-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, MIZY9izjfhdrmW8yccR4vDyvhDJQIlFwZwGK4uSN1tgiLUunDrC3BfjhnSbUVPhw yk4olSBwpv4hL8Sj6XXOpA== 0000825063-05-000014.txt : 20050513 0000825063-05-000014.hdr.sgml : 20050513 20050513133146 ACCESSION NUMBER: 0000825063-05-000014 CONFORMED SUBMISSION TYPE: N-CSR/A PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20041231 FILED AS OF DATE: 20050513 DATE AS OF CHANGE: 20050513 EFFECTIVENESS DATE: 20050513 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FRANKLIN MUTUAL SERIES FUND INC CENTRAL INDEX KEY: 0000825063 IRS NUMBER: 222894171 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: N-CSR/A SEC ACT: 1940 Act SEC FILE NUMBER: 811-05387 FILM NUMBER: 05827950 BUSINESS ADDRESS: STREET 1: 51 JOHN F KENNEDY PKWY CITY: SHORT HILLS STATE: NJ ZIP: 07078 BUSINESS PHONE: 2019122088 MAIL ADDRESS: STREET 1: 51 JOHN F KENNEDY PARKWAY CITY: SHORT HILLS STATE: NJ ZIP: 07078 FORMER COMPANY: FORMER CONFORMED NAME: MUTUAL SERIES FUND INC DATE OF NAME CHANGE: 19920703 N-CSR/A 1 mseries_ar1204-amd.txt MUTUAL SERIES AMENDED 12/31/04 ANNUAL REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 AMENDED FORM N-CSR CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES Investment Company Act file number 811-05387 --------- 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: 12/31/04 -------- ITEM 1. REPORTS TO STOCKHOLDERS. MUTUAL BEACON FUND [GRAPHIC OMITTED] - -------------------------------------------------------------------------------- DECEMBER 31, 2004 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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](R) 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 Beacon Fund ........................................................ 4 Performance Summary ....................................................... 9 Your Fund's Expenses ...................................................... 14 Financial Highlights and Statement of Investments ......................... 16 Financial Statements ...................................................... 29 Notes to Financial Statements ............................................. 33 Report of Independent Registered Public Accounting Firm ........................................................... 49 Tax Designation ........................................................... 50 Board Members and Officers ................................................ 51 Shareholder Information ................................................... 56 - -------------------------------------------------------------------------------- ANNUAL REPORT MUTUAL BEACON FUND YOUR FUND'S GOALS AND MAIN 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 the Fund's managers believe are at prices below their intrinsic value in the U.S. and other countries. - -------------------------------------------------------------------------------- PERFORMANCE DATA QUOTED REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. PLEASE VISIT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236 FOR MOST RECENT MONTH-END PERFORMANCE. - -------------------------------------------------------------------------------- We are pleased to bring you Mutual Beacon Fund's annual report covering the fiscal year ended December 31, 2004. PERFORMANCE OVERVIEW Mutual Beacon Fund - Class Z posted a 14.52% cumulative total return for the 12 months ended December 31, 2004. The Fund outperformed its benchmark, the Standard & Poor's 500 Composite Index (S&P 500), which returned 10.87% over the same period.(1) You can find the Fund's long-term performance data in the Performance Summary beginning on page 9. ECONOMIC AND MARKET OVERVIEW During the year ended December 31, 2004, the domestic economy expanded solidly and broadly across most industries, sectors and regions as gross domestic product (GDP) rose an estimated 4.4%.(2) However, surging energy and other commodity prices had a dampening effect. Although consumer confidence remained below pre-recession levels, consumer spending supported strong auto sales, increased durable goods consumption and a healthy housing market. Similarly, business spending rose substantially even as business confidence wavered. The labor market firmed as employers hired 2.2 million workers in 2004, and unemployment dropped from 5.7% to 5.4% during the year.(3) The U.S. dollar weakened throughout 2004 and hit an all-time low against the euro and a multi-year low versus the yen. The widening trade and current (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 is unmanaged and includes reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. (2) Source: Bureau of Economic Analysis. (3) Source: Bureau of Labor Statistics. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND NAMES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 20. 4 | Annual Report account deficits and possibility for higher import prices contributed to inflationary pressures. The core inflation rate rose to 2.2% in 2004, or 3.3% including volatile food and energy costs. Aiming to keep inflation tame, the Federal Reserve Board raised the federal funds target rate five times between June and December, from 1.00% to 2.25%, the highest level in more than three years. Domestic equity markets rallied in early 2004 and then fluctuated; however, they were essentially flat through early November. After the elections concluded, the markets enjoyed another strong rally through year-end. The blue chip stocks of the Dow Jones Industrial Average gained 5.31% for the year under review, while the broader S&P 500 rose 10.87% and the technology-heavy NASDAQ Composite Index increased 9.15%.(4) Outside the U.S., the global economic recovery continued in 2004, led by growth in China. The 12-nation euro zone lagged other regions in the current recovery. However, the European Central Bank projected euro zone growth may be between 1.6% and 2.0% in 2004, compared with only 0.5% in 2003. In Japan, the economy struggled to emerge from a decade-long deflationary period. Although the country's consumer and business confidence reached their highest levels since 1991, economic growth slowed in response to higher oil prices and reduced external demand. The U.S. dollar decline hurt Japanese and European exports to the U.S., as it made their goods more expensive in the world's biggest market. For the 12-month period ended December 31, 2004, the Morgan Stanley Capital International (MSCI) World Index's total return was 15.25% in U.S. dollars.(5) Emerging markets, as measured by the MSCI Emerging Markets Index, had a total return of 25.95% in U.S. dollars.(6) In local currencies, these indexes had notably lower total returns of 11.83% and 16.45% for the same period.(5,6) During the period, most of the world's currencies strengthened in relation to the U.S. dollar, which benefited U.S.-based investors of non-U.S. developed and emerging market equities. INVESTMENT STRATEGY We follow a distinctive, three-pronged investment approach, which combines investments in what we believe are substantially undervalued common stocks (4) Source: Standard & Poor's Micropal. The Dow Jones Industrial Average is price weighted based on the average market price of 30 blue chip stocks of companies that are generally industry leaders. See footnote 1 for a description of the S&P 500. The NASDAQ Composite Index measures all domestic and international common stocks listed on The NASDAQ Stock Market. The index is market value weighted and includes over 3,000 companies. (5) Source: Standard & Poor's Micropal. The MSCI World Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in global developed markets. (6) Source: Standard & Poor's Micropal. The MSCI Emerging Markets Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in global emerging markets. [THE FOLLOWING TABLE WAS REPRESENTED AS A BAR GRAPH IN THE PRINTED MATERIAL.] GEOGRAPHIC DISTRIBUTION Based on Total Net Assets as of 12/31/04 U.S. 63.7% U.K. 10.8% Canada 4.3% Spain 3.0% France 2.4% Irish Republic 2.3% Japan 2.3% Denmark 2.2% Switzerland 2.1% Norway 1.3% South Africa 1.3% Netherlands 1.2% Other Countries 2.6% Other Net Assets 0.5% Annual Report | 5 TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/04 - -------------------------------------------------------------------------------- % OF TOTAL NET ASSETS - -------------------------------------------------------------------------------- Insurance 12.2% - -------------------------------------------------------------------------------- Metals & Mining 10.3% - -------------------------------------------------------------------------------- Tobacco 9.5% - -------------------------------------------------------------------------------- Media 9.0% - -------------------------------------------------------------------------------- Beverages 4.7% - -------------------------------------------------------------------------------- Food Products 4.1% - -------------------------------------------------------------------------------- Real Estate 3.4% - -------------------------------------------------------------------------------- Commercial Banks 2.9% - -------------------------------------------------------------------------------- Diversified Financial Services 2.3% - -------------------------------------------------------------------------------- Capital Markets 2.2% - -------------------------------------------------------------------------------- with distressed debt investing and risk arbitrage. Our style aims 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 bankrupt or distressed companies if we believe the market overreacted to adverse developments or failed to appreciate positive changes. MANAGER'S DISCUSSION All three prongs of our investment strategy contributed to the Fund's performance during the year under review, with the equity portion providing the greatest contribution. Three of the Fund's best performing stock investments were White Mountains Insurance Group, a property and casualty insurer; Altadis, a Franco-Spanish tobacco company; and Brascan, a Canadian diversified financial services company. White Mountains, one of the the largest contributors to Fund performance during the fiscal year, was an excellent example of how substantial shareholder value can be created when well-capitalized companies are run by strong managers. With the company's solid balance sheet, White Mountains' management team has made several acquisitions, enabling the company to profitably increase its bottom line while extending its exposure to attractive lines of business. In addition to exercising discipline with acquisitions, management remained committed to a conservative underwriting strategy. This strategy enabled White Mountains to continue to report solid underwriting results for 2004 despite record industry-wide insurance claims from the Atlantic hurricane season. During the year under review, the markets began to better appreciate White Mountains' consistent results, strong balance sheet, and disciplined acquisition and underwriting practices, as well as its shareholder-oriented management team. White Mountains' stock rose about 41% in 2004 and has increased more than 443% in the past five years. In 2004, tobacco companies operating in Europe, such as Altadis, encountered a challenging sales environment, especially in France after the government imposed two substantial tax increases by early 2004 that pressured volumes and contributed to reduced consumption of about 25% in volume. Despite challenges in France and elsewhere, Altadis shares performed well as management returned cash to shareholders through dividends and share repurchases. In addition, the company announced two acquisitions and a cost-restructuring program, all of which could enable management to continue to increase cash 6 | Annual Report flow and create shareholder value. As a result of these and other factors, Altadis shares appreciated about 65% in 2004. Despite this strong performance, the stock still traded at a significant discount to its European peers and our calculation of the stock's intrinsic value. In addition, some analysts believe the industry is ready for more consolidation. For these and other reasons, we remain enthusiastic about the prospects of our Altadis investment. Brascan's core businesses include real estate, fund management and power generation assets, and the company has been streamlining its operations to focus on these core functions over the past three years. The company's businesses have performed well recently, and Brascan's shares increased in value approximately 80% in 2004 largely as a result of reinvesting free cash flow into its businesses and a favorable operating environment. Also, the prospects for Brascan to invest proceeds from a potential sale of its Noranda stake appeared promising. Brascan identified excess capital for share buybacks and to expand core operations, as well as for other value-added programs. The potential effect of redeploying excess capital to higher return areas could create additional value for Brascan shareholders, and consistent with our strategy, we maintained our position in the company's stock. In general, if the value of the U.S. dollar goes up compared with a foreign currency, an investment traded in that foreign currency will go down in value because it will be worth fewer U.S. dollars. This can have a negative effect on Fund performance. Conversely, when the U.S. dollar weakens in relation to a foreign currency, an investment traded in that foreign currency will increase in value, which can contribute to Fund performance. At Mutual Series, we typically seek to hedge (protect) against currency risk, which can reduce or eliminate the positive or negative effect on Fund performance of holding investments denominated in currencies other than the U.S. dollar. In 2004, we remained less than fully hedged in foreign currencies allowing shareholders to benefit from a declining U.S. dollar. However, one cannot expect the same result in future periods. Although many of our investments performed well in 2004, some holdings underperformed. Positions that declined in value during the reporting period included Impala Platinum, a South African mining company; Eurotunnel, a distressed investment in the operator of the English Channel tunnel; and Coeur D'Alene, a U.S. mining firm. Impala Platinum detracted from Fund performance during the year largely due to the strengthening South African currency and a slower-than-expected approval process for a mine in Zimbabwe. Eurotunnel's debt securities declined mainly due to uncertainties surrounding the ultimate resolution of the company's financial situation, as well as mediocre operating results after the board and management team had been replaced in April 2004. Coeur TOP 10 HOLDINGS 12/31/04 - -------------------------------------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - -------------------------------------------------------------------------------- White Mountains Insurance Group Inc. 4.4% INSURANCE, U.S. - -------------------------------------------------------------------------------- Altadis SA 3.0% TOBACCO, SPAIN - -------------------------------------------------------------------------------- Berkshire Hathaway Inc., A & B 2.9% INSURANCE, U.S. - -------------------------------------------------------------------------------- International Steel Group 2.4% METALS & MINING, U.S. - -------------------------------------------------------------------------------- Washington Post Co., B 2.1% MEDIA, U.S. - -------------------------------------------------------------------------------- British American Tobacco PLC, ord. & ADR 1.9% TOBACCO, U.K. - -------------------------------------------------------------------------------- Newmont Mining Corp. 1.9% METALS & MINING, U.S. - -------------------------------------------------------------------------------- Brascan Corp., A 1.8% DIVERSIFIED FINANCIAL SERVICES, CANADA - -------------------------------------------------------------------------------- Carlsberg AS, A & B 1.6% BEVERAGES, DENMARK - -------------------------------------------------------------------------------- Florida East Coast Industries Inc. 1.5% ROAD & RAIL, U.S. - -------------------------------------------------------------------------------- Annual Report | 7 D'Alene's returns lagged during the reporting period in part because of an unsuccessful acquisition attempt of Wheaton River, another mining company. Thank you for your continued participation in Mutual Beacon 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/ Charles M. Lahr Charles M. Lahr, CFA Assistant Portfolio Manager Mutual Beacon Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2004, 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 ADVISER 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. CHARLES M. LAHR Charles Lahr is an assistant portfolio manager for Mutual Beacon Fund and Mutual Financial Services Fund. He is also an analyst for Franklin Mutual Advisers, LLC (Mutual Series). Mr. Lahr specializes in the analysis of foreign equities and focuses on non-U.S. financial services companies. Prior to joining Mutual Series in 2003, Mr. Lahr was an international equities research analyst for the State of Wisconsin Investment Board. He has 11 years of experience in the financial services industry. Mr. Lahr received a bachelor's of business administration in finance and investments as well as an M.B.A. from the University of Iowa. He is also a CFA charterholder and a member of the New York Society of Security Analysts. 8 | Annual Report PERFORMANCE SUMMARY AS OF 12/31/04 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 reinvestment of the Fund's dividends and capital gain distributions, if any, and any unrealized gains or losses. PRICE AND DISTRIBUTION INFORMATION
- ------------------------------------------------------------------------------------------- CLASS Z CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$1.54 $15.94 $14.40 - ------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------- Dividend Income $0.3746 - ------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.1457 - ------------------------------------------------------------------------------------------- TOTAL $0.5203 - ------------------------------------------------------------------------------------------- CLASS A CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$1.53 $15.87 $14.34 - ------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------- Dividend Income $0.3219 - ------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.1457 - ------------------------------------------------------------------------------------------- TOTAL $0.4676 - ------------------------------------------------------------------------------------------- CLASS B CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$1.48 $15.54 $14.06 - ------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------- Dividend Income $0.2322 - ------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.1457 - ------------------------------------------------------------------------------------------- TOTAL $0.3779 - ------------------------------------------------------------------------------------------- CLASS C CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$1.51 $15.77 $14.26 - ------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------- Dividend Income $0.2273 - ------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.1457 - ------------------------------------------------------------------------------------------- TOTAL $0.3730 - -------------------------------------------------------------------------------------------
Mutual Beacon Fund paid distributions derived from long-term capital gains of 14.57 cents ($0.1457) per share in December 2004. The Fund designated such distributions as capital gain dividends per Internal Revenue Code Section 852 (b)(3). Annual Report | 9 PERFORMANCE SUMMARY (CONTINUED) PERFORMANCE(1) CLASS A: 5.75% MAXIMUM INITIAL SALES CHARGE; CLASS B: CONTINGENT DEFERRED SALES CHARGE (CDSC) DECLINING FROM 4% TO 1% OVER SIX YEARS, AND ELIMINATED THEREAFTER; CLASS C: 1% CDSC IN FIRST YEAR ONLY. CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES. - -------------------------------------------------------------------------------- CLASS Z 1-YEAR 5-YEAR 10-YEAR - -------------------------------------------------------------------------------- Cumulative Total Return(2) 14.52% 59.97% 258.88% - -------------------------------------------------------------------------------- Average Annual Total Return(3) 14.52% 9.85% 13.63% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $ 11,452 $ 15,997 $ 35,888 - -------------------------------------------------------------------------------- CLASS A 1-YEAR 5-YEAR INCEPTION (11/1/96) - -------------------------------------------------------------------------------- Cumulative Total Return(2) 14.13% 57.13% 143.05% - -------------------------------------------------------------------------------- Average Annual Total Return(3) 7.60% 8.17% 10.69% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $ 10,760 $ 14,812 $ 22,910 - -------------------------------------------------------------------------------- CLASS B 1-YEAR 5-YEAR INCEPTION (1/1/99) - -------------------------------------------------------------------------------- Cumulative Total Return(2) 13.32% 52.21% 75.54% - -------------------------------------------------------------------------------- Average Annual Total Return(3) 9.32% 8.48% 9.73% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $ 10,932 $ 15,021 $ 17,454 - -------------------------------------------------------------------------------- CLASS C 1-YEAR 5-YEAR INCEPTION (11/1/96) - -------------------------------------------------------------------------------- Cumulative Total Return(2) 13.39% 52.21% 130.72% - -------------------------------------------------------------------------------- Average Annual Total Return(3) 12.39% 8.76% 10.78% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $ 11,239 $ 15,221 $ 23,072 - -------------------------------------------------------------------------------- PERFORMANCE DATA QUOTED REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. FOR MOST RECENT MONTH-END PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236. 10 | 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 any current, applicable, maximum sales charge, Fund expenses, account fees and reinvested distributions. The unmanaged index includes reinvestment of any income or distributions. It differs from the Fund in composition and does not pay management fees or expenses. One cannot invest directly in an index. [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual Beacon Fund - Class Z, as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 Index5 from 1/1/95-12/31/04. CLASS Z (1/1/95-12/31/04) MUTUAL BEACON S&P DATE FUND 500(5) ---- -------------- ------ 12/31/1995 $12,589 $13,753 1/31/1996 $13,072 $14,221 2/29/1996 $13,423 $14,353 3/31/1996 $13,598 $14,491 4/30/1996 $13,783 $14,705 5/31/1996 $13,976 $15,083 6/30/1996 $13,887 $15,141 7/31/1996 $13,342 $14,472 8/31/1996 $13,800 $14,778 9/30/1996 $14,186 $15,609 10/31/1996 $14,313 $16,039 11/30/1996 $15,035 $17,251 12/31/1996 $15,256 $16,909 1/31/1997 $15,781 $17,965 2/28/1997 $16,122 $18,106 3/31/1997 $15,898 $17,363 4/30/1997 $15,992 $18,399 5/31/1997 $16,650 $19,518 6/30/1997 $17,132 $20,392 7/31/1997 $18,082 $22,014 8/31/1997 $17,891 $20,782 9/30/1997 $18,776 $21,919 10/31/1997 $18,178 $21,188 11/30/1997 $18,441 $22,168 12/31/1997 $18,764 $22,548 1/31/1998 $18,658 $22,798 2/28/1998 $19,668 $24,441 3/31/1998 $20,505 $25,691 4/30/1998 $20,771 $25,950 5/31/1998 $20,837 $25,504 6/30/1998 $20,691 $26,540 7/31/1998 $20,187 $26,258 8/31/1998 $17,427 $22,465 9/30/1998 $17,062 $23,905 10/31/1998 $18,077 $25,847 11/30/1998 $19,105 $27,413 12/31/1998 $19,208 $28,992 1/31/1999 $19,545 $30,204 2/28/1999 $19,325 $29,265 3/31/1999 $20,218 $30,436 4/30/1999 $21,814 $31,614 5/31/1999 $22,019 $30,869 6/30/1999 $22,623 $32,581 7/31/1999 $22,145 $31,565 8/31/1999 $21,353 $31,408 9/30/1999 $20,800 $30,549 10/31/1999 $21,383 $32,481 11/30/1999 $21,891 $33,141 12/31/1999 $22,433 $35,092 1/31/2000 $21,882 $33,329 2/29/2000 $21,266 $32,699 3/31/2000 $23,390 $35,895 4/30/2000 $23,114 $34,816 5/31/2000 $23,406 $34,103 6/30/2000 $23,132 $34,944 7/31/2000 $23,721 $34,398 8/31/2000 $24,708 $36,534 9/30/2000 $24,760 $34,606 10/31/2000 $25,175 $34,459 11/30/2000 $24,517 $31,744 12/31/2000 $25,647 $31,900 1/31/2001 $27,315 $33,031 2/28/2001 $27,162 $30,021 3/31/2001 $26,376 $28,120 4/30/2001 $27,468 $30,304 5/31/2001 $28,388 $30,507 6/30/2001 $28,607 $29,765 7/31/2001 $28,783 $29,472 8/31/2001 $28,176 $27,629 9/30/2001 $25,689 $25,398 10/31/2001 $25,669 $25,882 11/30/2001 $26,590 $27,867 12/31/2001 $27,215 $28,111 1/31/2002 $27,111 $27,701 2/28/2002 $27,278 $27,167 3/31/2002 $28,029 $28,189 4/30/2002 $28,279 $26,481 5/31/2002 $28,383 $26,286 6/30/2002 $26,422 $24,414 7/31/2002 $24,693 $22,512 8/31/2002 $24,925 $22,659 9/30/2002 $23,575 $20,199 10/31/2002 $23,892 $21,975 11/30/2002 $24,356 $23,267 12/31/2002 $24,209 $21,901 1/31/2003 $23,952 $21,328 2/28/2003 $23,417 $21,008 3/31/2003 $23,481 $21,210 4/30/2003 $25,001 $22,958 5/31/2003 $26,350 $24,166 6/30/2003 $26,809 $24,475 7/31/2003 $27,111 $24,906 8/31/2003 $27,888 $25,391 9/30/2003 $27,845 $25,122 10/31/2003 $28,988 $26,543 11/30/2003 $30,023 $26,776 12/31/2003 $31,336 $28,179 1/31/2004 $31,467 $28,696 2/29/2004 $32,534 $29,095 3/31/2004 $32,490 $28,656 4/30/2004 $31,619 $28,207 5/31/2004 $31,793 $28,593 6/30/2004 $32,329 $29,149 7/31/2004 $31,912 $28,185 8/31/2004 $32,175 $28,298 9/30/2004 $32,745 $28,604 10/31/2004 $33,183 $29,041 11/30/2004 $34,915 $30,216 12/31/2004 $35,888 $31,243 AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------------------------------------------- CLASS Z 12/31/04 - -------------------------------------------------------------------------------- 1-Year 14.52% - -------------------------------------------------------------------------------- 5-Year 9.85% - -------------------------------------------------------------------------------- 10-Year 13.63% - -------------------------------------------------------------------------------- [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual Beacon Fund - Class A, as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 Index5 from 11/1/96-12/31/04. CLASS A (11/1/96-12/31/04) MUTUAL BEACON S&P DATE FUND 500(5) ---- -------------- ------- 11/1/1996 $9,425 $10,000 11/30/1996 $9,895 $10,755 12/31/1996 $10,038 $10,542 1/31/1997 $10,381 $11,200 2/28/1997 $10,598 $11,288 3/31/1997 $10,451 $10,825 4/30/1997 $10,512 $11,471 5/31/1997 $10,938 $12,169 6/30/1997 $11,255 $12,714 7/31/1997 $11,873 $13,725 8/31/1997 $11,747 $12,957 9/30/1997 $12,322 $13,666 10/31/1997 $11,920 $13,210 11/30/1997 $12,094 $13,821 12/31/1997 $12,302 $14,058 1/31/1998 $12,232 $14,213 2/28/1998 $12,887 $15,238 3/31/1998 $13,428 $16,018 4/30/1998 $13,603 $16,179 5/31/1998 $13,638 $15,901 6/30/1998 $13,542 $16,546 7/31/1998 $13,211 $16,371 8/31/1998 $11,398 $14,006 9/30/1998 $11,149 $14,904 10/31/1998 $11,816 $16,115 11/30/1998 $12,491 $17,091 12/31/1998 $12,550 $18,075 1/31/1999 $12,771 $18,831 2/28/1999 $12,617 $18,246 3/31/1999 $13,193 $18,975 4/30/1999 $14,228 $19,710 5/31/1999 $14,372 $19,245 6/30/1999 $14,757 $20,313 7/31/1999 $14,444 $19,679 8/31/1999 $13,916 $19,582 9/30/1999 $13,554 $19,046 10/31/1999 $13,925 $20,251 11/30/1999 $14,258 $20,662 12/31/1999 $14,608 $21,878 1/31/2000 $14,249 $20,779 2/29/2000 $13,836 $20,386 3/31/2000 $15,211 $22,379 4/30/2000 $15,031 $21,706 5/31/2000 $15,222 $21,262 6/30/2000 $15,029 $21,786 7/31/2000 $15,413 $21,446 8/31/2000 $16,046 $22,777 9/30/2000 $16,080 $21,575 10/31/2000 $16,351 $21,484 11/30/2000 $15,922 $19,791 12/31/2000 $16,638 $19,888 1/31/2001 $17,723 $20,593 2/28/2001 $17,611 $18,717 3/31/2001 $17,099 $17,532 4/30/2001 $17,798 $18,893 5/31/2001 $18,397 $19,020 6/30/2001 $18,521 $18,557 7/31/2001 $18,636 $18,374 8/31/2001 $18,228 $17,225 9/30/2001 $16,636 $15,834 10/31/2001 $16,611 $16,137 11/30/2001 $17,196 $17,374 12/31/2001 $17,600 $17,526 1/31/2002 $17,533 $17,271 2/28/2002 $17,627 $16,938 3/31/2002 $18,114 $17,575 4/30/2002 $18,277 $16,510 5/31/2002 $18,331 $16,388 6/30/2002 $17,054 $15,221 7/31/2002 $15,932 $14,035 8/31/2002 $16,083 $14,127 9/30/2002 $15,208 $12,593 10/31/2002 $15,399 $13,701 11/30/2002 $15,686 $14,506 12/31/2002 $15,591 $13,654 1/31/2003 $15,425 $13,297 2/28/2003 $15,080 $13,098 3/31/2003 $15,107 $13,223 4/30/2003 $16,089 $14,313 5/31/2003 $16,961 $15,066 6/30/2003 $17,253 $15,259 7/31/2003 $17,435 $15,528 8/31/2003 $17,922 $15,830 9/30/2003 $17,895 $15,663 10/31/2003 $18,633 $16,548 11/30/2003 $19,288 $16,694 12/31/2003 $20,111 $17,569 1/31/2004 $20,209 $17,891 2/29/2004 $20,869 $18,140 3/31/2004 $20,840 $17,866 4/30/2004 $20,265 $17,586 5/31/2004 $20,377 $17,827 6/30/2004 $20,730 $18,173 7/31/2004 $20,448 $17,572 8/31/2004 $20,603 $17,643 9/30/2004 $20,970 $17,833 10/31/2004 $21,239 $18,106 11/30/2004 $22,340 $18,838 12/31/2004 $22,910 $19,479 AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------------------------------------------- CLASS A 12/31/04 - -------------------------------------------------------------------------------- 1-Year 7.60% - -------------------------------------------------------------------------------- 5-Year 8.17% - -------------------------------------------------------------------------------- Since Inception (11/1/96) 10.69% - -------------------------------------------------------------------------------- Annual Report | 11 PERFORMANCE SUMMARY (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------------------------------------------- CLASS B 12/31/04 - -------------------------------------------------------------------------------- 1-Year 9.32% - -------------------------------------------------------------------------------- 5-Year 8.48% - -------------------------------------------------------------------------------- Since Inception (1/1/99) 9.73% - -------------------------------------------------------------------------------- [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual Beacon Fund - Class B, as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 Index5 from 1/1/99-12/31/04. CLASS B (1/1/99-12/31/04) MUTUAL BEACON S&P DATE FUND 500(5) ---- -------------- ------- 1/1/1999 $10,000 $10,000 1/31/1999 $10,160 $10,418 2/28/1999 $10,031 $10,094 3/31/1999 $10,481 $10,498 4/30/1999 $11,291 $10,905 5/31/1999 $11,398 $10,647 6/30/1999 $11,693 $11,238 7/31/1999 $11,436 $10,887 8/31/1999 $11,015 $10,834 9/30/1999 $10,719 $10,537 10/31/1999 $11,007 $11,203 11/30/1999 $11,265 $11,431 12/31/1999 $11,533 $12,104 1/31/2000 $11,247 $11,496 2/29/2000 $10,918 $11,279 3/31/2000 $11,996 $12,381 4/30/2000 $11,845 $12,009 5/31/2000 $11,988 $11,763 6/30/2000 $11,840 $12,053 7/31/2000 $12,127 $11,865 8/31/2000 $12,622 $12,601 9/30/2000 $12,631 $11,936 10/31/2000 $12,846 $11,886 11/30/2000 $12,496 $10,949 12/31/2000 $13,054 $11,003 1/31/2001 $13,896 $11,393 2/28/2001 $13,806 $10,355 3/31/2001 $13,390 $9,699 4/30/2001 $13,935 $10,453 5/31/2001 $14,401 $10,523 6/30/2001 $14,487 $10,267 7/31/2001 $14,568 $10,166 8/31/2001 $14,244 $9,530 9/30/2001 $12,990 $8,760 10/31/2001 $12,959 $8,927 11/30/2001 $13,415 $9,612 12/31/2001 $13,722 $9,696 1/31/2002 $13,658 $9,555 2/28/2002 $13,722 $9,371 3/31/2002 $14,097 $9,723 4/30/2002 $14,215 $9,134 5/31/2002 $14,258 $9,067 6/30/2002 $13,253 $8,421 7/31/2002 $12,375 $7,765 8/31/2002 $12,483 $7,816 9/30/2002 $11,801 $6,967 10/31/2002 $11,942 $7,580 11/30/2002 $12,169 $8,025 12/31/2002 $12,081 $7,554 1/31/2003 $11,950 $7,357 2/28/2003 $11,677 $7,246 3/31/2003 $11,688 $7,316 4/30/2003 $12,441 $7,919 5/31/2003 $13,107 $8,335 6/30/2003 $13,320 $8,442 7/31/2003 $13,463 $8,591 8/31/2003 $13,825 $8,758 9/30/2003 $13,793 $8,665 10/31/2003 $14,353 $9,155 11/30/2003 $14,848 $9,236 12/31/2003 $15,491 $9,720 1/31/2004 $15,546 $9,898 2/29/2004 $16,052 $10,036 3/31/2004 $16,019 $9,884 4/30/2004 $15,568 $9,729 5/31/2004 $15,645 $9,863 6/30/2004 $15,903 $10,054 7/31/2004 $15,681 $9,722 8/31/2004 $15,792 $9,761 9/30/2004 $16,069 $9,866 10/31/2004 $16,268 $10,017 11/30/2004 $17,099 $10,422 12/31/2004 $17,454 $10,777 AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------------------------------------------- CLASS C 12/31/04 - -------------------------------------------------------------------------------- 1-Year 12.39% - -------------------------------------------------------------------------------- 5-Year 8.76% - -------------------------------------------------------------------------------- Since Inception (11/1/96) 10.78% - -------------------------------------------------------------------------------- [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual Beacon Fund - Class C, as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 Index5 from 11/1/96-12/31/04. CLASS C (11/1/96-12/31/04) MUTUAL BEACON S&P DATE FUND 500(5) ---- -------------- ------- 11/1/1996 $10,000 $10,000 11/30/1996 $10,497 $10,755 12/31/1996 $10,645 $10,542 1/31/1997 $11,000 $11,200 2/28/1997 $11,221 $11,288 3/31/1997 $11,057 $10,825 4/30/1997 $11,123 $11,471 5/31/1997 $11,566 $12,169 6/30/1997 $11,894 $12,714 7/31/1997 $12,537 $13,725 8/31/1997 $12,403 $12,957 9/30/1997 $13,004 $13,666 10/31/1997 $12,578 $13,210 11/30/1997 $12,745 $13,821 12/31/1997 $12,953 $14,058 1/31/1998 $12,870 $14,213 2/28/1998 $13,562 $15,238 3/31/1998 $14,124 $16,018 4/30/1998 $14,290 $16,179 5/31/1998 $14,327 $15,901 6/30/1998 $14,217 $16,546 7/31/1998 $13,860 $16,371 8/31/1998 $11,956 $14,006 9/30/1998 $11,694 $14,904 10/31/1998 $12,378 $16,115 11/30/1998 $13,082 $17,091 12/31/1998 $13,134 $18,075 1/31/1999 $13,355 $18,831 2/28/1999 $13,184 $18,246 3/31/1999 $13,789 $18,975 4/30/1999 $14,866 $19,710 5/31/1999 $14,997 $19,245 6/30/1999 $15,397 $20,313 7/31/1999 $15,059 $19,679 8/31/1999 $14,505 $19,582 9/30/1999 $14,115 $19,046 10/31/1999 $14,495 $20,251 11/30/1999 $14,833 $20,662 12/31/1999 $15,189 $21,878 1/31/2000 $14,802 $20,779 2/29/2000 $14,372 $20,386 3/31/2000 $15,797 $22,379 4/30/2000 $15,598 $21,706 5/31/2000 $15,786 $21,262 6/30/2000 $15,580 $21,786 7/31/2000 $15,968 $21,446 8/31/2000 $16,616 $22,777 9/30/2000 $16,639 $21,575 10/31/2000 $16,910 $21,484 11/30/2000 $16,451 $19,791 12/31/2000 $17,196 $19,888 1/31/2001 $18,296 $20,593 2/28/2001 $18,180 $18,717 3/31/2001 $17,636 $17,532 4/30/2001 $18,348 $18,893 5/31/2001 $18,957 $19,020 6/30/2001 $19,076 $18,557 7/31/2001 $19,182 $18,374 8/31/2001 $18,759 $17,225 9/30/2001 $17,106 $15,834 10/31/2001 $17,067 $16,137 11/30/2001 $17,662 $17,374 12/31/2001 $18,065 $17,526 1/31/2002 $17,982 $17,271 2/28/2002 $18,079 $16,938 3/31/2002 $18,568 $17,575 4/30/2002 $18,721 $16,510 5/31/2002 $18,763 $16,388 6/30/2002 $17,450 $15,221 7/31/2002 $16,294 $14,035 8/31/2002 $16,435 $14,127 9/30/2002 $15,532 $12,593 10/31/2002 $15,729 $13,701 11/30/2002 $16,011 $14,506 12/31/2002 $15,899 $13,654 1/31/2003 $15,729 $13,297 2/28/2003 $15,360 $13,098 3/31/2003 $15,388 $13,223 4/30/2003 $16,381 $14,313 5/31/2003 $17,246 $15,066 6/30/2003 $17,537 $15,259 7/31/2003 $17,722 $15,528 8/31/2003 $18,208 $15,830 9/30/2003 $18,165 $15,663 10/31/2003 $18,893 $16,548 11/30/2003 $19,550 $16,694 12/31/2003 $20,389 $17,569 1/31/2004 $20,461 $17,891 2/29/2004 $21,133 $18,140 3/31/2004 $21,090 $17,866 4/30/2004 $20,504 $17,586 5/31/2004 $20,604 $17,827 6/30/2004 $20,938 $18,173 7/31/2004 $20,650 $17,572 8/31/2004 $20,794 $17,643 9/30/2004 $21,153 $17,833 10/31/2004 $21,412 $18,106 11/30/2004 $22,521 $18,838 12/31/2004 $23,072 $19,479 12 | Annual Report PERFORMANCE SUMMARY (CONTINUED) ENDNOTES THE FUND'S INVESTMENTS INCLUDE 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: Shares are available to certain eligible investors as described in the prospectus. CLASS A: Prior to 8/3/98, these shares were offered at a lower initial sales charge; thus actual total returns may differ. CLASS B: These shares have higher annual fees and expenses than Class A shares. CLASS C: Prior to 1/1/04, these shares were offered with an initial sales charge; thus actual total returns would have differed. 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. If the manager had not taken this action, 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 a sales charge. (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. (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. (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 | 13 YOUR FUND'S EXPENSES As a Fund shareholder, you can incur two types of costs: o Transaction costs, including sales charges (loads) on Fund purchases and redemption fees; and o Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. The following table shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated. ACTUAL FUND EXPENSES The first line (Actual) for each share class listed in the table below provides actual account values and expenses. The "Ending Account Value" is derived from the Fund's actual return, which includes the effect of Fund expenses. You can estimate the expenses you paid during the period, by following these steps. OF COURSE, YOUR ACCOUNT VALUE AND EXPENSES WILL DIFFER FROM THOSE IN THIS ILLUSTRATION: 1. Divide your account value by $1,000. IF AN ACCOUNT HAD AN $8,600 VALUE, THEN $8,600 / $1,000 = 8.6. 2. Multiply the result by the number under the heading "Expenses Paid During Period." IF EXPENSES PAID DURING PERIOD WERE $7.50, THEN 8.6 X $7.50 = $64.50. In this illustration, the estimated expenses paid this period are $64.50. HYPOTHETICAL EXAMPLE FOR COMPARISON WITH OTHER FUNDS Information in the second line (Hypothetical) for each class in the table can help you compare ongoing costs of investing in the Fund with those of other mutual funds. This information may not be used to estimate the actual ending account balance or expenses you paid during the period. The hypothetical "Ending Account Value" is based on the actual expense ratio for each class and an assumed 5% annual rate of return before expenses, which does not represent the Fund's actual return. The figure under the heading "Expenses Paid During Period" shows the hypothetical expenses your account would have incurred under this scenario. You can compare this figure with the 5% hypothetical examples that appear in shareholder reports of other funds. 14 | Annual Report YOUR FUND'S EXPENSES (CONTINUED) PLEASE NOTE THAT EXPENSES SHOWN IN THE TABLE ARE MEANT TO HIGHLIGHT ONGOING COSTS AND DO NOT REFLECT ANY TRANSACTION COSTS, SUCH AS SALES CHARGES OR REDEMPTION FEES. Therefore, the second line for each class is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transaction costs were included, your total costs would have been higher. Please refer to the Fund prospectus for additional information on operating expenses.
- -------------------------------------------------------------------------------------------------------- BEGINNING ACCOUNT ENDING ACCOUNT EXPENSES PAID DURING CLASS Z VALUE 6/30/04 VALUE 12/31/04 PERIOD* 6/30/04-12/31/04 - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,110.10 $4.35 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,021.01 $4.17 - -------------------------------------------------------------------------------------------------------- CLASS A - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,107.20 $6.20 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,019.25 $5.94 - -------------------------------------------------------------------------------------------------------- CLASS B - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,103.80 $9.62 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,015.99 $9.22 - -------------------------------------------------------------------------------------------------------- CLASS C - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,104.20 $9.63 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,015.99 $9.22 - --------------------------------------------------------------------------------------------------------
* Expenses are equal to the annualized expense ratio for each class (Z: 0.82%; A: 1.17%; B: 1.82%; and C: 1.82%), multiplied by the average account value over the period, multiplied by 184/366 to reflect the one-half year period. Annual Report | 15 MUTUAL BEACON FUND FINANCIAL HIGHLIGHTS
-------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2004 2003 2002 2001 2000 -------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ......................... $ 14.40 $ 11.31 $ 13.05 $ 13.38 $ 13.84 -------------------------------------------------------------------- Income from investment operations: Net investment income(a) .................................. .30 .19 .23 .21 .22 Net realized and unrealized gains (losses) ................ 1.76 3.13 (1.66) .60 1.62 -------------------------------------------------------------------- Total from investment operations ........................... 2.06 3.32 (1.43) .81 1.84 -------------------------------------------------------------------- Less distributions from: Net investment income ..................................... (.37) (.23) (.20) (.20) (.44) Net realized gains ........................................ (.15) -- (.11) (.94) (1.86) -------------------------------------------------------------------- Total distributions ........................................ (.52) (.23) (.31) (1.14) (2.30) -------------------------------------------------------------------- Redemption fees ............................................ --(d) -- -- -- -- -------------------------------------------------------------------- Net asset value, end of year ............................... $ 15.94 $ 14.40 $ 11.31 $ 13.05 $ 13.38 ==================================================================== Total return(b) ............................................ 14.52% 29.44% (11.05)% 6.11% 14.33% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............................ $3,359,389 $3,112,212 $2,572,002 $3,090,827 $3,041,905 Ratios to average net assets:* Expenses(c) ............................................... .83% .86% .80% .79% .83% Expenses, net of waiver and payments by affiliate(c) ...... .83% .86% .80% .79% .81% Net investment income ..................................... 1.99% 1.48% 1.88% 1.47% 1.55% Portfolio turnover rate .................................... 29.17% 49.61% 52.27% 55.25% 62.11% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .................................................. .82% .83% .79% .78% .80% Expenses net of waiver and payments by affiliate .......... .82% .83% .79% .78% .78%
(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 only operating expenses. (d) Amount is less than $0.001 per share. 16 | See notes to financial statements. | Annual Report MUTUAL BEACON FUND FINANCIAL HIGHLIGHTS (CONTINUED)
-------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2004 2003 2002 2001 2000 -------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ......................... $ 14.34 $ 11.27 $ 13.01 $ 13.34 $ 13.81 -------------------------------------------------------------------- Income from investment operations: Net investment income(a) .................................. .25 .14 .19 .16 .17 Net realized and unrealized gains (losses) ................ 1.75 3.12 (1.66) .60 1.61 -------------------------------------------------------------------- Total from investment operations ........................... 2.00 3.26 (1.47) .76 1.78 -------------------------------------------------------------------- Less distributions from: Net investment income ..................................... (.32) (.19) (.16) (.15) (.39) Net realized gains ........................................ (.15) -- (.11) (.94) (1.86) -------------------------------------------------------------------- Total distributions ........................................ (.47) (.19) (.27) (1.09) (2.25) -------------------------------------------------------------------- Redemption fees ............................................ --(d) -- -- -- -- -------------------------------------------------------------------- Net asset value, end of year ............................... $ 15.87 $ 14.34 $ 11.27 $ 13.01 $ 13.34 ==================================================================== Total return(b) ............................................ 14.13% 28.99% (11.41)% 5.78% 13.89% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............................ $1,462,133 $1,301,620 $ 918,983 $ 977,558 $ 757,323 Ratios to average net assets:* Expenses(c) ............................................... 1.18% 1.21% 1.15% 1.14% 1.18% Expenses, net of waiver and payments by affiliate(c) ...... 1.18% 1.21% 1.15% 1.14% 1.16% Net investment income ..................................... 1.64% 1.13% 1.53% 1.12% 1.20% Portfolio turnover rate .................................... 29.17% 49.61% 52.27% 55.25% 62.11% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................................... 1.17% 1.18% 1.14% 1.13% 1.15% Expenses net of waiver and payments by affiliate .......... 1.17% 1.18% 1.14% 1.13% 1.13%
(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 only operating expenses. (d) Amount is less than $0.001 per share. Annual Report | See notes to financial statements. | 17 MUTUAL BEACON FUND FINANCIAL HIGHLIGHTS (CONTINUED)
-------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2004 2003 2002 2001 2000 -------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ......................... $ 14.06 $ 11.07 $ 12.80 $ 13.18 $ 13.69 -------------------------------------------------------------------- Income from investment operations: Net investment income(a) .................................. .15 .05 .11 .06 -- Net realized and unrealized gains (losses) ................ 1.71 3.06 (1.63) .60 1.67 -------------------------------------------------------------------- Total from investment operations ........................... 1.86 3.11 (1.52) .66 1.67 -------------------------------------------------------------------- Less distributions from: Net investment income ..................................... (.23) (.12) (.10) (.10) (.32) Net realized gains ........................................ (.15) -- (.11) (.94) (1.86) -------------------------------------------------------------------- Total distributions ........................................ (.38) (.12) (.21) (1.04) (2.18) -------------------------------------------------------------------- Redemption fees ............................................ --(d) -- -- -- -- -------------------------------------------------------------------- Net asset value, end of year ............................... $ 15.54 $ 14.06 $ 11.07 $ 12.80 $ 13.18 ==================================================================== Total return(b) ............................................ 13.32% 28.22% (11.96)% 5.12% 13.19% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............................ $ 186,840 $ 155,572 $ 100,405 $ 64,512 $ 18,376 Ratios to average net assets:* Expenses(c) ............................................... 1.83% 1.86% 1.80% 1.79% 1.83% Expenses, net of waiver and payments by affiliate(c) ....... 1.83% 1.86% 1.80% 1.79% 1.81% Net investment income ..................................... .99% .48% .88% .44% .58% Portfolio turnover rate .................................... 29.17% 49.61% 52.27% 55.25% 62.11% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .................................................. 1.82% 1.83% 1.79% 1.78% 1.80% Expenses net of waiver and payments by affiliate .......... 1.82% 1.83% 1.79% 1.78% 1.78%
(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 only operating expenses. (d) Amount is less than $0.001 per share. 18 | See notes to financial statements. | Annual Report MUTUAL BEACON FUND FINANCIAL HIGHLIGHTS (CONTINUED)
-------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2004 2003 2002 2001 2000 -------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ......................... $ 14.26 $ 11.22 $ 12.94 $ 13.28 $ 13.75 -------------------------------------------------------------------- Income from investment operations: Net investment income(a) .................................. .14 .06 .11 .07 .08 Net realized and unrealized gains (losses) ................ 1.74 3.09 (1.64) .60 1.61 -------------------------------------------------------------------- Total from investment operations ........................... 1.88 3.15 (1.53) .67 1.69 -------------------------------------------------------------------- Less distributions from: Net investment income ..................................... (.23) (.11) (.08) (.07) (.30) Net realized gains ........................................ (.14) -- (.11) (.94) (1.86) -------------------------------------------------------------------- Total distributions ........................................ (.37) (.11) (.19) (1.01) (2.16) -------------------------------------------------------------------- Redemption fees ............................................ --(d) -- -- -- -- -------------------------------------------------------------------- Net asset value, end of year ............................... $ 15.77 $ 14.26 $ 11.22 $ 12.94 $ 13.28 ==================================================================== Total return(b) ............................................ 13.39% 28.24% (11.99)% 5.06% 13.21% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............................ $ 658,813 $ 579,825 $ 443,683 $ 482,080 $ 419,481 Ratios to average net assets:* Expenses(c) ............................................... 1.83% 1.86% 1.79% 1.78% 1.82% Expenses, net of waiver and payments by affiliate(c) ...... 1.83% 1.86% 1.79% 1.78% 1.80% Net investment income ..................................... .99% .48% .89% .48% .56% Portfolio turnover rate .................................... 29.17% 49.61% 52.27% 55.25% 62.11% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .................................................. 1.82% 1.83% 1.78% 1.77% 1.79% Expenses net of waiver and payments by affiliate .......... 1.82% 1.83% 1.78% 1.77% 1.77%
(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 only operating expenses. (d) Amount is less than $0.001 per share. Annual Report | See notes to financial statements. | 19 MUTUAL BEACON FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 76.0% AEROSPACE & DEFENSE .5% Northrop Grumman Corp. ............................................. United States 546,200 $ 29,691,432 ------------ AIRLINES .5% (a) Ace Aviation Holdings Inc. ......................................... Canada 865,215 25,645,899 (a),(b),(f) Air Canada Inc., Contingent Distribution ........................... Canada 288,242,292 -- ------------ 25,645,899 ------------ BEVERAGES 4.7% Brown-Forman Corp., A .............................................. United States 308,260 15,647,277 Brown-Forman Corp., B .............................................. United States 362,618 17,652,244 Carlsberg AS, A .................................................... Denmark 74,900 3,442,956 Carlsberg AS, B .................................................... Denmark 1,772,503 89,560,361 Coca-Cola Enterprises Inc. ......................................... United States 946,000 19,724,100 Diageo PLC ......................................................... United Kingdom 4,764,700 67,952,169 Heineken Holding NV, A ............................................. Netherlands 1,680,264 50,732,601 ------------ 264,711,708 ------------ CAPITAL MARKETS 2.2% Bear Stearns Cos. Inc. ............................................. United States 271,302 27,756,908 Irish Life & Permanent PLC ......................................... Irish Republic 2,265,819 41,908,366 (c) Leucadia National Corp. ............................................ United States 865,040 57,097,830 ------------ 126,763,104 ------------ CHEMICALS 1.1% Givaudan AG ........................................................ Switzerland 55,850 36,777,295 Solvay SA .......................................................... Belgium 243,964 26,815,779 ------------ 63,593,074 ------------ COMMERCIAL BANKS 2.9% Allied Irish Banks PLC ............................................. Irish Republic 2,193,118 45,474,194 Bank of Ireland .................................................... Irish Republic 2,675,749 44,182,973 BNP Paribas SA ..................................................... France 245,000 17,720,377 (a) Cerberus NCB Acquisition LP Ltd., wts., 8/29/13 .................... Japan 11,820,937 5,910,469 Danske Bank ........................................................ Denmark 996,500 30,492,211 (a),(c),(d) FE Capital Holdings Ltd. ........................................... Japan 13,981 18,594,719 Kansai Urban Banking Corp. ......................................... Japan 851,803 1,580,185 (a),(d) Nippon Investment LLC .............................................. Japan 10,862,000 -- ------------ 163,955,128 ------------ COMMERCIAL SERVICES & SUPPLIES (a) Comdisco Holding Co., Inc. ......................................... United States 75 1,674 (b) Comdisco, Contingent Distribution .................................. United States 54,914,113 -- (a),(b) Safety Kleen Corp., Contingent Distribution ........................ United States 630,000 -- ------------ 1,674 ------------ COMPUTERS & PERIPHERALS (a) DecisionOne Corp. .................................................. United States 278,121 -- ------------ DIVERSIFIED FINANCIAL SERVICES 2.4% Brascan Corp., A ................................................... Canada 2,889,000 103,939,926
20 | Annual Report MUTUAL BEACON FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) DIVERSIFIED FINANCIAL SERVICES (CONT.) (b) Marconi Corp., Contingent Distribution ............................. United Kingdom 42,651,300 $ -- Pargesa Holdings SA ................................................ Switzerland 8,947 31,421,924 ------------ 135,361,850 ------------ DIVERSIFIED TELECOMMUNICATION SERVICES 1.8% (a),(c),(e) AboveNet Inc. ...................................................... United States 439,477 10,531,363 (a),(b),(e) AboveNet Inc., Contingent Distribution ............................. United States 61,502,000 -- (a),(c),(e) AboveNet Inc., wts., 9/08/08 ....................................... United States 14,770 94,528 (a),(c),(e) AboveNet Inc., wts., 9/08/10 ....................................... United States 17,376 69,504 (b) Global Crossing Holdings Ltd., Contingent Distribution ............. United States 60,632,757 75,791 (a) MCI Inc ............................................................ United States 944,423 19,039,568 Sprint Corp. ....................................................... United States 158,600 3,941,210 (a),(b) Telewest Communications PLC, Contingent Distribution ............... United Kingdom 66,741,863 -- (a) Telewest Global Inc ................................................ United Kingdom 3,785,613 66,551,076 (a),(b) Telewest Finance Ltd., Contingent Distribution ..................... United Kingdom 7,240,000 -- ------------ 100,303,040 ------------ ELECTRIC UTILITIES .6% E.ON AG ............................................................ Germany 380,580 34,694,898 ------------ FOOD & STAPLES RETAILING .3% (a) Kroger Co. ......................................................... United States 1,103,040 19,347,322 ------------ FOOD PRODUCTS 4.5% Cadbury Schweppes PLC .............................................. United Kingdom 4,497,511 41,869,032 (d) Farmer Brothers Co ................................................. United States 1,033,896 25,061,639 Groupe Danone ...................................................... France 640,200 59,031,632 Nestle SA .......................................................... Switzerland 198,235 51,780,072 Orkla ASA .......................................................... Norway 2,289,200 75,118,238 ------------ 252,860,613 ------------ HEALTH CARE EQUIPMENT & SUPPLIES .9% (n) Guidant Corp. ...................................................... United States 176,500 12,725,650 Hillenbrand Industries Inc ......................................... United States 655,900 36,428,686 ------------ 49,154,336 ------------ HEALTH CARE PROVIDERS & SERVICES 1.2% (a) Alderwoods Group Inc. .............................................. United States 206,498 2,349,947 (a) Beverly Enterprises Inc. ........................................... United States 1,511,000 13,825,650 (a),(e) Kindred Healthcare Inc. ............................................ United States 1,364,570 38,825,428 (a),(e) Kindred Healthcare Inc., Jan. 26.00 Calls, 1/01/12 ................. United States 664 2,623 (a),(e) Kindred Healthcare Inc., Jan. 9.07 Calls, 1/01/13 .................. United States 332 6,930 (a),(e) Kindred Healthcare Inc., Jul. 23.75 Calls, 7/17/11 ................. United States 3,296 20,435 (a),(e) Kindred Healthcare Inc., wts., Series A, 4/20/06 ................... United States 121,432 3,608,473 (a),(e) Kindred Healthcare Inc., wts., Series B, 4/20/06 ................... United States 303,580 7,959,868 Select Medical Corp. ............................................... United States 178,600 3,143,360 ------------ 69,742,714 ------------
Annual Report | 21 MUTUAL BEACON FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) HOTELS RESTAURANTS & LEISURE .3% (a) Caesars Entertainment Inc. ......................................... United States 359,300 $ 7,236,302 (a),(d) FHC Delaware Inc ................................................... United States 507,977 3,997,779 Mandalay Resort Group .............................................. United States 86,000 6,056,980 ------------ 17,291,061 ------------ INSURANCE 12.2% (a) Alleghany Corp. .................................................... United States 159,830 45,591,507 (a) Berkshire Hathaway Inc., A ......................................... United States 741 65,133,900 (a) Berkshire Hathaway Inc., B ......................................... United States 33,690 98,913,840 Hartford Financial Services Group Inc. ............................. United States 605,600 41,974,136 Montpelier Re Holdings Ltd. ........................................ Bermuda 242,150 9,310,668 (a),(c) Occum Acquisition Corp. ............................................ United States 511,600 51,160,000 Old Republic International Corp .................................... United States 2,225,245 56,298,699 (a),(c) Olympus Re Holdings Ltd. ........................................... Bermuda 106,700 18,264,906 Prudential Financial Inc. .......................................... United States 541,900 29,782,824 St. Paul Travelers Cos. Inc. ....................................... United States 674,305 24,996,486 White Mountains Insurance Group Inc. ............................... United States 389,021 251,307,566 ------------ 692,734,532 ------------ LEISURE EQUIPMENT & PRODUCTS .3% Mattel Inc. ........................................................ United States 807,200 15,732,328 ------------ MACHINERY (a),(c) Lancer Industries Inc., B .......................................... United States 1 287,261 ------------ MEDIA 9.0% Clear Channel Communications Inc. .................................. United States 934,000 31,279,660 (a) Comcast Corp., A ................................................... United States 188,500 6,190,340 Dow Jones & Co. Inc ................................................ United States 191,200 8,233,072 E.W. Scripps Co., A ................................................ United States 1,099,050 53,062,134 EchoStar Communications Corp., A ................................... United States 670,330 22,281,769 (a) Fox Entertainment Group Inc., A .................................... United States 193,410 6,045,997 Hollinger International Inc ........................................ United States 985,458 13,906,783 (a) Liberty Media Corp., A ............................................. United States 6,957,360 76,391,813 Meredith Corp. ..................................................... United States 570,410 30,916,222 (a) News Corp. Ltd., A ................................................. United States 739,200 13,793,472 (a) NTL Inc ............................................................ United Kingdom 1,135,995 82,882,195 NV Holdingsmig De Telegraaf ........................................ Netherlands 530,294 13,132,858 Omnicom Group Inc. ................................................. United States 242,800 20,472,896 (a) TVMAX Holdings Inc. ................................................ United States 133,855 133,855 Viacom Inc., B ..................................................... United States 411,200 14,963,568 Washington Post Co., B ............................................. United States 119,022 117,001,006 ------------ 510,687,640 ------------ METALS & MINING 10.0% Anglo American PLC ................................................. United Kingdom 1,737,547 41,089,061 Anglo American PLC, ADR ............................................ United Kingdom 1,200 28,548 Barrick Gold Corp. ................................................. Canada 689,000 16,687,580 (a) Coeur D'Alene Mines Corp. .......................................... United States 6,326,300 24,862,359 Compania de Minas Buenaventura SA, ADR ............................. Peru 380,700 8,718,030 Consol Energy Inc. ................................................. United States 1,149,900 47,203,395
22 | Annual Report MUTUAL BEACON FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) METALS & MINING (CONT.) (a) Eldorado Gold Corp. ................................................ Canada 1,029,500 $ 3,047,255 Freeport McMoran Copper & Gold Inc., B ............................. United States 1,611,400 61,603,822 (a) Glamis Gold Ltd. ................................................... Canada 663,900 11,380,985 Gold Fields Ltd. ................................................... South Africa 331,307 4,064,578 Impala Platinum Holdings Ltd. ...................................... South Africa 809,948 68,484,570 (a),(c) International Steel Group .......................................... United States 3,546,660 136,659,903 Newmont Mining Corp. ............................................... United States 2,376,400 105,535,924 Noranda Inc ........................................................ Canada 1,145,400 20,112,664 (a),(d) PMG, LLC ........................................................... United States 48,890 3,226,751 (a) Randgold & Exploration Co. Ltd., ADR ............................... South Africa 172,500 303,600 (a) Rio Narcea Gold Mines Ltd. ......................................... Canada 1,213,700 2,782,903 (a) Wheaton River Minerals Ltd. ........................................ Canada 2,242,026 7,290,534 (a) Wheaton River Minerals Ltd., wts., 5/30/07 ......................... Canada 930,257 1,830,496 ------------ 564,912,958 ------------ MULTI-UTILITIES & UNREGULATED POWER .5% (a) Northwestern Corp. ................................................. United States 384,837 10,775,436 (a),(b) Northwestern Corp., Contingent Distribution ........................ United States 11,805,000 924,241 (a),(f) NRG Energy Inc. .................................................... United States 442,903 15,966,653 ------------ 27,666,330 ------------ OIL & GAS 2.2% (a),(d) Anchor Resources LLC ............................................... United States 69,184 -- BP PLC ............................................................. United Kingdom 2,690,300 26,232,723 BP PLC, ADR ........................................................ United Kingdom 26,100 1,524,240 Canadian Oil Sands Trust ........................................... Canada 865,700 48,801,415 (a) General Maritime Corp. ............................................. United States 16,800 671,160 Total SA, B ........................................................ France 207,900 45,336,712 ------------ 122,566,250 ------------ PERSONAL PRODUCTS .3% Beiersdorf AG ...................................................... Germany 155,088 18,082,235 ------------ PHARMACEUTICALS 1.7% Fujisawa Pharmaceutical Co. Ltd. ................................... Japan 756,100 20,707,484 Pfizer Inc. ........................................................ United States 481,500 12,947,535 (a) Pfizer Inc., Mar. 25.00 Puts, 3/18/05 .............................. United States 2,685 187,950 Takeda Pharmaceutical Co. Ltd. ..................................... Japan 732,680 36,912,993 Wyeth .............................................................. United States 605,500 25,788,245 Yamanouchi Pharmaceutical Co. Ltd. ................................. Japan 47,500 1,850,469 ------------ 98,394,676 ------------ REAL ESTATE 3.0% (a) Alexander's Inc .................................................... United States 38,800 8,342,000 (a) Canary Wharf Group PLC ............................................. United Kingdom 10,069,634 57,211,633 Homebanc Corp. ..................................................... United States 2,117,968 20,501,930 iStar Financial Inc. ............................................... United States 932,800 42,218,528 (a),(c) Security Capital European Realty ................................... Luxembourg 20,244 145,757 St. Joe Co. ........................................................ United States 400,698 25,724,812 Ventas Inc. ........................................................ United States 608,900 16,689,949 ------------ 170,834,609 ------------
Annual Report | 23 MUTUAL BEACON FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) ROAD & RAIL 1.8% CSX Corp. .......................................................... United States 474,500 $ 19,017,960 (c),(d) Florida East Coast Industries Inc. ................................. United States 1,967,636 84,303,364 ------------- 103,321,324 ------------- SOFTWARE .9% Nintendo Co. Ltd. .................................................. Japan 336,200 42,246,573 (a),(n) Symantec Corp ...................................................... United States 167,600 4,317,376 (a),(n) Veritas Software Corp. ............................................. United States 168,800 4,819,240 ------------- 51,383,189 ------------- THRIFTS & MORTGAGE FINANCE .7% Astoria Financial Corp ............................................. United States 346,145 13,835,416 First Niagara Financial Group Inc. ................................. United States 535,650 7,472,317 Hudson City Bancorp Inc. ........................................... United States 471,830 17,372,781 ------------- 38,680,514 ------------- TOBACCO 9.5% Altadis SA ......................................................... Spain 3,686,149 168,570,837 Altria Group Inc. .................................................. United States 1,182,459 72,248,245 British American Tobacco PLC ....................................... United Kingdom 6,316,228 108,810,600 British American Tobacco PLC, ADR .................................. United Kingdom 40,400 1,399,860 Imperial Tobacco Group PLC ......................................... United Kingdom 3,009,443 82,430,711 KT & G Corp. ....................................................... South Korea 204,000 6,099,111 KT & G Corp., GDR, 144A ............................................ South Korea 1,579,000 23,211,300 Reynolds American Inc. ............................................. United States 947,800 74,497,080 ------------- 537,267,744 ------------- WIRELESS TELECOMMUNICATION SERVICES (a) Vast Solutions Inc., B1 ............................................ United States 43,358 -- (a) Vast Solutions Inc., B2 ............................................ United States 43,358 -- (a) Vast Solutions Inc., B3 ............................................ United States 43,358 -- ------------- -- ------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $2,594,931,357) ............................................. 4,305,669,443 ------------- PREFERRED STOCKS .8% DIVERSIFIED TELECOMMUNICATION SERVICES PTV Inc., 10.00%, A, pfd. .......................................... United Kingdom 114,246 517,535 ------------- ELECTRIC UTILITIES (a) Montana Power Co., 8.45%, pfd. ..................................... United States 58,900 485,925 ------------- FOOD PRODUCTS .1% Unilever NV, pfd. .................................................. Netherlands 606,458 4,123,045 ------------- METALS & MINING .3% (a),(d),(e) Esmark Inc., Series A, 10.00%, cvt. pfd. ........................... United States 19,151 19,151,400 ------------- REAL ESTATE .4% Istar Financial Inc., 7.80%, pfd. .................................. United States 770,100 20,022,600 ------------- TOTAL PREFERRED STOCKS (COST $43,163,186) .......................... 44,300,505 -------------
24 | Annual Report MUTUAL BEACON FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- PRINCIPAL COUNTRY AMOUNT(g) VALUE - ----------------------------------------------------------------------------------------------------------------------------------- CORPORATE BONDS & NOTES 1.6% Anchor Resources LLC, 12.00%, 12/17/06 ............................. United States $ 32,368 $ 32,368 Calpine Generating Co., 144A, FRN, 11.169%, 4/01/11 ................ United States 10,441,000 10,258,282 Eurotunnel PLC, FRN, 6.347%, 12/31/18, Tier 2 .................................... United Kingdom 7,592,095 GBP 10,492,357 FRN, 6.347%, 12/31/25, Tier 3 .................................... United Kingdom 28,404,485 GBP 22,898,929 Participating Loan Note, 1.00%, 4/30/40 .......................... United Kingdom 858,000 GBP 189,393 Eurotunnel SA, FRN, 3.449%, 12/31/18, Tier 2 (LIBOR) ................................. France 1,880,987 EUR 1,837,798 3.449%, 12/31/25, Tier 3 (LIBOR) ................................. France 20,347,101 EUR 11,596,622 3.453%, 12/31/18, Tier 2 (PIBOR) ................................. France 832,034 EUR 812,930 3.453%, 12/31/25, Tier 3 (PIBOR) ................................. France 1,048,320 EUR 597,479 Guadalupe Power Partners LP, Power Sale Agreement, 6.00%, 9/21/06 ............................. United States 203,900 179,432 Term Loan, 4.313%, 9/21/06 ....................................... United States 1,506,803 1,325,986 Motor Coach Industries International Inc., FRN, 15.40%, 10/01/08 ................................................. United States 27,558,237 27,558,237 Reliant Energy Channelview LP Inc., Revolver, 5.50%, 8/15/07 ......................................... United States 342,900 291,465 Term Loan A, 3.813%, 11/26/17 .................................... United States 3,619,627 3,076,683 TVMAX Holdings Inc., PIK, 11.50%, 6/30/05 .................................................. United States 152,342 152,342 14.00%, 6/30/05 .................................................. United States 561,804 561,804 ------------ TOTAL CORPORATE BONDS & NOTES (COST $96,482,682) ................... 91,862,107 ------------ BONDS & NOTES IN REORGANIZATION 2.7% (a),(h) Adelphia Communications Corp., 9.25%, 10/01/02 .................................................. United States 3,244,000 3,122,350 8.125%, 7/15/03 .................................................. United States 825,000 779,625 7.50%, 1/15/04 ................................................... United States 2,160,000 2,008,800 10.50%, 7/15/04 .................................................. United States 3,375,000 3,341,250 9.875%, 3/01/05 .................................................. United States 1,304,000 1,255,100 10.25%, 11/01/06 ................................................. United States 4,751,000 4,644,102 9.875%, 3/01/07 .................................................. United States 187,000 179,987 8.375%, 2/01/08 .................................................. United States 4,959,000 4,698,652 7.75%, 1/15/09 ................................................... United States 5,790,000 5,442,600 7.875%, 5/01/09 .................................................. United States 4,398,000 4,112,130 9.375%, 11/15/09 ................................................. United States 959,000 951,807 10.875%, 10/01/10 ................................................ United States 3,621,000 3,602,895 (a),(h) Aiken Cnty S C Indl Rev Beloit, 6.00%, 12/01/11 .................... United States 420,000 2,100 (a),(h) Armstrong Holdings Inc., 6.50%, 8/15/05 ................................................... United States 1,046,000 760,965 9.75%, 4/15/08 ................................................... United States 1,953,000 1,420,807 Revolver, 10/29/03 ............................................... United States 1,880,775 1,297,735 Trade Claim ...................................................... United States 5,042,800 3,529,960 (a),(h) Century Communications Corp., 9.50%, 3/01/05 ................................................... United States 1,023,000 1,242,945 8.875%, 1/15/07 .................................................. United States 1,275,000 1,536,375 8.75%, 10/01/07 .................................................. United States 1,889,000 2,229,020 8.375%, 12/15/07 ................................................. United States 500,000 597,500
Annual Report | 25 MUTUAL BEACON FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- PRINCIPAL COUNTRY AMOUNT(g) VALUE - ----------------------------------------------------------------------------------------------------------------------------------- BONDS & NOTES IN REORGANIZATION (CONT.) (a),(h) Century Communications Corp., (cont.) Series B, zero cpn., 1/15/08 ..................................... United States $ 3,405,000 $ 2,400,525 zero cpn., 3/15/03 ............................................... United States 7,710,000 8,211,150 (h) DecisionOne Corp., Term Loan ....................................... United States 8,374,702 2,093,676 (a),(h) Harnischfeger Industries Inc., 8.90%, 3/01/22 ................................................... United States 3,775,000 35,108 8.70%, 6/15/22 ................................................... United States 3,460,000 32,870 7.25%, 12/15/25 .................................................. United States 5,165,000 48,551 6.875%, 2/15/27 .................................................. United States 4,430,000 40,756 Stipulated Bank Claim ............................................ United States 5,708,150 51,944 (a),(h) Mirant Americas Generation Inc., 7.625%, 5/01/06 .................................................. United States 863,000 932,040 8.30%, 5/01/11 ................................................... United States 4,134,000 4,392,375 9.125%, 5/01/31 .................................................. United States 3,137,000 3,286,008 (a),(h) Mirant Corp., Tranche C Revolver ............................................... United States 7,016,181 4,841,165 4 Year Revolver, 7/17/05 ......................................... United States 4,474,363 3,378,144 364 Day Revolver ................................................. United States 11,868,000 8,248,260 (a),(h) Owens Corning, Revolver ............................................ United States 31,524,863 28,057,128 (a),(h) Port Seattle Wash Rev Ref-Beloit Proj., 6.00%, 12/01/17 ............ United States 225,000 1,125 (a),(h) Safety Kleen Services, 9.25%, 6/01/08 .............................. United States 50,000 188 (a),(h) Teco Panda, Bank Claim ....................................................... United States 1,804,200 1,082,520 Bank Claim #2 .................................................... United States 14,519,100 9,147,033 Bank Claim #3 .................................................... United States 82,705 82,705 Debt Service Reserve L/C Loan .................................... United States 488,400 307,692 Project L/C Loan Facility ........................................ United States 1,995,490 1,257,159 (h) Trump Atlantic, 11.25%, 5/01/06 .................................................. United States 20,273,000 19,436,739 Series B, 11.25%, 5/01/06 ........................................ United States 5,945,000 5,699,769 Series B, 144A, 11.25%, 5/01/06 .................................. United States 369,000 353,779 ------------ TOTAL BONDS & NOTES IN REORGANIZATION (COST $129,375,220) .......... 150,175,114 ------------ ---------------- SHARES/PRINCIPAL AMOUNT(G) ---------------- COMPANIES IN LIQUIDATION (a) Brunos Inc., Liquidating Unit ...................................... United States 62,735 138,017 (a) City Investing Co. Liquidating Trust ............................... United States 423,187 816,751 (a) Eli Jacobs, bank claim ............................................. United States 25,305,910 136,652 (a) MBOP Liquidating Trust ............................................. United States 205,135 513 (a) United Cos. Financial Corp., Bank Claim ....................................................... United States 112,077 -- Revolver ......................................................... United States 28,431,827 -- ------------ TOTAL COMPANIES IN LIQUIDATION (COST $145,071) ..................... 1,091,933 ------------
26 | Annual Report MUTUAL BEACON FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- PRINCIPAL COUNTRY AMOUNT(g) VALUE - ----------------------------------------------------------------------------------------------------------------------------------- GOVERNMENT AGENCIES 19.2% (i) Federal Home Loan Bank, 1.000% - 2.846%, 1/03/05 - 11/17/05 ........ United States $1,021,478,000 $1,014,853,209 Federal Home Loan Mortgage Corp., 2.50%, 5/19/06 ................... United States 10,000,000 9,919,330 Federal National Mortgage Association, 1.44% - 2.20%, 6/01/05 - 12/29/06 ............................................... United States 43,375,000 42,788,451 U.S. Treasury Bills, 1.895% - 2.527%, 2/24/05 - 6/30/05 ............ United States 22,000,000 21,825,118 -------------- TOTAL GOVERNMENT AGENCIES (COST $1,091,882,612) .................... 1,089,386,108 -------------- TOTAL INVESTMENTS BEFORE REPURCHASE AGREEMENTS (COST $3,955,980,128) ............................................ 5,682,485,210 -------------- REPURCHASE AGREEMENTS (j),(k) Bank of America LLC, 2.32%, 1/03/05 (Maturity Value $6,001) Collateralized by U.S. Gov't Agency Securities, 3.929-6.50%, 11/1/17-12/1/34 ..................................... United States 6,000 6,000 (j),(k) Barclays Capital Inc., 2.25%, 1/03/05 (Maturity Value $10,003) Collateralized by U.S. Gov't Agency Securities, 0.00-7.00%, 3/21/05-8/15/19 ...................................... United States 10,001 10,001 (j),(k) Bear Stearns & Co. 2.25%, 1/03/05 (Maturity Value $10,003) Collateralized by U.S. Gov't Agency Securities, 0.00-8.625%, 1/11/05-3/18/33 ..................................... United States 10,001 10,001 (j),(k) Deutche Bank Securities Inc., 2.25%, 1/03/05 (Maturity Value $10,003) Collateralized by U.S. Gov't Agency Securities, 0.00-4.45%, 8/19/05-8/27/10 .......................... United States 10,001 10,001 (j),(k) JP Morgan Securities, 2.19%, 1/03/05 (Maturity Value $10,003) Collateralized by U.S. Gov't Agency Securities, 2.00-7.125%, 1/15/06-7/15/32 ..................................... United States 10,001 10,001 (j),(k) Morgan Stanley & Co. Inc., 2.30%, 1/03/05 (Maturity Value $10,003) Collateralized by U.S. Gov't Agency Securities, 4.00-8.00%, 7/1/08-1/1/35 ............................ United States 10,001 10,001 -------------- TOTAL REPURCHASE AGREEMENTS (COST $56,005) ......................... 56,005 -------------- TOTAL INVESTMENTS (COST $3,956,036,133) 100.3% ..................... 5,682,541,215 OPTIONS WRITTEN .................................................... (107,904) SECURITIES SOLD SHORT (.8)% ........................................ (44,521,228) NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS (1.0)% ........... (55,442,584) OTHER ASSETS, LESS LIABILITIES 1.5% ................................ 84,706,211 -------------- NET ASSETS 100.0% .................................................. $5,667,175,710 ==============
Annual Report | 27 MUTUAL BEACON FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- OPTIONS WRITTEN ISSUER HEALTH CARE EQUIPMENT & SUPPLIES (l) Guidant Corp., Jan. 70.00 Calls, 01/21/05 .......................... United States 181 $ 42,535 -------------- SOFTWARE (l) Symantec Corp., Jan. 25.00 Calls, 1/21/05 .......................... United States 254 38,100 (l) Symantec Corp., Jan. 27.50 Calls, 1/21/05 .......................... United States 169 6,929 (l) Veritas Software Corp., Jan. 30.00 Calls, 1/21/05 .................. United States 339 20,340 -------------- 65,369 -------------- TOTAL OPTIONS WRITTEN (PREMIUMS RECEIVED $113,289) ................. $ 107,904 -------------- -------------- SHARES -------------- SECURITIES SOLD SHORT .8% ISSUER COMMUNICATIONS EQUIPMENT (m) Tellabs Inc ........................................................ United States 78,092 670,810 -------------- DIVERSIFIED FINANCIAL SERVICES .1% (m) Nasdaq 100 ......................................................... United States 179,200 7,153,664 -------------- FOOD PRODUCTS .5% (m) Kraft Foods Inc., A ................................................ United States 776,718 27,658,928 -------------- HOTELS RESTAURANTS & LEISURE .1% (m) Harrah's Entertainment Inc. ........................................ United States 77,630 5,192,671 -------------- PHARMACEUTICALS .1% (m) Johnson & Johnson .................................................. United States 60,630 3,845,155 -------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $41,532,212) ................. $ 44,521,228 -------------- CURRENCY ABBREVIATIONS: | EUR - Euro | GBP - British Pound
(a) Non-income producing. (b) Contingent Distributions represent the right to receive additional distributions, if any, during the reorganization of the underlying company. Shares represent total underlying principal of debt securities. (c) See Note 10 regarding restricted securities. (d) See Note 11 regarding holdings of 5% voting securities. (e) See Note 12 regarding other considerations. (f) Security on loan. See Note 1(i). (g) The principal amount is stated in U.S. dollars unless otherwise indicated. (h) Defaulted securities. See Note 9. (i) See Note 1(h) regarding securities segregated with broker for securities sold short. (j) Investments from cash collateral received for loaned securities. See Note 1(i). (k) See Note 1(c) regarding repurchase agreements. (l) See Note 1(g) regarding written options. (m) See Note 1(h) regarding securities sold short. (n) A portion of the security held in connection with open option contracts. 28 | See notes to financial statements. | Annual Report MUTUAL BEACON FUND FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2004 Assets: Investments in securities: Cost - Unaffiliated issuers ................................................. $ 3,852,682,878 Cost - Non-controlled affiliated issuers (Note 11) .......................... 99,874,939 Cost - Controlled affiliates (Note 11) ...................................... 3,422,311 Cost - Repurchase agreements ................................................ 56,005 --------------- Total cost of investments ................................................... 3,956,036,133 =============== Value - Unaffiliated issuers (includes securities segregated with broker for securities sold short in the amount of $24,555,375) ........................ 5,528,149,558 Value - Non-controlled affiliated issuers (Note 11) ......................... 151,108,901 Value - Controlled affiliates (Note 11) ..................................... 3,226,751 Value - Repurchase agreements ............................................... 56,005 --------------- Total value of investments .................................................. 5,682,541,215 Cash ......................................................................... 12,414,391 Foreign currency, at value (cost $10,340,096) ................................ 12,148,712 Receivables: Investment securities sold .................................................. 25,531,371 Capital shares sold ......................................................... 3,362,102 Dividends and interest ...................................................... 12,968,049 Unrealized gain on forward exchange contracts (Note 8) ....................... 1,681,028 Due from broker - synthetic equity swaps ..................................... 1,048,568 Cash on deposit with brokers for securities sold short ....................... 44,952,783 --------------- Total assets ........................................................... 5,796,648,219 --------------- Liabilities: Payables: Investment securities purchased ............................................. 9,220,270 Capital shares redeemed ..................................................... 13,138,636 Affiliates .................................................................. 5,013,796 Options written, at value (premiums received $113,289) ....................... 107,904 Securities sold short, at value (proceeds $41,532,212) ....................... 44,521,228 Payable upon return of securities loaned ..................................... 56,005 Unrealized loss on forward exchange contracts (Note 8) ....................... 57,123,612 Other liabilities ............................................................ 291,058 --------------- Total liabilities ...................................................... 129,472,509 --------------- Net assets, at value ................................................. $ 5,667,175,710 =============== Net assets consist of: Distributions in excess of net investment income ............................. $ (12,838,004) Net unrealized appreciation (depreciation) ................................... 1,670,432,172 Accumulated net realized gain (loss) ......................................... 80,135,742 Capital shares ............................................................... 3,929,445,800 --------------- Net assets, at value ................................................. $ 5,667,175,710 ===============
Annual Report | See notes to financial statements. | 29 MUTUAL BEACON FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2004 CLASS Z: Net assets, at value ......................................................... $ 3,359,388,929 =============== Shares outstanding ........................................................... 210,815,754 =============== Net asset value and maximum offering price per share(a) ...................... $ 15.94 =============== CLASS A: Net assets, at value ......................................................... $ 1,462,133,389 =============== Shares outstanding ........................................................... 92,128,035 =============== Net asset value per share(a) ................................................. $ 15.87 =============== Maximum offering price per share (net asset value per share / 94.25%)......... $ 16.84 =============== CLASS B: Net assets, at value ......................................................... $ 186,840,161 =============== Shares outstanding ........................................................... 12,021,141 =============== Net asset value and maximum offering price per share(a) ...................... $ 15.54 =============== CLASS C: Net assets, at value ......................................................... $ 658,813,231 =============== Shares outstanding ........................................................... 41,784,988 =============== Net asset value and maximum offering price per share(a) ...................... $ 15.77 ===============
(a) Redemption price is equal to net asset value less contingent deferred sales charges, if applicable, and redemption fees retained by the Fund. 30 | See notes to financial statements. | Annual Report MUTUAL BEACON FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2004 Investment income: Dividends: (net of foreign taxes of $6,173,377) Unaffiliated issuers ........................................................ $ 95,732,358 Non-controlled affiliated issuers (Note 11) ................................. 571,280 Interest ..................................................................... 52,867,755 --------------- Total investment income ................................................. 149,171,393 --------------- Expenses: Management fees (Note 3) ..................................................... 31,706,865 Administrative fees (Note 3) ................................................. 4,079,418 Distribution fees (Note 3) Class A ..................................................................... 4,758,171 Class B ..................................................................... 1,676,046 Class C ..................................................................... 6,042,018 Transfer agent fees (Note 3) ................................................. 5,764,200 Custodian fees (Note 4) ...................................................... 443,700 Reports to shareholders ...................................................... 216,500 Registration and filing fees ................................................. 176,763 Professional fees ............................................................ 427,485 Directors' fees and expenses ................................................. 139,900 Dividends on securities sold short ........................................... 728,423 Other ........................................................................ 221,237 --------------- Total expenses .......................................................... 56,380,726 Expense reductions (Note 4) ............................................. (25,392) --------------- Net expenses .......................................................... 56,355,334 --------------- Net investment income ............................................... 92,816,059 --------------- Realized and unrealized gains (losses): Net realized gain (loss) from : Investments: Unaffiliated issuers ....................................................... 336,310,054 Non-controlled affiliated issuers (Note 11) ................................ 1,037,765 Written options ............................................................. 854,334 Foreign currency transactions ............................................... (103,206,358) Securities sold short ....................................................... (2,365,541) --------------- Net realized gain (loss) ................................................ 232,630,254 Net change in unrealized appreciation (depreciation) on: Investments ................................................................. 375,655,289 Translation of assets and liabilities denominated in foreign currencies ..... 11,661,121 --------------- Net change in unrealized appreciation (depreciation) .................... 387,316,410 --------------- Net realized and unrealized gain (loss) ...................................... 619,946,664 --------------- Net increase (decrease) in net assets resulting from operations .............. $ 712,762,723 ===============
Annual Report | See notes to financial statements. | 31 MUTUAL BEACON FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS for the years ended December 31, 2004 and 2003
--------------------------------- 2004 2003 --------------------------------- Increase (decrease) in net assets: Operations: Net investment income .................................................................... $ 92,816,059 $ 55,284,747 Net realized gain (loss) from investments, written options, foreign currency transactions, and securities sold short ............................................................. 232,630,254 22,660,560 Net change in unrealized appreciation (depreciation) on investments and translation of assets and liabilities denominated in foreign currencies ................ 387,316,410 1,087,534,740 --------------------------------- Net increase (decrease) in net assets resulting from operations ..................... 712,762,723 1,165,480,047 Distributions to shareholders from: Net investment income: Class Z ............................................................................... (77,913,804) (50,293,581) Class A ............................................................................... (29,186,869) (16,775,978) Class B ............................................................................... (2,726,902) (1,221,776) Class C ............................................................................... (9,336,828) (4,420,080) Net realized gains: Class Z ............................................................................... (30,107,862) -- Class A ............................................................................... (13,165,077) -- Class B ............................................................................... (1,717,371) -- Class C ............................................................................... (5,979,789) -- --------------------------------- Total distributions to shareholders ........................................................ (170,134,502) (72,711,415) Capital share transactions: (Note 2) Class Z ............................................................................... (76,914,860) (133,826,403) Class A ............................................................................... 21,294,207 115,460,107 Class B ............................................................................... 13,963,459 24,317,663 Class C ............................................................................... 16,973,359 15,436,107 --------------------------------- Total capital share transactions ........................................................... (24,683,835) 21,387,474 Redemption fees ............................................................................ 2,731 -- --------------------------------- Net increase (decrease) in net assets ............................................... 517,947,117 1,114,156,106 Net assets Beginning of year .......................................................................... 5,149,228,593 4,035,072,487 --------------------------------- End of year ................................................................................ $ 5,667,175,710 $ 5,149,228,593 ================================= Distributions in excess of net investment income/undistributed net investment income included in net assets: End of year ................................................................................ $ (12,838,004) $ 8,284,651 =================================
32 | See notes to financial statements. | Annual Report 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), consisting of 6 separate series. The Company is an open-end investment company registered under the Investment Company Act of 1940. The financial statements of the remaining funds in the Series are presented separately. 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 on a securities exchange or on the NASDAQ National Market System, are valued at the last quoted sale price or the official closing price of the day, respectively. Over-the-counter securities and listed securities for which there is no reported sale are valued within the range of the most recent quoted bid and ask prices. Securities that trade in multiple markets or on multiple exchanges are valued according to the broadest and most representative market. Repurchase agreements are valued at cost. Corporate debt securities and U.S. Government securities generally trade in the over-the-counter market rather than on a securities exchange. The Fund may utilize independent pricing services, quotations from bond dealers, and information with respect to bond and note transactions, to assist in determining a current market value for each security. The Fund's pricing services may use valuation models or matrix pricing which considers information with respect to comparable bond and note transactions, quotations from bond dealers, or by reference to other securities that are considered comparable in such characteristics as rating, interest rate and maturity date, option adjusted spread models, prepayment projections, interest rate spreads and yield curves, to determine current value. Foreign securities are valued as of the close of trading on the foreign stock exchange on which the security is primarily traded, or the NYSE, whichever is earlier. The value is then converted into its U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the day that the value of the foreign security is determined. If no sale is reported at that time, the foreign security will be valued within the range of the most recent quoted bid and ask prices. Annual Report | 33 MUTUAL BEACON FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. Some methods for valuing these securities may include: fundamental analysis, matrix pricing, discounts from market prices of similar securities, or discounts applied due to the nature and duration of restrictions on the disposition of the securities. Occasionally, events occur between the time at which trading in a security is completed and the close of the NYSE that might call into question the availability (including the reliability) of the value of a portfolio security held by the Fund. If such an event occurs, the securities may be valued using fair value procedures, which may include the use of independent pricing services. All security valuation procedures are approved by the Fund's 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, income and expense items denominated in foreign currencies are translated into U.S. dollars at the exchange rate in effect on the transaction date. Occasionally, events may impact the availability or reliability of foreign exchange rates used to convert the U.S. dollar equivalent value. If such an event occurs, the foreign exchange rate will be valued at fair value using procedures established and approved by the Fund's Board of Directors. 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 on the Statement of Operations. 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, 2004, 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 DELIVERY 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 by the Fund and any equity therein is included in the Statement of Assets and Liabilities. Realized and unrealized gains and losses on these contracts 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 on these contracts 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 to 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 synthetic 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. Upon closing of an option, other than by exercise, which 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 incurs 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 realizes a gain if the price of the security declines between those dates. Gains are limited to the price at which the Fund sold the security short, while losses are potentially unlimited in size. 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 with the broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. The Fund is obligated to pay the counterparty any dividends or interest due on securities sold short. Such dividends and interest are recorded as an expense to the Fund. I. SECURITIES LENDING The Fund loans securities to certain brokers through a securities lending agent for which it received cash collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. The collateral is invested in short-term instruments as noted in the Statement of Investments. The Fund received interest income of $47,170 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 collateral and the securities loaned. The securities lending agent has agreed to indemnify the Fund in the case of default of any securities borrower. 36 | Annual Report MUTUAL BEACON FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) J. INCOME TAXES No provision has been made for U.S. income taxes because the Fund's policy is to qualify as a regulated investment company under Sub Chapter M of the Internal Revenue Code and to distribute substantially all of its taxable income. Fund distributions to shareholders are determined on an income tax basis and may differ from net investment income and realized gains for financial reporting purposes. 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. Interest income and estimated expenses are accrued daily. Discounts and premiums 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 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 expenses during the reporting period. Actual results could differ from those estimates. M. REDEMPTION FEES Effective June 1, 2004, redemptions and exchanges of Fund shares held five trading days or less 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 as noted in the Statements of Changes in Net Assets. Annual Report | 37 MUTUAL BEACON FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) N. GUARANTEES AND INDEMNIFICATIONS Under the Fund's organizational documents, its officers and directors are indemnified by the Fund 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 five classes of shares: Class Z, Class A, Class B, Class C and Class R. Effective March 1, 2005, Class B shares will no longer be offered except to existing Class B shareholders through reinvested distributions or exchanges into other Franklin Templeton funds' Class B shares, as permitted by the applicable fund prospectus. 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, 2004, there were 1.55 billion 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, 2004 2003 -------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT -------------------------------------------------------------- CLASS Z SHARES: Shares sold .................... 9,311,423 $ 138,383,364 10,838,451 $ 134,762,381 Shares issued in reinvestment of distributions ................ 6,402,049 98,844,650 3,412,886 45,700,241 Shares redeemed ................ (21,085,193) (314,142,874) (25,512,048) (314,289,025) -------------------------------------------------------------- Net increase (decrease) ........ (5,371,721) $ (76,914,860) (11,260,711) $(133,826,403) ============================================================== CLASS A SHARES: Shares sold .................... 17,626,495 $ 260,036,176 22,121,507 $ 273,306,831 Shares issued in reinvestment of distributions ................ 2,612,744 40,150,928 1,202,510 15,931,792 Shares redeemed ................ (18,863,471) (278,892,897) (14,091,787) (173,778,516) -------------------------------------------------------------- Net increase (decrease) ........ 1,375,768 $ 21,294,207 9,232,230 $ 115,460,107 ============================================================== CLASS B SHARES: Shares sold .................... 1,843,917 $ 26,599,867 2,993,364 $ 35,998,720 Shares issued in reinvestment of distributions ................ 273,719 4,112,587 90,069 1,135,983 Shares redeemed ................ (1,158,155) (16,748,995) (1,089,762) (12,817,040) -------------------------------------------------------------- Net increase (decrease) ........ 959,481 $ 13,963,459 1,993,671 $ 24,317,663 ==============================================================
38 | Annual Report MUTUAL BEACON FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED)
-------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2004 2003 -------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT -------------------------------------------------------------- CLASS C SHARES: Shares sold .................... 6,114,281 $ 89,688,362 6,809,888 $ 83,970,999 Shares issued in reinvestment of distributions ................ 908,460 13,841,462 316,168 4,009,329 Shares redeemed ................ (5,908,416) (86,556,465) (6,010,932) (72,544,221) -------------------------------------------------------------- Net increase (decrease) ........ 1,114,325 $ 16,973,359 1,115,124 $ 15,436,107 ==============================================================
3. TRANSACTIONS WITH AFFILIATES Certain officers of the Fund are also officers and/or directors of the following entities:
- ------------------------------------------------------------------------------------- ENTITY AFFILIATION - ------------------------------------------------------------------------------------- Franklin Mutual Advisers, LLC (Franklin Mutual) Investment manager Franklin Templeton Services, LLC (FT Services) Administrative manager Franklin/Templeton Distributors, Inc. (Distributors) Principal underwriter Franklin/Templeton Investor Services, LLC (Investor Services) Transfer agent
A. MANAGEMENT FEES Effective July 1, 2004, the Fund pays an investment management fee to Franklin Mutual based on the average daily net assets of the Fund as follows: - ---------------------------------------------------------------------- ANNUALIZED FEE RATE NET ASSETS - ---------------------------------------------------------------------- 0.600% First $5 billion 0.570% Over $5 billion, up to and including $7 billion 0.550% Over $7 billion, up to and including $10 billion 0.540% Over $10 billion Prior to July 1, 2004, the Fund paid fees of 0.60% per year of the average daily net assets of the Fund. B. ADMINISTRATIVE FEES The Fund pays its allocated share of an administrative fee to FT Services based on the Fund's aggregate average daily net assets as follows: - -------------------------------------------------------------------------- ANNUALIZED FEE RATE 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 | 39 MUTUAL BEACON FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) C. DISTRIBUTION FEES The Fund reimburses Distributors 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, respectively, for costs incurred in marketing the Fund's shares under a Rule 12b-1 plan. Under the Class A distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. D. SALES CHARGES/UNDERWRITING AGREEMENTS Distributors has advised the Fund of the following commission transactions related to the sales and redemptions of the Fund's shares for the year: Net sales charges received.............................. $ 425,013 Contingent deferred sales charges retained.............. $ 311,416 E. TRANSFER AGENT FEES The Fund paid transfer agent fees of $5,764,200, of which $3,823,542, was paid to Investor Services. 4. EXPENSE OFFSET ARRANGEMENT The Fund has entered into an arrangement with its custodian whereby credits realized as a result of uninvested cash balances are used to reduce a portion of the Fund's custodian expenses. During the year ended December 31, 2004, the custodian fees were reduced as noted in the Statement of Operations. 5. INCOME TAXES 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, bond discounts and premiums, and certain dividends on securities sold short. Net realized gains differ for financial statement and tax purposes primarily due to differing treatments of wash sales, foreign currency transactions, passive foreign investment company shares, bond discounts and premiums, and certain dividends on securities sold short. 40 | Annual Report MUTUAL BEACON FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. INCOME TAXES (CONTINUED) At December 31, 2004, 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 .................................. $ 3,980,847,410 =============== Unrealized appreciation .............................. $ 1,762,750,280 Unrealized depreciation .............................. (61,056,475) --------------- Net unrealized appreciation (depreciation) ........... $ 1,701,693,805 =============== Undistributed ordinary income ........................ $ 6,959,551 Undistributed long term capital gains ................ 44,453,846 --------------- Distributable earnings ............................... $ 51,413,397 =============== The tax character of distributions paid during the years ended December 31, 2004 and 2003, was as follows: --------------------------- 2004 2003 --------------------------- Distributions paid from: Ordinary income ......................... $ 119,164,403 $ 72,711,415 Long term capital gain .................. 50,970,099 -- --------------------------- $ 170,134,502 $ 72,711,415 --------------------------- 6. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short-term securities and securities sold short) for the year ended December 31, 2004 aggregated $1,320,896,467 and $1,566,051,985, respectively. Transactions in options written during the year ended December 31, 2004 were as follows: --------------------------- NUMBER OF PREMIUMS CONTRACTS RECEIVED --------------------------- Options outstanding at December 31, 2003 ....................... 1,349,370 $ 337,343 Options written .......................... 18,663 1,562,296 Options expired .......................... (10,116) (646,019) Options exercised ........................ (1,354,528) (695,439) Options closed ........................... (2,446) (444,892) --------------------------- Options outstanding at December 31, 2004 ....................... 943 $ 113,289 =========================== Annual Report | 41 MUTUAL BEACON FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. SYNTHETIC EQUITY SWAPS As of December 31, 2004, the Fund had the following synthetic equity swaps outstanding:
- --------------------------------------------------------------------------------------------------------- NUMBER OF UNREALIZED CONTRACTS TO BUY CONTRACTS VALUE GAIN (LOSS) - --------------------------------------------------------------------------------------------------------- Christian Dior SA (47.22 - 55.43 EUR) ................ 82,441 $ 5,599,213 $ 50,834 ---------- Total contracts to buy ............................... $ 50,834 ----------
- --------------------------------------------------------------------------------------------------------- NUMBER OF UNREALIZED CONTRACTS TO SELL CONTRACTS VALUE GAIN (LOSS) - --------------------------------------------------------------------------------------------------------- LVMH Moet Hennessy Louis Vuitton (54.65 - 61.76 EUR) . 79,946 $ 6,113,224 $ 331,038 ---------- Total contracts to sell ................................................................ 331,038 ---------- Net unrealized gain (loss) ............................................................. $ 381,872 ==========
8. FORWARD EXCHANGE CONTRACTS At December 31, 2004, 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) - --------------------------------------------------------------------------------------------------------- 30,272,722 Canadian Dollars .................. U.S. $ 25,100,000 4/21/05 U.S. $ 138,555 ------------- ----------
- --------------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO SELL EXCHANGE FOR DATE GAIN (LOSS) - --------------------------------------------------------------------------------------------------------- 1,900,000 British Pounds .................... U.S. $ 3,649,387 2/10/05 U.S. $ 12,599 1,700,000 Euro .............................. 2,314,720 2/23/05 6,675 33,775,000 British Pounds .................... 64,850,929 3/21/05 341,064 67,400,000 British Pounds .................... 129,410,012 6/08/05 1,180,737 673,725,000 Korean Won ........................ 650,000 6/17/05 1,398 ------------- ---------- U.S. $ 200,875,048 1,542,473 ============= ---------- Unrealized gain on forward exchange contracts ................................ U.S. $1,681,028 ==========
42 | Annual Report MUTUAL BEACON FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. FORWARD EXCHANGE CONTRACTS (CONTINUED)
- ----------------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO BUY EXCHANGE FOR DATE GAIN (LOSS) - ----------------------------------------------------------------------------------------------------------- 22,000,000 South African Rand ................ U.S. $ 3,891,285 1/26/05 U.S. $ (23,028) 14,860,938 Canadian Dollars .................. 12,500,000 4/21/05 (110,344) ------------- ------------ U.S. $ 16,391,285 U.S. $ (133,372) ============= ============
- ----------------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO SELL EXCHANGE FOR DATE GAIN (LOSS) - ----------------------------------------------------------------------------------------------------------- 123,686,730 Canadian Dollars .................. U.S. $ 94,111,155 1/21/05 U.S. $ (9,003,140) 393,136,701 South African Rand ................ 62,086,884 1/26/05 (7,038,281) 51,850,000 British Pounds .................... 95,742,590 2/10/05 (3,503,447) 13,300,000 Euro .............................. 16,582,839 2/23/05 (1,474,221) 635,303,036 Danish Krona ...................... 103,835,559 3/17/05 (12,135,367) 7,934,564,068 Japanese Yen ...................... 72,569,145 3/28/05 (5,376,246) 54,156,980 Canadian Dollars .................. 41,246,383 4/21/05 (3,904,626) 41,122,677 Euro .............................. 51,910,292 4/25/05 (3,978,477) 17,300,000 Euro .............................. 21,412,553 5/23/05 (2,112,859) 15,900,000 Euro .............................. 21,179,436 6/13/05 (451,451) 17,543,384,965 Korean Won ........................ 16,725,000 6/17/05 (201,580) 27,000,000 Euro .............................. 34,095,600 7/25/05 (2,670,063) 12,500,000 Euro .............................. 15,452,812 8/23/05 (1,579,687) 16,700,000 Euro .............................. 20,340,600 9/13/05 (2,425,822) ------------- ------------ U.S. $ 667,290,848 (55,855,267) ============= ------------ Net unrealized loss on offsetting forward exchange contracts .......................... (1,134,973) ------------ Unrealized loss on forward exchange contracts ...................................... (57,123,612) ------------ Net unrealized loss on forward exchange contracts ............................... U.S. $(55,442,584) ============
Annual Report | 43 MUTUAL BEACON FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. CREDIT RISK AND DEFAULTED SECURITIES The Fund held defaulted securities and/or other securities for which the income has been deemed uncollectible. At December 31, 2004, the value of these securities was $150,175,114, representing 2.65% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. 10. RESTRICTED SECURITIES At December 31, 2004, investments in securities included issues that are restricted and 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, 2004, the Fund held investments in restricted and illiquid securities that were valued under approved methods by the Directors, as follows:
- ----------------------------------------------------------------------------------------------------- SHARES/ ACQUISITION WARRANTS ISSUER DATE COST VALUE - ----------------------------------------------------------------------------------------------------- 439,477 AboveNet Inc ........................... 10/01/03 $20,497,153 $ 10,531,363 14,770 AboveNet Inc., wts., 9/08/08 ........... 10/02/03 3,420,472 94,528 17,376 AboveNet Inc., wts., 9/08/10 ........... 10/02/03 1,972,095 69,504 13,981 FE Capital Holdings Ltd ................ 8/29/03 13,985,422 18,594,719 1,967,636 Florida East Coast Industries Inc ...... 7/15/04 46,735,956 84,303,364 3,546,660 International Steel Group .............. 4/25/03 17,173,750 136,659,903 1 Lancer Industries Inc., B .............. 8/11/89 -- 287,261 865,040 Leucadia National Corp ................. 12/20/02 30,492,660 57,097,830 511,600 Occum Acquisition Corp ................. 7/27/04 51,160,000 51,160,000 106,700 Olympus Re Holdings Ltd ................ 12/19/01 10,670,000 18,264,906 20,244 Security Capital European Realty ....... 11/08/99 1,108,993 145,757 ------------ TOTAL RESTRICTED SECURITIES (6.66% OF NET ASSETS) .................................... $377,209,135 ============
44 | Annual Report MUTUAL BEACON FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. 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, 2004 were as shown below.
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF SHARES HELD NUMBER OF AT BEGINNING GROSS GROSS SHARES HELD VALUE INVESTMENT REALIZED CAPITAL NAME OF ISSUER OF YEAR ADDITIONS REDUCTIONS AT END OF YEAR AT END OF YEAR INCOME GAINS/(LOSS) - ------------------------------------------------------------------------------------------------------------------------------------ CONTROLLED AFFILIATES(a) PMG, LLC ...................... -- 48,890 -- 48,890 $ 3,226,751 $ -- $ -- ---------------------------------------------- NON-CONTROLLED AFFILIATES Anchor Resources LLC .......... -- 69,184 -- 69,184 $ -- $ -- $ -- Esmark Inc., Series A, 10.00%, cvt. pfd .............. -- 19,151 -- 19,151 19,151,400 -- -- Farmer Brothers Co. ........... 92,236 941,660 -- 1,033,896 25,061,639 374,516 -- FE Capital Holdings Ltd. ...... 13,807 174 -- 13,981 18,594,719 -- -- FHC Delaware Inc. ............. 507,977 -- -- 507,977 3,997,779 -- -- Florida East Coast Industries Inc ........................... -- 1,967,636 -- 1,967,636 84,303,364 196,764 -- Kindred Healthcare Inc ........ 682,285 682,285 -- 1,364,570 --(b) -- -- Kindred Healthcare Inc Strike 23.75 Expires 7/11/11 Calls ... 1,106 2,190 -- 3,296 --(b) -- -- Kindred Healthcare Inc Strike 26.00 Expires 1/01/12 Calls ... 166 498 -- 664 --(b) -- -- Kindred Healthcare Inc wts, Series A, 4/20/06 ............. 121,432 -- -- 121,432 --(b) -- -- Kindred Healthcare Inc wts, Series B, 4/20/07 ............. 303,580 -- -- 303,580 --(b) -- -- Nippon Investment LLC ......... 10,862,000 -- -- 10,862,000 -- -- -- Southwest Royalties Inc. ...... 69,184 -- (69,184) -- --(b) -- 1,037,765 ---------------------------------------------- TOTAL NON-CONTROLLED AFFILIATES ................................................... $ 151,108,901 $ 571,280 $ 1,037,765 ---------------------------------------------- TOTAL AFFILIATED SECURITIES (2.72% OF NET ASSETS) ................................. $ 154,335,652 $ 571,280 $ 1,037,765 ==============================================
(a) Issuer in which the Fund owns 25% or more of the outstanding voting securities. (b) As of December 31, 2004, no longer an affiliate. 12. OTHER CONSIDERATIONS Franklin Mutual, as the Fund's Manager, may serve as a member on the board of directors of certain companies in which the Fund invests and/or may represent the Fund in certain corporate negotiations. At December 31, 2004, the Manager serves in one or more of these capacities for Kindred Healthcare, AboveNet Inc. and Esmark Inc. As a result of this involvement, the Manager may be in possession of certain 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. Annual Report | 45 MUTUAL BEACON FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY MATTERS INVESTIGATIONS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, including the Securities and Exchange Commission ("SEC"), the California Attorney General's Office ("CAGO"), and the National Association of Securities Dealers, Inc. ("NASD"), relating to certain practices in the mutual fund industry, including late trading, market timing and marketing support payments to securities dealers who sell fund shares, Franklin Resources, Inc. and certain of its subsidiaries (as used in this section, together, the "Company"), as well as certain current or former executives and employees of the Company, received subpoenas and/or requests for documents, information and/or testimony. The Company and its current employees provided documents and information in response to those requests and subpoenas. SETTLEMENTS Beginning in August 2004, the Company entered into settlements with certain regulators investigating the mutual fund industry practices noted above. The Company believes that settlement of each of the matters described in this section is in the best interest of the Company and shareholders of the Franklin, Templeton, and Mutual Series mutual funds (the "funds"). On August 2, 2004, Franklin Resources, Inc. announced that its subsidiary, Franklin Advisers, Inc., reached an agreement with the SEC that resolved the issues resulting from the SEC investigation into market timing activity. In connection with that agreement, the SEC issued an "Order Instituting Administrative and Cease-and-Desist Proceedings Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940 and Sections 9(b) and 9(f) of the Investment Company Act of 1940, Making Findings and Imposing Remedial Sanctions and a Cease-and-Desist Order" (the "Order"). The SEC's Order concerned the activities of a limited number of third parties that ended in 2000 and those that were the subject of the first Massachusetts administrative complaint described below. Under the terms of the SEC's Order, pursuant to which Franklin Advisers, Inc. neither admitted nor denied any of the findings contained therein, Franklin Advisers, Inc. agreed to pay $50 million, of which $20 million is a civil penalty, to be distributed to shareholders of certain funds in accordance with a plan to be developed by an independent distribution consultant. At this time, it is unclear which funds or which shareholders of any particular fund will receive distributions. The Order also required Franklin Advisers, Inc. to, among other things, enhance and periodically review compliance policies and procedures. On September 20, 2004, Franklin Resources, Inc. announced that two of its subsidiaries, Franklin Advisers, Inc. and Franklin Templeton Alternative Strategies, Inc. ("FTAS"), reached an agreement with the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts (the "State of Massachusetts") related to its administrative complaint filed on February 4, 2004, concerning one instance of market timing that was also a subject of the August 2, 2004 settlement that Franklin Advisers, Inc. reached with the SEC, as described above. 46 | Annual Report MUTUAL BEACON FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY MATTERS (CONTINUED) SETTLEMENTS (CONTINUED) Under the terms of the settlement consent order issued by the State of Massachusetts, Franklin Advisers, Inc. and FTAS consented to the entry of a cease-and-desist order and agreed to pay a $5 million administrative fine to the State of Massachusetts (the "Massachusetts Consent Order"). The Massachusetts Consent Order included two different sections: "Statements of Fact" and "Violations of Massachusetts Securities Laws." Franklin Advisers, Inc. and FTAS admitted the facts in the Statements of Fact. On October 25, 2004, the State of Massachusetts filed a second administrative complaint, alleging that Franklin Resources, Inc.'s Form 8-K filing (in which it described the Massachusetts Consent Order and stated that "Franklin did not admit or deny engaging in any wrongdoing") failed to state that Franklin Advisers, Inc. and FTAS admitted the Statements of Fact portion of the Massachusetts Consent Order (the "Second Complaint"). Franklin Resources, Inc. reached a second agreement with the State of Massachusetts on November 19, 2004, resolving the Second Complaint. As a result of the November 19, 2004 settlement, Franklin Resources, Inc. filed a new Form 8-K. The terms of the Massachusetts Consent Order did not change and there was no monetary fine associated with this second settlement. On November 17, 2004, Franklin Resources, Inc. announced that Franklin/Templeton Distributors, Inc. ("FTDI") reached an agreement with the CAGO, resolving the issues resulting from the CAGO's investigation concerning sales and marketing support payments. Under the terms of the settlement, FTDI neither admitted nor denied the allegations in the CAGO's complaint and agreed to pay $2 million to the State of California as a civil penalty, $14 million to the funds, to be allocated by an independent distribution consultant to be paid for by FTDI, and $2 million to the CAGO for its investigative costs. On December 13, 2004, Franklin Resources, Inc. announced that its subsidiaries FTDI and Franklin Advisers, Inc. reached an agreement with the SEC, resolving the issues resulting from the SEC's investigation concerning marketing support payments to securities dealers who sell fund shares. In connection with that agreement, the SEC issued an "Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940, Sections 9(b) and 9(f) of the Investment Company Act of 1940, and Section 15(b) of the Securities Exchange Act of 1934" (the "Second Order"). Under the terms of the Second Order, in which FTDI and Franklin Advisers, Inc. neither admitted nor denied the findings contained therein, they agreed to pay the funds a penalty of $20 million and disgorgement of $1 (one dollar). FTDI and Franklin Advisers, Inc. also agreed to implement certain measures and undertakings relating to marketing support payments to broker-dealers for the promotion or sale of fund shares, including making additional disclosures in the funds' Prospectuses and Statements of Additional Information. The Second Order further requires the appointment of an independent distribution consultant, at the Company's expense, who shall develop a plan for the distribution of the penalty and disgorgement to the funds. Annual Report | 47 MUTUAL BEACON FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY MATTERS (CONTINUED) OTHER LEGAL PROCEEDINGS The Fund, in addition to the Company and other funds, and certain current and former officers, employees, and directors have been named in multiple lawsuits in different federal courts in Nevada, California, Illinois, New York and Florida, alleging violations of various federal securities laws and seeking, among other relief, monetary damages, restitution, removal of fund trustees, directors, advisers, administrators, and distributors, rescission of management contracts and 12b-1 Plans, and/or attorneys' fees and costs. Specifically, the lawsuits claim breach of duty with respect to alleged arrangements to permit market timing and/or late trading activity, or breach of duty with respect to the valuation of the portfolio securities of certain Templeton funds managed by Franklin Resources, Inc. subsidiaries, resulting in alleged market timing activity. The majority of these lawsuits duplicate, in whole or in part, the allegations asserted in the February 4, 2004 Massachusetts administrative complaint and the findings in the SEC's August 2, 2004 Order, as described above. The lawsuits are styled as class actions, or derivative actions on behalf of either the named funds or Franklin Resources, Inc. In addition, the Company, as well as certain current and former officers, employees, and directors, have been named in multiple lawsuits alleging violations of various securities laws and pendent state law claims relating to the disclosure of directed brokerage payments and/or payment of allegedly excessive advisory, commission, and distribution fees, and seeking, among other relief, monetary damages, restitution, rescission of advisory contracts, including recovery of all fees paid pursuant to those contracts, an accounting of all monies paid to the named advisers, declaratory relief, injunctive relief, and/or attorneys' fees and costs. These lawsuits are styled as class actions or derivative actions brought on behalf of certain funds. The Company and fund management strongly believes that the claims made in each of the lawsuits identified above are without merit and intends to vigorously defend against them. The Company cannot predict with certainty, however, the eventual outcome of the remaining governmental investigations or private lawsuits, nor whether they will have a material negative impact on the Company. Public trust and confidence are critical to the Company's business and any material loss of investor and/or client confidence could result in a significant decline in assets under management by the Company, which would have an adverse effect on the Company's future financial results. If it is determined that the Company bears responsibility for any unlawful or inappropriate conduct that caused losses to the Fund, it is committed to making the Fund or its shareholders whole, as appropriate. The Company is committed to taking all appropriate actions to protect the interests of its funds' shareholders. 48 | Annual Report MUTUAL BEACON FUND REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 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, 2004, 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 five years in the period then ended. 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 the standards of the Public Company Accounting Oversight Board (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 consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Fund's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of December 31, 2004, by correspondence with the custodian and brokers or by other appropriate auditing procedures where replies from brokers were not received. 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, 2004, 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 five years in the period then ended, in conformity with U.S. generally accepted accounting principles. /s/ ERNST & YOUNG LLP Boston, Massachusetts February 7, 2005 Annual Report | 49 MUTUAL BEACON FUND TAX DESIGNATION Under Section 852(b)(3)(C) of the Internal Revenue Code (Code), the Fund designated $95,423,945 as a capital gain dividend for the fiscal year ended December 31, 2004. Under Section 854(b)(2) of the Code, the Fund hereby designates up to a maximum of $88,271,656 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2004. In January 2005, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2004. 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 29.47% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2004. 50 | 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. 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. (63) 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; and Director, Stern School of Business M.B.A. Program. - ------------------------------------------------------------------------------------------------------------------------------------ ANN TORRE GRANT (46) 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 (75) 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 (74) 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 (75) 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 | 51
- ------------------------------------------------------------------------------------------------------------------------------------ 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 (74) Director Since 1998 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. - ------------------------------------------------------------------------------------------------------------------------------------ LEONARD RUBIN (79) 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 (58) Director Since 1991 12 Director, El Oro Mining and 51 John F. Kennedy Parkway Exploration Co., p.l.c. Short Hills, NJ 07078 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 (79) 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 (65) 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, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. - ------------------------------------------------------------------------------------------------------------------------------------
52 | 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 (42) Director, Director 7 None 51 John F. Kennedy Parkway President, since 2001, Short Hills, NJ 07078-2702 Chairman of President the Board and since 1999, Chief Chairman of Executive the Board Officer- and Chief Investment Executive Management Officer- Investment Management since 2002 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Chief Investment Officer, and Chief Executive Officer, Franklin Mutual Advisers, officer and/or director, as the case LLC; and may be, of three of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ JAMES M. DAVIS (52) Chief Since July Not Applicable Not Applicable One Franklin Parkway Compliance 2004 San Mateo, CA 94403-1906 Officer PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Officer of 51 of the investment companies in Franklin Templeton Investments; Director, Global Compliance, Franklin Resources, Inc.; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - ------------------------------------------------------------------------------------------------------------------------------------ JIMMY D. GAMBILL (57) Senior Vice Since 2002 Not Applicable Not Applicable 500 East Broward Blvd. President and Suite 2100 Chief Fort Lauderdale, 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 (57) Vice President Since 2000 Not Applicable Not Applicable One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior 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). - ------------------------------------------------------------------------------------------------------------------------------------
Annual Report | 53
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ BARBARA J. GREEN (57) Vice President Since 2000 Not Applicable Not Applicable 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). - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL O. MAGDOL (67) Vice President Since 2002 Not Applicable Not Applicable 600 Fifth Avenue -AML Rockefeller Center Compliance New York, NY 10020-2302 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice Chairman, Chief Banking Officer and Director, Fiduciary Trust Company International; Director, FTI Banque, Arch Chemicals, Inc. and Lingnan Foundation; 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. - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL MORANTZ (35) Treasurer Since July Not Applicable Not Applicable 500 East Broward Blvd. 2004 Suite 2100 Fort Lauderdale, FL 33394-3091 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ MURRAY L. SIMPSON (67) Vice President Since 2000 Not Applicable Not Applicable 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). - ------------------------------------------------------------------------------------------------------------------------------------
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 - ------------------------------------------------------------------------------------------------------------------------------------ GALEN G. VETTER (53) Chief Financial Since May Not Applicable Not Applicable 500 East Broward Blvd. Officer and 2004 Suite 2100 Chief Fort Lauderdale, FL 33394-3091 Accounting Officer PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Officer of 51 of the investment companies in Franklin Templeton Investments; Senior Vice President, Franklin Templeton Services, LLC; and FORMERLY, Managing Director, RSM McGladrey, Inc.; and Partner, McGladrey & Pullen, LLP. - ------------------------------------------------------------------------------------------------------------------------------------
* 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 to be 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 to be 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 to be an interested person of Mutual Series under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC, Mutual Series' adviser. 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 | 55 MUTUAL BEACON FUND SHAREHOLDER INFORMATION 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. Copies of the Fund's proxy voting records are also made available online at franklintempleton.com and posted on the Securities and Exchange Commission's website at sec.gov and reflect the 12-month period beginning July 1, 2003, and ending June 30, 2004. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the Securities and Exchange Commission for the first and third quarters for each fiscal year on Form N-Q. Shareholders may view the filed Form N-Q by visiting the Commission's website at sec.gov. The filed form may also be viewed and copied at the Commission's Public Reference Room in Washington, DC. Information regarding the operations of the Public Reference Room may be obtained by calling 1-800/SEC-0330. 56 | Annual Report LITERATURE REQUEST LITERATURE REQUEST. TO RECEIVE A BROCHURE AND PROSPECTUS, PLEASE CALL US AT 1-800/DIAL BEN(R) (1-800/342-5236) OR VISIT FRANKLINTEMPLETON.COM. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. 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 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(2) Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund(3) 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(4) 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 Technology Fund Franklin Utilities Fund Mutual Financial Services Fund ASSET ALLOCATION Franklin Templeton Corefolio Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives 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(5) Franklin's AGE High Income Fund Franklin Floating Rate Daily Access Fund Franklin Floating Rate Trust(3) Franklin Income Fund Franklin Limited Maturity U.S. Government Securities Fund(5,6) Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund(5) Templeton Global Bond Fund TAX-FREE INCOME(7) NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(8) 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 Alabama Arizona California(9) Colorado Connecticut Florida(9) Georgia Kentucky Louisiana Maryland Massachusetts(8) Michigan(8) Minnesota(8) Missouri New Jersey New York(9) North Carolina Ohio(8) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(10) (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 and select retirement plans. (3) 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. (4) Upon reaching approximately $350 million in assets, the fund intends to close to all investors. (5) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (6) Formerly Franklin Short-Intermediate U.S. Government Securities Fund. Effective 9/1/04, the fund's name changed; its investment goal and strategy remained the same. (7) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (8) Portfolio of insured municipal securities. (9) These funds are available in two or more variations, including long-term portfolios, portfolios of insured securities, a high-yield portfolio (CA) and limited-term, intermediate-term and money market portfolios (CA and NY). (10) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 11/04 Not part of the annual report [LOGO](R) FRANKLIN(R) TEMPLETON(R) One Franklin Parkway INVESTMENTS San Mateo, CA 94403-1906 o 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, CFA 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) Authorized for distribution only when accompanied or preceded by a prospectus. Investors should carefully consider a fund's investment goals, risks, charges and expenses before investing. The prospectus contains this and other information; please read it carefully before investing. 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 A2004 02/05 MUTUAL DISCOVERY FUND [GRAPHIC OMITTED] - -------------------------------------------------------------------------------- DECEMBER 31, 2004 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- ANNUAL REPORT AND SHAREHOLDER LETTER | GLOBAL - -------------------------------------------------------------------------------- Want to receive this document FASTER via email? MUTUAL DISCOVERY FUND Eligible shareholders can sign up for eDelivery at franklintempleton.com. See inside for details. - -------------------------------------------------------------------------------- [LOGO](R) 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 Discovery Fund ..................................................... 4 Performance Summary ....................................................... 10 Your Fund's Expenses ...................................................... 15 Financial Highlights and Statement of Investments ......................... 17 Financial Statements ...................................................... 33 Notes to Financial Statements ............................................. 37 Report of Independent Registered Public Accounting Firm ................... 54 Tax Designation ........................................................... 55 Board Members and Officers ................................................ 60 Shareholder Information ................................................... 65 - -------------------------------------------------------------------------------- ANNUAL REPORT MUTUAL DISCOVERY FUND YOUR FUND'S GOAL AND MAIN INVESTMENTS: Mutual Discovery Fund seeks long-term capital appreciation by investing primarily in common and preferred stocks, bonds and convertible securities. The Fund may invest up to 100% of its assets in foreign securities. - -------------------------------------------------------------------------------- PERFORMANCE DATA QUOTED REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. PLEASE VISIT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236 FOR MOST RECENT MONTH-END PERFORMANCE. - -------------------------------------------------------------------------------- We are pleased to bring you Mutual Discovery Fund's annual report covering the fiscal year ended December 31, 2004. PERFORMANCE OVERVIEW Mutual Discovery Fund - Class Z posted a 19.39% cumulative total return for the 12 months ended December 31, 2004. The Fund outperformed its benchmarks, the Standard & Poor's 500 Composite Index (S&P 500) and Morgan Stanley Capital International (MSCI) World Index, which returned 10.87% and 15.25% for the same period.(1) You can find the Fund's long-term performance data in the Performance Summary beginning on page 9. ECONOMIC AND MARKET OVERVIEW The global economic recovery continued in 2004, led by growth in China and the U.S. As of December 31, 2004, U.S. gross domestic product (GDP) had increased for 13 consecutive quarters.(2) In China, GDP grew 9.5% in 2004.(3) The 12-nation euro zone lagged other regions in the current recovery. However, the European Central Bank projected euro zone growth may be between 1.6% and 2.0% in 2004, compared with only 0.5% in 2003. In Japan, the economy struggled to emerge from a decade-long deflationary period. Although the country's consumer and business confidence reached (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 a free float-adjusted, market capitalization- weighted index designed to measure equity market performance in global developed markets. The indexes are unmanaged and include reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. (2) Source: Bureau of Economic Analysis. (3) Source: National Bureau of Statistics of China. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND NAMES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 22. 4 | Annual Report their highest levels since 1991, economic growth slowed in response to higher oil prices and reduced external demand. In addition, the U.S. dollar declined approximately 4% versus the yen and 7% versus the euro during 2004.(4) This hurt Japanese and European exports into the U.S., as it made their goods more expensive in the world's biggest market. However, the greenback's protracted decline should also benefit the U.S. current account deficit by making U.S. goods more competitive in international markets. Oil prices increased during most of 2004, reaching $56 dollars per barrel in October, but declined to end the year at $43. Higher oil prices triggered investor worries about inflation, decreased spending -- due to cautionary consumer and business sentiment -- and slower economic and corporate profit growth. As of December 31, 2004, the 12-month moving average price of oil was about $41 per barrel.(5) In this environment, the MSCI World Index's total return was 15.25% in U.S. dollars for the 12-month period ended December 31, 2004.6 Emerging markets, as measured by the MSCI Emerging Markets Index, had a one-year total return of 25.95% in U.S. dollars.(7) In local currencies, these indexes had notably lower total returns of 11.83% and 16.45% for the same period.(6), (7) In 2004, most of the world's currencies strengthened in relation to the U.S. dollar, which benefited U.S.-based investors of non-U.S. developed and emerging market equities. 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 perceive 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 (4) Source: FactSet Research Systems Inc. (5) Source: U.S. Department of Energy. (6) Source: Standard & Poor's Micropal. See footnote 1 for a description of the MSCI World Index. (7) Source: Standard & Poor's Micropal. The MSCI Emerging Markets Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in global emerging markets. GEOGRAPHIC DISTRIBUTION Based on Total Net Assets as of 12/31/04 U.S. 33.7% U.K. 15.6% Canada 6.3% Switzerland 4.9% France 4.1% South Korea 3.5% Irish Republic 3.3% Japan 3.2% Spain 3.0% Denmark 2.9% Germany 2.8% Norway 2.7% Hong Kong 2.0% South Africa 2.0% Netherlands 1.8% Luxembourg 1.5% Other Countries 6.5% Other Net Assets 0.2% Annual Report | 5 TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/04 - -------------------------------------------------------------------------------- % OF TOTAL NET ASSETS - -------------------------------------------------------------------------------- Tobacco 13.3% - -------------------------------------------------------------------------------- Insurance 10.0% - -------------------------------------------------------------------------------- Media 8.6% - -------------------------------------------------------------------------------- Metals & Mining 8.3% - -------------------------------------------------------------------------------- Diversified Financial Services 6.6% - -------------------------------------------------------------------------------- Food Products 6.4% - -------------------------------------------------------------------------------- Beverages 5.4% - -------------------------------------------------------------------------------- Commercial Banks 4.0% - -------------------------------------------------------------------------------- Oil & Gas 3.1% - -------------------------------------------------------------------------------- Chemicals 2.9% - -------------------------------------------------------------------------------- situation and focus our efforts on those we believe have limited risk and substantial upside potential. Lastly, the Fund invests in 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 believe 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, should allow the Fund to achieve attractive risk-adjusted returns over time. MANAGER'S DISCUSSION Notwithstanding positive overall performance from our distressed debt and risk arbitrage investments, the Fund's equity portfolio was the strongest contributor to performance in 2004. Three of our best performing stock investments were Altadis, a Franco-Spanish tobacco company; Orkla, a Norwegian conglomerate; and White Mountains Insurance Group, a U.S. property and casualty insurer. In 2004, tobacco companies operating in Europe, such as Altadis, encountered a challenging sales environment, especially in France after the government imposed two substantial tax increases by early 2004 that pressured volumes and contributed to reduced consumption of about 25% in volume. Despite 6 | Annual Report challenges in France and elsewhere, Altadis shares performed well as management returned cash to shareholders through dividends and share repurchases. In addition, the company announced two acquisitions and a cost-restructuring program, all of which could enable management to continue to increase cash flow and create shareholder value. As a result of these and other factors, Altadis shares appreciated about 65% in 2004. Despite this strong performance, the stock still traded at a significant discount to its European peers and our calculation of the stock's intrinsic value. In addition, some analysts believe the industry is ready for more consolidation. For these and other reasons, we remain enthusiastic about the prospects of our Altadis investment. Oslo-based Orkla is one of Norway's largest conglomerates with operations in food, media, chemicals and beverages. In early 2004, Orkla's management announced it would divest the company's beverage operations, a 40% stake in the Danish company Carlsberg Breweries. We believed the negotiated price for Carlsberg was favorable, and the market rewarded management's decision to return part of the proceeds to shareholders in the form of a special dividend. The equity market anticipates Orkla to further divest non-core assets and return the proceeds to shareholders. The company reported better-than-expected quarterly results for most of 2004 as its restructuring program progressed ahead of expectations and as some new product launches experienced success. Largely as a result, the stock's discount to its intrinsic value narrowed, and including the special dividend, Orkla shares returned 73% in 2004. White Mountains, a significant contributor to Fund performance during the fiscal year, was an excellent example of how substantial shareholder value can be created when well-capitalized companies are run by strong managers. With the company's solid balance sheet, White Mountains' management team has made several acquisitions, enabling the company to profitably increase its bottom line while extending its exposure to attractive lines of business. In addition to exercising discipline with acquisitions, management remained committed to a conservative underwriting strategy. This strategy enabled White Mountains to continue to report solid underwriting results for 2004 despite record industry-wide insurance claims from the Atlantic hurricane season. During the year under review, the markets began to better appreciate White Mountains' consistent results, strong balance sheet, and disciplined acquisition and underwriting practices, as well as its shareholder-oriented management team. White Mountains' stock rose about 41% in 2004 and has increased more than 443% in the past five years. TOP 10 HOLDINGS 12/31/04 - -------------------------------------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - -------------------------------------------------------------------------------- Berkshire Hathaway Inc., A & B 3.2% INSURANCE, U.S. - -------------------------------------------------------------------------------- British American Tobacco PLC 3.0% TOBACCO, U.K. - -------------------------------------------------------------------------------- Imperial Tobacco Group PLC 2.7% TOBACCO, U.K. - -------------------------------------------------------------------------------- Orkla ASA 2.6% FOOD PRODUCTS, NORWAY - -------------------------------------------------------------------------------- Altadis SA 2.5% TOBACCO, SPAIN - -------------------------------------------------------------------------------- White Mountains Insurance Group Inc. 1.9% INSURANCE, U.S. - -------------------------------------------------------------------------------- Potlatch Corp. 1.9% PAPER & FOREST PRODUCTS, U.S. - -------------------------------------------------------------------------------- KT&G Corp., ord. & GDR 1.8% TOBACCO, SOUTH KOREA - -------------------------------------------------------------------------------- Schindler Holding AG, ord. & Reg D 1.8% MACHINERY, SWITZERLAND - -------------------------------------------------------------------------------- International Steel Group 1.8% METALS & MINING, U.S. - -------------------------------------------------------------------------------- Annual Report | 7 In general, if the value of the U.S. dollar goes up compared with a foreign currency, an investment traded in that foreign currency will go down in value because it will be worth fewer U.S. dollars. This can have a negative effect on Fund performance. Conversely, when the U.S. dollar weakens in relation to a foreign currency, an investment traded in that foreign currency will increase in value, which can contribute to Fund performance. At Mutual Series, we typically seek to hedge (protect) against currency risk, which can reduce or eliminate the positive or negative effect on Fund performance of holding investments denominated in currencies other than the U.S. dollar. In 2004, we remained less than fully hedged in foreign currencies allowing shareholders to benefit from a declining U.S. dollar. However, one cannot expect the same result in future periods. Detractors from Fund performance during the fiscal year included Eurotunnel, the operator of the English Channel tunnel; MG Technologies, a German industrial firm; and Impala Platinum, a South African mining company. Eurotunnel's debt securities declined in value during 2004 largely due to uncertainties surrounding the ultimate resolution of the company's financial situation, as well as continuing mediocre operating results after the board and management team were replaced in April 2004. MG Technologies' stock fell in value mainly due to a failed attempt to dispose of an asset, a division's slower-than- expected turnaround, and the chief executive officer's resignation. Impala Platinum underperformed during the period because of the strengthening South African currency and a slower-than-expected approval process for a mine in Zimbabwe. 8 | Annual Report Thank you for your continued participation in Mutual Discovery Fund. We look forward to serving your future investment needs. /s/ David J. Winters [PHOTO OMITTED] David J. Winters, CFA Portfolio Manager /s/ F. David Segal [PHOTO OMITTED] F. David Segal, CFA Assistant Portfolio Manager Mutual Discovery Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2004, 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 ADVISER 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. - -------------------------------------------------------------------------------- F. DAVID SEGAL David Segal is an assistant portfolio manager for Mutual Discovery Fund and an analyst for Franklin Mutual Advisers, LLC (Mutual Series). He specializes in the analysis of the oil and gas, paper and forest products and the defense sectors. Prior to joining Mutual Series in 2002, Mr. Segal was an associate director in the structured finance group at MetLife. He has 12 years of experience in the financial services industry. Mr. Segal received a bachelor of arts degree from the University of Michigan, Ann Arbor and an M.B.A. from New York University's Stern School of Business. He is also a CFA charter-holder and a member of the New York Society of Security Analysts. - -------------------------------------------------------------------------------- Annual Report | 9 PERFORMANCE SUMMARY AS OF 12/31/04 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 reinvestment of the Fund's dividends and capital gain distributions, if any, and any unrealized gains or losses. PRICE AND DISTRIBUTION INFORMATION
- ------------------------------------------------------------------------------------------------------ CLASS Z CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------------------ Net Asset Value (NAV) +$3.45 $24.26 $20.81 - ------------------------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------------------ Dividend Income $0.5428 - ------------------------------------------------------------------------------------------------------ CLASS A CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------------------ Net Asset Value (NAV) +$3.40 $24.07 $20.67 - ------------------------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------------------ Dividend Income $0.4733 - ------------------------------------------------------------------------------------------------------ CLASS B CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------------------ Net Asset Value (NAV) +$3.32 $23.67 $20.35 - ------------------------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------------------ Dividend Income $0.3539 - ------------------------------------------------------------------------------------------------------ CLASS C CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------------------ Net Asset Value (NAV) +$3.38 $23.97 $20.59 - ------------------------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------------------ Dividend Income $0.3384 - ------------------------------------------------------------------------------------------------------ CLASS R CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------------------ Net Asset Value (NAV) +$3.37 $23.94 $20.57 - ------------------------------------------------------------------------------------------------------ Distributions (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------------------ Dividend Income $0.4557 - ------------------------------------------------------------------------------------------------------
10 | Annual Report PERFORMANCE SUMMARY (CONTINUED) PERFORMANCE CLASS A: 5.75% MAXIMUM INITIAL SALES CHARGE; CLASS B: CONTINGENT DEFERRED SALES CHARGE (CDSC) DECLINING FROM 4% TO 1% OVER SIX YEARS, AND ELIMINATED THEREAFTER; CLASS C: 1% CDSC IN FIRST YEAR ONLY; CLASS R: 1% CDSC FOR FIRST 18 MONTHS ONLY. CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES.
- ------------------------------------------------------------------------------------------------------------- CLASS Z(1) 1-YEAR 5-YEAR 10-YEAR - ------------------------------------------------------------------------------------------------------------- Cumulative Total Return(2) 19.39% 62.85% 300.20% - ------------------------------------------------------------------------------------------------------------- Average Annual Total Return(3) 19.39% 10.24% 14.88% - ------------------------------------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,939 $16,285 $40,020 - ------------------------------------------------------------------------------------------------------------- CLASS A(1) 1-YEAR 5-YEAR INCEPTION (11/1/96) - ------------------------------------------------------------------------------------------------------------- Cumulative Total Return(2) 18.98% 60.09% 153.66% - ------------------------------------------------------------------------------------------------------------- Average Annual Total Return(3) 12.14% 8.58% 11.27% - ------------------------------------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,214 $15,089 $23,905 - ------------------------------------------------------------------------------------------------------------- CLASS B(1) 1-YEAR 5-YEAR INCEPTION (1/1/99) - ------------------------------------------------------------------------------------------------------------- Cumulative Total Return(2) 18.22% 54.91% 94.49% - ------------------------------------------------------------------------------------------------------------- Average Annual Total Return(3) 14.22% 8.87% 11.63% - ------------------------------------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,422 $15,291 $19,349 - ------------------------------------------------------------------------------------------------------------- CLASS C(1) 1-YEAR 5-YEAR INCEPTION (11/1/96) - ------------------------------------------------------------------------------------------------------------- Cumulative Total Return(2) 18.17% 54.97% 140.94% - ------------------------------------------------------------------------------------------------------------- Average Annual Total Return(3) 17.17% 9.16% 11.37% - ------------------------------------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,717 $15,497 $24,094 - ------------------------------------------------------------------------------------------------------------- CLASS R 1-YEAR INCEPTION (1/1/02) - ------------------------------------------------------------------------------------------------------------- Cumulative Total Return(2) 18.84% 40.77% - ------------------------------------------------------------------------------------------------------------- Average Annual Total Return(3) 17.84% 12.10% - ------------------------------------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,784 $14,077 - -------------------------------------------------------------------------------------------------------------
PERFORMANCE DATA QUOTED REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. FOR MOST RECENT MONTH-END PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236. Annual Report | 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 any current, applicable, maximum sales charge, Fund expenses, account fees and reinvested distributions. The unmanaged indexes include reinvestment of any income or distributions. They differ from the Fund in composition and do not pay management fees or expenses. One cannot invest directly in an index. CLASS Z (1/1/95-12/31/04)(1) GRAPHIC MATERIAL (1) This graph compares the performance of Mutual Discovery Fund - Class Z, 1 as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 Index5 and the MSCI World Index5 from 1/1/95-12/31/04. Mutual Discovery Date Fund S&P 500 Index MSCI World Index 1/1/1995 $10,000 $10,000 $10,000 1/31/1995 $10,215 $10,259 $9,852 2/28/1995 $10,582 $10,659 $9,997 3/31/1995 $10,590 $10,973 $10,481 4/30/1995 $10,996 $11,295 $10,849 5/31/1995 $11,251 $11,746 $10,943 6/30/1995 $11,554 $12,019 $10,942 7/31/1995 $12,011 $12,417 $11,492 8/31/1995 $12,276 $12,448 $11,238 9/30/1995 $12,590 $12,973 $11,567 10/31/1995 $12,389 $12,927 $11,387 11/30/1995 $12,630 $13,493 $11,785 12/31/1995 $12,863 $13,753 $12,132 1/31/1996 $13,338 $14,221 $12,353 2/29/1996 $13,788 $14,353 $12,431 3/31/1996 $13,983 $14,491 $12,640 4/30/1996 $14,288 $14,705 $12,939 5/31/1996 $14,534 $15,083 $12,953 6/30/1996 $14,515 $15,141 $13,021 7/31/1996 $14,082 $14,472 $12,563 8/31/1996 $14,567 $14,778 $12,710 9/30/1996 $14,922 $15,609 $13,210 10/31/1996 $15,295 $16,039 $13,304 11/30/1996 $15,927 $17,251 $14,052 12/31/1996 $16,069 $16,909 $13,830 1/31/1997 $16,836 $17,965 $13,999 2/28/1997 $17,164 $18,106 $14,162 3/31/1997 $17,005 $17,363 $13,884 4/30/1997 $17,033 $18,399 $14,341 5/31/1997 $17,650 $19,518 $15,228 6/30/1997 $18,305 $20,392 $15,990 7/31/1997 $19,100 $22,014 $16,729 8/31/1997 $18,919 $20,782 $15,613 9/30/1997 $19,871 $21,919 $16,463 10/31/1997 $19,300 $21,188 $15,599 11/30/1997 $19,414 $22,168 $15,878 12/31/1997 $19,756 $22,548 $16,074 1/31/1998 $19,767 $22,798 $16,524 2/28/1998 $20,781 $24,441 $17,645 3/31/1998 $21,973 $25,691 $18,392 4/30/1998 $22,381 $25,950 $18,575 5/31/1998 $22,685 $25,504 $18,345 6/30/1998 $22,120 $26,540 $18,783 7/31/1998 $21,600 $26,258 $18,755 8/31/1998 $18,655 $22,465 $16,257 9/30/1998 $17,819 $23,905 $16,547 10/31/1998 $18,312 $25,847 $18,046 11/30/1998 $19,233 $27,413 $19,122 12/31/1998 $19,381 $28,992 $20,059 1/31/1999 $19,516 $30,204 $20,501 2/28/1999 $19,291 $29,265 $19,959 3/31/1999 $20,178 $30,436 $20,793 4/30/1999 $21,536 $31,614 $21,615 5/31/1999 $21,547 $30,869 $20,828 6/30/1999 $22,313 $32,581 $21,803 7/31/1999 $22,062 $31,565 $21,740 8/31/1999 $21,800 $31,408 $21,705 9/30/1999 $21,514 $30,549 $21,497 10/31/1999 $21,960 $32,481 $22,618 11/30/1999 $23,112 $33,141 $23,257 12/31/1999 $24,575 $35,092 $25,142 1/31/2000 $24,482 $33,329 $23,705 2/29/2000 $25,262 $32,699 $23,772 3/31/2000 $26,346 $35,895 $25,418 4/30/2000 $26,054 $34,816 $24,346 5/31/2000 $26,206 $34,103 $23,733 6/30/2000 $26,281 $34,944 $24,535 7/31/2000 $26,617 $34,398 $23,848 8/31/2000 $27,403 $36,534 $24,627 9/30/2000 $27,129 $34,606 $23,320 10/31/2000 $27,341 $34,459 $22,932 11/30/2000 $26,879 $31,744 $21,543 12/31/2000 $27,670 $31,900 $21,894 1/31/2001 $28,518 $33,031 $22,320 2/28/2001 $28,518 $30,021 $20,436 3/31/2001 $27,670 $28,120 $19,097 4/30/2001 $28,474 $30,304 $20,514 5/31/2001 $29,336 $30,507 $20,259 6/30/2001 $29,472 $29,765 $19,627 7/31/2001 $29,413 $29,472 $19,369 8/31/2001 $29,117 $27,629 $18,443 9/30/2001 $26,642 $25,398 $16,820 10/31/2001 $26,716 $25,882 $17,144 11/30/2001 $27,398 $27,867 $18,161 12/31/2001 $28,020 $28,111 $18,277 1/31/2002 $28,113 $27,701 $17,725 2/28/2002 $28,390 $27,167 $17,575 3/31/2002 $29,330 $28,189 $18,355 4/30/2002 $29,838 $26,481 $17,739 5/31/2002 $30,069 $26,286 $17,780 6/30/2002 $28,224 $24,414 $16,705 7/31/2002 $26,363 $22,512 $15,299 8/31/2002 $26,626 $22,659 $15,331 9/30/2002 $25,231 $20,199 $13,648 10/31/2002 $25,324 $21,975 $14,658 11/30/2002 $25,696 $23,267 $15,451 12/31/2002 $25,482 $21,901 $14,706 1/31/2003 $25,057 $21,328 $14,261 2/28/2003 $24,379 $21,008 $14,017 3/31/2003 $24,489 $21,210 $13,979 4/30/2003 $26,365 $22,958 $15,227 5/31/2003 $27,848 $24,166 $16,105 6/30/2003 $28,321 $24,475 $16,389 7/31/2003 $28,671 $24,906 $16,725 8/31/2003 $29,527 $25,391 $17,091 9/30/2003 $29,686 $25,122 $17,199 10/31/2003 $30,955 $26,543 $18,223 11/30/2003 $32,034 $26,776 $18,505 12/31/2003 $33,521 $28,179 $19,670 1/31/2004 $33,940 $28,696 $19,990 2/29/2004 $35,020 $29,095 $20,332 3/31/2004 $34,891 $28,656 $20,205 4/30/2004 $34,295 $28,207 $19,803 5/31/2004 $34,278 $28,593 $19,997 6/30/2004 $34,931 $29,149 $20,416 7/31/2004 $34,575 $28,185 $19,755 8/31/2004 $34,802 $28,298 $19,850 9/30/2004 $35,742 $28,604 $20,231 10/31/2004 $36,471 $29,041 $20,731 11/30/2004 $38,562 $30,216 $21,830 12/31/2004 $40,020 $31,243 $22,670 AVERAGE ANNUAL TOTAL RETURN - ------------------------------------- CLASS Z(1) 12/31/04 - ------------------------------------- 1-Year 19.39% - ------------------------------------- 5-Year 10.24% - ------------------------------------- 10-Year 14.88% - ------------------------------------- CLASS A (11/1/96-12/31/04)(1) GRAPHIC MATERIAL (2) This graph compares the performance of Mutual Discovery Fund - Class A, 1 as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 Index 5 and the MSCI World Index 5 from 11/1/96-12/31/04. Mutual Discovery S&P 500 MSCI World Date Fund Index Index 11/1/1996 $9,424 $10,000 $10,000 11/30/1996 $9,808 $10,755 $10,562 12/31/1996 $9,887 $10,542 $10,395 1/31/1997 $10,348 $11,200 $10,522 2/28/1997 $10,544 $11,288 $10,645 3/31/1997 $10,446 $10,825 $10,436 4/30/1997 $10,463 $11,471 $10,779 5/31/1997 $10,838 $12,169 $11,446 6/30/1997 $11,235 $12,714 $12,019 7/31/1997 $11,718 $13,725 $12,574 8/31/1997 $11,607 $12,957 $11,735 9/30/1997 $12,188 $13,666 $12,374 10/31/1997 $11,830 $13,210 $11,725 11/30/1997 $11,900 $13,821 $11,934 12/31/1997 $12,109 $14,058 $12,082 1/31/1998 $12,109 $14,213 $12,420 2/28/1998 $12,726 $15,238 $13,262 3/31/1998 $13,453 $16,018 $13,824 4/30/1998 $13,697 $16,179 $13,962 5/31/1998 $13,877 $15,901 $13,789 6/30/1998 $13,530 $16,546 $14,118 7/31/1998 $13,208 $16,371 $14,097 8/31/1998 $11,398 $14,006 $12,219 9/30/1998 $10,885 $14,904 $12,438 10/31/1998 $11,181 $16,115 $13,564 11/30/1998 $11,741 $17,091 $14,373 12/31/1998 $11,822 $18,075 $15,077 1/31/1999 $11,905 $18,831 $15,409 2/28/1999 $11,760 $18,246 $15,002 3/31/1999 $12,303 $18,975 $15,629 4/30/1999 $13,122 $19,710 $16,247 5/31/1999 $13,129 $19,245 $15,655 6/30/1999 $13,594 $20,313 $16,388 7/31/1999 $13,440 $19,679 $16,341 8/31/1999 $13,266 $19,582 $16,314 9/30/1999 $13,091 $19,046 $16,158 10/31/1999 $13,357 $20,251 $17,000 11/30/1999 $14,056 $20,662 $17,481 12/31/1999 $14,941 $21,878 $18,898 1/31/2000 $14,877 $20,779 $17,818 2/29/2000 $15,353 $20,386 $17,868 3/31/2000 $16,008 $22,379 $19,105 4/30/2000 $15,823 $21,706 $18,300 5/31/2000 $15,915 $21,262 $17,839 6/30/2000 $15,954 $21,786 $18,442 7/31/2000 $16,152 $21,446 $17,925 8/31/2000 $16,624 $22,777 $18,510 9/30/2000 $16,449 $21,575 $17,528 10/31/2000 $16,579 $21,484 $17,237 11/30/2000 $16,289 $19,791 $16,192 12/31/2000 $16,773 $19,888 $16,457 1/31/2001 $17,281 $20,593 $16,776 2/28/2001 $17,272 $18,717 $15,360 3/31/2001 $16,746 $17,532 $14,354 4/30/2001 $17,227 $18,893 $15,419 5/31/2001 $17,744 $19,020 $15,227 6/30/2001 $17,822 $18,557 $14,752 7/31/2001 $17,786 $18,374 $14,558 8/31/2001 $17,605 $17,225 $13,862 9/30/2001 $16,098 $15,834 $12,643 10/31/2001 $16,143 $16,137 $12,886 11/30/2001 $16,549 $17,374 $13,650 12/31/2001 $16,918 $17,526 $13,738 1/31/2002 $16,975 $17,271 $13,323 2/28/2002 $17,134 $16,938 $13,210 3/31/2002 $17,695 $17,575 $13,797 4/30/2002 $17,995 $16,510 $13,333 5/31/2002 $18,126 $16,388 $13,364 6/30/2002 $17,009 $15,221 $12,556 7/31/2002 $15,888 $14,035 $11,499 8/31/2002 $16,039 $14,127 $11,523 9/30/2002 $15,191 $12,593 $10,258 10/31/2002 $15,248 $13,701 $11,017 11/30/2002 $15,465 $14,506 $11,614 12/31/2002 $15,331 $13,654 $11,053 1/31/2003 $15,073 $13,297 $10,719 2/28/2003 $14,662 $13,098 $10,536 3/31/2003 $14,729 $13,223 $10,507 4/30/2003 $15,846 $14,313 $11,445 5/31/2003 $16,734 $15,066 $12,105 6/30/2003 $17,006 $15,259 $12,319 7/31/2003 $17,218 $15,528 $12,571 8/31/2003 $17,727 $15,830 $12,846 9/30/2003 $17,823 $15,663 $12,927 10/31/2003 $18,572 $16,548 $13,697 11/30/2003 $19,215 $16,694 $13,909 12/31/2003 $20,103 $17,569 $14,785 1/31/2004 $20,346 $17,891 $15,025 2/29/2004 $20,979 $18,140 $15,282 3/31/2004 $20,901 $17,866 $15,187 4/30/2004 $20,541 $17,586 $14,884 5/31/2004 $20,531 $17,827 $15,030 6/30/2004 $20,910 $18,173 $15,345 7/31/2004 $20,695 $17,572 $14,848 8/31/2004 $20,822 $17,643 $14,920 9/30/2004 $21,380 $17,833 $15,207 10/31/2004 $21,800 $18,106 $15,582 11/30/2004 $23,043 $18,838 $16,408 12/31/2004 $23,905 $19,479 $17,039 AVERAGE ANNUAL TOTAL RETURN - ------------------------------------- CLASS A(1) 12/31/04 - ------------------------------------- 1-Year 12.14% - ------------------------------------- 5-Year 8.58% - ------------------------------------- Since Inception (11/1/96) 11.27% - ------------------------------------- 12 | Annual Report PERFORMANCE SUMMARY (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - ------------------------------------- CLASS B(1) 12/31/04 - ------------------------------------- 1-Year 14.22% - ------------------------------------- 5-Year 8.87% - ------------------------------------- Since Inception (1/1/99) 11.63% - ------------------------------------- CLASS B (1/1/99-12/31/04)(1) GRAPHIC MATERIAL (3) This graph compares the performance of Mutual Discovery Fund - Class B, 1 as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 Index 5 and the MSCI World Index 5 from 1/1/99-12/31/04. Mutual Discovery S&P 500 MSCI World Date Fund Index Index 1/1/1999 $10,000 $10,000 $10,000 1/31/1999 $10,070 $10,418 $10,220 2/28/1999 $9,942 $10,094 $9,950 3/31/1999 $10,396 $10,498 $10,366 4/30/1999 $11,076 $10,905 $10,776 5/31/1999 $11,076 $10,647 $10,383 6/30/1999 $11,462 $11,238 $10,869 7/31/1999 $11,320 $10,887 $10,838 8/31/1999 $11,172 $10,834 $10,820 9/30/1999 $11,018 $10,537 $10,717 10/31/1999 $11,231 $11,203 $11,275 11/30/1999 $11,816 $11,431 $11,594 12/31/1999 $12,555 $12,104 $12,534 1/31/2000 $12,495 $11,496 $11,818 2/29/2000 $12,885 $11,279 $11,851 3/31/2000 $13,420 $12,381 $12,672 4/30/2000 $13,264 $12,009 $12,137 5/31/2000 $13,330 $11,763 $11,831 6/30/2000 $13,356 $12,053 $12,231 7/31/2000 $13,517 $11,865 $11,889 8/31/2000 $13,903 $12,601 $12,277 9/30/2000 $13,755 $11,936 $11,626 10/31/2000 $13,851 $11,886 $11,432 11/30/2000 $13,607 $10,949 $10,740 12/31/2000 $13,998 $11,003 $10,915 1/31/2001 $14,411 $11,393 $11,127 2/28/2001 $14,396 $10,355 $10,188 3/31/2001 $13,961 $9,699 $9,520 4/30/2001 $14,351 $10,453 $10,227 5/31/2001 $14,771 $10,523 $10,100 6/30/2001 $14,832 $10,267 $9,785 7/31/2001 $14,787 $10,166 $9,656 8/31/2001 $14,627 $9,530 $9,194 9/30/2001 $13,373 $8,760 $8,385 10/31/2001 $13,403 $8,927 $8,547 11/30/2001 $13,730 $9,612 $9,054 12/31/2001 $14,028 $9,696 $9,112 1/31/2002 $14,068 $9,555 $8,837 2/28/2002 $14,193 $9,371 $8,761 3/31/2002 $14,656 $9,723 $9,151 4/30/2002 $14,892 $9,134 $8,843 5/31/2002 $14,994 $9,067 $8,864 6/30/2002 $14,061 $8,421 $8,328 7/31/2002 $13,121 $7,765 $7,627 8/31/2002 $13,247 $7,816 $7,643 9/30/2002 $12,536 $6,967 $6,804 10/31/2002 $12,576 $7,580 $7,307 11/30/2002 $12,749 $8,025 $7,703 12/31/2002 $12,633 $7,554 $7,331 1/31/2003 $12,410 $7,357 $7,110 2/28/2003 $12,068 $7,246 $6,988 3/31/2003 $12,115 $7,316 $6,969 4/30/2003 $13,032 $7,919 $7,591 5/31/2003 $13,749 $8,335 $8,029 6/30/2003 $13,971 $8,442 $8,170 7/31/2003 $14,131 $8,591 $8,338 8/31/2003 $14,540 $8,758 $8,520 9/30/2003 $14,612 $8,665 $8,574 10/31/2003 $15,221 $9,155 $9,085 11/30/2003 $15,742 $9,236 $9,225 12/31/2003 $16,452 $9,720 $9,806 1/31/2004 $16,646 $9,898 $9,966 2/29/2004 $17,155 $10,036 $10,136 3/31/2004 $17,082 $9,884 $10,073 4/30/2004 $16,775 $9,729 $9,872 5/31/2004 $16,759 $9,863 $9,969 6/30/2004 $17,058 $10,054 $10,178 7/31/2004 $16,871 $9,722 $9,848 8/31/2004 $16,969 $9,761 $9,895 9/30/2004 $17,416 $9,866 $10,086 10/31/2004 $17,749 $10,017 $10,335 11/30/2004 $18,757 $10,422 $10,883 12/31/2004 $19,349 $10,777 $11,301 AVERAGE ANNUAL TOTAL RETURN - ------------------------------------- CLASS C(1) 12/31/04 - ------------------------------------- 1-Year 17.17% - ------------------------------------- 5-Year 9.16% - ------------------------------------- Since Inception (11/1/96) 11.37% - ------------------------------------- CLASS C (11/1/96-12/31/04)(1) This graph compares the performance of Mutual Discovery Fund - Class C, 1 as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 Index 5 and the MSCI World Index 5 from 11/1/96-12/31/04 Mutual Discovery S&P 500 MSCI World Date Fund Index Index 11/1/1996 $10,000 $10,000 $10,000 11/30/1996 $10,408 $10,755 $10,562 12/31/1996 $10,491 $10,542 $10,395 1/31/1997 $10,980 $11,200 $10,522 2/28/1997 $11,182 $11,288 $10,645 3/31/1997 $11,066 $10,825 $10,436 4/30/1997 $11,078 $11,471 $10,779 5/31/1997 $11,469 $12,169 $11,446 6/30/1997 $11,878 $12,714 $12,019 7/31/1997 $12,390 $13,725 $12,574 8/31/1997 $12,266 $12,957 $11,735 9/30/1997 $12,868 $13,666 $12,374 10/31/1997 $12,483 $13,210 $11,725 11/30/1997 $12,551 $13,821 $11,934 12/31/1997 $12,768 $14,058 $12,082 1/31/1998 $12,761 $14,213 $12,420 2/28/1998 $13,400 $15,238 $13,262 3/31/1998 $14,161 $16,018 $13,824 4/30/1998 $14,412 $16,179 $13,962 5/31/1998 $14,589 $15,901 $13,789 6/30/1998 $14,222 $16,546 $14,118 7/31/1998 $13,874 $16,371 $14,097 8/31/1998 $11,970 $14,006 $12,219 9/30/1998 $11,428 $14,904 $12,438 10/31/1998 $11,734 $16,115 $13,564 11/30/1998 $12,311 $17,091 $14,373 12/31/1998 $12,395 $18,075 $15,077 1/31/1999 $12,468 $18,831 $15,409 2/28/1999 $12,316 $18,246 $15,002 3/31/1999 $12,872 $18,975 $15,629 4/30/1999 $13,724 $19,710 $16,247 5/31/1999 $13,724 $19,245 $15,655 6/30/1999 $14,205 $20,313 $16,388 7/31/1999 $14,030 $19,679 $16,341 8/31/1999 $13,846 $19,582 $16,314 9/30/1999 $13,656 $19,046 $16,158 10/31/1999 $13,927 $20,251 $17,000 11/30/1999 $14,645 $20,662 $17,481 12/31/1999 $15,556 $21,878 $18,898 1/31/2000 $15,489 $20,779 $17,818 2/29/2000 $15,972 $20,386 $17,868 3/31/2000 $16,640 $22,379 $19,105 4/30/2000 $16,447 $21,706 $18,300 5/31/2000 $16,529 $21,262 $17,839 6/30/2000 $16,557 $21,786 $18,442 7/31/2000 $16,756 $21,446 $17,925 8/31/2000 $17,232 $22,777 $18,510 9/30/2000 $17,049 $21,575 $17,528 10/31/2000 $17,168 $21,484 $17,237 11/30/2000 $16,867 $19,791 $16,192 12/31/2000 $17,349 $19,888 $16,457 1/31/2001 $17,867 $20,593 $16,776 2/28/2001 $17,849 $18,717 $15,360 3/31/2001 $17,303 $17,532 $14,354 4/30/2001 $17,793 $18,893 $15,419 5/31/2001 $18,311 $19,020 $15,227 6/30/2001 $18,382 $18,557 $14,752 7/31/2001 $18,335 $18,374 $14,558 8/31/2001 $18,129 $17,225 $13,862 9/30/2001 $16,575 $15,834 $12,643 10/31/2001 $16,612 $16,137 $12,886 11/30/2001 $17,015 $17,374 $13,650 12/31/2001 $17,393 $17,526 $13,738 1/31/2002 $17,441 $17,271 $13,323 2/28/2002 $17,595 $16,938 $13,210 3/31/2002 $18,164 $17,575 $13,797 4/30/2002 $18,454 $16,510 $13,333 5/31/2002 $18,589 $16,388 $13,364 6/30/2002 $17,429 $15,221 $12,556 7/31/2002 $16,264 $14,035 $11,499 8/31/2002 $16,420 $14,127 $11,523 9/30/2002 $15,546 $12,593 $10,258 10/31/2002 $15,585 $13,701 $11,017 11/30/2002 $15,808 $14,506 $11,614 12/31/2002 $15,658 $13,654 $11,053 1/31/2003 $15,384 $13,297 $10,719 2/28/2003 $14,964 $13,098 $10,536 3/31/2003 $15,013 $13,223 $10,507 4/30/2003 $16,147 $14,313 $11,445 5/31/2003 $17,046 $15,066 $12,105 6/30/2003 $17,316 $15,259 $12,319 7/31/2003 $17,513 $15,528 $12,571 8/31/2003 $18,024 $15,830 $12,846 9/30/2003 $18,112 $15,663 $12,927 10/31/2003 $18,869 $16,548 $13,697 11/30/2003 $19,507 $16,694 $13,909 12/31/2003 $20,401 $17,569 $14,785 1/31/2004 $20,639 $17,891 $15,025 2/29/2004 $21,273 $18,140 $15,282 3/31/2004 $21,174 $17,866 $15,187 4/30/2004 $20,798 $17,586 $14,884 5/31/2004 $20,778 $17,827 $15,030 6/30/2004 $21,152 $18,173 $15,345 7/31/2004 $20,923 $17,572 $14,848 8/31/2004 $21,043 $17,643 $14,920 9/30/2004 $21,590 $17,833 $15,207 10/31/2004 $22,009 $18,106 $15,582 11/30/2004 $23,244 $18,838 $16,408 12/31/2004 $24,094 $19,479 $17,039 Annual Report | 13 PERFORMANCE SUMMARY (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - ------------------------------------- CLASS R 12/31/04 - ------------------------------------- 1-Year 17.84% - ------------------------------------- Since Inception (1/1/02) 12.10% - ------------------------------------- CLASS R (1/1/02-12/31/04)(1) GRAPHIC MATERIAL (5) This graph compares the performance of Mutual Discovery Fund - Class R, 1 as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 Index 5 and the MSCI World Index 5 from 1/1/02-12/31/04. Mutual Discovery S&P 500 MSCI World Date Fund Index Index 1/1/2002 $10,000 $10,000 $10,000 1/31/2002 $10,033 $9,854 $9,698 2/28/2002 $10,127 $9,664 $9,616 3/31/2002 $10,459 $10,028 $10,043 4/30/2002 $10,630 $9,420 $9,705 5/31/2002 $10,708 $9,351 $9,728 6/30/2002 $10,050 $8,685 $9,140 7/31/2002 $9,382 $8,008 $8,370 8/31/2002 $9,471 $8,061 $8,388 9/30/2002 $8,970 $7,185 $7,467 10/31/2002 $9,004 $7,817 $8,020 11/30/2002 $9,132 $8,277 $8,454 12/31/2002 $9,051 $7,791 $8,046 1/31/2003 $8,893 $7,587 $7,803 2/28/2003 $8,655 $7,473 $7,669 3/31/2003 $8,689 $7,545 $7,648 4/30/2003 $9,351 $8,167 $8,331 5/31/2003 $9,871 $8,596 $8,811 6/30/2003 $10,033 $8,706 $8,967 7/31/2003 $10,153 $8,860 $9,151 8/31/2003 $10,454 $9,032 $9,351 9/30/2003 $10,505 $8,937 $9,410 10/31/2003 $10,949 $9,442 $9,970 11/30/2003 $11,324 $9,525 $10,125 12/31/2003 $11,845 $10,024 $10,762 1/31/2004 $11,989 $10,208 $10,937 2/29/2004 $12,364 $10,350 $11,124 3/31/2004 $12,312 $10,194 $11,055 4/30/2004 $12,099 $10,034 $10,835 5/31/2004 $12,093 $10,171 $10,941 6/30/2004 $12,316 $10,369 $11,170 7/31/2004 $12,189 $10,026 $10,808 8/31/2004 $12,258 $10,066 $10,860 9/30/2004 $12,589 $10,175 $11,069 10/31/2004 $12,838 $10,331 $11,343 11/30/2004 $13,568 $10,749 $11,944 12/31/2004 $14,077 $11,114 $12,403 ENDNOTES THE FUND'S INVESTMENTS INCLUDE 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: Shares are available to certain eligible investors as described in the prospectus. CLASS A: Prior to 8/3/98, these shares were offered at a lower initial sales charge; thus actual total returns may differ. CLASS B: These shares have higher annual fees and expenses than Class A shares. CLASS C: Prior to 1/1/04, these shares were offered with an initial sales charge; thus actual total returns would have differed. These shares have higher annual fees and expenses than Class A shares. CLASS R: 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. If the manager had not taken this action, 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 a sales charge. (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. (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. (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 a free float-adjusted, market capitalization-weighted index designed to measure equity securities in global developed markets. 14 | Annual Report YOUR FUND'S EXPENSES As a Fund shareholder, you can incur two types of costs: o Transaction costs, including sales charges (loads) on Fund purchases and redemption fees; and o Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. The following table shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated. ACTUAL FUND EXPENSES The first line (Actual) for each share class listed in the table below provides actual account values and expenses. The "Ending Account Value" is derived from the Fund's actual return, which includes the effect of Fund expenses. You can estimate the expenses you paid during the period, by following these steps. OF COURSE, YOUR ACCOUNT VALUE AND EXPENSES WILL DIFFER FROM THOSE IN THIS ILLUSTRATION: 1. Divide your account value by $1,000. IF AN ACCOUNT HAD AN $8,600 VALUE, THEN $8,600 / $1,000 = 8.6. 2. Multiply the result by the number under the heading "Expenses Paid During Period." IF EXPENSES PAID DURING PERIOD WERE $7.50, THEN 8.6 / $7.50 = $64.50. In this illustration, the estimated expenses paid this period are $64.50. HYPOTHETICAL EXAMPLE FOR COMPARISON WITH OTHER FUNDS Information in the second line (Hypothetical) for each class in the table can help you compare ongoing costs of investing in the Fund with those of other mutual funds. This information may not be used to estimate the actual ending account balance or expenses you paid during the period. The hypothetical "Ending Account Value" is based on the actual expense ratio for each class and an assumed 5% annual rate of return before expenses, which does not represent the Fund's actual return. The figure under the heading "Expenses Paid During Period" shows the hypothetical expenses your account would have incurred under this scenario. You can compare this figure with the 5% hypothetical examples that appear in shareholder reports of other funds. Annual Report | 15 YOUR FUND'S EXPENSES (CONTINUED) PLEASE NOTE THAT EXPENSES SHOWN IN THE TABLE ARE MEANT TO HIGHLIGHT ONGOING COSTS AND DO NOT REFLECT ANY TRANSACTION COSTS, SUCH AS SALES CHARGES OR REDEMPTION FEES. Therefore, the second line for each class is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transaction costs were included, your total costs would have been higher. Please refer to the Fund prospectus for additional information on operating expenses.
- ---------------------------------------------------------------------------------------------------------------- BEGINNING ACCOUNT ENDING ACCOUNT EXPENSES PAID DURING CLASS Z VALUE 6/30/04 VALUE 12/31/04 PERIOD* 6/30/04-12/31/04 - ---------------------------------------------------------------------------------------------------------------- Actual $1,000 $1,145.70 $ 5.72 - ---------------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,019.81 $ 5.38 - ---------------------------------------------------------------------------------------------------------------- Class A - ---------------------------------------------------------------------------------------------------------------- Actual $1,000 $1,143.90 $ 7.60 - ---------------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,018.05 $ 7.15 - ---------------------------------------------------------------------------------------------------------------- Class B - ---------------------------------------------------------------------------------------------------------------- Actual $1,000 $1,140.20 $11.08 - ---------------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,014.78 $10.43 - ---------------------------------------------------------------------------------------------------------------- Class C - ---------------------------------------------------------------------------------------------------------------- Actual $1,000 $1,139.70 $11.08 - ---------------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,014.78 $10.43 - ---------------------------------------------------------------------------------------------------------------- Class R - ---------------------------------------------------------------------------------------------------------------- Actual $1,000 $1,142.90 $ 8.40 - ---------------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,017.29 $ 7.91 - ----------------------------------------------------------------------------------------------------------------
* Expenses are equal to the annualized expense ratio for each class (Z: 1.06%; A: 1.41%; B: 2.06%; C: 2.06%; and R: 1.56%), multiplied by the average account value over the period, multiplied by 184/366 to reflect the one-half year period. 16 | Annual Report MUTUAL DISCOVERY FUND FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2004 2003 2002 2001 2000 --------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .................. $ 20.81 $ 16.16 $ 18.19 $ 18.93 $ 21.10 --------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ........................... .41 .28 .33 .37 .36 Net realized and unrealized gains (losses) ......... 3.58 4.80 (1.96) (.14) 2.14 --------------------------------------------------------------------------- Total from investment operations .................... 3.99 5.08 (1.63) .23 2.50 --------------------------------------------------------------------------- Less distributions from: Net investment income .............................. (.54) (.43) (.32) (.34) (.63) Net realized gains ................................. -- -- (.08) (.63) (4.04) --------------------------------------------------------------------------- Total distributions ................................. (.54) (.43) (.40) (.97) (4.67) --------------------------------------------------------------------------- Redemption fees ..................................... --(d) -- -- -- -- --------------------------------------------------------------------------- Net asset value, end of year ........................ $ 24.26 $ 20.81 $ 16.16 $ 18.19 $ 18.93 =========================================================================== Total return(b) ..................................... 19.39% 31.55% (9.06)% 1.26% 12.59% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ..................... $2,578,585 $2,168,161 $1,673,786 $1,931,117 $2,010,578 Ratios to average net assets:* Expenses(c) ........................................ 1.07% 1.11% 1.04% 1.04% 1.07% Expenses, net of waiver and payments by affiliate(c) 1.07% 1.11% 1.04% 1.04% 1.05% Net investment income .............................. 1.87% 1.55% 1.88% 1.93% 1.64% Portfolio turnover rate ............................. 34.34% 46.34% 40.95% 59.32% 75.34% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ........................................... 1.06% 1.08% 1.03% 1.02% 1.04% Expenses, net of waiver and payments by affiliate .. 1.06% 1.08% 1.03% 1.02% 1.02%
(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 only operating expenses. (d) Amount is less than $0.001 per share. Annual Report | See notes to financial statements. | 17 MUTUAL DISCOVERY FUND FINANCIAL HIGHLIGHTS (CONTINUED)
----------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2004 2003 2002 2001 2000 ----------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .................. $ 20.67 $ 16.06 $ 18.08 $ 18.83 $ 21.00 ----------------------------------------------------------------------- Income from investment operations: Net investment income(a) ........................... .33 .21 .27 .30 .28 Net realized and unrealized gains (losses) ......... 3.54 4.78 (1.95) (.14) 2.14 ----------------------------------------------------------------------- Total from investment operations .................... 3.87 4.99 (1.68) .16 2.42 ----------------------------------------------------------------------- Less distributions from: Net investment income .............................. (.47) (.38) (.26) (.28) (.55) Net realized gains ................................. -- -- (.08) (.63) (4.04) ----------------------------------------------------------------------- Total distributions ................................. (.47) (.38) (.34) (.91) (4.59) ----------------------------------------------------------------------- Redemption fees ..................................... --(d) -- -- -- -- ----------------------------------------------------------------------- Net asset value, end of year ........................ $ 24.07 $ 20.67 $ 16.06 $ 18.08 $ 18.83 ======================================================================= Total return(b) ..................................... 18.98% 31.13% (9.39)% .86% 12.27% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ..................... $2,106,695 $1,439,579 $925,278 $911,434 $877,528 Ratios to average net assets:* Expenses(c) ........................................ 1.42% 1.46% 1.39% 1.39% 1.42% Expenses, net of waiver and payments by affiliate(c) 1.42% 1.46% 1.39% 1.39% 1.40% Net investment income .............................. 1.52% 1.20% 1.53% 1.57% 1.30% Portfolio turnover rate ............................. 34.34% 46.34% 40.95% 59.32% 75.34% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ........................................... 1.41% 1.43% 1.38% 1.37% 1.39% Expenses, net of waiver and payments by affiliate .. 1.41% 1.43% 1.38% 1.37% 1.37%
(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 only operating expenses. (d) Amount is less than $0.001 per share. 18 | See notes to financial statements. | Annual Report MUTUAL DISCOVERY FUND FINANCIAL HIGHLIGHTS (CONTINUED)
------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2004 2003 2002 2001 2000 ------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .................. $ 20.35 $ 15.85 $ 17.87 $ 18.66 $ 20.90 ------------------------------------------------------------------- Income from investment operations: Net investment income(a) ........................... .18 .09 .16 .16 .15 Net realized and unrealized gains (losses) ......... 3.49 4.69 (1.92) (.12) 2.11 ------------------------------------------------------------------- Total from investment operations .................... 3.67 4.78 (1.76) .04 2.26 ------------------------------------------------------------------- Less distributions from: Net investment income .............................. (.35) (.28) (.18) (.20) (.46) Net realized gains ................................. -- -- (.08) (.63) (4.04) ------------------------------------------------------------------- Total distributions ................................. (.35) (.28) (.26) (.83) (4.50) ------------------------------------------------------------------- Redemption fees ..................................... --(d) -- -- -- -- ------------------------------------------------------------------- Net asset value, end of year ........................ $ 23.67 $ 20.35 $ 15.85 $ 17.87 $ 18.66 =================================================================== Total return(b) ..................................... 18.22% 30.22% (9.94)% .21% 11.50% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ..................... $186,841 $115,801 $64,747 $41,346 $19,949 Ratios to average net assets:* Expenses(c) ........................................ 2.07% 2.11% 2.04% 2.04% 2.07% Expenses, net of waiver and payments by affiliate(c) 2.07% 2.11% 2.04% 2.04% 2.05% Net investment income .............................. .87% .55% .88% .85% .70% Portfolio turnover rate ............................. 34.34% 46.34% 40.95% 59.32% 75.34% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ........................................... 2.06% 2.08% 2.03% 2.02% 2.04% Expenses, net of waiver and payments by affiliate .. 2.06% 2.08% 2.03% 2.02% 2.02%
(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 only operating expenses. (d) Amount is less than $0.001 per share. Annual Report | See notes to financial statements. | 19 MUTUAL DISCOVERY FUND FINANCIAL HIGHLIGHTS (CONTINUED)
--------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2004 2003 2002 2001 2000 --------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .................. $ 20.59 $ 16.02 $ 18.03 $ 18.77 $ 20.95 --------------------------------------------------------------------- Income from investment operations: Net investment income(a) ........................... .19 .10 .16 .18 .14 Net realized and unrealized gains (losses) ......... 3.53 4.73 (1.94) (.13) 2.13 --------------------------------------------------------------------- Total from investment operations .................... 3.72 4.83 (1.78) .05 2.27 --------------------------------------------------------------------- Less distributions from: Net investment income .............................. (.34) (.26) (.15) (.16) (.41) Net realized gains ................................. -- -- (.08) (.63) (4.04) --------------------------------------------------------------------- Total distributions ................................. (.34) (.26) (.23) (.79) (4.45) --------------------------------------------------------------------- Redemption fees ..................................... --(d) -- -- -- -- --------------------------------------------------------------------- Net asset value, end of year ........................ $ 23.97 $ 20.59 $ 16.02 $ 18.03 $ 18.77 ===================================================================== Total return(b) ..................................... 18.17% 30.29% (9.98)% .25% 11.53% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ..................... $968,934 $725,489 $525,375 $561,808 $554,968 Ratios to average net assets:* Expenses(c) ........................................ 2.07% 2.11% 2.03% 2.03% 2.07% Expenses, net of waiver and payments by affiliate(c) 2.07% 2.11% 2.03% 2.03% 2.04% Net investment income .............................. .87% .55% .89% .93% .65% Portfolio turnover rate ............................. 34.34% 46.34% 40.95% 59.32% 75.34% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ........................................... 2.06% 2.08% 2.02% 2.01% 2.04% Expenses, net of waiver and payments by affiliate .. 2.06% 2.08% 2.02% 2.01% 2.01%
(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 only operating expenses. (d) Amount is less than $0.001 per share. 20 | See notes to financial statements. | Annual Report MUTUAL DISCOVERY FUND FINANCIAL HIGHLIGHTS (CONTINUED)
------------------------------------ YEAR ENDED DECEMBER 31, CLASS R 2004 2003 2002(e) ------------------------------------ PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .................................................. $ 20.57 $ 16.01 $18.08 ------------------------------------ Income from investment operations: Net investment income(a) ........................................................... .29 .17 .25 Net realized and unrealized gains (losses) ......................................... 3.54 4.76 (1.95) ------------------------------------ Total from investment operations .................................................... 3.83 4.93 (1.70) ------------------------------------ Less distributions from: Net investment income .............................................................. (.46) (.37) (.29) Net realized gains ................................................................. -- -- (.08) ------------------------------------ Total distributions ................................................................. (.46) (.37) (.37) ------------------------------------ Redemption fees ..................................................................... --(d) -- -- ------------------------------------ Net asset value, end of year ........................................................ $ 23.94 $ 20.57 $16.01 ==================================== Total return(b) ..................................................................... 18.84% 30.87% (9.49)% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ..................................................... $46,690 $19,546 $3,932 Ratios to average net assets:* Expenses(c) ........................................................................ 1.57% 1.61% 1.54%(f) Net investment income .............................................................. 1.37% 1.05% 1.38%(f) Portfolio turnover rate ............................................................. 34.34% 46.34% 40.95% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ........................................................................... 1.56% 1.58% 1.54%(f)
(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 only operating expenses. (d) Amount is less than $0.001 per share. (e) Effective date of Class R shares was January 2, 2002. (f) Annualized. Annual Report | See notes to financial statements. | 21 MUTUAL DISCOVERY FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004
- --------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - --------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 92.0% AEROSPACE & DEFENSE .4% Northrop Grumman Corp. ................................. United States 433,600 $ 23,570,496 -------------- AIRLINES .6% (a)Ace Aviation Holdings Inc. ............................. Canada 1,198,374 35,521,077 (a),(b),(f)Air Canada Inc., Contingent Distribution ............... Canada 249,992,002 -- -------------- 35,521,077 -------------- AUTOMOBILES .2% Hero Honda Motors Ltd. ................................. India 1,042,903 13,771,142 -------------- BEVERAGES 5.3% Brown-Forman Corp., A .................................. United States 143,200 7,268,832 Brown-Forman Corp., B .................................. United States 391,650 19,065,522 Carlsberg AS, A ........................................ Denmark 113,300 5,208,103 Carlsberg AS, B ........................................ Denmark 1,876,968 94,838,728 Coca-Cola Enterprises Inc. ............................. United States 894,300 18,646,155 Diageo PLC ............................................. United Kingdom 5,181,408 73,895,085 Fomento Economico Mexicano SA de CV Femsa, ADR ......... Mexico 991,000 52,136,510 Heineken Holding NV, A ................................. Netherlands 1,453,069 43,872,849 -------------- 314,931,784 -------------- CAPITAL MARKETS 2.2% (a)A.B. Watley Group Inc. ................................. United States 128,355 21,820 Guinness Peat Group PLC ................................ New Zealand 19,778,076 30,817,590 Irish Life & Permanent PLC ............................. Irish Republic 2,899,665 53,631,919 (c)Leucadia National Corp. ................................ United States 684,780 45,199,589 -------------- 129,670,918 -------------- CHEMICALS 2.9% Givaudan AG ............................................ Switzerland 88,065 57,990,913 Linde AG ............................................... Germany 440,300 27,430,621 (a)MG Technologies AG ..................................... Germany 2,933,641 34,634,257 Solvay SA .............................................. Belgium 437,923 48,135,161 -------------- 168,190,952 -------------- COMMERCIAL BANKS 4.0% Allied Irish Banks PLC ................................. Irish Republic 4,877,727 101,139,430 Bank of Ireland ........................................ Irish Republic 2,475,126 40,870,211 BNP Paribas SA ......................................... France 427,700 30,934,715 (a)Cerberus NCB Acquisition LP Ltd., wts., 8/29/13 ........ Japan 9,799,350 4,899,675 Danske Bank ............................................ Denmark 1,352,880 41,397,192 (a),(c),(d)FE Capital Holdings Ltd. ............................... Japan 11,589 15,412,910 Kansai Urban Banking Corp. ............................. Japan 678,808 1,259,261 (a),(d)Nippon Investment LLC .................................. Japan 8,656,000 -- -------------- 235,913,394 --------------
22 | Annual Report MUTUAL DISCOVERY FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) COMMERCIAL SERVICES & SUPPLIES .5% (a)Comdisco Holding Co., Inc. ................................... United States 57 $ 1,272 (b)Comdisco, Contingent Distribution ............................ United States 41,726,153 -- (a)Fursys Inc. .................................................. South Korea 319,900 4,326,314 Republic Services Inc. ....................................... United States 731,600 24,537,864 (a),(b)Safety Kleen Corp., Contingent Distribution .................. United States 520,000 -- ------------ 28,865,450 ------------ COMPUTERS & PERIPHERALS (a)DecisionOne Corp. ............................................ United States 87,619 -- ------------ CONSTRUCTION MATERIALS 1.1% Ciments Francais SA .......................................... France 399,572 37,304,665 (a)Hanil Cement Manufacturing Co. Ltd. .......................... South Korea 45,950 2,663,254 RMC Group PLC ................................................ United Kingdom 1,357,750 22,126,180 ------------ 62,094,099 ------------ DISTRIBUTORS .5% Compania de Distribucion Integral Logista SA ................. Spain 564,170 30,538,920 ------------ DIVERSIFIED FINANCIAL SERVICES 6.7% Brascan Corp., A ............................................. Canada 2,147,100 77,247,980 Deutsche Bourse AG ........................................... Germany 409,100 24,581,974 Euronext ..................................................... Netherlands 1,329,836 40,549,062 Jardine Matheson Holdings Ltd. ............................... Hong Kong 3,381,000 53,757,900 Jardine Strategic Holdings Ltd. .............................. Hong Kong 7,110,400 58,305,280 London Stock Exchange PLC .................................... United Kingdom 5,600 62,559 (b)Marconi Corp., Contingent Distribution ....................... United Kingdom 33,909,700 -- Pargesa Holdings SA .......................................... Switzerland 18,959 66,584,134 Remgro Ltd. .................................................. South Africa 4,382,450 72,996,996 ------------ 394,085,885 ------------ DIVERSIFIED TELECOMMUNICATION SERVICES 2.4% (a),(c),(e)AboveNet Inc. ................................................ United States 332,512 7,968,118 (a),(b),(e)AboveNet Inc., Contingent Distribution ....................... United States 46,367,000 -- (a),(c),(e)AboveNet Inc., wts., 9/08/08 ................................. United States 11,105 71,072 (a),(c),(e)AboveNet Inc., wts., 9/08/10 ................................. United States 13,066 52,264 (a)Belgacom SA .................................................. Belgium 458,000 19,763,882 Chunghwa Telecom Co. Ltd., ADR ............................... Taiwan 999,982 21,049,621 (b)Global Crossing Holdings Ltd., Contingent Distribution ....... United States 45,658,716 57,073 Koninklijke KPN NV ........................................... Netherlands 2,137,200 20,272,252 (a)MCI Inc. ..................................................... United States 774,034 15,604,526 Sprint Corp. ................................................. United States 162,100 4,028,185 (a),(b)Telewest Communications PLC, Contingent Distribution ......... United Kingdom 53,009,022 -- (a),(b)Telewest Finance Ltd., Contingent Distribution ............... United Kingdom 5,738,000 -- (a)Telewest Global Inc. ......................................... United Kingdom 3,124,100 54,921,678 ------------ 143,788,671 ------------
Annual Report | 23 MUTUAL DISCOVERY FUND Statement of Investments, December 31, 2004 (continued)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) ELECTRIC UTILITIES .5% E.ON AG ...................................................... Germany 320,100 $ 29,181,347 ------------ FOOD & STAPLES RETAILING .2% (a)Kroger Co. ................................................... United States 722,800 12,677,912 ------------ FOOD PRODUCTS 6.7% Cadbury Schweppes PLC ........................................ United Kingdom 4,575,019 42,590,583 CSM NV ....................................................... Netherlands 7,700 239,489 (d)Farmer Brothers Co. .......................................... United States 904,637 21,928,401 General Mills Inc. ........................................... United States 478,600 23,791,206 Groupe Danone ................................................ France 606,400 55,914,997 (a)Lotte Confectionary Co. Ltd. ................................. South Korea 50,489 38,676,369 Nestle SA .................................................... Switzerland 219,229 57,263,820 Orkla ASA .................................................... Norway 4,611,582 151,325,317 ------------ 391,730,182 ------------ GAS UTILITIES .4% Tokyo Gas Co. Ltd. ........................................... Japan 6,217,500 25,496,485 ------------ HEALTH CARE EQUIPMENT & SUPPLIES .2% (n)Guidant Corp. ................................................ United States 180,200 12,992,420 ------------ HEALTH CARE PROVIDERS & SERVICES .6% (a)Alderwoods Group Inc. ........................................ United States 50,322 572,664 (a),(e)Kindred Healthcare Inc. ...................................... United States 934,740 26,595,690 (a),(e)Kindred Healthcare Inc., Jul. 23.75 Calls, 7/17/11 ........... United States 2,259 14,006 (a),(e)Kindred Healthcare Inc., Jan. 26.00 Calls, 1/01/12 ........... United States 452 1,785 (a),(e)Kindred Healthcare Inc., Jan. 9.07 Calls, 1/01/13 ............ United States 226 4,718 (a),(e)Kindred Healthcare Inc., wts., Series A, 4/20/06 ............. United States 88,766 2,637,771 (a),(e)Kindred Healthcare Inc., wts., Series B, 4/20/06 ............. United States 221,915 5,818,611 Select Medical Corp. ......................................... United States 177,100 3,116,960 ------------ 38,762,205 ------------ HOTELS RESTAURANTS & LEISURE .2% (a)Caesars Entertainment Inc. ................................... United States 67,100 1,351,394 (a)FHC Delaware Inc. ............................................ United States 212,022 1,668,613 (a),(c),(d)Hancock Discovery LLC ........................................ United States 8,758,216 500,007 Mandalay Resort Group ........................................ United States 83,200 5,859,776 ------------ 9,379,790 ------------ HOUSEHOLD PRODUCTS .7% (a)Amorepacific Corp. ........................................... South Korea 111,070 27,842,606 KAO Corp. .................................................... Japan 520,900 13,325,112 ------------ 41,167,718 ------------ INDUSTRIAL CONGLOMERATES .1% Swire Pacific Ltd., B ........................................ Hong Kong 5,062,100 7,522,033 ------------ INSURANCE 10.0% (a)Alleghany Corp. .............................................. United States 72,132 20,575,653 (a)Berkshire Hathaway Inc., A ................................... United States 853 74,978,700 (a)Berkshire Hathaway Inc., B ................................... United States 38,270 112,360,720
24 | Annual Report MUTUAL DISCOVERY FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) INSURANCE (CONT.) Catlin Group ....................................................... United Kingdom 4,088,580 $ 25,721,373 E-L Financial Corp. Ltd. ........................................... Canada 177,619 50,022,404 Hartford Financial Services Group Inc. ............................. United States 511,000 35,417,410 (a),(c),(d)Imagine Group Holdings Ltd. ........................................ Bermuda 4,551,501 46,614,334 IPC Holdings Ltd. .................................................. Bermuda 325,665 14,169,684 Montpelier Re Holdings Ltd. ........................................ Bermuda 107,027 4,115,188 Old Republic International Corp. ................................... United States 1,518,550 38,419,315 (a),(c)Olympus Re Holdings Ltd. ........................................... Bermuda 47,160 8,072,849 Prudential Financial Inc. .......................................... United States 421,200 23,149,152 St. Paul Travelers Cos. Inc. ....................................... United States 559,763 20,750,414 White Mountains Insurance Group Inc. ............................... United States 175,415 113,318,090 ------------ 587,685,286 ------------ LEISURE EQUIPMENT & PRODUCTS .5% Agfa Gevaert NV .................................................... Belgium 367,220 12,438,000 Mattel Inc. ........................................................ United States 721,400 14,060,086 Shimano Inc. ....................................................... Japan 34,800 993,849 ------------ 27,491,935 ------------ MACHINERY 1.8% Schindler Holding AG ............................................... Switzerland 201,292 79,707,355 Schindler Holding AG, Reg D ........................................ Switzerland 65,126 27,160,850 ------------ 106,868,205 ------------ MARINE .5% A P Moller - Maersk A/S ............................................ Denmark 3,748 30,902,037 ------------ MEDIA 8.6% Astral Media Inc., A ............................................... Canada 1,394,900 37,892,060 British Sky Broadcasting Group PLC ................................. United Kingdom 2,146,300 23,152,916 Clear Channel Communications Inc. .................................. United States 945,700 31,671,493 (a)Comcast Corp., A ................................................... United States 179,400 5,891,496 Daekyo Co. Ltd. .................................................... South Korea 31,760 2,141,468 E.W. Scripps Co., A ................................................ United States 290,600 14,030,168 EchoStar Communications Corp., A ................................... United States 581,900 19,342,356 Hollinger International Inc. ....................................... United States 880,440 12,424,769 (a)JC Decaux SA ....................................................... France 494,086 14,401,790 (a)Liberty Media Corp., A ............................................. United States 4,255,518 46,725,588 (a)News Corp. Ltd., A ................................................. United States 1,615,600 30,147,096 (a)NTL Inc. ........................................................... United Kingdom 1,315,722 95,995,077 Omnicom Group Inc. ................................................. United States 197,900 16,686,928 SES Global, FDR .................................................... Luxembourg 6,440,290 83,461,936 (a)TVMAX Holdings Inc. ................................................ United States 118,432 118,432 Viacom Inc., B ..................................................... United States 388,900 14,152,071 Washington Post Co., B ............................................. United States 60,003 58,984,149 ------------ 507,219,793 ------------
Annual Report | 25 MUTUAL DISCOVERY FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) METALS & MINING 8.0% Anglo American PLC ..................................................... United Kingdom 3,561,117 $ 84,212,372 Anglo American PLC, ADR ................................................ United Kingdom 1,000 23,790 (a)Apollo Gold Corp. ...................................................... Canada 1,115,900 958,333 Barrick Gold Corp. ..................................................... Canada 547,000 13,248,340 Freeport McMoran Copper & Gold Inc., B ................................. United States 723,200 27,647,936 (a),(d)Gammon Lake Resources Inc. ............................................. Canada 2,136,800 11,455,892 (a),(d)Gammon Lake Resources Inc., wts., 4/30/05 .............................. Canada 2,265,300 12,144,811 (a)Glamis Gold Ltd. ....................................................... Canada 782,700 13,417,528 Gold Fields Ltd. ....................................................... South Africa 152,344 1,869,004 Harmony Gold Mining Ltd., ADR .......................................... South Africa 438,500 4,064,895 Hindalco Industries Inc. ............................................... India 397,500 13,113,364 Impala Platinum Holdings Ltd. .......................................... South Africa 462,062 39,069,320 (a),(c)International Steel Group .............................................. United States 2,689,230 103,621,410 (a)Kinross Gold Corp. ..................................................... Canada 687,500 4,843,770 (a)LionOre Mining International Ltd. ...................................... Canada 3,598,900 20,584,862 Newmont Mining Corp. ................................................... United States 1,874,600 83,250,986 Noranda Inc. ........................................................... Canada 1,069,800 18,785,165 Placer Dome Inc. ....................................................... Canada 326,500 6,146,971 (a)Randgold & Exploration Co. Ltd., ADR ................................... South Africa 143,100 251,856 (a)Wheaton River Minerals Ltd. ............................................ Canada 1,868,279 6,075,198 (a)Wheaton River Minerals Ltd., wts., 5/30/07 ............................. Canada 600,670 1,181,957 (n)WMC Resources Ltd. ..................................................... Australia 1,073,300 6,065,693 ------------ 472,033,453 ------------ MULTI-UTILITIES & UNREGULATED POWER .4% (a)Northwestern Corp. ..................................................... United States 319,179 8,937,012 (a),(b)Northwestern Corp., Contingent Distribution ............................ United States 9,790,000 766,482 (a),(f)NRG Energy Inc. ........................................................ United States 358,328 12,917,724 ------------ 22,621,218 ------------ OIL & GAS 3.1% (a)Anchor Resources LLC ................................................... United States 53,272 -- Bharat Petroleum Corp. Ltd. ............................................ India 211,700 2,245,978 BP PLC ................................................................. United Kingdom 2,095,000 20,428,040 BP PLC, ADR ............................................................ United Kingdom 180,900 10,564,560 Canadian Oil Sands Trust ............................................... Canada 389,100 21,934,424 Eni SpA ................................................................ Italy 847,600 21,186,549 (a)General Maritime Corp. ................................................. United States 17,000 679,150 Oil & Natural Gas Corp. Ltd. ........................................... India 861,829 16,330,912 Suncor Energy Inc. ..................................................... Canada 1,037,600 36,681,736 Total SA, B ............................................................ France 127,671 27,841,190 Total SA, B, ADR ....................................................... France 208,648 22,917,896 ------------ 180,810,435 ------------ PAPER & FOREST PRODUCTS 1.9% (d)Potlatch Corp. ......................................................... United States 2,190,150 110,777,787 ------------
26 | Annual Report MUTUAL DISCOVERY FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) PERSONAL PRODUCTS .3% Beiersdorf AG ...................................................... Germany 130,510 $ 15,216,603 ------------ PHARMACEUTICALS 2.3% Fujisawa Pharmaceutical Co. Ltd. ................................... Japan 1,218,800 33,379,555 Pfizer Inc. ........................................................ United States 491,500 13,216,435 (a)Pfizer Inc., Mar. 25.00 Puts, 3/18/05 .............................. United States 2,776 194,320 Sanofi-Aventis ..................................................... France 388,595 31,006,603 Takeda Pharmaceutical Co. Ltd. ..................................... Japan 672,500 33,881,078 Wyeth .............................................................. United States 540,300 23,011,377 Yamanouchi Pharmaceutical Co. Ltd. ................................. Japan 42,300 1,647,891 ------------ 136,337,259 ------------ REAL ESTATE 1.8% (a)Canary Wharf Group PLC ............................................. United Kingdom 5,400,183 30,681,680 iStar Financial Inc. ............................................... United States 1,056,000 47,794,560 (a),(c)Security Capital European Realty ................................... Luxembourg 14,787 106,466 (a),(c)(d)Torre Mayor Investments, LP ........................................ Mexico 170 11,050,000 Ventas Inc. ........................................................ United States 516,500 14,157,265 ------------ 103,789,971 ------------ ROAD & RAIL 1.9% CSX Corp. .......................................................... United States 443,700 17,783,496 (c),(d)Florida East Coast Industries Inc. ................................. United States 2,247,600 96,298,422 ------------ 114,081,918 ------------ SEMICONDUCTORS & SEMICONDUCTOR EQUIPMENT .4% Samsung Electronics Co. Ltd. ....................................... South Korea 55,500 24,152,579 ------------ SOFTWARE .6% Nintendo Co. Ltd. .................................................. Japan 200,200 25,156,942 (a),(n)Symantec Corp. ..................................................... United States 171,100 4,407,536 (a),(n)Veritas Software Corp. ............................................. United States 172,800 4,933,440 ------------ 34,497,918 ------------ THRIFTS & MORTGAGE FINANCE .2% Hudson City Bancorp Inc. ........................................... United States 376,333 13,856,581 ------------ TOBACCO 13.3% Altadis SA ......................................................... Spain 3,181,151 145,476,834 Altria Group Inc. .................................................. United States 995,105 60,800,915 British American Tobacco PLC ....................................... United Kingdom 10,342,443 178,170,805 Gallaher Group PLC ................................................. United Kingdom 3,944,642 59,929,059 Imperial Tobacco Group PLC ......................................... United Kingdom 5,733,336 157,040,011 ITC Ltd. ........................................................... India 1,202,467 36,415,983 Japan Tobacco Inc. ................................................. Japan 2,997 34,236,380 KT & G Corp. ....................................................... South Korea 1,335,770 39,936,323 KT & G Corp., GDR, 144A ............................................ South Korea 4,680,078 68,797,147 ------------ 780,803,457 ------------
Annual Report | 27 MUTUAL DISCOVERY FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) WIRELESS TELECOMMUNICATION SERVICES (a)Vast Solutions Inc., B1 .......................................... United States 36,976 $ -- (a)Vast Solutions Inc., B2 .......................................... United States 36,976 -- (a)Vast Solutions Inc., B3 .......................................... United States 36,976 -- -------------- -- -------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $3,658,167,648) .......................................... 5,418,999,315 -------------- PREFERRED STOCKS .4% DIVERSIFIED TELECOMMUNICATION SERVICES PTV Inc., 10.00%, A, pfd ......................................... United Kingdom 86,280 390,848 -------------- ELECTRIC UTILITIES (a)Montana Power Co., 8.45%, pfd .................................... United States 49,500 408,375 -------------- FOOD PRODUCTS .1% Unilever NV, pfd ................................................. Netherlands 494,300 3,360,532 -------------- METALS & MINING .3% (a),(d),(e)Esmark Inc., Series A, 10.00%, cvt., pfd ......................... United States 18,647 18,646,800 -------------- TOTAL PREFERRED STOCKS (COST $22,524,301) ........................ 22,806,555 -------------- ------------------- PRINCIPAL AMOUNT(g) ------------------- CORPORATE BONDS & NOTES 1.7% Anchor Resources LLC, 12.00%, 12/17/06 ........................... United States $ 24,923 24,923 Calpine Generating Co., 144A, FRN, 11.169%, 4/01/11 .............. United States 9,411,000 9,246,308 Eurotunnel PLC, FRN, 6.347%, 12/31/18, Tier 2 ....................................... United Kingdom 6,155,799GBP 8,507,381 6.347%, 12/31/25, Tier 3 ....................................... United Kingdom 23,082,138GBP 18,608,196 Eurotunnel SA, FRN, 3.449%, 12/31/18, Tier 2 (LIBOR) ............................... France 1,420,047EUR 1,387,442 3.449%, 12/31/25, Tier 3 (LIBOR) ............................... France 27,236,561EUR 15,523,199 3.453%, 12/31/18, Tier 2 (PIBOR) ............................... France 628,134EUR 613,711 3.453%, 12/31/25, Tier 3 (PIBOR) ............................... France 5,943,809EUR 3,387,613 Guadalupe Power Partners LP, Power Sale Agreement, 6.00%, 9/21/06 ........................... United States 180,700 159,016 Term Loan, 4.313%, 9/21/06 ..................................... United States 1,335,767 1,175,475 Motor Coach Industries International Inc., FRN, 15.40%, 10/01/08 . United States 25,087,380 25,087,380 Reliant Energy Channelview LP Inc., Revolver, 5.50%, 8/15/07 ....................................... United States 306,300 260,355 Term Loan A, 3.813%, 11/26/17 .................................. United States 3,232,461 2,747,592 Seton House Finance Ltd., zero cpn., 2/07/12 ..................... United Kingdom 41,212,000EUR 14,260,788 TVMAX Holdings Inc., PIK, 11.50%, 6/30/05 ................................................ United States 119,035 119,035 14.00%, 6/30/05 ................................................ United States 477,104 477,104 -------------- TOTAL CORPORATE BONDS & NOTES (Cost $107,487,633) ................ 101,585,518 --------------
28 | Annual Report MUTUAL DISCOVERY FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------- COUNTRY PRINCIPAL AMOUNT(g) VALUE - ------------------------------------------------------------------------------------------------------------------------------- BONDS & NOTES IN REORGANIZATION 2.2% (a),(h)Adelphia Communications Corp., 9.25%, 10/01/02 .............................................. United States $ 4,491,000 $ 4,322,587 8.125%, 7/15/03 .............................................. United States 650,000 614,250 7.50%, 1/15/04 ............................................... United States 1,655,000 1,539,150 10.50%, 7/15/04 .............................................. United States 2,605,000 2,578,950 9.875%, 3/01/05 .............................................. United States 1,168,000 1,124,200 10.25%, 11/01/06 ............................................. United States 4,326,000 4,228,665 9.875%, 3/01/07 .............................................. United States 167,000 160,737 8.375%, 2/01/08 .............................................. United States 4,053,000 3,840,217 7.75%, 1/15/09 ............................................... United States 4,500,000 4,230,000 7.875%, 5/01/09 .............................................. United States 4,280,000 4,001,800 9.375%, 11/15/09 ............................................. United States 829,000 822,783 10.875%, 10/01/10 ............................................ United States 3,229,000 3,212,855 (a),(h)Aiken Cnty S C Indl Rev Beloit, 6.00%, 12/01/11 ................ United States 280,000 1,400 (a),(h)Armstrong Holdings Inc., 6.50%, 8/15/05 ............................................... United States 982,000 714,405 9.75%, 4/15/08 ............................................... United States 1,837,000 1,336,418 Revolver, 10/29/03 ........................................... United States 1,912,950 1,319,936 Trade Claim .................................................. United States 5,129,100 3,590,370 (a),(h)Century Communications Corp., 9.50%, 3/01/05 ............................................... United States 870,000 1,057,050 8.875%, 1/15/07 .............................................. United States 1,101,000 1,326,705 8.75%, 10/01/07 .............................................. United States 1,677,000 1,978,860 8.375%, 12/15/07 ............................................. United States 392,000 468,440 Series B, zero cpn., 1/15/08 ................................. United States 3,017,000 2,126,985 zero cpn., 3/15/03 ........................................... United States 6,285,000 6,693,525 (h)DecisionOne Corp., Term Loan ................................... United States 2,638,349 659,587 (a),(h)Harnischfeger Industries Inc., 8.90%, 3/01/22 ............................................... United States 2,885,000 26,831 8.70%, 6/15/22 ............................................... United States 2,715,000 25,793 7.25%, 12/15/25 .............................................. United States 3,930,000 36,942 6.875%, 2/15/27 .............................................. United States 3,670,000 33,764 Stipulated Bank Claim ........................................ United States 4,550,000 41,405 (a),(h)Mirant Americas Generation Inc., 7.625%, 5/01/06 .............................................. United States 834,000 900,720 8.30%, 5/01/11 ............................................... United States 3,665,000 3,894,063 9.125%, 5/01/31 .............................................. United States 2,868,000 3,004,230 (a),(h)Mirant Corp., Tranche C Revolver ........................................... United States 5,745,885 3,964,661 4 Year Revolver, 7/17/05 ..................................... United States 3,663,585 2,766,006 364 Day Revolver ............................................. United States 9,888,400 6,872,438 (a),(h)Owens Corning, Revolver ........................................ United States 24,781,989 22,055,970 (a),(h)Port Seattle Wash Rev Ref-Beloit Proj., 6.00%, 12/01/17 ........ United States 150,000 750 (a),(h)Safety Kleen Services, 9.25%, 6/01/08 .......................... United States 40,000 150
Annual Report | 29 MUTUAL DISCOVERY FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ COUNTRY PRINCIPAL AMOUNT(g) VALUE - ------------------------------------------------------------------------------------------------------------------------------------ BONDS & NOTES IN REORGANIZATION (CONT.) (a),(h)Teco Panda, Bank Claim ....................................................... United States $ 1,664,400 $ 998,640 Bank Claim 2 ..................................................... United States 12,815,600 8,073,828 Bank Claim 3 ..................................................... United States 75,608 75,608 Debt Service Reserve L/C Loan .................................... United States 413,400 260,442 Project L/C Loan Facility ........................................ United States 1,757,010 1,106,916 (h)Trump Atlantic, 11.25%, 5/01/06 .................................................. United States 18,480,000 17,717,700 Series B, 11.25%, 5/01/06 ........................................ United States 5,431,000 5,206,971 Series B, 144A, 11.25%, 5/01/06 .................................. United States 335,000 321,181 -------------- TOTAL BONDS & NOTES IN REORGANIZATION (COST $109,513,222) .......... 129,334,884 -------------- ---------------- SHARES/PRINCIPAL AMOUNT(g) ---------------- COMPANIES IN LIQUIDATION (a)Brunos Inc., Liquidating Unit ...................................... United States 40,574 89,263 (a)City Investing Co. Liquidating Trust ............................... United States 125,500 242,215 (a)MBOP Liquidating Trust ............................................. United States 273,144 683 (a)Petrie Stores Liquidating Trust, CBI ............................... United States 1,213,700 534,028 (a)United Cos. Financial Corp., Bank Claim ....................................................... United States 77,701 -- Revolver ......................................................... United States 19,711,401 -- -------------- TOTAL COMPANIES IN LIQUIDATION (COST $102,845) ..................... 866,189 -------------- GOVERNMENT AGENCIES 4.1% (i)Federal Home Loan Bank, 1.25% - 2.26%, 1/03/05 - 1/26/07 ........... United States 171,656,000 170,401,126 Federal National Mortgage Association, 1.81% - 2.20%, 12/23/05 - 12/18/06 ......................................................... United States 20,000,000 19,692,690 Federal Republic of Germany, 4.25%, 2/18/05 ........................ Germany 15,000,000EUR 20,408,118 German Treasury Bill, 2.028% - 2.090%, 1/12/05 - 3/16/05 ........... Germany 10,000,000EUR 13,533,183 Kingdom of Norway, 6.75%, 1/15/07 .................................. Norway 51,550,000NOK 9,215,834 U.S. Treasury Bill, 1.895%, 2/24/05 ................................ United States 10,000,000 9,971,590 -------------- TOTAL GOVERNMENT AGENCIES (COST $239,395,817) ...................... 243,222,541 -------------- TOTAL INVESTMENTS BEFORE REPURCHASE AGREEMENTS (COST $4,137,191,466) ............................................ 5,916,815,002 --------------
30 | Annual Report MUTUAL DISCOVERY FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ COUNTRY PRINCIPAL AMOUNT(g) VALUE - ------------------------------------------------------------------------------------------------------------------------------------ REPURCHASE AGREEMENTS (j),(k)Bank of America LLC, 2.32%, 1/03/05 (Maturity Value $20,005), Collateralized by U.S. Government Agency Securities, 3.929-6.50%, 11/1/17-12/1/34 ....................................... United States $ 20,001 $ 20,001 (j),(k)Barclays Capital Inc., 2.25%, 1/03/05 (Maturity Value $20,2005), Collateralized by U.S. Government Agency Securities, 0.00-7.00%, 3/21/05-8/15/19 ........................................ United States 20,001 20,001 (j),(k)Bear Stearns & Co. 2.25% 1/03/05 (Maturity Value $20,005), Collateralized by U.S. Treasury Bond, 11/15/21; and U.S. Treasury Note, 2/15/07 ........................................ United States 20,001 20,001 (j),(k)Goldman Sachs & Co., 2.29%, 1/03/05 (Maturity Value $15,004), Collateralized by U.S. Government Agency Securities, 4.00-6.50%, 3/01/17-1/01/35 ........................................ United States 15,001 15,001 (j),(k)Morgan Stanley & Co. Inc., 2.25%, 1/03/05 (Maturity Value $20,005), Collateralized by U.S. Government Agency Securities, 4.00-8.00%, 7/01/08-1/01/35 ........................................ United States 20,001 20,001 --------------- TOTAL REPURCHASE AGREEMENTS (COST $95,005) ........................... 95,005 --------------- TOTAL INVESTMENTS (COST $4,137,286,471) 100.4% ....................... 5,916,910,007 OPTIONS WRITTEN ...................................................... (201,533) SECURITIES SOLD SHORT (.6)% .......................................... (36,223,652) NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS (1.3)% ............. (78,710,158) OTHER ASSETS, LESS LIABILITIES 1.5% .................................. 85,970,349 --------------- NET ASSETS 100.0% .................................................... $ 5,887,745,013 --------------- OPTIONS WRITTEN --------- ISSUER CONTRACTS --------- HEALTH CARE EQUIPMENT & Supplies (l)Guidant Corp., Jan. 70.00 Calls, 1/21/05 ............................. United States 183 43,005 --------------- METALS & MINING (l)WMC Resources Ltd., Jan. 7.00 Calls, 1/26/05 ......................... Australia 279 73,159 (l)WMC Resources Ltd., Jan. 7.25 Calls, 1/26/05 ......................... Australia 126 18,246 --------------- 91,405 --------------- SOFTWARE (l)Symantec Corp., Jan. 25.00 Calls, 1/21/05 ............................ United States 261 39,150 (l)Symantec Corp., Jan. 27.50 Calls, 1/21/05 ............................ United States 173 7,093 (l)Veritas Software Corp., Jan. 30.00 Calls, 1/21/05 .................... United States 348 20,880 --------------- 67,123 --------------- TOTAL OPTIONS WRITTEN (PREMIUMS RECEIVED $187,538) ................... $ 201,533 ---------------
Annual Report | 31 MUTUAL DISCOVERY FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
SECURITIES SOLD SHORT .6% ----------------------------------------------------- ISSUER COUNTRY SHARES VALUE ----------------------------------------------------- COMMUNICATIONS EQUIPMENT (m)Tellabs Inc. United States 72,497 $ 622,749 -------------- DIVERSIFIED FINANCIAL SERVICES .1% (m)Nasdaq 100 United States 178,100 7,109,752 -------------- FOOD PRODUCTS .4% (m)Kraft Foods Inc., A United States 661,443 23,553,985 -------------- HOTELS RESTAURANTS & LEISURE (m)Harrah's Entertainment Inc. United States 15,000 1,003,350 -------------- PHARMACEUTICALS .1% (m)Johnson & Johnson United States 62,028 3,933,816 -------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $34,463,607) $ 36,223,652 --------------
CURRENCY ABBREVIATIONS: | EUR - Euro | GBP - British Pound | NOK - Norwegian Krone (a) Non-income producing. (b) Contingent Distributions represent the right to receive additional distributions, if any, during the reorganization of the underlying company. Shares represent total underlying principal of debt securities. (c) See Note 10 regarding restricted securities. (d) See Note 11 regarding holdings of 5% voting securities. (e) See Note 12 regarding other considerations. (f) Security on loan. See Note 1(i). (g) The principal amount is stated in U.S. dollars unless otherwise indicated. (h) Defaulted securities. See Note 9. (i) See Note 1(h) regarding securities segregated with broker for securities sold short. (j) See Note 1(c) regarding repurchase agreements. (k) Investments from cash collateral received for loaned securities. See Note 1(i). (l) See Note 1(g) regarding written options. (m) See Note 1(h) regarding securities sold short. (n) A portion of the security held in connection with open option contracts. 32 | See notes to financial statements. | Annual Report MUTUAL DISCOVERY FUND FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2004 Assets: Investments in securities: Cost - Unaffiliated issuers ............................................................................... $ 3,834,861,535 Cost - Controlled affiliates (Note 11) .................................................................... 13,458,320 Cost - Non-controlled affiliated issuers (Note 11) ........................................................ 288,871,611 Cost - Repurchase agreements .............................................................................. 95,005 --------------- Total cost of investments ................................................................................. 4,137,286,471 =============== Value - Unaffiliated issuers (includes securities segregated with broker for securities sold short in the amount of $19,165,387) .............................................................................. 5,571,985,638 Value - Controlled affiliates (Note 11) ................................................................... 500,007 Value - Non-controlled affiliated issuers (Note 11) ....................................................... 344,329,357 Value - Repurchase agreements ............................................................................. 95,005 --------------- Total value of investments ................................................................................ 5,916,910,007 Cash ....................................................................................................... 7,063,536 Foreign currency, at value (cost $10,995,492) .............................................................. 11,014,524 Receivables: Investment securities sold ................................................................................ 25,155,546 Capital shares sold ....................................................................................... 11,272,115 Dividends and interest .................................................................................... 15,004,182 Unrealized gain on forward exchange contracts (Note 8) ..................................................... 5,886,272 Due from broker - synthetic equity swaps ................................................................... 3,622,149 Cash on deposit with brokers for securities sold short ..................................................... 38,155,045 --------------- Total assets .......................................................................................... 6,034,083,376 --------------- Liabilities: Payables: Investment securities purchased ........................................................................... 11,906,130 Capital shares redeemed ................................................................................... 5,491,930 Affiliates ................................................................................................ 6,739,933 Options written, at value (premiums received $187,538) ..................................................... 201,533 Securities sold short, at value (proceeds $34,463,607) ..................................................... 36,223,652 Payable upon return of securities loaned ................................................................... 95,005 Unrealized loss on forward exchange contracts (Note 8) ..................................................... 84,596,430 Deferred tax ............................................................................................... 563,650 Other liabilities .......................................................................................... 520,100 --------------- Total liabilities ..................................................................................... 146,338,363 --------------- Net assets, at value ................................................................................ $ 5,887,745,013 =============== Net assets consist of: Distributions in excess of net investment income ........................................................... $ (31,462,123) Net unrealized appreciation (depreciation) ................................................................. 1,699,381,958 Accumulated net realized gain (loss) ....................................................................... 9,860,772 Capital shares ............................................................................................. 4,209,964,406 --------------- Net assets, at value ................................................................................ $ 5,887,745,013 ===============
Annual Report | See notes to financial statements. | 33 MUTUAL DISCOVERY FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2004 CLASS Z: Net assets, at value .......................................................... $2,578,584,837 ============== Shares outstanding ............................................................ 106,297,981 ============== Net asset value and maximum offering price per share(a) ....................... $ 24.26 ============== CLASS A: Net assets, at value .......................................................... $2,106,695,119 ============== Shares outstanding ............................................................ 87,510,451 ============== Net asset value per sharea .................................................... $ 24.07 ============== Maximum offering price per share (net asset value per share / 94.25%) ......... $ 25.54 ============== CLASS B: Net assets, at value .......................................................... $ 186,841,082 ============== Shares outstanding ............................................................ 7,894,501 ============== Net asset value and maximum offering price per share(a) ....................... $ 23.67 ============== CLASS C: Net assets, at value .......................................................... $ 968,933,673 ============== Shares outstanding ............................................................ 40,422,852 ============== Net asset value and maximum offering price per share(a) ....................... $ 23.97 ============== CLASS R: Net assets, at value .......................................................... $ 46,690,302 ============== Shares outstanding ............................................................ 1,949,950 ============== Net asset value and maximum offering price per share(a) ....................... $ 23.94 ==============
(a) Redemption price is equal to net asset value less contingent deferred sales charges, if applicable, 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, 2004 Investment income: Dividends: (net of foreign taxes of $10,781,725) Unaffiliated issuers .................................................................. $ 100,224,497 Non-controlled affiliated issuers (Note 11) ........................................... 6,872,137 Interest ............................................................................... 38,669,278 ------------- Total investment income ........................................................... 145,765,912 ------------- Expenses: Management fees (Note 3) ............................................................... 39,454,603 Administrative fees (Note 3) ........................................................... 3,821,604 Distribution fees (Note 3) Class A ............................................................................... 5,894,152 Class B ............................................................................... 1,446,706 Class C ............................................................................... 8,100,985 Class R ............................................................................... 163,534 Transfer agent fees (Note 3) ........................................................... 6,931,200 Custodian fees (Note 4) ................................................................ 845,132 Reports to shareholders ................................................................ 290,500 Registration and filing fees ........................................................... 245,500 Professional fees ...................................................................... 509,630 Directors' fees and expenses ........................................................... 124,200 Dividends on securities sold short ..................................................... 578,566 Other .................................................................................. 206,038 ------------- Total expenses .................................................................... 68,612,350 Expense reductions (Note 4) ....................................................... (20,510) ------------- Net expenses .................................................................... 68,591,840 ------------- Net investment income ....................................................... 77,174,072 ------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments: Unaffiliated issuers ................................................................. 334,479,656 Non-controlled affiliated issuers (Note 11) .......................................... 799,076 Written options ....................................................................... 1,030,921 Foreign currency transactions ......................................................... (144,638,938) Securities sold short ................................................................. (1,980,229) ------------- Net realized gain (loss) .......................................................... 189,690,486 Net change in unrealized appreciation (depreciation) on: Investments ........................................................................... 629,231,511 Translation of assets and liabilities denominated in foreign currencies ............... 11,521,106 Deferred taxes ........................................................................ 457,330 ------------- Net change in unrealized appreciation (depreciation) .............................. 641,209,947 ------------- Net realized and unrealized gain (loss) ................................................. 830,900,433 ------------- Net increase (decrease) in net assets resulting from operations ......................... $ 908,074,505 =============
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, 2004 and 2003
------------------------------------ 2004 2003 ------------------------------------ Increase (decrease) in net assets: Operations: Net investment income .................................................................... $ 77,174,072 $ 45,532,915 Net realized gain (loss) from investments, written options, foreign currency transactions, and securities sold short ............................................................... 189,690,486 29,981,143 Net change in unrealized appreciation (depreciation) on investments, translation of assets and liabilities denominated in foreign currencies, and deferred taxes ............ 641,209,947 953,339,663 ------------------------------------ Net increase (decrease) in net assets resulting from operations ....................... 908,074,505 1,028,853,721 Distributions to shareholders from: Net investment income: Class Z ................................................................................. (56,656,081) (44,545,119) Class A ................................................................................. (39,448,944) (24,770,503) Class B ................................................................................. (2,633,811) (1,472,248) Class C ................................................................................. (13,213,407) (8,953,988) Class R ................................................................................. (815,309) (310,609) ------------------------------------ Total distributions to shareholders ....................................................... (112,767,552) (80,052,467) Capital share transactions (Note 2): Class Z ................................................................................. 50,114,536 13,927,225 Class A ................................................................................. 391,763,708 225,050,877 Class B ................................................................................. 47,123,925 28,358,365 Class C ................................................................................. 113,386,535 47,141,801 Class R ................................................................................. 21,446,986 12,178,619 ------------------------------------ Total capital share transactions .......................................................... 623,835,690 326,656,887 Redemption fees ........................................................................... 25,982 -- ------------------------------------ Net increase (decrease) in net assets ................................................. 1,419,168,625 1,275,458,141 Net assets: Beginning of year ......................................................................... 4,468,576,388 3,193,118,247 ------------------------------------ End of year ............................................................................... $ 5,887,745,013 $ 4,468,576,388 ==================================== Distributions in excess of net investment income included in net assets: End of year ............................................................................... $ (31,462,123) $ (12,232,773) ====================================
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), consisting of 6 separate series. The Company is an open-end investment company registered under the Investment Company Act of 1940. The financial statements of the remaining funds in the series are presented separately. The 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. The following summarizes the Fund's significant accounting policies. A. SECURITY VALUATION Securities listed on a securities exchange or on the NASDAQ National Market System, are valued at the last quoted sale price or the official closing price of the day, respectively. Over-the-counter securities and listed securities for which there is no reported sale are valued within the range of the most recent quoted bid and ask prices. Securities that trade in multiple markets or on multiple exchanges are valued according to the broadest and most representative market. Repurchase agreements are valued at cost. Corporate debt securities and U.S. Government securities generally trade in the over-the-counter market rather than on a securities exchange. The Fund may utilize independent pricing services, quotations from bond dealers, and information with respect to bond and note transactions, to assist in determining a current market value for each security. The Fund's pricing services may use valuation models or matrix pricing which considers information with respect to comparable bond and note transactions, quotations from bond dealers, or by reference to other securities that are considered comparable in such characteristics as rating, interest rate and maturity date, option adjusted spread models, prepayment projections, interest rate spreads and yield curves, to determine current value. Foreign securities are valued as of the close of trading on the foreign stock exchange on which the security is primarily traded, or the NYSE, whichever is earlier. The value is then converted into its U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the day that the value of the foreign security is determined. If no sale is reported at that time, the foreign security will be valued within the range of the most recent quoted bid and ask prices. Annual Report | 37 MUTUAL DISCOVERY FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. Some methods for valuing these securities may include: fundamental analysis, matrix pricing, discounts from market prices of similar securities, or discounts applied due to the nature and duration of restrictions on the disposition of the securities. Occasionally, events occur between the time at which trading in a security is completed and the close of the NYSE that might call into question the availability (including the reliability) of the value of a portfolio security held by the Fund. If such an event occurs, the securities may be valued using fair value procedures, which may include the use of independent pricing services. All security valuation procedures are approved by the Fund's 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, income and expense items denominated in foreign currencies are translated into U.S. dollars at the exchange rate in effect on the transaction date. Occasionally, events may impact the availability or reliability of foreign exchange rates used to convert the U.S. dollar equivalent value. If such an event occurs, the foreign exchange rate will be valued at fair value using procedures established and approved by the Fund's Board of Directors. 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 on the Statement of Operations. 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, 2004, all repurchase agreements held by the Fund had been entered into on that date. 38 | Annual Report MUTUAL DISCOVERY FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) D. SECURITIES PURCHASED ON A WHEN-ISSUED OR DELAYED DELIVERY 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 by the Fund and any equity therein is included in the Statement of Assets and Liabilities. Realized and unrealized gains and losses on these contracts 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 on these contracts 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 to 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 synthetic 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 | 39 MUTUAL DISCOVERY 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. Upon closing of an option, other than by exercise, which 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 incurs 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 realizes a gain if the price of the security declines between those dates. Gains are limited to the price at which the Fund sold the security short, while losses are potentially unlimited in size. 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 with the broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. The Fund is obligated to pay the counterparty any dividends or interest due on securities sold short. Such dividends and interest are recorded as an expense to the Fund. I. SECURITIES LENDING The Fund loans securities to certain brokers through a securities lending agent for which it received cash collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. The collateral is invested in short-term instruments as noted in the Statement of Investments. The Fund received interest income of $45,049 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 collateral and the securities loaned. The securities lending agent has agreed to indemnify the Fund in the case of default of any securities borrower. 40 | Annual Report MUTUAL DISCOVERY FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) J. INCOME AND DEFERRED TAXES No provision has been made for U.S. income taxes because the Fund's policy is to qualify as a regulated investment company under Sub Chapter M of the Internal Revenue Code and to distribute substantially all of its taxable income. Fund distributions to shareholders are determined on an income tax basis and may differ from net investment income and realized gains for financial reporting purposes. The Fund is subject to a tax imposed on net realized gains of securities of certain foreign countries. When the Fund invests in these securities, the Fund records an estimated deferred tax liability for net unrealized gains. 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. Interest income and estimated expenses are accrued daily. Discounts and premiums 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 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 expenses during the reporting period. Actual results could differ from those estimates. M. REDEMPTION FEES Redemptions and exchanges of Fund shares held five trading days or less (30 days or less prior to June 1, 2004 and 90 days or less prior to 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 as noted in the Statements of Changes in Net Assets. Annual Report | 41 MUTUAL DISCOVERY FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) N. GUARANTEES AND INDEMNIFICATIONS Under the Fund's organizational documents, its officers and directors are indemnified by the Fund 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. Effective March 1, 2005, Class B shares will no longer be offered except to existing Class B shareholders through reinvested distributions or exchanges into other Franklin Templeton funds' Class B shares, as permitted by the applicable fund prospectus. 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, 2004 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 DECEMBER 31, 2004 2003 ---------------------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT ---------------------------------------------------------------------------- CLASS Z SHARES: Shares sold ................................... 7,946,686 $ 174,333,866 9,521,544 $ 169,344,371 Shares issued in reinvestment of distributions ................................ 2,248,630 51,872,202 2,060,606 40,579,936 Shares redeemed ............................... (8,088,625) (176,091,532) (10,979,119) (195,997,082) ---------------------------------------------------------------------------- Net increase (decrease) ....................... 2,106,691 $ 50,114,536 603,031 $ 13,927,225 ============================================================================ CLASS A SHARES: Shares sold ................................... 28,991,422 $ 629,994,733 22,055,132 $ 399,929,888 Shares issued in reinvestment of distributions ................................ 1,608,954 36,824,687 1,194,006 23,361,387 Shares redeemed ............................... (12,750,856) (275,055,712) (11,199,697) (198,240,398) ---------------------------------------------------------------------------- Net increase (decrease) ....................... 17,849,520 $ 391,763,708 12,049,441 $ 225,050,877 ============================================================================
42 | Annual Report MUTUAL DISCOVERY FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED)
-------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2004 2003 SHARES AMOUNT SHARES AMOUNT -------------------------------------------------------------------------- CLASS B SHARES: Shares sold ..................................... 2,611,993 $ 55,685,546 2,016,211 $ 35,204,480 Shares issued in reinvestment of distributions .................................. 106,415 2,382,517 69,605 1,329,652 Shares redeemed ................................. (514,048) (10,944,138) (481,371) (8,175,767) -------------------------------------------------------------------------- Net increase (decrease) ......................... 2,204,360 $ 47,123,925 1,604,445 $ 28,358,365 ========================================================================== CLASS C SHARES: Shares sold ..................................... 9,235,697 $ 199,753,205 6,757,550 $ 121,233,343 Shares issued in reinvestment of distributions .................................. 519,083 11,739,964 418,839 8,050,042 Shares redeemed ................................. (4,560,279) (98,106,634) (4,741,353) (82,141,584) -------------------------------------------------------------------------- Net increase (decrease) ......................... 5,194,501 $ 113,386,535 2,435,036 $ 47,141,801 ========================================================================== CLASS R SHARES: Shares sold ..................................... 1,223,108 $ 26,261,073 854,653 $ 14,829,497 Shares issued in reinvestment of distributions .................................. 35,218 803,727 15,801 308,897 Shares redeemed ................................. (258,493) (5,617,814) (165,979) (2,959,775) -------------------------------------------------------------------------- Net increase (decrease) ......................... 999,833 $ 21,446,986 704,475 $ 12,178,619 ==========================================================================
3. TRANSACTIONS WITH AFFILIATES Certain officers of the Fund are also officers and/or directors of the following entities:
- -------------------------------------------------------------------------------------------------- ENTITY AFFILIATION - -------------------------------------------------------------------------------------------------- Franklin Mutual Advisers, LLC (Franklin Mutual) Investment manager Franklin Templeton Services, LLC (FT Services) Administrative manager Franklin/Templeton Distributors, Inc. (Distributors) Principal underwriter Franklin/Templeton Investor Services, LLC (Investor Services) Transfer agent
A. MANAGEMENT FEES Effective July 1, 2004, the Fund pays an investment management fee to Franklin Mutual based on the average daily net assets of the Fund as follows:
- -------------------------------------------------------------------------------------------------- ANNUALIZED FEE RATE NET ASSETS - -------------------------------------------------------------------------------------------------- 0.800% First $4 billion 0.770% Over $4 billion, up to and including $7 billion 0.750% Over $7 billion, up to and including $10 billion 0.730% Over $10 billion
Annual Report | 43 MUTUAL DISCOVERY FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) A. MANAGEMENT FEES (CONTINUED) Prior to July 1, 2004, the Fund paid fees of 0.80% per year of the average daily net assets of the Fund. B. ADMINISTRATIVE FEES The Fund pays its allocated share of an administrative fee to FT Services based on the Fund's aggregated average daily net assets as follows: - -------------------------------------------------------------------------------- ANNUALIZED FEE RATE 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 C. DISTRIBUTION FEES The Fund reimburses Distributors up to 0.35% , 1.00%, 1.00%, and 0.50% per year of the average daily net asset of Class A, Class B, Class C, and Class R , respectively, for costs incurred in marketing the Fund's shares under a Rule 12b-1 plan. Under the Class A distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. D. SALES CHARGES/UNDERWRITING AGREEMENTS Distributors has advised the Fund of the following commission transactions related to the sales and redemptions of the Fund's shares for the year: Net sales charges received .............................. $ 804,272 Contingent deferred sales charges retained .............. $ 209,083 E. TRANSFER AGENT FEES The Fund paid transfer agent fees of $6,931,200, of which $4,610,634 was paid to Investor Services. 4. EXPENSE OFFSET ARRANGEMENT The Fund has entered into an arrangement with its custodian whereby credits realized as a result of uninvested cash balances are used to reduce a portion of the Fund's custodian expenses. During the period ended December 31, 2004, the custodian fees were reduced as noted in the Statement of Operations. 44 | Annual Report MUTUAL DISCOVERY FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. INCOME TAXES At December 31, 2004, the Fund had tax basis capital losses of $20,570,378 which may be carried over to offset future capital gains. Such losses expire in year 2011. At December 31, 2004, the Fund had deferred capital losses occurring subsequent to October 31, 2004 of $24,933,773. For tax purposes, such losses will be reflected in the year ending December 31, 2005. 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, bond discounts and premiums, and certain dividends on securities sold short. Net realized gains differ for financial statement and tax purposes primarily due to differing treatments of wash sales, foreign currency transactions, passive foreign investment company shares, bond discounts and premiums, and certain dividends on securities sold short. At December 31, 2004, the cost of investments, net unrealized appreciation (depreciation), and undistributed ordinary income for income tax purposes were as follows: Cost of investments ....................................... $ 4,213,041,550 =============== Unrealized appreciation ................................... $ 1,788,258,135 Unrealized depreciation ................................... (84,389,678) --------------- Net unrealized appreciation (depreciation) ................ $ 1,703,868,457 =============== Distributable earnings--undistributed ordinary income ..... $ 39,518,138 =============== The tax character of distributions paid during the years ended December 31, 2004 and 2003, was as follows: ---------------------------- 2004 2003 ---------------------------- Distributions paid from -- ordinary income $112,767,552 $80,052,467 Annual Report | 45 MUTUAL DISCOVERY FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short-term securities and securities sold short) for the period ended December 31, 2004, aggregated $2,224,719,762 and $1,629,659,359, respectively. Transactions in options written during the period ended December 31, 2004 were as follows: ------------------------------------ NUMBER PREMIUMS OF CONTRACTS RECEIVED ------------------------------------ Options outstanding at December 31, 2003 1,044,821 $ 279,446 Options written 895,988 2,156,163 Options expired (450,098) (826,698) Options exercised (1,486,906) (980,125) Options closed (2,435) (441,248) ------------------------------------ Options outstanding at December 31, 2004 1,370 $ 187,538 ==================================== 7. SYNTHETIC EQUITY SWAPS As of December 31, 2004, the Fund had the following synthetic equity swaps outstanding:
- --------------------------------------------------------------------------------------------------------------- NUMBER OF UNREALIZED CONTRACTS TO BUY CONTRACTS VALUE GAIN (LOSS) - --------------------------------------------------------------------------------------------------------------- Christian Dior SA (46.76 - 55.43 EUR) ..................... 97,920 $6,650,513 $ 79,995 London Stock Exchange PLC (5.36 - 5.71 GBP) ............... 82,453 921,103 33,074 -------- Total contracts to buy .................................... ..................................... $113,069 ======== - --------------------------------------------------------------------------------------------------------------- NUMBER OF UNREALIZED CONTRACTS TO SELL CONTRACTS VALUE GAIN (LOSS) - --------------------------------------------------------------------------------------------------------------- LVMH Moet Hennessy Louis Vuitton (53.87 - 61.76 EUR) ...... 98,272 $7,514,557 $242,572 -------- Total contracts to sell ......................................................................... 242,572 -------- Net unrealized gain (loss) ...................................................................... $355,641 ========
46 | Annual Report MUTUAL DISCOVERY FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. FORWARD EXCHANGE CONTRACTS At December 31, 2004, 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) - ------------------------------------------------------------------------------------------------------------------ 60,808,319 Canadian Dollars ....... U.S. $ 47,202,905 1/21/05 U.S. $ 3,491,352 77,880,000 Taiwan Dollar .......... 2,400,000 2/16/05 49,827 19,144,132 Canadian Dollars ....... 15,875,001 4/21/05 85,580 -------------- ------------- U.S. $ 65,477,906 U.S. 3,626,759 ============== ============= - ------------------------------------------------------------------------------------------------------------------ IN SETTLEMENT UNREALIZED CONTRACTS TO SELL: EXCHANGE FOR DATE GAIN/(LOSS) - ------------------------------------------------------------------------------------------------------------------ 1,700,000 British Pounds ......... U.S. $ 3,265,241 2/10/05 U.S. $ 11,273 46,501,643 British Pounds ......... 89,290,624 3/21/05 473,017 99,779,534 British Pounds ......... 191,593,440 6/08/05 1,761,729 5,130,675,000 Korean Won ............. 4,950,000 6/17/05 13,494 -------------- ------------- U.S. $ 289,099,305 2,259,513 ============== ------------- Unrealized gain on forward exchange contracts .......................................... U.S. $ 5,886,272 ============= - ------------------------------------------------------------------------------------------------------------------ IN SETTLEMENT UNREALIZED CONTRACTS TO BUY: EXCHANGE FOR DATE GAIN/(LOSS) - ------------------------------------------------------------------------------------------------------------------ 8,367,365 Canadian Dollars ....... U.S. $ 7,050,000 4/21/05 U.S. $ (74,076) -------------- ------------- - ------------------------------------------------------------------------------------------------------------------ IN SETTLEMENT UNREALIZED CONTRACTS TO SELL: EXCHANGE FOR DATE GAIN/(LOSS) - ------------------------------------------------------------------------------------------------------------------ 208,456,395 Canadian Dollars ....... U.S. $ 158,576,382 1/21/05 U.S. $(15,208,098) 536,212,973 South African Rand ..... 85,111,067 1/26/05 (9,171,176) 67,800,000 British Pounds ......... 125,159,520 2/10/05 (4,616,396) 418,626,000 Taiwan Dollar .......... 12,850,000 2/16/05 (318,483) 20,150,000 Euro ................... 24,885,250 2/23/05 (2,471,875) 808,433,744 Danish Krona ........... 132,694,884 3/17/05 (14,880,060) 11,980,853,199 Japanese Yen ........... 110,442,169 3/28/05 (7,252,045) 79,867,880 Canadian Dollars ....... 60,694,327 4/21/05 (5,892,018) 66,334,148 Euro ................... 83,735,049 4/25/05 (6,417,980) 21,400,000 Euro ................... 26,445,894 5/23/05 (2,654,905) 120,676,802,260 Korean Won ............. 115,075,000 6/17/05 (1,358,949) 45,000,000 Euro ................... 56,826,000 7/25/05 (4,450,104) 21,000,000 Euro ................... 25,960,725 8/23/05 (2,653,874) 15,500,000 Euro ................... 18,879,000 9/13/05 (2,251,512) -------------- ------------- U.S. $1,037,335,267 (79,597,475) ============== ------------- Net unrealized loss on offsetting forward exchange contracts ............................. (4,924,879) ------------- Unrealized loss on forward exchange contracts .......................................... (84,596,430) ------------- Net unrealized loss on forward exchange contracts .................................... U.S. $(78,710,158) =============
Annual Report | 47 MUTUAL DISCOVERY FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. CREDIT RISK AND DEFAULTED SECURITIES The Fund held defaulted securities and/or other securities for which the income has been deemed uncollectible. At December 31, 2004, the value of these securities was $129,334,884, representing 2.19% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. 10. RESTRICTED SECURITIES At December 31, 2004, investments in securities included issues that are restricted and 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, 2004, the Fund held investments in restricted and illiquid securities that were valued under approved methods by the Directors, as follows:
- ---------------------------------------------------------------------------------------------------------------- SHARES/ ACQUISITION WARRANTS ISSUER DATE COST VALUE - ---------------------------------------------------------------------------------------------------------------- 332,512 AboveNet Inc. ................................ 10/02/01 $14,529,931 $ 7,968,118 11,105 AboveNet Inc., wts., 9/08/08 ................. 10/02/01 1,437,838 71,072 13,066 AboveNet Inc., wts., 9/08/10 ................. 10/02/01 1,768,651 52,264 11,589 FE Capital Holdings Ltd. ..................... 8/29/03 11,592,327 15,412,910 2,247,600 Florida East Coast Industries Inc. ........... 12/29/95 67,070,841 96,298,422 8,758,216 Hancock Discovery LLC ........................ 3/06/97 13,458,320 500,007 4,551,501 Imagine Group Holdings Ltd. .................. 8/31/04 46,614,334 46,614,334 2,689,230 International Steel Group .................... 4/10/02 12,990,000 103,621,410 684,780 Leucadia National Corp. ...................... 12/20/02 24,138,495 45,199,589 47,160 Olympus Re Holdings Ltd. ..................... 12/19/01 4,716,000 8,072,849 14,787 Security Capital European Realty ............. 4/08/98 810,051 106,466 170 Torre Mayor Investments, LP .................. 10/28/02 17,000,000 11,050,000 ------------ TOTAL RESTRICTED SECURITIES (5.69% OF NET ASSETS) ............................................ $334,967,441 ============
48 | Annual Report MUTUAL DISCOVERY FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. 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, 2004 were as shown below.
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF NUMBER OF SHARES HELD AT SHARES REALIZED BEGINNING GROSS GROSS HELD AT VALUE AT INVESTMENT CAPITAL NAME OF ISSUER OF YEAR ADDITIONS REDUCTIONS END OF YEAR END OF YEAR INCOME GAIN/(LOSS) - ------------------------------------------------------------------------------------------------------------------------------------ CONTROLLED AFFILIATES(a) Hancock Discovery LLC .................. 8,758,216 -- -- 8,758,216 $ 500,007 $ -- $ -- --------------------------------------- NON-CONTROLLED AFFILIATES Esmark Inc., Series A, 10.00%, cvt., pfd ............................ -- 18,647 -- 18,647 $ 18,646,800 $ -- $ -- Farmer Brothers Co. .................... 81,152 823,485 -- 904,637 21,928,401 326,527 -- FE Capital Holdings Ltd. ............... 11,445 144 -- 11,589 15,412,910 -- -- Florida East Coast Industries Inc. ...................... -- 2,247,600 -- 2,247,600 96,298,422 224,760 -- Gammon Lake Resources Inc. ............. -- 2,136,800 -- 2,136,800 11,455,892 -- -- Gammon Lake Resources Inc., wts., 4/30/05 ........................ -- 2,265,300 -- 2,265,300 12,144,811 -- -- Imagine Group Holdings Ltd. ............ -- 4,551,501 -- 4,551,501 46,614,334 -- -- Nippon Investment LLC .................. 8,656,000 -- -- 8,656,000 -- -- -- Potlatch Corp. ......................... 1,111,450 1,078,700 -- 2,190,150 110,777,787 6,320,850 -- Southwest Royalties Inc., A ............ 53,272 -- 53,272 -- (b) -- 799,076 Torre Mayor Investments, LP ............ 170 -- -- 170 11,050,000 -- -- --------------------------------------- TOTAL NON-CONTROLLED AFFILIATES ........ ............................................... $344,329,357 $6,872,137 $799,076 --------------------------------------- TOTAL AFFILIATED SECURITIES (5.86% OF NET ASSETS) ...................................... $344,829,364 $6,872,137 $799,076 =======================================
(a) Issuer in which the Fund owns 25% or more of the outstanding voting securities. (b) As of December 31, 2004, no longer an affiliate. 12. OTHER CONSIDERATIONS Franklin Mutual, as the Fund's Manager, may serve as a member on the board of directors of certain companies in which the Fund invests and/or may represent the Fund in certain corporate negotiations. At December 31, 2004, the Manager serves in one or more of these capacities for Kindred Healthcare, AboveNet Inc., and Esmark Inc. As a result of this involvement, the Manager may be in possession of certain 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. Annual Report | 49 MUTUAL DISCOVERY FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY MATTERS INVESTIGATIONS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, including the Securities and Exchange Commission ("SEC"), the California Attorney General's Office ("CAGO"), and the National Association of Securities Dealers, Inc. ("NASD"), relating to certain practices in the mutual fund industry, including late trading, market timing and marketing support payments to securities dealers who sell fund shares, Franklin Resources, Inc. and certain of its subsidiaries (as used in this section, together, the "Company"), as well as certain current or former executives and employees of the Company, received subpoenas and/or requests for documents, information and/or testimony. The Company and its current employees provided documents and information in response to those requests and subpoenas. SETTLEMENTS Beginning in August 2004, the Company entered into settlements with certain regulators investigating the mutual fund industry practices noted above. The Company believes that settlement of each of the matters described in this section is in the best interest of the Company and shareholders of the Franklin, Templeton, and Mutual Series mutual funds (the "funds"). On August 2, 2004, Franklin Resources, Inc. announced that its subsidiary, Franklin Advisers, Inc., reached an agreement with the SEC that resolved the issues resulting from the SEC investigation into market timing activity. In connection with that agreement, the SEC issued an "Order Instituting Administrative and Cease-and-Desist Proceedings Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940 and Sections 9(b) and 9(f) of the Investment Company Act of 1940, Making Findings and Imposing Remedial Sanctions and a Cease-and-Desist Order" (the "Order"). The SEC's Order concerned the activities of a limited number of third parties that ended in 2000 and those that were the subject of the first Massachusetts administrative complaint described below. Under the terms of the SEC's Order, pursuant to which Franklin Advisers, Inc. neither admitted nor denied any of the findings contained therein, Franklin Advisers, Inc. agreed to pay $50 million, of which $20 million is a civil penalty, to be distributed to shareholders of certain funds in accordance with a plan to be developed by an independent distribution consultant. At this time, it is unclear which funds or which shareholders of any particular fund will receive distributions. The Order also required Franklin Advisers, Inc. to, among other things, enhance and periodically review compliance policies and procedures. On September 20, 2004, Franklin Resources, Inc. announced that two of its subsidiaries, Franklin Advisers, Inc. and Franklin Templeton Alternative Strategies, Inc. ("FTAS"), reached an agreement with the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts (the "State of Massachusetts") related to its administrative complaint filed on February 4, 2004, concerning one instance of market timing that was also a subject of the August 2, 2004 settlement that Franklin Advisers, Inc. reached with the SEC, as described above. 50 | Annual Report MUTUAL DISCOVERY FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY MATTERS (continued) SETTLEMENTS (CONTINUED) Under the terms of the settlement consent order issued by the State of Massachusetts, Franklin Advisers, Inc. and FTAS consented to the entry of a cease-and-desist order and agreed to pay a $5 million administrative fine to the State of Massachusetts (the "Massachusetts Consent Order"). The Massachusetts Consent Order included two different sections: "Statements of Fact" and "Violations of Massachusetts Securities Laws." Franklin Advisers, Inc. and FTAS admitted the facts in the Statements of Fact. On October 25, 2004, the State of Massachusetts filed a second administrative complaint, alleging that Franklin Resources, Inc.'s Form 8-K filing (in which it described the Massachusetts Consent Order and stated that "Franklin did not admit or deny engaging in any wrongdoing") failed to state that Franklin Advisers, Inc. and FTAS admitted the Statements of Fact portion of the Massachusetts Consent Order (the "Second Complaint"). Franklin Resources, Inc. reached a second agreement with the State of Massachusetts on November 19, 2004, resolving the Second Complaint. As a result of the November 19, 2004 settlement, Franklin Resources, Inc. filed a new Form 8-K. The terms of the Massachusetts Consent Order did not change and there was no monetary fine associated with this second settlement. On November 17, 2004, Franklin Resources, Inc. announced that Franklin/Templeton Distributors, Inc. ("FTDI") reached an agreement with the CAGO, resolving the issues resulting from the CAGO's investigation concerning sales and marketing support payments. Under the terms of the settlement, FTDI neither admitted nor denied the allegations in the CAGO's complaint and agreed to pay $2 million to the State of California as a civil penalty, $14 million to the funds, to be allocated by an independent distribution consultant to be paid for by FTDI, and $2 million to the CAGO for its investigative costs. On December 13, 2004, Franklin Resources, Inc. announced that its subsidiaries FTDI and Franklin Advisers, Inc. reached an agreement with the SEC, resolving the issues resulting from the SEC's investigation concerning marketing support payments to securities dealers who sell fund shares. In connection with that agreement, the SEC issued an "Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940, Sections 9(b) and 9(f) of the Investment Company Act of 1940, and Section 15(b) of the Securities Exchange Act of 1934" (the "Second Order"). Annual Report | 51 MUTUAL DISCOVERY FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY MATTERS (CONTINUED) SETTLEMENTS (CONTINUED) Under the terms of the Second Order, in which FTDI and Franklin Advisers, Inc. neither admitted nor denied the findings contained therein, they agreed to pay the funds a penalty of $20 million and disgorgement of $1 (one dollar). FTDI and Franklin Advisers, Inc. also agreed to implement certain measures and undertakings relating to marketing support payments to broker-dealers for the promotion or sale of fund shares, including making additional disclosures in the funds' Prospectuses and Statements of Additional Information. The Second Order further requires the appointment of an independent distribution consultant, at the Company's expense, who shall develop a plan for the distribution of the penalty and disgorgement to the funds. OTHER LEGAL PROCEEDINGS The Fund, in addition to the Company and other funds, and certain current and former officers, employees, and directors have been named in multiple lawsuits in different federal courts in Nevada, California, Illinois, New York and Florida, alleging violations of various federal securities laws and seeking, among other relief, monetary damages, restitution, removal of fund trustees, directors, advisers, administrators, and distributors, rescission of management contracts and 12b-1 Plans, and/or attorneys' fees and costs. Specifically, the lawsuits claim breach of duty with respect to alleged arrangements to permit market timing and/or late trading activity, or breach of duty with respect to the valuation of the portfolio securities of certain Templeton funds managed by Franklin Resources, Inc. subsidiaries, resulting in alleged market timing activity. The majority of these lawsuits duplicate, in whole or in part, the allegations asserted in the February 4, 2004 Massachusetts administrative complaint and the findings in the SEC's August 2, 2004 Order, as described above. The lawsuits are styled as class actions, or derivative actions on behalf of either the named funds or Franklin Resources, Inc. In addition, the Company, as well as certain current and former officers, employees, and directors, have been named in multiple lawsuits alleging violations of various securities laws and pendent state law claims relating to the disclosure of directed brokerage payments and/or payment of allegedly excessive advisory, commission, and distribution fees, and seeking, among other relief, monetary damages, restitution, rescission of advisory contracts, including recovery of all fees paid pursuant to those contracts, an accounting of all monies paid to the named advisers, declaratory relief, injunctive relief, and/or attorneys' fees and costs. These lawsuits are styled as class actions or derivative actions brought on behalf of certain funds. 52 | Annual Report MUTUAL DISCOVERY FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY MATTERS (CONTINUED) OTHER LEGAL PROCEEDINGS (CONTINUED) The Company and fund management strongly believes that the claims made in each of the lawsuits identified above are without merit and intends to vigorously defend against them. The Company cannot predict with certainty, however, the eventual outcome of the remaining governmental investigations or private lawsuits, nor whether they will have a material negative impact on the Company. Public trust and confidence are critical to the Company's business and any material loss of investor and/or client confidence could result in a significant decline in assets under management by the Company, which would have an adverse effect on the Company's future financial results. If it is determined that the Company bears responsibility for any unlawful or inappropriate conduct that caused losses to the Fund, it is committed to making the Fund or its shareholders whole, as appropriate. The Company is committed to taking all appropriate actions to protect the interests of its funds' shareholders. Annual Report | 53 MUTUAL DISCOVERY FUND REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 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.) (the Fund), as of December 31, 2004, 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 the standards of the Public Company Accounting Oversight Board (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 consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Fund's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of December 31, 2004, by correspondence with the custodian and brokers or by other appropriate auditing procedures where replies from brokers were not received. 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, 2004, 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 U.S. generally accepted accounting principles. /s/ Ernst & Young LLP Boston, Massachusetts February 7, 2005 54 | Annual Report MUTUAL DISCOVERY FUND TAX DESIGNATION (UNAUDITED) Under Section 854(b)(2) of the Internal Revenue Code (Code), the Fund designated up to a maximum of $ 106,530,570 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended 2004. In January 2005, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2004. 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 17.39% of the ordinary income dividends as income qualifying for the dividends received deducion for the fiscal year ended 2004. At 2004, 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 tables 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 16, 2004, 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, Class C and Class R 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 | 55 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 - ----------------------------------------------------------------------------------------------------------------------- Australia ................................... 0.0000 0.0004 0.0004 0.0002 Belgium ..................................... 0.0010 0.0047 0.0047 0.0020 Bermuda ..................................... 0.0000 0.0021 0.0012 0.0014 Canada ...................................... 0.0045 0.0148 0.0139 0.0069 Denmark ..................................... 0.0017 0.0081 0.0081 0.0035 France ...................................... 0.0048 0.0297 0.0230 0.0166 Germany ..................................... 0.0011 0.0096 0.0051 0.0067 Hong Kong ................................... 0.0000 0.0005 0.0000 0.0005 India ....................................... 0.0000 0.0027 0.0027 0.0012 Ireland ..................................... 0.0000 0.0176 0.0176 0.0075 Italy ....................................... 0.0005 0.0022 0.0022 0.0009 Japan ....................................... 0.0005 0.0090 0.0048 0.0063 Jersey Islands .............................. 0.0000 0.0017 0.0000 0.0017 Luxembourg .................................. 0.0011 0.0049 0.0049 0.0021 Mexico ...................................... 0.0000 0.0013 0.0013 0.0006 Netherlands ................................. 0.0020 0.0091 0.0089 0.0040 New Zealand ................................. 0.0001 0.0009 0.0000 0.0009 Norway ...................................... 0.0073 0.0369 0.0337 0.0176 South Africa ................................ 0.0000 0.0119 0.0044 0.0094 South Korea ................................. 0.0048 0.0200 0.0200 0.0086 Spain ....................................... 0.0022 0.0102 0.0102 0.0044 Sweden ...................................... 0.0005 0.0026 0.0026 0.0011 Switzerland ................................. 0.0026 0.0121 0.0121 0.0052 Taiwan ...................................... 0.0011 0.0038 0.0038 0.0016 United Kingdom .............................. 0.0092 0.0800 0.0629 0.0441 ------------------------------------------------------------------ TOTAL ....................................... $0.0450 $0.2968 $0.2485 $0.1550 ==================================================================== - ----------------------------------------------------------------------------------------------------------------------- CLASS A ADJUSTED FOREIGN TAX FOREIGN FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS SOURCE INCOME COUNTRY PER SHARE PER SHARE PER SHARE PER SHARE - ----------------------------------------------------------------------------------------------------------------------- Australia ................................... 0.0000 0.0003 0.0003 0.0001 Belgium ..................................... 0.0010 0.0040 0.0040 0.0017 Bermuda ..................................... 0.0000 0.0018 0.0011 0.0012 Canada ...................................... 0.0045 0.0127 0.0119 0.0059 Denmark ..................................... 0.0017 0.0069 0.0069 0.0030 France ...................................... 0.0048 0.0255 0.0197 0.0142 Germany ..................................... 0.0011 0.0082 0.0043 0.0057 Hong Kong ................................... 0.0000 0.0004 0.0000 0.0004 India ....................................... 0.0000 0.0023 0.0023 0.0010 Ireland ..................................... 0.0000 0.0151 0.0151 0.0065 Italy ....................................... 0.0005 0.0019 0.0019 0.0008 Japan ....................................... 0.0005 0.0078 0.0042 0.0054 Jersey Islands .............................. 0.0000 0.0014 0.0000 0.0014 Luxembourg .................................. 0.0011 0.0042 0.0042 0.0018 Mexico ...................................... 0.0000 0.0012 0.0012 0.0005 Netherlands ................................. 0.0020 0.0078 0.0076 0.0035 New Zealand ................................. 0.0001 0.0008 0.0000 0.0008 Norway ...................................... 0.0073 0.0317 0.0289 0.0152 South Africa ................................ 0.0000 0.0102 0.0038 0.0080 South Korea ................................. 0.0048 0.0172 0.0172 0.0074 Spain ....................................... 0.0022 0.0088 0.0088 0.0038 Sweden ...................................... 0.0005 0.0022 0.0022 0.0009 Switzerland ................................. 0.0026 0.0104 0.0104 0.0045 Taiwan ...................................... 0.0011 0.0033 0.0033 0.0014 United Kingdom .............................. 0.0092 0.0688 0.0541 0.0379 -------------------------------------------------------------------- TOTAL ....................................... $0.0450 $0.2549 $0.2134 $0.1330 ====================================================================
56 | Annual Report MUTUAL DISCOVERY FUND TAX DESIGNATION (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------- CLASS B ADJUSTED FOREIGN TAX FOREIGN FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS SOURCE INCOME COUNTRY PER SHARE PER SHARE PER SHARE PER SHARE - ----------------------------------------------------------------------------------------------------------------------- Australia ................................. 0.0000 0.0002 0.0002 0.0001 Belgium ................................... 0.0010 0.0029 0.0029 0.0012 Bermuda ................................... 0.0000 0.0013 0.0008 0.0008 Canada .................................... 0.0045 0.0092 0.0087 0.0042 Denmark ................................... 0.0017 0.0050 0.0050 0.0021 France .................................... 0.0048 0.0184 0.0142 0.0103 Germany ................................... 0.0011 0.0059 0.0031 0.0041 Hong Kong ................................. 0.0000 0.0003 0.0000 0.0003 India ..................................... 0.0000 0.0017 0.0017 0.0007 Ireland ................................... 0.0000 0.0109 0.0109 0.0047 Italy ..................................... 0.0005 0.0014 0.0014 0.0006 Japan ..................................... 0.0005 0.0056 0.0030 0.0039 Jersey Islands ............................ 0.0000 0.0010 0.0000 0.0010 Luxembourg ................................ 0.0011 0.0030 0.0030 0.0013 Mexico .................................... 0.0000 0.0008 0.0008 0.0003 Netherlands ............................... 0.0020 0.0056 0.0055 0.0025 New Zealand ............................... 0.0001 0.0005 0.0000 0.0005 Norway .................................... 0.0073 0.0229 0.0209 0.0110 South Africa .............................. 0.0000 0.0074 0.0027 0.0059 South Korea ............................... 0.0048 0.0124 0.0124 0.0053 Spain ..................................... 0.0022 0.0063 0.0063 0.0027 Sweden .................................... 0.0005 0.0016 0.0016 0.0007 Switzerland ............................... 0.0026 0.0075 0.0075 0.0032 Taiwan .................................... 0.0011 0.0024 0.0024 0.0010 United Kingdom ............................ 0.0092 0.0496 0.0390 0.0273 -------------------------------------------------------------------- Total ..................................... $0.0450 $0.1838 $0.1540 $0.0957 ==================================================================== - ----------------------------------------------------------------------------------------------------------------------- CLASS C ADJUSTED FOREIGN TAX FOREIGN FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS SOURCE INCOME COUNTRY PER SHARE PER SHARE PER SHARE PER SHARE - ----------------------------------------------------------------------------------------------------------------------- Australia ................................. 0.0000 0.0002 0.0002 0.0001 Belgium ................................... 0.0010 0.0027 0.0027 0.0012 Bermuda ................................... 0.0000 0.0013 0.0008 0.0008 Canada .................................... 0.0045 0.0087 0.0082 0.0040 Denmark ................................... 0.0017 0.0048 0.0048 0.0021 France .................................... 0.0048 0.0174 0.0135 0.0097 Germany ................................... 0.0011 0.0056 0.0030 0.0039 Hong Kong ................................. 0.0000 0.0003 0.0000 0.0003 India ..................................... 0.0000 0.0016 0.0016 0.0007 Ireland ................................... 0.0000 0.0103 0.0103 0.0044 Italy ..................................... 0.0005 0.0013 0.0013 0.0006 Japan ..................................... 0.0005 0.0053 0.0028 0.0037 Jersey Islands ............................ 0.0000 0.0010 0.0000 0.0010 Luxembourg ................................ 0.0011 0.0029 0.0029 0.0012 Mexico .................................... 0.0000 0.0008 0.0008 0.0003 Netherlands ............................... 0.0020 0.0053 0.0052 0.0023 New Zealand ............................... 0.0001 0.0005 0.0000 0.0005 Norway .................................... 0.0073 0.0217 0.0198 0.0104 South Africa .............................. 0.0000 0.0070 0.0026 0.0055 South Korea ............................... 0.0048 0.0118 0.0118 0.0051 Spain ..................................... 0.0022 0.0060 0.0060 0.0026 Sweden .................................... 0.0005 0.0015 0.0015 0.0006 Switzerland ............................... 0.0026 0.0071 0.0071 0.0030 Taiwan .................................... 0.0011 0.0023 0.0023 0.0010 United Kingdom ............................ 0.0092 0.0470 0.0370 0.0259 -------------------------------------------------------------------- Total ..................................... $0.0450 $0.1744 $0.1462 $0.0909 ====================================================================
Annual Report | 57 MUTUAL DISCOVERY FUND TAX DESIGNATION (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------- CLASS R ADJUSTED FOREIGN TAX FOREIGN FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS SOURCE INCOME COUNTRY PER SHARE PER SHARE PER SHARE PER SHARE - ----------------------------------------------------------------------------------------------------------------------- Australia ................................... 0.0000 0.0003 0.0003 0.0001 Belgium ..................................... 0.0010 0.0039 0.0039 0.0017 Bermuda ..................................... 0.0000 0.0018 0.0011 0.0012 Canada ...................................... 0.0045 0.0122 0.0115 0.0056 Denmark ..................................... 0.0017 0.0067 0.0067 0.0029 France ...................................... 0.0048 0.0245 0.0189 0.0137 Germany ..................................... 0.0011 0.0079 0.0042 0.0055 Hong Kong ................................... 0.0000 0.0004 0.0000 0.0004 India ....................................... 0.0000 0.0022 0.0022 0.0009 Ireland ..................................... 0.0000 0.0145 0.0145 0.0062 Italy ....................................... 0.0005 0.0018 0.0018 0.0008 Japan ....................................... 0.0005 0.0075 0.0040 0.0052 Jersey Islands .............................. 0.0000 0.0014 0.0000 0.0014 Luxembourg .................................. 0.0011 0.0040 0.0040 0.0017 Mexico ...................................... 0.0000 0.0011 0.0011 0.0005 Netherlands ................................. 0.0020 0.0075 0.0074 0.0033 New Zealand ................................. 0.0001 0.0007 0.0000 0.0007 Norway ...................................... 0.0073 0.0305 0.0278 0.0146 South Africa ................................ 0.0000 0.0098 0.0036 0.0077 South Korea ................................. 0.0048 0.0166 0.0166 0.0071 Spain ....................................... 0.0022 0.0084 0.0084 0.0036 Sweden ...................................... 0.0005 0.0021 0.0021 0.0009 Switzerland ................................. 0.0026 0.0100 0.0100 0.0043 Taiwan ...................................... 0.0011 0.0032 0.0032 0.0014 United Kingdom .............................. 0.0092 0.0662 0.0520 0.0365 -------------------------------------------------------------------- Total ....................................... $0.0450 $0.2452 $0.2053 $0.1279 ====================================================================
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. 58 | Annual Report MUTUAL DISCOVERY FUND TAX DESIGNATION (CONTINUED) 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. In January 2005, shareholders will receive Form 1099-DIV which will include their share of taxes paid and foreign source income distributed during the calendar year 2004. 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 2004 individual income tax returns. Annual Report | 59 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. 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. (63) 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; and Director, Stern School of Business M.B.A. Program. - ------------------------------------------------------------------------------------------------------------------------------------ ANN TORRE GRANT (46) 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 (75) Director Since 2002 12 Director, Fiduciary 51 John F. Kennedy Parkway Emerging Markets Bond Fund Short Hills, NJ 07078 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 (74) 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 (75) 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). - ------------------------------------------------------------------------------------------------------------------------------------
60 | 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 (74) Director Since 1998 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. - ------------------------------------------------------------------------------------------------------------------------------------ LEONARD RUBIN (79) 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 (58) Director Since 1991 12 Director, El Oro Mining and 51 John F. Kennedy Parkway Exploration Co., p.l.c. Short Hills, NJ 07078 - ------------------------------------------------------------------------------------------------------------------------------------ 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 (79) 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 (65) Director Since 2002 7 Director, Fortune Brands, 600 Fifth Avenue, 7th Floor Inc. (consumer products) New York, NY 10020-2302 and 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, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. - ------------------------------------------------------------------------------------------------------------------------------------
Annual Report | 61
- ------------------------------------------------------------------------------------------------------------------------------------ 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 (42) 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 officer and/or director, as the case may be, of three of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ JAMES M. DAVIS (52) Chief Since July 2004 Not Applicable Not Applicable One Franklin Parkway Compliance San Mateo, CA 94403-1906 Officer - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Officer of 51 of the investment companies in Franklin Templeton Investments; Director, Global Compliance, Franklin Resources, Inc.; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - ---------------------------------------------------------------------------------------------------------------------------------- JIMMY D. GAMBILL (57) Senior Vice Since 2002 Not Applicable Not Applicable 500 East Broward Blvd. President and Suite 2100 Chief Executive Fort Lauderdale, FL 33394-3091 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 (57) Vice President Since 2000 Not Applicable Not Applicable One Franklin Parkway San Mateo, CA 94403-1906 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior 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). - ------------------------------------------------------------------------------------------------------------------------------------
62 | Annual Report
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ BARBARA J. GREEN (57) Vice President Since 2000 Not Applicable Not Applicable 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). - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL O. MAGDOL (67) Vice President - Since 2000 Not Applicable Not Applicable 600 Fifth Avenue AML Compliance Rockefeller Center New York, NY 10020-2302 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice Chairman, Chief Banking Officer and Director, Fiduciary Trust Company International; Director, FTI Banque, Arch Chemicals, Inc. and Lingnan Foundation; 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. - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL MORANTZ (35) Treasurer Since July 2004 Not Applicable Not Applicable 500 East Broward Blvd. Suite 2100 Fort Lauderdale, FL 33394-3091 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ MURRAY L. SIMPSON (67) Vice President Since 2000 Not Applicable Not Applicable 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). - ------------------------------------------------------------------------------------------------------------------------------------
Annual Report | 63
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ GALEN G. VETTER (53) Chief Financial Since May 2004 Not Applicable Not Applicable 500 East Broward Blvd. Officer and Suite 2100 Chief Accounting Fort Lauderdale, FL 33394-3091 Officer - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Officer of 51 of the investment companies in Franklin Templeton Investments; Senior Vice President, Franklin Templeton Services, LLC; and FORMERLY, Managing Director, RSM McGladrey, Inc.; and Partner, McGladrey & Pullen, LLP. - ------------------------------------------------------------------------------------------------------------------------------------
* 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 to be 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 to be 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 to be an interested person of Mutual Series under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC, Mutual Series' adviser. 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. 64 | Annual Report MUTUAL DISCOVERY FUND SHAREHOLDER INFORMATION 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. Copies of the Fund's proxy voting records are also made available online at franklintempleton.com and posted on the Securities and Exchange Commission's website at sec.gov and reflect the 12-month period beginning July 1, 2003, and ending June 30, 2004. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the Securities and Exchange Commission for the first and third quarters for each fiscal year on Form N-Q. Shareholders may view the filed Form N-Q by visiting the Commission's website at sec.gov. The filed form may also be viewed and copied at the Commission's Public Reference Room in Washington, DC. Information regarding the operations of the Public Reference Room may be obtained by calling 1-800/SEC-0330. Annual Report | 65 This page intentionally left blank. This page intentionally left blank. This page intentionally left blank. LITERATURE REQUEST LITERATURE REQUEST. TO RECEIVE A BROCHURE AND PROSPECTUS, PLEASE CALL US AT 1-800/DIAL BEN(R) (1-800/342-5236) OR VISIT FRANKLINTEMPLETON.COM. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. 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 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 Fund2 Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund(3) 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(4) 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 Technology Fund Franklin Utilities Fund Mutual Financial Services Fund ASSET ALLOCATION Franklin Templeton Corefolio Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives 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(5) Franklin's AGE High Income Fund Franklin Floating Rate Daily Access Fund Franklin Floating Rate Trust(3) Franklin Income Fund Franklin Limited Maturity U.S. Government Securities Fund(5), (6) Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund(5) Templeton Global Bond Fund TAX-FREE INCOME(7) National Funds Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(8) 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 Alabama Arizona California(9) Colorado Connecticut Florida(9) Georgia Kentucky Louisiana Maryland Massachusetts(8) Michigan(8) Minnesota(8) Missouri New Jersey New York(9) North Carolina Ohio(8) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(10) (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 and select retirement plans. (3) 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. (4) Upon reaching approximately $350 million in assets, the fund intends to close to all investors. (5) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (6) Formerly Franklin Short-Intermediate U.S. Government Securities Fund. Effective 9/1/04, the fund's name changed; its investment goal and strategy remained the same. (7) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (8) Portfolio of insured municipal securities. (9) These funds are available in two or more variations, including long-term portfolios, portfolios of insured securities, a high-yield portfolio (CA) and limited-term, intermediate-term and money market portfolios (CA and NY). (10) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 11/04 Not part of the annual report [LOGO](R) FRANKLIN(R) TEMPLETON(R) One Franklin Parkway INVESTMENTS San Mateo, CA 94403-1906 o 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, CFA 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) Authorized for distribution only when accompanied or preceded by a prospectus. Investors should carefully consider a fund's investment goals, risks, charges and expenses before investing. The prospectus contains this and other information; please read it carefully before investing. 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 A2004 02/05 MUTUAL EUROPEAN FUND [GRAPHIC OMITTED] - -------------------------------------------------------------------------------- DECEMBER 31, 2004 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- ANNUAL REPORT AND SHAREHOLDER LETTER INTERNATIONAL - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- WANT TO RECEIVE THIS DOCUMENT FASTER VIA EMAIL? MUTUAL EUROPEAN FUND Eligible shareholders can sign up for eDelivery at franklintempleton.com. See inside for details. - -------------------------------------------------------------------------------- [LOGO](R) 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 ...................................................... 4 Performance Summary ....................................................... 9 Your Fund's Expenses ...................................................... 14 Financial Highlights and Statement of Investments ......................... 16 Financial Statements ...................................................... 25 Notes to Financial Statements ............................................. 29 Report of Independent Registered Public Accounting Firm ........................................................... 43 Tax Designation ........................................................... 44 Board Members and Officers ................................................ 48 Shareholder Information ................................................... 53 - -------------------------------------------------------------------------------- ANNUAL REPORT MUTUAL EUROPEAN FUND YOUR FUND'S GOALS AND MAIN 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 who earn at least 50% of their revenue from, European countries. - -------------------------------------------------------------------------------- PERFORMANCE DATA QUOTED REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. PLEASE VISIT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236 FOR MOST RECENT MONTH-END PERFORMANCE. - -------------------------------------------------------------------------------- We are pleased to bring you Mutual European Fund's annual report for the fiscal year ended December 31, 2004. PERFORMANCE OVERVIEW Mutual European Fund - Class Z posted a 21.58% cumulative total return for the 12 months ended December 31, 2004. The Fund performed in line with its benchmark, the Morgan Stanley Capital International (MSCI) All Country (AC) Europe Index, which returned 21.61% over the same period.(1) You can find the Fund's long-term performance data in the Performance Summary beginning on page 9. ECONOMIC AND MARKET OVERVIEW The global economic recovery continued in 2004, led by growth in the U.S. As of December 31, 2004, U.S. gross domestic product (GDP) had increased for 13 consecutive quarters.(2) The 12-nation euro zone lagged other regions in the current recovery. However, the European Central Bank projected euro zone growth may be between 1.6% and 2.0% in 2004, compared with only 0.5% in 2003. The U.S. dollar declined about 7% versus the euro during 2004.(3) (1) Source: Standard & Poor's Micropal. The MSCI AC 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 is unmanaged and includes reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. (2) Source: Bureau of Economic Analysis. (3) Source: FactSet Research Systems Inc. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND NAMES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 20. 4 | Annual Report This hurt European exports into the U.S., as it made their goods more expensive in the world's biggest market. Oil prices increased during most of 2004, reaching $56 dollars per barrel in October, but declined to end the year at $43. Higher oil prices triggered investor worries about inflation, decreased spending -- due to cautionary consumer and business sentiment -- and slower economic and corporate profit growth. As of December 31, 2004, the 12-month moving average price of oil was about $41 per barrel.(4) In this environment, the MSCI World ex-U.S. Index's total return was 20.84% in U.S. dollars for the 12-month period ended December 31, 2004.(5) European markets, as measured by the MSCI AC Europe Index, had a one-year total return of 21.61% in U.S. dollars.(6) In local currencies, these indexes had notably lower total returns of 13.16% and 12.90% for the same period.(5), (6) In 2004, most of the world's currencies strengthened in relation to the U.S. dollar, which benefited U.S.-based investors of non-U.S. developed and emerging market equities. INVESTMENT STRATEGY We follow a distinctive, three-pronged investment approach, which combines investments in what we believe are undervalued common stocks with distressed debt investing and risk arbitrage. Our style aims 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 bankrupt or distressed companies if we believe the market overreacted to adverse developments or failed to appreciate positive changes. (4) Source: U.S. Department of Energy. (5) Source: Standard & Poor's Micropal. The MSCI World ex-U.S. Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in global developed markets, excluding the U.S. (6) Source: Standard & Poor's Micropal. See footnote 1 for a description of the MSCI AC Europe Index. GEOGRAPHIC DISTRIBUTION* Based on Total Net Assets as of 12/31/04 [THE FOLLOWING TABLE WAS REPRESENTED AS A BAR GRAPH IN THE PRINTED MATERIAL.] U.K. 24.3% Germany 10.5% U.S. 9.4% Switzerland 8.5% Netherlands 8.3% Irish Republic 7.2% France 6.6% Norway 4.7% Spain 4.6% Denmark 3.7% Belgium 3.4% Finland 2.7% Luxembourg 1.6% Italy 1.4% Poland 1.2% Other Countries 2.4% * Other Net Assets = -0.5% because of foreign currency hedging. Annual Report | 5 TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/04 - -------------------------------------------------------------------------------- % OF TOTAL NET ASSETS - -------------------------------------------------------------------------------- Tobacco 10.1% - -------------------------------------------------------------------------------- Food Products 9.3% - -------------------------------------------------------------------------------- Commercial Banks 7.6% - -------------------------------------------------------------------------------- Media 6.3% - -------------------------------------------------------------------------------- Metals & Mining 5.6% - -------------------------------------------------------------------------------- Machinery 5.6% - -------------------------------------------------------------------------------- Beverages 5.5% - -------------------------------------------------------------------------------- Insurance 4.5% - -------------------------------------------------------------------------------- Chemicals 3.9% - -------------------------------------------------------------------------------- Diversified Telecommunication Services 3.3% - -------------------------------------------------------------------------------- MANAGER'S DISCUSSION The Fund's equity investments provided the most significant contribution to performance in 2004. Examples of holdings that performed well included Altadis, a Franco-Spanish tobacco company; Orkla, a Norwegian conglomerate; and Almanij, a Belgian financial holding company. In 2004, tobacco companies operating in Europe, such as Altadis, encountered a challenging sales environment, especially in France after the government imposed two substantial tax increases by early 2004 that pressured volumes and contributed to reduced consumption of about 25% in volume. Despite challenges in France and elsewhere, Altadis shares performed well as management returned cash to shareholders through dividends and share repurchases. In addition, the company announced two acquisitions and a cost-restructuring program, all of which could enable management to continue to increase cash flow and create shareholder value. As a result of these and other factors, Altadis shares appreciated about 65% in 2004. Despite this strong performance, the stock still traded at a significant discount to its European peers and our calculation of the stock's intrinsic value. In addition, some analysts believe the industry is ready for more consolidation. For these and other reasons, we remain enthusiastic about the prospects of our Altadis investment. Oslo-based Orkla is one of Norway's largest conglomerates with operations in food, media, chemicals and beverages. In early 2004, Orkla's management announced it would divest the company's beverage operations, a 40% stake in the Danish company Carlsberg Breweries. We believed the negotiated price for Carlsberg was favorable, and the market rewarded management's decision to return part of the proceeds to shareholders in the form of a special dividend. The equity market anticipates Orkla to further divest non-core assets and return the proceeds to shareholders. The company reported better-than-expected quarterly results for most of 2004 as its restructuring program progressed ahead of expectations and as some new product launches experienced success. Largely as a result, the stock's discount to its intrinsic value narrowed, and including the special dividend, Orkla shares returned 73% in 2004. Almanij is a Belgian holding company that owns equity stakes in a number of European financial institutions, with its primary investment being a controlling interest in Belgian bank KBC Bancassurance (KBC). For many years, Almanij shares traded at a substantial discount to the sum of its parts largely due to the complex nature of its holding structure, as well as the low valuation afforded by the market to KBC. We bought the company's shares bearing in mind the potential for cost rationalization in KBC's Belgian home market, the growth of KBC's operations in central Europe and the opportunities to simplify Almanij's ownership structure. In 2004, KBC succeeded in controlling its 6 | Annual Report costs and realized strong growth in its central European operations. Largely as a result, KBC shares appreciated sharply. Furthermore, with the aim of untangling the relationship between the two companies, KBC and Almanij in December 2004 entered into an agreement whereby KBC will acquire Almanij at a significant premium. With the rise in KBC's stock price during the period and KBC's share offer, Almanij stock appreciated 108% in 2004. At period-end, we continued to own Almanij shares as we believed the shares in KBC, which we will receive in exchange for our Almanij shares, were still priced below our estimate of their intrinsic value. In general, if the value of the U.S. dollar goes up compared with a foreign currency, an investment traded in that foreign currency will go down in value because it will be worth fewer U.S. dollars. This can have a negative effect on Fund performance. Conversely, when the U.S. dollar weakens in relation to a foreign currency, an investment traded in that foreign currency will increase in value, which can contribute to Fund performance. At Mutual Series, we typically seek to hedge (protect) against currency risk, which can reduce or eliminate the positive or negative effect on Fund performance of holding investments denominated in currencies other than the U.S. dollar. In 2004, we remained less than fully hedged in foreign currencies allowing shareholders to benefit from a declining U.S. dollar. However, one cannot expect the same result in future periods. Although many of our investments performed well, there were several detractors from Fund performance during the fiscal year. Positions that declined in value during the period included Eurotunnel, a distressed investment in the operator of the English Channel tunnel; MG Technologies, a German conglomerate with interests in the engineering and chemicals sectors; and Highland Gold Mining, a U.K.-based gold mining company operating mainly in eastern Europe. Eurotunnel's debt securities declined in 2004 largely due to uncertainties surrounding the ultimate resolution of the company's financial situation, as well as continuing mediocre operating results after the board and management team were replaced in April 2004. Distressed investing can be a lengthy process, and it is not unusual for securities to weaken somewhat before a restructuring or financial resolution is ultimately worked out. MG Technologies declined mainly due to the failed divestment of its plastics operations, the slower-than-expected turnaround of the company's plant engineering division, and the sudden departure of its chief executive officer. The company is also in the midst of a restructuring. In December, Highland's share price fell in anticipation of an equity offering, which was subsequently priced at a discount to the market. However, the fundamental stock valuations improved because of the offering. TOP 10 HOLDINGS 12/31/04 - -------------------------------------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - -------------------------------------------------------------------------------- British American Tobacco PLC 3.5% TOBACCO, U.K. - -------------------------------------------------------------------------------- Altadis SA 3.4% TOBACCO, SPAIN - -------------------------------------------------------------------------------- NTL Inc. 3.1% MEDIA, U.K. - -------------------------------------------------------------------------------- Schindler Holding AG, ord. & Reg D 3.1% MACHINERY, SWITZERLAND - -------------------------------------------------------------------------------- Orkla ASA 3.1% FOOD PRODUCTS, NORWAY - -------------------------------------------------------------------------------- Allied Irish Banks PLC 2.6% COMMERCIAL BANKS, IRISH REPUBLIC - -------------------------------------------------------------------------------- White Mountains Insurance Group Inc. 2.6% INSURANCE, U.S. - -------------------------------------------------------------------------------- Imperial Tobacco Group PLC 2.2% TOBACCO, U.K. - -------------------------------------------------------------------------------- Carlsberg AS, A & B 2.0% BEVERAGES, DENMARK - -------------------------------------------------------------------------------- Anglo American PLC, ord. & ADR 1.9% METALS & MINING, U.K. - -------------------------------------------------------------------------------- Annual Report | 7 Thank you for your continued participation in Mutual European Fund. We look forward to serving your future investment needs. [PHOTO OMITTED] /s/ David J. Winters, CFA David J. Winters, CFA [PHOTO OMITTED] /s/ Philippe Brugere-Trelat Philippe Brugere-Trelat Co-Portfolio Managers Mutual European Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2004, 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 ADVISER 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. - -------------------------------------------------------------------------------- PHILIPPE BRUGERE-TRELAT Philippe Brugere-Trelat is vice president of Franklin Mutual Advisers, LLC (Mutual Series) and portfolio manager of Mutual European Fund. Mr. Brugere-Trelat brings over 20 years of experience in the European equity markets. He is intimately familiar with Mutual Series' approach to investing, having begun his career with Mutual Series Fund in 1984 under Max Heine and Michael Price. He spent over 10 years (1984-1994) following European investments for the funds. Prior to rejoining Mutual Series in 2004, Mr. Brugere-Trelat was president and portfolio manager of Eurovest, a French registered fund exclusively invested in European markets (1996-2004). Before that, he was a principal of Omega Advisors Inc., a large New York-based hedge fund, where he was responsible for European equity markets (1994-1996). Mr. Brugere-Trelat is a graduate of the University of Paris, France, where he earned a master's degree in law and political science. - -------------------------------------------------------------------------------- 8 | Annual Report PERFORMANCE SUMMARY AS OF 12/31/04 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 reinvestment of the Fund's dividends and capital gain distributions, if any, and any unrealized gains or losses.
PRICE AND DISTRIBUTION INFORMATION - --------------------------------------------------------------------------------------------- CLASS Z CHANGE 12/31/04 12/31/03 - --------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$2.96 $19.75 $16.79 - --------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - --------------------------------------------------------------------------------------------- Dividend Income $0.6010 - --------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.0230 - --------------------------------------------------------------------------------------------- TOTAL $0.6240 - --------------------------------------------------------------------------------------------- CLASS A CHANGE 12/31/04 12/31/03 - --------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$2.91 $19.50 $16.59 - --------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - --------------------------------------------------------------------------------------------- Dividend Income $0.5419 - --------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.0230 - --------------------------------------------------------------------------------------------- TOTAL $0.5649 - --------------------------------------------------------------------------------------------- CLASS B CHANGE 12/31/04 12/31/03 - --------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$2.83 $19.14 $16.31 - --------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - --------------------------------------------------------------------------------------------- Dividend Income $0.4350 - --------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.0230 - --------------------------------------------------------------------------------------------- TOTAL $0.4580 - --------------------------------------------------------------------------------------------- CLASS C CHANGE 12/31/04 12/31/03 - --------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$2.90 $19.50 $16.60 - --------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - --------------------------------------------------------------------------------------------- Dividend Income $0.4279 - --------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.0230 - --------------------------------------------------------------------------------------------- TOTAL $0.4509 - ---------------------------------------------------------------------------------------------
Mutual European Fund paid distributions derived from long-term capital gains of 2.30 cents ($0.0230) per share in December 2004. The Fund designated such distributions as capital gain dividends per Internal Revenue Code Section 852 (b)(3). Annual Report | 9 PERFORMANCE SUMMARY (CONTINUED) PERFORMANCE(1) CLASS A: 5.75% MAXIMUM INITIAL SALES CHARGE; CLASS B: CONTINGENT DEFERRED SALES CHARGE (CDSC) DECLINING FROM 4% TO 1% OVER SIX YEARS, AND ELIMINATED THEREAFTER; CLASS C: 1% CDSC IN FIRST YEAR ONLY. CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES.
- ------------------------------------------------------------------------------------------ CLASS Z 1-YEAR 5-YEAR INCEPTION (7/3/96) - ------------------------------------------------------------------------------------------ Cumulative Total Return(2) 21.58% 62.53% 252.75% - ------------------------------------------------------------------------------------------ Average Annual Total Return(3) 21.58% 10.20% 15.99% - ------------------------------------------------------------------------------------------ Value of $10,000 Investment(4) $12,158 $16,253 $35,275 - ------------------------------------------------------------------------------------------ CLASS A 1-YEAR 5-YEAR INCEPTION (11/1/96) - ------------------------------------------------------------------------------------------ Cumulative Total Return(2) 21.23% 59.77% 214.10% - ------------------------------------------------------------------------------------------ Average Annual Total Return(3) 14.27% 8.53% 14.22% - ------------------------------------------------------------------------------------------ Value of $10,000 Investment(4) $11,427 $15,060 $29,610 - ------------------------------------------------------------------------------------------ CLASS B 1-YEAR 5-YEAR INCEPTION (1/1/99) - ------------------------------------------------------------------------------------------ Cumulative Total Return(2) 20.41% 54.03% 124.48% - ------------------------------------------------------------------------------------------ Average Annual Total Return(3) 16.41% 8.82% 14.35% - ------------------------------------------------------------------------------------------ Value of $10,000 Investment(4) $11,641 $15,263 $22,348 - ------------------------------------------------------------------------------------------ CLASS C 1-YEAR 5-YEAR INCEPTION (11/1/96) - ------------------------------------------------------------------------------------------ Cumulative Total Return(2) 20.43% 54.83% 199.58% - ------------------------------------------------------------------------------------------ Average Annual Total Return(3) 19.43% 9.14% 14.38% - ------------------------------------------------------------------------------------------ Value of $10,000 Investment(4) $11,943 $15,483 $29,958 - ------------------------------------------------------------------------------------------
PERFORMANCE DATA QUOTED REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. FOR MOST RECENT MONTH-END PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236. 10 | 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 any current, applicable, maximum sales charge, Fund expenses, account fees and reinvested distributions. The unmanaged index includes reinvestment of any income or distributions. It differs from the Fund in composition and does not pay management fees or expenses. One cannot invest directly in an index. [THE FOLLOWING TABLE WAS REPRESENTED AS A BAR GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual European Fund - Class Z, as tracked by the growth in value of a $10,000 investment, to that of the MSCI All Country Europe Index5 from 7/3/96-12/31/04. CLASS Z (7/3/96-12/31/04) MUTUAL EUROPEAN MSCI AC EUROPE DATE FUND INDEX(5) ---- --------------- -------------- 7/3/1996 $10,000 $10,000 7/31/1996 $10,060 $9,892 8/31/1996 $10,430 $10,191 9/30/1996 $10,640 $10,399 10/31/1996 $10,840 $10,636 11/30/1996 $11,260 $11,171 12/31/1996 $11,461 $11,393 1/31/1997 $11,985 $11,468 2/28/1997 $12,237 $11,625 3/31/1997 $12,398 $11,992 4/30/1997 $12,377 $11,926 5/31/1997 $12,538 $12,443 6/30/1997 $12,961 $13,065 7/31/1997 $13,526 $13,668 8/31/1997 $13,283 $12,900 9/30/1997 $14,164 $14,168 10/31/1997 $13,628 $13,472 11/30/1997 $13,769 $13,673 12/31/1997 $14,116 $14,215 1/31/1998 $14,351 $14,726 2/28/1998 $15,135 $15,878 3/31/1998 $16,222 $17,013 4/30/1998 $16,636 $17,381 5/31/1998 $17,219 $17,652 6/30/1998 $16,827 $17,824 7/31/1998 $16,692 $18,208 8/31/1998 $14,793 $15,837 9/30/1998 $13,434 $15,203 10/31/1998 $13,826 $16,423 11/30/1998 $14,724 $17,319 12/31/1998 $14,784 $18,079 1/31/1999 $14,820 $17,989 2/28/1999 $15,008 $17,553 3/31/1999 $15,350 $17,757 4/30/1999 $16,246 $18,310 5/31/1999 $16,282 $17,466 6/30/1999 $16,848 $17,764 7/31/1999 $16,872 $17,958 8/31/1999 $17,027 $18,148 9/30/1999 $17,027 $18,019 10/31/1999 $17,576 $18,671 11/30/1999 $19,055 $19,193 12/31/1999 $21,705 $21,215 1/31/2000 $22,193 $19,731 2/29/2000 $25,034 $20,747 3/31/2000 $24,263 $21,246 4/30/2000 $23,594 $20,318 5/31/2000 $23,633 $20,143 6/30/2000 $23,650 $20,530 7/31/2000 $23,799 $20,206 8/31/2000 $24,395 $19,952 9/30/2000 $23,799 $19,020 10/31/2000 $24,070 $18,867 11/30/2000 $23,975 $18,064 12/31/2000 $24,845 $19,334 1/31/2001 $25,533 $19,364 2/28/2001 $25,389 $17,635 3/31/2001 $24,397 $16,325 4/30/2001 $25,133 $17,519 5/31/2001 $25,565 $16,692 6/30/2001 $25,406 $16,066 7/31/2001 $25,262 $16,085 8/31/2001 $25,021 $15,675 9/30/2001 $22,161 $14,099 10/31/2001 $22,884 $14,567 11/30/2001 $23,366 $15,166 12/31/2001 $23,668 $15,566 1/31/2002 $24,176 $14,780 2/28/2002 $24,537 $14,759 3/31/2002 $25,506 $15,572 4/30/2002 $26,031 $15,481 5/31/2002 $26,179 $15,449 6/30/2002 $25,179 $14,905 7/31/2002 $23,225 $13,255 8/31/2002 $23,258 $13,260 9/30/2002 $21,785 $11,530 10/31/2002 $21,851 $12,645 11/30/2002 $22,066 $13,271 12/31/2002 $21,842 $12,788 1/31/2003 $21,236 $12,187 2/28/2003 $20,579 $11,804 3/31/2003 $20,882 $11,625 4/30/2003 $22,549 $13,220 5/31/2003 $23,981 $14,102 6/30/2003 $24,301 $14,249 7/31/2003 $24,860 $14,532 8/31/2003 $25,385 $14,533 9/30/2003 $25,792 $14,835 10/31/2003 $26,876 $15,812 11/30/2003 $27,859 $16,480 12/31/2003 $29,016 $17,842 1/31/2004 $29,344 $18,058 2/29/2004 $30,312 $18,603 3/31/2004 $30,191 $18,066 4/30/2004 $29,949 $17,901 5/31/2004 $30,036 $18,202 6/30/2004 $30,711 $18,456 7/31/2004 $30,362 $17,953 8/31/2004 $30,449 $17,982 9/30/2004 $31,355 $18,715 10/31/2004 $32,157 $19,399 11/30/2004 $33,865 $20,809 12/31/2004 $35,275 $21,697 AVERAGE ANNUAL TOTAL RETURN - ----------------------------------------------- CLASS Z 12/31/04 - ----------------------------------------------- 1-Year 21.58% - ----------------------------------------------- 5-Year 10.20% - ----------------------------------------------- Since Inception (7/3/96) 15.99% - ----------------------------------------------- [THE FOLLOWING TABLE WAS REPRESENTED AS A BAR GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual European Fund - Class A, as tracked by the growth in value of a $10,000 investment, to that of the MSCI All Country Europe Index5 from 11/1/96-12/31/04. CLASS A (11/1/96-12/31/04) MUTUAL EUROPEAN MSCI AC EUROPE DATE FUND INDEX(5) ---- --------------- -------------- 11/1/1996 $9,426 $10,000 11/30/1996 $9,783 $10,503 12/31/1996 $9,954 $10,712 1/31/1997 $10,409 $10,783 2/28/1997 $10,619 $10,930 3/31/1997 $10,759 $11,276 4/30/1997 $10,742 $11,213 5/31/1997 $10,873 $11,699 6/30/1997 $11,240 $12,284 7/31/1997 $11,723 $12,851 8/31/1997 $11,512 $12,129 9/30/1997 $12,269 $13,321 10/31/1997 $11,802 $12,667 11/30/1997 $11,917 $12,856 12/31/1997 $12,214 $13,366 1/31/1998 $12,419 $13,846 2/28/1998 $13,079 $14,929 3/31/1998 $14,002 $15,996 4/30/1998 $14,352 $16,342 5/31/1998 $14,858 $16,597 6/30/1998 $14,517 $16,759 7/31/1998 $14,374 $17,120 8/31/1998 $12,737 $14,890 9/30/1998 $11,559 $14,294 10/31/1998 $11,889 $15,442 11/30/1998 $12,657 $16,284 12/31/1998 $12,711 $16,999 1/31/1999 $12,742 $16,914 2/28/1999 $12,895 $16,504 3/31/1999 $13,180 $16,696 4/30/1999 $13,955 $17,216 5/31/1999 $13,965 $16,422 6/30/1999 $14,442 $16,702 7/31/1999 $14,463 $16,885 8/31/1999 $14,597 $17,063 9/30/1999 $14,587 $16,942 10/31/1999 $15,050 $17,555 11/30/1999 $16,308 $18,046 12/31/1999 $18,565 $19,947 1/31/2000 $18,975 $18,552 2/29/2000 $21,402 $19,507 3/31/2000 $20,737 $19,976 4/30/2000 $20,161 $19,104 5/31/2000 $20,194 $18,939 6/30/2000 $20,190 $19,303 7/31/2000 $20,319 $18,999 8/31/2000 $20,810 $18,759 9/30/2000 $20,307 $17,883 10/31/2000 $20,529 $17,739 11/30/2000 $20,447 $16,985 12/31/2000 $21,177 $18,178 1/31/2001 $21,756 $18,206 2/28/2001 $21,618 $16,581 3/31/2001 $20,777 $15,350 4/30/2001 $21,398 $16,472 5/31/2001 $21,756 $15,694 6/30/2001 $21,614 $15,105 7/31/2001 $21,475 $15,124 8/31/2001 $21,282 $14,738 9/30/2001 $18,834 $13,256 10/31/2001 $19,456 $13,696 11/30/2001 $19,857 $14,259 12/31/2001 $20,106 $14,636 1/31/2002 $20,529 $13,897 2/28/2002 $20,825 $13,876 3/31/2002 $21,642 $14,642 4/30/2002 $22,079 $14,555 5/31/2002 $22,206 $14,526 6/30/2002 $21,342 $14,014 7/31/2002 $19,694 $12,462 8/31/2002 $19,708 $12,467 9/30/2002 $18,458 $10,841 10/31/2002 $18,501 $11,889 11/30/2002 $18,671 $12,478 12/31/2002 $18,489 $12,023 1/31/2003 $17,970 $11,459 2/28/2003 $17,408 $11,098 3/31/2003 $17,653 $10,930 4/30/2003 $19,065 $12,430 5/31/2003 $20,261 $13,260 6/30/2003 $20,529 $13,397 7/31/2003 $20,993 $13,664 8/31/2003 $21,442 $13,664 9/30/2003 $21,776 $13,948 10/31/2003 $22,675 $14,867 11/30/2003 $23,501 $15,495 12/31/2003 $24,468 $16,776 1/31/2004 $24,733 $16,979 2/29/2004 $25,545 $17,492 3/31/2004 $25,442 $16,986 4/30/2004 $25,235 $16,831 5/31/2004 $25,294 $17,114 6/30/2004 $25,862 $17,353 7/31/2004 $25,550 $16,880 8/31/2004 $25,625 $16,907 9/30/2004 $26,368 $17,596 10/31/2004 $27,037 $18,240 11/30/2004 $28,480 $19,566 12/31/2004 $29,610 $20,400 AVERAGE ANNUAL TOTAL RETURN - ----------------------------------------------- CLASS A 12/31/04 - ----------------------------------------------- 1-Year 14.27% - ----------------------------------------------- 5-Year 8.53% - ----------------------------------------------- Since Inception (11/1/96) 14.22% - ----------------------------------------------- Annual Report | 11 PERFORMANCE SUMMARY (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - ----------------------------------------------- CLASS B 12/31/04 - ----------------------------------------------- 1-Year 16.41% - ----------------------------------------------- 5-Year 8.82% - ----------------------------------------------- Since Inception (1/1/99) 14.35% - ----------------------------------------------- [THE FOLLOWING TABLE WAS REPRESENTED AS A BAR GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual European Fund - Class B, as tracked by the growth in value of a $10,000 investment, to that of the MSCI All Country Europe Index5 from 1/1/99-12/31/04. CLASS B (1/1/99-12/31/04) MUTUAL EUROPEAN MSCI AC EUROPE DATE FUND INDEX(5) ---- --------------- -------------------- 1/1/1999 $10,000 $10,000 1/31/1999 $10,016 $9,950 2/28/1999 $10,136 $9,709 3/31/1999 $10,361 $9,822 4/30/1999 $10,954 $10,128 5/31/1999 $10,962 $9,661 6/30/1999 $11,334 $9,826 7/31/1999 $11,342 $9,933 8/31/1999 $11,439 $10,038 9/30/1999 $11,431 $9,967 10/31/1999 $11,788 $10,327 11/30/1999 $12,770 $10,616 12/31/1999 $14,517 $11,735 1/31/2000 $14,831 $10,914 2/29/2000 $16,713 $11,476 3/31/2000 $16,190 $11,752 4/30/2000 $15,729 $11,239 5/31/2000 $15,746 $11,141 6/30/2000 $15,738 $11,356 7/31/2000 $15,820 $11,177 8/31/2000 $16,206 $11,036 9/30/2000 $15,802 $10,520 10/31/2000 $15,967 $10,436 11/30/2000 $15,894 $9,992 12/31/2000 $16,450 $10,694 1/31/2001 $16,894 $10,710 2/28/2001 $16,775 $9,754 3/31/2001 $16,114 $9,030 4/30/2001 $16,580 $9,690 5/31/2001 $16,861 $9,232 6/30/2001 $16,744 $8,886 7/31/2001 $16,624 $8,897 8/31/2001 $16,462 $8,670 9/30/2001 $14,572 $7,798 10/31/2001 $15,028 $8,057 11/30/2001 $15,332 $8,389 12/31/2001 $15,518 $8,610 1/31/2002 $15,838 $8,175 2/28/2002 $16,058 $8,163 3/31/2002 $16,675 $8,613 4/30/2002 $17,006 $8,563 5/31/2002 $17,094 $8,545 6/30/2002 $16,425 $8,244 7/31/2002 $15,136 $7,331 8/31/2002 $15,147 $7,334 9/30/2002 $14,169 $6,378 10/31/2002 $14,203 $6,994 11/30/2002 $14,325 $7,340 12/31/2002 $14,182 $7,073 1/31/2003 $13,778 $6,741 2/28/2003 $13,329 $6,529 3/31/2003 $13,520 $6,430 4/30/2003 $14,586 $7,312 5/31/2003 $15,494 $7,800 6/30/2003 $15,696 $7,881 7/31/2003 $16,034 $8,038 8/31/2003 $16,373 $8,038 9/30/2003 $16,621 $8,205 10/31/2003 $17,298 $8,746 11/30/2003 $17,919 $9,115 12/31/2003 $18,642 $9,869 1/31/2004 $18,836 $9,988 2/29/2004 $19,442 $10,290 3/31/2004 $19,351 $9,993 4/30/2004 $19,191 $9,902 5/31/2004 $19,225 $10,068 6/30/2004 $19,633 $10,209 7/31/2004 $19,391 $9,930 8/31/2004 $19,437 $9,946 9/30/2004 $19,990 $10,352 10/31/2004 $20,485 $10,730 11/30/2004 $21,568 $11,510 12/31/2004 $22,348 $12,001 AVERAGE ANNUAL TOTAL RETURN - ----------------------------------------------- CLASS C 12/31/04 - ----------------------------------------------- 1-Year 19.43% - ----------------------------------------------- 5-Year 9.14% - ----------------------------------------------- Since Inception (11/1/96) 14.38% - ----------------------------------------------- [THE FOLLOWING TABLE WAS REPRESENTED AS A BAR GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual European Fund - Class C, as tracked by the growth in value of a $10,000 investment, to that of the MSCI All Country Europe Index5 from 11/1/96-12/31/04. CLASS C (11/1/96-12/31/04) MUTUAL EUROPEAN MSCI AC EUROPE DATE FUND INDEX(5) ---- --------------- -------------- 11/1/1996 $10,000 $10,000 11/30/1996 $10,369 $10,503 12/31/1996 $10,552 $10,712 1/31/1997 $11,025 $10,783 2/28/1997 $11,248 $10,930 3/31/1997 $11,378 $11,276 4/30/1997 $11,359 $11,213 5/31/1997 $11,489 $11,699 6/30/1997 $11,869 $12,284 7/31/1997 $12,370 $12,851 8/31/1997 $12,137 $12,129 9/30/1997 $12,929 $13,321 10/31/1997 $12,435 $12,667 11/30/1997 $12,556 $12,856 12/31/1997 $12,862 $13,366 1/31/1998 $13,067 $13,846 2/28/1998 $13,776 $14,929 3/31/1998 $14,751 $15,996 4/30/1998 $15,110 $16,342 5/31/1998 $15,634 $16,597 6/30/1998 $15,264 $16,759 7/31/1998 $15,122 $17,120 8/31/1998 $13,383 $14,890 9/30/1998 $12,140 $14,294 10/31/1998 $12,487 $15,442 11/30/1998 $13,288 $16,284 12/31/1998 $13,332 $16,999 1/31/1999 $13,354 $16,914 2/28/1999 $13,515 $16,504 3/31/1999 $13,814 $16,696 4/30/1999 $14,607 $17,216 5/31/1999 $14,618 $16,422 6/30/1999 $15,116 $16,702 7/31/1999 $15,127 $16,885 8/31/1999 $15,257 $17,063 9/30/1999 $15,246 $16,942 10/31/1999 $15,722 $17,555 11/30/1999 $17,030 $18,046 12/31/1999 $19,385 $19,947 1/31/2000 $19,802 $18,552 2/29/2000 $22,336 $19,507 3/31/2000 $21,630 $19,976 4/30/2000 $21,017 $19,104 5/31/2000 $21,040 $18,939 6/30/2000 $21,026 $19,303 7/31/2000 $21,147 $18,999 8/31/2000 $21,659 $18,759 9/30/2000 $21,111 $17,883 10/31/2000 $21,342 $17,739 11/30/2000 $21,233 $16,985 12/31/2000 $21,987 $18,178 1/31/2001 $22,574 $18,206 2/28/2001 $22,431 $16,581 3/31/2001 $21,529 $15,350 4/30/2001 $22,159 $16,472 5/31/2001 $22,531 $15,694 6/30/2001 $22,371 $15,105 7/31/2001 $22,213 $15,124 8/31/2001 $21,998 $14,738 9/30/2001 $19,460 $13,256 10/31/2001 $20,090 $13,696 11/30/2001 $20,492 $14,259 12/31/2001 $20,745 $14,636 1/31/2002 $21,166 $13,897 2/28/2002 $21,471 $13,876 3/31/2002 $22,284 $14,642 4/30/2002 $22,734 $14,555 5/31/2002 $22,850 $14,526 6/30/2002 $21,950 $14,014 7/31/2002 $20,238 $12,462 8/31/2002 $20,252 $12,467 9/30/2002 $18,950 $10,841 10/31/2002 $18,979 $11,889 11/30/2002 $19,155 $12,478 12/31/2002 $18,952 $12,023 1/31/2003 $18,406 $11,459 2/28/2003 $17,831 $11,098 3/31/2003 $18,067 $10,930 4/30/2003 $19,497 $12,430 5/31/2003 $20,722 $13,260 6/30/2003 $20,972 $13,397 7/31/2003 $21,432 $13,664 8/31/2003 $21,877 $13,664 9/30/2003 $22,218 $13,948 10/31/2003 $23,123 $14,867 11/30/2003 $23,953 $15,495 12/31/2003 $24,921 $16,776 1/31/2004 $25,176 $16,979 2/29/2004 $25,987 $17,492 3/31/2004 $25,867 $16,986 4/30/2004 $25,657 $16,831 5/31/2004 $25,702 $17,114 6/30/2004 $26,251 $17,353 7/31/2004 $25,933 $16,880 8/31/2004 $25,994 $16,907 9/30/2004 $26,735 $17,596 10/31/2004 $27,401 $18,240 11/30/2004 $28,838 $19,566 12/31/2004 $29,958 $20,400 12 | 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: Shares are available to certain eligible investors as described in the prospectus. CLASS A: Prior to 8/3/98, these shares were offered at a lower initial sales charge; thus actual total returns may differ. CLASS B: These shares have higher annual fees and expenses than Class A shares. CLASS C: Prior to 1/1/04, these shares were offered with an initial sales charge; thus actual total returns would have differed. 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. If the manager had not taken this action, 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 a sales charge. (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. (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. (5) Source: Standard & Poor's Micropal. The MSCI AC 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 | 13 YOUR FUND'S EXPENSES As a Fund shareholder, you can incur two types of costs: o Transaction costs, including sales charges (loads) on Fund purchases and redemption fees; and o Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. The following table shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated. ACTUAL FUND EXPENSES The first line (Actual) for each share class listed in the table below provides actual account values and expenses. The "Ending Account Value" is derived from the Fund's actual return, which includes the effect of Fund expenses. You can estimate the expenses you paid during the period, by following these steps. OF COURSE, YOUR ACCOUNT VALUE AND EXPENSES WILL DIFFER FROM THOSE IN THIS ILLUSTRATION: 1. Divide your account value by $1,000. IF AN ACCOUNT HAD AN $8,600 VALUE, THEN $8,600 / $1,000 = 8.6. 2. Multiply the result by the number under the heading "Expenses Paid During Period." IF EXPENSES PAID DURING PERIOD WERE $7.50, THEN 8.6 X $7.50 = $64.50. In this illustration, the estimated expenses paid this period are $64.50. HYPOTHETICAL EXAMPLE FOR COMPARISON WITH OTHER FUNDS Information in the second line (Hypothetical) for each class in the table can help you compare ongoing costs of investing in the Fund with those of other mutual funds. This information may not be used to estimate the actual ending account balance or expenses you paid during the period. The hypothetical "Ending Account Value" is based on the actual expense ratio for each class and an assumed 5% annual rate of return before expenses, which does not represent the Fund's actual return. The figure under the heading "Expenses Paid During Period" shows the hypothetical expenses your account would have incurred under this scenario. You can compare this figure with the 5% hypothetical examples that appear in shareholder reports of other funds. 14 | Annual Report YOUR FUND'S EXPENSES (CONTINUED) PLEASE NOTE THAT EXPENSES SHOWN IN THE TABLE ARE MEANT TO HIGHLIGHT ONGOING COSTS AND DO NOT REFLECT ANY TRANSACTION COSTS, SUCH AS SALES CHARGES OR REDEMPTION FEES. Therefore, the second line for each class is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transaction costs were included, your total costs would have been higher. Please refer to the Fund prospectus for additional information on operating expenses.
- -------------------------------------------------------------------------------------------------- BEGINNING ACCOUNT ENDING ACCOUNT EXPENSES PAID DURING CLASS Z VALUE 6/30/04 VALUE 12/31/04 PERIOD* 6/30/04-12/31/04 - -------------------------------------------------------------------------------------------------- Actual $1,000 $1,148.70 $ 5.73 - -------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,019.81 $ 5.38 - -------------------------------------------------------------------------------------------------- CLASS A - -------------------------------------------------------------------------------------------------- Actual $1,000 $1,146.90 $ 7.61 - -------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,018.05 $ 7.15 - -------------------------------------------------------------------------------------------------- CLASS B - -------------------------------------------------------------------------------------------------- Actual $1,000 $1,143.40 $11.10 - -------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,014.78 $10.43 - -------------------------------------------------------------------------------------------------- CLASS C - -------------------------------------------------------------------------------------------------- Actual $1,000 $1,143.30 $11.10 - -------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,014.78 $10.43 - --------------------------------------------------------------------------------------------------
* Expenses are equal to the annualized expense ratio for each class (Z: 1.06%; A: 1.41%; B: 2.06%; and C: 2.06%), multiplied by the average account value over the period, multiplied by 184/366 to reflect the one-half year period. Annual Report | 15 MUTUAL EUROPEAN FUND FINANCIAL HIGHLIGHTS
------------------------------------------------------------ YEAR ENDED DECEMBER 31, CLASS Z 2004 2003 2002 2001 2000 ------------------------------------------------------------ PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ........................... $ 16.79 $ 12.97 $ 14.43 $ 15.52 $ 16.89 ------------------------------------------------------------ Income from investment operations: Net investment income(a) .................................... .37 .32 .27 .35 .35 Net realized and unrealized gains (losses) .................. 3.21 3.93 (1.38) (1.08) 1.98 ------------------------------------------------------------ Total from investment operations ............................. 3.58 4.25 (1.11) (.73) 2.33 ------------------------------------------------------------ Less distributions from: Net investment income ....................................... (.60) (.43) (.25) (.32) (.54) Net realized gains .......................................... (.02) -- (.10) (.04) (3.16) ------------------------------------------------------------ Total distributions .......................................... (.62) (.43) (.35) (.36) (3.70) ------------------------------------------------------------ Redemption fees .............................................. --(d) --(d) -- -- -- ------------------------------------------------------------ Net asset value, end of year ................................. $ 19.75 $ 16.79 $ 12.97 $ 14.43 $ 15.52 ============================================================ Total return(b) .............................................. 21.58% 32.84% (7.71)% (4.74)% 14.46% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) .............................. $ 650,547 $ 498,667 $ 376,828 $448,732 $ 577,663 Ratios to average net assets:* Expenses(c) ................................................. 1.07% 1.08% 1.05% 1.05% 1.04% Expenses, net of waiver and payments by affiliate(c) ........ 1.07% 1.08% 1.05% 1.05% 1.03% Net investment income ....................................... 2.10% 2.19% 1.88% 2.27% 1.93% Portfolio turnover rate ...................................... 33.11% 52.33% 29.86% 52.15% 111.83% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .................................................... 1.07% 1.08% 1.04% 1.04% 1.04% Expenses, net of waiver and payments by affiliate ........... 1.07% 1.08% 1.04% 1.04% 1.03%
(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 only operating expenses. (d) Amount is less than $0.001 per share. 16 | See notes to financial statements. | Annual Report MUTUAL EUROPEAN FUND FINANCIAL HIGHLIGHTS (CONTINUED)
------------------------------------------------------------ YEAR ENDED DECEMBER 31, CLASS A 2004 2003 2002 2001 2000 ------------------------------------------------------------ PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ........................... $ 16.59 $ 12.83 $ 14.27 $ 15.36 $ 16.75 ------------------------------------------------------------ Income from investment operations: Net investment income(a) .................................... .31 .26 .22 .28 .28 Net realized and unrealized gains (losses) .................. 3.16 3.88 (1.35) (1.06) 1.97 ------------------------------------------------------------ Total from investment operations ............................. 3.47 4.14 (1.13) (.78) 2.25 ------------------------------------------------------------ Less distributions from: Net investment income ....................................... (.54) (.38) (.21) (.27) (.48) Net realized gains .......................................... (.02) -- (.10) (.04) (3.16) ------------------------------------------------------------ Total distributions .......................................... (.56) (.38) (.31) (.31) (3.64) ------------------------------------------------------------ Redemption fees .............................................. --(d) --(d) -- -- -- ------------------------------------------------------------ Net asset value, end of year ................................. $ 19.50 $ 16.59 $ 12.83 $ 14.27 $ 15.36 ============================================================ Total return(b) .............................................. 21.23% 32.34% (8.05)% (5.05)% 14.07% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) .............................. $ 545,120 $ 417,630 $ 302,735 $254,632 $ 223,831 Ratios to average net assets:* Expenses(c) ................................................. 1.42% 1.43% 1.40% 1.40% 1.39% Expenses, net of waiver and payments by affiliate(c) ....... 1.42% 1.43% 1.40% 1.40% 1.38% Net investment income ....................................... 1.75% 1.84% 1.53% 1.88% 1.56% Portfolio turnover rate ...................................... 33.11% 52.33% 29.86% 52.15% 111.83% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .................................................... 1.42% 1.43% 1.39% 1.39% 1.39% Expenses, net of waiver and payments by affiliate ........... 1.42% 1.43% 1.39% 1.39% 1.38%
(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 only operating expenses. (d) Amount is less than $0.001 per share. Annual Report | See notes to financial statements. | 17 MUTUAL EUROPEAN FUND FINANCIAL HIGHLIGHTS (CONTINUED)
------------------------------------------------------------ YEAR ENDED DECEMBER 31, CLASS B 2004 2003 2002 2001 2000 ------------------------------------------------------------ PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ........................... $ 16.31 $ 12.64 $ 14.09 $ 15.19 $ 16.66 ------------------------------------------------------------ Income from investment operations: Net investment income(a) .................................... .19 .16 .10 .18 .16 Net realized and unrealized gains (losses) .................. 3.10 3.81 (1.31) (1.03) 1.95 ------------------------------------------------------------ Total from investment operations ............................. 3.29 3.97 (1.21) (.85) 2.11 ------------------------------------------------------------ Less distributions from: Net investment income ....................................... (.44) (.30) (.14) (.21) (.42) Net realized gains .......................................... (.02) -- (.10) (.04) (3.16) ------------------------------------------------------------ Total distributions .......................................... (.46) (.30) (.24) (.25) (3.58) ------------------------------------------------------------ Redemption fees .............................................. --(d) --(d) -- -- -- ------------------------------------------------------------ Net asset value, end of year ................................. $ 19.14 $ 16.31 $ 12.64 $ 14.09 $ 15.19 ============================================================ Total return(b) .............................................. 20.41% 31.45% (8.61)% (5.66)% 13.31% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) .............................. $ 50,216 $ 38,526 $ 24,855 $ 12,960 $ 6,655 Ratios to average net assets:* Expenses(c) ................................................. 2.07% 2.08% 2.05% 2.03% 2.04% Expenses, net of waiver and payments by affiliate(c) ....... 2.07% 2.08% 2.05% 2.03% 2.03% Net investment income ....................................... 1.10% 1.19% .87% 1.20% .92% Portfolio turnover rate ...................................... 33.11% 52.33% 29.86% 52.15% 111.83% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .................................................... 2.07% 2.08% 2.04% 2.02% 2.04% Expenses, net of waiver and payments by affiliate ........... 2.07% 2.08% 2.04% 2.02% 2.03%
(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 only operating expenses. (d) Amount is less than $0.001 per share. 18 | See notes to financial statements. | Annual Report MUTUAL EUROPEAN FUND FINANCIAL HIGHLIGHTS (CONTINUED)
------------------------------------------------------------ YEAR ENDED DECEMBER 31, CLASS C 2004 2003 2002 2001 2000 ------------------------------------------------------------ PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ........................... $ 16.60 $ 12.85 $ 14.29 $ 15.37 $ 16.75 ------------------------------------------------------------ Income from investment operations: Net investment income(a) .................................... .20 .17 .13 .19 .16 Net realized and unrealized gains (losses) .................. 3.15 3.87 (1.35) (1.06) 1.99 ------------------------------------------------------------ Total from investment operations ............................. 3.35 4.04 (1.22) (.87) 2.15 ------------------------------------------------------------ Less distributions from: Net investment income ....................................... (.43) (.29) (.12) (.17) (.37) Net realized gains .......................................... (.02) -- (.10) (.04) (3.16) ------------------------------------------------------------ Total distributions .......................................... (.45) (.29) (.22) (.21) (3.53) ------------------------------------------------------------ Redemption fees .............................................. --(d) --(d) -- -- -- ------------------------------------------------------------ Net asset value, end of year ................................. $ 19.50 $ 16.60 $ 12.85 $ 14.29 $ 15.37 ============================================================ Total return(b) .............................................. 20.43% 31.49% (8.65)% (5.65)% 13.42% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) .............................. $ 205,197 $ 166,758 $ 123,374 $117,238 $ 127,408 Ratios to average net assets:* Expenses(c) ................................................. 2.07% 2.08% 2.02% 2.04% 2.03% Expenses, net of waiver and payments by affiliate(c) ....... 2.07% 2.08% 2.02% 2.04% 2.02% Net investment income ....................................... 1.10% 1.19% .91% 1.27% .92% Portfolio turnover rate ...................................... 33.11% 52.33% 29.86% 52.15% 111.83% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .................................................... 2.07% 2.08% 2.01% 2.03% 2.03% Expenses, net of waiver and payments by affiliate ........... 2.07% 2.08% 2.01% 2.03% 2.02%
(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 only operating expenses. (d) Amount is less than $0.001 per share. Annual Report | See notes to financial statements. | 19 MUTUAL EUROPEAN FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004
- ---------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES/WARRANTS VALUE - ---------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 84.3% BEVERAGES 5.5% C&C Group PLC ................................................. Irish Republic 1,697,600 $ 6,818,781 Carlsberg AS, A ............................................... Denmark 28,600 1,314,667 Carlsberg AS, B ............................................... Denmark 539,506 27,259,955 Diageo PLC .................................................... United Kingdom 1,721,908 24,557,135 Heineken Holding NV, A ........................................ Netherlands 671,476 20,274,041 ------------------ 80,224,579 ------------------ CAPITAL MARKETS 2.7% Aareal Bank AG ................................................ Germany 22,600 745,237 Irish Life & Permanent PLC .................................... Irish Republic 1,045,905 19,344,956 (a) Schroders PLC, non-voting ..................................... United Kingdom 244,377 3,304,610 Schroders PLC ................................................. United Kingdom 1,139,584 16,427,264 ------------------ 39,822,067 ------------------ CHEMICALS 3.9% Givaudan AG ................................................... Switzerland 32,675 21,516,528 Linde AG ...................................................... Germany 184,723 11,508,214 (a) MG Technologies AG ............................................ Germany 1,023,294 12,080,901 Solvay SA ..................................................... Belgium 109,700 12,057,890 ------------------ 57,163,533 ------------------ COMMERCIAL BANKS 7.6% Allied Irish Banks PLC ........................................ Irish Republic 1,813,400 37,600,760 Almanij NV .................................................... Belgium 265,474 27,162,704 Bank of Ireland ............................................... Irish Republic 1,034,775 17,086,594 BNP Paribas SA ................................................ France 200,200 14,480,079 Danske Bank ................................................... Denmark 444,900 13,613,632 ------------------ 109,943,769 ------------------ COMMERCIAL SERVICES & SUPPLIES .5% (a) Techem AG ..................................................... Germany 211,581 7,694,690 ------------------ CONSTRUCTION & ENGINEERING 1.5% Imtech NV ..................................................... Netherlands 606,012 21,340,188 ------------------ CONSTRUCTION MATERIALS 2.8% Ciments Francais SA ........................................... France 113,977 10,641,070 CRH PLC ....................................................... Irish Republic 500,200 13,385,366 Italcementi SpA ............................................... Italy 722,765 11,622,381 RMC Group PLC ................................................. United Kingdom 343,335 5,595,060 ------------------ 41,243,877 ------------------ CONSUMER FINANCE .7% Provident Financial PLC ....................................... United Kingdom 764,922 9,866,551 ------------------ CONTAINERS & PACKAGING 1.1% Huhtamaki OYJ ................................................. Finland 1,017,240 16,343,866 ------------------ DISTRIBUTORS 1.4% Compania de Distribucion Integral Logista SA .................. Spain 322,008 17,430,520 Inchcape PLC .................................................. United Kingdom 61,661 2,313,856 ------------------ 19,744,376 ------------------
20 | Annual Report MUTUAL EUROPEAN FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES/WARRANTS VALUE - ---------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) DIVERSIFIED FINANCIAL SERVICES 2.9% Deutsche Bourse AG ............................................ Germany 203,100 $ 12,203,859 Euronext ...................................................... Netherlands 453,279 13,821,282 London Stock Exchange PLC ..................................... United Kingdom 2,800 31,280 (b) Marconi Corp., Contingent Distribution ........................ United Kingdom 28,582,000 -- Pargesa Holdings SA ........................................... Switzerland 4,384 15,396,637 ------------------ 41,453,058 ------------------ DIVERSIFIED TELECOMMUNICATION SERVICES 3.3% (a),(c),(d) AboveNet Inc. ................................................. United States 83,713 2,006,048 (a),(b),(d) AboveNet Inc., Contingent Distribution ........................ United States 11,722,000 -- (a),(c),(d) AboveNet Inc., wts., 9/08/08 .................................. United States 2,816 18,022 (a),(c),(d) AboveNet Inc., wts., 9/08/10 .................................. United States 3,313 13,252 (a) Belgacom SA ................................................... Belgium 169,600 7,318,678 Koninklijke KPN NV ............................................ Netherlands 1,085,300 10,294,533 Swisscom AG ................................................... Switzerland 35,000 13,644,146 Telekom Austria AG ............................................ Austria 615,000 11,642,037 (a),(b) Telewest Communications PLC, Contingent Distribution .......... United Kingdom 1,090,947 -- (a),(b) Telewest Finance Ltd., Contingent Distribution ................ United Kingdom 1,465,000 -- (a) Telewest Global Inc. .......................................... United Kingdom 199,109 3,500,336 ------------------ 48,437,052 ------------------ ELECTRIC UTILITIES .6% E.ON AG ....................................................... Germany 93,800 8,551,110 ------------------ ENERGY EQUIPMENT & SERVICES .5% Fugro NV ...................................................... Netherlands 90,665 7,554,186 ------------------ FOOD & STAPLES RETAILING .6% Groupe Bourbon ................................................ France 169,849 8,327,423 ------------------ FOOD PRODUCTS 9.2% Cadbury Schweppes PLC ......................................... United Kingdom 2,410,112 22,436,645 CSM NV ........................................................ Netherlands 234,900 7,305,960 Groupe Danone ................................................. France 267,470 24,662,903 Nestle SA ..................................................... Switzerland 96,837 25,294,356 Orkla ASA ..................................................... Norway 1,355,140 44,467,818 Rieber & Son ASA .............................................. Norway 1,006,050 9,290,010 ------------------ 133,457,692 ------------------ HEALTH CARE PROVIDERS & SERVICES .7% OPG Groep NV .................................................. Netherlands 124,065 7,239,313 Rhoen-Klinikum AG ............................................. Germany 44,307 2,717,631 ------------------ 9,956,944 ------------------ HOUSEHOLD DURABLES 1.2% Hunter Douglas NV ............................................. Netherlands 328,929 17,519,491 ------------------ INDUSTRIAL CONGLOMERATES .2% Wendel Investissement ......................................... France 31,413 2,295,487 ------------------ INSURANCE 4.5% (a) Berkshire Hathaway Inc., A .................................... United States 203 17,843,700 Catlin Group .................................................. United Kingdom 1,003,900 6,315,564 Montpelier Re Holdings Ltd. ................................... Bermuda 36,493 1,403,156
Annual Report | 21 MUTUAL EUROPEAN FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES/WARRANTS VALUE - ---------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS and Other Equity Interests (CONT.) INSURANCE (CONT.) (a),(c) Olympus Re Holdings Ltd. ...................................... Bermuda 16,080 $ 2,752,574 White Mountains Insurance Group Inc. .......................... United States 58,172 37,579,112 ------------------ 65,894,106 ------------------ LEISURE EQUIPMENT & PRODUCTS .2% Agfa Gevaert NV ............................................... Belgium 95,626 3,238,920 ------------------ MACHINERY 5.0% Alfa Laval AB ................................................. Sweden 312,700 5,059,718 Kone Corp., B ................................................. Finland 289,690 22,424,912 Schindler Holding AG .......................................... Switzerland 62,378 24,700,363 Schindler Holding AG, Reg D ................................... Switzerland 49,081 20,469,270 ------------------ 72,654,263 ------------------ MARINE .8% A P Moller - Maersk A/S ....................................... Denmark 1,374 11,328,548 ------------------ MEDIA 6.3% British Sky Broadcasting Group PLC ............................ United Kingdom 533,400 5,753,979 Hollinger International Inc. .................................. United States 215,694 3,043,874 (a) JC Decaux SA .................................................. France 212,783 6,202,273 (a) NTL Inc. ...................................................... United Kingdom 623,405 45,483,629 NV Holdingsmig De Telegraaf ................................... Netherlands 274,319 6,793,575 SES Global, FDR ............................................... Luxembourg 1,806,864 23,415,773 ------------------ 90,693,103 ------------------ METALS & MINING 5.6% Anglo American PLC ............................................ United Kingdom 1,189,981 28,140,362 Anglo American PLC, ADR ....................................... United Kingdom 200 4,758 Barrick Gold Corp. ............................................ Canada 111,300 2,695,686 Highland Gold Mining Ltd. ..................................... United Kingdom 2,407,200 8,825,199 (a) KGHM Polska Miedz SA .......................................... Poland 1,572,454 16,337,862 (a) KGHM Polska Miedz SA, GDR ..................................... Poland 26,800 562,800 (a) Rio Narcea Gold Mines Ltd. .................................... Canada 4,430,100 10,157,815 Vedanta Resources PLC ......................................... United Kingdom 1,999,000 15,146,555 ------------------ 81,871,037 ------------------ MULTILINE RETAIL .2% Jelmoli Holding AG ............................................ Switzerland 2,100 3,033,057 ------------------ OIL & GAS 3.2% BP PLC ........................................................ United Kingdom 747,800 7,291,689 Eni SpA ....................................................... Italy 361,200 9,028,529 Norsk Hydro ASA ............................................... Norway 88,200 6,937,381 Royal Dutch Petroleum Co. ..................................... Netherlands 110,700 6,361,810 Statoil ASA ................................................... Norway 329,800 5,166,338 Total SA, B ................................................... France 53,750 11,721,252 ------------------ 46,506,999 ------------------ PERSONAL PRODUCTS .3% Beiersdorf AG ................................................. Germany 32,735 3,816,685 ------------------
22 | Annual Report MUTUAL EUROPEAN FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES/WARRANTS VALUE - ---------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) PHARMACEUTICALS .5% Sanofi-Aventis ................................................ France 94,596 $ 7,547,963 ------------------ REAL ESTATE .1% (a) Canary Wharf Group PLC ........................................ United Kingdom 192,100 1,091,436 (a),(c) Security Capital European Realty .............................. Luxembourg 5,281 38,023 ------------------ 1,129,459 ------------------ SPECIALTY RETAIL .6% Fielmann AG ................................................... Germany 114,876 8,137,284 ------------------ TOBACCO 10.1% Altadis SA .................................................... Spain 1,086,551 49,688,933 British American Tobacco PLC .................................. United Kingdom 2,957,758 50,953,737 Gallaher Group PLC ............................................ United Kingdom 967,200 14,694,207 Imperial Tobacco Group PLC .................................... United Kingdom 1,163,365 31,865,367 ------------------ 147,202,244 ------------------ TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $810,538,930)................................ 1,223,993,607 ------------------ PREFERRED STOCKS 1.1% DIVERSIFIED TELECOMMUNICATION SERVICES PTV Inc., 10.00%, A, pfd. ..................................... United Kingdom 46,841 212,190 ------------------ FOOD PRODUCTS .1% Unilever NV, pfd. ............................................. Netherlands 275,284 1,871,537 ------------------ HEALTH CARE PROVIDERS & SERVICES .4% Rhoen Klinikum AG, pfd. ....................................... Germany 79,126 4,840,417 ------------------ MACHINERY .6% Jungheinrich AG, pfd. ......................................... Germany 448,649 8,505,165 ------------------ TOTAL PREFERRED STOCKS (COST $15,906,033)...................... 15,429,309 ------------------ ------------------- PRINCIPAL AMOUNT(e) ------------------- CORPORATE BONDS & NOTES 4.0% Eurotunnel PLC, FRN, 6.347%, 12/31/18, Tier 2 ................................... United Kingdom 7,595,283 GBP 10,496,763 6.347%, 12/31/25, Tier 3 ................................... United Kingdom 14,210,422 GBP 11,456,058 Participating Loan Note, 1.00%, 4/30/40 .................... United Kingdom 210,000 GBP 46,355 Eurotunnel SA, FRN, 3.449%, 12/31/18, Tier 2 (LIBOR) ........................... France 988,713 EUR 966,012 3.449%, 12/31/25, Tier 3 (LIBOR) ........................... France 8,732,014 EUR 4,976,722 3.453%, 12/31/18, Tier 2 (PIBOR) ........................... France 437,395 EUR 427,352 3.453%, 12/31/25, Tier 3 (PIBOR) ........................... France 5,798,977 EUR 3,305,068 Seton House Finance Ltd., zero cpn., 2/07/12 .................. United Kingdom 76,357,000 EUR 26,422,183 ------------------ TOTAL CORPORATE BONDS & NOTES (COST $59,566,419)............... 58,096,513 ------------------ GOVERNMENT AGENCIES 11.1% Bank of Ireland, 2.35%, 2/22/05 ............................... Irish Republic 10,000,000 9,962,311 Federal Home Loan Bank, 1.250% - 2.743%, 1/03/05 - 11/16/05 ... United States 75,100,000 74,715,718 Federal Republic of Germany, 2.50% - 4.25%, 2/18/05 - 9/16/05 . Germany 22,500,000 EUR 30,601,999
Annual Report | 23 MUTUAL EUROPEAN FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- COUNTRY PRINCIPAL AMOUNT(e) VALUE - ---------------------------------------------------------------------------------------------------------------------------------- GOVERNMENT AGENCIES (CONT.) German Treasury Bills, 2.028% - 2.090%, 1/12/05 - 3/16/05 ..... Germany 30,000,000 EUR $ 40,546,234 Kingdom of Norway, 6.75%, 1/15/07 ............................. Norway 13,450,000 NOK 2,404,519 U.S. Treasury Bill, 1.895%, 2/24/05 ........................... United States 3,000,000 2,991,477 ------------------ TOTAL GOVERNMENT AGENCIES (COST $153,536,935) ................. 161,222,258 ------------------ TOTAL INVESTMENTS (COST $1,039,548,317) 100.5% ................ 1,458,741,687 NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS (1.5)% ...... (21,568,703) OTHER ASSETS, LESS LIABILITIES 1.0% ........................... 13,907,067 ------------------ NET ASSETS 100.0% ............................................. $ 1,451,080,051 ==================
CURRENCY ABBREVIATIONS: | EUR - Euro | GBP - British Pound | NOK - Norwegian Krone (a) Non-income producing. (b) Contingent Distributions represent the right to receive additional distributions, if any, during the reorganization of the underlying company. Shares represent total underlying principal of debt securities. (c) See Note 9 regarding restricted securities. (d) See Note 10 regarding other considerations. (e) The principal amount is stated in U.S. Dollars unless otherwise indicated. 24 | See notes to financial statements. | Annual Report MUTUAL EUROPEAN FUND FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2004 Assets: Investments in securities: Cost ..................................................... $ 1,039,548,317 ================ Value .................................................... 1,458,741,687 Cash ...................................................... 3,011,980 Foreign currency, at value (cost $4,103,493) .............. 4,171,898 Receivables: Investment securities sold ............................... 2,206,446 Capital shares sold ...................................... 2,767,577 Dividends and interest ................................... 4,448,887 Unrealized gain on forward exchange contracts (Note 8) ...................................... 622,537 Due from broker - synthetic equity swaps .................. 1,004,258 Cash on deposit with brokers for securities sold short ................................... 402,535 ---------------- Total assets ......................................... 1,477,377,805 ---------------- Liabilities: Payables: Investment securities purchased .......................... 1,435,030 Capital shares redeemed .................................. 854,458 Affiliates ............................................... 1,629,809 Unrealized loss on forward exchange contracts (Note 8) ...................................... 22,191,240 Other liabilities ......................................... 187,217 ---------------- Total liabilities .................................... 26,297,754 ---------------- Net assets, at value ............................... $ 1,451,080,051 ================ Net assets consist of: Distributions in excess of net investment income ....................................... $ (7,485,194) Net unrealized appreciation (depreciation) ................ 398,030,123 Accumulated net realized gain (loss) ...................... 4,537,083 Capital shares ............................................ 1,055,998,039 ---------------- Net assets, at value ............................... $ 1,451,080,051 ================ Annual Report | See notes to financial statements. | 25 MUTUAL EUROPEAN FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2004 CLASS Z: Net assets, at value ...................................... $ 650,547,205 ================ Shares outstanding ........................................ 32,946,989 ================ Net asset value and maximum offering price per share(a) ... $ 19.75 ================ CLASS A: Net assets, at value ...................................... $ 545,120,003 ================ Shares outstanding ........................................ 27,959,724 ================ Net asset value per share(a) .............................. $ 19.50 ================ Maximum offering price per share (Net asset value per share / 94.25%) .......................................... $ 20.69 ================ CLASS B: Net assets, at value ...................................... $ 50,216,323 ================ Shares outstanding ........................................ 2,623,050 ================ Net asset value and maximum offering price per share(a) ... $ 19.14 ================ CLASS C: Net assets, at value ...................................... $ 205,196,520 ================ Shares outstanding ........................................ 10,523,291 ================ Net asset value and maximum offering price per share(a) ... $ 19.50 ================ (a) Redemption price is equal to net asset value less contingent deferred sales charges, if applicable, and redemption fees retained by the Fund. 26 | See notes to financial statements. | Annual Report MUTUAL EUROPEAN FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2004 Investment income Dividends (net of foreign taxes of $3,638,487) ............ $ 27,368,288 Interest .................................................. 11,517,696 ---------------- Total investment income ............................. 38,885,984 ---------------- Expenses: Management fees (Note 3 ................................... 9,763,736 Administrative fees (Note3) ............................... 946,718 Distribution fees (Note 3) Class A .................................................. 1,598,442 Class B .................................................. 427,815 Class C .................................................. 1,781,252 Transfer agent fees (Note 3) .............................. 1,700,100 Custodian fees (Note 4) ................................... 317,669 Reports to shareholders ................................... 71,800 Registration and filing fees .............................. 83,600 Professional fees ......................................... 101,050 Directors' fees and expenses .............................. 32,300 Dividends on securities sold short ........................ 7,019 Other ..................................................... 62,243 ---------------- Total expenses ....................................... 16,893,744 Expense reductions (Note 4) .......................... (984) ---------------- Net expenses ....................................... 16,892,760 ---------------- Net investment income ......................... 21,993,224 ---------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments ............................................. 101,132,292 Written options ......................................... 38,401 Foreign currency transactions ........................... (50,583,697) Securities sold short ................................... (305,514) ---------------- Net realized gain (loss) ........................... 50,281,482 Net change in unrealized appreciation (depreciation) on: Investments .............................................. 162,019,483 Translation of assets and liabilities denominated in foreign currencies .................................. 13,280,678 ---------------- Net change in unrealized appreciation (depreciation) ................................... 175,300,161 ---------------- Net realized and unrealized gain (loss) .................... 225,581,643 ---------------- Net increase (decrease) in net assets resulting from operations .......................................... $ 247,574,867 ================ Annual Report | See notes to financial statements. | 27 MUTUAL EUROPEAN FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS for the years ended December 31, 2004 and 2003
---------------------------------- 2004 2003 ---------------------------------- Increase (decrease) in net assets: Operations: Net investment income ........................................................ $ 21,993,224 $ 17,284,876 Net realized gain (loss) from investments, written options, foreign currency transactions, and securities sold short .................................... 50,281,482 30,833,499 Net change in unrealized appreciation (depreciation) on investments and translation of assets and liabilities denominated in foreign currencies .... 175,300,161 221,319,572 ---------------------------------- Net increase (decrease) in net assets resulting from operations .......... 247,574,867 269,437,947 Distributions to shareholders from: Net investment income: Class Z ..................................................................... (19,099,453) (12,312,122) Class A ..................................................................... (14,530,645) (9,204,752) Class B ..................................................................... (1,110,260) (674,637) Class C ..................................................................... (4,388,373) (2,826,2118) Net realized gains: Class Z ..................................................................... (737,739) -- Class A ..................................................................... (624,939) -- Class B ..................................................................... (59,493) -- Class C ..................................................................... (236,978) -- ---------------------------------- Total distributions to shareholders ........................................... (40,787,880) (25,017,729) Capital share transactions (Note 2): Class Z ..................................................................... 58,975,823 11,633,420 Class A ..................................................................... 50,452,466 24,799,438 Class B ..................................................................... 4,515,208 5,657,600 Class C ..................................................................... 8,767,698 7,277,297 ---------------------------------- Total capital share transactions .............................................. 122,711,195 49,367,755 Redemption fees ............................................................... 787 1,100 ---------------------------------- Net increase (decrease) in net assets ..................................... 329,498,969 293,789,073 Net assets: Beginning of year ............................................................. 1,121,581,082 827,792,009 ---------------------------------- End of year ................................................................... $ 1,451,080,051 $ 1,121,581,082 ================================== Distributions in excess of net investment income/undistributed net investment income included in net assets: End of year ................................................................... $ (7,485,194) $ 2,043,383 ==================================
28 | See notes to financial statements. | Annual Report 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), consisting of 6 separate series. The Company is an open-end investment company registered under the Investment Company Act of 1940. The financial statements of the remaining funds in the series are presented separately. 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 on a securities exchange or on the NASDAQ National Market System, are valued at the last quoted sale price or the official closing price of the day, respectively. Over-the-counter securities and listed securities for which there is no reported sale are valued within the range of the most recent quoted bid and ask prices. Securities that trade in multiple markets or on multiple exchanges are valued according to the broadest and most representative market. Corporate debt securities and U.S. Government securities generally trade in the over-the-counter market rather than on a securities exchange. The Fund may utilize independent pricing services, quotations from bond dealers, and information with respect to bond and note transactions, to assist in determining a current market value for each security. The Fund's pricing services may use valuation models or matrix pricing which considers information with respect to comparable bond and note transactions, quotations from bond dealers, or by reference to other securities that are considered comparable in such characteristics as rating, interest rate and maturity date, option adjusted spread models, prepayment projections, interest rate spreads and yield curves, to determine current value. Foreign securities are valued as of the close of trading on the foreign stock exchange on which the security is primarily traded, or the NYSE, whichever is earlier. The value is then converted into its U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the day that the value of the foreign security is determined. If no sale is reported at that time, the foreign security will be valued within the range of the most recent quoted bid and ask prices. Annual Report | 29 MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. Some methods for valuing these securities may include: fundamental analysis, matrix pricing, discounts from market prices of similar securities, or discounts applied due to the nature and duration of restrictions on the disposition of the securities. Occasionally, events occur between the time at which trading in a security is completed and the close of the NYSE that might call into question the availability (including the reliability) of the value of a portfolio security held by the Fund. If such an event occurs, the securities may be valued using fair value procedures, which may include the use of independent pricing services. All security valuation procedures are approved by the Fund's 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, income and expense items denominated in foreign currencies are translated into U.S. dollars at the exchange rate in effect on the transaction date. Occasionally, events may impact the availability or reliability of foreign exchange rates used to convert the U.S. dollar equivalent value. If such an event occurs, the foreign exchange rate will be valued at fair value using procedures established and approved by the Fund's Board of Directors. 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 on the Statement of Operations. 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. SECURITIES PURCHASED ON A WHEN-ISSUED OR DELAYED DELIVERY 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. 30 | Annual Report MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) D. 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 by the Fund and any equity therein is included in the Statement of Assets and Liabilities. Realized and unrealized gains and losses on these contracts 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 on these contracts 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. E. 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 to 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 synthetic equity swaps include unfavorable price movements in the underlying securities or the inability of the counterparties to fulfill their obligations under the contract. F. 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. Upon closing of an option, other than by exercise, which 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) G. 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 incurs 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 realizes a gain if the price of the security declines between those dates. Gains are limited to the price at which the Fund sold the security short, while losses are potentially unlimited in size. 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 with the broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. The Fund is obligated to pay the counterparty any dividends or interest due on securities sold short. Such dividends and interest are recorded as an expense to the Fund. H. INCOME TAXES No provision has been made for U.S. income taxes because the Fund's policy is to qualify as a regulated investment company under Sub Chapter M of the Internal Revenue Code and to distribute substantially all of its taxable income. Fund distributions to shareholders are determined on an income tax basis and may differ from net investment income and realized gains for financial reporting purposes. 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. Interest income and estimated expenses are accrued daily. Discounts and premiums 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 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. J. 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 expenses during the reporting period. Actual results could differ from those estimates. 32 | Annual Report MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) K. REDEMPTION FEES Redemptions and exchanges of Fund shares held five trading days or less (30 days or less prior to June 1, 2004 and 90 days or less prior to 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 as noted in the Statements of Changes in Net Assets. L. GUARANTEES AND INDEMNIFICATIONS Under the Fund's organizational documents, its officers and directors are indemnified by the Fund 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. Effective March 1, 2005, Class B shares will no longer be offered except to existing Class B shareholders through reinvested distributions or exchanges into other Franklin Templeton funds' Class B shares, as permitted by the applicable fund prospectus. 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, 2004, 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 DECEMBER 31, 2004 2003 -------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT -------------------------------------------------------- CLASS Z SHARES: Shares sold ......................... 5,037,189 $ 89,701,240 4,684,777 $ 68,107,081 Shares issued in reinvestment of distributions ...................... 985,268 18,482,745 714,450 11,398,120 Shares redeemed ..................... (2,784,547) (49,208,162) (4,740,063) (67,871,781) -------------------------------------------------------- Net increase (decrease) ............. 3,237,910 $ 58,975,823 659,164 $ 11,633,420 ======================================================== CLASS A SHARES: Shares sold ......................... 7,412,359 $130,660,983 12,000,233 $ 166,037,567 Shares issued in reinvestment of distributions ...................... 644,632 11,925,302 458,004 7,210,266 Shares redeemed ..................... (5,274,697) (92,133,819) (10,877,741) (148,448,395) -------------------------------------------------------- Net increase (decrease) ............. 2,782,294 $ 50,452,466 1,580,496 $ 24,799,438 ========================================================
Annual Report | 33 MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED)
-------------------------------------------------------- YEAR ENDED DECEMBER 31, 2004 2003 -------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT -------------------------------------------------------- CLASS B SHARES: Shares sold ......................... 470,582 $ 8,073,637 659,571 $ 9,134,856 Shares issued in reinvestment of distributions ...................... 57,630 1,042,916 39,099 602,729 Shares redeemed ..................... (267,734) (4,601,345) (303,139) (4,079,985) -------------------------------------------------------- Net increase (decrease) ............. 260,478 $ 4,515,208 395,531 $ 5,657,600 ======================================================== CLASS C SHARES: Shares sold ......................... 1,880,792 $ 33,100,927 2,531,542 $ 35,820,953 Shares issued in reinvestment of distributions ...................... 224,707 4,138,711 162,005 2,534,802 Shares redeemed ..................... (1,629,046) (28,471,940) (2,246,768) (31,078,458) -------------------------------------------------------- Net increase (decrease) .............. 476,453 $ 8,767,698 446,779 $ 7,277,297 ========================================================
3. TRANSACTIONS WITH AFFILIATES Certain officers of the Series Fund are also officers and/or directors of the following entities:
- -------------------------------------------------------------------------------------------- ENTITY AFFILIATION - -------------------------------------------------------------------------------------------- Franklin Mutual Advisers, LLC (Franklin Mutual) Investment manager Franklin Templeton Services, LLC (FT Services) Administrative manager Franklin/Templeton Distributors, Inc. (Distributors) Principal underwriter Franklin/Templeton Investor Services, LLC (Investor Services) Transfer agent
A. MANAGEMENT FEES Effective July 1, 2004, the Fund pays an investment management fee to Franklin Mutual based on the average daily net assets of the Fund as follows: - -------------------------------------------------------------------------------- ANNUALIZED FEE RATE NET ASSETS - -------------------------------------------------------------------------------- 0.800% First $1 billion 0.770% Over $1 billion, up to and including $2 billion 0.750% Over $2 billion, up to and including $5 billion 0.730% Over $5 billion Prior to July 1, 2004, the fund paid fees 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) B. ADMINISTRATION FEES 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 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 C. DISTRIBUTION FEES The Fund reimburses Distributors 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, respectively, for costs incurred in marketing the Fund's shares under a Rule 12b-1 plan. Under the Class A distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. D. SALES CHARGES/ UNDERWRITING AGREEMENTS Distributors has advised the Fund of the following commission transactions related to the sales and redemptions of the Fund's shares for the year: Net sales charges received ............................ $ 155,256 Contingent deferred sales charges retained ............ $ 68,951 E. TRANSFER AGENT FEES The Fund paid transfer agent fees of $1,700,100, of which $1,096,339 was paid to Investors Services. 4. EXPENSE OFFSET ARRANGEMENT The Fund has entered into an arrangement with its custodian whereby credits realized as a result of uninvested cash balances are used to reduce a portion of the Fund's custodian expenses. During the year ended December 31, 2004, the custodian fees were reduced as noted in the Statement of Operations. Annual Report | 35 MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. INCOME TAXES At December 31, 2004, the Fund had deferred capital losses occurring subsequent to October 31, 2004 of $10,455,954. For tax purposes, such losses will be reflected in the year ending December 31, 2005. 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 differ for financial statement and tax purposes primarily due to differing treatments of wash sales, foreign currency transactions, passive foreign investment company shares and bond discounts and premiums. At December 31, 2004, the cost of investments, net unrealized appreciation (depreciation), and undistributed ordinary income for income tax purposes were as follows: Cost of investments ......................................... $ 1,053,757,447 ----------------- Unrealized appreciation ..................................... $ 424,558,305 Unrealized depreciation ..................................... (19,574,065) ----------------- Net unrealized appreciation (depreciation) .................. $ 404,984,240 ================= Distributable earnings -- undistributed ordinary income ..... $ 5,767,195 ================= The tax character of distributions paid during the years ended December 31, 2004 and 2003, was as follows: ---------------------------- 2004 2003 ---------------------------- Distributions paid from: Ordinary income ....................... $ 39,137,765 $ 25,017,729 Long term capital gain ................ 1,650,115 -- ---------------------------- $ 40,787,880 $ 25,017,729 ============================ 36 | Annual Report MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short-term securities and securities sold short) for the year ended December 31, 2004 aggregated $420,335,439 and $363,600,508, respectively. Transactions in options written during the year ended December 31, 2004 were as follows: -------------------------- NUMBER OF PREMIUMS CONTRACTS RECEIVED -------------------------- Options outstanding at December 31, 2003 ................. 880 $ 8,580 Options written .................... 242,380 74,958 Options expired .................... (122,070) (38,401) Options exercised .................. (121,190) (45,137) Options closed ..................... -- -- -------------------------- Options outstanding at December 31, 2004.................. -- $ -- ========================== 7. SYNTHETIC EQUITY SWAPS As of December 31, 2004, the Fund had the following synthetic equity swaps outstanding:
- -------------------------------------------------------------------------------------- NUMBER OF UNREALIZED CONTRACTS TO BUY CONTRACTS VALUE GAIN (LOSS) - -------------------------------------------------------------------------------------- AAReal Bank AG (23.48 - 25.89 EUR) ....... 284,453 $ 9,379,862 $ (91,948) Christian Dior SA (48.05 - 55.43 EUR) .... 48,024 3,261,685 54,709 London Stock Exchange PLC (5.36 - 5.71GBP) ........................ 40,765 455,396 16,316 ----------- Total contracts to buy ............................................... $ (20,923) -----------
- -------------------------------------------------------------------------------------- NUMBER OF UNREALIZED CONTRACTS TO SELL CONTRACTS VALUE GAIN (LOSS) - -------------------------------------------------------------------------------------- LVMH Moet Hennessy Louis Vuitton (53.87 - 61.76 EUR) ..................... 48,965 $ 3,744,203 $ 124,005 ----------- Total contracts to sell .................. 124,005 ----------- Net unrealized gain (loss) ............ $ 103,082 -----------
8. FORWARD EXCHANGE CONTRACTS At December 31, 2004, 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) - ------------------------------------------------------------------------------------------------- 2,020,930 Canadian Dollars .............. U.S. $ 1,675,001 4/21/05 U.S. $ 9,861 ------------ ----------
Annual Report | 37 MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. FORWARD EXCHANGE CONTRACTS (CONTINUED)
- ------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO SELL EXCHANGE FOR DATE GAIN (LOSS) - ------------------------------------------------------------------------------------------------- 12,818,327 British Pounds .......... U.S. $ 24,611,675 3/21/05 U.S. $ 128,817 27,486,715 British Pounds .......... 52,777,650 6/08/04 483,859 ------------ ---------- U.S. $ 77,389,325 612,676 ============ ---------- Unrealized gain on forward exchange contracts ....................... U.S. $ 622,537 ==========
- ------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO BUY EXCHANGE FOR DATE GAIN (LOSS) - ------------------------------------------------------------------------------------------------- 980,269 Canadian Dollars U.S. $ 825,000 4/21/05 U.S. $ (7,744) ------------ ---------- - ------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO SELL EXCHANGE FOR DATE GAIN (LOSS) - ------------------------------------------------------------------------------------------------- 8,317,150 Canadian Dollars ........ U.S. $ 6,341,525 1/21/05 U.S. $ (592,259) 26,000,000 British Pounds .......... 47,957,000 2/10/05 (1,809,576) 11,938,325 Euro .................... 14,743,831 2/23/05 (1,464,519) 249,900,617 Danish Krone ............ 40,877,048 3/17/05 (4,740,876) 317,400 Canadian Dollars ........ 250,000 4/21/05 (14,618) 33,195,409 Euro .................... 41,903,428 4/25/05 (3,211,595) 14,500,000 Euro .................... 17,928,115 5/23/05 (1,789,716) 46,807,966 Poland Zloty ............ 14,423,309 5/31/05 (877,745) 22,000,000 Euro .................... 27,781,600 7/25/05 (2,175,606) 13,000,000 Euro .................... 16,070,925 8/23/05 (1,642,874) 12,000,000 Euro .................... 14,616,000 9/13/05 (1,743,105) ------------ ------------- U.S. $242,892,781 (20,062,489) ============ ------------- Net unrealized loss on offsetting forward exchange contracts ............ (2,121,007) ------------- Unrealized loss on forward exchange contracts ........................ (22,191,240) ------------- Net unrealized loss on forward exchange contracts ............... U.S. $ (21,568,703) =============
9. RESTRICTED SECURITIES At December 31, 2004, investments in securities included issues that are restricted and 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, 2004, the fund held investments in restricted and illiquid securities that were valued under approved methods by the Directors, as follows: Annual Report | 38 MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. RESTRICTED SECURITIES (CONTINUED)
- --------------------------------------------------------------------------------------------- SHARES/ ACQUISITION WARRANTS ISSUER DATE COST VALUE - --------------------------------------------------------------------------------------------- 83,713 AboveNet Inc ............................ 10/02/01 3,899,186 $2,006,048 2,816 AboveNet Inc., wts., 9/08/08 ............ 10/02/01 348,479 18,022 3,313 AboveNet Inc., wts., 9/08/10 ............ 10/02/01 373,672 13,252 16,080 Olympus Re Holdings Ltd ................. 12/19/01 1,608,000 2,752,574 5,281 Security Capital European Realty ........ 4/08/98 289,278 38,023 ---------- TOTAL RESTRICTED SECURITIES (.33% OF NET ASSETS) ............................... $4,827,919 ==========
10. OTHER CONSIDERATIONS Franklin Mutual, as the Fund's Manager, may serve as member on the board of directors of certain companies in which the Fund invests and/or may represent the Fund in certain corporate negotiations. At December 31, 2004, the Manager serves in one or more of these capacities for AboveNet Inc. As a result of this involvement, the Manager may be in possession of certain 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. 11. REGULATORY MATTERS INVESTIGATIONS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, including the Securities and Exchange Commission ("SEC"), the California Attorney General's Office ("CAGO"), and the National Association of Securities Dealers, Inc. ("NASD"), relating to certain practices in the mutual fund industry, including late trading, market timing and marketing support payments to securities dealers who sell fund shares, Franklin Resources, Inc. and certain of its subsidiaries (as used in this section, together, the "Company"), as well as certain current or former executives and employees of the Company, received subpoenas and/or requests for documents, information and/or testimony. The Company and its current employees provided documents and information in response to those requests and subpoenas. SETTLEMENTS Beginning in August 2004, the Company entered into settlements with certain regulators investigating the mutual fund industry practices noted above. The Company believes that settlement of each of the matters described in this section is in the best interest of the Company and shareholders of the Franklin, Templeton, and Mutual Series mutual funds (the "funds"). Annual Report | 39 MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. REGULATORY MATTERS (CONTINUED) SETTLEMENTS (CONTINUED) On August 2, 2004, Franklin Resources, Inc. announced that its subsidiary, Franklin Advisers, Inc., reached an agreement with the SEC that resolved the issues resulting from the SEC investigation into market timing activity. In connection with that agreement, the SEC issued an "Order Instituting Administrative and Cease-and-Desist Proceedings Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940 and Sections 9(b) and 9(f) of the Investment Company Act of 1940, Making Findings and Imposing Remedial Sanctions and a Cease-and-Desist Order" (the "Order"). The SEC's Order concerned the activities of a limited number of third parties that ended in 2000 and those that were the subject of the first Massachusetts administrative complaint described below. Under the terms of the SEC's Order, pursuant to which Franklin Advisers, Inc. neither admitted nor denied any of the findings contained therein, Franklin Advisers, Inc. agreed to pay $50 million, of which $20 million is a civil penalty, to be distributed to shareholders of certain funds in accordance with a plan to be developed by an independent distribution consultant. At this time, it is unclear which funds or which shareholders of any particular fund will receive distributions. The Order also required Franklin Advisers, Inc. to, among other things, enhance and periodically review compliance policies and procedures. On September 20, 2004, Franklin Resources, Inc. announced that two of its subsidiaries, Franklin Advisers, Inc. and Franklin Templeton Alternative Strategies, Inc. ("FTAS"), reached an agreement with the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts (the "State of Massachusetts") related to its administrative complaint filed on February 4, 2004, concerning one instance of market timing that was also a subject of the August 2, 2004 settlement that Franklin Advisers, Inc. reached with the SEC, as described above. Under the terms of the settlement consent order issued by the State of Massachusetts, Franklin Advisers, Inc. and FTAS consented to the entry of a cease-and-desist order and agreed to pay a $5 million administrative fine to the State of Massachusetts (the "Massachusetts Consent Order"). The Massachusetts Consent Order included two different sections: "Statements of Fact" and "Violations of Massachusetts Securities Laws." Franklin Advisers, Inc. and FTAS admitted the facts in the Statements of Fact. On October 25, 2004, the State of Massachusetts filed a second administrative complaint, alleging that Franklin Resources, Inc.'s Form 8-K filing (in which it described the Massachusetts Consent Order and stated that "Franklin did not admit or deny engaging in any wrongdoing") failed to state that Franklin Advisers, Inc. and FTAS admitted the Statements of Fact portion of the Massachusetts Consent Order (the "Second Complaint"). Franklin Resources, Inc. reached a second agreement with the State of Massachusetts on November 19, 2004, resolving the Second Complaint. As a result of the November 19, 2004 settlement, Franklin Resources, Inc. filed a new Form 8-K. The terms of the Massachusetts Consent Order did not change and there was no monetary fine associated with this second settlement. 40 | Annual Report MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. REGULATORY MATTERS (CONTINUED) SETTLEMENTS (CONTINUED) On November 17, 2004, Franklin Resources, Inc. announced that Franklin/Templeton Distributors, Inc. ("FTDI") reached an agreement with the CAGO, resolving the issues resulting from the CAGO's investigation concerning sales and marketing support payments. Under the terms of the settlement, FTDI neither admitted nor denied the allegations in the CAGO's complaint and agreed to pay $2 million to the State of California as a civil penalty, $14 million to the funds, to be allocated by an independent distribution consultant to be paid for by FTDI, and $2 million to the CAGO for its investigative costs. On December 13, 2004, Franklin Resources, Inc. announced that its subsidiaries FTDI and Franklin Advisers, Inc. reached an agreement with the SEC, resolving the issues resulting from the SEC's investigation concerning marketing support payments to securities dealers who sell fund shares. In connection with that agreement, the SEC issued an "Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940, Sections 9(b) and 9(f) of the Investment Company Act of 1940, and Section 15(b) of the Securities Exchange Act of 1934" (the "Second Order"). Under the terms of the Second Order, in which FTDI and Franklin Advisers, Inc. neither admitted nor denied the findings contained therein, they agreed to pay the funds a penalty of $20 million and disgorgement of $1 (one dollar). FTDI and Franklin Advisers, Inc. also agreed to implement certain measures and undertakings relating to marketing support payments to broker-dealers for the promotion or sale of fund shares, including making additional disclosures in the funds' Prospectuses and Statements of Additional Information. The Second Order further requires the appointment of an independent distribution consultant, at the Company's expense, who shall develop a plan for the distribution of the penalty and disgorgement to the funds. OTHER LEGAL PROCEEDINGS The Fund, in addition to the Company and other funds, and certain current and former officers, employees, and directors have been named in multiple lawsuits in different federal courts in Nevada, California, Illinois, New York and Florida, alleging violations of various federal securities laws and seeking, among other relief, monetary damages, restitution, removal of fund trustees, directors, advisers, administrators, and distributors, rescission of management contracts and 12b-1 Plans, and/or attorneys' fees and costs. Specifically, the lawsuits claim breach of duty with respect to alleged arrangements to permit market timing and/or late trading activity, or breach of duty with respect to the valuation of the portfolio securities of certain Templeton funds managed by Franklin Resources, Inc. subsidiaries, resulting in alleged market timing activity. The majority of these lawsuits duplicate, in whole or in part, the allegations asserted in the February 4, 2004 Massachusetts administrative complaint and the findings in the SEC's August 2, 2004 Order, as described above. The lawsuits are styled as class actions, or derivative actions on behalf of either the named funds or Franklin Resources, Inc. Annual Report | 41 MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. REGULATORY MATTERS (CONTINUED) OTHER LEGAL PROCEEDINGS (CONTINUED) In addition, the Company, as well as certain current and former officers, employees, and directors, have been named in multiple lawsuits alleging violations of various securities laws and pendent state law claims relating to the disclosure of directed brokerage payments and/or payment of allegedly excessive advisory, commission, and distribution fees, and seeking, among other relief, monetary damages, restitution, rescission of advisory contracts, including recovery of all fees paid pursuant to those contracts, an accounting of all monies paid to the named advisers, declaratory relief, injunctive relief, and/or attorneys' fees and costs. These lawsuits are styled as class actions or derivative actions brought on behalf of certain funds. The Company and fund management strongly believes that the claims made in each of the lawsuits identified above are without merit and intends to vigorously defend against them. The Company cannot predict with certainty, however, the eventual outcome of the remaining governmental investigations or private lawsuits, nor whether they will have a material negative impact on the Company. Public trust and confidence are critical to the Company's business and any material loss of investor and/or client confidence could result in a significant decline in assets under management by the Company, which would have an adverse effect on the Company's future financial results. If it is determined that the Company bears responsibility for any unlawful or inappropriate conduct that caused losses to the Fund, it is committed to making the Fund or its shareholders whole, as appropriate. The Company is committed to taking all appropriate actions to protect the interests of its funds' shareholders. 42 | Annual Report MUTUAL EUROPEAN FUND REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 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, 2004, 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 five years in the period then ended. 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 the standards of the Public Company Accounting Oversight Board (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 consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Fund's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of December 31, 2004, 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, 2004, 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 five years in the period then ended, in conformity with U.S. generally accepted accounting principles. /s/ Ernst & Young LLP Boston, Massachusetts February 7, 2005 Annual Report | 43 MUTUAL EUROPEAN FUND TAX DESIGNATION (UNAUDITED) Under Section 852(b)(3)(C) of the Internal Revenue Code (Code), the Fund designated $1,650,115 as a capital gain dividend for the fiscal year ended December 31, 2004. Under Section 854(b)(2) of the Code, the Fund hereby designates up to a maximum of $29,652,743 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2004. In January 2005, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2004. 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 1.46% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2004. At December 31, 2004, 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 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 16, 2004, 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. 44 | Annual Report MUTUAL EUROPEAN 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 - -------------------------------------------------------------------------------------------------------------------- Austria .................................... 0.0002 0.0010 0.0010 0.0004 Belgium .................................... 0.0019 0.0092 0.0092 0.0039 Bermuda .................................... 0.0000 0.0013 0.0005 0.0010 Canada ..................................... 0.0002 0.0008 0.0008 0.0003 Denmark .................................... 0.0018 0.0088 0.0088 0.0038 Finland .................................... 0.0022 0.0108 0.0108 0.0046 France ..................................... 0.0057 0.0411 0.0285 0.0248 Germany .................................... 0.0019 0.0323 0.0082 0.0276 Ireland .................................... 0.0000 0.0285 0.0284 0.0123 Italy ...................................... 0.0013 0.0062 0.0062 0.0027 Luxembourg ................................. 0.0010 0.0049 0.0049 0.0021 Netherlands ................................ 0.0058 0.0284 0.0280 0.0124 Norway ..................................... 0.0104 0.0544 0.0513 0.0251 Spain ...................................... 0.0027 0.0131 0.0131 0.0056 Sweden ..................................... 0.0006 0.0029 0.0029 0.0012 Switzerland ................................ 0.0043 0.0209 0.0209 0.0090 United Kingdom ............................. 0.0104 0.1496 0.0734 0.1077 ------------------------------------------------------------------ TOTAL ...................................... $ 0.0504 $ 0.4142 $ 0.2969 $ 0.2445 ==================================================================
- -------------------------------------------------------------------------------------------------------------------- CLASS A ADJUSTED FOREIGN TAX FOREIGN FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS SOURCE INCOME COUNTRY PER SHARE PER SHARE PER SHARE PER SHARE - -------------------------------------------------------------------------------------------------------------------- Austria .................................... 0.0002 0.0009 0.0009 0.0004 Belgium .................................... 0.0019 0.0081 0.0081 0.0035 Bermuda .................................... 0.0000 0.0011 0.0004 0.0009 Canada ..................................... 0.0002 0.0007 0.0007 0.0003 Denmark .................................... 0.0018 0.0078 0.0078 0.0033 Finland .................................... 0.0022 0.0096 0.0096 0.0041 France ..................................... 0.0057 0.0364 0.0252 0.0220 Germany .................................... 0.0019 0.0286 0.0073 0.0244 Ireland .................................... 0.0000 0.0252 0.0251 0.0109 Italy ...................................... 0.0013 0.0055 0.0055 0.0024 Luxembourg ................................. 0.0010 0.0043 0.0043 0.0018 Netherlands ................................ 0.0058 0.0251 0.0248 0.0109 Norway ..................................... 0.0104 0.0482 0.0455 0.0222 Spain ...................................... 0.0027 0.0116 0.0116 0.0050 Sweden ..................................... 0.0006 0.0026 0.0026 0.0011 Switzerland ................................ 0.0043 0.0185 0.0185 0.0079 United Kingdom ............................. 0.0104 0.1324 0.0650 0.0953 ------------------------------------------------------------------ TOTAL ...................................... $ 0.0504 $ 0.3666 $ 0.2629 $ 0.2164 ==================================================================
Annual Report | 45 MUTUAL EUROPEAN FUND TAX DESIGNATION (UNAUDITED) (CONTINUED)
- -------------------------------------------------------------------------------------------------------------------- CLASS B ADJUSTED FOREIGN TAX FOREIGN FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS SOURCE INCOME COUNTRY PER SHARE PER SHARE PER SHARE PER SHARE - -------------------------------------------------------------------------------------------------------------------- Austria .................................... 0.0002 0.0007 0.0007 0.0003 Belgium .................................... 0.0019 0.0062 0.0062 0.0027 Bermuda .................................... 0.0000 0.0009 0.0004 0.0007 Canada ..................................... 0.0002 0.0005 0.0005 0.0002 Denmark .................................... 0.0018 0.0060 0.0060 0.0026 Finland .................................... 0.0022 0.0073 0.0073 0.0031 France ..................................... 0.0057 0.0278 0.0193 0.0168 Germany .................................... 0.0019 0.0219 0.0056 0.0187 Ireland .................................... 0.0000 0.0193 0.0192 0.0083 Italy ...................................... 0.0013 0.0042 0.0042 0.0018 Luxembourg ................................. 0.0010 0.0033 0.0033 0.0014 Netherlands ................................ 0.0058 0.0192 0.0190 0.0083 Norway ..................................... 0.0104 0.0368 0.0347 0.0170 Spain ...................................... 0.0027 0.0089 0.0089 0.0038 Sweden ..................................... 0.0006 0.0020 0.0020 0.0009 Switzerland ................................ 0.0043 0.0142 0.0142 0.0061 United Kingdom ............................. 0.0104 0.1010 0.0496 0.0727 ------------------------------------------------------------------ TOTAL ...................................... $ 0.0504 $ 0.2802 $ 0.2011 $ 0.1654 ==================================================================
- -------------------------------------------------------------------------------------------------------------------- CLASS C ADJUSTED FOREIGN TAX FOREIGN FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS SOURCE INCOME COUNTRY PER SHARE PER SHARE PER SHARE PER SHARE - -------------------------------------------------------------------------------------------------------------------- Austria .................................... 0.0002 0.0007 0.0007 0.0003 Belgium .................................... 0.0019 0.0061 0.0061 0.0026 Bermuda .................................... 0.0000 0.0008 0.0003 0.0006 Canada ..................................... 0.0002 0.0005 0.0005 0.0002 Denmark .................................... 0.0018 0.0059 0.0059 0.0025 Finland .................................... 0.0022 0.0071 0.0071 0.0030 France ..................................... 0.0057 0.0272 0.0189 0.0164 Germany .................................... 0.0019 0.0214 0.0055 0.0183 Ireland .................................... 0.0000 0.0189 0.0188 0.0082 Italy ...................................... 0.0013 0.0041 0.0041 0.0018 Luxembourg ................................. 0.0010 0.0032 0.0032 0.0014 Netherlands ................................ 0.0058 0.0188 0.0186 0.0082 Norway ..................................... 0.0104 0.0360 0.0340 0.0166 Spain ...................................... 0.0027 0.0087 0.0087 0.0037 Sweden ..................................... 0.0006 0.0019 0.0019 0.0008 Switzerland ................................ 0.0043 0.0139 0.0139 0.0060 United Kingdom ............................. 0.0104 0.0989 0.0485 0.0712 ------------------------------------------------------------------ TOTAL ...................................... $ 0.0504 $ 0.2741 $ 0.1967 $ 0.1618 ==================================================================
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). 46 | Annual Report MUTUAL EUROPEAN FUND TAX DESIGNATION (UNAUDITED) (CONTINUED) 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. In January 2005, shareholders will receive Form 1099-DIV which will include their share of taxes paid and foreign source income distributed during the calendar year 2004. 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 2004 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. 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. (63) 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; and Director, Stern School of Business M.B.A. Program. - ------------------------------------------------------------------------------------------------------------------------------------ ANN TORRE GRANT (46) 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 (75) 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 (74) 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 (75) 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 VicePresident, 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 (74) Director Since 1998 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. - ------------------------------------------------------------------------------------------------------------------------------------ LEONARD RUBIN (79) 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 (58) Director Since 1991 12 Director, El Oro Mining and 51 John F. Kennedy Parkway Exploration Co., p.l.c. Short Hills, NJ 07078 - ------------------------------------------------------------------------------------------------------------------------------------ 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 (79) 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 (65) 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, as the case may be, 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 (42) Director, Director 7 None 51 John F. Kennedy Parkway President, since 2001, Short Hills, NJ 07078-2702 Chairman President of the since 1999, Board and Chairman of Chief the Board Executive and Chief Officer - Executive Investment 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 officer and/or director, as the case may be, of three of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ JAMES M. DAVIS (52) Chief Since July Not Applicable Not Applicable One Franklin Parkway Compliance 2004 San Mateo, CA 94403-1906 Officer - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Officer of 51 of the investment companies in Franklin Templeton Investments; Director, Global Compliance, Franklin Resources, Inc.; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - ------------------------------------------------------------------------------------------------------------------------------------ JIMMY D. GAMBILL (57) Senior Since 2002 Not Applicable Not Applicable 500 East Broward Blvd. Vice Suite 2100 President 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 (57) Vice Since 2000 Not Applicable Not Applicable One Franklin Parkway President San Mateo, CA 94403-1906 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior 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). - ------------------------------------------------------------------------------------------------------------------------------------
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 - ------------------------------------------------------------------------------------------------------------------------------------ BARBARA J. GREEN (57) Vice Since 2000 Not Applicable Not Applicable One Franklin Parkway President 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). - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL O. MAGDOL (67) Vice Since 2002 Not Applicable Not Applicable 600 Fifth Avenue President Rockefeller Center - AML New York, NY 10020-2302 Compliance - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice Chairman, Chief Banking Officer and Director, Fiduciary Trust Company International; Director, FTI Banque, Arch Chemicals, Inc. and Lingnan Foundation; 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. - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL MORANTZ (35) Treasurer Since July Not Applicable Not Applicable 500 East Broward Blvd. 2004 Suite 2100 Fort Lauderdale, FL 33394-3091 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ MURRAY L. SIMPSON (67) Vice Since 2000 Not Applicable Not Applicable 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). - ------------------------------------------------------------------------------------------------------------------------------------
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 - ------------------------------------------------------------------------------------------------------------------------------------ GALEN G. VETTER (53) Chief Since May Not Applicable Not Applicable 500 East Broward Blvd. Financial 2004 Suite 2100 Officer Fort Lauderdale, FL 33394-3091 and Chief Accounting Officer - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Officer of 51 of the investment companies in Franklin Templeton Investments; Senior Vice President, Franklin Templeton Services, LLC; and FORMERLY, Managing Director, RSM McGladrey, Inc.; and Partner, McGladrey & Pullen, LLP. - ------------------------------------------------------------------------------------------------------------------------------------ * 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 to be 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 to be 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 to be an interested person of Mutual Series under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC, Mutual Series' adviser. 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 EUROPEAN FUND SHAREHOLDER INFORMATION 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. Copies of the Fund's proxy voting records are also made available online at franklintempleton.com and posted on the Securities and Exchange Commission's website at sec.gov and reflect the 12-month period beginning July 1, 2003, and ending June 30, 2004. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the Securities and Exchange Commission for the first and third quarters for each fiscal year on Form N-Q. Shareholders may view the filed Form N-Q by visiting the Commission's website at sec.gov. The filed form may also be viewed and copied at the Commission's Public Reference Room in Washington, DC. Information regarding the operations of the Public Reference Room may be obtained by calling 1-800/SEC-0330. Annual Report | 53 This page intentionally left blank. This page intentionally left blank. This page intentionally left blank. LITERATURE REQUEST LITERATURE REQUEST. TO RECEIVE A BROCHURE AND PROSPECTUS, PLEASE CALL US AT 1-800/DIAL BEN(R) (1-800/342-5236) OR VISIT FRANKLINTEMPLETON.COM. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. 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 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(2) Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund(3) 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(4) 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 Technology Fund Franklin Utilities Fund Mutual Financial Services Fund ASSET ALLOCATION Franklin Templeton Corefolio Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives 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(5) Franklin's AGE High Income Fund Franklin Floating Rate Daily Access Fund Franklin Floating Rate Trust(3) Franklin Income Fund Franklin Limited Maturity U.S. Government Securities Fund(5),(6) Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund(5) Templeton Global Bond Fund TAX-FREE INCOME(7) NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(8) 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 Alabama Arizona California(9) Colorado Connecticut Florida(9) Georgia Kentucky Louisiana Maryland Massachusetts(8) Michigan(8) Minnesota(8) Missouri New Jersey New York(9) North Carolina Ohio(8) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(10) (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 and select retirement plans. (3) 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. (4) Upon reaching approximately $350 million in assets, the fund intends to close to all investors. (5) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (6) Formerly Franklin Short-Intermediate U.S. Government Securities Fund. Effective 9/1/04, the fund's name changed; its investment goal and strategy remained the same. (7) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (8) Portfolio of insured municipal securities. (9) These funds are available in two or more variations, including long-term portfolios, portfolios of insured securities, a high-yield portfolio (CA) and limited-term, intermediate-term and money market portfolios (CA and NY). (10) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 11/04 Not part of the annual report [LOGO](R) 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 EUROPEAN FUND CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER David J. Winters, CFA 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) Authorized for distribution only when accompanied or preceded by a prospectus. Investors should carefully consider a fund's investment goals, risks, charges and expenses before investing. The prospectus contains this and other information; please read it carefully before investing. 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 A2004 02/05 MUTUAL QUALIFIED FUND [GRAPHIC OMITTED] - -------------------------------------------------------------------------------- DECEMBER 31, 2004 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- ANNUAL REPORT AND SHAREHOLDER LETTER VALUE - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- WANT TO RECEIVE THIS DOCUMENT FASTER VIA EMAIL? MUTUAL QUALIFIED FUND Eligible shareholders can sign up for eDelivery at franklintempleton.com. See inside for details. - -------------------------------------------------------------------------------- [LOGO](R) 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 ..................................................... 4 Performance Summary ....................................................... 9 Your Fund's Expenses ...................................................... 14 Financial Highlights and Statement of Investments ......................... 16 Financial Statements ...................................................... 30 Notes to Financial Statements ............................................. 34 Report of Independent Registered Public Accounting Firm ................... 51 Tax Designation ........................................................... 52 Board Members and Officers ................................................ 53 Shareholder Information ................................................... 58 - -------------------------------------------------------------------------------- ANNUAL REPORT MUTUAL QUALIFIED FUND YOUR FUND'S GOALS AND MAIN 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 of companies the Fund's managers believe are at prices below their intrinsic value in the U.S. and other countries. - -------------------------------------------------------------------------------- PERFORMANCE DATA QUOTED REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. PLEASE VISIT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236 FOR MOST RECENT MONTH-END PERFORMANCE. - -------------------------------------------------------------------------------- We are pleased to bring you Mutual Qualified Fund's annual report covering the fiscal year ended December 31, 2004. PERFORMANCE OVERVIEW Mutual Qualified Fund - Class Z posted a 16.64% cumulative total return for the 12 months ended December 31, 2004. The Fund outperformed its benchmark, the Standard & Poor's 500 Composite Index (S&P 500), which returned 10.87% over the same period.(1) You can find the Fund's long-term performance data in the Performance Summary beginning on page 9. ECONOMIC AND MARKET OVERVIEW During the year ended December 31, 2004, the domestic economy expanded solidly and broadly across most industries, sectors and regions as gross domestic product (GDP) rose an estimated 4.4%.(2) However, surging energy and other commodity prices had a dampening effect. Although consumer confidence remained below pre-recession levels, consumer spending supported strong auto sales, increased durable goods consumption and a healthy housing market. Similarly, business spending rose substantially even as business confidence wavered. The labor market firmed as employers hired 2.2 million workers in 2004, and unemployment dropped from 5.7% to 5.4% during the year.(3) The U.S. dollar weakened throughout 2004 and hit an all-time low against the euro and a multi-year low versus the yen. The widening trade and current account deficits and possibility for higher import prices contributed to inflationary (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 is unmanaged and includes reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. (2) Source: Bureau of Economic Analysis. (3) Source: Bureau of Labor Statistics. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND NAMES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 20. 4 | Annual Report pressures. The core inflation rate rose to 2.2% in 2004, or 3.3% including volatile food and energy costs. Aiming to keep inflation tame, the Federal Reserve Board raised the federal funds target rate five times between June and December, from 1.00% to 2.25%, the highest level in more than three years. Domestic equity markets rallied in early 2004 and then fluctuated; however, they were essentially flat through early November. After the elections concluded, the markets enjoyed another strong rally through year-end. The blue chip stocks of the Dow Jones Industrial Average gained 5.31% for the year under review, while the broader S&P 500 rose 10.87% and the technology-heavy NASDAQ Composite Index increased 9.15%.(4) Outside the U.S., the global economic recovery continued in 2004, led by growth in China. The 12-nation euro zone lagged other regions in the current recovery. However, the European Central Bank projected euro zone growth may be between 1.6% and 2.0% in 2004, compared with only 0.5% in 2003. In Japan, the economy struggled to emerge from a decade-long deflationary period. Although the country's consumer and business confidence reached their highest levels since 1991, economic growth slowed in response to higher oil prices and reduced external demand. The U.S. dollar decline hurt Japanese and European exports to the U.S., as it made their goods more expensive in the world's biggest market. For the 12-month period ended December 31, 2004, the Morgan Stanley Capital International (MSCI) World Index's total return was 15.25% in U.S. dollars.(5) Emerging markets, as measured by the MSCI Emerging Markets Index, had a total return of 25.95% in U.S. dollars.(6) In local currencies, these indexes had notably lower total returns of 11.83% and 16.45% for the same period.(5)(6) During the period, most of the world's currencies strengthened in relation to the U.S. dollar, which benefited U.S.-based investors of non-U.S. developed and emerging market equities. INVESTMENT STRATEGY At Mutual Series, we remained committed to our three-pronged approach to investing, which utilizes in-depth, fundamental analysis to identify attractive (4) Source: Standard & Poor's Micropal. The Dow Jones Industrial Average is price weighted based on the average market price of 30 blue chip stocks of companies that are generally industry leaders. See footnote 1 for a description of the S&P 500. The NASDAQ Composite Index measures all domestic and international common stocks listed on The NASDAQ Stock Market. The index is market value weighted and includes over 3,000 companies. (5) Source: Standard & Poor's Micropal. The MSCI World Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in global developed markets. (6) Source: Standard & Poor's Micropal. The MSCI Emerging Markets Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in global emerging markets. GEOGRAPHIC DISTRIBUTION Based on Total Net Assets as of 12/31/04 [THE FOLLOWING TABLE WAS REPRESENTED AS A BAR GRAPH IN THE PRINTED MATERIAL.] U.S. 62.2% U.K. 9.8% France 5.3% Irish Republic 2.9% Spain 2.5% Canada 2.4% Japan 1.7% South Korea 1.6% Norway 1.6% Germany 1.5% Finland 1.2% Bermuda 1.2% Switzerland 1.2% Other Countries 3.6% Other Net Assets 1.3% Annual Report | 5 TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/04 - -------------------------------------------------------------------------------- % OF TOTAL NET ASSETS - -------------------------------------------------------------------------------- Insurance 11.9% - -------------------------------------------------------------------------------- Metals & Mining 9.0% - -------------------------------------------------------------------------------- Media 8.0% - -------------------------------------------------------------------------------- Tobacco 7.8% - -------------------------------------------------------------------------------- Commercial Banks 6.0% - -------------------------------------------------------------------------------- Food Products 4.6% - -------------------------------------------------------------------------------- Real Estate 3.6% - -------------------------------------------------------------------------------- Thrifts & Mortgage Finance 3.2% - -------------------------------------------------------------------------------- Pharmaceuticals 3.1% - -------------------------------------------------------------------------------- Capital Markets 2.7% - -------------------------------------------------------------------------------- investment opportunities in undervalued equities, distressed debt and arbitrage securities. 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. MANAGER'S DISCUSSION In 2004, many of our long-held positions were some of the largest contributors to the Fund's performance. Examples include White Mountains Insurance Group, a U.S. property and casualty insurer; Altadis, a Franco-Spanish tobacco company; and Orkla, a Norwegian conglomerate. White Mountains, one of the largest contributors to Fund performance during the fiscal year, was an excellent example of how substantial shareholder value can be created when well-capitalized companies are run by strong managers. With the company's solid balance sheet, White Mountains' management team has made several acquisitions, enabling the company to profitably increase its bottom line while extending its exposure to attractive lines of business. In addition to exercising discipline with acquisitions, management remained committed to a conservative underwriting strategy. This strategy enabled White Mountains to continue to report solid underwriting results for 2004 despite record industry-wide insurance claims from the Atlantic hurricane season. During the year under review, the markets began to better appreciate White Mountains' consistent results, strong balance sheet, and disciplined acquisition and underwriting practices, as well as its shareholder-oriented management team. White Mountains' stock rose about 41% in 2004 and has increased more than 443% in the past five years. In 2004, tobacco companies operating in Europe, such as Altadis, encountered a challenging sales environment, especially in France after the government imposed two substantial tax increases by early 2004 that pressured volumes and contributed to reduced consumption of about 25% in volume. Despite challenges in France and elsewhere, Altadis shares performed well as 6 | Annual Report management returned cash to shareholders through dividends and share repurchases. In addition, the company announced two acquisitions and a cost-restructuring program, all of which could enable management to continue to increase cash flow and create shareholder value. As a result of these and other factors, Altadis shares appreciated about 65% in 2004. Despite this strong performance, the stock still traded at a significant discount to its European peers and our calculation of the stock's intrinsic value. In addition, some analysts believe the industry is ready for more consolidation. For these and other reasons, we remain enthusiastic about the prospects of our Altadis investment. Oslo-based Orkla is one of Norway's largest conglomerates with operations in food, media, chemicals and beverages. In early 2004, Orkla's management announced it would divest the company's beverage operations, a 40% stake in the Danish company Carlsberg Breweries. We believed the negotiated price for Carlsberg was favorable, and the market rewarded management's decision to return part of the proceeds to shareholders in the form of a special dividend. The equity market anticipates Orkla to further divest non-core assets and return the proceeds to shareholders. The company reported better-than-expected quarterly results for most of 2004 as its restructuring program progressed ahead of expectations and as some new product launches experienced success. Largely as a result, the stock's discount to its intrinsic value narrowed, and including the special dividend, Orkla shares returned 73% in 2004. In general, if the value of the U.S. dollar goes up compared with a foreign currency, an investment traded in that foreign currency will go down in value because it will be worth fewer U.S. dollars. This can have a negative effect on Fund performance. Conversely, when the U.S. dollar weakens in relation to a foreign currency, an investment traded in that foreign currency will increase in value, which can contribute to Fund performance. At Mutual Series, we typically seek to hedge (protect) against currency risk, which can reduce or eliminate the positive or negative effect on Fund performance of holding investments denominated in currencies other than the U.S. dollar. In 2004, we remained less than fully hedged in foreign currencies allowing shareholders to benefit from a declining U.S. dollar. However, one cannot expect the same result in future periods. Although many of the Fund's investments performed well in 2004, some holdings underperformed. Positions that declined in value included Eurotunnel, a distressed investment in the operator of the English Channel tunnel; Sovereign Bancorp, one of the largest financial institutions serving New England and the Mid-Atlantic states; and AboveNet, a distressed investment in an operator of optical network data centers. Eurotunnel's debt securities declined during 2004 largely due to uncertainties surrounding the ultimate resolution of the company's financial situation, as TOP 10 HOLDINGS 12/31/04 - -------------------------------------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - -------------------------------------------------------------------------------- White Mountains Insurance Group Inc. 5.1% INSURANCE, U.S. - -------------------------------------------------------------------------------- Altadis SA 2.5% TOBACCO, SPAIN - -------------------------------------------------------------------------------- International Steel Group 2.4% METALS & MINING, U.S. - -------------------------------------------------------------------------------- Sovereign Bancorp Inc. 1.9% THIRFTS & MORTGAGE FINANCE, U.S. - -------------------------------------------------------------------------------- Allied Irish Banks PLC 1.9% COMMERCIAL BANKS, IRISH REPUBLIC - -------------------------------------------------------------------------------- Newmont Mining Corp. 1.8% METALS & MINING, U.S. - -------------------------------------------------------------------------------- Orkla ASA 1.6% FOOD PRODUCTS, NORWAY - -------------------------------------------------------------------------------- British American Tobacco PLC 1.5% TOBACCO, U.K. - -------------------------------------------------------------------------------- NTL Inc. 1.5% MEDIA, U.K. - -------------------------------------------------------------------------------- Liberty Media Corp., A 1.5% MEDIA, U.S. - -------------------------------------------------------------------------------- Annual Report | 7 well as continuing mediocre operating results after the company's board and management team were replaced in April 2004. Distressed investing can be a lengthy process, and it is not unusual for securities to weaken somewhat before a restructuring or financial resolution is ultimately worked out. Sovereign Bancorp declined in 2004 after some investors were disappointed that the company continued to expand its northeast U.S. banking franchise through acquisitions rather than focusing on improving the company's core profitability. However, we believe Sovereign Bancorp's management has created one of the premier banking franchises in the northeast U.S., and many industry experts regard the company as a prime acquisition candidate. AboveNet made distributions under a reorganization plan in late 2003. As one of the company's largest creditors, the Mutual Series funds were appointed a seat on the board and collectively received more than 20% of the company's stock in reorganization. The underperformance of our AboveNet investment during the period largely reflected a liquidity discount. 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, CFA Assistant Portfolio Manager Mutual Qualified Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2004, 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 ADVISER 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 12/31/04 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 reinvestment of the Fund's dividends and capital gain distributions, if any, and any unrealized gains or losses. PRICE AND DISTRIBUTION INFORMATION
- ------------------------------------------------------------------------------------------ CLASS Z CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------ Net Asset Value (NAV) +$1.61 $19.49 $17.88 - ------------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------ Dividend Income $0.3891 - ------------------------------------------------------------------------------------------ Short-Term Capital Gain $0.1247 - ------------------------------------------------------------------------------------------ Long-Term Capital Gain $0.8080 - ------------------------------------------------------------------------------------------ TOTAL $1.3218 - ------------------------------------------------------------------------------------------ CLASS A CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------ Net Asset Value (NAV) +$1.60 $19.41 $17.81 - ------------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------ Dividend Income $0.3244 - ------------------------------------------------------------------------------------------ Short-Term Capital Gain $0.1247 - ------------------------------------------------------------------------------------------ Long-Term Capital Gain $0.8080 - ------------------------------------------------------------------------------------------ TOTAL $1.2571 - ------------------------------------------------------------------------------------------ CLASS B CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------ Net Asset Value (NAV) +$1.54 $19.08 $17.54 - ------------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------ Dividend Income $0.2146 - ------------------------------------------------------------------------------------------ Short-Term Capital Gain $0.1247 - ------------------------------------------------------------------------------------------ Long-Term Capital Gain $0.8080 - ------------------------------------------------------------------------------------------ TOTAL $1.1473 - ------------------------------------------------------------------------------------------ CLASS C CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------ Net Asset Value (NAV) +$1.58 $19.30 $17.72 - ------------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------ Dividend Income $0.2003 - ------------------------------------------------------------------------------------------ Short-Term Capital Gain $0.1247 - ------------------------------------------------------------------------------------------ Long-Term Capital Gain $0.8080 - ------------------------------------------------------------------------------------------ TOTAL $1.1330 - ------------------------------------------------------------------------------------------
Mutual Qualified Fund paid distributions derived from long-term capital gains of 80.80 cents ($0.8080) per share in December 2004. The Fund designated such distributions as capital gain dividends per Internal Revenue Code Section 852 (b)(3). Annual Report | 9 PERFORMANCE SUMMARY (CONTINUED) PERFORMANCE(1) CLASS A: 5.75% MAXIMUM INITIAL SALES CHARGE; CLASS B: CONTINGENT DEFERRED SALES CHARGE (CDSC) DECLINING FROM 4% TO 1% OVER SIX YEARS, AND ELIMINATED THEREAFTER; CLASS C: 1% CDSC IN FIRST YEAR ONLY. CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES. - -------------------------------------------------------------------------------- CLASS Z 1-YEAR 5-YEAR 10-YEAR - -------------------------------------------------------------------------------- Cumulative Total Return(2) 16.64% 64.28% 259.57% - -------------------------------------------------------------------------------- Average Annual Total Return(3) 16.64% 10.44% 13.65% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,664 $16,428 $35,957 - -------------------------------------------------------------------------------- CLASS A 1-YEAR 5-YEAR INCEPTION (11/1/96) - -------------------------------------------------------------------------------- Cumulative Total Return(2) 16.27% 61.39% 141.99% - -------------------------------------------------------------------------------- Average Annual Total Return(3) 9.56% 8.75% 10.62% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $10,956 $15,211 $22,805 - -------------------------------------------------------------------------------- CLASS B 1-YEAR 5-YEAR INCEPTION (1/1/99) - -------------------------------------------------------------------------------- Cumulative Total Return(2) 15.46% 56.32% 75.94% - -------------------------------------------------------------------------------- Average Annual Total Return(3) 11.46% 9.06% 9.77% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,146 $15,432 $17,494 - -------------------------------------------------------------------------------- CLASS C 1-YEAR 5-YEAR INCEPTION (11/1/96) - -------------------------------------------------------------------------------- Cumulative Total Return(2) 15.52% 56.37% 129.65% - -------------------------------------------------------------------------------- Average Annual Total Return(3) 14.52% 9.35% 10.72% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,452 $15,637 $22,965 - -------------------------------------------------------------------------------- PERFORMANCE DATA QUOTED REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. FOR MOST RECENT MONTH-END PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236. 10 | 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 any current, applicable, maximum sales charge, Fund expenses, account fees and reinvested distributions. The unmanaged index includes reinvestment of any income or distributions. It differs from the Fund in composition and does not pay management fees or expenses. One cannot invest directly in an index. [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual Qualified Fund - Class Z, as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 5 from 1/1/96-12/31/04. CLASS Z (1/1/95-12/31/04) MUTUAL QUALIFIED S&P DATE FUND 500(5) ---- ------------ ------- 1/1/1995 $10,000 $10,000 1/31/1995 $10,199 $10,259 2/28/1995 $10,607 $10,659 3/31/1995 $10,716 $10,973 4/30/1995 $10,997 $11,295 5/31/1995 $11,309 $11,746 6/30/1995 $11,372 $12,019 7/31/1995 $11,915 $12,417 8/31/1995 $12,138 $12,448 9/30/1995 $12,472 $12,973 10/31/1995 $12,199 $12,927 11/30/1995 $12,530 $13,493 12/31/1995 $12,545 $13,753 1/31/1996 $13,128 $14,221 2/29/1996 $13,499 $14,353 3/31/1996 $13,639 $14,491 4/30/1996 $13,711 $14,705 5/31/1996 $13,907 $15,083 6/30/1996 $13,826 $15,141 7/31/1996 $13,374 $14,472 8/31/1996 $13,822 $14,778 9/30/1996 $14,239 $15,609 10/31/1996 $14,401 $16,039 11/30/1996 $15,143 $17,251 12/31/1996 $15,342 $16,909 1/31/1997 $15,842 $17,965 2/28/1997 $16,187 $18,106 3/31/1997 $15,979 $17,363 4/30/1997 $16,121 $18,399 5/31/1997 $16,896 $19,518 6/30/1997 $17,453 $20,392 7/31/1997 $18,360 $22,014 8/31/1997 $18,207 $20,782 9/30/1997 $19,119 $21,919 10/31/1997 $18,591 $21,188 11/30/1997 $18,812 $22,168 12/31/1997 $19,164 $22,548 1/31/1998 $19,069 $22,798 2/28/1998 $20,176 $24,441 3/31/1998 $20,966 $25,691 4/30/1998 $20,987 $25,950 5/31/1998 $20,914 $25,504 6/30/1998 $20,776 $26,540 7/31/1998 $20,164 $26,258 8/31/1998 $17,164 $22,465 9/30/1998 $17,099 $23,905 10/31/1998 $18,096 $25,847 11/30/1998 $18,996 $27,413 12/31/1998 $19,260 $28,992 1/31/1999 $19,388 $30,204 2/28/1999 $18,862 $29,265 3/31/1999 $19,821 $30,436 4/30/1999 $21,565 $31,614 5/31/1999 $21,834 $30,869 6/30/1999 $22,480 $32,581 7/31/1999 $22,058 $31,565 8/31/1999 $21,021 $31,408 9/30/1999 $20,538 $30,549 10/31/1999 $21,093 $32,481 11/30/1999 $21,708 $33,141 12/31/1999 $21,886 $35,092 1/31/2000 $21,278 $33,329 2/29/2000 $20,307 $32,699 3/31/2000 $22,521 $35,895 4/30/2000 $22,547 $34,816 5/31/2000 $23,038 $34,103 6/30/2000 $22,672 $34,944 7/31/2000 $23,360 $34,398 8/31/2000 $24,397 $36,534 9/30/2000 $24,467 $34,606 10/31/2000 $24,678 $34,459 11/30/2000 $23,906 $31,744 12/31/2000 $25,006 $31,900 1/31/2001 $26,346 $33,031 2/28/2001 $26,301 $30,021 3/31/2001 $25,728 $28,120 4/30/2001 $26,948 $30,304 5/31/2001 $27,911 $30,507 6/30/2001 $28,347 $29,765 7/31/2001 $28,470 $29,472 8/31/2001 $27,975 $27,629 9/30/2001 $25,378 $25,398 10/31/2001 $25,193 $25,882 11/30/2001 $26,260 $27,867 12/31/2001 $27,059 $28,111 1/31/2002 $26,944 $27,701 2/28/2002 $27,075 $27,167 3/31/2002 $28,010 $28,189 4/30/2002 $28,206 $26,481 5/31/2002 $28,206 $26,286 6/30/2002 $26,287 $24,414 7/31/2002 $24,435 $22,512 8/31/2002 $24,652 $22,659 9/30/2002 $23,049 $20,199 10/31/2002 $23,366 $21,975 11/30/2002 $23,951 $23,267 12/31/2002 $23,623 $21,901 1/31/2003 $23,436 $21,328 2/28/2003 $22,945 $21,008 3/31/2003 $22,996 $21,210 4/30/2003 $24,571 $22,958 5/31/2003 $25,943 $24,166 6/30/2003 $26,370 $24,475 7/31/2003 $26,762 $24,906 8/31/2003 $27,427 $25,391 9/30/2003 $27,290 $25,122 10/31/2003 $28,449 $26,543 11/30/2003 $29,403 $26,776 12/31/2003 $30,826 $28,179 1/31/2004 $31,119 $28,696 2/29/2004 $31,878 $29,095 3/31/2004 $31,878 $28,656 4/30/2004 $30,946 $28,207 5/31/2004 $31,205 $28,593 6/30/2004 $31,794 $29,149 7/31/2004 $31,310 $28,185 8/31/2004 $31,725 $28,298 9/30/2004 $32,485 $28,604 10/31/2004 $32,848 $29,041 11/30/2004 $34,887 $30,216 12/31/2004 $35,957 $31,243 AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------------------------------------------- CLASS Z 12/31/04 - -------------------------------------------------------------------------------- 1-Year 16.64% - -------------------------------------------------------------------------------- 5-Year 10.44% - -------------------------------------------------------------------------------- 10-Year 13.65% - -------------------------------------------------------------------------------- [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual Qualified Fund - Class A, as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 5 from 11/1/96-12/31/03. CLASS A (11/1/96-12/31/04) MUTUAL QUALIFIED S&P DATE FUND 500(5) ---- ------------ ------- 11/1/1996 $9,425 $10,000 11/30/1996 $9,908 $10,755 12/31/1996 $10,035 $10,542 1/31/1997 $10,360 $11,200 2/28/1997 $10,579 $11,288 3/31/1997 $10,437 $10,825 4/30/1997 $10,530 $11,471 5/31/1997 $11,031 $12,169 6/30/1997 $11,389 $12,714 7/31/1997 $11,982 $13,725 8/31/1997 $11,875 $12,957 9/30/1997 $12,466 $13,666 10/31/1997 $12,120 $13,210 11/30/1997 $12,258 $13,821 12/31/1997 $12,488 $14,058 1/31/1998 $12,419 $14,213 2/28/1998 $13,135 $15,238 3/31/1998 $13,644 $16,018 4/30/1998 $13,658 $16,179 5/31/1998 $13,603 $15,901 6/30/1998 $13,506 $16,546 7/31/1998 $13,111 $16,371 8/31/1998 $11,153 $14,006 9/30/1998 $11,111 $14,904 10/31/1998 $11,762 $16,115 11/30/1998 $12,335 $17,091 12/31/1998 $12,507 $18,075 1/31/1999 $12,590 $18,831 2/28/1999 $12,240 $18,246 3/31/1999 $12,864 $18,975 4/30/1999 $13,992 $19,710 5/31/1999 $14,167 $19,245 6/30/1999 $14,577 $20,313 7/31/1999 $14,295 $19,679 8/31/1999 $13,620 $19,582 9/30/1999 $13,306 $19,046 10/31/1999 $13,659 $20,251 11/30/1999 $14,052 $20,662 12/31/1999 $14,166 $21,878 1/31/2000 $13,772 $20,779 2/29/2000 $13,134 $20,386 3/31/2000 $14,561 $22,379 4/30/2000 $14,570 $21,706 5/31/2000 $14,889 $21,262 6/30/2000 $14,655 $21,786 7/31/2000 $15,091 $21,446 8/31/2000 $15,746 $22,777 9/30/2000 $15,791 $21,575 10/31/2000 $15,918 $21,484 11/30/2000 $15,418 $19,791 12/31/2000 $16,123 $19,888 1/31/2001 $16,980 $20,593 2/28/2001 $16,951 $18,717 3/31/2001 $16,571 $17,532 4/30/2001 $17,360 $18,893 5/31/2001 $17,973 $19,020 6/30/2001 $18,241 $18,557 7/31/2001 $18,321 $18,374 8/31/2001 $17,991 $17,225 9/30/2001 $16,321 $15,834 10/31/2001 $16,201 $16,137 11/30/2001 $16,881 $17,374 12/31/2001 $17,388 $17,526 1/31/2002 $17,304 $17,271 2/28/2002 $17,388 $16,938 3/31/2002 $17,981 $17,575 4/30/2002 $18,097 $16,510 5/31/2002 $18,097 $16,388 6/30/2002 $16,855 $15,221 7/31/2002 $15,671 $14,035 8/31/2002 $15,800 $14,127 9/30/2002 $14,779 $12,593 10/31/2002 $14,972 $13,701 11/30/2002 $15,338 $14,506 12/31/2002 $15,129 $13,654 1/31/2003 $15,009 $13,297 2/28/2003 $14,693 $13,098 3/31/2003 $14,704 $13,223 4/30/2003 $15,716 $14,313 5/31/2003 $16,586 $15,066 6/30/2003 $16,856 $15,259 7/31/2003 $17,097 $15,528 8/31/2003 $17,513 $15,830 9/30/2003 $17,436 $15,663 10/31/2003 $18,158 $16,548 11/30/2003 $18,771 $16,694 12/31/2003 $19,665 $17,569 1/31/2004 $19,853 $17,891 2/29/2004 $20,328 $18,140 3/31/2004 $20,328 $17,866 4/30/2004 $19,720 $17,586 5/31/2004 $19,886 $17,827 6/30/2004 $20,257 $18,173 7/31/2004 $19,936 $17,572 8/31/2004 $20,190 $17,643 9/30/2004 $20,677 $17,833 10/31/2004 $20,898 $18,106 11/30/2004 $22,193 $18,838 12/31/2004 $22,805 $19,479 AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------------------------------------------- CLASS A 12/31/04 - -------------------------------------------------------------------------------- 1-Year 9.56% - -------------------------------------------------------------------------------- 5-Year 8.75% - -------------------------------------------------------------------------------- Since Inception (11/1/96) 10.62% - -------------------------------------------------------------------------------- Annual Report | 11 PERFORMANCE SUMMARY (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------------------------------------------- CLASS B 12/31/04 - -------------------------------------------------------------------------------- 1-Year 11.46% - -------------------------------------------------------------------------------- 5-Year 9.06% - -------------------------------------------------------------------------------- Since Inception (1/1/99) 9.77% - -------------------------------------------------------------------------------- [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual Qualified Fund - Class B, as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 5 from 1/1/99-12/31/03. CLASS B (1/1/99-12/31/04) MUTUAL QUALIFIED S&P DATE FUND 500(5) ---- ---------------- ------- 1/1/1999 $10,000 $10,000 1/31/1999 $10,061 $10,418 2/28/1999 $9,787 $10,094 3/31/1999 $10,274 $10,498 4/30/1999 $11,163 $10,905 5/31/1999 $11,297 $10,647 6/30/1999 $11,617 $11,238 7/31/1999 $11,385 $10,887 8/31/1999 $10,851 $10,834 9/30/1999 $10,588 $10,537 10/31/1999 $10,864 $11,203 11/30/1999 $11,171 $11,431 12/31/1999 $11,255 $12,104 1/31/2000 $10,933 $11,496 2/29/2000 $10,423 $11,279 3/31/2000 $11,550 $12,381 4/30/2000 $11,557 $12,009 5/31/2000 $11,805 $11,763 6/30/2000 $11,605 $12,053 7/31/2000 $11,946 $11,865 8/31/2000 $12,461 $12,601 9/30/2000 $12,491 $11,936 10/31/2000 $12,585 $11,886 11/30/2000 $12,186 $10,949 12/31/2000 $12,731 $11,003 1/31/2001 $13,405 $11,393 2/28/2001 $13,366 $10,355 3/31/2001 $13,064 $9,699 4/30/2001 $13,676 $10,453 5/31/2001 $14,156 $10,523 6/30/2001 $14,358 $10,267 7/31/2001 $14,413 $10,166 8/31/2001 $14,151 $9,530 9/30/2001 $12,830 $8,760 10/31/2001 $12,719 $8,927 11/30/2001 $13,252 $9,612 12/31/2001 $13,644 $9,696 1/31/2002 $13,569 $9,555 2/28/2002 $13,628 $9,371 3/31/2002 $14,089 $9,723 4/30/2002 $14,173 $9,134 5/31/2002 $14,165 $9,067 6/30/2002 $13,184 $8,421 7/31/2002 $12,253 $7,765 8/31/2002 $12,338 $7,816 9/30/2002 $11,536 $6,967 10/31/2002 $11,681 $7,580 11/30/2002 $11,963 $8,025 12/31/2002 $11,792 $7,554 1/31/2003 $11,689 $7,357 2/28/2003 $11,439 $7,246 3/31/2003 $11,448 $7,316 4/30/2003 $12,222 $7,919 5/31/2003 $12,900 $8,335 6/30/2003 $13,099 $8,442 7/31/2003 $13,280 $8,591 8/31/2003 $13,600 $8,758 9/30/2003 $13,523 $8,665 10/31/2003 $14,076 $9,155 11/30/2003 $14,543 $9,236 12/31/2003 $15,237 $9,720 1/31/2004 $15,368 $9,898 2/29/2004 $15,733 $10,036 3/31/2004 $15,715 $9,884 4/30/2004 $15,246 $9,729 5/31/2004 $15,359 $9,863 6/30/2004 $15,634 $10,054 7/31/2004 $15,382 $9,722 8/31/2004 $15,573 $9,761 9/30/2004 $15,938 $9,866 10/31/2004 $16,104 $10,017 11/30/2004 $17,086 $10,422 12/31/2004 $17,494 $10,777 AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------------------------------------------- CLASS C 12/31/04 - -------------------------------------------------------------------------------- 1-Year 14.52% - -------------------------------------------------------------------------------- 5-Year 9.35% - -------------------------------------------------------------------------------- Since Inception (11/1/96) 10.72% - -------------------------------------------------------------------------------- CLASS C 11/1/96-12/31/04) [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual Qualified Fund - Class C, as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 5 from 11/1/96-12/31/03. CLASS C 11/1/96-12/31/04) MUTUAL QUALIFIED S&P DATE FUND 500(5) ---- ---------------- ------- 11/1/1996 $10,000 $10,000 11/30/1996 $10,509 $10,755 12/31/1996 $10,637 $10,542 1/31/1997 $10,974 $11,200 2/28/1997 $11,204 $11,288 3/31/1997 $11,046 $10,825 4/30/1997 $11,138 $11,471 5/31/1997 $11,669 $12,169 6/30/1997 $12,043 $12,714 7/31/1997 $12,659 $13,725 8/31/1997 $12,545 $12,957 9/30/1997 $13,158 $13,666 10/31/1997 $12,785 $13,210 11/30/1997 $12,925 $13,821 12/31/1997 $13,158 $14,058 1/31/1998 $13,078 $14,213 2/28/1998 $13,827 $15,238 3/31/1998 $14,358 $16,018 4/30/1998 $14,358 $16,179 5/31/1998 $14,292 $15,901 6/30/1998 $14,190 $16,546 7/31/1998 $13,757 $16,371 8/31/1998 $11,698 $14,006 9/30/1998 $11,646 $14,904 10/31/1998 $12,318 $16,115 11/30/1998 $12,916 $17,091 12/31/1998 $13,082 $18,075 1/31/1999 $13,162 $18,831 2/28/1999 $12,794 $18,246 3/31/1999 $13,434 $18,975 4/30/1999 $14,602 $19,710 5/31/1999 $14,778 $19,245 6/30/1999 $15,200 $20,313 7/31/1999 $14,895 $19,679 8/31/1999 $14,196 $19,582 9/30/1999 $13,850 $19,046 10/31/1999 $14,212 $20,251 11/30/1999 $14,615 $20,662 12/31/1999 $14,722 $21,878 1/31/2000 $14,302 $20,779 2/29/2000 $13,636 $20,386 3/31/2000 $15,108 $22,379 4/30/2000 $15,117 $21,706 5/31/2000 $15,441 $21,262 6/30/2000 $15,178 $21,786 7/31/2000 $15,623 $21,446 8/31/2000 $16,305 $22,777 9/30/2000 $16,343 $21,575 10/31/2000 $16,457 $21,484 11/30/2000 $15,936 $19,791 12/31/2000 $16,653 $19,888 1/31/2001 $17,532 $20,593 2/28/2001 $17,491 $18,717 3/31/2001 $17,097 $17,532 4/30/2001 $17,885 $18,893 5/31/2001 $18,521 $19,020 6/30/2001 $18,789 $18,557 7/31/2001 $18,852 $18,374 8/31/2001 $18,509 $17,225 9/30/2001 $16,778 $15,834 10/31/2001 $16,643 $16,137 11/30/2001 $17,338 $17,374 12/31/2001 $17,845 $17,526 1/31/2002 $17,757 $17,271 2/28/2002 $17,834 $16,938 3/31/2002 $18,423 $17,575 4/30/2002 $18,532 $16,510 5/31/2002 $18,521 $16,388 6/30/2002 $17,252 $15,221 7/31/2002 $16,021 $14,035 8/31/2002 $16,143 $14,127 9/30/2002 $15,090 $12,593 10/31/2002 $15,278 $13,701 11/30/2002 $15,655 $14,506 12/31/2002 $15,430 $13,654 1/31/2003 $15,296 $13,297 2/28/2003 $14,962 $13,098 3/31/2003 $14,973 $13,223 4/30/2003 $15,987 $14,313 5/31/2003 $16,867 $15,066 6/30/2003 $17,135 $15,259 7/31/2003 $17,371 $15,528 8/31/2003 $17,785 $15,830 9/30/2003 $17,696 $15,663 10/31/2003 $18,424 $16,548 11/30/2003 $19,029 $16,694 12/31/2003 $19,929 $17,569 1/31/2004 $20,098 $17,891 2/29/2004 $20,582 $18,140 3/31/2004 $20,559 $17,866 4/30/2004 $19,940 $17,586 5/31/2004 $20,087 $17,827 6/30/2004 $20,453 $18,173 7/31/2004 $20,126 $17,572 8/31/2004 $20,374 $17,643 9/30/2004 $20,847 $17,833 10/31/2004 $21,061 $18,106 11/30/2004 $22,345 $18,838 12/31/2004 $22,965 $19,479 12 | Annual Report PERFORMANCE SUMMARY (CONTINUED) ENDNOTES THE FUND'S INVESTMENTS INCLUDE 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: Shares are available to certain eligible investors as described in the prospectus. CLASS A: Prior to 8/3/98, these shares were offered at a lower initial sales charge; thus actual total returns may differ. CLASS B: These shares have higher annual fees and expenses than Class A shares. CLASS C: Prior to 1/1/04, these shares were offered with an initial sales charge; thus actual total returns would have differed. 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. If the manager had not taken this action, 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 a sales charge. (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. (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. (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 | 13 YOUR FUND'S EXPENSES As a Fund shareholder, you can incur two types of costs: o Transaction costs, including sales charges (loads) on Fund purchases and redemption fees; and o Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. The following table shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated. ACTUAL FUND EXPENSES The first line (Actual) for each share class listed in the table below provides actual account values and expenses. The "Ending Account Value" is derived from the Fund's actual return, which includes the effect of Fund expenses. You can estimate the expenses you paid during the period, by following these steps. OF COURSE, YOUR ACCOUNT VALUE AND EXPENSES WILL DIFFER FROM THOSE IN THIS ILLUSTRATION: 1. Divide your account value by $1,000. IF AN ACCOUNT HAD AN $8,600 VALUE, THEN $8,600 / $1,000 = 8.6. 2. Multiply the result by the number under the heading "Expenses Paid During Period." IF EXPENSES PAID DURING PERIOD WERE $7.50, THEN 8.6 X $7.50 = $64.50. In this illustration, the estimated expenses paid this period are $64.50. HYPOTHETICAL EXAMPLE FOR COMPARISON WITH OTHER FUNDS Information in the second line (Hypothetical) for each class in the table can help you compare ongoing costs of investing in the Fund with those of other mutual funds. This information may not be used to estimate the actual ending account balance or expenses you paid during the period. The hypothetical "Ending Account Value" is based on the actual expense ratio for each class and an assumed 5% annual rate of return before expenses, which does not represent the Fund's actual return. The figure under the heading "Expenses Paid During Period" shows the hypothetical expenses your account would have incurred under this scenario. You can compare this figure with the 5% hypothetical examples that appear in shareholder reports of other funds. 14 | Annual Report YOUR FUND'S EXPENSES (CONTINUED) PLEASE NOTE THAT EXPENSES SHOWN IN THE TABLE ARE MEANT TO HIGHLIGHT ONGOING COSTS AND DO NOT REFLECT ANY TRANSACTION COSTS, SUCH AS SALES CHARGES OR REDEMPTION FEES. Therefore, the second line for each class is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transaction costs were included, your total costs would have been higher. Please refer to the Fund prospectus for additional information on operating expenses.
- -------------------------------------------------------------------------------------------------------- BEGINNING ACCOUNT ENDING ACCOUNT EXPENSES PAID DURING CLASS Z VALUE 6/30/04 VALUE 12/31/04 PERIOD* 6/30/04-12/31/04 - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,166.40 $4.52 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,020.96 $4.22 - -------------------------------------------------------------------------------------------------------- CLASS A - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,162.70 $6.41 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,019.20 $5.99 - -------------------------------------------------------------------------------------------------------- CLASS B - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,154.60 $9.86 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,015.99 $9.22 - -------------------------------------------------------------------------------------------------------- CLASS C - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,155.20 $9.86 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,015.99 $9.22 - --------------------------------------------------------------------------------------------------------
* Expenses are equal to the annualized expense ratio for each class (Z: 0.83%; A: 1.18%; B: 1.82%; and C: 1.82%), multiplied by the average account value over the period, multiplied by 184/366 to reflect the one-half year period. Annual Report | 15 MUTUAL QUALIFIED FUND FINANCIAL HIGHLIGHTS
-------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2004 2003 2002 2001 2000 -------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ......................... $ 17.88 $ 13.95 $ 16.49 $ 16.61 $ 16.91 -------------------------------------------------------------------- Income from investment operations: Net investment income(a) .................................. .37 .20 .28 .23 .24 Net realized and unrealized gains (losses) ................ 2.56 4.04 (2.34) 1.12 1.99 -------------------------------------------------------------------- Total from investment operations ........................... 2.93 4.24 (2.06) 1.35 2.23 -------------------------------------------------------------------- Less distributions from: Net investment income ..................................... (.39) (.31) (.26) (.20) (.55) Net realized gains ........................................ (.93) -- (.22) (1.27) (1.98) -------------------------------------------------------------------- Total distributions ........................................ (1.32) (.31) (.48) (1.47) (2.53) -------------------------------------------------------------------- Redemption fees ............................................ --(d) -- -- -- -- -------------------------------------------------------------------- Net asset value, end of year ............................... $ 19.49 $ 17.88 $ 13.95 $ 16.49 $ 16.61 ==================================================================== Total return(b) ............................................ 16.64% 30.50% (12.70)% 8.21% 14.25% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............................ $3,419,744 $3,102,506 $2,503,544 $3,022,299 $2,921,221 Ratios to average net assets:* Expenses(c) ............................................... .82% .85% .80% .80% .83% Expenses, net of waiver and payments by affiliate(c) ...... .82% .85% .80% .80% .80% Net investment income ..................................... 2.01% 1.34% 1.81% 1.29% 1.43% Portfolio turnover rate .................................... 37.61% 49.70% 51.24% 52.64% 54.73% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .................................................. .81% .82% .79% .79% .81% Expenses, net of waiver and payments by affiliate ......... .81% .82% .79% .79% .78%
(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 only operating expenses. (d) Amount is less than $0.001 per share. 16 | See notes to financial statements. | Annual Report MUTUAL QUALIFIED FUND FINANCIAL HIGHLIGHTS (CONTINUED)
-------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2004 2003 2002 2001 2000 -------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ......................... $ 17.81 $ 13.91 $ 16.44 $ 16.56 $ 16.87 -------------------------------------------------------------------- Income from investment operations: Net investment income(a) .................................. .31 .15 .23 .17 .18 Net realized and unrealized gains (losses) ................ 2.55 4.01 (2.33) 1.12 1.98 -------------------------------------------------------------------- Total from investment operations ........................... 2.86 4.16 (2.10) 1.29 2.16 -------------------------------------------------------------------- Less distributions from: Net investment income ..................................... (.33) (.26) (.21) (.14) (.49) Net realized gains ........................................ (.93) -- (.22) (1.27) (1.98) -------------------------------------------------------------------- Total distributions ........................................ (1.26) (.26) (.43) (1.41) (2.47) -------------------------------------------------------------------- Redemption fees ............................................ --(d) -- -- -- -- -------------------------------------------------------------------- Net asset value, end of year ............................... $ 19.41 $ 17.81 $ 13.91 $ 16.44 $ 16.56 ==================================================================== Total return(b) ............................................ 16.27% 29.98% (13.00)% 7.85% 13.81% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............................ $ 692,523 $ 625,088 $ 449,507 $ 482,182 $ 443,655 Ratios to average net assets:* Expenses(c) ............................................... 1.17% 1.20% 1.15% 1.15% 1.18% Expenses, net of waiver and payments by affiliate(c) ...... 1.17% 1.20% 1.15% 1.15% 1.15% Net investment income ..................................... 1.66% .99% 1.46% .94% 1.08% Portfolio turnover rate .................................... 37.61% 49.70% 51.24% 52.64% 54.73% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .................................................. 1.16% 1.17% 1.14% 1.14% 1.16% Expenses, net of waiver and payments by affiliate ......... 1.16% 1.17% 1.14% 1.14% 1.13%
(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 only operating expenses. (d) Amount is less than $0.001 per share. Annual Report | See notes to financial statements. | 17 MUTUAL QUALIFIED FUND FINANCIAL HIGHLIGHTS (CONTINUED)
-------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2004 2003 2002 2001 2000 -------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ......................... $ 17.54 $ 13.72 $ 16.25 $ 16.44 $ 16.78 -------------------------------------------------------------------- Income from investment operations: Net investment income((a)) ................................ .19 .05 .13 .04 .08 Net realized and unrealized gains (losses) ................ 2.50 3.94 (2.30) 1.13 1.96 -------------------------------------------------------------------- Total from investment operations ........................... 2.69 3.99 (2.17) 1.17 2.04 -------------------------------------------------------------------- Less distributions from: Net investment income ..................................... (.22) (.17) (.14) (.09) (.40) Net realized gains ........................................ (.93) -- (.22) (1.27) (1.98) -------------------------------------------------------------------- Total distributions ........................................ (1.15) (.17) (.36) (1.36) (2.38) -------------------------------------------------------------------- Redemption fees ............................................ --(d) -- -- -- -- -------------------------------------------------------------------- Net asset value, end of year ............................... $ 19.08 $ 17.54 $ 13.72 $ 16.25 $ 16.44 ==================================================================== Total return(b) ............................................ 15.46% 29.22% (13.58)% 7.17% 13.12% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............................ $ 67,714 $ 53,760 $ 36,023 $ 20,581 $ 6,278 Ratios to average net assets:* Expenses(c) ............................................... 1.82% 1.85% 1.80% 1.80% 1.82% Expenses, net of waiver and payments by affiliate(c) ...... 1.82% 1.85% 1.80% 1.80% 1.80% Net investment income ..................................... 1.01% .34% .81% .24% .45% Portfolio turnover rate .................................... 37.61% 49.70% 51.24% 52.64% 54.73% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .................................................. 1.81% 1.82% 1.79% 1.79% 1.80% Expenses, net of waiver and payments by affiliate ......... 1.81% 1.82% 1.79% 1.79% 1.78%
(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 only operating expenses. (d) Amount is less than $0.001 per share. 18 | See notes to financial statements. | Annual Report MUTUAL QUALIFIED FUND FINANCIAL HIGHLIGHTS (CONTINUED)
-------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2004 2003 2002 2001 2000 -------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ......................... $ 17.72 $ 13.85 $ 16.36 $ 16.49 $ 16.80 -------------------------------------------------------------------- Income from investment operations: Net investment income((a)) ................................ .19 .05 .13 .05 .07 Net realized and unrealized gains (losses) ................ 2.52 3.98 (2.31) 1.12 1.97 -------------------------------------------------------------------- Total from investment operations ........................... 2.71 4.03 (2.18) 1.17 2.04 -------------------------------------------------------------------- Less distributions from: Net investment income ..................................... (.20) (.16) (.11) (.03) (.37) Net realized gains ........................................ (.93) -- (.22) (1.27) (1.98) -------------------------------------------------------------------- Total distributions ........................................ (1.13) (.16) (.33) (1.30) (2.35) -------------------------------------------------------------------- Redemption fees ............................................ --(d) -- -- -- -- -------------------------------------------------------------------- Net asset value, end of year ............................... $ 19.30 $ 17.72 $ 13.85 $ 16.36 $ 16.49 ==================================================================== Total return(b) ............................................ 15.52% 29.16% (13.53)% 7.16% 13.11% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............................ $ 311,071 $ 285,668 $ 225,699 $ 251,798 $ 220,838 Ratios to average net assets:* Expenses(c) ............................................... 1.82% 1.85% 1.79% 1.79% 1.82% Expenses, net of waiver and payments by affiliate(c) ...... 1.82% 1.85% 1.79% 1.79% 1.79% Net investment income ..................................... 1.01% .34% .82% .30% .44% Portfolio turnover rate .................................... 37.61% 49.70% 51.24% 52.64% 54.73% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses .................................................. 1.81% 1.82% 1.78% 1.78% 1.80% Expenses, net of waiver and payments by affiliate ......... 1.81% 1.82% 1.78% 1.78% 1.77%
(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 only operating expenses. (d) Amount is less than $0.001 per share. Annual Report | See notes to financial statements. | 19 MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 79.9% AEROSPACE & DEFENSE .4% Northrop Grumman Corp. ............................................. United States 314,600 $ 17,101,656 -------------- AIRLINES .7% (a) Ace Aviation Holdings Inc. ......................................... Canada 1,087,471 32,233,792 (a),(b),(c) Air Canada Inc., Contingent Distribution ........................... Canada 238,886,992 -- -------------- 32,233,792 -------------- BEVERAGES 1.5% Brown-Forman Corp., A .............................................. United States 79,200 4,020,192 C&C Group PLC ...................................................... Irish Republic 2,877,654 11,558,725 Coca-Cola Enterprises Inc. ......................................... United States 730,100 15,222,585 Diageo PLC ......................................................... United Kingdom 2,580,700 36,804,870 -------------- 67,606,372 -------------- CAPITAL MARKETS 2.7% (a) A.B. Watley Group Inc .............................................. United States 128,325 21,815 (a),(e) KKR Financial Corp., 144A .......................................... United States 5,163,200 53,955,440 (d) Leucadia National Corp. ............................................ United States 691,640 45,652,390 MCG Capital Corp. .................................................. United States 1,244,149 21,312,273 -------------- 120,941,918 -------------- COMMERCIAL BANKS 6.0% Allied Irish Banks PLC ............................................. Irish Republic 4,041,494 83,800,180 Bank of Ireland .................................................... Irish Republic 2,248,075 37,121,059 BNP Paribas SA ..................................................... France 479,009 34,645,796 (a),(d) Centennial Bank Holdings Inc. ...................................... United States 1,735,639 18,224,210 (a) Cerberus NCB Acquisition LP Ltd., wts., 8/29/13 .................... Japan 9,375,044 4,687,522 Danske Bank ........................................................ Denmark 1,249,080 38,220,984 (a),(d),(e) Elephant Capital Holdings Ltd. ..................................... Japan 11,087 14,745,195 Kansai Urban Banking Corp. ......................................... Japan 714,567 1,325,598 (a),(e) Nippon Investment LLC .............................................. Japan 9,112,000 -- (a),(d),(e) State National Bancshares Inc. ..................................... United States 1,375,000 38,500,000 -------------- 271,270,544 -------------- COMMERCIAL SERVICES & SUPPLIES 1.3% (a) Comdisco Holding Co., Inc. ......................................... United States 62 1,383 (b) Comdisco, Contingent Distribution .................................. United States 44,591,246 -- (a) Insun ENT Co., Ltd. ................................................ South Korea 408,527 8,030,839 Republic Services Inc. ............................................. United States 1,589,000 53,295,060 (a),(b) Safety Kleen Corp., Contingent Distribution ........................ United States 535,000 -- -------------- 61,327,282 -------------- COMPUTERS & PERIPHERALS (a) DecisionOne Corp. .................................................. United States 245,461 -- -------------- CONSTRUCTION MATERIALS .6% Lafarge North America Inc. ......................................... United States 7,645 392,341 RMC Group PLC ...................................................... United Kingdom 1,762,111 28,715,733 -------------- 29,108,074 --------------
20 | Annual Report MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) CONSUMER FINANCE (a),(e) Union Acceptance Corp., A .......................................... United States 3,595,994 $ 539,399 -------------- DIVERSIFIED FINANCIAL SERVICES .5% Deutsche Bourse AG ................................................. Germany 379,953 22,830,591 London Stock Exchange PLC .......................................... United Kingdom 4,400 49,153 (a),(b) Marconi Corp., Contingent Distribution ............................. United Kingdom 34,293,500 -- -------------- 22,879,744 -------------- DIVERSIFIED TELECOMMUNICATION SERVICES 2.7% (a),(d),(f) AboveNet Inc. ...................................................... United States 365,293 8,753,662 (a),(b),(f) AboveNet Inc., Contingent Distribution ............................. United States 50,430,000 -- (a),(d),(f) AboveNet Inc., wts., 9/08/08 ....................................... United States 11,991 76,742 (a),(d),(f) AboveNet Inc., wts., 9/08/10 ....................................... United States 14,107 56,428 (a) Belgacom SA ........................................................ Belgium 396,300 17,101,368 Chunghwa Telecom Co. Ltd., ADR ..................................... Taiwan 974,078 20,504,342 (b) Global Crossing Holdings Ltd., Contingent Distribution ............. United States 49,411,586 61,765 (a) MCI Inc. ........................................................... United States 749,846 15,116,895 Sprint Corp. ....................................................... United States 123,900 3,078,915 (a),(b) Telewest Communications PLC, Contingent Distribution ............... United Kingdom 53,559,146 -- (a),(b) Telewest Finance Ltd., Contingent Distribution ..................... United Kingdom 5,795,000 -- (a) Telewest Global Inc. ............................................... United Kingdom 3,122,294 54,889,929 -------------- 119,640,046 -------------- ELECTRIC UTILITIES 1.0% (a) Aquila Inc ......................................................... United States 4,308,600 15,898,734 E.ON AG ............................................................ Germany 304,810 27,787,461 -------------- 43,686,195 -------------- FOOD & STAPLES RETAILING .6% Groupe Bourbon ..................................................... France 215,723 10,576,551 (a) Kroger Co. ......................................................... United States 828,700 14,535,398 -------------- 25,111,949 -------------- FOOD PRODUCTS 4.9% Cadbury Schweppes PLC .............................................. United Kingdom 2,728,621 25,401,766 CSM NV ............................................................. Netherlands 733,412 22,810,893 Groupe Danone ...................................................... France 660,860 60,936,651 Nestle SA .......................................................... Switzerland 160,750 41,988,783 Orkla ASA .......................................................... Norway 2,151,200 70,589,880 -------------- 221,727,973 -------------- HEALTH CARE EQUIPMENT & SUPPLIES .2% (n) Guidant Corp. ...................................................... United States 137,700 9,928,170 -------------- HEALTH CARE PROVIDERS & SERVICES 2.5% (a) Alderwoods Group Inc. .............................................. United States 172,684 1,965,144 (e) Generale de Sante .................................................. France 1,984,113 41,571,276 (a),(f) Kindred Healthcare Inc. ............................................ United States 1,208,060 34,372,327 (a),(f) Kindred Healthcare Inc., Jan. 26.00 Calls, 1/01/12 ................. United States 588 2,323 (a),(f) Kindred Healthcare Inc., Jan. 9.07 Calls, 1/01/13 .................. United States 294 6,137 (a),(f) Kindred Healthcare Inc., Jul. 23.75 Calls, 7/17/11 ................. United States 2,916 18,079
Annual Report | 21 MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) HEALTH CARE PROVIDERS & SERVICES (CONT.) (a),(f) Kindred Healthcare Inc., wts., Series A, 4/20/06 ................... United States 104,567 $ 3,107,313 (a),(f) Kindred Healthcare Inc., wts., Series B, 4/20/06 ................... United States 261,416 6,854,328 Select Medical Corp. ............................................... United States 138,100 2,430,560 (a) Triad Hospitals Inc. ............................................... United States 570,800 21,239,468 -------------- 111,566,955 -------------- HOTELS RESTAURANTS & LEISURE .3% (a) Caesars Entertainment Inc. ......................................... United States 279,000 5,619,060 (a),(e) FHC Delaware Inc. .................................................. United States 452,571 3,561,734 Mandalay Resort Group .............................................. United States 66,900 4,711,767 -------------- 13,892,561 -------------- INDUSTRIAL CONGLOMERATES Wendel Investissement .............................................. France 3,812 278,560 -------------- INSURANCE 11.9% (a) Alleghany Corp. .................................................... United States 138,214 39,425,544 (a) Berkshire Hathaway Inc., A ......................................... United States 468 41,137,200 (a) Berkshire Hathaway Inc., B ......................................... United States 3,750 11,010,000 Hartford Financial Services Group Inc. ............................. United States 482,200 33,421,282 (a),(d),(e) Imagine Group Holdings Ltd. ........................................ Bermuda 2,814,856 28,828,432 Montpelier Re Holdings Ltd. ........................................ Bermuda 220,816 8,490,375 (a),(d) Occum Acquisition Corp. ............................................ United States 394,800 39,480,000 Old Republic International Corp. ................................... United States 1,708,400 43,222,520 (a),(d) Olympus Re Holdings Ltd. ........................................... Bermuda 97,300 16,655,814 Prudential Financial Inc. .......................................... United States 461,000 25,336,560 St. Paul Travelers Cos. Inc. ....................................... United States 524,919 19,458,747 White Mountains Insurance Group Inc. ............................... United States 352,130 227,475,980 -------------- 533,942,454 -------------- MACHINERY 2.0% Kone Corp., B ...................................................... Finland 719,300 55,681,035 (a),(d),(e) Lancer Industries Inc., B .......................................... United States 4 2,871,815 NACCO Industries Inc., A ........................................... United States 274,700 28,953,380 -------------- 87,506,230 -------------- MEDIA 8.0% Clear Channel Communications Inc. .................................. United States 463,800 15,532,662 (a) Comcast Corp., A ................................................... United States 146,500 4,811,060 E.W. Scripps Co., A ................................................ United States 822,700 39,719,956 EchoStar Communications Corp., A United States 529,300 17,593,932 (a) Fox Entertainment Group Inc., A .................................... United States 181,400 5,670,564 Hollinger International Inc. ....................................... United States 767,234 10,827,206 (a) Liberty Media Corp., A ............................................. United States 6,148,259 67,507,884 Meredith Corp. ..................................................... United States 505,715 27,409,753 (a) News Corp. Ltd., A ................................................. United States 570,000 10,636,200 (a) NTL Inc. ........................................................... United Kingdom 927,728 67,687,035 Omnicom Group Inc. ................................................. United States 177,700 14,983,664 (a) TVMAX Holdings Inc. ................................................ United States 111,391 111,391
22 | Annual Report MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) MEDIA (CONT.) Viacom Inc., B ..................................................... United States 265,500 $ 9,661,545 Washington Post Co., B ............................................. United States 66,050 64,928,471 -------------- 357,081,323 -------------- METALS & MINING 8.7% Anglo American PLC ................................................. United Kingdom 1,226,724 29,009,251 (a) Apex Silver Mines Ltd. ............................................. United States 776,300 13,336,834 Barrick Gold Corp. ................................................. Canada 605,400 14,662,788 Consol Energy Inc. ................................................. United States 741,800 30,450,890 (a) Eldorado Gold Corp. ................................................ Canada 3,158,200 9,348,072 (a) Eldorado Gold Corp., wts., 8/25/05 ................................. Canada 800,000 -- Freeport McMoran Copper & Gold Inc., B ............................. United States 1,231,200 47,068,776 (a) Glamis Gold Ltd. ................................................... Canada 736,300 12,622,110 Gold Fields Ltd. ................................................... South Africa 146,300 1,794,855 Harmony Gold Mining Ltd., ADR ...................................... South Africa 341,800 3,168,486 (a),(d) International Steel Group .......................................... United States 2,855,428 110,025,352 Newmont Mining Corp. ............................................... United States 1,845,100 81,940,891 Noranda Inc. ....................................................... Canada 947,100 16,630,613 Placer Dome Inc. ................................................... Canada 253,900 4,780,141 (a) Randgold & Exploration Co. Ltd., ADR ............................... South Africa 133,800 235,488 (a) Wheaton River Minerals Ltd. ........................................ Canada 2,219,925 7,218,666 (a) Wheaton River Minerals Ltd., wts., 5/30/07 ......................... Canada 777,331 1,529,580 (n) WMC Resources Ltd. ................................................. Australia 843,800 4,768,687 -------------- 388,591,480 -------------- MULTI-UTILITIES & UNREGULATED POWER .5% (a) Northwestern Corp. ................................................. United States 303,164 8,488,592 (a),(b) Northwestern Corp., Contingent Distribution ........................ United States 9,300,000 728,118 (a),(c) NRG Energy Inc. .................................................... United States 347,613 12,531,449 -------------- 21,748,159 -------------- MULTILINE RETAIL .2% Jelmoli Holding AG ................................................. Switzerland 7,074 10,217,068 -------------- OIL & GAS 2.4% (a) Anchor Resources LLC ............................................... United States 58,923 -- BP PLC ............................................................. United Kingdom 1,221,600 11,911,643 BP PLC, ADR ........................................................ United Kingdom 193,700 11,312,080 Eni SpA ............................................................ Italy 1,452,100 36,296,589 (a) General Maritime Corp. ............................................. United States 13,300 531,335 Oil & Natural Gas Corp. Ltd. ....................................... India 674,700 12,784,980 Total SA, B ........................................................ France 166,368 36,279,837 -------------- 109,116,464 -------------- PAPER & FOREST PRODUCTS .2% Abitibi-Consolidated Inc. .......................................... Canada 1,139,500 7,847,809 -------------- PERSONAL PRODUCTS .4% Beiersdorf AG ...................................................... Germany 155,062 18,079,204 --------------
Annual Report | 23 MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) PHARMACEUTICALS 3.1% Fujisawa Pharmaceutical Co. Ltd. ................................... Japan 878,600 $ 24,062,419 Pfizer Inc. ........................................................ United States 380,800 10,239,712 (a) Pfizer Inc., Mar. 25.00 Puts, 3/19/05 .............................. United States 2,127 148,890 Sanofi-Aventis ..................................................... France 321,748 25,672,776 Takeda Pharmaceutical Co. Ltd. ..................................... Japan 634,000 31,941,418 Valeant Pharmaceuticals International .............................. United States 1,025,100 27,011,385 Wyeth .............................................................. United States 466,800 19,881,012 Yamanouchi Pharmaceutical Co. Ltd. ................................. Japan 37,000 1,441,418 -------------- 140,399,030 -------------- REAL ESTATE 3.6% (a) Alexander's Inc. ................................................... United States 108,590 23,346,850 (a) Canary Wharf Group PLC ............................................. United Kingdom 8,298,072 47,146,326 Medical Properties Trust ........................................... United States 823,500 8,440,875 (e) Saxon Capital Inc. ................................................. United States 2,663,585 63,899,404 (a),(d) Security Capital European Realty ................................... Luxembourg 17,603 126,742 Ventas Inc. ........................................................ United States 669,525 18,351,680 -------------- 161,311,877 -------------- ROAD & RAIL 1.5% CSX Corp. .......................................................... United States 78,100 3,130,248 (d) Florida East Coast Industries Inc. ................................. United States 1,497,000 64,138,965 -------------- 67,269,213 -------------- SEMICONDUCTORS & SEMICONDUCTOR EQUIPMENT .3% Samsung Electronics Co. Ltd. ....................................... South Korea 29,500 12,837,858 -------------- SOFTWARE .2% (a),(n) Symantec Corp. ..................................................... United States 132,400 3,410,624 (a),(n) Veritas Software Corp. ............................................. United States 132,600 3,785,730 -------------- 7,196,354 -------------- THRIFTS & MORTGAGE FINANCE 3.2% Astoria Financial Corp. ............................................ United States 104,500 4,176,865 Brookline Bancorp Inc. ............................................. United States 40,700 664,224 (a) Franklin Bank Corp., A, 144A ....................................... United States 724,979 13,230,867 (a) Franklin Bank Corp., Houston ....................................... United States 164,900 3,009,425 Hudson City Bancorp Inc. ........................................... United States 382,500 14,083,650 (a),(e) ITLA Capital Corp. ................................................. United States 445,796 26,208,347 Sovereign Bancorp Inc. ............................................. United States 3,735,520 84,235,976 -------------- 145,609,354 -------------- TOBACCO 7.8% Altadis SA ......................................................... Spain 2,499,700 114,313,480 Altria Group Inc. .................................................. United States 796,507 48,666,578 British American Tobacco PLC ....................................... United Kingdom 3,939,454 67,865,560 Imperial Tobacco Group PLC ......................................... United Kingdom 472,000 12,928,404 KT & G Corp. ....................................................... South Korea 1,051,600 31,440,321 KT & G Corp., GDR, 144A ............................................ South Korea 1,433,500 21,072,450 Reynolds American Inc. ............................................. United States 686,300 53,943,180 -------------- 350,229,973 --------------
24 | Annual Report MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) WIRELESS TELECOMMUNICATION SERVICES (a) Vast Solutions Inc., B1 ............................................ United States 37,029 $ -- (a) Vast Solutions Inc., B2 ............................................ United States 37,029 -- (a) Vast Solutions Inc., B3 ............................................ United States 37,029 -- -------------- -- -------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $2,205,392,824) 3,587,825,040 -------------- PREFERRED STOCKS .4% DIVERSIFIED TELECOMMUNICATION SERVICES PTV Inc., 10.00%, A, pfd. .......................................... United Kingdom 92,939 421,014 -------------- ELECTRIC UTILITIES (a) Montana Power Co., 8.45%, pfd. ..................................... United States 46,450 383,212 -------------- FOOD PRODUCTS .1% Unilever NV, pfd. .................................................. Netherlands 484,300 3,292,546 -------------- METALS & MINING .3% (a),(e),(f) Esmark Inc., Series A, 10.00%, cvt. pfd. ........................... United States 14,950 14,950,000 -------------- TOTAL PREFERRED STOCKS (COST $18,748,569) 19,046,772 -------------- ------------------ PRINCIPAL AMOUNT(g) ------------------ CORPORATE BONDS & NOTES 2.4% Anchor Resources LLC, 12.00%, 12/17/06 ............................. United States $ 27,567 27,567 Calpine Generating Co., 144A, FRN, 11.169%, 4/01/11 ................ United States 8,116,000 7,973,970 Eurotunnel PLC, FRN, 6.347%, 12/31/18, Tier 2 ................................... United Kingdom 10,332,415 GBP 14,279,510 FRN, 6.347%, 12/31/25, Tier 3 ................................... United Kingdom 23,862,608 GBP 19,237,390 Participating Loan Note, 1.00%, 4/30/40 ......................... United Kingdom 1,020,000 GBP 225,153 Eurotunnel SA, FRN, 3.449%, 12/31/18, Tier 2 (LIBOR) ................................ France 2,479,106 EUR 2,422,185 3.449%, 12/31/25, Tier 3 (LIBOR) ................................ France 37,541,397 EUR 21,396,334 3.453%, 12/31/18, Tier 2 (PIBOR) ................................ France 1,096,535 EUR 1,071,358 3.453%, 12/31/25, Tier 3 (PIBOR) ................................ France 6,693,302 EUR 3,814,779 Guadalupe Power Partners LP, Power Sale Agreement, 6.00%, 9/21/06 ............................ United States 159,400 140,272 Term Loan, 4.313%, 9/21/06 ...................................... United States 1,178,200 1,036,816 Motor Coach Industries International Inc., FRN, 15.40%, 10/01/08 ... United States 21,286,407 21,286,407 Reliant Energy Channelview LP Inc., Revolver, 5.50%, 8/15/07 ........................................ United States 265,300 225,505 Term Loan A, 3.813%, 11/26/17 ................................... United States 2,799,337 2,379,436 Seton House Finance Ltd., zero cpn., 2/07/12 ....................... United Kingdom 37,921,000 EUR 13,121,988 TVMAX Holdings Inc., PIK, 11.50%, 6/30/05 ................................................. United States 132,091 132,091 14.00%, 6/30/05 ................................................. United States 474,794 474,794 -------------- TOTAL CORPORATE BONDS & NOTES (COST $114,777,489) .................. 109,245,555 --------------
Annual Report | 25 MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- COUNTRY PRINCIPAL AMOUNT(g) VALUE - ----------------------------------------------------------------------------------------------------------------------------------- BONDS & NOTES IN REORGANIZATION 2.7% (a),(h) Adelphia Communications Corp., 9.25%, 10/01/02 ................................................. United States $ 2,551,000 $ 2,455,337 8.125%, 7/15/03 ................................................. United States 660,000 623,700 7.50%, 1/15/04 .................................................. United States 1,740,000 1,618,200 10.50%, 7/15/04 ................................................. United States 2,715,000 2,687,850 9.875%, 3/01/05 ................................................. United States 1,013,000 975,012 10.25%, 11/01/06 ................................................ United States 3,723,000 3,639,232 9.875%, 3/01/07 ................................................. United States 145,000 139,562 8.375%, 2/01/08 ................................................. United States 3,934,000 3,727,465 7.75%, 1/15/09 .................................................. United States 4,637,000 4,358,780 7.875%, 5/01/09 ................................................. United States 3,491,000 3,264,085 9.375%, 11/15/09 ................................................ United States 747,000 741,397 10.875%, 10/01/10 ............................................... United States 2,816,000 2,801,920 (a),(h) Aiken Cnty S C Indl Rev Beloit, 6.00%, 12/01/11 .................... United States 375,000 1,875 (a),(h) Armstrong Holdings Inc., 6.50%, 8/15/05 .................................................. United States 804,000 584,910 9.75%, 4/15/08 .................................................. United States 1,511,000 1,099,252 Revolver, 10/29/03 .............................................. United States 1,483,875 1,023,874 Trade Claim ..................................................... United States 3,978,800 2,785,160 (a),(h) Century Communications Corp., 9.50%, 3/01/05 .................................................. United States 810,000 984,150 8.875%, 1/15/07 ................................................. United States 995,000 1,198,975 8.75%, 10/01/07 ................................................. United States 1,472,000 1,736,960 8.375%, 12/15/07 ................................................ United States 400,000 478,000 Series B, zero cpn., 1/15/08 .................................... United States 2,672,000 1,883,760 zero cpn., 3/15/03 .............................................. United States 6,175,000 6,576,375 (h) DecisionOne Corp., Term Loan ....................................... United States 7,391,211 1,847,803 (a),(h) Harnischfeger Industries Inc., 8.90%, 3/01/22 .................................................. United States 3,155,000 29,341 8.70%, 6/15/22 .................................................. United States 2,970,000 28,215 7.25%, 12/15/25 ................................................. United States 4,414,000 41,492 6.875%, 2/15/27 ................................................. United States 3,705,000 34,086 Stipulated Bank Claim ........................................... United States 4,766,550 43,376 (a),(h) Mirant Americas Generation Inc., 7.625%, 5/01/06 ................................................. United States 672,000 725,760 8.30%, 5/01/11 .................................................. United States 3,196,000 3,395,750 9.125%, 5/01/31 ................................................. United States 2,425,000 2,540,188 (a),(h) Mirant Corp., Tranche C Revolver .............................................. United States 5,589,776 3,856,945 4 Year Revolver, 7/17/05 ........................................ United States 3,562,108 2,689,392 364 Day Revolver ................................................ United States 9,407,300 6,538,074 (a),(h) Owens Corning, Revolver ............................................ United States 25,806,811 22,968,062 (a),(h) Port Seattle Wash Rev Ref-Beloit Proj., 6.00%, 12/01/17 ............ United States 200,000 1,000 (a),(h) Safety Kleen Services, 9.25%, 6/01/08 .............................. United States 40,000 150 (a),(h) Teco Panda, Bank Claim ...................................................... United States 1,403,840 842,304 Bank Claim #2 ................................................... United States 11,358,350 7,155,761 Bank Claim #3 ................................................... United States 63,920 63,920 Debt Service Reserve L/C Loan ................................... United States 386,000 243,180 Project L/C Loan Facility ....................................... United States 1,561,960 984,035
26 | Annual Report MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- COUNTRY PRINCIPAL AMOUNT(g) VALUE - ---------------------------------------------------------------------------------------------------------------------------------- BONDS & NOTES IN REORGANIZATION (CONT.) (h) Trump Atlantic, 11.25%, 5/01/06 ................................................. United States $ 15,662,000 $ 15,015,943 Series B, 11.25%, 5/01/06 ....................................... United States 4,596,000 4,406,415 Series B, 144A, 11.25%, 5/01/06 ................................. United States 285,000 273,244 -------------- TOTAL BONDS & NOTES IN REORGANIZATION (COST $102,818,348) .......... 119,110,267 -------------- ---------------- SHARES/PRINCIPAL AMOUNT(g) ---------------- 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 3,102,446 (a),(e) MBOP Liquidating Trust ............................................. United States 412,418 1,031 (a) United Companies Financial Corp., Bank Claim ...................................................... United States 98,521 -- Revolver ........................................................ United States 24,993,011 -- -------------- TOTAL COMPANIES IN LIQUIDATION (COST $141,788) 3,225,430 -------------- ------------------ PRINCIPAL AMOUNT(g) ------------------ GOVERNMENT AGENCIES 14.0% (i) Federal Home Loan Bank, 1.75% - 2.51%, 1/03/05 - 7/02/07 ........... United States 571,246,000 567,511,302 Federal Home Loan Mortgage Corp., 2.50%, 5/19/06 ................... United States 10,000,000 9,919,330 Federal National Mortgage Association, 2.15% - 2.20%, 6/01/05 - 12/29/06 ....................................... United States 40,350,000 39,793,269 U.S. Treasury Bill, 2.53%, 6/30/05 ................................. United States 12,000,000 11,853,528 -------------- TOTAL GOVERNMENT AGENCIES (COST $630,727,944) ...................... 629,077,429 -------------- TOTAL INVESTMENTS BEFORE REPURCHASE AGREEMENTS (COST $3,072,606,962) ........................................... 4,467,530,493 -------------- REPURCHASE AGREEMENTS (j),(k) Citigroup Global Markets Inc., 2.28%, 01/03/05 (Maturity Value $16,004), Collateralized by U.S. Government Agency Securities, 0.00 - 7.75%, 6/15/05 - 9/15/34 .............. United States 16,001 16,001 (j),(k) Deutsche Bank Securities Inc., 2.25%, 1/03/05 (Maturity Value $17,004) Collateralized by U.S. Government Agency Securities, 0.00 - 4.45%, 8/19/05 - 8/27/10 ..................... United States 17,001 17,001 (j),(k) JP Morgan Securities, 2.19%, 1/03/05 (Maturity Value $17,004) Collateralized by U.S. Government Agency Securities, 2.00 - 7.125%, 1/15/06 - 7/15/32 ................................ United States 17,001 17,001 (j),(k) Merrill Lynch GSI, 2.28%, 1/03/05 (Maturity Value $17,004) Collateralized by U.S. Government Agency Securities, 0.00 - 7.415%, 1/05/05 - 8/06/38 ................................ United States 17,001 17,001 (j),(k) Morgan Stanley & Co. Inc., 2.30%, 1/03/05 (Maturity Value $17,004) Collateralized by U.S. Government Agency Securities, 4.00 - 8.00%, 7/01/08 - 1/01/35 ................................. United States 17,001 17,001 -------------- TOTAL REPURCHASE AGREEMENTS (COST $84,005) ......................... 84,005 --------------
Annual Report | 27 MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- COUNTRY VALUE - ---------------------------------------------------------------------------------------------------------------------------------- TOTAL INVESTMENTS (COST $3,072,690,967) 99.5% ...................... $4,467,614,498 OPTIONS WRITTEN .................................................... (156,906) SECURITIES SOLD SHORT (.7)% ........................................ (31,858,957) NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS (.7)% ............ (32,862,264) OTHER ASSETS, LESS LIABILITIES 2.0% ................................ 88,314,815 -------------- NET ASSETS 100.0% .................................................. $4,491,051,186 ============== ----------- OPTIONS WRITTEN CONTRACTS ----------- ISSUER HEALTH CARE EQUIPMENT & SUPPLIES (l) Guidant Corp., Jan. 70.00 Calls, 01/22/05 .......................... United States 143 33,605 -------------- METALS & MINING (l) WMC Resources Ltd., Jan. 7.00 Calls, 1/27/05 ...................... Australia 219 57,427 (l) WMC Resources Ltd., Jan. 7.25 Calls, 1/27/05 ....................... Australia 98 14,191 -------------- 71,618 -------------- SOFTWARE (l) Symantec Corp., Jan. 25.00 Calls, 1/22/05 .......................... United States 201 30,150 (l) Symantec Corp., Jan. 27.50 Calls, 1/22/05 .......................... United States 133 5,453 (l) Veritas Software Corp., Jan. 30.00 Calls, 1/22/05 .................. United States 268 16,080 -------------- 51,683 -------------- TOTAL OPTIONS WRITTEN (PREMIUMS RECEIVED $146,018) ................. $ 156,906 -------------- ----------- SECURITIES SOLD SHORT .7% SHARES ----------- ISSUER COMMUNICATIONS EQUIPMENT (m) Tellabs Inc ........................................................ United States 60,528 519,936 -------------- DIVERSIFIED FINANCIAL SERVICES .1% (m) Nasdaq 100 ......................................................... United States 138,000 5,508,960 -------------- FOOD PRODUCTS .4% (m) Kraft Foods Inc., A ................................................ United States 527,089 18,769,639 -------------- HOTELS RESTAURANTS & LEISURE .1% (m) Harrah's Entertainment Inc ......................................... United States 60,642 4,056,343 --------------
28 | Annual Report MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- INDUSTRY SHARES VALUE - ---------------------------------------------------------------------------------------------------------------------------------- SECURITIES SOLD SHORT (CONT.) PHARMACEUTICALS .1% (l) Johnson & Johnson .................................................. United States 47,368 $ 3,004,079 -------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $29,824,248) ................. $ 31,858,957 --------------
CURRENCY ABBREVIATIONS: | EUR - Euro | GBP - British Pound (a) Non-income producing. (b) Contingent Distributions represent the right to receive additional distributions, if any, during the reorganization of the underlying company. Shares represent total underlying principal of debt securities. (c) Security on loan. See Note 1(i). (d) See Note 10 regarding restricted securities. (e) See Note 11 regarding holdings of 5% voting securities. (f) See Note 12 regarding other considerations. (g) The principal amount is stated in U.S. dollars unless otherwise indicated. (h) Defaulted securities. See Note 9. (i) See Note 1(h) regarding securities segregated with broker for securities sold short. (j) Investments from cash collateral received for loaned securities. See Note 1(i). (k) See Note 1(c) regarding repurchase agreements. (l) See Note 1(g) regarding written options. (m) See Note 1(h) regarding securities sold short. (n) A portion of the security held in connection with open option contracts. Annual Report | See notes to financial statements. | 29 MUTUAL QUALIFIED FUND FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2004 Assets: Investments in securities: Cost - Unaffiliated issuers ................................................. $ 2,855,111,827 Cost - Non-controlled affiliated issuers .................................... 217,495,135 Cost - Repurchase agreements ................................................ 84,005 --------------- Total cost of investments ................................................... 3,072,690,967 =============== Value - Unaffiliated issuers (includes securities segregated with broker for securities sold short in the amount of $18,450,833) ............. 4,177,898,420 Value - Non-controlled affiliated issuers ................................... 289,632,073 Value - Repurchase agreements ............................................... 84,005 --------------- Total value of investments .................................................. 4,467,614,498 Cash ......................................................................... 11,101,566 Foreign currency, at value (cost $19,216,683) ................................ 19,292,868 Receivables: Investment securities sold .................................................. 28,675,682 Capital shares sold ......................................................... 1,795,473 Dividends and interest ...................................................... 13,391,538 Unrealized gain on forward exchange contracts (Note 8) ....................... 1,792,276 Due from brokers - synthetic equity swaps (Note 7) ........................... 2,361,464 Cash on deposit with brokers for securities sold short ....................... 32,235,533 --------------- Total assets ............................................................ 4,578,260,898 --------------- Liabilities: Payables: Investment securities purchased ............................................. 9,241,866 Capital shares redeemed ..................................................... 7,497,468 Affiliates .................................................................. 3,447,714 Options written, at value (premiums received $146,018) ....................... 156,906 Securities sold short, at value (proceeds $29,824,248) ....................... 31,858,957 Payable upon return of securities loaned ..................................... 84,005 Unrealized loss on forward exchange contracts (Note 8) ....................... 34,654,540 Deferred tax ................................................................. 5,883 Other liabilities ............................................................ 262,373 --------------- Total liabilities ....................................................... 87,209,712 --------------- Net assets, at value .................................................. $ 4,491,051,186 =============== Net assets consist of: Distributions in excess of net investment income ............................. $ (1,816,447) Net unrealized appreciation (depreciation) ................................... 1,360,602,965 Accumulated net realized gain (loss) ......................................... 69,447,847 Capital shares ............................................................... 3,062,816,821 --------------- Net assets, at value .................................................. $ 4,491,051,186 ===============
30 | See notes to financial statements. | Annual Report MUTUAL QUALIFIED FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2004 CLASS Z: Net assets, at value ......................................................... $ 3,419,743,861 =============== Shares outstanding ........................................................... 175,429,050 =============== Net asset value and maximum offering price per share(a) ...................... $ 19.49 =============== CLASS A: Net assets, at value ......................................................... $ 692,522,599 =============== Shares outstanding ........................................................... 35,674,066 =============== Net asset value per share(a) ................................................. $ 19.41 =============== Maximum offering price per share (net asset value per share / 94.25%) ........ $ 20.59 =============== CLASS B: Net assets, at value ......................................................... $ 67,714,144 =============== Shares outstanding ........................................................... 3,548,221 =============== Net asset value and maximum offering price per share(a) ...................... $ 19.08 =============== CLASS C: Net assets, at value ......................................................... $ 311,070,582 =============== Shares outstanding ........................................................... 16,119,277 =============== Net asset value and maximum offering price per share(a) ...................... $ 19.30 ===============
(a) Redemption price is equal to net asset value less contingent deferred sales charges, if applicable, and redemption fees retained by the Fund. Annual Report | See notes to financial statements. | 31 MUTUAL QUALIFIED FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2004 Investment income: Dividends: (net of foreign taxes of $5,302,171) Unaffiliated issuers ........................................................ $ 64,737,134 Non-controlled affiliated issuers (Note 11) ................................. 6,571,778 Interest ..................................................................... 45,261,376 --------------- Total investment income ................................................. 116,570,288 --------------- Expenses: Management fees (Note 3) ..................................................... 24,709,801 Administrative fees (Note 3) ................................................. 3,179,009 Distribution fees (Note 3) Class A ..................................................................... 2,181,182 Class B ..................................................................... 582,996 Class C ..................................................................... 2,885,511 Transfer agent fees (Note 3) ................................................. 4,192,600 Custodian fees (Note 4) ...................................................... 373,973 Reports to shareholders ...................................................... 183,700 Registration and filing fees ................................................. 157,500 Professional fees ............................................................ 318,043 Directors' fees and expenses ................................................. 102,900 Dividends on securities sold short ........................................... 589,365 Other ........................................................................ 175,164 --------------- Total expenses .......................................................... 39,631,744 Expense reductions (Note 4) ............................................. (19,546) --------------- Net expenses .......................................................... 39,612,198 --------------- Net investment income ............................................... 76,958,090 --------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments: Unaffiliated issuers .................................................... 316,567,410 Non-controlled affiliated issuers (Note 11) ............................. 5,703,907 Written options ........................................................... 823,322 Foreign currency transactions ............................................. (66,717,460) Securities sold short ..................................................... (2,035,099) --------------- Net realized gain (loss) ................................................ 254,342,080 Net change in unrealized appreciation (depreciation) on: Investments ............................................................... 298,884,063 Translation of assets and liabilities denominated in foreign currencies ... 12,590,490 Deferred taxes ............................................................ (5,883) --------------- Net change in unrealized appreciation (depreciation) .................... 311,468,670 --------------- Net realized and unrealized gain (loss) ....................................... 565,810,750 --------------- Net increase (decrease) in net assets resulting from operations ............... $ 642,768,840 ===============
32 | See notes to financial statements. | Annual Report MUTUAL QUALIFIED FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS for the years ended December 31, 2004 and 2003
---------------------------------- 2004 2003 ---------------------------------- Increase (decrease) in net assets: Operations: Net investment income .................................................................... $ 76,958,090 $ 42,074,132 Net realized gain (loss) from investments, written options, foreign currency transactions, and securities sold short ............................................................... 254,342,080 57,118,819 Net change in unrealized appreciation (depreciation) on investments, translation of assets and liabilities denominated in foreign currencies, and deferred taxes ................... 311,468,670 856,873,994 ---------------------------------- Net increase (decrease) in net assets resulting from operations ...................... 642,768,840 956,066,945 Distributions to shareholders from: Net investment income: Class Z ................................................................................. (64,408,817) (54,241,957) Class A ................................................................................. (10,952,485) (8,988,249) Class B ................................................................................. (717,882) (500,084) Class C ................................................................................. (3,064,752) (2,603,368) Net realized gains: Class Z ................................................................................. (154,113,777) -- Class A ................................................................................. (31,509,731) -- Class B ................................................................................. (3,127,895) -- Class C ................................................................................. (14,229,787) -- ---------------------------------- Total distributions to shareholders ....................................................... (282,125,126) (66,333,658) Capital share transactions (Note 2): Class Z ................................................................................. 40,783,518 (86,032,129) Class A ................................................................................. 13,145,836 43,560,544 Class B ................................................................................. 8,909,619 6,775,812 Class C ................................................................................. 544,813 (1,788,598) ---------------------------------- Total capital share transactions .......................................................... 63,383,786 (37,484,371) Redemption fees ........................................................................... 1,353 -- ---------------------------------- Net increase (decrease) in net assets ................................................. 424,028,853 852,248,916 Net assets: Beginning of year ......................................................................... 4,067,022,333 3,214,773,417 ---------------------------------- End of year ............................................................................... $ 4,491,051,186 $ 4,067,022,333 ================================== Distributions in excess of net investment income included in net assets: End of year ............................................................................... $ (1,816,447) $ (8,675,118) ==================================
Annual Report | See notes to financial statements. | 33 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), consisting of 6 separate series. The Company is an open-end investment company registered under the Investment Company Act of 1940. The financial statements of the remaining funds in the series are presented separately. 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 on a securities exchange or on the NASDAQ National Market System, are valued at the last quoted sale price or the official closing price of the day, respectively. Over-the-counter securities and listed securities for which there is no reported sale are valued within the range of the most recent quoted bid and ask prices. Securities that trade in multiple markets or on multiple exchanges are valued according to the broadest and most representative market. Repurchase agreements are valued at cost. Corporate debt securities and U.S. Government securities generally trade in the over-the-counter market rather than on a securities exchange. The Fund may utilize independent pricing services, quotations from bond dealers, and information with respect to bond and note transactions, to assist in determining a current market value for each security. The Fund's pricing services may use valuation models or matrix pricing which considers information with respect to comparable bond and note transactions, quotations from bond dealers, or by reference to other securities that are considered comparable in such characteristics as rating, interest rate and maturity date, option adjusted spread models, prepayment projections, interest rate spreads and yield curves, to determine current value. Foreign securities are valued as of the close of trading on the foreign stock exchange on which the security is primarily traded, or the NYSE, whichever is earlier. The value is then converted into its U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the day that the value of the foreign security is determined. If no sale is reported at that time, the foreign security will be valued within the range of the most recent quoted bid and ask prices. The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. Some methods for valuing these securities may include: fundamental analysis, matrix pricing, discounts from market prices of similar securities, or discounts applied due to the nature and 34 | Annual Report MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) duration of restrictions on the disposition of the securities. Occasionally, events occur between the time at which trading in a security is completed and the close of the NYSE that might call into question the availability (including the reliability) of the value of a portfolio security held by the Fund. If such an event occurs, the securities may be valued using fair value procedures, which may include the use of independent pricing services. All security valuation procedures are approved by the Fund's 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, income and expense items denominated in foreign currencies are translated into U.S. dollars at the exchange rate in effect on the transaction date. Occasionally, events may impact the availability or reliability of foreign exchange rates used to convert the U.S. dollar equivalent value. If such an event occurs, the foreign exchange rate will be valued at fair value using procedures established and approved by the Fund's Board of Directors. 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 on the Statement of Operations. 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, 2004, all repurchase agreements held by the Fund had been entered into on that date. D. SECURITIES PURCHASED ON A WHEN-ISSUED OR DELAYED DELIVERY 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 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 DELIVERY BASIS (CONTINUED) 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 by the Fund and any equity therein is included in the Statement of Assets and Liabilities. Realized and unrealized gains and losses on these contracts 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 on these contracts 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 to 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 synthetic 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. Upon 36 | Annual Report MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) G. OPTION CONTRACTS (CONTINUED) closing of an option, other than by exercise, which 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 incurs 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 realizes a gain if the price of the security declines between those dates. Gains are limited to the price at which the Fund sold the security short, while losses are potentially unlimited in size. 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 with the broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. The Fund is obligated to pay the counterparty any dividends or interest due on securities sold short. Such dividends and interest are recorded as an expense to the Fund. I. SECURITIES LENDING The Fund loans securities to certain brokers through a securities lending agent for which it received cash collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. The collateral is invested in short-term instruments as noted in the Statement of Investments. The Fund received interest income of $28,578 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 collateral and the securities loaned. The securities lending agent has agreed to indemnify the Fund in the case of default of any securities borrower. J. INCOME AND DEFERRED TAXES No provision has been made for U.S. income taxes because the Fund's policy is to qualify as a regulated investment company under Sub Chapter M of the Internal Revenue Code and to distribute substantially all of its taxable income. Fund distributions to shareholders are determined on an income tax basis and may differ from net investment income and realized gains for financial reporting purposes. Annual Report | 37 MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) J. INCOME AND DEFERRED TAXES (CONTINUED) The Fund is subject to a tax imposed on net realized gains of securities of certain foreign countries. When the Fund invests in these securities, the Fund records an estimated deferred tax liability for net unrealized gains on these securities as reflected in the accompanying financial statements. 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. Interest income and estimated expenses are accrued daily. Discounts and premiums 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 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 expenses during the reporting period. Actual results could differ from those estimates. M. REDEMPTION FEES Effective June 1, 2004, redemptions and exchanges of Fund shares held five trading days or less 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 as noted in the Statements of Changes in Net Assets. N. GUARANTEES AND INDEMNIFICATIONS Under the Fund's organizational documents, its officers and directors are indemnified by the Fund 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. 38 | Annual Report MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK The Fund offers four classes of shares: Class Z, Class A, Class B and Class C. Effective March 1, 2005, Class B shares will no longer be offered except to existing Class B shareholders through reinvested distributions or exchanges into other Franklin Templeton funds' Class B shares, as permitted by the applicable fund prospectus. 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, 2004, 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, 2004 2003 -------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT -------------------------------------------------------------- CLASS Z SHARES: Shares sold ..................... 7,659,738 $ 141,932,586 8,509,431 $ 131,224,611 Shares issued in reinvestment of distributions ................. 10,886,980 207,607,638 3,042,530 51,201,644 Shares redeemed ................. (16,670,287) (308,756,706) (17,445,911) (268,458,384) -------------------------------------------------------------- Net increase (decrease) ......... 1,876,431 $ 40,783,518 (5,893,950) $ (86,032,129) ============================================================== CLASS A SHARES: Shares sold ..................... 6,141,435 $ 113,698,317 8,305,112 $ 126,902,814 Shares issued in reinvestment of distributions ................. 2,136,124 40,591,446 507,445 8,466,348 Shares redeemed ................. (7,698,298) (141,143,927) (6,033,504) (91,808,618) -------------------------------------------------------------- Net increase (decrease) ......... 579,261 $ 13,145,836 2,779,053 $ 43,560,544 ============================================================== CLASS B SHARES: Shares sold ..................... 606,427 $ 11,012,963 785,351 $ 11,788,264 Shares issued in reinvestment of distributions ................. 191,893 3,585,999 28,905 466,222 Shares redeemed ................. (314,344) (5,689,343) (375,336) (5,478,674) -------------------------------------------------------------- Net increase (decrease) ......... 483,976 $ 8,909,619 438,920 $ 6,775,812 ============================================================== CLASS C SHARES: Shares sold ..................... 1,768,138 $ 32,469,438 2,196,889 $ 33,319,144 Shares issued in reinvestment of distributions ................. 848,386 16,032,272 146,988 2,376,905 Shares redeemed ................. (2,620,734) (47,956,897) (2,518,701) (37,484,647) -------------------------------------------------------------- Net increase (decrease) ......... (4,210) $ 544,813 (174,824) $ (1,788,598) ==============================================================
Annual Report | 39 MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES Certain officers of the Series Fund are also officers and/or directors of the following entities:
- ------------------------------------------------------------------------------------- ENTITY AFFILIATION - ------------------------------------------------------------------------------------- Franklin Mutual Advisers, LLC (Franklin Mutual) Investment manager Franklin Templeton Services, LLC (FT Services) Administrative manager Franklin/Templeton Distributors, Inc. (Distributors) Principal underwriter Franklin/Templeton Investor Services, LLC (Investor Services) Transfer agent
A. MANAGEMENT FEES Effective July 1, 2004, the Fund pays an investment management fee to Franklin Mutual based on the average daily net assets of the Fund as follows: - -------------------------------------------------------------------------- ANNUALIZED FEE RATE NET ASSETS - -------------------------------------------------------------------------- 0.600% First $5 billion 0.570% Over $5 billion, up to and including $7 billion 0.550% Over $7 billion, up to and including $10 billion 0.540% Over $10 billion Prior to July 1, 2004, the Fund paid fees of 0.60% per year of the average daily net assets of the Fund. B. ADMINISTRATIVE FEES 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 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 C. DISTRIBUTION FEES The Fund reimburses Distributors 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, respectively, for costs incurred in marketing the Fund's shares under a Rule 12b-1 plan. Under the Class A distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. D. SALES CHARGES/UNDERWRITING AGREEMENTS Distributors has advised the Fund of the following commission transactions related to the sales and redemptions of the Fund's shares for the year: Net sales charges received ........................... $ 193,980 Contingent deferred sales charges retained ........... $ 96,492 40 | Annual Report MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) E. TRANSFER AGENT FEES The Fund paid transfer agent fees of $4,192,600, of which $3,285,034 was paid to Investor Services. 4. EXPENSE OFFSET ARRANGEMENT The Fund has entered into an arrangement with its custodian whereby credits realized as a result of uninvested cash balances are used to reduce a portion of the Fund's custodian expenses. During the year ended December 31, 2004, the custodian fees were reduced as noted in the Statement of Operations. 5. INCOME TAXES Net investment income (loss) differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, bond discounts and premiums, and certain dividends on securities sold short. Net realized gains differ for financial statement and tax purposes primarily due to differing treatments of wash sales, foreign currency transactions, bond discounts and premiums, and certain dividends on securities sold short. At December 31, 2004, 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 .................................. $ 3,085,350,594 =============== Unrealized appreciation .............................. $ 1,459,957,570 Unrealized depreciation .............................. (77,693,666) --------------- Net unrealized appreciation (depreciation) ........... $ 1,382,263,904 =============== Undistributed ordinary income ........................ $ 10,140,854 Undistributed long term capital gains ................ 43,277,698 --------------- Distributable earnings ............................... $ 53,418,552 =============== The tax character of distributions paid during the years ended December 31, 2004, and 2003, was as follows: --------------------------- 2004 2003 --------------------------- Distributions paid from: Ordinary income ......................... $106,282,089 $ 66,333,658 Long term capital gain .................. 175,843,037 -- --------------------------- $282,125,126 $ 66,333,658 =========================== Annual Report | 41 MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short-term securities and securities sold short) for the year ended December 31, 2004 aggregated $1,394,516,912 and $1,506,647,501, respectively. Transactions in options written during the year ended December 31, 2004 were as follows: --------------------------- NUMBER OF PREMIUMS CONTRACTS RECEIVED --------------------------- Options outstanding at December 31, 2003 ....................... 1,082,985 $ 287,942 Options written .......................... 760,631 1,588,520 Options expired .......................... (382,551) (648,164) Options exercised ........................ (1,457,914) (702,596) Options closed ........................... (2,089) (379,684) --------------------------- Options outstanding at December 31, 2004 ....................... 1,062 $ 146,018 =========================== 7. SYNTHETIC EQUITY SWAPS As of December 31, 2004, the Fund had the following synthetic equity swaps outstanding: - ------------------------------------------------------------------------------- NUMBER OF UNREALIZED CONTRACTS TO BUY CONTRACTS VALUE GAIN (LOSS) - ------------------------------------------------------------------------------- Christian Dior SA (46.22 - 55.43 EUR) .... 85,617 $5,814,920 $ 73,914 London Stock Exchange PLC (5.36 - 5.71 GBP) ....................... 64,069 715,731 25,719 ---------- Total contracts to buy ................... $ 99,633 ---------- - -------------------------------------------------------------------------------- NUMBER OF UNREALIZED CONTRACTS TO SELL CONTRACTS VALUE GAIN (LOSS) - -------------------------------------------------------------------------------- LVMH Moet Hennessy Louis Vuitton (53.87 - 61.76 EUR) ..................... 85,883 $6,567,208 $ 225,141 ---------- Net unrealized gain (loss) ............... $ 324,774 ========== 42 | Annual Report MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. FORWARD EXCHANGE CONTRACTS At December 31, 2004, 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) - --------------------------------------------------------------------------------------------------------- 12,253,340 Canadian Dollars .................. U.S. $ 9,484,452 1/21/05 U.S. $ 730,828 915,000 South African Rand ................ 157,922 1/26/05 2,962 76,257,500 Taiwan dollar ..................... 2,350,000 2/16/05 48,789 3,796,742 Swiss Franc ....................... 3,305,769 2/17/05 35,629 10,914,113 Canadian Dollar ................... 9,050,000 4/21/05 49,164 ------------- ---------- U.S. $ 24,348,143 U.S. $ 867,372 ============= ========== - --------------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO SELL EXCHANGE FOR DATE GAIN (LOSS) - --------------------------------------------------------------------------------------------------------- 550,000 British Pounds .................... U.S. $ 1,056,402 2/10/05 U.S. $ 3,647 3,400,000 Euro .............................. 4,629,440 2/23/05 13,349 19,737,457 British Pounds .................... 37,895,151 3/21/05 196,834 40,972,792 British Pounds .................... 78,658,520 6/08/05 707,311 1,813,875,000 Korean Won ........................ 1,750,000 6/17/05 3,763 ------------- ---------- U.S. $ 123,989,513 924,904 ============= ========== Unrealized gain on forward exchange contracts ........................................ U.S. $1,792,276 ========== - --------------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO BUY EXCHANGE FOR DATE GAIN (LOSS) - --------------------------------------------------------------------------------------------------------- 785,000 South African Rand ................ U.S. $ 138,848 1/26/05 U.S. $ (822) 283,985 Swiss Franc ....................... 250,000 2/17/05 (73) 6,446,734 Canadian Dollars .................. 5,425,000 4/21/05 (50,318) ------------- ---------- U.S. $ 5,813,848 U.S. $ (51,213) ============= ==========
Annual Report | 43 MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. FORWARD EXCHANGE CONTRACTS (CONTINUED)
- ----------------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO SELL EXCHANGE FOR DATE GAIN (LOSS) - ----------------------------------------------------------------------------------------------------------- 57,888,020 Canadian Dollars .................. U.S. $ 44,051,654 1/21/05 U.S. $ (4,208,028) 10,798,200 South African Rand ................ 1,800,000 1/26/05 (98,646) 42,550,000 British Pounds .................... 78,514,770 2/10/05 (2,930,145) 407,268,000 Taiwan Dollar ..................... 12,500,000 2/16/05 (311,201) 4,080,727 Swiss Franc ....................... 3,281,331 2/17/05 (309,992) 16,621,770 Euro .............................. 20,527,885 2/23/05 (2,039,054) 177,492,776 Danish Krone ...................... 29,041,235 3/17/05 (3,359,052) 4,485,480,232 Japanese Yen ...................... 41,025,948 3/28/05 (3,037,280) 22,952,200 Canadian Dollars .................. 17,453,338 4/21/05 (1,682,053) 50,886,017 Euro .............................. 64,234,671 4/25/05 (4,923,201) 17,500,000 Euro .............................. 21,623,875 5/23/05 (2,173,507) 43,100,000 Euro .............................. 57,410,924 6/13/05 (1,223,745) 42,682,722,415 Korean Won ........................ 40,700,000 6/17/05 (482,049) 34,000,000 Euro .............................. 42,935,200 7/25/05 (3,362,301) 17,500,000 Euro .............................. 21,633,938 8/23/05 (2,211,562) 15,500,000 Euro .............................. 18,879,000 9/13/05 (2,251,511) ------------- ------------ U.S. $ 515,613,769 (34,603,327) ============= ------------ Unrealized loss on forward exchange contracts ................................ (34,654,540) ------------ Net unrealized loss on forward exchange contracts .......................... U.S. $(32,862,264) ============
9. CREDIT RISK AND DEFAULTED SECURITIES The fund held defaulted securities and/or other securities for which the income has been deemed uncollectible. At December 31, 2004 the value of these securities was $119,110,267, representing 2.65% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. 44 | Annual Report MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 10. RESTRICTED SECURITIES At December 31, 2004, investments in securities included issues that are restricted and 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, 2004, the Fund held investments in restricted and illiquid securities that were valued under approved methods by the Directors, as follows:
- ----------------------------------------------------------------------------------------------------- SHARES/ ACQUISITION WARRANTS ISSUER DATE COST VALUE - ----------------------------------------------------------------------------------------------------- 365,293 AboveNet Inc ........................... 10/02/01 $16,953,496 $ 8,753,662 11,991 AboveNet Inc., wts., 9/08/08 ........... 10/02/01 1,490,986 76,742 14,107 AboveNet Inc., wts., 9/08/10 ........... 10/02/01 1,600,719 56,428 1,735,639 Centennial Bank Holdings Inc. .......... 7/14/04 17,356,390 18,224,210 11,087 Elephant Capital Holdings Ltd. ......... 8/29/03 11,090,126 14,745,195 1,497,000 Florida East Coast Industries Inc. ..... 11/16/87 31,051,609 64,138,965 2,814,856 Imagine Group Holdings Ltd. ............ 8/31/04 28,828,432 28,828,432 2,855,428 International Steel Group .............. 4/10/02 13,796,250 110,025,352 4 Lancer Industries Inc., B .............. 8/11/89 -- 2,871,815 691,640 Leucadia National Corp. ................ 12/20/02 24,380,310 45,652,390 394,800 Occum Acquisition Corp. ................ 7/27/04 39,480,000 39,480,000 97,300 Olympus Re Holdings Ltd. ............... 12/19/01 9,730,000 16,655,814 17,603 Security Capital European Realty ....... 4/08/98 964,314 126,742 1,375,000 State National Bancshares Inc. ......... 8/09/00 22,000,000 38,500,000 ------------ TOTAL RESTRICTED SECURITIES (8.64% OF NET ASSETS) ......... $388,135,747 ============
Annual Report | 45 MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. 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, 2004 were as shown below.
- -------------------------------------------------------------------------------------------------------------------------------- NUMBER OF SHARES HELD NUMBER OF REALIZED AT BEGINNING GROSS GROSS SHARES HELD VALUE INVESTMENT CAPITAL NAME OF ISSUER OF YEAR ADDITIONS REDUCTIONS AT END OF YEAR AT END OF YEAR INCOME GAIN/(LOSS) - -------------------------------------------------------------------------------------------------------------------------------- NON-CONTROLLED AFFILIATES Elephant Capital Holdings Ltd. ................. 10,949 138 -- 11,087 $ 14,745,195 $ -- $ -- Esmark Inc., Series A, 10.00% cvt. pfd ...................... -- 14,950 -- 14,950 14,950,000 -- -- FHC Delaware Inc ............... 452,571 -- -- 452,571 3,561,734 -- -- Generale De Sante .............. 844,641 1,139,472 -- 1,984,113 41,571,276 445,532 -- Imagine Group Holdings Ltd. ................. -- 2,814,856 -- 2,814,856 28,828,432 -- -- ITLA Capital Corp. ............. 466,396 -- (20,600) 445,796 26,208,347 -- 764,891 KKR Financial Corp., 144A ................... -- 5,163,200 -- 5,163,200 53,955,440 -- -- Lancer Industries Inc., B ...... 4 -- -- 4 2,871,815 -- -- MBOP Liquidating Trust ......... 412,418 -- -- 412,418 1,031 -- -- Nippon Investment, LLC ......... 9,112,000 -- -- 9,112,000 -- -- 4,055,164 Saxon Capital Inc. ............. 1,996,385 667,200 -- 2,663,585 63,899,404 6,126,246 -- Southwest Royalties Inc., A .... 58,923 -- (58,923) -- -- -- 883,852 State National Bancshares Inc. ............... 1,375,000 -- -- 1,375,000 38,500,000 -- -- Union Acceptance Corp., A ....................... 3,595,994 -- -- 3,595,994 539,399 -- -- ----------------------------------------- TOTAL NON-CONTROLLED AFFILIATES (6.45% OF NET ASSETS) $ 289,632,073 $6,571,778 $ 5,703,907 =========================================
12. OTHER CONSIDERATIONS Franklin Mutual, as the Fund's Manager, may serve as a member on the board of directors of certain companies in which the Fund invests and/or may represent the Fund in certain corporate negotiations. At December 31, 2004, the Manager serves in one or more of these capacities for Kindred Healthcare, AboveNet Inc., and Esmark Inc. As a result of this involvement, the Manager may be in possession of certain 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. 46 | Annual Report MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY MATTERS INVESTIGATIONS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, including the Securities and Exchange Commission ("SEC"), the California Attorney General's Office ("CAGO"), and the National Association of Securities Dealers, Inc. ("NASD"), relating to certain practices in the mutual fund industry, including late trading, market timing and marketing support payments to securities dealers who sell fund shares, Franklin Resources, Inc. and certain of its subsidiaries (as used in this section, together, the "Company"), as well as certain current or former executives and employees of the Company, received subpoenas and/or requests for documents, information and/or testimony. The Company and its current employees provided documents and information in response to those requests and subpoenas. SETTLEMENTS Beginning in August 2004, the Company entered into settlements with certain regulators investigating the mutual fund industry practices noted above. The Company believes that settlement of each of the matters described in this section is in the best interest of the Company and shareholders of the Franklin, Templeton, and Mutual Series mutual funds (the "funds"). On August 2, 2004, Franklin Resources, Inc. announced that its subsidiary, Franklin Advisers, Inc., reached an agreement with the SEC that resolved the issues resulting from the SEC investigation into market timing activity. In connection with that agreement, the SEC issued an "Order Instituting Administrative and Cease-and-Desist Proceedings Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940 and Sections 9(b) and 9(f) of the Investment Company Act of 1940, Making Findings and Imposing Remedial Sanctions and a Cease-and-Desist Order" (the "Order"). The SEC's Order concerned the activities of a limited number of third parties that ended in 2000 and those that were the subject of the first Massachusetts administrative complaint described below. Under the terms of the SEC's Order, pursuant to which Franklin Advisers, Inc. neither admitted nor denied any of the findings contained therein, Franklin Advisers, Inc. agreed to pay $50 million, of which $20 million is a civil penalty, to be distributed to shareholders of certain funds in accordance with a plan to be developed by an independent distribution consultant. At this time, it is unclear which funds or which shareholders of any particular fund will receive distributions. The Order also required Franklin Advisers, Inc. to, among other things, enhance and periodically review compliance policies and procedures. On September 20, 2004, Franklin Resources, Inc. announced that two of its subsidiaries, Franklin Advisers, Inc. and Franklin Templeton Alternative Strategies, Inc. ("FTAS"), reached an agreement with the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts (the "State of Massachusetts") related to its administrative complaint filed on February 4, 2004, concerning one instance of market timing that was also a subject of the August 2, 2004 settlement that Franklin Advisers, Inc. reached with the SEC, as described above. Annual Report | 47 MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY MATTERS (CONTINUED) SETTLEMENTS (CONTINUED) Under the terms of the settlement consent order issued by the State of Massachusetts, Franklin Advisers, Inc. and FTAS consented to the entry of a cease-and-desist order and agreed to pay a $5 million administrative fine to the State of Massachusetts (the "Massachusetts Consent Order"). The Massachusetts Consent Order included two different sections: "Statements of Fact" and "Violations of Massachusetts Securities Laws." Franklin Advisers, Inc. and FTAS admitted the facts in the Statements of Fact. On October 25, 2004, the State of Massachusetts filed a second administrative complaint, alleging that Franklin Resources, Inc.'s Form 8-K filing (in which it described the Massachusetts Consent Order and stated that "Franklin did not admit or deny engaging in any wrongdoing") failed to state that Franklin Advisers, Inc. and FTAS admitted the Statements of Fact portion of the Massachusetts Consent Order (the "Second Complaint"). Franklin Resources, Inc. reached a second agreement with the State of Massachusetts on November 19, 2004, resolving the Second Complaint. As a result of the November 19, 2004 settlement, Franklin Resources, Inc. filed a new Form 8-K. The terms of the Massachusetts Consent Order did not change and there was no monetary fine associated with this second settlement. On November 17, 2004, Franklin Resources, Inc. announced that Franklin/Templeton Distributors, Inc. ("FTDI") reached an agreement with the CAGO, resolving the issues resulting from the CAGO's investigation concerning sales and marketing support payments. Under the terms of the settlement, FTDI neither admitted nor denied the allegations in the CAGO's complaint and agreed to pay $2 million to the State of California as a civil penalty, $14 million to the funds, to be allocated by an independent distribution consultant to be paid for by FTDI, and $2 million to the CAGO for its investigative costs. On December 13, 2004, Franklin Resources, Inc. announced that its subsidiaries FTDI and Franklin Advisers, Inc. reached an agreement with the SEC, resolving the issues resulting from the SEC's investigation concerning marketing support payments to securities dealers who sell fund shares. In connection with that agreement, the SEC issued an "Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940, Sections 9(b) and 9(f) of the Investment Company Act of 1940, and Section 15(b) of the Securities Exchange Act of 1934" (the "Second Order"). 48 | Annual Report MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY MATTERS (CONTINUED) SETTLEMENTS (CONTINUED) Under the terms of the Second Order, in which FTDI and Franklin Advisers, Inc. neither admitted nor denied the findings contained therein, they agreed to pay the funds a penalty of $20 million and disgorgement of $1 (one dollar). FTDI and Franklin Advisers, Inc. also agreed to implement certain measures and undertakings relating to marketing support payments to broker-dealers for the promotion or sale of fund shares, including making additional disclosures in the funds' Prospectuses and Statements of Additional Information. The Second Order further requires the appointment of an independent distribution consultant, at the Company's expense, who shall develop a plan for the distribution of the penalty and disgorgement to the funds. OTHER LEGAL PROCEEDINGS The Fund, in addition to the Company and other funds, and certain current and former officers, employees, and directors have been named in multiple lawsuits in different federal courts in Nevada, California, Illinois, New York and Florida, alleging violations of various federal securities laws and seeking, among other relief, monetary damages, restitution, removal of fund trustees, directors, advisers, administrators, and distributors, rescission of management contracts and 12b-1 Plans, and/or attorneys' fees and costs. Specifically, the lawsuits claim breach of duty with respect to alleged arrangements to permit market timing and/or late trading activity, or breach of duty with respect to the valuation of the portfolio securities of certain Templeton funds managed by Franklin Resources, Inc. subsidiaries, resulting in alleged market timing activity. The majority of these lawsuits duplicate, in whole or in part, the allegations asserted in the February 4, 2004 Massachusetts administrative complaint and the findings in the SEC's August 2, 2004 Order, as described above. The lawsuits are styled as class actions, or derivative actions on behalf of either the named funds or Franklin Resources, Inc. In addition, the Company, as well as certain current and former officers, employees, and directors, have been named in multiple lawsuits alleging violations of various securities laws and pendent state law claims relating to the disclosure of directed brokerage payments and/or payment of allegedly excessive advisory, commission, and distribution fees, and seeking, among other relief, monetary damages, restitution, rescission of advisory contracts, including recovery of all fees paid pursuant to those contracts, an accounting of all monies paid to the named advisers, declaratory relief, injunctive relief, and/or attorneys' fees and costs. These lawsuits are styled as class actions or derivative actions brought on behalf of certain funds. Annual Report | 49 MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY MATTERS (CONTINUED) OTHER LEGAL PROCEEDINGS (CONTINUED) The Company and fund management strongly believes that the claims made in each of the lawsuits identified above are without merit and intends to vigorously defend against them. The Company cannot predict with certainty, however, the eventual outcome of the remaining governmental investigations or private lawsuits, nor whether they will have a material negative impact on the Company. Public trust and confidence are critical to the Company's business and any material loss of investor and/or client confidence could result in a significant decline in assets under management by the Company, which would have an adverse effect on the Company's future financial results. If it is determined that the Company bears responsibility for any unlawful or inappropriate conduct that caused losses to the Fund, it is committed to making the Fund or its shareholders whole, as appropriate. The Company is committed to taking all appropriate actions to protect the interests of its funds' shareholders. 50 | Annual Report MUTUAL QUALIFIED FUND REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 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, 2004, 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 five years in the period then ended. 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 the standards of the Public Company Accounting Oversight Board (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 consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Fund's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of December 31, 2004, by correspondence with the custodian and brokers. 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, 2004, 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 five years in the period then ended, in conformity with U.S. generally accepted accounting principles. /s/ ERNST & YOUNG LLP Boston, Massachusetts February 7, 2005 Annual Report | 51 MUTUAL QUALIFIED FUND TAX DESIGNATION (UNAUDITED) Under Section 852(b)(3)(C) of the Internal Revenue Code (Code), the Fund designated $219,120,735 as a capital gain dividend for the fiscal year ended 2004. Under Section 854(b)(2) of the Code, the Fund hereby designates up to a maximum of $63,221,728 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2004. In January 2005, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2004. 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 18.84% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2004. 52 | 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. 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. (63) 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; and Director, Stern School of Business M.B.A. Program. - ------------------------------------------------------------------------------------------------------------------------------------ ANN TORRE GRANT (46) 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 (75) 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 (74) 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 (75) 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 | 53
- ------------------------------------------------------------------------------------------------------------------------------------ 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 (74) Director Since 1998 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. - ------------------------------------------------------------------------------------------------------------------------------------ LEONARD RUBIN (79) 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 (58) Director Since 1991 12 Director, El Oro Mining and 51 John F. Kennedy Parkway Exploration Co., p.l.c. Short Hills, NJ 07078 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 (79) 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 (65) 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, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. - ------------------------------------------------------------------------------------------------------------------------------------
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 - ------------------------------------------------------------------------------------------------------------------------------------ **DAVID J. WINTERS (42) Director, Director 7 None 51 John F. Kennedy Parkway President, since 2001, Short Hills, NJ 07078-2702 Chairman of President the Board and since 1999, Chief Chairman of Executive the Board Officer - and Chief Investment Executive Management Officer - Investment Management since 2002 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Chief Investment Officer, and Chief Executive Officer, Franklin Mutual and officer and/or director, as the case Advisers, LLC; may be, of three of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ JAMES M. DAVIS (52) Chief Since July Not Applicable Not Applicable One Franklin Parkway Compliance 2004 San Mateo, CA 94403-1906 Officer PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Officer of 51 of the investment companies in Franklin Templeton Investments; Director, Global Compliance, Franklin Resources, Inc.; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - ------------------------------------------------------------------------------------------------------------------------------------ JIMMY D. GAMBILL (57) Senior Vice Since 2002 Not Applicable Not Applicable 500 East Broward Blvd. President and Suite 2100 Chief Fort Lauderdale, 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 (57) Vice President Since 2000 Not Applicable Not Applicable One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior 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). - ------------------------------------------------------------------------------------------------------------------------------------
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 - ------------------------------------------------------------------------------------------------------------------------------------ BARBARA J. GREEN (57) Vice President Since 2000 Not Applicable Not Applicable 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). - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL O. MAGDOL (67) Vice President Since 2002 Not Applicable Not Applicable 600 Fifth Avenue - AML Rockefeller Center Compliance New York, NY 10020-2302 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice Chairman, Chief Banking Officer and Director, Fiduciary Trust Company FTI Banque, Arch Chemicals, Inc. and International; Director, Lingnan Foundation; 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. - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL MORANTZ (35) Treasurer Since July Not Applicable Not Applicable 500 East Broward Blvd. 2004 Suite 2100 Fort Lauderdale, FL 33394-3091 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ MURRAY L. SIMPSON (67) Vice President Since 2000 Not Applicable Not Applicable 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). - ------------------------------------------------------------------------------------------------------------------------------------
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 - ------------------------------------------------------------------------------------------------------------------------------------ GALEN G. VETTER (53) Chief Financial Since May Not Applicable Not Applicable 500 East Broward Blvd. Officer and 2004 Suite 2100 Chief Fort Lauderdale, FL 33394-3091 Accounting Officer PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Officer of 51 of the investment companies in Franklin Templeton Investments; Senior Vice President, Franklin Templeton Services, LLC; and FORMERLY, Managing Director, RSM McGladrey, Inc.; and Partner, McGladrey & Pullen, LLP. - ------------------------------------------------------------------------------------------------------------------------------------
* 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 to be 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 to be 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 to be an interested person of Mutual Series under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC, Mutual Series' adviser. 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 QUALIFIED FUND SHAREHOLDER INFORMATION 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. Copies of the Fund's proxy voting records are also made available online at franklintempleton.com and posted on the Securities and Exchange Commission's website at sec.gov and reflect the 12-month period beginning July 1, 2003, and ending June 30, 2004. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the Securities and Exchange Commission for the first and third quarters for each fiscal year on Form N-Q. Shareholders may view the filed Form N-Q by visiting the Commission's website at sec.gov. The filed form may also be viewed and copied at the Commission's Public Reference Room in Washington, DC. Information regarding the operations of the Public Reference Room may be obtained by calling 1-800/SEC-0330. 58 | Annual Report This page intentionally left blank. This page intentionally left blank. LITERATURE REQUEST LITERATURE REQUEST. TO RECEIVE A BROCHURE AND PROSPECTUS, PLEASE CALL US AT 1-800/DIAL BEN(R) (1-800/342-5236) OR VISIT franklintempleton.com. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. 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 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(2) Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund(3) 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(4) 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 Technology Fund Franklin Utilities Fund Mutual Financial Services Fund ASSET ALLOCATION Franklin Templeton Corefolio Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives 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(5) Franklin's AGE High Income Fund Franklin Floating Rate Daily Access Fund Franklin Floating Rate Trust(3) Franklin Income Fund Franklin Limited Maturity U.S. Government Securities Fund(5)(6) Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund(5) Templeton Global Bond Fund TAX-FREE INCOME(7) NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(8) 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 Alabama Arizona California(9) Colorado Connecticut Florida(9) Georgia Kentucky Louisiana Maryland Massachusetts(8) Michigan(8) Minnesota(8) Missouri New Jersey New York(9) North Carolina Ohio(8) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(10) (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 and select retirement plans. (3) 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. (4) Upon reaching approximately $350 million in assets, the fund intends to close to all investors. (5) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (6) Formerly Franklin Short-Intermediate U.S. Government Securities Fund. Effective 9/1/04, the fund's name changed; its investment goal and strategy remained the same. (7) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (8) Portfolio of insured municipal securities. (9) These funds are available in two or more variations, including long-term portfolios, portfolios of insured securities, a high-yield portfolio (CA) and limited-term, intermediate-term and money market portfolios (CA and NY). (10) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. Not part of the annual report [LOGO](R) FRANKLIN(R) TEMPLETON(R) One Franklin Parkway INVESTMENTS San Mateo, CA 94403-1906 o 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 QUALIFIED FUND CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER David J. Winters, CFA 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) Authorized for distribution only when accompanied or preceded by a prospectus. Investors should carefully consider a fund's investment goals, risks, charges and expenses before investing. The prospectus contains this and other information; please read it carefully before investing. 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 A2004 02/05 MUTUAL SHARES FUND [GRAPHIC OMITTED] - -------------------------------------------------------------------------------- DECEMBER 31, 2004 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- ANNUAL REPORT AND SHAREHOLDER LETTER | VALUE - -------------------------------------------------------------------------------- WANT TO RECEIVE THIS DOCUMENT FASTER VIA EMAIL? MUTUAL SHARES FUND Eligible shareholders can sign up for eDelivery at franklintempleton.com. See inside for details. - ------------------------------------------------------------------------------- [LOGO](R) 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 Shares Fund ........................................................ 4 Performance Summary ....................................................... 10 Your Fund's Expenses ...................................................... 15 Financial Highlights and Statement of Investments .................................................. 17 Financial Statements ...................................................... 32 Notes to Financial Statements ............................................. 36 Report of Independent Registered Public Accounting Firm ........................................................... 54 Tax Designation ........................................................... 55 Board Members and Officers ................................................ 56 Shareholder Information ................................................... 61 - -------------------------------------------------------------------------------- ANNUAL REPORT MUTUAL SHARES FUND YOUR FUND'S GOALS AND MAIN 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 of companies the Fund's managers believe are at prices below their intrinsic value in the U.S. and other countries. - -------------------------------------------------------------------------------- PERFORMANCE DATA QUOTED REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. PLEASE VISIT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236 FOR MOST RECENT MONTH-END PERFORMANCE. - -------------------------------------------------------------------------------- We are pleased to bring you Mutual Shares Fund's annual report covering the fiscal year ended December 31, 2004. PERFORMANCE OVERVIEW Mutual Shares Fund - Class Z posted a 13.89% cumulative total return for the 12 months ended December 31, 2004. The Fund outperformed its benchmark, the Standard & Poor's 500 Composite Index (S&P 500), which returned 10.87% over the same period.(1) You can find the Fund's long-term performance data in the Performance Summary beginning on page 10. ECONOMIC AND MARKET OVERVIEW During the year ended December 31, 2004, the domestic economy expanded solidly and broadly across most industries, sectors and regions as gross domestic product (GDP) rose by an estimated 4.4%.(2) However, surging energy and other commodity prices had a dampening effect. Although consumer confidence remained below pre-recession levels, consumer spending supported strong auto sales, increased durable goods consumption and a healthy housing market. Similarly, business spending rose substantially even as business confidence wavered. The labor market firmed as employers hired 2.2 million workers in 2004, and unemployment dropped from 5.7% to 5.4% during the year.(3) (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 is unmanaged and includes reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. (2) Source: Bureau of Economic Analysis. (3) Source: Bureau of Labor Statistics. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND NAMES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 22. 4 | Annual Report The U.S. dollar weakened throughout 2004 and hit an all-time low against the euro and a multi-year low versus the yen. The widening trade and current account deficits and the possibility for higher import prices contributed to inflationary pressures. The core inflation rate rose to 2.2% in 2004, or 3.3% including volatile food and energy costs. Aiming to keep inflation tame, the Federal Reserve Board raised the federal funds target rate five times between June and December, from 1.00% to 2.25%, the highest level in more than three years. Domestic equity markets rallied in early 2004 and then fluctuated; however, they were essentially flat through early November. After the elections concluded, the markets enjoyed another strong rally through year-end. The blue chip stocks of the Dow Jones Industrial Average gained 5.31% for the year under review, while the broader S&P 500 rose 10.87% and the technology-heavy NASDAQ Composite Index increased 9.15%.(4) Outside the U.S., the global economic recovery continued in 2004, led by growth in China. The 12-nation euro zone lagged other regions in the current recovery. However, the European Central Bank projected euro zone growth between 1.6% and 2.0% in 2004, compared with only 0.5% in 2003. In Japan, the economy struggled to emerge from a decade-long deflationary period. Although the country's consumer and business confidence reached their highest levels since 1991, economic growth slowed in response to higher oil prices and reduced external demand. The U.S. dollar decline hurt Japanese and European exports to the U.S., as it made their goods more expensive in the world's biggest market. For the 12-month period ended December 31, 2004, the Morgan Stanley Capital International (MSCI) World Index's total return was 15.25% in U.S. dollars.(5) Emerging markets, as measured by the MSCI Emerging Markets Index, had a total return of 25.95% in U.S. dollars.(6) In local currencies, these indexes had notably lower total returns of 11.83% and 16.45% for the same period.(5), (6) During the period, most of the world's currencies strengthened in relation to the U.S. dollar, which benefited U.S.-based investors of non-U.S. developed and emerging market equities. GEOGRAPHIC DISTRIBUTION Based on Total Net Assets as of 12/31/04 U.S. 67.2% U.K. 12.8% Canada 4.5% Spain 2.9% France 2.6% Irish Republic 2.0% Norway 1.6% Switzerland 1.4% Japan 1.3% Other Countries 2.9% Other Net Assets 0.8% (4) Source: Standard & Poor's Micropal. The Dow Jones Industrial Average is price weighted based on the average market price of 30 blue chip stocks of companies that are generally industry leaders. See footnote 1 for a description of the S&P 500. The NASDAQ Composite Index measures all domestic and international common stocks listed on The NASDAQ Stock Market. The index is market value weighted and includes over 3,000 companies. (5) Source: Standard & Poor's Micropal. The MSCI World Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in global developed markets. (6) Source: Standard & Poor's Micropal. The MSCI Emerging Markets Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in global emerging markets. Annual Report | 5 INVESTMENT STRATEGY At Mutual Series, we are committed to our distinctive three-pronged approach to investing, a strategy that we believe can generate 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, shareholder-oriented management teams and whose stocks are trading at discounts to our assessment of the companies' intrinsic or business value. This strict value approach not only intended to 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 All three prongs of our investment strategy contributed positively to the Fund's performance during the year under review, with the equity portfolio providing the greatest contribution. Three of the Fund's best performing stock 6 | Annual Report investments were White Mountains Insurance Group, a property and casualty insurer; Altadis, a Franco-Spanish tobacco company; and British American Tobacco (BAT), the world's second-largest tobacco company with about 15% of the global market. White Mountains, one of the largest contributors to Fund performance during the fiscal year, was an excellent example of how substantial shareholder value can be created when well-capitalized companies are run by strong managers. With the company's solid balance sheet, White Mountains' management team has made several acquisitions, enabling the company to profitably increase its bottom line while extending its exposure to attractive lines of business. In addition to exercising discipline with acquisitions, management remained committed to a conservative underwriting strategy. This strategy enabled White Mountains to continue to report solid underwriting results for 2004 despite record industry-wide insurance claims from the Atlantic hurricane season. During the year under review, the markets began to better appreciate White Mountains' consistent results, strong balance sheet, and disciplined acquisition and underwriting practices, as well as its shareholder-oriented management team. White Mountains' stock rose about 41% in 2004 and has increased more than 443% in the past five years. In 2004, tobacco companies operating in Europe, such as Altadis, encountered a challenging sales environment, especially in France after the government imposed two substantial tax increases by early 2004 that pressured volumes and contributed to reduced consumption of about 25% in volume. Despite challenges in France and elsewhere, Altadis shares performed well as management returned cash to shareholders through dividends and share repurchases. In addition, the company announced two acquisitions and a cost-restructuring program, all of which could enable management to continue to increase cash flow and create shareholder value. As a result of these and other factors, Altadis shares appreciated about 65% in 2004. Despite this strong performance, the stock still traded at a significant discount to its European peers and our calculation of the stock's intrinsic value. In addition, some analysts believe the industry is ready for more consolidation. For these and other reasons, we remain enthusiastic about the prospects of our Altadis investment. BAT shares appreciated after the U.S. Federal Trade Commission, in June 2004, approved the merger of Brown & Williamson, BAT's U.S. subsidiary, with R.J. Reynolds Tobacco Holdings to form Reynolds American. The company estimated that the proposed combination will generate cost savings of at least $500 million within 24 months of the deal's close, as well as enhance earnings and improve shareholder value. In addition, the combination could enable BAT to better protect itself from exposure to the often difficult U.S. TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/04 - --------------------------------------------------- % OF TOTAL NET ASSETS - --------------------------------------------------- Insurance 13.3% - --------------------------------------------------- Tobacco 10.9% - --------------------------------------------------- Media 7.8% - --------------------------------------------------- Metals & Mining 6.7% - --------------------------------------------------- Food Products 4.8% - --------------------------------------------------- Commercial Banks 3.6% - --------------------------------------------------- Oil & Gas 3.3% - --------------------------------------------------- Beverages 2.7% - --------------------------------------------------- Pharmaceuticals 2.6% - --------------------------------------------------- Real Estate 1.9% - --------------------------------------------------- Annual Report | 7 TOP 10 HOLDINGS 12/31/04 - --------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - --------------------------------------------------- Berkshire Hathaway Inc., A & B 4.7% INSURANCE, U.S. - --------------------------------------------------- White Mountains Insurance Group Inc. 3.9% INSURANCE, U.S. - --------------------------------------------------- British American Tobacco PLC, ord. & ADR 3.5% TOBACCO, U.K. - --------------------------------------------------- Altadis SA 2.9% TOBACCO, SPAIN - --------------------------------------------------- International Steel Group 1.9% METALS & MINING, U.S. - --------------------------------------------------- Washington Post Co., B 1.9% MEDIA, U.S. - --------------------------------------------------- Diageo PLC 1.9% BEVERAGES, U.K. - --------------------------------------------------- Reynolds American Inc. 1.8% TOBACCO, U.S. - --------------------------------------------------- Orkla ASA 1.6% FOOD PRODUCTS, NORWAY - --------------------------------------------------- Imperial Tobacco Group PLC 1.5% TOBACCO, U.K. - --------------------------------------------------- legal environment. Other factors that contributed to the stock's appreciation included the reportedly successful integration of ETI, the former Italian tobacco monopoly acquired in 2003, the implementation of a cost-saving plan, and the continuation of the company's share repurchase program. In general, if the value of the U.S. dollar goes up compared with a foreign currency, an investment traded in that foreign currency will go down in value because it will be worth fewer U.S. dollars. This can have a negative effect on Fund performance. Conversely, when the U.S. dollar weakens in relation to a foreign currency, an investment traded in that foreign currency will increase in value, which can contribute to Fund performance. At Mutual Series, we typically seek to hedge (protect) against currency risk, which can reduce or eliminate the positive or negative effect on Fund performance of holding investments denominated in currencies other than the U.S. dollar. In 2004, we remained less than fully hedged in foreign currencies allowing shareholders to benefit from a declining U.S. dollar. However, one cannot expect the same result in future periods. Although many of the Fund's investments performed well in 2004, some holdings underperformed. Positions that declined in value included Eurotunnel, a distressed investment in the operator of the English Channel tunnel; AboveNet, another distressed investment in an operator of optical network data centers; and Sovereign Bancorp, one of the largest financial institutions serving New England and the Mid-Atlantic states. Eurotunnel's debt securities declined during 2004 largely due to uncertainties surrounding the ultimate resolution of the company's financial situation, as well as continuing mediocre operating results after the company's board and management team were replaced in April 2004. Distressed investing can be a lengthy process, and it is not unusual for securities to weaken somewhat before a restructuring or financial resolution is ultimately worked out. AboveNet made distributions under a plan of reorganization in late 2003. As one of the company's largest creditors, the Mutual Series funds were appointed a seat on the board and collectively received more than 20% of the company's stock in reorganization. The underperformance of our AboveNet investment during the period largely reflected a liquidity discount. Sovereign Bancorp declined in 2004 after some investors were disappointed that the company continued to expand its northeast U.S. banking franchise through acquisitions rather than focusing on improving the company's core profitability. However, we believe Sovereign Bancorp's management has created one of the premier banking franchises in the northeast U.S., and many industry experts regard the company as a prime acquisition candidate. 8 | Annual Report Thank you for your continued participation in Mutual Shares Fund. We look forward to serving your future investment needs. /s/ David J. Winters [PHOTO OMITTED] David J. Winters, CFA Portfolio Manager /s/ Debbie A. Turner [PHOTO OMITTED] Debbie A. Turner, CFA Assistant Portfolio Manager Mutual Shares Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2004, 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 ADVISER 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 12/31/04 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 reinvestment of the Fund's dividends and capital gain distributions, if any, and any unrealized gains or losses. PRICE AND DISTRIBUTION INFORMATION
- ------------------------------------------------------------------------------------------------- CLASS Z CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$2.06 $23.05 $20.99 - ------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------------- Dividend Income $0.3946 - ------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.4241 - ------------------------------------------------------------------------------------------------- TOTAL $0.8187 - ------------------------------------------------------------------------------------------------- CLASS A CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$2.04 $22.94 $20.90 - ------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------------- Dividend Income $0.3227 - ------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.4241 - ------------------------------------------------------------------------------------------------- TOTAL $0.7468 - ------------------------------------------------------------------------------------------------- CLASS B CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$1.96 $22.50 $20.54 - ------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------------- Dividend Income $0.1943 - ------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.4241 - ------------------------------------------------------------------------------------------------- TOTAL $0.6184 - ------------------------------------------------------------------------------------------------- CLASS C CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$2.01 $22.76 $20.75 - ------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------------- Dividend Income $0.1865 - ------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.4241 - ------------------------------------------------------------------------------------------------- TOTAL $0.6106 - ------------------------------------------------------------------------------------------------- CLASS R CHANGE 12/31/04 12/31/03 - ------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$2.02 $22.85 $20.83 - ------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - ------------------------------------------------------------------------------------------------- Dividend Income $0.2982 - ------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.4241 - ------------------------------------------------------------------------------------------------- TOTAL $0.7223 - -------------------------------------------------------------------------------------------------
Mutual Shares Fund paid distributions derived from long-term capital gains of 42.41 cents ($0.4241) per share in December 2004. The Fund designated such distributions as capital gain dividends per Internal Revenue Code Section 852 (b)(3). 10 | Annual Report PERFORMANCE SUMMARY (CONTINUED) PERFORMANCE CLASS A: 5.75% MAXIMUM INITIAL SALES CHARGE; CLASS B: CONTINGENT DEFERRED SALES CHARGE (CDSC) DECLINING FROM 4% TO 1% OVER SIX YEARS, AND ELIMINATED THEREAFTER; CLASS C: 1% CDSC IN FIRST YEAR ONLY; CLASS R: 1% CDSC FOR FIRST 18 MONTHS ONLY. CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES.
- -------------------------------------------------------------------------------------------- CLASS Z(1) 1-YEAR 5-YEAR 10-YEAR - -------------------------------------------------------------------------------------------- Cumulative Total Return(2) 13.89% 55.53% 254.01% - -------------------------------------------------------------------------------------------- Average Annual Total Return(3) 13.89% 9.24% 13.48% - -------------------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,389 $15,553 $35,401 - -------------------------------------------------------------------------------------------- CLASS A(1) 1-YEAR 5-YEAR INCEPTION (11/1/96) - -------------------------------------------------------------------------------------------- Cumulative Total Return(2) 13.50% 52.81% 135.43% - -------------------------------------------------------------------------------------------- Average Annual Total Return(3) 6.99% 7.57% 10.25% - -------------------------------------------------------------------------------------------- Value of $10,000 Investment(4) $10,699 $14,404 $22,189 - -------------------------------------------------------------------------------------------- CLASS B(1) 1-YEAR 5-YEAR INCEPTION (1/1/99) - -------------------------------------------------------------------------------------------- Cumulative Total Return(2) 12.70% 47.86% 68.30% - -------------------------------------------------------------------------------------------- Average Annual Total Return(3) 8.70% 7.84% 8.96% - -------------------------------------------------------------------------------------------- Value of $10,000 Investment(4) $10,870 $14,586 $16,730 - -------------------------------------------------------------------------------------------- CLASS C(1) 1-YEAR 5-YEAR INCEPTION (11/1/96) - -------------------------------------------------------------------------------------------- Cumulative Total Return(2) 12.77% 47.93% 123.41% - -------------------------------------------------------------------------------------------- Average Annual Total Return(3) 11.77% 8.15% 10.35% - -------------------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,177 $14,793 $22,341 - -------------------------------------------------------------------------------------------- CLASS R 1-YEAR INCEPTION (1/1/02) - -------------------------------------------------------------------------------------------- Cumulative Total Return(2) 13.32% 26.74% - -------------------------------------------------------------------------------------------- Average Annual Total Return(3) 12.32% 8.23% - -------------------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,232 $12,674 - --------------------------------------------------------------------------------------------
PERFORMANCE DATA QUOTED REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. FOR MOST RECENT MONTH-END PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236. Annual Report | 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 any current, applicable, maximum sales charge, Fund expenses, account fees and reinvested distributions. The unmanaged index includes reinvestment of any income or distributions. 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) 12/31/04 - ----------------------------------- 1-Year 13.89% - ----------------------------------- 5-Year 9.24% - ----------------------------------- 10-Year 13.48% - ----------------------------------- [THE FOLLOWING TABLE WAS REPRESENTED AS LINE GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual Shares Fund - Class Z,1 as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 Index5 from 1/1/95-12/31/04. CLASS Z (1/1/95-12/31/04)(1) MUTUAL SHARES DATE FUND S&P 500(5) - -------------------------------------------------------------------------------- 1/1/95 $10,000 $10,000 1/31/95 $10,208 $10,259 2/28/95 $10,652 $10,659 3/31/95 $10,782 $10,973 4/30/95 $11,107 $11,295 5/31/95 $11,433 $11,746 6/30/95 $11,552 $12,019 7/31/95 $12,099 $12,417 8/31/95 $12,354 $12,448 9/30/95 $12,721 $12,973 10/31/95 $12,413 $12,927 11/30/95 $12,781 $13,493 12/31/95 $12,911 $13,753 1/31/96 $13,428 $14,221 2/29/96 $13,792 $14,353 3/31/96 $13,892 $14,491 4/30/96 $13,873 $14,705 5/31/96 $14,104 $15,083 6/30/96 $13,969 $15,141 7/31/96 $13,494 $14,472 8/31/96 $13,997 $14,778 9/30/96 $14,449 $15,609 10/31/96 $14,572 $16,039 11/30/96 $15,416 $17,251 12/31/96 $15,591 $16,909 1/31/97 $16,078 $17,965 2/28/97 $16,464 $18,106 3/31/97 $16,246 $17,363 4/30/97 $16,422 $18,399 5/31/97 $17,203 $19,518 6/30/97 $17,732 $20,392 7/31/97 $18,713 $22,014 8/31/97 $18,585 $20,782 9/30/97 $19,435 $21,919 10/31/97 $19,095 $21,188 11/30/97 $19,342 $22,168 12/31/97 $19,704 $22,548 1/31/98 $19,565 $22,798 2/28/98 $20,694 $24,441 3/31/98 $21,388 $25,691 4/30/98 $21,314 $25,950 5/31/98 $21,120 $25,504 6/30/98 $21,027 $26,540 7/31/98 $20,461 $26,258 8/31/98 $17,574 $22,465 9/30/98 $17,462 $23,905 10/31/98 $18,609 $25,847 11/30/98 $19,605 $27,413 12/31/98 $19,791 $28,992 1/31/99 $20,105 $30,204 2/28/99 $19,842 $29,265 3/31/99 $20,764 $30,436 4/30/99 $22,374 $31,614 5/31/99 $22,486 $30,869 6/30/99 $23,125 $32,581 7/31/99 $22,485 $31,565 8/31/99 $21,618 $31,408 9/30/99 $21,061 $30,549 10/31/99 $21,886 $32,481 11/30/99 $22,299 $33,141 12/31/99 $22,761 $35,092 1/31/00 $22,015 $33,329 2/29/00 $21,112 $32,699 3/31/00 $23,296 $35,895 4/30/00 $23,051 $34,816 5/31/00 $23,340 $34,103 6/30/00 $22,932 $34,944 7/31/00 $23,570 $34,398 8/31/00 $24,763 $36,534 9/30/00 $24,739 $34,606 10/31/00 $25,330 $34,459 11/30/00 $24,534 $31,744 12/31/00 $25,909 $31,900 1/31/01 $27,441 $33,031 2/28/01 $27,454 $30,021 3/31/01 $26,760 $28,120 4/30/01 $27,847 $30,304 5/31/01 $28,816 $30,507 6/30/01 $28,992 $29,765 7/31/01 $28,978 $29,472 8/31/01 $28,318 $27,629 9/30/01 $25,823 $25,398 10/31/01 $25,715 $25,882 11/30/01 $26,794 $27,867 12/31/01 $27,547 $28,111 1/31/02 $27,292 $27,701 2/28/02 $27,420 $27,167 3/31/02 $28,242 $28,189 4/30/02 $28,412 $26,481 5/31/02 $28,426 $26,286 6/30/02 $26,583 $24,414 7/31/02 $24,985 $22,512 8/31/02 $25,244 $22,659 9/30/02 $23,877 $20,199 10/31/02 $24,251 $21,975 11/30/02 $24,741 $23,267 12/31/02 $24,548 $21,901 1/31/03 $24,344 $21,328 2/28/03 $23,951 $21,008 3/31/03 $24,009 $21,210 4/30/03 $25,423 $22,958 5/31/03 $26,720 $24,166 6/30/03 $27,125 $24,475 7/31/03 $27,286 $24,906 8/31/03 $27,932 $25,391 9/30/03 $27,815 $25,122 10/31/03 $28,843 $26,543 11/30/03 $29,768 $26,776 12/31/03 $31,084 $28,179 1/31/04 $31,336 $28,696 2/29/04 $32,151 $29,095 3/31/04 $32,106 $28,656 4/30/04 $31,573 $28,207 5/31/04 $31,617 $28,593 6/30/04 $32,144 $29,149 7/31/04 $31,653 $28,185 8/31/04 $31,936 $28,298 9/30/04 $32,352 $28,604 10/31/04 $32,739 $29,041 11/30/04 $34,331 $30,216 12/31/04 $35,401 $31,243 AVERAGE ANNUAL TOTAL RETURN - ----------------------------------- CLASS A(1) 12/31/04 - ----------------------------------- 1-Year 6.99% - ----------------------------------- 5-Year 7.57% - ----------------------------------- Since Inception (11/1/96) 10.25% - ----------------------------------- [THE FOLLOWING TABLE WAS REPRESENTED AS LINE GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual Shares Fund - Class A,1 as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 Index5 from 11/1/96-12/31/04. CLASS A (11/1/96-12/31/04)(1) MUTUAL SHARES DATE 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 1/31/04 $19,749 $17,891 2/29/04 $20,266 $18,140 3/31/04 $20,228 $17,866 4/30/04 $19,890 $17,586 5/31/04 $19,909 $17,827 6/30/04 $20,237 $18,173 7/31/04 $19,916 $17,572 8/31/04 $20,086 $17,643 9/30/04 $20,350 $17,833 10/31/04 $20,585 $18,106 11/30/04 $21,575 $18,838 12/31/04 $22,189 $19,479 12 | Annual Report PERFORMANCE SUMMARY (CONTINUED) This graph compares the performance of Mutual Shares Fund - Class B,1 as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 Index5 from 1/1/99-12/31/04. CLASS B (1/1/99-12/31/04)(1) [THE FOLLOWING TABLE WAS REPRESENTED AS LINE GRAPH IN THE PRINTED MATERIAL.] MUTUAL SHARES DATE FUND S&P 500(5) - -------------------------------------------------------------------------------- 1/1/99 $10,000 $10,000 1/31/99 $10,154 $10,418 2/28/99 $10,005 $10,094 3/31/99 $10,467 $10,498 4/30/99 $11,262 $10,905 5/31/99 $11,313 $10,647 6/30/99 $11,627 $11,238 7/31/99 $11,293 $10,887 8/31/99 $10,844 $10,834 9/30/99 $10,556 $10,537 10/31/99 $10,964 $11,203 11/30/99 $11,157 $11,431 12/31/99 $11,382 $12,104 1/31/00 $11,000 $11,496 2/29/00 $10,539 $11,279 3/31/00 $11,618 $12,381 4/30/00 $11,489 $12,009 5/31/00 $11,624 $11,763 6/30/00 $11,411 $12,053 7/31/00 $11,720 $11,865 8/31/00 $12,303 $12,601 9/30/00 $12,279 $11,936 10/31/00 $12,558 $11,886 11/30/00 $12,157 $10,949 12/31/00 $12,827 $11,003 1/31/01 $13,574 $11,393 2/28/01 $13,568 $10,355 3/31/01 $13,213 $9,699 4/30/01 $13,745 $10,453 5/31/01 $14,204 $10,523 6/30/01 $14,279 $10,267 7/31/01 $14,265 $10,166 8/31/01 $13,921 $9,530 9/30/01 $12,691 $8,760 10/31/01 $12,624 $8,927 11/30/01 $13,144 $9,612 12/31/01 $13,501 $9,696 1/31/02 $13,367 $9,555 2/28/02 $13,416 $9,371 3/31/02 $13,805 $9,723 4/30/02 $13,875 $9,134 5/31/02 $13,875 $9,067 6/30/02 $12,964 $8,421 7/31/02 $12,175 $7,765 8/31/02 $12,290 $7,816 9/30/02 $11,616 $6,967 10/31/02 $11,781 $7,580 11/30/02 $12,017 $8,025 12/31/02 $11,908 $7,554 1/31/03 $11,800 $7,357 2/28/03 $11,605 $7,246 3/31/03 $11,619 $7,316 4/30/03 $12,297 $7,919 5/31/03 $12,910 $8,335 6/30/03 $13,093 $8,442 7/31/03 $13,166 $8,591 8/31/03 $13,464 $8,758 9/30/03 $13,391 $8,665 10/31/03 $13,885 $9,155 11/30/03 $14,313 $9,236 12/31/03 $14,934 $9,720 1/31/04 $15,043 $9,898 2/29/04 $15,428 $10,036 3/31/04 $15,385 $9,884 4/30/04 $15,115 $9,729 5/31/04 $15,123 $9,863 6/30/04 $15,362 $10,054 7/31/04 $15,114 $9,722 8/31/04 $15,238 $9,761 9/30/04 $15,428 $9,866 10/31/04 $15,596 $10,017 11/30/04 $16,340 $10,422 12/31/04 $16,730 $10,777 AVERAGE ANNUAL TOTAL RETURN - ----------------------------------- CLASS B(1) 12/31/04 - ----------------------------------- 1-Year 8.70% - ----------------------------------- 5-Year 7.84% - ----------------------------------- Since Inception (1/1/99) 8.96% - ----------------------------------- CLASS C (11/1/96-12/31/04)(1) This graph compares the performance of Mutual Shares Fund - Class C,1 as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 Index5 from 11/1/96-12/31/04. [THE FOLLOWING TABLE WAS REPRESENTED AS LINE GRAPH IN THE PRINTED MATERIAL.] MUTUAL SHARES DATE FUND S&P 500(5) - -------------------------------------------------------------------------------- 11/1/96 $10,000 $10,000 11/30/96 $10,573 $10,755 12/31/96 $10,683 $10,542 1/31/97 $11,011 $11,200 2/28/97 $11,266 $11,288 3/31/97 $11,105 $10,825 4/30/97 $11,214 $11,471 5/31/97 $11,738 $12,169 6/30/97 $12,089 $12,714 7/31/97 $12,750 $13,725 8/31/97 $12,652 $12,957 9/30/97 $13,222 $13,666 10/31/97 $12,977 $13,210 11/30/97 $13,135 $13,821 12/31/97 $13,368 $14,058 1/31/98 $13,261 $14,213 2/28/98 $14,018 $15,238 3/31/98 $14,473 $16,018 4/30/98 $14,410 $16,179 5/31/98 $14,265 $15,901 6/30/98 $14,189 $16,546 7/31/98 $13,798 $16,371 8/31/98 $11,838 $14,006 9/30/98 $11,755 $14,904 10/31/98 $12,517 $16,115 11/30/98 $13,177 $17,091 12/31/98 $13,295 $18,075 1/31/99 $13,494 $18,831 2/28/99 $13,302 $18,246 3/31/99 $13,912 $18,975 4/30/99 $14,973 $19,710 5/31/99 $15,042 $19,245 6/30/99 $15,459 $20,313 7/31/99 $15,013 $19,679 8/31/99 $14,421 $19,582 9/30/99 $14,038 $19,046 10/31/99 $14,575 $20,251 11/30/99 $14,839 $20,662 12/31/99 $15,140 $21,878 1/31/00 $14,625 $20,779 2/29/00 $14,013 $20,386 3/31/00 $15,453 $22,379 4/30/00 $15,281 $21,706 5/31/00 $15,461 $21,262 6/30/00 $15,177 $21,786 7/31/00 $15,587 $21,446 8/31/00 $16,361 $22,777 9/30/00 $16,329 $21,575 10/31/00 $16,699 $21,484 11/30/00 $16,167 $19,791 12/31/00 $17,059 $19,888 1/31/01 $18,050 $20,593 2/28/01 $18,041 $18,717 3/31/01 $17,572 $17,532 4/30/01 $18,276 $18,893 5/31/01 $18,893 $19,020 6/30/01 $18,996 $18,557 7/31/01 $18,969 $18,374 8/31/01 $18,522 $17,225 9/30/01 $16,876 $15,834 10/31/01 $16,795 $16,137 11/30/01 $17,475 $17,374 12/31/01 $17,956 $17,526 1/31/02 $17,779 $17,271 2/28/02 $17,845 $16,938 3/31/02 $18,367 $17,575 4/30/02 $18,460 $16,510 5/31/02 $18,460 $16,388 6/30/02 $17,242 $15,221 7/31/02 $16,201 $14,035 8/31/02 $16,343 $14,127 9/30/02 $15,454 $12,593 10/31/02 $15,672 $13,701 11/30/02 $15,984 $14,506 12/31/02 $15,841 $13,654 1/31/03 $15,698 $13,297 2/28/03 $15,432 $13,098 3/31/03 $15,461 $13,223 4/30/03 $16,353 $14,313 5/31/03 $17,180 $15,066 6/30/03 $17,420 $15,259 7/31/03 $17,506 $15,528 8/31/03 $17,908 $15,830 9/30/03 $17,812 $15,663 10/31/03 $18,463 $16,548 11/30/03 $19,036 $16,694 12/31/03 $19,859 $17,569 1/31/04 $20,003 $17,891 2/29/04 $20,520 $18,140 3/31/04 $20,472 $17,866 4/30/04 $20,108 $17,586 5/31/04 $20,118 $17,827 6/30/04 $20,442 $18,173 7/31/04 $20,105 $17,572 8/31/04 $20,269 $17,643 9/30/04 $20,528 $17,833 10/31/04 $20,749 $18,106 11/30/04 $21,739 $18,838 12/31/04 $22,341 $19,479 AVERAGE ANNUAL TOTAL RETURN - ----------------------------------- CLASS C(1) 12/31/04 - ----------------------------------- 1-Year 11.77% - ----------------------------------- 5-Year 8.15% - ----------------------------------- Since Inception (11/1/96) 10.35% - ----------------------------------- Annual Report | 13 PERFORMANCE SUMMARY (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - ----------------------------------- CLASS R 12/31/04 - ----------------------------------- 1-Year 12.32% - ----------------------------------- Since Inception (1/1/02) 8.23% - ----------------------------------- This graph compares the performance of Mutual Shares Fund - Class R, as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 Index5 from 1/1/02-12/31/04. CLASS R (1/1/02-12/31/04) [THE FOLLOWING TABLE WAS REPRESENTED AS LINE GRAPH IN THE PRINTED MATERIAL.] MUTUAL SHARES DATE FUND S&P 500(5) - -------------------------------------------------------------------------------- 1/1/02 $10,000 $10,000 1/31/02 $9,912 $9,854 2/28/02 $9,953 $9,664 3/31/02 $10,253 $10,028 4/30/02 $10,309 $9,420 5/31/02 $10,315 $9,351 6/30/02 $9,638 $8,685 7/31/02 $9,061 $8,008 8/31/02 $9,145 $8,061 9/30/02 $8,652 $7,185 10/31/02 $8,778 $7,817 11/30/02 $8,951 $8,277 12/31/02 $8,874 $7,791 1/31/03 $8,800 $7,587 2/28/03 $8,657 $7,473 3/31/03 $8,673 $7,545 4/30/03 $9,177 $8,167 5/31/03 $9,643 $8,596 6/30/03 $9,787 $8,706 7/31/03 $9,841 $8,860 8/31/03 $10,070 $9,032 9/30/03 $10,017 $8,937 10/31/03 $10,385 $9,442 11/30/03 $10,711 $9,525 12/31/03 $11,184 $10,024 1/31/04 $11,270 $10,208 2/29/04 $11,560 $10,350 3/31/04 $11,538 $10,194 4/30/04 $11,345 $10,034 5/31/04 $11,356 $10,171 6/30/04 $11,537 $10,369 7/31/04 $11,354 $10,026 8/31/04 $11,451 $10,066 9/30/04 $11,602 $10,175 10/31/04 $11,731 $10,331 11/30/04 $12,298 $10,749 12/31/04 $12,674 $11,114 ENDNOTES THE FUND'S INVESTMENTS INCLUDE 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: Shares are available to certain eligible investors as described in the prospectus. CLASS A: Prior to 8/3/98, these shares were offered at a lower initial sales charge; thus actual total returns may differ. CLASS B: These shares have higher annual fees and expenses than Class A shares. CLASS C: Prior to 1/1/04, these shares were offered with an initial sales charge; thus actual total returns would have differed. These shares have higher annual fees and expenses than Class A shares. CLASS R: 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. If the manager had not taken this action, 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 a sales charge. (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. (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. (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 | Annual Report YOUR FUND'S EXPENSES As a Fund shareholder, you can incur two types of costs: o Transaction costs, including sales charges (loads) on Fund purchases and redemption fees; and o Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. The following table shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated. ACTUAL FUND EXPENSES The first line (Actual) for each share class listed in the table below provides actual account values and expenses. The "Ending Account Value" is derived from the Fund's actual return, which includes the effect of Fund expenses. You can estimate the expenses you paid during the period, by following these steps. OF COURSE, YOUR ACCOUNT VALUE AND EXPENSES WILL DIFFER FROM THOSE IN THIS ILLUSTRATION: 1. Divide your account value by $1,000. IF AN ACCOUNT HAD AN $8,600 VALUE, THEN $8,600 / $1,000 = 8.6. 2. Multiply the result by the number under the heading "Expenses Paid During Period." IF EXPENSES PAID DURING PERIOD WERE $7.50, THEN 8.6 X $7.50 = $64.50. In this illustration, the estimated expenses paid this period are $64.50. HYPOTHETICAL EXAMPLE FOR COMPARISON WITH OTHER FUNDS Information in the second line (Hypothetical) for each class in the table can help you compare ongoing costs of investing in the Fund with those of other mutual funds. This information may not be used to estimate the actual ending account balance or expenses you paid during the period. The hypothetical "Ending Account Value" is based on the actual expense ratio for each class and an assumed 5% annual rate of return before expenses, which does not represent the Fund's actual return. The figure under the heading "Expenses Paid During Period" shows the hypothetical expenses your account would have incurred under this scenario. You can compare this figure with the 5% hypothetical examples that appear in shareholder reports of other funds. Annual Report | 15 YOUR FUND'S EXPENSES (CONTINUED) PLEASE NOTE THAT EXPENSES SHOWN IN THE TABLE ARE MEANT TO HIGHLIGHT ONGOING COSTS AND DO NOT REFLECT ANY TRANSACTION COSTS, SUCH AS SALES CHARGES OR REDEMPTION FEES. Therefore, the second line for each class is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transaction costs were included, your total costs would have been higher. Please refer to the Fund prospectus for additional information on operating expenses.
- -------------------------------------------------------------------------------------------------------- BEGINNING ACCOUNT ENDING ACCOUNT EXPENSES PAID DURING CLASS Z VALUE 6/30/04 VALUE 12/31/04 PERIOD* 6/30/04-12/31/04 - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,101.30 $4.17 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,021.17 $4.01 - -------------------------------------------------------------------------------------------------------- CLASS A - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,099.20 $6.02 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,019.41 $5.79 - -------------------------------------------------------------------------------------------------------- CLASS B - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,095.50 $9.43 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,016.14 $9.07 - -------------------------------------------------------------------------------------------------------- CLASS C - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,095.60 $9.43 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,016.14 $9.07 - -------------------------------------------------------------------------------------------------------- CLASS R - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,098.50 $6.80 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,018.65 $6.55 - --------------------------------------------------------------------------------------------------------
* Expenses are equal to the annualized expense ratio for each class (Z: 0.79%; A: 1.14%; B: 1.79%; C: 1.79%; and R: 1.29%), multiplied by the average account value over the period, multiplied by 184/366 to reflect the one-half year period. 16 | Annual Report MUTUAL SHARES FUND FINANCIAL HIGHLIGHTS
----------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2004 2003 2002 2001 2000 ----------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .......... $ 20.99 $ 16.84 $ 19.44 $ 19.79 $ 20.43 ----------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ................... .35 .24 .33 .29 .34 Net realized and unrealized gains (losses) . 2.52 4.23 (2.42) .95 2.23 ----------------------------------------------------------------------------- Total from investment operations ............ 2.87 4.47 (2.09) 1.24 2.57 ----------------------------------------------------------------------------- Less distributions from: Net investment income ...................... (.39) (.32) (.25) (.24) (.70) Net realized gains ......................... (.42) -- (.26) (1.35) (2.51) ----------------------------------------------------------------------------- Total distributions ......................... (.81) (.32) (.51) (1.59) (3.21) ----------------------------------------------------------------------------- Redemption fees ............................. --(d) -- -- -- -- ----------------------------------------------------------------------------- Net asset value, end of year ................ $ 23.05 $ 20.99 $ 16.84 $ 19.44 $ 19.79 ============================================================================= Total return(b) ............................. 13.89% 26.62% (10.89)% 6.32% 13.83% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............. $ 7,240,641 $ 5,782,145 $ 4,585,605 $ 5,465,075 $ 5,359,319 Ratios to average net assets:* Expenses(c) ................................ .81% .84% .79% .78% .82% Expenses, net of waiver and payments by affiliate(c) ........................... .81% .84% .79% .78% .79% Net investment income ...................... 1.62% 1.28% 1.79% 1.40% 1.69% Portfolio turnover rate ..................... 33.22% 54.65% 51.22% 52.98% 63.22% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................... .80% .81% .78% .77% .79% Expenses, net of waiver and payments by affiliate ................................. .80% .81% .78% .77% .76%
(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 only operating expenses. (d) Amount is less than $0.001 per share. Annual Report | See notes to financial statements. | 17 MUTUAL SHARES FUND FINANCIAL HIGHLIGHTS (CONTINUED)
------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2004 2003 2002 2001 2000 ------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .......... $ 20.90 $ 16.78 $ 19.37 $ 19.73 $ 20.38 ------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ................... .27 .17 .26 .22 .27 Net realized and unrealized gains (losses) . 2.51 4.21 (2.40) .95 2.22 ------------------------------------------------------------------------- Total from investment operations ............ 2.78 4.38 (2.14) 1.17 2.49 ------------------------------------------------------------------------- Less distributions from: Net investment income ...................... (.32) (.26) (.19) (.18) (.63) Net realized gains ......................... (.42) -- (.26) (1.35) (2.51) ------------------------------------------------------------------------- Total distributions ......................... (.74) (.26) (.45) (1.53) (3.14) ------------------------------------------------------------------------- Redemption fees ............................. --(d) -- -- -- -- ------------------------------------------------------------------------- Net asset value, end of year ................ $ 22.94 $ 20.90 $ 16.78 $ 19.37 $ 19.73 ========================================================================= Total return(b) ............................. 13.50% 26.18% (11.20)% 5.94% 13.42% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............. $ 2,940,029 $ 2,257,336 $ 1,543,833 $ 1,580,046 $ 1,283,230 Ratios to average net assets:* Expenses(c) ................................ 1.16% 1.19% 1.14% 1.13% 1.17% Expenses, net of waiver and payments by affiliate(c) ........................... 1.16% 1.19% 1.14% 1.13% 1.14% Net investment income ...................... 1.27% .93% 1.44% 1.05% 1.34% Portfolio turnover rate ..................... 33.22% 54.65% 51.22% 52.98% 63.22% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................... 1.15% 1.16% 1.13% 1.12% 1.14% Expenses, net of waiver and payments by affiliate .............................. 1.15% 1.16% 1.13% 1.12% 1.11%
(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 only operating expenses. (d) Amount is less than $0.001 per share. 18 | See notes to financial statements. | Annual Report MUTUAL SHARES FUND FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2004 2003 2002 2001 2000 ---------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .......... $ 20.54 $ 16.53 $ 19.12 $ 19.56 $ 20.26 ---------------------------------------------------------------- Income from investment operations: Net investment income(a) ................... .13 .04 .15 .08 .14 Net realized and unrealized gains (losses) . 2.44 4.14 (2.36) .95 2.20 ---------------------------------------------------------------- Total from investment operations ............ 2.57 4.18 (2.21) 1.03 2.34 ---------------------------------------------------------------- Less distributions from: Net investment income ...................... (.19) (.17) (.12) (.12) (.53) Net realized gains ......................... (.42) -- (.26) (1.35) (2.51) ---------------------------------------------------------------- Total distributions ......................... (.61) (.17) (.38) (1.47) (3.04) ---------------------------------------------------------------- Redemption fees ............................. --(d) -- -- -- -- ---------------------------------------------------------------- Net asset value, end of year ................ $ 22.50 $ 20.54 $ 16.53 $ 19.12 $ 19.56 ================================================================ Total return(b) ............................. 12.70% 25.41% (11.80)% 5.26% 12.69% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............. $ 588,401 $ 444,671 $ 235,470 $ 126,579 $ 34,778 Ratios to average net assets:* Expenses(c) ................................ 1.81% 1.84% 1.79% 1.78% 1.82% Expenses, net of waiver and payments by affiliate(c) .............................. 1.81% 1.84% 1.79% 1.78% 1.79% Net investment income ...................... .62% .28% .79% .37% .70% Portfolio turnover rate ..................... 33.22% 54.65% 51.22% 52.98% 63.22% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................... 1.80% 1.81% 1.78% 1.77% 1.79% Expenses, net of waiver and payments by affiliate ................................. 1.80% 1.81% 1.78% 1.77% 1.76%
(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 only operating expenses. (d) Amount is less than $0.001 per share. Annual Report | See notes to financial statements. | 19 MUTUAL SHARES FUND FINANCIAL HIGHLIGHTS (CONTINUED)
----------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2004 2003 2002 2001 2000 ----------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .......... $ 20.75 $ 16.68 $ 19.26 $ 19.63 $ 20.29 ----------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ................... .13 .05 .15 .08 .14 Net realized and unrealized gains (losses) . 2.49 4.17 (2.39) .95 2.20 ----------------------------------------------------------------------------- Total from investment operations ............ 2.62 4.22 (2.24) 1.03 2.34 ----------------------------------------------------------------------------- Less distributions from: Net investment income ...................... (.19) (.15) (.08) (.05) (.49) Net realized gains ......................... (.42) -- (.26) (1.35) (2.51) ----------------------------------------------------------------------------- Total distributions ......................... (.61) (.15) (.34) (1.40) (3.00) ----------------------------------------------------------------------------- Redemption fees ............................. --(d) -- -- -- -- ----------------------------------------------------------------------------- Net asset value, end of year ................ $ 22.76 $ 20.75 $ 16.68 $ 19.26 $ 19.63 ============================================================================= Total return(b) ............................. 12.77% 25.37% (11.78)% 5.26% 12.68% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............. $ 1,551,111 $ 1,272,590 $ 866,422 $ 885,658 $ 759,477 Ratios to average net assets:* Expenses(c) ................................ 1.81% 1.84% 1.78% 1.78% 1.81% Expenses, net of waiver and payments by affiliate(c) .............................. 1.81% 1.84% 1.78% 1.78% 1.78% Net investment income ...................... .62% .28% .80% .40% .70% Portfolio turnover rate ..................... 33.22% 54.65% 51.22% 52.98% 63.22% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................... 1.80% 1.81% 1.77% 1.77% 1.78% Expenses, net of waiver and payments by affiliate ................................. 1.80% 1.81% 1.77% 1.77% 1.75%
(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 only operating expenses. (d) Amount is less than $0.001 per share. 20 | See notes to financial statements. | Annual Report MUTUAL SHARES FUND FINANCIAL HIGHLIGHTS (CONTINUED)
YEAR ENDED DECEMBER 31, ------------------------------------------------ CLASS R 2004 2003 2002(e) ------------------------------------------------ PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .......... $ 20.83 $ 16.75 $ 19.36 ------------------------------------------------ Income from investment operations: Net investment income(a) ................... .24 .13 .24 Net realized and unrealized gains (losses) . 2.50 4.21 (2.37) ------------------------------------------------ Total from investment operations ............ 2.74 4.34 (2.13) ------------------------------------------------ Less distributions from: Net investment income ...................... (.30) (.26) (.22) Net realized gains ......................... (.42) -- (.26) ------------------------------------------------ Total distributions ......................... (.72) (.26) (.48) ------------------------------------------------ Redemption fees ............................. --(d) -- -- ------------------------------------------------ Net asset value, end of year ................ $ 22.85 $ 20.83 $ 16.75 ================================================ Total return(b) ............................. 13.32% 26.02% (11.26)% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............. $ 74,763 $ 46,933 $ 13,392 Ratios to average net assets:* Expenses(c) ................................ 1.31% 1.34% 1.29%(f) Net investment income ...................... 1.12% .78% 1.29%(f) Portfolio turnover rate ..................... 33.22% 54.65% 51.22% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................... 1.30% 1.31% 1.28%(f)
(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 only operating expenses. (d) Amount is less than $0.001 per share. (e) Effective date of Class R shares was January 2, 2002. (f) Annualized. Annual Report | See notes to financial statements. | 21 MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 72.3% AEROSPACE & DEFENSE .6% Gencorp Inc. .................................................... United States 1,000,000 $ 18,570,000 Northrop Grumman Corp. .......................................... United States 988,300 53,723,988 -------------- 72,293,988 -------------- AIRLINES .5% (a) Ace Aviation Holdings Inc. ...................................... Canada 2,252,672 66,771,574 (a),(b),(c) Air Canada Inc., Contingent Distribution ........................ Canada 537,421,436 -- -------------- 66,771,574 -------------- BEVERAGES 2.7% Brown-Forman Corp., A ........................................... United States 125,460 6,368,350 Brown-Forman Corp., B ........................................... United States 606,036 29,501,832 Coca-Cola Enterprises Inc. ...................................... United States 1,966,000 40,991,100 Diageo PLC ...................................................... United Kingdom 16,147,856 230,294,004 Heineken Holding NV, A .......................................... Netherlands 954,491 28,819,180 -------------- 335,974,466 -------------- CAPITAL MARKETS 1.3% Bear Stearns Cos. Inc. .......................................... United States 583,404 59,688,063 (d) Leucadia National Corp. ......................................... United States 1,551,229 102,390,421 -------------- 162,078,484 -------------- COMMERCIAL BANKS 3.6% Allied Irish Banks PLC .......................................... Irish Republic 7,670,230 159,041,842 Bank of Ireland ................................................. Irish Republic 5,404,128 89,234,993 BNP Paribas SA .................................................. France 536,357 38,793,666 (a),(d),(e) Centennial Bank Holdings Inc. ................................... United States 3,845,467 40,377,403 (a) Cerberus NCB Acquisition LP Ltd., wts., 8/29/13 ................. Japan 21,748,280 10,874,140 Danske Bank ..................................................... Denmark 2,253,600 68,958,602 (a),(d),(e) Elephant Capital Holdings Ltd. .................................. Japan 25,721 34,208,563 Kansai Urban Banking Corp. ...................................... Japan 1,485,126 2,755,067 (a),(e) Nippon Investment LLC ........................................... Japan 18,938,000 -- -------------- 444,244,276 -------------- COMMERCIAL SERVICES & SUPPLIES .9% (a) Comdisco Holding Co., Inc. ...................................... United States 130 2,900 (b) Comdisco, Contingent Distribution ............................... United States 95,431,240 -- Republic Services Inc. .......................................... United States 3,107,550 104,227,227 (a),(b) Safety Kleen Corp., Contingent Distribution ..................... United States 1,085,000 -- -------------- 104,230,127 -------------- COMPUTERS & PERIPHERALS (a),(e) DecisionOne Corp. ............................................... United States 457,492 -- -------------- CONSTRUCTION MATERIALS .4% Martin Marietta Materials Inc. .................................. United States 927,950 49,793,797 --------------
22 | Annual Report MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) DISTRIBUTORS .3% (a) United Stationers Inc. .......................................... United States 770,200 $ 35,583,240 -------------- DIVERSIFIED FINANCIAL SERVICES 1.1% Brascan Corp., A ................................................ Canada 3,716,100 133,697,182 London Stock Exchange PLC ....................................... United Kingdom 11,994 133,988 (b) Marconi Corp., Contingent Distribution .......................... United Kingdom 77,739,439 -- -------------- 133,831,170 -------------- DIVERSIFIED TELECOMMUNICATION SERVICES 1.7% (a),(d),(e),(f) AboveNet Inc. ................................................... United States 763,805 18,303,365 (a),(b),(e),(f) AboveNet Inc., Contingent Distribution .......................... United States 106,869,000 -- (a),(d),(e),(f) AboveNet Inc., wts., 9/08/08 .................................... United States 25,659 164,218 (a),(d),(e),(f) AboveNet Inc., wts., 9/08/10 .................................... United States 30,186 120,744 (b) Global Crossing Holdings Ltd., Contingent Distribution .......... United States 105,646,309 132,061 Koninklijke KPN NV .............................................. Netherlands 3,088,868 29,299,228 (a) MCI Inc. ........................................................ United States 1,743,298 35,144,888 Sprint Corp. .................................................... United States 343,400 8,533,490 (a),(b) Telewest Communications PLC, Contingent Distribution ............ United Kingdom 120,209,615 -- (a),(b) Telewest Finance Ltd., Contingent Distribution .................. United Kingdom 12,987,000 -- (a) Telewest Global Inc. ............................................ United Kingdom 7,073,342 124,349,352 -------------- 216,047,346 -------------- ELECTRIC UTILITIES .3% E.ON AG ......................................................... Germany 452,794 41,278,159 -------------- FOOD & STAPLES RETAILING .3% (a) Kroger Co. ...................................................... United States 2,160,070 37,887,628 -------------- FOOD PRODUCTS 5.1% Cadbury Schweppes PLC ........................................... United Kingdom 12,700,586 118,234,562 General Mills Inc. .............................................. United States 1,037,600 51,579,096 Groupe Danone ................................................... France 1,000,186 92,225,260 Nestle SA ....................................................... Switzerland 653,170 170,611,594 Orkla ASA ....................................................... Norway 5,916,440 194,143,172 -------------- 626,793,684 -------------- HEALTH CARE EQUIPMENT & SUPPLIES .7% (n) Guidant Corp. ................................................... United States 381,300 27,491,730 Hillenbrand Industries Inc. ..................................... United States 959,800 53,307,292 -------------- 80,799,022 -------------- HEALTH CARE PROVIDERS & SERVICES .8% (a) Alderwoods Group Inc. ........................................... United States 361,423 4,112,994 (a),(e),(f) Kindred Healthcare Inc. ......................................... United States 2,380,966 67,744,435 (a),(e),(f) Kindred Healthcare Inc., Jan. 9.07 Calls, 1/01/13 ............... United States 578 12,066 (a),(e),(f) Kindred Healthcare Inc., Jan. 26.00 Calls, 1/01/12 .............. United States 1,156 4,566 (a),(e),(f) Kindred Healthcare Inc., Jul. 23.75 Calls, 7/17/11 .............. United States 5,748 35,638 (a),(e),(f) Kindred Healthcare Inc., wts., Series A, 4/20/06 ................ United States 211,977 6,299,109 (a),(e),(f) Kindred Healthcare Inc., wts., Series B, 4/20/06 ................ United States 529,943 13,895,105 Select Medical Corp. ............................................ United States 375,400 6,607,040 -------------- 98,710,953 --------------
Annual Report | 23 MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) HOTELS RESTAURANTS & LEISURE .3% (a) Caesars Entertainment Inc. ...................................... United States 660,412 $ 13,300,698 (a),(e) FHC Delaware Inc. ............................................... United States 784,457 6,173,676 Mandalay Resort Group ........................................... United States 180,800 12,733,744 -------------- 32,208,118 -------------- HOUSEHOLD DURABLES (a) Bulova Corp. .................................................... United States 37,900 1,331,237 -------------- INSURANCE 13.3% (a) Alleghany Corp. ................................................. United States 335,113 95,590,983 (a) Berkshire Hathaway Inc., A ...................................... United States 1,590 139,761,000 (a) Berkshire Hathaway Inc., B ...................................... United States 151,630 445,185,680 (a) Conseco Inc. .................................................... United States 3,742,800 74,668,860 Hartford Financial Services Group Inc. .......................... United States 1,148,100 79,574,811 Montpelier Re Holdings Ltd. ..................................... Bermuda 459,289 17,659,662 Nationwide Financial Services Inc., A ........................... United States 1,616,150 61,785,415 Old Republic International Corp. ................................ United States 4,881,042 123,490,363 (a),(d) Olympus Re Holdings Ltd. ........................................ Bermuda 202,380 34,643,408 Prudential Financial Inc. ....................................... United States 948,700 52,140,552 St. Paul Travelers Cos. Inc. .................................... United States 1,231,429 45,649,073 (e) White Mountains Insurance Group Inc. ............................ United States 740,448 478,329,408 -------------- 1,648,479,215 -------------- LEISURE EQUIPMENT & PRODUCTS .2% Mattel Inc. ..................................................... United States 1,576,300 30,722,087 -------------- MACHINERY .4% (e) Federal Signal Corp. ............................................ United States 2,899,000 51,196,340 (a),(d),(e) Lancer Industries Inc., B ....................................... United States 3 2,440,923 -------------- 53,637,263 -------------- MEDIA 7.8% Clear Channel Communications Inc. ............................... United States 2,006,900 67,211,081 (a) Comcast Corp., A ................................................ United States 393,900 12,935,676 Dow Jones & Co. Inc. ............................................ United States 261,810 11,273,539 E.W. Scripps Co., A ............................................. United States 2,020,950 97,571,466 EchoStar Communications Corp., A ................................ United States 1,277,791 42,473,773 (a) Fox Entertainment Group Inc., A ................................. United States 399,085 12,475,397 Hollinger International Inc. .................................... United States 1,929,706 27,232,017 (a) Liberty Media Corp., A .......................................... United States 14,398,624 158,096,891 Meredith Corp. .................................................. United States 1,036,335 56,169,357 (a) News Corp. Ltd., A .............................................. United States 2,190,322 40,871,409 (a) NTL Inc. ........................................................ United Kingdom 1,824,784 133,133,614 Omnicom Group Inc. .............................................. United States 432,800 36,493,696 (a),(e) TVMAX Holdings Inc. ............................................. United States 257,217 257,217 Viacom Inc., B .................................................. United States 854,900 31,109,811 Washington Post Co., B .......................................... United States 238,238 234,192,719 -------------- 961,497,663 --------------
24 | Annual Report MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) METALS & MINING 6.4% Anglo American PLC .............................................. United Kingdom 5,137,645 $ 121,493,697 Anglo American PLC, ADR ......................................... United Kingdom 2,300 54,717 Barrick Gold Corp. .............................................. Canada 768,500 18,613,070 Compania de Minas Buenaventura SA, ADR .......................... Peru 330,900 7,577,610 Freeport McMoran Copper & Gold Inc., B .......................... United States 2,756,500 105,380,995 (a) Glamis Gold Ltd. ................................................ Canada 1,424,300 24,416,232 Gold Fields Ltd. ................................................ South Africa 642,754 7,885,508 Harmony Gold Mining Ltd., ADR ................................... South Africa 933,000 8,648,910 (a),(d),(e) International Steel Group ....................................... United States 6,143,191 236,709,436 Newmont Mining Corp. ............................................ United States 4,102,700 182,200,907 Noranda Inc. .................................................... Canada 2,037,700 35,781,016 Placer Dome Inc. ................................................ Canada 694,000 13,065,844 (a) Randgold & Exploration Co. Ltd., ADR ............................ South Africa 321,060 565,066 (a) Wheaton River Minerals Ltd. ..................................... Canada 3,289,916 10,698,022 (a) Wheaton River Minerals Ltd., wts., 5/30/07 ...................... Canada 1,819,489 3,580,268 (n) WMC Resources Ltd. .............................................. Australia 2,290,996 12,947,431 -------------- 789,618,729 -------------- MULTI-UTILITIES & UNREGULATED POWER .4% (a) Northwestern Corp. .............................................. United States 703,758 19,705,224 (a),(b) Northwestern Corp., Contingent Distribution ..................... United States 21,590,000 1,690,332 (a),(c) NRG Energy Inc. ................................................. United States 831,603 29,979,288 -------------- 51,374,844 -------------- OIL & GAS 3.3% (a),(e) Anchor Resources LLC ............................................ United States 123,013 -- BP PLC .......................................................... United Kingdom 5,707,068 55,648,788 BP PLC, ADR ..................................................... United Kingdom 46,400 2,709,760 (a) General Maritime Corp. .......................................... United States 36,300 1,450,185 Oil & Natural Gas Corp. Ltd. .................................... India 1,835,500 34,781,133 (a),(e) Opti Canada ..................................................... Canada 9,695,676 157,074,236 Suncor Energy Inc. .............................................. Canada 2,072,700 73,275,091 Total SA, B ..................................................... France 380,938 83,071,075 -------------- 408,010,268 -------------- PAPER & FOREST PRODUCTS .1% Abitibi-Consolidated Inc. ....................................... Canada 2,645,387 18,218,949 -------------- PERSONAL PRODUCTS .3% Beiersdorf AG ................................................... Germany 287,339 33,501,828 -------------- PHARMACEUTICALS 2.7% Fujisawa Pharmaceutical Co. Ltd. ................................ Japan 1,529,900 41,899,722 Pfizer Inc. ..................................................... United States 1,045,390 28,110,537 (a) Pfizer Inc., Mar. 25.00 Puts, 3/18/05 ........................... United States 5,859 410,130 Sanofi-Aventis .................................................. France 689,026 54,978,463 Takeda Pharmaceutical Co. Ltd. .................................. Japan 1,305,900 65,792,267 Valeant Pharmaceuticals International ........................... United States 3,520,835 92,774,002 Wyeth ........................................................... United States 1,211,100 51,580,749 Yamanouchi Pharmaceutical Co. Ltd. .............................. Japan 92,200 3,591,857 -------------- 339,137,727 --------------
Annual Report | 25 MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) REAL ESTATE 1.9% (a),(e) Alexander's Inc. ................................................ United States 326,675 $ 70,235,125 (a) Canary Wharf Group PLC .......................................... United Kingdom 14,262,931 81,036,270 (a),(d) Security Capital European Realty ................................ Luxembourg 28,412 204,566 St. Joe Co. ..................................................... United States 853,035 54,764,847 Ventas Inc. ..................................................... United States 1,072,765 29,404,489 -------------- 235,645,297 -------------- ROAD & RAIL 1.8% CSX Corp. ....................................................... United States 983,100 39,402,648 (d),(e) Florida East Coast Industries Inc. .............................. United States 4,423,071 189,506,477 -------------- 228,909,125 -------------- SEMICONDUCTORS & SEMICONDUCTOR EQUIPMENT .3% Samsung Electronics Co. Ltd. .................................... South Korea 91,400 39,775,599 -------------- SOFTWARE .2% (a),(n) Symantec Corp. .................................................. United States 362,800 9,345,728 (a),(n) Veritas Software Corp. .......................................... United States 365,400 10,432,170 -------------- 19,777,898 -------------- THRIFTS & MORTGAGE FINANCE 1.7% Fieldstone Investment Corp. ..................................... United States 2,365,900 40,811,775 Hudson City Bancorp Inc. ........................................ United States 886,055 32,624,545 Sovereign Bancorp Inc. .......................................... United States 5,828,890 131,441,469 -------------- 204,877,789 -------------- TOBACCO 10.9% Altadis SA ...................................................... Spain 7,776,607 355,631,081 Altria Group Inc. ............................................... United States 2,479,677 151,508,265 British American Tobacco PLC .................................... United Kingdom 25,341,243 436,557,365 British American Tobacco PLC, ADR ............................... United Kingdom 70,550 2,444,557 Imperial Tobacco Group PLC ...................................... United Kingdom 6,933,289 189,907,547 Reynolds American Inc. .......................................... United States 2,778,000 218,350,800 -------------- 1,354,399,615 -------------- WIRELESS TELECOMMUNICATION SERVICES (a) Vast Solutions Inc., B1 ......................................... United States 75,539 -- (a) Vast Solutions Inc., B2 ......................................... United States 75,539 -- (a) Vast Solutions Inc., B3 ......................................... United States 75,539 -- -------------- -- -------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $5,715,564,612)........................................... 8,957,441,165 --------------
26 | Annual Report MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) PREFERRED STOCKS .4% DIVERSIFIED TELECOMMUNICATION SERVICES PTV Inc., 10.00%, A, pfd. ....................................... United Kingdom 199,565 $ 904,029 -------------- ELECTRIC UTILITIES (a) Montana Power Co., 8.45%, pfd. .................................. United States 109,220 901,065 -------------- FOOD PRODUCTS .1% Unilever NV, pfd. ............................................... Netherlands 1,113,140 7,567,757 -------------- METALS & MINING .3% (a),(e),(f) Esmark Inc., Series A, 10.00%, cvt. pfd. ........................ United States 40,396 40,396,100 -------------- TOTAL PREFERRED STOCKS (COST $49,116,561)........................ 49,768,951 -------------- -------------------- PRINCIPAL AMOUNT(g) -------------------- CORPORATE BONDS & NOTES 1.9% (e) Anchor Resources LLC, 12.00%, 12/17/06 .......................... United States $ 57,552 57,552 Calpine Generating Co., 144A, FRN, 11.169%, 4/01/11 ............. United States 20,660,000 20,298,450 Eurotunnel PLC, FRN, 6.347%, 12/31/18, Tier 2 ................................ United Kingdom 13,617,682GBP 18,819,783 FRN, 6.347%, 12/31/25, Tier 3 ................................ United Kingdom 50,767,268GBP 40,927,200 Participating Loan Note, 1.00%, 4/30/40 ...................... United Kingdom 1,482,000GBP 327,134 Eurotunnel SA, FRN, 3.449%, 12/31/18, Tier 2 (LIBOR) ............................. France 3,151,383EUR 3,079,026 3.449%, 12/31/25, Tier 3 (LIBOR) ............................. France 77,744,116EUR 44,309,462 3.453%, 12/31/18, Tier 2 (PIBOR) ............................. France 1,393,972EUR 1,361,965 3.453%, 12/31/25, Tier 3 (PIBOR) ............................. France 13,502,354EUR 7,695,528 Guadalupe Power Partners LP, Power Sale Agreement, 6.00%, 9/21/06 ......................... United States 395,468 348,012 Term Loan, 4.313%, 9/21/06 ................................... United States 2,922,796 2,572,060 Motor Coach Industries International Inc., FRN, 15.40%, 10/01/08 United States 55,684,172 55,684,172 Reliant Energy Channelview LP Inc., Revolver, 5.50%, 8/15/07 ..................................... United States 669,900 569,415 Term Loan A, 3.813%, 11/26/17 ................................ United States 7,070,953 6,010,310 Seton House Finance Ltd., zero cpn., 2/07/12 .................... United Kingdom 90,451,691EUR 31,299,437 (e) TVMAX Holdings Inc., PIK, 11.50%, 2/01/05 .............................................. United States 264,487 264,487 14.00%, 2/01/05 .............................................. United States 1,045,014 1,045,014 -------------- TOTAL CORPORATE BONDS & NOTES (COST $249,418,107)................ 234,669,007 -------------- BONDS & NOTES IN REORGANIZATION 2.3% (a),(h) Adelphia Communications Corp., 9.25%, 10/01/02 .............................................. United States 11,465,000 11,035,062 8.125%, 7/15/03 .............................................. United States 1,442,000 1,362,690 7.50%, 1/15/04 ............................................... United States 3,750,000 3,487,500 10.50%, 7/15/04 .............................................. United States 6,320,000 6,256,800 9.875%, 3/01/05 .............................................. United States 2,564,000 2,467,850 10.25%, 11/01/06 ............................................. United States 9,950,000 9,726,125 9.875%, 3/01/07 .............................................. United States 366,000 352,275 8.375%, 2/01/08 .............................................. United States 9,037,000 8,562,557
Annual Report | 27 MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- COUNTRY PRINCIPAL AMOUNT(g) VALUE - ----------------------------------------------------------------------------------------------------------------------------------- BONDS & NOTES IN REORGANIZATION (CONT.) (a),(h) Adelphia Communications Corp., (cont.) 7.75%, 1/15/09 ............................................... United States $ 10,030,000 $ 9,428,200 7.875%, 5/01/09 .............................................. United States 7,952,000 7,435,120 9.375%, 11/15/09 ............................................. United States 1,823,000 1,809,327 10.875%, 10/01/10 ............................................ United States 7,041,000 7,005,795 (a),(h) Aiken Cnty S C Indl Rev Beloit, 6.00%, 12/01/11 ................. United States 775,000 3,875 (a),(h) Armstrong Holdings Inc., 6.50%, 8/15/05 ............................................... United States 2,157,000 1,569,217 9.75%, 4/15/08 ............................................... United States 4,047,000 2,944,192 Revolver, 10/29/03 ........................................... United States 4,049,775 2,794,345 Trade Claim .................................................. United States 10,859,300 7,601,510 (a),(h) Century Communications Corp., 9.50%, 3/01/05 ............................................... United States 1,903,000 2,312,145 8.875%, 1/15/07 .............................................. United States 2,405,000 2,898,025 8.75%, 10/01/07 .............................................. United States 3,666,000 4,325,880 8.375%, 12/15/07 ............................................. United States 875,000 1,045,625 Series B, zero cpn., 1/15/08 ................................. United States 6,600,000 4,653,000 zero cpn., 3/15/03 ........................................... United States 14,005,000 14,915,325 (e),(h) DecisionOne Corp., Term Loan .................................... United States 13,775,874 3,443,969 (a),(h) Harnischfeger Industries Inc., 8.90%, 3/01/22 ............................................... United States 6,565,000 61,055 8.70%, 6/15/22 ............................................... United States 6,004,000 57,038 7.25%, 12/15/25 .............................................. United States 8,965,000 84,271 6.875%, 2/15/27 .............................................. United States 7,663,000 70,500 Stipulated Bank Claim ........................................ United States 9,933,950 90,399 (a),(h) Mirant Americas Generation Inc., 7.625%, 5/01/06 .............................................. United States 1,816,000 1,961,280 8.30%, 5/01/11 ............................................... United States 8,079,000 8,583,938 9.125%, 5/01/31 .............................................. United States 6,333,000 6,633,818 (a),(h) Mirant Corp., Tranche C Revolver ........................................... United States 12,866,601 8,877,955 4 Year Revolver, 7/17/05 ..................................... United States 8,202,186 6,192,651 364 Day Revolver ............................................. United States 22,103,300 15,361,794 (a),(h) Owens Corning, Revolver ......................................... United States 56,034,383 49,870,601 (a),(h) Port Seattle Wash Rev Ref-Beloit Proj., 6.00%, 12/01/17 ......... United States 385,000 1,925 (a),(h) Safety Kleen Services, 9.25%, 6/01/08 ........................... United States 85,000 319 (a),(h) Teco Panda, Bank Claim ................................................... United States 3,669,320 2,201,592 Bank Claim #2 ................................................ United States 28,209,808 17,772,179 Bank Claim #3 ................................................ United States 166,990 166,990 Debt Service Reserve L/C Loan ................................ United States 908,743 572,508 Project L/C Loan Facility .................................... United States 3,867,109 2,436,279 (h) Trump Atlantic, 11.25%, 5/01/06 .............................................. United States 40,599,000 38,924,291 Series B, 11.25%, 5/01/06 .................................... United States 11,898,000 11,407,208 Series B, 144A, 11.25%, 5/01/06 .............................. United States 735,000 704,681 -------------- TOTAL BONDS & NOTES IN REORGANIZATION (COST $249,453,098)........ 289,469,681 --------------
28 | Annual Report MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- SHARES/PRINCIPAL COUNTRY AMOUNT(G) VALUE - ---------------------------------------------------------------------------------------------------------------------------------- COMPANIES IN LIQUIDATION .1% (a) Apco Oil Corp. .................................................. United States 9,200 $ -- (a) Brunos Inc., Liquidating Unit ................................... United States 98,873 217,520 (a),(e) City Investing Co. Liquidating Trust ............................ United States 4,373,476 8,440,809 (a),(e) MBOP Liquidating Trust .......................................... United States 574,712 1,437 Peregrine Investments Holdings Ltd., 6.70%, 1/15/98 ............................................... Hong Kong 95,000,000JPY 25,508 6.70%, 6/30/00 ............................................... Hong Kong 250,000,000JPY 67,125 zero cpn., 1/22/98 ........................................... Hong Kong 500,000 13,750 (a) PIV Investment Finance (Cayman) Ltd. ............................ Hong Kong 22,710,000 1,249,050 (a) United Cos. Financial Corp., Bank Claim ................................................... United States 179,680 -- Revolver ..................................................... United States 45,581,514 -- -------------- TOTAL COMPANIES IN LIQUIDATION (COST $683,828)................... 10,015,199 -------------- GOVERNMENT AGENCIES 23.0% (i) Federal Home Loan Bank, 1.142% - 2.891%, 1/03/05 - 7/02/07 ............................................ United States $2,715,560,000 2,698,334,331 Federal Home Loan Mortgage Corp., 2.50%, 5/19/06 ................ United States 25,000,000 24,798,325 Federal National Mortgage Association, 1.44% - 2.20%, 6/01/05 - 12/29/06 ........................................... United States 65,000,000 64,116,815 U.S. Treasury Bill, 1.895% - 2.536%, 2/24/05 - 6/30/05 .......... United States 62,000,000 61,440,360 -------------- TOTAL GOVERNMENT AGENCIES (COST $2,853,710,311).................. 2,848,689,831 -------------- TOTAL INVESTMENTS BEFORE REPURCHASE AGREEMENTS (COST $9,117,946,517)........................................... 12,390,053,834 --------------
Annual Report | 29 MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- COUNTRY PRINCIPAL AMOUNT VALUE - ----------------------------------------------------------------------------------------------------------------------------------- REPURCHASE AGREEMENTS (j),(k) Barclays Capital Inc., 2.30%, 1/03/05 (Maturity Value $6,001) Collateralized by U.S. Government Agency Securities, 3.00 - 7.50%, 8/30/07 - 1/25/35, U.S.Treasury Bills, 5/12/05 - 5/26/05, Notes and U.S. Treasury Bonds, 11/15/18-11/15/21 ....................... United States $ 6,000 $ 6,000 (j),(k) Citigroup Global Market Inc., 2.28%, 1/03/05 (Maturity Value $7,001) Collateralized by U.S. Corporate Bonds & Notes, 4.00 - 7.75%, 6/15/05 - 9/15/34, U.S. Government Agency Securities, 0.00 - 7.25%, 7/3/06 - 11/15/30............................................. United States 7,000 7,000 (j),(k) Deutshe Bank Securities Inc., 2.25%, 1/03/05 (Maturity Value $7,001) Collateralized by U.S. Government Agency Securities, 0.00 - 4.45%, 8/19/05 - 8/27/10............ United States 7,000 7,000 (j),(k) Goldman Sachs & Co. 2.29%, 1/03/05 (Maturity Value $7,001) Collateralized by U.S. Government Agency Securities, 4.00 - 6.50%, 3/1/17 - 1/01/35 ............ United States 7,000 7,000 (j),(k) JP Morgan Securities, 2.19%, 1/03/05 (Maturity Value $7,001) Collateralized by U.S. Government Agency Securities, 2.00 - 7.13%, 1/15/06 - 7/15/32 ........... United States 7,000 7,000 --------------- TOTAL REPURCHASE AGREEMENTS (COST $34,000)....................... 34,000 --------------- TOTAL INVESTMENTS (COST $9,117,980,517) 100.0%................... 12,390,087,834 OPTIONS WRITTEN ................................................. (421,309) SECURITIES SOLD SHORT (.7)%...................................... (92,248,734) NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS (.7)%.......... (74,748,166) OTHER ASSETS, LESS LIABILITIES 1.4%.............................. 172,275,099 --------------- NET ASSETS 100.0%................................................ $12,394,944,724 =============== -------------- CONTRACTS -------------- OPTIONS WRITTEN ISSUER HEALTH CARE EQUIPMENT & SUPPLIES (l) Guidant Corp., Jan. 70.00 Calls, 1/21/05 ........................ United States 390 91,650 --------------- METALS & MINING (l) WMC Resources Ltd., Jan. 7.00 Calls, 1/27/05 .................... Australia 595 156,021 (l) WMC Resources Ltd., Jan. 7.25 Calls, 1/27/05 .................... Australia 266 38,519 --------------- 194,540 --------------- SOFTWARE (l) Symantec Corp., Jan. 25.00 Calls, 1/21/05 ....................... United States 525 78,750 (l) Symantec Corp., Jan. 27.50 Calls, 1/21/05 ....................... United States 349 14,309 (l) Veritas Software Corp., Jan. 30.00 Calls, 1/21/05 ............... United States 701 42,060 --------------- 135,119 --------------- TOTAL OPTIONS WRITTEN (PREMIUMS RECEIVED $392,341)............... $ 421,309 ---------------
30 | Annual Report MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES VALUE - ----------------------------------------------------------------------------------------------------------------------------------- SECURITIES SOLD SHORT .7% ISSUER COMMUNICATIONS EQUIPMENT (m) Tellabs Inc. .................................................... United States 160,747 $ 1,380,817 -------------- DIVERSIFIED FINANCIAL SERVICES .1% (m) Nasdaq 100 ...................................................... United States 380,700 15,197,544 -------------- FOOD PRODUCTS .4% (m) Kraft Foods Inc., A ............................................. United States 1,623,881 57,826,402 -------------- HOTELS RESTAURANTS & LEISURE .1% (m) Harrah's Entertainment Inc. ..................................... United States 142,300 9,518,447 -------------- PHARMACEUTICALS .1% (m) Johnson & Johnson ............................................... United States 131,276 8,325,524 -------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $86,050,100)............... $ 92,248,734 --------------
CURRENCY ABBREVIATIONS: | EUR - Euro | GBP - British Pound | JPY - Japanese Yen (a) Non-income producing. (b) Contingent Distributions represent the right to receive additional distributions, if any, during the reorganization of the underlying company. Shares represent total underlying principal of debt securities. (c) Security on loan. See Note 1(i). (d) See Note 10 regarding restricted securities. (e) See Note 11 regarding holdings of 5% voting securities. (f) See Note 12 regarding other considerations. (g) The principal amount is stated in U.S. dollars unless otherwise indicated. (h) Defaulted securities. See Note 9. (i) See Note 1(h) regarding securities segregated with broker for securities sold short. (j) See Note 1(c) regarding repurchase agreements. (k) Investments from cash collateral received for loaned securities. See Note 1(i). (l) See Note 1(g) regarding written options. (m) See Note 1(h) regarding securities sold short. (n) A portion of the security is held in connection with open option contracts. Annual Report | 31 MUTUAL SHARES FUND FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2004 Assets: Investments in securities: Cost - Unaffiliated issuers .......................................... $ 8,449,689,058 Cost - Non-controlled affiliated issuers (Note 11) ................... 664,761,304 Cost - Controlled affiliated issuers (Note 11) ....................... 3,496,155 Cost - Repurchase agreements ......................................... 34,000 ---------------- Total cost of investments ............................................ 9,117,980,517 ================ Value - Unaffiliated issuers (includes securities segregated with broker for securities sold short in the amount of $34,549,565) ...... 10,963,316,416 Value - Non-controlled affiliated issuers (Note 11) .................. 1,426,737,418 Value - Controlled affiliated issuers (Note 11) ...................... -- Value - Repurchase agreement ......................................... 34,000 ---------------- Total value of investments ........................................... 12,390,087,834 Cash .................................................................. 4,207,023 Foreign currency, at value (cost $17,070,959) ......................... 17,399,825 Receivables: Investment securities sold ........................................... 56,522,487 Capital shares sold .................................................. 17,187,079 Dividends and interest ............................................... 27,205,757 Unrealized gain on forward exchange contracts (Note 8) ................ 6,266,612 Due from broker - synthetic equity swaps .............................. 8,537,685 Cash on deposit with brokers for securities sold short ................ 93,810,329 ---------------- Total assets ..................................................... 12,621,224,631 ---------------- Liabilities: Payables: Investment securities purchased ...................................... 20,553,961 Capital shares redeemed .............................................. 20,754,913 Affiliates ........................................................... 10,471,323 Options written, at value (premiums received $392,341) ................ 421,309 Securities sold short, at value (proceeds $86,050,100 ) ............... 92,248,734 Payable upon return of securities loaned .............................. 34,000 Unrealized loss on forward exchange contracts (Note 8) ................ 81,014,778 Deferred tax .......................................................... 16,070 Other liabilities ..................................................... 764,819 ---------------- Total liabilities ................................................ 226,279,907 ---------------- Net assets, at value ........................................... $ 12,394,944,724 ================ Net assets consist of: Distributions in excess of net investment income ...................... $ (5,984,486) Net unrealized appreciation (depreciation) ............................ 3,192,719,489 Accumulated net realized gain (loss) .................................. 67,905,441 Capital shares ........................................................ 9,140,304,280 ---------------- Net assets, at value ........................................... $ 12,394,944,724 ================
32 | See notes to financial statements. | Annual Report MUTUAL SHARES FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2004 CLASS Z: Net assets, at value ......................................... $ 7,240,641,423 =============== Shares outstanding ........................................... 314,160,095 =============== Net asset value and maximum offering price per share(a) ...... $ 23.05 =============== CLASS A: Net assets, at value ......................................... $ 2,940,028,819 =============== Shares outstanding ........................................... 128,178,485 =============== Net asset value per share(a) ................................. $ 22.94 =============== Maximum offering price per share (net asset value per share / 94.25%) ......................................... $ 24.34 =============== CLASS B: Net assets, at value ......................................... $ 588,401,281 =============== Shares outstanding ........................................... 26,146,062 =============== Net asset value and maximum offering price per share(a) ...... $ 22.50 =============== CLASS C: Net assets, at value ......................................... $ 1,551,110,515 =============== Shares outstanding ........................................... 68,153,028 =============== Net asset value and maximum offering price per share(a) ...... $ 22.76 =============== CLASS R: Net assets, at value ......................................... $ 74,762,686 =============== Shares outstanding ........................................... 3,271,466 =============== Net asset value and maximum offering price per share(a) ...... $ 22.85 =============== (a) Redemption price is equal to net asset value less contingent deferred sales charges, if applicable, and redemption fees retained by the Fund. Annual Report | See notes to financial statements. | 33 MUTUAL SHARES FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2004 Investment income: Dividends: (net of foreign taxes of $12,294,533) Unaffiliated issuers ....................................... $ 158,641,240 Non-controlled affiliated issuers (Note 11) ................ 2,432,258 Interest: Unaffiliated issuers ....................................... 100,421,795 Non-controlled affiliated issuers (Note 11) ................ 120,909 --------------- Total investment income ................................ 261,616,202 --------------- Expenses: Management fees (Note 3) .................................... 63,691,060 Administrative fees (Note 3) ................................ 8,331,402 Distribution fees (Note 3) Class A .................................................... 8,870,489 Class B .................................................... 5,071,548 Class C .................................................... 13,811,051 Class R .................................................... 302,300 Transfer agent fees (Note 3) ................................ 10,336,200 Custodian fees (Note 4) ..................................... 838,096 Reports to shareholders ..................................... 352,600 Registration and filing fees ................................ 478,600 Professional fees ........................................... 628,434 Directors' fees and expenses ................................ 297,900 Dividends on securities sold short .......................... 1,484,019 Other ....................................................... 536,995 --------------- Total expenses ......................................... 115,030,694 Expense reductions (Note 4) ............................ (54,180) --------------- Net expenses ......................................... 114,976,514 --------------- Net investment income .............................. 146,639,688 --------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments: Unaffiliated issuers ...................................... 511,136,311 Controlled affiliated issuers (Note 11) ................... 8,428,081 Non-controlled affiliated issuers (Note 11) ............... (8,111,449) Written options ............................................ 2,087,688 Foreign currency transactions .............................. (187,590,846) Securities sold short ...................................... (5,108,872) --------------- Net realized gain (loss) ............................... 320,840,913 Net change in unrealized appreciation (depreciation) on: Investments ................................................ 939,113,356 Translation of assets and liabilities denominated in foreign currencies ........................................ 31,860,351 Deferred taxes ............................................. (16,070) --------------- Net change in unrealized appreciation (depreciation) ... 970,977,637 --------------- Net realized and unrealized gain (loss) ...................... 1,291,818,550 --------------- Net increase (decrease) in net assets resulting from operations .................................................. $ 1,438,458,238 =============== 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, 2004 and 2003
----------------------------------- 2004 2003 ----------------------------------- Increase (decrease) in net assets: Operations: Net investment income .......................................................... $ 146,639,688 $ 83,777,908 Net realized gain (loss) from investments, written options, foreign currency transactions, and securities sold short ..................................... 320,840,913 107,908,202 Net change in unrealized appreciation (depreciation) on investments, translation of assets and liabilities denominated in foreign currencies and deferred taxes . 970,977,637 1,783,376,119 ----------------------------------- Net increase (decrease) in net assets resulting from operations ........ 1,438,458,238 1,975,062,229 Distributions to shareholders from: Net investment income: Class Z ..................................................................... (118,691,555) (86,237,828) Class A ..................................................................... (39,459,758) (27,241,185) Class B ..................................................................... (4,845,646) (3,088,304) Class C ..................................................................... (12,290,974) (8,533,693) Class R ..................................................................... (913,976) (444,646) Net realized gains: Class Z ..................................................................... (128,945,088) -- Class A ..................................................................... (52,647,915) -- Class B ..................................................................... (10,792,182) -- Class C ..................................................................... (28,220,750) -- Class R ..................................................................... (1,342,860) -- ----------------------------------- Total distributions to shareholders .............................................. (398,150,704) (125,545,656) Capital share transactions (Note 2): Class Z ........................................................................ 847,945,959 83,398,695 Class A ........................................................................ 438,813,545 91,264,831 Class B ........................................................................ 95,341,685 33,623,724 Class C ........................................................................ 146,965,374 74,641,988 Class R ........................................................................ 21,886,122 26,507,727 ----------------------------------- Total capital share transactions ................................................. 1,550,952,685 709,436,965 Redemption fees .................................................................. 9,352 -- ----------------------------------- Net increase (decrease) in net assets ..................................... 2,591,269,571 2,558,953,538 Net assets: Beginning of year ................................................................ 9,803,675,153 7,244,721,615 ----------------------------------- End of year ...................................................................... $ 12,394,944,724 $ 9,803,675,153 =================================== Distributions in excess of net investment income/undistributed net investment income included in net assets: End of year ...................................................................... $ (5,984,486) $ 13,216,978 ===================================
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), consisting of 6 separate series. The Company is an open-end investment company registered under the Investment Company Act of 1940. The financial statements of the remaining funds in the series are presented separately. 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 on a securities exchange or on the NASDAQ National Market System, are valued at the last quoted sale price or the official closing price of the day, respectively. Over-the-counter securities and listed securities for which there is no reported sale are valued within the range of the most recent quoted bid and ask prices. Securities that trade in multiple markets or on multiple exchanges are valued according to the broadest and most representative market. Repurchase agreements are valued at cost. Corporate debt securities and U.S. Government securities generally trade in the over-the-counter market rather than on a securities exchange. The Fund may utilize independent pricing services, quotations from bond dealers, and information with respect to bond and note transactions, to assist in determining a current market value for each security. The Fund's pricing services may use valuation models or matrix pricing which considers information with respect to comparable bond and note transactions, quotations from bond dealers, or by reference to other securities that are considered comparable in such characteristics as rating, interest rate and maturity date, option adjusted spread models, prepayment projections, interest rate spreads and yield curves, to determine current value. Foreign securities are valued as of the close of trading on the foreign stock exchange on which the security is primarily traded, or the NYSE, whichever is earlier. The value is then converted into its U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the day that the value of the foreign security is determined. If no sale is reported at that time, the foreign security will be valued within the range of the most recent quoted bid and ask prices. 36 | Annual Report MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. Some methods for valuing these securities may include: fundamental analysis, matrix pricing, discounts from market prices of similar securities, or discounts applied due to the nature and duration of restrictions on the disposition of the securities. Occasionally, events occur between the time at which trading in a security is completed and the close of the NYSE that might call into question the availability (including the reliability) of the value of a portfolio security held by the Fund. If such an event occurs, the securities may be valued using fair value procedures, which may include the use of independent pricing services. All security valuation procedures are approved by the Fund's 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, income and expense items denominated in foreign currencies are translated into U.S. dollars at the exchange rate in effect on the transaction date. Occasionally, events may impact the availability or reliability of foreign exchange rates used to convert the U.S. dollar equivalent value. If such an event occurs, the foreign exchange rate will be valued at fair value using procedures established and approved by the Fund's Board of Directors. 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 on the Statement of Operations. 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. dollars 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, 2004, all repurchase agreements held by the Fund had been entered into on that date. Annual Report | 37 MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) D. SECURITIES PURCHASED ON A WHEN-ISSUED OR DELAYED DELIVERY 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 by the Fund and any equity therein is included in the Statement of Assets and Liabilities. Realized and unrealized gains and losses on these contracts 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 on these contracts 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 to 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 synthetic equity swaps include unfavorable price movements in the underlying securities or the inability of the counterparties to fulfill their obligations under the contract. 38 | Annual Report MUTUAL SHARES 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. Upon closing of an option, other than by exercise, which 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 incurs 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 realizes a gain if the price of the security declines between those dates. Gains are limited to the price at which the Fund sold the security short, while losses are potentially unlimited in size. 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 with the broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. The Fund is obligated to pay the counterparty any dividends or interest due on securities sold short. Such dividends and interest are recorded as an expense to the Fund. I. SECURITIES LENDING The Fund loans securities to certain brokers through a securities lending agent for which it received cash collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. The collateral is invested in short-term instruments as noted in the Statement of Investments. The Fund received interest income of $178,361 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 collateral and the securities loaned. The securities lending agent has agreed to indemnify the Fund in the case of default of any securities borrower. Annual Report | 39 MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) J. INCOME AND DEFERRED TAXES No provision has been made for U.S. income taxes because the Fund's policy is to qualify as a regulated investment company under Sub Chapter M of the Internal Revenue Code and to distribute substantially all of its taxable income. Fund distributions to shareholders are determined on an income tax basis and may differ from net investment income and realized gains for financial reporting purposes. The Fund is subject to a tax imposed on net realized gains of securities of certain foreign countries. When the Fund invests in these securities, the Fund records an estimated deferred tax liability for net unrealized gains on these securities as reflected in the accompanying financial statements. 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. Interest income and estimated expenses are accrued daily. Discounts and premiums 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 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 expenses during the reporting period. Actual results could differ from those estimates. M. REDEMPTION FEES Effective June 1, 2004, redemptions and exchanges of Fund shares held five trading days or less 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 as noted in the Statements of Changes in Net Assets. 40 | Annual Report MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) N. GUARANTEES AND INDEMNIFICATIONS Under the Fund's organizational documents, its officers and directors are indemnified by the Fund 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. Effective March 1, 2005, Class B shares will no longer be offered except to existing Class B shareholders through reinvested distributions or exchanges into other Franklin Templeton funds' Class B shares, as permitted by the applicable fund prospectus. 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, 2004, 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 DECEMBER 31, 2004 2003 ----------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT ----------------------------------------------------------------- CLASS Z SHARES: Shares sold .................... 50,806,616 $1,104,922,147 21,151,259 $ 407,846,009 Shares issued in reinvestment of distributions ................. 9,758,882 219,303,487 3,736,749 73,434,642 Shares redeemed ................ (21,921,975) (476,279,675) (21,665,054) (397,881,956) ----------------------------------------------------------------- Net increase (decrease) ........ 38,643,523 $ 847,945,959 3,222,954 $ 83,398,695 ================================================================= CLASS A SHARES: Shares sold .................... 37,809,209 $ 815,970,082 35,425,425 $ 652,986,425 Shares issued in reinvestment of distributions ................. 3,786,200 84,685,091 1,293,317 25,145,030 Shares redeemed ................ (21,439,414) (461,841,628) (20,693,711) (386,866,624) ----------------------------------------------------------------- Net increase (decrease) ........ 20,155,995 $ 438,813,545 16,025,031 $ 291,264,831 ================================================================= CLASS B SHARES: Shares sold .................... 6,156,400 $ 129,929,525 9,236,787 $ 165,789,211 Shares issued in reinvestment of distributions ................. 670,932 14,717,392 154,276 2,877,950 Shares redeemed ................ (2,332,950) (49,305,232) (1,987,903) (35,043,437) ----------------------------------------------------------------- Net increase (decrease) ........ 4,494,382 $ 95,341,685 7,403,160 $ 133,623,724 =================================================================
Annual Report | 41 MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED)
----------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2004 2003 ----------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT ----------------------------------------------------------------- CLASS C SHARES: Shares sold .................... 13,913,529 $ 297,054,287 17,120,196 $ 312,711,634 Shares issued in reinvestment of distributions ................. 1,682,221 37,310,819 422,198 7,868,601 Shares redeemed ................ (8,770,041) (187,399,732) (8,145,439) (145,938,247) ----------------------------------------------------------------- Net increase (decrease) ........ 6,825,709 $ 146,965,374 9,396,955 $ 174,641,988 ================================================================= CLASS R SHARES: Shares sold .................... 1,573,958 $ 33,763,040 1,770,971 $ 32,403,265 Shares issued in reinvestment of distributions ................. 100,387 2,237,745 22,484 440,336 Shares redeemed ................ (656,261) (14,114,663) (339,764) (6,335,874) ----------------------------------------------------------------- Net increase (decrease) ........ 1,018,084 $ 21,886,122 1,453,691 $ 26,507,727 =================================================================
3. TRANSACTIONS WITH AFFILIATES Certain officers of the Fund are also officers and/or directors of the following entities:
- ------------------------------------------------------------------------------------------ ENTITY AFFILIATION - ------------------------------------------------------------------------------------------ Franklin Mutual Advisers, LLC (Franklin Mutual) Investment manager Franklin Templeton Services, LLC (FT Services) Administrative manager Franklin/Templeton Distributors, Inc. (Distributors) Principal underwriter Franklin/Templeton Investor Services, LLC (Investor Services) Transfer agent
A. MANAGEMENT FEES Effective July 1, 2004, the Fund pays an investment management fee to Franklin Mutual based on the average daily net assets of the Fund as follows: - -------------------------------------------------------------------------------- ANNUALIZED FEE RATE NET ASSETS - -------------------------------------------------------------------------------- 0.600% First $5 billion 0.570% Over $5 billion, up to and including $10 billion 0.550% Over $10 billion, up to and including $15 billion 0.530% Over $15 billion, up to and including $20 billion 0.510% Over $20 billion Prior to July 1, 2004, the Fund paid fees of 0.60% per year of the average daily net assets of the Fund. 42 | Annual Report MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) B. ADMINISTRATIVE FEES The Fund pays its allocated share of an administrative fee to FT Services based on the Fund's aggregate average daily net assets as follows: - -------------------------------------------------------------------------------- ANNUALIZED FEE RATE 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 C. DISTRIBUTION FEES The Fund reimburses Distributors 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, for costs incurred in marketing the Fund's shares under a Rule 12b-1 plan. Under the Class A distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. D. SALES CHARGES/UNDERWRITING AGREEMENTS Distributors has advised the Fund of the following commission transactions related to the sales and redemptions of the Fund's shares for the year: Net sales charges received ............................ $ 2,451,894 Contingent deferred sales charges retained ............ $ 917,576 E. TRANSFER AGENT FEES The Fund paid transfer agent fees of $10,336,200, of which $7,232,098 was paid to Investors Services. 4. EXPENSE OFFSET ARRANGEMENT The Fund has entered into an arrangement with its custodian whereby credits realized as a result of uninvested cash balances are used to reduce a portion of the Fund's custodian expenses. During the year ended December 31, 2004, the custodian fees were reduced as noted in the Statement of Operations. 5. INCOME TAXES Net investment income (loss) differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, bond discounts and premiums, and certain dividends on securities sold short. Net realized gains differ for financial statement and tax purposes primarily due to differing treatments of wash sales, foreign currency transactions, bond discounts and premiums on the sale of securities and foreign currencies. Annual Report | 43 MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. INCOME TAXES (CONTINUED) At December 31, 2004, 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 .......................................... $ 9,147,530,445 =============== Unrealized appreciation ...................................... $ 3,368,501,352 Unrealized depreciation ...................................... (125,943,963) --------------- Net unrealized appreciation (depreciation) ................... $ 3,242,557,389 =============== Undistributed ordinary income ................................ $ 12,726,716 Undistributed long term capital gains ........................ 14,920,950 --------------- Distributable earnings ....................................... $ 27,647,666 =============== The tax character of distributions paid during the years ended December 31, 2004 and 2003, was as follows: ---------------------------- 2004 2003 ---------------------------- Distributions paid from: Ordinary income .............................. $ 176,201,909 $ 125,545,656 Long term capital gain ....................... 221,948,795 -- ---------------------------- $ 398,150,704 $ 125,545,656 ============================ 6. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short-term securities) for the year ended December 31, 2004 aggregated $3,544,971,507 and $2,915,915,806, respectively. Transactions in options written during the year ended December 31, 2004 were as follows: ---------------------------- NUMBER OF PREMIUMS CONTRACTS RECEIVED ---------------------------- Options outstanding at December 31, 2003 ............................. 2,325,358 $ 621,717 Options written ................................ 1,972,223 4,026,069 Options expired ................................ (991,442) (1,642,081) Options exercised .............................. (3,297,995) (1,648,904) Options closed ................................. (5,318) (964,460) ---------------------------- Options outstanding at December 31, 2004 ............................. 2,826 $ 392,341 ============================ 44 | Annual Report MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. SYNTHETIC EQUITY SWAPS As of December 31, 2004, the Fund had the following synthetic equity swaps outstanding: - ------------------------------------------------------------------------------- NUMBER OF UNREALIZED CONTRACTS TO BUY CONTRACTS VALUE GAIN (LOSS) - ------------------------------------------------------------------------------- Christian Dior SA (46.76 - 55.43 EUR) .. 213,944 $14,530,610 $ 173,736 London Stock Exchange PLC (5.36 - 5.71 GBP) .................... 175,621 1,961,907 70,530 ----------- Total contracts to buy ........................................... $ 244,266 ----------- - ------------------------------------------------------------------------------- NUMBER OF UNREALIZED CONTRACTS TO SELL CONTRACTS VALUE GAIN (LOSS) - ------------------------------------------------------------------------------- LVMH Moet Hennessy Louis Vuitton (46.76 - 61.76 EUR) .................. 214,680 $16,415,918 $ 534,745 ----------- Total contracts to sell .......................................... 534,745 ----------- Net unrealized gain (loss) ....................................... $ 779,011 =========== 8. FORWARD EXCHANGE CONTRACTS At December 31, 2004, 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) - --------------------------------------------------------------------------------------------------- 1,990,575 Canadian Dollars ....... U.S. $ 1,500,000 1/21/05 U.S. $ 159,489 72,504,717 South African Rand ..... 11,007,475 1/26/05 1,741,018 61,876,617 Canadian Dollars ....... 51,299,999 4/21/05 286,919 -------------- -------------- U.S. $ 63,807,474 U.S. $ 2,187,426 ============== ============== - --------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO SELL: EXCHANGE FOR DATE GAIN/(LOSS) - --------------------------------------------------------------------------------------------------- 2,400,000 British Pounds ......... U.S. $ 4,609,752 2/10/05 U.S. $ 15,914 3,750,000 Euro ................... 5,106,000 2/23/05 14,724 87,957,678 British Pounds ......... 168,890,321 3/21/05 892,159 180,900,000 British Pounds ......... 347,318,785 6/08/05 3,154,454 932,850,000 Korean Won ............. 900,000 6/17/05 1,935 -------------- -------------- U.S. $ 526,824,858 4,079,186 ============== -------------- Unrealized gain on forward exchange contracts ............................... U.S. $ 6,266,612 ============== - --------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO BUY: EXCHANGE FOR DATE GAIN/(LOSS) - --------------------------------------------------------------------------------------------------- 3,500,000 South African Rand ..... U.S. 619,068 1/26/05 U.S. $ (3,664) 28,134,267 Canadian Dollars ....... 23,675,000 4/21/05 (219,287) -------------- -------------- U.S. $ 24,294,068 U.S. $ (222,951) ============== ==============
Annual Report | 45 MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. FORWARD EXCHANGE CONTRACTS (CONTINUED)
- --------------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO BUY: EXCHANGE FOR DATE GAIN/(LOSS) - --------------------------------------------------------------------------------------------------- 287,459,370 Canadian Dollars ....... U.S. $ 218,764,798 1/21/05 U.S. $ (20,882,333) 115,896,250 South African Rand ..... 18,297,007 1/26/05 (2,081,012) 164,450,000 British Pounds ......... 303,467,430 2/10/05 (11,306,161) 27,975,000 Euro ................... 34,737,586 2/23/05 (3,243,336) 320,116,142 Danish Krona ........... 52,361,484 3/17/05 (6,073,882) 8,694,961,719 Japanese ............... 79,529,771 3/28/05 (5,885,405) 110,367,120 Canadian Dollars ....... 83,964,062 4/21/05 (8,049,689) 79,382,752 Euro ................... 100,206,549 4/25/05 (7,680,501) 27,000,000 Euro ................... 33,362,550 5/23/05 (3,353,411) 39,300,000 Euro ................... 52,349,172 6/13/05 (1,115,852) 23,150,694,955 Korean Won ............. 22,075,000 6/17/05 (261,744) 54,000,000 Euro ................... 68,191,200 7/25/05 (5,340,125) 27,000,000 Euro ................... 33,378,075 8/23/05 (3,412,124) 14,500,000 Euro ................... 17,661,000 9/13/05 (2,106,252) -------------- -------------- U.S. $1,118,345,684 (80,791,827) ============== -------------- Unrealized loss on forward exchange contracts ............................... (81,014,778) -------------- Net unrealized loss on forward exchange contracts ......................... U.S. $ (74,748,166) ==============
9. CREDIT RISK AND DEFAULTED SECURITIES The Fund held defaulted securities and/or other securities for which the income has been deemed uncollectible. At December 31, 2004, the value of these securities was $289,469,681, representing 2.34% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. 46 | Annual Report MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 10. RESTRICTED SECURITIES At December 31, 2004, investments in securities included issues that are restricted and 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, 2004, the Fund held investments in restricted and illiquid securities that were valued under approved methods by the Directors, as follows:
- ------------------------------------------------------------------------------------------------------------- SHARES/ ACQUISITION WARRANTS ISSUER DATE COST VALUE - ------------------------------------------------------------------------------------------------------------- 763,805 AboveNet Inc. ................................ 10/02/01 $ 38,348,164 $ 18,303,365 25,659 AboveNet Inc., wts., 9/08/08 ................. 10/02/01 3,196,155 164,218 30,186 AboveNet Inc., wts., 9/08/10 ................. 10/02/01 3,430,956 120,744 3,845,467 Centennial Bank Holdings Inc. ................ 12/29/04 40,377,404 40,377,403 25,721 Elephant Capital Holdings Ltd. ............... 8/29/03 25,728,875 34,208,563 4,423,071 Florida East Coast Industries Inc. ........... 10/03/75 108,943,491 189,506,477 6,143,191 International Steel Group .................... 4/10/02 29,676,250 236,709,436 3 Lancer Industries Inc., B .................... 8/11/89 -- 2,440,923 1,551,229 Leucadia National Corp. ...................... 12/20/02 54,680,822 102,390,421 202,380 Olympus Re Holdings Ltd. ..................... 12/19/01 20,238,000 34,643,408 28,412 Security Capital European Realty ............. 4/08/98 1,556,398 204,566 --------------- TOTAL RESTRICTED SECURITIES (5.32% OF NET ASSETS) ................................. $ 659,069,524 ===============
Annual Report | 47 MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. 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, 2004 were as shown below.
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF SHARES/ NUMBER OF CONTRACTS/ SHARES/ WARRANTS CONTRACTS/ HELD AT WARRANTS VALUE AT REALIZED BEGINNING GROSS GROSS HELD AT END END OF INVESTMENT CAPITAL NAME OF ISSUER OF YEAR ADDITIONS REDUCTIONS OF YEAR YEAR INCOME GAIN/(LOSS) - ------------------------------------------------------------------------------------------------------------------------------------ (a)CONTROLLED AFFILIATES Nippon Investment LLC ......... 18,938,000 -- -- 18,938,000 $ -- $ -- $ 8,428,081 ------------------------------------------- NON-CONTROLLED AFFILIATES AboveNet Inc. ................. 141,884 621,921 -- 763,805 18,303,365 -- -- AboveNet Inc., Contingent Distribution ................ -- 106,869,000 -- 106,869,000 -- -- -- AboveNet Inc., wts., 9/08/08 .. -- 25,659 -- 25,659 164,218 -- -- AboveNet Inc., wts., 9/08/10 .. -- 30,186 -- 30,186 120,744 -- -- Alexander's Inc. .............. 326,675 -- -- 326,675 70,235,125 -- -- Anchor Resources LLC .......... -- 123,013 -- 123,013 -- -- -- Anchor Resources LLC, 12.00%, 12/17/06 .................... -- 57,552 -- 57,552 57,552 -- -- Centennial Bank Holdings Inc. ........................ -- 3,845,467 -- 3,845,467 40,377,403 -- -- City Investing Company Liquidating Trust ........... 4,373,476 -- -- 4,373,476 8,440,809 -- -- DecisionOne Corp. ............. 457,492 -- -- 457,492 -- -- -- Decision One Corp., Term Loan ........................ 13,862,298 -- (86,424) 13,775,874 3,443,969 -- 7,733 Elephant Capital Holdings Ltd. ........................ 25,401 320 -- 25,721 34,208,563 -- -- Esmark Inc., Series A, 10.00%, cvt. pfd ............ -- 40,396 -- 40,396 40,396,100 -- -- Federal Signal Corp. .......... -- 2,899,000 -- 2,899,000 51,196,340 1,025,540 -- FHC Delaware Inc. ............. 784,457 -- -- 784,457 6,173,676 -- -- Florida East Coast Industries Inc. ....................... -- 4,423,071 -- 4,423,071 189,506,477 442,307 -- Florida East Coast Industries Inc., A ..................... 2,472,271 -- (2,472,271) -- -- 226,563 -- International Steel Group ..... 6,143,191 -- -- 6,143,191 236,709,436 -- -- Kindred Healthcare Inc. ....... 1,190,483 1,190,483 -- 2,380,966 67,744,435 -- -- Kindred Healthcare Inc., Jan. 9.07 Calls, 1/01/13 ......... -- 578 -- 578 12,066 -- -- Kindred Healthcare Inc., Jan. 26.00 Calls, 1/01/12 ........ 289 867 -- 1,156 4,566 -- -- Kindred Healthcare Inc., Jul. 23.75 Calls, 7/11/11 ........ 1,928 3,820 -- 5,748 35,638 -- -- Kindred Healthcare Inc., wts Series A, 4/20/06 ........... 211,977 -- -- 211,977 6,299,109 -- -- Kindred Healthcare Inc., wts Series B, 4/20/06 ........... 529,943 -- -- 529,943 13,895,105 -- -- Lancer Industries Inc., B ..... 3 -- -- 3 2,440,923 -- -- MBOP Liquidating Trust ........ 574,712 -- -- 574,712 1,437 -- -- Opti Canada ................... -- 9,695,676 -- 9,695,676 157,074,236 -- -- Southwest Royalties Inc., A ... 123,013 -- (123,013) -- -- -- 1,845,190
48 | Annual Report MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF SHARES/ NUMBER OF CONTRACTS/ SHARES/ WARRANTS CONTRACTS/ HELD AT WARRANTS VALUE AT REALIZED BEGINNING GROSS GROSS HELD AT END END OF INVESTMENT CAPITAL NAME OF ISSUER OF YEAR ADDITIONS REDUCTIONS OF YEAR YEAR INCOME GAIN/(LOSS) - ------------------------------------------------------------------------------------------------------------------------------------ NON-CONTROLLED AFFILIATES (CONTINUED) TVMAX Holdings Inc. ........... 128,831 256,772 (128,386) 257,217 $ 257,217 $ -- $ (10,554,291) TVMAX Holdings Inc., PIK, 11.50%, 2/01/05....................... -- 267,061 (2,574) 264,487 264,487 31,030 -- TVMAX Holdings Inc., PIK, 14.00%, 2/01/05....................... 594,256 801,294 (350,536) 1,045,014 1,045,014 89,879 -- White Mountains Insurance Group Inc. ......................... 472,190 271,958 (3,700) 740,448 478,329,408 472,190 589,919 White Mountains Insurance Group Inc. (Restricted)............. 265,658 -- (265,658) -- -- 265,658 -- ------------------------------------------- TOTAL NON-CONTROLLED AFFILIATES................................................... $1,426,737,418 $2,553,167 $ (8,111,449) =========================================== TOTAL AFFILIATED SECURITIES (11.51% OF NET ASSETS)................................ $1,426,737,418 $2,553,167 $ 316,632 ===========================================
(a) Issuer in which the Fund owns 25% or more of the outstanding voting securities. 12. OTHER CONSIDERATIONS Franklin Mutual, as the Fund's Manager, may serve as a member on the board of directors of certain companies in which the Fund invests and/or may represent the Fund in certain corporate negotiations. At December 31, 2004, the Manager serves in one or more of these capacities for Kindred Healthcare, AboveNet Inc, and Esmark Inc. As a result of this involvement, the Manager may be in possession of certain 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. Annual Report | 49 MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY MATTERS INVESTIGATIONS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, including the Securities and Exchange Commission ("SEC"), the California Attorney General's Office ("CAGO"), and the National Association of Securities Dealers, Inc. ("NASD"), relating to certain practices in the mutual fund industry, including late trading, market timing and marketing support payments to securities dealers who sell fund shares, Franklin Resources, Inc. and certain of its subsidiaries (as used in this section, together, the "Company"), as well as certain current or former executives and employees of the Company, received subpoenas and/or requests for documents, information and/or testimony. The Company and its current employees provided documents and information in response to those requests and subpoenas. SETTLEMENTS Beginning in August 2004, the Company entered into settlements with certain regulators investigating the mutual fund industry practices noted above. The Company believes that settlement of each of the matters described in this section is in the best interest of the Company and shareholders of the Franklin, Templeton, and Mutual Series mutual funds (the "funds"). On August 2, 2004, Franklin Resources, Inc. announced that its subsidiary, Franklin Advisers, Inc., reached an agreement with the SEC that resolved the issues resulting from the SEC investigation into market timing activity. In connection with that agreement, the SEC issued an "Order Instituting Administrative and Cease-and-Desist Proceedings Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940 and Sections 9(b) and 9(f) of the Investment Company Act of 1940, Making Findings and Imposing Remedial Sanctions and a Cease-and-Desist Order" (the "Order"). The SEC's Order concerned the activities of a limited number of third parties that ended in 2000 and those that were the subject of the first Massachusetts administrative complaint described below. Under the terms of the SEC's Order, pursuant to which Franklin Advisers, Inc. neither admitted nor denied any of the findings contained therein, Franklin Advisers, Inc. agreed to pay $50 million, of which $20 million is a civil penalty, to be distributed to shareholders of certain funds in accordance with a plan to be developed by an independent distribution consultant. At this time, it is unclear which funds or which shareholders of any particular fund will receive distributions. The Order also required Franklin Advisers, Inc. to, among other things, enhance and periodically review compliance policies and procedures. 50 | Annual Report MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY MATTERS (CONTINUED) SETTLEMENTS (CONTINUED) On September 20, 2004, Franklin Resources, Inc. announced that two of its subsidiaries, Franklin Advisers, Inc. and Franklin Templeton Alternative Strategies, Inc. ("FTAS"), reached an agreement with the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts (the "State of Massachusetts") related to its administrative complaint filed on February 4, 2004, concerning one instance of market timing that was also a subject of the August 2, 2004 settlement that Franklin Advisers, Inc. reached with the SEC, as described above. Under the terms of the settlement consent order issued by the State of Massachusetts, Franklin Advisers, Inc. and FTAS consented to the entry of a cease-and-desist order and agreed to pay a $5 million administrative fine to the State of Massachusetts (the "Massachusetts Consent Order"). The Massachusetts Consent Order included two different sections: "Statements of Fact" and "Violations of Massachusetts Securities Laws." Franklin Advisers, Inc. and FTAS admitted the facts in the Statements of Fact. On October 25, 2004, the State of Massachusetts filed a second administrative complaint, alleging that Franklin Resources, Inc.'s Form 8-K filing (in which it described the Massachusetts Consent Order and stated that "Franklin did not admit or deny engaging in any wrongdoing") failed to state that Franklin Advisers, Inc. and FTAS admitted the Statements of Fact portion of the Massachusetts Consent Order (the "Second Complaint"). Franklin Resources, Inc. reached a second agreement with the State of Massachusetts on November 19, 2004, resolving the Second Complaint. As a result of the November 19, 2004 settlement, Franklin Resources, Inc. filed a new Form 8-K. The terms of the Massachusetts Consent Order did not change and there was no monetary fine associated with this second settlement. On November 17, 2004, Franklin Resources, Inc. announced that Franklin/Templeton Distributors, Inc. ("FTDI") reached an agreement with the CAGO, resolving the issues resulting from the CAGO's investigation concerning sales and marketing support payments. Under the terms of the settlement, FTDI neither admitted nor denied the allegations in the CAGO's complaint and agreed to pay $2 million to the State of California as a civil penalty, $14 million to the funds, to be allocated by an independent distribution consultant to be paid for by FTDI, and $2 million to the CAGO for its investigative costs. Annual Report | 51 MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY MATTERS (CONTINUED) SETTLEMENTS (CONTINUED) On December 13, 2004, Franklin Resources, Inc. announced that its subsidiaries FTDI and Franklin Advisers, Inc. reached an agreement with the SEC, resolving the issues resulting from the SEC's investigation concerning marketing support payments to securities dealers who sell fund shares. In connection with that agreement, the SEC issued an "Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940, Sections 9(b) and 9(f) of the Investment Company Act of 1940, and Section 15(b) of the Securities Exchange Act of 1934" (the "Second Order"). Under the terms of the Second Order, in which FTDI and Franklin Advisers, Inc. neither admitted nor denied the findings contained therein, they agreed to pay the funds a penalty of $20 million and disgorgement of $1 (one dollar). FTDI and Franklin Advisers, Inc. also agreed to implement certain measures and undertakings relating to marketing support payments to broker-dealers for the promotion or sale of fund shares, including making additional disclosures in the funds' Prospectuses and Statements of Additional Information. The Second Order further requires the appointment of an independent distribution consultant, at the Company's expense, who shall develop a plan for the distribution of the penalty and disgorgement to the funds. OTHER LEGAL PROCEEDINGS The Fund, in addition to the Company and other funds, and certain current and former officers, employees, and directors have been named in multiple lawsuits in different federal courts in Nevada, California, Illinois, New York and Florida, alleging violations of various federal securities laws and seeking, among other relief, monetary damages, restitution, removal of fund trustees, directors, advisers, administrators, and distributors, rescission of management contracts and 12b-1 Plans, and/or attorneys' fees and costs. Specifically, the lawsuits claim breach of duty with respect to alleged arrangements to permit market timing and/or late trading activity, or breach of duty with respect to the valuation of the portfolio securities of certain Templeton funds managed by Franklin Resources, Inc. subsidiaries, resulting in alleged market timing activity. The majority of these lawsuits duplicate, in whole or in part, the allegations asserted in the February 4, 2004 Massachusetts administrative complaint and the findings in the SEC's August 2, 2004 Order, as described above. The lawsuits are styled as class actions, or derivative actions on behalf of either the named funds or Franklin Resources, Inc. 52 | Annual Report MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY MATTERS (CONTINUED) OTHER LEGAL PROCEEDINGS (CONTINUED) In addition, the Company, as well as certain current and former officers, employees, and directors, have been named in multiple lawsuits alleging violations of various securities laws and pendent state law claims relating to the disclosure of directed brokerage payments and/or payment of allegedly excessive advisory, commission, and distribution fees, and seeking, among other relief, monetary damages, restitution, rescission of advisory contracts, including recovery of all fees paid pursuant to those contracts, an accounting of all monies paid to the named advisers, declaratory relief, injunctive relief, and/or attorneys' fees and costs. These lawsuits are styled as class actions or derivative actions brought on behalf of certain funds. The Company and fund management strongly believes that the claims made in each of the lawsuits identified above are without merit and intends to vigorously defend against them. The Company cannot predict with certainty, however, the eventual outcome of the remaining governmental investigations or private lawsuits, nor whether they will have a material negative impact on the Company. Public trust and confidence are critical to the Company's business and any material loss of investor and/or client confidence could result in a significant decline in assets under management by the Company, which would have an adverse effect on the Company's future financial results. If it is determined that the Company bears responsibility for any unlawful or inappropriate conduct that caused losses to the Fund, it is committed to making the Fund or its shareholders whole, as appropriate. The Company is committed to taking all appropriate actions to protect the interests of its funds' shareholders. Annual Report | 53 MUTUAL SHARES FUND REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 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.) (the Fund), as of December 31, 2004, 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 the standards of the Public Company Accounting Oversight Board (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 consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Fund's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of December 31, 2004, by correspondence with the custodian and brokers or by other appropriate auditing procedures where replies from brokers were not received. 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, 2004, 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 U.S. generally accepted accounting principles. /s/ Ernst & Young LLP Boston, Massachusetts February 7, 2005 54 | Annual Report MUTUAL SHARES FUND TAX DESIGNATION (UNAUDITED) Under Section 852(b)(3)(C) of the Internal Revenue Code (Code), the Fund designated $236,869,804 as a capital gain dividend for the fiscal year ended December 31, 2004. Under Section 854(b)(2) of the Code, the Fund hereby designates up to a maximum of $159,353,843 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2004. In January 2005, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2004. 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 29.20% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2004. Annual Report | 55 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. 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. (63) 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; and Director, Stern School of Business M.B.A. Program. - ---------------------------------------------------------------------------------------------------------------------------- ANN TORRE GRANT (46) 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 (75) 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 (74) 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 (75) 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). - ----------------------------------------------------------------------------------------------------------------------------
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 - ---------------------------------------------------------------------------------------------------------------------------- CHARLES RUBENS II (74) Director Since 1998 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 - ---------------------------------------------------------------------------------------------------------------------------- PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. - ---------------------------------------------------------------------------------------------------------------------------- LEONARD RUBIN (79) 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 (58) Director Since 1991 12 Director, El Oro Mining and 51 John F. Kennedy Parkway Exploration Co., p.l.c. Short Hills, NJ 07078 - ---------------------------------------------------------------------------------------------------------------------------- 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 (79) 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 (65) 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, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. - ----------------------------------------------------------------------------------------------------------------------------
Annual Report | 57
- ---------------------------------------------------------------------------------------------------------------------------- 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 (42) Director, Director 7 None 51 John F. Kennedy Parkway President, since 2001, Short Hills, NJ 07078-2702 Chairman President of the since 1999, Board and Chairman of Chief the Board Executive and Chief Officer - Executive Investment Officer - Management Investment Management since 2002 - ---------------------------------------------------------------------------------------------------------------------------- PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Chief Investment Officer, and Chief Executive Officer, Franklin Mutual officer and/or director, as the case Advisers, LLC; and may be, of three of the investment companies in Franklin Templeton Investments. - ---------------------------------------------------------------------------------------------------------------------------- JAMES M. DAVIS (52) Chief Since July Not Applicable Not Applicable One Franklin Parkway Compliance 2004 San Mateo, CA 94403-1906 Officer - ---------------------------------------------------------------------------------------------------------------------------- PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Officer of 51 of the investment companies in Franklin Templeton Investments; Director, Global Compliance, Franklin Resources, Inc.; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - ---------------------------------------------------------------------------------------------------------------------------- JIMMY D. GAMBILL (57) Senior Since 2002 Not Applicable Not Applicable 500 East Broward Blvd. Vice Suite 2100 President Fort Lauderdale, and 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 (57) Vice President Since 2000 Not Applicable Not Applicable One Franklin Parkway San Mateo, CA 94403-1906 - ---------------------------------------------------------------------------------------------------------------------------- PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior 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). - ----------------------------------------------------------------------------------------------------------------------------
58 | Annual Report
- ---------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ---------------------------------------------------------------------------------------------------------------------------- BARBARA J. GREEN (57) Vice President Since 2000 Not Applicable Not Applicable 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). - ---------------------------------------------------------------------------------------------------------------------------- MICHAEL O. MAGDOL (67) Vice Since 2002 Not Applicable Not Applicable 600 Fifth Avenue President - Rockefeller Center AML Compliance New York, NY 10048-0772 - ---------------------------------------------------------------------------------------------------------------------------- PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice Chairman, Chief Banking Officer and Director, Fiduciary Trust Company FTI Banque, Arch Chemicals, Inc. and International; Director, Lingnan Foundation; 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. - ---------------------------------------------------------------------------------------------------------------------------- MICHAEL MORANTZ (35) Treasurer Since July Not Applicable Not Applicable 500 East Broward Blvd. 2004 Suite 2100 Fort Lauderdale, FL 33394-3091 - ---------------------------------------------------------------------------------------------------------------------------- PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; and officer of two of the investment companies in Franklin Templeton Investments. - ---------------------------------------------------------------------------------------------------------------------------- MURRAY L. SIMPSON (67) Vice President Since 2000 Not Applicable Not Applicable 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). - ----------------------------------------------------------------------------------------------------------------------------
Annual Report | 59
- ---------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN LENGTH OF FUND COMPLEX OVERSEEN NAME, AGE AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ---------------------------------------------------------------------------------------------------------------------------- GALEN G. VETTER (53) Chief Since May Not Applicable Not Applicable 500 East Broward Blvd. Financial 2004 Suite 2100 Officer and Fort Lauderdale, Chief FL 33394-3091 Accounting Officer - ---------------------------------------------------------------------------------------------------------------------------- PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Officer of 51 of the investment companies in Franklin Templeton Investments; Senior Vice President, Franklin Templeton Services, LLC; and FORMERLY, Managing Director, RSM McGladrey, Inc.; and Partner, McGladrey & Pullen, LLP. - ----------------------------------------------------------------------------------------------------------------------------
* 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 to be 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 to be 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 to be an interested person of Mutual Series under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC, Mutual Series' adviser. 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. 60 | Annual Report MUTUAL SHARES FUND SHAREHOLDER INFORMATION 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. Copies of the Fund's proxy voting records are also made available online at franklintempleton.com and posted on the Securities and Exchange Commission's website at sec.gov and reflect the 12-month period beginning July 1, 2003, and ending June 30, 2004. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the Securities and Exchange Commission for the first and third quarters for each fiscal year on Form N-Q. Shareholders may view the filed Form N-Q by visiting the Commission's website at sec.gov. The filed form may also be viewed and copied at the Commission's Public Reference Room in Washington, DC. Information regarding the operations of the Public Reference Room may be obtained by calling 1-800/SEC-0330. Annual Report | 61 This page intentionally left blank. This page intentionally left blank. This page intentionally left blank. LITERATURE REQUEST LITERATURE REQUEST. TO RECEIVE A BROCHURE AND PROSPECTUS, PLEASE CALL US AT 1-800/DIAL BEN(R) (1-800/342-5236) OR VISIT FRANKLINTEMPLETON.COM. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. 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 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(2) Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund(3) 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(4) 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 Technology Fund Franklin Utilities Fund Mutual Financial Services Fund ASSET ALLOCATION Franklin Templeton Corefolio Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives 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(5) Franklin's AGE High Income Fund Franklin Floating Rate Daily Access Fund Franklin Floating Rate Trust(3) Franklin Income Fund Franklin Limited Maturity U.S. Government Securities Fund(5),(6) Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund(5) Templeton Global Bond Fund TAX-FREE INCOME(7) NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(8) 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 Alabama Arizona California(9) Colorado Connecticut Florida(9) Georgia Kentucky Louisiana Maryland Massachusetts(8) Michigan(8) Minnesota(8) Missouri New Jersey New York(9) North Carolina Ohio(8) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(10) (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 and select retirement plans. (3) 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. (4) Upon reaching approximately $350 million in assets, the fund intends to close to all investors. (5) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (6) Formerly Franklin Short-Intermediate U.S. Government Securities Fund. Effective 9/1/04, the fund's name changed; its investment goal and strategy remained the same. (7) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (8) Portfolio of insured municipal securities. (9) These funds are available in two or more variations, including long-term portfolios, portfolios of insured securities, a high-yield portfolio (CA) and limited-term, intermediate-term and money market portfolios (CA and NY). (10) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 11/04 Not part of the annual report [LOGO](R) 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 SHARES FUND CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF INVESTMENT OFFICER David J. Winters, CFA 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) Authorized for distribution only when accompanied or preceded by a prospectus. Investors should carefully consider a fund's investment goals, risks, charges and expenses before investing. The prospectus contains this and other information; please read it carefully before investing. 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 A2004 02/05 MUTUAL FINANCIAL SERVICES FUND [GRAPHIC OMITTED] - -------------------------------------------------------------------------------- DECEMBER 31, 2004 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- ANNUAL REPORT AND SHAREHOLDER LETTER SECTOR - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- WANT TO RECEIVE THIS DOCUMENT FASTER VIA EMAIL? MUTUAL FINANCIAL SERVICES FUND Eligible shareholders can sign up for eDelivery at franklintempleton.com. See inside for details. - -------------------------------------------------------------------------------- [LOGO](R) 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 ............................................. 4 Performance Summary ........................................................ 9 Your Fund's Expenses ....................................................... 14 Financial Highlights and Statement of Investments .......................... 16 Financial Statements ....................................................... 23 Notes to Financial Statements .............................................. 27 Report of Independent Registered Public Accounting Firm .................... 40 Tax Designation ............................................................ 41 Board Members and Officers ................................................. 42 Shareholder Information .................................................... 47 - -------------------------------------------------------------------------------- ANNUAL REPORT MUTUAL FINANCIAL SERVICES FUND YOUR FUND'S GOALS AND MAIN 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, investment companies and insurance companies. - -------------------------------------------------------------------------------- PERFORMANCE DATA QUOTED REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. PLEASE VISIT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236 FOR MOST RECENT MONTH-END PERFORMANCE. - -------------------------------------------------------------------------------- We are pleased to bring you Mutual Financial Services Fund's annual report covering the fiscal year ended December 31, 2004. PERFORMANCE OVERVIEW Mutual Financial Services Fund - Class Z posted a 15.62% cumulative total return for the 12 months ended December 31, 2004. The Fund outperformed its benchmarks, the Standard & Poor's 500 Composite Index (S&P 500) and S&P 500 Financials Index, which returned 10.87% and 10.89% for the same period.(1) You can find the Fund's long-term performance data in the Performance Summary beginning on page 9. ECONOMIC AND MARKET OVERVIEW During the year ended December 31, 2004, the domestic economy expanded solidly and broadly across most industries, sectors and regions as gross domestic product (GDP) rose an estimated 4.4%.(2) However, surging energy and other commodity prices had a dampening effect. Although consumer confidence remained below pre-recession levels, consumer spending supported strong auto sales, increased durable goods consumption and a healthy housing (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 are unmanaged and include reinvested dividends. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. (2) Source: Bureau of Economic Analysis. THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND NAMES OF ALL PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE SOI BEGINS ON PAGE 20. 4 | Annual Report market. Similarly, business spending rose substantially even as business confidence wavered. The labor market firmed as employers hired 2.2 million workers in 2004, and unemployment dropped from 5.7% to 5.4% during the year.(3) The U.S. dollar weakened throughout 2004 and hit an all-time low against the euro and a multi-year low versus the yen. The widening trade and current account deficits and possibility for higher import prices contributed to inflationary pressures. The core inflation rate rose 2.2% in 2004, or 3.3% including volatile food and energy costs. Aiming to keep inflation tame, the Federal Reserve Board raised the federal funds target rate five times between June and December, from 1.00% to 2.25%, the highest level in more than three years. Domestic equity markets rallied in early 2004 and then fluctuated; however, they were essentially flat through early November. After the elections concluded, the markets enjoyed another strong rally through year-end. The blue chip stocks of the Dow Jones Industrial Average gained 5.31% for the year under review, while the broader S&P 500 rose 10.87% and the technology-heavy NASDAQ Composite Index increased 9.15%.(4) Outside the U.S., the global economic recovery continued in 2004, led by growth in China. The 12-nation euro zone lagged other regions in the current recovery. However, the European Central Bank projected euro zone growth may be between 1.6% and 2.0% in 2004, compared with only 0.5% in 2003. In Japan, the economy struggled to emerge from a decade-long deflationary period. Although the country's consumer and business confidence reached their highest levels since 1991, economic growth slowed in response to higher oil prices and reduced external demand. The U.S. dollar decline hurt Japanese and European exports to the U.S., as it made their goods more expensive in the world's biggest market. For the 12-month period ended December 31, 2004, the Morgan Stanley Capital International (MSCI) World Index's total return was 15.25% in U.S. dollars.(5) In local currencies, the index had a notably lower total return of 11.83% for the same period.(5) During the period, most of the world's currencies strengthened in relation to the U.S. dollar, which benefited U.S.-based investors of non-U.S. equities. (3) Source: Bureau of Labor Statistics. (4) Source: Standard & Poor's Micropal. The Dow Jones Industrial Average is price weighted based on the average market price of 30 blue chip stocks of companies that are generally industry leaders. See footnote 1 for a description of the S&P 500. The NASDAQ Composite Index measures all domestic and international common stocks listed on The NASDAQ Stock Market. The index is market value weighted and includes over 3,000 companies. (5) Source: Standard & Poor's Micropal. The MSCI World Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in global developed markets. PORTFOLIO BREAKDOWN Based On Total Net Assets as of 12/31/04 [THE FOLLOWING TABLE WAS REPRESENTED AS A BAR GRAPH IN THE PRINTED MATERIAL.] Insurance 23.7% Commercial Banks 19.3% Real Estate 18.4% Government Agencies 16.9% Thrifts & Mortgage Finance 9.7% Capital Markets 5.9% Diversified Financial Services 3.9% Commercial Services & Supplies 1.0% Other Net Assets 1.2% Annual Report | 5 - -------------------------------------------------------------------------------- WHAT IS RETURN ON EQUITY? Return on equity is an amount, expressed as a percentage, earned on a company's common stock investment for a given period. It is calculated by dividing common stock equity (net worth) at the beginning of the accounting period into net income for the period after preferred stock dividends but before common stock dividends. Return on equity tells common shareholders how effectually their money is being employed. Comparing percentages for current and prior periods also reveals trends, and comparison with industry composites reveals how well a company is holding its own against its competitors. - -------------------------------------------------------------------------------- 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 determine each investment's intrinsic value as well as the price at which we would be willing to 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 During the Fund's fiscal year, some of the biggest contributors to performance were Saxon Capital, White Mountains Insurance Group and Safety Insurance Group. The Fund's investment in Saxon Capital, a residential mortgage finance company, highlights the flexibility of our approach and our goal of finding attractive long-term investments. 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 has transitioned to public ownership, improved its competitive position, benefited from a positive residential mortgage finance market, and appreciated significantly in 2004 and more than doubled in value since our initial purchase. The strong management team at White Mountains has created substantial shareholder value by consistently making prudent, return-driven capital allocation decisions. Highlighting management's disciplined underwriting strategy and attention to risk, the company reported solid underwriting results for 2004, despite a record level of industry-wide insurance claims from the dramatic 2004 hurricane season. The company's stock appreciated about 41% during the reporting period. Safety Insurance Group, a Massachusetts auto and homeowners insurance company, was also a top performer for the Fund. Safety's shares increased more than 86% during 2004 and have increased about 150% since our initial investment in November 2002. The company benefited from insurance premium rate increases, as well as disciplined underwriting and expense management in the difficult and unique Massachusetts auto insurance market. 6 | Annual Report In general, if the value of the U.S. dollar goes up compared with a foreign currency, an investment traded in that foreign currency will go down in value because it will be worth fewer U.S. dollars. This can have a negative effect on Fund performance. Conversely, when the U.S. dollar weakens in relation to a foreign currency, an investment traded in that foreign currency will increase in value, which can contribute to Fund performance. At Mutual Series, we typically seek to hedge (protect) against currency risk, which can reduce or eliminate the positive or negative effect on Fund performance of holding investments denominated in currencies other than the U.S. dollar. In 2004, we remained less than fully hedged in foreign currencies allowing shareholders to benefit from a declining U.S. dollar. However, one cannot expect the same result in future periods. Some holdings detracted from performance, as not all of the Fund's investments lived up to our expectations. Our investment in Falcon Financial, a lender to the auto-dealer community, declined after the company announced disappointing loan origination levels in early 2004. We believed Falcon's business model remained attractive, and consistent with our strategy, we utilized the share price decline as an opportunity to increase the Fund's investment in Falcon shares. Our investment in Integrated Alarm Services Group, which buys residential and commercial alarm contracts, underperformed as investors seemed to lose confidence in the company's sales and earnings targets. After reassessing the company's prospects following first quarter results, we added to the Fund's position at a reduced price, demonstrating our belief in the company's business model. Sovereign Bancorp declined during 2004 after some investors were disappointed that the company continued to expand its northeast U.S. banking franchise through acquisitions rather than focusing on improving the company's core profitability. However, we believe Sovereign Bancorp's management has created one of the premier banking franchises in the northeast U.S., and may be a prime acquisition candidate. TOP 10 HOLDINGS 12/31/04 - -------------------------------------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - -------------------------------------------------------------------------------- White Mountains Insurance Group Inc. 3.8% INSURANCE, U.S. - -------------------------------------------------------------------------------- Allied Irish Banks PLC 3.5% COMMERCIAL BANKS, IRISH REPUBLIC - -------------------------------------------------------------------------------- iStar Financial Inc., common & preferred 3.1% REAL ESTATE, U.S. - -------------------------------------------------------------------------------- Sovereign Bancorp Inc. 3.1% THRIFTS & MORTGAGE FINANCE, U.S. - -------------------------------------------------------------------------------- Saxon Capital Inc. 3.1% REAL ESTATE, U.S. - -------------------------------------------------------------------------------- Old Republic International Corp. 2.2% INSURANCE, U.S. - -------------------------------------------------------------------------------- Bank of Ireland 2.2% COMMERCIAL BANKS, IRISH REPUBLIC - -------------------------------------------------------------------------------- Euronext 2.2% DIVERSIFIED FINANCIAL SERVICES, NETHERLANDS - -------------------------------------------------------------------------------- State National Bancshares Inc. 2.2% COMMERCIAL BANKS, U.S. - -------------------------------------------------------------------------------- First Community Bancorp 2.1% COMMERCIAL BANKS, U.S. - -------------------------------------------------------------------------------- Annual Report | 7 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 Portfolio Manager [PHOTO OMITTED] /s/ Charles M. Lahr Charles M. Lahr, CFA Assistant Portfolio Manager Mutual Financial Services Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2004, 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 ADVISER 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. - -------------------------------------------------------------------------------- CHARLES M. LAHR Charles Lahr is an assistant portfolio manager for Mutual Beacon Fund and Mutual Financial Services Fund. He is also an analyst for Franklin Mutual Advisers, LLC (Mutual Series). Mr. Lahr specializes in the analysis of foreign equities and focuses on non-U.S. financial services companies. Prior to joining Mutual Series in 2003, Mr. Lahr was an international equities research analyst for the State of Wisconsin Investment Board. He has 11 years of experience in the financial services industry. Mr. Lahr received a bachelor's of business administration in finance and investments as well as an M.B.A. from the University of Iowa. He is also a CFA charterholder and a member of the New York Society of Security Analysts. - -------------------------------------------------------------------------------- 8 | Annual Report PERFORMANCE SUMMARY AS OF 12/31/04 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 reinvestment of the Fund's dividends and capital gain distributions, if any, and any unrealized gains or losses. PRICE AND DISTRIBUTION INFORMATION - --------------------------------------------------------------------------- CLASS Z CHANGE 12/31/04 12/31/03 - --------------------------------------------------------------------------- Net Asset Value (NAV) +$0.39 $ 20.45 $ 20.06 - --------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - --------------------------------------------------------------------------- Dividend Income $ 0.3181 - --------------------------------------------------------------------------- Short-Term Capital Gain $ 0.6092 - --------------------------------------------------------------------------- Long-Term Capital Gain $ 1.7198 - --------------------------------------------------------------------------- Total $ 2.6471 - --------------------------------------------------------------------------- CLASS A CHANGE 12/31/04 12/31/03 - --------------------------------------------------------------------------- Net Asset Value (NAV) +$0.39 $ 20.47 $ 20.08 - --------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - --------------------------------------------------------------------------- Dividend Income $ 0.2462 - --------------------------------------------------------------------------- Short-Term Capital Gain $ 0.6092 - --------------------------------------------------------------------------- Long-Term Capital Gain $ 1.7198 - --------------------------------------------------------------------------- Total $ 2.5752 - --------------------------------------------------------------------------- CLASS B CHANGE 12/31/04 12/31/03 - --------------------------------------------------------------------------- Net Asset Value (NAV) +$0.33 $ 20.09 $ 19.76 - --------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - --------------------------------------------------------------------------- Dividend Income $ 0.1203 - --------------------------------------------------------------------------- Short-Term Capital Gain $ 0.6092 - --------------------------------------------------------------------------- Long-Term Capital Gain $ 1.7198 - --------------------------------------------------------------------------- Total $ 2.4493 - --------------------------------------------------------------------------- CLASS C CHANGE 12/31/04 12/31/03 - --------------------------------------------------------------------------- Net Asset Value (NAV) +$0.37 $ 20.39 $ 20.02 - --------------------------------------------------------------------------- DISTRIBUTIONS (1/1/04-12/31/04) - --------------------------------------------------------------------------- Dividend Income $ 0.1082 - --------------------------------------------------------------------------- Short-Term Capital Gain $ 0.6092 - --------------------------------------------------------------------------- Long-Term Capital Gain $ 1.7198 - --------------------------------------------------------------------------- Total $ 2.4372 - --------------------------------------------------------------------------- Mutual Financial Services Fund paid distributions derived from long-term capital gains totaling $1.7198 per share in June and December 2004. The Fund designated such distributions as capital gain dividends per Internal Revenue Code Section 852 (b)(3). Annual Report | 9 PERFORMANCE SUMMARY (CONTINUED) PERFORMANCE(1) CLASS A: 5.75% MAXIMUM INITIAL SALES CHARGE; CLASS B: CONTINGENT DEFERRED SALES CHARGE (CDSC) DECLINING FROM 4% TO 1% OVER SIX YEARS, AND ELIMINATED THEREAFTER; CLASS C: 1% CDSC IN FIRST YEAR ONLY. CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES. - ---------------------------------------------------------------------------- CLASS Z 1-YEAR 5-YEAR INCEPTION (8/19/97) - ---------------------------------------------------------------------------- Cumulative Total Return(2) 15.62% 123.13% 210.25% - ---------------------------------------------------------------------------- Average Annual Total Return(3) 15.62% 17.41% 16.61% - ---------------------------------------------------------------------------- Value of $10,000 Investment(4) $ 11,562 $22,313 $31,025 - ---------------------------------------------------------------------------- CLASS A 1-YEAR 5-YEAR INCEPTION (8/19/97) - ---------------------------------------------------------------------------- Cumulative Total Return(2) 15.17% 119.27% 202.89% - ---------------------------------------------------------------------------- Average Annual Total Return(3) 8.53% 15.62% 15.30% - ---------------------------------------------------------------------------- Value of $10,000 Investment(4) $ 10,853 $20,663 $28,548 - ---------------------------------------------------------------------------- CLASS B 1-YEAR 5-YEAR INCEPTION (1/1/99) - ---------------------------------------------------------------------------- Cumulative Total Return(2) 14.51% 112.32% 120.15% - ---------------------------------------------------------------------------- Average Annual Total Return(3) 10.51% 16.03% 13.98% - ---------------------------------------------------------------------------- Value of $10,000 Investment(4) $ 11,051 $21,032 $21,915 - ---------------------------------------------------------------------------- CLASS C 1-YEAR 5-YEAR INCEPTION (8/19/97) - ---------------------------------------------------------------------------- Cumulative Total Return(2) 14.46% 112.32% 188.89% - ---------------------------------------------------------------------------- Average Annual Total Return(3) 13.46% 16.25% 15.49% - ---------------------------------------------------------------------------- Value of $10,000 Investment(4) $ 11,346 $21,232 $28,889 - ---------------------------------------------------------------------------- PERFORMANCE DATA QUOTED REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM FIGURES SHOWN. FOR MOST RECENT MONTH-END PERFORMANCE, SEE "FUNDS AND PERFORMANCE" AT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236. 10 | 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 any current, applicable, maximum sales charge, Fund expenses, account fees and reinvested distributions. The unmanaged indexes include reinvestment of any income or distributions. They differ from the Fund in composition and do not pay management fees or expenses. One cannot invest directly in an index. [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual Financial Services Fund - Class Z, as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 5 and the S&P 500 Financials Index 5 from 8/19/97-12/31/03. CLASS Z (8/19/97-12/31/04) MUTUAL FINANCIAL S&P S&P 500 FINANCIALS DATE SERVICES FUND 500(5) INDEX(5) ---------- ------------------ ------ ------------------ 8/19/1997 $10,000 $10,000 $10,000 8/31/1997 $10,080 $ 9,783 $ 9,711 9/30/1997 $11,270 $10,319 $10,495 10/31/1997 $11,590 $ 9,975 $10,277 11/30/1997 $11,770 $10,436 $10,683 12/31/1997 $12,402 $10,615 $11,219 1/31/1998 $12,523 $10,732 $10,899 2/28/1998 $13,756 $11,506 $11,924 3/31/1998 $14,553 $12,095 $12,604 4/30/1998 $14,937 $12,216 $12,812 5/31/1998 $14,614 $12,007 $12,504 6/30/1998 $14,442 $12,494 $13,028 7/31/1998 $14,398 $12,361 $13,030 8/31/1998 $11,634 $10,576 $10,025 9/30/1998 $11,879 $11,253 $10,227 10/31/1998 $12,399 $12,168 $11,467 11/30/1998 $12,950 $12,905 $12,249 12/31/1998 $13,281 $13,648 $12,501 1/31/1999 $13,239 $14,219 $12,766 2/28/1999 $12,971 $13,777 $12,937 3/31/1999 $13,291 $14,328 $13,432 4/30/1999 $14,138 $14,883 $14,342 5/31/1999 $14,313 $14,532 $13,546 6/30/1999 $14,965 $15,338 $14,106 7/31/1999 $14,809 $14,860 $13,230 8/31/1999 $14,114 $14,786 $12,622 9/30/1999 $13,937 $14,381 $11,966 10/31/1999 $14,954 $15,291 $13,963 11/30/1999 $14,643 $15,602 $13,278 12/31/1999 $13,904 $16,520 $13,016 1/31/2000 $13,041 $15,690 $12,604 2/29/2000 $11,955 $15,393 $11,239 3/31/2000 $13,659 $16,898 $13,325 4/30/2000 $13,553 $16,390 $12,905 5/31/2000 $14,416 $16,055 $13,771 6/30/2000 $14,051 $16,451 $12,936 7/31/2000 $14,956 $16,194 $14,273 8/31/2000 $16,100 $17,199 $15,643 9/30/2000 $17,179 $16,291 $16,015 10/31/2000 $17,038 $16,222 $15,945 11/30/2000 $16,536 $14,944 $15,005 12/31/2000 $18,394 $15,017 $16,360 1/31/2001 $18,631 $15,550 $16,315 2/28/2001 $18,687 $14,133 $15,244 3/31/2001 $18,811 $13,238 $14,784 4/30/2001 $19,600 $14,266 $15,335 5/31/2001 $20,457 $14,362 $15,953 6/30/2001 $20,981 $14,012 $15,947 7/31/2001 $21,245 $13,874 $15,689 8/31/2001 $21,085 $13,007 $14,733 9/30/2001 $19,419 $11,956 $13,863 10/31/2001 $19,224 $12,184 $13,606 11/30/2001 $20,062 $13,119 $14,577 12/31/2001 $20,660 $13,234 $14,896 1/31/2002 $21,057 $13,041 $14,663 2/28/2002 $21,193 $12,789 $14,450 3/31/2002 $22,410 $13,270 $15,411 4/30/2002 $23,081 $12,466 $15,000 5/31/2002 $23,254 $12,375 $14,975 6/30/2002 $22,378 $11,493 $14,264 7/31/2002 $21,273 $10,598 $13,133 8/31/2002 $21,705 $10,667 $13,401 9/30/2002 $19,940 $9,509 $11,834 10/31/2002 $20,473 $10,345 $12,905 11/30/2002 $20,676 $10,953 $13,435 12/31/2002 $20,604 $10,310 $12,715 1/31/2003 $20,371 $10,041 $12,503 2/28/2003 $19,944 $ 9,890 $12,113 3/31/2003 $20,125 $ 9,985 $12,065 4/30/2003 $21,510 $10,808 $13,543 5/31/2003 $22,727 $11,376 $14,259 6/30/2003 $22,805 $11,522 $14,295 7/31/2003 $23,505 $11,725 $14,951 8/31/2003 $23,907 $11,953 $14,800 9/30/2003 $23,855 $11,827 $14,899 10/31/2003 $25,281 $12,495 $15,925 11/30/2003 $25,800 $12,605 $15,881 12/31/2003 $26,832 $13,266 $16,661 1/31/2004 $27,675 $13,509 $17,192 2/29/2004 $28,077 $13,697 $17,647 3/31/2004 $28,184 $13,490 $17,473 4/30/2004 $27,127 $13,279 $16,667 5/31/2004 $27,287 $13,461 $16,974 6/30/2004 $27,638 $13,722 $17,058 7/31/2004 $27,270 $13,268 $16,708 8/31/2004 $27,624 $13,322 $17,270 9/30/2004 $28,428 $13,466 $17,122 10/31/2004 $28,482 $13,671 $17,209 11/30/2004 $30,077 $14,225 $17,718 12/31/2004 $31,025 $14,708 $18,476 AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------- CLASS Z 12/31/04 - -------------------------------------------- 1-Year 15.62% - -------------------------------------------- 5-Year 17.41% - -------------------------------------------- Since Inception (8/19/97) 16.61% - -------------------------------------------- [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual Financial Services Fund - Class A, as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 5 and the S&P 500 Financials Index5 from 8/19/97-12/31/03. CLASS A (8/19/97-12/31/04) MUTUAL FINANCIAL S&P S&P 500 FINANCIALS DATE SERVICES FUND 500(5) INDEX(5) ---------- ------------------ ------ ------------------ 8/19/1997 $ 9,425 $10,000 $10,000 8/31/1997 $ 9,500 $ 9,783 $ 9,711 9/30/1997 $10,622 $10,319 $10,495 10/31/1997 $10,924 $ 9,975 $10,277 11/30/1997 $11,093 $10,436 $10,683 12/31/1997 $11,681 $10,615 $11,219 1/31/1998 $11,795 $10,732 $10,899 2/28/1998 $12,955 $11,506 $11,924 3/31/1998 $13,716 $12,095 $12,604 4/30/1998 $14,068 $12,216 $12,812 5/31/1998 $13,764 $12,007 $12,504 6/30/1998 $13,593 $12,494 $13,028 7/31/1998 $13,554 $12,361 $13,030 8/31/1998 $10,953 $10,576 $10,025 9/30/1998 $11,173 $11,253 $10,227 10/31/1998 $11,653 $12,168 $11,467 11/30/1998 $12,172 $12,905 $12,249 12/31/1998 $12,476 $13,648 $12,501 1/31/1999 $12,437 $14,219 $12,766 2/28/1999 $12,185 $13,777 $12,937 3/31/1999 $12,476 $14,328 $13,432 4/30/1999 $13,271 $14,883 $14,342 5/31/1999 $13,436 $14,532 $13,546 6/30/1999 $14,035 $15,338 $14,106 7/31/1999 $13,889 $14,860 $13,230 8/31/1999 $13,236 $14,786 $12,622 9/30/1999 $13,061 $14,381 $11,966 10/31/1999 $14,005 $15,291 $13,963 11/30/1999 $13,713 $15,602 $13,278 12/31/1999 $13,019 $16,520 $13,016 1/31/2000 $12,212 $15,690 $12,604 2/29/2000 $11,186 $15,393 $11,239 3/31/2000 $12,780 $16,898 $13,325 4/30/2000 $12,681 $16,390 $12,905 5/31/2000 $13,478 $16,055 $13,771 6/30/2000 $13,135 $16,451 $12,936 7/31/2000 $13,981 $16,194 $14,273 8/31/2000 $15,040 $17,199 $15,643 9/30/2000 $16,037 $16,291 $16,015 10/31/2000 $15,905 $16,222 $15,945 11/30/2000 $15,426 $14,944 $15,005 12/31/2000 $17,172 $15,017 $16,360 1/31/2001 $17,382 $15,550 $16,315 2/28/2001 $17,424 $14,133 $15,244 3/31/2001 $17,540 $13,238 $14,784 4/30/2001 $18,264 $14,266 $15,335 5/31/2001 $19,062 $14,362 $15,953 6/30/2001 $19,535 $14,012 $15,947 7/31/2001 $19,781 $13,874 $15,689 8/31/2001 $19,621 $13,007 $14,733 9/30/2001 $18,069 $11,956 $13,863 10/31/2001 $17,888 $12,184 $13,606 11/30/2001 $18,658 $13,119 $14,577 12/31/2001 $19,206 $13,234 $14,896 1/31/2002 $19,575 $13,041 $14,663 2/28/2002 $19,702 $12,789 $14,450 3/31/2002 $20,820 $13,270 $15,411 4/30/2002 $21,431 $12,466 $15,000 5/31/2002 $21,593 $12,375 $14,975 6/30/2002 $20,774 $11,493 $14,264 7/31/2002 $19,748 $10,598 $13,133 8/31/2002 $20,137 $10,667 $13,401 9/30/2002 $18,499 $ 9,509 $11,834 10/31/2002 $18,982 $10,345 $12,905 11/30/2002 $19,171 $10,953 $13,435 12/31/2002 $19,097 $10,310 $12,715 1/31/2003 $18,870 $10,041 $12,503 2/28/2003 $18,475 $ 9,890 $12,113 3/31/2003 $18,630 $ 9,985 $12,065 4/30/2003 $19,911 $10,808 $13,543 5/31/2003 $21,025 $11,376 $14,259 6/30/2003 $21,104 $11,522 $14,295 7/31/2003 $21,739 $11,725 $14,951 8/31/2003 $22,111 $11,953 $14,800 9/30/2003 $22,051 $11,827 $14,899 10/31/2003 $23,358 $12,495 $15,925 11/30/2003 $23,826 $12,605 $15,881 12/31/2003 $24,787 $13,266 $16,661 1/31/2004 $25,552 $13,509 $17,192 2/29/2004 $25,910 $13,697 $17,647 3/31/2004 $26,009 $13,490 $17,473 4/30/2004 $25,022 $13,279 $16,667 5/31/2004 $25,157 $13,461 $16,974 6/30/2004 $25,472 $13,722 $17,058 7/31/2004 $25,133 $13,268 $16,708 8/31/2004 $25,447 $13,322 $17,270 9/30/2004 $26,188 $13,466 $17,122 10/31/2004 $26,226 $13,671 $17,209 11/30/2004 $27,684 $14,225 $17,718 12/31/2004 $28,548 $14,708 $18,476 AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------- CLASS A 12/31/04 - -------------------------------------------- 1-Year 8.53% - -------------------------------------------- 5-Year 15.62% - -------------------------------------------- Since Inception (8/19/97) 15.30% - -------------------------------------------- Annual Report | 11 PERFORMANCE SUMMARY (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------- CLASS B 12/31/04 - -------------------------------------------- 1-Year 10.51% - -------------------------------------------- 5-Year 16.03% - -------------------------------------------- Since Inception (1/1/99) 13.98% - -------------------------------------------- [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual Financial Services Fund - Class B, as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 5 and the S&P 500 Financials Index5 from 1/1/99-12/31/03. CLASS B (1/1/99-12/31/04) MUTUAL FINANCIAL S&P S&P 500 FINANCIALS DATE SERVICES FUND 500(5) INDEX(5) ---------- ------------------ ------ ------------------ 1/1/1999 $10,000 $10,000 $10,000 1/31/1999 $ 9,961 $10,418 $10,212 2/28/1999 $ 9,759 $10,094 $10,349 3/31/1999 $ 9,984 $10,498 $10,745 4/30/1999 $10,614 $10,905 $11,473 5/31/1999 $10,738 $10,647 $10,836 6/30/1999 $11,215 $11,238 $11,285 7/31/1999 $11,090 $10,887 $10,583 8/31/1999 $10,559 $10,834 $10,097 9/30/1999 $10,419 $10,537 $ 9,573 10/31/1999 $11,168 $11,203 $11,170 11/30/1999 $10,926 $11,431 $10,622 12/31/1999 $10,369 $12,104 $10,412 1/31/2000 $ 9,722 $11,496 $10,082 2/29/2000 $ 8,901 $11,279 $ 8,991 3/31/2000 $10,161 $12,381 $10,659 4/30/2000 $10,073 $12,009 $10,324 5/31/2000 $10,711 $11,763 $11,016 6/30/2000 $10,424 $12,053 $10,348 7/31/2000 $11,092 $11,865 $11,417 8/31/2000 $11,924 $12,601 $12,514 9/30/2000 $12,714 $11,936 $12,811 10/31/2000 $12,600 $11,886 $12,755 11/30/2000 $12,217 $10,949 $12,003 12/31/2000 $13,583 $11,003 $13,088 1/31/2001 $13,751 $11,393 $13,052 2/28/2001 $13,776 $10,355 $12,194 3/31/2001 $13,851 $ 9,699 $11,827 4/30/2001 $14,421 $10,453 $12,267 5/31/2001 $15,041 $10,523 $12,762 6/30/2001 $15,414 $10,267 $12,757 7/31/2001 $15,593 $10,166 $12,550 8/31/2001 $15,457 $ 9,530 $11,786 9/30/2001 $14,228 $ 8,760 $11,090 10/31/2001 $14,074 $ 8,927 $10,884 11/30/2001 $14,672 $ 9,612 $11,661 12/31/2001 $15,099 $ 9,696 $11,916 1/31/2002 $15,384 $ 9,555 $11,730 2/28/2002 $15,466 $ 9,371 $11,560 3/31/2002 $16,346 $ 9,723 $12,328 4/30/2002 $16,814 $ 9,134 $11,999 5/31/2002 $16,924 $ 9,067 $11,979 6/30/2002 $16,277 $ 8,421 $11,410 7/31/2002 $15,461 $ 7,765 $10,506 8/31/2002 $15,761 $ 7,816 $10,720 9/30/2002 $14,467 $ 6,967 $ 9,467 10/31/2002 $14,833 $ 7,580 $10,323 11/30/2002 $14,974 $ 8,025 $10,748 12/31/2002 $14,917 $ 7,554 $10,172 1/31/2003 $14,727 $ 7,357 $10,002 2/28/2003 $14,414 $ 7,246 $ 9,689 3/31/2003 $14,528 $ 7,316 $ 9,652 4/30/2003 $15,524 $ 7,919 $10,834 5/31/2003 $16,377 $ 8,335 $11,407 6/30/2003 $16,423 $ 8,442 $11,435 7/31/2003 $16,916 $ 8,591 $11,960 8/31/2003 $17,192 $ 8,758 $11,839 9/30/2003 $17,135 $ 8,665 $11,918 10/31/2003 $18,151 $ 9,155 $12,739 11/30/2003 $18,502 $ 9,236 $12,704 12/31/2003 $19,225 $ 9,720 $13,328 1/31/2004 $19,819 $ 9,898 $13,753 2/29/2004 $20,082 $10,036 $14,117 3/31/2004 $20,150 $ 9,884 $13,978 4/30/2004 $19,381 $ 9,729 $13,333 5/31/2004 $19,478 $ 9,863 $13,578 6/30/2004 $19,707 $10,054 $13,645 7/31/2004 $19,430 $ 9,722 $13,366 8/31/2004 $19,667 $ 9,761 $13,815 9/30/2004 $20,222 $ 9,866 $13,697 10/31/2004 $20,242 $10,017 $13,767 11/30/2004 $21,362 $10,422 $14,174 12/31/2004 $21,915 $10,777 $14,780 AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------- CLASS C 12/31/04 - -------------------------------------------- 1-Year 13.46% - -------------------------------------------- 5-Year 16.25% - -------------------------------------------- Since Inception (8/19/97) 15.49% - -------------------------------------------- [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] This graph compares the performance of Mutual Financial Services Fund - Class C, as tracked by the growth in value of a $10,000 investment, to that of the S&P 500 5 and the S&P 500 Financials Index 5 from 8/19/97-12/31/03. CLASS C (8/19/97-12/31/04) MUTUAL FINANCIAL S&P S&P 500 FINANCIALS DATE SERVICES FUND 500(5) INDEX(5) ---------- ------------------ ------ ------------------ 8/19/1997 $10,000 $10,000 $10,000 8/31/1997 $10,080 $ 9,783 $ 9,711 9/30/1997 $11,270 $10,319 $10,495 10/31/1997 $11,570 $ 9,975 $10,277 11/30/1997 $11,750 $10,436 $10,683 12/31/1997 $12,367 $10,615 $11,219 1/31/1998 $12,488 $10,732 $10,899 2/28/1998 $13,697 $11,506 $11,924 3/31/1998 $14,484 $12,095 $12,604 4/30/1998 $14,856 $12,216 $12,812 5/31/1998 $14,524 $12,007 $12,504 6/30/1998 $14,342 $12,494 $13,028 7/31/1998 $14,283 $12,361 $13,030 8/31/1998 $11,538 $10,576 $10,025 9/30/1998 $11,772 $11,253 $10,227 10/31/1998 $12,270 $12,168 $11,467 11/30/1998 $12,809 $12,905 $12,249 12/31/1998 $13,124 $13,648 $12,501 1/31/1999 $13,073 $14,219 $12,766 2/28/1999 $12,807 $13,777 $12,937 3/31/1999 $13,104 $14,328 $13,432 4/30/1999 $13,921 $14,883 $14,342 5/31/1999 $14,095 $14,532 $13,546 6/30/1999 $14,723 $15,338 $14,106 7/31/1999 $14,549 $14,860 $13,230 8/31/1999 $13,863 $14,786 $12,622 9/30/1999 $13,668 $14,381 $11,966 10/31/1999 $14,662 $15,291 $13,963 11/30/1999 $14,344 $15,602 $13,278 12/31/1999 $13,606 $16,520 $13,016 1/31/2000 $12,751 $15,690 $12,604 2/29/2000 $11,677 $15,393 $11,239 3/31/2000 $13,335 $16,898 $13,325 4/30/2000 $13,220 $16,390 $12,905 5/31/2000 $14,054 $16,055 $13,771 6/30/2000 $13,685 $16,451 $12,936 7/31/2000 $14,558 $16,194 $14,273 8/31/2000 $15,654 $17,199 $15,643 9/30/2000 $16,686 $16,291 $16,015 10/31/2000 $16,537 $16,222 $15,945 11/30/2000 $16,037 $14,944 $15,005 12/31/2000 $17,835 $15,017 $16,360 1/31/2001 $18,043 $15,550 $16,315 2/28/2001 $18,086 $14,133 $15,244 3/31/2001 $18,185 $13,238 $14,784 4/30/2001 $18,928 $14,266 $15,335 5/31/2001 $19,747 $14,362 $15,953 6/30/2001 $20,227 $14,012 $15,947 7/31/2001 $20,472 $13,874 $15,689 8/31/2001 $20,294 $13,007 $14,733 9/30/2001 $18,681 $11,956 $13,863 10/31/2001 $18,480 $12,184 $13,606 11/30/2001 $19,270 $13,119 $14,577 12/31/2001 $19,824 $13,234 $14,896 1/31/2002 $20,193 $13,041 $14,663 2/28/2002 $20,300 $12,789 $14,450 3/31/2002 $21,457 $13,270 $15,411 4/30/2002 $22,077 $12,466 $15,000 5/31/2002 $22,220 $12,375 $14,975 6/30/2002 $21,376 $11,493 $14,264 7/31/2002 $20,304 $10,598 $13,133 8/31/2002 $20,694 $10,667 $13,401 9/30/2002 $19,000 $ 9,509 $11,834 10/31/2002 $19,475 $10,345 $12,905 11/30/2002 $19,658 $10,953 $13,435 12/31/2002 $19,585 $10,310 $12,715 1/31/2003 $19,339 $10,041 $12,503 2/28/2003 $18,921 $ 9,890 $12,113 3/31/2003 $19,080 $ 9,985 $12,065 4/30/2003 $20,372 $10,808 $13,543 5/31/2003 $21,504 $11,376 $14,259 6/30/2003 $21,562 $11,522 $14,295 7/31/2003 $22,202 $11,725 $14,951 8/31/2003 $22,572 $11,953 $14,800 9/30/2003 $22,498 $11,827 $14,899 10/31/2003 $23,828 $12,495 $15,925 11/30/2003 $24,296 $12,605 $15,881 12/31/2003 $25,240 $13,266 $16,661 1/31/2004 $26,022 $13,509 $17,192 2/29/2004 $26,362 $13,697 $17,647 3/31/2004 $26,451 $13,490 $17,473 4/30/2004 $25,429 $13,279 $16,667 5/31/2004 $25,555 $13,461 $16,974 6/30/2004 $25,862 $13,722 $17,058 7/31/2004 $25,503 $13,268 $16,708 8/31/2004 $25,811 $13,322 $17,270 9/30/2004 $26,542 $13,466 $17,122 10/31/2004 $26,568 $13,671 $17,209 11/30/2004 $28,031 $14,225 $17,718 12/31/2004 $28,889 $14,708 $18,476 12 | Annual Report 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: Shares are available to certain eligible investors as described in the prospectus. CLASS A: Prior to 8/3/98, these shares were offered at a lower initial sales charge; thus actual total returns may differ. CLASS B: These shares have higher annual fees and expenses than Class A shares. CLASS C: Prior to 1/1/04, these shares were offered with an initial sales charge; thus actual total returns would have differed. 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. If the manager had not taken this action, 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 a sales charge. (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. (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. (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. Annual Report | 13 YOUR FUND'S EXPENSES As a Fund shareholder, you can incur two types of costs: o Transaction costs, including sales charges (loads) on Fund purchases and redemption fees; and o Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. The following table shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated. ACTUAL FUND EXPENSES The first line (Actual) for each share class listed in the table below provides actual account values and expenses. The "Ending Account Value" is derived from the Fund's actual return, which includes the effect of Fund expenses. You can estimate the expenses you paid during the period, by following these steps. OF COURSE, YOUR ACCOUNT VALUE AND EXPENSES WILL DIFFER FROM THOSE IN THIS ILLUSTRATION: 1. Divide your account value by $1,000. IF AN ACCOUNT HAD AN $8,600 VALUE, THEN $8,600 / $1,000 = 8.6. 2. Multiply the result by the number under the heading "Expenses Paid During Period." IF EXPENSES PAID DURING PERIOD WERE $7.50, THEN 8.6 X $7.50 = $64.50. In this illustration, the estimated expenses paid this period are $64.50. HYPOTHETICAL EXAMPLE FOR COMPARISON WITH OTHER FUNDS Information in the second line (Hypothetical) for each class in the table can help you compare ongoing costs of investing in the Fund with those of other mutual funds. This information may not be used to estimate the actual ending account balance or expenses you paid during the period. The hypothetical "Ending Account Value" is based on the actual expense ratio for each class and an assumed 5% annual rate of return before expenses, which does not represent the Fund's actual return. The figure under the heading "Expenses Paid During Period" shows the hypothetical expenses your account would have incurred under this scenario. You can compare this figure with the 5% hypothetical examples that appear in shareholder reports of other funds. 14 | Annual Report YOUR FUND'S EXPENSES (CONTINUED) PLEASE NOTE THAT EXPENSES SHOWN IN THE TABLE ARE MEANT TO HIGHLIGHT ONGOING COSTS AND DO NOT REFLECT ANY TRANSACTION COSTS, SUCH AS SALES CHARGES OR REDEMPTION FEES. Therefore, the second line for each class is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transaction costs were included, your total costs would have been higher. Please refer to the Fund prospectus for additional information on operating expenses.
- ---------------------------------------------------------------------------------------------------------- BEGINNING ACCOUNT ENDING ACCOUNT EXPENSES PAID DURING CLASS Z VALUE 6/30/04 VALUE 12/31/04 PERIOD* 6/30/04-12/31/04 - ---------------------------------------------------------------------------------------------------------- Actual $1,000 $1,122.60 $ 5.87 - ---------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,019.61 $ 5.58 - ---------------------------------------------------------------------------------------------------------- CLASS A - ---------------------------------------------------------------------------------------------------------- Actual $1,000 $1,120.80 $ 7.62 - ---------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,017.95 $ 7.25 - ---------------------------------------------------------------------------------------------------------- CLASS B - ---------------------------------------------------------------------------------------------------------- Actual $1,000 $1,117.10 $11.12 - ---------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,014.63 $10.58 - ---------------------------------------------------------------------------------------------------------- CLASS C - ---------------------------------------------------------------------------------------------------------- Actual $1,000 $1,117.00 $11.12 - ---------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,014.63 $10.58 - ----------------------------------------------------------------------------------------------------------
* Expenses are equal to the annualized expense ratio for each class (Z: 1.10%; A: 1.43%; B: 2.09%; and C: 2.09%), multiplied by the average account value over the period, multiplied by 184/366 to reflect the one-half year period. Annual Report | 15 MUTUAL FINANCIAL SERVICES FUND FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2004 2003 2002 2001 2000 --------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .............. $ 20.06 $ 15.92 $ 16.64 $ 16.33 $ 13.05 --------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ....................... .34 .23 .25 .24 .23 Net realized and unrealized gains (losses) ..... 2.70 4.58 (.26) 1.71 3.87 --------------------------------------------------------------------------- Total from investment operations ................ 3.04 4.81 (.01) 1.95 4.10 --------------------------------------------------------------------------- Less distributions from: Net investment income ......................... (.32) (.24) (.28) (.23) (.24) Net realized gains ............................. (2.33) (.43) (.43) (1.41) (.58) --------------------------------------------------------------------------- Total distributions ............................. (2.65) (.67) (.71) (1.64) (.82) --------------------------------------------------------------------------- Redemption fees ................................. --(d) -- -- -- -- --------------------------------------------------------------------------- Net asset value, end of year .................... $ 20.45 $ 20.06 $ 15.92 $ 16.64 $ 16.33 =========================================================================== Total return(b) ................................. 15.62% 30.23% (.27)% 12.31% 32.29% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................. $ 166,175 $ 151,918 $ 104,658 $ 96,936 $ 80,051 Ratios to average net assets:* Expenses(c) .................................... 1.10% 1.13% 1.09% 1.10% 1.24% Net investment income .......................... 1.65% 1.28% 1.47% 1.43% 1.65% Portfolio turnover rate ......................... 38.40% 25.78% 40.17% 83.41% 53.65% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ....................................... 1.09% 1.11% 1.09% 1.09% 1.23%
(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 only operating expenses. (d) Amount is less than $0.001 per share. 16 | See notes to financial statements. | Annual Report MUTUAL FINANCIAL SERVICES FUND FINANCIAL HIGHLIGHTS (CONTINUED)
--------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2004 2003 2002 2001 2000 --------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .............. $ 20.08 $ 15.95 $ 16.66 $ 16.35 $ 13.07 --------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ....................... .27 .16 .19 .19 .18 Net realized and unrealized gains (losses) ..... 2.70 4.58 (.25) 1.71 3.87 --------------------------------------------------------------------------- Total from investment operations ................ 2.97 4.74 (.06) 1.90 4.05 --------------------------------------------------------------------------- Less distributions from: Net investment income .......................... (.25) (.18) (.22) (.18) (.19) Net realized gains ............................. (2.33) (.43) (.43) (1.41) (.58) --------------------------------------------------------------------------- Total distributions ............................. (2.58) (.61) (.65) (1.59) (.77) --------------------------------------------------------------------------- Redemption fees ................................. --(d) -- -- -- -- --------------------------------------------------------------------------- Net asset value, end of year .................... $ 20.47 $ 20.08 $ 15.95 $ 16.66 $ 16.35 =========================================================================== Total return(b) ................................. 15.17% 29.79% (.57)% 11.85% 31.90% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................. $ 296,778 $ 264,411 $ 180,299 $ 167,903 $ 131,331 Ratios to average net assets:(*) Expenses(c) .................................... 1.44% 1.48% 1.44% 1.45% 1.59% Net investment income .......................... 1.31% .93% 1.12% 1.08% 1.30% Portfolio turnover rate ......................... 38.40% 25.78% 40.17% 83.41% 53.65% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ....................................... 1.43% 1.46% 1.44% 1.44% 1.58%
(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 only operating expenses. (d) Amount is less than $0.001 per share. Annual Report | See notes to financial statements. | 17 MUTUAL FINANCIAL SERVICES FUND FINANCIAL HIGHLIGHTS (CONTINUED)
--------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2004 2003 2002 2001 2000 --------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .............. $ 19.76 $ 15.73 $ 16.47 $ 16.21 $ 13.00 --------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ....................... .14 .05 .09 .07 .09 Net realized and unrealized gains (losses) ..... 2.64 4.49 (.26) 1.70 3.83 --------------------------------------------------------------------------- Total from investment operations ................ 2.78 4.54 (.17) 1.77 3.92 --------------------------------------------------------------------------- Less distributions from: Net investment income .......................... (.12) (.08) (.14) (.10) (.13) Net realized gains ............................. (2.33) (.43) (.43) (1.41) (.58) --------------------------------------------------------------------------- Total distributions ............................. (2.45) (.51) (.57) (1.51) (.71) --------------------------------------------------------------------------- Redemption fees ................................. --(d) -- -- -- -- --------------------------------------------------------------------------- Net asset value, end of year .................... $ 20.09 $ 19.76 $ 15.73 $ 16.47 $ 16.21 =========================================================================== Total return(b) ................................. 14.51% 28.88% (1.21)% 11.16% 31.00% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................. $ 42,614 $ 34,219 $ 20,776 $ 11,212 $ 4,429 Ratios to average net assets:* Expenses(c) .................................... 2.10% 2.12% 2.09% 2.10% 2.24% Net investment income .......................... .65% .29% .47% .42% .62% Portfolio turnover rate ......................... 38.40% 25.78% 40.17% 83.41% 53.65% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ....................................... 2.09% 2.10% 2.09% 2.09% 2.23%
(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 only operating expenses. (d) Amount is less than $0.001 per share. 18 | See notes to financial statements. | Annual Report MUTUAL FINANCIAL SERVICES FUND FINANCIAL HIGHLIGHTS (CONTINUED)
--------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2004 2003 2002 2001 2000 --------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .............. $ 20.02 $ 15.92 $ 16.63 $ 16.32 $ 13.05 --------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ....................... .13 .05 .08 .07 .09 Net realized and unrealized gains (losses) ..... 2.68 4.55 (.25) 1.71 3.86 --------------------------------------------------------------------------- Total from investment operations ................ 2.81 4.60 (.17) 1.78 3.95 --------------------------------------------------------------------------- Less distributions from: Net investment income .......................... (.11) (.07) (.11) (.06) (.10) Net realized gains ............................. (2.33) (.43) (.43) (1.41) (.58) --------------------------------------------------------------------------- Total distributions ............................. (2.44) (.50) (.54) (1.47) (.68) --------------------------------------------------------------------------- Redemption fees ................................. --(d) -- -- -- -- --------------------------------------------------------------------------- Net asset value, end of year .................... $ 20.39 $ 20.02 $ 15.92 $ 16.63 $ 16.32 =========================================================================== Total return(b) ................................. 14.46% 28.87% (1.20)% 11.15% 31.08% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................. $ 155,698 $ 141,233 $ 105,451 $ 106,248 $ 94,851 Ratios to average net assets:* Expenses(c) .................................... 2.10% 2.13% 2.07% 2.09% 2.23% Net investment income .......................... .65% .28% .49% .43% .67% Portfolio turnover rate ......................... 38.40% 25.78% 40.17% 83.41% 53.65% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ....................................... 2.09% 2.11% 2.07% 2.08% 2.22%
(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 only operating expenses. (d) Amount is less than $0.001 per share. Annual Report | See notes to financial statements. | 19 MUTUAL FINANCIAL SERVICES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004
- ---------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES/WARRANTS VALUE - ---------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 80.7% CAPITAL MARKETS 5.9% (a) A.B. Watley Group Inc. ............................................. United States 128,365 $ 21,822 Aareal Bank AG ..................................................... Germany 42,000 1,384,954 (a) DT Beteiligungs AG ................................................. Germany 484,099 6,897,681 Irish Life & Permanent PLC ......................................... Irish Republic 438,900 8,117,851 (a) KKR Financial Corp., 144A .......................................... United States 764,800 7,992,160 (b) Leucadia National Corp. ............................................ United States 87,450 5,772,225 MCG Capital Corp. .................................................. United States 505,900 8,666,067 -------------- 38,852,760 -------------- COMMERCIAL BANKS 19.3% Allied Irish Banks PLC ............................................. Irish Republic 1,106,400 22,941,150 Bank of Ireland .................................................... Irish Republic 895,572 14,788,021 BNP Paribas SA ..................................................... France 177,600 12,845,465 (a),(b) Centennial Bank Holdings Inc. United States 946,861 9,942,041 (a) Cerberus NCB Acquisition LP Ltd., wts., 8/29/13 .................... Japan 1,856,774 928,387 City National Corp. ................................................ United States 90,253 6,376,374 Danske Bank ........................................................ Denmark 431,100 13,191,362 (a),(b) Elephant Capital Holdings Ltd. Japan 2,090 2,779,673 First Community Bancorp ............................................ United States 327,160 13,969,732 Kansai Urban Banking Corp. ......................................... Japan 62,496 115,937 (a) Nippon Investment LLC .............................................. Japan 797,000 -- PNC Financial Services Group ....................................... United States 88,400 5,077,696 Prosperity Bancshares Inc. ......................................... United States 152,837 4,464,369 (a),(b),(c) State National Bancshares Inc. United States 507,936 14,222,208 (a) Texas Capital Bancshares Inc. ...................................... United States 282,000 6,096,840 -------------- 127,739,255 -------------- COMMERCIAL SERVICES & SUPPLIES 1.0% (d) Comdisco, Contingent Distribution .................................. United States 4,645,036 -- (a) Comdisco Holding Co., Inc. ......................................... United States 6 134 (a),(c) Integrated Alarm Services United States 1,277,700 6,989,019 -------------- 6,989,153 -------------- CONSUMER FINANCE (a) Union Acceptance Corp., A .......................................... United States 1,198,600 179,790 -------------- DIVERSIFIED FINANCIAL SERVICES 3.9% Deutsche Bourse AG ................................................. Germany 185,436 11,142,466 Euronext ........................................................... Netherlands 472,200 14,398,217 -------------- 25,540,683 -------------- INSURANCE 23.7% (a) Berkshire Hathaway Inc., A ......................................... United States 113 9,932,700 (a) Berkshire Hathaway Inc., B ......................................... United States 134 393,424 Catlin Group ....................................................... United Kingdom 1,437,200 9,041,466 (a) Conseco Inc. ....................................................... United States 567,475 11,321,126 Hartford Financial Services Group Inc. ............................. United States 171,400 11,879,734 (a),(b) Imagine Group Holdings Ltd. Bermuda 551,589 5,649,115 IPC Holdings Ltd. .................................................. Bermuda 162,800 7,083,428 (a) Meadowbrook Insurance Group Inc. ................................... United States 317,500 1,584,325 Montpelier Re Holdings Ltd. ........................................ Bermuda 180,275 6,931,574
20 | Annual Report MUTUAL FINANCIAL SERVICES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES/WARRANTS VALUE - ---------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONT.) INSURANCE (CONT.) Nationwide Financial Services Inc., A .............................. United States 171,400 $ 6,552,622 (a),(b) Occum Acquisition Corp. United States 117,300 11,730,000 Old Republic International Corp. ................................... United States 586,300 14,833,390 (a),(b) Olympus Re Holdings Ltd. Bermuda 7,480 1,280,426 Prudential Financial Inc. .......................................... United States 130,200 7,155,792 Safety Insurance Group Inc. ........................................ United States 387,100 12,058,165 St. Paul Travelers Cos. Inc. ....................................... United States 150,936 5,595,198 (a) United National Group Ltd. ......................................... United States 476,540 8,873,175 White Mountains Insurance Group Inc. ............................... United States 38,548 24,902,008 -------------- 156,797,668 -------------- REAL ESTATE 17.2% Aames Investment Corp. ............................................. United States 750,000 8,025,000 Bimini Mortgage Management Inc. .................................... United States 599,667 9,630,652 Bimini Mortgage Management Inc., A ................................. United States 242,400 3,892,944 Capital Lease Funding Inc. ......................................... United States 406,900 5,086,250 (c) Falcon Financial Investment Trust .................................. United States 1,086,100 7,602,700 Homebanc Corp. ..................................................... United States 956,293 9,256,916 iStar Financial Inc. ............................................... United States 278,100 12,586,806 (a) JER Investors Trust, 144A .......................................... United States 298,400 4,505,840 Medical Properties Trust ........................................... United States 676,500 6,934,125 Mortgageit Holdings Inc. ........................................... United States 531,200 9,535,040 New Century Financial Corp. ........................................ United States 125,000 7,988,750 New York Mortgage Trust Inc. ....................................... United States 744,440 8,337,728 Saxon Capital Inc. ................................................. United States 844,100 20,249,959 -------------- 113,632,710 -------------- THRIFTS & MORTGAGE FINANCE 9.7% Astoria Financial Corp. ............................................ United States 68,700 2,745,939 Bank Mutual Corp. .................................................. United States 889,200 10,821,564 Brookline Bancorp Inc. ............................................. United States 13,900 226,848 Commercial Cap Bancorp Inc. ........................................ United States 1,673 38,776 Fieldstone Investment Corp. ........................................ United States 509,700 8,792,325 First Niagara Financial Group Inc. ................................. United States 148,653 2,073,709 (a) Franklin Bank Corp., A, 144A ....................................... United States 300,000 5,475,000 (a) Franklin Bank Corp., Houston ....................................... United States 10,100 184,325 Golden West Financial Corp. ........................................ United States 66,800 4,102,856 Hudson City Bancorp Inc. ........................................... United States 236,798 8,718,902 Sovereign Bancorp Inc. ............................................. United States 898,800 20,267,940 (a) Sterling Financial Corp. ........................................... United States 11,050 433,804 -------------- 63,881,988 -------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $382,482,575).. 533,614,007 --------------
Annual Report | 21 MUTUAL FINANCIAL SERVICES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2004 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES VALUE - ---------------------------------------------------------------------------------------------------------------------------------- PREFERRED STOCKS (COST $7,448,950) 1.2% REAL ESTATE 1.2% iStar Financial Inc., 7.80%, pfd. .................................. United States 297,958 $ 7,818,418 -------------- ------------------- PRINCIPAL AMOUNT(f) ------------------- GOVERNMENT AGENCIES 16.9% (e) Federal Home Loan Bank, 1.163% - 2.743%, 1/03/05 - 11/16/05 ........ United States $ 109,050,000 108,657,508 U.S. Treasury Bill, 2.527%, 6/30/05 ................................ United States 3,000,000 2,963,382 -------------- TOTAL GOVERNMENT AGENCIES (COST $111,657,930) ...................... 111,620,890 -------------- TOTAL INVESTMENTS (COST $501,589,455) 98.8% ........................ 653,053,315 NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS (.6)% ............ (3,996,404) OTHER ASSETS, LESS LIABILITIES 1.8% ................................ 12,207,556 -------------- NET ASSETS 100.0% .................................................. $ 661,264,467 ==============
(a) Non-income producing. (b) See Note 9 regarding restricted securities. (c) See Note 10 regarding holdings of 5% voting securities. (d) Contingent Distributions represent the right to receive additional distributions, if any, during the reorganization of the underlying company. Shares represent total underlying principal of debt securities. (e) See Note 1(g) regarding securities segregated with broker for securities sold short. (f) The principal amount is stated in U.S. dollars unless otherwise indicated. 22 | See notes to financial statements. | Annual Report MUTUAL FINANCIAL SERVICES FUND FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2004 Assets: Investments in securities: Cost - Unaffiliated issuers .................................................. $ 475,445,738 Cost - Non-controlled affiliated issuers (Note 10) ........................... 26,143,717 --------------- Total cost of investments .................................................... 501,589,455 =============== Value - Unaffiliated issuers (includes securities segregated with broker for securities sold short in the amount of $3,957,364) .......... 624,239,388 Value - Non-controlled affiliated issuers (Note 10) .......................... 28,813,927 --------------- Total value of investments ................................................... 653,053,315 Cash .......................................................................... 5,373,667 Foreign currency, at value (cost $927,424) .................................... 947,338 Receivables: Investment securities sold ................................................... 2,419,050 Capital shares sold .......................................................... 1,036,231 Dividends and interest ....................................................... 2,324,795 Unrealized gain on forward exchange contracts (Note 8) ........................ 44,165 Due from broker - synthetic equity swaps (Note 7) ............................. 112,559 Cash on deposit with brokers for securities sold short ........................ 1,754,268 --------------- Total assets ............................................................. 667,065,388 --------------- Liabilities: Payables: Investment securities purchased .............................................. 93,124 Capital shares redeemed ...................................................... 700,628 Affiliates ................................................................... 862,894 Unrealized loss on forward exchange contracts (Note 8) ........................ 4,040,569 Other liabilities ............................................................. 103,706 --------------- Total liabilities ........................................................ 5,800,921 --------------- Net assets, at value .................................................... $ 661,264,467 =============== Net assets consist of: Undistributed net investment income ........................................... $ 1,266,786 Net unrealized appreciation (depreciation) .................................... 147,445,335 Accumulated net realized gain (loss) .......................................... 17,771,202 Capital shares ................................................................ 494,781,144 --------------- Net assets, at value .................................................... $ 661,264,467 ===============
Annual Report | See notes to financial statements. | 23 MUTUAL FINANCIAL SERVICES FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2004 CLASS Z: Net assets, at value ........................................................... $ 166,174,709 =============== Shares outstanding ............................................................. 8,127,073 =============== Net asset value and maximum offering price per share(a) ........................ $ 20.45 =============== CLASS A: Net assets, at value ........................................................... $ 296,777,628 =============== Shares outstanding ............................................................. 14,497,166 =============== Net asset value per share(a) ................................................... $ 20.47 =============== Maximum offering price per share (net asset value per share / 94.25%) .......... $ 21.72 =============== CLASS B: Net assets, at value ........................................................... $ 42,614,184 =============== Shares outstanding ............................................................. 2,121,351 =============== Net asset value and maximum offering price per share(a) ........................ $ 20.09 =============== CLASS C: Net assets, at value ........................................................... $ 155,697,946 =============== Shares outstanding ............................................................. 7,634,814 =============== Net asset value and maximum offering price per share(a) ........................ $ 20.39 ===============
(a) Redemption price is equal to net asset value less contingent deferred sales charges, if applicable, and redemption fees retained by the Fund. 24 | See notes to financial statements. | Annual Report MUTUAL FINANCIAL SERVICES FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2004 Investment income: Dividends (net of foreign taxes of $196,536) Unaffiliated issuers ......................................................... $ 15,428,465 Non-controlled affiliated issuers (Note 10) .................................. 108,610 Interest ...................................................................... 1,328,392 --------------- Total investment income .................................................. 16,865,467 --------------- Expenses: Management fees (Note 3) ...................................................... 4,909,585 Administrative fees (Note 3) .................................................. 474,041 Distribution fees (Note 3) Class A ...................................................................... 939,322 Class B ...................................................................... 381,343 Class C ...................................................................... 1,461,893 Transfer agent fees (Note 3) .................................................. 1,038,800 Custodian fees (Note 4) ....................................................... 27,401 Reports to shareholders ....................................................... 64,400 Registration and filing fees .................................................. 81,700 Professional fees ............................................................. 78,400 Directors' fees and expenses .................................................. 17,700 Dividends on securities sold short ............................................ 52,566 Other ......................................................................... 24,769 --------------- Total expenses ........................................................... 9,551,920 Expense reductions (Note 4) .............................................. (3,600) --------------- Net expenses ........................................................... 9,548,320 --------------- Net investment income ............................................... 7,317,147 --------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments: Unaffiliated issuers ........................................................ 76,007,872 Non-controlled affiliated issuers (Note 10) ................................. 3,687,864 Written options (Note 6) ..................................................... 2,677 Foreign currency transactions ................................................ (4,307,480) Securities sold short ........................................................ (237,652) --------------- Net realized gain (loss) ............................................... 75,153,281 Net change in unrealized appreciation (depreciation) on: Investments .................................................................. 4,865,490 Translation of assets and liabilities denominated in foreign currencies ...... (721,573) --------------- Net change in unrealized appreciation (depreciation) ................... 4,143,917 --------------- Net realized and unrealized gain (loss) ........................................ 79,297,198 --------------- Net increase (decrease) in net assets resulting from operations ................ $ 86,614,345 ===============
Annual Report | See notes to fiancial statements. | 25 MUTUAL FINANCIAL SERVICES FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS for the years ended December 31, 2004 and 2003
---------------------------------- 2004 2003 ---------------------------------- Increase (decrease) in net assets: Operations: Net investment income ........................................................ $ 7,317,147 $ 3,971,447 Net realized gain (loss) from investments, written options, foreign currency transactions, and securities sold short ............................ 75,153,281 23,885,829 Net change in unrealized appreciation (depreciation) on investments and translation of assets and liabilities denominated in foreign currencies ..... 4,143,917 103,309,303 ---------------------------------- Net increase (decrease) in net assets resulting from operations .............. 86,614,345 131,166,579 Distributions to shareholders from: Net investment income: Class Z ..................................................................... (2,336,535) (1,738,495) Class A ..................................................................... (3,220,768) (2,265,228) Class B ..................................................................... (231,903) (133,901) Class C ..................................................................... (755,016) (454,311) Net realized gains: Class Z ..................................................................... (17,118,618) (3,178,326) Class A ..................................................................... (30,433,763) (5,516,492) Class B ..................................................................... (4,488,054) (722,331) Class C ..................................................................... (16,255,643) (2,956,429) ---------------------------------- Total distributions to shareholders ........................................... (74,840,300) (16,965,513) Capital share transactions (Note 2): Class Z ...................................................................... 10,924,104 17,712,321 Class A ...................................................................... 27,243,812 33,006,442 Class B ...................................................................... 7,845,879 7,339,662 Class C ...................................................................... 11,696,402 8,335,815 ---------------------------------- Total capital share transactions .............................................. 57,710,197 66,394,240 Redemption fees ............................................................... 102 -- ---------------------------------- Net increase (decrease) in net assets ..................................... 69,484,344 180,595,306 Net assets: Beginning of year ............................................................. 591,780,123 411,184,817 ---------------------------------- End of year ................................................................... $ 661,264,467 $ 591,780,123 ================================== Undistributed net investment income/Distributions in excess of net investment income included in net assets: End of year ................................................................... $ 1,266,786 $ (568,646) ==================================
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, non-diversified series of Franklin Mutual Series Fund, Inc. (the Series Fund), consisting of 6 separate series. The Company is an open-end investment company registered under the Investment Company Act of 1940. The financial statements of the remaining funds in the series are presented separately. 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 on a securities exchange or on the NASDAQ National Market System, are valued at the last quoted sale price or the official closing price of the day, respectively. Over-the-counter securities and listed securities for which there is no reported sale are valued within the range of the most recent quoted bid and ask prices. Securities that trade in multiple markets or on multiple exchanges are valued according to the broadest and most representative market. U.S. Government securities generally trade in the over-the-counter market rather than on a securities exchange. The Fund may utilize independent pricing services, quotations from bond dealers, and information with respect to bond and note transactions, to assist in determining a current market value for each security. The Fund's pricing services may use valuation models or matrix pricing which considers information with respect to comparable bond and note transactions, quotations from bond dealers, or by reference to other securities that are considered comparable in such characteristics as rating, interest rate and maturity date, option adjusted spread models, prepayment projections, interest rate spreads and yield curves, to determine current value. Foreign securities are valued as of the close of trading on the foreign stock exchange on which the security is primarily traded, or the NYSE, whichever is earlier. The value is then converted into its U.S. dollar equivalent at the foreign exchange rate in effect at the close of the NYSE on the day that the value of the foreign security is determined. If no sale is reported at that time, the foreign security will be valued within the range of the most recent quoted bid and ask prices. The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. Some methods for valuing these securities may include: fundamental analysis, matrix pricing, discounts from market prices of similar securities, or discounts applied due to the nature and duration of restrictions on the disposition of the securities. Occasionally, events occur between the time at which trading in a security is completed and the close of the NYSE that might call into question the availability (including the reliability) of the value of a portfolio security held by the Fund. If such an event occurs, the securities may be valued using fair value procedures, which may include the use of independent pricing services. All security valuation procedures are approved by the Fund's Board of Directors. Annual Report | 27 MUTUAL FINANCIAL SERVICES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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, income and expense items denominated in foreign currencies are translated into U.S. dollars at the exchange rate in effect on the transaction date. Occasionally, events may impact the availability or reliability of foreign exchange rates used to convert the U.S. dollar equivalent value. If such an event occurs, the foreign exchange rate will be valued at fair value using procedures established and approved by the Fund's Board of Directors. 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 on the Statement of Operations. 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. dollars 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. SECURITIES PURCHASED ON A WHEN-ISSUED OR DELAYED DELIVERY 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. D. 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 by the Fund and any equity therein is included in the Statement of Assets and Liabilities. Realized and unrealized gains and losses on these contracts 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 on these contracts are included in the Statement of Operations. 28 | Annual Report MUTUAL FINANCIAL SERVICES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) D. FOREIGN CURRENCY CONTRACTS (CONTINUED) 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. E. 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 to 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 synthetic equity swaps include unfavorable price movements in the underlying securities or the inability of the counterparties to fulfill their obligations under the contract. F. 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. Upon closing of an option, other than by exercise, which 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. G. 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 incurs 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 realizes a gain if the price of the security declines between those dates. Gains are limited to the price at which the Fund sold the security short, while losses are potentially unlimited in size. Annual Report | 29 MUTUAL FINANCIAL SERVICES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) G. SECURITIES SOLD SHORT (CONTINUED) 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 with the broker consisting of cash and securities having a value equal to a specified percentage of the value of the securities sold short. The Fund is obligated to pay the counterparty any dividends or interest due on securities sold short. Such dividends and interest are recorded as an expense to the Fund. H. INCOME TAXES No provision has been made for U.S. income taxes because the Fund's policy is to qualify as a regulated investment company under Sub Chapter M of the Internal Revenue Code and to distribute substantially all of its taxable income. Fund distributions to shareholders are determined on an income tax basis and may differ from net investment income and realized gains for financial reporting purposes. 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. Interest income and estimated expenses are accrued daily. Discounts and premiums 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 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. J. 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 expenses during the reporting period. Actual results could differ from those estimates. 30 | Annual Report MUTUAL FINANCIAL SERVICES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) K. REDEMPTION FEES Effective June 1, 2004, redemptions and exchanges of Fund shares held five trading days or less 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 as noted in the Statements of Changes in Net Assets. L. GUARANTEES AND INDEMNIFICATIONS Under the Fund's organizational documents, its officers and directors are indemnified by the Fund 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. Effective March 1, 2005, Class B shares will no longer be offered except to existing Class B Shareholders through reinvested distributions or exchanges into other Franklin Templeton fund's Class B shares, as permitted by the applicable fund prospectus. 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, 2004, 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 DECEMBER 31, 2004 2003 ---------------------------------------------------- SHARES AMOUNT SHARES AMOUNT ---------------------------------------------------- CLASS Z SHARES: Shares sold ............................. 1,042,865 $ 21,517,260 1,693,414 $ 29,027,937 Shares issued in reinvestment of distributions .......................... 901,595 18,142,825 231,979 4,549,166 Shares redeemed ......................... (1,391,673) (28,735,981) (924,342) (15,864,782) ---------------------------------------------------- Net increase (decrease) ................. 552,787 $ 10,924,104 1,001,051 $ 17,712,321 ====================================================
Annual Report | 31 MUTUAL FINANCIAL SERVICES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED)
-------------------------------------------------------- YEAR ENDED DECEMBER 31, 2004 2003 -------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT -------------------------------------------------------- CLASS A SHARES: Shares sold ......................... 3,254,965 $ 67,432,442 4,956,672 $ 86,814,316 Shares issued in reinvestment of distributions ...................... 1,537,944 30,987,850 366,907 7,205,438 Shares redeemed ..................... (3,462,850) (71,176,480) (3,460,727) (61,013,312) -------------------------------------------------------- Net increase (decrease) ............. 1,330,059 $ 27,243,812 1,862,852 $ 33,006,442 ======================================================== CLASS B SHARES: Shares sold ......................... 450,980 $ 9,175,970 613,375 $ 10,682,088 Shares issued in reinvestment of distributions ...................... 216,541 4,282,882 40,714 787,759 Shares redeemed ..................... (277,807) (5,612,973) (243,494) (4,130,185) -------------------------------------------------------- Net increase (decrease) ............. 389,714 $ 7,845,879 410,595 $ 7,339,662 ======================================================== CLASS C SHARES: Shares sold ......................... 1,125,859 $ 23,236,590 1,711,334 $ 30,364,131 Shares issued in reinvestment of distributions ...................... 758,726 15,229,572 155,752 3,053,003 Shares redeemed ..................... (1,304,431) (26,769,760) (1,437,646) (25,081,319) -------------------------------------------------------- Net increase (decrease) ............. 580,154 $ 11,696,402 429,440 $ 8,335,815 ========================================================
3. TRANSACTIONS WITH AFFILIATES Certain officers of the Series Fund are also officers and/or directors of the following entities:
- ----------------------------------------------------------------------------------------- ENTITY AFFILIATION - ----------------------------------------------------------------------------------------- Franklin Mutual Advisers, LLC (Franklin Mutual) Investment manager Franklin Templeton Services, LLC (FT Services) Administrative manager Franklin/Templeton Distributors, Inc. (Distributors) Principal underwriter Franklin/Templeton Investor Services, LLC (Investor Services) Transfer agent
A. MANAGEMENT FEES Effective July 1, 2004, the Fund pays an investment management fee to Franklin Mutual based on the average daily net assets of the Fund as follows: - ------------------------------------------------------------------------------- ANNUALIZED FEE RATE NET ASSETS - ------------------------------------------------------------------------------- 0.800% First $1 billion 0.770% Over $1 billion, up to and including $2 billion 0.750% Over $2 billion, up to and including $5 billion 0.730% Over $5 billion Prior to July 1, 2004, the Fund paid fees of 0.80%, per year of the average daily net assets of the Fund. 32 | Annual Report MUTUAL FINANCIAL SERVICES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) B. ADMINISTRATIVE FEES The Fund pays its allocated share of an administrative fee to FT Services based on the Fund's aggregated average daily net assets as follows: - ------------------------------------------------------------------------------- ANNUALIZED FEE RATE 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 C. DISTRIBUTION FEES The Fund reimburses Distributors 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, respectively, for costs incurred in marketing the Fund's shares under a Rule 12b-1 plan. Under the Class A distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. D. SALES CHARGES/UNDERWRITING AGREEMENTS Distributors has advised the Fund of the following commission transactions related to the sales and redemptions of the Fund's shares for the year: Net sales charges received ................................. $ 141,953 Contingent deferred sales charges retained ................. $ 89,709 E. TRANSFER AGENT FEES The Fund paid transfer agent fees of $1,038,800, of which $708,882 was paid to Investor Services. 4. EXPENSE OFFSET ARRANGEMENT The Fund has entered into an arrangement with its custodian whereby credits realized as a result of uninvested cash balances are used to reduce a portion of the Fund's custodian expenses. During the year ended December 31, 2004, the custodian fees were reduced as noted in the Statement of Operations. 5. INCOME TAXES 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. Annual Report | 33 MUTUAL FINANCIAL SERVICES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. INCOME TAXES (CONTINUED) Net realized gains 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, 2004, 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 ........................................... $ 501,919,791 ============= Unrealized appreciation ....................................... $ 162,123,788 Unrealized depreciation ....................................... (10,990,264) ------------- Net unrealized appreciation (depreciation) .................... $ 151,133,524 ============= Undistributed ordinary income ................................. $ 4,125,183 Undistributed long term capital gains ......................... 12,406,633 ------------- Distributable earnings ........................................ $ 16,531,816 ============= The tax character of distributions paid during the years ended December 31, 2004 and 2003, was as follows: ------------------------- 2004 2003 ------------------------- Distributions paid from: Ordinary income ................................... $24,417,864 $ 4,591,935 Long term capital gain ............................ 50,422,436 12,373,578 ------------------------- $74,840,300 $16,965,513 ========================= 6. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short-term securities and securities sold short) for the year ended December 31, 2004 aggregated $206,322,305 and $275,899,367, respectively. Transactions in options written during the year ended December 31, 2004 were as follows: ------------------------- NUMBER OF PREMIUMS CONTRACTS RECEIVED ------------------------- Options outstanding at December 31, 2003 ...................... -- $ -- Options written ......................... 9,496 6,790 Options expired ......................... (4,748) (2,677) Options exercised ....................... (4,748) (4,113) Options closed .......................... -- -- ========================= Options outstanding at December 31, 2004 ...................... -- $ -- ========================= 34 | Annual Report MUTUAL FINANCIAL SERVICES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. SYNTHETIC EQUITY SWAPS As of December 31, 2004, the Fund had the following synthetic equity swaps outstanding: - ------------------------------------------------------------------------------- NUMBER OF UNREALIZED CONTRACTS TO BUY CONTRACTS VALUE GAIN (LOSS) - ------------------------------------------------------------------------------- Aareal Bank AG (23.43 - 25.89 EUR) ....... 209,553 $6,910,028 $ (47,974) ---------- 8. FORWARD EXCHANGE CONTRACTS At December 31, 2004, 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 SELL EXCHANGE FOR DATE GAIN (LOSS) - ----------------------------------------------------------------------------------------------- 3,555,206 British Pounds ............... U.S. $ 6,807,985 6/8/05 U.S. $ 44,165 ------------ ----------- - ----------------------------------------------------------------------------------------------- IN SETTLEMENT UNREALIZED CONTRACTS TO SELL EXCHANGE FOR DATE GAIN (LOSS) - ----------------------------------------------------------------------------------------------- 6,685,242 Euro ........................ U.S. $ 8,256,273 2/23/05 U.S. $ (820,103) 61,204,892 Danish Krona ................ 10,012,705 3/17/05 (1,159,897) 4,549,593 Euro ........................ 5,743,074 4/25/05 (440,160) 2,400,000 Euro ........................ 2,983,464 5/23/05 (280,177) 3,500,000 Euro ........................ 4,662,140 6/13/05 (99,376) 3,000,000 Euro ........................ 3,788,400 7/25/05 (296,674) 6,500,000 Euro ........................ 7,917,000 9/13/05 (944,182) ------------ ----------- U.S. $ 43,363,056 (4,040,569) ============ ----------- Unrealized loss on forward exchange contracts ........................... (4,040,569) ----------- Net unrealized loss on forward exchange contracts ............. U.S. $(3,996,404) ===========
Annual Report | 35 MUTUAL FINANCIAL SERVICES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. RESTRICTED SECURITIES At December 31, 2004, investments in securities included issues that are restricted and 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, 2004, the Fund held investments in restricted and illiquid securities that were valued under approved methods by the Directors, as follows:
- ----------------------------------------------------------------------------------------------------------- ACQUISITION SHARES/WARRANTS ISSUER DATE COST VALUE - ----------------------------------------------------------------------------------------------------------- 946,861 Centennial Bank Holdings Inc .............. 7/14/04 $ 9,468,610 $ 9,942,041 2,090 Elephant Capital Holdings Ltd ............. 8/29/03 2,090,642 2,779,673 551,589 Imagine Group Holdings Ltd ................ 8/31/04 5,649,099 5,649,115 87,450 Leucadia National Corp .................... 12/20/02 3,082,613 5,772,225 117,300 Occum Acquisition Corp .................... 7/27/04 11,730,000 11,730,000 7,480 Olympus Re Holdings Ltd ................... 12/19/01 748,000 1,280,426 507,936 State National Bancshares Inc.............. 6/08/98 7,333,326 14,222,208 ------------ TOTAL RESTRICTED SECURITIES (7.77% OF NET ASSETS) ......................................... $ 51,375,688 ============
10. 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, 2004 were as shown below.
- ----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF NUMBER OF REALIZED SHARES HELD AT GROSS GROSS SHARES HELD AT VALUE AT INVESTMENT CAPITAL NAME OF ISSUER BEGINNING OF YEAR ADDITIONS REDUCTIONS END OF YEAR END OF YEAR INCOME GAINS (LOSS) - ----------------------------------------------------------------------------------------------------------------------------------- NON-CONTROLLED AFFILIATES Falcon Financial Investment Trust ...................... 894,000 192,100 -- 1,086,100 $ 7,602,700 $ 108,610 $ -- Integrated Alarm Services .... 799,800 477,900 -- 1,277,700 6,989,019 -- -- Meadowbrook Insurance Group Inc. ................. 1,954,000 -- (1,636,500) 317,500 --(a) -- 3,887,864 Oxford Finance Corp. ......... 500,000 -- (500,000) -- -- -- (200,000) State National Bancshares Inc. ....................... 507,936 -- -- 507,936 14,222,208 -- -- -------------------------------------- TOTAL NON-CONTROLLED AFFILIATES (4.36% OF NET ASSETS) ..................................... $28,813,927 $ 108,610 $ 3,687,864 ======================================
(a) As of December 31, 2004, no longer an affiliate. 36 | Annual Report MUTUAL FINANCIAL SERVICES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. REGULATORY MATTERS INVESTIGATIONS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, including the Securities and Exchange Commission ("SEC"), the California Attorney General's Office ("CAGO"), and the National Association of Securities Dealers, Inc. ("NASD"), relating to certain practices in the mutual fund industry, including late trading, market timing and marketing support payments to securities dealers who sell fund shares, Franklin Resources, Inc. and certain of its subsidiaries (as used in this section, together, the "Company"), as well as certain current or former executives and employees of the Company, received subpoenas and/or requests for documents, information and/or testimony. The Company and its current employees provided documents and information in response to those requests and subpoenas. SETTLEMENTS Beginning in August 2004, the Company entered into settlements with certain regulators investigating the mutual fund industry practices noted above. The Company believes that settlement of each of the matters described in this section is in the best interest of the Company and shareholders of the Franklin, Templeton, and Mutual Series mutual funds (the "funds"). On August 2, 2004, Franklin Resources, Inc. announced that its subsidiary, Franklin Advisers, Inc., reached an agreement with the SEC that resolved the issues resulting from the SEC investigation into market timing activity. In connection with that agreement, the SEC issued an "Order Instituting Administrative and Cease-and-Desist Proceedings Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940 and Sections 9(b) and 9(f) of the Investment Company Act of 1940, Making Findings and Imposing Remedial Sanctions and a Cease-and-Desist Order" (the "Order"). The SEC's Order concerned the activities of a limited number of third parties that ended in 2000 and those that were the subject of the first Massachusetts administrative complaint described below. Under the terms of the SEC's Order, pursuant to which Franklin Advisers, Inc. neither admitted nor denied any of the findings contained therein, Franklin Advisers, Inc. agreed to pay $50 million, of which $20 million is a civil penalty, to be distributed to shareholders of certain funds in accordance with a plan to be developed by an independent distribution consultant. At this time, it is unclear which funds or which shareholders of any particular fund will receive distributions. The Order also required Franklin Advisers, Inc. to, among other things, enhance and periodically review compliance policies and procedures. On September 20, 2004, Franklin Resources, Inc. announced that two of its subsidiaries, Franklin Advisers, Inc. and Franklin Templeton Alternative Strategies, Inc. ("FTAS"), reached an agreement with the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts (the "State of Massachusetts") related to its administrative complaint filed on February 4, 2004, concerning one instance of market timing that was also a subject of the August 2, 2004 settlement that Franklin Advisers, Inc. reached with the SEC, as described above. Annual Report | 37 MUTUAL FINANCIAL SERVICES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. REGULATORY MATTERS (CONTINUED) SETTLEMENTS (CONTINUED) Under the terms of the settlement consent order issued by the State of Massachusetts, Franklin Advisers, Inc. and FTAS consented to the entry of a cease-and-desist order and agreed to pay a $5 million administrative fine to the State of Massachusetts (the "Massachusetts Consent Order"). The Massachusetts Consent Order included two different sections: "Statements of Fact" and "Violations of Massachusetts Securities Laws." Franklin Advisers, Inc. and FTAS admitted the facts in the Statements of Fact. On October 25, 2004, the State of Massachusetts filed a second administrative complaint, alleging that Franklin Resources, Inc.'s Form 8-K filing (in which it described the Massachusetts Consent Order and stated that "Franklin did not admit or deny engaging in any wrongdoing") failed to state that Franklin Advisers, Inc. and FTAS admitted the Statements of Fact portion of the Massachusetts Consent Order (the "Second Complaint"). Franklin Resources, Inc. reached a second agreement with the State of Massachusetts on November 19, 2004, resolving the Second Complaint. As a result of the November 19, 2004 settlement, Franklin Resources, Inc. filed a new Form 8-K. The terms of the Massachusetts Consent Order did not change and there was no monetary fine associated with this second settlement. On November 17, 2004, Franklin Resources, Inc. announced that Franklin/Templeton Distributors, Inc. ("FTDI") reached an agreement with the CAGO, resolving the issues resulting from the CAGO's investigation concerning sales and marketing support payments. Under the terms of the settlement, FTDI neither admitted nor denied the allegations in the CAGO's complaint and agreed to pay $2 million to the State of California as a civil penalty, $14 million to the funds, to be allocated by an independent distribution consultant to be paid for by FTDI, and $2 million to the CAGO for its investigative costs. On December 13, 2004, Franklin Resources, Inc. announced that its subsidiaries FTDI and Franklin Advisers, Inc. reached an agreement with the SEC, resolving the issues resulting from the SEC's investigation concerning marketing support payments to securities dealers who sell fund shares. In connection with that agreement, the SEC issued an "Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940, Sections 9(b) and 9(f) of the Investment Com- pany Act of 1940, and Section 15(b) of the Securities Exchange Act of 1934" (the "Second Order"). Under the terms of the Second Order, in which FTDI and Franklin Advisers, Inc. neither admitted nor denied the findings contained therein, they agreed to pay the funds a penalty of $20 million and disgorgement of $1 (one dollar). FTDI and Franklin Advisers, Inc. also agreed to implement certain measures and undertakings relating to marketing support payments to broker-dealers for the promotion or sale of fund shares, including making additional disclosures in the funds' Prospectuses and Statements of Additional Information. The Second Order further requires the appointment of an independent distribution consultant, at the Company's expense, who shall develop a plan for the distribution of the penalty and disgorgement to the funds. 38 | Annual Report MUTUAL FINANCIAL SERVICES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. REGULATORY MATTERS (CONTINUED) OTHER LEGAL PROCEEDINGS The Fund, in addition to the Company and other funds, and certain current and former officers, employees, and directors have been named in multiple lawsuits in different federal courts in Nevada, California, Illinois, New York and Florida, alleging violations of various federal securities laws and seeking, among other relief, monetary damages, restitution, removal of fund trustees, directors, advisers, administrators, and distributors, rescission of management contracts and 12b-1 Plans, and/or attorneys' fees and costs. Specifically, the lawsuits claim breach of duty with respect to alleged arrangements to permit market timing and/or late trading activity, or breach of duty with respect to the valuation of the portfolio securities of certain Templeton funds managed by Franklin Resources, Inc. subsidiaries, resulting in alleged market timing activity. The majority of these lawsuits duplicate, in whole or in part, the allegations asserted in the February 4, 2004 Massachusetts administrative complaint and the findings in the SEC's August 2, 2004 Order, as described above. The lawsuits are styled as class actions, or derivative actions on behalf of either the named funds or Franklin Resources, Inc. In addition, the Company, as well as certain current and former officers, employees, and directors, have been named in multiple lawsuits alleging violations of various securities laws and pendent state law claims relating to the disclosure of directed brokerage payments and/or payment of allegedly excessive advisory, commission, and distribution fees, and seeking, among other relief, monetary damages, restitution, rescission of advisory contracts, including recovery of all fees paid pursuant to those contracts, an accounting of all monies paid to the named advisers, declaratory relief, injunctive relief, and/or attorneys' fees and costs. These lawsuits are styled as class actions or derivative actions brought on behalf of certain funds. The Company and fund management strongly believes that the claims made in each of the lawsuits identified above are without merit and intends to vigorously defend against them. The Company cannot predict with certainty, however, the eventual outcome of the remaining governmental investigations or private lawsuits, nor whether they will have a material negative impact on the Company. Public trust and confidence are critical to the Company's business and any material loss of investor and/or client confidence could result in a significant decline in assets under management by the Company, which would have an adverse effect on the Company's future financial results. If it is determined that the Company bears responsibility for any unlawful or inappropriate conduct that caused losses to the Fund, it is committed to making the Fund or its shareholders whole, as appropriate. The Company is committed to taking all appropriate actions to protect the interests of its funds' shareholders. Annual Report | 39 MUTUAL FINANCIAL SERVICES FUND REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 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, 2004, 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 five years in the period then ended. 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 the standards of the Public Company Accounting Oversight Board (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 consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Fund's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of December 31, 2004, by correspondence with the custodian and brokers or by other appropriate auditing procedures where replies from brokers were not received. 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, 2004, 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 five years in the period then ended, in conformity with U.S. generally accepted accounting principles. /s/ ERNST & YOUNG LLP Boston, Massachusetts February 7, 2005 40 | Annual Report MUTUAL FINANCIAL SERVICES FUND TAX DESIGNATION (UNAUDITED) Under Section 852(b)(3)(C) of the Internal Revenue Code (Code), the Fund designated $52,958,630 as a capital gain dividend for the fiscal year ended December 31, 2004. Under Section 854(b)(2) of the Code, the Fund hereby designates up to a maximum of $7,816,776 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2004. In January 2005, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2004. 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 17.01% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2004. Annual Report | 41 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. 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. (63) 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; and Director, Stern School of Business M.B.A. Program. - ------------------------------------------------------------------------------------------------------------------------------------ ANN TORRE GRANT (46) 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 (75) 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 (74) 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 (75) 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). - ------------------------------------------------------------------------------------------------------------------------------------
42 | 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 (74) Director Since 1998 12 None 51 John F. Kennedy Parkway Short Hills, NJ 07078 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. - ------------------------------------------------------------------------------------------------------------------------------------ LEONARD RUBIN (79) 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 (58) Director Since 1991 12 Director, El Oro Mining and 51 John F. Kennedy Parkway Exploration Co., p.l.c. Short Hills, NJ 07078 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 (79) 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 (65) 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, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. - ------------------------------------------------------------------------------------------------------------------------------------
Annual Report | 43
- ------------------------------------------------------------------------------------------------------------------------------------ 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 (42) Director, Director 7 None 51 John F. Kennedy Parkway President, since 2001, Short Hills, NJ 07078-2702 Chairman of President the Board and since 1999, Chief Chairman of Executive the Board Officer - and Chief Investment Executive Management Officer Investment Management since 2002 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Chief Investment Officer, and Chief Executive Officer, Franklin Mutual Advisers, LLC; and officer and/or director, as the case may be, of three of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ JAMES M. DAVIS (52) Chief Since July Not Applicable Not Applicable One Franklin Parkway Compliance 2004 San Mateo, CA 94403-1906 Officer PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Officer of 51 of the investment companies in Franklin Templeton Investments; Director, Global Compliance, Franklin Resources, Inc.; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - ------------------------------------------------------------------------------------------------------------------------------------ JIMMY D. GAMBILL (57) Senior Vice Since 2002 Not Applicable Not Applicable 500 East Broward Blvd. President and Suite 2100 Chief Fort Lauderdale, 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 (57) Vice President Since 2000 Not Applicable Not Applicable One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior 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). - ------------------------------------------------------------------------------------------------------------------------------------
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 - ------------------------------------------------------------------------------------------------------------------------------------ BARBARA J. GREEN (57) Vice President Since 2000 Not Applicable Not Applicable 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). - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL O. MAGDOL (67) Vice President Since 2002 Not Applicable Not Applicable 600 Fifth Avenue - AML Rockefeller Center Compliance New York, NY 10020-2302 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice Chairman, Chief Banking Officer and Director, Fiduciary Trust Company International; Director, FTI Banque, Arch Chemicals, Inc. and Lingnan Foundation; 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. - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL MORANTZ (35) Treasurer Since July Not Applicable Not Applicable 500 East Broward Blvd. 2004 Suite 2100 Fort Lauderdale, FL 33394-3091 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ MURRAY L. SIMPSON (67) Vice President Since 2000 Not Applicable Not Applicable 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). - ------------------------------------------------------------------------------------------------------------------------------------
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 - ------------------------------------------------------------------------------------------------------------------------------------ GALEN G. VETTER (53) Chief Since May Not Applicable Not Applicable 500 East Broward Blvd. Financial 2004 Suite 2100 Officer and Fort Lauderdale, FL 33394-3091 Chief Accounting Officer PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Officer of 51 of the investment companies in Franklin Templeton Investments; Senior Vice President, Franklin Templeton Services, LLC; and FORMERLY, Managing Director, Rsm Mcgladrey, Inc.; and Partner, Mcgladrey & Pullen, Llp. - ------------------------------------------------------------------------------------------------------------------------------------
* 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 to be 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 to be 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 to be an interested person of Mutual Series under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC, Mutual Series' adviser. 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. 46 | Annual Report MUTUAL FINANCIAL SERVICES FUND SHAREHOLDER INFORMATION 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. Copies of the Fund's proxy voting records are also made available online at franklintempleton.com and posted on the Securities and Exchange Commission's website at sec.gov and reflect the 12-month period beginning July 1, 2003, and ending June 30, 2004. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the Securities and Exchange Commission for the first and third quarters for each fiscal year on Form N-Q. Shareholders may view the filed Form N-Q by visiting the Commission's website at sec.gov. The filed form may also be viewed and copied at the Commission's Public Reference Room in Washington, DC. Information regarding the operations of the Public Reference Room may be obtained by calling 1-800/SEC-0330. Annual Report | 47 This page intentionally left blank. LITERATURE REQUEST LITERATURE REQUEST. TO RECEIVE A BROCHURE AND PROSPECTUS, PLEASE CALL US AT 1-800/DIAL BEN(R) (1-800/342-5236) OR VISIT FRANKLINTEMPLETON.COM. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. 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 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(2) Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund(3) 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(4) 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 Technology Fund Franklin Utilities Fund Mutual Financial Services Fund ASSET ALLOCATION Franklin Templeton Corefolio Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives 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(5) Franklin's AGE High Income Fund Franklin Floating Rate Daily Access Fund Franklin Floating Rate Trust(3) Franklin Income Fund Franklin Limited Maturity U.S. Government Securities Fund(5)(6) Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund(5) Templeton Global Bond Fund TAX-FREE INCOME(7) NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(8) 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 Alabama Arizona California(9) Colorado Connecticut Florida(9) Georgia Kentucky Louisiana Maryland Massachusetts(8) Michigan(8) Minnesota(8) Missouri New Jersey New York(9) North Carolina Ohio(8) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust (10) (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 and select retirement plans. (3) 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. (4) Upon reaching approximately $350 million in assets, the fund intends to close to all investors. (5) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (6) Formerly Franklin Short-Intermediate U.S. Government Securities Fund. Effective 9/1/04, the fund's name changed; its investment goal and strategy remained the same. (7) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (8) Portfolio of insured municipal securities. (9) These funds are available in two or more variations, including long-term portfolios, portfolios of insured securities, a high-yield portfolio (CA) and limited-term, intermediate-term and money market portfolios (CA and NY). (10) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 11/04 Not part of the annual report [LOGO](R) FRANKLIN(R) TEMPLETON(R) One Franklin Parkway INVESTMENTS San Mateo, CA 94403-1906 o 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, CFA 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) Authorized for distribution only when accompanied or preceded by a prospectus. Investors should carefully consider a fund's investment goals, risks, charges and expenses before investing. The prospectus contains this and other information; please read it carefully before investing. 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 A2004 02/05 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 11(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 $340,000 for the fiscal year ended December 31, 2004 and $307,000 for the fiscal year ended December 31, 2003. (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 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 $50,000 for the fiscal year ended December 31, 2004 and $250 for the fiscal year ended December 31, 2003. The services for which these fees were paid included tax compliance and advise. (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 registrant'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 registrant by the auditors to the registrant's investment adviser or to any entity that controls, is controlled by or is under common control with the registrant's investment adviser and that provides ongoing services to the registrant where the non-audit services relate directly to the operations or financial reporting of the registrant; 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 $50,000 for the fiscal year ended December 31, 2004 and $250 for the fiscal year ended December 31, 2003. (h) The registrant's audit committee of the board of trustees has considered whether the provision of non-audit services that were rendered to the registrant's investment adviser (not including any subadviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser), and any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing services to the registrant that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X is compatible with maintaining the principal accountant's independence. " ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS. N/A ITEM 6. SCHEDULE OF INVESTMENTS. N/A ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END MANAGEMENT INVESTMENT COMPANIES. N/A ITEM 8. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT COMPANY AND AFFILIATED PURCHASES. N/A ITEM 9. SUBMISSION OF MATTERS TO A VOTE OF SECURITYU HOLDERS. There have been no changes to the procedures by which shareholders may rcommend nominees to the Registrant's Board of Directors that would require disclosure herein. ITEM 10. 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 11. EXHIBITS. (a) Code of Ethics (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 Galen G. Vetter, 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 Galen G. Vetter, 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 April 25, 2005 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 April 25, 2005 By /s/GALEN G. VETTER ------------------------------ Galen G. Vetter Chief Financial Officer Date April 25, 2005 EX-99.CODE ETH 2 ncsr-code704.txt N-CSR CODE OF ETHICS CODE OF ETHICS FOR PRINCIPAL EXECUTIVES & SENIOR FINANCIAL OFFICERS - ------------------------------------------------------------------------------ PROCEDURES Dated July 2004 - ------------------------------------------------------------------------------- FRANKLIN TEMPLETON FUNDS CODE OF ETHICS FOR PRINCIPAL EXECUTIVE AND SENIOR FINANCIAL OFFICERS I. Covered Officers and Purpose of the Code This code of ethics (the "Code") applies to the Principal Executive Officers, Principal Financial Officer and Principal Accounting Officer (the "Covered Officers," each of whom is set forth in Exhibit A) of each investment company advised by a Franklin Resources subsidiary and that is registered with the United States Securities & Exchange Commission ("SEC") (collectively, "FT Funds") for the purpose of promoting: o Honest and ethical conduct, including the ethical resolution of actual or apparent conflicts of interest between personal and professional relationships; o Full, fair, accurate, timely and understandable disclosure in reports and documents that a registrant files with, or submits to, the SEC and in other public communications made by or on behalf of the FT Funds; o Compliance with applicable laws and governmental rules and regulations; o The prompt internal reporting of violations of the Code to an appropriate person or persons identified in the Code; and o Accountability for adherence to the Code. Each Covered Officer will be expected to adhere to a high standard of business ethics and must be sensitive to situations that may give rise to actual as well as apparent conflicts of interest. II. Other Policies and Procedures This Code shall be the sole code of ethics adopted by the Funds for purposes of Section 406 of the Sarbanes-Oxley Act and the rules and forms applicable to registered investment companies thereunder. Franklin Resources, Inc. has separately adopted the CODE OF ETHICS AND BUSINESS CONDUCT ("Business Conduct"), which is applicable to all officers, directors and employees of Franklin Resources, Inc., including Covered Officers. It summarizes the values, principles and business practices that guide the employee's business conduct and also provides a set of basic principles to guide officers, directors and employees regarding the minimum ethical requirements expected of them. It supplements the values, principles and business conduct identified in the Code and other existing employee policies. Additionally, the Franklin Templeton Funds have separately adopted the CODE OF ETHICS AND POLICY STATEMENT ON INSIDER TRADING governing personal securities trading and other related matters. The Code for Insider Trading provides for separate requirements that apply to the Covered Officers and others, and therefore is not part of this Code. Insofar as other policies or procedures of Franklin Resources, Inc., the Funds, the Funds' adviser, principal underwriter, or other service providers govern or purport to govern the behavior or activities of the Covered Officers who are subject to this Code, they are superceded by this Code to the extent that they overlap or conflict with the provisions of this Code. Please review these other documents or consult with the Legal Department if have questions regarding the applicability of these policies to you. III. Covered Officers Should Handle Ethically Actual and Apparent Conflicts of Interest OVERVIEW. A "conflict of interest" occurs when a Covered Officer's private interest interferes with the interests of, or his or her service to, the FT Funds. For example, a conflict of interest would arise if a Covered Officer, or a member of his family, receives improper personal benefits as a result of apposition with the FT Funds. Certain conflicts of interest arise out of the relationships between Covered Officers and the FT Funds and already are subject to conflict of interest provisions in the Investment Company Act of 1940 ("Investment Company Act") and the Investment Advisers Act of 1940 ("Investment Advisers Act"). For example, Covered Officers may not individually engage in certain transactions (such as the purchase or sale of securities or other property) with the FT Funds because of their status as "affiliated persons" of the FT Funds. The FT Funds' and the investment advisers' compliance programs and procedures are designed to prevent, or identify and correct, violations of these provisions. This Code does not, and is not intended to, repeat or replace these programs and procedures, and such conflicts fall outside of the parameters of this Code. Although typically not presenting an opportunity for improper personal benefit, conflicts arise from, or as a result of, the contractual relationship between the FT Funds, the investment advisers and the fund administrator of which the Covered Officers are also officers or employees. As a result, this Code recognizes that the Covered Officers will, in the normal course of their duties (whether formally for the FT Funds, for the adviser, the administrator, or for all three), be involved in establishing policies and implementing decisions that will have different effects on the adviser, administrator and the FT Funds. The participation of the Covered Officers in such activities is inherent in the contractual relationship between the FT Funds, the adviser, and the administrator and is consistent with the performance by the Covered Officers of their duties as officers of the FT Funds. Thus, if performed in conformity with the provisions of the Investment Company Act and the Investment Advisers Act, such activities will be deemed to have been handled ethically. In addition, it is recognized by the FT Funds' Boards of Directors ("Boards") that the Covered Officers may also be officers or employees of one or more other investment companies covered by this or other codes. Other conflicts of interest are covered by the Code, even if such conflicts of interest are not subject to provisions in the Investment Company Act and the Investment Advisers Act. The following list provides examples of conflicts of interest under the Code, but Covered Officers should keep in mind that these examples are not exhaustive. The overarching principle is that the personal interest of a Covered Officer should not be placed improperly before the interest of the FT Funds. Each Covered Officer must: o Not use his or her personal influence or personal relationships improperly to influence investment decisions orfinancial reporting by the FT Funds whereby the Covered Officer would benefit personally to the detriment of the FT Funds; o Not cause the FT Funds to take action, or fail to take action, for the individual personal benefit of the Covered Officer rather than the benefit the FT Funds; o Not retaliate against any other Covered Officer or any employee of the FT Funds or their affiliated persons for reports of potential violations that are made in good faith; o Report at least annually the following affiliations or other relationships:/ 1 o all directorships for public companies and all companies that are required to file reports with the SEC; o any direct or indirect business relationship with any independent directors of the FT Funds; o any direct or indirect business relationship with any independent public accounting firm (which are not related to the routine issues related to the firm's service as the Covered Persons accountant); and o any direct or indirect interest in any transaction with any FT Fund that will benefit the officer (not including benefits derived from the advisory, sub-advisory, distribution or service agreements with affiliates of Franklin Resources). These reports will be reviewed by the Legal Department for compliance with the Code. There are some conflict of interest situations that should always be approved in writing by Franklin Resources General Counsel or Deputy General Counsel, if material. Examples of these include/2: o Service as a director on the board of any public or private Company; o The receipt of any gifts in excess of $100 from any person, from any corporation or association o The receipt of any entertainment from any Company with which the FT Funds has current or prospective business dealings unless such entertainment is business related, reasonable in cost, appropriate as to time and place, and not so frequent as to raise any question of impropriety. Notwithstanding the foregoing, the Covered Officers must obtain prior approval from the Franklin Resources General Counsel for any entertainment with a value in excess of $1000. o Any ownership interest in, or any consulting or employment relationship with, any of the FT Fund's service providers, other than an investment adviser, principal underwriter, administrator or any affiliated person thereof; o A direct or indirect financial interest in commissions, transaction charges or spreads paid by the FT Funds for effecting portfolio transactions or for selling or redeeming shares other than an interest arising from the Covered Officer's employment, such as compensation or equity ownership. Franklin Resources General Counsel or Deputy General Counsel will provide a report to the FT Funds Audit Committee of any approvals granted at the next regularly scheduled meeting. IV. Disclosure and Compliance o Each Covered Officer should familiarize himself with the disclosure requirements generally applicable to the FT Funds; o Each Covered Officer should not knowingly misrepresent, or cause others to misrepresent, facts about the FT Funds to others, whether within or outside the FT Funds, including to the FT Funds' directors and auditors, and to governmental regulators and self-regulatory organizations; o Each Covered Officer should, to the extent appropriate within his or her area of responsibility, consult with other officers and employees of the FT Funds, the FT Fund's adviser and the administrator with the goal of promoting full, fair, accurate, timely and understandable disclosure in the reports and documents the FT Funds file with, or submit to, the SEC and in other public communications made by the FT Funds; and o It is the responsibility of each Covered Officer to promote compliance with the standards and restrictions imposed by applicable laws, rules and regulations. V. Reporting and Accountability Each Covered Officer must: o Upon becoming a covered officer affirm in writing to the Board that he or she has received, read, and understands the Code (see Exhibit B); o Annually thereafter affirm to the Board that he has complied with the requirements of the Code; and o Notify Franklin Resources' General Counsel or Deputy General Counsel promptly if he or she knows of any violation of this Code. Failure to do so is itself is a violation of this Code. Franklin Resources' General Counsel and Deputy General Counsel are responsible for applying this Code to specific situations in which questions are presented under it and have the authority to interpret this Code in any particular situation./3 However, the Independent Directors of the respective FT Funds will consider any approvals or waivers/4 sought by any Chief Executive Officers of the Funds. The FT Funds will follow these procedures in investigating and enforcing this Code: o Franklin Resources General Counsel or Deputy General Counsel will take all appropriate action to investigate any potential violations reported to the Legal Department; o If, after such investigation, the General Counsel or Deputy General Counsel believes that no violation has occurred, The General Counsel is not required to take any further action; o Any matter that the General Counsel or Deputy General Counsel believes is a violation will be reported to the Independent Directors of the appropriate FT Fund; o If the Independent Directors concur that a violation has occurred, it will inform and make a recommendation to the Board of the appropriate FT Fund or Funds, which will consider appropriate action, which may include review of, and appropriate modifications to, applicable policies and procedures; notification to appropriate personnel of the investment adviser or its board; or a recommendation to dismiss the Covered Officer; o The Independent Directors will be responsible for granting waivers, as appropriate; and o Any changes to or waivers of this Code will, to the extent required, are disclosed as provided by SEC rules./5 VI. Other Policies and Procedures This Code shall be the sole code of ethics adopted by the FT Funds for purposes of Section 406 of the Sarbanes-Oxley Act and the rules and forms applicable to registered investment companies thereunder. Insofar as other policies or procedures of the FT Funds, the FT Funds' advisers, principal underwriter, or other service providers govern or purport to govern the behavior or activities of the Covered Officers who are subject to this Code, they are superseded by this Code to the extent that they overlap or conflict with the provisions of this Code. The FT Code of Ethics and Policy Statement On Insider Trading, adopted by the FT Funds, FT investment advisers and FT Fund's principal underwriter pursuant to Rule 17j-1 under the Investment Company Act, the Code of Ethics and Business Conduct and more detailed policies and procedures set forth in FT's Employee Handbook are separate requirements applying to the Covered Officers and others, and are not part of this Code. VII. Amendments Any amendments to this Code, other than amendments to Exhibit A, must be approved or ratified by a majority vote of the FT Funds' Board including a majority of independent directors. VIII. Confidentiality All reports and records prepared or maintained pursuant to this Code will be considered confidential and shall be maintained and protected accordingly. Except as otherwise required by law or this Code, such matters shall not be disclosed to anyone other than the FT Funds' Board and their counsel. IX. Internal Use The Code is intended solely for the internal use by the FT Funds and does not constitute an admission, by or on behalf of any FT Funds, as to any fact, circumstance, or legal conclusion. X. Disclosure on Form N-CSR Item 2 of Form N-CSR requires a registered management investment company to disclose annually whether, as of the end of the period covered by the report, it has adopted a code of ethics that applies to the registrant's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, regardless of whether these officers are employed by the registrant or a third party. If the registrant has not adopted such a code of ethics, it must explain why it has not done so. The registrant must also: (1) file with the SEC a copy of the code as an exhibit to its annual report; (2) post the text of the code on its Internet website and disclose, in its most recent report on Form N-CSR, its Internet address and the fact that it has posted the code on its Internet website; or (3) undertake in its most recent report on Form N-CSR to provide to any person without charge, upon request, a copy of the code and explain the manner in which such request may be made. Disclosure is also required of amendments to, or waivers (including implicit waivers) from, a provision of the code in the registrant's annual report on Form N-CSR or on its website. If the registrant intends to satisfy the requirement to disclose amendments and waivers by posting such information on its website, it will be required to disclose its Internet address and this intention. The Legal Department shall be responsible for ensuring that: o a copy of the Code is filed with the SEC as an exhibit to each Fund's annual report; and o any amendments to, or waivers (including implicit waivers) from, a provision of the Code is disclosed in the registrant's annual report on Form N-CSR. In the event that the foregoing disclosure is omitted or is determined to be incorrect, the Legal Department shall promptly file such information with the SEC as an amendment to Form N-CSR. In such an event, the Fund Chief Compliance Officer shall review the Code and propose such changes to the Code as are necessary or appropriate to prevent reoccurrences. EXHIBIT A Persons Covered by the Franklin Templeton Funds Code of Ethics August 2004 FRANKLIN GROUP OF FUNDS Edward B. Jamieson, President and Chief Executive Officer - Investment Management Charles B. Johnson, President and Chief Executive Officer - Investment Management Gregory E. Johnson, President and Chief Executive Officer - Investment Management Rupert H. Johnson, Jr. President and Chief Executive Officer - Investment Management William J. Lippman, President and Chief Executive Officer - Investment Management Christopher Molumphy President and Chief Executive Officer - Investment Management Jimmy D. Gambill, Senior Vice President and Chief Executive Officer - Finance and Administration Galen G. Vetter Chief Financial Officer FRANKLIN MUTUAL SERIES FUNDS David Winters Chairman of the Board, President, Chief Executive Officer-Investment Management Jimmy D. Gambill Senior Vice President and Chief Executive Officer- Finance and Administration Galen G. Vetter Chief Financial Officer TEMPLETON GROUP OF FUNDS Jeffrey A. Everett President and Chief Executive Officer - Investment Management Martin L. Flanagan President and Chief Executive Officer - Investment Management Mark Mobius President and Chief Executive Officer - Investment Management Christopher J. Molumphy President and Chief Executive Officer - Investment Management Gary P. Motyl President and Chief Executive Officer - Investment Management Donald F. Reed President and Chief Executive Officer - Investment Management Jimmy D. Gambill, Senior Vice President and Chief Executive Officer - Finance and Administration Galen G. Vetter Chief Financial Officer EXHIBIT B ACKNOWLEDGMENT FORM JULY 2004 FRANKLIN TEMPLETON FUNDS CODE OF ETHICS FOR PRINCIPAL EXECUTIVE AND SENIOR FINANCIAL OFFICERS. INSTRUCTIONS: 1. Complete all sections of this form. 2. Print the completed form, sign, and date. 3. Submit completed form to FT's General Counsel within 10 days of becoming a Covered Officer and by January 30th of each subsequent year. INTER-OFFICE MAIL: Murray Simpson, General Counsel, Legal SM-920/2 TELEPHONE: (650) 312-7331 Fax: (650) 312-2221 E-MAIL: Simpson, Murray (internal address); mlsimpson@frk.com (external address) - ---------------------------------------------------------------------------- COVERED OFFICER'S NAME: - ---------------------------------------------------------------------------- TITLE: - ---------------------------------------------------------------------------- DEPARTMENT: - ---------------------------------------------------------------------------- LOCATION: - ---------------------------------------------------------------------------- CERTIFICATION FOR YEAR ENDING: - ---------------------------------------------------------------------------- TO: Franklin Resources General Counsel, Legal Department I hereby acknowledge receipt of a copy of Franklin Templeton Fund's code of ethics for Principal Executive Officers and Senior Financial Officers (the "Code") that I have read and understand. I will comply fully with all provisions of the Code to the extent they apply to me during the period of my employment. I further understand and acknowledge that any violation of the Code may subject me to disciplinary action, including termination of employment - ---------------------------- ---------------------- Signature Date signed - ----------------------------- 1 Reporting of these affiliations or other relationships shall be made by completing the annual Directors and Officers Questionnaire and returning the questionnaire to Franklin Resources Inc, General Counsel or Deputy General Counsel. 2 Any activity or relationship that would present a conflict for a Covered Officer may also present a conflict for the Covered Officer if a member of the Covered Officer's immediate family engages in such an activity or has such a relationship. The Cover Person should also obtain written approval by FT's General Counsel in such situations. 3 Franklin Resources General Counsel and Deputy General Counsel are authorized to consult, as appropriate, with members of the Audit Committee, counsel to the FT Funds and counsel to the Independent Directors, and are encouraged to do so. 4 Item 2 of Form N-CSR defines "waiver" as "the approval by the registrant of a material departure from a provision of the code of ethics" and "implicit waiver," which must also be disclosed, as "the registrant's failure to take action within a reasonable period of time regarding a material departure from a provision of the code of ethics that has been made known to an executive officer" of the registrant. See Part X. 5 See Part X. EX-99.CERT 3 fms1204-302_amd.txt CERTIFICATIONS PURSUANT TO SECTION 302 Exhibit B(1) I, Jimmy D. Gambill, certify that: 1. I have reviewed this report on Form N-CSR of Franklin Mutual Series Fund, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, changes in net assets, and cash flows (if the financial statements are required to include a statement of cash flows) of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940) and internal control over financial reporting (as defined in Rule 30a-3(d) under the Investment Company Act of 1940) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of a date within 90 days prior to the filing date of this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. April 25, 2005 S\JIMMY D. GAMBILL Jimmy D. Gambill Chief Executive Officer - Finance and Administration I, Galen G. Vetter, certify that: 1. I have reviewed this report on Form N-CSR of Franklin Mutual Series Fund, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, changes in net assets, and cash flows (if the financial statements are required to include a statement of cash flows) of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940) and internal control over financial reporting (as defined in Rule 30a-3(d) under the Investment Company Act of 1940) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of a date within 90 days prior to the filing date of this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. April 25, 2005 S\GALEN G. VETTER Galen G. Vetter Chief Financial Officer EX-99.906 CERT 4 ex99-906cert_14649.txt CERTIFICATIONS PURSUANT TO SECTION 906 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURUSANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Galen G. Vetter, Chief Financial Officer of the FRANKLIN MUTUAL SERIES FUND, INC. (the "Registrant"), certify, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: 1. The periodic report on Form N-CSR of the Registrant for the period ended 12/31/04 (the "Form N-CSR") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Form N-CSR fairly presents, in all material respects, the financial condition and results of operations of the Registrant. Dated: February 18, 2005 S\GALEN G. VETTER Galen G. Vetter Chief Financial Officer A SIGNED ORIGINAL OF THIS WRITTEN STATEMENT REQUIRED BY SECTION 906, OR OTHER DOCUMENT AUTHENTICATING, ACKNOWLEDGING, OR OTHERWISE ADOPTING THE SIGNATURE THAT APPEARS IN TYPED FORM WITHIN THE ELECTRONIC VERSION OF THIS WRITTEN STATEMENT REQUIRED BY SECTION 906, HAS BEEN PROVIDED TO REGISTRANT AND WILL BE RETAINED BY REGISTRANT AND FURNISHED TO THE SECURITIES AND EXCHANGE COMMISSION OR ITS STAFF UPON REQUEST. CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURUSANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Jimmy D. Gambill, Chief Executive Officer of the FRANKLIN MUTUAL SERIES FUND, INC. (the "Registrant"), certify, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: 1. The periodic report on Form N-CSR of the Registrant for the period ended 12/31/04 (the "Form N-CSR") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Form N-CSR fairly presents, in all material respects, the financial condition and results of operations of the Registrant. Dated: February 18, 2005 S\JIMMY D. GAMBILL Jimmy D. Gambill Chief Executive Officer - Finance and Administration A SIGNED ORIGINAL OF THIS WRITTEN STATEMENT REQUIRED BY SECTION 906, OR OTHER DOCUMENT AUTHENTICATING, ACKNOWLEDGING, OR OTHERWISE ADOPTING THE SIGNATURE THAT APPEARS IN TYPED FORM WITHIN THE ELECTRONIC VERSION OF THIS WRITTEN STATEMENT REQUIRED BY SECTION 906, HAS BEEN PROVIDED TO REGISTRANT AND WILL BE RETAINED BY REGISTRANT AND FURNISHED TO THE SECURITIES AND EXCHANGE COMMISSION OR ITS STAFF UPON REQUEST. -----END PRIVACY-ENHANCED MESSAGE-----