N-CSR 1 mseriesannrpt1203.txt MUTUAL SERIES ANNUAL REPORTS DTD 12/31/03 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM N-CSR CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES Investment Company Act file number 811-5387 --------- FRANKLIN MUTUAL SERIES FUND INC. -------------------------------------------------- (Exact name of registrant as specified in charter) 51 JOHN F. KENNEDY PARKWAY, SHORT HILLS, NJ 07078-2702 -------------------------------------------------------- (Address of principal executive offices) (Zip code) MURRAY L. SIMPSON, ONE FRANKLIN PARKWAY, SAN MATEO, CA 94403-1906 ------------------------------------------------------------------- (Name and address of agent for service) Registrant's telephone number, including area code: (210) 912-2100 -------------- Date of fiscal year end: 12/31 ----- Date of reporting period: 12/31/03 -------- ITEM 1. REPORTS TO STOCKHOLDERS. DECEMBER 31, 2003 [GRAPHIC OMITTED] ANNUAL REPORT AND SHAREHOLDER LETTER VALUE Mutual Shares Fund Want to receive this document FASTER via email? Eligible shareholders can sign up for eDelivery at franklintempleton.com. See inside for details. [GRAPHIC OMITTED] [LOGO OMITTED] FRANKLIN(R) TEMPLETON(R) INVESTMENTS Franklin o Templeton o Mutual Series Thank You For Your Continued Participation At Mutual Series, we are pleased so many investors share our long-term investment philosophy and have remained shareholders for many years. Your ongoing support plays a significant role in contributing to the funds' success. Mutual Series is part of Franklin Templeton Investments, which offers the specialized expertise of three world-class investment management groups -- Franklin, Templeton and Mutual Series. Mutual Series is dedicated to a unique style of value investing, searching aggressively for opportunity among undervalued stocks, arbitrage situations and distressed companies. Franklin is a leader in tax-free fund management and an expert in U.S. equity and fixed income investing. Templeton pioneered international investing and, with offices in over 25 countries, offers the broadest global reach in the industry. Because these management groups work independently and adhere to distinctly different investment approaches, Franklin, Templeton and Mutual Series funds typically have a low overlap of securities. That's why the funds can be used to build truly diversified portfolios covering every major asset class. Franklin Templeton Investments seeks to consistently provide investors with exceptional risk-adjusted returns over the long term, as well as the reliable account services that have helped the firm become one of the most trusted names in financial services. SPECIALIZED EXPERTISE TRUE DIVERSIFICATION RELIABILITY YOU CAN TRUST MUTUAL FUNDS | RETIREMENT PLANS | 529 COLLEGE SAVINGS PLANS | SEPARATE ACCOUNTS [GRAPHIC OMITTED] Not part of the annual report Contents SHAREHOLDER LETTER ............... 1 ANNUAL REPORT Mutual Shares Fund ............... 5 Performance Summary .............. 10 Financial Highlights and Statement of Investments ......... 15 Financial Statements ............. 32 Notes to Financial Statements .... 36 Independent Auditors' Report ..... 47 Tax Designation .................. 48 Board Members and Officers ....... 49 Proxy Voting Policies and Procedures ................... 53 Regulatory Update AS OF FEBRUARY 12, 2004 On February 4, 2004, the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts filed an administrative complaint against Franklin Resources, Inc. and certain of its subsidiaries (the "Company"), alleging violations of the Massachusetts Uniform Securities Act. The complaint arises from activity that occurred in 2001 during which time an officer of a Company subsidiary was negotiating an agreement with an investor relating to investments in a mutual fund and a hedge fund. The Company, in addition to other entities within Franklin Templeton Investments, including the Fund and other funds, has been named in shareholder class actions related to the matter described above. The Company believes that the claims made in the lawsuit are without merit and it intends to defend vigorously against the allegations. It is anticipated that the Company may be named in additional similar civil actions related to the matter described above. In addition, as part of ongoing investigations by the U.S. Securities and Exchange Commission (the "SEC"), the U.S. Attorney for the Northern District of California, the New York Attorney General, the California Attorney General, the U.S. Attorney for the District of Massachusetts, the Florida Department of Financial Services, and the Commissioner of Securities and the Attorney General of the State of West Virginia, relating to certain practices in the mutual fund industry, including late trading, market timing and sales compensation arrangements, the Company and its subsidiaries, as well as certain current or former executives and employees of the Company, have received requests for information and/or subpoenas to testify or produce documents. The Company and its current employees are providing documents and information in response to these requests and subpoenas. In addition, the Company has responded to requests for similar kinds of information from regulatory authorities in some of the foreign countries where the Company conducts its global asset management business. The Staff of the SEC has informed the Company that it intends to recommend that the Commission authorize an action against an affiliate of the Fund's adviser and a senior executive officer relating to the frequent trading issues that are the subject of the SEC's investigation. These issues were previously disclosed as being under investigation by government authorities and the subject of an internal inquiry by the Company in its Annual Report on Form 10-K and on its public website. The Company currently is in discussions with the SEC Staff in an effort to resolve the issues raised in their investigation. Such discussions are preliminary and the Company cannot predict the likelihood of whether those discussions will result in a settlement and, if so, the terms of such settlement. The impact, if any, of these matters on the Fund is uncertain at this time. If it is found that the Company bears responsibility for any unlawful or improper conduct, we have committed to making the funds or their shareholders whole, as appropriate. Any further updates on these matters will be disclosed on the Company's website at franklintempleton.com under "Statement on Current Industry Issues." 4 | Not part of the annual report Annual Report Mutual Shares Fund YOUR FUND'S GOAL AND PRIMARY INVESTMENTS: Mutual Shares Fund seeks capital appreciation, with income as a secondary goal, by investing primarily in common and preferred stocks, bonds and convertible securities in the U.S. and other countries. We are pleased to bring you Mutual Shares Fund's annual report for the fiscal year ended December 31, 2003. PERFORMANCE OVERVIEW Mutual Shares Fund - Class Z posted a 26.62% cumulative total return for the 12 months ended December 31, 2003, as shown in the Performance Summary beginning on page 10. The Fund underperformed its benchmark, the Standard & Poor's 500 Composite Index (S&P 500), which returned 28.67% over the same period. 1 Because our conservative investment style typically assumes less risk than the markets, the Fund historically outperformed when indexes were weak and underperformed when markets rallied. ECONOMIC AND MARKET OVERVIEW Early in 2003, economic uncertainty and geopolitical events pushed U.S. interest rates to their lowest level in more than four decades. The U.S. government injected fiscal stimulus into the economy, approving another round of tax cuts and rebates that included dividend and capital gains tax reductions. In June, an accommodative Federal Reserve Board, in an attempt to bolster the economy, cut the federal funds target rate to 1.00%. During the year, the U.S. trade deficit increased significantly, contributing to the U.S. dollar's fall to record lows against the euro and other major currencies. However, the weak dollar provided a boost to the U.S. economy and corporate profits as exports became cheaper for foreign buyers. Robust consumer spending, 1. Source: Standard & Poor's Micropal. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The S&P 500 is one of the most widely used benchmarks of U.S. equity performance. The index includes reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND COMPLETE LEGAL TITLES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 20. Annual Report | 5 [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Geographic Distribution* Based on Total Net Assets as of 12/31/03 U.S. 66.4% U.K. 13.6% France 4.1% Canada 3.6% Spain 2.1% Switzerland 2.1% Irish Republic 1.9% Japan 1.7% Netherlands 1.4% Norway 1.0% Germany 1.0% Other Countries 2.3% *Other net assets = -1.2 because of foreign currency hedging. especially for autos and homes, and strong business spending, particularly for equipment and software, contributed to the accelerated economic activity. In addition, U.S. federal spending stayed firm and inflation remained benign. U.S. gross domestic product (GDP) grew an annualized 8.2% in third quarter 2003, its strongest pace in nearly 20 years, and overall, 2003 GDP grew an estimated 3.1%. As economic data improved, interest rates rose from their lows, and the 10-year Treasury note's yield ended the period at 4.27%. Foreign economies also showed signs of recovery following a low growth and disinflationary environment that facilitated monetary easing in many major economies during the reporting period. While economic growth accelerated in the U.S., it remained strong in Asia, and was weak, yet positive, in Europe. Despite these signs of economic recovery, benign inflationary trends continued, supported by cyclical productivity gains and excess capacity in labor and capital. A global equity market rally started in late March 2003 and continued through the end of the year. The rebound began with investors anticipating global economic recovery in the second half of 2003, and it continued as data showed robust economic growth. Improved sentiment led many investors to rotate into economically sensitive and financially leveraged companies, specifically cyclical, technology, small-capitalization and emerging market stocks, which had generally performed poorly in recent years. Consequently, domestic and foreign equity markets generally performed well. INVESTMENT STRATEGY At Mutual Series, we are committed to our distinctive three-pronged approach to investing, a strategy we believe generates above-average risk-adjusted returns over time for our shareholders. The first prong of our investment strategy, and the component that typically represents the largest portion of our portfolio, is investing in undervalued stocks. When selecting undervalued equities, we prefer to invest in fundamentally strong companies, with healthy balance sheets, high-quality assets, substantial free cash flow and shareholder-oriented management teams and whose stocks are trading at material discounts to our assessment of the companies' intrinsic or business value. This strict value approach not only 6 | Annual Report TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/03 --------------------------------------- % OF TOTAL NET ASSETS --------------------------------------- Insurance 11.8% --------------------------------------- Tobacco 8.1% --------------------------------------- Media 7.3% --------------------------------------- Metals & Mining 5.6% --------------------------------------- Thrifts & Mortgage Finance 5.3% --------------------------------------- Food Products 4.0% --------------------------------------- Beverages 4.0% --------------------------------------- Commercial Banks 2.8% --------------------------------------- Diversified Telecommunication Services 2.6% --------------------------------------- Real Estate 2.3% could improve the likelihood of upside potential, but it also helps reduce the risk of substantial declines. While the vast majority of our undervalued equity investments are made in publicly traded companies, we may invest occasionally in privately held companies as well. Our second investment prong is bankruptcy or distressed investing, a highly specialized field that has proven quite profitable during certain periods over the years. Distressed investing is complex and can take many forms. The most common distressed investment the Fund undertakes is the purchase of financially troubled or bankrupt companies' debt at a substantial discount to face value. After the financially distressed company is reorganized, often in bankruptcy court, the old bonds are typically replaced with new securities issued by the financially stronger company. The third prong of our investment strategy is participating in arbitrage situations, another highly specialized field. When companies announce mergers or takeovers, commonly referred to as "deals," the target company may trade at a discount to the bid it ultimately accepts. One form of arbitrage involves purchasing the target company's stock when it is trading below the value it would receive in a deal. In keeping with our commitment to a relatively conservative investment approach, we typically focus our arbitrage efforts on announced deals, and eschew rumored deals or other situations we consider relatively risky. MANAGER'S DISCUSSION While all three prongs of our investment strategy contributed to Fund performance during the year under review, the strongest contributors were the distressed and equity portfolios. Three of our best performers in 2003 included International Steel Group (ISG); White Mountains Insurance, a property and casualty (P&C) insurer; and NTL, a distressed cable company investment. ISG was formed in second quarter 2002 by a group of private equity investors, including the Fund, to purchase certain LTV steel production assets out of bankruptcy. After negotiating with the unions to craft an agreement, the purchased LTV assets were structured so that many "legacy" liabilities, such as pension and post-retirement health care costs, were shed. Using this cost reduction formula, ISG continued to acquire additional steel facilities out of bankruptcy in 2002 and 2003. As ISG restructured and assimilated these facilities, the company emerged as a competitive, low-cost operator and the nation's second-largest steel producer. Our ISG investment's value was highlighted in the public markets during the first half of December when the company raised capital through an initial public offer Annual Report | 7 TOP 10 HOLDINGS 12/31/03 ------------------------------------------------------------ COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS ------------------------------------------------------------ Berkshire Hathaway Inc., A & B 3.4% Insurance, U.S. ------------------------------------------------------------ White Mountains Insurance Group Inc., common & restricted 3.4% ------------------------------------------------------------ Insurance, U.S. British American Tobacco PLC, ord. & ADR 3.4% Tobacco, U.K. ------------------------------------------------------------ Freddie Mac 3.4% Thrifts & Mortgage Finance, U.S. ------------------------------------------------------------ Diageo PLC 2.2% Beverages, U.K. ------------------------------------------------------------ Altadis SA 2.1% Tobacco, Spain ------------------------------------------------------------ International Steel Group 2.1% Metals & Mining, U.S. ------------------------------------------------------------ Washington Post Co., B 1.9% Media, U.S. ------------------------------------------------------------ Liberty Media Corp., A 1.7% Media, U.S. ------------------------------------------------------------ Nestle SA 1.7% Food Products, Switzerland ------------------------------------------------------------ (IPO). The IPO was very well received and ISG's stock price appreciated almost 40% in December, contributing to a solid 2003. Our investment in White Mountains reflects our focus on companies with strong or improving fundamentals, attractive valuations and management teams who think like owners. During 2003, the company benefited from strong price increases for primary and reinsurance risks, disciplined underwriting and solid returns from its investment portfolio. While many companies within the P&C insurance industry struggled with eroding capital from past underwriting mistakes and significant losses in their investment portfolios, White Mountains utilized its much-improved balance sheet and industry knowledge to acquire undervalued or capital-constrained insurance companies and to increase exposure to its most attractive lines of businesses. Primarily as a result of these actions, the company continued to improve profitability and enjoyed a 13% increase in its book value during 2003. NTL, the U.K.'s largest cable company, was formed by a series of acquisitions of independent cable operators. These purchases were financed largely with debt, and in 2001, when NTL failed to generate enough cash flow to meet its interest payments, the company's bonds began to trade at significant discounts to face value. After completing an extensive fundamental analysis, we believed NTL's bonds were trading well below the fair value of the company's operations. We purchased a material amount of NTL debt and became an active member of the creditors committee formed to facilitate the reorganization process. During the restructuring, our investment in NTL bonds was converted to common shares, and the reorganized company emerged from bankruptcy in January 2003. As global cable valuations recovered, the new NTL shares performed well during the year and appreciated more than 15 times from their lows. Although the Fund's successes during the reporting period were many, not all of our investments performed as well as we hoped. Three of the Fund's significant underperformers included Allied Domecq (sold by year-end), one of the world's largest spirits and wine companies; Abitibi-Consolidated, a Canadian paper and forest products company; and Beiersdorf, a German personal care products company. Allied Domecq's stock declined after the company lowered its earnings outlook in February due to a weak U.S. dollar, higher pension expenses and weakness in its Spanish operations. Abitibi's shares underperformed in 2003 after a weak U.S. dollar, soft sales and higher energy prices forced the company to reduce its earnings outlook and cut its dividend. Beiersdorf, which had been the subject of takeover speculation earlier in the year, declined after the company's major shareholders announced the company would remain independent and not be sold. 8 | Annual Report Thank you for your continued participation in Mutual Shares Fund. We look forward to serving your future investment needs. PHOTO OMITTED /S/ DAVID J. WINTERS David J. Winters, CFA Portfolio Manager PHOTO OMITTED /S/ TIMOTHY M. RANKIN Timothy M. Rankin, CFA Assistant Portfolio Manager PHOTO OMITTED /S/ DEBBIE A. TURNER Debbie A. Turner, CFA Assistant Portfolio Manager Mutual Shares Fund THIS DISCUSSION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2003, THE END OF THE REPORTING PERIOD. THE WAY WE IMPLEMENT OUR MAIN INVESTMENT STRATEGIES AND THE RESULTING PORTFOLIO HOLDINGS MAY CHANGE DEPENDING ON FACTORS SUCH AS MARKET AND ECONOMIC CONDITIONS. THESE OPINIONS MAY NOT BE RELIED UPON AS INVESTMENT ADVICE OR AN OFFER FOR A PARTICULAR SECURITY. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR THE FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE, BUT THE ADVISOR MAKES NO REPRESENTATION OR WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR INVESTMENT MANAGEMENT PHILOSOPHY. Annual Report | 9 Performance Summary as of 12/31/03 Your dividend income will vary depending on dividends or interest paid by securities in the Fund's portfolio, adjusted for operating expenses of each class. Capital gain distributions are net profits realized from the sale of portfolio securities. The performance table and graphs do not reflect any taxes due on Fund dividends, capital gain distributions, if any, or any realized gains on the sale of Fund shares. Total return reflects the Fund's dividend income, capital gain distributions, if any, and any unrealized gains or losses.
PRICE AND DISTRIBUTION INFORMATION -------------------------------------------------------------------------------------------------- CLASS Z CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$4.14 $20.98 $16.84 -------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------------------------- Dividend Income $0.3203 -------------------------------------------------------------------------------------------------- CLASS A CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$4.11 $20.89 $16.78 -------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------------------------- Dividend Income $0.2618 -------------------------------------------------------------------------------------------------- CLASS B CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$4.01 $20.53 $16.52 -------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------------------------- Dividend Income $0.1696 -------------------------------------------------------------------------------------------------- CLASS C CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$4.06 $20.74 $16.68 -------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------------------------- Dividend Income $0.1537 -------------------------------------------------------------------------------------------------- CLASS R CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$4.08 $20.82 $16.74 -------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------------------------- Dividend Income $0.2553
10 | Past performance does not guarantee future results. | Annual Report Performance Summary (CONTINUED)
PERFORMANCE --------------------------------------------------------------------------------------------------------------------------- CLASS Z 1 1-YEAR 5-YEAR 10-YEAR --------------------------------------------------------------------------------------------------------------------------- Cumulative Total Return 2 26.62% 57.06% 224.97% Average Annual Total Return 3 26.62% 9.45% 12.51% Value of $10,000 Investment 4 $12,662 $15,706 $32,497 --------------------------------------------------------------------------------------------------------------------------- CLASS A 1 1-YEAR 5-YEAR INCEPTION (11/1/96) --------------------------------------------------------------------------------------------------------------------------- Cumulative Total Return 2 26.18% 54.33% 107.94% Average Annual Total Return 3 18.95% 7.78% 9.84% Value of $10,000 Investment 4 $11,895 $14,545 $19,599 --------------------------------------------------------------------------------------------------------------------------- CLASS B 1 1-YEAR 5-YEAR INCEPTION (1/1/99) --------------------------------------------------------------------------------------------------------------------------- Cumulative Total Return 2 25.41% 49.34% 49.34% Average Annual Total Return 3 21.41% 8.06% 8.06% Value of $10,000 Investment 4 $12,141 $14,734 $14,734 --------------------------------------------------------------------------------------------------------------------------- CLASS C 1 1-YEAR 5-YEAR INCEPTION (11/1/96) --------------------------------------------------------------------------------------------------------------------------- Cumulative Total Return 2 25.37% 49.37% 98.59% Average Annual Total Return 3 23.11% 8.13% 9.89% Value of $10,000 Investment 4 $12,311 $14,785 $19,661 --------------------------------------------------------------------------------------------------------------------------- CLASS R 1-YEAR INCEPTION (1/1/02) --------------------------------------------------------------------------------------------------------------------------- Cumulative Total Return 2 26.02% 11.90% Average Annual Total Return 3 25.02% 5.80% Value of $10,000 Investment 4 $12,502 $11,190
ONGOING MARKET VOLATILITY CAN SIGNIFICANTLY AFFECT SHORT-TERM PERFORMANCE; MORE RECENT RETURNS MAY DIFFER FROM THOSE SHOWN. SINCE MARKETS CAN GO DOWN AS WELL AS UP, INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE WITH MARKET CONDITIONS AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. FOR MORE CURRENT PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236. Annual Report | Past performance does not guarantee future results. | 11 Performance Summary (CONTINUED) TOTAL RETURN INDEX COMPARISON FOR HYPOTHETICAL $10,000 INVESTMENT Total return represents the change in value of an investment over the periods shown. It includes the current, applicable, maximum sales charge(s), Fund expenses, account fees and reinvested distributions. The unmanaged index includes reinvested dividends. It differs from the Fund in composition and does not pay management fees or expenses. One cannot invest directly in an index. AVERAGE ANNUAL TOTAL RETURN --------------------------------------- CLASS Z 1 12/31/03 --------------------------------------- 1-Year 26.62% --------------------------------------- 5-Year 9.45% --------------------------------------- 10-Year 12.51% [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Class Z (1/1/94-12/31/03) 1 MUTUAL SHARES FUND S&P 500 5 1/1/94 10000 10000 10188 10340 10051 10059 9692 9622 9917 9745 10140 9904 9928 9662 10280 9979 10778 10387 10618 10133 10638 10361 10322 9984 10455 10132 10673 10394 11136 10799 11272 11117 11612 11444 11953 11901 12077 12177 12649 12580 12916 12612 13299 13144 12978 13097 13362 13671 13498 13934 14038 14408 14419 14542 14524 14682 14504 14898 14746 15282 6/30/96 14604 15340 14108 14663 14633 14973 15106 15814 15235 16250 16117 17478 16300 17132 16809 18201 17213 18344 16984 17592 17169 18641 17985 19775 18538 20661 19564 22304 19431 21055 20319 22208 19964 21467 20221 22460 20599 22845 20454 23098 21635 24762 22360 26029 22283 26291 22080 25840 21983 26889 21391 26603 18373 22761 18256 24219 19455 26187 20497 27774 12/31/98 20691 29373 21020 30601 20744 29650 21708 30836 23392 32030 23508 31275 24176 33009 23507 31980 22601 31822 22019 30950 22882 32908 23313 33577 23796 35553 23016 33767 22072 33129 24355 36368 24099 35274 24402 34552 23974 35404 24642 34851 25889 37014 25864 35061 26481 34912 25650 32162 27087 32319 28689 33465 28702 30416 27977 28490 29113 30702 30126 30908 6/30/01 30310 30156 30296 29859 29605 27992 26997 25732 26884 26223 28012 28234 28800 28481 28533 28066 28666 27524 29526 28560 29703 26829 29718 26632 27791 24735 26121 22808 26392 22957 24963 20465 25354 22264 25865 23573 25664 22189 25451 21609 25040 21284 25100 21489 26579 23260 27935 24484 28358 24797 28527 25234 29203 25725 29080 25453 30154 26892 31122 27128 12/31/03 32497 28550 AVERAGE ANNUAL TOTAL RETURN --------------------------------------- CLASS A 1 12/31/03 --------------------------------------- 1-Year 18.95% --------------------------------------- 5-Year 7.78% --------------------------------------- Since Inception (11/1/96) 9.84% MUTUAL SHARES FUND S&P 500 5 11/1/96 $9,425 $10,000 11/30/96 $9,968 $10,755 12/31/96 $10,077 $10,542 1/31/97 $10,391 $11,200 2/28/97 $10,635 $11,288 3/31/97 $10,494 $10,825 4/30/97 $10,602 $11,471 5/31/97 $11,102 $12,169 6/30/97 $11,438 $12,714 7/31/97 $12,072 $13,725 8/31/97 $11,989 $12,957 9/30/97 $12,533 $13,666 10/31/97 $12,308 $13,210 11/30/97 $12,462 $13,821 12/31/97 $12,698 $14,058 1/31/98 $12,597 $14,213 2/28/98 $13,325 $15,238 3/31/98 $13,767 $16,018 4/30/98 $13,714 $16,179 5/31/98 $13,582 $15,901 6/30/98 $13,517 $16,546 7/31/98 $13,149 $16,371 8/31/98 $11,293 $14,006 9/30/98 $11,214 $14,904 10/31/98 $11,948 $16,115 11/30/98 $12,585 $17,091 12/31/98 $12,699 $18,075 1/31/99 $12,901 $18,831 2/28/99 $12,726 $18,246 3/31/99 $13,318 $18,975 4/30/99 $14,341 $19,710 5/31/99 $14,407 $19,245 6/30/99 $14,819 $20,313 7/31/99 $14,401 $19,679 8/31/99 $13,837 $19,582 9/30/99 $13,479 $19,046 10/31/99 $14,003 $20,251 11/30/99 $14,262 $20,662 12/31/99 $14,557 $21,878 1/31/00 $14,072 $20,779 2/29/00 $13,493 $20,386 3/31/00 $14,886 $22,379 4/30/00 $14,722 $21,706 5/31/00 $14,907 $21,262 6/30/00 $14,639 $21,786 7/31/00 $15,040 $21,446 8/31/00 $15,797 $22,777 9/30/00 $15,774 $21,575 10/31/00 $16,152 $21,484 11/30/00 $15,635 $19,791 12/31/00 $16,511 $19,888 1/31/01 $17,482 $20,593 2/28/01 $17,482 $18,717 3/31/01 $17,030 $17,532 4/30/01 $17,724 $18,893 5/31/01 $18,335 $19,020 6/30/01 $18,443 $18,557 7/31/01 $18,434 $18,374 8/31/01 $18,004 $17,225 9/30/01 $16,409 $15,834 10/31/01 $16,340 $16,137 11/30/01 $17,012 $17,374 12/31/01 $17,491 $17,526 1/31/02 $17,329 $17,271 2/28/02 $17,401 $16,938 3/31/02 $17,916 $17,575 4/30/02 $18,015 $16,510 5/31/02 $18,024 $16,388 6/30/02 $16,845 $15,221 7/31/02 $15,836 $14,035 8/31/02 $15,992 $14,127 9/30/02 $15,130 $12,593 10/31/02 $15,350 $13,701 11/30/02 $15,662 $14,506 12/31/02 $15,533 $13,654 1/31/03 $15,403 $13,297 2/28/03 $15,144 $13,098 3/31/03 $15,181 $13,223 4/30/03 $16,070 $14,313 5/31/03 $16,884 $15,066 6/30/03 $17,127 $15,259 7/31/03 $17,230 $15,528 8/31/03 $17,631 $15,830 9/30/03 $17,547 $15,663 10/31/03 $18,200 $16,548 11/30/03 $18,768 $16,694 12/31/03 $19,599 $17,569 12 | Past performance does not guarantee future results. | Annual Report Performance Summary (CONTINUED) AVERAGE ANNUAL TOTAL RETURN --------------------------------------- CLASS B 1 12/31/03 --------------------------------------- 1-Year 21.41% --------------------------------------- 5-Year 8.06% --------------------------------------- Since Inception (1/1/99) 8.06% [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Class B (1/1/99-12/31/03) 1 Date Mutual Shares Fund S&P 500 Index 5 1/99 10000 10000 10154 10418 10005 10094 10467 10498 11262 10905 11313 10647 11627 11238 11293 10887 10844 10834 10556 10537 10964 11203 11157 11431 12/99 11382 12104 11000 11496 10539 11279 11618 12381 11489 12009 11624 11763 11411 12053 11720 11865 12303 12601 12279 11936 12558 11886 12157 10949 12/00 12827 11003 13574 11393 13568 10355 13213 9699 13745 10453 14204 10523 14279 10267 14265 10166 13921 9530 12691 8760 12624 8927 13144 9612 12/01 13501 9696 13367 9555 13416 9371 13805 9723 13875 9134 13875 9067 12964 8421 12175 7765 12290 7816 11616 6967 11781 7580 12017 8025 12/02 11908 7554 11800 7357 11605 7246 11619 7316 12297 7919 12910 8335 13093 8442 13166 8591 13464 8758 13391 8665 13885 9155 14313 9236 12/03 14734 9720 AVERAGE ANNUAL TOTAL RETURN --------------------------------------- CLASS C 1 12/31/03 --------------------------------------- 1-Year 23.11% --------------------------------------- 5-Year 8.13% --------------------------------------- Since Inception (11/1/96) 9.89% [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Class C (11/1/96-12/31/03) 1 Date Mutual Shares Fund S&P 500 Index 5 9900 10000 10467 10755 12/96 10576 10542 10901 11200 11154 11288 10995 10825 11103 11471 11621 12169 11969 12714 12624 13725 12526 12957 13090 13666 12848 13210 13004 13821 12/97 13235 14058 13129 14213 13879 15238 14329 16018 14266 16179 14123 15901 14048 16546 13661 16371 11720 14006 11638 14904 12392 16115 13045 17091 12/98 13163 18075 13359 18831 13170 18246 13773 18975 14824 19710 14892 19245 15305 20313 14864 19679 14278 19582 13899 19046 14430 20251 14692 20662 12/99 14989 21878 14479 20779 13873 20386 15299 22379 15129 21706 15307 21262 15026 21786 15432 21446 16198 22777 16166 21575 16533 21484 16006 19791 12/00 16890 19888 17870 20593 17862 18717 17397 17532 18094 18893 18705 19020 18807 18557 18781 18374 18338 17225 16708 15834 16628 16137 17301 17374 12/01 17778 17526 17602 17271 17667 16938 18184 17575 18276 16510 18276 16388 17071 15221 16040 14035 16181 14127 15300 12593 15516 13701 15825 14506 12/02 15683 13654 15542 13297 15279 13098 15307 13223 16191 14313 17009 15066 17247 15259 17332 15528 17730 15830 17635 15663 18279 16548 18847 16694 12/03 19661 17569 Annual Report | Past performance does not guarantee future results. | 13 Performance Summary (CONTINUED) AVERAGE ANNUAL TOTAL RETURN -------------------------------------- CLASS R 12/31/03 -------------------------------------- 1-Year 25.02% -------------------------------------- Since Inception (1/1/02) 5.80% [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Class R (1/1/02-12/31/03) Date Mutual Shares Fund- Class R S&P 500 Index 5 1/1/02 $10,000 $10,000 1/31/02 $9,917 $9,854 2/28/02 $9,959 $9,664 3/31/02 $10,258 $10,028 4/30/02 $10,315 $9,420 5/31/02 $10,320 $9,351 6/30/02 $9,643 $8,685 7/31/02 $9,066 $8,008 8/31/02 $9,151 $8,061 9/30/02 $8,657 $7,185 10/31/02 $8,783 $7,817 11/30/02 $8,956 $8,277 12/31/02 $8,880 $7,791 1/31/03 $8,805 $7,587 2/28/03 $8,662 $7,473 3/31/03 $8,677 $7,545 4/30/03 $9,181 $8,167 5/31/03 $9,648 $8,596 6/30/03 $9,793 $8,706 7/31/03 $9,846 $8,860 8/31/03 $10,076 $9,032 9/30/03 $10,023 $8,937 10/31/03 $10,391 $9,442 11/30/03 $10,718 $9,525 12/31/03 $11,190 $10,024 ENDNOTES THE FUND INVESTS IN SMALLER-COMPANY STOCKS AND FOREIGN SECURITIES. SMALLER-COMPANY STOCKS HAVE HISTORICALLY EXHIBITED GREATER PRICE VOLATILITY THAN LARGER-COMPANY STOCKS, PARTICULARLY OVER THE SHORT TERM. FOREIGN SECURITIES RISKS INCLUDE EXPOSURE TO CURRENCY VOLATILITY AND POLITICAL, ECONOMIC AND REGULATORY UNCERTAINTY. THE FUND MAY ALSO INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, AS WELL AS LOWER-RATED "JUNK BONDS," WHICH ENTAIL HIGHER CREDIT RISK. THE FUND'S PROSPECTUS ALSO INCLUDES A DESCRIPTION OF THE MAIN INVESTMENT RISKS. CLASS Z: No initial sales charge or Rule 12b-1 fees; shares are available only to certain investors, as described in the prospectus. CLASS A: Subject to the current, maximum 5.75% initial sales charge. Prior to 8/3/98, Fund shares were offered at a lower initial sales charge; thus actual total returns may differ. CLASS B: Subject to no initial sales charge, but subject to a contingent deferred sales charge (CDSC) declining from 4% to 0% over six years. These shares have higher annual fees and expenses than Class A shares. CLASS C: Subject to 1% initial sales charge and 1% CDSC for shares redeemed within 18 months of investment. These shares have higher annual fees and expenses than Class A shares. CLASS R: No initial sales charge, but subject to 1% CDSC for shares redeemed within 18 months of investment; shares are available to certain eligible investors as described in the prospectus. These shares have higher annual fees and expenses than Class A shares. 1. Past expense reductions by the Fund's manager increased the Fund's total returns. Without these reductions, the Fund's total returns would have been lower. 2. Cumulative total return represents the change in value of an investment over the periods indicated and does not include sales charges. 3. Average annual total return represents the average annual change in value of an investment over the periods indicated and includes any current, applicable, maximum sales charge(s). 4. These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated and include any current, applicable, maximum sales charge(s). 5. Source: Standard & Poor's Micropal. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The S&P 500 is one of the most widely used benchmarks of U.S. equity performance. -------------------------------------------------------------------------------- 14 | Past performance does not guarantee future results. | Annual Report Mutual Shares Fund FINANCIAL HIGHLIGHTS
-------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2003 2002 2001 2000 1999 -------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ....................... $16.84 $19.44 $19.79 $20.43 $19.55 -------------------------------------------------------------- Income from investment operations: Net investment income a ................................. .24 .33 .29 .34 .33 Net realized and unrealized gains (losses) .............. 4.23 (2.42) .95 2.23 2.55 -------------------------------------------------------------- Total from investment operations ......................... 4.47 (2.09) 1.24 2.57 2.88 -------------------------------------------------------------- Less distributions from: Net investment income ................................... (.32) (.25) (.24) (.70) (.42) Net realized gains ...................................... -- (.26) (1.35) (2.51) (1.58) -------------------------------------------------------------- Total distributions ...................................... (.32) (.51) (1.59) (3.21) (2.00) -------------------------------------------------------------- Net asset value, end of year ............................. $20.99 $16.84 $19.44 $19.79 $20.43 ============================================================== Total return b ........................................... 26.62% (10.89)% 6.32% 13.83% 14.95% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) .......................... $5,782,145 $4,585,605 $5,465,075 $5,359,319 $5,571,867 Ratios to average net assets:* Expenses c .............................................. .84% .79% .78% .79% .77% Expenses, excluding waiver and payments by affiliate c .. .84% .79% .78% .82% .81% Net investment income ................................... 1.28% 1.79% 1.40% 1.69% 1.58% Portfolio turnover rate .................................. 54.65% 51.22% 52.98% 63.22% 66.24% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................................. .81% .78% .77% .76% .75% Expenses, excluding waiver and payments by affiliate ..... .81% .78% .77% .79% .79%
a Based on average daily shares outstanding. b Total return is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses. Annual Report | 15 Mutual Shares Fund FINANCIAL HIGHLIGHTS (CONTINUED)
-------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2003 2002 2001 2000 1999 -------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ...................... $16.78 $19.37 $19.73 $20.38 $19.50 -------------------------------------------------------------- Income from investment operations: Net investment income a ................................ .17 .26 .22 .27 .26 Net realized and unrealized gains (losses) ............. 4.21 (2.40) .95 2.22 2.54 -------------------------------------------------------------- Total from investment operations ........................ 4.38 (2.14) 1.17 2.49 2.80 -------------------------------------------------------------- Less distributions from: Net investment income .................................. (.26) (.19) (.18) (.63) (.34) Net realized gains ..................................... -- (.26) (1.35) (2.51) (1.58) -------------------------------------------------------------- Total distributions ..................................... (.26) (.45) (1.53) (3.14) (1.92) -------------------------------------------------------------- Net asset value, end of year ............................ $20.90 $16.78 $19.37 $19.73 $20.38 ============================================================== Total return b .......................................... 26.18% (11.20)% 5.94% 13.42% 14.57% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ......................... $2,257,336 $1,543,833 $1,580,046 $1,283,230 $1,365,694 Ratios to average net assets:* Expenses c ............................................. 1.19% 1.14% 1.13% 1.14% 1.12% Expenses, excluding waiver and payments by affiliate c . 1.19% 1.14% 1.13% 1.17% 1.16% Net investment income .................................. .93% 1.44% 1.05% 1.34% 1.23% Portfolio turnover rate ................................. 54.65% 51.22% 52.98% 63.22% 66.24% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................................ 1.16% 1.13% 1.12% 1.11% 1.10% Expenses, excluding waiver and payments by affiliate .... 1.16% 1.13% 1.12% 1.14% 1.14%
a Based on average daily shares outstanding. b Total return does not reflect sales commissions or the contingent deferred sales charge, and is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses. 16 Annual Report Mutual Shares Fund
FINANCIAL HIGHLIGHTS (CONTINUED) ---------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2003 2002 2001 2000 1999 ---------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................................ $16.53 $19.12 $19.56 $20.26 $19.50 ---------------------------------------------------------- Income from investment operations: Net investment income a .......................................... .04 .15 .08 .14 .09 Net realized and unrealized gains (losses) ....................... 4.14 (2.36) .95 2.20 2.55 ---------------------------------------------------------- Total from investment operations .................................. 4.18 (2.21) 1.03 2.34 2.64 ---------------------------------------------------------- Less distributions from: Net investment income ............................................ (.17) (.12) (.12) (.53) (.30) Net realized gains ............................................... -- (.26) (1.35) (2.51) (1.58) ---------------------------------------------------------- Total distributions ............................................... (.17) (.38) (1.47) (3.04) (1.88) ---------------------------------------------------------- Net asset value, end of year ...................................... $20.54 $16.53 $19.12 $19.56 $20.26 ========================================================== Total return b .................................................... 25.41% (11.80)% 5.26% 12.69% 13.76% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................................... $444,671 $235,470 $126,579 $34,778 $21,634 Ratios to average net assets:* Expenses c ....................................................... 1.84% 1.79% 1.78% 1.79% 1.77% Expenses, excluding waiver and payments by affiliate c ........... 1.84% 1.79% 1.78% 1.82% 1.81% Net investment income ............................................ .28% .79% .37% .70% .46% Portfolio turnover rate ........................................... 54.65% 51.22% 52.98% 63.22% 66.24% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .......................................................... 1.81% 1.78% 1.77% 1.76% 1.75% Expenses, excluding waiver and payments by affiliate .............. 1.81% 1.78% 1.77% 1.79% 1.79%
aBased on average daily shares outstanding. bTotal return does not reflect the contingent deferred sales charge, and is not annualized for periods less than one year. cIncludes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses. Annual Report | 17 Mutual Shares Fund FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------- YEAR ENDED DECEMBER 31, ---------------------------------------------------------- CLASS C 2003 2002 2001 2000 1999 PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .............................. $16.68 $19.26 $19.63 $20.29 $19.41 ---------------------------------------------------------- Income from investment operations: Net investment income a ........................................ .05 .15 .08 .14 .12 Net realized and unrealized gains (losses) ..................... 4.17 (2.39) .95 2.20 2.53 ---------------------------------------------------------- Total from investment operations ................................ 4.22 (2.24) 1.03 2.34 2.65 ---------------------------------------------------------- Less distributions from: Net investment income .......................................... (.15) (.08) (.05) (.49) (.20) Net realized gains ............................................. -- (.26) (1.35) (2.51) (1.57) ---------------------------------------------------------- Total distributions ............................................. (.15) (.34) (1.40) (3.00) (1.77) ---------------------------------------------------------- Net asset value, end of year .................................... $20.75 $16.68 $19.26 $19.63 $20.29 ========================================================== Total return b .................................................. 25.37% (11.78)% 5.26% 12.68% 13.87% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................................. $1,272,590 $866,422 $885,658 $759,477 $890,712 Ratios to average net assets:* Expenses c ..................................................... 1.84% 1.78% 1.78% 1.78% 1.76% Expenses, excluding waiver and payments by affiliate c ......... 1.84% 1.78% 1.78% 1.81% 1.80% Net investment income .......................................... .28% .80% .40% .70% .59% Portfolio turnover rate ......................................... 54.65% 51.22% 52.98% 63.22% 66.24% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ........................................................ 1.81% 1.77% 1.77% 1.75% 1.74% Expenses, excluding waiver and payments by affiliate ............ 1.81% 1.77% 1.77% 1.78% 1.78%
a Based on average daily shares outstanding. b Total return does not reflect sales commissions or the contingent deferred sales charge, and is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses. 18 Annual Report Mutual Shares Fund FINANCIAL HIGHLIGHTS (CONTINUED)
------------------------- YEAR ENDED DECEMBER 31, CLASS R 2003 2002 D ------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................................ $16.75 $19.36 ------------------------- Income from investment operations: Net investment income a .......................................... .13 .24 Net realized and unrealized gains (losses) ....................... 4.21 (2.37) ------------------------- Total from investment operations .................................. 4.34 (2.13) ------------------------- Less distributions from: Net investment income ............................................ (.26) (.22) Net realized gains ............................................... -- (.26) ------------------------- Total distributions ............................................... (.26) (.48) ------------------------- Net asset value, end of year ...................................... $20.83 $16.75 ========================= Total return b .................................................... 26.02% (11.26)% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................................... $46,933 $13,392 Ratios to average net assets:* Expenses c ....................................................... 1.34% 1.29% e Expenses, excluding waiver and payments by affiliate c ........... 1.34% 1.29% e Net investment income ............................................ .78% 1.29% e Portfolio turnover rate ........................................... 54.65% 51.22% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .......................................................... 1.31% 1.28% e Expenses, excluding waiver and payments by affiliate .............. 1.31% 1.28% e
a Based on average daily shares outstanding. b Total return does not reflect the contingent deferred sales charge, and is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses. d Effective date of Class R shares was January 2, 2002. e Annualized. Annual Report | See notes to financial statements. | 19 STATEMENT OF INVESTMENTS, DECEMBER 31, 2003
------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS 68.2% AEROSPACE & DEFENSE .6% Northrop Grumman Corp. ..................................... United States 640,200 $ 61,203,120 -------------------- AIRLINES a Atlantic Coast Airlines Holdings Inc. ...................... United States 97,500 965,250 -------------------- BEVERAGES 4.0% Brown-Forman Corp., A ...................................... United States 62,730 6,081,673 Brown-Forman Corp., B ...................................... United States 303,018 28,317,032 Coca-Cola Enterprises Inc. ................................. United States 555,500 12,148,785 Diageo PLC ................................................. United Kingdom 16,147,856 212,467,986 Heineken Holding NV, A ..................................... Netherlands 763,593 26,130,522 Orkla ASA .................................................. Norway 4,337,990 97,156,160 Pepsi Bottling Group Inc. .................................. United States 203,300 4,915,793 -------------------- 387,217,951 -------------------- BIOTECHNOLOGY a SICOR Inc. ................................................. United States 57,200 1,555,840 -------------------- CAPITAL MARKETS .3% Bear Stearns Cos. Inc. ..................................... United States 357,404 28,574,450 -------------------- CHEMICALS 1.8% Akzo Nobel NV .............................................. Netherlands 1,752,948 67,659,194 International Flavors & Fragrances Inc. .................... United States 2,215,225 77,355,657 Syngenta AG ................................................ Switzerland 431,617 29,071,111 -------------------- 174,085,962 -------------------- COMMERCIAL BANKS 3.0% Allied Irish Banks PLC ..................................... Irish Republic 6,271,530 100,306,509 Bank of Ireland ............................................ Irish Republic 5,404,128 73,550,128 Danske Bank ................................................ Denmark 2,699,400 63,333,458 Fleet Boston Financial Corp. ............................... United States 326,705 14,260,673 KeyCorp .................................................... United States 853,200 25,015,824 a,b,c Nippon Investment LLC ...................................... Japan 18,938,000 7,196,440 U.S. Bancorp ............................................... United States 324,340 9,658,845 -------------------- 293,321,877 -------------------- COMMERCIAL SERVICES & SUPPLIES 1.3% a Alderwoods Group Inc. ...................................... United States 1,111,060 10,466,185 a Cendant Corp. .............................................. United States 1,806,403 40,228,595 Republic Services Inc. ..................................... United States 3,107,550 79,646,507 -------------------- 130,341,287 -------------------- COMPUTERS & PERIPHERALS a,c DecisionOne Corp. .......................................... United States 457,492 914,984 -------------------- CONSTRUCTION MATERIALS .5% Martin Marietta Materials Inc. ............................. United States 927,950 43,585,812 --------------------
20 |Annual Report Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) DIVERSIFIED FINANCIAL SERVICES 1.7% Brascan Corp., A ........................................... Canada 2,477,400 $ 76,167,229 a,b,c Elephant Capital Holdings Ltd. ............................. Japan 25,401 25,401,000 a,b Leucadia National Corp. .................................... United States 1,551,229 67,936,074 -------------------- 169,504,303 -------------------- DIVERSIFIED TELECOMMUNICATION SERVICES 2.6% a,b,d AboveNet Inc. .............................................. United States 141,884 4,250,036 BCE Inc. ................................................... Canada 1,517,500 33,937,512 Global Crossing Holdings Ltd., Contingent Equity Distribution ............................. United States 105,801,010 92,576 a Global Crossing Ltd. ....................................... United States 160,324 5,290,676 a Koninklijke KPN NV ......................................... Netherlands 3,088,868 23,844,440 a NTL Inc. ................................................... United Kingdom 1,150,472 80,245,422 a,b NTL Inc. ................................................... United Kingdom 872,276 57,799,189 a Spectrasite Inc. ........................................... United States 1,135,010 39,441,598 a XO Communications Inc. ..................................... United States 2,321,108 9,864,709 -------------------- 254,766,158 -------------------- ELECTRIC UTILITIES 1.2% a Allegheny Energy Inc. ...................................... United States 4,675,400 59,658,104 E.ON AG .................................................... Germany 663,027 43,429,606 a,b PG & E Corp., wts., 9/02/06 ................................ United States 27,436 685,461 a Reliant Resources Inc. ..................................... United States 2,367,900 17,427,744 -------------------- 121,200,915 -------------------- FOOD & STAPLES RETAILING .4% a Kroger Co. ................................................. United States 1,613,070 29,857,925 a Safeway Inc. ............................................... United States 532,400 11,664,884 -------------------- 41,522,809 -------------------- FOOD PRODUCTS 4.2% Cadbury Schweppes PLC ...................................... United Kingdom 12,700,586 93,274,654 Groupe Danone .............................................. France 939,962 153,419,630 Nestle SA .................................................. Switzerland 653,170 163,193,474 -------------------- 409,887,758 -------------------- HEALTH CARE EQUIPMENT & SUPPLIES .1% Amersham PLC ............................................... United Kingdom 809,700 11,095,851 -------------------- HEALTH CARE PROVIDERS & SERVICES 1.4% a AdvancePCS ................................................. United States 78,900 4,154,874 HCA Inc. ................................................... United States 626,300 26,905,848 a Health Net Inc., A ......................................... United States 129,710 4,241,517 a,c,d Kindred Healthcare Inc. .................................... United States 1,190,483 58,787,241 c,d Kindred Healthcare Inc., Jul. 47.50 Calls, 7/11/11 ......... United States 1,928 863,744 c,d Kindred Healthcare Inc., Jan. 52.00 Calls, 1/01/12 ......... United States 289 -- a,c,d Kindred Healthcare Inc., wts., Series A, 4/20/06 ........... United States 211,977 4,929,737 a,c,d Kindred Healthcare Inc., wts., Series B, 4/20/06 ........... United States 529,943 11,100,980 a Laboratory Corp. of America Holdings ....................... United States 173,200 6,399,740 a Mid Atlantic Medical Services Inc. ......................... United States 67,500 4,374,000 Annual Report| 21
Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED) ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) HEALTH CARE PROVIDERS & SERVICES (CONT.) a Rotech Healthcare Inc. ..................................... United States 381,850 $ 8,782,550 a Wellpoint Health Networks Inc. ............................. United States 39,500 3,831,105 ------------------- 134,371,336 ------------------- HOTELS RESTAURANTS & LEISURE .2% Cara Operations Ltd., A .................................... Canada 160,400 878,801 a,c FHC Delaware Inc. .......................................... United States 784,457 6,173,676 a Park Place Entertainment Corp. ............................. United States 1,137,412 12,318,171 ------------------- 19,370,648 ------------------- HOUSEHOLD DURABLES a Bulova Corp. ............................................... United States 37,900 1,108,575 ------------------- INSURANCE 11.9% a Alleghany Corp. ............................................ United States 328,543 73,100,817 a Berkshire Hathaway Inc., A ................................. United States 1,590 133,957,500 a Berkshire Hathaway Inc., B ................................. United States 71,185 200,385,774 Hartford Financial Services Group Inc. ..................... United States 925,900 54,655,876 John Hancock Financial Services Inc. ....................... United States 341,800 12,817,500 a Montpelier Re Holdings Ltd. ................................ Bermuda 459,289 16,855,905 Nationwide Financial Services Inc., A ...................... United States 1,541,150 50,950,419 Old Republic International Corp. ........................... United States 3,684,143 93,429,853 a,b Olympus Re Holdings Ltd. ................................... Bermuda 202,380 32,010,443 Prudential Financial Inc. .................................. United States 1,265,000 52,839,050 Travelers Property Casualty Corp., A ....................... United States 4,362,320 73,199,730 c White Mountains Insurance Group Inc. ....................... United States 472,190 217,183,790 b,c White Mountains Insurance Group Inc. ....................... United States 265,658 116,079,927 Willis Group Holdings Ltd. ................................. United States 1,173,000 39,964,110 ------------------- 1,167,430,694 ------------------- IT SERVICES .1% Comdisco Contingent Equity Distribution .................... United States 3,425,000 353,096 a Comdisco Holding Co. Inc. .................................. United States 207 8,280 a Concord EFS Inc. ........................................... United States 429,300 6,370,812 ------------------- 6,732,188 ------------------- MACHINERY a,b,c Lancer Industries Inc., B .................................. United States 3 2,085,868 ------------------- MEDIA 7.3% Dow Jones & Co. Inc. ....................................... United States 261,810 13,051,229 E.W. Scripps Co., A ........................................ United States 1,010,475 95,126,117 a EchoStar Communications Corp., A ........................... United States 864,691 29,399,494 a Fox Entertainment Group Inc., A ............................ United States 399,085 11,633,328 Gannett Co. Inc. ........................................... United States 138,700 12,366,492 Lagardere SCA .............................................. France 1,595,174 92,092,727 a Liberty Media Corp., A ..................................... United States 14,398,624 171,199,639 McGraw-Hill Cos. Inc. ...................................... United States 147,500 10,313,200 Meredith Corp. ............................................. United States 1,036,335 50,583,511 a NTL Europe Inc. ............................................ United Kingdom 492,392 4,924
22 |Annual Report Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) MEDIA (CONT.) Omnicom Group Inc. ......................................... United States 217,300 $ 18,976,809 a Sinclair Broadcast Group Inc., A ........................... United States 1,098,838 16,394,663 a TVMAX Holdings Inc. ........................................ United States 128,831 322,078 Washington Post Co., B ..................................... United States 238,238 188,541,553 ------------------- 710,005,764 ------------------- METALS & MINING 5.7% Anglo American PLC ......................................... United Kingdom 3,721,450 80,410,128 Anglo American PLC, ADR .................................... United Kingdom 2,300 50,876 a Ashanti Goldfields Co. Ltd., GDR, Reg S .................... Ghana 339,700 4,429,688 Barrick Gold Corp. ......................................... Canada 2,898,200 65,818,122 Falconbridge Ltd. .......................................... Canada 80,400 1,951,127 a Glamis Gold Ltd. ........................................... Canada 730,500 12,594,730 Gold Fields Ltd. ........................................... South Africa 1,143,700 16,363,049 a,b,c International Steel Group .................................. United States 6,143,191 203,385,696 Newmont Mining Corp. ....................................... United States 2,695,800 131,042,839 Noranda Inc. ............................................... Canada 622,100 9,892,942 Pechiney SA, A ............................................. France 12,200 746,342 Placer Dome Inc. ........................................... Canada 895,800 16,061,665 a Randgold & Exploration Co. Ltd., ADR ....................... South Africa 59,020 967,869 a Wheaton River Minerals Ltd. ................................ Canada 2,388,616 7,153,371 a Wheaton River Minerals Ltd., wts., 5/30/07 ................. Canada 1,819,489 3,252,482 ------------------- 554,120,926 ------------------- MULTI-UTILITIES & UNREGULATED POWER .4% Suez SA .................................................... France 2,104,518 42,286,796 ------------------- OIL & GAS 1.4% BP PLC ..................................................... United Kingdom 5,707,068 46,280,980 BP PLC, ADR ................................................ United Kingdom 46,400 2,289,840 Occidental Petroleum Corp. ................................. United States 200,400 8,464,896 a,c Southwest Royalties Inc., A ................................ United States 123,013 3,690,380 Suncor Energy Inc. ......................................... Canada 74,200 1,866,125 Total SA, B ................................................ France 380,938 70,825,254 ------------------- 133,417,475 ------------------- PAPER & FOREST PRODUCTS .5% Abitibi-Consolidated Inc. .................................. Canada 5,680,487 45,584,562 ------------------- PERSONAL PRODUCTS .4% Beiersdorf AG .............................................. Germany 334,592 41,001,025 ------------------- PHARMACEUTICALS 1.8% Merck & Co. Inc. ........................................... United States 851,450 39,336,990 Takeda Chemical Industries Ltd. ............................ Japan 1,244,600 49,356,630 Valeant Pharmaceuticals International ...................... United States 2,821,135 70,951,545 Wyeth ...................................................... United States 336,100 14,267,445 ------------------- 173,912,610 -------------------
Annual Report | 23 Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) REAL ESTATE 2.3% a,c Alexander's Inc. ........................................... United States 326,675 $ 40,723,305 American Financial Realty Trust ............................ United States 322,100 5,491,805 a Canary Wharf Group PLC ..................................... United Kingdom 14,262,931 68,364,329 a Fieldstone Investment Corp. ................................ United States 2,365,900 39,628,825 a,b Security Capital European Realty ........................... Luxembourg 227,308 1,693,445 St. Joe Co. ................................................ United States 853,035 31,809,675 Ventas Inc. ................................................ United States 1,778,665 39,130,630 ------------------- 226,842,014 ------------------- ROAD & RAIL 2.1% Burlington Northern Santa Fe Corp. ......................... United States 1,208,355 39,090,284 Canadian National Railway Co. .............................. Canada 821,010 52,097,365 c Florida East Coast Industries Inc., A ...................... United States 2,472,271 81,832,170 Norfolk Southern Corp. ..................................... United States 1,558,100 36,849,065 ------------------- 209,868,884 ------------------- SPECIALTY RETAIL New Look Group ............................................. United Kingdom 690,560 3,844,617 ------------------- THRIFTS & MORTGAGE FINANCE 2.5% Freddie Mac ................................................ United States 1,059,200 61,772,544 Greenpoint Financial Corp. ................................. United States 390,580 13,795,286 Hudson City Bancorp Inc. ................................... United States 867,255 33,111,796 Sovereign Bancorp Inc. ..................................... United States 5,828,890 138,436,137 ------------------- 247,115,763 ------------------- TOBACCO 8.1% Altadis SA ................................................. Spain 7,317,351 207,669,532 Altria Group Inc. .......................................... United States 1,031,230 56,119,537 British American Tobacco PLC ............................... United Kingdom 23,826,046 328,423,326 British American Tobacco PLC, ADR .......................... United Kingdom 70,550 1,952,118 Imperial Tobacco Group PLC ................................. United Kingdom 6,933,289 136,528,489 R.J. Reynolds Tobacco Holdings Inc. ........................ United States 1,103,100 64,145,265 ------------------- 794,838,267 ------------------- TRANSPORTATION INFRASTRUCTURE .4% a Laidlaw International Inc. ................................. United States 1,754,245 24,261,209 Peninsular & Oriental Steam Navigation Co. ................. United Kingdom 3,332,788 13,722,297 ------------------- 37,983,506 ------------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (Cost $4,556,078,263) ...................................... 6,681,665,845 ------------------- PREFERRED STOCKS .3% ------------------- SHARES ------------------- ELECTRIC UTILITIES a Montana Power Co., 8.45%, pfd. ............................. United States 109,220 1,310,640 ------------------- FOOD PRODUCTS .1% Unilever NV, pfd. .......................................... Netherlands 1,113,140 7,989,110 -------------------
24 |Annual Report
Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED) ------------------------------------------------------------------------------------------------------------------------------------ COUNTRY SHARES VALUE ------------------------------------------------------------------------------------------------------------------------------------ PREFERRED STOCKS (CONT.) MEDIA .2% News Corp. Ltd., ADR, pfd. .................................. Australia 447,361 $ 13,532,670 NTL Europe Inc., 10.00%, A, pfd. ............................ United Kingdom 216,541 1,781,050 ------------------- 15,313,720 ------------------- TOTAL PREFERRED STOCKS (COST $21,439,800) ................... 24,613,470 ------------------- ------------------- PRINCIPAL AMOUNT D ------------------- CORPORATE BONDS & NOTES 3.7% Calpine Constructor Finance, 8.50%, 8/26/11 ............................................ United States $ 10,999,000 11,438,960 First Priority Term Loan, 8/26/09 ......................... United States 9,040,000 9,492,000 Calpine Corp., 144A, 9.875%, 12/01/11 ....................... United States 22,766,000 23,505,895 Charter Communications Operating LLC, Bank Claim ................................................. United States 16,237,200 15,668,898 c DecisionOne Corp., Term Loan ................................ United States 13,862,298 9,703,608 Eurotunnel PLC, 12/31/18, Tier 2 .......................................... United Kingdom 12,719,682 GBP 16,622,272 12/31/25, Tier 3 .......................................... United Kingdom 11,580,539 GBP 11,402,045 Participating Loan Note, 4/30/40 .......................... United Kingdom 1,482,000 GBP 570,398 Stabilization Advance S8, Tier 2 .......................... United Kingdom 2,066,242 GBP 702,791 Eurotunnel SA, 5.28%, 12/31/18, Tier 2 (Pibor) ........................... France 1,393,972 EUR 1,283,551 5.28%, 12/31/25, Tier 3 (Pibor) ........................... France 3,701,524 EUR 2,567,909 12/31/18, Tier 2 (Libor) .................................. France 3,151,383 EUR 2,901,753 12/31/25, Tier 3 (Libor) .................................. France 32,622,664 EUR 22,631,767 Stabilization Advance S6, Tier 1 (Pibor) .................. France 548,757 EUR 131,514 Stabilization Advance S6, Tier 2 (Libor) .................. France 1,963,236 EUR 470,503 Stabilization Advance S7, Tier 1 (Pibor) .................. France 2,110,667 EUR 505,836 b FE Capital LLC, 5.00%, 8/28/07 .............................. Japan 16,987,239 17,326,984 Healthsouth Corp., 8.50%, 2/01/08 ............................................ United States 11,945,000 11,526,926 7.00%, 6/15/08 ............................................ United States 6,330,000 5,934,376 8.375%, 10/01/11 .......................................... United States 3,815,000 3,624,251 7.625%, 6/01/12 ........................................... United States 30,717,000 28,873,981 cvt., 3.25% ............................................... United States 20,013,000 19,412,610 Marconi Corp., 10.00%, 10/31/08 ............................. United Kingdom 3,194,449 3,545,838 Marconi PLC, 8.00%, 4/30/08 ................................. United Kingdom 15,897,710 15,579,756 Mirant Mid-Atlantic LLC, 8.625%, 6/30/12 ........................................... United States 6,490,076 6,526,583 9.125%, 6/30/17 ........................................... United States 3,350,007 3,352,100 10.06%, 12/30/28 .......................................... United States 6,902,876 6,976,219 b MP Finance Ltd., 5.00%, 8/28/07 ............................. Japan 55,197,761 56,301,716 Providian Financial Corp., cvt., zero cpn., 2/15/21 .......................................... United States 30,645,000 14,632,988 Seton House Finance Ltd., zero cpn., 2/07/12 ................ United Kingdom 90,451,691 EUR 26,241,031
Annual Report| 25 Mutual Shares Fund
STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED) ------------------------------------------------------------------------------------------------------------------------------------ COUNTRY PRINCIPAL AMOUNT D VALUE ------------------------------------------------------------------------------------------------------------------------------------ CORPORATE BONDS & NOTES (CONT.) Teco Panda, Bank Claim #2 ............................................. United States $ 15,845,898 $ 11,329,811 Debt Service Reserve L/C Loan ............................. United States 908,743 649,752 Project L/C Loan Facility ................................. United States 2,271,758 1,624,307 TVMAX Holdings Inc., PIK, 14.00%, 2/01/06 ................... United States 594,256 594,256 ------------------- TOTAL CORPORATE BONDS & NOTES (COST $319,939,291) ........... 363,653,185 ------------------- BONDS & NOTES IN REORGANIZATION 6.4% a Adelphia Communications Corp., 9.25%, 10/01/02 ........................................... United States 11,945,000 11,108,850 8.125%, 7/15/03 ........................................... United States 1,442,000 1,341,060 7.50%, 1/15/04 ............................................ United States 3,750,000 3,468,750 10.50%, 7/15/04 ........................................... United States 6,320,000 5,972,400 10.25%, 11/01/06 .......................................... United States 12,344,000 11,541,640 8.375%, 2/01/08 ........................................... United States 11,570,000 10,846,876 7.75%, 1/15/09 ............................................ United States 10,030,000 9,378,051 7.875%, 5/01/09 ........................................... United States 7,221,000 6,643,320 9.375%, 11/15/09 .......................................... United States 4,315,000 4,099,250 10.25%, 6/15/11 ........................................... United States 11,713,000 11,127,350 a AES Drax Holdings Ltd., 10.41%, 12/31/20 .......................................... Cayman Islands 25,872,000 22,767,360 9.07%, 12/31/25 ........................................... Cayman Islands 11,784,000 GBP 18,247,364 a Aiken Cnty S C Indl Rev Beloit, 6.00%, 12/01/11 ............. United States 775,000 3,876 a Air Canada Inc., 6.75%, 2/02/04 ............................................ Canada 2,268,000 CAD 640,604 9.00%, 6/01/06 ............................................ Canada 3,980,000 CAD 1,139,563 10.00%, 6/01/06 ........................................... Canada 3,795,000 EUR 2,034,404 7.25%, 10/01/07 ........................................... Canada 7,072,000 CAD 1,929,101 10.25%, 3/15/11 ........................................... Canada 20,193,000 8,228,648 Bank Claim ................................................ Canada 23,729,900 CAD 6,610,767 Bank Claim ................................................ Canada 454,102,381 JPY 1,610,142 Term Loan ................................................. Canada 16,462,900 6,091,273 zero cpn., 7/31/05 ........................................ Canada 5,818,255 2,240,028 a Century Communications Corp., 9.50%, 3/01/05 ............................................ United States 743,000 720,710 8.875%, 1/15/07 ........................................... United States 572,000 557,700 8.375%, 12/15/07 .......................................... United States 875,000 855,313 zero cpn., 3/15/03 ........................................ United States 10,740,000 9,558,600 a Dow Corning Corp., 9.50, 8/10/95 ............................................. United States 1,250,000 2,725,000 8.55%, 3/01/01 ............................................ United States 500,000 925,001 9.375%, 2/01/08 ........................................... United States 2,170,000 4,730,601 8.15%, 10/15/29 ........................................... United States 5,280,000 10,032,000 Bank Claim ................................................ United States 1,000,000 1,800,000 Bank Claim #2 ............................................. United States 1,391,595 2,504,871 Bank Debt ................................................. United States 2,738,952 4,930,114 Bank Debt ................................................. United States 600,000,000 JPY 10,077,447 Bank Debt #1 .............................................. United States 7,500,000 13,500,000
26 | Annual Report Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------------ COUNTRY PRINCIPAL AMOUNT D VALUE ------------------------------------------------------------------------------------------------------------------------------------ BONDS & NOTES IN REORGANIZATION (CONT.) a Harnischfeger Industries Inc., 8.90%, 3/01/22 ............................................. United States $ 6,565,000 $ 36,765 8.70%, 6/15/22 ............................................. United States 6,004,000 34,223 7.25%, 12/15/25 ............................................ United States 8,965,000 51,101 6.875%, 2/15/27 ............................................ United States 7,663,000 42,913 Stipulated Bank Claim ...................................... United States 9,933,950 54,637 a Metromedia Fiber Network Inc., 14.00%, 3/15/07 ............................................ United States 40,151,000 21,280,030 10.00%, 11/15/08 ........................................... United States 26,680,000 1,834,250 senior note, 10.00%, 12/15/09 .............................. United States 27,413,000 1,953,177 senior note, 10.00%, 12/15/09 .............................. United States 12,625,000 EUR 1,194,343 a Mirant Corp., Tranche C Revolver ......................................... United States 12,866,601 7,977,293 4 Year Revolver, 7/17/05 ................................... United States 10,605,394 8,272,207 364 Day Revolver ........................................... United States 18,420,900 10,868,331 a Northwestern Corp., 8.75%, 3/15/12 ............................................. United States 14,155,000 12,845,663 6.95%, 11/15/28 ............................................ United States 7,435,000 6,663,619 a NRG Energy Inc., 7.625%, 2/01/06 ............................................ United States 10,210,000 5,768,650 6.75%, 7/15/06 ............................................. United States 18,345,000 10,364,925 7.50%, 6/15/07 ............................................. United States 10,555,000 6,016,350 7.50%, 6/01/09 ............................................. United States 9,355,000 5,332,350 8.25%, 9/15/10 ............................................. United States 12,350,000 7,224,750 7.75%, 4/01/11 ............................................. United States 1,300,000 747,500 8.00%, 11/01/13 ............................................ United States 13,065,000 7,512,375 8.70%, 3/15/20 ............................................. United States 6,325,000 3,668,500 8.625%, 4/01/31 ............................................ United States 9,260,000 5,417,100 Revolver ................................................... United States 40,338,582 25,009,921 a Owens Corning, Revolver ...................................... United States 45,786,959 34,340,219 a Parmalat Netherlands BV, 0.875%, 6/30/21 ..................... Italy 11,780,000 EUR 3,728,798 PG & E Corp., 7.375%, 11/01/05 ........................................... United States 36,340,000 37,066,800 Commercial Paper, 1/18/01 .................................. United States 1,465,000 1,472,325 Commercial Paper, 1/30/01 .................................. United States 735,000 738,675 Commercial Paper, 2/16/01 .................................. United States 2,200,000 2,211,000 FRN, 144A, 7.583%, 10/31/01 ................................ United States 12,650,000 12,903,000 MTN, 5.94%, 10/07/03 ....................................... United States 1,825,000 1,834,125 a Port Seattle Wash Rev Ref-Beloit Proj., 6.00%, 12/01/17 ....................................... United States 385,000 1,925 a Safety Kleen Corp., 9.25%, 5/15/09 ........................... United States 1,085,000 54,250 a Safety Kleen Services, 9.25%, 6/01/08 ........................ United States 85,000 425 a Telewest Communications PLC, 11.00%, 10/01/07 ........................................... United Kingdom 14,949,000 9,791,595 11.25%, 11/01/08 ........................................... United Kingdom 2,250,000 1,456,875 9.875%, 2/01/10 ............................................ United Kingdom 4,755,000 GBP 5,022,198 Bank Claim ................................................. United Kingdom 56,035,616 GBP 47,648,480 cvt., 5.25%, 2/19/07 ....................................... United Kingdom 14,165,000 GBP 13,439,520 senior disc. note, zero cpn., 4/15/09 ...................... United Kingdom 5,920,000 3,108,000
Annual Report | 27 Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------------ COUNTRY PRINCIPAL AMOUNT D VALUE ------------------------------------------------------------------------------------------------------------------------------------ BONDS & NOTES IN REORGANIZATION (CONT.) a Telewest Communications PLC, (cont.) senior disc. note, zero cpn., 2/01/10 ....................... United Kingdom $ 4,470,000 $ 2,212,650 zero cpn., 4/15/04 .......................................... United Kingdom 17,665,000 GBP 15,811,568 a Telewest Finance Ltd., cvt, 6.00%, 7/07/05 .................... United Kingdom 12,987,000 13,766,220 a WorldCom Inc., 7.875%, 5/15/03 ............................................. United States 13,515,000 4,561,313 6.25%, 8/15/03 .............................................. United States 1,575,000 531,563 6.50%, 5/15/04 .............................................. United States 1,970,000 664,875 6.40%, 8/15/05 .............................................. United States 16,920,000 5,710,500 7.375%, 1/15/06 ............................................. United States 3,670,000 1,241,479 8.00%, 5/15/06 .............................................. United States 6,140,000 2,072,250 7.75%, 4/01/07 .............................................. United States 9,220,000 3,111,750 8.25%, 5/15/10 .............................................. United States 15,830,000 5,342,625 7.375%, 1/15/11 ............................................. United States 34,836,000 11,757,150 7.50%, 5/15/11 .............................................. United States 33,075,000 11,162,813 7.75%, 4/01/27 .............................................. United States 3,000,000 1,012,500 6.95%, 8/15/28 .............................................. United States 830,000 280,125 8.25%, 5/15/31 .............................................. United States 41,967,000 14,163,849 ------------------- TOTAL BONDS & NOTES IN REORGANIZATION (COST $486,074,581) ...... 628,380,447 ------------------- ------------------ SHARES/PRINCIPAL AMOUNT D ------------------ COMPANIES IN LIQUIDATION .1% a Apco Oil Corp. .............................................. United States 9,200 -- a Brunos Inc., Liquidating Unit ............................... United States 98,873 217,521 a,c City Investing Company Liquidating Trust .................... United States 4,373,476 9,118,696 a Guangdong International Trust & Investment Corp., 144A, 8.75%, 10/24/16 ..................................... China 5,800,000 362,500 Revolver - Admitted Claim ................................. Hong Kong 1,197,441 74,840 Structured Note - Admitted Claim .......................... Hong Kong 1,894,157 118,383 Syndicated Loan - Admitted Claim .......................... Hong Kong 3,275,003 204,688 a,c MBOP Liquidating Trust ...................................... United States 574,712 1,435 a Peregrine Investments Holdings Ltd., 6.70%, 1/15/98 ......... Hong Kong 95,000,000 JPY 57,617 6.70%, 6/30/00 ............................................ Hong Kong 250,000,000 JPY 151,627 zero cpn., 1/22/98 ........................................ Hong Kong 500,000 12,500 a PIV Investment Finance (Cayman) Ltd. ........................ Hong Kong 22,710,000 2,725,208 a Roeser & Pendelton Liquidating Trust ........................ United States 2,800 6,940 ------------------- TOTAL COMPANIES IN LIQUIDATION (COST $1,423,696) .................. 13,051,955 -------------------
28 | Annual Report Mutual Shares Fund
STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED) ------------------------------------------------------------------------------------------------------------------------------------ COUNTRY PRINCIPAL AMOUNT D VALUE ------------------------------------------------------------------------------------------------------------------------------------ GOVERNMENT AGENCIES 22.9% Federal Republic of Germany, 4.25%, 3/12/04 ................. Germany $ 10,000,000 EUR $ 12,663,976 f Federal Home Loan Bank, 1.41% to 2.51%, with maturities to 7/02/07 .................................. United States 952,403,000 1,350,584,975 f Federal Home Loan Mortgage Corp, 1.23% to 1.37%, with maturities to 4/22/04 ....................................... United States 267,891,000 267,427,003 Federal National Mortgage Association, 1.20% to 2.20%, with maturities to 12/29/06 ...................................... United States 519,837,000 529,261,735 U.S. Treasury Bills, 0.93% to 1.04%, with maturities to 5/06/04 .................................. United States 80,000,000 89,866,605 ------------------- TOTAL GOVERNMENT AGENCIES (COST $2,249,213,073) 2,249,804,294 ------------------- TOTAL INVESTMENTS BEFORE REPURCHASE AGREEMENTS (COST 7,634,168,704) 9,961,169,196 REPURCHASE AGREEMENTS .4% g,h Bear Stearns & Co. Inc., 0.87%, 1/02/04 (Maturity Value $5,567,400) Collateralized by U.S. Treasury Bills, Notes and Bonds ............................................................. 5,567,135 5,567,135 g,h Barclays Capital Inc., 0.99%, 1/02/04 (Maturity Value $2,744,224) Collateralized by U.S. Treasury Bills, Notes and Bonds ...................... 2,744,075 2,744,075 g,h Deutsche Bank Securities Inc., 1.03%, 1/02/04 (Maturity Value $6,251,532) Collateralized by U.S. Treasury Bills, Notes and Bonds ............................................................. 6,251,179 6,251,179 g,h Goldman Sachs & Co., 1.02%, 1/02/04 (Maturity Value $6,000,505) Collateralized by U.S. Treasury Bills, Notes and Bonds ............................................................. 6,000,170 6,000,170 g,h Merrill Lynch GSI, 1.00%, 1/02/04 (Maturity Value $6,000,496) Collateralized by U.S. Treasury Bills, Notes and Bonds ...................... 6,000,167 6,000,167 g,h Morgan Stanley & Co., 1.03%, 1/02/04 (Maturity Value $6,000,511) Collateralized by U.S. Treasury Bills, Notes and Bonds ............................................................. 6,000,172 6,000,172 g,h UBS Securities LLC, 1.00%, 1/02/04 (Maturity Value $6,000,496) Collateralized by U.S. Treasury Bills, Notes and Bonds ...................... 6,000,167 6,000,167 ------------------- TOTAL REPURCHASE AGREEMENTS (COST $38,563,065) .............................. 38,563,065 ------------------- TOTAL INVESTMENTS (COST $7,672,731,769) 102% ................................ 9,999,732,261 =================== OPTIONS WRITTEN ............................................................. (13,695) SECURITIES SOLD SHORT (0.8)% ................................................ (78,333,866) NET EQUITY IN FORWARD CONTRACTS (1.1)% ...................................... (106,711,696) OTHER ASSETS, LESS LIABILITIES (0.1)% ....................................... (10,997,851) ------------------- Net Assets 100.0% ........................................................... $ 9,803,675,153 =================== ------------- CONTRACTS ------------- OPTIONS WRITTEN ISSUER DIVERSIFIED TELECOMMUNICATION SERVICES XO Communications Inc., Jun. 4.25 Calls, 6/21/04 ............... United States 2,321,108 $ -- ------------------- FOOD & STAPLES RETAILING Safeway PLC, Jan. 2.70 Puts, 1/16/04 ........................ United Kingdom 4,250 13,695 ------------------- TOTAL OPTIONS WRITTEN (PREMIUMS RECEIVED $621,717) .......... $ 13,695 ------------------- Annual Report | 29
Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED) ------------------------------------------------------------------------------------------------------------------------------------ SECURITIES SOLD SHORT COUNTRY SHARES VALUE ISSUER CAPITAL MARKETS i Lehman Brothers Holdings Inc. ............................. United States 21,426 $ 1,654,516 ------------------- COMMERCIAL BANKS 0.2% i Bank of America Corp. ..................................... United States 181,400 14,590,002 ------------------- FOOD PRODUCTS 0.2% i Kraft Foods Inc., A ....................................... United States 658,900 21,229,758 ------------------- HEALTH CARE PROVIDERS & SERVICES 0.1% i Anthem Inc. ............................................... United States 39,500 2,962,500 i Caremark RX Inc. .......................................... United States 170,000 4,306,100 i United Health Group Inc. .................................. United States 55,300 3,217,354 ------------------- 10,485,954 ------------------- INSURANCE 0.1% i Manulife Financial Corp. .................................. Canada 405,200 13,087,960 ------------------- INTERNET SOFTWARE & SERVICES i Yahoo! Inc. ............................................... United States 42,180 1,905,287 ------------------- IT SERVICES 0.1% fi First Data Corp. .......................................... United States 121,480 4,991,613 ------------------- MEDIA i News Corp. Ltd., ADR ...................................... Australia 103,100 3,721,910 ------------------- METALS & MINING 0.1% i Alcan Inc. ................................................ Canada 10,841 508,985 i AngloGold Ltd., ADR ....................................... South Africa 98,400 4,595,280 i Randgold Resources Ltd., ADR .............................. United Kingdom 34,658 946,163 ------------------- 6,050,428 ------------------- PHARMACEUTICALS i Teva Pharmaceutical Industries Ltd., ADR .................. Israel 10,870 616,438 ------------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $78,115,842) ........ $ 78,333,866 ------------------------------------------------------------------------------------------------------------------------------------ VALUE AT UNREALIZED SYNTHETIC EQUITY SWAPS (SES) COUNTRY SHARES 12/31/03 GAIN/LOSS ------------------------------------------------------------------------------------------------------------------------------------ ISSUER HEALTH CARE EQUIPMENT & SUPPLIES j Smith & Nephew PLC, ses., 3.752 GBP ....................... United Kingdom (2,277) $ (19,128) $ (1,592) j Smith & Nephew PLC, ses., 3.776 GBP ....................... United Kingdom (38,055) (319,674) (27,444) --------------------------------- (338,802) (29,036) ================================= INSURANCE j AXA SA, ses., 15.850 EUR .................................. France 34,623 741,110 29,093 j AXA SA, ses., 15.870 EUR .................................. France 8,500 181,944 4,718 j AXA SA, ses., 16.030 EUR .................................. France 61,258 1,311,236 (1,029) j AXA SA, ses., 16.700 EUR .................................. France (34,623) (741,110) 19,725 j AXA SA, ses., 16.770 EUR .................................. France (8,500) (181,944) 853 j AXA SA, ses., 17.000 EUR .................................. France (61,258) (1,311,236) (5,487) --------------------------------- -- 47,873 =================================
30 | Annual Report
Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED) ----------------------------------------------------------------------------------------------------------------------------- VALUE AT UNREALIZED SYNTHETIC EQUITY SWAPS (SES) (CONT.) COUNTRY SHARES 12/31/03 GAIN/LOSS ----------------------------------------------------------------------------------------------------------------------------- ISSUER REAL ESTATE j Chelsfield PLC, ses., 3.095 GBP ............................ United Kingdom 10,600 $ 58,303 $ (8,397) j Chelsfield PLC, ses., 3.107 GBP ............................ United Kingdom 53,000 291,514 (23,017) j Chelsfield PLC, ses., 3.112 GBP ............................ United Kingdom 33,300 183,159 (858) j Chelsfield PLC, ses., 3.154 GBP ............................ United Kingdom 24,033 132,188 (218) j Chelsfield PLC, ses., 3.160 GBP ............................ United Kingdom 352,200 1,937,191 (3,886) j Chelsfield PLC, ses., 3.165 GBP ............................ United Kingdom 120,300 661,681 (13,109) j Chelsfield PLC, ses., 3.166 GBP ............................ United Kingdom 176,100 968,596 (983) ------------------------------ 4,232,632 (50,468) ============================== TEXTILES, APPAREL & LUXURY GOODS j Christian Dior SA, ses., 46.766 EUR ........................ France 8,792 532,643 605 j Christian Dior SA, ses., 47.220 EUR ........................ France 17,601 1,066,317 (3,190) j Christian Dior SA, ses., 47.384 EUR ........................ France 6,718 406,995 (265) j Christian Dior SA, ses., 47.614 EUR ........................ France 17,601 1,066,317 3,077 j Christian Dior SA, ses., 47.794 EUR ........................ France 8,087 489,933 (2,454) j Christian Dior SA, ses., 48.208 EUR ........................ France 17,149 1,038,933 5,564 j Christian Dior SA, ses., 48.555 EUR ........................ France 10,579 640,905 (3,456) j Christian Dior SA, ses., 48.586 EUR ........................ France 17,617 1,067,286 (6,052) j Christian Dior SA, ses., 48.791 EUR ........................ France 7,055 427,411 (1,511) j Christian Dior SA, ses., 49.000 EUR ........................ France 2,605 157,818 5,455 j Christian Dior SA, ses., 49.027 EUR ........................ France 472 28,595 2,531 j LVMH Moet Hennessy Louis Vuitton, ses., 56.520 EUR .......................................... France (8,792) (639,882) (3,239) j LVMH Moet Hennessy Louis Vuitton, ses., 57.050 EUR ................................................ France (6,718) (488,936) 24,511 j LVMH Moet Hennessy Louis Vuitton, ses., 58.672 EUR .......................................... France (8,087) (588,572) 18,596 j LVMH Moet Hennessy Louis Vuitton, ses., 58.861 EUR .......................................... France (472) (34,352) 8,367 j LVMH Moet Hennessy Louis Vuitton, ses., 58.899 EUR .......................................... France (17,601) (1,281,001) 13,126 j LVMH Moet Hennessy Louis Vuitton, ses., 59.841 EUR .......................................... France (17,601) (1,281,001) (4,554) j LVMH Moet Hennessy Louis Vuitton, ses., 60.149 EUR .......................................... France (7,055) (513,463) 784 j LVMH Moet Hennessy Louis Vuitton, ses., 60.309 EUR .......................................... France (17,149) (1,248,105) 4,972 j LVMH Moet Hennessy Louis Vuitton, ses., 60.421 EUR .......................................... France (2,605) (189,592) 9,358 j LVMH Moet Hennessy Louis Vuitton, ses., 60.949 EUR .......................................... France (10,579) (769,940) 4,362 j LVMH Moet Hennessy Louis Vuitton, ses., 60.950 EUR .......................................... France (17,617) (1,282,166) 10,251 ------------------------------ (1,393,857) 86,838 ------------------------------ TOTAL SYNTHETIC EQUITY SWAPS ............................... $ 2,499,973 $55,207 ==============================
CURRENCY ABBREVIATIONS: | CAD - Canadian Dollar | EUR - Euro | GBP - British Pound | JPY - Japanese Yen a Non-income producing. b See Note 7 regarding restricted securities. c See Note 8 regarding Holdings of 5% Voting Securities. d A member of the Fund's Portfolio Management team serves as a member on the board of directors. As a result of this involvement, the Portfolio Manager could receive material non-public information which, pursuant to the Fund's policies and the requirements of the federal securities laws, could prevent the Fund from trading in the securities of such companies for limited or extended periods of time. e The principal amount is stated in U.S. dollars unless otherwise indicated. f See Note 1(h) regarding securities segregated with broker for securities sold short. g Collateral for loaned securities. See Note 1(i). h See Note 1(c) regarding repurchase agreements. iSee Note 1(h) regarding securities sold short. jSee Note 1(f) regarding synthetic equity swaps. Annual Report|See notes to financial statements. | 31 Mutual Shares Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2003 Assets: Investments in securities: Cost - Unaffiliated issuers ............................ $ 7,388,568,835 Cost - Non-controlled affiliated issuers ............... 284,162,934 =============== Value - Unaffiliated issuers (includes securities segregated with broker for securities sold short in the amount of $64,655,910) ........................ 9,200,559,584 Value - Non-controlled affiliated issuers .............. 799,172,677 Cash .................................................... 11,350,401 Foreign currency, at value (cost $725,555) .............. 1,499,726 Receivables: Investment securities sold ............................. 9,100,755 Capital shares sold .................................... 77,168,698 Dividends and interest ................................. 15,662,143 Unrealized gain on forward exchange contracts (Note 6) .. 2,052,733 Deposits with broker for securities sold short .......... 95,336,755 Due from broker - variation margin (Note 1f) ............ 1,178,257 ---------------- Total assets ....................................... 10,213,081,729 ---------------- Liabilities: Payables: Investment securities purchased ........................ 82,154,133 Capital shares redeemed ................................ 90,333,617 Affiliates ............................................. 10,189,416 Options written, at value (premiums received $621,717) .. 13,695 Securities sold short, at value (proceeds $78,115,842) .. 78,333,866 Payable upon return of securities loaned (Note 1i) ...... 38,563,065 Unrealized loss on forward exchange contracts (Note 6) .. 108,764,429 Other liabilities ....................................... 1,054,355 ---------------- Total liabilities .................................. 409,406,576 ---------------- Net assets, at value ............................. $ 9,803,675,153 ================ Net assets consist of: Undistributed net investment income ..................... $ 13,216,978 Net unrealized appreciation (depreciation) .............. 2,221,741,852 Accumulated net realized gain (loss) .................... (20,625,920) Capital shares .......................................... 7,589,342,243 ---------------- Net assets, at value ............................. $ 9,803,675,153 ================ 32 | Annual Report Mutual Shares Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2003 CLASS Z: Net asset value and maximum offering price per share ($5,782,144,772 / 275,516,572 shares outstanding) ........ $20.99 ============== CLASS A: Net asset value per share ($2,257,335,645 / 108,022,490 shares outstanding) ...................................... $20.90 ============== Maximum offering price per share ($20.90 / 94.25%) ....... $22.18 ============== CLASS B: Net asset value and maximum offering price per share ($444,671,434 / 21,651,680 shares outstanding) ........... $20.54 ============== CLASS C: Net asset value per share ($1,272,589,958 / 61,327,319 shares outstanding) a .................................... $20.75 ============== Maximum offering price per share ($20.75 / 99.00%) ....... $20.96 ============== CLASS R: Net asset value and maximum offering price per share ($ 46,933,344 / 2,253,382 shares outstanding) a .......... $20.83 ============== a Redemption price per share is equal to net asset value less any applicable sales charge Annual Report | See notes to financial statements. | 33 Mutual Shares Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2003 Investment income: (net of foreign taxes of $3,281,994) Dividends: Unaffiliated issuers .......................................$ 68,592,908 Non-controlled affiliated issuers (Note 8) ................. 3,768,119 Interest: Unaffiliated issuers ....................................... 98,661,248 Non-controlled affiliated issuers (Note 8) ................. 931,156 --------------- Total investment income ................................ 171,953,431 =============== Expenses: Management fees (Note 3) .................................... 48,387,143 Administrative fees (Note 3) ................................ 6,312,670 Distribution fees (Note 3) Class A .................................................... 6,397,423 Class B .................................................... 3,178,712 Class C .................................................... 10,065,153 Class R .................................................... 138,136 Transfer agent fees (Note 3) ................................ 9,164,600 Custodian fees .............................................. 580,100 Reports to shareholders ..................................... 526,300 Registration and filing fees ................................ 214,300 Professional fees ........................................... 147,363 Directors' fees and expenses ................................ 336,800 Dividends for securities sold short ......................... 2,653,423 Other ....................................................... 73,400 --------------- Total expenses ......................................... 88,175,523 --------------- Net investment income ................................ 83,777,908 --------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments: Unaffiliated issuers ...................................... 289,621,813 Non-controlled affiliated issuers (Note 8) ................ 12,635,009 Written options (Note 1g) .................................. 1,389,046 Foreign currency transactions .............................. (191,948,781) Securities sold short (Note 1h) ............................ (3,788,885) --------------- Net realized gain (loss) .................................... 107,908,202 Net unrealized appreciation (depreciation) on: Investments ................................................ 1,833,489,420 Translation of assets and liabilities denominated in foreign currencies ..................................... (50,113,301) --------------- Net unrealized appreciation (depreciation) ............. 1,783,376,119 --------------- Net realized and unrealized gain (loss) ...................... 1,891,284,321 --------------- Net increase (decrease) in net assets resulting from operations .............................................$1,975,062,229 ================ 34 | See notes to financial statements. | Annual Report Mutual Shares Fund FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF CHANGES IN NET ASSETS for the years ended December 31, 2003 and 2002 ----------------------------------------- 2003 2002 ----------------------------------------- Increase (decrease) in net assets: Operations: Net investment income ......................................................... $ 83,777,908 $ 123,521,214 Net realized gain (loss) from investments, written options, securities sold short, and foreign currency transactions ..................... 107,908,202 (87,244,195) Net unrealized appreciation (depreciation) on investments and translation of assets and liabilities denominated in foreign currencies ........................................................... 1,783,376,119 (956,944,242) ----------------------------------------- Net increase (decrease) in net assets resulting from operations ........... 1,975,062,229 (920,667,223) Distributions to shareholders from: Net investment income: Class Z ...................................................................... (86,237,828) (69,638,370) Class A ...................................................................... (27,241,185) (17,654,494) Class B ...................................................................... (3,088,304) (1,550,189) Class C ...................................................................... (8,533,693) (4,288,541) Class R ...................................................................... (444,646) (152,150) Net realized gains: Class Z ...................................................................... -- (70,735,994) Class A ...................................................................... -- (22,716,997) Class B ...................................................................... -- (2,822,885) Class C ...................................................................... -- (12,844,218) Class R ...................................................................... -- (53,475) ----------------------------------------- Total distributions to shareholders ............................................ (125,545,656) (202,457,313) Capital share transactions (Note 2): Class Z ....................................................................... 83,398,695 (156,154,587) Class A ....................................................................... 291,264,831 198,730,038 Class B ....................................................................... 133,623,724 140,143,972 Class C ....................................................................... 174,641,988 113,589,826 Class R ....................................................................... 26,507,727 14,178,941 ----------------------------------------- Total capital share transactions ............................................... 709,436,965 310,488,190 Net increase (decrease) in net assets ...................................... 2,558,953,538 (812,636,346) Net assets: Beginning of year .............................................................. 7,244,721,615 8,057,357,961 ----------------------------------------- End of year .................................................................... $9,803,675,153 $7,244,721,615 ========================================= Undistributed net investment income included in net assets: End of year .................................................................... $ 13,216,978 $ 32,543,477 =========================================
Annual Report | See notes to financial statements. | 35 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Mutual Shares Fund (the Fund) is a separate, diversified series of Franklin Mutual Series Fund, Inc. (the Series Fund), which is an open-end investment company registered under the Investment Company Act of 1940. The Fund seeks long-term capital appreciation and income through a flexible policy of investing in stocks and corporate debt securities. 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 last 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. Investments in open-end mutual funds are valued at the closing net asset value. Foreign securities are valued at the close of trading of the foreign exchange or the NYSE, whichever is earlier. If events occur that materially affect the values of securities after the prices or foreign exchange rates are determined, or if market quotations are not readily available, the securities will be valued at fair value as determined following procedures approved by the Board of Directors. 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, 2003, all repurchase agreements held by the Fund had been entered into on that date. 36 | Annual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) D. SECURITIES PURCHASED ON A WHEN-ISSUED OR DELAYED BASIS The Fund may purchase securities on a when-issued or delayed delivery basis, with payment and delivery scheduled for a future date. These transactions are subject to market fluctuations and are subject to the risk that the value at delivery may be more or less than the trade date purchase price. Although the Fund will generally purchase these securities with the intention of holding the securities, it may sell the securities before the settlement date. Sufficient assets have been segregated for these securities. E. FOREIGN CURRENCY CONTRACTS The Fund may enter into forward exchange contracts to hedge against fluctuations in foreign exchange rates. A forward exchange contract is an agreement between two parties to exchange different currencies at an agreed upon exchange rate at a future date. These contracts are valued daily and the Fund's equity therein is included in the Statement of Assets and Liabilities. Realized and unrealized gains and losses are included in the Statement of Operations. When the Fund purchases or sells foreign securities it may enter into foreign exchange contracts to minimize foreign exchange risk from the trade date to the settlement date of the transactions. Realized and unrealized gains and losses are included in the Statement of Operations. The risks of these contracts include movement in the values of the foreign currencies relative to the U.S. dollar and the possible inability of the counterparties to fulfill their obligations under the contracts. F. SYNTHETIC EQUITY SWAPS The Fund may engage in synthetic equity swaps. Synthetic equity swaps are contracts entered into between a broker and the Fund under which the parties agree to make payments to each other so as to replicate the economic consequences that would apply had a purchase or sale of the underlying security taken place. Upon entering into synthetic equity swaps, the Fund is required to pledge the broker an amount of cash and/or other assets equal to a certain percentage of the contract amount ("initial margin"). Subsequent payments known as "variation margin", are made or received by the Fund periodically, depending on fluctuations in the value of the underlying security. When the contract is closed, the Fund records a realized gain or loss equal to the difference between the value of the contract at the time it was opened and the value at the time it was closed. The risks of entering into equity swaps include unfavorable price movements in the underlying securities or the inability of the counterparties to fulfill their obligations under the contract. G. OPTION CONTRACTS The Fund may purchase or write options. Options are contracts entitling the holder to purchase or sell a specified number of shares or units of a particular security at a specified price. Options purchased are recorded as investments; options written (sold) are recorded as liabilities. When the exercise of an option results in a cash settlement, the difference between the premium (original option value) and the settlement proceeds is realized as a gain or loss. When securities are acquired Annual Report | 37 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) G. OPTION CONTRACTS (CONTINUED) or delivered upon exercise of an option, the acquisition cost or sale proceeds are adjusted by the amount of the premium. When an option is closed, the difference between the premium and the cost to close the position is realized as a gain or loss. When an option expires, the premium is realized as a gain for options written or as a loss for options purchased. The risks include the possibility there may be an illiquid options market or the inability of the counterparties to fulfill their obligations under the contract. Writing options involves, to varying degrees, elements of market risk in excess of the amount recognized in the Statement of Assets and Liabilities. H. SECURITIES SOLD SHORT The Fund is engaged in selling securities short, which obligates the Fund to replace a borrowed security with the same security at current market value. The Fund would incur a loss 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. The Fund would realize a gain if the price of the security declines between those dates. A gain, limited to the price at which the Fund sold the security short, or a loss, unlimited in size, will be recognized upon the termination of a short sale. The Fund is required to establish a margin account with the broker lending the security sold short. While the short sale is outstanding, the broker retains the proceeds of the short sale and the Fund must maintain a deposit for the broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. I. SECURITIES LENDING The Fund loans securities to certain brokers for which it received cash or securities collateral against loaned securities in an amount equal to at least 102% of the market value of the loaned securities. The cash collateral is invested in short-term instruments as noted in the Statement of Investments. The Fund received interest income of $120,970 from the investment of cash collateral, adjusted by lender fees and broker rebates. The fund bears the risk of loss with respect to the investment of the cash collateral. The securities lending agent has agreed to indemnify the Fund in the case of default of any securities borrower. J. 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. 38 | Annual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) K. 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. Discounts on securities purchased are amortized over the lives of the respective securities. Dividend income, dividends declared on securities sold short, and distributions to shareholders are recorded on the ex-dividend date. 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. Common expenses incurred by the Series Fund are allocated among the funds comprising the Series Fund 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. L. 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. M. GUARANTEES AND INDEMNIFICATIONS Under the Fund's organizational documents, its officers and trustees are indemnified against certain liability arising out of the performance of their duties to the Funds. Additionally, in the normal course of business, the Fund enters into contracts with service providers that contain general indemnification clauses. The Fund's maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Fund that have not yet occurred. However, based on experience, the Fund expects the risk of loss to be remote. 2. CAPITAL STOCK The Fund offers five classes of shares: Class Z, Class A, Class B, Class C and Class R shares. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. Annual Report | 39 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED) At December 31, 2003, there were 1.9 billion shares authorized ($0.001 par value) of which 1 billion, 250 million, 200 million, 250 million and 200 million were designated as Class Z, Class A, Class B, Class C and Class R shares, respectively. Transactions in the Fund's shares were as follows:
------------------------------------------------------------------- YEAR ENDED YEAR ENDED DECEMBER 31, 2003 DECEMBER 31, 2002 ------------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT ------------------------------------------------------------------- CLASS Z SHARES: Shares sold ....................... 21,151,259 $ 407,846,009 9,268,462 $ 171,604,715 Shares issued on reinvestment of distributions .................... 3,736,749 73,434,642 6,811,352 122,489,992 Shares redeemed ................... (21,665,054) (397,881,956) (24,910,917) (450,249,294) ------------------------------------------------------------------- Net increase (decrease) ........... 3,222,954 $ 83,398,695 (8,831,103) $(156,154,587) =================================================================== CLASS A SHARES: Shares sold ....................... 35,425,425 $ 652,986,425 31,808,676 $ 589,247,372 Shares issued on reinvestment of distributions .................... 1,293,317 25,145,030 2,103,103 37,899,492 Shares redeemed ................... (20,693,711) (386,866,624) (23,483,128) (428,416,826) ------------------------------------------------------------------- Net increase (decrease) ........... 16,025,031 $ 291,264,831 10,428,651 $ 198,730,038 =================================================================== CLASS B SHARES: Shares sold ....................... 9,236,787 $ 165,789,211 9,023,637 $ 164,128,670 Shares issued on reinvestment of distributions .................... 154,276 2,877,950 227,800 4,079,073 Shares redeemed ................... (1,987,903) (35,043,437) (1,623,056) (28,063,771) ------------------------------------------------------------------- Net increase (decrease) ........... 7,403,160 $ 133,623,724 7,628,381 $ 140,143,972 =================================================================== CLASS C SHARES: Shares sold ....................... 17,120,196 $ 312,711,634 13,881,568 $ 253,009,123 Shares issued on reinvestment of distributions .................... 422,198 7,868,601 878,112 16,037,876 Shares redeemed ................... (8,145,439) (145,938,247) (8,811,940) (155,457,173) ------------------------------------------------------------------- Net increase (decrease) ........... 9,396,955 $ 174,641,988 5,947,740 $ 113,589,826 =================================================================== ------------------------------------------------------------------- YEAR ENDED PERIOD ENDED DECEMBER 31, 2003 DECEMBER 31, 2002 A ------------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT ------------------------------------------------------------------- CLASS R SHARES: Shares sold ....................... 1,770,971 $ 32,403,265 856,889 $ 15,167,167 Shares issued on reinvestment of distributions .................... 22,484 440,336 11,723 203,042 Shares redeemed ................... (339,764) (6,335,874) (68,921) (1,191,268) ------------------------------------------------------------------- Net increase (decrease) ........... 1,453,691 $ 26,507,727 799,691 $ 14,178,941 ===================================================================
a Effective date of Class R shares was January 2, 2002. 40 | Annual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES Certain officers of the Series Fund are also officers and/or directors of Franklin Mutual Advisors, LLC (Franklin Mutual) and Franklin Templeton Services, LLC (FT Services), the Fund's investment manager and administrative manager, respectively. Franklin/Templeton Investor Services, LLC (Investor Services) and Franklin/Templeton Distributors, Inc. (Distributors) are the Fund's transfer agent and principal underwriter, respectively. The Fund pays an investment management fee to Franklin Mutual of 0.60% per year of the average daily net assets of the Fund. The Fund pays its allocated share of an administrative fee to FT Services based on the Series Fund's aggregate average daily net assets as follows: -------------------------------------------------------------------------------- ANNUALIZED FEE RATE AVERAGE DAILY NET ASSETS -------------------------------------------------------------------------------- 0.150% First $200 million 0.135% Over $200 million, up to and including $700 million 0.100% Over $700 million, up to and including $1.2 billion 0.075% Over $1.2 billion The Fund reimburses Distributors for costs incurred in marketing the Fund's shares up to 0.35%, 1.00%, 1.00% and 0.50% per year of the average daily net assets of Class A, Class B, Class C and Class R shares, respectively. Distributors received net commissions from sales of those Fund shares, and received contingent deferred sales charges for the period of $1,837,466 and $198,610, respectively. The Fund paid transfer agent fees/shareholder servicing fees of $9,164,600, of which $6,428,603 was paid to Franklin Templeton Investors Services Inc. 4. INCOME TAXES At December 31, 2003, the cost of investments, net unrealized appreciation (depreciation) undistributed ordinary income and undistributed long term capital gains for income tax purposes was as follows: Cost of investments ................................... $7,697,327,210 -------------- Unrealized appreciation ............................... 2,403,205,466 Unrealized depreciation ............................... (100,800,415) -------------- Net unrealized appreciation (depreciation) ............ $2,302,405,051 ============== Distributable earnings - undistributed ordinary income ...................................... $ 36,574,069 ============== Annual Report | 41 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 4. INCOME TAXES (CONTINUED) The tax character of distributions paid during the years ended December 31, 2003 and 2002, was as follows: ------------------------------ 2003 2002 ------------------------------ Distributions paid from: Ordinary income ...................... $125,545,656 $118,447,562 Long term capital gain ............... $ -- $ 84,009,751 ------------------------------ $125,545,656 $202,457,313 ============================== Net investment income (loss) differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, and bond discounts and premiums. Net realized gains (losses) differ for financial statement and tax purposes primarily due to differing treatment of wash sales, foreign currency transactions, bond discounts and premiums on the sale of securities and foreign currencies. At December 31, 2003, the Fund had deferred capital and currency losses occurring subsequent to October 31, 2003 of $42,633,926 and $519,358, respectively. For tax purposes, such losses will be reflected in the year ending December 31, 2004. At December 31, 2003, the Fund had tax basis capital losses of $70,865,418 which may be carried over to offset future capital gains. Such losses expire in 2010. 5. INVESTMENT TRANSACTIONS Purchases and sales of securities (excluding short-term securities and securities sold short) for the period ended December 31, 2003, aggregated $3,948,894,435 and $3,247,988,806, respectively. Transactions in options written during the year ended December 31, 2003 were as follows: ------------------------------ NUMBER OF CONTRACTS PREMIUM ------------------------------ Options outstanding at December 31, 2002 ................... 429,700 $ 278,132 Options written ...................... 2,403,289 3,354,062 Options expired ...................... (339,357) (1,164,244) Options terminated in closing transactions ........................ (1,134) (253,102) Options exercised .................... (167,140) (1,593,131) -------------------------------- Options outstanding at December 31, 2003 ................... 2,325,358 $ 621,717 ================================ 42 | Annual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. FORWARD EXCHANGE CONTRACTS At December 31, 2003, the Fund has outstanding forward exchange contracts as set out below. The contracts are reported in the financial statements at the Fund's net equity, as measured by the difference between the forward exchange rates at the reporting date and the forward exchange rates at the day of entry into the contracts.
--------------------------------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO BUY EXCHANGE FOR DATE GAIN (LOSS) --------------------------------------------------------------------------------------------------------------------------- 13,679,718 Canadian Dollars .............. U.S. $ 9,921,115 1/21/04 U.S. $ 654,485 3,850,000 British Pounds ................ 6,784,278 1/28/04 92,777 16,200,000 European Unit ................. 19,352,711 1/28/04 1,064,849 7,800,000 European Unit ................. 9,799,491 2/05/04 29,303 523,474,000 Japanese Yen .................. 4,824,786 3/25/04 72,911 908,484 European Unit ................. 1,097,630 4/28/04 44,605 ------------- ----------- U.S. $ 51,780,011 $1,958,930 ============= ===========
--------------------------------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO SELL EXCHANGE FOR DATE GAIN (LOSS) --------------------------------------------------------------------------------------------------------------------------- 18,230,298 South African Rand ............ U.S. $ 2,762,172 4/26/04 U.S. $ 93,803 ------------- ----------- U.S. $ 2,762,172 $ 93,803 ------------- ----------- Unrealized gain on forward exchange contracts .................................. $2,052,733 =========== --------------------------------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO SELL EXCHANGE FOR DATE GAIN (LOSS) --------------------------------------------------------------------------------------------------------------------------- 27,989,584 British Pounds ................ U.S. $ 49,653,521 1/06/04 U.S. $ (428,758) 32,950,000 European Unit ................. 41,055,700 1/06/04 (498,726) 119,620,949 British Pounds ................ 208,030,422 1/12/04 (5,909,258) 106,200,000 British Pounds ................ 179,570,882 1/20/04 (10,247,104) 230,410,993 Canadian Dollars .............. 164,169,971 1/21/04 (13,957,562) 99,001,134 British Pounds ................ 167,053,656 1/28/04 (9,786,924) 26,066,299 European Unit ................. 30,601,835 1/28/04 (2,250,648) 129,923,223 British Pounds ................ 225,238,888 2/11/04 (6,588,030) 66,626,181 European Unit ................. 73,634,509 2/23/04 (10,278,404) 37,500,000 British Pounds ................ 63,198,750 2/27/04 (3,632,510) 85,891,536 European Unit ................. 98,762,870 3/11/04 (9,364,069) 342,092,058 Danish Krona .................. 56,348,307 3/17/04 (1,473,326) 2,921,421,223 Japanese Yen .................. 25,500,000 3/18/04 (1,827,265) 69,313,373 European Unit ................. 79,138,696 3/25/04 (8,085,056) 5,053,876,766 Japanese Yen .................. 45,366,937 3/25/04 (1,917,849) 587,194,807 Norwegian Krone ............... 82,543,367 4/15/04 (5,423,374) 96,626,930 European Unit ................. 112,126,866 4/22/04 (9,380,508) 32,963,675 South African Rand ............ 4,686,893 4/26/04 (138,001) 76,950,000 European Unit ................. 90,563,168 4/28/04 (6,185,907) 3,313,843,376 Japanese Yen .................. 29,910,477 6/24/04 (1,188,827) -------------- ------------ U.S. $1,827,155,715 (108,562,106) ============== ============ Net unrealized loss on offsetting forward exchange contracts ................. (202,323) ------------ Unrealized loss on forward exchange contracts ................................ (108,764,429) ------------ Net unrealized loss on forward exchange contracts ......................... U.S. $(106,711,696) ------------
Annual Report | 43 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. RESTRICTED SECURITIES At December 31, 2003, investments in securities included issues that are restricted or illiquid. Restricted securities are often purchased in private placement transactions, are not registered under the Securities Act of 1933, may have contractual restrictions on resale, and are valued under methods approved by the Board of Directors as reflecting fair value. A security may also be considered illiquid if it lacks a readily available market or if its valuation has not changed for a certain period of time. At December 31, 2003, the Fund held investments in restricted and illiquid securities that were valued under approved methods by the Directors, as follows:
----------------------------------------------------------------------------------------------------- SHARES OR PRINCIPAL ACQUISITION AMOUNT ISSUER DATE COST VALUE ----------------------------------------------------------------------------------------------------- 141,884 AboveNet Inc. ......................... 10/2/01 $ 4,250,036 $ 4,250,036 25,401 Elephant Capital Holdings Ltd. ........ 8/29/03 25,401,000 25,401,000 16,987,239 FE Capital LLC, 5.00%, 8/28/07 ........ 8/29/03 16,670,169 17,326,984 6,143,191 International Steel Group ............. 4/10/02 29,676,250 203,385,696 3 Lancer Industries Inc., B ............. 8/11/89 -- 2,085,868 1,551,229 Leucadia Restricted (Common) .......... 12/20/02 54,680,822 67,936,074 55,197,761 MP Finance Ltd., 5.00%, 8/28/07 ....... 8/29/03 54,167,484 56,301,716 18,938,000 Nippon Investments LLC ................ 2/14/01 -- 7,196,440 872,276 NTL Inc. .............................. 1/8/03 45,574,811 57,799,189 202,380 Olympus RE Holdings Ltd. .............. 12/19/01 20,238,000 32,010,443 27,436 PG & E Corp., wts, 9/02/06 ............ 10/29/02 -- 685,461 227,308 Security Capital European Realty ...... 4/8/98 5,164,292 1,693,445 265,658 White Mountains Insurance Group Inc. .. 10/22/02 78,369,110 116,079,927 ------------- TOTAL RESTRICTED SECURITIES (6.04% OF NET ASSETS) ................................. $592,152,279 =============
44 | Annual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The Investment Company Act of 1940 defines "affiliated companies" to include investments in portfolio companies in which a fund owns 5% or more of the outstanding voting securities. Investments in "affiliated companies" for the Fund at December 31, 2003 were as shown below.
------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF REALIZED NUMBER OF SHARES/ INVESTMENT CAPITAL SHARES/ CONTRACTS HELD INCOME GAIN (LOSS) CONTRACTS HELD GROSS GROSS DEC. 31, VALUE 1/1/03- 1/1/03- NAME OF ISSUER DEC. 31, 2002 ADDITIONS REDUCTIONS 2003 DEC. 31, 2003 12/31/03 12/31/03 ------------------------------------------------------------------------------------------------------------------------------------ NON-CONTROLLED AFFILIATES Alexander's Inc. ............. 383,200 -- (56,525) 326,675 $ 40,723,305 $ -- $ 3,185,043 City Investing Company Liquidating Trust ........... 4,373,476 -- -- 4,373,476 9,118,696 -- -- Decision One Corp. ........... 457,492 -- -- 457,492 914,984 -- -- Decision One Corp., Term Loan ................... 14,864,808 -- (1,002,510) 13,862,298 9,703,608 -- 86,563 Elephant Capital Holdings .................... -- 25,401 -- 25,401 25,401,000 -- -- FHC Delaware Inc. ............ -- 784,457 -- 784,457 6,173,676 -- -- Florida East Coast Industries Inc., A .......... 1,986,960 572,111 (86,800) 2,472,271 81,832,170 3,295,929 26,233 International Steel Group .... 1,551 6,141,640 -- 6,143,191 203,385,696 -- -- Kindred Healthcare Inc. ...... 1,190,483 -- -- 1,190,483 58,787,241 -- -- Kindred Healthcare Inc., Jan 52.00 Calls, 1/01/12 ..... -- 289 -- 289 -- -- -- Kindred Healthcare Inc., Jul 47.50 Calls, 7/11/11 ..... -- 964 -- 1,928 863,744 -- -- Kindred Healthcare Inc., wts Series A, 4/20/06 ....... 211,977 -- -- 211,977 4,929,737 -- -- Kindred Healthcare Inc., wts Series B, 4/20/06 ....... 529,943 -- -- 529,943 11,100,980 -- -- Lancer Industries Inc., B .... 3 -- -- 3 2,085,868 -- 244,528 MBOP Liquidating Trust ....... 574,712 -- -- 574,712 1,435 -- -- aNippon Investment LLC ....... 18,938,000 -- -- 18,938,000 7,196,440 -- 9,092,642 Southwest Royalties Inc., A ..................... 123,013 -- -- 123,013 3,690,380 -- -- Southwest Royalties Inc., 10.50%, 6/30/04 ............. 8,200,000 -- (8,200,000) -- b -- -- -- White Mountains Insurance Group Inc. .................. 387,190 85,000 -- 472,190 217,183,790 387,190 -- White Mountains Insurance Group Inc. (Restricted) ..... 85,000 180,658 -- 265,658 116,079,927 85,000 -- White Mountains Insurance Group Inc., cvt. pfd ........ 265,658 -- (265,658) -- b -- -- -- ------------------------------------------ TOTAL NON-CONTROLLED AFFILIATES ...................................................... $799,172,677 $3,768,119 $12,635,009 ==========================================
a Indirectly owns 8.55% outstanding voting shares of Nippon Investment Partners LP. b As of December 31, 2003, no longer an affiliate. Annual Report | 45 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. INVESTMENTS IN FRANKLIN INSTITUTIONAL FIDUCIARY TRUST MONEY MARKET PORTFOLIO The Fund may invest in the Franklin Institutional Fiduciary Trust Money Market Portfolio (the Sweep Money Fund), an open-end investment company managed by Franklin Advisers Inc. (an affiliate of the advisor). Management fees paid by the Fund are reduced on assets invested in the Sweep Money Fund, in an amount not to exceed the management fees paid by the Sweep Money Fund. The Fund earned $595,077 of dividend income from investment in the Sweep Money Fund for the period ended December 31, 2003. 10. REGULATORY MATTERS On February 4, 2004, the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts filed an administrative complaint against Franklin Resources, Inc. and certain of its subsidiaries (the "Company"), alleging violations of the Massachusetts Uniform Securities Act. The complaint arises from activity that occurred in 2001 during which time an officer of a Company subsidiary was negotiating an agreement with an investor relating to investments in a mutual fund and a hedge fund. The Fund, in addition to other entities within Franklin Templeton Investments, including the Company and other funds, have been named in shareholder class actions related to the matter described above. The Fund's management believes that the claims made in the lawsuit are without merit and it intends to defend vigorously against the allegations. It is anticipated that the Fund may be named in additional similar civil actions related to the matter described above. In addition, as part of ongoing investigations by the U.S. Securities and Exchange Commission (the "SEC"), the U.S. Attorney for the Northern District of California, the New York Attorney General, the California Attorney General, the U.S. Attorney for the District of Massachusetts, the Florida Department of Financial Services, and the Commissioner of Securities and the Attorney General of the State of West Virginia, relating to certain practices in the mutual fund industry, including late trading, market timing and sales compensation arrangements, the Company and its subsidiaries, as well as certain current or former executives and employees of the Company, have received requests for information and/or subpoenas to testify or produce documents. The Company and its current employees are providing documents and information in response to these requests and subpoenas. In addition, the Company has responded to requests for similar kinds of information from regulatory authorities in some of the foreign countries where the Company conducts its global asset management business. The Staff of the SEC has informed the Company that it intends to recommend that the Commission authorize an action against an affiliate of the Fund's adviser and a senior executive officer relating to the frequent trading issues that are the subject of the SEC's investigation. These issues were previously disclosed as being under investigation by government authorities and the subject of an internal inquiry by the Company in its Annual Report on Form 10-K and on its public website. The Company currently is in discussions with the SEC Staff in an effort to resolve the issues raised in their investigation. Such discussions are preliminary and the Fund management has been advised that the Company cannot predict the likelihood of whether those discussions will result in a settlement and, if so, the terms of such settlement. The impact, if any, of these matters on the Fund is uncertain at this time. If the Company finds that it bears responsibility for any unlawful or improper conduct, it has committed to making the Fund or its shareholders whole, as appropriate. 46 | Annual Report Mutual Shares Fund REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS TO THE BOARD OF DIRECTORS OF FRANKLIN MUTUAL SERIES FUND INC. AND SHAREHOLDERS OF MUTUAL SHARES FUND We have audited the accompanying statement of assets and liabilities, including the statement of investments, of the Mutual Shares Fund (one of the portfolios constituting the Franklin Mutual Series Fund Inc. Mutual Shares Fund) as of December 31, 2003, and the related statement of operations for the year then ended, the statements of changes in net assets for each of the two years in the period then ended, and the financial highlights for each of the periods indicated therein. These financial statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights. Our procedures included confirmation of securities owned at December 31, 2003, by correspondence with the custodian and brokers or by other appropriate auditing procedures where replies from brokers were not received. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of the Mutual Shares Fund of the Franklin Mutual Series Fund Inc. as of December 31, 2003, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the periods indicated therein, in conformity with accounting principles generally accepted in the United States. Boston, Massachusetts February 4, 2004 [SIGNATURE OMITTED] Ernst & Young LLP Annual Report | 47 Mutual Shares Fund TAX DESIGNATION (UNAUDITED) Under Section 854(b)(2) of the Internal Revenue Code, the Fund hereby designates 30.71% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2003. Under Section 854(b)(2) of the Internal Revenue Code (Code), the Fund hereby designates up to maximum of $80,386,089 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2003. In January 2004, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year [YEAR]. Shareholders are advised to check with their tax advisors for information on the treatment of these amounts on their individual income tax returns. 48 | Annual Report Board Members and Officers The name, age and address of the officers and board members, as well as their affiliations, positions held with the Fund, principal occupations during the past five years and number of portfolios overseen in the Franklin Templeton Investments fund complex are shown below. Each board member will serve until that person's successor is elected and qualified. INDEPENDENT BOARD MEMBERS
--------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD --------------------------------------------------------------------------------------------------------------------------- EDWARD I. ALTMAN, PH.D. (62) Director Since 1987 7 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Max L. Heine Professor of Finance and Director of The Credit and Debt Markets Research Program, NYU Salomon Center, Stern School of Business, New York University; editor and author of numerous financial publications; and financial consultant; and FORMERLY Vice Director, NYU Salomon Center, Stern School of Business, New York University. -------------------------------------------------------------------------------------------------------------------------- ANN TORRE GRANT (45) Director Since 1994 7 Independent Director, SLM, Corporation 51 John F. Kennedy Parkway (Sallie Mae); and Allied Capital Short Hills, NJ 07078 Corporation (financial services). PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Independent strategic and financial consultant; and FORMERLY, Executive Vice President and Chief Financial Officer, NHP Incorporated (manager of multifamily housing) (1995-1997); and Vice President and Treasurer, US Airways, Inc. (until 1995). -------------------------------------------------------------------------------------------------------------------------- BURTON J. GREENWALD (74) Director Since 2002 12 Director, Fiduciary 51 John F. Kennedy Parkway Emerging Markets Short Hills, NJ 07078 Bond Fund PLC and Fiduciary International Ireland Limited. PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Managing Director, B.J. Greenwald Associates, management consultants to the financial services industry. -------------------------------------------------------------------------------------------------------------------------- BRUCE A. MACPHERSON (73) Director Since 1974 7 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Retired, former Chairman, A.A. MacPherson, Inc., Canton, MA (representative for electrical manufacturers); and part owner McKinstry Inc., Chicopee, MA (manufacturer of electrical enclosures). -------------------------------------------------------------------------------------------------------------------------- FRED R. MILLSAPS (74) Director Since 1996 28 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director of various business and nonprofit organizations; manager of personal investments (1978-present); and FORMERLY, Chairman and Chief Executive Officer, Landmark Banking Corporation (1969-1978); Financial Vice President, Florida Power and Light (1965-1969); and Vice President, Federal Reserve Bank of Atlanta (1958-1965). --------------------------------------------------------------------------------------------------------------------------
Annual Report | 49
-------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD --------------------------------------------------------------------------------------------------------------------------- CHARLES RUBENS II (73) Director Since 1998 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. -------------------------------------------------------------------------------------------------------------------------- LEONARD RUBIN (78) Director Since 1996 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Partner in LDR Equities, LLC (manages personal investments); and FORMERLY, President, F.N.C. Textiles, Inc.; and Chairman of the Board, Carolace Embroidery Co., Inc. (until 1996). -------------------------------------------------------------------------------------------------------------------------- ROBERT E. WADE (57) Director Since 1991 7 Director, El Oro Mining and 51 John F. Kennedy Parkway Exploration Co., p.l.c.; and Short Hills, NJ 07078 FORMERLY, Director, El Oro Mining and Exploration Company, p.l.c and The Exploration Company, p.l.c., (until 2003). PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Practicing attorney. -------------------------------------------------------------------------------------------------------------------------- INTERESTED BOARD MEMBERS AND OFFICERS --------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD --------------------------------------------------------------------------------------------------------------------------- **WILLIAM J. LIPPMAN (78) Director Since 1996 18 None One Parker Plaza, 9th Floor Fort Lee, NJ 07024 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Private Client Group, Inc.; President, Franklin Advisory Services, LLC.; and officer and/or director or trustee, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of seven of the investment companies in Franklin Templeton Investments. -------------------------------------------------------------------------------------------------------------------------- **ANNE M. TATLOCK (64) Director Since 2002 7 Director, Fortune Brands, Inc. 600 Fifth Avenue, 7th Floor (consumer products) and Merck New York, NY 10020 - 2302 & Co. Inc. (pharmaceuticals) PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman and Chief Executive Officer, Fiduciary Trust Company International; Vice Chairman, Member - Office of the Chairman and Director, Franklin Resources, Inc.; and officer and/or director of some of the other subsidiaries of Franklin Resources, Inc. --------------------------------------------------------------------------------------------------------------------------
50 | Annual Report
--------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD --------------------------------------------------------------------------------------------------------------------------- **DAVID J. WINTERS (41) Director, President, Director since 2001, 7 None 51 John F. Kennedy Parkway Chairman of the President since Short Hills, NJ 07078-2702 Board and Chief 1999, Chairman of Executive Officer - the Board and Chief Investment Executive Officer - Management Investment Management since 2002 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Chief Investment Officer, and Chief Executive Officer, Franklin Mutual Advisers, LLC., and of three of the investment companies in Franklin Templeton Investments. -------------------------------------------------------------------------------------------------------------------------- JIMMY D. GAMBILL (56) Senior Vice Since 2002 Not Applicable None 500 East Broward Blvd. President and Chief Suite 2100 Fort Lauderdale, Executive Officer - FL 33394-3091 Finance and Administration PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Franklin Templeton Services, LLC; Senior Vice President, Templeton Worldwide, Inc.; and officer of 51 of the investment companies in Franklin Templeton Investments. -------------------------------------------------------------------------------------------------------------------------- DAVID P. GOSS (56) Vice President Since 2000 Not Applicable None One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Associate General Counsel, Franklin Resources, Inc.; officer and director of one of the subsidiaries of Franklin Resources, Inc.; officer of 51 of the investment companies in Franklin Templeton Investments; and FORMERLY, President, Chief Executive Officer and Director, Property Resources Equity Trust (until 1999) and Franklin Select Realty Trust (until 2000). -------------------------------------------------------------------------------------------------------------------------- BARBARA J. GREEN (56) Vice President Since 2000 Not Applicable None One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Deputy General Counsel and Secretary, Franklin Resources, Inc.; Secretary and Senior Vice President, Templeton Worldwide, Inc.; Secretary, Franklin Advisers, Inc., Franklin Advisory Services, LLC, Franklin Investment Advisory Services, Inc., Franklin Mutual Advisers, LLC, Franklin Templeton Alternative Strategies, Inc., Franklin Templeton Investor Services, LLC, Franklin Templeton Services, LLC, Franklin Templeton Distributors, Inc., Templeton Investment Counsel, LLC, and Templeton/Franklin Investment Services, Inc.; and officer of some of the other subsidiaries of Franklin Resources, Inc. and of 51 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). -------------------------------------------------------------------------------------------------------------------------- Annual Report | 51
--------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD --------------------------------------------------------------------------------------------------------------------------- MICHAEL O. MAGDOL (66) Vice President Since 2002 Not Applicable Director, FTI 600 Fifth Avenue - AML Compliance Banque, Arch Rockefeller Center Chemicals, Inc. and New York, NY 10048-0772 Lingnan Foundation. PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice Chairman, Chief Banking Officer and Director, Fiduciary Trust Company International; and officer and/or director, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of 48 of the investment companies in Franklin Templeton Investments. -------------------------------------------------------------------------------------------------------------------------- KIMBERLEY H. MONASTERIO (40) Treasurer and Chief Treasurer and Not Applicable None One Franklin Parkway Financial Officer Chief Financial San Mateo, CA 94403-1906 Officer since 2003 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Templeton Services, LLC; and officer of 51 of the investment companies in Franklin Templeton Investments. -------------------------------------------------------------------------------------------------------------------------- MURRAY L. SIMPSON (66) Vice President Since 2000 Not Applicable None One Franklin Parkway and Secretary San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Executive Vice President and General Counsel, Franklin Resources, Inc.; officer and/or director, as the case may be, of some of the subsidiaries of Franklin Resources, Inc. and of 51 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). --------------------------------------------------------------------------------------------------------------------------
*We base the number of portfolios on each separate series of the U.S. registered investment companies within the Franklin Templeton Investments fund complex. These portfolios have a common investment adviser or affiliated investment advisers. **William J. Lippman is considered an interested person of Mutual Series under the federal securities laws due to his position as an officer of some of the subsidiaries of Franklin Resources, Inc. (Resources), which is the parent company of Mutual Series' adviser and distributor. Anne M. Tatlock is considered an interested person of Mutual Series under the federal securities laws due to her position as an officer and director of Resources. David J. Winters is considered an interested person of Mutual Series under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC. THE FUND'S BOARD OF DIRECTORS HAS DETERMINED THAT CERTAIN OF THE MEMBERS OF THE AUDIT COMMITTEE, INCLUDING ANN TORRE GRANT, ARE AUDIT COMMITTEE FINANCIAL EXPERTS, AND "INDEPENDENT," UNDER THOSE PROVISIONS OF THE SARBANES-OXLEY ACT OF 2002, AND THE RULES AND FORM AMENDMENTS ADOPTED BY THE SECURITIES AND EXCHANGE COMMISSION, RELATING TO AUDIT COMMITTEE FINANCIAL EXPERTS. THE STATEMENT OF ADDITIONAL INFORMATION (SAI) INCLUDES ADDITIONAL INFORMATION ABOUT THE BOARD MEMBERS AND IS AVAILABLE, WITHOUT CHARGE, UPON REQUEST. SHAREHOLDERS MAY CALL 1-800/DIAL BEN (1-800/342-5236) TO REQUEST THE SAI. 52 | Annual Report Mutual Shares Fund PROXY VOTING POLICIES AND PROCEDURES The Fund has established Proxy Voting Policies and Procedures ("Policies") that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund's complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at 1-954/847-2268 or by sending a written request to: Franklin Templeton Companies, LLC, 500 East Broward Boulevard, Suite 1500, Fort Lauderdale, FL 33394, Attention: Proxy Group. Annual Report | 53 This page intentionally left blank. This page intentionally left blank. This page intentionally left blank. Literature Request For a brochure and prospectus, which contains more complete information, including charges and expenses, call Franklin Templeton Investments at 1-800/DIAL BEN (R) (1-800/342-5236). Please read the prospectus carefully before investing or sending money. To ensure the highest quality of service, we may monitor, record and access telephone calls to or from our service departments. These calls can be identified by the presence of a regular beeping tone. Franklin Templeton Investments INTERNATIONAL Mutual European Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Foreign Fund Templeton Foreign Smaller Companies Fund Templeton International (Ex EM) Fund GLOBAL Franklin Global Aggressive Growth Fund Franklin Global Growth Fund Mutual Discovery Fund Templeton Capital Accumulator Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund Templeton Growth Fund Templeton World Fund GROWTH Franklin Aggressive Growth Fund Franklin Capital Growth Fund Franklin Flex Cap Growth Fund Franklin Small-Mid Cap Growth Fund Franklin Small Cap Growth Fund II 1 VALUE Franklin Balance Sheet Investment Fund 2 Franklin Equity Income Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund 3 Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund 4 Mutual Shares Fund BLEND Franklin Blue Chip Fund Franklin Convertible Securities Fund Franklin Growth Fund Franklin Rising Dividends Fund Franklin U.S. Long-Short Fund 5 SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Communications Fund Franklin Global Health Care Fund Franklin Gold and Precious Metals Fund Franklin Natural Resources Fund Franklin Real Estate Securities Fund Franklin Utilities Fund Franklin Technology Fund Mutual Financial Services Fund ASSET ALLOCATION Franklin Templeton Corefolio Allocation Fund Franklin Templeton Founding Funds Allocation Fund Target Funds Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund INCOME Franklin Adjustable U.S. Government Securities Fund 6 Franklin's AGE High Income Fund Franklin Federal Money Fund 6, 7 Franklin Floating Rate Daily Access Fund Franklin Floating Rate Trust 4 Franklin Income Fund Franklin Money Fund 6, 7 Franklin Short-Intermediate U.S. Government Securities Fund 6 Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio 6 Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund 6 Templeton Global Bond Fund TAX-FREE INCOME8 National Funds Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund 9 Tax-Exempt Money Fund 6, 7 LIMITED-TERM FUNDS California Limited-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Limited-Term Tax-Free Income Fund Intermediate-Term Funds California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC 8 Alabama Arizona California 10 Colorado Connecticut Florida 10 Georgia Kentucky Louisiana Maryland Massachusetts 9 Michigan 9 Minnesota 9 Missouri New Jersey New York 10 North Carolina Ohio 9 Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust 11 1.The fund is closed to new investors. Existing shareholders can continue adding to their accounts. 2.The fund is only open to existing shareholders as well as select retirement plans. 3.Effective June 30, 2003, the fund reopened to all new investors. 4.The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. 5.Upon reaching approximately $350 million in assets, the fund intends to close to all investors. 6.An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. 7.No assurance exists that the fund's $1.00 per share price will be maintained. It is possible to lose money by investing in the fund. 8.For investors subject to the alternative minimum tax, a small portion of these dividends may be taxable. Distributions of capital gains are generally taxable. 9.Portfolio of insured municipal securities. 10.These funds are available in two or more variations, including long-term portfolios, portfolios of insured securities, a high-yield portfolio (CA) and money market portfolios (CA and NY). 11.The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 11/03 Not part of the annual report [LOGO OMITTED] FRANKLIN(R) TEMPLETON(R) INVESTMENTS One Franklin Parkway San Mateo, CA 94403-1906 Want to receive this document FASTER via email? Eligible shareholders can sign up for eDelivery at franklintempleton.com. See inside for details. Annual Report and Shareholder Letter MUTUAL SHARES FUND CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF INVESTMENT OFFICER David J. Winters AUDITORS Ernst & Young LLP 200 Clarendon Streeet Boston, MA 02116 INVESTMENT MANAGER Franklin Mutual Advisers, LLC 51 John F. Kennedy Parkway Short Hills, NJ 07078 DISTRIBUTOR Franklin Templeton Distributors, Inc. 1-800/DIAL BEN (R) franklintempleton.com SHAREHOLDER SERVICES 1-800/632-2301 - (Class A, B, & C) 1-800/448-FUND - (Class Z) This report must be preceded or accompanied by the current Mutual Shares Fund prospectus, which contains more complete information, including risk factors, charges and expenses. To ensure the highest quality of service, telephone calls to or from our service departments may be monitored, recorded and accessed. These calls can be identified by the presence of a regular beeping tone. 474 A2003 02/04 [LOGO OMITTED] FRANKLIN(R) TEMPLETON(R) INVESTMENTS DECEMBER 31, 2003 [GRAPHIC OMITTED] ANNUAL REPORT AND SHAREHOLDER LETTER VALUE INTERNATIONAL Mutual Qualified Fund [LOGO OMITTED] Want to receive this document FASTER via email? Eligible shareholders can sign up for eDelivery at franklintempleton.com. See inside for details. [GRAPHIC OMITTED] [LOGO OMITTED] FRANKLIN(R) TEMPLETON(R) INVESTMENTS Franklin o Templeton o Mutual Series Thank You For Your Continued Participation At Mutual Series, we are pleased so many investors share our long-term investment philosophy and have remained shareholders for many years. Your ongoing support plays a significant role in contributing to the funds' success. SPECIALIZED EXPERTISE Mutual Series is part of Franklin Templeton Investments, which offers the specialized expertise of three world-class investment management groups -- Franklin, Templeton and Mutual Series. Mutual Series is dedicated to a unique style of value investing, searching aggressively for opportunity among undervalued stocks, arbitrage situations and distressed companies. Franklin is a leader in tax-free fund management and an expert in U.S. equity and fixed income investing. Templeton pioneered international investing and, with offices in over 25 countries, offers the broadest global reach in the industry. TRUE DIVERSIFICATION Because these management groups work independently and adhere to distinctly different investment approaches, Franklin, Templeton and Mutual Series funds typically have a low overlap of securities. That's why the funds can be used to build truly diversified portfolios covering every major asset class. RELIABILITY YOU CAN TRUST Franklin Templeton Investments seeks to consistently provide investors with exceptional risk-adjusted returns over the long term, as well as the reliable account services that have helped the firm become one of the most trusted names in financial services. MUTUAL FUNDS | RETIREMENT PLANS | 529 COLLEGE SAVINGS PLANS | SEPARATE ACCOUNTS [GRAPHIC OMITTED] Not part of the annual report Contents SHAREHOLDER LETTER 1 ANNUAL REPORT Mutual Qualified Fund 5 Performance Summary 10 Financial Highlights and Statement of Investments 15 Financial Statements 31 Notes to Financial Statements 35 Independent Auditors' Report 46 Tax Designation 47 Board Members and Officers 48 Proxy Voting Policies and Procedures 52 Regulatory Update AS OF FEBRUARY 12, 2004 On February 4, 2004, the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts filed an administrative complaint against Franklin Resources, Inc. and certain of its subsidiaries (the "Company"), alleging violations of the Massachusetts Uniform Securities Act. The complaint arises from activity that occurred in 2001 during which time an officer of a Company subsidiary was negotiating an agreement with an investor relating to investments in a mutual fund and a hedge fund. The Company, in addition to other entities within Franklin Templeton Investments, including the Fund and other funds, has been named in shareholder class actions related to the matter described above. The Company believes that the claims made in the lawsuit are without merit and it intends to defend vigorously against the allegations. It is anticipated that the Company may be named in additional similar civil actions related to the matter described above. In addition, as part of ongoing investigations by the U.S. Securities and Exchange Commission (the "SEC"), the U.S. Attorney for the Northern District of California, the New York Attorney General, the California Attorney General, the U.S. Attorney for the District of Massachusetts, the Florida Department of Financial Services, and the Commissioner of Securities and the Attorney General of the State of West Virginia, relating to certain practices in the mutual fund industry, including late trading, market timing and sales compensation arrangements, the Company and its subsidiaries, as well as certain current or former executives and employees of the Company, have received requests for information and/or subpoenas to testify or produce documents. The Company and its current employees are providing documents and information in response to these requests and subpoenas. In addition, the Company has responded to requests for similar kinds of information from regulatory authorities in some of the foreign countries where the Company conducts its global asset management business. The Staff of the SEC has informed the Company that it intends to recommend that the Commission authorize an action against an affiliate of the Fund's adviser and a senior executive officer relating to the frequent trading issues that are the subject of the SEC's investigation. These issues were previously disclosed as being under investigation by government authorities and the subject of an internal inquiry by the Company in its Annual Report on Form 10-K and on its public website. The Company currently is in discussions with the SEC Staff in an effort to resolve the issues raised in their investigation. Such discussions are preliminary and the Company cannot predict the likelihood of whether those discussions will result in a settlement and, if so, the terms of such settlement. The impact, if any, of these matters on the Fund is uncertain at this time. If it is found that the Company bears responsibility for any unlawful or improper conduct, we have committed to making the funds or their shareholders whole, as appropriate. Any further updates on these matters will be disclosed on the Company's website at franklintempleton.com under "Statement on Current Industry Issues." 4 | Not part of the annual report Annual Report Mutual Qualified Fund YOUR FUND'S GOAL AND PRIMARY INVESTMENTS: Mutual Qualified Fund seeks capital appreciation, with income as a secondary goal, by investing primarily in common and preferred stocks, bonds and convertible securities in the U.S. and other countries. We are pleased to bring you Mutual Qualified Fund's annual report for the fiscal year ended December 31, 2003. PERFORMANCE OVERVIEW Mutual Qualified Fund - Class Z posted a 30.50% cumulative total return for the 12 months ended December 31, 2003, as shown in the Performance Summary beginning on page 10. The Fund outperformed its benchmark, the Standard & Poor's 500 Composite Index (S&P 500), which returned 28.67% over the same period. 1 ECONOMIC AND MARKET OVERVIEW Early in 2003, economic uncertainty and geopolitical events pushed U.S. interest rates to their lowest level in more than four decades. The U.S. government injected fiscal stimulus into the economy, approving another round of tax cuts and rebates that included dividend and capital gains tax reductions. In June, an accommodative Federal Reserve Board, in an attempt to bolster the economy, cut the federal funds target rate to 1.00%. During the year, the U.S. trade deficit increased significantly, contributing to the U.S. dollar's fall to record lows against the euro and other major currencies. However, the weak dollar provided a boost to the U.S. economy and corporate profits as exports became cheaper for foreign buyers. Robust consumer spending, especially for autos and homes, and strong business spending, particularly for equipment and software, contributed to the accelerated economic activity. In addition, U.S. federal spending stayed firm and inflation remained benign. U.S. gross domestic product (GDP) grew an annualized 8.2% in third quarter 2003, its 1. Source: Standard & Poor's Micropal. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The S&P 500 is one of the most widely used benchmarks of U.S. equity performance. The index includes reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND COMPLETE LEGAL TITLES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 19. Annual Report | 5 strongest pace in nearly 20 years, and overall, 2003 GDP grew an estimated 3.1%. As economic data improved, interest rates rose from their lows, and the 10-year Treasury note's yield ended the period at 4.27%. Foreign economies also showed signs of recovery following a low growth and disinflationary environment that facilitated monetary easing in many major economies during the reporting period. While economic growth accelerated in the U.S., it remained strong in Asia, and was weak, yet positive, in Europe. Despite these signs of economic recovery, benign inflationary trends continued, supported by cyclical productivity gains and excess capacity in labor and capital. A global equity market rally started in late March 2003 and continued through the end of the year. The rebound began with investors anticipating global economic recovery in the second half of 2003, and it continued as data showed robust economic growth. Improved sentiment led many investors to rotate into economically sensitive and financially leveraged companies, specifically cyclical, technology, small-capitalization and emerging market stocks, which had generally performed poorly in recent years. Consequently, domestic and foreign equity markets generally performed well. INVESTMENT STRATEGY At Mutual Series, we remained committed to our three-pronged approach to investing, which utilizes in-depth, fundamental analysis to identify attractive investment opportunities in undervalued equities, distressed debt and arbitrage. The first prong of our investment strategy is to purchase equities trading at material discounts to our estimate of their intrinsic values. We purchase stocks after completing a comprehensive, industry-wide analysis of financial statements, management teams and business prospects. The second prong is to purchase distressed company securities. Our analysts focus on what we consider good operations of companies whose overleveraged balance sheets can benefit from financial reorganization and who can emerge as stronger, more viable entities after the restructuring process, in our opinion. The third prong is to participate in the arbitrage arena by positioning the securities of announced merger and acquisition transactions. We pay close attention to detail because we realize that when it comes to investing, surprises are rarely favorable. Through our intense research efforts and conservative investing strategy, we seek to generate above-average risk adjusted returns for our shareholders over time. Geographic Distribution* Based on Total Net Assets as of 12/31/03 [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: U.S. 65.9% U.K. 9.5% France 5.3% Canada 3.7% Irish Republic 2.0% Japan 1.8% Netherlands 1.8% Spain 1.7% Norway 1.7% Switzerland 1.4% Italy 1.1% Germany 1.1% Other Countries 3.6% *Other net assets = -0.6% because of foreign currency hedging. 6 | Annual Report MANAGER'S DISCUSSION All three prongs of our investment strategy contributed to Fund performance during the year under review. In particular, our three best performers were International Steel Group (ISG), an integrated steel producer; White Mountains Insurance Group, a property and casualty (P&C) insurer; and NTL Communications, a distressed cable company investment. ISG was formed in second quarter 2002 by a group of private equity investors, including the Fund, to purchase certain LTV steel production assets out of bankruptcy. After negotiating with the unions to craft an agreement, the purchased LTV assets were structured to eliminate many "legacy" liabilities, such as pension and post-retirement health care costs. Using this cost reduction formula, ISG continued to acquire additional steel facilities out of bankruptcy in 2002 and 2003. As ISG restructured and assimilated these facilities, the company emerged as a competitive, low-cost operator and the nation's second-largest steel producer. A weak U.S. dollar and higher raw material costs resulted in significant spot market price increases for steel in the second half of the year. Stock prices across the steel industry rose, and ISG capitalized on this momentum by selling its stock through an initial public offer (IPO) in early December. The IPO was very well received, and ISG's stock price appreciated almost 40% in December, contributing to a solid 2003. Our investment in White Mountains reflects our focus on companies with strong or improving fundamentals, attractive valuations and management teams who think like owners. During 2003, the company benefited from strong price increases for primary and reinsurance risks, disciplined underwriting and solid returns from its investment portfolio. While many companies within the P&C insurance industry struggled with eroding capital from past underwriting mistakes and significant losses in their investment portfolios, White Mountains utilized its much-improved balance sheet and industry knowledge to acquire undervalued or capital-constrained insurance companies and to increase exposure to its most attractive lines of businesses. Primarily as a result of these actions, the company continued to improve profitability and enjoyed a 13% increase in its book value during 2003. NTL, the U.K.'s largest cable company, was formed by a series of acquisitions of independent cable operators. These purchases were financed largely with debt, and in 2001, when NTL failed to generate enough cash flow to meet its interest payments, the company's bonds began to trade at significant discounts to face value. TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/03 % OF TOTAL NET ASSETS ------------------------------------------------- Insurance 9.4% Media 7.5% Metals & Mining 6.0% Thrifts & Mortgage Finance 5.9% Commercial Banks 5.0% Tobacco 4.7% Diversified Telecommunication Services 3.5% Real Estate 2.8% Food Products 2.7% Oil & Gas 2.5% Annual Report | 7 TOP 10 HOLDINGS 12/31/03 ------------------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS ------------------------------------------------------------- White Mountains Insurance Group Inc., common & restricted 3.9% INSURANCE, U.S. ------------------------------------------------------------- International Steel Group 2.3% METALS & MINING, U.S. ------------------------------------------------------------- Sovereign Bancorp Inc. 2.2% THRIFTS & MORTGAGE FINANCE, U.S. ------------------------------------------------------------- Liberty Media Corp., A 1.8% MEDIA, U.S. ------------------------------------------------------------- NTL Inc. 1.7% DIVERSIFIED TELECOMMUNICATION SERVICES, U.K. ------------------------------------------------------------- Altadis SA 1.7% TOBACCO, SPAIN ------------------------------------------------------------- Groupe Danone 1.3% FOOD PRODUCTS, FRANCE ------------------------------------------------------------- Washington Post Co., B 1.3% MEDIA, U.S. ------------------------------------------------------------- E.W. Scripps Co., A 1.3% MEDIA, U.S. ------------------------------------------------------------- Allied Irish Banks PLC 1.2% COMMERCIAL BANKS, IRISH REPUBLIC ------------------------------------------------------------- After completing an extensive fundamental analysis, we believed NTL's bonds were trading well below the fair value of the company's operations. We purchased a material amount of NTL debt and became an active member of the creditors committee formed to facilitate the reorganization process. During the restructuring, our investment in NTL bonds was converted to common shares, and the reorganized company emerged from bankruptcy in January 2003. As global cable valuations recovered and NTL operations improved through cost cutting and fewer member subscription cancellations, the new NTL shares performed well during the year and appreciated more than 15 times from their lows. Although the Fund's successes during the reporting period were many, not all of our investments performed as well as we hoped. Three of the Fund's significant underperformers included Allied Domecq (sold by year-end), one of the world's largest spirits and wine companies; Abitibi-Consolidated, a Canadian paper and forest products company; and Beiersdorf, a German personal care products company. Allied Domecq's stock declined after the company lowered its earnings outlook in February due to a weak U.S. dollar, higher pension expenses and weakness in its Spanish operations. Abitibi's shares underperformed in 2003 after a weak U.S. dollar, soft sales and higher energy prices forced the company to reduce its earnings outlook and cut its dividend. Beiersdorf owns leading skin care brand Nivea, which has approximately a 30% market share in Europe but very little in the U.S. marketplace. Beiersdorf declined after major shareholders announced the company would pursue its U.S. market share independently rather than selling itself to a competitor. Effective December 2003, Jeff Diamond, portfolio manager of Mutual Qualified Fund since 1998, resigned to pursue other career opportunities. Your Fund will continue to be managed by Anne Gudefin, who has been promoted to portfolio manager, and has been involved in management of Mutual Qualified Fund since July 2002. In addition, Shawn Tumulty has been promoted to assistant portfolio manager for the Fund. Mr. Tumulty's biography is on the next page. 8 | Annual Report Thank you for your continued participation in Mutual Qualified Fund. We look forward to serving your future investment needs. [PHOTO OMITTED] /S/ ANNE E. GUDEFIN Anne E. Gudefin, CFA Portfolio Manager [PHOTO OMITTED] /S/ SHAWN M. TUMULTY Shawn M. Tumulty Assistant Portfolio Manager Mutual Qualified Fund THIS DISCUSSION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2003, THE END OF THE REPORTING PERIOD. THE WAY WE IMPLEMENT OUR MAIN INVESTMENT STRATEGIES AND THE RESULTING PORTFOLIO HOLDINGS MAY CHANGE DEPENDING ON FACTORS SUCH AS MARKET AND ECONOMIC CONDITIONS. THESE OPINIONS MAY NOT BE RELIED UPON AS INVESTMENT ADVICE OR AN OFFER FOR A PARTICULAR SECURITY. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR THE FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE, BUT THE ADVISOR MAKES NO REPRESENTATION OR WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR INVESTMENT MANAGEMENT PHILOSOPHY. SHAWN TUMULTY is assistant portfolio manager of Mutual Qualified Fund. He specializes in the analysis of distressed debt. Mr. Tumulty has over 14 years of experience in the investment management industry. Prior to joining Franklin Mutual Advisers in 2000, he was an analyst and portfolio manager at Bankers Trust Company and Hamilton Partners Limited where he focused on distressed debt investing since 1989. Mr. Tumulty received a Bachelor of Arts degree in economics from Wagner College. Annual Report | 9 Performance Summary as of 12/31/03 Your dividend income will vary depending on dividends or interest paid by securities in the Fund's portfolio, adjusted for operating expenses of each class. Capital gain distributions are net profits realized from the sale of portfolio securities. The performance table and graphs do not reflect any taxes due on Fund dividends, capital gain distributions, if any, or any realized gains on the sale of Fund shares. Total return reflects the Fund's dividend income, capital gain distributions, if any, and any unrealized gains or losses. PRICE AND DISTRIBUTION INFORMATION
-------------------------------------------------------------------------------------------------- CLASS Z CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$3.92 $17.87 $13.95 -------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------------------------- Dividend Income $0.3134 -------------------------------------------------------------------------------------------------- CLASS A CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$3.89 $17.80 $13.91 -------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------------------------- Dividend Income $0.2619 -------------------------------------------------------------------------------------------------- CLASS B CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$3.82 $17.54 $13.72 -------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------------------------- Dividend Income $0.1729 -------------------------------------------------------------------------------------------------- CLASS C CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$3.86 $17.71 $13.85 -------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------------------------- Dividend Income $0.1626
10 | Past performance does not guarantee future results. | Annual Report Performance Summary (CONTINUED) PERFORMANCE 1
------------------------------------------------------------------------------------------------------- CLASS Z 1-YEAR 5-YEAR 10-YEAR ------------------------------------------------------------------------------------------------------- Cumulative Total Return 2 30.50% 60.05% 225.93% Average Annual Total Return 3 30.50% 9.86% 12.54% Value of $10,000 Investment 4 $13,050 $16,005 $32,593 ------------------------------------------------------------------------------------------------------- CLASS A 1-YEAR 5-YEAR INCEPTION (11/1/96) ------------------------------------------------------------------------------------------------------- Cumulative Total Return 2 29.98% 57.24% 108.64% Average Annual Total Return 3 22.50% 8.19% 9.89% Value of $10,000 Investment 4 $12,250 $14,821 $19,665 ------------------------------------------------------------------------------------------------------- CLASS B 1-YEAR 5-YEAR INCEPTION (1/1/99) ------------------------------------------------------------------------------------------------------- Cumulative Total Return 2 29.22% 52.37% 52.37% Average Annual Total Return 3 25.22% 8.50% 8.50% Value of $10,000 Investment 4 $12,522 $15,037 $15,037 ------------------------------------------------------------------------------------------------------- CLASS C 1-YEAR 5-YEAR INCEPTION (11/1/96) ------------------------------------------------------------------------------------------------------- Cumulative Total Return 2 29.16% 52.34% 99.29% Average Annual Total Return 3 26.88% 8.56% 9.95% Value of $10,000 Investment 4 $12,688 $15,078 $19,731
ONGOING MARKET VOLATILITY CAN SIGNIFICANTLY AFFECT SHORT-TERM PERFORMANCE; MORE RECENT RETURNS MAY DIFFER FROM THOSE SHOWN. SINCE MARKETS CAN GO DOWN AS WELL AS UP, INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE WITH MARKET CONDITIONS AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. FOR MORE CURRENT PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236. Annual Report | Past performance does not guarantee future results. | 11 Performance Summary (CONTINUED) TOTAL RETURN INDEX COMPARISON FOR HYPOTHETICAL $10,000 INVESTMENT1 Total return represents the change in value of an investment over the periods shown. It includes the current, applicable, maximum sales charge(s), Fund expenses, account fees and reinvested distributions. The unmanaged index includes reinvested dividends. It differs from the Fund in composition and does not pay management fees or expenses. One cannot invest directly in an index. AVERAGE ANNUAL TOTAL RETURN -------------------------------------- CLASS Z 12/31/03 -------------------------------------- 1-Year 30.50% -------------------------------------- 5-Year 9.86% -------------------------------------- 10-Year 12.54% [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Class Z (1/1/94-12/31/03) Mutual Qualified Fund S&P 500 Index5 1/1/94 $10,000 $10,000 10,233 10,340 10,111 10,059 9,844 9,622 10,041 9,745 10,222 9,904 10,030 9,662 10,387 9,979 10,879 10,387 10,734 10,133 10,749 10,361 10,476 9,984 10,573 10,132 10,783 10,394 11,215 10,799 11,330 11,117 11,627 11,444 11,956 11,901 12,024 12,177 12,597 12,580 12,833 12,612 13,186 13,144 12,898 13,097 13,247 13,671 13,263 13,934 13,880 14,408 14,272 14,542 14,420 14,682 14,497 14,898 14,704 15,282 6/30/96 14,618 15,340 14,140 14,663 14,613 14,973 15,054 15,814 15,226 16,250 16,010 17,478 16,221 17,132 16,750 18,201 17,115 18,344 16,895 17,592 17,045 18,641 17,864 19,775 18,454 20,661 19,413 22,304 19,250 21,055 20,215 22,208 19,657 21,467 19,890 22,460 20,262 22,845 20,162 23,098 21,332 24,762 22,168 26,029 22,190 26,291 22,112 25,840 21,967 26,889 21,320 26,603 18,148 22,761 18,080 24,219 19,133 26,187 20,085 27,774 12/31/98 20,364 29,373 20,500 30,601 19,943 29,650 20,958 30,836 22,801 32,030 23,085 31,275 23,769 33,009 23,322 31,980 22,226 31,822 21,716 30,950 22,302 32,908 22,952 33,577 23,141 35,553 22,498 33,767 21,471 33,129 23,811 36,368 23,839 35,274 24,359 34,552 23,972 35,404 24,698 34,851 25,795 37,014 25,869 35,061 26,092 34,912 25,276 32,162 26,439 32,319 27,855 33,465 27,808 30,416 27,203 28,490 28,492 30,702 29,511 30,908 6/30/01 29,972 30,156 30,103 29,859 29,579 27,992 26,832 25,732 26,636 26,223 27,765 28,234 28,609 28,481 28,488 28,066 28,627 27,524 29,616 28,560 29,824 26,829 29,824 26,632 27,794 24,735 25,835 22,808 26,064 22,957 24,370 20,465 24,706 22,264 25,323 23,573 24,976 22,189 24,779 21,609 24,260 21,284 24,314 21,489 25,979 23,260 27,429 24,484 27,881 24,797 28,296 25,234 28,998 25,725 28,854 25,453 30,080 26,892 31,089 27,128 12/31/03 32,593 28,550 AVERAGE ANNUAL TOTAL RETURN -------------------------------------- CLASS A 12/31/03 -------------------------------------- 1-Year 22.50% -------------------------------------- 5-Year 8.19% -------------------------------------- Since Inception (11/1/96) 9.89% [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Class A (11/1/96-12/31/03) Date Mutual Qualified Fund - Class A S&P 500 Index 11/96 $ 9,425 $10,000 9,908 10,755 10,035 10,542 10,360 11,200 10,579 11,288 10,437 10,825 10,530 11,471 11,031 12,169 11,389 12,714 11,982 13,725 11,875 12,957 12,466 13,666 12,120 13,210 12,258 13,821 12,488 14,058 12,419 14,213 13,135 15,238 13,644 16,018 13,658 16,179 13,603 15,901 13,506 16,546 13,111 16,371 8/98 11,153 14,006 11,111 14,904 11,762 16,115 12,335 17,091 12,507 18,075 12,590 18,831 12,240 18,246 12,864 18,975 13,992 19,710 14,167 19,245 14,577 20,313 14,295 19,679 13,620 19,582 13,306 19,046 13,659 20,251 14,052 20,662 14,166 21,878 13,772 20,779 13,134 20,386 14,561 22,379 14,570 21,706 5/00 14,889 21,262 14,655 21,786 15,091 21,446 15,746 22,777 15,791 21,575 15,918 21,484 15,418 19,791 16,123 19,888 16,980 20,593 16,951 18,717 16,571 17,532 17,360 18,893 17,973 19,020 18,241 18,557 18,321 18,374 17,991 17,225 16,321 15,834 16,201 16,137 16,881 17,374 17,388 17,526 17,304 17,271 2/02 17,388 16,938 17,981 17,575 18,097 16,510 18,097 16,388 16,855 15,221 15,671 14,035 15,800 14,127 14,779 12,593 14,972 13,701 15,338 14,506 15,129 13,654 15,009 13,297 14,693 13,098 14,704 13,223 15,716 14,313 16,586 15,066 16,856 15,259 17,097 15,528 17,513 15,830 17,436 15,663 18,158 16,548 18,771 16,694 12/03 19,665 17,569 12 | Past performance does not guarantee future results. | Annual Report Performance Summary (CONTINUED) AVERAGE ANNUAL TOTAL RETURN -------------------------------------- CLASS B 12/31/03 -------------------------------------- 1-Year 25.22% -------------------------------------- 5-Year 8.50% -------------------------------------- Since Inception (1/1/99) 8.50% -------------------------------------- [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Class B (11/1/99-12/31/03) Date Mutual Qualified Fund - Class B S&P 500 Index 1/1/99 $10,000 $10,000 1/31/99 10,061 10,418 2/28/99 9,787 10,094 3/31/99 10,274 10,498 4/30/99 11,163 10,905 5/31/99 11,297 10,647 6/30/99 11,617 11,238 7/31/99 11,385 10,887 8/31/99 10,851 10,834 9/30/99 10,588 10,537 10/31/99 10,864 11,203 11/30/99 11,171 11,431 12/31/99 11,255 12,104 1/31/00 10,933 11,496 2/29/00 10,423 11,279 3/31/00 11,550 12,381 4/30/00 11,557 12,009 5/31/00 11,805 11,763 6/30/00 11,605 12,053 7/31/00 11,946 11,865 8/31/00 12,461 12,601 9/30/00 12,491 11,936 10/31/00 12,585 11,886 11/30/00 12,186 10,949 12/31/00 12,731 11,003 1/31/01 13,405 11,393 2/28/01 13,366 10,355 3/31/01 13,064 9,699 4/30/01 13,676 10,453 5/31/01 14,156 10,523 6/30/01 14,358 10,267 7/31/01 14,413 10,166 8/31/01 14,151 9,530 9/30/01 12,830 8,760 10/31/01 12,719 8,927 11/30/01 13,252 9,612 12/31/01 13,644 9,696 1/31/02 13,569 9,555 2/28/02 13,628 9,371 3/31/02 14,089 9,723 4/30/02 14,173 9,134 5/31/02 14,165 9,067 6/30/02 13,184 8,421 7/31/02 12,253 7,765 8/31/02 12,338 7,816 9/30/02 11,536 6,967 10/31/02 11,681 7,580 11/30/02 11,963 8,025 12/31/02 11,792 7,554 1/31/03 11,689 7,357 2/28/03 11,439 7,246 3/31/03 11,448 7,316 4/30/03 12,222 7,919 5/31/03 12,900 8,335 6/30/03 13,099 8,442 7/31/03 13,280 8,591 8/31/03 13,600 8,758 9/30/03 13,523 8,665 10/31/03 14,076 9,155 11/30/03 14,543 9,236 12/31/03 15,037 9,720 AVERAGE ANNUAL TOTAL RETURN -------------------------------------- CLASS C 12/31/03 -------------------------------------- 1-Year 26.88% -------------------------------------- 5-Year 8.56% -------------------------------------- Since Inception (11/1/96) 9.95% [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Class C (11/1/96-12/31/03) Mutual Qualified Fund - Class C S&P 500 Index 11/1/96 $ 9,900 $10,000 10,404 10,755 10,531 10,542 10,865 11,200 11,092 11,288 10,936 10,825 11,027 11,471 11,553 12,169 11,923 12,714 12,532 13,725 12,420 12,957 13,027 13,666 12,658 13,210 12,796 13,821 13,026 14,058 12,947 14,213 13,689 15,238 14,215 16,018 14,215 16,179 14,150 15,901 14,049 16,546 13,620 16,371 8/31/98 11,582 14,006 11,530 14,904 12,195 16,115 12,787 17,091 12,951 18,075 13,031 18,831 12,666 18,246 13,300 18,975 14,456 19,710 14,631 19,245 15,048 20,313 14,747 19,679 14,054 19,582 13,712 19,046 14,070 20,251 14,470 20,662 14,576 21,878 14,159 20,779 13,500 20,386 14,957 22,379 14,966 21,706 5/31/00 15,287 21,262 15,027 21,786 15,468 21,446 16,143 22,777 16,180 21,575 16,293 21,484 15,777 19,791 16,487 19,888 17,357 20,593 17,317 18,717 16,927 17,532 17,707 18,893 18,337 19,020 18,602 18,557 18,664 18,374 18,325 17,225 16,611 15,834 16,477 16,137 17,165 17,374 17,667 17,526 17,581 17,271 2/28/02 17,656 16,938 18,239 17,575 18,347 16,510 18,337 16,388 17,080 15,221 15,862 14,035 15,982 14,127 14,940 12,593 15,126 13,701 15,499 14,506 15,276 13,654 15,144 13,297 14,813 13,098 14,824 13,223 15,828 14,313 16,699 15,066 16,965 15,259 17,198 15,528 17,608 15,830 17,519 15,663 18,241 16,548 18,840 16,694 12/31/03 19,731 17,569 Annual Report | Past performance does not guarantee future results. | 13 Performance Summary (CONTINUED) ENDNOTES THE FUND INVESTS IN SMALLER-COMPANY STOCKS AND FOREIGN SECURITIES. SMALLER-COMPANY STOCKS HAVE HISTORICALLY EXHIBITED GREATER PRICE VOLATILITY THAN LARGER-COMPANY STOCKS, PARTICULARLY OVER THE SHORT TERM. FOREIGN SECURITIES RISKS INCLUDE EXPOSURE TO CURRENCY VOLATILITY AND POLITICAL, ECONOMIC AND REGULATORY UNCERTAINTY. THE FUND MAY ALSO INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, AS WELL AS LOWER-RATED "JUNK BONDS," WHICH ENTAIL HIGHER CREDIT RISK. THE FUND'S PROSPECTUS ALSO INCLUDES A DESCRIPTION OF THE MAIN INVESTMENT RISKS. CLASS Z: No initial sales charge or Rule 12b-1 fees; shares are available only to certain investors, as described in the prospectus. CLASS A: Subject to the current, maximum 5.75% initial sales charge. Prior to 8/3/98, Fund shares were offered at a lower initial sales charge; thus actual total returns may differ. CLASS B: Subject to no initial sales charge, but subject to a contingent deferred sales charge (CDSC) declining from 4% to 0% over six years. These shares have higher annual fees and expenses than Class A shares. CLASS C: Subject to 1% initial sales charge and 1% CDSC for shares redeemed within 18 months of investment. These shares have higher annual fees and expenses than Class A shares. 1. Past expense reductions by the Fund's manager increased the Fund's total returns. Without these reductions, the Fund's total returns would have been lower. 2. Cumulative total return represents the change in value of an investment over the periods indicated and does not include sales charges. 3. Average annual total return represents the average annual change in value of an investment over the periods indicated and includes any current, applicable, maximum sales charge(s). 4. These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated and include any current, applicable, maximum sales charge(s). 5. Source: Standard & Poor's Micropal. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The S&P 500 is one of the most widely used benchmarks of U.S. equity performance. 14 | Past performance does not guarantee future results. | Annual Report Mutual Qualified Fund FINANCIAL HIGHLIGHTS
-------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2003 2002 2001 2000 1999 -------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ........................... $13.95 $16.49 $16.61 $16.91 $16.46 -------------------------------------------------------------------- Income from investment operations: Net investment income a ..................................... .20 .28 .23 .24 .23 Net realized and unrealized gains (losses) .................. 4.04 (2.34) 1.12 1.99 1.99 -------------------------------------------------------------------- Total from investment operations ............................. 4.24 (2.06) 1.35 2.23 2.22 -------------------------------------------------------------------- Less distributions from: Net investment income ....................................... (.31) (.26) (.20) (.55) (.29) Net realized gains .......................................... -- (.22) (1.27) (1.98) (1.48) -------------------------------------------------------------------- Total distributions .......................................... (.31) (.48) (1.47) (2.53) (1.77) -------------------------------------------------------------------- Net asset value, end of year ................................. $17.88 $13.95 $16.49 $16.61 $16.91 -------------------------------------------------------------------- Total return b ............................................... 30.50% (12.70)% 8.21% 14.25% 13.64% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) .............................. $3,102,506 $2,503,544 $3,022,299 $2,921,221 $3,152,050 Ratios to average net assets:* Expenses c .................................................. .85% .80% .80% .80% .80% Expenses, excluding waiver and payments by affiliate c ...... .85% .80% .80% .83% .85% Net investment income ....................................... 1.34% 1.81% 1.29% 1.43% 1.31% Portfolio turnover rate ...................................... 49.70% 51.24% 52.64% 54.73% 59.84% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ..................................................... .82% .79% .79% .78% .77% Expenses, excluding waiver and payments by affiliate ......... .82% .79% .79% .81% 82%
aBased on average daily shares outstanding. bTotal return is not annualized for periods less than one year. cIncludes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses. Annual Report | 15 Mutual Qualified Fund FINANCIAL HIGHLIGHTS (CONTINUED)
----------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2003 2002 2001 2000 1999 ----------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .......................... $13.91 $16.44 $16.56 $16.87 $16.42 ----------------------------------------------------------------- Income from investment operations: Net investment income a .................................... .15 .23 .17 .18 .17 Net realized and unrealized gains (losses) ................. 4.01 (2.33) 1.12 1.98 1.99 ----------------------------------------------------------------- Total from investment operations ............................ 4.16 (2.10) 1.29 2.16 2.16 ----------------------------------------------------------------- Less distributions from: Net investment income ...................................... (.26) (.21) (.14) (.49) (.23) Net realized gains ......................................... -- (.22) (1.27) (1.98) (1.48) ----------------------------------------------------------------- Total distributions ......................................... (.26) (.43) (1.41) (2.47) (1.71) ----------------------------------------------------------------- Net asset value, end of year ................................ $17.81 $13.91 $16.44 $16.56 $16.87 ----------------------------------------------------------------- Total return b .............................................. 29.98% (13.00)% 7.85% 13.81% 13.27% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............................. $625,088 $449,507 $482,182 $443,655 $471,313 Ratios to average net assets:* Expenses c ................................................. 1.20% 1.15% 1.15% 1.15% 1.14% Expenses, excluding waiver and payments by affiliate c ..... 1.20% 1.15% 1.15% 1.18% 1.19% Net investment income ...................................... .99% 1.46% .94% 1.08% .97% Portfolio turnover rate ..................................... 49.70% 51.24% 52.64% 54.73% 59.84% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................................... 1.17% 1.14% 1.14% 1.13% 1.11% Expenses, excluding waiver and payments by affiliate ....... 1.17% 1.14% 1.14% 1.16% 1.16%
aBased on average daily shares outstanding. bTotal return does not reflect the sales commissions or the contingent deferred sales charge, and is not annualized for periods less than one year. cIncludes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses. 16 | Annual Report Mutual Qualified Fund FINANCIAL HIGHLIGHTS (CONTINUED)
------------------------------------------------------------ YEAR ENDED DECEMBER 31, CLASS B 2003 2002 2001 2000 1999 ------------------------------------------------------------ PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ............................... $13.72 $16.25 $16.44 $16.78 $16.42 ------------------------------------------------------------ Income from investment operations: Net investment income a ......................................... .05 .13 .04 .08 .03 Net realized and unrealized gains (losses) ...................... 3.94 (2.30) 1.13 1.96 2.01 ------------------------------------------------------------ Total from investment operations ................................. 3.99 (2.17) 1.17 2.04 2.04 ------------------------------------------------------------ Less distributions from: Net investment income ........................................... (.17) (.14) (.09) (.40) (.20) Net realized gains .............................................. -- (.22) (1.27) (1.98) (1.48) ------------------------------------------------------------ Total distributions .............................................. (.17) (.36) (1.36) (2.38) (1.68) ------------------------------------------------------------ Net asset value, end of year ..................................... $17.54 $13.72 $16.25 $16.44 $16.78 ------------------------------------------------------------ Total return b ................................................... 29.22% (13.58)% 7.17% 13.12% 12.55% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) .................................. $53,760 $36,023 $20,581 $6,278 $4,168 Ratios to average net assets:* Expenses c ...................................................... 1.85% 1.80% 1.80% 1.80% 1.81% Expenses, excluding waiver and payments by affiliate c .......... 1.85% 1.80% 1.80% 1.82% 1.86% Net investment income ........................................... .34% .81% .24% .45% .20% Portfolio turnover rate .......................................... 49.70% 51.24% 52.64% 54.73% 59.84% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses 1.82% 1.79% 1.79% 1.78% 1.78% Expenses, excluding waiver and payments by affiliate 1.82% 1.79% 1.79% 1.80% 1.83%
aBased on average daily shares outstanding. bTotal return does not reflect the contingent deferred sales charge, and is not annualized for periods less than one year. cIncludes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses. Annual Report | 17 Mutual Qualified Fund FINANCIAL HIGHLIGHTS (CONTINUED)
-------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2003 2002 2001 2000 1999 -------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ............................... $13.85 $16.36 $16.49 $16.80 $16.35 -------------------------------------------------------------- Income from investment operations: Net investment income a ......................................... .05 .13 .05 .07 .05 Net realized and unrealized gains (losses) ...................... 3.98 (2.31) 1.12 1.97 1.98 -------------------------------------------------------------- Total from investment operations ................................. 4.03 (2.18) 1.17 2.04 2.03 -------------------------------------------------------------- Less distributions from: Net investment income ........................................... (.16) (.11) (.03) (.37) (.10) Net realized gains .............................................. -- (.22) (1.27) (1.98) (1.48) -------------------------------------------------------------- Total distributions .............................................. (.16) (.33) (1.30) (2.35) (1.58) Net asset value, end of year ..................................... $17.72 $13.85 $16.36 $16.49 $16.80 -------------------------------------------------------------- Total return b ................................................... 29.16% (13.53)% 7.16% 13.11% 12.54% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) .................................. $285,668 $225,699 $251,798 $220,838 $264,902 Ratios to average net assets:* Expenses c ...................................................... 1.85% 1.79% 1.79% 1.79% 1.80% Expenses, excluding waiver and payments by affiliate c .......... 1.85% 1.79% 1.79% 1.82% 1.84% Net investment income ........................................... .34% .82% .30% .44% .32% Portfolio turnover rate .......................................... 49.70% 51.24% 52.64% 54.73% 59.84% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ......................................................... 1.82% 1.78% 1.78% 1.77% 1.77% Expenses, excluding waiver and payments by affiliate ............. 1.82% 1.78% 1.78% 1.80% 1.81%
aBased on average daily shares outstanding. bTotal return does not reflect sales commissions or the contingent deferred sales charge, and is not annualized for periods less than one year. cIncludes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses. 18 | See notes to financial statements. | Annual Report Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003
--------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE --------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 70.9% AEROSPACE & DEFENSE .7% Northrop Grumman Corp. .................................... United States 284,200 $ 27,169,520 ----------------- AIRLINES a Atlantic Coast Airlines Holdings Inc. ..................... United States 26,900 266,310 ----------------- BEVERAGES 2.5% Brown-Forman Corp., A ..................................... United States 39,600 3,839,220 Brown-Forman Corp., B ..................................... United States 141,945 13,264,760 Coca-Cola Enterprises Inc. ................................ United States 233,700 5,111,019 Diageo PLC ................................................United Kingdom 2,580,700 33,955,971 Orkla ASA ................................................. Norway 1,842,400 41,263,468 Pepsi Bottling Group Inc. ................................. United States 88,100 2,130,258 ----------------- 99,564,696 ----------------- BIOTECHNOLOGY a SICOR Inc. ................................................ United States 26,600 723,520 ----------------- CHEMICALS 1.1% Akzo Nobel NV ............................................. Netherlands 854,371 32,976,479 Syngenta AG ............................................... Switzerland 172,870 11,643,478 ----------------- 44,619,957 ----------------- COMMERCIAL BANKS 5.2% Allied Irish Banks PLC ....................................Irish Republic 2,950,000 47,182,139 Bank of Ireland ...........................................Irish Republic 2,248,075 30,596,278 Danske Bank ............................................... Denmark 1,249,080 29,305,977 DNB Holding ASA ........................................... Norway 3,620,585 24,190,567 Fleet Boston Financial Corp. .............................. United States 167,640 7,317,486 a Franklin Bank Corp., Houston .............................. United States 164,900 3,133,100 a,c ITLA Capital Corp. ........................................ United States 466,396 23,366,440 KeyCorp ................................................... United States 364,500 10,687,140 a,b,c Nippon Investment LLC ..................................... Japan 9,112,000 3,462,560 a,b,c State National Bancshares Inc. ............................ United States 1,375,000 27,500,000 U.S. Bancorp .............................................. United States 152,899 4,553,332 ----------------- 211,295,019 ----------------- COMMERCIAL SERVICES & SUPPLIES 1.6% a Alderwoods Group Inc. ..................................... United States 530,784 4,999,985 a Cendant Corp. ............................................. United States 940,814 20,951,928 Republic Services Inc. .................................... United States 1,589,000 40,726,070 ----------------- 66,677,983 ----------------- COMPUTERS & PERIPHERALS a DecisionOne Corp. ......................................... United States 245,461 490,922 ----------------- CONSTRUCTION & ENGINEERING .8% Vinci SA .................................................. France 387,434 32,082,546 ----------------- CONSTRUCTION MATERIALS 1.0% Lafarge North America Inc. ................................ United States 563,945 22,851,051 RMC Group PLC .............................................United Kingdom 1,479,311 18,471,195 ----------------- 41,322,246 -----------------
Annual Report | 19 Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE --------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) CONSUMER FINANCE .5% MCG Capital Corp. ......................................... United States 1,095,149 $ 21,355,405 a,c Union Acceptance Corp., A ................................. United States 3,595,994 215,760 ----------------- 21,571,165 ----------------- DIVERSIFIED FINANCIAL SERVICES 1.0% a,b A.B. Watley Group Inc. .................................... United States 128,325 23,098 a,b,c Elephant Capital Holdings Ltd. ............................ Japan 10,949 10,948,800 a,b Leucadia National Corp. ................................... United States 691,640 30,290,374 ----------------- 41,262,272 ----------------- DIVERSIFIED TELECOMMUNICATION SERVICES 3.5% a,b,d AboveNet Inc. ............................................. United States 67,857 2,032,609 BCE Inc. .................................................. Canada 873,200 19,528,327 Chunghwa Telecom Co. Ltd., ADR ............................ Taiwan 974,078 14,124,131 Global Crossing Holdings Ltd., Contingent Equity Distribution ..................................... United States 49,482,261 43,297 a Global Crossing Ltd. ...................................... United States 75,164 2,480,408 a,b NTL Inc. ..................................................United Kingdom 443,332 29,376,287 a NTL Inc. ..................................................United Kingdom 585,096 40,810,446 a Spectrasite Inc. .......................................... United States 504,938 17,546,595 a Telecom Italia SpA, di Risp ............................... Italy 6,537,705 13,317,853 a XO Communications Inc. .................................... United States 1,081,175 4,594,994 ----------------- 143,854,947 ----------------- ELECTRIC UTILITIES .8% E.ON AG ................................................... Germany 355,810 23,306,273 a,b PG & E Corp., wts., 9/02/06 ............................... United States 12,976 324,192 a Reliant Resources Inc. .................................... United States 1,023,100 7,530,016 ----------------- 31,160,481 ----------------- FOOD & STAPLES RETAILING .6% a Kroger Co. ................................................ United States 1,103,700 20,429,487 a Safeway Inc. .............................................. United States 243,900 5,343,849 ----------------- 25,773,336 ----------------- FOOD PRODUCTS 2.8% Cadbury Schweppes PLC .....................................United Kingdom 2,728,621 20,039,326 Groupe Danone ............................................. France 330,430 53,932,444 Nestle SA ................................................. Switzerland 160,750 40,163,129 ----------------- 114,134,899 ----------------- HEALTH CARE EQUIPMENT & SUPPLIES .1% Amersham PLC ..............................................United Kingdom 345,100 4,729,132 ----------------- HEALTH CARE PROVIDERS & SERVICES 2.3% a AdvancePCS ................................................ United States 32,700 1,721,982 Generale De Sante ......................................... France 844,641 11,154,631 HCA Inc. .................................................. United States 275,000 11,814,000 a Health Net Inc., A ........................................ United States 74,925 2,450,048 a,d Kindred Healthcare Inc. ................................... United States 604,030 29,827,605 d Kindred Healthcare Inc., Jul. 47.50 Calls, 7/11/11 .................................................. United States 978 438,144
20 | Annual Report Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE --------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) HEALTH CARE PROVIDERS & SERVICES (CONT.) a,d Kindred Healthcare Inc., wts., Series A, 4/20/06 ....................................... United States 104,567 $ 2,431,810 a,d Kindred Healthcare Inc., wts., Series B, 4/20/06 ....................................... United States 261,416 5,476,012 a Laboratory Corp. of America Holdings ...................... United States 73,700 2,723,215 a Mid Atlantic Medical Services Inc. ........................ United States 28,200 1,827,360 a Rotech Healthcare Inc. .................................... United States 170,585 3,923,455 a Triad Hospitals Inc. ...................................... United States 570,800 18,990,516 a Wellpoint Health Networks Inc. ............................ United States 16,600 1,610,034 ----------------- 94,388,812 ----------------- HOTELS RESTAURANTS & LEISURE .8% Cara Operations Ltd. ...................................... Canada 10,300 57,308 Cara Operations Ltd., A ................................... Canada 437,600 2,397,530 a,c FHC Delaware Inc. ......................................... United States 452,571 3,561,734 a Park Place Entertainment Corp. ............................ United States 496,100 5,372,763 Prime Hospitality Corp. ................................... United States 1,883,780 19,214,556 ----------------- 30,603,891 ----------------- INSURANCE 9.5% a Alleghany Corp. ........................................... United States 135,504 30,149,640 a Berkshire Hathaway Inc., A ................................ United States 468 39,429,000 a Berkshire Hathaway Inc., B ................................ United States 2,750 7,741,250 Hartford Financial Services Group Inc. .................... United States 400,300 23,629,709 John Hancock Financial Services Inc. ...................... United States 144,400 5,415,000 a Montpelier Re Holdings Ltd. ............................... Bermuda 220,816 8,103,947 Old Republic International Corp. .......................... United States 912,000 23,128,320 a,b Olympus Re Holdings Ltd. .................................. Bermuda 97,300 15,389,941 Prudential Financial Inc. ................................. United States 614,600 25,671,842 Travelers Property Casualty Corp., A ...................... United States 1,859,990 31,210,632 White Mountains Insurance Group Inc. ...................... United States 226,990 104,404,051 b White Mountains Insurance Group Inc. ...................... United States 126,940 55,466,750 Willis Group Holdings Ltd. ................................ United States 501,400 17,082,698 ----------------- 386,822,780 ----------------- IT SERVICES .1% Comdisco Contingent Equity Distribution ................... United States 44,591,246 164,988 a Comdisco Holding Co. Inc. ................................. United States 96 3,840 a Concord EFS Inc. .......................................... United States 193,800 2,875,992 ----------------- 3,044,820 ----------------- MACHINERY .7% Kone Corp., B ............................................. Finland 461,300 26,474,710 a,b,c Lancer Industries Inc., B ................................. United States 4 2,454,083 ----------------- 28,928,793 ----------------- MEDIA 7.5% Dow Jones & Co. Inc. ...................................... United States 182,600 9,102,610 E.W. Scripps Co., A ....................................... United States 555,200 52,266,528 a EchoStar Communications Corp., A .......................... United States 358,600 12,192,400 a Fox Entertainment Group Inc., A ........................... United States 181,400 5,287,810 Gannett Co. Inc. .......................................... United States 59,100 5,269,356
Annual Report | 21 Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE --------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) MEDIA (CONT.) Lagardere SCA ............................................. France 685,401 $ 39,569,631 a Liberty Media Corp., A .................................... United States 6,148,259 73,102,800 McGraw-Hill Cos. Inc. ..................................... United States 64,900 4,537,808 Meredith Corp. ............................................ United States 505,715 24,683,949 a NTL Europe Inc. ...........................................United Kingdom 229,124 2,291 NV Holdingsmig de Telegraaf ............................... Netherlands 705,351 16,103,498 Omnicom Group Inc. ........................................ United States 102,700 8,968,791 a TVMAX Holdings Inc. ....................................... United States 64,341 160,853 Washington Post Co., B .................................... United States 66,050 52,271,970 ----------------- 303,520,295 ----------------- METALS & MINING 6.1% Anglo American PLC ........................................United Kingdom 1,054,800 22,791,278 a Ashanti Goldfields Co. Ltd., GDR, Reg S ................... Ghana 238,600 3,111,344 Barrick Gold Corp. ........................................ Canada 1,246,000 28,296,660 b Consol Energy Inc. ........................................ United States 938,100 21,867,111 Consol Energy Inc. ........................................ United States 26,800 694,120 a Eldorado Gold Corp. ....................................... Canada 2,408,200 7,547,464 a Eldorado Gold Corp., wts., 8/25/04 ........................ Canada 800,000 74,289 Falconbridge Ltd. ......................................... Canada 33,500 812,970 a Glamis Gold Ltd. .......................................... Canada 646,900 11,153,362 Gold Fields Ltd. .......................................... South Africa 483,500 6,917,491 Gold Fields Ltd., ADR ..................................... South Africa 1,100 15,334 a,b International Steel Group ................................. United States 2,855,428 94,536,082 Newmont Mining Corp. ...................................... United States 658,500 32,009,685 Noranda Inc. .............................................. Canada 258,200 4,106,024 Pechiney SA, A ............................................ France 5,100 311,995 Placer Dome Inc. .......................................... Canada 378,100 6,779,321 a Randgold & Exploration Co. Ltd., ADR ...................... South Africa 25,000 409,975 a Wheaton River Minerals Ltd. ............................... Canada 1,871,125 5,603,601 Wheaton River Minerals Ltd., wts., 5/30/07 ................ Canada 777,331 1,389,542 ----------------- 248,427,648 ----------------- MULTI-UTILITIES & UNREGULATED POWER .6% Suez SA ................................................... France 1,198,268 24,077,206 ----------------- OIL & GAS 2.5% BP PLC ....................................................United Kingdom 1,221,600 9,906,461 BP PLC, ADR ...............................................United Kingdom 193,700 9,559,095 Eni SpA ................................................... Italy 1,452,100 27,400,878 Occidental Petroleum Corp. ................................ United States 83,800 3,539,712 Royal Dutch Petroleum Co., N.Y. shs. ...................... Netherlands 314,800 16,492,372 a,c Southwest Royalties Inc., A ............................... United States 58,923 1,767,705 Suncor Energy Inc. ........................................ Canada 30,900 777,133 Total SA, B ............................................... France 166,368 30,931,689 ----------------- 100,375,045 ----------------- PAPER & FOREST PRODUCTS .7% Abitibi-Consolidated Inc. ................................. Canada 3,361,600 26,976,043 ----------------- PERSONAL PRODUCTS .4% Beiersdorf AG ............................................. Germany 142,900 17,511,018 -----------------
22 | Annual Report Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE --------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) PHARMACEUTICALS 1.6% Merck & Co. Inc. .......................................... United States 351,200 $ 16,225,440 Takeda Chemical Industries Ltd. ........................... Japan 606,500 24,051,740 Valeant Pharmaceuticals International ..................... United States 801,600 20,160,240 Wyeth ..................................................... United States 140,800 5,976,960 ----------------- 66,414,380 ----------------- REAL ESTATE 2.8% a Alexander's Inc. .......................................... United States 108,590 13,536,830 American Financial Realty Trust ........................... United States 137,900 2,351,195 a Canary Wharf Group PLC ....................................United Kingdom 8,298,072 39,773,881 Friedman Billings Ramsey Group Inc., A .................... United States 1,401,500 32,346,620 a,b Security Capital European Realty .......................... Luxembourg 140,834 1,049,213 Ventas Inc. ............................................... United States 1,110,125 24,422,750 ----------------- 113,480,489 ----------------- ROAD & RAIL 1.9% Canadian National Railway Co. ............................. Canada 313,200 19,874,173 Florida East Coast Industries Inc., A ..................... United States 1,260,100 41,709,310 Norfolk Southern Corp. .................................... United States 665,300 15,734,345 ----------------- 77,317,828 ----------------- SEMICONDUCTORS & SEMICONDUCTOR EQUIPMENT .2% Lattice Semiconductor Corp. ............................... United States 932,086 9,022,592 ----------------- SPECIALTY RETAIL .1% New Look Group ............................................United Kingdom 291,100 1,620,667 ----------------- THRIFTS & MORTGAGE FINANCE 5.9% Astoria Financial Corp. ................................... United States 358,700 13,343,640 Brookline Bancorp Inc. .................................... United States 991,000 15,201,940 Commercial Federal Corp. .................................. United States 713,910 19,068,536 a Franklin Bank Corp., 144A ................................. United States 724,979 13,774,601 Freddie Mac ............................................... United States 455,400 26,558,928 Greenpoint Financial Corp. ................................ United States 213,060 7,525,279 Hudson City Bancorp Inc. .................................. United States 378,300 14,443,494 a,c Saxon Capital Inc. ........................................ United States 1,996,385 41,824,266 Sovereign Bancorp Inc. .................................... United States 3,735,520 88,718,600 ----------------- 240,459,284 ----------------- TOBACCO 4.7% Altadis SA ................................................ Spain 2,467,900 70,040,048 Altria Group Inc. ......................................... United States 419,100 22,807,422 British American Tobacco PLC ..............................United Kingdom 3,221,620 44,407,501 Gallaher Group PLC ........................................United Kingdom 1,488,514 15,988,049 Gallaher Group PLC, ADR ...................................United Kingdom 16,650 708,291 Korea Tobacco & Ginseng Corp., GDR, 144A .................. South Korea 1,257,000 11,036,460 R.J. Reynolds Tobacco Holdings Inc. ....................... United States 460,000 26,749,000 ----------------- 191,736,771 ----------------- TRANSPORTATION INFRASTRUCTURE .3% a Laidlaw International Inc. ................................ United States 782,509 10,822,096 ----------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $1,886,641,609) 2,882,249,409 -----------------
Annual Report | 23 Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE --------------------------------------------------------------------------------------------------------------------------- PREFERRED STOCKS .2% ELECTRIC UTILITIES a Montana Power Co., 8.45%, pfd. ........................... United States 46,450 $ 557,400 ----------------- FOOD PRODUCTS .1% Unilever NV, pfd. ........................................ Netherlands 484,300 3,475,867 ----------------- MEDIA .1% News Corp. Ltd., ADR, pfd. ............................... Australia 53,000 1,603,250 NTL Europe Inc., 10.00%, A, pfd. ......................... United Kingdom 100,846 829,458 ----------------- TOTAL PREFERRED STOCKS (COST $5,396,053) ................. 6,465,975 ----------------- PRINCIPAL AMOUNT E CORPORATE BONDS & NOTES 4.3% Calpine Constructor Finance, First Priority Term Loan, 8/26/09 ....................... United States $ 3,903,000 $ 4,098,150 8.50%, 8/26/11 .......................................... United States 4,748,000 4,937,920 Calpine Corp., 144A, 9.875%, 12/01/11 ..................... United States 9,614,000 9,926,455 Charter Communications Operating LLC, Bank Claim .............................................. United States 7,131,600 6,881,994 DecisionOne Corp., Term Loan .............................. United States 7,437,580 5,206,306 Eurotunnel PLC, 12/31/18, Tier 2 ........................................United Kingdom 10,005,715 GBP 13,075,620 12/31/25, Tier 3 ........................................United Kingdom 8,208,908 GBP 8,082,382 Participating Loan Note, 4/30/40 ........................United Kingdom 1,020,000 GBP 392,582 Stabilization Advance S8, Tier 2 ........................United Kingdom 4,694,964 GBP 1,596,898 Eurotunnel SA, 5.28%, 12/31/18, Tier 2 (Pibor) .......................... France 1,096,535 EUR 1,009,675 5.28%, 12/31/25, Tier 3 (Pibor) .......................... France 2,898,202 EUR 2,010,609 12/31/18, Tier 2 (Libor) ................................. France 2,479,106 EUR 2,282,729 12/31/25, Tier 3 (Libor) ................................. France 19,287,827 EUR 13,380,808 Stabilization Advance S6, Tier 1 (Pibor) ................. France 643,780 EUR 154,286 Stabilization Advance S6, Tier 2 (Libor) ................. France 1,936,575 EUR 464,114 Stabilization Advance S7, Tier 1 (Pibor) ................. France 2,341,771 EUR 561,222 b FE Capital LLC, 5.00%, 8/28/07 ............................. Japan 31,114,000 31,736,280 Healthsouth Corp., 8.50%, 2/01/08 ...........................................United States 5,195,000 5,013,175 7.00%, 6/15/08 ...........................................United States 2,775,000 2,601,563 8.375%, 10/01/11 .........................................United States 1,680,000 1,596,000 7.625%, 6/01/12 ..........................................United States 13,466,000 12,658,040 cvt., 3.25% ..............................................United States 8,568,000 8,310,960 Marconi Corp., 10.00%, 10/31/08 ...........................United Kingdom 1,409,541 1,564,590 Marconi PLC, 8.00%, 4/30/08 ...............................United Kingdom 6,970,347 6,830,940 Mirant Mid-Atlantic LLC, 8.625%, 6/30/12 ..........................................United States 2,806,700 2,822,487 9.125%, 6/30/17 ..........................................United States 1,458,080 1,458,992 10.06%, 12/30/28 .........................................United States 2,981,341 3,013,018 Providian Financial Corp., cvt., zero cpn., 2/15/21 ................................................. United States 14,270,000 6,813,925 Seton House Finance Ltd., zero cpn., 2/07/12 ..............United Kingdom 37,921,000 EUR 11,001,299
24 | Annual Report Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- COUNTRY PRINCIPAL AMOUNT E VALUE --------------------------------------------------------------------------------------------------------------------------- CORPORATE BONDS & NOTES (CONT.) Teco Panda, Bank Claim #2 ................................................ United States $ 6,731,600 $ 4,813,094 Project L/C Loan Facility .................................... United States 965,000 689,975 Debt Service Reserve L/C Loan ................................ United States 386,000 275,990 TVMAX Holdings Inc., PIK, 14.00%, 2/01/06 ..................... United States 296,784 296,784 ----------------- TOTAL CORPORATE BONDS & NOTES (COST $154,418,850) ............. 175,558,862 ----------------- Bonds & Notes in Reorganization 7.3% a Adelphia Communications Corp., 9.25%, 10/01/02 .............................................. United States 2,652,000 2,466,360 8.125%, 7/15/03 .............................................. United States 660,000 613,800 7.50%, 1/15/04 ............................................... United States 1,740,000 1,609,500 10.50%, 7/15/04 .............................................. United States 2,715,000 2,565,675 10.25%, 11/01/06 ............................................. United States 4,172,000 3,900,820 8.375%, 2/01/08 .............................................. United States 5,350,000 5,015,625 7.75%, 1/15/09 ............................................... United States 4,637,000 4,335,595 7.875%, 5/01/09 .............................................. United States 3,201,000 2,944,920 9.375%, 11/15/09 ............................................. United States 1,895,000 1,800,250 10.25%, 6/15/11 .............................................. United States 5,380,000 5,111,000 a AES Drax Holdings Ltd., 10.41%, 12/31/20 .............................................Cayman Islands 11,605,000 10,212,400 9.07%, 12/31/25 ..............................................Cayman Islands 5,060,000 GBP 7,835,341 a Aiken Cnty S C Indl Rev Beloit, 6.00%, 12/01/11 ............... United States 375,000 1,875 a Air Canada Inc., 6.75%, 2/02/04 ............................................... Canada 980,000 CAD 276,804 9.00%, 6/01/06 ............................................... Canada 1,715,000 CAD 491,043 10.00%, 6/01/06 .............................................. Canada 3,960,000 EUR 2,122,856 7.25%, 10/01/07 .............................................. Canada 3,010,000 CAD 821,068 10.25%, 3/15/11 .............................................. Canada 8,570,000 3,492,275 Bank Claim ................................................... Canada 10,137,100 CAD 2,824,032 Bank Claim ................................................... Canada 195,739,000 JPY 694,045 Term Loan .................................................... Canada 7,048,600 2,607,982 zero cpn., 7/31/05 ........................................... Canada 7,727,292 2,975,007 a Century Communications Corp., 9.50%, 3/01/05 ............................................... United States 340,000 329,800 8.875%, 1/15/07 .............................................. United States 260,000 253,500 8.375%, 12/15/07 ............................................. United States 400,000 391,000 zero cpn., 3/15/03 ........................................... United States 4,990,000 4,441,100 a Dow Corning Corp., 9.30%, 1/27/98 ............................................... United States 1,835,000 4,000,300 8.55%, 3/01/01 ............................................... United States 1,000,000 1,850,000 9.375%, 2/01/08 .............................................. United States 735,000 1,602,300 8.15%, 10/15/29 .............................................. United States 5,150,000 9,785,000 Bank Claim ................................................... United States 7,437,830 13,388,095 Bank Debt .................................................... United States 1,801,364 3,242,455 Bank Debt #1 ................................................. United States 2,850,000 5,130,000 a Harnischfeger Industries Inc., 8.90%, 3/01/22 ............................................... United States 3,155,000 17,668 8.70%, 6/15/22 ............................................... United States 2,970,000 16,929 7.25%, 12/15/25 .............................................. United States 4,414,000 25,160 6.875%, 2/15/27 .............................................. United States 3,705,000 20,748 Stipulated Bank Claim ........................................ United States 4,766,550 26,216
Annual Report | 25 Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- COUNTRY PRINCIPAL AMOUNT E VALUE --------------------------------------------------------------------------------------------------------------------------- BONDS & NOTES IN REORGANIZATION (CONT.) a Metromedia Fiber Network Inc., 14.00%, 3/15/07 .............................................. United States $ 19,250,000 $ 10,202,500 10.00%, 11/15/08 ............................................. United States 12,495,000 859,031 senior note, 10.00%, 12/15/09 ................................ United States 12,775,000 910,219 senior note, 10.00%, 12/15/09 ................................ United States 5,910,000 EUR 559,094 a Mirant Corp., Tranche C Revolver ........................................... United States 5,589,776 3,465,661 4 Year Revolver, 7/17/05 ..................................... United States 4,605,795 3,592,520 364 Day Revolver ............................................. United States 7,998,500 4,719,115 a Northwestern Corp., 8.75%, 3/15/12 ............................................... United States 6,125,000 5,558,437 6.95%, 11/15/28 .............................................. United States 3,175,000 2,845,594 a NRG Energy Inc., 7.625%, 2/01/06 .............................................. United States 4,475,000 2,528,375 6.75%, 7/15/06 ............................................... United States 7,985,000 4,511,525 7.50%, 6/15/07 ............................................... United States 4,615,000 2,630,550 7.50%, 6/01/09 ............................................... United States 4,045,000 2,305,650 8.25%, 9/15/10 ............................................... United States 5,395,000 3,156,075 7.75%, 4/01/11 ............................................... United States 550,000 316,250 8.00%, 11/01/13 .............................................. United States 5,583,000 3,210,225 8.70%, 3/15/20 ............................................... United States 2,750,000 1,595,000 8.625%, 4/01/31 .............................................. United States 4,015,000 2,348,775 Revolver ..................................................... United States 17,547,948 10,879,728 a Owens Corning, Revolver ....................................... United States 21,847,586 16,385,690 a Parmalat Netherlands BV, 0.875%, 6/30/21 ...................... Italy 2,880,000 EUR 911,625 PG & E Corp., 7.375%, 11/01/05 ............................................. United States 17,404,000 17,752,080 Commercial Paper, 1/18/01 .................................... United States 695,000 698,475 Commercial Paper, 1/30/01 .................................... United States 350,000 351,750 Commercial Paper, 2/16/01 .................................... United States 1,050,000 1,055,250 FRN, 144A, 7.583%, 10/31/01 .................................. United States 5,784,000 5,899,680 MTN, 5.94%, 10/07/03 ......................................... United States 875,000 879,375 a Port Seattle Wash Rev Ref-Beloit Proj., 6.00%, 12/01/17 ............................................. United States 200,000 1,000 a Safety Kleen Corp., 9.25%, 5/15/09 ............................ United States 535,000 26,750 a Safety Kleen Services, 9.25%, 6/01/08 ......................... United States 40,000 200 a Telewest Communications PLC, 11.00%, 10/01/07 .............................................United Kingdom 6,636,000 4,346,580 11.25%, 11/01/08 .............................................United Kingdom 1,020,000 660,450 9.875%, 2/01/10 ..............................................United Kingdom 2,075,000 GBP 2,191,601 Bank Claim ...................................................United Kingdom 24,998,146 GBP 21,256,547 cvt., 5.25%, 2/19/07 .........................................United Kingdom 6,230,000 GBP 5,910,922 senior disc. note, zero cpn., 4/15/09 ........................United Kingdom 2,630,000 1,380,750 senior disc. note, zero cpn., 2/01/10 ........................United Kingdom 2,010,000 994,950 zero cpn., 4/15/04 ...........................................United Kingdom 7,960,000 GBP 7,124,828 a Telewest Finance Ltd., cvt, 6.00%, 7/07/05 ....................United Kingdom 5,795,000 6,142,700 a WorldCom Inc., 7.875%, 5/15/03 .............................................. United States 5,860,000 1,977,750 6.25%, 8/15/03 ............................................... United States 700,000 236,250 6.50%, 5/15/04 ............................................... United States 875,000 295,312
26 | Annual Report Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- COUNTRY PRINCIPAL AMOUNT E VALUE --------------------------------------------------------------------------------------------------------------------------- BONDS & NOTES IN REORGANIZATION (CONT.) a WorldCom Inc., (cont.) 6.40%, 8/15/05 ............................................... United States $ 7,310,000 $ 2,467,125 7.375%, 1/15/06 .............................................. United States 1,550,000 523,125 8.00%, 5/15/06 ............................................... United States 2,425,000 818,437 7.75%, 4/01/07 ............................................... United States 3,915,000 1,321,312 8.25%, 5/15/10 ............................................... United States 7,227,000 2,439,112 7.375%, 1/15/11 .............................................. United States 15,910,000 5,369,625 7.50%, 5/15/11 ............................................... United States 14,790,000 4,991,625 7.75%, 4/01/27 ............................................... United States 1,335,000 450,563 6.95%, 8/15/28 ............................................... United States 360,000 121,500 8.25%, 5/15/31 ............................................... United States 18,200,000 6,142,500 ----------------- TOTAL BONDS & NOTES IN REORGANIZATION (COST $224,303,989) ..... 296,558,307 ----------------- SHARES/ PRINCIPAL AMOUNT E COMPANIES IN LIQUIDATION .1% a Brunos Inc., Liquidating Unit ................................. United States 55,433 121,953 a City Investing Company Liquidating Trust ...................... United States 1,607,485 3,351,606 a Guangdong International Trust & Investment Corp., 144A, 8.75%, 10/24/16 ........................................ China 2,600,000 162,500 Revolver - Admitted Claim .................................... Hong Kong 536,784 33,549 Structured Note - Admitted Claim ............................. Hong Kong 849,105 53,069 Syndicated Loan - Admitted Claim ............................. Hong Kong 1,468,105 91,757 a,c MBOP Liquidating Trust ........................................ United States 412,418 1,031 ----------------- TOTAL COMPANIES IN LIQUIDATION (COST $473,453) 3,815,465 ----------------- PRINCIPAL AMOUNT E GOVERNMENT AGENCIES 18.5% Canada Treasury Bill, 3.353%, 2/26/04 ........................ Canada 13,400,000 CAD 10,326,822 f Federal Home Loan Bank, 0.75% to 2.51%, with maturities to 7/02/07 ....................................... United States 423,108,000 420,867,387 f Federal Home Loan Mortgage Corp., 1.172% to 2.500%, with maturities to 5/19/06 .................................. United States 95,000,000 94,832,130 Federal National Mortgage Association, 0.966% to 2.200%, with maturities to 12/29/06 ................................. United States 202,350,000 201,745,560 U.S. Treasury Bills, 0.934% to 1.035%, with maturities to 5/06/04 .................................. United States 26,000,000 25,946,680 ----------------- TOTAL GOVERNMENT AGENCIES (COST $752,741,440) ................ 753,718,579 ----------------- TOTAL INVESTMENTS BEFORE REPURCHASE AGREEMENTS (COST $3,023,975,394) ........................................ 4,118,366,597 ----------------- REPURCHASE AGREEMENTS 0.2% i,j Citigroup Global Markets Inc., 0.96%, 1/02/04 (Maturity Value $646,051) ................................... 646,017 646,017 Collateralized by U.S. Treasury Bills, Notes and Bonds i,j Deutsche Bank Securities Inc., 1.00%, 1/02/04 (Maturity Value $1,000,083) ................................. 1,000,028 1,000,028 Collateralized by U.S. Treasury Bills, Notes and Bonds
Annual Report | 27 Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
COUNTRY PRINCIPAL AMOUNT E VALUE REPURCHASE AGREEMENTS (CONT.) i,j Deutsche Bank Securities Inc., 1.03%, 1/02/04 (Maturity Value $900,077) Collateralized by U.S. Treasury Bills, Notes and Bonds ..... $ 900,026 $ 900,026 i,j Goldman Sachs & Co., 1.02%, 1/02/04 (Maturity Value $1,014,086) Collateralized by U.S. Treasury Bills, Notes and Bonds ..... 1,014,029 1,014,029 i,j JP Morgan Securities, 1.01%, 1/02/04 (Maturity Value $1,000,083) Collateralized by U.S. Treasury Bills, Notes and Bonds ..... 1,000,028 1,000,028 i,j Merrill Lynch GSI, 1.00%, 1/02/04 (Maturity Value $1,000,083) Collateralized by U.S. Treasury Bills, Notes and Bonds ..... 1,000,028 1,000,028 i,j Morgan Stanley & Co., 1.03%, 1/02/04 (Maturity Value $1,000,085) Collateralized by U.S. Treasury Bills, Notes and Bonds ..... 1,000,029 1,000,029 i,j UBS Securities LLC, 1.00%, 1/02/04 (Maturity Value $1,000,083) Collateralized by U.S. Treasury Bills, Notes and Bonds ..... 1,000,028 1,000,028 i,j Citigroup Global Markets Inc., 0.96%, 1/02/04 (Maturity Value $222,018) Collateralized by U.S. Treasury Bills, Notes and Bonds ..... 222,006 222,006 ----------------- TOTAL REPURCHASE AGREEMENTS (COST $7,782,219) .............. 7,782,219 ----------------- TOTAL INVESTMENTS (COST $3,031,757,613) 101.5% ............. 4,126,148,816 OPTIONS WRITTEN ............................................ (5,832) SECURITIES SOLD SHORT (0.9)% ............................... (35,626,231) NET EQUITY IN FORWARD CONTRACTS (1.1)% ..................... (45,450,165) Other Assets, less Liabilities .5% ......................... 21,955,745 ----------------- NET ASSETS 100.0% .......................................... $ 4,067,022,333 ----------------- OPTIONS WRITTEN CONTRACTS ISSUER DIVERSIFIED TELECOMMUNICATION SERVICES XO Communications Inc., Jun. 4.25 Calls, 6/21/04 ........United States 1,081,175 -- ----------------- FOOD & STAPLES RETAILING Safeway PLC, Jan. 2.70 Puts, 1/16/04 ...................United Kingdom 1,810 5,832 ----------------- TOTAL OPTIONS WRITTEN (PREMIUMS RECEIVED $287,942) ..... 5,832 ----------------- SECURITIES SOLD SHORT SHARES ISSUER CAPITAL MARKETS g Lehman Brothers Holdings Inc. .......................... United States 8,770 677,219 ----------------- COMMERCIAL BANKS 0.2% g Bank of America Corp. .................................. United States 93,100 7,488,033 ----------------- FOOD PRODUCTS 0.2% g Kraft Foods Inc., A .................................... United States 270,400 8,712,288 -----------------
28 | Annual Report Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
COUNTRY SHARES VALUE SECURITIES SOLD SHORT (CONT.) HEALTH CARE PROVIDERS & SERVICES 0.1% g Anthem Inc. ........................................... United States 16,600 $ 1,245,000 g Caremark RX Inc. ...................................... United States 70,100 1,775,633 g United Health Group Inc. .............................. United States 23,000 1,338,140 ----------------- 4,358,773 ----------------- INSURANCE 0.1% g Manulife Financial Corp. .............................. Canada 171,100 5,526,530 ----------------- INTERNET SOFTWARE & SERVICES g Yahoo! Inc. ........................................... United States 18,993 857,914 ----------------- IT SERVICES 0.1% g First Data Corp. ...................................... United States 56,140 2,306,793 ----------------- MEDIA 0.1% g News Corp. Ltd., ADR .................................. Australia 43,300 1,563,130 ----------------- METALS & MINING 0.1% g Alcan Inc. ............................................ Canada 4,611 216,486 g AngloGold Ltd., ADR ................................... South Africa 69,200 3,231,640 g Randgold Resources Ltd., ADR .......................... United Kingdom 14,715 401,720 ----------------- 3,849,846 ----------------- PHARMACEUTICALS g Teva Pharmaceutical Industries Ltd., ADR .............. Israel 5,038 285,705 ----------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $35,228,117) .... $ 35,626,231 ----------------- VALUE AT UNREALIZED SYNTHETIC EQUITY SWAPS (SES) COUNTRY SHARES 12/31/03 GAIN/LOSS ISSUER HEALTH CARE EQUIPMENT & SUPPLIES h Smith & Nephew PLC, ses., 3.752 GBP ................... United Kingdom 939 $ (7,888) $ (1,592) h Smith & Nephew PLC, ses., 3.776 GBP ................... United Kingdom 16,600 (139,445) (27,444) ------------------------------ (147,333) (29,036) ------------------------------ INSURANCE h AXA SA, ses., 15.850 EUR .............................. France 14,363 307,442 19,725 h AXA SA, ses., 15.870 EUR .............................. France 3,500 74,918 4,718 h AXA SA, ses., 16.030 EUR .............................. France 25,393 543,541 29,093 h AXA SA, ses., 16.700 EUR .............................. France 14,363 (307,442) (5,487) h AXA SA, ses., 16.770 EUR .............................. France 3,500 (74,918) (1,029) h AXA SA, ses., 17.000 EUR .............................. France 25,393 (543,541) 853 ------------------------------ -- 47,874 ------------------------------ REAL ESTATE h Chelsfield PLC, ses., 3.095 GBP ....................... United Kingdom 4,500 24,751 (218) h Chelsfield PLC, ses., 3.107 GBP ....................... United Kingdom 13,900 76,454 (983) h Chelsfield PLC, ses., 3.112 GBP ....................... United Kingdom 10,032 55,179 (858) h Chelsfield PLC, ses., 3.154 GBP ....................... United Kingdom 149,700 823,389 (23,017) h Chelsfield PLC, ses., 3.160 GBP ....................... United Kingdom 51,000 280,513 (8,397) h Chelsfield PLC, ses., 3.165 GBP ....................... United Kingdom 22,400 123,206 (3,886) h Chelsfield PLC, ses., 3.166 GBP ....................... United Kingdom 74,800 411,419 (13,109) ------------------------------ 1,794,911 (50,468) ------------------------------
Annual Report | 29 Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
VALUE AT UNREALIZED COUNTRY SHARES 12/31/03 GAIN/LOSS SYNTHETIC EQUITY SWAPS (SES) (CONT.) TEXTILES APPAREL & LUXURY GOODS h Christian Dior SA, ses., 46.766 EUR ...................... France 3,746 $ 226,943 $ 5,564 h Christian Dior SA, ses., 47.220 EUR ...................... France 2,797 169,450 2,531 h Christian Dior SA, ses., 47.384 EUR ...................... France 7,453 451,523 5,455 h Christian Dior SA, ses., 47.614 EUR ...................... France 7,453 451,523 3,078 h Christian Dior SA, ses., 47.794 EUR ...................... France 3,371 204,224 605 h Christian Dior SA, ses., 48.208 EUR ...................... France 7,263 440,012 (2,454) h Christian Dior SA, ses., 48.555 EUR ...................... France 4,454 269,836 (3,456) h Christian Dior SA, ses., 48.586 EUR ...................... France 7,443 450,917 (6,052) h Christian Dior SA, ses., 48.791 EUR ...................... France 2,971 179,991 (3,190) h Christian Dior SA, ses., 49.000 EUR ...................... France 198 11,995 (264) h Christian Dior SA, ses., 49.027 EUR ...................... France 1,102 66,762 (1,511) h LVMH Moet Hennessy Louis Vuitton, ses., 56.520 EUR ....... France 2,797 (203,566) (4,554) h LVMH Moet Hennessy Louis Vuitton, ses., 57.050 EUR ....... France 3,371 (245,341) (3,239) h LVMH Moet Hennessy Louis Vuitton, ses., 58.672 EUR ....... France 7,453 (542,429) 8,367 h LVMH Moet Hennessy Louis Vuitton, ses., 58.861 EUR ....... France 3,746 (272,634) 4,972 h LVMH Moet Hennessy Louis Vuitton, ses., 58.899 EUR ....... France 7,453 (542,429) 10,251 h LVMH Moet Hennessy Louis Vuitton, ses., 59.841 EUR ....... France 7,263 (528,601) 18,596 h LVMH Moet Hennessy Louis Vuitton, ses., 60.149 EUR ....... France 4,454 (324,162) 13,126 h LVMH Moet Hennessy Louis Vuitton, ses., 60.309 EUR ....... France 2,971 (216,229) 9,358 h LVMH Moet Hennessy Louis Vuitton, ses., 60.421 EUR ....... France 7,443 (541,702) 24,511 h LVMH Moet Hennessy Louis Vuitton, ses., 60.949 EUR ....... France 1,102 (80,204) 4,363 h LVMH Moet Hennessy Louis Vuitton, ses., 60.950 EUR ....... France 198 (14,410) 784 ------------------------------- (588,531) 86,841 ------------------------------- TOTAL SYNTHETIC EQUITY SWAPS ............................. $1,059,047 $ 55,211 ------------------------------- CURRENCY ABBREVIATIONS: | CAD - Canadian Dollar | EUR - Euro | GBP - British Pound | JPY - Japanese Yen
aNon-income producing. bSee Note 7 regarding restricted securities. cSee Note 8 regarding Holdings of 5% Voting Securities. dA member of the Fund's Portfolio Management team serves as a member on the board of directors. As a result of this involvement, the Portfolio Manager could receive material non-public information which, pursuant to the Fund's policies and the requirements of the federal securities laws, could prevent the Fund from trading in the securities of such companies for limited or extended periods of time. eThe principal amount is stated in U.S. dollars unless otherwise indicated. fSee Note 1(h) regarding securities segregated with broker for securities sold short. gSee Note 1(h) regarding securities sold short. hSee Note 1(f) regarding synthetic equity swaps. iCollateral for loaned securities. See Note 1(i). jSee Note 1(c) regarding repurchase agreements. 30 | See notes to financial statements. | Annual Report Mutual Qualified Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2003
Assets: Investments in securities: Cost - Unaffiliated issuers ............................................................................ $2,949,676,263 Cost - Non-controlled affiliated issuers ............................................................... 82,081,350 --------------- Value - Unaffiliated issuers (includes securities segregated with broker for securities sold short in the amount of $33,084,586) ................................................... 4,011,046,439 Value - Non-controlled affiliated issuers .............................................................. 115,102,377 Cash .................................................................................................... 5,008,698 Foreign currency, at value (cost $4,167,650) ............................................................ 4,303,967 Receivables: Investment securities sold ............................................................................. 4,308,817 Capital shares sold .................................................................................... 2,262,901 Dividends and interest ................................................................................. 8,432,190 Unrealized gain on forward exchange contracts (Note 6) .................................................. 485,751 Deposits with broker for securities sold short .......................................................... 42,838,021 Due from broker - Variation margin (Note 1f) ............................................................ 409,479 --------------- Total assets ....................................................................................... 4,194,198,640 --------------- Liabilities: Payables: Investment securities purchased ........................................................................ 26,193,170 Capital shares redeemed ................................................................................ 7,697,792 Affiliates ............................................................................................. 3,587,473 Options written, at value (premiums received $287,942) .................................................. 5,832 Securities sold short, at value (proceeds $35,228,117) .................................................. 35,626,231 Distributions to shareholders ........................................................................... 635 Payable upon return of securites loaned (Note 1i) ....................................................... 7,782,219 Unrealized loss on forward exchange contracts (Note 6) .................................................. 45,935,916 Other liabilities ....................................................................................... 347,039 --------------- Total liabilities ................................................................................. 127,176,307 --------------- Net assets, at value ............................................................................ $4,067,022,333 --------------- Net assets consist of: Accumulated distributions in excess of net investment income ............................................ $ (8,675,118) Net unrealized appreciation (depreciation) .............................................................. 1,049,134,295 Accumulated net realized gain (loss) .................................................................... 27,131,474 Capital shares .......................................................................................... 2,999,431,682 --------------- Net assets, at value ............................................................................ $4,067,022,333 ---------------
Annual Report | 31 Mutual Qualified Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2003
CLASS Z: Net asset value and maximum offering price per share ($3,102,506,049 (/) 173,552,619 shares outstanding) ..... $17.88 -------------------- CLASS A: Net asset value per share ($625,087,961 (/) 35,094,805 shares outstanding) ................................... $17.81 -------------------- Maximum offering price per share ($17.81 (/) 94.25%) ......................................................... $18.90 -------------------- CLASS B: Net asset value and maximum offering price per share ($53,760,212 (/) 3,064,245 shares outstanding) a ........ $17.54 -------------------- CLASS C: Net asset value per share ($285,668,111 (/) 16,123,487 shares outstanding) a ................................. $17.72 -------------------- Maximum offering price per share ($17.72 (/) 99.00%) ......................................................... $17.90 --------------------
aRedemption price is equal to net asset value less any applicable contingent deferred sales charge. 32 | See notes to financial statements. | Annual Report Mutual Qualified Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2003
Investment income: (net of foreign taxes of $1,395,974) Dividends: Unaffiliated issuers ..................................................................................... $ 33,292,387 Interest: Unaffiliated issuers ..................................................................................... 42,719,148 Non-controlled affiliated issuers (Note 8) ............................................................... 446,046 ------------- Total investment income .............................................................................. 76,457,581 ------------- Expenses: Management fees (Note 3) .................................................................................. 20,928,791 Administrative fees (Note 3) .............................................................................. 2,723,331 Distribution fees (Note 3) Class A .................................................................................................. 1,795,700 Class B .................................................................................................. 422,417 Class C .................................................................................................. 2,434,800 Transfer agent fees (Note 3) .............................................................................. 4,056,000 Custodian fees ............................................................................................ 297,900 Reports to shareholders ................................................................................... 224,000 Registration and filing fees .............................................................................. 91,800 Professional fees ......................................................................................... 49,057 Directors' fees and expenses .............................................................................. 143,500 Dividends on securities sold short ........................................................................ 1,157,153 Other ..................................................................................................... 59,000 ------------- Total expenses ....................................................................................... 34,383,449 ------------- Net investment income .............................................................................. 42,074,132 ------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments: Unaffiliated issuers .................................................................................... 133,678,455 Non-controlled affiliated issuers (Note 8) .............................................................. 16,859,771 Written options (Note 1g) ................................................................................ 649,690 Securities sold short (Note 1h) .......................................................................... (971,494) Foreign currency transactions ............................................................................ (93,097,603) ------------- Net realized gain (loss) ............................................................................. 57,118,819 ------------- Net unrealized appreciation (depreciation) on: Investments .............................................................................................. 868,334,717 Translation of assets and liabilities denominated in foreign currencies .................................. (11,460,723) ------------- Net unrealized appreciation (depreciation) ........................................................... 856,873,994 ------------- Net realized and unrealized gain (loss) .................................................................... 913,992,813 ------------- Net increase (decrease) in net assets resulting from operations ............................................ $953,066,945 -------------
Annual Report | See notes to financial statements. | 33 Mutual Qualified Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS for the years ended December 31, 2003 and 2002
2003 2002 Increase (decrease) in net assets: Operations: Net investment income ............................................................ $ 42,074,132 $ 60,429,773 Net realized gain (loss) from investments, written options, securities sold short, and foreign currency transactions ................................... 57,118,819 (10,759,022) Net unrealized appreciation (depreciation) on investments and translation of assets and liabilities denominated in foreign currencies ..................... 856,873,994 (538,526,066) ------------------------------------ Net increase (decrease) in net assets resulting from operations ............... 956,066,945 (488,855,315) Distributions to shareholders from: Net investment income: Class Z ......................................................................... (54,241,957) (46,691,663) Class A ......................................................................... (8,988,249) (6,751,499) Class B ......................................................................... (500,084) (343,981) Class C ......................................................................... (2,603,368) (1,813,765) Net realized gains: Class Z ......................................................................... -- (39,417,856) Class A ......................................................................... -- (6,936,156) Class B ......................................................................... -- (480,128) Class C ......................................................................... -- (3,555,739) ------------------------------------ Total distributions to shareholders ............................................... (66,333,658) (105,990,787) Capital share transactions (Note 2): Class Z .......................................................................... (86,032,129) (55,365,427) Class A .......................................................................... 43,560,544 50,629,003 Class B .......................................................................... 6,775,812 21,702,680 Class C .......................................................................... (1,788,598) 15,793,182 ------------------------------------ Total capital share transactions .................................................. (37,484,371) 32,759,438 Net increase (decrease) in net assets ......................................... 852,248,916 (562,086,664) Net assets: Beginning of year ................................................................. 3,214,773,417 3,776,860,081 ------------------------------------ End of year ....................................................................... $4,067,022,333 $3,214,773,417 ------------------------------------ Accumulated distributions in excess of net investment income included in net assets: End of year ....................................................................... $ (8,675,118) $ 9,817,090 ------------------------------------
34 | See notes to financial statements. | Annual Report Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Mutual Qualified Fund (the Fund) is a separate, diversified series of Franklin Mutual Series Fund, Inc. (the Series Fund), which is an open-end investment company registered under the Investment Company Act of 1940. The Fund seeks long-term capital appreciation, with income as a secondary objective, by investing primarily in common and preferred stocks, bonds, and convertible securities. The Fund may also invest in foreign securities. 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 last 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. Investments in open-end mutual funds are valued at the closing net asset value. Foreign securities are valued at the close of trading of the foreign exchange or the NYSE, whichever is earlier. If events occur that materially affect the values of securities after the prices or foreign exchange rates are determined, or if market quotations are not readily available, the securities will be valued at fair value as determined following procedures approved by the Board of Directors. 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, 2003, all repurchase agreements held by the Fund had been entered into on that date. Annual Report | 35 Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) D. SECURITIES PURCHASED ON A WHEN-ISSUED OR DELAYED BASIS The Fund may purchase securities on a when-issued or delayed delivery basis, with payment and delivery scheduled for a future date. These transactions are subject to market fluctuations and are subject to the risk that the value at delivery may be more or less than the trade date purchase price. Although the Fund will generally purchase these securities with the intention of holding the securities, it may sell the securities before the settlement date. Sufficient assets have been segregated for these securities. E. FOREIGN CURRENCY CONTRACTS The Fund may enter into forward exchange contracts to hedge against fluctuations in foreign exchange rates. A forward exchange contract is an agreement between two parties to exchange different currencies at an agreed upon exchange rate at a future date. These contracts are valued daily and the Fund's equity therein is included in the Statement of Assets and Liabilities. Realized and unrealized gains and losses are included in the Statement of Operations. When the Fund purchases or sells foreign securities it may enter into foreign exchange contracts to minimize foreign exchange risk from the trade date to the settlement date of the transactions. Realized and unrealized gains and losses are included in the Statement of Operations. The risks of these contracts include movement in the values of the foreign currencies relative to the U.S. dollar and the possible inability of the counterparties to fulfill their obligations under the contracts. F. SYNTHETIC EQUITY SWAPS The Fund may engage in synthetic equity swaps. Synthetic equity swaps are contracts entered into between a broker and the Fund under which the parties agree to make payments to each other so as to replicate the economic consequences that would apply had a purchase or sale of the underlying security taken place. Upon entering into synthetic equity swaps, the Fund is required to pledge the broker an amount of cash and/or other assets equal to a certain percentage of the contract amount ("initial margin"). Subsequent payments known as "variation margin", are made or received by the Fund periodically, depending on fluctuations in the value of the underlying security. When the contract is closed, the Fund records a realized gain or loss equal to the difference between the value of the contract at the time it was opened and the value at the time it was closed. The risks of entering into equity swaps include unfavorable price movements in the underlying securities or the inability of the counterparties to fulfill their obligations under the contract. 36 | Annual Report Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) G. OPTION CONTRACTS The Fund may purchase or write options. Options are contracts entitling the holder to purchase or sell a specified number of shares or units of a particular security at a specified price. Options purchased are recorded as investments; options written (sold) are recorded as liabilities. When the exercise of an option results in a cash settlement, the difference between the premium (original option value) and the settlement proceeds is realized as a gain or loss. When securities are acquired or delivered upon exercise of an option, the acquisition cost or sale proceeds are adjusted by the amount of the premium. When an option is closed, the difference between the premium and the cost to close the position is realized as a gain or loss. When an option expires, the premium is realized as a gain for options written or as a loss for options purchased. The risks include the possibility there may be an illiquid options market or the inability of the counterparties to fulfill their obligations under the contract. Writing options involves, to varying degrees, elements of market risk in excess of the amount recognized in the Statement of Assets and Liabilities. H. SECURITIES SOLD SHORT The Fund is engaged in selling securities short, which obligates the Fund to replace a borrowed security with the same security at current market value. The Fund would incur a loss 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. The Fund would realize a gain if the price of the security declines between those dates. A gain, limited to the price at which the Fund sold the security short, or a loss, unlimited in size, will be recognized upon the termination of a short sale. The Fund is required to establish a margin account with the broker lending the security sold short. While the short sale is outstanding, the broker retains the proceeds of the short sale and the Fund must maintain a deposit for the broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. I. SECURITIES LENDING The Fund loans securities to certain brokers for which it received cash or securities collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. The cash collateral is invested in short-term instruments as noted in the Statement of Investments. The Fund received interest income of $34,696 from the investment of cash collateral, adjusted by lender fees and broker rebates. The fund bears the risk of loss with respect to the investment of the cash collateral. The securities lending agent has agreed to indemnify the Fund in the case of default of any securities borrower. J. 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. Annual Report | 37 Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) K. 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. Discounts on securities purchased are amortized over the lives of the respective securities. Dividend income, dividends declared on securities sold short, and distributions to shareholders are recorded on the ex-dividend date. 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. Common expenses incurred by the Series Fund are allocated among the funds comprising the Series Fund 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. L. 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. M. GUARANTEES AND INDEMNIFICATIONS Under the Fund's organizational documents, its officers and trustees are indemnified against certain liability arising out of the performance of their duties to the Funds. Additionally, in the normal course of business, the Fund enters into contracts with service providers that contain general indemnification clauses. The Fund's maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Fund that have not yet occurred. However, based on experience, the Fund expects the risk of loss to be remote. 2. CAPITAL STOCK The Fund offers four classes of shares: Class Z, Class A, Class B, and Class C shares. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. 38 | Annual Report Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED) At December 31, 2003, there were 1.00 billion shares authorized ($0.001 par value) of which 500 million, 200 million, 100 million and 200 million were designated as Class Z, Class A, Class B, and Class C shares, respectively. Transactions in the Fund's shares were as follows:
--------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2003 2002 SHARES AMOUNT SHARES AMOUNT --------------------------------------------------------------- CLASS Z SHARES: Shares sold ......................... 8,509,431 $ 131,224,611 9,327,595 $ 145,787,747 Shares issued on reinvestment of distributions ....................... 3,042,530 51,201,644 5,451,501 82,419,037 Shares redeemed ..................... (17,445,911) (268,458,384) (18,601,460) (283,572,211) --------------------------------------------------------------- Net increase (decrease) ............. (5,893,950) $ (86,032,129) (3,822,364) $ (55,365,427) --------------------------------------------------------------- CLASS A SHARES: Shares sold ......................... 8,305,112 $ 126,902,814 10,310,943 $ 161,104,638 Shares issued on reinvestment of distributions ....................... 507,445 8,466,348 856,106 12,997,175 Shares redeemed ..................... (6,033,504) (91,808,618) (8,178,641) (123,472,810) --------------------------------------------------------------- Net increase (decrease) ............. 2,779,053 $ 43,560,544 2,988,408 $ 50,629,003 --------------------------------------------------------------- CLASS B SHARES: Shares sold ......................... 785,351 $ 11,788,264 1,660,153 $ 26,043,919 Shares issued on reinvestment of distributions ....................... 28,905 466,222 50,683 767,569 Shares redeemed ..................... (375,336) (5,478,674) (352,061) (5,108,808) --------------------------------------------------------------- Net increase (decrease) ............. 438,920 $ 6,775,812 1,358,775 $ 21,702,680 --------------------------------------------------------------- CLASS C SHARES: Shares sold ......................... 2,196,889 $ 33,319,144 3,690,904 $ 57,319,717 Shares issued on reinvestment of distributions ....................... 146,988 2,376,905 322,963 4,987,995 Shares redeemed ..................... (2,518,701) (37,484,647) (3,104,531) (46,514,530) --------------------------------------------------------------- Net increase (decrease) ............. (174,824) $ (1,788,598) 909,336 $ 15,793,182 ---------------------------------------------------------------
3. TRANSACTIONS WITH AFFILIATES Certain officers of the Series Fund are also officers and/or directors of Franklin Mutual Advisers, LLC (Franklin Mutual) and Franklin Templeton Services, LLC (FT Services), the Fund's investment manager and administrative manager, respectively. Franklin/Templeton Investor Services, LLC (Investor Services) and Franklin/Templeton Distributors, Inc. (Distributors) are the Fund's transfer agent and principal underwriter, respectively. The Fund pays an investment management fee to Franklin Mutual of 0.60% per year of the average daily net assets of the Fund. Annual Report | 39 Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) The Fund pays its allocated share of an administrative fee to FT Services based on the Series Fund's aggregate average daily net assets as follows: ANNUALIZED FEE RATE MONTH-END NET ASSETS 0.150% First $200 million 0.135% Over $200 million, up to and including $700 million 0.100% Over $700 million, up to and including $1.2 billion 0.075% Over $1.2 billion The Fund reimburses Distributors for costs incurred in marketing the Fund's shares up to 0.35%, 1.00%, and 1.00% per year of the average daily net assets of Class A, Class B, and C shares, respectively. Distributors received net commissions from sales of those Fund shares and received contingent deferred sales charges for the period of $173,888 and $36,813, respectively. The Fund paid transfer agent fees of $4,056,000, of which $3,275,066 was paid to Franklin Templeton Investors Services Inc. 4. INCOME TAXES At December 31, 2003, the cost of investments, net unrealized appreciation (depreciation) and undistributed ordinary income for income tax purposes were as follows: Cost of investments .................................... $3,046,206,075 --------------- Unrealized appreciation ................................ 1,144,520,684 Unrealized depreciation ................................ (64,577,943) --------------- Net unrealized appreciation (depreciation) ............. $1,079,942,741 --------------- Distributable earnings -- undistributed ordinary income ....................................... $ 2,685,938 The tax character of distributions paid during the years ended December 31, 2003, and 2002, was as follows: 2003 2002 Distributions paid from: Ordinary income $66,333,658 $ 62,901,634 Long term capital gain -- 43,089,153 ------------------------------ $66,333,658 $105,990,787 ------------------------------ Net investment income (loss) differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, and bond discounts and premiums. Net realized gains (losses) differ for financial statement and tax purposes primarily due to differing treatment of wash sales, foreign currency transactions, and bond discounts and premiums. 40 | Annual Report Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 4. INCOME TAXES (CONTINUED) At December 31, 2003, the Fund had deferred capital losses occurring subsequent to October 31, 2003 of $6,507,865. For tax purposes, such losses will be reflected in the year ending December 31, 2004. At December 31, 2003, the Fund had tax basis capital losses of $3,081,348 which may be carried over to offset future capital gains. Such losses expire in 2010. 5. INVESTMENT TRANSACTIONS Purchases and sales of securities (excluding short-term securities and securities sold short) for the period ended December, 2003, aggregated $1,416,727,767 and $1,512,907,071, respectively. Transactions in options written during the year ended December 31, 2003 were as follows: NUMBER OF CONTRACTS PREMIUM Options outstanding at December 31, 2002 ....................... 146,800 $ 50,996 Options written .......................... 1,137,186 1,585,494 Options expired .......................... (170,045) (548,050) Options terminated in closing transactions ............................ (18,278) (129,014) Options exercised ........................ (12,678) (671,484) ----------------------------- Options outstanding at December 31, 2003 ....................... 1,082,985 $ 287,942 ----------------------------- 6. FORWARD EXCHANGE CONTRACTS At December 31, 2003, the Fund has outstanding forward exchange contracts as set out below. The contracts are reported in the financial statements at the Fund's net equity, as measured by the difference between the forward exchange rates at the reporting date and the forward exchange rates at the day of entry into the contracts.
IN SETTLEMENT UNREALIZED CONTRACTS TO BUY EXCHANGE FOR DATE GAIN (LOSS) 950,000 British Pounds ........... U.S. $ 1,674,043 1/28/04 U.S. $ 22,893 8,600,000 European Unit ............ 10,496,124 1/28/04 342,828 800,000 British Pounds ........... 1,419,696 2/05/04 8,535 298,584,000 Japanese Yen ............. 2,749,830 3/25/04 43,764 426,090 European Unit ............ 514,802 4/28/04 20,920 --------------- ---------- U.S. $ 16,854,495 $ 438,940 --------------- ----------
Annual Report | 41 Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. FORWARD EXCHANGE CONTRACTS (CONTINUED)
IN SETTLEMENT UNREALIZED CONTRACTS TO SELL EXCHANGE FOR DATE GAIN (LOSS) 3,111,810,000 Korean Won ....................... U.S. $ 2,600,000 3/18/04 U.S. $ 7,128 7,303,811 South African Rand ............... 1,108,742 4/26/04 39,683 ------------- ------------ U.S. $ 3,708,742 46,811 ------------- ------------ Unrealized gain on forward exchange contracts ............................... $ 485,751 ------------ IN SETTLEMENT UNREALIZED CONTRACTS TO SELL EXCHANGE FOR DATE GAIN (LOSS) 6,745,177 British Pounds ................... U.S. $ 11,965,943 1/06/04 U.S. $ (103,326) 19,725,000 European Unit .................... 24,577,350 1/06/04 (298,554) 31,050,173 British Pounds ................... 53,998,515 1/12/04 (1,534,100) 27,500,000 British Pounds ................... 46,483,931 1/20/04 (2,668,561) 98,114,826 Canadian Dollars ................. 70,089,065 1/21/04 (5,762,142) 16,027,530 European Unit .................... 18,816,320 1/28/04 (1,383,868) 25,000,000 British Pounds ................... 42,170,000 1/28/04 (2,486,201) 33,000,000 British Pounds ................... 57,208,800 2/11/04 (1,674,347) 40,665,758 European Unit .................... 44,941,760 2/23/04 (6,275,076) 166,502,000 Taiwan Dollar .................... 4,900,000 2/25/04 (4,330) 12,250,000 British Pounds ................... 20,644,925 2/27/04 (1,186,620) 32,290,074 European Unit .................... 37,050,513 3/11/04 (3,598,742) 160,488,853 Danish Krona ..................... 26,433,737 3/17/04 (692,668) 1,254,397,410 Japanese Yen ..................... 10,950,000 3/18/04 (783,758) 7,463,233,500 Korean Won ....................... 6,200,000 3/18/04 (18,863) 44,563,476 European Unit .................... 50,885,182 3/25/04 (5,193,371) 2,042,751,840 Japanese Yen ..................... 18,337,090 3/25/04 (775,185) 374,775,462 Norwegian Krone .................. 52,696,255 4/15/04 (3,448,274) 39,440,198 European Unit .................... 45,766,070 4/22/04 (3,829,575) 14,257,163 South African Rand ............... 2,029,646 4/26/04 (57,175) 44,550,000 European Unit .................... 52,431,308 4/28/04 (3,581,315) 1,501,981,931 Japanese Yen ..................... 13,601,533 6/24/04 (494,062) ------------- ------------ U.S. $712,177,943 (45,850,113) ------------- ------------ Net unrealized loss on offsetting forward exchange contracts ......................... (85,803) ------------ Unrealized loss on forward exchange contracts ....................................... (45,935,916) ------------ Net unrealized loss on forward exchange contracts .................................. U.S. $(45,450,165) ------------
42 | Annual Report Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. RESTRICTED SECURITIES At December 31, 2003, investments in securities included issues that are restricted or illiquid. Restricted securities are often purchased in private placement transactions, are not registered under the Securities Act of 1933, may have contractual restrictions on resale, and are valued under methods approved by the Board of Directors as reflecting fair value. A security may also be considered illiquid if it lacks a readily available market or if its valuation has not changed for a certain period of time. At December 31, 2003, the Fund held investments in restricted and illiquid securities that were valued under approved methods by the Directors, as follows:
SHARES OR PRINCIPAL ACQUISITION AMOUNT ISSUER DATE COST VALUE 128,325 A.B. Watley Group Inc. ..................... 4/02/01 $ 407,333 $ 23,098 67,857 AboveNet Inc. .............................. 10/02/01 2,032,609 2,032,609 938,100 Consol Energy Inc. ......................... 9/17/03 16,866,642 21,867,111 10,949 Elephant Capital Holdings Ltd. ............. 8/29/03 10,948,800 10,948,800 31,114,000 FE Capital LLC, 5.00%, 8/28/07 ............. 8/29/03 30,533,251 31,736,280 2,855,428 International Steel Group .................. 4/10/02 13,796,250 94,536,082 4 Lancer Industries Inc., B .................. 8/11/89 -- 2,454,083 691,640 Leucadia National Corp. .................... 12/20/02 24,380,310 30,290,374 9,112,000 Nippon Investment LLC ...................... 2/14/01 -- 3,462,560 443,332 NTL Inc. ................................... 9/21/01 23,137,915 29,376,287 97,300 Olympus Re Holdings Ltd. ................... 12/19/01 9,730,000 15,389,941 12,976 PG & E Corp., wts., 9/2/06 ................. 10/29/02 -- 324,192 140,834 Security Capital European Realty ........... 4/08/98 3,199,693 1,049,213 1,375,000 State National Bancshares Inc. ............. 8/09/00 22,000,000 27,500,000 126,940 White Mountains Insurance Group Inc. ....... 6/01/01 37,447,300 55,466,750 ------------ TOTAL RESTRICTED SECURITIES (8.0% OF NET ASSETS) ................................. $326,457,380 ------------
Annual Report | 43 Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The Investment Company Act of 1940 defines "affiliated companies" to include investments in portfolio companies in which a fund owns 5% or more of the outstanding voting securities. Investments in "affiliated companies" for the Fund at December 31, 2003 were as shown below.
REALIZED CAPITAL INVESTMENT GAIN NUMBER OF NUMBER OF VALUE INCOME (LOSS) SHARES HELD GROSS GROSS SHARES HELD DEC. 31, 1/1/03- 1/1/03- NAME OF ISSUER DEC. 31, 2002 ADDITIONS REDUCTIONS DEC. 31, 2003 2003 12/31/03 12/31/03 NON-CONTROLLED AFFILIATES Elephant Capital Holdings Ltd. -- 10,949 -- 10,949 $ 10,948,800 $ -- $ -- FHC Delaware Inc. ........... 452,571 -- -- 452,571 3,561,734 -- -- ITLA Capital Corp. .......... 686,300 -- (219,904) 466,396 23,366,440 -- 7,505,238 Lancer Industries Inc., B .. 4 -- -- 4 2,454,083 -- 3,233,155 MBOP Liquidating Trust ...... 412,418 -- -- 412,418 1,031 -- -- Nippon Investment LLC ....... 9,112,000 -- -- 9,112,000 3,462,560 -- 4,374,915 Saxon Capital Inc. .......... 2,324,800 -- (328,415) 1,996,385 41,824,266 -- 1,746,463 Southwest Royalties Inc., A . 58,923 -- -- 58,923 1,767,705 -- -- Southwest Royalties Inc., 10.50%, 6/30/04 .......... 3,928,000 -- (3,928,000) -- -- 446,046 -- State National Bancshares Inc. .......... 1,375,000 -- -- 1,375,000 27,500,000 -- -- Union Acceptance Corp., A ... 3,595,994 -- -- 3,595,994 215,760 -- -- ---------------------------------------- TOTAL NON-CONTROLLED AFFILI ATES $115,102,379 $446,046 $16,859,771 ----------------------------------------
9. INVESTMENTS IN FRANKLIN INSTITUTIONAL FIDUCIARY TRUST MONEY MARKET PORTFOLIO The Fund may invest in the Franklin Institutional Fiduciary Trust Money Market Portfolio (the Sweep Money Fund), an open-end investment company managed by Franklin Advisers Inc. (an affiliate of the advisor). Management fees paid by the Fund are reduced on assets invested in the Sweep Money Fund, in an amount not to exceed the management fees paid by the Sweep Money Fund. The Fund earned $97,559 of dividend income from investment in the Sweep Money Fund for the year ended December 31, 2003. 44 | Annual Report Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 10. REGULATORY MATTERS On February 4, 2004, the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts filed an administrative complaint against Franklin Resources, Inc. and certain of its subsidiaries (the "Company"), alleging violations of the Massachusetts Uniform Securities Act. The complaint arises from activity that occurred in 2001 during which time an officer of a Company subsidiary was negotiating an agreement with an investor relating to investments in a mutual fund and a hedge fund. The Fund, in addition to other entities within Franklin Templeton Investments, including the Company and other funds, have been named in shareholder class actions related to the matter described above. The Fund's management believes that the claims made in the lawsuit are without merit and it intends to defend vigorously against the allegations. It is anticipated that the Fund may be named in additional similar civil actions related to the matter described above. In addition, as part of ongoing investigations by the U.S. Securities and Exchange Commission (the "SEC"), the U.S. Attorney for the Northern District of California, the New York Attorney General, the California Attorney General, the U.S. Attorney for the District of Massachusetts, the Florida Department of Financial Services, and the Commissioner of Securities and the Attorney General of the State of West Virginia, relating to certain practices in the mutual fund industry, including late trading, market timing and sales compensation arrangements, the Company and its subsidiaries, as well as certain current or former executives and employees of the Company, have received requests for information and/or subpoenas to testify or produce documents. The Company and its current employees are providing documents and information in response to these requests and subpoenas. In addition, the Company has responded to requests for similar kinds of information from regulatory authorities in some of the foreign countries where the Company conducts its global asset management business. The Staff of the SEC has informed the Company that it intends to recommend that the Commission authorize an action against an affiliate of the Fund's adviser and a senior executive officer relating to the frequent trading issues that are the subject of the SEC's investigation. These issues were previously disclosed as being under investigation by government authorities and the subject of an internal inquiry by the Company in its Annual Report on Form 10-K and on its public website. The Company currently is in discussions with the SEC Staff in an effort to resolve the issues raised in their investigation. Such discussions are preliminary and the Fund management has been advised that the Company cannot predict the likelihood of whether those discussions will result in a settlement and, if so, the terms of such settlement. The impact, if any, of these matters on the Fund is uncertain at this time. If the Company finds that it bears responsibility for any unlawful or improper conduct, it has committed to making the Fund or its shareholders whole, as appropriate. Annual Report | 45 Mutual Qualified Fund REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS TO THE BOARD OF DIRECTORS OF FRANKLIN MUTUAL SERIES FUND INC. AND SHAREHOLDERS OF MUTUAL QUALIFIED FUND We have audited the accompanying statement of assets and liabilities, including the statement of investments, of the Mutual Qualified Fund (one of the portfolios constituting the Franklin Mutual Series Fund Inc. [the Fund]) as of December 31, 2003, and the related statement of operations for the year then ended, the statements of changes in net assets for each of the two years in the period then ended, and the financial highlights for each of the periods indicated therein. These financial statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights. Our procedures included confirmation of securities owned at December 31, 2003, by correspondence with the custodian and brokers or by other appropriate auditing procedures where replies from brokers were not received. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of the Mutual Qualified Fund of the Franklin Mutual Series Fund Inc. as of December 31, 2003, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the periods indicated therein, in conformity with accounting principles generally accepted in the United States. Boston, Massachusetts February 4, 2004 /S/ ERNST & YOUNG LLP Ernst & Young LLP 46 | Annual Report Mutual Qualified Fund TAX DESIGNATION (UNAUDITED) Under Section 854(b)(2) of the Internal Revenue Code, the Fund hereby designates 28.82% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2003. Under Section 854(b)(2) of the Internal Revenue Code (Code), the Fund hereby designates up to a maximum of $37,464,057 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2003. In January 2004, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2003. Shareholders are advised to check with their tax advisors for information on the treatment of these amounts on their individual income tax returns. Annual Report | 47 Board Members and Officers The name, age and address of the officers and board members, as well as their affiliations, positions held with the Fund, principal occupations during the past five years and number of portfolios overseen in the Franklin Templeton Investments fund complex are shown below. Each board member will serve until that person's successor is elected and qualified. INDEPENDENT BOARD MEMBERS
----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ----------------------------------------------------------------------------------------------------------------------------------- EDWARD I. ALTMAN, PH.D. (62) Director Since 1987 7 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Max L. Heine Professor of Finance and Director of The Credit and Debt Markets Research Program, NYU Salomon Center, Stern School of Business, New York University; editor and author of numerous financial publications; and financial consultant; and FORMERLY Vice Director, NYU Salomon Center, Stern School of Business, New York University. ----------------------------------------------------------------------------------------------------------------------------------- ANN TORRE GRANT (45) Director Since 1994 7 Independent Director, SLM, 51 John F. Kennedy Parkway Corporation (Sallie Mae); and Allied Short Hills, NJ 07078 Capital Corporation (financial services). PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Independent strategic and financial consultant; and FORMERLY, Executive Vice President and Chief Financial Officer, NHP Incorporated (manager of multifamily housing) (1995-1997); and Vice President and Treasurer, US Airways, Inc. (until 1995). ----------------------------------------------------------------------------------------------------------------------------------- BURTON J. GREENWALD (74) Director Since 2002 12 Director, Fiduciary Emerging Markets 51 John F. Kennedy Parkway Bond Fund PLC and Fiduciary Short Hills, NJ 07078 International Ireland Limited. PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Managing Director, B.J. Greenwald Associates, management consultants to the financial services industry. ----------------------------------------------------------------------------------------------------------------------------------- BRUCE A. MACPHERSON (73) Director Since 1974 7 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Retired, former Chairman, A.A. MacPherson, Inc., Canton, MA (representative for electrical manufacturers); and part owner McKinstry Inc., Chicopee, MA (manufacturer of electrical enclosures). ----------------------------------------------------------------------------------------------------------------------------------- FRED R. MILLSAPS (74) Director Since 1996 28 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director of various business and nonprofit organizations; manager of personal investments (1978-present); and FORMERLY, Chairman and Chief Executive Officer, Landmark Banking Corporation (1969-1978); Financial Vice President, Florida Power and Light (1965-1969); and Vice President, Federal Reserve Bank of Atlanta (1958-1965). -----------------------------------------------------------------------------------------------------------------------------------
48 | Annual Report
----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ----------------------------------------------------------------------------------------------------------------------------------- CHARLES RUBENS II (73) Director Since 1998 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. ----------------------------------------------------------------------------------------------------------------------------------- LEONARD RUBIN (78) Director Since 1996 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Partner in LDR Equities, LLC (manages personal investments); and FORMERLY, President, F.N.C. Textiles, Inc.; and Chairman of the Board, Carolace Embroidery Co., Inc. (until 1996). ----------------------------------------------------------------------------------------------------------------------------------- ROBERT E. WADE (57) Director Since 1991 7 Director, El Oro Mining and 51 John F. Kennedy Parkway Exploration Co., p.l.c.; and FORMERLY, Short Hills, NJ 07078 Director, El Oro Mining and Exploration Company, p.l.c and The Exploration Company, p.l.c., (until 2003). PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Practicing attorney. ----------------------------------------------------------------------------------------------------------------------------------- INTERESTED BOARD MEMBERS AND OFFICERS ----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ----------------------------------------------------------------------------------------------------------------------------------- **WILLIAM J. LIPPMAN (78) Director Since 1996 18 None One Parker Plaza, 9th Floor Fort Lee, NJ 07024 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Private Client Group, Inc.; President, Franklin Advisory Services, LLC.; and officer and/or director or trustee, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of seven of the investment companies in Franklin Templeton Investments. ----------------------------------------------------------------------------------------------------------------------------------- **ANNE M. TATLOCK (64) Director Since 2002 7 Director, Fortune Brands, Inc. 600 Fifth Avenue, 7th Floor (consumer products) and Merck & New York, NY 10020-2302 Co. Inc. (pharmaceuticals) PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman and Chief Executive Officer, Fiduciary Trust Company International; Vice Chairman, Member - Office of the Chairman and Director, Franklin Resources, Inc.; and officer and/or director of some of the other subsidiaries of Franklin Resources, Inc. -----------------------------------------------------------------------------------------------------------------------------------
Annual Report | 49
----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ----------------------------------------------------------------------------------------------------------------------------------- **DAVID J. WINTERS (41) Director, Director since 7 None 51 John F. Kennedy Parkway President, 2001, President Short Hills, NJ 07078-2702 Chairman of since 1999, the Board Chairman of the and Chief Board and Chief Executive Executive Officer - Officer - Investment Investment Management Management since 2002 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Chief Investment Officer, and Chief Executive Officer, Franklin Mutual Advisers, LLC., and of three of the investment companies in Franklin Templeton Investments. ----------------------------------------------------------------------------------------------------------------------------------- JIMMY D. GAMBILL (56) Senior Vice Since 2002 Not Applicable None 500 East Broward Blvd. President and Suite 2100 Fort Lauderdale, FL Chief 33394-3091 Executive Officer - Finance and Administration PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Franklin Templeton Services, LLC; Senior Vice President, Templeton Worldwide, Inc.; and officer of 51 of the investment companies in Franklin Templeton Investments. ----------------------------------------------------------------------------------------------------------------------------------- DAVID P. GOSS (56) Vice President Since 2000 Not Applicable None One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Associate General Counsel, Franklin Resources, Inc.; officer and director of one of the subsidiaries of Franklin Resources, Inc.; officer of 51 of the investment companies in Franklin Templeton Investments; and FORMERLY, President, Chief Executive Officer and Director, Property Resources Equity Trust (until 1999) and Franklin Select Realty Trust (until 2000). ----------------------------------------------------------------------------------------------------------------------------------- BARBARA J. GREEN (56) Vice President Since 2000 Not Applicable None One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Deputy General Counsel and Secretary, Franklin Resources, Inc.; Secretary and Senior Vice President, Templeton Worldwide, Inc.; Secretary, Franklin Advisers, Inc., Franklin Advisory Services, LLC, Franklin Investment Advisory Services, Inc., Franklin Mutual Advisers, LLC, Franklin Templeton Alternative Strategies, Inc., Franklin Templeton Investor Services, LLC, Franklin Templeton Services, LLC, Franklin Templeton Distributors, Inc., Templeton Investment Counsel, LLC, and Templeton/Franklin Investment Services, Inc.; and officer of some of the other subsidiaries of Franklin Resources, Inc. and of 51 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). -----------------------------------------------------------------------------------------------------------------------------------
50 | Annual Report
----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ----------------------------------------------------------------------------------------------------------------------------------- MICHAEL O. MAGDOL (66) Vice Since 2002 Not Applicable Director, FTI Banque, Arch 600 Fifth Avenue President - Chemicals, Inc. and Lingnan Rockefeller Center AML Foundation. New York, NY 10048-0772 Compliance PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice Chairman, Chief Banking Officer and Director, Fiduciary Trust Company International; and officer and/or director, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of 48 of the investment companies in Franklin Templeton Investments. ----------------------------------------------------------------------------------------------------------------------------------- KIMBERLEY H. MONASTERIO (40) Treasurer Treasurer Not Applicable None One Franklin Parkway and Chief and Chief San Mateo, CA 94403-1906 Financial Financial Officer Officer since 2003 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Templeton Services, LLC; and officer of 51 of the investment companies in Franklin Templeton Investments. ----------------------------------------------------------------------------------------------------------------------------------- MURRAY L. SIMPSON (66) Vice Since 2000 Not Applicable None One Franklin Parkway President San Mateo, CA 94403-1906 and Secretary PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Executive Vice President and General Counsel, Franklin Resources, Inc.; officer and/or director, as the case may be, of some of the subsidiaries of Franklin Resources, Inc. and of 51 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). -----------------------------------------------------------------------------------------------------------------------------------
*We base the number of portfolios on each separate series of the U.S. registered investment companies within the Franklin Templeton Investments fund complex. These portfolios have a common investment adviser or affiliated investment advisers. **William J. Lippman is considered an interested person of Mutual Series under the federal securities laws due to his position as an officer of some of the subsidiaries of Franklin Resources, Inc. (Resources), which is the parent company of Mutual Series' adviser and distributor. Anne M. Tatlock is considered an interested person of Mutual Series under the federal securities laws due to her position as an officer and director of Resources. David J. Winters is considered an interested person of Mutual Series under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC. THE FUND'S BOARD OF DIRECTORS HAS DETERMINED THAT CERTAIN OF THE MEMBERS OF THE AUDIT COMMITTEE, INCLUDING ANN TORRE GRANT, ARE AUDIT COMMITTEE FINANCIAL EXPERTS, AND "INDEPENDENT," UNDER THOSE PROVISIONS OF THE SARBANES-OXLEY ACT OF 2002, AND THE RULES AND FORM AMENDMENTS ADOPTED BY THE SECURITIES AND EXCHANGE COMMISSION, RELATING TO AUDIT COMMITTEE FINANCIAL EXPERTS. THE STATEMENT OF ADDITIONAL INFORMATION (SAI) INCLUDES ADDITIONAL INFORMATION ABOUT THE BOARD MEMBERS AND IS AVAILABLE, WITHOUT CHARGE, UPON REQUEST. SHAREHOLDERS MAY CALL 1-800/DIAL BEN (1-800/342-5236) TO REQUEST THE SAI. Annual Report | 51 Mutual Qualified Fund PROXY VOTING POLICIES AND PROCEDURES The Fund has established Proxy Voting Policies and Procedures ("Policies") that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund's complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at 1-954/847-2268 or by sending a written request to: Franklin Templeton Companies, LLC, 500 East Broward Boulevard, Suite 1500, Fort Lauderdale, FL 33394, Attention: Proxy Group. 52 | Annual Report Literature Request For a brochure and prospectus, which contains more complete information, including charges and expenses, call Franklin Templeton Investments at 1-800/DIAL BEN(R) (1-800/342-5236). Please read the prospectus carefully before investing or sending money. To ensure the highest quality of service, we may monitor, record and access telephone calls to or from our service departments. These calls can be identified by the presence of a regular beeping tone. FRANKLIN TEMPLETON INVESTMENTS INTERNATIONAL Mutual European Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Foreign Fund Templeton Foreign Smaller Companies Fund Templeton International (Ex EM) Fund GLOBAL Franklin Global Aggressive Growth Fund Franklin Global Growth Fund Mutual Discovery Fund Templeton Capital Accumulator Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund Templeton Growth Fund Templeton World Fund GROWTH Franklin Aggressive Growth Fund Franklin Capital Growth Fund Franklin Flex Cap Growth Fund Franklin Small-Mid Cap Growth Fund Franklin Small Cap Growth Fund II 1 VALUE Franklin Balance Sheet Investment Fund 2 Franklin Equity Income Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund 3 Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund 4 Mutual Shares Fund BLEND Franklin Blue Chip Fund Franklin Convertible Securities Fund Franklin Growth Fund Franklin Rising Dividends Fund Franklin U.S. Long-Short Fund 5 SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Communications Fund Franklin Global Health Care Fund Franklin Gold and Precious Metals Fund Franklin Natural Resources Fund Franklin Real Estate Securities Fund Franklin Utilities Fund Franklin Technology Fund Mutual Financial Services Fund ASSET ALLOCATION Franklin Templeton Corefolio Allocation Fund Franklin Templeton Founding Funds Allocation Fund TARGET FUNDS Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund INCOME Franklin Adjustable U.S. Government Securities Fund 6 Franklin's AGE High Income Fund Franklin Federal Money Fund 6,7 Franklin Floating Rate Daily Access Fund Franklin Floating Rate Trust 4 Franklin Income Fund Franklin Money Fund 6,7 Franklin Short-Intermediate U.S. Government Securities Fund 6 Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio 6 Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund 6 Templeton Global Bond Fund TAX-FREE INCOME 8 NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund 9 Tax-Exempt Money Fund 6,7 LIMITED-TERM FUNDS California Limited-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Limited-Term Tax-Free Income Fund INTERMEDIATE-TERM FUNDS California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC 8 Alabama Arizona California 10 Colorado Connecticut Florida 10 Georgia Kentucky Louisiana Maryland Massachusetts 9 Michigan 9 Minnesota 9 Missouri New Jersey New York 10 North Carolina Ohio 9 Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust 11 1. The fund is closed to new investors. Existing shareholders can continue adding to their accounts. 2. The fund is only open to existing shareholders as well as select retirement plans. 3. Effective June 30, 2003, the fund reopened to all new investors. 4. The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. 5. Upon reaching approximately $350 million in assets, the fund intends to close to all investors. 6. An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. 7. No assurance exists that the fund's $1.00 per share price will be maintained. It is possible to lose money by investing in the fund. 8. For investors subject to the alternative minimum tax, a small portion of these dividends may be taxable. Distributions of capital gains are generally taxable. 9. Portfolio of insured municipal securities. 10. These funds are available in two or more variations, including long-term portfolios, portfolios of insured securities, a high-yield portfolio (CA) and money market portfolios (CA and NY). 11. The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 11/03 Not part of the annual report [GRAPHIC OMITTED] [LOGO OMITTED] FRANKLIN(R) TEMPLETON(R) INVESTMENTS One Franklin Parkway San Mateo, CA 94403-1906 ANNUAL REPORT AND SHAREHOLDER LETTER Mutual Qualified Fund CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF INVESTMENT OFFICER David J. Winters AUDITORS Ernst & Young LLP 200 Clarendon Streeet Boston, MA 02116 INVESTMENT MANAGER Franklin Mutual Advisers, LLC 51 John F. Kennedy Parkway Short Hills, NJ 07078 DISTRIBUTOR Franklin Templeton Distributors, Inc. 1-800/DIAL BEN (R) franklintempleton.com SHAREHOLDER SERVICES 1-800/632-2301 - (Class A, B, & C) 1-800/448-FUND - (Class Z) This report must be preceded or accompanied by the current Mutual Qualified Fund prospectus, which contains more complete information, including risk factors, charges and expenses. To ensure the highest quality of service, telephone calls to or from our service departments may be monitored, recorded and accessed. These calls can be identified by the presence of a regular beeping tone. 475 A2003 02/04 DECEMBER 31, 2003 -------------------------------------------------------------------------------- [PHOTO OMITTED] -------------------------------------------------------------------------------- ANNUAL REPORT AND SHAREHOLDER LETTER | VALUE -------------------------------------------------------------------------------- WANT TO RECEIVE THIS DOCUMENT FASTER VIA EMAIL? MUTUAL BEACON FUND Eligible shareholders can sign up for eDelivery at franklintempleton.com. See inside for details. -------------------------------------------------------------------------------- [LOGO] FRANKLIN[R] TEMPLETON[R] INVESTMENTS Franklin o Templeton o MUTUAL SERIES Thank You For Your Continued Participation At Mutual Series, we are pleased so many investors share our long-term investment philosophy and have remained shareholders for many years. Your ongoing support plays a significant role in contributing to the funds' success. SPECIALIZED EXPERTISE Mutual Series is part of Franklin Templeton Investments, which offers the specialized expertise of three world-class investment management groups -- Franklin, Templeton and Mutual Series. Mutual Series is dedicated to a unique style of value investing, searching aggressively for opportunity among undervalued stocks, arbitrage situations and distressed companies. Franklin is a leader in tax-free fund management and an expert in U.S. equity and fixed income investing. Templeton pioneered international investing and, with offices in over 25 countries, offers the broadest global reach in the industry. TRUE DIVERSIFICATION Because these management groups work independently and adhere to distinctly different investment approaches, Franklin, Templeton and Mutual Series funds typically have a low overlap of securities. That's why the funds can be used to build truly diversified portfolios covering every major asset class. RELIABILITY YOU CAN TRUST Franklin Templeton Investments seeks to consistently provide investors with exceptional risk-adjusted returns over the long term, as well as the reliable account services that have helped the firm become one of the most trusted names in financial services. -------------------------------------------------------------------------------- MUTUAL FUNDS | RETIREMENT PLANS | 529 COLLEGE SAVINGS LANS | SEPARATE ACCOUNTS -------------------------------------------------------------------------------- [PHOTO OMITTED] Not part of the annual report Contents SHAREHOLDER LETTER ....................... 1 ANNUAL REPORT Mutual Beacon Fund ....................... 5 Performance Summary ...................... 9 Financial Highlights and Statement of Investments ................. 14 Financial Statements ..................... 30 Notes to Financial Statements ............ 34 Independent Auditors' Report ............. 45 Tax Designation .......................... 46 Board Members and Officers ............... 47 Proxy Voting Policies and Procedures ..... 51 -------------------------------------------------------------------------------- Regulatory Update AS OF FEBRUARY 12, 2004 On February 4, 2004, the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts filed an administrative complaint against Franklin Resources, Inc. and certain of its subsidiaries (the "Company"), alleging violations of the Massachusetts Uniform Securities Act. The complaint arises from activity that occurred in 2001 during which time an officer of a Company subsidiary was negotiating an agreement with an investor relating to investments in a mutual fund and a hedge fund. The Company, in addition to other entities within Franklin Templeton Investments, including the Fund and other funds, has been named in shareholder class actions related to the matter described above. The Company believes that the claims made in the lawsuit are without merit and it intends to defend vigorously against the allegations. It is anticipated that the Company may be named in additional similar civil actions related to the matter described above. In addition, as part of ongoing investigations by the U.S. Securities and Exchange Commission (the "SEC"), the U.S. Attorney for the Northern District of California, the New York Attorney General, the California Attorney General, the U.S. Attorney for the District of Massachusetts, the Florida Department of Financial Services, and the Commissioner of Securities and the Attorney General of the State of West Virginia, relating to certain practices in the mutual fund industry, including late trading, market timing and sales compensation arrangements, the Company and its subsidiaries, as well as certain current or former executives and employees of the Company, have received requests for information and/or subpoenas to testify or produce documents. The Company and its current employees are providing documents and information in response to these requests and subpoenas. In addition, the Company has responded to requests for similar kinds of information from regulatory authorities in some of the foreign countries where the Company conducts its global asset management business. The Staff of the SEC has informed the Company that it intends to recommend that the Commission authorize an action against an affiliate of the Fund's adviser and a senior executive officer relating to the frequent trading issues that are the subject of the SEC's investigation. These issues were previously disclosed as being under investigation by government authorities and the subject of an internal inquiry by the Company in its Annual Report on Form 10-K and on its public website. The Company currently is in discussions with the SEC Staff in an effort to resolve the issues raised in their investigation. Such discussions are preliminary and the Company cannot predict the likelihood of whether those discussions will result in a settlement and, if so, the terms of such settlement. The impact, if any, of these matters on the Fund is uncertain at this time. If it is found that the Company bears responsibility for any unlawful or improper conduct, we have committed to making the funds or their shareholders whole, as appropriate. Any further updates on these matters will be disclosed on the Company's website at franklintempleton.com under "Statement on Current Industry Issues." 4 | Not part of the annual report Annual Report Mutual Beacon Fund YOUR FUND'S GOAL AND PRIMARY INVESTMENTS: Mutual Beacon Fund seeks capital appreciation, with income as a secondary goal, by investing primarily in common and preferred stocks, bonds and convertible securities in the U.S. and other countries. We are pleased to bring you Mutual Beacon Fund's annual report for the fiscal year ended December 31, 2003. PERFORMANCE OVERVIEW Mutual Beacon Fund - Class Z posted a 29.44% cumulative total return for the 12 months ended December 31, 2003, as shown in the Performance Summary beginning on page 9. The Fund outperformed its benchmark, the Standard & Poor's 500 Composite Index (S&P 500), which returned 28.67% over the same period.1 ECONOMIC AND MARKET OVERVIEW Early in 2003, economic uncertainty and geopolitical events pushed U.S. interest rates to their lowest level in more than four decades. The U.S. government injected fiscal stimulus into the economy, approving another round of tax cuts and rebates that included dividend and capital gains tax reductions. In June, an accommodative Federal Reserve Board, in an attempt to bolster the economy, cut the federal funds target rate to 1.00%. During the year, the U.S. trade deficit increased significantly, contributing to the U.S. dollar's fall to record lows against the euro and other major currencies. However, the weak dollar provided a boost to the U.S. economy and corporate profits as exports became cheaper for foreign buyers. Robust consumer spending, especially for autos and homes, and strong business spending, particularly for 1. Source: Standard & Poor's Micropal. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The S&P 500 is one of the most widely used benchmarks of U.S. equity performance. The index includes reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND COMPLETE LEGAL TITLES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 18. Annual Report | 5 equipment and software, contributed to the accelerated economic activity. In addition, U.S. federal spending stayed firm and inflation remained benign. U.S. gross domestic product (GDP) grew an annualized 8.2% in third quarter 2003, its strongest pace in nearly 20 years, and overall, 2003 GDP grew an estimated 3.1%. As economic data improved, interest rates rose from their lows, and the 10-year Treasury note's yield ended the period at 4.27%. Foreign economies also showed signs of recovery following a low growth and disinflationary environment that facilitated monetary easing in many major economies during the reporting period. While economic growth accelerated in the U.S., it remained strong in Asia, and was weak, yet positive, in Europe. Despite these signs of economic recovery, benign inflationary trends continued, supported by cyclical productivity gains and excess capacity in labor and capital. A global equity market rally started in late March 2003 and continued through the end of the year. The rebound began with investors anticipating global economic recovery in the second half of 2003, and it continued as data showed robust economic growth. Improved sentiment led many investors to rotate into economically sensitive and financially leveraged companies, specifically cyclical, technology, small-capitalization and emerging market stocks, which had generally performed poorly in recent years. Consequently, domestic and foreign equity markets generally performed well. INVESTMENT STRATEGY We follow a distinctive, three-pronged investment approach, which combines investments in what we believe are substantially undervalued common stocks with distressed debt investing and risk arbitrage. Our style is designed to provide our shareholders with superior risk-adjusted results over time. We employ rigorous, fundamental analysis to find compelling situations. In our opinion, successful investing is as much about assessing risk and containing losses as it is about achieving profits. In choosing investments, we look at the market price of an individual company's securities relative to our evaluation of its intrinsic value based on factors including book value, cash flow generation, long-term earnings potential and earnings multiples. We may invest in bankruptcy or distressed companies if we believe the market overreacted to adverse developments or failed to appreciate positive changes. MANAGER'S DISCUSSION While all three prongs of our investment strategy contributed to Fund performance during the year under review, the strongest contributors were the distressed and equity portfolios. Three of our best performers in 2003 included International GEOGRAPHIC DISTRIBUTION Based on Total Net Assets as of 12/31/03 U.S. 64.8% U.K. 11.0% Canada 4.0% France 2.8% Japan 2.3% Switzerland 2.1% Spain 2.0% Netherlands 2.0% Irish Republic 1.8% Denmark 1.8% South Africa 1.5% Norway 1.2% Germany 1.1% Other Countries 1.6% 6 | Annual Report Steel Group (ISG); White Mountains Insurance Group, a property and casualty (P&C) insurer; and NTL, a distressed cable company investment. ISG was formed in second quarter 2002 by a group of private equity investors, including the Fund, to purchase certain LTV steel production assets out of bankruptcy. After negotiating with the unions to craft an agreement, the LTV assets purchased were structured so that many "legacy" liabilities, such as pension and post-retirement health care costs, were shed. Using this cost reduction formula, ISG continued to acquire additional steel facilities out of bankruptcy in 2002 and 2003. As ISG restructured and assimilated these facilities, the company emerged as a competitive, low-cost operator and the nation's second-largest steel producer. Our ISG investment's value was highlighted in the public markets during the first half of December when the company raised capital through an initial public offer (IPO). The IPO was very well received and ISG's stock price appreciated almost 40% in December, contributing to a solid 2003 performance. Our investment in White Mountains reflects our focus on companies with strong or improving fundamentals, attractive valuations and management teams who think like owners. During 2003, the company benefited from strong price increases for primary and reinsurance risks, disciplined underwriting and solid returns from its investment portfolio. While many companies within the P&C insurance industry struggled with eroding capital from past underwriting mistakes and significant losses in their investment portfolios, White Mountains utilized its much-improved balance sheet and industry knowledge to acquire undervalued or capital-constrained insurance companies and to increase exposure to its most attractive lines of businesses. Primarily as a result of these actions, the company continued to improve profitability and enjoyed a 13% increase in its book value during 2003. NTL, the U.K.'s largest cable company, was formed by a series of acquisitions of independent cable operators. These purchases were financed largely with debt, and in 2001, when NTL failed to generate enough cash flow to meet its interest payments, the company's bonds began to trade at significant discounts to face value. After completing an extensive fundamental analysis, we believed NTL's bonds were trading well below the fair value of the company's operations. We purchased a material amount of NTL debt and became an active member of the creditors committee formed to facilitate the reorganization process. During the restructuring, our investment in NTL bonds was converted to common shares, and the reorganized company emerged from bankruptcy in January 2003. As global cable valuations recovered, the new NTL shares performed well during the year and appreciated more than 15 times from their lows. Although the Fund's successes during the reporting period were many, not all of our investments performed as well as we hoped. Three of the Fund's significant underperformers included Allied Domecq (sold by year-end), one of the TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/03 --------------------------------------------------- % OF TOTAL NET ASSETS --------------------------------------------------- Insurance 9.9% --------------------------------------------------- Metals & Mining 7.6% --------------------------------------------------- Media 6.7% --------------------------------------------------- Tobacco 6.1% --------------------------------------------------- Beverages 5.1% --------------------------------------------------- Food Products 4.3% --------------------------------------------------- Real Estate 4.0% --------------------------------------------------- Commercial Banks 3.5% --------------------------------------------------- Diversified Financial Services 3.5% --------------------------------------------------- Diversified Telecommunication Services 2.7% --------------------------------------------------- Annual Report | 7 world's largest spirits and wine companies; Abitibi-Consolidated (sold by year-end), a Canadian paper and forest products company; and Beiersdorf, a German personal care products company. Allied Domecq's stock declined after the company lowered its earnings outlook in February due to a weak U.S. dollar, higher pension expenses and weakness in its Spanish operations. Abitibi's shares underperformed in 2003 after a weak U.S. dollar, soft sales and higher energy prices forced the company to reduce its earnings outlook and cut its dividend. Beiersdorf, which had been the subject of takeover speculation earlier in the year, declined after the company's major shareholders announced the company would remain independent and not be sold. Thank you for your continued participation in Mutual Beacon Fund. We look forward to serving your future investment needs. [PHOTO OF DAVID J. WINTERS OMITTED] /S/David J. Winters David J. Winters, CFA [PHOTO OF MATTHEW T. HAYNES OMITTED] /S/Matthew T. Haynes Matthew T. Haynes, CFA Co-Portfolio Managers Mutual Beacon Fund [PHOTO OMITTED] TOP 10 HOLDINGS 12/31/03 ------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS ------------------------------------------------- White Mountains Insurance Group Inc., common & restricted 3.4% INSURANCE, U.S. ------------------------------------------------- Berkshire Hathaway Inc., A & B 2.6% INSURANCE, U.S. ------------------------------------------------- International Steel Group 2.3% METALS & MINING, U.S. ------------------------------------------------- Altadis SA 2.0% TOBACCO, SPAIN ------------------------------------------------- Washington Post Co., B 1.8% MEDIA, U.S. ------------------------------------------------- British American Tobacco PLC, ord. & ADR 1.7% TOBACCO, U.K. ------------------------------------------------- NTL Inc., common & restricted 1.7% DIVERSIFIED TELECOMMUNICATION SERVICES, U.K. ------------------------------------------------- Liberty Media Corp., A 1.6% MEDIA, U.S. ------------------------------------------------- Impala Platinum Holdings Ltd. 1.4% METALS & MINING, SOUTH AFRICA ------------------------------------------------- Carlsberg AS, A & B 1.3% BEVERAGES, DENMARK ------------------------------------------------- THIS DISCUSSION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2003, THE END OF THE REPORTING PERIOD. THE WAY WE IMPLEMENT OUR MAIN INVESTMENT STRATEGIES AND THE RESULTING PORTFOLIO HOLDINGS MAY CHANGE DEPENDING ON FACTORS SUCH AS MARKET AND ECONOMIC CONDITIONS. THESE OPINIONS MAY NOT BE RELIED UPON AS INVESTMENT ADVICE OR AN OFFER FOR A PARTICULAR SECURITY. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR THE FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE, BUT THE ADVISOR MAKES NO REPRESENTATION OR WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR INVESTMENT MANAGEMENT PHILOSOPHY. 8 | Annual Report Performance Summary as of 12/31/03 Your dividend income will vary depending on dividends or interest paid by securities in the Fund's portfolio, adjusted for operating expenses of each class. Capital gain distributions are net profits realized from the sale of portfolio securities. The performance table and graphs do not reflect any taxes due on Fund dividends, capital gain distributions, if any, or any realized gains on the sale of Fund shares. Total return reflects the Fund's dividend income, capital gain distributions, if any, and any unrealized gains or losses.
PRICE AND DISTRIBUTION INFORMATION ------------------------------------------------------------------------------------------------- CLASS Z CHANGE 12/31/03 12/31/02 ------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$3.08 $14.39 $11.31 ------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) ------------------------------------------------------------------------------------------------- Dividend Income $0.2313 ------------------------------------------------------------------------------------------------- CLASS A CHANGE 12/31/03 12/31/02 ------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$3.06 $14.33 $11.27 ------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) ------------------------------------------------------------------------------------------------- Dividend Income $0.1901 ------------------------------------------------------------------------------------------------- CLASS B CHANGE 12/31/03 12/31/02 ------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$2.99 $14.06 $11.07 ------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) ------------------------------------------------------------------------------------------------- Dividend Income $0.1201 ------------------------------------------------------------------------------------------------- CLASS C CHANGE 12/31/03 12/31/02 ------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$3.04 $14.25 $11.21 ------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) ------------------------------------------------------------------------------------------------- Dividend Income $0.1119 -------------------------------------------------------------------------------------------------
Annual Report | Past performance does not guarantee future results. | 9 Performance Summary (CONTINUED)
PERFORMANCE 1 ----------------------------------------------------------------------------------------------------- CLASS Z 1-YEAR 5-YEAR 10-YEAR ----------------------------------------------------------------------------------------------------- Cumulative Total Return 2 29.44% 63.14% 230.95% ----------------------------------------------------------------------------------------------------- Average Annual Total Return 3 29.44% 10.28% 12.71% ----------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $12,944 $16,314 $33,095 ----------------------------------------------------------------------------------------------------- CLASS A 1-YEAR 5-YEAR INCEPTION (11/1/96) ----------------------------------------------------------------------------------------------------- Cumulative Total Return 2 28.99% 60.24% 113.38% ----------------------------------------------------------------------------------------------------- Average Annual Total Return 3 21.54% 8.59% 10.24% ----------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $12,154 $15,101 $20,111 ----------------------------------------------------------------------------------------------------- CLASS B 1-YEAR 5-YEAR INCEPTION (1/1/99) ----------------------------------------------------------------------------------------------------- Cumulative Total Return 2 28.22% 54.91% 54.91% ----------------------------------------------------------------------------------------------------- Average Annual Total Return 3 24.22% 8.86% 8.86% ----------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $12,422 $15,291 $15,291 ----------------------------------------------------------------------------------------------------- CLASS C 1-YEAR 5-YEAR INCEPTION (11/1/96) ----------------------------------------------------------------------------------------------------- Cumulative Total Return 2 28.24% 55.24% 103.89% ----------------------------------------------------------------------------------------------------- Average Annual Total Return 3 26.01% 8.98% 10.30% ----------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $12,601 $15,371 $20,185 -----------------------------------------------------------------------------------------------------
ONGOING MARKET VOLATILITY CAN SIGNIFICANTLY AFFECT SHORT-TERM PERFORMANCE; MORE RECENT RETURNS MAY DIFFER FROM THOSE SHOWN. SINCE MARKETS CAN GO DOWN AS WELL AS UP, INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE WITH MARKET CONDITIONS AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. FOR MORE CURRENT PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236. 10 | Past performance does not guarantee future results. | Annual Report Performance Summary (CONTINUED) TOTAL RETURN INDEX COMPARISON FOR HYPOTHETICAL $10,000 INVESTMENT 1 Total return represents the change in value of an investment over the periods shown. It includes the current, applicable, maximum sales charge(s), Fund expenses, account fees and reinvested distributions. The unmanaged index includes reinvested dividends. It differs from the Fund in composition and does not pay management fees or expenses. One cannot invest directly in an index. CLASS Z (1/1/94-12/31/03) [LINE GRAPH OMITTED] Date Mutual Beacon Fund S&P 500 5 1/1/94 $10,000 $10,000 1/31/94 $10,363 $10,340 2/28/94 $10,270 $10,059 3/31/94 $10,084 $9,622 4/30/94 $10,251 $9,745 5/31/94 $10,357 $9,904 6/30/94 $10,283 $9,662 7/31/94 $10,551 $9,979 8/31/94 $10,959 $10,387 9/30/94 $10,817 $10,133 10/31/94 $10,794 $10,361 11/30/94 $10,529 $9,984 12/31/94 $10,561 $10,132 1/31/95 $10,783 $10,394 2/28/95 $11,150 $10,799 3/31/95 $11,222 $11,117 4/30/95 $11,538 $11,444 5/31/95 $11,831 $11,901 6/30/95 $11,964 $12,177 7/31/95 $12,496 $12,580 8/31/95 $12,690 $12,612 9/30/95 $13,034 $13,144 10/31/95 $12,772 $13,097 11/30/95 $13,096 $13,671 12/31/95 $13,296 $13,934 1/31/96 $13,806 $14,408 2/29/96 $14,176 $14,542 3/31/96 $14,361 $14,682 4/30/96 $14,557 $14,898 5/31/96 $14,761 $15,282 6/30/96 $14,666 $15,340 7/31/96 $14,091 $14,663 8/31/96 $14,575 $14,973 9/30/96 $14,983 $15,814 10/31/96 $15,116 $16,250 11/30/96 $15,879 $17,478 12/31/96 $16,113 $17,132 1/31/97 $16,667 $18,201 2/28/97 $17,027 $18,344 3/31/97 $16,791 $17,592 4/30/97 $16,890 $18,641 5/31/97 $17,585 $19,775 6/30/97 $18,094 $20,661 7/31/97 $19,098 $22,304 8/31/97 $18,895 $21,055 9/30/97 $19,830 $22,208 10/31/97 $19,199 $21,467 11/30/97 $19,476 $22,460 12/31/97 $19,817 $22,845 1/31/98 $19,705 $23,098 2/28/98 $20,772 $24,762 3/31/98 $21,656 $26,029 4/30/98 $21,937 $26,291 5/31/98 $22,007 $25,840 6/30/98 $21,853 $26,889 7/31/98 $21,321 $26,603 8/31/98 $18,406 $22,761 9/30/98 $18,020 $24,219 10/31/98 $19,092 $26,187 11/30/98 $20,178 $27,774 12/31/98 $20,286 $29,373 1/31/99 $20,642 $30,601 2/28/99 $20,410 $29,650 3/31/99 $21,353 $30,836 4/30/99 $23,039 $32,030 5/31/99 $23,255 $31,275 6/30/99 $23,893 $33,009 7/31/99 $23,388 $31,980 8/31/99 $22,552 $31,822 9/30/99 $21,968 $30,950 10/31/99 $22,583 $32,908 11/30/99 $23,120 $33,577 12/31/99 $23,693 $35,553 1/31/00 $23,111 $33,767 2/29/00 $22,460 $33,129 3/31/00 $24,703 $36,368 4/30/00 $24,412 $35,274 5/31/00 $24,720 $34,552 6/30/00 $24,431 $35,404 7/31/00 $25,053 $34,851 8/31/00 $26,095 $37,014 9/30/00 $26,150 $35,061 10/31/00 $26,589 $34,912 11/30/00 $25,894 $32,162 12/31/00 $27,087 $32,319 1/31/01 $28,849 $33,465 2/28/01 $28,687 $30,416 3/31/01 $27,857 $28,490 4/30/01 $29,011 $30,702 5/31/01 $29,982 $30,908 6/30/01 $30,213 $30,156 7/31/01 $30,399 $29,859 8/31/01 $29,758 $27,992 9/30/01 $27,131 $25,732 10/31/01 $27,111 $26,223 11/30/01 $28,083 $28,234 12/31/01 $28,743 $28,481 1/31/02 $28,633 $28,066 2/28/02 $28,810 $27,524 3/31/02 $29,602 $28,560 4/30/02 $29,867 $26,829 5/31/02 $29,977 $26,632 6/30/02 $27,906 $24,735 7/31/02 $26,080 $22,808 8/31/02 $26,325 $22,957 9/30/02 $24,899 $20,465 10/31/02 $25,233 $22,264 11/30/02 $25,723 $23,573 12/31/02 $25,569 $22,189 1/31/03 $25,297 $21,609 2/28/03 $24,732 $21,284 3/31/03 $24,800 $21,489 4/30/03 $26,405 $23,260 5/31/03 $27,829 $24,484 6/30/03 $28,315 $24,797 7/31/03 $28,634 $25,234 8/31/03 $29,454 $25,725 9/30/03 $29,408 $25,453 10/31/03 $30,615 $26,892 11/30/03 $31,709 $27,128 12/31/03 $33,095 $28,550 CLASS A (11/1/96-12/31/03) [LINE GRAPH OMITTED] Date Mutual Beacon Fund S&P 500 5 11/1/96 $9,425 $10,000 11/30/96 $9,895 $10,755 12/31/96 $10,038 $10,542 1/31/97 $10,381 $11,200 2/28/97 $10,598 $11,288 3/31/97 $10,451 $10,825 4/30/97 $10,512 $11,471 5/31/97 $10,938 $12,169 6/30/97 $11,255 $12,714 7/31/97 $11,873 $13,725 8/31/97 $11,747 $12,957 9/30/97 $12,322 $13,666 10/31/97 $11,920 $13,210 11/30/97 $12,094 $13,821 12/31/97 $12,302 $14,058 1/31/98 $12,232 $14,213 2/28/98 $12,887 $15,238 3/31/98 $13,428 $16,018 4/30/98 $13,603 $16,179 5/31/98 $13,638 $15,901 6/30/98 $13,542 $16,546 7/31/98 $13,211 $16,371 8/31/98 $11,398 $14,006 9/30/98 $11,149 $14,904 10/31/98 $11,816 $16,115 11/30/98 $12,491 $17,091 12/31/98 $12,550 $18,075 1/31/99 $12,771 $18,831 2/28/99 $12,617 $18,246 3/31/99 $13,193 $18,975 4/30/99 $14,228 $19,710 5/31/99 $14,372 $19,245 6/30/99 $14,757 $20,313 7/31/99 $14,444 $19,679 8/31/99 $13,916 $19,582 9/30/99 $13,554 $19,046 10/31/99 $13,925 $20,251 11/30/99 $14,258 $20,662 12/31/99 $14,608 $21,878 1/31/00 $14,249 $20,779 2/29/00 $13,836 $20,386 3/31/00 $15,211 $22,379 4/30/00 $15,031 $21,706 5/31/00 $15,222 $21,262 6/30/00 $15,029 $21,786 7/31/00 $15,413 $21,446 8/31/00 $16,046 $22,777 9/30/00 $16,080 $21,575 10/31/00 $16,351 $21,484 11/30/00 $15,922 $19,791 12/31/00 $16,638 $19,888 1/31/01 $17,723 $20,593 2/28/01 $17,611 $18,717 3/31/01 $17,099 $17,532 4/30/01 $17,798 $18,893 5/31/01 $18,397 $19,020 6/30/01 $18,521 $18,557 7/31/01 $18,636 $18,374 8/31/01 $18,228 $17,225 9/30/01 $16,636 $15,834 10/31/01 $16,611 $16,137 11/30/01 $17,196 $17,374 12/31/01 $17,600 $17,526 1/31/02 $17,533 $17,271 2/28/02 $17,627 $16,938 3/31/02 $18,114 $17,575 4/30/02 $18,277 $16,510 5/31/02 $18,331 $16,388 6/30/02 $17,054 $15,221 7/31/02 $15,932 $14,035 8/31/02 $16,083 $14,127 9/30/02 $15,208 $12,593 10/31/02 $15,399 $13,701 11/30/02 $15,686 $14,506 12/31/02 $15,591 $13,654 1/31/03 $15,425 $13,297 2/28/03 $15,080 $13,098 3/31/03 $15,107 $13,223 4/30/03 $16,089 $14,313 5/31/03 $16,961 $15,066 6/30/03 $17,253 $15,259 7/31/03 $17,435 $15,528 8/31/03 $17,922 $15,830 9/30/03 $17,895 $15,663 10/31/03 $18,633 $16,548 11/30/03 $19,288 $16,694 12/31/03 $20,111 $17,569 Annual Report | Past performance does not guarantee future results. | 11 Performance Summary (CONTINUED) AVERAGE ANNUAL TOTAL RETURN -------------------------------------- CLASS B 12/31/03 -------------------------------------- 1-Year 24.22% -------------------------------------- 5-Year 8.86% -------------------------------------- Since Inception (1/1/99) 8.86% -------------------------------------- CLASS B (1/1/99-12/31/03) [LINE GRAPH OMITTED] Date Mutual Beacon Fund S&P 500 5 1/1/99 $10,000 $10,000 1/31/99 $10,160 $10,418 2/28/99 $10,031 $10,094 3/31/99 $10,481 $10,498 4/30/99 $11,291 $10,905 5/31/99 $11,398 $10,647 6/30/99 $11,693 $11,238 7/31/99 $11,436 $10,887 8/31/99 $11,015 $10,834 9/30/99 $10,719 $10,537 10/31/99 $11,007 $11,203 11/30/99 $11,265 $11,431 12/31/99 $11,533 $12,104 1/31/00 $11,247 $11,496 2/29/00 $10,918 $11,279 3/31/00 $11,996 $12,381 4/30/00 $11,845 $12,009 5/31/00 $11,988 $11,763 6/30/00 $11,840 $12,053 7/31/00 $12,127 $11,865 8/31/00 $12,622 $12,601 9/30/00 $12,631 $11,936 10/31/00 $12,846 $11,886 11/30/00 $12,496 $10,949 12/31/00 $13,054 $11,003 1/31/01 $13,896 $11,393 2/28/01 $13,806 $10,355 3/31/01 $13,390 $9,699 4/30/01 $13,935 $10,453 5/31/01 $14,401 $10,523 6/30/01 $14,487 $10,267 7/31/01 $14,568 $10,166 8/31/01 $14,244 $9,530 9/30/01 $12,990 $8,760 10/31/01 $12,959 $8,927 11/30/01 $13,415 $9,612 12/31/01 $13,722 $9,696 1/31/02 $13,658 $9,555 2/28/02 $13,722 $9,371 3/31/02 $14,097 $9,723 4/30/02 $14,215 $9,134 5/31/02 $14,258 $9,067 6/30/02 $13,253 $8,421 7/31/02 $12,375 $7,765 8/31/02 $12,483 $7,816 9/30/02 $11,801 $6,967 10/31/02 $11,942 $7,580 11/30/02 $12,169 $8,025 12/31/02 $12,081 $7,554 1/31/03 $11,950 $7,357 2/28/03 $11,677 $7,246 3/31/03 $11,688 $7,316 4/30/03 $12,441 $7,919 5/31/03 $13,107 $8,335 6/30/03 $13,320 $8,442 7/31/03 $13,463 $8,591 8/31/03 $13,825 $8,758 9/30/03 $13,793 $8,665 10/31/03 $14,353 $9,155 11/30/03 $14,848 $9,236 12/31/03 $15,291 $9,720 AVERAGE ANNUAL TOTAL RETURN -------------------------------------- CLASS C 12/31/03 -------------------------------------- 1-Year 26.01% -------------------------------------- 5-Year 8.98% -------------------------------------- Since Inception (11/1/96) 10.30% -------------------------------------- CLASS C (11/1/96-12/31/03) [LINE GRAPH OMITTED] Date Mutual Beacon Fund S&P 500 5 11/1/96 $9,900 $10,000 11/30/96 $10,392 $10,755 12/31/96 $10,538 $10,542 1/31/97 $10,890 $11,200 2/28/97 $11,109 $11,288 3/31/97 $10,947 $10,825 4/30/97 $11,012 $11,471 5/31/97 $11,450 $12,169 6/30/97 $11,775 $12,714 7/31/97 $12,411 $13,725 8/31/97 $12,279 $12,957 9/30/97 $12,874 $13,666 10/31/97 $12,453 $13,210 11/30/97 $12,618 $13,821 12/31/97 $12,823 $14,058 1/31/98 $12,741 $14,213 2/28/98 $13,426 $15,238 3/31/98 $13,983 $16,018 4/30/98 $14,148 $16,179 5/31/98 $14,184 $15,901 6/30/98 $14,075 $16,546 7/31/98 $13,722 $16,371 8/31/98 $11,837 $14,006 9/30/98 $11,577 $14,904 10/31/98 $12,255 $16,115 11/30/98 $12,951 $17,091 12/31/98 $13,003 $18,075 1/31/99 $13,222 $18,831 2/28/99 $13,052 $18,246 3/31/99 $13,651 $18,975 4/30/99 $14,718 $19,710 5/31/99 $14,847 $19,245 6/30/99 $15,244 $20,313 7/31/99 $14,908 $19,679 8/31/99 $14,360 $19,582 9/30/99 $13,974 $19,046 10/31/99 $14,350 $20,251 11/30/99 $14,685 $20,662 12/31/99 $15,037 $21,878 1/31/00 $14,655 $20,779 2/29/00 $14,228 $20,386 3/31/00 $15,639 $22,379 4/30/00 $15,442 $21,706 5/31/00 $15,628 $21,262 6/30/00 $15,424 $21,786 7/31/00 $15,809 $21,446 8/31/00 $16,450 $22,777 9/30/00 $16,473 $21,575 10/31/00 $16,741 $21,484 11/30/00 $16,287 $19,791 12/31/00 $17,024 $19,888 1/31/01 $18,113 $20,593 2/28/01 $17,998 $18,717 3/31/01 $17,460 $17,532 4/30/01 $18,165 $18,893 5/31/01 $18,767 $19,020 6/30/01 $18,886 $18,557 7/31/01 $18,990 $18,374 8/31/01 $18,571 $17,225 9/30/01 $16,935 $15,834 10/31/01 $16,896 $16,137 11/30/01 $17,485 $17,374 12/31/01 $17,885 $17,526 1/31/02 $17,802 $17,271 2/28/02 $17,899 $16,938 3/31/02 $18,382 $17,575 4/30/02 $18,534 $16,510 5/31/02 $18,576 $16,388 6/30/02 $17,276 $15,221 7/31/02 $16,131 $14,035 8/31/02 $16,271 $14,127 9/30/02 $15,377 $12,593 10/31/02 $15,572 $13,701 11/30/02 $15,852 $14,506 12/31/02 $15,740 $13,654 1/31/03 $15,571 $13,297 2/28/03 $15,206 $13,098 3/31/03 $15,234 $13,223 4/30/03 $16,217 $14,313 5/31/03 $17,074 $15,066 6/30/03 $17,361 $15,259 7/31/03 $17,545 $15,528 8/31/03 $18,026 $15,830 9/30/03 $17,984 $15,663 10/31/03 $18,705 $16,548 11/30/03 $19,355 $16,694 12/31/03 $20,185 $17,569 12 | Past performance does not guarantee future results. | Annual Report Performance Summary (CONTINUED) ENDNOTES THE FUND INVESTS IN SMALLER-COMPANY STOCKS AND FOREIGN SECURITIES. SMALLER-COMPANY STOCKS HAVE HISTORICALLY EXHIBITED GREATER PRICE VOLATILITY THAN LARGER-COMPANY STOCKS, PARTICULARLY OVER THE SHORT TERM. FOREIGN SECURITIES RISKS INCLUDE EXPOSURE TO CURRENCY VOLATILITY AND POLITICAL, ECONOMIC AND REGULATORY UNCERTAINTY. THE FUND MAY ALSO INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, AS WELL AS LOWER-RATED "JUNK BONDS," WHICH ENTAIL HIGHER CREDIT RISK. THE FUND'S PROSPECTUS ALSO INCLUDES A DESCRIPTION OF THE MAIN INVESTMENT RISKS. CLASS Z: No initial sales charge or Rule 12b-1 fees; shares are available only to certain investors, as described in the prospectus. CLASS A: Subject to the current, maximum 5.75% initial sales charge. Prior to 8/3/98, Fund shares were offered at a lower initial sales charge; thus actual total returns may differ. CLASS B: Subject to no initial sales charge, but subject to a contingent deferred sales charge (CDSC) declining from 4% to 0% over six years. These shares have higher annual fees and expenses than Class A shares. CLASS C: Subject to 1% initial sales charge and 1% CDSC for shares redeemed within 18 months of investment. These shares have higher annual fees and expenses than Class A shares. 1. Past expense reductions by the Fund's manager increased the Fund's total returns. Without these reductions, the Fund's total returns would have been lower. 2. Cumulative total return represents the change in value of an investment over the periods indicated and does not include sales charges. 3. Average annual total return represents the average annual change in value of an investment over the periods indicated and includes any current, applicable, maximum sales charge(s). 4. These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated and include any current, applicable, maximum sales charge(s). 5. Source: Standard & Poor's Micropal. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The S&P 500 is one of the most widely used benchmarks of U.S. equity performance. Annual Report | Past performance does not guarantee future results. | 13 Mutual Beacon Fund FINANCIAL HIGHLIGHTS
-------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2003 2002 2001 2000 1999 -------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .......................... $11.31 $13.05 $13.38 $13.84 $13.12 -------------------------------------------------------------- Income from investment operations: Net investment income a .................................... .19 .23 .21 .22 .22 Net realized and unrealized gains (losses) ................. 3.13 (1.66) .60 1.62 1.95 -------------------------------------------------------------- Total from investment operations ............................ 3.32 (1.43) .81 1.84 2.17 -------------------------------------------------------------- Less distributions from: Net investment income ...................................... (.23) (.20) (.20) (.44) (.27) Net realized gains ......................................... -- (.11) (.94) (1.86) (1.18) -------------------------------------------------------------- Total distributions ......................................... (.23) (.31) (1.14) (2.30) (1.45) -------------------------------------------------------------- Net asset value, end of year ................................ $14.40 $11.31 $13.05 $13.38 $13.84 -------------------------------------------------------------- Total return b .............................................. 29.44% (11.05)% 6.11% 14.33% 16.79% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............................. $3,112,212 $2,572,002 $3,090,827 $3,041,905 $3,217,509 Ratios to average net assets:* Expensesc .................................................. .86% .80% .79% .81% .79% Expenses excluding waiver and payments by affiliatec ....... .86% .80% .79% .83% .83% Net investment income ...................................... 1.48% 1.88% 1.47% 1.55% 1.52% Portfolio turnover rate ..................................... 49.61% 52.27% 55.25% 62.11% 67.61% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................................... .83% .79% .78% .78% .78% Expenses, excluding waiver and payments by affiliate ....... .83% .79% .78% .80% .82% a Based on average daily shares outstanding. b Total return is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses.
14 | Annual Report Mutual Beacon Fund FINANCIAL HIGHLIGHTS (CONTINUED)
----------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2003 2002 2001 2000 1999 ----------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ............................. $11.27 $13.01 $13.34 $13.81 $13.09 ----------------------------------------------------------- Income from investment operations: Net investment income a ....................................... .14 .19 .16 .17 .17 Net realized and unrealized gains (losses) .................... 3.12 (1.66) .60 1.61 1.95 ----------------------------------------------------------- Total from investment operations ............................... 3.26 (1.47) .76 1.78 2.12 ----------------------------------------------------------- Less distributions from: Net investment income ......................................... (.19) (.16) (.15) (.39) (.21) Net realized gains ............................................ -- (.11) (.94) (1.86) (1.19) ----------------------------------------------------------- Total distributions ............................................ (.19) (.27) (1.09) (2.25) (1.40) ----------------------------------------------------------- Net asset value, end of year ................................... $14.34 $11.27 $13.01 $13.34 $13.81 ----------------------------------------------------------- Total return b ................................................. 28.99% (11.41)% 5.78% 13.89% 16.40% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................................ $1,301,620 $918,983 $977,558 $757,323 $760,769 Ratios to average net assets:* Expenses c .................................................... 1.21% 1.15% 1.14% 1.16% 1.14% Expenses excluding waiver and payments by affiliate c ......... 1.21% 1.15% 1.14% 1.18% 1.18% Net investment income ......................................... 1.13% 1.53% 1.12% 1.20% 1.18% Portfolio turnover rate ........................................ 49.61% 52.27% 55.25% 62.11% 67.61% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ...................................................... 1.18% 1.14% 1.13% 1.13% 1.13% Expenses, excluding waiver and payments by affiliate .......... 1.18% 1.14% 1.13% 1.15% 1.17% a Based on average daily shares outstanding. b Total return does not reflect the sales commissions or the contingent deferred sales charge, and is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses.
Annual Report | 15 Mutual Beacon Fund FINANCIAL HIGHLIGHTS (CONTINUED)
--------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2003 2002 2001 2000 1999 D --------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ............................... $11.07 $12.80 $13.18 $13.69 $13.09 --------------------------------------------------------- Income from investment operations: Net investment income a ......................................... .05 .11 .06 -- .05 Net realized and unrealized gains (losses) ...................... 3.06 (1.63) .60 1.67 1.93 --------------------------------------------------------- Total from investment operations ................................. 3.11 (1.52) .66 1.67 1.98 --------------------------------------------------------- Less distributions from: Net investment income ........................................... (.12) (.10) (.10) (.32) (.19) Net realized gains .............................................. -- (.11) (.94) (1.86) (1.19) --------------------------------------------------------- Total distributions .............................................. (.12) (.21) (1.04) (2.18) (1.38) --------------------------------------------------------- Net asset value, end of year ..................................... $14.06 $11.07 $12.80 $13.18 $13.69 --------------------------------------------------------- Total return b ................................................... 28.22% (11.96)% 5.12% 13.19% 15.33% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) .................................. $155,572 $100,405 $64,512 $18,376 $8,956 Ratios to average net assets:* Expenses c ...................................................... 1.86% 1.80% 1.79% 1.81% 1.79% Expenses excluding waiver and payments by affiliate c ........... 1.86% 1.80% 1.79% 1.83% 1.84% Net investment income ........................................... .48% .88% .44% .58% .37% Portfolio turnover rate .......................................... 49.61% 52.27% 55.25% 62.11% 67.61% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ........................................................ 1.83% 1.79% 1.78% 1.78% 1.78% Expenses, excluding waiver and payments by affiliate ............ 1.83% 1.79% 1.78% 1.80% 1.83% a Based on average daily shares outstanding. b Total return does not reflect contingent deferred sales charge, and is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses. d Effective date of Class B shares was January 1, 1999.
16 | Annual Report Mutual Beacon Fund FINANCIAL HIGHLIGHTS (CONTINUED)
--------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2003 2002 2001 2000 1999 --------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................................ $11.22 $12.94 $13.28 $13.75 $13.04 --------------------------------------------------------- Income from investment operations: Net investment income a .......................................... .06 .11 .07 .08 .07 Net realized and unrealized gains (losses) ....................... 3.09 (1.64) .60 1.61 1.94 --------------------------------------------------------- Total from investment operations .................................. 3.15 (1.53) .67 1.69 2.01 --------------------------------------------------------- Less distributions from: Net investment income ............................................ (.11) (.08) (.07) (.30) (.12) Net realized gains ............................................... -- (.11) (.94) (1.86) (1.18) --------------------------------------------------------- Total distributions ............................................... (.11) (.19) (1.01) (2.16) (1.30) --------------------------------------------------------- Net asset value, end of year ...................................... $14.26 $11.22 $12.94 $13.28 $13.75 --------------------------------------------------------- Total return b .................................................... 28.24% (11.99)% 5.06% 13.21% 15.65% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................................... $579,825 $443,683 $482,080 $419,481 $459,807 Ratios to average net assets:* Expenses c ....................................................... 1.86% 1.79% 1.78% 1.80% 1.78% Expenses excluding waiver and payments by affiliate c ............ 1.86% 1.79% 1.78% 1.82% 1.83% Net investment income ............................................ .48% .89% .48% .56% .52% Portfolio turnover rate ........................................... 49.61% 52.27% 55.25% 62.11% 67.61% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ......................................................... 1.83% 1.78% 1.77% 1.77% 1.77% Expenses, excluding waiver and payments by affiliate ............. 1.83% 1.78% 1.77% 1.79% 1.82% a Based on average daily shares outstanding. b Total return does not reflect the sales commissions or the contingent deferred sales charge, and is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses.
Annual Report | See notes to financial statements. | 17 Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003
------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE ------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS 70.2% AEROSPACE & DEFENSE .7% Northrop Grumman Corp. ......................................... United States 353,800 $ 33,823,280 --------------- AIRLINES a Atlantic Coast Airlines Holdings Inc. .......................... United States 33,800 334,620 --------------- BEVERAGES 5.1% Brown-Forman Corp., A .......................................... United States 154,130 14,942,904 Brown-Forman Corp., B .......................................... United States 181,309 16,943,326 a Carlsberg AS, A ................................................ Denmark 74,900 3,083,218 Carlsberg AS, B ................................................ Denmark 1,403,023 64,647,223 Coca-Cola Enterprises Inc. ..................................... United States 295,800 6,469,146 Diageo PLC ..................................................... United Kingdom 4,764,700 62,692,299 Heineken Holding NV, A ......................................... Netherlands 1,344,211 45,999,552 Orkla ASA ...................................................... Norway 2,066,250 46,276,944 Pepsi Bottling Group Inc. ...................................... United States 111,000 2,683,980 --------------- 263,738,592 --------------- BIOTECHNOLOGY a SICOR Inc. ..................................................... United States 31,700 862,240 --------------- CAPITAL MARKETS .3% Bear Stearns Cos. Inc. ......................................... United States 222,902 17,821,015 --------------- CHEMICALS 1.5% Agrium Inc. .................................................... Canada 824,400 13,569,624 Agrium Inc., fgn. .............................................. Canada 331,200 5,482,196 Givaudan AG .................................................... Switzerland 61,950 32,158,399 Solvay SA ...................................................... Belgium 289,602 25,113,695 --------------- 76,323,914 --------------- COMMERCIAL BANKS 3.6% Allied Irish Banks PLC ......................................... Irish Republic 1,321,618 21,137,886 Bank of Ireland ................................................ Irish Republic 2,675,749 36,416,917 Danske Bank .................................................... Denmark 996,500 23,379,933 DNB Holding ASA ................................................ Norway 2,807,050 18,755,016 First Niagara Financial Group Inc. ............................. United States 1,738,936 25,927,536 Fleet Boston Financial Corp. ................................... United States 155,480 6,786,702 KeyCorp ........................................................ United States 462,000 13,545,840 a,b,c Nippon Investment LLC .......................................... Japan 10,862,000 4,127,560 Unionbancal Corp. .............................................. United States 646,900 37,222,626 --------------- 187,300,016 --------------- COMMERCIAL SERVICES & SUPPLIES .6% a Alderwoods Group Inc. .......................................... United States 634,298 5,975,087 a Cendant Corp. .................................................. United States 1,034,843 23,045,954 --------------- 29,021,041 --------------- COMPUTERS & PERIPHERALS a DecisionOne Corp. .............................................. United States 278,121 556,242 --------------- CONSTRUCTION & ENGINEERING .5% Vinci SA ....................................................... France 334,854 27,728,513 ---------------
18 | Annual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE ------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) DIVERSIFIED FINANCIAL SERVICES 3.4% Brascan Corp., A ............................................... Canada 1,926,000 $ 59,214,533 a,b,c FE Capital Holdings Ltd. ....................................... Japan 13,807 13,807,200 a Irish Life & Permanent PLC ..................................... Irish Republic 2,265,819 36,439,445 a,b Leucadia National Corp. ........................................ United States 865,040 37,884,427 Luminent Mortgage Capital Inc. ................................. United States 269,697 3,802,728 Pargesa Holdings SA ............................................ Switzerland 9,656 25,764,948 --------------- 176,913,281 --------------- DIVERSIFIED TELECOMMUNICATION SERVICES 2.7% a,b,d AboveNet Inc. .................................................. United States 81,636 2,445,349 BCE Inc. ....................................................... Canada 786,900 17,598,305 Global Crossing Holdings Ltd., Contingent Equity Distribution .. United States 60,719,932 53,130 a Global Crossing Ltd. ........................................... United States 91,940 3,034,031 a NTL Inc. ....................................................... United Kingdom 716,421 49,970,365 a,b NTL Inc. ....................................................... United Kingdom 542,874 35,972,188 a Spectrasite Inc. ............................................... United States 632,164 21,967,699 a XO Communications Inc. ......................................... United States 1,349,370 5,734,823 --------------- 136,775,890 --------------- ELECTRIC UTILITIES .8% E.ON AG ........................................................ Germany 509,780 33,391,619 a,b PG & E Corp., wts., 9/02/06 .................................... United States 15,572 389,051 a Reliant Resources Inc. ......................................... United States 1,285,300 9,459,808 --------------- 43,240,478 --------------- FOOD & STAPLES RETAILING .4% a Kroger Co. ..................................................... United States 839,740 15,543,587 a Safeway Inc. ................................................... United States 286,000 6,266,260 --------------- 21,809,847 --------------- FOOD PRODUCTS 4.4% Cadbury Schweppes PLC .......................................... United Kingdom 4,497,511 33,030,270 CSM NV ......................................................... Netherlands 632,207 13,827,534 Farmer Brothers Co. ............................................ United States 93,236 29,019,705 Groupe Danone .................................................. France 361,000 58,922,048 Nestle SA ...................................................... Switzerland 198,235 49,528,696 Weetabix Ltd., A ............................................... United Kingdom 462,733 43,903,348 --------------- 228,231,601 --------------- HEALTH CARE EQUIPMENT & SUPPLIES .6% Hillenbrand Industries Inc. .................................... United States 471,400 29,255,084 --------------- HEALTH CARE PROVIDERS & SERVICES 1.4% a AdvancePCS ..................................................... United States 42,700 2,248,582 HCA Inc. ....................................................... United States 341,900 14,688,024 a,c,d Kindred Healthcare Inc. ........................................ United States 682,285 33,691,915 c,d Kindred Healthcare Inc., Jan. 52 Calls, 1/01/13 ................ United States 166 -- c,d Kindred Healthcare Inc., Jul. 47.50 Calls, 7/11/11 ............. United States 1,106 495,488 a,c,d Kindred Healthcare Inc., wts., Series A, 4/20/06 ............... United States 121,432 2,824,023 a,c,d Kindred Healthcare Inc., wts., Series B, 4/20/06 ............... United States 303,580 6,359,242
Annual Report | 19 Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE ------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) HEALTH CARE PROVIDERS & SERVICES (CONT.) a Laboratory Corp. of America Holdings ........................... United States 93,200 $ 3,443,740 a Mid Atlantic Medical Services Inc. ............................. United States 36,000 2,332,800 a Rotech Healthcare Inc. ......................................... United States 214,860 4,941,780 a Wellpoint Health Networks Inc. ................................. United States 21,200 2,056,188 --------------- 73,081,782 --------------- HOTELS RESTAURANTS & LEISURE .3% Cara Operations Ltd. ........................................... Canada 11,800 65,654 Cara Operations Ltd., A ........................................ Canada 331,400 1,815,680 a,c FHC Delaware Inc. .............................................. United States 507,977 3,997,779 a Park Place Entertainment Corp. ................................. United States 637,800 6,907,374 --------------- 12,786,487 --------------- INSURANCE 10.0% a Alleghany Corp. ................................................ United States 156,697 34,865,083 a Berkshire Hathaway Inc., A ..................................... United States 741 62,429,250 a Berkshire Hathaway Inc., B ..................................... United States 24,750 69,671,250 Hartford Financial Services Group Inc. ......................... United States 500,800 29,562,224 John Hancock Financial Services Inc. ........................... United States 183,600 6,885,000 a Montpelier Re Holdings Ltd. .................................... Bermuda 242,150 8,886,905 Old Republic International Corp. ............................... United States 1,655,145 41,974,477 a,b Olympus Re Holdings Ltd. ....................................... Bermuda 106,700 16,876,739 Prudential Financial Inc. ...................................... United States 722,500 30,178,825 Travelers Property Casualty Corp., A ........................... United States 2,388,800 40,084,064 White Mountains Insurance Group Inc. ........................... United States 248,918 114,489,834 b White Mountains Insurance Group Inc. ........................... United States 139,203 60,825,099 --------------- 516,728,750 --------------- IT SERVICES .1% Comdisco Contingent Equity Distribution ........................ United States 54,914,113 203,182 a Comdisco Holding Co. Inc. ...................................... United States 117 4,680 a Concord EFS Inc. ............................................... United States 246,100 3,652,124 --------------- 3,859,986 --------------- LEISURE EQUIPMENT & PRODUCTS .6% Nintendo Co. Ltd. .............................................. Japan 336,200 31,370,719 --------------- MACHINERY .8% a,b Lancer Industries Inc., B ...................................... United States 1 245,476 a Mueller Industries Inc. ........................................ United States 1,125,835 38,683,691 --------------- 38,929,167 --------------- MARINE .3% Alexander & Baldwin Inc. ....................................... United States 458,700 15,453,603 --------------- MEDIA 6.7% Dow Jones & Co. Inc. ........................................... United States 191,200 9,531,320 E.W. Scripps Co., A ............................................ United States 549,525 51,732,283 a EchoStar Communications Corp., A ............................... United States 455,830 15,498,220 a Fox Entertainment Group Inc., A ................................ United States 193,410 5,637,902 Gannett Co. Inc. ............................................... United States 74,800 6,669,168
20 | Annual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE ------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) MEDIA (CONT.) Lagardere SCA .................................................. France 109,611 $ 6,328,072 a Liberty Media Corp., A ......................................... United States 6,957,360 82,723,010 McGraw-Hill Cos. Inc. .......................................... United States 81,000 5,663,520 Meredith Corp. ................................................. United States 570,410 27,841,712 a NTL Europe Inc. ................................................ United Kingdom 281,656 2,817 NV Holdingsmig de Telegraaf .................................... Netherlands 1,116,761 25,496,183 Omnicom Group Inc. ............................................. United States 127,900 11,169,507 a TVMAX Holdings Inc. ............................................ United States 74,205 185,513 Washington Post Co., B ......................................... United States 119,022 94,194,011 --------------- 342,673,238 --------------- METALS & MINING 7.7% Alcan Inc. ..................................................... Canada 4,157 195,171 Anglo American PLC ............................................. United Kingdom 1,707,083 36,885,290 Anglo American PLC, ADR ........................................ United Kingdom 1,200 26,544 a Ashanti Goldfields Co. Ltd., GDR, Reg S ........................ Ghana 182,300 2,377,192 Barrick Gold Corp. ............................................. Canada 1,418,600 32,216,406 a Coeur D'Alene Mines Corp. ...................................... United States 4,394,400 25,399,632 Consol Energy Inc. ............................................. United States 34,000 880,600 b Consol Energy Inc. ............................................. United States 1,187,100 27,671,301 Falconbridge Ltd. .............................................. Canada 1,200 29,121 a Glamis Gold Ltd. ............................................... Canada 802,700 13,839,548 Gold Fields Ltd. ............................................... South Africa 555,700 7,950,465 Impala Platinum Holdings Ltd. .................................. South Africa 809,948 70,377,504 a,b International Steel Group ...................................... United States 3,546,660 117,421,046 Newmont Mining Corp. ........................................... United States 966,100 46,962,121 Noranda Inc. ................................................... Canada 71,300 1,133,848 Placer Dome Inc. ............................................... Canada 214,600 3,847,771 a Randgold & Exploration Co. Ltd., ADR ........................... South Africa 32,600 534,607 a Wheaton River Minerals Ltd. .................................... Canada 2,242,026 6,714,367 Wheaton River Minerals Ltd., wts., 5/30/07 ..................... Canada 930,257 1,662,908 --------------- 396,125,442 --------------- OIL & GAS 1.3% BP PLC ......................................................... United Kingdom 2,690,300 21,816,758 BP PLC, ADR .................................................... United Kingdom 26,100 1,288,035 Occidental Petroleum Corp. ..................................... United States 106,300 4,490,112 a,c Southwest Royalties Inc., A .................................... United States 69,184 2,075,530 Total SA, B .................................................... France 207,900 38,653,456 --------------- 68,323,891 --------------- PERSONAL PRODUCTS .4% Beiersdorf AG .................................................. Germany 180,500 22,118,536 --------------- PHARMACEUTICALS 1.1% Merck & Co. Inc. ............................................... United States 489,370 22,608,894 Takeda Chemical Industries Ltd. ................................ Japan 732,680 29,055,613 Wyeth .......................................................... United States 69,800 2,963,010 --------------- 54,627,517 ---------------
Annual Report | 21 Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE ------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) REAL ESTATE 3.6% a Alexander's Inc. ............................................... United States 38,800 $ 4,836,808 American Financial Realty Trust ................................ United States 1,985,200 33,847,660 a Canary Wharf Group PLC ......................................... United Kingdom 10,069,634 48,265,239 Friedman Billings Ramsey Group Inc., A ......................... United States 1,771,000 40,874,680 iStar Financial Inc. ........................................... United States 466,000 18,127,400 a,b Security Capital European Realty ............................... Luxembourg 161,960 1,206,602 St. Joe Co. .................................................... United States 400,698 14,942,028 Ventas Inc. .................................................... United States 1,009,500 22,209,000 --------------- 184,309,417 --------------- ROAD & RAIL 2.4% Burlington Northern Santa Fe Corp. ............................. United States 617,215 19,966,905 Canadian National Railway Co. .................................. Canada 463,445 29,408,001 Florida East Coast Industries Inc., A .......................... United States 1,558,536 51,587,542 Norfolk Southern Corp. ......................................... United States 843,900 19,958,235 --------------- 120,920,683 --------------- SPECIALTY RETAIL New Look Group ................................................. United Kingdom 222,700 1,239,858 --------------- THRIFTS & MORTGAGE FINANCE 2.4% Astoria Financial Corp. ........................................ United States 1,188,245 44,202,714 Commercial Federal Corp. ....................................... United States 778,267 20,787,512 Freddie Mac .................................................... United States 572,300 33,376,536 Greenpoint Financial Corp. ..................................... United States 162,427 5,736,922 Hudson City Bancorp Inc. ....................................... United States 471,130 17,987,743 --------------- 122,091,427 --------------- TOBACCO 6.1% Altadis SA ..................................................... Spain 3,686,149 104,614,471 Altria Group Inc. .............................................. United States 543,885 29,598,221 British American Tobacco PLC ................................... United Kingdom 6,316,228 87,064,241 British American Tobacco PLC, ADR .............................. United Kingdom 40,400 1,117,868 Imperial Tobacco Group PLC ..................................... United Kingdom 2,312,889 45,544,797 Korea Tobacco & Ginseng Corp., GDR, 144A ....................... South Korea 1,579,000 13,863,620 R.J. Reynolds Tobacco Holdings Inc. ............................ United States 584,200 33,971,230 --------------- 315,774,448 --------------- TRANSPORTATION INFRASTRUCTURE .4% a Laidlaw International Inc. ..................................... United States 977,902 13,524,385 Peninsular & Oriental Steam Navigation Co. ..................... United Kingdom 1,246,088 5,130,596 --------------- 18,654,981 --------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $2,387,406,199) ........................................ 3,612,805,586 --------------- PREFERRED STOCKS .6% ELECTRIC UTILITIES a Montana Power Co., 8.45%, pfd. ................................. United States 58,900 706,800 ---------------
22 | Annual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE ------------------------------------------------------------------------------------------------------------------------------ PREFERRED STOCKS (CONT.) FOOD PRODUCTS .1% Unilever NV, pfd. .............................................. Netherlands 606,458 $ 4,352,606 --------------- MEDIA .1% News Corp. Ltd., ADR, pfd. ..................................... Australia 67,100 2,029,775 NTL Europe Inc., 10.00%, A, pfd. ............................... United Kingdom 123,963 1,019,596 --------------- 3,049,371 --------------- REAL ESTATE .4% iStar Financial Inc., pfd. ..................................... United States 770,100 20,138,115 --------------- TOTAL PREFERRED STOCKS (COST $26,033,170) ...................... 28,246,892 --------------- ------------------- PRINCIPAL AMOUNT E ------------------- CORPORATE BONDS & NOTES 3.2% Calpine Constructor Finance, 8.50%, 8/26/11 ............................................... United States $ 6,157,000 6,403,280 First Priority Term Loan, 8/26/09 ............................ United States 4,900,000 5,145,000 Calpine Corp., 144A, 9.875%, 12/01/11 .......................... United States 12,156,000 12,551,070 Charter Communications Operating LLC, Bank Claim ............... United States 8,878,800 8,568,042 DecisionOne Corp., Term Loan ................................... United States 8,479,780 5,899,069 Eurotunnel PLC, 12/31/18, Tier 2 ............................................. United Kingdom 7,592,095 GBP 9,921,465 12/31/25, Tier 3 ............................................. United Kingdom 8,372,985 GBP 8,243,930 Participating Loan Note, 4/30/40 ............................. United Kingdom 858,000 GBP 330,230 Stabilization Advance S8, Tier 2 ............................. United Kingdom 4,204,174 GBP 1,429,966 Eurotunnel SA, 5.28%, 12/31/18, Tier 2 (Pibor) .............................. France 832,034 EUR 766,126 5.28%, 12/31/25, Tier 3 (Pibor) .............................. France 1,048,320 EUR 727,265 12/31/18, Tier 2 (Libor) ..................................... France 1,880,987 EUR 1,731,988 12/31/25, Tier 3 (Libor) ..................................... France 11,353,301 EUR 7,876,281 Stabilization Advance S6, Tier 1 (Pibor) ..................... France 435,330 EUR 104,330 Stabilization Advance S6, Tier 2 (Libor) ..................... France 1,261,133 EUR 302,239 Stabilization Advance S7, Tier 1 (Pibor) ..................... France 1,768,329 EUR 423,792 b FE Capital LLC, 5.00%, 8/28/07 ................................. Japan 18,902,566 19,280,618 Healthsouth Corp., 8.50%, 2/01/08 ............................................... United States 6,445,000 6,219,425 7.00%, 6/15/08 ............................................... United States 3,470,000 3,253,125 8.375%, 10/01/11 ............................................. United States 2,075,000 1,971,250 7.625%, 6/01/12 .............................................. United States 16,764,000 15,758,160 cvt., 3.25% .................................................. United States 10,784,000 10,460,480 Marconi Corp., 10.00%, 10/31/08 ................................ United Kingdom 1,753,238 1,946,094 Marconi PLC, 8.00%, 4/30/08 .................................... United Kingdom 8,720,291 8,545,885 Mirant Mid-Atlantic LLC, 8.625%, 6/30/12 .............................................. United States 3,522,191 3,533,137 9.125%, 6/30/17 .............................................. United States 1,815,891 1,817,026 10.06%, 12/30/28 ............................................. United States 3,726,676 3,766,272 Providian Financial Corp., cvt., zero cpn., 2/15/21 ............ United States 17,565,000 8,387,288
Annual Report | 23 Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------ COUNTRY PRINCIPAL AMOUNT E VALUE ------------------------------------------------------------------------------------------------------------------------------ CORPORATE BONDS & NOTES (CONT.) Teco Panda, Bank Claim #2 ................................................ United States $ 8,516,800 $ 6,089,512 Project L/C Loan Facility .................................... United States 1,221,000 873,015 Debt Service Reserve L/C Loan ................................ United States 488,400 349,206 TVMAX Holdings Inc., PIK, 14.00%, 2/01/06 ...................... United States 342,284 342,284 --------------- TOTAL CORPORATE BONDS & NOTES (COST $140,846,290) .............. 163,016,850 --------------- BONDS & NOTES IN REORGANIZATION 7.4% a Adelphia Communications Corp., 9.25%, 10/01/02 .............................................. United States 3,321,000 3,088,530 8.125%, 7/15/03 .............................................. United States 825,000 767,250 7.50%, 1/15/04 ............................................... United States 2,160,000 1,998,000 10.50%, 7/15/04 .............................................. United States 3,375,000 3,189,375 10.25%, 11/01/06 ............................................. United States 5,231,000 4,890,985 8.375%, 2/01/08 .............................................. United States 6,660,000 6,243,750 7.75%, 1/15/09 ............................................... United States 5,790,000 5,413,650 7.875%, 5/01/09 .............................................. United States 4,025,000 3,703,000 9.375%, 11/15/09 ............................................. United States 2,420,000 2,299,000 10.25%, 6/15/11 .............................................. United States 6,731,000 6,394,450 a AES Drax Holdings Ltd., 10.41%, 12/31/20 ............................................. Cayman Islands 5,790,000 5,095,200 9.07%, 12/31/25 .............................................. Cayman Islands 6,395,000 GBP 9,902,571 a Aiken Cnty S C Indl Rev Beloit, 6.00%, 12/01/11 ................ United States 420,000 2,100 a Air Canada Inc., 6.75%, 2/02/04 ............................................... Canada 1,244,000 CAD 351,372 9.00%, 6/01/06 ............................................... Canada 2,160,000 CAD 618,456 10.00%, 6/01/06 .............................................. Canada 2,035,000 EUR 1,090,912 7.25%, 10/01/07 .............................................. Canada 3,838,000 CAD 1,046,930 10.25%, 3/15/11 .............................................. Canada 5,576,000 2,272,220 Bank Claim ................................................... Canada 9,884,600 CAD 2,753,690 Bank Claim ................................................... Canada 245,929,000 JPY 872,007 Term Loan .................................................... Canada 7,212,000 2,668,440 zero cpn., 7/31/05 ........................................... Canada 10,363,692 3,990,021 a Barings BV, 1/22/01 ...................................................... Netherlands 25,350,000 8,872,500 bank claim ................................................... United Kingdom 993,558 GBP 1,778,625 a,b CA Ltd., 5.00%, 8/28/07 ........................................ Japan 20,334,434 20,741,123 a Century Communications Corp., 9.50%, 3/01/05 ............................................... United States 425,000 412,250 8.875%, 1/15/07 .............................................. United States 330,000 321,750 8.375%, 12/15/07 ............................................. United States 500,000 488,750 zero cpn., 3/15/03 ........................................... United States 6,175,000 5,495,750 a Dow Corning Corp., 9.50, 8/10/95 ................................................ United States 350,000 763,000 9.30%, 1/27/98 ............................................... United States 1,835,000 4,000,300 8.55%, 3/01/01 ............................................... United States 1,100,000 2,035,000 9.375%, 2/01/08 .............................................. United States 790,000 1,722,200 8.15%, 10/15/29 .............................................. United States 7,050,000 13,395,000 Bank Claim ................................................... United States 7,677,843 13,820,118
24 | Annual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------ COUNTRY PRINCIPAL AMOUNT E VALUE ------------------------------------------------------------------------------------------------------------------------------ BONDS & NOTES IN REORGANIZATION (CONT.) a Dow Corning Corp., (cont.) Bank Debt .................................................... United States $ 2,070,704 $ 3,727,267 Bank Debt #1 ................................................. United States 2,850,000 5,130,000 a Harnischfeger Industries Inc., 8.90%, 3/01/22 ............................................... United States 3,775,000 21,140 8.70%, 6/15/22 ............................................... United States 3,460,000 19,722 7.25%, 12/15/25 .............................................. United States 5,165,000 29,440 6.875%, 2/15/27 .............................................. United States 4,430,000 24,808 Stipulated Bank Claim ........................................ United States 5,708,150 31,395 a Metromedia Fiber Network Inc., 14.00%, 3/15/07 .............................................. United States 23,101,000 12,243,530 10.00%, 11/15/08 ............................................. United States 15,410,000 1,059,437 senior note, 10.00%, 12/15/09 ................................ United States 15,751,000 1,122,259 senior note, 10.00%, 12/15/09 ................................ United States 7,240,000 EUR 684,914 a Mirant Corp., Tranche C Revolver ........................................... United States 7,016,181 4,350,032 4 Year Revolver, 7/17/05 ..................................... United States 5,785,330 4,512,557 364 Day Revolver ............................................. United States 10,047,600 5,928,084 a Northwestern Corp., 8.75%, 3/15/12 ............................................... United States 7,795,000 7,073,962 6.95%, 11/15/28 .............................................. United States 4,010,000 3,593,962 a NRG Energy Inc., 7.625%, 2/01/06 .............................................. United States 5,570,000 3,147,050 6.75%, 7/15/06 ............................................... United States 9,980,000 5,638,700 7.50%, 6/15/07 ............................................... United States 5,750,000 3,277,500 7.50%, 6/01/09 ............................................... United States 5,085,000 2,898,450 8.25%, 9/15/10 ............................................... United States 6,710,000 3,925,350 7.75%, 4/01/11 ............................................... United States 695,000 399,625 8.00%, 11/01/13 .............................................. United States 7,075,000 4,068,125 8.70%, 3/15/20 ............................................... United States 3,440,000 1,995,200 8.625%, 4/01/31 .............................................. United States 5,000,000 2,925,000 Revolver ..................................................... United States 21,905,494 13,581,406 a Owens Corning, Revolver ........................................ United States 26,469,834 19,852,376 a Parmalat Netherlands BV, 0.875%, 6/30/21 ....................... Italy 3,680,000 EUR 1,164,854 a PG & E Corp., 7.375%, 11/01/05 ............................................. United States 20,804,000 21,220,080 Commercial Paper, 1/18/01 .................................... United States 835,000 839,175 Commercial Paper, 1/30/01 .................................... United States 415,000 417,075 Commercial Paper, 2/16/01 .................................... United States 1,260,000 1,266,300 FRN, 144A, 7.583%, 10/31/01 .................................. United States 7,332,000 7,478,640 MTN, 5.94%, 10/07/03 ......................................... United States 1,050,000 1,055,250 a Port Seattle Wash Rev Ref-Beloit Proj., 6.00%, 12/01/17 ........ United States 225,000 1,125 a Safety Kleen Corp., 9.25%, 5/15/09 ............................. United States 630,000 31,500 a Safety Kleen Services, 9.25%, 6/01/08 .......................... United States 50,000 250 a Telewest Communications PLC, 11.00%, 10/01/07 ............................................. United Kingdom 8,250,000 5,403,750 11.25%, 11/01/08 ............................................. United Kingdom 1,270,000 822,325 9.875%, 2/01/10 .............................................. United Kingdom 2,585,000 GBP 2,730,259 Bank Claim ................................................... United Kingdom 31,121,864 GBP 26,463,696 cvt., 5.25%, 2/19/07 ......................................... United Kingdom 7,750,000 GBP 7,353,073
Annual Report | 25 Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------ COUNTRY PRINCIPAL AMOUNT E VALUE ------------------------------------------------------------------------------------------------------------------------------ BONDS & NOTES IN REORGANIZATION (CONT.) a Telewest Communications PLC, (cont.) senior disc. note, zero cpn., 4/15/09 ........................ United Kingdom $ 3,290,000 $ 1,727,250 senior disc. note, zero cpn., 2/01/10 ........................ United Kingdom 2,525,000 1,249,875 zero cpn., 4/15/04 ........................................... United Kingdom 9,950,000 GBP 8,906,035 a Telewest Finance Ltd., cvt, 6.00%, 7/07/05 ..................... United Kingdom 7,240,000 7,674,400 a WorldCom Inc., 7.875%, 5/15/03 .............................................. United States 7,375,000 2,489,062 6.25%, 8/15/03 ............................................... United States 875,000 295,312 6.50%, 5/15/04 ............................................... United States 1,080,000 364,500 6.40%, 8/15/05 ............................................... United States 9,190,000 3,101,625 7.375%, 1/15/06 .............................................. United States 1,970,000 664,875 8.00%, 5/15/06 ............................................... United States 3,050,000 1,029,375 7.75%, 4/01/07 ............................................... United States 4,980,000 1,680,750 8.25%, 5/15/10 ............................................... United States 9,015,000 3,042,563 7.375%, 1/15/11 .............................................. United States 19,879,000 6,709,163 7.50%, 5/15/11 ............................................... United States 18,465,000 6,231,938 7.75%, 4/01/27 ............................................... United States 1,675,000 565,313 6.95%, 8/15/28 ............................................... United States 440,000 148,500 8.25%, 5/15/31 ............................................... United States 22,655,000 7,646,063 --------------- TOTAL BONDS & NOTES IN REORGANIZATION (COST $287,601,933) ...... 383,533,517 --------------- ----------------- SHARES/PRINCIPAL AMOUNT E ----------------- COMPANIES IN LIQUIDATION a Brunos Inc., Liquidating Unit .................................. United States 62,735 138,017 a City Investing Company Liquidating Trust ....................... United States 423,187 882,345 a Eli Jacobs, Bank Claim ......................................... United States 25,305,910 162,489 a Guangdong International Trust & Investment Corp., 144A, 8.75%, 10/24/16 ........................................ China 3,250,000 203,125 Revolver - Admitted Claim .................................... Hong Kong 670,980 41,936 Structured Note - Admitted Claim ............................. Hong Kong 1,061,381 66,336 Syndicated Loan - Admitted Claim ............................. Hong Kong 1,835,131 114,696 a MBOP Liquidating Trust ......................................... United States 205,135 513 --------------- TOTAL COMPANIES IN LIQUIDATION (COST $559,652) ................. 1,609,457 --------------- ------------------ PRINCIPAL AMOUNT E ------------------ GOVERNMENT AGENCIES 19.1% Canada Treasury Bill, 3.353%, 2/26/04 .......................... Canada 16,600,000 CAD 12,792,929 f Federal Home Loan Bank, 0.75% to 2.51%, with maturities to 7/02/07 United States 583,125,000 634,815,855 f Federal Home Loan Mortgage Corp., 0.99% to 2.50%, with maturities to 5/19/06 .................................... United States 105,000,000 104,830,260 Federal National Mortgage Association, 0.966% to 2.200%, with maturities to 12/29/06 ................................... United States 211,875,000 211,240,739 U.S. Treasury Bills, 0.934% to 1.035%, with maturities to 5/06/04 United States 14,000,000 20,965,220 --------------- TOTAL GOVERNMENT AGENCIES (COST $983,484,518) .................. 984,645,003 --------------- TOTAL INVESTMENTS BEFORE REPURCHASE AGREEMENTS (COST $3,825,931,762) ........................................ 5,173,857,305 ---------------
26 | Annual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------ COUNTRY PRINCIPAL AMOUNT E VALUE ------------------------------------------------------------------------------------------------------------------------------ REPURCHASE AGREEMENTS .3% g,h Deutsche Bank Securities Inc., 1.03%, 1/02/04 (Maturity Value $1,894,641) Collateralized by U.S. Treasury Bills, Notes and Bonds .............................................. $1,894,054 $ 1,894,054 g,h Goldman Sachs, 1.02%, 1/02/04 (Maturity Value $4,000,337) Collateralized by U.S. Treasury Bills, Notes and Bonds ....... 4,000,113 4,000,113 g,h JP Morgan Securities, 1.01%, 1/02/04 (Maturity Value $4,000,333) Collateralized by U.S. Treasury Bills, Notes and Bonds ....... 4,000,112 4,000,112 g,h Morgan Stanley & Co., 1.03%, 1/02/04 (Maturity Value $1,000,085) Collateralized by U.S. Treasury Bills, Notes and Bonds ....... 1,000,029 1,000,029 g,h Morgan Stanley & Co., 1.03%, 1/02/04 (Maturity Value $3,400,289) Collateralized by U.S. Treasury Bills, Notes and Bonds ....... 3,400,097 3,400,097 g,h UBS Securities LLC, 1.00%, 1/02/04 (Maturity Value $3,600,297) Collateralized by U.S. Treasury Bills, Notes and Bonds ....... 3,600,100 3,600,100 --------------- TOTAL REPURCHASE AGREEMENTS (COST $17,894,505) ................. 17,894,505 --------------- TOTAL INVESTMENTS (COST $3,843,826,267) 100.8% ................. 5,191,751,810 SECURITIES SOLD SHORT (.8)% .................................... (41,096,077) NET EQUITY IN FORWARD CONTRACTS (1.3)% ......................... (66,635,582) OTHER ASSETS, LESS LIABILITIES 1.3% ............................ 65,208,442 --------------- NET ASSETS 100.0% .............................................. $5,149,228,593 --------------- ------------- CONTRACTS ------------- OPTIONS WRITTEN (PREMIUMS RECEIVED $337,343) DIVERSIFIED TELECOMMUNICATION SERVICES XO Communications Inc., Jun. 4.25 Calls, 6/21/04 ............... United States 1,349,370 -- --------------- ------------- SECURITIES SOLD SHORT SHARES ------------- ISSUER CAPITAL MARKETS i Lehman Brothers Holdings Inc. .................................. United States 10,913 842,702 --------------- COMMERCIAL BANKS .1% i Bank of America Corp. .......................................... United States 86,400 6,949,152 --------------- FOOD PRODUCTS .2% i Kraft Foods Inc., A ............................................ United States 350,600 11,296,332 --------------- HEALTH CARE PROVIDERS & SERVICES .1% i Anthem Inc. .................................................... United States 21,200 1,590,000 i Caremark RX Inc. ............................................... United States 92,100 2,332,893 i United Health Group Inc. ....................................... United States 29,600 1,722,128 --------------- 5,645,021 --------------- INSURANCE .1% i Manulife Financial Corp. ....................................... Canada 217,600 7,028,480 --------------- INTERNET SOFTWARE & SERVICES i Yahoo! Inc. .................................................... United States 23,398 1,056,888 --------------- IT SERVICES .1% i First Data Corp. ............................................... United States 71,360 2,932,182 ---------------
Annual Report | 27 Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------ COUNTRY SHARES VALUE ------------------------------------------------------------------------------------------------------------------------------ SECURITIES SOLD SHORT (CONT.) MEDIA .1% i News Corp. Ltd., ADR ....................................... Australia 55,000 $ 1,985,500 --------------- METALS & MINING .1% i AngloGold Ltd., ADR ........................................ South Africa 52,900 2,470,430 i Randgold Resources Ltd., ADR ............................... United Kingdom 19,855 542,041 --------------- 3,012,471 --------------- PHARMACEUTICALS i Teva Pharmaceutical Industries Ltd., ADR ................... Israel 6,125 347,349 --------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $41,048,905) ......... $ 41,096,077 --------------- ----------------------------------------- VALUE AT UNREALIZED SYNTHETIC EQUITY SWAPS (SES) SHARES 12/31/03 GAIN/LOSS ----------------------------------------- ISSUER HEALTH CARE EQUIPMENT & SUPPLIES j Smith & Nephew PLC, ses., 3.752 GBP ........................ United Kingdom (1,160) $ (9,744) $ (1,967) j Smith & Nephew PLC, ses., 3.776 GBP ........................ United Kingdom (20,800) (174,727) (34,388) ------------------------------ (184,471) (36,355) ------------------------------ INSURANCE j AXA SA, ses., 15.850 EUR ................................... France 18,283 391,350 25,109 j AXA SA, ses., 15.870 EUR ................................... France 4,400 94,183 5,932 j AXA SA, ses., 16.700 EUR ................................... France (18,283) (391,350) (6,985) j AXA SA, ses., 16.770 EUR ................................... France (4,400) (94,183) (1,293) ------------------------------ -- 22,763 ------------------------------ REAL ESTATE j Chelsfield PLC, ses., 3.095 GBP ............................ United Kingdom 5,700 31,351 (276) j Chelsfield PLC, ses., 3.107 GBP ............................ United Kingdom 17,700 97,355 (1,251) j Chelsfield PLC, ses., 3.112 GBP ............................ United Kingdom 12,717 69,947 (1,087) j Chelsfield PLC, ses., 3.154 GBP ............................ United Kingdom 189,300 1,041,199 (29,106) j Chelsfield PLC, ses., 3.160 GBP ............................ United Kingdom 64,700 355,867 (10,653) j Chelsfield PLC, ses., 3.165 GBP ............................ United Kingdom 28,400 156,207 (4,927) j Chelsfield PLC, ses., 3.166 GBP ............................ United Kingdom 94,700 520,875 (16,597) ------------------------------ 2,272,801 (63,897) ------------------------------ TEXTILES APPAREL & LUXURY GOODS j Christian Dior SA, ses., 46.766 EUR ........................ France 4,725 286,253 7,018 j Christian Dior SA, ses., 47.220 EUR ........................ France 3,556 215,432 3,218 j Christian Dior SA, ses., 47.384 EUR ........................ France 9,430 571,295 6,901 j Christian Dior SA, ses., 47.614 EUR ........................ France 9,430 571,295 3,894 j Christian Dior SA, ses., 47.794 EUR ........................ France 4,277 259,112 768 j Christian Dior SA, ses., 48.208 EUR ........................ France 9,176 555,907 (3,101) j Christian Dior SA, ses., 48.555 EUR ........................ France 5,635 341,384 (4,373) j Christian Dior SA, ses., 48.586 EUR ........................ France 9,432 571,416 (7,669) j CChristian Dior SA, ses., 48.791 EUR ....................... France 3,757 227,609 (4,034) j Christian Dior SA, ses., 49.000 EUR ........................ France 251 15,206 (335) j Christian Dior SA, ses., 49.027 EUR ........................ France 1,393 84,392 (1,910)
28 | Annual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------ VALUE AT UNREALZED COUNTRY SHARES 12/31/03 GAIN/LOSS ------------------------------------------------------------------------------------------------------------------------------ SYNTHETIC EQUITY SWAPS (SES) (CONT.) TEXTILES APPAREL & LUXURY GOODS (CONT.) j LVMH Moet Hennessy Louis Vuitton, ses., 56.520 EUR ......... France (3,556) $ (258,806) $ (5,790) j LVMH Moet Hennessy Louis Vuitton, ses., 57.050 EUR ......... France (4,277) (311,280) (4,109) j LVMH Moet Hennessy Louis Vuitton, ses., 58.672 EUR ......... France (9,430) (686,316) 10,587 j LVMH Moet Hennessy Louis Vuitton, ses., 58.861 EUR ......... France (4,725) (343,886) 6,272 j LVMH Moet Hennessy Louis Vuitton, ses., 58.899 EUR ......... France (9,430) (686,316) 12,970 j LVMH Moet Hennessy Louis Vuitton, ses., 59.841 EUR ......... France (9,176) (667,829) 23,494 j LVMH Moet Hennessy Louis Vuitton, ses., 60.149 EUR ......... France (5,635) (410,115) 16,607 j LVMH Moet Hennessy Louis Vuitton, ses., 60.309 EUR ......... France (3,757) (273,435) 11,834 j LVMH Moet Hennessy Louis Vuitton, ses., 60.421 EUR ......... France (9,432) (686,461) 31,061 j LVMH Moet Hennessy Louis Vuitton, ses., 60.949 EUR ......... France (1,393) (101,383) 5,514 j LVMH Moet Hennessy Louis Vuitton, ses., 60.950 EUR ......... France (251) (18,268) 994 ------------------------------ (744,794) 109,811 ------------------------------ TOTAL SYNTHETIC EQUITY SWAPS ............................... $1,343,536 $ 32,322 ------------------------------ CURRENCY ABBREVIATIONS | CAD - Canadian Dollar | EUR - Euro | GBP - British Pound | JPY - Japanese Yen a Non-income producing. b See Note 7 regarding restricted securities. c See Note 8 regarding Holdings of 5% Voting Securities. d A member of the Fund's Portfolio Management team serves as a member on the board of directors. As a result of this involvement, the Portfolio Manager could receive material non-public information which, pursuant to the Fund's policies and the requirements of the federal securities laws, could prevent the Fund from trading in the securities of such companies for limited or extended periods of time. e The principal amount is stated in U.S. dollars unless otherwise indicated. f See Note 1(h) regarding securities segregated with broker for securities sold short. g Collateral for loaned securities. See Note 1(i). h See Note 1(c) regarding repurchase agreements. i See Note 1(h) regarding securities sold short. j See Note 1(f) regarding synthetic equity swaps.
Annual Report | See notes to financial statements. | 29 Mutual Beacon Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2003
Assets: Investments in securities: Cost - Unaffiliated issuers ........................................................................... $3,805,620,068 Cost - Non-controlled affiliated issuers .............................................................. 38,206,199 --------------- Value - Unaffiliated issuers (includes securities segregated with broker for securities sold short in the amount of $38,989,266) ........................................................................ 5,124,373,073 Value - Non-controlled affiliated issuers ............................................................. 67,378,737 Cash ................................................................................................... 1,499,149 Foreign currency, at value (cost $37,734,202) .......................................................... 38,906,110 Receivables: Investment securities sold ............................................................................ 25,256,189 Capital shares sold ................................................................................... 3,376,836 Dividends and interest ................................................................................ 10,172,745 Unrealized gain on forward exchange contracts (Note 6) ................................................. 4,018,333 Deposits with broker for securities sold short ......................................................... 43,361,093 Due from broker - variation margin (Note 1f) ........................................................... 427,274 --------------- Total assets ...................................................................................... 5,318,769,539 --------------- Liabilities: Payables: Investment securities purchased ....................................................................... 24,901,213 Capital shares redeemed ............................................................................... 8,946,634 Affiliates ............................................................................................ 5,449,355 Payable upon return of securities loaned (Note 1i) .................................................... 17,894,505 Dividends on securities sold short .................................................................... 291,107 Options written, at value (premiums received $337,343) ................................................. -- Securities sold short, at value (proceeds $41,048,905) ................................................. 41,096,077 Unrealized loss on forward exchange contracts (Note 6) ................................................. 70,653,915 Other liabilities ...................................................................................... 308,140 --------------- Total liabilities ................................................................................ 169,540,946 --------------- Net assets, at value ........................................................................... $5,149,228,593 --------------- Net assets consist of: Undistributed net investment income .................................................................... $ 8,284,651 Net unrealized appreciation (depreciation) ............................................................. 1,283,115,762 Accumulated net realized (loss) ........................................................................ (96,298,723) Capital shares ......................................................................................... 3,954,126,903 --------------- Net assets, at value ........................................................................... $5,149,228,593 ---------------
30 | Annual Report Mutual Beacon Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2003
CLASS Z: Net asset value and maximum offering price per share ($3,112,211,899 / 216,187,475 shares outstanding) . $14.40 ----------- CLASS A: Net asset value per share ($1,301,619,905 / 90,752,267 shares outstanding) ............................. $14.34 ----------- Maximum offering price per share ($14.34 / 94.25%) ..................................................... $15.21 ----------- CLASS B: Net asset value and maximum offering price per share ($155,572,020 / 11,061,660 shares outstanding) a .. $14.06 ----------- CLASS C: Net asset value per share ($579,824,769 / 40,670,663 shares outstanding)a .............................. $14.26 ----------- Maximum offering price per share ($14.26 / 99.00%) ..................................................... $14.40 -----------
a Redemption price is equal to net asset value less any applicable contingent deferred sales charge. Annual Report | See notes to financial statements. | 31 Mutual Beacon Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2003
Investment income: (net of foreign taxes of $3,089,292) Dividends - Unaffiliated issuers .......................................................... $ 53,787,030 Interest - Unaffiliated issuers ........................................................... 49,174,201 --------------- Total investment income .............................................................. 102,961,231 --------------- Expenses: Management fees (Note 3) .................................................................. 26,322,085 Administrative fees (Note 3) .............................................................. 3,420,924 Distribution fees (Note 3) Class A .................................................................................. 3,707,775 Class B .................................................................................. 1,208,233 Class C .................................................................................. 4,837,527 Transfer agent fees (Note 3) .............................................................. 5,539,900 Custodian fees ............................................................................ 424,000 Reports to shareholders ................................................................... 233,100 Registration and filing fees .............................................................. 106,600 Professional fees ......................................................................... 152,096 Directors' fees and expenses .............................................................. 187,700 Dividends on securities sold short ........................................................ 1,425,843 Other ..................................................................................... 110,701 --------------- Total expenses ....................................................................... 47,676,484 --------------- Net investment income .............................................................. 55,284,747 --------------- Realized and unrealized gains (losses): Investments: Unaffiliated issuers .................................................................... 167,147,529 Non-controlled affiliated issuers (Note 8) .............................................. 5,215,138 Written options (Note 1g) ................................................................ 662,654 Securities sold short (Note 1h) .......................................................... (1,153,342) Foreign currency transactions ............................................................ (149,211,419) --------------- Net realized gain (loss) ............................................................. 22,660,560 Net unrealized appreciation (depreciation) on: Investments .............................................................................. 1,106,317,362 Translation of assets and liabilities denominated in foreign currencies .................. (18,782,622) --------------- Net unrealized appreciation (depreciation) ........................................... 1,087,534,740 --------------- Net realized and unrealized gain (loss) .................................................... 1,110,195,300 --------------- Net increase (decrease) in net assets resulting from operations ............................ $1,165,480,047 ---------------
32 | See notes to financial statements. | Annual Report Mutual Beacon Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS for the years ended December 31, 2003 and 2002
------------------------------------ 2003 2002 ------------------------------------ Increase (decrease) in net assets: Operations: Net investment income ............................................................. $ 55,284,747 $ 74,476,851 Net realized gain (loss) from investments, written options, securities sold short, and foreign currency transactions ................................................ 22,660,560 (89,195,507) Net unrealized appreciation (depreciation) on investments and translation of assets and liabilities denominated in foreign currencies ................................ 1,087,534,740 (525,900,852) ------------------------------------ Net increase (decrease) in net assets resulting from operations ............... 1,165,480,047 (540,619,508) Distributions to shareholders from: Net investment income: Class Z .......................................................................... (50,293,581) (45,942,861) Class A .......................................................................... (16,775,978) (12,956,322) Class B .......................................................................... (1,221,776) (887,589) Class C .......................................................................... (4,420,080) (3,238,926) Net realized gains: Class Z .......................................................................... -- (25,922,177) Class A .......................................................................... -- (9,280,244) Class B .......................................................................... -- (834,458) Class C .......................................................................... -- (4,411,692) ------------------------------------ Total distributions to shareholders ................................................ (72,711,415) (103,474,269) Capital share transactions (Note 2): Class Z ........................................................................... (133,826,403) (109,913,749) Class A ........................................................................... 115,460,107 92,289,525 Class B ........................................................................... 24,317,663 50,136,321 Class C ........................................................................... 15,436,107 31,676,467 ------------------------------------ Total capital share transactions ................................................... 21,387,474 64,188,564 Net increase (decrease) in net assets ......................................... 1,114,156,106 (579,905,213) Net assets: Beginning of year .................................................................. 4,035,072,487 4,614,977,700 ------------------------------------ End of year ........................................................................ $5,149,228,593 $4,035,072,487 ------------------------------------ Undistributed net investment income included in net assets: End of year ........................................................................ $ 8,284,651 $ 15,930,330 ------------------------------------
Annual Report | See notes to financial statements. | 33 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Mutual Beacon Fund (the Fund) is a separate, diversified series of Franklin Mutual Series Fund, Inc. (the Series Fund), which is an open-end investment company registered under the Investment Company Act of 1940. The Fund seeks capital appreciation, with income as a secondary objective, by investing primarily in common and preferred stocks, bonds, and convertible securities in the U.S. and other countries. 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 last 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. Investments in open-end mutual funds are valued at the closing net asset value. Foreign securities are valued at the close of trading of the foreign exchange or the NYSE, whichever is earlier. If events occur that materially affect the values of securities after the prices or foreign exchange rates are determined, or if market quotations are not readily available, the securities will be valued at fair value as determined following procedures approved by the Board of Directors. 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, 2003, all repurchase agreements held by the Fund had been entered into on that date. 34 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) D. SECURITIES PURCHASED ON A WHEN-ISSUED OR DELAYED BASIS The Fund may purchase securities on a when-issued or delayed delivery basis, with payment and delivery scheduled for a future date. These transactions are subject to market fluctuations and are subject to the risk that the value at delivery may be more or less than the trade date purchase price. Although the Fund will generally purchase these securities with the intention of holding the securities, it may sell the securities before the settlement date. Sufficient assets have been segregated for these securities. E. FOREIGN CURRENCY CONTRACTS The Fund may enter into forward exchange contracts to hedge against fluctuations in foreign exchange rates. A forward exchange contract is an agreement between two parties to exchange different currencies at an agreed upon exchange rate at a future date. These contracts are valued daily and the Fund's equity therein is included in the Statement of Assets and Liabilities. Realized and unrealized gains and losses are included in the Statement of Operations. When the Fund purchases or sells foreign securities, it may enter into foreign exchange contracts to minimize foreign exchange risk from the trade date to the settlement date of the transactions. Realized and unrealized gains and losses are included in the Statement of Operations. The risks of these contracts include movement in the values of the foreign currencies relative to the U.S. dollar and the possible inability of the counterparties to fulfill their obligations under the contracts. F. SYNTHETIC EQUITY SWAPS The Fund may engage in synthetic equity swaps. Synthetic equity swaps are contracts entered into between a broker and the Fund under which the parties agree to make payments to each other so as to replicate the economic consequences that would apply had a purchase or sale of the underlying security taken place. Upon entering into synthetic equity swaps, the Fund is required to pledge the broker an amount of cash and/or other assets equal to a certain percentage of the contract amount ("initial margin"). Subsequent payments known as "variation margin", are made or received by the Fund periodically, depending on fluctuations in the value of the underlying security. When the contract is closed, the Fund records a realized gain or loss equal to the difference between the value of the contract at the time it was opened and the value at the time it was closed. The risks of entering into equity swaps include unfavorable price movements in the underlying securities or the inability of the counterparties to fulfill their obligations under the contract. Annual Report | 35 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) G. OPTION CONTRACTS The Fund may purchase or write options. Options are contracts entitling the holder to purchase or sell a specified number of shares or units of a particular security at a specified price. Options purchased are recorded as investments; options written (sold) are recorded as liabilities. When the exercise of an option results in a cash settlement, the difference between the premium (original option value) and the settlement proceeds is realized as a gain or loss. When securities are acquired or delivered upon exercise of an option, the acquisition cost or sale proceeds are adjusted by the amount of the premium. When an option is closed, the difference between the premium and the cost to close the position is realized as a gain or loss. When an option expires, the premium is realized as a gain for options written or as a loss for options purchased. The risks include the possibility there may be an illiquid options market or the inability of the counterparties to fulfill their obligations under the contract. Writing options involves, to varying degrees, elements of market risk in excess of the amount recognized in the Statement of Assets and Liabilities. H. SECURITIES SOLD SHORT The Fund is engaged in selling securities short, which obligates the Fund to replace a borrowed security with the same security at current market value. The Fund would incur a loss 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. The Fund would realize a gain if the price of the security declines between those dates. A gain, limited to the price at which the Fund sold the security short, or a loss, unlimited in size, will be recognized upon the termination of a short sale. The Fund is required to establish a margin account with the broker lending the security sold short. While the short sale is outstanding, the broker retains the proceeds of the short sale and the Fund must maintain a deposit for the broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. I. SECURITIES LENDING The Fund loans securities to certain brokers for which it received cash or securities collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. The cash collateral is invested in short-term instruments as noted in the Statement of Investments. The Fund received interest income of $67,077 from the investment of cash collateral, adjusted by lender fees and broker rebates. The fund bears the risk of loss with respect to the investment of the cash collateral. The securities lending agent has agreed to indemnify the Fund in the case of default of any securities borrower. J. 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. 36 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) K. 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. Discounts on securities purchased are amortized over the lives of the respective securities. Dividend income, dividends declared on securities sold short, and distributions to shareholders are recorded on the ex-dividend date. 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. Common expenses incurred by the Series Fund are allocated among the funds comprising the Series Fund 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. L. 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. M. GUARANTEES AND INDEMNIFICATIONS Under the Fund's organizational documents, its officers and trustees are indemnified against certain liability arising out of the performance of their duties to the Funds. Additionally, in the normal course of business, the Fund enters into contracts with service providers that contain general indemnification clauses. The Fund's maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Fund that have not yet occurred. However, based on experience, the Fund expects the risk of loss to be remote. 2. CAPITAL STOCK The Fund offers five classes of shares: Class Z, Class A, Class B, Class C and Class R shares. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. Annual Report | 37 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED) At December 31, 2003, there were 1.55 billion Fund shares authorized ($0.001 par value) of which 750 million, 300 million, 200 million, and 300 million were designated as Class Z, Class A, Class B, and Class C shares, respectively. Transactions in the Fund's shares were as follows:
---------------------------------------------------------------- YEAR ENDED DECEMBER 31, ---------------------------------------------------------------- 2003 2002 SHARES AMOUNT SHARES AMOUNT ---------------------------------------------------------------- CLASS Z SHARES: Shares sold ........................ 10,838,451 $ 134,762,381 13,579,907 $ 170,501,945 Shares issued on reinvestment of distributions ...................... 3,412,886 45,700,241 5,529,295 66,091,351 Shares redeemed .................... (25,512,048) (314,289,025) (28,451,189) (346,507,045) ---------------------------------------------------------------- Net increase (decrease) ............ (11,260,711) $(133,826,403) (9,341,987) $(109,913,749) ---------------------------------------------------------------- CLASS A SHARES: Shares sold ........................ 22,121,507 $ 273,306,831 24,205,719 $ 303,030,463 Shares issued on reinvestment of distributions ...................... 1,202,510 15,931,792 1,766,999 21,202,504 Shares redeemed .................... (14,091,787) (173,778,516) (19,590,510) (231,943,442) ---------------------------------------------------------------- Net increase (decrease) ............ 9,232,230 $ 115,460,107 6,382,208 $ 92,289,525 ---------------------------------------------------------------- CLASS B SHARES: Shares sold ........................ 2,993,364 $ 35,998,720 5,026,631 $ 61,637,676 Shares issued on reinvestment of distributions ...................... 90,069 1,135,983 134,635 1,598,913 Shares redeemed .................... (1,089,762) (12,817,040) (1,132,404) (13,100,268) ---------------------------------------------------------------- Net increase (decrease) ............ 1,993,671 $ 24,317,663 4,028,862 $ 50,136,321 ---------------------------------------------------------------- CLASS C SHARES: Shares sold ........................ 6,809,888 $ 83,970,999 8,716,309 $ 107,842,436 Shares issued on reinvestment of distributions ...................... 316,168 4,009,329 576,241 7,012,486 Shares redeemed .................... (6,010,932) (72,544,221) (6,983,210) (83,178,455) ---------------------------------------------------------------- Net increase (decrease) ............ 1,115,124 $ 15,436,107 2,309,340 $ 31,676,467 ----------------------------------------------------------------
3. TRANSACTIONS WITH AFFILIATES Certain officers of the Series Fund are also officers or directors of Franklin Mutual Advisers, LLC, (Franklin Mutual) and Franklin Templeton Services, LLC (FT Services), the Fund's investment manager and administrative manager, respectively. Franklin/Templeton Investor Services, LLC (Investor Services) and Franklin/Templeton Distributors, Inc. (Distributors), are the Fund's transfer agent and principal underwriter, respectively. The Fund pays an investment management fee to Franklin Mutual of 0.60% per year of the average daily net assets of the Fund. 38 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) The Fund pays its allocated share of an administrative fee to FT Services based on the Series Fund's aggregate average daily net assets as follows: ---------------------------------------------------------------------------- ANNUALIZED FEE RATE MONTH-END NET ASSETS ---------------------------------------------------------------------------- 0.150% First $200 million 0.135% Over $200 million, up to and including $700 million 0.100% Over $700 million, up to and including $1.2 billion 0.075% Over $1.2 billion The Fund reimburses Distributors for costs incurred in marketing the Fund's shares up to 0.35%, 1.00%, and 1.00% per year of the average daily net assets of Class A, Class B, and Class C shares, respectively. Distributors received net commissions from sales of those shares and received contingent deferred sales charges for the year of $344,120 and $82,682, respectively. The Fund paid transfer agent fees of $5,539,900, of which $3,726,846, was paid to Investor Services. 4. INCOME TAXES At December 31, 2003, the cost of investments, net unrealized appreciation (depreciation) and undistributed ordinary income for income tax purposes were as follows: Cost of investments ................................... $3,863,427,573 --------------- Unrealized appreciation ............................... 1,381,682,498 Unrealized depreciation ............................... (53,358,261) --------------- Net unrealized appreciation (depreciation) ............ $1,328,324,237 --------------- Distributable earnings-- undistributed ordinary income $26,815,884 The tax character of distributions paid during the years ended December 31, 2003 and 2002, was as follows: -------------------------- 2003 2002 -------------------------- Distributions paid from: Ordinary income $72,711,415 $ 72,570,262 Long term capital gain -- 30,904,007 -------------------------- $72,711,415 $103,474,269 -------------------------- Net investment income (loss) differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, passive foreign investment company shares and bond discounts and premiums. Annual Report | 39 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 4. INCOME TAXES (CONTINUED) Net realized gains/losses differ for financial statement and tax purposes primarily due to differing treatment of wash sales, foreign currency transactions, passive foreign investment company shares and bond discounts and premiums. At December 31, 2003, the Fund had deferred capital losses occurring subsequent to October 31, 2003 of $17,929,456. For tax purposes, such losses will be reflected in the year ending December 31, 2004. At December 31, 2003, the Fund had tax basis capital losses which may be carried over to offset future capital gains. Such losses expire as follows: Capital loss carryovers expiring in: 2010 ................................................. $100,171,758 2011 ................................................. 35,724,290 ------------ $135,896,048 ------------ 5. INVESTMENT TRANSACTIONS Purchases and sales of securities (excluding short-term securities and securities sold short) for the year ended December 31, 2003 aggregated $1,825,528,084 and $1,938,529,127, respectively. Transactions in options written during the year ended December 31, 2003 were as follows: --------------------------------- NUMBER OF CONTRACTS PREMIUM --------------------------------- Options outstanding at December 31, 2002 ................... 255,300 $ 158,500 Options written ...................... 1,369,925 1,831,070 Options expired ...................... (166,331) (545,205) Options terminated in closing transactions ........................ (592) (132,210) Options exercised .................... (108,932) (974,812) --------------------------------- Options outstanding at December 31, 2003 ................... 1,349,370 $ 337,343 --------------------------------- 40 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. FORWARD EXCHANGE CONTRACTS At December 31, 2003, the Fund has outstanding forward exchange contracts as set out below. The contracts are reported in the financial statements at the Fund's net equity, as measured by the difference between the forward exchange rates at the reporting date and the forward exchange rates at the day of entry into the contracts.
------------------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO BUY EXCHANGE FOR DATE GAIN (LOSS) ------------------------------------------------------------------------------------------------------------- 61,044,948 Canadian Dollars ............... U.S. $ 45,759,524 1/21/04 U.S. $ 1,433,476 1,900,000 British Pounds ................. 3,348,085 1/28/04 45,786 9,900,000 European Unit .................. 11,505,188 1/28/04 972,210 1,550,000 British Pounds ................. 2,750,661 2/05/04 16,537 6,000,000 European Unit .................. 7,538,070 2/05/04 22,541 3,243,166 Swiss Francs ................... 2,425,000 2/17/04 200,514 5,282,000 European Unit .................. 6,207,987 3/11/04 441,405 21,232,637 European Unit .................. 26,033,761 3/25/04 685,330 4,084,365 European Unit .................. 4,934,730 4/28/04 200,534 -------------- ------------- U.S. $ 110,503,006 4,018,333 -------------- ------------- Unrealized gain on forward exchange contracts ...................................... U.S. $ 4,018,333 ------------- ------------------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO SELL EXCHANGE FOR DATE GAIN (LOSS) ------------------------------------------------------------------------------------------------------------- 11,275,000 British Pounds ................. U.S. $ 20,001,850 1/06/04 U.S. $ (172,716) 25,450,000 European Unit .................. 31,710,700 1/06/04 (385,207) 46,668,970 British Pounds ................. 81,158,961 1/12/04 (2,307,560) 43,700,000 British Pounds ................. 73,874,434 1/20/04 (4,233,344) 208,074,370 Canadian Dollars ............... 147,178,327 1/21/04 (13,681,073) 12,461,544 European Unit .................. 14,629,853 1/28/04 (1,075,970) 48,750,000 British Pounds ................. 82,231,500 1/28/04 (4,848,092) 51,542,444 British Pounds ................. 89,354,198 2/11/04 (2,614,933) 20,985,302 Swiss Francs ................... 15,354,589 2/17/04 (1,634,119) 34,547,969 European Unit .................. 38,180,050 2/23/04 (5,331,685) 18,250,000 British Pounds ................. 30,756,725 2/27/04 (1,767,821) 75,250,000 European Unit .................. 86,355,025 3/11/04 (8,375,523) 491,377,266 Danish Krona ................... 80,934,348 3/17/04 (2,120,010) 13,580,731,750 Korean Won ..................... 11,300,000 3/18/04 (16,245) 1,603,895,999 Japanese Yen ................... 14,000,000 3/18/04 (1,003,003) 4,070,299,205 Japanese Yen ................... 36,537,695 3/25/04 (1,544,601) 60,203,250 European Unit .................. 68,654,705 3/25/04 (7,104,895) 392,104,206 Norwegian Krone ................ 55,105,796 4/15/04 (3,634,725) 40,680,827 European Unit .................. 47,205,440 4/22/04 (3,950,283) 249,080,115 South African Rand ............. 35,916,004 4/26/04 (541,859) 41,850,000 European Unit .................. 49,253,653 4/28/04 (3,364,264) 2,911,477,243 Japanese Yen ................... 26,377,246 6/24/04 (945,987) -------------- ------------ U.S. $1,136,071,100 (70,653,915) -------------- ------------ Unrealized loss on forward exchange contracts ........................................ (70,653,915) ------------ Net unrealized loss on forward exchange contracts ............................... U.S. $(66,635,582) ------------
Annual Report | 41 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. RESTRICTED SECURITIES At December 31, 2003, investments in securities included issues that are restricted or illiquid. Restricted securities are often purchased in private placement transactions, are not registered under the Securities Act of 1933, may have contractual restrictions on resale, and are valued under methods approved by the Board of Directors as reflecting fair value. A security may also be considered illiquid if it lacks a readily available market or if its valuation has not changed for a certain period of time. At December 31, 2003, the Fund held investments in restricted and illiquid securities that were valued under approved methods by the Directors, as follows:
------------------------------------------------------------------------------------------------------ SHARES OR ACQUISITION PRINCIPAL AMOUNT ISSUER DATE COST VALUE ------------------------------------------------------------------------------------------------------ 81,636 Abovenet Inc. ............................... 11/25/03 $ 2,445,349 $ 2,445,349 20,334,434 CA Ltd., 5.00%, 8/28/07 ..................... 8/29/03 19,954,888 20,741,123 1,187,100 Consol Energy Inc. .......................... 9/17/03 21,343,572 27,671,301 13,807 FE Capital Holdings Ltd. .................... 8/29/03 13,807,200 13,807,200 18,902,566 FE Capital LLC, 5.00%, 8/28/07 .............. 8/29/03 18,549,746 19,280,618 3,546,660 International Steel Group ................... 4/10/02 17,173,750 117,421,046 1 Lancer Industries Inc., B ................... 8/11/89 -- 245,476 865,040 Leucadia National Corp. ..................... 12/20/02 30,492,660 37,884,427 10,862,000 Nipon Investment LLC ........................ 2/14/01 -- 4,127,560 542,874 NTL Inc. .................................... 1/08/03 28,331,690 35,972,188 106,700 Olympus Re Holdings Ltd. .................... 12/19/01 10,670,000 16,876,739 15,572 PG & E Corp., wts., 9/02/06 ................. 10/29/02 -- 389,051 161,960 Security Capital European Realty ............ 4/08/88 3,679,664 1,206,602 139,203 White Mountains Insurance Group Inc. ........ 10/22/02 41,064,885 60,825,099 -------------- TOTAL RESTRICTED SECURITIES (7.0% OF NET ASSETS) ................................... $358,893,779 --------------
8. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The Investment Company Act of 1940 defines "affiliated companies" to include investments in portfolio companies in which a fund owns 5% or more of the outstanding voting securities. Investments in "affiliated companies" for the Fund at December 31, 2003 were as shown below.
------------------------------------------------------------------------------------------------------- REALIZED NUMBER OF NUMBER OF INVESTMENT CAPITAL SHARES HELD SHARES HELD VALUE INCOME GAIN/LOSS DEC. 31, GROSS GROSS DEC. 31, DEC. 31, 1/1/03- 1/1/03- NAME OF ISSUER 2002 ADDITIONS REDUCTIONS 2003 2003 12/31/03 12/31/03 ------------------------------------------------------------------------------------------------------- NON-CONTROLLED AFFILIATES FE Capital Holdings Ltd. . -- 13,807 -- 13,807 $13,807,200 $-- $ -- FHC Delaware Inc. ........ 507,977 -- -- 507,977 3,997,779 -- -- Kindred Healthcare Inc ... 682,285 -- -- 682,285 33,691,915 -- -- Kindred Healthcare Inc, Jul. 47.5 Calls, 7/11/11 . 553 553 -- 1,106 495,488 -- --
42 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES (CONTINUED)
---------------------------------------------------------------------------------------------------------------- REALIZED NUMBER OF NUMBER OF INVESTMENT CAPITAL SHARES HELD SHARES HELD VALUE INCOME GAIN/LOSS DEC. 31, GROSS GROSS DEC. 31, DEC. 31, 1/1/03- 1/1/03- NAME OF ISSUER 2002 ADDITIONS REDUCTIONS 2003 2003 12/31/03 12/31/03 ---------------------------------------------------------------------------------------------------------------- Kindred Healthcare Inc, Jan. 18.15 Calls, 1/01/13 ..... -- 166 -- 166 $ -- $-- $ -- Kindred Healthcare Inc, wts, Series A, 4/20/06 ........ 121,432 -- -- 121,432 2,824,023 -- -- Kindred Healthcare Inc, wts, Series B, 4/20/06 ........ 303,580 -- -- 303,580 6,359,242 -- -- Nippon Investment LLC ..10,862,000 -- -- 10,862,000 4,127,560 -- 5,215,138 Southwest Royalties Inc., A ........................ 69,184 -- -- 69,184 2,075,530 -- -- Southwest Royalties Inc., 10.5% 6/30/04 ...........4,612,000 -- (4,612,000) -- a -- -- -- ------------------------------------ TOTAL NON-CONTROLLED AFFILIATES ............................................................ $67,378,737 $-- $5,215,138 ------------------------------------ a As of December 31, 2003, no longer an affiliate.
9. INVESTMENTS IN FRANKLIN INSTITUTIONAL FIDUCIARY TRUST MONEY MARKET PORTFOLIO The Fund may invest in the Franklin Institutional Fiduciary Trust Money Market Portfolio (the Sweep Money Fund), an open-end investment company managed by Franklin Advisers Inc. (an affiliate of the investment manager). Management fees paid by the Fund are reduced on assets invested in the Sweep Money Fund, in an amount not to exceed the management fees paid by the Sweep Money Fund. The Fund earned $31,725 of dividend income from investment in the Sweep Money Fund for the year ended December 31, 2003. 10. REGULATORY MATTERS On February 4, 2004, the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts filed an administrative complaint against Franklin Resources, Inc. and certain of its subsidiaries (the "Company"), alleging violations of the Massachusetts Uniform Securities Act. The complaint arises from activity that occurred in 2001 during which time an officer of a Company subsidiary was negotiating an agreement with an investor relating to investments in a mutual fund and a hedge fund. The Fund, in addition to other entities within Franklin Templeton Investments, including the Company and other funds, has been named in shareholder class actions related to the matter described above. The Fund's management believes that the claims made in the lawsuit are without merit and it intends to defend vigorously against the allegations. It is anticipated that the Fund may be named in additional similar civil actions related to the matter described above. Annual Report | 43 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 10. REGULATORY MATTERS (CONTINUED) In addition, as part of ongoing investigations by the U.S. Securities and Exchange Commission (the "SEC"), the U.S. Attorney for the Northern District of California, the New York Attorney General, the California Attorney General, the U.S. Attorney for the District of Massachusetts, the Florida Department of Financial Services, and the Commissioner of Securities and the Attorney General of the State of West Virginia, relating to certain practices in the mutual fund industry, including late trading, market timing and sales compensation arrangements, the Company and its subsidiaries, as well as certain current or former executives and employees of the Company, have received requests for information and/or subpoenas to testify or produce documents. The Company and its current employees are providing documents and information in response to these requests and subpoenas. In addition, the Company has responded to requests for similar kinds of information from regulatory authorities in some of the foreign countries where the Company conducts its global asset management business. The Staff of the SEC has informed the Company that it intends to recommend that the Commission authorize an action against an affiliate of the Fund's adviser and a senior executive officer relating to the frequent trading issues that are the subject of the SEC's investigation. These issues were previously disclosed as being under investigation by government authorities and the subject of an internal inquiry by the Company in its Annual Report on Form 10-K and on its public website. The Company currently is in discussions with the SEC Staff in an effort to resolve the issues raised in their investigation. Such discussions are preliminary and the Fund's management has been advised that the Company cannot predict the likelihood of whether those discussions will result in a settlement and, if so, the terms of such settlement. The impact, if any, of these matters on the Fund is uncertain at this time. If the Company finds that it bears responsibility for any unlawful or improper conduct, it has committed to making the Fund or its shareholders whole, as appropriate. 44 | Annual Report Mutual Beacon Fund REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS TO THE BOARD OF DIRECTORS OF FRANKLIN MUTUAL SERIES FUND INC. AND SHAREHOLDERS OF MUTUAL BEACON FUND We have audited the accompanying statement of assets and liabilities, including the statement of investments, of the Mutual Beacon Fund (one of the portfolios constituting the Franklin Mutual Series Fund Inc. [the Fund]) as of December 31, 2003, and the related statement of operations for the year then ended, the statements of changes in net assets for each of the two years in the period then ended, and the financial highlights for each of the periods indicated therein. These financial statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights. Our procedures included confirmation of securities owned at December 31, 2003, by correspondence with the custodian and brokers or by other appropriate auditing procedures where replies from brokers were not received. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of the Mutual Beacon Fund of the Franklin Mutual Series Fund Inc. as of December 31, 2003, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the periods indicated therein, in conformity with accounting principles generally accepted in the United States. /S/ERNEST & YOUNG LLP Boston, Massachusetts February 4, 2004 Annual Report | 45 Mutual Beacon Fund TAX DESIGNATION (UNAUDITED) Under Section 854(b)(2) of the Internal Revenue Code, the Fund hereby designates 30.43% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2003. Under Section 854(b)(2) of the Internal Revenue Code (Code), the Fund hereby designates up to a maximum of $57,556,667 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2003. In January 2004, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2003. Shareholders are advised to check with their tax advisors for information on the treatment of these amounts on their individual income tax returns. 46 | Annual Report Board Members and Officers The name, age and address of the officers and board members, as well as their affiliations, positions held with the Fund, principal occupations during the past five years and number of portfolios overseen in the Franklin Templeton Investments fund complex are shown below. Each board member will serve until that person's successor is elected and qualified. INDEPENDENT BOARD MEMBERS
----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ----------------------------------------------------------------------------------------------------------------------------------- EDWARD I. ALTMAN, PH.D. (62) Director Since 1987 7 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Max L. Heine Professor of Finance and Director of The Credit and Debt Markets Research Program, NYU Salomon Center, Stern School of Business, New York University; editor and author of numerous financial publications; and financial consultant; and FORMERLY Vice Director, NYU Salomon Center, Stern School of Business, New York University. ----------------------------------------------------------------------------------------------------------------------------------- ANN TORRE GRANT (45) Director Since 1994 7 Independent Director, SLM, 51 John F. Kennedy Parkway Corporation (Sallie Mae); and Allied Short Hills, NJ 07078 Capital Corporation (financial services). PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Independent strategic and financial consultant; and FORMERLY, Executive Vice President and Chief Financial Officer, NHP Incorporated (manager of multifamily housing) (1995-1997); and Vice President and Treasurer, US Airways, Inc. (until 1995). ----------------------------------------------------------------------------------------------------------------------------------- BURTON J. GREENWALD (74) Director Since 2002 12 Director, Fiduciary Emerging Markets 51 John F. Kennedy Parkway Bond Fund PLC and Fiduciary Short Hills, NJ 07078 International Ireland Limited. PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Managing Director, B.J. Greenwald Associates, management consultants to the financial services industry. ----------------------------------------------------------------------------------------------------------------------------------- BRUCE A. MACPHERSON (73) Director Since 1974 7 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Retired, former Chairman, A.A. MacPherson, Inc., Canton, MA (representative for electrical manufacturers); and part owner McKinstry Inc., Chicopee, MA (manufacturer of electrical enclosures). ----------------------------------------------------------------------------------------------------------------------------------- FRED R. MILLSAPS (74) Director Since 1996 28 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director of various business and nonprofit organizations; manager of personal investments (1978-present); and FORMERLY, Chairman and Chief Executive Officer, Landmark Banking Corporation (1969-1978); Financial Vice President, Florida Power and Light (1965-1969); and Vice President, Federal Reserve Bank of Atlanta (1958-1965). -----------------------------------------------------------------------------------------------------------------------------------
Annual Report | 47
----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ----------------------------------------------------------------------------------------------------------------------------------- CHARLES RUBENS II (73) Director Since 1998 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. ----------------------------------------------------------------------------------------------------------------------------------- LEONARD RUBIN (78) Director Since 1996 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Partner in LDR Equities, LLC (manages personal investments); and FORMERLY, President, F.N.C. Textiles, Inc.; and Chairman of the Board, Carolace Embroidery Co., Inc. (until 1996). ----------------------------------------------------------------------------------------------------------------------------------- ROBERT E. WADE (57) Director Since 1991 7 Director, El Oro Mining and 51 John F. Kennedy Parkway Exploration Co., p.l.c.; and FORMERLY, Short Hills, NJ 07078 Director, El Oro Mining and Exploration Company, p.l.c and The Exploration Company, p.l.c., (until 2003). PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Practicing attorney. ----------------------------------------------------------------------------------------------------------------------------------- INTERESTED BOARD MEMBERS AND OFFICERS ----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ----------------------------------------------------------------------------------------------------------------------------------- **WILLIAM J. LIPPMAN (78) Director Since 1996 18 None One Parker Plaza, 9th Floor Fort Lee, NJ 07024 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Private Client Group, Inc.; President, Franklin Advisory Services, LLC.; and officer and/or director or trustee, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of seven of the investment companies in Franklin Templeton Investments. ----------------------------------------------------------------------------------------------------------------------------------- **ANNE M. TATLOCK (64) Director Since 2002 7 Director, Fortune Brands, Inc. 600 Fifth Avenue, 7th Floor (consumer products) and Merck & New York, NY 10020-2302 Co. Inc. (pharmaceuticals) PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman and Chief Executive Officer, Fiduciary Trust Company International; Vice Chairman, Member - Office of the Chairman and Director, Franklin Resources, Inc.; and officer and/or director of some of the other subsidiaries of Franklin Resources, Inc. -----------------------------------------------------------------------------------------------------------------------------------
48 | Annual Report
----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ----------------------------------------------------------------------------------------------------------------------------------- **DAVID J. WINTERS (41) Director, Director since 7 None 51 John F. Kennedy Parkway President, 2001, President Short Hills, NJ 07078-2702 Chairman of since 1999, the Board Chairman of the and Chief Board and Chief Executive Executive Officer - Officer - Investment Investment Management Management since 2002 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Chief Investment Officer, and Chief Executive Officer, Franklin Mutual Advisers, LLC., and of three of the investment companies in Franklin Templeton Investments. ----------------------------------------------------------------------------------------------------------------------------------- JIMMY D. GAMBILL (56) Senior Vice Since 2002 Not Applicable None 500 East Broward Blvd. President and Suite 2100 Fort Lauderdale, FL Chief 33394-3091 Executive Officer - Finance and Administration PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Franklin Templeton Services, LLC; Senior Vice President, Templeton Worldwide, Inc.; and officer of 51 of the investment companies in Franklin Templeton Investments. ----------------------------------------------------------------------------------------------------------------------------------- DAVID P. GOSS (56) Vice President Since 2000 Not Applicable None One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Associate General Counsel, Franklin Resources, Inc.; officer and director of one of the subsidiaries of Franklin Resources, Inc.; officer of 51 of the investment companies in Franklin Templeton Investments; and FORMERLY, President, Chief Executive Officer and Director, Property Resources Equity Trust (until 1999) and Franklin Select Realty Trust (until 2000). ----------------------------------------------------------------------------------------------------------------------------------- BARBARA J. GREEN (56) Vice President Since 2000 Not Applicable None One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Deputy General Counsel and Secretary, Franklin Resources, Inc.; Secretary and Senior Vice President, Templeton Worldwide, Inc.; Secretary, Franklin Advisers, Inc., Franklin Advisory Services, LLC, Franklin Investment Advisory Services, Inc., Franklin Mutual Advisers, LLC, Franklin Templeton Alternative Strategies, Inc., Franklin Templeton Investor Services, LLC, Franklin Templeton Services, LLC, Franklin Templeton Distributors, Inc., Templeton Investment Counsel, LLC, and Templeton/Franklin Investment Services, Inc.; and officer of some of the other subsidiaries of Franklin Resources, Inc. and of 51 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). -----------------------------------------------------------------------------------------------------------------------------------
Annual Report | 49
----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ----------------------------------------------------------------------------------------------------------------------------------- MICHAEL O. MAGDOL (66) Vice Since 2002 Not Applicable Director, FTI Banque, Arch 600 Fifth Avenue President - Chemicals, Inc. and Lingnan Rockefeller Center AML Foundation. New York, NY 10048-0772 Compliance PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice Chairman, Chief Banking Officer and Director, Fiduciary Trust Company International; and officer and/or director, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of 48 of the investment companies in Franklin Templeton Investments. ----------------------------------------------------------------------------------------------------------------------------------- KIMBERLEY H. MONASTERIO (40) Treasurer Treasurer Not Applicable None One Franklin Parkway and Chief and Chief San Mateo, CA 94403-1906 Financial Financial Officer Officer since 2003 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Templeton Services, LLC; and officer of 51 of the investment companies in Franklin Templeton Investments. ----------------------------------------------------------------------------------------------------------------------------------- MURRAY L. SIMPSON (66) Vice Since 2000 Not Applicable None One Franklin Parkway President San Mateo, CA 94403-1906 and Secretary PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Executive Vice President and General Counsel, Franklin Resources, Inc.; officer and/or director, as the case may be, of some of the subsidiaries of Franklin Resources, Inc. and of 51 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). -----------------------------------------------------------------------------------------------------------------------------------
*We base the number of portfolios on each separate series of the U.S. registered investment companies within the Franklin Templeton Investments fund complex. These portfolios have a common investment adviser or affiliated investment advisers. **William J. Lippman is considered an interested person of Mutual Series under the federal securities laws due to his position as an officer of some of the subsidiaries of Franklin Resources, Inc. (Resources), which is the parent company of Mutual Series' adviser and distributor. Anne M. Tatlock is considered an interested person of Mutual Series under the federal securities laws due to her position as an officer and director of Resources. David J. Winters is considered an interested person of Mutual Series under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC. THE FUND'S BOARD OF DIRECTORS HAS DETERMINED THAT CERTAIN OF THE MEMBERS OF THE AUDIT COMMITTEE, INCLUDING ANN TORRE GRANT, ARE AUDIT COMMITTEE FINANCIAL EXPERTS, AND "INDEPENDENT," UNDER THOSE PROVISIONS OF THE SARBANES-OXLEY ACT OF 2002, AND THE RULES AND FORM AMENDMENTS ADOPTED BY THE SECURITIES AND EXCHANGE COMMISSION, RELATING TO AUDIT COMMITTEE FINANCIAL EXPERTS. THE STATEMENT OF ADDITIONAL INFORMATION (SAI) INCLUDES ADDITIONAL INFORMATION ABOUT THE BOARD MEMBERS AND IS AVAILABLE, WITHOUT CHARGE, UPON REQUEST. SHAREHOLDERS MAY CALL 1-800/DIAL BEN (1-800/342-5236) TO REQUEST THE SAI. 50 | Annual Report Mutual Beacon Fund PROXY VOTING POLICIES AND PROCEDURES The Fund has established Proxy Voting Policies and Procedures ("Policies") that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund's complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at 1-954/847-2268 or by sending a written request to: Franklin Templeton Companies, LLC, 500 East Broward Boulevard, Suite 1500, Fort Lauderdale, FL 33394, Attention: Proxy Group. Annual Report | 51 This page intentionally left blank. Literature Request For a brochure and prospectus, which contains more complete information, including charges and expenses, call Franklin Templeton Investments at 1-800/DIAL BEN(R) (1-800/342-5236). Please read the prospectus carefully before investing or sending money. To ensure the highest quality of service, we may monitor, record and access telephone calls to or from our service departments. These calls can be identified by the presence of a regular beeping tone. FRANKLIN TEMPLETON INVESTMENTS INTERNATIONAL Mutual European Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Foreign Fund Templeton Foreign Smaller Companies Fund Templeton International (Ex EM) Fund GLOBAL Franklin Global Aggressive Growth Fund Franklin Global Growth Fund Mutual Discovery Fund Templeton Capital Accumulator Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund Templeton Growth Fund Templeton World Fund GROWTH Franklin Aggressive Growth Fund Franklin Capital Growth Fund Franklin Flex Cap Growth Fund Franklin Small-Mid Cap Growth Fund Franklin Small Cap Growth Fund II 1 VALUE Franklin Balance Sheet Investment Fund 2 Franklin Equity Income Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund 3 Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund 4 Mutual Shares Fund BLEND Franklin Blue Chip Fund Franklin Convertible Securities Fund Franklin Growth Fund Franklin Rising Dividends Fund Franklin U.S. Long-Short Fund 5 SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Communications Fund Franklin Global Health Care Fund Franklin Gold and Precious Metals Fund Franklin Natural Resources Fund Franklin Real Estate Securities Fund Franklin Utilities Fund Franklin Technology Fund Mutual Financial Services Fund ASSET ALLOCATION Franklin Templeton Corefolio Allocation Fund Franklin Templeton Founding Funds Allocation Fund TARGET FUNDS Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund INCOME Franklin Adjustable U.S. Government Securities Fund 6 Franklin's AGE High Income Fund Franklin Federal Money Fund 6,7 Franklin Floating Rate Daily Access Fund Franklin Floating Rate Trust 4 Franklin Income Fund Franklin Money Fund 6,7 Franklin Short-Intermediate U.S. Government Securities Fund 6 Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio 6 Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund 6 Templeton Global Bond Fund TAX-FREE INCOME 8 NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund 9 Tax-Exempt Money Fund 6,7 LIMITED-TERM FUNDS California Limited-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Limited-Term Tax-Free Income Fund INTERMEDIATE-TERM FUNDS California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC 8 Alabama Arizona California 10 Colorado Connecticut Florida 10 Georgia Kentucky Louisiana Maryland Massachusetts 9 Michigan 9 Minnesota 9 Missouri New Jersey New York 10 North Carolina Ohio 9 Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust 11 1. The fund is closed to new investors. Existing shareholders can continue adding to their accounts. 2. The fund is only open to existing shareholders as well as select retirement plans. 3. Effective June 30, 2003, the fund reopened to all new investors. 4. The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. 5. Upon reaching approximately $350 million in assets, the fund intends to close to all investors. 6. An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. 7. No assurance exists that the fund's $1.00 per share price will be maintained. It is possible to lose money by investing in the fund. 8. For investors subject to the alternative minimum tax, a small portion of these dividends may be taxable. Distributions of capital gains are generally taxable. 9. Portfolio of insured municipal securities. 10. These funds are available in two or more variations, including long-term portfolios, portfolios of insured securities, a high-yield portfolio (CA) and money market portfolios (CA and NY). 11. The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 11/03 Not part of the annual report [LOGO] FRANKLIN[R] TEMPLETON[R] One Franklin Parkway INVESTMENTS San Mateo, CA 94403-1906 WANT TO RECEIVE THIS DOCUMENT FASTER VIA EMAIL? Eligible shareholders can sign up for eDelivery at franklintempleton.com. See inside for details. ANNUAL REPORT AND SHAREHOLDER LETTER MUTUAL BEACON FUND CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF INVESTMENT OFFICER David J. Winters AUDITORS Ernst & Young LLP 200 Clarendon Streeet Boston, MA 02116 INVESTMENT MANAGER Franklin Mutual Advisers, LLC 51 John F. Kennedy Parkway Short Hills, NJ 07078 DISTRIBUTOR Franklin Templeton Distributors, Inc. 1-800/DIAL BEN(R) franklintempleton.com SHAREHOLDER SERVICES 1-800/632-2301 - (Class A, B, & C) 1-800/448-FUND - (Class Z) This report must be preceded or accompanied by the current Mutual Beacon Fund prospectus, which contains more complete information, including risk factors, charges and expenses. To ensure the highest quality of service, telephone calls to or from our service departments may be monitored, recorded and accessed. These calls can be identified by the presence of a regular beeping tone. 476 A2003 02/04 DECEMBER 31, 2003 -------------------------------------------------------------------------------- [GRAPHIC] -------------------------------------------------------------------------------- ANNUAL REPORT AND SHAREHOLDER LETTER | GLOBAL -------------------------------------------------------------------------------- WANT TO RECEIVE THIS DOCUMENT MUTUAL DISCOVERY FUND FASTER VIA EMAIL? Eligible shareholders can sign up for eDelivery at franklintempleton.com. See inside for details. -------------------------------------------------------------------------------- [LOGO OMITTED] FRANKLIN (R) TEMPLETON(R) INVESTMENTS Franklin o Templeton o Mutual Series Thank You For Your Continued Participation At Mutual Series, we are pleased so many investors share our long-term investment philosophy and have remained shareholders for many years. Your ongoing support plays a significant role in contributing to the funds' success. SPECIALIZED EXPERTISE Mutual Series is part of Franklin Templeton Investments, which offers the specialized expertise of three world-class investment management groups -- Franklin, Templeton and Mutual Series. Mutual Series is dedicated to a unique style of value investing, searching aggressively for opportunity among undervalued stocks, arbitrage situations and distressed companies. Franklin is a leader in tax-free fund management and an expert in U.S. equity and fixed income investing. Templeton pioneered international investing and, with offices in over 25 countries, offers the broadest global reach in the industry. TRUE DIVERSIFICATION Because these management groups work independently and adhere to distinctly different investment approaches, Franklin, Templeton and Mutual Series funds typically have a low overlap of securities. That's why the funds can be used to build truly diversified portfolios covering every major asset class. RELIABILITY YOU CAN TRUST Franklin Templeton Investments seeks to consistently provide investors with exceptional risk-adjusted returns over the long term, as well as the reliable account services that have helped the firm become one of the most trusted names in financial services. -------------------------------------------------------------------------------- MUTUAL FUNDS | RETIREMENT PLANS | 529 COLLEGE SAVINGS LANS | SEPARATE ACCOUNTS -------------------------------------------------------------------------------- [GRAPHIC OMITTED] Not part of the annual report Contents SHAREHOLDER LETTER ....................... 1 ANNUAL REPORT Mutual Discovery Fund .................... 5 Performance Summary ...................... 10 Financial Highlights and Statement of Investments ................. 15 Financial Statements ..................... 33 Notes to Financial Statements ............ 37 Independent Auditors' Report ............. 48 Tax Designation .......................... 49 Board Members and Officers ............... 54 Proxy Voting Policies and Procedures ..... 58 -------------------------------------------------------------------------------- Regulatory Update AS OF FEBRUARY 12, 2004 On February 4, 2004, the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts filed an administrative complaint against Franklin Resources, Inc. and certain of its subsidiaries (the "Company"), alleging violations of the Massachusetts Uniform Securities Act. The complaint arises from activity that occurred in 2001 during which time an officer of a Company subsidiary was negotiating an agreement with an investor relating to investments in a mutual fund and a hedge fund. The Company, in addition to other entities within Franklin Templeton Investments, including the Fund and other funds, has been named in shareholder class actions related to the matter described above. The Company believes that the claims made in the lawsuit are without merit and it intends to defend vigorously against the allegations. It is anticipated that the Company may be named in additional similar civil actions related to the matter described above. In addition, as part of ongoing investigations by the U.S. Securities and Exchange Commission (the "SEC"), the U.S. Attorney for the Northern District of California, the New York Attorney General, the California Attorney General, the U.S. Attorney for the District of Massachusetts, the Florida Department of Financial Services, and the Commissioner of Securities and the Attorney General of the State of West Virginia, relating to certain practices in the mutual fund industry, including late trading, market timing and sales compensation arrangements, the Company and its subsidiaries, as well as certain current or former executives and employees of the Company, have received requests for information and/or subpoenas to testify or produce documents. The Company and its current employees are providing documents and information in response to these requests and subpoenas. In addition, the Company has responded to requests for similar kinds of information from regulatory authorities in some of the foreign countries where the Company conducts its global asset management business. The Staff of the SEC has informed the Company that it intends to recommend that the Commission authorize an action against an affiliate of the Fund's adviser and a senior executive officer relating to the frequent trading issues that are the subject of the SEC's investigation. These issues were previously disclosed as being under investigation by government authorities and the subject of an internal inquiry by the Company in its Annual Report on Form 10-K and on its public website. The Company currently is in discussions with the SEC Staff in an effort to resolve the issues raised in their investigation. Such discussions are preliminary and the Company cannot predict the likelihood of whether those discussions will result in a settlement and, if so, the terms of such settlement. The impact, if any, of these matters on the Fund is uncertain at this time. If it is found that the Company bears responsibility for any unlawful or improper conduct, we have committed to making the funds or their shareholders whole, as appropriate. Any further updates on these matters will be disclosed on the Company's website at franklintempleton.com under "Statement on Current Industry Issues." 4 |Not part of the annual report Annual Report Mutual Discovery Fund YOUR FUND'S GOAL AND PRIMARY INVESTMENTS: Mutual Discovery Fund seeks long-term capital appreciation by investing primarily in common and preferred stocks and bonds. The Fund may also invest up to 100% of its assets in foreign securities. We are pleased to bring you Mutual Discovery Fund's annual report for the fiscal year ended December 31, 2003. PERFORMANCE OVERVIEW Mutual Discovery Fund - Class Z posted a 31.55% cumulative total return for the 12 months ended December 31, 2003, as shown in the Performance Summary beginning on page 10. Compared with its benchmarks over the same period, the Fund outperformed the Standard & Poor's 500 Composite Index's (S&P 500's) 28.67% return but underperformed the Morgan Stanley Capital International (MSCI) World Index's 33.76% return. 1 ECONOMIC AND MARKET OVERVIEW Early in 2003, economic uncertainty and geopolitical events pushed U.S. interest rates to their lowest level in more than four decades. The U.S. government injected fiscal stimulus into the economy, approving another round of tax cuts and rebates that included dividend and capital gains tax reductions. In June, an accommodative Federal Reserve Board, in an attempt to bolster the economy, cut the federal funds target rate to 1.00%. During the year, the U.S. trade deficit increased significantly, contributing to the U.S. dollar's fall to record lows against the euro and other major currencies. However, the weak dollar provided a boost to the U.S. economy and corporate 1. Source: Standard & Poor's Micropal. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The S&P 500 is one of the most widely used benchmarks of U.S. equity performance. The MSCI World Index is market capitalization-weighted and measures total returns of equity securities in developed markets globally. The indexes include reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND COMPLETE LEGAL TITLES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 20. Annual Report | 5 GEOGRAPHIC DISTRIBUTION* Based on Total Net Assets as of 12/31/03 U.S. 40.0% U.K. 14.3% Canada 7.0% France 6.7% Switzerland 4.5% Netherlands 3.8% Irish Republic 3.3% Japan 2.8% Norway 2.4% Spain 2.3% Denmark 2.3% Luxembourg 1.6% Germany 1.5% South Korea 1.4% Mexico 1.2% Belgium 1.2% Sweden 1.1% South Africa 1.1% Other Countries 3.3% *Other net assets = -1.8% because of foreign currency hedging. profits as exports became cheaper for foreign buyers. Robust consumer spending, especially for autos and homes, and strong business spending, particularly for equipment and software, contributed to the accelerated economic activity. In addition, U.S. federal spending stayed firm and inflation remained benign. U.S. gross domestic product (GDP) grew an annualized 8.2% in third quarter 2003, its strongest pace in nearly 20 years, and overall, 2003 GDP grew an estimated 3.1%. As economic data improved, interest rates rose from their lows, and the 10-year Treasury note's yield ended the period at 4.27%. Foreign economies also showed signs of recovery following a low growth and disinflationary environment that facilitated monetary easing in many major economies during the reporting period. While economic growth accelerated in the U.S., it remained strong in Asia, and was weak, yet positive, in Europe. Despite these signs of economic recovery, benign inflationary trends continued, supported by cyclical productivity gains and excess capacity in labor and capital. A global equity market rally started in late March 2003 and continued through the end of the year. The rebound began with investors anticipating global economic recovery in the second half of 2003, and it continued as data showed robust economic growth. Improved sentiment led many investors to rotate into economically sensitive and financially leveraged companies, specifically cyclical, technology, small-capitalization and emerging market stocks, which had generally performed poorly in recent years. Consequently, domestic and foreign equity markets generally performed well. INVESTMENT STRATEGY At Mutual Series, we follow a distinctive, three-pronged investment approach, which combines purchasing undervalued equities with investing in distressed debt and risk arbitrage. We invest in undervalued common stocks of companies we believe are trading at a substantial discount to their intrinsic or business value. We focus on situations we believe have limited downside risk and the potential for substantial long-term appreciation. In our opinion, successful investing is as much about avoiding and containing losses as it is about generating gains. We also invest in distressed securities and bankruptcy situations. We have been involved in this highly specialized field for many years and have found it can provide attractive returns over time. As with equities, we undertake our own rigorous fundamental analysis of each situation and focus our efforts on those we believe have limited risk and substantial upside potential. Lastly, the Fund invests in 6 | Annual Report arbitrage situations, another highly specialized field where we have been active for some time. In arbitrage investing, we generally seek to invest in companies in the process of being acquired or undergoing mergers. By buying those shares at a discount to the announced deal value, the Fund seeks to earn a return as that discount narrows and the transaction is completed. Although we believe returns from each of these three prongs can be attractive over time, we will migrate the Fund's capital toward areas where we find the most compelling opportunities at any given moment. Typically, the bulk of the Fund's assets will be invested in equities, while distressed investing and arbitrage will each represent a much smaller portion of the Fund. We may also hold a significant portion of the Fund's assets in cash or high-quality, short-term debt instruments when other investment opportunities are not sufficiently compelling to us. As a global fund, Mutual Discovery Fund will seek out opportunities around the world, with an emphasis on developed markets where we think political risks are low and potential returns are attractive. We will generally seek to hedge the Fund's currency exposure when we deem it advantageous, to focus our efforts on analyzing business fundamentals and assessing the value of company assets and liabilities. We believe our three-pronged approach, coupled with rigorous fundamental analysis and an aversion to risk, can allow the Fund to achieve attractive risk-adjusted returns over time. MANAGER'S DISCUSSION Several of the most significant contributors to the Fund's performance during the year under review were from our distressed portfolio such as NTL, International Steel Group (ISG), Telewest and Adelphia. We began investing in NTL bonds in 2001, and in January 2003, the company emerged from bankruptcy. In the process, our bonds were converted into the new company's equity, and share prices subsequently rose. We were one of the original investors in ISG, which was formed to purchase selected steel assets from bankrupt U.S. steel companies. ISG went public in December 2003, resulting in investment appreciation. Telewest Communications and Adelphia Communications bond prices rose as the companies progressed through their respective bankruptcy processes. TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/03 ------------------------------------------------- % OF TOTAL NET ASSETS ------------------------------------------------- Tobacco 8.9% ------------------------------------------------- Insurance 8.3% ------------------------------------------------- Media 7.6% ------------------------------------------------- Beverages 7.5% ------------------------------------------------- Metals & Mining 6.2% ------------------------------------------------- Diversified Financial Services 5.7% ------------------------------------------------- Food Products 4.8% ------------------------------------------------- Commercial Banks 4.4% ------------------------------------------------- Diversified Telecommunication Services 3.9% ------------------------------------------------- Chemicals 3.4% ------------------------------------------------- Annual Report | 7 TOP 10 HOLDINGS 12/31/03 ---------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS ---------------------------------------------- British American Tobacco PLC 3.1% TOBACCO, U.K. ---------------------------------------------- Berkshire Hathaway Inc., A & B 2.9% INSURANCE, U.S. ---------------------------------------------- NTL Inc. 2.2% DIVERSIFIED TELECOMMUNICATION SERVICES, U.K. ---------------------------------------------- International Steel Group 2.0% METALS & MINING, U.S. ---------------------------------------------- Altadis SA 1.9% TOBACCO, SPAIN ---------------------------------------------- White Mountains Insurance Group Inc., common & restricted 1.8% INSURANCE, U.S. ---------------------------------------------- Imperial Tobacco Group PLC 1.6% TOBACCO, U.K. ---------------------------------------------- Vinci SA 1.5% CONSTRUCTION & ENGINEERING, FRANCE ---------------------------------------------- Diageo PLC 1.5% BEVERAGES, U.K. ---------------------------------------------- Carlsberg AS, A & B 1.5% BEVERAGES, DENMARK ---------------------------------------------- Within equities, White Mountains Insurance Group was one of the Fund's largest contributors during the period. Our investment in White Mountains reflects our focus on companies with strong or improving fundamentals, attractive valuations and management teams who think like owners. During 2003, the company benefited from strong price increases for primary and reinsurance risks, disciplined underwriting and solid returns from its investment portfolio. While many companies within the property and casualty insurance industry struggled with eroding capital from past underwriting mistakes and significant losses in their investment portfolios, White Mountains utilized its much-improved balance sheet and industry knowledge to acquire undervalued or capital-constrained insurance companies and to increase exposure to its most attractive lines of businesses. Primarily as a result of these actions, the company continued to improve profitability and enjoyed a 13% increase in its book value during 2003. Also contributing positively to the Fund was SES Global, which offers global satellite services primarily to broadcasters, cable television networks and broadband telecommunications companies. We purchased most of the Fund's position in a single block trade from another company that was divesting non-core holdings to shore up its balance sheet. This is an excellent example of a situation where keeping a cash reserve enabled the Fund to take advantage of an opportunity that arose quickly. As SES generated improved free cash flow, reduced balance sheet debt and signed contracts for additional satellite capacity, and as the technical pressure due to the forced sale abated, the company's shares rose, resulting in a gain for the Fund. Detracting from Fund performance during the reporting period were Allied Domecq (sold by year-end), one of the world's largest spirits and wine companies; Abitibi-Consolidated, a Canadian paper and forest products company; and Beiersdorf, a German personal care products company. Allied Domecq's stock declined after the company lowered its earnings outlook in February due to a weak U.S. dollar, higher pension expenses and weakness in its Spanish operations. Abitibi's shares underperformed in 2003 after a weak U.S. dollar, soft sales and higher energy prices forced the company to reduce its earnings outlook and cut its dividend. Beiersdorf, which owns leading skin care brand Nivea, had been the subject of takeover speculation earlier in the year. Beiersdorf's shares declined after major shareholders announced the company would remain independent and not be sold. 8 | Annual Report Thank you for your continued participation in Mutual Discovery Fund. We look forward to serving your future investment needs. [PHOTO OF DAVID J. WINTERS OMITTED] /S/ DAVID J. WINTERS David J. Winters, CFA Portfolio Manager [PHOTO OF TIMOTHY M. RANKIN OMITTED] /S/ TIMOTHY M. RANKIN Timothy M. Rankin, CFA Assistant Portfolio Manager Mutual Discovery Fund THIS DISCUSSION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2003, THE END OF THE REPORTING PERIOD. THE WAY WE IMPLEMENT OUR MAIN INVESTMENT STRATEGIES AND THE RESULTING PORTFOLIO HOLDINGS MAY CHANGE DEPENDING ON FACTORS SUCH AS MARKET AND ECONOMIC CONDITIONS. THESE OPINIONS MAY NOT BE RELIED UPON AS INVESTMENT ADVICE OR AN OFFER FOR A PARTICULAR SECURITY. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR THE FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE, BUT THE ADVISOR MAKES NO REPRESENTATION OR WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR INVESTMENT MANAGEMENT PHILOSOPHY. Annual Report | 9 Performance Summary as of 12/31/03 Your dividend income will vary depending on dividends or interest paid by securities in the Fund's portfolio, adjusted for operating expenses of each class. Capital gain distributions are net profits realized from the sale of portfolio securities. The performance table and graphs do not reflect any taxes due on Fund dividends, capital gain distributions, if any, or any realized gains on the sale of Fund shares. Total return reflects the Fund's dividend income, capital gain distributions, if any, and any unrealized gains or losses.
PRICE AND DISTRIBUTION INFORMATION -------------------------------------------------------------------------------------------------- CLASS Z CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$4.64 $20.80 $16.16 -------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------------------------- Dividend Income $0.4315 -------------------------------------------------------------------------------------------------- CLASS A CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$4.60 $20.66 $16.06 -------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------------------------- Dividend Income $0.3753 -------------------------------------------------------------------------------------------------- CLASS B CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$4.49 $20.34 $15.85 -------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------------------------- Dividend Income $0.2795 -------------------------------------------------------------------------------------------------- CLASS C CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$4.57 $20.59 $16.02 -------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------------------------- Dividend Income $0.2630 -------------------------------------------------------------------------------------------------- CLASS R CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$4.55 $20.56 $16.01 -------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------------------------- Dividend Income $0.3677 --------------------------------------------------------------------------------------------------
10 | Past performance does not guarantee future results.|Annual Report Performance Summary (CONTINUED)
PERFORMANCE ----------------------------------------------------------------------------------------------------- CLASS Z 1 1-YEAR 5-YEAR 10-YEAR ----------------------------------------------------------------------------------------------------- Cumulative Total Return 2 31.55% 72.96% 247.33% ----------------------------------------------------------------------------------------------------- Average Annual Total Return 3 31.55% 11.58% 13.26% ----------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $13,155 $17,296 $34,733 ----------------------------------------------------------------------------------------------------- CLASS A 1 1-YEAR 5-YEAR INCEPTION (11/1/96) ----------------------------------------------------------------------------------------------------- Cumulative Total Return 2 31.13% 70.04% 113.32% ----------------------------------------------------------------------------------------------------- Average Annual Total Return 3 23.59% 9.89% 10.23% ----------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $12,359 $16,026 $20,103 ----------------------------------------------------------------------------------------------------- CLASS B 1 1-YEAR 5-YEAR INCEPTION (1/1/99) ----------------------------------------------------------------------------------------------------- Cumulative Total Return 2 30.22% 64.51% 64.51% ----------------------------------------------------------------------------------------------------- Average Annual Total Return 3 26.22% 10.20% 10.20% ----------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $12,622 $16,251 $16,251 ----------------------------------------------------------------------------------------------------- CLASS C 1 1-YEAR 5-YEAR INCEPTION (11/1/96) ----------------------------------------------------------------------------------------------------- Cumulative Total Return 2 30.29% 64.59% 104.01% ----------------------------------------------------------------------------------------------------- Average Annual Total Return 3 28.02% 10.26% 10.30% ----------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $12,802 $16,297 $20,195 ----------------------------------------------------------------------------------------------------- CLASS R 1-YEAR INCEPTION (1/1/02) ----------------------------------------------------------------------------------------------------- Cumulative Total Return 2 30.87% 18.45% ----------------------------------------------------------------------------------------------------- Average Annual Total Return 3 29.87% 8.86% ----------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $12,987 $11,845 -----------------------------------------------------------------------------------------------------
ONGOING MARKET VOLATILITY CAN SIGNIFICANTLY AFFECT SHORT-TERM PERFORMANCE; MORE RECENT RETURNS MAY DIFFER FROM THOSE SHOWN. SINCE MARKETS CAN GO DOWN AS WELL AS UP, INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE WITH MARKET CONDITIONS AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. FOR MORE CURRENT PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236. Annual Report | Past performance does not guarantee future results. | 11 Performance Summary (CONTINUED) TOTAL RETURN INDEX COMPARISON FOR HYPOTHETICAL $10,000 INVESTMENT Total return represents the change in value of an investment over the periods shown. It includes the current, applicable, maximum sales charge(s), Fund expenses, account fees and reinvested distributions. The unmanaged indexes include reinvested dividends. They differ from the Fund in composition and do not pay management fees or expenses. One cannot invest directly in an index. AVERAGE ANNUAL TOTAL RETURN -------------------------------------- CLASS Z 1 12/31/03 -------------------------------------- 1-Year 31.55% -------------------------------------- 5-Year 11.58% -------------------------------------- 10-Year 13.26% -------------------------------------- EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Class Z (1/1/94-12/31/03) 1 [GRAPHIC OMITTED] Mutual Discovery Fund S&P 500 Index 5 MSCI World Index 5 1/94 $10000 $10000 $10000 10559 10339 10661 10421 10059 10525 10314 9621 10073 10398 9744 10386 10406 9904 10414 10337 9661 10387 10571 9978 10586 10882 10387 10907 10711 10133 10622 10664 10360 10927 10345 9983 10455 10362 10131 10558 10585 10394 10401 10965 10798 10555 10973 11116 11066 11394 11444 11454 11658 11900 11554 11972 12176 11552 12446 12580 12133 12721 12611 11865 13046 13143 12213 12838 13096 12023 13088 13671 12442 13329 13934 12808 13821 14408 13042 14287 14542 13124 14489 14682 13345 14806 14898 13661 15061 15281 13675 6/96 15041 15340 13747 14592 14662 13264 15095 14972 13419 15462 15814 13947 15848 16250 14047 16503 17477 14836 16651 17131 14601 17446 18201 14780 17785 18344 14952 17620 17591 14659 17649 18641 15141 18289 19775 16078 18967 20660 16882 19791 22303 17663 19604 21055 16484 20591 22207 17382 19998 21466 16470 20117 22459 16764 20471 22845 16971 20482 23097 17446 21534 24762 18629 22769 26029 19419 23192 26291 19611 23506 25839 19368 22921 26888 19831 22382 26603 19802 19330 22760 17164 18465 24219 17471 18975 26187 19053 19929 27773 20189 12/98 20083 29373 21178 20222 30601 21645 19990 29650 21072 20908 30836 21953 22315 32030 22821 22327 31274 21991 23121 33009 23019 22861 31980 22953 22589 31821 22916 22293 30950 22697 22755 32908 23880 23949 33577 24555 25465 35553 26545 25368 33767 25028 26177 33128 25099 27299 36367 26837 26998 35273 25705 27155 34552 25057 27232 35403 25905 27581 34850 25178 28395 37014 26001 28111 35060 24621 28331 34912 24212 27853 32161 22745 28672 32319 23116 29550 33465 23565 29550 30415 21576 28672 28490 20163 29505 30702 21658 30398 30908 21389 6/01 30539 30156 20722 30478 29859 20449 30171 27992 19472 27607 25731 17759 27683 26222 18100 28390 28233 19174 29035 28481 19297 29130 28065 18714 29418 27524 18555 30391 28559 19380 30918 26828 18728 31158 26632 18772 29245 24735 17637 27317 22807 16152 27590 22957 16186 26144 20464 14409 26240 22264 15476 26626 23573 16313 26405 22189 15526 25964 21608 15057 25261 21284 14799 25376 21488 14758 27320 23259 16076 28856 24483 17003 29347 24796 17304 29709 25234 17658 30596 25725 18044 30761 25452 18159 32076 26891 19240 33194 27128 19537 12/03 34733 28550 20768 AVERAGE ANNUAL TOTAL RETURN -------------------------------------- CLASS A 1 12/31/03 -------------------------------------- 1-Year 23.59% -------------------------------------- 5-Year 9.89% -------------------------------------- Since Inception (11/1/96) 10.23% -------------------------------------- EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Class A (11/1/96-12/31/03) 1 [GRAPHIC OMITTED] Date Mutual Discovery Fund S&P 500 Index 5 MSCI World Index 5 11/1/96 $9,424 $10,000 $10,000 11/30/96 $9,808 $10,755 $10,562 12/31/96 $9,887 $10,542 $10,395 1/31/97 $10,348 $11,200 $10,522 2/28/97 $10,544 $11,288 $10,645 3/31/97 $10,446 $10,825 $10,436 4/30/97 $10,463 $11,471 $10,779 5/31/97 $10,838 $12,169 $11,446 6/30/97 $11,235 $12,714 $12,019 7/31/97 $11,718 $13,725 $12,574 8/31/97 $11,607 $12,957 $11,735 9/30/97 $12,188 $13,666 $12,374 10/31/97 $11,830 $13,210 $11,725 11/30/97 $11,900 $13,821 $11,934 12/31/97 $12,109 $14,058 $12,082 1/31/98 $12,109 $14,213 $12,420 2/28/98 $12,726 $15,238 $13,262 3/31/98 $13,453 $16,018 $13,824 4/30/98 $13,697 $16,179 $13,962 5/31/98 $13,877 $15,901 $13,789 6/30/98 $13,530 $16,546 $14,118 7/31/98 $13,208 $16,371 $14,097 8/31/98 $11,398 $14,006 $12,219 9/30/98 $10,885 $14,904 $12,438 10/31/98 $11,181 $16,115 $13,564 11/30/98 $11,741 $17,091 $14,373 12/31/98 $11,822 $18,075 $15,077 1/31/99 $11,905 $18,831 $15,409 2/28/99 $11,760 $18,246 $15,002 3/31/99 $12,303 $18,975 $15,629 4/30/99 $13,122 $19,710 $16,247 5/31/99 $13,129 $19,245 $15,655 6/30/99 $13,594 $20,313 $16,388 7/31/99 $13,440 $19,679 $16,341 8/31/99 $13,266 $19,582 $16,314 9/30/99 $13,091 $19,046 $16,158 10/31/99 $13,357 $20,251 $17,000 11/30/99 $14,056 $20,662 $17,481 12/31/99 $14,941 $21,878 $18,898 1/31/00 $14,877 $20,779 $17,818 2/29/00 $15,353 $20,386 $17,868 3/31/00 $16,008 $22,379 $19,105 4/30/00 $15,823 $21,706 $18,300 5/31/00 $15,915 $21,262 $17,839 6/30/00 $15,954 $21,786 $18,442 7/31/00 $16,152 $21,446 $17,925 8/31/00 $16,624 $22,777 $18,510 9/30/00 $16,449 $21,575 $17,528 10/31/00 $16,579 $21,484 $17,237 11/30/00 $16,289 $19,791 $16,192 12/31/00 $16,773 $19,888 $16,457 1/31/01 $17,281 $20,593 $16,776 2/28/01 $17,272 $18,717 $15,360 3/31/01 $16,746 $17,532 $14,354 4/30/01 $17,227 $18,893 $15,419 5/31/01 $17,744 $19,020 $15,227 6/30/01 $17,822 $18,557 $14,752 7/31/01 $17,786 $18,374 $14,558 8/31/01 $17,605 $17,225 $13,862 9/30/01 $16,098 $15,834 $12,643 10/31/01 $16,143 $16,137 $12,886 11/30/01 $16,549 $17,374 $13,650 12/31/01 $16,918 $17,526 $13,738 1/31/02 $16,975 $17,271 $13,323 2/28/02 $17,134 $16,938 $13,210 3/31/02 $17,695 $17,575 $13,797 4/30/02 $17,995 $16,510 $13,333 5/31/02 $18,126 $16,388 $13,364 6/30/02 $17,009 $15,221 $12,556 7/31/02 $15,888 $14,035 $11,499 8/31/02 $16,039 $14,127 $11,523 9/30/02 $15,191 $12,593 $10,258 10/31/02 $15,248 $13,701 $11,017 11/30/02 $15,465 $14,506 $11,614 12/31/02 $15,331 $13,654 $11,053 1/31/03 $15,073 $13,297 $10,719 2/28/03 $14,662 $13,098 $10,536 3/31/03 $14,729 $13,223 $10,507 4/30/03 $15,846 $14,313 $11,445 5/31/03 $16,734 $15,066 $12,105 6/30/03 $17,006 $15,259 $12,319 7/31/03 $17,218 $15,528 $12,571 8/31/03 $17,727 $15,830 $12,846 9/30/03 $17,823 $15,663 $12,927 10/31/03 $18,572 $16,548 $13,697 11/30/03 $19,215 $16,694 $13,909 12/31/03 $20,103 $17,569 $14,785 12 | Past performance does not guarantee future results.|Annual Report Performance Summary (CONTINUED) [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Class B (1/1/99-12/31/03) 1 Mutual Discovery Fund S&P 500 Index 5 MSCI World Index 5 1/99 $10000 $10000 $10000 10070 10418 10220 9942 10094 9949 10396 10498 10365 11076 10904 10775 11076 10647 10383 11462 11237 10869 11320 10887 10838 11172 10833 10820 11018 10537 10716 11231 11203 11275 11816 11431 11594 12555 12104 12534 12495 11496 11817 2/00 12885 11278 11851 13420 12381 12671 13264 12008 12137 13330 11763 11831 13356 12053 12231 13517 11864 11888 13903 12601 12276 13755 11936 11625 13851 11885 11432 13607 10949 10739 13998 11003 10914 14411 11393 11126 14396 10355 10187 13961 9699 9520 4/01 14351 10452 10226 14771 10522 10099 14832 10266 9784 14787 10165 9655 14627 9529 9194 13373 8760 8385 13403 8927 8546 13730 9612 9053 14028 9696 9111 14068 9554 8836 14193 9370 8761 14656 9723 9150 14892 9133 8843 14994 9066 8863 14061 8421 8327 7/02 13121 7764 7626 13247 7815 7642 12536 6967 6803 12576 7579 7307 12749 8025 7702 12633 7554 7331 12410 7356 7109 12068 7246 6987 12115 7315 6968 13032 7918 7591 13749 8335 8028 13971 8441 8170 14131 8590 8337 14540 8758 8520 14612 8665 8574 15221 9155 9084 15742 9235 9225 12/03 16251 9720 9806 AVERAGE ANNUAL TOTAL RETURN -------------------------------------- CLASS B 1 12/31/03 -------------------------------------- 1-Year 26.22% -------------------------------------- 5-Year 10.20% -------------------------------------- Since Inception (1/1/99) 10.20% -------------------------------------- EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Class C (11/1/96-12/31/03) 1 [GRAPHIC OMITTED] Date Mutual Discovery Fund S&P 500 Index 5 MSCI World Index 5 11/96 $ 9899 $10000 $10000 10303 10755 10562 10386 10542 10395 10869 11200 10522 11069 11288 10645 10954 10825 10436 10966 11471 10779 11353 12169 11446 11759 12714 12019 12265 13725 12574 12142 12957 11735 12739 13666 12374 12357 13210 11725 12425 13821 11934 12639 14058 12082 12632 14213 12420 13265 15238 13262 14018 16018 13824 14267 16179 13962 14442 15901 13789 14078 16546 14118 13734 16371 14097 8/98 11849 14006 12219 11313 14904 12438 11616 16115 13564 12186 17091 14373 12270 18075 15077 12342 18831 15409 12192 18246 15002 12742 18975 15629 13586 19710 16247 13586 19245 15655 14062 20313 16388 13888 19679 16341 13707 19582 16314 13518 19046 16158 13786 20251 17000 14497 20662 17481 15399 21878 18898 15333 20779 17818 15811 20386 17868 16472 22379 19105 16281 21706 18300 16362 21262 17839 6/00 16390 21786 18442 16587 21446 17925 17058 22777 18510 16877 21575 17528 16995 21484 17237 16697 19791 16192 17174 19888 16457 17687 20593 16776 17668 18717 15360 17129 17532 14354 17614 18893 15419 18126 19020 15227 18197 18557 14752 18150 18374 14558 17946 17225 13862 16407 15834 12643 16445 16137 12886 16843 17374 13650 17217 17526 13738 17265 17271 13323 17418 16938 13210 3/02 17981 17575 13797 18268 16510 13333 18401 16388 13364 17253 15221 12556 16100 14035 11499 16254 14127 11523 15389 12593 10258 15428 13701 11017 15649 14506 11614 15500 13654 11053 15229 13297 10719 14813 13098 10536 14861 13223 10507 15984 14313 11445 16874 15066 12105 17141 15259 12319 17336 15528 12571 17842 15830 12846 17929 15663 12927 18678 16548 13697 19311 16694 13909 12/03 20195 17569 14785 AVERAGE ANNUAL TOTAL RETURN -------------------------------------- CLASS C 1 12/31/03 -------------------------------------- 1-Year 28.02% -------------------------------------- 5-Year 10.26% -------------------------------------- Since Inception (11/1/96) 10.30% -------------------------------------- Annual Report | Past performance does not guarantee future results. |13 Performance Summary (CONTINUED) AVERAGE ANNUAL TOTAL RETURN -------------------------------------- CLASS R 12/31/03 -------------------------------------- 1-Year 29.87% -------------------------------------- Since Inception (1/1/02) 8.86% -------------------------------------- EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Class R (1/1/02-12/31/03) [GRAPHIC OMITTED] Date Mutual Discovery Fund S&P 500 Index 5 MSCI World Index 5 1/02 $10000 $10000 $10000 10033 9854 9698 10127 9664 9616 10459 10028 10043 10631 9420 9705 10709 9351 9728 6/02 10051 8685 9140 9383 8008 8370 9472 8061 8388 8971 7185 7467 9004 7817 8020 9132 8277 8454 12/02 9051 7791 8046 8893 7587 7803 8656 7473 7669 8689 7545 7648 9351 8167 8331 9871 8596 8811 6/03 10032 8706 8967 10152 8860 9151 10453 9032 9351 10505 8937 9410 10948 9442 9970 11323 9525 10125 12/03 11845 10024 10762 ENDNOTES THE FUND INVESTS IN FOREIGN SECURITIES AND SMALLER-COMPANY STOCKS. FOREIGN SECURITIES RISKS INCLUDE EXPOSURE TO CURRENCY VOLATILITY AND POLITICAL, ECONOMIC AND REGULATORY UNCERTAINTY. SMALLER-COMPANY STOCKS HAVE HISTORICALLY EXHIBITED GREATER PRICE VOLATILITY THAN LARGER-COMPANY STOCKS, PARTICULARLY OVER THE SHORT TERM. THE FUND MAY ALSO INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, AS WELL AS LOWER-RATED "JUNK BONDS," WHICH ENTAIL HIGHER CREDIT RISK. THE FUND'S PROSPECTUS ALSO INCLUDES A DESCRIPTION OF THE MAIN INVESTMENT RISKS. CLASS Z: No initial sales charge or Rule 12b-1 fees; shares are available only to certain investors, as described in the prospectus. CLASS A: Subject to the current, maximum 5.75% initial sales charge. Prior to 8/3/98, Fund shares were offered at a lower initial sales charge; thus actual total returns may differ. CLASS B: Subject to no initial sales charge, but subject to a contingent deferred sales charge (CDSC) declining from 4% to 0% over six years. These shares have higher annual fees and expenses than Class A shares. CLASS C: Subject to 1% initial sales charge and 1% CDSC for shares redeemed within 18 months of investment. These shares have higher annual fees and expenses than Class A shares. CLASS R: No initial sales charge, but subject to 1% CDSC for shares redeemed within 18 months of investment; shares are available to certain eligible investors as described in the prospectus. These shares have higher annual fees and expenses than Class A shares. 1. Past expense reductions by the Fund's manager increased the Fund's total returns. Without these reductions, the Fund's total returns would have been lower. 2. Cumulative total return represents the change in value of an investment over the periods indicated and does not include sales charges. 3. Average annual total return represents the average annual change in value of an investment over the periods indicated and includes any current, applicable, maximum sales charge(s). 4. These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated and include any current, applicable, maximum sales charge(s). 5. Source: Standard & Poor's Micropal. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The S&P 500 is one of the most widely used benchmarks of U.S. equity performance. The MSCI World Index is market capitalization-weighted and measures total returns of equity securities in developed markets globally. 14 | Past performance does not guarantee future results. | Annual Report Mutual Discovery Fund FINANCIAL HIGHLIGHTS
--------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2003 2002 2001 2000 1999 --------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ..................... $16.16 $18.19 $18.93 $21.10 $17.27 --------------------------------------------------------------- Income from investment operations: Net investment income a ............................... .28 .33 .37 .36 .25 Net realized and unrealized gains (losses) ............ 4.80 (1.96) (.14) 2.14 4.32 --------------------------------------------------------------- Total from investment operations ....................... 5.08 (1.63) .23 2.50 4.57 --------------------------------------------------------------- Less distributions from: Net investment income ................................. (.43) (.32) (.34) (.63) (.42) Net realized gains .................................... -- (.08) (.63) (4.04) (.32) --------------------------------------------------------------- Total distributions .................................... (.43) (.40) (.97) (4.67) (.74) --------------------------------------------------------------- Net asset value, end of year ........................... $20.81 $16.16 $18.19 $18.93 $21.10 --------------------------------------------------------------- Total return b ......................................... 31.55% (9.06)% 1.26% 12.59% 26.80% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ........................ $2,168,161 $1,673,786 $1,931,117 $2,010,578 $2,038,298 Ratios to average net assets:* Expenses c ............................................ 1.11% 1.04% 1.04% 1.05% 1.05% Expenses excluding waiver and payments by affiliate c . 1.11% 1.04% 1.04% 1.07% 1.11% Net investment income ................................. 1.55% 1.88% 1.93% 1.64% 1.33% Portfolio turnover rate ................................ 46.34% 40.95% 59.32% 75.34% 87.67% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .............................................. 1.08% 1.03% 1.02% 1.02% 1.03% Expenses, excluding waiver and payments by affiliate .. 1.08% 1.03% 1.02% 1.04% 1.09% a Based on average daily shares outstanding. b Total return is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses.
Annual Report | 15 Mutual Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED)
------------------------------------------------------------ YEAR ENDED DECEMBER 31, CLASS A 2003 2002 2001 2000 1999 ------------------------------------------------------------ PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ....................... $16.06 $18.08 $18.83 $21.00 $17.19 ------------------------------------------------------------ Income from investment operations: Net investment income a ................................. .21 .27 .30 .28 .18 Net realized and unrealized gains (losses) .............. 4.78 (1.95) (.14) 2.14 4.30 ------------------------------------------------------------ Total from investment operations ......................... 4.99 (1.68) .16 2.42 4.48 ------------------------------------------------------------ Less distributions from: Net investment income ................................... (.38) (.26) (.28) (.55) (.35) Net realized gains ...................................... -- (.08) (.63) (4.04) (.32) ------------------------------------------------------------ Total distributions ...................................... (.38) (.34) (.91) (4.59) (.67) ------------------------------------------------------------ Net asset value, end of year ............................. $20.67 $16.06 $18.08 $18.83 $21.00 ------------------------------------------------------------ Total return b ........................................... 31.13% (9.39)% .86% 12.27% 26.38% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) .......................... $1,439,579 $925,278 $911,434 $877,528 $844,462 Ratios to average net assets:* Expenses c .............................................. 1.46% 1.39% 1.39% 1.40% 1.40% Expenses excluding waiver and payments by affiliate c ... 1.46% 1.39% 1.39% 1.42% 1.46% Net investment income ................................... 1.20% 1.53% 1.57% 1.30% .98% Portfolio turnover rate .................................. 46.34% 40.95% 59.32% 75.34% 87.67% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................................ 1.43% 1.38% 1.37% 1.37% 1.38% Expenses, excluding waiver and payments by affiliate .... 1.43% 1.38% 1.37% 1.39% 1.44% a Based on average daily shares outstanding. b Total return does not reflect the sales commissions or the contingent deferred sales charge, and is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses.
16 | Annual Report Mutual Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED) Mutual Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED)
--------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2003 2002 2001 2000 1999 --------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ........................ $15.85 $17.87 $18.66 $20.90 $17.19 --------------------------------------------------------- Income from investment operations: Net investment income a .................................. .09 .16 .16 .15 .01 Net realized and unrealized gains (losses) ............... 4.69 (1.92) (.12) 2.11 4.33 --------------------------------------------------------- Total from investment operations .......................... 4.78 (1.76) .04 2.26 4.34 --------------------------------------------------------- Less distributions from: Net investment income .................................... (.28) (.18) (.20) (.46) (.31) Net realized gains ....................................... -- (.08) (.63) (4.04) (.32) --------------------------------------------------------- Total distributions ....................................... (.28) (.26) (.83) (4.50) (.63) --------------------------------------------------------- Net asset value, end of year .............................. $20.35 $15.85 $17.87 $18.66 $20.90 --------------------------------------------------------- Total return b ............................................ 30.22% (9.94)% .21% 11.50% 25.55% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ........................... $115,801 $64,747 $41,346 $19,949 $8,090 Ratios to average net assets:* Expenses c ............................................... 2.11% 2.04% 2.04% 2.05% 2.05% Expenses excluding waiver and payments by affiliate c .... 2.11% 2.04% 2.04% 2.07% 2.11% Net investment income .................................... .55% .88% .85% .70% .08% Portfolio turnover rate ................................... 46.34% 40.95% 59.32% 75.34% 87.67% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................................. 2.08% 2.03% 2.02% 2.02% 2.03% Expenses, excluding waiver and payments by affiliate ..... 2.08% 2.03% 2.02% 2.04% 2.09% a Based on average daily shares outstanding. b Total return does not reflect the contingent deferred sales charge, and is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses.
Annual Report | 17 Mutual Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED)
--------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2003 2002 2001 2000 1999 --------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .......................... $16.02 $18.03 $18.77 $20.95 $17.15 --------------------------------------------------------- Income from investment operations: Net investment income a .................................... .10 .16 .18 .14 .06 Net realized and unrealized gains (losses) ................. 4.73 (1.94) (.13) 2.13 4.28 --------------------------------------------------------- Total from investment operations ............................ 4.83 (1.78) .05 2.27 4.34 --------------------------------------------------------- Less distributions from: Net investment income ...................................... (.26) (.15) (.16) (.41) (.22) Net realized gains ......................................... -- (.08) (.63) (4.04) (.32) --------------------------------------------------------- Total distributions ......................................... (.26) (.23) (.79) (4.45) (.54) --------------------------------------------------------- Net asset value, end of year ................................ $20.59 $16.02 $18.03 $18.77 $20.95 --------------------------------------------------------- Total return b .............................................. 30.29% (9.98)% .25% 11.53% 25.57% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............................. $725,489 $525,375 $561,808 $554,968 $541,919 Ratios to average net assets:* Expenses c ................................................. 2.11% 2.03% 2.03% 2.04% 2.04% Expenses excluding waiver and payments by affiliate c ...... 2.11% 2.03% 2.03% 2.07% 2.10% Net investment income ...................................... .55% .89% .93% .65% .35% Portfolio turnover rate ..................................... 46.34% 40.95% 59.32% 75.34% 87.67% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .................................................... 2.08% 2.02% 2.01% 2.01% 2.02% Expenses, excluding waiver and payments by affiliate ........ 2.08% 2.02% 2.01% 2.04% 2.08% a Based on average daily shares outstanding. b Total return does not reflect the sales commissions or the contingent deferred sales charge, and is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses.
18 | Annual Report Mutual Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED) Mutual Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED)
-------------------------------- YEAR ENDED PERIOD ENDED DECEMBER 31, DECEMBER 31, CLASS R 2003 2002 D -------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................................... $16.01 $18.08 -------------------------------- Income from investment operations: Net investment income a ............................................. .17 .25 Net realized and unrealized gains (losses) .......................... 4.76 (1.95) -------------------------------- Total from investment operations ..................................... 4.93 (1.70) -------------------------------- Less distributions from: Net investment income ............................................... (.37) (.29) Net realized gains .................................................. -- (.08) -------------------------------- Total distributions .................................................. (.37) (.37) -------------------------------- Net asset value, end of year ......................................... $20.57 $16.01 -------------------------------- Total return b ....................................................... 30.87% (9.49)% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ...................................... $19,546 $3,932 Ratios to average net assets:* Expenses c .......................................................... 1.61% 1.54%e Expenses excluding waiver and payments by affiliate c ............... 1.61% 1.54%e Net investment income ............................................... 1.05% 1.38%e Portfolio turnover rate .............................................. 46.34% 40.95% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ............................................................ 1.58% 1.54% e Expenses, excluding waiver and payments by affiliate ................ 1.58% 1.54% e a Based on average daily shares outstanding. b Total return does not reflect the contingent deferred sales charge, and is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses. d Effective date of Class R shares was January 2, 2002. e Annualized.
Annual Report | See notes to financial statements. | 19 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003
--------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE --------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 81.6% AEROSPACE & Defense .6% Northrop Grumman Corp. ......................................... United States 281,000 $ 26,863,600 --------------- AIRLINES aAtlantic Coast Airlines Holdings Inc. .......................... United States 28,600 283,140 --------------- AUTO COMPONENTS .4% NGK Spark Plug Co. Ltd. ........................................ Japan 77,000 624,363 Trelleborg AB, B ............................................... Sweden 1,171,788 19,053,993 --------------- 19,678,356 --------------- BEVERAGES 7.5% Brown-Forman Corp., A .......................................... United States 71,600 6,941,620 Brown-Forman Corp., B .......................................... United States 203,475 19,014,739 aCarlsberg AS, A ................................................ Denmark 62,300 2,564,546 Carlsberg AS, B ................................................ Denmark 1,392,915 64,181,476 Coca-Cola Enterprises Inc. ..................................... United States 252,700 5,526,549 Diageo PLC ..................................................... United Kingdom 5,181,408 68,175,201 Fomento Economico Mexicano SA de CV Femsa, ADR ................. Mexico 991,000 36,548,080 Heineken Holding NV, A ......................................... Netherlands 1,162,455 39,779,773 Kirin Brewery Co. Ltd. ......................................... Japan 394,000 3,360,231 Molson Inc., A ................................................. Canada 991,000 27,684,349 Orkla ASA ...................................................... Norway 2,561,132 57,360,610 Pepsi Bottling Group Inc. ...................................... United States 89,700 2,168,946 --------------- 333,306,120 --------------- BIOTECHNOLOGY aSICOR Inc. ..................................................... United States 26,300 715,360 --------------- CAPITAL MARKETS .5% C.I. Fund Management Inc. ...................................... Canada 1,970,300 21,406,858 --------------- CHEMICALS 3.4% Akzo Nobel NV .................................................. Netherlands 825,200 31,850,555 Givaudan AG .................................................... Switzerland 93,476 48,523,624 MG Technologies AG ............................................. Germany 1,363,596 19,091,720 Solvay SA ...................................................... Belgium 437,923 37,975,790 Syngenta AG .................................................... Switzerland 199,949 13,467,355 --------------- 150,909,044 --------------- COMMERCIAL BANKS 4.4% Allied Irish Banks PLC ......................................... Irish Republic 3,789,427 60,607,889 aBanca Nazionale del Lavoro SpA ................................. Italy 4,480,820 10,710,335 Bank of Ireland ................................................ Irish Republic 2,475,126 33,686,440 Danske Bank .................................................... Denmark 1,352,880 31,741,338 DNB NOR ASA .................................................... Norway 5,642,329 37,698,642 Fleet Boston Financial Corp. ................................... United States 105,700 4,613,805 KeyCorp ........................................................ United States 387,100 11,349,772 a,b,cNippon Investment LLC ........................................ Japan 8,656,000 3,289,280 --------------- 193,697,501 ---------------
20 | Annual Report Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE --------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) COMMERCIAL SERVICES & SUPPLIES .8% aAlderwoods Group Inc. .......................................... United States 463,822 $ 4,369,203 aCendant Corp. .................................................. United States 557,800 12,422,206 Republic Services Inc. ......................................... United States 731,600 18,750,908 --------------- 35,542,317 --------------- COMPUTERS & PERIPHERALS aDecisionOne Corp. .............................................. United States 87,619 175,238 --------------- CONSTRUCTION & ENGINEERING 1.5% Vinci SA ....................................................... France 831,794 68,879,006 --------------- CONSTRUCTION MATERIALS 1.0% Ciments Francais SA ............................................ France 399,572 27,972,056 RMC Group PLC .................................................. United Kingdom 1,226,850 15,318,879 --------------- 43,290,935 --------------- DIVERSIFIED FINANCIAL SERVICES 5.7% a,bA.B. Watley Group Inc. ......................................... United States 128,355 23,104 Brascan Corp., A ............................................... Canada 1,431,400 44,008,142 E-L Financial Corp. Ltd. ....................................... Canada 140,000 32,772,296 Euronext ....................................................... Netherlands 1,294,536 32,771,617 a,b,cFE Capital Holdings Ltd. ....................................... Japan 11,445 11,444,600 aIrish Life & Permanent PLC ..................................... Irish Republic 2,899,665 46,633,109 a,bLeucadia National Corp. ........................................ United States 684,780 29,989,940 Pargesa Holdings SA ............................................ Switzerland 20,638 55,068,041 --------------- 252,710,849 --------------- DIVERSIFIED TELECOMMUNICATION SERVICES 3.9% a,b,dAboveNet Inc. .................................................. United States 61,768 1,850,217 BCE INC. ....................................................... Canada 795,100 17,781,691 Chunghwa Telecom Co. Ltd., ADR ................................. Taiwan 999,982 14,499,739 Global Crossing Holdings Ltd., Contingent Equity Distribution .. United States 45,724,238 40,009 aGlobal Crossing Ltd. ........................................... United States 69,314 2,287,363 aKoninklijke KPN NV ............................................. Netherlands 2,137,200 16,498,062 a,bNTL Inc. ....................................................... United Kingdom 627,046 41,549,636 aNTL Inc. ....................................................... United Kingdom 831,676 58,009,401 aSpectrasite Inc. ............................................... United States 501,256 17,418,646 aXO Communications Inc. ......................................... United States 1,042,901 4,432,329 --------------- 174,367,093 --------------- ELECTRIC UTILITIES .7% E.ON AG ........................................................ Germany 373,800 24,484,655 a,bPG & E Corp., wts., 9/02/06 .................................... United States 12,235 305,679 aReliant Resources Inc. ......................................... United States 1,057,000 7,779,520 --------------- 32,569,854 --------------- FOOD & STAPLES RETAILING .4% aKroger Co. ..................................................... United States 722,800 13,379,028 aSafeway Inc. ................................................... United States 215,100 4,712,841 --------------- 18,091,869 ---------------
Annual Report | 21 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE --------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) FOOD PRODUCTS 4.9% Cadbury Schweppes PLC .......................................... United Kingdom 4,575,019 $ 33,599,498 Farmer Brothers Co. ............................................ United States 81,152 25,258,560 Groupe Danone .................................................. France 407,800 66,560,696 aKoninklijke Numico NV .......................................... Netherlands 708,095 19,569,073 Lotte Confectionary Co. Ltd. ................................... South Korea 50,489 19,004,882 Nestle SA ...................................................... Switzerland 219,229 54,774,013 Weetabix Ltd., A ............................................... United Kingdom 25,100 2,381,447 --------------- 221,148,169 --------------- GAS UTILITIES .2% Tokyo Gas Co. Ltd. ............................................. Japan 2,101,400 7,490,294 --------------- HEALTH CARE EQUIPMENT & SUPPLIES .1% Amersham PLC ................................................... United Kingdom 367,300 5,033,353 --------------- HEALTH CARE PROVIDERS & SERVICES 1.2% aAdvancePCS ..................................................... United States 36,200 1,906,292 HCA Inc. ....................................................... United States 278,600 11,968,656 a,dKindred Healthcare Inc. ........................................ United States 467,370 23,079,198 dKindred Healthcare Inc., Jul. 47.50 Calls, 7/11/11 ............. United States 758 339,584 Kindred Healthcare Inc., Jan. 52.00 Calls, 1/01/12 ............. United States 113 -- a,dKindred Healthcare Inc., wts., Series A, 4/20/06 ............... United States 88,766 2,064,342 a,dKindred Healthcare Inc., wts., Series B, 4/20/06 ............... United States 221,915 4,648,565 aLaboratory Corp. of America Holdings ........................... United States 78,900 2,915,355 aMid Atlantic Medical Services Inc. ............................. United States 30,300 1,963,440 aRotech Healthcare Inc. ......................................... United States 171,385 3,941,855 aWellpoint Health Networks Inc. ................................. United States 17,900 1,736,121 --------------- 54,563,408 --------------- HOTELS RESTAURANTS & LEISURE .2% Cara Operations Ltd. ........................................... Canada 11,200 62,316 Cara Operations Ltd., A ........................................ Canada 458,900 2,514,229 aFHC Delaware Inc. .............................................. United States 212,022 1,668,613 a,b,cHancock LLC ................................................... United States 8,758,216 3,897,406 --------------- 8,142,564 --------------- HOUSEHOLD PRODUCTS .4% KAO Corp. ...................................................... Japan 812,900 16,535,616 --------------- INSURANCE 8.4% aAlleghany Corp. ................................................ United States 70,718 15,734,755 aBerkshire Hathaway Inc., A ..................................... United States 853 71,865,250 aBerkshire Hathaway Inc., B ..................................... United States 20,990 59,086,850 Guinness Peat Group PLC ........................................ New Zealand 3,943,591 4,841,748 Hartford Financial Services Group Inc. ......................... United States 408,600 24,119,658 IPC Holdings Ltd. .............................................. Bermuda 325,665 12,681,395 John Hancock Financial Services Inc. ........................... United States 155,800 5,842,500 aMontpelier Re Holdings Ltd. .................................... Bermuda 107,027 3,927,891 Old Republic International Corp. ............................... United States 1,024,350 25,977,516 a,bOlympus Re Holdings Ltd. ....................................... Bermuda 47,160 7,459,297 Prudential Financial Inc. ...................................... United States 561,600 23,458,032
22 | Annual Report Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE --------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) INSURANCE (CONT.) Travelers Property Casualty Corp., A ........................... United States 1,982,610 $ 33,268,196 United Fire & Casualty Co. ..................................... United States 206,943 8,352,220 White Mountains Insurance Group Inc. ........................... United States 112,000 51,514,400 bWhite Mountains Insurance Group Inc. ........................... United States 61,515 26,879,133 --------------- 375,008,841 --------------- IT SERVICES .1% Comdisco Contingent Equity Distribution ........................ United States 41,726,153 154,387 aComdisco Holding Co. Inc. ...................................... United States 87 3,480 aConcord EFS Inc. ............................................... United States 200,900 2,981,356 --------------- 3,139,223 --------------- LEISURE EQUIPMENT & PRODUCTS .6% Agfa Gevaert NV ................................................ Belgium 367,220 10,468,179 Nintendo Co. Ltd. .............................................. Japan 200,200 18,680,601 --------------- 29,148,780 --------------- MACHINERY 1.1% Alfa Laval AB .................................................. Sweden 1,684,100 25,629,084 aSchindler Holding AG ........................................... Switzerland 53,294 13,013,777 aSchindler Holding AG, Reg D .................................... Switzerland 35,778 9,922,663 --------------- 48,565,524 --------------- MEDIA 7.3% Astral Media Inc., A ........................................... Canada 1,394,900 30,278,155 Dow Jones & Co. Inc. ........................................... United States 35,100 1,749,735 E.W. Scripps Co., A ............................................ United States 145,300 13,678,542 aEchoStar Communications Corp., A ............................... United States 393,800 13,389,200 Gannett Co. Inc. ............................................... United States 63,200 5,634,912 aJC Decaux SA ................................................... France 494,086 8,076,885 Lagardere SCA .................................................. France 710,623 41,025,750 aLiberty Media Corp., A ......................................... United States 4,255,518 50,598,109 McGraw-Hill Cos. Inc. .......................................... United States 64,200 4,488,864 aNTL Europe Inc. ................................................ United Kingdom 211,598 2,116 NV Holdingsmig de Telegraaf .................................... Netherlands 865,945 19,769,935 Omnicom Group Inc. ............................................. United States 98,500 8,602,005 SES Global, FDR ................................................ Luxembourg 6,440,290 64,987,790 Torstar Corp., B ............................................... Canada 730,900 16,408,132 aTVMAX Holdings Inc. ............................................ United States 57,982 144,955 Washington Post Co., B ......................................... United States 60,003 47,486,374 --------------- 326,321,459 --------------- METALS & Mining 6.3% Anglo American PLC ............................................. United Kingdom 913,900 19,746,823 Anglo American PLC, ADR ........................................ United Kingdom 1,000 22,120 aApollo Gold Corp. .............................................. Canada 1,602,300 3,670,194 aAshanti Goldfields Co. Ltd., GDR, Reg S ........................ Ghana 253,700 3,308,248 Barrick Gold Corp. ............................................. Canada 1,300,900 29,543,439 Falconbridge Ltd. .............................................. Canada 36,800 893,053 aGlamis Gold Ltd. ............................................... Canada 675,400 11,644,738
Annual Report | 23 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE --------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) METALS & MINING (cont.) Gold Fields Ltd. ............................................... South Africa 520,500 $ 7,446,854 Impala Platinum Holdings Ltd. .................................. South Africa 462,062 40,149,208 a,bInternational Steel Group ...................................... United States 2,689,230 89,033,682 Newmont Mining Corp. ........................................... United States 1,185,700 57,636,877 Noranda Inc. ................................................... Canada 284,000 4,516,309 Pechiney SA, A ................................................. France 9,200 562,815 Placer Dome Inc. ............................................... Canada 407,900 7,313,634 aRandgold & Exploration Co. Ltd., ADR ........................... South Africa 25,700 421,454 aWheaton River Minerals Ltd. .................................... Canada 1,456,679 4,362,428 aWheaton River Minerals Ltd., wts., 5/30/07 ..................... Canada 600,670 1,073,745 --------------- 281,345,621 --------------- MULTI-UTILITIES & UNREGULATED POWER .7% Suez SA ........................................................ France 1,537,900 30,901,548 --------------- OIL & GAS 2.4% BP PLC ......................................................... United Kingdom 2,095,000 16,989,223 BP PLC, ADR .................................................... United Kingdom 180,900 8,927,415 Eni SpA ........................................................ Italy 847,600 15,994,067 Lukoil Holdings, ADR ........................................... Russia 63,800 5,938,504 Norsk Hydro ASA ................................................ Norway 111,800 6,898,434 Occidental Petroleum Corp. ..................................... United States 91,400 3,860,736 a,cSouthwest Royalties Inc., A .................................... United States 53,272 1,598,153 Suncor Energy Inc. ............................................. Canada 33,800 850,068 Total SA, B .................................................... France 127,671 23,737,015 Total SA, B, ADR ............................................... France 208,648 19,302,026 Yukos Corp., ADR ............................................... Russia 49,700 2,124,675 --------------- 106,220,316 --------------- PAPER & FOREST PRODUCTS 1.2% Abitibi-Consolidated Inc. ...................................... Canada 2,100,204 16,853,639 Potlatch Corp. ................................................. United States 1,111,450 38,645,117 --------------- 55,498,756 --------------- PERSONAL PRODUCTS .4% Beiersdorf AG .................................................. Germany 151,924 18,616,822 --------------- PHARMACEUTICALS 1.1% Merck & Co. Inc. ............................................... United States 334,800 15,467,760 Takeda Chemical Industries Ltd. ................................ Japan 632,200 25,070,915 Wyeth .......................................................... United States 152,900 6,490,605 --------------- 47,029,280 --------------- REAL ESTATE 2.1% American Financial Realty Trust ................................ United States 96,400 1,643,620 aCanary Wharf Group PLC ......................................... United Kingdom 5,400,183 25,883,873 iStar Financial Inc. ........................................... United States 804,200 31,283,380 a,bSecurity Capital European Realty ............................... Luxembourg 118,301 881,342 a,b,cTorre Mayor Investments, LP ......,,............................ Mexico 170 13,600,000 Ventas Inc. .................................................... United States 856,200 18,836,400 --------------- 92,128,615 ---------------
24 | Annual Report Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE --------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) ROAD & RAIL 1.4% Canadian National Railway Co. .................................. Canada 402,300 $ 25,528,033 Florida East Coast Industries Inc., A .......................... United States 636,200 21,058,220 Norfolk Southern Corp. ......................................... United States 707,000 16,720,550 --------------- 63,306,803 --------------- SPECIALTY RETAIL New Look Group ................................................. United Kingdom 314,600 1,751,501 --------------- THRIFTS & MORTGAGE FINANCE 1% Freddie Mac .................................................... United States 474,300 27,661,176 Greenpoint Financial Corp. ..................................... United States 62,294 2,200,224 Hudson City Bancorp Inc. ....................................... United States 371,733 14,192,766 --------------- 44,054,166 --------------- TOBACCO 8.9% Altadis SA ..................................................... Spain 2,916,251 82,764,439 Altria Group Inc. .............................................. United States 405,800 22,083,636 British American Tobacco PLC ................................... United Kingdom 9,981,818 137,591,519 Gallaher Group PLC ............................................. United Kingdom 1,624,963 17,453,640 Gallaher Group PLC, ADR ........................................ United Kingdom 17,700 752,958 Imperial Tobacco Group PLC ..................................... United Kingdom 3,570,147 70,302,388 ITC Ltd. ....................................................... India 1,202,467 25,948,250 KT&G Corp., GDR, 144A .......................................... South Korea 4,493,078 39,449,225 --------------- 396,346,055 --------------- TRADING COMPANIES & DISTRIBUTORS .4% Compania de Distribucion Intefral Logista SA ................... Spain 564,170 17,427,502 --------------- TRANSPORTATION INFRASTRUCTURE .4% aLaidlaw International Inc. ..................................... United States 818,364 11,317,974 Peninsular & Oriental Steam Navigation Co. ..................... United Kingdom 1,609,795 6,628,110 --------------- 17,946,084 --------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $2,589,272,087) 3,640,157,440 --------------- ------------- SHARES ------------- PREFERRED STOCKS .5% Electric Utilities aMontana Power Co., 8.45%, pfd. ................................. United States 49,500 594,000 --------------- FOOD PRODUCTS .1% Unilever NV, pfd. .............................................. Netherlands 494,300 3,547,637 --------------- INSURANCE .1% United Fire & Casualty Co., 6.375%, cvt. pfd. .................. United States 110,800 3,213,200 --------------- MEDIA .3% News Corp. Ltd., ADR, pfd. ..................................... Australia 542,900 16,422,725 NTL Europe Inc., 10.00%, A, pfd. ............................... United Kingdom 93,617 770,000 --------------- TOTAL PREFERRED STOCKS (COST $21,961,516) ...................... 24,547,562 ---------------
Annual Report | 25 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- COUNTRY PRINCIPAL AMOUNT E VALUE --------------------------------------------------------------------------------------------------------------------------- CORPORATE BONDS & NOTES 3.5% Calpine Constructor Finance, 8.50%, 8/26/11 ............................................... United States $ 4,935,000 $ 5,132,400 First Priority Term Loan, 8/26/09 ............................ United States 4,057,000 4,259,850 Calpine Corp., 144A, 9.875%, 12/01/11 .......................... United States 10,387,000 10,724,578 Charter Communications Operating LLC, Bank Claim ............... United States 7,043,400 6,796,881 DecisionOne Corp., Term Loan ................................... United States 2,671,452 1,858,431 Eurotunnel PLC, 12/31/18, Tier 2 ............................................. United Kingdom 5,731,599 GBP 7,490,140 12/31/25, Tier 3 ............................................. United Kingdom 5,190,338 GBP 5,110,338 Stabilization Advance S8, Tier 2 ............................. United Kingdom 3,751,379 GBP 1,275,956 Eurotunnel SA, 5.28%, 12/31/18, Tier 2 (Pibor) .............................. France 628,134 EUR 578,377 5.28%, 12/31/25, Tier 3 (Pibor) .............................. France 1,469,409 EUR 1,019,393 12/31/18, Tier 2 (Libor) ..................................... France 1,420,047 EUR 1,307,561 12/31/25, Tier 3 (Libor) ..................................... France 6,598,601 EUR 4,577,738 Stabilization Advance S6, Tier 1 (Pibor) ..................... France 494,873 EUR 118,600 Stabilization Advance S6, Tier 2 (Libor) ..................... France 1,153,486 EUR 276,441 Stabilization Advance S7, Tier 1 (Pibor) ..................... France 1,454,738 EUR 348,638 b,cFE Capital LLC, 5.00%, 8/28/07 ................................. Japan 32,523,000 33,173,460 Healthsouth Corp., 8.50%, 2/01/08 ............................................... United States 5,205,000 5,022,825 7.00%, 6/15/08 ............................................... United States 2,805,000 2,629,688 8.375%, 10/01/11 ............................................. United States 1,680,000 1,596,000 7.625%, 6/01/12 .............................................. United States 13,535,000 12,722,900 cvt., 3.25% .................................................. United States 9,015,000 8,744,550 Marconi Corp., 10.00%, 10/31/08 ................................ United Kingdom 1,393,910 1,547,240 Marconi PLC, 8.00%, 4/30/08 .................................... United Kingdom 6,967,370 6,828,023 Mirant Mid-Atlantic LLC, 8.625%, 6/30/12 .............................................. United States 2,893,945 2,902,938 9.125%, 6/30/17 .............................................. United States 1,484,916 1,485,844 10.06%, 12/30/28 ............................................. United States 3,030,056 3,062,250 Providian Financial Corp., cvt., zero cpn., 2/15/21 ............ United States 13,230,000 6,317,325 Seton House Finance Ltd., 2/07/12 .............................. United Kingdom 41,212,000 EUR 11,956,054 Teco Panda, Bank Claim #2 ................................................ United States 7,209,200 5,154,578 Debt Service Reserve L/C Loan ................................ United States 413,400 295,581 Project L/C Loan Facility .................................... United States 1,033,600 739,024 TVMAX Holdings Inc., PIK, 14.00%, 2/01/06 ...................... United States 267,452 267,452 --------------- TOTAL CORPORATE BONDS & NOTES (COST $136,594,006) .............. 155,321,054 --------------- BONDS & NOTES IN REORGANIZATION 6.4% aAdelphia Communications Corp., 9.25%, 10/01/02 .............................................. United States 4,663,000 4,336,590 8.125%, 7/15/03 .............................................. United States 650,000 604,500 7.50%, 1/15/04 ............................................... United States 1,655,000 1,530,875 10.50%, 7/15/04 .............................................. United States 2,605,000 2,461,725 10.25%, 11/01/06 ............................................. United States 4,947,000 4,625,445 8.375%, 2/01/08 .............................................. United States 5,130,000 4,809,375 7.75%, 1/15/09 ............................................... United States 4,500,000 4,207,500 7.875%, 5/01/09 .............................................. United States 3,946,000 3,630,320
26 | Annual Report Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- COUNTRY PRINCIPAL AMOUNT E VALUE --------------------------------------------------------------------------------------------------------------------------- BONDS & NOTES IN REORGANIZATION (CONT.) aAdelphia Communications Corp., (cont.) 9.375%, 11/15/09 ............................................. United States $ 1,950,000 $ 1,852,500 10.25%, 6/15/11 .............................................. United States 5,274,000 5,010,300 aAES Drax Holdings Ltd., 10.41%, 12/31/20 ............................................. Cayman Islands 12,185,000 10,722,800 9.07%, 12/31/25 .............................................. Cayman Islands 5,380,000 GBP 8,330,857 aAiken Cnty S C Indl Rev Beloit, 6.00%, 12/01/11 ................ United States 280,000 1,400 aAir Canada Inc., 6.75%, 2/02/04 ............................................... Canada 1,017,000 CAD 287,255 9.00%, 6/01/06 ............................................... Canada 1,785,000 CAD 511,085 10.00%, 6/01/06 .............................................. Canada 4,265,000 EUR 2,286,358 7.25%, 10/01/07 .............................................. Canada 3,243,000 CAD 884,626 10.25%, 3/15/11 .............................................. Canada 9,450,000 3,850,875 Bank Claim ................................................... Canada 10,715,600 CAD 2,985,193 Bank Claim ................................................... Canada 203,461,000 JPY 721,426 Term Loan .................................................... Canada 7,419,000 2,745,030 zero cpn., 7/31/05 ........................................... Canada 8,636,401 3,325,014 aCentury Communications Corp., 9.50%, 3/01/05 ............................................... United States 340,000 329,800 8.875%, 1/15/07 .............................................. United States 260,000 253,500 8.375%, 12/15/07 ............................................. United States 392,000 383,180 zero cpn., 3/15/03 ........................................... United States 4,770,000 4,245,300 aDow Corning Corp., 8.55%, 3/01/01 ............................................... United States 2,705,000 5,004,250 9.375%, 2/01/08 .............................................. United States 100,000 218,000 8.15%, 10/15/29 .............................................. United States 500,000 950,000 Bank Claim ................................................... United States 6,938,674 12,489,614 Bank Debt .................................................... United States 1,241,480 2,234,664 Bank Debt #1 ................................................. United States 3,250,000 5,850,000 aHarnischfeger Industries Inc., 8.90%, 3/01/22 ............................................... United States 2,885,000 16,156 8.70%, 6/15/22 ............................................... United States 2,715,000 15,475 7.25%, 12/15/25 .............................................. United States 3,930,000 22,401 6.875%, 2/15/27 .............................................. United States 3,670,000 20,552 Stipulated Bank Claim ........................................ United States 4,550,000 25,025 aMetromedia Fiber Network Inc., 14.00%, 3/15/07 .............................................. United States 17,490,000 9,269,700 10.00%, 11/15/08 ............................................. United States 11,585,000 796,469 senior note, 10.00%, 12/15/09 ................................ United States 11,832,000 843,030 senior note, 10.00%, 12/15/09 ................................ United States 5,460,000 EUR 516,524 aMirant Corp., Tranche C Revolver ........................................... United States 5,745,885 3,562,449 4 Year Revolver, 7/17/05 ..................................... United States 4,736,998 3,694,858 364 Day Revolver ............................................. United States 8,227,200 4,854,048 aNorthwestern Corp., 8.75%, 3/15/12 ............................................... United States 6,510,000 5,907,825 6.95%, 11/15/28 .............................................. United States 3,280,000 2,939,700 aNRG Energy Inc., 7.625%, 2/01/06 .............................................. United States 4,490,000 2,536,850 6.75%, 7/15/06 ............................................... United States 8,150,000 4,604,750
Annual Report | 27 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- COUNTRY PRINCIPAL AMOUNT E VALUE --------------------------------------------------------------------------------------------------------------------------- BONDS & NOTES IN REORGANIZATION (CONT.) aNRG Energy Inc., (cont.) 7.50%, 6/15/07 ............................................... United States $ 4,580,000 $ 2,610,600 7.50%, 6/01/09 ............................................... United States 4,150,000 2,365,500 8.25%, 9/15/10 ............................................... United States 5,426,000 3,174,210 7.75%, 4/01/11 ............................................... United States 575,000 330,625 8.00%, 11/01/13 .............................................. United States 5,950,000 3,421,250 8.70%, 3/15/20 ............................................... United States 2,760,000 1,600,800 8.625%, 4/01/31 .............................................. United States 4,085,000 2,389,725 Revolver ..................................................... United States 17,630,896 10,931,155 aOwens Corning, Revolver ........................................ United States 20,155,769 15,116,826 aParmalat Netherlands BV, 0.875%, 6/30/21 ....................... Italy 5,440,000 EUR 1,721,958 PG & E Corp., 7.375%, 11/01/05 ............................................. United States 16,128,000 16,450,560 Commercial Paper, 1/18/01 .................................... United States 660,000 663,300 Commercial Paper, 1/30/01 .................................... United States 325,000 326,625 Commercial Paper, 2/16/01 .................................... United States 975,000 979,875 FRN, 144A, 7.583%, 10/31/01 .................................. United States 5,561,000 5,672,220 MTN, 5.94%, 10/07/03 ......................................... United States 825,000 829,125 aPort Seattle Wash Rev Ref-Beloit Proj., 6.00%, 12/01/17 ........ United States 150,000 750 aSafety Kleen Corp., 9.25%, 5/15/09 ............................. United States 520,000 26,000 aSafety Kleen Services, 9.25%, 6/01/08 .......................... United States 40,000 200 aTelewest Communications PLC, 11.00%, 10/01/07 ............................................. United Kingdom 6,557,000 4,294,835 11.25%, 11/01/08 ............................................. United Kingdom 1,015,000 657,212 9.875%, 2/01/10 .............................................. United Kingdom 2,060,000 GBP 2,175,758 Bank Claim ................................................... United Kingdom 24,747,022 GBP 21,043,010 cvt., 5.25%, 2/19/07 ......................................... United Kingdom 6,145,000 GBP 5,830,275 senior disc. note, zero cpn., 4/15/09 ........................ United Kingdom 2,615,000 1,372,875 senior disc. note, zero cpn., 2/01/10 ........................ United Kingdom 2,020,000 999,900 zero cpn., 4/15/04 ........................................... United Kingdom 7,850,000 GBP 7,026,369 aTelewest Finance Ltd., cvt, 6.00%, 7/07/05 ..................... United Kingdom 5,738,000 6,082,280 aWorldCom Inc., 7.875%, 5/15/03 .............................................. United States 6,020,000 2,031,750 6.25%, 8/15/03 ............................................... United States 680,000 229,500 6.50%, 5/15/04 ............................................... United States 875,000 295,312 6.40%, 8/15/05 ............................................... United States 7,575,000 2,556,562 7.375%, 1/15/06 .............................................. United States 1,675,000 565,313 8.00%, 5/15/06 ............................................... United States 2,535,000 855,563 7.75%, 4/01/07 ............................................... United States 4,195,000 1,415,813 8.25%, 5/15/10 ............................................... United States 7,055,000 2,381,063 7.375%, 1/15/11 .............................................. United States 15,546,000 5,246,775 7.50%, 5/15/11 ............................................... United States 14,480,000 4,887,000 7.75%, 4/01/27 ............................................... United States 1,330,000 448,875 6.95%, 8/15/28 ............................................... United States 380,000 128,250 8.25%, 5/15/31 ............................................... United States 18,135,000 6,120,563 --------------- TOTAL BONDS & NOTES IN REORGANIZATION (COST $220,600,047) 286,561,326 ---------------
28 | Annual Report Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES/PRINCIPAL AMOUNT E VALUE --------------------------------------------------------------------------------------------------------------------------- COMPANIES IN LIQUIDATION aBrunos Inc., Liquidating Unit .................................. United States 40,574 $ 89,263 aCity Investing Company Liquidating Trust ....................... United States 125,500 261,667 aGuangdong International Trust & Investment Corp., 144A, 8.75%, 10/24/16 ........................................ China 2,600,000 162,500 Revolver - Admitted Claim .................................... Hong Kong 536,784 33,549 Structured Note - Admitted Claim ............................. Hong Kong 849,105 53,069 Syndicated Loan - Admitted Claim ............................. Hong Kong 1,468,105 91,757 aMBOP Liquidating Trust ......................................... United States 273,144 683 aPetrie Stores Liquidating Trust, CBI ........................... United States 1,213,700 807,110 --------------- TOTAL COMPANIES IN LIQUIDATION (COST $434,510) ................. 1,499,598 --------------- ------------------ PRINCIPAL AMOUNT E ------------------ GOVERNMENT AGENCIES 10.2% Canada Treasury Bill, 3.324%, 2/26/04 .......................... Canada 20,000,000 CAD 15,413,168 fFederal Home Loan Bank, 0.75% to 2.26%, with maturities to 1/26/07 United States 163,933,000 163,099,047 Federal Home Loan Mortgage Corp., 0.990% to 2.375%, with maturities to 5/19/06 ................................... United States 64,000,000 63,851,179 fFederal National Mortgage Association, 0.966% to 2.20%, with maturities to 12/18/06 .................................. United States 111,000,000 110,671,520 Federal Republic of Germany, 3.25% to 4.25%, with maturities to 6/25/04 ................................... Germany 45,000,000 EUR 57,107,720 German Treasury Bills, 2.07% to 2.12%, with maturities to 5/12/04 Germany 18,000,000 EUR 22,539,816 Kingdom of Norway, 5.75% to 6.75%, with maturities to 1/15/07 .. Norway 130,870,000 NOK 20,799,793 U.S. Treasury Bill, 0.942% to 0.934%, with maturities to 2/05/04 United States 1,000,000 999,243 --------------- TOTAL GOVERNMENT AGENCIES (COST $444,713,758) .................. 454,481,486 --------------- SHORT TERM INVESTMENTS .2% Alliance & Leicester PLC, Commercial Paper, 5/14/04 ............ United Kingdom 5,000,000 4,979,580 Bradford & Bingley PLC, Commercial Paper, 2/17/04 .............. United Kingdom 5,000,000 4,992,267 --------------- TOTAL SHORT TERM INVESTMENTS (COST $9,970,608) ................. 9,971,847 --------------- TOTAL INVESTMENTS BEFORE REPURCHASE AGREEMENTS (COST 3,423,546,532) 4,572,540,313 --------------- REPURCHASE AGREEMENTS .2% g,hBear Stearns & Co. Inc., .87%, 1/02/04 (Maturity Value $1,000,072) Collateralized by U.S. Treasury Bills, Notes and Bonds ....... 1,000,024 1,000,024 g,hCitigroup Global Markets Inc., .96%, 1/02/04 (Maturity Value $1,000,080) Collateralized by U.S. Treasury Bills, Notes and Bonds .............................................. 1,000,027 1,000,027 g,hDeutsche Bank Securities Inc., 1.03%, 1/02/04 (Maturity Value $2,117,180) Collateralized by U.S. Treasury Bills, Notes and Bonds .............................................. 2,117,061 2,117,061 g,hJP Morgan Securities, 1.01%, 1/02/04 (Maturity Value $2,000,167) Collateralized by U.S. Treasury Bills, Notes and Bonds ....... 2,000,056 2,000,056 g,hMerrill Lynch GSI, 1.00%, 1/02/04 (Maturity Value $2,000,166) Collateralized by U.S. Treasury Bills, Notes and Bonds ....... 2,000,056 2,000,056 g,hUBS Securities LLC, 1.00%, 1/02/04 (Maturity Value $1,458,121) Collateralized by U.S. Treasury Bills, Notes and Bonds ....... 1,458,041 1,458,041
Annual Report | 29 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- COUNTRY PRINCIPAL AMOUNT E VALUE --------------------------------------------------------------------------------------------------------------------------- REPURCHASE AGREEMENTS (CONT.) g,hCitigroup Global Markets Inc., .96%, 1/02/04 (Maturity Value $1,000,080) Collateralized by U.S. Treasury Bills, Notes and Bonds .............................................. $ 1,000,027 $ 1,000,027 --------------- TOTAL REPURCHASE AGREEMENTS (COST $10,575,292) ................. 10,575,292 --------------- TOTAL INVESTMENTS (COST 3,434,121,824) 102.6% .................. 4,583,115,605 --------------- OPTIONS WRITTEN ................................................ (6,187) SECURITIES SOLD SHORT (.8)% .................................... (33,984,109) NET EQUITY IN FORWARD CONTRACTS (2)% ........................... (89,964,497) OTHER ASSETS, LESS LIABILITIES .2% ............................. 9,415,576 --------------- NET ASSETS 100.0% .............................................. $4,468,576,388 --------------- OPTIONS WRITTEN -------------- ISSUER CONTRACTS -------------- DIVERSIFIED TELECOMMUNICATION SERVICES XO Communications Inc., Jun. 4.25 Calls, 6/21/04 ............... United States 1,042,901 -- --------------- FOOD & STAPLES RETAILING Safeway PLC, Jan. 2.70 Puts, 1/16/04 ........................... United Kingdom 1,920 6,187 --------------- TOTAL OPTIONS WRITTEN (PREMIUMS RECEIVED $279,446) ............. $ 6,187 --------------- SECURITIES SOLD SHORT -------------- ISSUER SHARES -------------- CAPITAL MARKETS iLehman Brothers Holdings Inc. .................................. United States 9,806 757,219 --------------- COMMERCIAL BANKS .1% iBank of America Corp. .......................................... United States 58,700 4,721,241 --------------- FOOD PRODUCTS .2% iKraft Foods Inc., A ............................................ United States 263,600 8,493,192 --------------- HEALTH CARE PROVIDERS & SERVICES .2% iAnthem Inc. .................................................... United States 17,900 1,342,500 iCaremark RX Inc. ............................................... United States 78,200 1,980,806 iUnited Health Group Inc. ....................................... United States 24,900 1,448,682 --------------- 4,771,988 --------------- INSURANCE .1% iManulife Financial Corp. ....................................... Canada 184,700 5,965,810 --------------- INTERNET SOFTWARE & SERVICES iYahoo! Inc. .................................................... United States 18,838 850,912 --------------- IT SERVICES .1% iFirst Data Corp. ............................................... United States 57,320 2,355,279 --------------- MEDIA iNews Corp. Ltd., ADR ........................................... Australia 46,900 1,693,090 ---------------
30 | Annual Report Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES VALUE --------------------------------------------------------------------------------------------------------------------------- METALS & MINING .1% iAlcan Inc. ..................................................... Canada 5,216 $ 244,891 iAngloGold Ltd., ADR ............................................ South Africa 73,500 3,432,450 iRandgold Resources Ltd., ADR ................................... United Kingdom 15,085 411,821 --------------- 4,089,162 --------------- PHARMACEUTICALS iTeva Pharmaceutical Industries Ltd., ADR ....................... Israel 5,047 286,215 --------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $33,628,258) ............. $ 33,984,109 --------------- ----------------------------------------------------------- VALUE AT UNREALIZED SYNTHETIC EQUITY SWAPS (SES) COUNTRY SHARES 12/31/03 GAIN/LOSS ----------------------------------------------------------- ISSUER HEALTH CARE EQUIPMENT & SUPPLIES jSmith & Nephew PLC, ses., 3.752 GBP ........................ United Kingdom 967 $ (8,123) $ (1,640) jSmith & Nephew PLC, ses., 3.776 GBP ........................ United Kingdom 16,700 (140,285) (27,609) ----------------------------- (148,408) (29,249) ----------------------------- INSURANCE jAXA SA, ses., 15.850 EUR ................................... France 15,685 335,740 21,541 jAXA SA, ses., 15.870 EUR ................................... France 3,800 81,340 5,123 jAXA SA, ses., 16.030 EUR ................................... France 27,888 596,947 31,952 jAXA SA, ses., 16.700 EUR ................................... France (15,685) (335,740) (5,993) jAXA SA, ses., 16.770 EUR ................................... France (3,800) (81,340) (1,117) jAXA SA, ses., 17.000 EUR ................................... France (27,888) (596,947) 937 ----------------------------- -- 52,443 ----------------------------- REAL ESTATE jChelsfield PLC, ses., 3.095 GBP ............................ United Kingdom 4,900 $ 26,951 $ (237) jChelsfield PLC, ses., 3.107 GBP ............................ United Kingdom 15,200 83,604 (1,075) jChelsfield PLC, ses., 3.112 GBP ............................ United Kingdom 10,947 60,211 (936) jChelsfield PLC, ses., 3.154 GBP ............................ United Kingdom 160,300 881,692 (24,647) jChelsfield PLC, ses., 3.160 GBP ............................ United Kingdom 54,700 300,864 (9,006) jChelsfield PLC, ses., 3.165 GBP ............................ United Kingdom 24,000 132,006 (4,163) jChelsfield PLC, ses., 3.166 GBP ............................ United Kingdom 80,100 440,571 (14,038) ----------------------------- 1,925,899 (54,102) ----------------------------- TEXTILES APPAREL & LUXURY GOODS jChristian Dior SA, ses., 46.766 EUR ........................ France 3,993 241,907 5,931 jChristian Dior SA, ses., 47.220 EUR ........................ France 3,062 185,504 2,771 jChristian Dior SA, ses., 47.384 EUR ........................ France 8,022 485,995 5,871 jChristian Dior SA, ses., 47.614 EUR ........................ France 8,022 485,995 3,312 jChristian Dior SA, ses., 47.794 EUR ........................ France 3,686 223,308 662 jChristian Dior SA, ses., 48.208 EUR ........................ France 7,807 472,969 (2,638) jChristian Dior SA, ses., 48.555 EUR ........................ France 4,817 291,827 (3,738) jChristian Dior SA, ses., 48.586 EUR ........................ France 8,018 485,752 (6,519) jChristian Dior SA, ses., 48.791 EUR ........................ France 3,209 194,410 (3,445) jChristian Dior SA, ses., 49.000 EUR ........................ France 214 12,965 (286) jChristian Dior SA, ses., 49.027 EUR ........................ France 1,185 71,791 (1,624)
Annual Report | 31 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
----------------------------------------------------------- VALUE AT UNREALIZED SYNTHETIC EQUITY SWAPS (SES) COUNTRY SHARES 12/31/03 GAIN/LOSS ----------------------------------------------------------- ISSUER jLVMH Moet Hennessy Louis Vuitton, ses., 56.520 EUR ......... France (3,062) $ (222,852) $ (4,986) jLVMH Moet Hennessy Louis Vuitton, ses., 57.050 EUR ......... France (3,686) (268,267) (3,542) jLVMH Moet Hennessy Louis Vuitton, ses., 58.672 EUR ......... France (8,022) (583,841) 9,006 jLVMH Moet Hennessy Louis Vuitton, ses., 58.861 EUR ......... France (3,993) (290,611) 5,300 jLVMH Moet Hennessy Louis Vuitton, ses., 58.899 EUR ......... France (8,022) (583,841) 11,033 jLVMH Moet Hennessy Louis Vuitton, ses., 59.841 EUR ......... France (7,807) (568,194) 19,989 jLVMH Moet Hennessy Louis Vuitton, ses., 60.149 EUR ......... France (4,817) (350,581) 14,196 jLVMH Moet Hennessy Louis Vuitton, ses., 60.309 EUR ......... France (3,209) (233,551) 10,108 jLVMH Moet Hennessy Louis Vuitton, ses., 60.421 EUR ......... France (8,018) (583,550) 26,405 jLVMH Moet Hennessy Louis Vuitton, ses., 60.949 EUR ......... France (1,185) (86,244) 4,691 jLVMH Moet Hennessy Louis Vuitton, ses., 60.950 EUR ......... France (214) (15,575) 847 ----------------------------- (634,684) 93,344 ----------------------------- TOTAL SYNTHETIC EQUITY SWAPS $1,142,807 $ 62,436 ----------------------------- CURRENCY ABBREVIATIONS: | CAD - Canadian Dollar | EUR - European Unit | GBP - British Pound | JPY - Japanese Yen NOK - Norwegian Krone a Non-income producing. b See Note 7 regarding restricted securities. c See Note 8 regarding Holdings of 5% Voting Securities. d A member of the Fund's Portfolio Management team serves as a member on the board of directors. As a result of this involvement, the Portfolio Manager could receive material non-public information which, pursuant to the Fund's policies and the requirements of the federal securities laws, could prevent the Fund from trading in the securities of such companies for limited or extended periods of time. e The principal amount is stated in U.S. dollars unless otherwise indicated. f See Note 1(g) regarding securities segregated with broker for securities sold short. g Collateral for loaned securities. See Note 1(h). h See Note 1(c) regarding repurchase agreements. i See Note 1(g) regarding securities sold short. j See Note 1(e) regarding synthetic equity swaps.
32 | See notes to financial statements.|Annual Report Mutual Discovery Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2003
Assets: Investments in securities: Cost - Unaffiliated issuers ............................................ $3,394,717,095 Cost - Controlled affiliates ........................................... 952,779 Cost - Non-controlled affiliated issuers ............................... 38,451,950 --------------- Value - Unaffiliated issuers (includes securities segregated with broker for securities sold short in the amount of $36,103,385) ... 4,549,286,164 Value - Controlled affiliates .......................................... 3,897,406 Value - Non-controlled affiliated issuers .............................. 29,932,033 Cash .................................................................... 6,032,493 Foreign currency, at value (cost $2,813,369) ............................ 2,813,369 Receivables: Investment securities sold ............................................. 3,484,766 Capital shares sold .................................................... 7,874,483 Dividends and interest ................................................. 9,178,016 Unrealized gain on forward exchange contracts (Note 6) .................. 2,516,936 Deposits with broker for securities sold short .......................... 43,181,455 Due from broker - variation margin (Note 1f) ............................ 446,556 --------------- Total assets ....................................................... 4,658,643,677 --------------- Liabilities: Payables: Investment securities purchased ........................................ 38,392,373 Capital shares redeemed ................................................ 7,241,458 Affiliates ............................................................. 6,008,050 Options written, at value (premiums received $279,446) .................. 6,187 Securities sold short, at value (proceeds $33,628,258) .................. 33,984,109 Payable upon return of securities loaned (Note 1i) ...................... 10,575,290 Unrealized loss on forward exchange contracts ........................... 92,481,433 Deferred tax (Note 1l) .................................................. 1,020,980 Other liabilities ....................................................... 357,409 --------------- Total liabilities .................................................. 190,067,289 --------------- Net assets, at value ............................................. $4,468,576,388 --------------- Net assets consist of: Accumulated distributions in excess of net investment income ............ $ (12,232,773) Net unrealized appreciation (depreciation) .............................. 1,058,172,011 Accumulated net realized gain (loss) .................................... (163,465,585) Capital shares .......................................................... 3,586,102,735 --------------- Net assets, at value ............................................. $4,468,576,388 ---------------
Annual Report | 33 Mutual Discovery Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2003
CLASS Z: Net asset value and maximum offering price per share ($2,168,161,205 (/) 104,191,290 shares outstanding) $20.81 -------- CLASS A: Net asset value per share ($1,439,579,240 (/) 69,660,931 shares outstanding) ........................... $20.67 -------- Maximum offering price per share ($20.67 (/) 94.25%) ................................................... $21.93 -------- CLASS B: Net asset value and maximum offering price per share ($115,801,217 (/) 5,690,141 shares outstanding) a . $20.35 -------- CLASS C: Net asset value per share ($725,489,015 (/) 35,228,351 shares outstanding) a ........................... $20.59 -------- Maximum offering price per share ($20.59 (/) 99.00%) ................................................... $20.80 -------- CLASS R: Net asset value and maximum offering price per share ($19,545,711 (/) 950,117 shares outstanding) a .... $20.57 -------- a Redemption price is equal to net asset value less any applicable contingent deferred sales charge and redemption fees retained by the Fund.
34 | See notes to financial statements.|Annual Report Mutual Discovery Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2003
Investment income: (net of foreign taxes of $4,289,379) Dividends: Unaffiliated issuers .............................................................. $ 54,446,182 Non-controlled affiliated issuers (Note 8) ........................................ 306,638 Interest: Unaffiliated issuers .............................................................. 40,851,990 Non-controlled affiliated issuers (Note 8) ........................................ 400,967 --------------- Total investment income ....................................................... 96,005,777 --------------- Expenses: Management fees (Note 3) ........................................................... 28,877,575 Administrative fees (Note 3) ....................................................... 2,813,647 Distribution fees (Note 3) Class A ........................................................................... 3,813,649 Class B ........................................................................... 837,003 Class C ........................................................................... 5,845,499 Class R ........................................................................... 57,603 Transfer agent fees (Note 3) ....................................................... 5,775,000 Custodian fees ..................................................................... 593,700 Reports to shareholders ............................................................ 268,600 Registration and filing fees ....................................................... 140,600 Professional fees .................................................................. 80,366 Directors' fees and expenses ....................................................... 161,600 Dividends for securities sold short ................................................ 1,115,920 Other .............................................................................. 92,100 --------------- Total expenses ................................................................ 50,472,862 --------------- Net investment income ....................................................... 45,532,915 --------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments: Unaffiliated issuers ............................................................. 185,863,610 Non-controlled affiliated issuers (Note 8) ....................................... 910,114 Written options (Note 1g) ......................................................... 434,720 Securities sold short (Note 1h) ................................................... (1,513,208) Foreign currency transactions ..................................................... (155,714,093) --------------- Net realized gain (loss) .................................................... 29,981,143 Net unrealized appreciation (depreciation) on: Investments ........................................................................ 995,227,924 Deferred taxes (Note 1l) ........................................................... (1,020,980) Translation of assets and liabilities denominated in foreign currencies ............ (40,867,281) --------------- Net unrealized appreciation (depreciation) .................................. 953,339,663 --------------- Net realized and unrealized gain (loss) ............................................. 983,320,806 --------------- Net increase (decrease) in net assets resulting from operations ..................... $1,028,853,721 ---------------
Annual Report | See notes to financial statements. | 35 Mutual Discovery Fund FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF CHANGES IN NET ASSETS for the years ended December 31, 2003 and 2002 ------------------------------------ 2003 2002 ------------------------------------ Increase (decrease) in net assets: Operations: Net investment income ............................................................. $ 45,532,915 $ 55,319,946 Net realized gain (loss) from investments, written options, securities sold short, and foreign currency transactions ......................................... 29,981,143 (152,264,558) Net unrealized appreciation (depreciation) on investments and translation of assets and liabilities denominated in foreign currencies ......................... 953,339,663 (242,273,171 ------------------------------------ Net increase (decrease) in net assets resulting from operations ................ 1,028,853,721 (339,217,783) Distributions to shareholders from: Net investment income: Class Z .......................................................................... (44,545,119) (32,672,055) Class A .......................................................................... (24,770,503) (14,607,025) Class B .......................................................................... (1,472,248) (690,755) Class C .......................................................................... (8,953,988) (4,741,427) Class R .......................................................................... (310,609) (60,810) Net realized gains: Class Z .......................................................................... -- (8,370,352) Class A .......................................................................... -- (4,428,903) Class B .......................................................................... -- (260,727) Class C .......................................................................... -- (2,591,831) Class R .......................................................................... -- (2,985) ------------------------------------ Total distributions to shareholders ................................................ (80,052,467) (68,426,870) Capital share transactions (Note 2): Class Z ........................................................................... 13,927,225 (43,529,993) Class A ........................................................................... 225,050,877 132,014,004 Class B ........................................................................... 28,358,365 31,294,863 Class C ........................................................................... 47,141,801 31,091,069 Class R ........................................................................... 12,178,619 4,180,662 ------------------------------------ Total capital share transactions ................................................... 326,656,887 155,050,605 Redemption fees (Note 1o) 7,611 Net increase (decrease) in net assets .......................................... 1,275,458,141 (252,586,437) Net assets: Beginning of year .................................................................. 3,193,118,247 3,445,704,684 ------------------------------------ End of year ........................................................................ $4,468,576,388 $3,193,118,247 ------------------------------------ Accumulated distributions in excess of net investment income included in net assets: End of year ........................................................................ $ (12,232,773) $ 6,039,875 ------------------------------------
36 | See notes to financial statements.|Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Mutual Discovery Fund (the Fund) is a separate, diversified series of Franklin Mutual Series Fund, Inc. (the Series Fund), which is an open-end investment company registered under the Investment Company Act of 1940. The Fund seeks long-term capital appreciation by investing primarily in common and preferred stocks and bonds. The Fund may also invest 50% or more of its assets in foreign securities. 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 last 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. Investments in open-end mutual funds are valued at the closing net asset value. Foreign securities are valued at the close of trading of the foreign exchange or the NYSE, whichever is earlier. If events occur that materially affect the values of securities after the prices or foreign exchange rates are determined, or if market quotations are not readily available, the securities will be valued at fair value as determined following procedures approved by the Board of Directors. 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, 2003, all repurchase agreements held by the Fund had been entered into on that date. Annual Report | 37 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) D. SECURITIES PURCHASED ON A WHEN-ISSUED OR DELAYED BASIS The Fund may purchase securities on a when-issued or delayed delivery basis, with payment and delivery scheduled for a future date. These transactions are subject to market fluctuations and are subject to the risk that the value at delivery may be more or less than the trade date purchase price. Although the Fund will generally purchase these securities with the intention of holding the securities, it may sell the securities before the settlement date. Sufficient assets have been segregated for these securities. E. FOREIGN CURRENCY CONTRACTS The Fund may enter into forward exchange contracts to hedge against fluctuations in foreign exchange rates. A forward exchange contract is an agreement between two parties to exchange different currencies at an agreed upon exchange rate at a future date. These contracts are valued daily and the Fund's equity therein is included in the Statement of Assets and Liabilities. Realized and unrealized gains and losses are included in the Statement of Operations. When the Fund purchases or sells foreign securities, it may enter into foreign exchange contracts to minimize foreign exchange risk from the trade date to the settlement date of the transactions. Realized and unrealized gains and losses are included in the Statement of Operations. The risks of these contracts include movement in the values of the foreign currencies relative to the U.S. dollar and the possible inability of the counterparties to fulfill their obligations under the contracts. F. SYNTHETIC EQUITY SWAPS The Fund may engage in synthetic equity swaps. Synthetic equity swaps are contracts entered into between a broker and the Fund under which the parties agree to make payments to each other so as to replicate the economic consequences that would apply had a purchase or sale of the underlying security taken place. Upon entering into synthetic equity swaps, the Fund is required to pledge the broker an amount of cash and/or other assets equal to a certain percentage of the contract amount ("initial margin"). Subsequent payments known as "variation margin", are made or received by the Fund periodically, depending on fluctuations in the value of the underlying security. When the contract is closed, the Fund records a realized gain or loss equal to the difference between the value of the contract at the time it was opened and the value at the time it was closed. The risks of entering into equity swaps include unfavorable price movements in the underlying securities or the inability of the counterparties to fulfill their obligations under the contract. G. OPTION CONTRACTS The Fund may purchase or write options. Options are contracts entitling the holder to purchase or sell a specified number of shares or units of a particular security at a specified price. Options purchased are recorded as investments; options written (sold) are recorded as liabilities. When the exercise of an option results in a cash settlement, the difference between the premium (original option 38 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) G. OPTION CONTRACTS (CONTINUED) value) and the settlement proceeds is realized as a gain or loss. When securities are acquired or delivered upon exercise of an option, the acquisition cost or sale proceeds are adjusted by the amount of the premium. When an option is closed, the difference between the premium and the cost to close the position is realized as a gain or loss. When an option expires, the premium is realized as a gain for options written or as a loss for options purchased. The risks include the possibility there may be an illiquid options market or the inability of the counterparties to fulfill their obligations under the contract. Writing options involves, to varying degrees, elements of market risk in excess of the amount recognized in the Statement of Assets and Liabilities. H. SECURITIES SOLD SHORT The Fund is engaged in selling securities short, which obligates the Fund to replace a borrowed security with the same security at current market value. The Fund would incur a loss 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. The Fund would realize a gain if the price of the security declines between those dates. A gain, limited to the price at which the Fund sold the security short, or a loss, unlimited in size, will be recognized upon the termination of a short sale. The Fund is required to establish a margin account with the broker lending the security sold short. While the short sale is outstanding, the broker retains the proceeds of the short sale and the Fund must maintain a deposit for the broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. I. SECURITIES LENDING The Fund loans securities to certain brokers for which it received cash or securities collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. The cash collateral is invested in short-term instruments as noted in the Statement of Investments. The Fund received interest income of $46,364 from the investments of cash collateral, adjusted by lender fees and broker rebates. The fund bears the risk of loss with respect to the investment of the cash collateral. The securities lending agent has agreed to indemnify the Fund in the case of default of any securities. J. 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. K. 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 Annual Report | 39 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) K. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS (CONTINUED) recorded as soon as information is available to the Fund. Interest income and estimated expenses are accrued daily. Discounts on securities purchased are amortized over the lives of the respective securities. Dividend income, dividends declared on securities sold short, and distributions to shareholders are recorded on the ex-dividend date. 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. Common expenses incurred by the Series Fund are allocated among the funds comprising the Series Fund 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. L. DEFERRED TAXES The Fund is subject to a tax imposed on net realized gains of securities of certain foreign countries. The Fund records an estimated deferred tax liability for net unrealized gains on these securities as reflected in the accompanying financial statements. M. 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. N. GUARANTEES AND INDEMNIFICATIONS Under the Fund's organizational documents, its officers and trustees are indemnified against certain liability arising out of the performance of their duties to the Funds. Additionally, in the normal course of business, the Fund enters into contracts with service providers that contain general indemnification clauses. The Fund's maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Fund that have not yet occurred. However, based on experience, the Fund expects the risk of loss to be remote. O. REDEMPTION FEES Redemption of Fund shares held 90 days or less (30 days or less effective January 1, 2004) may be subject to the Fund's redemption fee, which is 2% of the amount redeemed. Such fees are retained by the Fund and accounted for as additional paid in capital. 40 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK The Fund offers five classes of shares: Class Z, Class A, Class B, Class C and Class R. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. At December 31, 2003 there were 800 million shares authorized ($0.001 par value) of which 300 million, 100 million, 100 million, 100 million and 200 million were designated as Class Z, Class A, Class B, Class C and Class R, respectively. Transactions in the Fund's shares were as follows:
--------------------------------------------------------------- YEAR ENDED YEAR ENDED DECEMBER 31, 2003 DECEMBER 31, 2002 --------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT --------------------------------------------------------------- CLASS Z SHARES: Shares sold 9,521,544 $169,344,371 7,592,317 $ 136,738,634 Shares issued on reinvestment of distributions 2,060,606 40,579,936 2,257,247 38,046,663 Shares redeemed (10,979,119) (195,997,082) (12,423,671) (218,315,290) --------------------------------------------------------------- Net increase (decrease) 603,031 $ 13,927,225 (2,574,107) $ (43,529,993) --------------------------------------------------------------- CLASS A SHARES: Shares sold 22,055,132 $399,929,888 22,018,502 $ 386,680,451 Shares issued on reinvestment of distributions 1,194,006 23,361,387 1,070,357 17,995,086 Shares redeemed (11,199,697) (198,240,398) (15,885,271) (272,661,533) --------------------------------------------------------------- Net increase (decrease) 12,049,441 $225,050,877 7,203,588 $ 132,014,004 --------------------------------------------------------------- CLASS B SHARES: Shares sold 2,016,211 $ 35,204,480 2,193,300 $ 38,422,888 Shares issued on reinvestment of distributions 69,605 1,329,652 51,523 858,862 Shares redeemed (481,371) (8,175,767) (472,537) (7,986,887) --------------------------------------------------------------- Net increase (decrease) 1,604,445 $ 28,358,365 1,772,286 $ 31,294,863 --------------------------------------------------------------- CLASS C SHARES: Shares sold 6,757,550 $121,233,343 6,397,726 $ 112,767,752 Shares issued on reinvestment of distributions 418,839 8,050,042 390,105 6,661,968 Shares redeemed (4,741,353) (82,141,584) (5,153,458) (88,338,651) --------------------------------------------------------------- Net increase (decrease) 2,435,036 $ 47,141,801 1,634,373 $ 31,091,069 --------------------------------------------------------------- --------------------------------------------------------------- YEAR ENDED PERIOD ENDED DECEMBER 31, 2003 DECEMBER 31, 2002A --------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT --------------------------------------------------------------- CLASS R SHARES: Shares sold 854,653 $ 14,829,497 263,207 $ 4,475,317 Shares issued on reinvestment of distributions 15,801 308,897 3,923 63,361 Shares redeemed (165,979) (2,959,775) (21,488) (358,016) --------------------------------------------------------------- Net increase (decrease) 704,475 $ 12,178,619 245,642 $ 4,180,662 --------------------------------------------------------------- a Effective date of Class R shares was January 2, 2002.
Annual Report | 41 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES Certain officers of the Fund are also officers and/or directors of Franklin Mutual Advisers, LLC (Franklin Mutual) and Franklin Templeton Services, LLC (FT Services), the Fund's investment manager and administrative manager, respectively. Franklin/Templeton Investor Services, LLC (Investor Services) and Franklin/Templeton Distributors, Inc. (Distributors), are the Fund's transfer agent and principal underwriter, respectively. The Fund pays an investment management fee to Franklin Mutual of .80% per year of the average daily net assets of the Fund. The Fund pays its allocated share of an administrative fee to FT Services based on the Series Fund's aggregated average daily net assets as follows: ---------------------------------------------------------------------------- ANNUALIZED FEE RATE MONTH-END NET ASSETS ---------------------------------------------------------------------------- 0.150% First $200 million 0.135% Over $200 million, up to and including $700 million 0.100% Over $700 million, up to and including $1.2 billion 0.075% Over $1.2 billion The Fund reimburses Distributors for costs incurred in marketing the Fund's shares up to .35%, 1.00%, 1.00% and .50% per year of the average daily net assets of Class A, Class B, Class C and Class R shares, respectively. Distributors received net commissions from sales of Fund shares and received contingent deferred sales charges for the period of $461,074 and $65,389, respectively. The Fund paid transfer agent fees of $5,775,000, of which $4,169,546 was paid to Franklin Templeton Investors Services Inc. 4. INCOME TAXES At December 31, 2003, the cost of investments, net unrealized appreciation (depreciation) and undistributed ordinary income for income tax purposes were as follows: Cost of investments ................................... $3,466,973,031 --------------- Unrealized appreciation ............................... 1,167,700,176 Unrealized depreciation ............................... (51,557,604) --------------- Net unrealized appreciation (depreciation) ............ $1,116,142,572 --------------- Distributable earnings - undistributed ordinary income $ 19,007,482 --------------- 42 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 4. INCOME TAXES (CONTINUED) The tax character of distributions paid during the years ended December 31, 2003 and 2002, was as follows: -------------------------- 2003 2002 -------------------------- Distributions paid from: Ordinary income .......................... $80,052,467 $68,425,226 Long term capital gain ................... -- 1,644 -------------------------- $80,052,467 $68,426,870 -------------------------- Net investment income (loss) differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, passive foreign investment company shares, and bond discounts and premiums. Net realized gains (losses) differ for financial statement and tax purposes primarily due to differing treatment of wash sales, foreign currency transactions, passive foreign investment company shares and bond discounts and premiums. At December 31, 2003, the Fund had deferred capital losses occurring subsequent to October 31, 2003 of $35,510,691. For tax purposes, such losses will be reflected in the year ending December 31, 2004. At December 31, 2003, the Fund had tax basis capital losses which may be carried over to offset future capital gains. Such losses expire as follows: Capital loss carryovers expiring in: 2010 .................................. $144,728,368 2011 .................................. 63,959,606 ------------ $208,687,974 ------------ 5. INVESTMENT TRANSACTIONS Purchases and sales of securities (excluding short-term securities and securities sold short) for the year ended December 31, 2003, aggregated $1,902,844,845 and $1,487,583,391, respectively. Annual Report | 43 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. INVESTMENT TRANSACTIONS (CONTINUED) Transactions in options written during the period ended December 31, 2003 were as follows: -------------------------------- NUMBER OF CONTRACTS PREMIUM -------------------------------- Options outstanding at December 31, 2002 ................... 194,800 $ 123,438 Options written ...................... 1,060,266 1,459,870 Options expired ...................... (130,922) (339,440) Options terminated in closing transactions ........................ (477) (107,153) Options exercised .................... (78,846) (857,269) -------------------------------- Options outstanding at December 31, 2003 ................... 1,044,821 $ 279,446 -------------------------------- 6. FORWARD EXCHANGE CONTRACTS At December 31, 2003, the Fund has outstanding forward exchange contracts as set out below. The contracts are reported in the financial statements at the Fund's net equity, as measured by the difference between the forward exchange rates at the reporting date and the forward exchange rates at the day of entry into the contracts.
----------------------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO BUY EXCHANGE FOR DATE GAIN (LOSS) ----------------------------------------------------------------------------------------------------------------- 1,900,000 British Pounds .......... U.S. $ 3,348,085 1/28/04 U.S. $ 45,786 13,450,000 European Unit ........... 15,914,271 1/28/04 1,037,346 4,250,000 British Pounds .......... 7,542,135 2/05/04 45,344 11,400,000 European Unit ........... 14,322,333 2/05/04 42,828 2,973,601 Swiss Franc ............. 2,225,000 2/17/04 182,287 4,934,500 European Unit ........... 5,799,567 3/11/04 412,365 187,119,556 Swedish Krona ........... 25,547,614 3/23/04 356,227 252,114,000 Japanese Yen ............ 2,324,924 3/25/04 33,890 1,528,154 European Unit ........... 1,846,315 4/28/04 75,029 -------------- ---------------- U.S. $ 78,870,244 U.S. $ 2,231,102 -------------- ---------------- ----------------------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO SELL EXCHANGE FOR DATE GAIN (LOSS) ----------------------------------------------------------------------------------------------------------------- 16,037,790,000 Korean Won .............. U.S. $ 13,400,000 3/18/04 U.S. $ 36,734 48,237,232 South African Rand ...... 7,309,585 4/26/04 249,100 -------------- ---------------- U.S. $ 20,709,585 U.S. $ 285,834 -------------- ---------------- Unrealized gain on forward exchange contracts ......................................... $ 2,516,936 ----------------
44 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. FORWARD EXCHANGE CONTRACTS (CONTINUED)
---------------------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO SELL EXCHANGE FOR DATE GAIN (LOSS) ---------------------------------------------------------------------------------------------------------------- 12,199,020 British Pounds ........... U.S. $ 21,641,061 1/06/04 U.S. $ (186,871) 22,150,000 European Unit ............ 27,598,900 1/06/04 (335,259) 44,980,067 British Pounds ........... 78,225,833 1/12/04 (2,220,119) 44,200,000 British Pounds ........... 74,728,365 1/20/04 (4,273,094) 239,921,286 Canadian Dollars ......... 173,337,657 1/21/04 (12,142,152) 49,850,974 British Pounds ........... 84,277,811 1/28/04 (4,768,393) 19,742,924 European Unit ............ 23,178,193 1/28/04 (1,704,668) 51,140,767 British Pounds ........... 88,671,202 2/11/04 (2,581,202) 47,641,432 Swiss Franc .............. 34,961,409 2/17/04 (3,606,842) 89,417,638 European Unit ............ 98,820,243 2/23/04 (13,797,564) 163,104,000 Taiwan Dollar ............ 4,800,000 2/25/03 (4,242) 24,287,260 British Pounds ........... 41,288,687 2/27/04 (1,995,265) 65,450,000 European Unit ............ 74,902,175 3/11/04 (7,491,371) 527,950,624 Danish Krona ............. 86,956,305 3/17/04 (2,279,814) 1,317,525,210 Japanese Yen ............. 11,500,000 3/18/04 (824,262) 40,690,326,500 Korean Won ............... 33,800,000 3/18/04 (105,823) 501,984,172 Swedish Krona ............ 62,130,599 3/23/04 (7,360,635) 54,198,813 European Unit ............ 61,807,647 3/25/04 (6,395,986) 4,094,418,122 Japanese Yen ............. 36,754,202 3/25/04 (1,553,753) 557,964,169 Norwegian Krone .......... 78,394,505 4/15/04 (5,193,239) 74,469,071 European Unit ............ 86,414,591 4/22/04 (7,229,502) 102,661,273 South African Rand ....... 14,438,707 4/26/04 (587,826) ---------------------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO SELL (CONTINUED) EXCHANGE FOR DATE GAIN (LOSS) ---------------------------------------------------------------------------------------------------------------- 60,750,000 European Unit ............ 71,497,238 4/28/04 (4,883,611) 3,657,978,825 Japanese Yen ............. 33,368,959 6/24/04 (959,940) -------------- ------------- U.S. $1,403,494,289 (92,481,433) -------------- ------------- Unrealized loss on forward exchange contracts ........................................... (92,481,433) ------------- Net unrealized loss on forward exchange contracts ..................................... U.S. $(89,964,497) -------------
7. RESTRICTED SECURITIES At December 31, 2003, investments in securities included issues that are restricted or illiquid. Restricted securities are often purchased in private placement transactions, are not registered under the Securities Act of 1933, may have contractual restrictions on resale, and are valued under methods approved by the Board of Directors as reflecting fair value. A security may also be considered illiquid if it lacks a readily available market or if its valuation has not changed for a certain period of time. At December 31, 2003, the Fund held investments in restricted and illiquid securities that were valued under approved methods by the Directors, as follows: Annual Report | 45 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. RESTRICTED SECURITIES (CONTINUED)
----------------------------------------------------------------------------------------------------- SHARES OR PRINCIPAL ACQUISITION AMOUNT ISSUER DATE COST VALUE ----------------------------------------------------------------------------------------------------- 128,355 A.B. Watley Group Inc. 4/02/01 $ 407,498 $ 23,104 61,768 AboveNet Inc. 10/02/01 1,850,217 1,850,217 11,445 FE Capital Holdings Ltd. 8/29/03 11,444,600 11,444,600 32,523,000 FE Capital LLC, 5.00%, 8/28/07 8/29/03 31,915,952 33,173,460 8,758,216 Hancock LLC 3/06/97 952,779 3,897,406 2,689,230 International Steel Group 4/10/02 12,990,000 89,033,682 684,780 Leucadia National Corp. 12/20/02 24,138,495 29,989,940 8,656,000 Nippon Investment LLC 2/14/01 -- 3,289,280 627,046 NTL Inc. 1/08/03 32,880,475 41,549,636 47,160 Olympus Re Holdings Ltd. 12/19/01 4,716,000 7,459,297 12,235 PG & E Corp., wts., 9/02/06 10/29/02 -- 305,679 118,301 Security Capital European Realty 4/08/98 2,687,753 881,342 170 Torre Mayor Investments, LP 10/28/02 17,000,000 13,600,000 61,515 White Mountains Insurance Group Inc. 10/22/02 18,146,925 26,879,133 ------------- TOTAL RESTRICTED SECURITIES (5.89% OF NET ASSETS) ................................... $263,376,776 -------------
8. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The Investment Company Act of 1940 defines "affiliated companies" to include investments in portfolio companies in which a fund owns 5% or more of the outstanding voting securities. Investments in "affiliated companies" for the Fund at December 31, 2003 were as shown below.
-------------------------------------------------------------------------------------------------------- REALIZED CAPITAL NUMBER OF NUMBER OF INVESTMENT GAIN SHARES HELD SHARES HELD VALUE INCOME (LOSS) DEC. 31, GROSS GROSS DEC. 31, DEC. 31, 1/1/03- 1/1/03- NAME OF ISSUER 2002 ADDITIONS REDUCTIONS 2003 2003 12/31/03 12/31/03 -------------------------------------------------------------------------------------------------------- CONTROLLED AFFILIATES* Hancock LLC .............. 8,758,216 -- -- 8,758,216 3,897,406 -- -- -------------------------------------------------------------------------------------------------------- TOTAL CONTROLLED AFFILIATES ...................................... $ 3,897,406 $ -- $ -- -------------------------------------------------------------------------------------------------------- NON-CONTROLLED AFFILIATES FE Capital Holdings Ltd. . -- 11,445 -- 11,445 11,444,600 -- -- Nippon Investment LLC .... 8,656,000 -- -- 8,656,000 3,289,280 -- -- Southwest Royalties Inc., 10.50%, 6/30/04 ......... 3,551,000 -- (3,551,000) -- -- 400,967 -- Southwest Royalties Inc., A 53,272 -- -- 53,272 1,598,153 -- -- Torre Mayor Investments, LP 170 -- -- 170 13,600,000 -- -- United Fire & Casualty Co. 595,200 -- (388,257) ** ** 218,344 910,114 United Fire & Casualty Co., 6.375%, cvt., pfd. ...... 110,800 -- -- ** ** 88,294 -- -------------------------------------------------------------------------------------------------------- TOTAL NON-CONTROLLED AFFILIATES .................................. $29,932,033 $707,605 $910,114 -------------------------------------------------------------------------------------------------------- TOTAL CONTROLLED & NON-CONTROLLED AFFILIATES ....................................... $33,829,439 $707,605 $910,114 -------------------------------------------------------------------------------------------------------- *Issuer in which the Fund owns 25% or more of the outstanding voting securities. **As of December 31, 2003, no longer an affiliate.
46 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. REGULATORY MATTERS On February 4, 2004, the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts filed an administrative complaint against Franklin Resources, Inc. and certain of its subsidiaries (the "Company"), alleging violations of the Massachusetts Uniform Securities Act. The complaint arises from activity that occurred in 2001 during which time an officer of a Company subsidiary was negotiating an agreement with an investor relating to investments in a mutual fund and a hedge fund. The Fund, in addition to other entities within Franklin Templeton Investments, including the Company and other funds, has been named in shareholder class actions related to the matter described above. The Fund's management believes that the claims made in the lawsuit are without merit and it intends to defend vigorously against the allegations. It is anticipated that the Fund may be named in additional similar civil actions related to the matter described above. In addition, as part of ongoing investigations by the U.S. Securities and Exchange Commission (the "SEC"), the U.S. Attorney for the Northern District of California, the New York Attorney General, the California Attorney General, the U.S. Attorney for the District of Massachusetts, the Florida Department of Financial Services, and the Commissioner of Securities and the Attorney General of the State of West Virginia, relating to certain practices in the mutual fund industry, including late trading, market timing and sales compensation arrangements, the Company and its subsidiaries, as well as certain current or former executives and employees of the Company, have received requests for information and/or subpoenas to testify or produce documents. The Company and its current employees are providing documents and information in response to these requests and subpoenas. In addition, the Company has responded to requests for similar kinds of information from regulatory authorities in some of the foreign countries where the Company conducts its global asset management business. The Staff of the SEC has informed the Company that it intends to recommend that the Commission authorize an action against an affiliate of the Fund's adviser and a senior executive officer relating to the frequent trading issues that are the subject of the SEC's investigation. These issues were previously disclosed as being under investigation by government authorities and the subject of an internal inquiry by the Company in its Annual Report on Form 10-K and on its public website. The Company currently is in discussions with the SEC Staff in an effort to resolve the issues raised in their investigation. Such discussions are preliminary and the Fund management has been advised that the Company cannot predict the likelihood of whether those discussions will result in a settlement and, if so, the terms of such settlement. The impact, if any, of these matters on the Fund is uncertain at this time. If the Company finds that it bears responsibility for any unlawful or improper conduct, it has committed to making the Fund or its shareholders whole, as appropriate. Annual Report | 47 Mutual Discovery Fund REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS TO THE BOARD OF DIRECTORS OF FRANKLIN MUTUAL SERIES FUND INC. AND SHAREHOLDERS OF MUTUAL DISCOVERY FUND We have audited the accompanying statement of assets and liabilities, including the statement of investments, of the Mutual Discovery Fund (one of the portfolios constituting the Franklin Mutual Series Fund Inc. Mutual Discovery Fund) as of December 31, 2003, and the related statement of operations for the year then ended, the statements of changes in net assets for each of the two years in the period then ended, and the financial highlights for each of the periods indicated therein. These financial statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights. Our procedures included confirmation of securities owned at December 31, 2003, by correspondence with the custodian and brokers or by other appropriate auditing procedures where replies from brokers were not received. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of the Mutual Discovery Fund of the Franklin Mutual Series Fund Inc. as of December 31, 2003, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the periods indicated therein, in conformity with accounting principles generally accepted in the United States. [LOGO OMITTED] Ernst & Young LLP Boston, Massachusetts February 4, 2004 48 | Annual Report Mutual Discovery Fund TAX DESIGNATION (UNAUDITED) Under Section 854(b)(2) of the Internal Revenue Code, the Fund hereby designates 14.93% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2003. Under Section 854(b)(2) of the Internal Revenue Code (Code), the Fund hereby designates up to a maximum of $53,514,301 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2003. In January 2004, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2003. Shareholders are advised to check with their tax advisors for information on the treatment of these amounts on their individual income tax returns. At December 31, 2003, more than 50% of the Mutual Discovery Fund's 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. As shown in the table below the Fund hereby designates to shareholders the foreign source income and foreign taxes paid, pursuant to Section 853 of the Internal Revenue Code. This designation will allow shareholders of record on December 18, 2003, to treat their proportionate share of foreign taxes paid by the Fund as having been paid directly by them. The shareholder shall consider these amounts as foreign taxes paid in the tax year in which they receive the Fund distribution. The following tables provide a detailed analysis, by country, of Foreign Tax Paid, Foreign Source Income, Foreign Qualified Dividends and Adjusted Foreign Source Income as designated by the Fund, to Class A, Class B, Class C, Class R and Class Z shareholders of record. As a service to individual shareholders filing Form 1116, "Adjusted Foreign Source Income per Share" in column 4 below reports foreign source income with the required adjustments to foreign source qualified dividends. This information is provided to simplify your reporting of foreign source income for line 1 of Form 1116. Annual Report | 49 Mutual Discovery Fund TAX DESIGNATION (UNAUDITED) (CONTINUED)
------------------------------------------------------------------------------------------------------------ CLASS A ADJUSTED FOREIGN TAX FOREIGN FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS SOURCE INCOME COUNTRY PER SHARE PER SHARE PER SHARE PER SHARE ------------------------------------------------------------------------------------------------------------ Belgium .................................. 0.0003 0.0032 0.0012 0.0025 Bermuda .................................. 0.0000 0.0007 0.0007 0.0003 Canada ................................... 0.0015 0.0151 0.0066 0.0113 Cayman Islands ........................... 0.0000 0.0001 0.0000 0.0001 Denmark .................................. 0.0006 0.0045 0.0025 0.0031 France ................................... 0.0049 0.0256 0.0211 0.0135 Germany .................................. 0.0001 0.0087 0.0004 0.0085 India .................................... 0.0000 0.0012 0.0012 0.0005 Ireland .................................. 0.0000 0.0083 0.0083 0.0036 Japan .................................... 0.0004 0.0041 0.0023 0.0028 Mexico ................................... 0.0000 0.0001 0.0001 0.0000 Netherlands .............................. 0.0018 0.0076 0.0075 0.0033 Norway ................................... 0.0024 0.0106 0.0086 0.0057 South Africa ............................. 0.0000 0.0046 0.0046 0.0020 South Korea .............................. 0.0018 0.0067 0.0000 0.0067 Spain .................................... 0.0007 0.0094 0.0031 0.0076 Sweden ................................... 0.0001 0.0063 0.0003 0.0061 Switzerland .............................. 0.0018 0.0077 0.0077 0.0033 Taiwan ................................... 0.0000 0.0030 0.0000 0.0030 United Kingdom ........................... 0.0037 0.0352 0.0235 0.0218 ----------------------------------------------------------- TOTAL .................................... $0.0201 $0.1627 $0.0997 $0.1057 -----------------------------------------------------------
------------------------------------------------------------------------------------------------------------ CLASS B ADJUSTED FOREIGN TAX FOREIGN FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS SOURCE INCOME COUNTRY PER SHARE PER SHARE PER SHARE PER SHARE ------------------------------------------------------------------------------------------------------------ Belgium .................................. 0.0003 0.0023 0.0009 0.0018 Bermuda .................................. 0.0000 0.0005 0.0005 0.0002 Canada ................................... 0.0015 0.0108 0.0047 0.0081 Cayman Islands ........................... 0.0000 0.0001 0.0000 0.0001 Denmark .................................. 0.0006 0.0032 0.0017 0.0022 France ................................... 0.0049 0.0182 0.0150 0.0096 Germany .................................. 0.0001 0.0062 0.0003 0.0060 India .................................... 0.0000 0.0008 0.0008 0.0003 Ireland .................................. 0.0000 0.0059 0.0059 0.0025 Japan .................................... 0.0004 0.0029 0.0017 0.0019 Netherlands .............................. 0.0018 0.0054 0.0053 0.0024 Norway ................................... 0.0024 0.0076 0.0062 0.0041 South Africa ............................. 0.0000 0.0033 0.0033 0.0014 South Korea .............................. 0.0018 0.0048 0.0000 0.0048 Spain .................................... 0.0007 0.0067 0.0022 0.0054 Sweden ................................... 0.0001 0.0045 0.0002 0.0044 Switzerland .............................. 0.0018 0.0055 0.0055 0.0024 Taiwan ................................... 0.0000 0.0021 0.0000 0.0021 United Kingdom ........................... 0.0037 0.0251 0.0168 0.0155 ----------------------------------------------------------- TOTAL .................................... $0.0201 $0.1159 $0.0710 $0.0752 -----------------------------------------------------------
50 | Annual Report Mutual Discovery Fund TAX DESIGNATION (UNAUDITED) (CONTINUED)
------------------------------------------------------------------------------------------------------------ CLASS C ADJUSTED FOREIGN TAX FOREIGN FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS SOURCE INCOME COUNTRY PER SHARE PER SHARE PER SHARE PER SHARE ------------------------------------------------------------------------------------------------------------ Belgium .................................. 0.0003 0.0021 0.0008 0.0016 Bermuda .................................. 0.0000 0.0005 0.0005 0.0002 Canada ................................... 0.0015 0.0100 0.0044 0.0075 Cayman Islands ........................... 0.0000 0.0001 0.0000 0.0001 Denmark .................................. 0.0006 0.0030 0.0016 0.0021 France ................................... 0.0049 0.0169 0.0139 0.0090 Germany .................................. 0.0001 0.0057 0.0002 0.0056 India .................................... 0.0000 0.0008 0.0008 0.0003 Ireland .................................. 0.0000 0.0055 0.0055 0.0024 Japan .................................... 0.0004 0.0027 0.0015 0.0018 Netherlands .............................. 0.0018 0.0050 0.0050 0.0021 Norway ................................... 0.0024 0.0070 0.0057 0.0037 South Africa ............................. 0.0000 0.0030 0.0030 0.0013 South Korea .............................. 0.0018 0.0044 0.0000 0.0044 Spain .................................... 0.0007 0.0062 0.0021 0.0050 Sweden ................................... 0.0001 0.0042 0.0002 0.0041 Switzerland .............................. 0.0018 0.0051 0.0051 0.0022 Taiwan ................................... 0.0000 0.0020 0.0000 0.0020 United Kingdom ........................... 0.0037 0.0232 0.0155 0.0143 ----------------------------------------------------------- TOTAL .................................... $0.0201 $0.1074 $0.0658 $0.0697 -----------------------------------------------------------
------------------------------------------------------------------------------------------------------------ CLASS R ADJUSTED FOREIGN TAX FOREIGN FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS SOURCE INCOME COUNTRY PER SHARE PER SHARE PER SHARE PER SHARE ------------------------------------------------------------------------------------------------------------ Belgium .................................. 0.0003 0.0032 0.0012 0.0025 Bermuda .................................. 0.0000 0.0007 0.0007 0.0003 Canada ................................... 0.0015 0.0148 0.0065 0.0111 Cayman Islands ........................... 0.0000 0.0001 0.0000 0.0001 Denmark .................................. 0.0006 0.0044 0.0024 0.0030 France ................................... 0.0049 0.0250 0.0206 0.0132 Germany .................................. 0.0001 0.0085 0.0004 0.0083 India .................................... 0.0000 0.0011 0.0011 0.0005 Ireland .................................. 0.0000 0.0081 0.0081 0.0035 Japan .................................... 0.0004 0.0040 0.0023 0.0027 Mexico ................................... 0.0000 0.0001 0.0001 0.0000 Netherlands .............................. 0.0018 0.0074 0.0073 0.0032 Norway ................................... 0.0024 0.0104 0.0085 0.0055 South Africa ............................. 0.0000 0.0045 0.0045 0.0019 South Korea .............................. 0.0018 0.0066 0.0000 0.0066 Spain .................................... 0.0007 0.0092 0.0030 0.0075 Sweden ................................... 0.0001 0.0062 0.0003 0.0060 Switzerland .............................. 0.0018 0.0076 0.0076 0.0033 Taiwan ................................... 0.0000 0.0029 0.0000 0.0029 United Kingdom ........................... 0.0037 0.0345 0.0231 0.0213 ----------------------------------------------------------- TOTAL .................................... $0.0201 $ 0.1593 $0.0977 $0.1034 -----------------------------------------------------------
Annual Report | 51 Mutual Discovery Fund TAX DESIGNATION (UNAUDITED) (CONTINUED)
------------------------------------------------------------------------------------------------------------ CLASS Z ADJUSTED FOREIGN TAX FOREIGN FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS SOURCE INCOME COUNTRY PER SHARE PER SHARE PER SHARE PER SHARE ------------------------------------------------------------------------------------------------------------ Belgium .................................... 0.0003 0.0038 0.0015 0.0029 Bermuda .................................... 0.0000 0.0008 0.0008 0.0003 Canada ..................................... 0.0015 0.0177 0.0077 0.0133 Cayman Islands ............................. 0.0000 0.0002 0.0000 0.0002 Denmark .................................... 0.0006 0.0053 0.0029 0.0036 France ..................................... 0.0049 0.0299 0.0247 0.0158 Germany .................................... 0.0001 0.0102 0.0004 0.0100 India ...................................... 0.0000 0.0014 0.0014 0.0006 Ireland .................................... 0.0000 0.0097 0.0097 0.0042 Japan ...................................... 0.0004 0.0048 0.0027 0.0033 Luxembourg ................................. 0.0000 0.0001 0.0000 0.0001 Mexico ..................................... 0.0000 0.0001 0.0001 0.0000 Netherlands ................................ 0.0018 0.0089 0.0088 0.0039 Norway ..................................... 0.0024 0.0124 0.0101 0.0066 South Africa ............................... 0.0000 0.0054 0.0054 0.0023 South Korea ................................ 0.0018 0.0078 0.0000 0.0078 Spain ...................................... 0.0007 0.0109 0.0036 0.0088 Sweden ..................................... 0.0001 0.0074 0.0004 0.0072 Switzerland ................................ 0.0018 0.0091 0.0091 0.0039 Taiwan ..................................... 0.0000 0.0035 0.0001 0.0034 United Kingdom ............................. 0.0037 0.0412 0.0275 0.0255 ----------------------------------------------------------- TOTAL ...................................... $0.0201 $0.1906 $0.1169 $0.1237 -----------------------------------------------------------
Foreign Tax Paid per Share (Column 1) is the amount per share available to you, as a tax credit or deduction (assuming you held your shares in the fund for a minimum of 16 days during the 30-day period beginning 15 days before the ex-dividend date of the fund's distribution to which the foreign taxes relate). Foreign Source Income per Share (Column 2) is the amount per share of income dividends paid to you that is attributable to foreign securities held by the fund, plus any foreign taxes withheld on these dividends. The amounts reported include foreign source qualified dividends without adjustment for the lower U.S. tax rates. Generally, this is the foreign source income to be reported by certain trusts and corporate shareholders. Foreign Qualified Dividends per Share (Column 3) is the amount per share of foreign source qualified dividends the fund paid to you, plus any foreign taxes withheld on these dividends. These amounts represent the portion of the Foreign Source Income reported to you in column 2 that were derived from qualified foreign securities held by the fund. If you are an individual shareholder who does not meet the qualified dividend holding period requirements, you may find this information helpful to calculate the foreign source income adjustment needed to complete line 1 of Form 1116. Adjusted Foreign Source Income per Share (Column 4) is the adjusted amount per share of foreign source income the fund paid to you. These amounts reflect the Foreign Source Income reported in column 2 adjusted for the tax rate differential on foreign source qualified dividends that may be required for certain individual shareholders pursuant to Internal Revenue Code 904(b)(2)(B). If you 52 | Annual Report Mutual Discovery Fund TAX DESIGNATION (UNAUDITED) (CONTINUED) are an individual shareholder who meets the qualified dividend holding period requirements, generally, these Adjusted Foreign Source Income amounts may be reported directly on line 1 of Form 1116 without additional adjustment. In January 2004, shareholders will receive Form 1099-DIV which will include their share of taxes paid and foreign source income distributed during the calendar year 2003. The Foreign Source Income reported on Form 1099-DIV has been reduced to take into account the tax rate differential on foreign source qualified dividend income pursuant to Internal Revenue Code 904(b)(2)(B). Shareholders are advised to check with their tax advisors for information on the treatment of these amounts on their 2003 individual income tax returns. Annual Report | 53 Board Members and Officers The name, age and address of the officers and board members, as well as their affiliations, positions held with the Fund, principal occupations during the past five years and number of portfolios overseen in the Franklin Templeton Investments fund complex are shown below. Each board member will serve until that person's successor is elected and qualified. INDEPENDENT BOARD MEMBERS
-------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD -------------------------------------------------------------------------------------------------------------------------- EDWARD I. ALTMAN, PH.D. (62) Director Since 1987 7 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Max L. Heine Professor of Finance and Director of The Credit and Debt Markets Research Program, NYU Salomon Center, Stern School of Business, New York University; editor and author of numerous financial publications; and financial consultant; and FORMERLY Vice Director, NYU Salomon Center, Stern School of Business, New York University. -------------------------------------------------------------------------------------------------------------------------- ANN TORRE GRANT (45) Director Since 1994 7 Independent Director, SLM, 51 John F. Kennedy Parkway Corporation (Sallie Mae); and Short Hills, NJ 07078 Allied Capital Corporation (financial services). PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Independent strategic and financial consultant; and FORMERLY, Executive Vice President and Chief Financial Officer, NHP Incorporated (manager of multifamily housing) (1995-1997); and Vice President and Treasurer, US Airways, Inc. (until 1995). -------------------------------------------------------------------------------------------------------------------------- BURTON J. GREENWALD (74) Director Since 2002 12 Director, Fiduciary Emerging 51 John F. Kennedy Parkway Markets Bond Fund PLC and Short Hills, NJ 07078 Fiduciary International Ireland Limited. PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Managing Director, B.J. Greenwald Associates, management consultants to the financial services industry. -------------------------------------------------------------------------------------------------------------------------- BRUCE A. MACPHERSON (73) Director Since 1974 7 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Retired, former Chairman, A.A. MacPherson, Inc., Canton, MA (representative for electrical manufacturers); and part owner McKinstry Inc., Chicopee, MA (manufacturer of electrical enclosures). -------------------------------------------------------------------------------------------------------------------------- FRED R. MILLSAPS (74) Director Since 1996 28 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director of various business and nonprofit organizations; manager of personal investments (1978-present); and FORMERLY, Chairman and Chief Executive Officer, Landmark Banking Corporation (1969-1978); Financial Vice President, Florida Power and Light (1965-1969); and Vice President, Federal Reserve Bank of Atlanta (1958-1965). --------------------------------------------------------------------------------------------------------------------------
54 | Annual Report
-------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD -------------------------------------------------------------------------------------------------------------------------- CHARLES RUBENS II (73) Director Since 1998 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. -------------------------------------------------------------------------------------------------------------------------- LEONARD RUBIN (78) Director Since 1996 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Partner in LDR Equities, LLC (manages personal investments); and FORMERLY, President, F.N.C. Textiles, Inc.; and Chairman of the Board, Carolace Embroidery Co., Inc. (until 1996). -------------------------------------------------------------------------------------------------------------------------- ROBERT E. WADE (57) Director Since 1991 7 Director, El Oro Mining and 51 John F. Kennedy Parkway Exploration Co., p.l.c.; and Short Hills, NJ 07078 FORMERLY, Director, El Oro Mining and Exploration Company, p.l.c and The Exploration Company, p.l.c., (until 2003). PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Practicing attorney. -------------------------------------------------------------------------------------------------------------------------- INTERESTED BOARD MEMBERS AND OFFICERS -------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD -------------------------------------------------------------------------------------------------------------------------- **WILLIAM J. LIPPMAN (78) Director Since 1996 18 None One Parker Plaza, 9th Floor Fort Lee, NJ 07024 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Private Client Group, Inc.; President, Franklin Advisory Services, LLC.; and officer and/or director or trustee, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of seven of the investment companies in Franklin Templeton Investments. -------------------------------------------------------------------------------------------------------------------------- **ANNE M. TATLOCK (64) Director Since 2002 7 Director, Fortune Brands, Inc. 600 Fifth Avenue, 7th Floor (consumer products) and Merck New York, NY 10020-2302 & Co. Inc. (pharmaceuticals) PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman and Chief Executive Officer, Fiduciary Trust Company International; Vice Chairman, Member - Office of the Chairman and Director, Franklin Resources, Inc.; and officer and/or director of some of the other subsidiaries of Franklin Resources, Inc. --------------------------------------------------------------------------------------------------------------------------
Annual Report | 55
-------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD -------------------------------------------------------------------------------------------------------------------------- **DAVID J. WINTERS (41) Director, Director since 7 None 51 John F. Kennedy Parkway President, 2001, President Short Hills, NJ 07078-2702 Chairman of since 1999, the Board Chairman of the and Chief Board and Chief Executive Executive Officer - Officer - Investment Investment Management Management since 2002 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Chief Investment Officer, and Chief Executive Officer, Franklin Mutual Advisers, LLC., and of three of the investment companies in Franklin Templeton Investments. -------------------------------------------------------------------------------------------------------------------------- JIMMY D. GAMBILL (56) Senior Vice Since 2002 Not Applicable None 500 East Broward Blvd. President and Suite 2100 Fort Lauderdale, Chief FL 33394-3091 Executive Officer - Finance and Administration PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Franklin Templeton Services, LLC; Senior Vice President, Templeton Worldwide, Inc.; and officer of 51 of the investment companies in Franklin Templeton Investments. -------------------------------------------------------------------------------------------------------------------------- DAVID P. GOSS (56) Vice President Since 2000 Not Applicable None One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Associate General Counsel, Franklin Resources, Inc.; officer and director of one of the subsidiaries of Franklin Resources, Inc.; officer of 51 of the investment companies in Franklin Templeton Investments; and FORMERLY, President, Chief Executive Officer and Director, Property Resources Equity Trust (until 1999) and Franklin Select Realty Trust (until 2000). -------------------------------------------------------------------------------------------------------------------------- BARBARA J. GREEN (56) Vice President Since 2000 Not Applicable None One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Deputy General Counsel and Secretary, Franklin Resources, Inc.; Secretary and Senior Vice President, Templeton Worldwide, Inc.; Secretary, Franklin Advisers, Inc., Franklin Advisory Services, LLC, Franklin Investment Advisory Services, Inc., Franklin Mutual Advisers, LLC, Franklin Templeton Alternative Strategies, Inc., Franklin Templeton Investor Services, LLC, Franklin Templeton Services, LLC, Franklin Templeton Distributors, Inc., Templeton Investment Counsel, LLC, and Templeton/Franklin Investment Services, Inc.; and officer of some of the other subsidiaries of Franklin Resources, Inc. and of 51 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). --------------------------------------------------------------------------------------------------------------------------
56 | Annual Report
-------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD -------------------------------------------------------------------------------------------------------------------------- MICHAEL O. MAGDOL (66) Vice President Since 2002 Not Applicable Director, FTI Banque, Arch 600 Fifth Avenue - AML Chemicals, Inc. and Lingnan Rockefeller Center Compliance New York, NY 10048-0772 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice Chairman, Chief Banking Officer and Director, Fiduciary Trust Company International; and officer and/or director, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of 48 of the investment companies in Franklin Templeton Investments. -------------------------------------------------------------------------------------------------------------------------- KIMBERLEY H. MONASTERIO (40) Treasurer and Treasurer and Not Applicable None One Franklin Parkway Chief Chief Financial San Mateo, CA 94403-1906 Financial Officer since Officer 2003 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Templeton Services, LLC; and officer of 51 of the investment companies in Franklin Templeton Investments. -------------------------------------------------------------------------------------------------------------------------- MURRAY L. SIMPSON (66) Vice President Since 2000 Not Applicable None One Franklin Parkway and Secretary San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Executive Vice President and General Counsel, Franklin Resources, Inc.; officer and/or director, as the case may be, of some of the subsidiaries of Franklin Resources, Inc. and of 51 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). --------------------------------------------------------------------------------------------------------------------------
*We base the number of portfolios on each separate series of the U.S. registered investment companies within the Franklin Templeton Investments fund complex. These portfolios have a common investment adviser or affiliated investment advisers. **William J. Lippman is considered an interested person of Mutual Series under the federal securities laws due to his position as an officer of some of the subsidiaries of Franklin Resources, Inc. (Resources), which is the parent company of Mutual Series' adviser and distributor. Anne M. Tatlock is considered an interested person of Mutual Series under the federal securities laws due to her position as an officer and director of Resources. David J. Winters is considered an interested person of Mutual Series under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC. THE FUND'S BOARD OF DIRECTORS HAS DETERMINED THAT CERTAIN OF THE MEMBERS OF THE AUDIT COMMITTEE, INCLUDING ANN TORRE GRANT, ARE AUDIT COMMITTEE FINANCIAL EXPERTS, AND "INDEPENDENT," UNDER THOSE PROVISIONS OF THE SARBANES-OXLEY ACT OF 2002, AND THE RULES AND FORM AMENDMENTS ADOPTED BY THE SECURITIES AND EXCHANGE COMMISSION, RELATING TO AUDIT COMMITTEE FINANCIAL EXPERTS. THE STATEMENT OF ADDITIONAL INFORMATION (SAI) INCLUDES ADDITIONAL INFORMATION ABOUT THE BOARD MEMBERS AND IS AVAILABLE, WITHOUT CHARGE, UPON REQUEST. SHAREHOLDERS MAY CALL 1-800/DIAL BEN (1-800/342-5236) TO REQUEST THE SAI. Annual Report | 57 Mutual Discovery Fund PROXY VOTING POLICIES AND PROCEDURES The Fund has established Proxy Voting Policies and Procedures ("Policies") that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund's complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at 1-954/847-2268 or by sending a written request to: Franklin Templeton Companies, LLC, 500 East Broward Boulevard, Suite 1500, Fort Lauderdale, FL 33394, Attention: Proxy Group. 58 | Annual Report This page intentionally left blank. This page intentionally left blank. Literature Request For a brochure and prospectus, which contains more complete information, including charges and expenses, call Franklin Templeton Investments at 1-800/DIAL BEN(R) (1-800/342-5236). Please read the prospectus carefully before investing or sending money. To ensure the highest quality of service, we may monitor, record and access telephone calls to or from our service departments. These calls can be identified by the presence of a regular beeping tone. FRANKLIN TEMPLETON INVESTMENTS INTERNATIONAL Mutual European Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Foreign Fund Templeton Foreign Smaller Companies Fund Templeton International (Ex EM) Fund GLOBAL Franklin Global Aggressive Growth Fund Franklin Global Growth Fund Mutual Discovery Fund Templeton Capital Accumulator Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund Templeton Growth Fund Templeton World Fund GROWTH Franklin Aggressive Growth Fund Franklin Capital Growth Fund Franklin Flex Cap Growth Fund Franklin Small-Mid Cap Growth Fund Franklin Small Cap Growth Fund II 1 VALUE Franklin Balance Sheet Investment Fund 2 Franklin Equity Income Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund 3 Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund 4 Mutual Shares Fund BLEND Franklin Blue Chip Fund Franklin Convertible Securities Fund Franklin Growth Fund Franklin Rising Dividends Fund Franklin U.S. Long-Short Fund 5 SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Communications Fund Franklin Global Health Care Fund Franklin Gold and Precious Metals Fund Franklin Natural Resources Fund Franklin Real Estate Securities Fund Franklin Utilities Fund Franklin Technology Fund Mutual Financial Services Fund ASSET ALLOCATION Franklin Templeton Corefolio Allocation Fund Franklin Templeton Founding Funds Allocation Fund TARGET FUNDS Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund INCOME Franklin Adjustable U.S. Government Securities Fund 6 Franklin's AGE High Income Fund Franklin Federal Money Fund 6, 7 Franklin Floating Rate Daily Access Fund Franklin Floating Rate Trust 4 Franklin Income Fund Franklin Money Fund 6, 7 Franklin Short-Intermediate U.S. Government Securities Fund 6 Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio 6 Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund 6 Templeton Global Bond Fund TAX-FREE INCOME8 NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund 9 Tax-Exempt Money Fund 6, 7 LIMITED-TERM FUNDS California Limited-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Limited-Term Tax-Free Income Fund INTERMEDIATE-TERM FUNDS California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC 8 Alabama Arizona California10 Colorado Connecticut Florida10 Georgia Kentucky Louisiana Maryland Massachusetts 9 Michigan 9 Minnesota 9 Missouri New Jersey New York 10 North Carolina Ohio 9 Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust 11 1. The fund is closed to new investors. Existing shareholders can continue adding to their accounts. 2. The fund is only open to existing shareholders as well as select retirement plans. 3. Effective June 30, 2003, the fund reopened to all new investors. 4. The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. 5. Upon reaching approximately $350 million in assets, the fund intends to close to all investors. 6. An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. 7. No assurance exists that the fund's $1.00 per share price will be maintained. It is possible to lose money by investing in the fund. 8. For investors subject to the alternative minimum tax, a small portion of these dividends may be taxable. Distributions of capital gains are generally taxable. 9. Portfolio of insured municipal securities. 10. These funds are available in two or more variations, including long-term portfolios, portfolios of insured securities, a high-yield portfolio (CA) and money market portfolios (CA and NY). 11. The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 11/03 Not part of the annual report [LOGO] FRANKLIN[R] TEMPLETON[R] One Franklin Parkway INVESTMENTS San Mateo, CA 94403-1906 WANT TO RECEIVE THIS DOCUMENT FASTER VIA EMAIL? Eligible shareholders can sign up for eDelivery at franklintempleton.com. See inside for details. ANNUAL REPORT AND SHAREHOLDER LETTER MUTUAL DISCOVERY FUND CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF INVESTMENT OFFICER David J. Winters AUDITORS Ernst & Young LLP 200 Clarendon Streeet Boston, MA 02116 INVESTMENT MANAGER Franklin Mutual Advisers, LLC 51 John F. Kennedy Parkway Short Hills, NJ 07078 DISTRIBUTOR Franklin Templeton Distributors, Inc. 1-800/DIAL BEN (R) franklintempleton.com SHAREHOLDER SERVICES 1-800/632-2301 - (Class A, B, & C) 1-800/448-FUND - (Class Z) This report must be preceded or accompanied by the current Mutual Discovery Fund prospectus, which contains more complete information, including risk factors, charges and expenses. To ensure the highest quality of service, telephone calls to or from our service departments may be monitored, recorded and accessed. These calls can be identified by the presence of a regular beeping tone. 477 A2003 02/04 DECEMBER 31, 2003 [GRAPHIC] ANNUAL REPORT AND SHAREHOLDER LETTER | INTERNATIONAL MUTUAL EUROPEAN FUND WANT TO RECEIVE THIS DOCUMENT FASTER VIA EMAIL? Eligible shareholders can sign up for eDelivery at franklintempleton.com. See inside for details. [LOGO] FRANKLIN[R] TEMPLETON[R] INVESTMENTS Franklin o Templeton o MUTUAL SERIES Thank You For Your Continued Participation At Mutual Series, we are pleased so many investors share our long-term investment philosophy and have remained shareholders for many years. Your ongoing support plays a significant role in contributing to the funds' success. SPECIALIZED EXPERTISE Mutual Series is part of Franklin Templeton Investments, which offers the specialized expertise of three world-class investment management groups -- Franklin, Templeton and Mutual Series. Mutual Series is dedicated to a unique style of value investing, searching aggressively for opportunity among undervalued stocks, arbitrage situations and distressed companies. Franklin is a leader in tax-free fund management and an expert in U.S. equity and fixed income investing. Templeton pioneered international investing and, with offices in over 25 countries, offers the broadest global reach in the industry. TRUE DIVERSIFICATION Because these management groups work independently and adhere to distinctly different investment approaches, Franklin, Templeton and Mutual Series funds typically have a low overlap of securities. That's why the funds can be used to build truly diversified portfolios covering every major asset class. RELIABILITY YOU CAN TRUST Franklin Templeton Investments seeks to consistently provide investors with exceptional risk-adjusted returns over the long term, as well as the reliable account services that have helped the firm become one of the most trusted names in financial services. MUTUAL FUNDS | RETIREMENT PLANS | 529 COLLEGE SAVINGS PLANS | SEPARATE ACCOUNTS [GRAPHIC OMITTED] Not part of the annual report Contents SHAREHOLDER LETTER.......................... 1 ANNUAL REPORT Mutual European Fund........................ 5 Performance Summary......................... 9 Financial Highlights and Statement of Investments ...................14 Financial Statements........................26 Notes to Financial Statements...............30 Independent Auditors' Report................39 Tax Designation.............................40 Board Members and Officers..................44 Proxy Voting Policies and Procedures........48 -------------------------------------------------------------------------------- Regulatory Update AS OF FEBRUARY 12, 2004 On February 4, 2004, the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts filed an administrative complaint against Franklin Resources, Inc. and certain of its subsidiaries (the "Company"), alleging violations of the Massachusetts Uniform Securities Act. The complaint arises from activity that occurred in 2001 during which time an officer of a Company subsidiary was negotiating an agreement with an investor relating to investments in a mutual fund and a hedge fund. The Company, in addition to other entities within Franklin Templeton Investments, including the Fund and other funds, has been named in shareholder class actions related to the matter described above. The Company believes that the claims made in the lawsuit are without merit and it intends to defend vigorously against the allegations. It is anticipated that the Company may be named in additional similar civil actions related to the matter described above. In addition, as part of ongoing investigations by the U.S. Securities and Exchange Commission (the "SEC"), the U.S. Attorney for the Northern District of California, the New York Attorney General, the California Attorney General, the U.S. Attorney for the District of Massachusetts, the Florida Department of Financial Services, and the Commissioner of Securities and the Attorney General of the State of West Virginia, relating to certain practices in the mutual fund industry, including late trading, market timing and sales compensation arrangements, the Company and its subsidiaries, as well as certain current or former executives and employees of the Company, have received requests for information and/or subpoenas to testify or produce documents. The Company and its current employees are providing documents and information in response to these requests and subpoenas. In addition, the Company has responded to requests for similar kinds of information from regulatory authorities in some of the foreign countries where the Company conducts its global asset management business. The Staff of the SEC has informed the Company that it intends to recommend that the Commission authorize an action against an affiliate of the Fund's adviser and a senior executive officer relating to the frequent trading issues that are the subject of the SEC's investigation. These issues were previously disclosed as being under investigation by government authorities and the subject of an internal inquiry by the Company in its Annual Report on Form 10-K and on its public website. The Company currently is in discussions with the SEC Staff in an effort to resolve the issues raised in their investigation. Such discussions are preliminary and the Company cannot predict the likelihood of whether those discussions will result in a settlement and, if so, the terms of such settlement. The impact, if any, of these matters on the Fund is uncertain at this time. If it is found that the Company bears responsibility for any unlawful or improper conduct, we have committed to making the funds or their shareholders whole, as appropriate. Any further updates on these matters will be disclosed on the Company's website at franklintempleton.com under "Statement on Current Industry Issues." 4 | Not part of the annual report Annual Report Mutual European Fund YOUR FUND'S GOAL AND PRIMARY INVESTMENTS: Mutual European Fund seeks capital appreciation, with income as a secondary goal, by investing primarily in common and preferred stocks, bonds and convertible securities. The Fund normally will invest at least 80% of its assets in the securities of issuers organized under the laws of or whose principal business operations are located in or at least 50% of whose revenue is earned from, European countries. This annual report for Mutual European Fund covers the fiscal year ended December 31, 2003. PERFORMANCE OVERVIEW Mutual European Fund - Class Z posted a 32.84% cumulative total return for the 12 months ended December 31, 2003, as shown in the Performance Summary beginning on page 9. The Fund underperformed its benchmark, the Morgan Stanley Capital International (MSCI) All Country Europe Index, which returned 39.52% over the same period. 1 ECONOMIC AND MARKET OVERVIEW Late March 2003 saw the start of a global equity market rally that produced the strongest annual total returns since 1986. The rally's main catalyst was an improving global economy, underpinned by expansionary fiscal and monetary policies, corporate restructuring and consolidation, and more than two years of declining equity markets that created potential opportunities in Asia, Europe and the Americas. In the U.S. and many European countries, gross domestic product (GDP) growth accelerated in 2003, particularly in the second half of the year. In the U.S., GDP grew at annualized rates of 3.1% and 8.2% in the second and third quarters. Over the same periods, consumer spending rose at annualized rates of 3.3% and 6.9% 1. Source: Standard & Poor's Micropal. The MSCI All Country Europe Index is market capitalization-weighted and measures total returns of equity securities available to foreign (non-local) investors in developed and emerging markets in Europe. The index includes reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND COMPLETE LEGAL TITLES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 18. Annual Report | 5 spurred largely by tax cuts, car-buying incentives and mortgage refinancing, as interest rates reached the lowest level in more than four decades. Consumer sentiment, business sentiment and industrial production increased in several European countries. Europe's economic recovery was slower than that of the U.S., but gained momentum in the second half of 2003. In 2003, the value of the U.S. dollar fell against some major currencies, including a 17% decline versus the euro. 2 While the decline magnified top-line and earnings-per-share growth in the U.S., it had the opposite effect in Europe. The dollar decline also benefited U.S. investors in international equities because it increased the returns of investments denominated in currencies that appreciated against the dollar, such as the euro. Although the dollar's decline significantly affected equity market returns, it was not the only reason for the past year's gains. Equity markets in many countries produced stronger gains than the U.S. equity market, even in their local currencies. These countries benefited from improving economic and financial market conditions in 2003. INVESTMENT STRATEGY We follow a distinctive, three-pronged investment approach, which combines investments in what we believe are substantially undervalued common stocks with distressed debt investing and risk arbitrage. Our style is designed to provide our shareholders with superior risk-adjusted results over time. We employ rigorous, fundamental analysis to find compelling situations. In our opinion, successful investing is as much about assessing risk and containing losses as it is about achieving profits. In choosing investments, we look at the market price of an individual company's securities relative to our evaluation of its intrinsic value based on factors including book value, cash flow generation, long-term earnings potential and earnings multiples. We may invest in bankruptcy or distressed com-panies if we believe the market overreacted to adverse developments or failed to appreciate positive changes. MANAGER'S DISCUSSION While all three prongs of our investment strategy contributed to Fund performance during the year under review, the strongest contributors were the distressed and equity portfolios. Three of our best performers in 2003 included NTL, a distressed 2. Source: European Central Bank. [BAR CHART OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: GEOGRAPHIC DISTRIBUTION* Based on Total Net Assets as of 12/31/03 U.K. 37.3% France 9.9% Netherlands 9.4% Switzerland 7.3% Norway 6.0% Irish Republic 5.6% U.S. 4.9% Denmark 3.1% Belgium 3.0% Spain 2.8% Finland 2.8% Germany 2.3% Italy 2.0% Luxembourg 1.8% Sweden 1.5% Other Countries 1.3% *Other net assets = -1.0% because of foreign currency hedging. 6 | Annual Report cable company investment; Koninklijke Nedlloyd Groep (Royal Nedlloyd), a Dutch container shipping company; and Kingspan Group, an Irish building products company. NTL, the U.K.'s largest cable company, was formed by a series of acquisitions of independent cable operators. These purchases were financed largely with debt, and in 2001, when NTL failed to generate enough cash flow to meet its interest payments, the company's bonds began to trade at significant discounts to face value. After completing an extensive fundamental analysis, we believed NTL's bonds were trading well below the fair value of the company's operations. We purchased a material amount of NTL debt and became an active member of the creditors committee formed to facilitate the reorganization process. During the restructuring, our investment in NTL bonds was converted to common shares, and the reorganized company emerged from bankruptcy in January 2003. As global cable valuations recovered, the new NTL shares performed well during the year and appreciated more than 15 times from their lows. Royal Nedlloyd is a holding company whose primary assets include a 50% stake in the container shipping company P&O Nedlloyd and a 50% stake in the charter and freight airline Martinair. Royal Nedlloyd's common stock began the year trading for less than one-third of its tangible book value. During the year, Royal Nedlloyd benefited from a general economic rebound, improved investor sentiment toward cyclical stocks, and favorable conditions in each of its businesses. For example, rising container shipping rates and improved efficiency helped P&O Nedlloyd, while a reduced cost base benefited Martinair. By year-end, Royal Nedlloyd's stock nearly tripled from its lows and was liquidated by the Fund. Kingspan's building components sales are heavily dependent on the macroeconomic environment. As the year began, expectations were for a continuation of the same depressed level of building activity that hurt the company's results in 2002. The company cut costs by shutting production facilities and reducing headcount. New U.K. government regulations regarding thermal efficiency for new buildings, and a general improvement in the level of building activity, resulted in a recovery in demand for Kingspan's products during 2003. The company's shares nearly tripled as the economic rebound gained momentum and investor sentiment toward building products companies improved. TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/03 % OF TOTAL NET ASSETS Commercial Banks 8.3% Tobacco 7.3% Beverages 7.2% Food Products 6.7% Diversified Telecommunication Services 6.1% Construction & Engineering 5.6% Insurance 5.1% Media 5.0% Chemicals 5.0% Diversified Financial Services 3.6% Annual Report | 7 TOP 10 HOLDINGS 12/31/03 COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS ------------------------------------------------------------- NTL Inc., common & restricted 4.2% DIVERSIFIED TELECOMMUNICATION SERVICES, U.K. ------------------------------------------------------------- British American Tobacco PLC TOBACCO, U.K. 3.5% ------------------------------------------------------------- DNB Holding ASA COMMERCIAL BANKS, NORWAY 3.1% ------------------------------------------------------------- Vinci SA 3.1% CONSTRUCTION & ENGINEERING, FRANCE ------------------------------------------------------------- White Mountains Insurance Group Inc., common & restricted 2.4% INSURANCE, U.S. ------------------------------------------------------------- Diageo PLC 2.0% BEVERAGES, U.K. ------------------------------------------------------------- Orkla ASA 2.0% BEVERAGES, NORWAY ------------------------------------------------------------- Seton House Finance Ltd. 2.0% CONSUMER FINANCE, U.K. ------------------------------------------------------------- Imperial Tobacco Group PLC 2.0% TOBACCO, U.K. ------------------------------------------------------------- Groupe Danone 1.9% FOOD PRODUCTS, FRANCE ------------------------------------------------------------- Despite a generally favorable market environment, not all of our investments performed well during the year. Three of the Fund's significant underperformers included Allied Domecq (sold by year-end), one of the world's largest spirits and wine companies; and German household and personal care products companies Henkel (sold by year-end) and Beiersdorf. Allied Domecq's stock declined after the company lowered its earnings outlook in February due to a weak U.S. dollar, higher pension expenses and weakness in its Spanish operations. Henkel shares also fell due to dollar weakness as well as investor perceptions that the company would overpay for acquisitions. Beiersdorf, which had been the subject of takeover speculation earlier in the year, declined after the company's major shareholders announced the company would remain independent and not be sold. Thank you for your continued participation in Mutual European Fund. We look forward to serving your future investment needs. [PHOTO OF DAVID J. WINTERS OMITTED] /S/David J. Winters David J. Winters, CFA [PHOTO OF MATTHEW T. HAYNES OMITTED] /S/Matthew T. Haynes Matthew T. Haynes, CFA Co-Portfolio Managers Mutual European Fund THIS DISCUSSION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2003, THE END OF THE REPORTING PERIOD. THE WAY WE IMPLEMENT OUR MAIN INVESTMENT STRATEGIES AND THE RESULTING PORTFOLIO HOLDINGS MAY CHANGE DEPENDING ON FACTORS SUCH AS MARKET AND ECONOMIC CONDITIONS. THESE OPINIONS MAY NOT BE RELIED UPON AS INVESTMENT ADVICE OR AN OFFER FOR A PARTICULAR SECURITY. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR THE FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE, BUT THE ADVISOR MAKES NO REPRESENTATION OR WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR INVESTMENT MANAGEMENT philosophy. 8 | Annual Report Performance Summary as of 12/31/03 Your dividend income will vary depending on dividends or interest paid by securities in the Fund's portfolio, adjusted for operating expenses of each class. Capital gain distributions are net profits realized from the sale of portfolio securities. The performance table and graphs do not reflect any taxes due on Fund dividends, capital gain distributions, if any, or any realized gains on the sale of Fund shares. Total return reflects the Fund's dividend income, capital gain distributions, if any, and any unrealized gains or losses. PRICE AND DISTRIBUTION INFORMATION CLASS Z CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------- Net Asset Value (NAV) +$3.81 $16.78 $12.97 -------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------- Dividend Income $0.4253 -------------------------------------------------------------------------------- CLASS A CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------- Net Asset Value (NAV) +$3.75 $16.58 $12.83 -------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------- Dividend Income $0.3768 -------------------------------------------------------------------------------- CLASS B CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------- Net Asset Value (NAV) +$3.66 $16.30 $12.64 -------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------- Dividend Income $0.2962 -------------------------------------------------------------------------------- CLASS C CHANGE 12/31/03 12/31/02 -------------------------------------------------------------------------------- Net Asset Value (NAV) +$3.74 $16.59 $12.85 -------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) -------------------------------------------------------------------------------- Dividend Income $0.2882 Annual Report | Past performance does not guarantee future results. | 9 Performance Summary (CONTINUED) PERFORMANCE 1 CLASS Z 1-YEAR 5-YEAR INCEPTION (7/3/96) -------------------------------------------------------------------------------- Cumulative Total Return 2 32.84% 96.26% 190.14% -------------------------------------------------------------------------------- Average Annual Total Return 3 32.84% 14.44% 15.27% -------------------------------------------------------------------------------- Value of $10,000 Investment 4 $13,284 $19,626 $29,014 -------------------------------------------------------------------------------- CLASS A 1-YEAR 5-YEAR INCEPTION (11/1/96) -------------------------------------------------------------------------------- Cumulative Total Return 2 32.34% 92.49% 159.57% -------------------------------------------------------------------------------- Average Annual Total Return 3 24.75% 12.65% 13.30% -------------------------------------------------------------------------------- Value of $10,000 Investment 4 $12,475 $18,143 $24,468 -------------------------------------------------------------------------------- CLASS B 1-YEAR 5-YEAR INCEPTION (1/1/99) -------------------------------------------------------------------------------- Cumulative Total Return 2 31.45% 86.42% 86.42% -------------------------------------------------------------------------------- Average Annual Total Return 3 27.45% 13.02% 13.02% -------------------------------------------------------------------------------- Value of $10,000 Investment 4 $12,745 $18,442 $18,442 -------------------------------------------------------------------------------- CLASS C 1-YEAR 5-YEAR INCEPTION (11/1/96) -------------------------------------------------------------------------------- Cumulative Total Return 2 31.49% 86.92% 149.21% -------------------------------------------------------------------------------- Average Annual Total Return 3 29.19% 13.09% 13.43% -------------------------------------------------------------------------------- Value of $10,000 Investment 4 $12,919 $18,498 $24,671 ONGOING MARKET VOLATILITY CAN SIGNIFICANTLY AFFECT SHORT-TERM PERFORMANCE; MORE RECENT RETURNS MAY DIFFER FROM THOSE SHOWN. SINCE MARKETS CAN GO DOWN AS WELL AS UP, INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE WITH MARKET CONDITIONS AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. FOR MORE CURRENT PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236. 10 | Past performance does not guarantee future results. | Annual Report Performance Summary (CONTINUED) TOTAL RETURN INDEX COMPARISON FOR HYPOTHETICAL $10,000 INVESTMENT 1 Total return represents the change in value of an investment over the periods shown. It includes the current, applicable, maximum sales charge(s), Fund expenses, account fees and reinvested distributions. The unmanaged index includes reinvested dividends. It differs from the Fund in composition and does not pay management fees or expenses. One cannot invest directly in an index. CLASS Z (7/3/96-12/31/03) [LINE GRAPH OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Date Mutual European Fund MSCI All Country Europe Index 5 7/3/96 $10,000 $10,000 7/31/96 $10,060 $9,892 8/31/96 $10,430 $10,191 9/30/96 $10,640 $10,399 10/31/96 $10,840 $10,636 11/30/96 $11,260 $11,171 12/31/96 $11,461 $11,393 1/31/97 $11,984 $11,468 2/28/97 $12,236 $11,625 3/31/97 $12,397 $11,992 4/30/97 $12,376 $11,926 5/31/97 $12,537 $12,443 6/30/97 $12,960 $13,065 7/31/97 $13,525 $13,668 8/31/97 $13,282 $12,900 9/30/97 $14,163 $14,168 10/31/97 $13,627 $13,472 11/30/97 $13,768 $13,673 12/31/97 $14,115 $14,215 1/31/98 $14,350 $14,726 2/28/98 $15,134 $15,878 3/31/98 $16,221 $17,013 4/30/98 $16,635 $17,381 5/31/98 $17,218 $17,652 6/30/98 $16,826 $17,824 7/31/98 $16,691 $18,208 8/31/98 $14,792 $15,837 9/30/98 $13,433 $15,203 10/31/98 $13,825 $16,423 11/30/98 $14,723 $17,319 12/31/98 $14,783 $18,079 1/31/99 $14,819 $17,989 2/28/99 $15,007 $17,553 3/31/99 $15,349 $17,757 4/30/99 $16,245 $18,310 5/31/99 $16,281 $17,466 6/30/99 $16,847 $17,764 7/31/99 $16,871 $17,958 8/31/99 $17,026 $18,148 9/30/99 $17,026 $18,019 10/31/99 $17,575 $18,671 11/30/99 $19,054 $19,193 12/31/99 $21,704 $21,215 1/31/00 $22,192 $19,731 2/29/00 $25,032 $20,747 3/31/00 $24,261 $21,246 4/30/00 $23,592 $20,318 5/31/00 $23,631 $20,143 6/30/00 $23,648 $20,530 7/31/00 $23,797 $20,206 8/31/00 $24,393 $19,952 9/30/00 $23,797 $19,020 10/31/00 $24,068 $18,867 11/30/00 $23,973 $18,064 12/31/00 $24,843 $19,334 1/31/01 $25,531 $19,364 2/28/01 $25,387 $17,635 3/31/01 $24,395 $16,325 4/30/01 $25,131 $17,519 5/31/01 $25,563 $16,692 6/30/01 $25,404 $16,066 7/31/01 $25,260 $16,085 8/31/01 $25,019 $15,675 9/30/01 $22,160 $14,099 10/31/01 $22,883 $14,567 11/30/01 $23,365 $15,166 12/31/01 $23,666 $15,566 1/31/02 $24,174 $14,780 2/28/02 $24,535 $14,759 3/31/02 $25,504 $15,572 4/30/02 $26,029 $15,481 5/31/02 $26,177 $15,449 6/30/02 $25,177 $14,905 7/31/02 $23,224 $13,255 8/31/02 $23,257 $13,260 9/30/02 $21,784 $11,530 10/31/02 $21,850 $12,645 11/30/02 $22,065 $13,271 12/31/02 $21,841 $12,788 1/31/03 $21,235 $12,187 2/28/03 $20,578 $11,804 3/31/03 $20,881 $11,625 4/30/03 $22,548 $13,220 5/31/03 $23,979 $14,102 6/30/03 $24,299 $14,249 7/31/03 $24,858 $14,532 8/31/03 $25,383 $14,533 9/30/03 $25,790 $14,835 10/31/03 $26,874 $15,812 11/30/03 $27,857 $16,480 12/31/03 $29,014 $17,842 CLASS A (11/1/96-12/31/03) [LINE GRAPH OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Date Mutual European Fund MSCI All Country Europe Index 5 11/1/96 $9,426 $10,000 11/30/96 $9,783 $10,503 12/31/96 $9,954 $10,712 1/31/97 $10,409 $10,783 2/28/97 $10,619 $10,930 3/31/97 $10,759 $11,276 4/30/97 $10,742 $11,213 5/31/97 $10,873 $11,699 6/30/97 $11,240 $12,284 7/31/97 $11,723 $12,851 8/31/97 $11,512 $12,129 9/30/97 $12,269 $13,321 10/31/97 $11,802 $12,667 11/30/97 $11,917 $12,856 12/31/97 $12,214 $13,366 1/31/98 $12,419 $13,846 2/28/98 $13,079 $14,929 3/31/98 $14,002 $15,996 4/30/98 $14,352 $16,342 5/31/98 $14,858 $16,597 6/30/98 $14,517 $16,759 7/31/98 $14,374 $17,120 8/31/98 $12,737 $14,890 9/30/98 $11,559 $14,294 10/31/98 $11,889 $15,442 11/30/98 $12,657 $16,284 12/31/98 $12,711 $16,999 1/31/99 $12,742 $16,914 2/28/99 $12,895 $16,504 3/31/99 $13,180 $16,696 4/30/99 $13,955 $17,216 5/31/99 $13,965 $16,422 6/30/99 $14,442 $16,702 7/31/99 $14,463 $16,885 8/31/99 $14,597 $17,063 9/30/99 $14,587 $16,942 10/31/99 $15,050 $17,555 11/30/99 $16,308 $18,046 12/31/99 $18,565 $19,947 1/31/00 $18,975 $18,552 2/29/00 $21,402 $19,507 3/31/00 $20,737 $19,976 4/30/00 $20,161 $19,104 5/31/00 $20,194 $18,939 6/30/00 $20,190 $19,303 7/31/00 $20,319 $18,999 8/31/00 $20,810 $18,759 9/30/00 $20,307 $17,883 10/31/00 $20,529 $17,739 11/30/00 $20,447 $16,985 12/31/00 $21,177 $18,178 1/31/01 $21,756 $18,206 2/28/01 $21,618 $16,581 3/31/01 $20,777 $15,350 4/30/01 $21,398 $16,472 5/31/01 $21,756 $15,694 6/30/01 $21,614 $15,105 7/31/01 $21,475 $15,124 8/31/01 $21,282 $14,738 9/30/01 $18,834 $13,256 10/31/01 $19,456 $13,696 11/30/01 $19,857 $14,259 12/31/01 $20,106 $14,636 1/31/02 $20,529 $13,897 2/28/02 $20,825 $13,876 3/31/02 $21,642 $14,642 4/30/02 $22,079 $14,555 5/31/02 $22,206 $14,526 6/30/02 $21,342 $14,014 7/31/02 $19,694 $12,462 8/31/02 $19,708 $12,467 9/30/02 $18,458 $10,841 10/31/02 $18,501 $11,889 11/30/02 $18,671 $12,478 12/31/02 $18,489 $12,023 1/31/03 $17,970 $11,459 2/28/03 $17,408 $11,098 3/31/03 $17,653 $10,930 4/30/03 $19,065 $12,430 5/31/03 $20,261 $13,260 6/30/03 $20,529 $13,397 7/31/03 $20,993 $13,664 8/31/03 $21,442 $13,664 9/30/03 $21,776 $13,948 10/31/03 $22,675 $14,867 11/30/03 $23,501 $15,495 12/31/03 $24,468 $16,776 Annual Report | Past performance does not guarantee future results. | 11 Performance Summary (CONTINUED) AVERAGE ANNUAL TOTAL RETURN ------------------------------------ CLASS B 12/31/03 ------------------------------------ 1-Year 27.45% ------------------------------------ 5-Year 13.02% ------------------------------------ Since Inception (1/1/99) 13.02% CLASS B (1/1/99-12/31/03) [LINE GRAPH OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Date Mutual European Fund MSCI All Country Europe Index 5 1/1/99 $10,000 $10,000 1/31/99 $10,016 $9,950 2/28/99 $10,136 $9,709 3/31/99 $10,361 $9,822 4/30/99 $10,954 $10,128 5/31/99 $10,962 $9,661 6/30/99 $11,334 $9,826 7/31/99 $11,342 $9,933 8/31/99 $11,439 $10,038 9/30/99 $11,431 $9,967 10/31/99 $11,788 $10,327 11/30/99 $12,770 $10,616 12/31/99 $14,517 $11,735 1/31/00 $14,831 $10,914 2/29/00 $16,713 $11,476 3/31/00 $16,190 $11,752 4/30/00 $15,729 $11,239 5/31/00 $15,746 $11,141 6/30/00 $15,738 $11,356 7/31/00 $15,820 $11,177 8/31/00 $16,206 $11,036 9/30/00 $15,802 $10,520 10/31/00 $15,967 $10,436 11/30/00 $15,894 $9,992 12/31/00 $16,450 $10,694 1/31/01 $16,894 $10,710 2/28/01 $16,775 $9,754 3/31/01 $16,114 $9,030 4/30/01 $16,580 $9,690 5/31/01 $16,861 $9,232 6/30/01 $16,744 $8,886 7/31/01 $16,624 $8,897 8/31/01 $16,462 $8,670 9/30/01 $14,572 $7,798 10/31/01 $15,028 $8,057 11/30/01 $15,332 $8,389 12/31/01 $15,518 $8,610 1/31/02 $15,838 $8,175 2/28/02 $16,058 $8,163 3/31/02 $16,675 $8,613 4/30/02 $17,006 $8,563 5/31/02 $17,094 $8,545 6/30/02 $16,425 $8,244 7/31/02 $15,136 $7,331 8/31/02 $15,147 $7,334 9/30/02 $14,169 $6,378 10/31/02 $14,203 $6,994 11/30/02 $14,325 $7,340 12/31/02 $14,182 $7,073 1/31/03 $13,778 $6,741 2/28/03 $13,329 $6,529 3/31/03 $13,520 $6,430 4/30/03 $14,586 $7,312 5/31/03 $15,494 $7,800 6/30/03 $15,696 $7,881 7/31/03 $16,034 $8,038 8/31/03 $16,373 $8,038 9/30/03 $16,621 $8,205 10/31/03 $17,298 $8,746 11/30/03 $17,919 $9,115 12/31/03 $18,442 $9,869 AVERAGE ANNUAL TOTAL RETURN ------------------------------------ CLASS C 12/31/03 ------------------------------------ 1-Year 29.19% ------------------------------------ 5-Year 13.09% ------------------------------------ Since Inception (11/1/96) 13.43% CLASS C (11/1/96-12/31/03) [LINE GRAPH OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AS FOLLOWS: Date Mutual European Fund MSCI All Country Europe Index 5 11/1/96 $9,900 $10,000 11/30/96 $10,265 $10,503 12/31/96 $10,446 $10,712 1/31/97 $10,915 $10,783 2/28/97 $11,135 $10,930 3/31/97 $11,263 $11,276 4/30/97 $11,245 $11,213 5/31/97 $11,374 $11,699 6/30/97 $11,750 $12,284 7/31/97 $12,246 $12,851 8/31/97 $12,015 $12,129 9/30/97 $12,799 $13,321 10/31/97 $12,310 $12,667 11/30/97 $12,430 $12,856 12/31/97 $12,733 $13,366 1/31/98 $12,936 $13,846 2/28/98 $13,637 $14,929 3/31/98 $14,603 $15,996 4/30/98 $14,958 $16,342 5/31/98 $15,477 $16,597 6/30/98 $15,111 $16,759 7/31/98 $14,970 $17,120 8/31/98 $13,249 $14,890 9/30/98 $12,018 $14,294 10/31/98 $12,362 $15,442 11/30/98 $13,155 $16,284 12/31/98 $13,199 $16,999 1/31/99 $13,220 $16,914 2/28/99 $13,379 $16,504 3/31/99 $13,676 $16,696 4/30/99 $14,460 $17,216 5/31/99 $14,471 $16,422 6/30/99 $14,964 $16,702 7/31/99 $14,975 $16,885 8/31/99 $15,104 $17,063 9/30/99 $15,093 $16,942 10/31/99 $15,564 $17,555 11/30/99 $16,859 $18,046 12/31/99 $19,190 $19,947 1/31/00 $19,603 $18,552 2/29/00 $22,112 $19,507 3/31/00 $21,413 $19,976 4/30/00 $20,806 $19,104 5/31/00 $20,829 $18,939 6/30/00 $20,814 $19,303 7/31/00 $20,935 $18,999 8/31/00 $21,441 $18,759 9/30/00 $20,899 $17,883 10/31/00 $21,128 $17,739 11/30/00 $21,019 $16,985 12/31/00 $21,766 $18,178 1/31/01 $22,347 $18,206 2/28/01 $22,205 $16,581 3/31/01 $21,313 $15,350 4/30/01 $21,936 $16,472 5/31/01 $22,304 $15,694 6/30/01 $22,146 $15,105 7/31/01 $21,990 $15,124 8/31/01 $21,777 $14,738 9/30/01 $19,264 $13,256 10/31/01 $19,889 $13,696 11/30/01 $20,286 $14,259 12/31/01 $20,537 $14,636 1/31/02 $20,954 $13,897 2/28/02 $21,255 $13,876 3/31/02 $22,060 $14,642 4/30/02 $22,506 $14,555 5/31/02 $22,621 $14,526 6/30/02 $21,729 $14,014 7/31/02 $20,035 $12,462 8/31/02 $20,049 $12,467 9/30/02 $18,760 $10,841 10/31/02 $18,789 $11,889 11/30/02 $18,963 $12,478 12/31/02 $18,761 $12,023 1/31/03 $18,221 $11,459 2/28/03 $17,652 $11,098 3/31/03 $17,885 $10,930 4/30/03 $19,302 $12,430 5/31/03 $20,513 $13,260 6/30/03 $20,762 $13,397 7/31/03 $21,217 $13,664 8/31/03 $21,657 $13,664 9/30/03 $21,995 $13,948 10/31/03 $22,891 $14,867 11/30/03 $23,713 $15,495 12/31/03 $24,671 $16,776 12| Past performance does not guarantee future results. | Annual Report Performance Summary (CONTINUED) ENDNOTES BECAUSE THE FUND INVESTS PRIMARILY IN ISSUERS LOCATED IN A SINGLE REGION, IT MAY BE AFFECTED BY GREATER VOLATILITY THAN A MORE GEOGRAPHICALLY DIVERSIFIED FUND. FOREIGN SECURITIES RISKS INCLUDE EXPOSURE TO CURRENCY VOLATILITY AND POLITICAL, ECONOMIC AND REGULATORY UNCERTAINTY. SMALLER-COMPANY STOCKS HAVE HISTORICALLY EXHIBITED GREATER PRICE VOLATILITY THAN LARGER-COMPANY STOCKS, PARTICULARLY OVER THE SHORT TERM. THE FUND MAY ALSO INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, AS WELL AS LOWER-RATED "JUNK BONDS," WHICH ENTAIL HIGHER CREDIT RISK. THE FUND'S PROSPECTUS ALSO INCLUDES A DESCRIPTION OF THE MAIN INVESTMENT RISKS. CLASS Z: No initial sales charge or Rule 12b-1 fees; shares are available only to certain investors, as described in the prospectus. CLASS A: Subject to the current, maximum 5.75% initial sales charge. Prior to 8/3/98, Fund shares were offered at a lower initial sales charge; thus actual total returns may differ. CLASS B: Subject to no initial sales charge, but subject to a contingent deferred sales charge (CDSC) declining from 4% to 0% over six years. These shares have higher annual fees and expenses than Class A shares. CLASS C: Subject to 1% initial sales charge and 1% CDSC for shares redeemed within 18 months of investment. These shares have higher annual fees and expenses than Class A shares. 1. Past expense reductions by the Fund's manager increased the Fund's total returns. Without these reductions, the Fund's total returns would have been lower. 2. Cumulative total return represents the change in value of an investment over the periods indicated and does not include sales charges. 3. Average annual total return represents the average annual change in value of an investment over the periods indicated and includes any current, applicable, maximum sales charge(s). 4. These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated and include any current, applicable, maximum sales charge(s). 5. Source: Standard & Poor's Micropal. The MSCI All Country Europe Index is market capitalization-weighted and measures total returns of equity securities available to foreign (non-local) investors in developed and emerging markets in Europe. Annual Report | Past performance does not guarantee future results. | 13 Mutual European Fund FINANCIAL HIGHLIGHTS
YEAR ENDED DECEMBER 31, CLASS Z 2003 2002 2001 2000 1999 PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ........................... $12.97 $14.43 $15.52 $16.89 $12.54 --------------------------------------------------------- Income from investment operations: Net investment income a ..................................... .32 .27 .35 .35 .24 Net realized and unrealized gains (losses) .................. 3.93 (1.38) (1.08) 1.98 5.50 --------------------------------------------------------- Total from investment operations ............................. 4.25 (1.11) (.73) 2.33 5.74 --------------------------------------------------------- Less distributions from: Net investment income ....................................... (.43) (.25) (.32) (.54) (.50) Net realized gains .......................................... -- (.10) (.04) (3.16) (.89) --------------------------------------------------------- Total distributions .......................................... (.43) (.35) (.36) (3.70) (1.39) --------------------------------------------------------- Redemption fees .............................................. -- d -- -- -- -- --------------------------------------------------------- Net asset value, end of year ................................. $16.79 $12.97 $14.43 $15.52 $16.89 --------------------------------------------------------- Total return b ............................................... 32.84% (7.71)% (4.74)% 14.46% 46.81% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) .............................. $498,667 $376,828 $448,732 $577,663 $524,109 Ratios to average net assets:* Expenses c .................................................. 1.08% 1.05% 1.05% 1.03% 1.05% Expenses, excluding waiver and payments by affiliate c ...... 1.08% 1.05% 1.05% 1.04% 1.09% Net investment income ....................................... 2.19% 1.88% 2.27% 1.93% 1.69% Portfolio turnover rate ...................................... 52.33% 29.86% 52.15% 111.83% 127.05% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .................................................... 1.08% 1.04% 1.04% 1.03% 1.04% Expenses, excluding waiver and payments by affiliate ........ 1.08% 1.04% 1.04% 1.04% 1.08%
a Based on average daily shares outstanding. b Total return is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses. d Amount is less than $0.01 per share. 14 | Annual Report Mutual European Fund FINANCIAL HIGHLIGHTS (CONTINUED)
YEAR ENDED DECEMBER 31, CLASS A 2003 2002 2001 2000 1999 PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ........................... $12.83 $14.27 $15.36 $16.75 $12.47 ----------------------------------------------------------- Income from investment operations: Net investment income a ..................................... .26 .22 .28 .28 .19 Net realized and unrealized gains (losses) .................. 3.88 (1.35) (1.06) 1.97 5.43 ----------------------------------------------------------- Total from investment operations ............................. 4.14 (1.13) (.78) 2.25 5.62 ----------------------------------------------------------- Less distributions from: Net investment income ....................................... (.38) (.21) (.27) (.48) (.45) Net realized gains .......................................... -- (.10) (.04) (3.16) (.89) ----------------------------------------------------------- Total distributions .......................................... (.38) (.31) (.31) (3.64) (1.34) ----------------------------------------------------------- Redemption fees .............................................. -- d -- -- -- -- ----------------------------------------------------------- Net asset value, end of year ................................. $16.59 $12.83 $14.27 $15.36 $16.75 ----------------------------------------------------------- Total return b ............................................... 32.34% (8.05)% (5.05)% 14.07% 46.05% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) .............................. $417,630 $302,735 $254,632 $223,831 $177,217 Ratios to average net assets:* Expenses c .................................................. 1.43% 1.40% 1.40% 1.38% 1.40% Expenses, excluding waiver and payments by affiliate c ...... 1.43% 1.40% 1.40% 1.39% 1.44% Net investment income ....................................... 1.84% 1.53% 1.88% 1.56% 1.36% Portfolio turnover rate ...................................... 52.33% 29.86% 52.15% 111.83% 127.05% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses 1.43% 1.39% 1.39% 1.38% 1.39% Expenses, excluding waiver and payments by affiliate 1.43% 1.39% 1.39% 1.39% 1.43%
a Based on average daily shares outstanding. b Total return does not reflect the sales commissions or the contingent deferred sales charge, and is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses. d Amount is less than $0.01 per share. Annual Report | 15 Mutual European Fund FINANCIAL HIGHLIGHTS (CONTINUED)
YEAR ENDED DECEMBER 31, CLASS B 2003 2002 2001 2000 1999 E PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ........................... $12.64 $14.09 $15.19 $16.66 $12.47 --------------------------------------------------------- Income from investment operations: Net investment income a ..................................... .16 .10 .18 .16 .01 Net realized and unrealized gains (losses) .................. 3.81 (1.31) (1.03) 1.95 5.50 --------------------------------------------------------- Total from investment operations ............................. 3.97 (1.21) (.85) 2.11 5.51 --------------------------------------------------------- Less distributions from: Net investment income ....................................... (.30) (.14) (.21) (.42) (.43) Net realized gains .......................................... -- (.10) (.04) (3.16) (.89) --------------------------------------------------------- Total distributions .......................................... (.30) (.24) (.25) (3.58) (1.32) --------------------------------------------------------- Redemption fees .............................................. -- d -- -- -- -- --------------------------------------------------------- Net asset value, end of year ................................. $16.31 $12.64 $14.09 $15.19 $16.66 --------------------------------------------------------- Total return b ............................................... 31.45% (8.61)% (5.66)% 13.31% 45.17% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) .............................. $38,526 $24,855 $12,960 $6,655 $1,039 Ratios to average net assets:* Expenses c .................................................. 2.08% 2.05% 2.03% 2.03% 2.05% Expenses, excluding waiver and payments by affiliate c ...... 2.08% 2.05% 2.03% 2.04% 2.09% Net investment income ....................................... 1.19% .87% 1.20% .92% .04% Portfolio turnover rate ...................................... 52.33% 29.86% 52.15% 111.83% 127.05% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses 2.08% 2.04% 2.02% 2.03% 2.04% Expenses, excluding waiver and payments by affiliate 2.08% 2.04% 2.02% 2.04% 2.08%
a Based on average daily shares outstanding. b Total return does not reflect the contingent deferred sales charge, and is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses. d Amount is less than $0.01 per share. e Effective date of Class B shares was January 1, 1999. 16 | Annual Report Mutual European Fund FINANCIAL HIGHLIGHTS (CONTINUED)
YEAR ENDED DECEMBER 31, CLASS C 2003 2002 2001 2000 1999 PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ........................... $12.85 $14.29 $15.37 $16.75 $12.45 --------------------------------------------------------- Income from investment operations: Net investment income a ..................................... .17 .13 .19 .16 .10 Net realized and unrealized gains (losses) .................. 3.87 (1.35) (1.06) 1.99 5.44 --------------------------------------------------------- Total from investment operations ............................. 4.04 (1.22) (.87) 2.15 5.54 --------------------------------------------------------- Less distributions from: Net investment income ....................................... (.29) (.12) (.17) (.37) (.35) Net realized gains .......................................... -- (.10) (.04) (3.16) (.89) --------------------------------------------------------- Total distributions .......................................... (.29) (.22) (.21) (3.53) (1.24) --------------------------------------------------------- Redemption fees .............................................. -- d -- -- -- -- --------------------------------------------------------- Net asset value, end of year ................................. $16.60 $12.85 $14.29 $15.37 $16.75 --------------------------------------------------------- Total return b ............................................... 31.49% (8.65)% (5.65)% 13.42% 45.40% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) .............................. $166,758 $123,374 $117,238 $127,408 $103,987 Ratios to average net assets:* Expenses c .................................................. 2.08% 2.02% 2.04% 2.02% 2.04% Expenses, excluding waiver and payments by affiliate c ...... 2.08% 2.02% 2.04% 2.03% 2.08% Net investment income ....................................... 1.19% .91% 1.27% .92% .71% Portfolio turnover rate ...................................... 52.33% 29.86% 52.15% 111.83% 127.05% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .................................................... 2.08% 2.01% 2.03% 2.02% 2.03% Expenses, excluding waiver and payments by affiliate ........ 2.08% 2.01% 2.03% 2.03% 2.07%
a Based on average daily shares outstanding. b Total return does not reflect the sales commissions or the contingent deferred sales charge, and is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses. d Amount is less than $0.01 per share. Annual Report | See notes to financial statements. | 17 Mutual European Fund
STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 COUNTRY SHARES/WARRANTS VALUE COMMON STOCKS AND OTHER EQUITY INTERESTS 80.1% AUTO COMPONENTS .5% Trelleborg AB, B .............................................. Sweden 352,582 $ 5,733,200 ---------------- BEVERAGES 7.2% a Carlsberg AS, A ............................................... Denmark 15,700 646,282 Carlsberg AS, B ............................................... Denmark 393,585 18,135,253 Diageo PLC .................................................... United Kingdom 1,721,908 22,656,278 Heineken Holding NV, A ........................................ Netherlands 499,281 17,085,638 Orkla ASA ..................................................... Norway 991,240 22,200,391 ---------------- 80,723,842 ---------------- BUILDING PRODUCTS Wienerberger AG ............................................... Austria 7,429 198,469 ---------------- CHEMICALS 5.0% Akzo Nobel NV ................................................. Netherlands 345,200 13,323,814 Givaudan AG ................................................... Switzerland 36,275 18,830,443 MG Technologies AG ............................................ Germany 636,264 8,908,338 Solvay SA ..................................................... Belgium 109,700 9,512,961 Syngenta AG ................................................... Switzerland 75,000 5,051,546 ---------------- 55,627,102 ---------------- COMMERCIAL BANKS 8.3% Allied Irish Banks PLC ........................................ Irish Republic 1,162,400 18,591,363 Almanij Nv .................................................... Belgium 265,474 13,488,008 a Banca Nazionale del Lavoro SpA ................................ Italy 2,168,703 5,183,769 Bank of Ireland ............................................... Irish Republic 750,575 10,215,318 Danske Bank ................................................... Denmark 444,900 10,438,266 DNB Holding ASA ............................................... Norway 5,181,723 34,621,150 ---------------- 92,537,874 ---------------- COMMERCIAL SERVICES & SUPPLIES .2% Societe Generale de Surveillance Holdings SA .................. Switzerland 2,500 1,568,628 ---------------- CONSTRUCTION & ENGINEERING 5.6% a FLS Industries A/S ............................................ Denmark 400,800 4,616,925 Imtech NV ..................................................... Netherlands 692,055 17,964,798 Kingspan Group PLC ............................................ Irish Republic 1,154,631 6,116,865 Vinci SA ...................................................... France 415,361 34,395,118 ---------------- 63,093,706 ---------------- CONSTRUCTION MATERIALS 2.8% Ciments Francais SA ........................................... France 113,977 7,978,965 CRH PLC ....................................................... Irish Republic 486,200 9,977,894 a Dyckerhoff AG ................................................. Germany 15,456 427,925 Italcementi SpA ............................................... Italy 722,765 9,016,329 RMC Group PLC ................................................. United Kingdom 318,935 3,982,334 ---------------- 31,383,447 ---------------- CONSUMER FINANCE .8% Provident Financial PLC ....................................... United Kingdom 764,922 8,907,498 ----------------
18 | Annual Report Mutual European Fund
STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED) COUNTRY SHARES/WARRANTS VALUE COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) CONTAINERS & PACKAGING 1.1% Huhtamaki OYJ ................................................. Finland 1,017,240 $ 11,996,965 ---------------- DIVERSIFIED FINANCIAL SERVICES 3.6% Euronext ...................................................... Netherlands 453,279 11,474,911 a Irish Life & Permanent PLC .................................... Irish Republic 1,045,905 16,820,496 Pargesa Holdings SA ........................................... Switzerland 4,684 12,498,241 ---------------- 40,793,648 ---------------- DIVERSIFIED TELECOMMUNICATION SERVICES 6.1% a,b,c AboveNet Inc. United States 15,551 465,819 BCE Inc. ...................................................... Canada 168,500 3,768,350 a Koninklijke KPN NV ............................................ Netherlands 1,085,300 8,377,947 a NTL Inc. ...................................................... United Kingdom 392,946 27,407,984 a,b NTL Inc. .................................................... United Kingdom 298,059 19,750,134 Swisscom AG ................................................... Switzerland 27,500 9,072,165 ---------------- 68,842,399 ---------------- ELECTRIC UTILITIES .7% E.ON AG ....................................................... Germany 109,600 7,179,021 a,b PG & E Corp., wts., 9/02/06 ................................... United States 2,966 74,103 ---------------- 7,253,124 ---------------- ENERGY EQUIPMENT & SERVICES .4% Fugro NV ...................................................... Netherlands 90,665 4,665,908 ---------------- FOOD & STAPLES RETAILING 1.6% Colruyt NV .................................................... Belgium 69,412 6,689,048 Groupe Bourbon ................................................ France 36,400 3,755,701 Rieber & Son ASA .............................................. Norway 993,050 7,463,399 ---------------- 17,908,148 ---------------- FOOD PRODUCTS 6.5% Cadbury Schweppes PLC ......................................... United Kingdom 2,410,112 17,700,157 CSM NV ........................................................ Netherlands 312,618 6,837,533 Groupe Danone ................................................. France 133,735 21,828,089 a Koninklijke Numico NV ......................................... Netherlands 178,805 4,941,495 Nestle SA ..................................................... Switzerland 86,937 21,721,070 ---------------- 73,028,344 ---------------- HEALTH CARE EQUIPMENT & SUPPLIES .2% Amersham PLC .................................................. United Kingdom 184,700 2,531,066 ---------------- HOUSEHOLD DURABLES .8% Hunter Douglas NV ............................................. Netherlands 194,790 9,117,882 ---------------- INDUSTRIAL CONGLOMERATES .1% Arkivator AB .................................................. Sweden 150,000 1,271,663 ----------------
Annual Report | 19 Mutual European Fund
STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED) COUNTRY SHARES/WARRANTS VALUE COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) INSURANCE 5.1% a Berkshire Hathaway Inc., A .................................... United States 203 $ 17,102,750 a Montpelier Re Holdings Ltd. ................................... Bermuda 36,493 1,339,293 a,b Olympus Re Holdings Ltd. .................................... Bermuda 16,080 2,543,373 Sampo OYJ, A .................................................. Finland 966,300 9,994,526 White Mountains Insurance Group Inc. .......................... United States 37,500 17,248,125 b White Mountains Insurance Group Inc. .......................... United States 20,972 9,163,768 ---------------- 57,391,835 ---------------- LEISURE EQUIPMENT & PRODUCTS .3% Agfa Gevaert NV ............................................... Belgium 95,626 2,725,968 ---------------- MACHINERY 2.4% Alfa Laval AB ................................................. Sweden 544,300 8,283,303 Kone Corp., B ................................................. Finland 137,970 7,918,309 a Schindler Holding AG, Reg D ................................... Switzerland 39,957 11,081,666 ---------------- 27,283,278 ---------------- MEDIA 5.0% Axel Springer AG .............................................. Germany 3,070 271,065 a JC Decaux SA .................................................. France 212,783 3,478,390 Lagardere SCA ................................................. France 221,434 12,783,847 a NTL Europe Inc. ............................................... United Kingdom 115,080 1,151 NV Holdingsmig de Telegraaf ................................... Netherlands 145,794 3,328,546 SES Global, FDR ............................................... Luxembourg 1,806,864 18,232,735 Trinity Mirror PLC ............................................ United Kingdom 1,272,770 12,896,078 Wolters Kluwer NV ............................................. Netherlands 308,194 4,820,390 ---------------- 55,812,202 ---------------- METALS & MINING 3.6% Anglo American PLC ............................................ United Kingdom 527,900 11,406,443 Anglo American PLC, ADR ....................................... United Kingdom 200 4,424 Barrick Gold Corp. ............................................ Canada 228,900 5,198,319 Highland Gold Mining Ltd. ..................................... United Kingdom 2,390,000 12,300,621 Pechiney SA, A ................................................ France 2,337 142,967 a Vedanta Resources PLC ......................................... United Kingdom 1,712,400 11,280,915 ---------------- 40,333,689 ---------------- MULTI-UTILITIES & UNREGULATED POWER .8% Suez SA ....................................................... France 451,750 9,077,166 ---------------- OIL & GAS 2.2% BP PLC ........................................................ United Kingdom 747,800 6,064,220 Eni SpA ....................................................... Italy 361,200 6,815,782 Norsk Hydro ASA ............................................... Norway 28,300 1,746,205 Total SA, B ................................................... France 53,750 9,993,378 ---------------- 24,619,585 ----------------
20 | Annual Report Mutual European Fund
STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED) COUNTRY SHARES/WARRANTS VALUE COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) PERSONAL PRODUCTS .4% Beiersdorf AG ................................................. Germany 38,100 $ 4,668,788 ---------------- REAL ESTATE .1% a Canary Wharf Group PLC ........................................ United Kingdom 192,100 920,764 a,b Security Capital European Realty ............................ Luxembourg 42,252 314,777 ---------------- 1,235,541 ---------------- SPECIALTY RETAIL .3% Fielmann AG ................................................... Germany 66,534 3,088,359 New Look Group ................................................ United Kingdom 125,300 697,594 ---------------- 3,785,953 ---------------- TOBACCO 7.3% Altadis SA .................................................... Spain 723,710 20,539,196 British American Tobacco PLC .................................. United Kingdom 2,851,758 39,309,244 Imperial Tobacco Group PLC .................................... United Kingdom 1,118,365 22,022,547 ---------------- 81,870,987 ---------------- TRADING COMPANIES & DISTRIBUTORS .9% Compania de Distribucion Intefral Logista SA .................. Spain 322,008 9,946,993 ---------------- TRANSPORTATION INFRASTRUCTURE .2% Peninsular & Oriental Steam Navigation Co. .................... United Kingdom 488,255 2,010,323 ---------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $656,804,232) .......................................... 897,945,221 ---------------- PREFERRED STOCKS .2% FOOD PRODUCTS .2% Unilever NV, pfd. ............................................. Netherlands 275,284 1,975,739 ---------------- MEDIA NTL Europe Inc., 10.00%, A, pfd. .............................. United Kingdom 50,827 418,052 ---------------- TOTAL PREFERRED STOCKS (COST $1,830,944) ...................... 2,393,791 ---------------- PRINCIPAL AMOUNT E CORPORATE BONDS & NOTES 4.8% Eurotunnel PLC, 12/31/18, Tier 2 .............................. United Kingdom $ 7,491,083 GBP 9,789,460 12/31/25, Tier 3 ........................................... United Kingdom 1,755,822 GBP 1,728,759 Participating Loan Note, 4/30/40 ........................... United Kingdom 210,000 GBP 80,826 Stabilization Advance S8, Tier 2 ........................... United Kingdom 3,071,957 GBP 1,044,865 Eurotunnel SA, 5.28%, 12/31/18, Tier 2 (Pibor) ................ France 437,395 EUR 402,747 5.28%, 12/31/25, Tier 3 (Pibor) ............................ France 4,694,377 EUR 3,256,695 12/31/18, Tier 2 (Libor) ................................... France 988,713 EUR 910,394 12/31/25, Tier 3 (Libor) ................................... France 1,953,447 EUR 1,355,191 Stabilization Advance S6, Tier 1 (Pibor) ................... France 332,264 EUR 79,629 Stabilization Advance S6, Tier 2 (Libor) ................... France 851,877 EUR 204,158 Stabilization Advance S7, Tier 1 (Pibor) ................... France 1,284,285 EUR 307,788
Annual Report | 21 Mutual European Fund
STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED) COUNTRY PRINCIPAL AMOUNT D VALUE CORPORATE BONDS & NOTES (CONT.) Marconi Corp., 10.00%, 10/31/08 ............................... United Kingdom $ 1,241,075 $ 1,377,593 Marconi PLC, 8.00%, 4/30/08 ................................... United Kingdom 9,452,170 9,263,127 Providian Financial Corp., senior note, cvt., zero cpn., 2/15/21 United States 2,983,000 1,424,383 Seton House Finance Ltd., zero cpn., 2/07/12 .................. United Kingdom 76,357,000 EUR 22,152,006 ---------------- TOTAL CORPORATE BONDS & NOTES (COST $48,550,240) .............. 53,377,621 ---------------- BONDS & NOTES IN REORGANIZATION 1.1% a Metromedia Fiber Network Inc., 14.00%, 3/15/07 ................ United States 4,400,000 2,332,000 10.00%, 11/15/08 ........................................... United States 2,870,000 197,312 senior note, 10.00%, 12/15/09 .............................. United States 3,058,000 217,883 senior note, 10.00%, 12/15/09 .............................. United States 1,394,000 EUR 131,874 a Parmalat Netherlands BV, 0.875%, 6/30/21 ...................... Italy 1,310,000 EUR 414,663 a PG & E Corp., 7.375%, 11/01/05 ................................ United States 4,335,000 4,421,700 Commercial Paper, 1/18/01 .................................. United States 175,000 175,875 Commercial Paper, 1/30/01 .................................. United States 90,000 90,450 Commercial Paper, 2/16/01 .................................. United States 265,000 266,325 FRN, 144A, 7.583%, 10/31/01 ................................ United States 1,288,000 1,313,760 MTN, 5.94%, 10/07/03 ....................................... United States 220,000 221,100 a Telewest Communications PLC, Bank Claim ....................... United Kingdom 1,090,948 GBP 927,660 a Telewest Finance Ltd., cvt, 6.00%, 7/07/05 .................... United Kingdom 1,465,000 1,552,900 ---------------- TOTAL BONDS & NOTES IN REORGANIZATION (COST $10,040,599) ...... 12,263,502 ---------------- GOVERNMENT AGENCIES 14.9% Bundesrepublik Deutschland, 4.25%, 3/12/04 .................... Germany 10,000,000 EUR 12,663,976 e Federal Home Loan Bank, 0.75% to 1.42%, with maturities to 12/16/04 ..................................................... United States 63,300,000 63,139,901 Federal Home Loan Mortgage Corp., 0.990% to 2.375%, with maturities to 5/19/06 ........................................ United States 3,500,000 3,499,058 e Federal National Mortgage Association, 0.966% to 1.266%, with maturities to 4/02/04 ........................................ United States 3,000,000 2,993,364 Federal Republic of Germany, 3.25% to 4.00%, with maturities to 6/25/04 ................................................... Germany 20,000,000 EUR 25,356,963 German Treasury Bills, 0.922% to 2.120%, with maturities to 5/12/04 ................................................... Germany 42,000,000 EUR 52,692,577 Kingdom of Norway, 5.75% to 6.75%, with maturities to 1/15/07 . Norway 34,130,000 NOK 5,424,505 U.S. Treasury Bills, 0.985%, 4/01/04 .......................... United States 2,000,000 1,995,516 ---------------- TOTAL GOVERNMENT AGENCIES (COST $159,220,883) ................. 167,765,860 ----------------
22 | Annual Report Mutual European Fund
STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED) COUNTRY PRINCIPAL AMOUNT VALUE SHORT TERM INVESTMENTS 1.3% Alliance & Leicester PLC, Commercial Paper, 5/14/04 ........... United Kingdom $ 5,000,000 $ 4,979,580 Bradford & Bingley PLC, Commercial Paper, 1/08/04 ............. United Kingdom 5,000,000 4,998,800 Commercial Paper, 2/17/04 .................................. United Kingdom 5,000,000 4,992,267 ---------------- TOTAL SHORT TERM INVESTMENTS (COST $14,969,397) ............... 14,970,647 ---------------- TOTAL INVESTMENTS (COST $891,416,295) 102.4% .................. 1,148,716,642 OPTIONS WRITTEN ............................................... (2,836) SECURITIES SOLD SHORT (.1)% ................................... (998,816) NET EQUITY IN FORWARD CONTRACTS (3.1)% ........................ (34,987,351) OTHER ASSETS, LESS LIABILITIES .8% ............................ 8,853,443 ---------------- NET ASSETS 100.0% ............................................. $ 1,121,581,082 ---------------- OPTIONS WRITTEN (PREMIUMS RECEIVED $8,580) CONTRACTS ISSUER FOOD & STAPLES RETAILING Safeway PLC, Jan. 2.70 Puts, 1/16/04 .......................... United Kingdom 880 $ 2,836 ---------------- SECURITIES SOLD SHORT SHARES ISSUER COMMUNICATIONS EQUIPMENT .1% f Powerwave Technologies Inc. ................................... United States 105,000 $ 803,250 ---------------- DIVERSIFIED FINANCIAL SERVICES f Lehman Brothers Holdings Inc. ................................. United States 1,713 132,278 ---------------- METALS & MINING f Alcan Inc. .................................................... Canada 1,348 63,288 ---------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $912,587) ............... $ 998,816 ----------------
VALUE AT UNREALIZED SYNTHETIC EQUITY SWAPS (SES) COUNTRY SHARES 12/31/03 GAIN/LOSS ISSUER HEALTH CARE EQUIPMENT & SUPPLIES g Smith & Nephew PLC, ses., 3.752 GBP ...................... United Kingdom (230) $ (1,932) $ (390) g Smith & Nephew PLC, ses., 3.776 GBP ...................... United Kingdom (4,400) (36,961) (7,274) ----------------------------- (38,893) (7,664) -----------------------------
Annual Report | 23 Mutual European Fund
STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED) VALUE AT UNREALIZED SYNTHETIC EQUITY SWAPS (SES) (CONT.) COUNTRY SHARES 12/31/03 GAIN/LOSS ISSUER INSURANCE g AXA SA, ses., 15.850 EUR ................................. France 7,740 $ 165,676 $ 10,630 g AXA SA, ses., 15.870 EUR ................................. France 1,900 40,670 2,561 g AXA SA, ses., 16.030 EUR ................................. France 13,874 296,975 15,896 g AXA SA, ses., 16.700 EUR ................................. France (7,740) (165,676) (2,957) g AXA SA, ses., 16.770 EUR ................................. France (1,900) (40,670) (558) g AXA SA, ses., 17.000 EUR ................................. France (13,874) (296,975) 466 ----------------------------- -- 26,038 ----------------------------- REAL ESTATE g Chelsfield PLC, ses., 3.095 GBP .......................... United Kingdom 2,400 13,201 (116) g Chelsfield PLC, ses., 3.107 GBP .......................... United Kingdom 7,600 41,802 (537) g Chelsfield PLC, ses., 3.112 GBP .......................... United Kingdom 2,719 14,955 (232) g Chelsfield PLC, ses., 3.154 GBP .......................... United Kingdom 40,000 220,010 (6,150) g Chelsfield PLC, ses., 3.160 GBP .......................... United Kingdom 20,500 112,755 (3,375) g Chelsfield PLC, ses., 3.165 GBP .......................... United Kingdom 6,000 33,002 (1,041) g Chelsfield PLC, ses., 3.166 GBP .......................... United Kingdom 20,000 110,005 (3,505) ----------------------------- 545,730 (14,956) ----------------------------- TEXTILES APPAREL & LUXURY GOODS g Christian Dior SA, ses., 46.766 EUR ...................... France 2,037 123,407 3,026 g Christian Dior SA, ses., 47.220 EUR ...................... France 1,520 92,086 1,375 g Christian Dior SA, ses., 47.384 EUR ...................... France 4,030 244,148 2,949 g Christian Dior SA, ses., 47.614 EUR ...................... France 4,030 244,148 1,664 g Christian Dior SA, ses., 47.794 EUR ...................... France 1,826 110,624 328 g Christian Dior SA, ses., 48.208 EUR ...................... France 7,011 424,746 (2,369) g Christian Dior SA, ses., 48.555 EUR ...................... France 2,394 145,035 (1,858) g Christian Dior SA, ses., 48.586 EUR ...................... France 3,998 242,210 (3,251) g Christian Dior SA, ses., 48.791 EUR ...................... France 1,595 96,629 (1,712) g Christian Dior SA, ses., 49.000 EUR ...................... France 105 6,361 (140) g Christian Dior SA, ses., 49.027 EUR ...................... France 590 35,744 (809) g LVMH Moet Hennessy Louis Vuitton, ses., 56.520 EUR ....... France (1,520) (110,626) (2,475) g LVMH Moet Hennessy Louis Vuitton, ses., 57.050 EUR ....... France (1,826) (132,896) (1,754) g LVMH Moet Hennessy Louis Vuitton, ses., 58.672 EUR ....... France (4,030) (293,303) 4,524 g LVMH Moet Hennessy Louis Vuitton, ses., 58.861 EUR ....... France (2,037) (148,253) 2,704 g LVMH Moet Hennessy Louis Vuitton, ses., 58.899 EUR ....... France (4,030) (293,303) 5,543 g LVMH Moet Hennessy Louis Vuitton, ses., 59.841 EUR ....... France (7,011) (510,261) 17,951 g LVMH Moet Hennessy Louis Vuitton, ses., 60.149 EUR ....... France (2,394) (174,235) 7,055
24 | Annual Report Mutual European Fund
STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED) VALUE AT UNREALIZED SYNTHETIC EQUITY SWAPS (SES) (CONT.) COUNTRY SHARES 12/31/03 GAIN/LOSS ISSUER TEXTILES APPAREL & LUXURY GOODS (CONT.) g LVMH Moet Hennessy Louis Vuitton, ses., 60.309 EUR ....... France (1,595) $(116,084) $ 5,024 g LVMH Moet Hennessy Louis Vuitton, ses., 60.421 EUR ....... France (3,998) (290,975) 13,166 g LVMH Moet Hennessy Louis Vuitton, ses., 60.949 EUR ....... France (590) (42,940) 2,336 g LVMH Moet Hennessy Louis Vuitton, ses., 60.950 EUR ....... France (105) (7,642) 416 ---------------------------- (355,380) 53,693 ---------------------------- TOTAL SYNTHETIC EQUITY SWAPS ............................. $ 151,457 $ 57,111 ---------------------------- CURRENCY ABBREVIATIONS: | EUR - Euro | GBP - British Pound | NOK - Norwegian Krone
a Non-income producing. b See Note 7 regarding restricted securities. c A member of the Fund's Portfolio Management team serves as a member on the board of directors. As a result of this involvement, the Portfolio Manager could receive material non-public information which, pursuant to the Fund's policies and the requirements of the federal securities laws, could prevent the Fund from trading in the securities of such companies for limited or extended periods of time. d The principal amount is stated in U.S. dollars unless otherwise indicated. e See Note 1(f) regarding securities segregated with broker for securities sold short. f See Note 1(f) regarding securities sold short. g See Note 1(d) regarding synthetic equity swaps. Annual Report | See notes to financial statements. | 25 Mutual European Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2003
Assets: Investments in securities: Cost ......................................................... $ 891,416,295 --------------- Value - (includes securities segregated with broker for securities sold short in the amount of $2,093,414) .......... 1,148,716,642 Cash .......................................................... 34,775 Foreign currency, at value (cost $3,155,465) .................. 3,291,538 Receivables: Investment securities sold ................................... 3,084,103 Capital shares sold .......................................... 3,960,703 Dividends and interest ....................................... 3,509,340 Unrealized gain on forward exchange contracts (Note 6) ........ 1,782,454 Deposits with broker for securities sold short ................ 2,032,303 Due from broker variation margin .............................. 66,428 --------------- Total assets ............................................. 1,166,478,286 --------------- Liabilities: Payables: Investment securities purchased .............................. 4,607,469 Capital shares redeemed ...................................... 916,751 Affiliates ................................................... 1,496,575 Options written, at value (premiums received $8,580) .......... 2,836 Securities sold short, at value (proceeds $912,587) ........... 998,816 Unrealized loss on forward exchange contracts (Note 6) ........ 36,769,805 Other liabilities ............................................. 104,952 --------------- Total liabilities ........................................ 44,897,204 --------------- Net assets, at value ................................... $1,121,581,082 --------------- Net assets consist of: Undistributed net investment income (loss) .................... $ 2,043,383 Net unrealized appreciation (depreciation) .................... 222,729,962 Accumulated net realized gain (loss) .......................... (36,478,319) Capital shares ................................................ 933,286,056 --------------- Net assets, at value ................................... $1,121,581,082 ---------------
26 | Annual Report Mutual European Fund FINANCIAL STATEMENTS (CONTINUED)
STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2003 CLASS Z: Net asset value per share ($498,667,731 / 29,709,079 shares outstanding) ....................... $16.79 ---------- CLASS A: Net asset value per share ($417,629,518 / 25,177,430 shares outstanding) ....................... $16.59 ---------- Maximum offering price per share ($16.59 / 94.25%) ............................................. $17.60 ---------- CLASS B: Net asset value per share ($38,525,750 / 2,362,572 shares outstanding) a ....................... $16.31 ---------- CLASS C: Net asset value per share ($166,758,083 / 10,046,838 shares outstanding) a ..................... $16.60 ---------- Maximum offering price per share ($16.60 / 99.00%) ............................................. $16.77 ----------
a Redemption price per share is equal to net asset value less any applicable contingent deferred sales charge. Annual Report | See notes to financial statements. | 27 Mutual European Fund FINANCIAL STATEMENTS (CONTINUED)
STATEMENT OF OPERATIONS for the year ended December 31, 2003 Investment income: (net of foreign taxes of $2,826,821) Dividends ............................................................................................... $ 20,883,805 Interest ................................................................................................ 9,231,038 ------------- Total investment income ........................................................................... 30,114,843 ------------- Expenses: Management fees (Note 3) ................................................................................ 7,356,524 Administrative fees (Note 3) ............................................................................ 716,785 Distribution fees (Note 3) Class A ................................................................................................ 1,187,766 Class B ................................................................................................ 298,640 Class C ................................................................................................ 1,367,172 Transfer agent fees (Note 3) ............................................................................ 1,422,800 Custodian fees .......................................................................................... 236,700 Reports to shareholders ................................................................................. 92,100 Registration and filing fees ............................................................................ 53,500 Professional fees ....................................................................................... 37,200 Directors' fees and expenses ............................................................................ 35,400 Dividends on securities sold short ...................................................................... 3,980 Other ................................................................................................... 21,400 ------------- Total expenses ..................................................................................... 12,829,967 ------------- Net investment income ............................................................................ 17,284,876 ------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments ............................................................................................ 101,762,133 Written options (Note 1e) .............................................................................. 1,559 Securities sold short (Note 1f) ........................................................................ (298,716) Foreign currency transactions .......................................................................... (70,631,477) ------------- Net realized gain (loss) ......................................................................... 30,833,499 Net unrealized appreciation (depreciation) on: Investments ............................................................................................ 232,237,595 Translation of assets and liabilities denominated in foreign currencies ................................ (10,918,023) ------------- Net unrealized appreciation (depreciation) ....................................................... 221,319,572 ------------- Net realized and unrealized gain (loss) .................................................................. 252,153,071 ------------- Net increase (decrease) in net assets resulting from operations .......................................... $269,437,947 -------------
28 | See notes to financial statements. | Annual Report Mutual European Fund FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF CHANGES IN NET ASSETS for the years ended December 31, 2003 and 2002 2003 2002 Increase (decrease) in net assets: Operations: Net investment income (loss) ..................................................... $ 17,284,876 $ 13,979,269 Net realized gain (loss) from investments, written options, securities sold short and foreign currency transactions ........................................ 30,833,499 (49,056,871) Net unrealized appreciation (depreciation) on investments and translation of assets and liabilities denominated in foreign currencies ........................ 221,319,572 (43,955,257) ----------------------------------- Net increase (decrease) in net assets resulting from operations ............... 269,437,947 (79,032,859) Distributions to shareholders from: Net investment income: Class Z ......................................................................... (12,312,122) (7,252,039) Class A ......................................................................... (9,204,752) (4,788,653) Class B ......................................................................... (674,637) (265,371) Class C ......................................................................... (2,826,218) (1,129,935) Net realized gains: Class Z ......................................................................... -- (2,979,321) Class A ......................................................................... -- (2,333,082) Class B ......................................................................... -- (157,105) Class C ......................................................................... -- (963,971) ----------------------------------- Total distributions to shareholders................................................ (25,017,729) (19,869,477) Capital share transactions (Note 2): Class Z ......................................................................... 11,633,420 (29,940,007) Class A ......................................................................... 24,799,438 86,376,758 Class B ......................................................................... 5,657,600 15,125,074 Class C ......................................................................... 7,277,297 21,524,677 ----------------------------------- Total capital share transactions .................................................. 49,367,755 93,086,502 Redemption fees (Note 1m)......................................................... 1,100 46,091 Net increase (decrease) in net assets ......................................... 293,789,073 (5,769,743) Net assets: Beginning of year ................................................................. 827,792,009 833,561,752 ----------------------------------- End of year ....................................................................... $1,121,581,082 $827,792,009 ----------------------------------- Undistributed net investment income included in net assets: End of year ....................................................................... $ 2,043,383 $ 2,997,304 -----------------------------------
Annual Report | See notes to financial statements. | 29 Mutual European Fund NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Mutual European Fund (the Fund) is a separate, diversified series of Franklin Mutual Series Fund, Inc. (the Series Fund), which is an open-end investment company registered under the Investment Company Act of 1940. The Fund seeks long-term capital appreciation and income through a flexible policy of investing at least 80% of its invested assets in stocks and corporate debt securities of European countries. 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 last 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. Investments in open-end mutual funds are valued at the closing net asset value. Foreign securities are valued at the close of trading of the foreign exchange or the NYSE, whichever is earlier. If events occur that materially affect the values of securities after the prices or foreign exchange rates are determined, or if market quotations are not readily available, the securities will be valued at fair value as determined following procedures approved by the Board of Directors. 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. FOREIGN CURRENCY CONTRACTS The Fund may enter into forward exchange contracts to hedge against fluctuations in foreign exchange rates. A forward exchange contract is an agreement between two parties to exchange different currencies at an agreed upon exchange rate at a future date. These contracts are valued daily and the Fund's equity therein is included in the Statement of Assets and Liabilities. Realized and unrealized gains and losses are included in the Statement of Operations. 30 | Annual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) C. FOREIGN CURRENCY CONTRACTS (CONTINUED) When the Fund purchases or sells foreign securities, it may enter into foreign exchange contracts to minimize foreign exchange risk from the trade date to the settlement date of the transactions. Realized and unrealized gains and losses are included in the Statement of Operations. The risks of these contracts include movement in the values of the foreign currencies relative to the U.S. dollar and the possible inability of the counterparties to fulfill their obligations under the contracts. D. SYNTHETIC EQUITY SWAPS The Fund may engage in synthetic equity swaps. Synthetic equity swaps are contracts entered into between a broker and the Fund under which the parties agree to make payments to each other so as to replicate the economic consequences that would apply had a purchase or sale of the underlying security taken place. Upon entering into synthetic equity swaps, the Fund is required to pledge the broker an amount of cash and/or other assets equal to a certain percentage of the contract amount ("initial margin"). Subsequent payments known as "variation margin", are made or received by the Fund periodically, depending on fluctuations in the value of the underlying security. When the contract is closed, the Fund records a realized gain or loss equal to the difference between the value of the contract at the time it was opened and the value at the time it was closed. The risks of entering into equity swaps include unfavorable price movements in the underlying securities or the inability of the counterparties to fulfill their obligations under the contract. E. OPTION CONTRACTS The Fund may purchase or write options. Options are contracts entitling the holder to purchase or sell a specified number of shares or units of a particular security at a specified price. Options purchased are recorded as investments; options written (sold) are recorded as liabilities. When the exercise of an option results in a cash settlement, the difference between the premium (original option value) and the settlement proceeds is realized as a gain or loss. When securities are acquired or delivered upon exercise of an option, the acquisition cost or sale proceeds are adjusted by the amount of the premium. When an option is closed, the difference between the premium and the cost to close the position is realized as a gain or loss. When an option expires, the premium is realized as a gain for options written or as a loss for options purchased. The risks include the possibility there may be an illiquid options market or the inability of the counterparties to fulfill their obligations under the contract. Writing options involves, to varying degrees, elements of market risk in excess of the amount recognized in the Statement of Assets and Liabilities. Annual Report | 31 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) F. SECURITIES SOLD SHORT The Fund is engaged in selling securities short, which obligates the Fund to replace a borrowed security with the same security at current market value. The Fund would incur a loss 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. The Fund would realize a gain if the price of the security declines between those dates. A gain, limited to the price at which the Fund sold the security short, or a loss, unlimited in size, will be recognized upon the termination of a short sale. The Fund is required to establish a margin account with the broker lending the security sold short. While the short sale is outstanding, the broker retains the proceeds of the short sale and the Fund must maintain a deposit for the broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. G. SECURITY LENDING The Fund loans securities to certain brokers for which it received collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. H. 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. I. 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. Discounts on securities purchased are amortized over the lives of the respective securities. Dividend income, dividends declared on securities sold short and distributions to shareholders are recorded on the ex-dividend date. 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. Common expenses incurred by the Series Fund are allocated among the funds comprising the Series Fund 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. 32 | Annual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) J. SECURITIES ISSUED ON A WHEN-ISSUED OR DELAYED BASIS The Fund may purchase securities on a when-issued or delayed delivery basis, with payment and delivery scheduled for a future date. These transactions are subject to market fluctuations and are subject to the risk that the value at delivery may be more or less than the trade date purchase price. Although the Fund will generally purchase these securities with the intention of holding the securities, it may sell the securities before the settlement date. Sufficient assets have been segregated for these securities. K. 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. L. GUARANTEES AND INDEMNIFICATIONS Under the Fund's organizational documents, its officers and trustees are indemnified against certain liability arising out of the performance of their duties to the Funds. Additionally, in the normal course of business, the Fund enters into contracts with service providers that contain general indemnification clauses. The Fund's maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Fund that have not yet occurred. However, based on experience, the Fund expects the risk of loss to be remote. M. REDEMPTION FEES Redemption of Fund shares held 90 days or less (30 days or less effective January 1, 2004) may be subject to the Fund's redemption fee, which is 2% of the amount redeemed. Such fees are retained by the Fund and accounted for as additional paid in capital. 2. CAPITAL STOCK The Fund offers four classes of shares: Class Z, Class A, Class B, and Class C shares. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. Annual Report | 33 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED) At December 31, 2003, there were 500 million Fund shares authorized ($0.001 par value) of which 200 million, 100 million, 100 million and 100 million were designated as Class Z, Class A, Class B and Class C shares, respectively. Transactions in the Fund's shares were as follows:
2003 2002 SHARES AMOUNT SHARES AMOUNT --------------------------------------------------------------- CLASS Z SHARES: Shares sold ....................... 4,684,777 $ 68,107,081 7,302,015 $ 107,399,758 Shares issued on reinvestment of distributions 714,450 11,398,120 700,007 9,603,833 Shares redeemed ................... (4,740,063) (67,871,781) (10,055,156) (146,943,598) --------------------------------------------------------------- Net increase (decrease) ........... 659,164 $ 11,633,420 (2,053,134) $ (29,940,007) --------------------------------------------------------------- CLASS A SHARES: Shares sold ....................... 12,000,233 $ 166,037,567 17,596,910 $ 254,732,945 Shares issued on reinvestment of distributions 458,004 7,210,266 406,105 5,550,303 Shares redeemed ................... (10,877,741) (148,448,395) (12,244,521) (173,906,490) --------------------------------------------------------------- Net increase (decrease) ........... 1,580,496 $ 24,799,438 5,758,494 $ 86,376,758 --------------------------------------------------------------- CLASS B SHARES: Shares sold ....................... 659,571 $ 9,134,856 1,324,759 $ 18,907,172 Shares issued on reinvestment of distributions 39,099 602,729 27,250 368,524 Shares redeemed ................... (303,139) (4,079,985) (305,003) (4,150,622) --------------------------------------------------------------- Net increase (decrease) ........... 395,531 $ 5,657,600 1,047,006 $ 15,125,074 --------------------------------------------------------------- CLASS C SHARES: Shares sold ....................... 2,531,542 $ 35,820,953 3,467,474 $ 50,301,640 Shares issued on reinvestment of distributions 162,005 2,534,802 134,878 1,886,544 Shares redeemed ................... (2,246,768) (31,078,458) (2,205,493) (30,663,507) --------------------------------------------------------------- Net increase (decrease) ........... 446,779 $ 7,277,297 1,396,859 $ 21,524,677 ---------------------------------------------------------------
3. TRANSACTIONS WITH AFFILIATES Certain officers of the Series Fund are also officers and/or directors of Franklin Mutual Advisors, LLC (Franklin Mutual) and Franklin Templeton Services, LLC (FT Services), the Fund's investment manager and administrative manager, respectively. Franklin/Templeton Investor Services, LLC (Investor Services) and Franklin/Templeton Distributors, Inc. (Distributors), are the Fund's transfer agent and principal underwriter, respectively. The Fund pays an investment management fee to Franklin Mutual of 0.80% per year of the average daily net assets of the Fund. 34 | Annual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) The Fund pays its allocated share of an administrative fee to FT Services based on the Series Fund's aggregate average daily net assets as follows: ANNUALIZED FEE RATE AVERAGE DAILY NET ASSETS 0.150% First $200 million 0.135% Over $200 million, up to and including $700 million 0.100% Over $700 million, up to and including $1.2 billion 0.075% Over $1.2 billion The Fund reimburses Distributors for costs incurred in marketing the Fund's shares up to 0.35%, 1.00% and 1.00% per year of the average daily net assets of Class A, Class B, and Class C shares, respectively. Distributors received net commissions on sales of those shares and received contingent deferred sales charges for the year of $147,645 and $41,418, respectively. The Fund paid transfer agent fees of $1,422,800, of which $1,003,275 was paid to Investors Services. 4. INCOME TAXES At December 31, 2003, the cost of investments, net unrealized appreciation (depreciation) and undistributed ordinary income for income tax purposes were as follows: Cost of investments .................................. $898,065,510 ------------- Unrealized appreciation .............................. 253,997,555 Unrealized depreciation .............................. (3,346,424) ------------- Net unrealized appreciation (depreciation) ........... $250,651,131 ------------- Distributable earnings - undistributed ordinary income $ 7,913,798 ------------- The tax character of distributions paid during the years ended December 31, 2003 and 2002, was as follows: 2003 2002 Distributions paid from: Ordinary income $25,017,729 $19,869,080 Net investment income (loss) differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, passive foreign investment companies and bond discounts and premiums. Net realized capital losses differ for financial statement and tax purposes primarily due to differing treatments of wash sales, foreign currency transactions, and bond discounts and premiums. At December 31, 2003, the Fund had deferred capital losses occurring subsequent to October 31, 2003 of $6,696,576. For tax purposes, such losses will be reflected in the year ending December 31, 2004. Annual Report | 35 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 4. INCOME TAXES (CONTINUED) At December 31, 2003, the Fund had tax basis capital losses which may be carried over to offset future capital gains. Such losses expire as follows: Capital loss carryovers expiring in: 2010 ................................................. $56,018,300 2011 ................................................. 6,535,292 $62,553,592 5. INVESTMENT TRANSACTIONS Purchases and sales of securities (excluding short-term securities and securities sold short) for the year ended December 31, 2003 aggregated $451,128,789 and $411,897,912, respectively. Transactions in options written during the year ended December 31, 2003 were as follows: NUMBER OF CONTRACTS PREMIUM Options outstanding at December 31, 2002 25,800 $25,666 Options written..................... 4,901 68,825 Options expired..................... (930) (1,559) Options terminated in closing transactions ..................... -- -- Options exercised................... (28,891) (84,352) ------------------------------- Options outstanding at December 31, 2003 ................ 880 $8,580 ------------------------------- 6. FORWARD EXCHANGE CONTRACTS At December 31, 2003, the Fund has outstanding forward exchange contracts as set out below. The contracts are reported in the financial statements at the Fund's net equity, as measured by the difference between the forward exchange rates at the reporting date and the forward exchange rates at the day of entry into the contracts.
IN SETTLEMENT UNREALIZED CONTRACTS TO BUY EXCHANGE FOR DATE GAIN (LOSS) 750,000 British Pounds................ U.S. $ 1,321,613 1/28/04 U.S. $ 18,074 8,800,000 European Unit................. 10,282,409 1/28/04 808,611 2,500,000 British Pounds................ 4,436,550 2/05/04 26,673 9,800,000 European Unit................. 12,312,181 2/05/04 36,817 1,403,273 Swiss Franc................... 1,050,000 2/17/04 86,023 3,683,500 European Unit................. 4,329,254 3/11/04 307,822 110,936,858 Swedish Krona................. 15,182,885 3/23/04 174,511 8,862,735 European Unit................. 10,866,777 3/25/04 286,064 771,091 European Unit................. 931,633 4/28/04 37,859 ------------ ---------- U.S. $ 60,713,302 1,782,454 ------------ ---------- Unrealized gain on forward exchange contracts ..................................... U.S. $1,782,454 ----------
36 | Annual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. FORWARD EXCHANGE CONTRACTS (CONTINUED)
IN SETTLEMENT UNREALIZED CONTRACTS TO SELL EXCHANGE FOR DATE GAIN (LOSS) 5,217,294 British Pounds................ U.S. $ 9,255,480 1/06/04 U.S. $ (79,921) 18,225,000 European Unit................. 22,708,350 1/06/04 (275,850) 14,677,582 British Pounds................ 25,528,349 1/12/04 (722,215) 15,400,000 British Pounds................ 26,033,145 1/20/04 (1,492,251) 3,309,313 Canadian Dollars.............. 2,386,549 1/21/04 (171,835) 19,935,225 British Pounds................ 33,672,961 1/28/04 (1,936,295) 11,542,957 European Unit................. 13,551,432 1/28/04 (996,656) 22,742,300 British Pounds................ 39,459,498 2/11/04 (1,120,447) 18,778,376 Swiss Franc................... 13,666,473 2/17/04 (1,535,613) 32,828,580 European Unit................. 36,283,366 2/23/04 (5,062,869) 6,500,000 British Pounds................ 10,954,450 2/27/04 (629,635) 36,250,000 European Unit................. 41,458,750 3/11/04 (4,175,567) 181,587,670 Danish Krone.................. 29,908,437 3/17/04 (784,166) 218,673,361 Swedish Krona................. 27,065,210 3/23/04 (3,206,425) 32,333,896 European Unit................. 36,873,141 3/25/04 (3,815,742) 322,838,761 Norwegian Krona............... 45,362,486 4/15/04 (3,001,487) 54,241,647 European Unit................. 62,941,552 4/22/04 (5,266,763) 31,050,000 European Unit................. 36,543,033 4/28/04 (2,496,068) ------------- ------------ U.S. $513,652,662 (36,769,805) ------------- ------------ Unrealized loss on forward exchange contracts .............................. (36,769,805) ------------ Net unrealized loss on forward exchange contracts ....................... U.S. $(34,987,351) ------------
7. RESTRICTED SECURITIES At December 31, 2003, investments in securities included issues that are restricted or illiquid. Restricted securities are often purchased in private placement transactions, are not registered under the Securities Act of 1933, may have contractual restrictions on resale, and are valued under methods approved by the Board of Directors as reflecting fair value. A security may also be considered illiquid if it lacks a readily available market or if its valuation has not changed for a certain period of time. At December 31, 2003, the fund held investments in restricted and illiquid securities that were valued under approved methods by the Directors, as follows:
ACQUISITION SHARES ISSUER DATE COST VALUE 15,551 AboveNet Inc............................ 11/25/03 $ 465,819 $ 465,819 298,059 NTL Inc................................. 1/08/03 15,345,819 19,750,134 16,080 Olympus Re Holdings Ltd................. 12/19/01 1,608,000 2,543,374 2,966 PG & E Corp., wts. 9/02/06.............. 10/29/02 -- 74,103 42,252 Security Capital European Realty........ 4/08/98 959,917 314,777 20,972 White Mountains Insurance Group Inc..... 10/22/02 6,186,740 9,163,768 ------------ TOTAL RESTRICTED SECURITIES (2.88% OF NET ASSETS)................................... $32,311,975 ------------
Annual Report | 37 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. REGULATORY MATTERS On February 4, 2004, the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts filed an administrative complaint against Franklin Resources, Inc. and certain of its subsidiaries (the "Company"), alleging violations of the Massachusetts Uniform Securities Act. The complaint arises from activity that occurred in 2001 during which time an officer of a Company subsidiary was negotiating an agreement with an investor relating to investments in a mutual fund and a hedge fund. The Fund, in addition to other entities within Franklin Templeton Investments, including the Company and other funds, have been named in shareholder class actions related to the matter described above. The Fund's management believes that the claims made in the lawsuit are without merit and it intends to defend vigorously against the allegations. It is anticipated that the Fund may be named in additional similar civil actions related to the matter described above. In addition, as part of ongoing investigations by the U.S. Securities and Exchange Commission (the "SEC"), the U.S. Attorney for the Northern District of California, the New York Attorney General, the California Attorney General, the U.S. Attorney for the District of Massachusetts, the Florida Department of Financial Services, and the Commissioner of Securities and the Attorney General of the State of West Virginia, relating to certain practices in the mutual fund industry, including late trading, market timing and sales compensation arrangements, the Company and its subsidiaries, as well as certain current or former executives and employees of the Company, have received requests for information and/or subpoenas to testify or produce documents. The Company and its current employees are providing documents and information in response to these requests and subpoenas. In addition, the Company has responded to requests for similar kinds of information from regulatory authorities in some of the foreign countries where the Company conducts its global asset management business. The Staff of the SEC has informed the Company that it intends to recommend that the Commission authorize an action against an affiliate of the Fund's adviser and a senior executive officer relating to the frequent trading issues that are the subject of the SEC's investigation. These issues were previously disclosed as being under investigation by government authorities and the subject of an internal inquiry by the Company in its Annual Report on Form 10-K and on its public website. The Company currently is in discussions with the SEC Staff in an effort to resolve the issues raised in their investigation. Such discussions are preliminary and the Fund management has been advised that the Company cannot predict the likelihood of whether those discussions will result in a settlement and, if so, the terms of such settlement. The impact, if any, of these matters on the Fund is uncertain at this time. If the Company finds that it bears responsibility for any unlawful or improper conduct, it has committed to making the Fund or its shareholders whole, as appropriate. 38 | Annual Report Mutual European Fund REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS TO THE BOARD OF DIRECTORS OF FRANKLIN MUTUAL SERIES FUND INC. AND SHAREHOLDERS OF MUTUAL EUROPEAN FUND We have audited the accompanying statement of assets and liabilities, including the statement of investments, of the Mutual European Fund (one of the portfolios constituting the Franklin Mutual Series Fund Inc. [the Fund]) as of December 31, 2003, and the related statement of operations for the year then ended, the statements of changes in net assets for each of the two years in the period then ended, and the financial highlights for each of the periods indicated therein. These financial statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights. Our procedures included confirmation of securities owned at December 31, 2003, by correspondence with the custodian and brokers or by other appropriate auditing procedures where replies from brokers were not received. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of the Mutual European Fund of the Franklin Mutual Series Fund Inc. as of December 31, 2003, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the periods indicated therein, in conformity with accounting principles generally accepted in the United States. /S/ERNST & YOUNG LLP Boston, Massachusetts February 4, 2004 Annual Report | 39 Mutual European Fund TAX DESIGNATION (UNAUDITED) Under Section 854(b)(2) of the Internal Revenue Code (Code), the Fund hereby designates up to maximum of $19,812,832 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2003. In January 2004, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2003. Shareholders are advised to check with their tax advisors for information on the treatment of these amounts on their individual income tax returns. Under Section 854(b)(2) of the Code, the Fund hereby designates .33% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2003. At December 31, 2003, more than 50% of the Mutual European Fund's 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. As shown in the table below the Fund hereby designate to shareholders the foreign source income and foreign taxes paid, pursuant to Section 853 of the Internal Revenue Code. This designation will allow shareholders of record on December 18, 2003, to treat their proportionate share of foreign taxes paid by the Fund as having been paid directly by them. The shareholder shall consider these amounts as foreign taxes paid in the tax year in which they receive the Fund distribution. The following tables provide a detailed analysis, by country, of Foreign Tax Paid, Foreign Source Income, Foreign Qualified Dividends and Adjusted Foreign Source Income as designated by the Fund, to Class Z, Class A, Class B, and Class C shareholders of record. As a service to individual shareholders filing Form 1116, "Adjusted Foreign Source Income per Share" in column 4 below reports foreign source income with the required adjustments to foreign source qualified dividends. This information is provided to simplify your reporting of foreign source income for line 1 of Form 1116.
CLASS Z ADJUSTED FOREIGN TAX FOREIGN FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS SOURCE INCOME COUNTRY PER SHARE PER SHARE PER SHARE PER SHARE Belgium.................................... 0.0014 0.0098 0.0076 0.0055 Canada..................................... 0.0001 0.0018 0.0006 0.0015 Denmark.................................... 0.0006 0.0070 0.0030 0.0053 Finland.................................... 0.0029 0.0279 0.0159 0.0188 France..................................... 0.0032 0.0260 0.0187 0.0153 Germany.................................... 0.0001 0.0248 0.0004 0.0246 Greece..................................... 0.0000 0.0006 0.0006 0.0003 Ireland.................................... 0.0000 0.0221 0.0220 0.0095 Italy...................................... 0.0015 0.0104 0.0080 0.0058 Luxembourg................................. 0.0002 0.0013 0.0013 0.0006 Netherlands................................ 0.0096 0.0560 0.0419 0.0321 Norway..................................... 0.0112 0.0300 0.0262 0.0150 Spain...................................... 0.0022 0.0202 0.0121 0.0133 Sweden..................................... 0.0001 0.0105 0.0005 0.0102 Switzerland................................ 0.0021 0.0130 0.0130 0.0056 United Kingdom............................. 0.0079 0.0952 0.0619 0.0598 ------------------------------------------------------------------ TOTAL...................................... $0.0431 $0.3566 $0.2337 $0.2232 ------------------------------------------------------------------
40 | Annual Report Mutual European Fund TAX DESIGNATION (UNAUDITED) (CONTINUED)
CLASS A ADJUSTED FOREIGN TAX FOREIGN FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS SOURCE INCOME COUNTRY PER SHARE PER SHARE PER SHARE PER SHARE Belgium.................................... 0.0014 0.0088 0.0068 0.0049 Canada..................................... 0.0001 0.0016 0.0005 0.0013 Denmark.................................... 0.0006 0.0063 0.0027 0.0048 Finland.................................... 0.0029 0.0251 0.0143 0.0169 France..................................... 0.0032 0.0234 0.0168 0.0138 Germany.................................... 0.0001 0.0223 0.0004 0.0221 Greece..................................... 0.0000 0.0005 0.0005 0.0002 Ireland.................................... 0.0000 0.0199 0.0198 0.0086 Italy...................................... 0.0015 0.0093 0.0071 0.0052 Luxembourg................................. 0.0002 0.0011 0.0011 0.0005 Netherlands................................ 0.0096 0.0503 0.0376 0.0288 Norway..................................... 0.0112 0.0270 0.0236 0.0135 Spain...................................... 0.0022 0.0182 0.0109 0.0120 Sweden..................................... 0.0001 0.0094 0.0005 0.0091 Switzerland................................ 0.0021 0.0117 0.0117 0.0050 United Kingdom............................. 0.0079 0.0856 0.0556 0.0538 ------------------------------------------------------------------ TOTAL...................................... $0.0431 $0.3205 $0.2099 $0.2005 ------------------------------------------------------------------
CLASS B FOREIGN TAX FOREIGN FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS SOURCE INCOME COUNTRY PER SHARE PER SHARE PER SHARE PER SHARE Belgium.................................... 0.0014 0.0072 0.0056 0.0040 Canada..................................... 0.0001 0.0013 0.0004 0.0011 Denmark.................................... 0.0006 0.0051 0.0022 0.0038 Finland.................................... 0.0029 0.0204 0.0116 0.0138 France..................................... 0.0032 0.0191 0.0137 0.0113 Germany.................................... 0.0001 0.0182 0.0003 0.0180 Greece..................................... 0.0000 0.0004 0.0004 0.0002 Ireland.................................... 0.0000 0.0162 0.0161 0.0070 Italy...................................... 0.0015 0.0076 0.0058 0.0043 Luxembourg................................. 0.0002 0.0009 0.0009 0.0004 Netherlands................................ 0.0096 0.0410 0.0307 0.0235 Norway..................................... 0.0112 0.0220 0.0192 0.0110 Spain...................................... 0.0022 0.0148 0.0089 0.0097 Sweden..................................... 0.0001 0.0077 0.0004 0.0075 Switzerland................................ 0.0021 0.0095 0.0095 0.0041 United Kingdom............................. 0.0079 0.0698 0.0454 0.0439 ------------------------------------------------------------------ TOTAL...................................... $0.0431 $0.2612 $0.1711 $0.1636 ------------------------------------------------------------------
Annual Report | 41 Mutual European Fund TAX DESIGNATION (UNAUDITED) (CONTINUED)
CLASS C FOREIGN TAX FOREIGN FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS SOURCE INCOME COUNTRY PER SHARE PER SHARE PER SHARE PER SHARE Belgium.................................... 0.0014 0.0070 0.0054 0.0039 Canada..................................... 0.0001 0.0013 0.0004 0.0011 Denmark.................................... 0.0006 0.0050 0.0021 0.0038 Finland.................................... 0.0029 0.0199 0.0113 0.0134 France..................................... 0.0032 0.0185 0.0133 0.0109 Germany.................................... 0.0001 0.0177 0.0003 0.0175 Greece..................................... 0.0000 0.0004 0.0004 0.0002 Ireland.................................... 0.0000 0.0158 0.0157 0.0068 Italy...................................... 0.0015 0.0074 0.0057 0.0041 Luxembourg................................. 0.0002 0.0009 0.0009 0.0004 Netherlands................................ 0.0096 0.0399 0.0298 0.0229 Norway..................................... 0.0112 0.0214 0.0187 0.0107 Spain...................................... 0.0022 0.0144 0.0086 0.0095 Sweden..................................... 0.0001 0.0075 0.0004 0.0073 Switzerland................................ 0.0021 0.0092 0.0092 0.0039 United Kingdom............................. 0.0079 0.0678 0.0441 0.0426 ------------------------------------------------------------------ TOTAL...................................... $0.0431 $0.2541 $0.1663 $0.1590 ------------------------------------------------------------------
Foreign Tax Paid per Share (Column 1) is the amount per share available to you, as a tax credit or deduction (assuming you held your shares in the fund for a minimum of 16 days during the 30-day period beginning 15 days before the ex-dividend date of the fund's distribution to which the foreign taxes relate). Foreign Source Income per Share (Column 2) is the amount per share of income dividends paid to you that is attributable to foreign securities held by the fund, plus any foreign taxes withheld on these dividends. The amounts reported include foreign source qualified dividends without adjustment for the lower U.S. tax rates. Generally, this is the foreign source income to be reported by certain trusts and corporate shareholders. Foreign Qualified Dividends per Share (Column 3) is the amount per share of foreign source qualified dividends the fund paid to you, plus any foreign taxes withheld on these dividends. These amounts represent the portion of the Foreign Source Income reported to you in column 2 that were derived from qualified foreign securities held by the fund. If you are an individual shareholder who does not meet the qualified dividend holding period requirements, you may find this information helpful to calculate the foreign source income adjustment needed to complete line 1 of Form 1116. Adjusted Foreign Source Income per Share (Column 4) is the adjusted amount per share of foreign source income the fund paid to you. These amounts reflect the Foreign Source Income reported in column 2 adjusted for the tax rate differential on foreign source qualified dividends that may be required for certain individual shareholders pursuant to Internal Revenue Code 904(b)(2)(B). If you are an individual shareholder who meets the qualified dividend holding period requirements, generally, these Adjusted Foreign Source Income amounts may be reported directly on line 1 of Form 1116 without additional adjustment. 42 | Annual Report Mutual European Fund TAX DESIGNATION (UNAUDITED) (CONTINUED) In January 2004, shareholders will receive Form 1099-DIV which will include their share of taxes paid and foreign source income distributed during the calendar year 2003. The Foreign Source Income reported on Form 1099-DIV has been reduced to take into account the tax rate differential on foreign source qualified dividend income pursuant to Internal Revenue Code 904(b)(2)(B). Shareholders are advised to check with their tax advisors for information on the treatment of these amounts on their 2003 individual income tax returns. Annual Report | 43 Board Members and Officers The name, age and address of the officers and board members, as well as their affiliations, positions held with the Fund, principal occupations during the past five years and number of portfolios overseen in the Franklin Templeton Investments fund complex are shown below. Each board member will serve until that person's successor is elected and qualified. INDEPENDENT BOARD MEMBERS
NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ------------------------------------------------------------------------------------------------------------------------------------ EDWARD I. ALTMAN, PH.D. (62) Director Since 1987 7 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Max L. Heine Professor of Finance and Director of The Credit and Debt Markets Research Program, NYU Salomon Center, Stern School of Business, New York University; editor and author of numerous financial publications; and financial consultant; and FORMERLY Vice Director, NYU Salomon Center, Stern School of Business, New York University. ------------------------------------------------------------------------------------------------------------------------------------ ANN TORRE GRANT (45) Director Since 1994 7 Independent Director, SLM, 51 John F. Kennedy Parkway Corporation (Sallie Mae); Short Hills, NJ 07078 and Allied Capital . Corporation (financial services) PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Independent strategic and financial consultant; and FORMERLY, Executive Vice President and Chief Financial Officer, NHP Incorporated (manager of multifamily housing) (1995-1997); and Vice President and Treasurer, US Airways, Inc. (until 1995). ------------------------------------------------------------------------------------------------------------------------------------ BURTON J. GREENWALD (74) Director Since 2002 12 Director, Fiduciary Emerging 51 John F. Kennedy Parkway Markets Bond Fund PLC and Short Hills, NJ 07078 Fiduciary International . Ireland Limited PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Managing Director, B.J. Greenwald Associates, management consultants to the financial services industry. ------------------------------------------------------------------------------------------------------------------------------------ BRUCE A. MACPHERSON (73) Director Since 1974 7 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Retired, former Chairman, A.A. MacPherson, Inc., Canton, MA (representative for electrical manufacturers); and part owner McKinstry Inc., Chicopee, MA (manufacturer of electrical enclosures). ------------------------------------------------------------------------------------------------------------------------------------ FRED R. MILLSAPS (74) Director Since 1996 28 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director of various business and nonprofit organizations; manager of personal investments (1978-present); and FORMERLY, Chairman and Chief Executive Officer, Landmark Banking Corporation (1969-1978); Financial Vice President, Florida Power and Light (1965-1969); and Vice President, Federal Reserve Bank of Atlanta (1958-1965). ------------------------------------------------------------------------------------------------------------------------------------
44 | Annual Report
NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ------------------------------------------------------------------------------------------------------------------------------------ CHARLES RUBENS II (73) Director Since 1998 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. ------------------------------------------------------------------------------------------------------------------------------------ LEONARD RUBIN (78) Director Since 1996 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Partner in LDR Equities, LLC (manages personal investments); and FORMERLY, President, F.N.C. Textiles, Inc.; and Chairman of the Board, Carolace Embroidery Co., Inc. (until 1996). ------------------------------------------------------------------------------------------------------------------------------------ ROBERT E. WADE (57) Director Since 1991 7 Director, El Oro Mining and 51 John F. Kennedy Parkway Exploration Co., p.l.c.; and Short Hills, NJ 07078 FORMERLY, Director, El Oro Mining and Exploration Company, p.l.c and The Exploration Company, p.l.c., (until 2003). PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Practicing attorney. ------------------------------------------------------------------------------------------------------------------------------------ INTERESTED BOARD MEMBERS AND OFFICERS NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ------------------------------------------------------------------------------------------------------------------------------------ **WILLIAM J. LIPPMAN (78) Director Since 1996 18 None One Parker Plaza, 9th Floor Fort Lee, NJ 07024 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Private Client Group, Inc.; President, Franklin Advisory Services, LLC.; and officer and/or director or trustee, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of seven of the investment companies in Franklin Templeton Investments. ------------------------------------------------------------------------------------------------------------------------------------ **ANNE M. TATLOCK (64) Director Since 2002 7 Director, Fortune Brands, 600 Fifth Avenue, 7th Floor Inc. (consumer products) and New York, NY 10020-2302 Merck & Co. Inc. (pharmaceuticals) PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman and Chief Executive Officer, Fiduciary Trust Company International; Vice Chairman, Member - Office of the Chairman and Director, Franklin Resources, Inc.; and officer and/or director of some of the other subsidiaries of Franklin Resources, Inc. ------------------------------------------------------------------------------------------------------------------------------------
Annual Report | 45
NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ------------------------------------------------------------------------------------------------------------------------------------ **DAVID J. WINTERS (41) Director, Director since 7 None 51 John F. Kennedy Parkway President, 2001, President Short Hills, NJ 07078-2702 Chairman of since 1999, the Board and Chairman of the Chief Executive Board and Chief Officer - Executive Investment Officer - Investment Management Management since 2002 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Chief Investment Officer, and Chief Executive Officer, Franklin Mutual Advisers, LLC., and of three of the investment companies in Franklin Templeton Investments. ------------------------------------------------------------------------------------------------------------------------------------ JIMMY D. GAMBILL (56) Senior Vice Since 2002 Not Applicable None 500 East Broward Blvd. President Suite 2100 Fort Lauderdale, FL and Chief 33394-3091 Executive Officer - Finance and Administration PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Franklin Templeton Services, LLC; Senior Vice President, Templeton Worldwide, Inc.; and officer of 51 of the investment companies in Franklin Templeton Investments. ------------------------------------------------------------------------------------------------------------------------------------ DAVID P. GOSS (56) Vice President Since 2000 Not Applicable None One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Associate General Counsel, Franklin Resources, Inc.; officer and director of one of the subsidiaries of Franklin Resources, Inc.; officer of 51 of the investment companies in Franklin Templeton Investments; and FORMERLY, President, Chief Executive Officer and Director, Property Resources Equity Trust (until 1999) and Franklin Select Realty Trust (until 2000). ------------------------------------------------------------------------------------------------------------------------------------ BARBARA J. GREEN (56) Vice President Since 2000 Not Applicable None One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Deputy General Counsel and Secretary, Franklin Resources, Inc.; Secretary and Senior Vice President, Templeton Worldwide, Inc.; Secretary, Franklin Advisers, Inc., Franklin Advisory Services, LLC, Franklin Investment Advisory Services, Inc., Franklin Mutual Advisers, LLC, Franklin Templeton Alternative Strategies, Inc., Franklin Templeton Investor Services, LLC, Franklin Templeton Services, LLC, Franklin Templeton Distributors, Inc., Templeton Investment Counsel, LLC, and Templeton/Franklin Investment Services, Inc.; and officer of some of the other subsidiaries of Franklin Resources, Inc. and of 51 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). ------------------------------------------------------------------------------------------------------------------------------------
46 | Annual Report
NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL O. MAGDOL (66) Vice President Since 2002 Not Applicable Director, FTI Banque, 600 Fifth Avenue - AML Compliance Arch Chemicals, Inc. Rockefeller Center and Lingnan Foundation. New York, NY 10048-0772 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice Chairman, Chief Banking Officer and Director, Fiduciary Trust Company International; and officer and/or director, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of 48 of the investment companies in Franklin Templeton Investments. ------------------------------------------------------------------------------------------------------------------------------------ KIMBERLEY H. MONASTERIO (40) Treasurer and Treasurer and Not Applicable None One Franklin Parkway Chief Financial Chief Financial San Mateo, CA 94403-1906 Officer Officer since 2003 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Templeton Services, LLC; and officer of 51 of the investment companies in Franklin Templeton Investments. ------------------------------------------------------------------------------------------------------------------------------------ MURRAY L. SIMPSON (66) Vice President Since 2000 Not Applicable None One Franklin Parkway and Secretary San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Executive Vice President and General Counsel, Franklin Resources, Inc.; officer and/or director, as the case may be, of some of the subsidiaries of Franklin Resources, Inc. and of 51 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). ------------------------------------------------------------------------------------------------------------------------------------
*We base the number of portfolios on each separate series of the U.S. registered investment companies within the Franklin Templeton Investments fund complex. These portfolios have a common investment adviser or affiliated investment advisers. **William J. Lippman is considered an interested person of Mutual Series under the federal securities laws due to his position as an officer of some of the subsidiaries of Franklin Resources, Inc. (Resources), which is the parent company of Mutual Series' adviser and distributor. Anne M. Tatlock is considered an interested person of Mutual Series under the federal securities laws due to her position as an officer and director of Resources. David J. Winters is considered an interested person of Mutual Series under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC. THE FUND'S BOARD OF DIRECTORS HAS DETERMINED THAT CERTAIN OF THE MEMBERS OF THE AUDIT COMMITTEE, INCLUDING ANN TORRE GRANT, ARE AUDIT COMMITTEE FINANCIAL EXPERTS, AND "INDEPENDENT," UNDER THOSE PROVISIONS OF THE SARBANES-OXLEY ACT OF 2002, AND THE RULES AND FORM AMENDMENTS ADOPTED BY THE SECURITIES AND EXCHANGE COMMISSION, RELATING TO AUDIT COMMITTEE FINANCIAL EXPERTS. THE STATEMENT OF ADDITIONAL INFORMATION (SAI) INCLUDES ADDITIONAL INFORMATION ABOUT THE BOARD MEMBERS AND IS AVAILABLE, WITHOUT CHARGE, UPON REQUEST. SHAREHOLDERS MAY CALL 1-800/DIAL BEN (1-800/342-5236) TO REQUEST THE SAI. Annual Report | 47 Mutual European Fund PROXY VOTING POLICIES AND PROCEDURES The Fund has established Proxy Voting Policies and Procedures ("Policies") that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund's complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at 1-954/847-2268 or by sending a written request to: Franklin Templeton Companies, LLC, 500 East Broward Boulevard, Suite 1500, Fort Lauderdale, FL 33394, Attention: Proxy Group. 48 | Annual Report Literature Request For a brochure and prospectus, which contains more complete information, including charges and expenses, call Franklin Templeton Investments at 1-800/DIAL BEN(R) (1-800/342-5236). Please read the prospectus carefully before investing or sending money. To ensure the highest quality of service, we may monitor, record and access telephone calls to or from our service departments. These calls can be identified by the presence of a regular beeping tone. FRANKLIN TEMPLETON INVESTMENTS INTERNATIONAL Mutual European Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Foreign Fund Templeton Foreign Smaller Companies Fund Templeton International (Ex EM) Fund GLOBAL Franklin Global Aggressive Growth Fund Franklin Global Growth Fund Mutual Discovery Fund Templeton Capital Accumulator Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund Templeton Growth Fund Templeton World Fund GROWTH Franklin Aggressive Growth Fund Franklin Capital Growth Fund Franklin Flex Cap Growth Fund Franklin Small-Mid Cap Growth Fund Franklin Small Cap Growth Fund II 1 VALUE Franklin Balance Sheet Investment Fund 2 Franklin Equity Income Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund 3 Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund 4 Mutual Shares Fund BLEND Franklin Blue Chip Fund Franklin Convertible Securities Fund Franklin Growth Fund Franklin Rising Dividends Fund Franklin U.S. Long-Short Fund 5 SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Communications Fund Franklin Global Health Care Fund Franklin Gold and Precious Metals Fund Franklin Natural Resources Fund Franklin Real Estate Securities Fund Franklin Utilities Fund Franklin Technology Fund Mutual Financial Services Fund ASSET ALLOCATION Franklin Templeton Corefolio Allocation Fund Franklin Templeton Founding Funds Allocation Fund TARGET FUNDS Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund INCOME Franklin Adjustable U.S. Government Securities Fund 6 Franklin's AGE High Income Fund Franklin Federal Money Fund 6,7 Franklin Floating Rate Daily Access Fund Franklin Floating Rate Trust 4 Franklin Income Fund Franklin Money Fund 6,7 Franklin Short-Intermediate U.S. Government Securities Fund 6 Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio 6 Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund 6 Templeton Global Bond Fund TAX-FREE INCOME 8 NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund 9 Tax-Exempt Money Fund 6,7 LIMITED-TERM FUNDS California Limited-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Limited-Term Tax-Free Income Fund INTERMEDIATE-TERM FUNDS California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC 8 Alabama Arizona California 10 Colorado Connecticut Florida 10 Georgia Kentucky Louisiana Maryland Massachusetts 9 Michigan 9 Minnesota 9 Missouri New Jersey New York 10 North Carolina Ohio 9 Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust 11 1.The fund is closed to new investors. Existing shareholders can continue adding to their accounts. 2.The fund is only open to existing shareholders as well as select retirement plans. 3.Effective June 30, 2003, the fund reopened to all new investors. 4.The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. 5.Upon reaching approximately $350 million in assets, the fund intends to close to all investors. 6.An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. 7.No assurance exists that the fund's $1.00 per share price will be maintained. It is possible to lose money by investing in the fund. 8.For investors subject to the alternative minimum tax, a small portion of these dividends may be taxable. Distributions of capital gains are generally taxable. 9.Portfolio of insured municipal securities. 10.These funds are available in two or more variations, including long-term portfolios, portfolios of insured securities, a high-yield portfolio (CA) and money market portfolios (CA and NY). 11.The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 11/03 Not part of the annual report [LOGO] FRANKLIN[R] TEMPLETON[R] INVESTMENTS One Franklin Parkway San Mateo, CA 94403-1906 WANT TO RECEIVE THIS DOCUMENT FASTER VIA EMAIL? Eligible shareholders can sign up for eDelivery at franklintempleton.com. See inside for details. ANNUAL REPORT AND SHAREHOLDER LETTER MUTUAL EUROPEAN FUND CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF INVESTMENT OFFICER David J. Winters AUDITORS Ernst & Young LLP 200 Clarendon Streeet Boston, MA 02116 INVESTMENT MANAGER Franklin Mutual Advisers, LLC 51 John F. Kennedy Parkway Short Hills, NJ 07078 DISTRIBUTOR Franklin Templeton Distributors, Inc. 1-800/DIAL BEN(R) franklintempleton.com SHAREHOLDER SERVICES 1-800/632-2301 - (Class A, B, & C) 1-800/448-FUND - (Class Z) This report must be preceded or accompanied by the current Mutual European Fund prospectus, which contains more complete information, including risk factors, charges and expenses. To ensure the highest quality of service, telephone calls to or from our service departments may be monitored, recorded and accessed. These calls can be identified by the presence of a regular beeping tone. 478 A2003 2/04 DECEMBER 31, 2003 -------------------------------------------------------------------------------- [GRAPHIC OMITTED] -------------------------------------------------------------------------------- ANNUAL REPORT AND SHAREHOLDER LETTER | SECTOR -------------------------------------------------------------------------------- WANT TO RECEIVE THIS DOCUMENT MUTUAL FASTER VIA EMAIL? FINANCIAL SERVICES FUND ELIGIBLE SHAREHOLDERS CAN SIGN UP FOR EDELIVERY AT FRANKLINTEMPLETON.COM. SEE INSIDE FOR DETAILS. -------------------------------------------------------------------------------- [LOGO OMITTED] FRANKLIN(R) TEMPLETON(R) INVESTMENTS Franklin o Templeton o MUTUAL SERIES Thank You For Your Continued Participation At Mutual Series, we are pleased so many investors share our long-term investment philosophy and have remained shareholders for many years. Your ongoing support plays a significant role in contributing to the funds' success. SPECIALIZED EXPERTISE Mutual Series is part of Franklin Templeton Investments, which offers the specialized expertise of three world-class investment management groups -- Franklin, Templeton and Mutual Series. Mutual Series is dedicated to a unique style of value investing, searching aggressively for opportunity among undervalued stocks, arbitrage situations and distressed companies. Franklin is a leader in tax-free fund management and an expert in U.S. equity and fixed income investing. Templeton pioneered international investing and, with offices in over 25 countries, offers the broadest global reach in the industry. TRUE DIVERSIFICATION Because these management groups work independently and adhere to distinctly different investment approaches, Franklin, Templeton and Mutual Series funds typically have a low overlap of securities. That's why the funds can be used to build truly diversified portfolios covering every major asset class. RELIABILITY YOU CAN TRUST Franklin Templeton Investments seeks to consistently provide investors with exceptional risk-adjusted returns over the long term, as well as the reliable account services that have helped the firm become one of the most trusted names in financial services. ------------------------------------------------------------------------------- MUTUAL FUNDS | RETIREMENT PLANS | 529 COLLEGE SAVINGS PLANS | SEPARATE ACCOUNTS ------------------------------------------------------------------------------- [GRAPHIC OMITTED] Not part of the annual report Contents SHAREHOLDER LETTER ................................ 1 ANNUAL REPORT Mutual Financial Services Fund .................... 5 Performance Summary ............................... 10 Financial Highlights and Statement of Investments .......................... 15 Financial Statements .............................. 23 Notes to Financial Statements ..................... 27 Independent Auditors' Report ...................... 36 Tax Designation ................................... 37 Board Members and Officers ........................ 38 Proxy Voting Policies and Procedures .............. 42 -------------------------------------------------------------------------------- Regulatory Update AS OF FEBRUARY 12, 2004 On February 4, 2004, the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts filed an administrative complaint against Franklin Resources, Inc. and certain of its subsidiaries (the "Company"), alleging violations of the Massachusetts Uniform Securities Act. The complaint arises from activity that occurred in 2001 during which time an officer of a Company subsidiary was negotiating an agreement with an investor relating to investments in a mutual fund and a hedge fund. The Company, in addition to other entities within Franklin Templeton Investments, including the Fund and other funds, has been named in shareholder class actions related to the matter described above. The Company believes that the claims made in the lawsuit are without merit and it intends to defend vigorously against the allegations. It is anticipated that the Company may be named in additional similar civil actions related to the matter described above. In addition, as part of ongoing investigations by the U.S. Securities and Exchange Commission (the "SEC"), the U.S. Attorney for the Northern District of California, the New York Attorney General, the California Attorney General, the U.S. Attorney for the District of Massachusetts, the Florida Department of Financial Services, and the Commissioner of Securities and the Attorney General of the State of West Virginia, relating to certain practices in the mutual fund industry, including late trading, market timing and sales compensation arrangements, the Company and its subsidiaries, as well as certain current or former executives and employees of the Company, have received requests for information and/or subpoenas to testify or produce documents. The Company and its current employees are providing documents and information in response to these requests and subpoenas. In addition, the Company has responded to requests for similar kinds of information from regulatory authorities in some of the foreign countries where the Company conducts its global asset management business. The Staff of the SEC has informed the Company that it intends to recommend that the Commission authorize an action against an affiliate of the Fund's adviser and a senior executive officer relating to the frequent trading issues that are the subject of the SEC's investigation. These issues were previously disclosed as being under investigation by government authorities and the subject of an internal inquiry by the Company in its Annual Report on Form 10-K and on its public website. The Company currently is in discussions with the SEC Staff in an effort to resolve the issues raised in their investigation. Such discussions are preliminary and the Company cannot predict the likelihood of whether those discussions will result in a settlement and, if so, the terms of such settlement. The impact, if any, of these matters on the Fund is uncertain at this time. If it is found that the Company bears responsibility for any unlawful or improper conduct, we have committed to making the funds or their shareholders whole, as appropriate. Any further updates on these matters will be disclosed on the Company's website at franklintempleton.com under "Statement on Current Industry Issues." 4 | Not part of the annual report Annual Report Mutual Financial Services Fund YOUR FUND'S GOAL AND PRIMARY INVESTMENTS: Mutual Financial Services Fund seeks capital appreciation, with income as a secondary goal, by investing primarily in common and preferred stocks, bonds and convertible securities issued by companies in the financial services industry. The Fund normally will have at least 80% of its assets invested in securities of issuers such as banks, savings and loan organizations, credit card companies, brokerage firms, finance companies, sub-prime lending institutions, investment advisors and insurance companies. We are pleased to bring you Mutual Financial Services Fund's annual report for the fiscal year ended December 31, 2003. PERFORMANCE OVERVIEW Mutual Financial Services Fund - Class Z posted a 30.23% cumulative total return for the 12 months ended December 31, 2003, as shown in the Performance Summary beginning on page 10. Compared with its benchmarks over the same period, the Fund outperformed the Standard & Poor's 500 Composite Index's (S&P 500's) 28.67% return but slightly underperformed the S&P 500 Financial Index's 31.03% return. 1 ECONOMIC AND MARKET OVERVIEW Early in 2003, economic uncertainty and geopolitical events pushed U.S. interest rates to their lowest level in more than four decades. The U.S. government passed fiscal stimulus, approving another round of tax cuts and rebates that included dividend and capital gains tax reductions. In June, an accommodative Federal Reserve Board, in an attempt to bolster the economy, cut the federal funds target rate to 1.00%. During the year, the U.S. trade deficit increased significantly, contributing to the U.S. dollar's fall to record lows against the euro and other major currencies. 1. Source: Standard & Poor's Micropal. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The S&P 500 is one of the most widely used benchmarks of U.S. equity performance. The S&P 500 Financials Index is market value-weighted and includes all the financial stocks in the S&P 500. The indexes include reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND COMPLETE LEGAL TITLES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 19. Annual Report | 5 However, the weak dollar provided a boost to the U.S. economy and corporate profits as exports became cheaper for foreign buyers. Robust consumer spending, especially for autos and homes, and strong business spending, particularly for equipment and software, contributed to the accelerated economic activity. In addition, U.S. federal spending stayed firm and inflation remained benign. U.S. gross domestic product (GDP) grew an annualized 8.2% in third quarter 2003, its strongest pace in nearly 20 years, and total 2003 GDP grew an estimated 3.1%. As perception of economic data turned positive, interest rates rose from their lows, and the 10-year Treasury note's yield ended the period at 4.27%. An equity market rally started in late March 2003 and continued through the end of the year. The rebound began with investors anticipating global economic recovery in the second half of 2003, and it continued as data suggested robust economic growth. Improved sentiment led many investors to rotate into economically sensitive and financially leveraged companies, specifically cyclical, technology, small-capitalization and emerging market stocks, which had generally performed poorly in recent years. Consequently, domestic and foreign equity markets generally performed well. Within the financial services sector, stocks generally fared well during 2003. Insurers experienced positive pricing dynamics, and equity and debt market improvements drove positive investment portfolio performance. Consumer lenders, such as mortgage finance companies, benefited from exceptionally low mortgage rates, which drove record volumes, and a steep yield curve, which provided above-average profitability. Many banks and savings and loan companies benefited from these same trends as well as strong deposit flows and decreasing credit defaults. Lastly, capital markets firms generally performed well, driven by strong fixed income markets and anticipation of an equity market resurgence in late 2003 and into 2004. INVESTMENT STRATEGY We strive to provide investors with superior risk-adjusted returns over time through our distinctive, three-pronged investment style, which includes investments in undervalued common stocks, distressed debt and risk arbitrage. Rigorous fundamental analysis drives our investment process. We attempt to establish each investment's intrinsic value as well as the price at which we would be willing to PORTFOLIO BREAKDOWN Based on Total Net Assets as of 12/31/03 [BAR CHART OMITTED] Commercial Banks 29.2% Insurance 22.5% Thrifts & Mortgage Finance 16.9% Real Estate 9.4% Diversified Financial Services 7.5% Consumer Finance 1.5% Commercial Services & Supplies 1.1% Corporate Bonds 2.5% Government Agencies 7.6% Other Net Assets 1.8% 6 | Annual Report TOP 10 HOLDINGS 12/31/03 ----------------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS ----------------------------------------------------------- Sovereign Bancorp Inc. 3.8% THRIFTS & MORTGAGE FINANCE, U.S. ----------------------------------------------------------- White Mountains Insurance Group Inc., common & restricted 3.0% INSURANCE, U.S. ----------------------------------------------------------- DNB NOR ASA 2.6% COMMERCIAL BANKS, NORWAY ----------------------------------------------------------- iStar Financial Inc., common & preferred 2.6% REAL ESTATE, U.S. ----------------------------------------------------------- Saxon Capital Inc. 2.5% THRIFTS & MORTGAGE FINANCE, U.S. ----------------------------------------------------------- Allied Irish Banks PLC 2.1% COMMERCIAL BANKS, IRISH REPUBLIC ----------------------------------------------------------- First Community Bancorp 2.1% COMMERCIAL BANKS, U.S. ----------------------------------------------------------- Euronext 2.0% DIVERSIFIED FINANCIAL SERVICES, NETHERLANDS ----------------------------------------------------------- Danske Bank 1.8% COMMERCIAL BANKS, DENMARK ----------------------------------------------------------- Freddie Mac 1.7% THRIFTS & MORTGAGE FINANCE, U.S. ----------------------------------------------------------- commit shareholder funds. While valuation remains our key consideration, we utilize numerous fundamental factors such as return on equity, financial leverage and long-term earnings power. We also consider factors such as management quality and competitive position. As always, our approach to successful investing is as much about assessing risk and containing losses as it is about achieving profits. MANAGER'S DISCUSSION A discussion of some of our successful and disappointing investments during the year under review provides some interesting insight into our investment process. The Fund's top performing positions in 2003 were Sovereign Bancorp, Saxon Capital and White Mountains Insurance Group. The decline in Sovereign Bancorp's share price after the acquisition of its New England franchise in 1999 created an opportunity for patient investors. By utilizing our research process and understanding the company's goals, we sought to capitalize on the creation of one of the premier banking franchises in the northeast U.S. Sovereign's evolution to a full-service regional bank continued during 2003, and many now regard the company as a prime acquisition candidate. The Fund's investment in Saxon Capital highlights the flexibility of our approach. Our ability to participate in Saxon's early financing through a private placement in 2001 established our investment at a valuation substantially below our estimate of the firm's intrinsic value. Since that initial investment, Saxon transitioned to public ownership and became a national non-conforming residential mortgage lender. In 2003, Saxon improved its competitive position and benefited from a buoyant refinancing market. Our investment in White Mountains reflects our focus on companies with strong or improving fundamentals, attractive valuations and management teams who think like owners. During 2003, the company benefited from strong price increases for primary and reinsurance risks, disciplined underwriting and solid returns from its investment portfolio. While many companies within the property and casualty insurance industry struggled with eroding capital from past underwriting mistakes, White Mountains utilized its much-improved balance sheet and industry knowledge to acquire undervalued or capital-constrained insurance companies and to increase exposure to its most attractive lines of businesses. Annual Report | 7 Primarily as a result of these actions, the company continued to improve profitability and enjoyed a 13% increase in its book value during 2003. Two other notable investment successes during the period included Hudson City Bancorp and Meadowbrook Insurance Group. Our ability to understand complex business structures, such as Hudson City Bancorp's mutual holding company corporate structure, enabled the Fund to capitalize on one of the thrift industry's most profitable and growing businesses at a discounted valuation. Following our initial investment in 2002, Meadowbrook Insurance announced an unexpected charge, creating a substantial price decline in its shares. We relied on our in-depth analysis of the company's financial position and more than doubled our ownership during 2003's first half, enabling the Fund to benefit from share revaluation later in the year. As in the past, not all of our investments lived up to our expectations. Believing that Muenchener Rueckversicherungs-Gesellschaft (Munich Re) would be a primary beneficiary of the positive pricing trend for reinsurance risks, we purchased shares of the Germany-based company in late 2001. At that time, we believed that Munich Re's operational elements would drive stock price performance. However, macroeconomic factors tied to equity markets and the company's German holdings prevailed, resulting in a loss of value and we sold the stock by year-end. The Fund's Union Acceptance investment also disappointed. Following the company's reorganization in 2002, which resulted in a substantial loss for the Fund, the company's prospects remained dim. Consistent with our strategy, we held this stock and as Union Acceptance's reorganization process moves forward, we hope to recognize some recovery during the next several years. Lastly, after participating in an early stage financing for Luminent Mortgage Capital, a residential mortgage REIT, our investment declined as late summer bond market volatility resulted in adverse operating conditions for the company. However, our decision to participate in the company's recent initial public offering reflects our belief in Luminent's future prospects. Effective December 2003, Jeff Diamond, portfolio manager of Mutual Financial Services Fund since 1998, resigned to pursue other career opportunities. Your Fund will continue to be managed by Todd Jonasz, who has been promoted to co-portfolio manager and has been involved in management of Mutual Financial Services Fund since January 2003. In addition, John Wimsatt has been promoted to co-portfolio manager for the Fund. Mr. Wimsatt's biography is below. 8 | Annual Report Thank you for your continued participation in Mutual Financial Services Fund. We look forward to serving your future investment needs. [PHOTO OMITTED] /S/Todd J. Jonasz Todd J. Jonasz [PHOTO OMITTED] /S/John B. Wimsatt John B. Wimsatt Co-Portfolio Managers Mutual Financial Services Fund THIS DISCUSSION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2003, THE END OF THE REPORTING PERIOD. THE WAY WE IMPLEMENT OUR MAIN INVESTMENT STRATEGIES AND THE RESULTING PORTFOLIO HOLDINGS MAY CHANGE DEPENDING ON FACTORS SUCH AS MARKET AND ECONOMIC CONDITIONS. THESE OPINIONS MAY NOT BE RELIED UPON AS INVESTMENT ADVICE OR AN OFFER FOR A PARTICULAR SECURITY. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR THE FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE, BUT THE ADVISOR MAKES NO REPRESENTATION OR WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR INVESTMENT MANAGEMENT PHILOSOPHY. -------------------------------------------------------------------------------- JOHN WIMSATT is a co-manager of Mutual Financial Services Fund. Mr. Wimsatt's primary responsibilities include analyzing financial services companies. Prior to joining Franklin Mutual Advisers in 2001, Mr. Wimsatt was a managing director in the research department at Friedman, Billings, Ramsey Group in Virginia. He also served as an assistant portfolio manager and analyst for an internal hedge fund covering financial services and other sectors. Mr. Wimsatt has nine years of experience as an analyst of the financial services sector. Annual Report | 9 -------------------------------------------------------------------------------- Performance Summary as of 12/31/03 Your dividend income will vary depending on dividends or interest paid by securities in the Fund's portfolio, adjusted for operating expenses of each class. Capital gain distributions are net profits realized from the sale of portfolio securities. The performance table and graphs do not reflect any taxes due on Fund dividends, capital gain distributions, if any, or any realized gains on the sale of Fund shares. Total return reflects the Fund's dividend income, capital gain distributions, if any, and any unrealized gains or losses.
PRICE AND DISTRIBUTION INFORMATION ---------------------------------------------------------------------------------------------------------- CLASS Z CHANGE 12/31/03 12/31/02 ---------------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$4.13 $20.05 $15.92 ---------------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) ---------------------------------------------------------------------------------------------------------- Dividend Income $0.2366 ---------------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.4295 ---------------------------------------------------------------------------------------------------------- Total $0.6661 ---------------------------------------------------------------------------------------------------------- CLASS A CHANGE 12/31/03 12/31/02 ---------------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$4.13 $20.08 $15.95 ---------------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) ---------------------------------------------------------------------------------------------------------- Dividend Income $0.1779 ---------------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.4295 ---------------------------------------------------------------------------------------------------------- Total $0.6074 ---------------------------------------------------------------------------------------------------------- CLASS B CHANGE 12/31/03 12/31/02 ---------------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$4.02 $19.75 $15.73 ---------------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) ---------------------------------------------------------------------------------------------------------- Dividend Income $0.0820 ---------------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.4295 ---------------------------------------------------------------------------------------------------------- Total $0.5115 ---------------------------------------------------------------------------------------------------------- CLASS C CHANGE 12/31/03 12/31/02 ---------------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$4.09 $20.01 $15.92 ---------------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/03-12/31/03) ---------------------------------------------------------------------------------------------------------- Dividend Income $0.0664 ---------------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.4295 ---------------------------------------------------------------------------------------------------------- Total $0.4959 ----------------------------------------------------------------------------------------------------------
MUTUAL FINANCIAL SERVICES FUND PAID DISTRIBUTIONS DERIVED FROM LONG-TERM CAPITAL GAINS OF 42.95 CENTS ($0.4295) PER SHARE IN DECEMBER 2003. THE FUND HEREBY DESIGNATES SUCH DISTRIBUTIONS AS CAPITAL GAIN DIVIDENDS PER INTERNAL REVENUE CODE SECTION 852 (B)(3). 10 | Past performance does not guarantee future results. | Annual Report Performance Summary (CONTINUED)
PERFORMANCE 1 ---------------------------------------------------------------------------------------- CLASS Z 1-YEAR 5-YEAR INCEPTION (8/19/97) ---------------------------------------------------------------------------------------- Cumulative Total Return 2 30.23% 102.04% 168.32% ---------------------------------------------------------------------------------------- Average Annual Total Return 3 30.23% 15.10% 16.77% ---------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $13,023 $20,204 $26,832 ---------------------------------------------------------------------------------------- CLASS A 1-YEAR 5-YEAR INCEPTION (8/19/97) ---------------------------------------------------------------------------------------- Cumulative Total Return 2 29.79% 98.67% 162.99% ---------------------------------------------------------------------------------------- Average Annual Total Return 3 22.35% 13.36% 15.32% ---------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $12,235 $18,718 $24,787 ---------------------------------------------------------------------------------------- CLASS B 1-YEAR 5-YEAR INCEPTION (1/1/99) ---------------------------------------------------------------------------------------- Cumulative Total Return 2 28.88% 92.25% 92.25% ---------------------------------------------------------------------------------------- Average Annual Total Return 3 24.88% 13.73% 13.73% ---------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $12,488 $19,025 $19,025 ---------------------------------------------------------------------------------------- CLASS C 1-YEAR 5-YEAR INCEPTION (8/19/97) ---------------------------------------------------------------------------------------- Cumulative Total Return 2 28.87% 92.32% 152.40% ---------------------------------------------------------------------------------------- Average Annual Total Return 3 26.60% 13.74% 15.47% ---------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $12,660 $19,039 $24,990 ----------------------------------------------------------------------------------------
ONGOING MARKET VOLATILITY CAN SIGNIFICANTLY AFFECT SHORT-TERM PERFORMANCE; MORE RECENT RETURNS MAY DIFFER FROM THOSE SHOWN. SINCE MARKETS CAN GO DOWN AS WELL AS UP, INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE WITH MARKET CONDITIONS AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. FOR MORE CURRENT PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236. Annual Report | Past performance does not guarantee future results. | 11 Performance Summary (CONTINUED) TOTAL RETURN INDEX COMPARISON FOR HYPOTHETICAL $10,000 INVESTMENT 1 Total return represents the change in value of an investment over the periods shown. It includes the current, applicable, maximum sales charge(s), Fund expenses, account fees and reinvested distributions. The unmanaged indexes include reinvested dividends. They differ from the Fund in composition and do not pay management fees or expenses. One cannot invest directly in an index. AVERAGE ANNUAL TOTAL RETURN -------------------------------------- CLASS Z 12/31/03 -------------------------------------- 1-Year 30.23% -------------------------------------- 5-Year 15.10% -------------------------------------- Since Inception (8/19/97) 16.77% -------------------------------------- CLASS Z (8/19/97-12/31/03) [graphic omitted] edgar representation of data points used in printed graphic as follows: Mutual Financial S&P S&P 500 Services Fund 500 5 Financials Index 5 Date 8/19/97 $10,000 $10,000 $10,000 8/31/97 $10,080 $9,783 $9,711 9/30/97 $11,270 $10,319 $10,495 10/31/97 $11,590 $9,975 $10,277 11/30/97 $11,770 $10,436 $10,683 12/31/97 $12,402 $10,615 $11,219 1/31/98 $12,523 $10,732 $10,899 2/28/98 $13,756 $11,506 $11,924 3/31/98 $14,553 $12,095 $12,604 4/30/98 $14,937 $12,216 $12,812 5/31/98 $14,614 $12,007 $12,504 6/30/98 $14,442 $12,494 $13,028 7/31/98 $14,398 $12,361 $13,030 8/31/98 $11,634 $10,576 $10,025 9/30/98 $11,879 $11,253 $10,227 10/31/98 $12,399 $12,168 $11,467 11/30/98 $12,950 $12,905 $12,249 12/31/98 $13,281 $13,648 $12,501 1/31/99 $13,239 $14,219 $12,766 2/28/99 $12,971 $13,777 $12,937 3/31/99 $13,291 $14,328 $13,432 4/30/99 $14,138 $14,883 $14,342 5/31/99 $14,313 $14,532 $13,546 6/30/99 $14,965 $15,338 $14,106 7/31/99 $14,809 $14,860 $13,230 8/31/99 $14,114 $14,786 $12,622 9/30/99 $13,937 $14,381 $11,966 10/31/99 $14,954 $15,291 $13,963 11/30/99 $14,643 $15,602 $13,278 12/31/99 $13,904 $16,520 $13,016 1/31/00 $13,041 $15,690 $12,604 2/29/00 $11,955 $15,393 $11,239 3/31/00 $13,659 $16,898 $13,325 4/30/00 $13,553 $16,390 $12,905 5/31/00 $14,416 $16,055 $13,771 6/30/00 $14,051 $16,451 $12,936 7/31/00 $14,956 $16,194 $14,273 8/31/00 $16,100 $17,199 $15,643 9/30/00 $17,179 $16,291 $16,015 10/31/00 $17,038 $16,222 $15,945 11/30/00 $16,536 $14,944 $15,005 12/31/00 $18,394 $15,017 $16,360 1/31/01 $18,631 $15,550 $16,315 2/28/01 $18,687 $14,133 $15,244 3/31/01 $18,811 $13,238 $14,784 4/30/01 $19,600 $14,266 $15,335 5/31/01 $20,457 $14,362 $15,953 6/30/01 $20,981 $14,012 $15,947 7/31/01 $21,245 $13,874 $15,689 8/31/01 $21,085 $13,007 $14,733 9/30/01 $19,419 $11,956 $13,863 10/31/01 $19,224 $12,184 $13,606 11/30/01 $20,062 $13,119 $14,577 12/31/01 $20,660 $13,234 $14,896 1/31/02 $21,057 $13,041 $14,663 2/28/02 $21,193 $12,789 $14,450 3/31/02 $22,410 $13,270 $15,411 4/30/02 $23,081 $12,466 $15,000 5/31/02 $23,254 $12,375 $14,975 6/30/02 $22,378 $11,493 $14,264 7/31/02 $21,273 $10,598 $13,133 8/31/02 $21,705 $10,667 $13,401 9/30/02 $19,940 $9,509 $11,834 10/31/02 $20,473 $10,345 $12,905 11/30/02 $20,676 $10,953 $13,435 12/31/02 $20,604 $10,310 $12,715 1/31/03 $20,371 $10,041 $12,503 2/28/03 $19,944 $9,890 $12,113 3/31/03 $20,125 $9,985 $12,065 4/30/03 $21,510 $10,808 $13,543 5/31/03 $22,727 $11,376 $14,259 6/30/03 $22,805 $11,522 $14,295 7/31/03 $23,505 $11,725 $14,951 8/31/03 $23,907 $11,953 $14,800 9/30/03 $23,855 $11,827 $14,899 10/31/03 $25,281 $12,495 $15,925 11/30/03 $25,800 $12,605 $15,881 12/31/03 $26,832 $13,266 $16,661 AVERAGE ANNUAL TOTAL RETURN -------------------------------------- CLASS A 12/31/03 -------------------------------------- 1-Year 22.35% -------------------------------------- 5-Year 13.36% -------------------------------------- Since Inception (8/19/97) 15.32% -------------------------------------- CLASS A (8/19/97-12/31/03) [graphic omitted] edgar representation of data points used in printed graphic as follows: Mutual Financial S&P S&P 500 Services Fund 500 5 Financials Index 5 Date 8/19/97 $9,425 $10,000 $10,000 8/31/97 $9,500 $9,783 $9,711 9/30/97 $10,622 $10,319 $10,495 10/31/97 $10,924 $9,975 $10,277 11/30/97 $11,093 $10,436 $10,683 12/31/97 $11,681 $10,615 $11,219 1/31/98 $11,795 $10,732 $10,899 2/28/98 $12,955 $11,506 $11,924 3/31/98 $13,716 $12,095 $12,604 4/30/98 $14,068 $12,216 $12,812 5/31/98 $13,764 $12,007 $12,504 6/30/98 $13,593 $12,494 $13,028 7/31/98 $13,554 $12,361 $13,030 8/31/98 $10,953 $10,576 $10,025 9/30/98 $11,173 $11,253 $10,227 10/31/98 $11,653 $12,168 $11,467 11/30/98 $12,172 $12,905 $12,249 12/31/98 $12,476 $13,648 $12,501 1/31/99 $12,437 $14,219 $12,766 2/28/99 $12,185 $13,777 $12,937 3/31/99 $12,476 $14,328 $13,432 4/30/99 $13,271 $14,883 $14,342 5/31/99 $13,436 $14,532 $13,546 6/30/99 $14,035 $15,338 $14,106 7/31/99 $13,889 $14,860 $13,230 8/31/99 $13,236 $14,786 $12,622 9/30/99 $13,061 $14,381 $11,966 10/31/99 $14,005 $15,291 $13,963 11/30/99 $13,713 $15,602 $13,278 12/31/99 $13,019 $16,520 $13,016 1/31/00 $12,212 $15,690 $12,604 2/29/00 $11,186 $15,393 $11,239 3/31/00 $12,780 $16,898 $13,325 4/30/00 $12,681 $16,390 $12,905 5/31/00 $13,478 $16,055 $13,771 6/30/00 $13,135 $16,451 $12,936 7/31/00 $13,981 $16,194 $14,273 8/31/00 $15,040 $17,199 $15,643 9/30/00 $16,037 $16,291 $16,015 10/31/00 $15,905 $16,222 $15,945 11/30/00 $15,426 $14,944 $15,005 12/31/00 $17,172 $15,017 $16,360 1/31/01 $17,382 $15,550 $16,315 2/28/01 $17,424 $14,133 $15,244 3/31/01 $17,540 $13,238 $14,784 4/30/01 $18,264 $14,266 $15,335 5/31/01 $19,062 $14,362 $15,953 6/30/01 $19,535 $14,012 $15,947 7/31/01 $19,781 $13,874 $15,689 8/31/01 $19,621 $13,007 $14,733 9/30/01 $18,069 $11,956 $13,863 10/31/01 $17,888 $12,184 $13,606 11/30/01 $18,658 $13,119 $14,577 12/31/01 $19,206 $13,234 $14,896 1/31/02 $19,575 $13,041 $14,663 2/28/02 $19,702 $12,789 $14,450 3/31/02 $20,820 $13,270 $15,411 4/30/02 $21,431 $12,466 $15,000 5/31/02 $21,593 $12,375 $14,975 6/30/02 $20,774 $11,493 $14,264 7/31/02 $19,748 $10,598 $13,133 8/31/02 $20,137 $10,667 $13,401 9/30/02 $18,499 $9,509 $11,834 10/31/02 $18,982 $10,345 $12,905 11/30/02 $19,171 $10,953 $13,435 12/31/02 $19,097 $10,310 $12,715 1/31/03 $18,870 $10,041 $12,503 2/28/03 $18,475 $9,890 $12,113 3/31/03 $18,630 $9,985 $12,065 4/30/03 $19,911 $10,808 $13,543 5/31/03 $21,025 $11,376 $14,259 6/30/03 $21,104 $11,522 $14,295 7/31/03 $21,739 $11,725 $14,951 8/31/03 $22,111 $11,953 $14,800 9/30/03 $22,051 $11,827 $14,899 10/31/03 $23,358 $12,495 $15,925 11/30/03 $23,826 $12,605 $15,881 12/31/03 $24,787 $13,266 $16,661 12 | Past performance does not guarantee future results. | Annual Report Performance Summary (CONTINUED) AVERAGE ANNUAL TOTAL RETURN -------------------------------------- CLASS B 12/31/03 -------------------------------------- 1-Year 24.88% -------------------------------------- 5-Year 13.73% -------------------------------------- Since Inception (1/1/99) 13.73% -------------------------------------- CLASS B (1/1/99-12/31/03) [graphic omitted] edgar representation of data points used in printed graphic as follows: Mutual Financial S&P S&P 500 Services Fund 500 5 Financials Index 5 Date 1/1/99 $10,000 $10,000 $10,000 1/31/99 $9,961 $10,418 $10,212 2/28/99 $9,759 $10,094 $10,349 3/31/99 $9,984 $10,498 $10,745 4/30/99 $10,614 $10,905 $11,473 5/31/99 $10,738 $10,647 $10,836 6/30/99 $11,215 $11,238 $11,285 7/31/99 $11,090 $10,887 $10,583 8/31/99 $10,559 $10,834 $10,097 9/30/99 $10,419 $10,537 $9,573 10/31/99 $11,168 $11,203 $11,170 11/30/99 $10,926 $11,431 $10,622 12/31/99 $10,369 $12,104 $10,412 1/31/00 $9,722 $11,496 $10,082 2/29/00 $8,901 $11,279 $8,991 3/31/00 $10,161 $12,381 $10,659 4/30/00 $10,073 $12,009 $10,324 5/31/00 $10,711 $11,763 $11,016 6/30/00 $10,424 $12,053 $10,348 7/31/00 $11,092 $11,865 $11,417 8/31/00 $11,924 $12,601 $12,514 9/30/00 $12,714 $11,936 $12,811 10/31/00 $12,600 $11,886 $12,755 11/30/00 $12,217 $10,949 $12,003 12/31/00 $13,583 $11,003 $13,088 1/31/01 $13,751 $11,393 $13,052 2/28/01 $13,776 $10,355 $12,194 3/31/01 $13,851 $9,699 $11,827 4/30/01 $14,421 $10,453 $12,267 5/31/01 $15,041 $10,523 $12,762 6/30/01 $15,414 $10,267 $12,757 7/31/01 $15,593 $10,166 $12,550 8/31/01 $15,457 $9,530 $11,786 9/30/01 $14,228 $8,760 $11,090 10/31/01 $14,074 $8,927 $10,884 11/30/01 $14,672 $9,612 $11,661 12/31/01 $15,099 $9,696 $11,916 1/31/02 $15,384 $9,555 $11,730 2/28/02 $15,466 $9,371 $11,560 3/31/02 $16,346 $9,723 $12,328 4/30/02 $16,814 $9,134 $11,999 5/31/02 $16,924 $9,067 $11,979 6/30/02 $16,277 $8,421 $11,410 7/31/02 $15,461 $7,765 $10,506 8/31/02 $15,761 $7,816 $10,720 9/30/02 $14,467 $6,967 $9,467 10/31/02 $14,833 $7,580 $10,323 11/30/02 $14,974 $8,025 $10,748 12/31/02 $14,917 $7,554 $10,172 1/31/03 $14,727 $7,357 $10,002 2/28/03 $14,414 $7,246 $9,689 3/31/03 $14,528 $7,316 $9,652 4/30/03 $15,524 $7,919 $10,834 5/31/03 $16,377 $8,335 $11,407 6/30/03 $16,423 $8,442 $11,435 7/31/03 $16,916 $8,591 $11,960 8/31/03 $17,192 $8,758 $11,839 9/30/03 $17,135 $8,665 $11,918 10/31/03 $18,151 $9,155 $12,739 11/30/03 $18,502 $9,236 $12,704 12/31/03 $19,025 $9,720 $13,328 AVERAGE ANNUAL TOTAL RETURN ----------------------------------------- CLASS C 12/31/03 ----------------------------------------- 1-Year 26.60% ----------------------------------------- 5-Year 13.74% ----------------------------------------- Since Inception (8/19/97) 15.47% ----------------------------------------- CLASS C (8/19/97-12/31/03) [graphic omitted] edgar representation of data points used in printed graphic as follows: Mutual Financial S&P S&P 500 Services Fund 500 5 Financials Index 5 Date 8/19/97 $9,425 $10,000 $10,000 8/31/97 $9,500 $9,783 $9,711 9/30/97 $10,622 $10,319 $10,495 10/31/97 $10,924 $9,975 $10,277 11/30/97 $11,093 $10,436 $10,683 12/31/97 $11,681 $10,615 $11,219 1/31/98 $11,795 $10,732 $10,899 2/28/98 $12,955 $11,506 $11,924 3/31/98 $13,716 $12,095 $12,604 4/30/98 $14,068 $12,216 $12,812 5/31/98 $13,764 $12,007 $12,504 6/30/98 $13,593 $12,494 $13,028 7/31/98 $13,554 $12,361 $13,030 8/31/98 $10,953 $10,576 $10,025 9/30/98 $11,173 $11,253 $10,227 10/31/98 $11,653 $12,168 $11,467 11/30/98 $12,172 $12,905 $12,249 12/31/98 $12,476 $13,648 $12,501 1/31/99 $12,437 $14,219 $12,766 2/28/99 $12,185 $13,777 $12,937 3/31/99 $12,476 $14,328 $13,432 4/30/99 $13,271 $14,883 $14,342 5/31/99 $13,436 $14,532 $13,546 6/30/99 $14,035 $15,338 $14,106 7/31/99 $13,889 $14,860 $13,230 8/31/99 $13,236 $14,786 $12,622 9/30/99 $13,061 $14,381 $11,966 10/31/99 $14,005 $15,291 $13,963 11/30/99 $13,713 $15,602 $13,278 12/31/99 $13,019 $16,520 $13,016 1/31/00 $12,212 $15,690 $12,604 2/29/00 $11,186 $15,393 $11,239 3/31/00 $12,780 $16,898 $13,325 4/30/00 $12,681 $16,390 $12,905 5/31/00 $13,478 $16,055 $13,771 6/30/00 $13,135 $16,451 $12,936 7/31/00 $13,981 $16,194 $14,273 8/31/00 $15,040 $17,199 $15,643 9/30/00 $16,037 $16,291 $16,015 10/31/00 $15,905 $16,222 $15,945 11/30/00 $15,426 $14,944 $15,005 12/31/00 $17,172 $15,017 $16,360 1/31/01 $17,382 $15,550 $16,315 2/28/01 $17,424 $14,133 $15,244 3/31/01 $17,540 $13,238 $14,784 4/30/01 $18,264 $14,266 $15,335 5/31/01 $19,062 $14,362 $15,953 6/30/01 $19,535 $14,012 $15,947 7/31/01 $19,781 $13,874 $15,689 8/31/01 $19,621 $13,007 $14,733 9/30/01 $18,069 $11,956 $13,863 10/31/01 $17,888 $12,184 $13,606 11/30/01 $18,658 $13,119 $14,577 12/31/01 $19,206 $13,234 $14,896 1/31/02 $19,575 $13,041 $14,663 2/28/02 $19,702 $12,789 $14,450 3/31/02 $20,820 $13,270 $15,411 4/30/02 $21,431 $12,466 $15,000 5/31/02 $21,593 $12,375 $14,975 6/30/02 $20,774 $11,493 $14,264 7/31/02 $19,748 $10,598 $13,133 8/31/02 $20,137 $10,667 $13,401 9/30/02 $18,499 $9,509 $11,834 10/31/02 $18,982 $10,345 $12,905 11/30/02 $19,171 $10,953 $13,435 12/31/02 $19,097 $10,310 $12,715 1/31/03 $18,870 $10,041 $12,503 2/28/03 $18,475 $9,890 $12,113 3/31/03 $18,630 $9,985 $12,065 4/30/03 $19,911 $10,808 $13,543 5/31/03 $21,025 $11,376 $14,259 6/30/03 $21,104 $11,522 $14,295 7/31/03 $21,739 $11,725 $14,951 8/31/03 $22,111 $11,953 $14,800 9/30/03 $22,051 $11,827 $14,899 10/31/03 $23,358 $12,495 $15,925 11/30/03 $23,826 $12,605 $15,881 12/31/03 $24,787 $13,266 $16,661 Annual Report | Past performance does not guarantee future results. | 13 Performance Summary (CONTINUED) ENDNOTES INVESTING IN A SINGLE-SECTOR FUND INVOLVES SPECIAL RISKS, INCLUDING GREATER SENSITIVITY TO ECONOMIC, POLITICAL OR REGULATORY DEVELOPMENTS AFFECTING THE SECTOR. FOREIGN SECURITIES RISKS INCLUDE EXPOSURE TO CURRENCY VOLATILITY AND POLITICAL, ECONOMIC AND REGULATORY UNCERTAINTY. SMALLER-COMPANY STOCKS HAVE HISTORICALLY EXHIBITED GREATER PRICE VOLATILITY THAN LARGER-COMPANY STOCKS, PARTICULARLY OVER THE SHORT TERM. THE FUND MAY ALSO INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, AS WELL AS LOWER-RATED "JUNK BONDS," WHICH ENTAIL HIGHER CREDIT RISK. THE FUND'S PROSPECTUS ALSO INCLUDES A DESCRIPTION OF THE MAIN INVESTMENT RISKS. CLASS Z: No initial sales charge or Rule 12b-1 fees; shares are available only to certain investors, as described in the prospectus. CLASS A: Subject to the current, maximum 5.75% initial sales charge. Prior to 8/3/98, Fund shares were offered at a lower initial sales charge; thus actual total returns may differ. CLASS B: Subject to no initial sales charge, but subject to a contingent deferred sales charge (CDSC) declining from 4% to 0% over six years. These shares have higher annual fees and expenses than Class A shares. CLASS C: Subject to 1% initial sales charge and 1% CDSC for shares redeemed within 18 months of investment. These shares have higher annual fees and expenses than Class A shares. 1. Past expense reductions by the Fund's manager increased the Fund's total returns. Without these reductions, the Fund's total returns would have been lower. 2. Cumulative total return represents the change in value of an investment over the periods indicated and does not include sales charges. 3. Average annual total return represents the average annual change in value of an investment over the periods indicated and includes any current, applicable, maximum sales charge(s). 4. These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated and include any current, applicable, maximum sales charge(s). 5. Source: Standard & Poor's Micropal. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The S&P 500 is one of the most widely used benchmarks of U.S. equity performance. The S&P 500 Financials Index is market value-weighted and includes all the financial stocks in the S&P 500. 14 | Past performance does not guarantee future results. | Annual Report Mutual Financial Services Fund FINANCIAL HIGHLIGHTS
-------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2003 2002 2001 2000 1999 -------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ..................... $15.92 $16.64 $16.33 $13.05 $12.85 -------------------------------------------------------------- Income from investment operations: Net investment income a ............................... .23 .25 .24 .23 .16 Net realized and unrealized gains (losses) ............ 4.58 (.26) 1.71 3.87 .45 -------------------------------------------------------------- Total from investment operations ....................... 4.81 (.01) 1.95 4.10 .61 -------------------------------------------------------------- Less distributions from: Net investment income ................................. (.24) (.28) (.23) (.24) (.19) Net realized gains .................................... (.43) (.43) (1.41) (.58) (.22) -------------------------------------------------------------- Total distributions .................................... (.67) (.71) (1.64) (.82) (.41) -------------------------------------------------------------- Net asset value, end of year ........................... $20.06 $15.92 $16.64 $16.33 $13.05 -------------------------------------------------------------- Total return b ......................................... 30.23% (.27)% 12.31% 32.29% 4.78% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ........................ $151,918 $104,658 $96,936 $80,051 $76,916 Ratios to average net assets:* Expenses c ............................................ 1.13% 1.09% 1.10% 1.24% 1.07% Expenses, excluding waiver and payments by affiliate c 1.13% 1.09% 1.10% 1.24% 1.20% Net investment income ................................. 1.28% 1.47% 1.43% 1.65% 1.17% Portfolio turnover rate ................................ 25.78% 40.17% 83.41% 53.65% 81.81% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ............................................. 1.11% 1.09% 1.09% 1.23% 1.05% Expenses, excluding waiver and payments by affiliate . 1.11% 1.09% 1.09% 1.23% 1.18% a Based on average daily shares outstanding. b Total return is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses.
Annual Report | 15 Mutual Financial Services Fund FINANCIAL HIGHLIGHTS (CONTINUED)
------------------------------------------------------------ YEAR ENDED DECEMBER 31, CLASS A 2003 2002 2001 2000 1999 ------------------------------------------------------------ PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ........................ $15.95 $16.66 $16.35 $13.07 $12.87 ------------------------------------------------------------ Income from investment operations: Net investment income a .................................. .16 .19 .19 .18 .11 Net realized and unrealized gains (losses) ............... 4.58 (.25) 1.71 3.87 .45 ------------------------------------------------------------ Total from investment operations .......................... 4.74 (.06) 1.90 4.05 .56 ------------------------------------------------------------ Less distributions from: Net investment income .................................... (.18) (.22) (.18) (.19) (.14) Net realized gains ....................................... (.43) (.43) (1.41) (.58) (.22) ------------------------------------------------------------ Total distributions ....................................... (.61) (.65) (1.59) (.77) (.36) ------------------------------------------------------------ Net asset value, end of year .............................. $20.08 $15.95 $16.66 $16.35 $13.07 ------------------------------------------------------------ Total return b ............................................ 29.79% (.57)% 11.85% 31.90% 4.35% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ........................... $264,411 $180,299 $167,903 $131,331 $107,935 Ratios to average net assets:* Expenses c ............................................... 1.48% 1.44% 1.45% 1.59% 1.42% Expenses, excluding waiver and payments by affiliate c ... 1.48% 1.44% 1.45% 1.59% 1.55% Net investment income .................................... .93% 1.12% 1.08% 1.30% .82% Portfolio turnover rate ................................... 25.78% 40.17% 83.41% 53.65% 81.81% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................................. 1.46% 1.44% 1.44% 1.58% 1.40% Expenses, excluding waiver and payments by affiliate ..... 1.46% 1.44% 1.44% 1.58% 1.53% a Based on average daily shares outstanding. b Total return does not reflect the sales commissions or the contingent deferred sales charge, and is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses.
16 | Annual Report Mutual Financial Services Fund FINANCIAL HIGHLIGHTS (CONTINUED)
------------------------------------------------------------ YEAR ENDED DECEMBER 31, CLASS B 2003 2002 2001 2000 1999 D ------------------------------------------------------------ PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ...................... $15.73 $16.47 $16.21 $13.00 $12.87 ------------------------------------------------------------ Income from investment operations: Net investment income a ................................ .05 .09 .07 .09 .03 Net realized and unrealized gains (losses) ............. 4.49 (.26) 1.70 3.83 .44 ------------------------------------------------------------ Total from investment operations ........................ 4.54 (.17) 1.77 3.92 .47 ------------------------------------------------------------ Less distributions from: Net investment income .................................. (.08) (.14) (.10) (.13) (.12) Net realized gains ..................................... (.43) (.43) (1.41) (.58) (.22) ------------------------------------------------------------ Total distributions ..................................... (.51) (.57) (1.51) (.71) (.34) ------------------------------------------------------------ Net asset value, end of year ............................ $19.76 $15.73 $16.47 $16.21 $13.00 ------------------------------------------------------------ Total return b .......................................... 28.88% (1.21)% 11.16% 31.00% 3.69% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ......................... $34,219 $20,776 $11,212 $4,429 $1,065 Ratios to average net assets:* Expenses c ............................................. 2.12% 2.09% 2.10% 2.24% 2.08% Expenses, excluding waiver and payments by affiliate c . 2.12% 2.09% 2.10% 2.24% 2.21% Net investment income .................................. .29% .47% .42% .62% .19% Portfolio turnover rate ................................. 25.78% 40.17% 83.41% 53.65% 81.81% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ............................................... 2.10% 2.09% 2.09% 2.23% 2.06% Expenses, excluding waiver and payments by affiliate ... 2.10% 2.09% 2.09% 2.23% 2.19% a Based on average daily shares outstanding. b Total return does not reflect the contingent deferred sales charge, and is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses. d Effective date of Class B shares was January 1, 1999.
Annual Report | 17 Mutual Financial Services Fund FINANCIAL HIGHLIGHTS (CONTINUED)
------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2003 2002 2001 2000 1999 ------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ......................... $15.92 $16.63 $16.32 $13.05 $12.83 ------------------------------------------------------------- Income from investment operations: Net investment income a ................................... .05 .08 .07 .09 .02 Net realized and unrealized gains (losses) ................ 4.55 (.25) 1.71 3.86 .46 Total from investment operations ........................... 4.60 (.17) 1.78 3.95 .48 Less distributions from: Net investment income ..................................... (.07) (.11) (.06) (.10) (.04) Net realized gains ........................................ (.43) (.43) (1.41) (.58) (.22) ------------------------------------------------------------- Total distributions ........................................ (.50) (.54) (1.47) (.68) (.26) ------------------------------------------------------------- Net asset value, end of year ............................... $20.02 $15.92 $16.63 $16.32 $13.05 ------------------------------------------------------------- Total return b ............................................. 28.87% (1.20)% 11.15% 31.08% 3.75% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............................ $141,233 $105,451 $106,248 $94,851 $88,773 Ratios to average net assets:* Expenses c ................................................ 2.13% 2.07% 2.09% 2.23% 2.06% Expenses, excluding waiver and payments by affiliate c .... 2.13% 2.07% 2.09% 2.23% 2.19% Net investment income ..................................... .28% .49% .43% .67% .18% Portfolio turnover rate .................................... 25.78% 40.17% 83.41% 53.65% 81.81% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .................................................. 2.11% 2.07% 2.08% 2.22% 2.04% Expenses, excluding waiver and payments by affiliate ...... 2.11% 2.07% 2.08% 2.22% 2.17% a Based on average daily shares outstanding. b Total return does not reflect the sales commissions or the contingent deferred sales charge, and is not annualized for periods less than one year. c Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect consistent operating expenses.
18 | See notes to financial statements. | Annual Report Mutual Financial Services Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003
--------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES VALUE --------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS 87.7% COMMERCIAL BANKS 30.0% Allied Irish Banks PLC .................................. Irish Republic 781,200 $ 12,494,470 Anglo Irish Bank Corp. PLC .............................. Irish Republic 451,240 7,154,499 Bank Mutual Corp. ....................................... United States 788,100 8,976,459 Bank of Ireland ......................................... Irish Republic 629,940 8,573,477 Banknorth Group Inc. .................................... United States 126,432 4,112,833 Bolig-og Naeringsbanken ................................. Norway 95,000 3,327,171 City National Corp. ..................................... United States 106,753 6,631,496 Comerica Inc. ........................................... United States 60,000 3,363,600 Danske Bank ............................................. Denmark 464,400 10,895,776 DNB Holding ASA ......................................... Norway 2,341,420 15,643,957 First Community Bancorp ................................. United States 345,160 12,474,083 First Niagara Financial Group Inc. ...................... United States 522,753 7,794,247 First State Bancorp. .................................... United States 140,900 4,896,275 Fleet Boston Financial Corp. ............................ United States 107,700 4,701,105 a Franklin Bank Corp. Houston ............................. United States 35,100 666,900 Hibernia Corp., A ....................................... United States 286,600 6,737,966 KeyCorp ................................................. United States 276,000 8,092,320 a,b Nippon Investment LLC ................................... Japan 797,000 302,860 Pacific Crest Capital Inc. .............................. United States 200,000 5,170,000 PNC Financial Services Group ............................ United States 97,900 5,358,067 Prosperity Bancshares Inc. .............................. United States 164,837 3,712,129 Southtrust Corp. ........................................ United States 117,100 3,832,683 a,b,c State National Bancshares Inc. .......................... United States 507,936 10,158,720 Taylor Capital Group Inc. ............................... United States 148,456 3,953,383 a Texas Capital Bancshares Inc. ........................... United States 314,000 4,541,068 U.S. Bancorp ............................................ United States 69,173 2,059,972 Unionbancal Corp. ....................................... United States 113,000 6,502,020 Wachovia Corp. .......................................... United States 119,100 5,548,869 ------------- 177,676,405 ------------- COMMERCIAL SERVICES & SUPPLIES 1.1% a Integrated Alarm Services ............................... United States 799,800 6,798,300 ------------- CONSUMER FINANCE 1.5% MCG Capital Corp. ....................................... United States 445,700 8,691,150 a Union Acceptance Corp., A ............................... United States 1,198,600 71,916 ------------- 8,763,066 ------------- DIVERSIFIED FINANCIAL SERVICES 7.5% a,b A.B. Watley Group Inc. .................................. United States 128,365 23,106 Citigroup Inc. .......................................... United States 177,000 8,591,580 a,b Elephant Capital Holdings Ltd. .......................... Japan 2,064 2,064,000 Euronext ................................................ Netherlands 472,200 11,953,902 a Irish Life & Permanent PLC .............................. Irish Republic 438,900 7,058,495 a,b Leucadia National Corp. ................................. United States 87,450 3,829,873 Luminent Mortgage Capital Inc. .......................... United States 417,500 5,886,750 c Oxford Financial ........................................ United States 500,000 4,750,000 ------------- 44,157,706 -------------
Annual Report | 19 Mutual Financial Services Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES VALUE --------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS (CONT.) INSURANCE 22.5% a Berkshire Hathaway Inc., A .............................. United States 113 $ 9,520,250 a Berkshire Hathaway Inc., B .............................. United States 134 377,210 Hartford Financial Services Group Inc. .................. United States 159,000 9,385,770 IPC Holdings Ltd. ....................................... Bermuda 162,800 6,339,432 John Hancock Financial Services Inc. .................... United States 22,600 847,500 a,c Meadowbrook Insurance Group Inc. ........................ United States 1,954,000 8,265,420 MetLife Inc. ............................................ United States 160,270 5,396,291 Montpelier Re Holdings Ltd. ............................. Bermuda 163,300 5,993,110 a Montpelier Re Holdings Ltd. ............................. Bermuda 16,975 622,983 Nationwide Financial Services Inc., A ................... United States 180,700 5,973,942 Old Republic International Corp. ........................ United States 403,200 10,225,152 a,b Olympus Re Holdings Ltd. ................................ Bermuda 7,480 1,183,112 Prudential Financial Inc. ............................... United States 173,600 7,251,272 Safety Insurance Group Inc. ............................. United States 404,100 6,914,151 Sampo OYJ, A ............................................ Finland 662,700 6,854,364 Scottish Re Group Ltd. .................................. Cayman Islands 384,200 7,983,676 Travelers Property Casualty Corp., A .................... United States 569,549 9,557,032 Travelers Property Casualty Corp., B .................... United States 16,599 281,685 United Fire & Casualty Co. .............................. United States 16,838 679,582 a United National Group Ltd. .............................. United States 402,000 7,103,340 White Mountains Insurance Group Inc. .................... United States 25,300 11,636,735 b White Mountains Insurance Group Inc. .................... United States 14,148 6,182,004 Willis Group Holdings Ltd. .............................. United States 142,300 4,848,161 ------------- 133,422,174 ------------- IT SERVICES .1% Comdisco Contingent Equity Distribution ................. United States 4,645,036 17,187 a Comdisco Holding Co. Inc. ............................... United States 5 200 a Concord EFS Inc. ........................................ United States 34,800 516,432 ------------- 533,819 ------------- REAL ESTATE 8.1% American Financial Realty Trust ......................... United States 353,400 6,025,470 a Bimini Mortgage Management Inc. ......................... United States 433,000 6,495,000 a Falcon Financial Investment Trust ....................... United States 894,000 8,761,200 a Fieldstone Investment Corp. ............................. United States 509,700 8,537,475 Friedman Billings Ramsey Group Inc., A .................. United States 382,600 8,830,408 iStar Financial Inc. .................................... United States 197,300 7,674,970 Luminent Mortgage Capital Inc. .......................... United States 132,000 1,861,200 ------------- 48,185,723 ------------- THRIFTS & MORTGAGE FINANCE 16.9% Astoria Financial Corp. ................................. United States 235,700 8,768,040 Brookline Bancorp Inc. .................................. United States 359,500 5,514,730 Commercial Federal Corp. ................................ United States 192,900 5,152,359 a Franklin Bank Corp., 144A ............................... United States 300,000 5,700,000 Freddie Mac ............................................. United States 175,800 10,252,656 Golden West Financial Corp. ............................. United States 37,400 3,859,306 Greenpoint Financial Corp. .............................. United States 68,179 2,408,082
20 | Annual Report Mutual Financial Services Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
--------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES VALUE --------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS (CONT.) THRIFTS & MORTGAGE FINANCE (CONT.) a Hawthorne Financial Corp. .............................. United States 125,695 $ 3,516,946 Hudson City Bancorp Inc. ............................... United States 251,498 9,602,194 PMI Group Inc. ......................................... United States 93,500 3,481,005 a Saxon Capital Inc. ..................................... United States 693,800 14,535,110 Sovereign Bancorp Inc. ................................. United States 958,800 22,771,500 Waypoint Financial Corp. ............................... United States 198,730 4,310,454 ------------- 99,872,382 ------------- TOTAL COMMON STOCKS (COST $377,646,925) ................ 519,409,575 ------------- PREFERRED STOCKS 1.4% INSURANCE .1% United Fire & Casualty Co., 6.375%, cvt. pfd. .......... United States 13,900 403,100 ------------- REAL ESTATE 1.3% Istar Financial Inc., pfd. ............................. United States 297,958 7,717,112 ------------- TOTAL PREFERRED STOCKS (COST $7,796,450) ............... 8,120,212 ------------- ---------------- PRINCIPAL AMOUNT ---------------- CORPORATE BONDS & NOTES 2.5% a,b FE Capital LLC, 5.00%, 8/28/07 ......................... Japan $ 6,162,000 6,285,240 Providian Capital I, 9.525%, 2/01/27, 144A ............. United States 1,000,000 940,000 Providian Financial Corp., cvt., zero cpn., 2/15/21 .... United States 15,654,000 7,474,785 ------------- TOTAL CORPORATE BONDS & NOTES (COST $9,909,115) ........ 14,700,025 ------------- GOVERNMENT AGENCIES 7.6% d Federal Home Loan Bank, 0.75% to 1.42%, with maturities to 11/24/04 ............................ United States 27,488,000 27,368,500 Federal Home Loan Mortgage Corp., 1.286% to 1.302%, with maturities to 4/22/04 ............................................. United States 4,500,000 4,487,831 Federal National Mortgage Association, 1.010% to 1.286%, with maturities to 4/30/04 ............................................. United States 10,000,000 9,984,426 U.S. Treasury Bills, 1.035%, 5/06/04 ................... United States 3,000,000 2,990,730 ------------- TOTAL GOVERNMENT AGENCIES (COST $44,801,807) ........... 44,831,487 ------------- TOTAL INVESTMENTS (COST $440,154,297) 99.2% ............ 587,061,299 SECURITIES SOLD SHORT (1.0)% ........................... (6,209,508) NET EQUITY IN FORWARD CONTRACTS (.6)% .................. (3,328,576) OTHER ASSETS, LESS LIABILITIES 2.4% .................... 14,256,908 ------------- NET ASSETS 100.0% ...................................... $591,780,123 -------------
Annual Report | 21 Mutual Financial Services Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2003 (CONTINUED)
-------------------------------------------------------- SECURITIES SOLD SHORT COUNTRY SHARES VALUE -------------------------------------------------------- ISSUER CAPITAL MARKETS e Lehman Brothers Holdings Inc. ........................... United States 1,359 $ 104,942 ------------- COMMERCIAL BANKS .8% e Bank of America Corp. ................................... United States 59,700 4,801,671 ------------- INSURANCE .1% e Manulife Financial Corp. ................................ Canada 26,700 862,410 ------------- IT SERVICES .1% e First Data Corp. ........................................ United States 10,720 440,485 ------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $5,850,341) ....... $ 6,209,508 ------------- -------------------------------------------------------------------- VALUE AT UNREALIZED SYNTHETIC EQUITY SWAPS (SES) COUNTRY SHARES 12/31/03 GAIN/LOSS -------------------------------------------------------------------- ISSUER INSURANCE f AXA SA, ses., 15.850 EUR ..................... France 2,051 $ 43,902 $ 2,817 f AXA SA, ses., 15.870 EUR ..................... France 500 10,703 674 f AXA SA, ses., 16.700 EUR ..................... France (2,051) (43,902) (784) f AXA SA, ses., 16.770 EUR ..................... France (500) (10,703) (147) -------------------------------- TOTAL SYNTHETIC EQUITY SWAPS $ -- $ 2,560 -------------------------------- a Non-income producing. b See Note 7 regarding restricted securities. c See Note 8 regarding Holdings of 5% Voting Securities. d See Note 1(f) regarding securities segregated with broker for securities sold short. e See Note 1(f) regarding securities sold short. f See Note 1(d) regarding synthetic equity swaps.
22 | See notes to financial statements. | Annual Report Mutual Financial Services Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2003
Assets: Investments in securities: Cost - Unaffiliated issuers ............................................. $422,669,699 Cost - Non-controlled affiliated issuers ................................ 17,484,598 ------------- Value - Unaffiliated issuers (includes securities segregated with broker for securities sold short in the amount of $3,091,857) ......... 563,887,159 Value - Non-controlled affiliated issuers ............................... 23,174,140 Cash ..................................................................... 185,062 Foreign currency, at value (cost $833,495) ............................... 873,363 Receivables: Investment securities sold .............................................. 4,998,406 Capital shares sold ..................................................... 1,402,738 Dividends and interest .................................................. 1,171,315 Deposits with broker for securities sold short ........................... 7,789,963 Due from brokers - variation margin (Note 1d) ............................ 3,031 Unrealized gain on forward exchange contracts (Note 6) ................... 19,548 ------------- Total assets ........................................................ 603,504,725 ------------- Liabilities: Payables: Investment securities purchased ......................................... 289,438 Capital shares redeemed ................................................. 810,649 Affiliates .............................................................. 959,317 Dividends on securities sold short ...................................... 50,441 Securities sold short, at value (proceeds $5,850,341) .................... 6,209,508 Unrealized loss on forward exchange contracts (Note 6) ................... 3,348,124 Other liabilities ........................................................ 57,125 ------------- Total liabilities ................................................... 11,724,602 ------------- Net assets, at value ................................................ $591,780,123 ------------- Net assets consist of: Accumulated distributions in excess of net investment income ............. $ (568,646) Net unrealized appreciation (depreciation) ............................... 143,301,418 Accumulated net realized gain (loss) ..................................... 11,976,503 Capital shares ........................................................... 437,070,848 ------------- Net assets, at value ................................................ $591,780,123 -------------
Annual Report | 23 Mutual Financial Services Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2003
CLASS Z: Net asset value and maximum offering price per share ($151,918,128 (DIVIDE) 7,574,286 shares outstanding) .............. $20.06 ------------ CLASS A: Net asset value per share ($264,410,753 (DIVIDE) 13,167,107 shares outstanding) ............................................... $20.08 ------------ Maximum offering price per share ($20.08 (DIVIDE) 94.25%) .......... $21.31 ------------ CLASS B: Net asset value and maximum offering price per share ($34,218,685 (DIVIDE) 1,731,637 shares outstanding) a ............. $19.76 ------------ CLASS C: Net asset value per share ($141,232,557 (DIVIDE) 7,054,660 shares outstanding) a ............................................. $20.02 ------------ Maximum offering price per share ($20.02 (DIVIDE) 99.00%) .......... $20.22 ------------ a Redemption price is equal to net asset value less any applicable contingent deferred sales charge.
24 | See notes to financial statements. | Annual Report Mutual Financial Services Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2003 Investment income: (net of foreign taxes of $372,603) Dividends: Dividends - Unaffiliated issuers ............................. $ 9,393,778 Dividends - Non-controlled affiliated issuers (Note 8) ....... 260,000 Interest ...................................................... 1,950,768 ------------- Total investment income .................................. 11,604,546 ------------- Expenses: Management fees (Note 3) ...................................... 3,847,081 Administrative fees (Note 3) .................................. 375,837 Distribution fees (Note 3) Class A ...................................................... 751,357 Class B ...................................................... 257,578 Class C ...................................................... 1,171,440 Transfer agent fees (Note 3) .................................. 928,000 Custodian fees ................................................ 27,500 Reports to shareholders ....................................... 69,500 Registration and filing fees .................................. 61,600 Professional fees ............................................. 10,040 Directors' fees and expenses .................................. 21,500 Dividends on securities sold short ............................ 102,066 Other ......................................................... 9,600 ------------- Total expenses ........................................... 7,633,099 ------------- Net investment income .................................. 3,971,447 ------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Unaffiliated issuers ......................................... 31,230,189 Written options (Note 1e) .................................... 44,521 Securities sold short (Note 1f) .............................. 96,610 Foreign currency transactions ................................ (7,485,491) ------------- Net realized gain (loss) ............................... 23,885,829 ------------- Net unrealized appreciation (depreciation) on: Investments .................................................. 103,356,025 Translation of assets and liabilities denominated in foreign currencies ...................................... (46,722) ------------- Net unrealized appreciation (depreciation) ............. 103,309,303 ------------- Net realized and unrealized gain (loss) ........................ 127,195,132 ------------- Net increase (decrease) in net assets resulting from operations .................................... $131,166,579 ------------- Annual Report | See notes to financial statements. | 25 Mutual Financial Services Fund FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF CHANGES IN NET ASSETS for the years ended December 31, 2003 and 2002 ------------------------------ 2003 2002 ------------------------------ Increase (decrease) in net assets: Operations: Net investment income ........................................... $ 3,971,447 $ 4,355,421 Net realized gain (loss) from investments, written options, securities sold short, and foreign currency transactions ...... 23,885,829 4,385,097 Net unrealized appreciation (depreciation) on investments and translation of assets and liabilities denominated in foreign currencies ......................................... 103,309,303 (16,745,287) ------------------------------ Net increase (decrease) in net assets resulting from operations ............................................. 131,166,579 (8,004,769) Distributions to shareholders from: Net investment income: Class Z ........................................................ (1,738,495) (1,781,340) Class A ........................................................ (2,265,228) (2,419,541) Class B ........................................................ (133,901) (178,278) Class C ........................................................ (454,311) (731,472) Net realized gains: Class Z ........................................................ (3,178,326) (2,765,546) Class A ........................................................ (5,516,492) (5,109,739) Class B ........................................................ (722,331) (472,046) Class C ........................................................ (2,956,429) (2,930,633) ------------------------------ Total distributions to shareholders .............................. (16,965,513) (16,388,595) Capital share transactions (Note 2): Class Z ......................................................... 17,712,321 13,230,350 Class A ......................................................... 33,006,442 23,924,569 Class B ......................................................... 7,339,662 10,991,263 Class C ......................................................... 8,335,815 5,132,582 ------------------------------ Total capital share transactions ................................. 66,394,240 53,278,764 Net increase (decrease) in net assets ........................ 180,595,306 28,885,400 Net assets: Beginning of year ................................................ 411,184,817 382,299,417 ------------------------------ End of year ...................................................... $591,780,123 $411,184,817 ------------------------------ Accumulated distributions in excess of net investment income included in net assets: End of year ...................................................... $ (568,646) $ (333,534) ------------------------------
26 | See notes to financial statements. | Annual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Mutual Financial Services Fund (the Fund) is a separate, nondiversified series of Franklin Mutual Series Fund, Inc. (the Series Fund), which is an open-end investment company registered under the Investment Company Act of 1940. The Fund seeks long-term capital appreciation by investing approximately 80% of its assets in securities issued by companies in the financial services industry. 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 last 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. Investments in open-end mutual funds are valued at the closing net asset value. Foreign securities are valued at the close of trading of the foreign exchange or the NYSE, whichever is earlier. If events occur that materially affect the values of securities after the prices or foreign exchange rates are determined, or if market quotations are not readily available, the securities will be valued at fair value as determined following procedures approved by the Board of Directors. 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. FOREIGN CURRENCY CONTRACTS The Fund may enter into forward exchange contracts to hedge against fluctuations in foreign exchange rates. A forward exchange contract is an agreement between two parties to exchange different currencies at an agreed upon exchange rate at a future date. These contracts are valued daily and the Fund's equity therein is included in the Statement of Assets and Liabilities. Realized and unrealized gains and losses are included in the Statement of Operations. Annual Report | 27 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) C. FOREIGN CURRENCY CONTRACTS (CONTINUED) When the Fund purchases or sells foreign securities it may enter into foreign exchange contracts to minimize foreign exchange risk from the trade date to the settlement date of the transactions. Realized and unrealized gains and losses are included in the Statement of Operations. The risks of these contracts include movement in the values of the foreign currencies relative to the U.S. dollar and the possible inability of the counterparties to fulfill their obligations under the contracts. D. SYNTHETIC EQUITY SWAPS The Fund may engage in synthetic equity swaps. Synthetic equity swaps are contracts entered into between a broker and the Fund under which the parties agree to make payments to each other so as to replicate the economic consequences that would apply had a short sale of the underlying security taken place. Upon entering into synthetic equity swaps, the Fund is required to pledge the broker an amount of cash and/or other assets equal to a certain percentage of the contract amount ("initial margin"). Subsequent payments known as "variation margin", are made or received by the Fund periodically, depending on fluctuations in the value of the underlying security. When the contract is closed, the Fund records a realized gain or loss equal to the difference between the value of the contract at the time it was opened and the value at the time it was closed. The risks of entering into equity swaps include unfavorable price movements in the underlying securities or the inability of the counterparties to fulfill their obligations under the contract. E. OPTION CONTRACTS The Fund may purchase or write options. Options are contracts entitling the holder to purchase or sell a specified number of shares or units of a particular security at a specified price. Options purchased are recorded as investments; options written (sold) are recorded as liabilities. When the exercise of an option results in a cash settlement, the difference between the premium (original option value) and the settlement proceeds is realized as a gain or loss. When securities are acquired or delivered upon exercise of an option, the acquisition cost or sale proceeds are adjusted by the amount of the premium. When an option is closed, the difference between the premium and the cost to close the position is realized as a gain or loss. When an option expires, the premium is realized as a gain for options written or as a loss for options purchased. The risks include the possibility there may be an illiquid options market or the inability of the counterparties to fulfill their obligations under the contract. Writing options involves, to varying degrees, elements of market risk in excess of the amount recognized in the Statement of Assets and Liabilities. 28 | Annual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) F. SECURITIES SOLD SHORT The Fund is engaged in selling securities short, which obligates the Fund to replace a borrowed security with the same security at current market value. The Fund would incur a loss 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. The Fund would realize a gain if the price of the security declines between those dates. A gain, limited to the price at which the Fund sold the security short, or a loss, unlimited in size, will be recognized upon the termination of a short sale. The Fund is required to establish a margin account with the broker lending the security sold short. While the short sale is outstanding, the broker retains the proceeds of the short sale and the Fund must maintain a deposit for the broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. G. SECURITIES LENDING The Fund loans securities to certain brokers for which it received collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. H. 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. I. 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. Discounts on securities purchased are amortized over the lives of the respective securities. Dividend income, dividends declared on securities sold short, and distributions to shareholders are recorded on the ex-dividend date. 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. Common expenses incurred by the Series Fund are allocated among the funds comprising the Series Fund 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. Annual Report | 29 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) J. SECURITIES PURCHASED ON A WHEN-ISSUED OR DELAYED BASIS The Fund may purchase securities on a when-issued or delayed delivery basis, with payment and delivery scheduled for a future date. These transactions are subject to market fluctuations and are subject to the risk that the value at delivery may be more or less than the trade date purchase price. Although the Fund will generally purchase these securities with the intention of holding the securities, it may sell the securities before the settlement date. Sufficient assets have been segregated for these securities. K. 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. L. GUARANTEES AND INDEMNIFICATIONS Under the Fund's organizational documents, its officers and trustees are indemnified against certain liability arising out of the performance of their duties to the Fund. Additionally, in the normal course of business, the Fund enters into contracts with service providers that contain general indemnification clauses. The Fund's maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Fund that have not yet occurred. However, based on experience, the Fund expects the risk of loss to be remote. 2. CAPITAL STOCK The Fund offers four classes of shares: Class Z, Class A, Class B, and Class C shares. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class, and its exchange privilege. At December 31, 2003, there were 500 million shares authorized ($0.001 par value) of which 200 million, 100 million, 100 million, and 100 million were designated as Class Z, Class A, Class B, and Class C shares, respectively. Transactions in the Fund's shares were as follows:
----------------------------------------------------------- YEAR ENDED YEAR ENDED DECEMBER 31, 2003 DECEMBER 31, 2002 ----------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT ----------------------------------------------------------- CLASS Z SHARES: Shares sold ................................. 1,693,414 $ 29,027,937 2,148,607 $ 36,892,706 Shares issued on reinvestment of distributions .............................. 231,979 4,549,166 250,458 4,228,784 Shares redeemed ............................. (924,342) (15,864,782) (1,652,029) (27,891,140) ----------------------------------------------------------- Net increase (decrease) ..................... 1,001,051 $ 17,712,321 747,036 $ 13,230,350 -----------------------------------------------------------
30 | Annual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED)
--------------------------------------------------------------------------- YEAR ENDED YEAR ENDED DECEMBER 31, 2003 DECEMBER 31, 2002 --------------------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT --------------------------------------------------------------------------- CLASS A SHARES: Shares sold ................................. 4,956,672 $ 86,814,316 6,682,381 $115,275,042 Shares issued on reinvestment of distributions .............................. 366,907 7,205,438 410,095 6,986,545 Shares redeemed ............................. (3,460,727) (61,013,312) (5,865,191) (98,337,018) --------------------------------------------------------------------------- Net increase (decrease) ..................... 1,862,852 $ 33,006,442 1,227,285 $ 23,924,569 --------------------------------------------------------------------------- CLASS B SHARES: Shares sold ................................. 613,375 $ 10,682,088 884,232 $ 14,974,982 Shares issued on reinvestment of distributions .............................. 40,714 787,759 35,025 587,703 Shares redeemed ............................. (243,494) (4,130,185) (278,970) (4,571,422) --------------------------------------------------------------------------- Net increase (decrease) ..................... 410,595 $ 7,339,662 640,287 $ 10,991,263 --------------------------------------------------------------------------- CLASS C SHARES: Shares sold ................................. 1,711,334 $ 30,364,131 1,953,905 $ 33,714,362 Shares issued on reinvestment of distributions .............................. 155,752 3,053,003 193,936 3,322,028 Shares redeemed ............................. (1,437,646) (25,081,319) (1,911,802) (31,903,808) --------------------------------------------------------------------------- Net increase (decrease) ..................... 429,440 $ 8,335,815 236,039 $ 5,132,582 ---------------------------------------------------------------------------
3. TRANSACTIONS WITH AFFILIATES Certain officers of the Fund are also officers and/or directors of Franklin Mutual Advisers, LLC (Franklin Mutual) and Franklin Templeton Services, LLC (FT Services), the Fund's investment manager and administrative manager, respectively. Franklin/Templeton Investor Services, LLC (Investor Services) and Franklin/Templeton Distributors, Inc. (Distributors), are the Fund's transfer agent and principal underwriter, respectively. The Fund pays an investment management fee to Franklin Mutual of .80% per year of the average daily net assets of the Fund. The Fund pays its allocated share of an administrative fee to FT Services based on the Series Fund's aggregated average daily net assets as follows: ---------------------------------------------------------------------------- ANNUALIZED FEE RATE MONTH-END NET ASSETS ---------------------------------------------------------------------------- 0.150% First $200 million 0.135% Over $200 million, up to and including $700 million 0.100% Over $700 million, up to and including $1.2 billion 0.075% Over $1.2 billion Annual Report | 31 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) The Fund reimburses Distributors for costs incurred in marketing the Fund's shares up to .35%, 1.00%, and 1.00% per year of the average daily net assets of Class A, Class B and Class C shares, respectively. Distributors received net commissions from sales of those shares and received contingent deferred sales charges for the period of $131,560 and $50,080, respectively. The Fund paid transfer agent fees of $928,000, of which $652,275 was paid to Investor Services. 4. INCOME TAXES At December 31, 2003, the cost of investments, net unrealized appreciation (depreciation), undistributed ordinary income and undistributed long term capital gains for income tax purposes were as follows: Cost of investments ................................... $441,742,999 ------------- Unrealized appreciation ............................... 152,805,727 Unrealized depreciation ............................... (7,487,427) ------------- Net unrealized appreciation (depreciation) ............ $145,318,300 ------------- Undistributed ordinary income ......................... $ 246,464 Undistributed long term capital gains ................. 9,678,438 ------------- Distributable earnings ................................ $ 9,924,902 ------------- The tax character of distributions paid during the years ended December 31, 2003 and 2002, was as follows: --------------------------------- 2003 2002 --------------------------------- Distributions paid from: Ordinary income ........................ $ 4,591,935 $ 6,885,205 Long term capital gain ................. 12,373,578 9,503,390 --------------------------------- $16,965,513 $16,388,595 --------------------------------- Net investment income (loss) differs for financial statement and tax purposes primarily due to differing treatments of foreign currency transactions and bond discounts and premiums. Net realized gains/losses differ for financial statement and tax purposes primarily due to differing treatments of wash sales, foreign currency transactions and bond discounts and premiums. At December 31, 2003, the Fund had deferred currency losses occurring subsequent to October 31, 2003 of $523. For tax purposes, such losses will be reflected in the year ending December 31, 2004. 32 | Annual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. INVESTMENT TRANSACTIONS Purchases and sales of securities (excluding short-term securities and securities sold short) for the year ended December 31, 2003 aggregated $204,629,247 and $100,625,726 respectively. Transactions in options written during the year ended December 31, 2003 were as follows: -------------------------------- NUMBER OF CONTRACTS PREMIUM -------------------------------- Options outstanding at December 31, 2002 .................... 2,200 $ 2,771 Options written ....................... 4,378 62,615 Options expired ....................... (3,395) (39,364) Options terminated in closing transactions ......................... (2,217) (7,452) Options exercised ..................... (966) (18,570) -------------------------------- Options outstanding at December 31, 2003 .................... -- $ -- -------------------------------- 6. FORWARD EXCHANGE CONTRACTS At December 31, 2003, the Fund has outstanding forward exchange contracts as set out below. The contracts are reported in the financial statements at the Fund's net equity, as measured by the difference between the forward exchange rates at the reporting date and the forward exchange rates at the day of entry into the contracts.
-------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO BUY: EXCHANGE FOR DATE GAIN (LOSS) -------------------------------------------------------------------------------------------------- 6,300,000 Japanese Yen .................. U.S. $ 56,804 3/25/04 U.S. $ 2,139 1,809,873 Norwegian Krone ............... 253,725 4/15/04 17,409 ----------- ------------ U.S. $ 310,529 19,548 ----------- ------------ Unrealized gain on forward exchange contracts ............................... U.S. $ 19,548 ------------ -------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO SELL: EXCHANGE FOR DATE GAIN (LOSS) -------------------------------------------------------------------------------------------------- 19,800,096 European Unit ................. U.S. $23,545,459 3/11/04 U.S. $(1,380,440) 59,392,136 Danish Krona .................. 9,782,278 3/17/04 (256,395) 240,584,402 Japanese Yen .................. 2,100,000 3/18/04 (150,450) 817,783 European Unit ................. 956,336 3/25/04 (72,760) 41,323,904 Japanese Yen .................. 370,951 3/25/04 (15,682) 111,898,755 Norwegian Krone ............... 15,723,643 4/15/04 (1,039,736) 2,849,751 European Unit ................. 3,308,561 4/22/04 (274,972) 50,000,000 Japanese Yen .................. 450,248 6/24/04 (18,985) ----------- ------------ U.S. $56,237,476 (3,209,420) ----------- ------------ Net unrealized loss on offsetting forward exchange contracts ................ (138,704) ------------ Unrealized loss on forward exchange contracts ............................... (3,348,124) ------------ Net unrealized loss on forward exchange contracts .................... U.S. $(3,328,576) ------------
Annual Report | 33 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. RESTRICTED SECURITIES At December 31, 2003, investments in securities included issues that are restricted or illiquid. Restricted securities are often purchased in private placement transactions, are not registered under the Securities Act of 1933, may have contractual restrictions on resale, and are valued under methods approved by the Board of Directors as reflecting fair value. A security may also be considered illiquid if it lacks a readily available market or if its valuation has not changed for a certain period of time. At December 31, 2003, the Fund held investments in restricted and illiquid securities that were valued under approved methods by the Directors, as follows:
-------------------------------------------------------------------------------------------------------------------- SHARES OR ACQUISITION PRINCIPAL AMOUNT ISSUER DATE COST VALUE -------------------------------------------------------------------------------------------------------------------- 128,365 A.B. Watley Group Inc. ....................... 4/2/01 $ 407,560 $ 23,106 2,064 Elephant Capital Holdings Ltd. ............... 8/29/03 2,064,000 2,064,000 6,162,000 FE Capital LLC, 5%, 8/28/07 .................. 8/29/03 6,046,985 6,285,240 87,450 Leucadia National Corp. ...................... 12/20/02 3,082,613 3,829,873 797,000 Nippon Investment LLC ........................ 2/14/01 -- 302,860 7,480 Olympus Re Holdings Ltd. ..................... 12/19/01 748,000 1,183,112 507,936 State National Bancshares Inc. ............... 6/8/98 7,333,326 10,158,720 14,148 White Mountains Insurance Group Inc. ......... 10/22/02 4,173,660 6,182,004 ------------ TOTAL RESTRICTED SECURITIES (5.07% OF NET ASSETS) ................................................. $30,028,915 ------------
8. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The Investment Company Act of 1940 defines "affiliated companies" to include investments in portfolio companies in which a fund owns 5% or more of the outstanding voting securities. Investments in "affiliated companies" for the Fund at December 31, 2003 were as shown below.
---------------------------------------------------------------------------------------------------------------------------------- NUMBER OF NUMBER OF INVESTMENT REALIZED SHARES HELD SHARES HELD VALUE INCOME CAPITAL GAIN DEC. 31, GROSS GROSS DEC. 31, DEC. 31, 1/1/03- 1/1/03- NAME OF ISSUER 2002 ADDITIONS REDUCTIONS 2003 2003 12/31/03 12/31/03 ---------------------------------------------------------------------------------------------------------------------------------- NON-CONTROLLED AFFILIATES Meadowbrook Insurance Group Inc. ..................... 1,298,400 655,600 -- 1,954,000 $ 8,265,420 $ -- $-- Oxford Financial ................. 500,000 -- -- 500,000 4,750,000 260,000 -- State National Bancshares Inc. ........................... 507,936 -- -- 507,936 10,158,720 -- -- ---------------------------------------- TOTAL NON-CONTROLLED AFFILIATES ...................................................... $23,174,140 $260,000 $-- ----------------------------------------
9. INVESTMENTS IN FRANKLIN INSTITUTIONAL FIDUCIARY TRUST MONEY MARKET PORTFOLIO The Fund may invest in the Franklin Institutional Fiduciary Trust Money Market Portfolio (the Sweep Money Fund), an open-end investment company managed by Franklin Advisers Inc. (an affiliate of the investment manager). Management fees paid by the Fund are reduced on assets invested in the Sweep Money Fund, in an amount not to exceed the management fees paid by the Sweep Money Fund. The Fund earned $29,902 of dividend income from investment in the Sweep Money Fund for the year ended December 31, 2003. 34 | Annual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 10. REGULATORY MATTERS On February 4, 2004, the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts filed an administrative complaint against Franklin Resources, Inc. and certain of its subsidiaries (the "Company"), alleging violations of the Massachusetts Uniform Securities Act. The complaint arises from activity that occurred in 2001 during which time an officer of a Company subsidiary was negotiating an agreement with an investor relating to investments in a mutual fund and a hedge fund. The Fund, in addition to other entities within Franklin Templeton Investments, including the Company and other funds, has been named in shareholder class actions related to the matter described above. The Fund's management believes that the claims made in the lawsuit are without merit and it intends to defend vigorously against the allegations. It is anticipated that the Fund may be named in additional similar civil actions related to the matter described above. In addition, as part of ongoing investigations by the U.S. Securities and Exchange Commission (the "SEC"), the U.S. Attorney for the Northern District of California, the New York Attorney General, the California Attorney General, the U.S. Attorney for the District of Massachusetts, the Florida Department of Financial Services, and the Commissioner of Securities and the Attorney General of the State of West Virginia, relating to certain practices in the mutual fund industry, including late trading, market timing and sales compensation arrangements, the Company and its subsidiaries, as well as certain current or former executives and employees of the Company, have received requests for information and/or subpoenas to testify or produce documents. The Company and its current employees are providing documents and information in response to these requests and subpoenas. In addition, the Company has responded to requests for similar kinds of information from regulatory authorities in some of the foreign countries where the Company conducts its global asset management business. The Staff of the SEC has informed the Company that it intends to recommend that the Commission authorize an action against an affiliate of the Fund's adviser and a senior executive officer relating to the frequent trading issues that are the subject of the SEC's investigation. These issues were previously disclosed as being under investigation by government authorities and the subject of an internal inquiry by the Company in its Annual Report on Form 10-K and on its public website. The Company currently is in discussions with the SEC Staff in an effort to resolve the issues raised in their investigation. Such discussions are preliminary and the Fund's management has been advised that the Company cannot predict the likelihood of whether those discussions will result in a settlement and, if so, the terms of such settlement. The impact, if any, of these matters on the Fund is uncertain at this time. If the Company finds that it bears responsibility for any unlawful or improper conduct, it has committed to making the Fund or its shareholders whole, as appropriate. Annual Report | 35 Mutual Financial Services Fund REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS TO THE BOARD OF DIRECTORS OF FRANKLIN MUTUAL SERIES FUND INC. AND SHAREHOLDERS OF MUTUAL FINANCIAL SERVICES FUND We have audited the accompanying statement of assets and liabilities, including the statement of investments, of the Mutual Financial Services Fund (one of the portfolios constituting the Franklin Mutual Series Fund Inc. [the Fund]) as of December 31, 2003, and the related statement of operations for the year then ended, the statements of changes in net assets for each of the two years in the period then ended, and the financial highlights for each of the periods indicated therein. These financial statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights. Our procedures included confirmation of securities owned at December 31, 2003, by correspondence with the custodian and brokers or by other appropriate auditing procedures where replies from brokers were not received. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of the Mutual Financial Services Fund of the Franklin Mutual Series Fund Inc. as of December 31, 2003, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the periods indicated therein, in conformity with accounting principles generally accepted in the United States. Boston, Massachusetts February 4, 2004 36 | Annual Report Mutual Financial Services Fund TAX DESIGNATION (UNAUDITED) Under Section 854(b)(2) of the Internal Revenue Code, the Fund hereby designates 100% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2003. Under Section 854(b)(2) of the Internal Revenue Code (Code), the Fund hereby designates up to maximum of $8,508,226 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2003. In January 2004, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2003. Shareholders are advised to check with their tax advisors for information on the treatment of these amounts on their individual income tax returns. Under Section 852(b)(3)(C) of the Internal Revenue Code, the Fund hereby designates $22,052,015 as a capital gain dividend for the fiscal year ended December 31, 2003. Annual Report | 37 Board Members and Officers The name, age and address of the officers and board members, as well as their affiliations, positions held with the Fund, principal occupations during the past five years and number of portfolios overseen in the Franklin Templeton Investments fund complex are shown below. Each board member will serve until that person's successor is elected and qualified. INDEPENDENT BOARD MEMBERS
----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ----------------------------------------------------------------------------------------------------------------------------------- EDWARD I. ALTMAN, PH.D. (62) Director Since 1987 7 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Max L. Heine Professor of Finance and Director of The Credit and Debt Markets Research Program, NYU Salomon Center, Stern School of Business, New York University; editor and author of numerous financial publications; and financial consultant; and FORMERLY Vice Director, NYU Salomon Center, Stern School of Business, New York University. ----------------------------------------------------------------------------------------------------------------------------------- ANN TORRE GRANT (45) Director Since 1994 7 Independent Director, SLM, Corporation 51 John F. Kennedy Parkway (Sallie Mae); and Allied Capital Short Hills, NJ 07078 Corporation (financial services). PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Independent strategic and financial consultant; and FORMERLY, Executive Vice President and Chief Financial Officer, NHP Incorporated (manager of multifamily housing) (1995-1997); and Vice President and Treasurer, US Airways, Inc. (until 1995). ----------------------------------------------------------------------------------------------------------------------------------- BURTON J. GREENWALD (74) Director Since 2002 12 Director, Fiduciary Emerging Markets 51 John F. Kennedy Parkway Bond Fund PLC and Fiduciary Short Hills, NJ 07078 International Ireland Limited. PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Managing Director, B.J. Greenwald Associates, management consultants to the financial services industry. ----------------------------------------------------------------------------------------------------------------------------------- BRUCE A. MACPHERSON (73) Director Since 1974 7 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Retired, former Chairman, A.A. MacPherson, Inc., Canton, MA (representative for electrical manufacturers); and part owner McKinstry Inc., Chicopee, MA (manufacturer of electrical enclosures). ----------------------------------------------------------------------------------------------------------------------------------- FRED R. MILLSAPS (74) Director Since 1996 28 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director of various business and nonprofit organizations; manager of personal investments (1978-present); and FORMERLY, Chairman and Chief Executive Officer, Landmark Banking Corporation (1969-1978); Financial Vice President, Florida Power and Light (1965-1969); and Vice President, Federal Reserve Bank of Atlanta (1958-1965). -----------------------------------------------------------------------------------------------------------------------------------
38 | Annual Report
----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ----------------------------------------------------------------------------------------------------------------------------------- CHARLES RUBENS II (73) Director Since 1998 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. ----------------------------------------------------------------------------------------------------------------------------------- LEONARD RUBIN (78) Director Since 1996 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Partner in LDR Equities, LLC (manages personal investments); and FORMERLY, President, F.N.C. Textiles, Inc.; and Chairman of the Board, Carolace Embroidery Co., Inc. (until 1996). ----------------------------------------------------------------------------------------------------------------------------------- ROBERT E. WADE (57) Director Since 1991 7 Director, El Oro Mining and 51 John F. Kennedy Parkway Exploration Co., p.l.c.; and FORMERLY, Short Hills, NJ 07078 Director, El Oro Mining and Exploration Company, p.l.c and The Exploration Company, p.l.c., (until 2003). PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Practicing attorney. ----------------------------------------------------------------------------------------------------------------------------------- INTERESTED BOARD MEMBERS AND OFFICERS ----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ----------------------------------------------------------------------------------------------------------------------------------- **WILLIAM J. LIPPMAN (78) Director Since 1996 18 None One Parker Plaza, 9th Floor Fort Lee, NJ 07024 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Private Client Group, Inc.; President, Franklin Advisory Services, LLC.; and officer and/or director or trustee, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of seven of the investment companies in Franklin Templeton Investments. ----------------------------------------------------------------------------------------------------------------------------------- **ANNE M. TATLOCK (64) Director Since 2002 7 Director, Fortune Brands, Inc. 600 Fifth Avenue, 7th Floor (consumer products) and Merck & New York, NY 10020-2302 Co. Inc. (pharmaceuticals) PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman and Chief Executive Officer, Fiduciary Trust Company International; Vice Chairman, Member - Office of the Chairman and Director, Franklin Resources, Inc.; and officer and/or director of some of the other subsidiaries of Franklin Resources, Inc. -----------------------------------------------------------------------------------------------------------------------------------
Annual Report | 39
----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ----------------------------------------------------------------------------------------------------------------------------------- **DAVID J. WINTERS (41) Director, Director since 7 None 51 John F. Kennedy Parkway President, 2001, President Short Hills, NJ 07078-2702 Chairman of since 1999, the Board and Chairman of the Chief Board and Chief Executive Executive Officer - Officer - Investment Investment Management Management since 2002 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Chief Investment Officer, and Chief Executive Officer, Franklin Mutual Advisers, LLC., and of three of the investment companies in Franklin Templeton Investments. ----------------------------------------------------------------------------------------------------------------------------------- JIMMY D. GAMBILL (56) Senior Vice Since 2002 Not Applicable None 500 East Broward Blvd. President and Suite 2100 Fort Lauderdale, FL Chief 33394-3091 Executive Officer - Finance and Administration PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Franklin Templeton Services, LLC; Senior Vice President, Templeton Worldwide, Inc.; and officer of 51 of the investment companies in Franklin Templeton Investments. ----------------------------------------------------------------------------------------------------------------------------------- DAVID P. GOSS (56) Vice President Since 2000 Not Applicable None One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Associate General Counsel, Franklin Resources, Inc.; officer and director of one of the subsidiaries of Franklin Resources, Inc.; officer of 51 of the investment companies in Franklin Templeton Investments; and FORMERLY, President, Chief Executive Officer and Director, Property Resources Equity Trust (until 1999) and Franklin Select Realty Trust (until 2000). ----------------------------------------------------------------------------------------------------------------------------------- BARBARA J. GREEN (56) Vice President Since 2000 Not Applicable None One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Deputy General Counsel and Secretary, Franklin Resources, Inc.; Secretary and Senior Vice President, Templeton Worldwide, Inc.; Secretary, Franklin Advisers, Inc., Franklin Advisory Services, LLC, Franklin Investment Advisory Services, Inc., Franklin Mutual Advisers, LLC, Franklin Templeton Alternative Strategies, Inc., Franklin Templeton Investor Services, LLC, Franklin Templeton Services, LLC, Franklin Templeton Distributors, Inc., Templeton Investment Counsel, LLC, and Templeton/Franklin Investment Services, Inc.; and officer of some of the other subsidiaries of Franklin Resources, Inc. and of 51 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). -----------------------------------------------------------------------------------------------------------------------------------
40 | Annual Report
----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD ----------------------------------------------------------------------------------------------------------------------------------- MICHAEL O. MAGDOL (66) Vice President Since 2002 Not Applicable Director, FTI Banque, Arch 600 Fifth Avenue - AML Chemicals, Inc. and Lingnan Foundation. Rockefeller Center Compliance New York, NY 10048-0772 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice Chairman, Chief Banking Officer and Director, Fiduciary Trust Company International; and officer and/or director, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of 48 of the investment companies in Franklin Templeton Investments. ----------------------------------------------------------------------------------------------------------------------------------- KIMBERLEY H. MONASTERIO (40) Treasurer and Treasurer and Not Applicable None One Franklin Parkway Chief Financial Chief Financial San Mateo, CA 94403-1906 Officer Officer since 2003 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Templeton Services, LLC; and officer of 51 of the investment companies in Franklin Templeton Investments. ----------------------------------------------------------------------------------------------------------------------------------- MURRAY L. SIMPSON (66) Vice President Since 2000 Not Applicable None One Franklin Parkway and Secretary San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Executive Vice President and General Counsel, Franklin Resources, Inc.; officer and/or director, as the case may be, of some of the subsidiaries of Franklin Resources, Inc. and of 51 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). -----------------------------------------------------------------------------------------------------------------------------------
*We base the number of portfolios on each separate series of the U.S. registered investment companies within the Franklin Templeton Investments fund complex. These portfolios have a common investment adviser or affiliated investment advisers. **William J. Lippman is considered an interested person of Mutual Series under the federal securities laws due to his position as an officer of some of the subsidiaries of Franklin Resources, Inc. (Resources), which is the parent company of Mutual Series' adviser and distributor. Anne M. Tatlock is considered an interested person of Mutual Series under the federal securities laws due to her position as an officer and director of Resources. David J. Winters is considered an interested person of Mutual Series under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC. THE FUND'S BOARD OF DIRECTORS HAS DETERMINED THAT CERTAIN OF THE MEMBERS OF THE AUDIT COMMITTEE, INCLUDING ANN TORRE GRANT, ARE AUDIT COMMITTEE FINANCIAL EXPERTS, AND "INDEPENDENT," UNDER THOSE PROVISIONS OF THE SARBANES-OXLEY ACT OF 2002, AND THE RULES AND FORM AMENDMENTS ADOPTED BY THE SECURITIES AND EXCHANGE COMMISSION, RELATING TO AUDIT COMMITTEE FINANCIAL EXPERTS. THE STATEMENT OF ADDITIONAL INFORMATION (SAI) INCLUDES ADDITIONAL INFORMATION ABOUT THE BOARD MEMBERS AND IS AVAILABLE, WITHOUT CHARGE, UPON REQUEST. SHAREHOLDERS MAY CALL 1-800/DIAL BEN (1-800/342-5236) TO REQUEST THE SAI. Annual Report | 41 Mutual Financial Services Fund PROXY VOTING POLICIES AND PROCEDURES The Fund has established Proxy Voting Policies and Procedures ("Policies") that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund's complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at 1-954/847-2268 or by sending a written request to: Franklin Templeton Companies, LLC, 500 East Broward Boulevard, Suite 1500, Fort Lauderdale, FL 33394, Attention: Proxy Group. 42 | Annual Report This page intentionally left blank. This page intentionally left blank. Literature Request For a brochure and prospectus, which contains more complete information, including charges and expenses, call Franklin Templeton Investments at 1-800/DIAL BEN(R) (1-800/342-5236). Please read the prospectus carefully before investing or sending money. To ensure the highest quality of service, we may monitor, record and access telephone calls to or from our service departments. These calls can be identified by the presence of a regular beeping tone. FRANKLIN TEMPLETON INVESTMENTS INTERNATIONAL Mutual European Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Foreign Fund Templeton Foreign Smaller Companies Fund Templeton International (Ex EM) Fund GLOBAL Franklin Global Aggressive Growth Fund Franklin Global Growth Fund Mutual Discovery Fund Templeton Capital Accumulator Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund Templeton Growth Fund Templeton World Fund GROWTH Franklin Aggressive Growth Fund Franklin Capital Growth Fund Franklin Flex Cap Growth Fund Franklin Small-Mid Cap Growth Fund Franklin Small Cap Growth Fund II 1 VALUE Franklin Balance Sheet Investment Fund 2 Franklin Equity Income Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund 3 Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund 4 Mutual Shares Fund BLEND Franklin Blue Chip Fund Franklin Convertible Securities Fund Franklin Growth Fund Franklin Rising Dividends Fund Franklin U.S. Long-Short Fund 5 SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Communications Fund Franklin Global Health Care Fund Franklin Gold and Precious Metals Fund Franklin Natural Resources Fund Franklin Real Estate Securities Fund Franklin Utilities Fund Franklin Technology Fund Mutual Financial Services Fund ASSET ALLOCATION Franklin Templeton Corefolio Allocation Fund Franklin Templeton Founding Funds Allocation Fund TARGET FUNDS Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund INCOME Franklin Adjustable U.S. Government Securities Fund 6 Franklin's AGE High Income Fund Franklin Federal Money Fund 6,7 Franklin Floating Rate Daily Access Fund Franklin Floating Rate Trust 4 Franklin Income Fund Franklin Money Fund 6,7 Franklin Short-Intermediate U.S. Government Securities Fund 6 Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio 6 Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund 6 Templeton Global Bond Fund TAX-FREE INCOME 8 NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund 9 Tax-Exempt Money Fund 6,7 LIMITED-TERM FUNDS California Limited-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Limited-Term Tax-Free Income Fund INTERMEDIATE-TERM FUNDS California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC 8 Alabama Arizona California 10 Colorado Connecticut Florida 10 Georgia Kentucky Louisiana Maryland Massachusetts 9 Michigan 9 Minnesota 9 Missouri New Jersey New York 10 North Carolina Ohio 9 Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust 11 1. The fund is closed to new investors. Existing shareholders can continue adding to their accounts. 2. The fund is only open to existing shareholders as well as select retirement plans. 3. Effective June 30, 2003, the fund reopened to all new investors. 4. The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. 5. Upon reaching approximately $350 million in assets, the fund intends to close to all investors. 6. An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. 7. No assurance exists that the fund's $1.00 per share price will be maintained. It is possible to lose money by investing in the fund. 8. For investors subject to the alternative minimum tax, a small portion of these dividends may be taxable. Distributions of capital gains are generally taxable. 9. Portfolio of insured municipal securities. 10. These funds are available in two or more variations, including long-term portfolios, portfolios of insured securities, a high-yield portfolio (CA) and money market portfolios (CA and NY). 11. The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 11/03 Not part of the annual report [LOGO OMITTED] FRANKLIN(R) TEMPLETON(R) One Franklin Parkway INVESTMENTS San Mateo, CA 94403-1906 WANT TO RECEIVE THIS DOCUMENT FASTER VIA EMAIL? Eligible shareholders can sign up for eDelivery at franklintempleton.com. See inside for details. ANNUAL REPORT AND SHAREHOLDER LETTER MUTUAL FINANCIAL SERVICES FUND CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF INVESTMENT OFFICER David J. Winters AUDITORS Ernst & Young LLP 200 Clarendon Streeet Boston, MA 02116 INVESTMENT MANAGER Franklin Mutual Advisers, LLC 51 John F. Kennedy Parkway Short Hills, NJ 07078 DISTRIBUTOR Franklin Templeton Distributors, Inc. 1-800/DIAL BEN [R] franklintempleton.com SHAREHOLDER SERVICES 1-800/632-2301 - (Class A, B, & C) 1-800/448-FUND - (Class Z) This report must be preceded or accompanied by the current Mutual Financial Services Fund prospectus, which contains more complete information, including risk factors, charges and expenses. To ensure the highest quality of service, telephone calls to or from our service departments may be monitored, recorded and accessed. These calls can be identified by the presence of a regular beeping tone. 479 A2003 02/04 ITEM 2. CODE OF ETHICS. (a) The Registrant has adopted a code of ethics that applies to its principal executive officers and principal financial and accounting officer. (c) N/A (d) N/A (f) Pursuant to Item 10(a), the Registrant is attaching as an exhibit a copy of its code of ethics that applies to its principal executive officers financial and accounting officer. ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT. (a)(1) The registrant has an audit committee financial expert serving on its audit committee. (2) The audit committee financial expert is Ann Torre Grant, and she is "independent" as defined under the relevant Securities and Exchange Commission Rules and Releases. ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES. (a) Audit Fees The aggregate fees paid to the principal accountant for professional services rendered by the principal accountant for the audit of the registrant's annual financial statements or for services that are normally provided by the principal accountant in connection with statutory and regulatory filings or engagements were $307,000 for the fiscal year ended December 31, 2003 and $278,500 for the fiscal year ended December 31, 2002. (b) Audit-Related Fees There were no fees paid to the principal accountant for assurance and related services rendered by the principal accountant to the registrant that are reasonably related to the performance of the audit of the registrant's financial statements and are not reported under paragraph (a) of Item 4. There were no fees paid to the principal accountant for assurance and related services rendered by the principal accountant to the registrant's investment adviser and any entity controlling, controlled by or under common control with the investment adviser that provides ongoing services to the registrant that are reasonably related to the performance of the audit of the their financial statements. (c) Tax Fees There were no fees paid to the principal accountant for professional services rendered by the principal accountant to the registrant for tax compliance, tax advice and tax planning. The aggregate fees paid to the principal accountant for professional services rendered by the principal accountant to the registrant's investment adviser and any entity controlling, controlled by or under common control with the investment adviser that provides ongoing services to the registrant for tax compliance, tax advice and tax planning were $250 for the fiscal year ended December 31, 2003 and $0 for the fiscal year ended December 31, 2002. The services for which these fees were paid included payments for tax compliance and advice. (d) All Other Fees There were no fees paid to the principal accountant for products and services rendered by the principal accountant to the registrant, other than the services reported in paragraphs (a)-(c) of Item 4. There were no fees paid to the principal accountant for products and services rendered by the principal accountant to the registrant's investment adviser and any entity controlling, controlled by or under common control with the investment adviser that provides ongoing services to the registrant, other than the services reported in paragraphs (a)-(c) of Item 4. (e) (1) The Fund's audit committee is directly responsible for approving the services to be provided by the auditors, including: (i) pre-approval of all audit and audit related services; (ii) pre-approval of all non-audit related services to be provided to the Fund by the auditors; (iii) pre-approval of all non-audit related services to be provided to the Fund by the auditors to the Fund's investment adviser or to any entity that controls, is controlled by or is under common control with the Fund's investment adviser and that provides ongoing services to the Fund where the non-audit services relate directly to the operations or financial reporting of the Fund; and (iv)establishment by the audit committee, if deemed necessary or appropriate, as an alternative to committee pre-approval of services to be provided by the auditors, as required by paragraphs (ii) and (iii) above, of policies and procedures to permit such services to be pre-approved by other means, such as through establishment of guidelines or by action of a designated member or members of the committee; provided the policies and procedures are detailed as to the particular service and the committee is informed of each service and such policies and procedures do not include delegation of audit committee responsibilities, as contemplated under the Securities Exchange Act of 1934, to management; subject, in the case of (ii) through (iv), to any waivers, exceptions or exemptions that may be available under applicable law or rules. (e) (2) None of the services provided to the registrant described in paragraphs (b)-(d) of Item 4 were pre-approved by the audit committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of regulation S-X. (f) No disclosures are required by this Item 4(f). (g) The aggregate non-audit fees paid to the principal accountant for services rendered by the principal accountant to the registrant and the registrant's investment adviser and any entity controlling, controlled by or under common control with the investment adviser that provides ongoing services to the registrant were $250 for the fiscal year ended December 31, 2003 and $0 for the fiscal year ended December 31, 2002. (h) No disclosures are required by this Item 4(h). ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS. N/A ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END MANAGEMENT INVESTMENT COMPANIES. N/A ITEM 9. CONTROLS AND PROCEDURES. (a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. The Registrant maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Registrant's filings under the Securities Exchange Act of 1934 and the Investment Company Act of 1940 is recorded, processed, summarized and reported within the periods specified in the rules and forms of the Securities and Exchange Commission. Such information is accumulated and communicated to the Registrant's management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. The Registrant's management, including the principal executive officer and the principal financial officer, recognizes that any set of controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Within 90 days prior to the filing date of this Shareholder Report on Form N-CSR, the Registrant had carried out an evaluation, under the supervision and with the participation of the Registrant's management, including the Registrant's principal executive officer and the Registrant's principal financial officer, of the effectiveness of the design and operation of the Registrant's disclosure controls and procedures. Based on such evaluation, the Registrant's principal executive officer and principal financial officer concluded that the Registrant's disclosure controls and procedures are effective. (B) CHANGES IN INTERNAL CONTROLS. There have been no significant changes in the Registrant's internal controls or in other factors that could significantly affect the internal controls subsequent to the date of their evaluation in connection with the preparation of this Shareholder Report on Form N-CSR. ITEM 10. EXHIBITS. (a) Code of Ethics for Principal Executive and Senior Financial Officers. (b) (1) Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Jimmy D. Gambill, Chief Executive Officer - Finance and Administration, and Kimberley H. Monasterio, Chief Financial Officer (b) (2) Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Jimmy D. Gambill, Chief Executive Officer - Finance and Administration, and Kimberley H. Monasterio, Chief Financial Officer SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FRANKLIN MUTUAL SERIES FUND INC. By /s/JIMMY D. GAMBILL ----------------------- Jimmy D. Gambill Chief Executive Officer - Finance and Administration Date February 23, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By /s/JIMMY D. GAMBILL ----------------------- Jimmy D. Gambill Chief Executive Officer - Finance and Administration Date February 23, 2004 By /s/KIMBERLEY H. MONASTERIO ------------------------------ Kimberley H. Monasterio Chief Financial Officer Date February 23, 2004