Registration No. 33-59474
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
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POST-EFFECTIVE AMENDMENT NO. 10 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 Jones & Blouch
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, 1999, 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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<PAGE>
PRINCIPAL SPECIAL MARKETS FUND, INC.
PORTFOLIOS OF THE FUND
International Emerging Markets Portfolio International SmallCap Portfolio
International Securities Portfolio Mortgage-Backed Securities Portfolio
This Prospectus describes a mutual fund organized by Principal Life
Insurance Company. The Fund provides a choice of investment objectives through
International Growth-Oriented Portfolios and an Income-Oriented Portfolio.
The date of this Prospectus is May 1, 1999.
Neither the Securities and Exchange Commission nor any State Securities
Commission has approved or disapproved of these securities or determined if this
prospectus is accurate or complete. Any representation to the contrary is a
criminal offense.
TABLE OF CONTENTS
Fund Description..........................................................3
International Growth-Oriented Portfolio
International Emerging Markets Portfolio..............................4
International Securities Portfolio....................................6
International SmallCap Portfolio......................................8
Income-Oriented Portfolio
Mortgage-Backed Securities Portfolio.................................10
The Costs of Investing...................................................12
Certain Investment Strategies and Related Risks..........................12
Management, Organization and Capital Structure...........................15
Management Discussion of Fund Performance................................16
Pricing of Fund Shares...................................................20
Dividend and Distributions...............................................20
To Buy Shares............................................................21
Offering Price of Shares.................................................22
To Sell Shares...........................................................22
General Information about a Fund Account.................................24
Financial Highlights.....................................................26
FUND DESCRIPTION
The Principal Special Markets Fund, Inc. (the "Fund") is a no-load, open-end
management investment company. It consists of four series ("Portfolios"):
International Emerging Markets Portfolio, International Securities Portfolio,
International SmallCap Portfolio and Mortgage-Backed Securities Portfolio.
In the description for each Portfolio, you will find important information about
the Portfolio's:
Primary investment strategy
This section summarizes how the Portfolio intends to achieve its investment
objective. It identifies the Portfolio's primary investment strategy including
the type or types of securities in which the Portfolio invests.
Annual operating expenses
The annual operating expenses for each Portfolio are deducted from its assets
(stated as a percentage of the portfolio's assets) and are shown as of the end
of the most recent fiscal year. The examples on the following pages are intended
to help you compare the cost of investing in a particular Portfolio with the
cost of investing in other mutual funds.
Day-to-day Portfolio management
The investment professionals who manage the assets of each Portfolio are listed
with each Portfolio. Backed by their staffs of experienced securities analysts,
they provide the Portfolios with professional investment management.
Principal Management Corporation serves as the manager for the Fund. It has
signed a contract with Invista Capital Management LLC. Under the contract,
Invista provides investment advisory services for the Portfolios (see
Management, Organization and Capital Structure).
Portfolio Performance
Included in each Portfolio's description is a set of tables and a bar chart.
Together, these provide an indication of the risks involved when you invest.
The bar chart shows changes in the Portfolio's performance from year to year.
One of the tables compares the Portfolio's average annual returns for 1, 5 and
10 years with a broad based securities market index (a broad measure of market
performance) and an average of mutual funds with a similar investment objective
and management style. The averages used are prepared by Lipper, Inc. (an
independent statistical service). The other table for each Portfolio provides
the highest and lowest quarterly return for that Portfolio since the inception
of each Portfolio.
A Portfolio's past performance is not necessarily an indication of how the
Portfolio will perform in the future.
NOTE: Investments in these Portfolios are not deposits of a bank and are not
insured or guaranteed by the Federal Deposit Insurance Corporation or any
other government agency.
INTERNATIONAL GROWTH-ORIENTED PORTFOLIO
International Emerging Markets Portfolio
Main Strategies
The International Emerging Markets Portfolio seeks to achieve long-term growth
of capital by investing primarily in equity securities of issuers in emerging
market countries.
The International Emerging Markets Portfolio seeks to achieve its objective by
investing in common stocks of companies in emerging market countries. For this
Portfolio, the term "emerging market country" means any country which is
considered to be an emerging country by the international financial community
(including the International Bank for Reconstruction and Development (also 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.
Investing in many emerging market countries is not feasible or may involve
unacceptable political risk. Invista, the Sub-Advisor, focuses on those emerging
market countries that it believes have strongly developing economies and markets
which are becoming more sophisticated.
Under normal conditions, at least 65% of the Portfolio's assets are invested in
emerging market country equity securities. The Portfolio invests in securities
of:
o companies with their principal place of business or principal office in
emerging market countries;
o companies for which the principal securities trading market is an emerging
market country; or
o companies, regardless of where its securities are 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.
Main Risks
Investments in emerging market countries involve special risks. Certain emerging
market countries have historically experienced, and may continue to experience,
certain economic problems. These may include: 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 risks involved with any investment in foreign securities.
These include the risk that a foreign security could lose value as a result of
political, financial and economic events in foreign countries. In addition,
foreign securities may be subject to securities regulators with less stringent
accounting and disclosure standards than are required of U.S. companies.
Under unusual market or economic conditions, the Portfolio may invest in
securities issued by domestic corporations, governments or governmental
agencies, instrumentalities or political subdivisions. The securities may be
denominated in U.S. dollars or other currencies.
The International Emerging Markets Portfolio is generally a suitable investment
for investors seeking long-term growth who want to invest a portion of their
assets in securities of companies in emerging market countries. Because the
values of the Portfolio's assets are likely to rise or fall dramatically, when
shares of the Portfolio are sold they may be worth more or less than the amount
paid for them. This Portfolio is not an appropriate investment if you are
seeking either preservation of capital or high current income. You must be able
to assume the increased risks of higher price volatility and currency
fluctuations associated with investments in international stocks which trade in
non-U.S. currencies.
Portfolio Performance Information
------------------------------ ------------------------------------
Annual Total Returns Highest & lowest
1998 -17.21% quarterly total return
during the last 1 year
------------------------------------
Quarter Ended Quarterly Return
------------------------------------
12/31/98 14.06%
9/30/98 (19.25%)
------------------------------------
Calendar Years Ended December 31
--------------------------------------------------
Average annual total returns
for the period ending December 31, 1998
---------------------------------------------------
Past One Past Five
Year Years
-------- ---------
International Emerging
Markets Portfolio (17.21)% (14.76)%*
Morgan Stanley Capital
International EMF (27.52) (11.13)
Lipper Emerging Markets
Fund Average (26.83) (10.01)
---------------------------------------------------
* Period from November 26, 1997, date first offered
to the public, through December 31, 1998.
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The bar chart and tables shown above provide some indication of the risks
of investing in the Account by showing changes in the Account's
performance from year to year and by showing how the Account's average
annual returns compare with those of a broad measure of market
performance. The example shown below assumes 1) an investment of $10,000,
2) a 5% annual return and 3) that expenses are the same as the most
recent fiscal year expenses.
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Portfolio Operating Expenses Examples
------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
$117 $365 $633 $1,398
Management Fees...................... 1.15%
Other Expenses*...................... _
-----
Total Portfolio Operating Expenses 1.15%
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* In addition to brokerage and extraordinary
expenses, a Portfolio will pay only taxes
and interest expenses, which it is anticipated
to be minimal or nonexistent under normal
circumstances.
Day-to-day Portfolio management:
Since November 1997 Kurtis D. Spieler, CFA. Portfolio Manager of Invista
since 1995. Investment Officer 1994-95.
Prior thereto, Investment Manager.
INTERNATIONAL GROWTH-ORIENTED PORTFOLIO
International Securities Portfolio
Main Strategies
The International Securities Portfolio seeks long-term growth of capital by
investing in a portfolio of securities of companies domiciled in any of the
nations of the world.
The International Securities Portfolio invests in common stocks of companies
established outside of the U.S. The Portfolio has no limitation on the
percentage of assets that are invested in any one country or denominated in any
one currency. However under normal market conditions, the Portfolio intends to
have at least 65% of its assets invested in companies in at least three
different countries. One of those countries may be the U.S. though currently the
Portfolio does not intend to invest in equity securities of U.S. companies.
Investments may be made anywhere in the world. Primary consideration is given to
securities of corporations of Western Europe, North America and Australasia
(Australia, Japan and Far East Asia). Changes in investments are made as
prospects change for particular countries, industries or companies.
In choosing investments for the Portfolio, Invista pays particular attention to
the long-term earnings prospects of the various companies under consideration.
Invista then weighs those prospects relative to the price of the security.
Main Risks
The values of the stocks owned by the Portfolio change on a daily basis. Stock
prices reflect the activities of individual companies as well as general market
and economic conditions. In the short term, stock prices and currencies can
fluctuate dramatically in response to these factors. In addition, there are
risks involved with any investment in foreign securities that are not generally
found in securities of U.S. companies. These include the risk that a foreign
security could lose value as a result of political, financial and economic
events in foreign countries. In addition, foreign securities may be subject to
securities regulators with less stringent accounting and disclosure standards
than are required of U.S. companies.
The International Securities Portfolio is generally a suitable investment for
investors who seek long-term growth and who want to invest in non-U.S.
companies. This Portfolio is not an appropriate investment if you are seeking
either preservation of capital or high current income. Suitable investors must
be able to assume the increased risks of higher price volatility and currency
fluctuations associated with investments in international stocks which trade in
non-U.S. currencies. As with all mutual funds, the value of the Fund's assets
may rise or fall. If you sell your shares when their value is less than the
price you paid, you will lose money.
Under unusual market or economic conditions, the Portfolio may invest in
securities issued by domestic corporations, governments or governmental
agencies, instrumentalities or political subdivisions. The securities may be
denominated in U.S. dollars or other currencies.
Portfolio Performance Information
-------------------------- ------------------------------------
Annual Total Returns Highest & lowest
1994 -6.45% quarterly total return
1995 12.02% during the last 6 years
1996 24.12% ------------------------------------
1997 12.55% Quarter Ended Quarterly Return
1998 9.55% ------------------------------------
12/31/93 18.02%
9/30/98 (17.48%)
------------------------------------
Calendar Years Ended December 31
-------------------------------------------------
Average annual total returns
for the period ending December 31, 1998
--------------------------------------------------
Past One Past Five Ten
Year Years Years
-------- --------- -------
International Securities
Portfolio 9.55% 9.91% 13.87%*
Morgan Stanley Capital
International EAFE
(Europe, Australia
and Far East) Index 20.00 9.19 5.54
Lipper International
Fund Average 13.02 7.87 9.39
--------------------------------------------------
* Period from May 7, 1993, date first offered
to the public, through December 31, 1998.
----------------------------------------------------------------------------
The bar chart and tables shown above provide some indication of the risks
of investing in the Account by showing changes in the Account's
performance from year to year and by showing how the Account's average
annual returns compare with those of a broad measure of market
performance. The example shown below assumes 1) an investment of $10,000,
2) a 5% annual return and 3) that expenses are the same as the most
recent fiscal year expenses.
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Portfolio Operating Expenses Examples
-----------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
$92 $287 $498 $1,108
Management Fees...................... .90%
Other Expenses*...................... _
----
Total Portfolio Operating Expenses .90%
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* In addition to brokerage and extraordinary
expenses, a Portfolio will pay only taxes
and interest expenses, which it is anticipated
to be minimal or nonexistent under normal
circumstances.
Day-to-day Portfolio management:
Since April, 1994 Scott D. Opsal, CFA. Executive Vice President and
Chief Investment Officer of Invista since 1997. Vice
President, 1986-1997.
INTERNATIONAL GROWTH-ORIENTED PORTFOLIO
International SmallCap Portfolio
Main Strategies
The International SmallCap Portfolio seeks to achieve long-term growth of
capital by investing primarily in equity securities of non-United States
companies with comparatively smaller market capitalizations. The International
SmallCap Portfolio invests in stocks of non-U.S. companies with comparatively
smaller market capitalizations. Market capitalization is defined as total
current market value of a company's outstanding common stock. Under normal
market conditions, the Portfolio invests at least 65% of its assets in
securities of companies having market capitalizations of $1 billion or less.
Foreign stocks carry risks that are not generally found in stocks of U.S.
companies. These include the risk that a foreign security could lose value as a
result of political, financial and economic events in foreign countries. In
addition, foreign securities may be subject to securities regulators with less
stringent accounting and disclosure standards than are required of U.S.
companies.
Investments in companies with small market capitalizations carry their own
risks. Historically, small company securities have been more volatile in price
than larger company securities, especially over the short-term. While small,
unseasoned companies may offer greater opportunities for capital growth than
larger, more established companies, they also involve greater risks and should
be considered speculative.
Main Risks
The Portfolio diversifies its investments geographically. There is no limitation
of the percentage of assets that may be invested in one country or denominated
in any one currency. However, under normal market circumstances, the Portfolio
intends to have at least 65% of its assets invested in securities of companies
of at least three countries.
This Portfolio is not an appropriate investment if you are seeking either
preservation of capital or high current income. You must be able to assume the
increased risks of higher price volatility and currency fluctuations associated
with investments in international stocks which trade in non-U.S. currencies.
The International SmallCap Portfolio is generally a suitable investment for
investors seeking long-term growth who want to invest a portion of their assets
in smaller, non-U.S. companies. Because the values of the Portfolio's assets may
rise or fall, when shares of the Portfolio are sold they may be worth more or
less than the amount paid for them.
Portfolio Performance Information
---------------------------- ------------------------------------
Annual Total Returns Highest & lowest
1998 11.92% quarterly total return
during the last 1 year
------------------------------------
Quarter Ended Quarterly Return
------------------------------------
3/31/98 21.10%
9/30/98 (20.68%)
------------------------------------
Calendar Years Ended December 31
--------------------------------------------------
Average annual total returns
for the period ending December 31, 1998
---------------------------------------------------
Past One Past Five
Year Years
-------- ---------
International SmallCap
Portfolio 11.92% 12.43%*
Morgan Stanley Capital
International EAFE
(Europe, Australia and
Far East) Index 20.00 9.19
Lipper International
Small-Cap Fund Average 13.02 6.10
---------------------------------------------------
* Period from November 26, 1997, date first
offered to the public, through December 31,
1998.
----------------------------------------------------------------------------
The bar chart and tables shown above provide some indication of the risks
of investing in the Account by showing changes in the Account's
performance from year to year and by showing how the Account's average
annual returns compare with those of a broad measure of market
performance. The example shown below assumes 1) an investment of $10,000,
2) a 5% annual return and 3) that expenses are the same as the most
recent fiscal year expenses.
----------------------------------------------------------------------------
-----------------------------------------------------------------------------
Portfolio Operating Expenses Examples
-----------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
$102 $318 $552 $1,225
Management Fees.................... 1.00%
Other Expenses*.................... _
-----
Total Portfolio Operating Expenses 1.00%
-----------------------------------------------------------------------------
* In addition to brokerage and extraordinary
expenses, a Portfolio will pay only taxes
and interest expenses, which it is anticipated
to be minimal or nonexistent under normal
circumstances.
Day-to-day Portfolio management:
Since November 1997 Darren K. Sleister, CFA. Portfolio Manager of Invista
since 1995. Prior thereto, Securities Analyst.
INCOME-ORIENTED PORTFOLIO
Mortgage-Backed Securities Portfolio
Main Strategies
The Mortgage-Backed Securities Portfolio seeks a high level of current income,
liquidity and safety of principal by purchasing obligations issued or guaranteed
by the United States Government or its agencies, with emphasis on Government
National Mortgage Associations Certificates. The guarantees by the United States
Government extends only to principal and interest. There are certain risks
unique to GNMA Certificates.
The Mortgage-Backed Securities Portfolio invests in U.S. Government securities,
which include obligations issued or guaranteed by the U.S. Government or its
agencies or instrumentalities. The Portfolio may invest in securities supported
by:
o full faith and credit of the U.S. Government (e.g. GNMA certificates); or
o credit of the instrumentality (e.g. bonds issued by the Federal Home Loan
Mortgage Corp.).
In addition, the Portfolio may invest in money market investments.
Although some of the securities the Portfolio purchases are backed by the U.S.
government and its agencies, shares of the Portfolio are not guaranteed.
Generally, when interest rates fall, the value of the Portfolio's shares rises,
and when rates rise, the value declines. Because of the fluctuation in values of
the Portfolio's shares, when sold, shares of the Portfolio may be worth more or
less than the amount paid for them.
U.S. Government securities do not involve the degree of credit risk associated
with investments in lower quality fixed-income securities. As a result, the
yields available from U.S. Government securities are generally lower than the
yields available from many other fixed-income securities. Like other
fixed-income securities, the values of U.S. Government securities change as
interest rates fluctuate. Fluctuations in the value of the Portfolio's
securities do not effect interest income on securities already held by the
Portfolio, but are reflected in the Fund's price per share. Since the magnitude
of these fluctuation generally are greater at times when the Portfolio's average
maturity is longer, under certain market conditions the Portfolio may invest in
short term investments yielding lower current income rather than investing in
higher yielding longer term securities.
GNMA Certificates are mortgage backed securities representing an interest in a
pool of mortgage loans. Various lenders make the loans which are then insured
(by the Federal Housing Administration) or loans which are guaranteed (by
Veterans Administration or Farmers Home Administration). The lender or other
security issuer creates a pool of mortgages which it submits to GNMA for
approval.
The Portfolio invests in modified pass-through GNMA Certificates. Owners of
Certificates receive all interest and principal payments owed on the mortgages
in the pool, regardless of whether or not the mortgagor has made the payment.
Timely payment of interest and principal is guaranteed by the full faith and
credit of the U.S. Government.
Main Risks
Mortgage backed securities are subject to prepayment risk. Prepayments,
unscheduled principal payments, may result from voluntary prepayment,
refinancing or foreclosure of the underlying mortgage. When interest rates
decline, significant unscheduled prepayments may result. These prepayments must
then be reinvested at lower rates. Prepayments may also shorten the effective
maturities of these securities, especially during periods of declining interest
rates. On the other hand, during period of rising interest rates, a reduction in
prepayments may increase the effective maturities of these securities,
subjecting them to the risk of decline in market value in response to rising
interest and potentially increasing the volatility of the fund.
In addition, prepayments may cause losses on securities purchased at a premium
(dollar amount by which the price of the bond exceeds its face value). At times,
mortgage backed securities may have higher than market interest rates and are
purchased at a premium. Unscheduled prepayments are made at par and cause the
Portfolio to experience a loss of some or all of the premium.
The Mortgaged-Backed Securities Portfolio is generally a suitable investment for
investors who want monthly dividends to provide income or to be reinvested in
additional Portfolio shares to produce growth. Such investors prefer to have the
repayment of principal and interest on most of the securities in which the
Portfolio invests to be backed by the U.S. Government, its agencies or
instrumentalities.
Portfolio Performance Information
-------------------------- ------------------------------------
Annual Total Returns Highest & lowest
1994 -3.60% quarterly total return
1995 19.26% during the last 6 years
1996 4.20% ------------------------------------
1997 10.18% Quarter Ended Quarterly Return
1998 7.74% ------------------------------------
6/30/95 6.41%
3/31/94 (3.50%)
------------------------------------
Calendar Years Ended December 31
---------------------------------------------------
Average annual total returns
for the period ending December 31, 1998
----------------------------------------------------
Past One Past Five Ten
Year Years Years
-------- --------- -------
Mortgage-Backed Securities
Portfolio 7.74% 7.29% 7.25%*
Lehman Brothers Mortgage
Index 6.96 7.23 9.13
Lipper U.S. Mortgage Fund
Average 6.08 5.98 8.04
----------------------------------------------------
* Period from May 7, 1993, date first offered to the
public, through December 31, 1998.
----------------------------------------------------------------------------
The bar chart and tables shown above provide some indication of the risks
of investing in the Account by showing changes in the Account's
performance from year to year and by showing how the Account's average
annual returns compare with those of a broad measure of market
performance. The example shown below assumes 1) an investment of $10,000,
2) a 5% annual return and 3) that expenses are the same as the most
recent fiscal year expenses.
----------------------------------------------------------------------------
-----------------------------------------------------------------------------
Portfolio Operating Expenses Examples
-----------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
$46 $144 $252 $567
Management Fees...................... .45%
Other Expenses*...................... _
----
Total Portfolio Operating Expenses .45%
-----------------------------------------------------------------------------
* In addition to brokerage and extraordinary
expenses, a Portfolio will pay only taxes
and interest expenses, which it is anticipated
to be minimal or nonexistent under normal
circumstances.
Day-to-day Fund Management:
Since May 1993 Martin J. Schafer, Portfolio Manager of Invista since
1992.
THE COSTS OF INVESTING
Sales charge:
There is no sales charge on purchases or sales of shares of the Portfolios.
Ongoing fees. The Fund pays ongoing operating fees to its Manager, Underwriter
and others who provide services to the Fund. They reduce the value of each share
you own. See MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE.
CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS
The Statement of Additional Information (SAI) contains additional information
about investment strategies and their related risks.
Securities and Investment Practices
Equity Securities include common stocks, preferred stocks, convertible
securities and warrants. Common stocks, the most familiar type, represent an
equity (ownership) interest in a corporation. Although equity securities have a
history of long term growth in value, their prices fluctuate based on changes in
a company's financial condition and on overall market and economic conditions.
Smaller companies are especially sensitive to these factors.
Debt securities include bonds and other debt instruments that are used by
issuers to borrow money from investors. The issuer generally pays the investor a
fixed, variable or floating rate of interest. The amount borrowed must be repaid
at maturity. Some debt securities, such as zero coupon bonds, do not pay current
interest, but are sold at a discount from their face values.
Debt securities are sensitive to changes in interest rates. In general, bond
prices rise when interest rates fall and fall when interest rates rise. Longer
term bonds and zero coupon bonds are generally more sensitive to interest rate
changes.
Bond prices are also affected by the credit quality of the issuer. Investment
grade debt securities are medium and high quality securities. Some bonds may
have speculative characteristics and be particularly sensitive to economic
conditions and the financial condition of the issuers.
Repurchase Agreements and Loaned Securities
Each of the Fund's Portfolios may invest a portion of its assets in repurchase
agreements. Repurchase agreements typically involve the purchase of debt
securities from a financial institution such as a bank, savings and loan
association or broker-dealer. A repurchase agreement provides that the Portfolio
sells back to the seller and that the seller repurchases the underlying
securities at a specified price on a specific date. Repurchase agreements may be
viewed as loans by a Portfolio collateralized by the underlying securities. This
arrangement results in a fixed rate of return that is not subject to market
fluctuation while the Portfolio holds the security. In the event of a default or
bankruptcy by a selling financial institution, the affected Portfolio bears a
risk of loss. To minimize such risks, the Portfolio enters into repurchase
agreements only with large, well-capitalized and well-established financial
institutions. In addition, the value of the collateral underlying the repurchase
agreement is always at least equal to the repurchase price, including accrued
interest.
Each of the Fund's Portfolios may lend its portfolio securities to unaffiliated
broker-dealers and other unaffiliated qualified financial institutions.
Currency Contracts
The International Emerging Markets, International Securities and International
SmallCap Portfolios may each enter into forward currency contracts, currency
futures contracts and options, 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 in the contract. A Portfolio will not hedge currency exposure to
an extent greater than the aggregate market value of the securities held or to
be purchased by the Portfolio (denominated or generally quoted or currently
convertible into the currency).
Hedging is a technique used in an attempt to reduce risk. If a Portfolio's
Manager or Sub-Advisor hedges market conditions incorrectly or employs a
strategy that does not correlate well with the Portfolio's investment, these
techniques could result in a loss, regardless of whether the intent was to
reduce risk or to increase return. These techniques may increase the volatility
of a Portfolio and may involve a small investment of cash relative to the
magnitude of the risk assumed. In addition, these techniques could result in a
loss if the other party to the transaction does not perform as promised.
Additionally, there is the risk of government action through exchange controls
that would restrict the ability of the Portfolio to deliver or receive currency.
Warrants
Each of the Portfolios may invest up to 5% of its assets in warrants. Up to 2%
of a Portfolio's assets may be invested in warrants which are not listed on
either the New York or American Stock Exchanges. For the International,
International Emerging Markets and International SmallCap Funds, the 2%
limitation also applies to warrants not listed on the Toronto Stock and Chicago
Board Options Exchanges.
Options
Each of the Portfolios may buy and sell certain types of options. Each type is
more fully discussed in the SAI.
Foreign Securities
The International Emerging Markets, International Securities and International
SmallCap Portfolios each may invest in foreign securities (securities of
non-U.S. companies).
Investment in foreign securities presents certain risks including: fluctuations
in currency exchange rates, revaluation of currencies, the imposition of foreign
taxes, future political and economic developments including war, expropriations,
nationalization, the possible imposition of currency exchange controls and other
foreign governmental laws or restrictions. In addition, there may be reduced
availability of public information concerning issuers compared to domestic
issuers. Foreign issuers are not generally subject to uniform accounting,
auditing and financial reporting standards or to other regulatory practices and
requirements that apply to domestic issuers. Transactions in foreign securities
may be subject to higher costs. Each 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. Foreign securities markets,
particularly those in emerging market countries, are known to experience long
delays between the trade and settlement dates of securities purchased and sold.
Such delays may result in a lack of liquidity and greater volatility in the
price of securities on those markets. As a result of these factors, the Board of
Directors of the Fund has adopted Daily Pricing and Valuation Procedures for the
Portfolios. These procedures outline 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. The Executive Committee
of the Board of Directors oversees this process.
Securities of Smaller Companies
The Portfolios may invest in securities of companies with small- or mid-sized
market capitalizations. Market capitalization is defined as total current market
value of a company's outstanding common stock. Investments in companies with
smaller market capitalizations may involve greater risks and price volatility
(wide, rapid fluctuations) than investments in larger, more mature companies.
Smaller companies may be less mature than older companies. At this earlier stage
of development, the companies may have limited product lines, reduced market
liquidity for their shares, limited financial resources or less depth in
management than larger or more established companies. Small companies also may
be less significant within their industries and may be at a competitive
disadvantage relative to their larger competitors. While smaller companies may
be subject to these additional risks, they may also realize more substantial
growth than larger or more established companies.
Unseasoned Issuers
The Portfolios may invest in the securities of unseasoned issuers. Unseasoned
issuers are companies with a record of less than three years continuous
operation, including the operation of predecessors and parents. Unseasoned
issuers by their nature have only a limited operating history which can be used
for evaluating the companies growth prospects. As a result, investment decisions
for these securities may place a greater emphasis on current or planned product
lines and the reputation and experience of the companies management and less
emphasis on fundamental valuation factors than would be the case for more mature
growth companies. In addition, many unseasoned issuers also may be small
companies and involve the risks and price volatility associated with smaller
companies.
Temporary or Defensive Measures
For temporary or defensive purposes in times of unusual or adverse market
conditions, the Portfolios, may invest without limit in cash and cash
equivalents. For this purpose, cash equivalents include: bank certificates of
deposit, bank acceptances, repurchase agreements, commercial paper, and
commercial paper master notes which are floating rate debt instruments without a
fixed maturity. In addition, a Portfolio may purchase U.S. Government
securities, preferred stocks and debt securities, whether or not convertible
into or carrying rights for common stock.
Portfolio Turnover
"Portfolio Turnover" is the term used in the industry for measuring the amount
of trading that occurs in a fund's portfolio during the year. For example, a
100% turnover rate means that on average every security in the portfolio has
been replaced once during the year.
Funds with high turnover rates (more than 100%) often have higher transaction
costs (which are paid by the fund) and may generate short-term capital gains (on
which you pay taxes even if you don't sell any of your shares during the year).
You can find the turnover rate for each Portfolio in the Portfolio's Financial
Highlights table.
Please consider all the factors when you compare the turnover rates of different
funds. A fund with consistently higher total returns and higher turnover rates
than another fund may actually be achieving better performance precisely because
the managers are active traders. You should also be aware that the "total
return" line in the Financial Highlights already includes portfolio turnover
costs.
MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE
The Manager
Principal Management Corporation (the "Manager") serves as the manager for the
Fund. In its handling of the business affairs of each Portfolio, the Manager
provides clerical, recordkeeping and bookkeeping services, and keeps the
financial and accounting records required for the Fund. The Manager has signed
sub-advisory agreements with Invista for portfolio management functions for the
International Growth-Oriented Portfolios and the Income-Oriented Portfolio. The
Manager compensates Invista for its sub-advisory services as provided in the
Sub-Advisory Agreement between Invista and the Manager. The Manager may
periodically reallocate management fees between itself and Invista.
The Manager is a subsidiary of Princor Financial Services Corporation. It has
managed mutual funds since 1969. As of December 31, 1998, the Funds it managed
had assets of approximately $6.0 billion. The Manager's address is Principal
Financial Group, Des Moines, Iowa 50392-0200.
Invista is a subsidiary of Principal Life Insurance Company and is an affiliate
of the Manager. Invista has managed investments for institutional investors,
including Principal Life, since 1985. As of December 31, 1998, it managed assets
of approximately $31 billion. Invista's address is 1800 Hub Tower, 699 Walnut,
Des Moines, Iowa 50309.
The Manager or Invista provides the Board of Directors of the Fund a recommended
investment program for each of the four Portfolios. Each program must be
consistent with the Portfolio's investment objective and policies. Within the
scope of the approved investment program, the Manager or Invista advises each
Portfolio on its investment policies and determines which securities are bought
and sold, and in what amounts.
The Manager is paid a fee by each Portfolio for its services, which includes any
fee paid to Invista. The fee paid by each Portfolio (as a percentage of the
average daily net assets) is determined using the following rate:
<TABLE>
<CAPTION>
Fees Computed On Fees as a Percent of
Portfolio Net Asset Value of Portfolio Average Daily Net Assets
--------- ---------------------------- ------------------------
<S> <C> <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>
For the fiscal year ended December 31, 1998 the Management fee for each
Portfolio was:
International Emerging Markets Portfolio 1.15%
International Securities Portfolio .90%
International SmallCap Portfolio 1.00%
Mortgage-Backed Securities Portfolio .45%
MANAGEMENT DISCUSSION OF FUND PERFORMANCE
International Emerging Markets Portfolio
Comparison of Change in Value of $1.0 Million Investment in
the International Emerging Markets Portfolio, Lipper
Emerging Markets Fund Average and MSCI EMF Index
- ----------------------------------
Total Returns*
as of December 31, 1998
1 Year 5 Year 10 Year
- ----------------------------------
-17.21% -14.76%** --
** Since inception date 11/26/97
- ----------------------------------
1997 1998
(thousands)
International Emerging Markets Portfolio* $1,014 $839
Lipper Emerging Markets Fund Average 1,015 743
Morgan Stanley Capital International EMF
(Emerging Markets Free) Index 1,022 741
Note: Past performance is not predictive of future performance.
The International Emerging Market Portfolio experienced high volatility in 1998.
From early May to the low in early September, the Portfolio had a total return
of -38%. Negative macroeconomic conditions, including higher interest rates, a
deterioration in economic growth prospects and low liquidity in emerging markets
led to the negative returns. In the portfolio manager's view, emerging markets
became ridiculously oversold in September after the Russian debt moratorium and
devaluation. The 2nd and 3rd quarter of 1998 represented the two worst quarters
since inception of emerging market indices. From the September low, emerging
markets rallied with the Portfolio returning a positive 21% through December 31.
Reasons for the rally include the decline in interest rates in many countries,
including the U.S., increased stability in Asia and Latin America, and cheap
valuations.
The Portfolio, with a total return of -17.21%, outperformed both the MSCI
Emerging Market Free Index (-27.52) and Lipper Emerging Market Fund Average
(-26.83) during 1998. This was a result of the portfolio manager's focus on
countries that require less external financing from the international community.
This list includes countries such as Israel, Poland, Hungary, Hong Kong and
Singapore. The Portfolio is diversified by region with EMEA (Eastern Europe,
Middle East, Africa) constituting 37% of assets, Latin America 31% and Asia 27%.
The Portfolio is defensive by country and company with zero exposure in Russia
and Malaysia. The Portfolio owns companies that have strong cash generative
abilities and solid balance sheets. Overall, the emerging market strategy is
founded on the manager's belief that international markets are inefficient.
Value is added by buying high quality companies at discounts to their investment
value. Portfolio managers find these undervalued companies through application
of internal research and bottom-up process.
In the manager's opinion, the outlook for emerging markets has improved. The key
factors for future performance include the market for external financing of
countries, global growth, commodity prices and valuations. In recent years
macroeconomic factors, particularly sovereign risk, have dominated market
performance. The duration of the contraction in external financing is unknown
but the underlying country fundamentals have improved. The outlook for global
growth has also improved since the end of 1998 with commodity prices rebounding
off their trough. Finally, valuations in emerging markets are back to 1992
levels providing support for emerging markets.
International Securities Portfolio
Comparison of Change in Value of $1.0 Million Investment
in the International Securities Portfolio, Lipper
International Fund Average and MSCI EAFE Index
- ----------------------------------
Total Returns*
as of December 31, 1998
1 Year 5 Year 10 Year
- ----------------------------------
9.55% 9.91% 13.87%**
** Since inception date 5/7/93
- ----------------------------------
1993 1994 1995 1996 1997 1998
(thousands)
International Securities Portfolio* $1,299 $1,216 $1,362 $1,690 $1,902 $2,084
Lipper International Fund Average 1,225 1,216 1,331 1,488 1,568 1,773
Morgan Stanley Capital International
EAFE (Europe, Australia and Far
East) Index 1,095 1,141 1,269 1,346 1,370 1,644
Note: Past performance is not predictive of future performance.
The International Securities Portfolio's total return of 9.55% in 1998 was below
the EAFE index return of 20.00%. Most of the Portfolio's shortfall occurred
during the second half of the year. Two investment themes dominated returns and
performance during the second half of 1998. The most significant theme was the
third quarter collapse of emerging markets, brought on by Russia's devaluation
and debt default and the simultaneous currency crisis in Brazil. These events
shook investor confidence which created a flight to quality, soaring risk
premiums in most stocks, and a slower economic growth outlook.
A secondary theme was the ongoing economic problem in Japan. Japan's economy is
in a serious recession and is undoubtedly the weakest economy of any developed
nation. Its banking crisis is far from being solved, and government policy has
created a fiscal budget deficit equal to 10% of GDP, an unheard of level for a
major economy.
These two themes influenced the Portfolio's positioning of the International
Securities Portfolio. Exposure to defensive, or lower risk stocks was increased,
and the Japanese market was underweighted. One of the main reasons for the
Portfolio's underperformance was the execution of moving the portfolio into a
more defensive position which was not fully effective. Several of the stocks
were in low risk businesses, but had exposure to poor performing emerging
markets. The second area of underperformance was the underweight position of the
Japanese yen. Although economic analysis of Japan proved to be right on the mark
and Japan's stock market continued to languish, the Japanese yen was very strong
and outpaced the other developed market currencies.
The Portfolio continues to have a small weighting in the Japanese market and a
large weighting in Europe. Portfolio managers do not expect a severe recession
in Europe this year, but growth is slowing. Inflation does not appear to be a
risk and, therefore, interest rates should remain low helping to bolster stock
prices. Portfolio managers will continue to raise weightings in reasonably
priced names with growth and/or defensive characteristics.
International SmallCap Portfolio
Comparison of Change in Value of $1.0 Million Investment in
the International SmallCap Portfolio, Lipper International
Small-Cap Fund Average and MSCI EMF Index
- ----------------------------------
Total Returns*
as of December 31, 1998
1 Year 5 Year 10 Year
- ----------------------------------
11.92% 12.43%** --
** Since inception date 11/26/97
- ----------------------------------
1997 1998
(thousands)
International SmallCap Portfolio* $1,016 $1,137
Lipper International Small-Cap Fund Average 986 1,114
Morgan Stanley Capital International EAFE
(Europe, Australia and Far East) Index 1,009 1,210
Note: Past performance is not predictive of future performance.
The Portfolio's overweighting in Europe and its low exposure to Asia contributed
to its outperformance relative to its benchmark. The past year has shown the
volatility inherent with the international small cap asset class. Last fall
returns fell significantly in response to the Asian crisis and surprised many
investors who had underestimated the impact the crisis had on other economies.
The beginning of 1998 saw a dramatic recovery in Asian areas taking the markets
to valuations above the pre-crisis level. However, this fall the markets hovered
on the brink of collapse as several events sparked a growing global concern of
the impact these events would have on the financial markets. These events
included the Russian default on debt, whether the Latin American currencies
would devalue, the slowdown of growth in the emerging economies and the strength
of the dollar relative to the rest of the world economies, calling for a
lowering of interest rates. Resource-based countries, Australia, New Zealand,
and Canada lagged as commodity price deflation placed pressure on the
macroeconomic conditions in these countries.
Currency weakness helped U.S.-based international investors to slightly offset
the overall equity market decline. There is a question as to whether the dollar
is resuming its historic weakness or if this is a temporary adjustment. The euro
block currencies are likely to be of Germanic influence in warding off inflation
and, as such, will be a strong currency. Even though there remains a large
burden of proof, recent movements indicate investors are beginning to price this
expectation into the euro.
Portfolio managers are noticing a stability of stock prices in Asia and believe
the bottom is forming in equities. Thus it is possible the Portfolio's exposure
will increase in the Asian region. Europe has corrected to attractive levels and
managers continue to focus on quality growth at average or below average prices.
At the margin, holdings in Canada are declining given macro concerns and several
instances of highly questionable management practices. In short, the managers
favor higher levels of cash generation and stability of earnings over
exceptional growth or deep value situations at this time.
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 169 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 59 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 527 funds.
Note: Mutual fund data from Lipper Services, Inc.
Mortgage-Backed Securities Portfolio
Comparison of Change in Value of $1.0 Million Investment in the
Mortgage-Backed Securities Portfolio, Lipper U.S. Mortgage
Fund Average and Lehman Brothers Mortgage Index
- ----------------------------------
Total Returns*
as of December 31, 1998
1 Year 5 Year 10 Year
- ----------------------------------
7.74% 7.29% 7.25%**
** Since inception date 5/7/93
- ----------------------------------
1993 1994 1995 1996 1997 1998
(thousands)
Mortgage-Backed Securities Portfolio* $1,045 $1,007 $1,201 $1,251 $1,378 $2,485
Lipper U.S. Mortgage Fund Average 1,034 991 1,152 1,196 1,299 1,378
Lehman Brothers Mortgage Index 1,032 1,016 1,186 1,250 1,368 1,464
Note: Past performance is not predictive of future performance.
Interest rates declined significantly over the last twelve months, with medium
and long rates down about 1%. Bond prices, which move in the opposite direction
of interest rates, moved up, which led to another 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 key to 1998 was the U.S. Federal Reserve. By decisively reducing the Federal
Funds rate from 5.50% to 4.75% during the pinnacle of global risk, then holding
rates steady in December, the Fed demonstrated its commitment to maintaining
reasonable growth in the U.S. The actions of the Federal Reserve restored a
certain amount of calm and order to a very volatile and illiquid market. By
staying firm on rates in December, the Fed also signaled that the U.S. economy
was still very strong, with modest growth, low inflation and low unemployment.
Management views the economic outlook as range-bound for U.S. interest rates.
With the absolute level of interest rates being relatively low, the managers are
moving the duration of this portfolio closer to the Lehman MBS index. They are
shortening as opportunities present themselves.
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 73 mutual funds.
Note: Mutual fund data from Lipper Services, Inc.
PRICING OF FUND SHARES
Each Portfolio's shares are bought and sold at the current share price. The
share price of each Portfolio is calculated each day the New York Stock Exchange
is open. The share price is determined at the close of business of the Exchange
(normally at 3:00 p.m. Central Time). When Princor receives your order to buy or
sell shares, the share price used to fill the order is the next price calculated
after the order is placed.
For all Portfolios the share price is calculated by:
o taking the current market value of the total assets of the Portfolio
o subtracting liabilities of the Portfolio
o dividing the remainder by the total number of shares owned
NOTES:
o If current market values are not readily available for a security, its fair
value is determined using a policy adopted by the Fund's Board of
Directors.
o The Portfolio's securities may be traded on foreign securities markets
which generally complete trading at various times during the day prior to
the close of the New York Stock Exchange. The values of foreign securities
used in computing share price are determined at the time the foreign market
closes. Occasionally, events affecting the value of foreign securities
occur when the foreign market is closed and the New York Stock Exchange is
open. If the Manager believes the market value is materially affected, the
share price will be calculated using the policy adopted by the Fund.
o Foreign securities markets may trade on days when the New York Stock
Exchange is closed (such as customary U.S. holidays) and the Portfolio's
share price is not calculated. As a result, the value of a Portfolio's
assets may be significantly affected by such trading on days when you
cannot purchase or sell shares of the Portfolio.
DIVIDENDS AND DISTRIBUTIONS
The International Growth-Oriented and Income-Oriented Portfolios pay most of
their net dividend income to you every year. The payment schedule is:
<TABLE>
<CAPTION>
Portfolios Record Date Payable Date
---------- ----------- ------------
<S> <C> <C> <C>
International Emerging Markets, three business days before December 24
International Securities and each payable date (or previous business day)
International SmallCap
Mortgage-Backed Securities three business days before last business day of each
each payable date month
</TABLE>
Net realized capital gain for each of the Portfolios, if any, are 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. Payments are made to shareholders of record on the third business
day prior to the payable date. Capital gains may be taxable at different rates,
depending on the length of time that the Portfolio holds it's assets.
You can authorize income dividend and capital gain distributions to be:
o invested in additional shares of the Portfolio you own; or
o paid in cash.
NOTE: Payment of income dividends and capital gains shortly after you buy
shares has the effect of reducing the share price by the amount of the
payment.
Distributions from a Portfolio, whether received in cash or reinvested in
additional shares, may be subject to federal (and state) income tax.
You should consult your tax advisor as to the federal, state and local
tax consequences of Portfolio ownership.
TO BUY SHARES
Each Portfolio requires:
o A minimum initial investment of $1,000,000 which may be invested over a
three month period. If the minimum investment has not been met within 3
months, we will send you a notice. If following the notice, we do not
receive sufficient funds within 30 days to meet the required minimum, then
we will redeem the account and send you the proceeds.
o You may combine your investment with those of your spouse, dependent
children and/or a trust for the benefit of such persons to meet the
requirement;
o Subsequent purchases are not subject to limitations.
Fill out the Principal Mutual Fund application* completely. You must include:
o the name(s) you want to appear on the account;
o the Portfolio(s) you want to invest in;
o the amount of the investment;
o your Social Security number or Taxpayer I.D. number;
o investor information (used to help your Registered Representative confirm
that your investment selection is consistent with your goals and
circumstances) ; and
o other required information (may include corporate resolutions, trust
agreements, etc.).
* An application is included with this prospectus.
Invest by mail:
o Send a check and completed application to:
Principal Special Markets Fund, Inc.
P. O. Box 10423
Des Moines Iowa 50306
o Make your check payable to Principal Special Markets Fund, Inc.
o Your purchase will be priced at the next share price calculated after Fund
receives your completed paperwork.
Order by telephone:
o Call us at 1-800-521-1502 between 7:00 a.m. and 7:00 p.m. Central Time on
any day that the New York Stock Exchange is open.
o To buy shares the same day, you need to call before 3:00 p.m. Central Time.
o We must receive your payment for the order within three business days (or
the order will be canceled and you may be liable for any loss).
o For new accounts, you also need to send a completed application.
Wire money from your bank:
o Have your Registered Representative call Principal Mutual Funds
(1-800-521-1502) for an account number and wiring instructions.
o For both initial and subsequent purchases, federal funds should be wired
to:
Norwest Bank Iowa, N.A.
Des Moines, Iowa 50309
ABA No.: 073000228
For credit to: Principal Special Markets Fund
Account No.: 3000499968
For credit: Principal Special Markets Fund, Portfolios
Shareholder Account No. __________________
Shareholder Registration __________________
o Give the number and instructions to your bank (which may charge a wire
fee).
o To buy shares the same day, the wire must be received before 3:00 p.m.
Central Time.
o No wires are accepted on days when the New York Stock Exchange is closed or
when the Federal Reserve is closed (because the bank that would receive
your wire is closed).
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 is
an ongoing fee in an amount up to 0.10% on an annualized basis of the average
net asset value of shares held in your account the establishment of which is
attributable to the efforts of the registered representative or selected dealer.
TO SELL SHARES
After you place a sell order in proper form, shares are sold using the next
share price calculated. There is no charge for a sale. Generally, the sale
proceeds are sent out on 3 business days after the sell order has been placed.
At your request, the check will be sent overnight (a $15 overnight fee will be
deducted from your account unless other arrangements are made). The Fund can
only sell shares after your check making the Fund investment has cleared your
bank. To avoid the inconvenience of a delay in obtaining sale proceeds, shares
may be purchased with a cashier's check, money order or certified check. A sell
order from one owner is binding on all joint owners.
Selling shares may create a gain or a loss for federal (and state) income tax
purposes. You should maintain accurate records for use in preparing your income
tax returns.
Generally, sales proceeds checks are:
o payable to all owners on the account (as shown in the account registration)
and
o mailed to address on the account (if not changed within last month) or
previously authorized bank account.
For other payment arrangements, please call Principal Mutual Funds
(1-800-521-1502).
You should also call Principal Mutual Funds (1-800-521-1502) for special
instructions that may apply to sales from accounts:
o when an owner has died; or
o owned by corporations, partnerships, agents or fiduciaries.
The transaction is considered a sale for federal (and state) income tax purposes
even if the proceeds are reinvested. If a loss is realized on the sale, the
reinvestment may be subject to the "wash sale" rules resulting in the
postponement of the recognition of the loss for tax purposes.
Sell shares by mail
o Send a letter (signed by the owner of the account) to
Principal Mutual Funds
P. O. Box 10423
Des Moines Iowa 50306-9780
o Specify the Fund and account number.
o Specify the Portfolio(s).
o Specify the number of shares or the dollar amount to be sold.
o A signature guarantee* will be required if the:
o account address has been changed within three months of the sell order;
or
o check is payable to a party other than the account shareholder(s) or
Principal Life Insurance Company.
* If required, the signature(s) must be guaranteed by a commercial
bank, trust company, credit union, savings and loan, national
securities exchange member or brokerage firm. A signature guaranteed
by a notary public or savings bank is not acceptable.
Sell shares by telephone* (1-800-521-1502)
o Address on account must not have been changed within the last month and
telephone privileges must apply to the account from which the shares are
being sold.
o If our phone lines are busy, you may need to send in a written sell order.
o To sell shares the same day, the order must be received before 3:00 p.m.
Central Time.
o If previously authorized, checks can be sent to a shareholder's U.S. bank
account.
* The Fund and transfer agent reserve the right to refuse telephone orders
to sell shares. The shareholder is liable for a loss resulting from a
fraudulent telephone order that the Fund reasonably believes is genuine.
The Fund will use reasonable procedures to assure instructions are
genuine. If the procedures are not followed, the Fund may be liable for
loss due to unauthorized or fraudulent transactions. The procedures
include: recording all telephone instructions, requesting personal
identification information (name, phone number, social security number,
birth date, etc.) and sending written confirmation to the address on the
account.
Periodic withdrawal plans
You may set up a periodic withdrawal plan
o on a monthly, quarterly, semiannual or annual basis to:
o sell a fixed number of shares ($100 initial minimum amount),
o sell enough shares to provide a fixed amount of money ($100 initial
minimum amount).
You can set up a periodic withdrawal plan by:
o completing the applicable section of the application; o
o sending us your written instructions (and share certificate, if any, issued
for the account).
Your periodic withdrawal plan continues until:
o you instruct us to stop, or
o your Fund account is exhausted.
When you set up the withdrawal plan, you select which day you want the sale made
(if none selected, the sale will be made on the 15th of the month). If the
selected date is not a trading day, the sale will take place on the next trading
day (if that day falls in the month after your selected date, the transaction
will take place on the trading day before your selected date. If telephone
privileges apply to the account, you may change the date or amount by
telephoning us at 1-800-521-1502.
GENERAL INFORMATION ABOUT A FUND ACCOUNT
Statements
You will receive quarterly statements. The statements provide the number and
value of shares you own, transactions during the quarter, dividends declared or
paid and other information. The year end statement includes information for all
transactions that took place during the year. Please review your statement as
soon as your receive it. Keep your statements as you may need them for tax
reporting purposes.
Generally, each time you buy or sell shares between Portfolios, you will receive
a confirmation in the mail shortly thereafter. It summarizes all the key
information; what you bought or sold, the amount of the transaction, and other
vital data.
Certain purchases and sales are only included on your quarterly statement. These
include accounts
o when the only activity during the quarter:
o is purchase of shares from reinvested dividends and/or capital gains;
and
o sales under a periodic withdrawal plan; and
Signature Guarantees
Certain transactions require that your signature be guaranteed. If required, the
signature(s) must be guaranteed by a commercial bank, trust company, credit
union, savings and loan, national securities exchange member or brokerage firm.
A signature guaranteed by a notary public or savings bank is not acceptable.
Signature guarantees are required:
o if you sell more than $100,000;
o if a sales proceeds check is payable to other than the account
shareholder(s), Principal Life Insurance Company or one of its affiliates;
o to change ownership of an account;
o to add telephone transaction services to an existing account;
o to change bank account information designated under an existing telephone
withdrawal plan;
o to have a sales proceeds check mailed to an address other than the address
on the account or to the address on the account if it has been changed
within the preceding month; and
o to add wire privileges to an existing account.
Special Plans
The Fund reserves the right to amend or terminate the special plans described in
this prospectus. Such plans include periodic withdrawal for certain purchasers.
You would be notified of any such action to the extent required by law.
Telephone Orders
The Fund reserves the right to refuse telephone orders to sell shares. You are
liable for a loss resulting from a fraudulent telephone order that we reasonably
believe is genuine. We will use reasonable procedures to assure instructions are
genuine. If the procedures are not followed, we may be liable for loss due to
unauthorized or fraudulent transactions. The procedures include: recording all
telephone instructions, requesting personal identification information (name,
phone number, social security number, birth date, etc.) and sending written
confirmation to the shareholder's address of record.
Year 2000 Problem
The business operations of the Fund depends on computer systems that contain
date fields. These systems include securities transfer agent operations and
securities pricing systems. Many of these systems were constructed using a two
digit date field to represent the date. Unless these systems are changed or
modified, they may not be able to distinguish the Year 1900 from the Year 2000
(commonly referred to as the Year 2000 Problem).
When the Year 2000 arrives, the Fund's operations could be adversely affected if
the computer systems used by the Manager, the service providers and other third
parties it does business with are not Year 2000 compliant. For example, the
Fund's portfolios and operational areas could be impacted, included securities
pricing, dividend and interest payments, shareholder account servicing and
reporting functions. In addition, a Portfolio could experience difficulties in
transactions if foreign broker-dealers or foreign markets are not Year 2000
compliant.
The Manager relies on public filings and other statements made by companies
about their Year 2000 readiness. Issuers in countries outside of the U.S.,
particularly in emerging countries, may not be required to make the same
disclosures about their readiness as are required in the U.S. It is likely that
if a company a Portfolio invests in is adversely affected by Year 2000 problems,
the price of its securities will also be negatively impacted. A decrease in
value of one or more of a Portfolio's securities will decrease that Portfolio's
share price.
In addition, the Manager and affiliated service providers are working to
identify their Year 2000 problems and taking steps they reasonably believe will
address these issues. This process began in 1996 with the identification of
product vendors and service providers as well as the internal systems that might
be impacted.
At this time, testing of internal systems has been completed. The Manager is now
participating in a corporate-wide initiative lead by senior management
representatives of Principal Life. Currently they are engaged in regression
testing of internal programs. They are also participating in development of
contingency plans in the event that Year 2000 problems develop and/or persist on
or after January 1, 2000. The contingency plan calls for:
o identification of business risks;
o consideration of alternative approaches to critical business risks; and
o development of action plans to address problems.
Other important Year 2000 initiatives include:
o the service provider for our transfer agent system has renovated its code.
Client testing will occur in the first and second quarters of 1999. The
service provider is also participating in a securities industry wide
testing program.
o the securities pricing system we use has renovated its code and conducted
client testing in June 1998;
o Facilities Management of Principal Life has identified non-systems issues
(heat, lights, water, phone, etc.) and is working with these service
providers to ensure continuity of service; and
o the Manager and other areas of Principal Life have contacted all vendors
with which we do business to receive assurances that they are able to deal
with any Year 2000 problems. We continue to work with the vendors to
identify any areas of risk.
In its budget for 1999 and 2000, the Manager has estimated expenses of between
$100,000 and $500,000 to deal with Year 2000 issues.
Financial Statements
You will receive an annual financial statement for the Fund, examined by the
Fund's independent auditors, Ernst & Young LLP. That report is a part of this
prospectus. You will also receive a semiannual financial statement which is
unaudited. The following financial highlights are based on financial statements
which were audited by Ernst & Young LLP.
FINANCIAL HIGHLIGHTS
Selected data for a share of Capital Stock outstanding throughout each year
ended December 31 (except as noted):
INTERNATIONAL EMERGING
MARKETS PORTFOLIO 1998 1997(a)
---- ----
Net Asset Value, Beginning of Period................... $10.14 $9.94
Income from Investment Operations:
Net Investment Income............................... .17 .01
Net Realized and Unrealized Gain (Loss) on Investments (1.91) .21
------ ------
Total from Investment Operations (1.74) .22
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.17) (.02)
Distributions from Capital Gains.................... (.02) --
------ ------
Total Dividends and Distributions (.19) (.02)
------ ------
Net Asset Value, End of Period......................... $8.21 $10.14
====== ======
Total Return........................................... (17.21)% 1.40%(b)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $79,481 $32,488
Ratio of Expenses to Average Net Assets............. 1.15% 1.15%(c)
Ratio of Net Investment Income to Average Net Assets 2.11% .91%(c)
Portfolio Turnover Rate............................. 36.5% 12.3%(c)
<TABLE>
<CAPTION>
INTERNATIONAL SECURITIES PORTFOLIO 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $14.45 $13.67 $11.70 $11.29 $12.87
Income from Investment Operations:
Net Investment Income............................... .24 .24 .31 .19 .13
Net Realized and Unrealized Gain (Loss) on Investments 1.12 1.46 2.46 1.11 (.95)
------ ------ ------ ------ ------
Total from Investment Operations 1.36 1.70 2.77 1.30 (.82)
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.23) (.24) (.16) (.10) (.12)
Excess Distributions from Net Investment Income..... -- -- (.07) (.07) (.13)
Distributions from Capital Gains.................... (.68) (.68) (.57) (.72) (.51)
------ ------ ------ ------ ------
Total Dividends and Distributions (.91) (.92) (.80) (.89) (.76)
------ ------ ------ ------ ------
Net Asset Value, End of Period......................... $14.90 $14.45 $13.67 $11.70 $11.29
====== ====== ====== ====== ======
Total Return........................................... 9.55% 12.55% 24.12% 12.02% (6.45%)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $47,912 $37,684 $28,161 $17,251 $15,542
Ratio of Expenses to Average Net Assets................ .90% .90% .90% .90% .90%
Ratio of Net Investment Income to Average Net Assets... 1.60% 1.73% 1.90% 1.79% .94%
Portfolio Turnover Rate................................ 36.7% 30.8% 25.5% 46.0% 37.0%
</TABLE>
INTERNATIONAL SMALLCAP PORTFOLIO 1998 1997(a)
----- ----
Net Asset Value, Beginning of Period................... $9.97 $9.86
Income from Investment Operations:
Net Investment Income............................... .07 .01
Net Realized and Unrealized Gain (Loss) on Investments 1.11 .12
------ ------
Total from Investment Operations 1.18 .13
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.07) (.02)
Distributions from Capital Gains.................... (.02) --
------ ------
Total Dividends and Distributions (.09) (.02)
------ ------
Net Asset Value, End of Period......................... $11.06 $9.97
====== ======
Total Return........................................... 11.92% 1.59%(b)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $83,330 $31,968
Ratio of Expenses to Average Net Assets............. 1.00% 1.00%(c)
Ratio of Net Investment Income to Average Net Assets .78% .91%(c)
Portfolio Turnover Rate............................. 88.5% 30.3%(c)
<TABLE>
<CAPTION>
MORTGAGE-BACKED SECURITIES PORTFOLIO 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $10.27 $9.93 $10.17 $9.11 $10.10
Income from Investment Operations:
Net Investment Income............................... .65 .64 .64 .65 .63
Net Realized and Unrealized Gain (Loss) on Investments .12 .34 (.24) 1.06 (.99)
------ ------ ------ ------ ------
Total from Investment Operations .77 .98 .40 1.71 (.36)
Less Dividends from Net Investment Income (.65) (.64) (.64) (.65) (.63)
------ ------ ------ ------ ------
Net Asset Value, End of Period......................... $10.39 $10.27 $9.93 $10.17 $9.11
====== ====== ====== ====== ======
Total Return........................................... 7.74% 10.18% 4.20% 19.26% (3.60)%
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $14,861 $13,796 $14,968 $14,253 $14,714
Ratio of Expenses to Average Net Assets................ .45% .45% .45% .45% .45%
Ratio of Net Investment Income to Average Net Assets... 6.28% 6.37% 6.51% 6.66% 6.56%
Portfolio Turnover Rate................................ 13.8% 15.5% 28.7% 41.8% 41.8%
</TABLE>
Notes to Financial Highlights
(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 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.
Additional information about the Fund is available in the Statement of
Additional Information dated May 1, 1999 and which is part of this prospectus.
Information about the Fund's investments is also available in the Fund's annual
and semi-annual reports to shareholders. In the Fund's annual report, you will
find a discussion of the market conditions and investment strategies that
significantly affected the Fund's performance during its last fiscal year. The
Statement of Additional Information and annual and semi-annual reports can be
obtained free of charge by writing or telephoning Princor Financial Services
Corporation, P.O. Box 10423, Des Moines, IA 50306. Telephone 1-800-451-5447.
Information about the Fund can be reviewed and copied at the Securities and
Exchange Commission's Public Reference Room in Washington, D.C. Information on
the operation of the public reference room may be obtained by calling the
Commission at 1-800-SEC-0330. Reports and other information about the Fund are
available on the Commission's internet site at http://www.sec.gov. Copies of
this information may be obtained, upon payment of a duplicating fee, by writing
the Public Reference Section of the Commission, Washington, D.C. 20549-6009.
The U.S. Government does not insure or guarantee an investment in the Fund.
Shares of the Fund are not deposits or obligations of, or guaranteed or endorsed
by, any financial institution, nor are shares of the Fund federally insured by
the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any
other agency.
Principal Special Markets Fund, Inc. SEC File 811-07572
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, 1999
This Statement of Additional Information provides information about
each Portfolio in addition to the information that is contained in the
Prospectus, dated May 1, 1999.
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-8
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 ............................. 20
Offering Price ............................................................. 23
Determination of Net Asset Value ........................................... 23
Performance Calculation .................................................... 24
Tax Treatment, Dividends and Distributions ................................. 26
Financial Statements........................................................ 27
INVESTMENT POLICIES AND RESTRICTIONS
The following information supplements the information provided in the
Prospectus under the caption "Certain Investment Strategies and Related Risks."
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 that are
secured by real estate and securities of issuers that 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 that 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 "Certain
Investment Strategies and Related Risks."
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 call and 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 Portfolio'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 that 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
that 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 redemption 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 36.5% and 12.3%
(for the period beginning November 26, 1997 and ending December 31, 1997);
International Securities 36.7% and 30.8%; International SmallCap Portfolio
88.5%% and 30.3% (for the period beginning November 26, 1997 and ending December
31, 1997); Mortgage-Backed Securities 13.8% and 15.5%.
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 Life
Insurance Company. All mailing addresses are The Principal Financial Group, Des
Moines, Iowa 50392, unless otherwise indicated.
Michael W. Cumings, 47, Assistant Counsel. Counsel, Principal Life
Insurance Company since 1989.
@ James D. Davis, 65, Director. 4940 Center Court, Bettendorf, Iowa.
Attorney. Vice President, Deere and Company, retired.
*& Ralph C. Eucher, 46, Director and President. Vice President, Principal
Life Insurance Company. Director and President, Princor Financial
Services Corporation and Principal Management Corporation.
Pamela A. Ferguson, 55, Director, 4112 River Oaks Drive, Des Moines,
Iowa. Professor of Mathematics, Grinnell College, since 1998. Prior
thereto, President, Grinnell College.
*& J. Barry Griswell, 50, Director and Chairman of the Board. President,
Principal 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.
@& Barbara A. Lukavsky, 58, Director. 13731 Bay Hill Court, Clive, Iowa.
President and CEO, Barbican Enterprises, Inc., since 1977. President
and CEO, Lu San ELITE USA, L.C., 1985-1998.
* Craig L. Bassett, 47, Treasurer. Second Vice President and Treasurer,
Principal Life Insurance Company since 1998. Prior thereto, Director -
Treasury 1996-1998. Prior thereto, Associate Treasurer.
* Michael J. Beer, 38, Financial Officer. Executive Vice President and
Chief Operating Officer, Princor Financial Services Corporation and
Principal Management Corporation, since 1998. Prior thereto, Senior
Vice President and Chief Operating Officer 1997-1998. Prior thereto,
Vice President and Chief Operating Officer.
* Arthur S. Filean, 60, Vice President and Secretary. Vice President,
Princor Financial Services Corporation. Vice President, Principal
Management Corporation, since 1996.
* Ernest H. Gillum, 43, Assistant Secretary. Vice President-Compliance
and Product Development, Princor Financial Services Corporation and
Principal Management Corporation, since 1998. Prior thereto, Assistant
Vice President, Registered Products 1995-1998. Prior thereto, Product
Development and Compliance Officer.
Jane E. Karli, 42, Assistant Treasurer. Assistant Treasurer, Principal
Life Insurance Company since 1998. Senior Accounting and Custody
Administrator 1994-1998; Prior thereto, Senior Investment Cost
Accountant.
* Michael D. Roughton, 47, Counsel. Counsel, Principal Life Insurance
Company, since 1994. Prior thereto, Assistant Counsel. Counsel, Invista
Capital Management, LLC, 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.
COMPENSATION TABLE*
fiscal year ended December 31, 1998 Compensation
Director Compensation from the Fund from Fund Complex
---------------------------------------------------------------------------
James D. Davis $1,950 $53,375
Pamela A. Ferguson $1,950 $46,250
Barbara A. Lukavsky $1,950 $50,675
* The Fund does not provide retirement benefits for any of the directors.
As of April 7, 1999, Principal Life Insurance Company, a 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:
- --------------------------------------------------------------------------------
% of Outstanding
Portfolio Shares
--------- ------
International Emerging Markets Portfolio 83.2%
International Securities Portfolio 43.7%
International SmallCap Portfolio 98.6%
Mortgage-Backed Securities Portfolio 100.0%
- --------------------------------------------------------------------------------
As of April 7, 1999, 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 7, 1999, 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 15.6%
Quincy, MA 02171-2126
International Securities Portfolio
Centurion Life Insurance Company 206 8th Street 15.5%
Des Moines, IA 50309-8305
Miter & Co. P.O. Box 2977 8.4%
Milwaukee, WI 53201-2977
Norwest Financial Pension Trust
206 8th Street 6.5%
Des Moines, Iowa 50309-8305
Pigeon & Co.
P.O. Box 2479 12.8%
San Antonio, TX 78298-2479
- -------------------------------------------------------------------------------------------------------------
</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 an affiliate of Principal Life Insurance Company, a 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 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 Life
Insurance Company and an affiliate of the Manager, was founded in 1985 and
manages investments for institutional investors, including Principal Life.
Assets under management at December 31, 1998 were approximately $31 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 Executive Vice President and Chief
Operating Officer (Manager)
Arthur S. Filean Vice President and Vice President (Manager)
Secretary
Ernest H. Gillum Assistant Secretary Vice President - Compliance and
Product Development
J. Barry Griswell Director and Chairman Director and Chairman of
of the Board the Board (Manager)
Ralph C. Eucher 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 that
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:
<TABLE>
<CAPTION>
Fees Computed On Fees as a Percent of
Portfolio Net Asset Value of Portfolio Average Daily Net Assets
- ----------------------------------------------------------------------------------------------------------
<S> <C> <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 net assets of each portfolio on December 31, 1998 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, 1998 December 31, 1998
--------- ----------------- -----------------
International Emerging Markets $79,480,510 1.15%
International Securities 47,912,159 .90%
International SmallCap 82,329,857 1.00%
Mortgage Backed Securities 14,860,542 .45%
- --------------------------------------------------------------------------------
Fees paid for investment management services during the periods indicated
were as follows:
- --------------------------------------------------------------------------------
Management Fees for Fiscal
Portfolio Year Ended December 31
--------- ----------------------
1998 1997 1996
---- ---- ----
International Emerging Markets $856,612 $ 43,775* N/A
International 413,285 311,027 $185,375
Securities 731,367 37,932* N/A
International SmallCap 64,195 67,721 65,114
Mortgage-Backed Securities
- --------------------------------------------------------------------------------
* Period beginning November 26, 1997 and ended December 31, 1998.
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 14, 1998. 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
Life Insurance Company ("Principal Life") whereby Principal Life 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 Life 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 Life
employees, the Manager will reimburse Principal Life 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 14, 1998.
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,
1998 due to research services provided by such brokers. These portfolio
transactions resulted in commissions paid to the International Securities
Portfolio broker by the Fund in the amount of $3,362.
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 that provided research, statistical or other factual information.
- --------------------------------------------------------------------------------
Total Brokerage Commissions
Paid During Fiscal Year
Portfolio Ended December 31
--------- -----------------
1998 1997 1996
---- ---- ----
International Emerging Markets $373,096 $99,367 N/A
International Securities 101,586 78,786 $66,683
International SmallCap 417,318 80,568 N/A
Mortgage-Backed Securities -0- -0- -0-
- --------------------------------------------------------------------------------
Brokerage commissions paid to affiliates during the year ended December 31
were as follows:
Commissions Paid to Morgan Stanley & Co.
----------------------------------------
Percent of Dollar
Total Amount of
Dollar As Percent of Commissionable
Portfolio Amount Total Commissions Transactions
--------- ------ ----------------- -----------------
International Emerging Markets
1998 $20,062 5.38% 5.45%
1997 10,074 10.14 16.63
International Securities
1998 7,322 7.21 7.48
1997 1,394 1.77 1.99
1,655 2.02 2.10
1996
International SmallCap 24,089 5.77 9.80
1998
Commissions Paid to Goldman Sachs
---------------------------------
Percent of Dollar
Total Amount of
Dollar As Percent of Commissionable
Portfolio Amount Total Commissions Transactions
--------- ------ ----------------- -----------------
International Emerging Markets
1998 $17,124 4.59% 6.15%
International Securities
1998 6,290 6.19 4.66
International SmallCap
1998 11,465 2.75 3.02
Commissions Paid to J.P. Morgan Securities
------------------------------------------
Percent of Dollar
Total Amount of
Dollar As Percent of Commissionable
Portfolio Amount Total Commissions Transactions
--------- ------ ----------------- -----------------
International Emerging Markets
1998 $16,910 4.59% 6.15%
International Securities
1998 2,320 2.28 1.65
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. On December 1, 1998 Morgan Stanley Asset Management, Inc. changed its
name to Morgan Stanley Dean Witter Investment Management, Inc. but continues to
do business in certain instances using the name Morgan Stanley Asset Management.
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, 1998 average annual return for
each of the Portfolios for the periods indicated:
Portfolio 1-Year 5-Year 10-Year
- -----------------------------------------------------------------------
International Emerging Markets (17.21)% (14.76)(1) N/A
International Securities 9.55% 9.91% 13.87%(2)
International SmallCap Portfolio 11.92%) 12.73%(1) N/A
Mortgage-Backed Securities 7.74% 7.29% 7.25%(2)
(1)Period beginning November 26, 1997 and ending December 31, 1998.
(2)Period beginning May 7, 1993 and ending December 31, 1998.
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, 1998
was 6.73%.
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
Years 6% 8% 10%
0 $10,000 $10,000 $10,000
20 $32,071 $46,610 $67,275
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.
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 4.99%
(average six-month CD rate for the month of October, 1998, as reported in the
Federal Reserve Bulletin) and an inflation rate of 1.5% (rate of inflation for
the 12-month period ended October 31, 1998 as measured by the Consumer Price
Index) and an income tax bracket of 28% would be $(105).
($10,000 x 4.99%) / 2 = $250 Interest for six-month period
- 70 Federal income taxes (28%)
- 75 Inflation's impact on invested principal
($10,000 x 1.5%) / 2
($105)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 that 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, 1998
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 for each of the five years in
the period ended December 31, 1998 for International
Securities and Mortgage-Backed Securities
Portfolios.
Financial Highlights for the year ended December
31, 1998 and for the period from November 26, 1997
through December 31, 1997 for International
Emerging Markets and International SmallCap
Portfolios.
(2) Part B:
Annual Report dated 12/31/98 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 4/28/99)
(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, 1998, 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 Registrant
Principal Life Insurance Company (an Iowa corporation)
a life group, pension and individual insurance company.
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) 0.17% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on February 12, 1999.
Principal Blue Chip Fund, Inc.(a Maryland Corporation) 0.84% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on February 12, 1999.
Principal Bond Fund, Inc.(a Maryland Corporation) 0.62% of shares
outstanding owned by Principal Life Insurance Company (including
subsidiaries and affiliates) on February 12, 1999.
Principal Capital Value Fund, Inc. (a Maryland Corporation)
23.76% of outstanding shares owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on February 12,
1999.
Principal Cash Management Fund, Inc. (a Maryland Corporation)
8.51% of outstanding shares owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on February 12,
1999.
Principal Government Securities Income Fund, Inc. (a Maryland
Corporation) 0.04% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
February 12, 1999.
Principal Growth Fund, Inc. (a Maryland Corporation) 0.41% of
outstanding shares owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on February 12, 1999.
Principal High Yield Fund, Inc. (a Maryland Corporation) 7.38%
of shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on February 12, 1999.
Principal International Emerging Markets Fund, Inc. (a Maryland
Corporation) 47.07% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
February 12, 1999.
Principal International Fund, Inc. (a Maryland Corporation)
22.93% of shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on February 12,
1999.
Principal International SmallCap Fund, Inc. (a Maryland
Corporation) 43.01% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
February 12, 1999.
Principal Limited Term Bond Fund, Inc. (a Maryland Corporation)
31.37% of shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on February 12,
1999.
Principal MidCap Fund, Inc. (a Maryland Corporation) 0.66% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on February 12, 1999
Principal Real Estate Fund, Inc. (a Maryland Corporation) 68.91%
of shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on February 12, 1999
Principal SmallCap Fund, Inc.(a Maryland Corporation) 22.07% of
shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on February 12,
1999
Principal Special Markets Fund, Inc. (a Maryland Corporation)
83.30% of shares outstanding of the International Emerging
Markets Portfolio, 43.66% of the shares outstanding of the
International Securities Portfolio, 98.66% of shares outstanding
of the International SmallCap Portfolio and 100% of the shares
outstanding of the Mortgage-Backed Securities Portfolio were
owned by Principal Life Insurance Company (including subsidiaries
and affiliates) on February 12, 1999
Principal Tax-Exempt Bond Fund, Inc. (a Maryland Corporation)
0.05% of shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on February 12,
1999.
Principal Utilities Fund, Inc. (a Maryland Corporation) 0.25% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on February 12, 1999.
Principal Variable Contracts Fund, Inc. (a Maryland Corporation)
100% of shares outstanding of the following Accounts owned by
Principal Life Insurance Company and its Separate Accounts on
February 12, 1999: Aggressive Growth, Asset Allocation, Balanced,
Bond, Capital Value, Government Securities, Growth, High Yield,
International, International SmallCap, MicroCap, MidCap, MidCap
Growth, Money Market, Real Estate, SmallCap, SmallCap Growth,
SmallCap Value and Utilities.
Subsidiaries organized and wholly-owned by Principal Life
Insurance Company:
a. Principal Holding Company (an Iowa Corporation) A holding
company wholly-owned by Principal Life Insurance
Company.
b. PT Asuransi Jiwa Principal Egalita Indonesia (an Indonesia
Corporation)
c. Principal Development Investors, LLC (a Delaware
Corporation) A limited liability company engaged in
acquiring and improving real property through development
and redevelopment.
d. Principal Capital Management, LLC (a Delaware Corporation) A
limited liability company that provides investment
management services.
Subsidiaries wholly-owned by Principal Capital Management, LLC:
a. Principal Structured Investments, LLC (a Delaware
Corporation) a limited liability company that provides
product development administration, marketing and asset
management services associated with stable value products
together with other related institutional financial services
including derivatives, asset-liability management, fixed
income investment management and ancillary money management
products.
b. Principal Enterprise Capital, LLC (a Delaware Corporation) a
company engaged in the operation of nonresidential
buildings.
c. Principal Commercial Acceptance, LLC (a Delaware
Corporation) a limited liability company involved in
purchasing, managing and selling commercial real estate
assets in the secondary market.
d. Principal Real Estate Investors, LLC (a Delaware
Corporation) a registered investment advisor.
e. Principal Commercial Funding, LLC (a Delaware
Corporation) a correspondent lender and service provider for
loans.
f. Principal Real Estate Services, LLC (a Delaware Corporation)
a limited liability company which acts as a property manager
and real estate service provider.
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, LLC (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, d/b/a Trustar
Retirement Services (a Delaware Corporation) a nondepository
trust company.
i. The Admar Group, Inc. (a Florida Corporation) a national
managed care service organization that develops 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. Professional Pensions, Inc. (a Connecticut Corporation) a
corporation engaged in sales, marketing and administration
of group insurance plans and serves as a record keeper and
third party administrator for various clients' defined
contribution plans.
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.
v. Dental-Net, Inc. (an Arizona Corporation) holding company
of Employers Dental Services; a managed dental care services
organization. HMO and dental group practice.
w. Principal Investors Corporation (a New Jersey Corporation) a
registered broker-dealer with the Securities Exchange
Commission. It is not currently active.
Subsidiaries organized and wholly-owned by Princor Financial Services
Corporation:
a. Principal Management Corporation (an Iowa Corporation) a
registered investment advisor.
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.
Subsidiary owned by Principal Residential Mortgage, Inc.:
a. Principal Wholesale Mortgage, Inc. (an Iowa Corporation) a
brokerage and servicer of residential mortgages.
Subsidiaries owned by Dental-Net, Inc.
a. Employers Dental Services, Inc. (an Arizona corporation)
a prepaid dental plan organization.
Subsidiaries wholly-owned by Professional Pensions, Inc.:
a. Benefit Fiduciary Corporation (a Rhode Island corporation)
serves as a corporate trustee for retirement trusts.
b. PPI Employee Benefits Corporation (a Connecticut
corporation) a registered broker-dealer pursuant to Section
15(b) of the Securities Exchange Act an a member of the
National Association of Securities Dealers (NASD), limited
to the sale of open-end mutual funds and variable insurance
products.
c. Boston Insurance Trust, Inc. (a Massachusetts corporation)
authorized by charter to serve as a trustee in connection
with multiple-employer group life insurance trusts or
arrangements, and to generally participate in the
administration of insurance trusts.
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. Principal Afore, S.A. de C.V. (a Mexico Corporation),
pension.
h. Zao Principal International (a Russia Corporation) inactive.
i. Principal Trust Company (Asia) Limited (an Asia trust
company).
j. Principal Asset Management Company (Asia) Ltd. (Hong Kong)
a corporation which manages pension funds.
k. Principal Consulting (India) Private Limited (an India
corporation) an India consulting company.
Subsidiaries owned by Principal International Argentina, S.A.:
a. Principal Compania de Seguros de Retiro, S.A. (an Argentina
Corporation) an individual annuity/employee benefit company.
b. Principal Life Compania de Seguros, S.A. (an Argentina
Corporation) a life insurance company.
Subsidiary owned by Principal International de Chile, S.A.:
a. Principal Compania de Seguros de Vida Chile S.A. (a Chile
Corporation) life insurance and annuity company.
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 Principal Afore, S.A. de C.V.:
a. Siefore Principal, S.A. de C.V. (a Mexico
Corporation) an investment fund company.
Item 26. Number of Holders of Securities - As of: March 31, 1999
(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, are 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 as set out in the Statement
of Additional Information (See Part B) under the caption "Directors and Officers
of the Fund" is incorporated by reference.
John E. Aschenbrenner The Principal Senior Vice President
Director Financial Group Principal Life Insurance
Company
Craig R. Barnes Same President & Chief Executive
Vice President Officer, Invista Capital
Management, LLC
*Craig L. Bassett Same See Part B
Treasurer
*Michael J. Beer Same See Part B
Executive Vice President
Mary L. Bricker Same Counsel and Assistant
Assistant Corporate Corporate Secretary
Secretary Principal Life
Insurance Company
David J. Drury Same Chief Executive Officer
Director and Chairman of the Board
Principal Life
Insurance Company
*Ralph C. Eucher Same See Part B
President and Director
*Arthur S. Filean Same See Part B
Vice President
Dennis P. Francis Same Senior Vice President
Director Principal Life
Insurance Company
Paul N. Germain Same Vice President -
Vice President - Mutual Fund Operations
Mutual Fund Operations Princor Financial Services
Corporation
*Ernest H. Gillum Same See Part B
Vice President - Compliance
& Product Development
Thomas J. Graf Same Senior Vice President
Director Principal Life
Insurance Company
*J. Barry Griswell Same See Part B
Chairman of the Board
and Director
Joyce N. Hoffman Same Vice President and
Vice President and Corporate Secretary
Corporate Secretary Principal Life
Insurance Company
Ellen Z. Lamale Same Vice President & Chief Actuary
Director Principal Life Insurance
Company
Julia M. Lawler Same Second Vice President
Director Principal Life Insurance
Company
Gregg R. Narber Same Senior Vice President and
Director General Counsel
Principal Life
Insurance Company
Richard L. Prey Same Senior Vice President
Director Principal Life Insurance
Company
Layne A. Rasmussen Same Controller
Controller - Princor Financial Services
Mutual Funds Corporation
Elizabeth R. Ring Same Controller- Broker Dealer
Controller Operations
Princor Financial Services
Corporation
*Michael D. Roughton Same See Part B
Counsel
Jean B. Schustek Same Product Compliance Officer -
Product Compliance Officer - Princor Financial Services
Registered Products Corporation
Dewain A. Sparrgrove Same Vice President -
Vice President Investment Securities
Principal 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 Utilities Fund, Inc. and Principal
Variable Contracts Fund, Inc. - funds sponsored by Principal 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 Utilities Fund, Inc., Principal
Variable Contracts Fund, Inc. and for variable annuity contracts participating
in Principal 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 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 Director
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 Acting President Financial Officer
The Principal
Financial Group
Des Moines, IA 50392
Jerald L. Bogart Insurance License Officer None
The Principal
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 Sales, None
The Principal Princor Investment Network
Financial Group
Des Moines, IA 50392
David J. Drury Director None
The Principal
Financial Group
Des Moines, IA 50392
Ralph C. Eucher Director and President and
The Principal Executive Vice President Director
Financial Group
Des Moines, IA 50392
Arthur S. Filean Vice President Vice President and
The Principal Secretary
Financial Group
Des Moines, IA 50392
Dennis P. Francis Director Director
The Principal
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 Vice President- Assistant Vice
The Principal Compliance and Product President
Financial Group Development
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
Susan R. Haupts Marketing Officer None
The Principal
Financial Group
Des Moines, IA 50392
Joyce N. Hoffman Vice President and None
The Principal Corporate Secretary
Financial Group
Des Moines, IA 50392
Kraig L. Kuhlers Marketing Officer None
The Principal
Financial Group
Des Moines, IA 50392
Ellen Z. Lamale Director None
The Principal
Financial Group
Des Moines, IA 50392
Julia M. Lawler 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
Kelly A. Paul Systems & Technology None
The Principal Officer
Financial Group
Des Moines, IA 50392
Elise M. Pilkington Assistant Director - None
The Principal Retirement Consulting
Financial Group
Des Moines, IA 50392
Richard L. Prey Director None
The Principal
Financial Group
Des Moines, IA 50392
Layne A. Rasmussen Controller-Mutual Funds None
The Principal
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- None
The Principal Marketing
Financial Group
Des Moines, IA 50392
Minoo Spellerberg Compliance 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 28th day of April, 1999.
PRINCIPAL SPECIAL MARKETS FUND, INC.
(Registrant)
By /s/ R. C. Eucher
______________________________________
R. C. Eucher
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/ R. C. Eucher
_____________________________ President and Director 4/28/99
R. C. Eucher (Principal Executive Officer) __________
(J. B. Griswell)*
_____________________________ Director and 4/28/99
J. B. Griswell Chairman of the Board __________
/s/ M. J. Beer
_____________________________ Financial Officer (Principal 4/28/99
M. J. Beer Financial and Accounting Officer) __________
(J. D. Davis)*
_____________________________ Director 4/28/99
J. D. Davis __________
(P. A. Ferguson)*
_____________________________ Director 4/28/99
P. A. Ferguson __________
(B. A. Lukavsky)*
_____________________________ Director 4/28/99
B. A. Lukavsky __________
*By /s/R. C. Eucher
_____________________________________
R. C. Eucher
President and Director
Pursuant to Powers of Attorney
Previously Filed or Included
POWER OF ATTORNEY
The undersigned hereby constitutes and appoints J. B. Griswell, M. D. Roughton,
E. H. Gillum and A. S. Filean and each of them (with full power to each of them
to act alone), the undersigned's true and lawful attorney-in-fact and agent,
with full power of substitution to each, for and on behalf and in the name of
the undersigned, to execute and file any documents relating to registration
under the Securities Act of 1933 and the Investment Company Act of 1940 with
respect to open-end management investment companies currently organized or to be
organized in the future which are sponsored by Principal Life Insurance Company,
and any and all amendments thereto and reports thereunder with all exhibits and
all instruments necessary or appropriate in connection therewith, each of said
attorneys-in-fact and agents and his or their substitutes being empowered to act
with or without the others or other, and to have full power and authority to do
or cause to be done in the name and on behalf of the undersigned each and every
act and thing necessary or appropriate to be done in order to effectuate the
same, as fully to all intents and purposes as the undersigned might or could do
in person; hereby ratifying and confirming all that said attorneys-in-fact and
agents, or any of them, may do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has hereunto set his hand this 19th day of
April, 1999.
/s/ R. C. Eucher
----------------------------------
R. C. Eucher
Consent of Independent Auditors
We consent to the reference to our firm under the caption "Financial Statements"
in the Prospectus and in Part B and to the incorporation by reference in Part B
of our report dated January 22, 1999 on the financial statements and the
financial highlights of Principal Special Markets Fund, Inc., in this Post
Effective Amendment No. 10 to Form N-1A Registration Statement under the
Securities Act of 1933 (No. 33-59474) and related Prospectus of Principal
Special Markets Fund, Inc.
/s/ Ernst & Young LLP
Des Moines, Iowa
April 27, 1999
A MESSAGE FROM THE PRESIDENT
Dear Shareholder:
The U.S. stock market achieved its fourth-consecutive year of strong returns in
1998 after staging one of the century's most rapid recoveries from a steep
descent. However, the fourth-quarter recovery was led by a relatively small
number of blue chip growth companies, and investors had to sustain significant
volatility to achieve these returns.*
Domestic bond market returns last year varied widely across sectors. The highest
quality, longer-maturity bonds produced the best results. This reflected the
decline in interest rates and the 'flight to quality' caused by Asian economic
problems, the Russian financial crisis and concerns about currency stability in
Latin America, particularly Brazil. Yield spreads between mortgage-backed
securities, high-yield bonds, municipal bonds and emerging market debt relative
to Treasury bonds reached high levels.
Also of interest, European markets provided competitive returns to the U.S.
market, despite the Asian and Russian struggles and a severe slowdown in Latin
America. And inflation, as measured by the Consumer Price Index, rose 1.61
percent. This is the second lowest inflation rate in the last 33 years.
We hope you are pleased with the performance of your Principal Special Markets
Fund account. Thank you for investing with the Principal. We look forward to
serving all your future investment needs.
Sincerely,
/s/ Stephan L. Jones
Stephan L. Jones
President
*Past performance does not guarantee future results.
CONTENTS
Page
Financial Statements and Highlights
Statements of Assets and Liabilities............................. 2
Statements of Operations ........................................ 4
Statements of Changes in Net Assets.............................. 6
Notes to Financial Statements.................................... 8
Schedules of Investments
International Emerging Markets Portfolio.................... 16
International Securities Portfolio.......................... 18
International SmallCap Portfolio............................ 20
Mortgage-Backed Securities Portfolio........................ 23
Financial Highlights............................................. 24
Report of Independent Auditors....................................... 26
Federal Income Tax Information....................................... 28
<TABLE>
<CAPTION>
December 31, 1998
STATEMENTS OF ASSETS AND LIABILITIES
PRINCIPAL SPECIAL MARKETS FUND, INC.
Mortgage-
International International International Backed
Emerging Markets Securities SmallCap Securities
Portfolio Portfolio Portfolio Portfolio
<S> <C> <C> <C> <C>
Investment in securities -- at cost.............................. $92,740,587 $41,928,912 $84,301,092 $14,771,415
Assets
Investment in securities -- at value (Note 4).................... $79,789,603 $47,843,896 $83,218,319 $15,243,626
Cash............................................................. 67,146 46,337 199,711 50,293
Receivables:
Dividends and interest........................................ 176,693 89,263 98,316 76,595
Investment securities sold.................................... -- -- 71,346 --
Other assets..................................................... -- 109 -- 127
Total Assets 80,033,442 47,979,605 83,587,692 15,370,641
Liabilities
Accrued expenses................................................. 76,485 35,942 66,752 5,646
Payables:
Investment securities purchased............................... 352,853 -- 191,083 504,453
Net payable for foreign currency contracts (Note 5)........... 123,594 31,504 -- --
Total Liabilities 552,932 67,446 257,835 510,099
Net Assets Applicable to Outstanding Shares ................... $79,480,510 $47,912,159 $83,329,857 $14,860,542
Net Assets Consist of:
Capital Stock.................................................... $ 96,835 $ 32,152 $ 75,338 $ 14,298
Additional paid-in capital....................................... 98,328,517 40,865,888 82,608,638 15,450,048
Accumulated undistributed net investment income.................. 40,240 33,810 24,067 --
Accumulated undistributed net realized gain (loss) from
investment and foreign currency transactions.................. (5,911,305) 1,095,871 1,701,706 (1,076,015)
Net unrealized appreciation (depreciation) of investments........ (12,950,984) 5,914,984 (1,082,773) 472,211
Net unrealized appreciation (depreciation) on translation of
assets and liabilities in foreign currencies.................. (122,793) (30,546) 2,881 --
Total Net Assets $79,480,510 $47,912,159 $83,329,857 $14,860,542
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.................................... 9,683,451 3,215,199 7,533,783 1,429,826
Net Asset Value Per Share ...................................... $8.21 $14.90 $11.06 $10.39
See accompanying notes.
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31, 1998
STATEMENTS OF OPERATIONS
PRINCIPAL SPECIAL MARKETS FUND, INC.
Mortgage-
International International International Backed
Emerging Markets Securities SmallCap Securities
Portfolio Portfolio Portfolio Portfolio
Net Investment Income
Income:
<S> <C> <C> <C> <C>
Dividends....................................................... $ 2,190,065 $ 1,124,874 $1,119,264 $ --
Withholding tax on foreign dividends............................ (111,270) (127,991) (98,201) --
Interest........................................................ 351,296 153,277 278,613 960,039
Total Income 2,430,091 1,150,160 1,299,676 960,039
Expenses:
Management and investment advisory fees (Note 3) ............. 856,612 413,285 731,367 64,195
Net Investment Income 1,573,479 736,875 568,309 895,844
Net Realized and Unrealized Gain (Loss) on Investments
and Foreign Currencies
Net realized gain (loss) from:
Investment transactions......................................... (5,887,011) 2,908,081 1,723,164 2,046
Foreign currency transactions................................... (24,294) (19,515) (17,896) --
Change in unrealized appreciation/depreciation of:
Investments..................................................... (13,304,433) (20,537) (943,153) 167,122
Translation of assets and liabilities in foreign currencies..... (122,759) (34,804) 7,675 --
Net Realized and Unrealized Gain (Loss)
on Investments and Foreign Currencies (19,338,497) 2,833,225 769,790 169,168
Net Increase (Decrease) in Net Assets
Resulting from Operations $(17,765,018) $3,570,100 $1,338,099 $1,065,012
See accompanying notes.
</TABLE>
<TABLE>
<CAPTION>
Years Ended December 31, Except as Noted
STATEMENTS OF CHANGES IN NET ASSETS
PRINCIPAL SPECIAL MARKETS FUND, INC.
International International
Emerging Markets Securities
Portfolio Portfolio
1998 1997(a) 1998 1997
<S> <C> <C> <C> <C>
Operations
Net investment income ........................................... $ 1,573,479 $ 76,490 $ 736,875 $ 596,269
Net realized gain (loss) from investment and foreign
currency transactions......................................... (5,911,305) 58,141 2,888,566 1,806,668
Change in unrealized appreciation/depreciation of investments
and translation of assets and liabilities in foreign currencies (13,427,192) 353,415 (55,341) 824,126
Net Increase (Decrease) in Net Assets
Resulting from Operations (17,765,018) 488,046 3,570,100 3,227,063
Dividends and Distributions to Shareholders
From net investment income....................................... (1,546,178) (59,520) (703,066) (581,224)
From net realized gain on investments and foreign
currency transactions......................................... (62,172) -- (2,066,333) (1,645,552)
Total Dividends and Distributions (1,608,350) (59,520) (2,769,399) (2,226,776)
Capital Share Transactions (Note 6)
Shares sold...................................................... 65,000,000 32,000,000 8,238,836 15,749,696
Shares issued in reinvestment of dividends
and distributions............................................. 1,365,832 59,520 1,857,180 1,327,125
Shares redeemed.................................................. -- -- (668,569) (8,553,721)
Net Increase (Decrease) in Net Assets
from Capital Share Transactions 66,365,832 32,059,520 9,427,447 8,523,100
Total Increase (Decrease) 46,992,464 32,488,046 10,228,148 9,523,387
Net Assets
Beginning of period.............................................. 32,488,046 -- 37,684,011 28,160,624
End of period (including undistributed net investment
income as set forth below).................................... $79,480,510 $32,488,046 $47,912,159 $37,684,011
Undistributed Net Investment Income .......................... $ 40,240 $ 16,970 $ 33,810 $ 25,569
<FN>
(a) Period from November 17, 1997 (date operations commenced)
through December 31, 1997.
</FN>
See accompanying notes.
</TABLE>
<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
1998 1997(a) 1998 1997
<S> <C> <C> <C> <C>
Operations
Net investment income ........................................... $ 568,309 $ 54,940 $ 895,844 $ 956,959
Net realized gain (loss) from investment and foreign
currency transactions......................................... 1,705,268 57,135 2,046 22,412
Change in unrealized appreciation/depreciation of investments
and translation of assets and liabilities in foreign currencies (935,478) (144,414) 167,122 495,704
Net Increase (Decrease) in Net Assets
Resulting from Operations 1,338,099 (32,339) 1,065,012 1,475,075
Dividends and Distributions to Shareholders
From net investment income....................................... (548,766) (50,530) (895,844) (956,959)
From net realized gain on investments and foreign
currency transactions......................................... (60,583) -- -- --
Total Dividends and Distributions (609,349) (50,530) (895,844) (956,959)
Capital Share Transactions (Note 6)
Shares sold...................................................... 50,024,097 32,000,000 -- --
Shares issued in reinvestment of dividends
and distributions............................................. 609,349 50,530 895,844 827,979
Shares redeemed.................................................. -- -- -- (2,518,823)
Net Increase (Decrease) in Net Assets
from Capital Share Transactions 50,633,446 32,050,530 895,844 (1,690,844)
Total Increase (Decrease) 51,362,196 31,967,661 1,065,012 (1,172,728)
Net Assets
Beginning of period.............................................. 31,967,661 -- 13,795,530 14,968,258
End of period (including undistributed net investment
income as set forth below).................................... $83,329,857 $31,967,661 $14,860,542 $13,795,530
Undistributed Net Investment Income .......................... $ 24,067 $ 4,410 $ -- $ --
<FN>
(a) Period from November 17, 1997 (date operations commenced)
through December 31, 1997.
</FN>
See accompanying notes.
</TABLE>
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 (International Emerging Markets Portfolio,
International Securities Portfolio, International SmallCap Portfolio and
Mortgage-Backed Securities Portfolio) (known as the "Portfolios").
On November 17, 1997, the initial purchases of 3,100,000 shares of Capital Stock
of each of the International Emerging Markets and International SmallCap
Portfolios were made by Principal Life Insurance Company (see Note 3) (formerly
known as Principal Mutual Life Insurance Company). Effective November 26, 1997,
International Emerging Markets and International SmallCap Portfolios began
offering shares to the public.
The Portfolios value 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 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 each
portfolio'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 Principal Management Corporation
(formerly known as Princor Management Corporation) (the "Manager") under
procedures established and regularly reviewed by the Fund's Board of Directors.
To the extent each portfolio invests in foreign securities listed on foreign
exchanges which trade on days on which a portfolio does not determine its net
asset value, for example Saturdays and other customary national U.S. holidays,
each portfolio's net asset value could be significantly affected on days when
shareholders do not have access to the portfolio.
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-advisor is authorized to make such
determinations subject to such oversight by the Fund's Board of Directors as may
occasionally 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 Portfolios record 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 Portfolios record dividend
income on the ex-dividend date, except dividend income from foreign securities
whereby the ex-dividend date has passed; such dividends are recorded as soon as
the Portfolios are informed of the ex-dividend date. Interest income is
recognized on an accrual basis.
Reported net realized foreign exchange gains or losses arise from sales of
foreign currencies, currency gains or losses realized between the trade and
settlement dates on security transactions, and the difference between the amount
of dividends and foreign withholding taxes recorded on the books and the U.S.
dollar equivalent of the amounts actually received or paid. Net unrealized
appreciation or depreciation 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
Principal 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 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.
Reclassifications made for the periods ended December 31,1998 and 1997 were not
material.
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 tax return of capital distributions.
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 each
portfolio 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 approximates that used for
financial reporting purposes.
At December 31, 1998, the following Portfolios had approximate net capital loss
carryforwards as follows:
International Mortgaged-Backed
Net Capital Loss Emerging Markets Securities
Carryforwards Expire In: Portfolio Portfolio
2002 $ -- $ 751,000
2003 -- 300,000
2004 -- 25,000
2006 6,004,000 --
$6,004,000 $1,076,000
Note 3 -- Management Agreement and Transactions With Affiliates
The Fund has agreed to pay investment advisory and management fees, computed at
an annual percentage rate of each portfolio's average daily net assets, to
Principal Management Corporation and to Invista Capital Management, LLC
("Invista"). Principal Management Corporation is wholly owned by Princor
Financial Services Corporation, a subsidiary of Principal Life Insurance
Company. Invista is an indirect wholly owned subsidiary of Principal 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 to reimburse the
Manager for the other costs it incurs under the management agreement. The annual
rate used in this calculation for the Portfolios is as follows:
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, 1998 and 1997. Brokerage
commissions were paid to other affiliates by the following portfolios:
Year Periods
Ended Ended
December 31, December 31,
1998 1997
International Emerging Markets Portfolio $54,096 $10,074
International Securities Portfolio 15,932 1,394
International SmallCap Portfolio 35,554 --
At December 31, 1998, Principal Life Insurance Company owned shares of the
Fund's portfolios as follows:
International Emerging Markets Portfolio 8,065,929
International Securities Portfolio 1,398,736
International SmallCap Portfolio 7,432,590
Mortgage-Backed Securities Portfolio 1,429,826
Note 4 -- Investment Transactions
For the year ended December 31, 1998, 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 $ 91,451,269 $24,592,461
International Securities Portfolio 25,092,857 15,827,438
International SmallCap Portfolio 113,752,659 60,042,408
Mortgage-Backed Securities Portfolio 1,104,787 1,060,456
At December 31, 1998, net unrealized appreciation (depreciation) of investments
by the Portfolios 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 $ 7,507,374 $(20,458,358) $(12,950,984)
International Securities Portfolio 10,912,860 (4,997,876) 5,914,984
International SmallCap Portfolio 9,456,364 (10,539,137) (1,082,773)
Mortgage-Backed Securities Portfolio 483,618 (11,407) 472,211
</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, 1998, Mortgage-Backed Securities Portfolio had a TBA purchase commitment
involving a security with a face amount of $500,000, cost of $504,453 and market
value of $505,005. The portfolio has set aside investment securities and other
assets in excess of the commitment to serve as collateral.
At December 31, 1998, the Portfolios held the following securities which were
purchased in private placement transactions and may require registration, or an
exemption therefrom, in order to effect a sale in the ordinary course of
business.
<TABLE>
<CAPTION>
Value at Value as a
Date of December 31, Percentage of
Security Description Acquisition Cost 1998 Net Assets
International Emerging Markets Portfolio
<S> <C> <C> <C> <C>
Al Ahram Beverages Co. GDR 2/4/98 $ 194,250 $ 202,125 0.25%
2/13/98 58,500 57,750 0.07
2/23/98 26,400 23,100 0.03
3/5/98 90,000 86,625 0.11
3/20/98 90,750 86,625 0.11
9/28/98 116,100 103,950 0.13
11/6/98 249,546 245,438 0.31
11/25/98 29,750 28,875 0.04
12/14/98 158,600 176,137 0.22
Bank Handlowy w Warszawie GDR 2/17/98 220,500 195,000 0.25
2/23/98 233,250 195,000 0.25
3/5/98 147,500 130,000 0.16
4/2/98 66,500 52,000 0.06
4/21/98 96,600 78,000 0.10
Banque Libanaise Pour Le Commerce SAL ADR 1/15/98 210,000 223,500 0.29
2/13/98 104,013 98,712 0.12
2/19/98 55,800 55,875 0.07
2/23/98 124,575 122,925 0.15
3/9/98 106,500 111,750 0.14
3/20/98 53,400 55,875 0.07
Banque Marocaine du Commerce Exterieur 11/17/97 $ 190,000 $ 234,000 0.29%
12/3/97 20,100 23,400 0.03
1/16/98 73,815 86,580 0.11
2/13/98 70,740 84,240 0.10
2/23/98 99,500 117,000 0.15
3/5/98 102,500 117,000 0.15
4/6/98 4,470 4,680 0.01
Eesti Uhispank GDR 3/24/98 319,000 96,500 0.12
4/2/98 106,750 33,775 0.04
4/3/98 61,500 19,300 0.03
Industrial Credit & Investment Corp. 11/17/97 420,000 199,500 0.25
of India ADR 11/20/97 177,125 86,450 0.11
12/17/97 46,688 29,925 0.04
1/13/98 38,700 23,940 0.03
2/13/98 277,500 133,000 0.17
2/23/98 236,300 113,050 0.14
3/5/98 155,000 66,500 0.08
3/20/98 137,500 66,500 0.08
5/8/98 239,250 99,750 0.13
8/28/98 65,700 47,880 0.06
Mol Magyar Olaj-es Gazipari Rt. ADR 3/20/98 1,110,000 1,014,847 1.28
5/20/98 124,200 123,427 0.16
9/2/98 60,375 82,285 0.10
9/23/98 115,940 170,056 0.21
Paints & Chemical Industries Co. SAE GDR 11/17/97 148,125 97,500 0.12
11/18/97 146,250 97,500 0.12
11/24/97 210,000 136,500 0.17
1/26/98 17,250 13,000 0.02
2/16/98 114,125 71,500 0.09
2/23/98 187,000 110,500 0.14
3/5/98 139,800 78,000 0.10
3/20/98 84,000 45,500 0.06
4/2/98 69,000 39,000 0.05
4/6/98 67,500 39,000 0.05
5/8/98 99,900 58,500 0.07
6/5/98 78,800 52,000 0.06
7/20/98 101,370 70,850 0.09
Pick Szeged RT GDR 7/7/98 $ 169,905 $ 119,853 0.15%
7/8/98 174,840 119,853 0.15
7/14/98 90,650 59,501 0.08
9/2/98 81,600 102,002 0.13
9/23/98 96,600 170,004 0.21
10/22/98 95,140 113,903 0.14
10/27/98 113,040 122,403 0.16
Reliance Industries Ltd. GDR 12/2/97 170,000 113,500 0.14
12/12/97 72,500 56,750 0.07
1/2/98 52,605 35,753 0.05
1/13/98 23,250 17,593 0.02
2/13/98 131,400 102,150 0.13
2/23/98 140,600 107,825 0.14
3/5/98 132,800 90,800 0.11
4/6/98 92,000 56,750 0.07
7/14/98 102,950 80,585 0.10
12/22/98 183,150 188,977 0.24
Videsh Sanchar Nigam Ltd. GDR 11/17/97 312,375 257,250 0.32
11/24/97 104,000 98,000 0.12
12/12/97 30,820 28,175 0.04
1/2/98 55,400 49,000 0.06
1/13/98 24,970 26,950 0.03
2/13/98 236,250 220,500 0.28
2/23/98 161,925 155,575 0.20
3/5/98 261,000 245,000 0.31
3/20/98 83,650 85,750 0.11
4/30/98 123,750 122,500 0.15
5/8/98 225,900 220,500 0.28
7/30/98 65,250 73,500 0.09
9,553,100 12.02
International Securities Portfolio
Kemira OY 12/10/96 286,318 165,801 0.35
2/24/97 88,695 55,507 0.11
4/11/97 95,955 65,600 0.14
286,908 0.60
International SmallCap Portfolio
Bure Investment Aktiebolaget AB 11/18/97 $ 276,498 $ 326,320 0.39%
6/25/98 205,963 178,767 0.21
6/26/98 229,443 204,305 0.25
8/5/98 178,129 173,091 0.21
8/26/98 77,749 83,708 0.10
8/27/98 47,868 52,495 0.06
11/30/98 194,948 198,629 0.24
Computacenter PLC 5/21/98 733,979 510,986 0.61
9/30/98 273,953 234,263 0.28
10/2/98 75,597 69,547 0.09
Industrial & Financial Systems 12/4/98 113,329 263,582 0.31
12/7/98 813,251 847,846 1.02
12/8/98 200,853 206,482 0.25
Newsquest PLC 11/18/97 505,613 505,463 0.60
12/2/97 78,410 73,374 0.09
2/26/98 242,366 228,273 0.27
2/27/98 129,705 122,289 0.15
4/15/98 113,176 89,679 0.11
8/26/98 125,641 114,136 0.14
11/3/98 111,131 114,136 0.14
4,597,371 5.52
</TABLE>
The Mortgage-Backed Securities Portfolio's investments are with various issuers;
the other portfolios' investments are with various issuers in various
industries. The Schedules of Investments contained herein summarize
concentrations of credit risk for Mortgage-Backed Securities Portfolio by
issuers and the other portfolios by industry and issuer.
Note 5 -- Foreign Currency Contracts
At December 31, 1998, International Securities Portfolio and International
Emerging Markets Portfolio each owned a forward contract to sell Hong Kong
Dollars ("HKD") at a specified future date at a fixed exchange rate. Forward
foreign currency contracts are valued at the forward rate, and are
marked-to-market daily. The change in market value is recorded by each portfolio
as an unrealized gain or loss. When the contract is closed, each portfolio
records 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 1998 (Depreciation)
<S> <C> <C> <C> <C> <C>
International Emerging Markets Portfolio 20,718,750 HKD $2,550,000 3/1/99 $2,673,594 $(123,594)
International Securities Portfolio 5,281,250 HKD 650,000 3/1/99 681,504 (31,504)
</TABLE>
The use of forward foreign currency contracts does not eliminate fluctuations in
underlying prices of each portfolio's investments, but it does establish a rate
of exchange that can be achieved in the future. Although forward foreign
currency contracts limit the risk of loss due to a decline in the value of the
hedged currency, they also limit any potential gain that might result should the
value of the currency increase. In addition, the portfolios 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 Portfolio Portfolio Portfolio
Year Ended December 31, 1998:
<S> <C> <C> <C> <C>
Shares sold ................................. 6,311,934 521,541 4,270,347 --
Shares issued in reinvestment of
dividends and distributions .................. 166,787 126,754 57,958 86,540
Shares redeemed ............................. -- (41,219) -- --
Net Increase 6,478,721 607,076 4,328,305 86,540
Periods Ended December 31, 1997:
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)
</TABLE>
Note 7 -- Line of Credit
The Portfolios participate with other funds and accounts managed by Principal
Management Corporation in an unsecured joint line of credit with a bank, which
allows them to borrow up to $60,000,000, 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, accounts and portfolios in proportion to their average net
assets during each quarter. At December 31, 1998, the Portfolios had no
outstanding borrowings under the line of credit.
December 31, 1998
SCHEDULES OF INVESTMENTS
PRINCIPAL SPECIAL MARKETS FUND, INC.
International Emerging Markets Portfolio
Shares
Held Value
Common Stocks (88.09%)
Bakery Products (0.67%)
Nong Shim Co., Ltd. 9,300 $ 535,201
Beer, Wine & Distilled
Beverages (1.39%)
South African Breweries Ltd. 65,391 1,101,593
Beverages (9.15%)
Al-Ahram Beverages Co. GDR 35,000(a)(b) 1,010,625
Embotelladora Andina SA ADR,
Series A 59,300 859,850
Fomento Economico Mexicano SA ADR 63,050 1,678,706
PanAmerican Beverages, Inc. ADR 57,100 1,245,494
Pepsi-Gemex SA DE CV GDR 89,500 699,219
Quilmes Industrial Quines SA ADR 191,100 1,779,619
7,273,513
Blast Furnace & Basic Steel
Products (1.08%)
Hylsamex SA, Class B 234,100 291,154
Tubos De Acero De Mexico SA ADR 87,800 565,212
856,366
Cable & Other Pay TV Services (1.49%)
Ceske Radiokomunikace GDR 36,600(a) 1,180,350
Central Reserve Depositories (0.59%)
Banco Santiago SA ADR 31,500 468,562
Chemicals & Allied Products (0.79%)
Sarantis SA 44,043 629,085
Commercial Banks (5.77%)
Banco Portugues Do Atlantico 36,900(a) 756,255
Banco Rio De La Plata SA ADR 82,300 1,069,900
Bank Handlowy w Warszawie GDR 50,000(b) 650,000
Banque Libanaise Pour Le
Commerce SAL ADR 35,900(b) 668,637
Banque Marocaine du Commerce
Exterieur 28,500(b) 666,900
Big Bank Gdanski SA 699,000 627,323
Eesti Uhispank GDR 31,000(a)(b) 149,575
4,588,590
Communications Equipment (2.11%)
ECI Telecommunications Ltd. ADR 47,000 1,674,375
Computer & Data Processing
Services (1.21%)
Tecnomatix Technologies Ltd. ADR 55,000(a) 962,500
Computer & Office Equipment (2.69%)
Orbotech Ltd. ADR 36,100(a) 1,710,237
Sindo Ricoh Co. 12,000 430,117
2,140,354
Construction & Related
Machinery (0.73%)
Barlow Ltd. 150,793 579,321
Consumer Products (2.17%)
Rothmans Industries Ltd. 217,000 $1,302,034
Souza Cruz SA 65,800 424,798
1,726,832
Crude Petroleum & Natural Gas (1.75%)
Mol Magyar Olaj-es Gazipari Rt. ADR 50,700(b) 1,390,615
Drugs (1.34%)
Teva Pharmaceutical Industries Ltd.
ADR 26,100 1,061,944
Eating & Drinking Places (0.87%)
Cafe De Coral Holdings Ltd. 2,215,000 693,322
Electric Services (3.60%)
Companhia Paranaense de
Enersis-Copel ADR 155,500 1,107,938
Electricidade De Portugal SA 34,500 759,608
Enersis SA ADR 38,400 991,200
2,858,746
Electrical Industrial Apparatus (0.67%)
Guangdong Kelon Electric
Holdings Ltd. 598,000 532,598
Electronic Components &
Accessories (3.35%)
Elec & Eltek International Co.
Ltd. ADR 231,100 1,247,940
Varitronix International Ltd. 549,000 1,027,519
Wong Circuits Holdings Ltd. ADR 479,000 383,200
2,658,659
Electronic Distribution
Equipment (2.58%)
Techtronic Industries Co. 6,180,000 1,100,822
Vtech Holdings Ltd. 217,000 946,730
2,047,552
Engines & Turbines (0.59%)
First Tractor Co. Ltd. 2,062,000 471,098
Federal & Federally Sponsored
Credit (1.09%)
Industrial Credit & Investment Corp.
of India ADR 130,300(b) 866,495
Fire, Marine & Casualty
Insurance (0.69%)
Aksigorta AS 18,000,000 547,892
Foreign Banks, Branches &
Agencies (1.33%)
Bank Leumi Le - Israel 343,000 484,818
Credicorp Ltd. ADR 63,840 574,560
1,059,378
Furniture & Home Furnishing
Stores (0.86%)
Grupo Elektra SA CPO 1,354,000 681,812
Glass & Glassware, Pressed or
Blown (1.25%)
Vitro SA ADR 218,000 994,625
Grocery Stores (1.08%)
Blue Square Chain Investments &
Property Ltd. 71,675(a) 859,756
Holding Offices (1.82%)
The India Fund, Inc. ADR 229,700(a) $1,449,981
Measuring & Controlling
Devices (2.60%)
IDT Holdings Singapore Ltd. ADR 1,116,000 1,004,400
Moulin International Holding Ltd. 8,780,000 1,065,300
2,069,700
Meat Products (1.02%)
Pick Szeged RT GDR 95,000(b) 807,519
Medical Instruments & Supplies (1.71%)
Medison Co. Ltd. 116,500 1,356,381
Metal Cans & Shipping
Containers (0.46%)
Colep Portugal-Embalagens, Produtos,
Enchimentos e. Equipamentos, SA 49,000(a) 365,935
Miscellaneous Electrical Equipment &
Supplies (1.31%)
G.P. Batteries International Ltd. 488,000 1,041,094
Miscellaneous Food & Kindred
Products (0.92%)
Thai Union Frozen Products
Public Co. Ltd. 166,500 728,616
Miscellaneous Investing (1.02%)
Banco Latino Americano De
Exportaciones ADR 48,540 806,978
Miscellaneous Non-Durable
Goods (1.76%)
Desc SA, Series B 1,664,000 1,396,522
Miscellaneous Services, NEC (0.77%)
IDT International Ltd. 4,582,000 615,089
Miscellaneous Textile Goods (2.39%)
Esprit Holdings Ltd. 2,430,000 1,050,753
Reliance Industries Ltd. GDR 149,900(b) 850,683
1,901,436
Oil & Gas Field Services (0.13%)
Gulf Indonesia Resources Ltd. ADR 16,500(a) 107,250
Paints & Allied Products (1.14%)
Paints & Chemical Industries
Co. SAE GDR 139,900(b) 909,350
Paperboard Containers & Boxes (0.67%)
Hung Hing Print Group 1,364,000 532,586
Petroleum Refining (3.44%)
Sasol Ltd. 247,000 934,235
YPF Sociedad Anonima ADR 64,300 1,796,381
2,730,616
Search & Navigation Equipment (1.72%)
Elbit Systems Ltd. ADR 114,100 1,369,200
Security & Commodity
Exchanges (0.55%)
OTK Holdings Ltd. ADR 835,000 440,025
Security Brokers & Dealers (0.00%)
Peregrine Investment Holdings Ltd. 160,000(a)(c)$ 0
Telephone Communication (13.77%)
Compania Anonima Telefonos De
Venezuela ADR 25,300 450,656
Compania De Telecomunicacion De
Chile ADR 33,700 697,169
Global Telesystems Group, Inc. ADR 24,100(a) 1,343,575
Hellenic Telecom
Organization SA - ADR 71,000 940,750
Hellenic Telecommunication 31,989 851,006
Investec-Consultadoria
Internacional SA 11,400 392,627
Matav Tavkozlesi Rt ADR 55,300 1,648,631
Panafon SA 17,200(a) 460,646
Tele Norte Leste Participacoes
SA 22,000,000(a) 180,269
Tele Norte Leste Participacoes
SA ADR 9,200(a) 114,425
Telecelular Sul Participacoes SA 92,000,000 155,339
Tele Celular Sul Participacoes
SA ADR 10,200(a) 177,863
Telecomunicacoes Brasileiras
SA - Receipts 22,990,000 1,027,530
Telefonica De Argentina SA ADR 33,000 921,938
Videsh Sanchar Nigam Ltd. GDR 129,200(b) 1,582,700
10,945,124
Total Common Stocks 70,014,536
Preferred Stocks (7.11%)
Cement, Hydraulic (1.81%)
Titan Cement Co. SA 22,500 1,441,794
Central Reserve Depositories (0.55%)
Banco Ganadero SA ADR Preference 48,800 442,250
Electric Services (1.18%)
Centrais Electricas De Santa
Catarina SA 2,094,000 935,906
Industrial Inorganic Chemicals (0.31%)
Fertilizantes Fosfatados SA
Fosfertil NPV 95,000,000 243,752
Telephone Communication (3.26%)
Telemig Celular SA - Pref C 4,890,000(a) 95,922
Telesp Celular SA - Pref B 7,870,000(a) 358,261
Telecentro Sul Participacoes SA 57,000,000(a) 494,894
Telec De Sao Paulo SA 12,030,000 1,639,914
2,588,991
Total Preferred Stocks 5,652,693
Principal
Amount Value
Commercial Paper (5.19%)
Business Credit Institutions (2.24%)
General Electric Capital Corp.;
4.90%; 1/7/1999 $1,780,000 $1,778,546
Personal Credit Institutions (2.95%)
Household Finance Corp.;
6.00%; 1/4/1999 $2,345,000 $2,343,828
Total Commercial Paper 4,122,374
Total Portfolio Investments (100.39%) 79,789,603
Liabilities, net of cash and receivables (-0.39%) (309,093)
Total Net Assets (100.00%) $79,480,510
(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 $5,567,838 6.98%
Brazil 6,956,809 8.72
Chile 3,016,781 3.78
China 1,003,697 1.26
Colombia 442,250 0.55
Czech Republic 2,523,925 3.16
Egypt 1,919,975 2.41
Estonia 149,575 0.19
Greece 4,323,281 5.42
Hong Kong 7,032,121 8.81
Hungary 3,846,765 4.82
India 4,749,859 5.95
Indonesia 107,250 0.13
Israel 8,122,831 10.18
Korea, Republic of 2,321,699 2.91
Lebanon 668,638 0.84
Mexico 7,552,745 9.47
Morocco 666,900 0.84
Panama 806,977 1.01
Peru 574,560 0.72
Poland 1,277,323 1.60
Portugal 2,274,425 2.85
Singapore 4,978,668 6.24
South Africa 3,055,174 3.83
Thailand 728,616 0.91
Turkey 547,892 0.69
United States 4,122,373 5.17
Venezuela 450,656 0.56
Total $79,789,603 100.00%
International Securities Portfolio
Shares
Held Value
Common Stocks (98.45%)
Advertising (2.07%)
WPP Group PLC 163,700 $ 991,405
Beverages (0.96%)
PanAmerican Beverages, Inc. ADR 21,100 460,244
Blast Furnace & Basic Steel
Products (0.23%)
Tubos De Acero De Mexico SA ADR 17,000 109,438
Central Reserve Depositories (2.58%)
National Westminster Bank 37,408 720,732
Union Bank of Norway 26,480 514,393
1,235,125
Commercial Banks (12.99%)
Australia & New Zealand Banking
Group 129,000 845,038
Bank of Ireland 53,536 1,176,646
Barclays PLC 16,600 357,115
Kapital Holdings 4,441 219,805
Merita PLC, Class A 149,950 953,608
National Australia Bank Ltd. 45,734 690,064
Royal Bank of Canada Montreal,
Quebec 11,600 578,134
San Paolo-Imi SPA 35,530 629,196
Svenska Handelsbanken AB Free 17,050 654,188
Svenska Handelsbanken, Class A 2,800 118,141
6,221,935
Communications Equipment (2.10%)
ECI Telecommunications Ltd. ADR 28,200 1,004,625
Communications Services, NEC (1.83%)
Koninklijke KPN NV 17,514 877,255
Computer & Office Equipment (1.58%)
Orbotech Ltd. ADR 16,000(a) 758,000
Concrete, Gypsum & Plaster
Products (1.53%)
Lafarge SA 7,700 731,954
Consumer Products (6.23%)
Imasco Ltd. 51,541 1,097,300
Imperial Tobacco Group PLC 38,000 407,797
Swedish Nationale D'Exploitation
Industrielle Des Tabacs Et
Allumettes 11,000 689,222
Swedish Match Co. 217,000 789,768
2,984,087
Copper Ores (0.82%)
Trelleborg AB, Class B 48,000 390,844
Deep Sea Foreign Transportation of
Freight (0.34%)
Van Ommeren NV 5,238 163,281
Drugs (4.32%)
Novartis AG 578 1,136,236
Pharmacia & Upjohn, Inc. 16,500 934,313
2,070,549
Electric Services (1.10%)
Enersis SA ADR 20,500 $ 529,156
Electrical Goods (0.99%)
Smiths Industries PLC 34,000 476,312
Electronic Components &
Accessories (1.62%)
Elec & Eltek International Co.
Ltd. ADR 105,600 570,240
Varitronix International Ltd. 111,000 207,750
777,990
Electronic Distribution
Equipment (2.73%)
Philips Electronics 19,500 1,309,236
Engines & Turbines (0.51%)
RHI AG 8,900 232,031
Scapa Group PLC 6,000 9,933
241,964
Farm & Garden Machinery (0.76%)
New Holland NV 26,500 362,719
Finance Services (1.19%)
Takefuji Corp. 7,800 570,496
Gas Production & Distribution (0.72%)
OMV AG 3,650 344,191
Industrial Inorganic Chemicals (0.60%)
Kemira OY 39,800(b) 286,908
Investment Offices (1.38%)
AMVESCAP PLC 85,400 660,711
Life Insurance (1.90%)
National Mutual Asia Ltd. 697,000 521,807
QBE Insurance Group Ltd. 93,586 387,464
909,271
Meat Products (5.24%)
Danisco AS 14,800 802,282
Orkla ASA, Class A 15,000 223,461
Orkla ASA, Class B 41,600 543,290
Unilever NV 11,000 940,764
2,509,797
Miscellaneous Chemical Products (1.42%)
Hoechst AG 16,500 682,578
Miscellaneous Converted Paper
Products (1.28%)
Bunzl PLC 156,000 611,247
Miscellaneous Food & Kindred
Products (2.00%)
Bols Wessanen CVA 47,000 606,074
Greencore Group PLC 78,000 352,992
959,066
Miscellaneous Non-Durable
Goods (2.53%)
Desc SA, Class B 392,000 328,988
Diageo PLC 78,515 882,427
1,211,415
Miscellaneous Primary Metal
Products (0.69%)
Charter PLC 61,000 $ 330,863
Miscellaneous Textile Goods (0.99%)
Esprit Holdings Ltd. 1,094,000 473,055
Miscellaneous Transportation
Equipment (1.32%)
Autoliv, Inc. 5,200 186,687
Autoliv, Inc. ADR 12,000 446,250
632,937
Motor Vehicles & Equipment (3.54%)
DaimlerChrysler AG 5,300 526,651
E.C.I.A. Equipment & Composants 1,900 254,762
Lucasvarity PLC 149,000 490,854
Mayflower Corp. PLC 196,000 423,936
1,696,203
Newspapers (0.78%)
Publishing & Broadcasting Ltd. 86,000 376,100
Oil & Gas Field Services (0.97%)
Eni Spa 71,000 465,040
Paperboard Containers & Boxes (0.87%)
Buhrmann NV 23,200 415,375
Personnel Supply Services (1.41%)
Vedior NV 34,329 676,824
Petroleum Refining (3.78%)
Repsol Petroleo SA 10,600 566,316
Sasol Ltd. 95,000 359,321
YPF Sociedad Anonima ADR 31,700 885,619
1,811,256
Plastic Materials & Synthetics (0.74%)
Astra AB 17,333 352,838
Pulp Mills (2.17%)
Lassila & Tikanoja Ltd. OY 16,400 404,875
Upm-Kymmene OY 22,700 636,622
1,041,497
Radio & Television Broadcasting (2.63%)
Carlton Communications PLC 91,000 834,246
Mirror Group PLC 172,000 427,829
1,262,075
Security Brokers & Dealers (0.00%)
Peregrine Investment Holdings 227,000(a)(c) 0
Soap, Cleaners & Toilet Goods (3.12%)
Benckiser NV, Class B 11,900 779,947
Reckitt & Colman PLC 54,292 717,228
1,497,175
Special Industry Machinery (1.52%)
Cookson Group 336,000 726,748
Sugar & Confectionery Products (2.27%)
Nestle 500 1,088,475
Telephone Communication (7.74%)
Hellenic Telecom Organization SA ADR 60,000 $ 795,000
Nokia Corp. ADR, Class A 7,800 939,412
Telecom Corp. of New Zealand Ltd. 168,000 732,165
Telecom Italia-DI 197,000 1,242,531
3,709,108
Watches, Clocks, Watchcases &
Parts (0.36%)
Tag Heuer International SA 2,500 172,190
Total Common Stocks 47,169,558
Preferred Stock (0.40%)
Commercial Banks (0.40%)
National Australia Bank ECU Convertible6,800 189,550
Principal
Amount Value
Commercial Paper (1.01%)
Business Credit Institutions (1.01%)
General Electric Capital Corp.;
5.25%; 1/4/1999 $485,000 484,788
Total Portfolio Investments (99.86%) 47,843,896
Cash, receivables and other assets,
net of liabilities (0.14%) 68,263
Total Net Assets (100.00%) $47,912,159
(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 $ 885,619 1.85%
Australia 2,488,217 5.20
Austria 576,222 1.20
Canada 1,675,434 3.50
Chile 529,156 1.11
Denmark 1,022,087 2.14
Finland 3,221,426 6.73
France 1,675,938 3.50
Germany 1,209,229 2.53
Greece 795,000 1.66
Hong Kong 1,202,613 2.52
Israel 1,762,625 3.68
Italy 2,336,766 4.89
Japan 570,496 1.19
Mexico 898,670 1.88
Netherlands 6,131,474 12.82
New Zealand 732,165 1.53
Norway 1,281,145 2.68
Singapore 570,240 1.19
South Africa 359,321 0.75
Spain 566,316 1.18
Sweden 2,938,717 6.14
Switzerland 2,396,901 5.01
United Kingdom 10,599,021 22.15
United States 1,419,098 2.97
Total $47,843,896 100.00%
International SmallCap Portfolio
Shares
Held Value
Common Stocks (99.08%)
Advertising (2.95%)
Industrial & Financial Systems 114,250(a)(b)$1,317,910
United Group Ltd. 639,000 1,136,618
2,454,528
Air Transportation, Scheduled (1.89%)
Ryanair Holdings PLC ADR 41,800(a) 1,577,950
Airports, Flying Fields &
Services (3.54%)
Aeroporti Di Roma 70,400 614,813
Auckland International Airport
Ltd. 1,201,000(a) 1,681,259
Virgin Express Holdings ADR 81,800(a) 654,400
2,950,472
Bakery Products (1.07%)
Kamps AG 14,000(a) 891,011
Central Reserve Depositories (1.19%)
Union Bank of Norway 50,940 989,546
Commercial Banks (1.52%)
Banco Pastor SA 20,200 $1,268,815
Communications Equipment (2.36%)
Gilat Satellite Networks Ltd. 7,000(a) 385,875
Research In Motion Ltd. 236,900(a) 1,580,936
1,966,811
Communications Services, NEC (1.62%)
RSL Communications Ltd. 45,900(a) 1,354,050
Computer & Data Processing
Services (9.39%)
Computacenter PLC 111,300(a)(b) 814,796
Computershare Ltd. 220,000 1,081,268
Ecsoft Group PLC ADR 30,800(a) 1,085,700
Equant ADR 30,700(a) 2,081,844
Intentia International AB 17,300(a) 586,944
Ixos Software AG 3,900(a) 878,102
Merkantildata ASA 73,200 720,589
New Dimension Software Ltd. 12,000(a) 577,500
7,826,743
Computer & Office Equipment (2.22%)
Orbotech Ltd. ADR 39,000(a) 1,847,625
Drugs (1.46%)
Fabrica Espanola de Productos 75,160 1,220,032
Electric Services (3.32%)
Independent Energy Holdings ADR 132,700(a) 1,194,300
Vestas Wind Systems 29,400(a) 1,575,244
2,769,544
Electrical Industrial Apparatus (0.35%)
Doncasters PLC ADR 18,200(a) 294,613
Electrical Work (1.92%)
Internatio-Muller NV 6,600 163,535
Telesystem International Wireless,
Inc. 114,900(a) 1,440,046
1,603,581
Electronic Components &
Accessories (2.65%)
Celestica, Inc. 43,000(a) 1,061,563
Elec & Eltek International ADR 212,000 1,144,800
2,206,363
Electronic Distribution
Equipment (4.26%)
C/TAC NV 43,500(a) 897,043
Jot Automation Group OYJ 20,600(a) 858,454
PMG Automec Corp. OYJ 13,500(a) 309,285
Techtronic Industries Co. 3,494,000 622,374
Vtech Holdings Ltd. 198,000 863,836
3,550,992
Fabricated Rubber
Products, NEC (0.91%)
Semperit AG Holding 6,900 758,272
Grocery Stores (1.00%)
Superdiplo SA 29,500(a) 831,755
Hose, Belting, Gaskets &
Packing (1.59%)
Phoenix AG 70,200 1,327,690
Hotels & Motels (0.68%)
Choice Hotels Scandinavia 400,700(a) $ 562,754
Household Furniture (0.60%)
Ekornes ASA 62,000 496,406
Hunting, Trapping & Game
Propagation (1.59%)
Rapala Normark Corp. 152,500(a) 1,325,226
Investment Offices (0.86%)
Tyndall Australia Ltd. 466,729 715,682
Life Insurance (1.11%)
Scor SA 14,000 926,064
Measuring & Controlling
Devices (0.70%)
Sensonor ASA 223,400(a) 586,447
Meat Products (0.90%)
Perkins Foods PLC 323,600 748,384
Medical Instruments & Supplies (0.92%)
Cochlear Ltd. 136,000 767,436
Medical & Dental Laboratories (0.55%)
Qiagen NV 7,100(a) 459,543
Metalworking Machinery (1.73%)
Mikron Holding AG 7,200 1,438,970
Miscellaneous Amusement, Recreation
Service (2.04%)
Aristocrat Leisure Ltd. 54,273 229,693
Tab Ltd. 738,300(a) 1,467,214
1,696,907
Miscellaneous Business Services (0.40%)
Enator AB 12,000 333,105
Miscellaneous Electrical Equipment &
Supplies (2.18%)
Kaba Holding AG, Class B 3,700 1,818,371
Miscellaneous Food & Kindred
Products (1.46%)
Greencore Group PLC 269,000 1,217,369
Miscellaneous Manufacturers (0.87%)
Docdata NV 71,100(a) 727,417
Miscellaneous Non-Durable
Goods (2.23%)
Austria Tabakwerke AG 24,200 1,856,605
Miscellaneous Plastics Products (1.28%)
Airspray NV 37,800(a) 1,067,531
Miscellaneous Primary Metal
Products (0.00%)
YBM Magnex International, Inc. 107,000(a) 697
Miscellaneous Transportation (0.34%)
ASG AB, Class B 15,100 285,959
Motor Vehicles & Equipment (0.99%)
E.C.I.A. Equipment & Composants 3,323 $ 445,565
Mayflower Corp. PLC 176,000 380,677
826,242
Newspapers (1.50%)
Newsquest PLC 306,000(b) 1,247,350
Non-Classifiable Establishments (1.46%)
Bure Investment Aktiebolaget AB 85,800(b) 1,217,315
Non-Residential Building
Construction (1.00%)
Algeco 9,400 836,340
Oil & Gas Field Services (3.51%)
Cie Generale de Geophysique 2,800(a) 163,258
Cie Generale de Geophysique ADR 22,000(a) 239,250
Det Sondenfjelds-Norske
Dampskibsselskab 49,200(a) 387,464
Fortum Corp. 214,400(a) 1,439,697
Hydralift ASA, A Shares 75,000 334,700
Hydralift ASA, B Shares 15,000 55,127
Petrolia Drilling ASA 260,000(a) 303,724
2,923,220
Personnel Supply Services (2.80%)
Dis Deutshcer Industries Service AG 9,000 421,489
Unique International NV 83,400 1,910,941
2,332,430
Pulp Mills (2.46%)
Lassila & Tikanoja Ltd. OY 46,200 1,140,563
Miquel Y Costas 26,700 904,502
2,045,065
Real Estate Agents &
Managers (1.46%)
Tornet Fastighet 83,000 1,213,429
Sanitary Services (1.83%)
De Sammensluttede Vognmand AS 17,300 1,522,230
Security Brokers & Dealers (4.12%)
AOT NV 101,400 1,242,735
Kempen & Co. NV 27,520 1,463,497
Van Der Moolen Holdings 11,312 729,352
3,435,584
Services To Buildings (0.54%)
Spotless Group Ltd. 195,000 450,912
Special Industry Machinery (1.26%)
Aixtron 5,700 1,048,949
Telephone Communication (9.39%)
AAPT Ltd. 501,700(a) 1,292,435
Esat Telecom Group PLC ADR 47,700(a) 1,836,450
Esprit Telecom Group PLC ADR 27,800(a) 1,299,650
Metronet Communications ADR,
Class B 101,300(a) 3,393,550
7,822,085
Trusts (1.11%)
NHP PLC 366,666 $ 921,189
Total Common Stocks 82,563,606
Principal
Amount Value
Commercial Paper (0.79%)
Business Credit Institutions (0.79%)
General Electric Capital Corp.;
5.25%; 1/4/1999 $655,000 $ 654,713
Total Portfolio Investments (99.87%) 83,218,319
Cash and receivables, net of liabilities (0.13%) 111,538
Total Net Assets (100.00%) $83,329,857
(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 $7,141,257 8.58%
Austria 2,614,877 3.14
Belgium 654,400 0.79
Canada 7,476,791 8.98
Denmark 3,097,474 3.72
Finland 5,073,225 6.10
France 2,610,476 3.14
Germany 4,567,241 5.49
Hong Kong 1,486,211 1.79
Ireland 3,414,400 4.10
Israel 2,811,000 3.38
Italy 614,813 0.74
Netherlands 10,743,438 12.91
New Zealand 1,681,259 2.02
Norway 4,436,758 5.33
Singapore 1,144,800 1.37
Spain 4,225,104 5.08
Sweden 4,954,663 5.95
Switzerland 3,257,342 3.91
United Kingdom 10,558,077 12.69
United States 654,713 0.79
Total $83,218,319 100.00%
Mortgage-Backed Securities Portfolio
Description of Issue Principal
Type Rate Maturity Amount Value
Federal National Mortgage Association (FNMA)
Certificates (26.55%)
FNMA 6.25% 4/1/2026 $ 315,547 $ 315,358
FNMA 6.50 12/1/2028 500,000 503,442
FNMA 7.00 8/1/2023 2,488,184 2,540,759
FNMA 7.50 6/1/2023 570,324 586,127
Total FNMA Certificates 3,945,686
Government National Mortgage Association (GNMA)
Certificates (60.25%)
GNMA I 6.50 12/15/2023-1/15/2029 3,169,178 3,201,502
GNMA I 7.00 4/15/2028 356,637 364,887
GNMA I 7.50 6/15/2023-3/15/2027 995,895 1,026,756
GNMA II 5.50 3/20/2026 178,423 172,016
GNMA II 6.00 9/20/2023-5/20/2028 3,911,305 3,857,524
GNMA II 6.50 10/20/2025 329,157 330,712
Total GNMA Certificates 8,953,397
Federal Home Loan Mortgage Corporation
(FHLMC) Certificates (12.08%)
FHLMC 5.50 2/15/2024-3/1/2024 567,889 549,966
FHLMC 6.00 4/1/2024 101,547 100,433
FHLMC 6.50 12/1/2013-12/1/2027 1,132,414 1,144,001
Total FHLMC Certificates 1,794,400
Federal Agency Short-Term Obligations (3.70%)
Investment in Joint Trade Account;
Federal Home Loan Bank System;
4.30%; 1/4/1999 550,340 550,143
Total Portfolio Investments (102.58%) 15,243,626
Liabilities, net of cash, receivables and
other assets (-2.58%) (383,084)
Total Net Assets (100.00%) $14,860,542
FINANCIAL HIGHLIGHTS
Selected data for a share of Capital Stock outstanding throughout each year
ended December 31 (except as noted):
PRINCIPAL SPECIAL MARKETS FUND, INC.
INTERNATIONAL EMERGING
MARKETS PORTFOLIO 1998 1997(a)
-----------------------------------------------------------
Net Asset Value, Beginning of Period................... $10.14 $9.94
Income from Investment Operations:
Net Investment Income............................... .17 .01
Net Realized and Unrealized Gain (Loss) on Investments (1.91) .21
Total from Investment Operations (1.74) .22
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.17) (.02)
Distributions from Capital Gains.................... (.02) --
Total Dividends and Distributions (.19) (.02)
Net Asset Value, End of Period......................... $8.21 $10.14
Total Return........................................... (17.21)% 1.40%(b)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $79,481 $32,488
Ratio of Expenses to Average Net Assets............. 1.15% 1.15%(c)
Ratio of Net Investment Income to Average Net Assets 2.11% .91%(c)
Portfolio Turnover Rate............................. 36.5% 12.3%(c)
<TABLE>
<CAPTION>
INTERNATIONAL SECURITIES PORTFOLIO 1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $14.45 $13.67 $11.70 $11.29 $12.87
Income from Investment Operations:
Net Investment Income............................... .24 .24 .31 .19 .13
Net Realized and Unrealized Gain (Loss) on Investments 1.12 1.46 2.46 1.11 (.95)
Total from Investment Operations 1.36 1.70 2.77 1.30 (.82)
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.23) (.24) (.16) (.10) (.12)
Excess Distributions from Net Investment Income..... -- -- (.07) (.07) (.13)
Distributions from Capital Gains.................... (.68) (.68) (.57) (.72) (.51)
Total Dividends and Distributions (.91) (.92) (.80) (.89) (.76)
Net Asset Value, End of Period......................... $14.90 $14.45 $13.67 $11.70 $11.29
Total Return........................................... 9.55% 12.55% 24.12% 12.02% (6.45%)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $47,912 $37,684 $28,161 $17,251 $15,542
Ratio of Expenses to Average Net Assets............. .90% .90% .90% .90% .90%
Ratio of Net Investment Income to Average Net Assets 1.60% 1.73% 1.90% 1.79% .94%
Portfolio Turnover Rate............................. 36.7% 30.8% 25.5% 46.0% 37.0%
</TABLE>
Selected data for a share of Capital Stock outstanding throughout each year
ended December 31 (except as noted):
INTERNATIONAL SMALLCAP PORTFOLIO 1998 1997(a)
--------------------------------------------
Net Asset Value, Beginning of Period................... $9.97 $9.86
Income from Investment Operations:
Net Investment Income............................... .07 .01
Net Realized and Unrealized Gain (Loss) on Investments 1.11 .12
Total from Investment Operations 1.18 .13
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.07) (.02)
Distributions from Capital Gains.................... (.02) --
Total Dividends and Distributions (.09) (.02)
Net Asset Value, End of Period......................... $11.06 $9.97
Total Return........................................... 11.92% 1.59%(b)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $83,330 $31,968
Ratio of Expenses to Average Net Assets............. 1.00% 1.00%(c)
Ratio of Net Investment Income to Average Net Assets .78% .91%(c)
Portfolio Turnover Rate............................. 88.5% 30.3%(c)
<TABLE>
<CAPTION>
MORTGAGE-BACKED SECURITIES PORTFOLIO 1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $10.27 $9.93 $10.17 $9.11 $10.10
Income from Investment Operations:
Net Investment Income............................... .65 .64 .64 .65 .63
Net Realized and Unrealized Gain (Loss) on Investments .12 .34 (.24) 1.06 (.99)
Total from Investment Operations .77 .98 .40 1.71 (.36)
Less Dividends from Net Investment Income.............. (.65) (.64) (.64) (.65) (.63)
Net Asset Value, End of Period......................... $10.39 $10.27 $9.93 $10.17 $9.11
Total Return........................................... 7.74% 10.18% 4.20% 19.26% (3.60)%
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $14,861 $13,796 $14,968 $14,253 $14,714
Ratio of Expenses to Average Net Assets............. .45% .45% .45% .45% .45%
Ratio of Net Investment Income to Average Net Assets 6.28% 6.37% 6.51% 6.66% 6.56%
Portfolio Turnover Rate................................ 13.8% 15.5% 28.7% 41.8% 41.8%
</TABLE>
Notes to Financial Highlights
(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 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.
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. (comprised
of the International Emerging Markets, International Securities, International
SmallCap and Mortgage-Backed Securities Portfolios) as of December 31, 1998, 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, 1998, by correspondence with the custodians
and brokers. As to securities relating to uncompleted transactions, we performed
other audit procedures. 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, 1998, 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.
Ernst & Young LLP
Des Moines, Iowa
January 22, 1999
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, 1998
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
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
International 2/6/98 $.0072 00.00% 2/6/98 $.0194
Emerging Markets 12/24/98 .1599 00.00%
Portfolio $.1671 $.0194 $.1865
International 2/6/98 $.1027 $.0018
Securities 12/24/98 $.2268 00.00% 12/24/98 .5783 .0000
Portfolio $.2268 $.6828 $.9096
International 2/6/98 $.0015 00.00% 2/6/98 $.0189
SmallCap 12/24/98 .0727 00.00%
Portfolio $.0742 $.0189 $.0931
</TABLE>
<TABLE>
<CAPTION>
Per Share Income Dividend Distributions/Payable Date
1/30/98 2/27/98 3/31/98 4/30/98 5/29/98 6/30/98 7/31/98 8/31/98 9/30/98 10/30/98 11/30/98 12/31/98
Mortgage-Backed
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities Portfolio $.0537 $.0529 $.0531 $.0548 $.0533 $.0533 $.0585 $.0507 $.0538 $.0549 $.0515 $.0674
</TABLE>
* Percent qualifying for deduction by shareholders who are corporations.
** Taxable as long-term capital gain.
***Taxable at ordinary income rates.
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-31-1998
<PERIOD-END> DEC-31-1998
<INVESTMENTS-AT-COST> 41,928,912
<INVESTMENTS-AT-VALUE> 47,843,896
<RECEIVABLES> 89,263
<ASSETS-OTHER> 109
<OTHER-ITEMS-ASSETS> 46,337
<TOTAL-ASSETS> 47,979,605
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 67,446
<TOTAL-LIABILITIES> 67,446
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 40,898,040
<SHARES-COMMON-STOCK> 3,215,199
<SHARES-COMMON-PRIOR> 2,608,123
<ACCUMULATED-NII-CURRENT> 33,810
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 1,095,871
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 5,884,438
<NET-ASSETS> 47,912,159
<DIVIDEND-INCOME> 996,883
<INTEREST-INCOME> 153,277
<OTHER-INCOME> 0
<EXPENSES-NET> (413,285)
<NET-INVESTMENT-INCOME> 736,875
<REALIZED-GAINS-CURRENT> 2,888,566
<APPREC-INCREASE-CURRENT> (55,341)
<NET-CHANGE-FROM-OPS> 3,570,100
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (703,066)
<DISTRIBUTIONS-OF-GAINS> (2,066,333)
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 521,541
<NUMBER-OF-SHARES-REDEEMED> (41,219)
<SHARES-REINVESTED> 126,754
<NET-CHANGE-IN-ASSETS> 10,228,148
<ACCUMULATED-NII-PRIOR> 25,569
<ACCUMULATED-GAINS-PRIOR> 249,173
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 413,285
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 413,285
<AVERAGE-NET-ASSETS> 46,078,425
<PER-SHARE-NAV-BEGIN> 14.45
<PER-SHARE-NII> .24
<PER-SHARE-GAIN-APPREC> 1.12
<PER-SHARE-DIVIDEND> (.23)
<PER-SHARE-DISTRIBUTIONS> (.68)
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 14.90
<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-31-1998
<PERIOD-END> DEC-31-1998
<INVESTMENTS-AT-COST> 84,301,092
<INVESTMENTS-AT-VALUE> 83,218,319
<RECEIVABLES> 169,662
<ASSETS-OTHER> 0
<OTHER-ITEMS-ASSETS> 199,711
<TOTAL-ASSETS> 83,587,692
<PAYABLE-FOR-SECURITIES> 191,083
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 66,752
<TOTAL-LIABILITIES> 257,835
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 82,683,976
<SHARES-COMMON-STOCK> 7,533,783
<SHARES-COMMON-PRIOR> 3,205,478
<ACCUMULATED-NII-CURRENT> 24,067
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 1,701,706
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (1,079,892)
<NET-ASSETS> 83,329,857
<DIVIDEND-INCOME> 1,021,063
<INTEREST-INCOME> 278,613
<OTHER-INCOME> 0
<EXPENSES-NET> (731,367)
<NET-INVESTMENT-INCOME> 568,309
<REALIZED-GAINS-CURRENT> 1,705,268
<APPREC-INCREASE-CURRENT> (935,478)
<NET-CHANGE-FROM-OPS> 1,338,099
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (548,766)
<DISTRIBUTIONS-OF-GAINS> (60,583)
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 4,270,347
<NUMBER-OF-SHARES-REDEEMED> 0
<SHARES-REINVESTED> 57,958
<NET-CHANGE-IN-ASSETS> 51,362,196
<ACCUMULATED-NII-PRIOR> 4,410
<ACCUMULATED-GAINS-PRIOR> 57,135
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 731,367
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 731,367
<AVERAGE-NET-ASSETS> 73,477,206
<PER-SHARE-NAV-BEGIN> 9.97
<PER-SHARE-NII> .07
<PER-SHARE-GAIN-APPREC> 1.11
<PER-SHARE-DIVIDEND> (.07)
<PER-SHARE-DISTRIBUTIONS> (.02)
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 11.06
<EXPENSE-RATIO> 1.00
<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-31-1998
<PERIOD-END> DEC-31-1998
<INVESTMENTS-AT-COST> 92,740,587
<INVESTMENTS-AT-VALUE> 79,789,603
<RECEIVABLES> 176,693
<ASSETS-OTHER> 0
<OTHER-ITEMS-ASSETS> 67,146
<TOTAL-ASSETS> 80,033,442
<PAYABLE-FOR-SECURITIES> 352,853
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 200,079
<TOTAL-LIABILITIES> 552,932
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 98,425,352
<SHARES-COMMON-STOCK> 9,683,451
<SHARES-COMMON-PRIOR> 3,204,730
<ACCUMULATED-NII-CURRENT> 40,240
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (5,911,305)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (13,073,777)
<NET-ASSETS> 79,480,510
<DIVIDEND-INCOME> 2,078,795
<INTEREST-INCOME> 351,296
<OTHER-INCOME> 0
<EXPENSES-NET> (856,612)
<NET-INVESTMENT-INCOME> 1,573,479
<REALIZED-GAINS-CURRENT> (5,911,305)
<APPREC-INCREASE-CURRENT> (13,427,192)
<NET-CHANGE-FROM-OPS> (17,765,018)
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (1,546,178)
<DISTRIBUTIONS-OF-GAINS> (62,172)
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 6,311,934
<NUMBER-OF-SHARES-REDEEMED> 0
<SHARES-REINVESTED> 166,787
<NET-CHANGE-IN-ASSETS> 46,992,464
<ACCUMULATED-NII-PRIOR> 16,970
<ACCUMULATED-GAINS-PRIOR> 58,141
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 856,612
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 856,612
<AVERAGE-NET-ASSETS> 74,804,632
<PER-SHARE-NAV-BEGIN> 10.14
<PER-SHARE-NII> .17
<PER-SHARE-GAIN-APPREC> (1.91)
<PER-SHARE-DIVIDEND> (.17)
<PER-SHARE-DISTRIBUTIONS> (.02)
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 8.21
<EXPENSE-RATIO> 1.15
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<INVESTMENTS-AT-COST> 14,771,415
<INVESTMENTS-AT-VALUE> 15,243,626
<RECEIVABLES> 76,595
<ASSETS-OTHER> 127
<OTHER-ITEMS-ASSETS> 50,293
<TOTAL-ASSETS> 15,370,641
<PAYABLE-FOR-SECURITIES> 504,453
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 5,646
<TOTAL-LIABILITIES> 510,099
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 15,464,346
<SHARES-COMMON-STOCK> 1,429,826
<SHARES-COMMON-PRIOR> 1,343,286
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (1,076,015)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 472,211
<NET-ASSETS> 14,860,542
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 960,039
<OTHER-INCOME> 0
<EXPENSES-NET> (64,195)
<NET-INVESTMENT-INCOME> 895,844
<REALIZED-GAINS-CURRENT> 2,046
<APPREC-INCREASE-CURRENT> 167,122
<NET-CHANGE-FROM-OPS> 1,065,012
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (895,844)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 0
<NUMBER-OF-SHARES-REDEEMED> 0
<SHARES-REINVESTED> 86,540
<NET-CHANGE-IN-ASSETS> 1,065,012
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (1,078,061)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 64,195
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 64,195
<AVERAGE-NET-ASSETS> 14,307,727
<PER-SHARE-NAV-BEGIN> 10.27
<PER-SHARE-NII> .65
<PER-SHARE-GAIN-APPREC> .12
<PER-SHARE-DIVIDEND> (.65)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 10.39
<EXPENSE-RATIO> .45
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
