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>
