Registration No. 33-59474
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
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POST-EFFECTIVE AMENDMENT NO. 8 TO
FORM N-1A
REGISTRATION STATEMENT
under
THE SECURITIES ACT OF 1933
and
REGISTRATION STATEMENT
under
THE INVESTMENT COMPANY ACT OF 1940
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PRINCIPAL SPECIAL MARKETS FUND, INC.
(Exact name of Registrant as specified in Charter)
The Principal Financial Group
Des Moines, Iowa 50392
(Address of principal executive offices)
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Telephone Number (515) 248-3842
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MICHAEL D. ROUGHTON Copy to:
The Principal Financial Group JOHN W. BLOUCH, L.L.P.
Des Moines, Iowa 50392 Suite 405 West
1025 Thomas Jefferson Street, N.W.
Washington, DC 20007-0805
(Name and address of agent for service)
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It is proposed that this filing will become effective (check appropriate box)
immediately upon filing pursuant to paragraph (b)of Rule 485
X on May 1, 1998, pursuant to paragraph (b) of Rule 485
60 days after filing pursuant to paragraph (a)(1) of Rule 485
on (date) pursuant to paragraph (a)(1) of Rule 485
75 days after filing pursuant to paragraph (a)(2) of Rule 485
on (date) pursuant to paragraph (a)(2) of Rule 485
If appropriate, check the following box:
This post-effective amendment designates a new effective date for
a previously filed post-effective amendment.
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Pursuant to the provisions of Rule 24f-2 under the Investment Company Act
of 1940, Registrant has registered an indefinite number of shares under the
Securities Act of 1933; Registrant filed a Rule 24f-2 Notice for the
fiscal year ended December 31, 1996 on February 27, 1997.
<PAGE>
PRINCIPAL SPECIAL MARKETS FUND, INC.
International Emerging Markets Portfolio
International Securities Portfolio
International SmallCap Portfolio
Mortgage-Backed Securities Portfolio
The Principal Financial Group(R)
Des Moines, Iowa 50392-0200
1-800-451-5447
Principal Special Markets Fund, Inc. (the "Fund") is a no-load, open-end
management investment company, currently consisting of four series
("Portfolios"), each of which is classified as a diversified investment company.
Each Portfolio is designed to meet the investment needs of institutions,
corporations and high net worth individuals desiring professional investment
management for the type of securities in which each Portfolio invests. The
investment objective of each Portfolio is as follows:
International Emerging Markets Portfolio: Long-term growth of capital by
investing primarily in equity securities of issuers in emerging market
countries.
International Securities Portfolio: Long-term growth of capital by investing in
a portfolio of securities of companies domiciled in any of the nations of the
world.
International SmallCap Portfolio: Long-term growth of capital by investing
primarily in equity securities of non-United States companies with comparatively
smaller market capitalizations.
Mortgage-Backed Securities Portfolio: A total investment return consisting of
current income and capital appreciation while maintaining liquidity and safety
of principal. The Portfolio seeks to achieve its objective through the purchase
of mortgage-backed securities and other obligations issued or guaranteed by the
United States Government or its agencies or instrumentalities. Portfolio shares
are not guaranteed by the United States Government.
This Prospectus concisely states information that an investor ought to know
before investing. It should be read and retained for future reference.
Additional information about the Fund has been filed with the Securities and
Exchange Commission, including a document called a Statement of Additional
Information dated May 1, 1998, which is incorporated by reference herein. The
Statement of Additional Information can be obtained free of charge by writing or
telephoning Princor Financial Services Corporation, P.O. Box 10423, Des Moines,
Iowa 50306-0423. Telephone 1-800-451-5447.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
The date of this Prospectus is May 1, 1998.
TABLE OF CONTENTS
Page
Summary.................................................... 3
Financial Highlights....................................... 5
Investment Objectives, Policies and Restrictions........... 7
Certain Investment Policies and Restrictions............... 10
Risk Factors............................................... 12
Manager and Investment Sub-Advisor ........................ 12
Duties Performed by the Manager and Sub-Advisor............ 13
Managers' Comments......................................... 14
Determination of Net Asset Value .......................... 17
Performance Calculation ................................... 17
Shareholder Rights ................ 17
Distribution of Income Dividends and Realized Capital Gains 18
Tax Treatment, Dividends and Distributions ................ 19
How to Invest ............................................. 19
Offering Price of Shares .................................. 20
Minimum Investment Requirement............................. 20
Open Account System........................................ 20
Redemption of Shares....................................... 21
Periodic Withdrawal Plan................................... 22
Additional Information..................................... 23
This Prospectus does not constitute an offer to sell, or a solicitation of
an offer to buy, the securities of any Portfolio in any jurisdiction in which
such sale, offer to sell, or solicitation may not be lawfully made. No dealer,
salesperson, or other person has been authorized to give any information or to
make any representations, other than those contained in this Prospectus, in
connection with the offer contained in this Prospectus, and, if given or made,
such other information or representations must not be relied upon as having been
authorized by Principal Special Markets Fund, Inc. or its Manager or
Sub-Advisor.
SUMMARY
The following summarized information should be read in conjunction with the
detailed information appearing elsewhere in the Prospectus.
What benefits are offered investors?
Professional Investment Management: Experienced securities analysts provide
each Portfolio with professional investment management.
Diversification: Each Portfolio will diversify by investing in securities
issued by a number of issuers. Diversification reduces investment risk.
Economies of Scale: Pooling individual shareholder's investments in the
Portfolios creates administrative efficiencies and in certain circumstances
saves on brokerage commissions through the purchase of larger blocks of
securities.
Liquidity: Upon request each Portfolio will redeem its shares and promptly
pay the investor the current net asset value next determined of the shares
redeemed. See "Redemption of Shares."
Dividends: Each Portfolio will normally declare a dividend payable from
investment income in accordance with its distribution policy. See "Distribution
of Income Dividends and Realized Capital Gains."
Convenient Investment and Recordkeeping Services: Shareholders will receive
a statement of account each time there is activity in their account.
No Sales Charge: Each Portfolio offers its shares at net asset value,
without a sales charge.
What are the Portfolio investment objectives?
The investment objective of the International Emerging Markets Portfolio is
to seek long-term growth of capital by investing primarily in equity securities
of issuers in emerging market countries.
The investment objective of the International Securities Portfolio is to
seek long-term growth of capital by investing in a portfolio of securities of
companies domiciled in any of the nations of the world.
The investment objective of the International SmallCap Portfolio is to seek
long-term growth of capital by investing in a portfolio of equity securities of
non-United States companies with comparatively smaller market capitalizations.
The investment objective of the Mortgage-Backed Securities Portfolio is to
generate a total investment return consisting of current income and capital
appreciation while maintaining liquidity and safety of principal. The Portfolio
seeks to achieve its objective through the purchase of mortgage-backed
securities and other obligations issued or guaranteed by the United States
Government or its agencies or instrumentalities. Portfolio shares are not
guaranteed by the United States Government.
There can be no assurance that the investment objectives will be realized.
See "Investment Objectives, Policies and Restrictions."
What are the risk factors?
Because each Portfolio has a different investment objective, each Portfolio
is subject to different financial and market risks. Financial risk refers to the
earnings stability and overall financial soundness of an issuer of an equity
security and to the ability of an issuer of a debt security to pay interest and
principal when due. Market risk refers to the degree to which the price of a
security will react to changes in securities markets in general and, with
particular reference to debt securities, to changes in the overall level of
interest rates. See "Risk Factors", and "Investment Objectives, Policies and
Restrictions."
What minimum amount may be invested?
The minimum initial purchase in the Fund is $1.0 million. The minimum
initial purchase of $1.0 million may be invested over a three month period.
Investments in any of the Portfolios by an investor, investor's spouse and
dependent children, or a trustee may be combined to meet this minimum. There is
no minimum for subsequent investments. Each Portfolio may involuntarily redeem
all shares in an account which, after a redemption, has a value of less than
$5,000 and mail the proceeds of such redemption to the shareholder at the
address of record. See "Minimum Investment Requirement."
How may investments be withdrawn?
Withdrawals, which are also known as redemptions, may be made by mail or by
telephone if telephone transaction services apply to the account. Upon proper
authorization certain redemptions may be processed through a selected dealer.
Redemptions may also be made through a Periodic Withdrawal Plan. Withdrawals are
made at net asset value without charge. See "Redemption of Shares."
Who manages each Portfolio?
Principal Management Corporation, a corporation organized in 1969 by
Principal Mutual Life Insurance Company, is the Manager for each of the
Portfolios. It is also the dividend disbursing and transfer agent. See
"Manager." Invista Capital Management, Inc. ("Invista"), an indirect
wholly-owned subsidiary of Principal Mutual Life Insurance Company and an
affiliate of the Manager, has executed an agreement with the Manager to assume
the obligations of the Manager to provide investment advisory services for each
Portfolio.
What fees and expenses apply to ownership of shares?
The following table depicts fees and expenses applicable to the purchase
and ownership of shares of each Portfolio.
<TABLE>
<CAPTION>
Shareholder Transaction Expenses
Maximum Sales Load Imposed
on Purchases
Portfolio (as a percentage of offering price) Redemption Fee
<S> <C> <C>
International Emerging Markets Portfolio None None
International Securities Portfolio None None
International SmallCap Portfolio None None
Mortgage-Backed Securities Portfolio None None
</TABLE>
<TABLE>
<CAPTION>
Annual Portfolio Operating Expenses
(as a percentage of average net assets)
Management 12b-1 Other Total Operating
Portfolio Fee Fee Expenses* Expenses
<S> <C> <C> <C> <C>
International Emerging Markets Portfolio 1.15% None None 1.15%
International Securities Portfolio .90% None None .90%
International SmallCap Portfolio 1.00% None None 1.00%
Mortgage-Backed Securities Portfolio .45% None None .45%
</TABLE>
* In addition to brokerage and extraordinary expenses, a Portfolio will pay
only taxes and interest expenses, which it is anticipated will be minimal or
nonexistent under normal circumstances.
The purpose of the above table is to assist the investor in understanding
the various expenses that an investor in each Portfolio will bear directly or
indirectly. The fee payable by the International Emerging Markets, International
Securities and International SmallCap Portfolios are higher than that paid by
most funds to their advisors, but not higher than the fees paid by many funds
with similar investment objectives and policies and does cover substantially all
expenses of the Portfolios, unlike many other funds. See "How to Invest" and
"Duties Performed by the Manager and Sub-Advisor."
Examples
You would pay the following expenses on a $1,000 investment, assuming (1)
5% annual return and (2) redemption at the end of each time period:
<TABLE>
<CAPTION>
Period (in years)
Portfolio 1 3 5 10
<S> <C> <C> <C> <C>
International Emerging Markets Portfolio $12 $37 N/A N/A
International Securities Portfolio $9 $29 $50 $111
International SmallCap Portfolio $10 $32 N/A N/A
Mortgage-Backed Securities Portfolio $5 $14 $25 $57
</TABLE>
The Examples are based on each Portfolio's Annual Operating Expenses
described above. The Examples should not be considered a representation of
past or future expenses; actual expenses may be greater or less than those
shown.
FINANCIAL HIGHLIGHTS
The following financial highlights have been derived from financial
statements which have been audited by Ernst & Young LLP, independent auditors
whose report thereon has been incorporated by reference herein. The financial
highlights should be read in conjunction with the financial statements, related
notes and other financial information for each portfolio incorporated by
reference herein. The financial statements may be obtained by shareholders,
without charge, by telephoning 1-800-451-5447.
International Emerging Markets Portfolio
Period
Ended
December 31,
1997(a)
Net Asset Value at Beginning of Period................... $9.94
Income from Investment Operations:
Net Investment Income................................. .01
Net Realized and Unrealized Gains (Losses)
on Investments..................................... .21
Total from Investment Operations .22
Less Distributions:
Dividends (from net investment income)................ (.02)
Distributions (from capital gains).................... --
Total Distributions (.02)
Net Asset Value at End of Period......................... $10.14
Total Return............................................. 1.40%(b)
Ratios/Supplemental Data:
Net Assets, End of Period (in thousands).............. $32,488
Ratio of Expenses to Average Net Assets............... 1.15%(c)
Ratio of Net Investment Income to Average
Net Assets......................................... .91%(c)
Portfolio Turnover Rate............................... 12.3%(c)
Average Commission Rate Paid(d)....................... $.0029
<TABLE>
<CAPTION>
International Securities Portfolio
Year Year Year Year Period
Ended Ended Ended Ended Ended
December 31, December 31, December 31, December 31, December 31,
1997 1996 1995 1994 1993(e)
<S> <C> <C> <C> <C> <C>
Net Asset Value at Beginning of Period................... $13.67 $11.70 $11.29 $12.87 $10.01
Income from Investment Operations:
Net Investment Income................................. .24 .31 .19 .13 .07
Net Realized and Unrealized Gains (Losses)
on Investments..................................... 1.46 2.46 1.11 (.95) 2.91
Total from Investment Operations 1.70 2.77 1.30 (.82) 2.98
Less Distributions:
Dividends (from net investment income)................ (.24) (.16) (.10) (.12) (.10)
Excess distribution of net investment income.......... -- (.07) (.07) (.13) --
Distributions (from capital gains).................... (.68) (.57) (.72) (.51) (.02)
Total Distributions (.92) (.80) (.89) (.76) (.12)
Net Asset Value at End of Period......................... $14.45 $13.67 $11.70 $11.29 $12.87
Total Return............................................. 12.55% 24.12% 12.02% (6.45)% 29.95%(b)
Ratios/Supplemental Data:
Net Assets, End of Period (in thousands).............. $37,684 $28,161 $17,251 $15,542 $16,838
Ratio of Expenses to Average Net Assets............... .90% .90% .90% .90% .90%(c)
Ratio of Net Investment Income to Average
Net Assets......................................... 1.73% 1.90% 1.79% .94% 1.21%(c)
Portfolio Turnover Rate............................... 30.8% 25.5% 46.0% 37.0% 6.9%(c)
Average Commission Rate Paid(d)....................... $.0187 $.0187 -- -- --
</TABLE>
International SmallCap Portfolio
Period
Ended
December 31,
1997(a)
Net Asset Value at Beginning of Period................... $9.86
Income from Investment Operations:
Net Investment Income................................. .01
Net Realized and Unrealized Gains (Losses)
on Investments..................................... .12
Total from Investment Operations .13
Less Distributions:
Dividends (from net investment income)................ (.02)
Distributions (from capital gains).................... --
Total Distributions (.02)
Net Asset Value at End of Period......................... $9.97
Total Return............................................. 1.59%(b)
Ratios/Supplemental Data:
Net Assets, End of Period (in thousands).............. $31,968
Ratio of Expenses to Average Net Assets............... 1.00%(c)
Ratio of Net Investment Income to Average
Net Assets......................................... .91%(c)
Portfolio Turnover Rate............................... 30.3%(c)
Average Commission Rate Paid(d)....................... $.0111
<TABLE>
<CAPTION>
Mortgage-Backed Securities Portfolio
Year Year Year Year Period
Ended Ended Ended Ended Ended
December 31, December 31, December 31, December 31, December 31,
1997 1996 1995 1994 1993(e)
<S> <C> <C> <C> <C> <C>
Net Asset Value at Beginning of Period................... $ 9.93 $10.17 $ 9.11 $10.10 $10.01
Income from Investment Operations:
Net Investment Income................................. .64 .64 .65 .63 .34
Net Realized and Unrealized Gains (Losses)
on Investments..................................... .34 (.24) 1.06 (.99) .09
Total from Investment Operations .98 .40 1.71 (.36) .43
Less Distributions:
Dividends (from net investment income)................ (.64) (.64) (.65) (.63) (.34)
Net Asset Value at End of Period......................... $10.27 $ 9.93 $10.17 $ 9.11 $10.10
Total Return............................................. 10.18% 4.20% 19.26% (3.60)% 4.47%(b)
Ratios/Supplemental Data:
Net Assets, End of Period (in thousands).............. $13,796 $14,968 $14,253 $14,714 $24,309
Ratio of Expenses to Average Net Assets............... .45% .45% .45% .45% .45%(c)
Ratio of Net Investment Income to Average
Net Assets......................................... 6.37% 6.51% 6.66% 6.56% 5.23%(c)
Portfolio Turnover Rate(d)............................ 15.5% 28.7% 9.9% 41.8% 9.6%(c)
</TABLE>
(a) Period from November 26, 1997, date shares first offered to the public,
through December 31, 1997. Net investment income, aggregating $.02 per
share for the International Emerging Markets Portfolio and $.01 per share
for the International SmallCap Portfolio for the period from the initial
purchase of shares on November 17, 1997 through November 25, 1997, was
recognized, none of which was distributed to the sole shareholder,
Principal Mutual Life Insurance Company. Additionally, the portfolios
incurred unrealized losses on investments of ($.08) per share and ($.15)
per share respectively, during the interim period. This represents
activities of each portfolio prior to the initial offering.
(b) Total return amounts have not been annualized.
(c) Computed on an annualized basis.
(d) The International Portfolios identified the cost of commissions paid on
purchases and sales charged to each portfolio in the local currency in the
respective country involved. The value of the commissions is translated
into U.S. dollars at approximate rates when acquired or sold. This
translation can give the appearance that the International Portfolios'
average commissions are substantially different from the other funds.
(e) 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.
INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS
The investment objectives and policies of the Portfolios are described
below. There can be no assurance that the objectives will be realized.
The International Emerging Markets Portfolio, International Securities
Portfolio and International SmallCap Portfolio (together the "International
Portfolios") each seek to be fully invested under normal conditions in the
following equity securities: common stocks; preferred stocks and debt securities
that are convertible into common stock, that carry rights or warrants to
purchase common stock or that carry rights to participate in earnings; rights or
warrants to subscribe to or purchase any of the foregoing securities; and
sponsored and unsponsored American Depository Receipts (ADRs) based on any of
the foregoing securities. Unsponsored ADRs are not created by the issuer of the
underlying security, may be subject to fees imposed by the issuing bank that, in
the case of sponsored ADRs, would be paid by the issuer of a sponsored ADR and
may involve additional risks such as reduced availability of information about
the issuer of the underlying security.
Each Portfolio may invest in the securities of other investment companies
but may not invest more than 10% of its assets in securities of other investment
companies, invest more than 5% of its total assets in the securities of any one
investment company, or acquire more than 3% of the outstanding voting securities
of any one investment company except in connection with a merger, consolidation
or plan of reorganization. The Manager will waive its management fee on the
portfolio's assets invested in securities of other open-end investment
companies. The Portfolio will generally invest only in those investment
companies that have investment policies requiring investment in securities
comparable in quality to those in which the Portfolio invests.
When in the opinion of Invista current market or economic conditions
warrant, the Portfolios each may for temporary defensive purposes place all or a
portion of its assets in cash, on which the Portfolio would earn no income, cash
equivalents, bank certificates of deposit, bankers acceptances, repurchase
agreements, commercial paper, commercial paper master notes which are floating
rate debt instruments without a fixed maturity, government securities, and
preferred stock and investment grade debt securities, whether or not convertible
into or carrying rights for common stock. These securities may be issued by
domestic or foreign corporations, governments or governmental agencies,
instrumentalities or political subdivisions and may be denominated in United
States dollars or some other currency. When investing for temporary defensive
purposes, the Portfolio is not investing so as to achieve its investment
objective. The Portfolio may also maintain reasonable amounts in cash or
short-term debt securities (rated by a nationally recognized statistical rating
organization in one of the two highest rating categories for short-term debt
obligations) for daily cash management purposes or pending selection of
particular long-term investments.
International Emerging Markets Portfolio
The investment objective of the International Emerging Markets Portfolio is
long-term growth of capital. The Portfolio seeks to achieve this objective by
investing primarily in equity securities of issuers in emerging market
countries. As used in this Prospectus, the term "emerging market country" means
any country which, in the opinion of Invista, is generally considered to be an
emerging country by the international financial community, including the
International Bank for Reconstruction and Development (more commonly known as
the World Bank) and the International Financial Corporation. These countries
generally include every nation in the world except the United States, Canada,
Japan, Australia, New Zealand and most nations located in Western Europe.
Currently, investing in many emerging countries is not feasible or may involve
unacceptable political risks. The Portfolio focuses on those emerging market
countries in which it believes the economies are developing strongly and in
which the markets are becoming more sophisticated.
Investments in emerging market countries involve special risks. Certain
emerging market countries have historically experienced, and may continue to
experience, high rates of inflation, high interest rates, exchange rate
fluctuations, large amounts of debt, balance of payments and trade difficulties,
and extreme poverty and unemployment. In addition, there are certain risks
associated with investments in foreign securities (see "Risk Factors").
Under normal conditions at least 65% of the Portfolio's total assets will
be invested in emerging market country equity securities. The Portfolio invests
in securities of (1) issuers with their principal place of business or principal
office in emerging market countries, or (2) issuers for which the principal
securities trading market is an emerging market country, or (3) issuers,
regardless of where the security is traded, that derive 50% or more of their
total revenue from either goods or services produced in emerging market
countries or sales made in emerging market countries.
A small portion of the Portfolio assets may also be invested in closed end
country specific investment companies and sovereign debt of developing
countries. Closed end investment companies provide a way to gain exposure to
countries where the mechanics of trading securities are not cost effective.
Investment in sovereign debt may have the potential for returns that are higher
than returns on stocks within the country.
International Securities Portfolio
The investment objective of the International Securities Portfolio is to
seek long-term growth of capital through investment in a portfolio of securities
of companies domiciled in any of the nations of the world. In choosing
investments, which will consist primarily of equity securities of foreign
corporations, Invista intends to pay particular attention to long-term earnings
prospects and the relationship of then-current prices to such prospects.
Short-term trading is not generally intended, but occasional investments may be
made for the purpose of seeking short-term or medium-term gain. The Portfolio
expects its investment objective to be met over long periods which may include
several market cycles. For a description of certain investment risks and tax
implications associated with foreign securities, see "Risk Factors," and "Tax
Treatment, Dividends and Distributions."
The Portfolio intends that its investments normally will be allocated among
various countries. Although there is no limitation on the percentage of assets
that may be invested in any one country or denominated in any one currency, the
Portfolio intends under normal market conditions to have at least 65% of its
assets invested in securities issued by corporations of at least three countries
other than the United States. Investments may be made anywhere in the world, but
it is expected that primary consideration will be given to investing in the
securities issued by corporations of Western Europe, North America and
Australasia (Australia, Japan and Far East Asia) that have developed or
developing economies. Changes in investments may be made as prospects change for
particular countries, industries or companies.
International SmallCap Portfolio
The investment objective of the International SmallCap Portfolio is
long-term growth of capital. The strategy of this Portfolio is to invest
primarily in equity securities of non-United States companies with comparatively
smaller market capitalizations. Under normal market conditions, the Portfolio
invests at least 65% of its assets in securities of companies having a total
market capitalization of $1 billion or less.
The Portfolio diversifies its investments geographically. Although there is
no limitation on the percentage of assets that may be invested in any one
country or denominated in any one currency, the Portfolio intends, under normal
market conditions, to have at least 65% of its assets invested in securities
issued by corporations of at least three countries. For a description of certain
investment risks associated with foreign securities, see "Risk Factors."
Mortgage-Backed Securities Portfolio
The investment objective of the Mortgage-Backed Securities Portfolio is to
generate a total investment return consisting of current income and capital
appreciation while maintaining liquidity and safety of principal.
The Portfolio will invest in mortgage-backed securities and other
obligations issued or guaranteed by the United States Government or by its
agencies or instrumentalities ("U.S. Government Securities") and in repurchase
agreements collateralized by such obligations. Under normal market conditions,
the Portfolio intends to invest at least 65% of its assets in mortgage-backed
securities. The U.S. Government Securities in which the Portfolio intends to
invest include Government National Mortgage Association ("GNMA") Certificates of
the modified pass-through type, Federal National Mortgage Association ("FNMA")
Obligations, Federal Home Loan Mortgage Corporation ("FHLMC") Certificates and
Student Loan Marketing Association ("SLMA") Certificates and collateralized
mortgage obligations issued by private issuers for which the underlying
mortgage-backed securities serving as collateral are guaranteed by the U.S.
Government or its agencies or instrumentalities. GNMA is a wholly-owned
corporate instrumentality of the United States whose securities and guarantees
are backed by the full faith and credit of the United States. FNMA, a federally
chartered and privately-owned corporation, FHLMC, a federal corporation, and
SLMA, a government sponsored stockholder-owned organization, are
instrumentalities of the United States. The securities and guarantees of FNMA,
FHLMC and SLMA are backed by the credit of the issuing organization but are not
backed, directly or indirectly, by the full faith and credit of the United
States. Although the Secretary of the Treasury of the United States has
discretionary authority to lend FNMA up to $2.25 billion outstanding at any
time, neither the United States nor any agency thereof is obligated to finance
the operations of FNMA, FHLMC or SLMA or to assist them in any other manner. The
Portfolio may maintain reasonable amounts of cash or short-term debt securities
for daily cash management purposes or pending selection of particular long-term
investments.
GNMA Certificates are mortgage-backed securities representing an interest
in a pool of mortgage loans. Such loans are made by lenders such as mortgage
bankers, insurance companies, commercial banks and savings and loan
associations. Then, they are either insured by the Federal Housing
Administration (FHA) or they are guaranteed by the Veterans Administration (VA)
or Farmers Home Administration (FmHA). The lender or other prospective issuer
creates a specific pool of such mortgages, which it submits for approval to
GNMA, a United States Government corporation within the Department of Housing
and Urban Development. After approval, a GNMA Certificate is typically offered
by the issuer to investors through securities dealers.
GNMA Certificates differ from bonds in that the principal is scheduled to
be paid back by the borrower on a monthly basis over the life of the loan rather
than returned in a lump sum at maturity. Modified pass-through GNMA Certificates
entitle the holder to receive all interest and principal payments owed on the
mortgages in the pool whether or not the mortgagor has made such payment. The
timely payment of interest and principal is guaranteed by the full faith and
credit of the United States Government.
Although the payment of interest and principal is guaranteed, the guarantee
does not extend to the value of a GNMA Certificate or the value of the shares of
the Portfolio. The market value of a GNMA Certificate typically will fluctuate
to reflect changes in prevailing interest rates. It falls when rates increase
(as does the market value of other debt securities) and it rises when rates
decline (but it may not rise on a comparable basis with other debt securities
because of its prepayment feature), and, therefore, may be more or less than the
face amount of the GNMA Certificate, which reflects the aggregate principal
amount of the underlying mortgages. As a result the net asset value of shares
will fluctuate as interest rates change.
Mortgagors may pay off their mortgages at any time. Prepayments of the
mortgages can affect the market value of the GNMA Certificate and the return
ultimately received. Prepayments, like scheduled payments of principal, are
reinvested by the Portfolio at prevailing interest rates which may be less than
the rate on the GNMA Certificate. Prepayments are likely to increase as the
interest rate for new mortgages moves lower than the rate on the GNMA
Certificate. Moreover, if the GNMA Certificate had been purchased at a premium
above principal because its rate exceeded prevailing rates, the premium is not
guaranteed and a decline in value to par may result in a loss of the premium
especially in the event of prepayment.
The FNMA and FHLMC securities in which the Portfolio invests are very
similar to GNMA certificates as described above but are not guaranteed by the
full faith and credit of the United States but rather by the agency itself. FNMA
and FHLMC securities are rated Aaa by Moody's and AAA by Standard & Poor's.
These ratings reflect the status of FNMA and FHLMC as federal agencies as well
as the important role each plays in financing purchases of homes in the U.S.
Student Loan Marketing Association is a government sponsored
stockholder-owned organization whose goal is to provide liquidity to financial
and educational institutions. SLMA provides liquidity by purchasing student
loans, which are principally government guaranteed loans issued under the
Federal Guaranteed Student Loan Program and the Health Education Assistance Loan
Program. SLMA securities are not guaranteed by the U.S. Government but are
obligations solely of the agency. SLMA senior debt issues in which the Fund
invests are rated AAA by Standard & Poor's and Aaa by Moody's.
There are other obligations issued or guaranteed by the United States
Government (such as U.S. Treasury securities) or by its agencies or
instrumentalities that are either supported by the full faith and credit of the
U.S. Treasury or the credit of a particular agency or instrumentality. Included
in the latter category are Federal Home Loan Bank and Farm Credit Banks.
Obligations not guaranteed by the United States Government are highly rated
because they are issued by indirect branches of government. Such obligations are
issued as needs arise by an agency and are traded regularly in denominations
similar to those in which government obligations are traded.
The Portfolio may enter into contracts with dealers in securities whereby
the Portfolio agrees to purchase or sell an agreed-upon principal amount of the
securities at a specified price on a certain date. The Portfolio may enter into
similar purchase agreements with issuers of securities other than Principal
Mutual Life Insurance Company. The Portfolio may also purchase optional delivery
standby commitments which give the Portfolio the right to sell particular
securities at a specified price on a specified date. Failure of the other party
to such a contract or commitment to abide by the terms thereof could result in a
loss to the Portfolio. When the Portfolio enters into a forward commitment
contract to purchase securities, it assumes the rights and risks of an owner of
the securities, including the risk of price and yield fluctuation. The Portfolio
accrues no interest until the securities are delivered, and although payment for
and delivery of the securities will occur at a later date, it records the
purchase price as a liability and segregates portfolio assets having a value
equal to the purchase price. The availability of liquid assets for this purpose
and the effect of asset segregation on the Portfolio's ability to meet its
current obligations, to honor requests for redemption and to have its investment
portfolio managed properly will limit the extent to which the Portfolio may
engage in forward commitment agreements. Except as may be imposed by these
factors, there is no limit on the percent of the Portfolio's total assets that
may be committed to transactions in such agreements. The Portfolio intends to be
active in the forward commitment market when the return from holding forward
positions appears to be greater than the return from holding the actual
securities. The Portfolio will enter into forward commitment contracts to
purchase securities for the purpose of acquiring those securities and not for
the purpose of investment leverage or to speculate on interest rate changes, but
as delivery dates approach, a determination will be made whether to take
delivery of a specific forward position, or sell that position and purchase
another forward position. Because of this strategy, it is anticipated that its
annual portfolio turnover rate should generally exceed 100% and may be as much
as 600% or more, although this rate should not be construed as a limiting
factor. The effect of a high turnover rate would be to incur more transaction
expenses than would be incurred at a lower turnover rate, and there is no
assurance that the additional transactions that cause the higher turnover rate
would result in gains for the Portfolio or in sufficient gains to offset the
increased transaction expenses.
CERTAIN INVESTMENT POLICIES AND RESTRICTIONS
Following is a discussion of certain investment practices that each
Portfolio may use in an effort to achieve its investment objective.
Each Portfolio may enter into repurchase agreements with, and may lend its
portfolio securities to, unaffiliated broker-dealers and other unaffiliated
qualified financial institutions. These transactions must be fully
collateralized at all times, but involve some credit risk if the other party
should default on its obligations, and the Portfolio is delayed or prevented
from recovering on the collateral. See the Statement of Additional Information
for further information regarding the credit risks associated with repurchase
agreements and the standards adopted by the Board of Directors to deal with
those risks. The Portfolios do not intend (i) to enter into repurchase
agreements that mature in more than seven days if any such investment, together
with any other illiquid securities held by the Portfolio, would amount to more
than 15% of its total assets or (ii) to lend securities in excess of 33% of its
total assets.
From time to time, a Portfolio may enter into forward commitment agreements
which call for it to purchase or sell a security on a future date and at a price
fixed at the time the Portfolio enters into the agreement. Each Portfolio may
acquire rights to sell its investments to other parties, either on demand or at
specific intervals. The International Portfolios each may invest in warrants up
to 5% of its assets, of which not more than 2% may be invested in warrants that
are not listed on the New York, American or Toronto Stock Exchanges or the
Chicago Board Options Exchange.
As a matter of fundamental policy, each Portfolio may borrow money (a) for
temporary or emergency purposes in an amount not to exceed 5% of the value of
the Portfolio's total assets at the time of the borrowing and (b) for any
purpose from banks in an amount not to exceed one-third of the Portfolio's total
assets (including the amount borrowed) less all liabilities and indebtedness
other than borrowings deemed to be senior securities and while any such
borrowing exceeds 5% of the Portfolios total assets, no additional purchases of
investment securities will be made.
Each Portfolio may purchase covered spread options, which would give the
Portfolio the right to sell a security that it owns at a fixed dollar spread or
yield spread in relationship to another security that the Portfolio does not
own, but which is used as a benchmark. Each Portfolio may also purchase and sell
covered financial futures contracts, options on financial futures contracts and
options on securities and securities indices, but will not invest more than 5%
of its assets in initial margin and premiums on financial futures contracts and
options thereon. Each Portfolio may write options on securities and securities
indices to generate additional revenue and for hedging purposes and may enter
into transactions in financial futures contracts and options on those contracts
for hedging purposes. The use of futures contracts and options involves certain
risks, including their failure as hedges when the price movements of the
securities underlying the futures and options do not follow the price movements
of the portfolio securities subject to the hedge; the inability to control
losses by closing a position when a liquid secondary market does not exist; and
the ability of Invista to predict correctly the direction of stock prices,
interest rates and other market and economic factors.
Additional information about risks is included in the Statement of Additional
Information.
The International Portfolios each may enter into forward currency
contracts, currency futures contracts and options thereon and options on
currencies for hedging and other non-speculative purposes. A forward currency
contract involves a privately negotiated obligation to purchase or sell a
specific currency at a future date at a price set at the time of the contract. A
Portfolio will not enter into a transaction to hedge currency exposure to an
extent greater in effect than the aggregate market value of the securities held
or to be purchased by the Portfolio that are denominated or generally quoted in
or currently convertible into the currency. When a Portfolio enters into a
contract to buy or sell a foreign currency, it generally will hold an amount of
that currency, liquid securities denominated in that currency or a forward
contract for such securities equal to the Portfolio's obligation, or it will
segregate liquid high grade debt obligations equal to the amount of the
Portfolio's obligations. The use of currency contracts involves many of the same
risks as transactions in futures contracts and options as well as the risk of
government action through exchange controls or otherwise that would restrict the
ability of the Portfolio to deliver or receive currency.
The Statement of Additional Information includes additional information
concerning the investment policies and restrictions applicable to the
Portfolios. Certain investment policies and restrictions are designated in this
Prospectus or in the Statement of Additional Information as fundamental and may
not be changed as to any Portfolio without approval by the holders of the lesser
of: (i) 67% of the shares of that Portfolio represented at a meeting at which
more than 50% of the outstanding shares of the Portfolio are represented or (ii)
more than 50% of the outstanding shares of the Portfolio. The investment
objectives of the Portfolios and all other investment policies and restrictions
described in this Prospectus and the Statement of Additional Information are not
fundamental and may be changed by the Board of Directors without shareholder
approval. A change of an investment objective may result in a Portfolio having
an investment objective different from the objective which a shareholder
considered appropriate at the time of investment in the Portfolio. Shareholders
must be given 30 days prior written notice before the investment objectives of
the Portfolios may be changed at the discretion of the Board of Directors.
RISK FACTORS
An investment in an International Portfolio involves the financial and
market risks that are inherent in any investment in securities. These risks
include changes in the financial condition of issuers, in economic conditions
generally and in the conditions in securities markets. They also include the
extent to which the prices of securities will react to those changes. Investment
in foreign securities presents certain risks which may affect net asset value.
These risks include, but are not limited to, those resulting from fluctuations
in currency exchange rates, revaluation of currencies, the imposition of foreign
taxes, the withholding of taxes on dividends at the source, future political and
economic developments including war, expropriations, nationalization, the
possible imposition of currency exchange controls and other foreign governmental
laws or restrictions, reduced availability of public information concerning
issuers, and the fact that foreign issuers are not generally subject to uniform
accounting, auditing and financial reporting standards or to other regulatory
practices and requirements comparable to those applicable to domestic issuers.
Moreover, securities of many foreign issuers may be less liquid and their prices
more volatile than those of comparable domestic issuers. In addition,
transactions in foreign securities may be subject to higher costs, and the time
for settlement of transactions in foreign securities may be longer than the
settlement period for domestic issuers. Investment in foreign securities may
also result in higher custodial costs and the costs associated with currency
conversions.
Securities of many foreign issuers may be less liquid and their prices more
volatile than those of comparable domestic issuers. In particular, securities
markets in emerging market countries are known to experience long delays between
the trade and settlement dates of securities purchased and sold, potentially
resulting in a lack of liquidity and greater volatility in the price of
securities on those markets. In addition, investments in smaller companies may
present greater opportunities for capital appreciation, but may also involve
greater risks than large, mature issuers. Such companies may have limited
product lines and financial resources. Their securities may trade in more
limited volume than larger companies and may therefore experience significantly
more price volatility and less liquidity than securities of larger companies. As
a result of these factors, the Board of Directors of the Fund has adopted Daily
Pricing and Valuation Procedures for the Portfolios which sets forth the steps
to be followed by the Manager and Sub-Advisor to establish a reliable market or
fair value if a reliable market value is not available through normal market
quotations. Oversight of this process is provided by the Executive Committee of
the Board of Directors.
An investment in the Mortgage-Backed Securities Portfolio involves market
risks associated with movements in interest rates. The market value of
investments will fluctuate in response to changes in interest rates and other
factors. During periods of falling interest rates, the values of outstanding
long-term fixed-income securities generally rise. Conversely, during periods of
rising interest rates, the values of such securities generally decline. Changes
by recognized rating agencies in their ratings of any fixed-income security and
in the ability of an issuer to make payments of interest and principal may also
affect the value of these investments. Changes in the value of portfolio
securities will affect the net asset value but will not affect cash income
derived from the securities unless a change results from a failure of an issuer
to pay interest or principal when due.
MANAGER AND INVESTMENT SUB-ADVISOR
The Manager for the Funds is Principal Management Corporation (the
"Manager"), an indirectly wholly-owned subsidiary of Principal Mutual Life
Insurance Company, a mutual life insurance company organized in 1879 under the
laws of the State of Iowa. The address of the Manager is The Principal Financial
Group, Des Moines, Iowa 50392. The Manager was organized on January 10, 1969,
and since that time has managed various mutual funds sponsored by Principal
Mutual Life Insurance Company. As of December 31, 1997 the Manager had assets
under management of approximately $5.3 billion.
The Manager has executed an agreement with Invista Capital Management, Inc.
("Invista") under which Invista has agreed to assume the obligations of the
Manager to provide investment advisory services for each Portfolio and to
reimburse the Manager for the other costs it incurs under the Management
Agreement. Invista, an indirectly wholly-owned subsidiary of Principal Mutual
Life Insurance Company and an affiliate of the Manager, was founded in 1985 and
manages investments for institutional investors, including Principal Mutual
Life. Assets under management at December 31,1997 were approximately $25.8
billion. Invista's address is 1800 Hub Tower, 699 Walnut, Des Moines, Iowa
50309.
Invista has assigned certain individuals the primary responsibility for the
day-to-day management of each portfolio. The persons primarily responsible for
the day-to-day management of each Portfolio are identified in the table below:
<TABLE>
<CAPTION>
Primarily
Fund Responsible Since Person Primarily Responsible
<S> <C> <C>
International Emerging Markets November, 1997 Kurtis D. Spieler, CFA (MBA degree, Drake University).
Portfolio (Portfolio's inception) Vice President, Invista Capital Management, Inc. since
1995; Investment Officer, 94-95. Prior Thereto, Investment
Manager, Principal Mutual Life Insurance Company.
International Securities April, 1994 Scott D. Opsal, CFA (MBA degree, University of
Portfolio Minnesota). Executive Vice President and Chief Investment
Officer, Invista Capital Management, Inc. since 1997.
Vice President, 1986-1997.
International SmallCap November, 1997 Darren K. Sleister, CFA (MBA degree, University of
Portfolio (Portfolio's inception) Iowa). Investment Officer, Invista Capital Management,
Inc. since 1995; Prior thereto, Security Analyst.
Mortgage-Backed Securities May, 1993 Martin J. Schafer (BBA degree, University of Iowa). Vice
Portfolio (Portfolio's inception) President, Invista Capital Management, Inc. since 1992.
Director - Securities Trading, Principal Mutual Life
Insurance Company 1992; Prior thereto, Associate Director.
</TABLE>
DUTIES PERFORMED BY THE MANAGER AND SUB-ADVISOR
Under Maryland law, the business and affairs of the Fund are managed under
the direction of its Board of Directors. The investment services and certain
other services referred to under the heading "Cost of Manager's Services" in the
Statement of Additional Information are furnished to each Portfolio under the
terms of a Management Agreement between the Fund and the Manager and a
sub-advisory agreement between the Manager and Invista. Invista advises each
Portfolio on investment policies and on the composition of each Portfolio. In
this connection, Invista furnishes to the Board of Directors a recommended
investment program consistent with each Portfolio's investment objective and
policies. Invista is authorized, within the scope of the approved investment
program, to determine which securities are to be bought or sold, and in what
amounts.
The Management Fees are computed at the following annual rates:
<TABLE>
<CAPTION>
Fees Computed On Fees as a Percent of
Portfolio Net Asset Value of Portfolio Average Daily Net Assets
<S> <C> <C>
International Emerging Markets Portfolio First $250 million 1.15%
Next $250 million 1.05%
Over $500 million 0.95%
International Securities Portfolio Entire Portfolio 0.90%
International SmallCap Portfolio First $250 million 1.00%
Next $250 million 0.90%
Over $500 million 0.80%
Mortgage-Backed Securities Portfolio Entire Portfolio 0.45%
</TABLE>
The fee payable by the International Portfolios are higher than that paid
by most funds to their advisors, but it is not higher than the fees paid by many
funds with similar investment objectives and policies and does cover
substantially all expenses of the Portfolio, unlike many other funds. The only
expenses paid by each Portfolio are brokerage commissions on portfolio
transactions, taxes, interest (if any) and extraordinary expenses.
The Manager and Invista may purchase at their own expense statistical and
other information or services from outside sources, including Principal Mutual
Life Insurance Company. An Investment Service Agreement between the Fund, the
Manager, and Principal Mutual Life Insurance Company provides that Principal
Mutual Life Insurance Company will furnish certain personnel, services and
facilities required by the Manager and Invista in connection with the
performance of their services for each Portfolio and that the Manager will
reimburse Principal Mutual Life Insurance Company for its costs incurred in this
regard. The Manager serves as dividend disbursing agent and transfer agent for
each Portfolio.
MANAGERS' COMMENTS
Principal Management Corporation and Invista, the adviser and sub-advisor
to the Fund, are staffed with investment professionals who manage each
Portfolio. Comments by these individuals in the following paragraphs summarize
in capsule form the general strategy and recent results of each Portfolio
throughout the fiscal year ended December 31, 1997. The accompanying charts
display results for the life of the Fund through December 31, 1997. Average
Annual Total Return figures provided for each portfolio in the graphs below
reflect all expenses of the Fund and assume all distributions are reinvested at
net asset value. Past performance is not predictive of future performance.
Returns and net asset values fluctuate. Shares are redeemable at current net
asset value, which may be more or less than original cost.
International Emerging Markets Portfolio
Historical records indicate that fourth quarter 1997 emerging market returns
represented the weakest period of performance in this asset class in the last
decade. Asian markets continued to underperform with various countries
experiencing currency devaluation. The difference in the fourth quarter was the
impact of the Asian problems on the rest of the emerging markets universe. Latin
America, Eastern Europe, and Africa joined in the sell-off as investors avoided
`risky' assets.
In general, equity market returns are driven by interest rates and earnings or
cash flow growth. As a result of the loss of confidence in Asia, interest rates
rose in virtually every Asian market as governments tried to stabilize their
currency. Many emerging countries outside of Asia, including Brazil, Argentina,
Chile, and South Africa, also increased their interest rates in an attempt to
avoid currency speculation. In addition to the interest rate increase, many
economists are now predicting recessions throughout Asia and a slowdown in
growth from other emerging countries. Thus, emerging markets were hit by the
double impact of increased interest rates and low earnings growth.
The Portfolio's inception in late November allowed it to miss most of the
dramatic capitulations occurring in the second half of 1997. The 1.40% return is
respectable considering most of the emerging indices registered double digit
declines in the fourth quarter.
The Portfolio is diversified by region with Latin America constituting 40% of
the fund, EMEA (Eastern Europe, Middle East, Africa) 35% and Asia 25%. The
Portfolio's managers continue to focus primarily on companies in Latin America,
Eastern Europe and the Middle East due to the strong government response to
problems and the stronger economic fundamentals. The Portfolio sold out of
several leveraged companies in Latin America and remains focused on cash
generative businesses. Managers are cautious in Asia, primarily playing net
exporters with strong balance sheets but continually monitoring the situation
for value opportunities. Risk management entails limitations on country (20%),
industry (25%), and company exposure (5%).
Comparison of Change in Value of $1.0 Million Investment
in the International Emerging Markets Portfolio,
MSCI EMF and Lipper Emerging Markets Fund Average
International Emerging Markets Portfolio
MSCI Lipper Emerging
EMF ID Markets
Year Ended December 31, 1997 IEP INDEX Fund Avg.
1,000,000 1,000,000 1,000,000
1,014,000 1,021,800 1,015,300
Note: Past performance is not predictive of future performance.
- -------------------------------------------------
International Emerging Markets Portfolio
Total Returns
As of December 31, 1997
1 Year 5 Year 10 Year
1.40%* -- --
* - Since Inception Date 11/26/97
- -------------------------------------------------
International Securities Portfolio
The International Securities Portfolio's return of 12.55% in 1997 compared
favorably with the return generated by the EAFE index of 1.78%. The Portfolio
benefited from its overweight position in Europe. European markets were very
strong in 1997 and with all markets up for the year and only two markets, Norway
and Austria, up less than 10%. The environment for equities in Europe was very
positive in 1997; inflation remained low, interest rates were low and falling
and economic growth began to pick up. The strong U.S. dollar was another factor
boosting the performance of European equities because of its positive effect on
the profitability of exporters based in Europe.
While almost everything was going right in Europe, almost everything went wrong
in Asia. The currency crisis that started in Thailand in the third quarter
spread to other Asian countries employing a currency peg system in the months
that followed. The currency depreciation that these countries experienced had a
significant negative ripple effect on the profitability of their corporate
sector and on near-term economic growth prospects. Stock market performance
reflected those problems, with five markets (Thailand, South Korea, Indonesia,
Malaysia, Philippines) all down more than 60%. Hong Kong and Singapore were down
30% or less. The Portfolio benefited from its underweight position in Asia
relative to the EAFE index. A large portion of the Asian exposure in the
Portfolio in 1997 resided in Hong Kong, another positive for relative
performance.
The Portfolio remains underweighted in the Japanese market, which was down 23.7%
in 1997, another reason the Portfolio outperformed. Valuations continue to be
high in Japan and the outlook for economic growth is not good given the
continued weakness of the Japanese economy and the subdued growth outlook of its
Asian neighbors.
The strong U.S. dollar had an equally negative effect on the returns of the
account and the EAFE Index, reducing both by 10.5%.
Comparison of Change in Value of $1.0 Million Investment in the International
Securities Portfolio, EAFE Index and Lipper International Fund Average
Fund Morgan Stanley Lipper
Total EAFE International
Year Ended December 31 Return Index Index
1,000,000 1,000,000 1,000,000
1993 1,299,450 1,058,800 1,225,000
1994 1,215,602 1,141,175 1,216,303
1995 1,361,697 1,269,100 1,330,757
1996 1,690,200 1,345,881 1,487,520
1997 1,902,357 1,369,838 1,568,441
Note: Past performance is not predictive of future performance.
- ---------------------------------------------------------
International Securities Portfolio
Total Returns
As of December 31, 1997
1 Year Since Inception Date 5/7/93 10 Year
12.55% 14.83% --
- ---------------------------------------------------------
International SmallCap Portfolio
The fourth quarter of 1997 proved to be a challenging period to hold equities in
the international arena. The International SmallCap Portfolio clearly benefited
from a low exposure to the Asian region and a high level of European holdings.
Most of Asia registered double-digit losses in dollar terms. While this
portfolio's managers were correct in their assessment of Asia, the negative
impact the crisis would exert on non-Asian companies with indirect Asian
involvement was not anticipated. The Portfolio missed most of the equity market
capitulation that occurred during the last half of 1997. However, by the end of
year most of the markets had begun to level off. Inception of the Portfolio
occurred in late November, returning 1.59% to investors in a little over a
month's time. This return was respectable considering the severe impact Asia had
on the rest of the world's markets.
As the investment philosophy of the Portfolio requires long term forecasts of a
company's value as a business, the managers feel conditions in Asia are too
unsettled at this time to make such forecasts. Thus, the Portfolio's holdings in
the region have been limited. The impact the Southeast Asian economies has had
on Europe has driven the price of European companies to unjustified valuations
and the Portfolio will continue to hold on to many European companies as their
valuations are now quite attractive. The Portfolio managers continue to search
for undervalued European small caps that are believed to benefit from the
changing economic conditions in Europe as the European Economic and Monetary
Union ("EMU") continues to progress.
Comparison of Change in Value of $1.0 Million Investment
in the International SmallCap Portfolio,
MSCI EAFE Index and Lipper International SmallCap Fund Average
Lipper
MSCI International
Year Ended EAFE ND SmallCap
December 31, 1997 ICP INDEX Fund Avg.
1,000,000 1,000,000 1,000,000
1,015,900 1,008,700 985,500
Note: Past performance is not predictive of future performance.
- ------------------------------------------
International SmallCap Portfolio
Total Returns
As of December 31, 1997
1 Year 5 Year 10 Year
1.59%* -- --
* - Since Inception Date 11/26/97
- ------------------------------------------
Important Notes:
Lipper Emerging Markets Fund Average: This average consists of funds which
invest at least 65% of their total assets in emerging market equity securities,
where "emerging market" is defined by a country's GNP per capita or other
economic measures. The one-year average currently contains 130 funds.
Morgan Stanley Capital International EMF (Emerging Markets Free) Index: This
average is capitalization weighted and consists of stocks from 26 countries.
These countries include: Argentina, Brazil, Chile, China Free, Columbia, Czech
Republic, Greece, Hungary, India, Indonesia Free, Israel, Jordan, Korea at 50%,
Malaysia Free, Mexico Free, Pakistan, Peru, Philippines Free, Poland, Portugal,
South Africa, Sri Lanka, Taiwan at 50%, Thailand Free, Turkey and Venezuela.
Lipper International Small Cap Funds Average: This average consists of funds
which invest at least 65% of their assets in equity securities of non-United
States companies with market capitalizations less than U.S. $1 billion at the
time of purchase. The one-year average currently contains 29 funds.
Morgan Stanley Capital International EAFE (Europe, Australia and Far East)
Index: This average reflects an arithmetic, market value weighted average of
performance of more than 900 securities which are listed on the stock exchanges
of the following countries: Australia, Austria, Belgium, Denmark, Netherlands,
New Zealand, Norway, Singapore/Malaysia, Spain, Sweden, Switzerland, and the
United Kingdom.
Lipper International Fund Average: This average consists of funds which invest
in securities primarily traded in markets outside of the United States. The
one-year average currently contains 421 funds.
Note: Mutual fund data from Lipper Analytical Services, Inc.
Mortgage-Backed Securities Portfolio
Interest rates fell for most of 1997, which led to a very strong year for the
Mortgage-Backed Securities Portfolio. The Portfolio outperformed both the Lehman
Brothers MBS Index as well as the Lipper U.S. Mortgage Fund Average mostly due
to its slightly longer duration.
The Portfolio added to its results last year by identifying and selecting
certain undervalued sectors of mortgage-backed securities for a portion of the
Portfolio. These securities have now become very popular with Wall Street and
other investors, resulting in the securities increasing in value.
Portfolio management believes its current portfolio to be well positioned for
the period ahead. It has a number of securities that are "seasoned" (e.g.,
original 30 year loans that have been outstanding for three years or more) and
therefore valued more highly in the marketplace. The majority of its securities
are priced below par, so prepayment risk is negligible. The current strategy of
staying fully invested in generic MBS pass-throughs with a mix of coupons has
served the Portfolio well and this should continue going forward.
Comparison of Change in Value of $1.0 Million Investment
in the Mortgage-Backed Securities
Portfolio, Lehman Brothers Mortgage Index and Lipper U.S. Mortgage Fund Average
Lehman Brothers Lipper U.S.
Fund Mortgage Mortgage Fund
Year Ended December 31, Value Index Average
1,000,000 1,000,000 1,000,000
1993 1,044,651 1,032,308 1,033,900
1994 1,006,746 1,015,723 990,786
1995 1,200,601 1,186,333 1,151,591
1996 1,251,002 1,249,802 1,196,158
1997 1,378,369 1,368,408 1,298,788
Note: Past performance is not predictive of future performance.
--------------------------------------------------------
Mortgage-Backed Securities Portfolio
Total Returns
As of December 31, 1997
1 Year Since Inception Date 5/7/93 10 Year
10.18% 7.14% --
--------------------------------------------------------
Important Notes:
Lehman Brothers Mortgage Index: an unmanaged index of 15- and 30-year fixed rate
securities backed by mortgage pools of the Government National Mortgage
Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), and Federal
National Mortgage Association (FNMA).
Lipper U.S. Mortgage Fund Average: this average consists of mutual funds
investing at least 65% of their assets in mortgages/securities issued or
guaranteed as to principal and interest by the U.S. Government and certain
federal agencies. The one-year average currently contains 59 mutual funds.
Note: Mutual fund data from Lipper Analytical Services, Inc.
DETERMINATION OF NET ASSET VALUE
The net asset value of each Portfolio is determined daily, Monday through
Friday, as of the close of trading on the New York Stock Exchange except on days
on which changes in the value of the portfolio securities will not materially
affect the current net asset value of the redeemable securities, on days during
which a Portfolio receives no order for the purchase or sale of its redeemable
securities and no tender of such a security for redemption, and on customary
national business holidays. The net asset value per share of each Portfolio is
determined by dividing the value of the Portfolios' securities plus all other
assets, less all liabilities, by the number of Portfolio shares outstanding.
Securities for which market quotations are readily available are valued
using those quotations. Other securities 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
Board of Directors. Securities with remaining maturities of 60 days or less are
valued at amortized cost. Other assets are valued at fair value as determined in
good faith through procedures established by the Board of Directors of the Fund.
Trading of foreign securities is substantially completed each day at
various times prior to the close of the New York Stock Exchange. The values of
such securities used in computing net asset value per share are usually
determined as of such times. Occasionally, events which affect the values of
such securities and foreign currency exchange rates may occur between the times
at which they are generally determined and the close of the New York Stock
Exchange and would therefore not be reflected in the computation of the net
asset value. If events materially affecting the value of such securities occur
during such period, then these securities will be valued at their fair value as
determined in good faith by the Manager or Invista under procedures established
and regularly reviewed by the Board of Directors. To the extent the
International Portfolios invest in foreign securities listed on foreign
exchanges which trade on days on which the Portfolios do not determine net asset
value, for example Saturdays and other customary national U.S. holidays, the net
asset value could be significantly affected on days when shareholders have no
access to the Portfolios.
PERFORMANCE CALCULATION
From time to time, the Fund may publish advertisements containing
information (including graphs, charts, tables and examples) about the
performance of one or more of its Portfolios. The yield and total return figures
described below will vary depending upon market conditions, the composition of
portfolios and operating expenses. These factors and possible differences in the
methods used in calculating yield and total return should be considered when
comparing performance figures for the Portfolios to performance figures
published for other investment vehicles. Any performance data quoted for a
Portfolio represents only historical performance and is not intended to indicate
future performance. For further information on how the Fund calculates yield and
total return figures for its Portfolios, see the Statement of Additional
Information.
The Mortgage-Backed Securities Portfolio may advertise its yield and
average annual and cumulative total return. The International Portfolios may
advertise average annual and cumulative total return. Yield is determined by
annualizing a Portfolio's net investment income per share for a specific,
historical 30-day period and dividing the result by the ending net asset value
of the Portfolio for the same period. Average annual total return for each
Portfolio is computed by calculating the average annual compounded rate of
return over the stated period that would equate an initial $1,000 investment to
the ending redeemable value assuming the reinvestment of all dividends and
capital gains distributions at net asset value. Cumulative total return is
computed by dividing the ending redeemable value by the initial investment on
the basis of the same assumptions. Each Portfolio may also quote rankings,
yields or returns as published by independent statistical services or
publishers, and information regarding the performance of certain market indices.
SHAREHOLDER RIGHTS
Each share is entitled to one vote either in person or by proxy at all
shareholder meetings. This includes the right to vote on the election of
directors, selection of independent accountants and other matters submitted to
meetings of shareholders. Shares of each Portfolio generally vote in the
aggregate without regard to series, except where otherwise required by the
Investment Company Act of 1940 in which case any matter being voted upon must be
approved by each Portfolio affected by the matter being voted upon. Matters
required by the Investment Company Act of 1940 to be voted upon by each affected
Portfolio include changes to the Management Agreement, a subadvisory agreement
and fundamental investment policies and restrictions. Each share of a Portfolio
has equal rights with every other share of that Portfolio as to dividends,
earnings, voting, assets and redemption. Shares are fully paid and
non-assessable, have no preemptive or conversion rights, and are freely
transferable. Shares may be issued as full or fractional shares, and each
fractional share has proportionately the same rights, including voting, as are
provided for a full share. Shareholders of the Fund may remove any director with
or without cause by the vote of a majority of the votes entitled to be cast at a
meeting of shareholders. Shareholders will be assisted with shareholder
communication in connection with such matter, and the Fund will hold a meeting
of shareholders for such purpose when requested to do so in writing by the
holders of 10% or more of the outstanding shares of the Fund.
The articles of incorporation of the Fund provide that the Board of
Directors may increase or decrease the aggregate number of shares which the Fund
has authority to issue and may create additional series of shares at any time
without a shareholder vote.
The Fund intends to hold meetings of shareholders only when required by law
and at such other times as may be deemed appropriate by the Board of Directors.
The Fund will hold annual meetings of shareholders only when the election of
directors by shareholders is required under the Investment Company Act of 1940
and special meetings of shareholders when the approval by shareholders of such
matters as investment advisory agreements and distribution agreements is
required under that Act.
Shareholder inquiries should be directed to the Fund at The Principal
Financial Group, Des Moines, Iowa 50392.
NON-CUMULATIVE VOTING: The shares have non-cumulative voting rights which
means that the holders of more than 50% of the shares voting for the election of
directors can elect 100% of the directors if they choose to do so, and in such
event, the holders of the remaining shares voting for the election of directors
will not be able to elect any directors.
As of April 9, 1998, Principal Mutual Life Insurance Company and its
subsidiaries and affiliates owned the following number and percentage of the
outstanding shares of each Portfolio of the Fund:
Percentage of
Number of Outstanding Shares
Portfolio Shares Owned Owned
International Emerging Markets Portfolio 6,974,330 81.19%
International Securities Portfolio 1,325,824 43.28%
International SmallCap Portfolio 5,869,848 98.32%
Mortgage-Backed Securities Portfolio 1,364,224 100.00%
DISTRIBUTION OF INCOME DIVIDENDS AND REALIZED CAPITAL GAINS
Any dividends from the net income of the International Portfolios normally
will be distributed to shareholders annually on the 24th of December (or the
preceding business day if the 24th is not a business day) to shareholders of
record three business days before the payable date.
Any dividends from the net income of the Mortgage-Backed Securities
Portfolio normally will be declared daily. Normal payment of dividends is on the
last business day of each month. A shareholder who redeems the entire balance of
an account during the month will receive the dividends declared through the date
of the redemption.
Net realized capital gains for each of the Portfolios, if any, will be
distributed annually,on the 24th of December (or the preceding business day if
the 24th is not a business day) to shareholders of record three business days
before the payable date. In the application, the shareholder authorizes income
dividends and capital gains distributions to be invested in additional shares at
net asset value as of the payment date. At any time on ten days written notice
to the Fund, the shareholder may, without charge, have future dividends (or
dividends and capital gains distributions) paid in cash. Any dividends or
distributions paid shortly after a purchase of shares by an investor will have
the effect of reducing the per share net asset value by the amount of the
dividends or distributions. These dividends or distributions are subject to
taxation like other dividends and distributions, even though they are in effect
a return of capital.
TAX-TREATMENT, DIVIDENDS AND DISTRIBUTIONS
It is the policy of each Portfolio to distribute substantially all net
investment income and net realized gains. Through such distributions, and by
satisfying certain other requirements, the Fund intends to qualify each
Portfolio for the tax treatment accorded to regulated investment companies under
the applicable provisions of the Internal Revenue Code. This means that in each
year in which a Portfolio so qualifies, it will be exempt from federal income
tax upon the amounts so distributed to investors. The Tax Reform Act of 1986
imposed an excise tax on mutual funds which fail to distribute net investment
income and capital gains by the end of the calendar year in accordance with the
provisions of the Act. The Fund intends to comply with the Act's requirements
and to avoid this excise tax.
When at the close of a fiscal year, more than 50% of each of the value of
the International Portfolio's total assets are invested in securities of foreign
corporations, the Fund may elect pursuant to Section 853 of the Internal Revenue
Code to permit International Portfolio shareholders to take a credit (or a
deduction) for foreign income taxes paid by the Fund. In that case,
International Portfolio shareholders should include in gross income for federal
income tax purposes both cash dividends received from the Fund and the amount
which the Fund advises is their pro rata portion of foreign income taxes paid
with respect to, or withheld from, dividends and interest paid to the Fund from
its foreign investments. International Portfolio shareholders would then be
entitled to subtract from their federal income taxes the amount of such taxes
withheld, or else treat such foreign taxes as a deduction from gross income, if
that should be more advantageous. As in the case of individuals receiving income
directly from foreign sources, the above-described tax credit for tax deduction
is subject to certain limitations.
Under the federal income tax law, dividends paid from investment income and
from realized short-term capital gains, if any, are generally taxable at
ordinary income rates whether received in cash or additional shares.
Dividends from the International Portfolios and the Mortgage-Backed
Securities Portfolio are not expected to qualify for the 70% dividends received
deduction for corporations. Dividends and capital gains are taxable in the year
in which distributed, whether received in cash or reinvested in additional
shares. Dividends declared with a record date in December and paid in January
will be deemed to have been distributed to shareholders in December. The Fund
will inform shareholders of the amount and nature of their income dividends and
capital gains distributions. Dividends from net income and distributions of
capital gains may also be subject to state and local taxation.
The Fund is required by law to withhold 31% of dividends paid to investors
who do not furnish their correct taxpayer identification number, which, in the
case of most individuals is their social security number. If, at the time the
account is established the investor does not have a taxpayer identification
number but certifies that one has been applied for, such withholding will be
delayed but will commence 60 days after the date of such certification if within
such time the investor has not provided such number to the Fund.
Shareholders should consult their own tax advisors as to the federal, state
and local tax consequences of ownership of shares of a Portfolio in their
particular circumstances.
HOW TO INVEST
Investments by check - An account may be established by submitting a
completed application and check made payable to Princor Financial Services
Corporation (the "Distributor") to the Distributor or other dealers which it
selects. An application is attached to this Prospectus. All applications are
subject to acceptance by the Fund and the Distributor. If an application and
check are properly submitted to the Distributor, the shares will be issued at
the net asset value next determined after the check has been converted into
Federal Funds, ordinarily within one business day following receipt of the
check.
Investments By Wire - Shares may also be purchased by wiring Federal Funds
directly to Norwest Bank Iowa, N.A., on a day on which the New York Stock
Exchange, Norwest Bank Iowa, N.A., and, in the case of an initial purchase,
Princor Financial Services Corporation are open for business. It is possible the
shareholder's bank will charge a fee for transmitting funds by wire. FOR AN
INITIAL PURCHASE, FIRST OBTAIN AN ACCOUNT NUMBER BY TELEPHONING THE DISTRIBUTOR
TOLL FREE 1-800-521-1502. Princor Financial Services Corporation requests the
following information:
1. Name in which the account will be registered
2. Address and Telephone Number
3. Tax Identification Number registered representative, if any.
4. Dividend distribution election
5. Amount being wired and wiring bank
6. Name of Princor Financial Services Corporation
7. Portfolio for which shares are being purchased.
Princor Financial Services Corporation will assign an account number
immediately upon receipt of the above information. After an account number is
assigned, the purchaser should instruct the bank to wire transfer Federal Funds
to: Norwest Bank Iowa, N.A., Des Moines, Iowa , ABA No. 073000228, for credit
to: Princor Financial Services Corporation, Account Number 073-330; for further
credit to: Purchaser's Name and Account Number.
To make subsequent purchases by wire, the investor should instruct the bank
to wire Federal Funds to: Norwest Bank Iowa, N.A., Des Moines, Iowa, ABA No.
073000228, for credit to: Principal Management Corporation, Account Number
3000499968, for further credit to: Investor's Name and Fund Account Number. It
is the shareholder's responsibility to advise Princor Financial Services
Corporation when a subsequent purchase has been wired so that proper credit can
be given.
Payment of Federal Funds normally must be received by Norwest Bank before
3:00 p.m. Central Time for an order to be accepted on that day. If payment is
received after that time, the order will not be accepted until the next business
day. Wire transfers may take two hours or more to complete. Investors may make
special arrangements to transmit orders for Portfolio shares to the Distributor
prior to 3:00 p.m. (Central Time) on a day when the Fund is open for business
with the investor's assurance that payment for such shares will be made by
wiring Federal Funds directly to Norwest Bank Iowa, N.A. prior to 10:00 a.m.
(Central Time) the following regular business day. Such orders will be effected
at the Portfolio's net asset value per share next determined after such purchase
order is received by the Distributor.
Promptly after the initial purchase, INVESTORS SHOULD COMPLETE AN ACCOUNT
APPLICATION and mail to Princor Financial Services Corporation, P.O. Box 10423,
Des Moines, Iowa 50306-0423.
Investments through a Selected Dealer - If the application and settlement
funds are submitted through a selected dealer, the shares will be issued in
accordance with the following: An order accepted by a dealer on any day before
the close of the Exchange and received by the Distributor as principal
underwriter before the close of its business on that day will be executed at the
net asset value computed as of the close of the Exchange on that day. An order
accepted by such dealer after the close of the Exchange and received by the
Distributor before its closing on the following business day will be executed at
the net asset value computed as of the close of the Exchange on such following
business day. Dealers have the responsibility to transmit orders to the
Distributor promptly. After an open account has been established (see "Open
Account System"), purchases will be executed at the price next computed after
receipt of the investor's funds at the main office of the Distributor. Wire
purchases through a selected dealer may involve other procedures established by
that dealer.
OFFERING PRICE OF SHARES
The Fund offers shares of each Portfolio continuously through Princor
Financial Services Corporation which is the principal underwriter for the Fund
and sells shares as agent for the Fund. Shares are sold to the public at net
asset value, subject to the minimum investment requirements. In certain
circumstances, Princor Financial Services Corporation will compensate its
registered representatives or a selected dealer with whom it has entered into a
selling agreement for their efforts in distributing shares of the fund.
Compensation will be an ongoing fee in an amount up to 0.10% on an annualized
basis of the average net asset value of shares held in a customer account the
establishment of which is attributable to the efforts of the registered
representative or selected dealer.
MINIMUM INVESTMENT REQUIREMENT
The minimum initial purchase in the Fund is $1.0 million. The minimum
initial purchase of $1.0 million may be invested over a three month period.
Investments in any of the Portfolios by an investor, the investor's spouse,
dependent children or a trustee may be combined to meet this minimum. There is
no minimum for additional investments. If the total $1.0 million investment is
not completed within the three month period, the shareholder will be given
notice of the additional investment needed to meet the minimum and if not
remitted within 30 days, the account will be redeemed.
OPEN ACCOUNT SYSTEM
Share certificates will not ordinarily be issued to shareholders.
Shareholders of each Portfolio will receive a statement of account each time
they invest. The statement will record the current investment and the total
number of shares then owned.
The Fund treats the statement of account as evidence of ownership of
shares. This is known as an open account system. It avoids the trouble and
expense of safeguarding share certificates and the cost of a lost instrument
bond if certificates are lost or destroyed. Certificates, which can be stolen or
lost, are unnecessary except for special purposes such as collateral for a loan.
A shareholder may obtain a certificate at any time for full shares by requesting
it from the Fund in writing. The certificate will be delivered promptly at no
cost. In cases where certificates have been issued, the certificate must be
surrendered in connection with a redemption, transfer or exchange.
The Fund has adopted the policy of requiring signature guarantees in
certain circumstances to safeguard shareholder accounts. A signature guarantee
is necessary under the following circumstances:
1. If a redemption payment is to be made payable to a payee other than
the registered shareholder or joint shareholders, or to Principal
Mutual Life Insurance Company or any of its affiliated companies;
2. To change the ownership of the account;
3. If a redemption payment is to be mailed to an address other than the
address of record or to an address of record that has been changed
within the preceding three months.
4. To add telephone transaction services to an account after the initial
application is processed.
5. To change the designated commercial bank account authorized to accept
redemption proceeds.
A shareholder's signature must be guaranteed by a commercial bank, trust
company, credit union, savings and loan association, national securities
exchange member, or brokerage firm. A signature guaranteed by a notary public is
not acceptable.
Although there currently is no minimum balance, due to the
disproportionately high cost of maintaining small accounts, the Fund reserves
the right to redeem all shares in an account with a value of less than $5,000
and to mail the proceeds to the shareholder. Involuntary redemptions will not be
triggered solely by market activity. Shareholders will be notified before these
redemptions are to be made and will have thirty days to make an additional
investment to bring their accounts up to the required minimum. The Fund reserves
the right to increase the required minimum.
All orders are subject to acceptance by the Fund and the Distributor. The
Fund's Board of Directors reserves the right to change or waive minimum
investment requirements at any time, which would be applicable to all investors
alike.
REDEMPTION OF SHARES
Each Portfolio will redeem its shares upon request. There is no charge for
redemptions. Princor Financial Services usually requires additional
documentation for the sale of shares by a corporation, partnership, agent or
fiduciary, or a surviving joint owner. Contact Princor Financial Services for
details. Shareholders may redeem in one of two ways:
By Mail - If no certificates have been issued, a shareholder simply writes
a letter to the Fund, at Princor Financial Services Corporation, P.O. Box 10423,
Des Moines, Iowa 50306-0423, requesting redemption of any part or all of the
shares owned by specifying either a dollar or share amount. The letter must
provide the account number, shareholder social security number, or tax
identification number and be signed by a registered owner. If certificates have
been issued, they must be properly endorsed and forwarded with the redemption
request. If redemption proceeds are to be sent by wire transfer to a bank
account previously designated as authorized to accept a wire transfer, or if
payment is to be mailed to the address of record, which has not been changed
within the three month period preceding the redemption request, and is made
payable to the registered shareholder or joint shareholders, or to Principal
Mutual Life Insurance Company or any of its affiliated companies, the Fund will
not require a signature guarantee as a part of a proper endorsement; otherwise
the shareholder's signature must be guaranteed by either a commercial bank,
trust company, credit union, savings and loan association, national securities
exchange member, or by a brokerage firm. A signature guaranteed by a notary
public or savings bank is not acceptable.
By Telephone - Shareholders may, by telephone, direct proceeds from
redemptions from the shareholder's account to be sent to the address of record,
if such address has not changed within the three month period preceding the date
of the request, or transferred to a commercial bank account in the United States
previously authorized in writing by the shareholder. The telephone redemption
privilege is available only if telephone transaction services apply to the
account from which shares are redeemed. Telephone transaction services apply to
all accounts, unless the shareholder has specifically declined this service on
the account application or in writing to the Fund. If certificates have been
issued, the telephone redemption privilege will not be allowed on those shares.
Shareholders may exercise the telephone redemption privilege by telephoning
1-800-521-1502. If all telephone lines are busy, shareholders might not be able
to request telephone redemptions and would have to submit written redemption
requests. Redemption proceeds may be sent to the previously designated bank by
check or wire transfer. If proceeds are to be used to settle a securities
transaction with a selected dealer, telephone redemptions may be requested by
the shareholder or upon appropriate authorization from an authorized
representative of the dealer, and the proceeds will be wired to the dealer.
Telephone redemption requests must be received by the Fund by the close of
the New York Stock Exchange on a day when the Fund is open for business to be
effective that day. Requests made after that time or on a day when the Fund is
not open for business will be effective the next business day. Although the Fund
and the transfer agent are not responsible for the authenticity of redemption
requests received by telephone, the right is reserved to refuse telephone
redemptions when in the opinion of the Fund or the transfer agent it seems
prudent to do so. The shareholder bears the risk of loss caused by a fraudulent
telephone redemption request which the Fund reasonably believes to be genuine.
The Fund will employ reasonable procedures to confirm that instructions
communicated by telephone are genuine and if such procedures are not followed,
the Fund may be liable for losses due to unauthorized or fraudulent
transactions. Such procedures include requiring the caller to provide the
shareholder's social security number or tax identification number, date of birth
(if an individual) and current address; mailing written confirmation of the
transaction to the address of record; and recording telephone instructions. In
addition, the Fund directs redemption proceeds made payable to the owner or
owners of the account only to the address of record that has not been changed
within the three month period prior to the date of the telephone request or to a
previously authorized bank account.
General - Redemptions, whether in writing or by telephone or other means,
by any joint owner shall be binding upon all joint owners. The price at which
the shares are redeemed will be the net asset value per share as next determined
after the request is received by the Fund in proper and complete form. The
amount received for shares upon redemption may be more or less than the cost of
such shares depending upon the net asset value at the time of redemption.
Accurate records should be kept for the duration of the account for tax
purposes.
Redemption proceeds will be sent within three business days after receipt
of a request for redemption in proper form. However, the Fund may suspend the
right of redemption during any period when (a) trading on the New York Stock
Exchange is restricted as determined by the Securities and Exchange Commission
or such Exchange is closed for other than weekends and holidays; (b) an
emergency exists, as determined by the Securities and Exchange Commission, as a
result of which (i) disposal by the Fund of securities owned by it is not
reasonably practicable, or (ii) it is not reasonably practicable for the Fund
fairly to determine the value of its net assets; or (c) the Commission by order
so permits for the protection of security holders of the Fund.
The Fund will redeem only Portfolio shares for which it has received good
payment. To avoid the inconvenience of such a delay, shares may be purchased
with a certified check, bank cashier's check or money order.
The Fund reserves the right to modify any of the methods of redemption or
to charge a fee for providing these services upon written notice to
shareholders.
PERIODIC WITHDRAWAL PLAN
A shareholder may request that a fixed number of shares ($100 initial
minimum amount) or enough shares to produce a fixed amount of money ($100
initial minimum payment) be withdrawn from an account monthly, quarterly,
semi-annually or annually. The Fund makes no recommendation as to either the
number of shares or the fixed amount that the investor may withdraw. An investor
may initiate a Periodic Withdrawal Plan by signing an Agreement for Periodic
Withdrawal Form and depositing any share certificates that have been issued or,
if no certificates have been issued and telephone transaction services apply to
the account, by telephoning the Fund.
Cash withdrawals are made out of the proceeds of redemption on the day
designated by the shareholder, so long as the day is a trading day, and will
continue until cancelled. If the designated day is not a trading day, the
redemption will occur on the next trading day occurring during that month. If
the next trading day occurs in the following month, the redemption will occur on
the day prior to the designated day. Withdrawal payments will be sent on or
before the third business day following such redemption. The redemption of
shares to make payments under this Plan will reduce and may eventually exhaust
the account.
Each redemption of shares may result in a gain or loss, which may be
reportable for income tax purposes. An investor should keep an accurate record
of any gain or loss on each withdrawal. Any income dividends or capital gains
distributions on shares held under a Periodic Withdrawal Plan are reinvested in
additional shares at net asset value. Withdrawals may be stopped at any time
without penalty, subject to notice in writing which is received by the Fund.
ADDITIONAL INFORMATION
Organization: The Fund was incorporated in the state of Maryland on January
28, 1993.
Custodian: Bank of New York, 48 Wall Street, New York, New York 10286, is
custodian of the portfolio securities and cash assets of the Mortgage-Backed
Securities Portfolio. The custodian for the International Emerging Markets
Portfolio, International Securities Portfolio and the International SmallCap
Portfolio is Chase Manhattan Bank, N.A., Global Security Services, Chase Metro
Tech Center, Brooklyn, New York 11245. The custodians perform no managerial or
policymaking functions for the Fund.
Capitalization: The authorized capital stock of each Portfolio consists of
100,000,000 shares of common stock, $.01 par value.
Financial Statements: Copies of the financial statements of the Fund will
be mailed to each shareholder semi-annually. At the close of each fiscal year,
the Fund's financial statements will be audited by a firm of independent
auditors. The firm of Ernst & Young LLP has been appointed to audit the
financial statements of the Fund.
Registration Statement: This Prospectus omits some information contained in
the Statement of Additional Information (also known as Part B of the
Registration Statement) and Part C of the Registration Statement which the Fund
has filed with the Securities and Exchange Commission. The Fund's Statement of
Additional Information is hereby incorporated by reference into this Prospectus.
A copy of this Statement of Additional Information can be obtained upon request,
free of charge, by writing or telephoning Princor Financial Services
Corporation. You may obtain a copy of Part C of the Registration Statement filed
with the Securities and Exchange Commission, Washington, D.C. from the
Commission upon payment of the prescribed fees.
Principal Underwriter: Princor Financial Services Corporation, P.O. Box
10423, Des Moines, Iowa 50306-0423, is the principal underwriter for the Fund.
Transfer Agent and Dividend Disbursing Agent: Principal Management
Corporation, The Principal Financial Group, Des Moines, Iowa, 50392-0200, is the
transfer agent and dividend disbursing agent for the Fund.
PART B
PRINCIPAL SPECIAL MARKETS FUND, INC.
INTERNATIONAL EMERGING MARKETS PORTFOLIO
INTERNATIONAL SECURITIES PORTFOLIO
INTERNATIONAL SMALLCAP PORTFOLIO
MORTGAGE-BACKED SECURITIES PORTFOLIO
Statement of Additional Information
dated May 1, 1998
This Statement of Additional Information provides information about
each Portfolio in addition to the information that is contained in the
Prospectus, dated May 1, 1998.
This Statement of Additional Information is not a prospectus. It should
be read in conjunction with the Prospectus, a copy of which can be obtained free
of charge by writing or telephoning:
Princor Financial Services Corporation
P.O. Box 10423
Des Moines, Iowa 50306-0423
Telephone: 1-800-451-5447
FV 76 B-7
TABLE OF CONTENTS
Investment Policies and Restrictions ........................... 2
Investments .................................................... 4
Directors and Officers of the Fund.............................. 14
Manager and Sub-Advisor ........................................ 16
Cost of Manager's Services ..................................... 17
Brokerage on Purchases and Sales of Securities ................. 19
Offering Price ................................................. 21
Determination of Net Asset Value ............................... 21
Performance Calculation ........................................ 22
Tax Treatment, Dividends and Distributions ..................... 24
Financial Statements............................................ 25
INVESTMENT POLICIES AND RESTRICTIONS
The following information supplements the information provided in the
Prospectus under the caption "Investment Objectives, Policies and Restrictions."
INVESTMENT RESTRICTIONS
In implementing the investment policies of the Portfolios, the Fund is
subject to fundamental and nonfundamental restrictions. Nonfundamental
restrictions may be changed by the Board of Directors without shareholder
approval. Fundamental restrictions may only be changed by a vote of the lesser
of (i) 67% or more of the shares represented at a meeting at which more than 50%
of the outstanding shares are represented or (ii) more than 50% of the
outstanding shares. The required shareholder approval shall be effective with
respect to a Portfolio if a majority of the outstanding voting securities of
that Portfolio votes to approve the matter, notwithstanding that the matter has
not been approved by a majority of the outstanding voting securities of the Fund
or of any other Portfolio affected by the matter.
The investment objective and investment policies and restrictions of
each Portfolio discussed in the Prospectus and the Statement of Additional
Information, except for those investment restrictions identified below under the
caption "Fundamental Restrictions," are not fundamental and may be changed by
the Fund's Board of Directors without shareholder approval. Shareholders must be
given 30 days prior written notice before the investment objectives of the
Portfolios may be amended at the discretion of the Board of Directors.
All percentage limitations apply at the time of acquisition of a
security, and any subsequent change in any applicable percentage resulting from
changes in the values or nature of a Portfolio's assets will not require
elimination of the security from the Portfolio.
Fundamental Restrictions. Each of the following restrictions is fundamental
and may not be changed without shareholder approval. Each Portfolio will not
(unless specifically excepted):
(1) With respect to 75% of its total assets, purchase the securities
of any issuer if the purchase would cause more than 5% of the
total assets of the Portfolio to be invested in the securities of
any one issuer (other than securities issued or guaranteed by the
United States Government or its agencies or instrumentalities) or
cause more than 10% of the outstanding voting securities of any
one issuer to be held by the Portfolio.
(2) Borrow money, except (a) for temporary or emergency purposes in
an amount not to exceed 5% of the value of the Portfolio's total
assets at the time of the borrowing and (b) for any purpose from
banks in an amount not to exceed one-third of the Portfolio's
total assets (including the amount borrowed) less all liabilities
and indebtedness other than borrowings deemed to be senior
securities.
(3) Issue any senior securities as defined in the Investment Company
Act of 1940. For purposes of this restriction, purchasing and
selling securities, currency and futures contracts and options
and borrowing money in accordance with restrictions described
herein do not involve the issuance of a senior security.
(4) Act as an underwriter of securities, except to the extent the
Portfolio may be deemed to be an underwriter in connection with
the sale of securities held in its portfolio.
(5) Concentrate its investments in any particular industry or
industries, except that the Portfolio may invest not more than
25% of the value of its total assets in a single industry. For
purposes of this restriction, foreign government and
supranational issuers are not considered members of any industry.
(6) Invest in real estate, although it may invest in securities which
are secured by real estate and securities of issuers which invest
or deal in real estate.
(7) Invest in commodities or commodity contracts, but it may purchase
and sell currency and financial futures contracts and options on
such contracts.
(8) Make loans, except that the Portfolio may (i) purchase and hold
debt obligations in accordance with its investment objective and
policies, (ii) enter into repurchase agreements, and (iii) lend
its portfolio securities but not in excess of 33% of the value of
its total assets. The deposit of underlying securities and other
assets in escrow and other collateral arrangements in connection
with options, currency and futures transactions are not deemed to
be the making of loans.
Nonfundamental Restrictions. Each of the following restrictions is
nonfundamental and may be changed by the Board of Directors without shareholder
approval. Each Portfolio will not (unless specifically excepted):
(1) Invest more than 15% of its total assets in securities not
readily marketable and in repurchase agreements maturing in more
than seven days. The value of any options purchased in the
over-the-counter market are included as part of this 15%
limitation.
(2) Sell securities short (except where the Portfolio holds or has
the right to obtain at no added cost a long position in the
securities sold that equals or exceeds the securities sold short)
or purchase any securities on margin, except it may obtain such
short-term credits as are necessary for the clearance of
transactions. The deposit or payment of margin in connection with
options, currency and futures transactions is not considered the
purchase of securities on margin.
(3) Invest in companies for the purpose of exercising control or
management.
(4) Purchase puts, calls, straddles, spreads or any combination
thereof if by reason thereof the value of its aggregate
investment in such classes of securities will exceed 5% of its
total assets. Options will be used solely for hedging purposes;
not for speculation.
(5) Invest more than 5% of its assets in initial margin and premiums
on futures contracts and options on such contracts.
(6) Purchase securities of other investment companies if the purchase
would cause more than 10% of its total assets to be invested in
securities of other investment companies or more than 5% of its
total assets to be invested in the securities of any investment
company or would cause the Portfolio to own more than 3% of the
outstanding voting securities of any investment company. These
restrictions do not apply to purchases in connection with a
merger, consolidation, or plan of reorganization. [For purposes
of these restrictions, privately issued collateralized mortgage
obligations will not be treated as investment company securities
if issued by "Exemptive Issuers." Exemptive Issuers are defined
as unmanaged, fixed-asset issuers that (i) invest primarily in
mortgage-backed securities, (ii) do not issue redeemable
securities as defined in section 2(a)(32) of the Investment
Company Act of 1940, (iii) operate under general exemptive orders
exempting them from "all provisions of the Investment Company Act
of 1940," and (iv) are not registered or regulated under the
Investment Company Act of 1940 as investment companies.]
(7) Pledge, mortgage or hypothecate its assets, except to secure
permitted borrowings. The deposit of underlying securities and
other assets in escrow and other collateral arrangements in
connection with options, currency and futures transactions are
not deemed to be pledges or other encumbrances.
(8) Purchase warrants in excess of 5% of its total assets, of which
2% may be invested in warrants that are not listed on the New
York, American or Toronto Stock Exchanges or the Chicago Board
Options Exchange. This restriction does not apply to warrants
included in units or attached to other securities.
(9) Invest in interests in oil, gas or other mineral exploration or
development programs, although the Portfolio may invest in
securities of issuers which invest in or sponsor such programs.
(10) Purchase securities of any issuer having less than three years'
continuous operation (including operations of any predecessors)
if such purchase would cause the value of the Portfolio's
investments in all such issuers to exceed 5% of the value of its
total assets.
(11) Purchase or retain in its portfolio securities of any issuer if
those officers or directors of the Fund or its Manager owning
beneficially more than one-half of 1% (0.5%) of the securities of
the issuer together own beneficially more than 5% of such
securities.
(12) Invest in arbitrage transactions.
(13) Invest in mineral leases.
(14) Invest in real estate limited partnership interests.
(15) Invest more than 25% of the value of its total assets (i) in the
securities issued by a single foreign government; or (ii) in
securities issued by supranational issuers.
The Manager will waive its management fee on Portfolio assets invested
in securities of other open-end investment companies and will generally invest
only in those open-end investment companies that have investment policies
requiring investment in securities comparable to those in which the Portfolio
invests.
INVESTMENTS
The following information further supplements the discussion of the
investment objectives and policies in the Prospectus under the caption
"INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS."
In making selections of equity securities, Invista will use an approach
described broadly as fundamental analysis. Fundamental analysis consists of
three steps. First is the continuing study of basic economic factors in an
effort to conclude what the future general economic climate is likely to be over
the next one to two years. Second, given some conviction as to the likely
economic climate, Invista attempts to identify the prospects for the major
industrial, commercial and financial segments of the economy, by looking at such
factors as demand for products, capacity to produce, operating costs, pricing
structure, marketing techniques, adequacy of raw materials and components,
domestic and foreign competition, and research productivity, to ascertain
prospects for each industry for the near and intermediate term. Finally, Invista
determines what the earnings prospects are for individual companies within each
industry by considering the same types of factors described above. Invista
evaluates these earnings prospects in relation to the current price of the
securities of each company.
Although each Portfolio may pursue the investment practices described
under the captions Restricted Securities, Foreign Securities, Spread
Transactions, Options on Securities and Securities Indices, and Futures
Contracts and Options on Futures Contracts, Currency Contracts, Repurchase
Agreements, Lending of Portfolio Securities and When-Issued and Delayed Delivery
Securities, none of the Portfolios currently intends to commit during the
present fiscal year more than 5% of its net assets to any of the practices, with
the exception that the Mortgage-Backed Securities Portfolio may commit more than
5% of its net assets in When-Issued and Delayed Delivery Securities. The
International Emerging Markets Portfolio, International Securities Portfolio and
International SmallCap Portfolio will each invest more than 5% of its net assets
in foreign securities. Each Portfolio may commit more than 5% of its assets to
Currency Contracts.
Restricted Securities
Each Portfolio is subject to an investment restriction that limits its
investments in illiquid securities to 15% of its net asset value. In computing
the Portfolio's net asset value per share, illiquid securities are valued at
their fair value as determined in good faith by or under the direction of the
Board of Directors.
Each Portfolio may acquire securities that are subject to legal or
contractual restrictions upon resale. Securities subject to such restrictions
("restricted securities") are frequently treated as illiquid for purposes of the
15% restriction. Such securities may be sold only in a public offering with
respect to which a registration statement is in effect under the Securities Act
of 1933 ("1933 Act") or in a transaction which is exempt from the registration
requirements of that act. One such exemption is provided by Rule 144A under the
1933 Act, pursuant to which certain restricted securities may be sold at a
readily ascertainable price. The Board of Directors has adopted procedures to
determine the liquidity of restricted securities qualifying for Rule 144A
treatment, and any such securities so determined to be liquid will be excluded
when applying the Portfolio's limitation on illiquid securities. To the extent
Rule 144A securities held by a Portfolio should become illiquid because of a
lack of interest on the part of qualified institutional investors, the overall
liquidity of the Portfolio could be adversely affected.
When registration of a restricted security is required, a Portfolio may
be obligated to pay all or a part of the registration expenses and a
considerable period may elapse between the time of the decision to sell and the
time the Portfolio may be permitted to sell the security under an effective
registration statement. If during such a period adverse market conditions were
to develop, the Portfolio might obtain a less favorable price than prevailed
when it decided to sell.
Foreign Securities
Investment in foreign securities presents certain risks, including those
resulting from fluctuations in currency exchange rates, revaluation of
currencies, the imposition of foreign taxes, the withholding of taxes on
dividends at the source, future political and economic developments including
war, expropriations, nationalization, the possible imposition of currency
exchange controls and other foreign governmental laws or restrictions, reduced
availability of public information concerning issuers, and the fact that foreign
issuers are not generally subject to uniform accounting, auditing and financial
reporting standards or to other regulatory practices and requirements comparable
to those applicable to domestic issuers. Moreover, securities of many foreign
issuers may be less liquid and their prices more volatile than those of
comparable domestic issuers. In addition, transactions in foreign securities may
be subject to higher costs, and the time for settlement of transactions in
foreign securities may be longer than the settlement period for domestic
issuers. A Portfolio's investment in foreign securities may also result in
higher custodial costs and the costs associated with currency conversions.
Securities of many foreign issuers may be less liquid and their prices
more volatile than those of comparable domestic issuers. In particular,
securities markets in emerging market countries are known to experience long
delays between the trade and settlement dates of securities purchased and sold,
potentially resulting in a lack of liquidity and greater volatility in the price
of securities on those markets. In addition, investments in smaller companies
may present greater opportunities for capital appreciation, but may also involve
greater risks than large, mature issuers. Such companies may have limited
product lines and financial resources. Their securities may trade in more
limited volume than larger companies and may therefore experience significantly
more price volatility and less liquidity than securities of larger companies. As
a result of these factors, the Boards of Directors of the Funds have adopted
Daily Pricing and Valuation Procedures for the Funds which set forth the steps
to be followed by the Manager and Sub-Advisor to establish a reliable market or
fair value if a reliable market value is not available through normal market
quotations. Oversight of this process is provided by the Executive Committee of
the Boards of Directors.
Spread Transactions, Options on Securities and Securities Indices, Futures
Contracts and Options on Futures Contracts, and Currency Contracts
Except as specifically indicated otherwise, each Portfolio may engage in
the practices described under this heading to attempt to hedge market value,
interest rate and currency risks and, in certain cases, to enhance its income.
Spread Transactions
A Portfolio may purchase from securities dealers covered spread options.
Such covered spread options are not presently exchange listed or traded. The
purchase of a spread option gives the Portfolio the right to put, or sell, a
security that it owns at a fixed dollar spread or fixed yield spread in
relationship to another security that the Portfolio does not own, but which is
used as a benchmark. The risk to the Portfolio in purchasing covered spread
options is the cost of the premium paid for the spread option and any
transaction costs. In addition, there is no assurance that closing transactions
will be available. The purchase of spread options can be used to protect the
Portfolio against adverse changes in prevailing credit quality spreads, i.e.,
the yield spread between high quality and lower quality securities. The security
covering the spread option will be maintained in a segregated account by the
Portfolio's custodian. A security covered by a spread option is not considered
to be "pledged" as that term is used in the Portfolio's policy limiting the
pledging or mortgaging of assets.
Options on Securities and Securities Indices
Each Portfolio may write (sell) and purchase call and put options on
securities in which it may invest and on securities indices based on securities
in which the Portfolio may invest. The Portfolio may write calland put options
to generate additional revenue, and may write and purchase call and put options
in seeking to hedge against a decline in the value of securities owned or an
increase in the price of securities which the Portfolio plans to purchase.
Writing Covered Call and Put Options. When a Portfolio writes a call
option, it gives the purchaser of the option, in return for the premium it
receives, the right to buy from the Portfolio the underlying security at a
specified price at any time before the option expires. When a Portfolio writes a
put option, it gives the purchaser of the option, in return for the premium it
receives, the right to sell to the Portfolio the underlying security at a
specified price at any time before the option expires.
The premium received by a Portfolio, when it writes a put or call
option, reflects, among other factors, the current market price of the
underlying security, the relationship of the exercise price to the market price,
the time period until the expiration of the option and interest rates. The
premium will generate additional income for the Portfolio if the option expires
unexercised or is closed out at a profit. By writing a call, a Portfolio limits
its opportunity to profit from any increase in the market value of the
underlying security above the exercise price of the option, but it retains the
risk of loss if the price of the security should decline. By writing a put, a
Portfolio assumes the risk that it may have to purchase the underlying security
at a price that may be higher than its market value at time of exercise.
The Portfolios write only covered options and will comply with
applicable regulatory and exchange cover requirements. A Portfolio will own the
underlying security covered by any outstanding call option that it has written
or will be able to acquire such security through the exercise of conversion
privileges on convertible securities or otherwise at no additional cost. With
respect to an outstanding put option that it has written, each Portfolio will
deposit and maintain with its custodian cash, U.S. Government securities or
other liquid securities with a value at least equal to the exercise price of the
option.
Once a Portfolio has written an option, it may terminate its obligation,
before the option is exercised, by effecting a closing transaction, which is
accomplished by the Portfolio's purchasing an option of the same series as the
option previously written. The Portfolio will have a gain or loss depending on
whether the premium received when the option was written exceeds the closing
purchase price plus related transaction costs.
Purchasing Call and Put Options. When a Portfolio purchases a call
option, it receives, in return for the premium it pays, the right to buy from
the writer of the option the underlying security at a specified price at any
time before the option expires. The Portfolio may purchase call options in
anticipation of an increase in the market value of securities that it intends
ultimately to buy. During the life of the call option, the Portfolio would be
able to buy the underlying security at the exercise price regardless of any
increase in the market price of the underlying security. In order for a call
option to result in a gain, the market price of the underlying security must
rise to a level that exceeds the sum of the exercise price, the premium paid and
transaction costs. If the option expires unexercised, the Portfolio will lose
the premium paid and any transaction costs incurred.
When a Portfolio purchases a put option, it receives, in return for the
premium it pays, the right to sell to the writer of the option the underlying
security at a specified price at any time before the option expires. The
Portfolio may purchase put options in anticipation of a decline in the market
value of the underlying security. During the life of the put option, the
Portfolio would be able to sell the underlying security at the exercise price
regardless of any decline in the market price of the underlying security. In
order for a put option to result in a gain, the market price of the underlying
security must decline, during the option period, below the exercise price
sufficiently to cover the premium and transaction costs.
Once a Portfolio has purchased an option, it may close out its position
by selling an option of the same series as the option previously purchased. The
Portfolio will have a gain or loss depending on whether the closing sale price
exceeds the initial purchase price plus related transaction costs.
Options on Securities Indices. Each Portfolio may purchase and sell put
and call options on any securities index based on securities in which the
Portfolio may invest. Securities index options are designed to reflect price
fluctuations in a group of securities or segment of the securities market rather
than price fluctuations in a single security. Options on securities indices are
similar to options on securities, except that the exercise of securities index
options requires cash payments and does not involve the actual purchase or sale
of securities. A Portfolio would engage in transactions in put and call options
on securities indices for the same purposes as it would engage in transactions
in options on securities. When a Portfolio writes call options on securities
indices, it will hold in its portfolio underlying securities which, in the
judgment of Invista, correlate closely with the securities index and which have
a value at least equal to the aggregate amount of the securities index options.
Risks Associated with Options Transactions. An options position may be
closed out only on an exchange which provides a secondary market for an option
of the same series. Although a Portfolio will generally purchase or write only
those options for which there appears to be an active secondary market, there is
no assurance that a liquid secondary market on an exchange will exist for any
particular option, or at any particular time. For some options, no secondary
market on an exchange or elsewhere may exist. If a Portfolio is unable to effect
closing sale transactions in options it has purchased, the Portfolio would have
to exercise its options in order to realize any profit and may incur transaction
costs upon the purchase or sale of underlying securities pursuant thereto. If a
Portfolio is unable to effect a closing purchase transaction for a covered
option that it has written, it will not be able to sell the underlying
securities, or dispose of the assets held in a segregated account, until the
option expires or is exercised. A Portfolio's ability to terminate option
positions established in the over-the-counter market may be more limited than
for exchange-traded options and may also involve the risk that broker-dealers
participating in such transactions might fail to meet their obligations.
A Portfolio's hedging strategy that employs options on a securities
index may be unsuccessful due to imperfect correlation between the securities in
the index and the securities owned by the Portfolio. In addition, if Invista is
incorrect in predicting the direction of stock prices, interest rates and other
economic factors, hedging through the use of options could result in a lower
return than if the Portfolio had not hedged its investments.
Futures Contracts and Options on Futures
Each Portfolio may purchase and sell financial futures contracts and
options on those contracts. Financial futures contracts are commodities
contracts based on financial instruments such as U.S. Treasury bonds or bills or
on securities indices such as the S&P 500 Index. Futures contracts, options on
futures contracts and the commodity exchanges on which they are traded are
regulated by the Commodity Futures Trading Commission ("CFTC"). Through the
purchase and sale of futures contracts and related options, a Portfolio may seek
to hedge against a decline in securities owned by the Portfolio or an increase
in the price of securities which the Portfolio plans to purchase.
Futures Contracts. When a Portfolio sells a futures contract based on a
financial instrument, the Portfolio becomes obligated to deliver that kind of
instrument at a specified future time for a specified price. When a Portfolio
purchases the futures contract, it becomes obligated to take delivery of the
instrument at a specified time and to pay the specified price. In most
instances, these contracts are closed out by entering into an offsetting
transaction before the settlement date, thereby canceling the obligation to make
or take delivery of specific securities. The Portfolio realizes a gain or loss
depending on whether the price of an offsetting purchase plus transaction costs
are less or more than the price of the initial sale or on whether the price of
an offsetting sale is more or less than the price of the initial purchase plus
transaction costs. Although a Portfolio will usually liquidate futures contracts
on financial instruments in this manner, it may instead make or take delivery of
the underlying securities whenever it appears economically advantageous to do
so.
A futures contract based on a securities index provides for the purchase
or sale of a group of securities at a specified future time for a specified
price. These contracts do not require actual delivery of securities, but result
in a cash settlement based upon the difference in value of the index between the
time the contract was entered into and the time it is liquidated, which may be
at its expiration or earlier if it is closed out by entering into an offsetting
transaction.
When a futures contract is purchased or sold a brokerage commission is
paid, but unlike the purchase or sale of a security or option, no price or
premium is paid or received. Instead, an amount of cash or U.S. Government
securities, which varies, but is generally about 5% of the contract amount, is
deposited by the Portfolio with its custodian for the benefit of the futures
commission merchant through which the Portfolio engages in the transaction. This
amount is known as "initial margin." It does not involve the borrowing of funds
by the Portfolio to finance the transaction, but instead represents a "good
faith" deposit assuring the performance of both the purchaser and the seller
under the futures contract. It is returned to the Portfolio upon termination of
the futures contract, if all the Portfolio's contractual obligations have been
satisfied.
Subsequent payments to and from the broker, known as "variation margin,"
are required to be made on a daily basis as the price of the futures contract
fluctuates, making the long or short positions in the futures contract more or
less valuable, a process known as "marking to market." If the position is closed
out by taking an opposite position prior to the settlement date of the futures
contract, a final determination of variation margin is made, additional cash is
required to be paid to or released by the broker, and the Portfolio realizes a
loss or gain.
In using futures contracts, a Portfolio will seek to establish more
certainly than would otherwise be possible the effective price of or rate of
return on portfolio securities or securities that the Portfolio proposes to
acquire. A Portfolio, for example, may sell futures contracts in anticipation of
a rise in interest rates which would cause a decline in the value of its debt
investments. When this kind of hedging is successful, the futures contracts
should increase in value when the Portfolio's debt securities decline in value
and thereby keep the Portfolio's net asset value from declining as much as it
otherwise would. A Portfolio may also sell futures contracts on securities
indices in anticipation of or during a stock market decline in an endeavor to
offset a decrease in the market value of its equity investments. When a
Portfolio is not fully invested and anticipates an increase in the cost of
securities it intends to purchase, it may purchase financial futures contracts.
When increases in the prices of equities are expected, a Portfolio may purchase
futures contracts on securities indices in order to gain rapid market exposure
that may partially or entirely offset increases in the cost of the equity
securities it intends to purchase.
Options on Futures. A Portfolio may also purchase and write call and put
options on futures contracts. A call option on a futures contract gives the
purchaser the right, in return for the premium paid, to purchase a futures
contract (assume a long position) at a specified exercise price at any time
before the option expires. A put option gives the purchaser the right, in return
for the premium paid, to sell a futures contract (assume a short position), for
a specified exercise price, at any time before the option expires.
Upon the exercise of a call, the writer of the option is obligated to
sell the futures contract (to deliver a long position to the option holder) at
the option exercise price, which will presumably be lower than the current
market price of the contract in the futures market. Upon exercise of a put, the
writer of the option is obligated to purchase the futures contract (deliver a
short position to the option holder) at the option exercise price, which will
presumably be higher than the current market price of the contract in the
futures market. However, as with the trading of futures, most options are closed
out prior to their expiration by the purchase or sale of an offsetting option at
a market price that will reflect an increase or a decrease from the premium
originally paid.
Options on futures can be used to hedge substantially the same risks as
might be addressed by the direct purchase or sale of the underlying futures
contracts. For example, if a Portfolio anticipated a rise in interest rates and
a decline in the market value of the debt securities in its portfolio, it might
purchase put options or write call options on futures contracts instead of
selling futures contracts.
If a Portfolio purchases an option on a futures contract, it may obtain
benefits similar to those that would result if it held the futures position
itself. But in contrast to a futures transaction, the purchase of an option
involves the payment of a premium in addition to transaction costs. In the event
of an adverse market movement, however, the Portfolio will not be subject to a
risk of loss on the option transaction beyond the price of the premium it paid
plus its transaction costs.
When a Portfolio writes an option on a futures contract, the premium
paid by the purchaser is deposited with the Portfolio's custodian, and the
Portfolio must maintain with its custodian all or a portion of the initial
margin requirement on the underlying futures contract. The Portfolio assumes a
risk of adverse movement in the price of the underlying futures contract
comparable to that involved in holding a futures position. Subsequent payments
to and from the broker, similar to variation margin payments, are made as the
premium and the initial margin requirement are marked to market daily. The
premium may partially offset an unfavorable change in the value of portfolio
securities, if the option is not exercised, or it may reduce the amount of any
loss incurred by the Portfolio if the option is exercised.
Risks Associated with Futures Transactions. There are a number of risks
associated with transactions in futures contracts and related options. A
Portfolio's successful use of futures contracts is subject to Invista's ability
to predict correctly the factors affecting the market values of the Portfolio's
portfolio securities. For example, if a Portfolio was hedged against the
possibility of an increase in interest rates which would adversely affect debt
securities held by the Portfolio and the prices of those debt securities instead
increased, the Portfolio would lose part or all of the benefit of the increased
value of its securities which it hedged because it would have offsetting losses
in its futures positions. Other risks include imperfect correlation between
price movements in the financial instrument or securities index underlying the
futures contract, on the one hand, and the price movements of either the futures
contract itself or the securities held by the Portfolio, on the other hand. If
the prices do not move in the same direction or to the same extent, the
transaction may result in trading losses.
Prior to exercise or expiration, a position in futures may be terminated
only by entering into a closing purchase or sale transaction. This requires a
secondary market on the relevant contract market. The Portfolio will enter into
a futures contract or related option only if there appears to be a liquid
secondary market. There can be no assurance, however, that such 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 out a futures
position once it has been established. Under such circumstances, the Portfolio
would continue to be required to make daily cash payments of variation margin in
the event of adverse price movements. In such situations, if the Portfolio has
insufficient cash, it may be required to sell portfolio securities to meet daily
variation margin requirements at a time when it may be disadvantageous to do so.
In addition, the Portfolio may be required to perform under the terms of the
futures contracts it holds. The inability to close out futures positions also
could have an adverse impact on a Portfolio's ability effectively to hedge its
portfolio.
Most United States futures exchanges limit the amount of fluctuation
permitted in futures contract prices during a single trading day. This daily
limit establishes the maximum amount that the price of a futures contract may
vary either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.
Limitations on the Use of Futures and Options on Futures. The Fund
intends that each Portfolio will come within an exclusion from the definition of
"commodity pool operator" provided by CFTC regulations by complying with certain
limitations on the use of futures and related options prescribed by those
regulations.
No Portfolio will purchase or sell futures contracts or options thereon
if immediately thereafter the aggregate initial margin and premiums exceed 5% of
the fair market value of the Portfolio's assets, after taking into account
unrealized profits and unrealized losses on any such contracts it has entered
into (except that in the case of an option that is in-the-money at the time of
purchase, the in-the-money amount generally may be excluded in computing the
5%).
The Portfolios will enter into futures contracts and related options
transactions only for bona fide hedging purposes as permitted by the CFTC and
for other appropriate risk management purposes, if any, which the CFTC may deem
appropriate for mutual funds excluded from the regulations governing commodity
pool operators. A Portfolio is not permitted to engage in speculative futures
trading. Invista will determine that the price fluctuations in the futures
contracts and options on futures used for hedging or risk management purposes
for a Portfolio are substantially related to price fluctuations in securities
held by the Portfolio or which it expects to purchase. In pursuing traditional
hedging activities, each Portfolio will sell futures contracts or acquire puts
to protect against a decline in the price of securities that the Portfolio owns,
and each Portfolio will purchase futures contracts or calls on futures contracts
to protect the Portfolio against an increase in the price of securities the
Portfolio intends to purchase before it is in a position to do so.
When a Portfolio purchases a futures contract, or purchases a call
option on a futures contract, it will comply with applicable cover requirements,
such as maintaining an amount of cash, cash equivalents or short-term high grade
fixed income securities in a segregated account with the Portfolio's custodian,
so that the amount so segregated plus the amount of initial margin held for the
account of its broker equals the market value of the futures contract.
A Portfolio will not maintain open short positions in futures contracts,
call options written on futures contracts, and call options written on
securities indices if, in the aggregate, the value of the open positions (marked
to market) exceeds the current market value of that portion of its securities
portfolio being hedged by those futures and options plus or minus the unrealized
gain or loss on those open positions, adjusted for the historical volatility
relationship between that portion of the portfolio and the contracts (i.e., the
Beta volatility factor). To the extent a Portfolio has written call options on
specific securities in that portion of its portfolio, the value of those
securities will be deducted from the current market value of that portion of the
securities portfolio. If this limitation should be exceeded at any time, the
Portfolio will take prompt action to close out the appropriate number of open
short positions to bring its open futures and options positions within this
limitation.
Currency Contracts
The International Emerging Markets Portfolio, International Securities
Portfolio and International SmallCap Portfolio each may engage in currency
transactions with securities dealers, financial institutions or other parties
that are deemed credit worthy by Invista to hedge the value of portfolio
securities denominated in particular currencies against fluctuations in relative
value. Currency transactions include forward currency contracts, exchange-listed
currency futures contracts and options thereon and exchange-listed and
over-the-counter options on currencies. A forward currency contract involves a
privately negotiated obligation to purchase or sell (with delivery generally
required) a specific currency at a future date, which may be any fixed number of
days from the date of the contract agreed upon the parties, at a price set at
the time of the contract.
A Portfolio will engage in currency transactions only for hedging and
other non-speculative purposes, including transaction hedging and position
hedging. Transaction hedging is entering into a currency transaction with
respect to specific assets or liabilities of a Portfolio, which will generally
arise in connection with the purchase or sale of the Portfolio's portfolio
securities or the receipt of income from them. Position hedging is entering into
a currency transaction with respect to portfolio securities positions
denominated or generally quoted in that currency. A Portfolio will not enter
into a transaction to hedge currency exposure to an extent greater, after
netting all transactions intended wholly or partially to offset other
transactions, than the aggregate market value (at the time of entering into the
transaction) of the securities held by the Portfolio that are denominated or
generally quoted in or currently convertible into the currency, other than with
respect to proxy hedging as described below.
A Portfolio may cross-hedge currencies by entering into transactions to
purchase or sell one or more currencies that are expected to increase or decline
in value relative to other currencies to which the Portfolio has or in which the
Portfolio expects to have exposure. To reduce the effect of currency
fluctuations on the value of existing or anticipated holdings of its securities,
a Portfolio may also engage in proxy hedging. Proxy hedging is often used when
the currency to which a Portfolio's holding is exposed is difficult to hedge
generally or difficult to hedge against the dollar. Proxy hedging entails
entering into a forward contract to sell a currency, the changes in the value of
which are generally considered to be linked to a currency or currencies in which
some or all of a Portfolio's securities are or are expected to be denominated,
and to buy dollars. The amount of the contract would not exceed the market value
of the Portfolios's securities denominated in linked currencies.
Except when a Portfolio enters into a forward contract in connection
with the purchase or sale of a security denominated in a foreign currency or for
other non-speculative purposes, which requires no segregation, a currency
contract that obligates the Portfolio to buy or sell a foreign currency will
generally require the Portfolio to place any asset, including equity securities
and non-investment grade debt, in a segregated account, so long as the asset is
liquid and marked to the market daily. The amount so segregated shall be equal
to the amount of the Portfolio's obligation.
Currency hedging involves some of the same risks and considerations as
other transactions with similar instruments. Currency transactions can result in
losses to a Portfolio if the currency being hedged fluctuates in value to a
degree or in a direction that is not anticipated. Further, the risk exists that
the perceived linkage between various currencies may not be present or may not
be present during the particular time that a Portfolio is engaging in proxy
hedging. Currency transactions are also subject to risks different from those of
other portfolio transactions. Because currency control is of great importance to
the issuing governments and influences economic planning and policy, purchases
and sale of currency and related instruments can be adversely affected by
government exchange controls, limitations or restrictions on repatriation of
currency, and manipulations or exchange restrictions imposed by governments.
These forms of governmental actions can result in losses to a Portfolio if it is
unable to deliver or receive currency or monies in settlement of obligations and
could also cause hedges it has entered into to be rendered useless, resulting in
full currency exposure as well as incurring transaction costs. Currency exchange
rates may also fluctuate based on factors extrinsic to a country's economy.
Buyers and sellers of currency futures contracts are subject to the same risks
that apply to the use of futures contracts generally. Further, settlement of a
currency futures contract for the purchase of most currencies must occur at a
bank based in the issuing nation. Trading options on currency futures contracts
is relative new, and the ability to establish and close out positions on these
options is subject to the maintenance of a liquid market that may not always be
available.
Repurchase Agreements
Each Portfolio may invest in repurchase agreements. No Portfolio will
enter into repurchase agreements that do not mature within seven days if any
such investment, together with other illiquid securities held by the Portfolio,
would amount to more than 15% of its assets. Repurchase agreements will
typically involve the acquisition by the Portfolio of debt securities from a
selling financial institution such as a bank, savings and loan association or
broker-dealer. A repurchase agreement provides that the Portfolio will sell back
to the seller and that the seller will repurchase the underlying securities at a
specified price and at a fixed time in the future. Repurchase agreements may be
viewed as loans by a Portfolio collateralized by the underlying securities
("collateral"). This arrangement results in a fixed rate of return that is not
subject to market fluctuation during the Portfolio's holding period. Although
repurchase agreements involve certain risks not associated with direct
investments in debt securities, each Portfolio follows procedures established by
the Board of Directors which are designed to minimize such risks. These
procedures include entering into repurchase agreements only with large,
well-capitalized and well-established financial institutions, which have been
approved by the Board of Directors and which Invista believes present minimum
credit risks. In addition, the value of the collateral underlying the repurchase
agreement will always be at least equal to the repurchase price, including
accrued interest. In the event of a default or bankruptcy by a selling financial
institution, the affected Portfolio bears a risk of loss. In seeking to
liquidate the collateral, a Portfolio may be delayed in or prevented from
exercising its rights and may incur certain costs. Further to the extent that
proceeds from any sale upon a default of the obligation to repurchase were less
than the repurchase price, the Portfolio could suffer a loss.
Lending of Portfolio Securities
Each Portfolio may lend its portfolio securities. No Portfolio intends
to lend its portfolio securities if as a result the aggregate of such loans made
by the Portfolio would exceed 33% of its total assets. Portfolio securities may
be lent to unaffiliated broker-dealers and other unaffiliated qualified
financial institutions provided that such loans are callable at any time on not
more than five business days' notice and that cash or government securities
equal to at least 100% of the market value of the securities loaned, determined
daily, is deposited by the borrower with the Portfolio and is maintained each
business day in a segregated account. While such securities are on loan, the
borrower will pay the Portfolio any income accruing thereon, and the Portfolio
may invest any cash collateral, thereby earning additional income, or may
receive an agreed upon fee from the borrower. Borrowed securities must be
returned when the loan is terminated. Any gain or loss in the market price of
the borrowed securities which occurs during the term of the loan inures to the
Portfolio and its shareholders. A Portfolio may pay reasonable administrative,
custodial and other fees in connection with such loans and may pay a negotiated
portion of the interest earned on the cash or government securities pledged as
collateral to the borrower or placing broker. The Fund does not vote securities
that have been loaned, but it will call a loan of securities in anticipation of
an important vote.
When-Issued and Delayed Delivery Securities
Each of the Portfolios may from time to time purchase securities on a
when-issued basis and may purchase or sell securities on a delayed delivery
basis. The price of such a transaction is fixed at the time of the commitment,
but delivery and payment take place on a later settlement date, which may be a
month or more after the date of the commitment. No interest accrues to the
purchaser during this period, and the securities are subject to market
fluctuation, which involves the risk for the purchaser that yields available in
the market at the time of delivery may be higher than those obtained in the
transaction. Each Portfolio will only purchase securities on a when-issued or
delayed delivery basis for the purpose of acquiring the securities and not for
the purpose of investment leverage or to speculate on interest rate changes, but
a Portfolio may sell the securities before the settlement date, if such action
is deemed advisable. At the time a Portfolio makes the commitment to purchase
securities on a when-issued or delayed delivery basis, the Fund will record the
transaction and thereafter reflect the value, each day, of the securities in
determining the net asset value of the Portfolio. Each Portfolio will also
establish a segregated account with its custodian bank in which it will maintain
cash or cash equivalents, United States Government securities and other high
grade debt obligations equal in value to the Portfolio's commitments for such
when-issued or delayed delivery securities. The availability of liquid assets
for this purpose and the effect of asset segregation on a Portfolio's ability to
meet its current obligations, to honor requests for redemption and to have its
investment portfolio managed properly will limit the extent to which the
Portfolio may engage in forward commitment agreements. Except as may be imposed
by these factors, there is no limit on the percent of a Portfolio's total assets
that may be committed to transactions in such agreements.
Portfolio Turnover
Portfolio turnover will normally differ for each Portfolio, may vary
from year to year, as well as within a year, and may be affected by portfolio
sales necessary to meet cash requirements for redemptions of Portfolio shares.
The portfolio turnover rate for a Portfolio is calculated by dividing the lesser
of purchases or sales of its portfolio securities during the fiscal year by the
monthly average of the value of its portfolio securities (excluding from the
computation all securities, including options, with maturities at the time of
acquisition of one year or less). A high rate of portfolio turnover generally
involves correspondingly greater brokerage commission expenses, which must be
borne directly by the Portfolio.
The Mortgage-Backed Securities Portfolio intends to be active in the
forward commitment market when the return from holding forward positions appears
to be greater than the return from holding the actual securities. The Portfolio
will enter into forward commitment contracts to purchase securities for the
purpose of acquiring those securities and not for the purpose of investment
leverage or to speculate on interest rate changes, but as delivery dates
approach, a determination will be made whether to take delivery of a specific
forward position, or sell that position and purchase another forward position.
Because of this strategy, it is anticipated that its annual portfolio turnover
rate should generally exceed 100% and may be as much as 600% or more, although
this rate should not be construed as a limiting factor. The effect of a high
turnover rate would be to incur more transaction expenses than would be incurred
at a lower turnover rate, and there is no assurance that the additional
transactions that cause the higher turnover rate would result in gains for the
Portfolio or in sufficient gains to offset the increased transaction expenses.
The annualized portfolio turnover rates for each portfolio for its most recent
and immediately preceding fiscal year were as follows (annualized when reporting
period is less than one year): International Emerging Markets 12.3% (for the
period beginning November 26, 1997 and ending December 31, 1997); International
Securities 30.8% and 25.5%; International SmallCap Portfolio 30.3% (for the
period beginning November 26, 1997 and ending December 31, 1997);
Mortgage-Backed Securities 15.5% and 28.7%.
DIRECTORS AND OFFICERS OF THE FUND
The following listing discloses the principal occupations and other
principal business affiliations of the Fund's Officers and Directors during the
past five years. All Directors and Officers listed here also hold similar
positions with each of the other mutual funds sponsored by Principal Mutual Life
Insurance Company. All mailing addresses are The Principal Financial Group, Des
Moines, Iowa 50392, unless otherwise indicated.
David J. Brown, 38, Assistant Counsel. Counsel, Principal Mutual Life
Insurance Company since 1995. Attorney, 1994-1995. Prior thereto, Attorney,
Dickinson, Mackaman, Tyler & Hogan, P.C..
Michael W. Cumings, 46, Assistant Counsel. Counsel, Principal Mutual Life
Insurance Company.
@James D. Davis, 64, Director. 4940 Center Court, Bettendorf, Iowa.
Attorney. Vice President, Deere and Company, retired.
Pamela A. Ferguson, 54, Director, 4112 River Oaks Drive, Des Moines, Iowa.
Professor of Mathematics, Grinnell College since 1998. Prior thereto, President,
Grinnell College.
*&J. Barry Griswell, 49, Director and Chairman of the Board. President,
Principal Mutual Life Insurance Company, since 1998; Executive Vice President,
1996-1998, Senior Vice President, 1991-1996. Director and Chairman of the Board,
Principal Management Corporation and Princor Financial Services Corporation.
*&Stephan L. Jones, 62, Director and President. Vice President, Principal
Mutual Life Insurance Company. Director and President, Princor Financial
Services Corporation and Principal Management Corporation.
@&Barbara A. Lukavsky, 57, Director. 3930 Grand Avenue, #304, Des Moines,
Iowa. President and CEO, Barbican Enterprises, Inc. Since 1977. President and
CEO, Lu San ELITE USA, L.C., 1985-1998.
*Craig L. Bassett, 46, Treasurer. Treasurer, Principal Mutual Life
Insurance Company since 1996. Prior thereto, Associate Treasurer. Treasurer,
Princor Financial Services Corporation and Principal Management Corporation
since 1996.
*Michael J. Beer, 37, Financial Officer. Senior Vice President and Chief
Operating Officer, Princor Financial Services Corporation and Principal
Management Corporation, since 1997. Prior thereto, Vice President and Chief
Operating Officer.
*Arthur S. Filean, 59, Vice President and Secretary. Vice President,
Princor Financial Services Corporation. Vice President, Principal Management
Corporation, since 1996.
*Ernest H. Gillum, 42, Assistant Secretary. Assistant Vice President,
Registered Products, Princor Financial Services Corporation and Principal
Management Corporation, since 1995. Prior thereto, Product Development and
Compliance Officer.
Jane E. Karli, 41, Assistant Treasurer. Assistant Treasurer, Principal
Mutual Life Insurance Company since 1998. Senior Accounting and Custody
Administrator 1994-1998; Prior thereto, Senior Investment Cost Accountant
1993-1994.
*Michael D. Roughton, 46, Counsel. Counsel, Principal Mutual Life Insurance
Company, since 1994. Prior thereto Assistant Counsel. Counsel, Invista Capital
Management, Inc., Princor Financial Services Corporation, Principal Investors
Corporation and Principal Management Corporation.
@ Member of Audit and Nominating Committee.
* Affiliated with the Manager of the Fund or its parent and considered an
"Interested Persons," as defined in the Investment Company Act of 1940, as
amended.
& Member of the Executive Committee. The Executive Committee is elected by
the Board of Directors and may exercise all the powers of the Board of
Directors, with certain exceptions, when the Board is not in session and shall
report its actions to the Board.
The Fund does not pay fees or other remuneration to its directors and
officers.
As of April 9, 1998, Principal Mutual Life Insurance Company, a mutual life
insurance company organized in 1879 under the laws of Iowa, its subsidiaries and
affiliates owned of record and beneficially the following number of shares or
percentage of the outstanding shares of each Portfolio:
No. of Shares % of Outstanding
Portfolio Owned Shares
--------- -------------- -------------
International Emerging Markets Portfolio 6,974,330 81.19%
International Securities Portfolio 1,325,824 43.28%
International SmallCap Portfolio 5,869,848 98.32%
Mortgage-Backed Securities Portfolio 1,364,224 100.00%
- ------------------------------------------------------------------------------
As of April 9, 1998, the Officers and Directors of the Fund as a group
owned less than 1% of the outstanding shares of any Portfolio of the Fund.
As of April 9, 1998, the following shareholders of the Fund owned 5% or
more of the outstanding shares of any Portfolio of the Fund:
<TABLE>
<CAPTION>
Percentage
Name Address of Ownership
<S> <C> <C>
International Emerging Markets Portfolio
ConAgra Master Pension Trust 1 Enterprise Drive 17.66%
Quincy, MA 02171-2126
International Securities Portfolio
Centurion Life Insurance Company 206 8th Street 16.43%
Des Moines, IA 50309-3805
Miter & Co. P.O. Box 2977 7.78%
Milwaukee, WI 53201-2977
Pigeon & Co. P.O. Box 2479 12.69%
San Antonio, TX 78298-2479
Norwest Financial Pension Trust 206 8th Street 6.98%
Des Moines, IA 50309-3805
</TABLE>
- --------------------------------------------------------------------------------
MANAGER AND SUB-ADVISOR
The Manager of each Portfolio of the Fund is Principal Management
Corporation, a wholly-owned subsidiary of Princor Financial Services Corporation
which is a wholly-owned subsidiary of Principal Holding Company. Principal
Holding Company is a holding company which is a wholly-owned subsidiary of
Principal Mutual Life Insurance Company, a mutual life insurance company
organized in 1879 under the laws of the state of Iowa. The address of the
Manager is The Principal Financial Group, Des Moines, Iowa 50392-0200. The
Manager was organized on January 10, 1969 and since that time has managed
various mutual funds sponsored by Principal Mutual Life Insurance Company.
The Manager has executed an agreement with Invista Capital Management,
Inc. ("Invista") under which Invista has agreed to assume the obligations of the
Manager to provide investment advisory services for each Portfolio and to
reimburse the Manager for the other costs it incurs under the Management
Agreement. Invista, an indirectly wholly-owned subsidiary of Principal Mutual
Life Insurance Company and an affiliate of the Manager, was founded in 1985 and
manages investments for institutional investors, including Principal Mutual
Life. Assets under management at December 31, 1997 were approximately $25.8
billion. Invista's address is 1800 Hub Tower, 699 Walnut, Des Moines, Iowa
50309.
Each of the persons affiliated with the Fund who is also an affiliated
person of the Manager or Invista is named below, together with the capacities in
which such person is affiliated with the Fund, Invista and the Manager:
Office Held With Office Held With
Name Each Fund The Manager/Invista
Craig L. Bassett Treasurer Treasurer (Manager)
Michael J. Beer Financial Officer Senior Vice President and Chief
Operating Officer (Manager)
Arthur S. Filean Vice President and Vice President (Manager)
Secretary
Ernest H. Gillum Assistant Secretary Assistant Vice President -
Registered Products (Manager)
J. Barry Griswell Director and Chairman Director and Chairman of
of the Board the Board (Manager)
Stephan L. Jones Director and Director and President
President (Manager)
Michael D. Roughton Counsel Counsel (Manager; Invista)
COST OF MANAGER'S SERVICES
The Manager has entered into a Management Agreement with the Fund which
requires the Manager to act as investment adviser and manager of each Portfolio.
As compensation for its services and other responsibilities, the Manager
receives a fee computed and accrued daily and payable monthly. Under a Sub-
Advisory Agreement between Invista and the Manager, Invista performs all
investment advisory responsibilities of the Manger under the Management
Agreement and receive the full amount of the compensation paid by the Fund to
the Manager.
The Management Fees are computed at the following annual rates:
Fees Computed Fees as a Percent
One Net Asset Value of Average Daily
Portfolio of Portfolio Net Assets
International Emerging
Markets Portfolio First $250 million 1.15%
Next $250 million 1.05%
Over $500 million 0.95%
International Securities
Portfolio Entire Portfolio 0.90%
International SmallCap
Portfolio First $250 million 1.00%
Next $250 million 0.90%
Over $500 million 0.80%
Mortgage-Backed Securities
Portfolio Entire Portfolio 0.45%
The net assets of each portfolio on December 31, 1997 and the rate of
the fee for each portfolio for investment management services as provided in the
Management Agreement for the fiscal year then ended were as follows:
Management Fee for
Net Assets as of Fiscal Year Ended
Portfolio December 31, 1997 December 31, 1997
--------- ----------------- -----------------
International Emerging Markets $32,488,046 1.15%
International Securities $37,684,011 .90%
International SmallCap $31,967,661 1.00%
Mortgage Backed Securities $13,795,530 .45%
- ---------------------------------------------- ----------------
Fees paid for investment management services during the periods
indicated were as follows:
Management Fees for Fiscal
Portfolio Year Ended December 31
--------- ----------------------
1997 1996 1995
---- ---- ----
International Emerging Markets $ 43,775 N/A N/A
International Securities 311,027 $185,375 $146,209
International SmallCap 37,932 N/A N/A
Mortgage-Backed Securities 67,721 $ 65,114 $ 61,455
- ---------------------------------------------------------- --------------
In addition to investment advisory services, the responsibilities of
the Manager under the Management Agreement include various corporate and
administrative services, including furnishing the services of its officers and
employees that are elected to serve as officers or directors of the Fund;
furnishing office space and all necessary office facilities and equipment for
the general corporate functions of the Fund; furnishing the services of
supervisory and clerical personnel necessary to perform such functions;
determining the net asset value per share for the shares of each Portfolio;
acting as and performing the services of transfer and paying agent (including
preparing and distributing prospectuses, shareholder reports, tax information,
notices and proxy statements, making dividend payments, maintaining shareholder
records in an open account system and processing redemptions, repurchases and
remittances to shareholders); and qualifying Fund shares for sale in various
jurisdictions.
In addition, the Manager is responsible for all expenses of each
Portfolio except (i) the management fee paid to it by the Fund, (ii) taxes,
including in case of redeemed shares any initial transfer taxes, (iii) portfolio
brokerage fees and incidental brokerage expenses, (iv) interest and (v)
extraordinary expenses. Since brokerage fees are treated as part of the price
paid or received upon the purchase or sale of securities and since taxes,
interest and extraordinary expenses are expected to be minimal, the management
fee should tend to give shareholders an idea as to the expected level of
operating expenses of the Portfolios in which they invest. This arrangement is
different from the fee structures of most mutual funds where one fee is paid to
the investment adviser for advisory services and many or all other expenses
involved with the operation of the fund are paid directly by the fund.
Under the terms of the Sub-Advisory Agreement with the Manager, Invista
has agreed to reimburse the Manager for all of its costs in performing corporate
and administrative services and to pay all expenses of the Fund that the Manager
has undertaken to pay under the Management Agreement.
The Management Agreement and Sub-Advisory Agreement ("Agreements") were
last approved by the Fund's Board of Directors on September 8, 1997. Both kinds
of agreements provide that each will continue in effect as to any Portfolio from
year to year only so long such continuance is specifically approved at least
annually either by the Board of Directors of the Fund or by a vote of a majority
of the outstanding voting securities of the Fund and in either event by vote of
a majority of the directors of the Fund who are not interested persons of the
Manager, Principal Mutual Life Insurance Company, the Fund and, in the case of
the Sub-Advisory Agreement, Invista cast in person at a meeting called for the
purpose of voting on such approval. Each Agreement may, on sixty days' written
notice, be terminated at any time without the payment of any penalty, by the
Board of Directors of the Fund, by vote of a majority of the outstanding voting
securities of the Fund, as to any Portfolio by the vote of a majority of the
outstanding voting securities of that Portfolio, by the Manager, and in the case
of the Sub-Advisory Agreement by Invista. Each Agreement shall automatically
terminate in the event of its assignment.
The required shareholder approval of any continuance of either
Agreement shall be effective with respect to any Portfolio if a majority of the
outstanding voting securities of that Portfolio votes to approve the
continuance, notwithstanding that the amendment may not have been approved by a
majority of the outstanding voting securities of the Fund or of any other
Portfolio affected by the amendment. If the shareholders of any Portfolio of the
Fund fail to approve the continuance of either Agreement and that failure causes
the Agreement to be invalid with respect to that Portfolio, the Manager and
Invista will continue to act as investment adviser and sub-adviser with respect
to that Portfolio pending the required approval of the Agreement's continuance
or of a new contract or other definitive action, provided that the compensation
received by each of the Manager and Invista, in case of the invalidity of the
Management Agreement, or by Invista, in case of the invalidity of the
Sub-Advisory Agreement, in respect of that Portfolio during such period will be
no more than its actual costs incurred in furnishing services to that Portfolio
or the amount it would have received under the Agreement in respect of that
Portfolio, whichever is less.
The Management Agreement may be amended but such amendment will not be
effective until specifically approved by vote of the holders of a majority of
the Fund's outstanding voting securities and by vote of a majority of the
directors of the Fund who are not interested persons of the Manager, Principal
Mutual Life Insurance Company or the Fund cast in person at a meeting called for
the purpose of voting on such approval. The required shareholder approval of any
amendment to the Management Agreement shall be effective with respect to any
Portfolio if a majority of the outstanding voting securities of that Portfolio
votes to approve the amendment, notwithstanding that the amendment may not have
been approved by a majority of the outstanding voting securities of the Fund or
of any other Portfolio affected by the matter.
The Manager has entered into an Investment Service Agreement with
Principal Mutual Life Insurance Company ("Principal Mutual") whereby Principal
Mutual has agreed to provide on a part-time basis such employees as the parties
may agree are reasonably needed by the Manager and Invista in the performance of
investment advisory services (but not corporate or administrative services)
under the Management Agreement. Principal Mutual also agreed to permit such
employees, in performing services for the Manager and Invista, full access to
statistical and economic data, investment research reports and other
non-confidential materials in the files of its Investment Department. For the
services of Principal Mutual employees, the Manager will reimburse Principal
Mutual for the direct and indirect costs fairly attributable to their services
performed for the Manager, and the Manager will be reimbursed for such costs by
Invista. The Investment Service Agreement contains provisions on continuation
and termination comparable to those described above for the Management
Agreement. The Management Agreement was last approved by the Funds Board of
Directors on September 8, 1997.
BROKERAGE ON PURCHASES AND SALES OF SECURITIES
In distributing brokerage business arising out of the placement of
orders for the purchase and sale of securities for any Portfolio, Invista's
objective is to obtain the best overall terms. In pursuing this objective,
Invista considers all matters it deems relevant, including the breadth of the
market in the security, the price of the security, the financial condition and
executing capability of the broker or dealer and the reasonableness of the
commission, if any (for the specific transaction and on a continuing basis).
This may mean in some instances that Invista will pay a broker commissions that
are in excess of the amount of commission another broker might have charged for
executing the same transaction when Invista believes that such commissions are
reasonable in light of (a) the size and difficulty of transactions (b) the
quality of the execution provided and (c) the level of commissions paid relative
to commissions paid by other institutional investors. (Such factors are viewed
both in terms of that particular transaction and in terms of all transactions
that broker executes for accounts over which Invista exercises investment
discretion. Invista may purchase securities in the over-the-counter market,
utilizing the services of principal market matters, unless better terms can be
obtained by purchases through brokers or dealers, and may purchase securities
listed on the New York Stock Exchange from non-Exchange members in transactions
off the Exchange.) Invista gives consideration in the allocation of business to
services performed by a broker (e.g. the furnishing of statistical data and
research generally consisting of information of the following types: analyses
and reports concerning issuers, industries, economic factors and trends,
portfolio strategy and performance of client accounts). If any such allocation
is made, the primary criteria used will be to obtain the best overall terms for
such transactions. Invista may pay additional commission amounts for research
services but generally does not do so. Such statistical data and research
information received from brokers or dealers may be useful in varying degrees
and Invista may use it in servicing some or all of the accounts it manages. Some
statistical data and research information may not be useful to Invista in
managing the client account, brokerage for which resulted in Invista's receipt
of the statistical data and research information. However, in Invista's opinion,
the value thereof is not determinable and it is not expected that Invista's
expenses will be significantly raised since the receipt of such statistical data
and research information is only supplementary to Invista's own research
efforts. The Manager, or Sub- advisor, allocated portfolio transactions for the
International Emerging Markets, International Securities and International
SmallCap Portfolios to certain brokers during the fiscal year ended December 31,
1997 due to research services provided by such brokers. These portfolio
transactions resulted in commissions paid to such brokers by the Fund in the
amounts of $1,100, $4,841 and $317, respectively.
Some products and services brokers provide to Invista (such as computer
hardware) may perform an administrative function (e.g. client accounting) as
well as a research function. In such cases, Invista makes a reasonable
allocation of the cost of the product or service according to Invista's use.
Invista pays for the portion of the product or service that consists of research
in commission dollars. Invista pays for the portion that provides it with
administrative or non-research assistance with its own money. Invista's
allocation of such products and services between research and non-research
functions poses a conflict of interest between Invista and its clients.
Annually the officers of Invista call a meeting to determine dollar
limits on business done with brokers who provide useful research information. A
list of products, research and services is kept in Invista's office.
Purchases and sales of debt securities and money market instruments
usually will be principal transactions and will normally be purchased directly
from the issuer or from an underwriter or marketmaker for the securities. Such
transactions are usually conducted on a net basis with a Portfolio paying no
brokerage commissions. Purchases from underwriters will include a commission or
concession paid by the issuer to the underwriter, and the purchases from dealers
serving as marketmakers will include the spread between the bid and asked
prices.
The following table shows the brokerage commissions paid during the
periods indicated. In each year, 100% of the commissions paid by each Fund went
to broker-dealers which provided research, statistical or other factual
information.
Total Brokerage Commissions
Portfolio Paid During Fiscal Year
Ended December 31
-----------------
1997 1996 1995
---- ---- ----
International Emerging Markets $99,367 N/A N/A
International Securities $78,786 $66,683 $54,987
International SmallCap $80,568 N/A N/A
Mortgage-Backed Securities $ -0- $ -0- $ -0-
- ------------------------------------------------------------------------
Brokerage commissions paid to affiliates during the year ended December
31, 1997 were as follows:
Commissions Paid to Morgan Stanley & Co.
Percent of Dollar
Amount of
Total Dollar As Percent of Commissionable
Amount Total Commissions Transactions
International Emerging Markets $10,074 10.14% 16.63%
International Securities $1,394 1.77% 1.99%
Morgan Stanley and Co. is affiliated with Morgan Stanley Asset Management,
Inc., which acts as sub- advisor to two mutual funds included in the Fund
Complex.
The Manager acts as investment advisor for other funds sponsored by
Principal Mutual Life Insurance Company. Invista furnishes certain personnel,
services and facilities required by the Manager to assist the Manager in
carrying out its investment advisory responsibilities to such other funds. If,
in carrying out the investment objectives of these entities, occasions arise
when purchases or sales of the same equity securities are to be made for two or
more of the entities at the same time, Invista may submit the orders to
purchase, or whenever possible, to sell, to a broker/dealer for execution on an
aggregate or "bunched" basis. Invista may create several aggregate or "bunched"
orders relating to a single security at different times during the same day. On
such occasion, Invista will employ a computer program to randomly order the
entities whose individual orders for purchase or sale make up each aggregate or
"bunched" order. Securities purchased or proceeds of sales received on each
trading day with respect to each such aggregate or "bunched" order shall be
allocated to the various entities whose individual orders for purchase or sale
make up the aggregate or "bunched" order. Securities purchased for entities
participating in an aggregate or "bunched" order will be placed into those
accounts, and where applicable, other client accounts at a price equal to the
average of the prices achieved in the course of filling the aggregate or
"bunched" order.
OFFERING PRICE
Each Portfolio offers its shares continuously through Princor Financial
Services Corporation which is principal underwriter for the Fund and sells
shares as agent for the Fund. Shares are sold at net asset value, without a
sales charge. In certain circumstances, Princor Financial Services Corporation
will compensate its registered representatives or a selected dealer with whom it
has entered into a selling agreement for their efforts in distributing shares
held in a customer account the establishment of which is attributable to the
efforts of the registered representatives or selected dealer.
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of each Portfolio is determined daily,
Monday through Friday, as of the close of trading on the New York Stock
Exchange, except on days on which changes in the value of a Portfolio's
portfolio securities will not materially affect the current net asset value of
that Portfolio's redeemable securities, on days during which a Portfolio
receives no order for the purchase or sale of its redeemable securities and no
tender of such a security for redemption, and on customary national business
holidays. The Portfolios treat as customary national business holidays those
days on which the New York Stock Exchange is closed for New Year's Day, Martin
Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving Day, and Christmas Day. The net asset value per
share for each Portfolio is determined by dividing the value of securities in
the Portfolio's investment portfolio plus all other assets, less all
liabilities, by the number of Portfolio shares outstanding. Securities for which
market quotations are readily available, including options and futures traded on
an exchange, are valued at market value, which is for exchanged-listed
securities, the closing sale price; for United Kingdom-listed securities, the
market-maker provided price; and for non-listed equity securities, the bid
price. Non-listed corporate debt securities and government securities are
usually valued using an evaluated bid price provided by a pricing service. If
closing prices are unavailable for exchange-listed securities, generally the bid
price, or in the case of debt securities an evaluated bid price, is used to
value such securities. When reliable market quotations are not considered to be
readily available, which may be the case, for example, with respect to certain
debt securities, preferred stocks, foreign securities and over-the-counter
options, the investments are valued by using market quotations, prices provided
by market makers, which may include dealers with which the Portfolio has
executed transactions, 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
Board of Directors. Securities with remaining maturities of 60 days or less are
valued at amortized cost. Other assets are valued at fair value as determined in
good faith through procedures established by the Board of Directors.
Generally, trading in foreign securities is substantially completed each
day at various times prior to the close of the New York Stock Exchange. The
values of such securities used in computing net asset value per share are
usually determined as of such times. Occasionally, events which affect the
values of such securities and foreign currency exchange rates may occur between
the times at which they are generally determined and the close of the New York
Stock Exchange and would therefore not be reflected in the computation of the
net asset values of the Portfolios. If events materially affecting the value of
such securities occur during such period, then these securities will be valued
at their fair value as determined in good faith by the Manager or Invista under
procedures established and regularly reviewed by the Board of Directors. To the
extent the Portfolio invests in foreign securities listed on foreign exchanges
which trade on days on which the Portfolio does not determine its net asset
value, for example Saturdays and other customary national U.S. holidays, the
Portfolio's net asset value could be significantly affected on days when
shareholders have no access to the Portfolio.
PERFORMANCE CALCULATION
Each Portfolio may from time to time advertise its performance in terms
of total return or yield. The figures used for total return and yield are based
on the historical performance of a Portfolio, show the performance of a
hypothetical investment and are not intended to indicate future performance.
Total return and yield will vary from time to time depending upon market
conditions, the composition of a Portfolio's portfolio and operating expenses.
These factors and possible differences in the methods used in calculating
performance figures should be considered when comparing a Portfolio's
performance to the performance of some other kind of investment.
A Portfolio may also include in its advertisements performance rankings
and other performance-related information published by independent statistical
services or publishers, such as Lipper Analytical Services, Weisenberger
Investment Companies Services, Money Magazine, Forbes, The Wall Street Journal,
Baron's and Changing Times, and comparisons of the performance of a Portfolio to
that of various market indices, such as the S&P 500 Index, Dow Jones Industrials
Index, Morgan Stanley Capital International EAFE (Europe, Australia and Far
East) Index and World Index, Lehman Brothers GNMA Index and the Salomon Brothers
Investment Grade Bond Index.
Total Return
When advertising total return figures, each Portfolio will include its
average annual total return for each of the one, five and ten year periods (or
if shorter, the period during which its registration statement has been in
effect) that end on the last day of the most recent calendar quarter. Average
annual total return is computed by calculating the average annual compounded
rate of return over the stated period that would equate an initial $1,000
investment to the ending redeemable value assuming the reinvestment of all
dividends and capital gains distributions at net asset value. In its
advertising, a Portfolio may also include average annual total
return for some other period or cumulative total return for a specified period.
Cumulative total return is computed by dividing the difference between the
ending redeemable value (assuming the reinvestment of all dividends and capital
gains distributions) and the initial investment by the initial investment.
The following table shows as of December 31, 1997 average annual return
for each of the Portfolios for the periods indicated:
Portfolio 1-Year 5-Year 10-Year
--------- ------ ------ -------
International Emerging Markets 1.40%(1) N/A N/A
International Securities 12.55% 14.83%(2) N/A
International SmallCap Portfolio 1.59%(1) N/A N/A
Mortgage-Backed Securities 10.18% 7.14%(2) N/A
(1) Period beginning November 26, 1997 and ending December 31, 1997.
(2) Period beginning May 7, 1993 and ending December 31, 1997.
Yield
The Mortgage-Backed Securities Portfolio calculates its yield by
determining its net investment income per share for a 30-day (or one month)
period, annualizing that figure (assuming semi-annual compounding) and dividing
the result by the net asset value per share for the last day of the same period.
The yield for the Mortgage-Backed Securities Portfolio as of December 31, 1997
was 6.35%.
A Portfolio may include in its advertisements the compounding effect of
reinvested dividends over an extended period of time as illustrated below.
The Power of Compounding
Shareholders who choose to reinvest their distributions get the advantage of
compounding. Here's what happens to a $10,000 investment with monthly income
reinvested at 6 percent, 8 percent and 10 percent over 20 years.
These figures assume no fluctuation in the value of principal. This chart is for
illustration purposes only and is not intended as an indication of the results a
shareholder may receive as a shareholder of a specific Portfolio. The return and
capital value of an investment in a Portfolio will fluctuate so that the value,
when redeemed, may be worth more or less than the original cost.
Years 6% 8% 10%
0 $10,000 $10,000 $10,000
20 $32,071 $46,610 $67,275
A Portfolio may also include in its advertisements an illustration of
the impact of income taxes and inflation on earnings from bank certificates of
deposit ("CD's"). The interest rate on the hypothetical CD will be based upon
average CD rates for a stated period as reported in the Federal Reserve
Bulletin. The illustrated annual rate of inflation will be the core inflation
rate as measured by the Consumer Price Index for the 12-month period ended as of
the most recent month prior to the advertisement's publication. The illustrated
income tax rate may include any federal income tax rate applicable to
individuals at the time the advertisement is published. Any such advertisement
will indicate that, unlike bank CD's, an investment in the Fund is not insured
nor is there any guarantee that the Fund's net asset value or any stated rate of
return will remain constant.
An example of a typical calculation included in such advertisements is
as follows: the after-tax and inflation-adjusted earnings on a bank CD, assuming
a $10,000 investment in a six-month bank CD with an annual interest rate of
5.72% (average six-month CD rate for the month of October, 1997, as reported in
the Federal Reserve Bulletin) and an inflation rate of 2.1% (rate of inflation
for the 12-month period ended October 31, 1997 as measured by the Consumer Price
Index) and an income tax bracket of 28% would be $(101).
($10,000 x 5.72%) / 2 = $286 Interest for six-month period
- 80 Federal income taxes (28%)
- 105 Inflation's impact on invested principal
($10,000 x 2.1%) / 2
($101) After-tax, inflation-adjusted earnings
TAX TREATMENT, DIVIDENDS AND DISTRIBUTIONS
It is the policy of each Portfolio to distribute substantially all net
investment income and net realized gains. Through such distributions, and by
satisfying certain other requirements, the Fund intends to qualify each
portfolio for the tax treatment accorded to regulated investment companies under
the applicable provisions of the Internal Revenue Code. This means that in each
year in which a Portfolio so qualifies, it will be exempt from federal income
tax upon the amount so distributed to investors. The Tax Reform Act of 1986
imposed an excise tax on mutual funds which fail to distribute net investment
income and capital gains by the end of the calendar year in accordance with the
provisions of the Act. Each Portfolio intends to comply with the Act's
requirements and to avoid this excise tax.
Distributions from the International Emerging Markets Portfolio,
International Securities Portfolio, International SmallCap Portfolio and
Mortgage-Backed Securities Portfolio will generally not be eligible for the 70%
corporate dividends received deduction. All taxable dividends and capital gains
are taxable in the year in which distributed, whether received in cash or
reinvested in additional shares. Dividends declared with a record date in
December and paid in January will be deemed to have been distributed to
shareholders in December. Each Portfolio will inform its shareholders of the
amount and nature of their taxable income dividends and capital gain
distributions. Dividends from a Portfolio's net income and distributions of
capital gains, if any, may also be subject to state and local taxation.
As previously discussed, a Portfolio may invest in futures contracts or
options thereon, index options or options traded on qualified exchanges. For
federal income tax purposes, capital gains and losses on futures contracts or
options thereon, index options or options traded on qualified exchanges are
generally treated as 60% long-term and 40% short-term. In addition, a Portfolio
must recognize any unrealized gains and losses on such positions held at the end
of the fiscal year. A Portfolio may elect out of such tax treatment, however,
for a futures or options position that is part of an "identified mixed straddle"
such as a put option purchased with respect to a portfolio security. Gains and
losses on futures and options included in an identified mixed straddle will be
considered 100% short-term and unrealized gain or loss on such positions will
not be realized at year end. The straddle provisions of the Code may require the
deferral of realized losses to the extent that a Portfolio has unrealized gains
in certain offsetting positions at the end of the fiscal year, and may also
require recharacterization of all or a part of losses on certain offsetting
positions from short-term to long-term, as well as adjustment of the holding
periods of straddle positions.
Each Portfolio is required by law under certain circumstances to
withhold 31% of dividends paid to investors who do not furnish their correct
taxpayer identification number (in the case of individuals, their social
security number).
Shareholders should consult their own tax advisors as to the federal,
state and local tax consequences of ownership of shares of the Portfolios in
their particular circumstances.
Special Tax Considerations
International Emerging Markets Portfolio, International Securities
Portfolio and International SmallCap Portfolio
When at the close of a fiscal year more than 50% of the value of a
Portfolio's total assets are invested in securities of foreign corporations, the
Fund may elect pursuant to Section 853 of the Code to permit its Shareholders to
take a credit (or a deduction) for foreign income taxes paid by the Portfolio.
In that case, Shareholders should include in their report of gross income in
their federal income tax returns both cash dividends received from the Portfolio
and also the amount which the Portfolio advises is their pro rata portion of
foreign income taxes paid with respect to, or withheld from, dividends and
interest paid to the Portfolio from its foreign investments. Shareholders would
then be entitled to subtract from their federal income taxes the amount of such
taxes withheld, or treat such foreign taxes as a deduction from gross income, if
that should be more advantageous. As in the case of individuals receiving income
directly from foreign sources, the above-described tax credit or tax deduction
is subject to certain limitations. Shareholders or prospective shareholders
should consult their tax advisors on how these provisions apply to them.
FINANCIAL STATEMENTS
The financial statements of the Fund for the year ended December 31,
1997 appearing in the Annual Report to Shareholders and the report thereon of
Ernst & Young LLP, independent auditors, appearing therein are incorporated by
reference in this Statement of Additional Information. The Annual Report will be
furnished without charge, to investors who request copies of the Statement of
Additional Information.
<PAGE>
PART C
OTHER INFORMATION
Item 24. Financial Statements and Exhibits
(a) Financial Statements included in the Registration Statement
(1) Part A:
Financial Highlights
(2) Part B:
Annual Report dated 12/31/97 incorporated by
reference
(b) Exhibits
(1a) Articles of Amendment and Restatement
(Filed 4/12/96)
(1b) Articles of Amendment (Filed 9/12/97)
(2) Bylaws (Filed 4/12/96)
(5a) Management Agreement (Filed 9/12/97)
(5b) Investment Service Agreement (Filed 9/12/97)
(5c) Sub-Advisory Agreement (Filed 9/12/97)
(6a) Distribution Agreement (Filed 9/12/97)
(6b) Fund Application (Filed 11/21/97)
(8a) Domestic Custody Agreement (Filed 4/12/96)
(8b) Global Custody Agreement (Filed 4/12/96)
(9a) Dealer Selling Agreement (Filed 9/12/97)
(10) Opinion of Counsel (Filed 4/12/96)
(11) Consent of Independent Auditors
(12) Audited Financial Statements as of December
31, 1997, including the Report of Ernst &
Young LLP, independent auditors for the
Registrant.
(13) Investment Letter (Filed 4/12/96)
(16) Performance Quotations (Filed 4/12/96)
(27) Financial Data Schedules
Item 25. Persons Controlled by or Under Common Control with Depositor
Principal Mutual Life Insurance Company (incorporated as a
mutual life insurance company under the laws of Iowa);
Sponsored the organization of the following mutual funds,
some of which it controls by virtue of owning voting
securities:
Principal Balanced Fund, Inc.(a Maryland Corporation) 0.74% of
shares outstanding owned by Principal Mutual Life Insurance
Company (including subsidiaries and affiliates) on January 30,
1998.
Principal Blue Chip Fund, Inc.(a Maryland Corporation) 0.95% of
shares outstanding owned by Principal Mutual Life Insurance
Company (including subsidiaries and affiliates) on January 30,
1998.
Principal Bond Fund, Inc.(a Maryland Corporation) 1.35% of shares
outstanding owned by Principal Mutual Life Insurance Company
(including subsidiaries and affiliates) on January 30, 1998.
Principal Capital Value Fund, Inc. (a Maryland Corporation)
27.36% of outstanding shares owned by Principal Mutual Life
Insurance Company (including subsidiaries and affiliates) on
January 30, 1998.
Principal Cash Management Fund, Inc. (a Maryland Corporation)
2.34% of outstanding shares owned by Principal Mutual Life
Insurance Company (including subsidiaries and affiliates) on
January 30, 1998.
Principal Government Securities Income Fund, Inc. (a Maryland
Corporation) 0.40% of shares outstanding owned by Principal
Mutual Life Insurance Company (including subsidiaries and
affiliates) on January 30, 1998.
Principal Growth Fund, Inc. (a Maryland Corporation) 0.48% of
outstanding shares owned by Principal Mutual Life Insurance
Company (including subsidiaries and affiliates) on January 30,
1998.
Principal High Yield Fund, Inc. (a Maryland Corporation) 16.72%
of shares outstanding owned by Principal Mutual Life Insurance
Company (including subsidiaries and affiliates) on January 30,
1998.
Principal International Emerging Markets Fund, Inc. (a Maryland
Corporation) 66.10% of shares outstanding owned by Principal
Mutual Life Insurance Company (including subsidiaries and
affiliates) on January 30, 1998.
Principal International Fund, Inc. (a Maryland Corporation)
23.63% of shares outstanding owned by Principal Mutual Life
Insurance Company (including subsidiaries and affiliates) on
January 30, 1998.
Principal International SmallCap Fund, Inc. (a Maryland
Corporation) 61.51% of shares outstanding owned by Principal
Mutual Life Insurance Company (including subsidiaries and
affiliates) on January 30, 1998.
Principal Limited Term Bond Fund, Inc. (a Maryland Corporation)
45.48% of shares outstanding owned by Principal Mutual Life
Insurance Company(including subsidiaries and affiliates) on
January 30, 1998.
Principal MidCap Fund, Inc. (a Maryland Corporation) 0.60% of
shares outstanding owned by Principal Mutual Life Insurance
Company (including subsidiaries and affiliates) on January 30,
1998
Principal Real Estate Fund, Inc. (a Maryland Corporation) 95.34%
of shares outstanding owned by Principal Mutual Life Insurance
Company (including subsidiaries and affiliates) on January 30,
1998
Principal SmallCap Fund, Inc.(a Maryland Corporation) 88.70% of
shares outstanding owned by Principal Mutual Life Insurance
Company (including subsidiaries and affiliates) on January 30,
1998
Principal Special Markets Fund, Inc. (a Maryland Corporation)
96.92% of shares outstanding of the International Emerging
Markets Portfolio, 50.28% of the shares outstanding of the
International Securities Portfolio, 96.87% of shares outstanding
of the International SmallCap Portfolio and 100% of the shares
outstanding of the Mortgage-Backed Securities Portfolio were
owned by Principal Mutual Life Insurance Company (including
subsidiaries and affiliates) on January 30, 1998
Principal Tax-Exempt Bond Fund, Inc. (a Maryland Corporation)
0.56% of shares outstanding owned by Principal Mutual Life
Insurance Company (including subsidiaries and affiliates) on
January 30, 1998.
Principal Tax-Exempt Cash Management Fund, Inc. (a Maryland
Corporation) 0.99% of shares outstanding owned by Principal
Mutual Life Insurance Company (including subsidiaries and
affiliates) on January 30, 1998.
Principal Utilities Fund, Inc. (a Maryland Corporation) 1.45% of
shares outstanding owned by Principal Mutual Life Insurance
Company (including subsidiaries and affiliates) on January 30,
1998.
Principal Variable Contracts Fund, Inc. (a Maryland Corporation)
100% of shares outstanding of the following Accounts owned by
Principal Mutual Life Insurance Company and its Separate Accounts
on January 30, 1998: Aggressive Growth, Asset Allocation,
Balanced, Bond, Capital Value, Government Securities, Growth,
High Yield, International, MidCap and Money Market.
Subsidiaries organized and wholly-owned by Principal Mutual Life
Insurance Company:
a. Principal Holding Company (an Iowa Corporation) A holding
company wholly-owned by Principal Mutual Life Insurance
Company.
b. PT Asuransi Jiwa Principal Egalita Indonesia (an Indonesia
Corporation)
Subsidiaries wholly-owned by Principal Holding Company:
a. Petula Associates, Ltd. (an Iowa Corporation) a real estate
development company.
b. Patrician Associates, Inc. (a California Corporation) a real
estate development company.
c. Principal Development Associates, Inc. (a California
Corporation) a real estate development company.
d. Princor Financial Services Corporation (an Iowa Corporation)
a registered broker-dealer.
e. Invista Capital Management, Inc. (an Iowa Corporation) a
registered investment adviser.
f. Principal Marketing Services, Inc. (a Delaware Corporation)
a corporation formed to serve as an interface between
marketers and manufacturers of financial services products.
g. The Principal Financial Group, Inc. (a Delaware corporation)
a general business corporation established in connection
with the new corporate identity. It is not currently active.
h. Delaware Charter Guarantee & Trust Company (a Delaware
Corporation) a nondepository trust company.
i. The Admar Group, Inc. (a Florida Corporation) a national
managed care service organization that developes and manages
preferred provider organizations.
j. Principal Health Care, Inc. (an Iowa Corporation) a
developer and administrator of managed care systems.
k. Principal Financial Advisors, Inc. (an Iowa Corporation) a
registered investment advisor.
l. Principal Asset Markets, Inc. (an Iowa Corporation) a
residential mortgage loan broker.
m. Principal Portfolio Services, Inc. (an Iowa Corporation) a
mortgage due diligence company.
n. Principal International, Inc. (an Iowa Corporation) a
company formed for the purpose of international business
development.
o. Principal Spectrum Associates, Inc. (a California
Corporation) a real estate development company.
p. Principal Commercial Advisors, Inc. (an Iowa Corporation) a
company that purchases, manages and sells commercial real
estate assets.
q. Principal FC, Ltd. (an Iowa Corporation) a limited purpose
investment corporation.
r. Principal Residential Mortgage, Inc. (an Iowa Corporation) a
residential mortgage loan broker.
s. Equity FC, Ltd. (an Iowa Corporation) engaged in investment
transactions including limited partnership and limited
liability companies.
t. Principal Bank (a Federal Corporation) a Federally chartered
direct delivery savings bank.
u. HealthRisk Resource Group, Inc. (an Iowa Corporation) a
management services organization.
Subsidiaries organized and wholly-owned by Princor Financial Services
Corporation:
a. Principal Management Corporation (an Iowa Corporation) a
registered investment advisor.
b. Principal Investors Corporation (a New Jersey Corporation) a
registered broker-dealer with the Securities Exchange
Commission. It is not currently active.
Subsidiary wholly owned by Delaware Charter Guarantee & Trust Company:
a. Trust Consultants, Inc. (a California Corporation) a
Consulting and Administration of Employee Benefit Plans.
Subsidiary organized and wholly-owned by Principal Health Care, Inc.:
a. Principal Health Care of Texas, Inc. ( a Texas Corporation)
a health maintenance organization.
Subsidiaries owned by The Admar Group, Inc.:
a. Admar Corporation (a California Corporation) a managed care
services organization.
b. Admar Insurance Marketing, Inc. (a California Corporation) a
managed care services organization.
c. Benefit Plan Administrators, Inc. (a Colorado Corporation) a
managed care services organization.
d. SelectCare Management Co., Inc. (a California Corporation) a
managed care services organization.
e. Image Financial & Insurance Services, Inc. (a California
Corporation) a managed care services organization.
f. WM. G. Hofgard & Co., Inc. (a California Corporation) a
managed care services organization.
Subsidiary owned by Petula Associates, Ltd.
a. Magnus Properties, Inc. (an Iowa Corporation) which owns
real estate.
Subsidiaries owned by Principal International, Inc.:
a. Principal Insurance Company (Hong Kong) Limited (a Hong Kong
Corporation) group life and group pension products.
b. Principal International Argentina, S.A. (an Argentina
services corporation).
c. Principal International Asia Limited (a Hong Kong
Corporation) a corporation operating as a regional
headquarters for Asia.
d. Principal International de Chile, S.A. (a Chile
Corporation) a holding company.
e. Principal International Espana, S.A. de Seguros de Vida (a
Spain Corporation) a life insurance company (individual
group), annuities and pension.
f. Principal Mexico Compania de Seguros, S.A. de C.V. (a Mexico
Corporation) a life insurance company (individual and
group), personal accidents.
g. Qualitas Medica, S.A. (an Argentina HMO) a health
maintenance organization.
h. Afore Confia-Principal, S.a. de C.V. (a Mexico Corporation),
pension.
i. Zao Principal International (a Russia Corporation) inactive.
j. Principal Trust Company (Asia) Limited (an Asia trust
company).
k. Principal Asset Management Company (Asia) Ltd. (Hong Kong)
a corporation which manages pension funds.
Subsidiaries owned by Principal International Argentina, S.A.:
a. Ethika Administradora de Fondos de Jubilaciones y Pensions
S.A. (an Argentina company) a pension company.
b. Principal Compania de Seguros de Retiro, S.A. (an Argentina
Corporation) an individual annuity/employee benefit company.
c. Principal Life Compania de Seguros, S.A. (an Argentina
Corporation) a life insurance company.
Subsidiary owned by Principal International de Chile, S.A.:
a. BanRenta Compania de Seguros de Vida, S.A. (a Chile
Corporation) group life and supplemental health, individual
annuities.
Subsidiary owned by Principal International Espana, S.A. de Seguros de
Vida:
a. Princor International Espana Sociedad Anonima de Agencia de
Seguros (a Spain Corporation) an insurance agency.
Subsidiary owned by Afore Confia-Principal, S.A. de C.V.:
a. Siefore Confia-Principal, S.A. de C.V. (a Mexico
Corporation) an investment fund company.
Item 26. Number of Holders of Securities - As of: March 31, 1998
(1) (2)
Title of Class Number of Holders
Principal Special Markets Fund, Inc.
Common - International Securities Portfolio 19
Common - Mortgage-Backed Securities Portfolio 1
Common - International Emerging Markets Portfolio 3
Common - International SmallCap Portfolio 2
Item 27. Indemnification
Under Section 2-418 of the Maryland General Corporation Law, with respect
to any proceedings against a present or former director, officer, agent or
employee (a "corporate representative") of the Registrant, the Registrant may
indemnify the corporate representative against judgments, fines, penalties, and
amounts paid in settlement, and against expenses, including attorneys' fees, if
such expenses were actually incurred by the corporate representative in
connection with the proceeding, unless it is established that:
(i) The act or omission of the corporate representative was
material to the matter giving rise to the proceeding; and
1. Was committed in bad faith; or
2. Was the result of active and deliberate dishonesty; or
(ii) The corporate representative actually received an improper
personal benefit in money, property, or services; or
(iii) In the case of any criminal proceeding, the corporate
representative had reasonable cause to believe that the act or
omission was unlawful.
If a proceeding is brought by or on behalf of the Registrant, however, the
Registrant may not indemnify a corporate representative who has been adjudged to
be liable to the Registrant. Under the Registrant's Articles of Incorporation
and Bylaws, directors and officers of Registrant are entitled to indemnification
by the Registrant to the fullest extent permitted under Maryland law and the
Investment Company Act of 1940. Reference is made to Article VI, Section 7 of
the Registrant's Articles of Incorporation, Article 12 of Registrant's Bylaws
and Section 2-418 of the Maryland General Corporation Law.
The Registrant has agreed to indemnify, defend and hold the Distributor,
its officers and directors, and any person who controls the Distributor within
the meaning of Section 15 of the Securities Act of 1933, free and harmless from
and against any and all claims, demands, liabilities and expenses (including the
cost of investigating or defending such claims, demands or liabilities and any
counsel fees incurred in connection therewith) which the Distributor, its
officers, directors or any such controlling person may incur under the
Securities Act of 1933, or under common law or otherwise, arising out of or
based upon any untrue statement of a material fact contained in the Registrant's
registration statement or prospectus or arising out of or based upon any alleged
omission to state a material fact required to be stated in either thereof or
necessary to make the statements in either thereof not misleading, except
insofar as such claims, demands, liabilities or expenses arise out of or are
based upon any such untrue statement or omission made in conformity with
information furnished in writing by the Distributor to the Registrant for use in
the Registrant's registration statement or prospectus: provided, however, that
this indemnity agreement, to the extent that it might require indemnity of any
person who is also an officer or director of the Registrant or who controls the
Registrant within the meaning of Section 15 of the Securities Act of 1933, shall
not inure to the benefit of such officer, director or controlling person unless
a court of competent jurisdiction shall determine, or it shall have been
determined by controlling precedent that such result would not be against public
policy as expressed in the Securities Act of 1933, and further provided, that in
no event shall anything contained herein be so construed as to protect the
Distributor against any liability to the Registrant or to its security holders
to which the Distributor would otherwise be subject by reason of willful
misfeasance, bad faith, or gross negligence, in the performance of its duties,
or by reason of its reckless disregard of its obligations under this Agreement.
The Registrant's agreement to indemnify the Distributor, its officers and
directors and any such controlling person as aforesaid is expressly conditioned
upon the Registrant being promptly notified of any action brought against the
Distributor, its officers or directors, or any such controlling person, such
notification to be given by letter or telegram addressed to the Registrant.
Item 28. Business or Other Connection of Investment Adviser
A complete list of the officers and directors of the investment adviser,
Principal Management Corporation, is set out below. This list includes some of
the same people (designated by an *), who are serving as officers and directors
of the Registrant. For these people the information set out in the Statement of
Additional Information (See Part B) under the caption "Directors and Officers of
the Fund" is incorporated by reference. The principal business address for these
individuals is The Principal Financial Group, Des Moines, Iowa 50392.
Name and Position Position or Office Held with
or Office Held with Registrant or Other Substantial
Investment Adviser Business Affiliation
------------------- -------------------------------
John E. Aschenbrenner Senior Vice President
Director Principal Mutual Life
Insurance Company
Craig R. Barnes President and Director
Vice President Invista Capital
Management, Inc.
*Craig L. Bassett See Part B
Treasurer
*Michael J. Beer See Part B
Senior Vice President and
Chief Operating Officer
Mary L. Bricker Counsel & Assistant
Assistant Corporate Corporate Secretary
Secretary Principal Mutual Life
Insurance Company
David J. Drury Chief Executive Officer
Director and Chairman of the Board
Principal Mutual Life
Insurance Company
*Arthur S. Filean See Part B
Vice President
Paul N. Germain Vice President
Vice President - Mutual Fund Operations
- Mutual Fund Operations Princor Financial Services
Corporation
*Ernest H. Gillum See Part B
Assistant Vice President
- Registered Products
Thomas J. Graf Senior Vice President
Director Principal Mutual Life
Insurance Company
*J. Barry Griswell See Part B
Chairman of the Board
and Director
Joyce N. Hoffman Vice President and
Vice President and Corporate Secretary
Corporate Secretary Principal Mutual Life
Insurance Company
*Stephan L. Jones See Part B
Director and President
Ronald E. Keller Executive Vice President
Director Principal Mutual Life
Insurance Company
Ellen Z. Lamale Vice President & Chief Actuary
Director Principal Mutual Life
Insurance Company
Gregg R. Narber Senior Vice President &
Director General Counsel
Principal Mutual Life
Insurance Company
Richard L. Prey Senior Vice President
Director Principal Mutual Life
Insurance Company
Layne A. Rasmussen Controller
Controller - Mutual Funds Princor Financial Services
Corporation
Elizabeth R. Ring Controller
Controller Princor Financial Services
Corporation
*Michael D. Roughton See Part B
Counsel
Jean B. Schustek Product Compliance Officer
Product Compliance Officer Princor Financial Services
- Registered Products Corporation
Dewain A. Sparrgrove Vice President- Investment
Vice President Securities
Principal Mutual Life
Insurance Company
Principal Management Corporation serves as investment adviser and dividend
disbursing and transfer agent for, Principal Balanced Fund, Inc., Principal Blue
Chip Fund, Inc., Principal Bond Fund, Inc., Principal Capital Value Fund, Inc.,
Principal Cash Management Fund, Inc., Principal Government Securities Income
Fund, Inc., Principal Growth Fund, Inc., Principal High Yield Fund, Inc.,
Principal International Emerging Markets Fund, Inc., Principal International
Fund, Inc., Principal International SmallCap Fund, Inc., Principal Limited Term
Bond Fund, Inc., Principal MidCap Fund, Inc., Principal Real Estate Fund, Inc.,
Principal SmallCap Fund, Inc., Principal Special Markets Fund, Inc., Principal
Tax-Exempt Bond Fund, Inc., Principal Tax-Exempt Cash Management Fund, Inc.,
Principal Utilities Fund, Inc. and Principal Variable Contracts Fund, Inc. -
funds sponsored by Principal Mutual Life Insurance Company.
Invista Capital Management, Inc.
Name and Position Position or Office Held with
or Office Held with Registrant or Other Substantial
Investment Adviser Business Affiliation
- ------------------- -------------------------------
Kelly R. Alexander None
Vice President
Douglas M. Angstrom None
Director of Institutional
Marketing
Craig R. Barnes None
President and Director
*Craig L. Bassett Second Vice President and
Assistant Treasurer Treasurer
Principal Mutual Life
Insurance Company
Mary L. Bricker Counsel and Assistant
Assistant Corporate Corporate Secretary
Secretary Principal Mutual Life
Insurance Company
Dennis W. Cameron None
Chief Financial Officer
Catherine A. Green None
Vice President
Michael R. Hamilton None
Vice President
Gregory C. Hauser Vice President - Commercial
Director Real Estate Underwriting
Principal Mutual Life
Insurance Company
Joyce N. Hoffman Vice President and
Vice President and Corporate Secretary
Corporate Secretary Principal Mutual Life
Insurance Company
*Stephan L. Jones Vice President
Director Principal Mutual Life
Insurance Company
*Ronald E. Keller Executive Vice President
Chairman and Director Principal Mutual Life
Insurance Company
Scott D. Opsal None
Executive Vice President
and Director
*Michael D. Roughton See Part B
Counsel
Martin J. Schafer None
Vice President
Judith A. Vogel None
Vice President
David L. White None
Executive Vice President,
Treasurer and Director
Larry D. Zimpleman Vice President - Pension
Director Principal Mutual Life
Insurance Company
Item 29. Principal Underwriters
(a) Princor Financial Services Corporation, principal underwriter for
Registrant, acts as principal underwriter for, Principal Balanced Fund, Inc.,
Principal Blue Chip Fund, Inc., Principal Bond Fund, Inc., Principal Capital
Value Fund, Inc., Principal Cash Management Fund, Inc., Principal Government
Securities Income Fund, Inc., Principal Growth Fund, Inc., Principal High Yield
Fund, Inc., Principal International Emerging Markets Fund, Inc., Principal
International Fund, Inc., Principal International SmallCap Fund, Inc., Principal
Limited Term Bond Fund, Inc., Principal MidCap Fund, Inc., Principal Real Estate
Fund, Inc., Principal SmallCap Fund, Inc., Principal Special Markets Fund, Inc.,
Principal Tax-Exempt Bond Fund, Inc., Principal Tax-Exempt Cash Management Fund,
Inc., Principal Utilities Fund, Inc., Principal Variable Contracts Fund, Inc.
and for variable annuity contracts participating in Principal Mutual Life
Insurance Company Separate Account B, a registered unit investment trust for
retirement plans adopted by public school systems or certain tax-exempt
organizations pursuant to Section 403(b) of the Internal Revenue Code, Section
457 retirement plans, Section 401(a) retirement plans, certain non- qualified
deferred compensation plans and Individual Retirement Annuity Plans adopted
pursuant to Section 408 of the Internal Revenue Code, and for variable life
insurance contracts issued by Principal Mutual Life Insurance Company Variable
Life Separate Account, a registered unit investment trust.
(b) (1) (2) (3)
Positions
and offices Positions and
Name and principal with principal offices with
business address underwriter registrant
John E. Aschenbrenner Director None
The Principal
Financial Group
Des Moines, IA 50392
Robert W. Baehr Marketing Services None
The Principal Officer
Financial Group
Des Moines, IA 50392
Craig L. Bassett Treasurer Treasurer
The Principal
Financial Group
Des Moines, IA 50392
Michael J. Beer Senior Vice President and Vice President
The Principal Chief Operating Officer
Financial Group
Des Moines, IA 50392
Mary L. Bricker Assistant Corporate None
The Principal Secretary
Financial Group
Des Moines, IA 50392
Lynn A. Brones Vice President - None
The Principal Investment Network
Financial Group
Des Moines, IA 50392
David J. Drury Director None
The Principal
Financial Group
Des Moines, IA 50392
Arthur S. Filean Vice President Vice President
The Principal and Secretary
Financial Group
Des Moines, IA 50392
Paul N. Germain Vice President None
The Principal - Mutual Fund Operations
Financial Group
Des Moines, IA 50392
Ernest H. Gillum Assistant Vice President - Assistant
The Principal Registered Products Secretary
Financial Group
Des Moines, IA 50392
William C. Gordon Insurance License Officer None
The Principal
Financial Group
Des Moines, IA 50392
Thomas J. Graf Director None
The Principal
Financial Group
Des Moines, IA 50392
J. Barry Griswell Director and Director and
The Principal Chairman of the Chairman of the
Financial Group Board Board
Des Moines, IA 50392
Joyce N. Hoffman Vice President and None
The Principal Corporate Secretary
Financial Group
Des Moines, IA 50392
Stephan L. Jones Director and Director and
The Principal President President
Financial Group
Des Moines, IA 50392
Ronald E. Keller Director Director
The Principal
Financial Group
Des Moines, IA 50392
Ellen Z. Lamale Director None
The Principal
Financial Group
Des Moines, IA 50392
John R. Lepley Senior Vice None
The Principal President - Marketing
Financial Group and Distribution
Des Moines, IA 50392
Gregg R. Narber Director None
The Principal
Financial Group
Des Moines, IA 50392
Mark M. Oswald Compliance Officer None
The Principal
Financial Group
Des Moines, IA 50392
Kelly A. Paul Systems/Technology - None
The Principal Officer
Financial Group
Des Moines, IA 50392
Richard L. Prey Director None
The Principal
Financial Group
Des Moines, IA 50392
Layne A. Rasmussen Controller - None
The Principal Mutual Funds
Financial Group
Des Moines, IA 50392
Martin R. Richardson Operations Officer - None
The Principal Broker/Dealer Services
Financial Group
Des Moines, IA 50392
Elizabeth R. Ring Controller None
The Principal
Financial Group
Des Moines, IA 50392
Michael D. Roughton Counsel Counsel
The Principal
Financial Group
Des Moines, IA 50392
Jean B. Schustek Product Compliance Officer - None
The Principal Registered Products
Financial Group
Des Moines, IA 50392
Kyle R. Selberg Vice President-Marketing None
The Principal
Financial Group
Des Moines, IA 50392
Susan R. Sorensen Marketing Officer None
The Principal
Financial Group
Des Moines, IA 50392
Roger C. Stroud Assistant Director - None
The Principal Marketing
Financial Group
Des Moines, IA 50392
(c) Inapplicable.
Item 30. Location of Accounts and Records
All accounts, books or other documents of the Registrant are located at the
offices of the Registrant and its Investment Adviser in the Principal Mutual
Life Insurance Company home office building, The Principal Financial Group, Des
Moines, Iowa 50392.
Item 31. Management Services
Inapplicable.
Item 32. Undertakings
Indemnification
Reference is made to Item 27 above, which discusses circumstances under
which directors and officers of the Registrant shall be indemnified by the
Registrant against certain liabilities and expenses incurred by them by reason
of being a director or officer of the Registrant.
Notwithstanding the provisions of Registrant's Articles of Incorporation
and Bylaws, the Registrant hereby makes the following undertaking:
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant, pursuant to the foregoing provisions or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant, in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person of the Registrant, in connection with
the securities being registered, the Registrant will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question whether such indemnification by
it is against public policy as expressed in the Act and will be governed by the
final adjudication of such issue
Shareholder Communications
Registrant hereby undertakes to call a meeting of shareholders for the
purpose of voting upon the question of removal of a director or directors when
requested in writing to do so by the holders of at least 10% of the Registrant's
outstanding shares of common stock and in connection with such meeting to comply
with the provisions of Section 16(c) of the Investment Company Act of 1940
relating to shareholder communications
Delivery of Annual Report to Shareholders
The registrant hereby undertakes to furnish each person to whom a
prospectus is delivered a copy of the registrant's latest annual report to
shareholders, upon request and without charge.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940 the Registrant certifies that it meets all of the
requirments for effectiveness of this Registration Statement and has duly caused
this Amendment to the Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized in the City of Des Moines and State of
Iowa, on the 13th day of April, 1998.
PRINCIPAL SPECIAL MARKETS FUND, INC.
(Registrant)
By /s/ S. L. JONES
______________________________________
S. L. Jones
President and Director
Attest:
/s/ E. H. GILLUM
______________________________________
E. H. Gillum
Assistant Secretary
<PAGE>
Pursuant to the requirement of the Securities Act of 1933, this Amendment
to the Registration Statement has been signed below by the following persons in
the capacities and on the dates indicated.
Signature Title Date
/s/ S. L. Jones
_____________________________ President and Director 4/13/98
S. L. Jones (Principal Executive Officer) __________
(J. B. Griswell)*
_____________________________ Director and 4/13/98
J. B. Griswell Chairman of the Board __________
/s/ M. J. Beer
_____________________________ Financial Officer (Principal 4/13/98
M. J. Beer Financial and Accounting Officer) __________
(J. D. Davis)*
_____________________________ Director 4/13/98
J. D. Davis __________
(P. A. Ferguson)*
_____________________________ Director 4/13/98
P. A. Ferguson __________
(B. A. Lukavsky)*
_____________________________ Director 4/13/98
B. A. Lukavsky __________
*By /s/ S. L. JONES
_____________________________________
S. L. Jones
President and Director
Pursuant to Powers of Attorney
Previously Filed or Included
ERNST & YOUNG LLP Suite 3400 Phone: 515 243 2727
801 Grand Avenue
Des Moines, Iowa 50309-2764
Consent of Independent Auditors
The Board of Directors and Shareholders
Principal Special Markets Fund, Inc.
We consent to the reference to our firm under the captions "Financial
Highlights" and "Additional Information Financial Statements" in the Prospectus
in Part A and "Financial Statements" in Part B and to the incorporation by
reference in Part B of our report dated January 16, 1998 on the financial
statements and the financial highlights of Principal Special Market Fund, Inc.,
in this Post Effective Amendment No. 8 to Form N-1A Registration Statement under
the Securities Act of 1933 (No. 33-59474) and Registration Statement under the
Investment Company Act of 1940 (No. 811-7572) of Principal Special Markets Fund,
Inc.
/s/ Ernst & Young LLP
Des Moines, Iowa
April 14, 1998
Ernst & Young LLP is a member of Ernst & Young International, Ltd.
A MESSAGE FROM THE PRESIDENT
Dear Shareholder:
Stock and bond markets began the second half of the 1997 quite strong. Then,
after reaching record levels, most equity markets experienced a dramatic market
correction in late October. This decline was precipitated by large sell offs in
various international markets, particularly those in Asia. Europe and Latin
America fared somewhat better, ending the year on a positive note. U.S. bond
markets also experienced some volatility, but still finished well. Given the
continuing strong U.S. economy and few signs of inflation, the long-term
investment outlook remains good.
In November, two new portfolios were added to the Principal Special Markets
Fund--International Emerging Markets Portfolio and International SmallCap
Portfolio. These portfolios will offer investors more opportunities to
participate in foreign equity markets.
All four portfolios posted positive returns in 1997. The two original
portfolios--International Portfolio and Mortgage-Backed Securities
Portfolio--returned 12.55% and 10.18%, respectively for the year. Since its
inception on 11/26/97, International Emerging Markets Portfolio posted a return
of 1.40% through year-end; while International SmallCap Portfolio returned 1.59%
for the same period. As always, investors are reminded that past performance in
no way guarantees future results.
Thank you for helping us enjoy another successful year. We remain committed to
delivering the quality financial products and services our shareholders deserve.
Sincerely,
/s/ Stephan L. Jones
Stephan L. Jones
President
<PAGE>
TABLE OF CONTENTS
Page
Statements of Assets and Liabilities................ 4
Statements of Operations ........................... 6
Statements of Changes in Net Assets................. 8
Notes to Financial Statements....................... 10
Schedules of Investments
International Emerging Markets Portfolio....... 16
International Securities Portfolio............. 18
International SmallCap Portfolio............... 20
Mortgage-Backed Securities Portfolio........... 22
Financial Highlights................................ 24
Report of Independent Auditors...................... 26
Federal Income Tax Information...................... 28
<PAGE>
December 31, 1997
<TABLE>
<CAPTION>
STATEMENTS OF ASSETS AND LIABILITIES
PRINCIPAL SPECIAL MARKETS FUND, INC.
International International International Mortgage-Backed
Emerging Markets Securities SmallCap Securities
Portfolio Portfolio Portfolio Portfolio
<S> <C> <C> <C> <C>
Investment in securities -- at cost.............................. $31,496,417 $30,620,263 $31,012,948 $13,745,498
Assets
Investment in securities -- at value (Note 4).................... $31,849,866 $36,555,784 $30,873,328 $14,050,587
Cash............................................................. 20,460 27,756 41,321 20,117
Receivables:
Dividends and interest........................................ 30,776 81,047 21,149 75,748
Investment securities sold.................................... 63,372 45,450 335,721 --
Capital Stock sold............................................ 1,000,000 1,000,000 1,000,000 --
Net receivable for foreign currency contract (Note 5)............ -- 15,828 -- --
Other assets..................................................... -- 109 -- 127
Total Assets 32,964,474 37,725,974 32,271,519 14,146,579
Liabilities
Accrued expenses................................................. 31,048 41,963 26,974 7,557
Investment securities purchased.................................. 445,380 -- 276, 884 343,492
Total Liabilities 476,428 41,963 303,858 351,049
Net Assets Applicable to Outstanding Shares ................... $32,488,046 $37,684,011 $31,967,661 $13,795,530
Net Assets Consist of:
Capital Stock.................................................... $ 32,047 $ 26,081 $ 32,055 $ 13,433
Additional paid-in capital....................................... 32,027,473 31,443,409 32,018,475 14,555,069
Accumulated undistributed net investment income.................. 16,970 25,569 4,410 --
Accumulated undistributed net realized gain (loss) from:
Investment transactions ...................................... 62,185 266,112 57,172 (1,078,061)
Foreign currency transactions................................. (4,044) (16,939) (37) --
Net unrealized appreciation (depreciation) of investments........ 353,449 5,935,521 (139,620) 305,089
Net unrealized appreciation (depreciation) on translation of
assets and liabilities in foreign currencies.................. (34) 4,258 (4,794) --
Total Net Assets $32,488,046 $37,684,011 $31,967,661 $13,795,530
Capital Stock (par value: $.01 a share):
Shares authorized................................................ 100,000,000 100,000,000 100,000,000 100,000,000
Shares issued and outstanding.................................... 3,204,730 2,608,123 3,205,478 1,343,286
Net Asset Value Per Share ...................................... $10.14 $14.45 $9.97 $10.27
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31, 1997, Except as Noted
STATEMENTS OF OPERATIONS
PRINCIPAL SPECIAL MARKETS FUND, INC.
International International International Mortgage-Backed
Emerging Markets Securities SmallCap Securities
Portfolio(a) Portfolio Portfolio(a) Portfolio
Net Investment Income
Income:
<S> <C> <C> <C> <C>
Dividends....................................................... $ 65,878 $ 916,034 $ 30,500 $ --
Withholding tax on foreign dividends............................ (7,957) (103,317) (4,098) --
Interest........................................................ 62,344 94,579 66,470 1,024,680
Total Income 120,265 907,296 92,872 1,024,680
Expenses:
Management and investment advisory fees (Note 3) ............. 43,775 311,027 37,932 67,721
Net Investment Income 76,490 596,269 54,940 956,959
Net Realized and Unrealized Gain (Loss) on Investments
and Foreign Currencies Net realized gain (loss) from:
Investment transactions......................................... 62,185 1,823,607 57,172 22,412
Foreign currency transactions................................... (4,044) (16,939) (37) --
Change in unrealized appreciation/depreciation of:
Investments..................................................... 353,449 820,001 (139,620) 495,704
Translation of assets and liabilities in foreign currencies..... (34) 4,125 (4,794) --
Net Realized and Unrealized Gain (Loss)
on Investments and Foreign Currencies 411,556 2,630,794 (87,279) 518,116
Net Increase (Decrease) in Net
Assets Resulting from Operations $488,046 $3,227,063 $ (32,339) $1,475,075
<FN>
(a) Period from November 17, 1997 (date operations commenced) through
December 31, 1997.
</FN>
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
STATEMENTS OF CHANGES IN NET ASSETS
PRINCIPAL SPECIAL MARKETS FUND, INC.
International International
Emerging Markets Securities
Portfolio Portfolio
1997(a) 1997 1996
Operations
<S> <C> <C> <C>
Net investment income............................................ $ 76,490 $ 596,269 $ 394,151
Net realized gain (loss) from:
Investment transactions....................................... 62,185 1,823,607 951,597
Foreign currency transactions................................. (4,044) (16,939) (4,388)
Change in unrealized appreciation/
depreciation of investments and translation of
assets and liabilities in foreign currencies.................. 353,415 824,126 3,301,549
Net Increase (Decrease) in Net
Assets Resulting from Operations 488,046 3,227,063 4,642,909
Dividends and Distributions to Shareholders
From net investment income....................................... (59,520) (581,224) (296,191)
Excess distribution of net investment income (Note 1)............ -- -- (154,476)
From net realized gain on investments and
foreign currency transactions................................. -- (1,645,552) (1,043,459)
Total Dividends and Distributions (59,520) (2,226,776) (1,494,126)
Capital Share Transactions (Note 6)
Shares sold...................................................... 32,000,000 15,749,696 7,000,000
Shares issued in reinvestment of dividends
and distributions............................................. 59,520 1,327,125 963,318
Shares redeemed.................................................. -- (8,553,721) (202,611)
Net Increase (Decrease) in Net Assets from
Capital Share Transactions 32,059,520 8,523,100 7,760,707
Total Increase (Decrease) 32,488,046 9,523,387 10,909,490
Net Assets
Beginning of period.............................................. -- 28,160,624 17,251,134
End of period (including undistributed net investment
income as set forth below).................................... $32,488,046 $37,684,011 $28,160,624
Undistributed Net Investment Income .......................... $ 16,970 $ 25,569 $ 10,524
<FN>
(a) Period from November 17, 1997 (date operations commenced) through
December 31, 1997.
</FN>
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31, Except as Noted
STATEMENTS OF CHANGES IN NET ASSETS
PRINCIPAL SPECIAL MARKETS FUND, INC.
International Mortgage-Backed
SmallCap Securities
Portfolio Portfolio
1997(a) 1997 1996
Operations
<S> <C> <C> <C>
Net investment income............................................ $ 54,940 $ 956,959 $ 939,015
Net realized gain (loss) from:
Investment transactions....................................... 57,172 22,412 (25,440)
Foreign currency transactions................................. (37) -- --
Change in unrealized appreciation/
depreciation of investments and translation of
assets and liabilities in foreign currencies.................. (144,414) 495,704 (318,191)
Net Increase (Decrease) in Net
Assets Resulting from Operations (32,339) 1,475,075 595,384
Dividends and Distributions to Shareholders
From net investment income....................................... (50,530) (956,959) (939,015)
Excess distribution of net investment income (Note 1)............ -- -- --
From net realized gain on investments and
foreign currency transactions................................. -- -- --
Total Dividends and Distributions (50,530) (956,959) (939,015)
Capital Share Transactions (Note 6)
Shares sold...................................................... 32,000,000 -- --
Shares issued in reinvestment of dividends
and distributions............................................. 50,530 827,979 788,841
Shares redeemed.................................................. -- (2,518,823) --
Net Increase (Decrease) in Net Assets from
Capital Share Transactions 32,050,530 (1,690,844) 788,841
Total Increase (Decrease) 31,967,661 (1,172,728) 445,210
Net Assets
Beginning of period.............................................. -- 14,968,258 14,523,048
End of period (including undistributed net investment
income as set forth below).................................... $31,967,661 $13,795,530 $14,968,258
Undistributed Net Investment Income .......................... $ 4,410 $ -- $ --
<FN>
(a) Period from November 17, 1997 (date operations commenced) through
December 31, 1997.
</FN>
See accompanying notes.
</TABLE>
<PAGE>
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 four portfolios (known as the International Emerging
Markets, International Securities, International SmallCap and Mortgage-Backed
Securities Portfolios).
On November 17, 1997, the initial purchases of 3,100,000 shares of Capital Stock
of International Emerging Markets and International SmallCap Portfolios were
made by Principal Mutual Life Insurance Company (see Note 3). Effective November
26, 1997, International Emerging Markets and International SmallCap Portfolios
began offering shares to the public.
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, preferred stocks and foreign
securities, 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.
Generally, trading in foreign securities is substantially completed each day at
various times prior to the close of the New York Stock Exchange. The values of
such securities used in computing net asset value per share are usually
determined as of such times. Occasionally, events which affect the values of
such securities and foreign currency exchange rates may occur between the times
at which they are generally determined and the close of the New York Stock
Exchange and would therefore not be reflected in the computation of the Fund's
net asset value. If events materially affecting the value of such securities
occur during such period, then these securities are valued at their fair value
as determined in good faith by the Manager under procedures established and
regularly reviewed by the Board of Directors. To the extent the Fund invests in
foreign securities listed on foreign exchanges which trade on days on which the
Fund does not determine its net asset value, for example Saturdays and other
customary national U.S. holidays, the Fund's net asset value could be
significantly affected on days when shareholders have no access to the Fund.
Certain securities issued by companies in emerging market countries may have
more than one quoted valuation at any given point in time, sometimes referred to
as a "local" price and a "premium" price. The premium price is often a
negotiated price which may not consistently represent a price at which a
specific transaction can be effected. It is the policy of the International
Emerging Markets, International Securities and International SmallCap Portfolios
to value such securities at prices at which it is expected those shares may be
sold, and the Manager or any sub-adviser is authorized to make such
determinations subject to such oversight by the Fund's Board of Directors as may
from time to time be necessary.
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 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,
except for short-term investment transactions which are recorded generally on
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.
<PAGE>
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 security 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 appreciation on translation of assets and liabilities in foreign
currencies arise from changes in the exchange rate relating to assets and
liabilities, other than investments in securities, purchased and held in
non-U.S. denominated currencies.
The portfolios may, pursuant to an exemptive order issued by the Securities and
Exchange Commission, transfer uninvested funds into a joint trading account. The
order permits the portfolios' cash balances to be deposited into a single joint
account along with the cash of other registered investment companies managed by
Princor Management Corporation. These balances may be invested in one or more
short-term instruments.
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 other portfolios are recorded on the ex-dividend date.
Dividends and distributions to shareholders from net investment income and net
realized gain from investments and foreign currency transactions are determined
in accordance with federal income tax regulations, which may differ from
generally accepted accounting principles. Permanent book and tax basis
differences are reclassified within the capital accounts based on their federal
tax-basis treatment; temporary differences do not require reclassification.
Dividends and distributions which exceed net investment income and net realized
capital gains for financial reporting purposes but not for tax purposes are
reported as dividends in excess of net investment income or distributions in
excess of net realized capital gains. To the extent distributions exceed current
and accumulated earnings and profits for federal income tax purposes, they are
reported as distributions of paid-in-capital.
Reclassifications made for the periods ended December 31, 1997 and 1996 were not
material.
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, 1997, the Mortgage-Backed Securities Portfolio had a net capital
loss carryforward of approximately $1,078,000 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 fees are computed at an annual
percentage rate (as shown below) of each portfolio's average daily net assets.
Net Asset Value of Portfolio
(in millions)
First Next Over
$250 $250 $500
International Emerging Markets Portfolio 1.15% 1.05% .95%
International Securities Portfolio .90% .90% .90%
International SmallCap Portfolio 1.00% .90% .80%
Mortgage-Backed Securities Portfolio .45% .45% .45%
No brokerage commissions were paid by the Fund to Princor Financial Services
Corporation during the periods ended December 31, 1997 and 1996. Brokerage
commissions were paid to other affiliates by the following portfolios:
Periods Ended Year Ended
December 31, December 31,
1997 1996
International Emerging Markets Portfolio $10,074 $ --
International Securities Portfolio 1,394 1,655
At December 31, 1997, Principal Mutual Life Insurance Company owned shares of
the Fund's portfolios as follows:
International Emerging Markets Portfolio 3,106,111
International Securities Portfolio 1,316,510
International SmallCap Portfolio 3,105,177
Mortgage-Backed Securities Portfolio 1,343,286
Note 4 -- Investment Transactions
For the periods ended December 31, 1997, the cost of investment securities
purchased and proceeds from investment securities sold (not including short-term
investments and U.S. government securities) by the portfolios were as follows:
Purchases Sales
International Emerging Markets Portfolio $28,217,904 $ 633,672
International Securities Portfolio 15,010,626 10,169,003
International SmallCap Portfolio 29,466,770 1,310,994
Mortgage-Backed Securities Portfolio 1,506,703 2,189,856
At December 31, 1997, net unrealized appreciation (depreciation) of investments
by the Fund was composed of the following:
<TABLE>
<CAPTION>
Gross Unrealized Net Unrealized
------------------------------------ Appreciation (Depreciation)
Appreciation (Depreciation) of Investments
<S> <C> <C> <C>
International Emerging Markets Portfolio $1,696,135 $(1,342,686) $ 353,449
International Securities Portfolio 8,635,596 (2,700,075) 5,935,521
International SmallCap Portfolio 1,252,721 (1,392,341) (139,620)
Mortgage-Backed Securities Portfolio 337,577 (32,488) 305,089
</TABLE>
The Mortgage-Backed Securities Portfolio may trade portfolio securities on a
"to-be-announced" (TBA) basis. In a TBA transaction, the portfolio commits to
purchase or sell securities for which all specific information is not known at
the time of the trade. Securities purchased on a TBA basis are not settled until
they are delivered to the portfolio, normally 15 to 30 days later. These
transactions are subject to market fluctuations and their current value is
determined in the same manner as for other portfolio securities. As of December
31, 1997, Mortgage-Backed Securities Portfolio had TBA purchase commitments
involving securities with a face amount of $350,000, cost of $343,492 and market
value of $346,661. The portfolio has set aside investment securities and other
assets in excess of the commitments to serve as collateral.
At December 31, 1997, the Fund held the following securities which were
purchased in a private placement transaction and may require registration in
order to effect a sale in the ordinary course of business.
<PAGE>
<TABLE>
<CAPTION>
Value at Value as a
Date of December 31, Percentage of
Security Description Acquisition Cost 1997 Net Assets
<S> <C> <C> <C> <C> <C>
International Emerging
Markets Portfolio Banque Marocaine du Commerce 11/17/97 $190,000 $ 203,100 0.63%
Exterieur 12/3/97 20,100 20,310 0.06
Industrial Credit & Investment Corp. 11/17/97 420,000 387,750 1.19
of India 11/20/97 177,125 168,025 0.52
12/17/97 46,688 58,163 0.18
Paints & Chemical Industries Co. GDR 11/17/97 148,125 157,500 0.48
11/18/97 146,250 157,500 0.48
11/24/97 210,000 220,500 0.69
Reliance Industries GDR 12/2/97 170,000 168,750 0.52
12/12/97 72,500 84,375 0.26
Videsh Sanchar Nigam Ltd. GDR 11/17/97 312,375 292,425 0.90
11/24/97 104,000 111,400 0.34
12/12/97 30,820 32,028 0.10
2,061,826 6.35
International Securities
Portfolio Alfa SA Convertible Subordinated
Debentures 9/26/95 199,250 286,000 0.76
Fokus Bank 10/3/96 79,958 130,083 0.35
Hyundai Motor Co. Ltd. GDR 10/3/96 94,600 14,405 0.04
Kemira OY 12/10/96 286,318 217,520 0.58
2/24/97 88,695 72,822 0.19
4/11/97 95,955 86,062 0.23
Voest-Alpine Stahl 10/27/95 103,583 130,885 0.35
1/11/96 54,207 65,442 0.17
3/27/96 55,366 65,442 0.17
12/9/96 109,873 119,336 0.32
1,187,997 3.15
International SmallCap
Portfolio Bure Investment Aktiebolaget AB 11/18/97 $540,975 592,675 1.85
Industrial & Financial Systems 11/18/97 473,303 519,891 1.63
12/30/97 75,867 76,250 0.24
Newsquest PLC 11/18/97 505,613 543,740 1.70
12/2/97 78,410 78,930 0.25
1,811,486 5.67
</TABLE>
The Mortgage-Backed Securities Portfolio's investments are with various issuers;
while the other portfolios' 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 Emerging Markets, International Securities and International
SmallCap Portfolios by industry and issuer.
<PAGE>
Note 5 -- Foreign Currency Contracts
At December 31, 1997, the International Securities Portfolio owned a forward
contract to sell Hong Kong Dollars ("HKD") at a specified future date at a fixed
exchange rate. The forward foreign currency contract is valued at the forward
rate, and is marked-to-market daily. The change in market value is recorded by
the portfolio as an unrealized gain or loss. When the contract is closed, the
portfolio will record a realized gain or loss equal to the difference between
the value of the contract at the time it was opened and the value at the time it
was closed.
<TABLE>
<CAPTION>
Value at
Contracts In Exchange Settlement December 31, Net Unrealized
to Deliver For Date 1997 Appreciation
<S> <C> <C> <C> <C> <C>
International Securities Portfolio 3,975,000 HKD $ 500,000 4/30/98 $ 484,172 $15,828
</TABLE>
The use of forward foreign currency contracts does not eliminate fluctuations in
underlying prices of the portfolio's investments, but it does establish a rate
of exchange that can be achieved in the future. Although a forward foreign
currency contract limits the risk of loss due to a decline in the value of the
hedged currency, it also limits any potential gain that might result should the
value of the currency increase. In addition, the portfolio could be exposed to
risks if the counterparties to the contract are unable to meet the terms of
their contract.
Note 6 -- Capital Share Transactions
Transactions in Capital Stock by portfolio were as follows:
<TABLE>
<CAPTION>
International International International Mortgage-Backed
Emerging Securities SmallCap Securities
Markets Portfolio(a) Portfolio Portfolio(a) Portfolio
Periods Ended December 31, 1997:
<S> <C> <C> <C> <C>
Shares sold ................................. 3,198,619 966,897 3,200,301 --
Shares issued in reinvestment of
dividends and distributions .................. 6,111 93,449 5,177 82,583
Shares redeemed ............................. -- (512,039) -- (246,872)
Net Increase (Decrease) 3,204,730 548,307 3,205,478 (164,289)
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
<FN>
(a) Period from November 17, 1997 (date operations commenced) through
December 31, 1997.
</FN>
</TABLE>
Note 7 -- Line of Credit
The International Securities and Mortgage-Backed Securities Portfolios
participate with other funds managed by Princor Management Corporation in an
unsecured joint line of credit with a bank, which allows them to borrow up to
$40,000,000 collectively. Borrowings are made solely to facilitate the handling
of unusual and/or unanticipated short-term cash requirements. Interest is
charged to each participant, based on its borrowings, at a rate equal to the Fed
Funds Rate plus .50%. Additionally, a commitment fee is charged at the annual
rate of .08% on the average unused portion of the line of credit. The commitment
fee is allocated among the participating funds and portfolios in proportion to
their average net assets during each quarter. At December 31, 1997, the
International Securities and Mortgage-Backed Securities Portfolios had no
outstanding borrowings under the line of credit.
<PAGE>
December 31, 1997
SCHEDULES OF INVESTMENTS
PRINCIPAL SPECIAL MARKETS FUND, INC.
International Emerging Markets Portfolio
Shares
Held Value
Common Stocks (85.06%)
Beer, Wine & Distilled Beverages (1.46%)
South African Breweries Ltd. 19,200 $ 473,455
Beverages (6.86%)
Embotelladora Andina ADR, Series A 22,900 476,606
Fomento Economico Mexicano,
Class B (FEMSA) 69,000 551,192
PanAmerican Beverages ADR 17,400 567,675
Quilmes Industrial Quines SA ADR 46,400 635,100
2,230,573
Blast Furnace & Basic Steel
Products (2.44%)
Hylsamex SA, Class B 68,000 404,872
Tubos de Acero de Mexico ADR 18,000(a) 389,250
794,122
Central Reserve Depositories (2.60%)
Banco Ganadero SA ADR Preference 17,000 408,000
Banco Santiago SA ADR 19,600 436,100
844,100
Chemicals & Allied Products (1.06%)
Sarantis SA 27,000 345,945
Commercial Banks (3.18%)
Banco Rio de La Plata ADR 8,800 123,200
Banco Rio de La Plata SA ADR 26,000(a) 364,000
Bank Inicjatyw Gospodarczych 330,000(a) 322,986
Banque Marocaine du Commerce
Exterieur 11,000(b) 223,410
1,033,596
Communications Equipment (3.06%)
ECI Telecommunications Ltd. ADR 23,200 591,600
Ericsson Telecomunicacoes 12,600,000(a) 404,186
995,786
Computer & Data Processing
Services (1.09%)
Tecnomatix Technologies Ltd. 10,500(a) 354,375
Computer & Office Equipment (1.61%)
Orbotech Ltd. ADR 16,400(a) 522,750
Construction & Related
Machinery (1.15%)
Barlow Ltd. 44,100 374,270
Consumer Products (1.38%)
Rothmans Industries Ltd. 86,000 449,156
Drugs (1.75%)
Teva Pharmaceutical ADR 12,000 567,750
Electric Services (5.21%)
Centrais Electricas de Santa
Catarina 358,000 445,888
Companhia Paranaense de
Enersis-Copel ADR 27,000 369,563
Electricidade de Portugal SA 25,000 473,906
Enersis SA ADR 13,900 403,100
1,692,457
Electrical Goods (1.31%)
Empresa Nacional de Electric
Sponsored ADR 24,000 424,500
Electrical Industrial Apparatus (0.57%)
Guangdong Kelon Electric Holdings 180,000 184,686
Electronic Components &
Accessories (2.42%)
Elec & Eltek International 56,100 256,938
Varitronix 224,000 384,499
Wong Circuits Holdings Ltd. 220,000(a) 144,100
785,537
Electronic Distribution
Equipment (6.62%)
KCE Electronics Public Co. Ltd. 27,000 71,778
Tadiran Ltd. ADR 16,000 566,000
Techtronic Industries Co. 3,410,000 792,177
Vtech Holdings Ltd. 244,000 719,567
2,149,522
Engines & Turbines (0.78%)
First Tractor Co. Ltd. 420,000(a) 253,411
Federal & Federally Sponsored
Credit (1.89%)
Industrial Credit & Investment Corp.
of India 47,500(b) 613,938
Fire, Marine & Casualty
Insurance (0.87%)
Alfa, Series A 42,000 284,452
Foreign Banks, Branches &
Agencies (1.63%)
Credicorp Ltd. ADR 23,500 423,000
Housing & Commercial Bank 15,000 105,000
528,000
Furniture & Home Furnishings
Stores (1.72%)
Grupo Elektra SA CPO 316,000 557,384
Grocery Stores (1.00%)
Blue Square Chain Investments &
Property Ltd. 33,875(a) 323,690
Holding Offices (1.52%)
The India Fund, Inc. ADR 67,000 494,125
Measuring & Controlling Devices (1.12%)
IDT Holdings Singapore Ltd. 280,000 364,000
Meat Products (1.04%)
Davomas Abadi 600,000 109,193
PT Daya Guna Samudera 301,000 228,701
337,894
Metal Cans & Shipping
Containers (1.18%)
Colep 27,000(a) 381,845
Miscellaneous Electrical Equipment &
Supplies (1.33%)
G. P. Batteries International 166,000 431,517
Miscellaneous Investing (1.11%)
Banco Latino Americano de
Exportaciones 8,740 361,618
Miscellaneous Non-Durable Goods (1.65%)
Desc SA ADR 14,300 536,250
Miscellaneous Textile Goods (1.61%)
Esprit Holdings Ltd. 830,000 270,480
Reliance Industries GDR 30,000(b) 253,125
523,605
Motor Vehicles & Equipment (1.42%)
Qingling Motors 434,000 212,848
Tata Engineering & Locomotive
Ltd. Co. GDR 30,000 250,050
462,898
Paints & Allied Products (1.65%)
Paints & Chemical Industries Co. GDR 51,000(a)(b) 535,500
Petroleum Refining (4.00%)
Sasol Ltd. 60,200 629,666
YPF Sociedad Anonima ADR 19,600 670,075
1,299,741
Search & Navigation Equipment (1.97%)
Elbit Systems, Ltd. 46,600 640,750
Security & Commodity Exchanges (1.00%)
OTK Holdings Ltd. 395,000 324,678
Security Brokers & Dealers (0.35%)
Peregrine Investment Holdings 160,000(c) 113,574
Telephone Communications (11.01%)
Compania Anonima Telefonos de
Venezuela ADR 10,400 432,900
Hellenic Telecommunication 19,000 389,776
Matav RT ADR 20,700(a) 538,200
Telec de Sao Paulo SA 1,980,000 526,908
Telecommunicacoes Brasileiras SA 6,500,000 661,054
Telefonica de Argentina ADR 11,100 413,475
Teletypos/Mega Channel 30,000 177,652
Videsh Sanchar Nigam Ltd. GDR 31,300(b) 435,853
3,575,818
Water Supply (1.44%)
Companhia de Saneamento Basocp do
Estado de Sao Paulo - SABESP 1,970,000(a) 467,778
Total Common Stocks 27,635,046
Preferred Stock (1.12%)
Cement, Hydraulic (1.12%)
Titan Cement Co. 9,000 364,820
Principal
Amount Value
Commercial Paper (11.85%)
Federal & Federally Sponsored
Credit (11.85%)
FHLMC Commercial Paper;
4.75%; 1/2/98 $3,850,000 $3,850,000
Total Portfolio Investments (98.03%) 31,849,866
Cash, receivables and other assets,
net of liabilities (1.97%) 638,180
Total Net Assets (100.00%) $32,488,046
(a) Non-income producing security - No dividend paid during
the period.
(b) Restricted security - See Note 4 to the financial statements.
(c) On January 12, 1998 Peregrine Investment Holdings filed a plan of
liquidation.
International Emerging Markets Portfolio
Investments by Country
Total Percentage of
Country Value Total Value
Argentina $ 2,205,850 6.92%
Brazil 2,875,378 9.03
Chile 1,740,306 5.46
China 397,534 1.25
Columbia 408,000 1.28
Egypt 535,500 1.68
Greece 1,278,193 4.01
Hungary 538,200 1.69
Hong Kong 2,533,708 7.95
Indonesia 337,894 1.06
India 2,047,090 6.43
Israel 3,566,915 11.20
Mexico 3,291,074 10.33
Morocco 223,410 0.70
Panama 361,618 1.14
Peru 423,000 1.33
Poland 322,986 1.01
Portugal 855,751 2.69
Singapore 1,645,711 5.17
South Africa 1,802,070 5.66
South Korea 105,000 0.33
Thailand 71,778 0.23
United States 3,850,000 12.09
Venezuela 432,900 1.36
Total $31,849,866 100.00%
International Securities Portfolio
Shares
Held Value
Common Stocks (92.15%)
Advertising (2.01%)
WPP Group PLC 170,700 $ 756,945
Beverages (1.82%)
Lion Nathan 70,000 156,893
PanAmerican Beverages ADR 16,200 528,525
685,418
Blast Furnace & Basic
Steel Products (1.01%)
Voest-Alpine Stahl 9,900(b) 381,105
Central Reserve Depositories (3.22%)
Banco Totta & Acores 9,600 188,716
National Westminster Bank 45,008 747,598
Wing Hang Bank 98,400 278,122
1,214,436
Combination Utility Services (0.87%)
ABB AG 260 327,105
Commercial Banks (11.90%)
ABN-AMRO Holdings NV 31,913 621,817
Bank of Ireland 66,435 1,019,892
Barclays PLC 22,900 608,527
Fokus Bank 14,000(b) 130,083
Istituto Mobiliare Italiano 34,000 403,847
National Australia Bank Ltd. 38,533 538,053
Royal Bank of Canada 11,600 612,822
Svenska Handelsbanken AB Free 17,050 549,039
4,484,080
Communications Equipment (0.82%)
ECI Telecommunications Ltd. ADR 12,100 308,550
Communication Services, NEC (1.08%)
KPN Royal PTT Nederland 9,714 405,384
Computer & Office Equipment (0.12%)
Canon, Inc. 2,000 46,762
Construction & Related Machinery (0.51%)
Powerscreen International PLC 19,400 193,919
Consumer Products (4.10%)
Imasco Ltd. 20,647 728,649
Imperial Tobacco Group PLC 78,000 492,831
Swedish Match Co. 97,000 323,971
1,545,451
Crude Petroleum & Natural Gas (0.79%)
Hardy Oil & Gas 63,000 296,467
Deep Sea Foreign Transportation
of Freight (0.68%)
Van Ommeren NV 7,642 256,338
Department Stores (0.94%)
Vendex International 6,414 354,044
Drugs (6.83%)
Elan Corp. PLC ADR 10,500(a)$ 537,469
Novartis AG 578 939,192
Pharmacia & Upjohn, Inc. 16,500 604,313
Teva Pharmaceutical ADR 10,400 492,050
2,573,024
Electric Services (0.81%)
Enersis SA ADR 10,500 304,500
Electronic Components &
Accessories (2.05%)
Amtek Engineering 78,500 47,521
Elec & Eltek International 105,600 483,648
Murata Mfg. 2,000 50,453
Varitronix 111,000 190,533
772,155
Electronic Distribution
Equipment (1.34%)
Phillips Electronics 8,400 503,861
Engines & Turbines (2.06%)
Mabuchi Motor 1,100 56,091
PT United Tractors 100,000 11,829
Radex-Heraklith
Industriebeteiligungs 8,900 306,027
Scapa Group PLC 106,000 402,893
776,840
Farm & Garden Machinery (1.86%)
New Holland NV 26,500 700,594
Finance Services (0.01%)
MBF Capital Berhad 6,000 1,395
Functions Closely Related
to Banking (0.66%)
Liechtenstein Global Trust AG 400 248,192
Gas Production & Distribution (1.34%)
OMV AG 3,650 504,907
General Industrial Machinery (0.81%)
SKF AB 'B' Free 14,400 306,717
Holding Offices (0.46%)
First Pacific Co., Ltd. 360,893 174,665
Hose, Belting, Gaskets & Packing (0.17%)
Phoenix AG 3,600 64,070
Industrial Inorganic Chemicals (2.03%)
Bayer AG 10,500 389,799
Kemira OY 39,800(b) 376,404
766,203
Investment Offices (2.13%)
Amvescap PLC 93,400 801,444
Life Insurance (1.12%)
QBE Insurance Group Ltd. 93,586 421,173
Meat Products (5.74%)
Danisco AS 14,800 821,356
Davomas Abadi 270,000 49,137
Orkla, B Ordinary Shares 7,900 615,095
Unilever NV 11,000 678,266
2,163,854
Miscellaneous Chemical Products (1.03%)
Hoechst AG 11,200 388,066
Miscellaneous Converted Paper
Products (1.24%)
Bunzl PLC 120,000 467,953
Miscellaneous Food & Kindred
Products (0.99%)
Greencore Group PLC 78,000 374,757
Miscellaneous Manufacturers (0.17%)
Carter Holt Harvey Ltd. 41,000 63,326
Miscellaneous Non-Durable
Goods (1.87%)
Diageo PLC 76,985(a) 707,459
Miscellaneous Textile Goods (0.67%)
Esprit Holdings Ltd. 774,000 252,231
Miscellaneous Transportation
Equipment (1.04%)
Autoliv Inc. 12,000 393,000
Miscellaneous Wood Products (0.34%)
Enso OY 16,300 126,318
Motor Vehicles & Equipment (1.20%)
E.C.I.A. - Equipment & Composants 1,900 382,156
Hyundai Motor Co. Ltd. GDR 8,600(b) 14,405
UMW Holdings Berhad 71,000 53,810
450,371
Newspapers (1.01%)
Publishing & Broadcasting Ltd. 86,000 381,036
Oil & Gas Field Services (0.69%)
Eni SPA 46,000 260,962
Petroleum Refining (5.28%)
Repsol Petroleo SA 14,700 626,905
Sasol Ltd. 69,000 721,711
YPF Sociedad Anonima ADR 18,700 639,306
1,987,922
Photographic Equipment &
Supplies (0.11%)
PT Bunas Finance 730,000 43,177
Plastic Materials & Synthetics (0.77%)
Astra AB 17,333 291,637
Pulp Mills (2.29%)
Lassila & Tikanoja Ltd. OY 17,600 408,853
UPM-Kymmene OY 22,700 454,376
863,229
Security Brokers & Dealers (0.43%)
Peregrine Investment Holdings 227,000(c) 161,133
Peregrine Investment - Warrants 14,800(a)(c) 19
161,152
Soap, Cleaners, & Toilet Goods (3.07%)
Benckiser NV B Shares 11,900(a) 492,500
Reckitt & Colman PLC 42,292 664,907
1,157,407
Special Industry Machinery (1.94%)
Cookson Group 187,000 601,535
IHC Caland NV 2,500 129,734
731,269
Sugar & Confectionary Products (2.43%)
Nestle 610 915,491
Telephone Communications (5.67%)
Nokia Corp. Class A ADR 6,800 476,000
Telecom Corp. of New Zealand Ltd. 120,000 581,816
Telecom Italia-DI 118,000(a) 520,589
Telefonica de Espana SA 19,600 559,392
2,137,797
Trusts (0.04%)
Fairfax Trust 86,000(a) 14,569
Watches, Clocks, Watchcases &
Parts (0.58%)
Tag Heuer International SA 2,500(a) 217,682
Total Common Stocks 34,726,409
Preferred Stock (0.51%)
Commercial Banks (0.51%)
National Australia Bank ECU Convertible6,800 193,375
Principal
Amount Value
Bond (0.76%)
Fire, Marine & Casualty
Insurance (0.76%)
Alfa SA Convertible Subordinated
Debentures; 8.00%; 9/15/00 $ 200,000(b) $ 286,000
Commercial Paper (3.58%)
Business Credit Institutions (3.58%)
General Electric Capital;
6.50%; 1/2/98 1,350,000 1,350,000
Total Portfolio Investments (97.00%) 36,555,784
Cash, receivables and other assets,
net of liabilities (3.00%) 1,128,227
Total Net Assets (100.00%) $37,684,011
(a) Non-income producing security - No dividend paid during
the period.
(b) Restricted security - See Note 4 to the financial statements.
(c) On January 12, 1998 Peregrine Investment Holdings filed a plan of
liquidation.
International Securities Portfolio
Investments by Country
Total Percentage of
Country Value Total Value
Argentina $ 639,306 1.75%
Australia 1,548,205 4.24
Austria 1,192,039 3.26
Canada 1,341,471 3.67
Chile 304,500 0.83
Denmark 821,356 2.25
Finland 1,841,950 5.04
France 382,156 1.05
Germany 841,935 2.30
Hong Kong 1,056,702 2.89
Indonesia 104,143 0.28
Israel 800,600 2.19
Italy 1,185,398 3.24
Japan 153,306 0.42
Korea 14,405 0.04
Malaysia 55,206 0.15
Mexico 814,525 2.23
Netherlands 4,142,537 11.33
New Zealand 802,035 2.19
Norway 745,179 2.04
Portugal 188,716 0.52
Singapore 531,169 1.45
South Africa 721,711 1.97
Spain 1,186,298 3.25
Sweden 1,864,363 5.10
Switzerland 2,647,662 7.24
United Kingdom 8,674,598 23.73
United States 1,954,313 5.35
Total $36,555,784 100.00%
International SmallCap Portfolio
Shares
Held Value
Common Stocks (87.82%)
Advertising (3.55%)
Industrial & Financial Systems 86,000(a)(b)$ 596,141
United Group Ltd. 275,000 537,542
1,133,683
Air Transportation, Scheduled (1.96%)
Ryanair Holdings PLC ADR 25,000(a) 628,125
Airports, Flying Fields &
Services (3.81%)
Aeroporti Di Roma 45,000(a) 467,054
Virgin Express Holdings ADR 36,200(a) 751,150
1,218,204
Automotive Rentals, No Drivers (0.99%)
Avis Europe PLC 110,000 314,930
Cable & Other Pay TV Services (0.80%)
Tri-Vision International Ltd. 97,000(a) 254,189
Central Reserve Depositories (1.45%)
Union Bank of Norway 13,000 463,770
Chemicals & Allied Products (1.60%)
Sarantis SA 40,000 512,511
Communications Equipment (0.77%)
ASM Pacific 387,000 244,738
Computer & Data Processing
Services (3.69%)
Merkantildata ASA 14,500 499,580
Prosolvia AB 17,000(a) 679,198
1,178,778
Computer & Office Equipment (1.98%)
Orbotech Ltd. ADR 19,900(a) 634,312
Consumer Products (0.52%)
Rothmans Industries Ltd. 32,000 167,128
Crude Petroleum & Natural Gas (1.13%)
Hardy Oil & Gas 77,000 362,350
Deep Sea Foreign Transportation
of Freight (1.15%)
Van Ommeren NV 11,000 368,977
Drugs (1.91%)
Bio Technology General Corp. 36,000(a) 387,000
Teva Pharmaceutical ADR 4,700 222,369
609,369
Eating & Drinking Places (0.74%)
Restaurant Brands New Zealand Ltd. 240,000(a) 236,907
Electrical Industrial Apparatus (1.59%)
Doncasters PLC ADR 24,000(a) 507,000
Electrical Work (0.59%)
Internatio-Muller NV 6,000 188,829
Electronic Components &
Accessories (0.72%)
Elec & Eltek International 50,000 229,000
Electronic Distribution (4.07%)
ASM Lithography Holdings NV 3,700(a) 249,750
Techtronic Industries Co. 3,040,000 706,223
Vtech Holding Ltd. 116,000 342,089
1,298,062
Engineering & Architects (1.92%)
Cie Generale De Geophysique 22,400(a) 614,948
Engines & Turbines (1.61%)
Radex-Heraklith
Industriebeteiligungs AG 15,000 515,776
General Industrial Machinery (0.37%)
BE Semiconductor Industries NV 12,000(a)$ 118,388
Glass & Glassware, Pressed or
Blown (0.49%)
Vidrala SA 3,500 156,382
Hose, Belting, Gaskets & Packing (1.56%)
Phoenix AG 28,100 500,099
Hotels & Motels (1.69%)
Choice Hotels Scandinavia 159,500(a) 540,884
Life Insurance (1.33%)
Scor SA 8,900 425,778
Meat Products (0.78%)
Perkins Food PLC 145,000 249,320
Metal Services, NEC (3.22%)
Philip Services Corp. ADR 71,700(a) 1,030,688
Miscellaneous Business Services (0.81%)
Jaakko Poyry Group 24,200(a) 257,755
Miscellaneous Food & Kindred
Products (2.31%)
Greencore Group PLC 154,000 739,905
Miscellaneous Manufacturers (1.57%)
Docdata NV 29,000(a) 500,684
Miscellaneous Primary Metal
Products (1.74%)
YBM Magnex International, Inc. 53,000(a) 555,548
Miscellaneous Textile Goods (0.44%)
Esprit Holdings Ltd. 430,000 140,128
Miscellaneous Transportation
Equipment (2.32%)
ASG AB, Class B 30,000 742,971
Motor Vehicles & Equipment (3.35%)
E.C.I.A. Equipment & Composants 1,900 382,156
Mayflower Corp. PLC 226,000 687,943
1,070,099
Newspapers (1.95%)
Newsquest PLC 142,000(a)(b) 622,670
Non-Classifiable Establishments (1.85%)
Bure Investment Aktiebolaget AB 45,000(b) 592,675
Non-Residential Building
Construction (1.11%)
Algeco 8,000 355,061
Oil & Gas Field Services (2.11%)
Det Sondenfjelds-Norske
Dampskibsselskab 15,000(a) 313,340
Farstad Shipping 66,000 362,579
675,919
Personnel Supply Services (2.64%)
Dis Deutshcer Industries Service AG 10,000 417,120
Unique International NV 20,000 426,198
843,318
Petroleum Refining (1.71%)
Ocean Rig ASA 517,000(a) 547,002
Pulp Mills (2.17%)
Lassila & Tikanoja Ltd. Oy 29,900 694,585
Real Estate Operators & Lessors (1.03%)
Castellum AB 33,000(a) 328,571
Residential Building Construction (0.73%)
Volker Wessels Stevin NV 7,500 233,077
Sanitary Services (1.86%)
De Sammensluttede Vognmand AS 800 595,863
Search & Navigation Equipment (1.98%)
Elbit Systems Ltd. 46,000 632,500
Security Brokers & Dealers (1.85%)
Van Der Moolen Holdings 20,000 591,942
Telegraph & Other
Communications (0.67%)
Colt Telecom Group PLC ADR 5,000(a) 213,125
Telephone Communications (5.62%)
Colt Telecom Group PLC 12,000 121,727
Energis PLC 82,000 342,704
Metronet Communications, Class B ADR 76,500(a) 1,329,188
1,793,619
Women's & Children's
Undergarments (2.01%)
CSP International SPA 57,000(a) 643,186
Total Common Stocks 28,073,328
Principal
Amount Value
Commercial Paper (8.76%)
Federal & Federally Sponsored
Credit (8.76%)
FHLMC Commercial Paper;
4.75%; 1/2/98 $2,800,000 $2,800,000
Total Portfolio Investments (96.58%) 30,873,328
Cash, receivables and other assets,
net of liabilities (3.42%) 1,094,333
Total Net Assets (100.00%) $31,967,661
(a) Non-income producing security - No dividend paid during
the period.
(b) Restricted security - See Note 4 to the financial statements.
International SmallCap Portfolio
Investments by Country
Total Percentage of
Country Value Total Value
Australia $ 537,542 1.74%
Austria 515,776 1.67
Belgium 751,150 2.43
Canada 3,169,613 10.27
Denmark 595,863 1.93
Finland 952,340 3.08
France 1,777,943 5.76
Germany 917,219 2.97
Greece 512,511 1.66
Hong Kong 1,433,179 4.64
Ireland 628,125 2.03
Israel 1,876,181 6.08
Italy 1,110,240 3.60
Netherlands 2,677,845 8.67
New Zealand 236,907 0.77
Norway 2,727,155 8.83
Singapore 396,128 1.28
Spain 156,382 0.51
Sweden 2,939,556 9.52
United Kingdom 4,161,673 13.49
United States 2,800,000 9.07
Total $30,873,328 100.00%
Mortgage-Backed Securities Portfolio
Description of Issue Principal
Type Rate Maturity Amount Value
Federal National Mortgage Association (FNMA)
Certificates (30.56%)
FNMA 6.25% 4/1/26 $ 392,525 $ 383,387
FNMA 7.00 8/1/23 3,025,073 3,062,584
FNMA 7.50 6/1/23 747,208 769,782
Total FNMA Certificates 4,215,753
Government National Mortgage Association (GNMA)
Certificates (58.15%)
GNMA I 6.50 2/15/23-1/15/24 2,434,530 2,415,823
GNMA I 7.50 6/15/23-3/15/27 1,279,264 1,313,395
GNMA II 5.50 3/20/26 180,994 165,666
GNMA II 6.00 9/20/23-9/20/26 3,916,196 3,769,033
GNMA II 6.50 10/20/25 363,217 358,655
Total GNMA Certificates 8,022,572
Federal Home Loan Mortgage Corporation
(FHLMC) Certificates (10.37%)
FHLMC 5.50 2/15/24-3/1/24 665,305 632,895
FHLMC 6.00 4/1/24 162,401 157,146
FHLMC 6.50 12/1/13-2/15/28 645,013 640,875
Total FHLMC Certificates 1,430,916
Federal Agency Short-Term Obligations (2.77%)
Principal
Amount Value
Investment in Joint Trade Account;
Federal Home Loan Mortgage Corp.;
4.75%; 1/2/98 $ 381,346 $ 381,346
Total Portfolio Investments (101.85%) 14,050,587
Liabilities, net of cash, receivables and
other assets (-1.85%) (255,057)
Total Net Assets (100.00%) $13,795,530
<PAGE>
FINANCIAL HIGHLIGHTS
PRINCIPAL SPECIAL MARKETS FUND, INC.
Selected data for a share of Capital Stock outstanding throughout each period:
<TABLE>
<CAPTION>
Income from
Investment Operations Less Distributions
------------------------------------ ----------------------------------
Net Realized
and Excess
Net Asset Net Unrealized Total Dividends Distributions
Value at Invest- Gain from from Net from Net
Beginning ment (Loss) on Investment Investment Investment
of Period Income Investments Operations Income Income
INTERNATIONAL EMERGING
MARKETS PORTFOLIO
<S> <C> <C> <C> <C> <C> <C>
Period Ended December 31, 1997(a) $ 9.94 $.01 $ .21 $ .22 $(.02) $ --
INTERNATIONAL SECURITIES PORTFOLIO
Year Ended December 31,
1997 13.67 .24 1.46 1.70 (.24) --
1996 11.70 .31 2.46 2.77 (.16) (.07)
1995 11.29 .19 1.11 1.30 (.10) (.07)
1994 12.87 .13 (.95) (.82) (.12) (.13)
Period Ended December 31, 1993(d) 10.01 .07 2.91 2.98 (.10) --
INTERNATIONAL SMALLCAP PORTFOLIO
Period Ended December 31, 1997(a) 9.86 .01 .12 .13 (.02) --
MORTGAGE-BACKED SECURITIES PORTFOLIO
Year Ended December 31,
1997 9.93 .64 .34 .98 (.64) --
1996 10.17 .64 (.24) .40 (.64) --
1995 9.11 .65 1.06 1.71 (.65) --
1994 10.10 .63 (.99) (.36) (.63) --
Period Ended December 31, 1993(d) 10.01 .34 .09 .43 (.34) --
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
----------------------------
Net Asset
Distributions Value at
from Total End of Total
Capital Gains Distributions Period Return
INTERNATIONAL EMERGING
MARKETS PORTFOLIO
<S> <C> <C> <C> <C>
Period Ended December 31, 1997(a) $-- $(.02) $10.14 1.40%(b)
INTERNATIONAL SECURITIES PORTFOLIO
Year Ended December 31,
1997 (.68) (.92) 14.45 12.55
1996 (.57) (.80) 13.67 24.12
1995 (.72) (.89) 11.70 12.02
1994 (.51) (.76) 11.29 (6.45)
Period Ended December 31, 1993(d) (.02) (.12) 12.87 29.95(b)
INTERNATIONAL SMALLCAP PORTFOLIO
Period Ended December 31, 1997(a) -- (.02) 9.97 1.59(b)
MORTGAGE-BACKED SECURITIES PORTFOLIO
Year Ended December 31,
1997 -- (.64) 10.27 10.18
1996 -- (.64) 9.93 4.20
1995 -- (.65) 10.17 19.26
1994 -- (.63) 9.11 (3.60)
Period Ended December 31, 1993(d) -- (.34) 10.10 4.47(b)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Ratios/Supplemental Data
----------------------------------------------------------------
Ratio of Net
Ratio of Investment
Net Assets at Expenses to Income to Portfolio Average
End of Period Average Average Turnover Commission
(in thousands) Net Assets Net Assets Rate Rate(e)
INTERNATIONAL EMERGING
MARKETS PORTFOLIO
<S> <C> <C> <C> <C> <C>
Period Ended December 31, 1997(a) $32,488 1.15%(c) .91%(c) 12.3%(c) $.0029
INTERNATIONAL SECURITIES PORTFOLIO
Year Ended December 31,
1997 37,684 .90 1.73 30.8 .0187
1996 28,161 .90 1.90 25.5 .0187
1995 17,251 .90 1.79 46.0 N/A
1994 15,542 .90 .94 37.0 N/A
Period Ended December 31, 1993(d) 16,838 .90(c) 1.21(c) 6.9(c) N/A
INTERNATIONAL SMALLCAP PORTFOLIO
Period Ended December 31, 1997(a) 31,968 1.00(c) .91(c) 30.3(c) .0111
MORTGAGE-BACKED SECURITIES PORTFOLIO
Year Ended December 31,
1997 13,796 .45 6.37 15.5 N/A
1996 14,968 .45 6.51 28.7 N/A
1995 14,253 .45 6.66 9.9 N/A
1994 14,714 .45 6.56 41.8 N/A
Period Ended December 31, 1993(d) 24,309 .45(c) 5.23(c) 9.6(c) N/A
<FN>
(a) Period from November 26, 1997, date shares first offered to the public,
through December 31, 1997. Net investment income, aggregating $.02 per
share for the International Emerging Markets Portfolio and $.01 per share
for the International SmallCap Portfolio for the period from the initial
purchase of shares on November 17, 1997 through November 25, 1997, was
recognized, none of which was distributed to the sole shareholder,
Principal Mutual Life Insurance Company. Additionally, the portfolios
incurred unrealized losses on investments of ($.08) per share and ($.15)
per share respectively, during the interim period. This represents
activities of each portfolio prior to the initial offering.
(b) Total return amounts have not been annualized.
(c) Computed on an annualized basis.
(d) 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.
(e) The International Portfolios identified the cost of commissions paid on
purchases and sales charged to each portfolio in the local currency in the
respective country involved. The value of the commissions is translated
into U.S. dollars at approximate rates when acquired or sold. This
translation can give the appearance that the International Portfolios'
average commissions are substantially different from the other funds.
</FN>
</TABLE>
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board 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 Emerging Markets, International
Securities, International SmallCap and Mortgage-Backed Securities Portfolios) as
of December 31, 1997, and the related statements of operations, 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 Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements and financial highlights. Our procedures included confirmation of
securities owned as of December 31, 1997, 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, 1997, and the results of their operations, the changes in
their net assets and the financial highlights for each of the periods indicated
therein, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Des Moines, Iowa
January 16, 1998
<PAGE>
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.
<TABLE>
<CAPTION>
Year Ended December 31, 1997
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
Emerging Markets
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Portfolio 12/22/97 $.0192 00.00%
$.0192 $.0192
International
Securities Portfolio 2/5/97 $.0022 00.00% 2/5/97 $.0456 $.0009
12/22/97 .2354 00.00% 12/22/97 .4575 .1751
$.2376 $.6791 $.9167
International
SmallCap Portfolio 12/22/97 $.0163 00.00%
$.0163 $.0163
</TABLE>
<TABLE>
<CAPTION>
Per Share Income Dividend Distributions/Payable Date
1/31/97 2/28/97 3/31/97 4/30/97 5/30/97 6/30/97 7/31/97 8/29/97 9/30/97 10/31/97 11/28/97 12/31/97
Mortgage-Backed
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities Portfolio $.0552 $.0528 $.0502 $.0533 $.0540 $.0506 $.0530 $.0545 $.0511 $.0568 $.0507 $.0538
<FN>
* Percent qualifying for deduction by shareholders who are corporations.
** Taxable as long-term capital gain.
*** Taxable at ordinary income rates.
</FN>
</TABLE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<INVESTMENTS-AT-COST> 31,496,417
<INVESTMENTS-AT-VALUE> 31,849,866
<RECEIVABLES> 1,094,148
<ASSETS-OTHER> 0
<OTHER-ITEMS-ASSETS> 20,460
<TOTAL-ASSETS> 32,964,474
<PAYABLE-FOR-SECURITIES> 445,380
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 31,048
<TOTAL-LIABILITIES> 476,428
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 32,059,520
<SHARES-COMMON-STOCK> 3,204,730
<SHARES-COMMON-PRIOR> 0
<ACCUMULATED-NII-CURRENT> 16,970
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 58,141
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 353,415
<NET-ASSETS> 32,488,046
<DIVIDEND-INCOME> 57,921
<INTEREST-INCOME> 62,344
<OTHER-INCOME> 0
<EXPENSES-NET> (43,775)
<NET-INVESTMENT-INCOME> 76,490
<REALIZED-GAINS-CURRENT> 58,141
<APPREC-INCREASE-CURRENT> 353,415
<NET-CHANGE-FROM-OPS> 488,046
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (59,520)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 3,198,619
<NUMBER-OF-SHARES-REDEEMED> 0
<SHARES-REINVESTED> 6,111
<NET-CHANGE-IN-ASSETS> 32,488,046
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 43,775
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 43,775
<AVERAGE-NET-ASSETS> 30,909,230
<PER-SHARE-NAV-BEGIN> 9.94
<PER-SHARE-NII> .01
<PER-SHARE-GAIN-APPREC> .21
<PER-SHARE-DIVIDEND> (.02)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 10.14
<EXPENSE-RATIO> 1.15
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<INVESTMENTS-AT-COST> 30,620,263
<INVESTMENTS-AT-VALUE> 36,555,784
<RECEIVABLES> 1,142,325
<ASSETS-OTHER> 109
<OTHER-ITEMS-ASSETS> 27,756
<TOTAL-ASSETS> 37,725,974
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 41,963
<TOTAL-LIABILITIES> 41,963
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 31,469,490
<SHARES-COMMON-STOCK> 2,608,123
<SHARES-COMMON-PRIOR> 2,059,816
<ACCUMULATED-NII-CURRENT> 25,569
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 249,173
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 5,939,779
<NET-ASSETS> 37,684,011
<DIVIDEND-INCOME> 812,717
<INTEREST-INCOME> 94,579
<OTHER-INCOME> 0
<EXPENSES-NET> (311,027)
<NET-INVESTMENT-INCOME> 596,269
<REALIZED-GAINS-CURRENT> 1,806,668
<APPREC-INCREASE-CURRENT> 824,126
<NET-CHANGE-FROM-OPS> 3,227,063
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (581,224)
<DISTRIBUTIONS-OF-GAINS> (1,645,552)
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 966,897
<NUMBER-OF-SHARES-REDEEMED> (512,039)
<SHARES-REINVESTED> 93,449
<NET-CHANGE-IN-ASSETS> 9,523,387
<ACCUMULATED-NII-PRIOR> 10,524
<ACCUMULATED-GAINS-PRIOR> 88,057
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 311,027
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 311,027
<AVERAGE-NET-ASSETS> 34,558,488
<PER-SHARE-NAV-BEGIN> 13.67
<PER-SHARE-NII> .24
<PER-SHARE-GAIN-APPREC> 1.46
<PER-SHARE-DIVIDEND> (.24)
<PER-SHARE-DISTRIBUTIONS> (.68)
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 14.45
<EXPENSE-RATIO> .90
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<INVESTMENTS-AT-COST> 31,012,948
<INVESTMENTS-AT-VALUE> 30,873,328
<RECEIVABLES> 1,356,870
<ASSETS-OTHER> 0
<OTHER-ITEMS-ASSETS> 41,321
<TOTAL-ASSETS> 32,271,519
<PAYABLE-FOR-SECURITIES> 276,884
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 26,974
<TOTAL-LIABILITIES> 303,858
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 32,050,530
<SHARES-COMMON-STOCK> 3,205,478
<SHARES-COMMON-PRIOR> 0
<ACCUMULATED-NII-CURRENT> 4,410
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 57,135
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (144,414)
<NET-ASSETS> 31,967,661
<DIVIDEND-INCOME> 26,402
<INTEREST-INCOME> 66,470
<OTHER-INCOME> 0
<EXPENSES-NET> (37,932)
<NET-INVESTMENT-INCOME> 54,940
<REALIZED-GAINS-CURRENT> 57,135
<APPREC-INCREASE-CURRENT> (144,414)
<NET-CHANGE-FROM-OPS> (32,339)
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (50,530)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 3,200,301
<NUMBER-OF-SHARES-REDEEMED> 0
<SHARES-REINVESTED> 5,177
<NET-CHANGE-IN-ASSETS> 31,967,661
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 37,932
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 37,932
<AVERAGE-NET-ASSETS> 30,792,942
<PER-SHARE-NAV-BEGIN> 9.86
<PER-SHARE-NII> .01
<PER-SHARE-GAIN-APPREC> .12
<PER-SHARE-DIVIDEND> (.02)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 9.97
<EXPENSE-RATIO> 1.00
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<INVESTMENTS-AT-COST> 13,745,498
<INVESTMENTS-AT-VALUE> 14,050,587
<RECEIVABLES> 75,748
<ASSETS-OTHER> 127
<OTHER-ITEMS-ASSETS> 20,117
<TOTAL-ASSETS> 14,146,579
<PAYABLE-FOR-SECURITIES> 343,492
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 7,557
<TOTAL-LIABILITIES> 351,049
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 14,568,502
<SHARES-COMMON-STOCK> 1,343,286
<SHARES-COMMON-PRIOR> 1,507,575
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (1,078,061)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 305,089
<NET-ASSETS> 13,795,530
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 1,024,680
<OTHER-INCOME> 0
<EXPENSES-NET> (67,721)
<NET-INVESTMENT-INCOME> 956,959
<REALIZED-GAINS-CURRENT> 22,412
<APPREC-INCREASE-CURRENT> 495,704
<NET-CHANGE-FROM-OPS> 1,475,075
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (956,959)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 0
<NUMBER-OF-SHARES-REDEEMED> (246,872)
<SHARES-REINVESTED> 82,583
<NET-CHANGE-IN-ASSETS> (1,172,728)
<ACCUMULATED-NII-PRIOR> 0
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<EXPENSE-RATIO> .45
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</TABLE>
