision and regulation than in
the U.S. The fund 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 U.S.
companies in U.S. courts.
CURRENCY Many of the fund's investments are 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.
Devaluation of a currency by a country's government or banking authority also
will have a significant impact on the value of any securities denominated in
that currency. Currency markets generally are not as regulated as securities
markets.
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. If the fund holds investments in countries
with currencies replaced by the euro, the investment process, including
trading, foreign exchange, payments, settlements, cash accounts, custody and
accounting will be impacted.
Because this change to a single currency is new and untested, the
establishment of the euro may result in market volatility. For the same
reason, it is not possible to predict the impact of the euro on the business
or financial condition of European issuers which the fund may hold in its
portfolio, and their impact on fund performance. To the extent the fund holds
non-U.S. dollar (euro or other) denominated securities, it will still be
exposed to currency risk due to fluctuations in those currencies versus the
U.S. dollar.
ILLIQUID SECURITIES The fund may invest up to 10% of its net assets in
illiquid securities. Illiquid securities are generally those that cannot be
sold within seven days in the normal course of business for approximately the
amount at which the fund has valued them. A limited trading market can result
from political or economic conditions affecting previously established
securities markets, particularly in emerging market conditions.
INTEREST RATE When interest rates rise, debt security prices fall. The
opposite is also true; debt security prices go up when interest rates fall.
Generally, interest rates rise during times of inflation or a growing
economy, and fall during an economic slowdown or recession. Securities with
longer maturities usually are more sensitive to interest rate changes than
securities with shorter maturities.
CREDIT This is the possibility that an issuer will be unable to make
interest payments or repay principal. Changes in an issuer's financial
strength or in a security's credit rating may affect its value and, thus,
impact the value of fund shares.
YEAR 2000 When evaluating current and potential portfolio positions, Year
2000 is one of the factors the fund's manager considers.
The manager will rely upon public filings and other statements made by
companies about their Year 2000 readiness. Issuers in countries outside the
U.S., particularly in emerging markets, may not be required to make the same
level of disclosure about Year 2000 readiness as is required in the U.S. The
manager, of course, cannot audit each company and its major suppliers to
verify their Year 2000 readiness.
If a company in which the fund is invested is adversely affected by Year 2000
problems, it is likely that the price of its securities will also be
adversely affected. A decrease in the value of one or more of the fund's
portfolio holdings will have a similar impact on the fund's performance.
Please see page 25 for more information.
More detailed information about the fund, its policies, including temporary
investments, and risks can be found in the fund's Statement of Additional
Information (SAI).
[Begin callout]
Mutual fund shares are not deposits or obligations of, or guaranteed or
endorsed by, any bank, and are not federally insured by the Federal Deposit
Insurance Corporation, the Federal Reserve Board, or any other agency of the
U.S. government. Mutual fund shares involve investment risks, including the
possible loss of principal.
[End callout]
[Insert graphic of bull and bear] PERFORMANCE
This bar chart and table show the volatility of the fund's returns, which is
one indicator of the risks of investing in the fund. The bar chart shows
changes in the fund's returns from year to year over the past seven calendar
years. The table shows how the fund's average annual total returns compare to
those of a broad-based securities market index. Of course, past performance
cannot predict or guarantee future results.
CLASS A ANNUAL TOTAL RETURNS 1
[Insert bar graph]
3.65% 60.93% -10.68% 5.85% 11.85% -37.78% -8.25%
92 93 94 95 96 97 98
YEAR
[Begin callout]
BEST
QUARTER:
Q4 '98
30.78%
WORST
QUARTER:
Q4 '97
- -32.38%
[End callout]
AVERAGE ANNUAL TOTAL RETURNS
For the periods ended December 31, 1998
SINCE
INCEPTION
1 YEAR 5 YEARS (9/20/91)
- --------------------------------------------------------------------------------
Templeton Pacific Growth Fund - Class A 2 -13.51% -10.67% -0.23%
MSCI Pacific Index 3 2.69% -3.95% -0.87%
SINCE
INCEPTION
1 YEAR (1/2/97)
- ------------------------------------------------------------------------
Templeton Pacific Growth Fund - Class C 2 -10.23% -25.15%
MSCI Pacific Index 3 2.69% -12.44%
1. Figures do not reflect sales charges. If they did, returns would be lower.
2. Figures reflect sales charges.
All fund performance assumes reinvestment of dividends and capital gains.
3. Source: Standard & Poor's(R) Micropal. The unmanaged MSCI Pacific Index
tracks the performance of approximately 450 companies in Australia, Hong
Kong, Japan, New Zealand, and Singapore. It includes reinvested dividends.
One cannot invest directly in an index, nor is an index representative of the
fund's portfolio.
[Insert graphic of percentage sign] FEES AND EXPENSES
This table describes the fees and expenses that you may pay if you buy and
hold shares of the fund.
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT)
CLASS A 1 CLASS C 1
- --------------------------------------------------------------------------
Maximum sales charge (load)
as a percentage of offering price 5.75% 1.99%
Load imposed on purchases 5.75% 1.00%
Maximum deferred sales charge (load) None 2 0.99% 3
Exchange fee None None
Please see "Choosing a Share Class" on page 26 for an explanation of how and
when these sales charges apply.
ANNUAL FUND OPERATING EXPENSES (EXPENSES DEDUCTED FROM FUND ASSETS)
CLASS A 1 CLASS C 1
- ------------------------------------------------------------------------------
Management fees 0.50% 0.50%
Distribution and service (12b-1) fees 4 0.25% 1.00%
Other expenses 1.12% 1.12%
--------------------
Total annual fund operating expenses 1.87% 2.62%
====================
1. Before January 1, 1999, Class A shares were designated Class I and Class C
shares were designated Class II.
2. Except for investments of $1 million or more (see page 26) and purchases
by certain retirement plans without an initial sales charge.
3. This is equivalent to a charge of 1% based on net asset value.
4. Because of the distribution and service (12b-1) fees, over the long term
you may indirectly pay more than the equivalent of the maximum permitted
initial sales charge.
EXAMPLE
This example can help you compare the cost of investing in the fund with the
cost of investing in other mutual funds.
The example assumes you invest $10,000 for the periods shown and then sell
all of your shares at the end of those periods. The example also assumes your
investment has a 5% return each year and the fund's operating expenses remain
the same. Although your actual costs may be higher or lower, based on these
assumptions your costs would be:
1 YEAR 3 YEARS 5 YEARS 10 YEARS
- ----------------------------------------------------------------
CLASS A $754 1 $1,129 $1,528 $2,639
CLASS C $460 2 $906 $1,476 $3,024
1. Assumes a contingent deferred sales charge (CDSC) will not apply.
2. For the same Class C investment, your costs would be $362 if you did not
sell your shares at the end of the first year. Your costs for the remaining
periods would be the same.
[INSERT GRAPHIC OF BRIEFCASE] MANAGEMENT
Franklin Advisers, Inc. (Advisers), 777 Mariners Island Blvd., San Mateo, CA
94404, is the fund's investment manager. Together, Advisers and its
affiliates manage over $220 billion in assets.
Under an agreement with Advisers, Templeton Investment Counsel, Inc.
(Investment Counsel), 500 East Broward Boulevard, Ft. Lauderdale, FL 33394,
is the fund's sub-advisor. Investment Counsel provides Advisers with
investment management advice and assistance.
The team responsible for the fund's management is:
WILLIAM T. HOWARD, Jr. CFA, SENIOR VICE PRESIDENT OF INVESTMENT COUNSEL
Mr. Howard has been a manager of the fund since 1993. He joined the Franklin
Templeton Group in 1993.
MARK R. BEVERIDGE CFA, SENIOR VICE PRESIDENT OF INVESTMENT COUNSEL
Mr. Beveridge has been a manager of the fund since 1994. He joined the
Franklin Templeton Group in 1985.
GARY CLEMONS, SENIOR VICE PRESIDENT OF INVESTMENT COUNSEL
Mr. Clemons has been a manager of the fund since 1993. He joined the Franklin
Templeton Group in 1990.
The fund pays the manager a fee for managing the fund's assets and making its
investment decisions. For the fiscal year ended October 31, 1998, the fund
paid 0.50% of its average daily net assets to the manager.
[INSERT GRAPHIC OF DOLLAR BILL] FINANCIAL HIGHLIGHTS
This table presents the fund's financial performance for the past five years.
This information has been audited by PricewaterhouseCoopers LLP.
CLASS A YEAR ENDED OCTOBER 31,
- --------------------------------------------------------------------------
1998 1997 1996 1995 1994
- --------------------------------------------------------------------------
PER SHARE DATA ($)
Net asset value, beginning of year 10.88 14.50 14.11 15.40 14.44
------------------------------------
Net investment income .13 .14 .12 .15 .21
Net realized and unrealized
gains (losses) (2.98) (3.65) 1.41 (1.01) 1.01
------------------------------------
Total from investment operations (2.85) (3.51) 1.53 (.86) 1.22
------------------------------------
Dividends from net investment income (.13) (.11) (.21) (.16) (.20)
Distributions from net realized gains (.07) - (.93) (.27) (.06)
------------------------------------
Total distributions (.20) (.11) (1.14) (.43) (.26)
------------------------------------
Net asset value, end of year $7.83 10.88 14.50 14.11 15.40
====================================
Total return (%) 1 (26.37)(24.42) 11.27 (5.54) 8.46
RATIOS/SUPPLEMENTAL DATA
Net assets, end of year ($ x 1,000) 42,200 40,958 59,740 50,247 58,241
Ratios to average net assets: (%)
Expenses 1.90 1.63 1.52 1.72 1.22
Expenses excluding waiver and
payments by affiliate 1.90 1.63 1.52 1.72 1.72
Net investment income 1.43 .97 1.06 1.04 1.54
Portfolio turnover rate (%) 19.61 24.79 13.48 36.21 9.16
CLASS C
- --------------------------------------------------------------------------------
1998 1997 3
- --------------------------------------------------------------------------------
PER SHARE DATA ($)
Net asset value, beginning of year 10.81 15.10
----------------------------------------
Net investment income .08 .05
Net realized and unrealized
gains (losses) (2.92) (4.31)
----------------------------------------
Total from investment operations (2.84) (4.26)
Dividends from net investment income (.10) (.03)
Distributions from net realized gains (.07) -
----------------------------------------
Total distributions (.17) (.03)
----------------------------------------
Net asset value, end of year 7.80 10.81
========================================
Total return (%) 1 (26.47) (28.28)
RATIOS/SUPPLEMENTAL DATA
Net assets, end of year ($ x 1,000) 6,183 2,307
Ratios to average net assets: (%)
Expenses 2.63 2.48 2
Net investment income .67 .93 2
Portfolio turnover rate (%) 19.61 24.79
1. Total return does not include sales charges, and is not annualized.
2. Annualized
3. For the period January 2, 1997 (effective date) to October 31, 1997.
[Insert graphic of dollar signs and stacks of coins]
DISTRIBUTIONS AND TAXES;
YEAR 2000 PROBLEM
INCOME AND CAPITAL GAINS DISTRIBUTIONS Each fund intends to pay a dividend
at least semiannually representing its net investment income. Capital gains,
if any, may be distributed annually. The amount of these distributions will
vary and there is no guarantee the fund will pay dividends.
To receive a distribution, you must be a shareholder on the record date. The
record dates for the funds' distributions will vary. Please keep in mind that
if you invest in a fund shortly before the record date of a distribution, any
distribution will lower the value of the fund's shares by the amount of the
distribution and you will receive some of your investment back in the form of
a taxable distribution. If you would like information on upcoming record
dates for the fund's distributions, please call 1-800/DIAL BEN(R).
TAX CONSIDERATIONS In general, fund distributions are taxable to you as
either ordinary income or capital gains. This is true whether you reinvest
your distributions in additional shares of the fund or receive them in cash.
Any capital gains the fund distributes are taxable to you as long-term
capital gains no matter how long you have owned your shares.
[Begin callout]
Backup Withholding
By law, the fund must withhold 31% of your taxable distributions and proceeds
if you do not provide your correct taxpayer identification number (TIN) or
certify that your TIN is correct, or if the IRS instructs the fund to do so.
[End callout]
Every January, you will receive a statement that shows the tax status of
distributions you received for the previous year. Distributions declared in
December but paid in January are taxable as if they were paid in December.
When you sell your shares of the fund, you may have a capital gain or loss.
For tax purposes, an exchange of your fund shares for shares of a different
Franklin Templeton Fund is the same as a sale. The individual tax rate on any
gain from the sale or exchange of your shares depends on how long you have
held your shares.
Fund distributions and gains from the sale or exchange of your shares will
generally be subject to state and local income tax. Any foreign taxes the
fund pays on its investments may be passed through to you as a foreign tax
credit. Non-U.S. investors may be subject to U.S. withholding and estate tax.
You should consult your tax advisor about the federal, state, local or
foreign tax consequences of your investment in the fund.
YEAR 2000 PROBLEM Each fund's business operations depend on a worldwide
network of computer systems that contain date fields, including securities
trading systems, securities transfer agent operations and stock market links.
Many of the systems currently use a two digit date field to represent the
date, and unless these systems are changed or modified, they may not be able
to distinguish the Year 1900 from the Year 2000 (commonly referred to as the
Year 2000 problem). In addition, the fact that the Year 2000 is a leap year
may create difficulties for some systems.
When the Year 2000 arrives, a fund's operations could be adversely affected
if the computer systems used by the manager, its service providers and other
third parties it does business with are not Year 2000 ready. For example, a
fund's portfolio and operational areas could be impacted, including
securities trade processing, interest and dividend payments, securities
pricing, shareholder account services, reporting, custody functions and
others. A fund could experience difficulties in effecting transactions if any
of its foreign subcustodians, or if foreign broker-dealers or foreign markets
are not ready for Year 2000.
Each fund's manager and its affiliated service providers are making a
concerted effort to take steps they believe are reasonably designed to
address their Year 2000 problems. Of course, a fund's ability to reduce the
effects of the Year 2000 problem is also very much dependent upon the efforts
of third parties over which the fund and its manager may have no control.
YOUR ACCOUNT
[Insert graphic of pencil marking an X] CHOOSING A SHARE CLASS
Each class has its own sales charge and expense structure, allowing you to
choose the class that best meets your situation. Your investment
representative can help you decide.
CLASS A CLASS B CLASS C
- --------------------------------------------------------------------------------
o Initial sales charge of o No initial sales o Initial sales charge
5.75% or less charge of 1%
o Deferred sales charge o Deferred sales charge o Deferred sales charge
of 1% on purchases of of 4% or less on of 1% on shares you
$1 million or more sold shares you sell sell within 18 months
within 12 months within six years
o Lower annual expenses o Higher annual o Higher annual
than Class B or C due expenses than Class A expenses than Class A
to lower distribution (same as Class C) due (same as Class B) due
fees to higher to higher
distribution fees. distribution fees. No
Automatic conversion conversion to Class A
to Class A shares shares, so annual
after eight years, expenses do not
reducing future decrease.
annual expenses.
BEFORE JANUARY 1, 1999, CLASS A SHARES WERE DESIGNATED
CLASS I AND CLASS C SHARES WERE DESIGNATED CLASS II.
TEMPLETON FOREIGN SMALLER COMPANIES FUND BEGAN OFFERING
CLASS B SHARES ON JANUARY 1, 1999.
SALES CHARGES - CLASS A
THE SALES CHARGE
MAKES UP THIS % WHICH EQUALS THIS %
WHEN YOU INVEST THIS AMOUNT OF THE OFFERING PRICE OF YOUR NET INVESTMENT
- --------------------------------------------------------------------------------
Under $50,000 5.75 6.10
$50,000 but under $100,000 4.50 4.71
$100,000 but under $250,000 3.50 3.63
$250,000 but under $500,000 2.50 2.56
$500,000 but under $1 million 2.00 2.04
INVESTMENTS OF $1 MILLION OR MORE If you invest $1 million or more, either
as a lump sum or through our cumulative quantity discount or letter of intent
programs (see page 29), you can buy Class A shares without an initial sales
charge. However, there is a 1% contingent deferred sales charge (CDSC) on any
shares you sell within 12 months of purchase. The way we calculate the CDSC
is the same for each class (please see page 28).
DISTRIBUTION AND SERVICE (12B-1) FEES Class A has a distribution plan,
sometimes known as a Rule 12b-1 plan, that allows the fund to pay
distribution fees of up to 0.25% per year to those who sell and distribute
Class A shares and provide other services to shareholders. Because these fees
are paid out of Class A's assets on an on-going basis, over time these fees
will increase the cost of your investment and may cost you more than paying
other types of sales charges.
SALES CHARGES - CLASS B
IF YOU SELL YOUR 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
With Class B shares, there is no initial sales charge. However, there is a
CDSC if you sell your shares within six years, as described in the table
above. The way we calculate the CDSC is the same for each class (please see
page 28). After 8 years, your Class B shares automatically convert to Class A
shares, lowering your annual expenses from that time on.
MAXIMUM PURCHASE AMOUNT The maximum amount you may invest in Class B shares
at one time is $249,999. We invest any investment of $250,000 or more in
Class A shares, since a reduced initial sales charge is available and Class
A's annual expenses are lower.
RETIREMENT PLANS Class B shares are not available to all retirement plans.
Class B shares are only available to IRAs (of any type), Franklin Templeton
Trust Company 403(b) plans, and Franklin Templeton Trust Company qualified
plans with participant or earmarked accounts.
DISTRIBUTION AND SERVICE (12B-1) FEES Class B has a distribution plan,
sometimes known as a Rule 12b-1 plan, that allows the fund to pay
distribution and other fees of up to 1% per year for the sale of Class B
shares and for services provided to shareholders. Because these fees are paid
out of Class B's assets on an on-going basis, over time these fees will
increase the cost of your investment and may cost you more than paying other
types of sales charges.
SALES CHARGES - CLASS C
THE SALES CHARGE
MAKES UP THIS % WHICH EQUALS THIS %
WHEN YOU INVEST THIS AMOUNT OF THE OFFERING PRICE OF YOUR NET INVESTMENT
- --------------------------------------------------------------------------------
Under $1 million 1.00 1.01
WE INVEST ANY INVESTMENT OF $1 MILLION OR MORE IN
CLASS A SHARES, SINCE THERE IS NO INITIAL SALES
CHARGE AND CLASS A'S ANNUAL EXPENSES ARE LOWER.
CDSC There is a 1% contingent deferred sales charge (CDSC) on any Class C
shares you sell within 18 months of purchase. The way we calculate the CDSC
is the same for each class (please see below).
DISTRIBUTION AND SERVICE (12B-1) FEES Class C has a distribution plan,
sometimes known as a Rule 12b-1 plan, that allows the fund to pay
distribution and other fees of up to 1% per year for the sale of Class C
shares and for services provided to shareholders. Because these fees are paid
out of Class C's assets on an on-going basis, over time these fees will
increase the cost of your investment and may cost you more than paying other
types of sales charges.
CONTINGENT DEFERRED SALES CHARGE (CDSC) -
CLASS A, B & C
The CDSC for each class is based on the current value of the shares being
sold or their net asset value when purchased, whichever is less. There is no
CDSC on shares you acquire by reinvesting your dividends.
[Begin callout]
The HOLDING PERIOD FOR THE CDSC begins on the day you buy your shares. Your
shares will age one month on that same date the next month and each following
month.
For example, if you buy shares on the 18th of the month, they will age one
month on the 18th day of the next month and each following month.
[End callout]
To keep your CDSC as low as possible, each time you place a request to sell
shares we will first sell any shares in your account that are not subject to
a CDSC. If there are not enough of these to meet your request, we will sell
the shares in the order they were purchased. We will use this same method if
you exchange your shares into another Franklin Templeton Fund (please see
page 36 for exchange information).
SALES CHARGE REDUCTIONS AND WAIVERS
If you qualify for any of the sales charge reductions or waivers below,
please let us know at the time you make your investment to help ensure you
receive the lower sales charge.
QUANTITY DISCOUNTS 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 of Class A shares.
[Begin callout]
The FRANKLIN TEMPLETON Funds include all of the Franklin Templeton U.S.
registered mutual funds, except Franklin Valuemark Funds, Templeton Capital
Accumulator Fund, Inc., and Templeton Variable Products Series Fund.
[End callout]
o CUMULATIVE QUANTITY DISCOUNT - lets you combine all of your shares in
the Franklin Templeton Funds for purposes of calculating the sales
charge. You may also combine the shares of your spouse, and your
children or grandchildren, if they are under the age of 21. Certain
company and retirement plan accounts may also be included.
o LETTER OF INTENT (LOI) - expresses your intent to buy a stated dollar
amount of shares over a 13-month period and lets you receive the same
sales charge as if all shares had been purchased at one time. We will
reserve a portion of your shares to cover any additional sales charge
that may apply if you do not buy the amount stated in your LOI.
TO SIGN UP FOR THESE PROGRAMS, COMPLETE
THE APPROPRIATE SECTION OF YOUR ACCOUNT APPLICATION.
REINSTATEMENT PRIVILEGE If you sell shares of a Franklin Templeton Fund, you
may reinvest some or all of the proceeds within 365 days without an initial
sales charge. The proceeds must be reinvested within the same share class,
except proceeds from the sale of Class B shares will be reinvested in Class A
shares.
If you paid a CDSC when you sold your Class A or C shares, we will credit
your account with the amount of the CDSC paid but a new CDSC will apply. For
Class B shares reinvested in Class A, a new CDSC will not apply, although
your account will not be credited with the amount of any CDSC paid when you
sold your Class B shares.
Proceeds immediately placed in a Franklin Bank Certificate of Deposit (CD)
also may be reinvested without an initial sales charge if you reinvest them
within 365 days from the date the CD matures, including any rollover.
This privilege does not apply to shares you buy and sell under our exchange
program. Shares purchased with the proceeds from a money fund may be subject
to a sales charge.
WAIVERS FOR INVESTMENTS FROM CERTAIN PAYMENTS Class A shares may be
purchased without an initial sales charge or CDSC by investors who reinvest
within 365 days:
o certain payments received under an annuity contract that offers a
Franklin Templeton insurance fund option
o distributions from an existing retirement plan invested in the Franklin
Templeton Funds
o dividend or capital gain distributions from a real estate investment
trust sponsored or advised by Franklin Properties, Inc.
o redemption proceeds from a repurchase of Franklin Floating Rate Trust
shares held continuously for at least 12 months
o redemption proceeds from Class A of any Templeton Global Strategy Fund,
if you are a qualified investor. If you paid a CDSC when you sold your
shares, we will credit your account with the amount of the CDSC paid but
a new CDSC will apply.
WAIVERS FOR CERTAIN INVESTORS Class A shares also may be purchased without
an initial sales charge or CDSC by various individuals and institutions,
including:
o certain trust companies and bank trust departments investing $1 million or
more in assets over which they have full or shared investment discretion
o government entities that are prohibited from paying mutual fund sales
charges
o certain unit investment trusts and their holders reinvesting trust
distributions
o group annuity separate accounts offered to retirement plans
o employees and other associated persons or entities of Franklin Templeton
or of certain dealers
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 Chilean retirement plans that meet the requirements for retirement plans
described below.
IF YOU THINK YOU MAY BE ELIGIBLE FOR A SALES CHARGE WAIVER,
CALL YOUR INVESTMENT REPRESENTATIVE OR CALL SHAREHOLDER SERVICES AT
1-800/632-2301 FOR MORE INFORMATION.
CDSC WAIVERS The CDSC for each class generally will be waived:
o to pay account fees
o to make payments through systematic withdrawal plans, up to 1% monthly,
3% quarterly, 6% semiannually or 12% annually depending on the frequency
of your plan
o for redemptions of Class A shares by investors who purchased $1 million
or more without an initial sales charge if Franklin Templeton
Distributors, Inc. did not make any payment to the securities dealer of
record in connection with the purchase
o for redemptions by Franklin Templeton Trust Company employee benefit
plans or employee benefit plans serviced by ValuSelect(R)
(not applicable to Class B)
o for IRA distributions 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 to return excess contributions (and earnings, if applicable) from
retirement plan accounts
o for redemptions following the death of the shareholder or beneficial
owner
o for participant initiated distributions from employee benefit plans or
participant initiated exchanges among investment choices in employee
benefit plans (not applicable to Class B)
RETIREMENT PLANS Certain retirement plans may buy Class A shares without an
initial sales charge. To qualify, the plan must be sponsored by an employer:
o with at least 100 employees, or
o with retirement plan assets of $1 million or more, or
o that agrees to invest at least $500,000 in the Franklin Templeton Funds
over a 13-month period
A CDSC may apply. Retirement plans other than SIMPLEs, SEPs, or plans that
qualify under section 401 of the Internal Revenue Code also must qualify
under our group investment program to buy Class A shares without an initial
sales charge.
FOR MORE INFORMATION, CALL YOUR INVESTMENT REPRESENTATIVE OR
RETIREMENT PLAN SERVICES AT 1-800/527-2020.
GROUP INVESTMENT PROGRAM Allows established groups of 11 or more investors
to invest as a group. For sales charge purposes, the group's investments are
added together. There are certain other requirements and the group must have
a purpose other than buying fund shares at a discount.
[INSERT GRAPHIC OF PAPER WITH LINES AND SOMEONE WRITING]
BUYING SHARES
MINIMUM INVESTMENTS
- --------------------------------------------------------------------------
INITIAL ADDITIONAL
- --------------------------------------------------------------------------
Regular accounts $1,000 $50
- --------------------------------------------------------------------------
UGMA/UTMA accounts $100 $50
- --------------------------------------------------------------------------
Retirement accounts no minimum no minimum
(other than IRAs, IRA rollovers, Education
IRAs or Roth IRAs)
- --------------------------------------------------------------------------
IRAs, IRA rollovers, Education IRAs or
Roth IRAs $250 $50
- --------------------------------------------------------------------------
Broker-dealer sponsored wrap account $250 $50
programs
- --------------------------------------------------------------------------
Full-time employees, officers, trustees and $100 $50
directors of
- --------------------------------------------------------------------------
Franklin Templeton entities, and their
immediate family members
- --------------------------------------------------------------------------
ACCOUNT APPLICATION If you are opening a new account, please complete and
sign the enclosed account application. Make sure you indicate the share class
you have chosen. If you do not indicate a class, we will invest your purchase
in Class A shares. To save time, you can sign up now for services you may
want on your account by completing the appropriate sections of the
application (see the next page).
BUYING SHARES
- --------------------------------------------------------------------------------
OPENING AN ACCOUNT ADDING TO AN ACCOUNT
- --------------------------------------------------------------------------------
[Insert graphic of hands
shaking]
THROUGH YOUR INVESTMENT Contact your investment Contact your investment
REPRESENTATIVE representative representative
- --------------------------------------------------------------------------------
Make your check payable Make your check payable
[Insert graphic of to the fund in which you to the fund in which you
envelope] are investing. are investing. Include
your account number on
BY MAIL Mail the check and your the check.
signed application to
Investor Services.
Fill out the deposit
slip from your account
statement. If you do not
have a slip, include a
note with your name, the
fund name, and your
account number.
Mail the check and
deposit slip or note to
Investor Services.
- --------------------------------------------------------------------------------
[Insert graphic of three Call to receive a wire Call to receive a wire
lightning bolts] control number and wire control number and wire
instructions. instructions.
BY WIRE Wire the funds and mail To make a same day wire
your signed application investment, please call
1-800/632-2301 to Investor Services. us by 1:00 p.m. pacific
(or 1-650/312-2000 Please include the wire time and make sure your
collect) control number or your wire arrives by 3:00 p.m.
new account number on the
application.
To make a same day wire
investment, please call
us by 1:00 p.m. pacific
time and make sure your
wire arrives by 3:00 p.m.
- --------------------------------------------------------------------------------
[Insert graphic of two Call Shareholder Services Call Shareholder
arrows pointing in at the number below, or Services at the number
opposite directions] send signed written below or our automated
instructions. The TeleFACTS system, or
BY EXCHANGE TeleFACTS system cannot send signed written
be used to open a new instructions.
account.
TeleFACTS(R) (Please see page 36 for (Please see page 36 for
1-800/247-1753 information on exchanges.) information on
(around-the-clock access) exchanges.)
- --------------------------------------------------------------------------------
FRANKLIN TEMPLETON INVESTOR SERVICES 777 MARINERS ISLAND BLVD., P.O. BOX 7777,
SAN MATEO, CA 94403-7777
CALL TOLL-FREE: 1-800/632-2301
(MONDAY THROUGH FRIDAY 5:30 A.M. TO 5:00 P.M., PACIFIC TIME
SATURDAY 6:30 A.M. TO 2:30 P.M., PACIFIC TIME)
[INSERT GRAPHIC OF PERSON WITH HANDSET] INVESTOR SERVICES
AUTOMATIC INVESTMENT PLAN This plan offers a convenient way for you to
invest in the fund by automatically transferring money from your checking or
savings account each month to buy shares. The minimum investment to open an
account with an automatic investment plan is $50 ($25 for an Education IRA).
To sign up, complete the appropriate section of your account application.
AUTOMATIC PAYROLL DEDUCTION You may be able to invest automatically in Class
A shares of the fund by transferring money from your paycheck to the fund by
electronic funds transfer. If you are interested, indicate on your
application that you would like to receive an Automatic Payroll Deduction
Program kit.
DISTRIBUTION OPTIONS You may reinvest distributions you receive from the
fund in an existing account in the same share class* of the fund or another
Franklin Templeton Fund. Initial sales charges and CDSCs will not apply if
you reinvest your distributions within 365 days. You can also have your
distributions deposited in a bank account, or mailed by check. Deposits to a
bank account may be made by electronic funds transfer.
[Begin callout]
For Franklin Templeton Trust Company retirement plans, special forms may be
needed to receive distributions in cash. Please call 1-800/527-2020 for
information.
[End callout]
Please indicate on your application the distribution option you have chosen,
otherwise we will reinvest your distributions in the same share class of the
fund.
*Class B and C shareholders may reinvest their distributions in Class A
shares of any Franklin Templeton money fund.
RETIREMENT PLANS Franklin Templeton offers a variety of retirement plans for
individuals and businesses. These plans require separate applications and
their policies and procedures may be different than those described in this
prospectus. For more information, including a free retirement plan brochure
or application, please call Retirement Plan Services at 1-800/527-2020.
TELEFACTS(R) Our TeleFACTS system offers around-the-clock access to information
about your account or any Franklin Templeton Fund. This service is available
from touch-tone phones at 1-800/247-1753. For a free TeleFACTS brochure, call
1-800/DIAL BEN(R)
TELEPHONE PRIVILEGES You will automatically receive telephone privileges
when you open your account, allowing you and your investment representative
to sell or exchange your shares and make certain other changes to your
account by phone.
For accounts with more than one registered owner, telephone privileges also
allow the fund to accept written instructions signed by only one owner for
transactions and account changes that could otherwise be made by phone. For
all other transactions and changes, all registered owners must sign the
instructions.
As long as we take certain measures to verify telephone requests, we will not
be responsible for any losses that may occur from unauthorized requests. Of
course, you can decline telephone exchange or redemption privileges on your
account application.
EXCHANGE PRIVILEGE You can exchange shares between most Franklin Templeton
Funds within the same class*, generally without paying any additional sales
charges. If you exchange shares held for less than six months, however, you
may be charged the difference between the initial sales charge of the two
funds if the difference is more than 0.25%. If you exchange shares from a
money fund, a sales charge may apply no matter how long you have held the
shares.
*Certain Class Z shareholders of Franklin Mutual Series Fund Inc. may
exchange into Class A without any sales charge.
[Begin callout]
An EXCHANGE is really two transactions: a sale of one fund and the purchase
of another. In general, the same policies that apply to purchases and sales
apply to exchanges, including minimum investment amounts. Exchanges also have
the same tax consequences as ordinary sales and purchases.
[End callout]
Generally exchanges may only be made between identically registered accounts,
unless you send written instructions with a signature guarantee. Any CDSC
will continue to be calculated from the date of your initial investment and
will not be charged at the time of the exchange. The purchase price for
determining a CDSC on exchanged shares will be the price you paid for the
original shares. If you exchange shares subject to a CDSC into a Class A
money fund, the time your shares are held in the money fund will not count
towards the CDSC holding period.
If you exchange your Class B shares for the same class of shares of another
Franklin Templeton Fund, the time your shares are held in that fund will
count towards the eight year period for automatic conversion to Class A
shares.
Frequent exchanges can interfere with fund management or operations and drive
up costs for all shareholders. To protect shareholders, there are limits on
the number and amount of exchanges you may make (please see "Market Timers"
on page 41).
SYSTEMATIC WITHDRAWAL PLAN This plan allows you to automatically sell your
shares and receive regular payments from your account. A CDSC may apply to
withdrawals that exceed certain amounts. Certain terms and minimums apply. To
sign up, complete the appropriate section of your application.
[INSERT GRAPHIC OF CERTIFICATE] SELLING SHARES
You can sell your shares at any time.
SELLING SHARES IN WRITING Requests to sell $100,000 or less can generally be
made over the phone or with a simple letter. Sometimes, however, to protect
you and the fund we will need written instructions signed by all registered
owners, with a signature guarantee for each owner, if:
[Begin callout]
A SIGNATURE GUARANTEE helps protect your account against fraud. You can
obtain a signature guarantee at most banks and securities dealers.
A notary public CANNOT provide a signature guarantee.
[End callout]
o you are selling more than $100,000 worth of shares
o you want your proceeds paid to someone who is not a registered owner
o you want to send your proceeds somewhere other than the address of
record, or preauthorized bank or brokerage firm account
We may also require a signature guarantee on instructions we receive from an
agent, not the registered owners, or when we believe it would protect the
fund against potential claims based on the instructions received.
SELLING RECENTLY PURCHASED SHARES If you sell shares recently purchased with
a check or draft, we may delay sending you the proceeds until your check or
draft has cleared, which may take seven business days or more. A certified or
cashier's check may clear in less time.
REDEMPTION PROCEEDS Your redemption check will be sent within seven days
after we receive your request in proper form. We are not able to receive or
pay out cash in the form of currency. Redemption proceeds may be delayed if
we have not yet received your signed account application.
RETIREMENT PLANS You may need to complete additional forms to sell shares in
a Franklin Templeton Trust Company retirement plan. For participants under
age 591/2, tax penalties may apply. Call Retirement Plan Services at
1-800/527-2020 for details.
SELLING SHARES
- --------------------------------------------------------------------------------
TO SELL SOME OR ALL OF YOUR SHARES
- --------------------------------------------------------------------------------
[Insert graphic of hands shaking]
THROUGH YOUR INVESTMENT Contact your investment representative
REPRESENTATIVE
- --------------------------------------------------------------------------------
[Insert graphic of envelope] Send written instructions and endorsed
share certificates (if you hold share
certificates) to Investor Services.
BY MAIL Corporate, partnership or trust
accounts may need to send additional
documents.
Specify the fund, the account number
and the dollar value or number of
shares you wish to sell. If you own
both Class A and B shares, also
specify the class of shares, otherwise
we will sell your Class A shares
first. Be sure to include all
necessary signatures and any
additional documents, as well as
signature guarantees if required.
A check will be mailed to the name(s)
and address on the account, or
otherwise according to your written
instructions.
- --------------------------------------------------------------------------------
[Insert graphic of phone] As long as your transaction is for
$100,000 or less, you do not hold
BY PHONE share certificates and you have not
changed your address by phone within
1-800/632-2301 the last 15 days, you can sell your
shares by phone.
A check will be mailed to the name(s)
and address on the account. Written
instructions, with a signature
guarantee, are required to send the
check to another address or to make it
payable to another person.
- --------------------------------------------------------------------------------
You can call or write to have
[Insert graphic of three lightning redemption proceeds of $1,000 or more
bolts] wired to a bank or escrow account. See
the policies above for selling shares
by mail or phone.
BY WIRE Before requesting a bank wire, 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, your bank
account number, the ABA routing
number, and a signature guarantee.
Requests received in proper form by
1:00 p.m. pacific time will be wired
the next business day.
- --------------------------------------------------------------------------------
[Insert graphic of two arrows pointing Obtain a current prospectus for the
in opposite directions] fund you are considering.
Call Shareholder Services at the
BY EXCHANGE number below or our automated
TeleFACTS system, or send signed
written instructions. See the policies
above for selling shares by mail or
phone.
TeleFACTS(R) If you hold share certificates, you
1-800/247-1753 will need to return them to the fund
(around-the-clock access) before your exchange can be processed.
- --------------------------------------------------------------------------------
FRANKLIN TEMPLETON INVESTOR SERVICES 777 MARINERS ISLAND BLVD., P.O. BOX 7777,
SAN MATEO, CA 94403-7777
CALL TOLL-FREE: 1-800/632-2301
(MONDAY THROUGH FRIDAY 5:30 A.M. TO 5:00 P.M., PACIFIC TIME
SATURDAY 6:30 A.M. TO 2:30 P.M., PACIFIC TIME)
[Insert graphic of paper and pen] ACCOUNT POLICIES
CALCULATING SHARE PRICE The fund calculates the net asset value per share
(NAV) each business day at the close of trading on the New York Stock
Exchange (normally 1:00 p.m. pacific time). Each class's NAV is calculated by
dividing its net assets by the number of its shares outstanding.
[Begin callout]
When you buy shares, you pay the offering price. The offering price is the
NAV plus any applicable sales charge.
When you sell shares, you receive the NAV minus any applicable contingent
deferred sales charge (CDSC).
[End callout]
The fund's assets are generally valued at their market value. If market
prices are unavailable, or if an event occurs after the close of the trading
market that materially affects the values, assets may be valued at their fair
value. If the fund holds securities listed primarily on a foreign exchange
that trades on days when the fund is not open for business, the value of your
shares may change on days that you cannot buy or sell shares.
Requests to buy and sell shares are processed at the NAV next calculated
after we receive your request in proper form.
ACCOUNTS WITH LOW BALANCES If the value of your account falls below $250
($50 for employee and UGMA/UTMA accounts) because you sell some of your
shares, we may mail you a notice asking you to bring the account back up to
its applicable minimum investment amount. If you choose not to do so within
30 days, we may close your account and mail the proceeds to the address of
record. You will not be charged a CDSC if your account is closed for this
reason.
STATEMENTS AND REPORTS You will receive confirmations and account statements
that show your account transactions. You will also 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 will also receive confirmations, account statements and
other information about your account directly from the fund.
STREET OR NOMINEE ACCOUNTS You may transfer your shares from the street or
nominee name account of one dealer to another, as long as both dealers have
an agreement with Franklin Templeton Distributors, Inc. We will process the
transfer after we receive authorization in proper form from your delivering
securities dealer.
JOINT ACCOUNTS Unless you specify a different registration, accounts with
two or more owners are registered as "joint tenants with rights of
survivorship" (shown as "Jt Ten" on your account statement). To make any
ownership changes to a joint account, all owners must agree in writing,
regardless of the law in your state.
MARKET TIMERS The fund may restrict or refuse exchanges by market timers. If
accepted, each exchange by a market timer will be charged $5. You will be
considered a market timer if you have (i) requested an exchange out of the
fund within two weeks of an earlier exchange request, or (ii) exchanged
shares out of the fund more than twice in a calendar quarter, or (iii)
exchanged shares equal to at least $5 million, or more than 1% of the fund's
net assets, or (iv) otherwise seem to follow a timing pattern. Shares under
common ownership or control are combined for these limits. Templeton Pacific
Growth Fund does not allow investments by market timers.
ADDITIONAL POLICIES Please note that the fund maintains additional policies
and reserves certain rights, including:
o The fund may refuse any order to buy shares, including any purchase
under the exchange privilege.
o At any time, the fund may change its investment minimums or waive or
lower its minimums for certain purchases.
o The fund may modify or discontinue the exchange privilege on
60 days' notice.
o You may only buy shares of a fund eligible for sale in your state or
jurisdiction.
o In unusual circumstances, we may temporarily suspend redemptions, or
postpone the payment of proceeds, as allowed by federal securities laws.
o For redemptions over a certain amount, the fund reserves the right to
make payments in securities or other assets of the fund, in the case of
an emergency or if the payment by check or wire would be harmful to
existing shareholders.
o To permit investors to obtain the current price, dealers are responsible
for transmitting all orders to the fund promptly.
DEALER COMPENSATION Qualifying dealers who sell fund shares may receive
sales commissions and other payments. These are paid by Franklin Templeton
Distributors, Inc. 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 0.25 2 1.00 3
A dealer commission of up to 1% may be paid on Class A NAV purchases by
certain retirement plans1 and up to 0.25% 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 0.25% 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.
3. 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.
[INSERT GRAPHIC OF QUESTION MARK] QUESTIONS
If you have any questions about the fund or your account, you can write to us
at 777 Mariners Island Blvd., P.O. Box 7777, San Mateo, CA 94403-7777. You
can also call us at one of the following numbers. For your protection and to
help ensure we provide you with quality service, all calls may be monitored
or recorded.
HOURS (PACIFIC TIME,
DEPARTMENT NAME TELEPHONE NUMBER MONDAY THROUGH FRIDAY)
- ------------------------------------------------------------------------------
Shareholder Services 1-800/ 632-2301 5:30 a.m. to 5:00 p.m.
6:30 a.m. to 2:30 p.m. (Saturday)
Fund Information 1-800/ DIAL BEN 5:30 a.m. to 8:00 p.m.
(1-800/ 342-5236) 6:30 a.m. to 2:30 p.m. (Saturday)
Retirement Plan Services 1-800/ 527-2020 5:30 a.m. to 5:00 p.m.
Dealer Services 1-800/ 524-4040 5:30 a.m. to 5:00 p.m.
Institutional Services 1-800/ 321-8563 6:00 a.m. to 5:00 p.m.
TDD (hearing impaired) 1-800/ 851-0637 5:30 a.m. to 5:00 p.m.
FOR MORE INFORMATION
You can learn more about each fund in the following documents:
ANNUAL/SEMIANNUAL REPORT TO SHAREHOLDERS
Includes a discussion of recent market conditions and fund strategies,
financial statements, detailed performance information, portfolio holdings,
and the auditor's report.
STATEMENT OF ADDITIONAL INFORMATION (SAI)
Contains more information about each fund, its investments and policies. It
is incorporated by reference (is legally a part of this prospectus).
For a free copy of the current annual/semiannual report or the SAI, please
contact your investment representative or call us at the number below.
FRANKLIN(R)TEMPLETON(R)
1-800/DIAL BEN(R) (1-800/342-5236)
TDD (Hearing Impaired) 1-800/851-0637
www.franklin-templeton.com
You can also obtain information about each fund by visiting the SEC's Public
Reference Room in Washington D.C. (phone 1-800/SEC-0330) or by sending your
request and a duplicating fee to the SEC's Public Reference Section,
Washington, DC 20549-6009. You can also visit the SEC's Internet site at
http://www.sec.gov.
Investment Company Act file #811-6336 FTIT P 03/99
PROSPECTUS
FRANKLIN TEMPLETON
INTERNATIONAL TRUST
ADVISOR CLASS
TEMPLETON FOREIGN SMALLER COMPANIES FUND
TEMPLETON PACIFIC GROWTH FUND
INVESTMENT STRATEGY
GLOBAL GROWTH
MARCH 1, 1999
[Insert Franklin Templeton Ben Head]
LIKE ALL MUTUAL FUND SHARES, THE SEC HAS NOT APPROVED OR DISAPPROVED THESE
SECURITIES OR PASSED UPON THE ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
CONTENTS
THE FUNDS
[BEGIN - CALL OUT BOX]
Information about each fund you should know before investing
[END - CALL OUT BOX]
2 Templeton Foreign Smaller Companies Fund
12 Templeton Pacific Growth Fund
21 Distributions and taxes; Year 2000 problem
YOUR ACCOUNT
[BEGIN - CALL OUT BOX]
Information about qualified investors, account transactions and services
[END - CALL OUT BOX]
23 Qualified Investors
25 Buying Shares
26 Investor Services
28 Selling Shares
30 Account Policies
32 Questions
FOR MORE INFORMATION
[BEGIN - CALL OUT BOX]
Where to learn more about each fund
[END - CALL OUT BOX]
Back Cover
TEMPLETON FOREIGN
SMALLER COMPANIES FUND
[Insert graphic of bullseye and arrows] GOAL AND STRATEGIES
GOAL The fund's investment goal is long-term capital growth.
PRINCIPAL INVESTMENTS Under normal market conditions, the fund will invest at
least 65% of its total assets in equity securities of smaller companies located
outside the U.S. Smaller companies generally are those with market
capitalization of less than $1 billion. In some emerging markets, the fund may
invest in companies that qualify as small cap but are still among the largest in
the market.
Equity securities generally entitle the holder to participate in a company's
general operating results. These include common stocks and preferred stocks. The
fund also invests in American, Global, and European Depositary Receipts, which
are certificates typically issued by a bank or trust company that give their
holders the right to receive securities issued by a foreign or domestic
corporation.
[BEGIN - CALL OUT BOX]
The fund invests primarily in an internationally diversified portfolio of
smaller companies' common stocks.
[END - CALL OUT BOX]
The fund may invest up to 35% of its total assets in any combination of:
o equity securities of larger capitalized companies located outside the U.S.;
o equity securities of U.S. companies. The fund presently does not expect to
invest more than 5% of its assets in these securities;
o both rated and unrated debt securities. Debt securities represent an
obligation of the issuer to repay a loan of money to it, and generally
provide for the payment of interest. These include bonds, notes and
debentures.
The fund may invest more that 25% of its assets in the securities of issuers of
any one country.
The Templeton investment philosophy is "bottom-up", value-oriented, and
long-term. In choosing equity investments, the fund's manager will focus on the
market price of a company's securities relative to its evaluation of a company's
long-term earnings, asset value and cash flow potential. A company's historical
value measures, including price/earnings ratios, profit margins and liquidation
value, will also be considered.
TEMPORARY INVESTMENTS The manager may take a temporary defensive position when
the securities trading markets or the economies of countries where the fund
invests are experiencing excessive volatility or a prolonged general decline, or
other adverse conditions exist. Under these circumstances, the fund may be
unable to pursue its investment goal because it may not invest or may invest
substantially less in international smaller companies' stocks.
[Insert graphic of chart with line going up and down] MAIN RISKS
[BEGIN - CALL OUT BOX]
Because the stocks the fund holds fluctuate in price, the value of your
investment in the fund will go up and down. This means you could lose money over
short or even extended periods.
[END - CALL OUT BOX]
STOCKS While stocks have historically outperformed other asset classes over the
long term, they tend to go up and down more dramatically over the shorter term.
These price movements may result from factors affecting individual companies,
industries or the securities market as a whole. Value stock prices are
considered "cheap" relative to the company's perceived value. They may not
increase in value, as anticipated by the manager, if other investors fail to
recognize the company's value and bid up the price or if they trade in markets
favoring faster-growing companies.
SMALLER COMPANIES Historically, smaller company securities have been more
volatile in price than larger company securities, especially over the
short-term. Among the reasons for the greater price volatility are the less
certain growth prospects of smaller companies, the lower degree of liquidity in
the markets for such securities and the greater sensitivity of smaller companies
to changing economic conditions.
In addition, smaller companies may lack depth of management, they may be unable
to generate funds necessary for growth or development or they may be developing
or marketing new products or services for which markets are not yet established
and may never become established.
Therefore, while smaller companies may offer greater opportunities for capital
growth than larger, more established companies, they also involve greater risks
and should be considered speculative.
FOREIGN SECURITIES Securities of companies and governments located outside the
U.S. may involve risks that can increase the potential for losses in the fund.
Investments in Depositary Receipts also involve some or all of the following
risks.
COUNTRY. General securities market movements in any country where the fund has
investments are likely to affect the value of the securities the fund owns that
trade in that country. These movements will affect the fund's share price and
fund performance.
The political, economic and social structures of some countries the fund invests
in 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, currency devaluations, foreign ownership limitations,
expropriation, restrictions on removal of currency or other assets,
nationalization of assets, punitive taxes and certain custody and settlement
risks.
The fund's investments in developing or emerging markets are subject to all of
the risks of foreign investing generally, and have additional heightened risks
due to a lack of established legal, business and social frameworks to support
securities markets. Foreign securities markets, including emerging markets, may
have substantially lower trading volumes than U.S. markets, resulting in less
liquidity and more volatility than experienced in the U.S. While short-term
volatility in these markets can be disconcerting, declines in excess of 50% are
not unusual.
COMPANY. Foreign companies are not subject to the same disclosure, accounting,
auditing and financial reporting standards and practices as U.S. companies and
their securities may not be as liquid as securities of similar U.S. companies.
Foreign stock exchanges, trading systems, brokers and companies generally have
less government supervision and regulation than in the U.S. The fund 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 U.S. companies in U.S. courts.
CURRENCY Many of the fund's investments are 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. Devaluation of a currency by
a country's government or banking authority also will have a significant impact
on the value of any securities denominated in that currency. Currency markets
generally are not as regulated as securities markets.
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. If the fund holds investments in countries with
currencies replaced by the euro, the investment process, including trading,
foreign exchange, payments, settlements, cash accounts, custody and accounting
will be impacted.
Because this change to a single currency is new and untested, the establishment
of the euro may result in market volatility. For the same reason, it is not
possible to predict the impact of the euro on the business or financial
condition of European issuers which the fund may hold in its portfolio, and
their impact on fund performance. To the extent the fund holds non-U.S. dollar
(euro or other) denominated securities, it will still be exposed to currency
risk due to fluctuations in those currencies versus the U.S. dollar.
ILLIQUID SECURITIES The fund may invest up to 10% of its net assets in illiquid
securities. Illiquid securities are generally those that cannot be sold within
seven days in the normal course of business for approximately the amount at
which the fund has valued them. A limited trading market can result from
political or economic conditions affecting previously established securities
markets, particularly in emerging market conditions.
INTEREST RATE When interest rates rise, debt security prices fall. The opposite
is also true; debt security prices go up when interest rates fall. Generally,
interest rates rise during times of inflation or a growing economy, and fall
during an economic slowdown or recession. Securities with longer maturities
usually are more sensitive to interest rate changes than securities with shorter
maturities.
CREDIT This is the possibility that an issuer will be unable to make interest
payments or repay principal. Changes in an issuer's financial strength or in a
security's credit rating may affect its value and, thus, impact the value of
fund shares.
YEAR 2000 When evaluating current and potential portfolio positions, Year 2000
is one of the factors the fund's manager considers.
The manager will rely upon public filings and other statements made by companies
about their Year 2000 readiness. Issuers in countries outside the U.S.,
particularly in emerging markets, may not be required to make the same level of
disclosure about Year 2000 readiness as is required in the U.S. The manager, of
course, cannot audit each company and its major suppliers to verify their Year
2000 readiness.
If a company in which the fund is invested is adversely affected by Year 2000
problems, it is likely that the price of its securities will also be adversely
affected. A decrease in the value of one or more of the fund's portfolio
holdings will have a similar impact on the fund's performance. Please see page
22 for more information.
More detailed information about the fund, its policies (including temporary
investments), and risks can be found in the fund's Statement of Additional
Information (SAI).
[BEGIN - CALL OUT BOX]
Mutual fund shares are not deposits or obligations of, or guaranteed or endorsed
by, any bank, and are not federally insured by the Federal Deposit Insurance
Corporation, the Federal Reserve Board, or any other agency of the U.S.
government. Mutual fund shares involve investment risks, including the possible
loss of principal.
[END - CALL OUT BOX]
[Insert graphic of bull and bear] PERFORMANCE
This bar chart and table show the volatility of the fund's returns, which is one
indicator of the risks of investing in the fund. The bar chart shows changes in
the fund's returns from year to year over the past seven calendar years. The
table shows how the fund's average annual total returns compare to those of a
broad-based securities market index. Of course, past performance cannot predict
or guarantee future results.
ADVISOR CLASS ANNUAL TOTAL RETURNS 1
0.89% 33.02% -0.11% 10.71% 24.18% 3.13% -6.32%
92 93 94 95 96 97 98
YEAR
[BEGIN - CALL OUT BOX]
BEST
QUARTER:
Q4 '93
16.09%
WORST
QUARTER:
Q3 '98
- -16.49%
[END - CALL OUT BOX]
AVERAGE ANNUAL TOTAL RETURNS
For the periods ended December 31, 1998
SINCE INCEPTION
1 YEAR 5 YEARS (9/20/91)
- -------------------------------------------------------------------------------
Templeton Foreign Smaller
Companies Fund - Advisor Class 1 -6.32% 5.82% 8.79%
MSCI EAFE Index 2 20.33% 9.50% 9.32%
1. Performance figures reflect a "blended" figure combining the following
methods of calculation: (a) For periods before January 1, 1997, a restated
figure is used based on the fund's Class A performance, excluding the effect of
Class A's maximum initial sales charge and including the effect of the Class A
distribution and service (12b-1) fees; and (b) for periods after January 1,
1997, an actual Advisor Class figure is used reflecting a deduction of all
applicable charges and fees for that class. This blended figure assumes
reinvestment of dividends and capital gains.
2. Source: Standard & Poor's(R) Micropal. The unmanaged MSCI Europe Australia
Far East (EAFE) index tracks the performance of approximately 1,000 securities
in 20 countries. It includes reinvested dividends. One cannot invest directly in
an index, nor is an index representative of the fund's portfolio.
[Insert graphic of percentage sign] FEES AND EXPENSES
This table describes the fees and expenses that you may pay if you buy and hold
shares of the fund.
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT)
ADVISOR CLASS
- ------------------------------------------------------------------------------
Maximum sales charge (load)
imposed on purchases None
Exchange fee 1 $5.00
ANNUAL FUND OPERATING EXPENSES (EXPENSES DEDUCTED FROM FUND ASSETS) 2
ADVISOR CLASS
- ------------------------------------------------------------------------------
Management fees 3 0.50%
Distribution and service (12b-1) fees None
Other expenses 0.80%
Total annual fund operating expenses 3 1.30%
1. The fee is only for market timers (see page 31).
2. The fund began offering Advisor Class shares on January 1, 1997. Annual fund
operating expenses are based on the expenses for the fund's Class A shares for
the fiscal year ended October 31, 1998.
3. For the fiscal year ended October 31, 1998, the manager had agreed in advance
to limit its management fees and to assume as its own expense certain expenses
otherwise payable by the fund. With this reduction, management fees were 0.47%
and total annual fund operating expenses were 1.27%. The manager may end this
arrangement at any time upon notice to the fund's Board of Trustees.
EXAMPLE
This example can help you compare the cost of investing in the fund with the
cost of investing in other mutual funds.
The example assumes you invest $10,000 for the periods shown and then sell all
of your shares at the end of those periods. The example also assumes your
investment has a 5% return each year and the fund's operating expenses remain
the same. Although your actual costs may be higher or lower, based on these
assumptions your costs would be:
1 YEAR 3 YEARS 5 YEARS 10 YEARS
- ------------------------------------------------------------------------------
$132 $412 $713 $1,568
[Insert graphic of briefcase] MANAGEMENT
Franklin Advisers, Inc. (Advisers), 777 Mariners Island Blvd., San Mateo, CA
94404, is the fund's investment manager. Together, Advisers and its affiliates
manage over $220 billion in assets.
Under an agreement with Advisers, Templeton Investment Counsel, Inc. (Investment
Counsel), 500 East Broward Boulevard, Ft. Lauderdale, FL 33394, is the fund's
sub-advisor. Investment Counsel provides Advisers with investment management
advice and assistance.
The team responsible for the fund's management is:
SIMON RUDOLPH, SENIOR VICE PRESIDENT OF INVESTMENT COUNSEL
Mr. Rudolph has been a manager of the fund since 1997. He joined the Franklin
Templeton Group in 1997. Previously, he was an executive director with Morgan
Stanley.
PETER N. NORI CFA, SENIOR VICE PRESIDENT OF INVESTMENT COUNSEL
Mr. Nori has been a manager of the fund since 1997. He joined the Franklin
Templeton Group in 1987.
JUAN J. BENITO, VICE PRESIDENT OF INVESTMENT COUNSEL
Mr. Benito has been a manager of the fund since 1997. He joined the Franklin
Templeton Group in 1996. Previously, he was a management consultant and case
team leader with Monitor Company, a leading global strategy consulting firm.
The fund pays the manager a fee for managing the fund's assets and making its
investment decisions. For the fiscal year ended October 31, 1998, management
fees, before any advance waiver, were 0.50% of the fund's average daily net
assets. Under an agreement by the manager to limit its fees, the fund paid 0.47%
of its average daily net assets to the manager. The manager may end this
arrangement at any time upon notice to the fund's Board of Trustees.
[Insert graphic of a dollar bill] FINANCIAL HIGHLIGHTS
This table presents the financial performance for Advisor Class for the past two
years. This information has been audited by PricewaterhouseCoopers LLP.
YEAR ENDED
ADVISOR CLASS OCTOBER 31,
- -----------------------------------------------------------------
1998 1997 1
- -----------------------------------------------------------------
PER SHARE DATA ($)
Net asset value,
Beginning of year 15.09 14.00
------------------
Net investment income .32 .20
Net realized and unrealized gains (losses) (2.13) .98
------------------
Total from investment operations (1.81) 1.18
Less distributions from: Net investment income (.27) (.09)
------------------
Net realized gains (.67) -
==================
Net asset value, end of year 12.34 15.09
==================
Total return (%) 2 (12.55) 8.43
RATIOS/SUPPLEMENTAL DATA
Net assets, end of year ($ x 1,000) 12,402 3,726
Ratios to average net assets: (%)
Expenses 1.31 1.24 3
Expenses excluding waiver and
payments by affiliate 1.33 1.36 3
Net investment income 1.43 2.66 3
Portfolio turnover rate (%) 22.82 33.62
1. For the period from January 2, 1997 (commencement of sales) through October
31, 1997.
2. Total return is not annualized.
3. Annualized
TEMPLETON PACIFIC
GROWTH FUND
[Insert graphic of bullseye and arrows] GOAL AND STRATEGIES
GOAL The fund's investment goal is long-term capital growth.
PRINCIPAL INVESTMENTS Under normal market conditions, the fund will invest at
least 65% of its total assets in equity securities that trade on Pacific Rim
markets and are issued by companies that have their principal activities in the
Pacific Rim.
For purposes of the fund's investments, Pacific Rim countries include Australia,
China, Hong Kong, India, Indonesia, Japan, Malaysia, New Zealand, Pakistan,
Philippines, Singapore, South Korea and Thailand. At least 65% of the fund's
total assets will be invested in issuers in at least three of these countries.
Equity securities generally entitle the holder to participate in a company's
general operating results. These include common stocks and preferred stocks. The
fund also invests in American and Global Depositary Receipts, which are
certificates typically issued by a bank or trust company that give their holders
the right to receive securities issued by a foreign or domestic corporation.
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The fund invests primarily in common stocks of Pacific Rim companies.
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The fund may invest up to 35% of its total assets in any combination of:
o securities of issuers domiciled outside the Pacific Rim. These investments
may include securities of issuers that are linked by tradition, economic
markets, cultural similarities or geography to countries in the Pacific Rim
or that have operations in the Pacific Rim or that stand to benefit from
political and economic events in the Pacific Rim;
o both rated and unrated debt and synthetic convertible securities. The fund
currently has no intention of investing more than 5% of its net assets in
synthetic convertible securities. Debt securities represent an obligation
of the issuer to repay a loan of money to it, and generally provide for the
payment of interest. These include bonds, notes and debentures.
The fund may invest more that 25% of its assets in the securities of issuers of
any one country.
The Templeton investment philosophy is "bottom-up", value-oriented, and
long-term. In choosing equity investments, the fund's manager will focus on the
market price of a company's securities relative to its evaluation of a company's
long-term earnings, asset value and cash flow potential. A company's historical
value measures, including price/earnings ratios, profit margins and liquidation
value, will also be considered.
TEMPORARY INVESTMENTS The manager may take a temporary defensive position when
the securities trading markets or the economies of countries where the fund
invests are experiencing excessive volatility or a prolonged general decline, or
other adverse conditions exist. Under these circumstances, the fund may be
unable to pursue its investment goal because it may not invest or may invest
substantially less in Pacific Rim companies' stocks.
[Insert graphic of chart with line going up and down] MAIN RISKS
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Because the stocks the fund holds fluctuate in price, the value of your
investment in the fund will go up and down. This means you could lose money over
short or even extended periods.
[END - CALL OUT BOX]
STOCKS While stocks have historically outperformed other asset classes over the
long term, they tend to go up and down more dramatically over the shorter term.
These price movements may result from factors affecting individual companies,
industries or the securities market as a whole. Value stock prices are
considered "cheap" relative to the company's perceived value. They may not
increase in value, as anticipated by the manager, if other investors fail to
recognize the company's value and bid up the price or if they trade in markets
favoring faster-growing companies.
FOREIGN SECURITIES Securities of companies and governments located outside the
U.S. may involve risks that can increase the potential for losses in the fund.
Investments in Depositary Receipts also involve some or all of the following
risks.
COUNTRY. General securities market movements in any country where the fund has
investments are likely to affect the value of the securities the fund owns that
trade in that country. These movements will affect the fund's share price and
fund performance.
The political, economic and social structures of some countries the fund invests
in 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, currency devaluations, foreign ownership limitations,
expropriation, restrictions on removal of currency or other assets,
nationalization of assets, punitive taxes and certain custody and settlement
risks.
The fund's investments in developing or emerging markets are subject to all of
the risks of foreign investing generally, and have additional heightened risks
due to a lack of established legal, business and social frameworks to support
securities markets. Foreign securities markets, including emerging markets, may
have substantially lower trading volumes than U.S. markets, resulting in less
liquidity and more volatility than experienced in the U.S. While short-term
volatility in these markets can be disconcerting, declines in excess of 50% are
not unusual.
Because the fund invests a significant amount of its assets in issuers located
in a particular region of the world, it may be subject to greater risks and may
experience greater volatility than a fund that is more broadly diversified
geographically.
COMPANY. Foreign companies are not subject to the same disclosure, accounting,
auditing and financial reporting standards and practices as U.S. companies and
their securities may not be as liquid as securities of similar U.S. companies.
Foreign stock exchanges, trading systems, brokers and companies generally have
less government supervision and regulation than in the U.S. The fund 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 U.S. companies in U.S. courts.
CURRENCY Many of the fund's investments are 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. Devaluation of a currency by
a country's government or banking authority also will have a significant impact
on the value of any securities denominated in that currency. Currency markets
generally are not as regulated as securities markets.
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. If the fund holds investments in countries with
currencies replaced by the euro, the investment process, including trading,
foreign exchange, payments, settlements, cash accounts, custody and accounting
will be impacted.
Because this change to a single currency is new and untested, the establishment
of the euro may result in market volatility. For the same reason, it is not
possible to predict the impact of the euro on the business or financial
condition of European issuers which the fund may hold in its portfolio, and
their impact on fund performance. To the extent the fund holds non-U.S. dollar
(euro or other) denominated securities, it will still be exposed to currency
risk due to fluctuations in those currencies versus the U.S. dollar.
ILLIQUID SECURITIES The fund may invest up to 10% of its net assets in illiquid
securities. Illiquid securities are generally those that cannot be sold within
seven days in the normal course of business for approximately the amount at
which the fund has valued them. A limited trading market can result from
political or economic conditions affecting previously established securities
markets, particularly in emerging market conditions.
INTEREST RATE When interest rates rise, debt security prices fall. The opposite
is also true; debt security prices go up when interest rates fall. Generally,
interest rates rise during times of inflation or a growing economy, and fall
during an economic slowdown or recession. Securities with longer maturities
usually are more sensitive to interest rate changes than securities with shorter
maturities.
CREDIT This is the possibility that an issuer will be unable to make interest
payments or repay principal. Changes in an issuer's financial strength or in a
security's credit rating may affect its value and, thus, impact the value of
fund shares.
YEAR 2000 When evaluating current and potential portfolio positions, Year 2000
is one of the factors the fund's manager considers.
The manager will rely upon public filings and other statements made by companies
about their Year 2000 readiness. Issuers in countries outside the U.S.,
particularly in emerging markets, may not be required to make the same level of
disclosure about Year 2000 readiness as is required in the U.S. The manager, of
course, cannot audit each company and its major suppliers to verify their Year
2000 readiness.
If a company in which the fund is invested is adversely affected by Year 2000
problems, it is likely that the price of its securities will also be adversely
affected. A decrease in the value of one or more of the fund's portfolio
holdings will have a similar impact on fund's performance shares. Please see
page 22 for more information.
More detailed information about the fund, its policies (including temporary
investments), and risks can be found in the fund's Statement of Additional
Information (SAI).
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Mutual fund shares are not deposits or obligations of, or guaranteed or endorsed
by, any bank, and are not federally insured by the Federal Deposit Insurance
Corporation, the Federal Reserve Board, or any other agency of the U.S.
government. Mutual fund shares involve investment risks, including the possible
loss of principal.
[END - CALL OUT BOX]
[Insert graphic of bull and bear] PERFORMANCE
This bar chart and table show the volatility of the fund's returns, which is one
indicator of the risks of investing in the fund. The bar chart shows changes in
the fund's returns from year to year over the past seven calendar years. The
table shows how the fund's average annual total returns compare to those of a
broad-based securities market index. Of course, past performance cannot predict
or guarantee future results.
ADVISOR CLASS ANNUAL TOTAL RETURNS 1
3.65% 60.93% -10.68% 5.85% 11.85% -37.66% -7.54%
92 93 94 95 96 97 98
YEAR
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BEST
QUARTER:
Q4 '98
31.00%
WORST
QUARTER:
Q4 '97
- -32.28%
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AVERAGE ANNUAL TOTAL RETURNS
For the periods ended December 31, 1998
SINCE
INCEPTION
1 YEAR 5 YEARS (9/20/91)
- --------------------------------------------------------------------------------
Templeton Pacific Growth Fund - Advisor Class 1 -7.54% -9.43% 0.72%
MSCI Pacific Index 2 2.69% -3.95% -0.87%
1. Performance figures reflect a "blended" figure combining the following
methods of calculation: (a) For periods before January 1, 1997, a restated
figure is used based on the fund's Class A performance, excluding the effect of
Class A's maximum initial sales charge and including the effect of the Class A
distribution and service (12b-1) fees; and (b) for periods after January 1,
1997, an actual Advisor Class figure is used reflecting a deduction of all
applicable charges and fees for that class. This blended figure assumes
reinvestment of dividends and capital gains.
2. Source: Standard &Poor's(R) Micropal. The unmanaged MSCI Pacific Index tracks
the performance of approximately 450 companies in Australia, Hong Kong, Japan,
New Zealand, and Singapore. It includes reinvested dividends. One cannot invest
directly in an index, nor is an index representative of the fund's portfolio.
[Insert graphic of percentage sign] FEES AND EXPENSES
This table describes the fees and expenses that you may pay if you buy and hold
shares of the fund.
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT)
ADVISOR CLASS
- ------------------------------------------------------------------------------
Maximum sales charge (load) imposed on purchases None
Exchange fee None
ANNUAL FUND OPERATING EXPENSES (EXPENSES DEDUCTED FROM FUND ASSETS) 1
ADVISOR CLASS
- ------------------------------------------------------------------------------
Management fees 0.50%
Distribution and service (12b-1) fees None
Other expenses 1.12%
----------
Total annual fund operating expenses 1.62%
==========
1. The fund began offering Advisor Class shares on January 1, 1997. Annual fund
operating expenses are based on the expenses for the fund's Class A shares for
the fiscal year ended October 31, 1998.
EXAMPLE
This example can help you compare the cost of investing in the fund with the
cost of investing in other mutual funds.
The example assumes you invest $10,000 for the periods shown and then sell all
of your shares at the end of those periods. The example also assumes your
investment has a 5% return each year and the fund's operating expenses remain
the same. Although your actual costs may be higher or lower, based on these
assumptions your costs would be:
1 YEAR 3 YEARS 5 YEARS 10 YEARS
- --------------------------------------------------------------------------------
$165 $511 $881 $1,922
[Insert graphic of briefcase] MANAGEMENT
Franklin Advisers, Inc. (Advisers), 777 Mariners Island Blvd., San Mateo, CA
94404, is the fund's investment manager. Together, Advisers and its affiliates
manage over $220 billion in assets.
Under an agreement with Advisers, Templeton Investment Counsel, Inc. (Investment
Counsel), 500 East Broward Boulevard, Ft. Lauderdale, FL 33394, is the fund's
sub-advisor. Investment Counsel provides Advisers with investment management
advice and assistance.
The team responsible for the fund's management is:
WILLIAM T. HOWARD, JR. CFA,
SENIOR VICE PRESIDENT OF INVESTMENT COUNSEL
Mr. Howard has been a manager of the fund since 1993. He joined the Franklin
Templeton Group in 1993.
MARK R. BEVERIDGE CFA, SENIOR VICE PRESIDENT OF INVESTMENT COUNSEL
Mr. Beveridge has been a manager of the fund since 1994. He joined the Franklin
Templeton Group in 1985.
GARY CLEMONS, SENIOR VICE PRESIDENT OF INVESTMENT COUNSEL
Mr. Clemons has been a manager of the fund since 1993. He joined the Franklin
Templeton Group in 1990.
The fund pays the manager a fee for managing the fund's assets and making its
investment decisions. For the fiscal year ended October 31, 1998, the fund paid
0.50% of its average daily net assets to the manager.
[Insert graphic of a dollar bill] FINANCIAL HIGHLIGHTS
This table presents the financial performance for Advisor Class for the past two
years. This information has been audited by PricewaterhouseCoopers LLP.
YEAR ENDED
ADVISOR CLASS OCTOBER 31,
1998 1997 1
- ---------------------------------------------------------------
PER SHARE DATA ($)
Net asset value, beginning of year 10.88 15.10
------------------
Net investment income .15 .12
Net realized and unrealized gains (losses) (2.93) (4.30)
-------------------
Total from investment operations (2.78) (4.18)
Less distributions from:
Net investment income (.15) (.04)
Net realized gains (.07) -
-------------------
Total distributions (.22) (.04)
===================
Net asset value, end of year 7.88 10.88
===================
Total return (%) 2 (25.68) (27.74)
RATIOS/SUPPLEMENTAL DATA
Net assets, end of year ($ x 1,000) 1,454 1,357
Ratios to average net assets: (%)
Expenses 1.62 1.483
Net investment income 1.78 1.553
Portfolio turnover rate (%) 19.61 24.79
1. For the period from January 2, 1997 (commencement of sales) through October
31, 1997.
2. Total return is not annualized.
3. Annualized
[Insert graphic of dollar
signs and stacks of coins]
DISTRIBUTIONS AND TAXES;
YEAR 2000 PROBLEM
INCOME AND CAPITAL GAINS DISTRIBUTIONS Each fund intends to pay a dividend at
least semiannually representing its net investment income. Capital gains, if
any, may be distributed annually. The amount of these distributions will vary
and there is no guarantee the fund will pay dividends.
To receive a distribution, you must be a shareholder on the record date. The
record dates for the funds' distributions will vary. Please keep in mind that if
you invest in a fund shortly before the record date of a distribution, any
distribution will lower the value of the fund's shares by the amount of the
distribution and you will receive some of your investment back in the form of a
taxable distribution. If you would like information on upcoming record dates for
the fund's distributions, please call 1-800/DIAL BEN(R).
TAX CONSIDERATIONS In general, fund distributions are taxable to you as either
ordinary income or capital gains. This is true whether you reinvest your
distributions in additional shares of the fund or receive them in cash. Any
capital gains the fund distributes are taxable to you as long-term capital gains
no matter how long you have owned your shares.
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Backup Withholding
By law, the fund must withhold 31% of your taxable distributions and proceeds if
you do not provide your correct taxpayer identification number (TIN) or certify
that your TIN is correct, or if the IRS instructs the fund to do so.
[END - CALL OUT BOX]
Every January, you will receive a statement that shows the tax status of
distributions you received for the previous year. Distributions declared in
December but paid in January are taxable as if they were paid in December.
When you sell your shares of the fund, you may have a capital gain or loss. For
tax purposes, an exchange of your fund shares for shares of a different Franklin
Templeton Fund is the same as a sale. The individual tax rate on any gain from
the sale or exchange of your shares depends on how long you have held your
shares.
Fund distributions and gains from the sale or exchange of your shares will
generally be subject to state and local income tax. Any foreign taxes the fund
pays on its investments may be passed through to you as a foreign tax credit.
Non-U.S. investors may be subject to U.S. withholding and estate tax. You should
consult your tax advisor about the federal, state, local or foreign tax
consequences of your investment in the fund.
YEAR 2000 PROBLEM Each fund's business operations depend on a worldwide network
of computer systems that contain date fields, including securities trading
systems, securities transfer agent operations and stock market links. Many of
the systems currently use a two digit date field to represent the date, and
unless these systems are changed or modified, they may not be able to
distinguish the Year 1900 from the Year 2000 (commonly referred to as the Year
2000 problem). In addition, the fact that the Year 2000 is a leap year may
create difficulties for some systems.
When the Year 2000 arrives, a fund's operations could be adversely affected if
the computer systems used by the manager, its service providers and other third
parties it does business with are not Year 2000 ready. For example, a fund's
portfolio and operational areas could be impacted, including securities trade
processing, interest and dividend payments, securities pricing, shareholder
account services, reporting, custody functions and others. A fund could
experience difficulties in effecting transactions if any of its foreign
subcustodians, or if foreign broker-dealers or foreign markets are not ready for
Year 2000.
Each fund's manager and its affiliated service providers are making a concerted
effort to take steps they believe are reasonably designed to address their Year
2000 problems. Of course, a fund's ability to reduce the effects of the Year
2000 problem is also very much dependent upon the efforts of third parties over
which the fund and its manager may have no control.
YOUR ACCOUNT
[Insert graphic of pencil marking an "X"] QUALIFIED INVESTORS
The following investors may qualify to buy Advisor Class shares of the fund.
o Qualified registered investment advisors or certified financial planners
with clients invested in any series of Franklin Mutual Series Fund Inc. on
October 31, 1996, or who buy through a broker-dealer or service agent who
has an agreement with Franklin Templeton Distributors, Inc. (Distributors).
Minimum investments: $1,000 initial and $50 additional.
o Broker-dealers, registered investment advisors or certified financial
planners who have an agreement with Distributors for clients participating
in comprehensive fee programs. Minimum investments: $250,000 initial
($100,000 initial for an individual client) and $50 additional.
o Officers, trustees, directors and full-time employees of Franklin Templeton
and their immediate family members. Minimum investments: $100 initial ($50
for accounts with an automatic investment plan) and $50 additional.
o Each series of the Franklin Templeton Fund Allocator Series. Minimum
investments: $1,000 initial and $1,000 additional.
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The FRANKLIN TEMPLETON FUNDS include all of the Franklin Templeton U.S.
registered mutual funds, except Franklin Valuemark Funds, Templeton Capital
Accumulator Fund, Inc., and Templeton Variable Products Series Fund.
[END - CALL OUT BOX]
o Governments, municipalities, and tax-exempt entities that meet the
requirements for qualification under section 501 of the Internal Revenue
Code. Minimum investments: $1 million initial investment in Advisor Class
or Class Z shares of any of the Franklin Templeton Funds and $50
additional.
o Accounts managed by the Franklin Templeton Group. Minimum investments: No
initial minimum and $50 additional.
o The Franklin Templeton Profit Sharing 401(k) Plan. Minimum investments: No
initial or additional minimums.
o Defined contribution plans such as employer stock, bonus, pension or profit
sharing plans that meet the requirements for qualification under section
401 of the Internal Revenue Code, including salary reduction plans
qualified under section 401(k) of the Internal Revenue Code, and that are
sponsored by an employer (i) with at least 10,000 employees, or (ii) with
retirement plan assets of $100 million or more. Minimum investments: No
initial or additional minimums.
o Trust companies and bank trust departments initially investing in the
Franklin Templeton Funds 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. Minimum investments: No initial or additional
minimums.
o Individual investors. Minimum investments: $5 million initial and $50
additional. You may combine all of your shares in the Franklin Templeton
Funds for purposes of determining whether you meet the $5 million minimum,
as long as $1 million is in Advisor Class or Class Z shares of any of the
Franklin Templeton Funds.
o Any other investor, including a private investment vehicle such as a family
trust or foundation, who is a member of an established group of 11 or more
investors. Minimum investments: $5 million initial and $50 additional. For
minimum investment purposes, the group's investments are added together.
The group may combine all of its shares in the Franklin Templeton Funds for
purposes of determining whether it meets the $5 million minimum, as long as
$1 million is in Advisor Class or Class Z shares of any of the Franklin
Templeton Funds. There are certain other requirements and the group must
have a purpose other than buying fund shares without a sales charge.
Please note that Advisor Class shares of the fund are no longer available to
retirement plans through Franklin Templeton's ValuSelect(R) program. Retirement
plans in the ValuSelect program before January 1, 1998, however, may continue to
invest in the fund's Advisor Class shares.
[Insert graphic of a paper with lines and someone writing]
BUYING SHARES
ACCOUNT APPLICATION If you are opening a new account, please complete and sign
the enclosed account application. To save time, you can sign up now for services
you may want on your account by completing the appropriate sections of the
application (see the next page).
BUYING SHARES
- --------------------------------------------------------------------------------
OPENING AN ACCOUNT ADDING TO AN ACCOUNT
- --------------------------------------------------------------------------------
[Insert graphic of hands
shaking]
THROUGH YOUR INVESTMENT Contact your investment Contact your investment
REPRESENTATIVE representative representative
- --------------------------------------------------------------------------------
Make your check payable Make your check payable
to the fund to the fund in which you
[Insert graphic of in which you are are investing. Include
envelope] investing. your account number on
the check.
BY MAIL Mail the check and your Fill out the deposit
signed application to slip from your account
Investor Services. statement. If you do not
have a slip, include a
note with your name, the
fund name, and your
account number.
Mail the check and
deposit slip or note to
Investor Services.
- --------------------------------------------------------------------------------
[Insert graphic of Call to receive a wire Call to receive a wire
three lightning control number and wire control number and wire
bolts] instructions. instructions.
BY WIRE Wire the funds and mail To make a same day wire
your signed application investment, please call
to Investor Services. us by
Please include the wire 1:00 p.m. pacific time
control number or your and make sure your wire
1-800/632-2301 new account number on the arrives by 3:00 p.m.
(or 1-650/312-2000 application.
collect)
To make a same day wire
investment, please call
us by
1:00 p.m. pacific time
and make sure your wire
arrives by 3:00 p.m.
- --------------------------------------------------------------------------------
[Insert graphic of two Call Shareholder Services Call Shareholder
arrows pointing on at the number below, or Services at the number
opposite directions] send signed written below, or send signed
instructions. (Please see written instructions.
BY EXCHANGE page 27 for information (Please see page 27 for
on exchanges.) information on
exchanges.)
- --------------------------------------------------------------------------------
FRANKLIN TEMPLETON INVESTOR SERVICES 777 MARINERS ISLAND BLVD., P.O. BOX 7777,
SAN MATEO, CA 94403-7777
CALL TOLL-FREE: 1-800/632-2301
(MONDAY THROUGH FRIDAY 5:30 A.M. TO 5:00 P.M., PACIFIC TIME
SATURDAY 6:30 A.M. TO 2:30 P.M., PACIFIC TIME)
[Insert graphic of person with a headset] INVESTOR SERVICES
AUTOMATIC INVESTMENT PLAN This plan offers a convenient way for you to invest in
the fund by automatically transferring money from your checking or savings
account each month to buy shares. To sign up, complete the appropriate section
of your account application.
DISTRIBUTION OPTIONS You may reinvest distributions you receive from the fund in
an existing account in the same share class of the fund or in Advisor Class or
Class A shares of another Franklin Templeton Fund. To reinvest your
distributions in Advisor Class shares of another Franklin Templeton Fund, you
must qualify to buy that fund's Advisor Class shares. For distributions
reinvested in Class A shares of another Franklin Templeton Fund, initial sales
charges and contingent deferred sales charges (CDSCs) will not apply if you
reinvest your distributions within 365 days. You can also have your
distributions deposited in a bank account, or mailed by check. Deposits to a
bank account may be made by electronic funds transfer.
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For Franklin Templeton Trust Company retirement plans, special forms may be
needed to receive distributions in cash. Please call 1-800/527-2020 for
information.
[END - CALL OUT BOX]
Please indicate on your application the distribution option you have chosen,
otherwise we will reinvest your distributions in the same share class of the
fund.
RETIREMENT PLANS Franklin Templeton offers a variety of retirement plans for
individuals and businesses. These plans require separate applications and their
policies and procedures may be different than those described in this
prospectus. For more information, including a free retirement plan brochure or
application, please call Retirement Plan Services at 1-800/527-2020.
TELEFACTS(R) Our TeleFACTS system offers around-the-clock access to information
about your account or any Franklin Templeton Fund. This service is available
from touch-tone phones at 1-800/247-1753. For a free TeleFACTS brochure, call
1-800/DIAL BEN.
TELEPHONE PRIVILEGES You will automatically receive telephone privileges when
you open your account, allowing you and your investment representative to sell
or exchange your shares and make certain other changes to your account by phone.
For accounts with more than one registered owner, telephone privileges also
allow the fund to accept written instructions signed by only one owner for
transactions and account changes that could otherwise be made by phone. For all
other transactions and changes, all registered owners must sign the
instructions.
As long as we take certain measures to verify telephone requests, we will not be
responsible for any losses that may occur from unauthorized requests. Of course,
you can decline telephone exchange or redemption privileges on your account
application.
EXCHANGE PRIVILEGE You can exchange shares between most Franklin Templeton Funds
within the same class. You also may exchange your Advisor Class shares for Class
A shares of a fund that does not currently offer an Advisor Class (without any
sales charge)* or for Class Z shares of Franklin Mutual Series Fund Inc.
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An EXCHANGE is really two transactions: a sale of one fund and the purchase of
another. In general, the same policies that apply to purchases and sales apply
to exchanges, including minimum investment amounts. Exchanges also have the same
tax consequences as ordinary sales and purchases.
[END - CALL OUT BOX]
If you do not qualify to buy Advisor Class shares of Templeton Developing
Markets Trust, Templeton Foreign Fund or Templeton Growth Fund, you also may
exchange your shares for Class A shares of those funds (without any sales
charge)* or for shares of Templeton Institutional Funds, Inc.
Generally exchanges may only be made between identically registered accounts,
unless you send written instructions with a signature guarantee.
Frequent exchanges can interfere with fund management or operations and drive up
costs for all shareholders. To protect shareholders, there are limits on the
number and amount of exchanges you may make (please see "Market Timers" on page
31).
SYSTEMATIC WITHDRAWAL PLAN This plan allows you to automatically sell your
shares and receive regular payments from your account. Certain terms and
minimums apply. To sign up, complete the appropriate section of your
application.
*If you exchange into Class A shares and you later decide you would like to
exchange into a fund that offers an Advisor Class, you may exchange your Class A
shares for Advisor Class shares if you otherwise qualify to buy the fund's
Advisor Class shares.
[Insert graphic of a certificate] SELLING SHARES
You can sell your shares at any time.
SELLING SHARES IN WRITING Requests to sell $100,000 or less can generally be
made over the phone or with a simple letter. Sometimes, however, to protect you
and the fund we will need written instructions signed by all registered owners,
with a signature guarantee for each owner, if:
[BEGIN - CALL OUT BOX]
A SIGNATURE GUARANTEE helps protect your account against fraud. You can obtain a
signature guarantee at most banks and securities dealers.
A notary public CANNOT provide a signature guarantee.
[END - CALL OUT BOX]
o you are selling more than $100,000 worth of shares
o you want your proceeds paid to someone who is not a registered owner
o you want to send your proceeds somewhere other than the address of record,
or preauthorized bank or brokerage firm account
We may also require a signature guarantee on instructions we receive from an
agent, not the registered owners, or when we believe it would protect the fund
against potential claims based on the instructions received.
SELLING RECENTLY PURCHASED SHARES If you sell shares recently purchased with a
check or draft, we may delay sending you the proceeds until your check or draft
has cleared, which may take seven business days or more. A certified or
cashier's check may clear in less time.
REDEMPTION PROCEEDS Your redemption check will be sent within seven days after
we receive your request in proper form. We are not able to receive or pay out
cash in the form of currency. Redemption proceeds may be delayed if we have not
yet received your signed account application.
RETIREMENT PLANS You may need to complete additional forms to sell shares in a
Franklin Templeton Trust Company retirement plan. For participants under age
591/2, tax penalties may apply. Call Retirement Plan Services at 1-800/527-2020
for details.
SELLING SHARES
- --------------------------------------------------------------------------------
To sell some or all of your shares
- --------------------------------------------------------------------------------
[Insert graphic of
hands shaking]
THROUGH YOUR INVESTMENT Contact your investment representative
REPRESENTATIVE
- --------------------------------------------------------------------------------
[Insert graphic of Send written instructions and endorsed share
envelope] certificates (if you hold share certificates) to
Investor Services. Corporate, partnership or
BY MAIL trust accounts may need to send additional
documents.
Specify the fund, the account number and the
dollar value or number of shares you wish to
sell. Be sure to include all necessary signatures
and any additional documents, as well as
signature guarantees if required.
A check will be mailed to the name(s) and address
on the account, or otherwise according to your
written instructions.
- --------------------------------------------------------------------------------
[Insert graphic of phone] As long as your transaction is for $100,000 or
less, you do not hold share certificates and you
BY PHONE have not changed your address by phone within the
last 15 days, you can sell your shares by phone.
1-800/632-2301
A check will be mailed to the name(s) and address
on the account. Written instructions, with a
signature guarantee, are required to send the
check to another address or to make it payable to
another person.
- --------------------------------------------------------------------------------
[Insert graphic of three You can call or write to have redemption proceeds
lightning bolts] of $1,000 or more wired to a bank or escrow
account. See the policies above for selling
shares by mail or phone.
BY WIRE Before requesting a bank wire, 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, your bank account number, the ABA
routing number, and a signature
guarantee.
Requests received in proper form by 1:00 p.m.
pacific time will be wired the next business day.
- --------------------------------------------------------------------------------
[Insert graphic of two Obtain a current prospectus for the fund you are
arrows pointing on considering.
opposite directions]
Call Shareholder Services at the number below, or
BY EXCHANGE send signed written instructions. See the
policies above for selling shares by mail or
phone.
If you hold share certificates, you will need to
return them to the fund before your exchange can
be processed.
- --------------------------------------------------------------------------------
FRANKLIN TEMPLETON INVESTOR SERVICES 777 MARINERS ISLAND BLVD., P.O. BOX 7777,
SAN MATEO, CA 94403-7777
CALL TOLL-FREE: 1-800/632-2301
(MONDAY THROUGH FRIDAY 5:30 A.M. TO 5:00 P.M., PACIFIC TIME
SATURDAY 6:30 A.M. TO 2:30 P.M., PACIFIC TIME)
[Insert graphic of paper and pen] ACCOUNT POLICIES
CALCULATING SHARE PRICE The fund calculates the net asset value per share (NAV)
each business day at the close of trading on the New York Stock Exchange
(normally 1:00 p.m. pacific time). The NAV for Advisor Class is calculated by
dividing its net assets by the number of its shares outstanding.
The fund's assets are generally valued at their market value. If market prices
are unavailable, or if an event occurs after the close of the trading market
that materially affects the values, assets may be valued at their fair value. If
the fund holds securities listed primarily on a foreign exchange that trades on
days when the fund is not open for business, the value of your shares may change
on days that you cannot buy or sell shares.
Requests to buy and sell shares are processed at the NAV next calculated after
we receive your request in proper form.
ACCOUNTS WITH LOW BALANCES If the value of your account falls below $250 ($50
for employee accounts) because you sell some of your shares, we may mail you a
notice asking you to bring the account back up to its applicable minimum
investment amount. If you choose not to do so within 30 days, we may close your
account and mail the proceeds to the address of record.
STATEMENTS AND REPORTS You will receive confirmations and account statements
that show your account transactions. You will also 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 will also receive confirmations, account statements and other
information about your account directly from the fund.
STREET OR NOMINEE ACCOUNTS You may transfer your shares from the street or
nominee name account of one dealer to another, as long as both dealers have an
agreement with Franklin Templeton Distributors, Inc. We will process the
transfer after we receive authorization in proper form from your delivering
securities dealer.
JOINT ACCOUNTS Unless you specify a different registration, accounts with two or
more owners are registered as "joint tenants with rights of survivorship" (shown
as "Jt Ten" on your account statement). To make any ownership changes to a joint
account, all owners must agree in writing, regardless of the law in your state.
MARKET TIMERS The fund may restrict or refuse exchanges by market timers. If
accepted, each exchange by a market timer will be charged $5. You will be
considered a market timer if you have (i) requested an exchange out of the fund
within two weeks of an earlier exchange request, or (ii) exchanged shares out of
the fund more than twice in a calendar quarter, or (iii) exchanged shares equal
to at least $5 million, or more than 1% of the fund's net assets, or (iv)
otherwise seem to follow a timing pattern. Shares under common ownership or
control are combined for these limits. Templeton Pacific Growth Fund does not
allow investments by market timers.
ADDITIONAL POLICIES Please note that the fund maintains additional policies and
reserves certain rights, including:
o The fund may refuse any order to buy shares, including any purchase under
the exchange privilege.
o At any time, the fund may change its investment minimums or waive or lower
its minimums for certain purchases.
o The fund may modify or discontinue the exchange privilege on 60 days'
notice.
o You may only buy shares of a fund eligible for sale in your state or
jurisdiction.
o In unusual circumstances, we may temporarily suspend redemptions, or
postpone the payment of proceeds, as allowed by federal securities laws.
o For redemptions over a certain amount, the fund reserves the right to make
payments in securities or other assets of the fund, in the case of an
emergency or if the payment by check or wire would be harmful to existing
shareholders.
o To permit investors to obtain the current price, dealers are responsible
for transmitting all orders to the fund promptly.
DEALER COMPENSATION Qualifying dealers who sell Advisor Class shares may receive
up to 0.25% of the amount invested. This amount is paid by Franklin Templeton
Distributors, Inc. from its own resources.
[Insert graphic of question mark] QUESTIONS
If you have any questions about the fund or your account, you can write to us at
777 Mariners Island Blvd., P.O. Box 7777, San Mateo, CA 94403-7777. You can also
call us at one of the following numbers. For your protection and to help ensure
we provide you with quality service, all calls may be monitored or recorded.
HOURS (PACIFIC TIME,
DEPARTMENT NAME TELEPHONE NUMBER MONDAY THROUGH FRIDAY)
- --------------------------------------------------------------------------------
Shareholder Services 1-800/632-2301 5:30 a.m. to 5:00 p.m.
6:30 a.m. to 2:30 p.m. (Saturday)
Fund Information 1-800/DIAL BEN 5:30 a.m. to 8:00 p.m.
(1-800/342-5236) 6:30 a.m. to 2:30 p.m. (Saturday)
Retirement Plan Services 1-800/527-2020 5:30 a.m. to 5:00 p.m.
Dealer Services 1-800/524-4040 5:30 a.m. to 5:00 p.m.
Institutional Services 1-800/321-8563 6:00 a.m. to 5:00 p.m.
TDD (hearing impaired) 1-800/851-0637 5:30 a.m. to 5:00 p.m.
FOR MORE INFORMATION
You can learn more about each fund in the following documents:
ANNUAL/SEMIANNUAL REPORT TO SHAREHOLDERS
Includes a discussion of recent market conditions and fund strategies, financial
statements, detailed performance information, portfolio holdings, and the
auditor's report.
STATEMENT OF ADDITIONAL INFORMATION (SAI)
Contains more information about each fund, its investments and policies. It is
incorporated by reference (is legally a part of this prospectus).
For a free copy of the current annual/semiannual report or the SAI, please
contact your investment representative or call us at the number below.
FRANKLIN(R)TEMPLETON(R)
1-800/DIAL BEN(R) (1-800/342-5236)
TDD (Hearing Impaired) 1-800/851-0637
www.franklin-templeton.com
You can also obtain information about each fund by visiting the SEC's Public
Reference Room in Washington D.C. (phone 1-800/SEC-0330) or by sending your
request and a duplicating fee to the SEC's Public Reference Section, Washington,
DC 20549-6009. You can also visit the SEC's Internet site at http://www.sec.gov.
Investment Company Act file #811-6336 FTIT PA 03/99
FRANKLIN TEMPLETON
INTERNATIONAL TRUST
TEMPLETON FOREIGN SMALLER
COMPANIES FUND - CLASS A, B & C
TEMPLETON PACIFIC GROWTH FUND - CLASS A & C
STATEMENT OF
ADDITIONAL INFORMATION
MARCH 1, 1999
777 MARINERS ISLAND BLVD., P.O. BOX 7777
SAN MATEO, CA 94403-7777 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 March 1, 1999, which we may amend from time to
time, contains the basic information you should know before investing in the
funds. 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 October 31, 1998, 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
Goal and Strategies......................................... 2
Risks....................................................... 13
Officers and Trustees....................................... 18
Management and Other Services............................... 22
Portfolio Transactions...................................... 24
Distributions and Taxes..................................... 25
Organization, Voting Rights
and Principal Holders...................................... 26
Buying and Selling Shares................................... 28
Pricing Shares.............................................. 34
The Underwriter............................................. 35
Performance................................................. 37
Miscellaneous Information................................... 39
Description of Bond Ratings................................. 40
- --------------------------------------------------------------------------------
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.
- --------------------------------------------------------------------------------
FTIT SAI 03/99
GOAL AND STRATEGIES
- --------------------------------------------------------------------------------
The investment goal of each fund is long-term capital growth. This goal is
fundamental, which means it 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, warrants
or rights. Convertible securities typically are debt securities or preferred
stocks which are convertible into common stock after certain time periods or
under certain circumstances. Warrants or rights give the holder the right to
purchase a common stock at a given time for a specified price.
DEBT SECURITIES A debt security typically has a fixed payment schedule which
obligates the issuer to pay interest to the lender and to return the lender's
money over a certain time period. A company typically meets its payment
obligations associated with its outstanding debt securities before it
declares and pays any dividend to holders of its equity securities. Bonds,
notes, debentures and commercial paper differ in the length of the issuer's
payment schedule, with bonds carrying the longest repayment schedule and
commercial paper the shortest.
The market value of debt securities generally varies in response to changes
in interest rates and the financial condition of each issuer. During periods
of declining interest rates, the value of debt securities generally
increases. Conversely, during periods of rising interest rates, the value of
such securities generally declines. These changes in market value will be
reflected in the fund's net asset value.
Independent rating organizations rate debt securities based upon their
assessment of the financial soundness of the issuer. Generally, a lower
rating indicates higher risk.
The Smaller Companies Fund may buy debt securities which are rated C or
better by Moody's or S&P; or unrated debt which it determines to be of
comparable quality. At present, the fund does not intend to invest more than
5% of its total assets in non-investment grade securities (rated lower than
BBB by S&P or Baa by Moody's), including defaulted securities.
The Pacific Fund may buy debt securities which are rated Baa by Moody's or
BBB by S&P or better; or unrated debt which it determines to be of comparable
quality. The fund's investments in debt instruments may include U.S. and
foreign government and corporate securities, including Samurai bonds, Yankee
bonds and Eurobonds.
FOREIGN INVESTMENTS The fund invests in securities of foreign issuers. The
funds may invest up to 100% of total assets in emerging markets. The Smaller
Companies Fund may invest up to 5% of its total assets in Russian securities.
On occasion the fund may invest more than 25% of its assets in the securities
of issuers in one industrialized country that, in the view of the manager,
poses no unique investment risk. Consistent with this policy, the fund may
invest up to 30% of its assets in securities issued by Hong Kong companies.
However, each fund will not invest more than 25% of its assets in any one
industry or securities issued by any foreign government.
CURRENCY TRANSACTIONS Although each fund has the authority to enter into
forward currency exchange contracts ("forward contracts") and currency
futures contracts and options on these 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, they presently have no intention of entering into
such transactions.
A forward contract involves an obligation to buy or sell a specific currency
at a future date, that may be any fixed number of days from the date of the
contract agreed upon by the parties, at a price set at the time of the
contract. These contracts are traded in the interbank market conducted
directly between currency traders (usually large commercial banks).
Each fund may engage in cross-hedging by using forward contracts in one
currency to hedge against fluctuations in the value of securities denominated
in a different currency if the managers determine that there is a pattern of
correlation between the two currencies. Each fund may also buy and sell
forward contracts (to the extent they are not deemed "commodities") for
non-hedging purposes when the managers anticipate that the foreign currency
will appreciate or depreciate in value, but securities denominated in that
currency do not present attractive investment opportunities and are not held
in the funds' portfolio.
Each fund's custodian bank will place cash or liquid high grade debt
securities (securities rated in one of the top three ratings categories by
Moody's or S&P or, if unrated, deemed by the managers to be of comparable
quality) into a segregated account of the fund maintained by its custodian
bank in an amount equal to the value of the funds' total assets committed to
the forward foreign currency exchange contracts requiring the funds to
purchase foreign currencies. If the value of the securities placed in the
segregated account declines, additional cash or securities is placed in the
account on a daily basis so that the value of the account equals the amount
of the funds' commitments with respect to such contracts. The segregated
account is marked-to-market on a daily basis. Although the contracts are not
presently regulated by the Commodity Futures Trading Commission (the "CFTC"),
the CFTC may in the future assert authority to regulate these contracts. In
such event, the funds' ability to utilize forward foreign currency exchange
contracts may be restricted.
The fund generally will not enter into a forward contract with a term of
greater than one year.
A currency futures contract is a standardized contract for the future
delivery of a specified amount of currency at a future date at a price set at
the time of the contract. Each fund may enter into currency futures contracts
traded on regulated commodity exchanges, including non-U.S. exchanges.
The funds may either accept or make delivery of the currency specified at the
maturity of a forward or futures contract or, prior to maturity, enter into a
closing transaction involving the purchase or sale of an offsetting contract.
Closing transactions with respect to forward contracts are usually effected
with the currency trader who is a party to the original forward contract.
Each fund may enter into forward currency exchange contracts and currency
futures contracts in several circumstances. For example, when a fund enters
into a contract for the purchase or sale of a security denominated in a
foreign currency (or options contracts with respect to such futures
contracts), or when a fund anticipates the receipt in a foreign currency of
dividends or interest payments on such a security that it holds, it may
desire to "lock in" the U.S. dollar price of the security or the U.S. dollar
equivalent of such dividend or interest payment, as the case may be. In
addition, when the managers believe that the currency of a particular country
may suffer a substantial decline against the U.S. dollar, they may enter into
a forward or futures contract to sell, for a fixed amount of U.S. dollars,
the amount of that currency approximating the value of some or all of the
fund's portfolio securities denominated in that currency. The precise
matching of the forward contract amounts and the value of the securities
involved is not generally possible because the future value of these
securities in foreign currencies changes as a consequence of market movements
in the value of those securities between the date on which the contract is
entered into and the date it matures. Using forward contracts to protect the
value of a 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 a fund can achieve
at some future point in time. The precise projection of short-term currency
market movements is not possible, and short-term hedging provides a means of
fixing the dollar value of only a portion of the fund's foreign assets.
Each fund may write covered put and call options and buy put and call options
on foreign currencies for the purpose of protecting against declines in the
dollar value of portfolio securities and against increases in the dollar cost
of securities to be acquired. The fund may use options on currency to
cross-hedge, which involves writing or purchasing options on one currency to
hedge against changes in exchange rates for a different currency with a
pattern of correlation. In addition, the funds may buy call options on
currency for non-hedging purposes when the managers anticipate that the
currency will appreciate in value, but the securities denominated in that
currency do not present attractive investment opportunities and are not
included in the fund's portfolio.
A call option written by a fund obligates the fund to sell specified currency
to the holder of the option at a specified price at any time before the
expiration date. A put option written by a fund would obligate the fund to
buy specified currency from the option holder at a specified time before the
expiration date. The writing of currency options involves risk that a fund
will, upon exercise of the option, be required to sell currency subject to a
call at a price that is less than the currency's market value or be required
to buy currency subject to a put at a price that exceeds the currency's
market value.
The fund may terminate its obligations under a call or put option by buying
an option identical to the one it has written. Such purchases are referred to
as "closing purchase transactions." A fund would also be able to enter into
closing sale transactions in order to realize gains or minimize losses on
options bought by the fund.
The fund would normally buy call options in anticipation of an increase in
the dollar value of the currency in which securities to be acquired by the
fund are denominated. The purchase of a call option would entitle the fund,
in return for the premium paid, to purchase specified currency at a specified
price during the option period. The fund would ordinarily realize a gain if,
during the option period, the value of such currency exceeded the sum of the
exercise price, the premium paid and transaction costs; otherwise the fund
would realize either no gain or a loss on the purchase of the call option. A
fund may forfeit the entire amount of the premium plus related transaction
costs if exchange rates move in a manner adverse to the fund's position.
The fund would normally buy put options in anticipation of a decline in the
dollar value of currency in which securities in its portfolio are denominated
("protective puts"). Buying a put option would entitle the fund, in exchange
for the premium paid, to sell specific currency at a specified price during
the option period. Buying protective puts is designed merely to offset or
hedge against a decline in the dollar value of the fund's portfolio
securities due to currency exchange rate fluctuations. The fund would
ordinarily realize a gain if, during the option period, the value of the
underlying currency decreased below the exercise price sufficiently to more
than cover the premium and transaction costs; otherwise, the fund would
realize either no gain or a loss on the purchase of the put option. The fund
will buy and sell foreign currency options traded on U.S. or foreign
exchanges or over-the-counter.
The fund will not enter into forward currency exchange contracts or currency
futures contracts or buy or write such options or maintain a net exposure to
such contracts where the completion of the contracts would obligate the fund
to deliver an amount of currency other than U.S. dollars in excess of the
value of the fund's portfolio securities or other assets denominated in that
currency or, in the case of cross-hedging, in a currency closely correlated
to that currency.
OPTIONS ON SECURITIES AND SECURITIES INDICES Although the funds have the
authority to enter into these transactions, they currently have no intention
of doing so.
WRITING CALL AND PUT OPTIONS ON SECURITIES. A fund may write options to
generate additional income and to hedge its investment portfolio against
anticipated adverse market and/or exchange rate movements. A fund may write
covered call and put options on any securities in which it may invest. A fund
may buy and write these options on securities that are listed on domestic or
foreign securities exchanges or traded in the over-the-counter market. Call
options written by a fund give the holder the right to buy the underlying
securities from the fund at a stated exercise price. Put options written by a
fund give the holder the right to sell the underlying security to the fund at
a stated exercise price. All options written by a fund will be "covered." The
purpose of writing covered call options is to realize greater income than
would be realized on portfolio securities transactions alone. However, in
writing covered call options for additional income, a fund may forego the
opportunity to profit from an increase in the market price of the underlying
security.
A call option written by a fund is covered if the fund owns the underlying
security covered by the call or has an absolute and immediate right to
acquire that security without additional cash consideration (or for
additional cash consideration held in a segregated account by its custodian
bank) upon conversion or exchange of other securities held in its portfolio.
A call option is also covered if a fund holds a call on the same security and
in the same principal amount as the call written where the exercise price of
the call held (i) is equal to or less than the exercise price of the call
written or (ii) 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.
A put option written by a fund is "covered" if the fund maintains cash and
high-grade debt securities with a value equal to the exercise price in a
segregated account with its custodian bank, or else holds a put on the same
security and in the same principal amount as the put written where the
exercise price of the put held is equal to or greater than the exercise price
of the put written. The 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 that wishes to terminate its obligation may effect a
closing purchase transaction. 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.
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. There is no guarantee that either a closing purchase or a
closing sale transaction can be effected when the fund so desires.
BUYING PUT OPTIONS. A fund may buy put options on securities in order to
protect against a decline in the market value of the underlying security
below the exercise price less the premium paid for the option. A put option
gives the holder the right to sell the underlying security at the option
exercise price at any time during the option period. The ability to buy put
options will allow the fund to protect the unrealized gain in an appreciated
security in its portfolio without actually selling the security. In addition,
the fund will continue to receive interest or dividend income on the
security. The fund may sell a put option that it has previously purchased
prior to the sale of the securities underlying that option. These sales will
result in a net gain or loss depending on whether the amount received on the
sale is more or less than the premium and other transaction costs paid for
the put option that is sold. This 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.
BUYING CALL OPTIONS. A fund may buy call options on securities that it
intends to buy in order to limit the risk of a substantial increase in the
market price of this security. A 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.
OPTIONS ON STOCK INDICES. A fund may buy and write call and put options on
stock indices in order to hedge against the risk of market or industry-wide
stock price fluctuations or to increase income to the fund. Call and put
options on stock indices are similar to options on securities except that,
rather than the right to buy or sell particular securities at a specified
price, options on a stock index give the holder the right to receive, upon
exercise of the option, an amount of cash if the closing level of the
underlying stock index is greater than (or less than, in the case of puts)
the exercise price of the option. This amount of cash is equal to the
difference between the closing price of the index and the exercise price of
the option, expressed in dollars multiplied by a specified number. Thus,
unlike options on individual securities, all settlements are in cash, and
gain or loss depends on price movements in the stock market generally (or in
a particular industry or segment of the market) rather than price movements
in individual securities.
All options written on stock indices must be covered. When a fund writes an
option on a stock index, it 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 option and will maintain the
account while the option is open or will otherwise cover the transaction.
OVER-THE-COUNTER OPTIONS ON SECURITIES ("OTC OPTIONS"). A 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 may engage in exchange
traded options. OTC options differ from exchange traded options in certain
material respects. OTC options are arranged directly with dealers and not, 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.
The funds understand the current position of the staff of the SEC to be that
purchased OTC options and the assets used as "cover" for written OTC options
are illiquid securities. The funds and their managers disagree with this
position. Nevertheless, pending a change in the staff's position, the funds
will treat OTC options as subject to its limitation on illiquid securities.
Please see "Illiquid Investments" below.
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, 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. If a
put option is exercised, the writer must fulfill its obligation to buy the
underlying security at the exercise price, which will usually exceed the then
market value of the underlying security.
FORWARD CONVERSIONS. In a forward conversion, a fund will buy securities and
write call options and buy put options on these securities. All options
written by the fund will be covered. By buying puts, the fund protects the
underlying security from depreciation in value. By selling or writing calls
on the same security, the fund receives premiums that may offset part or all
of the cost of purchasing the puts while foregoing the opportunity for
appreciation in the value of the underlying security. The fund will not
exercise a put it has purchased while a call option on the same security is
outstanding. The use of options in connection with forward conversions is
intended to hedge against fluctuations in the market value of the underlying
security. Although it is generally intended in forward conversion
transactions that the exercise price of put and call options would be
identical, situations might occur in which some option positions are acquired
with different exercise prices. Therefore, the fund's return may depend in
part on movements in the price of the underlying security because of the
different exercise prices of the call and put options. These price movements
may also affect a fund's total return if the conversion is terminated prior
to the expiration date of the options. In this event, the fund's return may
be greater or less than it would otherwise have been if it had hedged the
security only by buying put options.
SPREAD AND STRADDLE TRANSACTIONS. A fund may engage in "spread" transactions
in which it buys and writes a put or call option on the same underlying
security, with the options having different exercise prices and/or expiration
dates. All options written by the fund will be covered. A fund may also
engage in so-called "straddles," in which it buys or writes combinations of
put and call options on the same security. Because buying options in
connection with these transactions may, under certain circumstances, involve
a limited degree of investment leverage, the fund will not enter into any
spreads or straddles if, as a result, more than 5% of its net assets will be
invested at any time in these options transactions. A fund's ability to
engage in spread or straddle transactions may be further limited by state
securities laws.
FUTURES TRANSACTIONS Although each fund has the authority to enter into these
transactions, it currently has no intention of doing so.
Each fund may buy or sell (i) financial futures contracts such as interest
rate futures contracts; (ii) options on interest rate futures contracts;
(iii) stock index futures contracts; and (iv) options on stock index futures
contracts (collectively, "Futures Transactions") for bona fide hedging
purposes. Each fund may enter into these Futures Transactions on domestic
exchanges and, to the extent these transactions have been approved by the
CFTC for sale to customers in the U.S., on foreign exchanges. The fund will
not engage in Futures Transactions for speculation but only as a hedge
against changes resulting from market conditions such as changes in interest
rates, currency exchange rates, or securities that it intends to buy. Each
fund will not enter into any Futures Transactions if, immediately thereafter,
more than 20% of the fund's net assets would be represented by futures
contracts or options thereon. In addition, each fund will not engage in any
Futures Transactions if, immediately thereafter, the sum of the amount of
initial margin deposits on the fund's futures positions and premiums paid for
options on its futures contracts would exceed 5% of the market value of the
fund's total assets.
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 will be required to pay to the futures commission merchant
an amount equal to this change in value.
A futures contract may generally be described as an agreement between two
parties to buy and sell particular financial instruments for an agreed price
during a designated month (or to deliver the final cash settlement price, in
the case of a contract relating to an index or otherwise not calling for
physical delivery at the end of trading in the contract).
When interest rates are rising or securities prices are falling, a fund can
seek, through the sale of futures contracts, to offset a decline in the value
of its current portfolio securities. When rates are falling or prices are
rising, a fund, through the purchase of futures contracts, can attempt to
secure better rates or prices than might later be available in the market
when it affects anticipated purchases. Similarly, the fund can sell futures
contracts on a specified currency to protect against a decline in the value
of this currency and its portfolio securities that are denominated in this
currency. Each fund can buy futures contracts on foreign currency to fix the
price in U.S. dollars of a security denominated in this currency that the
fund has acquired or expects to acquire.
Although futures contracts by their terms generally call for the actual
delivery or acquisition of underlying 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 this delivery. The contractual
obligation is offset 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
or the cash value of the index underlying the contractual obligations. A fund
may incur brokerage fees when it buys or sells futures contracts.
Positions taken in the futures markets are not normally held to maturity, but
are instead liquidated through offsetting transactions that may result in a
profit or a loss. While the funds' futures contracts on securities or
currency will usually be liquidated in this manner, each fund may instead
make or take delivery of the underlying securities or currency whenever it
appears economically advantageous for it to do so. A clearing corporation
associated with the exchange on which futures on securities or currency are
traded guarantees that, if still open, the buying or selling will be
performed on the settlement date.
OPTIONS ON FUTURES CONTRACTS. The acquisition of put and call options on
futures contracts will give each fund the right, but not the obligation, for
a specified price, to sell or to buy, respectively, the underlying futures
contract at any time during the option period. As the purchaser of an option
on a futures contract, each fund obtains the benefit of the futures position
if prices move in a favorable direction but limits its risk of loss in the
event of an unfavorable price movement to the loss of the premium and
transaction costs.
FINANCIAL FUTURES CONTRACTS. Financial futures are contracts that obligate
the holder to take or make delivery of a specified quantity of a financial
instrument, such as a U.S. Treasury security or foreign currencies, during a
specified future period at a specified price. A "sale" of a financial 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 financial 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. Examples of financial futures
contracts include interest rate futures contracts and stock index futures
contracts.
INTEREST RATE FUTURES CONTRACTS. Interest rate futures contracts are futures
contracts on debt securities. The value of these instruments changes in
response to changes in the value of the underlying debt security, that
depends primarily on prevailing interest rates. Each fund may enter into
interest rate futures contracts in order to protect its portfolio securities
from fluctuations in interest rates without necessarily buying or selling the
underlying fixed-income securities. For example, if a fund owns bonds, and
interest rates are expected to increase, it might sell futures contracts on
debt securities having characteristics similar to those held in the
portfolio. A sale would have much the same effect as selling an equivalent
value of the bonds owned by the fund. If interest rates did increase, the
value of the debt securities in the portfolio would decline, but the value of
the futures contracts to the fund would increase at approximately the same
rate, thereby keeping the Net Asset Value of the fund from declining as much
as it otherwise could have.
STOCK INDEX FUTURES CONTRACTS. A stock index futures contract obligates the
seller to deliver (and the purchaser to take) an amount of cash equal to a
specific dollar amount times the difference between the value of a specific
stock index at the close of the last trading day of the contract and the
price at which the agreement was made. Open futures contracts are valued on a
daily basis, and a fund may be obligated to provide or receive cash
reflecting any decline or increase in the contract's value. No physical
delivery of the underlying stocks in the index is made in the future.
Each fund may sell stock index futures contracts in anticipation of or during
a market decline in an attempt to offset the decrease in market value of its
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 offset
increases in the cost of common stocks that it intends to buy.
OPTIONS ON STOCK INDEX FUTURES CONTRACTS. 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 a stock index
futures contract 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 that 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.
HEDGING STRATEGIES WITH FUTURES. Hedging by use of futures contracts seeks to
establish with more certainty, than would otherwise be possible, the
effective price, rate of return or currency exchange rate on portfolio
securities or securities that a fund owns or proposes to acquire. The fund
may, for example, take a "short" position in the futures market by selling
futures contracts in order to hedge against an anticipated rise in interest
rates or a decline in market prices of foreign currency rates that would
adversely affect the dollar value of the fund's portfolio securities. These
futures contracts may include contracts for the future delivery of securities
held by the fund or securities with characteristics similar to those of the
fund's portfolio securities. Similarly, the fund may sell futures contracts
on currency in which its portfolio securities are denominated or in one
currency to hedge against fluctuations in the value of securities denominated
in a different currency if there is an established historical pattern of
correlation between the two currencies.
If, in the opinion of the managers, there is a sufficient degree of
correlation between price trends for the funds' portfolio securities and
futures contracts based on other financial instruments, securities indices or
other indices, the funds may also enter into these futures contracts as part
of its hedging strategy. Although under some circumstances prices of
securities in the funds' portfolio may be more or less volatile than prices
of these futures contracts, the managers will attempt to estimate the extent
of this difference in volatility based on historical patterns and to
compensate for it by having the funds enter into a greater or fewer number of
futures contracts or by attempting to achieve only a partial hedge against
price changes affecting the funds' securities portfolio. When hedging of this
character is successful, any depreciation in the value of the portfolio
securities will substantially be offset by appreciation in the value of the
futures position. On the other hand, any unanticipated appreciation in the
value of the funds' portfolio securities would be substantially offset by a
decline in the value of the futures position.
On other occasions, a fund may take a "long" position by buying these futures
contracts. This would be done, for example, when a fund anticipates the
subsequent buy of particular securities when it has the necessary cash, but
expects the prices or currency exchange rates then available in the
applicable market to be less favorable than prices or rates that are
currently available.
The CFTC and U.S. commodities 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 funds do not believe that these
trading and positions limits will have an adverse impact on their strategies
for hedging their securities. The need to hedge against these risks will
depend on the extent of diversification of each funds' common stock portfolio
and the sensitivity of these investments to factors influencing the stock
market as a whole.
OTHER CONSIDERATIONS In certain cases, the options and futures markets
provide investment or risk management opportunities that are not available
from direct investments in securities. In addition, some strategies can be
performed more effectively and at a lower cost by utilizing the options and
futures markets rather than purchasing or selling portfolio securities.
However, there are risks involved in these transactions as discussed below.
The funds will engage in futures and related options transactions only for
bona fide hedging or other appropriate risk management purposes in accordance
with CFTC regulations that permit principals of an investment company
registered under the Investment Company Act of 1940 ("1940 Act") to engage in
these transactions without registering as commodity pool operators.
"Appropriate risk management purposes" means activities in addition to bona
fide hedging that the CFTC deems appropriate for operators of entities,
including registered investment companies, that are excluded from the
definition of commodity pool operator. The funds are not permitted to engage
in speculative futures trading. Each fund will determine that the price
fluctuations in the futures contracts and options on futures used for hedging
purposes are substantially related to price fluctuations in securities held
by the fund or which it expects to buy.
Except as stated below, the funds' futures transactions will be entered into
for traditional hedging purposes - that is, futures contracts will be sold to
protect against a decline in the price of securities it intends to buy (or
the currency will be purchased to protect the fund against an increase in the
price of the securities (or the currency in which they are denominated)). As
evidence of this hedging intent, each fund expects that on 75% or more of the
occasions on which it takes a long futures (or option) position involving the
purchase of futures contracts, the fund will have bought, or will be in the
process of buying, equivalent amounts of related securities (or assets
denominated in the related currency) in the cash market at the time when the
futures (or option) position is closed out. However, in particular cases when
it is economically advantageous for the fund to do so, a long futures
position may be terminated (or an option may expire) without the
corresponding purchase of securities or other assets. In the alternative, a
CFTC regulation permits the fund to elect to comply with a different test,
under which (i) the fund's long futures positions will be used as part of its
portfolio management strategy and will be incidental to its activities in the
underlying cash market and (ii) the aggregate initial margin and premiums
required to establish these positions will not exceed 5% of the liquidation
value of the fund's investment portfolio (a) after taking into account
unrealized profits and losses on any such contracts into which the fund has
entered and (b) excluding the in-the-money amount with respect to any option
that is in-the-money at the time of purchase.
Each fund will engage in transactions in futures contracts and related
options only to the extent these transactions are consistent with the
requirements of the Code for maintaining its qualification as a regulated
investment company for federal income tax purposes.
Each fund will not buy or sell futures contracts or buy or sell related
options, except for closing purchase or sale transactions, if immediately
thereafter the sum of the amount of margin deposits on the fund's outstanding
futures and related options positions and the amount of premiums paid for
outstanding options on futures would exceed 5% of the market value of the
fund's total assets. These transactions involve brokerage costs, require
margin deposits and, in the case of contracts and options obligating the fund
to buy securities or currencies, require the fund to segregate assets to
cover these contracts and options.
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
managers may still not result in a successful transaction.
Perfect correlation between a fund's futures positions and portfolio
positions may be difficult to achieve because no futures contracts based on
corporate fixed-income securities are currently available. In addition, it is
not possible to hedge fully or perfectly against currency fluctuations
affecting the value of securities denominated in foreign currencies because
the value of these securities is likely to fluctuate as a result of
independent factors not related to currency fluctuations.
OTHER INVESTMENT POLICIES
CONVERTIBLE SECURITIES As with a straight fixed-income security, a
convertible security tends to increase in market value when interest rates
decline and decrease in value when interest rates rise. Like a common stock,
the value of a convertible security also tends to increase as the market
value of the underlying stock rises, and it tends to decrease as the market
value of the underlying stock declines. Because its value can be influenced
by both interest rate and market movements, a convertible security is not as
sensitive to interest rates as a similar fixed-income security, nor is it as
sensitive to changes in share price as its underlying stock.
A convertible security is usually issued either by an operating company or by
an investment bank. When issued by an operating company, a convertible
security tends to be senior to common stock, but subordinate to other types
of fixed-income securities issued by that company. When a convertible
security issued by an operating company is "converted," the operating company
often issues new stock to the holder of the convertible security but, if the
parity price of the convertible security is less than the call price, the
operating company may pay out cash instead of common stock. If the
convertible security is issued by an investment bank, the security is an
obligation of and is convertible through the issuing investment bank. The
issuer of a convertible security may be important in determining the
security's true value. This is because the holder of a convertible security
will have recourse only to the issuer.
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.
Each fund may invest in convertible preferred stocks that offer enhanced
yield features, such as Preferred Equity Redemption Cumulative Stocks
("PERCS"), which provide an investor, such as the fund, with the opportunity
to earn higher dividend income than is available on a company's common stock.
PERCS are preferred stocks that generally feature a mandatory conversion
date, as well as a capital appreciation limit which is usually expressed in
terms of a stated price. Most PERCS expire three years from the date of
issue, at which time they are convertible into common stock of the issuer.
PERCS are generally not convertible into cash at maturity. Under a typical
arrangement, after three years PERCS convert into one share of the issuer's
common stock if the issuer's common stock is trading at a price below that
set by the capital appreciation limit, and into less than one full share if
the issuer's common stock is trading at a price above that set by the capital
appreciation limit. The amount of that fractional share of common stock is
determined by dividing the price set by the capital appreciation limit by the
market price of the issuer's common stock. PERCS can be called at any time
prior to maturity, and hence do not provide call protection. If called early,
however, the issuer must pay a call premium over the market price to the
investor. This call premium declines at a preset rate daily, up to the
maturity date.
Each fund may also invest in other classes of enhanced convertible
securities. These include but are not limited to ACES (Automatically
Convertible Equity Securities), PEPS (Participating Equity Preferred Stock),
PRIDES (Preferred Redeemable Increased Dividend Equity Securities), SAILS
(Stock Appreciation Income Linked Securities), TECONS (Term Convertible
Notes), QICS (Quarterly Income Cumulative Securities), and DECS (Dividend
Enhanced Convertible Securities). ACES, PEPS, PRIDES, SAILS, TECONS, QICS,
and DECS all have the following features: they are issued by the company, the
common stock of which will be received in the event the convertible preferred
stock is converted; unlike PERCS they do not have a capital appreciation
limit; they seek to provide the investor with high current income with some
prospect of future capital appreciation; they are typically issued with three
or four-year maturities; they typically have some built-in call protection
for the first two to three years; investors have the right to convert them
into shares of common stock at a preset conversion ratio or hold them until
maturity; and, upon maturity, they will necessarily convert into either cash
or a specified number of shares of common stock.
Similarly, there may be enhanced convertible debt obligations issued by the
operating company, whose common stock is to be acquired in the event the
security is converted, or by a different issuer, such as an investment bank.
These securities may be identified by names such as ELKS (Equity Linked
Securities) or similar names. Typically they share most of the salient
characteristics of an enhanced convertible preferred stock but will be ranked
as senior or subordinated debt in the issuer's corporate structure according
to the terms of the debt indenture. There may be additional types of
convertible securities not specifically referred to herein which may be
similar to those described above in which a fund may invest, consistent with
its goal and policies.
An investment in an enhanced convertible security or any other security may
involve additional risks to the fund. 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.
REPURCHASE TRANSACTIONS Each fund may enter into repurchase agreements. A
repurchase agreement is an agreement in which the seller of a security agrees
to repurchase the security sold at a mutually agreed upon time and price.
Under the 1940 Act, a repurchase agreement is deemed to be the loan of money
by a fund to the seller, collateralized by the underlying security. The
resale price is normally in excess of the purchase price, reflecting an
agreed upon interest rate. The interest rate is effective for the period of
time in which the fund is invested in the agreement and is not related to the
coupon rate on the underlying security. The period of these repurchase
agreements will usually be short, from overnight to one week, and at no time
will a fund invest in repurchase agreements for more than one year. However,
the securities that are subject to repurchase agreements may have maturity
dates in excess of one year from the effective date of the repurchase
agreements. The fund will make payment for these securities only upon
physical delivery or evidence of book entry transfer to the account of their
custodian bank. The fund may not enter into a repurchase agreement with more
than seven days duration if, as a result, the market value of the fund's net
assets, together with investments in other securities deemed to be not
readily marketable, would be invested in these repurchase agreements in
excess of the fund's policy on investments in illiquid securities.
ILLIQUID INVESTMENTS Securities that are acquired by the fund 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 are not considered by the fund to
be illiquid assets, so long as the fund acquires and holds the securities
with the intention of reselling the securities in the foreign trading market,
the fund reasonably believes it can readily dispose of the securities for
cash in the U.S. or foreign market, and current market quotations are readily
available. Investments may be in securities of foreign issuers, whether
located in developed or undeveloped countries. The board has authorized each
fund to invest in restricted securities where this investment is consistent
with the fund's investment objective and has authorized these securities to
be considered liquid to the extent the managers, as the case may be,
determine that there is a liquid institutional or other market for these
securities, for example, restricted securities that may be freely transferred
among qualified institutional buyers pursuant to Rule 144A under the
Securities Act of 1933 and for which a liquid institutional market has
developed. The board reviews any determination by the managers to treat a
restricted security as liquid on a quarterly basis, including the managers'
assessment of current trading activity and the availability of reliable price
information. In determining whether a restricted security is properly
considered a liquid security, the managers 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 purchasers; (iii) dealer undertakings to make a
market in the security; and (iv) the nature of the security and the nature of
the marketplace trades (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 in the fund may be increased if qualified institutional
buyers become uninterested in purchasing 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 their assets in high quality money market
instruments. These include government securities, bank obligations, the
highest quality commercial paper and repurchase agreements. For the Pacific
Fund, these securities must be rated A-1 or A-2 by S&P or Prime-1 or Prime-2
by Moody's or if unrated, determined to be of comparable quality. The Smaller
Companies Fund may also invest in non-U.S. currency, short-term instruments
denominated in non-U.S. currencies and medium-term (up to five years to
maturity) obligations issued or guaranteed by the U.S. government or the
governments of foreign countries, their agencies or instrumentalities.
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.
Each fund may not:
1. Purchase the securities of any one issuer (other than cash, cash items
and obligations of the U.S. government) if immediately thereafter and as a
result of the purchase, with respect to 75% of its total assets, 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 or all classes of
the outstanding voting 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 either fund's
portfolio securities, or to the extent the entry into a repurchase agreement
may be deemed a loan;
3. Borrow money, except for temporary or emergency (but not investment)
purposes from banks and only in an amount up to 10% of the value of the
assets. While borrowings exceed 5% of a fund's total assets, it 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, except insofar as a fund may be
technically deemed an underwriter under the federal securities laws in
connection with the disposition of portfolio securities;
6. Purchase illiquid securities, including illiquid securities which, at the
time of acquisition, could be disposed of publicly by each fund only after
registration under the 1933 Act, if as a result more than 10% of their net
assets would be invested in such illiquid securities;
7. Invest in securities for the purpose of exercising management or control
of the issuer;
8. Maintain a margin account with a securities dealer, except that either
fund may obtain such short-term credits as may be necessary for the clearance
of purchases and sales of securities, nor invest in commodities or
commodities contracts or interests (other than publicly-traded equity
securities) or leases with respect to any oil, gas or other mineral
exploration or development programs, except that either fund may enter into
contracts for hedging purposes and make margin deposits in connection
therewith;
9. Effect short sales, unless at the time the fund owns securities
equivalent in kind and amount to those sold;
10. Invest more than 5% of total assets in companies which have a record of
less than three years continuous operation, including the operations of any
predecessor companies;
11. Invest directly in real estate or real estate limited partnerships
(although either fund may invest in real estate investment trusts) or in the
securities of other investment companies, except to the extent permitted
under the 1940 Act or pursuant to any exemptions therefrom, including any
exemption permitting either fund to invest in shares of one or more money
market funds managed by the manager or its affiliates, or except that
securities of another investment company may be acquired pursuant to a plan
of reorganization, merger, consolidation or acquisition; or
12. Purchase or retain in either fund's portfolio any security if any
officer, trustee or securityholder of the issuer is at the same time an
officer, trustee or employee of the Trust or of its investment advisor and
such person owns beneficially more than 1/2 of 1% of the securities, and if
all such persons owning more than 1/2 of 1% own more than 5% of the
outstanding securities of the issuer.
Each fund presently has the following additional restrictions, which are not
fundamental and may be changed without shareholder approval. Each fund may
not issue senior securities except to the extent that this restriction shall
not be deemed to prohibit the fund from making any permitted borrowings,
pledging, mortgaging or hypothecating the fund's assets as security for
loans, entering into repurchase transactions, engaging in joint and several
trading accounts in securities, except that an order to purchase or sell may
be combined with orders from other persons to obtain lower brokerage
commissions and except as the fund may participate in a joint repurchase
agreement account with other funds in the Franklin Templeton Group of Funds.
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.
If a percentage restriction is met at the time of investment, a later
increase or decrease in the percentage due to a change in the value or
liquidity of portfolio securities or the amount of assets will not be
considered a violation of any of the foregoing restrictions.
RISKS
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FOREIGN SECURITIES Since foreign companies are not subject to uniform
accounting, auditing and financial reporting practices and requirements
comparable to those applicable to U.S. companies, there may be less publicly
available information about a foreign company than about a U.S. company.
Volume and liquidity in most foreign bond markets are less than in the U.S.,
and securities of many foreign companies are less liquid and more volatile
than securities of comparable U.S. companies. Fixed commissions on foreign
securities exchanges are generally higher than negotiated commissions on U.S.
exchanges, although each fund endeavors to achieve the most favorable net
results on its portfolio transactions. There is generally less government
supervision and regulation of securities exchanges, brokers, dealers and
listed companies than in the U.S., thus increasing the risk of delayed
settlements of portfolio transactions or loss of certificates for portfolio
securities.
Foreign markets also have different clearance and settlement procedures, and
in certain markets there have been times when settlements have been unable to
keep pace with the volume of securities transactions, making it difficult to
conduct these transactions. These delays in settlement could result in
temporary periods when a portion of the assets of the fund is uninvested and
no return is earned thereon. The inability of each fund to make intended
security purchases due to settlement problems could cause the fund to miss
attractive investment opportunities. Losses to a fund due to subsequent
declines in the value of portfolio securities, or losses arising out of the
fund's inability to fulfill a contract to sell these securities, could result
in potential liability to the fund. In addition, with respect to certain
foreign countries, there is the possibility of expropriation or confiscatory
taxation, political or social instability, or diplomatic developments that
could affect the fund's investments in those countries. Moreover, individual
foreign economies may differ favorably or unfavorably from the U.S. economy
in growth of gross national product, rate of inflation, capital reinvestment,
resource self-sufficiency and balance of payments positions.
Investments in foreign securities where delivery takes place outside the U.S.
will have to be made in compliance with any applicable U.S. and foreign
currency restrictions and tax laws (including laws imposing withholding taxes
on any dividend or interest income) and laws limiting the amount and types of
foreign investments. Changes of governmental administrations or of economic
or monetary policies, in the U.S. or abroad, or changed circumstances in
dealings between nations, or currency convertibility or exchange rates could
result in investment losses for a fund. Investments in foreign securities may
also subject the fund to losses due to nationalization, expropriation or
differing accounting practices and treatments. Moreover, you should recognize
that foreign securities are often traded with less frequency and volume, and
therefore may have greater price volatility, than is the case with many U.S.
securities. Brokerage commissions, custodial services, and other costs
relating to investment in foreign countries are generally more expensive than
in the U.S. Notwithstanding the fact that a fund generally intends to acquire
the securities of foreign issuers where there are public trading markets,
investments by a fund in the securities of foreign issuers may tend to
increase the risks with respect to the liquidity of a fund's portfolio and
the fund's ability to meet a large number of shareholder redemption requests
should there be economic or political turmoil in a country in which a fund
has a substantial portion of its assets invested or should relations between
the U.S. and foreign countries deteriorate markedly. Furthermore, the
reporting and disclosure requirements applicable to foreign issuers may
differ from those applicable to domestic issuers, and there may be
difficulties in obtaining or enforcing judgments against foreign issuers.
Depositary Receipts (such as American Depositary Receipts, European
Depositary Receipts and Global Depositary Receipts) may not necessarily be
denominated in the same currency as the underlying securities into which they
may be converted. In addition, the issuers of the securities underlying
unsponsored Depositary Receipts are not obligated to disclose material
information in the U.S. and, therefore, there may be less information
available regarding these issuers and there may not be a correlation between
such information and the market value of the Depositary Receipts. Depositary
Receipts also involve the risks of other investments in foreign securities,
as discussed above.
DEVELOPING MARKETS Investments in companies domiciled in developing countries
may be subject to potentially higher risks than investments in companies in
developed countries. These risks include (i) less social, political and
economic stability; (ii) the smaller size of the markets for these securities
and the currently low or nonexistent volume of trading, that result in a lack
of liquidity and in greater price volatility; (iii) the lack of publicly
available information, including reports of payments of dividends or interest
on outstanding securities; (iv) certain national policies that may restrict a
fund's investment opportunities, including restrictions on investment in
issuers or industries deemed sensitive to national interests; (v) foreign
taxation; (vi) the absence of developed structures governing private or
foreign investment or allowing for judicial redress for injury to private
property; (vii) the absence, until recently in certain Eastern European
countries and Russia, of a capital market structure or market-oriented
economy; (viii) the possibility that recent favorable economic developments
in Eastern Europe and Russia may be slowed or reversed by unanticipated
political or social events in these countries; (ix) restrictions that may
make it difficult or impossible for the fund to vote proxies, exercise
shareholder rights, pursue legal remedies, and obtain judgments in foreign
courts; (x) the risk of uninsured loss due to lost, stolen, or counterfeit
stock certificates; and (xi) possible losses through the holding of
securities in domestic and foreign custodial banks and depositories.
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.
Repatriation of investment income, capital and proceeds of sales by foreign
investors may require governmental registration and/or approval in some
developing countries. The funds could be adversely affected by delays in or a
refusal to grant any required governmental registration or approval for
repatriation.
Further, the economies of developing countries generally are heavily
dependent upon international trade and, accordingly, have been and may
continue to be adversely affected by trade barriers, exchange controls,
managed adjustments in relative currency values and other protectionist
measures imposed or negotiated by the countries with which they trade.
Investments in Eastern European countries may involve risks of
nationalization, expropriation and confiscatory taxation. The communist
governments of a number of Eastern European countries expropriated large
amounts of private property in the past, in many cases without adequate
compensation, and there can be no assurance that this expropriation will not
occur in the future. In the event of this expropriation, the Smaller
Companies Fund could lose a substantial portion of any investments it has
made in the affected countries. Further, no accounting standards exist in
Eastern European countries. Finally, even though certain Eastern European
currencies may be convertible into U.S. dollars, the conversion rates may be
artificial relative to the actual market values and may be unfavorable to
fund investors.
Certain Eastern European countries, which do not have market economies, are
characterized by an absence of developed legal structures governing private
and foreign investments and private property. Certain countries require
governmental approval prior to investments by foreign persons, or limit the
amount of investment by foreign persons in a particular company, or limit the
investment of foreign persons to only a specific class of securities of a
company that may have less advantageous terms than securities of the company
available for purchase by nationals.
Authoritarian governments in certain Eastern European countries may require
that a governmental or quasi-governmental authority act as custodian of the
Smaller Companies Fund's assets invested in this country. To the extent these
governmental or quasi-governmental authorities do not satisfy the
requirements of the 1940 Act to act as foreign custodians of the Smaller
Companies Fund's cash and securities, the fund's investment in these
countries may be limited or may be required to be effected through
intermediaries. The risk of loss through governmental confiscation may be
increased in these countries.
Investing in Russian securities 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. These risks include:
(a) delays in settling portfolio transactions and risk of loss arising out of
Russia's unique system of share registration and custody; (b) the risk that
it may be impossible or more difficult than in other countries to obtain
and/or enforce a judgment; (c) pervasiveness of corruption and crime in the
Russian economic system; (d) currency exchange rate volatility and the lack
of available currency hedging instruments; (e) higher rates of inflation
(including the risk of social unrest associated with periods of
hyperinflation or other factors); (f) controls on foreign investment and
local practices disfavoring foreign investors and limitations on repatriation
of invested capital, profits and dividends, and on the Smaller Companies
Fund's ability to exchange local currencies for U.S. dollars; (g) the risk
that the Russian government or other executive or legislative bodies may
decide not to continue to support the economic reform programs implemented
since the dissolution of the Soviet Union and could follow radically
different political and/or economic policies to the detriment of investors,
including non-market oriented policies such as the support of certain
industries at the expense of other sectors or investors, or a return to the
centrally planned economy that existed prior to the dissolution of the Soviet
Union; (h) the financial condition of Russian companies, including large
amounts of inter-company debt that may create a payments crisis on a national
scale; (i) dependency on exports and the corresponding importance of
international trade; (j) the risk that the Russian tax system will not be
reformed to prevent inconsistent, retroactive and/or exorbitant taxation; and
(k) possible difficulty in identifying a purchaser of securities held by the
Smaller Companies Fund due to the underdeveloped nature of the securities
markets.
There is little historical data on Russian securities markets because they
are relatively new and a substantial proportion of securities transactions in
Russia are privately negotiated outside of stock exchanges. Because of the
recent formation of the securities markets, as well as the underdeveloped
state of the banking and telecommunications systems, settlement, clearing and
registration of securities transactions are subject to significant risks.
Ownership of shares (except where shares are held through depositaries that
meet the requirements of the 1940 Act) is defined according to entries in the
company's share register and normally evidenced by extracts from the register
or by formal share certificates. However, there is no central registration
system for shareholders and these services are carried out by the companies
themselves or by registrars located throughout Russia. These registrars are
not necessarily subject to effective state supervision and it is possible for
the fund to lose its registration through fraud, negligence or even mere
oversight. While a 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 a 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 a 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 1,000 shareholders is required by law to contract out the maintenance of
its shareholder register to an independent entity that meets certain
criteria, in practice this regulation has not always been strictly enforced.
Because of this lack of independence, management of a company may be able to
exert considerable influence over who can buy and sell the company's shares
by illegally instructing the registrar to refuse to record transactions in
the share register. This practice may prevent a fund from investing in the
securities of certain Russian issuers deemed suitable by the managers.
Further, this could cause a delay in the sale of Russian securities by a fund
if a potential purchaser is deemed unsuitable, which may expose that fund to
potential loss on the investment.
FORWARD TRANSACTIONS While each fund will enter into forward contracts to
reduce currency exchange rate risks, transactions in these contracts involve
certain other risks. Thus, while a fund may benefit from these transactions,
unanticipated changes in currency prices may result in a poorer overall
performance for the fund than if it had not engaged in any of these
transactions. Moreover, there may be imperfect correlation between the fund's
portfolio holdings of securities denominated in a particular currency and
forward contracts entered into by the fund. This imperfect correlation may
cause a fund to sustain losses that will prevent the fund from achieving a
complete hedge or expose the fund to risk of foreign exchange loss.
OPTIONS AND FUTURES Each 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, securities or currencies underlying the hedging instrument
and the hedged securities that would result in a l oss on both these
securities and the hedging instrument. In addition, it is not possible to
hedge fully or perfectly against currency fluctuations affecting the value of
securities denominated in foreign currencies because the value of these
securities is also likely to fluctuate as a result of independent factors not
related to currency fluctuations. Therefore, perfect correlation between the
fund's futures positions and portfolio positions will be impossible to
achieve. Accordingly, successful use by the fund of options on stock indices,
financial and currency futures contracts and related options, and currency
options will be subject to the fund's managers' ability to predict correctly
movements in the direction of the securities and currency markets generally
or of a particular segment. If the fund's managers are not successful in
employing these instruments in managing the fund's investments, the fund's
performance will be worse than if it did not employ these strategies. In
addition, the fund will pay commissions and other costs in connection with
these investments, that may increase the fund's expenses and reduce the
return. In writing options on futures, the fund's loss is potentially
unlimited and may exceed the amount of the premium received.
Positions in stock index options, stock index futures contracts, financial
futures contracts, foreign currency futures contracts, related options on
futures and options on currencies 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, futures contract or
option thereon at any specific time. Thus, it may not be possible to close
such an option or futures position. The inability to close options or futures
positions could have an adverse impact on a fund's ability to effectively
hedge its securities or foreign currency exposure. Each fund will enter into
options or futures positions only if its managers believe that a liquid
secondary market for these options or futures contracts exist.
In the case of OTC options on securities, 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 prior to
its expiration only by entering into a closing purchase transaction with the
dealer to which the fund originally wrote it. If the fund, on a covered call
option, cannot effect a closing transaction, it cannot sell the underlying
security until the option expires or the option is exercised. Therefore, when
a fund writes an OTC call option, it may not be able to sell the underlying
security even though it might otherwise be advantageous to do so. Likewise, a
fund may be unable to sell the securities it has pledged to secure OTC put
options while it is obligated as a put writer. Similarly, when a fund is a
buyer of a put or call option, the fund might find it difficult to terminate
its position on a timely basis in the absence of a secondary market. The
ability to terminate OTC options is more limited than with exchange traded
options and may involve the risk that broker-dealers participating in such
transactions will not fulfill their obligations. Until such time as the staff
of the SEC changes its position, the fund will treat purchased OTC options
and all assets used to cover written OTC options as illiquid securities,
except that with respect to options written with primary dealers in U.S.
government securities pursuant to an agreement requiring a closing purchase
transaction at a formula price, the amount of illiquid securities may be
calculated with reference to a formula approved by the staff of the SEC.
Reasons for the absence of a liquid secondary market on an exchange include
the following: (i) there may be insufficient trading interest in certain
options; (ii) restrictions may be imposed by an exchange on opening
transactions or closing transactions or both; (iii) trading halts,
suspensions or other restrictions may be imposed with respect to particular
classes or series of options; (iv) unusual or unforeseen circumstances may
interrupt normal operations on an exchange; (v) the facilities of an exchange
or the Options Clearing Corporation (the "OCC") may not at all times be
adequate to handle current trading volume; or (vi) one or more exchanges
could, for economic or other reasons, decide or be compelled at some future
date to discontinue the trading of options (or a particular class or series
of options), in which event the secondary market on that exchange (or in that
class or series of options) would cease to exist, although outstanding
options on that exchange that had been issued by the OCC as a result of
trades on that exchange would continue to be exercisable in accordance with
their terms.
HIGH YIELDING, FIXED-INCOME SECURITIES The Smaller Companies Fund may invest
up to 5% of its assets in fixed income securities that are rated below
investment grade or are unrated but deemed by the managers to be of
equivalent quality.
The market value of lower rated, fixed-income securities and unrated
securities of comparable quality, commonly known as junk bonds, tends to
reflect individual developments affecting the issuer to a greater extent than
the market value of higher rated securities, that react primarily to
fluctuations in the general level of interest rates. Lower rated securities
also tend to be more sensitive to economic conditions than higher rated
securities. These lower rated fixed-income securities are considered by the
rating agencies, on balance, to be predominantly speculative with respect to
the issuer's capacity to pay interest and repay principal in accordance with
the terms of the obligation and will generally involve more credit risk than
securities in the higher rating categories. Even securities rated "BBB" by
S&P or "Baa" by Moody's, ratings that are considered investment grade,
possess some speculative characteristics.
Issuers of high yielding, fixed-income securities are often highly leveraged
and may not have more traditional methods of financing available to them.
Therefore, the risk associated with acquiring the securities of these issuers
is generally greater than is the case with higher rated securities. For
example, during an economic downturn or a sustained period of rising interest
rates, highly leveraged issuers of high yielding securities may experience
financial stress. During these periods, these issuers may not have sufficient
cash flow to meet their interest payment obligations. The issuer's ability to
service its debt obligations may also be adversely affected by specific
developments affecting the issuer, the issuer's inability to meet specific
projected business forecasts, or the unavailability of additional financing.
The risk of loss due to default by the issuer may be significantly greater
for the holders of high yielding securities because the securities are
generally unsecured and are often subordinated to other creditors of the
issuer. Current prices for defaulted bonds are generally significantly lower
than their purchase price, and the Smaller Companies Fund may have unrealized
losses on defaulted securities that are reflected in the price of the Smaller
Companies Fund's shares. In general, securities that default lose much of
their value in the time period before the actual default so that the Smaller
Companies Fund's net assets are impacted prior to the default. The Smaller
Companies Fund may retain an issue that has defaulted because the issue may
present an opportunity for subsequent price recovery. The Smaller Companies
Fund may be required under the Code and U.S. Treasury regulations to accrue
income for income tax purposes on defaulted obligations and to distribute the
income to the Smaller Companies Fund's shareholders even though the Smaller
Companies Fund is not currently receiving interest or principal payments on
these obligations. In order to generate cash to satisfy any or all of these
distribution requirements, the Smaller Companies Fund may be required to
dispose of portfolio securities that it otherwise would have continued to
hold or to use cash flows from other sources such as the sale of fund shares.
The Smaller Companies Fund may have difficulty disposing of certain high
yielding securities because there may be a thin trading market for a
particular security at any given time. The market for lower rated,
fixed-income securities generally tends to be concentrated among a smaller
number of dealers than is the case for securities that trade in a broader
secondary retail market. Generally, buyers of these securities are
predominantly dealers and other institutional buyers, rather than
individuals. To the extent the secondary trading market for a particular high
yielding, fixed-income security does exist, it is generally not as liquid as
the secondary market for higher rated securities. Reduced liquidity in the
secondary market may have an adverse impact on market price and the Smaller
Companies Fund's ability to dispose of particular issues, when necessary, to
meet the Smaller Companies Fund's liquidity needs or in response to a
specific economic event, such as a deterioration in the creditworthiness of
the issuer.
The Smaller Companies Fund may acquire high yielding, fixed-income securities
during an initial underwriting. These securities involve special risks
because they are new issues. The managers will carefully review their credit
and other characteristics. The Smaller Companies 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
prior to 1990 paralleled a long economic expansion. The recession that began
in 1990 disrupted the market for high yielding securities and adversely
affected the value of outstanding securities and the ability of issuers of
these securities to meet their obligations. Although the economy has improved
considerably and high yielding securities have performed more consistently
since that time, there is no assurance that the adverse effects previously
experienced will not reoccur. The Smaller Companies Fund will rely on the
managers' judgment, analysis and experience in evaluating the
creditworthiness of an issuer. In this evaluation, the managers will take
into consideration, among other things, the issuer's financial resources, its
sensitivity to economic conditions and trends, its operating history, the
quality of the issuer's management and regulatory matters.
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.
Franklin Resources, Inc. has created an interdepartmental team to handle all
euro-related changes to enable the Franklin Templeton Funds to process
transactions accurately and completely with minimal disruption to business
activities. While the implementation of the euro could have a negative effect
on the 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 affiliations of the officers and board members and their principal
occupations for the past five years are shown below.
POSITION(S) HELD PRINCIPAL OCCUPATION(S) DURING
NAME, AGE AND ADDRESS WITH THE TRUST THE PAST FIVE YEARS
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Frank H. Abbott, III (77)
1045 Sansome Street
San Francisco, CA 94111
Trustee
President and Director, Abbott Corporation (an investment company); director
or trustee, as the case may be, of 27 of the investment companies in the
Franklin Templeton Group of Funds; and FORMERLY, Director, MotherLode Gold
Mines Consolidated (gold mining) and Vacu-Dry Co. (food processing).
Harris J. Ashton (66)
191 Clapboard Ridge Road
Greenwich, CT 06830
Trustee
Director, RBC Holdings, Inc. (bank holding company) and Bar-S Foods (meat
packing company); director or trustee, as the case may be, of 49 of the
investment companies in the Franklin Templeton Group of Funds; and FORMERLY,
President, Chief Executive Officer and Chairman of the Board, General Host
Corporation (nursery and craft centers).
*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 53 of the investment
companies in the Franklin Templeton Group of Funds.
S. Joseph Fortunato (66)
Park Avenue at Morris County
P.O. Box 1945
Morristown, NJ 07962-1945
Trustee
Member of the law firm of Pitney, Hardin, Kipp & Szuch; director or trustee,
as the case may be, of 51 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 25 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
Advisory Services, Inc., Franklin Investment Advisory Services, Inc. and
Franklin Templeton Distributors, Inc.; Director, Franklin/Templeton Investor
Services, Inc. and Franklin Templeton Services, Inc.; officer and/or director
or trustee, as the case may be, of most of the other subsidiaries of Franklin
Resources, Inc. and of 50 of the investment companies in the Franklin
Templeton Group of Funds.
*Rupert H. Johnson, Jr. (58)
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 and
Director, Franklin Advisory Services, Inc.; Director, Franklin/Templeton
Investor Services, Inc.; and officer and/or director or trustee, as the case
may be, of most of the other subsidiaries of Franklin Resources, Inc. and of
53 of the investment companies in the Franklin Templeton Group of Funds.
Frank W.T. LaHaye (69)
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, Quarterdeck Corporation
(software firm) and Digital Transmission Systems, Inc. (wireless
communications); director or trustee, as the case may be, of 27 of the
investment companies in the Franklin Templeton Group of Funds; and FORMERLY,
Director, Fischer Imaging Corporation (medical imaging systems) and General
Partner, Peregrine Associates, which was the General Partner of Peregrine
Ventures (venture capital firm).
Gordon S. Macklin (70)
8212 Burning Tree Road
Bethesda, MD 20817
Trustee
Director, Fund American Enterprises Holdings, Inc. (holding company), Martek
Biosciences Corporation, MCI WorldCom (information services), MedImmune, Inc.
(biotechnology), Spacehab, Inc. (aerospace services) and Real 3D (software);
director or trustee, as the case may be, of 49 of the investment companies in
the Franklin Templeton Group of Funds; and FORMERLY, Chairman, White River
Corporation (financial services) and Hambrecht and Quist Group (investment
banking), and President, National Association of Securities Dealers, Inc.
Martin L. Flanagan (38)
777 Mariners Island Blvd.
San Mateo, CA 94404
Vice President
and Chief
Financial Officer
Senior Vice President and Chief Financial Officer, Franklin Resources, Inc.,
Franklin/Templeton Investor Services, Inc. and Franklin Mutual Advisers,
Inc.; Executive Vice President and Director, Templeton Worldwide, Inc.;
Executive Vice President, Chief Operating Officer and Director, Templeton
Investment Counsel, Inc.; Executive Vice President and Chief Financial
Officer, Franklin Advisers, Inc.; Chief Financial Officer, Franklin Advisory
Services, Inc. and Franklin Investment Advisory Services, Inc.; President and
Director, Franklin Templeton Services, Inc.; officer and/or director of some
of the other subsidiaries of Franklin Resources, Inc.; and officer and/or
director or trustee, as the case may be, of 53 of the investment companies in
the Franklin Templeton Group of Funds.
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. and
Franklin Mutual Advisers, Inc.; Vice President, Franklin Advisory Services,
Inc.; Vice President, Chief Legal Officer and Chief Operating Officer,
Franklin Investment Advisory Services, Inc.; and officer of 54 of the
investment companies in the Franklin Templeton Group of Funds.
Charles E. Johnson (42)
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 34 of the
investment companies in the Franklin Templeton Group of Funds.
Diomedes Loo-Tam (60)
777 Mariners Island Blvd.
San Mateo, CA 94404
Treasurer and
Principal
Accounting Officer
Senior Vice President, Franklin Templeton Services, Inc.; and officer of 32
of the investment companies in the Franklin Templeton Group of Funds.
Edward V. McVey (61)
777 Mariners Island Blvd.
San Mateo, CA 94404
Vice President
Senior Vice President and National Sales Manager, Franklin Templeton
Distributors, Inc.; and officer of 28 of the investment companies in the
Franklin Templeton Group of Funds.
R. Martin Wiskemann (72)
777 Mariners Island Blvd.
San Mateo, CA 94404
Vice President
Senior Vice President, Portfolio Manager and Director, Franklin Advisers,
Inc.; Senior Vice President, Franklin Management, Inc.; Vice President and
Director, ILA Financial Services, Inc.; and officer and/or director or
trustee, as the case may be, of 15 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 $300 per quarter plus $150 per
meeting attended. Board members who serve on the audit committee of the trust
and other funds in the Franklin Templeton Group of Funds receive a flat fee
of $2,000 per committee meeting attended, a portion of which is allocated to
the trust. Members of a committee are not compensated for any committee
meeting held on the day of a board meeting. Noninterested board members may
also serve as directors or trustees of other funds in the Franklin Templeton
Group of Funds and may receive fees from these funds for their services. The
fees payable to noninterested board members by the trust are subject to
reductions resulting from fee caps limiting the amount of fees payable to
board members who serve on other boards within the Franklin Templeton Group
of Funds. The following table provides the total fees paid to noninterested
board members by the trust and by the Franklin Templeton Group of Funds.
<TABLE>
<CAPTION>
NUMBER OF
TOTAL FEES BOARDS IN THE
TOTAL FEES RECEIVED FROM THE FRANKLIN TEMPLETON
RECEIVED FRANKLIN TEMPLETON GROUP OF FUNDS ON
NAME FROM THE TRUST 1 GROUP OF FUNDS 2 WHICH EACH SERVES 3
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Frank H. Abbott, III......... $540 $159,051 27
Harris J. Ashton............. 716 361,157 49
S. Joseph Fortunato.......... 668 367,835 51
Edith E. Holiday............. 900 211,400 25
Frank W.T. LaHaye............ 690 163,753 27
Gordon S. Macklin............ 716 361,157 49
</TABLE>
1. For the fiscal year ended October 31, 1998. During the period from October
31, 1997, through May 31, 1998, noninterested board members were not paid
fees.
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 164 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
- --------------------------------------------------------------------------------
MANAGER AND SERVICES PROVIDED The funds' manager is Franklin Advisers, Inc.
The manager is wholly owned by Franklin Resources, Inc. (Resources), a
publicly owned company engaged in the financial services industry through its
subsidiaries. Charles B. Johnson and Rupert H. Johnson, Jr. are the principal
shareholders of Resources.
The 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 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 Templeton organization has been investing globally since 1940. The
manager and its affiliates have offices in Argentina, Australia, Bahamas,
Brazil, the British Virgin Islands, Canada, China, Cyprus, France, Germany,
Hong Kong, India, Italy, Japan, Korea, Luxembourg, Mauritius, the
Netherlands, Poland, Russia, Singapore, South Africa, Spain, Sweden,
Switzerland, Taiwan, United Kingdom, and the U.S.
The manager and its affiliates manage numerous other investment companies and
accounts. The manager may give advice and take action with respect to any of
the other funds it manages, or for its own account, that may differ from
action taken by the manager on behalf of the fund. Similarly, with respect to
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 fund's code of ethics.
Under each 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 funds' sub-advisor is Templeton Investment Counsel, Inc. The sub-advisor
has an agreement with the manager and provides the manager with investment
management advice and assistance. The sub-advisor recommends the optimal
equity allocation and provides advice regarding the fund's investments. The
sub-advisor also determines which securities will be purchased, retained or
sold and executes these transactions. 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 Each fund pays the manager a fee equal to an annual rate of:
o 1% of the value of net assets up to and including $100 million;
o 0.90% of the value of net assets over $100 million up to and including
$250 million;
o 0.80% of the value of net assets over $250 million up to and including
$500 million;
o 0.75% of the value of net assets over of $500 million.
The fee is computed at the close of business on the last business day of each
month according to the terms of the management agreement. Each class of each
fund's shares pays its proportionate share of the fee.
For the last three fiscal years ended October 31, the funds paid the
following management fees:
MANAGEMENT FEES PAID ($)
--------------------------------
1998 1997 1996
- ---------------------------------------------------------------
Smaller Companies
Fund 1...................... 657,454 866,624 595,387
Pacific Fund................. 229,542 571,117 623,230
1. Management fees, before any advance waiver, totaled $697,463 for 1998 and
$958,913 for 1997. Under an agreement by the manager to 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 0.50% of the value of the fund's average daily net assets up to and
including $100 million;
o 0.40% of the value of the fund's average daily net assets over $100
million up to and including $250 million;
o 0.30% of the value of the fund's average daily net assets over $250
million up to and including $500 million; and
o 0.25% of the value of the fund's average daily assets over $500 million.
The manager pays this fee from the management fees it receives from each
fund. For the last three fiscal years ended October 31, the manager paid the
following sub-advisory fees:
SUB-ADVISORY FEES PAID ($)
--------------------------------
1998 1997 1996
- ---------------------------------------------------------------
Smaller Companies
Fund........................ 659,180 451,416 317,709
Pacific Fund................. 229,541 284,645 332,419
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 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 The manager pays FT Services a monthly fee equal to an
annual rate of:
o 0.15% of the fund's average daily net assets up to $200 million;
o 0.135% of average daily net assets over $200 million up to $700 million;
o 0.10% of average daily net assets over $700 million up to $1.2 billion;
and
o 0.075% of average daily net assets over $1.2 billion.
During the last three fiscal years ended October 31, the manager paid FT
Services the following administration fees:
ADMINISTRATION
FEES PAID ($)
--------------------
1998 1997
- ---------------------------------------------------------
Smaller Companies Fund.......... 209,389 153,165
Pacific Fund.................... 68,924 93,491
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., P.O. Box 7777, San Mateo,
CA 94403-7777.
For its services, Investor Services receives a fixed fee per account. The
funds may also 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 may not exceed the per account fee payable
by the funds to Investor Services in connection with maintaining shareholder
accounts.
CUSTODIANS Bank of New York, Mutual Funds Division, 90 Washington Street, New
York, NY 10286, acts as custodian of the securities and other assets of the
Pacific Fund. The Chase Manhattan Bank, at its principal office at MetroTech
Center, Brooklyn, NY 11245, and at the offices of its branches and agencies
throughout the world, acts as custodian of the Smaller Companies Fund's
assets. As foreign custody manager, the bank selects and monitors foreign
sub-custodian banks, selects and evaluates non-compulsory foreign
depositories, and furnishes information relevant to the selection of
compulsory depositories.
AUDITOR PricewaterhouseCoopers LLP, 200 East Las Olas, Ft. Lauderdale, FL
33301, 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
- --------------------------------------------------------------------------------
The managers select brokers and dealers to execute the fund's portfolio
transactions in accordance with criteria set forth in the management and
sub-advisory agreements and any directions that the board may give.
When placing a portfolio transaction, the managers seek to obtain prompt
execution of orders at the most favorable net price. For portfolio
transactions on a securities exchange, the amount of commission paid is
negotiated between the managers and the broker executing the transaction. The
determination and evaluation of the reasonableness of the brokerage
commissions paid are based to a large degree on the professional opinions of
the persons responsible for placement and review of the transactions. These
opinions are based on the experience of these individuals in the securities
industry and information available to them about the level of commissions
being paid by other institutional investors of comparable size. The managers
will ordinarily place orders to buy and sell over-the-counter securities on a
principal rather than agency basis with a principal market maker unless, in
the opinion of the managers, a better price and execution can otherwise be
obtained. Purchases of portfolio securities from underwriters will include a
commission or concession paid by the issuer to the underwriter, and purchases
from dealers will include a spread between the bid and ask price.
The managers may pay certain brokers commissions that are higher than those
another broker may charge, if the managers determine in good faith that the
amount paid is reasonable in relation to the value of the brokerage and
research services they receive. This may be viewed in terms of either the
particular transaction or the managers' overall responsibilities to client
accounts over which it exercises investment discretion. The services that
brokers may provide to the managers include, among others, supplying
information about particular companies, markets, countries, or local,
regional, national or transnational economies, statistical data, quotations
and other securities pricing information, and other information that provides
lawful and appropriate assistance to the managers in carrying out its
investment advisory responsibilities. These services may not always directly
benefit the fund. They must, however, be of value to the managers in carrying
out its overall responsibilities to their clients.
It is not possible to place a dollar value on the special executions or on
the research services the managers receive from dealers effecting
transactions in portfolio securities. The allocation of transactions in order
to obtain additional research services allows the managers to supplement
their own research and analysis activities and to receive the views and
information of individuals and research staffs of other securities firms. As
long as it is lawful and appropriate to do so, the managers and their
affiliates may use this research and data in their investment advisory
capacities with other clients. If a 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, may also 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 a 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 managers will be reduced by the amount of any
fees received by Distributors in cash, less any costs and expenses incurred
in connection with the tender.
If purchases or sales of securities of a fund and one or more other
investment companies or clients supervised by the managers 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 managers, 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 Octo-
ber 31, the funds paid the following brokerage commissions:
BROKERAGE COMMISSIONS ($)
--------------------------------
1998 1997 1996
- --------------------------------------------------------------
Smaller Companies
Fund........................ 208,436 372,889 132,084
Pacific Fund................. 139,234 141,188 121,723
As of October 31, 1998, the funds did not own securities of their regular
broker-dealers.
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. The funds do not pay "interest" or guarantee any fixed rate of
return on an investment in its 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.
A fund may be subject to foreign withholding taxes on income from certain of
its foreign securities. If more than 50% of a fund's total assets at the end
of the fiscal year are invested in securities of foreign corporations, a 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 a
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. A 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 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 investment company under Subchapter M of the
Internal Revenue Code, has qualified as such for its most recent fiscal year,
and intends to so qualify during the current fiscal year. As regulated
investment companies, the funds generally pay no federal income tax on the
income and gains they distribute to 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 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 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.
DIVIDENDS-RECEIVED DEDUCTION FOR CORPORATIONS As a corporate shareholder, you
should note that no portion of the Smaller Companies Fund's distributions
will generally be eligible for the intercorporate dividends-received
deduction. None of the dividends paid by the fund for the most recent
calendar year qualified for such deduction, and it is anticipated that none
of the current year's dividends will so qualify.
You should also note that 1.96% of the dividends paid by the Pacific 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 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 is a diversified series of Franklin Templeton International Trust,
an open-end management investment company, commonly called a mutual fund. The
trust was organized as a Delaware business trust, and is registered with the
SEC.
The Smaller Companies Fund currently offers four classes of shares, Class A,
Class B, Class C and Advisor Class. The Smaller Companies Fund began offering
Class B shares on January 1, 1999. The Pacific Growth Fund currently offers
three classes of shares, Class A, Class C and Advisor Class. Each fund may
offer additional classes of shares in the future. The full title of each
class is:
o Templeton Foreign Smaller Companies Fund - Class A
o Templeton Foreign Smaller Companies Fund - Class B
o Templeton Foreign Smaller Companies Fund - Class C
o Templeton Foreign Smaller Companies Fund - Advisor Class
o Templeton Pacific Growth Fund - Class A
o Templeton Pacific Growth Fund - Class C
o Templeton Pacific Growth Fund - Advisor Class
Shares of each class represent proportionate interests in the fund's assets.
On matters that affect a fund as a whole, each class has the same voting and
other rights and preferences as any other class. On matters that affect only
one class, only shareholders of that class may vote. Each class votes
separately on matters affecting only that class, or expressly required to be
voted on separately by state or federal law. Shares of each class of a series
have the same voting and other rights and preferences as the other classes
and series of the trust for matters that affect the trust as a whole.
Additional series may be offered in the future.
The trust has noncumulative voting rights. For board member elections, this
gives holders of more than 50% of the shares voting the ability to elect all
of the members of the board. If this happens, holders of the remaining shares
voting will not be able to elect anyone to the board.
The trust does not intend to hold annual shareholder meetings. The trust or a
series of the trust may hold special meetings, however, for matters requiring
shareholder approval. A meeting may 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 may also be called by the board in its
discretion.
As of December 7, 1998, the principal shareholders of the funds, beneficial
or of record, were:
<TABLE>
<CAPTION>
NAME AND ADDRESS SHARE CLASS PERCENTAGE (%)
FOREIGN SMALLER COMPANIES FUND
<S> <C> <C>
Dai-Ichi Kangyo Bank of California Ttee
1200 5th Ave., Ste. 600, Seattle, WA 98101-1188 A 5
Raymond James Assoc., Inc.
FAO Larry A Loftin And Wanda A Loftin Ten Com
Elite 50197725
106 Lybrook Rd., Advance, NC 27006-7629...... C 8
Raymond James Assoc., Inc.
Cust Sara T Jones MD IRA
321 Banbury Rd., Winston Salem, NC 27104-1827 C 7
Raymond James & Assoc., Inc.
Elite Acct 50177379
FAO Fred Penzias Ttee UA DTD
4/8/97 Penzias Revoc Tr
3455 S Corona St., Apt. 217, Englewood, CO 80110-2864 C 6
Frederick D. Richburg And Lauretta L. Richburg JT WROS
7831 S. Argonne St., Aurora, CO 80016........ C 5
Franklin Templeton Trust Company1 TTEE for ValuSelect
Franklin Resources PSP
Attn: Trading
P.O. Box 2438, Rancho Cordova, CA 95741-2438. Advisor 5
PACIFIC FUND
Rosalind Achtel
150 Prospect St., Clark, NJ 07066............ Advisor 7
Franklin Templeton Trust Company1 TTEE for ValuSelect
Franklin Resources PSP
Attn: Trading
P.O. Box 2438, Rancho Cordova, CA 95741-2438. Advisor 65
</TABLE>
1. Franklin Templeton Trust Company is a California corporation and is wholly
owned by Franklin Resources, Inc.
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 December 7, 1998, the officers and board members, as a group, owned of
record and beneficially 3% of the Pacific Growth Fund's Advisor Class shares
and less than 1% of the outstanding shares of the other classes of that fund
and any classes of the Smaller Companies Fund. The board members may own
shares in other funds in the Franklin Templeton Group of Funds.
BUYING AND SELLING SHARES
- --------------------------------------------------------------------------------
A 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 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 a fund must be denominated in U.S. dollars. We may, in our sole
discretion, either (a) reject any order to buy or sell shares denominated in
any other currency or (b) honor the transaction or make adjustments to your
account for the transaction as of a date and with a foreign currency exchange
factor determined by the drawee bank.
When you buy shares, if you submit a check or a draft that is returned unpaid
to 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 Valuemark Funds, 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 may also 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 may also 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 may also 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 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 Valuemark Funds 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 may also 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
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 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:
SALES
SIZE OF PURCHASE - U.S. DOLLARS 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.
Either Distributors or one of its affiliates may pay the following amounts,
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: 1% on sales of $500,000 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. Distributors may make these payments
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.
These breakpoints are reset every 12 months for purposes of additional
purchases.
Distributors and/or its affiliates 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. 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 may also 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 THIS % IS
CLASS B SHARES WITHIN THIS DEDUCTED FROM YOUR
MANY YEARS AFTER BUYING THEM 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 will generally 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 Distributors did not make any
payment to the securities dealer of record 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 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 goal exist immediately. This money will then be withdrawn from the
short-term, interest-bearing money market instruments and invested in
portfolio securities in as orderly a manner as is possible when attractive
investment opportunities arise.
The proceeds from the sale of shares of an investment company 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. Once your plan
is established, any distributions paid by the fund will be automatically
reinvested in your account.
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 may
also 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.
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 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 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 fund
on behalf of numerous beneficial owners for recordkeeping operations
performed with respect to such owners. For each beneficial owner in the
omnibus account, each fund may reimburse Investor Services an amount not to
exceed the per account fee that the fund normally pays Investor Services.
These financial institutions may also 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
- --------------------------------------------------------------------------------
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.
Trading in securities on European and Far Eastern securities exchanges and
over-the-counter markets is normally completed well before the close of
business of the NYSE on each day that the NYSE is open. Trading in European
or Far Eastern securities generally, or in a particular country or countries,
may not take place on every NYSE business day. Furthermore, trading takes
place in various foreign markets on days that are not business days for the
NYSE and on which the fund's NAV is not calculated. Thus, the calculation of
the fund's NAV does not take place contemporaneously with the determination
of the prices of many of the portfolio securities used in the calculation
and, if events materially affecting the values of these foreign securities
occur, the securities will be valued at fair value as determined by
management and approved in good faith by the board.
Generally, trading in corporate bonds, U.S. government securities and money
market instruments is substantially completed each day at various times
before the close of the NYSE. The value of these securities used in computing
the NAV is determined as of such times. Occasionally, events affecting the
values of these securities may occur between the times at which they are
determined and the close of the NYSE that will not be reflected in the
computation of the NAV. If events materially affecting the values of these
securities occur during this period, the securities will be valued at their
fair value as determined in good faith by the board.
Other securities for which market quotations are readily available are valued
at the current market price, which may be obtained from a pricing service,
based on a variety of factors including recent trades, institutional size
trading in similar types of securities (considering yield, risk and maturity)
and/or developments related to specific issues. Securities and other assets
for which market prices are not readily available are valued at fair value as
determined following procedures approved by the board. With the approval of
the board, the fund may use a pricing service, bank or securities dealer to
perform any of the above described functions.
THE UNDERWRITER
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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 funds pay 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
October 31:
<TABLE>
<CAPTION>
AMOUNT RECEIVED
TOTAL IN CONNECTION WITH
COMMISSIONS AMOUNT RETAINED REDEMPTIONS AND
RECEIVED ($) BY DISTRIBUTORS ($) REPURCHASES ($)
- -------------------------------------------------------------------------------------
1998
<S> <C> <C> <C>
Smaller Companies Fund..... 423,903 63,831 3,023
Pacific Growth Fund........ 582,215 82,792 8,598
AMOUNT RECEIVED
TOTAL IN CONNECTION WITH
COMMISSIONS AMOUNT RETAINED REDEMPTIONS AND
RECEIVED ($) BY DISTRIBUTORS ($) REPURCHASES ($)
- --------------------------------------------------------------------------------------
1997
<S> <C> <C> <C>
Smaller Companies Fund..... 1,059,592 156,055 0
Pacific Growth Fund........ 483,600 64,068 600
1996
Smaller Companies Fund..... 336,526 38,426 0
Pacific Growth Fund........ 412,861 46,160 0
</TABLE>
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 each 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 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, the fund pays
Distributors up to 0.75% per year of the class's average daily net assets,
payable quarterly, 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 may
also pay a servicing fee of up to 0.25% per year of the class's average daily
net assets, 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 are also 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 may also be terminated by any act that constitutes an assignment of the
underwriting agreement with Distributors. Distributors or any dealer or other
firm may also 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 October 31, 1998, Distributors' eligible
expenditures for advertising, printing, and payments to underwriters and
broker-dealers pursuant to the plans and the amounts the funds paid
Distributors under the plans were:
DISTRIBUTORS' AMOUNT
ELIGIBLE PAID BY THE
EXPENSES ($) FUND ($)
- ------------------------------------------------------------
Smaller Companies
Fund -Class A............. 629,935 259,193
Smaller Companies
Fund -Class C............. 3,905 856
Pacific Fund - Class A..... 378,426 110,366
Pacific Fund - Class C..... 112,367 49,105
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 quotations used by a fund are based on the
standardized methods of computing performance mandated by the SEC. If a Rule
12b-1 plan is adopted, performance figures reflect fees from the date of the
plan's implementation. An explanation of these and other methods used by the
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, 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 October 31,
1998, were:
SINCE
INCEPTION
CLASS A 1 YEAR 5 YEARS (9/21/91)
- ------------------------------------------------------------------
Smaller Companies
Fund ........................ -17.67% 5.37% 7.65%
Pacific Fund ................. -30.58% -9.77% -1.25%
SINCE
INCEPTION
CLASS C1 1 YEAR (1/2/97)
- -----------------------------------------------------
Pacific Fund.................. -27.94% -29.92%
1. Since the Smaller Companies Fund Class C shares have been in existence for
less than 1 year, average annual total returns are not provided.
These figures were calculated according to the SEC formula:
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, and income dividends and capital gain distributions are
reinvested at net asset value. Cumulative total return, however, is based on
the actual return for a specified period rather than on the average return
over the periods indicated above. The cumulative total returns for the
indicated periods ended October 31, 1998, were:
SINCE
INCEPTION
CLASS A 1 YEAR 5 YEARS (9/21/91)
- -----------------------------------------------------------------
Smaller Companies
Fund......................... -17.67% 30.01% 69.08%
Pacific Fund.................. -30.58% -40.20% -8.57%
SINCE
CLASS C 1 YEAR INCEPTION
- -----------------------------------------------------
Smaller Companies
Fund 1....................... N/A -15.12%
Pacific Fund 2................ -27.94% -47.78%
1. Inception date: 7/1/98
2. Inception date: 1/2/97
VOLATILITY Occasionally statistics may be used to show the funds' volatility
or risk. Measures of volatility or risk are generally used to compare the
funds' 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 Each fund may also 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 a 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 funds may
satisfy your investment goal, advertisements and other materials about each
fund may discuss certain measures of fund performance as reported by various
financial publications. Materials may also compare performance (as calculated
above) to performance as reported by other investments, indices, and
averages. These comparisons may include, but are not limited to, the
following examples:
(i) unmanaged indices so that you may compare the fund's results with those
of a group of unmanaged securities widely regarded by investors as
representative of the securities market in general; (ii) other groups of
mutual funds tracked by Lipper Analytical Services, Inc., a widely used
independent research firm that ranks mutual funds by overall performance,
investment goals and assets, or tracked by other services, companies,
publications, or persons who rank mutual funds on overall performance or
other criteria; and (iii) the Consumer Price Index (measure for inflation) to
assess the real rate of return from an investment in the fund. Unmanaged
indices may assume the reinvestment of dividends but generally do not reflect
deductions for administrative and management costs and expenses.
From time to time, the fund and the managers may also refer to the following
information:
o The managers' and their affiliates' market share of international
equities managed in mutual funds prepared or published by Strategic
Insight or a similar statistical organization.
o The performance of U.S. equity and debt markets relative to foreign
markets prepared or published by Morgan Stanley Capital International(R)
or a similar financial organization.
o The capitalization of U.S. and foreign stock markets as prepared or
published by the International Finance Corporation, Morgan Stanley
Capital International(R) or a similar financial organization.
o The geographic and industry distribution of the fund's portfolio and the
fund's top ten holdings.
o The gross national product and populations, including age
characteristics, literacy rates, foreign investment improvements due to
a liberalization of securities laws and a reduction of foreign exchange
controls, and improving communication technology, of various countries
as published by various statistical organizations.
o To assist investors in understanding the different returns and risk
characteristics of various investments, the fund may show historical
returns of various investments and published indices (E.G., Ibbotson
Associates, Inc. Charts and Morgan Stanley EAFE - Index).
o The major industries located in various jurisdictions as published by
the Morgan Stanley Index.
o Rankings by DALBAR Surveys, Inc. with respect to mutual fund shareholder
services.
o Allegorical stories illustrating the importance of persistent long-term
investing.
o The funds' portfolio turnover rate and its ranking relative to industry
standards as published by Lipper Analytical Services, Inc. or
Morningstar, Inc.
o A description of the Templeton organization's investment management
philosophy and approach, including its worldwide search for undervalued
or "bargain" securities and its diversification by industry, nation and
type of stocks or other securities.
o Comparison of the characteristics of various emerging markets, including
population, financial and economic conditions.
o Quotations from the Templeton organization's founder, Sir John
Templeton,* advocating the virtues of diversification and long-term
investing.
*Sir John Templeton sold the Templeton organization to Franklin Resources,
Inc. in October 1992 and resigned from the Board on April 16, 1995. He is no
longer involved with the investment management process.
From time to time, advertisements or information for a fund may include a
discussion of certain attributes or benefits to be derived from an investment
in the fund. The advertisements or information may include symbols,
headlines, or other material that highlights or summarizes the information
discussed in more detail in the communication.
Advertisements or information may also compare a fund's performance to the
return on certificates of deposit (CDs) or other investments. You should be
aware, however, that an investment in the fund involves the risk of
fluctuation of principal value, a risk generally not present in an investment
in a CD issued by a bank. For example, as the general level of interest rates
rise, the value of the fund's fixed-income investments, if any, as well as
the value of its shares that are based upon the value of such portfolio
investments, can be expected to decrease. Conversely, when interest rates
decrease, the value of the fund's shares can be expected to increase. CDs are
frequently insured by an agency of the U.S. government. An investment in 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 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 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 the 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 3 million
shareholder accounts. In 1992, Franklin, a leader in managing fixed-income
mutual funds and an innovator in creating domestic equity funds, joined
forces with Templeton, a pioneer in international investing. The Mutual
Series team, known for its value-driven approach to domestic equity
investing, became part of the organization four years later. Together, the
Franklin Templeton Group has over $220 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 115 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 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 funds and their 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 BOND RATINGS
- --------------------------------------------------------------------------------
CORPORATE AND FOREIGN GOVERNMENT
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 may also reflect the
filing of a bankruptcy petition under circumstances where debt service
payments are continuing. The C1 rating is reserved for income bonds on which
no interest is being paid.
D - Debt rated D is in default and payment of interest and/or repayment of
principal is in arrears.
PLUS (+) OR MINUS (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
COMMERCIAL PAPER RATINGS
MOODY'S
Moody's commercial paper ratings are opinions of the ability of issuers to
repay punctually their promissory obligations not having an original maturity
in excess of nine months. Moody's employs the following designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers:
P-1 (PRIME-1): Superior capacity for repayment.
P-2 (PRIME-2): Strong capacity for repayment.
S&P
S&P's ratings are a current assessment of the likelihood of timely payment of
debt having an original maturity of no more than 365 days. Ratings are graded
into four categories, ranging from "A" for the highest quality obligations to
"D" for the lowest. Issues within the "A" category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety, as follows:
A-1: This designation indicates the degree of safety regarding timely payment
is very strong. A "plus" (+) designation indicates an even stronger
likelihood of timely payment.
A-2: Capacity for timely payment on issues with this designation is strong.
The relative degree of safety, however, is not as overwhelming as for issues
designated A-1.
A-3: Issues carrying this designation have a satisfactory capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse effects
of changes in circumstances than obligations carrying the higher designations.
FRANKLIN TEMPLETON
INTERNATIONAL TRUST
TEMPLETON FOREIGN SMALLER COMPANIES FUND
TEMPLETON PACIFIC GROWTH FUND
ADVISOR CLASS
STATEMENT OF
ADDITIONAL INFORMATION
MARCH 1, 1999
777 MARINERS ISLAND BLVD., P.O. BOX 7777
SAN MATEO, CA 94403-7777 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 March 1, 1999, which we may amend from time to
time, contains the basic information you should know before investing in each
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 October 31, 1998, 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
Goal and Strategies ........................................... 2
Risks ......................................................... 13
Officers and Trustees ......................................... 18
Management and Other Services ................................. 22
Portfolio Transactions ........................................ 24
Distributions and Taxes ....................................... 25
Organization, Voting Rights
and Principal Holders ........................................ 27
Buying and Selling Shares ..................................... 28
Pricing Shares ................................................ 31
The Underwriter ............................................... 31
Performance ................................................... 32
Miscellaneous Information ..................................... 34
Description of Bond Ratings ................................... 34
- --------------------------------------------------------------------------------
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.
- --------------------------------------------------------------------------------
GOAL AND STRATEGIES
- --------------------------------------------------------------------------------
The investment goal of each fund is long-term capital growth. This goal is
fundamental, which means it 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, warrants
or rights. Convertible securities typically are debt securities or preferred
stocks which are convertible into common stock after certain time periods or
under certain circumstances. Warrants or rights give the holder the right to
purchase a common stock at a given time for a specified price.
DEBT SECURITIES A debt security typically has a fixed payment schedule which
obligates the issuer to pay interest to the lender and to return the lender's
money over a certain time period. A company typically meets its payment
obligations associated with its outstanding debt securities before it
declares and pays any dividend to holders of its equity securities. Bonds,
notes, debentures and commercial paper differ in the length of the issuer's
payment schedule, with bonds carrying the longest repayment schedule and
commercial paper the shortest.
The market value of debt securities generally varies in response to changes
in interest rates and the financial condition of each issuer. During periods
of declining interest rates, the value of debt securities generally
increases. Conversely, during periods of rising interest rates, the value of
such securities generally declines. These changes in market value will be
reflected in the fund's net asset value.
Independent rating organizations rate debt securities based upon their
assessment of the financial soundness of the issuer. Generally, a lower
rating indicates higher risk.
The Smaller Companies Fund may buy debt securities which are rated C or
better by Moody's or S&P; or unrated debt which it determines to be of
comparable quality. At present, the fund does not intend to invest more than
5% of its total assets in non-investment grade securities (rated lower than
BBB by S&P or Baa by Moody's), including defaulted securities.
The Pacific Fund may buy debt securities which are rated Baa by Moody's or
BBB by S&P or better; or unrated debt which it determines to be of comparable
quality. The fund's investments in debt instruments may include U.S. and
foreign government and corporate securities, including Samurai bonds, Yankee
bonds and Eurobonds.
FOREIGN INVESTMENTS The funds invest in securities of foreign issuers. The
funds may invest up to 100% of total assets in emerging markets. The Smaller
Companies Fund may invest up to 5% of its total assets in Russian securities.
On occasion each fund may invest more than 25% of its assets in the
securities of issuers in one industrialized country that, in the view of the
manager, poses no unique investment risk. Consistent with this policy, the
fund may invest up to 30% of its assets in securities issued by Hong Kong
companies. However, each fund will not invest more than 25% of its assets in
any one industry or securities issued by any foreign government.
CURRENCY TRANSACTIONS Although each fund has the authority to enter into
forward currency exchange contracts ("forward contracts") and currency
futures contracts and options on these 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, it presently has no intention of entering into
such transactions.
A forward contract involves an obligation to buy or sell a specific currency
at a future date, that may be any fixed number of days from the date of the
contract agreed upon by the parties, at a price set at the time of the
contract. These contracts are traded in the interbank market conducted
directly between currency traders (usually large commercial banks).
Each fund may engage in cross-hedging by using forward contracts in one
currency to hedge against fluctuations in the value of securities denominated
in a different currency if the managers determine that there is a pattern of
correlation between the two currencies. Each fund may also buy and sell
forward contracts (to the extent they are not deemed "commodities") for
non-hedging purposes when the managers anticipate that the foreign currency
will appreciate or depreciate in value, but securities denominated in that
currency do not present attractive investment opportunities and are not held
in the funds' portfolio.
Each fund's custodian bank will place cash or liquid high grade debt
securities (securities rated in one of the top three ratings categories by
Moody's or S&P or, if unrated, deemed by the managers to be of comparable
quality) into a segregated account of the fund maintained by its custodian
bank in an amount equal to the value of the funds' total assets committed to
the forward foreign currency exchange contracts requiring the funds to
purchase foreign currencies. If the value of the securities placed in the
segregated account declines, additional cash or securities is placed in the
account on a daily basis so that the value of the account equals the amount
of the funds' commitments with respect to such contracts. The segregated
account is marked-to-market on a daily basis. Although the contracts are not
presently regulated by the Commodity Futures Trading Commission (the "CFTC"),
the CFTC may in the future assert authority to regulate these contracts. In
such event, the fund's ability to utilize forward foreign currency exchange
contracts may be restricted.
The fund generally will not enter into a forward contract with a term of
greater than one year.
A currency futures contract is a standardized contract for the future
delivery of a specified amount of currency at a future date at a price set at
the time of the contract. Each fund may enter into currency futures contracts
traded on regulated commodity exchanges, including non-U.S. exchanges.
The funds may either accept or make delivery of the currency specified at the
maturity of a forward or futures contract or, prior to maturity, enter into a
closing transaction involving the purchase or sale of an offsetting contract.
Closing transactions with respect to forward contracts are usually effected
with the currency trader who is a party to the original forward contract.
Each fund may enter into forward currency exchange contracts and currency
futures contracts in several circumstances. For example, when a fund enters
into a contract for the purchase or sale of a security denominated in a
foreign currency (or options contracts with respect to such futures
contracts), or when a fund anticipates the receipt in a foreign currency of
dividends or interest payments on such a security that it holds, it may
desire to "lock in" the U.S. dollar price of the security or the U.S. dollar
equivalent of such dividend or interest payment, as the case may be. In
addition, when the managers believe that the currency of a particular country
may suffer a substantial decline against the U.S. dollar, they may enter into
a forward or futures contract to sell, for a fixed amount of U.S. dollars,
the amount of that currency approximating the value of some or all of the
fund's portfolio securities denominated in that currency. The precise
matching of the forward contract amounts and the value of the securities
involved is not generally possible because the future value of these
securities in foreign currencies changes as a consequence of market movements
in the value of those securities between the date on which the contract is
entered into and the date it matures. Using forward contracts to protect the
value of a 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 a fund can achieve
at some future point in time. The precise projection of short-term currency
market movements is not possible, and short-term hedging provides a means of
fixing the dollar value of only a portion of the fund's foreign assets.
Each fund may write covered put and call options and buy put and call options
on foreign currencies for the purpose of protecting against declines in the
dollar value of portfolio securities and against increases in the dollar cost
of securities to be acquired. The fund may use options on currency to
cross-hedge, which involves writing or purchasing options on one currency to
hedge against changes in exchange rates for a different currency with a
pattern of correlation. In addition, the funds may buy call options on
currency for non-hedging purposes when the managers anticipate that the
currency will appreciate in value, but the securities denominated in that
currency do not present attractive investment opportunities and are not
included in the fund's portfolio.
A call option written by a fund obligates the fund to sell specified currency
to the holder of the option at a specified price at any time before the
expiration date. A put option written by a fund would obligate the fund to
buy specified currency from the option holder at a specified time before the
expiration date. The writing of currency options involves risk that a fund
will, upon exercise of the option, be required to sell currency subject to a
call at a price that is less than the currency's market value or be required
to buy currency subject to a put at a price that exceeds the currency's
market value.
The fund may terminate its obligations under a call or put option by buying
an option identical to the one it has written. Such purchases are referred to
as "closing purchase transactions." A fund would also be able to enter into
closing sale transactions in order to realize gains or minimize losses on
options bought by the fund.
The fund would normally buy call options in anticipation of an increase in
the dollar value of the currency in which securities to be acquired by the
fund are denominated. The purchase of a call option would entitle the fund,
in return for the premium paid, to purchase specified currency at a specified
price during the option period. The fund would ordinarily realize a gain if,
during the option period, the value of such currency exceeded the sum of the
exercise price, the premium paid and transaction costs; otherwise the fund
would realize either no gain or a loss on the purchase of the call option. A
fund may forfeit the entire amount of the premium plus related transaction
costs if exchange rates move in a manner adverse to the fund's position.
The fund would normally buy put options in anticipation of a decline in the
dollar value of currency in which securities in its portfolio are denominated
("protective puts"). Buying a put option would entitle the fund, in exchange
for the premium paid, to sell specific currency at a specified price during
the option period. Buying protective puts is designed merely to offset or
hedge against a decline in the dollar value of the fund's portfolio
securities due to currency exchange rate fluctuations. The fund would
ordinarily realize a gain if, during the option period, the value of the
underlying currency decreased below the exercise price sufficiently to more
than cover the premium and transaction costs; otherwise, the fund would
realize either no gain or a loss on the purchase of the put option. The fund
will buy and sell foreign currency options traded on U.S. or foreign
exchanges or over-the-counter.
The fund will not enter into forward currency exchange contracts or currency
futures contracts or buy or write such options or maintain a net exposure to
such contracts where the completion of the contracts would obligate the fund
to deliver an amount of currency other than U.S. dollars in excess of the
value of the fund's portfolio securities or other assets denominated in that
currency or, in the case of cross-hedging, in a currency closely correlated
to that currency.
OPTIONS ON SECURITIES AND SECURITIES INDICES Although the funds have the
authority to enter into these transactions, they currently have no intention
of doing so.
WRITING CALL AND PUT OPTIONS ON SECURITIES. A fund may write options to
generate additional income and to hedge its investment portfolio against
anticipated adverse market and/or exchange rate movements. A fund may write
covered call and put options on any securities in which it may invest. The
fund may buy and write these options on securities that are listed on
domestic or foreign securities exchanges or traded in the over-the-counter
market. Call options written by a 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. All options written by a fund will be
"covered." The purpose of writing covered call options is to realize greater
income than would be realized on portfolio securities transactions alone.
However, in writing covered call options for additional income, a fund may
forego the opportunity to profit from an increase in the market price of the
underlying security.
A call option written by a fund is covered if the fund owns the underlying
security covered by the call or has an absolute and immediate right to
acquire that security without additional cash consideration (or for
additional cash consideration held in a segregated account by its custodian
bank) upon conversion or exchange of other securities held in its portfolio.
A call option is also covered if a fund holds a call on the same security and
in the same principal amount as the call written where the exercise price of
the call held (i) is equal to or less than the exercise price of the call
written or (ii) 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.
A put option written by a fund is "covered" if the fund maintains cash and
high-grade debt securities with a value equal to the exercise price in a
segregated account with its custodian bank, or else holds a put on the same
security and in the same principal amount as the put written where the
exercise price of the put held is equal to or greater than the exercise price
of the put written. The 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 that wishes to terminate its obligation may effect a
closing purchase transaction. 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.
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. There is no guarantee that either a closing purchase or a
closing sale transaction can be effected when the fund so desires.
BUYING PUT OPTIONS. A fund may buy put options on securities in order to
protect against a decline in the market value of the underlying security
below the exercise price less the premium paid for the option. A put option
gives the holder the right to sell the underlying security at the option
exercise price at any time during the option period. The ability to buy put
options will allow the fund to protect the unrealized gain in an appreciated
security in its portfolio without actually selling the security. In addition,
the fund will continue to receive interest or dividend income on the
security. The fund may sell a put option that it has previously purchased
prior to the sale of the securities underlying that option. These sales will
result in a net gain or loss depending on whether the amount received on the
sale is more or less than the premium and other transaction costs paid for
the put option that is sold. This 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.
BUYING CALL OPTIONS. A fund may buy call options on securities that it
intends to buy in order to limit the risk of a substantial increase in the
market price of this security. A 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.
OPTIONS ON STOCK INDICES. A fund may buy and write call and put options on
stock indices in order to hedge against the risk of market or industry-wide
stock price fluctuations or to increase income to the fund. Call and put
options on stock indices are similar to options on securities except that,
rather than the right to buy or sell particular securities at a specified
price, options on a stock index give the holder the right to receive, upon
exercise of the option, an amount of cash if the closing level of the
underlying stock index is greater than (or less than, in the case of puts)
the exercise price of the option. This amount of cash is equal to the
difference between the closing price of the index and the exercise price of
the option, expressed in dollars multiplied by a specified number. Thus,
unlike options on individual securities, all settlements are in cash, and
gain or loss depends on price movements in the stock market generally (or in
a particular industry or segment of the market) rather than price movements
in individual securities.
All options written on stock indices must be covered. When a fund writes an
option on a stock index, it 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 option and will maintain the
account while the option is open or will otherwise cover the transaction.
OVER-THE-COUNTER OPTIONS ON SECURITIES ("OTC OPTIONS"). A 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 may engage in exchange
traded options. OTC options differ from exchange traded options in certain
material respects. OTC options are arranged directly with dealers and not, 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.
The funds understand the current position of the staff of the SEC to be that
purchased OTC options and the assets used as "cover" for written OTC options
are illiquid securities. The funds and their managers disagree with this
position. Nevertheless, pending a change in the staff's position, the funds
will treat OTC options as subject to its limitation on illiquid securities.
Please see "Illiquid Investments" below.
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, 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. If a
put option is exercised, the writer must fulfill its obligation to buy the
underlying security at the exercise price, which will usually exceed the then
market value of the underlying security.
FORWARD CONVERSIONS. In a forward conversion, a fund will buy securities and
write call options and buy put options on these securities. All options
written by the fund will be covered. By buying puts, the fund protects the
underlying security from depreciation in value. By selling or writing calls
on the same security, the fund receives premiums that may offset part or all
of the cost of purchasing the puts while foregoing the opportunity for
appreciation in the value of the underlying security. The fund will not
exercise a put it has purchased while a call option on the same security is
outstanding. The use of options in connection with forward conversions is
intended to hedge against fluctuations in the market value of the underlying
security. Although it is generally intended in forward conversion
transactions that the exercise price of put and call options would be
identical, situations might occur in which some option positions are acquired
with different exercise prices. Therefore, the fund's return may depend in
part on movements in the price of the underlying security because of the
different exercise prices of the call and put options. These price movements
may also affect a fund's total return if the conversion is terminated prior
to the expiration date of the options. In this event, the fund's return may
be greater or less than it would otherwise have been if it had hedged the
security only by buying put options.
SPREAD AND STRADDLE TRANSACTIONS. A fund may engage in "spread" transactions
in which it buys and writes a put or call option on the same underlying
security, with the options having different exercise prices and/or expiration
dates. All options written by the fund will be covered. A fund may also
engage in so-called "straddles," in which it buys or writes combinations of
put and call options on the same security. Because buying options in
connection with these transactions may, under certain circumstances, involve
a limited degree of investment leverage, the fund will not enter into any
spreads or straddles if, as a result, more than 5% of its net assets will be
invested at any time in these options transactions. A fund's ability to
engage in spread or straddle transactions may be further limited by state
securities laws.
FUTURES TRANSACTIONS Although each fund has the authority to enter into
these transactions, it currently has no intention of doing so.
Each fund may buy or sell (i) financial futures contracts such as interest
rate futures contracts; (ii) options on interest rate futures contracts;
(iii) stock index futures contracts; and (iv) options on stock index futures
contracts (collectively, "Futures Transactions") for bona fide hedging
purposes. Each fund may enter into these Futures Transactions on domestic
exchanges and, to the extent these transactions have been approved by the
CFTC for sale to customers in the U.S., on foreign exchanges. Each fund will
not engage in Futures Transactions for speculation but only as a hedge
against changes resulting from market conditions such as changes in interest
rates, currency exchange rates, or securities that it intends to buy. Each
fund will not enter into any Futures Transactions if, immediately thereafter,
more than 20% of the fund's net assets would be represented by futures
contracts or options thereon. In addition, the funds will not engage in any
Futures Transactions if, immediately thereafter, the sum of the amount of
initial margin deposits on the fund's futures positions and premiums paid for
options on its futures contracts would exceed 5% of the market value of the
fund's total assets.
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 will be required to pay to the futures commission merchant
an amount equal to this change in value.
A futures contract may generally be described as an agreement between two
parties to buy and sell particular financial instruments for an agreed price
during a designated month (or to deliver the final cash settlement price, in
the case of a contract relating to an index or otherwise not calling for
physical delivery at the end of trading in the contract).
When interest rates are rising or securities prices are falling, a fund can
seek, through the sale of futures contracts, to offset a decline in the value
of its current portfolio securities. When rates are falling or prices are
rising, the fund, through the purchase of futures contracts, can attempt to
secure better rates or prices than might later be available in the market
when it affects anticipated purchases. Similarly, the fund can sell futures
contracts on a specified currency to protect against a decline in the value
of this currency and its portfolio securities that are denominated in this
currency. Each fund can buy futures contracts on foreign currency to fix the
price in U.S. dollars of a security denominated in this currency that the
fund has acquired or expects to acquire.
Although futures contracts by their terms generally call for the actual
delivery or acquisition of underlying 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 this delivery. The contractual
obligation is offset 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
or the cash value of the index underlying the contractual obligations. A fund
may incur brokerage fees when it buys or sells futures contracts.
Positions taken in the futures markets are not normally held to maturity, but
are instead liquidated through offsetting transactions that may result in a
profit or a loss. While the funds' futures contracts on securities or
currency will usually be liquidated in this manner, each fund may instead
make or take delivery of the underlying securities or currency whenever it
appears economically advantageous for it to do so. A clearing corporation
associated with the exchange on which futures on securities or currency are
traded guarantees that, if still open, the buying or selling will be
performed on the settlement date.
OPTIONS ON FUTURES CONTRACTS. The acquisition of put and call options on
futures contracts will give each fund the right, but not the obligation, for
a specified price, to sell or to buy, respectively, the underlying futures
contract at any time during the option period. As the purchaser of an option
on a futures contract, each fund obtains the benefit of the futures position
if prices move in a favorable direction but limits its risk of loss in the
event of an unfavorable price movement to the loss of the premium and
transaction costs.
FINANCIAL FUTURES CONTRACTS. Financial futures are contracts that obligate
the holder to take or make delivery of a specified quantity of a financial
instrument, such as a U.S. Treasury security or foreign currencies, during a
specified future period at a specified price. A "sale" of a financial 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 financial 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. Examples of financial futures
contracts include interest rate futures contracts and stock index futures
contracts.
INTEREST RATE FUTURES CONTRACTS. Interest rate futures contracts are futures
contracts on debt securities. The value of these instruments changes in
response to changes in the value of the underlying debt security, that
depends primarily on prevailing interest rates. Each fund may enter into
interest rate futures contracts in order to protect its portfolio securities
from fluctuations in interest rates without necessarily buying or selling the
underlying fixed-income securities. For example, if a fund owns bonds, and
interest rates are expected to increase, it might sell futures contracts on
debt securities having characteristics similar to those held in the
portfolio. A sale would have much the same effect as selling an equivalent
value of the bonds owned by the fund. If interest rates did increase, the
value of the debt securities in the portfolio would decline, but the value of
the futures contracts to the fund would increase at approximately the same
rate, thereby keeping the Net Asset Value of the fund from declining as much
as it otherwise could have.
STOCK INDEX FUTURES CONTRACTS. A stock index futures contract obligates the
seller to deliver (and the purchaser to take) an amount of cash equal to a
specific dollar amount times the difference between the value of a specific
stock index at the close of the last trading day of the contract and the
price at which the agreement was made. Open futures contracts are valued on a
daily basis, and a fund may be obligated to provide or receive cash
reflecting any decline or increase in the contract's value. No physical
delivery of the underlying stocks in the index is made in the future.
Each fund may sell stock index futures contracts in anticipation of or during
a market decline in an attempt to offset the decrease in market value of its
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 offset
increases in the cost of common stocks that it intends to buy.
OPTIONS ON STOCK INDEX FUTURES CONTRACTS. 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 a stock index
futures contract 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 that 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.
HEDGING STRATEGIES WITH FUTURES. Hedging by use of futures contracts seeks to
establish with more certainty, than would otherwise be possible, the
effective price, rate of return or currency exchange rate on portfolio
securities or securities that a fund owns or proposes to acquire. Each fund
may, for example, take a "short" position in the futures market by selling
futures contracts in order to hedge against an anticipated rise in interest
rates or a decline in market prices of foreign currency rates that would
adversely affect the dollar value of the fund's portfolio securities. These
futures contracts may include contracts for the future delivery of securities
held by the fund or securities with characteristics similar to those of the
fund's portfolio securities. Similarly, the fund may sell futures contracts
on currency in which its portfolio securities are denominated or in one
currency to hedge against fluctuations in the value of securities denominated
in a different currency if there is an established historical pattern of
correlation between the two currencies.
If, in the opinion of the managers, there is a sufficient degree of
correlation between price trends for the funds' portfolio securities and
futures contracts based on other financial instruments, securities indices or
other indices, the funds may also enter into these futures contracts as part
of its hedging strategy. Although under some circumstances prices of
securities in the funds' portfolio may be more or less volatile than prices
of these futures contracts, the managers will attempt to estimate the extent
of this difference in volatility based on historical patterns and to
compensate for it by having the funds enter into a greater or fewer number of
futures contracts or by attempting to achieve only a partial hedge against
price changes affecting the funds' securities portfolio. When hedging of this
character is successful, any depreciation in the value of the portfolio
securities will substantially be offset by appreciation in the value of the
futures position. On the other hand, any unanticipated appreciation in the
value of the funds' portfolio securities would be substantially offset by a
decline in the value of the futures position.
On other occasions, a fund may take a "long" position by buying these futures
contracts. This would be done, for example, when a fund anticipates the
subsequent buy of particular securities when it has the necessary cash, but
expects the prices or currency exchange rates then available in the
applicable market to be less favorable than prices or rates that are
currently available.
The CFTC and U.S. commodities 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 funds do not believe that these
trading and positions limits will have an adverse impact on their strategies
for hedging their securities. The need to hedge against these risks will
depend on the extent of diversification of each funds' common stock portfolio
and the sensitivity of these investments to factors influencing the stock
market as a whole.
OTHER CONSIDERATIONS In certain cases, the options and futures markets
provide investment or risk management opportunities that are not available
from direct investments in securities. In addition, some strategies can be
performed more effectively and at a lower cost by utilizing the options and
futures markets rather than purchasing or selling portfolio securities.
However, there are risks involved in these transactions as discussed below.
The fund will engage in futures and related options transactions only for
bona fide hedging or other appropriate risk management purposes in accordance
with CFTC regulations that permit principals of an investment company
registered under the Investment Company Act of 1940 ("1940 Act") to engage in
these transactions without registering as commodity pool operators.
"Appropriate risk management purposes" means activities in addition to bona
fide hedging that the CFTC deems appropriate for operators of entities,
including registered investment companies, that are excluded from the
definition of commodity pool operator. The funds are not permitted to engage
in speculative futures trading. Each fund will determine that the price
fluctuations in the futures contracts and options on futures used for hedging
purposes are substantially related to price fluctuations in securities held
by the fund or which it expects to buy.
Except as stated below, the funds' futures transactions will be entered into
for traditional hedging purposes - that is, futures contracts will be sold to
protect against a decline in the price of securities it intends to buy (or
the currency will be purchased to protect the fund against an increase in the
price of the securities (or the currency in which they are denominated)). As
evidence of this hedging intent, each fund expects that on 75% or more of the
occasions on which it takes a long futures (or option) position involving the
purchase of futures contracts, the fund will have bought, or will be in the
process of buying, equivalent amounts of related securities (or assets
denominated in the related currency) in the cash market at the time when the
futures (or option) position is closed out. However, in particular cases when
it is economically advantageous for the fund to do so, a long futures
position may be terminated (or an option may expire) without the
corresponding purchase of securities or other assets. In the alternative, a
CFTC regulation permits the fund to elect to comply with a different test,
under which (i) the fund's long futures positions will be used as part of its
portfolio management strategy and will be incidental to its activities in the
underlying cash market and (ii) the aggregate initial margin and premiums
required to establish these positions will not exceed 5% of the liquidation
value of the fund's investment portfolio (a) after taking into account
unrealized profits and losses on any such contracts into which the fund has
entered and (b) excluding the in-the-money amount with respect to any option
that is in-the-money at the time of purchase.
Each fund will engage in transactions in futures contracts and related
options only to the extent these transactions are consistent with the
requirements of the Code for maintaining its qualification as a regulated
investment company for federal income tax purposes.
Each fund will not buy or sell futures contracts or buy or sell related
options, except for closing purchase or sale transactions, if immediately
thereafter the sum of the amount of margin deposits on the fund's outstanding
futures and related options positions and the amount of premiums paid for
outstanding options on futures would exceed 5% of the market value of the
fund's total assets. These transactions involve brokerage costs, require
margin deposits and, in the case of contracts and options obligating the fund
to buy securities or currencies, require the fund to segregate assets to
cover these contracts and options.
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
managers may still not result in a successful transaction.
Perfect correlation between a fund's futures positions and portfolio
positions may be difficult to achieve because no futures contracts based on
corporate fixed-income securities are currently available. In addition, it is
not possible to hedge fully or perfectly against currency fluctuations
affecting the value of securities denominated in foreign currencies because
the value of these securities is likely to fluctuate as a result of
independent factors not related to currency fluctuations.
OTHER INVESTMENT POLICIES
CONVERTIBLE SECURITIES As with a straight fixed-income security, a
convertible security tends to increase in market value when interest rates
decline and decrease in value when interest rates rise. Like a common stock,
the value of a convertible security also tends to increase as the market
value of the underlying stock rises, and it tends to decrease as the market
value of the underlying stock declines. Because its value can be influenced
by both interest rate and market movements, a convertible security is not as
sensitive to interest rates as a similar fixed-income security, nor is it as
sensitive to changes in share price as its underlying stock.
A convertible security is usually issued either by an operating company or by
an investment bank. When issued by an operating company, a convertible
security tends to be senior to common stock, but subordinate to other types
of fixed-income securities issued by that company. When a convertible
security issued by an operating company is "converted," the operating company
often issues new stock to the holder of the convertible security but, if the
parity price of the convertible security is less than the call price, the
operating company may pay out cash instead of common stock. If the
convertible security is issued by an investment bank, the security is an
obligation of and is convertible through the issuing investment bank. The
issuer of a convertible security may be important in determining the
security's true value. This is because the holder of a convertible security
will have recourse only to the issuer.
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.
Each fund may invest in convertible preferred stocks that offer enhanced
yield features, such as Preferred Equity Redemption Cumulative Stocks
("PERCS"), which provide an investor, such as the fund, with the opportunity
to earn higher dividend income than is available on a company's common stock.
PERCS are preferred stocks that generally feature a mandatory conversion
date, as well as a capital appreciation limit which is usually expressed in
terms of a stated price. Most PERCS expire three years from the date of
issue, at which time they are convertible into common stock of the issuer.
PERCS are generally not convertible into cash at maturity. Under a typical
arrangement, after three years PERCS convert into one share of the issuer's
common stock if the issuer's common stock is trading at a price below that
set by the capital appreciation limit, and into less than one full share if
the issuer's common stock is trading at a price above that set by the capital
appreciation limit. The amount of that fractional share of common stock is
determined by dividing the price set by the capital appreciation limit by the
market price of the issuer's common stock. PERCS can be called at any time
prior to maturity, and hence do not provide call protection. If called early,
however, the issuer must pay a call premium over the market price to the
investor. This call premium declines at a preset rate daily, up to the
maturity date.
Each fund may also invest in other classes of enhanced convertible
securities. These include but are not limited to ACES (Automatically
Convertible Equity Securities), PEPS (Participating Equity Preferred Stock),
PRIDES (Preferred Redeemable Increased Dividend Equity Securities), SAILS
(Stock Appreciation Income Linked Securities), TECONS (Term Convertible
Notes), QICS (Quarterly Income Cumulative Securities), and DECS (Dividend
Enhanced Convertible Securities). ACES, PEPS, PRIDES, SAILS, TECONS, QICS,
and DECS all have the following features: they are issued by the company, the
common stock of which will be received in the event the convertible preferred
stock is converted; unlike PERCS they do not have a capital appreciation
limit; they seek to provide the investor with high current income with some
prospect of future capital appreciation; they are typically issued with three
or four-year maturities; they typically have some built-in call protection
for the first two to three years; investors have the right to convert them
into shares of common stock at a preset conversion ratio or hold them until
maturity; and, upon maturity, they will necessarily convert into either cash
or a specified number of shares of common stock.
Similarly, there may be enhanced convertible debt obligations issued by the
operating company, whose common stock is to be acquired in the event the
security is converted, or by a different issuer, such as an investment bank.
These securities may be identified by names such as ELKS (Equity Linked
Securities) or similar names. Typically they share most of the salient
characteristics of an enhanced convertible preferred stock but will be ranked
as senior or subordinated debt in the issuer's corporate structure according
to the terms of the debt indenture. There may be additional types of
convertible securities not specifically referred to herein which may be
similar to those described above in which a fund may invest, consistent with
its goal and policies.
An investment in an enhanced convertible security or any other security may
involve additional risks to the fund. 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, intends to acquire liquid securities, though there can be no
assurances that this will be achieved.
REPURCHASE TRANSACTIONS Each fund may enter into repurchase agreements. A
repurchase agreement is an agreement in which the seller of a security agrees
to repurchase the security sold at a mutually agreed upon time and price.
Under the 1940 Act, a repurchase agreement is deemed to be the loan of money
by a fund to the seller, collateralized by the underlying security. The
resale price is normally in excess of the purchase price, reflecting an
agreed upon interest rate. The interest rate is effective for the period of
time in which the fund is invested in the agreement and is not related to the
coupon rate on the underlying security. The period of these repurchase
agreements will usually be short, from overnight to one week, and at no time
will a fund invest in repurchase agreements for more than one year. However,
the securities that are subject to repurchase agreements may have maturity
dates in excess of one year from the effective date of the repurchase
agreements. The fund will make payment for these securities only upon
physical delivery or evidence of book entry transfer to the account of their
custodian bank. The fund may not enter into a repurchase agreement with more
than seven days duration if, as a result, the market value of the fund's net
assets, together with investments in other securities deemed to be not
readily marketable, would be invested in these repurchase agreements in
excess of the fund's policy on investments in illiquid securities.
ILLIQUID INVESTMENTS Securities that are acquired by the fund 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 are not considered by the fund to
be illiquid assets, so long as the fund acquires and holds the securities
with the intention of reselling the securities in the foreign trading market,
the fund reasonably believes it can readily dispose of the securities for
cash in the U.S. or foreign market, and current market quotations are readily
available. Investments may be in securities of foreign issuers, whether
located in developed or undeveloped countries. The board has authorized each
fund to invest in restricted securities where this investment is consistent
with the fund's investment objective and has authorized these securities to
be considered liquid to the extent the managers, as the case may be,
determine that there is a liquid institutional or other market for these
securities, for example, restricted securities that may be freely transferred
among qualified institutional buyers pursuant to Rule 144A under the
Securities Act of 1933 and for which a liquid institutional market has
developed. The board reviews any determination by the managers to treat a
restricted security as liquid on a quarterly basis, including the managers'
assessment of current trading activity and the availability of reliable price
information. In determining whether a restricted security is properly
considered a liquid security, the managers 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 purchasers; (iii) dealer undertakings to make a
market in the security; and (iv) the nature of the security and the nature of
the marketplace trades (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 in the fund may be increased if qualified institutional
buyers become uninterested in purchasing 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 their assets in high quality money market
instruments. These include government securities, bank obligations, the
highest quality commercial paper and repurchase agreements. For the Pacific
Fund, these securities must be rated A-1 or A-2 by S&P or Prime-1 or Prime-2
by Moody's or if unrated, determined to be of comparable quality. The Smaller
Companies Fund may also invest in non-U.S. currency, short-term instruments
denominated in non-U.S. currencies and medium-term (up to five years to
maturity) obligations issued or guaranteed by the U.S. government or the
governments of foreign countries, their agencies or instrumentalities.
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.
Each fund may not:
1. Purchase the securities of any one issuer (other than cash, cash items
and obligations of the U.S. government) if immediately thereafter and as a
result of the purchase, with respect to 75% of its total assets, 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 or all classes of
the outstanding voting 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 either fund's
portfolio securities, or to the extent the entry into a repurchase agreement
may be deemed a loan;
3. Borrow money, except for temporary or emergency (but not investment)
purposes from banks and only in an amount up to 10% of the value of the
assets. While borrowings exceed 5% of a fund's total assets, it 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, except insofar as a fund may be
technically deemed an underwriter under the federal securities laws in
connection with the disposition of portfolio securities;
6. Purchase illiquid securities, including illiquid securities which, at the
time of acquisition, could be disposed of publicly by each fund only after
registration under the 1933 Act, if as a result more than 10% of their net
assets would be invested in such illiquid securities;
7. Invest in securities for the purpose of exercising management or control
of the issuer;
8. Maintain a margin account with a securities dealer, except that either
fund may obtain such short-term credits as may be necessary for the clearance
of purchases and sales of securities, nor invest in commodities or
commodities contracts or interests (other than publicly-traded equity
securities) or leases with respect to any oil, gas or other mineral
exploration or development programs, except that either fund may enter into
contracts for hedging purposes and make margin deposits in connection
therewith;
9. Effect short sales, unless at the time the fund owns securities
equivalent in kind and amount to those sold;
10. Invest more than 5% of total assets in companies which have a record of
less than three years continuous operation, including the operations of any
predecessor companies;
11. Invest directly in real estate or real estate limited partnerships
(although either fund may invest in real estate investment trusts) or in the
securities of other investment companies, except to the extent permitted
under the 1940 Act or pursuant to any exemptions therefrom, including any
exemption permitting either fund to invest in shares of one or more money
market funds managed by the manager or its affiliates, or except that
securities of another investment company may be acquired pursuant to a plan
of reorganization, merger, consolidation or acquisition; or
12. Purchase or retain in either fund's portfolio any security if any
officer, trustee or securityholder of the issuer is at the same time an
officer, trustee or employee of the Trust or of its investment advisor and
such person owns beneficially more than 1/2 of 1% of the securities, and if
all such persons owning more than 1/2 of 1% own more than 5% of the
outstanding securities of the issuer.
Each fund presently has the following additional restrictions, which are not
fundamental and may be changed without shareholder approval. Each fund may
not issue senior securities except to the extent that this restriction shall
not be deemed to prohibit the fund from making any permitted borrowings,
pledging, mortgaging or hypothecating the fund's assets as security for
loans, entering into repurchase transactions, engaging in joint and several
trading accounts in securities, except that an order to purchase or sell may
be combined with orders from other persons to obtain lower brokerage
commissions and except as the fund may participate in a joint repurchase
agreement account with other funds in the Franklin Templeton Group of Funds.
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.
If a percentage restriction is met at the time of investment, a later
increase or decrease in the percentage due to a change in the value or
liquidity of portfolio securities or the amount of assets will not be
considered a violation of any of the foregoing restrictions.
RISKS
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FOREIGN SECURITIES Since foreign companies are not subject to uniform
accounting, auditing and financial reporting practices and requirements
comparable to those applicable to U.S. companies, there may be less publicly
available information about a foreign company than about a U.S. company.
Volume and liquidity in most foreign bond markets are less than in the U.S.,
and securities of many foreign companies are less liquid and more volatile
than securities of comparable U.S. companies. Fixed commissions on foreign
securities exchanges are generally higher than negotiated commissions on U.S.
exchanges, although each fund endeavors to achieve the most favorable net
results on its portfolio transactions. There is generally less government
supervision and regulation of securities exchanges, brokers, dealers and
listed companies than in the U.S., thus increasing the risk of delayed
settlements of portfolio transactions or loss of certificates for portfolio
securities.
Foreign markets also have different clearance and settlement procedures, and
in certain markets there have been times when settlements have been unable to
keep pace with the volume of securities transactions, making it difficult to
conduct these transactions. These delays in settlement could result in
temporary periods when a portion of the assets of the fund is uninvested and
no return is earned thereon. The inability of each fund to make intended
security purchases due to settlement problems could cause the fund to miss
attractive investment opportunities. Losses to a fund due to subsequent
declines in the value of portfolio securities, or losses arising out of the
fund's inability to fulfill a contract to sell these securities, could result
in potential liability to the fund. In addition, with respect to certain
foreign countries, there is the possibility of expropriation or confiscatory
taxation, political or social instability, or diplomatic developments that
could affect the fund's investments in those countries. Moreover, individual
foreign economies may differ favorably or unfavorably from the U.S. economy
in growth of gross national product, rate of inflation, capital reinvestment,
resource self-sufficiency and balance of payments positions.
Investments in foreign securities where delivery takes place outside the U.S.
will have to be made in compliance with any applicable U.S. and foreign
currency restrictions and tax laws (including laws imposing withholding taxes
on any dividend or interest income) and laws limiting the amount and types of
foreign investments. Changes of governmental administrations or of economic
or monetary policies, in the U.S. or abroad, or changed circumstances in
dealings between nations, or currency convertibility or exchange rates could
result in investment losses for a fund. Investments in foreign securities may
also subject the fund to losses due to nationalization, expropriation or
differing account-ing practices and treatments. Moreover, you should
recognize that foreign securities are often traded with less frequency and
volume, and therefore may have greater price volatility, than is the case
with many U.S. securities. Brokerage commissions, custodial services, and
other costs relating to investment in foreign countries are generally more
expensive than in the U.S. Notwithstanding the fact that a fund generally
intends to acquire the securities of foreign issuers where there are public
trading markets, investments by a fund in the securities of foreign issuers
may tend to increase the risks with respect to the liquidity of a fund's
portfolio and the fund's ability to meet a large number of shareholder
redemption requests should there be economic or political turmoil in a
country in which a fund has a substantial portion of its assets invested or
should relations between the U.S. and foreign countries deteriorate markedly.
Furthermore, the reporting and disclosure requirements applicable to foreign
issuers may differ from those applicable to domestic issuers, and there may
be difficulties in obtaining or enforcing judgments against foreign issuers.
Depositary Receipts (such as American Depositary Receipts, European
Depositary Receipts and Global Depositary Receipts) may not necessarily be
denominated in the same currency as the underlying securities into which they
may be converted. In addition, the issuers of the securities underlying
unsponsored Depositary Receipts are not obligated to disclose material
information in the U.S. and, therefore, there may be less information
available regarding these issuers and there may not be a correlation between
such information and the market value of the Depositary Receipts. Depositary
Receipts also involve the risks of other investments in foreign securities,
as discussed above.
DEVELOPING MARKETS Investments in companies domiciled in developing
countries may be subject to potentially higher risks than investments in
companies in developed countries. These risks include (i) less social,
political and economic stability; (ii) the smaller size of the markets for
these securities and the currently low or nonexistent volume of trading, that
result in a lack of liquidity and in greater price volatility; (iii) the lack
of publicly available information, including reports of payments of dividends
or interest on outstanding securities; (iv) certain national policies that
may restrict a fund's investment opportunities, including restrictions on
investment in issuers or industries deemed sensitive to national interests;
(v) foreign taxation; (vi) the absence of developed structures governing
private or foreign investment or allowing for judicial redress for injury to
private property; (vii) the absence, until recently in certain Eastern
European countries and Russia, of a capital market structure or
market-oriented economy; (viii) the possibility that recent favorable
economic developments in Eastern Europe and Russia may be slowed or reversed
by unanticipated political or social events in these countries; (ix)
restrictions that may make it difficult or impossible for the fund to vote
proxies, exercise shareholder rights, pursue legal remedies, and obtain
judgments in foreign courts; (x) the risk of uninsured loss due to lost,
stolen, or counterfeit stock certificates; and (xi) possible losses through
the holding of securities in domestic and foreign custodial banks and
depositories.
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.
Repatriation of investment income, capital and proceeds of sales by foreign
investors may require governmental registration and/or approval in some
developing countries. The funds could be adversely affected by delays in or a
refusal to grant any required governmental registration or approval for
repatriation.
Further, the economies of developing countries generally are heavily
dependent upon international trade and, accordingly, have been and may
continue to be adversely affected by trade barriers, exchange controls,
managed adjustments in relative currency values and other protectionist
measures imposed or negotiated by the countries with which they trade.
Investments in Eastern European countries may involve risks of
nationalization, expropriation and confiscatory taxation. The communist
governments of a number of Eastern European countries expropriated large
amounts of private property in the past, in many cases without adequate
compensation, and there can be no assurance that this expropriation will not
occur in the future. In the event of this expropriation, the Smaller
Companies Fund could lose a substantial portion of any investments it has
made in the affected countries. Further, no accounting standards exist in
Eastern European countries. Finally, even though certain Eastern European
currencies may be convertible into U.S. dollars, the conversion rates may be
artificial relative to the actual market values and may be unfavorable to
fund investors.
Certain Eastern European countries, which do not have market economies, are
characterized by an absence of developed legal structures governing private
and foreign investments and private property. Certain countries require
governmental approval prior to investments by foreign persons, or limit the
amount of investment by foreign persons in a particular company, or limit the
investment of foreign persons to only a specific class of securities of a
company that may have less advantageous terms than securities of the company
available for purchase by nationals.
Authoritarian governments in certain Eastern European countries may require
that a governmental or quasi-governmental authority act as custodian of the
Smaller Companies Fund's assets invested in this country. To the extent these
governmental or quasi-governmental authorities do not satisfy the
requirements of the 1940 Act to act as foreign custodians of the Smaller
Companies Fund's cash and securities, the fund's investment in these
countries may be limited or may be required to be effected through
intermediaries. The risk of loss through governmental confiscation may be
increased in these countries.
Investing in Russian securities 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. These risks include:
(a) delays in settling portfolio transactions and risk of loss arising out of
Russia's unique system of share registration and custody; (b) the risk that
it may be impossible or more difficult than in other countries to obtain
and/or enforce a judgment; (c) pervasiveness of corruption and crime in the
Russian economic system; (d) currency exchange rate volatility and the lack
of available currency hedging instruments; (e) higher rates of inflation
(including the risk of social unrest associated with periods of
hyperinflation or other factors); (f) controls on foreign investment and
local practices disfavoring foreign investors and limitations on repatriation
of invested capital, profits and dividends, and on the Smaller Companies
Fund's ability to exchange local currencies for U.S. dollars; (g) the risk
that the Russian government or other executive or legislative bodies may
decide not to continue to support the economic reform programs implemented
since the dissolution of the Soviet Union and could follow radically
different political and/or economic policies to the detriment of investors,
including non-market oriented policies such as the support of certain
industries at the expense of other sectors or investors, or a return to the
centrally planned economy that existed prior to the dissolution of the Soviet
Union; (h) the financial condition of Russian companies, including large
amounts of inter-company debt that may create a payments crisis on a national
scale; (i) dependency on exports and the corresponding importance of
international trade; (j) the risk that the Russian tax system will not be
reformed to prevent inconsistent, retroactive and/or exorbitant taxation; and
(k) possible difficulty in identifying a purchaser of securities held by the
Smaller Companies Fund due to the underdeveloped nature of the securities
markets.
There is little historical data on Russian securities markets because they
are relatively new and a substantial proportion of securities transactions in
Russia are privately negotiated outside of stock exchanges. Because of the
recent formation of the securities markets, as well as the underdeveloped
state of the banking and telecommunications systems, settlement, clearing and
registration of securities transactions are subject to significant risks.
Ownership of shares (except where shares are held through depositaries that
meet the requirements of the 1940 Act) is defined according to entries in the
company's share register and normally evidenced by extracts from the register
or by formal share certificates. However, there is no central registration
system for shareholders and these services are carried out by the companies
themselves or by registrars located throughout Russia. These registrars are
not necessarily subject to effective state supervision and it is possible for
the fund to lose its registration through fraud, negligence or even mere
oversight. While a 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 a 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 a 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 1,000 shareholders is required by law to contract out the maintenance of
its shareholder register to an independent entity that meets certain
criteria, in practice this regulation has not always been strictly enforced.
Because of this lack of independence, management of a company may be able to
exert considerable influence over who can buy and sell the company's shares
by illegally instructing the registrar to refuse to record transactions in
the share register. This practice may prevent a fund from investing in the
securities of certain Russian issuers deemed suitable by the managers.
Further, this could cause a delay in the sale of Russian securities by a fund
if a potential purchaser is deemed unsuitable, which may expose that fund to
potential loss on the investment.
FORWARD TRANSACTIONS While each fund will enter into forward contracts to
reduce currency exchange rate risks, transactions in these contracts involve
certain other risks. Thus, while each fund may benefit from these
transactions, unanticipated changes in currency prices may result in a poorer
overall performance for the fund than if it had not engaged in any of these
transactions. Moreover, there may be imperfect correlation between the fund's
portfolio holdings of securities denominated in a particular currency and
forward contracts entered into by the fund. This imperfect correlation may
cause a fund to sustain losses that will prevent the fund from achieving a
complete hedge or expose the fund to risk of foreign exchange loss.
OPTIONS AND FUTURES Each 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, securities or currencies underlying the hedging instrument
and the hedged securities that would result in a loss on both these
securities and the hedging instrument. In addition, it is not possible to
hedge fully or perfectly against currency fluctuations affecting the value of
securities denominated in foreign currencies because the value of these
securities is also likely to fluctuate as a result of independent factors not
related to currency fluctuations. Therefore, perfect correlation between the
fund's futures positions and portfolio positions will be impossible to
achieve. Accordingly, successful use by the fund of options on stock indices,
financial and currency futures contracts and related options, and currency
options will be subject to the fund's managers' ability to predict correctly
movements in the direction of the securities and currency markets generally
or of a particular segment. If the fund's managers are not successful in
employing these instruments in managing the fund's investments, the fund's
performance will be worse than if it did not employ these strategies. In
addition, the fund will pay commissions and other costs in connection with
these investments, that may increase the fund's expenses and reduce the
return. In writing options on futures, the fund's loss is potentially
unlimited and may exceed the amount of the premium received.
Positions in stock index options, stock index futures contracts, financial
futures contracts, foreign currency futures contracts, related options on
futures and options on currencies 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, futures contract or
option thereon at any specific time. Thus, it may not be possible to close
such an option or futures position. The inability to close options or futures
positions could have an adverse impact on a fund's ability to effectively
hedge its securities or foreign currency exposure. Each fund will enter into
options or futures positions only if its managers believe that a liquid
secondary market for these options or futures contracts exist.
In the case of OTC options on securities, 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 prior to
its expiration only by entering into a closing purchase transaction with the
dealer to which the fund originally wrote it. If the fund, on a covered call
option, cannot effect a closing transaction, it cannot sell the underlying
security until the option expires or the option is exercised. Therefore, when
a fund writes an OTC call option, it may not be able to sell the underlying
security even though it might otherwise be advantageous to do so. Likewise, a
fund may be unable to sell the securities it has pledged to secure OTC put
options while it is obligated as a put writer. Similarly, when a fund is a
buyer of a put or call option, the fund might find it difficult to terminate
its position on a timely basis in the absence of a secondary market. The
ability to terminate OTC options is more limited than with exchange traded
options and may involve the risk that broker-dealers participating in such
transactions will not fulfill their obligations. Until such time as the staff
of the SEC changes its position, the fund will treat purchased OTC options
and all assets used to cover written OTC options as illiquid securities,
except that with respect to options written with primary dealers in U.S.
government securities pursuant to an agreement requiring a closing purchase
transaction at a formula price, the amount of illiquid securities may be
calculated with reference to a formula approved by the staff of the SEC.
Reasons for the absence of a liquid secondary market on an exchange include
the following:
(i) there may be insufficient trading interest in certain options; (ii)
restrictions may be imposed by an exchange on opening transactions or closing
transactions or both; (iii) trading halts, suspensions or other restrictions
may be imposed with respect to particular classes or series of options; (iv)
unusual or unforeseen circumstances may interrupt normal operations on an
exchange; (v) the facilities of an exchange or the Options Clearing
Corporation (the "OCC") may not at all times be adequate to handle current
trading volume; or (vi) one or more exchanges could, for economic or other
reasons, decide or be compelled at some future date to discontinue the
trading of options (or a particular class or series of options), in which
event the secondary market on that exchange (or in that class or series of
options) would cease to exist, although outstanding options on that exchange
that had been issued by the OCC as a result of trades on that exchange would
continue to be exercisable in accordance with their terms.
HIGH YIELDING, FIXED-INCOME SECURITIES The Smaller Companies Fund may invest
up to 5% of its assets in fixed income securities that are rated below
investment grade or are unrated but deemed by the managers to be of
equivalent quality.
The market value of lower rated, fixed-income securities and unrated
securities of comparable quality, commonly known as junk bonds, tends to
reflect individual developments affecting the issuer to a greater extent than
the market value of higher rated securities, that react primarily to
fluctuations in the general level of interest rates. Lower rated securities
also tend to be more sensitive to economic conditions than higher rated
securities. These lower rated fixed-income securities are considered by the
rating agencies, on balance, to be predominantly speculative with respect to
the issuer's capacity to pay interest and repay principal in accordance with
the terms of the obligation and will generally involve more credit risk than
securities in the higher rating categories. Even securities rated "BBB" by
S&P or "Baa" by Moody's, ratings that are considered investment grade,
possess some speculative characteristics.
Issuers of high yielding, fixed-income securities are often highly leveraged
and may not have more traditional methods of financing available to them.
Therefore, the risk associated with acquiring the securities of these issuers
is generally greater than is the case with higher rated securities. For
example, during an economic downturn or a sustained period of rising interest
rates, highly leveraged issuers of high yielding securities may experience
financial stress. During these periods, these issuers may not have sufficient
cash flow to meet their interest payment obligations. The issuer's ability to
service its debt obligations may also be adversely affected by specific
developments affecting the issuer, the issuer's inability to meet specific
projected business forecasts, or the unavailability of additional financing.
The risk of loss due to default by the issuer may be significantly greater
for the holders of high yielding securities because the securities are
generally unsecured and are often subordinated to other creditors of the
issuer. Current prices for defaulted bonds are generally significantly lower
than their purchase price, and the Smaller Companies Fund may have unrealized
losses on defaulted securities that are reflected in the price of the Smaller
Companies Fund's shares. In general, securities that default lose much of
their value in the time period before the actual default so that the Smaller
Companies Fund's net assets are impacted prior to the default. The Smaller
Companies Fund may retain an issue that has defaulted because the issue may
present an opportunity for subsequent price recovery. The Smaller Companies
Fund may be required under the Code and U.S. Treasury regulations to accrue
income for income tax purposes on defaulted obligations and to distribute the
income to the Smaller Companies Fund's shareholders even though the Smaller
Companies Fund is not currently receiving interest or principal payments on
these obligations. In order to generate cash to satisfy any or all of these
distribution requirements, the Smaller Companies Fund may be required to
dispose of portfolio securities that it otherwise would have continued to
hold or to use cash flows from other sources such as the sale of fund shares.
The Smaller Companies Fund may have difficulty disposing of certain high
yielding securities because there may be a thin trading market for a
particular security at any given time. The market for lower rated,
fixed-income securities generally tends to be concentrated among a smaller
number of dealers than is the case for securities that trade in a broader
secondary retail market. Generally, buyers of these securities are
predominantly dealers and other institutional buyers, rather than
individuals. To the extent the secondary trading market for a particular high
yielding, fixed-income security does exist, it is generally not as liquid as
the secondary market for higher rated securities. Reduced liquidity in the
secondary market may have an adverse impact on market price and the Smaller
Companies Fund's ability to dispose of particular issues, when necessary, to
meet the Smaller Companies Fund's liquidity needs or in response to a
specific economic event, such as a deterioration in the creditworthiness of
the issuer.
The Smaller Companies Fund may acquire high yielding, fixed-income securities
during an initial underwriting. These securities involve special risks
because they are new issues. The managers will carefully review their credit
and other characteristics. The Smaller Companies 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
prior to 1990 paralleled a long economic expansion. The recession that began
in 1990 disrupted the market for high yielding securities and adversely
affected the value of outstanding securities and the ability of issuers of
these securities to meet their obligations. Although the economy has improved
considerably and high yielding securities have performed more consistently
since that time, there is no assurance that the adverse effects previously
experienced will not reoccur. The Smaller Companies Fund will rely on the
managers' judgment, analysis and experience in evaluating the
creditworthiness of an issuer. In this evaluation, the managers will take
into consideration, among other things, the issuer's financial resources, its
sensitivity to economic conditions and trends, its operating history, the
quality of the issuer's management and regulatory matters.
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.
Franklin Resources, Inc. has created an interdepartmental team to handle all
euro-related changes to enable the Franklin Templeton Funds to process
transactions accurately and completely with minimal disruption to business
activities. While the implementation of the euro could have a negative effect
on the 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
- --------------------------------------------------------------------------------
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 affiliations of the officers and board members and their principal
occupations for the past five years are shown below.
POSITION(S) HELD PRINCIPAL OCCUPATION(S) DURING
NAME, AGE AND ADDRESS WITH THE TRUST THE PAST FIVE YEARS
- --------------------------------------------------------------------------------
Frank H. Abbott, III (77)
1045 Sansome Street
San Francisco, CA 94111
Trustee
President and Director, Abbott Corporation (an investment company); director
or trustee, as the case may be, of 27 of the investment companies in the
Franklin Templeton Group of Funds; and FORMERLY, Director, MotherLode Gold
Mines Consolidated (gold mining) and Vacu-Dry Co. (food processing).
Harris J. Ashton (66)
191 Clapboard Ridge Road
Greenwich, CT 06830
Trustee
Director, RBC Holdings, Inc. (bank holding company) and Bar-S Foods (meat
packing company); director or trustee, as the case may be, of 49 of the
investment companies in the Franklin Templeton Group of Funds; and FORMERLY,
President, Chief Executive Officer and Chairman of the Board, General Host
Corporation (nursery and craft centers).
*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 53 of the investment
companies in the Franklin Templeton Group of Funds.
S. Joseph Fortunato (66)
Park Avenue at Morris County
P.O. Box 1945
Morristown, NJ 07962-1945
Trustee
Member of the law firm of Pitney, Hardin, Kipp & Szuch; director or trustee,
as the case may be, of 51 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 25 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 and Trustee
Chairman of
the Board
President, Chief Executive Officer and Director, Franklin Resources, Inc.;
Chairman of the Board and Director, Franklin Advisers, Inc., Franklin
Advisory Services, Inc., Franklin Investment Advisory Services, Inc. and
Franklin Templeton Distributors, Inc.; Director, Franklin/Templeton Investor
Services, Inc. and Franklin Templeton Services, Inc.; officer and/or director
or trustee, as the case may be, of most of the other subsidiaries of Franklin
Resources, Inc. and of 50 of the investment companies in the Franklin
Templeton Group of Funds.
*Rupert H. Johnson, Jr. (58)
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 and
Director, Franklin Advisory Services, Inc.; Director, Franklin/ Templeton
Investor Services, Inc.; and officer and/or director or trustee, as the case
may be, of most of the other subsidiaries of Franklin Resources, Inc. and of
53 of the investment companies in the Franklin Templeton Group of Funds.
Frank W.T. LaHaye (69)
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, Quarterdeck Corporation
(software firm) and Digital Transmission Systems, Inc. (wireless
communications); director or trustee, as the case may be, of 27 of the
investment companies in the Franklin Templeton Group of Funds; and FORMERLY,
Director, Fischer Imaging Corporation (medical imaging systems) and General
Partner, Peregrine Associates, which was the General Partner of Peregrine
Ventures (venture capital firm).
Gordon S. Macklin (70)
8212 Burning Tree Road
Bethesda, MD 20817
Trustee
Director, Fund American Enterprises Holdings, Inc., (holding company) Martek
Biosciences Corporation, MCI WorldCom (information services), MedImmune, Inc.
(biotechnology), Spacehab, Inc. (aerospace services) and Real 3D (software);
director or trustee, as the case may be, of 49 of the investment companies in
the Franklin Templeton Group of Funds; and FORMERLY, Chairman, White River
Corporation (financial services) and Hambrecht and Quist Group (investment
banking), and President, National Association of Securities Dealers, Inc.
Martin L. Flanagan (38)
777 Mariners Island Blvd.
San Mateo, CA 94404
Vice President
and Chief
Financial Officer
Senior Vice President and Chief Financial Officer, Franklin Resources, Inc.,
Franklin/Templeton Investor Services, Inc. and Franklin Mutual Advisers,
Inc.; Executive Vice President and Director, Templeton Worldwide, Inc.;
Executive Vice President, Chief Operating Officer and Director, Templeton
Investment Counsel, Inc.; Executive Vice President and Chief Financial
Officer, Franklin Advisers, Inc.; Chief Financial Officer, Franklin Advisory
Services, Inc. and Franklin Investment Advisory Services, Inc.; President and
Director, Franklin Templeton Services, Inc.; officer and/or director of some
of the other subsidiaries of Franklin Resources, Inc.; and officer and/or
director or trustee, as the case may be, of 53 of the investment companies in
the Franklin Templeton Group of Funds.
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. and
Franklin Mutual Advisers, Inc.; Vice President, Franklin Advisory Services,
Inc.; Vice President, Chief Legal Officer and Chief Operating Officer,
Franklin Investment Advisory Services, Inc.; and officer of 54 of the
investment companies in the Franklin Templeton Group of Funds.
Charles E. Johnson (42)
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 34 of the
investment companies in the Franklin Templeton Group of Funds.
Diomedes Loo-Tam (60)
777 Mariners Island Blvd.
San Mateo, CA 94404
Treasurer and
Principal
Accounting
Officer
Senior Vice President, Franklin Templeton Services, Inc.; and officer of 32
of the investment companies in the Franklin Templeton Group of Funds.
Edward V. McVey (61)
777 Mariners Island Blvd.
San Mateo, CA 94404
Vice President
Senior Vice President and National Sales Manager, Franklin Templeton
Distributors, Inc.; and officer of 28 of the investment companies in the
Franklin Templeton Group of Funds.
R. Martin Wiskemann (72)
777 Mariners Island Blvd.
San Mateo, CA 94404
Vice President
Senior Vice President, Portfolio Manager and Director, Franklin Advisers,
Inc.; Senior Vice President, Franklin Management, Inc.; Vice President and
Director, ILA Financial Services, Inc.; and officer and/or director or
trustee, as the case may be, of 15 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 $300 per quarter plus $150 per
meeting attended. Board members who serve on the audit committee of the trust
and other funds in the Franklin Templeton Group of Funds receive a flat fee
of $2,000 per committee meeting attended, a portion of which is allocated to
the trust. Members of a committee are not compensated for any committee
meeting held on the day of a board meeting. Noninterested board members may
also serve as directors or trustees of other funds in the Franklin Templeton
Group of Funds and may receive fees from these funds for their services. The
fees payable to noninterested board members by the trust are subject to
reductions resulting from fee caps limiting the amount of fees payable to
board members who serve on other boards within the Franklin Templeton Group
of Funds. The following table provides the total fees paid to noninterested
board members by the trust and by the Franklin Templeton Group of Funds.
<TABLE>
<CAPTION>
NUMBER OF BOARDS
IN THE FRANKLIN
TOTAL FEES RECEIVED FROM THE TEMPLETON GROUP
RECEIVED FROM FRANKLIN TEMPLETON OF FUNDS ON WHICH
NAME THE TRUST 1 GROUP OF FUNDS 2 EACH SERVES 3
- ------------------------------------------------------------------------------------
<S> <C> <C> <C>
Frank H. Abbott, III....... $540 $159,051 27
Harris J. Ashton........... 716 361,157 49
S. Joseph Fortunato........ 668 367,835 51
Edith E. Holiday........... 900 211,400 25
Frank W.T. LaHaye.......... 690 163,753 27
Gordon S. Macklin.......... 716 361,157 49
</TABLE>
1. For the fiscal year ended October 31, 1998. During the period from October
31, 1997, through May 31, 1998, noninterested board members were not paid fees.
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 164 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
- --------------------------------------------------------------------------------
MANAGER AND SERVICES PROVIDED The funds' manager is Franklin Advisers, Inc.
The manager is wholly owned by Franklin Resources, Inc. (Resources), a
publicly owned company engaged in the financial services industry through its
subsidiaries. Charles B. Johnson and Rupert H. Johnson, Jr. are the principal
shareholders of Resources.
The 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 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 Templeton organization has been investing globally since 1940. The
manager and its affiliates have offices in Argentina, Australia, Bahamas,
Brazil, the British Virgin Islands, Canada, China, Cyprus, France, Germany,
Hong Kong, India, Italy, Japan, Korea, Luxembourg, Mauritius, the
Netherlands, Poland, Russia, Singapore, South Africa, Spain, Sweden,
Switzerland, Taiwan, United Kingdom, and the U.S.
The manager and its affiliates manage numerous other investment companies and
accounts. The manager may give advice and take action with respect to any of
the other funds it manages, or for its own account, that may differ from
action taken by the manager on behalf of the fund. Similarly, with respect to
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 fund's code of ethics.
Under each 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 funds' sub-advisor is Templeton Investment Counsel, Inc. The sub-advisor
has an agreement with the manager and provides the manager with investment
management advice and assistance. The sub-advisor recommends the optimal
equity allocation and provides advice regarding the fund's investments. The
sub-advisor also determines which securities will be purchased, retained or
sold and executes these transactions. 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 Each fund pays the manager a fee equal to an annual rate of:
o 1% of the value of net assets up to and including $100 million;
o 0.90% of the value of net assets over $100 million up to and including
$250 million;
o 0.80% of the value of net assets over $250 million up to and including
$500 million;
o 0.75% of the value of net assets over of $500 million.
The fee is computed at the close of business on the last business day of each
month according to the terms of the management agreement. Each class of each
fund's shares pays its proportionate share of the fee.
For the last three fiscal years ended October 31, the fund paid the following
management fees:
MANAGEMENT FEES PAID ($)
----------------------------------
1998 1997 1996
- ----------------------------------------------------------------
Smaller Companies
Fund 1...................... 657,454 866,624 595,387
Pacific Fund................. 229,542 571,117 623,230
1. Management fees, before any advance waiver, totaled $697,463 for 1998 and
$958,913 for 1997. Under an agreement by the manager to 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 0.50% of the value of the fund's average daily net assets up to and
including $100 million;
o 0.40% of the value of the fund's average daily net assets over $100
million up to and including $250 million;
o 0.30% of the value of the fund's average daily net assets over $250
million up to and including $500 million; and
o 0.25% of the value of the fund's average daily assets over $500 million.
The manager pays this fee from the management fees it receives from each
fund. For the last three fiscal years ended October 31, the manager paid the
following sub-advisory fees:
SUB-ADVISORY FEES PAID ($)
----------------------------------
1998 1997 1996
- ----------------------------------------------------------------
Smaller Companies
Fund........................ 659,180 451,416 317,709
Pacific Fund................. 229,541 284,645 332,419
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 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 The manager pays FT Services a monthly fee equal to an
annual rate of:
o 0.15% of the fund's average daily net assets up to $200 million;
o 0.135% of average daily net assets over $200 million up to $700 million;
o 0.10% of average daily net assets over $700 million up to $1.2 billion;
and
o 0.075% of average daily net assets over $1.2 billion.
During the last three fiscal years ended October 31, the manager paid FT
Services the following administration fees:
ADMINISTRATION
FEES PAID ($)
----------------------
1998 1997
- -----------------------------------------------------
Smaller Companies
Fund........................ 209,389 153,165
Pacific Fund................. 68,924 93,491
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., P.O. Box 7777, San Mateo,
CA 94403-7777.
For its services, Investor Services receives a fixed fee per account. The
funds may also 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 may not exceed the per account fee payable
by the funds to Investor Services in connection with maintaining shareholder
accounts.
CUSTODIANS Bank of New York, Mutual Funds Division, 90 Washington Street,
New York, NY 10286, acts as custodian of the securities and other assets of
the Pacific Fund. The Chase Manhattan Bank, at its principal office at
MetroTech Center, Brooklyn, NY 11245, and at the offices of its branches and
agencies throughout the world, acts as custodian of the Smaller Companies
Fund's assets. As foreign custody manager, the bank selects and monitors
foreign sub-custodian banks, selects and evaluates non-compulsory foreign
depositories, and furnishes information relevant to the selection of
compulsory depositories.
AUDITOR PricewaterhouseCoopers LLP, 200 East Las Olas, Ft. Lauderdale, FL
33301, 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
- --------------------------------------------------------------------------------
The managers select brokers and dealers to execute the fund's portfolio
transactions in accordance with criteria set forth in the management and
sub-advisory agreements and any directions that the board may give.
When placing a portfolio transaction, the managers seek to obtain prompt
execution of orders at the most favorable net price. For portfolio
transactions on a securities exchange, the amount of commission paid is
negotiated between the managers and the broker executing the transaction. The
determination and evaluation of the reasonableness of the brokerage
commissions paid are based to a large degree on the professional opinions of
the persons responsible for placement and review of the transactions. These
opinions are based on the experience of these individuals in the securities
industry and information available to them about the level of commissions
being paid by other institutional investors of comparable size. The managers
will ordinarily place orders to buy and sell over-the-counter securities on a
principal rather than agency basis with a principal market maker unless, in
the opinion of the managers, a better price and execution can otherwise be
obtained. Purchases of portfolio securities from underwriters will include a
commission or concession paid by the issuer to the underwriter, and purchases
from dealers will include a spread between the bid and ask price.
The managers may pay certain brokers commissions that are higher than those
another broker may charge, if the managers determine in good faith that the
amount paid is reasonable in relation to the value of the brokerage and
research services they receive. This may be viewed in terms of either the
particular transaction or the managers' overall responsibilities to client
accounts over which it exercises investment discretion. The services that
brokers may provide to the managers include, among others, supplying
information about particular companies, markets, countries, or local,
regional, national or transnational economies, statistical data, quotations
and other securities pricing information, and other information that provides
lawful and appropriate assistance to the managers in carrying out its
investment advisory responsibilities. These services may not always directly
benefit the fund. They must, however, be of value to the managers in carrying
out its overall responsibilities to their clients.
It is not possible to place a dollar value on the special executions or on
the research services the managers receive from dealers effecting
transactions in portfolio securities. The allocation of transactions in order
to obtain additional research services allows the managers to supplement
their own research and analysis activities and to receive the views and
information of individuals and research staffs of other securities firms. As
long as it is lawful and appropriate to do so, the managers and their
affiliates may use this research and data in their investment advisory
capacities with other clients. If a 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, may also 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 a 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 managers will be reduced by the amount of any
fees received by Distributors in cash, less any costs and expenses incurred
in connection with the tender.
If purchases or sales of securities of a fund and one or more other
investment companies or clients supervised by the managers 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 managers, 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 October 31, the funds paid the
following brokerage commissions:
BROKERAGE COMMISSIONS ($)
----------------------------------
1998 1997 1996
- ----------------------------------------------------------------
Smaller Companies
Fund........................ 208,436 372,889 132,084
Pacific Fund................. 139,234 141,188 121,723
As of October 31, 1998, the funds did not own securities of their regular
broker-dealers.
DISTRIBUTIONS AND TAXES
- --------------------------------------------------------------------------------
The funds calculates dividends and capital gains the same way for each class.
The amount of any income dividends per share will differ, however, generally
due to the difference in any distribution and service (Rule 12b-1) fees of
each class. The funds do not pay "interest" or guarantee any fixed rate of
return on an investment in its 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.
A fund may be subject to foreign withholding taxes on income from certain of
its foreign securities. If more than 50% of a fund's total assets at the end
of the fiscal year are invested in securities of foreign corporations, a 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 a
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. A 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 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 investment company under Subchapter M of the
Internal Revenue Code, has qualified as such for its most recent fiscal year,
and intends to so qualify during the current fiscal year. As regulated
investment companies, the funds generally pay no federal income tax on the
income and gains they distribute to 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 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.
DIVIDENDS-RECEIVED DEDUCTION FOR CORPORATIONS As a corporate shareholder,
you should note that no portion of the Smaller Companies Fund's distributions
will generally be eligible for the intercorporate dividends-received
deduction. None of the dividends paid by the fund for the most recent
calendar year qualified for such deduction, and it is anticipated that none
of the current year's dividends will so qualify.
You should also note that 1.96% of the dividends paid by the Pacific 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 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 is a diversified series of Franklin Templeton International Trust,
an open-end management investment company, commonly called a mutual fund. The
trust was organized as a Delaware business trust, and is registered with the
SEC.
The Smaller Companies Fund currently offers four classes of shares, Class A,
Class B, Class C and Advisor Class. The Smaller Companies Fund began offering
Class B shares on January 1, 1999. The Pacific Growth Fund currently offers
three classes of shares, Class A, Class C and Advisor Class. Each fund may
offer additional classes of shares in the future. The full title of each
class is:
o Templeton Foreign Smaller Companies Fund - Class A
o Templeton Foreign Smaller Companies Fund - Class B
o Templeton Foreign Smaller Companies Fund - Class C
o Templeton Foreign Smaller Companies Fund - Advisor Class
o Templeton Pacific Growth Fund - Class A
o Templeton Pacific Growth Fund - Class C
o Templeton Pacific Growth Fund - Advisor Class
Shares of each class represent proportionate interests in the fund's assets.
On matters that affect a fund as a whole, each class has the same voting and
other rights and preferences as any other class. On matters that affect only
one class, only shareholders of that class may vote. Each class votes
separately on matters affecting only that class, or expressly required to be
voted on separately by state or federal law. Shares of each class of a series
have the same voting and other rights and preferences as the other classes
and series of the trust for matters that affect the trust as a whole.
Additional series may be offered in the future.
The trust has noncumulative voting rights. For board member elections, this
gives holders of more than 50% of the shares voting the ability to elect all
of the members of the board. If this happens, holders of the remaining shares
voting will not be able to elect anyone to the board.
The trust does not intend to hold annual shareholder meetings. The trust or a
series of the trust may hold special meetings, however, for matters requiring
shareholder approval. A meeting may 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 may also be called by the board in its
discretion.
As of December 7, 1998, the principal shareholders of the funds, beneficial
or of record, were:
SHARE PERCENT-
NAME AND ADDRESS CLASS AGE (%)
- --------------------------------------------------------------------------------
FOREIGN SMALLER COMPANIES FUND
Dai-Ichi Kangyo
Bank of California Ttee
1200 5th Ave. Ste. 600
Seattle, WA 98101-1188.................... A 5
Raymond James Assoc., Inc.
FAO Larry A. Loftin
And Wanda A. Loftin Ten Com
Elite 50197725
106 Lybrook Rd.
Advance, NC 27006-7629.................... C 8
Raymond James Assoc., Inc.
Cust Sara T Jones MD IRA
321 Banbury Rd.
Winston Salem, NC
27104-1827................................ C 7
Raymond James & Assoc., Inc.
Elite Acct 50177379
FAO Fred Penzias Ttee UA DTD
4/8/97 Penzias Revoc Tr
3455 S Corona St., Apt. 217
Englewood, CO
80110-2864................................ C 6
Frederick D. Richburg
And Lauretta L. Richburg
JT WROS
7831 S. Argonne St.
Aurora, CO 80016.......................... C 5
Franklin Templeton
Trust Company 1
TTEE for ValuSelect
Franklin Resources PSP
Attn: Trading
P.O. Box 2438
Rancho Cordova, CA
95741-2438................................ Advisor 5
PACIFIC FUND
Rosalind Achtel
150 Prospect St.
Clark, NJ 07066........................... Advisor 7
SHARE PERCENT-
NAME AND ADDRESS CLASS AGE (%)
- --------------------------------------------------------------------------------
Franklin Templeton
Trust Company 1
TTEE for ValuSelect
Franklin Resources PSP
Attn: Trading
P.O. Box 2438
Rancho Cordova, CA
95741-2438................................ Advisor 65
1. Franklin Templeton Trust Company is a California corporation and is wholly
owned by Franklin Resources, Inc.
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 December 7, 1998, the officers and board members, as a group, owned of
record and beneficially 3% of the Pacific Growth Fund's Advisor Class shares
and less than 1% of the outstanding shares of the other classes and of that
fund and of any classes of the Smaller Companies Fund. The board members may
own shares in other funds in the Franklin Templeton Group of Funds.
BUYING AND SELLING SHARES
- --------------------------------------------------------------------------------
A 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 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 a fund must be denominated in U.S. dollars. We may, in our sole
discretion, either (a) reject any order to buy or sell shares denominated in
any other currency or
(b) honor the transaction or make adjustments to your account for the
transaction as of a date and with a foreign currency exchange factor
determined by the drawee bank.
When you buy shares, if you submit a check or a draft that is returned unpaid
to 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.
GROUP PURCHASES As described in the prospectus, members of a qualified group
may add the group's investments together for minimum investment purposes.
A qualified group is one that:
o Was formed at least six months ago,
o Has a purpose other than buying fund shares 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.
DEALER COMPENSATION Distributors and/or its affiliates 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. The amount of support may be affected by: total sales;
net sales; levels of redemptions; the proportion of a securities dealer's
sales and marketing efforts in the Franklin Templeton Group of Funds; a
securities dealer's support of, and participation in, Distributors' marketing
programs; a securities dealer's compensation programs for its registered
representatives; and the extent of a securities dealer's marketing programs
relating to the Franklin Templeton Group of Funds. Financial support to
securities dealers may be made by payments from Distributors' resources, from
Distributors' retention of underwriting concessions and, in the case of funds
that have Rule 12b-1 plans, from payments to Distributors under such plans.
In addition, certain securities dealers may receive brokerage commissions
generated by fund portfolio transactions in accordance with the rules of the
National Association of Securities Dealers, Inc.
Distributors routinely sponsors due diligence meetings for registered
representatives during which they receive updates on various Franklin
Templeton Funds and are afforded the opportunity to speak with portfolio
managers. Invitation to these meetings is not conditioned on selling a
specific number of shares. Those who have shown an interest in the Franklin
Templeton Funds, however, are more likely to be considered. To the extent
permitted by their firm's policies and procedures, registered
representatives' expenses in attending these meetings may be covered by
Distributors.
EXCHANGE PRIVILEGE If you request the exchange of the total value of your
account, declared but unpaid income dividends and capital gain distributions
will be reinvested in the fund and exchanged into the new fund at net asset
value when paid. Backup withholding and information reporting may apply.
If a substantial number of shareholders should, within a short period, sell
their fund shares under the exchange privilege, the funds might have to sell
portfolio securities they 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 goal exist immediately. This money will then be withdrawn from the
short-term, interest-bearing money market instruments and invested in
portfolio securities in as orderly a manner as is possible when attractive
investment opportunities arise.
The proceeds from the sale of shares of an investment company 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. Once your plan
is established, any distributions paid by the fund will be automatically
reinvested in your account.
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.
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.
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 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 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 fund
on behalf of numerous beneficial owners for recordkeeping operations
performed with respect to such owners. For each beneficial owner in the
omnibus account, each fund may reimburse Investor Services an amount not to
exceed the per account fee that the fund normally pays Investor Services.
These financial institutions may also 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
- --------------------------------------------------------------------------------
When you buy and sell shares, you pay the net asset value (NAV) per share.
The value of a mutual fund is determined by deducting the fund's liabilities
from the total assets of the portfolio. The net asset value per share is
determined by dividing the net asset value of the fund by the number of
shares outstanding.
The fund calculates the NAV per share of each class each business day at the
close of trading on the New York Stock Exchange (normally 1:00 p.m. pacific
time). The fund does not calculate the NAV on days the New York Stock
Exchange (NYSE) is closed for trading, which include New Year's Day, Martin
Luther King Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving Day and Christmas Day.
When determining its NAV, the fund values cash and receivables at their
realizable amounts, and records interest as accrued and dividends on the
ex-dividend date. If market quotations are readily available for portfolio
securities listed on a securities exchange or on the NASDAQ National Market
System, the fund values those securities at the last quoted sale price of the
day or, if there is no reported sale, within the range of the most recent
quoted bid and ask prices. The fund values over-the-counter portfolio
securities within the range of the most recent quoted bid and ask prices. If
portfolio securities trade both in the over-the-counter market and on a stock
exchange, the fund values them according to the broadest and most
representative market as determined by the manager.
The fund values portfolio securities underlying actively traded call options
at their market price as determined above. The current market value of any
option the fund holds is its last sale price on the relevant exchange before
the fund values its assets. If there are no sales that day or if the last
sale price is outside the bid and ask prices, the fund values options within
the range of the current closing bid and ask prices if the fund believes the
valuation fairly reflects the contract's market value.
Trading in securities on European and Far Eastern securities exchanges and
over-the-counter markets is normally completed well before the close of
business of the NYSE on each day that the NYSE is open. Trading in European
or Far Eastern securities generally, or in a particular country or countries,
may not take place on every NYSE business day. Furthermore, trading takes
place in various foreign markets on days that are not business days for the
NYSE and on which the fund's NAV is not calculated. Thus, the calculation of
the fund's NAV does not take place contemporaneously with the determination
of the prices of many of the portfolio securities used in the calculation
and, if events materially affecting the values of these foreign securities
occur, the securities will be valued at fair value as determined by
management and approved in good faith by the board.
Generally, trading in corporate bonds, U.S. government securities and money
market instruments is substantially completed each day at various times
before the close of the NYSE. The value of these securities used in computing
the NAV is determined as of such times. Occasionally, events affecting the
values of these securities may occur between the times at which they are
determined and the close of the NYSE that will not be reflected in the
computation of the NAV. If events materially affecting the values of these
securities occur during this period, the securities will be valued at their
fair value as determined in good faith by the board.
Other securities for which market quotations are readily available are valued
at the current market price, which may be obtained from a pricing service,
based on a variety of factors including recent trades, institutional size
trading in similar types of securities (considering yield, risk and maturity)
and/or developments related to specific issues. Securities and other assets
for which market prices are not readily available are valued at fair value as
determined following procedures approved by the board. With the approval of
the board, the fund may use a pricing service, bank or securities dealer to
perform any of the above described functions.
THE UNDERWRITER
- --------------------------------------------------------------------------------
Franklin Templeton Distributors, Inc. (Distributors) acts as the principal
underwriter in the continuous public offering of the fund's shares.
Distributors is located at 777 Mariners Island Blvd., San Mateo, CA 94404.
Distributors pays the expenses of the distribution of fund shares, including
advertising expenses and the costs of printing sales material and
prospectuses used to offer shares to the public. The fund pays the expenses
of preparing and printing amendments to its registration statements and
prospectuses (other than those necessitated by the activities of
Distributors) and of sending prospectuses to existing shareholders.
Distributors does not receive compensation from the fund for acting as
underwriter of the fund's Advisor Class shares.
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 quotations used by a fund are based on the
standardized methods of computing performance mandated by the SEC.
For periods before January 2, 1997, Advisor Class standardized performance
quotations are calculated by substituting Class A performance for the
relevant time period, excluding the effect of Class A's maximum initial sales
charge, and including the effect of the distribution and service (Rule 12b-1)
fees applicable to the fund's Class A shares. For periods after January 2,
1997, Advisor Class standardized performance quotations are calculated as
described below.
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 income dividends and capital gain
distributions are reinvested at net asset value. The quotation assumes the
account was completely redeemed at the end of each period and the deduction
of all applicable charges and fees. If a change is made to the sales charge
structure, historical performance information will be restated to reflect the
maximum initial sales charge currently in effect.
The average annual total returns for the indicated periods ended October 31,
1998, were:
SINCE
INCEPTION
ADVISOR CLASS 1 YEAR 5 YEARS (9/20/91)
- -----------------------------------------------------------------
Smaller Companies
Fund......................... -12.55% 6.70% 8.60%
Pacific Fund.................. -25.68% -8.52% -0.29%
These figures were calculated according to the SEC formula:
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 income dividends and capital gain distributions are reinvested
at net asset value. Cumulative total return, however, is based on the actual
return for a specified period rather than on the average return over the
periods indicated above. The cumulative total returns for the indicated
periods ended October 31, 1998, were:
SINCE
INCEPTION
ADVISOR CLASS 1 YEAR 5 YEARS (9/20/91)
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Smaller Companies
Fund......................... -12.55% 37.95% 79.38%
Pacific Fund.................. -25.68% -36.56% -2.99%
VOLATILITY Occasionally statistics may be used to show the funds' volatility
or risk. Measures of volatility or risk are generally used to compare the
funds' net asset value or performance to a market index. One measure of
volatility is beta. Beta is the volatility of a fund relative to the total
market, as represented by an index considered representative of the types of
securities in which the fund invests. A beta of more than 1.00 indicates
volatility greater than the market and a beta of less than 1.00 indicates
volatility less than the market. Another measure of volatility or risk is
standard deviation. Standard deviation is used to measure variability of net
asset value or total return around an average over a specified period of
time. The idea is that greater volatility means greater risk undertaken in
achieving performance.
OTHER PERFORMANCE QUOTATIONS Sales literature referring to the use of a 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 funds may
satisfy your investment goal, advertisements and other materials about each
fund may discuss certain measures of fund performance as reported by various
financial publications. Materials may also compare performance (as calculated
above) to performance as reported by other investments, indices, and
averages. These comparisons may include, but are not limited to, the
following examples:
(i) unmanaged indices so that you may compare the fund's results with those
of a group of unmanaged securities widely regarded by investors as
representative of the securities market in general; (ii) other groups of
mutual funds tracked by Lipper Analytical Services, Inc., a widely used
independent research firm that ranks mutual funds by overall performance,
investment goals and assets, or tracked by other services, companies,
publications, or persons who rank mutual funds on overall performance or
other criteria; and (iii) the Consumer Price Index (measure for inflation) to
assess the real rate of return from an investment in the fund. Unmanaged
indices may assume the reinvestment of dividends but generally do not reflect
deductions for administrative and management costs and expenses.
From time to time, the fund and the managers may also refer to the following
information:
o The managers' and their affiliates' market share of international
equities managed in mutual funds prepared or published by Strategic
Insight or a similar statistical organization.
o The performance of U.S. equity and debt markets relative to foreign
markets prepared or published by Morgan Stanley Capital International(R)
or a similar financial organization.
o The capitalization of U.S. and foreign stock markets as prepared or
published by the International Finance Corporation, Morgan Stanley
Capital International(R) or a similar financial organization.
o The geographic and industry distribution of the fund's portfolio and the
fund's top ten holdings.
o The gross national product and populations, including age
characteristics, literacy rates, foreign investment improvements due to
a liberalization of securities laws and a reduction of foreign exchange
controls, and improving communication technology, of various countries
as published by various statistical organizations.
o To assist investors in understanding the different returns and risk
characteristics of various investments, the fund may show historical
returns of various investments and published indices (e.g., Ibbotson
Associates, Inc. Charts and Morgan Stanley EAFE - Index).
o The major industries located in various jurisdictions as published by
the Morgan Stanley Index.
o Rankings by DALBAR Surveys, Inc. with respect to mutual fund shareholder
services.
o Allegorical stories illustrating the importance of persistent long-term
investing.
o The fund's portfolio turnover rate and its ranking relative to industry
standards as published by Lipper Analytical Services, Inc. or
Morningstar, Inc.
o A description of the Templeton organization's investment management
philosophy and approach, including its worldwide search for undervalued
or "bargain" securities and its diversification by industry, nation and
type of stocks or other securities.
o Comparison of the characteristics of various emerging markets, including
population, financial and economic conditions.
o Quotations from the Templeton organization's founder, Sir John
Templeton,* advocating the virtues of diversification and long-term
investing.
*Sir John Templeton sold the Templeton organization to Franklin Resources,
Inc. in October 1992 and resigned from the board on April 16, 1995. He is no
longer involved with the investment management process.
From time to time, advertisements or information for the fund may include a
discussion of certain attributes or benefits to be derived from an investment
in the fund. The advertisements or information may include symbols,
headlines, or other material that highlights or summarizes the information
discussed in more detail in the communication.
Advertisements or information may also compare a fund's performance to the
return on certificates of deposit (CDs) or other investments. You should be
aware, however, that an investment in the fund involves the risk of
fluctuation of principal value, a risk generally not present in an investment
in a CD issued by a bank. For example, as the general level of interest rates
rise, the value of the fund's fixed-income investments, if any, as well as
the value of its shares that are based upon the value of such portfolio
investments, can be expected to decrease. Conversely, when interest rates
decrease, the value of the fund's shares can be expected to increase. CDs are
frequently insured by an agency of the U.S. government. An investment in 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 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 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 the 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 3 million
shareholder accounts. In 1992, Franklin, a leader in managing fixed-income
mutual funds and an innovator in creating domestic equity funds, joined
forces with Templeton, a pioneer in international investing. The Mutual
Series team, known for its value-driven approach to domestic equity
investing, became part of the organization four years later. Together, the
Franklin Templeton Group has over $220 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 115 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 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 funds and their 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 BOND RATINGS
- --------------------------------------------------------------------------------
CORPORATE AND FOREIGN GOVERNMENT 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 may also reflect the
filing of a bankruptcy petition under circumstances where debt service
payments are continuing. The C1 rating is reserved for income bonds on which
no interest is being paid.
D - Debt rated D is in default and payment of interest and/or repayment of
principal is in arrears.
PLUS (+) OR MINUS (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
COMMERCIAL PAPER RATINGS
MOODY'S
Moody's commercial paper ratings are opinions of the ability of issuers to
repay punctually their promissory obligations not having an original maturity
in excess of nine months. Moody's employs the following designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers:
P-1 (PRIME-1): Superior capacity for repayment.
P-2 (PRIME-2): Strong capacity for repayment.
S&P
S&P's ratings are a current assessment of the likelihood of timely payment of
debt having an original maturity of no more than 365 days. Ratings are graded
into four categories, ranging from "A" for the highest quality obligations to
"D" for the lowest. Issues within the "A" category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety, as follows:
A-1: This designation indicates the degree of safety regarding timely payment
is very strong. A "plus" (+) designation indicates an even stronger
likelihood of timely payment.
A-2: Capacity for timely payment on issues with this designation is strong.
The relative degree of safety, however, is not as overwhelming as for issues
designated A-1.
A-3: Issues carrying this designation have a satisfactory capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse effects
of changes in circumstances than obligations carrying the higher designations.
FTIT SAIA 03/99
