SHAREHOLDER LETTER
CONTENTS
Shareholder Letter 1
Manager's Discussion 3
Performance Summary 5
Financial Highlights &
Statement of Investments 7
Financial Statements 11
Notes to
Financial Statements 14
Report of Independent
Accountants 17
Dear Shareholder:
It's a pleasure to bring you the Franklin Strategic Mortgage Portfolio's annual
report for the period ended September 30, 1997.
During the one-year reporting period, economic conditions were very favorable
for investors. Although in the beginning of the period, growth was a little
sluggish, the economy soon strengthened to a point where the Federal Reserve
Board (the Fed) began to worry it might overheat. Concerned that this strong
growth might lead to higher inflation, the Fed increased short-term interest
rates in March by 25 basis points, from 5.25% to 5.50%. This rate hike had the
desired effect of moderating economic growth. Interest rates also became more
stable, reversing their general rise, and ended the period down from where they
began. The 30-year U.S. Treasury bond started the one-year period with a rate of
6.93% and finished at 6.41% on September 30, 1997.1
The Fed raised rates only once during the reporting period. Despite continued
strong economic growth, there have been remarkably few signs of increased
inflation. This low inflation, combined with a balanced budget agreement between
the President and Congress, greatly contributed to a beneficial environment of
falling interest rates.
1. Source: Federal Reserve H15 Report.
At the end of the period, we believe the economy's growth rate is again
accelerating, as consumer spending strengthens. Rising growth would increase the
possibility of a Fed rate hike in the future. Our positioning of the Franklin
Strategic Mortgage Portfolio, in light of this possibility, and over the course
of the reporting period, is detailed in the Manager's Discussion on page 3 of
this report.
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
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.1
Favorable economic conditions contributed to a strong performance for the
Franklin Strategic Mortgage Portfolio. The Portfolio enjoyed a cumulative total
return, excluding sales charges, of 9.84% for the one-year period ended
September 30, 1997. An environment of relatively stable and falling interest
rates contributed to this strong performance by positively influencing the
mortgage pass-through securities market in which the Portfolio invests. Mortgage
securities offer advantages in both yield and income over lower-risk U.S.
Treasury securities, and benefited from the relatively stable and decreasing
interest-rate environment.
What is a "pass-through" security?
A mortgage security is an interest in a pool of mortgage loans. Most mortgage
securities are pass-through securities, which means that they provide investors
with monthly payments consisting of a prorated share of both regular interest
and principal payments -- as well as unscheduled early prepayments -- on the
underlying mortgage pool. The primary issuers or guarantors of these mortgage
securities are the Government National Mortgage Association (GNMA), Federal
National Mortgage Association (FNMA), and Federal Home Loan Mortgage Corporation
(FHLMC). Securities issued by these agencies are generally considered to be high
quality investments having minimal credit risks.
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 the timely payment of principal and interest. Yields and share price are not
guaranteed and will fluctuate with market conditions.
GRAPHIC MATERIAL 1 OMITTED - SEE APPENDIX AT END OF DOCUMENT
Our investment approach, which utilizes low portfolio turnover, helps reduce
unnecessary transaction costs. Over the one-year reporting period, we continued
our strategy of purchasing high credit quality mortgage pass-through securities.
In an effort to reduce risk and further diversify our holdings we invested in a
variety of pass-through coupon and maturity sectors, and different agency
mortgage securities, including GNMA, FNMA and FHLMC issues.
In addition, in seeking to reduce our risk exposure, we managed the fund's
portfolio with a slightly lower interest-rate risk than that of the Salomon
Brothers Mortgage Index.2 The relatively lower interest-rate risk of our
securities, compared with the index, made them less susceptible to a loss in
value that would result from a rise in interest rates. This action should
position the Portfolio to perform relatively well if the Fed increases rates,
which we believe is likely.
This discussion reflects the strategies we employed for the Portfolio during the
year 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 Portfolio.
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.
2. Source: Salomon Brothers. Risk measured by duration as of 9/30/97.
PERFORMANCE SUMMARY
Franklin Strategic Mortgage Portfolio's share price, as measured by net asset
value, increased 22 cents, from $9.74 on September 30, 1996, to $9.96 on
September 30, 1997.
At the end of the reporting period, the fund's distribution rate was 6.96%,
based on an annualization of the current, monthly dividend of 5.9499 cents
($0.059499) per share and the maximum offering price of $10.40 on September 30,
1997.
The chart on page 6 illustrates that since its inception in 1993, the Franklin
Strategic Mortgage Portfolio slightly underperformed the unmanaged Solomon
Brothers Mortgage Index. Comparing a mutual fund with an index, however, is
never an apples-to-apples comparison. An index doesn't pay management fees to
cover salaries of securities analysts or portfolio managers, or pay commissions
or market spreads to buy and sell securities. Unlike an index, mutual funds are
never fully invested because they must have cash on hand to redeem shares. In
addition, the performance shown for the fund includes the maximum initial sales
charge, all fund expenses and account fees. If the fund's costs had been applied
to the index, the index's performance would have been lower. Please remember
that an index is simply a measure of performance and one cannot invest in it
directly.
Dividend Distributions
10/1/96 - 9/30/97*
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
April 5.8692 cents
May 5.5897 cents
June 5.9096 cents
July 5.7814 cents
August 5.3395 cents
September 6.3204 cents
- ----------------------------------------
Total 70.773 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.
Dividends will vary based on the earnings of the fund's portfolio, and past
distributions are not indicative of future trends.
GRAPHIC MATERIAL 2 OMITTED - SEE APPENDIX AT END OF DOCUMENT
Periods ended September 30, 1997
Since
Inception
1-Year 3-Year (2/1/93)
- -----------------------------------------------------------------
Cumulative Total Return1 9.84% 31.49% 37.30%
Average Annual Total Return2 5.20% 7.97% 6.06%
Distribution Rate3 6.96%
30-Day Standardized Yield4 6.95%
1. Cumulative total returns measure the change in value of an investment over
the periods indicated and do not include the sales charge.
2. Average annual total returns measure the average annual change in value of an
investment over the periods indicated and include the current, maximum 4.25%
initial sales charge. See Note below.
3. Based on an annualization of the current, monthly dividend of 5.9499 cents
per share and the maximum offering price of $10.40 on September 30, 1997.
4. Yield, calculated as required by the SEC, is based on the earnings of the
fund's portfolio for the 30 days ended September 30, 1997.
Note: Prior to July 1, 1994, fund shares were offered at a higher initial sales
charge; thus, actual total returns would be lower. Your investment return and
principal value will fluctuate with market conditions, and you may have a gain
or loss when you sell your shares.
The fund's manager has agreed to waive all or a portion of its management fees
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 6.35%. The fee waiver may be discontinued at any
time upon notification to the fund's Board of Directors.
*Includes all sales charges and represents the change in value of an investment
during the period shown. Total return assumes reinvestment of dividends and
capital gains at net asset value. Index is unmanaged and includes reinvested
dividends.
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Financial Highlights
<TABLE>
<CAPTION>
Year Ended September 30,
-------------------------------------------------------------
1997 1996 1995 1994 1993***
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Per Share Operating Performance
(for a share outstanding throughout the year)
Net asset value, beginning of year $9.74 $9.91 $9.42 $10.24 $10.00
Income from investment operations:
Net investment income .708 .717 .714 .553 .365
Net realized and unrealized gains (losses) .220 (.170) .490 (.711) .240
Total from investment operations .928 .547 1.204 (.158) .605
Less distributions:
Dividends from net investment income (.708) (.717) (.714) (.553) (.365)
Distributions from net realized gains -- -- -- (.109) --
Total distributions (.708) (.717) (.714) (.662) (.365)
Net asset value, end of year $9.96 $9.74 $9.91 $9.42 $10.24
Total return+ 9.84% 5.69% 13.27% (1.61)% 6.13%
Ratios/Supplemental Data:
Net assets, end of year (000's) $8,934 $6,847 $5,980 $5,223 $5,306
Ratios to average net assets:
Expenses --% --% --% --% --%
Expenses excluding waiver and payments by affiliate .82% 1.11% 1.24% 1.28% 1.22%*
Net investment income 7.18% 7.26% 7.42% 5.65% 3.59%*
Portfolio turnover rate** 13.59% 17.64% 34.20% 86.38% 104.33%
</TABLE>
+Total return does not reflect sales commissions and is not annualized.
*Annualized
**The portfolio turnover rate excludes mortgage dollar roll transactions.
***For the period February 1, 1993 (effective date) to September 30, 1993.
See notes to financial statements.
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Statement of Investments, September 30, 1997 (cont.)
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
- ------------------------------------------------------------------------------------------------------------------
bMortgage-Backed Securities 82.8%
Federal Home Loan Mortgage Corp. (FHLMC) 23.1%
<S> <C> <C>
9.00%, 6/01/01 $ 67,290 $ 69,172
6.50%, 11/01/01 161,441 162,345
6.50%, 3/01/09 105,822 105,528
7.00%, 6/01/09 70,595 71,524
8.00%, 1/01/10 48,317 50,143
7.50%, 4/01/10 66,936 68,693
6.00%, 7/01/10 116,614 114,277
6.50%, 4/01/11 63,213 62,892
7.00%, 7/01/11 91,587 92,638
9.50%, 12/01/22 82,544 89,075
7.00%, 6/01/24 126,888 127,124
7.50%, 7/01/24 128,085 130,748
8.00%, 7/01/24 112,749 116,763
8.50%, 12/01/24 149,057 156,187
8.00%, 6/01/25 40,487 41,881
7.00%, 9/01/25 70,799 70,814
7.00%, 10/01/25 45,106 45,116
7.50%, 10/01/25 42,885 43,722
7.50%, 1/01/26 64,399 65,655
8.00%, 1/01/26 80,199 82,960
7.00%, 3/01/26 58,854 58,803
7.00%, 3/01/26 109,139 109,044
7.50%, 5/01/26 46,561 47,460
7.50%, 1/01/27 75,221 76,673
----------
Total Federal Home Loan Mortgage Corp. (Cost $2,001,527) 2,059,237
----------
Federal National Mortgage Association (FNMA) 35.5%
6.00%, 3/01/01 190,653 189,309
6.50%, 9/01/08 108,478 108,256
7.00%, 7/01/09 85,620 86,705
7.50%, 7/01/09 61,156 62,752
6.00%, 4/01/11 47,659 46,549
6.50%, 4/01/11 46,758 46,530
6.00%, 5/01/11 49,115 47,971
7.00%, 11/01/11 32,625 33,001
6.00%, 12/01/23 24,932 23,827
6.50%, 6/01/24 424,958 416,251
7.00%, 6/01/24 333,943 333,944
8.50%, 7/01/24 70,132 73,466
8.00%, 1/01/25 137,635 142,395
8.00%, 1/01/25 22,056 22,802
9.00%, 1/01/25 134,962 144,042
7.50%, 8/01/25 201,673 205,427
7.50%, 11/01/25 48,832 49,742
7.00%, 1/01/26 56,304 56,216
7.50%, 3/01/26 49,138 50,049
7.00%, 6/01/26 71,620 71,455
Federal National Mortgage Association (FNMA) (cont.)
8.00%, 6/01/26 $ 26,609 $ 27,519
8.00%, 7/01/26 48,462 50,119
8.00%, 8/01/26 82,130 84,938
7.50%, 10/01/26 96,388 98,174
7.00%, 4/01/27 300,000 299,202
8.00%, 9/15/27 297,000 306,838
6.116%, 11/01/35 95,204 94,789
-----------
Total Federal National Mortgage Association (Cost $3,049,986) 3,172,268
-----------
Government National Mortgage Association (GNMA), SF, 24.2%
9.00%, 12/15/16 107,080 116,393
10.00%, 10/15/18 52,738 57,966
9.50%, 10/15/20 94,348 102,671
8.00%, 2/15/23 178,054 184,943
7.00%, 6/15/23 241,592 242,711
7.50%, 6/15/23 129,569 132,438
6.50%, 1/15/24 248,911 244,349
8.50%, 7/15/24 106,478 111,715
8.00%, 1/15/25 37,212 38,520
7.50%, 9/15/25 44,718 45,559
7.50%, 9/15/25 23,196 23,632
7.00%, 1/15/26 47,775 47,846
7.50%, 1/15/26 72,255 73,592
7.00%, 3/15/26 24,222 24,259
7.50%, 5/15/26 21,647 22,048
8.00%, 6/15/26 50,209 51,994
8.00%, 6/15/26 36,612 37,914
8.50%, 8/15/26 24,666 25,870
8.00%, 8/20/26 32,522 33,556
7.50%, 10/15/26 38,474 39,186
7.50%, 9/15/27 495,000 504,049
----------
Total Government National Mortgage Association (Cost $2,126,691) 2,161,211
----------
Total Mortgage-Backed Securities (Cost $7,178,204) 7,392,716
----------
</TABLE>
<TABLE>
<CAPTION>
Repurchase Agreement 15.9%
Joint Repurchase Agreement, 6.007%, 10/01/97, (Maturity Value $1,424,348)
(Cost $1,424,111)
Aubrey G. Lanston & Co., Inc., (Maturity Value $108,356) B.A. Securities,
Inc., (Maturity Value $108,356) Barclays de Zoete Wedd Securities, Inc.,
(Maturity Value $124,076) Bear, Stearns & Co., Inc., (Maturity Value
$108,356) CIBC Wood Gundy Securities Corp., (Maturity Value $108,356)
Donaldson, Lufkin & Jenrette Securities Corp., (Maturity Value $108,356)
Dresdner Bank, (Maturity Value $108,356) Fuji Securities, Inc., (Maturity
Value $108,356) Lehman Brothers, Inc., (Maturity Value $108,356) Sanwa
Securities (USA) Co., L.P., (Maturity Value $108,356) SBC Warburg, Inc.,
(Maturity Value $108,356) The Nikko Securities Co. International, Inc.,
(Maturity Value $108,356) UBS Securities L.L.C., (Maturity Value $108,356)
<S> <C> <C>
Collateralized by U.S. Treasury Bills & Notes $1,424,111 $1,424,111
------------
Total Investments (Cost $8,602,315) 98.7% 8,816,827
Other Assets, less Liabilities 1.3% 117,118
------------
Net Assets 100.0% $8,933,945
============
</TABLE>
aSee Note 1(b) regarding joint repurchase agreement.
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Financial Statements
Statement of Assets and Liabilities
September 30, 1997
<TABLE>
<CAPTION>
Assets:
<S> <C>
Investments in securities, at value (cost $7,178,204) $7,392,716
Repurchase agreement, at value and cost 1,424,111
Cash 6,027
Receivables:
Investment securities sold 866
Capital shares sold 64,762
Interest 45,463
-----------------
Total assets and net assets, at value 8,933,945
=================
Net assets consist of:
Net unrealized appreciation $ 214,512
Accumulated net realized loss (191,107)
Capital shares 8,910,540
-----------------
Net assets, at value $8,933,945
=================
Net asset value per share ($8,933,945 / 896,996 shares outstanding)* $9.96
=================
Maximum offering price per share ($9.96 / 95.75%) $10.40
=================
</TABLE>
*Redemption price is equal to net asset value less any applicable sales charge.
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Financial Statements (continued)
Statement of Operations
for the year ended September 30, 1997
Investment income:
Interest $540,924
Expenses:
Management fees (Note 3) $30,144
Transfer agent fees (Note 3) 1,438
Custodian fees 76
Reports to shareholders 1,060
Registration and filing fees 16,300
Professional fees 11,105
Amortization of organization costs (Note 1) 1,200
Other 776
------------
Total expenses 62,099
---------
Expenses waived/paid by affiliate (Note 3) (62,099)
---------
Net expenses --
---------
Net investment income 540,924
---------
Realized and unrealized gains:
Net realized gain from investments 1,854
Net unrealized appreciation on investments 166,546
---------
Net realized and unrealized gain 168,400
---------
Net increase in net assets resulting from operations $709,324
=========
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Financial Statements (continued)
Statement of Changes in Net Assets
for the years ended September 30, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
----------------------------
Increase (decrease) in net assets:
Operations:
<S> <C> <C>
Net investment income $ 540,924 $ 461,328
Net realized gain from investments 1,854 --
Net unrealized appreciation (depreciation) on investments 166,546 (107,488)
----------------------------
Net increase in net assets resulting from operations 709,324 353,840
Distributions to shareholders from net investment income (539,448) (461,328)
Capital share transactions (Note 2) 1,916,844 974,807
----------------------------
Net increase in net assets 2,086,720 867,319
Net assets (there was no undistributed net investment income at end of year):
Beginning of year 6,847,225 5,979,906
----------------------------
End of year $8,933,945 $6,847,225
============================
</TABLE>
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Notes to Financial Statements
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Franklin Strategic Mortgage Portfolio (the Fund) is registered under the
Investment Company Act of 1940 as a diversified, open-end investment company.
The Fund seeks total return.
The following summarizes the Fund's significant accounting policies.
a. Security Valuation
Securities listed or traded on a recognized national exchange or NASDAQ are
valued at the latest reported sales price. Over-the-counter securities and
listed securities for which no sale is reported are valued within the range of
the latest quoted bid and asked prices. Securities for which market quotations
are not readily available are valued at fair value as determined by management
in accordance with procedures established by the Board of Trustees.
b. Joint Repurchase Agreement
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. 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 a loan by the Fund to the seller, collateralized
by 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 Funds, with the value of the
underlying securities marked to market daily to maintain coverage of at least
100%. At September 30, 1997, all outstanding repurchase agreements held by the
Fund had been entered into on that date.
c. Income Taxes
No provision has been made for income taxes because the Fund's policy is to
qualify as a regulated investment company under the Internal Revenue Code and
distribute all of its taxable income.
d. Security Transactions, Investment Income, Expenses and Distributions
Security transactions are accounted for on trade date. Realized gains and losses
on security transactions are determined on a specific identification basis.
Interest income and estimated expenses are accrued daily. Dividends from net
investment income are normally declared daily and distributed monthly to
shareholders.
e. Organization Costs
Organization costs are amortized on a straight line basis over five years.
f. 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.
2. CAPITAL STOCK
At September 30, 1997, there were an unlimited number of shares authorized
($0.01 par value). Transactions in the Fund's shares were as follows:
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------------------------------------
1997 1996
---------------------------------------------------------------
Shares Amount Shares Amount
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Shares sold 163,167 $1,611,537 55,521 $545,307
Shares issued in reinvestment of distributions 52,806 521,075 46,337 455,627
Shares redeemed (21,862) (215,768) (2,685) (26,127)
---------------------------------------------------------------
Net increase 194,111 $1,916,844 99,173 $974,807
===============================================================
</TABLE>
3. TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES
Certain officers and trustees of the Fund are also officers and/or trustees of
Franklin Institutional Services Corporation (FISCO), Franklin/Templeton
Distributors, Inc. (Distributors), Franklin Templeton Services, Inc. (FT
Services) and Franklin/Templeton Investor Services, Inc. (Investor Services),
the Fund's investment advisor, principal underwriter, administrative manager,
and transfer agent, respectively.
The Fund pays an investment management fee to FISCO based on the average net
assets of the Fund as follows:
Annualized
Fee Rate Average Daily Net Assets
------------------------------------------------------------------
.400% First $250 million
.380% Over $250 million, up to and including $500 million
.360% In excess of $500 million
Under an agreement with FISCO, FT Services provides administrative services to
the fund. The fee is paid by FISCO based on average daily net assets, and is not
an additional expense of the fund.
FISCO agreed in advance to waive management fees and assume payment of other
expenses as noted in the Statement of Operations.
Distributors received net commissions from sales of Fund shares for the year of
$1,194.
At September 30, 1997, Franklin Resources owned 76.84% of the Fund.
4. INCOME TAXES
At September 30, 1997, the Fund had tax basis capital losses which may be
carried over to offset future capital gains. Such losses expire as follows:
Expiring in: 2002 $106,746
2004 54,436
----------
$161,182
==========
At September 30, 1997, the net unrealized appreciation based on the cost of
investments for income tax purposes of $8,617,776 was as follows:
Unrealized appreciation $208,142
Unrealized depreciation (9,091)
---------
Net unrealized appreciation $199,051
=========
Net realized capital gains and losses differ for financial statement and tax
purposes primarily due to differing treatment of mortgage dollar roll
transactions.
5. INVESTMENT TRANSACTIONS
Purchases and sales of securities (excluding short-term securities) for the year
ended September 30, 1997 aggregated $1,524,605 and $904,597, respectively.
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Report of Independent Accountants
To the Shareholders and Board of Trustees
of the Franklin Strategic Mortgage Portfolio:
We have audited the accompanying statement of assets and liabilities of the
Franklin Strategic Mortgage Portfolio (the Fund), including the statement of
investments, as of September 30, 1997, and the related statement of operations
for the year then ended, the statements of changes in net assets for each of the
two years in the period then ended, and the financial highlights for each of the
periods presented. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
September 30, 1997, by correspondence with the custodian. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of the
Fund as of September 30, 1997, the results of its operations for the year then
ended, the changes in its net assets for each of the two years in the period
then ended, and its financial highlights for each of the periods presented, in
conformity with generally accepted accounting principles.
COOPERS & LYBRAND L.L.P.
San Francisco, California
November 4, 1997
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO ANNUAL REPORT SEPTEMBER 30, 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 investment holdings of the fund on 9/30/97,
based on total net assets.
Investment Holdings
Federal National Mortgage Association (FNMA) 35.5%
Government National Mortgage Association (GNMA) 24.2%
Federal Home Loan Mortgage Corporation (FHLMC) 23.1%
Cash & Equivalents 17.2%
GRAPHIC MATERIAL (2)
The following line graph hypothetically compares the performance of the Franklin
Strategic Mortgage Portfolio to that of the Salomon Brothers Mortgage Index,
based on a $10,000 investment from 2/1/93 to 9/30/97.
Period Ending Fund Index
2/1/1993 $9,579 $ 10,000
Feb-93 $9,718 $ 10,092
Mar-93 $9,780 $ 10,153
Apr-93 $9,839 $ 10,222
May-93 $9,859 $ 10,269
Jun-93 $10,007 $ 10,368
Jul-93 $10,014 $ 10,411
Aug-93 $10,130 $ 10,453
Sep-93 $10,166 $ 10,463
Oct-93 $10,215 $ 10,497
Nov-93 $10,133 $ 10,478
Dec-93 $10,230 $ 10,557
Jan-94 $10,349 $ 10,664
Feb-94 $10,187 $ 10,598
Mar-94 $9,984 $ 10,336
Apr-94 $9,932 $ 10,271
May-94 $9,959 $ 10,306
Jun-94 $9,925 $ 10,280
Jul-94 $10,109 $ 10,480
Aug-94 $10,139 $ 10,502
Sep-94 $10,002 $ 10,362
Oct-94 $9,978 $ 10,358
Nov-94 $9,952 $ 10,321
Dec-94 $10,043 $ 10,407
Jan-95 $10,248 $ 10,640
Feb-95 $10,511 $ 10,911
Mar-95 $10,546 $ 10,956
Apr-95 $10,685 $ 11,103
May-95 $11,033 $ 11,463
Jun-95 $11,101 $ 11,523
Jul-95 $11,116 $ 11,546
Aug-95 $11,228 $ 11,653
Sep-95 $11,329 $ 11,756
Oct-95 $11,446 $ 11,864
Nov-95 $11,571 $ 12,003
Dec-95 $11,706 $ 12,152
Jan-96 $11,803 $ 12,246
Feb-96 $11,709 $ 12,149
Mar-96 $11,658 $ 12,108
Apr-96 $11,628 $ 12,052
May-96 $11,591 $ 12,036
Jun-96 $11,727 $ 12,190
Jul-96 $11,782 $ 12,239
Aug-96 $11,778 $ 12,242
Sep-96 $11,974 $ 12,447
Oct-96 $12,206 $ 12,689
Nov-96 $12,377 $ 12,864
Dec-96 $12,329 $ 12,807
Jan-97 $12,414 $ 12,916
Feb-97 $12,437 $ 12,930
Mar-97 $12,392 $ 12,823
Apr-97 $12,569 $ 13,018
May-97 $12,679 $ 13,139
Jun-97 $12,807 $ 13,290
Jul-97 $13,012 $ 13,536
Aug-97 $13,003 $ 13,511
Sep-97 $13,152 $ 13,672
Cum. TR 36.72%
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