A MESSAGE FROM THE PRESIDENT
Dear Shareholder:
Strong financial market, both domestic and international, helped the portfolios
of the Principal Special Markets Fund end the year with positive total returns.
For the twelve months ending December 31, 1996, the Mortgage-Backed Securities
Portfolio returned 4.18% while the International Securities Portfolio returned
24.12%. Of course, investors should always remember that past performance in not
a guarantee of future results.
Marty Schafer--Mortgage-Backed Securities Portfolio
"In general, 1996 proved rather lean for the mortgage-backed securities markets.
Though interest rates rose somewhat during the year, the Fund still performed
well. In this age of economic prosperity, we believe that high quality bonds
will continue to do well. However, until an extended shock occurs to the equity
markets, many investors will shun fixed-income investments in favor of stocks."
Scott Opsal--International Securities Portfolio
"International equity markets continued their run with double digit gains in
Europe and most other markets in positive territory. Japan and the troubled
Asian markets were the only poor performers. The Fund benefited from these
strong market advances across Europe and experienced little, if any, pain from
the weak Asian markets and Japan. Our current strategy remains focused on stable
growth stocks. Due to the large outperformance of European markets and
correspondingly higher stock prices, we are making an effort to find new growth
names in markets outside of Europe. The weaker Asian economies should provide
interesting opportunities at some point, but at this time we remain in a wait
and see mode."
We hope you find this Annual Report helpful in the monitoring of your
investment. We look forward to another good year in 1997. Please contact us if
you have any questions regarding this report at (800) 521-1502.
Sincerely,
/s/ Stephan L. Jones
Stephan L. Jones
President
INDEX TO REPORT FOR
PRINCIPAL SPECIAL MARKETS FUND, INC.
Page
Statements of Assets and Liabilities................ 2
Statements of Operations ........................... 3
Statements of Changes in Net Assets................. 4
Notes to Financial Statements....................... 5
Schedules of Investments ........................... 8
Financial Highlights................................ 12
Report of Independent Auditors...................... 14
Federal Income Tax Information...................... 16
December 31, 1996
STATEMENTS OF ASSETS AND LIABILITIES
PRINCIPAL SPECIAL MARKETS FUND, INC.
International Mortgage-Backed
Securities Securities
Portfolio Portfolio
Investments in Securities -- at cost.............. $23,425,496 $15,087,971
Assets
Investment in securities -- at value (Note 4)..... 28,541,016 14,897,356
Cash ............................................. 41,787 5,057
Dividends and interest receivable................. 59,219 84,948
Other assets...................................... 109 540
Total Assets 28,642,131 14,987,901
Liabilities
Accrued expenses.................................. 17,718 6,684
Dividends and distributions to shareholders....... 463,789 12,959
Total Liabilities 481,507 19,643
Net Assets Applicable to Outstanding Shares $28,160,624 $14,968,258
Capital Stock (par value: $.01 a share)
Shares authorized.............................. 100,000,000 100,000,000
Shares issued and outstanding.................. 2,059,816 1,507,575
Net Asset Value Per Share ................... $13.67 $9.93
Net Assets Consist of:
Capital Stock.................................. $ 20,598 $ 15,076
Additional paid-in capital..................... 22,925,792 16,244,270
Accumulated undistributed net
investment income............................ 10,524 --
Accumulated undistributed net realized
gain (loss) from:
Investment transactions..................... 92,445 (1,100,473)
Foreign currency transactions............... (4,388) --
Net unrealized appreciation
(depreciation) of investments............... 5,115,520 (190,615)
Net unrealized appreciation on
translation of assets and liabilities
in foreign currencies....................... 133 --
Total Net Assets $28,160,624 $14,968,258
See accompanying notes.
<PAGE>
Year Ended December 31, 1996
STATEMENTS OF OPERATIONS
PRINCIPAL SPECIAL MARKETS FUND, INC.
Mortgage-
International Backed
Securities Securities
Portfolio Portfolio
Net Investment Income
Income:
Dividends........................................$ 586,088 $ --
Less: Withholding tax on foreign dividends....... (71,699) --
Interest......................................... 65,137 1,004,129
Total Income 579,526 1,004,129
Expenses:
Management and investment
advisory fees (Note 3) 185,375 65,114
Net Investment Income 394,151 939,015
Net Realized and Unrealized Gain (Loss)
on Investments
and Foreign Currency
Net realized gain (loss) from:
Investment transactions.......................... 951,597 (25,440)
Foreign currency transactions.................... (4,388) --
Net increase (decrease) in unrealized
appreciation/ depreciation on:
Investments.................................... 3,302,023 (318,191)
Translation of assets and liabilities
in foreign currencies........................ (474) --
Net Realized and Unrealized Gain (Loss) on
Investments and Foreign Currency 4,248,758 (343,631)
Net Increase in Net Assets
Resulting from Operations $4,642,909 $ 595,384
See accompanying notes.
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31
STATEMENTS OF CHANGES IN NET ASSETS
PRINCIPAL SPECIAL MARKETS FUND, INC.
International Mortgage-Backed
Securities Securities
Portfolio Portfolio
1996 1995 1996 1995
Operations
<S> <C> <C> <C> <C>
Net investment income .......................................... $ 394,151 $ 290,053 $ 939,015 $ 909,265
Net realized gain (loss) from investment transactions............ 951,597 962,249 (25,440) (299,517)
Net realized (loss) from foreign currency transactions........... (4,388) (3,282) -- --
Net increase (decrease) in unrealized appreciation/
depreciation on investments and translation of
assets and liabilities in foreign currencies.................. 3,301,549 620,488 (318,191) 1,764,884
Net Increase in Net Assets
Resulting from Operations 4,642,909 1,869,508 595,384 2,374,632
Dividends and Distributions to Shareholders
From net investment income....................................... (296,191) (142,902) (939,015) (909,265)
Excess distribution of net investment income (Note 1) ........... (154,476) (97,960) -- --
From net realized gain on investments and
foreign currency transactions................................. (1,043,459) (1,015,198) -- --
(1,494,126) (1,256,060) (939,015) (909,265)
Capital Share Transactions (Note 5)
Shares sold...................................................... 7,000,000 100,000 -- --
Shares issued in reinvestment of dividends
and distributions............................................. 963,318 996,091 788,841 739,171
Shares redeemed ................................................ (202,611) -- -- (2,395,235)
Net Increase (Decrease) in Net Assets from
Capital Share Transactions 7,760,707 1,096,091 788,841 (1,656,064)
Total Increase (Decrease) 10,909,490 1,709,539 445,210 (190,697)
Net Assets
Beginning of period.............................................. 17,251,134 15,541,595 14,523,048 14,713,745
End of period (including undistributed (overdistributed) net
investment income as set forth below)......................... $28,160,624 $17,251,134 $14,968,258 $14,523,048
Undistributed (Overdistributed) Net Investment Income ...... $ 10,524 $ (97,960) $ -- $ --
<FN>
See accompanying notes.
</FN>
</TABLE>
NOTES TO FINANCIAL STATEMENTS
PRINCIPAL SPECIAL MARKETS FUND, INC.
Note 1 -- Significant Accounting Policies
Principal Special Markets Fund, Inc. (the "Fund") is registered under the
Investment Company Act of 1940, as amended, as an open-end diversified
management investment company and operates in the mutual fund industry. The Fund
currently consists of two portfolios (known as the International Securities and
Mortgage-Backed Securities Portfolios).
The Fund values securities for which market quotations are readily available at
market value, which is determined using the last reported sale price or, if no
sales are reported, as is regularly the case for some securities traded
over-the-counter, the last reported bid price. When reliable market quotations
are not considered to be readily available, which may be the case, for example,
with respect to certain debt securities and preferred stocks, the investments
are valued by using market quotations, prices provided by market makers or
estimates of market values obtained from yield data and other factors relating
to instruments or securities with similar characteristics in accordance with
procedures established in good faith by the Fund's Board of Directors.
Securities with remaining maturities of 60 days or less are valued at amortized
cost, which approximates market.
With respect to the International Securities Portfolio, the value of foreign
securities in foreign currency amounts is expressed in U.S. dollars at the
closing daily rate of exchange. The identified cost of the portfolio holdings is
translated at approximate rates prevailing when acquired. Income and expense
amounts are translated at approximate rates prevailing when received or paid,
with daily accruals of such amounts reported at approximate rates prevailing at
the date of valuation.
Since the carrying amount of the foreign securities of the International
Securities Portfolio is determined based on the exchange rate and market values
at the close of the period, it is not practicable to isolate that portion of the
results of operations arising as a result of changes in the foreign exchange
rates from the fluctuations arising from changes in the market prices of
securities during the period.
The Fund records investment transactions generally one day after the trade date.
The identified cost basis has been used in determining the net realized gain or
loss from investment transactions and unrealized appreciation or depreciation of
investments. The Fund records dividend income on the ex-dividend date, except
dividend income from certain foreign securities whereby the ex-dividend date has
passed; such dividends are recorded as soon as the Fund is informed of the
ex-dividend date. Interest income is recognized on an accrual basis.
Reported net realized foreign exchange gains or losses arise from sales of
foreign currencies, currency gains or losses realized between the trade and
settlement dates on securities transactions, and the difference between the
amount of dividends and foreign withholding taxes recorded on the portfolio's
books and the U.S. dollar equivalent of the amounts actually received or paid.
Net unrealized foreign exchange gains and losses arise from changes in the value
of assets and liabilities other than investments in securities at fiscal year
end, resulting from changes in the exchange rate.
With respect to the Mortgage-Backed Securities Portfolio, all net investment
income is declared as a dividend daily to shareholders of record as of that day,
and all distributions of realized gains from investment transactions are
recorded on the ex-dividend date. Dividends and distributions to shareholders of
the International Securities Portfolio are recorded on the ex-dividend date.
Dividends and distributions to shareholders from net investment income and net
realized gain from investment and foreign currency transactions are determined
in accordance with federal income tax regulations, which may differ from
generally accepted accounting principles. To the extent these "book/tax"
differences are permanent in nature (i.e. that they result from other than
timing of recognition - "temporary"), such amounts are reclassified within the
capital accounts based on their federal tax-basis treatment; temporary
differences do not require reclassification. Reclassifications made for the
years ended December 31, 1996 and 1995 were not significant.
Due to the timing of dividend distributions and the differences in accounting
for income and realized gains (losses) for financial statement and federal
income tax purposes, the fiscal year in which amounts are distributed may differ
from the year in which the income and realized gains (losses) are recorded for
financial statement purposes by the portfolio. The differences between the
income and gains distributed on a book versus tax basis are shown as excess
distributions of net investment income and net realized gain on investments in
the accompanying Statements of Changes in Net Assets.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Note 2 -- Federal Income Taxes
No provision for federal income taxes is considered necessary because the Fund
is qualified as a "regulated investment company" under the Internal Revenue Code
and intends to distribute each year, substantially all of its net investment
income and realized capital gains to shareholders. The cost of investments for
federal income tax reporting purposes is approximately the same as that for
financial reporting purposes.
At December 31, 1996, Principal Special Markets Mortgage-Backed Securities
Portfolio had a net capital loss carryforward of approximately $1,100,000
expiring in 2002 through 2004.
Note 3 -- Management Agreement and Transactions With Affiliates
The Fund has agreed to pay investment advisory and management fees to Princor
Management Corporation (wholly owned by Princor Financial Services Corporation,
a subsidiary of Principal Mutual Life Insurance Company) (the "Manager") and to
Invista Capital Management, Inc. ("Invista"), an indirect wholly-owned
subsidiary of Principal Mutual Life Insurance Company, pursuant to a
sub-advisory agreement. Invista has agreed to assume the obligations of the
Manager to provide investment advisory services for the Fund in return for the
advisory fee paid by the Fund and to reimburse the Manager for the other costs
it incurs under the management agreement. The annual rate used in this
calculation for the International Securities Portfolio and the Mortgage-Backed
Securities Portfolio is .90% and .45%, respectively, of the average daily value
of each portfolio's net assets.
Brokerage commissions were paid to an affiliate by the International Securities
Portfolio in the amount of $1,655 and $2,888 during the years ended December 31,
1996 and 1995, respectively.
At December 31, 1996, Principal Mutual Life Insurance Company owned shares of
the Fund's portfolios as follows:
International Securities Portfolio 1,236,430
Mortgage-Backed Securities Portfolio 1,260,703
Note 4 -- Investment Transactions
For the year ended December 31, 1996, the cost of investment securities
purchased and proceeds from investment securities sold (not including short-term
investments and U.S. government securities) by the Fund were as follows:
Purchases Sales
International Securities Portfolio $11,641,938 $5,042,552
Mortgage-Backed Securities Portfolio 484,500 2,447,469
At December 31, 1996, net unrealized appreciation (depreciation) of investments
by the Fund was composed of the following:
<TABLE>
<CAPTION>
Net Unrealized
Gross Unrealized Appreciation (Depreciation)
Appreciation (Depreciation) of Investments
<S> <C> <C> <C>
International Securities Portfolio $6,187,497 $(1,071,977) $5,115,520
Mortgage-Backed Securities Portfolio 66,796 (257,411) (190,615)
</TABLE>
At December 31, 1996, International Securities Portfolio held the following
securities which may require registration under the Securities Act of 1933 or an
exemption therefrom in order to effect a sale in the ordinary course of
business.
<TABLE>
<CAPTION>
Value at Value as a
Date of December 31, Percentage of
Security Description Acquisition Cost 1996 Net Assets
Alfa SA; Convertible
<S> <C> <C> <C> <C>
Subordinated Debentures 9/26/95 $199,250 $ 219,000 .78%
Fokus Bank 10/3/96 165,626 199,377 .70%
Hyundai Motor 10/3/96 94,600 59,770 .21%
Kemira OY 12/10/96 286,318 289,433 1.01%
Royal Plastics Group 11/23/94 58,057 131,313 .47%
Voest-Alpine Stahl 10/27/95 103,583 120,824 .43%
1/11/96 54,207 60,412 .21%
3/27/96 55,367 60,412 .21%
12/9/96 109,873 110,164 .40%
$1,250,705 4.42%
</TABLE>
The Mortgage-Backed Securities Portfolio's investments are with various issuers;
while the International Securities Portfolio's investments are with various
issuers in various industries. The Schedules of Investments contained herein
summarize the concentration of credit risk for Mortgage-Backed Securities
Portfolio by issuers and International Securities Portfolio by industry and
issuer.
Note 5 -- Capital Share Transactions
Transactions in Capital Stock by portfolio were as follows:
International Mortgage-Backed
Securities Securities
Portfolio Portfolio
Year Ended December 31, 1996:
Shares sold ................................. 528,303 --
Shares issued in reinvestment of
dividends and distributions .................. 73,625 80,137
Shares redeemed ............................. (16,274) --
Net Increase 585,654 80,137
Year Ended December 31, 1995:
Shares sold ................................. 9,107 --
Shares issued in reinvestment of
dividends and distributions .................. 88,579 75,504
Shares redeemed ............................. -- (262,636)
Net Increase (Decrease) 97,686 (187,132)
Note 6 -- Line of Credit
The Fund has an unsecured line of credit with a bank which allows each portfolio
to borrow up to $500,000. Borrowings are made solely to facilitate the handling
of unusual and/or unanticipated short-term cash requirements. Interest is
charged to each portfolio, based on its borrowings, at a rate equal to the
bank's Fed Funds Unsecured Rate plus 100 basis points. Additionally, a
commitment fee is charged at the annual rate of .25% on the line of credit. At
December 31, 1996, the Fund had no outstanding borrowings under the line of
credit.
<PAGE>
December 31, 1996
SCHEDULES OF INVESTMENTS
PRINCIPAL SPECIAL MARKETS FUND, INC.
International Securities Portfolio
Shares
Held Value
Common Stocks (97.91%)
Aircraft & Parts (0.13%)
Cemex SA 9,928 $ 35,628
Beverages (0.73%)
Lion Nathan 86,000 205,984
Blast Furnace & Basic
Steel Products (1.25%)
Voest-Alpine Stahl 9,900(b) 351,812
Broadwoven Fabric Mills,
Cotton (0.34%)
Roda Vivatex 150,000 96,825
Cement, Hydraulic (0.49%)
Apasco SA 20,000 137,195
Central Reserve Depositories (4.36%)
Banco Totta & Acores 9,600 180,808
Barclays PLC 33,000 565,011
Ergo Bank 2,200 111,511
Wing Hang Bank 82,000 372,101
1,229,431
Combination Utility Services (2.90%)
ABB AG 390 483,608
Iberdrola 1 SA 23,600 333,838
817,446
Commercial Banks (7.93%)
ABN-AMRO Holdings NV 7,746 503,343
Bangkok Bank 17,000 164,430
Bank of Ireland 29,188 266,485
Fokus Bank 29,000(b) 199,377
Grupo Financiero Bancomer;
Series B 141,000(a) 56,421
National Australia Bank Ltd. 37,654 442,633
Siam City Bank 139,000 130,109
Svenska Handelsbanken AB Free 17,050 469,448
2,232,246
Communication Services, NEC (1.28%)
KPN Royal PTT Nederland 9,472 360,867
Computer & Data Processing
Services (0.90%)
Intentia International AB 17,000(a) 253,953
Computer & Office Equipment (0.15%)
Canon, Inc. 2,000 44,111
Construction & Related Machinery (0.88%)
Keumkang 1,300 59,196
Powerscreen International PLC 19,400 187,576
246,772
Consumer Products (1.78%)
Imasco Ltd. 20,500 $ 502,534
Copper Ores (0.37%)
Reliance Industries 9,600 104,352
Crude Petroleum & Natural Gas (1.15%)
Hardy Oil & Gas 63,000 323,975
Deep Sea Foreign Transportation
of Freight (0.51%)
Van Ommeren NV 3,200 144,299
Department Stores (0.96%)
Vendex International 6,334 270,609
Drugs (3.78%)
Elan Corp. PLC ADR 8,100(a) 269,325
Galenica Holdings AG 350 124,598
Roussel-Uclaf 1,150 337,784
Teva Pharmaceutical ADR 6,600 331,650
1,063,357
Electric Light & Wiring
Equipment (0.62%)
Clipsal Industries Holdings 20,000 72,800
Otra NV 5,900 101,304
174,104
Electric Services (2.19%)
Korea Electric Power Corp. 4,800 139,657
Korea Mobil Telecommunications Corp. 290 156,404
Northern Ireland Electric 49,100 320,135
616,196
Electronic Components &
Accessories (2.91%)
Amtek Engineering 94,500 187,809
Elec & Eltek International 96,000 364,800
Murata Mfg. 2,000 66,339
Varitronix 111,000 200,905
819,853
Electronic Distribution
Equipment (1.61%)
Phillips Electronics 11,200 453,248
Engines & Turbines (3.39%)
Mabuchi Motor 1,100 55,251
PT United Tractors 123,000 257,714
Radex-Heraklith Industriebeteiligungs 8,900 281,627
Scapa Group PLC 86,000 360,571
955,163
Farm & Garden Machinery (1.28%)
New Holland NV 17,200(a) 359,050
Finance Services (0.98%)
MBF Capital Berhad 170,000 275,984
Foreign Banks, Branches &
Agencies (0.13%)
Shinhan Bank 2,740 37,268
Forest Products (0.32%)
Metsa-Serla 12,000 89,824
Functions Closely Related
to Banking (0.73%)
Liechtenstein Global Trust AG 400 $ 204,361
Gas Production & Distribution (1.54%)
Hafslund ASA 3,113 21,305
OMV AG 3,650 411,148
432,453
Highway & Street Construction (0.43%)
Bau Holdings AG 2,430 121,281
Holding Offices (1.45%)
First Pacific Co., Ltd. 314,892 409,137
Household Appliances (1.19%)
Fisher & Paykel 85,262 334,339
Household Audio & Video
Equipment (0.54%)
SKF 'B' Free 6,400 151,376
Industrial Inorganic Chemicals (3.07%)
Bayer AG 10,500 425,489
Kemira OY 23,000(b) 289,433
Rhone Poulenc 4,400 149,721
864,643
Investment Offices (1.47%)
Invesco Funding 12,400(a) 55,066
Invesco PLC 81,000 359,707
414,773
Meat Products (6.17%)
Danisco AS 6,900 418,756
Davomas Abadi 270,000 242,857
Orkla B Ordinary Shares 7,900 501,067
Unilever NV 3,250 574,191
1,736,871
Medical Instruments & Supplies (0.17%)
Nycomed 3,113 47,777
Miscellaneous Chemical Products (4.19%)
Hoechst AG 11,200 518,172
Novartis AG 578 660,674
1,178,846
Miscellaneous Durable Goods (0.86%)
Hagemeyer NV 3,051 243,588
Mscellaneous Equipment Rental &
Leasing (1.03%)
Insituto Mobiliane Italian 34,000 290,694
Miscellaneous Food &
Kindred Products (0.47%)
Burns, Philp & Co., Ltd. 73,998 131,652
Miscellaneous Furniture &
Fixtures (0.16%)
Pt Surya Toto 22,200 44,165
Miscellaneous Manufacturers (0.33%)
Carter Holt Harvey Ltd. 41,000 $ 92,987
Miscellaneous Non-Durable
Goods (2.10%)
Grand Metropolitan PLC 75,300 591,472
Miscellaneous Plastics
Products, NEC (0.47%)
Royal Plastics Group 7,100(a)(b) 131,313
Miscellaneous Textile Goods (0.35%)
Espirit Asia 220,000 97,414
Miscellaneous Transportation
Equipment (0.67%)
Autoliv AB 4,300 188,297
Miscellaneous Wood Products (0.46%)
Enso OY 16,300 130,852
Motor Vehicles & Equipment (2.17%)
E.C.I.A. - Equipment & Composants 1,900 293,110
Hyundai Motor Co. Ltd. GDR 8,600(b) 59,770
Volvo AB 11,700 257,886
610,766
Newspapers (0.74%)
Publishing & Broadcasting Ltd. 43,000 209,016
Oil & Gas Field Services (1.65%)
Repsol Petroleo SA 12,100 463,256
Personal Credit Institutions (0.47%)
Manhattan Card Co. 263,000 133,455
Photographic Equipment &
Supplies (1.14%)
PT Bunas Finance Indonesia 270,000 320,000
Plastic Materials & Synthetics (1.44%)
Astra AB 8,400 404,744
Primary Nonferrous Metals (0.91%)
British Steel PLC 93,000 255,437
Pulp Mills (1.82%)
Lassila & Tikanoja Ltd. OY 4,400 278,759
UPM-Kymmene OY 11,200 234,497
513,256
Railroad Equipment (0.48%)
Vae AG 1,200 136,057
Security Brokers & Dealers (0.92%)
Peregrine Investment Holdings 148,000 253,523
Peregrine Investment - Warrants 14,800(a) 4,736
258,259
Security & Commodity Services (1.19%)
Corporacion Bancaria de Espania SA 7,500 334,999
Ship & Boat Building &
Repairing (0.41%)
Unitor Ships Service 9,100 $ 116,861
Soap, Cleaners, & Toilet Goods (1.41%)
Reckitt & Colman PLC 32,000 396,474
Special Industry Machinery (1.55%)
Bobst SA 120 161,761
IHC Caland NV 2,500 142,652
Sulzer AG 250 133,311
437,724
Sugar & Confectionary Products (2.91%)
Nestle 470 503,001
Tate & Lyle 39,000 316,351
819,352
Telephone Communication (5.88%)
Cable & Wireless PLC 14,900 123,795
Nokia Corp. Class A ADR 6,800 391,850
Tele Danmark B 2,900 159,775
Telecom Italia-DI 203,000 395,186
Telefonica De Espana SA 19,600 454,307
Telefonos De Mexico SA ADR 4,000 132,000
1,656,913
Water Supply (0.80%)
Wessex Water PLC 35,011 225,282
Water Transportation of
Freight, NEC (0.85%)
ICB Shipping AB 'B' Free 20,466 239,788
Total Common Stock 27,572,016
Principal
Amount Value
Bonds (0.78%)
Fire, Marine & Casualty
Insurance (0.78%)
Alfa SA Convertible Subordinated
Debentures; 8.00%; 9/15/00 $ 200,000(b) $ 219,000
Commercial Paper (2.66%)
Business Credit Institutions (2.66%)
General Electric Capital Corp.;
6.65%; 1/2/97 750,000 750,000
Total Portfolio Investments (101.35%) 28,541,016
Liabilities, net of cash, receivables
and other assets (-1.35%) $ (380,392)
Total Net Assets (100.00%) $28,160,624
(a) Non-income producing security - No dividend paid during
the period.
(b) Restricted security - See Notes 4 to the financial statements.
International Securities Portfolio
Investments by Country
Total Market Percentage of Total
Country Value Market Value
Australia $ 783,301 2.74%
Austria 1,301,925 4.56
Canada 633,848 2.22
Denmark 578,531 2.03
Finland 1,415,215 4.96
France 780,614 2.74
Germany 943,661 3.31
Greece 111,511 .39
Hong Kong 1,471,271 5.15
India 104,352 0.37
Indonesia 961,561 3.37
Israel 331,650 1.16
Italy 685,880 2.40
Japan 165,702 0.58
Korea 452,295 1.58
Malaysia 275,984 0.97
Mexico 580,244 2.03
Netherlands 3,153,152 11.05
New Zealand 633,309 2.22
Norway 886,386 3.11
Portugal 180,808 0.63
Singapore 625,408 2.19
Spain 1,586,400 5.56
Sweden 1,965,492 6.89
Switzerland 2,271,313 7.96
Thailand 294,539 1.03
United Kingdom 4,616,664 16.17
United States 750,000 2.63
Total Market Value $28,541,016 100.00%
Mortgage-Backed Securities Portfolio
Description of Issue Principal
Type Rate Maturity Amount Value
Federal National Mortgage Association (FNMA)
Certificates (35.28%)
FNMA 6.00% 11/1/23-3/1/26 $1,170,580 $1,090,435
FNMA 7.00 8/1/23 3,413,766 3,357,385
FNMA 7.50 6/1/23 829,573 833,049
Total FNMA Certificates 5,280,869
Government National Mortgage Association (GNMA)
Certificates (56.38%)
GNMA I 6.00 12/15/23 894,055 833,922
GNMA I 6.50 12/15/23-1/15/24 2,614,795 2,511,170
GNMA I 7.50 6/15/23-9/15/23 953,533 957,891
GNMA II 5.50 3/20/2 183,476 161,400
GNMA II 6.00 11/20/23-9/20/26 3,903,575 3,601,942
GNMA II 6.50 10/20/25 391,840 372,887
Total GNMA Certificates 8,439,212
Federal Home Loan Mortgage Corporation
(FHLMC) Certificates (5.63%)
FHLMC Gold 5.50 2/1/24-3/1/24 751,467 688,675
FHLMC Gold 6.00 4/1/24 164,610 153,600
Total FHLMC Certificates 842,275
Federal Agency Short-Term Obligations (2.24%)
Principal
Amount Value
Federal Home Loan Mortgage Corp.;
5.40%; 1/2/97 $ 335,000 $335,000
Total Portfolio Investments (99.53%) 14,897,356
Cash, receivables and other assets,
net of liabilities (0.47%) 70,902
Total Net Assets (100.00%) $14,968,258
See accompanying notes.
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL HIGHLIGHTS
PRINCIPAL SPECIAL MARKETS FUND, INC.
International Securities Portfolio
Year Year Year Period
Ended Ended Ended Ended
December 31, December 31, December 31, December 31,
1996 1995 1994 1993(a)
<S> <C> <C> <C> <C>
Net Asset Value at Beginning of Period................... $11.70 $11.29 $12.87 $10.01
Income from Investment Operations:
Net Investment Income................................. .31 .19 .13 .07
Net Realized and Unrealized Gains (Losses)
on Investments..................................... 2.46 1.11 (.95) 2.91
Total from Investment Operations 2.77 1.30 (.82) 2.98
Less Distributions:
Dividends (from net investment income)................ (.16) (.10) (.12) (.10)
Excess distribution of net investment income.......... (.07) (.07) (.13) --
Distributions (from capital gains).................... (.57) (.72) (.51) (.02)
Total Distributions (.80) (.89) (.76) (.12)
Net Asset Value at End of Period......................... $13.67 $11.70 $11.29 $12.87
Total Return............................................. 24.12% 12.02% (6.45)% 29.95%(c)
Ratios/Supplemental Data:
Net Assets, End of Period (in thousands).............. $28,161 $17,251 $15,542 $16,838
Ratio of Expenses to Average Net Assets............... .90% .90% .90% .90%(b)
Ratio of Net Investment Income to Average
Net Assets......................................... 1.90% 1.79% .94% 1.21%(b)
Portfolio Turnover Rate............................... 25.52% 46.0% 37.0% 6.9%(b)
Average Commission Rate Paid..........................$ .0187 -- -- --
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL SPECIAL MARKETS FUND, INC.
Mortgage-Backed Securities Portfolio
Year Year Year Period
Ended Ended Ended Ended
December 31, December 31, December 31, December 31,
1996 1995 1994 1993(a)
<S> <C> <C> <C> <C>
Net Asset Value at Beginning of Period................... $10.17 $ 9.11 $10.10 $10.01
Income from Investment Operations:
Net Investment Income................................. .64 .65 .63 .34
Net Realized and Unrealized Gains (Losses)
on Investments..................................... (.24) 1.06 (.99) .09
Total from Investment Operations .40 1.71 (.36) .43
Less Distributions:
Dividends (from net investment income)................ (.64) (.65) (.63) (.34)
Net Asset Value at End of Period......................... $ 9.93 $10.17 $ 9.11 $10.10
Total Return............................................. 4.20% 19.26% (3.60)% 4.47%(c)
Ratios/Supplemental Data:
Net Assets, End of Period (in thousands).............. $14,968 $14,253 $14,714 $24,309
Ratio of Expenses to Average Net Assets............... .45% .45% .45% .45%(b)
Ratio of Net Investment Income to Average
Net Assets......................................... 6.51% 6.66% 6.56% 5.23%(b)
Portfolio Turnover Rate............................... 28.7% 9.9% 41.8% 9.6%(b)
<FN>
(a)Period from May 7, 1993, date shares first offered to the public, through
December 31, 1993. Net investment income, aggregating $.01 per share for the
International Securities Portfolio and $.01 per share for the Mortgage-Backed
Securities Portfolio for the period from the initial purchase of shares on
April 26, 1993 through May 6, 1993, was recognized, none of which was
distributed from the International Securities Portfolio and all of which was
distributed from the Mortgage-Backed Securities Portfolio to the sole
shareholder, Principal Mutual Life Insurance Company, during the period.
Additionally, the Mortgage-Backed Securities Portfolio incurred unrealized
gains on investments of $.01 per share during the intitial interim period.
This represented activities of each portfolio prior to the initial offering.
(b)Computed on an annualized basis.
(c)Total return amounts have not been annualized.
<PAGE>
</FN>
</TABLE>
REPORT OF INDEPENDENT AUDITORS
The Boards of Directors and Shareholders
Principal Special Markets Fund, Inc.
We have audited the accompanying statements of assets and liabilities, including
the schedules of investments, of Principal Special Markets Fund, Inc.
(comprising, respectively, the International Securities and Mortgage-Backed
Securities Portfolios) as of December 31, 1996, and the related statements of
operations for the year then ended, and the statements of changes in net assets
and the financial highlights for each of the periods indicated therein. These
financial statements and financial highlights are the responsibility of the
Funds' management. Our responsibility is to express an opinion on these
financial statements and financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
December 31, 1996, by correspondence with the custodians and brokers. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of each
of the respective portfolios constituting the Principal Special Markets Fund,
Inc. at December 31, 1996, and the results of their operations for the year then
ended, and the changes in their net assets and the financial highlights for each
of the periods indicated therein, in conformity with generally accepted
accounting principles.
ERNST & YOUNG LLP
Des Moines, Iowa
January 17, 1997
FEDERAL INCOME TAX INFORMATION
Information for federal income tax purposes is presented as an aid to
shareholders in reporting the dividend distributions shown below. Shareholders
should consult a tax adviser on how to report these distributions for state and
local purposes.
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31, 1996
Per Share Per Share
Income Dividend Distributions Capital Gain Distributions
------------------------------------------- ---------------------------------------------
Total
Total Dividends
Payable Per Total Deductible Payable Long- Short- Capital Gain and
Date Share Dividends Percentage* Date Term** Term*** Distributions Distributions
International
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities Portfolio 1/31/96 $.0432 -0- 1/31/96 $.1863 $.0006
12/31/96 .1926 12/31/96 .2889 .0933
$.2358 $.5691 $.8049
</TABLE>
<TABLE>
<CAPTION>
Per Share Income Dividend Distributions/Payable Date
1/31/96 2/29/96 3/29/96 4/30/96 5/31/96 6/28/96 7/31/96 8/30/96 9/30/96 10/31/96 11/29/96 12/31/96
Mortgage-Backed
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities Portfolio $.0532 $.0542 $.0526 $.0517 $.0567 $.0503 $.0519 $.0548 $.0499 $.0527 $.0609 $.0525
<FN>
* Percent qualifying for deduction by shareholders who are corporations.
** Taxable as long-term capital gain.
*** Taxable at ordinary income rates.
</FN>
</TABLE>
