MESSAGE FROM THE CHAIRMAN
- --------------------------------------------------------------------------------
May 15, 1997
Dear Shareholder:
It's a pleasure to bring you the semi-annual report for the Franklin Strategic
Mortgage Portfolio for the period ended March 31, 1997.
Expectations for continued economic growth, without a need to moderate inflation
by raising interest rates, characterized much of the six-month period. These
expectations, however, began to fade in December.
After previously declining, interest rates reversed course in December amidst
reports of positive economic growth. Despite a strong U.S. dollar during the
period, export growth was healthy, and housing markets continued to be strong,
supporting increased demand for durable goods. Also, spending in the fourth
quarter of 1996 expanded faster than inventories, indicating a likelihood for
increased production in 1997. Anticipating a higher risk of inflation, the
Federal Reserve ("the Fed"), increased the federal funds rate by 25 basis points
in March. The Fed's modest rate increase was largely based on fears that
continued growth would push wages higher in an already tight labor market.
Despite the concern generated by these reports, inflation remained low during
the six-month period which contributed to the relatively low-level of volatility
in the bond market. The re-election of both President Clinton and a Republican
Congress also encouraged stability in the bond market. The election helped to
maintain the existing political status quo and probably diminished the chances
for future unexpected political actions.
Looking forward, we anticipate that interest rate volatility may increase. The
Manager's Discussion on page 3 of this report contains more detailed information
about our expectations for the market and the fund.
We appreciate your continued support, welcome your comments, and look forward to
serving you in the years to come.
Sincerely,
Charles B. Johnson
Chairman
Franklin Strategic Mortgage Portfolio
- --------------------------------------------------------------------------------
- Celebrating 50 Years -
This year marks 50 years of business for Franklin Templeton. Over these years,
the mutual fund industry has experienced profound changes in technology,
regulations and customer expectations. As one of the largest mutual fund
families, we're proud to be an innovative industry leader, providing people like
you with an opportunity to invest around the globe. We thank you for your past
support and look forward to serving your investment needs in the years ahead.
- --------------------------------------------------------------------------------
MANAGER'S DISCUSSION
- --------------------------------------------------------------------------------
Your Fund's Objective:
Seeks to obtain a high level of total return relative to the performance of the
general mortgage securities market 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.*
Mortgage securities performed well on a total return basis compared to other
federal government bonds during the reporting period. Lower market volatility
and decreasing prepayment risk made these securities more attractive to
government bond investors.
In comparison to Treasuries, investors purchased a relatively larger amount of
mortgage securities for added income. These purchases caused the difference in
yield between mortgage securities and U.S. Treasuries to narrow. Consequently,
the returns of mortgage securities became more competitive over the period.
Shareholders often ask:
What is "prepayment risk"?
In general, prepayment refers to paying a debt obligation before it is due.
Homeowners, for instance, may prepay their mortgage -- by refinancing -- when
interest rates are low. Prepayment risk is a situation experienced by the
mortgage lender. There is the risk that the borrower -- or homeowner, in this
case -- will prepay his high interest rate loan and replace it with a low
interest rate loan. When this occurs, the lender loses his high interest
earnings and is forced to now lend money at the current, lower interest rate.
Prepayment risk is, however, more than just refinancing risk. General economic
conditions can result in increased housing turnover. In fact, any number of
situations, including relocation, death, and divorce, may result in a home being
sold and its mortgage paid off.
*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 the timely payment of principal and interest. Yields and share price are not
guaranteed and will fluctuate with market conditions.
Also, we took advantage of the drop in prepayment risk and increased our
exposure to current coupon mortgage securities during this period. Normally,
such securities pay higher interest rates and face greater prepayment risk than
mortgage securities with protection against prepayment.
In addition, we adjusted our interest rate risk, seeking to approximate that of
the Salomon Brothers Mortgage Index. In the last half of the period, however, we
managed the fund's portfolio to a slightly lower interest rate risk than that of
the mortgage index. We took this step to reduce our interest rate risk exposure.
The relatively lower rate risk of the securities we held made them less
susceptible to a loss in value resulting from an interest rate hike than those
composing the index.
GRAPHIC MATERIAL 1 OMITTED - SEE APPENDIX AT END OF DOCUMENT
This discussion reflects the strategies we employed for the fund during the six
months under review, and includes our opinions as of the close of the period.
Since economic and market conditions are constantly changing, our strategies,
and our evaluations, conclusions and decisions
regarding portfolio holdings, may change as new circumstances arise. Although
past performance of a specific investment or sector cannot guarantee future
performance, such information can be useful in analyzing securities we purchase
or sell for the fund.
We appreciate your participation in the Franklin Strategic Mortgage Portfolio
and look forward to serving your investment needs in the months and years to
come.
Performance Summary
The Franklin Strategic Mortgage Portfolio's share price, as measured by net
asset value, declined two cents, from $9.74 on September 30, 1996, to $9.72 on
March 31, 1997.
At the end of the reporting period, the fund's distribution rate was 7.53%,
based on an annualization of March's monthly dividend of 6.279 cents ($0.06279)
per share and the maximum offering price of $10.15 on March 31, 1997. Dividends
will vary based on the earnings of the fund's portfolio, and past distributions
are not indicative of future trends.
Franklin Strategic Mortgage Portfolio
Dividend Distributions 10/1/96 - 3/31/97+
Dividend
Month per Share
- --------------------------------------------------------------------------------
October 5.9315 cents
November 5.7671 cents
December 6.1516 cents
January 5.8502 cents
February 5.7977 cents
March 6.4651 cents
Total 35.9632 cents
+Assumes shares were purchased and held for the entire accrual period. Since
dividends accrue daily, your actual distributions will vary depending on the day
you purchased your shares and any account activity during the month. Income
distributions and total return calculations include all accrued income earned by
the fund during the reporting period.
================================================================================
Franklin Strategic Mortgage Portfolio
Periods ended March 31, 1997
Since
Inception
1-Year 3-Year (2/1/93)
- --------------------------------------------------------------------------------
Cumulative Total Return1................ 6.30% 24.12% 29.37%
Average Annual Total Return2............ 1.75% 5.92% 5.29%
Distribution Rate3................ 7.53%
30-Day Standardized Yield4........ 7.74%
- --------------------------------------------------------------------------------
1. Cumulative total return measures the change in value of an investment over
the periods indicated and does not include the sales charge. See Note below.
2. Average annual total return represents the average annual change in value of
an investment over the periods indicated and includes the current, maximum 4.25%
initial sales charge. See Note below.
3. Based on an annualization of the current 6.279 cents per share monthly
dividend and the maximum offering price of $10.15 on March 31, 1997.
4. Yield, calculated as required by the SEC, is based on the earnings of the
fund's portfolio for the 30 days ended March 31, 1997.
Note: 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 different than noted above. Your 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 is not predictive of future
results.
The fund's manager agreed in advance to waive all of its management expenses and
made payments of other expenses, which reduces operating expenses and increases
yield, distribution rate and total return to shareholders. Without these
reductions, the fund's distribution rate would have been lower, and yield for
the period would have been 6.78%. The fee waiver may be discontinued at any time
upon notification to the fund's Board of Directors.
================================================================================
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
================================================================================
Statement of Investments in Securities and Net Assets, March 31, 1997
(unaudited)
<TABLE>
<CAPTION>
Face Value
Amount (Note 1)
- ----------------------------------------------------------------------------------------------------------------
Mortgage-Backed Securities 91.6%
Federal Home Loan Mortgage Corp. (FHLMC) 29.2%
<S> <C> <C> <C>
$ 75,058 9.00%, 06/01/01 ........................................................ $ 77,192
162,375 6.50%, 11/01/01 ........................................................ 160,469
113,596 6.50%, 03/01/09 ........................................................ 110,208
76,127 7.00%, 06/01/09 ........................................................ 75,279
52,050 8.00%, 01/01/10 ........................................................ 53,187
72,984 7.50%, 04/01/10 ........................................................ 73,314
125,392 6.00%, 07/01/10 ........................................................ 118,751
68,340 6.50%, 04/01/11 ........................................................ 65,988
96,794 7.00%, 07/01/11 ........................................................ 95,385
91,666 9.50%, 12/01/22 ........................................................ 98,537
128,009 7.00%, 06/01/24 ........................................................ 123,389
128,906 7.50%, 07/01/24 ........................................................ 127,554
119,106 8.00%, 07/01/24 ........................................................ 120,465
157,975 8.50%, 12/01/24 ........................................................ 162,558
43,623 8.00%, 06/01/25 ........................................................ 44,000
73,759 7.00%, 09/01/25 ........................................................ 70,865
52,770 7.00%, 10/01/25 ........................................................ 50,700
45,523 7.50%, 10/01/25 ........................................................ 44,917
67,577 7.50%, 01/01/26 ........................................................ 66,676
84,574 8.00%, 01/01/26 ........................................................ 85,306
59,202 7.00%, 03/01/26 ........................................................ 56,852
114,773 7.00%, 03/01/26 ........................................................ 110,217
46,836 7.50%, 05/01/26 ........................................................ 46,180
75,646 7.50%, 01/01/27 ........................................................ 74,586
----------------
Total Federal Home Loan Mortgage Corp. (Cost $2,109,108) ............... 2,112,575
----------------
Federal National Mortgage Association (FNMA)38.2%
192,522 6.00%, 03/01/01 ........................................................ 187,134
117,559 6.50%, 09/01/08 ........................................................ 114,185
88,025 7.00%, 07/01/09 ........................................................ 86,956
69,392 7.50%, 07/01/09 ........................................................ 69,713
48,862 6.00%, 04/01/11 ........................................................ 46,045
48,175 6.50%, 04/01/11 ........................................................ 46,434
51,475 6.00%, 05/01/11 ........................................................ 48,507
33,827 7.00%, 11/01/11 ........................................................ 33,282
26,058 6.00%, 12/01/23 ........................................................ 23,725
442,820 6.50%, 06/01/24 ........................................................ 414,803
393,681 7.00%, 06/01/24 ........................................................ 378,863
88,986 8.50%, 07/01/24 ........................................................ 91,491
145,241 8.00%, 01/01/25 ........................................................ 146,544
Federal National Mortgage Association (FNMA) (cont.)
$ 24,765 8.00%, 01/01/25 ........................................................ $ 24,929
151,082 9.00%, 01/01/25 ........................................................ 158,635
212,095 7.50%, 08/01/25 ........................................................ 209,004
49,171 7.50%, 11/01/25 ....................................................... 48,455
58,032 7.00%, 01/01/26 ........................................................ 55,692
49,566 7.50%, 03/01/26 ........................................................ 48,769
73,837 7.00%, 06/01/26 ........................................................ 70,756
28,796 8.00%, 06/01/26 ........................................................ 28,970
50,419 8.00%, 07/01/26 ........................................................ 50,724
86,418 8.00%, 08/01/26 ........................................................ 86,940
96,791 7.50%, 10/01/26 ........................................................ 95,234
100,000 a6.07%, 04/01/27 ....................................................... 98,563
100,999 6.10%, 11/01/35 ........................................................ 99,626
----------------
Total Federal National Mortgage Association (Cost $2,720,690)........... 2,763,979
----------------
Government National Mortgage Association (GNMA), SF,24.2%
130,752 9.00%, 12/15/16 ........................................................ 139,527
53,186 10.00%, 10/15/18 ....................................................... 58,638
105,058 9.50%, 10/15/20 ........................................................ 113,361
190,606 8.00%, 02/15/23 ........................................................ 192,974
262,917 7.00%, 06/15/23 ........................................................ 252,916
147,999 7.50%, 06/15/23 ........................................................ 146,207
259,830 6.50%, 01/15/24 ........................................................ 242,853
123,143 8.50%, 07/15/24 ........................................................ 126,899
39,635 8.00%, 01/15/25 ....................................................... 39,953
48,846 7.50%, 09/15/25 ........................................................ 48,038
25,042 7.50%, 09/15/25 ........................................................ 24,628
48,731 7.00%, 01/15/26 ........................................................ 46,590
72,920 7.50%, 01/15/26 ........................................................ 71,626
25,089 7.00%, 03/15/26 ........................................................ 23,986
23,401 7.50%, 05/15/26 ........................................................ 22,986
50,435 8.00%, 06/15/26 ........................................................ 50,793
39,046 8.00%, 06/15/26 ........................................................ 39,323
34,356 8.50%, 08/15/26 ........................................................ 35,307
33,920 8.00%, 08/20/26 ........................................................ 34,026
39,449 7.50%, 10/15/26 ........................................................ 38,750
-----------------
Total Government National Mortgage Association (Cost $1,768,559) ....... 1,749,381
-----------------
Total Mortgage-Backed Securities (Cost $6,598,357) ..................... 6,625,935
-----------------
</TABLE>
<TABLE>
<CAPTION>
bReceivables from Repurchase Agreements 8.9%
<S> <C> <C>
$ 651,297 Joint Repurchase Agreements, 6.417%, 04/01/97 (Maturity Value $640,749) ...........(Cost $640,635)
Aubrey G. Lanston & Co., Inc., (Maturity Value $77,012)
Collateral: U.S. Treasury Bills, 09/04/97
U.S. Treasury Notes, 6.75% - 7.00%, 04/15/99 - 05/31/99
Barclays de Zoete Wedd Securities, Inc., (Maturity Value $38,506)
Collateral: U.S. Treasury Notes, 6.00% - 7.125%, 09/30/98 - 09/30/99
CIBC Wood Gundy Securities Corp., (Maturity Value $77,012)
Collateral: U.S. Treasury Notes, 6.25%, 06/30/98
Daiwa Securities America, Inc., (Maturity Value $77,012)
Collateral: U.S. Treasury Notes, 5.00% - 7.50%, 06/30/98 - 12/31/01
Fuji Securities, Inc., (Maturity Value $77,012)
Collateral: U.S. Treasury Bills, 07/31/97
U.S. Treasury Notes, 5.875%, 04/30/98
Sanwa Securities (USA) Co., L.P. (Maturity Value $77,012)
Collateral: U.S. Treasury Bills, 05/15/97
U.S. Treasury Notes, 5.625% - 6.75%, 05/15/98 - 11/30/00
SBC Warburg, Inc., (Maturity Value $77,012)
Collateral: U.S. Treasury Notes, 6.875%, 03/31/00
The Nikko Securities Co. International, Inc., (Maturity Value $63,159)
Collateral: U.S. Treasury Notes, 4.75% - 6.50%, 05/31/98 - 09/30/01
UBS Securities L.L.C., (Maturity Value $77,012)
Collateral: U.S. Treasury Notes, 5.00% - 6.875%, 04/30/97 - 04/30/00 .............. $ 640,635
-----------------
Total Investments (Cost $7,238,992)100.5% ......................................... 7,266,570
Liabilities in Excess of Other Assets, Net(0.5%)................................... (37,931)
-----------------
Net Assets100.0% .................................................................. $7,228,639
=================
At March 31, 1997, the net unrealized appreciation based on the
cost of investments for income tax purposes of $7,211,597 was as
follows:
Aggregate gross unrealized appreciation for all investments in which there was an
excess of value over tax cost .................................................... $ 123,633
Aggregate gross unrealized depreciation for all investments in which there was an
excess of tax cost over value .................................................... (68,660)
-----------------
Net unrealized appreciation ....................................................... $ 54,973
=================
</TABLE>
PORTFOLIO ABBREVIATION:
SF - Single Family
aSee Note 1(g) regarding securities purchased on a when-issued basis. bFace
amount for repurchase agreements is for the underlying collateral. See Note 1(f)
regarding joint repurchase agreement.
The accompanying notes are an integral part of these financial statements.
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
================================================================================
FINANCIAL STATEMENTS
STATEMENT OF ASSETS AND LIABILITIES
March 31, 1997 (unaudited)
Assets:
Investments in securities, at value
(identified cost $6,598,357) $6,625,935
Receivables from repurchase
agreements, at value and cost 640,635
Receivables:
Capital shares sold 19,055
Dividends and interest 41,678
Investment securities sold 1,330
-----------
Total assets 7,328,633
-----------
Liabilities:
Payables:
Investment securities purchased on
a when-issued basis (Note 1) 98,917
Dividends to shareholders 1,077
------------
Total liabilities 99,994
------------
Net assets, at value $7,228,639
============
Net assets consist of:
Unrealized appreciation on investments 27,578
Accumulated net realized loss (192,789)
Capital shares 7,393,850
------------
Net assets, at value $7,228,639
============
Net asset value per share
($7,228,639 / 743,742 shares
outstanding) $9.72
============
Statement of Operations
for the six months ended March 31, 1997 (unaudited)
Investment income:
Interest $257,359
Expenses:
Management fees (Note 6) 14,061
Shareholder servicing costs (Note 6) 49
Registration fees 11,093
Professional fees 7,047
Reports to shareholders 4,414
Amortization of organization costs
(Note 2) 1,202
Custodian fees 157
Other 974
Management fees waived by
manager (Note 6) (14,061)
Other expenses assumed by
manager (Note 6) (24,936)
------------
----------
Total expenses --
----------
Net investment income 257,359
Net unrealized depreciation
on investments (20,388)
Net increase in net assets
resulting from operations $236,971
==========
The accompanying notes are an integral part of these financial statements.
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
================================================================================
Financial Statements (cont.)
Statements of Changes in Net Assets for the six months ended March 31, 1997
(unaudited) and the year ended September 30, 1996
<TABLE>
<CAPTION>
Six Months Year
Ended Ended
3/31/1997 9/30/1996
-------- --------
Increase (decrease) in net assets:
Operations:
<S> <C> <C>
Net investment income ............................................................. $ 257,359 $ 461,328
Net unrealized depreciation on investments......................................... (20,388) (107,488)
-------- --------
Net increase in net assets resulting from operations ............................... 236,971 353,840
Distributions to shareholders from undistributed net investment income.............. (257,359) (461,328)
Increase in net assets from capital share transactions (Note 4)..................... 401,802 974,807
-------- --------
Net increase in net assets ......................................................... 381,414 867,319
Net assets (there is no undistributed net investment income at beginning or end of period):
Beginning of period ............................................................... 6,847,225 5,979,906
-------- --------
End of period ..................................................................... $7,228,639 $6,847,225
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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 investment objective of the Fund is total
return.
The following is a summary of 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 Valuations:
Portfolio securities listed on a securities exchange or on the NASDAQ for which
market quotations are readily available are valued at the last sale price or, if
there is no sale price, within the range of the most recent quoted bid and asked
prices. Other securities are valued based on a variety of factors, including
yield, risk, maturity, trade activity and recent developments related to the
securities. The Fund may utilize a pricing service, bank or broker/dealer
experienced in such matters to perform any of the pricing functions, under
procedures approved by the Board of Trustees (the Board). Securities for which
market quotations are not available are valued in accordance with procedures
established by the Board.
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.
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.
d. Investment Income, Expenses and Distributions:
Dividend income and distributions to shareholders are recorded on the
ex-dividend date. Interest income and estimated expenses are accrued daily. Bond
discount is 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 commence on the day
following 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 an amount
per day set from time to time by the Board, and are payable to shareholders of
record at the beginning of business on the ex-dividend date. Once each month
dividends are reinvested in additional shares of the Fund, or paid in cash as
requested by the shareholders.
Net realized capital gains and losses differ for financial statement and tax
purposes primarily due to differing treatment of mortgage dollar rolls.
e. Accounting Estimates:
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the amounts of income and expense during the reporting
period. Actual results could differ from those estimates.
f. 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. A repurchase agreement is accounted for as
1. SIGNIFICANT ACCOUNTING POLICIES (cont.)
f. Repurchase Agreements: (cont.)
a loan by the Fund to the seller, collateralized by underlying U.S. government
securities, which are delivered to the Fund's custodian. The market value,
including accrued interest, of the initial collateralization is required to be
at least 102% of the dollar amount invested by the Fund with the value of the
underlying securities marked to market daily to maintain coverage of at least
100%. At March 31, 1997, all outstanding repurchase agreements held by the Fund
had been entered into on that date.
g. Securities Purchased on a When-Issued or Delayed Delivery:
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 holding the
securities, it may sell the 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.
h. 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. 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).
3. DISTRIBUTIONS AND CAPITAL LOSS CARRYOVERS
At September 30, 1996, for tax purposes, the Fund had net capital loss
carryovers as follows:
Expiring in: 2002 ........ $109,092
2004 ........ 56,302
------------
$165,394
============
For tax purposes, the aggregate cost of securities is lower (and unrealized
appreciation is higher) than for financial statement purposes at March 31, 1997
by $27,395.
4. CAPITAL STOCK
At March 31, 1997, there were an unlimited number of $.01 par value shares of
beneficial interest authorized. Transactions for the periods ended March 31,
1997 and September 30, 1996 were as follows:
<TABLE>
<CAPTION>
Six Months Ended Year Ended
March 31, 1997 September 30, 1996
--------------- ---------------
Shares Amount Shares Amount
------ ------- ----- -------
<S> <C> <C> <C> <C>
Shares sold........................................................ 27,051 $265,799 55,521 $545,307
Shares issued in reinvestment of distributions..................... 25,495 250,907 46,337 455,627
Shares redeemed.................................................... (11,689) (114,904) (2,685) (26,127)
------ ------- ----- -------
Net increase....................................................... 40,857 $401,802 99,173 $974,807
====== ======= ===== =======
</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 year ended March 31,
1997 aggregated $374,954 and $326,923, respectively.
6. TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES
a. Management Agreement:
Under the terms of a management agreement, Franklin Institutional Services
Corporation (FISCO), provides investment advice, administrative services, office
space and facilities to the Fund, and receives fees computed monthly based on
the average daily net assets of the Fund as follows:
Annualized Fee Rate Average Daily Net Assets
-------------------- -------------------------------------------------
0.400% First $250 million
0.380% over $250 million, up to and including $500 million
0.360% over $500 million
The terms of the management agreement provide that aggregate annual 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. For the period ended March 31, 1997,
the Fund's expenses did not exceed these limitations. However, FISCO agreed in
advance to waive management fees and made payments of other expenses as shown in
the Statement of Operations.
Under an agreement with FISCO, Franklin Templeton Services, Inc. (FT Services)
provides administrative services and facilities for the Fund. The fee is paid by
FISCO and computed monthly based on average daily net assets. It is not a
separate expense of the Fund.
b. Shareholder Services Agreement:
Under the terms of a shareholder service agreement with Franklin/Templeton
Investors Services, Inc. (Investor Services), the Fund pays costs on a per
shareholder account basis. Shareholder servicing costs incurred by the Fund for
the period ended March 31, 1997 aggregated $49.
c. Underwriting Agreement:
In its capacity as underwriter for the shares of the Fund, Franklin/Templeton
Distributors, Inc. (Distributors) receives commissions on sales of the Fund's
shares of beneficial interest. Commissions are deducted from the gross proceeds
6. TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES (cont.)
c. Underwriting Agreement: (cont.)
received from the sale of shares of the Fund, and as such are not expenses of
the Fund. Distributors may also make payments, out of its own resources, to the
dealers for certain sales of the Fund's shares. Commissions received by
Distributors and the amounts paid to other dealers for the year ended March 31,
1997 amounted to $2,441 and $2,266, respectively.
d. Other Affiliated Parties and Transactions
Certain officers and trustees of the Fund are also officers and/or directors of
FISCO, Distributors, and Investors Services, all wholly-owned subsidiaries of
Franklin Resources, Inc. (Resources).
At March 31,1997, Resources owned 89.48% of the Fund's outstanding shares.
7. FINANCIAL HIGHLIGHTS
Selected data for each share of beneficial interest outstanding throughout each
period are as follows:
<TABLE>
<CAPTION>
Six Months Ended Year ended September 30,
- ---------------------------------------------------------------------------------------------------------------------------
March 31, 1997 1996 1995 1994 1993***
------------ ------ ------ ------- --------
Per Share Operating Performance:
<S> <C> <C> <C> <C> <C>
Net asset value at beginning of period............ $9.74 $ 9.91 $ 9.42 $10.24 $10.00
------------ ------ ------ ------- --------
Net investment income............................. 0.360 0.717 0.714 0.553 0.365
Net realized and unrealized gain (loss)
on securities.................................... (0.020) (0.170) 0.490 (0.711) 0.240
------------ ------ ------ ------- --------
Total from investment operations ................. 0.340 0.547 1.204 (0.158) 0.605
------------ ------ ------ ------- --------
Less distributions:
Dividends from undistributed net investment
income........................................... (0.360) (0.717) (0.714) (0.553) (0.365)
Distributions from net capital gains.............. -- -- -- (0.109) --
------------ ------ ------ ------- --------
Total distributions............................... (0.360) (0.717) (0.714) (0.662) (0.365)
------------ ------ ------ ------- --------
Net asset value at end of period ................. $9.72 $ 9.74 $ 9.91 $ 9.42 $10.24
============ ====== ====== ======= ========
TotalReturn+...................................... 3.50% 5.69% 13.27% (1.61)% 6.13%
Ratios/Supplemental Data:
Net assets at end of year (in 000's).............. $7,229 $6,487 $5,980 $5,223 $5,306
Ratio of expenses to average net assets++......... --% --% --% --% --%
Ratio of expenses to average net assets (excluding
waiver and payments by Manager) (Note 6)......... 1.10% 1.11% 1.24% 1.28% 1.22%*
Ratio of net income to average net assets......... 7.34% 7.26% 7.42% 5.65% 3.59%*
Portfolio turnover rate+++........................ 4.90% 17.64% 34.20% 86.38% 104.33%**
</TABLE>
+Total return measures the change in value of an investment over the periods
indicated. It is not annualized. It does not include the maximum initial sales
charge and assumes reinvestment of dividends and capital gains, if any, at net
asset value.
++During the year, FISCO agreed in advance to waive the management fees and made
payments of other expenses.
+++The portfolio turnover rate excludes mortgage dollar roll transactions.
*Annualized
**The portfolio turnover rates for this period has been restated to exclude
purchases and sales of mortgage dollar roll transactions.
***For the period February 1, 1993 (effective date) to September 30, 1993.
Franklin Strategic Mortgage Portfolio Semi-Annual Report March 31, 1997.
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 format the fund's investment holdings on 3/31/97, based
on total net assets.
Investment Holdings on March 31, 1997
Federal National Mortgage 38.2%
Association (FNMA)
Federal Home Loan Mortgage 29.2%
Corporation (FHLMC)
Government National Mortgage 24.2%
Association (GNMA)
Cash & Equivalents 8.4%
