PROSPECTUS
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
INVESTMENT STRATEGY
GROWTH & INCOME
FEBRUARY 1, 1999
[Insert Franklin Templeton Ben Head]
LIKE ALL MUTUAL FUND SHARES, THE SEC HAS NOT APPROVED OR DISAPPROVED THESE
SECURITIES OR PASSED UPON THE ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
CONTENTS
THE FUND
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INFORMATION ABOUT THE FUND YOU SHOULD KNOW BEFORE INVESTING
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2 Goal and Strategies
4 Main Risks
6 Performance
7 Fees and Expenses
8 Management
10 Distributions and Taxes
11 Financial Highlights
YOUR ACCOUNT
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INFORMATION ABOUT THE FUND YOU SHOULD KNOW BEFORE INVESTING
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12 Sales Charges
16 Buying Shares
18 Investor Services
21 Selling Shares
23 Account Policies
25 Questions
FOR MORE INFORMATION
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WHERE TO LEARN MORE ABOUT THE FUND Back Cover
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THE FUND
[Insert graphic of bullseye and arrows] GOAL AND STRATEGIES
GOAL The fund's investment goal is high total return (a combination of high
current income and capital appreciation) relative to the performance of the
general mortgage securities market.
PRINCIPAL INVESTMENTS The fund will normally invest at least 65% of total
assets in mortgage securities issued or guaranteed by the U.S. government,
its agencies or instrumentalities. The fund focuses on mortgage pass-through
securities, which are securities representing interests in "pools" of
mortgage loans, issued or guaranteed by the Government National Mortgage
Association ("GNMA"), the Federal National Mortgage Association ("FNMA"), and
the Federal Home Loan Mortgage Corporation ("FHLMC").
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The fund normally invests in mortgage pass-through securities issued or
guaranteed by GNMA, FNMA and FHLMC.
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Government agency or instrumentality issues have different levels of credit
support. GNMA pass-through mortgage certificates are supported by the full
faith and credit of the U.S. government; FNMA securities are supported by
that instrumentality which ultimately has the right to borrow from the U.S.
Treasury under certain circumstances; and FHLMC securities are supported only
by the credit of that instrumentality. Investors should remember that
guarantees of timely repayment of principal and interest do not apply to the
market prices and yields of the securities or to the net asset value or
performance of the fund, which will vary with changes in interest rates and
other market conditions.
At least 65% of total assets will be invested in securities rated AAA by
Standard & Poor's ("S&P") or Aaa by Moody's Investors Service, Inc.
("Moody's) or in unrated securities the fund's manager determines are
comparable. The remaining 35% will be rated at least AA by S&P or Aa by
Moody's.
The fund may invest up to 35% of total assets in higher income producing
mortgage securities including adjustable rate mortgage securities ("ARMS"),
collateralized mortgage obligations ("CMOs"), and stripped mortgage-backed
securities ("SMBS") which may or may not be issued or guaranteed by the U.S.
government, its agencies or instrumentalities.
The fund may buy securities on a "when-issued" or "delayed delivery" basis.
This means that the securities will be paid for and delivered to the fund at
a future date, generally in 30 to 45 days.
TEMPORARY INVESTMENTS The manager may take a temporary defensive position
when the securities trading markets or the economy are experiencing excessive
volatility or a prolonged general decline, or other adverse conditions exist.
Under these circumstances, the fund may be unable to pursue its investment
goal, because it may not invest or may invest substantially less in mortgage
securities.
[Insert graphic of chart with line going up and down] MAIN RISKS
INTEREST RATE When interest rates rise, debt securities prices fall. The
opposite is also true: debt securities prices rise when interest rates fall.
Generally, interest rates rise during times of inflation or a growing
economy, and will fall during an economic slowdown or recession. Securities
with longer maturities usually are more sensitive to interest rate changes
than securities with shorter maturities. Loan rates on adjustable rate
securities lag behind changes in market rates. If the fund holds these
securities, its net asset value may vary to the extent the current interest
rate on these securities differs from market interest rates during periods
between the interest rate reset dates.
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Changes in interest rates affect the prices of the fund's mortgage
pass-through securities. If rates rise, the value of all the fund's mortgage
securities will fall and so too will the fund's share price. If rates fall,
mortgage holders may refinance their mortgage loans at lower interest rates.
This means you could lose money.
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MORTGAGE SECURITIES Mortgage securities differ from conventional debt
securities because principal is paid back over the life of the security
rather than at maturity. The fund may receive unscheduled prepayments of
principal prior to the security's maturity date due to voluntary prepayments,
refinancing or foreclosure on the underlying mortgage loans. To the fund this
means a loss of anticipated interest, and a portion of its principal
investment represented by any premium the fund may have paid. Mortgage
prepayments generally increase with falling interest rates and decrease with
rising interest rates.
INCOME Since the fund can only distribute what it earns, the fund's
distributions to its shareholders may decline when interest rates fall.
CREDIT This is the possibility that an issuer will be unable to make
interest payments or repay principal. While securities directly issued by the
U.S. Treasury and certain agencies that are backed by the full faith and
credit of the U.S. government present little credit risk, securities issued
by other agencies or by private issuers may have greater credit risks.
However, with respect to mortgage securities issued by government agencies or
instrumentalities, there is no guarantee that the government would support
such securities. Consequently, such securities may still involve a risk of
non-payment of principal and interest. Changes in an issuer's financial
strength or in a security's credit rating may affect its value and, thus,
impact the value of fund shares.
DERIVATIVE SECURITIES CMOs and SMBS are considered derivative investments,
ones whose values depend on (or are derived from) the value of an underlying
asset. These instruments are subject to credit risk and prepayment risk
associated with the underlying mortgage assets.
YEAR 2000 When evaluating current and potential portfolio positions, Year
2000 is one of the factors the fund's manager considers.
The manager will rely upon public filings and other statements made by
issuers about their Year 2000 readiness. The manager, of course, cannot audit
each issuer and its major suppliers to verify their Year 2000 readiness.
If an issuer in which the fund is invested is adversely affected by Year 2000
problems, it is likely that the price of its security will also be adversely
affected. A decrease in the value of one or more of the fund's portfolio
holdings will have a similar impact on the price of the fund's shares and the
fund's performance. Please see page 8 for more information.
More detailed information about the fund, its policies, including temporary
investments, and risks can be found in the fund's Statement of Additional
Information (SAI).
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Mutual fund shares are not deposits or obligations of, or guaranteed or
endorsed by, any bank, and are not federally insured by the Federal Deposit
Insurance Corporation, the Federal Reserve Board, or any other agency of the
U.S. government. Mutual fund shares involve investment risks, including the
possible loss of principal.
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[Insert graphic of a bull and a bear] PERFORMANCE
This bar chart and table show the volatility of the fund's returns, which is
one indicator of the risks of investing in the fund. The bar chart shows
changes in the fund's returns from year to year over the past 4 calendar
years. The table shows how the fund's average annual total returns compare to
those of a broad-based securities market index. Of course, past performance
cannot predict or guarantee future results.
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BEST QUARTER:
Q2 '955.26%
WORST QUARTER:
Q1 '94-2.41%
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ANNUAL TOTAL RETURNS 1
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- -1.83% 16.56% 5.32% 8.99%
94 95 96 97
YEAR
AVERAGE ANNUAL TOTAL RETURNS
For the periods ended December 31, 1997
SINCE
INCEPTION
1 YEAR (2/1/93)
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Franklin Strategic Mortgage Portfolio 2 4.33% 6.20%
Salomon Brothers Mortgage-Backed 9.26% 7.07%
Securities Index 3
1. Figures do not reflect sales charges. If they did, returns would be lower.
As of September 30, 1998, the fund's year-to-date return was 6.41%.
2. Figures reflect sales charges.
All fund performance assumes reinvestment of dividends and capital gains.
3. Source: Standard & Poor's(R) Micropal. The unmanaged Salomon Brothers
Mortgage-Backed Securities Index includes approximately 178 issues with an
average maturity of 24.3 years, average duration of 4.67 years, and average
quality of AAA. This total return index includes GNMA, FNMA, and FHLMC
issues. One cannot invest directly in an index, nor is an index
representative of the fund's portfolio.
[Insert graphic of percentage sign] FEES AND EXPENSES
This table describes the fees and expenses that you may pay if you buy and
hold shares of the fund.
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT)
Maximum sales charge (Load)
as a percentage of offering price 4.25%
Load imposed on purchases 4.25%
Maximum Deferred Sales Charge (Load) None
Exchange fee $5.00 1
Please see "Sales Charges" on page 12 for an explanation of how and when
these sales charges apply.
ANNUAL FUND OPERATING EXPENSES (EXPENSES DEDUCTED FROM FUND
ASSETS)
Management fees 2 0.40%
Distribution and service (12b-1) fees None
Other expenses 0.34%
Total annual fund operating expenses 2 0.74%
1. This fee is only for market timers (see page 24).
2. For the fiscal year ended September 30, 1998, the manager had agreed in
advance to waive its management fees and to assume as its own expense certain
expenses otherwise payable by the fund. With this reduction, management fees
were 0.00% and total annual fund operating expenses were 0.00%. The manager
may end this arrangement at any time upon notice to the fund's Board of
Trustees.
EXAMPLE
This example can help you compare the cost of investing in the fund with the
cost of investing in other mutual funds.
The example assumes you invest $10,000 for the periods shown and then sell
all of your shares at the end of those periods. The example also assumes your
investment has a 5% return each year and the fund's operating expenses remain
the same. Although your actual costs may be higher or lower, based on these
assumptions your costs would be:
1 YEAR 3 YEARS 5 YEARS 10 YEARS
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$497 $651 $819 $1,304
[Insert graphic of briefcase] MANAGEMENT
Franklin Advisers, Inc. (Advisers), 777 Mariners Island Blvd., San Mateo, CA
94403, is the fund's investment manager*. Together, Advisers and its
affiliates manage over $222 billion in assets.
*As of February 26, 1998. The terms and conditions of the management services
the manager provides are the same as those of the previous manager.
The team responsible for the fund's management is:
ROGER BAYSTON CFA, PORTFOLIO MANAGER OF ADVISERS
Mr. Bayston has been a manager on the fund since 1993. He joined the Franklin
Templeton Group in 1991.
JACK LEMEIN, EXECUTIVE VICE PRESIDENT OF ADVISERS
Mr. Lemein has been a manager on the fund since 1993. He joined the Franklin
Templeton Group in 1984.
T. ANTHONY COFFEY CFA, PORTFOLIO MANAGER OF ADVISERS
Mr. Coffey has been a manager on the fund since August 1998. He joined the
Franklin Templeton Group in 1989.
The fund pays the manager a fee for managing the fund's assets and making its
investment decisions. For the fiscal year ended September 30, 1998,
management fees, before any advance waiver, were 0.40% of the fund's average
monthly net assets. Under an agreement by the manager to waive its fees, the
fund did not pay any management fees. The manager may end this arrangement at
any time upon notice to the fund's Board of Trustees.
YEAR 2000 PROBLEM The fund's business operations depend on a worldwide
network of computer systems that contain date fields, including securities
trading systems, securities transfer agent operations and stock market links.
Many of the systems currently use a two digit date field to represent the
date, and unless these systems are changed or modified, they may not be able
to distinguish the Year 1900 from the Year 2000 (commonly referred to as the
Year 2000 problem). In addition, the fact that the Year 2000 is a
non-standard leap year may create difficulties for some systems.
When the Year 2000 arrives, the fund's operations could be adversely affected
if the computer systems used by the manager, its service providers and other
third parties it does business with are not Year 2000 ready. For example, the
fund's portfolio and operational areas could be impacted, including
securities trade processing, interest and dividend payments, securities
pricing, shareholder account services, reporting, custody functions and
others.
The fund's manager and its affiliated service providers are making a
concerted effort to take steps they believe are reasonably designed to
address their Year 2000 problems. Of course, the fund's ability to reduce the
effects of the Year 2000 problem is also very much dependent upon the efforts
of third parties over which the fund and its manager may have no control.
[Insert graphic of dollar signs and stacks of coins] DISTRIBUTIONS AND TAXES
INCOME AND CAPITAL GAINS DISTRIBUTIONS The fund declares dividends daily
from its net investment income and pays them monthly on or about the last day
of the month. Your account may begin to receive dividends on the day after we
receive your investment and will continue to receive dividends through the
day we receive a request to sell your shares. Capital gains, if any, may be
distributed annually. The amount of these distributions will vary and there
is no guarantee the fund will pay dividends.
Please keep in mind that if you invest in the fund shortly before the fund
deducts a capital gain distribution from its net asset value, you will
receive some of your investment back in the form of a taxable distribution.
TAX CONSIDERATIONS In general, fund distributions are taxable to you as
either ordinary income or capital gains. This is true whether you reinvest
your distributions in additional shares of the fund or receive them in cash.
Any capital gains the fund distributes are taxable to you as long-term
capital gains no matter how long you have owned your shares.
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BACKUP WITHHOLDING
By law, the fund must withhold 31% of your taxable distributions and proceeds
if you do not provide your correct taxpayer identification number (TIN) or
certify that your TIN is correct, or if the IRS instructs the fund to do so.
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Every January, you will receive a statement that shows the tax status of
distributions you received for the previous year. Distributions declared in
December but paid in January are taxable as if they were paid in December.
When you sell your shares of the fund, you may have a capital gain or loss.
For tax purposes, an exchange of your fund shares for shares of a different
Franklin Templeton Fund is the same as a sale. The individual tax rate on any
gain from the sale or exchange of your shares depends on how long you have
held your shares.
Fund distributions and gains from the sale or exchange of your shares will
generally be subject to state and local income tax. Non-U.S. investors may be
subject to U.S. withholding and estate tax. You should consult your tax
advisor about federal, state, local or foreign tax consequences of your
investment in the fund.
[Insert graphic of a dollar bill] FINANCIAL HIGHLIGHTS
This table presents the fund's financial performance for the past five years.
This information has been audited by PricewaterhouseCoopers LLP.
YEAR ENDED SEPTEMBER 30,
1998 1997 1996 1995 1994
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PER SHARE DATA ($)
Net asset value, beginning of
year 9.96 9.74 9.91 9.42 10.24
---------------------------------------------
Net investment income .66 .71 .72 .71 .55
Net realized and unrealized gains
(losses) .18 .22 (.17) .49 (.71)
---------------------------------------------
Total from investment operations .84 .93 .55 1.20 (.16)
---------------------------------------------
Dividends from net investment
income (.66) (.71) (.72) (.71) (.55)
Distributions from net realized
gains - - - - (.11)
---------------------------------------------
Total distributions (.66) (.71) (.72) (.71) (.66)
---------------------------------------------
Net asset value, end of year 10.14 9.96 9.74 9.91 9.42
=============================================
Total return (%) 1 8.71 9.84 5.69 13.27 (1.61)
RATIOS/SUPPLEMENTAL DATA
Net assets, end of year
($ x 1,000) 14,551 8,934 6,847 5,980 5,223
Ratios to average net assets: (%)
Expenses - - - - -
Expenses excluding waiver and
payments by affiliate .74 .82 1.11 1.24 1.28
Net investment income 6.56 7.18 7.26 7.42 5.65
Portfolio turnover rate (%) 2 38.15 13.59 17.64 34.20 86.38
1. Total return does not include sales charges, and is not annualized.
2. The rate excludes mortgage dollar roll transactions.
YOUR ACCOUNT
[Insert graphic of percentage sign] SALES CHARGES
THE SALES CHARGE
MAKES UP THIS % WHICH EQUALS THIS %
WHEN YOU INVEST THIS AMOUNT OF THE OFFERING PRICE OF YOUR NET INVESTMENT
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Under $100,000 4.25 4.44
$100,000 but under $250,000 3.50 3.63
$250,000 but under $500,000 2.50 2.56
$500,000 but under $1 million 2.00 2.04
INVESTMENTS OF $1 MILLION OR MORE If you invest $1 million or more, either
as a lump sum or through our cumulative quantity discount or letter of intent
programs (see page 13), you can buy shares without an initial sales charge.
CONTINGENT DEFERRED SALES CHARGE (CDSC) Most Franklin Templeton Funds impose
a CDSC on certain investments sold within 12 months. While the fund generally
does not impose a CDSC, it will do so if you sell shares that were exchanged
into the fund from another Franklin Templeton Fund and those shares would
have been assessed a CDSC in the other fund. The CDSC is 1% and is based on
the current value of the shares being sold or their net asset value when
purchased, whichever is less. The time the shares are held in the fund does
not count towards the 12 month holding period.
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The HOLDING PERIOD FOR THE CDSC begins on the day you buy your shares. Your
shares will age one month on that same date the next month and each following
month.
For example, if you buy shares on the 18th of the month, they will age one
month on the 18th day of the next month and each following month.
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To keep your CDSC as low as possible, each time you place a request to sell
shares we will first sell any shares in your account that are not subject to
a CDSC. If there are not enough of these to meet your request, we will sell
the shares in the order they were purchased. We will use this same method if
you exchange your shares into another Franklin Templeton Fund (please see
page 19 for exchange information).
SALES CHARGE REDUCTIONS AND WAIVERS If you qualify for any of the sales
charge reductions or waivers below, please let us know at the time you make
your investment to help ensure you receive the lower sales charge.
QUANTITY DISCOUNTS We offer several ways for you to combine your purchases
in the Franklin Templeton Funds to take advantage of the lower sales charges
for large purchases of fund shares.
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The FRANKLIN TEMPLETON FUNDS include all of the Franklin Templeton U.S.
registered mutual funds, except Franklin Valuemark Funds, Templeton Capital
Accumulator Fund, Inc., and Templeton Variable Products Series Fund.
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o Cumulative Quantity Discount - lets you combine all of your shares in
the Franklin Templeton Funds for purposes of calculating the sales
charge. You may also combine the shares of your spouse, and your
children or grandchildren, if they are under the age of 21. Certain
company and retirement plan accounts may also be included.
o Letter of Intent (LOI) - expresses your intent to buy a stated dollar
amount of shares over a 13-month period and lets you receive the same
sales charge as if all shares had been purchased at one time. We will
reserve a portion of your shares to cover any additional sales charge
that may apply if you do not buy the amount stated in your LOI.
TO SIGN UP FOR THESE PROGRAMS, COMPLETE THE APPROPRIATE SECTION OF YOUR
ACCOUNT APPLICATION.
REINSTATEMENT PRIVILEGE If you sell shares of a Franklin Templeton Fund, you
may reinvest some or all of the proceeds within 365 days without an initial
sales charge. The proceeds must be reinvested within the same share class,
except proceeds from the sale of Class B shares will be reinvested in Class A
shares.
Certain Franklin Templeton Funds offer multiple share classes not offered by
this fund. For purposes of this privilege, the fund's shares are considered
Class A shares.
Proceeds immediately placed in a Franklin Bank Certificate of Deposit (CD)
also may be reinvested without an initial sales charge if you reinvest them
within 365 days from the date the CD matures, including any rollover.
This privilege does not apply to shares you buy and sell under our exchange
program. Shares purchased with the proceeds from a money fund may be subject
to a sales charge.
WAIVERS FOR INVESTMENTS FROM CERTAIN PAYMENTS Shares of the fund may be
purchased without an initial sales charge by investors who reinvest within
365 days:
o certain payments received under an annuity contract that offers a
Franklin Templeton insurance fund option
o distributions from an existing retirement plan invested in the Franklin
Templeton Funds
o dividend or capital gain distributions from a real estate investment
trust sponsored or advised by Franklin Properties, Inc.
o redemption proceeds from a repurchase of Franklin Floating Rate Trust
shares held continuously for at least 12 months
o redemption proceeds from Class A of any Templeton Global Strategy Fund,
if you are a qualified investor.
WAIVERS FOR CERTAIN INVESTORS Shares of the fund also may be purchased
without an initial sales charge by various individuals and institutions,
including:
o certain trust companies and bank trust departments investing $1 million
or more in assets over which they have full or shared investment
discretion
o government entities that are prohibited from paying mutual fund sales
charges
o certain unit investment trusts and their holders reinvesting trust
distributions
o group annuity separate accounts offered to retirement plans
o employees and other associated persons or entities of Franklin Templeton
or of certain dealers
o Chilean retirement plans that meet the requirements for retirement plans
described below.
IF YOU THINK YOU MAY BE ELIGIBLE FOR A SALES CHARGE WAIVER,
CALL YOUR INVESTMENT REPRESENTATIVE OR CALL SHAREHOLDER SERVICES
AT 1-800/632-2301 FOR MORE INFORMATION.
RETIREMENT PLANS Certain retirement plans may buy shares of the fund without
an initial sales charge. To qualify, the plan must be sponsored by an
employer:
o with at least 100 employees, or
o with retirement plan assets of $1 million or more, or
o that agrees to invest at least $500,000 in the Franklin Templeton Funds
over a 13-month period
FOR MORE INFORMATION, CALL YOUR INVESTMENT REPRESENTATIVE OR
RETIREMENT PLAN SERVICES AT 1-800/527-2020.
GROUP INVESTMENT PROGRAM Allows established groups of 11 or more investors
to invest as a group. For sales charge purposes, the group's investments are
added together. There are certain other requirements and the group must have
a purpose other than buying fund shares at a discount.
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BUYING SHARES
MINIMUM INVESTMENTS
INITIAL ADDITIONAL
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Regular accounts $1,000 $50
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UGMA/UTMA accounts $100 $50
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Retirement accounts no minimum no minimum
(other than IRAs, IRA rollovers, Education IRAs or Roth IRAs)
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IRAs, IRA rollovers, Education IRAs or Roth IRAs $250 $50
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Broker-dealer sponsored wrap account programs $250 $50
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Full-time employees, officers, trustees and directors of $100 $50
Franklin Templeton entities, and their immediate family members
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Certain Franklin Templeton Funds offer multiple share classes not offered by
this fund. Please note that for selling or exchanging your shares, or for
other purposes, the fund's shares are considered Class A shares. Before
January 1, 1999, the fund's shares were considered Class I shares.
ACCOUNT APPLICATION If you are opening a new account, please complete and
sign the enclosed account application. To save time, you can sign up now for
services you may want on your account by completing the appropriate sections
of the application (see the next page).
BUYING SHARES
OPENING AN ACCOUNT ADDING TO AN ACCOUNT
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[Insert graphic of
hands shaking]
THROUGH YOUR INVESTMENT Contact your investment Contact your investment
REPRESENTATIVE representative representative
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Make your check payable to Make your check payable
Franklin to Franklin
[Insert graphic of Strategic Mortgage Strategic Mortgage
envelope] Portfolio. Portfolio. Include
your account number on
the check.
BY MAIL Mail the check and your Fill out the deposit slip
signed from your account
application to Investor statement. If you do not
Services. have a slip,
include a note with your
name, the fund
name, and your account
number.
Mail the check and
deposit slip or note
to Investor Services.
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[Insert graphic of three Call to receive a wire Call to receive a wire
lightning bolts] control number control number
and wire instructions. and wire instructions.
BY WIRE Mail your signed To make a same day wire
application to Investor investment,
1-800/632-2301 Services. Please include please call us by 1:00
(or 1-650/312-2000 the wire control p.m. pacific time
collect) number or your new account and make sure your wire
number on arrives by
the application. 3:00 p.m.
To make a same day wire
investment,
please call us by 1:00
p.m. pacific time
and make sure your wire
arrives by
3:00 p.m.
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[Insert graphic of two Call Shareholder Services Call Shareholder Services
arrows pointing in at the number at the number
opposite directions] below, or send signed below or our automated
written instructions. TeleFACTS
The TeleFACTS system system, or send signed
cannot be used to written
open a new account. instructions.
BY EXCHANGE
(Please see page 19 for (Please see page 19 for
TeleFACTS(R) information information
1-800/247-1753 on exchanges.) on exchanges.)
(around-the-clock
access)
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FRANKLIN TEMPLETON INVESTOR SERVICES 777 MARINERS ISLAND BLVD., P.O. BOX 7777,
SAN MATEO, CA 94403-7777
CALL TOLL-FREE: 1-800/632-2301
(MONDAY THROUGH FRIDAY 5:30 A.M. TO 5:00 P.M., PACIFIC TIME)
[Insert graphic of person with a headset] INVESTOR SERVICES
AUTOMATIC INVESTMENT PLAN This plan offers a convenient way for you to
invest in the fund by automatically transferring money from your checking or
savings account each month to buy shares. The minimum investment to open an
account with an automatic investment plan is $50 ($25 for an Education IRA).
To sign up, complete the appropriate section of your account application.
AUTOMATIC PAYROLL DEDUCTION You may be able to invest automatically in
shares of the fund by transferring money from your paycheck to the fund by
electronic funds transfer. If you are interested, indicate on your
application that you would like to receive an Automatic Payroll Deduction
Program kit.
DISTRIBUTION OPTIONS You may reinvest distributions you receive from the
fund in an existing account in the same share class of the fund or another
Franklin Templeton Fund. Initial sales charges and CDSCs will not apply if
you reinvest your distributions within 365 days. You can also have your
distributions deposited in a bank account, or mailed by check. Deposits to a
bank account may be made by electronic funds transfer.
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For Franklin Templeton Trust Company retirement plans, special forms may be
needed to receive distributions in cash. Please call 1-800/527-2020 for
information.
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Please indicate on your application the distribution option you have chosen,
otherwise we will reinvest your distributions in the fund.
RETIREMENT PLANS Franklin Templeton offers a variety of retirement plans for
individuals and businesses. These plans require separate applications and
their policies and procedures may be different than those described in this
prospectus. For more information, including a free retirement plan brochure
or application, please call Retirement Plan Services at 1-800/527-2020.
TELEFACTS(R) Our TeleFACTS system offers around-the-clock access to
information about your account or any Franklin Templeton Fund. This service
is available from touch-tone phones at 1-800/247-1753. For a free TeleFACTS
brochure, call 1-800/DIAL BEN.
TELEPHONE PRIVILEGES You will automatically receive telephone privileges
when you open your account, allowing you and your investment representative
to sell or exchange your shares and make certain other changes to your
account by phone.
For accounts with more than one registered owner, telephone privileges also
allow the fund to accept written instructions signed by only one owner for
transactions and account changes that could otherwise be made by phone. For
all other transactions and changes, all registered owners must sign the
instructions.
As long as we take certain measures to verify telephone requests, we will not
be responsible for any losses that may occur from unauthorized requests. Of
course, you can decline telephone exchange or redemption privileges on your
account application.
EXCHANGE PRIVILEGE You can exchange shares between most Franklin Templeton
Funds within the same class*, generally without paying any additional sales
charges. If you exchange shares held for less than six months, however, you
may be charged the difference between the initial sales charge of the two
funds if the difference is more than 0.25%. If you exchange shares from a
money fund, a sales charge may apply no matter how long you have held the
shares.
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An EXCHANGE is really two transactions: a sale of one fund and the purchase
of another. In general, the same policies that apply to purchases and sales
apply to exchanges, including minimum investment amounts. Exchanges also have
the same tax consequences as ordinary sales and purchases.
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*Certain Class Z shareholders of Franklin Mutual Series Fund Inc. may
exchange into the fund without any sales charge. Advisor Class shareholders
of another Franklin Templeton Fund also may exchange into the fund without
any sales charge. Advisor Class shareholders who exchange their shares for
shares of the fund and later decide they would like to exchange into another
fund that offers Advisor Class may do so.
Generally exchanges may only be made between identically registered accounts,
unless you send written instructions with a signature guarantee. Any CDSC
will continue to be calculated from the date of your initial investment and
will not be charged at the time of the exchange. The purchase price for
determining a CDSC on exchanged shares will be the price you paid for the
original shares. The time the shares are held in the fund does not count
towards the CDSC holding period. If you exchange shares subject to a CDSC
into a Class A money fund, the time your shares are held in the money fund
also will not count towards the CDSC holding period.
Frequent exchanges can interfere with fund management or operations and drive
up costs for all shareholders. To protect shareholders, there are limits on
the number and amount of exchanges you may make (please see "Market Timers"
on page 24).
SYSTEMATIC WITHDRAWAL PLAN This plan allows you to automatically sell your
shares and receive regular payments from your account. Certain terms and
minimums apply. To sign up, complete the appropriate section of your
application.
[Insert graphic of a certificate] SELLING SHARES
You can sell your shares at any time.
SELLING SHARES IN WRITING Requests to sell $100,000 or less can generally be
made over the phone or with a simple letter. Sometimes, however, to protect
you and the fund we will need written instructions signed by all registered
owners, with a signature guarantee for each owner, if:
[BEGIN - CALL OUT BOX]
A SIGNATURE GUARANTEE helps protect your account against fraud. You can
obtain a signature guarantee at most banks and securities dealers.
A notary public CAN-NOT provide a signature guarantee.
[END - CALL OUT BOX]
o you are selling more than $100,000 worth of shares
o you want your proceeds paid to someone who is not a registered owner
o you want to send your proceeds somewhere other than the address of
record, or preauthorized bank or brokerage firm account
o you have changed the address on your account by phone within the last 15
days
We may also require a signature guarantee on instructions we receive from an
agent, not the registered owners, or when we believe it would protect the
fund against potential claims based on the instructions received.
SELLING RECENTLY PURCHASED SHARES If you sell shares recently purchased with
a check or draft, we may delay sending you the proceeds until your check or
draft has cleared, which may take seven business days or more. A certified or
cashier's check may clear in less time.
REDEMPTION PROCEEDS Your redemption check will be sent within seven days
after we receive your request in proper form. We are not able to receive or
pay out cash in the form of currency. Redemption proceeds may be delayed if
we have not yet received your signed account application.
RETIREMENT PLANS You may need to complete additional forms to sell shares in
a Franklin Templeton Trust Company retirement plan. For participants under
age 591/2, tax penalties may apply. Call Retirement Plan Services at
1-800/527-2020 for details.
SELLING SHARES
TO SELL SOME OR ALL OF YOUR SHARES
- -------------------------------------------------------------------------------
[Insert graphic of
hands shaking]
THROUGH YOUR INVESTMENT Contact your investment representative
REPRESENTATIVE
- -------------------------------------------------------------------------------
[Insert graphic of Send written instructions and endorsed share
envelope] certificates (if you hold share certificates) to
Investor Services. Corporate, partnership or trust
BY MAIL accounts may need to send additional documents.
Specify the fund, the account number and the dollar
value or number of shares you wish to sell. Be sure
to include all necessary signatures and any
additional documents, as well as signature guarantees
if required.
A check will be mailed to the name(s) and address on
the account, or otherwise according to your written
instructions.
- -------------------------------------------------------------------------------
[Insert graphic of As long as your transaction is for $100,000 or less,
phone] you do not hold share certificates and you have not
changed your address by phone within the last 15
BY PHONE days, you can sell your shares by phone.
1-800/632-2301 A check will be mailed to the name(s) and address on
the account. Written instructions, with a signature
guarantee, are required to send the check to another
address or to make it payable to another person.
- -------------------------------------------------------------------------------
[Insert graphic of You can call or write to have redemption proceeds of
three $1,000 or more wired to a bank or escrow account. See
lightning bolts] the policies above for selling shares by mail or
phone.
BY WIRE Before requesting a wire, please make sure we have
your bank account information on file. If we do not
have this information, you will need to send written
instructions with your bank's name and address, your
bank account number, the ABA routing number, and a
signature guarantee.
Requests received in proper form by 1:00 p.m. pacific
time will be wired the next business day.
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[Insert graphic of two Obtain a current prospectus for the fund you are
arrows considering.
pointing in opposite
directions]
BY EXCHANGE Call Shareholder Services at the number below or our
automated TeleFACTS system, or send signed written
TeleFACTS(R) instructions. See the policies above for selling
1-800/247-1753 shares by mail or phone.
(around-the-clock
access) If you hold share certificates, you will need to
return them to the fund before your exchange can be
processed.
- -------------------------------------------------------------------------------
FRANKLIN TEMPLETON INVESTOR SERVICES 777 MARINERS ISLAND BLVD.,P.O. BOX 7777,
SAN MATEO, CA 94403-7777
CALL TOLL-FREE: 1-800/632-2301
(MONDAY THROUGH FRIDAY 5:30 A.M. TO 5:00 P.M., PACIFIC TIME)
[Insert graphic of paper and pin] ACCOUNT POLICIES
CALCULATING SHARE PRICE The fund calculates the net asset value per share
(NAV) each business day at the close of trading on the New York Stock
Exchange (normally 1:00 p.m. pacific time). The fund's NAV is calculated by
dividing its net assets by the number of its shares outstanding.
[BEGIN - CALL OUT BOX]
When you buy shares, you pay the offering price. The offering price is the
NAV plus any applicable sales charge.
When you sell shares, you receive the NAV minus any applicable contingent
deferred sales charge (CDSC).
[END - CALL OUT BOX]
The fund's assets are generally valued at their market value. If market
prices are unavailable, or if an event occurs after the close of the trading
market that materially affects the values, assets may be valued at their fair
value.
Requests to buy and sell shares are processed at the NAV next calculated
after we receive your request in proper form.
ACCOUNTS WITH LOW BALANCES If the value of your account falls below $250
($50 for employee and UGMA/UTMA accounts) because you sell some of your
shares, we may mail you a notice asking you to bring the account back up to
its applicable minimum investment amount. If you choose not to do so within
30 days, we may close your account and mail the proceeds to the address of
record.
STATEMENTS AND REPORTS You will receive confirmations and account statements
that show your account transactions. You will also receive the fund's
financial reports every six months. To reduce fund expenses, we try to
identify related shareholders in a household and send only one copy of the
financial reports. If you need additional copies, please call 1-800/DIAL BEN.
If there is a dealer or other investment representative of record on your
account, he or she will also receive confirmations, account statements and
other information about your account directly from the fund.
STREET OR NOMINEE ACCOUNTS You may transfer your shares from the street or
nominee name account of one dealer to another, as long as both dealers have
an agreement with Franklin Templeton Distributors, Inc. We will process the
transfer after we receive authorization in proper form from your delivering
securities dealer.
JOINT ACCOUNTS Unless you specify a different registration, accounts with
two or more owners are registered as "joint tenants with rights of
survivorship" (shown as "Jt Ten" on your account statement). To make any
ownership changes to a joint account, all owners must agree in writing,
regardless of the law in your state.
MARKET TIMERS The fund may restrict or refuse exchanges by market timers. If
accepted, each exchange by a market timer will be charged $5. You will be
considered a market timer if you have (i) requested an exchange out of the
fund within two weeks of an earlier exchange request, or (ii) exchanged
shares out of the fund more than twice in a calendar quarter, or (iii)
exchanged shares equal to at least $5 million, or more than 1% of the fund's
net assets, or (iv) otherwise seem to follow a timing pattern. Shares under
common ownership or control are combined for these limits.
ADDITIONAL POLICIES Please note that the fund maintains additional policies
and reserves certain rights, including:
o The fund may refuse any order to buy shares, including any purchase
under the exchange privilege.
o At any time, the fund may change its investment minimums or waive or
lower its minimums for certain purchases.
o The fund may modify or discontinue the exchange privilege on 60 days'
notice.
o You may only buy shares of a fund eligible for sale in your state or
jurisdiction.
o In unusual circumstances, we may temporarily suspend redemptions, or
postpone the payment of proceeds, as allowed by federal securities laws.
o For redemptions over a certain amount, the fund reserves the right to
make payments in securities or other assets of the fund, in the case of
an emergency or if the payment by check would be harmful to existing
shareholders.
o To permit investors to obtain the current price, dealers are responsible
for transmitting all orders to the fund promptly.
DEALER COMPENSATION Qualifying dealers who sell fund shares may receive
sales commissions and other payments. These are paid by Franklin Templeton
Distributors, Inc. (Distributors) from sales charges and its other resources.
COMMISSION (%) -
Investment under $100,000 4.00
$100,000 but under $250,000 3.25
$250,000 but under $500,000 2.25
$500,000 but under $1 million 1.85
$1 million or more None
A dealer commission of up to 0.25% may be paid on NAV purchases by certain
trust companies and bank trust departments, retirement plans, eligible
governmental authorities, and broker-dealers or others on behalf of clients
participating in comprehensive fee programs.
[Insert graphic of question mark] QUESTIONS
If you have any questions about the fund or your account, you can write to us
at 777 Mariners Island Blvd., P.O. Box 7777, San Mateo, CA 94403-7777. You
can also call us at one of the following numbers. For your protection and to
help ensure we provide you with quality service, all calls may be monitored
or recorded.
HOURS (PACIFIC TIME,
DEPARTMENT NAME TELEPHONE NUMBER MONDAY THROUGH FRIDAY)
Shareholder Services 1-800/ 632-2301 5:30 a.m. to 5:00 p.m.
Fund Information 1-800/ DIAL BEN 5:30 a.m. to 8:00 p.m.
(1-800/ 342-5236) 6:30 a.m. to 2:30 p.m. (Saturday)
Retirement Plan Services 1-800/ 527-2020 5:30 a.m. to 5:00 p.m.
Dealer Services 1-800/ 524-4040 5:30 a.m. to 5:00 p.m.
Institutional Services 1-800/ 321-8563 6:00 a.m. to 5:00 p.m.
TDD (hearing impaired) 1-800/ 851-0637 5:30 a.m. to 5:00 p.m.
FOR MORE INFORMATION
You can learn more about the fund in the following documents:
ANNUAL/SEMIANNUAL REPORT TO SHAREHOLDERS Includes a discussion of recent
market conditions and fund strategies, financial statements, detailed
performance information, portfolio holdings, and the auditor's report.
STATEMENT OF ADDITIONAL INFORMATION (SAI)Contains more information about the
fund, its investments and policies. It is incorporated by reference (is
legally a part of this prospectus).
For a free copy of the current annual/semiannual report or the SAI, please
contact your investment representative or call us at the number below.
Franklin(R)Templeton(R)
1-800/DIAL BEN(R) (1-800/342-5236)
TDD (Hearing Impaired) 1-800/851-0637
www.franklin-templeton.com
You can also obtain information about the fund by visiting the SEC's Public
Reference Room in Washington D.C. (phone 1-800/SEC-0330) or by sending your
request and a duplicating fee to the SEC's Public Reference Section,
Washington, DC 20549-6009. You can also visit the SEC's Internet site at
http://www.sec.gov.
Investment Company Act file #811-7288 157 P 02/99
FRANKLIN
STRATEGIC MORTGAGE
PORTFOLIO
STATEMENT OF
ADDITIONAL INFORMATION
FEBRUARY 1, 1999
777 MARINERS ISLAND BLVD., P.O. BOX 7777
SAN MATEO, CA 94403-7777 1-800/DIAL BEN(R)
- ------------------------------------------------------------------------------
This Statement of Additional Information (SAI) is not a prospectus. It
contains information in addition to the information in the fund's prospectus.
The fund's prospectus, dated February 1, 1999, which we may amend from time
to time, contains the basic information you should know before investing in
the fund. You should read this SAI together with the fund's prospectus.
The audited financial statements and auditor's report in the trust's Annual
Report to Shareholders, for the fiscal year ended September 30, 1998, are
incorporated by reference (are legally a part of this SAI).
For a free copy of the current prospectus or annual report, contact your
investment representative or call 1-800/DIAL BEN (1-800/342-5236).
CONTENTS
Goal and Strategies ............................................. 2
Risks ........................................................... 8
Officers and Trustees ........................................... 9
Management and Other Services ................................... 13
Portfolio Transactions .......................................... 15
Distributions and Taxes ......................................... 15
Organization, Voting Rights
and Principal Holders .......................................... 17
Buying and Selling Shares ....................................... 17
Pricing Shares .................................................. 22
The Underwriter ................................................. 23
Performance ..................................................... 24
Miscellaneous Information ....................................... 26
Description of Bond Ratings ..................................... 27
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MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS:
o ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION,
THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT;
o ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY
BANK;
o ARE SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF
PRINCIPAL. MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS:
o ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION,
THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT;
o ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY
BANK;
o ARE SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF
PRINCIPAL.
- -------------------------------------------------------------------------------
GOAL AND STRATEGIES
- ------------------------------------------------------------------------------
The fund's investment goal is high total return (a combination of high
current income and capital appreciation) relative to the performance of the
general mortgage securities market. This goal is fundamental, which means it
may not be changed without shareholder approval.
The fund tries to achieve its investment goal by investing at least 65% of
its total assets in mortgage securities issued or guaranteed by the U.S.
government, its agencies or instrumentalities. The mortgage securities in
which the fund may invest are issued or guaranteed by the Government National
Mortgage Association ("GNMA"), the Federal National Mortgage Association
("FNMA"), and the Federal Home Loan Mortgage Corporation ("FHLMC").
The fund seeks higher interest return than may generally be available from
fixed-rate mortgage securities by investing up to 35% of its assets in higher
income producing mortgage securities such as adjustable rate mortgage
securities ("ARMS"), collateralized mortgage obligations ("CMOs"), and
stripped mortgage-backed securities ("SMBS").
The fund may also invest in obligations of the U.S. government; notes, bonds,
and discount instruments of U.S. government agencies or instrumentalities
such as Federal Home Loan Banks, FNMA, GNMA, the Student Loan Marketing
Association, the Resolution Funding Corporation, and the Federal Farm Credit
Bank; time and savings deposits (including fixed- or adjustable-rate
certificates of deposit) in commercial or savings banks or in institutions
whose accounts are insured by the FDIC; and other securities which are
consistent with the fund's investment goal. The fund's investment in time
deposits will not exceed 10% of its total assets. The fund also has the
authority to invest in futures contracts and options on future contracts
although it presently does not intend to participate in these transactions.
At least 65% of the fund's total assets will be invested in securities rated
AAA by Standard & Poor's ("S&P") or Aaa by Moody's Investors Services
("Moody's"), respectively, or, if unrated, deemed to be of comparable quality
by the manager. As to the remaining 35% of the fund's assets, the portfolio
securities will be rated at least AA by S&P or Aa by Moody's, respectively,
or, if unrated, will be deemed to be of comparable quality by the manager. In
the event the rating of an issue is changed by the ratings service or the
security goes into default, the fund will consider that event in its
evaluation of the overall investment merits of that security, but will not
necessarily dispose of the security immediately. Please see Description of
Bond Ratings for a discussion of the ratings.
The following is a description of the various types of securities the fund
may buy.
MORTGAGE SECURITIES A mortgage security is an interest in a pool of mortgage
loans. The dominant issuers or guarantors of mortgage securities today are
GNMA, FNMA, and FHLMC. GNMA creates mortgage securities from pools of
government guaranteed or insured (Federal Housing Authority or Veterans
Administration) mortgages originated by mortgage bankers, commercial banks,
and savings and loan associations. FNMA and FHLMC issue mortgage securities
from pools of conventional and federally insured and/or guaranteed
residential mortgages obtained from various entities, including savings and
loan associations, savings banks, commercial banks, credit unions, and
mortgage bankers.
Most mortgage securities issued or guaranteed by GNMA, FNMA, or FHLMC are
called pass-through securities, which means that they provide investors with
monthly payments consisting of a pro rata share of both regular interest and
principal payments, as well as unscheduled early prepayments, on the
underlying mortgage pool. The fund invests in both "modified" and "straight"
pass-through securities. For "modified pass-through" type mortgage
securities, principal and interest are guaranteed, whereas "straight
pass-through" securities do not carry such a guarantee. Collateralized
mortgage obligations and stripped mortgage-backed securities are not
pass-through securities.
The principal and interest on GNMA securities are guaranteed by GNMA and
backed by the full faith and credit of the U.S. government. Mortgage
securities from FNMA and FHLMC are not backed by the full faith and credit of
the U.S. government. FNMA guarantees full and timely payment of all interest
and principal, and FHLMC guarantees timely payment of interest and the
ultimate collection of principal. Securities issued by FNMA are supported by
that instrumentality's right to borrow money from the U.S. Treasury under
certain circumstances. Securities issued by FHLMC are supported only by the
credit of that instrumentality. There is no guarantee that the government
would support government agency or instrumentality securities and,
accordingly, they may involve a risk of non-payment of principal and
interest. Notwithstanding the foregoing, because FNMA and FHLMC are
instrumentalities of the U.S. government, these securities are generally
considered to be high-quality investments having minimal credit risks.
Guarantees as to the timely payment of principal and interest do not extend
to the value or yield of mortgage securities, nor do they extend to the value
of the fund's shares. In general, the value of fixed-income securities varies
with changes in market interest rates. Fixed-rate mortgage securities
generally decline in value during periods of rising interest rates, whereas
interest rates of Adjustable Rate Mortgage Securities ("ARMS") move with
market interest rates, and thus their value tends to fluctuate to a lesser
degree. In view of such factors, the ability of the fund to obtain a high
level of total return may be limited under varying market conditions.
ADJUSTABLE RATE MORTGAGE SECURITIES ARMS, like traditional mortgage
securities, are interests in pools of mortgage loans and are issued or
guaranteed by a federal agency or instrumentality or by private issuers.
Unlike fixed-rate mortgages, which generally decline in value during periods
of rising interest rates, the interest rates on the mortgages underlying ARMS
are reset periodically and thus allow the fund to participate in increases in
interest rates, resulting in both higher current yields and lower price
fluctuations.
The rate of amortization of principal, as well as interest payments, for
certain types of ARMS change in accordance with movements in a pre-specified,
published interest rate index. There are several categories of indices,
including those based on U.S. Treasury securities, those derived from a
calculated measure, such as a cost of funds index, or a moving average of
mortgage rates and actual market rates. The amount of interest due to an ARM
security holder is calculated by adding a specified additional amount, the
"margin," to the index, subject to limitations or "caps" on the maximum and
minimum interest that is charged to the mortgagor during the life of the
mortgage or to maximum and minimum changes to that interest rate during a
given period. The interest rates paid on the ARMS in which the fund may
invest are generally readjusted at intervals of one year or less, although
instruments with longer resets such as three years and five years are also
permissible investments.
The underlying mortgages which collateralize the ARMS in which the fund may
invest will frequently have caps and floors which limit the maximum amount by
which the loan rate to the residential borrower may change up or down (1) per
reset or adjustment interval and (2) over the life of the loan. Some
residential mortgage loans restrict periodic adjustments by limiting changes
in the borrower's monthly principal and interest payments rather than
limiting interest rate changes. These payment caps may result in negative
amortization, which can extend the average life of the securities. Since most
ARMS in the fund's portfolio will generally have annual reset limits or caps
of 100 to 200 basis points, fluctuations in interest rates above these levels
could cause such mortgage securities to "cap out" and to behave more like
long-term, fixed-rate debt securities.
STRIPPED MORTGAGE-BACKED SECURITIES ("SMBS") The fund may invest in SMBS to
achieve a higher yield than may be available from fixed-rate mortgage
securities. The SMBS in which the fund may invest will not be limited to
those issued or guaranteed by agencies or instrumentalities of the U.S.
government, although such securities are more liquid than privately issued
SMBS.
SMBS are usually structured with two classes, each receiving different
proportions of the interest and principal distributions on a pool of mortgage
assets. Typically, one class will receive some of the interest and most of
the principal from the mortgage assets, while the other class will receive
most of the interest and the remainder of the principal. In the most extreme
case, one class will receive all of the interest (the interest-only or "IO"
class), while the other class will receive all of the principal (the
principal-only or "PO" class). The yield to maturity of an IO or PO class is
extremely sensitive not only to changes in prevailing interest rates but also
to the rate of principal payments (including prepayments) on the related
underlying mortgage assets. If the underlying mortgage assets experience
greater than anticipated prepayments of principal, the fund may fail to
recoup fully its initial investment in an IO even if the securities are rated
in the highest rating categories, AAA by S&P or Aaa by Moody's, respectively.
SMBS are purchased and sold by institutional investors, such as the fund,
through several investment banking firms acting as brokers or dealers. As
these securities were only recently developed, traditional trading markets
have not yet been established for all SMBS. Accordingly, some of these
securities may be illiquid. The staff of the SEC has indicated that only
government-issued IO or PO securities that are backed by fixed-rate mortgages
may be deemed to be liquid, if procedures with respect to determining
liquidity are established by a fund's board. The fund's board of trustees
may, in the future, adopt procedures that would permit the fund to acquire,
hold, and treat as liquid government-issued IO and PO securities. At the
present time, however, all such securities will continue to be treated as
illiquid and will, together with any other illiquid investments, not exceed
10% of the fund's net assets. This position may be changed in the future,
without notice to shareholders, in response to the SEC staff's continued
reassessment of this matter, as well as to changing market conditions.
COLLATERALIZED MORTGAGE OBLIGATIONS CMOs are fixed-income securities which
are collateralized by pools of mortgage loans created by commercial banks,
savings and loan institutions, private mortgage insurance companies, mortgage
bankers, and other issuers in the U.S. Timely payment of interest and
principal (but not the market value) of some of these pools is supported by
various forms of insurance or guarantees issued by private issuers, those who
pool the mortgage assets and, in some cases, by U.S. government agencies or
instrumentalities. Prepayments of the mortgages underlying a CMO, which
usually increase when interest rates decrease, will generally reduce the life
of the mortgage pool, thereby impacting the CMO's yield. Under such
circumstances, the reinvestment of prepayments will generally be at a rate
lower than the rate applicable to the original CMO. The fund will invest in
privately issued CMOs and CMOs issued or guaranteed by U.S. government
agencies or instrumentalities, which will be:
(1) collateralized by pools of mortgages in which each mortgage is guaranteed
as to payment of principal and interest by an agency or instrumentality of
the U.S. government; or
(2) collateralized by pools of mortgages in which payment of principal and
interest are guaranteed by the issuer and the guarantee is collateralized
100% by U.S. government securities. The guarantee is provided by a special
purpose entity without assets other than the mortgages and the government
securities.
With a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of a CMO, often referred to as a "tranche," is issued at a
specified coupon rate or adjustable rate and has a stated maturity or final
distribution date. Principal prepayments on collateral underlying a CMO,
however, may cause it to be retired substantially earlier than the stated
maturities or final distribution dates. Interest is paid or accrues on all
classes of a CMO on a monthly, quarterly, or semiannual basis. The principal
and interest on the underlying mortgages may be allocated among several
classes of a series in many ways. In a common structure, payments of
principal, including any principal prepayments, on the underlying mortgages
are applied to the classes of a series of a CMO in the order of their
respective stated maturities or final distribution dates, so that no payment
of principal will be made on any class of a CMO until all other classes
having an earlier stated maturity or final distribution date have been paid
in full.
The fund will limit its investments in any privately issued CMOs considered
by the Securities and Exchange Commission ("SEC") to be an investment
company, in a manner consistent with the provisions of the Investment Company
Act of 1940, as amended.
WHEN-ISSUED AND DELAYED-DELIVERY TRANSACTIONS The fund may purchase U.S.
government obligations on a "when-issued" or "delayed-delivery" basis. These
transactions are arrangements under which the fund purchases securities which
have been authorized but not yet issued with payment for and delivery of the
security scheduled for a future time, generally in 30 to 45 days. Purchases
of U.S. government securities on a when-issued or delayed-delivery basis are
subject to the risk that the value or yields at delivery may be more or less
than the purchase price or the yields available when the transaction was
entered into. Although the fund will generally buy U.S. government securities
on a when-issued basis with the intention of holding such securities, it may
sell them before the settlement date if it is deemed advisable. When the fund
is the buyer in such a transaction, it will maintain, in a segregated account
with its custodian bank, cash or high-grade marketable securities having an
aggregate value equal to the amount of the fund's purchase commitments until
payment is made. To the extent the fund engages in when-issued and
delayed-delivery transactions, it will do so only for the purpose of
acquiring portfolio securities consistent with the fund's investment goal and
policies, and not for the purpose of investment leverage. In when-issued and
delayed-delivery transactions, the fund relies on the seller to complete the
transaction. The seller's failure to do so may cause the fund to miss a price
or yield considered advantageous. Securities purchased on a when-issued or
delayed-delivery basis do not generally earn interest until their scheduled
delivery date. Entering into a when-issued or delayed-delivery transaction is
a form of leverage that may exacerbate changes in net asset value per share.
The fund is not subject to any percentage limit on the amount of its assets
which may be invested in when-issued purchase obligations.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS Although the fund has the
authority to, it does not presently intend to enter into the following
transactions: contracts for the purchase or sale for future delivery of debt
securities ("futures contracts") and options to buy or sell futures contracts
("options on futures contracts") traded on U.S. and foreign exchanges.
Options, futures and options on futures are generally considered "derivative
securities."
Financial futures contracts are commodity contracts that obligate the long or
short holder to take or make delivery of a specified quantity of a financial
instrument, such as a security, or the cash value of a securities index
during a specified future period at a specified price. A "sale" of a futures
contract means the acquisition of a contractual obligation to deliver the
securities called for by the contract at a specified price on a specified
date. A "purchase" of a futures contract means the acquisition of a
contractual obligation to acquire the securities called for by the contract
at a specified price on a specified date. Futures contracts have been
designed by exchanges which have been designated "contracts markets" by the
Commodity Futures Trading Commission ("CFTC") and must be executed through a
futures commission merchant or brokerage firm that is a member of the
relevant contract market.
Although financial futures contracts by their terms call for the actual
delivery or acquisition of securities, in most cases the contractual
obligation is fulfilled before the date of the contract without having to
make or take delivery of the securities. The offsetting of a contractual
obligation is accomplished by buying (or selling, as the case may be) on a
commodities exchange an identical futures contract calling for delivery in
the same month. Such a transaction, which is effected through a member of an
exchange, cancels the obligation to take delivery of the securities. Since
all transactions in the futures market are made, offset, or fulfilled through
a clearinghouse associated with the exchange on which the contracts are
traded, the fund will incur brokerage fees when it purchases or sells futures
contracts.
The purpose of the acquisition or sale of a futures contract is to attempt to
protect the fund from fluctuations in the price of portfolio securities
without actually buying or selling the underlying security. To the extent
required by SEC rules, when the fund enters into a futures contract, it will
deposit in a segregated account with its custodian bank cash or U.S. Treasury
obligations equal to a specified percentage of the value of the futures
contract (the "initial margin") as required by the relevant contract, market,
and futures commission merchant. The futures contract will be
marked-to-market daily. Should the value of the futures contract decline
relative to the fund's position, the fund will be required to pay the futures
commission merchant an amount equal to such change in value.
The fund may take advantage of opportunities in the area of options and
futures contracts, options on futures contracts, and any other derivative
investments which are not presently contemplated for use by the fund or which
are not currently available but which may be developed, to the extent such
opportunities are both consistent with the fund's investment goal and legally
permissible for the fund. Prior to investing in any such investment vehicle,
the fund will supplement its Prospectus, if appropriate.
MORTGAGE DOLLAR ROLLS The fund may enter into mortgage "dollar rolls" in
which the fund sells mortgage-backed securities for delivery in the current
month and simultaneously contracts to repurchase substantially similar (name,
type, coupon, and maturity) securities on a specified future date. During the
period between the sale and repurchase (the "roll period"), the fund forgoes
principal and interest paid on the mortgage-backed securities. The fund is
compensated by the difference between the current sales price and the lower
forward price for the future purchase (often referred to as the "drop"), as
well as by the interest earned on the cash proceeds of the initial sale. A
"covered roll" is a specific type of mortgage dollar roll for which there is
an offsetting cash position or a cash equivalent security position. The fund
could suffer a loss if the contracting party fails to perform the future
transaction in that the fund may not be able to buy back the mortgage-backed
securities it initially sold. The fund intends to enter into mortgage dollar
rolls only with government securities dealers recognized by the Federal
Reserve Board or with member banks of the Federal Reserve System.
INVERSE FLOATERS The fund may invest up to 5% of its total assets in inverse
floaters. Inverse floaters are instruments with floating or variable interest
rates that move in the opposite direction, usually at an accelerated speed,
to short-term interest rates or interest rate indices.
BORROWING The fund may not borrow money or mortgage or pledge any of its
assets, except that it may borrow from banks for temporary or emergency
purposes up to 20% of its total assets and pledge its assets in connection
therewith and except to the extent that an uncovered mortgage dollar roll may
be considered to be a borrowing. The fund may not, however, purchase any
portfolio securities while borrowings representing more than 5% of its total
assets are outstanding.
LOANS OF PORTFOLIO SECURITIES Consistent with procedures approved by the
fund's board of trustees and subject to the following conditions, the fund
may lend its portfolio securities to qualified securities dealers or other
institutional investors, if such loans do not exceed 10% of the value of the
fund's total assets at the time of the most recent loan. The borrower must
deposit with the fund's custodian bank collateral with an initial market
value of at least 102% of the market value of the securities loaned,
including any accrued interest, with the value of the collateral and loaned
securities marked-to-market daily to maintain collateral coverage of at least
102%. This collateral shall consist of cash. The lending of securities is a
common practice in the securities industry. The fund may engage in security
loan arrangements with the primary objective of increasing the fund's income
either through investing cash collateral in short-term interest-bearing
obligations or by receiving a loan premium from the borrower. Under the
securities loan agreement, the fund continues to be entitled to all dividends
or interest on any loaned securities. As with any extension of credit, there
are risks of delay in recovery and loss of rights in the collateral should
the borrower of the security fail financially.
ILLIQUID SECURITIES The fund's policy is not to invest more than 10% of its
net assets in illiquid securities. Illiquid securities are generally
securities that cannot be sold within seven days in the normal course of
business at approximately the amount at which the fund has valued them. These
securities include, among other things, those with legal or contractual
restrictions on resale (although the fund may invest in such securities to
the extent permitted under the federal securities laws), repurchase
agreements of more than seven days duration, over-the-counter options and the
assets used to cover such options, and other securities which are not readily
marketable.
RESETS Commonly utilized indices include the one-, three-, and five-year
constant-maturity U.S. Treasury rates, the three-month U.S. Treasury bill
rate, the six-month U.S. Treasury bill rate, rates on longer-term U.S.
Treasury securities, the 11th District Federal Home Loan Bank Cost of Funds,
the National Median Cost of Funds, the one-, three-, and six-month or
one-year London Interbank Offered Rate (LIBOR), the prime rate of a specific
bank, or commercial paper rates. Some indices, such as the one-year
constant-maturity U.S. Treasury rate, closely mirror changes in market
interest rate levels. Others, such as the 11th District Home Loan Bank Cost
of Funds index, tend to lag behind changes in market rate levels and to be
somewhat less volatile.
INTEREST RATE TRANSACTIONS To attempt to protect the value of the fund's
portfolio from interest rate fluctuations, the fund may enter into various
hedging transactions, such as interest rate swaps and the purchase or sale of
interest rate caps and floors. The fund will enter into these transactions
primarily to preserve a return or spread on a particular investment or
portion of its portfolio; to protect against any increase in the price of
securities the fund anticipates purchasing at a later date; or to shorten the
effective duration of its portfolio investments. The fund intends to use
these transactions as a hedge and not as a speculative investment. The fund
will not sell interest rate caps or floors it does not own.
Interest rate swaps involve the exchange by the fund with another party of
their respective commitments to pay or receive interest, for example, an
exchange of floating-rate payments for fixed-rate payments. The purchase of
an interest rate cap entitles the purchaser, to the extent that a specified
index exceeds a predetermined interest rate, to receive payments of interest
on a notional principal amount from the party selling the interest rate cap.
The purchase of an interest rate floor entitles the purchaser, to the extent
that a specified index falls below a predetermined interest rate, to receive
payments of interest on a notional principal amount from the party selling
the interest rate floor.
A specific type of interest rate swap in which the fund may invest is a
mortgage swap. In a mortgage swap, cash flows based on a group of GNMA
mortgage pools are exchanged for cash flows based on a floating interest
rate. A mortgage swap is affected by changes in interest rates which in turn
affect the prepayment rate of the underlying mortgages upon which the
mortgage swap is based.
The fund may enter into interest rate swaps, caps, and floors on either an
asset-based or liability-based basis, depending on whether it is hedging its
assets or its liabilities, and will usually enter into interest rate swaps on
a net basis, which means the two payment streams are netted out, with the
fund receiving or paying, as the case may be, the net amount of the two
payments. Because these hedging transactions are entered into for good-faith
hedging purposes, the manager and the fund believe such obligations do not
constitute senior securities and, accordingly, will not treat them as being
subject to its borrowing restrictions. If a swap agreement calls for payments
by the fund, the fund must be prepared to make such payments when due. An
amount of cash or liquid securities having an aggregate net asset value at
least equal to the net amount of the excess, if any, of the fund's
obligations over its entitlement with respect to each interest rate swap will
be maintained in a segregated account by the fund's custodian bank, to avoid
any potential leveraging of the fund. The fund will not enter into any
interest rate swap, cap, or floor transaction unless the unsecured senior
debt or the claims-paying ability of the other party is considered
creditworthy by the manager. If the other party's creditworthiness declines,
the value of a swap agreement would be likely to decline, potentially
resulting in losses. If there is a default by the other party, the fund will
have contractual remedies pursuant to the agreements related to the
transaction.
The swap market has grown substantially in recent years, with a large number
of banks and investment banking firms acting both as principals and agents,
utilizing standardized swap documentation. As a result, the swap market has
become relatively liquid in comparison with markets for other similar
instruments which are traded in the interbank market.
INVESTMENT RESTRICTIONS The fund has adopted the following restrictions as
fundamental policies. This means they may only be changed if the change is
approved by (i) more than 50% of the fund's outstanding shares or (ii) 67% or
more of the fund's shares present at a shareholder meeting if more than 50%
of the fund's outstanding shares are represented at the meeting in person or
by proxy, whichever is less.
The fund may not:
1. Borrow money or mortgage or pledge any of its assets, except that
borrowings (and a pledge of assets therefor) for temporary or emergency
purposes may be made from banks in an amount up to 20% of its total asset
value. The fund will not purchase additional portfolio securities while
borrowings in excess of 5% of its total assets are outstanding.
2. Buy any securities on "margin" or sell any securities "short," except for
any delayed-delivery or when-issued securities as described in the prospectus.
3. Lend any funds or other assets, except by the purchase of bonds,
debentures, notes, or other debt securities as described in its prospectus;
and except that securities of the fund may be loaned to qualified
broker-dealers or other institutional investors if at least 102% cash
collateral is pledged and maintained by the borrower, provided such loans may
not be made if, as a result, the aggregate of such loans exceeds 10% of the
value of the fund's total assets at the time of the most recent loan. Also,
the entry into repurchase agreements is not considered a loan for purposes of
this restriction.
4. Act as underwriter of securities issued by other persons except insofar
as the fund may be technically deemed an underwriter under the federal
securities laws in connection with the disposition of portfolio securities.
5. Invest more than 5% of the value of its total assets in the securities of
any one issuer, but this limitation does not apply to investments in
securities issued or guaranteed by the U.S. government, its agencies or
instrumentalities.
6. Purchase the securities of any issuer which would result in owning more
than 10% of any class of the outstanding voting securities of such issuer.
7. Purchase from or sell to the officers and trustees of the fund, or to any
firm of which any officer or trustee is a member, as principal, any
securities, but may deal with such persons or firms as brokers and pay a
customary brokerage commission; or retain securities of any issuer if, to the
knowledge of the fund, one or more of its officers, trustees or the
administrator own beneficially more than one-half of 1% of the securities of
such issuer, and all such officers and trustees together own beneficially
more than 5% of such securities.
8. Purchase any securities issued by a corporation which has not been in
continuous operation for three years, but such period may include the
operation of a predecessor. (This limitation does not apply to issuers of
collateralized mortgage obligations.)
9. Acquire, lease, or hold real estate. (Does not preclude investments in
securities collateralized by real estate or interests therein.)
10. Invest in commodities and commodity contracts, puts, calls, straddles,
spreads, or any combination thereof, or interests in oil, gas, or other
mineral exploration or development program, except the fund may enter into
commodities contracts for hedging purposes. (Futures and related options are
not considered to be within the meaning of "commodity contracts, puts, calls,
straddles, spreads, or any combination thereof" for purposes of this
restriction.)
11. Invest in companies for the purpose of exercising control or management.
12. Purchase securities of other investment companies, except to the extent
permitted by the Investment Company Act of 1940 (the "1940 Act") or other
applicable state law, and except in connection with a merger, consolidation,
acquisition, or reorganization. To the extent permitted by exemptions which
may be granted under the 1940 Act, the fund may invest in shares of one or
more money market funds managed by the manager or its affiliates.
13. Issue senior securities as defined in the 1940 Act, except that this
restriction will not prevent the fund from entering into repurchase
agreements or making borrowings, mortgages, and pledges as permitted by
restriction #1 above.
In addition, it is the fund's present policy (which may be changed without
the approval of the fund's shareholders) not to invest in warrants.
If a bankruptcy or other extraordinary event occurs concerning a particular
security the fund owns, the fund may receive stock, real estate, or other
investments that the fund would not, or could not, buy. If this happens, the
fund intends to sell such investments as soon as practicable while maximizing
the return to shareholders.
If a percentage restriction is met at the time of investment, a later
increase or decrease in the percentage due to a change in the value or
liquidity of portfolio securities or the amount of assets will not be
considered a violation of any of the foregoing restrictions.
RISKS
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MORTGAGE SECURITIES Mortgage securities differ from conventional bonds in
that principal is paid back over the life of the mortgage security rather
than at maturity. As a result, the holder of a mortgage security (i.e., the
fund) receives monthly scheduled payments of principal and interest, and may
receive unscheduled principal payments representing prepayments on the
underlying mortgages. When the holder reinvests the payments and any
unscheduled prepayments of principal it receives, it may receive a rate of
interest that is lower than the rate on the existing mortgage securities. For
this reason, mortgage securities may be less effective than other types of
U.S. government securities as a means of "locking in" long-term interest
rates.
The market value of mortgage securities, like other U.S. government
securities, will generally vary inversely with changes in market interest
rates, declining when interest rates rise and rising when interest rates
decline. Mortgage securities, while having less risk of a decline during
periods of rapidly rising rates, may also have less potential for capital
appreciation than other investments of comparable maturities due to the
likelihood of increased prepayments of mortgages as interest rates decline.
In addition, to the extent mortgage securities are purchased at a premium,
mortgage foreclosures and unscheduled principal prepayments may result in
some loss of the holder's principal investment to the extent of the premium
paid. On the other hand, if mortgage securities are purchased at a discount,
both a scheduled payment of principal and an unscheduled prepayment of
principal will increase current and total returns and will accelerate the
recognition of income which, when distributed to shareholders, will be
taxable as ordinary income.
INTEREST RATE RISK Changes in interest rates will affect the value of the
fund's portfolio and its share price. Rising interest rates, which often
occur during times of inflation or a growing economy, are likely to have a
negative effect on the value of the fund's shares. Interest rates have
increased and decreased in the past. These changes are unpredictable.
FUTURES AND OPTIONS ON FUTURES Successful use by the fund of financial
futures and related options will be subject to the manager's ability to
predict correctly movements in the direction of the securities markets
generally or of a particular segment. This requires different skills and
techniques than predicting changes in the price of individual securities.
Positions in financial futures and related options may be closed out only on
an exchange which provides a secondary market. There can be no assurance that
a liquid secondary market will exist for any particular futures contract or
related option at any specific time. Thus, it may not be possible to close an
option or futures position. The inability to close options or futures
positions also could have an adverse impact on the fund's ability to hedge
its securities effectively. The fund will enter into an option or futures
position only if there appears to be a liquid secondary market for such
options or futures.
There can be no assurance that a continuous liquid secondary market will
exist for any particular over-the-counter ("OTC") option at any specific
time. Consequently, the fund may be able to realize the value of an OTC
option it has purchased only by exercising it or entering into a closing sale
transaction with the dealer that issued it. Similarly, when the fund writes
an OTC option, it generally can close out that option prior to its expiration
only by entering into a closing purchase transaction with the dealer who
originally wrote it.
The CFTC and the various exchanges have established limits referred to as
"speculative position limits" on the maximum net long or net short position
which any person may hold or control in a particular futures contract.
Trading limits are imposed on the maximum number of contracts which any
person may trade on a particular trading day. An exchange may order the
liquidation of positions found to be in violation of these limits, and it may
impose other sanctions or restrictions.
The ordinary spreads between prices in the cash and futures markets, due to
differences in the nature of those markets, are subject to distortions.
First, all participants in the futures market are subject to initial deposit
and variation margin requirements. Rather than meeting additional variation
margin requirements, investors may close futures contracts through offsetting
transactions which could distort the normal relationship between the cash and
futures markets. Second, the liquidity of the futures market depends on
participants entering into offsetting transactions rather than making or
taking delivery. To the extent participants decide to make or take delivery,
liquidity in the futures market could be reduced, thus producing distortion.
Third, from the point of view of speculators, the margin deposit requirements
in the futures market are less onerous than margin requirements in the
securities market. Therefore, increased participation by speculators in the
futures market may cause temporary price distortions. Due to the possibility
of distortion, a correct forecast of general interest rate trends by the
investment manager may still not result in a successful transaction.
In addition, futures contracts entail the risk that the fund's overall
performance may be poorer than if it had not entered into any futures
contract if the manager's judgment about the general direction of interest
rates is incorrect. For example, if the fund has hedged against the
possibility of an increase in interest rates which would adversely affect the
price of bonds held in its portfolio and interest rates decrease instead, the
fund will lose part or all of the benefit of the increased value of the
hedged bonds because it will have offsetting losses in its futures positions.
In addition, in such situations, if the fund has insufficient cash, it may
have to sell securities from its portfolio to meet daily variation margin
requirements. Such sales may be, but will not necessarily be, at increased
prices which reflect the rising market. The fund may have to sell securities
at a time when it may be disadvantageous to do so.
The fund's sales of futures contracts and purchases of put options on futures
contracts will be solely to protect its investments against declines in
value. The fund expects that it will normally purchase securities upon
termination of long futures contracts and long call options on future
contracts, but under unusual market conditions it may terminate any of these
positions without a corresponding purchase of securities.
OFFICERS AND TRUSTEES
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The trust has a board of trustees. The board is responsible for the overall
management of the trust, including general supervision and review of the
fund's investment activities. The board, in turn, elects the officers of the
trust who are responsible for administering the trust's day-to-day operations.
The affiliations of the officers and board members and their principal
occupations for the past five years are shown below.
POSITION(S) HELD PRINCIPAL OCCUPATION(S) DURING
NAME, AGE AND ADDRESS WITH THE TRUST THE PAST FIVE YEARS
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Frank H. Abbott, III (77)
1045 Sansome Street
San Francisco, CA 94111
Trustee
President and Director, Abbott Corporation (an investment company); director
or trustee, as the case may be, of 27 of the investment companies in the
Franklin Templeton Group of Funds; and FORMERLY, Director, MotherLode Gold
Mines Consolidated (gold mining) and Vacu-Dry Co. (food processing).
Harris J. Ashton (66)
191 Clapboard Ridge Road
Greenwich, CT 06830
Trustee
Director, RBC Holdings, Inc. (a bank holding company) and Bar-S Foods (a meat
packing company); director or trustee, as the case may be, of 49 of the
investment companies in the Franklin Templeton Group of Funds; and FORMERLY,
President, Chief Executive Officer and Chairman of the Board, General Host
Corporation (nursery and craft centers).
*Harmon E. Burns (53)
777 Mariners Island Blvd.
San Mateo, CA 94404
Vice President
and Trustee
Executive Vice President and Director, Franklin Resources, Inc., Franklin
Templeton Distributors, Inc. and Franklin Templeton Services, Inc.; Executive
Vice President, Franklin Advisers, Inc.; Director, Franklin/Templeton
Investor Services, Inc.; and officer and/or director or trustee, as the case
may be, of most of the other subsidiaries of Franklin Resources, Inc. and of
53 of the investment companies in the Franklin Templeton Group of Funds.
S. Joseph Fortunato (66)
Park Avenue at Morris County
P.O. Box 1945
Morristown, NJ 07962-1945
Trustee
Member of the law firm of Pitney, Hardin, Kipp & Szuch; director or trustee,
as the case may be, of 51 of the investment companies in the Franklin
Templeton Group of Funds.
*Charles B. Johnson (66)
777 Mariners Island Blvd.
San Mateo, CA 94404
Chairman of
the Board
and Trustee
President, Chief Executive Officer and Director, Franklin Resources, Inc.;
Chairman of the Board and Director, Franklin Advisers, Inc., Franklin
Advisory Services, Inc., Franklin Investment Advisory Services, Inc. and
Franklin Templeton Distributors, Inc.; Director, Franklin/Templeton Investor
Services, Inc. and Franklin Templeton Services, Inc.; officer and/or director
or trustee, as the case may be, of most of the other subsidiaries of Franklin
Resources, Inc. and of 50 of the investment companies in the Franklin
Templeton Group of Funds.
*Rupert H. Johnson, Jr. (58)
777 Mariners Island Blvd.
San Mateo, CA 94404
President
and Trustee
Executive Vice President and Director, Franklin Resources, Inc. and Franklin
Templeton Distributors, Inc.; President and Director, Franklin Advisers,
Inc.; Senior Vice President and Director, Franklin Advisory Services, Inc.
and Franklin Investment Advisory Services, Inc.; Director, Franklin/Templeton
Investor Services, Inc.; and officer and/or director or trustee, as the case
may be, of most of the other subsidiaries of Franklin Resources, Inc. and of
53 of the investment companies in the Franklin Templeton Group of Funds.
Frank W.T. LaHaye (69)
20833 Stevens Creek Blvd.
Suite 102
Cupertino, CA 95014
Trustee
General Partner, Miller & LaHaye, which is the General Partner of Peregrine
Ventures II (venture capital firm); Director, Quarterdeck Corporation
(software firm) and Digital Transmission Systems, Inc. (wireless
communications); director or trustee, as the case may be, of 27 of the
investment companies in the Franklin Templeton Group of Funds; and FORMERLY,
Director, Fischer Imaging Corporation (medical imaging systems) and General
Partner, Peregrine Associates, which was the General Partner of Peregrine
Ventures (venture capital firm).
Gordon S. Macklin (70)
8212 Burning Tree Road
Bethesda, MD 20817
Trustee
Director, Fund American Enterprises Holdings, Inc., Martek Biosciences
Corporation, MCI WorldCom, MedImmune, Inc. (biotechnology), Spacehab, Inc.
(aerospace services) and Real 3D (software); director or trustee, as the case
may be, of 49 of the investment companies in the Franklin Templeton Group of
Funds; and FORMERLY, Chairman, White River Corporation (financial services)
and Hambrecht and Quist Group (investment banking), and President, National
Association of Securities Dealers, Inc.
Martin L. Flanagan (38)
777 Mariners Island Blvd.
San Mateo, CA 94404
Vice President
and Chief
Financial Officer
Senior Vice President and Chief Financial Officer, Franklin Resources, Inc.;
Executive Vice President and Director, Templeton Worldwide, Inc.; Executive
Vice President, Chief Operating Officer and Director, Templeton Investment
Counsel, Inc.; Executive Vice President and Chief Financial Officer, Franklin
Advisers, Inc.; Chief Financial Officer, Franklin Advisory Services, Inc. and
Franklin Investment Advisory Services, Inc.; President and Director, Franklin
Templeton Services, Inc.; Senior Vice President and Chief Financial Officer,
Franklin/Templeton Investor Services, Inc.; officer and/or director of some
of the other subsidiaries of Franklin Resources, Inc.; and officer and/or
director or trustee, as the case may be, of 53 of the investment companies in
the Franklin Templeton Group of Funds.
Deborah R. Gatzek (50)
777 Mariners Island Blvd.
San Mateo, CA 94404
Vice President
and Secretary
Senior Vice President and General Counsel, Franklin Resources, Inc.; Senior
Vice President, Franklin Templeton Services, Inc. and Franklin Templeton
Distributors, Inc.; Executive Vice President, Franklin Advisers, Inc.; Vice
President, Franklin Advisory Services, Inc.; Vice President, Chief Legal
Officer and Chief Operating Officer, Franklin Investment Advisory Services,
Inc.; and officer of 53 of the investment companies in the Franklin Templeton
Group of Funds.
Charles E. Johnson (42)
500 East Broward Blvd.
Fort Lauderdale, FL
33394-3091
Vice President
Senior Vice President and Director, Franklin Resources, Inc.; Senior Vice
President, Franklin Templeton Distributors, Inc.; President and Director,
Templeton Worldwide, Inc.; Chairman and Director, Templeton Investment
Counsel, Inc.; Vice President, Franklin Advisers, Inc.; officer and/or
director of some of the other subsidiaries of Franklin Resources, Inc.; and
officer and/or director or trustee, as the case may be, of 34 of the
investment companies in the Franklin Templeton Group of Funds.
Diomedes Loo-Tam (59)
777 Mariners Island Blvd.
San Mateo, CA 94404
Treasurer and
Principal
Accounting
Officer
Senior Vice President, Franklin Templeton Services, Inc.; and officer of 32
of the investment companies in the Franklin Templeton Group of Funds.
Edward V. McVey (61)
777 Mariners Island Blvd.
San Mateo, CA 94404
Vice President
Senior Vice President and National Sales Manager, Franklin Templeton
Distributors, Inc.; and officer of 28 of the investment companies in the
Franklin Templeton Group of Funds.
*This board member is considered an "interested person" under federal
securities laws.
Note: Charles B. Johnson and Rupert H. Johnson, Jr. are brothers and the
father and uncle, respectively, of Charles E. Johnson.
Currently, the trust does not pay noninterested board members fees for
attending meetings. Board members who serve on the audit committee of the
trust and other funds in the Franklin Templeton Group of Funds receive a flat
fee of $2,000 per committee meeting attended, a portion of which is allocated
to the trust. Members of a committee are not compensated for any committee
meeting held on the day of a board meeting. Noninterested board members may
also serve as directors or trustees of other funds in the Franklin Templeton
Group of Funds and may receive fees from these funds for their services. The
fees payable to noninterested board members by the trust are subject to
reductions resulting from fee caps limiting the amount of fees payable to
board members who serve on other boards within the Franklin Templeton Group
of Funds. The following table provides the total fees paid to noninterested
board members by the Franklin Templeton Group of Funds.
TOTAL FEES NUMBER OF BOARDS
RECEIVED FROM IN THE FRANKLIN
THE FRANKLIN TEMPLETON GROUP OF
TEMPLETON GROUP FUNDS ON WHICH
NAME OF FUNDS 1 EACH SERVES 2
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Frank H. Abbott, III ............ $159,051 27
Harris J. Ashton ................ 361,157 49
S. Joseph Fortunato ............. 367,835 51
Frank W.T. LaHaye ............... 163,753 27
Gordon S. Macklin ............... 361,157 49
1. For the calendar year ended December 31, 1998.
2. We base the number of boards on the number of registered investment
companies in the Franklin Templeton Group of Funds. This number does not
include the total number of series or funds within each investment company
for which the board members are responsible. The Franklin Templeton Group of
Funds currently includes 54 registered investment companies, with
approximately 166 U.S. based funds or series.
Noninterested board members are reimbursed for expenses incurred in
connection with attending board meetings, paid pro rata by each fund in the
Franklin Templeton Group of Funds for which they serve as director or
trustee. No officer or board member received any other compensation,
including pension or retirement benefits, directly or indirectly from the
fund or other funds in the Franklin Templeton Group of Funds. Certain
officers or board members who are shareholders of Franklin Resources, Inc.
may be deemed to receive indirect remuneration by virtue of their
participation, if any, in the fees paid to its subsidiaries.
Board members historically have followed a policy of having substantial
investments in one or more of the funds in the Franklin Templeton Group of
Funds, as is consistent with their individual financial goals. In February
1998, this policy was formalized through adoption of a requirement that each
board member invest one-third of fees received for serving as a director or
trustee of a Templeton fund in shares of one or more Templeton funds and
one-third of fees received for serving as a director or trustee of a Franklin
fund in shares of one or more Franklin funds until the value of such
investments equals or exceeds five times the annual fees paid such board
member. Investments in the name of family members or entities controlled by a
board member constitute fund holdings of such board member for purposes of
this policy, and a three year phase-in period applies to such investment
requirements for newly elected board members. In implementing such policy, a
board member's fund holdings existing on February 27, 1998, are valued as of
such date with subsequent investments valued at cost.
MANAGEMENT AND OTHER SERVICES
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MANAGER AND SERVICES PROVIDED As of February 26, 1998, the fund's manager is
Franklin Advisers, Inc. The terms and conditions of the management services
the manager provides are the same as those of the previous manager. The
manager is wholly owned by Franklin Resources, Inc. (Resources), a publicly
owned company engaged in the financial services industry through its
subsidiaries. Charles B. Johnson and Rupert H. Johnson, Jr. are the principal
shareholders of Resources.
The manager provides investment research and portfolio management services,
and selects the securities for the fund to buy, hold or sell. The manager
also selects the brokers who execute the fund's portfolio transactions. The
manager provides periodic reports to the board, which reviews and supervises
the manager's investment activities. To protect the fund, the manager and its
officers, directors and employees are covered by fidelity insurance.
The manager and its affiliates manage numerous other investment companies and
accounts. The manager may give advice and take action with respect to any of
the other funds it manages, or for its own account, that may differ from
action taken by the manager on behalf of the fund. Similarly, with respect to
the fund, the manager is not obligated to recommend, buy or sell, or to
refrain from recommending, buying or selling any security that the manager
and access persons, as defined by applicable federal securities laws, may buy
or sell for its or their own account or for the accounts of any other fund.
The manager is not obligated to refrain from investing in securities held by
the fund or other funds it manages. Of course, any transactions for the
accounts of the manager and other access persons will be made in compliance
with the fund's code of ethics.
Under the fund's code of ethics, employees of the Franklin Templeton Group
who are access persons may engage in personal securities transactions subject
to the following general restrictions and procedures: (i) the trade must
receive advance clearance from a compliance officer and must be completed by
the close of the business day following the day clearance is granted; (ii)
copies of all brokerage confirmations and statements must be sent to a
compliance officer; (iii) all brokerage accounts must be disclosed on an
annual basis; and (iv) access persons involved in preparing and making
investment decisions must, in addition to (i), (ii) and (iii) above, file
annual reports of their securities holdings each January and inform the
compliance officer (or other designated personnel) if they own a security
that is being considered for a fund or other client transaction or if they
are recommending a security in which they have an ownership interest for
purchase or sale by a fund or other client.
MANAGEMENT FEES The fund pays the manager a fee equal to an annual rate of:
o 40/100 of 1% of the value of net assets up to and including $250 million;
o 38/100 of 1% of the value of net assets over $250 million and not over
$500 million; and
o 36/100 of 1% of the value of net assets in excess of $500 million.
The fee is computed at the close of business on the last business day of each
month according to the terms of the management agreement.
For the last three fiscal years ended September 30, the fund paid the
following management fees:
MANAGEMENT
FEES PAID ($) 1
- -----------------------------------------
1998 .................. 0
1997 .................. 0
1996 .................. 0
1. Management fees, before any advance waiver, totaled $25,479 in 1996,
$30,144 in 1997 and $47,370 in 1998. Under an agreement by the manager to
waive its fees, the fund paid the management fees shown.
ADMINISTRATOR AND SERVICES PROVIDED Franklin Templeton Services, Inc. (FT
Services) has an agreement with the manager to provide certain administrative
services and facilities for the fund. FT Services is wholly owned by
Resources and is an affiliate of the fund's manager and principal underwriter.
The administrative services FT Services provides include preparing and
maintaining books, records, and tax and financial reports, and monitoring
compliance with regulatory requirements.
ADMINISTRATION FEES The manager pays FT Services a monthly fee equal to an
annual rate of:
o 0.15% of the fund's average daily net assets up to $200 million;
o 0.135% of average daily net assets over $200 million up to $700 million;
o 0.10% of average daily net assets over $700 million up to $1.2 billion;
and
o 0.075% of average daily net assets over $1.2 billion.
During the last two fiscal years ended September 30, the manager paid FT
Services the following administration fees:
ADMINISTRATION
FEES PAID ($)
- --------------------------------------
1998 .................. 0
1997 .................. 0
SHAREHOLDER SERVICING AND TRANSFER AGENT Franklin/Templeton Investor
Services, Inc. (Investor Services) is the fund's shareholder servicing agent
and acts as the fund's transfer agent and dividend-paying agent. Investor
Services is located at 777 Mariners Island Blvd., P.O. Box 7777, San Mateo,
CA 94403-7777.
For its services, Investor Services receives a fixed fee per account. The
fund may also reimburse Investor Services for certain out-of-pocket expenses,
which may include payments by Investor Services to entities, including
affiliated entities, that provide sub-shareholder services, recordkeeping
and/or transfer agency services to beneficial owners of the fund. The amount
of reimbursements for these services per benefit plan participant fund
account per year may not exceed the per account fee payable by the fund to
Investor Services in connection with maintaining shareholder accounts.
CUSTODIAN Bank of New York, Mutual Funds Division, 90 Washington Street, New
York, NY 10286, acts as custodian of the fund's securities and other assets.
AUDITOR PricewaterhouseCoopers LLP, 333 Market Street, San Francisco, CA
94105, is the fund's independent auditor. The auditor gives an opinion on the
financial statements included in the trust's Annual Report to Shareholders
and reviews the trust's registration statement filed with the U.S. Securities
and Exchange Commission (SEC).
PORTFOLIO TRANSACTIONS
- ------------------------------------------------------------------------------
Since most purchases by the fund are principal transactions at net prices,
the fund incurs little or no brokerage costs. The fund deals directly with
the selling or buying principal or market maker without incurring charges for
the services of a broker on its behalf, unless it is determined that a better
price or execution may be obtained by using the services of a broker.
Purchases of portfolio securities from underwriters will include a commission
or concession paid by the issuer to the underwriter, and purchases from
dealers will include a spread between the bid and ask prices. The fund seeks
to obtain prompt execution of orders at the most favorable net price.
Transactions may be directed to dealers in return for research and
statistical information, as well as for special services provided by the
dealers in the execution of orders.
It is not possible to place a dollar value on the special executions or on
the research services the manager receives from dealers effecting
transactions in portfolio securities. The allocation of transactions in order
to obtain additional research services allows the manager to supplement its
own research and analysis activities and to receive the views and information
of individuals and research staffs of other securities firms. As long as it
is lawful and appropriate to do so, the manager and its affiliates may use
this research and data in their investment advisory capacities with other
clients. If the fund's officers are satisfied that the best execution is
obtained, the sale of fund shares, as well as shares of other funds in the
Franklin Templeton Group of Funds, may also be considered a factor in the
selection of broker-dealers to execute the fund's portfolio transactions.
Because Franklin Templeton Distributors, Inc. (Distributors) is a member of
the National Association of Securities Dealers, Inc., it may sometimes
receive certain fees when the fund tenders portfolio securities pursuant to a
tender-offer solicitation. To recapture brokerage for the benefit of the
fund, any portfolio securities tendered by the fund will be tendered through
Distributors if it is legally permissible to do so. In turn, the next
management fee payable to the manager will be reduced by the amount of any
fees received by Distributors in cash, less any costs and expenses incurred
in connection with the tender.
If purchases or sales of securities of the fund and one or more other
investment companies or clients supervised by the manager are considered at
or about the same time, transactions in these securities will be allocated
among the several investment companies and clients in a manner deemed
equitable to all by the manager, taking into account the respective sizes of
the funds and the amount of securities to be purchased or sold. In some cases
this procedure could have a detrimental effect on the price or volume of the
security so far as the fund is concerned. In other cases it is possible that
the ability to participate in volume transactions may improve execution and
reduce transaction costs to the fund.
During the last three fiscal years ended September 30, 1996, 1997, and 1998,
the fund did not pay any brokerage commissions.
As of September 30, 1998, the fund did not own securities of its regular
broker-dealers.
DISTRIBUTIONS AND TAXES
- ------------------------------------------------------------------------------
DISTRIBUTIONS OF NET INVESTMENT INCOME The fund receives income generally in
the form of interest on its investments. This income, less expenses incurred
in the operation of the fund, constitutes the fund's net investment income
from which dividends may be paid to you. Any distributions by the fund from
such income will be taxable to you as ordinary income, whether you take them
in cash or in additional shares.
DISTRIBUTIONS OF CAPITAL GAINS The fund may derive capital gains and losses
in connection with sales or other dispositions of its portfolio securities.
Distributions from net short-term capital gains will be taxable to you as
ordinary income. Distributions from net long-term capital gains will be
taxable to you as long-term capital gain, regardless of how long you have
held your shares in the fund. Any net capital gains realized by the fund
generally will be distributed once each year, and may be distributed more
frequently, if necessary, in order to reduce or eliminate excise or income
taxes on the fund.
INFORMATION ON THE TAX CHARACTER OF DISTRIBUTIONS The fund will inform you
of the amount of your ordinary income dividends and capital gains
distributions at the time they are paid, and will advise you of their tax
status for federal income tax purposes shortly after the close of each
calendar year. If you have not held fund shares for a full year, the fund may
designate and distribute to you, as ordinary income or capital gain, a
percentage of income that is not equal to the actual amount of such income
earned during the period of your investment in the fund.
ELECTION TO BE TAXED AS A REGULATED INVESTMENT COMPANY The fund has elected
to be treated as a regulated investment company under Subchapter M of the
Internal Revenue Code, has qualified as such for its most recent fiscal year,
and intends to so qualify during the current fiscal year. As a regulated
investment company, the fund generally pays no federal income tax on the
income and gains it distributes to you. The board reserves the right not to
maintain the qualification of the fund as a regulated investment company if
it determines such course of action to be beneficial to shareholders. In such
case, the fund will be subject to federal, and possibly state, corporate
taxes on its taxable income and gains, and distributions to you will be taxed
as ordinary dividend income to the extent of the fund's earnings and profits.
EXCISE TAX DISTRIBUTION REQUIREMENTS To avoid federal excise taxes, the
Internal Revenue Code requires the fund to distribute to you by December 31
of each year, at a minimum, the following amounts: 98% of its taxable
ordinary income earned during the calendar year; 98% of its capital gain net
income earned during the twelve month period ending October 31; and 100% of
any undistributed amounts from the prior year.
The fund intends to declare and pay these amounts in December (or in January
that are treated by you as received in December) to avoid these excise taxes,
but can give no assurances that its distributions will be sufficient to
eliminate all such taxes.
REDEMPTION OF FUND SHARES Redemptions and exchanges of fund shares are
taxable transactions for federal and state income tax purposes. If you redeem
your fund shares, or exchange your fund shares for shares of a different
Franklin Templeton Fund, the IRS will require that you report a gain or loss
on your redemption or exchange. If you hold your shares as a capital asset,
the gain or loss that you realize will be capital gain or loss. Any loss
incurred on the redemption or exchange of shares held for six months or less
will be treated as a long-term capital loss to the extent of any long-term
capital gains distributed to you by the fund on those shares.
All or a portion of any loss that you realize upon the redemption of your
fund shares will be disallowed to the extent that you buy other shares in the
fund (through reinvestment of dividends or otherwise) within 30 days before
or after your share redemption. Any loss disallowed under these rules will be
added to your tax basis in the new shares you buy.
DEFERRAL OF BASIS If you redeem some or all of your shares in the fund, and
then reinvest the sales proceeds in the fund or in another Franklin Templeton
Fund within 90 days of buying the original shares, the sales charge that
would otherwise apply to your reinvestment may be reduced or eliminated. The
IRS will require you to report gain or loss on the redemption of your
original shares in the fund. In doing so, all or a portion of the sales
charge that you paid for your original shares in the fund will be excluded
from your tax basis in the shares sold (for the purpose of determining gain
or loss upon the sale of such shares). The portion of the sales charge
excluded will equal the amount that the sales charge is reduced on your
reinvestment. Any portion of the sales charge excluded from your tax basis in
the shares sold will be added to the tax basis of the shares you acquire from
your reinvestment.
U.S. GOVERNMENT OBLIGATIONS Many states grant tax-free status to dividends
paid to you from interest earned on direct obligations of the U.S.
government, subject in some states to minimum investment requirements that
must be met by the fund. Investments in Government National Mortgage
Association or Federal National Mortgage Association securities, bankers'
acceptances, commercial paper and repurchase agreements collateralized by
U.S. government securities do not generally qualify for tax-free treatment.
The rules on exclusion of this income are different for corporations.
DIVIDENDS-RECEIVED DEDUCTION FOR CORPORATIONS Because the fund's income
consists of interest rather than dividends, no portion of its distributions
will generally be eligible for the intercorporate dividends-received
deduction. None of the dividends paid by the fund for the most recent
calendar year qualified for such deduction, and it is anticipated that none
of the current year's dividends will so qualify.
INVESTMENT IN COMPLEX SECURITIES The fund may invest in complex securities.
These investments may be subject to numerous special and complex tax rules.
These rules could affect whether gains and losses recognized by the fund are
treated as ordinary income or capital gain, accelerate the recognition of
income to the fund and/or defer the fund's ability to recognize losses. In
turn, these rules may affect the amount, timing or character of the income
distributed to you by the fund.
ORGANIZATION, VOTING RIGHTS
AND PRINCIPAL HOLDERS
- ------------------------------------------------------------------------------
The fund is a diversified series of Franklin Strategic Mortgage Portfolio, an
open-end management investment company, commonly called a mutual fund. The
trust was organized as a Delaware business trust on September 23, 1992, and
is registered with the SEC.
Certain funds in the Franklin Templeton Funds offer multiple classes of
shares. The different classes have proportionate interests in the same
portfolio of investment securities. They differ, however, primarily in their
sales charge structures and Rule 12b-1 plans. Because the fund's sales charge
structure is similar to that of Class A shares, shares of the fund are
considered Class A shares for redemption, exchange and other purposes. Before
January 1, 1999, the fund's shares were considered Class I shares.
The trust has noncumulative voting rights. For board member elections, this
gives holders of more than 50% of the shares voting the ability to elect all
of the members of the board. If this happens, holders of the remaining shares
voting will not be able to elect anyone to the board.
The trust does not intend to hold annual shareholder meetings. The trust or a
series of the trust may hold special meetings, however, for matters requiring
shareholder approval. A meeting may be called by the board to consider the
removal of a board member if requested in writing by shareholders holding at
least 10% of the outstanding shares. In certain circumstances, we are
required to help you communicate with other shareholders about the removal of
a board member. A special meeting may also be called by the board in its
discretion.
As of November 5, 1998, the principal shareholders of the fund, beneficial or
of record, were:
NAME AND ADDRESS PERCENTAGE (%)
- ------------------------------------------------------------------------------
Franklin Resources, Inc. 1
777 Mariners Island Blvd.
San Mateo, CA
94404-1584................................ 45.857%
1. Franklin Resources, Inc. is a Delaware corporation.
From time to time, the number of fund shares held in the "street name"
accounts of various securities dealers for the benefit of their clients or in
centralized securities depositories may exceed 5% of the total shares
outstanding.
As of November 5, 1998, the officers and board members, as a group, owned of
record and beneficially less than 1% of the outstanding shares of the fund.
The board members may own shares in other funds in the Franklin Templeton
Group of Funds.
BUYING AND SELLING SHARES
- ------------------------------------------------------------------------------
The fund continuously offers its shares through securities dealers who have
an agreement with Franklin Templeton Distributors, Inc. (Distributors). A
securities dealer includes any financial institution that, either directly or
through affiliates, has an agreement with Distributors to handle customer
orders and accounts with the fund. This reference is for convenience only and
does not indicate a legal conclusion of capacity. Banks and financial
institutions that sell shares of the fund may be required by state law to
register as securities dealers.
For investors outside the U.S., the offering of fund shares may be limited in
many jurisdictions. An investor who wishes to buy shares of the fund should
determine, or have a broker-dealer determine, the applicable laws and
regulations of the relevant jurisdiction. Investors are responsible for
compliance with tax, currency exchange or other regulations applicable to
redemption and purchase transactions in any jurisdiction to which they may be
subject. Investors should consult appropriate tax and legal advisors to
obtain information on the rules applicable to these transactions.
All checks, drafts, wires and other payment mediums used to buy or sell
shares of the fund must be denominated in U.S. dollars. We may, in our sole
discretion, either (a) reject any order to buy or sell shares denominated in
any other currency or (b) honor the transaction or make adjustments to your
account for the transaction as of a date and with a foreign currency exchange
factor determined by the drawee bank.
When you buy shares, if you submit a check or a draft that is returned unpaid
to the fund we may impose a $10 charge against your account for each returned
item.
INITIAL SALES CHARGES The maximum initial sales charge is 4.25%. The initial
sales charge may be reduced for certain large purchases, as described in the
prospectus. We offer several ways for you to combine your purchases in the
Franklin Templeton Funds to take advantage of the lower sales charges for
large purchases. The Franklin Templeton Funds include the U.S. registered
mutual funds in the Franklin Group of Funds(R) and the Templeton Group of Funds
except Franklin Valuemark Funds, Templeton Capital Accumulator Fund, Inc.,
and Templeton Variable Products Series Fund.
CUMULATIVE QUANTITY DISCOUNT. For purposes of calculating the sales charge,
you may combine the amount of your current purchase with the cost or current
value, whichever is higher, of your existing shares in the Franklin Templeton
Funds. You may also combine the shares of your spouse, children under the age
of 21 or grandchildren under the age of 21. If you are the sole owner of a
company, you may also add any company accounts, including retirement plan
accounts. Companies with one or more retirement plans may add together the
total plan assets invested in the Franklin Templeton Funds to determine the
sales charge that applies.
LETTER OF INTENT (LOI). You may buy shares at a reduced sales charge by
completing the letter of intent section of your account application. A letter
of intent is a commitment by you to invest a specified dollar amount during a
13 month period. The amount you agree to invest determines the sales charge
you pay. By completing the letter of intent section of the application, you
acknowledge and agree to the following:
o You authorize Distributors to reserve 5% of your total intended purchase
in shares registered in your name until you fulfill your LOI. Your
periodic statements will include the reserved shares in the total shares
you own, and we will pay or reinvest dividend and capital gain
distributions on the reserved shares according to the distribution
option you have chosen.
o You give Distributors a security interest in the reserved shares and
appoint Distributors as attorney-in-fact.
o Distributors may sell any or all of the reserved shares to cover any
additional sales charge if you do not fulfill the terms of the LOI.
o Although you may exchange your shares, you may not sell reserved shares
until you complete the LOI or pay the higher sales charge.
After you file your LOI with the fund, you may buy shares at the sales charge
applicable to the amount specified in your LOI. Sales charge reductions based
on purchases in more than one Franklin Templeton Fund will be effective only
after notification to Distributors that the investment qualifies for a
discount. Any purchases you made within 90 days before you filed your LOI may
also qualify for a retroactive reduction in the sales charge. If you file
your LOI with the fund before a change in the fund's sales charge, you may
complete the LOI at the lower of the new sales charge or the sales charge in
effect when the LOI was filed.
Your holdings in the Franklin Templeton Funds acquired more than 90 days
before you filed your LOI will be counted towards the completion of the LOI,
but they will not be entitled to a retroactive reduction in the sales charge.
Any redemptions you make during the 13 month period, except in the case of
certain retirement plans, will be subtracted from the amount of the purchases
for purposes of determining whether the terms of the LOI have been completed.
If the terms of your LOI are met, the reserved shares will be deposited to an
account in your name or delivered to you or as you direct. If the amount of
your total purchases, less redemptions, is more than the amount specified in
your LOI and is an amount that would qualify for a further sales charge
reduction, a retroactive price adjustment will be made by Distributors and
the securities dealer through whom purchases were made. The price adjustment
will be made on purchases made within 90 days before and on those made after
you filed your LOI and will be applied towards the purchase of additional
shares at the offering price applicable to a single purchase or the dollar
amount of the total purchases.
If the amount of your total purchases, less redemptions, is less than the
amount specified in your LOI, the sales charge will be adjusted upward,
depending on the actual amount purchased (less redemptions) during the
period. You will need to send Distributors an amount equal to the difference
in the actual dollar amount of sales charge paid and the amount of sales
charge that would have applied to the total purchases if the total of the
purchases had been made at one time. Upon payment of this amount, the
reserved shares held for your account will be deposited to an account in your
name or delivered to you or as you direct. If within 20 days after written
request the difference in sales charge is not paid, we will redeem an
appropriate number of reserved shares to realize the difference. If you
redeem the total amount in your account before you fulfill your LOI, we will
deduct the additional sales charge due from the sale proceeds and forward the
balance to you.
For LOIs filed on behalf of certain retirement plans, the level and any
reduction in sales charge for these plans will be based on actual plan
participation and the projected investments in the Franklin Templeton Funds
under the LOI. These plans are not subject to the requirement to reserve 5%
of the total intended purchase or to the policy on upward adjustments in
sales charges described above, or to any penalty as a result of the early
termination of a plan, nor are these plans entitled to receive retroactive
adjustments in price for investments made before executing the LOI.
GROUP PURCHASES. If you are a member of a qualified group, you may buy shares
at a reduced sales charge that applies to the group as a whole. The sales
charge is based on the combined dollar value of the group members' existing
investments, plus the amount of the current purchase.
A qualified group is one that:
o Was formed at least six months ago,
o Has a purpose other than buying fund shares at a discount,
o Has more than 10 members,
o Can arrange for meetings between our representatives and group members,
o Agrees to include Franklin Templeton Fund sales and other materials in
publications and mailings to its members at reduced or no cost to
Distributors,
o Agrees to arrange for payroll deduction or other bulk transmission of
investments to the fund, and
o Meets other uniform criteria that allow Distributors to achieve cost
savings in distributing shares.
A qualified group does not include a 403(b) plan that only allows salary
deferral contributions, although any such plan that purchased the fund's
shares at a reduced sales charge under the group purchase privilege before
February 1, 1998, may continue to do so.
WAIVERS FOR INVESTMENTS FROM CERTAIN PAYMENTS. Fund shares may be purchased
without an initial sales charge by investors who reinvest within 365 days:
o Dividend and capital gain distributions from any Franklin Templeton
Fund. The distributions generally must be reinvested in the same share
class. Certain exceptions apply, however, to Class C shareholders of
another Franklin Templeton Fund who chose to reinvest their
distributions in shares of the fund before November 17, 1997, and to
Advisor Class or Class Z shareholders of a Franklin Templeton Fund who
may reinvest their distributions in the fund.
o Dividend or capital gain distributions from a real estate investment
trust (REIT) sponsored or advised by Franklin Properties, Inc.
o Annuity payments received under either an annuity option or from death
benefit proceeds, if the annuity contract offers as an investment option
the Franklin Valuemark Funds or the Templeton Variable Products Series
Fund. You should contact your tax advisor for information on any tax
consequences that may apply.
o Redemption proceeds from a repurchase of shares of Franklin Floating
Rate Trust, if the shares were continuously held for at least 12 months.
If you immediately placed your redemption proceeds in a Franklin Bank CD
or a Franklin Templeton money fund, you may reinvest them as described
above. The proceeds must be reinvested within 365 days from the date the
CD matures, including any rollover, or the date you redeem your money
fund shares.
o Redemption proceeds from the sale of Class A shares of any of the
Templeton Global Strategy Funds if you are a qualified investor.
If you immediately placed your redemption proceeds in a Franklin
Templeton money fund, you may reinvest them as described above. The
proceeds must be reinvested within 365 days from the date they are
redeemed from the money fund.
o Distributions from an existing retirement plan invested in the Franklin
Templeton Funds
WAIVERS FOR CERTAIN INVESTORS. Fund shares may also be purchased without an
initial sales charge by various individuals and institutions due to
anticipated economies in sales efforts and expenses, including:
o Trust companies and bank trust departments agreeing to invest in
Franklin Templeton Funds over a 13 month period at least $1 million of
assets held in a fiduciary, agency, advisory, custodial or similar
capacity and over which the trust companies and bank trust departments
or other plan fiduciaries or participants, in the case of certain
retirement plans, have full or shared investment discretion. We will
accept orders for these accounts by mail accompanied by a check or by
telephone or other means of electronic data transfer directly from the
bank or trust company, with payment by federal funds received by the
close of business on the next business day following the order.
o Any state or local government or any instrumentality, department,
authority or agency thereof that has determined the fund is a legally
permissible investment and that can only buy fund shares without paying
sales charges. Please consult your legal and investment advisors to
determine if an investment in the fund is permissible and suitable for
you and the effect, if any, of payments by the fund on arbitrage rebate
calculations.
o Broker-dealers, registered investment advisors or certified financial
planners who have entered into an agreement with Distributors for
clients participating in comprehensive fee programs
o Qualified registered investment advisors who buy through a broker-dealer
or service agent who has entered into an agreement with Distributors
o Registered securities dealers and their affiliates, for their investment
accounts only
o Current employees of securities dealers and their affiliates and their
family members, as allowed by the internal policies of their employer
o Officers, trustees, directors and full-time employees of the Franklin
Templeton Funds or the Franklin Templeton Group, and their family
members, consistent with our then-current policies
o Investment companies exchanging shares or selling assets pursuant to a
merger, acquisition or exchange offer
o Accounts managed by the Franklin Templeton Group
o Certain unit investment trusts and their holders reinvesting
distributions from the trusts
o Group annuity separate accounts offered to retirement plans
o Chilean retirement plans that meet the requirements described under
"Retirement plans" below
RETIREMENT PLANS. Retirement plans sponsored by an employer (i) with at least
100 employees, or (ii) with retirement plan assets of $1 million or more, or
(iii) that agrees to invest at least $500,000 in the Franklin Templeton Funds
over a 13 month period may buy shares without an initial sales charge.
Retirement plans that are not qualified retirement plans (employer sponsored
pension or profit-sharing plans that qualify under section 401 of the
Internal Revenue Code, including 401(k), money purchase pension, profit
sharing and defined benefit plans), SIMPLEs (savings incentive match plans
for employees) or SEPs (employer sponsored simplified employee pension plans
established under section 408(k) of the Internal Revenue Code) must also meet
the group purchase requirements described above to be able to buy shares
without an initial sales charge. We may enter into a special arrangement with
a securities dealer, based on criteria established by the fund, to add
together certain small qualified retirement plan accounts for the purpose of
meeting these requirements.
SALES IN TAIWAN. Under agreements with certain banks in Taiwan, Republic of
China, the fund's shares are available to these banks' trust accounts without
a sales charge. The banks may charge service fees to their customers who
participate in the trusts. A portion of these service fees may be paid to
Distributors or one of its affiliates to help defray expenses of maintaining
a service office in Taiwan, including expenses related to local literature
fulfillment and communication facilities.
The fund's shares may be offered to investors in Taiwan through securities
advisory firms known locally as Securities Investment Consulting Enterprises.
In conformity with local business practices in Taiwan, shares may be offered
with the following schedule of sales charges:
SALES
SIZE OF PURCHASE - U.S. DOLLARS CHARGE (%)
- --------------------------------------------------------------
Under $30,000................................... 3.0
$30,000 but less than $100,000.................. 2.0
$100,000 but less than $400,000................. 1.0
$400,000 or more................................ 0
DEALER COMPENSATION Securities dealers may at times receive the entire sales
charge. A securities dealer who receives 90% or more of the sales charge may
be deemed an underwriter under the Securities Act of 1933, as amended.
Financial institutions or their affiliated brokers may receive an agency
transaction fee in the percentages indicated in the dealer compensation table
in the fund's prospectus.
Distributors and/or its affiliates provide financial support to various
securities dealers that sell shares of the Franklin Templeton Group of Funds.
This support is based primarily on the amount of sales of fund shares. The
amount of support may be affected by: total sales; net sales; levels of
redemptions; the proportion of a securities dealer's sales and marketing
efforts in the Franklin Templeton Group of Funds; a securities dealer's
support of, and participation in, Distributors' marketing programs; a
securities dealer's compensation programs for its registered representatives;
and the extent of a securities dealer's marketing programs relating to the
Franklin Templeton Group of Funds. Financial support to securities dealers
may be made by payments from Distributors' resources, from Distributors'
retention of underwriting concessions and, in the case of funds that have
Rule 12b-1 plans, from payments to Distributors under such plans. In
addition, certain securities dealers may receive brokerage commissions
generated by fund portfolio transactions in accordance with the rules of the
National Association of Securities Dealers, Inc.
Distributors routinely sponsors due diligence meetings for registered
representatives during which they receive updates on various Franklin
Templeton Funds and are afforded the opportunity to speak with portfolio
managers. Invitation to these meetings is not conditioned on selling a
specific number of shares. Those who have shown an interest in the Franklin
Templeton Funds, however, are more likely to be considered. To the extent
permitted by their firm's policies and procedures, registered
representatives' expenses in attending these meetings may be covered by
Distributors.
EXCHANGE PRIVILEGE If you request the exchange of the total value of your
account, accrued but unpaid income dividends and capital gain distributions
will be reinvested in the fund at net asset value on the date of the
exchange, and then the entire share balance will be exchanged into the new
fund. Backup withholding and information reporting may apply.
If a substantial number of shareholders should, within a short period, sell
their fund shares under the exchange privilege, the fund might have to sell
portfolio securities it might otherwise hold and incur the additional costs
related to such transactions. On the other hand, increased use of the
exchange privilege may result in periodic large inflows of money. If this
occurs, it is the fund's general policy to initially invest this money in
short-term, interest-bearing money market instruments, unless it is believed
that attractive investment opportunities consistent with the fund's
investment goal exist immediately. This money will then be withdrawn from the
short-term, interest-bearing money market instruments and invested in
portfolio securities in as orderly a manner as is possible when attractive
investment opportunities arise.
The proceeds from the sale of shares of an investment company are generally
not available until the seventh day following the sale. The funds you are
seeking to exchange into may delay issuing shares pursuant to an exchange
until that seventh day. The sale of fund shares to complete an exchange will
be effected at net asset value at the close of business on the day the
request for exchange is received in proper form.
SYSTEMATIC WITHDRAWAL PLAN Our systematic withdrawal plan allows you to sell
your shares and receive regular payments from your account on a monthly,
quarterly, semiannual or annual basis. The value of your account must be at
least $5,000 and the minimum payment amount for each withdrawal must be at
least $50. For retirement plans subject to mandatory distribution
requirements, the $50 minimum will not apply. There are no service charges
for establishing or maintaining a systematic withdrawal plan. Once your plan
is established, any distributions paid by the fund will be automatically
reinvested in your account.
Payments under the plan will be made from the redemption of an equivalent
amount of shares in your account, generally on the 25th day of the month in
which a payment is scheduled. If the 25th falls on a weekend or holiday, we
will process the redemption on the next business day. When you sell your
shares under a systematic withdrawal plan, it is a taxable transaction.
To avoid paying sales charges on money you plan to withdraw within a short
period of time, you may not want to set up a systematic withdrawal plan if
you plan to buy shares on a regular basis.
Redeeming shares through a systematic withdrawal plan may reduce or exhaust
the shares in your account if payments exceed distributions received from the
fund. This is especially likely to occur if there is a market decline. If a
withdrawal amount exceeds the value of your account, your account will be
closed and the remaining balance in your account will be sent to you. Because
the amount withdrawn under the plan may be more than your actual yield or
income, part of the payment may be a return of your investment.
You may discontinue a systematic withdrawal plan, change the amount and
schedule of withdrawal payments, or suspend one payment by notifying us by
mail or by phone at least seven business days before the end of the month
preceding a scheduled payment. The fund may discontinue a systematic
withdrawal plan by notifying you in writing and will automatically
discontinue a systematic withdrawal plan if all shares in your account are
withdrawn or if the fund receives notification of the shareholder's death or
incapacity.
REDEMPTIONS IN KIND The fund has committed itself to pay in cash (by check)
all requests for redemption by any shareholder of record, limited in amount,
however, during any 90-day period to the lesser of $250,000 or 1% of the
value of the fund's net assets at the beginning of the 90-day period. This
commitment is irrevocable without the prior approval of the U.S. Securities
and Exchange Commission (SEC). In the case of redemption requests in excess
of these amounts, the board reserves the right to make payments in whole or
in part in securities or other assets of the fund, in case of an emergency,
or if the payment of such a redemption in cash would be detrimental to the
existing shareholders of the fund. In these circumstances, the securities
distributed would be valued at the price used to compute the fund's net
assets and you may incur brokerage fees in converting the securities to cash.
The fund does not intend to redeem illiquid securities in kind. If this
happens, however, you may not be able to recover your investment in a timely
manner.
SHARE CERTIFICATES We will credit your shares to your fund account. We do
not issue share certificates unless you specifically request them. This
eliminates the costly problem of replacing lost, stolen or destroyed
certificates. If a certificate is lost, stolen or destroyed, you may have to
pay an insurance premium of up to 2% of the value of the certificate to
replace it.
Any outstanding share certificates must be returned to the fund if you want
to sell or exchange those shares or if you would like to start a systematic
withdrawal plan. The certificates should be properly endorsed. You can do
this either by signing the back of the certificate or by completing a share
assignment form. For your protection, you may prefer to complete a share
assignment form and to send the certificate and assignment form in separate
envelopes.
GENERAL INFORMATION If dividend checks are returned to the fund marked
"unable to forward" by the postal service, we will consider this a request by
you to change your dividend option to reinvest all distributions. The
proceeds will be reinvested in additional shares at net asset value until we
receive new instructions.
Distribution or redemption checks sent to you do not earn interest or any
other income during the time the checks remain uncashed. Neither the fund nor
its affiliates will be liable for any loss caused by your failure to cash
such checks. The fund is not responsible for tracking down uncashed checks,
unless a check is returned as undeliverable.
In most cases, if mail is returned as undeliverable we are required to take
certain steps to try to find you free of charge. If these attempts are
unsuccessful, however, we may deduct the costs of any additional efforts to
find you from your account. These costs may include a percentage of the
account when a search company charges a percentage fee in exchange for its
location services.
The wiring of redemption proceeds is a special service that we make available
whenever possible. By offering this service to you, the fund is not bound to
meet any redemption request in less than the seven day period prescribed by
law. Neither the fund nor its agents shall be liable to you or any other
person if, for any reason, a redemption request by wire is not processed as
described in the prospectus.
Franklin Templeton Investor Services, Inc. (Investor Services) may pay
certain financial institutions that maintain omnibus accounts with the fund
on behalf of numerous beneficial owners for recordkeeping operations
performed with respect to such owners. For each beneficial owner in the
omnibus account, the fund may reimburse Investor Services an amount not to
exceed the per account fee that the fund normally pays Investor Services.
These financial institutions may also charge a fee for their services
directly to their clients.
If you buy or sell shares through your securities dealer, we use the net
asset value next calculated after your securities dealer receives your
request, which is promptly transmitted to the fund. If you sell shares
through your securities dealer, it is your dealer's responsibility to
transmit the order to the fund in a timely fashion. Your redemption proceeds
will not earn interest between the time we receive the order from your dealer
and the time we receive any required documents. Any loss to you resulting
from your dealer's failure to transmit your redemption order to the fund in a
timely fashion must be settled between you and your securities dealer.
Certain shareholder servicing agents may be authorized to accept your
transaction request.
For institutional accounts, there may be additional methods of buying or
selling fund shares than those described in this SAI or in the prospectus.
In the event of disputes involving multiple claims of ownership or authority
to control your account, the fund has the right (but has no obligation) to:
(a) freeze the account and require the written agreement of all persons
deemed by the fund to have a potential property interest in the account,
before executing instructions regarding the account; (b) interplead disputed
funds or accounts with a court of competent jurisdiction; or (c) surrender
ownership of all or a portion of the account to the IRS in response to a
notice of levy.
PRICING SHARES
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When you buy shares, you pay the offering price. The offering price is the
net asset value (NAV) per share plus any applicable sales charge, calculated
to two decimal places using standard rounding criteria. When you sell shares,
you receive the NAV minus any applicable contingent deferred sales charge
(CDSC).
The value of a mutual fund is determined by deducting the fund's liabilities
from the total assets of the portfolio. The net asset value per share is
determined by dividing the net asset value of the fund by the number of
shares outstanding.
The fund calculates the NAV per share each business day at the close of
trading on the New York Stock Exchange (normally 1:00 p.m. pacific time). The
fund does not calculate the NAV on days the New York Stock Exchange (NYSE) is
closed for trading, which include New Year's Day, Martin Luther King Jr. Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day.
When determining its NAV, the fund values cash and receivables at their
realizable amounts, and records interest as accrued and dividends on the
ex-dividend date. If market quotations are readily available for portfolio
securities listed on a securities exchange or on the NASDAQ National Market
System, the fund values those securities at the last quoted sale price of the
day or, if there is no reported sale, within the range of the most recent
quoted bid and ask prices. The fund values over-the-counter portfolio
securities within the range of the most recent quoted bid and ask prices. If
portfolio securities trade both in the over-the-counter market and on a stock
exchange, the fund values them according to the broadest and most
representative market as determined by the manager.
The fund values portfolio securities underlying actively traded call options
at their market price as determined above. The current market value of any
option the fund holds is its last sale price on the relevant exchange before
the fund values its assets. If there are no sales that day or if the last
sale price is outside the bid and ask prices, the fund values options within
the range of the current closing bid and ask prices if the fund believes the
valuation fairly reflects the contract's market value.
Generally, trading in corporate bonds, U.S. government securities and money
market instruments is substantially completed each day at various times
before the close of the NYSE. The value of these securities used in computing
the NAV is determined as of such times. Occasionally, events affecting the
values of these securities may occur between the times at which they are
determined and the close of the NYSE that will not be reflected in the
computation of the NAV. If events materially affecting the values of these
securities occur during this period, the securities will be valued at their
fair value as determined in good faith by the board.
Other securities for which market quotations are readily available are valued
at the current market price, which may be obtained from a pricing service,
based on a variety of factors including recent trades, institutional size
trading in similar types of securities (considering yield, risk and maturity)
and/or developments related to specific issues. Securities and other assets
for which market prices are not readily available are valued at fair value as
determined following procedures approved by the board. With the approval of
the board, the fund may use a pricing service, bank or securities dealer to
perform any of the above described functions.
THE UNDERWRITER
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Franklin Templeton Distributors, Inc. (Distributors) acts as the principal
underwriter in the continuous public offering of the fund's shares.
Distributors is located at 777 Mariners Island Blvd., San Mateo, CA 94404.
Distributors pays the expenses of the distribution of fund shares, including
advertising expenses and the costs of printing sales material and
prospectuses used to offer shares to the public. The fund pays the expenses
of preparing and printing amendments to its registration statements and
prospectuses (other than those necessitated by the activities of
Distributors) and of sending prospectuses to existing shareholders.
The table below shows the aggregate underwriting commissions Distributors
received in connection with the offering of the fund's shares, the net
underwriting discounts and commissions Distributors retained after allowances
to dealers, and the amounts Distributors received in connection with
redemptions or repurchases of shares for the last three fiscal years ended
September 30:
AMOUNT RECEIVED
TOTAL AMOUNT IN CONNECTION WITH
COMMISSIONS RETAINED BY REDEMPTIONS OR
RECEIVED ($)DISTRIBUTORS ($)REPURCHASES ($)
- -------------------------------------------------------------------------------
1998............................. 103,876 6,408 0
1997............................. 19,564 1,209 0
1996............................. 8,061 556 0
Except as noted, Distributors received no other compensation from the fund
for acting as underwriter.
PERFORMANCE
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Performance quotations are subject to SEC rules. These rules require the use
of standardized performance quotations or, alternatively, that every
non-standardized performance quotation furnished by the fund be accompanied
by certain standardized performance information computed as required by the
SEC. Average annual total return and current yield quotations used by the
fund are based on the standardized methods of computing performance mandated
by the SEC. If a Rule 12b-1 plan is adopted, performance figures reflect fees
from the date of the plan's implementation. An explanation of these and other
methods used by the fund to compute or express performance follows.
Regardless of the method used, past performance does not guarantee future
results, and is an indication of the return to shareholders only for the
limited historical period used.
AVERAGE ANNUAL TOTAL RETURN Average annual total return is determined by
finding the average annual rates of return over the periods indicated below
that would equate an initial hypothetical $1,000 investment to its ending
redeemable value. The calculation assumes the maximum initial sales charge is
deducted from the initial $1,000 purchase, and income dividends and capital
gain distributions are reinvested at net asset value. The quotation assumes
the account was completely redeemed at the end of each period and the
deduction of all applicable charges and fees. If a change is made to the
sales charge structure, historical performance information will be restated
to reflect the maximum initial sales charge currently in effect.
When considering the average annual total return quotations, you should keep
in mind that the maximum initial sales charge reflected in each quotation is
a one time fee charged on all direct purchases, which will have its greatest
impact during the early stages of your investment. This charge will affect
actual performance less the longer you retain your investment in the fund.
The average annual total returns for the indicated periods ended September
30, 1998, were:
SINCE
INCEPTION
1 YEAR 5 YEARS (2/1/93)
- ----------------------------------------
4.11% 6.14% 6.52%
These figures were calculated according to the SEC formula:
n
P(1+T) = ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at the
beginning of each period at the end of each period
CUMULATIVE TOTAL RETURN Like average annual total return, cumulative total
return assumes the maximum initial sales charge is deducted from the initial
$1,000 purchase, and income dividends and capital gain distributions are
reinvested at net asset value. Cumulative total return, however, is based on
the actual return for a specified period rather than on the average return
over the periods indicated above. The cumulative total returns for the
indicated periods ended September 30, 1998, were:
SINCE
INCEPTION
1 YEAR 5 YEARS (2/1/93)
- ------------------------------------------
4.11% 34.72% 42.97%
CURRENT YIELD Current yield shows the income per share earned by the fund.
It is calculated by dividing the net investment income per share earned
during a 30-day base period by the applicable maximum offering price per
share on the last day of the period and annualizing the result. Expenses
accrued for the period include any fees charged to all shareholders of the
class during the base period. The yield for the 30-day period ended September
30, 1998, was 6.09%.
This figure was obtained using the following SEC formula:
6
Yield = 2 [(a-b + 1) - 1]
----
cd
where:
a = interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the period
that were entitled to receive dividends
d = the maximum offering price per share on the last day of the period
CURRENT DISTRIBUTION RATE Current yield, which is calculated according to a
formula prescribed by the SEC, is not indicative of the amounts which were or
will be paid to shareholders. Amounts paid to shareholders are reflected in
the quoted current distribution rate. The current distribution rate is
usually computed by annualizing the dividends paid per share during a certain
period and dividing that amount by the current maximum offering price. The
current distribution rate differs from the current yield computation because
it may include distributions to shareholders from sources other than
dividends and interest, such as premium income from option writing and
short-term capital gains, and is calculated over a different period of time.
The current distribution rate for the 30-day period ended September 30, 1998,
was 6.11%.
VOLATILITY Occasionally statistics may be used to show the fund's volatility
or risk. Measures of volatility or risk are generally used to compare the
fund's net asset value or performance to a market index. One measure of
volatility is beta. Beta is the volatility of a fund relative to the total
market, as represented by an index considered representative of the types of
securities in which the fund invests. A beta of more than 1.00 indicates
volatility greater than the market and a beta of less than 1.00 indicates
volatility less than the market. Another measure of volatility or risk is
standard deviation. Standard deviation is used to measure variability of net
asset value or total return around an average over a specified period of
time. The idea is that greater volatility means greater risk undertaken in
achieving performance.
OTHER PERFORMANCE QUOTATIONS The fund may also quote the performance of
shares without a sales charge. Sales literature and advertising may quote a
cumulative total return, average annual total return and other measures of
performance with the substitution of net asset value for the public offering
price.
Sales literature referring to the use of the fund as a potential investment
for IRAs, business retirement plans, and other tax-advantaged retirement
plans may quote a total return based upon compounding of dividends on which
it is presumed no federal income tax applies.
The fund may include in its advertising or sales material information
relating to investment goals and performance results of funds belonging to
the Franklin Templeton Group of Funds. Franklin Resources, Inc. is the parent
company of the advisors and underwriter of the Franklin Templeton Group of
Funds.
COMPARISONS To help you better evaluate how an investment in the fund may
satisfy your investment goal, advertisements and other materials about the
fund may discuss certain measures of fund performance as reported by various
financial publications. Materials may also compare performance (as calculated
above) to performance as reported by other investments, indices, and
averages. These comparisons may include, but are not limited to, the
following examples:
o Lipper - Mutual Fund Performance Analysis and Lipper - Fixed Income Fund
Performance Analysis - measure total return and average current yield
for the mutual fund industry and rank individual mutual fund performance
over specified time periods, assuming reinvestment of all distributions,
exclusive of any applicable sales charges.
o CDA Mutual Fund Report, published by CDA Investment Technologies, Inc. -
analyzes price, current yield, risk, total return, and average rate of
return (average annual compounded growth rate) over specified time
periods for the mutual fund industry.
o Mutual Fund Source Book, published by Morningstar, Inc. - analyzes
price, yield, risk, and total return for mutual funds.
o Financial publications: THE WALL STREET JOURNAL, AND BUSINESS WEEK,
CHANGING TIMES, FINANCIAL WORLD, FORBES, FORTUNE, AND MONEY MAGAZINES -
provide performance statistics over specified time periods.
o Consumer Price Index (or Cost of Living Index), published by the U.S.
Bureau of Labor Statistics - a statistical measure of change, over time,
in the price of goods and services in major expenditure groups.
o Stocks, Bonds, Bills, and Inflation, published by Ibbotson Associates -
historical measure of yield, price, and total return for common and
small company stock, long-term government bonds, Treasury bills, and
inflation.
o Savings and Loan Historical Interest Rates - as published in the U.S.
Savings & Loan League Fact Book.
o Salomon Brothers Broad Bond Index or its component indices - measures
yield, price and total return for Treasury, agency, corporate and
mortgage bonds.
o Lehman Brothers Aggregate Bond Index or its component indices - measures
yield, price and total return for Treasury, agency, corporate, mortgage
and Yankee bonds.
o Salomon Brothers Composite High Yield Index or its component indices -
measures yield, price and total return for the Long-Term High-Yield
Index, Intermediate-Term High-Yield Index, and Long-Term Utility
High-Yield Index.
o Historical data supplied by the research departments of CS First Boston
Corporation, the J. P. Morgan companies, Salomon Brothers, Merrill
Lynch, Lehman Brothers and Bloomberg L.P.
o Morningstar - information published by Morningstar, Inc., including
Morningstar proprietary mutual fund ratings. The ratings reflect
Morningstar's assessment of the historical risk-adjusted performance of
a fund over specified time periods relative to other funds within its
category.
From time to time, advertisements or information for the fund may include a
discussion of certain attributes or benefits to be derived from an investment
in the fund. The advertisements or information may include symbols,
headlines, or other material that highlights or summarizes the information
discussed in more detail in the communication.
Advertisements or information may also compare the fund's performance to the
return on certificates of deposit (CDs) or other investments. You should be
aware, however, that an investment in the fund involves the risk of
fluctuation of principal value, a risk generally not present in an investment
in a CD issued by a bank. For example, as the general level of interest rates
rise, the value of the fund's fixed-income investments, as well as the value
of its shares that are based upon the value of such portfolio investments,
can be expected to decrease. Conversely, when interest rates decrease, the
value of the fund's shares can be expected to increase. CDs are frequently
insured by an agency of the U.S. government. An investment in the fund is not
insured by any federal, state or private entity.
In assessing comparisons of performance, you should keep in mind that the
composition of the investments in the reported indices and averages is not
identical to the fund's portfolio, the indices and averages are generally
unmanaged, and the items included in the calculations of the averages may not
be identical to the formula used by the fund to calculate its figures. In
addition, there can be no assurance that the fund will continue its
performance as compared to these other averages.
MISCELLANEOUS INFORMATION
- ------------------------------------------------------------------------------
The fund may help you achieve various investment goals such as accumulating
money for retirement, saving for a down payment on a home, college costs and
other long-term goals. The Franklin College Costs Planner may help you in
determining how much money must be invested on a monthly basis in order to
have a projected amount available in the future to fund a child's college
education. (Projected college cost estimates are based upon current costs
published by the College Board.) The Franklin Retirement Planning Guide leads
you through the steps to start a retirement savings program. Of course, an
investment in the fund cannot guarantee that these goals will be met.
The fund is a member of the Franklin Templeton Group of Funds, one of the
largest mutual fund organizations in the U.S., and may be considered in a
program for diversification of assets. Founded in 1947, Franklin is one of
the oldest mutual fund organizations and now services more than 3 million
shareholder accounts. In 1992, Franklin, a leader in managing fixed-income
mutual funds and an innovator in creating domestic equity funds, joined
forces with Templeton, a pioneer in international investing. The Mutual
Series team, known for its value-driven approach to domestic equity
investing, became part of the organization four years later. Together, the
Franklin Templeton Group has over $222 billion in assets under management for
approximately 7 million U.S. based mutual fund shareholder and other
accounts. The Franklin Templeton Group of Funds offers 115 U.S. based
open-end investment companies to the public. The fund may identify itself by
its NASDAQ symbol or CUSIP number.
Currently, there are more mutual funds than there are stocks listed on the
New York Stock Exchange. While many of them have similar investment goals, no
two are exactly alike. Shares of the fund are generally sold through
securities dealers, whose investment representatives are experienced
professionals who can offer advice on the type of investments suitable to
your unique goals and needs, as well as the risks associated with such
investments.
The Information Services & Technology division of Franklin Resources, Inc.
(Resources) established a Year 2000 Project Team in 1996. This team has
already begun making necessary software changes to help the computer systems
that service the fund and its shareholders to be Year 2000 compliant. After
completing these modifications, comprehensive tests are conducted in one of
Resources' U.S. test labs to verify their effectiveness. Resources continues
to seek reasonable assurances from all major hardware, software or
data-services suppliers that they will be Year 2000 compliant on a timely
basis. Resources is also beginning to develop a contingency plan, including
identification of those mission critical systems for which it is practical to
develop a contingency plan. However, in an operation as complex and
geographically distributed as Resources' business, the alternatives to use of
normal systems, especially mission critical systems, or supplies of
electricity or long distance voice and data lines are limited.
DESCRIPTION OF BOND RATINGS
CORPORATE BOND RATINGS
MOODY'S INVESTORS SERVICE, INC. (MOODY'S)
AAA - Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as
"gilt-edged." Interest payments are protected by a large or exceptionally
stable margin, and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
AA - Bonds rated Aa are judged to be high quality by all standards. Together
with the Aaa group, they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large, fluctuation of protective elements may be of greater
amplitude, or there may be other elements present that make the long-term
risks appear somewhat larger.
A - Bonds rated A possess many favorable investment attributes and are
considered upper medium-grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
that suggest a susceptibility to impairment sometime in the future.
BAA - Bonds rated Baa are considered medium-grade obligations. They are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may
be lacking or may be characteristically unreliable over any great length of
time. These bonds lack outstanding investment characteristics and, in fact,
have speculative characteristics as well.
BA - Bonds rated Ba are judged to have predominantly speculative elements and
their future cannot be considered well assured. Often the protection of
interest and principal payments is very moderate and, thereby, not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
Note: Moody's applies numerical modifiers 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond ratings. The modifier
1 indicates that the security ranks in the higher end of its generic rating
category; modifier 2 indicates a mid-range ranking; and modifier 3 indicates
that the issue ranks in the lower end of its generic rating category.
STANDARD & POOR'S CORPORATION (S&P)
AAA - This is the highest rating assigned by S&P to a debt obligation and
indicates an extremely strong capacity to pay principal and interest.
AA - Bonds rated AA also qualify as high-quality debt obligations. Capacity
to pay principal and interest is very strong and, in the majority of
instances, differ from AAA issues only in a small degree.
A - Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions.
BBB - Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit protection parameters,
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity to pay principal and interest for bonds in this
category than for bonds in the A category.
BB, B, CCC, CC - Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal in accordance with the terms of the obligations.
BB indicates the lowest degree of speculation and CC the highest degree of
speculation. While these bonds will likely have some quality and protective
characteristics, they are outweighed by large uncertainties or major risk
exposures to adverse conditions.
Plus (+) or minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
