As filed with the Securities and Exchange Commission on November 21, 2001
Securities Act Registration No. 333-
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM N-14
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[_] Pre-Effective Amendment No. _____[_] Post-Effective Amendment No. _____
(Check appropriate box or boxes)
FRANKLIN TEMPLETON VARIABLE INSURANCE PRODUCTS TRUST
(Exact Name of Registrant as Specified in Charter)
1 (800) 321-8563
(Registrant's Area Code and Telephone Number)
One Franklin Parkway, San Mateo, CA 94403-1906
(Address of Principal Executive Offices: Number, Street, City, State, Zip Code)
Karen L. Skidmore, Assistant Secretary
(650) 312-5651
One Franklin Parkway, San Mateo, CA 94403-1906
(Name and Address of Agent for Service, Number, Street, City, State, Zip Code)
Approximate date of proposed public offering: As soon as practicable after this
registration statement becomes effective under the Securities Act of 1933, as
amended.
Calculation of Registration Fee under the Securities Act of 1933:
TITLE OF SECURITIES BEING REGISTERED
Shares of Beneficial Interest, Par Value $0.01 Per Share
Templeton International Securities Fund - Class 1
Templeton International Securities Fund - Class 2
No filing fee is due because an indefinite number of shares is deemed to have
been registered in reliance on Section 24(f) of the Investment Company Act of
1940.
It is proposed that this filing will become effective December 21, 2001,
pursuant to Rule 488.
FRANKLIN TEMPLETON VARIABLE INSURANCE PRODUCTS TRUST
CROSS REFERENCE SHEET
Items Required by Form N-14
Part A
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Item No. Form N-14 Item Caption Prospectus Caption
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1. Beginning of Registration Statement and Cover Page of Registration Statement; Cross
Outside Front Cover Page of Prospectus Reference Sheet; Front Cover Page of Prospectus
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2. Beginning and Outside Back Cover Page of Table of Contents
Prospectus
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3. Fee Table, Synopsis Information and Risk Summary; Some Important Information About The
Factors Funds
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4. Information About the Transaction Information About the Transaction
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5. Information About the Registrant Incorporation of Documents By Reference in the
Prospectus; Exhibit B; Exhibit C
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6. Information About the Company Being Acquired Incorporation of Documents By Reference in the
Prospectus; Exhibit D; Exhibit E
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7. Voting Information Voting Information
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8. Interest of Certain Persons and Experts Not Applicable
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9. Additional Information Required for Not Applicable
Reoffering by Persons Deemed to be
Underwriters
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Part B
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Item No.
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10. Cover Page Cover Page of Statement of Additional
Information
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11. Table of Contents Table of Contents of Statement of Additional
Information
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12. Additional Information About the Registrant Statement of Additional Information of
Franklin Templeton Variable Insurance Products
Trust, dated May 1, 2001
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Item No. Form N-14 Item Caption Prospectus Caption
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13. Additional Information About the Company Statement of Additional Information of
Being Acquired Franklin Templeton Variable Insurance Products
Trust, dated May 1, 2001
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14. Financial Statements Financial Statements as Noted in the Statement
of Additional Information
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Part C
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Item No.
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15. Indemnification Indemnification
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16. Exhibits Exhibits
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17. Undertakings Undertakings
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[logo]
FRANKLIN TEMPLETON VARIABLE INSURANCE PRODUCTS TRUST
January 16, 2002
The Board of Trustees of Franklin Templeton Variable Insurance Products
Trust (the Trust) has called a special meeting of shareholders (the Meeting) for
February 26, 2002, at which shareholders of Templeton International Smaller
Companies Fund (International Smaller Companies) will be asked to vote on a Plan
of Reorganization (Plan) which provides for a transaction (Transaction) in which
the assets of International Smaller Companies are to be acquired by, and in
exchange for, shares of Templeton International Securities Fund (International
Securities), another fund in the Trust. As a contract owner, you will receive a
voting instructions card for International Smaller Companies.
The Trustees of your Fund recommend that you vote in favor of this
--------
proposal.
On the following pages, you will find a notice of the Meeting, a brief
overview of the Plan and a complete Prospectus and Proxy Statement, which
discusses the Transaction. There will be no change in the value of your contract
as a result of the Transaction. After the Transaction, your contract value will
depend on the performance of International Securities instead of that of
International Smaller Companies. We request that you review the enclosed
materials and return the completed voting instruction card in the enclosed
postage-paid envelope as soon as you can.
We appreciate your taking the time to respond on this important matter.
Sincerely,
Charles E. Johnson
President
PROSPECTUS AND PROXY STATEMENT
Dated January 16, 2002
Acquisition of the Assets of
TEMPLETON INTERNATIONAL SMALLER COMPANIES FUND
By and in Exchange for Shares of
TEMPLETON INTERNATIONAL SECURITIES FUND
(Both funds (Funds) are series of Franklin Templeton Variable Insurance
Products Trust, an open-end management investment company.)
One Franklin Parkway
San Mateo, California 94403-1906
1 (800) 342-3863
This Prospectus and Proxy Statement is being furnished in connection with a
solicitation of proxies by the Board of Trustees of Franklin Templeton Variable
Insurance Products Trust (the Trust), on behalf of its series Templeton
International Smaller Companies Fund (International Smaller Companies), for use
at a special meeting of the shareholders (Meeting) of International Smaller
Companies, which is scheduled for 10:00 a.m. Pacific time on February 26, 2002,
at the offices of the Trust at One Franklin Parkway, San Mateo, California
94403-1906, and any adjournments of the Meeting.
At the Meeting, shareholders of International Smaller Companies will be
asked to consider and approve or disapprove a Plan of Reorganization (Plan). If
the Plan is approved, the assets of International Smaller Companies will be
acquired by, and in exchange for, shares of Templeton International Securities
Fund (International Securities), another series of the Trust, and International
Smaller Companies will be dissolved.
If shareholders of International Smaller Companies vote to approve the
Plan, the separate accounts of your insurance company invested in International
Smaller Companies will receive either Class 1 or Class 2 shares of International
Securities. The separate accounts holding Class 1 shares of International
Smaller Companies will receive Class 1 shares of International Securities. The
separate accounts holding Class 2 shares of International Smaller Companies will
receive Class 2 shares of International Securities. The exchange of shares will
be made at the Funds' respective net asset values.
As an owner of a variable annuity or variable life insurance contract
(contract) issued by an insurance company, you have the right to instruct the
insurance company how to vote certain shares of International Smaller Companies
at the Meeting. Although you are not directly a shareholder of International
Smaller Companies, some of your contract value is invested by your insurance
company, as provided by your contract, in International Smaller Companies. You
have the right under your contract to instruct the insurance company how to vote
the shares attributable to your contract. For the limited purpose of this
prospectus and proxy statement, the term "shareholder" refers to you as a
contract owner, unless the context otherwise requires. As a contract owner, you
should complete and return the enclosed voting instruction card in the enclosed
envelope.
This Prospectus and Proxy Statement sets forth concisely the
information you should know before voting on the Plan. You should read it
carefully and retain it for future reference. Additional information about
International Smaller Companies and International Securities has been filed with
the Securities and Exchange Commission (SEC) and can be found in the following
documents:
. The Prospectuses of International Securities - Classes 1 and 2, dated
May 1, 2001, are enclosed with and considered a part of this Prospectus
and Proxy Statement.
. The Prospectuses of International Smaller Companies - Classes 1 and 2,
dated May 1, 2001, are enclosed with and considered a part of this
Prospectus and Proxy Statement.
. The Annual Report to Shareholders of International Securities, dated
December 31, 2000, is enclosed with and considered a part of this
Prospectus and Proxy Statement.
. The Semi-Annual Report to Shareholders of International Securities,
dated June 30, 2001, is enclosed with and considered a part of this
Prospectus and Proxy Statement.
. A Statement of Additional Information (SAI) dated January 16, 2002,
relating to this Prospectus and Proxy Statement has been filed with the
SEC and is incorporated by reference into this Prospectus and Proxy
Statement.
You may request a free copy of the SAI and other information by calling
1 (800) 342-3863 or by writing to International Securities at One Franklin
Parkway, San Mateo, California 94403-1906. The Trust files reports, proxy
materials and other information with the SEC. You can inspect those reports,
proxy materials and other information at the public reference facilities
maintained by the SEC at 450 Fifth Street N.W., Washington D. C. 20549. Copies
of such materials may also be obtained from the Public Reference Branch, Office
of Consumer Affairs and Information Services, Securities and Exchange
Commission, 450 Fifth Street, Washington D.C. 20549, at prescribed rates, or at
no charge from the EDGAR database on the SEC's Web site at www.sec.gov.
-----------
The SEC has not approved or disapproved these securities or passed upon
the adequacy of this Prospectus and Proxy Statement. Any representation to the
contrary is a criminal offense.
Mutual fund shares are not deposits or obligations of, or guaranteed by
or endorsed by, any bank, and are not federally insured by the Federal Deposit
Insurance Corporation, the Federal Reserve Board, or any other U.S. government
agency. Mutual fund shares involve investment risks, including the possible loss
of principal.
TABLE OF CONTENTS
PAGE
OUTSIDE FRONT COVER .................................................................................... Cover
TABLE OF CONTENTS ...................................................................................... i
SUMMARY
What will happen if shareholders approve the Plan and it
becomes effective? ................................................................... 1
Why has the Board of Trustees of the Trust decided to recommend
the acquisition of International Smaller Companies by
International Securities? ............................................................
How have the Funds performed in relation to each other? .......................................
What are the potential benefits of the Plan? ..................................................
Who will pay the fees and expenses incurred by the Funds in
connection with the Plan? ............................................................
What are the investment goals, strategies and procedures of the Funds? ........................
How have the expense ratios of the Funds compared? ............................................
What might be the size of International Securities after the Transaction? .....................
What are the likely federal tax implications? .................................................
Has the Board approved the Plan? ..............................................................
VOTING INFORMATION
Why is the Meeting being called? ..............................................................
Who is eligible to vote? ......................................................................
Why am I giving voting instructions? ..........................................................
How are proxies being solicited? ..............................................................
Can I revoke my voting instructions? ..........................................................
SOME IMPORTANT INFORMATION ABOUT THE FUNDS
What are the risks of an investment in the Funds? .............................................
How do the performance records of International Securities and
International Smaller Companies compare? .............................................
Who manages the Funds? ........................................................................
What service providers do the Funds use? ......................................................
How are shares bought and sold? ...............................................................
When are dividends and distributions made? ....................................................
How do the investment goals and strategies of the Funds compare? ..............................
How do the fundamental investment restrictions of the
Funds compare? .......................................................................
What distribution and service fees do the Funds have? .........................................
What are the fees and expenses of the Funds and what might
they be after the transaction? ................................................................
INFORMATION ABOUT THE TRANSACTION
What are the terms of the Plan? ...............................................................
Who will pay the expenses of the Transaction? .................................................
What are the reasons for recommending the Plan? ...............................................
What are the federal tax consequences of the Transaction? .....................................
What other things should I know about the shares of International
Securities? ...................................................................................
What is the capitalization of each Fund and what might the
capitalization of International Securities be after the Transaction? ..........................
ANNUAL MEETINGS AND SPECIAL MEETINGS
OTHER BUSINESS .........................................................................................
PRINCIPAL SHAREHOLDERS .................................................................................
EXHIBITS TO PROSPECTUS AND PROXY STATEMENT
Exhibit A Franklin Templeton Variable Insurance Products Trust
Plan of Reorganization of Templeton International Smaller
Companies Fund and Templeton International Securities
Fund
Exhibit B Prospectus of Templeton International Securities Fund
-Class 1, dated May 1, 2001.
Exhibit C Prospectus of Templeton International Securities Fund
-Class 2, dated May 1, 2001.
Exhibit D Prospectus of Templeton International Smaller Companies
Fund -Class 1, dated May 1, 2001.
Exhibit E Prospectus of Templeton International Smaller Companies
Fund -Class 2, dated May 1, 2001.
Exhibit F Annual Report to Shareholders of Templeton International
Securities Fund, dated December 31, 2000.
Exhibit G Semi-Annual Report to Shareholders of Templeton
International Securities Fund, dated June 30, 2001.
SUMMARY
IMPORTANT INFORMATION TO HELP YOU
UNDERSTAND AND VOTE ON THE PROPOSAL
Please read the complete Prospectus and Proxy Statement, and its Exhibits,
which include the Plan, important prospectuses and reports to shareholders. This
brief overview of the Plan is provided for your convenience and is qualified in
its entirety by reference to the complete Prospectus and Proxy Statement.
What will happen if shareholders approve the Plan and it becomes effective?
At the effective time, which is scheduled for the close of business on the
New York Stock Exchange on April 30, 2002, (Effective Time) a transaction will
occur (Transaction) in which International Securities will acquire all the
assets and assume all the liabilities of International Smaller Companies and
will issue to International Smaller Companies shares having a value equal to the
net assets acquired. Immediately thereafter, International Smaller Companies
will distribute those shares to its shareholders and thereby redeem all its
outstanding shares, and then it will be dissolved. Shareholders will receive
shares of International Securities equal in aggregate value to the shares of
International Smaller Companies which they own at the Effective Time. The
Transaction will not dilute the value of the shares.
Why has the Board of Trustees of the Trust decided to recommend the acquisition
of International Smaller Companies by International Securities?
The Board of Trustees of the Trust (Board) reviewed the potential benefits
and costs of the Transaction to shareholders of International Smaller Companies
and International Securities; the expense ratios of International Smaller
Companies and International Securities; the comparative investment performance
of International Smaller Companies and International Securities; the
compatibility of the investment goals, strategies, and restrictions of
International Securities with those of International Smaller Companies; and the
likely tax consequences of the Transaction.
The Board considered that shareholders of both Funds, but primarily those
of International Smaller Companies, potentially could be advantaged by the
growth in assets realized by combining the Funds. A larger fund should have an
enhanced ability to effect portfolio transactions on more favorable terms and
should have greater investment flexibility. Higher aggregate net assets and the
opportunity for net cash inflows also may reduce the risk that, if the net
assets of International Smaller Companies fail to grow, or diminish, its total
expense ratio could rise as certain fixed expenses become a larger percentage of
net assets. Shareholders of International Smaller Companies are projected to
achieve a lower expense ratio after the Transaction.
How have the Funds performed in relation to each other?
For the one year period, International Smaller Companies has
outperformed International Securities. However, International Securities has
outperformed International Smaller Companies significantly over a five year
period. Moreover, International Securities has a longer-term record of
performance than International Smaller Companies.
What are the potential benefits of the Plan?
Because International Securities is substantially larger than International
Smaller Companies, shareholders should potentially benefit from certain
operational economies of scale by spreading fixed costs over a larger pool of
assets and by efficiencies in portfolio management. In addition, there should be
benefits to shareholders in the management of the portfolio as the substantially
larger assets may also afford greater flexibility and diversification in
pursuing the Fund's investment objectives. Also, International Securities has
had a lower expense ratio than International Smaller Companies.
Who will pay the fees and expenses incurred by the Funds in connection with the
Plan?
Fees and expenses incurred in connection with the Transaction will be
divided equally between International Smaller Companies and its principal
underwriter, Franklin Templeton Distributors, Inc. It is not expected that
International Securities will incur any significant expenses in connection with
the Transaction.
What are the investment goals, strategies and procedures of the Funds?
International Smaller Companies and International Securities have the same
investment objective, which is to provide investors with long-term capital
appreciation. (In their current prospectuses, the investment objective of
International Smaller Companies is stated as long-term capital appreciation,
while the investment objective of International Securities is stated as
long-term capital growth.)
International Smaller Companies seeks to achieve its investment goal by
normally investing at least 65% of its assets in equity securities of smaller
companies located outside the U.S., including those in emerging markets.
International Securities seeks to achieve its investment goal by normally
investing at least 65% in equity securities of companies located outside the
U.S., including those in emerging markets. Because of new SEC regulations that
affect all mutual funds, International Securities is expected to increase this
"65%" investment policy to "80%" as of May 1, 2002.
The Funds also have the same distribution, purchase and redemption
procedures, the same dividend payment and reinvestment procedures and the same
exchange rights.
How have the expense ratios of the Funds compared?
International Securities has had a lower expense ratio than International
Smaller Companies. For the six month period ended June 30, 2001, the annualized
expense ratios
for International Securities were 0.97% for Class 1 shares and 1.22% for Class 2
shares, while the annualized expense ratios for International Smaller Companies
were 1.15% for Class 1 shares and 1.40% for Class 2 shares. Shareholders of
International Smaller Companies are projected to achieve a reduction in expense
ratio as a result of the Transaction.
What might be the size of International Securities after the Transaction?
As of November 13, 2001, International Smaller Companies had net assets of
$27 million, and International Securities had net assets of $796 million. The
net assets of International Smaller Companies represent less than 4% of the net
assets of International Securities, and the manager of the fund believes that
their transfer will permit them to be managed more efficiently and will not have
any adverse effect on International Securities.
What are the likely federal tax implications?
The Transaction contemplated by the Plan is not expected to qualify as a
tax-free "reorganization" under the Internal Revenue Code of 1986, as amended.
However, the Transaction will not proceed unless, prior to the Effective Time,
the Trust has received an opinion of tax counsel that (i) any gains recognized
by International Smaller Companies on the Transaction will be offset by a
deduction for dividends paid to its shareholders, and (ii) no gain or loss will
be recognized by any contract owner as a result of the Transaction.
The insurance companies that hold shares of International Smaller Companies
in one or more separate accounts with respect to variable life insurance or
annuity contracts that have shares of International Smaller Companies as an
underlying investment will not incur any tax on any dividends that may be paid
to them by International Smaller Companies as a result of the Transaction, and
will not impose any charges under any contract as a result of the Transaction.
Has the Board approved the Plan?
Yes. The Board has approved the Plan. The Board recommends that you vote in
favor of the Plan.
VOTING INFORMATION
Why is the Meeting being called?
This Prospectus and Proxy Statement is furnished to the shareholders of
International Smaller Companies in connection with the solicitation by the Board
of proxies to be used at the Meeting, to be held on February 26, 2002, and at
any adjournment thereof. The purpose of the Meeting is to obtain shareholder
approval of the Plan (attached as Exhibit A) which provides for the combination
of International Smaller Companies and International Securities, in a
transaction more fully described below. This
Prospectus and Proxy Statement is first being furnished to shareholders on or
about January 16, 2002.
At a meeting held on November 20 2001, the Board approved the Plan and
determined to recommend that shareholders of International Smaller Companies
vote FOR the Plan and the Transaction.
Shareholders of record of International Smaller Companies at the close of
business on December 28, 2001, the record date, are entitled to vote at the
Meeting. As of the record date, International Smaller Companies had
[_____________] shares outstanding and entitled to be voted. The approval of the
Plan requires the affirmative vote of a majority of all the votes outstanding
and entitled to be cast by shareholders of International Smaller Companies.
If a sufficient vote in favor of approving the Plan is not received by the
time scheduled for the Meeting, the persons named in the proxy may propose one
or more adjournments of the Meeting to permit further solicitation of proxies
with respect to the proposal. Any proposed adjournment requires the affirmative
vote of a majority of shares present at the Meeting.
Who is eligible to vote?
All shares will vote together as a single class. Currently, only separate
accounts of insurance companies are shareholders of record of the Class 1 and
Class 2 shares of International Smaller Companies. In order to complete the
Plan, the approval of shareholders of record of International Smaller Companies
as of the close of business on December 28, 2001 is required.
Each share is entitled to one vote. Shareholders may vote by executing a
proxy card. You will be able to give your insurance company voting instructions
for those shares attributable to your contract as of the record date for the
Meeting. A voting instruction card is, in essence, a ballot. While only
insurance companies are the shareholders of record of the Fund, these insurance
companies will vote in accordance with your instructions.
The vote of the shareholders of International Securities is not being
solicited, because their approval and consent is not necessary for the approval
of the Plan.
Why am I giving voting instructions?
If you complete and sign the voting instruction card, the shares
attributable to your contract will be voted as you instruct. If you simply sign
the voting instruction card without otherwise completing it, those shares will
be voted for the proposals. If you do not return a voting instruction card at
all, those shares will be voted in the same proportion as shares for which the
insurance company has received voting instructions from other contract owners.
How are proxies being solicited?
We will solicit proxies primarily by mail. Additional solicitations may be
made by telephone, facsimile or personal contact by officers or employees of the
Trust or Franklin Templeton Investments who will not be specially compensated
for these services. International Smaller Companies and Franklin Templeton
Distributors, Inc., the principal underwriter of the Funds, will share equally
in the costs of the Meeting, including costs of preparing and mailing this
notice, prospectus and proxy statement, and proxy, and of soliciting proxies.
Can I revoke my voting instructions?
You may revoke your voting instructions at any time before the proxy is
voted by: (i) delivering a written revocation to the Secretary of the Trust at
One Franklin Parkway, San Mateo, California 94403-1906 prior to the Meeting;
(ii) forwarding a later-dated voting instruction that is received by the Trust
prior to the Meeting; or (iii) being present at the Meeting and giving new
voting instructions in person.
SOME IMPORTANT INFORMATION ABOUT THE FUNDS
What are the risks of an investment in the Funds?
Investments in International Smaller Companies and International
Securities involve risks common to many mutual funds, including the risks of
investing in stocks. There is no guarantee against losses resulting from an
investment in either Fund, or that either Fund will achieve its investment
goals. Both Funds also have risks associated with investments in foreign
securities and emerging markets, including risks relating to currency exchange
rates, political and economic developments, trading practices, limited
availability of information and limited markets. Both funds also have risks
associated with investments in derivative securities.
International Securities also has risks associated with investing
assets in certain countries or sectors, including financial services, while
International Smaller Companies also has risks associated with smaller company
investments.
For a more complete discussion of the risks of investing in
International Smaller Companies and International Securities, please consult
their prospectuses, which are enclosed with and considered a part of this
Prospectus and Proxy Statement.
How do the performance records of International Securities and International
Smaller Companies compare?
For the one year period, International Smaller Companies has
outperformed International Securities. However, International Securities has
outperformed International Smaller Companies significantly over a five year
period. Moreover, International Securities has a longer-term record of
performance than International Smaller Companies. The performance of the Funds
as of September 30, 2001, is shown below:
Class 1 Comparative Performance
Average Annual Returns Cumulative Total Returns
(%) (%)
----------------------------------------------------------------------------------------
Fund Inception 1 Year 5 Years From Inception 1 Year 5 Years From
Date to 9.30.01 to 9.30.01 to 9.30.01 to 9.30.01 to 9.30.01 Inception
to 9.30.01
----------------------------------------------------------------------------------------
International 05.01.96 -16.30 -0.44 0.33 -16.30 -2.20 1.81
Smaller
Companies
International 05.01.92 -21.28 5.09 9.07 -21.28 28.20 126.51
Securities
Class 2 Comparative Performance
Average Annual Returns Cumulative Total Returns
(%) (%)
--------------------------------------------------------------------------------------
Fund Inception 1 Year 5 Years From Inception 1 Year 5 Years From
Date to 9.30.01 to 9.30.01 to 9.30.01 to 9.30.01 to 9.30.01 Inception to
9.30.01
--------------------------------------------------------------------------------------
International 05.01.96/1/ -16.53 -0.52 0.26 -16.53 -2.58 1.42
Smaller
Companies
International 05.01.92/1/ -21.57 4.84 8.93 -21.57 26.65 123.77
Securities
Performance reflects all Fund expenses (including 12b-1 distribution
and service fees for Class 2 shares) but does not include any expenses, fees or
sales charges imposed by the variable insurance contract for which the Fund is
an investment option. It they had been included, performance would be lower.
Total return figures are based on the inception of each Fund, which may
have started before the contract. Total return represents the cumulative or
average annual change in value, assuming reinvestment of dividends and capital
gains. Average returns smooth out variations in returns, which can be
significant; they are not the same as year by year results.
_______________________________
1. Because Class 2 shares of International Smaller Companies and International
Securities were not offered until 01.06.99 and 05.01.97, respectively, Class
2 share performance for prior periods represents the historical results of
Class 1 shares. For periods beginning after the respective effective
periods, Class 2 share performance reflect an additional 12b-1 fee, which
also affects future performance.
Who manages the Funds?
The management of the business and affairs of the Funds is the
responsibility of the Board.
Templeton Investment Counsel, LLC (TIC), is the investment advisor of
both International Securities and International Smaller Companies. Under an
agreement with TIC, Franklin Templeton Investments (Asia) Limited (FTI Asia)
serves as subadvisor for International Smaller Companies. Both TIC and FTI Asia
are wholly owned subsidiaries of Franklin Resources, Inc. (Resources). Resources
is a publicly-owned company engaged in various aspects of the financial services
industry through its subsidiaries. Together, TIC, FTI Asia and their affiliates
serve as investment managers of administrators to 52 registered investment
companies, with approximately 156 U.S.-based funds or series. As of October 31,
2001, combined assets under management were$251 billion for more than 5 million
U.S.-based mutual fund shareholders and other accounts. The principal
shareholders of Resources are Charles B. Johnson and Rupert H. Johnson, Jr.
Mr. Peter A. Nori, CFA, and Mr. Mark R. Beveridge, CFA, are responsible
for the day to day management of the portfolio of International Securities. They
have been with Franklin Templeton Investments since 1987 and 1985, respectively.
Mr. Simon Rudolph,
Mr. Tucker Scott, CFA, and Ms. Cindy L. Sweeting, CFA, are responsible for the
day to day management of the portfolio of International Smaller Companies. Mr.
Rudolph and Ms. Sweeting have both been with Franklin Templeton Investments
since 1997, and Mr. Scott since 1996.
Under the investment advisory agreement between TIC and the Trust on
behalf of International Smaller Companies, TIC receives a management fee based
on the schedule below:
================================================================================
Rate Net Assets
--------------------------------------------------------------------------------
0.850% First $200 million;
0.765% Over $200 million, up to and including $1.3 billion;
0.680% Over $1.3 billion.
=================================================================================
Under the investment advisory agreement between TIC and the Trust on
behalf of International Securities, TIC receives a management fee based on the
schedule below:
=================================================================================
Rate Net Assets
---------------------------------------------------------------------------------
0.750% First $200 million;
0.675% Over $200 million, up to and including $1.3 billion;
0.600% Over $1.3 billion.
=================================================================================
What service providers do the Funds use?
Administrative services. Franklin Templeton Services, LLC, a wholly
owned subsidiary of Resources, provides certain administrative services
and facilities for each of the Funds.
Auditor. PricewaterhouseCoopers LLP, 333 Market Street, San Francisco,
California 94105 is the Trust's independent auditor. The auditor gives
an opinion on the financial statements included in the Trust's Annual
Report to Shareholders and reviews the Trust's registration statement
filed with the SEC.
Custody services. J.P. Morgan Chase Bank (formerly The Chase Manhattan
Bank), at its principal office at MetroTech Center, Brooklyn, New York
11245, and at the offices of its branches and agencies throughout the
world, acts as custodian of the Funds' assets. As foreign custody
manager, the bank selects and monitors foreign sub-custodian banks,
selects and evaluates non-compulsory foreign depositories, and
furnishes information relevant to the selection of compulsory
depositories.
Distribution services. Franklin Templeton Distributors, Inc.
(Distributors) acts as the principal underwriter in the continuous
public offering of both of the Funds' shares.
Shareholder servicing and transfer agent. Franklin Templeton Investor
Services, LLC is the Funds' shareholder servicing agent and acts as the
Funds' transfer agent and dividend-paying agent.
How are shares bought and sold?
Shares of both International Smaller Companies and International
Securities are offered and sold only to insurance company separate accounts.
Shares are sold at net asset value and are redeemed at net asset value.
Individuals may not purchase these shares directly from the Funds. Class 1 and
Class 2 shares of both Funds may serve as the underlying investment vehicles for
both variable annuity and variable life insurance contracts issued by insurance
companies.
Contract owners may exchange shares of any one class for shares of
other classes or shares of other Funds through a transfer between investment
options available under a variable insurance contract, subject to the terms and
any specific limitations on the exchange (or transfer) privilege described in
the contract prospectus.
When are dividends and distributions made?
Both International Smaller Companies and International Securities
normally intend to pay an annual dividend representing substantially all of
their net investment income and to distribute annually any net realized capital
gains. If the Plan is approved, International Smaller Companies will pay a
special dividend in order to distribute its net investment income and net
realized capital gains prior to the Effective Time.
How do the investment goals and strategies of the Funds compare?
Each of International Smaller Companies and International Securities
has the same investment goal, which is to provide investors with long-term
capital appreciation. (In their current prospectuses, the goal of International
Smaller Companies is stated as long-term capital appreciation while the goal of
International Securities is stated as long-term capital growth.)
International Smaller Companies seeks to achieve its investment goal by
normally investing at least 65%* of its assets in equity securities of smaller
companies located outside the U.S., including those in emerging markets. Smaller
companies are generally defined by the Fund as those companies with market
capitalization values (share price multiplied by the number of common stock
shares outstanding) of less than $2 billion, at the time of purchase. The Fund
may also invest in equity securities of larger capitalization companies located
outside the U.S.
International Securities seeks to achieve its investment goal by
investing at least 65% of its assets in equity securities of companies located
outside the U.S., including those in emerging markets. Because of new SEC
regulations that affect all mutual funds, International Securities is expected
to increase this "65%" investment policy to "80%" as of May 1, 2002. While there
are no set percentage targets, the Fund generally invests in
_________________________
* New SEC regulations applicable to all mutual funds would require this 65%
level to increase to 80% as of May 1, 2002.
large to medium capitalization companies with market capitalization values
(share price multiplied by the number of common stock shares outstanding)
greater than $2 billion. The Fund may from time to time have significant
investments in one or more countries or in particular sectors such as financial
services.
The main differences between the portfolios of International Smaller
Companies and International Securities are: (i) International Smaller Companies
generally invests in smaller companies with capitalizations of less than $2
billion, while International Securities generally invests in medium to large
companies with capitalizations of more than $2 billion; and (ii) International
Securities may from time to time have significant investments in certain
sectors, such as financial services, or in one or more countries, while
International Smaller Companies has generally tended to hold a more diversified
sector and country portfolio structure.
How do the fundamental investment restrictions of the Funds compare?
Policies or restrictions that are deemed fundamental by International
Smaller Companies or International Securities may only be changed with the
approval of the lesser of: (i) more than 50% of the Fund's outstanding shares;
or (ii) 67% or more of the Fund's shares present at a shareholder meeting, if
more than 50% of the Fund's outstanding shares are represented at the meeting in
person or by proxy (Majority Vote).
Although there are differences in the fundamental policies of the
Funds, in some cases a policy that is a fundamental policy of one Fund and not
the other may have been adopted as an operating policy by the other Fund. For
example, as discussed below, International Smaller Companies has a fundamental
policy which requires that it not invest its assets in a manner which does not
comply with the investment diversification requirement of Section 817(h) of the
Internal Revenue Code (Code). This is not a fundamental policy of International
Securities, however, as an insurance products fund, International Securities is
subject to that same section of the Code and has adopted compliance with those
diversification requirements as an operating policy.
As described below, the Funds have adopted several restrictions as
fundamental policies which may only be changed by Majority Vote.
Diversification of investments. International Smaller Companies may
not, with respect to 75% of its total assets, purchase the securities
of any one issuer (other than cash, cash items and obligations of the
U.S. government) if immediately thereafter, and as a result of the
purchase, the Fund would: (i) have more than 5% of the value of its
total assets invested in the securities of such issuer; or (ii) hold
more than 10% of any or all classes of the securities of any one
issuer. International Securities may not purchase the securities of any
one issuer (other than the U.S. government or any of its agencies or
instrumentalities, or securities of other investment companies) if
immediately after such investment: (i) more than 5% of the value of the
Fund's total assets would be invested in such issuer; or (ii) more than
10% of the outstanding voting securities of such issuer would be
owned by the Fund, except that up to 25% of the value of the Fund's total assets
may be invested without regard to such 5% and 10% limitations.
Borrowing. International Smaller Companies may not borrow money from banks in an
amount exceeding 33 1/3% of the value of the Fund's total assets, including the
amount borrowed. The Fund may also pledge, mortgage or hypothecate its assets to
secure borrowings to an extent not greater than 15% of its total assets.
Arrangements with respect to margin for futures contracts, forward contracts and
related options are not deemed to be a pledge of assets. International
Securities may not borrow money, except that the Fund may borrow money from
banks to the extent permitted by the Investment Company Act of 1940, as amended
(1940 Act), or any exemptions therefrom which may be granted by the SEC, or from
any person for temporary or emergency purposes and then in an amount not
exceeding 33 1/3% of the value of the Fund's total assets (including the amount
borrowed).
Lending. International Smaller Companies may not lend its assets, except through
the purchase or acquisition of bonds, debentures or other debt securities of any
type customarily purchased by institutional investors, or through loans of
portfolio securities, or to the extent the entry into a repurchase agreement may
be deemed a loan. International Securities may not make loans to other persons
except: (i) through the lending of its portfolio securities; (ii) through the
purchase of debt securities, loan participations and/or engaging in direct
corporate loans in accordance with its investment objectives and policies; and
(iii) to the extent the entry into a repurchase agreement is deemed to be a
loan. The Fund may also make loans to affiliated investment companies to the
extent permitted by the 1940 Act or any exemptions therefrom which may be
granted by the SEC.
Underwriting. Neither Fund is permitted to underwrite securities of other
issuers, except that: (i) International Smaller Companies may be technically
deemed an underwriter under the federal securities laws in connection with the
disposition of portfolio securities; and (ii) International Securities may
invest in securities for the purpose of exercising management or control of the
issuer and may act as an underwriter to the extent that it may be deemed to be
an underwriter when disposing of securities it owns or when selling its own
shares.
Concentration. International Smaller Companies may not invest more than 25% of
its assets (measured at the time of the most recent investment) in any single
industry. International Securities may not concentrate (invest more than 25% of
its total assets) in securities of issuers in a particular industry (other than
securities issued or guaranteed by the U.S. government or any of its agencies or
instrumentalities or securities of other investment companies).
Commodities and real estate. International Smaller Companies may not invest in
commodities or commodity pools, except that the Fund may enter into futures
contracts and may invest in foreign currency. Securities or other instruments
backed by commodities are not considered commodities or commodity contracts
for the purpose of this restriction. International Securities may not
purchase or sell real estate and commodities, except that the Fund may
purchase or sell securities of real estate investment trusts, may
purchase or sell currencies, may enter into futures contracts on
securities, currencies, and other indices or any other financial
instruments, and may purchase and sell options on such futures
contracts.
The following fundamental restrictions are applicable only to International
Smaller Companies:
Exercise control. The Fund may not invest in securities for the purpose
of exercising management or control of the issuer.
Margin. The Fund may not maintain a margin account with a securities
dealer or effect short sales, except that it may make initial deposits
and pay variation margin in connection with futures contracts.
REITs. The Fund may not invest directly in real estate. First mortgage
loans or other direct obligations secured by real estate are not
considered real estate for purposes of this restriction.
Assessable securities. The Fund may not invest in assessable securities
or securities involving unlimited liability on the part of the Fund.
Section 817(h) of the Internal Revenue Code (Code). The Fund may not
invest its assets in a manner which does not comply with the investment
diversification requirement of Section 817(h) of the Code.
Foreign issuers. The Fund may not invest more than 15% of its assets in
securities of foreign issuers that are not listed on a recognized U.S.
or foreign securities exchange, including no more than 10% in illiquid
investments.
The following fundamental restriction is applicable only to International
Securities:
Senior securities. The Fund may not issue securities senior to the
Fund's presently authorized shares of beneficial interest, except that
this restriction shall not be deemed to prohibit the Fund from: (i)
making any permitted borrowings, loans, mortgages or pledges; (ii)
entering into options, futures contracts, forward contracts, repurchase
transactions or reverse repurchase transactions; or (iii) making short
sales of securities to the extent permitted by the 1940 Act and any
rule or order thereunder, or SEC staff interpretations thereof.
What distribution and service fees do the Funds have?
Class 2 shares of each Fund have a distribution plan, sometimes known
as a rule 12b-1 plan, that allows the Fund to pay distribution fees to those who
sell and distribute
Class 2 shares and provide services to shareholders and contract owners. For
International Smaller Companies, the maximum amount payable under the plan is
0.35% per year of the Fund's average net assets; however, the Board has set the
current rate at 0.25%. For International Securities, the maximum amount payable
under the plan is 0.25% per year of the Fund's average net assets, and that is
the rate currently being charged. A portion of the fees payable to Distributors
or others under the plan may be retained by Distributors for distribution
expenses.
What are the fees and expenses of the Funds and what might they be after the
transaction?
Fee Tables
The tables below describe the fees and expenses of the Funds for the fiscal
year ended December 31, 2000, and for the six month period ended June 30, 2001.
The tables and the examples do not include any fees, expenses or sales charges
imposed by the variable insurance contract for which the Funds are investment
options. If they were included, your costs would be higher.
Fiscal year ended December 31, 2000
Projected/1/
International International International
Smaller Companies Securities Securities After
Transaction
Class 1 Class 2 Class 1 Class 2 Class 1 Class 2
Description of Fees (%) (%) (%) (%) (%) (%)
- -------------------------------------------------------------------------------------------------------------------
Shareholder Fees
. Maximum sales charge (load) imposed 0.00 0.00 0.00 0.00 0.00 0.00
on purchases 0.00 0.00 0.00 0.00 0.00 0.00
. Maximum deferred sales charge (load)
Management fees 0.85 0.85 0.67 0.67 0.67 0.67
Distribution and service (12b-1) fees 0.00 0.25/2/ 0.00 0.25 0.00 0.25
Other expenses 0.26 0.26 0.20 0.20 0.20 0.20
-----------------------------------------------------------------------
Total annual Fund operating expenses 1.11 1.36 0.87 1.12 0.87 1.12
-----------------------------------------------------------------------
1. Projected expenses based on current International Securities expenses.
2. While the maximum amount payable under the Funds' Class 2 shares rule
12b-1 plan is 0.35% per year of the Fund's average daily net assets,
the Board has set the current rate at 0.25% per year.
EXAMPLE
The examples below can help you compare the cost of investing in the Funds
with the cost of investing in other mutual funds. They assume:
. You invest $10,000 for the periods shown;
. Your investment has a 5% return each year; and
. The Funds' operating expenses remain the same.
Although your actual costs may be higher or lower, based on these assumptions
your costs would be:
Fund 1 Year 3 Years 5 Years 10 Years
($) ($) ($) ($)
- -------------------------------------------------------------------------------------------------- -------------------
International Smaller Companies
. Class 1 113 353 612 1,352
. Class 2 138 431 745 1,636
International Securities
. Class 1 89 278 482 1,073
. Class 2 114 356 617 1,364
Projected International Securities
(after Transaction)
. Class 1 89 278 482 1,073
. Class 2 114 356 617 1,364
Six month period ended June 30, 2001/1/
Projected/2/
International International International
Smaller Companies Securities Securities After
Transaction
Class 1 Class 2 Class 1 Class 2 Class 1 Class 2
Description of Fees (%) (%) (%) (%) (%) (%)
- -------------------------------------------------------------------------------------------------------------------
Shareholder Fees
. Maximum sales charge (load) 0.00 0.00 0.00 0.00 0.00 0.00
imposed on purchases 0.00 0.00 0.00 0.00 0.00 0.00
. Maximum deferred sales charge
(load)
Management fees 0.85 0.85 0.69 0.69 0.69 0.69
Distribution and service (12b-1) fees 0.00 0.25/3/ 0.00 0.25 0.00 0.25
Other expenses 0.30 0.30 0.28 0.28 0.28 0.28
-----------------------------------------------------------------------
Total annual Fund operating expenses 1.15 1.40 0.97 1.22 0.97 1.22
-----------------------------------------------------------------------
1. Annualized.
2. Projected expenses based on current International Securities expenses.
3. While the maximum amount payable under the Funds' Class 2 shares rule
12b-1 plan is 0.35% per year of the Fund's average daily net assets,
the Board has set the current rate at 0.25% per year.
EXAMPLE
The example is based on the same assumptions as those for the fiscal
year ended December 31, 2000. The semi-annual numbers for June 30, 2001 are,
however, annualized:
Fund 1 Year 3 Years 5 Years 10 Years
($) ($) ($) ($)
- ----------------------------------------------------------------------------------------------------------------------
International Smaller Companies 117 365 633 1,398
. Class 1 143 443 766 1,680
. Class 2
International Securities
. Class 1 99 309 536 1,190
. Class 2 124 387 670 1,477
Projected International Securities
(after Transaction)
. Class 1 99 309 536 1,190
. Class 2 124 387 670 1,477
INFORMATION ABOUT THE TRANSACTION
What are the terms of the Plan?
The terms of the Plan are summarized below. The summary is qualified in
its entirety by reference to the Plan, a copy of which is attached as Exhibit A.
If the shareholders of International Smaller Companies approve the
Plan, the Transaction will take place after various conditions are satisfied by
the Trust on behalf of the Funds, including the preparation of certain
documents. If the shareholders of International Smaller Companies do not approve
the Plan, the Transaction will not take place. In such case, we will consider
what further action is appropriate, including the liquidation of International
Smaller Companies.
If the shareholders of International Smaller Companies approve the
Plan, International Smaller Companies will transfer substantially all of its
assets to International Securities, in exchange for Class 1 or Class 2 shares of
International Securities equal in value to the Class 1 or Class 2 shares of
International Smaller Companies. The International Securities Class 1 or Class 2
shares issued to International Smaller Companies will then be distributed by
International Smaller Companies to the insurance company separate accounts which
hold its shares, in redemption of its outstanding shares. As a result, the
separate accounts will cease to own shares of the International Smaller
Companies and will instead own shares of Class 1 or Class 2 of International
Securities having an aggregate net asset value equal to all Class 1 and Class 2
shares of International Smaller Companies at the Effective Time. International
Smaller Companies then will be dissolved. The Transaction is expected to take
place at the close of business on the New York Stock Exchange on April 30, 2002,
or such other date as is determined by the Board. After the Transaction, your
contract values will depend on the performance of International Securities
instead of that of International Smaller Companies.
To the extent permitted by law, the Trust may, on behalf of the Funds,
agree to amend the Plan without shareholder approval. The Trust may also decide
to delay the timing of, or to terminate and abandon the Transaction, at any time
before or, to the extent permitted by law, after the approval of shareholders of
International Smaller Companies.
Who will pay the expenses of the Transaction?
All fees and expenses to be incurred in connection with the
Transaction, whether or not the Plan is approved at the Meeting or the
Transaction is consummated, will be divided equally between International
Smaller Companies and its principal underwriter, Distributors. The share of
expenses to be borne by International Smaller Companies is estimated to be
approximately $40,000. It is not expected that International Securities will
incur any significant expenses in connection with the Transaction.
What are the reasons for recommending the Plan?
Shareholders of both Funds, but primarily those of International
Smaller Companies, potentially could be advantaged by the growth in assets
realized by combining the Funds. A larger fund should have an enhanced ability
to effect portfolio transactions on more favorable terms and should have greater
investment flexibility. Higher aggregate net assets and the opportunity for net
cash inflows may also reduce the risk that, if the net assets of International
Smaller Companies fail to grow, or diminish, its total expense ratio could rise
as certain fixed expenses become a larger percentage of net assets. Shareholders
of International Smaller Companies are projected to achieve a reduction in
expense ratio following the Transaction.
At the meeting held on October 9, 2001, the Board reviewed the
potential benefits and costs of the Transaction to shareholders of International
Smaller Companies and International Securities; the expense ratios of
International Smaller Companies and International Securities; the comparative
investment performance of International Smaller Companies and International
Securities; the compatibility of the investment goals, policies, restrictions
and investments of International Securities with those of International Smaller
Companies; and the tax consequences of the Transaction. The Board also reviewed
the allocation of expenses of the Transaction, which will be paid one-half by
International Smaller Companies, and one-half by Distributors.
The Board, including a majority of the trustees who are not interested
persons of the Funds, concluded that the Transaction is in the best interests of
the shareholders of both Funds and that no dilution of value of the interests of
the shareholders of International Securities would result from the Transaction.
It approved the Plan on November 20 2001, and recommended that shareholders of
International Smaller Companies vote to approve the Plan.
What are the federal tax consequences of the transaction?
It is not expected that the Transaction will qualify as a tax-free
"reorganization" under the applicable provisions of the Internal Revenue Code of
1986, as amended. However, the consummation of the Transaction is subject to
receipt of an opinion of tax counsel to the Trust that: (i) no gain or loss will
be recognized by International Securities in connection with the Transaction,
(ii) any gains recognized by International Smaller Companies in connection with
the Transaction will be offset by a deduction for dividends paid to its
shareholders, and (iii) no gain or loss will be recognized in connection with
the Transaction by contract owners for whose contracts shares of either
International Smaller Companies or International Securities are underlying
investments.
The insurance companies that hold shares of International Smaller
Companies in one or more separate accounts with respect to variable life
insurance or annuity contracts that have shares of International Smaller
Companies as an underlying investment will not incur tax on any dividends that
may be paid to them by International Smaller Companies as a result of the
Transaction, and will not impose any charges under the contracts as a
result of the Transaction.
The foregoing is only a summary of the principal federal income tax
consequences of the Transaction and should not be considered to be tax advice.
There can be no assurance that the Internal Revenue Service will concur on all
or any of the issues discussed above. You may wish to consult with your own tax
advisers regarding the federal, state, and local tax consequences with respect
to the foregoing matters and any other considerations that may apply in your
particular circumstances.
What other things should I know about the shares of International Securities?
Shares of International Securities will be distributed to shareholders
of the corresponding class of International Smaller Companies and will have the
same legal characteristics as the shares of International Smaller Companies with
respect to such matters as voting rights, assessibility, conversion rights, and
transferability. Both International Smaller Companies and International
Securities are series of the Trust. The Trust is an open-end management
investment company, commonly called a mutual fund. The Trust was organized as a
Massachusetts business trust on April 26, 1988, and is registered with the SEC.
As a shareholder of a Massachusetts business trust, you could, under
certain circumstances, be held personally liable as a partner for its
obligations. The Agreement and Declaration of Trust (Declaration), however,
contains an express disclaimer of shareholder liability for acts or obligations
of the Fund. The Declaration also provides for indemnification and reimbursement
of expenses out of the Fund's assets if you are held personally liable for
obligations of the Fund. The Declaration provides that the Fund shall, upon
request, assume the defense of any claim made against you for any act or
obligation of the Fund and satisfy any judgment thereon. All such rights are
limited to the assets of the Fund. The Declaration further provides that the
Fund may maintain appropriate insurance (for example, fidelity bonding and
errors and omissions insurance) for the protection of the Fund, its
shareholders, trustees, officers, employees and agents to cover possible tort
and other liabilities. Furthermore, the activities of the Fund as an investment
company, as distinguished from an operating company, would not likely give rise
to liabilities in excess of the Fund's total assets. Thus, the risk that you
would incur financial loss on account of shareholder liability is limited to the
unlikely circumstance in which both inadequate insurance exists and the Fund
itself is unable to meet its obligations.
What is the capitalization of each Fund and what might the capitalization of
International Securities be after the Transaction?
The following table sets forth, as of November 13, 2001, the
capitalization of International Smaller Companies and International Securities.
The table also shows the projected capitalization of International Securities as
adjusted to give effect to the proposed Transaction, as if the Transaction had
occurred on that date. The capitalization of International Securities and its
classes is likely to be different when the Transaction is
consummated, due to changes in market value of portfolio securities of the Funds
between November 13, 2001, and the Effective Time, changes in the amount of
undistributed net investment income and net realized capital gains of both Funds
during that period resulting from income and distributions, and changes in the
accrued liabilities of both Funds during the same period. It is not possible to
predict the number or value of shares of International Securities that actually
will be issued and distributed in connection with the Transaction.
International Smaller International International Securities -
Companies Securities Projected
(unaudited) (unaudited) After Transaction
(unaudited)
- -------------------------------------------------------------------------------------------------------------------------------
Net assets (all classes) (thousands) $ 26,620 $ 796,246 $ 822,866
Total shares outstanding (all classes) 2,898,151 69,728,370 72,063,763
Class 1 net assets (thousands) $ 12,990 $ 557,084 $ 570,074
Class 1 shares outstanding 1,412,783 48,657,923 49,792,401
Class 1 net asset value per share $ 9.19 $ 11.45 $ 11.45
Class 2 net assets (thousands) $ 13,631 $ 239,161 252,792
Class 2 shares outstanding 1,485,368 21,070,447 22,271,362
Class 2 net asset value per share $ 9.18 $ 11.35 $ 11.35
ANNUAL MEETINGS AND SPECIAL MEETINGS
The Trust's Agreement and Declaration of Trust does not provide for
annual meetings of shareholders. The Trust does not intend to hold such a
meeting in the year 2002. Proposals included in the proxy statement for any
subsequent meeting must be received within a reasonable time before any such
meeting at the Trust's offices, One Franklin Parkway, San Mateo, California
94403-1906. If a shareholder submits a proposal after that time, the proposal
will not appear in the proxy statement.
OTHER BUSINESS
We do not know of any business to be brought before the Meeting other
than the matters set forth in this Prospectus and Proxy Statement. Should any
other matters requiring a vote of shareholders arise, however, the proxies will
vote on such matters according to their best judgment.
PRINCIPAL SHAREHOLDERS
Your insurance company will vote on the Plan as you instruct. Thus,
your insurance company does not exercise control over International Securities
solely as the record owner of the Fund's shares. As of December 28, 2001, the
Trustees and officers of the Trust, as a group, owned less than 1% of the
outstanding shares of International Smaller Companies.
The name, address and percentage of ownership of shareholders that
owned of record 5% or more of International Smaller Companies and International
Securities, on behalf of certain separate accounts, on December 28, 2001, and
the percentage that would be owned by these shareholders after the Transaction
based upon their holdings as of December 28, 2001, are as follows:
Pro Forma
Percentage of
Class of
International
Percentage Securities
- -------------------------------------------------------------------- of Class Owned After
Class of Owned on Transaction
Name and Address of Shareholder Shares Record
Owned Date
-------------------------------------------------
International Smaller Companies
[name of 5% holder] Class 1 % %
[address]
[name of 5% holder] Class 2 % %
[address]
International Securities
[name of 5% holder] Class 1 % %
[address]
[name of 5% holder] Class 2 % %
[address]
* Christopher H. Pinkerton serves as Trustee of the Trust and is
President, USAllianz Investor Services, LLC and USAllianz Advisors;
Senior Vice President, Variable Products Division, Allianz Life
Insurance Company of North America. Mr. Pinkerton may not be viewed as
an independent person of the Trust under the 1940 Act because of the
share ownership of Allianz Life.
EXHIBITS TO PROSPECTUS AND PROXY STATEMENT
Exhibit
A Franklin Templeton Variable Insurance Products Trust Plan
of Reorganization of Templeton International Smaller
Companies Fund and Templeton International Securities Fund
(attached)
B Prospectus of Templeton International Securities Fund -
Class 1, dated May 1, 2001 (enclosed)
C Prospectus of Templeton International Securities Fund -
Class 2, dated May 1, 2001 (enclosed)
D Prospectus of Templeton International Smaller Companies
Fund - Class 1, dated May 1, 2001 (enclosed)
E Prospectus of Templeton International Smaller Companies
Fund - Class 2, dated May 1, 2001 (enclosed)
F Annual Report to Shareholders of Templeton International
Securities Fund dated December 31, 2000 (enclosed)
G Semi Annual Report to Shareholders of Templeton
International Securities Fund dated June 30, 2001
(enclosed)
EXHIBIT A
Franklin Templeton Variable Insurance Products Trust
Plan of Reorganization
of
Templeton International Smaller Companies Fund
and
Templeton International Securities Fund
This Plan of Reorganization (the "Plan") is hereby adopted by the Franklin
Templeton Variable Insurance Products Trust, a Massachusetts business trust (the
"Trust"), as of this __/th/ day of November, 2001, on behalf of its series
designated Templeton International Smaller Companies Fund (the "Acquired Fund")
and Templeton International Securities Fund ("the Acquiring Fund").
1. Prior to the Closing (defined below), the Acquired Fund shall calculate,
declare and pay ordinary and capital gains dividends on its Class 1 and
Class 2 shares in amounts sufficient to distribute all of its investment
company taxable income and all capital gains to the close of business on
the date of the Closing. Such dividends shall be automatically reinvested
in additional shares, of the corresponding class, of the Acquired Fund.
2. At the Closing (defined below), the Acquired Fund shall transfer all of its
assets to the Acquiring Fund in exchange for which the Acquiring Fund shall
simultaneously assume all of the liabilities of the Acquired Fund and shall
issue to the Acquired Fund Class 1 and Class 2 shares of the Acquiring Fund
(including any fractional share rounded to the nearest one-thousandth of a
share) equal in aggregate value, in the case of the Acquiring Fund's Class
1 shares, to the net asset value of the Acquired Fund attributable to the
Acquired Fund's Class 1 shares and, in the case of the Acquiring Fund's
Class 2 shares, the net asset value of the Acquired Fund attributable to
the Acquired Fund's Class 2 shares.
3. The Acquired Fund immediately shall distribute to each holder of its
outstanding shares that number of Class 1 or Class 2 shares of the
Acquiring Fund (including any fractional share rounded to the nearest
one-thousandth of a share) as shall have an aggregate value equal to the
aggregate value of the shares of the same class of the Acquired Fund
(including any fractional share rounded to the nearest one-thousandth of a
share) which were owned by such shareholder immediately prior to the
Closing, such values to be determined by the net asset
3. values per share of the appropriate class of the Acquired Fund and the
Acquiring Fund at the time of Closing, in exchange for and in cancellation
of the shareholder's shares of the Acquired Fund.
4. The distribution to the shareholders of the Acquired Fund shall be
accomplished by establishing an account on the share records of the
Acquiring Fund in the name of each registered shareholder of the Acquired
Fund, and crediting that account with a number of shares of the appropriate
class of the Acquiring Fund determined pursuant to the preceding paragraph.
5. The Acquired Fund shall terminate automatically immediately after the
Closing, subject to section 9 below.
6. The completion of the transactions described in sections 2, 3 and 4
above (the "Closing") shall occur on April 30, 2002, at the close of
business on the New York Stock Exchange at the offices of Franklin
Templeton Investments, One Franklin Parkway, San Mateo, California
94403-1906, or such other date, time, or place as may be determined by the
Board of Trustees of the Trust; provided, however, that the Closing shall
not occur unless and until the Trust shall have received an opinion of tax
counsel, in such form and with such qualifications or limitations, if any,
as reasonably may be acceptable to the Trust, which concludes: (i) that no
gain or loss will be recognized by the Acquiring Fund in connection with
the transactions contemplated herein; (ii) that any gains recognized by the
Acquired Fund as a result of the transactions contemplated herein will be
offset by a deduction for dividends paid to its shareholders; and (iii)
that no gain or loss will be recognized by any contract owner for whom
shares of either the Acquiring Fund or the Acquired Fund are underlying
investments as a result of the transactions contemplated herein.
7. This Plan may be amended at any time, and may be terminated at any time
before the Closing, regardless of whether or not this Plan has been
approved by the shareholders of the Acquired Fund, by action of the Trust,
provided that no amendment shall have a material adverse effect upon the
interests of shareholders of the Acquired Fund or the Acquiring Fund.
8. A copy of the Trust's Declaration of Trust is on file with the Secretary of
the Commonwealth of Massachusetts, and notice is hereby given that this
Plan is executed on behalf of the
trustees of the Trust as the trustees of the Trust and not individually and
that the obligations under this instrument are not binding upon any of the
trustees, officers or shareholders of the Trust individually, but binding
only upon the assets and property of the Acquired Fund and the Acquiring
Fund.
9. At any time after the Closing, the Trust on behalf of the Acquired Fund
shall execute and deliver such additional instruments of transfer or other
written assurances and take such other action as the Trust may reasonably
request in order to vest in the Acquiring Fund title to the assets
transferred by the Acquired Fund under this Plan.
10. This Plan shall be construed in accordance with applicable Federal law and
the laws of the State of California, except as to the provisions of section
8 hereof which shall be construed in accordance with the laws of the
Commonwealth of Massachusetts.
Dated: November __ 2001
Franklin Templeton Variable Insurance
Products Trust
By__________________________________________
Name:
Title:
Exhibit B
Prospectus
Franklin Templeton
Variable Insurance
Products Trust
Class 1 Shares
May 1, 2001
[GRAPHIC OMITTED]
As with all fund prospectuses, the SEC has not approved or disapproved these
securities or passed upon the adequacy of this prospectus. Any representation to
the contrary is a criminal offense.
Contents
FRANKLIN TEMPLETON VARIABLE
- ---------------------------INSURANCE PRODUCTS TRUST
Information about each Fund i Overview
you should know before
investing Individual Fund Description
TI-1 Templeton International
Securities Fund
Additional Information,
All Funds
1 Distributions and Taxes
- ------------------------------------FUND ACCOUNT INFORMATION
Information about Fund 2 Buying Shares
account transactions 2 Selling Shares
and services 2 Exchanging Shares
2 Fund Account Policies
3 Questions
- ------------------------------------FOR MORE INFORMATION
Where to learn more about Back Cover
each Fund
Franklin Templeton
Variable Insurance Products Trust
OVERVIEW
- --------
[GRAPHIC OMITTED]
Franklin Templeton Variable Insurance Products Trust (the Trust) currently
consists of twenty-seven (27) separate series (the Fund or Funds), offering a
wide variety of investment choices. Each Fund generally has two classes of
shares, Class 1 and Class 2. The Funds are generally only available as
investment options in variable annuity or variable life insurance contracts. The
accompanying contract prospectus indicates which Funds and classes are available
to you.
INVESTMENT CONSIDERATIONS
. Each Fund has its own investment strategy and risk profile. Generally, the
higher the expected rate of return, the greater the risk of loss.
. No single Fund can be a complete investment program; consider diversifying
your Fund choices.
. You should evaluate each Fund in relation to your personal financial
situation, investment goals, and comfort with risk. Your investment
representative can help you determine which Funds are right for you.
RISKS
. There can be no assurance that any Fund will achieve its investment goal.
. Because you could lose money by investing in a Fund, take the time to read
each Fund description and consider all risks before investing.
. All securities markets, interest rates, and currency valuations move up and
down, sometimes dramatically, and mixed with the good years can be some bad
years. Since no one can predict exactly how financial markets will perform,
you may want to exercise patience and focus not on short-term market
movements, but on your long-term investment goals.
. Fund shares are not deposits or obligations of, or guaranteed or endorsed
by, any bank, and are not federally insured by the Federal Deposit
Insurance Corporation, the Federal Reserve Board, or any other agency of
the U.S. government. Fund shares involve investment risks, including the
possible loss of principal.
More detailed information about each Fund,
its investment policies, and its particular
risks can be found in the Trust's Statement of
Additional Information (SAI).
MANAGEMENT
The Funds' investment managers and their affiliates manage over $225 billion in
assets. In 1992, Franklin joined forces with Templeton, a pioneer in
international investing. The Mutual Advisers organization became part of the
Franklin Templeton organization four years later. Today, Franklin Templeton
Investments is one of the largest mutual fund organizations in the United
States, and offers money management expertise spanning a variety of investment
objectives.
i
Templeton International Securities Fund
GOAL AND STRATEGIES
- ------------------
[GRAPHIC]
GOAL The Fund's investment goal is long-term capital growth.
The Fund invests primarily in an international portfolio of common stocks.
MAIN INVESTMENTS Under normal market conditions, the Fund will invest at least
65% of its total assets in equity securities of companies located outside the
U.S., including those in emerging markets. While there are no set percentage
targets, the Fund generally invests in large to medium capitalization companies
with market capitalization values (share price multiplied by the number of
common stock shares outstanding) greater than $2 billion. An equity security
represents a proportionate share of the ownership of a company; its value is
based on the success of the company's business, any income paid to
stockholders, the value of its assets, and general market conditions. Common
and preferred stocks, and securities convertible into common stock are examples
of equity securities.
The Fund may from time to time have significant investments in one or more
countries or in particular sectors such as financial services.
The Fund may use various derivative strategies seeking to protect its assets,
implement a cash management strategy or enhance its returns. The Fund currently
may invest up to 5% of its total assets in swap agreements, put and call options
and collars. With derivatives, the manager attempts to predict whether an
underlying investment will increase or decrease at some future time. The manager
considers various factors, such as availability and cost, in deciding whether to
use a particular instrument or strategy.
PORTFOLIO SELECTION The manager's investment philosophy is "bottom-up,"
value-oriented, and long-term. In choosing investments, the Fund's manager will
focus on the market price of a company's securities relative to its evaluation
of the company's potential long-term earnings, asset value and cash flow. A
company's historical value measures, including price/earnings ratio, profit
margins and liquidation value, will also be considered, but are not limiting
factors.
TEMPORARY INVESTMENTS When the manager believes market or economic conditions
are unfavorable for investors, is unable to locate suitable investment
opportunities, or seeks to maintain liquidity, it may invest all or
substantially all of the Fund's assets in U.S. or non-U.S. currency short-term
investments, including cash or cash equivalents. Under these circumstances, the
Fund may temporarily be unable to pursue its investment goal.
================================================================================
MAIN RISKS
- ----------
[GRAPHIC]
The Fund's main risks can affect the Fund's share price, its distributions or
income and, therefore, the Fund's performance.
STOCKS While stocks have historically outperformed other asset classes over the
long term, their value tends to go up and down more dramatically over the short
term. These price movements may result from factors affecting individual
companies, industries, or securities markets.
VALUE STYLE INVESTING Value stock prices are considered "cheap" relative to the
company's perceived value and are often out of favor with other investors. The
manager may invest in such stocks if it believes the market may have
overreacted to adverse developments or failed to appreciate positive changes.
However, if other investors fail to recognize the company's value (and do not
become buyers, or become sellers), or favor investing in faster-growing
companies, value stocks may not increase in value as anticipated by the manager
and may even decline further.
FOREIGN SECURITIES Investing in foreign securities typically involves more
risks than investing in U.S. securities. Certain of these risks also may apply
to securities of U.S. companies with significant foreign operations.
Currency exchange rates. Many of the Fund's investments are issued and traded
in foreign
------------------------------------------------------
TI-1 Templeton International Securities Fund - Class 1
------------------------------------------------------
currencies. Changes in foreign currencies and in currency exchange rates can
---
increase or dramatically decrease the Fund's returns from its foreign portfolio
------------
holdings. The impact of the euro, a relatively new currency adopted by certain
European countries to replace their national currencies, is unclear.
Because the stocks the Fund holds fluctuate in price with foreign market
conditions and currencies, the value of your investment in the Fund will go up
and down. This means you could lose money over short or even extended periods.
Political and economic developments. The political, economic and social
structures of some countries the Fund invests in may be less stable and more
volatile than those in the U.S. The risks of investing in these countries
include the imposition of exchange controls, internal and external conflicts,
currency devaluations, foreign ownership limitations, tax increases,
restrictions on the removal of currency or other assets, nationalization of
assets, and expropriation. The Fund may have greater difficulty voting proxies,
exercising shareholder rights and pursuing legal remedies with respect to its
foreign investments.
Trading practices. Brokerage commissions and other fees generally are higher
for foreign securities. Government supervision and regulation of foreign stock
exchanges, currency markets, trading systems and brokers may be less than in
the U.S. The procedures and rules governing foreign transactions and custody
also may involve delays in payment, delivery or recovery of money or
investments.
Availability of information. Foreign companies may not be subject to the same
disclosure, accounting, auditing and financial reporting standards and
practices as U.S. companies, and there may be less publicly available
information about them.
Limited markets. Certain foreign securities may be less liquid and more
volatile than many U.S. securities, which could limit the Fund's ability to
sell them at favorable prices.
Emerging markets. The Fund's investments in emerging markets countries are
subject to all the risks of foreign investing generally, and have additional,
heightened risks due to a lack of established legal, political, business and
social frameworks to support securities markets. These countries also are more
likely to experience high levels of inflation, deflation or currency
devaluation, which can harm their economies and securities markets and increase
volatility. Short-term volatility in these markets, and declines of 50% or
more, are not unusual.
SECTOR FOCUS By focusing on particular sectors from time to time, the Fund
carries greater risk of adverse developments in a sector than a fund that
always invests in a wide variety of sectors.
Financial services companies. Financial services companies are subject to
extensive government regulation which may affect their profitability in many
ways, including by limiting the amount and types of loans and other commitments
they can make, and the interest rates and fees they can charge. A financial
services company's profitability, and therefore its stock price, is especially
sensitive to interest rate changes throughout the world as well as the ability
of borrowers to repay their loans. Changing regulations, continuing
consolidations, and development of new products and structures are all likely
to have a significant impact on financial services companies.
DERIVATIVE SECURITIES The performance of derivative investments depends, at
least in part, on the performance of an underlying asset. Derivatives involve
costs, may be volatile, and may involve a small investment relative to the risk
assumed. Their successful use will depend on the manager's ability to predict
market movements. Risks include delivery failure, default by the other party or
the inability to close out a position because the trading market becomes
illiquid.
More detailed information about the Fund, its policies, and risks can be found
in the SAI.
------------------------------------------------------
TI-2 Templeton International Securities Fund - Class 1
------------------------------------------------------
PAST PERFORMANCE
- ----------------
[GRAPHIC]
This bar chart and table show the volatility of the Fund's returns, which is
one indicator of the risks of investing in the Fund. The bar chart shows
changes in the Fund's returns from year to year over the past ten calendar
years or since the Fund's inception. The table shows how the Fund's average
annual total returns compare to those of a broad-based securities market index.
Of course, past performance cannot predict or guarantee future results.
Performance reflects all Fund expenses but does not include any fees or sales
charges imposed by the variable insurance contract for which the Fund is an
investment option. If they had been included, performance would be lower.
TEMPLETON INTERNATIONAL SECURITIES FUND
CLASS 1 ANNUAL TOTAL RETURNS/1/
[GRAPH APPEARS HERE]
AVERAGE ANNUAL TOTAL RETURNS
For the periods ended December 31, 2000
Since
Inception
1 Year 5 Years 05/01/92
-----------------------------------------------------------------
Templeton International
Securities Fund
- Class 1/1/ -2.19% 13.32% 13.18%
MSCI EAFE Index/2/ -13.96% 7.43% 9.98%
Ongoing stock market volatility can dramatically change the Fund's short-term
performance; current results may differ.
1. All Fund performance assumes reinvestment of dividends and capital gains.
Performance prior to the May 1, 2000 merger reflects the historical performance
of Templeton International Fund.
2. Source: Standard & Poor's Micropal. The unmanaged Morgan Stanley Capital
International Europe, Australia, Far East (MSCI EAFE) Index tracks the
performance of approximately 1000 securities in 20 countries. The average
company, the securities of which are a component of that index, has a market
capitalization of over $3 billion. Indexes include reinvested dividends and/or
interest. One cannot invest directly in an index, nor is an index representative
of the Fund's investments.
- --------------------------------------------------------------------------------
FEES AND EXPENSES
- -----------------
[GRAPHIC]
TEMPLETON INTERNATIONAL SECURITIES FUND - CLASS 1
This table describes the fees and expenses that you may pay if you buy and hold
shares of the Fund. The table and the example do not include any fees or sales
charges imposed by the variable insurance contract for which the Fund is an
investment option. If they were included, your costs would be higher. Investors
should consult the contract prospectus or disclosure document for more
information.
SHAREHOLDER FEES
(fees paid directly from your investment)
Class 1
- -----------------------------------------------------------
Maximum sales charge (load) imposed on purchases 0.00%
Maximum deferred sales charge (load) 0.00%
ANNUAL FUND OPERATING EXPENSES
(expenses deducted from Fund assets)
Class 1
- -----------------------------------------------
Management fees 0.67%
Other expenses 0.20%
----
Total annual Fund operating expenses 0.87%
====
EXAMPLE
This example can help you compare the cost of investing in the Fund with the
cost of investing in other mutual funds. It assumes:
. You invest $10,000 for the periods shown;
. Your investment has a 5% return each year; and
. The Fund's operating expenses remain the same.
Although your actual costs may be higher or lower, based on these assumptions
your costs would be:
1 Year 3 Years 5 Years 10 Years
- -------------------------------------------------------
Class 1 $89 $278 $482 $1,073
------------------------------------------------------
TI-3 Templeton International Securities Fund - Class 1
------------------------------------------------------
MANAGEMENT
- ----------
[GRAPH]
Templeton Investment Counsel, LLC (TIC), Broward Financial Centre, Suite 2100,
Fort Lauderdale, Florida 33394, is the Fund's investment manager.
MANAGEMENT TEAM The team responsible for the Fund's management is:
Peter A. Nori, CFA Mr. Nori has been a manager of the Fund since 1999, and has been with
SENIOR VICE PRESIDENT, TIC Franklin Templeton Investments since 1987.
Mark R. Beveridge, CFA Mr. Beveridge has been a manager of the Fund since 1994, and has been
SENIOR VICE PRESIDENT, TIC with Franklin Templeton Investments since 1985.
The Fund pays TIC a fee for managing the Fund's assets. For fiscal year ended
December 31, 2000, the Fund paid 0.67% of its average daily net assets to TIC
for its services.
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS/1/
- --------------------
[GRAPHIC]
The financial highlights table provides further details to help you understand
the financial performance of Class 1 shares for the past five years or since
the Fund's inception. The table shows certain information on a single Fund
share basis (per share performance). It also shows some key Fund statistics,
such as total return (past performance) and expense ratios. Total return
represents the annual change in value of a share assuming reinvestment of
dividends and capital gains. This information has been audited by
PricewaterhouseCoopers LLP (PWC), independent auditors, starting with the
fiscal year ended December 31, 1999, and by other auditors for the fiscal years
before 1999. PWC's report, along with the financial statements, is included in
the Fund's Annual Report (available upon request).
Class 1 Year ended December 31,
- --------------------------------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
--------------------------------------------------------------
Per share data ($)
Net asset value, beginning of year 22.25 20.69 20.18 18.40 15.13
--------------------------------------------------------------
Net investment income/2/ .40 .33 .60 .49 .43
Net realized and unrealized gains (losses) (.95) 3.78 1.29 2.01 3.15
--------------------------------------------------------------
Total from investment operations (.55) 4.11 1.89 2.50 3.58
--------------------------------------------------------------
Distributions from net investment income (.43) (.57) (.49) (.51) (.24)
Distributions from net realized gains (2.49) (1.98) (.89) (.21) (.07)
--------------------------------------------------------------
Total distributions (2.92) (2.55) (1.38) (.72) (.31)
--------------------------------------------------------------
Net asset value, end of year 18.78 22.25 20.69 20.18 18.40
==============================================================
Total return (%)/3/ (2.19) 23.61 9.33 13.95 24.04
Ratios/supplemental data
Net assets, end of year ($ x 1 million) 776 1,057 980 938 683
Ratios to average net assets: (%)
Expenses .87 .85 .86 .81 .65
Net investment income 2.08 1.69 2.81 2.70 3.23
Portfolio turnover rate (%) 32.81 30.04 29.56 16.63 9.46
1. Financial highlights for periods prior to the May 1, 2000 merger reflect the
historical information of Templeton International Fund.
2. Based on average shares outstanding effective year ended December 31, 1999.
3. Total return does not include any fees, charges or expenses imposed by the
variable annuity and life insurance contracts for which the Fund serves as an
underlying investment vehicle. If they had been included, total return would
be lower.
------------------------------------------------------
TI-4 Templeton International Securities Fund - Class 1
------------------------------------------------------
Additional Information, All Funds
DISTRIBUTIONS AND TAXES
- -----------------------
[GRAPHIC OMITTED]
INCOME AND CAPITAL GAINS DISTRIBUTIONS Each Fund will declare as dividends
substantially all of its net investment income. Except for the Franklin Money
Market Fund, each Fund typically pays dividends from net investment income and
net capital gains, if any, at least annually. Dividends or distributions by the
Funds will reduce the per share net asset value (NAV) by the per share amount
paid.
The Franklin Money Market Fund declares a dividend each day the Fund's NAV is
calculated, equal to all of its daily net income, payable as of the close of
business the preceding day. The amount of dividend may fluctuate from day to
day and may be omitted on some days, depending on changes in the factors that
comprise the Fund's net income.
Dividends paid by a Fund will be automatically reinvested in additional shares
of that Fund or, if requested, paid in cash to the insurance company
shareholder.
TAX CONSIDERATIONS The tax consequences for contract owners from their
investment in variable annuity or variable life insurance contracts will depend
on the provisions of these contracts. Contract owners should consult the
accompanying contract prospectus for more information on these tax
consequences.
1 Franklin Templeton Variable Insurance Products Trust
Fund Account Information
BUYING SHARES
- -----------------
[GRAPHIC OMITTED]
Shares of each Fund are sold at net asset value (NAV) to insurance company
separate accounts to serve as investment options for variable annuity or
variable life insurance contracts, and for qualified pension and retirement
plans. The Funds' Board of Trustees (Board) monitors this to be sure there are
no material conflicts of interest between the two different types of contract
owners, given their differences, including tax treatment. If there were, the
Board would take corrective action.
Contract owners' payments will be allocated by the insurance company separate
account to purchase shares of the Fund chosen by the contract owner, and are
subject to any limits or conditions in the contract. Requests to buy shares are
processed at the NAV next calculated after we receive the request in proper
form. The Funds do not issue share certificates.
================================================================================
SELLING SHARES
- -----------------
[GRAPHIC OMITTED]
Each insurance company shareholder sells shares of the applicable Fund to make
benefit or surrender payments or to execute exchanges (transfers) between
investment options under the terms of its contracts. Requests to sell shares
are processed at the NAV next calculated after the Fund receives the request in
proper form.
================================================================================
EXCHANGING SHARES
- -----------------
[GRAPHIC OMITTED]
Contract owners may exchange shares of any one class or Fund for shares of
other classes or Funds through a transfer between investment options available
under a variable insurance contract, subject to the terms and any specific
limitations on the exchange (or "transfer") privilege described in the contract
prospectus.
Frequent exchanges can interfere with Fund management or operations and
increase Fund costs. To protect shareholders, there are limits on the number
and amount of Fund exchanges that may be made (please see "Market Timers"
below).
================================================================================
FUND ACCOUNT POLICIES
- ---------------------
[GRAPHIC OMITTED]
CALCULATING SHARE PRICE The Funds calculate their NAV per share each business
day at the close of trading on the New York Stock Exchange (normally 1:00 p.m.
Pacific time). Each class' NAV is calculated by dividing its net assets by the
number of its shares outstanding.
The Funds' assets are generally valued at their market value, except that the
Franklin Money Market Fund's assets are generally valued at their amortized
cost. If market prices are unavailable, or if an event occurs after the close
of the trading market that materially affects the values, assets may be valued
at their fair value. If a Fund holds securities listed primarily on a foreign
exchange that trades on days when the Fund is not open for business, the value
of the shares may change on days that the insurance company shareholders cannot
buy or sell shares.
Requests to buy and sell shares are processed on any day the Funds are open for
business at the NAV next calculated after the Fund receives the request in
proper form.
STATEMENTS AND REPORTS Contract owners will receive confirmations and account
statements that show account transactions. Insurance company contract owners
will receive the Funds' financial reports every six months from their insurance
company.
If there is a dealer or other investment representative of record on the
account, he or she will also receive
2 Franklin Templeton Variable Insurance Products Trust
confirmations, account statements and other information about the contract
owner's account directly from the contract's administrator.
MARKET TIMERS The Funds may restrict or refuse investments by market timers.
The following Funds currently do not allow investments by market timers:
Franklin Aggressive Growth Securities Fund, Franklin Global Health Care
Securities Fund, Franklin High Income Fund, Franklin Rising Dividends
Securities Fund, Franklin Technology Securities Fund, Franklin Value Securities
Fund, Mutual Discovery Securities Fund, Mutual Shares Securities Fund,
Templeton Asset Strategy Fund and Templeton Developing Markets Securities Fund.
As of July 1, 2001, the following Funds also will not allow investments by
market timers: Franklin Global Communications Securities Fund, Franklin Income
Securities Fund, Franklin Large Cap Growth Securities Fund, Franklin Small Cap
Fund, Templeton Growth Securities Fund, Templeton International Securities Fund
and Templeton International Smaller Companies Fund.
You will be considered a market timer if you have (i) requested an exchange out
of the Fund within two weeks of an earlier exchange request, or (ii) exchanged
shares out of the Fund more than twice in a calendar quarter, or (iii)
exchanged shares equal to at least $5 million, or more than 1% of the Fund's
net assets, or (iv) otherwise seem to follow a timing pattern. Accounts under
common ownership or control are combined for these limits.
ADDITIONAL POLICIES Please note that the Funds maintain additional policies and
reserve certain rights, including:
. Each Fund may refuse any order to buy shares.
. At any time, the Funds may establish or change investment minimums.
. The Funds may modify or discontinue the exchange privilege on 60 days'
notice to insurance company shareholders.
. You may only buy shares of the Funds eligible for sale in your state or
jurisdiction.
. In unusual circumstances, we may temporarily suspend redemptions, or
postpone the payment of proceeds, as allowed by federal securities laws.
. To permit investors to obtain the current price, insurance companies are
responsible for transmitting all orders to the Fund promptly.
SHARE CLASSES Each Fund generally has two classes of shares, Class 1 and Class
2. Each class is identical except that Class 2 has a distribution plan or "rule
12b-1" plan which is described in prospectuses offering Class 2 shares.
================================================================================
QUESTIONS
- -----------------
[GRAPHIC OMITTED]
More detailed information about the Trust and the Funds' account policies can
be found in the Funds' Statement of Additional Information. If you have any
questions about the Funds, you can write to us at 777 Mariners Island Blvd.,
P.O. Box 7777, San Mateo, CA 94403-7777. You can also call us at
1-800/321-8563. For your protection and to help ensure we provide you with
quality service, all calls may be monitored or recorded.
3 Franklin Templeton Variable Insurance Products Trust
For More Information
The Funds of Franklin Templeton Variable Insurance Products Trust (the Trust)
are generally only available as investment options in variable annuity or
variable life insurance contracts. Please consult the accompanying contract
prospectus for information about the terms of an investment in a contract.
You can learn more about the Funds in the following documents:
ANNUAL/SEMIANNUAL FUND REPORTS TO SHAREHOLDERS
Includes a discussion of recent market conditions and investment strategies,
financial statements, detailed performance information, Fund holdings, and the
auditor's report (Annual Report only).
STATEMENT OF ADDITIONAL INFORMATION
Contains more information about the Funds, their investments, policies, and
risks. It is incorporated by reference (is legally a part of this prospectus).
For a free copy of the current annual/semiannual report or SAI, please contact
your investment representative or call us at the number below.
Franklin/registered trademark/Templeton/registered trademark/ Investments
1-800/321-8563
You also can obtain information about the Funds by visiting the SEC's Public
Reference Room in Washington, D.C. (phone 1-202/942-8090) or the EDGAR Database
on the SEC's Internet site at http://www.sec.gov. You can obtain copies of this
information, after paying a duplicating fee, by writing to the SEC's Public
Reference Section, Washington, D.C. 20549-0102 or by electronic request at the
following E-mail address: publicinfo@sec.gov.
Investment Company Act file #811-5479 Lit. Code # FTVIPI P01 5/01
Exhibit C
Prospectus
Franklin Templeton
Variable Insurance
Products Trust
Class 2 Shares
May 1, 2001
[GRAPHIC OMITTED]
As with all fund prospectuses, the SEC has not approved or disapproved these
securities or passed upon the adequacy of this prospectus. Any representation to
the contrary is a criminal offense.
Contents
FRANKLIN TEMPLETON VARIABLE
- ------------------------------INSURANCE PRODUCTS TRUST
Information about each Fund i Overview
you should know before
investing Individual Fund Description
TI-1 Templeton International
Securities Fund
Additional Information, All Funds
1 Distributions and Taxes
- ------------------------------FUND ACCOUNT INFORMATION
Information about Fund 2 Buying Shares
account transactions 2 Selling Shares
and services 2 Exchanging Shares
2 Fund Account Policies
3 Questions
- ------------------------------FOR MORE INFORMATION
Where to learn more about Back Cover
each Fund
Franklin Templeton Variable Insurance Products Trust
OVERVIEW
- --------
[GRAPHIC OMITTED]
Franklin Templeton Variable Insurance Products Trust (the Trust) currently
consists of twenty-seven (27) separate series (the Fund or Funds), offering a
wide variety of investment choices. Each Fund generally has two classes of
shares, Class 1 and Class 2. The Funds are generally only available as
investment options in variable annuity or variable life insurance contracts. The
accompanying contract prospectus indicates which Funds and classes are available
to you.
INVESTMENT CONSIDERATIONS
. Each Fund has its own investment strategy and risk profile. Generally, the
higher the expected rate of return, the greater the risk of loss.
. No single Fund can be a complete investment program; consider diversifying
your Fund choices.
. You should evaluate each Fund in relation to your personal financial
situation, investment goals, and comfort with risk. Your investment
representative can help you determine which Funds are right for you.
RISKS
. There can be no assurance that any Fund will achieve its investment goal.
. Because you could lose money by investing in a Fund, take the time to read
each Fund description and consider all risks before investing.
. All securities markets, interest rates, and currency valuations move up and
down, sometimes dramatically, and mixed with the good years can be some bad
years. Since no one can predict exactly how financial markets will perform,
you may want to exercise patience and focus not on short-term market
movements, but on your long-term investment goals.
. Fund shares are not deposits or obligations of, or guaranteed or endorsed by,
any bank, and are not federally insured by the Federal Deposit Insurance
Corporation, the Federal Reserve Board, or any other agency of the U.S.
government. Fund shares involve investment risks, including the possible loss
of principal.
More detailed information about each Fund,
its investment policies, and its particular
risks can be found in the Trust's Statement of
Additional Information (SAI).
MANAGEMENT
The Funds' investment managers and their affiliates manage over $225 billion in
assets. In 1992, Franklin joined forces with Templeton, a pioneer in
international investing. The Mutual Advisers organization became part of the
Franklin Templeton organization four years later. Today, Franklin Templeton
Investments is one of the largest mutual fund organizations in the United
States, and offers money management expertise spanning a variety of investment
objectives.
i
Templeton International Securities Fund
GOAL AND STRATEGIES
- -------------------
[LOGO]
GOAL The Fund's investment goal is long-term capital growth.
The Fund invests primarily in an international portfolio of common stocks.
MAIN INVESTMENTS Under normal market conditions, the Fund will invest at least
65% of its total assets in equity securities of companies located outside the
U.S., including those in emerging markets. While there are no set percentage
targets, the Fund generally invests in large to medium capitalization companies
with market capitalization values (share price multiplied by the number of
common stock shares outstanding) greater than $2 billion. An equity security
represents a proportionate share of the ownership of a company; its value is
based on the success of the company's business, any income paid to
stockholders, the value of its assets, and general market conditions. Common
and preferred stocks, and securities convertible into common stock are examples
of equity securities.
The Fund may from time to time have significant investments in one or more
countries or in particular sectors such as financial services.
The Fund may use various derivative strategies seeking to protect its assets,
implement a cash management strategy or enhance its returns. The Fund currently
may invest up to 5% of its total assets in swap agreements, put and call options
and collars. With derivatives, the manager attempts to predict whether an
underlying investment will increase or decrease at some future time. The manager
considers various factors, such as availability and cost, in deciding whether to
use a particular instrument or strategy.
PORTFOLIO SELECTION The manager's investment philosophy is "bottom-up,"
value-oriented, and long-term. In choosing investments, the Fund's manager will
focus on the market price of a company's securities relative to its evaluation
of the company's potential long-term earnings, asset value and cash flow. A
company's historical value measures, including price/earnings ratio, profit
margins and liquidation value, will also be considered, but are not limiting
factors.
TEMPORARY INVESTMENTS When the manager believes market or economic conditions
are unfavorable for investors, is unable to locate suitable investment
opportunities, or seeks to maintain liquidity, it may invest all or
substantially all of the Fund's assets in U.S. or non-U.S. currency short-term
investments, including cash or cash equivalents. Under these circumstances, the
Fund may temporarily be unable to pursue its investment goal.
================================================================================
MAIN RISKS
- ----------
[LOGO]
The Fund's main risks can affect the Fund's share price, its distributions or
income and, therefore, the Fund's performance.
STOCKS While stocks have historically outperformed other asset classes over the
long term, their value tends to go up and down more dramatically over the short
term. These price movements may result from factors affecting individual
companies, industries, or securities markets.
VALUE STYLE INVESTING Value stock prices are considered "cheap" relative to the
company's perceived value and are often out of favor with other investors. The
manager may invest in such stocks if it believes the market may have
overreacted to adverse developments or failed to appreciate positive changes.
However, if other investors fail to recognize the company's value (and do not
become buyers, or become sellers), or favor investing in faster-growing
companies, value stocks may not increase in value as anticipated by the manager
and may even decline further.
FOREIGN SECURITIES Investing in foreign securities typically involves more
risks than investing in U.S. securities. Certain of these risks also may apply
to securities of U.S. companies with significant foreign operations.
Currency exchange rates. Many of the Fund's investments are issued and traded
in foreign
-------------------------------------------------------------
TI-1 Templeton International Securities Fund - Class 2
-------------------------------------------------------------
currencies. Changes in foreign currencies and in currency exchange rates can
increase or dramatically decrease the Fund's returns from its foreign portfolio
holdings. The impact of the euro, a relatively new currency adopted by certain
European countries to replace their national currencies, is unclear.
Because the stocks the Fund holds fluctuate in price with foreign market
conditions and currencies, the value of your investment in the Fund will go up
and down. This means you could lose money over short or even extended periods.
Political and economic developments. The political, economic and social
structures of some countries the Fund invests in may be less stable and more
volatile than those in the U.S. The risks of investing in these countries
include the imposition of exchange controls, internal and external conflicts,
currency devaluations, foreign ownership limitations, tax increases,
restrictions on the removal of currency or other assets, nationalization of
assets, and expropriation. The Fund may have greater difficulty voting proxies,
exercising shareholder rights and pursuing legal remedies with respect to its
foreign investments.
Trading practices. Brokerage commissions and other fees generally are higher
for foreign securities. Government supervision and regulation of foreign stock
exchanges, currency markets, trading systems and brokers may be less than in
the U.S. The procedures and rules governing foreign transactions and custody
also may involve delays in payment, delivery or recovery of money or
investments.
Availability of information. Foreign companies may not be subject to the same
disclosure, accounting, auditing and financial reporting standards and
practices as U.S. companies, and there may be less publicly available
information about them.
Limited markets. Certain foreign securities may be less liquid and more
volatile than many U.S. securities, which could limit the Fund's ability to
sell them at favorable prices.
Emerging markets. The Fund's investments in emerging markets countries are
subject to all the risks of foreign investing generally, and have additional,
heightened risks due to a lack of established legal, political, business and
social frameworks to support securities markets. These countries also are more
likely to experience high levels of inflation, deflation or currency
devaluation, which can harm their economies and securities markets and increase
volatility. Short-term volatility in these markets, and declines of 50% or
more, are not unusual.
SECTOR FOCUS By focusing on particular sectors from time to time, the Fund
carries greater risk of adverse developments in a sector than a fund that
always invests in a wide variety of sectors.
Financial services companies. Financial services companies are subject to
extensive government regulation which may affect their profitability in many
ways, including by limiting the amount and types of loans and other commitments
they can make, and the interest rates and fees they can charge. A financial
services company's profitability, and therefore its stock price, is especially
sensitive to interest rate changes throughout the world as well as the ability
of borrowers to repay their loans. Changing regulations, continuing
consolidations, and development of new products and structures are all likely
to have a significant impact on financial services companies.
DERIVATIVE SECURITIES The performance of derivative investments depends, at
least in part, on the performance of an underlying asset. Derivatives involve
costs, may be volatile, and may involve a small investment relative to the risk
assumed. Their successful use will depend on the manager's ability to predict
market movements. Risks include delivery failure, default by the other party or
the inability to close out a position because the trading market becomes
illiquid.
More detailed information about the Fund, its policies, and risks can be found
in the SAI.
-------------------------------------------------------------
TI-2 Templeton International Securities Fund - Class 2
-------------------------------------------------------------
PAST PERFORMANCE
[LOGO]
This bar chart and table show the volatility of the Fund's returns, which is
one indicator of the risks of investing in the Fund. The bar chart shows
changes in the Fund's returns from year to year over the past ten calendar
years or since the Fund's inception. The table shows how the Fund's average
annual total returns compare to those of a broad-based securities market index.
Of course, past performance cannot predict or guarantee future results.
Performance reflects all Fund expenses but does not include any fees or sales
charges imposed by the variable insurance contract for which the Fund is an
investment option. If they had been included, performance would be lower.
TEMPLETON INTERNATIONAL SECURITIES FUND
CLASS 2 ANNUAL TOTAL RETURNS/1/
[GRAPH APPEARS HERE]
AVERAGE ANNUAL TOTAL RETURNS
For the periods ended December 31, 2000
Since
Inception
1 Year 5 Years 05/01/92
- -------------------------------------------------------------
Templeton International
Securities Fund
- Class 2/1/ -2.38% 13.11% 13.06%
MSCI EAFE Index/2/ -13.96% 7.43% 9.98%
Ongoing stock market volatility can dramatically change the Fund's short-term
performance; current results may differ.
1. All Fund performance assumes reinvestment of dividends and capital gains.
Performance prior to the 5/1/00 merger reflects the historical performance of
Templeton International Fund. In addition, because Class 2 shares were not
offered until 5/1/97, Class 2 Fund performance for prior periods represents the
historical results of Class 1 shares. For periods beginning on 5/1/97, Class 2's
results reflect an additional 12b-1 fee expense, which also affects future
performance.
2. Source: Standard & Poor's Micropal. The unmanaged Morgan Stanley Capital
International Europe, Australia, Far East (MSCI EAFE) Index tracks the
performance of approximately 1000 securities in 20 countries. The average
company, the securities of which are a component of that index, has a market
capitalization of over $3 billion. Indexes include reinvested dividends and/or
interest. One cannot invest directly in an index, nor is an index representative
of the Fund's investments.
--------------------------------------------------------------
TI-3 Templeton International Securities Fund - Class 2
--------------------------------------------------------------
FEES AND EXPENSES
- -----------------
[GRAPHIC]
TEMPLETON INTERNATIONAL SECURITIES FUND - CLASS 2
This table describes the fees and expenses that you may pay if you buy and hold
shares of the Fund. The table and the example do not include any fees or sales
charges imposed by the variable insurance contract for which the Fund is an
investment option. If they were included, your costs would be higher. Investors
should consult the contract prospectus or disclosure document for more
information.
SHAREHOLDER FEES
(fees paid directly from your investment)
Class 2
- ---------------------------------------------------------------
Maximum sales charge (load) imposed on purchases 0.00%
Maximum deferred sales charge (load) 0.00%
ANNUAL FUND OPERATING EXPENSES
(expenses deducted from Fund assets)
Class 2
- ----------------------------------------------------
Management fees 0.67%
Distribution and service (12b-1) fees 0.25%
Other expenses 0.20%
----
Total annual Fund operating expenses 1.12%
====
EXAMPLE
This example can help you compare the cost of investing in the Fund with the
cost of investing in other mutual funds. It assumes:
. You invest $10,000 for the periods shown;
. Your investment has a 5% return each year; and
. The Fund's operating expenses remain the same.
Although your actual costs may be higher or lower, based on these assumptions
your costs would be:
1 Year 3 Years 5 Years 10 Years
- --------------------------------------------------------
Class 2 $114 $356 $617 $1,364
================================================================================
MANAGEMENT
- ----------
[GRAPHIC]
Templeton Investment Counsel, LLC (TIC), Broward Financial Centre, Suite 2100,
Fort Lauderdale, Florida 33394, is the Fund's investment manager.
MANAGEMENT TEAM The team responsible for the Fund's management is:
Peter A. Nori, CFA Mr. Nori has been a manager of the Fund since 1999, and has been with
SENIOR VICE PRESIDENT, TIC Franklin Templeton Investments since 1987.
Mark R. Beveridge, CFA Mr. Beveridge has been a manager of the Fund since 1994, and has been
SENIOR VICE PRESIDENT, TIC with Franklin Templeton Investments since 1985.
The Fund pays TIC a fee for managing the Fund's assets. For fiscal year ended
December 31, 2000, the Fund paid 0.67% of its average daily net assets to TIC
for its services.
--------------------------------------------------------------
TI-4 Templeton International Securities Fund - Class 2
--------------------------------------------------------------
FINANCIAL HIGHLIGHTS/1/
- ---------------------
[GRAPHIC]
The financial highlights table provides further details to help you understand
the financial performance of Class 2 shares for the past five years or since
the Fund's inception. The table shows certain information on a single Fund
share basis (per share performance). It also shows some key Fund statistics,
such as total return (past performance) and expense ratios. Total return
represents the annual change in value of a share assuming reinvestment of
dividends and capital gains. This information has been audited by
PricewaterhouseCoopers LLP (PWC), independent auditors, starting with the
fiscal year ended December 31, 1999, and by other auditors for the fiscal years
before 1999. PWC's report, along with the financial statements, is included in
the Fund's Annual Report (available upon request).
Class 2 Year ended December 31,
- ---------------------------------------------------------------------------------------------------
2000 1999 1998 1997/4/
---------------------------------------------------
Per share data ($)
Net asset value, beginning of year 22.13 20.61 20.14 18.40
---------------------------------------------------
Net investment income/2/ .31 .25 .59 .07
Net realized and unrealized gains (losses) ( .90) 3.78 1.25 1.67
---------------------------------------------------
Total from investment operations ( .59) 4.03 1.84 1.74
---------------------------------------------------
Distributions from net investment income ( .38) ( .53) ( .48) --
Distributions from net realized gains (2.49) (1.98) ( .89) --
---------------------------------------------------
Total distributions (2.87) (2.51) (1.37) --
---------------------------------------------------
Net asset value, end of year 18.67 22.13 20.61 20.14
===================================================
Total return (%)/3/ (2.38) 23.23 9.08 9.46
Ratios/supplemental data
Net assets, end of year ($ x 1,000) 187,115 101,365 39,886 17,606
Ratios to average net assets: (%)
Expenses 1.12 1.10 1.11 1.13/5/
Net investment income 1.66 1.26 2.69 1.14/5/
Portfolio turnover rate (%) 32.81 30.04 29.56 16.63
1. Financial highlights for periods prior to the May 1, 2000 merger reflect the
historical information of Templeton International Fund.
2. Based on average shares outstanding effective year ended December 31, 1999.
3. Total return does not include any fees, charges or expenses imposed by the
variable annuity and life insurance contracts for which the Fund serves as an
underlying investment vehicle. If they had been included, total return would be
lower. Total return is not annualized for periods less than one year.
4. For the period May 1, 1997 (effective date) to December 31, 1997.
5. Annualized.
------------------------------------------------------------
TI-5 Templeton International Securities Fund - Class 2
------------------------------------------------------------
Additional Information, All Funds
DISTRIBUTIONS AND TAXES
- -----------------------
[GRAPHIC OMITTED]
INCOME AND CAPITAL GAINS DISTRIBUTIONS Each Fund will declare as dividends
substantially all of its net investment income. Except for the Franklin Money
Market Fund, each Fund typically pays dividends from net investment income and
net capital gains, if any, at least annually. Dividends or distributions by the
Funds will reduce the per share net asset value (NAV) by the per share amount
paid.
The Franklin Money Market Fund declares a dividend each day the Fund's NAV is
calculated, equal to all of its daily net income, payable as of the close of
business the preceding day. The amount of dividend may fluctuate from day to
day and may be omitted on some days, depending on changes in the factors that
comprise the Fund's net income.
Dividends paid by a Fund will be automatically reinvested in additional shares
of that Fund or, if requested, paid in cash to the insurance company
shareholder.
TAX CONSIDERATIONS The tax consequences for contract owners from their
investment in variable annuity or variable life insurance contracts will depend
on the provisions of these contracts. Contract owners should consult the
accompanying contract prospectus for more information on these tax
consequences.
1 Franklin Templeton Variable Insurance Products Trust
Fund Account Information
BUYING SHARES
- -----------------
[GRAPHIC OMITTED]
Shares of each Fund are sold at net asset value (NAV) to insurance company
separate accounts to serve as investment options for variable annuity or
variable life insurance contracts, and for qualified pension and retirement
plans. The Funds' Board of Trustees (Board) monitors this to be sure there are
no material conflicts of interest between the two different types of contract
owners, given their differences, including tax treatment. If there were, the
Board would take corrective action.
Contract owners' payments will be allocated by the insurance company separate
account to purchase shares of the Fund chosen by the contract owner, and are
subject to any limits or conditions in the contract. Requests to buy shares are
processed at the NAV next calculated after we receive the request in proper
form. The Funds do not issue share certificates.
================================================================================
SELLING SHARES
- -----------------
[GRAPHIC OMITTED]
Each insurance company shareholder sells shares of the applicable Fund to make
benefit or surrender payments or to execute exchanges (transfers) between
investment options under the terms of its contracts. Requests to sell shares
are processed at the NAV next calculated after the Fund receives the request in
proper form.
================================================================================
EXCHANGING SHARES
- -----------------
[GRAPHIC OMITTED]
Contract owners may exchange shares of any one class or Fund for shares of
other classes or Funds through a transfer between investment options available
under a variable insurance contract, subject to the terms and any specific
limitations on the exchange (or "transfer") privilege described in the contract
prospectus.
Frequent exchanges can interfere with Fund management or operations and
increase Fund costs. To protect shareholders, there are limits on the number
and amount of Fund exchanges that may be made (please see "Market Timers"
below).
================================================================================
FUND ACCOUNT POLICIES
- ---------------------
[GRAPHIC OMITTED]
CALCULATING SHARE PRICE The Funds calculate their NAV per share each business
day at the close of trading on the New York Stock Exchange (normally 1:00 p.m.
Pacific time). Each class' NAV is calculated by dividing its net assets by the
number of its shares outstanding.
The Funds' assets are generally valued at their market value, except that the
Franklin Money Market Fund's assets are generally valued at their amortized
cost. If market prices are unavailable, or if an event occurs after the close
of the trading market that materially affects the values, assets may be valued
at their fair value. If a Fund holds securities listed primarily on a foreign
exchange that trades on days when the Fund is not open for business, the value
of the shares may change on days that the insurance company shareholders cannot
buy or sell shares.
Requests to buy and sell shares are processed on any day the Funds are open for
business at the NAV next calculated after the Fund receives the request in
proper form.
STATEMENTS AND REPORTS Contract owners will receive confirmations and account
statements that show account transactions. Insurance company contract owners
will receive the Funds' financial reports every six months from their insurance
company.
If there is a dealer or other investment representative of record on the
account, he or she will also receive
2 Franklin Templeton Variable Insurance Products Trust
confirmations, account statements and other information about the contract
owner's account directly from the contract's administrator.
MARKET TIMERS The Funds may restrict or refuse investments by market timers.
The following Funds currently do not allow investments by market timers:
Franklin Aggressive Growth Securities Fund, Franklin Global Health Care
Securities Fund, Franklin High Income Fund, Franklin Rising Dividends
Securities Fund, Franklin Technology Securities Fund, Franklin Value Securities
Fund, Mutual Discovery Securities Fund, Mutual Shares Securities Fund,
Templeton Asset Strategy Fund and Templeton Developing Markets Securities Fund.
As of July 1, 2001, the following Funds also will not allow investments by
market timers: Franklin Global Communications Securities Fund, Franklin Income
Securities Fund, Franklin Large Cap Growth Securities Fund, Franklin Small Cap
Fund, Templeton Growth Securities Fund, Templeton International Securities Fund
and Templeton International Smaller Companies Fund.
You will be considered a market timer if you have (i) requested an exchange out
of the Fund within two weeks of an earlier exchange request, or (ii) exchanged
shares out of the Fund more than twice in a calendar quarter, or (iii)
exchanged shares equal to at least $5 million, or more than 1% of the Fund's
net assets, or (iv) otherwise seem to follow a timing pattern. Accounts under
common ownership or control are combined for these limits.
ADDITIONAL POLICIES Please note that the Funds maintain additional policies and
reserve certain rights, including:
. Each Fund may refuse any order to buy shares.
. At any time, the Funds may establish or change investment minimums.
. The Funds may modify or discontinue the exchange privilege on 60 days'
notice to insurance company shareholders.
. You may only buy shares of the Funds eligible for sale in your state or
jurisdiction.
. In unusual circumstances, we may temporarily suspend redemptions, or
postpone the payment of proceeds, as allowed by federal securities laws.
. To permit investors to obtain the current price, insurance companies are
responsible for transmitting all orders to the Fund promptly.
SHARE CLASSES Each Fund generally has two classes of shares, Class 1 and Class
2. Each class is identical except that Class 2 has a distribution plan or "rule
12b-1" plan which is described in below.
Distribution and service (12b-1) fees. Class 2 has a distribution plan,
sometimes known as a rule 12b-1 plan, that allows the Funds to pay distribution
fees to those who sell and distribute Class 2 shares and provide services to
shareholders and contract owners. Because these fees are paid out of Class 2's
assets on an on-going basis, over time these fees will increase the cost of an
investment, and may cost you more than paying other types of sales charges.
While the maximum amount payable under most Funds' Class 2 rule 12b-1 plan is
0.35% per year of a Fund's average net assets, the Board of Trustees has set the
current rate at 0.25%. However, Franklin S&P 500 Index Fund, Franklin Strategic
Income Securities Fund, Templeton Asset Strategy Fund, Templeton Developing
Markets Securities Fund, Templeton Global Income Securities Fund and Templeton
International Securities Fund each have a maximum rule 12b-1 plan fee of 0.25%
per year. A portion of the fees payable to Franklin Templeton Distributors, Inc.
(Distributors) or others under the rule 12b-1 plan may be retained by
Distributors for distribution expenses.
================================================================================
QUESTIONS
- -----------------
[GRAPHIC OMITTED]
More detailed information about the Trust and the Funds' account policies can
be found in the Funds' Statement of Additional Information. If you have any
questions about the Funds, you can write to us at 777 Mariners Island Blvd.,
P.O. Box 7777, San Mateo, CA 94403-7777. You can also call us at
1-800/321-8563. For your protection and to help ensure we provide you with
quality service, all calls may be monitored or recorded.
3 Franklin Templeton Variable Insurance Products Trust
For More Information
The Funds of Franklin Templeton Variable Insurance Products Trust (the Trust)
are generally only available as investment options in variable annuity or
variable life insurance contracts. Please consult the accompanying contract
prospectus for information about the terms of an investment in a contract.
You can learn more about the Funds in the following documents:
ANNUAL/SEMIANNUAL FUND REPORTS TO SHAREHOLDERS
Includes a discussion of recent market conditions and investment strategies,
financial statements, detailed performance information, Fund holdings, and the
auditor's report (Annual Report only).
STATEMENT OF ADDITIONAL INFORMATION
Contains more information about the Funds, their investments, policies, and
risks. It is incorporated by reference (is legally a part of this prospectus).
For a free copy of the current annual/semiannual report or SAI, please contact
your investment representative or call us at the number below.
Franklin/registered trademark/Templeton/registered trademark/ Investments
1-800/321-8563
You also can obtain information about the Funds by visiting the SEC's Public
Reference Room in Washington, D.C. (phone 1-202/942-8090) or the EDGAR Database
on the SEC's Internet site at http://www.sec.gov. You can obtain copies of this
information, after paying a duplicating fee, by writing to the SEC's Public
Reference Section, Washington, D.C. 20549-0102 or by electronic request at the
following E-mail address: publicinfo@sec.gov.
Investment Company Act file #811-5479 Lit. Code # FTVIPI P01 5/01
Exhibit D
Prospectus
Franklin Templeton
Variable Insurance
Products Trust
Class 1 Shares
May 1, 2001
[GRAPHIC OMITTED]
As with all fund prospectuses, the SEC has not approved or disapproved these
securities or passed upon the adequacy of this prospectus. Any representation to
the contrary is a criminal offense.
Contents
FRANKLIN TEMPLETON VARIABLE
- ------------------------------INSURANCE PRODUCTS TRUST
Information about each Fund i Overview
you should know before
investing Individual Fund Description
TIS-1 Templeton International
Smaller Companies Fund
Additional Information,
All Funds
1 Distributions and Taxes
- ------------------------------FUND ACCOUNT INFORMATION
Information about Fund 2 Buying Shares
account transactions 2 Selling Shares
and services 2 Exchanging Shares
2 Fund Account Policies
3 Questions
- ------------------------------FOR MORE INFORMATION
Where to learn more about Back Cover
each Fund
Franklin Templeton
Variable Insurance Products Trust
OVERVIEW
- --------
[GRAPHIC OMITTED]
Franklin Templeton Variable Insurance Products Trust (the Trust) currently
consists of twenty-seven (27) separate series (the Fund or Funds), offering a
wide variety of investment choices. Each Fund generally has two classes of
shares, Class 1 and Class 2. The Funds are generally only available as
investment options in variable annuity or variable life insurance contracts. The
accompanying contract prospectus indicates which Funds and classes are available
to you.
INVESTMENT CONSIDERATIONS
. Each Fund has its own investment strategy and risk profile. Generally, the
higher the expected rate of return, the greater the risk of loss.
. No single Fund can be a complete investment program; consider diversifying
your Fund choices.
. You should evaluate each Fund in relation to your personal financial
situation, investment goals, and comfort with risk. Your investment
representative can help you determine which Funds are right for you.
RISKS
. There can be no assurance that any Fund will achieve its investment goal.
. Because you could lose money by investing in a Fund, take the time to read
each Fund description and consider all risks before investing.
. All securities markets, interest rates, and currency valuations move up and
down, sometimes dramatically, and mixed with the good years can be some bad
years. Since no one can predict exactly how financial markets will perform,
you may want to exercise patience and focus not on short-term market
movements, but on your long-term investment goals.
. Fund shares are not deposits or obligations of, or guaranteed or endorsed
by, any bank, and are not federally insured by the Federal Deposit
Insurance Corporation, the Federal Reserve Board, or any other agency of
the U.S. government. Fund shares involve investment risks, including the
possible loss of principal.
More detailed information about each Fund,
its investment policies, and its particular
risks can be found in the Trust's Statement of
Additional Information (SAI).
MANAGEMENT
The Funds' investment managers and their affiliates manage over $225 billion in
assets. In 1992, Franklin joined forces with Templeton, a pioneer in
international investing. The Mutual Advisers organization became part of the
Franklin Templeton organization four years later. Today, Franklin Templeton
Investments is one of the largest mutual fund organizations in the United
States, and offers money management expertise spanning a variety of investment
objectives.
i
Templeton International Smaller Companies Fund
GOAL AND STRATEGIES
- -------------------
[LOGO]
GOAL The Fund's investment goal is long-term capital appreciation.
The Fund invests primarily in the common stocks of smaller companies outside
the U.S.
MAIN INVESTMENTS Under normal market conditions, the Fund will invest at least
65% of its total assets in the equity securities of smaller companies located
outside the U.S., including those in emerging markets. Smaller companies
generally are those with market capitalization values (share price multiplied by
the number of common stock shares outstanding) of less than $2 billion, at the
time of purchase. An equity security represents a proportionate share of the
ownership of a company; its value is based on the success of the company's
business, any income paid to stockholders, the value of its assets, and general
market conditions. Common and preferred stocks, and securities convertible into
common stock are examples of equity securities.
In addition to the Fund's main investments, the Fund may also invest in equity
securities of larger capitalization companies located outside the U.S.
The Fund may use various derivative strategies seeking to protect its assets,
implement a cash management strategy or enhance its returns. The Fund currently
may invest up to 5% of its total assets in swap agreements, put and call
options and collars. With derivatives, the manager attempts to predict whether
an underlying investment will increase or decrease at some future time. The
manager considers various factors, such as availability and cost, in deciding
whether to use a particular instrument or strategy.
PORTFOLIO SELECTION The manager's investment philosophy is "bottom-up,"
value-oriented, and long-term. In choosing equity investments, the Fund's
manager will focus on the market price of a company's securities relative to
its evaluation of the company's potential long-term earnings, asset value and
cash flow. A company's historical value measures, including price/earnings
ratio, profit margins and liquidation value, will also be considered, but are
not limiting factors. The Fund may, from time to time, have significant
investments in one or more countries, sectors or industries.
TEMPORARY INVESTMENTS When the manager believes market or economic conditions
are unfavorable for investors, is unable to locate suitable investment
opportunities, or seeks to maintain liquidity, it may invest all or
substantially all of the Fund's assets in U.S. or non-U.S. currency
investments. Such investments may be medium-term (less than 5 years for this
Fund) or short-term, including cash or cash equivalents. Under these
circumstances, the Fund may temporarily be unable to pursue its investment
goal.
================================================================================
[LOGO]
MAIN RISKS
- -----------
The Fund's main risks can affect the Fund's share price, its distributions or
income and, therefore, the Fund's performance.
STOCKS While stocks have historically outperformed other asset classes over the
long term, their value tends to go up and down more dramatically over the short
term. These price movements may result from factors affecting individual
companies, industries, or securities markets.
VALUE STYLE INVESTING Value stock prices are considered "cheap" relative to the
company's perceived value and are often out of favor with other investors. The
manager may invest in such stocks if it believes the market may have
overreacted to adverse developments or failed to appreciate positive changes.
However, if other investors fail to recognize the company's value (and do not
become buyers, or become sellers), or favor investing in faster-growing
companies, value stocks may not increase in value as anticipated by the manager
and may even decline further.
SMALLER COMPANIES While smaller companies may offer opportunities for capital
growth, they also have significant risk. Historically, smaller company
securities have been more volatile in price and have fluctuated independently
from larger company securities, especially over the short term. Smaller or
--------------------------------------------------------------
TIS-1 Templeton International Smaller Companies Fund - Class 1
--------------------------------------------------------------
relatively new companies can be particularly sensitive to changing economic
conditions, including increases in interest rates because it may be more
difficult for them to make interest payments or to obtain credit to expand, and
their growth prospects may be less certain.
Because the stocks the Fund holds fluctuate in price with foreign market
conditions and currencies, the value of your investment in the Fund will go up
and down. This means you could lose money over short or even extended periods.
For example, smaller companies may lack depth of management or may have limited
financial resources for growth or development. They may have limited product
lines or market share. Smaller companies may be in new industries, or their new
products or services may not find an established market or may rapidly become
obsolete. Smaller companies' securities may be less liquid which may adversely
affect their price. Investments in these companies may be considered
speculative.
FOREIGN SECURITIES Investing in foreign securities typically involves more
risks than investing in U.S. securities. Certain of these risks also may apply
to securities of U.S. companies with significant foreign operations.
Currency exchange rates. Many of the Fund's investments are issued and traded
in foreign currencies. Changes in foreign currencies and in currency exchange
rates can increase or dramatically decrease the Fund's returns from its foreign
--- ------------
portfolio holdings. The impact of the euro, a relatively new currency adopted
by certain European countries to replace their national currencies, is unclear.
Political and economic developments. The political, economic and social
structures of some countries the Fund invests in may be less stable and more
volatile than those in the U.S. The risks of investing in these countries
include the imposition of exchange controls, internal and external conflicts,
currency devaluations, foreign ownership limitations, tax increases,
restrictions on the removal of currency or other assets, nationalization of
assets, and expropriation. The Fund may have greater difficulty voting proxies,
exercising shareholder rights and pursuing legal remedies with respect to its
foreign investments.
Trading practices. Brokerage commissions and other fees generally are higher
for foreign securities. Government supervision and regulation of foreign stock
exchanges, currency markets, trading systems and brokers may be less than in
the U.S. The procedures and rules governing foreign transactions and custody
also may involve delays in payment, delivery or recovery of money or
investments.
Availability of information. Foreign companies may not be subject to the same
disclosure, accounting, auditing and financial reporting standards and
practices as U.S. companies, and there may be less publicly available
information about them.
Limited markets. Certain foreign securities may be less liquid and more
volatile than many U.S. securities, which could limit the Fund's ability to
sell them at favorable prices.
Emerging markets. The Fund's investments in emerging markets countries are
subject to all the risks of foreign investing generally, and have additional,
heightened risks due to a lack of established legal, political, business and
social frameworks to support securities markets. These countries also are more
likely to experience high levels of inflation, deflation or currency
devaluation, which can harm their economies and securities markets and increase
volatility. Short-term volatility in these markets, and declines of 50% or
more, are not unusual.
INTEREST RATE Rate changes can be sudden and unpredictable. Increases in
interest rates may have an effect on the types of companies in which the Fund
normally invests because they may find it more difficult to obtain credit to
expand, or may have more difficulty meeting interest payments. Similarly,
emerging market economies may be especially sensitive to interest rate changes.
DERIVATIVE SECURITIES The performance of derivative investments depends, at
least in part, on the performance of an underlying asset. Derivatives involve
costs, may be volatile, and may involve a small investment relative to the risk
assumed. Their successful use will depend on the manager's ability to predict
market movements. Risks include delivery failure, default by the other party or
the inability to close out a position because the trading market becomes
illiquid.
More detailed information about the Fund, its policies, and risks can be found
in the SAI.
--------------------------------------------------------------
TIS-2 Templeton International Smaller Companies Fund - Class 1
--------------------------------------------------------------
PAST PERFORMANCE
- ----------------
[LOGO]
This bar chart and table show the volatility of the Fund's returns, which is
one indicator of the risks of investing in the Fund. The bar chart shows
changes in the Fund's returns from year to year over the past ten calendar
years or since the Fund's inception. The table shows how the Fund's average
annual total returns compare to those of a broad-based securities market index.
Of course, past performance cannot predict or guarantee future results.
Performance reflects all Fund expenses but does not include any fees or sales
charges imposed by the variable insurance contract for which the Fund is an
investment option. If they had been included, performance would be lower.
TEMPLETON INTERNATIONAL SMALLER COMPANIES FUND
CLASS 1 ANNUAL TOTAL RETURNS/1/
[GRAPH APPEARS HERE]
Best Quarter: Worst Quarter:
Q2 '99 Q3 '98
15.81% -19.96%
AVERAGE ANNUAL TOTAL RETURNS
For the periods ended December 31, 2000
Since
Inception
1 Year 05/01/96
- --------------------------------------------------------------------------------
Templeton International Smaller
Companies Fund - Class 1/1/ -1.03% 3.83%
Salomon Global Ex-U.S.
Less than $1 Billion Index/2/ -16.62% -2.27%
Salomon Global Ex-U.S.
Less than $2 Billion Custom Index/2,3/ -14.28% -1.37%
Ongoing stock market volatility can dramatically change the Fund's short term
performance; current results may differ.
1. All Fund performance assumes reinvestment of dividends and capital gains.
2. Source: Standard & Poor's(R) Micropal. The Salomon Smith Barney Global
Ex-U.S. Less Than $1 Billion Index includes companies from developed and
emerging markets, excluding the U.S., with a market capitalization below U.S.
$1 billion. The Salomon Smith Barney Global Ex-U.S. Less Than $2 Billion Index
includes companies from developed and emerging markets, excluding the U.S., with
a market capitalization below U.S. $2 billion. Indexes include reinvested
dividends and/or interest. One cannot invest directly in an index, nor is an
index representative of the Fund's investments.
3. We are replacing Salomon Smith Barney Global Ex-U.S. less than $1 Billion
Index with Salomon Smith Barney Global Ex-U.S. less than $2 Billion Index as the
new index better reflects the Fund's holdings.
--------------------------------------------------------------
TIS-3 Templeton International Smaller Companies Fund - Class 1
--------------------------------------------------------------
FEES AND EXPENSES
- -----------------
[LOGO]
TEMPLETON INTERNATIONAL SMALLER COMPANIES FUND - CLASS 1
This table describes the fees and expenses that you may pay if you buy and hold
shares of the Fund. The table and the example do not include any fees or sales
charges imposed by the variable insurance contract for which the Fund is an
investment option. If they were included, your costs would be higher. Investors
should consult the contract prospectus or disclosure document for more
information.
SHAREHOLDER FEES
(fees paid directly from your investment)
Class 1
- --------------------------------------------------------------------------------
Maximum sales charge (load) imposed on purchases 0.00%
Maximum deferred sales charge (load) 0.00%
ANNUAL FUND OPERATING EXPENSES
(expenses deducted from Fund assets)
Class 1
- --------------------------------------------------------------------------------
management fees 0.85%
Other expenses 0.27%
----
Total annual Fund operating expenses 1.12%
====
EXAMPLE
This example can help you compare the cost of investing in the Fund with the
cost of investing in other mutual funds. It assumes:
. You invest $10,000 for the periods shown;
. Your investment has a 5% return each year; and
. The Fund's operating expenses remain the same.
Although your actual costs may be higher or lower, based on these assumptions
your costs would be:
1 Year 3 Years 5 Years 10 Years
- --------------------------------------------------------------------------------
Class 1 $114 $356 $617 $1,363
================================================================================
MANAGEMENT
- ----------
[LOGO]
Templeton Investment Counsel, LLC (TIC), Broward Financial Centre, Suite 2100,
Fort Lauderdale, Florida 33394, is the Fund's investment manager.
Under an agreement with TIC, Templeton Asset Management Ltd. (TAML), Two
Exchange Square, Hong Kong, serves as the Fund's sub-advisor. TAML provides TIC
with investment management advice and assistance.
MANAGEMENT TEAM The team responsible for the Fund's management is:
Simon Rudolph Mr. Rudolph has been a manager of the Fund since 1997. Before joining
SENIOR VICE PRESIDENT, TIC Franklin Templeton Investments in 1997, he was an executive director
PORTFOLIO MANAGER, TAML with Morgan Stanley.
Tucker Scott, CFA Mr. Scott has been a manager of the Fund since 2000, and has been with
VICE PRESIDENT, TIC Franklin Templeton Investments since 1996.
Cindy L. Sweeting, CFA Ms. Sweeting has been a manager of the Fund since January 2001. Before
SENIOR VICE PRESIDENT, TIC joining Franklin Templeton Investments in 1997, she was Vice President
of Investments with McDermott International Investments Co., Inc. in
Nassau, Bahamas.
The Fund pays TIC a fee for managing the Fund's assets. For the fiscal year
ended December 31, 2000, the Fund paid 0.85% of its average daily net assets to
TIC for its services.
--------------------------------------------------------------
TIS-4 Templeton International Smaller Companies Fund - Class 1
--------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- --------------------
[LOGO]
The financial highlights table provides further details to help you understand
the financial performance of Class 1 shares for the past five years or since
the Fund's inception. The table shows certain information on a single Fund
share basis (per share performance). It also shows some key Fund statistics,
such as total return (past performance) and expense ratios. Total return
represents the annual change in value of a share assuming reinvestment of
dividends and capital gains. This information has been audited by
PricewaterhouseCoopers LLP, independent auditors. Their report, along with the
financial statements, is included in the Fund's Annual Report (available upon
request).
Class 1 Year ended December 31,
- ---------------------------------------------------------------------------------------------------------------
2000 1999 1998 1997 1996/3/
- ---------------------------------------------------------------------------------------------------------------
Per share data ($)
Net asset value, beginning of year 11.07 9.20 11.02 11.25 10.00
------------------------------------------------------------
Net investment income/1/ .29 .26 .25 .23 .10
Net realized and unrealized gains (losses) (.39) 1.93 (1.52) (.39) 1.15
------------------------------------------------------------
Total from investment operations (.10) 2.19 (1.27) (.16) 1.25
------------------------------------------------------------
Distributions from net investment income (.20) (.32) (.25) (.07) --
Distributions from net realized gains -- -- (.30) -- --
------------------------------------------------------------
Total distributions (.20) (.32) (.55) (.07) --
------------------------------------------------------------
Net asset value, end of year 10.77 11.07 9.20 11.02 11.25
============================================================
Total return (%)/2/ (1.03) 23.90 (12.27) (1.50) 12.50
Ratios/supplemental data
Net assets, end of year ($ x 1,000) 19,983 23,541 24,999 32,201 16,255
Ratios to average net assets: (%)
Expenses 1.12 1.11 1.10 1.06 1.16/4/
Net investment income 2.63 2.52 2.26 2.74 2.51/4/
Portfolio turnover rate (%) 29.58 15.80 18.45 21.38 --
1. Based on average shares outstanding effective year ended December 31, 1999.
2. Total return does not include any fees, charges or expenses imposed by the
variable annuity and life insurance contracts for which the Fund serves as an
underlying investment vehicle. If they had been included, total return would be
lower. Total return is not annualized for periods less than one year.
3. For the period May 1, 1996 (effective date) to December 31, 1996.
4. Annualized.
--------------------------------------------------------------
TIS-5 Templeton International Smaller Companies Fund - Class 1
--------------------------------------------------------------
Additional Information, All Funds
DISTRIBUTIONS AND TAXES
- -----------------------
[GRAPHIC OMITTED]
INCOME AND CAPITAL GAINS DISTRIBUTIONS Each Fund will declare as dividends
substantially all of its net investment income. Except for the Franklin Money
Market Fund, each Fund typically pays dividends from net investment income and
net capital gains, if any, at least annually. Dividends or distributions by the
Funds will reduce the per share net asset value (NAV) by the per share amount
paid.
The Franklin Money Market Fund declares a dividend each day the Fund's NAV is
calculated, equal to all of its daily net income, payable as of the close of
business the preceding day. The amount of dividend may fluctuate from day to
day and may be omitted on some days, depending on changes in the factors that
comprise the Fund's net income.
Dividends paid by a Fund will be automatically reinvested in additional shares
of that Fund or, if requested, paid in cash to the insurance company
shareholder.
TAX CONSIDERATIONS The tax consequences for contract owners from their
investment in variable annuity or variable life insurance contracts will depend
on the provisions of these contracts. Contract owners should consult the
accompanying contract prospectus for more information on these tax
consequences.
1 Franklin Templeton Variable Insurance Products Trust
Fund Account Information
BUYING SHARES
- -----------------
[GRAPHIC OMITTED]
Shares of each Fund are sold at net asset value (NAV) to insurance company
separate accounts to serve as investment options for variable annuity or
variable life insurance contracts, and for qualified pension and retirement
plans. The Funds' Board of Trustees (Board) monitors this to be sure there are
no material conflicts of interest between the two different types of contract
owners, given their differences, including tax treatment. If there were, the
Board would take corrective action.
Contract owners' payments will be allocated by the insurance company separate
account to purchase shares of the Fund chosen by the contract owner, and are
subject to any limits or conditions in the contract. Requests to buy shares are
processed at the NAV next calculated after we receive the request in proper
form. The Funds do not issue share certificates.
================================================================================
SELLING SHARES
- -----------------
[GRAPHIC OMITTED]
Each insurance company shareholder sells shares of the applicable Fund to make
benefit or surrender payments or to execute exchanges (transfers) between
investment options under the terms of its contracts. Requests to sell shares
are processed at the NAV next calculated after the Fund receives the request in
proper form.
================================================================================
EXCHANGING SHARES
- -----------------
[GRAPHIC OMITTED]
Contract owners may exchange shares of any one class or Fund for shares of
other classes or Funds through a transfer between investment options available
under a variable insurance contract, subject to the terms and any specific
limitations on the exchange (or "transfer") privilege described in the contract
prospectus.
Frequent exchanges can interfere with Fund management or operations and
increase Fund costs. To protect shareholders, there are limits on the number
and amount of Fund exchanges that may be made (please see "Market Timers"
below).
================================================================================
FUND ACCOUNT POLICIES
- ---------------------
[GRAPHIC OMITTED]
CALCULATING SHARE PRICE The Funds calculate their NAV per share each business
day at the close of trading on the New York Stock Exchange (normally 1:00 p.m.
Pacific time). Each class' NAV is calculated by dividing its net assets by the
number of its shares outstanding.
The Funds' assets are generally valued at their market value, except that the
Franklin Money Market Fund's assets are generally valued at their amortized
cost. If market prices are unavailable, or if an event occurs after the close
of the trading market that materially affects the values, assets may be valued
at their fair value. If a Fund holds securities listed primarily on a foreign
exchange that trades on days when the Fund is not open for business, the value
of the shares may change on days that the insurance company shareholders cannot
buy or sell shares.
Requests to buy and sell shares are processed on any day the Funds are open for
business at the NAV next calculated after the Fund receives the request in
proper form.
STATEMENTS AND REPORTS Contract owners will receive confirmations and account
statements that show account transactions. Insurance company contract owners
will receive the Funds' financial reports every six months from their insurance
company.
If there is a dealer or other investment representative of record on the
account, he or she will also receive
2 Franklin Templeton Variable Insurance Products Trust
confirmations, account statements and other information about the contract
owner's account directly from the contract's administrator.
MARKET TIMERS The Funds may restrict or refuse investments by market timers.
The following Funds currently do not allow investments by market timers:
Franklin Aggressive Growth Securities Fund, Franklin Global Health Care
Securities Fund, Franklin High Income Fund, Franklin Rising Dividends
Securities Fund, Franklin Technology Securities Fund, Franklin Value Securities
Fund, Mutual Discovery Securities Fund, Mutual Shares Securities Fund,
Templeton Asset Strategy Fund and Templeton Developing Markets Securities Fund.
As of July 1, 2001, the following Funds also will not allow investments by
market timers: Franklin Global Communications Securities Fund, Franklin Income
Securities Fund, Franklin Large Cap Growth Securities Fund, Franklin Small Cap
Fund, Templeton Growth Securities Fund, Templeton International Securities Fund
and Templeton International Smaller Companies Fund.
You will be considered a market timer if you have (i) requested an exchange out
of the Fund within two weeks of an earlier exchange request, or (ii) exchanged
shares out of the Fund more than twice in a calendar quarter, or (iii)
exchanged shares equal to at least $5 million, or more than 1% of the Fund's
net assets, or (iv) otherwise seem to follow a timing pattern. Accounts under
common ownership or control are combined for these limits.
ADDITIONAL POLICIES Please note that the Funds maintain additional policies and
reserve certain rights, including:
. Each Fund may refuse any order to buy shares.
. At any time, the Funds may establish or change investment minimums.
. The Funds may modify or discontinue the exchange privilege on 60 days'
notice to insurance company shareholders.
. You may only buy shares of the Funds eligible for sale in your state or
jurisdiction.
. In unusual circumstances, we may temporarily suspend redemptions, or
postpone the payment of proceeds, as allowed by federal securities laws.
. To permit investors to obtain the current price, insurance companies are
responsible for transmitting all orders to the Fund promptly.
SHARE CLASSES Each Fund generally has two classes of shares, Class 1 and Class
2. Each class is identical except that Class 2 has a distribution plan or "rule
12b-1" plan which is described in prospectuses offering Class 2 shares.
================================================================================
QUESTIONS
- -----------------
[GRAPHIC OMITTED]
More detailed information about the Trust and the Funds' account policies can
be found in the Funds' Statement of Additional Information. If you have any
questions about the Funds, you can write to us at 777 Mariners Island Blvd.,
P.O. Box 7777, San Mateo, CA 94403-7777. You can also call us at
1-800/321-8563. For your protection and to help ensure we provide you with
quality service, all calls may be monitored or recorded.
3 Franklin Templeton Variable Insurance Products Trust
For More Information
The Funds of Franklin Templeton Variable Insurance Products Trust (the Trust)
are generally only available as investment options in variable annuity or
variable life insurance contracts. Please consult the accompanying contract
prospectus for information about the terms of an investment in a contract.
You can learn more about the Funds in the following documents:
ANNUAL/SEMIANNUAL FUND REPORTS TO SHAREHOLDERS
Includes a discussion of recent market conditions and investment strategies,
financial statements, detailed performance information, Fund holdings, and the
auditor's report (Annual Report only).
STATEMENT OF ADDITIONAL INFORMATION
Contains more information about the Funds, their investments, policies, and
risks. It is incorporated by reference (is legally a part of this prospectus).
For a free copy of the current annual/semiannual report or SAI, please contact
your investment representative or call us at the number below.
Franklin/registered trademark/Templeton/registered trademark/ Investments
1-800/321-8563
You also can obtain information about the Funds by visiting the SEC's Public
Reference Room in Washington, D.C. (phone 1-202/942-8090) or the EDGAR Database
on the SEC's Internet site at http://www.sec.gov. You can obtain copies of this
information, after paying a duplicating fee, by writing to the SEC's Public
Reference Section, Washington, D.C. 20549-0102 or by electronic request at the
following E-mail address: publicinfo@sec.gov.
Investment Company Act file #811-5479 Lit. Code # FTVIPI P01 5/01
EXHIBIT E
Prospectus
Franklin Templeton
Variable Insurance
Products Trust
Class 2 Shares
May 1, 2001
[GRAPHIC OMITTED]
As with all fund prospectuses, the SEC has not approved or disapproved these
securities or passed upon the adequacy of this prospectus. Any representation to
the contrary is a criminal offense.
Contents
FRANKLIN TEMPLETON VARIABLE
- ------------------------------INSURANCE PRODUCTS TRUST
Information about each Fund i Overview
you should know before
investing Individual Fund Description
TIS-1 Templeton International
Smaller Companies Fund
Additional Information, All Funds
1 Distributions and Taxes
- ------------------------------FUND ACCOUNT INFORMATION
Information about Fund 2 Buying Shares
account transactions 2 Selling Shares
and services 2 Exchanging Shares
2 Fund Account Policies
3 Questions
- ------------------------------FOR MORE INFORMATION
Where to learn more about Back Cover
each Fund
Franklin Templeton Variable Insurance Products Trust
OVERVIEW
- --------
[GRAPHIC OMITTED]
Franklin Templeton Variable Insurance Products Trust (the Trust) currently
consists of twenty-seven (27) separate series (the Fund or Funds), offering a
wide variety of investment choices. Each Fund generally has two classes of
shares, Class 1 and Class 2. The Funds are generally only available as
investment options in variable annuity or variable life insurance contracts. The
accompanying contract prospectus indicates which Funds and classes are available
to you.
INVESTMENT CONSIDERATIONS
. Each Fund has its own investment strategy and risk profile. Generally, the
higher the expected rate of return, the greater the risk of loss.
. No single Fund can be a complete investment program; consider diversifying
your Fund choices.
. You should evaluate each Fund in relation to your personal financial
situation, investment goals, and comfort with risk. Your investment
representative can help you determine which Funds are right for you.
RISKS
. There can be no assurance that any Fund will achieve its investment goal.
. Because you could lose money by investing in a Fund, take the time to read
each Fund description and consider all risks before investing.
. All securities markets, interest rates, and currency valuations move up and
down, sometimes dramatically, and mixed with the good years can be some bad
years. Since no one can predict exactly how financial markets will perform,
you may want to exercise patience and focus not on short-term market
movements, but on your long-term investment goals.
. Fund shares are not deposits or obligations of, or guaranteed or endorsed
by, any bank, and are not federally insured by the Federal Deposit
Insurance Corporation, the Federal Reserve Board, or any other agency of
the U.S. government. Fund shares involve investment risks, including the
possible loss of principal.
More detailed information about each Fund,
its investment policies, and its particular
risks can be found in the Trust's Statement of
Additional Information (SAI).
MANAGEMENT
The Funds' investment managers and their affiliates manage over $225 billion in
assets. In 1992, Franklin joined forces with Templeton, a pioneer in
international investing. The Mutual Advisers organization became part of the
Franklin Templeton organization four years later. Today, Franklin Templeton
Investments is one of the largest mutual fund organizations in the United
States, and offers money management expertise spanning a variety of investment
objectives.
i
Templeton International Smaller Companies Fund
GOAL AND STRATEGIES
- -------------------
[LOGO]
GOAL The Fund's investment goal is long-term capital appreciation.
The Fund invests primarily in the common stocks of smaller companies outside
the U.S.
MAIN INVESTMENTS Under normal market conditions, the Fund will invest at least
65% of its total assets in the equity securities of smaller companies located
outside the U.S., including those in emerging markets. Smaller companies
generally are those with market capitalization values (share price multiplied by
the number of common stock shares outstanding) of less than $2 billion, at the
time of purchase. An equity security represents a proportionate share of the
ownership of a company; its value is based on the success of the company's
business, any income paid to stockholders, the value of its assets, and general
market conditions. Common and preferred stocks, and securities convertible into
common stock are examples of equity securities.
In addition to the Fund's main investments, the Fund may also invest in equity
securities of larger capitalization companies located outside the U.S.
The Fund may use various derivative strategies seeking to protect its assets,
implement a cash management strategy or enhance its returns. The Fund currently
may invest up to 5% of its total assets in swap agreements, put and call
options and collars. With derivatives, the manager attempts to predict whether
an underlying investment will increase or decrease at some future time. The
manager considers various factors, such as availability and cost, in deciding
whether to use a particular instrument or strategy.
PORTFOLIO SELECTION The manager's investment philosophy is "bottom-up,"
value-oriented, and long-term. In choosing equity investments, the Fund's
manager will focus on the market price of a company's securities relative to
its evaluation of the company's potential long-term earnings, asset value and
cash flow. A company's historical value measures, including price/earnings
ratio, profit margins and liquidation value, will also be considered, but are
not limiting factors. The Fund may, from time to time, have significant
investments in one or more countries, sectors or industries.
TEMPORARY INVESTMENTS When the manager believes market or economic conditions
are unfavorable for investors, is unable to locate suitable investment
opportunities, or seeks to maintain liquidity, it may invest all or
substantially all of the Fund's assets in U.S. or non-U.S. currency
investments. Such investments may be medium-term (less than 5 years for this
Fund) or short-term, including cash or cash equivalents. Under these
circumstances, the Fund may temporarily be unable to pursue its investment
goal.
================================================================================
MAIN RISKS
- -----------
[LOGO]
The Fund's main risks can affect the Fund's share price, its distributions or
income and, therefore, the Fund's performance.
STOCKS While stocks have historically outperformed other asset classes over the
long term, their value tends to go up and down more dramatically over the short
term. These price movements may result from factors affecting individual
companies, industries, or securities markets.
VALUE STYLE INVESTING Value stock prices are considered "cheap" relative to the
company's perceived value and are often out of favor with other investors. The
manager may invest in such stocks if it believes the market may have
overreacted to adverse developments or failed to appreciate positive changes.
However, if other investors fail to recognize the company's value (and do not
become buyers, or become sellers), or favor investing in faster-growing
companies, value stocks may not increase in value as anticipated by the manager
and may even decline further.
SMALLER COMPANIES While smaller companies may offer opportunities for capital
growth, they also have significant risk. Historically, smaller company
securities have been more volatile in price and have fluctuated independently
from larger company securities, especially over the short term. Smaller or
--------------------------------------------------------------
TIS-1 Templeton International Smaller Companies Fund - Class 2
--------------------------------------------------------------
relatively new companies can be particularly sensitive to changing economic
conditions, including increases in interest rates because it may be more
difficult for them to make interest payments or to obtain credit to expand, and
their growth prospects may be less certain.
Because the stocks the Fund holds fluctuate in price with foreign market
conditions and currencies, the value of your investment in the Fund will go up
and down. This means you could lose money over short or even extended periods.
For example, smaller companies may lack depth of management or may have limited
financial resources for growth or development. They may have limited product
lines or market share. Smaller companies may be in new industries, or their new
products or services may not find an established market or may rapidly become
obsolete. Smaller companies' securities may be less liquid which may adversely
affect their price. Investments in these companies may be considered
speculative.
FOREIGN SECURITIES Investing in foreign securities typically involves more
risks than investing in U.S. securities. Certain of these risks also may apply
to securities of U.S. companies with significant foreign operations.
Currency exchange rates. Many of the Fund's investments are issued and traded
in foreign currencies. Changes in foreign currencies and in currency exchange
rates can increase or dramatically decrease the Fund's returns from its foreign
portfolio holdings. The impact of the euro, a relatively new currency adopted
by certain European countries to replace their national currencies, is unclear.
Political and economic developments. The political, economic and social
structures of some countries the Fund invests in may be less stable and more
volatile than those in the U.S. The risks of investing in these countries
include the imposition of exchange controls, internal and external conflicts,
currency devaluations, foreign ownership limitations, tax increases,
restrictions on the removal of currency or other assets, nationalization of
assets, and expropriation. The Fund may have greater difficulty voting proxies,
exercising shareholder rights and pursuing legal remedies with respect to its
foreign investments.
Trading practices. Brokerage commissions and other fees generally are higher
for foreign securities. Government supervision and regulation of foreign stock
exchanges, currency markets, trading systems and brokers may be less than in
the U.S. The procedures and rules governing foreign transactions and custody
also may involve delays in payment, delivery or recovery of money or
investments.
Availability of information. Foreign companies may not be subject to the same
disclosure, accounting, auditing and financial reporting standards and
practices as U.S. companies, and there may be less publicly available
information about them.
Limited markets. Certain foreign securities may be less liquid and more
volatile than many U.S. securities, which could limit the Fund's ability to
sell them at favorable prices.
Emerging markets. The Fund's investments in emerging markets countries are
subject to all the risks of foreign investing generally, and have additional,
heightened risks due to a lack of established legal, political, business and
social frameworks to support securities markets. These countries also are more
likely to experience high levels of inflation, deflation or currency
devaluation, which can harm their economies and securities markets and increase
volatility. Short-term volatility in these markets, and declines of 50% or
more, are not unusual.
INTEREST RATE Rate changes can be sudden and unpredictable. Increases in
interest rates may have an effect on the types of companies in which the Fund
normally invests because they may find it more difficult to obtain credit to
expand, or may have more difficulty meeting interest payments. Similarly,
emerging market economies may be especially sensitive to interest rate changes.
DERIVATIVE SECURITIES The performance of derivative investments depends, at
least in part, on the performance of an underlying asset. Derivatives involve
costs, may be volatile, and may involve a small investment relative to the risk
assumed. Their successful use will depend on the manager's ability to predict
market movements. Risks include delivery failure, default by the other party or
the inability to close out a position because the trading market becomes
illiquid.
More detailed information about the Fund, its policies, and risks can be found
in the SAI.
--------------------------------------------------------------
TIS-2 Templeton International Smaller Companies Fund - Class 2
--------------------------------------------------------------
PAST PERFORMANCE
- ----------------
[LOGO]
This bar chart and table show the volatility of the Fund's returns, which is
one indicator of the risks of investing in the Fund. The bar chart shows
changes in the Fund's returns from year to year over the past ten calendar
years or since the Fund's inception. The table shows how the Fund's average
annual total returns compare to those of a broad-based securities market index.
Of course, past performance cannot predict or guarantee future results.
Performance reflects all Fund expenses but does not include any fees or sales
charges imposed by the variable insurance contract for which the Fund is an
investment option. If they had been included, performance would be lower.
TEMPLETON INTERNATIONAL SMALLER COMPANIES FUND
CLASS 2 ANNUAL TOTAL RETURNS/1/
[GRAPH APPEAR HERE]
Best Quarter: Worst Quarter:
Q2 '99 Q3 '98
15.82% -19.96%
AVERAGE ANNUAL TOTAL RETURNS
For the periods ended December 31, 2000
Since
Inception
1 Year 05/01/96
- -------------------------------------------------------------------------------
Franklin Templeton International
Smaller Companies Fund - Class 2/1/ -1.24% 3.79%
Salomon Smith Barney Global
Ex-U.S. less than $1 Billion Index/2,3/ -16.62% -2.27%
Salomon Smith Barney Global
Ex-U.S. less than $2 Billion Index/2,3/ -14.28% -1.37%
Ongoing stock market volatility can dramatically change the Fund's short term
performance; current results may differ.
1. All Fund performance assumes reinvestment of dividends and capital gains.
Because Class 2 shares were not offered until 1/6/99, Class 2 Fund performance
for prior periods represents the historical results of Class 1 shares. For
periods beginning on 1/6/99, Class 2's results reflect an additional 12b-1 fee
expense, which also affects future performance.
2. Source: Standard & Poor's(R) Micropal. The Salomon Smith Barney Global
Ex-U.S. less than $1 Billion Index includes companies from developed and
emerging markets, excluding the U.S., with a market capitalization below U.S.
$1 billion. The Salomon Smith Barney Global Ex-U.S. less than $2 billion
includes companies from developed and emerging markets, excluding the U.S.,
with a market capitalization below U.S. $2 Billion. Indexes include reinvested
dividends and/or interest. One cannot invest directly in an index, nor is an
index representative of the Fund's investments.
3. We are replacing Salomon Smith Barney Global Ex-U.S. less than $1 Billion
Index with the Salomon Smith Barney Global Ex-U.S. less than $2 Billion Index as
the new index better reflects the Fund's holdings.
--------------------------------------------------------------
TIS-3 Templeton International Smaller Companies Fund - Class 2
--------------------------------------------------------------
FEES AND EXPENSES
- -----------------
[LOGO]
TEMPLETON INTERNATIONAL SMALLER COMPANIES FUND - CLASS 2
This table describes the fees and expenses that you may pay if you buy and hold
shares of the Fund. The table and the example do not include any fees or sales
charges imposed by the variable insurance contract for which the Fund is an
investment option. If they were included, your costs would be higher. Investors
should consult the contract prospectus or disclosure document for more
information.
SHAREHOLDER FEES
(fees paid directly from your investment)
Class 2
- --------------------------------------------------------------------------------
Maximum sales charge (load) imposed on purchases 0.00%
Maximum deferred sales charge (load) 0.00%
ANNUAL FUND OPERATING EXPENSES
(expenses deducted from Fund assets)
Class 2
- --------------------------------------------------------------------------------
Management fees 0.85%
Distribution and service (12b-1) fees1 0.25%
Other expenses 0.26%
----
Total annual Fund operating expenses 1.36%
====
1. While the maximum amount payable under the Fund's Class 2 rule 12b-1 plan is
0.35% per year of the Fund's average daily net assets, the Fund's Board of
Trustees has set the current rate at 0.25% per year.
EXAMPLE
This example can help you compare the cost of investing in the Fund with the
cost of investing in other mutual funds. It assumes:
. You invest $10,000 for the periods shown;
. Your investment has a 5% return each year; and
. The Fund's operating expenses remain the same.
Although your actual costs may be higher or lower, based on these assumptions
your costs would be:
1 Year 3 Years 5 Years 10 Years
- --------------------------------------------------------------------------------
Class 2 $138 $431 $745 $1,636
================================================================================
MANAGEMENT
- ----------
[LOGO]
Templeton Investment Counsel, LLC (TIC), Broward Financial Centre, Suite 2100,
Fort Lauderdale, Florida 33394, is the Fund's investment manager.
Under an agreement with TIC, Templeton Asset Management Ltd. (TAML), Two
Exchange Square, Hong Kong, serves as the Fund's sub-advisor. TAML provides TIC
with investment management advice and assistance.
MANAGEMENT TEAM The team responsible for the Fund's management is:
Simon Rudolph Mr. Rudolph has been a manager of the Fund since 1997. Before joining
SENIOR VICE PRESIDENT, TIC Franklin Templeton Investments in 1997, he was an executive director
PORTFOLIO MANAGER, TAML with Morgan Stanley.
Tucker Scott, CFA Mr. Scott has been a manager of the Fund since 2000, and has been with
VICE PRESIDENT, TIC Franklin Templeton Investments since 1996.
Cindy L. Sweeting, CFA Ms. Sweeting has been a manager of the Fund since January 2001. Before
SENIOR VICE PRESIDENT, TIC joining Franklin Templeton Investments in 1997, she was Vice President
of Investments with McDermott International Investments Co., Inc. in
Nassau, Bahamas.
The Fund pays TIC a fee for managing the Fund's assets. For the fiscal year
ended December 31, 2000, the Fund paid 0.85% of its average daily net assets to
TIC for its services.
--------------------------------------------------------------
TIS-4 Templeton International Smaller Companies Fund - Class 2
--------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- --------------------
[LOGO]
The financial highlights table provides further details to help you understand
the financial performance of Class 2 shares for the past five years or since
the Fund's inception. The table shows certain information on a single Fund
share basis (per share performance). It also shows some key Fund statistics,
such as total return (past performance) and expense ratios. Total return
represents the annual change in value of a share assuming reinvestment of
dividends and capital gains. This information has been audited by
PricewaterhouseCoopers LLP, independent auditors. Their report, along with the
financial statements, is included in the Fund's Annual Report (available upon
request).
Class 2 Year ended December 31,
- --------------------------------------------------------------------------------
2000 19993
- --------------------------------------------------------------------------------
Per share data ($)
Net asset value, beginning of year 11.07 9.44
----------------------
Net investment income/1/ .23 .13
Net realized and unrealized gains (losses) (.35) 1.82
----------------------
Total from investment operations (.12) 1.95
----------------------
Distributions from net investment income (.20) (.32)
----------------------
Net asset value, end of year 10.75 11.07
======================
Total return (%)/2/ (1.24) 20.75
Ratios/supplemental data
Net assets, end of year ($ x 1,000) 10,379 2,049
Ratios to average net assets: (%)
Expenses 1.36 1.38/4/
Net investment income 2.07 1.21/4/
Portfolio turnover rate (%) 29.58 15.80
1. Based on average shares outstanding.
2. Total return does not include any fees, charges or expenses imposed by the
variable annuity and life insurance contracts for which the Fund serves as an
underlying investment vehicle. If they had been included, total return would be
lower. Total return is not annualized for periods less than one year.
3. For the period January 6, 1999 (effective date) to December 31, 1999.
4. Annualized.
--------------------------------------------------------------
TIS-5 Templeton International Smaller Companies Fund - Class 2
--------------------------------------------------------------
Additional Information, All Funds
DISTRIBUTIONS AND TAXES
- -----------------------
[GRAPHIC OMITTED]
INCOME AND CAPITAL GAINS DISTRIBUTIONS Each Fund will declare as dividends
substantially all of its net investment income. Except for the Franklin Money
Market Fund, each Fund typically pays dividends from net investment income and
net capital gains, if any, at least annually. Dividends or distributions by the
Funds will reduce the per share net asset value (NAV) by the per share amount
paid.
The Franklin Money Market Fund declares a dividend each day the Fund's NAV is
calculated, equal to all of its daily net income, payable as of the close of
business the preceding day. The amount of dividend may fluctuate from day to
day and may be omitted on some days, depending on changes in the factors that
comprise the Fund's net income.
Dividends paid by a Fund will be automatically reinvested in additional shares
of that Fund or, if requested, paid in cash to the insurance company
shareholder.
TAX CONSIDERATIONS The tax consequences for contract owners from their
investment in variable annuity or variable life insurance contracts will depend
on the provisions of these contracts. Contract owners should consult the
accompanying contract prospectus for more information on these tax
consequences.
1 Franklin Templeton Variable Insurance Products Trust
Fund Account Information
BUYING SHARES
- -----------------
[GRAPHIC OMITTED]
Shares of each Fund are sold at net asset value (NAV) to insurance company
separate accounts to serve as investment options for variable annuity or
variable life insurance contracts, and for qualified pension and retirement
plans. The Funds' Board of Trustees (Board) monitors this to be sure there are
no material conflicts of interest between the two different types of contract
owners, given their differences, including tax treatment. If there were, the
Board would take corrective action.
Contract owners' payments will be allocated by the insurance company separate
account to purchase shares of the Fund chosen by the contract owner, and are
subject to any limits or conditions in the contract. Requests to buy shares are
processed at the NAV next calculated after we receive the request in proper
form. The Funds do not issue share certificates.
================================================================================
SELLING SHARES
- -----------------
[GRAPHIC OMITTED]
Each insurance company shareholder sells shares of the applicable Fund to make
benefit or surrender payments or to execute exchanges (transfers) between
investment options under the terms of its contracts. Requests to sell shares
are processed at the NAV next calculated after the Fund receives the request in
proper form.
================================================================================
EXCHANGING SHARES
- -----------------
[GRAPHIC OMITTED]
Contract owners may exchange shares of any one class or Fund for shares of
other classes or Funds through a transfer between investment options available
under a variable insurance contract, subject to the terms and any specific
limitations on the exchange (or "transfer") privilege described in the contract
prospectus.
Frequent exchanges can interfere with Fund management or operations and
increase Fund costs. To protect shareholders, there are limits on the number
and amount of Fund exchanges that may be made (please see "Market Timers"
below).
================================================================================
FUND ACCOUNT POLICIES
- ---------------------
[GRAPHIC OMITTED]
CALCULATING SHARE PRICE The Funds calculate their NAV per share each business
day at the close of trading on the New York Stock Exchange (normally 1:00 p.m.
Pacific time). Each class' NAV is calculated by dividing its net assets by the
number of its shares outstanding.
The Funds' assets are generally valued at their market value, except that the
Franklin Money Market Fund's assets are generally valued at their amortized
cost. If market prices are unavailable, or if an event occurs after the close
of the trading market that materially affects the values, assets may be valued
at their fair value. If a Fund holds securities listed primarily on a foreign
exchange that trades on days when the Fund is not open for business, the value
of the shares may change on days that the insurance company shareholders cannot
buy or sell shares.
Requests to buy and sell shares are processed on any day the Funds are open for
business at the NAV next calculated after the Fund receives the request in
proper form.
STATEMENTS AND REPORTS Contract owners will receive confirmations and account
statements that show account transactions. Insurance company contract owners
will receive the Funds' financial reports every six months from their insurance
company.
If there is a dealer or other investment representative of record on the
account, he or she will also receive
2 Franklin Templeton Variable Insurance Products Trust
confirmations, account statements and other information about the contract
owner's account directly from the contract's administrator.
MARKET TIMERS The Funds may restrict or refuse investments by market timers.
The following Funds currently do not allow investments by market timers:
Franklin Aggressive Growth Securities Fund, Franklin Global Health Care
Securities Fund, Franklin High Income Fund, Franklin Rising Dividends
Securities Fund, Franklin Technology Securities Fund, Franklin Value Securities
Fund, Mutual Discovery Securities Fund, Mutual Shares Securities Fund,
Templeton Asset Strategy Fund and Templeton Developing Markets Securities Fund.
As of July 1, 2001, the following Funds also will not allow investments by
market timers: Franklin Global Communications Securities Fund, Franklin Income
Securities Fund, Franklin Large Cap Growth Securities Fund, Franklin Small Cap
Fund, Templeton Growth Securities Fund, Templeton International Securities Fund
and Templeton International Smaller Companies Fund.
You will be considered a market timer if you have (i) requested an exchange out
of the Fund within two weeks of an earlier exchange request, or (ii) exchanged
shares out of the Fund more than twice in a calendar quarter, or (iii)
exchanged shares equal to at least $5 million, or more than 1% of the Fund's
net assets, or (iv) otherwise seem to follow a timing pattern. Accounts under
common ownership or control are combined for these limits.
ADDITIONAL POLICIES Please note that the Funds maintain additional policies and
reserve certain rights, including:
. Each Fund may refuse any order to buy shares.
. At any time, the Funds may establish or change investment minimums.
. The Funds may modify or discontinue the exchange privilege on 60 days'
notice to insurance company shareholders.
. You may only buy shares of the Funds eligible for sale in your state or
jurisdiction.
. In unusual circumstances, we may temporarily suspend redemptions, or
postpone the payment of proceeds, as allowed by federal securities laws.
. To permit investors to obtain the current price, insurance companies are
responsible for transmitting all orders to the Fund promptly.
SHARE CLASSES Each Fund generally has two classes of shares, Class 1 and Class
2. Each class is identical except that Class 2 has a distribution plan or "rule
12b-1" plan which is described in below.
Distribution and service (12b-1) fees. Class 2 has a distribution plan,
sometimes known as a rule 12b-1 plan, that allows the Funds to pay distribution
fees to those who sell and distribute Class 2 shares and provide services to
shareholders and contract owners. Because these fees are paid out of Class 2's
assets on an on-going basis, over time these fees will increase the cost of an
investment, and may cost you more than paying other types of sales charges.
While the maximum amount payable under most Funds' Class 2 rule 12b-1 plan is
0.35% per year of a Fund's average net assets, the Board of Trustees has set the
current rate at 0.25%. However, Franklin S&P 500 Index Fund, Franklin Strategic
Income Securities Fund, Templeton Asset Strategy Fund, Templeton Developing
Markets Securities Fund, Templeton Global Income Securities Fund and Templeton
International Securities Fund each have a maximum rule 12b-1 plan fee of 0.25%
per year. A portion of the fees payable to Franklin Templeton Distributors, Inc.
(Distributors) or others under the rule 12b-1 plan may be retained by
Distributors for distribution expenses.
================================================================================
QUESTIONS
- -----------------
[GRAPHIC OMITTED]
More detailed information about the Trust and the Funds' account policies can
be found in the Funds' Statement of Additional Information. If you have any
questions about the Funds, you can write to us at 777 Mariners Island Blvd.,
P.O. Box 7777, San Mateo, CA 94403-7777. You can also call us at
1-800/321-8563. For your protection and to help ensure we provide you with
quality service, all calls may be monitored or recorded.
3 Franklin Templeton Variable Insurance Products Trust
For More Information
The Funds of Franklin Templeton Variable Insurance Products Trust (the Trust)
are generally only available as investment options in variable annuity or
variable life insurance contracts. Please consult the accompanying contract
prospectus for information about the terms of an investment in a contract.
You can learn more about the Funds in the following documents:
ANNUAL/SEMIANNUAL FUND REPORTS TO SHAREHOLDERS
Includes a discussion of recent market conditions and investment strategies,
financial statements, detailed performance information, Fund holdings, and the
auditor's report (Annual Report only).
STATEMENT OF ADDITIONAL INFORMATION
Contains more information about the Funds, their investments, policies, and
risks. It is incorporated by reference (is legally a part of this prospectus).
For a free copy of the current annual/semiannual report or SAI, please contact
your investment representative or call us at the number below.
Franklin/registered trademark/Templeton/registered trademark/ Investments
1-800/321-8563
You also can obtain information about the Funds by visiting the SEC's Public
Reference Room in Washington, D.C. (phone 1-202/942-8090) or the EDGAR Database
on the SEC's Internet site at http://www.sec.gov. You can obtain copies of this
information, after paying a duplicating fee, by writing to the SEC's Public
Reference Section, Washington, D.C. 20549-0102 or by electronic request at the
following E-mail address: publicinfo@sec.gov.
Investment Company Act file #811-5479 Lit. Code # FTVIPI P01 5/01
EXHIBIT F
Templeton International Securities Fund
- --------------------------------------------------------------------------------
Fund Goal and Primary Investments: Templeton International Securities Fund
(formerly Templeton International Fund) seeks long-term capital growth. The
Fund invests primarily in equity securities of companies located outside the
U.S., including those in emerging markets.
- --------------------------------------------------------------------------------
During the 12 months under review, stock markets around the world suffered as
the bubble in technology, media and telecommunications (TMT) stocks began to
deflate. The over capacity caused by the higher-than-normal level of technology
infrastructure investment led to severe pricing pressures and contributed to
the demise of companies with questionable business models. In our opinion, the
"TMT bubble" was spurred by excess liquidity in the financial system, easy
availability of debt and equity financing, Y2K-induced capital spending and the
extreme speculation that accompanies market bubbles.
European markets turned in weak performances during the year, weighed down by
the decline in TMT stocks and the weakening euro. Asian markets likewise turned
in very poor results primarily due to concerns over Korea's and Taiwan's
economic reforms, Japan's slower than expected corporate restructuring and
worries about the region's economic health. Asian TMT stocks again were the
hardest hit, with significant damage done to the Jasdaq and Kosdaq Indexes, the
principal TMT indexes in Japan and Korea. Latin American stocks also performed
poorly, hurt in part by interest-rate worries and concerns over the U.S.
economy's health.
For the year ended December 31, 2000, Templeton International Securities Fund
outperformed its benchmark, the Morgan Stanley Capital International Europe,
Australasia, Far East (MSCI(R) EAFE(R)) Index, which returned -13.96%./1/ The
Fund's outperformance was primarily a result of its low exposure to the poorly
performing TMT industries.
During the year, we reduced our European holdings in the finance,
telecommunications and technology areas while increasing exposure to utilities,
industrials and consumer products. Significant purchases during the year
included U.K. utility Powergen; Unilever, a Dutch-Anglo consumer non-durables
manufacturer; French engineering company Alstom SA; and BAE, a U.K.-based
defense company we think is well positioned to benefit from the next upcycle in
defense spending.
1. Source: Standard and Poor's Micropal. For an index description, please see
the Index Definitions following the Fund Summaries.
Geographic Distribution
Temple International Securities Fund
Based on Total Net Assets
12/31/00
[PIE CHART APPEARS HERE]
TI-1
Top 10 Holdings
Templeton International Securities Fund
12/31/00
Company % of Total
Industry, Country Net Assets
- ---------------------------------------
Zurich Financial
Services AG 2.4%
Insurance, Switzerland
Cheung Kong
Holdings Ltd. 2.4%
Real Estate, Hong Kong
Ace Ltd. 2.2%
Insurance, Bermuda
Aventis SA 1.9%
Pharmaceuticals, France
Unilever PLC 1.9%
Food Products, U.K.
ING Groep NV 1.9%
Diversified Financials,
Netherlands
Akzo Nobel NV 1.8%
Chemicals, Netherlands
AXA SA 1.8%
Insurance, France
Nordea AB 1.8%
Banks, Sweden
E.On AG 1.7%
Electric Utilities,
Germany
The dollar value, number of shares or principal value, and complete legal titles
of all portfolio holdings are listed in the Fund's Statement of Investments.
In our opinion, these companies offered low valuations, improving fundamentals
and increasing cash flows. To fund these purchases we eliminated several
holdings due to their high valuations, including telecommunications providers
Telecom Italia and Portugal Telecom, and finance companies Royal Bank of
Scotland and Muenchener Rueckversicherungs-Gesellschaft, and reduced our
holdings in AXA, Nordea, Philips, Elan, Total SA and Teva Pharmaceuticals. Over
the course of the year, our European portfolio weighting increased from 53.0% of
total net assets on December 31, 1999, to 60.3% at the end of the period.
In Asia, we bought a combination of "old" and "new" economy stocks during the
year, with Fujitsu, Korea Telecom, and Nippon Telegraph and Telephone
representing the new economy. Old economy purchases included capital equipment
manufacturer Komatsu and transportation company Nippon Express. We concentrated
our selling in a handful of stocks, including Singapore Airlines and Sony
Corporation. Our exposure to Asia increased modestly during the year, from 18.6%
of total net assets at the beginning of the period, to 19.1% at period-end.
Our Latin American weighting declined dramatically during the 12-month period,
due to a combination of Fund sales and significant merger and acquisition
activity involving many of the region's companies. We used the tremendous
volatility during the year to liquidate our exposure to many of the region's TMT
stocks, including the complete sale of Telefonica del Peru. Despite the Latin
American markets' poor performances, we continued to find better bargains in
other regions of the world. As a result, our exposure to Latin America declined
from 11.2% of total net assets on December 31, 1999, to 5.2% at the end of the
period. The Fund's cash reserves remained relatively steady during the Fund's
fiscal year, and ended the period at approximately 5% of total net assets.
Looking forward, we feel the uncertainty surrounding the global economy's health
is creating a favorable environment for value investing. We continue to find
tremendous bargains in non-TMT industries and remain optimistic toward the
longer-term outlook for these stocks.
Despite the ongoing bear market in technology stocks, their valuations are not
yet compelling in our opinion, and there is further potential risk should the
global economic trends worsen. Although we do not dismiss lightly the Internet's
impact, we do recognize that traditional
TI-2
valuation metrics remain valid. We believe the current, severe TMT correction
will create several "value" stocks and are actively researching stocks in these
areas with intentions to add to our exposure in 2001 when the valuations become
more attractive. Yet, with most telecommunications providers battling heavy
debt loads, less accommodating capital markets and slower global economic
growth, we are concerned about the health of overall information technology
(IT) spending.
We are positive for Europe's outlook in the year to come. Although the euro's
decline hurt our performance in 2000, it appears undervalued relative to
Europe's future economic growth and is creating many fundamental, positive
changes. Labor markets are slowly becoming more flexible, capital markets are
evolving, cross-border mergers are becoming common and tax rates are projected
to decline over the next few years. In addition, globalization and technology
advances are forcing European corporations and governments to become more
globally competitive. We believe these structural changes in Europe will help
close the growth gap versus the U.S., increase the attractiveness of European
assets and consequently improve the valuation of the euro versus the U.S.
dollar.
As always, the Templeton research team will scour the world for those stocks
whose prices in our opinion are selling at the lowest value in relation to
their long-term earnings potential since such shares help reduce risk while
offering the potential for attractive long-term returns.
- --------------------------------------------------------------------------------
This discussion reflects our views, opinions and portfolio holdings as of
December 31, 2000, the end of the reporting period. The information provided is
not a complete analysis of every aspect of any country, industry, security or
the Fund. Our strategies and the Fund's portfolio composition will change
depending on market and economic conditions. Although historical performance is
no guarantee of future results, these insights may help you understand our
investment and management philosophy.
- --------------------------------------------------------------------------------
TI-3
Templeton International Securities Fund
Class 1
Performance reflects the Fund's Class 1 operating expenses, but does not include
any contract fees, expenses or sales charges. If they had been included,
performance would be lower. These charges and deductions, particularly for
variable life policies, can have a significant effect on contract values and
insurance benefits. See the contract prospectus for a complete description of
these expenses, including sales charges.
Since markets can go down as well as up, investment return and the value of your
principal will fluctuate with market conditions, and you may have a gain or loss
when you sell your shares.
Performance Summary as of 12/31/00
Total return of Class 1 shares represents the cumulative or average annual
change in value, assuming reinvestment of dividends and capital gains. Average
returns smooth out variations in returns, which can be significant; they are
not the same as year-by-year results.
Templeton International Securities Fund - Class 1*
Periods ended 12/31/00
Since
Inception
1-Year 5-Year (5/1/92)
- --------------------------------------------------------------------------------
Average Annual Total Return -2.19% +13.32% +13.18%
Cumulative Total Return -2.19% +86.86% +192.55%
Value of $10,000 Investment $9,781 $18,686 $29,255
*Performance prior to the 5/1/00 merger reflects the historical performance of
Templeton International Fund.
Ongoing stock market volatility can dramatically change the Fund's short-term
performance; current results may differ.
Total Return Index Comparison
for $10,000 Investment (5/1/92-12/31/00)
The graph compares the performance of Templeton International Securities Fund -
Class 1 and the Morgan Stanley Capital International Europe, Australasia, Far
East (MSCI EAFE) Index. One cannot invest directly in an index, nor is an index
representative of the Fund's portfolio. Please see Important Notes to
Performance Information preceding the Fund Summaries.
[GRAPH APPEARS HERE]
*Source: Standard and Poor's Micropal
For an index description, please see the Index Definitions following the Fund
Summaries.
Past performance does not guarantee future results.
TI-4
Templeton International Securities Fund
- --------------------------------------------------------------------------------
Fund Goal and Primary Investments: Templeton International Securities Fund
(formerly Templeton International Fund) seeks long-term capital growth. The
Fund invests primarily in equity securities of companies located outside the
U.S., including those in emerging markets.
- --------------------------------------------------------------------------------
During the 12 months under review, stock markets around the world suffered as
the bubble in technology, media and telecommunications (TMT) stocks began to
deflate. The over capacity caused by the higher-than-normal level of technology
infrastructure investment led to severe pricing pressures and contributed to
the demise of companies with questionable business models. In our opinion, the
"TMT bubble" was spurred by excess liquidity in the financial system, easy
availability of debt and equity financing, Y2K-induced capital spending and the
extreme speculation that accompanies market bubbles.
European markets turned in weak performances during the year, weighed down by
the decline in TMT stocks and the weakening euro. Asian markets likewise turned
in very poor results primarily due to concerns over Korea's and Taiwan's
economic reforms, Japan's slower than expected corporate restructuring and
worries about the region's economic health. Asian TMT stocks again were the
hardest hit, with significant damage done to the Jasdaq and Kosdaq Indexes, the
principal TMT indexes in Japan and Korea. Latin American stocks also performed
poorly, hurt in part by interest-rate worries and concerns over the U.S.
economy's health.
For the year ended December 31, 2000, Templeton International Securities Fund
outperformed its benchmark, the Morgan Stanley Capital International Europe,
Australasia, Far East (MSCI(R) EAFE(R)) Index, which returned -13.96%./1/ The
Fund's outperformance was primarily a result of its low exposure to the poorly
performing TMT industries.
During the year, we reduced our European holdings in the finance,
telecommunications and technology areas while increasing exposure to utilities,
industrials and consumer products. Significant purchases during the year
included U.K. utility Powergen; Unilever, a Dutch-Anglo consumer non-durables
manufacturer; French engineering company Alstom SA; and BAE, a U.K.-based
defense company we think is well positioned to benefit from the next upcycle in
defense spending.
1. Source: Standard and Poor's Micropal. For an index description, please see
the Index Definitions following the Fund Summaries.
Geographic Distribution
Templeton International Securities Fund
Based on Total Net Assets
12/31/00
[PIE CHART APPEARS HERE]
Europe 60.3%
Asia 19.1%
North American 5.3%
Latin American 5.2%
Australia/New Zealand 4.1%
Mid-East/Africa 1.4%
Short-Term Investments
& Other Net Assets 4.6%
TI-1
Top 10 Holdings
Templeton International Securities Fund
12/31/00
Company % of Total
Industry, Country Net Assets
- --------------------------- ------------
Zurich Financial
Services AG 2.4%
Insurance, Switzerland
Cheung Kong
Holdings Ltd. 2.4%
Real Estate, Hong Kong
Ace Ltd. 2.2%
Insurance, Bermuda
Aventis SA 1.9%
Pharmaceuticals, France
Unilever PLC 1.9%
Food Products, U.K.
ING Groep NV 1.9%
Diversified Financials,
Netherlands
Akzo Nobel NV 1.8%
Chemicals, Netherlands
AXA SA 1.8%
Insurance, France
Nordea AB 1.8%
Banks, Sweden
E.On AG 1.7%
Electric Utilities,
Germany
The dollar value, number of shares or principal value, and complete legal
titles of all portfolio holdings are listed in the Fund's Statement of
Investments.
In our opinion, these companies offered low valuations, improving fundamentals
and increasing cash flows. To fund these purchases we eliminated several
holdings due to their high valuations, including telecommunications providers
Telecom Italia and Portugal Telecom, and finance companies Royal Bank of
Scotland and Muenchener Rueckversicherungs-Gesellschaft, and reduced our
holdings in AXA, Nordea, Philips, Elan, Total SA and Teva Pharmaceuticals. Over
the course of the year, our European portfolio weighting increased from 53.0%
of total net assets on December 31, 1999, to 60.3% at the end of the period.
In Asia, we bought a combination of "old" and "new" economy stocks during the
year, with Fujitsu, Korea Telecom, and Nippon Telegraph and Telephone
representing the new economy. Old economy purchases included capital equipment
manufacturer Komatsu and transportation company Nippon Express. We concentrated
our selling in a handful of stocks, including Singapore Airlines and Sony
Corporation. Our exposure to Asia increased modestly during the year, from
18.6% of total net assets at the beginning of the period, to 19.1% at
period-end.
Our Latin American weighting declined dramatically during the 12-month period,
due to a combination of Fund sales and significant merger and acquisition
activity involving many of the region's companies. We used the tremendous
volatility during the year to liquidate our exposure to many of the region's
TMT stocks, including the complete sale of Telefonica del Peru. Despite the
Latin American markets' poor performances, we continued to find better bargains
in other regions of the world. As a result, our exposure to Latin America
declined from 11.2% of total net assets on December 31, 1999, to 5.2% at the
end of the period. The Fund's cash reserves remained relatively steady during
the Fund's fiscal year, and ended the period at approximately 5% of total net
assets.
Looking forward, we feel the uncertainty surrounding the global economy's
health is creating a favorable environment for value investing. We continue to
find tremendous bargains in non-TMT industries and remain optimistic toward the
longer-term outlook for these stocks.
Despite the ongoing bear market in technology stocks, their valuations are not
yet compelling in our opinion, and there is further potential risk should the
global economic trends worsen. Although we do not dismiss lightly the
Internet's impact, we do recognize that traditional
TI-2
valuation metrics remain valid. We believe the current, severe TMT correction
will create several "value" stocks and are actively researching stocks in these
areas with intentions to add to our exposure in 2001 when the valuations become
more attractive. Yet, with most telecommunications providers battling heavy
debt loads, less accommodating capital markets and slower global economic
growth, we are concerned about the health of overall information technology
(IT) spending.
We are positive for Europe's outlook in the year to come. Although the euro's
decline hurt our performance in 2000, it appears undervalued relative to
Europe's future economic growth and is creating many fundamental, positive
changes. Labor markets are slowly becoming more flexible, capital markets are
evolving, cross-border mergers are becoming common and tax rates are projected
to decline over the next few years. In addition, globalization and technology
advances are forcing European corporations and governments to become more
globally competitive. We believe these structural changes in Europe will help
close the growth gap versus the U.S., increase the attractiveness of European
assets and consequently improve the valuation of the euro versus the U.S.
dollar.
As always, the Templeton research team will scour the world for those stocks
whose prices in our opinion are selling at the lowest value in relation to
their long-term earnings potential since such shares help reduce risk while
offering the potential for attractive long-term returns.
- --------------------------------------------------------------------------------
This discussion reflects our views, opinions and portfolio holdings as of
December 31, 2000, the end of the reporting period. The information provided
is not a complete analysis of every aspect of any country, industry, security
or the Fund. Our strategies and the Fund's portfolio composition will change
depending on market and economic conditions. Although historical performance
is no guarantee of future results, these insights may help you understand our
investment and management philosophy.
- --------------------------------------------------------------------------------
TI-3
Templeton International Securities Fund
Class 2
- --------------------------------------------------------------------------------
Performance reflects the Fund's Class 2 operating expenses, but does not
include any contract fees, expenses or sales charges. If they had been
included, performance would be lower. These charges and deductions,
particularly for variable life policies, can have a significant effect on
contract values and insurance benefits. See the contract prospectus for a
complete description of these expenses, including sales charges.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Since markets can go down as well as up, investment return and the value of
your principal will fluctuate with market conditions, and you may have a
gain or loss when you sell your shares.
- --------------------------------------------------------------------------------
Performance Summary as of 12/31/00
Total return of Class 2 shares represents the cumulative or average annual
change in value, assuming reinvestment of dividends and capital gains. Average
returns smooth out variations in returns, which can be significant; they are
not the same as year-by-year results.
Templeton International Securities Fund - Class 2*
Periods ended 12/31/00
Since Since Class 2
Inception Inception
1-Year 5-Year (5/1/92) (5/1/97)
- ----------------------------------------------------------------------------------------
Average Annual Total Return -2.38% +13.11% +13.06% +10.37%
Cumulative Total Return -2.38% +85.12% +189.83% +43.63%
Value of $10,000 Investment $ 9,762 $ 18,512 $ 28,983 $ 14,363
* Performance prior to the 5/1/00 merger reflects the historical performance of
Templeton International Fund. Additionally, because Class 2 shares were not
offered until 5/1/97, standardized Class 2 Fund performance for prior periods
represents the historical results of Class 1 shares. For periods beginning on
5/1/97, Class 2's results reflect an additional 12b-1 fee expense, which also
affects future performance.
Ongoing stock market volatility can dramatically change the Fund's short-term
performance; current results may differ.
Total Return Index Comparison
for $10,000 Investment (5/1/92-12/31/00)
The graph compares the performance of Templeton International Securities Fund -
Class 2* and the Morgan Stanley Capital International Europe, Australasia, Far
East (MSCI EAFE) Index. One cannot invest directly in an index, nor is an index
representative of the Fund's portfolio. Please see Important Notes to
Performance Information preceding the Fund Summaries.
[LINE CHART APPEARS HERE]
** Source: Standard and Poor's Micropal.
For an index description, please see the Index Definitions following the Fund
Summaries.
Past performance does not guarantee future results.
TI-4
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Financial Highlights
Class 1
------------------------------------------------------------------
Year Ended December 31,
------------------------------------------------------------------
2000 1999 1998 1997 1996
------------------------------------------------------------------
Per share operating performance/c/
(for a share outstanding throughout the year)
Net asset value, beginning of year .................. $ 22.25 $ 20.69 $ 20.18 $ 18.40 $ 15.13
-------------------------------------------------------------
Income from investment operations:
Net investment income/b/ ........................... .40 .33 .60 .49 .43
Net realized and unrealized gains (losses) ......... (.95) 3.78 1.29 2.01 3.15
-------------------------------------------------------------
Total from investment operations .................... (.55) 4.11 1.89 2.50 3.58
-------------------------------------------------------------
Less distributions from:
Net investment income .............................. (.43) (.57) (.49) (.51) (.24)
Net realized gains ................................. (2.49) (1.98) (.89) (.21) (.07)
-------------------------------------------------------------
Total distributions ................................. (2.92) (2.55) (1.38) (.72) (.31)
-------------------------------------------------------------
Net asset value, end of year ........................ $ 18.78 $ 22.25 $ 20.69 $ 20.18 $ 18.40
=============================================================
Total return/a/ ..................................... ( 2.19)% 23.61% 9.33% 13.95% 24.04%
Ratios/supplemental data
Net assets, end of year (000's) ..................... $776,495 $1,056,798 $980,470 $938,410 $682,984
Ratios to average net assets:
Expenses ........................................... .87% .85% .86% .81% .65%
Net investment income .............................. 2.08% 1.69% 2.81% 2.70% 3.23%
Portfolio turnover rate ............................. 32.81% 30.04% 29.56% 16.63% 9.46%
/a/Total return does not include any fees, charges or expenses imposed by the
variable annuity and life insurance contracts for which the Franklin Templeton
Variable Insurance Products Trust serves as an underlying investment vehicle.
/b/Based on average shares outstanding effective year ended December 31, 1999.
/c/Financial highlights presented reflect historical financial information from
TVP - Templeton International Fund as a result of the merger discussed in Note
6.
TI-5
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Financial Highlights (continued)
Class 2
--------------------------------------------------------
Year Ended December 31,
--------------------------------------------------------
2000 1999 1998 1997/c/
--------------------------------------------------------
Per share operating performance/e/
(for a share outstanding throughout the year)
Net asset value, beginning of year .................. $ 22.13 $ 20.61 $ 20.14 $ 18.40
----------------------------------------------------
Income from investment operations:
Net investment income/d/ ........................... .31 .25 .59 .07
Net realized and unrealized gains (losses) ......... (.90) 3.78 1.25 1.67
----------------------------------------------------
Total from investment operations .................... (.59) 4.03 1.84 1.74
----------------------------------------------------
Less distributions from:
Net investment income .............................. (.38) (.53) (.48) --
Net realized gains ................................. (2.49) (1.98) (.89) --
----------------------------------------------------
Total distributions ................................. (2.87) (2.51) (1.37) --
----------------------------------------------------
Net asset value, end of year ........................ $ 18.67 $ 22.13 $ 20.61 $ 20.14
====================================================
Total return/b/ ..................................... (2.38)% 23.23% 9.08% 9.46%
Ratios/supplemental data
Net assets, end of year (000's) ..................... $187,115 $101,365 $ 39,886 $17,606
Ratios to average net assets:
Expenses ........................................... 1.12% 1.10% 1.11% 1.13%/a/
Net investment income .............................. 1.66% 1.26% 2.69% 1.14%/a/
Portfolio turnover rate ............................. 32.81% 30.04% 29.56% 16.63%
/a/Annualized
/b/Total return does not include any fees, charges or expenses imposed by the
variable annuity and life insurance contracts for which the Franklin Templeton
Variable Insurance Products Trust serves as an underlying investment vehicle.
Total return is not annualized for periods less than one year.
/c/For the period May 1, 1997 (effective date) to December 31, 1997.
/d/Based on average shares outstanding effective year ended December 31, 1999.
/e/Financial highlights presented reflect historical financial information from
TVP - Templeton International Fund as a result of the merger discussed in Note
6.
See notes to financial statements.
TI-6
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Statement of Investments, December 31, 2000
COUNTRY SHARES VALUE
- ------------------------------------------------------------------------------------------------------------
Common Stocks 92.3%
Aerospace & Defense 2.0%
BAE Systems PLC ....................................... United Kingdom 2,764,936 $ 15,777,685
Saab AB, B ............................................ Sweden 423,593 3,501,696
------------
19,279,381
------------
Air Freight & Couriers 1.1%
Mayne Nickless Ltd., A ................................ Australia 3,119,588 10,123,073
------------
Airlines .9%
British Airways PLC ................................... United Kingdom 1,500,553 8,725,188
------------
Auto Components .6%
Autoliv Inc., SDR ..................................... Sweden 393,611 6,173,963
------------
Automobiles 1.0%
Volkswagen AG ......................................... Germany 181,815 9,652,942
------------
Banks 8.7%
Australia & New Zealand Banking Group Ltd. ............ Australia 1,712,582 13,683,984
BA Holding AG ......................................... Austria 56,130 3,088,091
BA Holding AG, 144A ................................... Austria 134,116 7,378,628
Banca Nazionale del Lavoro SpA ........................ Italy 3,283,734 10,081,220
Foreningssparbanken AB, A ............................. Sweden 275,345 4,216,772
HSBC Holdings PLC ..................................... Hong Kong 370,855 5,491,577
HSBC Holdings PLC, ADR ................................ Hong Kong 105,243 7,745,885
National Bank of Canada ............................... Canada 523,079 9,263,583
Nordea AB ............................................. Sweden 2,135,083 16,838,036
Unibanco Uniao de Bancos Brasileiros SA, GDR .......... Brazil 209,029 6,153,291
------------
83,941,067
------------
Beverages .3%
PanAmerican Beverages Inc., A ......................... Mexico 168,995 2,397,617
------------
Building Products .9%
Hepworth PLC .......................................... United Kingdom 775,101 3,253,565
Novar PLC ............................................. United Kingdom 1,902,783 5,713,209
------------
8,966,774
------------
Chemicals 5.6%
Akzo Nobel NV ......................................... Netherlands 329,003 17,668,239
BASF AG ............................................... Germany 276,469 12,575,857
Clariant AG ........................................... Switzerland 31,760 11,386,955
/a/Elementis PLC ......................................... United Kingdom 3,163,208 5,245,001
Imperial Chemical Industries PLC ...................... United Kingdom 499,408 4,121,759
Kemira OY ............................................. Finland 634,389 3,216,228
------------
54,214,039
------------
/a/Commercial Services & Supplies 1.0%
Chubb PLC ............................................. United Kingdom 2,724,071 6,348,014
Kidde PLC ............................................. United Kingdom 2,724,071 2,889,160
------------
9,237,174
------------
Communications Equipment .9%
Alcatel SA ............................................ France 62,176 3,531,633
Alcatel SA, ADR ....................................... France 92,583 5,178,862
------------
8,710,495
------------
Computers & Peripherals .7%
Fujitsu Ltd. .......................................... Japan 470,271 6,934,644
------------
Construction & Engineering .3%
Fletcher Challenge Building Ltd. ...................... New Zealand 3,662,514 3,176,494
------------
TI-7
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Statement of Investments, December 31, 2000 (cont.)
COUNTRY SHARES VALUE
- ------------------------------------------------------------------------------------------------------------
Common Stocks (cont.)
Diversified Financials 4.1%
ING Groep NV ......................................... Netherlands 225,305 $ 17,996,817
Nomura Securities Co. Ltd. ........................... Japan 834,730 15,020,754
Swire Pacific Ltd., B ................................ Hong Kong 7,938,127 6,920,507
------------
39,938,078
------------
Diversified Telecommunication Services 6.0%
/a/ Cia de Telecomunicaciones de Chile SA, ADR ........... Chile 251,452 3,316,023
Korea Telecom Corp., ADR ............................. South Korea 200,070 6,202,170
Nippon Telegraph & Telephone Corp. ................... Japan 1,463 10,543,336
Philippine Long Distance Telephone Co., ADR .......... Philippines 502,088 8,943,443
Telecom Corp. of New Zealand Ltd. .................... New Zealand 2,964,626 6,309,976
/a/ Telefonica SA, ADR ................................... Spain 253,427 12,671,350
Telefonos de Mexico SA (Telmex), L, ADR .............. Mexico 210,229 9,486,584
------------
57,472,882
------------
Electric Utilities 8.3%
CLP Holdings Ltd. .................................... Hong Kong 2,378,158 11,860,453
E.On AG .............................................. Germany 271,353 16,508,477
Gener SA, ADR ........................................ Chile 177,037 3,164,536
Hong Kong Electric Holdings Ltd. ..................... Hong Kong 2,367,298 8,740,905
Iberdrola SA, Br. .................................... Spain 918,222 11,508,702
Innogy Holdings PLC .................................. United Kingdom 1,149,686 3,207,264
International Power PLC .............................. United Kingdom 1,149,686 4,177,601
Korea Electric Power Corp. ........................... South Korea 250,000 4,664,032
Powergen PLC ......................................... United Kingdom 1,707,059 16,077,868
------------
79,909,838
------------
Electrical Equipment 1.4%
Alstom SA ............................................ France 528,574 13,646,959
------------
Electronic Equipment & Instruments 1.0%
Hitachi Ltd. ......................................... Japan 1,078,067 9,610,089
------------
Food & Drug Retailing 1.3%
Safeway PLC .......................................... United Kingdom 2,880,587 12,930,648
------------
Food Products 3.0%
Northern Foods PLC ................................... United Kingdom 1,910,572 3,924,289
Tate & Lyle PLC ...................................... United Kingdom 1,925,078 7,117,351
Unilever PLC ......................................... United Kingdom 2,112,924 18,038,272
------------
29,079,912
------------
Health Care Equipment & Supplies .8%
Nycomed Amersham PLC ................................. United Kingdom 918,222 7,496,965
------------
/a/ Hotels Restaurants & Leisure .4%
P & O Princess Cruises PLC ........................... United Kingdom 789,853 3,333,186
------------
Household Durables 2.5%
Koninklijke Philips Electronics NV ................... Netherlands 392,839 14,391,274
Sony Corp. ........................................... Japan 138,634 9,590,268
------------
23,981,542
------------
Insurance 10.0%
Ace Ltd. ............................................. Bermuda 497,103 21,095,809
AXA SA ............................................... France 111,323 16,095,446
AXA SA, 144A ......................................... France 10,120 1,463,183
/a/ Pacific Century Regional Developments Ltd. ........... Singapore 6,410,127 3,271,605
Scor ................................................. France 145,685 7,563,753
TI-8
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Statement of Investments, December 31, 2000 (cont.)
COUNTRY SHARES VALUE
- -----------------------------------------------------------------------------------------------------------
Common Stocks (cont.)
Insurance (cont.)
Swiss Reinsurance Co. ............................... Switzerland 6,369 $ 15,269,093
XL Capital Ltd., A .................................. Bermuda 99,328 8,678,784
Zurich Financial Services AG ........................ Switzerland 38,597 23,270,144
------------
96,707,817
------------
Machinery 2.8%
IHC Caland NV ....................................... Netherlands 109,264 5,129,139
Invensys PLC ........................................ United Kingdom 1,829,526 4,236,089
Komatsu Ltd. ........................................ Japan 2,196,343 9,712,375
Volvo AB, B ......................................... Sweden 491,704 8,155,548
------------
27,233,151
------------
Marine .7%
Koninklijke Nedlloyd Groep NV ....................... Netherlands 126,047 2,757,311
Peninsular & Oriental Steam Navigation Co. .......... United Kingdom 789,853 3,737,298
------------
6,494,609
------------
Media 1.7%
Wolters Kluwer NV ................................... Netherlands 600,280 16,366,201
------------
Metals & Mining 3.4%
Barrick Gold Corp. .................................. Canada 607,739 9,957,694
BHP Ltd. ............................................ Australia 551,005 5,803,694
Corus Group PLC ..................................... United Kingdom 4,733,704 4,967,550
Industrias Penoles SA ............................... Mexico 461,125 311,943
Pohang Iron & Steel Co. Ltd. ........................ South Korea 185,150 11,196,818
------------
32,237,699
------------
Multiline Retail 1.7%
Hudsons Bay Co. ..................................... Canada 210,238 2,057,589
Marks & Spencer PLC ................................. United Kingdom 2,780,830 7,736,874
Mothercare PLC ...................................... United Kingdom 661,679 1,383,790
Next PLC ............................................ United Kingdom 451,914 5,565,975
------------
16,744,228
------------
Oil & Gas 5.4%
Eni SpA ............................................. Italy 2,115,960 13,508,706
Repsol YPF SA ....................................... Spain 730,405 11,671,339
Shell Transport & Trading Co. PLC ................... United Kingdom 1,679,653 13,737,210
Total Fina Elf SA, B ................................ France 86,277 12,830,619
------------
51,747,874
------------
Paper & Forest Products 1.4%
Stora Enso OYJ, R ................................... Finland 584,330 6,905,071
UPM-Kymmene Corp. ................................... Finland 204,542 7,018,871
------------
13,923,942
------------
Pharmaceuticals 6.3%
Aventis SA .......................................... France 212,048 18,614,149
/a/Elan Corp. PLC, ADR ................................. Irish Republic 264,619 12,387,477
Merck KGAA .......................................... Germany 370,710 16,183,954
Teva Pharmaceutical Industries Ltd., ADR ............ Israel 187,622 13,743,312
------------
60,928,892
------------
Real Estate 2.4%
Cheung Kong Holdings Ltd. ........................... Hong Kong 1,808,137 23,123,586
------------
TI-9
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Statement of Investments, December 31, 2000 (cont.)
COUNTRY SHARES VALUE
- ------------------------------------------------------------------------------------------------------------------------------
Common Stocks (cont.)
Road & Rail 2.5%
Nippon Express Co. Ltd. ................................................... Japan 2,115,342 $ 12,780,960
Seino Transportation Co. Ltd. ............................................. Japan 321,672 1,354,853
Stagecoach Holdings PLC ................................................... United Kingdom 9,856,847 9,791,619
------------
23,927,432
------------
/a/Semiconductor Equipment & Products .4%
Hyundai Electronics Industries Co. ........................................ South Korea 1,088,500 3,463,409
------------
Transportation Infrastructure .1%
Hong Kong Aircraft Engineering Co. Ltd. ................................... Hong Kong 551,901 976,453
------------
Wireless Telecommunication Services .7%
Smartone Telecommunications Holdings Ltd. ................................. Hong Kong 4,459,118 6,431,503
------------
Total Common Stocks (Cost $806,960,832).................................... 889,239,746
------------
Preferred Stocks 3.1%
Cia Vale do Rio Doce, A, ADR, pfd. ........................................ Brazil 204,192 5,028,228
Embratel Participacoes SA, ADR, pfd. ...................................... Brazil 231,091 3,625,240
Petroleo Brasileiro SA, pfd. .............................................. Brazil 300,000 7,043,077
Telecomunicacoes Brasileiras SA (Telebras), ADR, pfd. ..................... Brazil 129,339 9,425,580
Volkswagen AG, pfd. ....................................................... Germany 160,254 4,889,783
------------
Total Preferred Stocks (Cost $27,493,443).................................. 30,011,908
------------
PRINCIPAL
AMOUNT
--------------
Short Term Investments .5%
Sallie Mae, 6.264%, 4/19/01 (Cost $5,000,000).............................. United States $ 5,000,000 4,999,230
------------
Total Investments before Repurchase Agreements (Cost $839,454,275)......... 924,250,884
------------
/b/Repurchase Agreements 5.4%
Lehman Brothers Inc., 6.40%, 1/02/01 (Maturity Value $25,017,778)
Collateralized by Federal Home Loan Mortgage Corp. Discount Notes ......... United States 25,000,000 25,000,000
Paribas Corp., 6.45%, 1/02/01 (Maturity Value $26,780,179)
Collateralized by Fannie Mae Discount Notes ............................... United States 26,761,000 26,761,000
------------
Total Repurchase Agreements (Cost $51,761,000)............................. 51,761,000
------------
Total Investments (Cost $891,215,275) 101.3%............................... 976,011,884
Other Assets, less Liabilities (1.3%) ..................................... (12,401,366)
------------
Total Net Assets 100.0% ................................................... $963,610,518
============
/a/Non-income producing
/b/See Note 1(c) regarding repurchase agreements.
See notes to financial statements.
TI-10
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Financial Statements
Statement of Assets and Liabilities
December 31, 2000
Assets:
Investments in securities:
Cost................................................. $ 839,454,275
=============
Value................................................ 924,250,884
Repurchase agreements, at value and cost.............. 51,761,000
Receivables:
Investment securities sold........................... 98,283
Capital shares sold.................................. 2,872,986
Dividends and interest............................... 5,750,668
-------------
Total assets........................................ 984,733,821
-------------
Liabilities:
Payables:
Capital shares redeemed.............................. 19,743,969
Affiliates........................................... 882,563
Professional fees.................................... 34,792
Reports to shareholders.............................. 319,156
Funds advanced by custodian........................... 1,198
Other liabilities..................................... 141,625
-------------
Total liabilities................................... 21,123,303
-------------
Net assets, at value............................... $ 963,610,518
=============
Net assets consist of:
Undistributed net investment income................... $ 25,867,852
Net unrealized appreciation........................... 84,796,609
Accumulated net realized gain......................... 197,744,112
Capital shares........................................ 655,201,945
-------------
Net assets, at value............................... $ 963,610,518
=============
Class 1:
Net assets, at value.................................. $ 776,495,026
=============
Shares outstanding.................................... 41,338,300
=============
Net asset value and offering price per share.......... $ 18.78
=============
Class 2:
Net assets, at value.................................. $ 187,115,492
=============
Shares outstanding.................................... 10,021,735
=============
Net asset value and offering price per share.......... $ 18.67
=============
See notes to financial statements.
TI-11
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Financial Statements (continued)
Statement of Operations
for the year ended December 31, 2000
Investment income:
(net of foreign taxes of $3,906,045)
Dividends.................................................... $ 38,435,733
Interest..................................................... 4,808,680
--------------
Total investment income.................................... 43,244,413
--------------
Expenses:
Management fees (Note 3)..................................... 9,942,391
Administrative fees (Note 3)................................. 1,563,478
Distribution fees - Class 2 (Note 3)......................... 376,383
Custodian fees............................................... 500,000
Reports to shareholders...................................... 698,534
Registration and filing fees................................. 3,050
Professional fees (Note 3)................................... 55,150
Trustees' fees and expenses.................................. 13,550
Other........................................................ 17,827
--------------
Total expenses............................................. 13,170,363
--------------
Net investment income..................................... 30,074,050
--------------
Realized and unrealized gains (losses):
Net realized gain (loss) from:
Investments................................................. 142,591,527
Foreign currency transactions............................... (1,345,593)
--------------
Net realized gain.......................................... 141,245,934
Net unrealized depreciation on investments................... (180,372,699)
--------------
Net realized and unrealized loss.............................. (39,126,765)
--------------
Net decrease in net assets resulting from operations.......... $ (9,052,715)
==============
See notes to financial statements.
TI-12
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Financial Statements (continued)
Statements of Changes in Net Assets
for the years ended December 31, 2000 and 1999
2000 1999
------------------------------------
Increase (decrease) in net assets:
Operations:
Net investment income .................................................... $ 30,074,050 $ 17,320,878
Net realized gain from investments and foreign currency transactions ..... 141,245,934 84,997,543
Net unrealized appreciation (depreciation) on investments ................ (180,372,699) 128,046,409
------------------------------------
Net increase (decrease) in net assets resulting from operations ........ (9,052,715) 230,364,830
Distributions to shareholders from:
Net investment income:
Class 1 ................................................................. (20,195,709) (26,406,410)
Class 2 ................................................................. (2,255,259) (1,047,921)
Net realized gains:
Class 1 ................................................................. (118,600,706) (91,727,528)
Class 2 ................................................................. (14,798,195) (3,898,692)
------------------------------------
Total distributions to shareholders ....................................... (155,849,869) (123,080,551)
Capital share transactions: (Note 2)
Class 1 ................................................................. (129,050,261) (14,797,710)
Class 2 ................................................................. 99,400,896 45,319,734
------------------------------------
Total capital share transactions .......................................... (29,649,365) 30,522,024
Net increase (decrease) in net assets .................................. (194,551,949) 137,806,303
Net assets:
Beginning of year ......................................................... 1,158,162,467 1,020,356,164
------------------------------------
End of year ............................................................... $ 963,610,518 $1,158,162,467
====================================
Undistributed net investment income included in net assets:
End of year ............................................................... $ 25,867,852 $ 16,772,639
====================================
See notes to financial statements.
TI-13
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Notes to Financial Statements
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
The Templeton International Securities Fund (the Fund) is a separate,
diversified series of the Franklin Templeton Variable Insurance Products Trust
(the Trust), which is an open-end investment company registered under the
Investment Company Act of 1940. Shares of the Fund are sold only to insurance
company separate accounts to fund the benefits of variable life insurance
policies or variable annuity contracts. As of December 31, 2000, 54% of the
Fund's shares were sold through one insurance company. The Fund seeks long-term
capital growth. The portfolio invests primarily in equity securities of
companies outside the U.S., including emerging markets.
Effective May 1, 2000, the name of the Templeton International Equity Fund
changed to Templeton International Securities Fund as a result of fund mergers,
as discussed in Note 6. The Fund's investment objectives and other policies did
not change as a result of the name change.
The following summarizes the Fund's significant accounting policies.
a. Security Valuation
Securities listed or traded on a recognized national exchange or NASDAQ are
valued at the latest reported sales price. Over-the-counter securities and
listed securities for which no sale is reported are valued within the range of
the latest quoted bid and asked prices. Securities for which market quotations
are not readily available are valued at fair value as determined by management
in accordance with procedures established by the Board of Trustees.
b. Foreign Currency Translation
Portfolio securities and other assets and liabilities denominated in foreign
currencies are translated into U.S. dollars based on the exchange rate of such
currencies against U.S. dollars on the date of valuation. Purchases and sales
of securities and income items denominated in foreign currencies are translated
into U.S. dollars at the exchange rate in effect on the transaction date.
The Fund does not separately report the effect of changes in foreign exchange
rates from changes in market prices on securities held. Such changes are
included in net realized and unrealized gain or loss from investments.
Realized foreign exchange gains or losses arise from sales of foreign
currencies, currency gains or losses realized between the trade and settlement
dates on securities transactions and the difference between the recorded
amounts of dividends, interest, and foreign withholding taxes and the U.S.
dollar equivalent of the amounts actually received or paid. Net unrealized
foreign exchange gains and losses arise from changes in foreign exchange rates
on foreign denominated assets and liabilities other than investments in
securities held at the end of the reporting period.
c. Repurchase Agreements
The Fund may enter into repurchase agreements, which are accounted for as a
loan by the Fund to the seller, collateralized by securities which are
delivered to the Fund's custodian. The market value, including accrued
interest, of the initial collateralization is required to be at least 102% of
the dollar amount invested by the Funds, with the value of the underlying
securities marked to market daily to maintain coverage of at least 100%. At
December 31, 2000, all repurchase agreements held by the Fund had been entered
into on December 29, 2000.
TI-14
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (cont.)
d. Income Taxes
No provision has been made for income taxes because the Fund's policy is to
qualify as a regulated investment company under the Internal Revenue Code and
to distribute substantially all of its taxable income.
e. Security Transactions, Investment Income, Expenses and Distributions
Security transactions are accounted for on trade date. Realized gains and losses
on security transactions are determined on a specific identification basis.
Interest income and estimated expenses are accrued daily. Dividend income and
distributions to shareholders are recorded on the ex-dividend date.
Common expenses incurred by the Trust are allocated among the funds based on the
ratio of net assets of each fund to the combined net assets. Other expenses
are charged to each fund on a specific identification basis.
Realized and unrealized gains and losses and net investment income, other than
class specific expenses, are allocated daily to each class of shares based upon
the relative proportion of net assets of each class.
f. Accounting Estimates
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the amounts of income
and expense during the reporting period. Actual results could differ from those
estimates.
2. SHARES OF BENEFICIAL INTEREST
The Fund offers two classes of shares: Class 1 and Class 2. Each class of shares
differ by its distribution fees, voting rights on matters affecting a single
class, and its exchange privilege.
At December 31, 2000, there were an unlimited number of shares authorized ($.01
par value). Transactions in the Fund's shares were as follows:
Year Ended December 31,
----------------------------------------------------------------------
2000 1999
----------------------------------------------------------------------
Shares Amount Shares Amount
Class 1 Shares: ----------------------------------------------------------------------
Shares sold ........................................ 12,544,954 $ 237,099,440 4,898,075 $ 98,598,572
Shares issued on merger (Note 6) ................... 35,794,416 651,458,377 -- --
Shares issued on reinvestment of distributions ..... 7,326,841 138,796,415 6,924,615 118,133,938
Shares redeemed .................................... (61,827,748) (1,156,404,493) (11,722,543) (231,530,220)
----------------------------------------------------------------------
Net increase (decrease) ............................ (6,161,537) $ (129,050,261) 100,147 $ (14,797,710)
======================================================================
Class 2 Shares:
Shares sold ........................................ 51,772,474 $ 972,961,568 57,320,488 $ 1,117,974,227
Shares issued on merger (Note 6) ................... 177,521 3,216,683 -- --
Shares issued on reinvestment of distributions ..... 904,696 17,053,454 290,806 4,946,613
Shares redeemed .................................... (47,412,674) (893,830,809) (54,967,087) (1,077,601,106)
----------------------------------------------------------------------
Net increase ....................................... 5,442,017 $ 99,400,896 2,644,207 $ 45,319,734
======================================================================
TI-15
Franklin Templeton Variable Insurance Products Trust
Templton International Securities Fund
Notes to Financial Statements (continued)
3. TRANSACTIONS WITH AFFILIATES
Certain officers and trustees of the Trust are also officers and/or directors of
the following entities:
Entity Affiliation
--------------------------------------------------------------------------------------
Franklin Templeton Services, LLC (FT Services) Administrative manager
Templeton Investment Counsel, LLC (TIC) Investment manager
Franklin/Templeton Distributors, Inc. (Distributors) Principal underwriter
Franklin/Templeton Investor Services, LLC (Investor Service) Transfer agent
The Fund pays an investment management fee to TIC based on the average net
assets of the Fund as follows:
Annualized Fee Rate Daily Net Assets
------------------------------------------------------------------------------------
.75% First $200 million
.675% Over $200 million, up to and including $1.3 billion
.60% Over $1.3 billion
The Fund pays administrative fees to FT Services based on the average net
assets of the Fund as follows:
Annualized Fee Rate Daily Net Assets
-------------------------------------------------------------------------------------
.15% First $200 million
.135% Over $200 million, up to and including $700 million
.10% Over $700 million, up to and including $1.2 billion
Fees are further reduced on net assets over $1.2 billion.
The Fund reimburses Distributors up to .25% per year of its average daily net
assets of Class 2, for costs incurred in marketing the Fund's shares.
Investor Services, under terms of an agreement, performs shareholder servicing
for the Fund and is not paid by the Fund for the services.
Included in professional fees are legal fees of $9,632 that were paid to a law
firm in which a partner of that firm was an officer of the Fund.
4. INCOME TAXES
Net investment income and net realized capital gains (losses) differ for
financial statement and tax purposes primarily due to differing treatments of
wash sales, foreign currency transactions, merger related expenses, and gains
(losses) realized on in-kind shareholder redemptions.
At December 31, 2000, the net unrealized appreciation based on the cost of
investments for income tax purposes of $891,353,012 was as follows:
Unrealized appreciation ................ $ 235,847,269
Unrealized depreciation ................ (151,188,397)
--------------
Net unrealized appreciation ............ $ 84,658,872
==============
TI-16
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Notes to Financial Statements (continued)
5. INVESTMENT TRANSACTIONS
Purchases and sales of securities (excluding short-term securities) for the
year ended December 31, 2000 aggregated $439,898,109 and $1,229,714,659,
respectively.
6. MERGERS
On May 1, 2000, the Franklin Templeton Variable Insurance Products Trust
(FTVIPT) - Templeton International Securities Fund acquired the net assets of
Templeton Variable Products Series Fund (TVP) - Templeton International Fund
pursuant to a plan of reorganization approved by the TVP - Templeton
International Fund's shareholders. The merger was accounted for by the method
of accounting for tax-free business combinations of investment companies. The
financial statements of TVP - Templeton International Fund survived the
reorganization; therefore, the financial statements of FTVIPT - Templeton
International Securities Fund reflect the financial statements of TVP -
Templeton International Fund. Immediately preceding the merger, FTVIPT -
Templeton International Securities Fund completed a reverse split of its shares
in the ratio of one new Class 1 share for each .6496 existing Class 1 share and
one new Class 2 share for each .6496 existing Class 2 share. As a result, the
FTVIPT - Templeton International Securities Fund net asset value per share was
$18.20 for Class 1 and $18.12 for Class 2 on May 1, 2000. TVP - Templeton
International Fund's shareholders contributed net assets having an aggregate
value of $1,071,394,151 (including $137,586,448 of unrealized appreciation) in
exchange for 35,794,416 Class 1 shares and 177,521 Class 2 shares (post-split)
of the FTVIPT - Templeton International Securities Fund. Immediately prior to
the merger, FTVIPT - Templeton International Securities Fund had net assets of
$654,675,060 (including unrealized appreciation of $16,819,111). Upon
completion of the merger, the combined net assets of the FTVIPT - Templeton
International Securities Fund were $1,726,069,211.
TI-17
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Independent Auditors' Report
To the Board of Trustees and Shareholders
of Franklin Templeton Variable Insurance Products Trust
In our opinion, the accompanying statement of assets and liabilities, including
the statement of investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of the Templeton International
Securities Fund (the Fund), a series of Franklin Templeton Variable Insurance
Products Trust, at December 31, 2000, the results of its operations for the
year then ended, the changes in its net assets and the financial highlights for
each of the two years in the period then ended, in conformity with accounting
principles generally accepted in the United States of America. These financial
statements and financial highlights (hereafter referred to as "financial
statements") are the responsibility of the Fund's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these financial statements in accordance
with auditing standards generally accepted in the United States of America,
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities at December 31, 2000 by correspondence with the
custodian, provide a reasonable basis for our opinion. The financial highlights
for each of the three years in the period ended December 31, 1998 were audited
by other independent accountants whose report dated January 28, 1999 expressed
an unqualified opinion on those statements.
PricewaterhouseCoopers LLP
San Francisco, California
February 6, 2001
TI-18
Franklin TEmpleton Variable Insurance Products Trust
Templeton International Securities Fund
Tax Designation
Under Section 852(b)(3)(C) of the Internal Revenue Code, the Fund hereby
designates $155,849,714 as a capital gain dividend for the fiscal year ended
December 31, 2000.
TI-19
EXHIBIT G
Templeton International Securities Fund
- --------------------------------------------------------------------------------
Fund Goal and Primary Investments: Templeton International Securities Fund
seeks long-term capital growth. The Fund invests primarily in equity securities
of companies located outside the U.S., including those in emerging markets.
- --------------------------------------------------------------------------------
The six months under review were marked by mixed returns in the world's stock
markets as well as sharply diverging performances among different industries.
Although many sectors posted positive results, the once high-flying technology,
media and telecommunications (TMT) stocks continued to falter. Aided by six
Federal Reserve Board (the Fed) short-term interest rate cuts (including
surprise cuts in January and April), TMT stocks enjoyed sharp rallies in
January and April. The group faltered late in the period as a series of profit
warnings and layoff announcements from leading TMT companies such as Nokia,
Nortel Networks and Ericsson prompted many investors to focus on the sectors'
deteriorating fundamentals.
European markets turned in poor performances during the period, weighed down by
the decline in TMT stocks and the euro's persistent weakness. The currency's
feebleness was tied to fundamental factors such as slowing European economic
activity, perceived European Central Bank weakness and outflows into the U.S.,
in both equity investments and foreign direct investment.
Asian markets turned in relatively strong performances largely due to Japan's
increasing optimism and signs of Korea's restructuring. Dominating Japan's news
was the unexpected April election of Junichiro Koizumi and the perception that
he may be the catalyst to implement the reform measures that will turn Japan's
economy.
Latin America produced mixed performances, with Mexico posting positive returns
while the Brazilian market fell and Argentina's delivered a flat return. Mexico
continued to benefit from its ties to the U.S. economy while political and
economic turmoil hurt Brazil and Argentina.
In this environment, Templeton International Securities Fund outperformed its
benchmark, the Morgan Stanley Capital International Europe Australasia Far East
Index, which returned -14.40% during the
Geographic Distribution
Templeton International Securities Fund
Based on Total Net Assets
6/30/01
[PIE CHART APPEARS HERE]
Europe 55.6%
Asia 21.6%
North America 4.8%
Australia/New Zealand 4.5%
Latin America 4.2%
Mid-East/Africa 0.9%
Short-Term Investments
& Other Net Assets 8.4%
TI-1
Top 10 Holdings
Templeton International Securities
Fund
6/30/01
Company % of Total
Industry, Country Net Assets
------------------------------------------
Cheung Kong
Holdings Ltd. 2.0%
Real Estate, Hong Kong
Unilever PLC 1.9%
Food Products, U.K.
Aventis SA 1.9%
Pharmaceuticals, France
Australia & New Zealand
Banking Group Ltd. 1.8%
Banks, Australia
Wolters Kluwer NV 1.8%
Media, Netherlands
Nomura Securities Co. Ltd. 1.7%
Diversified Financials,
Japan
Ace Ltd. 1.7%
Insurance, Bermuda
ING Groep NV 1.6%
Diversified Financials,
Netherlands
Alstom SA 1.6%
Electrical Equipment,
France
J. Sainsbury PLC 1.6%
Food & Drug Retailing,
U.K.
The dollar value, number of shares or principal value, and complete legal
titles of all portfolio holdings are listed in the Fund's Statement of
Investments.
period./1/ The Fund's outperformance relative to the index was primarily due to
strong stock selection leading to low exposure to the poorly performing TMT
sectors.
Although we outperformed our benchmark, the Fund unfortunately turned in a
negative absolute return as the equity sell-off spread beyond the TMT sector to
other industries later in the period. Among our worst performers were AXA,
Nordea and Zurich Financial Services in financials, Philips in household
durables and Telebras and Embratel in telecommunications. Conversely, we had a
number of strong performers from a wide variety of sectors including utilities
Powergen and Iberdrola; pharmaceuticals company Elan PLC; industrial companies
Pechiney SA, IHC Caland and Alstom; energy producer Repsol YPF; and
telecommunications giant Telmex.
Fund purchases during the period included an array of companies in different
industries as we attempted to maintain the Fund's broad diversification. These
included bank Lloyds TSB; retailer J. Sainsbury PLC; metals producer Pechiney
SA; industrial company Valeo SA and consumer goods provider Societe BIC. We
even uncovered select opportunities in technology and telecommunications and
purchased Korean semiconductor producer Samsung Electronics and British firm
Cable & Wireless while adding to our holding in NEC Corporation in Japan.
We concentrated most of the selling in January, focusing on reducing a handful
of large holdings in financials Ace Ltd., Cheung Kong Holdings,
Foreningssparbanken AB and Zurich Financial; utilities provider Powergen PLC;
pharmaceuticals company Teva Pharmaceuticals and French technology firm Alcatel
SA. Other sales were due to what we believed were either high valuations in
stocks such as Next PLC, America Movil, Safeway PLC or worsening fundamentals
at companies like Corus PLC and Mothercare PLC.
Geographically, in Europe, we reduced our position from 60.3% of total net
assets to 55.6% at period-end, mainly due to falling share prices and the sales
mentioned above. Despite Japan's problems, our analysts identified a handful of
what we believed to be bargain stocks
1. Source: Standard & Poor's Micropal. The unmanaged Morgan Stanley Capital
International Europe Australasia Far East Index is an equity index that
measures the total returns (gross dividends are reinvested) of equity
securities in the developed markets in Europe, Australasia and the Far East.
Securities included in the index are weighted according to their market
capitalization (outstanding shares times price). One cannot invest directly in
an index nor is an index representative of the Fund's portfolio.
TI-2
during the period. Additionally, we absorbed Templeton Pacific Growth
Securities Fund's assets, which increased our Japan weighting from 7.7% of
total net assets on December 31, 2000, to 10.4% at period-end. In Latin
America, the sale of America Movil caused the weighting to slightly decline
from 5.2% of total net assets to 4.2% at period-end.
Looking forward, the euro is substantially undervalued versus the U.S. dollar
in our opinion. Although our position on the euro has been incorrect in the
past, we believe that progress toward European restructuring, reduced U.S.
interest rates and a narrowing of the growth gap between the U.S. and Europe
should lead to the currency's rebound.
While we welcome the appearance of change in Japan, the government has thus far
provided very little detail regarding policy initiatives and timing. The
Japanese banking sector remains a concern and the handling of the
non-performing loans in the systems bears watching. It appears more details
will emerge after the Upper House elections in late July, giving investors
further insights into the Koizumi administration. We continue to focus on
research efforts seeking to uncover companies with progressive management teams
that are restructuring their operations to become globally competitive.
As for the TMT stocks, it appears to us that lower interest rates will not
erase the impact of the capital markets-induced and Y2K and Internet-led
overspending on technology in 1999 and 2000. Although we believe that demand
for technology products will eventually return, we are concerned about high
inventory levels in items from semiconductors to cellular phones and the
continued relatively high valuations placed on many TMT stocks. In many cases,
leading stocks in these sectors recently traded at significant premiums
relative to past industry cycles. We suspect that despite recent major
inventory writedowns from companies like Cisco Systems and Nortel Networks, the
industry will grapple with excess inventories for several quarters. If the
global economies continue to weaken, this process may take longer to unwind.
Yet, we may gradually increase our exposure to TMT stocks over the course of
the year, as potentially lower share prices would allow our analysts to
identify bargain stocks trading at a discount to future growth prospects.
TI-3
As always, we will attempt to avoid fashionable but highly priced stocks and
concentrate on opportunities in the world's out-of-favor markets and sectors.
We intend to focus our attention on long-term opportunities, rather than
speculating on short-term market movements. Patient and disciplined value
investing has been Templeton's hallmark for many years, and this philosophy
continues to drive our stock selection process.
- --------------------------------------------------------------------------------
This discussion reflects our views, opinions and portfolio holdings as of June
30, 2001, the end of the reporting period. These opinions may not be relied upon
as investment advice or an offer for a particular security. The information
provided is not a complete analysis of every aspect of any country, industry,
security or the Fund. Our strategies and the Fund's portfolio composition will
change depending on market and economic conditions. Although historical
performance is no guarantee of future results, these insights may help you
understand our investment and management philosophy.
- --------------------------------------------------------------------------------
TI-4
Performance Summary as of 6/30/01
Templeton International Securities Fund - Class 1 delivered a
- -8.50% cumulative total return for the six-month period ended
6/30/01. Total return of Class 1 shares represents the cumulative or average
annual change in value, assuming reinvestment of dividends and capital gains.
Average returns smooth out variations in returns, which can be significant;
they are not the same as year-by-year results.
Templeton International Securities Fund - Class 1*
Periods ended 6/30/01
Since
Inception
1-Year 5-Year (5/1/92)
------------------------------------------------------------------------------
Cumulative Total Return -11.01% +54.18% +167.69%
Average Annual Total Return -11.01% +9.04% +11.34%
Value of $10,000 Investment $ 8,899 $ 15,418 $ 26,769
* Performance prior to the 5/1/00 merger reflects the historical performance of
Templeton International Fund.
Ongoing stock market volatility can dramatically change the Fund's short-term
performance; current results may differ.
Templeton International
Securities Fund
Class 1
- --------------------------------------------------------------------------------
Performance reflects the Fund's Class 1 operating expenses, but does not include
any contract fees, expenses or sales charges. If they had been included,
performance would be lower. These charges and deductions, particularly for
variable life policies, can have a significant effect on contract values and
insurance benefits. See the contract prospectus for a complete description of
these expenses, including sales charges.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Since markets can go down as well as up, investment return and the value of your
principal will fluctuate with market conditions, and you may have a gain or loss
when you sell your shares.
- --------------------------------------------------------------------------------
Past performance does not guarantee future results.
TI-5
Templeton International Securities Fund
- --------------------------------------------------------------------------------
Fund Goal and Primary Investments: Templeton International Securities Fund
seeks long-term capital growth. The Fund invests primarily in equity securities
of companies located outside the U.S., including those in emerging markets.
- --------------------------------------------------------------------------------
The six months under review were marked by mixed returns in the world's stock
markets as well as sharply diverging performances among different industries.
Although many sectors posted positive results, the once high-flying technology,
media and telecommunications (TMT) stocks continued to falter. Aided by six
Federal Reserve Board (the Fed) short-term interest rate cuts (including
surprise cuts in January and April), TMT stocks enjoyed sharp rallies in
January and April. The group faltered late in the period as a series of profit
warnings and layoff announcements from leading TMT companies such as Nokia,
Nortel Networks and Ericsson prompted many investors to focus on the sectors'
deteriorating fundamentals.
European markets turned in poor performances during the period, weighed down by
the decline in TMT stocks and the euro's persistent weakness. The currency's
feebleness was tied to fundamental factors such as slowing European economic
activity, perceived European Central Bank weakness and outflows into the U.S.,
in both equity investments and foreign direct investment.
Asian markets turned in relatively strong performances largely due to Japan's
increasing optimism and signs of Korea's restructuring. Dominating Japan's news
was the unexpected April election of Junichiro Koizumi and the perception that
he may be the catalyst to implement the reform measures that will turn Japan's
economy.
Latin America produced mixed performances, with Mexico posting positive returns
while the Brazilian market fell and Argentina's delivered a flat return. Mexico
continued to benefit from its ties to the U.S. economy while political and
economic turmoil hurt Brazil and Argentina.
In this environment, Templeton International Securities Fund outperformed its
benchmark, the Morgan Stanley Capital International Europe Australasia Far East
Index, which returned -14.40% during the
Geographic Distribution
Templeton International Securities Fund
Based on Total Net Assets
6/30/01
[PIE CHART APPEARS HERE]
Europe 55.6%
Asia 21.6%
North America 4.8%
Australia/New Zealand 4.5%
Latin America 4.2%
Mid-East/Africa 0.9%
Short-Term Investments
& Other Net Assets 8.4%
TI-1
Top 10 Holdings
Templeton International Securities
Fund
6/30/01
Company % of Total
Industry, Country Net Assets
- ------------------------------- ------------
Cheung Kong
Holdings Ltd. 2.0%
Real Estate, Hong Kong
Unilever PLC 1.9%
Food Products, U.K.
Aventis SA 1.9%
Pharmaceuticals, France
Australia & New Zealand
Banking Group Ltd. 1.8%
Banks, Australia
Wolters Kluwer NV 1.8%
Media, Netherlands
Nomura Securities Co. Ltd. 1.7%
Diversified Financials,
Japan
Ace Ltd. 1.7%
Insurance, Bermuda
ING Groep NV 1.6%
Diversified Financials,
Netherlands
Alstom SA 1.6%
Electrical Equipment,
France
J. Sainsbury PLC 1.6%
Food & Drug Retailing,
U.K.
The dollar value, number of shares or principal value, and complete legal
titles of all portfolio holdings are listed in the Fund's Statement of
Investments.
period./1/ The Fund's outperformance relative to the index was primarily due to
strong stock selection leading to low exposure to the poorly performing TMT
sectors.
Although we outperformed our benchmark, the Fund unfortunately turned in a
negative absolute return as the equity sell-off spread beyond the TMT sector to
other industries later in the period. Among our worst performers were AXA,
Nordea and Zurich Financial Services in financials, Philips in household
durables and Telebras and Embratel in telecommunications. Conversely, we had a
number of strong performers from a wide variety of sectors including utilities
Powergen and Iberdrola; pharmaceuticals company Elan PLC; industrial companies
Pechiney SA, IHC Caland and Alstom; energy producer Repsol YPF; and
telecommunications giant Telmex.
Fund purchases during the period included an array of companies in different
industries as we attempted to maintain the Fund's broad diversification. These
included bank Lloyds TSB; retailer J. Sainsbury PLC; metals producer Pechiney
SA; industrial company Valeo SA and consumer goods provider Societe BIC. We
even uncovered select opportunities in technology and telecommunications and
purchased Korean semiconductor producer Samsung Electronics and British firm
Cable & Wireless while adding to our holding in NEC Corporation in Japan.
We concentrated most of the selling in January, focusing on reducing a handful
of large holdings in financials Ace Ltd., Cheung Kong Holdings,
Foreningssparbanken AB and Zurich Financial; utilities provider Powergen PLC;
pharmaceuticals company Teva Pharmaceuticals and French technology firm Alcatel
SA. Other sales were due to what we believed were either high valuations in
stocks such as Next PLC, America Movil, Safeway PLC or worsening fundamentals
at companies like Corus PLC and Mothercare PLC.
Geographically, in Europe, we reduced our position from 60.3% of total net
assets to 55.6% at period-end, mainly due to falling share prices and the sales
mentioned above. Despite Japan's problems, our analysts identified a handful of
what we believed to be bargain stocks
1. Source: Standard & Poor's Micropal. The unmanaged Morgan Stanley Capital
International Europe Australasia Far East Index is an equity index that
measures the total returns (gross dividends are reinvested) of equity
securities in the developed markets in Europe, Australasia and the Far East.
Securities included in the index are weighted according to their market
capitalization (outstanding shares times price). One cannot invest directly in
an index nor is an index representative of the Fund's portfolio.
TI-2
during the period. Additionally, we absorbed Templeton Pacific Growth
Securities Fund's assets, which increased our Japan weighting from 7.7% of
total net assets on December 31, 2000, to 10.4% at period-end. In Latin
America, the sale of America Movil caused the weighting to slightly decline
from 5.2% of total net assets to 4.2% at period-end.
Looking forward, the euro is substantially undervalued versus the U.S. dollar
in our opinion. Although our position on the euro has been incorrect in the
past, we believe that progress toward European restructuring, reduced U.S.
interest rates and a narrowing of the growth gap between the U.S. and Europe
should lead to the currency's rebound.
While we welcome the appearance of change in Japan, the government has thus far
provided very little detail regarding policy initiatives and timing. The
Japanese banking sector remains a concern and the handling of the
non-performing loans in the systems bears watching. It appears more details
will emerge after the Upper House elections in late July, giving investors
further insights into the Koizumi administration. We continue to focus on
research efforts seeking to uncover companies with progressive management teams
that are restructuring their operations to become globally competitive.
As for the TMT stocks, it appears to us that lower interest rates will not
erase the impact of the capital markets-induced and Y2K and Internet-led
overspending on technology in 1999 and 2000. Although we believe that demand
for technology products will eventually return, we are concerned about high
inventory levels in items from semiconductors to cellular phones and the
continued relatively high valuations placed on many TMT stocks. In many cases,
leading stocks in these sectors recently traded at significant premiums
relative to past industry cycles. We suspect that despite recent major
inventory writedowns from companies like Cisco Systems and Nortel Networks, the
industry will grapple with excess inventories for several quarters. If the
global economies continue to weaken, this process may take longer to unwind.
Yet, we may gradually increase our exposure to TMT stocks over the course of
the year, as potentially lower share prices would allow our analysts to
identify bargain stocks trading at a discount to future growth prospects.
TI-3
As always, we will attempt to avoid fashionable but highly priced stocks and
concentrate on opportunities in the world's out-of-favor markets and sectors.
We intend to focus our attention on long-term opportunities, rather than
speculating on short-term market movements. Patient and disciplined value
investing has been Templeton's hallmark for many years, and this philosophy
continues to drive our stock selection process.
- -------------------------------------------------------------------------------
This discussion reflects our views, opinions and portfolio holdings as of June
30, 2001, the end of the reporting period. These opinions may not be relied
upon as investment advice or an offer for a particular security. The
information provided is not a complete analysis of every aspect of any
country, industry, security or the Fund. Our strategies and the Fund's
portfolio composition will change depending on market and economic conditions.
Although historical performance is no guarantee of future results, these
insights may help you understand our investment and management philosophy.
- -------------------------------------------------------------------------------
TI-4
Performance Summary as of 6/30/01
Templeton International Securities Fund - Class 2 delivered a -8.62% cumulative
total return for the six-month period ended 6/30/01. Total return of Class 2
shares represents the cumulative or average annual change in value, assuming
reinvestment of dividends and capital gains. Average returns smooth out
variations in returns, which can be significant; they are not the same as
year-by-year results.
Templeton International Securities Fund - Class 2*
Periods ended 6/30/01
Since
Inception
1-Year 5-Year (5/1/92)
- ------------------------------------------------------------------------------------------------------
Cumulative Total Return -11.19% +52.53% +164.83%
Average Annual Total Return -11.19% +8.81% +11.21%
Value of $10,000 Investment $ 8,881 $ 15,253 $ 26,483
* Performance prior to the 5/1/00 merger reflects the historical performance of
Templeton International Fund. In addition, because Class 2 shares were not
offered until 5/1/97, standardized Class 2 Fund performance for prior periods
represents the historical results of Class 1 shares. For periods beginning on
5/1/97, Class 2's results reflect an additional 12b-1 fee expense, which also
affects future performance. Since 5/1/97 (commencement of sales), the
cumulative and average annual total returns of Class 2 shares were +31.25% and
+6.75%.
Ongoing stock market volatility can dramatically change the Fund's short-term
performance; current results may differ.
Templeton International Securities Fund
Class 2
- -------------------------------------------------------------------------------
Performance reflects the Fund's Class 2 operating expenses, but does not
include any contract fees, expenses or sales charges. If they had been
included, performance would be lower. These charges and deductions,
particularly for variable life policies, can have a significant effect on
contract values and insurance benefits. See the contract prospectus for a
complete description of these expenses, including sales charges.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Since markets can go down as well as up, investment return and the value of
your principal will fluctuate with market conditions, and you may have a
gain or loss when you sell your shares.
- -------------------------------------------------------------------------------
Past performance does not guarantee future results.
TI-5
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Financial Highlights/a/
Class 1
-----------------------------------------------------------------------------
Six Months Ended Year Ended December 31,
June 30, 2001 ----------------------------------------------------------
(unaudited) 2000 1999 1998 1997 1996
-----------------------------------------------------------------------------
Per share operating performance
(for a share outstanding throughout the period)
Net asset value, beginning of period .............. $ 18.78 $ 22.25 $ 20.69 $ 20.18 $ 18.40 $ 15.13
-------- -------- ---------- -------- -------- --------
Income from investment operations:
Net investment income/b/ ......................... .19 .40 .33 .60 .49 .43
Net realized and unrealized gains (losses) ....... (1.75) (.95) 3.78 1.29 2.01 3.15
-------- -------- ---------- -------- -------- --------
Total from investment operations .................. (1.56) (.55) 4.11 1.89 2.50 3.58
-------- -------- ---------- -------- -------- --------
Less distributions from:
Net investment income ............................ (.51) (.43) (.57) (.49) (.51) (.24)
Net realized gains ............................... (3.84) (2.49) (1.98) (.89) (.21) (.07)
-------- -------- ---------- -------- -------- --------
Total distributions ............................... (4.35) (2.92) (2.55) (1.38) (.72) (.31)
-------- -------- ---------- -------- -------- --------
Net asset value, end of period .................... $ 12.87 $ 18.78 $ 22.25 $ 20.69 $ 20.18 $ 18.40
======== ======== ========== ======== ======== ========
Total return/c/ ................................... (8.50)% (2.19)% 23.61% 9.33% 13.95% 24.04%
Ratios/supplemental data
Net assets, end of period (000's) ................. $682,344 $776,495 $1,056,798 $980,470 $938,410 $682,984
Ratios to average net assets:
Expenses ......................................... .97%/d/ .87% .85% .86% .81% .65%
Net investment income ............................ 2.21%/d/ 2.08% 1.69% 2.81% 2.70% 3.23%
Portfolio turnover rate ........................... 11.26% 32.81% 30.04% 29.56% 16.63% 9.46%
/a/Financial highlights presented reflect historical financial information from
Templeton Variable Products Series Fund-Templeton International Fund as a
result of a merger on May 1, 2000.
/b/Based on average shares outstanding effective year ended December 31, 1999.
/c/Total return does not include any fees, charges or expenses imposed by the
variable annuity and life insurance contracts for which the Franklin Templeton
Variable Insurance Products Trust serves as an underlying investment vehicle.
Total return is not annualized for periods less than one year.
/d/Annualized
TI-6
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Financial Highlights/a/ (continued)
Class 2
--------------------------------------------------------------------------
Six Months Ended Year Ended December 31,
June 30, 2001 -------------------------------------------------------
(unaudited) 2000 1999 1999 1997/e/
--------------------------------------------------------------------------
Per share operating performance
(for a share outstanding throughout the period)
Net asset value, beginning of period ................ $ 18.67 $ 22.13 $ 20.61 $ 20.14 $ 18.40
--------------------------------------------------------------------------
Income from investment operations:
Net investment income/b/ ........................... .18 .31 .25 .59 .07
Net realized and unrealized gains (losses) ......... (1.75) (.90) 3.78 1.25 1.67
--------------------------------------------------------------------------
Total from investment operations .................... (1.57) (.59) 4.03 1.84 1.74
--------------------------------------------------------------------------
Less distributions from:
Net investment income .............................. (.49) (.38) (.53) (.48) --
Net realized gains ................................. (3.84) (2.49) (1.98) (.89) --
--------------------------------------------------------------------------
Total distributions ................................. (4.33) (2.87) (2.51) (1.37) --
--------------------------------------------------------------------------
Net asset value, end of period ...................... $ 12.77 $ 18.67 $ 22.13 $ 20.61 $ 20.14
==========================================================================
Total return/c/ ..................................... (8.62)% (2.38)% 23.23% 9.08% 9.46%
Ratios/supplemental data
Net assets, end of period (000's) ................... $231,296 $ 187,115 $ 101,365 $ 39,886 $ 17,606
Ratios to average net assets:
Expenses ........................................... 1.22%/d/ 1.12% 1.10% 1.11% 1.13%/d/
Net investment income .............................. 2.06%/d/ 1.66% 1.26% 2.69% 1.14%/d/
Portfolio turnover rate ............................. 11.26% 32.81% 30.04% 29.56% 16.63%
/a/Financial highlights presented reflect historical financial information from
Templeton Variable Products Series Fund-Templeton International Fund as a
result of a merger on May 1, 2000.
/b/Based on average shares outstanding effective year ended December 31, 1999.
/c/Total return does not include any fees, charges or expenses imposed by the
variable annuity and life insurance contracts for which the Franklin
Templeton Variable Insurance Products Trust serves as an underlying
investment vehicle. Total return is not annualized for periods less than one
year.
/d/Annualized
/e/For the period May 1, 1997 (effective date) to December 31, 1997.
See notes to financial statements.
TI-7
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Statement of Investments, June 30, 2001 (unaudited)
COUNTRY SHARES VALUE
- -------------------------------------------------------------------------------------------------------------
Common Stocks 90.6%
Aerospace & Defense 2.0%
BAE Systems PLC ....................................... United Kingdom 2,764,936 $ 13,240,243
Saab AB, B ............................................ Sweden 506,393 4,745,101
------------
17,985,344
------------
Airlines .8%
British Airways PLC ................................... United Kingdom 1,500,553 7,259,447
------------
Auto Components 1.7%
Autoliv Inc., SDR ..................................... Sweden 393,611 6,761,864
Michelin SA, B ........................................ France 266,820 8,440,969
Valeo SA .............................................. France 2,600 104,967
------------
15,307,800
------------
Automobiles .9%
Volkswagen AG ......................................... Germany 181,815 8,496,100
------------
Banks 9.6%
Australia & New Zealand Banking Group Ltd. ............ Australia 1,917,792 16,471,737
Banca Nazionale del Lavoro SpA ........................ Italy 3,283,734 10,285,384
Bayerische Hypo-Und Vereinsbank AG .................... Germany 56,130 2,748,839
Bayerische Hypo-Und Vereinsbank AG, 144A .............. Germany 134,116 6,568,025
HSBC Holdings PLC ..................................... Hong Kong 454,655 5,377,239
HSBC Holdings PLC, ADR ................................ Hong Kong 105,243 6,304,056
Lloyds TSB Group PLC .................................. United Kingdom 1,246,500 12,472,713
National Bank of Canada ............................... Canada 523,079 9,995,579
Nordea AB, FDR ........................................ Sweden 2,135,083 12,236,417
Unibanco Uniao de Bancos Brasileiros SA, GDR .......... Brazil 209,029 5,319,788
------------
87,779,777
------------
Building Products .5%
Novar PLC ............................................. United Kingdom 1,902,783 4,294,949
------------
Chemicals 4.6%
Akzo Nobel NV ......................................... Netherlands 329,003 13,925,817
BASF AG ............................................... Germany 276,469 10,836,231
Clariant AG ........................................... Switzerland 317,600 7,642,048
/a/Elementis PLC ......................................... United Kingdom 3,163,208 3,114,007
Imperial Chemical Industries PLC ...................... United Kingdom 499,408 2,928,770
Kemira OY ............................................. Finland 634,389 3,222,239
------------
41,669,112
------------
Commercial Services & Supplies 1.1%
Chubb PLC ............................................. United Kingdom 2,724,071 6,369,038
Kidde PLC ............................................. United Kingdom 2,724,071 3,122,265
Societe BIC SA ........................................ France 23,250 846,335
------------
10,337,638
------------
Communications Equipment .2%
Alcatel SA, ADR ....................................... France 92,583 1,920,171
------------
Computers & Peripherals 2.0%
Fujitsu Ltd. .......................................... Japan 670,271 7,040,210
NEC Corp. ............................................. Japan 865,000 11,686,377
------------
18,726,587
------------
Construction & Engineering .1%
Fletcher Building Ltd. ................................ New Zealand 1,083,314 1,042,473
------------
TI-8
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Statement of Investments, June 30, 2001 (unaudited) (cont.)
COUNTRY SHARES VALUE
- --------------------------------------------------------------------------------------------------------------
Common Stocks (cont.)
Diversified Financials 4.0%
ING Groep NV ......................................... Netherlands 225,305 $ 14,724,446
Nomura Securities Co. Ltd. ........................... Japan 834,730 15,995,868
Swire Pacific Ltd., B ................................ Hong Kong 7,938,127 5,699,241
------------
36,419,555
------------
Diversified Telecommunication Services 7.3%
Cable & Wireless PLC ................................. United Kingdom 1,520,000 8,940,736
/a/Cia de Telecomunicaciones de Chile SA, ADR ........... Chile 251,452 3,540,444
Korea Telecom Corp., ADR ............................. South Korea 302,920 6,658,182
Nippon Telegraph & Telephone Corp. ................... Japan 2,159 11,252,004
/a/Pacific Century Regional Developments Ltd. ........... Singapore 6,410,127 2,146,091
Philippine Long Distance Telephone Co., ADR .......... Philippines 502,088 7,054,336
Telecom Corp. of New Zealand Ltd. .................... New Zealand 2,964,626 6,777,320
Telefonica SA, ADR ................................... Spain 263,664 9,818,847
Telefonos de Mexico SA de CV, L, ADR ................. Mexico 297,529 10,440,293
------------
66,628,253
------------
Electric Utilities 7.2%
CLP Holdings Ltd. .................................... Hong Kong 3,246,189 13,609,198
E.ON AG .............................................. Germany 271,353 14,104,374
Hong Kong Electric Holdings Ltd. ..................... Hong Kong 2,367,298 9,105,109
Iberdrola SA, Br. .................................... Spain 918,222 11,776,362
Innogy Holdings PLC .................................. United Kingdom 1,149,686 3,524,759
Korea Electric Power Corp. ........................... South Korea 250,000 4,652,057
Powergen PLC ......................................... United Kingdom 851,059 8,605,623
------------
65,377,482
------------
Electrical Equipment 1.6%
Alstom SA ............................................ France 528,574 14,703,617
------------
Electronic Equipment & Instruments 1.3%
Hitachi Ltd. ......................................... Japan 1,174,867 11,539,545
------------
Food & Drug Retailing 1.6%
J.Sainsbury PLC ...................................... United Kingdom 2,300,000 14,337,398
------------
Food Products 1.9%
Unilever PLC ......................................... United Kingdom 2,112,924 17,799,363
------------
Health Care Equipment & Supplies .7%
Nycomed Amersham PLC ................................. United Kingdom 918,222 6,737,277
------------
Health Care Providers & Services 1.1%
Mayne Nickless Ltd., A ............................... Australia 3,119,588 10,223,636
------------
Hotels Restaurants & Leisure .4%
P & O Princess Cruises PLC ........................... United Kingdom 789,853 4,109,999
------------
Household Durables 2.1%
Koninklijke Philips Electronics NV ................... Netherlands 392,839 10,412,344
Sony Corp. ........................................... Japan 138,634 9,114,808
------------
19,527,152
------------
Insurance 7.4%
Ace Ltd. ............................................. Bermuda 387,103 15,131,856
AXA SA ............................................... France 445,292 12,684,717
AXA SA, 144A ......................................... France 40,480 1,153,125
Scor SA .............................................. France 145,685 6,474,779
Swiss Reinsurance Co. ................................ Switzerland 6,369 12,600,164
TI-9
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Statement of Investments, June 30, 2001 (unaudited) (cont.)
COUNTRY SHARES VALUE
- ------------------------------------------------------------------------------------------------------------
Common Stocks (cont.)
Insurance (cont.)
XL Capital Ltd., A .................................. Bermuda 99,328 $ 8,154,829
Zurich Financial Services AG ........................ Switzerland 32,812 11,190,162
------------
67,389,632
------------
Machinery 3.4%
IHC Caland NV ....................................... Netherlands 109,264 5,503,575
Invensys PLC ........................................ United Kingdom 4,349,526 8,257,897
Komatsu Ltd. ........................................ Japan 2,196,343 10,073,029
Volvo AB, B ......................................... Sweden 491,704 7,362,901
------------
31,197,402
------------
Marine .3%
Peninsular & Oriental Steam Navigation Co. .......... United Kingdom 789,853 2,954,756
------------
Media 1.8%
Wolters Kluwer NV ................................... Netherlands 600,280 16,134,237
------------
Metals & Mining 3.8%
Barrick Gold Corp. .................................. Canada 607,739 9,250,640
BHP Billiton Ltd. ................................... Australia 1,338,050 7,063,766
Pechiney SA, A ...................................... France 174,700 8,873,501
Pohang Iron & Steel Co. Ltd. ........................ South Korea 125,150 10,008,151
------------
35,196,058
------------
Multiline Retail 1.4%
Hudsons Bay Co. ..................................... Canada 210,238 2,260,862
Marks & Spencer PLC ................................. United Kingdom 2,780,830 10,246,357
------------
12,507,219
------------
Oil & Gas 5.6%
Eni SpA ............................................. Italy 1,057,980 12,897,062
Repsol YPF SA ....................................... Spain 730,405 12,057,275
Shell Transport & Trading Co. PLC ................... United Kingdom 1,679,653 13,960,495
Total Fina Elf SA, B ................................ France 86,277 12,080,401
------------
50,995,233
------------
Paper & Forest Products 1.3%
Stora Enso OYJ, R ................................... Finland 584,330 6,146,406
UPM-Kymmene Corp. ................................... Finland 204,542 5,781,623
------------
11,928,029
------------
Pharmaceuticals 7.0%
Aventis SA .......................................... France 212,048 16,927,651
/a/Elan Corp. PLC, ADR ................................. Irish Republic 232,119 14,159,259
Merck KGAA .......................................... Germany 370,710 13,023,665
Ono Pharmaceutical Co. Ltd. ......................... Japan 335,000 10,636,626
Teva Pharmaceutical Industries Ltd., ADR ............ Israel 141,622 8,823,051
------------
63,570,252
------------
Real Estate 2.0%
Cheung Kong Holdings Ltd. ........................... Hong Kong 1,681,137 18,320,318
------------
Road & Rail 2.2%
Nippon Express Co. Ltd. ............................. Japan 2,115,342 9,548,890
Stagecoach Holdings PLC ............................. United Kingdom 9,856,847 10,916,473
------------
20,465,363
------------
TI-10
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Statement of Investments, June 30, 2001 (unaudited) (cont.)
COUNTRY SHARES VALUE
- ---------------------------------------------------------------------------------------------------------------------------
Common Stocks (cont.)
Semiconductor Equipment & Products 1.1%
/a/Hynix Semiconductor Inc., GDR, 144A ............................... South Korea 236,830 $ 2,528,160
Samsung Electronics Co. Ltd. ...................................... South Korea 49,050 7,241,521
-------------
9,769,681
-------------
Wireless Telecommunication Services .6%
Smartone Telecommunications Holdings Ltd. ......................... Hong Kong 4,459,118 5,145,202
-------------
Total Common Stocks (Cost $795,399,992)............................ 827,796,057
-------------
Preferred Stocks 2.7%
Cia Vale Do Rio Doce, A, ADR, pfd. ................................ Brazil 204,192 4,737,254
Embratel Participacoes SA, ADR, pfd. .............................. Brazil 231,091 1,728,561
Petroleo Brasileiro SA, pfd. ...................................... Brazil 300,000 7,013,248
Telecomunicacoes Brasileiras SA, ADR, pfd. ........................ Brazil 129,339 6,046,598
Volkswagen AG, pfd. ............................................... Germany 160,254 4,883,849
-------------
Total Preferred Stocks (Cost $28,335,729).......................... 24,409,510
-------------
Total Long Term Investments (Cost $823,735,721).................... 852,205,567
-------------
/b/Short Term Investments 8.4%
Franklin Institutional Fiduciary Trust Money Market Portfolio
(Cost $77,257,092 ................................................. United States 77,257,092 77,257,092
-------------
Total Investments (Cost $900,992,813) 101.7%....................... 929,462,659
Other Assets, less Liabilities (1.7)% ............................. (15,823,008)
-------------
Total Net Assets 100.0% ........................................... $ 913,639,651
=============
/a/Non-income producing.
/b/The Franklin Institutional Fiduciary Trust Money Market Portfolio is managed
by Franklin Advisers, Inc.
See notes to financial statements.
TI-11
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Financial Statements
Statement of Assets and Liabilities
June 30, 2001 (unaudited)
Assets:
Investments in securities:
Cost ................................................ $ 900,992,813
=============
Value ............................................... 929,462,659
Cash ................................................. 3,595
Receivables:
Investment securities sold .......................... 514,459
Capital shares sold ................................. 591,958
Dividends ........................................... 4,417,294
-------------
Total assets ....................................... 934,989,965
-------------
Liabilities:
Payables:
Investment securities purchased ..................... 2,077,221
Capital shares redeemed ............................. 17,785,207
Affiliates .......................................... 695,307
Professional fees ................................... 54,108
Reports to shareholders ............................. 588,023
Other liabilities .................................... 150,448
-------------
Total liabilities .................................. 21,350,314
-------------
Net assets, at value .............................. $ 913,639,651
=============
Net assets consist of:
Undistributed net investment income .................. $ 9,902,412
Net unrealized appreciation .......................... 28,469,846
Accumulated net realized loss ........................ (29,265,150)
Capital shares ....................................... 904,532,543
-------------
Net assets, at value .............................. $ 913,639,651
=============
Class 1:
Net assets, at value ................................. $ 682,343,777
=============
Shares outstanding ................................... 53,006,381
=============
Net asset value and offering price per share ......... $ 12.87
=============
Class 2:
Net assets, at value ................................. $ 231,295,874
=============
Shares outstanding ................................... 18,111,581
=============
Net asset value and offering price per share ......... $ 12.77
=============
See notes to financial statements.
TI-12
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Financial Statements (continued)
Statement of Operations
for the six months ended June 30, 2001 (unaudited)
Investment Income:
(net of foreign taxes and fees of $1,588,901)
Dividends ................................................... $ 14,049,400
Interest .................................................... 901,137
-------------
Total investment income .................................... 14,950,537
-------------
Expenses:
Management fees (Note 3) .................................... 3,196,219
Administrative fees (Note 3) ................................ 602,598
Distribution fees - Class 2 (Note 3) ........................ 264,552
Transfer agent fees ......................................... 12,769
Custodian fees .............................................. 172,787
Reports to shareholders ..................................... 487,035
Professional fees ........................................... 39,572
Trustees' fees and expenses ................................. 6,233
Other ....................................................... 5,604
-------------
Total expenses ............................................. 4,787,369
-------------
Net investment income .................................... 10,163,168
-------------
Realized and unrealized gains (losses):
Net realized loss from:
Investments ................................................ (29,112,685)
Foreign currency transactions .............................. (10,662)
-------------
Net realized loss ........................................ (29,123,347)
Net unrealized depreciation on investments .................. (56,326,763)
-------------
Net realized and unrealized loss ............................. (85,450,110)
-------------
Net decrease in net assets resulting from operations ......... $ (75,286,942)
=============
See notes to financial statements.
TI-13
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Financial Statements (continued)
Statements of Changes in Net Assets
for the six months ended June 30, 2001 (unaudited) and the year ended December
31, 2000
Six Months Ended Year Ended
June 30, 2001 December 31, 2000
-------------------------------------
Increase (decrease) in net assets:
Operations:
Net investment income ...................................................... $ 10,163,168 $ 30,074,050
Net realized gain (loss) from investments and foreign currency transactions (29,123,347) 141,245,934
Net unrealized depreciation on investments ................................. (56,326,763) (180,372,699)
-------------------------------------
Net decrease in net assets resulting from operations ...................... (75,286,942) (9,052,715)
Distributions to shareholders from:
Net investment income:
Class 1 .................................................................. (20,393,444) (20,195,709)
Class 2 .................................................................. (5,735,164) (2,255,259)
Net realized gains:
Class 1 .................................................................. (173,173,004) (118,600,706)
Class 2 .................................................................. (24,712,911) (14,798,195)
-------------------------------------
Total distributions to shareholders ......................................... (224,014,523) (155,849,869)
Capital share transactions: (Note 2)
Class 1 .................................................................. 140,750,303 (129,050,261)
Class 2 .................................................................. 108,580,295 99,400,896
-------------------------------------
Total capital share transactions ............................................ 249,330,598 (29,649,365)
Net decrease in net assets .............................................. (49,970,867) (194,551,949)
Net assets:
Beginning of period ......................................................... 963,610,518 1,158,162,467
-------------------------------------
End of period ............................................................... $ 913,639,651 $ 963,610,518
=====================================
Undistributed net investment income included in net assets:
End of period ............................................................... $ 9,902,412 $ 25,867,852
=====================================
See notes to financial statements.
TI-14
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Notes to Financial Statements (unaudited)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Franklin Templeton Variable Insurance Products Trust (the Trust) is registered
under the Investment Company Act of 1940 as an open-end investment company,
consisting of twenty-seven series (the Funds). Templeton International
Securities Fund (the Fund) included in this report is diversified. Shares of
the Fund are sold only to insurance company separate accounts to fund the
benefits of variable life insurance policies or variable annuity contracts. As
of June 30, 2001, over 54% of the Fund's shares were sold through one insurance
company. The Fund's investment objective is capital growth.
The following summarizes the Fund's significant accounting policies.
a. Security Valuation
Securities listed or traded on a recognized national exchange or NASDAQ are
valued at the latest reported sales price. Over-the-counter securities and
listed securities for which no sale is reported are valued within the range of
the latest quoted bid and asked prices. Restricted securities and securities
for which market quotations are not readily available are valued at fair value
as determined by management in accordance with procedures established by the
Board of Trustees.
b. Foreign Currency Translation
Portfolio securities and other assets and liabilities denominated in foreign
currencies are translated into U.S. dollars based on the exchange rate of such
currencies against U.S. dollars on the date of valuation. Purchases and sales
of securities and income items denominated in foreign currencies are translated
into U.S. dollars at the exchange rate in effect on the transaction date.
The Fund does not separately report the effect of changes in foreign exchange
rates from changes in market prices on securities held. Such changes are
included in net realized and unrealized gain or loss from investments.
Realized foreign exchange gains or losses arise from sales of foreign
currencies, currency gains or losses realized between the trade and settlement
dates on securities transactions and the difference between the recorded
amounts of dividends, interest, and foreign withholding taxes and the U.S.
dollar equivalent of the amounts actually received or paid. Net unrealized
foreign exchange gains and losses arise from changes in foreign exchange rates
on foreign denominated assets and liabilities other than investments in
securities held at the end of the reporting period.
c. Income Taxes
No provision has been made for income taxes because the Fund's policy is to
qualify as a regulated investment company under the Internal Revenue Code and
to distribute substantially all of its taxable income.
d. Security Transactions, Investment Income, Expenses and Distributions
Security transactions are accounted for on trade date. Realized gains and
losses on security transactions are determined on a specific identification
basis. Certain income from foreign securities is recorded as soon as
information is available to the Fund. Interest income and estimated expenses
are accrued daily. Dividend income and distributions to shareholders are
recorded on the ex-dividend date.
Common expenses incurred by the Trust are allocated among the funds based on
the ratio of net assets of each fund to the combined net assets. Other expenses
are charged to each fund on a specific identification basis.
Realized and unrealized gains and losses and net investment income, other than
class specific expenses, are allocated daily to each class of shares based upon
the relative proportion of net assets of each class.
TI-15
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Notes to Financial Statements (unaudited) (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (cont.)
e. Accounting Estimates
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities at the date of the financial statements and the
amounts of income and expense during the reporting period. Actual results could
differ from those estimates.
2. SHARES OF BENEFICIAL INTEREST
The Fund offers two classes of shares: Class 1 and Class 2. Each class of
shares differs by its distribution fees, voting rights on matters affecting a
single class and its exchange privilege.
At June 30, 2001, there were an unlimited number of shares authorized ($.01 par
value). Transactions in the Fund's shares were as follows:
Six Months Ended Year Ended
June 30, 2001 December 31, 2000
-------------------------------------------------------------------
Shares Amount Shares Amount
Class 1 Shares: -------------------------------------------------------------------
Shares sold ................................... 13,349,183 $ 228,265,174 12,544,954 $ 237,099,440
Shares issued on merger/a/ .................... -- -- 35,794,416 651,458,377
Shares issued on reinvestment of
distributions................................. 13,351,812 173,173,003 7,326,841 138,796,415
Shares redeemed ............................... (15,032,914) (260,687,874) (61,827,748) (1,156,404,493)
-------------------------------------------------------------------
Net increase (decrease) ....................... 11,668,081 $ 140,750,303 (6,161,537) $ (129,050,261)
===================================================================
Class 2 Shares:
Shares sold ................................... 71,843,240 $ 1,221,005,346 51,772,474 $ 972,961,568
Shares issued on merger/a/ .................... -- -- 177,521 3,216,683
Shares issued on reinvestment of
distributions................................. 3,950,390 50,841,517 904,696 17,053,454
Shares redeemed ............................... (67,703,784) (1,163,266,568) (47,412,674) (893,830,809)
-------------------------------------------------------------------
Net increase .................................. 8,089,846 $ 108,580,295 5,442,017 $ 99,400,896
===================================================================
/a/ On May 1, 2000, the Fund acquired the net assets of the Templeton Variable
Products Series Fund (TVP) - Templeton International Fund in a tax free
exchange pursuant to a plan of reorganization approved by the TVP -
International Fund's shareholders.
3. TRANSACTIONS WITH AFFILIATES
Certain officers and trustees of the Trust are also officers and/or directors
of the following entities:
Entity Affiliation
----------------------------------------------------------------------------------------
Franklin Templeton Services, LLC (FT Services) Administrative manager
Templeton Investment Counsel, LLC (TIC) Investment manager
Franklin/Templeton Distributors, Inc. (Distributors) Principal underwriter
Franklin/Templeton Investor Services, LLC (Investor Services) Transfer agent
The Fund pays an investment management fee to TIC based on the average net
assets of the Fund as follows:
Annualized Fee Rate Daily Net Assets
------------------- ---------------------------------------------------
.75% First $200 million
.675% Over $200 million, up to and including $1.3 billion
.60% Over $1.3 billion
TI-16
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Notes to Financial Statements (unaudited) (continued)
3. TRANSACTIONS WITH AFFILIATES (cont.)
Management fees were reduced on assets invested in the Sweep Money Fund.
The Fund pays administrative fees to FT Services based on the average net
assets of the Fund as follows:
Annualized Fee Rate Daily Net Assets
------------------- ---------------------------------------------------
.15% First $200 million
.135% Over $200 million, up to and including $700 million
.10% Over $700 million, up to and including $1.2 billion
Fees are further reduced on net assets over $1.2 billion.
The Fund reimburses Distributors up to .25% per year of its average daily net
assets of Class 2 shares for costs incurred in marketing the Fund's shares.
Investor Services, under terms of an agreement, performs shareholder servicing
for the Fund and is not paid by the Fund for the services.
4. INCOME TAXES
Net investment income differs for financial statement and tax purposes
primarily due to differing treatments of foreign currency transactions.
Net realized gains differ for financial statement and tax purposes primarily
due to differing treatment of wash sales and foreign currency transactions.
At June 30, 2001, the net unrealized appreciation based on the cost of
investments for income tax purposes of $901,130,550 was as follows.
Unrealized appreciation ........... $ 175,415,331
Unrealized depreciation ........... (147,083,222)
-------------
Net unrealized appreciation ....... $ 28,332,109
=============
5. INVESTMENT TRANSACTIONS
Purchases and sales of securities (excluding short-term securities) for the
period ended June 30, 2001 aggregated $118,262,930 and $100,019,207,
respectively.
6. LIQUIDATION OF TEMPLETON PACIFIC GROWTH FUND
On March 30, 2001, as a result of a substitution transaction, the Templeton
International Securities Fund acquired all of the net assets of the Templeton
Pacific Growth Fund. In connection with this liquidation, the Templeton
International Securities Fund acquired the portfolio securities and other
assets and liabilities of the liquidating fund in exchange for capital shares
with an equivalent value.
The Templeton International Securities Fund acquired net assets from the
Templeton Pacific Growth Fund in the amount of $39,368,803 and issued 2,347,649
Class 1 shares and 5,573 Class 2 shares.
TI-17
Franklin Templeton Variable Insurance Products Trust
Templeton International Securities Fund
Tax Designation
At December 31, 2000, more than 50% of the Templeton International Securities
Fund total assets were invested in securities of foreign issuers. In most
instances, foreign taxes were withheld from dividends paid to the Fund on these
investments. The Fund intends to make an election under Section 853 of the
Internal Revenue Code. This election will allow shareholders to treat their
proportionate share of foreign taxes paid by the funds as having been paid
directly by them.
The following table provides a breakdown by country of foreign source income
and foreign taxes paid, as designated by the Fund, to Class 1 and Class 2
shareholders of record on December 31, 2000.
Class 1 Class 2
-------------------------------------------------------
Foreign Tax Foreign Foreign Tax Foreign
Paid Source Income Paid Source Income
Country Per Share Per Share Per Share Per Share
- -------------------------------------------------------------------------------
Argentina ............ 0.0000 0.0017 0.0000 0.0016
Australia ............ 0.0002 0.0296 0.0002 0.0291
Austria .............. 0.0016 0.0089 0.0016 0.0087
Bermuda .............. 0.0000 0.0098 0.0000 0.0097
Brazil ............... 0.0035 0.0277 0.0035 0.0272
Canada ............... 0.0019 0.0112 0.0019 0.0110
Chile ................ 0.0003 0.0033 0.0003 0.0032
China ................ 0.0000 0.0002 0.0000 0.0002
Finland .............. 0.0031 0.0142 0.0031 0.0139
France ............... 0.0055 0.0332 0.0055 0.0326
Germany .............. 0.0037 0.0310 0.0037 0.0304
Hong Kong ............ 0.0007 0.0438 0.0007 0.0431
Israel ............... 0.0003 0.0011 0.0003 0.0011
Italy ................ 0.0015 0.0087 0.0015 0.0086
Japan ................ 0.0017 0.0099 0.0017 0.0097
Mexico ............... 0.0006 0.0076 0.0006 0.0075
Netherlands .......... 0.0080 0.0591 0.0080 0.0580
New Zealand .......... 0.0045 0.0256 0.0045 0.0252
Peru ................. 0.0000 0.0050 0.0000 0.0049
Philippines .......... 0.0002 0.0008 0.0002 0.0008
Portugal ............. 0.0009 0.0050 0.0009 0.0049
South Korea .......... 0.0005 0.0026 0.0005 0.0025
Spain ................ 0.0029 0.0167 0.0029 0.0164
Sweden ............... 0.0024 0.0141 0.0024 0.0139
Switzerland .......... 0.0010 0.0055 0.0010 0.0054
United Kingdom ....... 0.0236 0.2725 0.0236 0.2677
-----------------------------------------------------
TOTAL ................ $0.0686 $0.6488 $0.0686 $0.6373
=====================================================
TI-18
PROXY CARD (For Participating Insurance Companies)
Templeton International Smaller Companies Fund
Special Meeting of Shareholders To Be Held On
February 26, 2002
By signing and dating the lower portion of this card you authorize the proxies
to vote your shares as marked below.
This proxy is solicited by the Board of Trustees of Franklin Templeton Variable
Insurance Products Trust (the Trust), on behalf of its series Templeton
International Smaller Companies Fund (International Smaller Companies). The
undersigned appoints Harmon E. Burns, Murray L. Simpson, Karen L. Skidmore and
Joan E. Boros, with full power of substitution, to vote all the shares of
International Smaller Companies attributable to him or her at the special
meeting of shareholders (Meeting) to be held at One Franklin Parkway at 10:00
a.m. Pacific time on February 26, 2002, or an adjournment of the Meeting as,
follows:
Please vote by filling in the appropriate boxes below.
Proposal 1 To approve a Plan of Reorganization involving International
Smaller Companies Fund and Templeton International Securities
Fund (International Securities), another series of the Trust,
under which the following will occur:
. The acquisition of the assets of International Smaller
Companies by International Securities in exchange for
shares of International Securities.
. The distribution of such shares to the shareholders of
International Smaller Companies.
. The dissolution of International Smaller Companies.
This is described more fully in the Prospectus and Proxy Statement.
For [_] Against [_] Abstain [_]
Other Business To vote upon any other business which may be legally presented at
the Meeting or any adjournment.
Grant [_] Withhold [_]
THE BOARD OF TRUSTEES OF THE TRUST RECOMMENDS VOTING IN FAVOR OF THE PROPOSAL
AND GRANTING AUTHORITY TO THE PROXY HOLDERS TO VOTE ON OTHER BUSINESS.
SIGN HERE:______________________________ DATE:_______________
PLEASE DATE, SIGN AND RETURN THIS PROXY IN THE ENCLOSED ENVELOPE PROMPTLY.
STATEMENT OF ADDITIONAL INFORMATION
Dated January 16, 2002
Acquisition of the Assets of
TEMPLETON INTERNATIONAL SMALLER COMPANIES FUND
By and in Exchange for Shares of
TEMPLETON INTERNATIONAL SECURITIES FUND
(Both funds (Funds) are series of Franklin Templeton Variable Insurance
Products Trust (Trust) an open-end management investment company.)
This Statement of Additional Information (SAI) is not a prospectus and
should be read in conjunction with the Prospectus and Proxy Statement dated
January 16, 2002, for the special meeting of the holders of beneficial interest
of $0.01 par value shares of Templeton International Smaller Companies Fund
(International Smaller Companies), a diversified series of the Trust. The
meeting is to be held on February 26, 2002.
The Prospectus and Proxy Statement describes certain transactions
contemplated by the proposed combination of the International Smaller Companies
with Templeton International Securities Fund (International Securities) pursuant
to the terms of the Plan of Reorganization (Plan). Under the Plan, International
Securities will acquire all the assets and assume all the liabilities of the
International Smaller Companies and issue in exchange Class 1 or Class 2 shares
of International Securities equal in value to the Class 1 or Class 2 shares of
International Smaller Companies. The International Smaller Companies would
immediately redeem all of its outstanding shares by distributing the
International Securities shares to the insurance company separate accounts which
hold its shares, and thereafter be dissolved. As a result, the separate accounts
will cease to own shares of the International Smaller Companies and will instead
own shares of Class 1 or Class 2 of International Securities having an aggregate
net asset value equal to all Class 1 and Class 2 shares of International Smaller
Companies at the time of the Transaction. International Smaller Companies and
Franklin Templeton Distributors, Inc., the principal underwriter of the Trust,
have agreed to each pay one-half of the expenses incurred in connection with the
Plan.
FINANCIAL STATEMENTS
The following audited historical financial statements and footnotes
thereto of International Smaller Companies and International Securities,
together with the report of independent auditors thereon, are incorporated
herein by reference from the Trust's Annual Report to Shareholders for the year
ended December 30, 2000:
(1) Financial Highlights for each of the Funds;
(2) Statement of Investments for each of the Funds as of December 31, 2000;
(3) Statement of Assets and Liabilities for each of the Funds as of
December 31, 2000;
(4) Statement of Operations for each of the Funds as of December 31, 2000;
(5) Statement of Changes in Net Assets for each of the Funds for the years
ended December 31, 2000 and 1999; and
(6) Notes to Financial Statements.
The following unaudited historical financial statements and footnotes
thereto of the International Smaller Companies and the International Securities
are incorporated herein by reference from the Trust's Semi- Annual Report to
Shareholders for the period ended June 30, 2001:
(1) Financial Highlights for each of the Funds (unaudited);
(2) Statement of Investments for each of the Funds as of June 30, 2001
(unaudited);
(3) Statement of Assets and Liabilities for each of the Funds as of June
30, 2001 (unaudited);
(4) Statement of Operations for each of the Funds for the six months ended
June 30, 2001 (unaudited);
(5) Statement of Changes in Net Assets for each of the Funds for the six
months ended June 30, 2001 (unaudited) and for the fiscal year ended
December 31, 2000; and
(6) Notes to Financial Statements.
OTHER INFORMATION
The information otherwise required to be set forth in this SAI
is included in the Funds' Prospectuses, both dated May 1, 2001, and
Statement of Additional Information of the Trust, dated May 1, 2001,
and in the Funds' Annual Reports to Shareholders for the year ended
December 31, 2001 and Semi-Annual Reports to Shareholders for the
period ended June 30, 2001, all of which are incorporated herein by
reference.
FRANKLIN TEMPLETON
VARIABLE INSURANCE
PRODUCTS TRUST
CLASS 1 & 2
STATEMENT OF ADDITIONAL INFORMATION
May 1, 2001
[GRAPHIC OMITTED]
777 Mariners Island Blvd., P.O. Box 7777
San Mateo CA 94403-7777 1/800 342-3863
- --------------------------------------------------------------------------------
1
Franklin Templeton Variable Insurance Products Trust (Trust) consists of 27
series (Fund or Funds). Each Fund offers Class 1 and Class 2 shares, which are
generally available only to insurance companies for use as investment options in
variable annuity or variable life insurance contracts.
This Statement of Additional Information (SAI) is not a prospectus. It contains
information in addition to the information in the Funds' prospectuses. The
Funds' prospectuses, dated May 1, 2001, which we may amend from time to time,
contain the basic information you should know before investing in the Funds. You
should read this SAI together with the Funds' prospectuses.
The audited financial statements and auditor's report in the Franklin Templeton
Variable Insurance Products Trust Annual Report to Shareholders, for the fiscal
year ended December 31, 2000 are incorporated by reference (are legally a part
of this SAI)
To obtain a free additional copy of a prospectus for Class 1 or Class 2, or an
annual report, please call Franklin Templeton at 1-800/342-3863, or your
insurance company.
Contents
Introduction....................................................................
The Funds - Goals and Strategies
Franklin Aggressive Growth Securities Fund.............................
Franklin Global Communications Securities Fund.........................
Franklin Global Health Care Securities Fund............................
Franklin Growth and Income Securities Fund.............................
Franklin High Income Fund..............................................
Franklin Income Securities Fund........................................
Franklin Large Cap Growth Securities Fund..............................
Franklin Money Market Fund.............................................
Franklin Natural Resources Securities Fund.............................
Franklin Real Estate Fund..............................................
Franklin Rising Dividends Securities Fund..............................
Franklin S&P 500 Index Fund............................................
Franklin Small Cap Fund................................................
Franklin Strategic Income Securities Fund..............................
Franklin Technology Securities Fund....................................
Franklin U.S. Government Fund..........................................
Franklin Value Securities Fund.........................................
Franklin Zero Coupon Funds 2005, and 2010..............................
Mutual Discovery Securities Fund.......................................
Mutual Shares Securities Fund..........................................
Templeton Asset Strategy Fund..........................................
Templeton Developing Markets Securities Fund...........................
Templeton Global Income Securities Fund................................
Templeton Growth Securities Fund.......................................
Templeton International Securities Fund................................
Templeton International Smaller Companies Fund.........................
Securities, Investment Techniques and their Risks...............................
Common to More Than One Fund...................................................
Non-Fundamental Policies........................................................
Fundamental Investment Restrictions.............................................
2
Officers and Trustees...........................................................
Management and Other Services...................................................
Portfolio Transactions..........................................................
Distributions and Taxes.........................................................
Organization, Voting Rights and Principal Holders...............................
Pricing Shares..................................................................
The Underwriter.................................................................
Performance.....................................................................
Miscellaneous Information.......................................................
Description of Bond Ratings.....................................................
- --------------------------------------------------------------------------------
Mutual funds, annuities, and other investment products:
. are not insured by the Federal Deposit Insurance Corporation, the
Federal Reserve Board, or any other agency of the U.S. government;
. are not deposits or obligations of, or guaranteed or endorsed by, any
bank;
. are subject to investment risks, including the possible loss of
principal.
- --------------------------------------------------------------------------------
3
Introduction
- --------------------------------------------------------------------------------
The information provided with respect to each Fund is in addition to that set
out in the Fund's prospectus.
In addition to the investments and strategies primarily undertaken by each Fund
as described in the prospectuses, the Funds may, to a lesser extent, also invest
in other types of securities and engage in and pursue other investment
strategies, which are described in this SAI. Each type of investment and
investment strategy mentioned with respect to each Fund is discussed in greater
detail in the Section entitled "Securities, Investment Techniques and their
Risks Common to More than One Fund," which appears after "The Funds - Goals and
Strategies" Section.
Generally, the policies and restrictions discussed in this SAI and in the
prospectuses apply when a Fund makes an investment. In most cases, the Fund is
not required to sell a security because circumstances change and the security no
longer meets one or more of a Fund's policies or restrictions. If a percentage
restriction or limitation is met at the time of investment, a later increase or
decrease in the percentage due to a change in the value or liquidity of
portfolio securities will not be considered a violation of the restriction or
limitation. If a bankruptcy or other extraordinary event occurs concerning a
particular security the Fund owns, the Fund may receive stock, real estate, or
other investments that the Fund would not, or could not, buy. If this happens,
the Fund intends to sell such investments as soon as practicable while
maximizing the return to shareholders.
Various adjectives or phrases, rather than percentages, may be used to describe
certain limitations related to the Funds' investment policies and strategies.
Typically, these adjectives and phrases are broadly identified with the
following percentages:
small portion generally from 10% to 15%
significant generally from 25% to 30%
substantial generally from 35% to 45%
primarily generally from 55% to 65%
predominantly generally from 75% to 85%
Each Fund is also subject to various Fundamental Investment Restrictions which
are described in further detail in the Section entitled "Fundamental Investment
Restrictions." Fundamental Investment Restrictions may only be changed with the
approval of the lesser of (1) more than 50% of the Fund's outstanding shares or
(2) 67% or more of the Fund's shares present at a shareholder meeting if more
than 50% of the Fund's outstanding shares are represented at the meeting in
person or by proxy.
The Funds - Goals and Strategies
- --------------------------------------------------------------------------------
Franklin Aggressive Growth Securities Fund
(Aggressive Growth Fund)
4
The Fund's investment goal is capital appreciation. This goal is fundamental,
which means it may not be changed without shareholder approval.
Other Investments and Strategies
. Convertible securities Although the Fund may invest in convertible
securities without limit, it currently intends to limit these
investments to no more than 5% of its net assets. The Fund intends to
invest in liquid convertible securities but there can be no assurance
that it will always be able to do so.
. Foreign securities Although the Fund may invest in foreign securities,
it intends to limit such investments to 10% of its total assets.
. The Fund also may:
. write covered put and call options, and purchase put and call
options, on securities or financial indices. The Fund will
only buy options if the premiums paid for such options total
5% or less of its net assets;
. purchase and sell futures contracts or related options with
respect to securities, indices, and currencies. The Fund will
not enter into a futures contract if the amounts paid for its
open contracts, including required initial deposits, would
exceed 5% of its net assets;
. invest in illiquid securities up to 15% of its net assets;
. lend its portfolio securities up to 33 1/3% of the value of
its total assets;
. borrow up to 33 1/3% of the value of its assets; and
. enter into repurchase and reverse repurchase agreements.
The Fund is subject to Fundamental Investment Restrictions 1.1, 2.3, 3.1, 4.1,
7.1, 10.3 and 18.
Franklin Global Communications Securities Fund
(Global Communications Fund)
Before November 15, 1999, the Fund's name was "Franklin Global Utilities
Securities Fund," and before May 1, 1998, the Fund's name was "Utility Equity
Fund."
The Fund's investment goals are capital appreciation and current income. These
goals are fundamental, which means they may not be changed without shareholder
approval.
The Fund currently expects to invest in common stocks that the manager expects
to pay dividends. At the present time, many of the securities of the global
communications companies in which the Fund invests do not pay dividends.
Other Investments and Strategies
. Utilities companies Utility companies in the U.S. and in non-U.S.
countries have generally been subject to substantial government
regulation. Major changes in government policies,
5
ranging from increased regulation or expropriation to deregulation,
privatization or increased competition, may dramatically increase or
reduce opportunities for these companies. For example, while certain
companies may develop more profitable opportunities, others may be
forced to defend their core businesses and may be less profitable.
Utility company stocks often pay relatively high dividends, so they are
particularly sensitive to interest rate movements. Therefore, like
bonds, their stock prices may rise as interest rates fall or fall as
interest rates rise.
. Electric utilities companies Electric utility companies have
historically been subject to price regulation; risks associated with
high interest costs on borrowings or reduced ability to borrow;
restrictions on operations and increased costs due to environmental and
safety regulations; regulators disallowing these higher costs in rate
authorizations; difficulties in obtaining fuel for electric generation
at reasonable prices; risks associated with the operation of nuclear
power plants; and the effects of energy conservation and other factors
affecting the level of demand for services.
. Gas and water companies The utility companies in which the Fund may
invest include gas transmission and distribution companies and
companies in the water supply industry. Like electric utility
companies, gas transmission and distribution companies continue to
undergo significant changes. Many companies have diversified into oil
and gas exploration and development. This makes returns more sensitive
to energy prices. The water supply industry is highly fragmented due to
local ownership. Water supply company securities are often thinly
traded and their markets are less liquid than other utility securities.
. Foreign securities The Fund will normally invest at least 65% of its
assets in issuers located in at least three different countries. As a
non-fundamental policy, the Fund will limit its investments in
securities of Russian issuers to 5% of assets.
. Debt securities The Fund may invest up to 5% of its assets in debt
securities, including convertible bonds issued by public utility
issuers. These debt securities may be rated Ba or lower by Moody's
Investors Service (Moody's) or BB or lower by Standard & Poor's
Corporation (S&P(R)) or unrated securities that the manager determines
are of comparable quality.
. Convertible securities The Fund currently intends to invest no more
than 5% of its assets in preferred stocks or convertible preferred
stocks issued by public utility issuers. Subject to these limits, the
Fund may invest up to 5% of its assets in enhanced convertible
securities.
. The Fund also may:
. write covered call options;
. lend its portfolio securities up to 30% of its assets;
. borrow up to 5% of the value of its total assets, except from
banks for temporary or emergency purposes, and not for direct
investments in securities; and
. enter into repurchase transactions.
6
The Fund is subject to Fundamental Investment Restrictions 1, 2, 3, 4, 5, 6, 8,
9, 10, 11, 12, 13, 14 and 15.
Franklin Global Health Care Securities Fund
(Global Health Care Fund)
The Fund's investment goal is capital appreciation. This goal is fundamental,
which means it may not be changed without shareholder approval.
Other Considerations
Health care companies are those that, based on their most recently reported
fiscal year, (i) derived at least 50% of their earnings or revenues from health
care activities, or (ii) have devoted at least 50% of their assets to health
care activities.
Often major developments in health care come from foreign companies. Therefore,
in the opinion of the manager, a portfolio of global health care company
securities may provide greater potential for investment participation in present
and future opportunities than may be present in domestic health care related
industries. The manager also believes that U.S. health care companies may be
subject to increasing regulation and government control. By investing in
foreign, as well as U.S. health care companies, the manager believes that the
Fund will be able to lessen the impact of U.S. government regulation on its
portfolio. By investing in multiple countries, the risk of a single government's
actions on the portfolio also may be reduced.
The Fund will mix its investments globally by investing at least 70% of its
assets in securities of issuers located in at least three different countries,
one of which may be the U.S. The Fund does not currently intend to invest more
than 10% of its assets in securities of emerging markets. The Fund will not
invest more than 40% of its net assets in any one country, other than the U.S.
From time to time, the Fund may invest a significant portion of its assets in
securities of U.S. issuers, the prices of which may fluctuate independently from
comparable foreign securities. As a global fund, it may invest in securities
issued in any currency, including multinational currency units such as the Euro
or European Currency Unit, and may hold currency. As a non-fundamental policy,
the Fund will limit its investments in securities of Russian issuers to 5% of
its assets.
Other Investments and Strategies
. Convertible securities The Fund may invest up to 10% of its assets in
convertible securities.
. Debt securities Depending upon current market conditions, the Fund may
invest up to 30% of its assets in debt securities issued by U.S. and
non-U.S. corporations and governments. The Fund will invest in debt
securities rated B or above by Moody's or S&P(R), or in unrated
securities of similar quality and, in any event, does not currently
expect investments in such lower rated debt securities to exceed 5% of
the Fund's assets. Securities rated below BBB are considered to be
below investment grade.
. The Fund also may:
7
. engage in short sale transactions, in which the Fund sells a
security it does not own to a purchaser at a specified price;
. write covered put and call options on securities or financial
indices;
. purchase put and call options on securities or financial
indices;
. purchase and sell futures contracts or related options with
respect to securities, indices and currencies;
. invest in restricted or illiquid securities;
. lend portfolio securities up to 33 1/3% of its assets; o
borrow up to 33 1/3% of the value of its assets from banks;
. enter into repurchase or reverse repurchase agreements; and
. enter into foreign currency exchange contracts.
The Fund is subject to Fundamental Investment Restrictions 2.1, 3, 4, 5.1, 6,
9.2, 10.1, 11, 13 and 15.
Franklin Growth and Income Securities Fund
(Growth and Income Fund)
The Fund's principal investment goal is capital appreciation. Its secondary goal
is current income. These goals are fundamental, which means they may not be
changed without shareholder approval.
Other Investments and Strategies
. Foreign Securities. The Fund may invest up to 30% of its total assets
in foreign securities, including those in emerging markets, but
currently intends to limit such investments to 10%.
. The Fund also may:
. purchase enhanced convertible securities;
. purchase American Depositary Receipts;
. write covered call and put options;
. purchase call and put options on securities and indices of
securities, including "forward conversion" transactions;
. lend its portfolio securities up to 30% of its assets;
. borrow up to 5% of the value of its total assets, except from
banks for temporary or emergency purposes, and not for direct
investments in securities; and
. enter into repurchase transactions.
8
The Fund is subject to Fundamental Investment Restrictions 1, 2, 3, 4, 5, 6, 7,
8.1, 9.1, 10, 11, 12, 13, 14 and 15.
Franklin High Income Fund
(High Income Fund)
The Fund's principal investment goal is to earn a high level of current income.
Its secondary goal is capital appreciation. These goals are fundamental, which
means they may not be changed without shareholder approval.
Other Considerations
The Fund does not intend to invest more than 5%, at the time of purchase, in
securities in the lowest rating categories, i.e., rated below Caa by Moody's or
CCC by S&P(R) or unrated securities that the manager determines are of
comparable quality. The Fund also may buy lower-rated zero-coupon, deferred
interest and pay-in-kind securities. The Fund may occasionally participate on
creditors' committees for issuers of defaulted debt. If it does, the Fund is
generally restricted from selling those securities to anyone other than another
member of the creditors' committee, which restricts the liquidity of the
holding.
Ratings assigned by the rating agencies are based largely on the issuer's
historical financial condition and the rating agencies' investment analysis at
the time of the rating. Credit quality in the high yield debt market, however,
can change suddenly and unexpectedly, and credit ratings may not reflect the
issuer's current financial condition. For these reasons, the manager does not
rely principally on the ratings assigned by rating agencies, but performs its
own independent investment analysis of securities being considered for the
Fund's portfolio.
Other Investments and Strategies
. The Fund also may:
. acquire loan participations;
. purchase debt securities on a "when-issued" basis;
. write covered call options;
. lend its portfolio securities up to 30% of its assets;
. borrow up to 5% of the value of its total assets, except from
banks for temporary or emergency purposes, and not for direct
investments in securities; and
. enter into repurchase agreements and forward currency exchange
contracts, participate in interest rate swaps, invest in
restricted securities, and invest in trade claims.
The Fund is subject to Fundamental Investment Restrictions 1, 2, 3, 4, 5, 6, 7,
8, 9, 10, 11, 12, 13, 14 and 15.
Franklin Income Securities Fund
(Income Securities Fund)
9
The Fund's investment goal is to maximize income while maintaining prospects for
capital appreciation. This goal is fundamental, which means it may not be
changed without shareholder approval.
Other Considerations
The Fund's investments may include zero coupon, deferred interest or pay-in-kind
bonds, or preferred stocks. Because the manager has the discretion to choose the
percentage of assets that can be invested in a particular type of security as
market conditions change, the Fund's portfolio may be entirely invested in debt
securities or, conversely, in common stocks.
Other Investments and Strategies
Other Debt Securities The Fund currently does not intend to invest in defaulted
debt securities, or more than 5% of its assets in loan participations and other
related direct or indirect bank securities. The Fund may invest up to 5% of its
assets in trade claims. Both loan participations and trade claims carry a high
degree of risk. The Fund does not intend to invest more than 5% of its assets in
enhanced convertible securities.
. The Fund also may:
. lend its portfolio securities up to 30% of its assets;
. borrow up to 5% of the value of its total assets, except from
banks for temporary or emergency purposes, and not for direct
investments in securities;
. enter into repurchase transactions;
. purchase securities on a "when-issued" or "delayed-delivery"
basis; and
. write covered call options on securities.
The Fund is subject to Fundamental Investment Restrictions 1, 2, 3, 4, 5, 6, 7,
8, 9.1, 10, 11, 12, 13, 14 and 15.
Franklin Large Cap Growth Securities Fund
(Large Cap Fund)
Before December 15, 1999, the Fund's name was the Franklin Capital Growth Fund.
The Fund's investment goal is capital appreciation. Current income is only a
secondary consideration in selecting portfolio securities. This goal is
fundamental, which means it may not be changed without shareholder approval.
Other Considerations
Some of the Fund's investments in large-cap companies may yield little or no
current income. The Fund's assets may be invested in shares of common stock
traded on any national securities
10
exchange or over-the-counter, and in convertible securities including
convertible preferred stocks.
Health care companies The Fund may, at times, have significant investments in
securities of health care companies. Because the activities of health care
companies may be heavily dependent on federal and state government funding, the
profitability of these companies could be adversely affected if that funding is
reduced or discontinued. Stocks of these companies also may be affected by
government policies on health care reimbursements, regulatory approval for new
drugs and medical instruments, or legislative reform of the health care system.
Health care companies are also subject to the risks of product liability
lawsuits and the risk that their products and services may become obsolete.
Financial services companies The Fund also may invest in financial services
companies. Financial services companies are subject to extensive government
regulation of the amount and types of loans and other financial commitments they
can make, and of the interest rates and fees they can charge. These limitations
can have a significant impact on a financial services company's profitability
because its profitability is affected by its ability to make financial
commitments such as loans. In addition, changing regulations, continuing
consolidations, and development of new products and structures are all likely to
have a significant impact on the financial services industry.
Other Investments and Strategies
. Debt securities including lower rated securities To the extent the Fund
invests in debt securities and convertible debt securities, it does not
intend to invest more than 5% in those rated Ba or lower by Moody's or
BB or lower by S&P(R) or unrated securities that the manager determines
are of comparable quality.
. Foreign securities The Fund may invest up to 25% of it total assets in
foreign securities, including those in emerging markets. The Fund will
limit its investments in emerging markets to less than 5% of its total
assets.
. The Fund also may:
. write covered call options;
. purchase put options on securities;
. lend its portfolio securities up to 30% of its assets;
. borrow up to 5% of the value of its total assets, except from
banks for temporary or emergency purposes, and not for direct
investments in securities;
. enter into repurchase transactions; and
. invest in restricted or illiquid securities.
The Fund is subject to Fundamental Investment Restrictions 1, 2, 3, 4, 5, 6, 7,
8.1, 9, 10, 11, 13, 14 and 15.
11
Franklin Money Market Fund
(Money Fund)
The Fund's investment goal is high current income, consistent with liquidity and
capital preservation. This goal is fundamental, which means it may not be
changed without shareholder approval. The Fund also seeks to maintain a stable
share price of $1.00.
Other Considerations
If the disposition of a portfolio security results in a dollar-weighted average
portfolio maturity in excess of 90 days, the Fund will invest its available
assets so that it reduces its dollar-weighted average portfolio maturity to 90
days or less as soon as is reasonably practicable.
Although the Fund may invest up to 5% of assets in securities rated in the
second highest category (or unrated securities the manager determines are
comparable), it generally invests in securities rated in the highest category.
The Fund may, at times, hold a small portion of its assets in asset-backed
securities, typically commercial paper backed by loans or accounts receivable of
an entity or number of different entities, such as banks or credit card
companies.
The Fund may invest in obligations of U.S. branches of foreign banks, which are
considered domestic banks. The Fund will only make these investments if the
branches have a federal or state charter to do business in the U.S. and are
subject to U.S. regulatory authorities. The Fund also may invest in time
deposits, which are non-negotiable deposits maintained in a banking institution
for a specified period of time at a stated interest rate. The Fund may invest up
to 10% of its assets in time deposits with maturities in excess of seven
calendar days.
Financial services companies Financial services companies such as banks are
highly dependent on the supply of short-term financing. The value of securities
issued by financial services companies can be sensitive to changes in government
regulation and interest rates and to economic downturns in the U.S. and
overseas.
Other Investments
. obligations, with fixed, floating or variable interest rates, issued or
guaranteed by U.S. banks with assets of at least one billion dollars,
bank notes, loan participation interests and time deposits;
. obligations of foreign branches of foreign banks, U.S. branches of
foreign banks (Yankee Dollar Investments), and foreign branches of U.S.
banks (Eurodollar Investments), all of which include certificates of
deposit, bank notes, loan participation interests, commercial paper,
unsecured promissory notes, time deposits, and bankers' acceptances,
where the parent bank has more than five billion dollars in total
assets at the time of purchase;
. taxable municipal securities, up to 10% of the Fund's assets; and
. unrated notes, paper, securities or other instruments that the manager
determines to be of comparable high quality.
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Other Investment Strategies The Fund may not invest more than 5% of its total
assets in securities of a single issuer, other than U.S. government securities,
although it may invest more than 5% of its total assets in securities of a
single issuer that are rated in the highest rating category for a period of up
to three business days after purchase. The Fund also may not invest more than
(a) the greater of 1% of its total assets or $1 million in securities issued by
a single issuer that are rated in the second highest rating category; and (b) 5%
of its total assets in securities rated in the second highest rating category.
. The Fund also may:
. buy U.S. government securities on a when-issued or delayed
delivery basis;
. lend portfolio securities up to 30% of its assets;
. borrow up to 5% of the value of its total assets, except from
banks for temporary or emergency purposes, and not for direct
investments in securities; and
. enter into repurchase agreements.
The Fund is subject to Fundamental Investment Restrictions 1, 2, 3, 4, 5, 6, 7,
8, 9, 10, 11, 12, 13, 14 and 15.
Franklin Natural Resources Securities Fund
(Natural Resources Fund)
Prior to May 1, 1997, the Natural Resources Fund was known as the Precious
Metals Fund and had different investment goals and policies.
The Fund's principal investment goal is capital appreciation. Its secondary goal
is to provide current income. These goals are fundamental, which means they may
not be changed without shareholder approval.
Other Considerations
While the Fund generally expects to invest primarily in equity securities, the
manager may vary the mixture of common stocks, preferred stocks and debt
securities depending on how each category may contribute to attaining the Fund's
investment goal.
The Fund may invest up to 35% of its assets in equity or debt securities of
foreign or domestic issuers outside the natural resources sector. Some of these
issuers may be in industries related to the natural resources sector and,
therefore, may be subject to similar risks. The Fund may have significant
investments in companies involved in the development and/or production of
alternative energy sources, which include batteries, switching technology and
utilities, and also may invest in REITs. The value of companies involved in
alternative energy sources may be affected by conditions impacting natural
resources companies. For example, when oil prices are high, alternative energy
sources may be in greater demand, but when oil prices fall, demand for
alternative energy sources may fall, and companies in that industry may be
adversely affected.
13
Natural resources Commodities producers may have limited ability to individually
vary the prices they charge for their products. Similarly, companies which use
certain commodities will generally have a limited ability to choose or affect
the price they pay for those commodities. These factors can affect the overall
profitability of an individual company operating within the natural resources
sector. While the manager may strive to diversify among the industries within
the natural resources sector to reduce this volatility, the value of an
individual company's securities may prove more volatile than the broader market.
In addition, many of these companies operate in, or are dependent upon resources
from, areas of the world where they are subject to unstable political
environments, currency fluctuations and inflationary pressures.
Prices of various commodities (i.e. raw materials) may fluctuate widely and
unpredictably due to factors which affect their supply (for example, political
turmoil in exporting countries, economic slow-down among users or reduction in
demand among users.)
Smaller exploration companies The Fund's investments in small capitalization
companies may include investments in small mining or oil and gas exploration
concerns that the manager believes may have significant potential for
appreciation but are subject to the risk that their exploration efforts will not
be successful.
Other Investments and Strategies
Foreign Securities The Fund has authority to invest 50% or more of its total
assets in foreign securities, including those in emerging markets, but currently
intends to invest more in the U.S.
REITs The Fund may invest up to 10% of its total assets in real estate
investment trusts (REITs), which may be in or outside the natural resources
sector.
. Debt securities The Fund may invest in debt securities issued by
domestic or foreign corporations or governments. The Fund may invest,
without percentage limitation, in debt securities rated as "investment
grade" by Moody's or S&P(R) or, in unrated debt securities that the
manager determines are of similar quality. The Fund also may invest up
to 15% of its assets in debt securities rated BB or lower by S&P(R) or
Ba or lower by Moody's, so long as they are not rated lower than B by
Moody's or S&P(R) or, if unrated, that the manager determines to be of
comparable quality. The manager does not currently expect investments
in lower rated debt securities to exceed 5% of the Fund's assets.
. The Fund also may:
. write covered put and call options, although no more than 15%
of the Fund's assets will be subject to covered call options;
o invest up to 5% in commodities (including gold bullion or
gold coins) or futures on commodities related to the natural
resources sector;
. purchase securities on a "when-issued" or "delayed delivery"
basis;
. lend its portfolio securities up to 30% of its assets;
. borrow up to 5% of the value of its total assets, except from
banks for temporary or emergency purposes, and not for direct
investments in securities;
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. enter into repurchase transactions; and
. invest in restricted or illiquid securities.
The Fund is subject to Fundamental Investment Restrictions 1, 2, 3, 4, 5, 6,
8.2, 9.3, 10.2, 11, 12, 13, 14 and 15.
Franklin Real Estate Fund
(Real Estate Fund)
The Fund's principal goal is capital appreciation. Its secondary goal is to earn
current income. These goals are fundamental, which means they may not be changed
without shareholder approval.
Other Considerations
As used by the Fund, "real estate securities" will include equity, debt and
convertible securities of companies having the following characteristics and
limitations:
o Companies qualifying as a REIT for federal income tax purposes. In
order to qualify as a REIT, a company must derive at least 75% of its
gross income from real estate sources (rents, mortgage interest, gains
form the sale of real estate assets), and at least 95% from real estate
sources, plus dividends, interest and gains from the sale of
securities. Real property, mortgage loans, cash and certain securities
must comprise 75% of a company's assets. In order to qualify as a REIT,
a company must also make distributions to shareholders aggregating
annually at least 95% of its REIT taxable income.
o Companies that have at least 50% of their assets or revenues
attributable to the ownership, construction, management or other
services, or sale of residential, commercial or industrial real estate.
These companies would include real estate operating companies, real
estate services and homebuilders.
The Fund will generally invest in real estate securities listed on a securities
exchange or traded over-the-counter. The Fund also may invest in mortgage REITs,
which specialize in lending money to developers, and hybrid REITs, which have a
mix of equity and debt instruments. Mortgage REITs pass interest income on to
shareholders. Mortgage REITs can be affected by the quality of any credit
extended. Hybrid REITs can be affected by both the quality of any credit
extended and, like equity REITs, by changes in the value of their holdings.
In addition to its investments in real estate securities, the Fund also may
invest a portion of its assets in debt and equity securities of issuers whose
products and services are closely related to the real estate industry and that
are publicly traded on an exchange or in the over-the-counter market. These
issuers may include, for example, manufacturers and distributors of building
supplies, and financial institutions that issue or service mortgages, such as
savings and loan associations or mortgage bankers. Also, the Fund may invest in
companies whose principal business is unrelated to the real estate industry but
who have at least 50% of their assets in real estate holdings.
Other Investments and Strategies
. Debt and convertible securities including enhanced and convertible
securities As an operating policy, the Fund will not invest more than
10% of its net assets in debt securities, including convertible debt
securities, rated Ba or lower by Moody's or unrated securities that the
manager determines are of comparable quality. Generally, however, the
Fund will not acquire any securities rated lower than B by Moody's or
unrated securities that the manager determines are of comparable
quality.
. Foreign securities The Fund may invest up to 10% in foreign securities,
including those in emerging markets.
. The Fund also may:
. write covered call options;
. lend its portfolio securities up to 30% of its assets;
. borrow up to 5% of the value of its assets for any purpose
other than direct investments in securities, and up to 33 1/3%
of the value of its total assets from banks for temporary or
emergency purposes; and
. engage in repurchase transactions.
The Fund is subject to Fundamental Investment Restrictions 1, 2, 3, 4, 5, 6,
8.1, 9, 10, 11, 12, 13, 14 and 15.
Franklin Rising Dividends Securities Fund
(Rising Dividends Fund)
The Fund's investment goal is long-term capital appreciation. This goal is
fundamental, which means it may not be changed without shareholder approval.
Preservation of capital, while not a goal, is also an important consideration.
The Fund's policy of investing at least 65% of its net assets in financially
sound companies that have paid consistently rising dividends is fundamental.
Other Investments and Strategies
. Foreign securities The Fund may invest up to 10% of its net assets in
foreign securities, including those in emerging markets.
. The Fund also may:
. invest in illiquid securities up to 15% of its net assets;
. lend its portfolio securities up to 33 1/3% of its assets;
. borrow up to 33 1/3% of the value of its total assets;
. enter into repurchase transactions; and
15
. write covered call options.
The Fund is subject to Fundamental Investment Restrictions 1.1, 2.3, 3.1, 4.1,
7.2, 10.3 and 18.
Franklin S&P 500 Index Fund
(S&P 500 Index Fund)
The Fund's investment goal is to match the performance of the Standard & Poor's
500 Composite Stock Price Index (S&P 500 Index) before the deduction of Fund
expenses. This goal is fundamental, which means that it may not be changed
without shareholder approval.
Other Investments and Strategies
. Options, futures and options on financial futures The Fund may buy and
sell financial futures contracts, options on such contracts, and
options on securities and securities indices. The Fund may only sell
covered options. The Fund may not commit more than 5% of its total
assets to initial margin deposits on futures and related options
contracts and premiums paid for related options.
. The Fund also may:
. invest in illiquid securities up to 15% of its net assets;
. lend its portfolio securities up to 33 1/3% of the value of
the its total assets; and
. borrow up to 33 1/3% of the value of its total assets.
The Fund is subject to Fundamental Investment Restrictions 1.1, 2.2, 3.1, 4.1,
7.1, 10.3 and 18.
Franklin Small Cap Fund
(Small Cap Fund)
The Fund's investment objective is long-term capital growth. This goal is
fundamental, which means it may not be changed without shareholder approval.
Other Considerations
Although the Fund purchases securities of small cap companies, it may, at times,
have a significant percentage of its assets in mid- and large-cap companies.
This is, in part, because the Fund will not dispose of securities of companies
whose successes lead them into the mid- and large-cap range. This also may be a
result of the Fund's purchases of securities of larger companies. The Fund may
invest up to 35% of its assets in securities other than those of small cap
companies, including equity securities of larger companies. This may cause its
performance to vary from that of the small capitalization equity markets. The
Fund may invest in equity securities of larger companies that the Fund's manager
believes have strong growth potential, or in equity securities of relatively
well-known, larger companies in mature industries that the manager believes have
the potential for appreciation.
16
Equity securities of small-cap companies may consist of common stock, preferred
stock, warrants for the purchase of common stock, and convertible securities.
The Fund currently does not intend to invest more than 10% of its assets in
convertible securities.
The Fund may purchase securities in private placements, particularly late stage
private placements. Late stage private placements are sales of securities made
in non-public, unregistered transactions shortly before a company expects to go
public. The Fund may do this in order to invest in securities of companies whose
initial public offerings are expected to be "hot" issues. If the Fund were to
wait for the initial public offerings for some of these companies, its small cap
restriction might preclude it from buying these securities. This is because, by
the time the companies go public, the price at which the offering is finally
sold may put some companies into the mid-cap range or the amount that might be
allocated to the Fund would be much less than it desires to buy. There is no
public market for shares sold in these private placements and it is possible
that an initial public offering will never be completed. Moreover, even after an
initial public offering, there may be a limited trading market for the
securities or the Fund may be subject to contractual limitations on its ability
to sell the shares.
Other Investments and Strategies
. Foreign securities Although the Fund may invest up to 25% of its assets
in foreign securities, including those in emerging markets, it does not
intend to invest more than 10% in foreign securities, generally, nor
more than 5% in emerging markets securities, specifically.
. Debt securities The Fund also may invest in debt securities that the
manager believes have the potential for capital appreciation as a
result of improvement in the creditworthiness of the issuer. The
receipt of income is incidental to the Fund's goal of capital growth.
The Fund may invest in debt securities rated B or above by Moody's or
S&P(R), or in unrated securities the manager determines are of
comparable quality. Currently, however, the Fund does not intend to
invest more than 5% of its assets in debt securities (including
convertible debt securities) rated lower than BBB by S&P(R) or Baa by
Moody's or, if unrated, that the manager determines to be of comparable
quality.
. REITs The Fund currently does not intend to invest more than 10% of its
assets in real estate investment trusts (REITs), including small
company REITs.
. Loans of portfolio securities The Fund intends to take full advantage
of its authority to lend its portfolio securities up to 20% of its
total assets in order to generate additional income.
. The Fund also may:
. write covered put and call options on securities or financial
indices;
. purchase put and call options on securities or financial
indices;
. purchase and sell futures contracts or related options with
respect to securities, indices and currencies;
. invest in illiquid or restricted securities up to 15% of its
net assets;
17
. borrow up to 33 1/3% of the value of its total assets; and
. enter into repurchase or reverse repurchase agreements.
The Fund is subject to Fundamental Investment Restrictions 1.1, 2.3, 3.1, 4.1,
7.2, 10.3 and 18.
Franklin Strategic Income Securities Fund
(Strategic Income Fund)
The Fund's principal goal is to earn a high level of current income. Its
secondary goal is long-term capital appreciation. These goals are fundamental,
which means they may not be changed without shareholder approval.
Other Considerations
The Fund may invest up to 35% of its total assets in common stocks.
Debt ratings The Fund may invest in debt securities in any rating category.
Ratings assigned by the rating agencies are based largely on the issuer's
historical financial condition and the rating agencies' investment analysis at
the time of the rating. The Fund also may buy defaulted debt securities if, in
the opinion of the manager, it appears the issuer may resume interest payments
or other advantageous developments appear likely in the near future.
Other Investments and Strategies
. Portfolio turnover The manager's rebalancing of the portfolio when
seeking to keep interest rate risk, market and country allocations, and
bond maturities at desired levels may cause the Fund's portfolio
turnover rate to be high. High turnover generally increases the Fund's
transaction costs. Moreover, in shifting assets strategically from one
sector to another, there is no guarantee that the manager will
consistently select the sectors that are the most advantageous.
. Indebtedness and participations The Fund may invest in secured or
unsecured corporate indebtedness, including loan participations and
trade claims.
18
. Derivative investments The Fund may invest limited amounts in various
derivative investments, which carry high risk. Such derivatives could
include: stripped mortgage-backed securities (including interest-only
or principal-only securities); CMOs; options on securities, on
securities indices, on futures contracts, and financial futures
contracts; interest rate swap agreements; and mortgage dollar rolls.
The Fund may only buy options on securities and securities indices if
the total premium paid for such options is 5% or less of total assets.
The Fund may not commit more than 5% of its total assets to initial
margin deposits on futures contracts. The Fund may invest up to 5% of
its total assets in inverse floaters.
. Currency hedging The Fund also may use the following currency hedging
techniques: investments in foreign currency futures contracts, options
on foreign currencies or currency futures, forward foreign currency
exchange contracts (forward contracts), and currency swaps.
. The Fund also may:
. invest in illiquid securities up to 15% of its net assets;
. lend its portfolio securities up to 33 1/3% of the value of
its total assets;
. borrow up to 33 1/3% of the value of its total assets; and
. enter into repurchase or reverse repurchase agreements.
The Fund is subject to Fundamental Investment Restrictions 2.3, 3.1, 4.1, 7.1,
10.3 and 18.
Franklin Technology Securities Fund
(Technology Fund)
The Fund's investment goal is capital appreciation. This goal is fundamental,
which means it may not be changed without shareholder approval.
Other Considerations
The Fund may invest in companies of any size. Small-cap companies generally have
market capitalizations of up to $1.5 billion, at the time of purchase. Mid-cap
companies generally have market capitalizations of $1.5 to $8 billion at the
time of the Fund's investment. Market capitalization is the total market value
of a company's outstanding stock.
The Fund may invest up to 5% of its assets in private placements, particularly
late stage private placements. Late stage private placements are sales of
securities made in non-public, unregistered transactions shortly before a
company expects to go public. The Fund may do this in order to participate in
companies whose initial public offerings are expected to be "hot" issues. There
is no public market for shares sold in these private placements and it is
possible that an initial public offering will never be completed. Moreover, even
after an initial public offering, there may be a limited trading market for the
securities or the Fund may be subject to contractual limitations on its ability
to sell the shares.
19
Other Investments and Strategies
. Foreign securities The Fund may invest up to 35% of its total assets in
foreign securities, including those in emerging markets. The Fund may
buy securities that are traded in the U.S. or directly in foreign
markets. For this Fund, emerging market countries include those
generally considered low or middle income countries by the
International Bank for Reconstruction and Development (commonly known
as the World Bank) and the International Finance Corporation.
. Convertible securities The Fund may invest in convertible securities up
to 20% of its assets, principally in preferred stocks.
. Debt securities The Fund will invest less than 5% of its net assets
debt securities. The Fund may buy rated and unrated debt securities.
Independent rating agencies rate debt securities based upon their
assessment of the financial soundness of the issuer. Generally, a lower
rating indicates higher risk.
. The Fund also may:
. engage in repurchase agreements;
. invest in illiquid securities up to 15% of its net assets;
. lend its portfolio securities up to 33 1/3% of the value of
its total assets;
. borrow up to 33 1/3% of the value of its total assets;
. invest its assets in securities issued by companies engaged in
securities related businesses;
. buy equity securities on a "when-issued" or "delayed delivery"
basis;
. buy equity securities under a standby commitment agreement;
. buy and sell options on securities and securities indices
(provided the premiums paid for such options total 5% or less
of the Fund's net assets);
. buy and sell futures contracts for securities and currencies;
. buy and sell securities index futures and options on
securities index futures; and
. buy or write covered put and call options on securities listed
on a national securities exchange and in the over-the-counter
(OTC) market and on securities indices.
The Fund is subject to Fundamental Investment Restrictions 2.3, 3.1, 4.1, 10.3
and 18.
Franklin U.S. Government Fund
(Government Fund)
The Fund's investment goal is income. This goal is fundamental, which means it
may not be changed without shareholder approval.
Other Considerations
Government National Mortgage Association (GNMA) obligations (Ginnie Maes)
Payments to holders of Ginnie Maes consist of the monthly distributions of
interest and principal less
20
GNMA's and issuers' fees. The Fund will reinvest the return of principal in
securities that may have different interest rates than the Ginnie Mae on which
the principal was returned.
Unscheduled principal payments are passed through to the Ginnie Mae holders,
such as the Fund, when mortgages in the pool underlying a Ginnie Mae are prepaid
by borrowers (because a home is sold and the mortgage is paid off, or the
mortgage is refinanced) or as a result of foreclosure. Accordingly, a Ginnie
Mae's life is likely to be shorter than the stated maturity of the mortgages in
the underlying pool. Because of such variation in prepayment rates, it is not
possible to accurately predict the life of a particular Ginnie Mae.
Other Investments and Strategies
. Other mortgage securities The Fund also may invest in fixed-rate
mortgage-backed securities, adjustable-rate mortgage-backed securities
(ARMS), or a hybrid of the two. In addition to ARMS, the Fund also may
invest in adjustable rate U.S. government securities, which may include
securities backed by other types of assets, including business loans
guaranteed by the U.S. Small Business Administration and obligations of
the Tennessee Valley Authority. Some government agency obligations or
guarantees are supported by the full faith and credit of the U.S.
government, while others are supported principally by the issuing
agency and may not permit recourse against the U.S. Treasury if the
issuing agency does not meet its commitments.
. Other Pass-Through Securities The Fund may invest in certain other
types of pass-through debt securities, issued or guaranteed by U.S.
government agencies or instrumentalities.
. The Fund also may:
. purchase securities on a "to be announced" and "delayed
delivery" basis;
. enter into covered mortgage "dollar rolls;"
. lend portfolio securities up to 30% of its assets;
. borrow up to 5% of the value its total assets for any purpose
other than direct investments in securities, and up to 33 1/3%
of the value of its total assets from banks for temporary or
emergency purposes; and
. engage in repurchase agreements.
The Fund is subject to Fundamental Investment Restrictions 1, 2, 3, 4, 5, 6, 7,
8, 9, 10, 11, 12, 13, 14 and 15.
Franklin Value Securities Fund
(Value Fund)
The Fund's investment goal is long-term total return. This goal is fundamental,
which means it may not be changed without shareholder approval.
Other Considerations
21
The Fund may invest in preferred stocks, securities convertible into common
stocks, warrants, secured and unsecured debt securities, and notes. The Fund
may, from time to time, hold up to 100% of its total assets in money market
instruments while awaiting suitable investment opportunities meeting its value
standards.
The Fund may purchase securities based on company stock buy-backs and company
insiders' purchases and sales.
Control The Fund purchases securities for investment purposes and not for the
purpose of influencing or controlling management of the issuer. However, if the
manager perceives that the Fund may benefit, the manager may, but is not
obligated to, seek to influence or control management.
Companies emerging from bankruptcy The Fund may buy securities of companies
emerging from bankruptcy, which have special risks. Companies emerging from
bankruptcy may have difficulty retaining customers and suppliers who prefer
transacting with solvent organizations. If new management is installed in a
company emerging from bankruptcy, the management may be considered untested; if
the existing management is retained, the management may be considered
incompetent. Further, even when a company has emerged from bankruptcy with a
lower level of debt, it may still retain a relatively weak balance sheet. During
economic downturns, these companies may not have sufficient cash flow to pay
their debt securities and also may have difficulty finding additional financing.
In addition, reduced liquidity in the secondary market may make it difficult for
the Fund to sell these securities or to value them based on actual trades.
Other Investments and Strategies
. Foreign securities The Fund may invest up to 25% of its total assets in
foreign securities, but currently intends to limit its investments in
foreign securities generally to less than 10% and in emerging markets
securities to less than 5%.
. Convertible securities The Fund may invest in convertible securities,
enhanced convertible securities and synthetic convertibles. The Fund
applies the same rating criteria and investment policies to convertible
debt securities as its investments in debt securities.
. Lower-rated securities The Fund may invest up to 25% of its assets in
debt securities rated below BBB by S&P(R) or Baa by Moody's, or in
unrated debt securities that the manager determines to be comparable.
Such securities, sometimes called "junk bonds," are regarded as
predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal in accordance with the terms of the
obligation. Therefore, these securities involve special risks. Debt
securities rated D by S&P(R) are in default and may be considered
speculative.
. The Fund also may:
. sell short securities it does not own, up to 5% of its assets;
22
. sell securities "short against the box" without limit;
. lend its portfolio securities up to 33 1/3% of its assets;
. borrow up to 33 1/3% of the value of its total assets from
banks;
. invest in zero coupon securities, pay-in-kind bonds,
structured notes, mortgage-backed and asset-backed securities;
. purchase loan participations and trade claims, both of which
carry a high degree of risk;
. purchase and sell exchange-listed and over-the-counter put and
call options on securities and financial indices;
. purchase and sell futures contracts or related options with
respect to securities and indices; and
. invest in restricted or illiquid securities.
The Fund is subject to Fundamental Investment Restrictions 2.1, 3, 4, 5.1, 7,
9.2, 10.1, 11, 13 and 15.
Franklin Zero Coupon Funds 2005, and 2010 (Zero Coupon Funds):
Maturing in December of 2005, 2010
Each Fund's investment goal is to provide as high an investment return as is
consistent with capital preservation. This goal is fundamental, which means it
may not be changed without shareholder approval.
Other Considerations
The Funds may purchase zero coupon bonds issued by foreign government issuers,
and domestic and foreign corporations.
The Funds also may purchase zero coupon bonds or stripped securities including:
. securities issued by the U.S. Treasury (Stripped Treasury Securities).
The Funds do not anticipate that these securities will exceed 55% of a
Fund's assets;
. securities issued by the U.S. government and its agencies and
instrumentalities (Stripped Government Securities);
. debt securities denominated in U.S. dollars that are issued by foreign
issuers, often subsidiaries of domestic corporations (Stripped
Eurodollar Obligations); and
. to a lesser extent, zero coupon securities issued by domestic
corporations, which consist of corporate debt securities without
interest coupons, and, if available, interest coupons that have been
stripped from corporate debt securities, and receipts and certificates
for such stripped debt securities and stripped coupons (collectively,
"Stripped Corporate Securities).
Zero coupon bonds and stripped securities, like other debt securities, are
subject to certain risks, including credit and market risks. To the extent the
Funds invest in securities other than U.S.
23
Treasury securities, these investments will be rated at least A by nationally
recognized statistical rating agencies or unrated securities that the manager
determines are of comparable quality. Debt securities rated A are regarded as
having an adequate capacity to pay principal and interest but are vulnerable to
adverse economic conditions and have some speculative characteristics. The Funds
will also attempt to minimize the impact of individual credit risks by
diversifying their portfolio investments. The availability of stripped
securities, other than Stripped Treasury Securities, may be limited at times.
During such periods, because the Funds must meet annuity tax diversification
rules, they may invest in other types of fixed-income securities.
Because each Fund will be primarily invested in zero coupon securities,
investors who hold shares to maturity will experience a return consisting
primarily of the amortization of discount on the underlying securities in the
Fund. However, the net asset value of a Fund's shares increases or decreases
with changes in the market value of that Fund's investments.
Maturity The estimated expense of terminating and liquidating a Fund will be
accrued ratably over year preceding its Target Date. These expenses, which are
charged to income like all expenses, are not expected to exceed significantly
the ordinary annual expenses incurred by the Fund and, therefore, should have no
significant additional effect on the maturity value of the Fund.
Tax considerations Under federal income tax law, a portion of the difference
between the purchase price of the zero coupon securities and their face value
(original issue discount) is considered to be income to the Zero Coupon Funds
each year, even though the Funds will not receive cash payments representing the
discount from these securities. This original issue discount will comprise a
part of the net taxable investment income of the Funds that must be
"distributed" to the insurance company, as shareholder, each year whether or not
the distributions are paid in cash. To the extent the distributions are paid in
cash, the Fund may have to generate the required cash from interest earned on
non-zero coupon securities or possibly from the disposition of zero coupon
securities.
Other Investments and Strategies
. Foreign securities Although each Fund reserves the right to invest up
to 10% of its assets in foreign securities, each Fund typically invests
less than that and only in dollar denominated foreign securities.
. Structured notes Although each Fund reserves the right to invest up to
10%, each Fund currently does not intend to invest more than 5% of its
assets in certain structured notes that are comparable to zero coupon
bonds in terms of credit quality, interest rate volatility, and yield.
. Money Market Instruments Each Fund may invest up to, but under normal
circumstances will have less than, 20% of its assets in money market
instruments for purposes of providing income for expenses, redemption
payments, and cash dividends.
. Each Fund also may:
24
. lend portfolio securities up to 30% of its assets;
. borrow up to 5% of the value of its total assets, except from
banks for temporary or emergency purposes, and not for direct
investments in securities; and
. enter into repurchase agreements.
The Fund is subject to Fundamental Investment Restrictions 1, 2, 3, 4, 5, 6, 7,
8, 9, 10, 11,12, 13, 14 and 15.
Mutual Discovery Securities Fund
(Mutual Discovery Fund)
The Fund's investment goal is capital appreciation. This goal is fundamental,
which means it may not be changed without shareholder approval.
Other Considerations
The Fund may invest in securities that are traded on U.S. or foreign exchanges,
the NASDAQ national market or in the over-the-counter market, and may invest in
any industry or sector. From time to time, the Fund may hold significant cash
positions, consistent with its policy on temporary investments, until suitable
investment opportunities are available.
Debt securities in which the Fund may invest include securities or indebtedness
issued by corporations or governments in any form, as well as distressed
mortgage obligations and other debt secured by real property. The Fund does not
have established percentage limits for its investment in equity securities, debt
securities or money market instruments.
Restructuring or distressed companies The Fund does not presently anticipate
investing more than 50% of its assets in such investments, but is not restricted
to that amount.
Control The Fund may invest in other entities that purchase securities for the
purpose of influencing or controlling management. These entities may invest in a
potential takeover or leveraged buyout or invest in other entities engaged in
such practices.
Lower-rated securities The Fund may invest in debt securities in any rating
category. In general, the Fund will invest in these instruments for the same
reasons as equity securities, i.e., the manager believes that the securities may
be acquired at prices less than their intrinsic values. Consequently, the
manager's own analysis of a debt instrument exercises a greater influence over
the investment decision than the stated coupon rate or credit rating. The Fund
expects to invest in debt securities issued by reorganizing or restructuring
companies, or companies that recently emerged from, or are facing the prospect
of a financial restructuring. It is under these circumstances, which usually
involve unrated or low rated securities that are often in, or are about to,
default, that the manager seeks to identify securities which are sometimes
available at prices which it believes are less than their intrinsic values. The
Fund may invest without limit in defaulted debt securities, subject to the
Fund's restriction on investments in illiquid securities. The purchase of debt
of a troubled company always involves a risk that the investment may be
25
lost. However, the debt securities of reorganizing or restructuring companies
typically rank senior to the equity securities of such companies.
Other Investments and Strategies
. Other Indebtedness The Fund also may invest in other forms of secured
or unsecured indebtedness or participations (indebtedness), which may
have very long maturities or may be illiquid.
. Foreign securities The Fund presently does not intend to invest more
than 5% of its assets in securities of emerging market countries
including Eastern European countries and Russia. Foreign investments
may include both voting and non-voting securities, sovereign debt and
participation in foreign government deals.
. Closed-end investment companies While the Fund may not purchase
securities of registered open-end investment companies or affiliated
investment companies, it may invest from time to time in other
investment company securities. The Fund may not however, purchase more
than 3% of the voting securities of another investment company. In
addition, the Fund will not invest more than 5% of its assets in the
securities of any single investment company and will not invest more
than 10% of its assets in investment company securities. Investors
should recognize that they indirectly bear a proportionate share of the
expenses of these investment companies, including operating costs, and
investment advisory and administrative fees.
. Currency hedging To the extent that hedging is available, the Fund may
use the following currency hedging techniques: foreign currency futures
contracts, options on foreign currencies or currency futures, forward
foreign currency exchange contracts and currency swaps.
. The Fund also may:
. sell short securities it does not own up to 5% of its assets;
. sell securities "short against the box" without limit;
. lend its portfolio securities up to 33 1/3% of its assets;
. borrow up to 33 1/3% of the value of its total assets from
banks;
. enter into repurchase transactions;
. purchase securities on a "when-issued" or "delayed delivery"
basis;
. invest in restricted or illiquid securities;
. purchase and sell exchange-listed and over-the-counter put and
call options on securities, equity and fixed-income indices
and other financial instruments; and
. purchase and sell financial futures contracts and related
options.
The Fund is subject to Fundamental Investment Restrictions 1, 2.1, 3, 4, 5.1, 7,
9.2, 10.1, 11, 13 and 15.
26
Mutual Shares Securities Fund
(Mutual Shares Fund)
The Fund's principal goal is capital appreciation. Its secondary goal is income.
These goals are fundamental, which means they may not be changed without
shareholder approval.
Other Considerations
The Fund may invest in securities that are traded on U.S. or foreign exchanges,
the NASDAQ national market or in the over-the-counter market, and may invest in
any industry sector. From time to time, the Fund may hold significant cash
positions, consistent with its policy on temporary investments, until suitable
investment opportunities are available.
Debt securities in which the Fund may invest include securities or indebtedness
issued by corporations or governments in any form, as well as distressed
mortgage obligations and other debt secured by real property. The Fund does not
have established percentage limits for its investment in equity securities, debt
securities or money market instruments.
Control The Fund may invest in other entities that purchase securities for the
purpose of influencing or controlling management. These entities may invest in a
potential takeover or leveraged buyout or invest in other entities engaged in
such practices.
Restructuring or distressed companies The Fund does not presently anticipate
investing more than 50% of its assets in such investments, but is not restricted
to that amount.
Lower-rated securities The Fund may invest in debt securities in any rating
category. In general, the Fund will invest in these instruments for the same
reasons as equity securities, i.e., the manager believes that the securities are
available at prices less than their intrinsic values. Consequently, the
manager's own analysis of a debt instrument exercises a greater influence over
the investment decision than the stated coupon rate or credit rating. The Fund
expects to invest in debt securities issued by reorganizing or restructuring
companies, or companies that recently emerged from, or are facing the prospect
of a financial restructuring. It is under these circumstances, which usually
involve unrated or lower rated securities that are often in, or are about to,
default, that the manager seeks to identify securities which are sometimes
available at prices which it believes are less than their intrinsic values. The
Fund may invest without limit in defaulted debt securities, subject to the
Fund's restriction on investments in illiquid securities. The purchase of debt
of a troubled company always involves a risk that the investment may be lost.
However, the debt securities of reorganizing or restructuring companies
typically rank senior to the equity securities of such companies.
Other Investments and Strategies
. Indebtedness The Fund also may invest in other forms of secured or
unsecured indebtedness or participations (indebtedness), which may have
very long maturities or may be illiquid.
27
. Foreign securities Although the Fund reserves the right to purchase
securities in any foreign country without percentage limitation, the
Fund's current investment strategy is to invest primarily in domestic
securities, with approximately 15-20% of its assets in foreign
securities. The Fund presently does not intend to invest more than 5%
of its assets in securities of emerging markets, including Eastern
European countries and Russia. Foreign investments may include both
voting and non-voting securities, sovereign debt and participation in
foreign government deals.
. Closed-end investment companies While the Fund may not purchase
securities of registered open-end investment companies or affiliated
investment companies, it may invest from time to time in other
investment company securities. The Fund may not purchase more than 3%
of the voting securities of another investment company. In addition,
the Fund will not invest more than 5% of its assets in the securities
of any single investment company and will not invest more than 10% of
its assets in investment company securities. Investors should recognize
that they indirectly bear a proportionate share of the expenses of
these investment companies, including operating costs, and investment
advisory and administrative fees.
. Currency hedging The Fund may use the following currency hedging
techniques: investments in foreign currency futures contracts, options
on foreign currencies or currency futures, forward foreign currency
exchange contracts and currency swaps.
. The Fund also may:
. sell short securities it does not own up to 5% of its assets;
. sell securities "short against the box" without limit;
. lend its portfolio securities up to 33 1/3% of its assets;
. borrow up to 33 1/3% of the value of its assets from banks;
. enter into repurchase transactions;
. purchase securities on a "when-issued" or "delayed delivery"
basis;
. invest in restricted or illiquid securities: purchase and sell
exchange-listed and over-the- counter put and call options on
securities, equity and fixed-income indices and other
financial instruments; and
. purchase and sell financial futures contracts and related
options.
The Fund is subject to Fundamental Investment Restrictions 1, 2.1, 3, 4, 5.1, 7,
9.2, 10.1, 11, 13 and 15.
Templeton Asset Strategy Fund
(Asset Strategy Fund)
The Fund's investment goal is high total return. This goal is fundamental, which
means it may not be changed without shareholder approval.
Other Considerations
28
The Fund will normally invest its assets in at least three countries, except
during defensive periods.
Other Investments and Strategies
. Foreign securities The Fund has an unlimited ability to purchase
exchange listed securities in any foreign country, developed or
emerging. The Fund will not invest more than 15% of its total assets in
securities of foreign issuers that are not listed on a recognized U.S.
or foreign securities exchange. As a non-fundamental policy, the Fund
will limit its investments in securities of Russian issuers to 5% of
its assets.
. Debt securities The Fund may invest in debt securities issued by
governments or companies, whether domestic or foreign, such as bonds,
debentures, notes, commercial paper, collateralized mortgage
obligations (CMOs) and securities issued or guaranteed by governments
agencies and instrumentalities. The Fund may invest in preferred stocks
and certain debt securities, rated or unrated, such as convertible
bonds and bonds selling at a discount. The average maturity of debt
securities in the Fund's portfolio is medium-term (about 5 to 15
years), but will fluctuate depending on the manager's outlook on the
issuer's country and future interest rate changes.
. Money Market Instruments The Fund may hold cash and time deposits with
banks in the currency of any major nation and invest in certificates of
deposit of federally insured savings and loan associations having total
assets in excess of $1 billion. The Fund also may invest in commercial
paper rated Prime-1 or Prime-2 by Moody's or A-1 or A-2 by S&P(R) or,
unrated commercial paper issued by companies having outstanding debt
issue currently rated Aaa or Aa by Moody's or AAA or AA by S&P(R).
. The Fund also may:
. invest in illiquid securities up to 15% of its net assets;
. invest in collateralized mortgage obligations;
. purchase securities on a "when-issued" basis;
. invest in REITS;
. enter into repurchase transactions;
. lend its portfolio securities up to 33 1/3% of its assets;
. borrow up to 33 1/3% of the value of its assets;
. invest in forward foreign currency exchange contracts; and
. purchase and sell financial futures contracts, stock index
futures contracts, and foreign currency futures contracts for
hedging purpose only and not for speculation. It may engage in
these transactions only if the total contract value of the
futures contract does not exceed 20% of the Fund's total
assets.
29
The Fund is subject to Fundamental Investment Restrictions 1.1, 2.4, 3.1, 4.1,
7.2, 10.3 and 18.
Templeton Developing Markets Securities Fund
(Developing Markets Fund)
The Fund's investment goal is long-term capital appreciation. This goal is
fundamental, which means it may not be changed without shareholder approval.
Other Considerations
For this Fund, emerging market countries include: (i) countries that are
generally considered low or middle income countries by the International Bank
for Reconstruction and Development (commonly known as the World Bank) and the
International Finance Corporation; or (ii) countries that are classified by
United Nations or otherwise regarded by their authorities as emerging; or (iii)
countries with a market capitalization of less than 3% of the Morgan Stanley
Capital World Index.
Emerging market companies are: (i) companies the principal securities trading
markets of which are in emerging market countries; or (ii) companies that derive
a significant share of their total revenue from either goods or services
produced or sales made in emerging market countries; or (iii) companies that
have a significant portion of their assets in emerging market countries; or (iv)
companies that are linked to currencies of emerging market countries; or (v)
companies that are organized under the laws of, or with principal offices in,
emerging market countries. The manager will determine eligibility based on
publicly available information and inquiries to the companies.
The manager will determine the eligibility of investments based on publicly
available information and inquiries made to companies.
From time to time, the Fund may hold significant cash positions until suitable
investment opportunities are available, consistent with its policy on temporary
investments.
The Fund seeks to benefit from economic and other developments in emerging
markets. The investment goal of the Fund reflects the belief that investment
opportunities may result from an evolving, long-term international trend
favoring more market-oriented economies. This trend may be facilitated by local
or international political, economic or financial developments that could
benefit the capital markets of such countries. Countries in the process of
developing more market-oriented economies may experience relatively high rates
of economic growth, but there are many factors that may slow development and
growth. Other countries, although having relatively
30
mature emerging markets, also may be in a position to benefit from local or
international developments encouraging greater market orientation and
diminishing governmental intervention in economic affairs.
Other Investments and Strategies
. Smaller companies The Fund may invest significantly in smaller
companies, which have market capitalizations of $1.5 billion or less.
Market capitalization is the total market value of a company's
outstanding stock.
. Debt securities Depending upon current market conditions, the Fund may
invest up to 35% of its assets in fixed-income debt securities for
capital appreciation.
To the extent the Fund invests in debt securities, it will invest in
those rated at least C by Moody's or S&P(R) or, if unrated, that the
manager determines to be of comparable quality. As a fundamental
policy, the Fund will not invest more than 10% of its assets in
defaulted debt securities. The Fund does not, however, currently intend
to invest in defaulted debt. As an operating policy (which may be
changed without shareholder approval), the Fund will not invest more
than 5% of its assets in lower-rated debt securities which include debt
securities rated BBB or lower by S&P(R) or Baa or lower by Moody's (the
lowest category of "investment grade" rating).
. Closed end investment companies The Fund may invest up to 10% of its
total assets in securities of closed-end investment companies to
facilitate foreign investment. Investors should realize that they
indirectly bear a proportionate share of the expenses of these
investment companies, including operating costs, and investment
advisory or administrative fees.
. Foreign securities The Fund will at all times, except during defensive
periods, maintain investments in at least three emerging markets
countries. As a non-fundamental policy, however, the Fund will limit
its investments in securities of Russian issuers to 5% of assets. The
Fund may, but currently does not intend to, invest more than 15% of its
total assets in securities of foreign issuers that are not listed on a
recognized U.S. or foreign securities exchange
. The Fund also may:
. lend its portfolio securities up to 33 1/3% of its assets;
. borrow up to 33 1/3% of the value of its assets;
. purchase convertible securities and warrants;
. invest up to 15% of its net assets in illiquid securities;
31
. engage in repurchase transactions;
. enter into forward foreign currency exchange contracts; and
. enter into futures contracts, and related options, with
respect to securities, securities indices and foreign
currencies. The value of the underlying securities of written
futures contracts will not exceed at any time, 25% of the
Fund's total assets.
When deemed appropriate by the manager, the Fund may invest cash balances in
repurchase agreements and other money market investments to maintain liquidity
in an amount to meet expenses or for day-to-day operating purposes.
The Fund is subject to Fundamental Investment Restrictions 1.1, 2.4, 3.1, 4.1,
7.2, 10.3 and 18.
Templeton Global Income Securities Fund
(Global Income Fund)
The Fund's investment goal is high current income consistent with preservation
of capital. This goal is fundamental, which means it may not be changed without
shareholder approval. Capital appreciation is a secondary consideration.
Other Considerations
A supranational organization is an entity designated or supported by the
national government of one or more countries to promote economic reconstruction
or development. The Fund selects investments to provide a high current yield and
currency stability, or a combination of yield, capital appreciation, and
currency appreciation. As a global fund, the Fund may invest in securities
issued in any currency and may hold foreign currency.
Under normal market conditions, the Fund will have at least 25% of its assets
invested in debt securities issued or guaranteed by foreign governments. Under
normal circumstances, at least 65% of the Fund's assets will be invested in
issuers located in at least three countries, one of which may be the U.S.
The Fund may invest a significant portion of its assets in securities and
currency in emerging market countries.
Other Investments and Strategies
32
. Debt securities The Fund may invest in debt or equity securities of any
type of issuer, including domestic and foreign corporations, domestic
and foreign banks (with assets in excess of one billion dollars), other
business organizations, and domestic and foreign governments and their
political subdivisions, including the U.S. government, its agencies,
and authorities or instrumentalities, and supranational organizations.
The Fund is further authorized to invest in "semi-governmental
securities," which are debt securities issued by entities owned by
either a national, state, or equivalent government or of a government
jurisdiction that are not backed by its full faith and credit and
general taxing powers. The Fund considers securities issued by central
banks that are guaranteed by their national governments to be
government securities.
The debt securities in which the Fund invests may have equity features,
such as conversion or exchange rights or warrants for the acquisition
of stock of the same or a different issuer; participation based on
revenues, sales or profits; or the purchase of common stock in a unit
transaction (where an issuer's debt securities and common stock are
offered as a unit).
The Fund may invest in debt securities with varying maturities. Under
current market conditions, it is expected that the average life span of
all of the Fund's investments (the dollar-weighted average maturity of
the Fund's investments) will not exceed 15 years. Generally, the
portfolio's average maturity will be shorter when the manager expects
interests rates worldwide or in a particular country to rise and longer
when the manager expects interest rates to fall.
. Portfolio turnover The manager's rebalancing of the portfolio when
seeking to keep interest rate risk, country allocations, and bond
maturities at desired levels, may cause the Fund's portfolio turnover
rate to be high. High turnover generally increases the Fund's
transaction costs.
. The Fund also may:
. use forward and futures contracts, options on currencies, and
interest rate swaps;
. invest in preferred stock;
. invest in structured notes;
. purchase and sell call and put options on U.S. or foreign
securities;
. acquire loan participations;
. lend its portfolio securities up to 30% of its assets;
. borrow up to 5% of the value of its total assets, except from
banks for temporary or emergency purposes, and not for direct
investments in securities;
. enter into repurchase, reverse repurchase, and "when-issued"
transactions; and
. enter into futures contracts for the purchase or sale of U.S.
Treasury or foreign securities or based upon financial
indices.
The Fund is subject to Fundamental Investment Restrictions 2, 3, 4, 5, 6, 7,
8.1, 9.3, 10.1, 11, 12, 13, 14 and 15.
33
Templeton Growth Securities Fund
(Growth Securities Fund)
The Fund's investment goal is long-term capital growth. This goal is
fundamental, which means it may not be changed without shareholder approval. Any
income the Fund earns will be incidental.
Other Considerations
The Fund considers emerging market countries to include those generally
considered low or middle income countries by the International Bank for
Reconstruction and Development (commonly known as the World Bank) and the
International Finance Corporation. As a non-fundamental policy, the Fund will
limit its investments in securities of Russian issuers to 5% of assets.
Other Investments and Strategies
. Debt securities The Fund may invest in bonds, convertible bonds, and
bonds selling at a discount, as a defensive measure while looking for
attractive equity investments. The Fund also may invest in debt
securities for capital appreciation. The Fund may invest in debt
securities that are rated as low as C by Moody's or S&P(R)(the lowest
rating category) or, if unrated, that the manager determines to be of
comparable quality, but intends to invest in those that are highly
rated. However, as a policy established by the Board, the Fund will not
invest more than 5% of its assets in debt securities rated BBB or lower
by S&P(R)or Baa or lower by Moody's. Consistent with the goal of the
Fund, the Board may consider a change if economic conditions change
such that a higher level of investment in high risk, lower quality debt
securities would be appropriate. As a fundamental policy, the Fund may
not invest more than 10% of its assets in defaulted debt securities.
The Fund, however, does not currently intend to invest in any defaulted
debt securities.
. Stock Index Futures The Fund may purchase and sell stock index futures
contracts up to, in the aggregate, 20% of its assets. It may not at any
time commit more than 5% of its assets to initial margin deposits on
futures contracts.
. Loans of portfolio securities In order to increase income to the Fund,
the Fund may lend certain of its portfolio securities up to 30% of its
total assets to qualified banks and broker dealers.
. The Fund also may:
. purchase preferred stocks;
. invest up to 10% of its assets in securities with a limited
trading market, i.e., "illiquid securities";
. enter into repurchase agreements;
34
. borrow up to 5% of the value of its total assets, except from
banks for temporary or emergency purposes, and not for direct
investments in securities; and
. invest in restricted securities.
The Fund is subject to Fundamental Investment Restrictions 1, 2, 3, 4, 5, 6, 7,
8.1, 9.3, 10.1, 11, 12, 13, 14, 15, 16 and 17.
Templeton International Securities Fund
(International Securities Fund)
The Fund's investment goal is long-term capital growth. This goal is
fundamental, which means it may not be changed without shareholder approval.
Other Considerations
As an international fund, the Fund will invest at least 65% of its total assets
in securities of issuers in at least three countries outside the U.S. The Fund
will invest predominantly in large-cap and mid-cap companies with market
capitalizations of $5 billion or more, and $2 billion to $5 billion,
respectively. It also may invest to a lesser extent in smaller companies.
Other Investments and Strategies
. Foreign securities As a non-fundamental policy, the Fund will limit its
investments in securities of Russian issuers to 5% of its assets.
. Debt securities The Fund may invest up to 35% of its assets in debt
securities including in medium and lower quality debt securities that
are rated between BBB and as low as D by S&P(R), and between Baa and as
low as C by Moody's or unrated securities the manager determines are of
comparable quality. As an operating policy (which may be changed by the
Board without shareholder approval) the Fund will not invest more than
5% of its assets in lower-rated securities rated BB or lower by S&P(R),
Ba or lower by Moody's, or lower unrated securities that the manager
determines are an equivalent investment quality.
. The Fund also may:
. invest up to 15% of its net assets in illiquid securities;
. enter into firm commitment agreements;
. purchase securities on a "when issued" basis;
. purchase and sell financial futures contracts, stock index
futures contracts, and foreign currency futures contracts. It may
engage in these transactions only if the total contract value of
the futures do not exceed 20% of the Fund's total assets;
35
. lend its portfolio securities up to 33 1/3% of its total
assets; and
. borrow up to 33 1/3% of the value of its total assets.
The Fund is subject to Fundamental Investment Restrictions 1.1, 2.4, 3.1, 4.1,
7.2, 10.3 and 18.
Templeton International Smaller Companies Fund
(International Smaller Companies Fund)
The Fund's investment goal is long-term capital appreciation. This goal is
fundamental, which means it may not be changed without shareholder approval.
Other Considerations
The manager believes that international small cap companies may provide
attractive investment opportunities because these securities comprise a majority
of the world's equity securities. These companies also are frequently overlooked
by investors or undervalued in relation to their perceived earning power. In
addition, such securities may provide investors with the opportunity to increase
the diversification of their overall investment portfolios because the market
performance of these securities may differ from U.S. small-cap stocks and
large-cap stocks of any nation. As an operating policy, the Fund will not invest
more than 10% of its assets in securities of companies with less than three
years of continuous operation.
The Fund may invest up to 35% of its assets in: equity securities of larger
issuers outside the U.S.; or equity securities of larger or smaller issuers
within the U.S., although the Fund does not expect these investments to exceed
5% of assets; or debt securities issued by companies or governments of any
nation. These investments may cause the Fund's performance to vary from those of
international smaller equity markets.
Foreign securities As a non-fundamental policy, the Fund will limit its
investments in securities of Russian issuers to 5% of assets.
Other Investments and Strategies
. Debt securities The Fund may invest in debt securities that are rated
at least C by Moody's or S&P(R) or, if unrated, that the manager
determines to be of comparable quality. As a current policy, however,
the Fund will not invest more than 5% of its assets in debt securities
rated lower than BBB by S&P(R) or Baa by Moody's. The Fund may invest
up to 10% of its assets in defaulted debt securities.
36
. Warrants While the Fund may invest in warrants, as a non-fundamental
investment policy, the Fund may not invest more than 5% of its assets
in warrants, whether or not listed on the New York or American Stock
Exchanges, including no more than 2% of its total assets in warrants
that are not listed on those exchanges. Warrants acquired by the Fund
in units or attached to securities are not included in this
restriction.
. Currency hedging The Fund may, but with respect to equity securities
currently does not intend to, employ the following currency hedging
techniques: foreign currency futures contracts and forward foreign
currency exchange contracts (forward contracts). Further, the Fund will
not enter into forward contracts if, as a result, the Fund would have
more than 20% of its assets committed to such contracts.
. Hedging For hedging purposes only, the Fund may enter into futures
contracts and related options. The value of the underlying securities
on which futures contracts will be written at any one time will not
exceed 25% of the assets of the Fund.
. The Fund also may:
. enter into repurchase agreements;
. invest in illiquid securities;
. lend its portfolio securities up to 30% of its assets; and
. borrow up to 33 1/3% of the value of its total assets from
banks.
The Fund is subject to Fundamental Investment Restrictions 1, 2.1, 3, 4, 6, 7,
9.3, 10.1, 11, 13, 15 and 17.
37
Securities, Investment Techniques and Their Risks Common to More than One Fund
This section describes certain types of securities and investment techniques
that a Fund may use to help it achieve its investment goals and to the extent
not expressly prohibited by its investment restrictions. Not all investments,
strategies and techniques are available to all Funds. You should refer to the
information in the Fund's prospectus or earlier in this SAI to determine if an
investment, strategy or technique may be used by a particular Fund. If there
appears to be an inconsistency between this section and the individual Fund
section with respect to investments, strategies or techniques, the individual
Fund section controls and should be relied upon.
Each Fund is also subject to investment restrictions that are described under
the heading "Fundamental Investment Restrictions" in this SAI. The investment
goal of each Fund and its listed investment restrictions are "fundamental
policies" of each Fund, which means that they may not be changed without a
majority vote of shareholders of the Fund. With the exception of a Fund's
investment goal and those restrictions specifically identified as fundamental,
all investment policies and practices described in the Fund's prospectus and in
this SAI are not fundamental, which means that the Board of Trustees (Board) may
change them without shareholder approval.
The value of your shares will increase as the value of the securities owned by a
Fund increases and will decrease as the value of the Fund's investments
decrease. In this way, you participate in any change in the value of the
securities owned by the Fund. In addition to the factors that affect the value
of any particular security that the Fund owns, the value of Fund shares also may
change with movements in the stock and bond markets as a whole.
The U.S. economy has recently experienced the longest period of expansion in its
history. Over the past few years, gains in the stock market, and for many
individual securities, have significantly exceeded prior historical norms.
Investors should not have unrealistic expectations that such expansion or the
pace of gains will resume or continue in the future.
In addition to the risks described in each Fund's prospectus and the individual
Fund summaries in this SAI, investors should consider the risks that pertain to
the Funds that may invest in the instruments or engage in the following
strategies.
BORROWING
None of the Funds will purchase additional securities while its borrowing
exceeds its stated percentage limitations on borrowing. Under federal securities
laws, a fund may borrow from banks provided it maintains continuous asset
coverage of 300% with respect to such borrowings, including selling (within
three days) sufficient portfolio holdings to restore such coverage should it
decline to less than 300% due to market fluctuations or otherwise, even if
disadvantageous from an investment standpoint.
Leveraging by means of borrowing may make any change in the Fund's net asset
value even greater and thus result in increased volatility of returns. The
Fund's assets that are used as collateral to secure the borrowing may decrease
in value while the borrowing is outstanding,
38
which may force the Fund to use its other assets to increase the collateral. In
addition, the money borrowed will be subject to interest and other costs (which
may include commitment fees and/or the cost of maintaining minimum average
balances). The cost of borrowing may exceed the income received from the
securities purchased with borrowed funds.
In addition to borrowing for leverage purposes, the Funds also may borrow money
to meet redemptions in order to avoid forced, unplanned sales of portfolio
securities. This allows the Funds greater flexibility to buy and sell portfolio
securities for investment or tax considerations, rather than cash flow
considerations. See "Fundamental Investment Restrictions" for more information
about the Funds' policies with respect to borrowing.
CONVERTIBLE SECURITIES
IN GENERAL. A convertible security is generally a debt obligation or preferred
stock that may be converted within a specified period of time into a certain
amount of common stock of the same or a different issuer. A convertible security
provides a fixed-income stream and the opportunity, through its conversion
feature, to participate in the capital appreciation resulting from a market
price advance in its underlying common stock. As with a straight fixed-income
security, a convertible security tends to increase in market value when interest
rates decline and decrease in value when interest rates rise. Like a common
stock, the value of a convertible security also tends to increase as the market
value of the underlying stock rises, and it tends to decrease as the market
value of the underlying stock declines. Because both interest rate and market
movements can influence its value, a convertible security is not as sensitive to
interest rates as a similar fixed-income security, nor as sensitive to changes
in share price as its underlying stock.
A convertible security is usually issued either by an operating company or by an
investment bank. When issued by an operating company, a convertible security
tends to be senior to common stock, but subordinate to other types of
fixed-income securities issued by that company. When that convertible security
is "converted," the operating company often issues new stock to the holder of
the convertible security. If, however, the parity price (the price at which the
common stock underlying the convertible security may be obtained) of the
convertible security is less than the call price (the price of the bond,
including any premium related to the conversion feature), the operating company
may pay out cash instead of common stock. When a convertible security is issued
by an investment bank, the security is an obligation of and is convertible
through the issuing investment bank.
In addition, the issuer of a convertible security may be important in
determining the security's true value. This is because the holder of a
convertible security will have recourse only to the
39
issuer. A convertible security may be subject to redemption by the issuer, but
only after a specified date and under circumstances established at the time the
security is issued.
While each Fund uses the same criteria to rate a convertible debt security that
it uses to rate a more conventional debt security, a convertible preferred stock
is treated like a preferred stock for the Fund's financial reporting, credit
rating, and investment limitation purposes. A preferred stock is subordinated to
all debt obligations of the issuer in the event of insolvency, and an issuer's
failure to make a dividend payment is generally not an event of default
entitling the preferred shareholder to take action. A preferred stock generally
has no maturity date, so its market value is dependent on the issuer's business
prospects for an indefinite period of time. In addition, distributions from
preferred stock are dividends, rather than interest payments, and are usually
treated as such for corporate tax purposes.
ENHANCED CONVERTIBLE SECURITIES. In addition to "plain vanilla" convertibles, a
number of different structures have been created to fit the characteristics of
specific investors and issuers. Examples of these enhanced characteristics for
investors include yield enhancement, increased equity exposure and enhanced
downside protection. From an issuer's perspective, enhanced structures are
designed to meet balance sheet criteria, interest/dividend payment deductibility
and reduced equity dilution. The following are descriptions of common structures
of enhanced convertible securities.
Enhanced convertible preferred securities (e.g., QUIPS, TOPrS, and TECONS) are,
from an investor's viewpoint, essentially convertible preferred securities,
i.e., they are issued as preferred stock convertible into common stock at a
premium and pay quarterly dividends. Through this structure, the company
establishes a wholly-owned, special purpose vehicle whose sole purpose is to
issue convertible preferred stock. The proceeds of the convertible preferred
stock offering pass through to the company. The company then issues a
convertible subordinated debenture to the special purpose vehicle. This
convertible subordinated debenture has identical terms to the convertible
preferred issued to investors. Benefits to the issuer include increased equity
credit from rating agencies and the deduction of coupon payments for tax
purposes.
LIQUIDITY CONSIDERATION. An investment in an enhanced convertible security may
involve additional risks. A Fund may have difficulty disposing of such
securities because there may be a thin trading market for a particular security
at any given time. Reduced liquidity may have an adverse impact on market price
and the Fund's ability to dispose of particular securities, when necessary, to
meet the Fund's liquidity needs or in response to a specific economic event,
such as the deterioration in the credit worthiness of an issuer. The Funds,
however, intend to acquire liquid convertible securities, though there can be no
assurances that this will be achieved. Reduced liquidity in the secondary market
for certain securities also may make it more difficult for a Fund to obtain
market quotations based on actual trades for purposes of valuing the Fund's
portfolio.
MANDATORILY CONVERTIBLE SECURITIES. Mandatorily convertible securities (e.g.,
ACES, DECS, PRIDES, SAILS - each issuer has a different acronym for their
version of these securities) are considered the most like equity of convertible
securities. At maturity these securities are mandatorily convertible into common
stock offering investors some form of yield
40
enhancement in return for some of the upside potential in the form of a
conversion premium. Typical characteristics of mandatory convertibles include:
issued as preferred stock, convertible at premium, pay fixed quarterly dividend
(typically 500 to 600 basis points higher than common stock dividend), and
non-callable for the life of the security (usually three to five years). An
important feature of mandatory convertibles is that the number of shares
received at maturity is determined by the difference between the price of the
common stock at maturity and the price of the common stock at issuance.
EXCHANGEABLE SECURITIES. Exchangeable securities are often used by a company
divesting a holding in another company. The primary difference between
exchangeable and standard convertible securities is that the issuing company is
a different company from that which issued the underlying shares.
YIELD ENHANCED STOCK. Yield enhanced stock (YES, also known as PERCS)
mandatorily converts into common stock at maturity and offers investors a higher
current dividend than the underlying common stock. The difference between these
structures and other mandatory convertibles is that the participation in stock
price appreciation is capped.
ZERO COUPON AND DEEP DISCOUNT CONVERTIBLE BONDS. Zero-coupon and deep-discount
convertible bonds (OID and LYONs) include the following characteristics: no or
low coupon payments, imbedded put options allowing the investor to put them on
select dates prior to maturity, call protection (usually three to five years),
and lower than normal conversion premiums at issuance. A benefit to the issuer
is that, while no cash interest is actually paid, the accrued interest may be
deducted for tax purposes. Because of their put options, these bonds tend to be
less sensitive to changes in interest rates than either long maturity bonds or
preferred stocks. The put options also provide enhanced downside protection
while retaining the equity participation characteristics of traditional
convertible bonds.
SYNTHETIC CONVERTIBLE SECURITIES. A synthetic convertible is created by
combining distinct securities that together possess fixed income payments and
the right to acquire the underlying equity security. This combination is
achieved by investing in nonconvertible fixed-income securities and in warrants
or stock or stock index call options that grant the holder the right to purchase
a specified quantity of securities within a specified period of time at a
specified price or to receive cash in the case of stock index options. Synthetic
convertible securities are generally not considered to be equity securities for
purposes of each Fund's investment policy regarding those securities.
Synthetic convertible securities differ from a true convertible security in the
following respects:
. The value of a synthetic convertible is the sum of the values
of its fixed-income and convertibility components, which means
that the values of a synthetic convertible and a true
convertible security will respond differently to market
fluctuations.
. Typically, the two components of a synthetic convertible
represent one issuer, but a Fund may combine components
representing distinct issuers or combine a fixed income
security with a call option on a stock index when the manager
determines that such a combination would better promote
pursuing a Fund's investment objectives.
41
. The component parts of a synthetic convertible security may be
purchased simultaneously or separately.
. The holder of a synthetic convertible faces the risk that the
price of the stock, or the level of the market index
underlying the convertibility component will decline.
DEBT SECURITIES
IN GENERAL. In general, debt securities represent a loan of money by the
purchaser of the securities to the issuer. A debt security typically has a fixed
payment schedule that obligates the issuer to pay interest to the lender and to
return the lender's money over a certain time period. A company typically meets
its payment obligations associated with its outstanding debt securities before
it declares and pays any dividend to holders of its equity securities. Bond,
notes and commercial paper are types of debt securities. Each of these differs
in the length of the issuer's payment schedule, with commercial paper having the
shortest payment schedule.
Debt securities can provide the potential for capital appreciation based on
various factors such as changes in interest rates, economic and market
conditions, improvement in an issuer's ability to repay principal and pay
interest, and ratings upgrades.
Interest Rate The market value of debt securities generally varies in response
to changes in interest rates and the financial condition of each issuer. To the
extent a Fund invests in debt securities, changes in interest rates in any
country where the Fund is invested will affect the value of the Fund's portfolio
and its share price. During periods of declining interest rates, the value of
debt securities generally increases. Conversely, rising interest rates, which
will often occur during times of inflation or a growing economy, are likely to
have a negative effect on the value of the Fund's shares. Of course, interest
rates throughout the world have increased and decreased, sometimes very
dramatically, in the past. These changes are likely to occur again in the future
at unpredictable times.
Adjustable Rate Securities (ARS) are debt securities with interest rates that
are adjusted periodically pursuant to a pre-set formula and interval. Movements
in the relevant index on which adjustments are based, as well as the applicable
spread relating to the ARS, will affect the interest paid on ARS and, therefore,
the current income earned by a Fund by investing in ARS. (See "Resets.")
The interest rates on ARS are readjusted periodically to an amount above the
chosen interest rate index. These readjustments occur at intervals ranging from
one to sixty months. The degree of volatility in the market value of the
securities held by a Fund and of the net asset value of the Fund's shares will
be a function primarily of the length of the adjustment period and the degree of
volatility in the applicable indices. It will also be a function of the maximum
increase or decrease of the interest rate adjustment on any one adjustment date,
in any one year, and over the life of the securities. These maximum increases
and decreases are typically referred to as "caps" and "floors," respectively. A
Fund does not seek to maintain an overall average cap or floor, although the
manager will consider caps or floors in selecting ARS for a Fund.
42
While the Funds investing in ARS do not attempt to maintain a stable net asset
value per share, during periods when short-term interest rates move within the
caps and floors of the securities held by a Fund, the fluctuation in market
value of the ARS held by the Fund is expected to be relatively limited, since
the interest rates on the ARS generally adjust to market rates within a short
period of time. In periods of substantial short-term volatility in interest
rates, the value of a Fund's holdings may fluctuate more substantially because
the caps and floors of its ARS may not permit the interest rates to adjust to
the full extent of the movements in the market rates during any one adjustment
period. In the event of dramatic increases in interest rates, the lifetime caps
on the ARS may prevent the securities from adjusting to prevailing rates over
the term of the loan. In this case, the market value of the ARS may be
substantially reduced, with a corresponding decline in a Fund's net asset value.
Inverse Floaters are instruments with floating or variable interest rates that
move in the opposite direction, usually at an accelerated speed, to short-term
interest rates or interest rate indices.
Structured Notes Structured notes may be much more volatile than the underlying
instruments themselves, depending on the direction of interest rates, and may
present many of the same risks as investing in futures and options. Certain
structured notes without leverage characteristics may still be considered risky
and an investor could lose an amount equal to the amount invested. As with any
debt instruments, structured notes pose credit risk, i.e., the issuer may be
unable to make the required payments. Finally, some structured notes may be
illiquid, that is, the securities may not be sold as readily as other securities
because few investors or dealers trade in such securities or because the notes
are complex and difficult to price. Such potential illiquidity may be especially
pronounced during severe bond market corrections, i.e., a change or a reversal
in the direction of the market. The Board will monitor the liquidity of
structured notes. Notes determined to be illiquid will be subject to a Fund's
percentage limits on illiquid securities. These notes would have coupon resets
that may cause the current coupon to fall to, but not below, zero. Existing
credit quality, duration and liquidity standards would apply so that a Fund may
not invest in structured notes unless the manager believes that the notes pose
no greater credit or market risk than stripped notes. These notes may, however,
carry risks similar to those of stripped securities.
RATINGS. Various investment services publish ratings of some of the debt
securities in which the Funds may invest. These ratings represent the opinions
of the rating services with respect to the issuer's ability to pay interest and
repay principal. They do not purport to reflect other risks, such as the risk of
fluctuations in market value, and are not absolute standards of quality. See
"Description of Bond Ratings" for a for a more complete discussion of the
ratings.
Regardless of rating levels, all debt securities considered for purchase
(whether rated or unrated) will be carefully analyzed by the manager to assess
whether, at the time of purchase, the planned investment offers potential
returns that are reasonable in light of the risks involved. The manager, in its
evaluation of the overall investment merits of a security, will consider the
fact that the rating on an issue held in a Fund's portfolio is changed by the
rating service or that the security goes into default, but, in general, will not
automatically sell the security.
43
Lower-Rated Securities Higher yields are ordinarily available from securities in
the lower rating categories, such as securities rated Ba or lower by Moody's or
BB or lower by S&P(R) or from unrated securities deemed by a Fund's manager to
be of comparable quality. However, lower- rated securities typically are riskier
than investment grade securities. Bonds that are rated C by Moody's are the
lowest rated class of bonds and can be regarded as having extremely poor
prospects of ever attaining any real investment standing. Bonds rated C by
S&P(R) are securities on which no interest is being paid.
An investment in any Fund that invests in non-investment grade securities,
including those issued by foreign companies and governments, is subject to a
higher degree of risk than an investment in a Fund that invests primarily in
higher-quality securities. You should consider the increased risk of loss to
income and principal that is present with an investment in higher risk
securities, such as those in which certain of the Funds invest. Accordingly, an
investment in any Fund should not be considered a complete investment program
and should be carefully evaluated for its appropriateness in light of your
overall investment needs and goals.
Adverse publicity and investor perceptions, whether or not based on fundamental
analysis, may decrease the values and liquidity of lower-rated debt securities,
especially in a thinly traded market. Analysis of the creditworthiness of
issuers of lower-rated debt securities may be more complex than for issuers of
higher rated securities. The ability of a Fund to achieve its investment goal
may, to the extent of investment in lower-rated debt securities, be more
dependent upon such creditworthiness analysis than would be the case if the Fund
were investing in higher rated securities. A Fund relies on the manager's
judgment, analysis and experience in evaluating the creditworthiness of an
issuer. In this evaluation, the manager takes into consideration, among other
things, the issuer's financial resources, its sensitivity to economic conditions
and trends, its operating history, the quality of the issuer's management and
regulatory matters.
Lower-rated debt securities may be more susceptible to real or perceived adverse
economic and competitive industry conditions than investment grade securities.
The prices of lower-rated debt securities may to be less sensitive to interest
rate changes than higher rated investments, but more sensitive to adverse
economic downturns or individual corporate developments. A projection of an
economic downturn or of a period of raising interest rates, for example, could
cause a decline in lower rated debt securities prices. This is because the
advent of a recession could lessen the ability of a highly leveraged company to
make principal and interest payments on its debt securities. If the issuer of
lower-rated debt securities defaults, the Fund may incur additional expenses to
seek recovery.
High yield, fixed-income securities frequently have call or buy-back features
that allow an issuer to redeem the securities from a Fund. Although these
securities are typically not callable for a period of time, usually for three to
five years from the date of issue, if an issuer calls its securities during
periods of declining interest rates, the manager may find it necessary to
replace the securities with lower-yielding securities, which could result in
less net investment income for a Fund. The premature disposition of a high yield
security due to a call or buy-back feature, the deterioration of an issuer's
creditworthiness, or a default by an issuer may make it more difficult for a
Fund to manage the timing of its income. To generate cash for distributions, a
Fund may
44
have to sell portfolio securities that it otherwise may have continued to hold
or use cash flows from other sources, such as the sale of Fund shares. A
portfolio may be required under the Internal Revenue Code and U.S. Treasury
Regulations to accrue income for income tax purposes on defaulted obligations
and to distribute such income to the portfolio shareholders even though the
portfolio is not currently receiving interest principal payments on such
obligations.
The markets in which lower rated and unrated debt securities are traded are more
limited than those in which high rated securities are traded. The existence of
limited markets for particular securities may diminish the Fund's ability to
sell the securities at fair value either to meet redemption requests or to
respond to a specific economic event, such as deterioration in the
creditworthiness of the issuer. Reduced secondary market liquidity for certain
lower rated or unrated debt securities also may make it more difficult for the
Fund to obtain accurate market quotations for the purposes of valuing the Fund's
portfolio. Market quotations are generally available on many lower rated or
unrated securities only from a limited number of dealers and may not necessarily
represent firm bids of such dealers or prices for actual sales.
High yield, fixed-income securities that are sold without registration under the
federal securities laws carry restrictions on resale. While many high yielding
securities have been sold with registration rights, covenants and penalty
provisions for delayed registration, if a Fund is required to sell restricted
securities before the securities have been registered, it may be deemed an
underwriter of the securities under the Securities Act of 1933, which entails
special responsibilities and liabilities. A Fund also may incur special costs in
disposing of restricted securities, although the Fund will generally not incur
any costs when the issuer is responsible for registering the securities.
High yield, fixed-income securities acquired during an initial underwriting
involve special risks because they are new issues. The manager will carefully
review their credit and other characteristics. The Funds have no arrangement
with their underwriter or any other person concerning the acquisition of these
securities.
The high yield securities market is relatively new and much of its growth before
1990 paralleled a long economic expansion. Since 1990, the market for high yield
securities has been adversely affected during periods of recessions. When
recessions occur in the future, the market for high yield securities may be
adversely affected. Factors adversely impacting the market value of high yield
securities may lower a Fund's net asset value.
The credit risk factors above also apply to lower-quality zero coupon, deferred
interest and pay-in-kind securities. These securities have an additional risk,
however, because unlike securities that pay interest throughout the time until
maturity, a Fund will not receive any cash until the cash payment date. If the
issuer defaults, a Fund may not obtain any return on its investment.
Certain of the high yielding, fixed-income securities in which the Funds may
invest may be purchased at a discount. When held to maturity or retired, these
securities may include an element of capital gain. Capital losses may be
realized when securities purchased at a premium,
45
that is, in excess of their stated or par value, are held to maturity or are
called or redeemed at a price lower than their purchase price. Capital gains or
losses also may be realized upon the sale of securities.
Defaulted Debt The risk of loss due to default may be considerably greater with
lower-quality securities because they are generally unsecured and are often
subordinated to other creditors of the issuer. If the issuer of a security in a
Fund's portfolio defaults, the Fund may have unrealized losses on the security,
which may lower the Fund's net asset value. Defaulted securities tend to lose
much of their value before they default. Thus, a Fund's net asset value may be
adversely affected before an issuer defaults. In addition, a Fund may incur
additional expenses if it must try to recover principal or interest payments on
a defaulted security.
A Fund will buy defaulted debt securities if, in the opinion of the manager,
they may present an opportunity for later price recovery, the issuer may resume
interest payments, or other advantageous developments appear likely in the near
future. Defaulted debt securities may be illiquid and, as such, will be part of
the percentage limits on investments in illiquid securities discussed under
"Fundamental Investment Restrictions."
LOAN PARTICIPATIONS. Loan participations are interests in floating or variable
rate senior loans to U.S. corporations, partnerships and other entities.
Generally, these instruments are sold without a guarantee by the lending
institution, and are subject to the credit risks of both the borrower and the
lending institution. While loan participations generally trade at par value, a
Fund also may be able to acquire loan participations that sell at a discount
because of the borrower's credit problems. To the extent the borrower's credit
problems are resolved, such loan participations may appreciate in value. The
manager may acquire loan participations for a Fund when it believes that
appreciation will occur over the long term. Most loan participations in which
the Funds intend to invest are illiquid and, to that extent, will be included in
a Fund's limitation on illiquid investments described under "Illiquid
Securities." An investment in these securities carries substantially the same
risks as those for defaulted debt securities. Interest payments on these
securities may be reduced, deferred, suspended or eliminated and principal
payments may likewise be reduced, deferred, suspended or canceled, causing the
loss of the entire amount of the investment.
BANK OBLIGATIONS. Bank obligations, or instruments secured by bank obligations,
include fixed, floating or variable rate CDs, letters of credit, time deposits,
bank notes and bankers' acceptances. Certificates of deposit are negotiable
certificates issued against funds deposited in a commercial bank for a definite
period of time and earning a specified return. Time deposits are non-negotiable
deposits that are held in a banking institution for a specified time at a stated
interest rate. Bankers' acceptances are negotiable drafts or bills of exchange
normally drawn by an importer or exporter to pay for specific merchandise. When
a bank "accepts" a bankers' acceptance, the bank, in effect, unconditionally
agrees to pay the face value of the instrument upon maturity.
Certain Funds may invest in obligations of U.S. banks, foreign branches of U.S.
banks, foreign branches of foreign banks, and U.S. branches of foreign banks
that have a federal or state charter to do business in the U.S. and are subject
to U.S. regulatory authorities. The Funds that are
46
permitted to invest in bank obligations may invest in dollar-denominated
certificates of deposit and bankers' acceptances of foreign and domestic banks
having total assets in excess of $1 billion, certificates of deposit of
federally insured savings and loan associations having total assets in excess of
$1 billion, or cash and time deposits with banks in the currency of any major
nation.
COMMERCIAL PAPER. Commercial paper typically refers to short-term obligations of
banks, corporations and other borrowers with maturities of up to 270 days. A
Fund may invest in domestic or foreign commercial paper. Investments in
commercial paper are generally limited to obligations rated Prime-1 or Prime-2
by Moody's or A-1 or A-2 by S&P(R) or, if unrated, issued by companies having an
outstanding debt issue currently rated Aaa or Aa by Moody's or AAA or AA by
S&P(R). Certain Funds also may invest in lower rated commercial paper to the
extent permitted by their policies on lower rated debt securities generally. See
"Description of Bond Ratings" for a for a more complete description of
commercial paper ratings.
DEFERRED INTEREST AND PAY-IN-KIND BONDS. Deferred interest and pay-in-kind bonds
are bonds issued at a discount that defer the payment of interest until a later
date or pay interest through the issuance of additional bonds, known as
pay-in-kind bonds. A Fund will accrue income on deferred interest bonds for tax
and accounting purposes. Similarly, a Fund will be deemed to receive interest
over the life of such bonds and be treated as if interest were paid on a current
basis for federal income tax purposes, although no cash interest payments are
received by the Fund until the cash payment date or until the bonds mature. This
accrued income from both deferred interest and pay-in-kind bonds must be
"distributed" to the insurance company shareholders each year, whether or not
such distributions are paid in cash. To the extent such distributions are paid
in cash, a Fund may be required to dispose of portfolio securities that it
otherwise would have continued to hold or to use other sources such as sales of
Fund shares. See "Lower-Rated Securities" above for more information about these
bonds.
MORTGAGE-BACKED SECURITIES. Mortgage-backed securities differ from conventional
bonds in that the principal is paid back over the life of the certificate rather
than at maturity. As a result, Funds invested in these securities will receive
monthly scheduled payments of interest as well as principal on their
investments. In addition, the Funds may receive unscheduled principal payments
representing prepayments on the underlying mortgages. When a Fund reinvests the
payments and any unscheduled prepayments of principal it receives, it may not be
able to purchase another security with a rate of interest that is as low as the
rate on the existing security. For this reason, mortgage-backed securities may
be less effective than other types of U.S. government securities as a means of
"locking in" long-term interest rates.
The market value of mortgage-backed securities, like other U.S. government
securities held by the Funds, will generally vary inversely with changes in
market interest rates, declining when interest rates rise and rising when
interest rates decline. However, mortgage-backed securities, while having
comparable risk of decline in value during periods of rising rates, may have
less potential for capital appreciation than other investments of comparable
maturities due to the likelihood of increased prepayments of mortgages as
interest rates decline. To the extent these securities are purchased at a
premium, mortgage foreclosures
47
and unscheduled principal prepayments may result in some loss of a Fund's
principal investment to the extent of the premium paid.
1. Adjustable rate mortgage securities (ARMS), like traditional mortgage
securities, are interests in pools of mortgage loans. The interest rates on the
mortgages underlying ARMS are reset periodically. The adjustable interest rate
feature of the mortgages underlying the mortgage securities in which the Funds
invest generally will act as a buffer to reduce sharp changes in a Fund's net
asset value in response to normal interest rate fluctuations. As the interest
rates are reset, the yields of the securities will gradually align themselves to
reflect changes in market rates so that their market value will remain
relatively stable compared to fixed-rate securities. As a result, a Fund's net
asset value should fluctuate less significantly than if the Fund invested in
more traditional long-term, fixed-rate securities. During periods of extreme
fluctuation in interest rates, however, a Fund's net asset value will fluctuate.
Because the interest rates on the mortgages underlying ARMS are reset
periodically, a Fund may participate in increases in interest rates resulting in
both higher current yields and lower price fluctuations. This is different from
fixed-rate mortgages, which generally decline in value during periods of rising
interest rates. A Fund, however, will not benefit from increases in interest
rates to the extent that interest rates exceed the maximum allowable annual or
lifetime reset limits (or "cap rates") for a particular mortgage security. Since
most mortgage securities held by the Funds will generally have annual reset
limits or caps of 100 to 200 basis points, short-term fluctuations in interest
rates above these levels could cause these mortgage securities to "cap out" and
behave more like long-term, fixed-rate debt securities. If prepayments of
principal are made on the underlying mortgages during periods of rising interest
rates, a Fund generally will be able to reinvest these amounts in securities
with a higher current rate of return.
During periods of rising interest rates, changes in the interest rates on
mortgages underlying ARMS lag behind changes in the market rate. This may result
in a lower net asset value until the interest rate resets to market rates. Thus,
you could suffer some principal loss if you sell your shares of a Fund before
the interest rates on the mortgages underlying the ARMS in the Fund's portfolio
reset to market rates. Also, a Fund's net asset value could vary to the extent
that current yields on mortgage-backed securities are different from market
yields during interim periods between coupon reset dates. A portion of the ARMS
in which the Funds may invest may not reset for up to five years.
During periods of declining interest rates, the interest rates may reset
downward, resulting in lower yields to a Fund. As a result, the value of ARMS is
unlikely to rise during periods of declining interest rates to the same extent
as the value of fixed-rate securities. As with other mortgage-backed securities,
declining interest rates may result in accelerated prepayments of mortgages, and
a Fund may have to reinvest the proceeds from the prepayments at the lower
prevailing interest rates.
For certain types of ARMS, the rate of amortization of principal, as well as
interest payments, changes in accordance with movements in a pre-specified,
published interest rate index. The amount of interest due to an ARMS holder is
calculated by adding a specified additional amount, the "margin," to the index,
subject to limitations or "caps" on the maximum and
48
minimum interest that is charged to the mortgagor during the life of the
mortgage or to maximum and minimum changes to that interest rate during a given
period.
Mortgage loan pools offering pass-through investments in addition to those
described above may be created in the future. The mortgages underlying these
securities may be alternative mortgage instruments, that is, mortgage
instruments whose principal or interest payments may vary or whose terms to
maturity may differ from customary long-term, fixed-rate mortgages. As new types
of mortgage securities are developed and offered to investors, a Fund may invest
in them if they are consistent with the Fund's goal, policies, and quality
standards.
2. Collateralized mortgage obligations (CMOs), real estate mortgage investment
conduits (REMICs), and multi-class pass-throughs are debt obligations that are
collateralized by mortgage loans or mortgage pass-through securities. These
obligations may be issued and guaranteed by U.S. government agencies or
instrumentalities or issued by certain financial institutions and other mortgage
lenders. CMOs and REMICs are debt instruments issued by special purpose entities
and are secured by pools of mortgages backed by residential and various types of
commercial properties. Multi-class pass-through securities are equity interests
in a trust composed of mortgage loans or other mortgage-backed securities.
CMOs are debt instruments that are collateralized by pools of mortgage loans
created by commercial banks, savings and loan institutions, private mortgage
insurance companies, mortgage bankers, and other issuers in the U.S. Principal
and interest on the underlying collateral are paid to the issuer of the CMOs to
make required payments on these securities. In effect, CMOs "pass-through" the
monthly payments made by individual borrowers on their mortgage loans. Timely
payment of interest and principal (but not market value) of these pools is
supported by various forms of insurance or guarantees issued by U.S. government
agencies, private issuers, and mortgage poolers; however, the obligations
themselves are not guaranteed.
A CMO is a mortgage-backed security that separates mortgage pools into short-,
medium-, and long-term components. Each component pays a fixed rate of interest
to security holders at regular intervals. These components enable an investor,
such as a Fund, to predict more accurately the pace at which principal is
returned.
CMOs and REMICS purchased by a Fund may be:
(1) collateralized by pools of mortgages in which each mortgage is
guaranteed as to payment of principal and interest by an
agency or instrumentality of the U.S. government; or
(2) collateralized by pools of mortgages in which payment of
principal and interest are guaranteed by the issuer, an entity
specifically created for this purpose, and the guarantee is
collateralized by U.S. government securities.
If the collateral securing the obligation is insufficient to make payment on the
obligation, a holder could sustain a loss. In addition, a Fund may buy CMOs
without insurance or guarantees
49
if, in the opinion of the manager, the sponsor is creditworthy. The ratings of
the CMOs will be consistent with the ratings criteria of the Fund. Prepayments
of the mortgages included in the mortgage pool may influence the yield of the
CMO. Prepayments usually increase when interest rates are decreasing, thereby
decreasing the life of the pool. Reinvestment of prepayments may be at a lower
rate than that on the original CMO. As a result, the value of CMOs decrease like
other debt obligations when interest rates rise, but when interest rates
decline, they may not increase as much as other debt obligations due to the
prepayment feature.
3. Resets The interest rates paid on ARMS, ARS, and CMOs generally are
readjusted at intervals of one year or less to an increment over some
predetermined interest rate index, although some securities in which the Funds
may invest may have intervals as long as five years. There are three main
categories of indices: those based on LIBOR, those based on U.S. Treasury
securities, and those derived from a calculated measure such as a cost of funds
index or a moving average of mortgage rates. Commonly used indices include:
. the one-, three-, and five-year constant-maturity Treasury rates;
. the three-month Treasury bill rate;
. the 180-day Treasury bill rate;
. rates on longer-term Treasury securities;
. the 11th District Federal Home Loan Bank Cost of Funds;
. the National Median Cost of Funds;
. the one-, three-, six-month, or one-year LIBOR;
. the prime rate of a specific bank; or
. commercial paper rates.
Some indices, such as the one-year constant-maturity Treasury rate, closely
mirror changes in market interest rate levels. Others, such as the 11th District
Federal Home Loan Bank Cost of Funds, tend to lag behind changes in market
interest rate levels and tend to be somewhat less volatile.
4. Caps and floors. The underlying mortgages that collateralize ARMS and CMOs
will frequently have caps and floors that limit the maximum amount by which the
loan rate to the borrower may change up or down (a) per reset or adjustment
interval and (b) over the life of the loan. Some residential mortgage loans
restrict periodic adjustments by limiting changes in the borrower's monthly
principal and interest payments rather than limiting interest rate changes.
These payment caps may result in negative amortization (an increase in the
principal due). In periods of rising interest rates, certain coupons may be
temporarily "capped out" resulting in declines in the prices of those securities
and, therefore, a negative affect on share price. Conversely, in periods of
declining interval rates, certain coupons may be temporarily "floored out"
resulting in an increase in the price of those securities and, therefore, a
positive effect on a Fund's share price.
5. Stripped mortgage securities are derivative multi-class mortgage securities.
The stripped mortgage securities in which a Fund may invest will only be issued
or guaranteed by the U.S. government, its agencies or instrumentalities, or
issued by private originators of, or investors in, mortgage loans, including
saving and loan associations, mortgagers, banks,
50
commercial banks, investment banks, and special purpose subsidiaries of any of
these. Stripped mortgage securities have greater market volatility than other
types of mortgage securities in which a Fund invests.
Stripped mortgage securities are usually structured with two classes, each
receiving different proportions of the interest and principal distributions on a
pool of mortgage assets. A common type of stripped mortgage security has one
class that receives some of the interest and most of the principal from the
mortgage assets, while the other class receives most of the interest and the
remainder of the principal. In the most extreme case, one class receives all of
the interest (the interest-only or "IO" class), while the other class receives
the entire principal (the principal-only or "PO" class). The yield to maturity
on an IO class is extremely sensitive not only to changes in prevailing interest
rates but also to the rate of principal payments (including prepayments) on the
underlying mortgage assets. A rapid rate of principal payments may have a
material adverse effect on the yield to maturity of any IO class held by a Fund.
If the underlying mortgage assets experience greater than anticipated
prepayments of principal, the Fund may fail to recoup its initial investment
fully, even if the securities are rated in the highest rating categories, AAA or
Aaa, by S&P(R) or Moody's, respectively.
Stripped mortgage securities are purchased and sold by institutional investors,
such as a Fund, through several investment banking firms acting as brokers or
dealers. These securities were only recently developed, and traditional trading
markets have not yet been established for all stripped mortgage securities.
Accordingly, some of these securities may be illiquid. The staff of the SEC has
indicated that only government-issued IO or PO securities that are backed by
fixed-rate mortgages may be deemed to be liquid. In addition, even with respect
to those securities, if procedures with respect to determining liquidity must be
established by a Fund's Board. The Board may, in the future, adopt procedures
that would permit a Fund to acquire, hold, and treat as liquid government-issued
IO and PO securities. At the present time, however, all such securities will
continue to be treated as illiquid and will, together with any other illiquid
investments, not exceed a Fund's limitation on illiquid securities. This
position may be changed in the future, without notice to shareholders, in
response to the SEC staff's continued reassessment of this matter, as well as to
changing market conditions.
6. Mortgage dollar rolls. In a mortgage dollar roll, a Fund sells
mortgage-backed securities for delivery in the current month and simultaneously
contracts to repurchase substantially similar (name, type, coupon, and maturity)
securities on a specified future date. During the period between the sale and
repurchase (the "roll period"), the Fund foregoes principal and interest paid on
the mortgage-backed securities. The Fund is compensated by the difference
between the current sales price and the lower forward price for the future
purchase (often referred to as the "drop"), as well as by the interest earned on
the cash proceeds of the initial sale.
A "covered roll" is a specific type of mortgage dollar roll for which there is
an offsetting cash position or a cash equivalent security position that matures
on or before the forward settlement date of the dollar roll transaction and is
maintained in a segregated account. A Fund will not enter into any dollar rolls
that are not covered rolls. The Fund could suffer a loss if the contracting
party fails to perform the future transaction and the Fund is therefore unable
to buy back the mortgage-backed securities it initially sold.
51
The Funds intend to enter into mortgage dollar rolls only with government
securities dealers recognized by the Federal Reserve Board or with member banks
of the Federal Reserve System. As a matter of non-fundamental policy, the Funds
do not consider the purchase and/or sale of a mortgage dollar roll to be a
borrowing.
ASSET-BACKED SECURITIES. Asset-backed securities, including adjustable-rate
asset-backed securities (which have interest rates that reset at periodic
intervals), are similar to mortgage-backed securities except that the underlying
assets may include receivables on home equity and credit card loans, and
automobile, mobile home, and recreational vehicle loans and leases. The issuer
intends to repay using the assets backing the securities (once collected).
Therefore, repayment depends largely on the cash-flows generated by the assets
backing the securities. Sometimes, the credit support for these securities is
limited to the underlying assets. Such assets are more likely than real estate
collateral to be inadequate to cover payments on these securities. In other
cases, it may be provided by a third party through a letter of credit or
insurance guarantee.
Asset-backed commercial paper is often backed by a pool of assets representing
the obligations of a number of different parties. To lessen the effect of
failures by obligators on these underlying assets to make payment, the
securities may contain elements of credit support. The credit support falls into
two categories: liquidity protection and protection against ultimate default on
the underlying assets. Liquidity protection refers to the provision of advances,
generally by the entity administering the pool of assets, to ensure that
scheduled payments on the underlying pool are made in a timely fashion.
Protection against ultimate default ensures payment on at least a portion of the
assets in the pool. This protection may be provided through guarantees,
insurance policies or letters of credit obtained from third parties, through
various means of structuring the transaction or through a combination of these
approaches. The degree of credit support provided on each issue is based
generally on historical information respecting the level of credit risk
associated with the payments. Delinquency or loss that exceeds the anticipated
amount could adversely impact the return on an investment in an asset-backed
security.
Asset-backed securities are issued in either a pass-through structure (similar
to a mortgage pass-through structure) or a pay-through structure (similar to a
CMO structure). There may be other types of asset-backed securities that are
developed in the future in which a Fund may invest. In general, collateral
supporting asset-backed securities has shorter maturities than mortgage loans
and historically has been less likely to experience substantial prepayment.
STRIPPED SECURITIES. Stripped securities are the separate income and principal
components of a debt security. Once the securities have been stripped, the
principal portion may be referred to as a zero coupon security or as a
"principal-only strip." Stripped securities do not make periodic payments of
interest prior to maturity and the stripping of the interest coupons causes them
to be offered at a discount from their face amount. This results in the security
being subject to greater fluctuations in response to changing interest rates
than interest-paying securities of similar maturities. Stripped securities
include: U.S. Treasury STRIPS, Stripped Government Securities, Stripped
Obligations of the Financing Corporation (FICO STRIPS), Stripped Corporate
Securities, and Stripped Eurodollar Obligations.
52
1. U.S. Treasury STRIPS (Separate Trading of Registered Interest and Principal
of Securities) are considered U.S. Treasury securities for purposes of a Fund's
investment policies. Their risks are similar to those of other U.S. government
securities, although they may be more volatile. The U.S. Treasury has
facilitated transfers of ownership of zero coupon securities by accounting
separately for the beneficial ownership of particular interest coupon and
principal payments on Treasury securities through the Federal Reserve book-entry
record-keeping system.
2. Stripped government securities are issued by the U.S. government and its
agencies and instrumentalities, by a variety of tax-exempt issuers (such as
state and local governments and their agencies and instrumentalities), and by
"mixed-ownership government corporations."
3. FICO STRIPS represent interests in securities issued by the Financing
Corporation (FICO). FICO is the financing vehicle for the recapitalization of
the Federal Savings and Loan Insurance Corporation (FSLIC). FICO STRIPS are not
backed by the full faith and credit of the U.S. government but are generally
treated as U.S. government agency securities.
4. Stripped corporate securities are zero coupon securities issued by domestic
corporations. They consist of corporate debt obligations without interest
coupons, interest coupons that have been stripped from corporate debt
obligations, and receipts and certificates for stripped debt obligations and
stripped coupons.
5. Stripped eurodollar obligations are stripped debt obligations denominated in
U.S. dollars that are issued by foreign issuers, often subsidiaries of domestic
corporations.
U.S. GOVERNMENT SECURITIES. U.S. government securities include: (1) U.S.
Treasury obligations with varying interest rates, maturities and dates of
issuance, such as U.S. Treasury bills (maturities of one year or less), U.S.
Treasury notes (original maturities of one to ten years) and U.S. Treasury bonds
(generally original maturities of greater than ten years); and (2) obligations
issued or guaranteed by U.S. government agencies and instrumentalities such as
the Government National Mortgage Association, the Export-Import Bank and the
Farmers Home Administration. Some of the Funds' investments will include
obligations that are supported by the full faith and credit of the U.S.
government. In the case of U.S. government securities that are not backed by the
full faith and credit of the U.S. government (e.g., obligations of the Federal
National Mortgage Association (FNMA) or a Federal Home Loan Bank), the Fund must
look principally to the agency issuing or guaranteeing the obligation for
ultimate repayment and may not be able to assert a claim against the U.S. itself
in the event the agency or instrumentality does not meet its commitments.
1. Government National Mortgage Association obligations (Ginnie Maes). The
Government National Mortgage Association's guarantee of payment of principal and
interest on Ginnie Maes is backed by the full faith and credit of the U.S.
government. The Government
53
National Mortgage Association may borrow U.S. Treasury funds to the extent
needed to make payments under its guarantee. Ginnie Mae yields (interest income
as a percentage of price) have historically exceeded the current yields on other
types of U.S. government securities with comparable maturities. The effects of
interest rate fluctuations and unpredictable prepayments of principal, however,
can greatly change realized yields. As with most bonds, in a period of rising
interest rates, the value of a Ginnie Mae will generally decline. In a period of
declining interest rates, it is more likely that mortgages contained in Ginnie
Mae pools will be prepaid, thus reducing the effective yield. This potential for
prepayment during periods of declining interest rates may reduce the general
upward price increases of Ginnie Maes as compared to the increases experienced
by noncallable debt securities over the same periods. In addition, any premium
paid on the purchase of a Ginnie Mae will be lost if the obligation is prepaid.
Of course, price changes of Ginnie Maes and other securities held by the Funds
will have a direct impact on the net asset value per share of the Funds.
2. Small Business Administration (SBA) securities are pools of loans to small
businesses that are guaranteed as to principal and interest by the SBA, and
supported by the full faith and credit of the U.S. government. SBA loans
generally have variable interest rates that are set at a premium above the prime
rate, and generally have no interest rate caps or floors. The terms on SBA loans
currently range from 7 to 25 years from the time they are issued. As with
mortgage-backed securities such as GNMAs, prepayments can greatly change
realized yields for SBA securities. While the prepayment rate of mortgage-backed
securities has generally been a function of market interest rates, the
prepayment rate of SBA securities has historically depended more on the purpose
and term of the loan and the rate of borrower default. Shorter-term SBA loans
have had the highest prepayment rates, particularly if the loans were for
working capital; long-term, real-estate backed SBA loans prepay much more
slowly. SBA securities are sometimes offered at a premium above their principal
amount, which increases the risks posed by prepayment.
U.S. TREASURY ROLLS. In "U.S. Treasury rolls," a Fund sells outstanding U.S.
Treasury securities and buys back "when-issued" U.S. Treasury securities of
slightly longer maturity for simultaneous settlement on the settlement date of
the "when-issued" U.S. Treasury security. Two potential advantages of this
strategy are (1) the Fund can regularly and incrementally adjust its weighted
average maturity of its portfolio securities (which otherwise would constantly
diminish with the passage of time); and (2) in a normal yield curve environment
(in which shorter maturities yield less than longer maturities), a gain in yield
to maturity can be obtained along with the desired extension.
During the period before the settlement date, the Fund continues to earn
interest on the securities it is selling. It does not earn interest on the
securities that it is purchasing until after the settlement date. The Fund could
suffer an opportunity loss if the counterparty to the roll failed to perform its
obligations on the settlement date, and if market conditions changed adversely.
The Fund intends, however, to enter into U.S. Treasury rolls only with
government securities dealers recognized by the Federal Reserve Board or with
member banks of the Federal Reserve System.
MUNICIPAL SECURITIES. Municipal securities are issued by state and local
governments, their agencies and authorities, as well as by the District of
Columbia and U.S. territories and
54
possessions, to borrow money for various public or private projects. The issuer
pays a fixed, floating or variable rate of interest, and must repay the amount
borrowed (the "principal) at maturity. Municipal securities generally pay
interest free from federal income tax.
ZERO COUPON BONDS. Zero coupon bonds are debt obligations that are issued at a
significant discount from the value set forth on the face of the bond. The
original discount approximates the total amount of interest the bonds will
accumulate and compounds over the period until maturity or the first interest
accumulation date at a rate of interest reflecting the market rate of the
security at the time of issuance. Although a zero coupon bond pays no interest
to its holder during its life, a Fund will be deemed to have received income on
such investments for tax and accounting purposes. That income is distributable
to shareholders even though no cash is received at the time of accrual, which
may require the liquidation of other portfolio securities to satisfy the Fund's
distribution obligations. Zero coupon bonds may include stripped securities as
noted above.
Zero coupon or deferred interest securities are debt securities that make no
periodic interest payments before maturity or a specified date when the
securities begin paying current interest (the "cash payment date), and therefore
are generally issued and traded at a discount from their face amount or par
value. The discount varies depending on the time remaining until maturity or the
cash payment date, as well as prevailing interest rates, liquidity of the
security, and the perceived credit quality of the issuer. The discount, in the
absence of financial difficulties of the issuer, typically decreases as the
final maturity or cash payment date approaches.
The value of zero coupon securities is generally more volatile than the value of
other fixed-income securities that pay interest periodically. Zero-coupon
securities are also likely to respond to changes in interest rates to a greater
degree than other fixed-income securities having similar maturities and credit
quality.
DERIVATIVE SECURITIES
IN General. In general, derivative securities are those securities whose values
are dependent upon the performance of one or more securities, indices or
currencies and include:
. adjustable rate mortgage securities;
. adjustable rate securities;
. collateralized mortgage obligations;
. convertible securities with enhanced yield features such as
PERCS, ACES, DECS, and PEPS;
. forward contracts;
. futures contracts;
. inverse floaters;
. mortgage pass-throughs, including multiclass pass-throughs,
stripped mortgage securities, and other asset-backed
securities;
. options;
. re-securitized government project loans;
. spreads and straddles;
55
. swaps;
. synthetic convertible securities; and
. uncovered mortgage dollar rolls.
Derivatives may be used for "hedging," which means that they may help manage
risks relating to interest rates, currency fluctuations and other market
factors. They also may be used to increase liquidity or to invest in a
particular stock or bond in a more efficient or less expensive way.
Futures contracts. Although futures contracts by their terms call for the actual
delivery or acquisition of securities, or the cash value of the index, in most
cases the contractual obligation is fulfilled before the date of the contract
without having to make or take delivery of the securities or cash. A contractual
obligation is offset by buying (or selling, as the case may be) on a commodities
exchange an identical financial futures contract calling for delivery in the
same month. This transaction, which is effected through a member of an exchange,
cancels the obligation to make or take delivery of the securities or cash. Since
all transactions in the futures market are made, offset or fulfilled through a
clearinghouse associated with the exchange on which the contracts are traded,
the Fund will incur brokerage fees when it buys or sells financial futures
contracts.
A "sale" of a futures contract means the acquisition of a contractual obligation
to deliver the securities called for by the contract at a specified price on a
specified date. A "purchase" of a futures contract means the acquisition of a
contractual obligation to acquire the securities called for by the contract at a
specified price on a specified date. The purpose of the acquisition or sale of a
futures contract is to attempt to protect the Fund from fluctuations in the
price of portfolio securities without actually buying or selling the underlying
security. Futures contracts have been designed by exchanges that have been
designated "contracts markets" by the Commodity Futures Trading Commission
(CFTC) and must be executed through a futures commission merchant, or brokerage
firm, that is a member of the relevant contract market. The exchanges guarantee
performance of the contracts as between the clearing members of the exchange.
A purchase or sale of a futures contract may result in losses in excess of the
amount invested. A Fund may not be able to properly hedge its securities where a
liquid secondary market is unavailable for the futures contract the Fund wishes
to close. In addition, there may be an imperfect correlation between movements
in the securities or foreign currency on which the futures or options contract
is based and movements in the securities or currency held by the Fund. Adverse
market movements could cause the Fund to lose up to its full investment in a
call option contract and/or to experience substantial losses on an investment in
a futures contract. There is also the risk of loss by the Fund of margin
deposits in the event of bankruptcy of a broker with whom the Fund has an open
position in a futures contract or option.
Although the manager believes that the use of futures contracts may benefit
certain Funds, if the manager's investment judgment about the general direction
of interest or currency exchange rates is incorrect, a Fund's overall
performance would be poorer than if it had not entered into any such contract.
For example, if a Fund has hedged against the possibility of an increase
56
in interest rates that would adversely affect the price of bonds held in its
portfolio and interest rates decrease instead, the Fund will lose part or all of
the benefit of the increased value of the bonds which it has hedged because it
will have offsetting losses in its futures positions. Similarly, if a Fund sells
a foreign currency futures contract and the U.S. dollar value of the currency
unexpectedly increases, the Fund will lose the beneficial effect of the increase
on the value of the security denominated in that currency. In addition, in such
situations, if a Fund has insufficient cash, it may have to sell bonds from its
portfolio to meet daily variation margin requirements. Sales of bonds may be,
but are not necessarily, at increased prices that reflect the rising market. A
Fund may have to sell securities at a time when it may be disadvantageous to do
so.
The ordinary spreads between prices in the cash and futures markets, due to
differences in the nature of those markets, are subject to distortions. First,
all participants in the futures market are subject to initial deposit and
variation margin requirements. Rather than meeting additional variation margin
requirements, investors may close futures contracts through offsetting
transactions that could distort the normal relationship between the cash and
futures markets. Second, the liquidity of the futures market depends on
participants entering into offsetting transactions rather than making or taking
delivery. To the extent participants decide to make or take delivery, liquidity
in the futures market could be reduced, thus producing distortion. Third, from
the point of view of speculators, the margin deposit requirements in the futures
market are less onerous than margin requirements in the securities market.
Therefore, increased participation by speculators in the futures market may
cause temporary price distortions. Due to the possibility of distortion, a
correct forecast of general interest rate trends by the manager may still not
result in a successful transaction.
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The 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. Once the daily limit has been
reached in a futures contract subject to the limit, 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 work to prevent the liquidation of
unfavorable positions. For example, futures prices have occasionally moved to
the daily limit for several consecutive trading days with little or no trading,
thereby preventing prompt liquidation of positions and subjecting some holders
of futures contracts to substantial losses.
The Funds that are authorized to engage in futures transactions intend to
purchase or sell futures only on exchanges or boards of trade where there
appears to be an active secondary market, but there is no assurance that a
liquid secondary market will exist for any particular contract or at any
particular time. In addition, many of the futures contracts available may be
relatively new instruments without a significant trading history. As a result,
there can be no assurance that an active secondary market will develop or
continue to exist. A Fund may not be able to achieve a perfect correlation
between its futures positions and portfolio positions in corporate fixed-income
securities because futures contracts based on these securities are not currently
available.
57
Futures contracts that are purchased on foreign exchanges may not be as liquid
as those purchased on CFTC-designated contract markets. In addition, foreign
futures contracts may be subject to varied regulatory oversight. The price of
any foreign futures contract and, therefore, the potential profit and loss
thereon, may be affected by any variance in the foreign exchange rate between
the time a particular order is placed and the time it is liquidated, offset or
exercised.
A Fund may enter into futures contracts on foreign currencies, interest rates,
or on debt securities that are backed by the full faith and credit of the U.S.
government, such as long-term U.S. Treasury bonds, Treasury notes, Government
National Mortgage Association modified pass-through mortgage-backed securities,
and three-month U.S. Treasury bills. A Fund also may enter into futures
contracts on corporate securities and non-U.S. government debt securities, but
such futures contracts are not currently available.
At the same time a futures contract is purchased or sold, the Fund must allocate
cash or securities as a deposit payment (initial deposit). Daily thereafter, the
futures contract is valued and the payment of "variation margin" may be required
since each day the Fund would provide or receive cash that reflects any decline
or increase in the contract's value. In addition, the Fund must maintain with
its custodian bank, to the extent required by the rules of the Securities and
Exchange Commission (SEC), assets in a segregated account to cover its
obligations with respect to such contract, which will consist of cash, cash
equivalents or high quality debt securities from its portfolio in an amount
equal to the market value of such futures contract or related option.
At the time of delivery of securities on the settlement date of a contract,
adjustments are made to recognize differences in value arising from the delivery
of securities with a different interest rate from that specified in the
contract. In some (but not many) cases, securities called for by a futures
contract may not have been issued when the contract was written.
A Fund will not engage in transactions in futures contracts for speculation.
Futures contracts will be used as a hedge against changes resulting from market
conditions in the values of its securities or securities that it intends to buy
or to attempt to protect a Fund from fluctuations in price of portfolio
securities without actually buying or selling the underlying security.
The CFTC and the various exchanges have established limits referred to as
"speculative position limits" on the maximum net long or net short position
which any person may hold or control in a particular futures contract. Trading
limits are also imposed on the maximum number of contracts that any person may
trade on a particular trading day. An exchange may order the liquidation of
positions found to be in violation of these limits and it may impose other
sanctions or restrictions. The Funds do not believe that these trading and
positions limits will have an adverse impact on the Funds' strategies for
hedging their securities.
1. Financial futures. Financial futures contracts are commodity contracts that
obligate the purchase or seller to take or make delivery of a specified quantity
of a financial instrument, such as a security, or the cash value of a securities
index during a specified future period at a specified price.
58
Although financial futures contracts by their terms call for the actual delivery
or acquisition of securities, or the cash value of the index, in most cases the
contractual obligation is fulfilled before the date of the contract without
having to make or take delivery of the securities or cash. The obligation to
make or take delivery is ended by buying (or selling, as the case may be) on an
exchange an identical financial futures contract calling for delivery in the
same month. All transactions in the futures market are made, offset or fulfilled
through a clearinghouse associated with the exchange on which the contracts are
traded. The Fund will incur brokerage fees when it buys or sells financial
futures.
2. Options on futures contracts. A Fund may purchase and write options on
futures contracts for hedging purposes only. The purchase of a call option on a
futures contract is similar in some respects to the purchase of a call option on
an individual security or currency. Depending on the price of the option
compared to either the price of the futures contract upon which it is based or
the price of the underlying securities or currency, the option may be less risky
than direct ownership of the futures contract or the underlying securities or
currency. As with the purchase of futures contracts, when a Fund is not fully
invested, it may purchase a call option on a futures contract to hedge against a
market advance due to declining interest rates or appreciation in the value of a
foreign currency against the U.S. dollar.
If a Fund writes a call option on a futures contract and the futures price at
expiration of the option is below the exercise price, the Fund will retain the
full amount of the option premium, which may provide a partial hedge against any
decline that may have occurred in the value of the Fund's holdings. If the
futures price at expiration of the option is higher than the exercise price, the
Fund will retain the full amount of the option premium, which may provide a
partial hedge against any increase in the price of securities that the Fund
intends to purchase. If a put or call option a Fund has written is exercised,
the Fund will incur a loss that will be reduced by the amount of the premium it
received. Depending on the degree of correlation between changes in the value of
its portfolio securities and changes in the value of its futures positions, a
Fund's losses from existing options on futures may be affected by changes in the
value of its portfolio securities.
The amount of risk a Fund assumes when it purchases an option on a futures
contract is the premium paid for the option plus related transaction costs. In
writing options on futures, a Fund's loss is potentially unlimited and may
exceed the amount of the premium received. Also, a Fund may not be able to
properly hedge its securities or close out option contract positions where a
liquid secondary market is unavailable for the option the Fund wishes to close.
In addition to the correlation risks discussed above, the purchase of an option
also entails the risk that changes in the value of the underlying futures
contract will not be fully reflected in the value of the option purchased.
Unless a Fund has a stated policy otherwise, it will purchase a put option on a
futures contract only to hedge the Fund's portfolio against the risk of rising
interest rates or the decline in the value of securities denominated in a
foreign currency.
3. Bond index futures and options on such futures. A Fund may buy and sell
futures contracts based on an index of debt securities and options on such
futures contracts to the extent they currently exist and, in the future, may be
developed. The Fund also reserves the right to conduct futures and options
transactions based on an index that may be developed in the future to
59
correlate with price movements in certain categories of debt securities. A
Fund's investment strategy in employing futures contracts based on an index of
debt securities may be similar to that used by it in other financial futures
transactions. A Fund also may buy and write put and call options on such index
futures and enter into closing transactions with respect to such options.
4. Stock index futures and options on such futures. A Fund may buy and sell
stock index futures contracts and options on stock index futures contracts that
trade on domestic exchanges and, to the extent such contracts have been approved
by the CFTC for sale to customers in the U.S., on foreign exchanges. In general,
these Funds may invest in index futures for hedging purposes. Open futures
contracts are valued on a daily basis and a Fund may be obligated to provide or
receive cash reflecting any decline or increase in the contracts value.
Stock index futures contracts obligate the seller to deliver (and the buyer to
take) an amount of cash equal to a specific dollar amount times the difference
between the value of a specific stock index at the close of the last trading day
of the contract and the price at which the agreement is made. No physical
delivery of the underlying stocks in the index is made.
A Fund may sell stock index futures contracts in anticipation of or during a
market decline to attempt to offset a possible decrease in market value of its
equity securities. When a Fund is not fully invested in stocks and anticipates a
significant market advance, it may buy stock index futures in order to gain
rapid market exposure that may in part or entirely offset increases in the cost
of common stocks that it intends to buy.
Options on stock index futures. To hedge against risks of market price
fluctuations, a Fund may buy and sell call and put options on stock index
futures. The need to hedge against these risks will depend on the extent of
diversification of the Fund's common stock portfolio and the sensitivity of such
investments to factors influencing the stock market as a whole.
Call and put options on stock index futures are similar to options on securities
except that, rather than the right to buy or sell stock at a specified price,
options on stock index futures give the holder the right to receive cash. Upon
exercise of the option, the writer of the option will deliver to the holder of
the option the accumulated balance in the writer's futures margin account
representing the amount that the market price of the futures contract, at
exercise, exceeds, in the case of a call, or is less than, in the case of a put,
the exercise price of the option on the futures contract. If an option is
exercised on the last trading day before the expiration date of the option, the
settlement will be made entirely in cash equal to the difference between the
exercise price of the option and the closing price of the futures contract on
the expiration date.
5. Future developments. The Funds may take advantage of opportunities in the
area of options, futures, and options in futures and any other derivative
investments that are not presently contemplated for use by the Funds or that are
not currently available but which may be developed, to the extent such
opportunities are consistent with the Funds' investment goals and legally
permissible for the Funds.
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Forward conversions. In a forward conversion, a Fund buys securities and writes
call options and buys put options on such securities. By purchasing puts, a Fund
protects the underlying security from depreciation in value. By selling calls on
the same security, a Fund receives premiums which may offset part or all of the
cost of purchasing the puts while foregoing the opportunity for appreciation in
the value of the underlying security. A Fund will not exercise a put it has
purchased while a call option on the same security is outstanding.
Although it is generally intended that the exercise price of put and call
options would be identical, situations might occur in which some option
positions are acquired with different exercise prices. Therefore, a Fund's
return may depend in part on movements in the price of the underlying security.
FORWARD CONTRACTS. Forward contracts are not traded on contract markets
regulated by the CFTC or by the SEC. The ability of a Fund to use forward
contracts could be restricted to the extent that Congress authorizes the CFTC or
the SEC to regulate such transactions. Forward contracts are traded through
financial institutions acting as market makers. Also, a hedging strategy may not
be successful if the Fund is unable to sell its forward contract, currency
futures contract, or option on a foreign currency with the market maker from
which it bought the security.
OPTIONS. A stock option is a contract that provides the holder the right to buy
or sell shares of the stock at a fixed price, within a specified period of time.
An option on a stock index is a contract that allows the buyer of the option the
right to receive from the seller cash, in an amount equal to the difference
between the index's closing price and the option's exercise price. A futures
contract is an obligation to buy or sell a specified security or currency at a
set price on a specified future date. A stock index futures contract is an
agreement to take or make delivery of an amount of cash based on the difference
between the value of the index at the beginning and end of the contract period.
Unless otherwise noted in a Fund's policies, the value of the underlying
securities on which options may be written at any one time will not exceed 15%
of the Fund's assets. Nor will a Fund purchase put or call options if the
aggregate premium paid for such options would exceed 5% of its assets at the
time of purchase. Unless otherwise noted in a Fund's policies, none of the Funds
permitted to purchase contracts will purchase or sell futures contracts or
options on futures contracts if, immediately thereafter, the aggregate amount of
initial margin deposits on all the
61
futures positions of the Fund and the premiums paid on options on futures
contracts would exceed 5% of the market value of the Fund's total assets.
A Fund may write (sell) covered put and call options and buy put and call
options on securities listed on a national securities exchange and in the
over-the-counter (OTC) market. Additionally, a Fund may "close out" options it
has entered into.
A call option gives the option holder the right to buy the underlying security
from the option writer at the option exercise price at any time prior to the
expiration of the option. A put option gives the option holder the right to sell
the underlying security to the option writer at the option exercise price at any
time prior to the expiration of the option. The OTC market is the
dealer-to-dealer market in securities, in this case, option securities in which
the Fund may buy or sell.
A Fund's options investments involve certain risks. The effectiveness of an
options strategy depends on the degree to which price movements in the
underlying securities correlate with price movements in the relevant portion of
the Fund's portfolio. In addition, the Fund bears the risk that the prices of
its portfolio securities will not move in the same amount as the option it has
purchased, or that there may be a negative correlation that would result in a
loss on both the securities and the option. If the manager is not successful in
using options in managing a Fund's investments, the Fund's performance will be
worse than if the manager did not employ such strategies.
When trading options on foreign exchanges or in the over-the-counter market,
many of the protections afforded to exchange participants will not be available.
For example, there are no daily price fluctuation limits, and adverse market
movements could therefore continue to an unlimited extent over a period of time.
The purchaser of an option can lose the amount of the premium plus related
transaction costs. Moreover, a Fund as an option writer could lose amounts
substantially in excess of its initial investment, due to the margin and
collateral requirements associated with option writing.
Options on securities traded on national securities exchanges are within the
jurisdiction of the SEC, as are other securities traded on such exchanges. As a
result, many of the protections provided to traders on organized exchanges will
be available with respect to such transactions. In particular, all option
positions entered into on a national securities exchange are cleared and
guaranteed by the Options Clearing Corporation, thereby reducing the risk of
counterparty default. Further, a liquid secondary market in options traded on a
national securities exchange may be more readily available than in the
over-the-counter market, potentially permitting a Fund to liquidate open
positions at a profit prior to exercise or expiration, or to limit losses in the
event of adverse market movements.
Although a Fund 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 may
exist and a Fund may have difficulty effecting closing transactions in
particular options. Therefore, the Fund would have to exercise its options in
order to realize any profit and would incur transaction costs upon the sale of
underlying securities
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where a buyer exercises put or call options. If a Fund as a covered call option
writer is unable to effect a closing purchase transaction in a secondary market,
it will not be able to sell the underlying security until the option expires or
it delivers the underlying security upon exercise. There is no assurance that
higher than anticipated trading activity or other unforeseen events might not,
at times, render certain of the facilities of the Options Clearing Corporation
inadequate, and thereby result in the institution by an exchange of special
procedures which may interfere with the timely execution of customers' orders.
A Fund also may use "collars." A"collar" position combines a long put option
(the right of the Fund to sell a specific security within a specified period)
with a short call option (the right of the counterparty to buy the same
security) in a single instrument. The Fund's right to sell the security is
typically set at a price that is below the counterparty's right to buy the
security. Thus, the combined position "collars" the performance of the
underlying security, providing protection from depreciation below the price
specified in the put option, and allowing for participation in any appreciation
up to the price specified by the call option.
1. Buying call and put options on securities. The premium paid by the buyer of
an option will reflect, among other things, the relationship of the exercise
price to the market price and the volatility of the underlying security, the
remaining term of the option, supply and demand and interest rates.
A Fund may buy call options on securities that it intends to buy in order to
limit the risk of a substantial increase in the market price of the security
before the purchase is effected. A Fund also may buy call options on securities
held in its portfolio and on which it has written call options.
As the holder of a put option, a Fund has the right to sell the underlying
security at the exercise price at any time during the option period. A Fund may
enter into closing sale transactions with respect to put options, exercise them
or permit them to expire.
A Fund may buy a put option on an underlying security or currency owned by the
Fund (a protective put) as a hedging technique in order to protect against an
anticipated decline in the market value of the security. Such hedge protection
is provided only during the life of the put option when a Fund, as the holder of
the put option, is able to sell the underlying security at the put exercise
price, regardless of any decline in the underlying security's market price or
currency's exchange value. For example, a put option may be purchased in order
to protect unrealized appreciation of a security when the manager deems it
desirable to continue to hold the security or currency because of tax
considerations. The premium paid for the put option and any transaction costs
would reduce any short-term capital gain that may be available for distribution
when the security is eventually sold.
A Fund also may buy put options at a time when it does not own the underlying
security. By buying put options on a security it does not own, the Fund seeks to
benefit from a decline in the market price of the underlying security. If the
put option is not sold when it has remaining value, and if the market price of
the underlying security remains equal to or greater than the exercise price
during the life of the put option, the Fund will lose its entire investment in
the put option.
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In order for the purchase of a put option to be profitable, the market price of
the underlying security must decline sufficiently below the exercise price to
cover the premium and transaction costs, unless the put option is sold in a
closing sale transaction.
2. Writing covered call and put options on securities. A Fund may write options
to generate additional income and to hedge its portfolio against market or
exchange rate movements. The writer of covered calls gives up the potential for
capital appreciation above the exercise price of the option should the
underlying stock rise in value. If the value of the underlying stock rises above
the exercise price of the call option, the security may be "called away" and a
Fund required to sell shares of the stock at the exercise price. A Fund will
realize a gain or loss from the sale of the underlying security depending on
whether the exercise price is greater or less than the purchase price of the
stock. Any gain will be increased by the amount of the premium received from the
sale of the call; any loss will be decreased by the amount of the premium
received. If a covered call option expires unexercised, a Fund will realize a
gain in the amount of the premium received. If, however, the stock price
decreases, the hedging benefit of the covered call option is limited to the
amount of the premium received.
A call option written by a Fund is "covered" if a Fund:
(a) owns the underlying security that is subject to the call; or
(b) has an absolute and immediate right to acquire that security
without additional cash consideration (or for additional cash
consideration held in a segregated account by its custodian
bank) upon conversion or exchange of other securities held in
its portfolio.
A call option is also covered if a Fund holds a call on the same security and in
the same principal amount as the call written where the exercise price of the
call held:
(a) is equal to or less than the exercise price of the call
written; or
(b) is greater than the exercise price of the call written if the
difference in exercise prices is maintained by a Fund in cash
and marketable securities.
Options may be written in connection with "buy-and-write" transactions; that is,
a Fund may purchase a security and then write a call option against that
security. The exercise price of the call will depend upon the expected price
movement of the underlying security. The exercise price of a call option may be
below (in-the-money), equal to (at-the-money), or above (out-of-the-money) the
current value of the underlying security at the time the option is written.
When a Fund writes a covered call option, the underlying securities that are
subject to the call will be held in a segregated account (or escrow) with the
Fund's custodian. It will be unable to sell the underlying securities that are
subject to the call until it either effects a closing transaction with respect
to the call, or otherwise satisfies the conditions for release of the underlying
securities from escrow, as may be imposed by the broker through which the call
is effected. In addition, if the broker fails to timely issue instructions to
the Fund's custodian to permit the release of the underlying security when the
escrow is no longer required, the Fund may be unable to sell the securities when
it desires to do so.
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The writer of covered puts retains the risk of loss should the underlying
security decline in value. If the value of the underlying stock declines below
the exercise price of the put option, the security may be "put to" a Fund and
the Fund required to buy the stock at the exercise price. A Fund will incur an
unrealized loss to the extent that the current market value of the underlying
security is less than the exercise price of the put option. However, the loss
will be offset at least in part by the premium received from the sale of the
put. If a put option written by a Fund expires unexercised, the Fund will
realize a gain in the amount of the premium received.
A put option written by the Fund is "covered" if the Fund maintains cash and
marketable securities with a value equal to the exercise price in a segregated
account with its custodian bank. A put option is also covered if the Fund holds
a put on the same security and in the same principal amount as the put written
where the exercise price of the put held is equal to or greater than the
exercise price of the put written.
The writer of an option may have no control over when the underlying securities
must be sold, in the case of a call option, or purchased, in the case of a put
option, since the writer may be assigned an exercise notice at any time prior to
the termination of the obligation. Whether or not an option expires unexercised,
the writer retains the amount of the premium. This amount may, in the case of a
covered call option, be offset by a decline in the market value of the
underlying security during the option period. If a call option is exercised, the
writer experiences a profit or loss from the sale of the underlying security. If
a put option is exercised, the writer must fulfill the obligation to buy the
underlying security at the exercise price, which will usually exceed the market
value of the underlying security at that time.
If the writer of an option wants to terminate its obligation, the writer may
effect a "closing purchase transaction" by buying an option of the same series
as the option previously written. The effect of the purchase is that the
clearing corporation will cancel the writer's position. However, a writer may
not effect a closing purchase transaction after being notified of the exercise
of an option. Likewise, the holder of an option may liquidate its position by
effecting a "closing sale transaction" by selling an option of the same series
as the option previously purchased. There is no guarantee that either a closing
purchase or a closing sale transaction may be made at the time desired by a
Fund.
Effecting a closing transaction in the case of a written call option allows the
Fund to write another call option in the underlying security with a different
exercise price, expiration date or both. In the case of a written put option, a
closing transaction allows the Fund to write another covered put option.
Effecting a closing transaction also allows the cash or proceeds from the sale
of any securities subject to the option to be used for other Fund investments.
If the Fund wants to sell a particular security from its portfolio on which it
has written a call option, it will effect a closing transaction prior to or at
the same time as the sale of the security.
A Fund will realize a profit from a closing transaction if the price of the
transaction is less than the premium received from writing the option or is more
than the premium paid to buy the option. Likewise, a Fund will realize a loss
from a closing transaction if the price of the transaction is more than the
premium received from writing the option. Increases in the market price of a
call option will generally reflect increases in the market
65
price of the underlying security. As a result, any loss resulting from the
repurchase of a call option is likely to be offset in whole or in part by
appreciation of the underlying security owned by the Fund.
3. Options on stock indices. A Fund also may buy and sell both call and put
options on stock indices in order to hedge against the risk of market or
industry-wide stock price fluctuations or to increase income to the Fund. Call
and put options on stock indices are similar to options on securities except
that, rather than the right to buy or sell stock at a specified price, options
on a stock index give the holder the right to receive, upon exercise of the
option, an amount of cash if the closing level of the underlying stock index is
greater (or less, in the case of puts) than the exercise price of the option.
This amount of cash is equal to the difference between the closing price of the
index and the exercise price of the option expressed in dollars multiplied by a
specified number. Thus, unlike stock options, all settlements are in cash, and
gain or loss depends on the price movements in the stock market generally (or in
a particular industry or segment of the market) rather than price movements in
individual stock.
When a Fund writes an option on a stock index, the Fund may cover the option by
owning securities whose price changes, in the opinion of the manager, are
expected to be similar to those of the index, or in such other manner as may be
in accordance with the rules of the exchange on which the option is traded and
applicable laws and regulations. The Funds also may cover by establishing a
segregated account containing cash or marketable securities with its custodian
bank in an amount at least equal to the market value of the underlying stock
index. The Fund will maintain the account while the option is open or it will
otherwise cover the transaction.
A Fund's ability to effectively use options on stock indices depends on the
degree to which price movements in the underlying index or underlying securities
correlate with price movements in the relevant portion of the Fund's portfolio.
Inasmuch as these securities will not duplicate the components of any index, the
correlation will not be perfect. Consequently, a Fund bears the risk that the
prices of the securities underlying the option will not move in the same amount
as the option. It is also possible that there may be a negative correlation
between the index and the hedged securities that would result in a loss on both
the securities and the instrument. Accordingly, successful use by a Fund of
options on stock indices, will be subject to the manager's ability to predict
correctly movements in the direction of the securities markets generally or of a
particular segment. This requires different skills and techniques than
predicting changes in the price of individual stocks.
Positions in stock index options may be closed out only on an exchange that
provides a secondary market. There can be no assurance that a liquid secondary
market will exist for any particular stock index option at any specific time.
Thus, it may not be possible to close an option position. The inability to close
options positions could have an adverse impact on the Fund's performance.
4. Over-the-counter (OTC) options. Like exchange traded options, OTC options
give the holder the right to buy, in the case of OTC call options, or sell, in
the case of OTC put options, an underlying security from or to the writer at a
stated exercise price. OTC options, however, differ from exchange traded options
in certain material respects.
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OTC options are arranged directly with dealers and not with a clearing
corporation. Thus, there is a risk of non-performance by the dealer. Because
there is no exchange, pricing is typically done based on information from market
makers. OTC options are available for a greater variety of securities and in a
wider range of expiration dates and exercise prices, however, than exchange
traded options and the writer of an OTC option is paid the premium in advance by
the dealer.
There can be no assurance that a continuous liquid secondary market will exist
for any particular OTC option at any specific time. A Fund may be able to
realize the value of an OTC option it has purchased only by exercising it or
entering into a closing sale transaction with the dealer that issued it. A Fund
may suffer a loss if it is not able to exercise or sell its position on a timely
basis. When a Fund writes an OTC option, it generally can close out that option
prior to its expiration only by entering into a closing purchase transaction
with the dealer with which the Fund originally wrote the option. If a Fund as a
covered call option writer is unable to effect a closing purchase transaction in
a secondary market, it will not be able to sell the underlying security until
the option expires or it delivers the underlying security upon exercise.
The Funds understand the current position of the staff of the SEC to be that
purchased OTC options are illiquid securities and that the assets used to cover
the sale of an OTC option are considered illiquid. The Funds and the manager
disagree with this position. Nevertheless, pending a change in the staff's
position, the Funds will treat OTC options and "cover" assets as subject to a
Fund's limitation on illiquid securities.
5. Spread and straddle options transactions. In "spread" transactions, a Fund
buys and writes a put or buys and writes a call on the same underlying security
with the options having different exercise prices and/or expiration dates. In
"straddles," a Fund purchases or writes combinations of put and call options on
the same security. When a Fund engages in spread and straddle transactions, it
seeks to profit from differences in the option premiums paid and received and in
the market prices of the related options positions when they are closed out or
sold. Because these transactions require a Fund to buy and/or write more than
one option simultaneously, the Fund's ability to enter into such transactions
and to liquidate its positions when necessary or deemed advisable may be more
limited than if the Fund was to buy or sell a single option. Similarly, costs
incurred by a Fund in connection with these transactions will in many cases be
greater than if the Fund was to buy or sell a single option.
SWAP AGREEMENTS. A Fund may enter into swap agreements for the purpose of
attempting to obtain a particular desired return at a lower cost to the Fund
than if the Fund had invested directly in a security that yielded or produced
that desired return. These instruments also may be used for tax and/or cash
management purposes. Swap agreements are two-party contracts entered into
primarily by institutional investors for periods ranging from a few weeks to
more than one year (swap transaction). In a standard swap transaction, two
parties agree to exchange the returns (or differentials in rates of return)
earned or realized on particular predetermined investments or instruments. The
gross returns to be exchanged or "swapped" between the parties are calculated
with respect to a "notional amount," i.e., the return on or increase in value of
a particular dollar amount invested in a particular security, or at a particular
interest rate, in a
67
particular foreign currency, or in a "basket" of securities representing a
particular index. The notional amount of the swap agreement is only a fictive
basis on which to calculate the obligations that the parties to a swap agreement
have agreed to exchange. A Fund's obligations (or rights) under a swap agreement
will generally be equal only to the net amount to be paid or received under the
agreement based on the relative values of the positions held by each party to
the agreement. A Fund's obligations under a swap agreement will be accrued daily
(offset against any amounts owing to the Fund) and any accrued but unpaid net
amounts owed to a swap counterparty will be covered by the maintenance of a
segregated account consisting of cash, U.S government securities, or high grade
debt obligations, to limit any potential leveraging of the Fund's portfolio.
Whether a Fund's use of swap agreements will be successful in furthering its
investment objective will depend on the ability of the manager correctly to
spredict whether certain types of investments are likely to produce greater
returns than other investments. Because they are two-party contracts and may
have terms of greater than seven days, swap agreements may be considered to be
illiquid. Moreover, a Fund bears the risk of loss of the amount expected to be
received under a swap agreement in the event of the default or bankruptcy of a
swap agreement counterparty. The manager will cause a Fund to enter into swap
agreements only with counterparties that would be eligible for consideration as
repurchase agreement counterparties under the Fund's repurchase agreement
guidelines. Certain positions adopted by the Internal Revenue Service may limit
a Fund's ability to use swap agreements in a desired tax strategy. The swap
market is a relatively new market and is largely unregulated. It is possible
that developments in the swap market and the laws relating to swaps, including
potential government regulation, could adversely effect a Fund's ability to
terminate existing swap agreements, to realize amounts to be received under such
agreements, or to enter into swap agreements, or could have adverse tax
consequences.
1. Interest rate swaps. An interest rate swap is an agreement between two
parties to exchange sets of cash flows over a period in the future. Most
corporate and government bonds pay fixed coupons, and are exposed to the risk of
rising interest rates. Swapping fixed payments for floating payments, an
interest rate swap is a vehicle to hedge interest rate risk.
An example of an interest rate swap is an exchange between one obligation that
has an interest rate fixed to maturity with another that has an interest rate
that changes with changes in a designated benchmark, such as the London
Interbank Offered Rate (LIBOR), prime, commercial paper, or other benchmarks.
The obligations to make repayment of principal on the underlying securities are
not transferred. Similarly, the right to receive such payments is not
transferred. These transactions generally require the participation of an
intermediary, frequently a bank. The entity holding the fixed rate obligation
will transfer the obligation to the intermediary, and the entity will then be
obligated to pay to the intermediary a floating rate of interest, generally
including a fractional percentage as a commission for the intermediary. The
intermediary also makes arrangements with a second entity that has a
floating-rate obligation that substantially mirrors the obligation desired by
the first entity. In return for assuming a fixed obligation, the second entity
will pay the intermediary all sums that the intermediary pays on behalf of the
first entity, plus an arrangement fee and other agreed upon fees.
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Interest rate swaps permit the party seeking a floating rate obligation the
opportunity to acquire the obligation at a lower rate than is directly available
in the credit market, while permitting the party desiring a fixed rate
obligation the opportunity to acquire a fixed rate obligation, also frequently
at a price lower than is available in the capital markets. The success of the
transaction depends in large part on the availability of fixed rate obligations
at a low enough coupon rate to cover the cost involved.
Certain Funds intend to participate in interest rate swaps involving obligations
held in a Fund's portfolio on which it is receiving payments of principal and
interest. A Fund might do this, for example, in order to gain or reduce its
exposure to fixed interest rate payments under certain market conditions. To the
extent, a Fund does not own the underlying obligation, however, the Fund will
maintain, in a segregated account with its custodian bank, cash or marketable
securities with an aggregate value equal to the amount of the Fund's outstanding
swap obligation.
A Fund will only enter into interest rate swaps on a net basis, which means that
the Fund will receive or pay, as the case may be, only the net amount of the two
payments. Interest rate swaps do not involve the delivery of securities, other
underlying assets or principal. Accordingly, a Fund's risk of loss with respect
to interest rate swaps is limited to the net amount of interest payments that
the Fund must make. If the other party to an interest rate swap defaults, a
Fund's risk of loss consists of the net amount of interest payments that the
Fund is entitled to receive.
DIVERSIFICATION
Each Fund, except the Global Health Care, Global Income, Value, Strategic Income
and Technology Funds, will operate as a diversified fund under federal
securities law. Each diversified Fund may not, with respect to 75% of its total
assets, purchase the securities of any one issuer (except U.S. government
securities) if (a) more than 5% of the value of the Fund's assets would be
invested in such issuer, or (b) hold more than 10% of any or all classes of the
securities of any one issuer or, in the case of the S&P 500 Index, Asset
Strategy, Developing Markets, International Securities, Rising Dividends, Small
Cap and Aggressive Growth Funds, the Fund would hold more than 10% of the
outstanding voting securities of such issuer.
In addition, each diversified Fund intends to diversify its investments to meet
the requirements under federal tax laws relating to regulated investment
companies and variable contracts issued by insurance companies.
A Fund's investments in U.S. government securities are not subject to these
limitations. In the case of Funds investing in obligations of U.S. government
agencies or instrumentalities, each agency or instrumentality is treated as a
separate issuer for purposes of the above rules.
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FOREIGN CURRENCY TECHNIQUES AND HEDGING
The Funds typically enter into forward currency exchange contracts to protect
against declines in the value of a Fund's portfolio securities and the income on
these securities. A Fund will normally conduct its foreign currency exchange
transactions either on a spot (i.e., cash) basis at the spot rate prevailing in
the foreign currency exchange market, or through entering into forward contracts
to purchase or sell foreign currencies. Successful use of forward contracts,
currency futures contracts and options on foreign currencies depends on the
manager's ability to properly predict movements in the foreign currency markets.
There may be an imperfect correlation between movements in the foreign currency
on which a forward contract, currency futures contract, or option on a foreign
currency is based and movements in the foreign currency. The Funds may, but do
not presently intend to, enter into other transactions, or use other techniques.
FORWARD CURRENCY EXCHANGE CONTRACTS. The Funds use forward currency exchange
contracts in an effort to minimize the risk of adverse changes in the
relationship between currencies or to enhance income. A forward contract
involves an obligation to buy or sell a specific currency at a future date,
which may be any fixed number of days from the date of the contract agreed upon
by the parties, at a price set at the time of the contract. These contracts are
traded in the interbank market conducted directly between currency traders
(usually large commercial banks).
A Fund may either accept or make delivery of the currency specified at the
maturity of a forward contract or, prior to maturity, enter into a closing
transaction involving the purchase or sale of an offsetting contract. Closing
transactions with respect to forward contracts are usually effected with the
currency trader who is a party to the original forward contract.
A Fund may construct an investment position by combining a debt security
denominated in one currency with a forward contract calling for the exchange of
that currency for another currency. The investment position is not itself a
security but is a combined position (i.e., a debt security coupled with a
forward contract) that is intended to be similar in overall performance to a
debt security denominated in the currency purchased.
A Fund may enter into a forward contract, for example, when it enters into a
contract for the purchase or sale of a security denominated in a foreign
currency in order to "lock in" the U.S. dollar price of that security by buying
the amount of foreign currency needed to settle the transaction. Thus, for
example, when a Fund believes that a foreign currency may suffer a substantial
decline against the U.S. dollar, it may enter into a forward contract to sell an
amount of that foreign currency approximating the value of some or all of the
Fund's portfolio securities denominated in such foreign currency. Similarly,
when a Fund believes that the U.S. dollar may suffer a substantial decline
against a foreign currency, it may enter into a forward contract to buy that
foreign currency for a fixed dollar amount. A Fund also may purchase and sell
forward contracts for non-hedging purposes when the manager anticipates that the
foreign currency will appreciate or depreciate in value but securities
denominated in that currency do not present attractive investment opportunities
and are held in a Fund.
70
A Fund sets aside or segregates sufficient cash, cash equivalents, or readily
marketable debt securities held by its custodian bank as deposits for
commitments created by open forward contracts. The Fund will cover any
commitments under these contracts to sell currency by owning or acquiring the
underlying currency (or an absolute right to acquire such currency). The
segregated account will be marked-to-market daily. The ability of a Fund to
enter into forward contracts is limited only to the extent forward contracts
would, in the opinion of the manager, impede portfolio management or the ability
of the Fund to honor redemption requests.
Forward contracts may limit potential gain from a positive change in the
relationship between the U.S. dollar and foreign currencies or between foreign
currencies. Unanticipated changes in currency exchange rates also may result in
poorer overall performance for the Fund than if it had not entered into such
contracts.
The Funds generally will not enter into a forward contract with a term of
greater than one year.
If a Fund retains a portfolio security and enters into a closing transaction,
the Fund will have a gain or a loss to the extent that the forward contract
prices have increased or decreased. If a Fund enters into a closing transaction,
it may subsequently enter into a new forward contract to sell the foreign
currency. If forward prices decline between the date that a Fund enters into a
forward contract for the sale of a foreign currency and the date it enters into
an offsetting contract for the purchase of the foreign currency, the Fund will
realize a gain. If forward prices increase, a Fund will suffer a loss.
The purchase and sale of exchange-traded foreign currency options are subject to
the risks of the availability of a liquid secondary market, as well as the risks
of adverse market movements, possible intervention by governmental authorities,
and the effects of other political and economic events.
CURRENCY RATE SWAPS. A currency rate swap is the transfer between two
counterparties of their respective rights to receive payments in specified
currencies.
Currency swaps usually involve the delivery of the entire principal value of one
designated currency in exchange for the other designated currency. Therefore, a
Fund could lose the entire principal value of a currency swap if the other party
defaults.
The use of interest rate and currency swaps is a highly specialized activity
that involves investment techniques and risks different from those associated
with ordinary portfolio securities transactions. If the managers are incorrect
in their forecasts of market values, interest rates and currency exchange rates,
the investment performance of a Fund would be less favorable than it would have
been if this investment technique were not used.
CURRENCY FUTURES CONTRACTS. Currency futures contracts are traded on regulated
commodity exchanges, including non-U.S. exchanges. A currency futures contract
is a standardized contract for the future delivery of a specified amount of
currency at a future date at a price set at the time of the contract. A Fund may
use currency futures contracts to hedge
71
against anticipated future changes in exchange rates which otherwise might
adversely affect the value of the Fund's portfolio securities or adversely
affect the prices of securities that a Fund intends to purchase at a later date.
A Fund may either accept or make delivery of the currency specified at the
maturity of a currency futures contract or, prior to maturity, enter into a
closing transaction involving the purchase or sale of an offsetting contract.
Closing transactions with respect to currency futures contracts are effected on
the exchange on which the contract was entered into (or on a linked exchange).
OPTIONS ON FOREIGN CURRENCIES. A Fund may buy and write put and call options on
foreign currencies (traded on U.S. and foreign exchanges or over-the-counter)
for hedging purposes to protect against declines in the U.S. dollar value of
foreign portfolio securities and against increases in the U.S. dollar cost of
foreign securities or other assets to be acquired. As in the case of other kinds
of options, however, the writing of an option on foreign currency will
constitute only a partial hedge, up to the amount of the premium received. A
Fund could be required to buy or sell foreign currencies at disadvantageous
exchange rates, thereby incurring losses. The purchase of an option on foreign
currency may constitute an effective hedge against fluctuations in exchange
rates although, in the event of rate movements adverse to a Fund's position, the
Fund may lose the entire amount of the premium plus related transaction costs.
FOREIGN SECURITIES AND INVESTMENTS
IN GENERAL. Funds may invest in foreign securities, provided the investments are
consistent with their objectives and comply with their concentration and
diversification policies. The Funds may buy the securities of foreign issuers
directly in foreign markets, both in developed and developing countries. The
securities of foreign issuers may be denominated in foreign currency. The Funds
also may buy foreign securities that are traded in the U.S. Investments in
foreign securities may offer potential benefits not available from investments
solely in securities of domestic issuers or dollar-denominated securities. These
benefits may include the opportunity to invest in foreign issuers that appear,
in the opinion of the manager, to offer:
. a better outlook for long-term capital appreciation or current
earnings than investments in domestic issuers;
. an opportunity to invest in foreign nations whose economic
policies or business cycles are different from those of the
U.S.; and,
. the opportunity to reduce fluctuations in portfolio value by
taking advantage of foreign securities markets that do not
necessarily move in a manner parallel to U.S. markets.
Investments in foreign securities where delivery takes place outside the U.S.
will be made in compliance with any applicable U.S. and foreign currency
restrictions and tax and other laws limiting the amount and types of foreign
investments. A Fund could experience investment losses if there are changes of:
. governmental administrations;
72
. economic or monetary policies in the U.S. or abroad;
. circumstances in dealings between nations; or
. currency convertibility or exchange rates.
The value of foreign (and U.S.) securities is affected by general economic
conditions and individual company and industry earnings prospects. While foreign
securities may offer significant opportunities for gain, they also involve
additional risks that can increase the potential for losses in a Fund. These
risks can be significantly greater for investments in emerging markets.
Investments in Depositary Receipts also involve some or all of the risks
described below.
The political, economic, and social structures of some countries in which a Fund
invests may be less stable and more volatile than those in the U.S. The risks of
investing in these countries include the possibility of the imposition of
exchange controls, expropriation, restrictions on removal of currency or other
assets, nationalization of assets, and punitive taxes.
There may be less publicly available information about foreign companies or
governments compared to the reports and ratings published about U.S. companies
and available information about public entities in the U.S. Certain countries'
financial markets and services are less developed than those in the U.S. or
other major economies. As a result, they may not have uniform accounting,
auditing, and financial reporting standards and may have less government
supervision of financial markets. A Fund, therefore, may encounter difficulty in
obtaining market quotations for purposes of valuing its portfolio and
calculating its net asset value. Foreign securities markets may have
substantially lower trading volumes than U.S. markets, resulting in less
liquidity and more volatility than experienced in the U.S. Transaction costs
(the costs associates with buying and selling securities) on foreign securities
markets, including those for custodial services are generally higher than in the
U.S. The settlement practices may be cumbersome and result in delays that may
affect portfolio liquidity. A Fund may have greater difficulty voting proxies,
exercising shareholder rights, pursuing legal remedies, and obtaining judgments
with respect to foreign investments in foreign courts than with respect to
domestic issuers in U.S. courts.
Investments in securities of issuers in foreign nations also may be affected by
cessation of trading on national exchanges, expropriation, nationalization, or
confiscatory taxation, withholding, and other foreign taxes on income or other
amounts, foreign exchange controls (which may include suspension of the ability
to transfer currency from a given country), default in foreign government
securities, political or social instability, or diplomatic developments.
Expropriation of assets refers to the possibility that a country's laws will
prohibit the return to the U.S. of any monies which a Fund has invested in the
country. Confiscatory taxation refers to the possibility that a foreign country
will adopt a tax law which has the effect of requiring the Fund to pay
significant amounts, if not all, of the value of the Fund's investment to the
foreign country's taxing authority. Diplomatic developments means that all
communications and other official governmental relations between the country and
the United States could be severed. This may occur as a result of certain
actions occurring within a foreign country, such as significant civil rights
violations, or because of the actions of the United States during a time of
crisis in the particular country. As a result of such diplomatic developments,
U.S. investors' money in the
73
particular country, including that of the Funds, could be abandoned with no way
to recover the money.
A Fund's investments in foreign securities may increase the risks with respect
to the liquidity of the Fund's portfolio. This could inhibit the Fund's ability
to meet a large number of shareholder redemption requests in the event of
economic or political turmoil in a country in which the Fund has a substantial
portion of its assets invested or deterioration in relations between the U.S.
and the foreign country.
Through the Funds' flexible policy, management endeavors to avoid unfavorable
consequences and to take advantage of favorable developments in particular
nations where, from time to time, it places the Funds' investments. The exercise
of this flexible policy may include decisions to purchase securities with
substantial risk characteristics and other decisions such as changing the
emphasis on investments from one nation to another and from one type of security
to another. Some of these decisions may later prove profitable and others may
not. No assurance can be given that profits, if any, will exceed losses.
The Board considers the degree of risk involved through the holding of portfolio
securities in domestic and foreign securities depositories. However, in the
absence of willful misfeasance, bad faith, or gross negligence on the part of
the Funds' manager, any losses resulting from the holding of the Funds'
portfolio securities in foreign countries and/or with securities depositories
will be at the risk of the shareholders. No assurance can be given that the
Board's appraisal of the risks will always be correct or that such exchange
control restrictions or political acts of foreign governments might not occur.
CURRENCY CONSIDERATIONS. If a Fund holds securities denominated in foreign
currencies, changes in foreign currency exchange rates will affect the value of
what the Funds owns and its share price. In addition, changes in foreign
currency exchange rates will affect a Fund's income and distributions to
shareholders. Some countries in which the Funds may invest also may have fixed
or managed currencies that are not free-floating against the U.S. dollar.
Certain currencies may not be internationally traded. To the extent that the
manager intends to hedge currency risk in certain Funds, the Funds endeavor to
buy and sell foreign currencies on as favorable a basis as practicable. Some
price spread in currency exchange (to cover service charges) may be incurred,
particularly when a Fund changes investments from one country to another or when
proceeds of the sale of shares in U.S. dollars are used for the purchase of
securities in foreign countries. Some countries may adopt policies that would
prevent the Funds from transferring cash out of the country or withhold portions
of interest and dividends at the source.
Certain currencies have experienced a steady devaluation relative to the U.S.
dollar. Any devaluations in the currencies in which a Fund's portfolio
securities are denominated may have a detrimental impact on the Fund. Where the
exchange rate for a currency declines materially after a Fund's income has been
accrued and translated into U.S. dollars, a Fund may need to redeem portfolio
securities to make required distributions. Similarly, if an exchange rate
declines between the time a Fund incurs expenses in U.S. dollars and the time
such expenses are paid, the
74
Fund will have to convert a greater amount of the currency into U.S. dollars in
order to pay the expenses.
Euro On January 1, 1999, the European Economic and Monetary Union (EMU)
introduced a new single currency called the euro. By July 1, 2002, the euro,
which will be implemented in stages, is schedule to have replaced the national
currencies of certain member countries, including: Austria, Belgium, Finland,
France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and
Spain.
The exchange rate of the currencies of each of these countries has been fixed to
the euro. The euro trades on currency exchanges and is available for non-cash
transaction. The participating countries currently issue sovereign debt
exclusively in euro. By July 1, 2002, euro-denominated bills and coins will
replace the bills and coins of the above countries.
The European Central Bank has control over each country's monetary policies.
Therefore, the participating countries no longer control their own monetary
policies by directing independent interest rates for their currencies. The
national governments of the participating countries, however, have retained the
authority to set tax policies and public debt levels.
The change to the euro as a single currency is relatively new and untested. It
is not possible to predict the impact of the euro on currency values or on the
business or financial condition of European countries and issuers, and issuers
in other regions, whose securities the Fund may hold, or the impact, if any, on
Fund performance. In the first six months of the euro's existence, the exchange
rates of the euro versus many of the world's major currencies steadily declined.
In this environment, U.S. and other foreign investors experienced erosion of
their investment returns on their euro-denominated securities. The transition
and the elimination of currency risk among EMU countries may change the economic
environment and behavior of investors, particularly in European markets.
While the implementation of the euro could have a negative effect on the Fund,
the Fund's manager and its affiliated service providers are taking steps they
believe are reasonably designed to address the euro issue.
EMERGING MARKETS. Each Fund that invests in emerging market securities may use a
slightly different definition of emerging market countries. Emerging market
countries generally include countries that are generally considered low or
middle income countries by the International Bank for Reconstruction and
Development (commonly known as the World Bank) or the International Finance
Corporation.
As many developing countries restructure their existing bank debt and economic
conditions improve, these obligations have become available and may offer the
Funds the potential for current U.S. dollar income. Such instruments are not
traded on any exchange. However, the managers believe there may be a market for
such securities either in multi-national companies wishing to purchase such
assets at a discount for further investment or from the issuing governments that
may decide to redeem their obligations at a discount.
75
Investments in companies domiciled or operating in emerging countries may be
subject to potentially higher risks, making these investments more volatile,
than investments in developed countries. These risks include (i) less social,
political and economic stability; (ii) the risk that the small size of the
markets for such securities and the low or nonexistent volume of trading may
result in a lack of liquidity and in greater price volatility; (iii) the
existence of certain national policies which may restrict each Fund's investment
opportunities, including restrictions on investment in issuers or industries
deemed sensitive to national interests; (iv) foreign taxation; (v) the absence
of developed legal structures governing private or foreign investment or
allowing for judicial redress for injury to private property; (vi) the absence,
until recently in many developing countries, of a capital market structure or
market-oriented economy; and (vii) the possibility that recent favorable
economic developments in some emerging countries may be slowed or reversed by
unanticipated political or social events in such countries.
In addition, many countries in which the Funds may invest have experienced
substantial, and in some periods extremely high, rates of inflation for many
years. Inflation and rapid fluctuations in inflation rates have had and may
continue to have negative effects on the economies and securities markets of
certain countries. Moreover, the economies of some emerging countries may differ
favorably or unfavorably from the U.S. economy in such respects as growth of
gross domestic product, rate of inflation, currency depreciation, capital
reinvestment, resource self-sufficiency and balance of payments position.
Investments in emerging countries may involve increased risks of
nationalization, expropriation and confiscatory taxation. For example, the
governments of a number of Eastern European countries expropriated large amounts
of private property in the past, in many cases without adequate compensation,
and there can be no assurance that such expropriation will not occur in the
future. In the event of expropriation, each Fund could lose a substantial
portion of any investments it has made in the affected countries. Further, no
accounting standards exist in certain emerging countries. Finally, even though
the currencies of some emerging countries, such as certain Eastern European
countries may be convertible into U.S. dollars, the conversion rates may be
artificial to the actual market values and may be adverse to a Funds'
shareholders.
Repatriation, that is, the return to an investor's homeland, of investment
income, capital and proceeds of sales by foreign investors may require
governmental registration or approval in some developing countries. Delays in or
a refusal to grant any required governmental registration or approval for such
repatriation could adversely affect the Funds. Further, the economies of
emerging countries generally are heavily dependent upon international trade and,
accordingly, have been and may continue to be adversely affected by trade
barriers, exchange controls, managed adjustments in relative currency values and
other protectionist measures imposed or negotiated by the countries with which
they trade. These economies also have been and may continue to be adversely
affected by economic conditions in the countries with which they trade.
Russian securities involve all of the risks of emerging markets. No Fund will
invest more than 5% of its assets in Russian securities.
76
Investing in Russian companies involves a high degree of risk and special
considerations not typically associated with investing in the U.S. securities
markets, and should be considered highly speculative. Such risks include,
together with Russia's continuing political and economic instability and the
slow-paced development of its market economy, the following:
(a) delays in settling portfolio transactions and the risk of loss arising
out of Russia's unsophisticated system of share registration and
custody;
(b) the risk that it may be impossible or more difficult than in other
countries to obtain and/or enforce a court-ordered judgment;
(c) the pervasiveness of corruption, insider-trading, and crime in the
Russian economic system;
(d) currency exchange rate volatility and the lack of available currency
hedging instruments such as the techniques discussed under "Currency
techniques and hedging" in this SAI;
(e) higher rates of inflation (including the risk of social unrest
associated with periods of hyper-inflation);
(f) controls on foreign investment and local practices disfavoring foreign
investors, and limitations on repatriation of invested capital, profits
and dividends;
(g) the risk that the government of Russia or other executive or
legislative bodies may decide not to continue to support the economic
reform programs implemented since the dissolution of the Soviet Union
and could follow radically different political and/or economic policies
to the detriment of investors, including non-market-oriented policies
such as the support of certain industries at the expense of other
sectors or investors, a return to the centrally planned economy that
existed prior to the dissolution of the Soviet Union, or the
nationalization of privatized enterprises;
(h) the risks of investing in securities with substantially less liquidity
and in issuers having significantly smaller market capitalizations,
when compared to securities and issuers in more developed markets;
(i) the difficulties associated in obtaining accurate market valuations of
many Russian securities, based partly on the limited amount of publicly
available information;
(j) the financial condition of Russian companies, including large amounts
of inter-company debt which may create a payments crisis on a national
scale;
(k) dependency on exports and the corresponding importance of international
trade;
(l) the risk that the Russian tax system will not be reformed to prevent
inconsistent, retroactive and/or exorbitant taxation or, in the
alternative, the risk that a reformed tax system may result in the
inconsistent and unpredictable enforcement of the new tax laws;
(m) possible difficulty in identifying a purchaser of securities held by
the Funds due to the underdeveloped nature of the securities markets;
(n) the possibility that legislation could restrict the levels of foreign
investment in certain industries, thereby limiting the number of
investment opportunities in Russia;
(o) the risk that legislation would confer to Russian courts the exclusive
jurisdiction to resolve disputes between foreign investors and the
Russian government, instead of bringing such disputes before an
internationally-accepted third-country arbitrator; and
(p) the difficulty in obtaining information about the financial condition
of Russian issuers, in light of the different disclosure and accounting
standards applicable to Russian companies.
There is little long-term historical data on Russian securities markets because
they are relatively new and a substantial proportion of securities transactions
in Russia is privately negotiated
77
outside of stock exchanges. Because of the recent formation of the securities
markets as well as the underdeveloped state of the banking and
telecommunications systems, settlement, clearing and registration of securities
transactions are subject to significant risks. Ownership of shares (except where
shares are held through depositories that meet the requirements of the
Investment Company Act of 1940 (1940 Act) is defined according to entries in the
company's share register and normally evidenced by extracts from the register or
by formal share certificates. However, there is no central registration system
for shareholders and these services are carried out by the companies themselves
or by registrars located throughout Russia. These registrars are not necessarily
subject to effective state supervision nor are they licensed with any
governmental entity and it is possible for the Funds to lose their registration
through fraud, negligence or even mere oversight. While each Fund will endeavor
to ensure that its interest continues to be appropriately recorded by either
itself or through a custodian or other agent inspecting the share register and
by obtaining extracts of share registers through regular confirmations, these
extracts have no legal enforceability and it is possible that subsequent illegal
amendment or other fraudulent act may deprive the Funds of their ownership
rights or improperly dilute their interests. In addition, while applicable
Russian regulations impose liability on registrars for losses resulting from
their errors, it may be difficult for the Funds to enforce any rights they may
have against the registrar or issuer of the securities in the event of loss of
share registration. Furthermore, although a Russian public enterprise with more
than 500 shareholders is required by law to contract out the maintenance of its
shareholder register to an independent entity that meets certain criteria, in
practice this regulation has not always been strictly enforced. Because of this
lack of independence, management of a company may be able to exert considerable
influence over who can purchase and sell the company's shares by illegally
instructing the registrar to refuse to record transactions in the share
register. In addition, so-called "financial-industrial groups" have emerged in
recent years that seek to deter outside investors from interfering in the
management of companies they control. These practices may prevent the Funds from
investing in the securities of certain Russian companies deemed suitable by the
manager. Further, this also could cause a delay in the sale of Russian company
securities by a Fund if a potential purchaser is deemed unsuitable, which may
expose the Fund to potential loss on the investment.
FOREIGN DEBT. Certain Funds may invest in debt securities issued by foreign
corporations, governments and their instrumentalities, and by supranational
entities. A supranational entity is an entity designated or supported by the
national government of one or more countries to promote economic reconstruction
or development. Examples of supranational entities include the World Bank, the
European Development Bank and the Asian Development Bank.
Many debt obligations of foreign issuers, and especially emerging markets
issuers, are either (i) rated below investment grade or (ii) not rated by U.S.
rating agencies so that their selection depends on the managers' individual
analysis.
DEPOSITARY RECEIPTS. American Depositary Receipts (ADRs) are typically issued by
a U.S. bank or trust company and evidence ownership of underlying securities
issued by a foreign corporation. European Depositary Receipts (EDRs) and Global
Depositary Receipts (GDRs) are typically issued by foreign banks or trust
companies, although they may be issued by U.S. banks or trust companies, and
evidence ownership of underlying securities issued by either a foreign or a U.S.
corporation. Generally, depositary receipts in registered form are designed for
use in the
78
U.S. securities market and depositary receipts in bearer form are designed for
use in securities markets outside the U.S. Depositary receipts may not
necessarily be denominated in the same currency as the underlying securities
into which they may be converted.
Depositary receipts may be issued by sponsored or unsponsored programs. In
sponsored programs, an issuer has made arrangements to have its securities
traded in the form of depositary receipts. In unsponsored programs, the issuer
may not be directly involved in the creation of the program. Although regulatory
requirements with respect to sponsored and unsponsored programs are generally
similar, in some cases it may be easier to obtain financial information from an
issuer that has participated in the creation of a sponsored program.
Accordingly, there may be less information available regarding issuers of
securities underlying unsponsored programs, and there may not be a correlation
between the availability of such information and the market value of the
depositary receipts. To the extent a Fund acquires depositary receipts through
banks that do not have a contractual relationship with the foreign issuer of the
security underlying the depository receipt to issue and service such depository
receipts, there are may be an increased possibility that the Fund would not
become aware of and be able to respond to corporate actions such as stock splits
or rights offerings involving the foreign issuer in a timely manner.
Depositary receipts also involve the same risks as direct investments in foreign
securities, as discussed below. For purposes of a Fund's investment policies,
the Fund will consider its investments in depositary receipts to be investments
in the underlying securities.
LIMITATIONS. Certain countries do not permit direct investments. Some countries,
such as South Korea, Chile and India, have authorized the formation of
closed-end investment companies to facilitate indirect foreign investment in
their capital markets. In order to gain investment access to these countries, a
Fund may invest up to 10% of its assets in shares of such closed-end investment
companies and up to 5% of its assets in any one closed-end investment company as
long as the investment does not represent more than 3% of the voting stock of
the acquired investment company. If a Fund acquires shares of closed-end
investment companies, shareholders would bear both their share of expenses of
the Fund (including management and advisory fees) and, indirectly, the expenses
of such closed-end investment companies.
ILLIQUID SECURITIES
Each Fund may invest in securities that cannot be offered to the public for sale
without first being registered under the Securities Act of 1933 (restricted
securities), or in other securities which, in the opinion of the Board, may be
illiquid. See "Fundamental Investment Restrictions" for more information about
the Fund's policies with respect to illiquid securities.
Illiquid securities are generally securities that cannot be sold within seven
days in the normal course of business at approximately the amount at which a
Fund has valued them. Reduced liquidity in the secondary market for certain
securities may make it more difficult for the Fund to obtain market quotations
based on actual trades for purposes of valuing the Fund's portfolio.
Securities acquired outside of the U.S. and that are publicly traded in the U.S.
or on a foreign
79
securities market are not considered to be illiquid assets if: (a) the Fund
reasonably believes it can readily dispose of the securities for cash in the
U.S. or foreign market, or (b) current market quotations are readily available.
The Funds will not acquire the securities of foreign issuers outside of the U.S.
if, at the time of acquisition, the Funds have reason to believe that they could
not resell the securities in a public trading market.
Subject to each Fund's percentage limitation on illiquid securities, the Board
has authorized each Fund to invest in restricted securities where such
investment is consistent with each Fund's investment goal. The Board has
authorized these securities to be considered liquid to the extent the investment
manager determines on a daily basis that there is a liquid institutional or
other market for such securities - for example, restricted securities which may
be freely transferred among qualified institutional buyers pursuant to Rule 144A
under the Securities Act of 1933, as amended, and for which a liquid
institutional market has developed. The Fund's Board will review any
determination by the manager to treat a restricted security as a liquid security
on an ongoing basis, including the managers' assessment of current trading
activity and the availability of reliable price information. In spite of the
managers' determinations in this regard, the Board will remain responsible for
such determinations and will consider appropriate action, consistent with a
Fund's goals and policies, if the security should become illiquid after
purchase. In determining whether a restricted security is properly considered a
liquid security, the investment manager and the Board will take into account,
among others, the following factors: (i) the frequency of trades and quotes for
the security; (ii) the number of dealers willing to buy or sell the security and
the number of other potential buyers; (iii) dealer undertakings to make a market
in the security; and (iv) the nature of the security and the nature of the
marketplace trades (e.g., the time needed to dispose of the security, the method
of soliciting offers, and the mechanics of transfer). To the extent a Fund
invests in restricted securities that are deemed liquid, the general level of
illiquidity in the Fund may be increased if qualified institutional buyers
become uninterested in buying these securities or the market for these
securities contracts.
LOANS OF PORTFOLIO SECURITIES
To generate additional income, each Fund may lend certain of its portfolio
securities to qualified banks and broker-dealers. For each loan, the borrower
must maintain with the Fund's custodian collateral (consisting of any
combination of cash, securities issued by the U.S. government and its agencies
and instrumentalities, or irrevocable letters of credit) with a value at least
equal to 102% of the current market value of the loaned securities. The Fund
retains all or a portion of the interest received on investment of the cash
collateral or receives a fee from the borrower. The Fund also continues to
receive any distributions paid on the loaned securities. The Fund may terminate
a loan at any time and obtain the return of the securities loaned within the
normal settlement period for the security involved.
Where voting rights with respect to the loaned securities pass with the lending
of the securities, the managers intend to call the loaned securities to vote
proxies, or to use other practicable and legally enforceable means to obtain
voting rights, when the managers have knowledge that, in their opinion, a
material event affecting the loaned securities will occur or the managers
otherwise believe it necessary to vote. As with other extensions of credit,
there are risks of delay in
80
recovery or even loss of rights in collateral in the event of default or
insolvency of the borrower. Each Fund will loan its securities only to parties
who meet creditworthiness standards approved by the Fund's Board, i.e., banks or
broker-dealers that the manager has determined present no serious risk of
becoming involved in bankruptcy proceedings within the time frame contemplated
by the loan.
PORTFOLIO TURNOVER
Portfolio turnover is a measure of how frequently a portfolio's securities are
bought and sold. As required by the SEC, annual portfolio turnover is calculated
generally as the dollar value of the lesser of a portfolio's purchases or sales
of portfolio securities during a given year, divided by the monthly average
value of the portfolio's securities during that year (excluding securities whose
maturity or expiration at the time of acquisition were less than one year). For
example, a portfolio reporting a 100% portfolio turnover rate would have
purchased and sold securities worth as much as the monthly average value of its
portfolio securities during the year. The portfolio turnover rates for each Fund
are disclosed in the section entitled "Financial Highlights" of the Fund's
prospectus. Except for certain Funds noted in the prospectus, the Funds
generally do not expect their annual turnover rates to exceed 100%. It is not
possible to estimate future turnover rates with complete accuracy, however,
because so many variable factors are beyond the control of the managers.
Portfolio turnover is affected by factors within and outside the control of the
Fund and its managers. The investment outlook for the type of securities in
which each Fund invests may change as a result of unexpected developments in
national or international securities markets, or in economic, monetary or
political relationships. High market volatility may result in a manager using a
more active trading strategy than it might have otherwise pursued. Each Fund's
manager will consider the economic effects of portfolio turnover but generally
will not treat portfolio turnover as a limiting factor in making investment
decisions. Investment decisions affecting turnover may include changes in
investment policies, including changes in management personnel, as well as
individual portfolio transactions.
Moreover, turnover may be increased by certain factors wholly outside the
control of the managers. For example, during periods of rapidly declining
interest rates, such as the U.S. experienced in 1991 through 1993, the rate of
mortgage prepayments may increase rapidly. When this happens, "sales" of
portfolio securities are increased due to the return of principal to Funds that
invest in mortgage securities. Similarly, the rate of bond calls by issuers of
fixed income securities may increase as interest rates decline. This causes
"sales" of called bonds by Funds that invest in fixed-income securities and the
subsequent purchase of replacement investments. In other periods, increased
merger and acquisition activity, or increased rates of bankruptcy or default,
may create involuntary transactions for portfolios that hold affected stocks and
bonds, especially high-yield bonds. Global or international fixed income
securities funds may have higher turnover rates due to the rebalancing of the
portfolio to keep interest rate risk and country allocations at desired levels.
In addition, redemptions or exchanges by investors may require the liquidation
of portfolio securities. Changes in particular portfolio holdings may be made
whenever it is considered that a
81
security is no longer the most appropriate investment for a Fund, or that
another security appears to have a relatively greater opportunity, and will be
made without regard to the length of time a security has been held.
Higher portfolio turnover rates generally increase transaction costs, which are
portfolio expenses, but would not create taxable capital gains for investors
because of the tax-deferred status of variable annuity and life insurance
investments.
REAL ESTATE
IN GENERAL. Although none of the Funds invest directly in real estate, through
an investment in a company in the real estate sector, a Fund could ultimately
own real estate directly as a result of a default on debt securities it may own.
Receipt of rental income or income from the disposition of real property by a
Fund may adversely affect its ability to retain its tax status as a regulated
investment company.
REAL ESTATE INVESTMENT TRUSTS (REITs). REITs typically invest directly in real
estate and/or in mortgages and loans collateralized by real estate. "Equity"
REITs are real estate companies that own and manage income-producing properties
such as apartments, hotels, shopping centers or office buildings. The income,
primarily rent from these properties, is generally passed on to investors in the
form of dividends. These companies provide experienced property management and
generally concentrate on a specific geographic region or property type.
"Mortgage" REITs make loans to commercial real estate developers and earn income
from interest payments.
REPURCHASE AGREEMENTS
IN GENERAL. The Funds generally will have a portion of their assets in cash or
cash equivalents for a variety of reasons, including waiting for a special
investment opportunity or taking a defensive position. To earn income on this
portion of its assets, a Fund may enter into repurchase agreements. Under a
repurchase agreement, the Fund agrees to buy securities guaranteed as to payment
of principal and interest by the U.S. government or its agencies from a
qualified bank or broker-dealer and then to sell the securities back to the bank
or broker-dealer after a short period of time (generally, less than seven days)
at a higher price. The bank or broker-dealer must transfer to the Fund's
custodian securities with an initial market value of at least 102% of the dollar
amount invested by the Fund in each repurchase agreement. The manager will
monitor the value of such securities daily to determine that the value equals or
exceeds the repurchase price.
Repurchase agreements may involve risks in the event of default or insolvency of
the bank or broker-dealer, including possible delays or restrictions upon the
Fund's ability to sell the underlying securities. The use of repurchase
agreements involves certain risks. For example, if the other party to the
agreement defaults on its obligation to repurchase the underlying security at a
time when the value of the security has declined, a Fund may incur a loss upon
disposition of the security. If the other party to the agreement becomes
insolvent and subject to liquidation or reorganization under the bankruptcy code
or other laws, a court may determine that the underlying security is collateral
for a loan by a Fund not within the control of a Fund, and
82
therefore the realization by the Fund on the collateral may be automatically
stayed. Finally, it is possible that the Fund may not be able to substantiate
its interest in the underlying security and may be deemed an unsecured creditor
of the other party to the agreement. While the manager acknowledges these risks,
it is expected that if repurchase agreements are otherwise deemed useful to a
Fund, these risks can be controlled through careful monitoring procedures. A
Fund will enter into repurchase agreements only with parties who meet certain
creditworthiness standards, i.e., banks or broker-dealers that the manager has
determined present no serious risk of becoming involved in bankruptcy
proceedings within the time frame contemplated by the repurchase transaction.
REVERSE REPURCHASE AGREEMENTS. Reverse repurchase agreements are considered
borrowings by the Funds and as such are subject to the investment limitations
discussed under "Fundamental Investment Restrictions." These transactions may
increase the volatility of a Fund's income or net asset value. The Fund carries
the risk that any securities purchased with the proceeds of the transaction will
depreciate or not generate enough income to cover the Fund's obligations under
the reverse repurchase transaction. These transactions also increase the
interest and operating expenses of a Fund. Reverse repurchase agreements are the
opposite of repurchase agreements but involve similar mechanics and risks. A
Fund sells securities to a bank or dealer and agrees to repurchase them at a
mutually agreed price and date. Cash or liquid high-grade debt securities having
an initial market value, including accrued interest, equal to at least 102% of
the dollar amount sold by the Fund are segregated, i.e., set aside, as
collateral and marked-to-market daily to maintain coverage of at least 100%.
Reverse repurchase agreements involve the risk that the market value of the
securities retained by a Fund may decline below the price of the securities the
Fund has sold but is obligated to repurchase under the agreement. A default by
the purchaser might cause the Fund to experience a loss or delay in the
liquidation costs. The Funds intend to enter into reverse repurchase agreements
with domestic or foreign banks or securities dealers. The manager will evaluate
the creditworthiness of these entities prior to engaging in such transactions
and it will conduct these activities under the general supervision of the Board.
SECTOR
By having significant investments in one or more sectors from time to time, a
Fund carries greater risk of adverse developments in a sector than a fund that
invests more broadly.
TECHNOLOGY COMPANIES. Technology company stocks can be subject to abrupt or
erratic price movements and have been volatile in price, especially over the
short term, due to the rapid pace of product change and development affecting
such companies. Technology companies are subject to significant competitive
pressures, such as new market entrants, aggressive pricing, and tight profit
margins. Prices of technology company stocks often change collectively without
regard to the merits of individual companies.
1. Electronic technology and technology services companies. These companies also
face the risks that new services, equipment or technologies will not be accepted
by consumers and businesses or will rapidly become obsolete. These factors can
affect the profitability of technology companies and, as a result, their value.
In addition, because many Internet-related
83
companies are in the emerging stage of development, they are particularly
vulnerable to these risks.
2. Biotechnology and health technology companies. These companies may be
affected by government regulatory requirements, regulatory approval for new
drugs and medical products, patent considerations, product liability, and
similar matters. For example, in the past several years, the U.S. Congress has
considered legislation concerning health care reform and changes to the U.S.
Food and Drug Administration's (FDA) approval process, which would, if enacted,
affect the biotechnology and health technology industries. In addition, these
industries are characterized by competition and rapid technological
developments, which may make a company's products or services obsolete in a
short period of time.
COMMUNICATIONS COMPANIES. The securities of communications companies may
experience more price volatility than securities of companies in some other
sectors or industries. Communications companies are subject to a variety of risk
factors including: significant competitive pressures, such as new market
entrants, aggressive pricing and competition for market share; the potential for
falling profit margins; and the risks that new services, equipment or
technologies will not be accepted by consumers and businesses or will become
rapidly obsolete. These factors can affect the profitability of communications
companies and, as a result, the value of their securities. In addition, many
wireless telecommunication and Internet-related companies are in the emerging
stage of development and are particularly vulnerable to the risks of rapidly
changing technologies, as well as the potential of both accidental and
deliberate disruption or failure of services or equipment. Prices of these
companies' securities historically have been more volatile than other
securities, especially over the short term. Portions of the communications
sector are also subject to government regulation, which may affect company
profitability and share price.
FINANCIAL SERVICES COMPANIES. Financial services companies are subject to
extensive government regulation, which may affect their profitability in many
ways. A financial services company's profitability, and therefore its stock
price, is especially sensitive to interest rate changes throughout the world.
Changing regulations, continuing consolidations, and development of new products
and structures are all likely to have a significant impact on financial services
companies.
1. Banking and thrift institutions. Banking and thrift institutions are
subject to extensive government regulation. These regulations may limit
both the amounts and types of loans and other financial commitments
that the institutions can make, and the interest rates and fees they
can charge. The profitability of these institutions largely depends
upon the availability and cost of capital funds. Their profits have
recently fluctuated significantly as a result of volatile interest rate
levels. In addition, general economic conditions influence the
operations of these institutions. Financial institutions are exposed to
credit losses, which result when borrowers suffer financial
difficulties.
2. Insurance companies. Insurance companies are also affected by economic
and financial conditions and are subject to extensive government
regulation, including rate regulation. Property and casualty companies
may be exposed to material risks, including reserve inadequacy. Latent
health exposure and inability to collect from their reinsurance
carriers.
84
These industries are currently undergoing rapid change as existing distinctions
between different businesses become blurred. On November 12, 1999, the
Gramm-Leach-Bliley Act was signed into law. This new law, which became effective
March 11, 2000, repealed the sections of the Glass-Steagall Act prohibiting
banks and bank holding companies, and their subsidiaries, from engaging in the
business of underwriting securities, distributing securities, or sponsoring,
organizing or controlling a registered open-end investment company that
continuously offers its shares. Banks and bank holding companies that satisfy
certain capitalization, managerial and other criteria are now permitted to
engage in such underwriting and distribution activities. Recent business
combinations have included insurance, finance and securities brokerage under
single ownership.
HEALTH CARE COMPANIES. The activities of health care companies are strongly
affected by government activities, regulation and legislation. Health care
companies may be funded or subsidized by federal and state governments, and if
such subsidies are discontinued or reduced, the profitability of these companies
could be adversely affected. Stocks held by a Fund also may be affected by
government policies on health care reimbursements, regulatory approval for new
drugs and medical instruments, and similar matters. Health care companies are
also subject to legislative risk, which is the risk of changes in the health
care system through legislation. Health care companies may face lawsuits related
to product liability issues and the risk that their products and services may
rapidly become obsolete. Price changes among stocks in the health care sector
are often affected by developments pertaining only to one or a few companies and
the value of an investment in the Fund may fluctuate significantly over
relatively short periods of time.
NATURAL RESOURCES COMPANIES. The securities of companies in the natural
resources sector may experience more price volatility than securities of
companies in other industries. Some of the commodities that these industries use
or provide are subject to limited pricing flexibility because of supply and
demand factors. Others are subject to broad price fluctuations as a result of
the volatility of the prices for certain raw materials and the instability of
supplies of other materials. For example, commodity prices and the supply or
demand for commodities change dramatically for reasons beyond a company's
control. In addition, supply and demand factors may dictate the prices at which
a company acquires raw materials or sells its products or services. Moreover,
many natural resources companies will hedge commodity prices seeking to create
more stable and predictable cash flows. Although the Funds' managers attempt to
determine the impact of such hedging, extreme events in the natural resources
sector may result in these hedges becoming financial liabilities. These factors
can affect the profitability of companies in the natural resources sector and,
as a result, the value of their securities.
1. Energy companies. Companies that are involved in oil or gas
exploration, production, refining, marketing or distribution, or any
combination of the above are greatly affected by the prices and
supplies of raw materials such as oil or gas. The earnings and
dividends of energy companies can fluctuate significantly as a result
of international economic, political, and regulatory developments.
UTILITIES COMPANIES. Utilities companies have generally been subject to
substantial government regulation. Major changes in government policies, ranging
from increased regulation
85
or expropriation to deregulation, privatization or increased competition, may
dramatically increase or reduce opportunities for these companies. For example,
while certain companies may develop more profitable opportunities, others may be
forced to defend their core businesses and may be less profitable.
SHORT SALES
In a short sale, the Fund sells a security it does not own in anticipation of a
decline in the market value of that security. To complete the transaction, the
Fund must borrow the security to make delivery to the buyer. The Fund is then
obligated to replace the security borrowed by purchasing it at the market price
at the time of replacement. Until the security is replaced, the Fund must pay
the lender any dividends or interest that accrues during the period of the loan.
To borrow the security, the Fund also may be required to pay a premium, which
would increase the cost of the security sold. The proceeds of the short sale
will be retained by the broker, to the extent necessary to meet margin
requirements, until the short position is closed out.
The Fund will incur a loss as a result of the short sale if the price of the
security increases between the date of the short sale and the date on which the
Fund replaces the borrowed security, and the Fund will realize a gain if the
security declines in price between those same dates. The amount of any gain will
be decreased, and the amount of any loss increased, by the amount of any
premium, dividends or interest the Fund is required to pay in connection with
the short sale.
The Fund will segregate, in accordance with the law, an amount equal to the
difference between (a) the market value of the securities sold short at the time
they were sold short and (b) any cash or securities required to be deposited as
collateral with the broker in connection with the short sale (not including the
proceeds from the short sale). The segregated amount will be marked-to-market
daily and at no time will the amount segregated d deposited with the broker as
collateral be less than the market value of the securities at the time they sold
short.
A Fund may make a short sale when the manager believes the price of the stock
may decline and when, for tax or other reasons, the manager does not currently
want to sell the stock or convertible security it owns. In this case, any
decline in the value of a Fund's portfolio securities would be reduced by a gain
in the short sale transaction. Conversely, any increase in the value of a Fund's
portfolio securities would be reduced by a loss in the short sale transaction.
Short sales "against the box" are transactions in which a Fund sells a security
short for which it owns an equal amount of the securities sold short or owns
securities that are convertible or exchangeable, without payment of further
consideration, into an equal amount of such security.
SECURITIES INDUSTRY RELATED INVESTMENTS
Companies engaged in securities related businesses, including companies that are
securities brokers, dealers, underwriters or investment advisors are considered
to be part of the financial services sector. Generally, under the 1940 Act, a
Fund may not acquire a security or any interest in a securities related business
to the extent such acquisition would result in the Fund
86
acquiring in excess of 5% of a class of an issuer's outstanding equity
securities or 10% of the outstanding principal amount of an issuer's debt
securities, or investing more than 5% of the value of the Fund's total assets in
securities of the issuer. In addition, any equity security of a
securities-related business must be a marginable security under Federal Reserve
Board regulations and any debt security of a securities-related business must be
investment grade as determined by the Board. The Funds that invest in these
securities do not believe that these limitations will impede the attainment of
their investment goal(s).
STANDBY COMMITMENT AGREEMENTS
If a Fund enters into a standby commitment agreement, it will be obligated, for
a set period of time, to buy a certain amount of a security that may be issued
and sold to the Fund at the option of the issuer. The price of the security is
set at the time of the agreement. The Fund will receive a commitment fee
typically equal to 0.5% of the purchase price of the security. The Fund will
receive this fee regardless of whether the security is actually issued.
A Fund may enter into a standby commitment agreement to invest in the security
underlying the commitment at a yield or price that the manager believes is
advantageous to the Fund. A Fund will not enter into a standby commitment if the
remaining term of the commitment is more than 45 days. If a Fund enters into a
standby commitment, it will keep cash or high-grade marketable securities in a
segregated account with its custodian bank in an amount equal to the purchase
price of the securities underlying the commitment.
The purchase of a security subject to a standby commitment agreement and the
related commitment fee will be recorded on the Fund's books on the date the
security can reasonably be expected to be issued. The value of the security will
then be reflected in the calculation of the Fund's net asset value. The cost
basis of the security will be adjusted by the amount of the commitment fee. If
the security is not issued, the commitment fee will be recorded as income on the
expiration date of the standby commitment.
TEMPORARY INVESTMENTS
When the manager believes market or economic conditions are unfavorable for
investors, the manager may invest up to 100% of the Fund's assets in a temporary
defensive manner or hold a substantial portion of the Fund's portfolio in cash.
Unfavorable market or economic conditions may include excessive volatility or a
prolonged general decline in the securities market, the securities in which the
Fund normally invests, or the economies of the countries where the Fund invests.
Temporary defensive investments for all Funds (other than the Money Market Fund)
generally may include high quality money market instruments or, in the case of
the Technology and Strategic Income Funds, short-term debt instruments.
High-quality money market instruments include government securities, bank
obligations, the highest quality commercial paper and repurchase agreements.
Short-term debt instruments include high-grade commercial paper, repurchase
agreements, and other money market equivalents. To the extent allowed by
exemptions granted under the 1940 Act and the Funds' other investment policies
and
87
restrictions, a manager also may invest the Fund's assets in shares of one or
more money market funds managed by the manager or its affiliates. The manager
also may invest in these types of securities or hold cash while looking for
suitable investment opportunities or to maintain liquidity.
In addition, certain Funds also may invest in short-term (less than twelve
months to maturity) fixed-income securities, non-U.S. currency, short-term
instruments denominated in non-U.S. currencies, or medium-term (not more than
five years to maturity) obligations issued or guaranteed by the U.S. government
or the governments of foreign countries, their agencies or instrumentalities.
Certain Funds also may invest cash, including cash resulting from purchases and
sales of Fund shares, temporarily in short-term debt instruments.
Because each Fund has its own goals and strategies, as well as cash flows in and
out, the cash positions of the Funds may vary significantly. When a Fund's
investments in cash or cash equivalents increase, it may not participate in
market advances or declines to the same extent as it would if the Fund were
fully invested in stocks or bonds.
Any decision to make a substantial withdrawal for a sustained period of time
from a Fund's investment goals will be reviewed by the Board.
TRADE CLAIMS
Trade claims are purchased from creditors of companies in financial difficulty.
For buyers, such as a Fund, trade claims offer the potential for profits since
they are often purchased at a significantly discounted value and, consequently,
may generate capital appreciation if the value of the claim increases as the
debtor's financial position improves. If the debtor is able to pay the full
obligation on the face of the claim as a result of a restructuring or an
improvement in the debtor's financial condition, trade claims offer the
potential for higher income due to the difference in the face value of the claim
as compared to the discounted purchase price.
An investment in trade claims is speculative and carries a high degree of risk.
There can be no guarantee that the debtor will ever be able to satisfy the
obligation on the trade claim. Trade claims are not regulated by federal
securities laws or the SEC. Currently, trade claims are regulated primarily by
bankruptcy laws. Because trade claims are unsecured, holders of trade claims may
have a lower priority in terms of payment than most other creditors in a
bankruptcy proceeding.
WHEN-ISSUED, DELAYED DELIVERY AND TO-BE-ANNOUNCED (TBA) TRANSACTIONS
When-issued, delayed delivery and to-be-announced (TBA) transactions are
arrangements under which a Fund buys securities that have been authorized but
not yet issued with payment for and delivery of the security scheduled for a
future time, generally within 15 to 60 days. Purchases of securities on a
when-issued or delayed delivery basis are subject to the risk that the value or
the yields at delivery may be more or less than the purchase price or yields
available when the transaction was entered into. To the extent a Fund engages in
these transactions, it will do so only for
88
the purpose of acquiring portfolio securities consistent with its investment
objectives and policies, and not for the purpose of investment leverage.
Although the Funds will generally buy securities on a when-issued or TBA basis
with the intention of holding the securities, they may sell the securities
before the settlement date if the manager believes it is advisable to do so.
When a Fund is the buyer in this type of transaction, it will maintain, in a
segregated account with its custodian bank, cash or marketable securities having
an aggregate value equal to the amount of the Fund's purchase commitments until
payment is made. As a buyer in one of these transactions, the Fund relies on the
seller to complete the transaction. The seller's failure to do so may cause a
Fund to miss a price or yield considered advantageous to the Fund. Securities
purchased on a when-issued or delayed delivery basis do not generally earn
interest until their scheduled delivery date. Entering into a when-issued,
delayed delivery or TBA transaction is a form of leverage that may affect
changes in net asset value to a greater extent.
The securities underlying these transactions are subject to market fluctuation
prior to the delivery and generally do not earn interest until their scheduled
delivery date. There is the risk that the value or yield of the security at the
time of delivery may be more or less than the price for the security or the
yield available when the transaction was entered into.
Non-Fundamental Policies
- --------------------------------------------------------------------------------
It is the present policy of each Fund, except the Mutual Discovery Fund and
Mutual Shares Fund, (which may be changed without the approval of a majority of
its outstanding shares) not to pledge, mortgage or hypothecate its assets as
security for loans (except to the extent of allowable temporary loans), nor to
engage in joint or joint and several trading accounts in securities, except that
the Funds (including the Mutual Discovery Fund and Mutual Shares Fund) may
participate with other investment companies in Franklin Templeton Investments in
a joint account to engage in certain large repurchase transactions and may
combine orders to purchase or sell securities with orders from other persons to
obtain lower brokerage commissions. It is not any Fund's policy to invest in
interests (other than publicly traded equity securities) in oil, gas or other
mineral exploration or development programs.
Fundamental Investment Restrictions
Each Fund has adopted several of the following restrictions as fundamental
policies. This means they may only be changed if the change is approved by (i)
more than 50% of the Fund's outstanding shares or (ii) 67% or more of the Fund's
shares present at a shareholder meeting if more than 50% of the Fund's
outstanding shares are represented at the meeting in person or by proxy,
whichever is less. In the discussion of each Fund which appears above, the
fundamental restrictions applicable to that Fund have been set out using the
numerical designations below.
A Fund with this restriction will not:
Diversification
89
1. With respect to 75% of its total assets, purchase the securities of any
one issuer (other than cash, cash items and obligations of the U.S.
government) if immediately thereafter, and as a result of the purchase,
the Fund would (a) have more than 5% of the value of its total assets
invested in the securities of such issuer or (b) hold more than 10% of
any or all classes of the securities of any one issuer.
1.1. Purchase the securities of any one issuer (other than the U.S.
government or any of its agencies or instrumentalities, or securities
of other investment companies) if immediately after such investment (a)
more than 5% of the value of the Fund's total assets would be invested
in such issuer or (b) more than 10% of the outstanding voting
securities of such issuer would be owned by the Fund, except that up to
25% of the value of the Fund's total assets may be invested without
regard to such 5% and 10% limitations.
Borrowing
2. Borrow money in an amount in excess of 5% of the value of its total
assets, except from banks for temporary or emergency purposes, and not
for direct investment in securities.
2.1. Borrow money from banks in an amount exceeding 33 1/3% of the value of
the Fund's total assets including the amount borrowed. A Fund may also
pledge, mortgage or hypothecate its assets to secure borrowings to an
extent not greater than 15% of the Fund's total assets. Arrangements
with respect to margin for futures contracts, forward contracts and
related options are not deemed to be a pledge of assets.
2.2. Borrow money, except that the Fund may borrow money from banks or
affiliated investment companies to the extent permitted (a) by the 1940
Act, or (b) any exemptions therefrom which may be granted by the SEC,
or (c) for temporary or emergency purposes and then in an amount not
exceeding 33 1/3% of the value of the Fund's total assets (including
the amount borrowed).
2.3. Borrow money, except that the Fund may borrow money from banks or
affiliated investment companies to the extent permitted by the 1940
Act, or any exemptions therefrom which may be granted by the SEC, or
for temporary or emergency purposes and then in an amount not exceeding
33 1/3% of the value of the Fund's total assets (including the amount
borrowed).
2.4. Borrow money, except that the Fund may borrow money from banks to the
extent permitted by the 1940 Act, or any exemptions therefrom which may
be granted by the SEC, or from any person for temporary or emergency
purposes and then in an amount not exceeding 33 1/3% of the value of
the Fund's total assets (including the amount borrowed).
Lending
90
3. Lend its assets, except through the purchase or acquisition of bonds,
debentures or other debt securities of any type customarily purchased
by institutional investors, or through loans of portfolio securities,
or to the extent the entry into a repurchase agreement may be deemed a
loan.
3.1. Make loans to other persons except (a) through the lending of its
portfolio securities, (b) through the purchase of debt securities, loan
participations and/or engaging in direct corporate loans in accordance
with its investment objectives and policies, and (c) to the extent the
entry into a repurchase agreement is deemed to be a loan. The Fund may
also make loans to affiliated investment companies to the extent
permitted by the 1940 Act or any exemptions therefrom which may be
granted by the SEC.
Underwriting
4. Underwrite securities of other issuers, except as noted in number 6
below and except insofar as a Fund may be technically deemed an
underwriter under the federal securities laws in connection with the
disposition of portfolio securities.
4.1. Act as an underwriter except to the extent the Fund may be deemed to be
an underwriter when disposing of securities it owns or when selling its
own shares.
Restricted Securities
5. Invest more than 10% of its assets in illiquid securities which include
securities with legal or contractual restrictions on resale, illiquid
securities which at the time of acquisition could be disposed of
publicly by the Funds only after registration under the Securities Act
of 1933, repurchase agreements of more than seven days duration,
over-the-counter options and assets used to cover such options, and
other securities which are not readily marketable, as more fully
described in the prospectus and this SAI.
5.1. Purchase illiquid securities, including illiquid securities which, at
the time of acquisition, could be disposed of publicly by the Funds
only after registration under the Securities Act of 1933, if as a
result more than 15% of their net assets would be invested in such
illiquid securities.
Exercising Control
6. Invest in securities for the purpose of exercising management or
control of the issuer.
Concentration
7. Invest more than 25% of its assets (measured at the time of the most
recent investment) in any single industry.
7.1. Concentrate (invest more than 25% of its total assets) in securities of
issuers in a particular industry (other than securities issued or
guaranteed by the U.S. government
91
or any of its agencies or instrumentalities or securities of other
investment companies).
7.2. Concentrate (invest more than 25% of its net assets) in securities of
issuers in a particular industry (other than securities issued or
guaranteed by the U.S. government or any of its agencies or
instrumentalities or securities of other investment companies).
Unseasoned companies
8. Invest in companies which have a record of less than three years of
continuous operation, including the operations of any predecessor
companies.
8.1. Invest up to 5% of their total net assets invest in companies which
have a record of less than three years of continuous operation,
including the operations of any predecessor.
8.2. Invest up to 10% of its total net assets in companies which have a
record of less than three years of continuous operation, including the
operations of any predecessor companies.
Margin
9. Maintain a margin account with a securities dealer or effect short
sales.
9.1. Maintain a margin account with a securities dealer or effect short
sales, except if the Fund owns securities equivalent in kind and amount
to those sold.
9.2. Maintain a margin account with a securities dealer or effect short
sales, except that a Fund may engage in short sales to the extent
described in the prospectus and this SAI and may make initial deposits
and pay variation margin in connection with futures contracts.
9.3. Maintain a margin account with a securities dealer or effect short
sales, except that a Fund may make initial deposits and pay variation
margin in connection with futures contracts.
Commodities and real estate
10. Invest in commodities or commodity pools, except that certain Funds may
purchase and sell Forward Contracts in amounts necessary to effect
transactions in foreign securities. Securities or other instruments
backed by commodities are not considered commodities or commodity
contracts for the purpose of this restriction.
10.1. Invest in commodities or commodity pools, except that the Fund may
enter into Futures Contracts and may invest in foreign currency.
Securities or other instruments backed by commodities are not
considered commodities or commodity contracts for the purpose of this
restriction.
92
10.2. Invest in commodities or commodity pools, except that the Fund may
invest in commodities and commodity futures contracts with respect to
commodities related to the natural resources sector as defined in the
prospectus. Securities or other instruments backed by commodities are
not considered commodities or commodity contracts for the purpose of
this restriction.
10.3. Purchase or sell real estate and commodities, except that the Fund may
purchase or sell securities of real estate investment trusts, may
purchase or sell currencies, may enter into futures contracts on
securities, currencies, and other indices or any other financial
instruments, and may purchase and sell options on such futures
contracts.
REITS
11. Invest directly in real estate, although certain Funds may invest in
real estate investment trusts or other publicly traded securities
engaged in the real estate industry. First mortgage loans or other
direct obligations secured by real estate are not considered real
estate for purposes of this restriction.
Other investment companies
12. Invest in the securities of other open-end investment companies (except
that securities of another open-end investment company may be acquired
pursuant to a plan of reorganization, merger, consolidation or
acquisition).
Assessable securities
13. Invest in assessable securities or securities involving unlimited
liability on the part of the Fund.
Ownership by officers and directors
14. Purchase or retain any security if any officer, director or security
holder of the issuer is at the same time an officer, trustee or
employee of the Trust or of the Fund's Manager and such person owns
beneficially more than one-half of 1% of the securities and all such
persons owning more than one-half of 1% own more than 5% of the
outstanding securities of the issuer.
Section 817(h) of the Internal Revenue Code
15. Invest its assets in a manner which does not comply with the investment
diversification requirements of Section 817(h) of the Code.
Warrants
16. Invest more than 5% of its assets in warrants, whether or not listed on
the New York or American Exchange, including no more than 2% of its
total assets which may be invested
93
in warrants that are not listed on those exchanges. Warrants acquired
by the Fund in units or attached to securities are not included in this
restriction.
Foreign issuers
17. Invest more than 15% of its assets in securities of foreign issuers
that are not listed on a recognized U.S. or foreign securities
exchange, including no more than 10% in illiquid investments.
Senior securities
18. Issue securities senior to the Fund's presently authorized shares of
beneficial interest, except that this restriction shall not be deemed
to prohibit the Fund from (a) making any permitted borrowings, loans,
mortgages or pledges, (b) entering into options, futures contracts,
forward contracts, repurchase transactions or reverse repurchase
transactions, or (c) making short sales of securities to the extent
permitted by the 1940 Act and any rule or order thereunder, or SEC
staff interpretations thereof.
Officers and Trustees
- --------------------------------------------------------------------------------
The Trust's Board is responsible for the overall management of the Trust,
including general supervision and review of each Fund's investment activities.
The Board, in turn, elects the officers of the Trust who are responsible for
administering the Trust's day-to-day operations. The Board also monitors each
Fund to ensure no material conflicts exist among share classes, among different
insurance companies or between owners of variable annuity and variable life
insurance contracts. While none is expected, the Board will act appropriately to
resolve any material conflict that may arise.
The name, age and address of the officers and Board members, as well as their
affiliations, positions held with the Trust, and principal occupations during
the past five years are shown below.
Frank H. Abbott, III (80)
1045 Sansome Street, San Francisco, CA 94111
Trustee
President and Director, Abbott Corporation (an investment company); director or
trustee, as the case may be, of 28 of the investment companies in Franklin
Templeton Investments; and formerly, Director, MotherLode Gold Mines
Consolidated (gold mining) (until 1996) and Vacu-Dry Co. (food processing)
(until 1996).
Harris J. Ashton (68)
191 Clapboard Ridge Road, Greenwich, CT 06830
Trustee
Director, RBC Holdings, Inc. (bank holding company) and Bar-S Foods (meat
packing
94
company); director or trustee, as the case may be, of 48 of the investment
companies in Franklin Templeton Investments; and formerly, President, Chief
Executive Officer and Chairman of the Board, General Host Corporation (nursery
and craft centers) (until 1998).
Robert F. Carlson (73)
2120 Lambeth Way, Carmichael, CA 95608
Trustee
Vice President and past President, Board of Administration, California Public
Employees Retirement Systems (CALPERS); director or trustee, as the case may be,
of 11 of the investment companies in Franklin Templeton Investments; and
formerly, member and Chairman of the Board, Sutter Community Hospitals, member,
Corporate Board, Blue Shield of California, and Chief Counsel, California
Department of Transportation.
S. Joseph Fortunato (68)
Park Avenue at Morris County, P.O. Box 1945
Morristown, NJ 07962-1945
Trustee
Member of the law firm of Pitney, Hardin, Kipp & Szuch; and director or trustee,
as the case may be, of 49 of the investment companies in Franklin Templeton
Investments.
Robert S. James (62)
1750 Hennepin Avenue South, Minneapolis, MN 55403-2195
Trustee
President, Individual Insurance Division, Allianz Life Insurance Company of
North America; and Director, Preferred Life Insurance Company of New York and
LifeUSA of Minneapolis.
*Charles B. Johnson (68)
777 Mariners Island Blvd., San Mateo, CA 94404
Chairman of the Board and Trustee
Chairman of the Board, Chief Executive Officer, Member - Office of the Chairman
and Director, Franklin Resources, Inc.; Vice President, Franklin Templeton
Distributors, Inc.; and officer and/or director or trustee, as the case may be,
of most of the other subsidiaries of Franklin Resources, Inc. and of 48 of the
investment companies in Franklin Templeton Investments.
*Charles E. Johnson (44)
777 Mariners Island Blvd., San Mateo, CA 94404
President and Trustee
President, Member - Office of the President and Director, Franklin Resources,
Inc.; Senior Vice President, Franklin Templeton Distributors, Inc.; President
and Director, Templeton Worldwide, Inc. and Franklin Advisers, Inc.; Chairman of
the Board and President, Franklin Investment Advisory Services, Inc.; officer
and/or director of some of the other subsidiaries of Franklin Resources, Inc.;
and officer and/or director or trustee, as the case may be, of 33 of the
investment
95
companies in Franklin Templeton Investments.
*Rupert H. Johnson, Jr. (60)
777 Mariners Island Blvd., San Mateo, CA 94404
Vice President and Trustee
Vice Chairman, Member - Office of the Chairman and Director, Franklin Resources,
Inc.; Vice President and Director, Franklin Templeton Distributors, Inc.;
Director, Franklin Advisers, Inc. and Franklin Investment Advisory Services,
Inc.; Senior Vice President, Franklin Advisory Services, LLC; and officer and/or
director or trustee, as the case may be, of most of the other subsidiaries of
Franklin Resources, Inc. and of 51 of the investment companies in Franklin
Templeton Investments.
Frank W.T. LaHaye (72)
20833 Stevens Creek Blvd., Suite 102, Cupertino, CA 95014
Trustee
Chairman, Peregrine Venture Management Company (venture capital); Director, The
California Center for Land Recycling (redevelopment); director or trustee, as
the case may be, of 28 of the investment companies in Franklin Templeton
Investments; and formerly, General Partner, Miller & LaHaye and Peregrine
Associates, the general partners of Peregrine Venture funds.
Gordon S. Macklin (72)
8212 Burning Tree Road, Bethesda, MD 20817
Trustee
Director, Martek Biosciences Corporation, WorldCom, Inc. (communications
services), MedImmune, Inc. (biotechnology), Overstock.com (internet services),
White Mountains Insurance Group, Ltd. (holding company) and Spacehab, Inc.
(aerospace services); director or trustee, as the case may be, of 48 of the
investment companies in Franklin Templeton Investments; and formerly, Chairman,
White River Corporation (financial services) (until 1998) and Hambrecht & Quist
Group (investment banking) (until 1992), and President, National Association of
Securities Dealers, Inc. (until 1987).
Harmon E. Burns (56)
777 Mariners Island Blvd., San Mateo, CA 94404
Vice President
Vice Chairman, Member - Office of the Chairman and Director, Franklin Resources,
Inc.; Vice President and Director, Franklin Templeton Distributors, Inc.;
Executive Vice President, Franklin Advisers, Inc.; Director, Franklin Investment
Advisory Services, Inc.; and officer and/or director or trustee, as the case may
be, of most of the other subsidiaries of Franklin Resources, Inc. and of 51 of
the investment companies in Franklin Templeton Investments.
Martin L. Flanagan (40)
777 Mariners Island Blvd., San Mateo, CA 94404
96
Vice President and Chief Financial Officer
President, Member - Office of the President, Chief Financial Officer and Chief
Operating Officer, Franklin Resources, Inc.; Executive Vice President,
Franklin/Templeton Investor Services, LLC; President and Chief Financial
Officer, Franklin Mutual Advisers, LLC; Executive Vice President, Chief
Financial Officer and Director, Templeton Worldwide, Inc.; Executive Vice
President and Chief Operating Officer, Templeton Investment Counsel, LLC;
Executive Vice President, Franklin Advisers, Inc. and Franklin Investment
Advisory Services, Inc.; Chief Financial Officer, Franklin Advisory Services,
LLC; officer and/or director of some of the other subsidiaries of Franklin
Resources, Inc.; and officer and/or director or trustee, as the case may be, of
51 of the investment companies in Franklin Templeton Investments.
David Goss (53)
777 Mariners Island Blvd., San Mateo, CA 94404
Vice President
Associate General Counsel, Franklin Templeton Investments; President, Chief
Executive Officer and Director, Franklin Select Realty Trust, Property
Resources, Inc., Property Resources Equity Trust, Franklin Real Estate
Management, Inc. and Franklin Properties, Inc.; officer and director of some of
the other subsidiaries of Franklin Resources, Inc.; officer of 52 of the
investment companies in Franklin Templeton Investments; and formerly, President,
Chief Executive Officer and Director, Franklin Real Estate Income Fund and
Franklin Advantage Real Estate Income Fund (until 1996).
Barbara J. Green (53)
777 Mariners Island Blvd., San Mateo, CA 94404
Vice President
Vice President and Deputy General Counsel, Franklin Resources, Inc.; Senior Vice
President, Templeton Worldwide, Inc.; officer of 52 of the investment companies
in Franklin Templeton Investments; and formerly, Deputy Director, Division of
Investment Management, Executive Assistant and Senior Advisor to the Chairman,
Counselor to the Chairman, Special Counsel and Attorney Fellow, U.S. Securities
and Exchange Commission (1986-1995), Attorney, Rogers & Wells (until 1986), and
Judicial Clerk, U.S. District Court (District of Massachusetts) (until 1979).
Edward V. McVey (63)
777 Mariners Island Blvd., San Mateo, CA 94404
Vice President
Senior Vice President, Franklin Templeton Distributors, Inc.; officer of one of
the other subsidiaries of Franklin Resources, Inc. and of 29 of the investment
companies in Franklin Templeton Investments.
Kimberley Monasterio (37)
777 Mariners Island Blvd., San Mateo, CA 94404
97
Treasurer and Principal Accounting Officer
Senior Vice President, Franklin Templeton Services, LLC; and officer of 33 of
the investment companies in Franklin Templeton Investments.
Murray L. Simpson (63)
777 Mariners Island Blvd., San Mateo, CA 94404
Vice President and Secretary
Executive Vice President and General Counsel, Franklin Resources, Inc.; officer
and/or director of some of the subsidiaries of Franklin Resources, Inc.; officer
of 52 of the investment companies in Franklin Templeton Investments; and
formerly, Chief Executive Officer and Managing Director, Templeton Franklin
Investment Services (Asia) Limited (until 2000) and Director, Templeton Asset
Management Ltd. (until 1999).
*This Board member is considered an "interested person" under federal securities
laws.
Note: Charles B. Johnson and Rupert H. Johnson, Jr. are brothers and the father
and uncle, respectively, of Charles E. Johnson.
The Trust pays noninterested Board members $675 per month plus $550 per meeting
attended. Board members who serve on the audit committee of the Trust and other
funds in Franklin Templeton Investments receive a flat fee of $2,000 per
committee meeting attended, a portion of which is allocated to the Trust.
Members of a committee are not compensated for any committee meeting held on the
day of a Board meeting. Noninterested Board members also may serve as directors
or trustees of other funds in Franklin Templeton Investments and may receive
fees from these funds for their services. The fees payable to certain
noninterested Board members by the Trust are subject to reductions resulting
from fee caps limiting the amount of fees payable to Board members who serve on
other Boards within Franklin Templeton Investments. The following table provides
the total fees paid to noninterested Board members by the Trust and by Franklin
Templeton Investments.
98
Total Fees Received Total Fees Received from Number of Boards in
from the Franklin Templeton Franklin Templeton
Trust(1)($) Investments(2)($) Investments on which Each
Name Serves(3)
- --------------------------------- ------------------------- ------------------------------ -----------------------------
Frank H. Abbott 156,953 28
Harris Ashton 359,404 48
Robert F. Carlson 90,815 11
S. Joseph Fortunato 359,629 49
Robert S. James - - 1
Frank W.T. LaHaye 165,529 28
Gordon Macklin 11,274 359,504 48
(1). For the fiscal year ended December 31, 2000.
(2). For the calendar year ended December 31, 2000.
(3). We base the number of boards on the number of registered investment
companies in Franklin Templeton Investments. This number does not include the
total number of series or funds within each investment company for which the
board members are responsible. Franklin Templeton Investments currently includes
52 registered investment companies, with approximately 156 U.S. based funds or
series.
Noninterested Board members are reimbursed for expenses incurred in connection
with attending Board meetings, paid pro rata by each fund in Franklin Templeton
Investments for which they serve as director or trustee. No officer or Board
member received any other compensation, including pension or retirement
benefits, directly or indirectly from the Fund or other funds in Franklin
Templeton Investments. Certain officers or Board members who are shareholders of
Franklin Resources, Inc. (Resources) may be deemed to receive indirect
remuneration by virtue of their participation, if any, in the fees paid to its
subsidiaries.
Board members historically have followed a policy of having substantial
investments in one or more of the funds in Franklin Templeton Investments, as is
consistent with their individual financial goals. In February 1998, this policy
was formalized through adoption of a requirement that each board member invest
one-third of fees received for serving as a director or trustee of a Templeton
fund in shares of one or more Templeton funds and one-third of fees received for
serving as a director or trustee of a Franklin fund in shares of one or more
Franklin funds until the value of such investments equals or exceeds five times
the annual fees paid such board member. Investments in the name of family
members or entities controlled by a board member constitute fund holdings of
such board member for purposes of this policy, and a three year phase-in period
applies to such investment requirements for newly elected board members. In
implementing such policy, a board member's fund holdings existing on February
27, 1998, are valued as of such date with subsequent investments valued at cost.
Management and Other Services
- --------------------------------------------------------------------------------
Managers and services provided
The managers are:
Investment Adviser Fund
- --------------------------------------- ---------------------------------------
Franklin Advisers, Inc. (Advisers) Aggressive Growth Fund Global
Communications Fund
99
Investment Adviser Fund
- --------------------------------------- ---------------------------------------
Global Health Care Fund Growth and
Income Fund High Income Fund Income
Securities Fund Large Cap Growth Fund
Money Fund Natural Resources Fund Real
Estate Fund S&P 500 Index Fund Small Cap
Fund Strategic Income Fund Technology
Fund Government Fund Zero Coupon Fund -
2005 Zero Coupon Fund - 2010 Global
Income Fund
Franklin Advisory Services, LLC (FAS) Rising Dividends Fund Value Fund
Franklin Mutual Advisers, LLC (FMA) Mutual Discovery Fund Mutual Shares Fund
Templeton Investment Counsel, Asset Strategy Fund
LLC (TIC) International Securities Fund
International Smaller Companies Fund
Templeton Global Advisors Growth Securities Fund
Limited (TGAL)
Templeton Asset Management Developing Markets Securities Fund
LTD. (TAML)
100
Peter A. Nori, CFA, has been a manager of the International Securities Fund
since November 1999. He was a manager of the Templeton International Equity Fund
from 1996 until its merger and reorganization into the International Securities
Fund on May 1, 2000. Mr. Nori has been with Franklin Templeton Investments since
1987.
The managers are directly or indirectly wholly owned by Franklin Resources, Inc.
(Resources), a publicly owned company engaged in the financial services industry
through its subsidiaries. Charles B. Johnson and Rupert H. Johnson, Jr. are the
principal shareholders of Resources.
The managers provide investment research and portfolio management services, and
select the securities for the Funds to buy, hold or sell. The managers also
select the brokers who execute the Funds' portfolio transactions. The managers
provide periodic reports to the Board, which reviews and supervises the
managers' investment activities. To protect the Funds, the managers and their
officers, directors and employees are covered by fidelity insurance. TAML and
TGAL render their services to the Funds from outside the U.S.
The Templeton organization has been investing globally since 1940. The managers
and their affiliates have offices in Argentina, Australia, Bahamas, Belgium,
Brazil, Canada, Peoples' Republic of China, Cyprus, France, Germany, Hong Kong,
Hungary, India, Ireland, Italy, Japan, Korea, Luxembourg, Malaysia, Mauritius,
the Netherlands, Poland, Russia, Singapore, South Africa, Spain, Sweden,
Switzerland, Taiwan, Turkey, United Arab Emirates, United Kingdom, Venezuela and
U.S.
The managers and their affiliates manage numerous other investment companies and
accounts. The managers may give advice and take action with respect to any of
the other funds they manage, or for their own accounts, that may differ from
action taken by the managers on behalf of the Funds. Similarly, with respect to
the Funds, the managers are not obligated to recommend, buy or sell, or to
refrain from recommending, buying or selling any security that the managers and
access persons, as defined by applicable federal securities laws, may buy or
sell for their own account or for the accounts of any other fund. The managers
are not obligated to refrain from investing in securities held by the Funds or
other funds they manage.
101
The Funds, their managers and principal underwriter have each adopted a code of
ethics, as required by federal securities laws. Under the code of ethics,
employees who are designated as access persons may engage in personal securities
transactions, including transactions involving securities that are being
considered for the Funds or that are currently held by the Funds, subject to
certain general restrictions and procedures. The personal securities
transactions of access persons of the Funds, their manager and their principal
underwriter will be governed by the code of ethics. The code of ethics is on
file with, and available from, the SEC.
Templeton Investment Counsel, LLC is the sub-advisor to Strategic Income Fund
and Global Income Securities. State Street Global Advisors (SsgA), a division of
State Street Bank and Trust Company is the sub-advisor to the S&P 500 Index
Fund. Templeton Asset Management Ltd. is the subadvisor for International
Smaller Companies Fund. The sub-advisors have agreements with the managers and
provide the managers with investment management advice and assistance. The
sub-advisors' activities are subject to the Board's review and control, as well
as the managers' instructions and supervision. The code of ethics of SsgA, the
sub-advisor for the S&P 500 Index Fund, is filed with, and available from, the
SEC.
Management fees Each Fund pays the manager a fee equal to an annual rate as
follows:
Fund Management Fee Rates
- -------------------------------------- -----------------------------------------
Global Communications Fund 0.625% of the value of net assets up to
and including
Growth and Income Fund $100 million; plus
High Income Fund 0.50% of the value of net assets over
$100 million up to
Income Securities Fund and including $250 million; plus
Money Fund 0.45% of the value of net assets over
$250 million up to
Natural Resources Fund and including $10 billion; plus
Real Estate Fund 0.44% of the value of net assets over $10
billion up to
Government Fund and including $12.5 billion; plus
Zero Coupon Fund - 2005 0.42% of the value of net assets over
$12.5 billion up
Zero Coupon Fund - 2010 to and including $15 billion; plus
Global Income Fund 0.40% of the value of net assets over $15
billion.
Large Cap Fund 0.75% of the value of net assets up to
$500 million;
Rising Dividends Fund 0.625% of the value of net assets over
$500 million up to and including $1
billion; and 0.50% of the value of net
assets in excess of $1 billion.
Growth Securities Fund 1.00% of the value of net assets up to
$100 million; 0.90% of the value of net
assets over $100 million up to and
including $250 million; 0.80% of the
value of net assets over $250 million up
to and including $500 million; and 0.75%
of the value of net assets over $500
million.
102
Fund Management Fee Rates
- -------------------------------------- -----------------------------------------
International Securities Fund 0.75% of the value of net assets up
to and including $200 million; 0.675% of
the value of net assets over $200 million
up to and including $1.3 billion; 0.60%
of the value of net assets over $1.3
billion.
Developing Markets Fund 1.25% of the value of net assets.
Asset Strategy Fund 0.65% of the value of net assets up to
and including $200 million; 0.585% of the
value of net assets over $200 million up
to and including $1.3 billion; 0.52% of
the value of net assets over $1.3
billion.
International Smaller Companies Fund 0.85% of the value of net assets
up to and including $200 million; 0.765%
of the value of the Fund's net assets
over $200 million up to and including
$1.3 billion; 0.68% of the value of the
Fund's net assets over $1.3 billion.
Global Health Care Fund 0.60% of the value of net assets up to an
Value Fund including $200 million; 0.50% of the
value of net assets up to and including
$1.3 billion; and 0.40% of value of net
assets over $1.3 billion.
Mutual Discovery Fund 0.80% of the value of net assets.
Mutual Shares Fund 0.60% of the value of net assets.
Aggressive Growth Fund 0.500% of the value of net assets up to
$500 million;
0.400% of the value of net assets over
$500 million up to and including $1
billion;
0.350% of the value of net assets over $1
billion up to and including $1.5 billion;
0.300% of the value of net assets over
$1.5 billion up to and including $6.5
billion;
0.275% of the value of net assets over
$6.5 billion up to and including $11.5
billion;
0.250% of the value of net assets over
$11.5 billion up to and including $16.5
billion;
0.240% of the value of net assets over
$16.5 billion up to and including $19
billion;
0.230% of the value of net assets over
$19 billion up to and including $21.5
billion; and
0.220% of the value of net assets over
$21.5 billion.
103
Fund Management Fee Rates
- -------------------------------------- -----------------------------------------
Small Cap Fund 0.550% of the value of net assets up to
Technology Fund $500 million; and 0.450% of the value of
net assets over $500 million up to and
including $1 billion; and 0.400% of the
value of net assets over $1 billion up to
and including $1.5 billion; and 0.350% of
the value of net assets over $1.5 billion
up to and including $6.5 billion; and
0.325% of the value of net assets over
$6.5 billion up to and including $11.5
billion; and 0.300% of the value of net
assets over $11.5 billion up to and
including $16.5 billion; and 0.290% of
the value of net assets over $16.5
billion up to and including $19 billion;
and 0.280% of the value of net assets
over $19 billion up to and including
$21.5 billion; and 0.270% of the value of
net assets over $21.5 billion.
S&P 500 Index Fund 0.15% of the value of net assets.
Strategic Income Fund 0.425% of the value of net assets up to
$500 million; 0.325% of the value of net
assets over $500 million up to and
including $1 billion;
0.280% of the value of net assets over $1
billion up to and including $1.5 billion;
0.235% of the value of net assets over
$1.5 billion up to and including $6.5
billion;
0.215% of the value of net assets over
$6.5 billion up to and including $11.5
billion;
0.200% of the value of net assets over
$11.5 billion up to and including $16.5
billion;
0.190% of the value of net assets over
$16.5 billion up to and including $19
billion;
0.180% of the value of net assets over
$19 billion up to and including $21.5
billion; and
0.170% of the value of net assets over
$21.5 billion.
The fees are computed daily according to the terms of the management agreements.
Each class of a Fund's shares pays its proportionate share of the fee.
For the last three fiscal years ended December 31, the Funds paid the following
management fees:
Management fees paid ($)
- -----------------------------------------------------------------------------
2000 1999 1998
- -----------------------------------------------------------------------------
Aggressive Growth Fund 22,838(1) n/a n/a
Global Communications Fund 4,032,318 4,247,909 4,965,295
Global Health Care Fund 169,755(1) 59,620 18,1195
Growth and Income Fund 3,976,995 5,454,205 6,301,582
104
Management fees paid ($)
- -----------------------------------------------------------------------------------
2000 1999 1998
- -----------------------------------------------------------------------------------
High Income Fund 1,350,684 1,992,885 2,439,509
Income Securities Fund 3,327,614 4,605,869 6,133,729
Large Cap Fund 3,420,758 2,501,063 1,140,016
Money Fund 1,599,158 1,971,026 1,671,303(1)
Natural Resources Fund 288,538 293,810 388,527
Real Estate Fund 932,495 1,197,913 1,911,113
Rising Dividends Fund 2,738,475 4,308,795 5,508,829
S&P 500 Index Fund 70,310(1) 0(3) n/a
Small Cap Fund 3,511.885(1) 2,375,111 2,365,309
Strategic Income Fund 25,664(1) 0(1,2) n/a
Technology Fund 25,076(1) n/a n/a
U.S. Government Fund 2,315,683 3,000,062 3,530,641
Value Fund(1) 110,031 62,295 17,968(5)
Zero Coupon Fund - 2005 374,270 470,096 292,474(1)
Zero Coupon Fund - 2010 358,565 502,424 326,495(1)
Mutual Discovery Fund 1,602,379 1,617,147 1,904,631
Mutual Shares Fund 2,544,563 2,833,172 2,841,641
Asset Strategy Fund 4,131,722 4,072,911(4) 4,500,289(4)
Developing Markets Fund 4,860,007 3,292,465(4) 2,255,183(4)
Global Income Fund 541,042 714,454 959,858
Growth Securities Fund 8,610,867 5,923,920 6,409,332
International Securities Fund 9,942,391 7,168,839(4) 7,098,752(4)
International Smaller Companies Fund 258,272 201,942 259,908
(1). The Fund's fees, before any advance waiver, were ($):
2000 1999 1998
- -----------------------------------------------------------------------------------
Aggressive Growth Fund 25,512(a) n/a n/a
Global Health Care Fund 177,735(a) n/a n/a
Money Fund n/a n/a 1,986,485(b)
S&P 500 Index Fund 73,826(a) 1,735(b) n/a
Small Cap Fund 3,797,838(a) n/a n/a
Strategic Income Fund 31,828(a,b) 6,732(b) n/a
Technology Fund 26,813 n/a n/a
Value Fund 113,954(a) n/a n/a
Zero Coupon Fund - 2005 n/a n/a 498,204(b)
Zero Coupon Fund - 2010 n/a n/a 552,900(b)
(a). The manager agreed in advance to reduce its fees to reflect
reduced services from the Fund's investment in a Franklin
Templeton money fund, as required by the Board and an SEC
order.
(b). The manager agreed in advance to waive or limit its fees.
(2). For the period July 1, 1999 (effective date) to December 31, 1999.
(3). For the period November 1, 1999 (effective date) to December 31, 1999.
(4). Included in the financials in the Templeton Variable Products Series
Fund (TVP) Annual Report to Shareholders for the fiscal year ended
December 31, 1999.
(5). For the period May 1, 1998 (effective date) to December 31, 1998.
For services provided to the Funds, the managers pay the sub-advisors the
following fees:
105
Sub-Advisor Fund Annual Fee Rates
- --------------------------------------------------------------------------------
SsgA S&P 500 Index Fund 0.05% of the value of the Fund's net
assets up to and including
$50,000,000; and 0.04% of the value
of the Fund's net assets over
$50,000,000 up to and including
$100,000,000; and
0.02% of the value of the Fund's net
assets over $100,000,0000.
TIC Strategic Income Fund 25% of the fees received by the
manager.
TIC Global Income Fund 0.35% of the value of the net assets
up to and including $100 million;
0.25% of the value of net assets
over $100 million up to and
including $250 million; and
0.20% of the value of net assets
over $250 million.
TAML International Smaller 0.60% of the value of the net assets
Companies Fund up to and including $200 million;
0.535% of the value of the net
assets over $200 million up to and
including $1.3 billion; and 0.48% of
the value of the net assets over
$1.3 billion.
The managers pay sub-advisory fees from the management fees they receive from
the Funds. For the last three fiscal years, the managers paid the following
sub-advisory fees:
sub-advisory fees paid ($)
- -------------------------------------------------------------------------------
2000 1999 1998
- -------------------------------------------------------------------------------
Global Income Fund 298,522 394,727 517,646
S&P 500 Index Fund 10,747 576(1) n/a
Strategic Income Fund 5,636 0(1) n/a
106
(1). For the period November 1, 1999 (effective date) to December 31, 1999.
Administrator and services provided Franklin Templeton Services, LLC (FT
Services) provides certain administrative services and facilities for each Fund.
FT Services has direct agreements with the following Funds:
Aggressive Growth Fund
Global Health Care Fund
S&P 500 Index Fund
Small Cap Fund
Strategic Income Fund
Technology Fund
Value Fund
Mutual Discovery Fund
Mutual Shares Fund
Asset Strategy Fund
Developing Markets Fund
International Securities Fund
International Smaller Companies Fund
FT Services has subcontracts with the managers of all other Funds. The
administrative services provided by FT Services include preparing and
maintaining books, records, and tax and financial reports, and monitoring
compliance with regulatory requirements. FT Services may make certain payments
to insurance companies for administrative services. FT Services subcontracted
with Templeton Funds Annuity Company (TFAC) to provide certain of these
services. FT Services and TFAC are direct or indirect wholly owned subsidiaries
of Resources and are affiliates of the Trust's managers and principal
underwriter.
Administration fees The Funds, in the case of the Funds with direct agreements
with FT Services (except for Aggressive Growth Fund, S&P 500 Index Fund, Small
Cap Fund, Strategic Income Fund and Technology Fund) and the managers for all
other Funds, pay FT Services a monthly fee for each Fund, equal to an annual
rate of:
. 0.15% of the Fund's average daily net assets up to $200
million;
. 0.135% of average daily net assets over $200 million up to
$700 million;
. 0.10% of average daily net assets over $700 million up to $1.2
billion; and
107
. 0.075% of average daily net assets over $1.2 billion.
Small Cap Fund and Technology Fund each pays FT Services a monthly fee equal to
an annual rate of 0.25% of the average daily net assets of the Fund during the
preceding month.
Strategic Income Fund and Aggressive Growth Fund each pays FT Services a monthly
fee equal to an annual rate of 0.20% of the average daily net assets of the Fund
during the preceding month.
S&P 500 Index Fund pays FT Services a monthly fee equal to an annual rate of
0.10% of the Fund's average daily net assets.
During the last three fiscal years ended December 31, the Funds or the managers,
as applicable, paid FT services the following administration fees:
Administration fees paid ($)
- ------------------------------------------------------------------------------
2000 1999 1998
- ------------------------------------------------------------------------------
Aggressive Growth Fund 10,051(2) n/a n/a
Global Communications Fund 1,108,980 1,163,467 1,323,099
Global Health Care Fund 44,498 15,012 4,471(6)
Growth and Income Fund 1,101,761 1,427,064 1,583,739
High Income Fund 361,578 553,410 687,089
Income Securities Fund 948,430 1,243,737 1,555,839
Large Cap Fund 644,210 479,784 227,544
Money Fund 436,105 546,502 550,742
Natural Resources Fund 68,982 70,473 93,364
Real Estate Fund 241,521 318,900 528,864
Rising Dividends Fund 525,587 826,684 1,054,751
S&P 500 Index Fund 48,367 0(4) n/a
Small Cap Fund 1,588,387(3) 457,520 455,754
Strategic Income Fund 15,004 0(4) n/a
Technology Fund 0(4) n/a n/a
Government Fund 648,078 855,487 1,004,140
Value Fund 28,354 15,666 4,433(6)
Zero Coupon Fund - 2005 89,608 112,884 119,555
Zero Coupon Fund - 2010 85,841 120,676 132,677
Mutual Discovery Fund 300,017 302,448 351,377
Mutual Shares Fund 602,528 667,459 669,378
Asset Strategy Fund(1) 850,678 650,654(5) 715,727(5,7)
Templeton Developing Markets Fund(1) 499,440 254,273(5) 172,848(5,7)
108
Administration fees paid ($)
- ---------------------------------------------------------------------------------
2000 1999 1998
- ---------------------------------------------------------------------------------
Global Income Fund 127,938 177,066 250,588
Growth Securities Fund 1,343,436 982,673 1,048,256
International Securities Fund(1) 1,563,478 1,004,768(5) 986,271(5,7)
International Smaller Companies Fund 45,582 35,637 45,867
(1). Before the merger on May 1, 2000, the Fund's administrative fees were
based on the total net assets of TVP, with each Fund paying its
proportionate share based on each Fund's average net assets.
(2). For the period May 1, 2000 (effective date) to December 31, 2000.
(3). Before May 1, 2000, the administration fee was paid indirectly through
the management fee.
(4). No fees paid under an advance agreement by the administrator to waive
its fees.
(5). Included in the financials in the TVP Annual Report to Shareholders.
(6). For the period May 1, 1998 (effective date) to December 31, 1998.
(7). Before November 1, 1998, TFAC acted as Fund administrator of the Trust.
TFAC was responsible for providing substantially the same services as
FT Services now performs under a contract with an identical fee
schedule.
Shareholder servicing and transfer agent Franklin/Templeton Investor Services,
LLC (Investor Services) is the Funds' shareholder servicing agent and acts as
the Funds' transfer agent and dividend-paying agent. Investor Services is
located at 777 Mariners Island Blvd., P.O. Box 7777, San Mateo, CA 94403-7777.
Custodians Bank of New York, Mutual Funds Division, 90 Washington Street, New
York, NY 10286, acts as custodian of the Funds' securities and other assets,
except as noted below. In addition, The Chase Manhattan Bank, at its principal
office at MetroTech Center, Brooklyn, NY 11245, and at the offices of its
branches and agencies throughout the world, acts as custodian of the assets of
Asset Strategy Fund, Developing Markets Fund, Global Income Fund, Growth
Securities Fund, International Securities Fund and International Smaller
Companies Fund. As foreign custody manager, the bank selects and monitors
foreign sub-custodian banks, selects and evaluates non-compulsory foreign
depositories, and furnishes information relevant to the selection of compulsory
depositories.
Auditor PricewaterhouseCoopers LLP, 333 Market Street, San Francisco, CA 94105
is the Trust's independent auditor. The auditor gives an opinion on the
financial statements included in the Trust's Annual Report to Shareholders and
reviews the Trust's registration statement filed with the SEC.
109
Research services The managers may receive services from various affiliates. The
services may include information, analytical reports, computer screening
studies, statistical data, and factual resumes pertaining to securities eligible
for purchase by the Funds. Such supplemental research, when utilized, is subject
to analysis by the managers before being incorporated into the investment
advisory process.
Portfolio Transactions
- --------------------------------------------------------------------------------
The managers select brokers and dealers to execute the Funds' portfolio
transactions in accordance with criteria set forth in the management agreements
and any directions that the Board may give.
When placing a portfolio transaction, the managers seek to obtain prompt
execution of orders at the most favorable net price. For portfolio transactions
on a securities exchange, the amount of commission paid is negotiated between
the manager and the broker executing the transaction. The determination and
evaluation of the reasonableness of the brokerage commissions paid are based to
a large degree on the professional opinions of the persons responsible for
placement and review of the transactions. These opinions are based on the
experience of these individuals in the securities industry and information
available to them about the level of commissions being paid by other
institutional investors of comparable size. The managers will ordinarily place
orders to buy and sell over-the-counter securities on a principal rather than
agency basis with a principal market maker unless, in the opinion of the
managers, a better price and execution can otherwise be obtained. Purchases of
portfolio securities from underwriters will include a commission or concession
paid by the issuer to the underwriter, and purchases from dealers will include a
spread between the bid and ask price.
The managers may pay certain brokers commissions that are higher than those
another broker may charge, if the managers determine in good faith that the
amount paid is reasonable in relation to the value of the brokerage and research
services they receive. This may be viewed in terms of either the particular
transaction or the managers' overall responsibilities to client accounts over
which they exercise investment discretion. The services that brokers may provide
to the managers include, among others, supplying information about particular
companies, markets, countries, or local, regional, national or transnational
economies, statistical data, quotations and other securities pricing
information, and other information that provides lawful and appropriate
assistance to the managers in carrying out their investment advisory
responsibilities. These services may not always directly benefit the Funds. They
must, however, be of value to the managers in carrying out their overall
responsibilities to their clients.
To the extent a Fund invests in bonds or participates in other principal
transactions at net prices, the Fund incurs little or no brokerage costs. The
Fund deals directly with the selling or buying principal or market maker without
incurring charges for the services of a broker on its behalf, unless it is
determined that a better price or execution may be obtained by using the
services of a broker.
Purchases of portfolio securities from underwriters will include a commission or
concession paid by the issuer to the underwriter, and purchases from dealers
will include a spread between the
110
bid and ask prices. The Funds seek to obtain prompt execution of orders at the
most favorable net price. Transactions may be directed to dealers in return for
research and statistical information, as well as for special services provided
by the dealers in the execution of orders.
It is not possible to place a dollar value on the special executions or on the
research services the managers receive from dealers effecting transactions in
portfolio securities. The allocation of transactions to obtain additional
research services allows the managers to supplement their own research and
analysis activities and to receive the views and information of individuals and
research staffs of other securities firms. As long as it is lawful and
appropriate to do so, the managers and their affiliates may use this research
and data in their investment advisory capacities with other clients. If the
Trust's officers are satisfied that the best execution is obtained, the sale of
Fund shares, as well as shares of other funds in the Franklin Templeton
Investments, also may be considered a factor in the selection of broker-dealers
to execute the Funds' portfolio transactions.
Because Franklin Templeton Distributors, Inc. (Distributors) is a member of the
National Association of Securities Dealers, Inc., it may sometimes receive
certain fees when the Fund tenders portfolio securities pursuant to a
tender-offer solicitation. To recapture brokerage for the benefit of the Fund,
any portfolio securities tendered by the Fund will be tendered through
Distributors if it is legally permissible to do so. In turn, the next management
fee payable to the manager will be reduced by the amount of any fees received by
Distributors in cash, less any costs and expenses incurred in connection with
the tender.
If purchases or sales of securities of a Fund and one or more other investment
companies or clients supervised by the manager are considered at or about the
same time, transactions in these securities will be allocated among the several
investment companies and clients in a manner deemed equitable to all by the
manager, taking into account the respective sizes of the Funds and the amount of
securities to be purchased or sold. In some cases this procedure could have a
detrimental effect on the price or volume of the security so far as the Fund is
concerned. In other cases it is possible that the ability to participate in
volume transactions may improve execution and reduce transaction costs to the
Fund.
During the last three fiscal years ended December 31, the Funds paid the
following brokerage commissions:
Broker Commissions ($) 2000 1999 1998
- ------------------------------------------------------------------------------------
Aggressive Growth Fund 7,134(1) n/a n/a
Global Communications Fund 1,591,960 2,240,233 1,260,209
Global Health Care Fund 58,935 34,233 7,679(4)
Growth and Income Fund 1,609,865 1,462,576 978,165
High Income Fund 12,917 1,469 0
Income Securities Fund 0 0 135,052
Large Cap Fund 389,057 285,773 97,932
Money Fund 0 0 0
111
Broker Commissions ($) 2000 1999 1998
- ------------------------------------------------------------------------------------
Natural Resources Fund 120,287 118,031 221,927
Real Estate Fund 198,320 321,201 360,482
Rising Dividends Fund 327,751 468,845 687,070
S&P 500 Index Fund 15,697 4,396(2) n/a
Small Cap Fund 178,280 170,758 205,822
Strategic Income Fund 263 353 n/a
Technology Fund 7,764(1) n/a n/a
Government Fund 0 0 0
Value Fund 38,164 29,749 23,936(4)
Zero Coupon Fund - 2005 0 0 0
Zero Coupon Fund - 2010 0 0 0
Mutual Discovery Fund 469,166 826,555 752,153
Mutual Shares Fund 824,600 1,073,693 856,291
Asset Strategy Fund 755,161 1,099,879(3) 755,187(3)
Developing Markets Fund 1,787,125 1,207,123(3) 623,160(3)
Global Income Fund 0 0 0
Growth Securities Fund 2,738,293 1,563,908 965,410
International Securities Fund 1,954,173 1,430,2762(3) 1,302,179(3)
International Smaller Companies Fund 60,502 27,797 26,352
(1). From May 1, 2000 (effective date) to December 31, 2000.
(2). From November 1, 1999 (effective date) to December 31, 1999.
(3). Included in the financials in the TVP Annual Report to Shareholders.
(4). From May 1, 1998 (effective date) to December 31, 1998.
The following table identifies each Fund which held securities of its regular
brokers or dealers during 2000, the names of each such broker or dealer, and the
value, if any, of such securities as of December 31, 2000.
December 31,
2000 value ($)
Fund Name Regular Broker or Dealer (in 1,000's)
- --------------------------------------------------------------------------------
Money Fund Banc of America Securities LLC 10,000
Merrill Lynch Pierce Fenner 9,967
Deutsche Bank Securities 5,000
Goldman Sachs & Co. 9,952
Growth and Income Banc of America Securities LLC 8,946
J.P. Morgan Chase & Co. 7,795
FleetBoston Robertson Stephens 16,357
112
Natural Resources Merrill Lynch Pierce Fenner 1,199
International Securities HSBC Securities, Inc. 13,237
Developing Markets HSBC Securities, Inc. 1,123
Growth Securities HSBC Securities, Inc. 28,147
Merrill Lynch Pierce Fenner 17,047
Large Cap Banc of America Securities LLC 4,129
First Union Securities, Inc. 4,033
J.P. Morgan Chase & Co. 2,272
Mutual Discovery Lehman Brothers, Inc. 284
Mutual Shares J.P. Morgan Chase & Co. 3,894
Lehman Brothers, Inc. 3,760
Allmerica Financial Life & Annuity 3,357
S&P 500 Morgan Stanley Dean Witter 404
J.P. Morgan Chase & Co. 116
Banc of America Securities, LLC 336
Lehman Brothers, Inc. 74
Marsh & Mclannan Securities Corp. 145
American Express Financial Advisors 331
Salomon Smith Barney, Inc. 1,159
Because certain Funds may, from time to time, invest in broker-dealers, it is
possible that a Fund will own more than 5% of the voting securities of one or
more broker-dealers through whom a Fund places portfolio brokerage transactions.
In such circumstances, the broker-dealer would be considered an affiliated
person of the Fund. To the extent a Fund places brokerage transactions through
such a broker-dealer at a time when the broker-dealer is considered to be an
affiliate of the Fund, the Fund will be required to adhere to certain rules
relating to the payment of commissions to an affiliated broker-dealer. These
rules require the Fund to adhere to procedures adopted by the Board relating to
ensuring that the commissions paid to such broker-dealers do not exceed what
would otherwise be the usual and customary brokerage commissions for similar
transactions.
113
Distributions and Taxes
- --------------------------------------------------------------------------------
Each Fund calculates income dividends and capital gain distributions the same
way for each class. The amount of any income dividends per share will differ,
however, generally due to the difference in the distribution and service (Rule
12b-1) fees applicable to each class.
Investments in foreign securities The next three paragraphs describe tax
considerations that are applicable to funds that invest in foreign securities.
Effect of foreign withholding taxes. A Fund may be subject to foreign
withholding taxes on income from certain foreign securities. This, in turn,
could reduce the income dividends paid by the Fund.
Effect of foreign debt investments and hedging on distributions. Most foreign
exchange gains realized on the sale of debt securities are treated as ordinary
income by a Fund. Similarly, foreign exchange losses realized on the sale of
debt securities generally are treated as ordinary losses. These gains when
distributed are taxable as ordinary income, and any losses reduce the Fund's
ordinary income otherwise available for distribution. This treatment could
increase or decrease the Fund's ordinary income distributions, and may cause
some or all of the Fund's previously distributed income to be classified as a
return of capital.
PFIC securities. A Fund may invest in securities of foreign entities that could
be deemed for tax purposes to be passive foreign investment companies (PFICs).
When investing in PFIC securities, each Fund intends to mark-to-market these
securities and recognize any gains at the end of its fiscal and excise tax
years. Deductions for losses are allowable only to the extent of any current or
previously recognized gains. These gains (reduced by allowable losses) are
treated as ordinary income that a Fund is required to distribute, even though it
has not sold the securities.
Election to be taxed as a regulated investment company Each Fund has elected to
be treated as a regulated investment company under Subchapter M of the Internal
Revenue Code (Code). Each has qualified as a regulated investment company for
its most recent fiscal year, and intends to continue to qualify during the
current fiscal year. As a regulated investment company, a Fund generally pays no
federal income tax on the income and gains it distributes. To ensure that
individuals holding the variable annuity and variable life insurance contracts
whose assets are invested in a Fund will not be subject to federal income tax on
distributions made by a Fund prior to receipt of payments under the variable
annuity and variable life insurance contracts, each Fund intends to comply with
the additional requirements of Section 817(h) of the
114
Code relating to diversification of its assets. The Board reserves the right not
to maintain the qualification of a Fund as a regulated investment company if it
determines this course of action to be beneficial to shareholders. In that case,
the Fund would be subject to federal, and possibly state, corporate taxes on its
taxable income and gains.
Excise tax distribution requirements To avoid federal excise taxes, the Code
requires a Fund to make certain minimum distributions by December 31 of each
year. Federal excise taxes will not apply to a Fund, however, in any calendar
year in which all of its shareholders are segregated asset accounts of life
insurance companies where the shares are held in connection with variable
products.
Investment in complex securities Each Fund may invest in complex securities that
may be subject to numerous special and complex tax rules. For example, a Fund
may invest in securities issued or purchased at a discount, such as zero coupon,
step-up or payment-in-kind (PIK) bonds, that may require it to accrue and
distribute income not yet received. In order to generate sufficient cash to make
these distributions, a Fund may be required to sell securities in its portfolio
that it otherwise might have continued to hold. Other investments may be subject
to rules that could affect whether gains or losses recognized by a Fund are
treated as ordinary income or capital gain, or may defer a Fund's ability to
recognize losses. These rules could affect the amount, timing and tax character
of income distributed by a Fund.
Organization, Voting Rights and Principal Holders
- --------------------------------------------------------------------------------
The Trust is an open-end management investment company, commonly called a mutual
fund. The Trust was organized as a Massachusetts business trust on April 26,
1988, and is registered with the SEC. Each Fund, except the Global Health Care
Fund, Strategic Income Fund, Technology Fund, Value Fund and Global Income Fund,
is a diversified series of the Trust.
115
As a shareholder of a Massachusetts business trust, you could, under certain
circumstances, be held personally liable as a partner for its obligations. The
Agreement and Declaration of Trust, however, contains an express disclaimer of
shareholder liability for acts or obligations of the Fund. The Agreement and
Declaration of Trust also provides for indemnification and reimbursement of
expenses out of the Fund's assets if you are held personally liable for
obligations of the Fund. The Agreement and Declaration of Trust provides that
the Fund shall, upon request, assume the defense of any claim made against you
for any act or obligation of the Fund and satisfy any judgment thereon. All such
rights are limited to the assets of the Fund. The Declaration of Trust further
provides that the Fund may maintain appropriate insurance (for example, fidelity
bonding and errors and omissions insurance) for the protection of the Fund, its
shareholders, trustees, officers, employees and agents to cover possible tort
and other liabilities. Furthermore, the activities of the Fund as an investment
company, as distinguished from an operating company, would not likely give rise
to liabilities in excess of the Fund's total assets. Thus, the risk that you
would incur financial loss on account of shareholder liability is limited to the
unlikely circumstance in which both inadequate insurance exists and the Fund
itself is unable to meet its obligations.
Each of the Funds currently offer two classes of shares, Class 1 and Class 2,
except for the S&P 500 Index Fund which currently offers Class 1, Class 2 and
Class 3. The Trust may offer additional classes of shares in the future. The
full title of each series and class is:
. Franklin Aggressive Growth Securities Fund - Class 1
. Franklin Aggressive Growth Securities Fund - Class 2
. Franklin Global Communications Securities Fund - Class 1(1)
(prior to 11/15/99, Franklin Global Utilities Securities Fund)
(prior to 5/1/98, Utility Equity Fund)
. Franklin Global Communications Securities Fund - Class 2(1)
(prior to 11/15/99, Franklin Global Utilities Securities Fund)
. Franklin Global Health Care Securities Fund - Class 1(1)
. Franklin Global Health Care Securities Fund - Class 2(1)
. Franklin Growth and Income Fund - Class 1(1) (prior to 5/1/95,
Equity Growth Fund)
. Franklin Growth and Income Fund - Class 2(1)
. Franklin High Income Fund - Class 1(1)
. Franklin High Income Fund - Class 2(1)
. Franklin Income Securities Fund - Class 1(1)
. Franklin Income Securities Fund Class 2(1)
. Franklin Large Cap Growth Securities Fund - Class 1(1) (prior
to 12/15/99, Franklin Capital Growth Fund)
. Franklin Large Cap Growth Securities Fund - Class 2(1) (same
as Class 1)
. Franklin Money Market Fund - Class 1(1)
. Franklin Money Market Fund - Class 2(1)
116
. Franklin Natural Resources Securities Fund - Class 1(1) (prior
to 5/1/97, Precious Metals Fund)
. Franklin Natural Resources Securities Fund - Class 2(1)
. Franklin Real Estate Fund - Class 1 (prior to September 1999,
Real Estate Securities Fund)
. Franklin Real Estate Fund - Class 2 (same as Class 1)
. Franklin Rising Dividend Securities Fund - Class 1 (prior to
September 1999, Rising Dividends Fund)
. Franklin Rising Dividend Securities Fund - Class 2 (same as
Class 1)
. Franklin S&P 500 Index Fund - Class 1(2)
. Franklin S&P 500 Index Fund - Class 2(2)
. Franklin S&P 500 Index Fund - Class 3(2)
. Franklin Small Cap Fund - Class 1(1)
. Franklin Small Cap Fund - Class 2(1)
. Franklin Strategic Income Securities Fund - Class 1(2)
. Franklin Strategic Income Securities Fund - Class 2(2)
. Franklin Technology Securities Fund - Class 1
. Franklin Technology Securities Fund - Class 2
. Franklin U.S. Government Fund - Class 1(1)
. Franklin U.S. Government Fund - Class 2(1)
. Franklin Value Securities Fund - Class 1(1)
. Franklin Value Securities Fund - Class 2(1)
. Franklin Zero Coupon Fund - 2005 - Class 1(1)
. Franklin Zero Coupon Fund - 2005 - Class 2(1)
. Franklin Zero Coupon Fund - 2010 - Class 1(1)
. Franklin Zero Coupon Fund - 2010 - Class 2(1)
. Mutual Discovery Securities Fund - Class 1
. Mutual Discovery Securities Fund - Class 2
. Mutual Shares Securities Fund - Class 1
. Mutual Shares Securities Fund - Class 2
. Templeton Asset Strategy Fund - Class 1 (prior to May 1, 2000,
Templeton Asset Allocation Fund)
. Templeton Asset Strategy Fund - Class 2(2) (same as Class 1)
. Templeton Developing Markets Securities Fund - Class 1(2)
(prior to May 1, 2000, Templeton Developing Markets Fund)
. Templeton Developing Markets Securities Fund - Class 2(2)
(same as Class 1)
. Templeton Growth Securities Fund - Class 1
117
. Templeton Growth Securities Fund - Class 2
. Templeton Global Income Securities Fund Class 1 (prior to
5/1/96, Global Income Fund)
. Templeton Global Income Securities Fund Class 2
. Templeton International Securities Fund - Class 1(2) (prior to
May 1, 2000, Templeton International Fund)
. Templeton International Securities Fund - Class 2(2) (same as
Class 1)
. Templeton International Smaller Companies Fund - Class 1
. Templeton International Smaller Companies Fund - Class 2
(1). In September 1999, the names of the Funds were changed to include
"Franklin". (2). On February 8, 2000, Fund shareholders approved a
merger and reorganization that combined the Fund, a series of TVP with
a similar fund of the Trust, effective May 1, 2000. The Fund is the
surviving fund of the merger.
Shares of each class represent proportionate interests in a Fund's assets and
are identical except that the Fund's Class 2 shares will bear the expense of the
Class 2 distribution plan. (See "The Underwriter" below, for a description of
the Class 2 plans.) On matters that affect the Fund as a whole, each class has
the same voting and other rights and preferences as any other class. On matters
that affect only one class, only shareholders of that class may vote. Each class
votes separately on matters affecting only that class, or expressly required to
be voted on separately by state or federal law. Shares of each class of a series
have the same voting and other rights and preferences as the other classes and
series of the Trust for matters that affect the Trust as a whole. Additional
series may be offered in the future.
The Trust has non-cumulative voting rights. For Board member elections, this
gives holders of more than 50% of the shares voting the ability to elect all of
the members of the Board. If this happens, holders of the remaining shares
voting will not be able to elect anyone to the Board.
The Trust does not intend to hold annual shareholder meetings. The Trust or a
series of the Trust may hold special meetings, however, for matters requiring
shareholder approval. A meeting may also be called by the Board to consider the
removal of a Board member if requested in writing by shareholders holding at
least 10% of the outstanding shares. In certain circumstances, we are required
to help shareholders communicate with other shareholders about the removal of a
Board member. A special meeting may also be called by the Board in its
discretion.
Principal Shareholders Class 1 and Class 2 shares of the Funds generally are
sold to and owned only by insurance company separate accounts to serve as the
investment vehicle for variable annuity and life insurance contracts.
118
The insurance companies will exercise voting rights attributable to shares they
own in accordance with voting instructions received by owners of the contracts
issued by the insurance companies. To this extent, the insurance companies do
not exercise control over the Trust by virtue of the voting rights from their
ownership of Trust shares.
As of March 31, 2001, the principal shareholders of the Funds, beneficial or of
record, were:
Name and Address Share class Percentage (%)
- ------------------------------------ ------------------------------------------- --------------------------
Aggressive Growth Securities Fund - Class 1
Allianz Life Insurance 96.09
1750 Hennepin Ave.
Minneapolis, MN 55403
Aggressive Growth Securities Fund - Class 2
Preferred Life Insurance 100.00
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
Global Communications Fund - Class 1
Allianz Life Insurance 91.70
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 8.30
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
Global Communications Fund - Class 2
Allianz Life Insurance 98.26
1750 Hennepin Ave.
Minneapolis, MN 55403
Global Health Care Fund- Class 1
Allianz Life Insurance 92.51
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 7.49
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
119
Name and Address Share class Percentage (%)
- ------------------------------------ ------------------------------------------- --------------------------
Global Health Care Fund - Class 2
Allianz Life Insurance 98.09
1750 Hennepin Ave.
Minneapolis, MN 55403
Growth and Income Fund - Class 1
Allianz Life Insurance 91.47
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 8.53
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
Growth and Income Fund - Class 2
Allianz Life Insurance 99.36
1750 Hennepin Ave.
Minneapolis, MN 55403
High Income Fund - Class 1
Allianz Life Insurance 91.56
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 8.44
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
High Income Fund - Class 2
Allianz Life Insurance 100.00
1750 Hennepin Ave.
Minneapolis, MN 55403
Income Securities Fund - Class 1
Allianz Life Insurance 93.17
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 6.83
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
Income Securities Fund - Class 2
Allianz Life Insurance 46.12
1750 Hennepin Ave.
Minneapolis, MN 55403
American Enterprise Life 53.58
IDS Tower 10 T11/1646
Minneapolis, MN 55440
120
Name and Address Share class Percentage (%)
- ------------------------------------ ------------------------------------------- --------------------------
Large Cap Fund - Class 1
Allianz Life Insurance 91.36
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 6.62
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
Large Cap Fund - Class 2
Allianz Life Insurance 98.52
1750 Hennepin Ave.
Minneapolis, MN 55403
Money Fund - Class 1
Allianz Life Insurance 92.72
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 7.28
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
Money Fund - Class 2
Allianz Life Insurance 100.00
1750 Hennepin Ave.
Minneapolis, MN 55403
Natural Resources Fund - Class 1
Allianz Life Insurance 92.89
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 7.11
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
Natural Resources Fund - Class 2
Allmerica Financial Life & 81.37
Annuity Co.
440 Lincoln Street Mail Stop S-310
Worcester, MA 01653
First Allmerica Life & Annuity Co. 16.99
440 Lincoln Street Mail Stop S-10
Worcester, MA 01653
121
Name and Address Share class Percentage (%)
- ------------------------------------ ------------------------------------------- --------------------------
Real Estate Fund - Class 1
Allianz Life Insurance 93.50
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 6.50
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
Real Estate Fund - Class 2
IDS Life Insurance 69.99
Company of New York
IDS Tower 10 T11/1646
Minneapolis, MN 55440
Hartford Life 20.79
PO Box 2999
Hartford, CT 06104-2999
Rising Dividends Fund - Class 1
Allianz Life Insurance 90.25
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 9.75
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
Rising Dividends Fund - Class 2
Allianz Life Insurance 100.00
1750 Hennepin Ave.
Minneapolis, MN 55403
S&P 500 Index Fund - Class 1
Allianz Life Insurance 94.46
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 5.54
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
S&P 500 Index Fund - Class 2
Preferred Life Insurance 100.00
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
Small Cap Fund - Class 1
Allianz Life Insurance 92.98
1750 Hennepin Ave.
Minneapolis, MN 55403
122
Name and Address Share class Percentage (%)
- ------------------------------------ ------------------------------------------- --------------------------
Preferred Life Insurance 5.06
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
Small Cap Fund - Class 2
Pruco Life of Arizona 31.39
100 Mulberry Street
Gateway Center Three
6th, 7th & 8th Floors
Newark, NJ 07102-4077
Hartford Life 17.53
PO Box 2999
Hartford, CT 06104-2999
Allmerica Financial Life & 18.29
Annuity Co.
440 Lincoln Street Mail Stop S-310
Worcester, MA 01653
Travelers Life & Annuity 12.16
One Tower Square
Hartford, CT 06183
Strategic Income Fund - Class 1
Hartford Life 100
PO Box 2999
Hartford, CT 06104-2999
Technology Fund - Class 1
Allianz Life Insurance 91.50
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 8.50
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
Technology Fund - Class 2
Hartford Life 100.00
PO Box 2999
Hartford, CT 06104-2999
U.S. Government Fund - Class 1
Allianz Life Insurance 89.94
1750 Hennepin Ave.
Minneapolis, MN 55403
123
Name and Address Share class Percentage (%)
- ------------------------------------ ------------------------------------------- --------------------------
Preferred Life Insurance 10.06
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
U. S. Government Fund - Class 2
Allianz Life Insurance 85.08
1750 Hennepin Ave.
Minneapolis, MN 55403
SAFECO 14.92
5069 154th Place NE
Redmond, WA 98052
Value Fund - Class 1
Allianz Life Insurance 95.12
1750 Hennepin Ave.
Minneapolis, MN 55403
Value Fund - Class 2
IDS Life Insurance Company 94.59
IDS Tower 10 T11/1646
Minneapolis, MN 55440
Zero Coupon Fund - 2005 - Class 1
Allianz Life Insurance 90.28
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 9.72
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
Zero Coupon Fund - 2010 - Class 1
Allianz Life Insurance 92.38
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 7.62
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
Mutual Discovery Fund - Class 1
Allianz Life Insurance 94.29
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 5.71
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
124
Name and Address Share class Percentage (%)
- ------------------------------------ ------------------------------------------- --------------------------
Mutual Discovery Fund - Class 2
Allianz Life Insurance 99.97
1750 Hennepin Ave.
Minneapolis, MN 55403
Mutual Shares Fund - Class 1
Allianz Life Insurance 92.08
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 5.46
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
Mutual Shares Fund - Class 2
Hartford Life & Annuity 56.59
PO Box 2999
Hartford, CT 06104-2999
Allmerica Financial Life & 13.96
Annuity Co.
440 Lincoln Street Mail Stop S-310
Worcester, MA 01653
Lincoln Life & Annuity Co. 1300 8.57
South Clinton
Fort Wayne, IN 46802
Phoenix Variable Life 5.72
One American Row 1st Floor
Hartford, CT 06115
Allianz Life Insurance 5.02
1750 Hennepin Ave.
Minneapolis, MN 55403
Phoenix Home Life 5.72
One America Row
Hartford, CT 06115
Asset Strategy Fund - Class 1
VALIC 46.62
2929 Allen Parkway
Houston, TX 77019
Travelers Insurance Company 33.95
One Tower Square
Hartford, CT 06183
Phoenix Home Life 11.81
One American Row
Hartford, CT 06115
125
Name and Address Share class Percentage (%)
------------------------------------ ------------------------------------------- --------------------------
Allianz Life Insurance 6.68
1750 Hennepin Ave.
Minneapolis, MN 55403
Asset Strategy Fund - Class 2
Hartford Life & Annuity 34.92
PO Box 2999
Hartford, CT 06104-2999
Phoenix Home Life 30.49
One American Row
Hartford, CT 06115
Phoenix Variable Life 16.94
One American Row 1st Floor
Hartford, CT 06115
American General Life 5.65
PO Box 1591
Houston, TX 77251
Developing Markets Fund - Class 1
IDS Life Insurance Company 55.53
IDS Tower 10 T11/1646
Minneapolis, MN 55440
Allianz Life Insurance 28.76
1750 Hennepin Ave.
Minneapolis, MN
Developing Markets Fund - Class 2
Phoenix Home Life 9.23
One American Row
Hartford, CT 06115
CUNA 25.52
2000 Heritage Way
Waverly, IA 50677
Minnesota Life Insurance Company 22.40
400 Robert Street North
St. Paul, MN 55101-2098
Travelers Life & Annuity 12.16
One Tower Square
Hartford, CT 06183
John Hancock 7.81
One Financial Center 9th Floor
Boston, MA 02111
126
Name and Address Share class Percentage (%)
- ------------------------------------ ------------------------------------------- --------------------------
Phoenix Variable Life 7.61
One American Row 1st Floor
Hartford, CT 06115
Allianz Life Insurance 5.60
1750 Hennepin Ave.
Minneapolis, MN 55403
Global Income Fund - Class 1
Allianz Life Insurance 71.12
1750 Hennepin Ave.
Minneapolis, MN 55403
Preferred Life Insurance 7.55
Company of New York
152 West 57th Street, 18th Floor
New York, NY 10019
Travelers Insurance Co. 12.84
One Tower Square
Hartford, CT 06183
Phoenix Home Life 6.74
One American Row
Hartford, CT 06115
Global Income Fund - Class 2
Allianz Life Insurance 34.23
1750 Hennepin Ave.
Minneapolis, MN 55403
Glenbrook 65.77
3100 Sanders Road
Northbrook, IL 60062
Growth Securities Fund - Class 1
Allianz Life Insurance 44.12
1750 Hennepin Ave.
Minneapolis, MN 55403
Travelers Insurance Company 37.76
One Tower Square
Hartford, CT 06183
Phoenix Home Life 13.37
One American Row
Hartford, CT 06115
127
Name and Address Share class Percentage (%)
- ------------------------------------ ------------------------------------------- --------------------------
Growth Securities Fund - Class 2
Glenbrook 10.48
3100 Sanders Road
Northbrook, IL 60062
Hartford Life & Annuity 21.75
PO Box 2999
Hartford, CT 06104-2999
Phoenix Variable Life 33.20
One American Row 1st Floor
Hartford, CT 06115
Phoenix Home Life 10.01
One American Row
Hartford, CT 06115
Union Central 5.72
PO Box 40888
1876 Waycross Road
Cincinnati, OH 45240
International Securities Fund - Class 1
Phoenix Home Life 6.75
One American Row
Hartford, CT 06115
Allianz Life Insurance 66.86
1750 Hennepin Ave.
Minneapolis, MN 55403
Jefferson Pilot 9.26
One Granit Place
PO Box 515
Concord, NH 03302-0515
International Securities Fund - Class 2
Union Central 7.35
PO Box 40888
1876 Waycross Road
Cincinnati, OH 45240
Travelers Life & Annuity 21.10
One Tower Square
Hartford, CT 06183
Phoenix Home Life 5.92
One America Row
Hartford, CT 06115
Hartford Life 8.34
PO Box 2999
Hartford CT 06104-2999
128
Name and Address Share class Percentage (%)
- ------------------------------------ ------------------------------------------- --------------------------
Connecticut Mutual 6.90
1295 State Street
Springfield, MA 01111
Phoenix Home Life 8.29
One American Row
Hartford, CT 06115
John Hancock 6.14
One Financial Center 9th Floor
Boston, MA 02111
Allianz Life Insurance 8.73
1750 Hennepin Ave.
Minneapolis, MN 55403
International Smaller Companies Fund -
Class 1
Allianz Life Insurance 95.05
1750 Hennepin Ave.
Minneapolis, MN 55403
International Smaller Companies Fund -
Class 2
IDS Life Insurance Co. 67.35
IDS Tower 10 T11/1646
Minneapolis, MN 55440
Allianz Life Insurance 15.69
1750 Hennepin Ave.
Minneapolis, MN 55403
Allmerica Financial Life & 10.45
Annuity Co.
440 Lincoln Street
Mail Stop S-310
Worcester, MA 01653
As of March 31, 2001, Board members and officers, as a group, owned less than
1%, of record or beneficially, of the outstanding shares of Trust. The Board
members may own shares in other funds in Franklin Templeton Investments.
Pricing Shares
- --------------------------------------------------------------------------------
When they buy and sell shares, the Trust's shareholders pay and receive the net
asset value (NAV) per share.
The value of a mutual fund is determined by deducting the fund's liabilities
from the total assets of the portfolio. The net asset value per share is
determined by dividing the net asset value of the fund by the number of shares
outstanding.
129
The Funds calculate the NAV per share of each class each business day at the
close of trading on the New York Stock Exchange (normally 1:00 p.m. Pacific
time). The Funds do not calculate the NAV on days the New York Stock Exchange
(NYSE) is closed for trading, which include New Year's Day, Martin Luther King
Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day and Christmas Day.
Funds other than Money Fund When determining its NAV, a Fund values cash and
receivables at their realizable amounts, and records interest as accrued and
dividends on the ex-dividend date. If market quotations are readily available
for portfolio securities listed on a securities exchange or on the Nasdaq
National Market System, the Fund values those securities at the last quoted sale
price of the day or, if there is no reported sale, within the range of the most
recent quoted bid and ask prices. The Fund values over-the-counter portfolio
securities within the range of the most recent quoted bid and ask prices. If
portfolio securities trade both in the over-the-counter market and on a stock
exchange, the Fund values them according to the broadest and most representative
market as determined by the manager.
A Fund values portfolio securities underlying actively traded call options at
their market price as determined above. The current market value of any option
the Fund holds is its last sale price on the relevant exchange before the Fund
values its assets. If there are no sales that day or if the last sale price is
outside the bid and ask prices, the Fund values options within the range of the
current closing bid and ask prices if the Fund believes the valuation fairly
reflects the contract's market value.
A Fund determines the value of a foreign security as of the close of trading on
the foreign exchange on which the security is traded or as of the close of
trading on the NYSE, if that is earlier. The value is then converted into its
U.S. dollar equivalent at the foreign exchange rate in effect at noon, New York
time, on the day the value of the foreign security is determined. If no sale is
reported at that time, the foreign security is valued within the range of the
most recent quoted bid and ask prices. Occasionally events that affect the
values of foreign securities and foreign exchange rates may occur between the
times at which they are determined and the close of the exchange and will,
therefore, not be reflected in the computation of the NAV. If events materially
affecting the values of these foreign securities occur during this period, the
securities will be valued in accordance with procedures established by the
Board. Generally, trading in corporate bonds, U.S. government securities and
money market instruments is substantially completed each day at various times
before the close of the NYSE. The value of these securities used in computing
the NAV is determined as of such times. Occasionally, events affecting the
values of these securities may occur between the times at which they are
determined and the close of the NYSE that will not be reflected in the
computation of the NAV. If events materially affecting the values of these
securities occur during this period, the securities will be valued at their fair
value as determined in good faith by the Board.
Other securities for which market quotations are readily available are valued at
the current market price, which may be obtained from a pricing service, based on
a variety of factors including recent trades, institutional size trading in
similar types of securities (considering yield, risk and maturity) and/or
developments related to specific issues. Securities and other assets for which
market prices are not readily available are valued at fair value as determined
following
130
procedures approved by the Board. With the approval of the Board, the fund may
use a pricing service, bank or securities dealer to perform any of the above
described functions.
Money Fund The valuation of the Fund's portfolio securities, including any
securities set aside on the Fund's books for when-issued securities, is based on
the amortized cost of the securities, which does not take into account
unrealized capital gains or losses. This method involves valuing an instrument
at its cost and thereafter assuming a constant amortization to maturity of any
discount or premium, regardless of the impact of fluctuating interest rates on
the market value of the instrument. While this method provides certainty in
calculation, it may result in periods during which value, as determined by
amortized cost, is higher or lower than the price the Fund would receive if it
sold the instrument. During periods of declining interest rates, the daily yield
on shares of the Fund computed as described above may tend to be higher than a
like computation made by a Fund with identical investments but using a method of
valuation based upon market prices and estimates of market prices for all of its
portfolio instruments. Thus, if the use of amortized cost by the Fund resulted
in a lower aggregate portfolio value on a particular day, a prospective investor
in the Fund would be able to obtain a somewhat higher yield than would result
from an investment in a Fund using only market values, and existing investors in
the Fund would receive less investment income. The opposite would be true in a
period of rising interest rates. The Fund's use of amortized cost, which helps
the Fund maintain a $1 share price, is permitted by a rule adopted by the SEC.
The Board has established procedures designed to stabilize, to the extent
reasonably possible, the Fund's price per share at $1, as computed for the
purpose of sales and redemptions. These procedures include a review of the
Fund's holdings by the Board, at such intervals as it may deem appropriate, to
determine if the Fund's net asset value calculated by using available market
quotations deviates from $1 per share based on amortized cost. The extent of any
deviation will be examined by the Board. If a deviation exceeds 1/2 of 1%, the
Board will promptly consider what action, if any, will be initiated. If the
Board determines that a deviation exists that may result in material dilution or
other unfair results to investors or existing shareholders, it will take
corrective action that it regards as necessary and appropriate, which may
include selling portfolio instruments before maturity to realize capital gains
or losses or to shorten average portfolio maturity, withholding dividends,
redeeming shares in kind, or establishing a net asset value per share by using
available market quotations.
Redemptions in kind The Fund has committed itself to pay in cash (by check) all
requests for redemption by any shareholder of record, limited in amount,
however, during any 90-day period to the lesser of $250,00 or 1% of the value of
the Fund's net assets at the beginning of the 90-day period. This commitment is
irrevocable without the prior approval of the SEC. In the case of redemption
requests in excess of these amounts, the Board reserves the right to make
payments in whole or in part in securities or other assets of the Fund, in case
of an emergency, or if the payment of such a redemption in cash would be
detrimental to the existing shareholders of the Fund. In these circumstances,
the securities distributed would be valued at the price used to compute the
Fund's net assets and you may incur brokerage fees in converting the securities
to cash. The Fund does not intend to redeem illiquid securities in kind. If this
happens, however, you may not be able to recover your investment in a timely
manner.
131
The Underwriter
- --------------------------------------------------------------------------------
Distributors acts as the principal underwriter in the continuous public offering
of the Trust's shares. Distributors is located at 777 Mariners Island Blvd., San
Mateo, CA 94404.
Distributors pays the expenses of the distribution of Fund shares, including
advertising expenses and the costs of printing sales material and prospectuses
used to offer shares to the public except to the extent these expenses are borne
by the insurance companies The Fund pays the expenses of preparing and printing
amendments to its registration statements and prospectuses (other than those
necessitated by the activities of Distributors) and of sending prospectuses to
existing shareholders.
Distributors may be entitled to receive payment under Class 2 Rule 12b-1 plans
as described below. Except as noted below, Distributors does not receive
compensation from the Trust for acting as underwriter.
Distribution and service (12b-1) fees The Board has adopted a plan pursuant to
Rule 12b-1 for each Class 2 shares. Under each Fund's Class 2 plan (except for
S&P 500 Index Fund, Strategic Income Fund, Asset Strategy Fund, Global Income
Fund, International Fund and Developing Markets Fund), the Fund may pay up to a
maximum of 0.35% per year of the average daily net assets attributable to its
Class 2 shares. The Board, however, has set the current rate at 0.25% per year,
effective July 1, 1999. From January 6, 1999 to June 30, 1999, the fees were set
at 0.30% per year. The maximum rate for Class 2 shares of S&P 500 Index Fund,
Strategic Income Fund, Global Income Fund, Asset Strategy Fund, Developing
Markets Fund and International Fund has been set at 0.25% per year under each
plan.
The plans are expected to, among other things, increase advertising of the
Funds, encourage sales of the Funds and service to its shareholders, and
increase or maintain assets of the Fund so that certain fixed expenses may be
spread over a broader asset base, resulting in lower per share expense ratios.
In addition, a positive cash flow into the Funds is useful in managing the Funds
because the managers have more flexibility in taking advantage of new investment
opportunities and handling shareholder redemptions.
Under each plan, the Funds pay Distributors, the insurance companies or others
to assist in the promotion and distribution of Class 2 shares or variable
contracts offering Class 2 shares. Payments made under the plans may be used
for, among other things, the printing of prospectuses and reports used for sales
purposes, preparing and distributing sales literature and related expenses,
advertisements, education of contract owners or dealers and their
representatives, and other distribution-related expenses, including a prorated
portion of Distributors' or the insurance companies' overhead expenses
attributable to the distribution of these variable contracts or shares of the
Funds. Payments made under the plans may also be used to pay insurance
companies, dealers or others for, among other things, furnishing personal
132
services and maintaining customer accounts and records, or as service fees as
defined under NASD rules. Together, these expenses, including the service fees,
are "eligible expenses."
Agreements for the payment of fees to the insurance companies or others shall be
in a form which has been approved from time to time by the Board, including the
non-interested Board members.
For the fiscal year ended December 31, 2000, the amounts paid by each Fund's
Class 2 shares pursuant to the plans, which were used by Distributors to pay
insurance companies or their affiliates were as follows:
Amounts
Fund Paid ($)
----------------------------------------------------------------------
Aggressive Growth Fund 0
Global Communications Fund 1,489
Global Health Care Fund 561
Growth and Income Fund 2,657
High Income Fund 1,052
Income Securities Fund 3,817
Large Cap Fund 2,794
Money Fund 16,512
Natural Resources Fund 456
Real Estate Fund 17,546
Rising Dividends Fund 1,353
Small Cap Fund 293,132
Strategic Income Fund 0
S&P 500 Index Fund - Class 2 217
Technology Fund 108
U.S. Government Fund 4,863
Value Fund 7,648
Zero Coupon Fund - 2005 0
Zero Coupon Fund - 2010 0
Mutual Discovery Fund 1,375
Mutual Shares Fund 36,875
Asset Strategy Fund 59,994
Developing Markets Fund 137,544
Global Income Fund 1,958
Growth Securities Fund 96,873
International Securities Fund 334,839
133
Distributors must provide written reports to the Board at least quarterly on the
amounts and purpose of any payment made under the plans and any related
agreements, and furnish the Board with such other information as the Board may
reasonably request to enable it to make an informed determination of whether the
plans should be continued.
Each plan has been approved according to the provisions of Rule 12b-1. The terms
and provisions of each plan also are consistent with Rule 12b-1.
Performance
- --------------------------------------------------------------------------------
Performance quotations are subject to SEC rules. These rules require the use of
standardized performance quotations or, alternatively, that every
non-standardized performance quotation furnished by the Fund be accompanied by
certain standardized performance information computed as required by the SEC.
Average annual total return and current yield quotations used by a Fund are
based on the standardized methods of computing performance mandated by the SEC.
Performance figures reflect Rule 12b-1 fees from the date of the plan's
implementation. An explanation of these and other methods used by the Fund to
compute or express performance follows.
For share classes offered only to insurance company separate accounts for use in
variable annuity and variable life insurance contracts, to the extent required
by SEC rules, the advertised performance of such share classes will be displayed
no more prominently than standardized performance of the applicable insurance
company separate accounts/contracts. For information about how an insurance
company may advertise such performance, please consult the contract prospectus
which accompanies the Trust prospectus.
Regardless of the method used, past performance does not guarantee future
results, and is an indication of the return to shareholders only for the limited
historical period used.
For Class 2 shares which were started at a later date than Class 1 shares,
standardized Fund performance represents, a "blended" figure, combining: (a) for
periods prior to January 6, 1999 (or May 1, 1997 for Asset Strategy Fund,
Developing Markets Fund and International Securities Fund) historical results of
Class 1 shares; and (b) for periods beginning January 6, 1999 (or May 1, 1997),
Class 2's results reflect an additional 12b-1 fee expense which also affects
future performance. Historical performance data for Class 2 shares, based on
Class 1 performance, will generally not be restated to include 12b-1 fees,
although each Fund may restate these figures consistent with SEC rules.
For Asset Strategy Fund, Developing Markets Fund and International Securities
Fund, performance prior to the May 1, 2000 merger reflects the historical
performance of Templeton Asset Allocation Fund, Templeton Developing Markets
Fund and Templeton International Fund, respectively.
134
Average annual total return is determined by finding the average annual rates of
return over the periods indicated below that would equate an initial
hypothetical $1,000 investment to its ending redeemable value. The calculation
assumes income dividends and capital gain distributions are reinvested at net
asset value. The quotation assumes the account was completely redeemed at the
end of each period and the deduction of all applicable fund charges and fees. It
does not however, include any fees or sales charges imposed by the variable
insurance contract for which the funds' Class 1 and Class 2 shares are
investment options. If they were included, performance would be lower. The
average annual total returns for each Fund for the periods ended December 31,
2000, are reflected in the Trust's Annual Report to Shareholders for the fiscal
year ended December 31, 2000.
The following SEC formula was used to calculate the figures:
P(1+T)n = ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of each period at the end of each period
Cumulative total return Like average annual total return, the cumulative total
return assumes income dividends and capital gain distributions are reinvested at
net asset value. It does not however, include any fees or sales charges imposed
by the variable insurance contract for which the Funds' Class 1 and Class 2
shares are investment options. If they were included, performance would be
lower. Cumulative total return, however, is based on the actual return for a
specified period rather than on the average return over the periods indicated in
the annual report. The cumulative total returns for the indicated periods ended
December 31, 2000, were:
Ten Year
One Five or From
Year Year Inception
(%) (%) (%)
-------------------- ------------------- --------------------
Aggressive Growth Fund -Class 1 -- -- -24.10(1)
Global Communications Fund - Class 1 -32.85 41.28 145.60
Global Communications Fund - Class 2 -32.97 40.61 144.44
Global Health Care Fund - Class 1
72.57 -- 69.86(2)
Global Health Care Fund - Class 2 72.13 -- 68.91(2)
Growth and Income Fund - Class 1 17.99 88.52 257.17
135
Ten Year
One Five or From
Year Year Inception
(%) (%) (%)
-------------------- ------------------- --------------------
Growth and Income Fund - Class 2 17.79 87.72 255.64
High Income Fund - Class 1 -13.00 11.48 128.40
High Income Fund - Class 2 -13.15 10.96 127.33
Income Securities Fund - Class 1 19.77 55.74 235.60
Income Securities Fund Class 2 19.43 54.89 233.78
Large Cap Fund - Class 1 5.75 -- 125.08(3)
Franklin Large Cap Growth Fund - Class 2 5.46 -- 123.72(3)
Money Fund - Class 1 5.95 29.28 58.23
Money Fund - Class 2 5.69 28.61 57.41
Natural Resources Fund - Class 1 36.48 13.49 65.35
Natural Resources Fund - Class 2 36.26 13.10 64.78
Real Estate Fund - Class 1 31.95 65.15 255.66
Real Estate Fund - Class 2 31.59 64.32 253.88
Franklin Rising Dividend Securities Fund - Class 1 21.05 93.06 154.64(4)
Franklin Rising Dividends Fund - Class 2 20.71 91.88 153.08(4)
S&P 500 Index Fund - Class 1 -8.47 -- -3.34(5)
Small Cap Fund - Class 1 -14.60 152.42 158.22(6)
Small Cap Fund - Class 2 -14.76 151.18 156.96(6)
Strategic Income Fund - Class 1 4.95 -- 7.68(5)
Technology Fund -Class 1 -- -- -24.20(1)
Technology Fund - Class 2 -- -- -24.30(1)
U.S. Government Fund - Class 1 11.82 34.79 110.52
U.S. Government Fund - Class 2 11.39 34.06 109.37
Value Fund - Class 1 25.23 -- -0.83(2)
Value Fund - Class 2 25.02 -- -1.25(2)
Zero Coupon Fund - 2005 - Class 1 12.56 32.10 156.57
Zero Coupon Fund - 2010 - Class 1 18.72 35.27 185.80
Mutual Discovery Fund - Class 1 10.45 -- 58.11(7)
Mutual Discovery Fund - Class 2 10.21 -- 57.43(7)
Mutual Shares Fund - Class 1 13.62 -- 57.14(7)
Mutual Shares Fund - Class 2 13.25 -- 56.88(7)
Asset Strategy Fund - Class 1 .29 80.04 272.63
Asset Strategy Fund - Class 2 .04 78.37 269.17
Developing Markets Fund - Class 1 -31.76 -- -44.60(8)
Developing Markets Fund - Class 2 -32.04 -- -45.18(8)
Growth Securities Fund - Class 1 1.74 84.73 114.79(9)
Growth Securities Fund - Class 2 1.47 83.94 113.87(9)
Global Income Securities Fund - Class 1 4.31 18.24 68.21
Global Income Securities Fund -Class 2 4.14 17.66 67.38
International Securities Fund - Class 1 -2.19 86.86 192.55(10)
International Securities Fund - Class 2 -2.38 85.12 189.83
International Smaller Companies Fund - Class 1 -1.03 -- 19.20
International Smaller Companies Fund - Class 2 -1.24 -- 18.96
136
(1). Inception date 05-01-00
(2). Inception date 05-01-98.
(3). Inception date 05-01-96.
(4). Inception date 01-27-92.
(5). Inception date 11-01-99
(6). Inception date 11-01-95.
(7). Inception date 11-08-96.
(8). Inception date 03-04-96.
(9). Inception date 03-15-94.
(10). Inception date 05-01-92.
Yield, Money Fund
Current yield. Current yield shows the income per share earned by the Fund. It
is calculated by determining the net change, excluding capital changes, in the
value of a hypothetical pre-existing account having a balance of one share at
the beginning of the period, subtracting a hypothetical charge reflecting
deductions from shareholder accounts, and dividing the difference by the value
of the account at the beginning of the base period to obtain the base period
return. The result is then annualized by multiplying the base period return by
(365/7). It does not include any fees or sales charges imposed by the variable
insurance contract for which the Fund is an investment option. The Fund's
current yield for the seven-day period ended December 31, 2000, was 6.02% for
Class 1 and 5.78% for Class 2.
Effective yield. The fund's effective yield is calculated in the same manner as
its current yield, except the annualization of the return for the seven-day
period reflects the results of compounding. The fund's effective yield for the
seven-day period ended December 31, 2000, was 6.20% for Class 1 and 5.94% for
Class 2.
This figure was obtained using the following SEC formula:
365/7
Effective Yield = [(Base Period Return + 1) ] - 1
Yield, other than Money Fund From time to time, the current yields of the Funds
may be published in advertisements and communications to Contract Owners. The
current yield for each Fund will be calculated by dividing the annualization of
the income earned by the Fund during a recent 30-day period by the net asset
value per share at the end of such period. In addition, aggregate, cumulative
and average total return information for each Fund over different periods of
time may also be advertised. Except as stated above, each Fund will use the same
methods for calculating its performance.
137
A distribution rate for each Fund may also be published in communications
preceded or accompanied by a copy of the Trust's current prospectus. The Fund's
current distribution rate will be calculated by dividing the annualization of
the total distributions made by that Fund during the most recent preceding
fiscal quarter by the net asset value per share at the end of such period. The
current distribution rate may differ from current yield because the distribution
rate will be for a different period of time and may contain items of capital
gain and other items of income, while current yield reflects only earned income.
Uniformly computed yield and total return figures for each Fund will also be
published along with publication of its distribution rate.
Hypothetical performance information may also be prepared for sales literature
or advertisements. See the appropriate insurance company separate account
prospectus and SAI.
Volatility Occasionally statistics may be used to show a Fund's volatility or
risk. Measures of volatility or risk are generally used to compare a fund's net
asset value or performance to a market index. One measure of volatility is beta.
Beta is the volatility of a fund relative to the total market, as represented by
an index considered representative of the types of securities in which the fund
invests. A beta of more than 1.00 indicates volatility greater than the market
and a beta of less than 1.00 indicates volatility less than the market. Another
measure of volatility or risk is standard deviation. Standard deviation is used
to measure variability of net asset value or total return around an average over
a specified period of time. The idea is that greater volatility means greater
risk undertaken in achieving performance.
Comparisons To help you better evaluate how an investment in a Fund may satisfy
your investment goal, advertisements and other materials about the Fund may
discuss certain measures of Fund performance as reported by various financial
publications. Materials may also compare performance (as calculated above) to
performance as reported by other investments, indices, and averages. These
comparisons may include, but are not limited to, the following examples:
o Consumer Price Index is a measure of the average change in
prices for a fixed basket of goods and services regularly
bought by consumers in the United States; published by the
U.S. Bureau of Labor Statistics.
o CDA Mutual Fund Report, published by CDA Investment
Technologies, Inc., analyzes price, current yield, risk, total
return, and average rate of return (average annual compounded
growth rate) over specified time periods for the mutual fund
industry.
138
o Credit Suisse First Boston Global High Yield (CSFB HY) Index,
an unmanaged, trader-priced portfolio constructed to mirror
the high yield debt market. The index has several modules
representing different sectors of the high yield market
including a cash paying module, a zerofix module, a
pay-in-kind module, and a defaulted module. The modular nature
of the index allows customization of data to meet client
needs. The index is divided into other categories including
industry, rating, seniority, liquidity, market value, security
price range, yield range and other sector divisions. The CSFB
HY Index follows a total of 250 sectors. CS First Boston has
maintained the index since January 1986. While the index is
priced and run weekly, monthly returns are typically used for
performance attribution.
o Dow Jones(R) Composite Average and its component averages,
price-weighted averages of 65 stocks that trade on the New
York Stock Exchange. The average is a combination of the Dow
Jones Industrial Average (30 blue-chip stocks that are
generally leaders in their industry), the Dow Jones
Transportation Average (20 transportation stocks), and the Dow
Jones Utilities Average (15 utility stocks involved in the
production of electrical energy).
o Dow Jones Industrial Average, price-weighted based on the
average market price of 30 blue chip stocks. The average is
found by adding the prices of the 30 stocks and dividing by a
denominator that has been adjusted for stock splits, stock
dividends, and substitutions of stocks. It represents about
25% of the NYSE market capitalizations.
139
o International Finance Corporation's (IFC) Investable Composite
Index, tracks the emerging stock markets of three world
regions based on market capitalization weighting. Those
regions are Latin America, Asia and Europe/Mideast/Africa. As
of January 2000, the regional weights of the IFC Composite
Index were distributed accordingly: Asia, 43%; Latin America,
26%; and Europe/Mideast/Africa, 31%.
o JP Morgan Global Government Bond Index, tracks total returns
of government bonds in developed countries globally. The bonds
included in the index are weighted according to their market
capitalization. The index is unhedged and expressed in terms
of U.S. dollars
o Lehman Brothers Government/CreditBond Index, includes
securities in the Lehman Brothers Government and Corporate
indices. These securities must have at least $100 million par
amount outstanding and must be rated investment grade (Baa3 or
better) by Moody's. If a Moody's rating is not available, the
Standard & Poor's or Fitch rating is used. These must be
fixed-rate securities, although they can carry a coupon that
steps up or changes according to a predetermined schedule, and
they must be dollar-denominated and non-convertible.
o Lehman Brothers Intermediate Government Bond Index, includes
securities issued by the U.S. government or its agencies with
maturities from one up to, but not including, 10 years. These
securities must have at least $150 million par amount
outstanding and must be rated investment grade (Baa3 or
better) by Moody's Investors Service. If a Moody's rating is
not available, the Standard & Poor's or Fitch rating is used.
These must be fixed-rate securities, although they can carry a
coupon that steps up or changes according to a predetermined
schedule, and they must be dollar-denominated and
non-convertible.
o Lehman Brothers U.S. Aggregate Index, includes fixed-rate debt
issues rated investment grade or higher by Moody's, S&P, or
Fitch, in that order. All issues have at least one year to
maturity and an outstanding par value of at least $150 million
for U.S. government issues and $50 million for all others. All
returns are market-value weighted inclusive of accrued
interest. The index is a composite of the Government/Credit
Index, Mortgage-Backed Securities Index Asset-Backed
Securities Index, and CMBS (Erisa eligible). Total return
includes price appreciation/depreciation and income as a
percentage of the original investment. The total return index
is rebalanced monthly by market capitalization.
140
o Lipper - Mutual Fund Performance Analysis and Lipper - Equity
Fund Performance Analysis, measure total return and average
current yield for the mutual fund industry and rank individual
mutual fund performance over specified time periods, assuming
reinvestment of all distributions, exclusive of any applicable
sales charges.
o Lipper VIP Growth & Income Funds Objective Average, an equally
weighted average calculation of performance figures for all
funds within the Lipper Growth and Income Funds Objective
Category, which is defined as all mutual funds that combine a
growth of earnings orientation and an income requirement for
level and/or rising dividends. As of 12/31/00, there were 224
funds in this category.
o Lipper VIP Income Funds Objective Average, an equally weighted
average calculation of performance figures for all funds
within the Lipper Income Funds Objective Category, which is
defined as all mutual funds that normally seek a high level of
current income through investing in income-producing stocks,
bonds and money market instruments. As of 12/31/00, there were
16 funds in this category.
o Lipper VIP U.S. Mortgage Funds Objective Average, an equally
weighted average calculation of performance figures for all
funds within the Lipper U.S. Mortgage Funds Objective
Classification in the Lipper VIP underlying funds universe.
o Lipper U.S. Mortgage Funds, defined as all funds that invest
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. As of 12/31/00, there were 7
funds in this category.
o Merrill Lynch Treasury Zero Coupon 1-, 5-, 10-, 20-Year Bond
Total Return, include zero coupon bonds that pay no interest
and are issued at a discount from redemption price.
o Morgan Stanley Capital International (MSCI) All Country World
Free Index, represents both developed and emerging markets
around the world. "Free" in the title reflects the actual
buying opportunities for global investors by taking into
account local market restrictions on share ownership by
foreigners. The MSCI indices define the local market for each
country by constructing a matrix of all listed securities,
sorting the matrix by industry, and seeking to capture 60% of
the market capitalization for each group by selecting the most
investable stocks in each industry. The index applies full
market capitalization weights to each included stock.
141
o Morgan Stanley Capital International (MSCI) All Country -
World Ex-U.S. Free Index, comprises 48 countries around the
world, both developed and emerging markets, except the U.S.
"Free" in the title reflects the actual buying opportunities
for global investors by taking into account local market
restrictions on share ownership by foreigners. The MSCI
indices define the local market for each country by
constructing a matrix of all listed securities, sorting the
matrix by industry, and seeking to capture 60% of the market
capitalization for each group by selecting the most investable
stocks in each industry. The index applies full market
capitalization weights to each included stock.
o Morgan Stanley Capital International (MSCI) Europe
Australasia, Far East (EAFE) Index, represents 20 developed
market countries for Europe Australasia and the Far East:
Australia, Austria, Belgium, Denmark, Finland, France,
Germany, Hong Kong, Ireland, Italy, Japan, the Netherlands,
New Zealand, Norway, Portugal, Singapore, Spain, Sweden,
Switzerland and the U.K. The MSCI indices define the local
market for each country by constructing a matrix of all listed
securities, sorting the matrix by industry, and seeking to
capture 60% of the market cap for each group by selecting the
most investable stocks in each industry. The index applies
full market cap weights to each included stock.
o Morgan Stanley Capital International (MSCI) Emerging Markets
Free Index, a market capitalization-weighted equity index
comprising 26 of the 48 countries in the MSCI universe. "Free"
denotes investment opportunities in the developing world
available to foreign investors. EMF performance data is
calculated in $US and local currency. The MSCI indices define
the local market for each country by constructing a matrix of
all listed securities, sorting the matrix by industry, and
seeking to capture 60% of the market cap for each group by
selecting the most investable stocks in each industry. The
index applies full market cap weights to each included stock.
o Morgan Stanley Capital International (MSCI) Pacific Index,
comprises five developed market countries or regions in the
Pacific: Australia, Hong Kong, Japan, New Zealand and
Singapore. The MSCI indices define the local market for each
country by constructing a matrix of all listed securities,
sorting the matrix by industry, and seeking to capture 60% of
the market capitalization for each group by selecting the most
investable stocks in each industry. The index applies full
market capitalization weights to each included stock.
o Morgan Stanley Capital International (MSCI) World Index,
comprises the developed markets of 22 countries around the
world. The MSCI indices define the local market for each
country by constructing a matrix of all listed securities,
sorting the matrix by industry, and seeking to capture 60% of
the market cap for each group by selecting the most investable
stocks in each industry. The index applies full market cap
weights to each included stock.
o New York Stock Exchange composite or component indices is an
unmanaged index of all industrial, utilities, transportation,
and finance stocks listed on the NYSE.
142
o Russell Midcap Value Index, measures the performance of those
Russell Midcap companies with lower price-to-book ratios and
lower forecasted growth values. The stocks are also members of
the Russell 1000 Value Index.
o Russell 1000 Index - Published by Frank Russell Company,
measures the performance of the 1,000 largest companies in the
Russell 3000 Index, representing 92% of the market
capitalization of the Russell 3000. The Russell 3000 contains
the 3,000 largest companies incorporated in the U.S. and its
territories. As of the latest reconstitution, the average
market capitalization of the companies in the Russell 1000 was
approximately $14.1 billion; the median market capitalization
was approximately $4.1 billion. The smallest company in the
index had an approximate market capitalization of $1.6
billion.
o Russell 2000 Value Index, measures the performance of those
Russell 2000 companies in with lower price-to-book ratios and
lower forecasted growth values
o Russell 2500 Growth Index, measures the performance of those
Russell 2500 companies with higher price-to-book ratios and
higher forecasted growth values.
o Russell 2500 Index - Published by Frank Russell Company,
measures the performance of the 2,500 smallest companies in
the Russell 3000 Index, representing approximately 16% of the
total market capitalization of the companies in the Russell
3000. The Russell 3000 contains the 3,000 largest companies
incorporated in the U.S. and its territories. As of the latest
reconstitution, the average market capitalization of the
Russell 2500 was approximately $958.8 million; the median
market capitalization was approximately $605.5 million. The
largest company in the index had an approximate market
capitalization of $4.06 billion.
o Russell 3000 Growth Index, measures the performance of those
Russell 3000 companies with higher price-to-book ratios and
higher forecasted growth values. The stocks in this index are
also members of either the Russell 1000 Growth or Russell 2000
Growth Indexes.
143
o Russell 3000 Value Index, measures the performance of those
Russell 3000 Index companies with lower price-to-book ratios
and lower forecasted growth values. The stocks in this index
are also members of either the Russell 1000 Value or the
Russell 2000 Value Indexes.
o Salomon Smith Barney Global Ex-U.S. Less Than $1 Billion
Index, a total-capitalization weighted index that includes all
developed and emerging countries, except the U.S., and
includes companies with a total market capitalization below
U.S. $1 billion.
o Salomon Smith Barney Global Ex-U.S. Less Than $2 Billion
Index, a total-capitalization weighted index that includes all
developed and emerging countries, except the U.S., and
includes companies with a total market capitalization below
U.S. $2 billion.
o Salomon Smith Barney World Ex-U.S. Extended Market Index
(EMI), a comprehensive float-weighted equity index consisting
of every company with an investable market capitalization of
over $100 million in 22 countries, except the U.S. The broad
market index (BMI) is segregated into the primary market index
(PMI) and extended market index (EMI), consisting of large and
small capitalization issues, respectively.
o Standard & Poor's(R) 500 Index (S&P 500), consists of 500
widely held domestic common stocks, consisting of four broad
sectors: industrials, utilities, financials and
transportation. It is a market value-weighted index, where the
stock price is multiplied by the number of shares outstanding,
with each stock affecting the index in proportion to its
market value. This index, calculated by Standard & Poor's, is
a total return index with dividends reinvested.
o Standard & Poor's Health Care Composite Index, a
capitalization-weighted index of all of the stocks in the
Standard & Poor's 500 that are involved in the business of
health care related products or services. The index was
developed with a base level of 100 as of January 14, 1987.
144
o Wilshire 5000 Equity Index, represents the return on the
market value of all common equity securities for which daily
pricing is available. Comparisons of performance assume
reinvestment of dividends.
o Wilshire Mid Cap Growth Index, measures mid-cap stocks that
exhibit growth characteristics. This is a market cap weighted
index including a selection of securities chosen from the
Wilshire Cap 500 Index with growth characteristics as defined
by Wilshire. The index is an excellent way to evaluate this
sector of the market and to gauge the performance of managers
focusing on this particular style. An equal weighting of this
index, along with the Wilshire Mid Cap Value Index, results in
approximately the same return as the Wilshire Mid Cap 500
Index.
o Wilshire Real Estate Securities Index, a broad measure of the
performance of publicly traded real estate securities, such as
Real Estate Investment Trusts (REITs) and Real Estate
Operating Companies (REOCs). The index is
capitalization-weighted. As of December 29, 2000, 106
companies were included in this index, with a total market cap
of $134.265 billion. The beginning date, January 1, 1978, was
selected because it coincides with the Russell/NCREIF Property
Index start date. The index is rebalanced monthly and returns
are calculated on a buy and hold bass .
o Wilshire Small Value Index measures small-cap stocks that
exhibit value characteristics. This is a market cap weighted
index including a selection of securities chosen from the
Wilshire Small Cap 1750 Index that meet Wilshire's definition
of value. The index is an excellent way to evaluate this
sector of the market and to gauge the performance of managers
focusing on this particular style. An equal weighting of this
index, along with the Wilshire Small Growth Index, results in
approximately the same return as the Wilshire Small Cap 1750
Index.
From time to time, the Funds and the managers also may refer to the following
information:
o The managers' and affiliates' market share of international
equities managed in mutual funds prepared or published by
Strategic Insight or a similar statistical organization.
o The performance of U.S. equity and debt markets relative to
foreign markets prepared or
145
published by Morgan Stanley Capital International or a similar
financial organization.
o The capitalization of U.S. and foreign stock markets as
prepared or published by the International Finance
Corporation, Morgan Stanley Capital International or a similar
financial organization.
o The geographic and industry distribution of the Fund's
portfolio and the Fund's top ten holdings.
o The gross national product and populations, including age
characteristics, literacy rates, foreign investment
improvements due to a liberalization of securities laws and a
reduction of foreign exchange controls, and improving
communication technology, of various countries as published by
various statistical organizations.
o To assist investors in understanding the different returns and
risk characteristics of various investments, the Fund may show
historical returns of various investments and published
indices (e.g., Ibbotson Associates, Inc. Charts and Morgan
Stanley Capital International EAFE(R)Index).
o The major industries located in various jurisdictions as
published by the Morgan Stanley Index.
o Rankings by DALBAR Surveys, Inc. with respect to mutual fund
shareholder services.
o Allegorical stories illustrating the importance of persistent
long-term investing.
o The Fund's portfolio turnover rate and its ranking relative to
industry standards as published by Lipper(R)Inc. or
Morningstar, Inc.
o A description of the Templeton organization's investment
management philosophy and approach, including its worldwide
search for undervalued or "bargain" securities and its
diversification by industry, nation and type of stocks or
other securities.
o Comparison of the characteristics of various emerging markets,
including population, financial and economic conditions.
o Quotations from the Templeton organization's founder, Sir John
Templeton,* advocating the virtues of diversification and
long-term investing.
From time to time, advertisements or information for the Fund may include a
discussion of certain attributes or benefits to be derived from an investment in
the Fund. The advertisements or information may include symbols, headlines, or
other material that highlights
- ----------------------
* Sir John Templeton sold the Templeton organization to Franklin
Resources, Inc. in October 1992 and resigned from the board on April
16, 1995. He is no longer involved with the investment management
process.
146
or summarizes the information discussed in more detail in the communication.
Advertisements or information also may compare the Fund's performance to the
return on certificates of deposit (CDs) or other investments. You should be
aware, however, that an investment in the Fund involves the risk of fluctuation
of principal value, a risk generally not present in an investment in a CD issued
by a bank. CDs are frequently insured by an agency of the U.S. government. An
investment in the Fund is not insured by any federal, state or private entity.
In assessing comparisons of performance, you should keep in mind that the
composition of the investments in the reported indices and averages is not
identical to the Fund's portfolio, the indices and averages are generally
unmanaged, and the items included in the calculations of the averages may not be
identical to the formula used by the Fund to calculate its figures. In addition,
there can be no assurance that the Fund will continue its performance as
compared to these other averages.
Miscellaneous Information
- --------------------------------------------------------------------------------
The Trust is a member of Franklin Templeton Investments, one of the largest
mutual fund organizations in the U.S., and may be considered in a program for
diversification of assets. Founded in 1947, Franklin is one of the oldest mutual
fund organizations and now services approximately 3 million shareholder
accounts. In 1992, Franklin, a leader in managing fixed-income mutual funds and
an innovator in creating domestic equity funds, joined forces with Templeton, a
pioneer in international investing. The Mutual Series team, known for its
value-driven approach to domestic equity investing, became part of the
organization four years later. Together, Franklin Templeton Investments has over
$225 billion in assets under management for more than 5 million U.S. based
mutual fund shareholder and other accounts. Franklin Templeton Investments
offers 107 U.S. based open-end investment companies to the public. Each Fund may
identify itself by its Nasdaq symbol or CUSIP number.
Fund similarity The investment objectives and policies of certain funds are
similar but not identical to those of certain public Franklin Templeton Funds
indicated in the following table. Because of differences in portfolio size, the
investments held, the timing of purchases of similar investments, cash flows,
minor differences in certain investment policies, insurance product related tax
diversification requirements, state insurance regulations, and additional
administrative and insurance costs associated with insurance company separate
accounts, the investment performance of the Funds will differ from the
performance of the corresponding Franklin Templeton funds:
Franklin Templeton Variable
Insurance Products Trust Franklin Templeton Funds
- ----------------------------------------- --------------------------------------------------
Franklin Custodian Funds:
Income Securities Fund Income Series
147
Franklin Templeton Variable
Insurance Products Trust Franklin Templeton Funds
- ----------------------------------------- --------------------------------------------------
Government Fund U.S. Government Securities Series
Franklin High Income Trust:
High Income Fund AGE High Income Fund
Franklin Investors Securities Trust:
Global Income Fund Franklin Global Government Income Fund
Growth and Income Fund Franklin Equity Income Fund
Franklin Managed Trust:
Rising Dividends Fund Franklin Rising Dividends Fund
Money Fund Franklin Money Fund
Franklin Mutual Series Fund Inc.:
Mutual Discovery Fund Mutual Discovery Fund
Mutual Shares Fund Mutual Shares Fund
Franklin Real Estate Securities Trust:
Real Estate Fund Franklin Real Estate Securities Fund
Franklin Strategic Series:
Aggressive Growth Fund Franklin Aggressive Growth Fund
Global Communications Fund Franklin Global Communications Fund
Global Health Care Fund Franklin Global Health Care Fund
Large Cap Fund Franklin Large Cap Growth Fund
Natural Resources Fund Franklin Natural Resources Fund
Small Cap Fund Franklin Small Cap Growth Fund
Strategic Income Fund Franklin Strategic Income Fund
Technology Fund Franklin Technology Fund
Franklin Value Investment Trust:
Value Fund Franklin Value Fund
Growth Securities Fund Templeton Growth Fund, Inc.
International Securities Fund Templeton Foreign Fund
Franklin Templeton International Trust:
International Smaller Companies Fund Templeton Foreign Smaller Companies Fund
Developing Markets Fund Templeton Developing Markets Trust
148
Description of Bond Ratings
- --------------------------------------------------------------------------------
Corporate Bond Ratings
Moody's Investors Service, Inc. (Moody's)
INVESTMENT GRADE
Aaa: Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as
"gilt-edged." Interest payments are protected by a large or exceptionally stable
margin, and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
Aa: Bonds rated Aa are judged to be high quality by all standards. Together with
the Aaa group, they comprise what are generally known as high-grade bonds. They
are rated lower than the best bonds because margins of protection may not be as
large, fluctuation of protective elements may be of greater amplitude, or there
may be other elements present that make the long-term risks appear somewhat
larger.
A: Bonds rated A possess many favorable investment attributes and are considered
upper medium-grade obligations. Factors giving security to principal and
interest are considered adequate, but elements may be present that suggest a
susceptibility to impairment sometime in the future.
Baa: Bonds rated Baa are considered medium-grade obligations. They are neither
highly protected nor poorly secured. Interest payments and principal security
appear adequate for the present but certain protective elements may be lacking
or may be characteristically unreliable over any great length of time. These
bonds lack outstanding investment characteristics and, in fact, have speculative
characteristics as well.
BELOW INVESTMENT GRADE
Ba: Bonds rated Ba are judged to have predominantly speculative elements and
their future cannot be considered well assured. Often the protection of interest
and principal payments is very moderate and, thereby, not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B: Bonds rated B generally lack characteristics of the desirable investment.
Assurance of interest and principal payments or of maintenance of other terms of
the contract over any long period of time may be small.
Caa: Bonds rated Caa are of poor standing. These issues may be in default or
there may be present elements of danger with respect to principal or interest.
149
Ca: Bonds rated Ca represent obligations that are speculative to a high degree.
These issues are often in default or have other marked shortcomings.
C: Bonds rated C are the lowest rated class of bonds and can be regarded as
having extremely poor prospects of ever attaining any real investment standing.
Note: Moody's applies numerical modifiers 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond ratings. The modifier 1
indicates that the security ranks in the higher end of its generic rating
category; modifier 2 indicates a mid-range ranking; and modifier 3 indicates
that the issue ranks in the lower end of its generic rating category.
Standard & Poor's Ratings Group (S&P(R))
INVESTMENT GRADE
AAA: This is the highest rating assigned by S&P to a debt obligation and
indicates an extremely strong capacity to pay principal and interest.
AA: Bonds rated AA also qualify as high-quality debt obligations. Capacity to
pay principal and interest is very strong and, in the majority of instances,
differ from AAA issues only in a small degree.
A: Bonds rated A have a strong capacity to pay principal and interest, although
they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions.
BBB: Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit protection parameters,
adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity to pay principal and interest for bonds in this category
than for bonds in the A category.
BELOW INVESTMENT GRADE
BB, B, CCC, CC: Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligations. BB
indicates the lowest degree of speculation and CC the highest degree of
speculation. While these bonds will likely have some quality and protective
characteristics, they are outweighed by large uncertainties or major risk
exposures to adverse conditions.
C: Bonds rated C are typically subordinated debt to senior debt that is assigned
an actual or implied CCC- rating. The C rating also may reflect the filing of a
bankruptcy petition under circumstances where debt service payments are
continuing. The C1 rating is reserved for income bonds on which no interest is
being paid.
D: Debt rated D is in default and payment of interest and/or repayment of
principal is in arrears.
150
Plus (+) or minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Short-Term Debt & Commercial Paper Ratings
Moody's
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted. Moody's commercial paper
ratings are opinions of the ability of issuers to repay punctually their
promissory obligations not having an original maturity in excess of nine months.
Moody's employs the following designations for both short-term debt and
commercial paper, all judged to be investment grade, to indicate the relative
repayment capacity of rated issuers:
P-1 (Prime-1): Superior capacity for repayment.
P-2 (Prime-2): Strong capacity for repayment.
S&P
S&P's ratings are a current assessment of the likelihood of timely payment of
debt having an original maturity of no more than 365 days. Ratings are graded
into four categories, ranging from "A" for the highest quality obligations to
"D" for the lowest. Issues within the "A" category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety, as follows:
A-1: This designation indicates the degree of safety regarding timely payment is
very strong. A "plus" (+) designation indicates an even stronger likelihood of
timely payment.
A-2: Capacity for timely payment on issues with this designation is strong. The
relative degree of safety, however, is not as overwhelming as for issues
designated A-1.
A-3: Issues carrying this designation have a satisfactory capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
151
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PART C. OTHER INFORMATION
Item 15. INDEMNIFICATION
Please see the Agreement and Declaration of Trust and the By-Laws
previously filed as exhibits and incorporated herein by reference.
Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to Trustees, 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
Trustee, officer or controlling person of the Registrant in the successful
defense of any action, suit or proceeding) is asserted by such Trustee,
officer or controlling person in connection with 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 or
appropriate jurisdiction the question whether such indemnification is
against public policy as expressed in the Act and will be governed by the
final adjudication of such issue.
Item 16. EXHIBITS (Incorporated by reference to prior filings, except as noted)
(1) copies of the charter of the registrant as now in effect;
(i) Agreement and Declaration of Trust dated April 20, 1988
Filing: Post-Effective Amendment No. 16 to Registration
Statement of Registrant on Form N-1A
File No. 33-23493
Filing Date: August 19, 1995
(ii) Certificate of Amendment of Agreement and Declaration of
Trust dated October 21, 1988
Filing: Post-Effective Amendment No. 16 to Registration
Statement of Registrant on Form N-1A
File No. 33-23493
Filing Date: August 19, 1995
(iii) Certificate of Amendment of Agreement and Declaration of
Trust
Filing: Post-Effective Amendment No. 26 to Registration
Statement of Registrant on Form N-1A
File No. 33-23493
Filing Date: November 30, 1998
(iv) Certificate of Amendment of Agreement and Declaration of
Trust of Franklin Valuemark Funds filed on July 1, 1999
Filing: Post-Effective Amendment No. 33 to Registration
Statement of the Registrant on Form N-1A
File No. 33-23493
Filing Date: April 29, 2000
(2) copies of the existing bylaws or corresponding instruments of the
registrant;
(i) By-Laws
Filing: Post-Effective Amendment No. 16 to Registration
Statement of Registrant on Form N-1A
File No. 33-23493
Filing Date: August 19, 1995
(ii) Certificate of Amendment of By-Laws dated May 16, 1995
Filing: Post-Effective Amendment No. 16 to
Registration Statement of Registrant on Form N-1A
File No. 33-23493
Filing Date: August 19, 1995
(3) copies of any voting trust agreement affecting more than 5% of any
class of equity securities of registrant;
Not Applicable
(4) copies of the agreement of acquisition, reorganization, merger,
liquidation and any amendments to it;
(i) Franklin Templeton Variable Insurance Products Trust Plan of
Reorganization of Templeton International Smaller Companies Fund
and Templeton International Securities Fund filed herewith as
Exhibit A to the Prospectus and Proxy Statement included as Part A
of this Registration Statement
(5) specimens or copies of each security being registered, including
copies of all constituent instruments defining the rights of holders of
the securities;
Not Applicable
(6) copies of all investment advisory contracts relating to the
management of the assets of the registrant;
(i) Investment Advisory Agreement between the Registrant, on
behalf of Templeton International Securities Fund, and
Templeton Investment Counsel, LLC, dated January 1, 2001.
Filing: Post-Effective Amendment No. 33 to Registration
Statement of Registrant on Form N-1A
File No. 33-23493
Filing Date: March 1, 2001
(7) copies of each underwriting or distribution contract between the
registrant and a principal underwriter, and specimens or copies of all
agreements between principal underwriters and dealers;
(i) Distribution Agreement between the Registrant and Franklin
Templeton Distributors, Inc.
Filing: Post-Effective Amendment No. 26 to Registration
Statement of Registrant on Form N-1A
File No. 33-23493
Filing Date: November 30, 1998
(8) copies of all bonus, profit sharing, pension or other similar
contracts or arrangements wholly or partly for the benefit of directors or
officers of the registrant in their capacity as such.
Not Applicable
(9) copies of all custodian agreements and depository contracts under
Section 17(f) of the 1940 Act, for securities and similar investments of
the registrant, including the schedule of remuneration;
(i) Amendment to Global Custody Agreement between the Registrant
and The Chase Manhattan Bank, N.A. dated April 1, 1996
Filing: Post-Effective Amendment No. 23 to Registration
Statement of the Registrant on Form N-1A
File No. 33-23493
Filing Date: April 29, 1997
(ii) Global Custody Agreement effective as of May 1, 2000 between The
Chase Manhattan Bank, N.A. and Franklin Templeton Variable
Insurance Products Trust
Filing: Post Effective Amendment No. 33 to Registration Statement
of the Registrant on Form N-1A
File No. 33-23493
Filing Date: April 29, 2000
(iii) Amendment effective as of May 1, 2001 between The Chase Manhattan
Bank, N.A. and Franklin Templeton Variable Insurance Products
Trust
(10) copies of any plan entered into by registrant pursuant to rule 12b-1 under
the 1940 Act and any agreements with any person relating to implementation
of the plan, and copies of any plan entered into by registrant pursuant to
Rule 18f-3 under the 1940 Act, any agreement with any person relating to
implementation of the plan, any amendment to the plan, and a copy of the
portion of a meeting of the minutes of the registrant's directors
describing any action taken to revoke the plan;
(i) Class 2 Distribution Plan pursuant to Rule 12b-1for all series
of the Registrant
Filing: Post Effective Amendment No. 26 to Registration
Statement of the Registrant on Form N-1A
File No. 33-23493
Filing Date November 30, 1998
(ii) Multiple Class Plan pursuant to Rule 18f-3 for all series of the
Registrant Filing: Post-Effective Amendment No. 26 to
Registration Statement of the Registrant on Form N-1A
File No. 33-23493
Filing Date: November 30, 1998
(11) an opinion and consent of counsel as to the legality of the securities
being registered, indicating whether they will, when sold, be legally
issued, fully paid and non-assessable;
(i) Legal Opinion, Securities Act of 1933, dated February 5, 1999
Filing: Post-Effective Amendment No. 27 to Registration
Statement of Registrant on Form N-1A
File No. 33-23493
Filing Date: February 25, 1999
(ii) Consent to Use of Opinion, dated November 16, 2001
(12) an opinion, and consent to their use, of counsel or, in lieu of an
opinion, a copy of the revenue ruling from the Internal Revenue Service,
supporting the tax matters and consequences to shareholders discussed in
the prospectus;
(i) Form of opinion of Jorden Burt LLP regarding tax matters and
consequences
(13) copies of all material contracts of the registrant not made in the
ordinary course of business which are to be performed in whole or in part
on or after the date of filing the registration statement;
Not Applicable
(14) copies of any other opinions, appraisals or rulings, and consents to their
use relied on in preparing the registration statement and required by
Section 7 of the 1933 Act;
Consent of Independent Auditors with respect to Templeton
International Securities Fund
Consent of Independent Auditors with respect to Templeton
International Smaller Companies Fund
(15) all financial statements omitted pursuant to Item 14(a)(1);
Not Applicable
(16) manually signed copies of any power of attorney pursuant to which the
name of any person has been signed to the registration statement; and
(i) Power of Attorney
(17) any additional exhibits which the registrant may wish to file.
(i) Form of Voting Instruction Card
Item 17. Undertakings.
(1) The undersigned registrant agrees that prior to any public reoffering
of the securities registered through the use of a prospectus that is part
of this registration statement by any person or party who is deemed to be
an underwriter within the meaning of Rule 145(c) of the Securities Act, the
reoffering prospectus will contain the information called for by the
applicable registration form for reofferings by persons who may be deemed
underwriters, in addition to the information called for by the other items
of the applicable form.
(2) The undersigned registrant agrees that every prospectus that is filed
under paragraph (1) above will be filed as part of an amendment to the
registration statement and will not be used until the amendment is
effective, and that, in determining any liability under the 1933 Act, each
post-effective amendment shall be deemed to be a new registration statement
for the securities offered therein, and the offering of the securities at
that time shall be deemed to be the initial bona fide offering of them.
As required by the Securities Act of 1933, this registration statement
has been signed on behalf of the registrant, in the City of San Mateo and State
of California, on the 19th day of November, 2001.
FRANKLIN TEMPLETON VARIABLE
INSURANCE PRODUCTS TRUST
By /s/ Charles E. Johnson*
------------------------
Charles E. Johnson, Principal Executive
Officer and Trustee
As required by the Securities Act of 1933, this Registration Statement
has been signed by the following persons in the capacities on the dates
indicated.
CHARLES E. JOHNSON* Principal Executive Officer and Trustee
Charles E. Johnson Dated: November 19, 2001
MARTIN L. FLANAGAN* Principal Financial Officer
Martin L. Flanagan Dated: November 19, 2001
KIMBERLY H. MONASTERIO* Principal Accounting Officer
Kimberley H. Monasterio Dated:
FRANK H. ABBOTT III* Trustee
Frank H. Abbott III Dated: November 19, 2001
HARRIS J. ASHTON* Trustee
Harris J. Ashton Dated: November 19, 2001
S. JOSEPH FORTUNATO* Trustee
S. Joseph Fortunato Dated: November 19, 2001
ROBERT F. CARLSON* Trustee
Robert F. Carlson Dated: November 19, 2001
CHARLES B. JOHNSON* Trustee
Charles B. Johnson Dated: November 19, 2001
RUPERT H. JOHNSON, JR.* Trustee
Rupert H. Johnson, Jr. Dated: November 19, 2001
FRANK W. T. LAHAYE* Trustee
Frank W. T. LaHaye Dated: November 19, 2001
GORDON S. MACKLIN* Trustee
Gordon S. Macklin Dated: November 19, 2001
CHRISTOPHER H. PINKERTON* Trustee
Christopher H. Pinkerton Dated: November 19, 2001
/s/ Karen L. Skidmore
* By KAREN L. SKIDMORE, ATTORNEY-IN-FACT
(Pursuant to Power of Attorney attached)
TEMPLETON INTERNATIONAL SECURITIES FUND
N-14 REGISTRATION STATEMENT
Item No. Exhibit
EX-99 (9)(iii) Amendment effective as of May 1, 2001 between Franklin
Templeton Variable Insurance Products Trust and The Chase
Manhattan Bank
EX-99 11(ii) Consent to Use of Opinion, dated November 16, 2001
EX-99 12(i) Form of Opinion of Jorden Burt LLP regarding tax matters and
consequences*
EX-99 14(i) Consent of Independent Auditors with respect to Templeton
International Securities Fund
EX-99 14(ii) Consent of Independent Auditors with respect to Templeton
International Smaller Companies Fund
EX-99 16(i) Power of Attorney
EX-99 17(i) Form of Voting Instruction Card
*to be filed by amendment