<PAGE>
===============================================================================
- -------------------------------------------------------------------------------
FUND OBJECTIVE:
- -------------------------------------------------------------------------------
The Franklin Strategic Mortgage Portfolio seeks to obtain a high level of total
return relative to the performance of the general mortgage securities market.
The fund seeks to achieve this objective by investing primarily in a portfolio
of mortgage securities created from pools of mortgages which are issued or
guaranteed by the U.S. Government, its agencies or instrumentalities.(1)
- -------------------------------------------------------------------------------
April 18, 1995
Dear Shareholder,
We are pleased to bring you the semi-annual report for the Franklin Strategic
Mortgage Portfolio, for the period ended March 31, 1995.
The fixed-income market received some favorable news regarding inflation and
interest rates, and saw some significant events occur at home and abroad
during the reporting period. In addition, agency mortgage securities generally
responded well to the economic environment. As always, we maintain a long-term
perspective in managing the fund.
Our managers seek to uncover the most attractive relative values in any given
interest-rate environment, rather than attempting to predict the direction of
interest rates or making decisions purely on short-term market "noise." We will
continue to emphasize quality in the portfolio, relying on extensive research
capabilities and traditional strategies in seeking to maximize the fund's total
return.
Thank you for your continued support of the Franklin Strategic Mortgage
Portfolio. We look forward to serving your investment needs in the future.
Sincerely,
Charles B. Johnson
Chairman of the Board
(1) U.S. government securities owned by the fund or held under repurchase
agreement, but not shares of the fund, are guaranteed by the U.S. government as
to timely payment of principal and interest. Yields and share price are not
guaranteed and will fluctuate with market conditions.
<PAGE>
===============================================================================
OVERVIEW OF THE ECONOMY
The U.S. economy continued to post positive growth during the past six-month
period. In the fourth quarter of 1994, the economy was especially robust, as
Gross Domestic Product (GDP) rose by 5.1%, fueled by strong consumer
spending.(2) The first quarter of 1995, however, saw lower levels of retail
sales and declining activity in sectors sensitive to interest rates, such as
housing and automobiles, which led fixed-income investors to believe that
overall growth was slowing. With some inflation fears relieved, bond prices
moved higher.
Economic figures released during the reporting period showed high levels of
manufacturing and production by the nation's factories, mines and utilities, as
well as continued strength in the employment sector. This growth was tempered by
only slight increases in the Consumer Price Index and Producer Price Index, two
primary indicators of inflation. The Federal Reserve Board, however, saw these
moderate price increases as short lived and believed the threat of inflation
remained as long as production and employment continued to increase.
Consequently, the Federal Reserve Board raised the federal funds rate (the
interest rate banks charge each other for overnight loans) and the discount rate
(the interest rate charged for loans to member banks) by 75 basis points each in
November 1994, and another 50 basis points each in February 1995. By the end of
the reporting period, the federal funds rate and the discount rate stood at
6.00% and 5.25%, respectively.
The U.S. Treasury market responded to declining inflationary expectations by
rallying on the long end of the yield curve. 30-year Treasury yields fell 39
basis points during the last six months, according to Bloomberg Financial
Markets. Com-
(2) Source: U.S. Commerce Department
2
<PAGE>
===============================================================================
bined with the Federal Reserve's monetary tightening, this caused the yield
curve to flatten. Since the end of September 1994, the yield spread between
one-year Treasury bills and 30-year Treasury bonds had narrowed by 93 basis
points.
The reporting period was also marked by significant financial events. In
December 1994, Orange County, California declared bankruptcy due in part to
problems involving derivative investments within its fund. Besides the obvious
negative impact to direct investors of uninsured Orange County municipal debt
securities, this caused many fixed income investors to move into higher quality,
non-derivative investments. In addition, financial and political instability in
Mexico served to dramatically devalue the peso versus the U.S. dollar. This
caused most economists to lower their estimates for first quarter 1995 U.S.
economic growth, as Mexico would likely import fewer goods made in the U.S.
until both its economy and currency stabilized or strengthened.
[PHOTO]
ROGER A. BAYSTON, CFA
PORTFOLIO MANAGER
Roger Bayston is portfolio manager for the Franklin Strategic Mortgage
Portfolio, Franklin Adjustable Rate Securities Fund and the Franklin Valuemark
Adjustable U.S. Government Securities Fund.
Before joining Franklin in 1991, Mr. Bayston managed portfolios of fixed-income
securities for Bankers Trust Company Investment Management Group. He holds a
Bachelor of Science degree from the University of Virginia and a Master of
Business Administration degree from the University of California at Los Angeles.
He is a member of the Security Analysts of San Francisco and the Association for
Investment Management and Research, and is a Chartered Financial Analyst (CFA).
3
<PAGE>
===============================================================================
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Agency mortgage securities performed well during the reporting period, as a
result of several factors. First, the overall rise in interest rates during 1994
caused a decline in the issuance of mortgage securities, as the housing sector
and refinancings declined. The reduced supply occurred simultaneously with
rising demand, since investors shifted allocations out of mortgage derivative
securities into straight, passthrough bonds. This helped to keep yield spreads
on agency mortgages from widening during the period. In addition, prices on
these securities declined along with other fixed-income securities during most
of 1994, and the overall universe of mortgage securities saw reduced prepayment
risk. Thus, the mortgage sector became an attractive alternative to investors.
During the six-month period, we continued to diversify the portfolio's holdings
across balloon, 15-year, and 30-year fixed-rate agency sectors, thereby reducing
our exposure to adjustable-rate mortgages and Treasury securities. The portfolio
has a slight overweighting in discount coupon bonds and 30-year securities
relative to its benchmark, the unmanaged Salomon Brothers Mortgage Index. Going
forward, we will continue to monitor the mortgage markets, looking for the best
relative value for the fund's shareholders.
GRAPHIC MATERIAL 1 OMITTED - SEE APPENDIX
4
<PAGE>
===============================================================================
PERFORMANCE SUMMARY
The Franklin Strategic Mortgage Portfolio paid distributions totaling 35.11
cents ($0.3511) per share for the six-month period ended March 31, 1995.(3) The
fund's distribution rate was 7.29%, based on an annualization of the fund's
dividend over the last 30 days of the period ($0.059863 per share), and the
maximum offering price of $9.99 on March 31, 1995. Dividends will vary based on
the earnings of the fund's portfolio, and past distributions are not necessarily
indicative of future trends.
The fund's share price as measured by net asset value, rose 15 cents ($0.15),
from $9.42 on September 30, 1994, to $9.57 on March 31, 1995.
The fund posted total returns of +5.44% and +5.63%, respectively, for the
six-month and one-year periods ended March 31, 1995. Total return measures the
change in value of an investment, assuming reinvestment of dividends and capital
gains, and does not include the initial sales charge. Of course, past
performance is not indicative of future results.
(3) Assumes shares were purchased and held for the entire accrual period. Since
dividends accrue daily, your actual distributions will vary, depending on the
date you purchased your shares and any account activity during the period.
- -------------------------------------------------------------------------------
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO(4)
Periods ended March 31, 1995
<TABLE>
<CAPTION>
SINCE
ONE- INCEPTION
YEAR (2/1/93)
- --------------------------------------------------------------------------
<S> <C> <C>
NAV Cumulative Total Return:(5) 5.63% 10.10%
NAV Average Annual Total Return:(6) 5.63% 4.55%
POP Average Annual Total Return:(7) 1.14% 2.49%
30-Day Standardized Yield:(8) 7.38%
Distribution Rate:(9) 7.29%
- --------------------------------------------------------------------------
</TABLE>
(4) The manager of the Franklin Strategic Mortgage Portfolio is voluntarily
waiving all of its fees, which reduces expenses and increases the distribution
rate, yield and total return to shareholders. Without these reductions, the
fund's distribution rate and total return would have been lower, and the 30-day
yield would have been 6.15%. The fee waiver may be discontinued at any time.
(5) NAV cumulative total return does not include the current maximum 4.25%
initial sales charge and reflects the change in value of an investment over the
periods indicated, assuming reinvestment of dividends and capital gains at net
asset value.
(6) NAV average annual total return does not include the current maximum 4.25%
initial sales charge and represents the average annual change in value of an
investment over the specified periods, assuming reinvestment of dividends and
capital gains at net asset value.
(7) POP average annual total return includes the current maximum 4.25% initial
sales charge and represents the average annual change in value of an investment
over the stated periods, assuming reinvestment of dividends and capital gains at
net asset value. Prior to July 1, 1994, fund shares were offered at a higher
initial sales charge. Thus, actual total returns for purchasers of shares during
that period would have been somewhat lower than that noted above.
(8) Yield, calculated as required by the SEC, is based on earnings of the fund's
portfolio during the 30 days ended on the date shown.
(9) Based on an annualization of the fund's dividend for the last 30 days of the
period ($0.059863 per share) and the maximum offering price of $9.99 on March
31, 1995. Investment return and principal value will fluctuate with market
conditions, and you may have a gain or loss when you sell your shares. Past
performance cannot guarantee future results.
- -------------------------------------------------------------------------------
5
<PAGE>
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
===============================================================================
STATEMENT OF INVESTMENTS IN SECURITIES AND NET ASSETS, MARCH 31, 1995
(UNAUDITED)
<TABLE>
<CAPTION>
FACE VALUE
AMOUNT (NOTE 1)
- --------------------------------------------------------------------------------------------------------
<S> <C> <C>
MORTGAGE-BACKED SECURITIES 97.5%
FEDERAL HOME LOAN MORTGAGE CORP. (FHLMC) 29.3%
$171,877 FHLMC, 9.00%, 06/01/01..................................................... $ 176,818
251,707 FHLMC, 6.50%, 11/01/01..................................................... 244,315
142,650 FHLMC, 6.50%, 03/01/09..................................................... 135,696
96,957 FHLMC, 9.00%, 06/01/09..................................................... 94,261
100,000 (a)FHLMC, 7.50%, 04/01/10..................................................... 99,031
100,000 (a)FHLMC, 8.00%, 04/01/10..................................................... 100,813
139,810 FHLMC, 9.50%, 12/01/22..................................................... 145,927
132,045 FHLMC, 7.00%, 06/01/24..................................................... 124,577
150,616 FHLMC, 7.50%, 06/01/24..................................................... 145,863
149,484 FHLMC, 8.00%, 07/01/24..................................................... 148,130
201,759 FHLMC, 8.50%, 12/01/24..................................................... 204,030
----------
TOTAL FEDERAL HOME LOAN MORTGAGE CORP. (COST $1,620,613).............. 1,619,461
----------
FEDERAL NATIONAL MORTGAGE ASSOCATION (FNMA) 39.4%
97,318 FNMA, 7.00%, 07/01/09...................................................... 94,581
95,222 FNMA, 7.50%, 07/01/09...................................................... 94,329
29,423 FNMA, 6.00%, 12/01/23...................................................... 25,966
235,723 FNMA, 6.00%, 03/01/01...................................................... 224,378
480,019 FNMA, 6.50%, 06/01/24...................................................... 438,320
471,012 FNMA, 7.00%, 06/01/24...................................................... 443,784
99,589 FNMA, 8.50%, 07/01/24...................................................... 100,617
278,340 FNMA, 9.00%, 12/01/24...................................................... 286,083
246,000 (a)FNMA, 7.50%, 12/15/24...................................................... 238,006
201,570 FNMA, 8.00%, 01/01/25...................................................... 199,618
30,767 FNMA, 8.00%, 01/01/25...................................................... 30,469
----------
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCATION (COST $2,160,455).......... 2,176,151
----------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (GNMA) 28.8%
194,142 GNMA, SF, 9.00%, 12/15/16.................................................. 200,453
145,209 GNMA, SF, 10.00%, 10/15/18................................................. 155,736
147,418 GNMA, SF, 9.50%, 10/15/20.................................................. 154,605
240,306 GNMA, SF, 8.00%, 02/15/23.................................................. 238,205
299,072 GNMA, SF, 7.00%, 06/15/23.................................................. 279,913
199,610 GNMA, SF, 7.50%, 06/15/23.................................................. 192,750
296,822 GNMA, SF, 6.50%, 01/15/24.................................................. 268,255
99,628 GNMA, SF, 8.50%, 09/15/24.................................................. 101,030
----------
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (COST $1,641,479)...... 1,590,947
----------
TOTAL MORTGAGE-BACKED SECURITIES (COST $5,422,547).................... 5,386,559
----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
===============================================================================
STATEMENT OF INVESTMENTS IN SECURITIES AND NET ASSETS, MARCH 31, 1995
(UNAUDITED)(CONT.)
<TABLE>
<CAPTION>
FACE VALUE
AMOUNT (NOTE 1)
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
(b),(c)RECEIVABLES FROM REPURCHASE AGREEMENTS 9.8%
$535,727 Joint Repurchase Agreement, 6.27%, 04/03/95 (Maturity Value $539,888) (COST $539,606)
Collateral: U.S. Treasury Notes, 5.00% - 9.25%, 08/31/96 - 12/31/99 ......................... $ 539,606
----------
TOTAL INVESTMENTS (COST $5,962,153) 107.3% ..................................... 5,926,165
LIABILITIES IN EXCESS OF OTHER ASSETS, NET (7.3)% .............................. (403,890)
----------
NET ASSETS 100.0% .............................................................. $5,522,275
==========
At March 31, 1995, the net unrealized depreciation based on the cost of investments
for income tax purposes of $5,962,153 was as follows:
Aggregate gross unrealized appreciation for all investments in which there was an
excess of value over tax cost............................................................ $ 45,576
Aggregate gross unrealized depreciation for all investments in which there was an
excess of tax cost over value............................................................ (81,564)
----------
Net unrealized depreciation................................................................ $ (35,988)
==========
</TABLE>
PORTFOLIO ABBREVIATIONS:
SF - Single Family
(a) See Note 1 regarding securities purchased on a when-issued or delayed
delivery basis.
(b) See Note 1(e) regarding Joint Repurchase Agreement.
(c) Face amount for repurchase agreements is for the underlying collateral.
The accompanying notes are an integral part of these financial statements.
7
<PAGE>
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
===============================================================================
FINANCIAL STATEMENTS
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1995 (UNAUDITED)
<TABLE>
<S> <C>
Assets:
Investments in securities, at value
(identified cost $5,422,547) $5,386,559
Receivables from repurchase agreements,
at value and cost 539,606
Receivables:
Interest 34,697
Investment securities sold 1,766
Unamortized organization costs (Note 2) 19,115
----------
Total assets 5,981,743
----------
Liabilities:
Payables:
Investment securities purchased
on when-issued basis (Note 1) 440,353
Accrued expenses and other liabilities 19,115
----------
Total liabilities 459,468
----------
Net assets, at value $5,522,275
==========
Net assets consist of:
Unrealized depreciation on investments $ (35,988)
Accumulated realized loss (192,960)
Capital shares 5,768
Additional paid-in capital 5,745,455
----------
Net assets, at value $5,522,275
==========
Net asset value per share
($5,522,275 divided by 576,759 shares
outstanding) $9.57
==========
</TABLE>
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED MARCH 31, 1995 (UNAUDITED)
<TABLE>
<S> <C> <C>
Investment income:
Interest (Note 1) $197,861
--------
Total income $197,861
Expenses:
Management fees (Note 6) --
Registration fees 8,352
Professional fees 6,003
Reports to shareholders 4,680
Amortization of organization costs
(Note 2) 3,474
Custodian fees 252
Other 408
Payments from Manager (Note 6) (23,169)
--------
Total expenses --
--------
Net investment income 197,861
--------
Realized and unrealized gain (loss)
on investments:
Net realized loss (76,212)
Net unrealized appreciation 163,796
--------
Net realized and unrealized gain on
investments 87,584
--------
Net increase in net assets resulting
from operations $285,445
========
</TABLE>
The accompanying notes are an integral part of these financial statements.
8
<PAGE>
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
===============================================================================
FINANCIAL STATEMENTS (CONT.)
STATEMENTS OF CHANGES IN NET ASSETS
FOR THE SIX MONTHS ENDED MARCH 31, 1995 (UNAUDITED)
AND THE YEAR ENDED SEPTEMBER 30, 1994
<TABLE>
<CAPTION>
SIX MONTHS YEAR
ENDED ENDED
03/31/95 09/30/94
-------- --------
<S> <C> <C>
Increase (decrease) in net assets:
Operations:
Net investment income....................................................................... $ 197,861 $ 297,090
Net realized loss on investments............................................................ (76,212) (116,748)
Net unrealized appreciation (depreciation) on investments................................... 163,796 (263,282)
---------- ----------
Net increase (decrease) in net assets resulting from operations......................... 285,445 (82,940)
Distributions to shareholders:
From undistributed net investment income.................................................... (197,861) (297,090)
From net realized capital gains............................................................. -- (56,643)
Increase in net assets from capital share transactions (Note 4)............................... 211,381 354,415
---------- ----------
Net increase (decrease) in net assets................................................... 298,965 (82,258)
Net assets (there is no undistributed net investment income at beginning or end of period):
Beginning of period......................................................................... 5,223,310 5,305,568
---------- ----------
End of period............................................................................... $5,522,275 $5,223,310
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
9
<PAGE>
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
================================================================================
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES
Franklin Strategic Mortgage Portfolio (the Fund) is an open-end, diversified
management investment company (mutual fund) registered under the Investment
Company Act of 1940 as amended.
The following is a summary of the significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles for
investment companies.
A. SECURITY VALUATION:
Portfolio securities listed on a securities exchange or on the NASDAQ National
Market System for which market quotations are readily available are valued at
the last quoted sale price of the day or, if there is no such reported sale,
within the range of the most recent quoted bid and asked prices. Other
securities for which market quotations are readily available are valued at
current market values, obtained from pricing services, which are 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 securities. Portfolio securities which are
traded both in the over-the-counter market and on a securities exchange are
valued according to the broadest and most representative market as determined by
the Manager. Other securities for which market quotations are not available, if
any, are valued in accordance with procedures established by the Board of
Trustees.
B. INCOME TAXES:
The Fund intends to continue to qualify for the tax treatment applicable to
regulated investment companies under the Internal Revenue Code and to make the
requisite distributions to its shareholders which will be sufficient to relieve
it from income and excise taxes. Therefore, no income tax provision is required.
C. SECURITY TRANSACTIONS:
Security transactions are accounted for on the date the securities are purchased
or sold (trade date). Realized gains and losses on security transactions are
determined on the basis of specific identification for both financial statement
and income tax purposes.
D. INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS:
Distributions to shareholders are recorded on the ex-dividend date. Interest
income and estimated expenses are accrued daily. Bond discount and premium, if
any, are amortized as required by the Internal Revenue Code. The Fund normally
declares dividends from its net investment income daily and distributes monthly.
Daily allocations of net investment income will commence on the date of receipt
of an investor's funds. Dividends are normally declared each day the New York
Stock Exchange is open for business and are equal to the Fund's total net
investment income and are payable to shareholders of record at the beginning of
business on the ex-date. Once each month, dividends are reinvested in additional
shares of the Fund or paid in cash as requested by the shareholders.
E. REPURCHASE AGREEMENTS:
The Fund may enter into a Joint Repurchase Agreement whereby its uninvested cash
balance is deposited into a joint cash account to be used to invest in one or
more repurchase agreements with government securities dealers recognized by the
Federal Reserve Board and/or member banks of the Federal Reserve System. The
value and face amount of the Joint Repurchase Agreement are allocated to the
Fund based on its pro-rata interest. In a repurchase agreement, the Fund
purchases a U.S. government security from a dealer or bank subject to an
agreement to resell it at a mutually agreed upon price and date. Such a
transaction is accounted for as a loan by the Fund to the seller, collateralized
by the
10
<PAGE>
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
================================================================================
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)(CONT.)
1. SIGNIFICANT ACCOUNTING POLICIES (cont.)
E. REPURCHASE AGREEMENTS: (CONT.)
underlying security. The transaction requires the initial collateralization of
the seller's obligation by U.S. government securities with market value,
including accrued interest, of at least 102% of the dollar amount invested by
the Fund, with the value of the underlying security marked to market daily to
maintain coverage of at least 100%. The collateral is delivered to the Fund's
custodian and held until resold to the dealer or bank. At March 31, 1995, all
outstanding repurchase agreements held by the Fund had been entered into on that
date.
F. SECURITIES PURCHASED ON A WHEN-ISSUED OR DELAYED DELIVERY BASIS:
The Fund may trade securities on a when-issued or delayed delivery basis, with
payment and delivery scheduled for a future date. These transactions are subject
to market fluctuations and are subject to the risk that the value at delivery
may be more or less than the trade date purchase price. Although the Fund will
generally purchase these securities with the intention of acquiring such
securities, it may sell such securities before the settlement date. These
securities are identified on the accompanying statement of investments in
securities and net assets. The Fund has set aside sufficient investment
securities as collateral for these purchase commitments.
G. MORTGAGE DOLLAR ROLLS:
The Fund may enter into mortgage dollar rolls in which the Fund sells
mortgage-backed securities and simultaneously contracts to repurchase
substantially similar, but not identical, securities on a specified future date,
generally at a price lower than the price of the security sold. The counterparty
receives all principal and interest payments, including prepayments, made on the
mortgage-backed security sold while it is the holder. Mortgage dollar rolls may
be renewed with a new sale and repurchase price fixed and a cash settlement made
without physical delivery of the securities subject to the contract, at the
renewal date. Mortgage dollar rolls are accounted for as non-collateralized
financing transactions.
2. UNAMORTIZED ORGANIZATION COSTS
The organization costs of the Fund are amortized on a straight line basis over a
period of five years from February 1, 1993, the effective date of registration
under the Securities Act of 1933. In the event that Franklin Resources, Inc.
(which was the sole shareholder prior to February 1, 1993) redeems its shares
within the five-year period, the pro-rata share of the then-unamortized deferred
organization costs will be deducted from the redemption price paid to Franklin
Resources, Inc. New investors purchasing shares of the Fund subsequent to that
date bear such costs during the amortization period only as such charges are
accrued daily against investment income.
3. DISTRIBUTIONS AND CAPITAL LOSS CARRYOVERS
At September 30, 1994, for tax purposes, the Fund had capital loss carryovers of
$116,748, expiring in 2002.
For tax purposes, the aggregate cost of securities and unrealized depreciation
of the Fund are the same as for financial statement purposes at March 31, 1995.
11
<PAGE>
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
================================================================================
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)(CONT.)
4. CAPITAL STOCK
At March 31, 1995, there were an unlimited number of $.01 par value shares of
beneficial interest authorized. Transactions for the six months ended March 31,
1995 and for the year ended September 30, 1994 were as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
MARCH 31, 1995 SEPTEMBER 30, 1994
------------------- --------------------
SHARES AMOUNT SHARES AMOUNT
------- -------- ------- --------
<S> <C> <C> <C> <C>
Shares sold........................................ 1,490 $ 14,018 1,960 $ 19,375
Shares issued in reinvestment of distributions..... 21,005 197,847 36,036 353,730
Shares redeemed.................................... (41) (399) __ __
Changes from exercise of exchange privilege:
Shares sold....................................... 842 7,960 __ __
Shares redeemed................................... (848) (8,045) (1,939) (18,690)
------ -------- ------- --------
Net increase....................................... 22,448 $211,381 36,057 $354,415
====== ======== ======= ========
</TABLE>
5. PURCHASES AND SALES OF SECURITIES
Purchases and sales of securities (excluding purchases and sales of short-term
securities and mortgage dollar roll transactions) for the six months ended March
31, 1995 aggregated $1,062,569 and $759,995 respectively.
6. TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES
Franklin Institutional Services Corporation (FISCO), under the terms of a
management agreement, provides investment advice, administrative services,
office space and facilities to the Fund, and receives fees computed and paid
monthly at the annual rate of .40 of 1% of average daily net assets up to and
including $250 million; .38 of 1% of average daily net assets in excess of $250
million, up to and including $500 million; and .36 of 1% of average daily net
assets in excess of $500 million. The terms of the management agreement provide
that annual aggregate expenses of the Fund be limited to the extent necessary to
comply with the limitations set forth in the laws, regulations and
administrative interpretations of the states in which the Fund's shares are
registered. The Fund's expenses did not exceed these limitations. However, for
the six months ended March 31, 1995, FISCO agreed in advance to waive $10,554 of
the management fees and made payments of $23,169 for other expenses as shown in
the Statement of Operations.
In its capacity as underwriter for the shares of the Fund, Franklin/Templeton
Distributors, Inc. received commissions on sales of the Fund's shares for the
six months ended March 31, 1995, totalling $625 of which $586 was paid to other
dealers. Commissions are deducted from the gross proceeds received from the sale
of shares of the Fund and as such are not expenses of the Fund.
Pursuant to a shareholder service agreement with Franklin/Templeton Investors
Services, Inc., the Fund pays costs on a per shareholder account basis. Fees
which would have been incurred by the Fund but were borne by Franklin/Templeton
Investors Services, Inc., totalled $39.
At March 31, 1995, Franklin Resources, Inc. owned 99.74% of the Fund's
outstanding shares.
Certain officers and trustees of the Fund are also officers and/or directors of
FISCO, Franklin/Templeton Distributors, Inc., and Franklin/Templeton Investors
Services, Inc., all wholly-owned subsidiaries of Franklin Resources, Inc.
12
<PAGE>
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
================================================================================
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)(CONT.)
7. FINANCIAL HIGHLIGHTS
Selected data for each share of beneficial interest outstanding throughout each
period are as follows:
<TABLE>
<CAPTION>
FEBRUARY 1, 1993
SIX MONTHS ENDED YEAR ENDED (EFFECTIVE DATE) TO
MARCH 31, 1995 SEPTEMBER 30, 1994 SEPTEMBER 30, 1993
---------------- ------------------ -------------------
<S> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value at beginning of period.......................... $ 9.42 $10.24 $ 10.00
------ ------ -------
Net investment income........................................... .35 .55 .36
Net realized and unrealized gain (loss) on securities........... .151 (.708) .245
------ ------ -------
Total from investment operations................................ .501 (.158) .605
------ ------ -------
Less distributions:
Dividends from net investment income............................ (.351) (.553) (.365)
Distributions from realized capital gains....................... -- (.109) --
------ ------ -------
Total distributions............................................. (.351) (.662) (.365)
------ ------ -------
Net asset value at end of period................................ $ 9.57 $ 9.42 $ 10.24
====== ====== =======
TOTAL RETURN+................................................... 5.44 % (1.61)% 6.13 %
RATIOS/SUPPLEMENTAL DATA:
Net assets at end of period (in 000's).......................... $5,522 $5,223 $ 5,306
Ratio of operating expenses to average net assets++............. --% --% --%
Ratio of operating expenses to average net assets
(excluding waiver) (Note 6).................................... 1.27%* 1.28% 1.22%*
Ratio of net investment income to average net assets............ 7.48%* 5.65% 3.59%*
Portfolio turnover rate......................................... 15.09%** 86.38%*** 104.33%***
</TABLE>
*Annualized
**The portfolio turnover rate excludes mortgage dollar roll transactions.
***The portfolio turnover rate for these periods have been restated to exclude
purchases and sales of mortgage dollar roll transactions.
+Total return measures the changes in value of an investment over the periods
indicated. It does not include the maximum initial sales charge and assumes
reinvestment of dividends and capital gains, if any, at net asset value and is
not annualized.
++During the period, FISCO agreed in advance to waive the management fees and
made payments of other expenses incurred by the Fund.
13
APPENDIX
DESCRIPTION OF GRAPHIC MATERIAL OMITTED FROM EDGAR FILING
(PURSUANT TO ITEM 304 (a) of REGULATION S-T)
GRAPHIC MATERIAL (1)
This chart shows in pie chart format the fund's securities breakdown by
investment holding as a percentage of the fund's total net assets.
<TABLE>
<CAPTION>
Investment Holdings Breakdown on 3/31/95
<S> <C>
Federal Home Loan Mortgage Corporation (FHLMC) 29.3%
Federal National Mortgage Association (FNMA) 39.4%
Government National Mortgage Association (GNMA) 28.8%
Cash and Equivalents 2.5%
</TABLE>
