SHAREHOLDER LETTER
Your Fund's Goal: Franklin Strategic Mortgage Portfolio seeks to obtain a high
level of total return relative to the performance of the general mortgage
securities market by investing primarily in a portfolio of mortgage securities
created from pools of mortgages which are issued or guaranteed by the U.S.
government, its agencies or instrumentalities.(1)
Dear Shareholder:
This semiannual report for Franklin Strategic Mortgage Portfolio covers the
period ended March 31, 2000.
ECONOMIC OVERVIEW
The U.S. economy was extremely strong during the six-month reporting period, as
evidenced by the gross domestic product's (GDP) growth rate accelerating to an
annualized 7.3% in the fourth quarter of 1999 and the unemployment rate
continuing to hover just above 4%. Although tight labor markets did not lead to
wage inflation during the period, the Federal Reserve Board (the Fed) was
concerned about the dwindling supply of available workers to fill new jobs. In
addition, commodity prices rose strongly near the end of the period as global
demand recovered from the crises of 1997 and 1998. These combined factors caused
the Fed to raise the federal funds target rate three times during the reporting
period, to 6.0%.
CONTENTS
Shareholder Letter .................... 1
Performance Summary ................... 5
Financial Highlights &
Statement of Investments .............. 6
Financial Statements .................. 10
Notes to
Financial Statements .................. 13
[PYRAMID GRAPH]
1. U.S. government securities owned by the fund or held under repurchase
agreement, but not shares of the fund, are guaranteed by the U.S. government as
to the timely payment of principal and interest. Yields and share price are not
guaranteed and will fluctuate with market conditions.
All portfolio holdings mentioned in the report are listed by their complete
legal titles in the fund's Statement of Investments (SOI), which is a complete
listing of the fund's portfolio holdings, including dollar value and number of
shares or principal amount. The SOI begins on page 7.
With the Fed in a tightening mode, short- and intermediate-term Treasury yields
rose substantially during the reporting period and bond prices generally fell.
However, expectations for a reduced supply of longer-term Treasuries led to
falling yields toward the end of the reporting period. The result of rising
short-term yields and declining long-term yields created an unusual situation
called a yield curve inversion, where shorter-term yields were higher than
longer-term yields.
PORTFOLIO BREAKDOWN
Based on Total Long-Term Investments
3/31/00 9/30/99
30-Year Mortgage Pass-Throughs 64.93% 78.45%
Adjustable Rate Mortgage 22.22% 3.79%
15-Year Mortgage Pass-Throughs 12.29% 15.78%
Balloon Mortgage Pass-Throughs 0.56% 0.72%
Cash & Equivalents 0.00% 1.26%
PORTFOLIO NOTES
The inverted yield-curve had an interesting effect on valuations of
mortgage-backed pass-through securities, the fund's principal investments.
Lower-coupon mortgage pass-throughs are priced based on the yield of 10- to
30-year Treasuries, whereas higher-coupon pass-throughs are priced according to
3- to 5-year Treasury note yields. Because shorter-term yields were higher than
longer-term yields during the period as reflected by the inverted yield curve,
prices for shorter-term securities were lower than for longer-term securities.
Yields and prices move in an inverse relationship, so as one rises the other
falls. Therefore, we purchased higher-coupon pass-throughs during the reporting
period, because their lower prices offered relatively more attractive yields in
this environment than their lower-coupon counterparts.
We also purchased adjustable-rate mortgage (ARM) securities, which made up
22.22% of the fund's total net assets on March 31, 2000. In our opinion, ARMs
offered very attractive yields -- about 7.2%, or on average 100 basis points
more than the 30-year Treasury bond during the period -- at considerably lower
interest-rate risk.(2) With such purchases, we were able to increase the
portfolio's yield without an equivalent rise in its interest-rate risk profile.
WHAT IS A MORTGAGE PASS-THROUGH SECURITY?
A mortgage pass-through security represents pooled mortgages that are repackaged
into a security and sold to investors. Such securities pass mortgage holder
principal and interest payments from the originating financial institutions
through a government agency or some other intermediary and then to investors.
2. Treasuries, if held to maturity, offer a fixed rate of return and fixed
principal value; their interest payments and principal are guaranteed.
Investment return and share price of Franklin Strategic Mortgage Portfolio
fluctuate with market conditions.
DIVIDEND DISTRIBUTIONS*
10/1/99 - 3/31/00
DIVIDEND
MONTH PER SHARE
--------------------------------------------------------------------------------
October 5.2716 cents
November 5.8753 cents
December 5.5024 cents
January 5.5263 cents
February 5.6254 cents
March 5.6369 cents
--------------------------------------------------------------------------------
TOTAL 33.4379 CENTS
Mortgage rates rose during the reporting period, reducing the incentive for
homeowners to refinance their mortgages. According to the Federal Home Loan
Mortgage Corporation, the conforming 30-year fixed mortgage rate rose from 7.70%
on October 1, 1999, to 8.23% on March 31, 2000. At these higher rates,
prepayments slowed, which should be positive for mortgage pass-through prices
going forward.
Over the near term, we expect the Fed to continue raising interest rates as it
attempts to slow the economy to a more sustainable pace of growth. In this
environment, we believe the portfolio is well-positioned to provide
significantly more income than a comparable portfolio of Treasury securities,
without additional interest-rate risk.(2)
Sincerely,
/s/ Roger A. Bayston
Roger A. Bayston
Portfolio Manager
Franklin Strategic Mortgage Portfolio
*Assumes shares were purchased and held for the entire accrual period. Since
dividends accrue daily, your actual distributions will vary depending on the
date you purchased your shares and any account activity during the month. Income
distributions include all accrued income earned by the fund during the reporting
period.
This discussion reflects our views, opinions and portfolio holdings as of March
31, 2000, the end of the reporting period. The information provided is not a
complete analysis of every aspect of any industry, security or the fund. Our
strategies and the fund's portfolio composition will change depending on market
and economic conditions. Although historical performance is no guarantee of
future results, these insights may help you understand our investment and
management philosophy.
SIX-MONTH PERFORMANCE SUMMARY AS OF 3/31/00
Six-month total return does not include sales charges. Distributions will vary
based on earnings of the fund's portfolio and any profits realized from the sale
of the portfolio's securities. Past distributions are not indicative of future
trends. All total returns include reinvested distributions at net asset value.
CLASS A
Six-Month Total Return +1.62%
Net Asset Value (NAV) $9.56 (3/31/00) $9.74 (9/30/99)
Change in NAV - $0.18
Distributions (10/1/99-3/31/00) Dividend Income $0.334379
ADDITIONAL PERFORMANCE
INCEPTION
CLASS A 1-YEAR 5-YEAR (2/1/93)
--------------------------------------------------------------------------------
Cumulative Total Return(1) +2.18% +40.94% +55.19%
Average Annual Total Return(2) -2.13% +6.19% +5.69%
Distribution Rate(3) 6.64%
30-Day Standardized Yield(4) 6.66%
CLASS A: Subject to the current, maximum 4.25% initial sales charge. Prior to
July 1, 1994, fund shares were offered at a higher initial sales charge; thus
actual total returns would be lower. The fund's manager agreed in advance to
waive a portion of its management fees, which reduces operating expenses and
increases yield, total return and distribution rate to shareholders. Without
this waiver, the fund's total return and distribution rate would have been lower
and yield for the period would have been 6.08%. The fee waiver may be
discontinued at any time upon notice to the fund's Board of Trustees.
1. Cumulative total return represents the change in value of an investment over
the periods indicated and does not include the sales charge.
2. Average annual total return represents the average annual change in value of
an investment over the periods indicated and includes the current, maximum sales
charge.
3. Distribution rate is based on an annualization of March's 5.6369 cent per
share monthly dividend and the maximum offering price of $9.98 on March 31,
2000.
4. Yield, calculated as required by the SEC, is based on the earnings of the
fund's portfolio for the 30 days ended March 31, 2000.
Since markets can go down as well as up, investment return and principal value
will fluctuate with market conditions, and you may have a gain or loss when you
sell your shares.
For updated performance figures, see "Prices and Performance" at
www.franklintempleton.com, or call Franklin Templeton at 1-800/342-5236.
Past performance does not guarantee future results.
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Financial Highlights
<TABLE>
<CAPTION>
SIX MONTHS ENDED
MARCH 31, 2000 YEAR ENDED SEPTEMBER 30,
(UNAUDITED) 1999 1998 1997 1996 1995
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the period)
Net asset value, beginning of period $9.74 $10.14 $ 9.96 $9.74 $9.91 $9.42
-----------------------------------------------------------------------------
Income from investment operations:
Net investment income .333 .627 .660 .708 .717 .714
Net realized and unrealized gains (losses) (.179) (.400) .179 .220 (.170) .490
-----------------------------------------------------------------------------
Total from investment operations .154 .227 .839 .928 .547 1.204
-----------------------------------------------------------------------------
Less distributions from net investment income (.334)(d) (.627) (.659) (.708) (.717) (.714)
-----------------------------------------------------------------------------
Net asset value, end of period $9.56 $ 9.74 $10.14 $9.96 $9.74 $9.91
-----------------------------------------------------------------------------
Total return(a) 1.62% 2.30% 8.71% 9.84% 5.69% 13.27%
-----------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period (000's) $39,359 $32,877 $14,551 $8,934 $6,847 $5,980
Ratios to average net assets:
Expenses -- % -- % -- % -- % -- % -- %
Expenses excluding waiver and payments by affiliate .57%(b) .65% .74% .82% 1.11% 1.24%
Net investment income 6.92%(b) 6.32% 6.56% 7.18% 7.26% 7.42%
Portfolio turnover rate(c) 18.89% 41.72% 38.15% 13.59% 17.64% 34.20%
</TABLE>
(a) Total return does not reflect sales commissions and is not annualized for
periods less than one year.
(b) Annualized
(c) The portfolio turnover rate excludes mortgage dollar roll transactions.
(d) Includes distributions in excess of net investment income in the amount of
$.001.
See notes to financial statements.
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
STATEMENT OF INVESTMENTS, MARCH 31, 2000 (UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
----------------------------------------------------------------------------------------------
<S> <C> <C>
MORTGAGE-BACKED SECURITIES 117.8%
FEDERAL HOME LOAN MORTGAGE CORP. (FHLMC) 28.2%
9.00%, 6/01/01 ........................................ $ 14,192 $ 14,209
6.50%, 11/01/01 ....................................... 93,757 92,816
6.50%, 3/01/09 ........................................ 60,737 58,889
7.00%, 6/01/09 ........................................ 37,695 37,068
8.00%, 1/01/10 ........................................ 16,041 16,252
7.50%, 4/01/10 ........................................ 24,104 24,180
6.50%, 4/01/11 ........................................ 36,831 35,610
7.00%, 7/01/11 ........................................ 51,677 50,768
6.845%, 11/01/16 ...................................... 1,514,250 1,534,762
6.875%, 4/01/18 ....................................... 1,068,309 1,100,971
6.988%, 11/01/19 ...................................... 1,546,252 1,596,623
6.928%, 5/01/20 ....................................... 1,922,057 1,959,294
6.80%, 5/01/22 ........................................ 1,366,449 1,409,903
9.50%, 12/01/22 ....................................... 32,268 34,066
7.00%, 6/01/24 ........................................ 63,880 61,778
7.50%, 7/01/24 ........................................ 75,120 74,218
8.00%, 7/01/24 ........................................ 35,748 35,980
8.50%, 12/01/24 ....................................... 79,779 81,546
8.00%, 6/01/25 ........................................ 6,040 6,075
7.00%, 9/01/25 ........................................ 50,058 48,322
7.00%, 10/01/25 ....................................... 18,253 17,620
7.50%, 10/01/25 ....................................... 16,144 15,938
7.50%, 1/01/26 ........................................ 29,988 29,607
8.00%, 1/01/26 ........................................ 28,668 28,831
7.00%, 3/01/26 ........................................ 87,114 83,934
7.50%, 5/01/26 ........................................ 20,812 20,533
7.50%, 1/01/27 ........................................ 28,783 28,396
7.00%, 4/01/28 ........................................ 365,778 352,288
7.00%, 5/01/28 ........................................ 337,461 325,143
6.50%, 6/01/29 ........................................ 490,554 460,773
(a)7.00%, 4/01/30 ........................................ 1,491,435 1,435,506
----------
TOTAL FEDERAL HOME LOAN MORTGAGE CORP. (COST $11,116,332)....................... 11,071,899
----------
FEDERAL NATIONAL MORTGAGE ASSOCIATION (FNMA) 61.6%
6.00%, 3/01/01 ........................................ 127,700 125,251
6.50%, 9/01/08 ........................................ 61,192 59,419
7.00%, 7/01/09 ........................................ 47,993 47,218
7.50%, 7/01/09 ........................................ 21,838 21,925
6.00%, 3/01/11 ........................................ 865,911 816,634
6.50%, 4/01/11 ........................................ 30,771 29,751
7.50%, 6/01/11 ........................................ 350,226 351,084
7.00%, 11/01/11 ....................................... 17,745 17,444
7.50%, 7/01/12 ........................................ 249,030 249,640
6.00%, 5/01/13 ........................................ 902,587 849,476
5.50%, 5/01/14 ........................................ 718,575 661,940
6.50%, 5/01/14 ........................................ 765,153 736,845
7.105%, 4/01/18 ....................................... 386,890 397,263
6.00%, 12/01/23 ....................................... 19,269 17,736
</TABLE>
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
STATEMENT OF INVESTMENTS, MARCH 31, 2000 (UNAUDITED) (CONT.)
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
--------------------------------------------------------------------------------------------------
<S> <C> <C>
MORTGAGE-BACKED SECURITIES (CONT.)
FEDERAL NATIONAL MORTGAGE ASSOCIATION (FNMA) (CONT.)
6.50%, 6/01/24 ............................................... $ 326,156 $ 307,823
7.00%, 6/01/24 ............................................... 170,498 164,651
8.50%, 7/01/24 ............................................... 17,178 17,531
7.62%, 12/01/24 .............................................. 939,970 940,863
8.00%, 1/01/25 ............................................... 46,662 46,904
9.00%, 1/01/25 ............................................... 42,651 44,160
7.50%, 8/01/25 ............................................... 81,887 80,807
7.50%, 11/01/25 .............................................. 17,414 17,184
8.00%, 12/01/25 .............................................. 111,115 111,692
7.00%, 1/01/26 ............................................... 32,146 31,014
7.00%, 6/01/26 ............................................... 44,516 42,904
8.00%, 6/01/26 ............................................... 4,754 4,774
8.00%, 7/01/26 ............................................... 10,559 10,605
8.00%, 8/01/26 ............................................... 21,713 21,807
7.50%, 10/01/26 .............................................. 23,312 22,990
7.00%, 4/01/27 ............................................... 163,728 157,541
6.50%, 12/01/27 .............................................. 1,634,117 1,533,993
6.00%, 3/01/28 ............................................... 913,288 832,622
6.50%, 3/01/28 ............................................... 819,584 769,479
7.00%, 10/01/28 .............................................. 758,749 729,767
6.00%, 12/01/28 .............................................. 949,344 865,493
6.00%, 2/01/29 ............................................... 966,296 880,948
6.00%, 3/01/29 ............................................... 483,900 441,160
6.50%, 3/01/29 ............................................... 972,378 912,340
6.00%, 4/01/29 ............................................... 466,944 425,337
(a)6.50%, 4/01/29 ............................................... 2,170,985 2,035,977
6.50%, 4/01/29 ............................................... 977,366 917,020
(a)7.00%, 4/01/29 ............................................... 2,695,000 2,592,253
(a)7.50%, 4/01/30 ............................................... 3,247,730 3,193,939
(a)8.00%, 4/01/30 ............................................... 699,430 701,616
(a)8.50%, 4/01/30 ............................................... 1,000,000 1,020,000
----------
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION (COST $24,805,064) ....................... 24,256,820
----------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (GNMA), SF, 26.5%
7.00%, 4/15/14 ............................................... 724,302 714,892
9.00%, 12/15/16 .............................................. 66,995 69,923
10.00%, 10/15/18 ............................................. 22,549 24,039
9.50%, 10/15/20 .............................................. 49,614 52,237
8.00%, 2/15/23 ............................................... 94,662 96,149
7.00%, 6/15/23 ............................................... 152,440 148,689
7.50%, 6/15/23 ............................................... 35,369 35,279
6.50%, 1/15/24 ............................................... 182,030 173,185
8.50%, 7/15/24 ............................................... 39,072 40,218
8.00%, 1/15/25 ............................................... 13,647 13,836
7.50%, 9/15/25 ............................................... 45,090 44,843
7.00%, 1/15/26 ............................................... 33,884 32,926
7.50%, 1/15/26 ............................................... 38,898 38,645
7.00%, 3/15/26 ............................................... 16,314 15,853
</TABLE>
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
STATEMENT OF INVESTMENTS, MARCH 31, 2000 (UNAUDITED) (CONT.)
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
---------------------------------------------------------------------------------------------------------------------------------
MORTGAGE-BACKED SECURITIES (CONT.)
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (GNMA), SF, (CONT.)
<S> <C> <C>
7.50%, 5/15/26 ........................................................................... $ 12,725 $ 12,642
8.00%, 6/15/26 ........................................................................... 30,665 31,071
8.50%, 8/15/26 ........................................................................... 4,249 4,367
8.00%, 8/20/26 ........................................................................... 10,683 10,757
7.50%, 10/15/26 .......................................................................... 26,740 26,566
8.00%, 7/15/27 ........................................................................... 782,884 792,253
7.50%, 9/15/27 ........................................................................... 572,802 568,767
8.00%, 11/15/27 .......................................................................... 23,744 24,029
7.00%, 12/15/27 .......................................................................... 997,046 967,070
8.00%, 1/15/28 ........................................................................... 664,487 672,406
6.50%, 4/15/28 ........................................................................... 468,033 441,960
7.50%, 5/15/28 ........................................................................... 546,324 541,954
6.50%, 2/15/29 ........................................................................... 427,372 403,343
6.00%, 3/15/29 ........................................................................... 493,084 451,570
6.50%, 4/15/29 ........................................................................... 490,938 463,335
7.00%, 4/15/29 ........................................................................... 673,534 652,698
6.50%, 5/15/29 ........................................................................... 1,537,573 1,451,122
7.00%, 5/15/29 ........................................................................... 736,153 713,379
7.50%, 10/15/29 .......................................................................... 700,070 694,374
----------
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (COST $10,747,638) ........................ 10,424,377
----------
PRUDENTIAL HOME MORTGAGE SECURITIES (PHMS) 1.5%
7.265%, 7/25/18 (COST $605,579) .......................................................... 607,097 600,931
----------
TOTAL MORTGAGE-BACKED SECURITIES (COST $47,274,613) ...................................... 46,354,027
==========
(b)REPURCHASE AGREEMENT 8.8%
Joint Repurchase Agreement, 6.081%, 4/03/00, (Maturity Value $3,473,481)
(COST $3,471,722) ....................................................................... 3,471,722 3,471,722
Banc of America Securities LLC
Barclays Capital Inc.
Bear, Stearns & Co. Inc.
Chase Securities Inc.
Donaldson, Lufkin & Jenrette Securities Corp.
Dresdner Kleinwort Benson, North America LLC
The Goldman Sachs Group Inc.
Lehman Brothers Holdings Inc.
Nesbitt Burns Inc.
Paribas Corp.
Societe Generale
Warburg Dillon Read LLC
Collateralized by U.S. Treasury Bills and Notes
----------
TOTAL INVESTMENTS (COST $50,746,335) 126.6% .............................................. 49,825,749
-----------
OTHER ASSETS, LESS LIABILITIES (26.6%) ................................................... (10,466,549)
-----------
NET ASSETS 100.0% ........................................................................ $39,359,200
===========
</TABLE>
(a) Sufficient collateral has been segregated for securities traded on a
when-issued or delayed delivery basis.
(b) Investment is through participation in a joint account with other funds
managed by the investment advisor. At March 31, 2000, all repurchase
agreements had been entered into on that date.
See notes to financial statements.
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Financial Statements
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 2000 (UNAUDITED)
<TABLE>
<CAPTION>
<S> <C>
Assets:
Investments in securities, at value (cost $50,746,335) ............... $49,825,749
Receivables:
Capital shares sold ................................................. 441,379
Interest ............................................................ 235,164
-----------
Total assets .................................................... 50,502,292
-----------
Liabilities:
Payables:
Investment securities purchased ..................................... 10,956,648
Capital shares redeemed ............................................. 92,687
Shareholders ........................................................ 802
Distributions to shareholders ........................................ 92,955
-----------
Total liabilities ............................................... 11,143,092
-----------
Net assets, at value ........................................... $39,359,200
-----------
Net assets consist of:
Accumulated distributions in excess of net investment income ......... $(6,076)
Net unrealized depreciation .......................................... (920,586)
Accumulated net realized loss ........................................ (316,048)
Capital shares ....................................................... 40,601,910
===========
Net assets, at value ............................................ $39,359,200
===========
Net asset value per share ($39,359,200 / 4,115,148 shares outstanding) $9.56
===========
Maximum offering price per share ($9.56 / 95.75%) .................... $9.98
===========
</TABLE>
See notes to financial statements.
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Financial Statements (continued)
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED MARCH 31, 2000 (UNAUDITED)
<TABLE>
<CAPTION>
<S> <C>
Investment income:
Interest .................................................................. $1,246,433
----------
Expenses:
Management fees (Note 3) .................................................. 72,192
Transfer agent fees (Note 3) .............................................. 8,356
Custodian fees ............................................................ 57
Reports to shareholders ................................................... 1,097
Registration and filing fees .............................................. 13,095
Professional fees ......................................................... 6,567
Other ..................................................................... 892
----------
Total expenses ....................................................... 102,256
Expenses waived/paid by affiliate (Note 3) ........................... (102,256)
----------
Net investment income ............................................... 1,246,433
----------
Realized and unrealized losses:
Net realized loss from investments ........................................ (144,699)
Net unrealized depreciation on investments ................................ (455,800)
----------
Net realized and unrealized loss ........................................... (600,499)
----------
Net increase in net assets resulting from operations ....................... $ 645,934
==========
</TABLE>
See notes to financial statements.
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Financial Statements (continued)
STATEMENTS OF CHANGES IN NET ASSETS
FOR THE SIX MONTHS ENDED MARCH 31, 2000 (UNAUDITED) AND
THE YEAR ENDED SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
MARCH 31, 2000 SEPTEMBER 30, 1999
--------------------------------------
<S> <C> <C>
Increase (decrease) in net assets:
Operations:
Net investment income ............................................................ $1,246,433 $1,396,274
Net realized loss from investments ............................................... (144,699) (20,112)
Net unrealized depreciation on investments ....................................... (455,800) (889,175)
--------------------------------------
Net increase in net assets resulting from operations ......................... 645,934 486,987
Distributions to shareholders from:
Net investment income ............................................................ (1,246,433) (1,391,928)
In excess of net investment income ............................................... (6,076) --
--------------------------------------
Total distributions to shareholders ............................................... (1,252,509) (1,391,928)
Capital share transactions (Note 2) ............................................... 7,089,452 19,230,447
--------------------------------------
Net increase in net assets ................................................... 6,482,877 18,325,506
Net assets:
Beginning of period ............................................................... 32,876,323 14,550,817
--------------------------------------
End of period ..................................................................... $39,359,200 $32,876,323
======================================
Accumulated distributions in excess of net investment income included in net assets:
End of period ..................................................................... $(6,076) $ --
======================================
</TABLE>
See notes to financial statements.
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Notes to Financial Statements (unaudited)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Franklin Strategic Mortgage Portfolio (the Trust) is registered under the
Investment Company Act of 1940 as a diversified, open-end investment company.
The Trust consists of one Fund, the Franklin Strategic Mortgage Portfolio (the
Fund), which seeks total return. The following summarizes the Fund's significant
accounting policies.
a. SECURITY VALUATION:
Securities listed or traded on a recognized national exchange or NASDAQ are
valued at the latest reported sales price. Over-the-counter securities and
listed securities for which no sale is reported are valued within the range of
the latest quoted bid and asked prices. Securities for which market quotations
are not readily available are valued at fair value as determined by management
in accordance with procedures established by the Board of Trustees.
b. INCOME TAXES:
No provision has been made for income taxes because the Fund's policy is to
qualify as a regulated investment company under the Internal Revenue Code and to
distribute substantially all of its taxable income.
c. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS:
Security transactions are accounted for on trade date. Realized gains and losses
on security transactions are determined on a specific identification basis.
Interest income and estimated expenses are accrued daily. Dividends from net
investment income are normally declared daily and distributed monthly to
shareholders.
d. ACCOUNTING ESTIMATES:
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the amounts of income and expense during the reporting
period. Actual results could differ from those estimates.
e. MORTGAGE DOLLAR ROLLS:
The Fund may enter into dollar roll transactions under which it may sell
mortgage-backed securities and agree to repurchase mortgage-backed securities at
an agreed upon price in the future. When the repurchased securities are
substantially similar to those sold, the transaction is accounted for as a
financing transaction and any gain or loss is deferred until the disposition of
the repurchased security. If the securities repurchased are not substantially
similar to those sold, the transaction is accounted for as a sale and subsequent
purchase, and any gain or loss is realized at the commencement of the dollar
roll transaction.
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Notes to Financial Statements (unaudited)(continued)
2. SHARES OF BENEFICIAL INTEREST
At March 31, 2000, there were an unlimited number of shares authorized ($0.01
par value). Transactions in the Fund's shares were as follows:
<TABLE>
<CAPTION>
PERIOD ENDED YEAR ENDED
MARCH 31, 2000 SEPTEMBER 30, 1999
---------------------------------------------------------------------
SHARES AMOUNT SHARES AMOUNT
---------------------------------------------------------------------
<S> <C> <C> <C> <C>
Shares sold .................................. 1,427,533 $13,682,547 2,311,776 $22,889,797
Shares issued in reinvestment of distributions 74,644 715,597 73,906 729,087
Shares redeemed .............................. (763,225) (7,308,692) (444,661) (4,388,437)
---------------------------------------------------------------------
Net increase ................................. 738,952 $7,089,452 1,941,021 $19,230,447
=====================================================================
</TABLE>
3. TRANSACTIONS WITH AFFILIATES
Certain officers and trustees of the Fund are also officers and/or directors of
Franklin Advisers, Inc. (Advisers), Franklin/Templeton Distributors, Inc.
(Distributors), Franklin Templeton Services, Inc. (FT Services) and
Franklin/Templeton Investor Services, Inc. (Investor Services), the Fund's
investment manager, principal underwriter, administrative manager, and transfer
agent, respectively.
The Fund pays an investment management fee to Advisers based on the average net
assets of the Fund as follows:
ANNUALIZED
FEE RATE AVERAGE DAILY NET ASSETS
-----------------------------------------------------------------------
.40% First $250 million
.38% Over $250 million, up to and including $500 million
.36% In excess of $500 million
Under an agreement with Advisers, FT Services provides administrative services
to the Fund. The fee is paid by Advisers based on average daily net assets, and
is not an additional expense of the Fund.
Advisers agreed in advance to waive management fees and assume payment of other
expenses, as noted in the Statement of Operations.
Distributors received net commissions from sales of Fund shares for the period
of $7,338.
At March 31, 2000, Franklin Resources owned 16.99% of the Fund.
Included in professional fees are legal fees of $51 that were paid to a law firm
in which a partner is an officer of the Fund.
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Notes to Financial Statements (unaudited)(continued)
4. INCOME TAXES
At March 31, 2000, the net unrealized depreciation based on the cost of
investments for income tax purposes of $50,752,885 was as follows:
Unrealized appreciation .................... $ 97,083
Unrealized depreciation .................... (1,024,219)
Net unrealized depreciation ................ $ (927,136)
===========
At September 30, 1999, the Fund had tax basis capital losses of $144,687 which
may be carried over to offset future capital gains. Such losses expire as
follows:
Capital loss carryovers expiring in:
2002 ................................ $ 90,251
2004 ................................ 54,436
------
$144,687
========
At September 30, 1999 the Fund has deferred capital losses occurring subsequent
to October 31, 1998 of $20,112. For tax purposes, such losses will be reflected
in the year ending September 30, 2000.
Net realized capital gains and losses differ for financial statement and tax
purposes primarily due to differing treatments of wash sales and mortgage dollar
roll transactions.
Distributions of income to shareholders may not equal net investment income due
to differing treatments of mortgage dollar roll transactions for book and tax
purposes.
5. INVESTMENT TRANSACTIONS
Purchases and sales of securities (excluding short-term securities) for the
period ended March 31, 2000 aggregated $21,649,734 and $6,912,191, respectively.
